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Organic Law of Georgia on the National Bank of Georgia

By:   •  July 3, 2012  •  Essay  •  3,485 Words (14 Pages)  •  1,442 Views

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Banks are supervised to: 1. protect interests of depositors, 2. control whether banks meet all requirements by law, 3. avoid such complication of problems when it becomes impossible to correct them if not too expansive for government financial decisions are made, 4. be aware of problems and weaknesses a particular bank faces and examine reasons for that that helps supervisors to give recommendations and directives to such banks about how to overcome problems and difficulties they face.

Through regular monitoring the supervisors of commercial banks make all efforts to ensure that the banks in Georgia:

a) are financially reliable;

b) are managed skillfully;

c) do not endanger depositors' interests.

In compliance with the "Organic Law of Georgia on the National Bank of Georgia" (chapter VIII) NBG is authorized to police commercial bank activities, NBG assesses and controls risk level each commercial bank faces, hence protects them from choosing risky activities and whole banking system from the danger of undesirable failure, keeping safety and stability of banking sector. NBG has worked out "The Manual for Commercial Bank Supervision", which describes and explains policy and administration of bank inspection. NBG evaluates financial condition of each particular bank by use of rating system. General Rating System is an instrument to discover degree of stability of supervised bank and to expose banks with financial or operational weaknesses, those been in need of special attention. According to this rating system each bank is given composite rating, which is made up of five major components describing financial condition of commercial bank. This system called CAMEL rating evaluates capital adequacy (rating from 1 denoting well capitalized, to 5-undercapitalized banks), asset quality (form rate 1- banks with high quality assets to rate 5- critical standard of asset quality), management (from rate 1- banks with strong management to rate 5- weak management), earnings (from rate 1- high income banks to rate 5- banks experiencing loss that bank capital are not enough to absorb it) and liquidity (from rate 1- banks with high liquidity to rate 5- critical liquidity level). Composite rating is an average grade of all five component rates.

According to the CAMEL composite rating banks are ranked from 1 to 5 (table 10). 1 indicates the highest rating, strongest performance and risk assessment practices, hence does not need to be strictly supervised, herewith 5 is the lowest rating, weakest performance, banks given this rating has inadequate risk management practices and therefore are in need of sever control and requires corrective arrangements.

Table 10 CAMEL Composite Rating

Composite1– satisfactory

Banks in this group are stable in all its aspects and have components rated 1 or 2. Weaknesses are insignificant and can be handled through everyday management process. In an event of business fluctuations they keep their stability best. They follow legislation and have adequate risk management methods. Banks from this group are in need of less attention and supervision.

Composite2– adequate Banks in this group are fundamentally stable and sound. No component rating can be more than 3. Weaknesses are moderate and can be corrected. Such banks easily endure business fluctuations. They follow legislation. Risk management methods are satisfactory. Banks from this group need insignificant supervisory reactions.

Composite3–less adequate Banks in this group are with some weaknesses that bank management is unable to timely cope with. No component rating can be more than 4. They are very sensitive toward external effects and are less consistent to business fluctuations. Banks most probably break legislation. Risk management practices are not adequate. Considering financial condition of these banks it is less probable for them to fail, but strict supervision is still required.

Composite4– inadequate Banks in this group are less stable, with serious financial and managerial gaps. They are not resistant to environmental fluctuations. Have seriously violated legislation. Such banks need detailed supervision and serious corrective arrangements not to fail and hence shake the stability of banking systems.

Composite5– critical Extremely unstable banks. Their risk management is inadequate. They create serious supervisory problems. External financial support or other type of assistance is necessary to keep such banks solvent. They need to be permanently supervised. The probability of their failure is very high and thus banking system stability may be at serious risk if banks from this group will not get over the weaknesses they have.

Source: National Bank of Georgia, 2007

http://www.nbg.gov.ge/uploads/publications/thematicpublications/cnobari_metoduri_saxelm.pdf

Capital Adequacy Standards

The issue of capital adequacy is a complicated question. The level of capital is different for each bank and depends on the size of the bank and level of risk bank faces. According to "The Manual for Commercial Bank Supervision" bank supervisors can analyze bank risks and determine minimal level of capital adequate for bank safety. Capital adequacy standards determined by NBG are based on the system worked out by the Basel Committee. According to it primary and supervisory capital has to be not less than correspondingly 8% and 12% of risk weighted assets. Risk weighted assets are divided into four categories (table 11).

Table 11 Categories of Risk Weighted Assets

Asset categories Risk Weight (Conversion Factor) Risk Coefficient

1st category 0 % 0

2nd category 20 % 0.2

3rd category 50 % 0.5

4th category 100 % 1.0

Source: National Bank of Georgia, 2007

http://www.nbg.gov.ge/uploads/publications/thematicpublications/cnobari_metoduri_saxelm.pdf

To measure risk weighted assets each asset category is multiplied by its risk coefficient determining relative risk of each asset categories. Asset categories are shown by the table 12.

Table 12 Composition of Asset Categories

1st category- 0% risk assets

Cash, required reserves and correspondent accounts at NBG

2nd category- 20% risk assets

T-bills issued and guaranteed by Ministry of Finance of Georgia, other short-term government securities, gold corresponding to the international standards and other precious metals, claims or portion of claims collateralized by gold corresponding to the international standards and other precious metals, correspondent accounts at other commercial banks.

3rd category- 50% risk assets

Debt securities issued and guaranteed by municipalities of Georgia, other long-term securities, corporate bond, loans secured by the collateral, mortgage loans.

4th category- 100% risk assets

Loans and other assets not included in 0%, 20% and 50% risk asset categories.

Source: National Bank of Georgia, 2007

http://www.nbg.gov.ge/uploads/publications/thematicpublications/cnobari_metoduri_saxelm.pdf

Table 13 Simplified Calculation of Risk Weighted Assets and Capital Adequacy Coefficient

a) Balance Sheet (000 GEL)

Asset Liability

Cash 20 Deposits 190

Corresponding accounts 50 Primary capital 8

Mortgage loans 30 Retained earnings 2

Other loans 100 Total capital 10

Total assets 200 Total liabilities 200

b) Risk weighted assets

Total capital 10

Risk Weighted Assets (RWA) Risk Coefficient Calculated RWA

Cash (0%) 20 x 0.00 = 0

Corresponding accounts (20%) 50 x 0.20 = 10

Mortgage loans (50%) 30 x 0.50 = 15

Other loans (100%) 100 x 1.00 =

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