## cr1880-costaricafianciasectorreview ## Source details **Canonical URL:** [cr1880-costaricafianciasectorreview](https://www.imf.org/-/media/files/publications/cr/2018/cr1880-costaricafianciasectorreview.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr1880-costaricafianciasectorreview.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr1880-costaricafianciasectorreview.pdf.json) --- ### Mission, scope, and methodology - FSSR mission visited San José, Costa Rica, during September 11–28, 2017. Mission leader: Antonio Pancorbo (MCM). - Mission team: André Caccavo, Paul Castillo, James Hambric, Jose María Lamamié de Clairac, Cristina Pailhé, Ignacio Santillán, Rodolfo Wehrhahn (MCM Experts), Martín Auqui (STA Expert). Aditya Narain joined closing meeting. - Scope: banking supervision, securities markets, insurance and pensions, bank resolution and deposit insurance, monitoring of financial stability, financial stability under dollarization, financial deepening and inclusion. - Methodologies and standards selectively used: Basel Core Principles, Insurance Core Principles, IOSCO Principles, IMF Staff Guidance Note on Macroprudential Policies, IMF stress-testing toolkits, Key Attributes of Effective Resolution Regimes, Revised Core Principles for Effective Deposit Insurance (IADI), IMF Financial Soundness Indicators Compilation Guide, G20 Principles for Innovative Financial Inclusion, Basel Committee Guidance on Application of Core Principles to inclusion, OECD-G20 High-Level Principles on Financial Consumer Protection, OECD High-Level Principles on National Strategies for Financial Education. - FSSR diagnostic role: demand-driven baseline diagnostic and prioritized medium-term TA roadmap; distinct from an FSAP and does not include graded assessments. ### Executive summary — overall assessment and fiscal context - Overall assessment: - Costa Rica’s financial stability framework is not well prepared to handle a potential systemic financial crisis without seriously compromising fiscal resources. - Supervision is becoming risk-based and intensive but lacks key legal powers, tools, and responsibilities. - Serious vulnerabilities: pension sector, secondary markets, financial-crisis safety nets. - Key prior recommendations remain unimplemented; insufficient legislative backing is a main reason. - Success of proposals depends on strong political support for swift enactment of necessary legislation. - Fiscal context (selected points): - Persistently large fiscal deficits and increasing public debt are urgent national priorities from a financial stability viewpoint. - Fiscal deficits increase sovereign risk for financial institutions and exert pressure for financial sector lending to government. - Political preoccupation with fiscal reforms is preempting financial sector reforms. ### Financial system structure and key statistics - Banks concentrate 80 percent of the financial system assets. - Twenty-seven percent of bank credit is in US dollars to non-generators of foreign currency, amounting to 17 percent of GDP and 140 percent of all the capital in the banking sector. - Insurance sector premium of $1.2 billion approximately. - Public debt was $21.7 billion in October 2017. - Pension sector manages third-party assets equal to 34 percent of GDP. - Second pillar covers over 2.4 million participants. - Latest actuarial report of the FPJ shows a $10 billion reserve gap. - Since 2011, current RIVM individual contributions do not cover benefit payments; reserve projected to start being deployed around 2023 and become exhausted around 2030. ### Main gaps, risks, and macrofinancial vulnerabilities - Banking supervision: - Lacks legal powers and tools for early risk identification and proactive corrective measures. - Draft law on fit-and-proper requirements finalized; draft law on consolidated supervision under development. - Risk-based supervision: - Paradigm shift requires careful management and legal protection for supervisors. - Public safety nets and crisis management: - No timely emergency liquidity support mechanism at BCCR; crisis management protocols are absent. - Draft LDGF (Deposit Guarantee Fund and Bank Resolution) under consideration but governance and operational autonomy issues noted. - Pensions: - State-run defined-benefit schemes under severe stress; first-pillar reserves (RIVM) projected to be deployed around 2023 and exhausted around 2030; FPJ reserve gap $10 billion. - Dollarization: - Financial dollarization around 45 percent of credit and deposits (another cited figure near 40 percent); concentrated in private banks and financial companies where dollarization reaches 78 and 75 percent, respectively. - 70 percent of dollar-denominated loans of private banks allocated to non-dollar earners; equivalent to 55 percent of private banks’ total credit. - Dollar loans to non-dollar-earners’ households equivalent to 55 percent of total credit in dollars provided by the financial system. - Generates liquidity risk (limited BCCR capacity to provide dollar ELA) and solvency risk (abrupt colón depreciation can raise NPLs). - Securities markets / public debt markets: - Outstanding public-debt securities totaled $21.7 billion approximately by October 2017. - Secondary market severely illiquid: prices essentially fixed, primary market practices inhibit secondary-market development, post-trading needs improvement. - Over 60 percent of outstanding public-debt subscribed by public entities as of October 2017. - BNV trading: only approximately 5.3 percent of 2017 trading corresponds to private issuers’ securities. - Legal framework and state dominance: - Highly fragmented legal framework with organic laws for state-owned institutions; state-owned banks enjoy explicit government blanket guarantee while other deposit-takers have no protection. - Costa Rica has the largest presence of state-owned financial institutions in Latin America; state-owned institutions dominate banking and insurance sectors (50 and 80 percent of total assets, respectively). - Other macro vulnerabilities: - High household leverage: long maturities (consumption loans up to 10 years; mortgages above 30 years) combined with unhedged dollarization and high unemployment risk. - Public-debt market dysfunctions risk liquidity tensions and unrealized losses for institutional investors. - Weak interagency coordination and gray legal areas hinder financial stability monitoring and macroprudential policy. ### Key high-level recommendations (selected) - Strengthen regulatory environment (CONASSIF, SUGEF, SUGESE, SUPEN): - Finalize law for SUGEF to exercise consolidated supervision (¶19, 25). - Implement fit-and-proper rules (¶20, 26). - Enhance legal/regulatory frameworks supporting corrective measures (¶22, 24). - Strengthen supervisory framework: - Provide legal protection for supervisors (¶23, 28, 30, 39). - Consolidate risk-based supervisory approach and wind down CAMELS (¶21, 23, 27, 29, 39). - Strengthen insurance and pension RBS with stress testing and forward-looking tools (¶40). - Foster secondary markets (SUGEVAL; BCCR, MoF): - Align primary markets with secondary markets’ liquidity needs (¶49). - Review valuation and price formation processes and implement trading mechanisms for fixed-income securities (¶44–46, 50–51). - Improve post-trading settlement failures management (¶47, 52). - Strengthen financial safety nets (BCCR, MoF, CONASSIF): - Implement ELA facility at BCCR for illiquid but solvent banks (¶74). - Use P&A resolution transactions to avoid delaying insured-deposit payments (¶72). - Create a crisis management committee and implement deposit insurance scheme for all deposit-taking institutions (¶66–75). - Mitigate dollarization risks: - Allow for higher exchange-rate volatility with targeted FX interventions (BCCR) (¶63, 64). - Recalibrate prudential regulation to accelerate de-dollarization (SUGEF). - Increase liquidity and reserve requirements in foreign exchange (BCCR). - Mitigate pension sustainability risks (SUPEN) (¶34, 37): - Introduce parametric reforms to first pillar considering second pillar interactions. - Close critical supervision/regulation gaps in first-pillar plans. - Introduce held-to-maturity valuation for some pension fund assets (subject to prudential analysis). - Strengthen financial stability monitoring (BCCR, CONASSIF): - Improve coordination and information-sharing; empower Financial Stability Commission; establish responsibilities matrix (¶54–59). - Advance financial deepening and inclusion: - Create national coordination mechanism and develop a National Strategy for Financial Inclusion (BCCR) (¶77, 82–83). - Review SUGEF regulatory perimeter and enhance consumer protection legal framework (CONASSIF) (¶81, 85). ### Banking supervision and regulation — diagnostics and recommendations - Consolidated supervision: - Current legal framework does not support consolidated supervision; supervisor cannot supervise onsite non-regulated entities within a financial group. - SUGEF preparing draft law on consolidated supervision; recommended to augment for authorization, transfer of significant ownership, and substantial acquisitions regimes. - Corporate governance supervision: - Supervisor lacks authority to object to appointments or force removal of directors/senior managers; fit-and-proper regime needs enhancement. - Consider using securities law reform opportunity to grant supervisory powers. - Supervisory approach: - 2016 RBS introduced while CAMELS from 2000 remains; dual systems create legal/reputational risks. - Re-evaluate SUGEF organizational structure and staff to implement RBS; prepare regulations on credit risk, country/transfer risk, concentration risk. - Incorporate macroprudential overlay and provide legal protection for supervisors per BCP Core Principle 2. - Corrective measures and sanctions: - Framework lacks broad, flexible corrective measures and dissuasive sanctions; legislative reform should strengthen personal liability of directors/managers. - Main operational recommendations: - Finalize and pass draft laws on consolidated supervision and fit-and-proper; implement RBS regulations and legal protections; include macroprudential inputs. ### Insurance and pensions — diagnostics and recommendations - Baseline diagnostics: - SUGESE and SUPEN moving toward RBS; calibration of risks and risk capital and early warning indicators pending. - Supervisory resources scarce; INS accounts for just over 80 percent of insurance market. - Reinsurance use needs stronger supervision; risk management of critical reinsurance not regulated. - First-pillar pensions (RIVM) project reserve deployment around 2023 and exhaustion around 2030; FPJ reserve gap $10 billion; RCC actuarially stable but indexation below inflation. - SUPEN’s supervisory powers over some first-pillar entities limited or under judicial dispute. - Second-pillar inefficiencies: mark-to-market valuation in illiquid market, concentration risk, short duration portfolios, costly freedom of transfer, outdated collection costs. - Main recommendations: - Urgent parametric reforms to secure first-pillar sustainability; strengthen second pillar role. - Close critical regulatory/supervisory gaps for first-pillar plans. - Introduce held-to-maturity valuation for certain pension assets subject to prudential analysis. - Draft and implement reinsurance regulation and market-conduct supervision; include fit-and-proper across supervised sectors. - Consolidate RBS, align supervisory structure/resources, provide legal protection, develop prompt corrective actions, and expand stress testing capacity for insurance and pensions. ### Secondary public debt market and post-trading — diagnostics and recommendations - Diagnostics: - Primary market practices (auctions, direct placements, reference-price placements) and fragmentation prevent benchmarks and liquidity. - Secondary market severely illiquid: prices essentially fixed; price vendors act as fixed-price sources; price formation does not reflect issuer credit quality. - Trading rules require routing through BNV and prevent market maker roles; principle of concentration and limits on negotiated transactions constrain liquidity. - Post-trading settlement fails are handled in trading environment; need separation of clearing/settlement and creation of a clearing and settlement entity separated from BNV, as foreseen by law. - Recommendations: - Align primary market issuance (BCCR, MoF) with secondary market liquidity needs: limit number of series and frequency of placements. - Revise valuation mechanisms and price-formation processes; strengthen SUGEVAL supervision of price vendors; establish a price repository with access to all public-debt transactions. - Implement specific trading mechanisms for fixed-income securities: increase direct market access for institutional investors, introduce market makers, broaden investor base, and remove barriers for foreign investors. - Separate clearing and settlement by market to better manage settlement failures and finality. ### Post-trading settlement failures — immediate recommendation - Create specific post-trading mechanisms to deal with cash and securities shortages operating in the post-trading environment. - Create a clearing and settlement entity separated from the BNV, as foreseen by law, to: - Allow better identification and management of settlement failures. - Improve operation of finality in cash and securities settlements. - Give additional security to participating entities. ### Monitoring financial stability and macroprudential policy — diagnostics and recommendations - Tools developed: - BCCR FSD tools: stress test models for credit/market/liquidity/contagion risks; systemic institution identification; financial stability map; CAMELS-like model; financial stress index; credit-to-GDP gap; step-in risk measures. - SUGEF tools: bottom-up stress tests and D-SIB identification; prudential tools (specific/generic/dynamic provisions); Basel III LCR; LTV and DSTI ratios for unhedged borrowers; concentration limits; individual credit growth limits. - Coordination and information sharing issues: - SUGEF interpretation of Law 7558 (Articles 40 and 132) limits information exchange with BCCR; seek Attorney General opinion if necessary. - Financial Stability Committee (FSC) established August 2016 with soft powers; needs empowerment and improved communications. - Stress testing: - Models broadly align with common practices; no remedial action framework currently if a bank fails. - Recommendations: - Establish a responsibility matrix among FSD, SUGEF, CONASSIF to specify leadership and avoid overlaps. - Empower FSC via law or regulation and implement “comply or explain” authority and communications (policy strategy, meeting records, periodic reports). - Strengthen stress testing with single-factor sensitivity analysis and improved coordination between FSD and SUGEF. - Build a countercyclical capital buffer gradually and improve measurement of capital flows. ### Deposit insurance, bank resolution, and crisis management — diagnostics and recommendations - Baseline gaps: - No timely ELA at BCCR for illiquid but solvent banks; crisis decisions ad hoc; draft LDGF has governance and operational autonomy shortcomings. - State-owned banks have blanket government guarantee; other deposit-takers have no protection. - Deposit insurance recommendations: - Amend LDGF or implementation regulations to ensure DGF used only to pay insured deposits (not to capitalize banks); proscribe payments to criminal actors; allow offset of insured deposits against past due loans. - House DGF in BCCR with own legal personality, reporting to BCCR Board; ensure operational autonomy and firewalls; discourage independent costly entity. - Bank resolution and crisis management recommendations: - CONASSIF should use P&A resolution transactions to avoid suspending operations and delay in paying insured deposits; prohibit DGF use to provide bank capital. - Require systemic banks to prepare recovery and resolution plans. - Implement ELA with clear collateral/valuation modalities; develop formal crisis management protocol and national contingency plan; establish working groups to gather crisis information. - Capacity building: - DGF, SUGEF, CONASSIF staff training on resolution/intervention and Purchase and Assumption methodology recommended. ### Financial deepening and inclusion — diagnostics and recommendations - Diagnostics and key indicators: - Nearly two-thirds of adults have an account in a financial institution. - Adults who have taken out a loan: almost 13 percent. - Adults who have savings in a financial institution: 24 percent. - Adults who possess a debit card: 54 percent. - Adults with credit cards: 14.5 percent. - Note: 54 percent state they save, but only 24 percent save in financial institutions. - No National Strategy for Financial Inclusion (NSFI) or national coordinating body; BCCR assigned leadership role but not yet developed. - Data infrastructure for inclusion is weak; payments modernization underway; banking agents and e-money nascent. - Competition from non-regulated sector constrains regulated-sector inclusion; some consumer segments show signs of over-indebtedness. - Access to finance for firms overly reliant on real-estate collateral; secured transactions use incipient. - Consumer protection legal framework fragmented; no harmonized coordination; no National Strategy for Financial Education (NSFE). - Recommendations: - Establish high-level institutional body to lead NSFI and NSFE; design and approve NSFI. - Continue financial deepening: lower electronic transaction costs; implement banking agents regulation. - Expand SUGEF regulatory perimeter to include non-regulated institutions with proportionate approach. - Distinguish microcredit types in regulation; promote secured transactions; gradually eliminate dollar-denominated private-bank contributions to development banking system. - Reform consumer protection: create administrative dispute-resolution body with indemnification powers; harmonize institutional coordination; improve transparency and disclosure on prices/conditions. ### Financial Soundness Indicators (FSIs), Balance Sheet Approach (BSA), and data recommendations - Costa Rica currently disseminates 12 core FSIs and one encouraged FSI; compiled for deposit takers (DTs) using IMF FSI Guide with STA assistance. - Coverage of DTs in FSIs (percent of total assets of DTs): - state-owned commercial banks: 40.5 percent - banks created by special laws: 10.8 percent - private banks: 30.8 percent - nonbank financial corporations: 1.1 percent - savings and loan cooperatives supervised by SUGEF: 9.9 percent - mutual savings and loans: 3.9 percent - one savings and loan institution: 3.4 percent - Selected FSIs (DC) values (exact figures preserved): - Regulatory Capital to Risk-Weighted Assets: 2015M12 16.2; 2016M12 16.4; 2017M06 16.1 - Regulatory Tier 1 Capital to Risk-Weighted Assets: 2015M12 12.6; 2016M12 12.2; 2017M06 12.5 - Non-performing Loans Net of Provisions to Capital: 2015M12 -2.0; 2016M12 -4.1; 2017M06 -5.1 - Non-performing Loans to Total Gross Loans: 2015M12 1.7; 2016M12 1.6; 2017M06 1.7 - Return on Assets: 2015M12 1.0; 2016M12 0.9; 2017M06 0.7 - Return on Equity: 2015M12 7.3; 2016M12 6.3; 2017M06 5.2 - Interest Margin to Gross Income: 2015M12 60.2; 2016M12 55.6; 2017M06 53.8 - Liquid Assets to Total Assets (Liquid Asset Ratio): 2015M12 28.6; 2016M12 27.8; 2017M06 28.3 - Net Open Position in Foreign Exchange to Capital: 2015M12 22.4; 2016M12 24.0; 2017M06 23.9 - Capital to Assets (encouraged FSI): 2015M12 9.7; 2016M12 9.4; 2017M06 9.5 - BSA and intersectoral matrices: - BCCR submitted BSA matrices using national accounts and sectoral balance sheets; completing nonfinancial sector positions would require about one month’s work. - Selected totals in BSA matrix (End of June 2017, In millions of Colones): - TOTAL * (Claims and Liabilities across sectors): 69,919,037 - TOTAL * In domestic currency: 41,157,479 - TOTAL * In foreign currency: 28,761,558 - FSI and data recommendations: - Increase number of FSIs compiled and disclosed. - Expand metadata reporting to include regulatory references and amendments. - Prepare periodic intersectoral matrices using BSA and incorporate them in financial stability monitoring. ### TA Roadmap — priorities, timelines, and selected activities (Annex III excerpts) - Classification: Immediate (can be initiated and concluded within six months), Medium-term, Conditioned (dependent on legislation or political commitment). - Key immediate and high-priority TA activities (selected): - #1 SUGEF RBS (IMMEDIATE): define supervisor risk appetite; develop missing RBS regulations; incorporate macroprudential inputs. - #2 SUGESE RBS (IMMEDIATE): define risk appetite; calibrate risks and capital; implement market-conduct supervision tools. - #3 SUPEN RBS (IMMEDIATE): define risk appetite; build RBS capacity for pension supervision; define risk-based minimum capital. - #9 Enhance ELA at BCCR (IMMEDIATE): consultancy on collateralization/valuation; develop framework for payment system liquidity and systemic liquidity prevention. - #13 Development of a responsibility matrix (IMMEDIATE): articulate roadmap for systemic risk indicators; define “who does what.” - #16 Design measures and enhance analytical tools to mitigate dollarization (IMMEDIATE): design de-dollarization measures; incorporate currency mismatches into macro models; measure FX credit risk. - #18 Price formation (IMMEDIATE): review public-debt price-setting mechanism and valuation techniques. - Conditioned or medium-term items: - #5 SUGEF Consolidated Supervision (conditioned on passing consolidated supervision law). - #6 Fitness and properness (conditioned on passing legal amendments). - #11 Crisis management framework and #12 Implementing DGF including P&A (conditioned on deposit insurance and bank resolution law). - #19 Modernize trading and #20 Resilience of post trading (conditioned on political commitment). - #21 Advance NSFI and NSFE (MEDIUM-TERM; conditioned on concluding external diagnosis). - Annex III lists detailed TA activities across: Strengthening Regulation/Supervision; Financial Safety Nets; Monitoring Financial Stability; Mitigating Dollarization; Fostering Secondary Markets; Financial Deepening and Inclusion — with responsible authorities and timing for each activity. *Source: IMF Financial Sector Stability Review mission to Costa Rica, September 11–28, 2017.* ### Preface................................................................................................................. ### Preface ### Mission details and scope - An FSSR mission from the IMF’s Monetary and Capital Markets Department (MCM) visited San José, Costa Rica, during September 11–28, 2017. - Mission leader: Antonio Pancorbo (MCM). - Mission team members: André Caccavo, Paul Castillo, James Hambric, Jose María Lamamié de Clairac, Cristina Pailhé, Ignacio Santillán, Rodolfo Wehrhahn (all MCM Experts), and Martín Auqui (STA Expert). - Aditya Narain, Deputy Director, MCM, joined the mission for the closing meeting. - Scope agreed during scoping discussions in San José, March 20–22, 2017, covering: banking supervision, securities markets, insurance and pensions, bank resolution and deposit insurance, monitoring of financial stability, financial stability issues under dollarization, and financial deepening and inclusion. - The FSSR provides a baseline diagnostic and a prioritized medium-term TA roadmap to support financial sector reform, financial stability, deepening, and inclusion. - The mission consulted policymakers, supervisory agencies, senior executives of financial institutions, market participants, associations, the stock exchange, experts, and analysts. - Findings and recommendations, including the country TA Roadmap, were presented to: Banco Central de Costa Rica (BCCR), National Council of Financial System Supervision (CONASSIF), the four sectoral supervisors (SUGEF, SUGESE, SUPEN, SUGEVAL), and the Ministry of Finance (MoF). - Report prepared by Antonio Pancorbo with contributions from the team. ### Diagnostic role of the FSSR - The FSSR is a demand-driven TA instrument offering a comprehensive diagnosis and prioritized TA plans. - The FSSR does not include graded assessments of international financial sector standards and is distinct from an FSAP; it prepares jurisdictions for a possible future FSAP. - Annex II contains IMF STA’s evaluation of key statistics and Financial Soundness Indicators (FSI) that supported the mission’s diagnostics. - Annexes and Section III present the proposed TA roadmap prioritizing areas where authorities would benefit from external assistance. ### Executive Summary ### Overall assessment - Despite progress, Costa Rica’s financial stability framework is not well prepared to handle a potential systemic financial crisis without seriously compromising fiscal resources. - Supervision is becoming risk-based and intensive but lacks key legal powers, tools, and responsibilities for effective oversight. - Serious vulnerabilities exist in: the pension sector, secondary markets, and financial-crisis safety nets. - Key recommendations from previous missions remain unimplemented; insufficient legislative backing is a main reason. - The success of the FSSR’s proposals depends on strong political support for swift enactment of necessary legislation. ### Main gaps and risks (baseline assessment) - Banking supervision: - Lacks legal powers and tools essential for early risk identification and proactive corrective measures. - Draft law on fit-and-proper requirements is finalized; draft law on consolidated supervision is under development. Authorities need to commit decisively. - Risk-based supervision: - Paradigm shift requires careful management and legal protection for supervisors. - Public safety nets and crisis management: - Incomplete; no timely emergency liquidity support mechanism at BCCR; crisis management protocols are absent. - BCCR has been working to establish deposit guarantees and improve bank resolution. - Pensions: - State-run defined-benefit pension schemes are under severe stress and require urgent parametric reforms to achieve sustainability. - Supervision of state-run pension plans is limited or under judicial dispute. - Dollarization: - Generates solvency and liquidity risks in the banking system. - Exchange-rate risk is perceived as low by banks’ managers and customers, partly due to BCCR intervention in the foreign-exchange market. - Recommendations include measures for market participants to internalize risks and for BCCR to contribute to de-dollarization. - Securities markets: - Public debt securities dominate; primary market design inhibits secondary market development. - Secondary markets are illiquid; pricing is essentially fixed and does not reflect market information; trading is inefficient; post-trading requires improvement. - Measures to promote securities market development are known; stronger policy commitment and coordination needed. - Financial stability monitoring: - Authorities need appropriate powers and mechanisms and clearer distribution of responsibilities; gray legal areas should be clarified. - Financial inclusion: - Requires a well-designed National Strategy and coordinated action among authorities and stakeholders. - Inclusion in the regulated sector is constrained by competition from the non-regulated sector in consumer loans, with potential consequences for financial stability (interconnection channels and over-indebtedness). - Legal, regulatory, and supervisory improvements needed to promote financial inclusion and consumer protection. ### Fiscal context - The report does not address fiscal matters in depth, but: - Persistently large fiscal deficits and increasing public debt are urgent national priorities from a financial stability viewpoint. - Fiscal reforms are preoccupying the legislature and preempting financial sector reforms. - Financial institutions face increasing sovereign risk; fiscal deficits pressure the financial sector to lend to government. - Conflict of interest between financial policy effectiveness and the government’s public deficit weakens political will and delays action. ### Key recommendations (high-level summary from Table 1) - Strengthening the regulatory environment (CONASSIF, SUGEF, SUGESE, SUPEN) - Finalize law for SUGEF to exercise consolidated supervision (¶19, 25). - Enhance legal/regulatory frameworks supporting corrective measures (¶22, 24). - Implement fit-and-proper rules (¶20, 26). - Strengthening the supervisory framework (SUGEF, SUGESE, SUPEN) - Provide legal protection for supervisors (¶23, 28, 30, 39). - Consolidate risk-based supervisory approach (¶21, 23, 27, 29, 39). - Strengthen insurance and pension RBS with stress testing and forward-looking tools (¶40). - Fostering secondary markets (SUGEVAL; BCCR, MoF) - Align primary markets with secondary markets’ liquidity needs (¶49). - Review valuation and price formation processes (¶44–5, 50). - Implement specific trading mechanisms for fixed-income securities (¶46, 51). - Improve post-trading settlement failures management (¶47, 52). - Strengthening financial safety nets (BCCR, MoF, CONASSIF) - Implement an ELA facility at BCCR to provide timely support to illiquid but solvent banks (¶74). - Use P&A resolution transactions to avoid delaying payment of insured deposits (¶72). - Create a crisis management committee to formalize decision-making (¶75). - Implement a deposit insurance scheme for all deposit-taking institutions (¶66–70). - Mitigating risks related to high dollarization - Allow for higher exchange-rate volatility (BCCR) (¶63, 64). - Recalibrate prudential regulation to accelerate reduction of dollarization (SUGEF). - Increase liquidity and reserve requirements in foreign exchange (BCCR). - Mitigating pension sustainability risks (SUPEN) (¶34, 37) - Introduce reforms for sustainability of first pillar with solutions that consider the second pillar (1). - Close critical gaps in regulation and supervision of first pillar pension plans (2). - Introduce held-to-maturity valuation for some pension fund assets. - Notes: (1) Government, first pillar providers, and SUPEN; (2) Attorney General of the Re. of Costa Rica. - Strengthening financial stability monitoring (BCCR, CONASSIF) - Improve coordination mechanisms and information-sharing arrangements (¶54, 55, 58). - Empower the newly created Financial Stability Commission (¶56, 59). - Establish a matrix of responsibilities for macroprudential policy (¶58). - Advancing financial deepening and inclusion - Create a national coordination mechanism for financial inclusion (BCCR) (¶77, 82). - Develop and approve a National Strategy for Financial Inclusion (BCCR) (¶82, 83). - Review the regulatory perimeter of SUGEF (¶83). - Enhance legal framework for financial consumer protection (CONASSIF) (¶81, 85). ### TA Roadmap and next steps - Table 2 (in the report) presents the FSSR TA Roadmap proposing targeted TA in collaboration with Costa Rican authorities to address identified gaps. - Annex III contains a detailed FSSR Technical Assistance Roadmap. ### I. Introduction (selected points) ### Scope of work and methodology - The FSSR mission conducted a broad diagnostic and proposed a targeted TA roadmap. Costa Rica’s FSSR excluded evaluation of payment systems and AML/CFT (an evaluation by the Financial Action Task Force is in progress). - Diagnostic review organized around seven areas of work (Annex I) and supported by STA’s evaluation of FSIs (Annex II). - Methodologies and standards selectively used included: Basel Core Principles (BCP), Insurance Core Principles, IOSCO Principles, IMF Staff Guidance Note on Macroprudential Policies, IMF stress-testing toolkits, Key Attributes of Effective Resolution Regimes, Revised Core Principles for Effective Deposit Insurance (IADI), IMF Financial Soundness Indicators Compilation Guide, G20 Principles for Innovative Financial Inclusion, Basel Committee Guidance on Application of Core Principles to inclusion, OECD-G20 High-Level Principles on Financial Consumer Protection, and OECD High-Level Principles on National Strategies for Financial Education. - FSSR differs from FSAPs: it does not include graded assessments but evaluates needs to strengthen financial stability frameworks and prepares for an FSAP later. ### Institutional and market structure (overview) - Supervisory architecture: - Banking, insurance, securities, and pensions each have dedicated supervisory agencies under BCCR aegis and CONASSIF coordination. - CONASSIF, founded in 1998, issues guidelines and regulations proposed by the four supervisors: SUGEF (financial intermediaries), SUGESE (insurers), SUGEVAL (securities), SUPEN (pensions). - BCCR sets monetary and exchange-rate policy and promotes liquidity, solvency, and proper functioning of the financial system. - New financial stability arrangements exist but currently have no macroprudential powers. - The mission notes the professionalism and high quality of technical staff across Costa Rica’s monetary and financial authorities. *Source: IMF Financial Sector Stability Review mission to Costa Rica, September 11–28, 2017.* ### 6. The financial system is highly dollarized and dominated by the banking sector. With ### 6. The financial system is highly dollarized and dominated by the banking sector. With ### Financial system structure and key statistics - Banks concentrate 80 percent of the financial system assets. - Twenty-seven percent of bank credit in Costa Rica is in US dollars to non-generators of foreign currency, amounting to 17 percent of GDP and 140 percent of all the capital in the banking sector. - The insurance sector produces a premium of $1.2 billion approximately. It opened in 2008 and is dominated by the state-owned Instituto Nacional de Seguros (INS). - Public debt was $21.7 billion in October 2017. - The pension sector manages third-party assets equal to 34 percent of GDP. - The second pillar covers over 2.4 million participants. - The latest actuarial report of the FPJ shows a $10 billion reserve gap. - Since 2011, current RIVM individual contributions do not cover the benefit payments; the reserve is projected to start being deployed around 2023 and become exhausted around 2030. ### Pensions and social/fiscal risks - The pension sector is multipillar with large fiscal and social implications if parametric changes are not introduced. - First pillar: Caja Costarricense del Seguro Social provides the national disability, survivor, and death regime (RIVM). Projected depletion timeline: reserve deployment around 2023 and exhaustion around 2030. - Other first-pillar providers: teachers’ pension fund and JUPEMA (collective contributing regime, RCC); judicial sector pension fund (FPJ) has a $10 billion reserve gap. - RCC shows actuarial stability but benefit indexation is below inflation. - Second pillar: administered by six pension administrators covering over 2.4 million participants. - Third pillar: voluntary individual accounts now administered by pension administrators. - Conclusion: Only major parametric changes will guarantee sustainability of the whole first pillar pension scheme; fiscal contingent liabilities and large fiscal deficits exacerbate the financial-fiscal nexus. ### Securities markets and public debt market dysfunctions - Securities markets are dominated by the public debt market. - The primary market is very active: MoF issues in a public deficit scenario and BCCR issues monetary stabilization bonds. - The secondary public debt market is managed by the National Stock Exchange (BNV) with cash trading and repo mechanisms. - Securities sold in the repo are blocked, which limits liquidity. - The repo market accounts for the largest volume of trading in the BNV but involves only a small percentage of the public debt in circulation. - The secondary market is severely illiquid due to specific primary market practices, a pernicious price formation process, disincentives for large public investors to trade, and rigid trading arrangements. - Post trading needs improvement in dealing with settlement fails. - Institutional investors, including pension funds and insurers with significant public debt portfolios, might face liquidity tension and unrealized losses. ### Legal framework, market structure, and state dominance - The legal framework governing the financial sector is highly fragmented: general laws coexist with organic laws for state-owned institutions, cooperatives, and “entidades de régimen especial.” - Not all entities are governed by the same rules, creating an unbalanced situation affecting level playing field and regulatory/supervisory powers. - The legal framework is deep-rooted; passing legal change is not a simple process. - State-owned banks enjoy an explicit government blanket guarantee for depositors, while other deposit-taking institutions have no protection. - Illiquid but solvent banks do not have timely access to emergency liquidity assistance (ELA) at BCCR. - Crisis management decisions would be ad hoc, as there are no formal protocols in place. - Costa Rica has the largest presence of state-owned financial institutions in Latin America. State-owned institutions dominate banking and insurance sectors (50 and 80 percent of total assets, respectively). - Competitive distortions persist, including obligations for private banks to lend to state-owned banks at below-market rates and explicit guarantees for state-owned banks (Art 59 and Art 4 of Law 1644 referenced in the source text). ### Main macrofinancial vulnerabilities (top-down) - High dollarization generates systemic risks: - Limited capacity of BCCR to be a lender of last resort in providing dollar liquidity. - Solvency risk from dollar credits to non-generators of dollars in depreciation scenarios. - High household leverage: - Consumption loans with maturities up to 10 years; mortgage loans above 30 years. - Combined risks with unhedged dollarization and high unemployment. - Legal and regulatory frameworks do not support effective supervision: - Limited powers, deep-rooted laws, prone to divergent interpretations. - Weaknesses in the public-sector safety net: - Lack of deposit insurance in private sector; blanket guarantee for state-owned banks creates unfair market advantage. - BCCR’s operational procedures do not provide timely ELA for solvent but illiquid banks. - Absence of formal crisis-management protocols. - Dysfunctional public debt markets: - Poor price formation, rigid trading, extreme illiquidity; large public-debt portfolios at risk of liquidity tensions and unrealized losses. - Sustainability of pensions: - First-pillar schemes require major parametric changes; fiscal contingent liabilities and large fiscal deficits exacerbate risks. ### Macro-policy and institutional recommendations - Address large and persistent public deficit as a national priority to enable effective financial policies and reforms. - Strengthen interagency coordination: - Implement coordination mechanisms for macroprudential monitoring to avoid overlap with microprudential supervision. - Clarify distribution of responsibilities; uncover gray legal areas; ensure confidentiality rules do not prevent sharing financial stability information. - Coordinate crisis management among supervisors and relevant authorities to avoid contagion and systemic risks. - In securities markets, involve authorities as issuers in policies on price formation transparency and market liquidity. - Reduce dominant and distortive role of state-owned institutions to promote a level playing field and reduce sovereign-concentration risk in financial institutions’ portfolios. ### IMF surveillance, past technical assistance, and policy guidance - 2017 Article IV highlighted: large dollarization of lending to unhedged borrowers, high net foreign liabilities of banks, rising household leverage, and sovereign exposure as key vulnerabilities. - Recommend further tightening of prudential requirements if foreign exchange exposures do not reduce within a reasonable time or if foreign-currency credit deceleration is temporary. - Encourage implementation of pending 2008 FSAP recommendations and adoption of Basel III standards (gradually introducing capital requirements and liquidity standards). - Financial deepening recommendations: increase competition in the banking sector, market-friendly public debt management, issuance strategies promoting larger secondary markets, refine loan-provisioning rules, and better protection of investor rights. - IMF technical assistance over two decades supported corporate governance, credit risk management, liquidity coverage ratio, market risk capital requirements, credit risk supervisory tools, consolidated and cross-border supervision, deposit insurance, debt management, stress testing design, and monetary statistics improvements. ### Banking supervision and regulation: baseline diagnostic and main recommendations - Legal framework limits effective banking supervision; decisive and timely legal reforms are encouraged. - Consolidated supervision: - Current legal framework does not support consolidated supervision; supervisor cannot supervise onsite non-regulated entities within a financial group. - SUGEF is preparing a draft law on consolidated supervision to be submitted to CONASSIF; the draft would address most current weaknesses but should be augmented for authorization, transfer of significant ownership, and substantial acquisitions regimes. - Constraints from lack of consolidated supervision weigh on the capital framework. - Corporate governance supervision: - New regulation on corporate governance enacted, but supervisor lacks authority to object to appointments or force removal of directors and senior managers, nor to require minimum fit-and-proper criteria. - Reform of securities market law could provide an opportunity to grant these supervisory powers. - Regulation of compensation is minimal to nonexistent. - Supervisory approach: - 2016 risk-based supervision (RBS) introduced alongside an obsolete CAMELS system from 2000; dual systems create legal and reputational risks. - SUGEF plans to replace CAMELS with the RBS-based rating system. - Organizational structure and resources may be insufficient for RBS implementation. - Regulations on credit risk, country and transfer risks, and concentration risk have not been issued. - Supervisory approach lacks a macroprudential overlay. - Legal framework does not provide adequate legal protection for supervisors acting in discharge of duties. - Corrective measures and sanctions: - Current framework lacks a broad and flexible range of corrective measures and a dissuasive sanctioning framework. - Draft consolidated supervision law proposes substantial reform to empower sanctioning framework; the legislative project should strengthen personal liability of directors and senior managers to sanctions. - Main recommendation: - Implement long-overdue legal reforms to provide SUGEF and CONASSIF with essential supervisory tools, including finalizing draft laws on fit-and-proper requirements and consolidated supervision. *Source: cr1880-costaricafianciasectorreview - 6. The financial system is highly dollarized and dominated by the banking sector. With* ### 25. The mission emphasized the importance of finalizing and passing the current draft ### cr1880-costaricafianciasectorreview - 25. The mission emphasized the importance of finalizing and passing the current draft ### Banking supervision: consolidated supervision, governance, and RBS transition - Finalize and pass the current draft law to allow SUGEF to exercise effective consolidated supervision. - Consider limiting to domestic subsidiaries the unlimited liability of the parent company of article 142 of the Organic Law of the BCCR (Law 7558). - Incorporate urgently improvements to the transfer of significant ownership regime: - Enable the supervisor to make a prior ruling on any substantial variation in the chain of holdings. - Establish generally the prior authorization regime for banks’ bylaws amendments. - Allow regulatory developments to determine which cases could be exempted from authorization. - Review and clarify the current authorization for the establishment and acquisition of financial institutions abroad, differentiating steps and requirements among different types of cross-border transactions. - Complement the corporate governance legal framework with fit-and-proper evaluations of directors and senior managers: - SUGEF should review the design and contents of its Register of Roles to support fit-and-proper evaluations. - CONASSIF should approve regulation that enhances fit-and-proper requirements for authorities of institutions supervised by SUGEF within the existing legal framework (supported by IMF TA). - In the medium term, consider and analyze implementation of the Financial Stability Board principles on sound compensation practices and the Basel Committee disclosure requirements on remuneration; analyze establishing a roadmap for progressive implementation to avoid undesired impacts. - SUGEF should continue implementing the RBS approach while winding down its CAMELS rating system: - Re-evaluate SUGEF’s organizational structure to adapt to RBS requirements and identify needed supervisory skills and staff. - Waiting to finalize the three-year supervisory cycle may be too late to gauge resources for the upcoming cycle. - Prepare regulations on credit risk management and concentration risk consistent with the RBS approach. - Incorporate macroprudential risk factors into supervisory planning under RBS. - Provide legal protection for supervisors according to best international practices: - RBS and corrective measures imply high supervisory judgment and qualitative assessment; Core Principle 2 of the BCP requires comprehensive legal protection. - Balance legal protection with an accountability framework and an appeal process concerning supervisory decisions. ### Insurance and pension sectors — Baseline diagnostic - Movement toward stronger risk-based supervision: - SUGESE and SUPEN have drafted several regulations enabling an RBS approach; calibration of risks and associated risk capital, and calibration of early warning indicators (insurance) or development of such an instrument (pensions) remain pending. - TA supported initial implementation of a generic RBS approach and needed regulations. - Lack of legal protection for supervisors weakens use of expert judgment to enforce preventive measures, hindering SUGESE’s and SUPEN’s RBS development. - Scarce supervisory resources limit supervision intensity, particularly modern market conduct supervision: - INS accounts for just over 80 percent of the market and requires significant supervisory attention. - Supervising full-range insurance companies requires specialized resources and understanding of home offices of international parents. - SUGESE and SUPEN, as market conduct supervisors and designated AML/CFT supervisors for insurance and pensions, need dedicated resources for AML/CFT supervision at required frequency. - Prudential regulation needs further development: - Insurance capital regime contains risk-sensitive elements beyond Solvency I but lacks calibration to meet SUGESE risk appetite. - Solvency ratio uses risk capital capturing investment risk, operation risk, insurance risk, reinsurance risk, and catastrophic risk; investment risk capital calculation is consistent with banking methodology, but other risk capital calculations lack calibration and use different international ranges. - Pension risk capital is indicated in a recent regulation but lacks specifics required for calculation. - Reinsurance use and supervision need enhancement: - SUGESE introduced prudential requirements assessing risk capital for credit risk and concentration risk when using reinsurance. - Risk management of critical reinsurance use is not regulated; new regulations should include explicit risk management requirements and internal reinsurance supervision guidelines defining supervisors’ responsibilities. This will require TA. - First-pillar pensions under stress and require urgent parametric changes: - Recent actuarial reports of the RIVM show the reserve is projected to start being deployed around 2023, and exhausted around 2030. - The latest actuarial report of the FPJ shows a $10 billion reserve gap. Two proposed legal reforms to this pension plan are under parliamentary discussions; these will mitigate the financial gap but not resolve sustainability. - The RCC shows actuarial stability but indexation of benefits is below inflation, reducing purchasing power—this technical parameter allowed actuarial stability. - Second-pillar inefficiencies hindering growth: - Inefficiencies include mark-to-market valuation in an illiquid market, concentration risk and short duration in investment portfolios, costly freedom of transfer between pension administrators of questionable value to participants, and collection costs not revised since 2001. - Supervisory and regulatory powers challenged and prone to diverging interpretations: - SUPEN does not regulate the RIVM; its supervision powers over the RIVM are limited. The RIVM is administered by the Caja Costarricense del Seguro Social (CCSS), an autonomous entity not supervised. - SUPEN’s powers to regulate and supervise the FPJ are under judicial dispute despite an Office of the Attorney General acknowledgment in response to an SUPEN inquiry. - Regulation and supervision of the RCC is carried out by SUPEN with regard to its organic law, which supersedes regulations issued by CONASSIF. ### Insurance and pensions — Main recommendations - Implement urgent parametric reforms to secure sustainability of the first pillar and strengthen the second pillar: - Implement changes guided by equity principles affecting different stakeholders and generations. - Strengthen the role of the second pillar to complement retirement income from the first pillar. - Close critical gaps in regulation and supervision of first-pillar plans. - Introduce held-to-maturity valuation for some assets held to maturity in a pension operator, with prior prudential analysis of accounting, financial, and economic criteria and principles. - Consider revising transfer right frequency and the transfer process between pension operators. - Key measures to strengthen insurance regulatory environment: - Draft and implement regulations on the use of reinsurance. - Assess sufficiency of technical provisions for selected lines of business, including life. - Implement envisioned market conduct and intermediaries’ regulation and supervision. - Include fit-and-proper requirements in regulation (SUGEF’s proposed law changes should include the whole regulated financial sector). - Strengthen supervisory framework for insurance and pensions: - Consolidate the newly introduced RBS approach and align supervisory structure and resources for optimal delivery. - Undertake legislative changes to provide proper legal protection for supervisors and staff in line with international best practices. - Consider quantitative metrics linked to different risk levels and a set of prompt corrective actions (by SUGESE). - Develop onsite risk-based inspections; SUPEN can reinforce onsite work with audit firms to supervise correct allocation of contributions and confirmation of custodian accounts. - Enhance forward-looking supervision using stress testing, systemic risk, and contagion risk analysis. - Support RBS with forward-looking tools and systemic risk analysis: - Market-wide stress testing and systemic risk analysis for insurance sector are not currently carried out. - Contagion risk to the wider financial sector is negligible given sector size, but systemic risk affecting insurers is possible and not monitored. - Improve SUGESE and SUPEN capacities to elaborate stress tests for pensions and insurance companies (bottom-up and top-down). ### Secondary public debt market — Baseline diagnostic - Securities market dominated by public debt: - Outstanding public-debt issued securities totaled $21.7 billion, approximately, by October 2017, according to the MoF. - The MoF and the BCCR are the main issuers on the primary market. - The equities market is small; banks issue non-serial short-term debt subscribed by money market funds. - According to the BNV, only approximately 5.3 percent of the total trading in the BNV in 2017 corresponds to private issuers’ securities. - Primary market design affects secondary market development: - A system focusing on transparency and public debt benchmarks has not been achieved. - Public debt is purchased on the primary market in auctions that do not operate as such and in direct placements with little transparency; some issues placed directly without public terms, auctions frequently place securities only at reference price. - Over 60 percent of total outstanding public-debt securities as of October 2017 are subscribed by public entities (pension funds, insurance companies, the Costa Rican Social Security Fund, and public banks), which maintain large public debt portfolios. - Low secondary-market trading volume explained by market characteristics: - Difficulty identifying benchmarks; prices are essentially fixed and do not show liquidity spreads. - Inadequate transparency, little appetite for trading by major portfolio holders, rigid trading systems, and absence of participants that promote liquidity (market makers). - Fragmentation and frequency of primary market issues are serious obstacles to liquidity and reference benchmarks. - Valuation and price formation issues: - Trading prices are essentially fixed and do not reflect liquidity or react to information. - Regulations call for valuations provided by price vendors; in practice these act as fixed prices and do not reflect issuer credit quality. - Price vendors’ techniques can force entities to change valuation of entire curves of similar securities after a transaction, creating a strong disincentive for large portfolio holders to trade. - Trading rules hamper secondary market development: - Rules require routing all transactions through the BNV with intermediation of a securities broker (puestos de bolsa) and prevent market maker roles. - The “principle of concentration” and limitations on transactions between institutional investors at agreed terms limit operating capacity and liquidity, creating potential liquidity risk for large portfolios. - Post-trading arrangements are adequate given limited volumes but need improvements for incident resolution if volumes increase. ### Secondary public debt market — Main recommendations - Promote a transparent and liquid secondary market through coordinated stakeholder commitment: - Stakeholders include regulators, authorities, supervisors, and industry operators. - Objectives: deeper issuances, reference benchmark prices, greater transparency, accurate pricing, more active operators, and broadened investor base including foreign investors. - Align primary market practices with secondary market liquidity needs: - BCCR and MoF encouraged to limit number of series and frequency of placements to serve as benchmarks and promote secondary trading. - Prioritize and coordinate implementation among relevant parties. - Revise valuation mechanisms and price formation processes: - Comprehensive revision recommended, including more intrusive supervision of price vendors by SUGEVAL. - Revise public debt asset valuation for certain institutional investors. - Establish a price repository where all market operators have access to every public debt transaction in primary and secondary markets to increase transparency. - Implement specific market trading mechanisms for fixed-income securities: - Revise application of trading rules that limit institutional investors executing transactions at agreed terms. - Implement specific trading systems for fixed-income securities. - Increase direct market access for institutional investors and banks with client portfolios, introduce market makers, broaden potential investor base, and avoid regulatory barriers for foreign investors. *Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1880-costaricafianciasectorreview.pdf* ### 52. Improve post-trading settlement failures management. Post-trading operations for ### 52. Improve post-trading settlement failures management. Post-trading operations for ### Post-trading settlement failures — Baseline diagnostic and recommendation - Post-trading operations for dealing with settlement fails in cash and securities legs need a comprehensive revision, by establishing specific mechanisms to deal with cash and securities shortages. - These mechanisms should be operated in the post-trading environment instead of in the trading environment, as it is today. - Recommendation: create a clearing and settlement entity separated from the BNV, as foreseen by the law. - Current practice: the payment system settles cash from operations within different markets in a one single process. - Rationale for separating clearings and settlements by market: - Would allow better identification and management of settlement failures. - Would allow better operation of finality in cash and securities settlements. - Would give additional security to participating entities. ### Monitoring of Financial Stability and Macroprudential Policy — Baseline diagnostic - The Financial Stability Department (FSD) of the BCCR and SUGEF has acted proactively to build a set of tools to be used for macroprudential policy. - FSD tools developed include: stress test models to address credit, market, liquidity and contagion risks; systemically important institutions identification (not only deposit takers but also money market funds and insurance companies); financial stability map; CAMELS-like model; financial stress index; credit-to-GDP gap; and step-in risk measures. - SUGEF tools developed include: bottom-up stress test and D-SIBs identification models; prudential tools such as specific, generic, and dynamic provisions; Basel III liquidity coverage ratio; loan-to-value (LTV) and debt-service-to-income (DSTI) ratios for provisions to unhedged borrowers; concentration limits; individual credit growth limits; and LTV as an input to risk weights and DSTI as an input to calibrate provisions. - Information sharing between SUGEF and BCCR is not as smooth and comprehensive as it should be: - SUGEF’s interpretation of law 7558 (Ley Orgánica del Banco Central de Costa Rica) limits SUGEF’s exchange of information with the BCCR. - Article 40 specifies any information, report, and assessment held by any public entity must be provided to the BCCR upon request. - Article 132 forbids SUGEF from disseminating information about supervised entities; one exception is information requested by the agreement of at least five members of the Board of the BCCR, as far as such information is deemed necessary for the discharge of legally prescribed duties. - SUGEF’s interpretation is that the agreement should be specific; BCCR understands the agreement could also be generic. - Insufficient coordination between SUGEF and FSD can lead to duplicate work and confusion despite skilled staff. - Financial Stability Committee (FSC): - Established since August 2016 for coordination of macroprudential policy. - Comprises the president of the BCCR, the president of CONASSIF, and the Minister of Finance. - Formally established by an agreement among its members and has only soft powers. - Has not yet established communications policies with the general public; meeting minutes are the only record. - Stress testing: - Use of macroeconomic stress test models is broadly in line with common practices and helps identify weaknesses. - Stress test models cover a broad range of risks. - Currently there is no remedial action taken if a bank fails. - Since 2015, IMF-led TA missions have helped develop and strengthen stress testing models of market, liquidity, and credit risks, as well as contagion risk tools. ### Monitoring of Financial Stability and Macroprudential Policy — Main recommendations - Improve coordination and information sharing between FSD and SUGEF while minimizing overlaps: - Establish a responsibility matrix among FSD, SUGEF, and CONASSIF specifying “who does what,” where responsibility denotes leadership in coordination but not exclusivity. - Other authorities could be included in the matrix. - FSC could act as a common leader in monitoring financial stability. - When the legal interpretation of Law 7558 hinders information sharing, seek the legal opinion of the Attorney General's Office. - IMF doctrine: authorities involved in macroprudential policies should be under a legal obligation—not simply possess the legal authority—to share pertinent information with other relevant authorities. - Strengthen effectiveness of the FSC: - Empower FSC by turning its current agreement into law or enacting regulation. - Augment its advisory role with authority to stipulate “comply or explain.” - Use communications tools such as publication of a policy strategy, record of meetings, and periodic reports (for example, financial stability reports). - Strengthen stress test framework: - Improve sensitivity analysis by complementing scenario analysis with single factor sensitivity analysis to cover a range of outcomes. - Enhance communication and information sharing between FSD and SUGEF to develop and run stress tests. - Use results to challenge risk management and capital adequacy where banks take excessive risk. - Improve use of macroprudential tools: - Build a countercyclical capital buffer as part of macroprudential policy to help the banking sector accumulate capital in good times and maintain credit flow in bad times. - Implement this policy gradually and consider the current accumulation phase of recently implemented dynamic provisions. - Improve detailed measurement of capital flows, which is currently deficient, to help assess systemic risk. ### Financial Stability Issues under Dollarization — Baseline diagnostic - Dollarization generates two potential sources of systemic risk: liquidity and solvency risk. - Liquidity risk: BCCR’s limited capacity to fulfill lender of last resort in foreign currency. - Liquidity risk to Costa Rica’s financial system created by dollarization is moderate, but could increase with significant capital outflows or reversal of wholesale funding, particularly if current financial dollarization levels are not reduced while the financial system expands. - Solvency risk: abrupt depreciation in the colón could significantly increase nonperforming loans if non-dollar earners have dollar loans and cannot hedge. - Financial dollarization in Costa Rica: - Has remained at around 45 percent of credit and deposits. - Is close to 40 percent in another cited figure; concentrated in private banks and financial companies where dollarization reaches 78 and 75 percent, respectively. - 70 percent of dollar-denominated loans of private banks are allocated to non-dollar earners, equivalent to 55 percent of private banks’ total credit. - Dollar loans to non-dollar-earners’ households are equivalent to 55 percent of total credit in dollars provided by the financial system. - Challenges faced by BCCR in partially dollarized economy: - Allowing greater exchange-rate volatility while managing systemic risk. - Maintaining an appropriate level of international liquidity in the context of a 15 percent limit on dollar reserve requirements and a widening fiscal deficit. - Increasing financial institutions’ awareness of exchange-rate risk given low perceived cost of dollar loans. - Harmonizing SUGEF regulatory measures with monetary policy actions aimed at reducing dollarization; no evaluation has been conducted of the impact of SUGEF regulations to disincentivize non-dollar earners to borrow in dollars. ### Financial Stability Issues under Dollarization — Main recommendations - Allow greater exchange-rate volatility with a single objective for foreign exchange interventions: reduce excessive volatility generated by market pressures not correlated to fundamentals and that threaten financial stability. - Tolerate temporary upward and downward exchange-rate movements. - Given lack of foreign exchange market depth, estimate the level of depreciation of the colón required to trigger a balance sheet effect to establish a relevant benchmark for increased volatility. - Reduce the reserve requirement rate in domestic currency (15 percent currently) to levels closer to banks’ operative requirements to increase deposit rates and reduce loan rates in local currency, favoring deposit and credit de-dollarization. - Modify current Basel III liquidity coverage ratio to strengthen international liquidity position; for example, gradually increase weights of banks’ liabilities denominated in foreign currency. - Assess impact of macroprudential measures already adopted to appropriately calibrate them and ensure they encourage a gradual long-term decrease in financial dollarization. - Note: in August 2013, credit risk weight was increased for borrowers with high exchange risk, and separate liquidity requirements were established by currency. - Study adding new domestic- and foreign-currency-denominated liquidity injection instruments at different terms to meet banks’ liquidity needs across terms and currencies. - Analyze introducing greater flexibility in regulations that impose a limit on the BCCR’s use of reserve requirements to improve capacity to reduce liquidity risk generated by dollarization and to use reserve requirements cyclically. ### Deposit Insurance, Bank Resolution, and Crisis Management — Baseline diagnostic - Costa Rica needs to improve its financial safety net by: 1. providing an effective lender of last resort process; 2. implementing a deposit insurance fund for all banks; 3. developing effective bank resolution mechanisms; 4. establishing crisis management protocols. - Current gaps: - Effective bank supervision needs enforcement measures and early intervention allowances. - Illiquid but solvent banks do not have access to ELA at the BCCR. - Crisis management decisions are ad hoc due to lack of formal protocols. - State-owned banks enjoy a government blanket guarantee for depositors while other deposit-taking institutions have no protection. - A draft law for a deposit insurance fund is in process of approval but would have benefited from following steps based on IADI Core Principles and Key Attributes for Effective Resolution. - Draft Law on the Deposit Guarantee Fund and Bank Resolution (LDGF): - Draft is positive but has areas for improvement. - Many traditional roles of the DGF board appear to be within CONASSIF. - Role of calculating insured deposits is in SUGEF, inconsistent with international best practices for deposit insurance. - Under the draft law, IADI’s Core Principle on governance and operational autonomy is not met. ### Deposit Insurance — Main recommendations - Amend LDGF or implementation regulations to clearly articulate DGF operations: - DGF should be used only to support payment of insured deposits and not to capitalize banks. - Proscribe payments to depositors involved in money laundering and criminal activities, and to service providers who misrepresented a bank’s condition. - Insured deposits of depositors with past due loans should be offset; DGF to determine whether offset equals past due amount or full deposit and consider payment history. - Issue implementation regulations to provide legal certainty for DGF organization and governance during initial stages. - Organizational placement and governance: - House DGF in the BCCR with its own legal personality, reporting to the Board of the BCCR; justified by Costa Rican banking sector size and DGF’s paybox mandate. - Primary responsibilities: collect premiums, invest fund assets, educate depositors, and pay insured deposits as directed by CONASSIF during resolution. - SUGEF provides information required for payment of insured deposits. - Operational autonomy will be difficult under the draft law; implement agreements for DGF’s operating expenses leveraging BCCR resources while maintaining adequate fire walls. - Creating an independent organization is discouraged due to operation costs affecting fund buildup. - Member institutions support DGF within BCCR; perceived conflicts of interest within BCCR are deemed not relevant. *Source: IMF country report excerpt (cr1880-costaricafianciasectorreview).* ### 69. The authorities could usefully consider the social and economic benefits from an ### cr1880-costaricafianciasectorreview - 69. The authorities could usefully consider the social and economic benefits from an ### State-owned bank blanket guarantee and deposit insurance - Blanket guarantees for depositors at state-owned banks create competitive advantages for these banks and result in large contingent liabilities for the government in the event of a bank failure. - Implementation of an explicit guarantee scheme for all deposit-taking institutions will move toward leveling the playing field and share the financial burden of a banking crisis within the industry. - Recommendation: Authorities could consider the social and economic benefits from an eventual rollback of the blanket guarantee for state-owned banks. ### Capacity building for resolution and intervention - DGF, SUGEF, and CONASSIF staff would benefit from training in bank resolution and intervention, including the Purchase and Assumption methodology. - Training objectives: improve design and drafting of operating policies, avoid suspending bank operations, and ensure prompt payment to depositors. ### Bank resolution—baseline diagnostic and main recommendations - BCCR has been working on an effective bank resolution framework for several years; progress has slowed despite IMF TA support. - The draft LDGF: - Establishes CONASSIF as the resolution authority with the ability to implement a variety of options not subject to court approval. - Provides for a special bank resolution regime and for depositor preference for the DGF, giving the DGF a favorable legal framework to meet its mandate. - Government financial support to ailing banks should be legally permitted under strict conditions, including at minimum: - that shareholders take first loss, - change intervention in management, - limits on executive compensation, - limits on dividend payments, - and that all actions are taken according to an exit strategy. - Mission recommendations: - CONASSIF should use purchase and acquisition resolution transactions (P&A) to avoid suspending bank operations and delaying payment of insured deposits. - Through planning, early intervention, and use of P&A, CONASSIF should be able to meet IADI’s core principle on prompt payment to depositors. - Prohibit the use of the DGF for providing bank capital. - CONASSIF and SUGEF could require systemic banks to prepare recovery and resolution plans. ### Crisis management—baseline diagnostic and main recommendations - Limited efforts on planning for a financial crisis: - No emergency liquidity support for illiquid but solvent banks. - No formal process for gathering and reviewing information needed to make informed decisions in a crisis. - Current ad hoc decision-making is inadequate for crisis management. - BCCR and ELA: - The banking law provides BCCR with legal ability to provide ELA, but unclear modalities could open the door to undue influence and potential provision of solvency support instead of emergency liquidity. - BCCR is working on ELA and should move promptly to implement. - Policy development must address: types of assets to accept as collateral, valuation of pledged assets, and determination of liquidity versus solvency. - Need to establish a formal crisis management protocol assigning roles and responsibilities to key stakeholders. - CONASSIF is the intergovernmental coordination committee responsible for preparing and coordinating actions during a financial crisis, but the decision-making process needs institutionalization. - Recommendation: develop working groups responsible for gathering required information and drafting a national contingency plan immediately. ### Financial deepening and inclusion—baseline diagnostic - Financial inclusion indicators: - Nearly two-thirds of adults have an account in a financial institution, which is above the one-half average for Latin America and the Caribbean. - Adults who have taken out a loan: almost 13 percent. - Adults who have savings in a financial institution: 24 percent. - Adults who possess a debit card: 54 percent. - Adults with credit cards: 14.5 percent. - Note: difference between percentage of adults who state that they save (54 percent) and the percentage who say they do so in a financial institution (24 percent). - Coordination and data shortcomings: - No National Strategy for Financial Inclusion (NSFI) and no national coordinating body to head, implement, and monitor such a strategy. - Office of the Vice President assigned a leadership role on financial inclusion-related matters to the BCCR, which has yet to be developed in practice. - No sound data infrastructure with supply and demand data to monitor financial inclusion and pursue evidence-based policies. - Payments and innovations: - Ambitious plan to upgrade retail payments and encourage electronic means of payment; challenge remains to reduce the cost of certain transactions. - Banking agents have only just started to appear; e-money is not significant. - Competition from non-regulated sector: - Financial inclusion in the regulated sector has been severely constrained by competition from the non-regulated sector, particularly for consumer loans. - Some consumer client segments show signs of over-indebtedness; lack of aggregate information makes extent uncertain. - Interconnections between regulated and non-regulated sectors may have unwanted consequences for financial inclusion and financial stability. - Access to finance for firms: - Lending relies excessively on the use of real estate collateral; secured transactions framework in place but its use is incipient. - Development banking system needs to expand within a context of sound risk-taking. - Dollar resources from private bank contributions to the development banking system are not being directed to productive projects because of exposure to exchange-rate risk. - Regulated institutions do not grant traditional microcredit; prudential treatment of microcredit appears geared to small loans rather than micro. - Consumer protection: - Legal framework for financial consumer protection is fragmented with considerable differences among powers of various superintendencies. - No formal coordination mechanisms among institutions involved in financial consumer protection. - Regulations on transparency are not comprehensive and suffer considerable shortcomings in financial intermediation sector. - Cases of abuse, improper transactions, and lack of transparency, especially among non-regulated lenders competing with regulated institutions. - No National Strategy for Financial Education (NSFE). ### Financial deepening and inclusion—main recommendations - Establish a high-level institutional body to lead and coordinate financial inclusion policies, with representation from institutions responsible for financial inclusion. This body should direct development, approval, implementation, monitoring, and review of a NSFI and preparation of a NSFE. - Continue financial deepening strategy to lower costs of electronic transactions and encourage greater use; move forward with regulation of banking agents. - Widen SUGEF’s regulatory perimeter to include broad powers with respect to currently non-regulated institutions. - For firm financing: - Distinguish clearly between different types of microcredit in regulations. - Promote use of secured transactions and stricter rules for valuation of real collateral. - Gradually eliminate dollar-denominated funds provided by private banks to the development banking system, given they are not meeting their purpose. - Reform legal framework to enhance financial consumer protection: - Create a flexible and expeditious administrative body empowered to hand down resolutions and indemnify (as opposed to resorting to judicial proceedings). - Establish a new institutional structure for coordination among institutions. - Regulators and industry should disclose comprehensive information about prices and conditions of financial products to promote market discipline. ### The Technical Assistance (TA) Roadmap—overview and priorities - FSSR initiative: proposed TA Roadmap based on baseline diagnostic assessments; recommends action plans for financial sector reforms over the following three years with prioritized and sequenced TA activities. - TA activities classification and timing: - Activities divided between those that can be carried out immediately (can be initiated and concluded within six months) and those to be initiated in the medium term and concluded before the end of the three-year horizon. - Specific timeframes to be determined when preparing Terms of Reference. - TA activities classified as high, medium-high, and medium priority depending on potential negative effects if left unattended. - Political viability: - Authorities should assess political viability of TA activities before finalizing the Roadmap. - Weak political support for legislative reforms in a financial system dominated by state-owned institutions has impeded earlier recommendations. - Successful TA Roadmap should be predicated on assessing political viability and a strong commitment by policymakers to coordinate and ensure implementation. ### TA recommendations by area (high-level) - Banking regulation and supervision: - TA to support regulatory developments following approval of legislative projects. - High-priority TA: review design/content of Register of Roles once law amendments on fitness and properness are in place; support implementation planning for BCBS disclosure requirements on remuneration; support regulatory powers for consolidated supervision once draft law passed. - Immediate high-priority TA: support preparation of regulations missing for RBS approach and completion of risk matrix design; include macroprudential inputs if progress achieved. - Medium-term TA: analyze impact of Basel II/III standards and help implementation planning. - Insurance and pensions supervision: - High-priority TA: support SUGESE and SUPEN move to stronger risk-based approach and develop related regulations. - Medium-high-priority TA: assist SUPEN in developing supervision protocols under new regulations, including over capital. - Develop internal reinsurance supervision and authority guidelines plus capacity building. - Medium-priority TA: accompany implementation phase, separate market conduct supervisory approach from prudential supervisors. - Financial stability tools and statistics: - TA to develop responsibility matrix and roadmap for new systemic risk indicators (high-priority). - Medium-priority TA: enhance forward-looking analysis using market-wide stress testing, systemic risk, and contagion risk analysis (including insurance and pensions); complete cross-sectoral financial relationships (BSA Matrix). - Deposit Guarantee Fund (DGF) and crisis coordination: - TA to support development of operational policies and procedures for DGF, including project plan, policies and operating procedures, staffing plans, and training on best practices (including P&A methodology). - Medium-high-priority TA: assist in developing operating policies and establishing intergovernmental coordinating committee and national contingency plan. - Emergency Liquidity Assistance (ELA): - High-priority TA, to be carried out immediately, to support implementation of ELA focusing on non-liquid collateral valuation methodologies. - Dollarization and systemic risk: - TA to strengthen capacities to measure systemic risk associated with dollarization, including: - measuring exchange credit risk in the banking system; - evaluating systemic liquidity risk in foreign currency; - developing macroeconomic models that consider effects of exchange credit risk. - TA to assist with prudential management of exchange rate risk and development of a strategy for communicating monetary policy objectives and operations. - Secondary public debt market: - TA to create a transparent and liquid secondary public debt market requires strong political commitment. - High-priority TA: immediate review of harmful effects of current public debt price-setting mechanism, including lack of liquidity, impact on portfolio valuations, and disincentives to development of secondary market. *IMF staff report: Costa Rica Financial Sector Assessment and Strengthening Recommendations (selected sections).* ### 96. TA to advance the agenda on financial deepening and inclusion is recommended in ### 96. TA to advance the agenda on financial deepening and inclusion is recommended in ### TA recommendations to strengthen coordination and leadership - High-priority TA areas for the authorities: - Design of a NSFI and an NSFE, provided as both a diagnostic assessment and a roadmap for identifying objectives, components, and implementation. - Support to design the data infrastructure for financial inclusion, with supply and demand data. - Review of the current legal framework and recommendations to improve powers vested in SUGEF in areas relating to consumer protection and its regulatory perimeter. ### Technical Assistance Priorities and Timeline (strategic objectives and numbered TA activities) - Strengthening financial regulation and supervision: - Immediate: #1 SUGEF RBS; #2 SUGESE RBS; #3 SUPEN RBS - Medium Term: #4 Reinsurance development; #7 Basel standards for compensation; #8 Insurance pensions markets developments - Conditioned: #5 SUGEF Consolidated Supervision (1); #6 Fitness and properness (2) - Strengthening financial safety nets: - Immediate: #9 Enhance ELA at the BCCR - Medium Term: #10 Capacity building - Conditioned: #11 Crisis management framework (3); #12 Implementing DGF, including P&A (3) - Strengthening the monitoring of financial stability: - Immediate: #13 Development of a responsibility matrix; #14 Stress testing including insurance and pensions; #15 STA’s BSA Assessments - Mitigating risks related to high dollarization: - Immediate: #16 Design measures and enhance analytical tools; #17 Assess and recalibrate macroprudencial measures - Fostering secondary markets: - Immediate: #18 Price formation - Conditioned: #19 Modernize trading (4); #20 Resilience of post trading (4) - Advancing the national agenda for financial deepening and inclusion: - Medium Term: #21 Advance NSFI and NSFE (5) - Conditioned: #22 Data collection; #23 SUGEF regulatory perimeter; #24 Consumer protection - Priority classifications: HIGH, MEDIUM-HIGH, MEDIUM - Notes on conditioned TA: - (1) passing of the law on consolidated supervision; - (2) passing the legal amendments to fitness and properness; - (3) passing the law on deposit insurance and bank resolution; - (4) political commitment to act upon; - (5) concluding the external diagnosis commissioned by the BCCR. ### Annex I — Mission findings by area (MCM expertise) - Banking Supervision and Regulation, Jose María Lamamié de Clairac: - Identified serious weaknesses in the general framework for supervision; most critical: absence of a legal framework for consolidated supervision, limited adequacy and effectiveness of corrective actions, and an incomplete and barely dissuasive sanctioning regime. - Insurance and Pension Sectors, Rodolfo Wehrhahn: - Identified main vulnerabilities in regulation and supervision that could materialize within the next two to three years; provided detailed discussion of authorities’ ability to supervise and key areas for improvement. - Situation of the Secondary Market of Public Debt, Ignacio Santillán: - Identified significant lack of liquidity in secondary markets, misalignment of primary market practices with secondary market liquidity needs, deficient price formation, and a rigid trading environment; recommendations made on these topics. - Monitoring of Financial Stability, André Caccavo: - Discussed challenges for the newly created FSC operating without effective powers and no clear separation between microprudential supervision and macroprudential monitoring. - Financial Stability and Monetary Policy Challenges under Dollarization, Paul Castillo: - Analyzed high dollarization of credit and deposits, increasing solvency and liquidity risks; recommended properly calibrated macroprudential and monetary policy instruments, including foreign exchange intervention, to reduce dollarization. - Deposit Insurance, Bank Resolution, and Crisis Management, James Hambric: - Reviewed law and plans to establish a deposit guarantee fund; recommended improvements to governance and operations, implementation of purchase and assumption resolution transactions to avoid suspending bank operations, implementation of an emergency liquidity facility at BCCR, and establishment of a formal crisis management protocol assigning roles and responsibilities. - Financial Deepening and Inclusion, Cristina Pailhé: - Reviewed institutional framework supporting financial inclusion; identified need for a NSFI and a national coordination mechanism, a robust financial inclusion data infrastructure, challenges from the shadow banking sector, review of existing providers and products, and the need for a common, harmonized framework for consumer protection in the regulated financial sector. ### Annex II — FSIs compiled by Costa Rica and Balance Sheet Approach (BSA) findings - Costa Rica disseminates the 12 core FSIs and one of the 28 FSIs encouraged by the IMF. SUGEF compiles the FSIs using the IMF’s Financial Soundness Indicators Compilation Guide with STA assistance. The 13 FSIs correspond exclusively to deposit takers (DTs). - Coverage of DTs in FSIs (percent of total assets of DTs): - state-owned commercial banks: 40.5 percent - banks created by special laws: 10.8 percent - private banks: 30.8 percent - nonbank financial corporations: 1.1 percent - savings and loan cooperatives supervised by SUGEF: 9.9 percent - mutual savings and loans: 3.9 percent - one savings and loan institution: 3.4 percent - Table 01: Costa Rica Financial Soundness Indicators for Deposit Takers (percent unless stated otherwise; DC: Domestic consolidation basis) - 1 Regulatory Capital to Risk-Weighted Assets (DC): 2015M12 16.2; 2016M12 16.4; 2017M06 16.1 - 2 Regulatory Tier 1 Capital to Risk-Weighted Assets (DC): 2015M12 12.6; 2016M12 12.2; 2017M06 12.5 - 3 Non-performing Loans Net of Provisions to Capital (DC): 2015M12 -2.0; 2016M12 -4.1; 2017M06 -5.1 - 4 Non-performing Loans to Total Gross Loans (DC): 2015M12 1.7; 2016M12 1.6; 2017M06 1.7 - 5 Sectoral Distribution of Total Loans: Residents (DC): 2015M12 99.4; 2016M12 99.8; 2017M06 99.8 - 5 Sectoral Distribution of Total Loans: Deposit-takers (DC): 2015M12 5.9; 2016M12 5.5; 2017M06 5.3 - 5 Sectoral Distribution of Total Loans: Central bank (DC): 2015M12 ...; 2016M12 ...; 2017M06 ... - 5 Sectoral Distribution of Total Loans: Other financial corporations (DC): 2015M12 ...; 2016M12 ...; 2017M06 ... - 5 Sectoral Distribution of Total Loans: General government (DC): 2015M12 9.9; 2016M12 9.9; 2017M06 10.4 - 5 Sectoral Distribution of Total Loans: Nonfinancial corporations (DC): 2015M12 33.7; 2016M12 34.4; 2017M06 34.1 - 5 Sectoral Distribution of Total Loans: Other domestic sectors (DC): 2015M12 49.8; 2016M12 50.0; 2017M06 50.0 - 5 Sectoral Distribution of Total Loans: Nonresidents (DC): 2015M12 0.2; 2016M12 0.2; 2017M06 0.2 - 6 Return on Assets (DC): 2015M12 1.0; 2016M12 0.9; 2017M06 0.7 - 7 Return on Equity (DC): 2015M12 7.3; 2016M12 6.3; 2017M06 5.2 - 8 Interest Margin to Gross Income (DC): 2015M12 60.2; 2016M12 55.6; 2017M06 53.8 - 9 Non-interest Expenses to Gross Income (DC): 2015M12 66.4; 2016M12 64.4; 2017M06 63.0 - 10 Liquid Assets to Total Assets (Liquid Asset Ratio) (DC): 2015M12 28.6; 2016M12 27.8; 2017M06 28.3 - 11 Liquid Assets to Short Term Liabilities (DC): 2015M12 130.3; 2016M12 132.4; 2017M06 132.5 - 12 Net Open Position in Foreign Exchange to Capital (DC): 2015M12 22.4; 2016M12 24.0; 2017M06 23.9 - 13 Capital to Assets (encouraged FSI) (DC): 2015M12 9.7; 2016M12 9.4; 2017M06 9.5 - Notes: (-) Indicates that a figure is zero / (...) Indicates a lack of statistical data that can be reported or calculated from underlying observations - Recommendation 1: - The Costa Rican authorities should increase the number of FSIs compiled and disclosed on the IMF’s website. To implement the increase, SUGEF and the BCCR must work in a coordinated manner to structure and validate the information required for compiling the additional FSIs. - Recommendation 2: - The Costa Rican authorities should increase the information reported in the metadata files to foster better understanding of the regulations related to compilation and analysis of FSIs. Include references and/or links to SUGEF’s regulatory standards in “Definition Comments” and “Regulatory Framework Comments,” and mention amendments to regulatory standards that impact FSIs (e.g., new general provisioning requirements introduced in 2013). - BSA and intersectoral matrices: - Costa Rica has made progress generating intersectoral financial position matrices consistent with the BSA. The BCCR submitted matrices using national accounts for the public sector and sectoral balance sheets of financial institutions (DTs and other financial corporations). - BCCR notes that capturing nonfinancial sector positions in the sectoral matrices would require about one month’s work and would need standardized forms and automation for periodic generation. - Table 02: Additional FSIs that could be compiled by SUGEF and BCCR: - Deposit Takers: 1 Large Exposures to Capital; 2 Trading Income to Total Income; 3 Personnel Expenses to Non-interest Expenses; 4 Customer Deposits to Total (Non-interbank) Loans; 5 Foreign-Currency-Denominated Loans to Total Loans; 6 Foreign-Currency-Denominated Liabilities to Total Liabilities - Other Financial Corporations: 7 Assets to Total Financial System Assets; 8 Assets to Gross Domestic Product (GDP) - Households: 9 Household Debt to GDP - Real Estate Markets: 10 Residential Real Estate Loans to Total Loans - Recommendation 3: - The BCCR, in coordination with CONASSIF and the FSC, should examine the feasibility of periodically preparing intersectoral matrices (complete information) using the BSA Matrix and incorporating analysis of these matrices as an additional tool for monitoring financial stability and the Costa Rican economy. The FSSR identified intersectoral financial relationships that could be sources of vulnerability: - (1) public sector financing needs met by depository corporations and other financial corporations; - (2) currency mismatches initially faced by the financial system and then transferred to the nonfinancial sector (by granting loans in dollars to agents that do not generate foreign currency); - (3) households as principal creditors in the financial system (deposits, investments, and pension contributions); - (4) increasing indebtedness of some sectors of the economy. - Table 03: Costa Rica Matrix of Intersectoral Asset and Liability Positions (End of June 2017, In millions of Colones) — selected totals and structural notes: - TOTAL * (Claims and Liabilities across sectors): 69,919,037 (both claims and liabilities) - TOTAL * In domestic currency: 41,157,479 (claims and liabilities) - TOTAL * In foreign currency: 28,761,558 (claims and liabilities) - Source note: BCCR - BSA Matrix; (*) Not completed information (nonfinancial private sector and nonresidents positions only include reported information by central bank and financial sector) *Source: cr1880-costaricafianciasectorreview - 96. TA to advance the agenda on financial deepening and inclusion is recommended in* ### Annex III. Costa Rica: Detailed FSSR Technical Assistance Roadmap ### Annex III. Costa Rica: Detailed FSSR Technical Assistance Roadmap ### Strengthening Financial Regulation and Supervision - Priority: HIGH PRIORITY (banking, insurance, pension) and other specified priorities per topical area. - Key vulnerabilities: - Insufficient implementation of an effective approach to risk-based supervision (Banking, Insurance, Pension). - Current organic law of the BCCR does not allow effective consolidated supervision (Banking regulation and supervision). - The law regulating the securities market does not provide powers to request changes in boards and senior management (Financial regulation and supervision). - Gaps with international standards provide room for unhealthy practices and regulatory arbitrage (Banking regulation). - Improper use of reinsurance to hide insolvencies; Insufficient reinsurance protection (Insurance). - Sustainability issues of mandatory insurance; entry barriers for private sector too high (Insurance and pension). - Strategic TA objectives: - Effective prudential risk-based supervision. - Improved regulation and supervision. - Resilient insurance sector; Pension competition. - Set out roadmaps for the progressive implementation of Basel II/III and of international standards on remunerations. - Technical assistance activities (by topical area): 1. Banking supervision (IMMEDIATE) - Define the risk appetite of the supervisor. - Provide assistance in the development of regulations on risk management that are still lacking. - Provide support for the analysis of which macroprudential inputs could be considered in the supervisory planning process and incorporate these into the relevant risk-based supervision guidelines. - Contribute to the analysis and redesign of the elements of the risk matrix. - Responsible authority: SUGEF 2. Insurance supervision (IMMEDIATE) - Define the risk appetite of the supervisor. - Building on the risk-based approach, provide capacity to supervisors and the market, including the courts. - Align the supervisory structure and resources for an optimal RBS. - Calibrate risks and capital aligned with the risk appetite definition. - Calibrate the early warning systems to the Costa Rican market conditions. - Create consistency in the risk classification. - Contribute to develop a limited set of prompt corrective actions. - Improve the risk-based onsite inspections framework. - Suggest and implement adjustments to the supervisory system. - Responsible authority: SUGESE 3. Pension supervision (IMMEDIATE) - Define the risk appetite of the supervisor. - Provide capacity building on the risk-based approach. - Define risk-based minimum capital according to risk management, for second pillar managers. - Suggest and implement adjustments to the supervisory system. - Responsible authority: SUPEN - Note: TA projects #1, #2, and #3 have to be conducted in a coordinated manner with the strategic objective of strengthening consistently the RBS approach across the supervision of the different sectors. Securities can also be considered in this consistent approach to RBS based on a sufficient definition of the supervisors’ risk appetites. 4. Insurance supervision — reinsurance (MEDIUM-TERM) - Analyze the existing reinsurance contracts. - Provide capacity building on the supervision on the use reinsurance. - Develop a supervisory guide on the use of reinsurance. - Carry out the onsite inspections using the supervisory guide. - Responsible authority: SUGESE 5. Banking regulation and supervision (Within six months after the draft law on consolidated supervision is approved) - Assist in the development of regulations improving the transfer of significant ownership regime and establish a regime of prior authorization for bylaw changes applicable to all supervised institutions. - Assist in the development of regulations complementing the current regime of capital adequacy measurement, to include the consolidated basis, and in the revision of the supervisory information package, to adapt it to consolidated supervision. - Responsible authority: SUGEF 6. Financial regulation and supervision (Within 12 months after the draft law amendments on fitness and properness are approved) - Assist in the review of the design and contents of SUGEF, SUGEVAL, SUPEN, SUGESE Roles Register to adapt it to become a supporting tool in the new ex ante regime for the assessment of fitness and properness. - Training may also be provided on fitness and properness ex ante assessment. - Responsible authorities: SUGEF, SUGEVAL, SUGESE, SUPEN 7. Banking regulation — Basel II/III and remuneration standards - Assist in the analysis of the potential impact of Basel II/III framework and in the design of the roadmap for its progressive implementation. - Assist in the analysis of the potential impact of Basel Committee’s disclosure standards on remuneration and in the design of the roadmap for its progressive implementation. - Training may also be provided on remuneration practices. - Responsible authority: SUGEF 8. Insurance and pension — mandatory products and competition - Carry out an actuarial assessment of the reserves of the two existing mandatory products. - Suggest changes to the products and to the operating process, including the distribution, claims assessment, and benefit payments. - Create data structure to measure costs by product and a model to estimate the administrative fee for pension managers, II Pillar. - Promote pension competition and analyze entry barriers. - Provide support with drafting the regulations for a modern market conduct regulation and supervision. - Responsible authorities: SUGESE, SUPEN ### Strengthening Financial Safety Nets - Priority: HIGH PRIORITY for crisis management, deposit insurance, crisis management and bank resolution. - Key vulnerabilities: - Ineffective emergency liquidity facility at BCCR. - Lack of practical experience in Costa Rica with deposit insurance, crisis management and bank resolution. - Lack of a well-articulated crisis management arrangement. - Potential loss of public confidence resulting in delays in payment of depositors in the event of a bank failure. - Strategic TA objectives: - Implementation of an emergency liquidity facility limited to solvent institutions. - Capacity building on bank intervention and resolution. - Establish a framework for crisis management. - Implement a deposit insurance scheme for all deposit-taking institutions and implement P&A resolution transactions to avoid suspending bank operations and delaying payment of insured deposits. - Technical assistance activities: 9. Crisis management — emergency liquidity facility (IMMEDIATE) - Provide consultancy on collateralization and valuation of pledged assets. - Develop a framework to analyze payment system liquidity and operational risks, and introduce mechanisms for prevention and mitigation of systemic liquidity risk. - Responsible authorities: BCCR, SUGEF, FSC 10. Deposit insurance, crisis management and bank resolution (MEDIUM-TERM) - Train on best practices for bank intervention and resolution, including the use of the Purchase and Assumption methodology. - Train, including simulations, on crisis management. - Conduct Bank Resolution Simulation workshop. - Responsible authorities: DGF, SUGEF, BCCR, CONASSIF 11. Crisis management — crisis arrangements (Within three months of the approval of the draft deposit insurance and bank resolution law) - Develop operating policies and establish an inter-government coordinating committee responsible for preparing for and coordinating actions during a financial crisis. - Develop a national contingency plan. - Develop operating procedures for nationalized or bridge bank managers. - Responsible authority: FSC 12. Deposit insurance (Within 3 months of the approval of the draft deposit insurance and bank resolution law) - Develop a project plan to establish the DGF. - Develop policies and operating procedures for a DGF including but not limited to: calculation of premiums, investment policy, fund accounting policies, allocation of cost, provisioning for potential losses, and payment of insured deposits. - Develop resolution planning and practices to ensure prompt payment to insured depositors. - Conduct bank resolution simulation workshop. - Consult on the establishment and operations of a DGF. - Develop staffing plans based on the organizational structure of the DGF. - Develop resolution planning and practices to ensure prompt payment to insured depositors. - Responsible authorities: DGF, SUGEF, BCCR, CONASSIF ### Strengthening the Monitoring of Financial Stability - Priority: HIGH PRIORITY - Key vulnerabilities: - Lack of clarity on the responsibilities of each participant in financial stability. - Insurance and pension often left out in stress analysis. - Current cross-sectoral financial relationships incomplete or unclear. - Strategic TA objectives: - To have a responsibilities matrix between macroprudential, microprudential, fiscal, and monetary issues. - To improve capacities to elaborate stress test for pension and insurance (bottom-up and top-down). - Complete information on cross-sectoral financial relationships (BSA matrix). - Technical assistance activities: 13. Financial Stability — responsibilities matrix (IMMEDIATE) - Articulate a roadmap for the preparation of new systemic risk indicators. - Elaborate a matrix identifying specific responsibilities. - Clarify the interrelationships and concomitant responsibilities between the policy and instruments. - Provide training to participants. - Responsible authorities: BCCR, MoF, CONASSIF 14. Financial Stability — stress testing insurance and pension - Review the data, relevance, and capacities in the central bank and regulated entities. - Develop scenarios, communications, proofs, and strategies. - Analyze the results, improve the tool. - Send feedback to the central bank and regulated entities. - Responsible authorities: BCCR, SUGESE, SUPEN 15. Balance Sheet Approach (BSA) Assessments - Build and validate the sources of information used to compile and update the BSA matrix. - Improve the information used for the construction of nonfinancial sectors’ balance sheets. - Develop skills to assess BSA matrix for detection and measurement of economic vulnerabilities. - Link such assessments with other tools used to monitor financial stability (FSIs, stress testing, etc.). - Responsible authorities: BCCR, SUGEF, CONASSIF ### Mitigating Risks Related to High Dollarization - Priority: HIGH PRIORITY - Key vulnerabilities: - High degree of dollar credit granted to non-generators of dollars (households and non-tradable firms). - Stress on banking sector with regulation on de-dollarization. - Strategic TA objectives: - Reduce significantly the amount of credit to non-generators of dollars. - Measuring the impact of macroprudential measures already taken to calibrate them properly and verify they comply with goal of promoting a gradual but permanent reduction of financial dollarization. - Technical assistance activities: 16. Stability issues under dollarization (IMMEDIATE) - Design measures to encourage de-dollarization. - Assess existing macroeconomic models and develop a plan to incorporate currency mismatches into the models used by the BCCR. - Incorporate foreign exchange sensibility and impact in credit risk. - Measure foreign exchange credit risk in the banks. - Responsible authorities: BCCR, SUGEF, CONASSIF 17. Stability issues under dollarization - Analyze existing regulations on banking sector with the aimed of reducing the dollarization. - Develop tools to measure the impact of these regulations and achievement of results. - Recommend how to improve those measures. - Responsible authorities: BCCR, SUGEF, CONASSIF ### Fostering Secondary Markets - Priority: HIGH PRIORITY (Securities items) - Key vulnerabilities: - Non-reliable price formation process in public debt secondary markets. - Lack of specific trading systems for fixed-income securities. - Lack of robust system to deal with settlement failures in post trading. - Strategic TA objectives: - Overcoming the current rigid valuation system in Public Debt. - Developing a modern and effective trading system for fixed-income securities, including potential measures to increase liquidity, such as market makers. - Increasing the resilience of the post-trading system when dealing with settlement failures. - Technical assistance activities: 18. Securities — valuation (IMMEDIATE) - Provide training on securities valuation techniques in the area of supervision as well as evaluation of alternative valuation methods. - Provide assistance on the evaluation of potential measures to reduce current investors’ and markets’ dependence upon non-market formed prices and values. - Responsible authority: SUGEVAL 19. Securities — trading system (MEDIUM-TERM) - Analyze different fixed-income trading venue models to find the most appropriate for the Costa Rican market. - Provide advice and support in the actual implementation of the trading system, the pricing formation process, and the transparency regime. - Provide recommendations to make the trading system attractive to institutional investors’ needs. - Responsible authority: SUGEVAL 20. Securities — post-trading settlement failures - Undertake analysis, preparation, and implementation measures to deal with cash and securities failures in settlement, placing them in a post-trading environment. - Review the effectiveness of the finality rule. - Responsible authorities: SUGEVAL, BCCR ### Advancing the National Agenda for Financial Deepening and Inclusion - Priority: HIGH PRIORITY (overall), MEDIUM-TERM for some activities. - Key vulnerabilities: - Lack of coordination and leadership regarding financial inclusion. - Weak data structure for financial inclusion. - Weak legal powers to supervise the shadow banking sector. - Weak legal powers for financial consumer protection. - Strategic TA objectives: - Advancing the national agenda for financial deepening and inclusion. - Strengthening the regulatory environment. - Technical assistance activities: 21. Financial deepening and inclusion — NSFI/NSFE roadmap (MEDIUM-TERM) - Design a roadmap for the NSFI and for the NSFE, identifying main steps to be taken. - Help with diagnosis and identify key topics to be included in the NSFI and in the NSFE. - Responsible authorities: BCCR, CONASSIF, SUGEF, SUGESE, SUGEVAL, SUPEN 22. Financial deepening and inclusion — data (no explicit timeframe) - Enhance supply-side data: review existing information and develop a set of key indicators that should be monitored. Suggest relevant dimensions (gender, age, geographic location, other). - Enhance demand-side data: identify key issues to be included in a survey on financial inclusion. Propose a set of specific questions that should be included in a survey. - Responsible authorities: BCCR, CONASSIF, SUGEF, SUGESE, SUGEVAL, SUPEN 23. Financial deepening and inclusion — shadow banking perimeter - Propose amendments to the law to enhance SUGEF’s ability to include institutions under the regulatory perimeter, with a proportionate approach. - Responsible authority: SUGEF 24. Financial deepening and inclusion — consumer protection (Within 12 months after the consumer protection law is enacted) - Review the legal framework to enhance consumer protection, particularly for SUGEF but also for the BCCR; the Ministry of Economy, Industry, and Trade (MEIC); and other superintendencies. - Within 12 months after the consumer protection law is enacted: build a harmonized framework for consumer protection in the regulated financial sector. - Responsible authorities: SUGEF, SUGESE, SUGEVAL, SUPEN, BCCR, MEIC *Annex III. Costa Rica: Detailed FSSR Technical Assistance Roadmap* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1880-costaricafianciasectorreview.pdf_