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The Nature And Art Of Financial Supervision – MFSA Publication Targeting The Supervision Of Credit Institutions – Financial Services


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On the 13th November 2020, the MFSA published
first volume
 on the nature and art of financial
supervision of Banking and credit institutions, examining their
operations in the Maltese banking sector and publishing the
findings, risks, and challenges, which the MFSA Banking supervision
function deemed pertinent. The said publication provides a
background on the Banking Supervisory approach undertaken through
the Supervisory Review and Evaluation Process (SREP) and the
MFSA’s supervisory approach. The publication then moves on to
detail the findings and prevailing risks and its recommendations in
relation thereto. 

The MFSA found that boards of banks lacked proper insight on
their bank’s risk profile; failed to ensure the ongoing
review of policies; failed to improve the customer due-diligence
review backlog; or ensure that their ICAAPs covered the risk
analysis necessary. A key issue giving rise to these defaults was
the fact that banks sought to decrease costs by merging into one:
risk, compliance, MLRO, and legal compliance responsibilities.
Sufficient resources need to be allocated for each of these
responsibilities thereby ensuring adequate oversight of a
bank’s business model. Additionally, the MFSA found that
boards need to significantly improve financial resilience planning,
primarily by understanding their business model’s resilience
in stress scenarios and business planning a proper assessment of
all risks different scenarios may pose.

The MFSA found that boards failed to ensure internal control
frameworks were operating properly and that internal-governance
frameworks did not clearly identify the roles and responsibilities
of key persons/functions and how each function complements and
operates in parallel with the other. Senior Management and board
members must ensure that each function has the necessary staff,
skills, and support, as well as proper direction and resources.
This failure, coupled with the merging of roles as discussed above
and/or otherwise the third line of defence failing in its
functions, resulted in weak decision making, risk management and
control within banks. The MFSA further found record-keeping
failures, and that policies and procedures were not in place, or
otherwise when in place were not properly documented. In its
recommendations, the MFSA proposed that risk management,
compliance, and auditing functions be given proper resources and
expertise, enabling boards to ensure proper internal control
frameworks. Additionally, the MFSA recommended that boards maintain
a diverse and high level of skill-set, enabling them to also
challenge management to prepare realistic and tested business
plans, based on records of delivery thereby allowing banks to
develop effective Risk and

The MFSA further proposed that institutions must invest in their
staff and provide training to employees to ensure they can perform
and avoid any regulatory failures, and this given that in its
findings it found that the staff working within the banking sector
lacked skills, knowledge, and expertise.

In reporting its findings on credit risk, the MFSA found
inappropriate monitoring processes, boards unable to report,
challenge, and oversee credit risk, and ineffective collateral
management processes. For credit standards to be maintained boards
must play an active role in setting them out to senior management
and lending teams, whilst at the same time ensuring that the
lending process has a sound risk governance oversight.

Finally, the MFSA found several deficiencies concerning 
 Risk oversight within banks, in particular on
the part of the board of directors, MLROs, and compliance officers.
The MFSA proposed that institutions ensure that AML/CFT processes
are conducted through proper IT structures; that institutions
provide AML/CFT training to their employees; that board of
directors are knowledgeable and able to ensure adequate control
infrastructures within institutions; and that MLROs were properly
trained and able to identify AML/CFT risks and given the necessary
powers to effectively mitigate risks.

As part of its next supervisory assessment, the MFSA’s
focus is now on the effectiveness of the implementation of the
5th AML directive, as well as other supervisory
areas such as strategic planning, stress testing, COVID-19 impacts
and support systems, internal governance efficacy, growth
strategies, AML/CFT controls, and mitigation of IT and cyber
security risks.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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