## EXECUTIVE SUMMARY ## Source details **Canonical URL:** [EXECUTIVE SUMMARY](https://www.imf.org/-/media/files/publications/cr/2018/cr18238-perufssa.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18238-perufssa.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18238-perufssa.pdf.json) --- ### Key findings on resilience and vulnerabilities - Peru’s financial system has developed and become more resilient since the previous FSAP in 2011, but some challenges remain. - Main external vulnerabilities: - Reliance on commodity exports → vulnerability to growth in trading partners. - Significant dollarization → vulnerability to exchange rate depreciation. - These external risks were confirmed by Growth-at-Risk (GaR) analysis. - Domestic vulnerability: - Uncertainty and spillovers from the ongoing Lava Jato investigation. - Banking sector concentration: - The four largest banks account for 83 percent of total private banking sector assets. - These top four banks are classified as domestic-systemically important banks (D-SIBs) and are subject to elevated supervision. - Stress-test results: - Banking system largely resilient to adverse shocks because of initial strong capital buffers and profitability. - In the adverse scenario, all large banks experience credit losses but remain above the minimum regulatory capital adequacy ratio (CAR) threshold of 10 percent; a few small banks fall below the regulatory threshold. - Aggregate capital shortfall for banks facing losses is modest. - Interconnectedness/contagion: - Joint probability of distress across all banks has fallen since the post-global financial crisis peak level in 2010. - Shocks affecting credit exposures—strongly correlated among large banks—can become systemic due to concentration. ### Policy priorities (high level) - Increase risk weights for foreign currency loans consistent with Basel III requirements because of high dollarization. - Strengthen countercyclical provisions to help smaller banks build buffers against macroeconomic shocks. - Increase capital surcharges for systemic banks to levels in line with the Basel III framework to build resilience given concentration and correlated credit risk. - Continue close monitoring of banks’ off-balance-sheet exposures due to uncertainty from the Lava Jato investigation (priority for Superintendencia de Banca y Seguros del Perú (SBS)). - Continuously review the macroprudential toolkit to ensure SBS and Banco Central de Reserva del Peru (BCRP) are ready with instruments to address potential systemic risks. ### Source attribution - *Peru — INTERNATIONAL MONETARY FUND (EXECUTIVE SUMMARY).* --- ### FINANCIAL STRUCTURE ### System composition and sizes - Financial system dominated by banks. - Two large financial conglomerates and the private defined-contribution pension system (Administradora de Fondos de Pensiones (AFP), four fund managers) comprise about 23 percent of total financial-sector assets. - Microfinance institutions (MFIs) provide services in rural areas and to lower-income urban populations. ### Selected figures on financial sector structure (as presented) - Total system assets (Millions of Soles): 2011 = 351,340; 2017 = 669,476. - Total system assets (Percent of GDP): 2011 = 75.6; 2017 = 98.6. - Banks total assets (Millions of Soles): 2011 = 224,639; 2017 = 425,375. - Banks (Percent of total system assets): 2011 = 63.9; 2017 = 63.5. - Commercial banks (Millions of Soles): 2011 = 193,056; 2017 = 371,303. - Four largest (Millions of Soles): 2011 = 160,820; 2017 = 309,539. - Foreign-owned (Millions of Soles): 2011 = 92,212; 2017 = 181,998. - Pension Funds (Millions of Soles): 2011 = 81,881; 2017 = 156,247 (23.3 percent of total system assets in 2017). - Insurers (Millions of Soles): 2011 = 19,786; 2017 = 45,146. - Non-bank MFIs (Millions of Soles): 2011 = 16,345; 2017 = 28,218. - Financial markets (Outstanding Securities in Millions of Soles): - Stock Market: 2011 = 327,823; 2017 = 526,354 (Percent of GDP: 2011 = 70.5; 2017 = 77.5). - Government Debt: 2011 = 31,244; 2017 = 100,661 (Percent of GDP: 2011 = 6.7; 2017 = 14.8). - Corporate Debt: 2011 = 17,372; 2017 = 24,728 (Percent of GDP: 2011 = 3.7; 2017 = 3.6). ### Capital markets and liquidity - Domestic capital markets remain shallow and illiquid. - Local stock market capitalization as a share of GDP has increased only marginally; turnover ratio has remained around 3.5 percent over the past 5 years. - Local-currency bond markets remain subdued. - Domestic currency money markets are relatively small, short maturity, dominated by unsecured interbank transactions. - Repo market nascent; relies almost uniquely on BCRP-issued certificates of deposit (CDs) as underlying instruments; activity is sporadic; repo master agreement developed in 2015 but high transaction and settlement costs limit activity. --- ### FINANCIAL SOUNDNESS INDICATORS ### Key indicators (Table 3, year-end in percent) - Capital Adequacy: - Regulatory capital to risk-weighted assets: 2013 = 13.9; 2014 = 14.2; 2015 = 14.3; 2016 = 15.1; 2017 = 15.2. - Regulatory Tier-1 capital to risk-weighted assets: 2013 = 10.4; 2014 = 10.4; 2015 = 10.3; 2016 = 11.0; 2017 = 11.4. - Regulatory Tier-1 capital to total exposure: 2013 = 7.9; 2014 = 8.3; 2015 = 7.9; 2016 = 8.7; 2017 = 9.4. - Asset Quality: - Nonperforming loans to total gross loans: 2013 = 2.6; 2014 = 2.9; 2015 = 2.9; 2016 = 3.1; 2017 = 3.3. - Nonperforming loans net of specific provisions to capital: 2013 = -0.7; 2014 = -0.2; 2015 = -0.3; 2016 = -0.4; 2017 = -0.5. - Provisions to nonperforming loans: 2013 = 175.2; 2014 = 157.7; 2015 = 161.8; 2016 = 157.1; 2017 = 151.0. - Sectoral Loan Distribution (percent): - Consumer loans: 2013 = 18.4; 2014 = 18.1; 2015 = 18.3; 2016 = 18.9; 2017 = 19.2. - Mortgage loans: 2013 = 15.3; 2014 = 15.5; 2015 = 15.2; 2016 = 15.1; 2017 = 15.4. - Large corporations: 2013 = 17.6; 2014 = 17.2; 2015 = 21.4; 2016 = 22.2; 2017 = 22.6. - Small corporations: 2013 = 15.5; 2014 = 17.0; 2015 = 15.8; 2016 = 14.8; 2017 = 14.3. - Medium size firms: 2013 = 17.6; 2014 = 18.3; 2015 = 16.9; 2016 = 16.4; 2017 = 15.4. - Small firms: 2013 = 11.4; 2014 = 10.1; 2015 = 9.0; 2016 = 9.1; 2017 = 9.4. - Microenterprises: 2013 = 4.3; 2014 = 3.8; 2015 = 3.4; 2016 = 3.6; 2017 = 3.7. - Earnings and Profitability: - Return on assets: 2013 = 2.0; 2014 = 1.9; 2015 = 2.1; 2016 = 2.0; 2017 = 2.1. - Return on equity: 2013 = 20.0; 2014 = 18.2; 2015 = 21.1; 2016 = 19.2; 2017 = 17.7. - Foreign Currency Position and Dollarization: - Share of foreign currency deposits in total deposits: 2013 = 43.6; 2014 = 43.4; 2015 = 49.5; 2016 = 44.1; 2017 = 39.3. - Share of foreign currency loans in total credit: 2013 = 41.1; 2014 = 38.4; 2015 = 30.1; 2016 = 28.8; 2017 = 29.4. - Liquidity and Funding: - Liquid assets to short-term liabilities (domestic): 2013 = 31.4; 2014 = 25.3; 2015 = 26.2; 2016 = 26.7; 2017 = 33.0. - Liquid assets to short-term liabilities (foreign): 2013 = 56.4; 2014 = 55.2; 2015 = 47.5; 2016 = 44.9; 2017 = 45.7. ### Notable balance-sheet features - Banks hold large volumes of very liquid assets largely due to high reserve requirements of BCRP. - Marginal reserve requirement for foreign-currency liabilities: stood at 36 percent at end-March 2018; was as high as 70 percent in December 2016. - More than 17 percent of bank assets are very liquid assets, mostly cash and central bank reserves. --- ### STRESS TESTS, SYSTEMIC RISK, AND INTERCONNECTEDNESS ### Growth-at-Risk (GaR) findings - GaR used almost 30 Peru-specific macroeconomic and financial variables to model conditional distribution of future GDP growth at horizons from one quarter to three years. - Major risk factors for tail GDP outcomes: external conditions, leverage, and price of risk. - External conditions (driven by major trading partner growth and FX developments in Peru) are most crucial; their contribution to tail risks is twice as high as leverage and price-of-risk contributions. ### Banking sector stress tests — scenarios and design - Stress tests used baseline and adverse scenarios over a three-year horizon. - Adverse scenario annual GDP growth shocks: -3.6 percent, -5.1 percent, and -0.9 percent during the three-year scenario period. - The likelihood of adverse GDP growth of -1.2 percent in the second year (deviation of 5.1 percent from baseline) estimated at 4.2 percent. - Tests included top-down adverse macroeconomic scenario, sensitivity analyses, and assumptions on off-balance-sheet guarantees (capturing construction-sector-related guarantees). ### Banking sector stress-test results — solvency and capital - Starting total capital ratio (2017 Q2): 15.5 percent. - System-wide average Total Capital Ratio under Adverse scenario: - 2018: 14.4 percent - 2019: 14.7 percent - 2020: 14.8 percent - System-wide average Total Capital Ratio under Baseline: - 2018: 15.8 percent - 2019: 16.1 percent - 2020: 16.3 percent - At end of adverse-scenario simulation: - All large banks remain above the minimum regulatory CAR threshold of 10 percent. - A few small banks (holding approximately 6 percent of total private banking-sector assets) fall below the regulatory threshold. - Total capital shortfall is less than 0.1 percent of GDP. - Major driver of capital change in the adverse scenario: loan-loss provisions (credit risk). - Off-balance-sheet guarantees: - Notional value of guarantees corresponds to 118 percent of total bank capital on average. - FSAP used 60 percent of guarantees as basis for loss estimation. - Triggering of construction-sector-related guarantees contributed to a decline of approximately 0.3 percentage points in the system-wide total capital ratio. ### Profitability, liquidity, and funding assessments - Banking system remains profitable on average with small declines in system-wide capital levels. - Liquidity: - As of 2017 all banks meet the regulatory minimum LCR requirement of 80 percent and are close to or above 100 percent. - Most banks have NSFR well above 100 percent; only two banks slightly below 100 percent. - Cash-flow-based test: all banks maintain positive cash buffers up to one-year horizon (including central bank reserves); results sensitive to assumed run-off rates on unused credit lines — increasing run-off rate from 5 percent to 10 percent would cause three banks to experience cash shortfalls. - Banks’ FX liquidity risk limited; high level of FX reserve requirements provides significant buffer. ### Interconnectedness, contagion, and systemic risk indicators - Domestic contagion analysis did not find large risks of either direct exposure between important banks or indirect fire-sale effects. - A few small banks have large exposures (exceeding 40 percent of their capital) to other banks. - Cross-border contagion: potential spillovers limited; direct cross-border banking exposures appear limited due to standalone foreign subsidiaries and limited cross-border activities of domestic Peruvian banks. - Joint distress, common exposures: - Joint probability of distress (PoD) has come down since 2010 but banks’ common exposures can amplify shocks because of concentration. - Conditional likelihood of cascades of distress is high and could lead to a systemic event if an initial bank becomes distressed. ### Recommendations to strengthen resilience (banking system) - Continue strengthening capacity to monitor systemic risk and strengthen resilience. - Increase capital surcharges for systemic banks to levels in line with the Basel III framework. - Strengthen countercyclical provisions to help smaller banks build buffers. - Increase prudential requirements on unsecured interbank exposures to contain direct contagion risk. - Enhance monitoring of banks’ off-balance-sheet exposures, especially to the construction sector. - Given dollarization and its potential risks, increase risk weights for foreign currency loans consistent with Basel III requirements. - Continuously review macroprudential toolkit to ensure SBS and BCRP have instruments to address potential systemic risks. --- ### MACROPRUDENTIAL FRAMEWORK, SUPERVISION, AND OVERSIGHT ### Macroprudential governance and tools - Framework functions effectively but can be improved. - Desirables: - Enhanced mandate to BCRP and SBS for macroprudential policy. - Implement an MoU to strengthen coordination between BCRP and SBS. - Introduce new risk-monitoring tools: growth-at-risk, systemic risk models, corporate sector vulnerability monitoring. - Existing toolkit (mostly with SBS): capital surcharges for systemically important financial institutions, capital conservation buffers, countercyclical capital requirements, dynamic provisioning, liquidity requirements, capital surcharges for a range of risks. - BCRP measures to reduce dollarization: reserve requirements, FX credit limits, de-dollarization repos. ### Supervisory framework and perimeter — main findings and gaps - SBS has made significant progress implementing Basel III regulatory reform; capital and liquidity frameworks aim to achieve objectives and broadly equivalent overall capital levels recommended by Basel. - Need to amend law to grant SBS powers for full consolidated supervision; current limitation impairs group-level supervision. - Enhance supervisory approach for financial conglomerates: group governance, consolidated capital adequacy and liquidity assessment, lead supervisor, supervisory group rating. - Implement recovery and resolution planning requirements for D-SIBs and financial groups. - Strengthen legal protection of all SBS staff in line with international best practice. - Improve internal governance, control and accountability within SBS (enhanced internal audit, Audit Committee). - Activation trigger of countercyclical buffer could be enhanced; systemic and single name risk buffers not commensurate with intended risks. ### Insurance, cooperatives, and supervision perimeter - Insurance supervision strengthened; transition to risk-based regime underway; valuation requirements for solvency need updating. - Passage of law to bring financial cooperatives (COOPAC) under SBS supervision is important; three-tiered supervision model proposed and phased in over several years with FENACREP involvement. - After formalizing supervision of cooperatives, evaluate deposit-insurance and liquidity management options; ensure fit and proper tests and capacity to close problem cooperatives swiftly. --- ### FINANCIAL SAFETY NET, CRISIS MANAGEMENT, AND CONTINGENCY PLANNING ### Crisis coordination committee (CC) — recommendations and institutional design - Form a high-level CC comprised of: - the Minister of the MEF, - the governor of the BCRP, - the Superintendent of the SBS, - the President of the FSD. - Complementary actions: - Legislative support for a crisis management CC. - A MoU among CC members and other relevant entities based on statutory duties and roles. - National contingency plan framework: - Create an over-arching national contingency plan assembled from individual agency contingency plans. - Implementation relies on ex-ante preparations: subcommittees, working groups, designation of responsibilities, information collection and analysis, documentation, training, and drilling (simulations). - Each CC member should create a working group to develop CPs to be combined into a national contingency plan. - Extraordinary powers: - Authorities have some resolution powers usable in systemic crisis situations but lack a more comprehensive framework for prompt resolution. - Recommendation: reconsider draft law or pursue a similar initiative to provide extraordinary powers for prompt resolution when necessary. ### Financial safety net observations and recommendations - SBS has effective process for early identification and supervision of problem institutions; SBS management long-tenured and experienced. - Legal foundation for early intervention and resolution generally well developed but remedies are subject to broad judicial review; recommendation to limit remedies under judicial review to monetary damages rather than annulment of SBS decisions. - Resolution framework should be strengthened for systemic cases (consider authority for SBS to appoint a special administrator in systemic cases). - Enhance Emergency Liquidity Assistance (ELA) framework by specifying eligibility and collateral requirements and by providing for enhanced supervision. - FSD was effective in recent failures; operational responsibilities may need expansion for systemic crises; enhance information-sharing between SBS and FSD. - Operational recommendation: require payout of most insured deposits within seven working days. --- ### DEVELOPMENT CHALLENGES AND PRIORITY ACTIONS ### A. Financial Inclusion - National Financial Inclusion Strategy (launched in 2015) aims to increase formal account ownership from current 43 percent to 75 percent by 2021 through six goals and 65 projects. - Modelo Peru (mobile-technology platform) has had limited uptake due to lack of interoperability between banks and e-money accounts. - Recommendation: conduct a comprehensive review of Modelo Peru’s technical and business model shortcomings. ### B. Pensions - 2016 law allows private pension contributors reaching minimum retirement age to withdraw up to 95.5 percent of their capitalized accounts. - About 92 percent of contributors that have reached the entitlement age have been withdrawing the maximum allowed. - Result: drop in total premiums for annuities of 38 percent over two years. - Risks: long-term social protection goals undermined without prompt action. - Recommendations: - Repeal the 2016 law. - Design reforms to improve replacement rates and increase overall contribution rates. - Decrease overall cost of the system, e.g., by lowering pension management fees through caps on commissions. - Interim options: require employers to participate at current contribution rates; make employer-contributed share ineligible for withdrawal; provide incentives to purchase fixed-term annuities. ### C. Market Conduct - INDECOPI is main body for consumer protection; SBS handles market conduct for financial services. - 2017 SBS regulatory update established market conduct as essential element of enterprise culture. - Gaps: powers to address anti-competitive behavior in financial services remain with INDECOPI; SBS scope limited in supervised entities and conduct behaviors. - Recommendation: evaluate legal and institutional framework to improve competition, market conduct, and consumer protection while preserving technical expertise and minimizing mandate conflicts. ### D. Capital Markets - Priority constraints: develop fixed-income markets at all tenors; develop repo markets. - Recommended measures: - Improve clearing and settlement infrastructure. - Lower fees to promote repo use. - Public debt management strategy to prioritize issuance around benchmark tenors and greater collaboration between BCRP and government in short-term issuance. - Review taxation of capital-markets instruments to ensure even playing field with bank savings products. --- ### NONPERFORMING LOANS (NPLs), CREDIT CYCLE, AND CORPORATE VULNERABILITIES ### Nonperforming loans - NPLs were 3.3 percent at end-2017. - Increase concentrated mainly in medium-sized enterprises segments. - Recent increase largely due to pick-up in delinquencies among dollar loans to small-to-medium enterprises and individuals (mainly car loans) with less capacity to protect against exchange-rate risk. - NPLs remained low and stable in corporate loans and mortgages. - Note: higher dollar credit delinquencies partly reflect a statistical effect of substitution of credits in dollars for credits in soles, decreasing the denominator of NPL ratios in dollars. ### Credit cycle and macro outlook - Credit cycle: expansionary until end-2015; negative gap since late 2016; may be at a turning point. - Private credit growth: - slowed to around 5 percent year-over-year in 2016 and the first half of 2017 (from 14 percent in 2015). - accelerated since the second half of 2017 supported by monetary policy actions and improved terms of trade. - Real GDP growth: - averaged above 5 percent during 2008–2016. - estimated to have closed 2017 at 2.5 percent. - expected to grow near potential of 4.0 percent in the coming years, driven by increasing investment. - Inflation averaged 3.25 percent per year over 2008–2016. - Housing prices stable; mortgage interest rates declined; mortgage lending de-dollarized substantially; mortgage credit increased. - Price-to-rent ratio: Peru stands relatively high among Latin American countries, but absolute value not excessive; property price indexes reflect only Lima. ### Corporate sector resilience and vulnerabilities - Analysis of 93 listed firms: median interest coverage ratio remains above one under applied FX, earnings, and interest expense shocks, but sectoral vulnerabilities exist. - Domestic-oriented sectors’ debt repayment capacity relatively more sensitive to shocks; share of distressed debt in domestic-oriented sector doubles after shocks. - Guarantees to the construction sector pose indirect risk to banks; requires close monitoring by SBS. - Sensitivity shock specifications used in corporate analysis: - Scenario 1: FX shock only (depreciation of local currency by 15 percent). - Scenario 2: Scenario 1 + earnings shock of 15 percent + interest expense increase of 30 percent. - Scenario 3: FX and earnings shocks doubled (to 30 percent respectively) + interest expense shock of 30 percent. - Natural hedge of 75 percent applied to export-oriented sectors. - Debt includes bank borrowing and bond issuance; share of FX debt assumed to be 60 percent. ### Key systemic vulnerabilities identified - Commodity price volatility: - Mineral exports (largely copper, also gold, lead, and zinc) represent about 60 percent of total goods exports and slightly over 11 percent of GDP. - High financial dollarization: - At end-2017 under one-third of credit in the banking system consisted of FX credit; FX share of deposits was approximately 40 percent. - Domestic headwinds: - Uncertainty from the Lava Jato investigation and vulnerability to El Niño extreme weather events can reduce investment, delay infrastructure rebuilding, and increase NPLs. --- ### FINANCIAL INTEGRITY (AML/CFT) ### Framework, limitations, and recommendations - Authorities completed the ML/TF national risk assessment and several sectoral risk assessments; identified key threats: drug trafficking, corruption, and environmental crimes. - Key vulnerabilities: size of informal economy, inadequate controls over movement of cash, acquisition of real estate as ML typology. - Recommended actions: - Strengthen risk-based AML/CFT supervision of banks and high-risk reporting entities; expand sanctioning powers beyond fines up to $ 250,000. - Require banks to report suspicious activities material to safety, soundness or reputation of the bank. - Require banks to develop internal CDD policies and customer acceptance policies identifying business relationships to reject. - Require entities to gather sufficient information about respondent banks and not allow relationships with correspondent banks not effectively supervised. - FIU should engage reporting entities to improve quality of suspicious transaction reports and bolster financial investigations through robust information exchanges and enhanced entity transparency (registry of beneficial ownership). - Consider law requiring property transactions above a given threshold to be coursed through the formal financial system. --- ### BANKING SUPERVISION: MAIN FINDINGS AND RECOMMENDATIONS ### Preconditions and supervisory capacity - Sound macroeconomic policies and public infrastructure support supervision: LGSF mandate, SBS accounting and audit requirements, SMV regulation of securities markets, BCRP payment system regulation, INDECOPI consumer protection. - SBS manages a Risk Registry providing integrated information on debtors. ### Main supervisory findings - SBS responsibilities, objectives and powers clearly defined; shortcoming: limited supervisory powers over holding companies and affiliates outside direct perimeter. - Operational independence and no budget constraints, but legal protection for staff is limited (extends only to Superintendent and Deputy Superintendents and only for first five years after leaving office). - Cooperation arrangements with domestic and foreign supervisors exist; SBS actively engages in cross-border cooperation. - Supervisory approach robust and moving toward risk-based framework; on- and off-site techniques well developed though off-site IT platform could be improved. - Corrective and sanctioning powers strong but would benefit from written procedures to operationalize actions. - Corporate governance regulation updated in 2017; engagement with boards could be intensified. - Capital adequacy: significant progress on Basel III implementation; countercyclical buffer activation threshold and systemic/single-name buffers need review. - Liquidity: LCR implemented; NSFR in process; group-level liquidity contingency plans in initial phase. - Internal control, audit, reporting and disclosures broadly adequate; engagement with external auditors could be improved. - Prudential rules: market risk regulation updated; credit risk framework adequate; some provisioning CCF practices less conservative for undisbursed/unused lines. ### Recommended legal and regulatory reforms (selected) - Amend legal framework to grant SBS powers to exercise full consolidated supervision. - Strengthen legal protection of SBS staff in line with international best practice. - Enhance supervisory approach to financial conglomerates, including lead supervisor, group rating, and consolidated capital and liquidity assessment. - Implement recovery and resolution planning requirements for D-SIBs and financial groups. - Operationalize corrective powers into documented procedures; enhance engagement with boards; set expectations for Board effectiveness assessments. - Review Additional Capital Requirements Regulation, countercyclical buffer trigger, systemic and single-name risk buffers. - Establish Crisis Management Groups for systemic conglomerates and form a high-level CC for crisis coordination. --- *Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18238-perufssa.pdf* ### EXECUTIVE SUMMARY __________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### Key findings on resilience and vulnerabilities - Peru’s financial system has developed and become more resilient since the previous FSAP in 2011, but some challenges remain. - Main external vulnerabilities: - Reliance on commodity exports → vulnerability to growth in trading partners. - Significant dollarization → vulnerability to exchange rate depreciation. - These external risks were confirmed by Growth-at-Risk (GaR) analysis. - Domestic vulnerability: - Uncertainty and spillovers from the ongoing Lava Jato investigation. - Banking sector concentration: - The four largest banks account for 83 percent of total private banking sector assets. - These top four banks are classified as domestic-systemically important banks (D-SIBs) and are subject to elevated supervision. - Stress-test results: - The banking system is largely resilient to adverse shocks because of initial strong capital buffers and profitability. - In the adverse scenario, all large banks experience credit losses, but initial high capital and profitability help them remain above the minimum regulatory capital adequacy ratio (CAR) threshold of 10 percent. - For a few small banks, CARs fall below the regulatory threshold. - Aggregate capital shortfall for banks facing losses is modest. - Interconnectedness/contagion: - The joint probability of distress across all banks has fallen since the post-global financial crisis peak level in 2010. - However, shocks affecting credit exposures—strongly correlated among large banks—can become systemic due to concentration. ### Policy priorities (high level) - Increase risk weights for foreign currency loans consistent with Basel III requirements because of high dollarization. - Strengthen countercyclical provisions to help smaller banks build buffers against macroeconomic shocks. - Increase capital surcharges for systemic banks to levels in line with the Basel III framework to build resilience given concentration and correlated credit risk. - Continue close monitoring of banks’ off-balance-sheet exposures due to uncertainty from the Lava Jato investigation (priority for Superintendencia de Banca y Seguros del Perú (SBS)). - Continuously review the macroprudential toolkit to ensure SBS and Banco Central de Reserva del Peru (BCRP) are ready with instruments to address potential systemic risks. --- ### FINANCIAL STRUCTURE ### System composition and sizes - The financial system is dominated by banks. - Two large financial conglomerates and the private defined-contribution pension system (Administradora de Fondos de Pensiones (AFP), four fund managers) comprise about 23 percent of total financial-sector assets. - Microfinance institutions (MFIs) provide services in rural areas and to lower-income urban populations. ### Table 2: Selected figures on financial sector structure (as presented) - Total system assets (Millions of Soles): 2011 = 351,340; 2017 = 669,476. - Total system assets (Percent of GDP): 2011 = 75.6; 2017 = 98.6. - Banks total assets (Millions of Soles): 2011 = 224,639; 2017 = 425,375. - Banks (Percent of total system assets): 2011 = 63.9; 2017 = 63.5. - Commercial banks (Millions of Soles): 2011 = 193,056; 2017 = 371,303. - Four largest (Millions of Soles): 2011 = 160,820; 2017 = 309,539. - Foreign-owned (Millions of Soles): 2011 = 92,212; 2017 = 181,998. - Pension Funds (Millions of Soles): 2011 = 81,881; 2017 = 156,247 (23.3 percent of total system assets in 2017). - Insurers (Millions of Soles): 2011 = 19,786; 2017 = 45,146. - Non-bank MFIs (Millions of Soles): 2011 = 16,345; 2017 = 28,218. - Financial markets (Outstanding Securities in Millions of Soles): - Stock Market: 2011 = 327,823; 2017 = 526,354 (Percent of GDP: 2011 = 70.5; 2017 = 77.5). - Government Debt: 2011 = 31,244; 2017 = 100,661 (Percent of GDP: 2011 = 6.7; 2017 = 14.8). - Corporate Debt: 2011 = 17,372; 2017 = 24,728 (Percent of GDP: 2011 = 3.7; 2017 = 3.6). ### Capital markets and liquidity - Domestic capital markets remain shallow and illiquid. - Local stock market capitalization as a share of GDP has increased only marginally; turnover ratio has remained around 3.5 percent over the past 5 years. - Local-currency bond markets remain subdued. - Domestic currency money markets are relatively small, short maturity, dominated by unsecured interbank transactions. - Repo market nascent; relies almost uniquely on BCRP-issued certificates of deposit (CDs) as underlying instruments; activity is sporadic; repo master agreement developed in 2015 but high transaction and settlement costs limit activity. --- ### FINANCIAL SOUNDNESS INDICATORS ### Key indicators (Table 3, year-end in percent) - Capital Adequacy: - Regulatory capital to risk-weighted assets: 2013 = 13.9; 2014 = 14.2; 2015 = 14.3; 2016 = 15.1; 2017 = 15.2. - Regulatory Tier-1 capital to risk-weighted assets: 2013 = 10.4; 2014 = 10.4; 2015 = 10.3; 2016 = 11.0; 2017 = 11.4. - Regulatory Tier-1 capital to total exposure: 2013 = 7.9; 2014 = 8.3; 2015 = 7.9; 2016 = 8.7; 2017 = 9.4. - Asset Quality: - Nonperforming loans to total gross loans: 2013 = 2.6; 2014 = 2.9; 2015 = 2.9; 2016 = 3.1; 2017 = 3.3. - Nonperforming loans net of specific provisions to capital: 2013 = -0.7; 2014 = -0.2; 2015 = -0.3; 2016 = -0.4; 2017 = -0.5. - Provisions to nonperforming loans: 2013 = 175.2; 2014 = 157.7; 2015 = 161.8; 2016 = 157.1; 2017 = 151.0. - Sectoral Loan Distribution (percent): - Consumer loans: 2013 = 18.4; 2014 = 18.1; 2015 = 18.3; 2016 = 18.9; 2017 = 19.2. - Mortgage loans: 2013 = 15.3; 2014 = 15.5; 2015 = 15.2; 2016 = 15.1; 2017 = 15.4. - Large corporations: 2013 = 17.6; 2014 = 17.2; 2015 = 21.4; 2016 = 22.2; 2017 = 22.6. - Small corporations: 2013 = 15.5; 2014 = 17.0; 2015 = 15.8; 2016 = 14.8; 2017 = 14.3. - Medium size firms: 2013 = 17.6; 2014 = 18.3; 2015 = 16.9; 2016 = 16.4; 2017 = 15.4. - Small firms: 2013 = 11.4; 2014 = 10.1; 2015 = 9.0; 2016 = 9.1; 2017 = 9.4. - Microenterprises: 2013 = 4.3; 2014 = 3.8; 2015 = 3.4; 2016 = 3.6; 2017 = 3.7. - Earnings and Profitability: - Return on assets: 2013 = 2.0; 2014 = 1.9; 2015 = 2.1; 2016 = 2.0; 2017 = 2.1. - Return on equity: 2013 = 20.0; 2014 = 18.2; 2015 = 21.1; 2016 = 19.2; 2017 = 17.7. - Foreign Currency Position and Dollarization: - Share of foreign currency deposits in total deposits: 2013 = 43.6; 2014 = 43.4; 2015 = 49.5; 2016 = 44.1; 2017 = 39.3. - Share of foreign currency loans in total credit: 2013 = 41.1; 2014 = 38.4; 2015 = 30.1; 2016 = 28.8; 2017 = 29.4. - Liquidity and Funding: - Liquid assets to short-term liabilities (domestic): 2013 = 31.4; 2014 = 25.3; 2015 = 26.2; 2016 = 26.7; 2017 = 33.0. - Liquid assets to short-term liabilities (foreign): 2013 = 56.4; 2014 = 55.2; 2015 = 47.5; 2016 = 44.9; 2017 = 45.7. ### Notable balance-sheet features - Banks hold large volumes of very liquid assets largely due to high reserve requirements of BCRP. - Marginal reserve requirement for foreign-currency liabilities: stood at 36 percent at end-March 2018; was as high as 70 percent in December 2016. - More than 17 percent of bank assets are very liquid assets, mostly cash and central bank reserves. --- ### POLICY RECOMMENDATIONS (FSAP KEY RECOMMENDATIONS, selected) ### Systemic risk and macroprudential policy (Table 1 highlights) - Increase capital surcharges for systemic banks to levels in line with Basel III framework; increase countercyclical provisioning for smaller banks. (SBS) #24 — ST - Enhance monitoring of off-balance-sheet exposures of banks. (SBS) #24 — IT - Increase foreign currency lending risk weights in line with Basel III guidelines. (SBS) #24 — ST - Introduce new risk-monitoring tools (growth-at-risk, systemic risk analysis, corporate sector stress testing); give enhanced mandate for macroprudential policy to BCRP and SBS; implement MoU between BCRP and SBS to strengthen coordination. (BCRP, SBS) #29 — ST/MT ### Financial sector oversight and supervision - Amend legal framework to grant SBS powers to exercise full consolidated supervision. (SBS) #33 — MT - Enhance financial group supervisory and regulatory approach (group governance, consolidated capital adequacy and liquidity assessment, lead supervisor, supervisory group rating). (SBS) #33 — ST - Implement recovery and resolution planning requirements for D-SIBs and financial groups. (SBS) #32 — MT - Strengthen legal protection of all SBS staff in line with international best practice. Ministerio de Economia y Fianzas (MEF) #30 — MT - Finalize review of methodology for additional capital requirements; enhance activation trigger of countercyclical buffer; enhance systemic and single name risk buffers. (SBS) #31 — ST ### Insurance, cooperatives, and crisis management - Implement risk-based supervision for all insurers and brokers. (SBS) #35 — ST - After passage of law to bring financial cooperatives under SBS supervision, design a deposit-insurance system. (BCRP, MEF, SBS) #37 — MT - Strengthen crisis preparedness and management arrangements; enhance information-sharing between SBS and Fondo de Seguro de Depósitos (FSD); require payout of most insured deposits within seven working days and provide legal protection to FSD staff/agents. (MEF, BCRP, SBS, FSD) #46, #45 — MT - Enhance Emergency Liquidity Assistance (ELA) framework by specifying eligibility and collateral requirements, and by providing for enhanced supervision. (BCRP) #44 — ST ### Financial integrity and market development - Strengthen risk-based AML/CFT supervision, including sanctioning powers over banks and other high-risk reporting entities, focusing on preventive measures for laundering of proceeds of corruption and drug trafficking. (MEF, SBS) #39, 40 — ST/MT - Deepen repo markets, improve clearing and settlement infrastructure, and prioritize medium- and long-term issuance around benchmark tenors. (BCRP, MEF) #53 — ST/MT - Design reforms to improve the private pension system. (MEF) #50 — ST/MT --- ### OVERSIGHT, MACROPRUDENTIAL FRAMEWORK, AND DEVELOPMENT CHALLENGES ### Macroprudential governance and tools - The macroprudential framework functions effectively but can be improved. - Desirables: - Enhanced mandate to BCRP and SBS for macroprudential policy to foster willingness and ability to act. - Implement an MoU to strengthen coordination between BCRP and SBS to reduce policy inaction and improve accountability, while preserving institutional independence. - Introduce new risk-monitoring tools: growth-at-risk, systemic risk models, corporate sector vulnerability monitoring. ### Supervisory framework and perimeter - SBS has made significant progress implementing Basel III regulatory reform; capital and liquidity frameworks aim to achieve objectives and broadly equivalent overall capital levels recommended by Basel. - SBS moving toward a more risk-based framework for banks and insurance companies. - Need to amend law to regulate and supervise financial and mixed conglomerates on a consolidated basis more effectively. - Enhance supervisory approach to financial conglomerates, including supervisory group capital adequacy assessment. - Extend supervisory perimeter to include unsupervised cooperatives. ### Crisis management - Current legal framework provides for interagency cooperation in certain crisis situations, but: - Form a high-level coordinating committee (CC) to prepare for and manage systemic financial crises. - Legislative support for CC and an MoU among CC members and other relevant entities recommended; MoU should be based on each authority’s statutory duties and elaborate roles and cooperation expectations. ### Financial market development - Strengthening fixed-income markets is important for development and financial stability: - Develop repo markets to better facilitate liquidity management. - Public debt-management strategy should prioritize issuance around benchmark tenors to deepen fixed-income markets. - Review taxation of capital-markets instruments to ensure a level playing field with bank savings products. - Improve infrastructure and trading facilities to support market development. ### Pension system reform - Measures required to reduce inequities and enhance social protection: - Urgent need to repeal current law that allows almost a full lump-sum withdrawal when contributors reach minimum retirement age. - Consider incentives to improve replacement rates, including incentives to increase overall contribution rates, incentives to purchase fixed-term annuities for workers, and to lower overall costs. *Peru — INTERNATIONAL MONETARY FUND (EXECUTIVE SUMMARY).* ### 5. NPLs have been rising slowly (3.3 percent at end- 2017), mainly in the medium-sized ### 5. NPLs have been rising slowly (3.3 percent at end- 2017), mainly in the medium-sized ### Nonperforming loans (NPLs) - NPLs were 3.3 percent at end-2017. - The increase is concentrated mainly in the medium-sized enterprises segments of the marketplace. - Recent increase largely due to pick-up in delinquencies among dollar loans to small-to-medium enterprises and individuals (mainly car loans) with less capacity to protect against exchange-rate risk. - NPLs have remained at a low and stable level in the segments of corporate loans and mortgages. - Note: higher dollar credit delinquencies partly reflect a statistical effect of substitution of credits in dollars for credits in soles, which decreases the denominator of NPL ratios in dollars. ### Credit cycle, credit growth, and housing - Credit cycle: expansionary until end-2015; negative gap since late 2016; may be at a turning point. - Private credit growth: - slowed to around 5 percent year-over-year in 2016 and the first half of 2017 (from 14 percent in 2015). - accelerated since the second half of 2017 supported by monetary policy actions and improved terms of trade. - Real GDP growth: - averaged above 5 percent during 2008–2016. - estimated to have closed 2017 at 2.5 percent. - expected to grow near potential of 4.0 percent in the coming years, driven by increasing investment. - Inflation averaged 3.25 percent per year over 2008–2016. - Housing prices have remained stable; mortgage interest rates declined, mortgage lending de-dollarized substantially, and mortgage credit increased. - Price-to-rent ratio: Peru stands relatively high among Latin American countries, but absolute value not excessive; property price indexes reflect only Lima. ### Financial dollarization - Financial dollarization has declined since early 2000s but remains high. - At end-2017: - under one-third of credit in the banking system consisted of FX credit. - FX share of deposits was approximately 40 percent. - Credit de-dollarization continued; policy measures included de-dollarization repos, FX credit-reduction targets, and additional capital surcharges on dollar lending. ### Corporate sector resilience and sectoral vulnerabilities - Analysis of 93 listed firms: median interest coverage ratio remains above one under applied FX, earnings, and interest expense shocks, but sectoral vulnerabilities exist. - Domestic-oriented sectors’ debt repayment capacity is relatively more sensitive to shocks; share of distressed debt in domestic-oriented sector doubles after shocks. - Guarantees to the construction sector pose indirect risk to banks; requires close monitoring by SBS. - Sensitivity shock specifications (used in corporate analysis): - Scenario 1: FX shock only (depreciation of local currency by 15 percent). - Scenario 2: Scenario 1 + earnings shock of 15 percent + interest expense increase of 30 percent. - Scenario 3: FX and earnings shocks doubled (to 30 percent respectively) + interest expense shock of 30 percent. - Natural hedge of 75 percent applied to export-oriented sectors. - Debt includes bank borrowing and bond issuance; share of FX debt assumed to be 60 percent. ### Key systemic vulnerabilities identified - Commodity price volatility: - Mineral exports (largely copper, also gold, lead, and zinc) represent about 60 percent of total goods exports and slightly over 11 percent of GDP. - High financial dollarization: - Current levels of credit and deposit dollarization are a source of structural vulnerability; sharp depreciation can increase defaults among unhedged FX debtors. - Domestic headwinds: - Uncertainty from the ongoing Lava Jato investigation and vulnerability to El Niño extreme weather events can reduce investment, delay infrastructure rebuilding, and increase NPLs. ### Growth-at-Risk (GaR) findings - GaR incorporated almost 30 Peru-specific macroeconomic and financial variables to model conditional distribution of future GDP growth at horizons from one quarter to three years. - Major risk factors for tail GDP outcomes: external conditions, leverage, and price of risk. - External conditions (driven by major trading partner growth and FX developments in Peru) are most crucial; their contribution to tail risks is twice as high as leverage and price-of-risk contributions. ### Banking sector stress tests — scenarios and design - Stress tests used baseline and adverse scenarios over a three-year horizon. - Adverse scenario annual GDP growth shocks: -3.6 percent, -5.1 percent, and -0.9 percent during the three-year scenario period. - The likelihood of adverse GDP growth of -1.2 percent in the second year (deviation of 5.1 percent from baseline) estimated at 4.2 percent. - Tests included top-down adverse macroeconomic scenario, sensitivity analyses, and assumptions on off-balance-sheet guarantees (capturing construction-sector-related guarantees). ### Banking sector stress-test results — solvency - Starting total capital ratio (2017 Q2): 15.5 percent. - System-wide average Total Capital Ratio under Adverse scenario: - 2018: 14.4 percent - 2019: 14.7 percent - 2020: 14.8 percent - System-wide average Total Capital Ratio under Baseline: - 2018: 15.8 percent - 2019: 16.1 percent - 2020: 16.3 percent - At end of adverse-scenario simulation: - All large banks remain above the minimum regulatory CAR threshold of 10 percent. - A few small banks (holding approximately 6 percent of total private banking-sector assets) fall below the regulatory threshold. - Total capital shortfall is less than 0.1 percent of GDP. - Major driver of capital change in the adverse scenario: loan-loss provisions (credit risk). - Off-balance-sheet guarantees: - Notional value of guarantees corresponds to 118 percent of total bank capital on average. - FSAP used 60 percent of guarantees as basis for loss estimation. - Triggering of construction-sector-related guarantees contributed to a decline of approximately 0.3 percentage points in the system-wide total capital ratio. ### Banking sector stress-test results — profitability and concentration risks - Banking system remains profitable on average with small declines in system-wide capital levels. - Banks’ strong initial capital and profitability buffers absorb most potential credit and market losses. - Losses and profit declines in the adverse scenario are likely to lead to increased risk aversion. - Banking-sector concentration and correlated exposures of large banks pose a vulnerability; losses at any large bank could reduce total credit provision. ### Liquidity stress tests and funding risks - Cash-flow-based liquidity stress test, LCR, and NSFR assessed. - As of 2017: - All banks meet the regulatory minimum LCR requirement of 80 percent and are close to or above 100 percent. - Most banks have NSFR well above 100 percent; only two banks slightly below 100 percent. - Cash-flow-based test results: - All banks maintain positive cash buffers up to one-year horizon (including central bank reserves). - Results sensitive to assumed run-off rates on unused credit lines: increasing assumed run-off rate from 5 percent to 10 percent would cause three banks to experience cash shortfalls. - Banks’ FX liquidity risk limited; high level of FX reserve requirements provides significant buffer. ### Financial interconnectedness and contagion - Limited scope for direct contagion across sub-sectors within Peru. - Largest inter-subsector positions: - Deposits of pension funds in banks represent less than 3 percent of bank funding. - Banking-sector loans to non-bank financial entities remain below 2 percent of banks’ capital. *Source: IMF staff and FSAP material in the provided content.* ### 21. The domestic contagion analysis for banks did not find large risks of either direct ### cr18238-perufssa - 21. The domestic contagion analysis for banks did not find large risks of either direct ### Domestic contagion (banks) - The domestic contagion analysis did not find large risks of either direct exposure between the important banks or indirect risks coming from “fire sale” effects. - Institutions that hold significant amounts of assets potentially subject to a price decline are also the best-capitalized institutions. - A few small banks have large exposures (exceeding 40 percent of their capital) to other banks. - Regulatory recommendation: Regulate the unsecured total exposure of each bank to the banking system to limit the risk that, were a large bank to default, a second wave of defaults by small banks would hurt the reputation (and thus the liquidity) of other banks. ### Cross-border contagion - The cross-border contagion analysis indicated that potential spillovers would be limited. - Despite a large foreign presence in the banking system, direct cross-border banking exposures appear limited, in part because of the establishment of standalone foreign subsidiaries in Peru and limited cross-border activities of domestic Peruvian banks. ### Joint distress, common exposures, and systemic risk - Although the risk of joint distress has fallen since 2010, banks’ common exposures have the potential to amplify shocks since the banking system is concentrated. - The analysis showed that although the joint probability of distress (PoD) is low, if one bank is already in distress, it is likely that another bank would also experience distress. - The PoD have come down since 2010, helped by adequate provisions and higher levels of regulatory capital. - Large banks have similar loan portfolios, and credit risk is strongly correlated across banks. - Systemic risk indicators show that the conditional likelihood of cascades of distress (the likelihood that at least one additional bank is in distress when a first bank is already in distress) is high and could lead to a systemic event. ### Recommendations to strengthen resilience (banking system) - Continue strengthening capacity to monitor systemic risk and strengthen resilience. - Increase capital surcharges for systemic banks to levels in line with the Basel III framework to build further resilience given the concentration in the banking system. - Strengthen countercyclical provisions, which would help smaller banks that are more exposed to the macroeconomic cycle and build buffers against potential shocks. - Increase prudential requirements on unsecured interbank exposures to help contain direct contagion risk. - Enhance monitoring of banks’ off-balance-sheet exposures, especially exposures to the construction sector. - Given high levels of dollarization and its potential risks, increase the risk weights for foreign currency loans consistent with Basel III requirements. - Continuously review the macroprudential toolkit to ensure the SBS and the BCRP have the instruments to address potential systemic risks. ### Cyber risk - Cyber risk is recognized by the authorities as an important financial stability risk. - Cyber risk assessments are part of operational risk-related regulations. - All banks manage cyber risk under their operational risk frameworks, incorporate cyber risk in business impact analysis and stress-testing exercises, monitor cyber risk regularly, maintain organized cyber risk event databases, and have specific cyber risk insurance coverage. - Some banks would like to see cyber risk standards more specifically included in regulations, aligned with international standards. - The SBS has not carried out any cyber-attack simulations so far. ### Macroprudential framework and policies - Peru’s macroprudential framework is less formal than that of many other countries but has several elements supporting effective macroprudential policy in line with IMF guidance. - Close coordination between the BCRP and the SBS has made the existing informal arrangement work well. - There is no designated macroprudential authority; coordination occurs via regular informal meetings of high-level staff of the Ministerio de Economía y Finanzas (MEF), BCRP, and the SBS, and the SBS Superintendent attends the quarterly meetings of the BCRP Board of Directors. - Both BCRP and SBS conduct systemic risk monitoring and prepare separate Financial Stability Reports (only the BCRP publishes semiannually). - Recommendation: An enhanced mandate to BCRP and the SBS for macroprudential policy would be desirable to foster willingness and ability to act, improve accountability, and safeguard institutional norms—while preserving institutional independence of policy functions. - The authorities have developed an extensive macroprudential toolkit (mostly residing with the SBS): capital surcharges for systemically important financial institutions, capital conservation buffers, countercyclical capital requirements, dynamic provisioning, liquidity requirements, and capital surcharges for a range of risks. - The BCRP has implemented reserve requirements, FX credit limits, and de-dollarization repos to reduce dollarization, particularly in household borrowing. - Recommendation: Implement a Memorandum of Understanding (MoU) between the BCRP and SBS to strengthen coordination, collaborate systematically on stress testing (design of scenarios and discussion of results), close information gaps (corporate sector, financial cooperatives, housing market, household-income data), and introduce new risk-monitoring tools (GaR, systemic risk models, monitoring of corporate sector vulnerabilities). ### Banking sector oversight and regulatory reform impact - The SBS followed up on most recommendations from the 2011 Basel Core Principles (BCP) assessment, expanding resources and specialized units, strengthening consolidated supervision, establishing continuous monitoring of beneficial ownership, and implementing Pillar 2. - Supervision of governance, management, and internal controls has improved. - One unrealized recommendation: improvement of legal protection of SBS staff (requires amendment of the General Financial System Law (LGFS)). - The SBS has made considerable progress on Basel reforms. Implemented methodologies for capital conservation buffer, counter-cyclical buffer, and D-SIBs differ from Basel but aim for the same objectives. - The activation trigger of the counter-cyclical buffer could be enhanced, and systemic and single name risk buffers are currently not commensurate with the risks they are supposed to cover. - A substantive remaining difference is the use of the Basel II capital definition, embedded in the LGFS. - The SBS implemented the LCR, is in the process of implementing a tailored NSFR, and incorporated Basel corporate governance guidelines into its regulatory framework. - Areas for improvement: strengthen SBS internal governance, control and accountability (enhance internal audit department position and set up an Audit Committee), engagement with boards of supervised institutions, and establish recovery and resolution plans for D-SIBs and financial groups. - Consolidated supervision is a priority but impaired by gaps in the legal framework; SBS lacks formal legal powers to bring holding companies and wider groups within the supervisory perimeter. - Recommendation: Obtain necessary legal powers and enhance supervisory approach to group-level assessment (group rating, lead supervisor) for governance, risk management, capital adequacy and liquidity risk management. - Empirical analysis found no long-lasting effects of increased capital requirements on credit growth: loan growth was slightly lower in the first three months following a change in requirements, but over any period longer than a quarter, loan growth did not significantly differ between periods with and without a change—suggesting gradual implementation and high profitability allowed compliance through retained earnings. ### Insurance supervision - Insurance supervision has been strengthened; requirements for insurers’ risk management and internal controls have been considerably improved and are expected to be fully implemented during 2018. - SBS has begun transition from rules-based to a modern risk-based regime for capital requirements and supervision; additional changes, including legislative ones, are required. - Current regulatory requirements for valuation of assets and liabilities for solvency purposes need updating. ### Supervision of cooperatives - FSAP reviewed oversight arrangements and strategies to incorporate financial cooperatives within the SBS perimeter. - Passage of law migrating supervision of savings and credit cooperatives (Cooperativas de Ahorro y Crédito: COOPAC) directly to the SBS is important to strengthen oversight and control risks. - The law introduces a three-tiered supervision model: SBS will supervise eight to ten of the largest COOPACs; Tier 2 institutions will be supervised by Federación de Cooperativas de Ahorro y Crédito (FENACREP); Tier 3 COOPACs will be registered and receive basic monitoring. The tiered system will be phased in over several years, with FENACREP playing a key role. - After formalizing supervision, new responsibilities arise for deposit protection and provision of liquidity in times of stress. Current legislation provides for establishment of a deposit insurance scheme for cooperatives. - Recommendation: Evaluate alternative policy options for managing liquidity in times of stress given cooperatives’ unique challenges (e.g., inability to directly participate in payment systems); ensure adequate fit and proper tests for cooperative management and ability to swiftly close problem cooperatives. ### Financial integrity (AML/CFT) - Authorities have completed the ML/TF national risk assessment and several sectoral risk assessments. - Identified key threats: drug trafficking, corruption, and environmental crimes; major vulnerabilities: size of the informal economy and inadequate controls over movement of cash. Acquisition of real estate recently noted as a significant ML typology. - Authorities are finalizing a national plan for AML/CFT following the 2017 national policy (an update of 2011 policy). - Recommendation: Strengthen risk-based AML/CFT supervision of banks and high-risk reporting entities. SBS assesses key risk factors for each bank and engages compliance officers to strengthen AML/CFT controls. - Current low number of effective sanctions demonstrates need to strengthen SBS sanctioning powers. - The FIU faces operational challenges in supervising more than 6,000 reporting entities (including notaries public). - Some financial reporting entities (for example, money exchange businesses and loan companies) should be subject to effective admission licensing or registration frameworks to facilitate FIU supervision. - Effective use of AML/CFT measures should mitigate ML/TF risks from drug trafficking and corruption and address real estate vulnerabilities. - Recommendations: FIU should continue engaging reporting entities (especially high-risk ones) to improve quality of suspicious transaction reports; bolster financial investigations via robust exchanges of information (including items covered by bank and tax secrecy restrictions); enhance entity transparency (e.g., registry of beneficial ownership of companies) and customer due-diligence for politically exposed persons. - Recommendation: A law requiring property transactions above a given threshold to be coursed through the formal financial system would have a positive impact in limiting ML/TF risks from the real estate sector. ### Financial safety net and crisis management - SBS has an effective process for early identification and supervision of problem financial institutions; SBS management team is long-tenured and applies well-seasoned judgment. - Peru’s legal foundation for early intervention and resolution is generally well developed, but SBS remedies and actions are subject to broad judicial review; Peruvian courts could reverse SBS decisions on grounds of illegality (e.g., lack of compliance with legal framework, due process). - Recommendation: Preferable for legal framework to limit remedies awarded under judicial review to monetary damages rather than annulment of SBS decisions. - Peruvian bank resolution framework should be strengthened for systemic cases: under the surveillance regime SBS cannot take control; in the intervention stage SBS may take control but the operations of the entity cease by operation of law. - Recommendation: Consider authority for SBS to appoint a special administrator in systemic cases to take control and prepare to quickly resolve a failing bank (only needed in systemic situations and when other remedies are not likely to be effective). - Recommendation: Enhance emergency liquidity assistance (ELA) framework with clearly defined solvency and collateralization requirements and enhanced supervision of recipient entities to ensure ELA effectiveness for individual and temporary liquidity needs. - Deposit-insurance program (Fondo de Seguro de Depósitos, FSD) was effective in recent failures, but operational responsibilities may need expansion to function in a systemic crisis; SBS is the resolution authority and makes decisions, FSD has no decision-making authority but funds SBS resolution decisions. - Recommendation: Enhance information-sharing between SBS and FSD to be better prepared for idiosyncratic and systemic situations. - Operational recommendation: Ensuring confidence in the FSD and avoiding disruption to insured depositors would require a payout of most deposits within seven working days. _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18238-perufssa.pdf_ ### 46. A high-level CC should be formed to assist in preparing for and managing a financial ### A high-level CC should be formed to assist in preparing for and managing a financial crisis ### Crisis coordination committee (CC) — recommendations and institutional design - Form a high-level CC comprised of: - the Minister of the MEF, - the governor of the BCRP, - the Superintendent of the SBS, - the President of the FSD. - Complementary actions: - Legislative support for a crisis management CC. - A MoU among CC members and other relevant entities. - The MoU should be based on each authority’s statutory duties, elaborate roles in crisis management, and set out expectations of cooperation toward the shared goal of financial stability. ### National contingency plan framework — structure and implementation requirements - Create one over-arching national contingency plan framework for financial stability built from each individual agency’s contingency plan (CP). - Benefits: - Instills confidence that each agency can orderly manage issues and tasks in its area of responsibility. - Ensures procedures are well coordinated and avoids gaps or overlaps that could lead to delays or confusion. - Implementation relies on ex-ante preparations: - Creation of subcommittees and working groups. - Designation of responsibilities. - Information collection and analysis. - Documentation, training, and drilling (simulations). - Operational recommendation: - Each CC member should create a working group to develop CPs, which could be combined to form a national contingency plan. ### Extraordinary powers — legislative recommendation - Rationale: - Extraordinary powers may be required to maintain financial stability in a crisis for prompt resolution. - Current status: - Authorities have some resolution powers usable in systemic crisis situations, but lack a more comprehensive framework for prompt resolution. - During an earlier crisis period, a draft law pertaining to extraordinary powers and principles was developed but not taken up. - Recommendation: - Authorities should reconsider the proposed law or pursue a similar initiative. ### Developmental challenges — overview and priority actions - Focus: financial inclusion, pensions, market conduct, and capital markets. H3: A. Financial Inclusion - Objective: - National Financial Inclusion Strategy (launched in 2015) works toward six goals (through 65 projects), including increasing the number of people with accounts at a formal financial institution from the current 43 percent level to 75 percent by 2021. - Current status and issue: - Many studies and assessments have been completed; emphasis now on implementation. - Modelo Peru (a mobile-technology platform developed to increase financial inclusion) has had only limited uptake, partly because of lack of interoperability between banks and e-money accounts. - Recommendation: - Conduct a comprehensive review of Modelo Peru’s technical and business model shortcomings. H3: B. Pensions - Problem statement: - The 2016 law allows private pension system contributors that reach the minimum retirement age to withdraw up to 95.5 percent of their capitalized accounts. - About 92 percent of contributors that have reached the entitlement age have been withdrawing the maximum allowed. - Resulted in a drop in total premiums for annuities of 38 percent over two years as people have not reinvested their capitalized accounts into pension-like products. - Risks: - Long-term social protection goals will be undermined if prompt action is not taken. - Recommendations: - Repeal the 2016 law. - Design reforms to improve replacement rates and increase overall contribution rates. - Decrease overall cost of the system, for example by lowering pension management fees through introducing caps on commissions. - Interim policy options to incentivize retention in the current system: - Require employers to participate at the current contribution rates. - Make the employer-contributed share ineligible for withdrawal. - Provide incentives to purchase fixed-term annuities. H3: C. Market Conduct - Institutional roles: - INDECOPI has been the main body in charge of consumer protection in all sectors. - SBS has been in charge of market conduct regarding financial services. - Recent regulatory action: - In 2017 the SBS updated the regulatory framework to establish market conduct as an essential element of enterprise culture, institutional policies and incentives, and to ensure fair treatment for consumers throughout the financial product life cycle. - Gaps and issues: - Powers to address complaints pertaining to anti-competitive behavior in financial services remain with INDECOPI. - Limited actions by INDECOPI with respect to anti-competitive behaviors in the financial service industry. - SBS is limited in the type of supervised entities and its scope in business conduct behaviors, constraining activities it can undertake. - Recommendation: - Evaluate the legal and institutional framework to improve competition in the financial sector while safeguarding financial stability, by considering alternatives that: - More effectively oversee competition, market conduct, and consumer protection in financial services. - Preserve necessary technical expertise in financial matters. - Minimize potential conflicts between different mandates. H3: D. Capital Markets - Priority structural constraints and development needs: - Further develop fixed-income markets at all tenors. - Develop repo markets to better facilitate liquidity management by the central bank and market participants. - Recommended measures: - Improve clearing and settlement infrastructure. - Lower fees to promote use of repos. - Public debt management strategy should prioritize: - Greater collaboration between BCRP and the government in short-term issuance. - Prioritizing issuance in the medium- and long-term around benchmark tenors to deepen fixed-income markets. - Review taxation of capital-markets instruments to ensure an even playing field with bank savings products. ### Financial stability risks and stress-testing — RAM and STeM highlights - Risk Assessment Matrix (RAM) — key risks and assessments: - Structurally weak growth in key advanced and emerging economies / significant China slowdown and its spillovers. - Overall Level of Concern: High / Medium - Relative Likelihood: Medium - Expected impacts: Lower exports, low growth, low investment, high structural unemployment, low FDI, fiscal pressures, higher domestic yields, lower corporate profits and household income, higher NPLs and credit losses for banks. - Tightening of global financial conditions and higher volatility, accompanied by significant strengthening of the U.S. dollar against the Sol. - Overall Level of Concern: High - Relative Likelihood: High - Expected impacts: Funding pressures for banks, higher borrowing costs for nonfinancial corporates, increased defaults among corporates and households with unhedged FX debt, higher credit losses for banks, reduced consumption and investment demand; depreciation could strengthen competitiveness. - Homegrown economic weakness (uncertainty, Lava Jato spillovers, El Niño repeat). - Overall Level of Concern: Medium - Relative Likelihood: Medium - Expected impacts: Lower investment and growth, higher defaults and credit losses for banks. - Top-down Stress Test by FSAP Team (STeM) — key assumptions and design: - Institutional perimeter: - Includes a set of banks that hold approximately 92 percent of the banking sector assets. - Data source: supervisory and publicly-available data; baseline date: end-June 2017. - Methodology: - Balance sheet-based approach with satellite models for macro-financial linkages. - SBS satellite models for NPL ratio and provisioning ratio for credit losses. - Methodologies to calculate market losses from holdings of debt instruments, sovereign risk, shocks to bank funding costs. - Net fee income and commission income projected based on nominal GDP growth and expert judgment. - Stress test horizon: - 3 years (2017 Q3-2020 Q2). - Scenario analysis: - Baseline scenario based on the October 2017 IMF World Economic Outlook (WEO) projections. - Adverse scenarios simulated using the IMF’s Flexible System of Global Models. - Three major drivers of the adverse scenario: - Shock 1. Structurally weak growth in key advanced and emerging economies, including a significant slowdown in China. - Shock 2. Tightening of global financial conditions and higher volatility accompanied by a depreciation of the Sol. - Shock 3. Homegrown economic weakness related to uncertainties and spillovers from the ongoing Lava Jato investigation and a repeat of the El Niño event. - Under the adverse scenario, the Peruvian economy goes through a V-shaped growth path, with a cumulative deviation of real GDP growth of close to 8.8 percentage points over the first two years. - Sensitivity analysis: - Evaluate impacts of three single risk factors on existing capital buffers as of 2017 Q2: - Exchange rate risk; - Interest rate risk; - Concentration risk. *Source: IMF staff text in “cr18238-perufssa - 46. A high-level CC should be formed to assist in preparing for and managing a financial crisis.”* ### 4. Risks ### 4. Risks and Buffers ### Overview of Risks Assessed - Credit loss from banks’ loan portfolios and sovereign exposures, including off-balance sheet credit guarantees. - Market loss from valuation adjustments of banks’ holding of debt securities and existing net open foreign exchange positions. - Losses from bonds and money market instruments (sovereign and other issuers) in the banking and trading books. - Increase in funding costs. ### Behavioral Adjustments (Stress Test Assumptions) - Passive balance sheet assumption: - (1) the balance sheet growth is identical to the overall credit growth, which is linked to nominal GDP growth (with a zero-floor); - (2) the balance sheet composition remains constant throughout the stress test horizon; - (3) banks build capital only through retained earnings; and - (4) maturing capital instruments are not renewed. - Dividends are paid out by banks that remain adequately capitalized throughout the stress period. The dividend payout ratio is assumed to be 50 percent. ### Calibration of Risk Parameters - Projected losses distributed across different asset classes. - Point in time probability of default and downturn loss-given default used for calculating credit losses. - Risk weights of the untriggered off-balance sheet guarantees are assumed to increase from 50% to 75%. The 25-percentage point increase corresponds to a roughly 3-notch downgrade of loan exposures. - Regulatory/accounting and market-based standards: Basel II standardized approach. ### Output Presentation for Solvency Stress Tests - System-wide capital shortfall. - Percentage of banking assets in the system that fall below the capital. --- ### Banking Sector: Liquidity Risk ### Institutional Perimeter and Data - A set of banks that hold approximately 92 percent of the banking sector assets. - Source: Supervisory data. - Baseline date: End-June 2017. - Scope of Consolidation: Consolidated level data for banks that have their headquarters in Peru, and subsidiary level data for the subsidiaries of foreign banks. ### Channels of Risk Propagation and Methodology - Cash-flow based liquidity stress test using maturity buckets. - Basel III-LCR and NSFR ratios. - All analyses are carried out separately for the Sol and USD. ### Risks and Buffers - Risks: - Funding liquidity (liquidity outflows). - Market liquidity (price shocks) and haircuts. - Buffers: - Counterbalancing capacity (HQLA). - Central Bank facilities. ### Tail Shocks (Size of the Shock) - Run-off rates calculated following historical events and LCR/NSFR rates. - Bank run and dry up of wholesale funding markets, taking into account haircuts to liquid assets. ### Regulatory and Market-Based Standards - National regulatory framework. - LCR: 100 percent, consistent with Basel III LCR framework. - NSFR: Basel Committee on Banking Supervision (2014), “Basel III: The Net Stable funding ratio” Basel, October. ### Reporting / Output Presentation - System-wide liquidity gaps. - Survival period by bank, number of banks that can still meet their obligations. --- ### Banking Sector: Interconnectedness ### Institutional Perimeter and Data - A set of banks that hold approximately 92 percent of the banking sector assets. - Other major non-bank financial institutions. - Source: Supervisory data. - Baseline date: End-June 2017. - Scope of Consolidation: Consolidated level data for banks that have their headquarters in Peru, and subsidiary level data for the subsidiaries of foreign banks. ### Channels of Risk Propagation and Methodology - Interbank model by Cifuentes et al (2005). - Cross-border network model by Espinosa-Vega and Solé (2010). ### Risks and Buffers - Risks: - Credit and funding losses related to interbank cross-exposures (and cross-border banking exposures). - Fire-sale of assets. - Buffers: - Banks’ own capital and liquidity buffers. ### Tail Shocks (Size of the Shock) - Pure contagion: default of institutions. - Fire sale haircuts. ### Reporting / Output Presentation - Network analyses with supervisory data: - System-wide capital shortfall. - Bank-level capital shortfall. - Number of undercapitalized and failed institutions, and their shares of assets in the system. - Evolution and direction of spillovers. --- ### Systemic Risk Analysis ### Institutional Perimeter and Data - A set of banks that hold approximately 92 percent of the banking sector assets. - Period of analysis: January 2011-August 2017. - Supervisory data. - Scope of consolidation: perimeter of individual banks. ### Channels of Risk Propagation and Methodology - Construction of probabilities of distress of individual institutions based on balance-sheet data. - Systemic risk analysis (Segoviano and Goodhart (2006); Segoviano and Espinoza (2017)). ### Risks and Buffers - Risks: Method captures systemic risk from common exposures and fire-sale externalities. - Buffers: Banks’ own capital and liquidity buffers. ### Tail Shocks (Size of the Shock) - Shocks to balance sheets are those obtained from the banking sector solvency stress test. ### Reporting / Output Presentation - Systemic risk indicators: - Expected number of banks in distress if one is in distress. - Distress dependence matrix. - Marginal contribution to systemic risk. *Source: cr18238-perufssa - 4. Risks* ### 6. An effective system of banking supervision needs to be able to develop, implement, ### cr18238-perufssa - 6. An effective system of banking supervision needs to be able to develop, implement, ### Preconditions for effective supervision - Sound and sustainable macroeconomic policies: See the section ‘The Macrofinancial Context’ in this report. - A well-established framework for financial stability policy formulation: See the section ‘Macroprudential Framework and Policies’ in this report. - A well-developed public infrastructure: - The General Financial System Law (LGSF) provides the SBS the mandate for financial sector supervision. - The SBS issues accounting rules and establishes the structure of the financial statements of financial institutions; issued accounting standards are based (with some minor deviations) on the International Financial Reporting Standards (IFRS). - The SBS establishes external audit requirements for supervised institutions, based on the International Standards on Auditing and Related Services issued by the International Auditing and Assurance Standards Board (IAASB) of IFAC. - The Securities Market Superintendence (SMV) regulates and supervises securities market and security settlement systems; the Central Bank regulates payment systems. - The National Institute for the Protection of Competition and Copyright (INDECOPI) protects consumer rights and ensures adequacy of financial services based on provided information. - The SBS manages a well-established Risk Registry: an integrated system for registering financial, credit, commercial and insurance risk containing information on debtors of the supervised institutions; provides global and systematised information to third parties (e.g., commercial credit registries) and plays a key role in SBS’ credit risk supervision. - A clear framework for crisis management, recovery and resolution: See the section ‘Financial Safety Net and Crisis Management’ in this report. - Appropriate level of systemic protection (public safety net): See the section ‘Financial Safety Net and Crisis Management’ in this report. - Effective market discipline: - Commercial banks are by Law required to be listed and are subject to SMV disclosure requirements, including the requirement to publish annually a self-assessment against the Corporate Governance Code (appendix to the annual report). - Required disclosures are published and accessible on the SMV website. ### Main findings — Responsibilities, objectives, powers, independence, and accountabilities (CPs 1–2) - SBS responsibilities, objectives and powers: - Clearly defined; SBS can authorize banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions. - Shortcoming: supervisory powers limited regarding direct access to parents and affiliates, including non-financial subsidiaries and other affiliates outside direct supervisory perimeter. - SBS uses licensed subsidiaries and powers over licensed institutions to address group-level weaknesses, but regulations imposed this way are not as comprehensive (particularly on corporate governance and risk management). - Root cause: absence of adequate powers to include holding companies and affiliates in scope of supervision. - Operational independence and legal protections: - SBS has operational independence and no budget constraints. - Legal protection is limited: current provisions extend only to the Superintendent and Deputy Superintendents and only for the first five years after they have left office. - Governance and accountability could be enhanced: need improved assessment of effectiveness of supervisory activities and greater disclosure beyond annual reports. - Resource allocation considers risk profile and systemic importance, but staff proportion allocated to banks and banking groups vs. microfinance institutions may need reevaluation. ### Main findings — Cooperation, consolidated supervision and home-host relationships (CPs 3, 12 and 13) - Cooperation arrangements: - Frameworks for cooperation with domestic and foreign supervisors exist and reflect need to protect confidential information. - SBS is actively engaged in cross-border cooperation, including information exchanges and cooperation on examinations, even beyond its supervisory powers. - With domestic authorities, SBS does not seem to require extensive information exchange to perform supervisory duties, though it provides information when requested. - Consolidated supervision: - Priority for SBS but impaired by legal framework. - SBS has gathered information on conglomerates, monitored activities, and enforced prudential requirements via supervised entities and moral suasion, acting as a “de facto” home supervisor. - Concerns: lack of legal enforceability of supervisory requirements directly to holding company; existence of non-negligible cross-border operations outside direct supervisory perimeter; holding companies can invest in non-financial entities without formal SBS scrutiny (investments are deducted from regulatory capital at group level). - Supervisory approach to group-level governance, risk management, capital adequacy and liquidity risk management needs enhancement. ### Main findings — Permissible activities, licensing, transfer of ownership and major acquisitions (CPs 4–7) - Authorizations regime: - Market entry is highly controlled; SBS performs thorough reviews for authorizations. - SBS can review, reject and impose prudential conditions on transfer of significant ownership or controlling interest above 10 percent held directly or indirectly in existing banks. - Legal/regulatory shortfall: concept of significant influence is not used as qualitative indicator for significant ownership (situations of significant influence below 10 percent). - SBS can approve or reject major acquisitions or investments by a bank including establishment of cross-border operations. - Investment limits: investments in publicly traded companies limited to no more than 50 percent of the invested company, up to 10 percent of regulatory capital — may still allow banks to have high stakes and controlling interest/influence in non-financial companies. ### Main findings — Ongoing supervision (CPs 8–10) - Supervisory approach: - Robust and moving towards more risk-based framework. - Supported by a rating methodology with forward-looking perspective; assesses risk from banks and banking system. - Conglomerate elements are considered for overriding purposes but not embedded into the rating. - SBS has deep knowledge of major banks’ operations and risk profiles and uses a broad range of information sources. - Interactions with senior management and board have improved but room for further enhancement. - Resolvability of banks is a topic yet to be tackled by SBS. - Techniques and tools: - Broad range of on-site and off-site techniques supported by multiple prudential reports. - Integration of on- and off-site activities beneficial; split between specialized risk Deputy Superintendence (SAR) and another (SABM) for individual banks works well. - Some overlap in reports produced by Superintendences. - Off-site surveillance lacks a platform similar to on-site activities to facilitate analysis and monitoring of follow-up. ### Main findings — Corrective and sanctioning powers (CP 11) - Early action and moral suasion: - Broad legal powers plus a culture of moral suasion enable SBS to address unsafe and unsound practices at an early stage. - Experienced senior staff ensure consistency in corrective actions. - Recommendation: SBS would benefit from written procedures operationalizing broad legal powers into a range of supervisory tools to be systematically applied depending on severity. ### Main findings — Corporate governance and risk management (CPs 14–15) - Corporate Governance and Risk Management Regulation: - New regulation issued in 2017 incorporating main elements of the Basel Corporate Governance Principles for Banks. - Emphasis in regulation on risk management and corporate governance of licensed institutions; sets clear expectations regarding Board roles and committee structures. - Actual engagement with Board and individual Board members could be intensified; currently engagement is mainly limited to an annual meeting with one independent Board member. - Group-level application: - Essential criteria for evaluation of corporate governance apply explicitly to banks and banking groups, but regulation does not apply on a group-level for institutions for which SBS is the home supervisor. - Consequences: group Board members are not subject to formal fit and propriety review by SBS; group Board members are not required to sign-off on responsibilities as required for supervised institutions; supervisory approach to group-level corporate governance is less developed. - Root cause: limited powers regarding indirect supervision of financial groups. - Consolidated Supervision Regulation: - Requires licensed institution to assure group has adequate risk management frameworks. - This indirect regulation currently works because main activities of Peruvian conglomerates take place in Peru, but may become ineffective as cross-border activities increase. ### Main findings — Capital adequacy (CP 16) - Basel III implementation: - SBS has made significant progress implementing Basel III reforms; differences exist regarding capital buffers, but approaches aim to achieve same objectives and broadly equivalent overall capital levels. - Improvements: Basel III capital definition introduced; supervisory review of the Internal Capital Adequacy Assessment Process (ICAAP) incorporated into SBS’ internal rating methodology. - Issues and recommended enhancements: - Countercyclical buffer activation threshold: activated if GDP growth is above 5 percent — may be ineffective when excessive credit growth occurs while GDP growth is below 5 percent. - Systemic risk and single name risk buffers need review as currently not commensurate with the risk they are intended to cover. - These issues are identified by SBS and are part of the review of the Additional Capital Requirements Regulation currently taking place. - Supervisory group capital adequacy assessment needs enhancement: - Should consider: i) capital adequacy of holding company on a solo level (to determine if excess capital is available at holding company level); ii) location of capital within conglomerate, including risk of ringfencing/non-transferability of capital allocated to entities supervised by authorities abroad; iii) extent to which excess capital at group level can be allocated to support financial activities of the conglomerate. - Assessment does not adequately adjust for change in accounting standards: solo financials based on SBS accounting standards, while consolidated financials might be based on IFRS (which could impact provisioning levels and available consolidated capital). ### Main findings — Prudential regulations and requirements (CPs 17–25) - General assessment: - Regulatory and supervisory approach and practices regarding other prudential regulations and requirements are generally sound. - Market risk: - Market risk regulation was outdated (as observed in 2011 BCP assessment). - SBS issued a revised regulation for consultation; after completion of the assessment (November 1, 2017) the SBS issued the revised market risk regulation (Resolution SBS No. 4906-2017) on December 20, 2017. - In practice, outdated regulation did not constrain SBS’ effective supervision. - Liquidity: - SBS implemented the LCR (tailored to local circumstances) and is in the process of implementing the NSFR. - Revised liquidity risk management regulation (issued in 2012) requires groups for which SBS acts as home supervisor to have liquidity contingency plans on a group level. - Actual development of these plans is still in their initial phase. ### Main findings — Internal control, audit, financial reporting and disclosures (CP 26–28) - Frameworks: - Regulatory and supervisory frameworks for internal control, internal and external audit, financial reporting and disclosures are adequate. - Disclosures and auditor engagement: - SBS could further improve qualitative disclosures by implementing recommendations of the Enhanced Disclosure Task Force of the Financial Stability Board and/or implementation of Pillar 3. - SBS could improve engagement with external auditors. - Accounting standards transition: - SBS could assess more in depth whether current provisioning requirements are adequate compared with IFRS9, while considering possible issues from widening gap between SBS accounting standards (used by supervised institutions) and consolidated financial groups that might be based on IFRS. - Overall frameworks are considered adequate given current state of development and complexity of financial markets and banking system. ### Main findings — Abuse of financial services (CP 29) - AML/CFT framework: - SBS has a robust AML/CFT framework with strengthened regulation and supervisory procedures. - Limitation: sanctioning for banks is confined to fines up to $ 250,000, which may not be sufficient to curb behavior. *International Monetary Fund — CR18238 (Peru FSSA), chapter content provided in source document.* ### 3. Cooperation and ### 3. Cooperation and ### Cooperation and collaboration - Arrangements in place in Peru provide a framework for cooperation and collaboration with relevant domestic and foreign supervisors and reflect the need to protect confidential information. - Regarding domestic authorities, SBS does not seem to feel the need to exchange much information to perform its supervisory duties, although providing information when requested. ### Permissible activities - Permissible activities of institutions licensed and supervised as banks operating in Peru are clearly defined. - Use of the word “bank” in names is controlled. ### Licensing criteria - SBS has a sound and comprehensive licensing process encompassing assessment of: - ownership structure and governance, - strategic and operating plans, - internal controls, - risk management, - projected financial conditions. - A non-objection is required where the parent is a foreign bank. ### Transfer of significant ownership - SBS can review, reject and impose prudential conditions on proposals to transfer significant ownership or controlling interest above 10 percent held directly or indirectly in existing banks. - Legal and regulatory framework falls short with regard to significant influence (situations with stakes below 10 percent that may nonetheless influence management and policies). ### Major acquisitions - SBS can approve or reject major acquisitions or investments by a bank including establishment of cross-border operations. - Limit for investments in publicly traded companies (not higher than 50 percent of the invested company) might result in banks having high stakes and controlling interest/influence in non-financial companies. ### Supervisory approach - SBS has a sound and comprehensive supervisory approach, moving towards a more risk-based framework. - Supported by a rating methodology and forward-looking perspective assessing and addressing risk from banks and the banking system. - Elements related to the conglomerate are considered for overriding purposes, but are not embedded into the supervisory rating methodology. - SBS has deep knowledge of major banks’ operations and risk profiles, making effective use of a broad range of information sources. - Interactions with senior management and board have been enhanced but can be further improved. - Resolvability of banks is yet to be tackled by SBS. ### Supervisory techniques and tools - SBS has a broad range of techniques and tools; integration of on- and off-site activities has been beneficial. - Organizational split between a specialized risk Deputy Superintendence and a Superintendence for general supervision of individual banks seems to work well. - On-site examinations are complemented by an array of reports from both Superintendences, sometimes with overlap. - Off-site surveillance lacks a platform comparable to on-site activities to facilitate analysis and monitoring of follow-up activities. ### Supervisory reporting - SBS collects, reviews and analyses prudential reports and statistical returns from banks on both a solo and a consolidated basis. - SBS independently verifies these reports through on-site examinations. ### Corrective actions and sanctioning powers of supervisors - SBS acts effectively at an early stage to address unsafe and unsound practices or activities that could pose risks to banks or the banking system. - Broad legal powers, paired with a moral suasion culture, have enabled SBS to successfully tackle supervisory concerns. - Experienced senior staff ensure consistency in application of corrective actions. - SBS would benefit from documenting the operational procedures and framework for corrective actions to provide further assurance of consistent application. ### Consolidated supervision - Legal framework empowers SBS to exercise full consolidated supervision only from the licensed bank downwards; holding companies of banks are not formally regulated or supervised. - Vast majority of foreign exposures are held through holding companies. - By enforcing through supervised entities and moral suasion, SBS has gathered information on conglomerates, monitored activities and required prudential requirements and controls. - SBS acts “de facto” as the home supervisor and systematically conducts examinations of financial subsidiaries of the holding company (for which it has no formal supervisory powers). - Weaknesses remain in supervisory approach at group-level for governance, risk management, capital adequacy assessment and liquidity risk management. ### Home-host relationships - SBS actively cooperates with home and host supervisors. - Cross-border operations are concentrated in the two systemic conglomerates and represent almost 22 percent of gross total assets. - From a legal perspective the vast majority of those operations are outside the supervisory perimeter (investments through the holding company); SBS acts de facto as the home supervisor. - None of the foreign operations are material from a host supervisor perspective. - SBS has not established Crisis Management Groups for the two Peruvian financial conglomerates. ### Corporate governance - SBS’ governance requirements do not apply on a group-level for institutions for which SBS acts as the home supervisor. - Individual group Board members are not subject to a formal fit and propriety review by SBS; group Board members are not required (GIR, article 9) to sign-off on their responsibilities as required for Board members of supervised institutions. - Supervisory approach to corporate governance on a group-level is less developed. - SBS regulation places significant emphasis on corporate governance of licensed institutions and sets clear expectations regarding Board roles and committee structures. - Actual engagement with Boards and individual Board members could be further enhanced; current engagement is not commensurate with regulatory emphasis. - Requirements regarding composition of committees (number of independent Board members and independent Chair) could be further aligned with the Basel Corporate Governance Principles issued in July 2015. - New Corporate Governance & GIR (coming into effect per April 1, 2018) sets expectation of a periodic Board effectiveness self-assessment. - SBS has not yet developed clear expectations for standards of such an assessment, an internal framework for assessing collective suitability and effectiveness of the Board, nor assessment criteria for expected seniority and experience for key Board positions. - Intensified engagement with Board members would help develop a more comprehensive view of composition and effectiveness of the Board (currently mainly based on review of Board and Committee minutes). - Consider inviting new Board members (or key Board members or Board members of systemically important institutions) for a meeting/interview upon appointment to convey expectations and gauge experience. - Per regulation independent Board members at a group level can also act as independent Board members at a subsidiary level; this dual position could result in divided loyalties in certain situations. ### Risk management process - Regulatory framework for risk management is tailored to Peru’s economic circumstances and sets clear expectations for material risks to which the banking sector is exposed. - Consolidated Supervision Regulation partially redresses that risk management regulations (GIR and its successor Corporate Governance & GIR) do not apply on a group-wide basis; indirect regulation is not optimal. - SBS reviews models in practice (country risk, internal rating and credit scoring models and methodologies), but regulatory framework could be enhanced by providing model governance guidelines and expectations. - SBS is working on a proposal to establish guidelines for model governance covering: - relationship between model management and risk appetite; - responsibilities in model management; - development, validation, approval and monitoring processes; - supporting documentation; - processes of outsourcing and system support. - No formal requirements for recovery and resolution plans for D-SIBs; FIs are required to have capital and liquidity contingency plans, taking into account stress-testing results. These provide D-SIBs a good starting point for developing recovery and resolution plans. ### Capital adequacy - SBS has made significant progress on implementation of the Basel III regulatory reform agenda. - Implemented approaches differ in particular regarding different capital buffers, but aim to achieve same objectives and broadly equivalent overall capital levels. - ICAAP and its supervisory review are not yet integrated in SBS’ rating methodology, but can be taken into account as an override on the internal rating if needed. - A revised rating methodology which will include results of the SREP is planned to be rolled-out in 2019. - Activation trigger of the countercyclical buffer is based only on GDP growth and may be not effective in situations where there is excessive credit growth when GDP growth is below 5 percent. - The systemic risk and single name risk buffers need review as they are currently not commensurate with the risk they are supposed to cover; these issues are part of the review of the Additional Capital Requirements Regulation currently taking place. - Supervisory group capital adequacy assessment could be improved by taking into account: - capital adequacy of the holding company on a solo level (to determine if excess capital is available on holding company level); - location of capital within the conglomerate, including risk of ringfencing/non-transferability of capital allocated to entities supervised by authorities abroad; - extent to which excess capital at group level can be completely allocated to support financial activities of the conglomerate. - Assessment of consolidated capital adequacy does not adequately account for necessary adjustments to account for change in accounting standards; solo financials are based on SBS accounting standards, while consolidated financials might be based on IFRS (for groups whose holding company’s financial statements are prepared in accordance with the IFRS), which could impact provisioning levels and therefore available capital on a consolidated basis. ### Credit risk - SBS has an adequate regulatory and supervisory framework for credit risk. - Credit Risk Management Regulation issued in 2011 and Credit Risk Capital Requirements Regulation (Resolution SBS No. 8548-2012) address comments made in the 2011 BCP assessment. ### Problem assets, provisions, and reserves - LGSF and SBS regulations provide a detailed framework for identification and management of problem assets, asset classification, provisioning and write-offs. - Supervisory approach and practices to assure adequate policies and practices by FIs are sound; supervisory action is undertaken when deficiencies or weaknesses are observed. - Credit Conversion Factor (CCF) used for provisioning purposes for undisbursed granted credits and unused lines of credit deviates from factors used for credit risk capital requirements (Resolution SBS No. 14354-2009, which incorporates CCFs based on the Basel II capital requirements for credit risk). - Basel II framework: commitments with an original maturity up to one year and commitments with an original maturity over one year receive CCF of 20 percent and 50 percent, respectively. - Only commitments unconditionally cancellable at any time by the bank without prior notice, or that effectively provide for automatic cancellation due to deterioration in a borrower’s creditworthiness, receive a 0 percent CCF. - Assessors observe (as a relatively minor issue) that current blanket approach of assigning a 0 percent CCF for provisioning purposes to all undisbursed and unused lines of credit is less conservative. ### Concentration risk and large exposure limits - New rules on related parties and economic groups issued in 2015 (Resolution SBS N° 5780-2015) establish stricter criteria for determining a linkage and adopt international standards for defining an economic group. - Regulations do not consider a combined limit for large exposures. - Large exposure limit (maximum 10 percent for uncollateralized exposures) is conservative compared to international standards. - Additional Capital Requirements Regulation requires additional capital for single name concentration risk considering the top 20 exposures; charge may not be significant but has resulted in explicit attention to this risk in FIs’ risk management and ICAAPs. - SBS is reviewing the Additional Capital Requirements Regulation including adequacy of the capital charge for single name concentration risk (see also CP 16). ### Transactions with related parties - Resolution SBS N° 5780-2015 establishes stricter criteria for determining linkage and adopts international standards for defining an economic group, relevant for determining related parties of FIs and financial conglomerates. ### Country and transfer risks - Regulatory provisioning requirements for country risk are conservative. - Assessors consider regulatory framework and supervisory approach and practices to country risk adequate. ### Market risk - Considering limited trading activities in the banking system, current regulatory and supervisory framework is broadly adequate. - Existing Market Risk Management Regulation is outdated (1998). - A revised and updated Market Risk Management Regulation has been issued to the industry for consultation; assessors did not perform an in-depth review of the revised regulation. - Basel Committee is reviewing whether it will issue a simplified Basel III standard approach for market risk; SBS should evaluate extent to which current capital requirements need recalibration to align with the Basel III standard and whether the Basel III (simplified) standardized approach should be adopted. ### Interest rate risk in the banking book (IRRBB) - Overall regulatory and supervisory approach and practices are adequate. - IRRBB is included in the Additional Capital Requirements Regulation; requires an additional capital buffer if change in the Economic Value of Equity (EVE) is more than 15 percent of regulatory capital when applying a per maturity bucket prescribed interest rate shock. ### Liquidity risk - SBS has a well-established regulatory and supervisory framework for liquidity risk. - Inclusion of the LCR in 2012 aligned the framework with the Basel III framework. - SBS is working on implementation of the NSFR and is already monitoring banks on this ratio. - Apart from performing semi-annual stress-testing and developing a liquidity contingency plan, there are no group level liquidity requirements; group requirement is indirectly enforced via the licensed institution in Peru (indirect form of regulation is not optimal). - Adoption of group liquidity contingency plans by the two groups for which SBS acts as home supervisor is in its initial phase; SBS only recently started to push for more progress in this area. ### Operational risk - SBS has a sound regulatory and supervisory approach towards operational risk, performed by two specialized departments of the SAR. ### Internal control and audit - Regulatory framework and supervisory approach and practices for internal control and audit are consistent with the scale and nature of the financial system. ### Financial reporting and external audit - Regulatory and supervisory framework are broadly adequate. - SBS could improve engagement with external auditors. - SBS could assess more in depth whether current provisioning requirements are adequate compared with IFRS9, while considering possible issues related to difference in accounting standards (as a result of not implementing IFRS9) between supervised institutions (using SBS standards) and consolidated financial groups (which may use IFRS standards). ### Disclosure and transparency - Regulatory and supervisory approach and practices for disclosures and transparency are adequate for the level of development of the financial system. - Regulatory framework assures required disclosures are easily accessible on the website of the SMV. - Required annual disclosures are based on IAS1 and are complemented by quarterly disclosures required by SBS. - SBS publishes detailed quantitative financial information of supervised entities and the financial markets on its website. *Source: cr18238-perufssa - 3. Cooperation and (IMF).* ### 29. Abuse of ### 29. Abuse of financial services ### AML/CFT framework — overview and recent enhancements - The Superintendencia de Banca, Seguros y AFP (SBS) has a robust AML/CFT framework. - The framework has been strengthened in recent years with the issuance of the AML/CFT risk management regulation and continuous enhancements in supervisory procedures. - The regulation (SBS Resolution No. 4906-2017) has been issued after the assessment and will come into force June 1, 2018. ### Key limitations and supervisory gaps identified - Sanctioning powers for banks are confined to fines up to $ 250,000, which is judged "not enough to curb behavior." - Banks are not explicitly required to report to banking supervision suspicious activities in cases where such activities/incidents are material to the safety, soundness or reputation of the bank; there is a general requirement to inform major events related to the bank which has never been used. - The current framework regarding CDD does not encompass the overall requirements for banks to develop their own internal policies and criteria, in addition to the detailed requirements aiming at ensuring an effective CDD. - There are no requirements that the CDD management program has, as one of its essential elements, a customer acceptance policy that identifies business relationships that the bank will not accept. - There are no specific provisions requiring entities to gather sufficient information about their respondent banks to understand fully the nature of their business and customer base, and how they are supervised; nor for establishing relationships with those that are not effectively supervised by the relevant authorities. ### Recommended actions to improve compliance and effectiveness (selected, with emphasis on Principle 29) - Amend the legal/regulatory framework to: - Be able to impose sizable fines to banks. In addition, powers related to the possibility of suspending dividends, restrictions to asset growth, operating in certain business lines and others would be useful tools to support enforcement of banks’ compliance with the AML/CFT framework. - Explicitly require banks to report to the SBS suspicious activities in cases where such activities are material to the safety, soundness or reputation of the bank. - Require banks to develop their own internal policies and criteria for CDD beyond what is expressly prescribed in regulation. - Explicitly require entities to gather sufficient information about their respondent banks to understand fully the nature of their business and customer base, and how they are supervised. - Not allow banks to establish relationships with correspondent banks that are not effectively supervised by the relevant authorities. - Require CDD management programs to have a customer acceptance policy that identifies business relationships that the bank will not accept. - Other recommended actions across Principles (selected highlights from Appendix Table 2): - Principle 1: Amend the legal framework to grant SBS powers to exercise full consolidated supervision. - Principle 2: Amend the legal framework to further protect all SBS staff for acts or omissions in good faith including current and former staff (including senior management) even after leaving the SBS, irrespectively of the number of years of being out of the SBS; amend the legal framework so the Superintendence tenure does not coincide with the constitutional term of the government; review allocation of resources relative to systemic relevance and risk; enhance Internal Audit Function, including establishment of an Internal Audit Committee; operationalize the Financial Stability Committee; consider elaborating on discharge of supervision responsibilities through the Annual Report. - Principle 6: Adequately incorporate significant influence as a qualitative indicator for significant ownership in the regulatory framework. - Principle 7: Lower the maximum percentage allowed to be held on a non-financial company ensuring there is no controlling interest/influence. - Principle 8: Establish a process for assessing resolvability of systemic banks; consider establishing a rating for conglomerates and a lead supervisor for the conglomerate; further enhance interactions with senior management and the Board. - Principle 9: Streamline off-site surveillance report through further coordination between SAR and SABM; speed up process of establishing an off-site surveillance IT platform. - Principle 11: Operationalize legal powers into a regulation or procedures comprising a range of supervisory tools to be used depending on severity, encompassing full range of powers including withdrawing a license. - Principle 12: Amend legal and regulatory framework to enhance SBS’ powers and better support consolidated supervision. - Principle 13: Establish Crisis Management Groups for the two systemic conglomerates. - Principle 14: Apply at group-level, for groups where SBS is home supervisor, the same governance and fit and proper requirements as applied to licensed institutions; enhance Board committee composition requirements; intensify Board engagement; develop a framework for assessing collective suitability of the Board and assessment criteria for key Board positions. - Principle 15: Develop and issue guidelines for model governance; implement requirements for recovery and resolution planning for D-SIBs. - Principle 16: Incorporate ICAAP and related supervisory review in revised supervisory rating methodology; finalize review of current methodology regarding countercyclical buffer and single name concentration; enhance group capital adequacy assessment with analysis of solo holding company capital, location of capital within the conglomerate, and extent to which excess capital at group level can be allocated to support financial activities; review and revise group capital assessment methodology to account for differences in accounting standards between solo and consolidated levels. - Principle 17: Formalize developed risk-based supervisory cycle for assessing credit risk and incorporate in revised rating methodology expected to be rolled-out in 2019. - Principle 18: Review the CCFs applied to undisbursed and unused credit lines. - Principle 22: Issue the revised and updated Market Risk Management Regulation; evaluate recalibration of current capital requirements to align with Basel III standard and consider adopting the Basel III (simplified) standardized approach. - Principle 23: Review and consider implementation of the Basel III standards for IRRBB. - Principle 24: Intensify liquidity risk supervision of financial groups; continue work on implementation of the Basel III NSFR (tailored to local circumstances) as planned. - Principle 25: Follow up on recommendations (and lead by example) of the industry-wide business continuity stress-test. - Principle 27: Assess in more depth the potential impact of implementation of IFRS9 on FIs provisioning requirements; discuss and engage stakeholders on IFRS9 implementation strategy; consider developing a structured (risk-based) approach for trilateral meetings with external auditor and FIs to discuss management letter; strengthen engagement with external auditors and the audit profession. - Principle 28: Consider implementing recommendations of the Enhanced Disclosure Task Force of the FSB and Pillar 3 of the Basel framework. ### Authorities’ response to the assessment - The SBS appreciates the opportunity to provide comments and thanks the IMF and WB assessors for the full assessment as part of the Financial Stability Assessment Program. - The SBS notes the discussions were fruitful with seasoned supervisors and that many practical ideas and recommendations will enrich SBS internal discussions on future developments of Peruvian banking regulation and supervision. - The SBS considers the assessment to adequately reflect the current status of the Peruvian regulatory and supervisory frameworks, but expresses disagreement regarding the grading of Principle 1. The SBS states: - The Peruvian Banking Law defines ample legal powers for the SBS to authorize banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns. - The only area of weakness is limited legal powers for supervising holding companies, which the SBS considers has been over-weighted in the assessment of Principle 1. - Even though SBS does not have direct powers over holding companies, it has indirect legal powers to require information and impose prudential requirements through the supervised bank; these indirect powers have demonstrated effectiveness in supervision of the two major banking groups. - The SBS recognizes room for improvement in the legal framework to deal with potential future risks but does not consider current limited legal powers a major source of risk. - The SBS will carefully evaluate the recommendations and develop a plan to continue strengthening the regulatory and supervisory framework of the Peruvian Financial System. *International Monetary Fund — Financial Sector Assessment (Peru), Chapter 29: Abuse of financial services* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18238-perufssa.pdf_