Bank risk resilience and prudential ratios

Banking supervision regulations are not yet fully aligned with international standards and principles, which weakens the effectiveness of the supervisory framework in objectively identifying, assessing and mitigating risks in the banking sector. For example, insufficient supervisory tools for objectively assessing asset quality and risk levels may increase banks’ solvency and liquidity risks, which in turn could adversely affect the stability of the banking sector. Moreover, supervision remains primarily focused on compliance with laws and prudential ratios and is largely corrective in nature, addressing violations after they are detected. This limits the ability to identify emerging risks in banking operations in advance and to take prompt action.

Hence, there is a need to improve the supervisory framework so that it protects the funds of bank customers and depositors, reduces bank risks, and thereby increases the confidence of foreign investors and international financial institutions. Accordingly, banking supervision regulations need to be updated in line with international standards and principles, and a risk-based supervisory methodology aimed at identifying and assessing risks in advance and taking appropriate measures needs to be fully introduced.

The Basel series of standards, which are based on internationally applied general principles and good practices, are being partially or fully implemented over the medium and long term by central banks and regulatory authorities in more than 100 countries, adapted to the specific characteristics of their banking sectors and economies.

In Mongolia, the Bank of Mongolia is responsible for ensuring the solvency and liquidity of banks, developing the relevant rules, regulations, guidelines and methodologies, and overseeing their implementation. Within this mandate, the Bank of Mongolia has consistently incorporated into its policy documents, and continuously implemented, objectives aimed at strengthening banks’ risk-absorption capacity and improving supervisory tools. For instance, the prudential ratios currently in force incorporate only 6 of the 24 Basel standards, which is insufficient compared with other countries. This situation results in limiting banks’ ability to make progress in their operations, such as expanding internationally, attracting foreign investment, improving their credit ratings and establishing new correspondent relationships.

To address these difficulties, since 2023 the Bank of Mongolia has been implementing, in phases and as reflected in the State Monetary Policy Guidelines, the revision of the “Regulation on Setting and Monitoring Prudential Ratios to Banking Operation”, which banks are required to comply with on an ongoing basis. The revision aims to fully align the regulation with all three pillars of Basel II, and with the key requirements of Basel III, the international standards for risk-based supervision, while taking into account the specific characteristics of Mongolia’s financial sector in an optimal manner.

To adapt the international standards being introduced to the conditions and characteristics of Mongolia’s banking system, the Bank of Mongolia has collected feedback on the draft regulation and conducted a comprehensive quantitative and qualitative impact assessment of the revised version and plans to have the draft regulation approved in 2027.

At the same time, a methodology for implementing risk-based supervision will be introduced in phases over the medium term, strengthening a risk-based supervisory framework that identifies and assesses bank risks in advance, allocates supervisory resources efficiently in line with risk levels, and takes necessary measures in a timely manner.

As part of this measure, the “Policy Document on Supervisory Activities for Banks” was approved in 2025, aligning the supervision of banking operations with Principles 8–13 of the “Core Principles for Effective Banking Supervision” issued by the Basel Committee on Banking Supervision. Going forward, supervisory plans need to be implemented in a risk-focused manner, based on banks’ risky activities.

To promote financial stability, the Bank of Mongolia’s Medium-Term Strategy (2026–2030) calls for strengthening the banking supervision framework, aligning it with international standards, and adopting risk-based supervision. Key measures include:

• Revising banks’ capital requirements in line with Basel standards and requiring banks to comply with them.
• Revising banks’ liquidity ratio and introducing the Basel Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) by incorporating them into the relevant regulations.
• Optimally allocating limited supervisory resources to banks’ risky activities.

• The following measures will be taken to revise banks’ prudential ratios in line with the Basel II and Basel III standards and to ensure their implementation:
• Finalize the new methodologies and regulations in the draft regulation, namely: first, the tiered structure and minimum level of bank capital; second, the calculation of additional capital requirements for credit, market, operational, concentration and interest rate risk in the banking book; third, the short-term and long-term liquidity ratios; and fourth, the capital conservation buffer, the countercyclical buffer and buffer requirements for systemically important banks; and have the draft regulation approved in 2027.
• Approve the linked legal documents to ensure consistency between the prudential ratios consistently applied to banking operations and other risk-based supervisory regulations and introduce them in phases in line with economic and financial sector conditions.
• Develop a draft revised version of the “Regulation on Setting and Monitoring Prudential Ratios to Banking Operation”, present it for public consultation and collect feedback in accordance with the General Administrative Law, and determine the transition period.
• To ensure effective implementation of the newly introduced standards, training will be organized to build the capacity of staff with supervisory functions at banks and at the Bank of Mongolia.
• Phased transition to fully risk-based banking supervision, supported by stronger supervisory capacity to proactively identify, assess, and address risks within banks:
• Improve the integrated planning and assessment methodology for risk-based supervision and allocate supervisory resources in line with the risk level and characteristics of each bank.
• Strengthen the framework for comprehensively assessing bank risk in terms of risk types, risk management, internal control, solvency and liquidity.
• Develop early warning indicators and systems for risk and establish a framework for early detection of risk accumulation and adverse changes in banks’ financial condition, and for taking preventive measures.
• Improve the framework for taking timely risk-mitigation measures and, where necessary, enforcement actions based on supervisory findings.

By revising the “Regulation on Setting and Monitoring Prudential Ratios to Banking Operation” in line with the Basel II and Basel III standards, the Bank of Mongolia will introduce into banking regulation standards such as the Internal Capital Adequacy Assessment Process (ICAAP) and the Internal Liquidity Adequacy Assessment Process (ILAAP), the Capital Conservation Buffer (CCoB), the Countercyclical Capital Buffer (CCyB), the higher loss absorbency requirement for domestic systemically important banks (D-SIB/HLA), and additional Tier 1 and Tier 2 capital requirements (CET1, AT1, T2). This will increase the risk-absorption capacity of the banking sector and build up liquid assets, thereby preventing the emergence of systemic risk and ensuring stable operations.

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Furthermore, the phased introduction of risk-based supervision will increase the effectiveness of supervision by allocating supervisory resources for risk mitigation in a manner suited to the characteristics of Mongolia’s banking sector.