This content is from: Local Insights

On the path to compliance

Ana Luisa de Gordillo
During the financial crisis of 2007, banks and banking supervisors around the world were reminded of many lessons. One of the causes of the crisis was the deterioration of the capital base of banks; as a consequence, banks were not able to absorb credit losses. Loans are one of the main assets in which banks invest the money they obtain from depositors. Banks are then required to guard these assets from the inherent risk in order to anticipate the consequences of their deterioration.

In 2008, the Basel Committee on Banking Supervision published its principles of sound liquidity, risk management and supervision, and developed a framework aiming to strengthen global capital and liquidity rules for banks. The objective, as stated by the Committee, was to improve the stability of the international banking system aiming at stronger risk management practices.

One of the Committee's proposals was that in order to anticipate losses, banks should build up stronger capitalisation and provisioning practices, to deal with periods of financial distress. These practices require banks to have a strong provision to cover possible risk in loan deterioration.

These standards have been accepted by banking authorities throughout the world, by means of adopting new rules and regulations. Guatemala is no exception.

In 2008, international practices influenced Guatemala to adopt measures to strengthen the solvency of banking institutions. In this regard, the Monetary Board approved resolution JM-167-2008, which came into effect in 2010. According to these measures, banks are called to create reserves to be consistent with the risk inherent to loans granted.

Banks are required to establish two kinds of reserves to bear with risk of loan deterioration: specific, or allocated, reserves, which are reserves created to bear the risk associated with a particular or a group of loans; and Generic Reserves, which are created to bear the risk of losses not identified and that are not associated with the normal risks allocated to loans.

When we are reminded of the important role that banks play in the economy of a country and in the economy of the world, we can understand that banks have a strong responsibility to apply prudential practices in the way they conduct their business.

By adopting resolutions such as those referred to here, Guatemala is encouraging banks to guard against the risks inherent to their activities, thus aiming to strengthen the country's economy.

Ana Luisa de Gordillo

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