## EXECUTIVE SUMMARY (cr18339) ## Source details **Canonical URL:** [EXECUTIVE SUMMARY (cr18339)](https://www.imf.org/-/media/files/publications/cr/2018/cr18339.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18339.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18339.pdf.json) --- ### MACROFINANCIAL DEVELOPMENTS - Financial system size: nearly 200 percent of GDP. - Banking sector: controlled by three private and three public banks; accounts for about half of the financial system’s assets. - Investment funds: make up some 30 percent of total financial sector’s assets. - Pension funds and insurance sector: account for 13 and 8 percent of total assets, respectively. - Financial conglomerates: control around 85 percent of the system’s assets; the presence of the public sector as a share of total assets of financial conglomerates remains about 40 percent of total banking sector’s assets. - Public banks provide 55 percent of bank credit. - Earmarked credits: regulated allocation and lower interest rates reflecting embedded subsidies; have led to inefficiencies and segmentation of credit markets. - Government debt securities: centerpiece of the fixed income market and the single most important asset class held by investment funds, pension funds and insurance companies. - Structural liquidity surplus: around 17 percent of GDP; repos of government bonds channel liquidity between end-investors and intermediaries to the BCB via OMOs. - Market structure: dominated by short-term floating rate or inflation indexed securities indexed to SELIC or CDI; FX and fixed income derivatives markets are relatively large. - Interbank benchmark: overnight unsecured interbank rate is thinly traded; recommendation to replace it with the SELIC government securities repo rate as a benchmark. ### FINANCIAL SYSTEM RESILIENCE AND VULNERABILITIES - System resilience: despite a deep recession, the financial system remained resilient, supported by high profitability and large interest margins in the banking system. - Bank robustness: broadly resilient to severe macrofinancial shocks; current high profits and capital ratios support resilience under a severe stress test scenario. - Stress-scenario impacts (summary): - Reduced bank income, market loss on government bonds, and high credit losses on corporate exposures. - Small capital shortfalls result; outcome deteriorates if capital is adjusted for deferred tax assets. - Some banks exposed to concentration risk. - Liquidity: banks generally well-positioned for short- and medium-term liquidity pressures; interbank contagion seems limited. - Nonbank reliance: insurance companies rely heavily on investment income; investment funds dominated by government bonds and have registered sustained growth. - Household credit: share of earmarked household credit (mortgages) increased significantly. - Key macroeconomic numbers: - Recession lasted 11 quarters and reduced output by a cumulative 7.8 percent. - Unemployment doubled to 14 percent during the recession. - Medium-term growth projected to reach just over 2 percent by 2020 (conditional on fiscal measures). - Household mortgage share increased to almost 20 percent (up from 12 percent in 2012). - Household DSTI: 22 percent. ### SUPERVISION, REGULATION, AND OVERSIGHT - Strengthening since 2012 FSAP: risk-based supervision, off-site monitoring, use of large data resources, sanctioning powers, and phasing-in of Basel III requirements. - BCB actions: guidance for Recovery and Resolution Plans by D-SIBs; focus on frontier risks including interdependence, cyberattacks and potential payments system outages. - CVM oversight: oversight of FMIs and issuers’ financial disclosure in line with international standards. - Structural reforms implemented: revisions to pricing of directed subsidized credit and BNDES funding modalities; enactment of corporate governance law for state-owned enterprises; adoption of a new corporate governance code by CVM. - Remaining weaknesses: - BCB’s and SUSEP’s response times for corrective actions should be shortened. - Onus of producing and submitting supervisory indicators should be with banks rather than BCB. - Regulatory and supervisory approaches need upgrading for related party exposures and transactions, large exposures, country and transfer risk, and restructured loans. - CVM should strengthen oversight through industry specialization and more refined risk-criteria. - Enforcement—administrative and judicial—should strive for prompter results. - Resources should be enhanced, particularly at CVM and SUSEP. - BCB’s independence and legal protection of staff should be ingrained in law; autonomy of senior leadership of BCB and SUSEP should be protected by clear rules including fixed terms and conditions of dismissal. ### RISK ASSESSMENT AND SYSTEMIC CONCERNS - Tail risk: materialization of risks could result in a double dip recession amplified by the sovereign–bank nexus. - Sector vulnerabilities: household and corporate sectors exhibit vulnerabilities; corporate sector leverage and profitability remain concerns. - Sovereign–financial linkages: government central role via direct exposures, common holdings of government securities, and guarantees related to deferred tax credits. - Deferred tax credits (DTCs) and DTAs: identified as a nexus risk (Annex II referenced). ### CRISIS MANAGEMENT, RESOLUTION, AND SAFETY NETS - Current resolution regime: inadequate; recommendation to introduce a new framework aligned with international best practice promptly. - Key recommendations (timing indicated as ST = short term, MT = medium term): - Revise the draft resolution law in line with FSAP team’s recommendations and promptly enact it. (ST) - Revise the ELA framework: provide for a solvency test tied to enhanced supervision, remedial plans, and possibly restructuring measures; allow for ELA in systemic circumstances upon a MoF indemnity. (ST) - Ensure lending from the deposit insurance fund is not used to maintain weak or insolvent banks; transform FGC into a fully owned public institution. (ST; MT) - Strengthen crisis management institutional arrangements for inter-agency cooperation and exchange of information, including contingency planning. (MT) - Establish a multi-agency high-level committee with an explicit mandate for macroprudential policy and power to issue policy recommendations on a comply-or-explain basis. (ST) ### POLICY RECOMMENDATIONS TO STRENGTHEN RESILIENCE - Capital and supervision: - Use Pillar 2 capital requirements to handle bank-specific risk profiles. (ST) - Strengthen legal protection and independence of supervisors (BCB, SUSEP) through clear rules including fixed terms and conditions of dismissal. (ST) - Increase resources of CVM and SUSEP. (ST) - Upgrade banking sector regulatory and supervisory approach to credit risk for related party exposures and transactions, large exposures, country and transfer risk and restructured loans. (MT) - Strengthen enforcement function of CVM by raising level of sanctions and ensuring adequate resources for prosecution; strengthen cooperation to allow CVM proper oversight of ANBIMA’s SRO activities. (ST) - Implement consistent group-wide supervision of insurance groups and conglomerates (BCB, ANS and SUSEP) with joint rule-making, implementation, on-site inspections and granular data sharing. (MT) ### FINANCIAL SECTOR DEVELOPMENT, EFFICIENCY, AND PUBLIC BANK REFORM - Intermediation efficiency challenges: - High margins in the free-credit market driven by high operating costs and loan loss provisions, credit-product level concentration, and cross subsidies to earmarked lending programs. - SMEs particularly affected; need to reduce information asymmetries, improve collateral enforcement and credit enforcement, and promote alternative products. - Actions to foster competition: client mobility and financial product cost transparency and comparability. (ST) - Public banks reform: - BNDES: adapt business strategy under the TLP reform to selectively assume risks that mobilize private finance and provide services to develop the financial sector. (ST) - Caixa: comprehensive reform to refocus on core mandate, improve governance, risk management and efficiency to boost capital; consider a strategic investor to improve corporate governance and know-how. (ST) - Long-term fixed income market: coordinated actions required including BNDES project-finance orientation, and revamping tax incentives to lengthen maturity of open pension funds liabilities and increase appetite for long-term funding. ### KEY RECOMMENDATIONS (selected highlights) - Establish a multi-agency high-level macroprudential committee. (ST) - Strengthen crisis management institutional arrangements. (MT) - Strengthen legal protection and independence for supervisors; increase CVM and SUSEP resources. (ST) - Use Pillar 2 capital as needed for bank-specific risks. (ST) - Upgrade supervision of related party exposures, large exposures, country and transfer risk, and restructured loans. (MT) - Strengthen CVM enforcement and oversight of SRO activities. (ST) - Implement consistent group-wide insurance supervision across BCB, ANS, SUSEP. (MT) - Revise and enact improved resolution law; revise ELA; transform FGC into a public institution. (ST; MT) - Complete national AML/CFT risk assessment and introduce a risk-based AML/CFT supervision approach. (ST) - Foster competition and improve financial product transparency to enhance intermediation efficiency. (ST) - Reform BNDES product offering under new strategy and focus Caixa on core activities while inviting a strategic investor. (ST) *Key stress-test and scenario outcomes (selected exact figures)* - Baseline stress-test trajectory for 12 largest banks: CET1 capital ratio series (percent) — Benchmark (no adjustments): 13.6, 12.5, 11.9, 11.4. - Adverse scenario — Benchmark (no adjustments): 13.6, 9.0, 8.1, 8.5. - Adverse scenario — With adjustments: 10.4, 5.9, 5.0, 5.5. - CET1 decline under adverse scenario: decline by 4.7 percentage points to 8.5 percent at end-2020. - Aggregated capital shortfalls in adverse scenario: R$46 billion (0.7 percent of GDP), nearly all for two public banks. - Deducting all existing DTAs and downgrading problem loans: immediate CET1 reduction by 3.3 percentage points (about 95 percent due to DTAs); under severe adjustment, aggregated capital shortfalls of R$136 billion (2 percent of GDP) and seven banks failing hurdle rates. - DTAs arising from loan loss provisions: R$146 billion; constitute about 25 percent of CET1 capital. ### SYSTEMIC LIQUIDITY, MARKETS AND BENCHMARKS - LCR (12 largest banks): about 250 percent on average; all banks comfortably above 100 percent regulatory hurdle. - NSFR tests: six banks would not be able to maintain required stable funding profile under stress within a year. - Investment fund redemption exercises: - Funds would use from R$437 to R$77 billion of reverse repos to meet extreme redemptions; followed by total sales ranging from R$194 to R$10 billion of government bonds. - Under 2017 market liquidity conditions, large-scale sale would raise government bond yields from 62 to 8 basis points on average. - Under September 2015 liquidity conditions, yield increases would range from 99 to 11 basis points on average. - Market liquidity features: - Large structural liquidity surplus around 20 percent of GDP (noted elsewhere as around 17 percent of GDP in Executive Summary). - Recommendation: urgent reform of CDI benchmark—replace with SELIC. - FX market: deliverable spot FX market constrained to around 180 authorized FX dealers; recommendation to update FX regulatory regime. ### DIRECTED (EARMARKED) CREDIT (Annex I — selected facts) - About half of the credit market is earmarked; large majority flows through public banks. - Caixa has more than 70 percent market share in the housing market. - Banco do Brasil dominates the rural finance market. - For households, earmarked credits predominantly for housing; for enterprises, earmarked credits tend to be for investment. - Earmarked loans have much longer maturities than free-market loans. - Funding sources include FAT, FGTS, and Constitutional Funds; these funds receive low remuneration enabling below-market lending. - Monetary policy interaction: impact of monetary policy rate tightening is reduced by one third for firms that receive earmarked credits. - Recent BNDES reform: transition over a 5-year period to TLP (starting January 2018) linking new loan rates to sovereign cost of funding (inflation indexed 5-year sovereign bond and actual inflation) replacing the TJLP. ### PUBLIC BANKS REFORM DIRECTION - Caixa reforms: focus on core competencies; solvency strategy; consider a socially-oriented strategic investor to improve governance and know-how. - BNDES reforms: move away from sole-financier model; assume limited risks to catalyze private finance (e.g., guarantee-type products); enable development of new financial institutions; migrate toward project-financing model. - Strong governance arrangements required, including independent monitoring and evaluation. ### AML/CFT, FMIs, INSURANCE, AND SECURITIES SUPERVISION (selected points) - AML/CFT: progress since 2010 assessments; remaining priorities include completing national AML/CFT risk assessment (including beneficial ownership), following up ENCCLA items, and introducing a risk-based AML/CFT supervision and sanctioning approach. (ST) - FMIs: enhancements in risk management; recommendations to disclose PFMI adoption and supervisory findings; CCPs should finalize robust recovery plans and an orderly resolution regime should be introduced (legal gap noted: CCPs currently subject to Bankruptcy Code). - Insurance (SUSEP): shifted toward risk-based supervision; key gaps include lack of independence and resources, absence of group-level supervision, and market conduct issues (high surrender rates; sales through banking branches). - Securities (CVM): strengthened fund regulation since 2015; resource shortfalls at CVM; recommend statutory basis for oversight of ANBIMA’s SRO activities and improved leverage and liquidity regulation for funds. *International Monetary Fund — cr18339 (excerpt).* ### EXECUTIVE SUMMARY __________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### MACROFINANCIAL DEVELOPMENTS - The financial system has grown to nearly 200 percent of GDP; its structure remains largely unchanged since the 2012 FSAP. - The banking sector, controlled by three private and three public banks, accounts for about half of the financial system’s assets. - Investment funds make up some 30 percent of total financial sector’s assets. - Pension funds and the insurance sector account for 13 and 8 percent of total assets, respectively. - Financial conglomerates control around 85 percent of the system’s assets; the presence of the public sector as a share of total assets of financial conglomerates remains about 40 percent of total banking sector’s assets. - Public banks provide 55 percent of bank credit. - Earmarked credits are loans with regulated allocation and lower interest rates reflecting embedded subsidies; these have led to inefficiencies and segmentation of credit markets. - Government debt securities are the centerpiece of the fixed income market and are the single most important asset class held by investment funds, pension funds and insurance companies, reinforcing interconnectedness through common asset holdings. - Brazil’s structural liquidity surplus is around 17 percent of GDP; repos of government bonds channel liquidity between end-investors and intermediaries to the BCB via OMOs. - Financial markets are dominated by short-term floating rate or inflation indexed securities indexed to SELIC or CDI; FX and fixed income derivatives markets are relatively large and important for risk transfer and price discovery. - The overnight unsecured interbank rate is thinly traded; recommendation to replace it with the SELIC government securities repo rate as a benchmark. ### FINANCIAL SYSTEM RESILIENCE AND VULNERABILITIES - Despite the deep recession, the financial system remained resilient, supported by high profitability and large interest margins in the banking system. - Banks are broadly resilient to severe macrofinancial shocks: current high profits and capital ratios support resilience under a severe stress test scenario. - Under the stress scenario: - Banks would experience reduced income, including from market loss on government bonds, and high credit losses on exposures to the corporate sector. - Small capital shortfalls result; the outcome deteriorates if capital is adjusted for deferred tax assets. - Some banks are exposed to concentration risk. - Banks are generally well-positioned to manage short-term and medium-term liquidity pressures and interbank contagion seems limited. - Insurance companies rely heavily on investment income. - Investment funds have registered sustained growth and are dominated by government bonds. - The share of earmarked household credit (mortgages) has increased significantly. ### SUPERVISION, REGULATION, AND OVERSIGHT - Supervision and regulation have strengthened at both micro and systemic levels: risk-based supervision, off-site monitoring, effective use of large data resources, sanctioning powers, and phasing-in of Basel III requirements. - The Banco Central do Brasil (BCB) has issued guidance for Recovery and Resolution Plans by D-SIBs and focused on frontier risks including interdependence, cyberattacks and potential payments system outages. - The securities commission’s (CVM) oversight of FMIs and issuers’ financial disclosure is in line with international standards. - Structural reforms implemented include revisions to pricing of directed subsidized credit and funding modalities of BNDES, enactment of corporate governance law for state-owned enterprises, and adoption of a new corporate governance code by CVM. - Remaining supervisory and regulatory weaknesses: - BCB’s and SUSEP’s response times for corrective actions should be shortened. - The onus of producing and submitting supervisory indicators should be with the banks rather than BCB. - Regulatory and supervisory approaches need upgrading for related party exposures and transactions, large exposures, country and transfer risk, and restructured loans. - CVM should strengthen oversight through industry specialization and more refined risk-criteria. - Enforcement—administrative and judicial—should strive for prompter results. - Resources should be enhanced, particularly at CVM and SUSEP. - BCB’s independence and legal protection of staff should be ingrained in law; autonomy of senior leadership of BCB and SUSEP should be protected by clear rules including fixed terms and conditions of dismissal. ### RISK ASSESSMENT AND SYSTEMIC CONCERNS - Materialization of risks could result in a double dip recession, which could affect the financial sector amplified by the nexus with the sovereign. - Vulnerabilities exist in the household and corporate sectors; the corporate sector, despite recent improvement, is still vulnerable to shocks. - Government plays a central role in financial sector interconnectedness through direct exposures, common holdings of government securities, and guarantees related to deferred tax credits. - Interconnectedness is reinforced by government guarantees of a large share of banks’ capital due to deferred tax credits (Annex II). ### CRISIS MANAGEMENT, RESOLUTION, AND SAFETY NETS - The existing resolution regime is inadequate; a new framework aligned with best international practice should be introduced promptly. - Recommendations on crisis management and resolution include: - Revise the draft resolution law in line with FSAP team’s recommendations and promptly enact it. (ST) - Revise the ELA framework to provide for a solvency test tied to enhanced supervision, remedial plans, and possibly restructuring measures, and allow for ELA in systemic circumstances upon a MoF indemnity. (ST) - Put in place mechanisms to ensure lending from the deposit insurance fund is not used to maintain weak or insolvent banks in operation; transform FGC into a fully owned public institution. (ST; MT) - Strengthen crisis management institutional arrangements for inter-agency cooperation and exchange of information, including contingency planning. (MT) - Establish a multi-agency high-level committee with an explicit mandate for macroprudential policy and power to issue policy recommendations on a comply-or-explain basis. (ST) ### POLICY RECOMMENDATIONS TO STRENGTHEN RESILIENCE - Use Pillar 2 capital requirements to handle bank-specific risk profiles to boost resilience and mitigate risks. (ST) - Strengthen legal protection and independence of supervisors (BCB, SUSEP) through clear rules including fixed terms and conditions of dismissal. (ST) - Increase resources of CVM and SUSEP. (ST) - Upgrade banking sector regulatory and supervisory approach to credit risk for related party exposures and transactions, large exposures, country and transfer risk and restructured loans. (MT) - Strengthen enforcement function of CVM by raising the level of sanctions and ensuring adequate resources for prosecution; strengthen cooperation to allow CVM proper oversight of ANBIMA’s SRO activities in the investment fund sector. (ST) - Implement consistent group-wide supervision of insurance groups and conglomerates (BCB, ANS and SUSEP) with joint rule-making, implementation, on-site inspections and granular data sharing. (MT) ### FINANCIAL SECTOR DEVELOPMENT, EFFICIENCY, AND PUBLIC BANK REFORM - Key challenges in financial intermediation efficiency: - High margins in the free-credit market driven by high operating costs and loan loss provisions, bank concentration at the credit-product level, and cross subsidies to earmarked lending programs. - SMEs are particularly affected; improving SME finance requires reducing information asymmetries, improving legal and institutional frameworks for credit enforcement, and promoting alternative products. - Actions to foster competition should include client mobility and financial product cost transparency and comparability. (ST) - Reforming the role of public banks: - BNDES should adapt its business strategy under the TLP reform to selectively assume risks that mobilize private finance and provide services that help develop the financial sector. (ST) - Caixa requires comprehensive reform: refocus on core mandate, improve governance, risk management and efficiency to boost capital; a strategic investor could provide stronger corporate governance and know-how. (ST) - Developing the long-term fixed income market: - Coordinated actions are required including BNDES operating under a project-finance financing model that engages investment partners, and revamping tax incentives to lengthen the maturity of open pension funds “liabilities” and increase appetite for and supply of long-term funding. ### KEY RECOMMENDATIONS (Table 1 highlights) - Establish a multi-agency high-level macroprudential committee. (ST) - Strengthen crisis management institutional arrangements. (MT) - Strengthen legal protection and independence for supervisors; increase CVM and SUSEP resources. (ST) - Use Pillar 2 capital as needed for bank-specific risks. (ST) - Upgrade supervision of related party exposures, large exposures, country and transfer risk, and restructured loans. (MT) - Strengthen CVM enforcement and oversight of SRO activities. (ST) - Implement consistent group-wide insurance supervision across BCB, ANS, SUSEP. (MT) - Revise and enact improved resolution law; revise ELA; transform FGC into a public institution. (ST; MT) - Complete national AML/CFT risk assessment and introduce a risk-based AML/CFT supervision approach. (ST) - Foster competition and improve financial product transparency to enhance intermediation efficiency. (ST) - Reform BNDES product offering under new strategy and focus Caixa on core activities while inviting a strategic investor. (ST) *International Monetary Fund — Brazil: Executive Summary (2018 FSAP).* ### 4. In two of the past 5 years, Brazil experienced a long and deep recession, but is now on ### 4. In two of the past 5 years, Brazil experienced a long and deep recession, but is now on the path of recovery ### Macroeconomic recovery and outlook - Recession lasted 11 quarters and reduced output by a cumulative 7.8 percent. - Unemployment doubled to 14 percent during the recession. - Since mid-2016 markets responded positively to the government’s reform agenda; economy exited the recession in 2017 Q1. - Following a contraction of credit during the recession, financial and credit conditions have eased and there are signs of recovery. - Medium-term growth is projected to reach just over 2 percent by 2020 (Table 3), conditional on sufficiently strong fiscal measures to ensure fiscal sustainability. - Inflation has recently declined rapidly mainly as the effects of sharp regulated-price adjustments in 2015 have waned, opening space for monetary easing. ### Corporate and household sector vulnerabilities - Corporate sector: leverage, profitability and liquidity indicators deteriorated during the recession; leverage remains high and profitability and liquidity indicators are below pre-recession levels. - Household sector: share of mortgage debt increased to almost 20 percent (up from 12 percent in 2012). - Household debt service-to-income ratio (DSTI) is 22 percent, described as still one of the highest in the world, reflecting high interest rates. ### Banking sector resilience - Banks have remained well capitalized, profitable, and liquid since the last FSAP despite record loan losses. - Profitability supported by prudent lending standards, high interest margins and fees. - Capital ratios well above regulatory minima overall, but capital ratios of public banks are much lower than those of private banks and are pressured by higher Basel III deductions from capital. - External funding exposures are low (at around 10 percent of total funding) and FX risks are largely hedged. - Liquidity has continued to be high due to large buffers of government bonds. - Non-performing loans remained low because of high write-offs due to the strict regulatory requirements. ### Nonbank financial sector - Assets managed by investment funds have grown steadily since the last FSAP, led by fixed income funds. - Insurance: growth of insurance premiums has declined since the last FSAP, but sector profitability and other key credit metrics have improved, mainly reflecting higher investment returns driven by higher interest rates. - Pension funds: have grown steadily as tax incentives support contributions; however, high unemployment has lowered contributions and poor performance of investment portfolios—driven by losses on equity investments—has weighed on the solvency of defined benefit pension plans, particularly of state owned enterprises. - As interest rates approach historical lows, lower returns will weigh on profits of the non-banking sector and a search for yield may increase risk-taking. - A new long-term interest rate, TLP, was introduced effective 2018 and will gradually converge towards the market-based yield of 5-year government bonds. ### Developmental issues - Public credit institutions account for about half of total credit. - Three largest public banks by loan portfolios: Banco do Brasil (BB), Caixa Economica Federal (Caixa), and BNDES; they intermediate most earmarked credit and are main providers of medium and long-term finance. - Since 2015 their loan portfolios have contracted reflecting weakening demand, tightening of origination standards and lower fiscal resources. - Financial intermediation costs measured by net interest margins (NIM) are particularly high in Brazil; operating costs are the main factor behind high NIMs, followed by loan loss provisions. - Regression analysis shows higher credit-product concentration, larger banks and share of earmarked credit are strongly correlated with higher interest rate spreads. - Structural deficiencies—poor collateral enforcement, low recovery ratios, inefficient judicial system—contribute to high delinquency costs. - SME productivity differential relative to large firms: micro, small, and medium firms are estimated to have productivity equal to 10, 27 and 40 percent, respectively, that of large firms in Brazil (ECLAC, 2013). - Large banks dominate credit markets for SMEs, lending mostly short-term; longer-term funding provided via earmarked credit. - Retail payments foundation is solid; BCB strengthened legal and regulatory framework governing retail payments, particularly regarding non-banks and banking correspondents. - Card market: second largest in the world; vertical integration and concentration persist—two firms control 80 percent of the acquirer market; interchange fees and scheme fees are substantially higher than in comparable markets; low interoperability among POS terminals and ATMs generates inefficiency. ### Risk assessment and macrofinancial adverse scenario - Major downside risks: political instability and spillovers from corruption investigations that could threaten the reform agenda and the recovery. - Main policy risk: reforms necessary to maintain the constitutional expenditure ceiling are diluted or delayed. - Main external risks: tighter or more volatile global financial conditions associated with the unwinding of unconventional monetary policy, trade and commodity price shocks arising from U.S. trade policy, and a significant slowdown in China. - Adverse scenario features a sudden stop of capital inflows and loss of confidence, occurring alongside a challenging global environment and weaker private sector balance sheets; scenario does not consider government default. - In the adverse scenario Brazil could experience a severe recession with: - Output falling by about 9 percent from the end-2017 level. - Large exchange rate depreciation and bond yield spikes. - Collapsing stock prices and declining equity and house prices. - Rising unemployment. - Initial monetary policy tightening to contain inflationary pressures. - Banks facing a relatively large increase in funding costs, reducing net interest margins. - Liquidity risk: funding outflows for banks and redemptions for investment funds. ### Bank solvency stress tests and fiscal-sourced vulnerabilities - Baseline stress-test outcome: CET1 capital ratio of the 12 largest banks on a downward trajectory; one public D-SIB struggling to meet capital requirements. - In the adverse scenario, CET1 capital ratio would decline by 4.7 percentage points to 8.5 percent at end-2020. - Adverse scenario drivers: negative net income, unrealized losses on debt securities (mostly government securities) reducing CET1 by 0.2 and 1.4 percentage points respectively, increase in risk-weighted assets (1.8 percentage points), reduced net interest income and substantial credit loss. - Four banks would fail to meet hurdle rates during the stress-testing horizon with aggregated capital shortfalls amounting to R$46 billion (0.7 percent of GDP), nearly all for two public banks. - BCB stress tests using same scenarios produced more favorable results, but some banks would similarly need additional capital. - Adjusting banks’ capital for deferred tax assets (DTAs) and problem loans materially worsens outcomes: - Deducting all existing DTAs from CET1 capital and downgrading all performing problem loans to the “E” credit category would immediately reduce CET1 capital ratio by 3.3 percentage points, about 95 percent of which is due to DTAs. - Under this severe adjustment, seven banks would fail to meet hurdle rates with aggregated capital shortfalls amounting to R$136 billion (2 percent of GDP). - Supervisory actions recommended to address macrofinancial risks posed by the sovereign-bank nexus related to deferred tax credits (DTCs) and DTAs. *Source: IMF staff estimates; CEIC; BCB; Haver.* ### 18. Banks are exposed to concentration risk, exchange rate risk, and market risk owing to ### 18. Banks are exposed to concentration risk, exchange rate risk, and market risk owing to ### Banking sector risks and exposures - Banks hold government debt and equity securities, exposing them to concentration risk, exchange rate risk, and market risk. - Default of the very largest borrowers of individual banks and of the system could have a large negative impact on capital, especially at public banks. - State-owned enterprises are among the largest borrowers of public banks and could give rise to contagion due to bank-sovereign linkages. - Despite banks’ small net open foreign exchange positions, depreciation-induced credit losses and increased risk-weighted assets could have a sizable impact. - Some banks could face significant losses when equity and government bonds’ prices fall sharply. ### Liquidity resilience and stress-test findings - The regulatory LCR for the 12 largest banks is about 250 percent on average, with all banks comfortably above 100 percent. - In a scenario of severe group-wide deposit outflows and significant stress in the bond market, only one D-SIB would have stressed LCR below 100 percent. - NSFR-based tests suggested that six banks would not be able to maintain the required stable funding profile under a stressed scenario within a year. - Cash-flow analysis results were consistent with the LCR and NSFR analysis. - Total liquidity shortfalls and funding gaps during the period of stress would be manageable within the BCB’s capacity, given substantial required reserves that could be released and provision of emergency liquidity assistance. ### Investment funds and government bond market impact - Three calibration approaches (fund-homogeneity, fund-heterogeneity and fund-family) were used to assess price effects from large-scale redemptions. - Under the exercises, funds would use from R$437 to R$77 billion of their reverse repos to meet extreme redemptions. - Followed by a total sale ranging from R$194 to R$10 billion of government bonds, respectively. - Under 2017 market liquidity conditions, this large-scale sale would raise government bond yields from 62 to 8 basis points on average. - Under more severe market liquidity conditions of September 2015, the average increase in bond yields would range from 99 to 11 basis points. ### Capital measures and supervisory recommendations - Pillar 2 capital requirements could help mitigate identified risks in the banking sector. - Given concentration risk, including large holdings of debt and equity securities, capital add-ons based on individual banks’ risk profiles should be considered. - Banks that would experience capital shortfalls in stress tests should be encouraged to build capital buffers, for example by a restriction on dividend distribution. ### BCB stress testing framework and suggested enhancements - The BCB’s stress testing framework is sound, with significant upgrades since the last FSAP. - Initiatives under way include development of a solvency-liquidity contagion module and bottom-up stress testing of banks. - Further enhancements could include: - handling of overseas operations; - estimation of credit loss based on default probability and loss given default; - incorporation of cash-flow analysis. - Given the prominent role of the government in the financial system, the BCB should take an integrated approach to assess the financial-sovereign linkages. ### Household sector vulnerabilities - Households remain vulnerable to adverse macrofinancial shocks due to large debt servicing obligations. - The share of financially weak households (debt-service-to-income above 40 percent and debt-to-income above 3) and the share of debt belonging to these households has increased only marginally since 2013. - Shocks such as falling income and rising interest rates would bring these figures well above their previous peaks during the last recession. - The share of debt-at-risk not covered by assets would still be relatively small, limiting financial stability implications. ### Corporate sector vulnerabilities - Financially weak corporates constitute a large fraction of the sector; low profitability remains a challenge especially for the energy sector. - About two-thirds of firms in the highly-leveraged services sector face difficulty in servicing their debt solely relying on operating income. - Macro-financial shocks could substantially raise debt-at-risk in the corporate sector. - Corporates with international activities utilize a reasonable degree of hedging against FX exposures. - Profitability and interest rate shocks could double the amount of debt at risk under the adverse scenario, with manufacturing and energy sectors most vulnerable. ### Interconnectedness and contagion analysis - Interbank exposures are relatively small—accounting for 5 percent of banks’ total assets—and about 60 percent of interbank exposures are secured. - Standalone network exercise: default of one large bank would lead to a default of a medium-sized bank; contagion limited when all other banks default. - Integrated exercise with bank solvency stress tests: CET1 capital ratio would fall to 7.1 percent, compared with 8.5 percent when credit loss associated with interbank exposures are not considered. - The public sector plays a central role: public banks and state-owned firms, repos collateralized by government securities, and government securities as the main liquid financial instrument are distinguishing features. - The investment fund industry has strong links with banks, and with insurance and pension fund sectors; institutional investors account for 80 percent of the industry’s assets under management. - The corporate sector seeks 30 percent of their funding from nonresidents. - Brazil faces both inward and outward cross-border spillovers in equity, sovereign credit risk and foreign exchange markets; spillovers for equity and sovereign credit risk are both inward and outward within Latin America and inward from Europe and the United States; FX spillovers are concentrated among large and financially integrated emerging market economies, with Brazil generating outward spillovers to smaller Latin American economies. ### Risk oversight and policy architecture - The architecture for supervision and regulation is hierarchical and broadly well-defined. - COREMEC is a high-level consultative forum for information exchange and coordination among financial regulatory agencies. - Since 2012 FSAP, progress on recommendations has been uneven. ### Macroprudential toolkit and monitoring - New tools introduced include: - a counter-cyclical capital buffer (CCyB), currently set at zero percent; - DSIB capital surcharges; - a loan-to-value (LTV) cap of 80 percent (90 percent for constant amortization loans) for residential mortgages under the Sistema Financeiro da Habitação (SFH); - differentiated risk weights for residential housing loans, based on LTV ratios and other loan characteristics. - In line with Basel III, a capital conservation buffer (CCB), LCR, and NSFR are being phased in. - Reserve requirements remain at relatively high levels, but the BCB has started to simplify and reduce them. - Progress was made on house price data and the introduction of a credit bureau, though availability of “positive” credit information is still pending. - Authorities could consider a DTI or DSTI limit as an additional instrument. ### Institutional gaps and recommended reforms - No single agency has a clear legal mandate and adequate powers for macroprudential policy; in practice the BCB has taken the lead. - Recommendation: establish a Financial Stability Committee comprising BCB, MoF, CVM, SUSEP, Previc, and FGC (once transformed into a public agency), with an explicit mandate for macroprudential policy and power to issue recommendations with a comply-or-explain requirement. - The BCB should have an important role in the committee; division of labor with COREMEC should be defined. ### Prudential supervision strengths and gaps - The BCB applies a proportionate approach and classifies the banking sector into tiers; supervisory intensity is adjusted accordingly. - Corporate governance assessment and conduct supervision have been integrated into the supervisory process. - The BCB’s use of data is a clear strength. - Recommendation: introduce disclosure requirements for banks to share information on the level of restructured loans in their portfolios. - Since the 2012 FSAP, the BCB dis-applied solo bank requirements—risk that an individual bank within a prudential conglomerate could face unforeseen restrictions in access to capital and/or liquidity. - Recommendation: re-instate prudential requirements and monitoring at the individual banking institution level for entities within the prudential conglomerate. - Other governance deficiencies: lack of formal independence of the supervisor, lack of legal protection for staff, potential for the BCB governor to be dismissed for any reason without cause being stated publicly. ### Government interventions and efficiency reforms - Reforms adopted to downsize public involvement and enhance corporate governance in financial institutions include: - Aligning cost of funding of BNDES with cost of sovereign debt (TLP reform). - Pre-payment of BNDES liabilities to the government reducing funds available for lending, affecting BNDES size and business model. - Caixa expected to organically generate resources to meet capital requirements, increasing focus on profitability and reducing non-core portfolio. - Strengthening corporate governance and internal controls, including public disclosure of appointments and remunerations of management and board members. *Source: cr18339 - 18. Banks are exposed to concentration risk, exchange rate risk, and market risk owing to* ### 36. But wider reforms are needed for a reduced role of public banks. For Caixa, reforms ### 36. But wider reforms are needed for a reduced role of public banks. For Caixa, reforms ### Public banks: Caixa and BNDES - Caixa: reforms should include focusing on core competencies; a solvency strategy that supports reform momentum; and a socially-oriented strategic investor that can improve governance and bring know-how. - BNDES: the TLP reform to its pricing and pre-payment of its borrowing opens the door for a strategic reorientation of the development bank. New strategy should focus on: - assuming limited risks to catalyze private sector finance (e.g., through guarantee-type products); - enabling the development of new financial institutions with a view to enhance competition. - Strong governance arrangements would be needed to guard against misuse, including an independent monitoring and evaluation function. *E. Further Progress is Needed to Address Governance Risks* ### AML/CFT and anti-corruption - Past assessments: Brazil’s AML/CFT system was last assessed in 2010 by the Financial Action Task Force (FATF) and by the Grupo de Acción Financiera de Latinoamérica (GAFILAT); the report identified important supervisory, customer due diligence and criminal justice gaps, many of which have since been addressed. - Improvements: technical improvements have supported an increase in the effectiveness of the system, most notably in regard to the number of corruption investigations, prosecutions and convictions. COAF, BCB and CVM issued updated customer due diligence regulations, and increased the number of AML/CFT inspections. - Remaining actions recommended: - complete the national AML/CFT risk assessment, including a targeted assessment of beneficial ownership risks; - follow-up on other pending ENCCLA action items to address remaining gaps in the legal framework; - introduce a risk-based approach specific to AML/CFT supervision and sanctioning to strengthen AML/CFT compliance. - Objective: addressing remaining shortcomings would strengthen defenses against terrorist financing and allow Brazil to avoid FATF’s call for countries to apply counter measures that would be harmful to Brazil’s financial sector. *F. Oversight of FMIs is Effective* ### Financial Market Infrastructures (FMIs) - Frontier risks identified and being addressed: interdependence in the financial system, cyber-attacks and payment systems outages. - Enhancements: FMIs have introduced significant enhancements to risk management frameworks to address liquidity, credit and operational risks; mission assessed FMI supervision and risks in the largest CCP, BM&FBOVESPA Clearinghouse. - Disclosure recommendations: - CVM should disclose its adoption of the PFMI, its specific objectives for FMI supervision, and consider producing a supervisory report disclosing its findings. - BCB and CVM should ensure publication of disclosure frameworks by all systemically important FMIs to improve transparency, governance, operations, and risk-management frameworks, and to promote objectivity and comparability of assessments of observance of the PFMI. - CCPs and resolution: - CCPs should finalize a robust and effective recovery plan consistent with CPMI–IOSCO Guidance. - BCB should set an action plan and schedule with B3 for finalizing such a plan. - Current legal gap: CCPs are presently subject to the Bankruptcy Code in case of insolvency, which means neither the BCB nor CVM can intervene on CCPs even in case of insolvency; recommendation to introduce an orderly resolution regime consistent with international guidance for CCPs. *G. Material Gaps Remain in Insurance Supervision* ### Insurance regulation and supervision - Progress: SUSEP has shifted from a compliance-orientation to a risk-based and outcome-focused approach; risk-based capital requirements together with the Liability Adequacy Test (LAT) have improved soundness. - Key gaps and risks: - lack of independence and resources of SUSEP: superintendents have been dismissed without clear/public explanation; staff lack appropriate legal protection; inability to impose sanctions promptly due to legal/procedural limitations; resources have eroded since the last FSAP; limited flexibility to hire experts. - resource shortages prevent proper implementation of new regulations and hinder industry growth. - Group supervision and coordination: - large insurance groups belong to financial groups; oversight is solely at entity level without group-level oversight. - recommendation: establish group supervision with enhanced coordination among SUSEP, ANS, BCB and CVM; some new regulations (enterprise risk management and governance) should have increased focus on groups. - Market conduct: - high surrender rates in annuity products indicate room for improvement in market conduct. - concerns: some insurance products sold as a requirement for loans within same financial group; need to improve transparency and quality of advice in the sales channel; clarify oversight responsibility for insurance sales through banking branches. *H. Securities Supervision Faces Resource Challenges to Meet Market Growth* ### Investment funds, CVM resources, and market conduct - Strengthening since 2012 FSAP: regulation and supervision of investment funds strengthened, notably through 2015 reform of rules on fiduciary administrators and asset managers. - Resource shortfall: CVM resources do not reflect the number of entities and growth of the investment fund sector; last open competition to recruit new staff was held in 2010; lack of resources means certain issues are not addressed appropriately. - ANBIMA and SRO oversight: - lack of a statutory basis for ANBIMA’s role means CVM is unable to oversee or take due account of ANBIMA’s activities; CVM not represented in ANBIMA decision-making bodies. - Leverage and liquidity management: - CVM should introduce a regulatory definition for leverage to measure and compare leverage across investment funds and set a cap on leverage for individual funds or groups of funds managed by the same asset manager. - liquidity framework is strong and balanced to prevent build-up of liquidity problems, but fiduciary administrators lack tools when illiquidity risk has crystallized and are obliged to move immediately to suspension of subscriptions and redemptions; recommendation to give fiduciary administrators access to a broader range of liquidity management tools. - Enforcement and corporate governance: - CVM’s enforcement powers were reinforced in 2017 legislation; authority to impose larger penalties; improved enforcement of good corporate governance, sanctions on fiduciary duties, related party transactions, conflict of interest violations; opined on share valuations in take-overs. - CVM should deepen risk analysis, including by industry specialization, add other indicators to risk-based methodology, increase number and type of company reviews, ensure staffing to analyze compliance with recently issued CG Code and annually report on developments. - SOE Law: - the 2016 SOE Law (Law 13.303) upgrades CG in SOEs but has lacunas and implementation challenges; mandatory issuance of the Annual Letter and impact sustainability report, adoption of a Code of Conduct, related party transaction and dividend policies, while appointment/evaluation policies of board members and senior executives, and remuneration disclosures may be challenging. CRISIS MANAGEMENT: ENHANCING POLICY RESPONSE ### Resolution framework and safety net improvements - Progress: creation within the BCB of a new Resolution Department; requirements for recovery and resolution planning established. - Limitations and Draft Law: - resolution powers remain limited; no inter-agency arrangements for crisis management in place. - BCB prepared a comprehensive draft law (the “Draft Law”) to introduce a new resolution regime in line with international best practices. - Draft Law expands toolkit (including bail-in and bridge banks), strengthens legal protection regime, and removes impediments to temporary public support; some elements remain unclear (application to medium and small-sized banks, elements of bail-in powers, bridge bank transactions and conditions for transfers to asset management companies). - Draft Law will require D-SIBs to prepare recovery plans; recommendation to extend RRP requirements proportionally to non-systemic institutions. - Institutional autonomy and coordination: - recommend greater operational autonomy for the BCB and establishment of formal inter-agency crisis management arrangements; test with regular multi-agency crisis exercises. - Emergency Liquidity Assistance (ELA) and the FGC: - ELA has not been used in over 20 years; suggested tightening of process for dealing with weak banks and providing ELA (including a solvency test of the recipient institution and escalating measures such as enhanced supervision). - indemnity of the MoF could operate in systemic circumstances when solvency is in doubt and assurances on repayment are insufficient. - FGC should be strengthened: bring it into the public sector and rule out open bank assistance from the deposit insurance fund. - issues with current FGC: non-profit private association composed of financial institutions; role in open bank assistance exposes fund to significant risk and could undermine depositor confidence. - benefits of public sector FGC: prevent conflicts of interest, improve exchange of confidential information, allow participation in high-level financial stability and crisis management committees, retain mandate for financial stability in public sector. - emergency liquidity provision by the FGC should be discontinued once the BCB ELA framework is fully operational; if solvency support is required in systemic circumstances, it should be provided from the resolution fund and open bank assistance from the deposit insurance fund should be ruled out. - interim measures should minimize risk of FGC lending to unviable and insolvent banks. SYSTEMIC LIQUIDITY MANAGEMENT ### Market liquidity, benchmarks, FX market, and authorities’ role - Market structure and resilience: - Brazil’s financial markets are generally liquid and sophisticated. - government bonds and overnight government securities repos are centerpiece of money and fixed income markets. - large structural liquidity surplus (around 20 percent of GDP) and Brazil’s substantial FX reserves bolster resiliency. - markets are highly interconnected and concentration is high as a handful of related banks and asset managers channel funds from end investors through to the BCB via repo transactions. - Derivatives and benchmarks: - derivatives are based on underlying instruments that are much less liquid. - interest rate derivatives use the overnight unsecured interbank CDI rate as benchmark—a market that is very lightly traded and is not generally perceived to be representative of the true cost of funding for large banks relative to the much more active SELIC repo market. - recommendation: CDI benchmark needs urgent reform, replacing it with SELIC. International efforts to reform interest rate benchmarks provide a guide. - FX spot market development: - spot FX market lags peers due to regulatory impediments: longstanding FX regulations limit transactions that physically settle in FX to around 180 authorized FX dealers and their customers with a defined underlying reason to trade FX. - consequence: price discovery occurs in less restricted derivatives markets; investors could have limited alternatives to trade/manage risk if FX derivatives markets become illiquid or close. - recommendation: update FX regulatory regime to reflect current market development so more entities can trade in deliverable instruments. - Authorities’ role in liquidity backstops: - BCB is a key supplier of high quality liquid assets via large OMO repo operations; BCB has intervened extensively in the FX futures markets to provide FX hedges. - MoF actively issues domestic debt and uses reverse auctions to provide liquidity in bond market during high volatility. - markets are comforted by authorities’ intervention roles, the BCB’s significant FX reserves and high degree of coordination between MOF and BCB during stress periods. - caveat: reliance on authorities may discourage market incentives to develop capacity to manage risks independently. *Italicized source: IMF staff report excerpt from the referenced PDF chapter.* ### 63. Planned changes to the central bank’s operating framework could challenge markets. ### 63. Planned changes to the central bank’s operating framework could challenge markets. ### Central bank operating framework and market implications - Legislative changes designed to reduce the variability of transfers between the BCB and MoF may mean the BCB has fewer government bonds to use in OMOs over time. - The BCB plans to introduce term deposits as an alternative tool to sterilize liquidity. - Term deposits: - do not currently fit within asset managers’ investment mandates; - may be costlier for the BCB due to their lower liquidity. - Using BCB securities would be better but requires legislative changes that should be pursued if a structural alternative sterilization instrument is needed. - The BCB should review its operational framework to accommodate new instruments and better align operations with policy settings. - The BCB should reform its OMO approach to accommodate more conventional fixed volume, variable priced auctions targeted at keeping rates close to the SELIC target rate. ### Financial intermediation efficiency (major findings and reform directions) - Financial intermediation displays high costs that vary substantially by product and bank. - Operating costs, loan loss provisioning, and bank concentration at the product level are strongly correlated with higher NIMs in Brazil vis-à-vis peers. - Other significant factors: - bank size—typically the larger the bank the wider the spreads; - the volume of earmarked-credit provision—among private banks, the higher the share of earmarked credit in their lending portfolio the higher interest rates in free-market loans. - Reform directions emerging from the analysis include: - addressing operational costs; - increasing the efficiency of credit enforcement; - reducing information asymmetries; - identifying options to strengthen market contestability. - A new law on electronic collateral registration may help reduce banks’ costs associated with SME lending. - To reduce market power, actions are needed to facilitate client mobility and financial product cost transparency and comparability. - The BCB and the competition authority, CADE, recently signed a memorandum of understanding to collaborate on facilitating efficient functioning of the financial market and a legal initiative on competition matters. ### SME financing (structure, constraints, and recommended initiatives) - The share of credit to SMEs as a percentage of total credit is low (approximately 36 percent in late 2017) and volatile. - Initiatives to foster SME financing should focus on three broad areas: - Information infrastructure to mitigate information asymmetries: - The adoption of centralized and digitalized business registries is recommended; - the “Cadastro Positivo” reform, pending approval in Congress, should ease information asymmetries.; - Legal and institutional frameworks for secured transactions, creditor rights, and insolvency to address issues of collateral registration and execution: - These include the use of movable assets as collateral, and improving the efficacy of the insolvency framework and of judicial enforcements with respect to collateral execution; - Availability of alternative products and sources of financing, including through fintechs. ### Digital access to payment services and financial inclusion - Brazil has long been at the forefront of payment systems but needs to adapt to rapid technological changes. - The BCB should actively pursue the objectives of interoperability and improved competition in the retail payments market, and promote innovation. - There is significant room for improved transparency, price differentiation, unbundling of services and cost reduction. - The BCB should promote open banking (open application programming interfaces (APIs) allowing authorized third parties to develop services and tools for customers) to facilitate the development of new entrants and new business models, as well as a specific FinTech framework to stimulate innovations. - E-money is underutilized, and its development would require a structured communication and education campaign. - The BCB is encouraged to continue its ongoing efforts to improve the legal framework and the payment system infrastructure: - The legal and regulatory framework that governs the National Payments System is complex, and could be consolidated and simplified. - The settlement guarantee mechanism should be extended to deal with the default of a participant. - A single platform for bill payment should be established. - NB PSP should be represented in the governance of CIP. - A structure to address the security of electronic payments is warranted. - The recent BCB regulation on interchange fees is a welcome step. ### Long-term financing and institutional investors (constraints) - Development of the private fixed income market remains a major challenge in Brazil’s capital market agenda. - Multiple causes interact to keep this market underdeveloped including: - (i) public banks have played a major role in the financing of large companies and infrastructure projects but the bulk of their financing has come at subsidized rates; - (ii) BNDES has structured financing for infrastructure under a corporate lending model, a model that is excessively onerous for infrastructure financing projects, which are typically highly leveraged; - (iii) vertically integrated, bank-dominated financial conglomerates make competition difficult for the development of strong independent capital market institutions; - (v) savings taxation provides weak incentives for long-term savings; and benefiting high-income people in their tax planning; and - (vi) pensions funds and fund managers are increasingly focused on showing short-term results. *IMF staff summary based on the source content provided.* ### 70. A reform agenda should include (i) a redefinition of BNDES’ role; (ii) new ways to ### 70. A reform agenda should include (i) a redefinition of BNDES’ role; (ii) new ways to ### Reform agenda — core policy recommendations - Redefine BNDES’ role: - Move away from a sole-financier business model and corporate guarantees. - Actively engage other partners. - Migrate toward project financing. - Develop new ways to distribute capital market products. - Restructure tax incentives: - Tax incentives should reduce deterrents to long-term savings. - Re-think regulation of pensions: - Supervision of pension funds should consolidate under one agency. - Strengthen competition and supervision: - Competition and supervisory authorities should be vigilant to business practices that reduce market contestability. ### Implementation and related institutional notes - The CMN has recently issued Resolution No. 4,649 that will pave the way for open banking. - Policy and supervisory adjustments implied: - Shift BNDES operations toward co-financing with institutional investors of a broader set of companies and projects to provide market access and facilitate long-term financing (noted elsewhere as mostly implemented in the 2012 FSAP follow-up). - Consolidation of pension supervision under a single agency to improve oversight and address incentives. ### Key implications and rationale - Reorienting BNDES from sole financier to co-financier and project financier is intended to: - Mobilize private and institutional capital. - Reduce reliance on corporate guarantees. - Improve market development and long-term financing availability. - Tax reform targeted at saving incentives aims to: - Encourage long-term household and institutional savings. - Support deeper domestic capital markets and pension accumulation. - Consolidated pension supervision aims to: - Improve regulatory coherence. - Enhance monitoring and reduce fragmentation of oversight responsibilities. - Vigilant competition and supervisory oversight aims to: - Preserve market contestability. - Prevent business practices that could entrench incumbents or impede market development. *Source: cr18339 - excerpt from IMF country report content provided.* ### Annex I. Directed Credit ### Annex I. Directed Credit ### Scope and channels of directed (earmarked) credit - About half of the credit market is earmarked and the large majority of the earmarked credit flows through the public banks. - Caixa Econômica Federal has more than 70 percent market share in the housing market. - Banco do Brasil dominates the rural finance market. - For households, earmarked credits are predominantly for housing. - For enterprises, earmarked credits tend to be for investment purposes. - Special programs are available to the agricultural sector. - The earmarked loans are of much longer maturities than those in the free market. ### Pricing, subsidies, and funding sources - On-budget fiscal subsidies are provided to reduce interest rates for some loans; these are the only costs explicitly recognized. - Implicit subsidies provided by below-market remuneration are not explicitly reported. - Interest rates on earmarked loans are, with a few exemptions, regulated and substantially below market rates and have often been below the monetary policy rate. - Exact interest rates depend on a complex set of eligibility criteria. - Special funds used extensively to fund directed credits include the Workers Guarantee Fund (FAT), the Severance Indemnity Fund (Fundo de Garantia do Tempo e Serviço, FGTS), and Constitutional Funds. - These funds receive a low remuneration allowing the financial intermediaries to lend at low rates. - The government has been lending directly to BNDES at well below market rates allowing it to on-lend at low rates. ### Regulatory channels and central bank role - Central Bank regulations channel a share of demand, savings, and rural savings deposits to housing, microcredit, and rural credit. - FGTS provides funding to Caixa Economica Federal to on-lend at below market rates. - The central bank has detailed regulations and supervision of the banks to ensure that the credit flows to the intended beneficiaries. ### Empirical evidence and macroeconomic interactions - Empirical literature suggests earmarked credits have had modest impact on firm performance. - In the aftermath of the global financial crisis, an expansion of earmarked credit provided a countercyclical credit measure. - Subsidized lending has reduced interest expenditures for firms, but investment and productivity have not been conclusively supported by these credits. - Monetary policy has been impeded by the earmarked credit at regulated rates: analysis has shown that the impact of the monetary policy rate tightening is reduced by one third for firms that receive earmarked credits. - Understanding the general equilibrium effects from both the microeconomic and the macroeconomic distortions is complex and remains to be done. ### Recent reform to BNDES lending - A recent reform aims to disconnect subsidies from BNDES lending by linking the interest to the Government’s cost of funds. - Previously, BNDES lending and borrowing has predominantly been done at the regulated TJLP interest rate, which was kept below market rates, implying a subsidy from those who lend to those who borrow. - The reform transitions over a 5-year period and the interest rates on new loans (TLP, starting January 2018) is linked to the sovereign cost of funding using the combination of an inflation indexed 5-year sovereign bond, actual inflation and the old TJLP. *Source: Annex I. Directed Credit, cr18339* ### 4. To catalyze efforts aimed at promoting financial inclusion in Brazil, BCB launched the ### 4. To catalyze efforts aimed at promoting financial inclusion in Brazil, BCB launched the National Partnership for Financial Inclusion (PNIF) ### PNIF and Financial Citizenship Program - PNIF launched the Plan for Strengthening Financial Citizenship in 2015, aimed at strengthening financial education, financial consumer protection and financial inclusion. - The program leverages existing financial inclusion initiatives, such as the PNIF and the National Plan for Consumption and Citizenship (Plandec). - The financial citizenship program is one of the central bank’s top priorities and its importance was further reinforced in its “Agenda BC+.” - PNIF objectives aim at: - (i) increasing the adequacy of the provision of financial services to the needs of the economy and the population; - (ii) raising the level of financial education of the population, combating over-indebtedness; - (iii) promoting savings; - (iv) strengthening mechanisms to protect users of financial services; - (v) encouraging the sustainable development of productive microcredit; - (vi) ensuring stability and encourage the improvement of the correspondent model in the country; - (vii) deepening knowledge of financial inclusion in Brazil. - Plano Nacional de Consumo e Cidadania (Plandec) was proposed by decree 7963 of 2013 and promotes best practices in consumer protection in Brazil through integration and coordination of policies, programs and actions. - Agenda BC+, launched in December 2016, aims at improving business environment and its efficiency by: - i) lowering the cost of credit; - ii) stimulating collateral development and use; - iii) increasing the effectiveness and transparency of the monetary policy framework; and - iv) promoting innovation. ### Bank Solvency Stress Test Results — Scenario Analysis (Table 1) - Source: IMF staff estimates. - CET1 capital ratio (in percent) by scenario and adjustments (Share of assets; 2017, 2018, 2019, 2020): - Baseline scenario — Benchmark (no adjustments): 13.6, 12.5, 11.9, 11.4; 1 1 20 6 0.1 - Baseline scenario — With adjustments: 10.4, 9.7, 9.5, 9.5; 6 5 63 44 0.5 - Baseline scenario — Derecognition of DTAs: 10.7, 10.0, 9.8, 9.7; 6 3 63 35 0.4 - Baseline scenario — Downgrading of problem loans: 13.3, 12.4, 11.7, 11.3; 1 1 20 10 0.1 - Baseline scenario — With interbank contagion: 13.6, 12.5, 11.9, 11.4; 1 1 20 6 0.1 - Adverse scenario — Benchmark (no adjustments): 13.6, 9.0, 8.1, 8.5; 4 3 24 46 0.7 - Adverse scenario — With adjustments: 10.4, 5.9, 5.0, 5.5; 7 6 65 136 2.0 - Adverse scenario — Derecognition of DTAs: 10.6, 6.1, 5.2, 5.8; 7 6 65 126 1.9 - Adverse scenario — Downgrading of problem loans: 13.3, 8.8, 7.9, 8.3; 4 3 24 53 0.8 - Adverse scenario — With interbank contagion: 13.6, 8.5, 6.7, 7.1; 6 5 43 81 1.2 - Table columns include: CET1 capital ratio (in percent), Amount of capital shortfalls (Billion R$), Banks not meeting the hurdle (Number), Share of assets (Percent of GDP). (Values listed above preserve the table’s exact numeric sequences.) ### Concentration, Market, Exchange Rate, and Interest Rate Risks (Table 2 — selected impacts) - Concentration risk (default of individual bank's largest borrowers and system largest borrowers; all banks / D-SIBs / Public / Private): - The largest borrower: -1.8 -1.5 -2.9 -0.9 - Five largest borrowers: -5.3 -4.1 -8.7 -2.4 - Banking system's largest borrowers — The largest borrower: -1.6 -1.3 -2.8 -0.5 - Banking system's largest borrowers — Five largest borrowers: -4.3 -3.3 -8.0 -1.0 - Market risk (market loss only): - Bond yield spike by 700 basis points: -1.1 -1.1 0.0 -2.0 - Equity price decline by 50 percent: -1.2 -0.3 -2.0 -0.5 - Exchange rate depreciation by 50 percent: 0.1 0.0 0.2 0.0 - Commodity price decline by 50 percent: 0.0 0.0 0.0 0.0 - Exchange rate risk: - Exchange rate depreciation by 50 percent: -1.8 -2.0 -1.5 -2.2 - Due to open position: 0.1 0.0 0.2 0.0 - Due to risk-weighted assets: -0.8 -0.7 -0.6 -1.0 - Due to depreciation-induced credit loss: -1.1 -1.4 -1.0 -1.2 - Interest rate risk: - Bond yield spike by 700 basis points: -3.5 -3.7 -2.7 -4.1 - Market loss for the trading account: -1.1 -1.1 0.0 -2.0 - Unrealized loss associated with AFS securities: -1.9 -1.9 -1.8 -1.9 - Unrealized loss associated with HTM securities: -0.5 -0.6 -0.9 -0.2 - Selic decrease by 200 basis points: -0.4 -0.3 -0.5 -0.3 - Related to interest income: -0.5 -0.5 -0.6 -0.4 - Related to credit loss: 0.1 0.1 0.1 0.1 ### Liquidity Stress Tests and Metrics - Figure 1: Brazil: Bank LCR and NSFR Stress Test Results — boxplot interpretation described: interquartile range, median, whiskers, mean (blue dot). - Table 3: Brazil: Bank Liquidity Stress Test Results — Sources: BCB and IMF staff estimates. Note: *Numbers are in % of foreign reserves. - Three types of liquidity tests used: - (i) Cash-flow analysis using maturity buckets; - (ii) LCR test; - (iii) NSFR test. - For the LCR and NSFR tests, the hurdle is set to 100 percent. - For the cash-flow analysis, the hurdle is to have a non-negative cash balance. - Buffers include liquidity obtained from markets through asset sales (subject to certain haircuts) and from BCB’s standing facilities. Expected cash inflows are also included. - Calibration: - Regulatory: haircuts and run-off rates based on regulatory LCR/NSFR parameters. - Stressed: more severe haircuts similar to the adverse scenario in the solvency stress tests and larger run-off rates to reflect more severe episodes of market and funding risks. ### Corporate Sector Sensitivity Analysis (Annex VIII) - Macro-financial shocks could lead to increase in debt at risk, with companies particularly sensitive to interest rate and profitability shocks. - Figure: Sensitivity Analysis, Impact on Corporate Debt Servicing Capacity, Share of Debt at Risk, 2017Q3 (ICR based on net interest expenses) — scenarios shown: - Baseline - Interest Rate Shock (8%) - FX shock (43%) oper and fin hedge - FX shock (43%) fin hedge only - Profit shock (10%) - Combined Shock - Combined Shock (only fin hedge) - Sources: Capital IQ, BCB and IMF calculations. ### Stress Test Matrix (STeM) for the Banking Sector — Key Assumptions and Design (Annex IX) - Coverage: 12 largest banks, representing 90 percent of banking system assets; supervisory data as of September 2017; consolidated data of prudential conglomerates. - Methodology: - Balance sheet approach; satellite models to estimate pre-impairment income and credit loss based on macrofinancial variables; market loss estimated based on detailed market exposure including derivatives and yield curves. - Stress test horizon: 3 years (2017Q4–2020Q4). - Scenarios: - Two macrofinancial scenarios agreed with authorities: Baseline (October 2017 WEO projections) and Adverse (severe double-dip recession and sudden stop to capital inflows; under adverse scenario Brazilian economy would contract for two years during 2018–19, with a cumulative decline in real GDP growth of 2 standard deviation over the 3-year horizon). - Sensitivity analysis (FSAP team): single-risk factors include concentration risk, exchange rate risk, interest rate risk, and other market risk. - Behavioral adjustments assumptions: - Quasi-static balance sheet assumption, balance sheet growth driven by projected bank-level credit growth; banks can accumulate capital through retained earnings only; treatment of dividends differs between authority and FSAP-team top-down variants. - Regulatory framework: national regulatory framework based on Basel III, standardized approach; hurdle rates based on minimum capital requirements (CET1, T1 and total capital) and applicable surcharges for D-SIBs; baseline hurdle rates include prevailing conservation capital buffer. ### Contagion and Interconnectedness Analyses - Contagion methodology: interbank network analysis based on Espinosa-Vega and Solé (2010). - Contagion assumptions: - Default threshold: banks default if CET1 capital ratios fall below 4.5 percent (regulatory minimum). - For standalone exercise, each individual bank assumed to default at the time; extended solvency contagion uses solvency stress test starting points. - Interconnectedness analysis: - Flow-of-funds dataset disaggregating ten institutional sectors; quarterly sample 2015Q1–2016Q4; financial instruments include deposits, debt securities, derivatives, equity and credit. - Cross-border spillovers examined across equity and FX markets and across sovereign CDS and bond/EMBI spreads; weekly observations between 2007Q4 and 2017Q4 for a broad set of countries. ### Appendix I — Basel Core Principles (BCP) Assessment: Overview and Methodology - Assessment completed as part of the 2018 FSAP update; BCP assessment mission took place from October 30th to November 21st, 2017. - The assessment reflects the regulatory and supervisory framework in place as of the date of completion and focused on the Central Bank of Brazil (BCB) as the supervisor of the banking system. - The 2012 revision of the Core Principles expanded and strengthened criteria: the revised CPs contain 247 separate essential and additional criteria. - Assessment approach: - Review of legal framework, policies and practices; meetings with BCB, Ministry of Finance, auditing firms, and banking sector participants. - Authorities provided comprehensive self-assessment and responses; high quality of cooperation noted. - Contextual considerations: - Ratings not directly comparable to previous assessments due to methodology changes. - Proportionality concept: supervisory expectations should be commensurate with complexity, interconnectedness, size, risk profile, and cross-border operations of banks. - Macroeconomic context noted: Brazil experienced a long and deep recession since the last FSAP, with recovery under way; government pursued reform agenda including a law to cap growth in federal noninterest spending in real terms; structural problems remain, and national elections scheduled for 2018. - Institutional roles: - CMN responsible for formulating overarching monetary and credit policy; CMN and BCB take a central role in shaping macroprudential policies, working with the Ministry of Finance and other financial regulators (CVM, Susep, Previc). - Legal basis: individual responsibilities of the CMN and the BCB are defined in Law 4,595. *Source: IMF staff estimates and IMF/World Bank FSAP documentation contained in the provided content.* ### 11. The BCB has the ability to design and implement tools to address vulnerabilities in ### 11. The BCB has the ability to design and implement tools to address vulnerabilities in ### Institutional framework and inter-agency coordination - The BCB can design and implement tools to address vulnerabilities in financial stability areas, either directly or indirectly by supporting CMN policymaking. When done indirectly through the CMN, CMN Resolutions set the framework in general terms while BCB Circulars calibrate requirements or define methodological details. - Other agencies and the MoF are also responsible for policy decisions supporting financial stability. - Bodies similar to the CMN exist for insurance and pensions: the National Council for Private Insurance (CNSP) and the National Council for Complementary Pensions (CNPC). - A high level consultative forum, COREMEC (Committee of Regulation and Supervision of Financial, Securities, Insurance, and Complementary Pension Markets), coordinates supervisory policies among BCB, CVM, Susep, and Previc with a rotating presidency. COREMEC provides coordination and information-sharing though members’ recommendations and advice are not binding. ### Supervisory leadership, mandate and legal context - The BCB, CVM, Susep and Previc are responsible for macro-prudential surveillance; the BCB takes a leadership position given its data-processing capacity and the bank-centric nature of Brazil’s financial system and is widely perceived to have a financial stability mandate. - Brazil’s legal system is civil law based. The Federal Supreme Court is the highest court and safeguards the Constitution; the Superior Court of Justice (STJ) is the highest court of law for federal law matters. - The Federal Accounting Council (CFC) approves Brazilian Accounting Norms (NBC) based on the International Standards on Auditing (ISA) issued by IAASB as of end 2010. The BCB enforces audit standards when an external auditor is auditing a banking group and issues accounting norms for the banking sector pursuant to the Banking Law and Law 11941 of 2009. - Consolidated statements based on IFRS are required for publicly listed financial institutions to those subject to the requirement to establish an Audit Committee. The CMN has promoted approximation with international accounting standards for individual financial and regulatory financial statements. The BCB has announced its commitment to revising the accounting of financial instruments with a view to enhancing convergence with IFRS 9. ### External auditors and audit oversight - Financial institutions must obtain an external auditor’s opinion on the financial statements (Resolution 3,198). - Only audit firms registered with the CVM may audit financial statements of listed companies and financial institutions. CVM requires all members of audit firms to be accountants (Instruction 308) and conducts periodic audits on the work of external auditors of listed or foreign entities. - External auditors are subject to regulations issued by the CMN and the BCB, as well as by CVM, CFC and Ibracon when not in conflict with CMN or BCB rules (Resolution 3,198). CFC Resolutions establish professional rules for external auditors. ### Resolution framework, emergency liquidity and deposit insurance - The BCB is the sole resolution authority for non-state-owned banks and has the power to trigger resolution and apply resolution powers. State-owned (federal) banks are not subject to resolution. - Resolution powers are based on the “temporary special administration regime”, “intervention” and “extrajudicial liquidation” prescribed in: Law 6,024, Decree-Law 2,321 and Law 9,447. - Emergency liquidity assistance can be provided at the BCB’s discretion, with maturities up to 359 days. Provision is subject to the Fiscal Responsibility Law (Complementary Law 101, Article 28, paragraph 2). For longer maturities, the BCB must liaise with the Ministry of Finance and the Government to set and approve specific legal provisions. - At the time of the assessment, a draft Bank Resolution Bill prepared by BCB to align Brazil’s Resolution Framework to the FSB Key Attributes was under consideration. The draft bill proposed making existing tools (reorganization, good-bank/bad-bank policy, liquidation) more effective and proposed new measures such as the creation of bridge banks. - Deposit insurance is provided by the Credit Guarantee Fund (FGC) and the Cooperative Guarantee Fund (FGCoop), private non-profit entities regulated by the CMN and BCB, managing protection mechanisms for investors and depositors of various financial institutions. - Recent regulation amended the FGC’s statute including restricting insurance coverage in cases of institutional investors (Resolution 4,469). Similar regulation is being evaluated for the FGCoop to allow the fund to act as a paybox and to offer liquidity assistance to associates. - Deposits and deposit-like instruments are covered by the FGC and the FGCoop up to R$250,000 per investor. - Pay-out funds sources: contributions of associated institutions, credit rights subrogated by the FGC/FGCoop from associated institutions under resolution regime, results of services rendered by the FGC/FGCoop, and proceeds from investments made by them. - Current monthly ordinary contribution of associated institutions is set at 0.0125 percent of the balance of the guaranteed accounts. - The FGC can perform pay box functions in interventions or extrajudicial liquidations and can provide financial support (e.g. loans, portfolio purchases, additional limit of insurance for certain affiliates’ operations) to support financial stability, including promoting transfer of control, split, merger or other corporate reorganization as needed. ### Main Findings — Objectives, Powers and Responsibilities (CP 1) - The Banking law clearly establishes the BCB with supervisory responsibility and a suite of tasks and powers. BCB corrective powers are triggered (Resolution 4019) to ensure the solidity, stability and regular operation of the National Financial System. - Updated Federal legislation and regulations governing the financial sector are publicly available. - The BCB cannot issue regulations independently but sits on the CMN that issues regulations and has the right of initiative for new regulation in its sphere; no practical impediment to regulatory development was identified. ### Main Findings — Independence (CP 2) - The BCB does not have full, de jure independence from the government and there are important deficiencies in relation to this principle. - While the BCB appears to enjoy de facto operational independence, this is not a full substitute for independence backed by law and due process of accountability. - Legal protection for BCB staff is lacking. There is no fixed mandate for the term of the Governor or for Board members. The Governor can be dismissed at the will of the President with no formal reasons required and no requirement for public disclosure of reasons for dismissal. - Ancillary points that should fall within BCB discretion include budget and personnel decisions. ### Main Findings — Cooperation, and Home-Host (CPs 3, 12 and 13) - Domestic coordination is less complex due to the wide scope of the BCB’s supervisory authority; cross-border activity is not a major feature of Brazil’s banking sector. - Legal gateways for exchange of information are in place and the BCB uses MoUs to facilitate group-wide understanding, particularly for cross-border financial groups. - As host to one GSIB, the BCB is a member of the general and core supervisory college; as a non-EU authority, it does not participate formally in EU joint decisions for the GSIB but its views are sought and considered. - Relevant MoUs are in place or being agreed to adapt to new recovery and resolution elements, though not all recovery and resolution architecture is complete in Brazil. - The BCB emphasizes proactive and timely information sharing and assistance when requested. ### Main Findings — Consolidated and Solo Supervision - The BCB’s supervisory approach is focused on consolidation; Resolution 4280 provides scope to define the “prudential conglomerate” and the BCB uses Contagion Risk analysis to gain group risk insights as part of continuous supervision. - The BCB does not systematically obtain or assess an individual banking entity within a prudential conglomerate against prudential standards; it has not communicated expectations or established requirements that an individual bank within a conglomerate continuously meets prudential standards required for authorization. - The absence of explicit monitoring at solo level impedes understanding of obstacles to transfer of liquidity and capital across group entities and limits resolvability assessment and planning. - It is appropriate for the BCB to expect prudential standards to be met and monitored at all times on a solo basis for any individual bank within a prudential conglomerate. ### Main Findings — Licensing and permitted activities (CPs 4 to 7) - Identity and permitted activities of entities operating under a banking authorization are clearly available. No institution may accept deposits without BCB authorization, but no authority actively monitors institutions presenting themselves as banks without authorization — an area for consideration. - The licensing, change of control and acquisition regime is comprehensive and tightly controlled. The BCB scrutinizes board members and senior executives after initial licensing and authorizes all acquisitions made by financial institutions. - Trading activities are exempted from some requirements, leading to an excessive number of filings that the BCB must consider, not all relevant to safety and soundness. ### Main Findings — Supervisory approach, techniques, reporting and corrective actions (CPs 8 to 11) - The BCB has developed its SRC methodology, integrating conduct supervision (a “hybrid twin peaks” model) and placing central emphasis on corporate governance. The sector is segmented for proportionate supervisory action from DSIBs to micro credits and cooperatives. - Recovery and resolution work is at an earlier stage; passage of the new resolution bill will be important for finalizing internal guidance and ensuring timely decision-making for recovery or resolution. - The BCB has a proactive supervisory planning process and has pioneered systemic risk monitoring using extensive data and contagion analyses; this helped communicate system resilience during Petrobras and “lava jato” episodes. - Gaps in supervisory data exist: in some risk areas (e.g., large exposures) the BCB has requested data only from significant banks rather than routinely; related party transactions and country and transfer risk are not clearly defined; prudential data is not routinely sought on a solo basis. - The BCB can aggregate exposures from registries and repositories and calculate prudential returns not submitted (e.g., large exposure profiles for conglomerates); at the time of the FSAP assessors were unaware of another authority with similar capability. - Reliance on BCB data capabilities presents a risk of the supervisor serving as a supplementary risk management function for banks. The BCB is strongly encouraged to maintain existing data requirements and cross checking and to require all banks to submit consolidated and solo prudential returns covering standard prudential data such as large exposures, related party exposure, and problem assets. - The BCB has powers and tools to impose corrective and remedial measures. Provisional Measure 784 had lapsed and was replaced by Ordinary Law 13,506; in the interim the BCB retained core powers but lacked important flexibility. The new Ordinary Law 13,506 remedied lack of graduated, escalation instruments. - The BCB is attentive to deterioration in condition and governance of institutions and ready to act early and escalate as needed, though overall timescales of processes are a concern. ### Main Findings — Corporate governance (CP 14) - The BCB has reoriented supervision to emphasize sound corporate governance. Internal documents and bank discussions confirm this emphasis. - Resolution 4557 (risk management and governance) had been in force for 6 months for systemic banks and was not yet in force (until February 2018) for the rest of the banking sector at the time of assessment. - Corporate governance requirements differ for listed and non-listed banking institutions. It is strongly advisable that the BCB should have power to require an institution authorized as a bank to create a board of directors, even when not a listed entity. *International Monetary Fund — cr18339 (excerpt).* ### 38. Banks in Brazil are implementing the Basel III capital requirements and the capital ### 38. Banks in Brazil are implementing the Basel III capital requirements and the capital ### Capital framework and Basel III implementation - The Basel Committee has assessed Brazil’s capital rules as compliant. - Deferred tax assets (DTAs) arising from loan loss provisions amount to R$146 billion and are included in CET1 capital. - These DTAs constitute about 25 percent of CET1 capital. - Banks are on the transition path and expect to fully implement Basel III by January 1, 2019. - Definitions of capital, Pillar 1 capital requirements, and the SREP under Pillar 2 apply to banks in all segments. - Pillar 2 ICAAP applies only to S1 institutions; a simplified ICAAP is planned to be introduced from 2018 for S2 institutions. - Banks are required to maintain capital for interest rate risk in the banking book through a Pillar II requirement. - Prudential capital requirements currently apply only at the consolidated level (at the level of the prudential conglomerate). ### Risk management framework (CP 15) - Regulatory and supervisory frameworks promote comprehensive risk management culture and frameworks in Brazilian banks. - Regulations explicitly establish detailed expectations for credit, market, operational and liquidity risk management and related governance. - Several key regulations were recently issued or revised but were not yet effectively in operation or were too new to assess effectiveness; these include regulations on: - integrated risk management, - stress testing, - problem asset classification and reclassification, - restructuring and forbearance, - compliance function, - internal audit function, - outsourcing. - Recovery and resolution planning work is progressing for large banks; stress testing and contingency planning requirements help assess resilience in other banks. ### Credit risk management (CPs 17 to 21) - Regulatory and supervisory requirements combine to assure adequate credit risk management frameworks; supervisors perform periodical monitoring and analyses to challenge bank systems and verify outputs. - Areas for improvement include: - need for comprehensive explicit definition of exposure from a credit risk management perspective, - clear norms for reclassification of assets to lower risk categories, - explicit adoption of expected loss approach for all exposures, - harmonization of norms for classification and provisioning irrespective of maturity, - norms for collateral eligibility and valuation for determining provisioning for problem exposures. - BCB monitors concentration risk using credit registry data; daily data from clearing houses, CCPs and trade repositories; and data from government agencies, including revenue authorities. - Gaps in concentration risk monitoring: - absence of an explicit reporting requirement from banks on exposures to name, sector, geographical and risk mitigant concentrations, - lack of explicit guidance on aggregation of exposures for concentration risk, - lack of guidance or database on inter-sector correlations or correlations among geographic regions or credit risk mitigants. ### Related-party, country and transfer risk - Historical prohibitions on lending to and investing in some related parties have been removed; BCB needs to review and revise frameworks to align closer to Basel norms. - Key improvements suggested: - more comprehensive definitions of related parties and related party transactions, - establishment of an aggregate prudential limit for exposure to related parties, - explicit governance requirements, - explicit supervisory (prudential) reporting requirements for transactions with and exposure to related parties, - application of prudential requirements at the solo bank(s) level within prudential conglomerates. - Country and transfer risk requirements are subsumed under risk management and credit risk regulations; some elements are not explicit or aligned with the Basel framework. - Regulatory description of country risk differs from the Basel definition. - Current supervisory approach focuses on ‘immediate risk’ (direct exposures) rather than comprehensive “ultimate” risk (direct and indirect exposures). - Regulations do not explicitly require banks to establish policies and procedures for identifying, measuring, monitoring and managing country and transfer risks, nor provide specific guidance on measurement, grading, provisioning and periodic reporting of these exposures to the BCB. ### Management of other risks (CPs 22 to 25) - Regulatory and supervisory frameworks for market risk, IRRBB and liquidity risk are in place and effective. - Market risk is systemically small but significant for several S3 and S4 institutions; unlisted institutions may need more frequent supervisory review. - Gaps in IRRBB regulations have been addressed with: - clear articulation of framework for measuring and reviewing IRRBB exposures, - introduction of conservative measurement requirements accounting for the Brazilian interest rate environment, - requirement for all banks to hold capital for IRRBB exposures, - improved regulations issued in 2017. - The liquidity coverage ratio set by the BCB complies with Basel standards. - Supervisors monitor liquidity almost daily, including potential stress from market risk situations; multiple liquidity monitoring tools and qualitative assessments bolster assurance of banks’ liquidity risk management. ### Operational risk, internal control and audit (CP 26) - Operational risk regulatory framework initially established in 2007 and recently improved, including IT risk, outsourcing, business continuity planning and compilation of operational risk loss data. - Improvements are expected to take time to produce results. - BCB is pursuing better operational risk loss information systems but has not yet established periodical regulatory reporting by banks on internal loss data and operational risk events. - Revised regulatory framework for internal control and audit came into operation from 31 December 2017. - Pre-revision, responsibility for internal control systems was on boards of directors and senior management; audit committees also had responsibilities. - Regulatory and market structure features that may undermine internal control and audit effectiveness in unlisted banks: - unlisted banks are not required to establish a board of directors (non-executive), - unlisted banks need not establish audit committees when they are small, - shareholders can constitute senior management. - Of the 116 unlisted banks, 41 have established Board of Directors. - Of the remaining 75 banks accounting for about R$540 billion in total assets (6.8 percent market share), 46 are foreign owned banks (5.8 percent market share). - Compliance function is not mandatory for banks. - BCB’s supervisory practices evaluate effectiveness of compliance and internal audit functions, including in small institutions, observing each institution’s supervisory cycle. ### Financial reporting, external audit, disclosure and transparency (CPs 27 & 28) - Supervised institutions regularly publish consolidated and, where appropriate, solo information that is easily accessible and reflects financial condition, performance, risk exposures, risk management strategies and corporate governance policies. - Publications include audited financial statements with notes in compliance with IFRS and BR-GAAP, and Pillar 3 disclosures on institutions’ websites. - Audits are performed by independent external auditors in compliance with international auditing standards. - Audited financial statements and auditors’ opinions are published at least at half-yearly intervals, both at solo and consolidated levels. - Laws, regulations and the supervisor ensure appropriate governance arrangements to oversee the external audit function. ### Abuse of financial services (CP 29) and AML/CFT oversight - Since the last FSAP, BCB introduced changes and enhancements in AML/CFT oversight. - The “twin peaks” approach has facilitated coordination between prudential and conduct supervision. - A new committee on punitive administrative processes was created and AML/CFT staffing levels were increased. - More effort is required to reduce time between detection of deficiencies and punitive action; BCB is aware and has changes in hand. - Next cycle of onsite inspections for major institutions will move beyond documentation/process adequacy to examine effectiveness of KYC and monitoring, analysis, selection and reporting procedures and tools. - Revised supervisory guidance on AML/CFT is expected to be issued by end 2018. - These supervisory components are important for AML/CFT supervision to graduate beyond compliance checks. ### Authorities’ response and selected supervisory views - Brazilian authorities expressed support for the FSAP and full agreement with staff views on necessary improvements in several areas (e.g., CP 2; resolution practices and regulation noted in CP 8). - Authorities dispute some staff comments/grades and provided clarifications and different views, for example: - On CP 10 (graded Compliant), authorities state that the onus for measuring, monitoring and managing risks is already fully on banks via CMN and BCB regulation, continuous supervision cycle, and supervisory actions and sanctions. - From the on-site perspective, the Risk and Controls Assessment System (SRC) conducts extensive analyses of inherent risks and related controls. - From the off-site perspective, significant information available to BCB allows close monitoring; this view is supported by positive findings in the FSB Peer Review of Brazil. - On corrective and sanctioning powers and AML/CFT (CPs 11 and 29): - Staff recommended additional inspections to improve supervision of smaller banks; BCB argues its remote inspection methodology addresses full inspection steps and has been sufficient to take actions (including liquidations) based on remote inspections. - BCB emphasizes that its design (continuous supervision for higher-risk and remote inspections for lower-risk institutions) aligns with FATF/GAFI’s risk-based approach. - Staff suggested a more disciplinarian approach than moral suasion; authorities note moral suasion is complementary and does not prevent corrective or sanctioning measures. - Law 13,506, passed on November 13, 2017, introduced changes in sanctioning procedures to improve timeliness of sanctioning processes. - Authorities indicate timelines are being reduced and corrective actions are taken in reasonable timeframes, often before sanctioning processes begin. - On consolidated supervision (CP 12): - Staff did not consider Brazil “compliant” because prudential regulations do not require individual institutions within a Prudential Conglomerate to observe prudential requirements individually. - Staff concluded it is unlikely a solo bank would deteriorate extensively before BCB detection; BCB receives and monitors significant sub-consolidated and standalone information and acts if necessary. - BCB performs analysis of group structure, business models and functional activities; individual institutions are thoroughly examined under a risk-based approach. - BCB will review application of prudential regulatory framework and make changes as necessary based on a risk-based and cost-effective approach considering proportionality. - On corporate governance (CP 14): - Authorities generally agree with assessment but contend several recent improvements were not fully taken into account by FSAP staff, who considered them too new to produce verifiable results. *cr18339 - 38. Banks in Brazil are implementing the Basel III capital requirements and the capital* ### 60. Resolution 4,557, of 2017, for instance, established risk management requirements for ### cr18339 - 60. Resolution 4,557, of 2017, for instance, established risk management requirements for ### Risk management framework and corporate governance - Resolution 4,557, of 2017 established risk management requirements for financial institutions following a proportionality approach, whereby requirements vary in accordance with the segmentation introduced by the Resolution 4,553 of 2017. - Compliance with the new framework has been required for internationally active and systemic banks since August 2017. - For other institutions, compliance has been required since February 2018. - Resolution 4,557 consolidated and improved requirements already in place for: - operational risk (Resolution 3,380 of 2006), - market risk (Resolution 3,464 of 2007), - credit risk (Resolution 3,721 of 2009), - liquidity risk (Resolution 3,988 of 2011). - Requirements regarding the audit committee were established in Resolution 3,198 of 2004. - The remuneration policy, including the requirement of a Remuneration Committee, were introduced by Resolution 3,921 of 2010. - Many features of Resolution 4,557 were already part of supervision manuals and thus required by supervisors before the regulation came into force. - The supervisory process incorporates current local standards and international best practices and recommendations; supervisory guidelines were published in March 2018, and institutions were informed of supervisory expectations concerning corporate governance through the supervision cycle prior to that publication. ### Board composition and market coverage - Under Brazilian corporate law (Law 6, 404 of 1976,) only publicly held companies are required to constitute boards. - 41 non-listed banks constituted boards of directors responding to recommendations of supervision. - In the absence of a board of directors, senior management must assume the board’s responsibilities relative to risk management and capital management, as established by Resolution 4,557. - Listed and unlisted banks that have a board of directors hold 93 percent of the total assets and 95 percent of total deposits of the Brazilian financial system as of September 2017. - Of the 75 banks that do not possess a board of directors: - 46 are foreign-owned institutions whose governance structures are monitored by their parent companies (representing 6 percent of system assets and 4 percent of system deposits), - the remainder consists of very small institutions (representing 1 percent of system assets and 1 percent of system deposits), the largest one being a cooperative bank. - As of November 2017, from a total of 135 banks, 107 either have a board of directors or are foreign-owned banks; the remaining 28 banks comprise only 1 percent of the market share, as measured by assets. ### Problem assets, provisions and expected credit loss (ECL) framework - Brazilian regulations require financial institutions to adopt an expected loss approach for assessing the amount of provisions. - Resolution 2,682 of 1999 establishes minimum provisioning levels according to the number of days past-due, clearly establishing that provisions shall be sufficient to cover the expected credit losses in any situation, including when a financial institution opts to use the number of days past-due as the sole criterion for risk classification of loans below fifty thousand of Brazilian reais. - The Brazilian provisioning framework is substantially different from IAS39, which requires provisions only for defaulted or almost-defaulted exposures, thus being closer to the IFRS9 standard. - Resolution 3,721 of 2011 established that the credit risk management structure must ensure provisioning levels compatible with the incurred credit risk; together with earlier regulations, supervision can require provisioning for all on- and off-balance sheet credit risk exposures. - Resolution 4,557 clearly establishes that, concerning credit risk, the integrated risk management structure must guarantee that provisions are sufficient to cover all expected credit losses. - Draft versions of regulation intended to replace Resolution 2,682 of 1999 have been submitted to public consultation; the proposed rules aim to reduce asymmetries between local accounting regulation and IFRS9. Final rules are expected to be published in 2018 and will clarify how concepts of Resolution 4,557 of 2017 and IFRS9 harmonize with each other. FSAP recommendations regarding collateral eligibility and valuation and reclassification of problem assets will be taken into consideration in the final version of the regulation. - Resolution 4,557 adopts a comprehensive approach to the definition of exposure: management requirements for credit risk (including the assessment of provisions) apply to any exposure that meets the risk definition, irrespective of its legal form or accounting denomination. - Gaps related to the lack of an explicit definition for credit risk exposure and the lack of an explicit command for provisioning exposures other than those mentioned in Resolutions 2,682 and 4,512 will be addressed by the regulation that will implement IFRS9 in Brazil. - Credit risk governance: Resolution 3,721 of 2009 and Resolution 4,557 assign the board of directors responsibilities to approve and review risk management policies and strategies and implement prompt correction of deficiencies in risk and capital management structures; the board periodically receives management reports including evaluation and estimation of assets exposed to credit risk, classification and provisions, and information on material exposures characterized as problem assets. ### Reporting and supervisory monitoring of provisioning and asset classification - Authorities consider reporting requirements on supervision tasks to have been addressed. - The credit bureau’s instructions demand that each operation’s record informs the adoption of restructuring practices as defined in Resolution 4,557 and Circular Letter 3,819 of 2018. - This information is already received from systemically important institutions since April 2018 and for the others it will be received starting in September 2018. ### Concentration risk and large exposure limits - The supervisor receives, on a monthly basis, reports from the largest banks, taking into account the concept of connected counterparties. - The BCB can monitor large exposures using connected counterparties through wide-range supervisory tools and procedures. - Authorities agree improvements are needed for the definition of exposure, the definition of connected counterparties, and the calculation method to aggregate exposures; these gaps will be addressed by a new regulation to replace Resolution 2,844 of 2001 to comply with BCBS 283 (“Supervisory framework for measuring and controlling large exposures”). - For the purpose of the large exposures limit, all exposures used in the calculation of capital requirement will be considered; this regulation is expected to be fully implemented according to the Basel timeline. - On February 9, 2018, a consultative document on this regulation was published on the website of the Central Bank of Brazil; the proposal was available for comments by March 20, 2018. - The Financial System Monitoring Department conducted a detailed study concluding that the information on large exposures already gathered by the BCB does not significantly differ from data to be collected and reported by banks under the new approach. - Compliance with regulatory limits is monitored, on a monthly basis, by the Financial System Monitoring Department. - The BCB is updating the Report on Operational Limits (DLO) received from banks to follow the latest BCBS recommendations for large exposures by including additional requirements for financial institutions; this will meet the FSAP recommendation of introducing explicit periodical reporting by banks on concentration risk exposures. - The BCB will broaden and regularly produce information on correlations among economic sectors or geographic regions through automatic procedures. - Authorities state they have enough data on credit risk mitigants and a comprehensive database of almost all connected parties; upcoming regulatory enhancements are expected to solve identified gaps. ### Transactions with related parties - Granting of loans to related parties was prohibited until Law 13,506 of 2017 came into force; that law amended existing legislation, permitting loans to related parties provided they are carried out under market conditions and includes a significant portion of parties listed in the footnote to CP 20 in its definition of “related party”. - Supervisory mechanisms used to assess exposures and risks from transactions with related parties have included: - regular information gathering of detailed accounting information for monitoring purposes, allowing identification of significant changes and atypical transactions (including transactions with related parties); - on-site examinations to verify formal segregation of duties and assess potential conflicts of interest. - New supervisory procedures under implementation by the BCB include: - requirement for the Board of Directors to ensure that transactions with related parties are properly reviewed regarding the risks and restrictions involved; - evaluation of the contagion risk arising from transactions with related parties that are out of the prudential conglomerate, as well as the policies adopted to control these transactions. - Resolution 4,636 of 2018 (and Resolution 3,750 of 2009) establishes procedures for disclosing information about transactions with related parties and uses a definition closely aligned with CP 20. - Authorities recognize need for regulatory and supervisory adjustments to comply with FSAP recommendations; improvements will encompass prudential limits applied to a broader range of transactions and a wider set of counterparties, focusing on prudential conglomerates and relevant individual entities. - Brazil intends to follow the recommendation to introduce periodical focused reporting by supervised institutions on exposures, transactions, exceptions and write-offs. ### Country and transfer risks - Authorities concur with some assessment points but strongly disagree with the emphasis staff assigned to country and transfer risks, arguing Brazil FX exposure is very low in financial institutions’ balance sheets and that the FSAP concerns are overstated. - Since 2009, Brazilian laws and regulations include country and transfer risks as elements of credit risk, requiring financial institutions to establish policies and procedures for identifying, measuring, monitoring and managing them accordingly. - These risks must be considered in the framework and, when relevant, in the stress testing process. - Authorities consider these risks not deemed relevant in the Brazilian financial system due to very low exposure across the majority of financial institutions. - Supervisors assess sufficiency and adequacy of risk management in the Risk and Controls Assessment System (SRC), which includes specific evaluation of elements for country and transfer risks. - Country and transfer risks are established as components of credit risk by Resolution 4,557 and are subject to applicable requirements, including the ECL framework and stress testing process. - Authorities concur with the recommendation to introduce more explicit requirements; these issues will be addressed in the regulation that will replace Resolution 2,682 and implement IFRS9 requirements for Brazilian banks. - The BCB supervisory process includes indirect exposures in default risk by considering that a local debtor may face financial difficulties due to events abroad; the BCB intends to review Resolution 4,557 of 2017 to make this clearer. - Authorities agree to introduce prudential reporting requirements to monitor banks’ exposure to these risks and will adopt necessary measures. ### Operational risk and cybersecurity - Authorities view current supervisory practices as in line with the guidelines of BCP 25. - Operational risk supervisory requirements in Brazil are constantly evolving and frequently incorporate items not explicitly required in regulations. - The BCB has IT expert supervisory teams since 1996 and has required banks’ compliance with features of the ISACA’s COBIT framework since 2000. - Supervisors closely monitor risk exposure of banks, especially systemically important ones, and operational risk management requirements are commensurate with the nature and complexity of institutions’ products, services, activities, processes and systems. - Supervision has focused on internal loss databases of operational risk events and has demanded banks, mainly the D-SIBs and ASA banks, collect data and adequately react to it. - The BCB is working with the industry on a project imposing periodical regulatory reporting by banks on their internal loss data and operational risk events. - Resolution 4,557 of February 23, 2017 consolidated different risk management requirements since 2006 and updated operational risk management requirements for banks in Brazil, taking into account post-crisis principles and supervisory practices. - On April 26, 2018, the National Monetary Council issued Resolution 4,658, establishing requirements for cybersecurity policy, including minimum requirements on outsourcing storage and data processing and on outsourcing cloud computing; this regulation covers recommended improvements related to cyber risks and prompt reporting of cyber threats. ### Internal control, compliance and internal audit - The assessment notes not all banks are required to establish a board of directors or an audit committee; however, the majority of banks do have boards or are foreign-owned (see board composition section). - Regulations permit internal audit to be part of the internal control function; the compliance function was not universally required prior to recent updates. - Resolutions 4,588 and 4,595, which updated requirements for the internal audit function and regulated the compliance function, came into force on December 31, 2017, introducing more prescriptive requirements in line with BCBS documents “Compliance and the Compliance Function in Banks” (2005) and “The Internal Audit Function in Banks” (2012). - Many features of these regulations were already part of supervision manuals and observed by banks; the Resolutions consolidate rules and practices already in place. _Italic: IMF staff report excerpt (content unit: cr18339)._ ### 2. Independence, ### 2. Independence, accountability, resourcing and legal protection for supervisors ### Independence and legal protection - Finding: "The BCB does not have full, de jure independence from the government to conduct its activities, and there are important deficiencies in relation to the assessment of this principle." - Finding: "The legal protection for staff of the BCB is lacking." - Finding: "Brazil also falls behind good practice in that there is no fixed mandate for the term of the Governor, or for Board members." - Finding: "The Governor can be dismissed from his/her position at the will of the President and there are no formal reasons for which dismissal can be made and no requirement for there to be a public disclosure of the reasons for dismissal." - Finding: "While the BCB appears to enjoy de facto operational independence, this is not a full substitute for independence that is confirmed in and backed by law, and is subject to due process of accountability." - Recommendation: Confirm and back operational independence in law, including due process protections for dismissal and fixed mandates for the Governor and Board members. - Recommendation: Strengthen legal protection for BCB staff. - Recommendation: Ensure ancillary operational decisions (budget and personnel) fall within the BCB’s own discretion. ### Accountability, resourcing and ancillary powers - Finding: Ancillary points that should fall within the BCB’s discretion include budget and personnel decisions (implicit need for formal protections). - Recommendation: Codify budgetary and personnel autonomy to align de facto operational independence with de jure legal protections and accountability mechanisms. ### Cooperation and collaboration - Finding: "The BCB has clear powers to exchange information with relevant authorities both domestically and abroad." - Finding: "Relevant MoUs are in place or are in the process of being agreed, in order to adapt to new elements of recovery and resolution, and the BCB places an emphasis on proactive and timely information sharing and of assistance when requested." ### Related supervisory practice observations (selected from BCP summary comments) - Licensing and permissible activities: - Finding: "Information on the identity and permitted activities of all entities operating under a banking authorization is clearly available on the BCB website." - Finding: "No institution in Brazil may accept deposits, of any form, without an authorization from the BCB." - Finding: "No authority actively monitors whether there are institutions presenting themselves as banks without the necessary authorizations." - Supervisory approach and tools: - Finding: The BCB has developed a high quality SRC methodology and introduced a twin peak model; it has reoriented emphasis toward corporate governance and segmented banks into five supervisory segments (DSIBs = segment 1 through segment 5). - Finding: The BCB has mobilized extensive primary transaction data—credit register and trade repositories—for systemic risk monitoring and supervisory analysis. - Recommendation: Ensure a clear decision-making process for recovery or resolution to avoid undue delay. - Supervisory reporting and solo vs consolidated data: - Finding: The BCB obtains a very wide range of data and can cross-check and recreate prudential returns from registries and repositories. - Finding: The BCB "does not require a full range of prudential information on a solo basis." - Recommendation: Require all banks to submit solo prudential returns covering standard prudential data such as large exposures, related party exposure, problem assets. - Corrective and sanctioning powers: - Finding: The BCB has a wide range of powers; Provisional Measure 784 lapsed and was replaced by "Ordinary Law (13,506)." Between lapse and enforcement, the BCB retained core powers but lacked important flexibility. - Finding: Lack of graduated escalation instruments contributed to lengthy timescales—this has been remedied by Ordinary Law 13,506. - Consolidated supervision: - Finding: The BCB’s prudential conglomerate methodology includes relevant entities and uses Contagion Risk analysis. - Finding: "The BCB does not, however, systematically obtain or assess an individual banking entity within a prudential conglomerate against prudential standards." - Recommendation: Communicate and establish requirements that individual banks within a conglomerate must continuously meet solo prudential standards; require information on obstacles to transfer of liquidity and capital across group entities. - Home-host relationships and recovery/resolution: - Finding: The BCB has established communication with peer authorities; banks report positive experience with international coordination. - Finding: Work on recovery and resolution planning is not yet fully completed; components of CP13 reflected in CP8. - Corporate governance and risk management: - Finding: The BCB reoriented supervision to weight corporate governance; Resolution 4557 on risk management and governance has only been in force for 6 months for systemic banks and will be in force for the rest of the sector "until February 2018." - Recommendation: Continue implementation of corporate governance framework following Resolution 4557. - Capital adequacy: - Finding: Banks in Brazil are implementing Basel III and expect to fully implement Basel III by "January 1, 2019." - Detail: Law No. 12,838 of July 2013 allows conversion of DTAs arising from loan loss provisions into eligible tax credits (DTCs) under specified conditions; DTCs arising from loan loss provisions amount to "R$146 billion" and are included in CET1 capital and constitute "about 25 percent of CET1 capital." - Finding: Prudential capital requirements currently apply only at the consolidated level (prudential conglomerate); BCB is yet to establish thresholds that might trigger supervisory action. - Problem assets, provisioning, concentration risk: - Finding: The supervisory framework for problem assets and provisioning is largely in place but lacks explicit reporting requirements, expected loss adoption for all exposures, and harmonized collateral/valuation guidance; Resolution 4557 of 2017 addresses some gaps. - Finding: Operating regulations for concentration risk for most banks (S2 to S5) have gaps; Resolution 4557 of 2017 became effective for S1 banks from "August 2017" and will become effective for other banks from "February 2018." - Recommendation: Establish explicit definitions of exposure, reporting on single/connected counterparties, and databases/guidance for sector, regional and credit risk mitigant exposures to strengthen concentration risk monitoring. *Source: cr18339 - 2. Independence,* ### 20. Transactions with ### 20. Transactions with related parties ### Key variances from the Basel norms - Non-inclusion of all types of related parties within the prudential purview. - Absence of an explicit and complete definition of related party transactions for prudential purposes. - Absence of a prudential limit on banks’ aggregate exposure to related parties. - Gaps in governance requirements related to related party exposures and transactions. - Absence of explicit requirement for policies and processes for related party transactions. - Absence of explicit and focused supervisory (prudential) reporting requirement for transactions with and exposure to related parties. - Application of the prudential requirements at the level of the prudential conglomerates and not at the level of the solo bank(s) within the conglomerates. - These factors collectively result in significant gaps in the prudential regime for transactions with related parties. ### BCB monitoring practices and data gaps - The BCB strives to monitor related party transactions by reviewing: - periodical accounting information received from the supervised entities, - SCR database, - the database on market transactions received from the TRs, and - the Unicad database. - Given the gaps in the definition of related party and the definition of related party transactions, and the absence of a dedicated off-site supervisory (prudential) report on related party exposures, it is unclear that the universe of the database that is reviewed by the BCB is complete. - Examples of transactions that may not be reflected in the reviewed databases: - transactions with related parties that are outside the list specified in law or regulations; - sale and purchase of assets that are outside the scope of the TRs; - service contracts with related parties. ### Supervisory routines and governance focus - Supervisory routines prescribed in the supervisory manual, with reference to assessment of inherent risks and control risks pertaining to credit risk, do not explicitly articulate a focus on related party exposures and related party transactions and the governance requirements relevant for such exposures and transactions. - Application of prudential framework principally at conglomerate level risks missing exposures at the solo bank level. ### Relevant contextual supervisory and sectoral information (from nearby chapters) - Resolution 4557 of 2017: became fully effective for all institutions from February 2018; effective for S1 banks from Aug 2017 and for other banks by Feb 2018 (noted in adjacent sections addressing market, IRRBB, operational risk). - Structure of unlisted banks (contextual governance concerns): - Of the 116 unlisted banks, 41 have established Board of Directors. - Of the remaining 75 banks accounting for about R$540 billion in total assets (6.8% market share), 46 are foreign owned banks (5.8% market share). ### Recommendations specific to related party transactions (Principle 20) - Introduce enhanced and explicit requirements for Board oversight of related party exposures and transactions. - Provide an explicit definition or articulation of list of “related parties”, to include at least those mentioned in the footnote to the CP. - Provide an explicit definition or articulation of the “related party transactions” for prudential purposes, to include at least those mentioned in the footnote 69 to the CP. - Introduce a prudential limit for aggregate exposures to related parties that are at least as conservative as the limits for connected counterparties. - Introduce periodical focused reporting by the supervised institutions on the exposures, transactions, exceptions and write-offs. - Apply the prudential framework for related party exposures and related party transactions to the solo bank(s) within the prudential conglomerate. - Make appropriate corresponding improvements to the supervisory manual. *Source: cr18339 - 20. Transactions with (extracted from the supplied IMF chapter content).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18339.pdf_