Central Bank Memorandum No. 2004/4: Corrective Actions and Penalties for Bank Violations

Corrective Actions and Penalties for Bank Violations Memorandum No. 2004/4 dated 2004/1/11

Framework of Corrective Procedures
The Central Bank, committed to strengthening the stability of the banking system and ensuring strict compliance with laws, regulations, and directives, aims to prevent unsafe and unsound banking practices that threaten the system or its components. To address weaknesses at an early stage and enhance the safety and soundness of the banking system, the Central Bank, in accordance with Article 28 of the Banks Law No. 28 of 2000 and Resolution No. 2004/1 dated 2004/1/7 of the Central Bank Board of Directors, has issued the following corrective actions and penalties to achieve the aforementioned objectives in accordance with the following standards:

First: Cases in which corrective actions will be taken The cases in which corrective actions will be taken are divided into four main categories:
A. The bank's violation of the Banks Law or other regulations, directives, and orders issued thereunder.
B. The bank or its subsidiaries engaging in unsafe or unsound banking practices.
C. The deterioration of the bank's rating in accordance with the CAMEL or ROCA evaluation system.
D. The deterioration of the bank's capital adequacy or capital adequacy beyond acceptable limits in relevant Central Bank directives.

A. The bank's violation of the Banks Law or other regulations, directives, and orders issued thereunder.
The Banks Law, regulations, directives, and orders issued thereunder stipulate standards for banking operations to ensure the stability and soundness of the banking system. The Central Bank monitors banks to ensure compliance with the Banks Law, directives, and orders. The Central Bank will take necessary corrective actions to ensure compliance.

B. The bank or its subsidiaries engaging in unsafe or unsound banking practices.
The corrective measures include that the definition of unsafe or unsound banking practices is broad and may include any practice considered unsafe or unsound. The Central Bank will provide the bank with a notice (1) listing examples of unsafe or unsound banking practices. The examples listed in the notice are not exhaustive, and other practices may be considered unsafe or unsound. However, it is not mandatory to consider every practice unsafe or unsound; the Central Bank must consider all relevant facts, including the bank's notice, and may define an action or practice as unsafe or unsound if it involves doing (or failing to do) an action that is contrary to sound banking standards, or if the community believes that the action or its continuation will cause significant losses to the bank, its shareholders, creditors, or depositors.

C. The deterioration of the bank's rating in accordance with the CAMEL or ROCA evaluation system.
The CAMEL and ROCA evaluation systems apply to the bank as a whole. Therefore, a decline in any indicator that is unsafe or unsound is considered a decline in the bank's rating. Additionally, violating Article 36(b) of the Banks Law is considered a violation of the law and directives. However, since this indicator is issued independently from categories (A) and (B) above, it is treated separately.

• If the bank is rated 3 according to the CAMEL or ROCA system, it has weaknesses that must be addressed. If not addressed, the weaknesses may worsen, leading to a further decline in the bank's rating or capital adequacy. If the bank is rated 4 or 5, corrective actions become more urgent.

D. The deterioration of the bank's capital adequacy or capital adequacy beyond acceptable limits.
The Central Bank monitors capital adequacy through Capital Adequacy Directive No. 2003/16 and the Directive on Capital Adequacy for Public Banks No. 2003/17. A decline in these ratios constitutes a violation of the Banks Law and directives, and is also considered unsafe and unsound. However, since this indicator is issued independently from categories (A) and (B) above, it is treated separately.

Second: Corrective actions to be taken in the aforementioned cases.

1. Financial Penalties
A. Financial penalties will be imposed in cases of a bank's violation of the Banks Law, regulations, directives, and orders, including any written directives, corrective plans, or orders to stop or restrict activities, or any unsafe or unsound banking practices. B. If these financial penalties are insufficient or if other measures are needed, the Central Bank may take additional corrective actions.
C. The Central Bank will consider the following factors when determining the amount of the financial penalty:
1. Repetition and continuity of violations.
2. Continuing the violation despite warnings or penalties.
3. Cooperation or lack thereof with the Central Bank in addressing the violations.
4. Attempts by the bank to conceal the violation.
5. The amount of loss or damage caused to the bank by the violation.
6. The existence and effectiveness of a corrective plan.
Other factors may be included in detailed directives on financial penalties issued later by the Central Bank.

2. Requiring the bank to submit a phased plan to be implemented by the corrective actions to eliminate violations or address weaknesses.
This measure is generally applied to banks rated 3 according to the CAMEL or ROCA systems.
The plan must include:
A. Decisions by the bank's Board of Directors directed at executive management to eliminate violations or address weaknesses. These decisions must be specific, measurable, achievable, realistic, and time-bound, with the Board of Directors monitoring executive management's compliance. B. Submission to the Central Bank of a phased corrective plan. The plan must be specific, measurable, achievable, realistic, and time-bound, with defined stages and measurable indicators. The plan must be signed by the Chairman of the Board of Directors of the concerned bank, the General Manager of the main branch, and the General Manager of the foreign branch or regional office.

3. Orders to stop or restrict certain activities:
A. These orders aim to stop the violation, correct its effects, and prevent further deterioration of the bank's condition due to the violation.
B. These orders apply not only to the bank as a whole but may also apply to specific branches, managers, employees, or agents.
C. If the bank fails to comply with these orders, the Central Bank may take further actions or impose financial penalties.
D. Activities that may be stopped or restricted include:

• Lending rates.
• Limiting cash flows for specific purposes or growth.
• Accepting deposits or imposing conditions.
  In cases of deterioration in capital adequacy, additional measures apply.

4. Requiring the bank to suspend or dismiss its managers or other officials under the Board of Directors' authority, temporarily or permanently, depending on the severity of the violation, or to remove the Chairman of the Board of Directors or other members.
Major reasons for the Central Bank to take such actions include:
A. Violating the law prohibiting the appointment of individuals directly or indirectly in violation of the Banks Law, regulations, directives, and orders, including written directives, corrective plans, or orders to stop/restrict activities, or engaging in unsafe or unsound practices, or failing to fulfill duties to the bank. B. The individual's actions caused or threatened to cause significant losses to the bank, its shareholders, or creditors, or the violation was not rectified despite warnings. If the Central Bank decides to appoint/reappoint a Chairman of the Board of Directors, General Manager, or other officials to positions in other financial institutions, it will notify the relevant institutions.

5. Dissolving the bank's Board of Directors and having the Central Bank manage the bank.
6. Merging the bank with another bank.
7. Revoking the bank's license.

Third: Corrective actions to be taken for each of the aforementioned cases.

1. Corrective actions related to the bank's violation of the Banks Law or other regulations, directives, and orders.
A. Financial penalties are the primary corrective action.
B. The Central Bank may take other corrective actions (3-7 above) alone or with financial penalties, considering:
1. The material impact of the violation on the bank's status.
2. The bank's financial adequacy and the severity of the financial penalty.
3. Whether the Central Bank considers the violation an unsafe or unsound practice.
4. The Central Bank's determination that the financial penalty will prevent similar violations in the future.

2. Corrective actions related to the bank or its subsidiaries engaging in unsafe or unsound banking practices.
Based on the nature and scope of the unsafe or unsound practices affecting all bank activities, the Central Bank will determine the size and nature of the corrective action based on the practice's nature, related circumstances, and the bank's size.

3. Corrective actions related to the deterioration of the bank's rating according to the CAMEL or ROCA system.

(1/3) Corrective actions for banks rated Category 3 according to the CAMEL or ROCA system.
A. Actions that may be taken:

1. Decisions by the bank's Board of Directors.
2. Submission to the Central Bank of a phased corrective plan.
   B. If the bank fails to take the actions in (A) above, the Central Bank may take further actions against the bank or its officials. Compliance with the corrective actions and addressing weaknesses are prerequisites for the success of these measures and the need for further actions.

(2/3) Corrective actions for banks rated Category 4 or 5 according to the CAMEL or ROCA system, or failure to implement or take the required corrective plan.
A. Actions that may be taken:
1. Orders to stop or restrict certain activities.
2. Requiring the bank to suspend or dismiss its managers or other officials under the Board of Directors' authority, temporarily or permanently, depending on the severity of the violation, or to remove the Chairman of the Board of Directors or other members.
3. Dissolving the bank's Board of Directors and having the Central Bank manage the bank.
4. Merging the bank with another bank.
5. Revoking the bank's license.
B. If the action taken in cases (3/B) above is an order to stop or restrict certain activities, further measures may apply.

4. Corrective actions related to the deterioration of the bank's capital adequacy or capital adequacy beyond acceptable limits.
These actions are among the most important because the greatest risk to a bank with deteriorating capital adequacy is the loss of depositors' funds and any losses the bank may suffer.
The primary basis for actions related to deteriorating capital adequacy is classifying banks into five groups based on financial adequacy or capital adequacy, with escalating measures.

(1/4) Criteria for classifying banks based on the degree of capital adequacy or capital adequacy.
A. The Central Bank monitors capital adequacy through Capital Adequacy Directive No. 2003/16 and the Directive on Capital Adequacy for Public Banks No. 2003/17. These directives are linked to the Capital Adequacy and Capital Adequacy Framework, which uses a composite standard for assessing capital adequacy, including the ratio of capital adequacy to risk-weighted assets, and the ratio of capital to total assets. Banks will be classified into five groups as shown in Table (1), which outlines the classification standards.

Table (1) Classification of Banks into Five Categories Based on Capital Adequacy and Capital Adequacy Level

Capital Adequacy Category	Leverage Ratio (Shareholders' Equity to Total Assets)	Tier 1 Capital Ratio (Tier 1 Capital to Risk-Weighted Assets and Off-Balance Sheet Items)	Capital Adequacy Ratio
Category 1: Well Capitalized	>= 8%	>= 7%	>= 14%
Category 2: Adequately Capitalized	>= 6%	>= 6%	>= 12%
Category 3: Undercapitalized	< 6%	< 6% or < 12%	< 12%
Category 4: Significantly Undercapitalized	< 4%	< 4% or < 8%	< 8%
Category 5: Critically Undercapitalized	<= 3%

A bank is classified as Significantly Undercapitalized if its Tier 1 capital to total assets ratio is equal to or less than 3%.
For the purpose of calculating Tier 1 capital, shareholders' equity is reduced by intangible assets (Goodwill) or similar items.

B. The Central Bank may upgrade a bank's rating to a higher category based on capital adequacy or capital adequacy.

• The Central Bank considers not only the current level of capital adequacy but also future risks the bank may face.
• The Central Bank may upgrade a bank's rating if the bank is in an unsafe or unsound condition, such as significant contingent liabilities or unsafe/unsound practices.
• Within this framework, the Central Bank may upgrade banks rated Category 4 or 5 under CAMEL/ROCA from Category 1 (Well Capitalized) to Category 2 (Adequately Capitalized), or from Category 2 to Category 3 (Undercapitalized).

(2/4) Actions to be taken based on the level of capital adequacy or capital adequacy:
A. Banks in Categories 1 and 2 (Well Capitalized and Adequately Capitalized):
These banks must comply with the prohibition on distributing dividends from capital accounts or paying bonuses to executive management or Board of Directors members, which would cause the bank to be classified in Category 3 (Undercapitalized).

B. Banks in Category 3 (Undercapitalized):

• These banks are subject to all actions related to banks in Categories 1 and 2, in addition to the prohibition on paying bonuses to executive management or Board of Directors members if this leads to a further decline in the bank's capital adequacy.
• The concerned bank must submit a Capital Restoration Plan to the Central Bank within 45 days. The plan must include direct steps to enhance the bank's capital adequacy, the timeframe for achieving the increase, and the mechanism for implementation.
• If the bank's rating is upgraded to a higher category, the Capital Restoration Plan will be implemented, and factors causing the decline in capital or adequacy will be eliminated.
• The bank is prohibited from distributing any shareholder dividends.
• The bank is prohibited from growing its deposits or other components.
• The Central Bank may impose conditions.
• The bank must obtain prior approval from the Central Bank before engaging in any new business or acquiring other banks, in addition to any other activities the Central Bank may restrict.

The bank may be subject to other preventive measures proposed for banks classified in Category 4 (Significantly Undercapitalized).
The Central Bank may take other actions deemed necessary to address the decline in capital adequacy or capital adequacy.

C. Banks in Category 4 (Significantly Undercapitalized):

• These banks are subject to all actions proposed for banks classified in Category 3 (Undercapitalized).
• The bank is also subject to the following additional actions:

1. Arranging for a merger with another bank if the bank cannot raise its capital.
2. Restricting deposit interest rates to be at or below the prevailing market rate.
3. Refusing to accept deposits from correspondent depository institutions.
4. Restricting the growth rate of the bank's deposits or other components, or requiring a reduction in their volume.
5. Revoking or restricting certain activities that expose the bank to significant risks.
6. Requiring the bank to suspend or dismiss its managers or other officials under the Board of Directors' authority, temporarily or permanently, or to remove the Chairman of the Board of Directors or other members, in accordance with the standards in (Third/4).
7. Restricting transactions with any affiliate or related party that poses a risk to the bank's financial condition.

• The Central Bank may take other actions deemed necessary to address the decline in capital adequacy or capital adequacy.

D. Banks in Category 5 (Critically Undercapitalized):

1. The Central Bank will either merge the concerned bank with another bank or revoke the bank's license within a period not exceeding 270 days from the date the bank was classified in this category.
2. The Central Bank may extend this period for an additional 270 days if:

• Shareholders have obligations to the bank.
• The bank is committed to a Capital Restoration Plan with significant progress.
• The bank earns profits or its revenues improve as a result of exceptional circumstances.
• The Central Bank determines that the bank is not viable and that the extension decision is in the best interest of the bank and its depositors.

3. During the periods specified in (1) and (2) above:

• The bank is subject to all actions proposed for banks classified in Category 4 (Significantly Undercapitalized).
• Bank activities are suspended to the extent possible.
• The bank must obtain prior approval from the Central Bank before:
• Engaging in any new business other than the bank's existing activities.
• Granting credit to related parties.
• Making any accounting changes.
• Paying bonuses or incentives.
• Paying interest on deposits at a weighted average rate higher than the prevailing market rate.
• The Central Bank may take other actions deemed necessary to address the decline in capital adequacy or capital adequacy.

Fourth: Final Notes:

• The Central Bank reserves the right to take other actions against any bank based on the aforementioned measures.
• These directives are effective from the date of issuance of this memorandum.

Appendix (1)
Examples of Unsafe or Unsound Banking Practices

A. Actions considered unsafe or unsound:

1. Failure to have adequate monitoring systems to prevent employees from engaging in unsafe or unsound practices or violating laws, regulations, and directives.
2. Establishing special funds for non-performing loans (public loans).
3. Incorrect accounting treatment of transactions or failure to provide accurate and complete information for accounts or customers or granted facilities.
4. Failure to establish appropriate settlement programs to collect public loans.

B. Actions considered unsafe or unsound:

1. Considering the nature of the bank's contingent liabilities.
2. Engaging in unsafe practices related to granting, monitoring, and collecting facilities, including:

• Granting facilities without adequate collateral.
• Granting facilities without obtaining complete and accurate information from the requesting party.
• Granting facilities to related parties without adequate controls.
• Concentration on granting facilities.

3. Conducting banking operations without adequate liquidity.
4. Conducting banking operations without adequate control and monitoring systems, including:

• Control and monitoring of foreign exchange transactions.
• Segregation of duties in the bank.

C. Conditions considered unsafe or unsound:

1. Maintaining a significantly low deposit interest rate spread.
2. High operating costs relative to the bank's portfolio size.
3. High ratio of public loans or loans under review to total loans or shareholders' equity.
4. High non-performing loans.
5. High ratio of public assets.
6. Concentration in asset types.

D. Violation of the Banks Law, directives, and orders issued by the Central Bank.

1. Concentration refers to a significant concentration in a specific sector, region, or type of asset, or any other type of concentration.