## 1fsmea2021001 ## Source details **Canonical URL:** [1fsmea2021001](https://www.imf.org/-/media/files/publications/cr/2021/english/1fsmea2021001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1fsmea2021001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1fsmea2021001.pdf.json) --- ### Summary of mission outcomes and priority recommendations - STA provided technical assistance on financial soundness indicators (FSI) to the Federated States of Micronesia Banking Board (FSMBB) during November 2-13, 2020; mission conducted remotely. - Main objectives: - review source data, institutional coverage and accounting and regulatory frameworks supporting FSI compilation; - provide guidance for mapping source data for the banking sector to the FSI reporting templates FS2 and FSD and for improving metadata; - agree timeline to begin regular reporting of FSIs for deposit-takers to STA, conditional on availability and completeness of source data; - agree on timeliness of data reporting. - Prior reporting status and outcomes: - FSM reported 11 core and 6 encouraged FSIs to STA but stopped reporting via the Integrated Collection System (ICS) in 2016Q2; FSMBB continued reporting via the National Summary Data Page (NSDP) with a twenty-month lag and not always consistent with the FSI Guide. - As a result of the mission, FSMBB is now in a position to report quarterly FSIs to STA in line with the 2019 FSI Guide. - Mission compiled, with FSMBB staff, 18 FSIs for deposit takers (DTs) and two FSIs on the size of OFC’s sector from available source data. - Coverage includes 2 commercial banks covering the entire DTs sector other than credit unions. - FSIs compiled cover capital adequacy, asset quality, earnings and profitability, and liquidity for DTs. - Data access and validation: - Mission had access to aggregate DT data for March 2006 to June 2020 and bank-by-bank data for June 2020; assisted FSMBB in mapping to the FSI workbook and validating aggregated data for June 2020. - Reviewed balance sheet, income statement, and supervisory data from March 2006 to June 2020 and made recommendations to improve source data collection. - Identified discrepancies and necessary corrections: - Series with discrepancies include sectoral distribution of loans, nonperforming loans (NPLs) net of provisions to capital, capital to risk weighted assets ratios, return on equity and liquid assets. - FSMBB recommended to compile FSIs in line with the 2019 FSI Guide and address observed data discrepancies before submission to STA. - Shortfalls to be addressed: - strengthen collection of liquid assets, customer deposits, risk weighted assets and regulatory capital series; - strengthen FSMBB validation and reconciliation among different call reports to ensure consistency, accuracy and completeness; - clarify definition of capital and reserves and specific provisions in the balance sheet. - Reporting timetable and dissemination: - Timeframe for reporting FSI data and metadata to the IMF discussed and agreed. - FSMBB staff could compile quarterly FSIs for DTs using mission-developed workbook and agreed to report FSI data and metadata to STA for dissemination on IMF’s FSI website. - As of November 2020, 143 countries’ FSI data are disseminated on the FSI website. ### Priority recommendations and agreed target dates - January 2021: - Implement quality control checks for data submitted by commercial banks and closely work with them to explain reporting requirements and resolve data discrepancies. — Responsible: FSMBB. - February 2021: - Finalize and report to STA for review the FSI sectoral financial statements (FS2 template) for DTs (balance sheets, income statements, memorandum series), the sectoral FSIs with underlying series (FSD template) for DTs with quarterly data beginning from 2006: Q1, the FSI institutional coverage (FS1 template) with annual data starting from 2006, and the FSI metadata (FSM template). — Responsible: FSMBB. - March 2021: - Start regular reporting to STA for dissemination on IMF’s FSI website of the FSD and FS2 templates with quarterly data starting from 2006: Q1, and the FS1 template with annual data starting from 2006; also report the FSM template periodically. — Responsible: FSMBB. - Selected additional high-priority milestones: - Align the sectoral classification of deposits (SS 1B form) with the 2019 FSI Guide. — 06/30/2021. - Collect data on the amount of specific provisions set aside for nonperforming loans in the Criticized Assets Call Report (Report No. 5). — 06/30/2021. - Clarify the definition of capital and reserves in the balance sheet and collect additional information on the subcomponents of capital and reserves. — 06/30/2021. - Provide a definition of nonperforming loans in Report No. 5 in line with the 2019 FSI Guide and eliminate partial reporting of NPLs based on collateralization. — 06/30/2021. - Calculate the spread between the reference lending and deposit rates using the template provided once data quality issues are resolved (Report No. 6.A). — 06/30/2021. - Provide clear instructions to banks to properly fill-in their Tier-1 capital in the call report (Report No. 3). — 12/31/2021. - Introduce a comprehensive definition of risk weighted assets and the necessary call report to collect additional information on capital adequacy ratios. — 12/31/2021. - Collect information on the maturity profile of assets and liabilities with a specific call report. — 12/31/2021. - Define liquid assets and collect data in line with the 2019 FSI Guide definition. — 12/31/2021. - Selected medium priority actions (target completion date 12/31/2021): - Revise the balance sheet call report (Report No. 1) to incorporate financial derivatives on both the asset and liability sides. - Collect memorandum items with detail of accrued interest by instrument. - Collect residential real estate and commercial real estate loans data in line with the 2019 FSI Guide definitions. - Collect other comprehensive income (OCI) data. - Collect call reports in electronic format. ### Background, institutional setting and COVID-19 impact - First STA mission on FSIs specifically for FSMBB; prior FSI workshops delivered in Fiji in 2015 and 2016 for Pacific Island countries. - Supervisory and legal framework: - FSMBB regulates and supervises commercial banks; FSMDB and credit unions are not regulated or supervised by FSMBB. - Banking Regulatory Reform project initiated July 2017; PFTAC and IMF Legal Department providing TA to review FSM Bank Act and bring FSMDB and credit unions under FSMBB surveillance and develop prudential regulations. - Deposit insurance and reporting ties: - Deposit takers insured by FDIC under the Compact of Free Association (CFA); Bank of FSM (BFSM) and Bank of Guam (branch) covered. - Deposit takers subject to regulatory reporting to the Federal Financial Institutions Examination Council (FFIEC). - Compact of Free Association (CFA): - CFA approved December 17, 2003 for 20 years; FSMBB optimistic about renewal in 2023; failure to renew could create important strains on FSM’s banking sector. - COVID-19 impact: - FSM economy negatively affected; tourism and related industries most affected. - FSMBB assessed effect on banking sector as manageable; FSIs have not shown financial stability risks stemming from Covid-19. - One commercial bank implemented a voluntary blanket moratorium of consumer loans and personal credit cards between May and July 2020. ### FSM financial system structure and key statistics (as of June 2020) - Financial system composition: - 2 deposit takers, 1 development bank, 32 insurers and 5 credit unions. - Aggregate assets (excluding insurance companies, the pension fund and credit unions): USD 479,7 million. - Asset shares: - Commercial banks constitute around 85 percent of this total. - FSM Development Bank (FSMDB) holds 15 percent share. - There is no central bank in the FSM. - Table 2 highlights (source: FSMBB; Nominal GDP based on end-2018): - Commercial Banks: Number of institutions: 2; Total assets (In Millions USD) June 2020: 411.4; Total assets (Percent of Nominal GDP**): 102. - o/w domestically controlled: 1; 196.8; 49. - o/w branches of foreign banks: 1; 214.6; 53. - Development banks: Number of institutions: 1; Total assets (In Millions USD) June 2020: 68.3; Total assets (Percent of Nominal GDP**): 17. - Other deposit takers: Number of institutions: 5; Total assets (In Millions USD) June 2020: 4.1*; Total assets (Percent of Nominal GDP**): 1. - Insurance: Number of institutions: 32; Total assets: NA. - o/w life and nonlife insurance: 7; NA. - o/w captive insurance: 25; NA. - Pension funds: Number of institutions: 1; Total assets: NA. - Note: * Data for the largest credit union based on FSMBB survey conducted in 2019. - Deposit taker details: - Bank of FSM (BFSM): domestically incorporated; central government owns 24 percent; deposits insured by FDIC under the CFA. - Bank of Guam – FSM Branch (BoG): branch of BoG (headquartered in Guam); as of 2020Q2 holds more than 50 percent of the total assets and total deposits in FSM deposit taker’s sector. - Credit unions: 5 credit unions accept deposits and extend loans only to members; excluded from Micronesia Bank Act and not subject to oversight by FSMBB; work ongoing to bring credit unions under FSMBB oversight. ### Consolidation basis, accounting and regulatory frameworks - Consolidation basis: - FSIs for DTs compiled on a domestic location (DL) basis (includes resident DTs and resident branches of foreign deposit takers); DL basis appropriate for FSM. - Legal/reporting basis: - Sections 604 and 605 of FSM Bank Act authorize FSMBB to require banks to submit regular and special reports. - Banking Supervision Policy No.1 (Call Reports) issued August 8, 1995 requires banks to submit certain call reports. - Accounting standards: - Commercial banks prepare financial statements in accordance with United States Generally Accepted Accounting Principles (US GAAP). - Accrual accounting used; accrued interest is calculated but not included with value of underlying instrument. - Nonperforming loans and provisioning: - NPLs defined when one or more contractual payments past due for 90 days or more; classification categories: “Standard”, “Special Mention”, “Substandard”, “Doubtful” and “Loss”. - Minimum specific provisioning requirements: Substandard 20 percent, Doubtful 50 percent, Loss 100 percent. - CoL documents do not specify general provisions for performing asset categories and do not introduce past due date backstops for asset categories. - FSMBB cooperating with PFTAC and IMF Legal to update credit classification and provisioning rules. - Capital adequacy and leverage: - No regulatory framework for computation of capital adequacy ratios; capital adequacy requirement introduced through Conditions of License (CoL) documents. - Bank required to maintain a 15 percent Tier-1 Capital Adequacy Ratio. - Risk Weighted Assets (RWA) calculated as required for reporting to the FFIEC Call Report Form 041; banks provide copy to FSMBB. - Tier-1 capital defined in Call Report No.3 as equity capital adjusted by deducting goodwill and intangibles, current year operating losses after tax not already deducted, and amount of loans classified as Loss not fully charged off against specific provisions. - Work ongoing concerning adoption of Basel-III definition for regulatory capital to introduce Common-Equity Tier-1. - FSMBB call reports do not define Tier 2 capital; Tier-1 equals total regulatory capital; items that would be Tier-2 under Basel-I are excluded. - CoL documents require a 6 percent minimum leverage ratio defined as Tier 1 Capital / Total Assets. - Risk reporting gaps: - No regulations or reporting requirements yet for liquidity risk, large exposures, or market risk (net open position in foreign currency). - Recommendation to enhance regulatory and reporting framework to measure and supervise liquidity risk, market risk and large exposures. ### Source data and reporting forms, frequency and data quality issues - Source data include income and expense statements, balance sheets and other call reports covering capital adequacy, leverage ratio, deposit structure, nonperforming assets, and provisioning. - Data frequency and timeliness: - Quarterly reporting; quarterly call reports due within 30 days of period end. - Reporting forms used for FSIs (Quarterly): - Report No. 1 Consolidated Balance Sheet - Schedule No.1A Loans, Leases and other Extensions of Credit - Schedule No. 1B Deposits - Report No. 2 Off-Balance Sheet Activity - Report No. 3 Capital Adequacy Analysis (Local Bank Only) - Report No. 5 Criticized Assets - Report No. 6 Consolidated Statement of Income and Expenses - Schedule No. 6A Supplemental Detail to Consolidated Statement of Income and Expenses - Data quality issues identified: - Provisioning figures in Report No. 5 do not match balance sheets for certain periods. - Weighted average lending rate and weighted average deposit rate missing for some banks. - Deposits in Supplementary Schedule 1B do not always align with balance sheet data. - Recommendations: - Implement quality control checks for bank-submitted data and explain reporting requirements to resolve discrepancies. - Start collecting call reports electronically to enhance timeliness and quality. ### Compilation framework and indicators compiled - Mission developed compilation spreadsheets mapping source data to IMF’s 2019 FSI Guide sectoral financial statement template using bridge tables; provided to FSMBB. - Indicators compiled with mission assistance: - 11 core FSIs and 7 additional FSIs for deposit-takers, plus two additional FSIs relating to the size of OFC subsectors. - Core FSIs not compiled include: - common equity tier 1 capital to risk-weighted assets - liquidity coverage ratio - net stable funding ratio - net open position in foreign exchange to capital - liquid assets to short term liabilities - residential and commercial real estate prices - Additional FSIs not available include: - large exposures to capital - spread between reference lending and deposit rates - spread between highest and lowest interbank rate - geographical distribution of loans to total loans - credit growth to the private sector - Provisions FSI: - New core FSI on provisions to nonperforming loans not compiled, but can be calculated as specific provisions divided by nonperforming loans. - Differences versus FSMBB existing FSIs stem from 2019 FSI Guide methodology (e.g., disaggregation of specific provisions, categorizing DT claims on another DT as interbank loans, annualization of income/expense, averaging capital and total assets). - Mapping notes and recommendations: - Call Report No.6 categorizes dividends on investments under interest income; 2019 FSI Guide recommends such dividends be non-interest income for equity stakes. - Chapter 6 section 618 of FSM Banking Law prohibits domestic banks from investing in stock of any other corporation. - Recommendation to align sectoral classification of deposits (SS 1B form) with 2019 FSI Guide. - Report No. 1 requires investment and securities together; FSI templates require debt securities disaggregated from shares and other equity. ### Accrual accounting, accrued interest and memorandum items - Key finding: - Accrual accounting used, but accrued interest is not included with the value of underlying instruments. - In Report No. 1, accrued interest included on asset side and on liability side under Other Liabilities. - Values are not significant: asset side 0.1-0.2 percent of total assets and liability side 0.2 percent of total liabilities. - Guide recommends including accrued interest not yet payable as part of underlying instrument; detailed data unavailable to map accrued interest to instruments. - Recommendation: - FSMBB to collect memorandum items with detail of accrued interest by instrument (Report No. 1). ### Loan loss provisions and nonperforming loans (NPLs) - Findings on provisions: - Provisions reported in Report No. 1 but specific and general provisions not readily available. - Mission estimated specific provisions by applying provisioning rates Substandard 20 percent, Doubtful 50 percent, Loss 100 percent to respective loan amounts and mapped remainder as general provisions. - Recommendation: - FSMBB to collect amount of specific provisions set aside for nonperforming loans in Report No. 5. - NPLs: - NPLs defined as payments past due for 90 days or more. - Report No. 5 allows loans to be split between fully secured portion and remaining portion and reporting only remaining portion under ‘Loss’ — may lead to underreporting. - Definition of NPLs not clearly provided in Report No. 5. - Recommendation: - FSMBB to provide NPL definition in Report No. 5 in line with 2019 FSI Guide and eliminate partial reporting of NPLs based on collateralization. ### Accumulated depreciation - Finding: - Accumulated depreciation collected under ‘other liabilities’ but should be contra asset reducing assets. - Mapped as contra asset to ‘Nonfinancial Assets’, reducing reported total assets by 1.3 percent as of 2020Q2. - Recommendation implied: - Correct treatment to reflect as contra asset in balance sheet. ### Capital and reserves; regulatory capital - Findings: - Capital and reserves available through consolidated balance sheet without disaggregation. - Consolidated Balance Sheet call report incorrectly includes subordinated debt in Capital and Reserves. - 2019 FSI Guide defines Capital and reserves as equity interest (difference between total assets and liabilities) including funds contributed by owners, retained earnings, current year result and general and special reserves. - Need to distinguish balance sheet capital and reserves from regulatory capital used for regulatory ratios; collect subcomponents of capital and reserves. - Recommendation: - FSMBB to clarify definition of capital and reserves in the balance sheet and collect subcomponents (Report No. 1). ### Financial derivatives - Finding: - Balance sheet does not include financial derivatives; commercial banks do not engage in derivatives so omission has no current consequences. - Recommendation: - Revise Report No. 1 to incorporate financial derivatives on asset and liability sides to be ready if activity occurs. ### Supervisory series — Regulatory Capital and Risk Weighted Assets (RWA) - Findings: - Capital adequacy ratios calculated using national definition of Tier-1 capital and FFIEC definition for RWAs. - Regulatory capital comprises Tier-1 only; Report No. 3 lacks clear guidance on capital elements and does not specify RWA calculation. - RWAs currently obtained via Schedule RC-R Part I – Regulatory Capital Components and Ratios (FFIEC). - FFIEC call report suggests Basel-III approach used for capital adequacy ratios. - FSMBB needs to develop its own report forms and preferred methodologies for RWA given possible CFA discontinuation beyond 2023. - Recommendations: - Provide clear instructions to banks to fill-in Tier-1 capital in Report No. 3. - Introduce a definition of risk weighted assets and the necessary call report to collect capital adequacy data. ### Liquidity indicators and maturity data - Findings: - FSMBB does not have a definition of liquid assets. - 2019 FSI Guide defines liquid assets as: (i) currency; (ii) deposits and other financial assets available on demand or within three months or less; and (ii) securities traded in liquid markets. - Components for FSIs derived from balance sheet: currency, cash items in process of collection, demand/overnight deposits with local and foreign banks, and securities abroad (mainly US Treasury and US Government Agency securities). - No local securities market in FSM. - Data gaps: - Short term liabilities series missing; production requires maturity schedule of liabilities and assets. - Recommendations: - Define liquid assets and collect data in line with 2019 FSI Guide. - Collect information on maturity profile of assets and liabilities with a specific call report. ### Large exposures and net open position in foreign currencies - Large exposures: - Defined as exposures >= 10 percent of eligible capital base; FSMBB has not introduced definition yet. - Internal work ongoing with PFTAC and IMF Legal to introduce definition. - Net open position in foreign currencies: - Can be calculated on-balance sheet or on- and off-balance sheet (latter preferred). - FSMBB does not require reporting of net open positions; memorandum items suggest exposures are insignificant. - FSMBB should be prepared to require reporting if foreign exposures increase. ### Spread between reference lending and deposit rates - Findings: - FSMBB receives average lending and deposit rate data via Report No. 6.A; data for one bank missing. - Mission provided a template to calculate the spread once data gap filled. - Recommendation: - Calculate spread between reference lending and deposit rates using provided template (Report No. 6.A) once data quality issues resolved. ### Real estate markets - Findings: - FSMBB collects loans collateralized by real estate and defines real estate credit accordingly. - 2019 FSI Guide distinguishes residential and commercial real estate loans; FSMBB lacks disaggregated data to compile those FSIs. - Recommendation: - Collect residential and commercial real estate loans data in line with 2019 FSI Guide. ### New FSI report forms and income statement items - Findings: - Extraordinary income/expenses should be mapped to other income/other expenses as per 2019 FSI Guide. - Provisions on performing loans and other assets currently mapped to other liabilities; should be reported under “General and other provisions” when new FSI report forms introduced. - 2019 FSI Guide recommends reporting other comprehensive income (OCI) as an additional line item; commercial banks report OCI in financial reports. - Recommendation: - FSMBB to collect OCI data. ### FSI metadata - Findings: - Metadata essential for interpretation and cross-country comparisons; deviations from 2019 FSI Guide should be explained. - Mission developed FSI metadata for DTs and two additional FSIs on size of OFC subsectors; metadata Excel file prepared for reporting to STA. - Recommendation: - Update metadata whenever changes occur to accounting/regulatory frameworks or call report instructions underlying source data. ### FSI data and metadata reporting - Findings: - FSMBB aims to regularly report sectoral FSIs to IMF with quarterly frequency, subject to management approval. - FSMBB can compile and report all 11 core and 7 additional FSIs for deposit-takers and two additional FSIs on OFC subsectors quarterly. - Underlying data available from 2006. - Mission completed FS1 institutional coverage template with DT counts, branches, ownership split and total assets; FS1 should be reported to IMF for dissemination. - Recommendations: - Finalize and report FS2, FSD, FS1 and FSM metadata templates to STA for review and posting; start regular reporting with quarterly data starting from 2006:Q1 for FSD and FS2 and annual data from 2006 for FS1. ### FSIs for Other Financial Corporations (OFCs) and insurance - Findings: - Two FSIs for OFCs compiled: OFC financial assets to total financial assets and OFC financial assets to gross domestic product. - OFC sector (solely FSMDB) accounts for 15 percent of reported assets of financial system. - Data on total assets for insurance sector unavailable. - Recommendation: - Monitor developments in OFC sector given FSMDB’s role in extending credit and importance of captive insurance sector. ### Resources, training and other issues - Recommendation: - Support FSMBB officials’ participation in IMF FSI training courses to improve methodological knowledge and compilation/interpretation skills. - Other issues: - FSM still reporting MFS data via non-standardized forms; FSMBB informed on importance of standardized forms. - FSM timely reporter to Financial Access Survey (FAS) but currently reports 29 of the 121 FAS series; encouraged to increase coverage (include credit unions, gender-disaggregated data, mobile/internet banking). ### Appendix I — Selected FSIs (Dec-16 to Jun-20) (Core FSIs, In percent) - Regulatory capital to risk-weighted assets: 24.79, 27.03, 35.47, 37.63, 33.27, 33.89, 35.24, 34.22 - Regulatory Tier 1 capital to risk-weighted assets: 24.79, 27.03, 35.47, 37.63, 33.27, 33.89, 35.24, 34.22 - Nonperforming loans net of provisions to capital: 10.35, 7.96, 3.75, 3.77, 3.25, 1.63, 1.93, 1.17 - Nonperforming loans to total gross loans: 1.08, 0.69, 0.35, 0.36, 0.31, 0.17, 0.33, 0.58 - Sectoral distribution of loans — Residents: 17.69, 14.95, 17.16, 15.90, 17.15, 16.06, 17.22, 15.14 - Sectoral distribution of loans — Nonresidents: 82.31, 85.05, 82.84, 84.10, 82.85, 83.94, 82.78, 84.86 - Return on assets: 1.03, 1.06, 1.05, 1.58, 1.80, 1.97, 1.98, 1.19 - Return on equity: 13.91, 15.35, 15.18, 23.07, 25.59, 26.99, 26.23, 15.45 - Interest margin to gross income: 83.01, 84.55, 84.13, 86.35, 86.98, 87.04, 86.59, 86.45 - Noninterest expenses to gross income: 65.28, 58.92, 56.42, 53.03, 49.77, 46.92, 46.95, 57.55 - Liquid assets to total assets: 56.44, 55.24, 58.64, 55.79, 61.12, 59.57, 62.24, 59.10 ### Appendix I — Additional FSIs (selected) - Capital to assets: 6.29, 5.95, 6.21, 5.84, 6.02, 5.98, 6.11, 5.95 - Gross asset position in financial derivatives to capital: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 - Gross liability position in financial derivatives to capital: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 - Trading income to total income: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 - Personnel expenses to noninterest expenses: 44.49, 46.23, 45.34, 46.22, 45.57, 45.23, 45.88, 48.94 - Customer deposits to total (noninterbank) loans: 376.4, 429.9, 416.3, 456.1, 422.0, 451.0, 418.6, 471.3 - Foreign-currency-denominated loans to total loans: 1.89, 0.71, 0.00, 0.00, 0.00, 0.16, 0.16, 0.14 - Foreign-currency-denominated liabilities to total liabilities: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 ### Appendix I — OFCs - OFC's financial assets to total financial assets: 14.72, 14.73, 15.38, 14.18, 14.38, 13.97, 14.85, 14.44 - OFC's financial assets to gross domestic product: 16.04, 17.77, 14.93 ### Appendix III — Selected methodological changes recommended (by indicator) - Total Capital to RWA / Tier 1 Capital to RWA: - Provide clear instructions to banks to properly fill-in Tier-1 capital in call report. - Introduce RWA definition and necessary call report to collect additional capital adequacy reporting. - NPLs net of provisions to capital: - Subtract only specific provisions from numerator; use regulatory capital as denominator. - Return on Assets (ROA) / Return on Equity (ROE): - Use annualized net income before tax for ROA and after tax for ROE; aggregate numerator and average denominator per guidance. - Liquid assets to total assets / to short-term liabilities: - Introduce liquid assets definition in line with 2019 FSI Guide and collect maturity profile to compute short-term liabilities. - Spread between reference lending and deposit rates: - Use provided template once complete data available. - Customer deposits to total non-interbank loans: - Align sectoral classification of deposits with 2019 FSI Guide. - Residential and commercial real estate loans to total loans: - Collect data per 2019 FSI Guide definitions. ### Appendix III — Comparison of selected FSIs (Mission vs FSMBB calculations, selected values) - Regulatory capital to risk-weighted assets: - Dec-17 (Mission): 35.47; Dec-18 (Mission): 33.27 - Dec-17 (FSMBB): 39.10; Dec-18 (FSMBB): 33.30 - Difference: Dec-17: -3.63; Dec-18: -0.03 - Nonperforming loans net of provisions to capital: - Dec-17 (Mission): 3.75; Dec-18 (Mission): 3.25 - Dec-17 (FSMBB): -4.18; Dec-18 (FSMBB): -6.29 - Difference: Dec-17: 7.93; Dec-18: 9.54 - Sectoral distribution of loans — Residents: - Dec-17 (Mission): 17.16; Dec-18 (Mission): 17.15 - Dec-17 (FSMBB): 69.66; Dec-18 (FSMBB): 66.52 - Difference: Dec-17: -52.49; Dec-18: -49.37 - Liquid assets to total assets: - Dec-17 (Mission): 58.64; Dec-18 (Mission): 61.12 - Dec-17 (FSMBB): 66.30; Dec-18 (FSMBB): 61.56 - Difference: Dec-17: -7.67; Dec-18: -0.45 - Other indicators previously submitted (FSMBB calculations): - Liquid assets to short-term liabilities: 240.04 (Dec-17); 240.35 (Dec-18) - Net open position in foreign exchange to capital: 0.00 (Dec-17); 0.00 (Dec-18) - Large exposures to capital: 126.47 (Dec-17); 132.74 (Dec-18) - Residential real estate loans to total gross loans: 0.00 (Dec-17); 0.00 (Dec-18) - Commercial real estate loans to total gross loans: 27.44 (Dec-17); 25.41 (Dec-18) - Summary observation: - Mission noted significant changes in capital adequacy ratios, NPL ratios, sectoral distribution of loans, return on equity and liquid assets indicators after applying recommended methodological and data revisions. ### Appendix IV — FSI metadata highlights - Residence of institutional units: - Foreign-owned companies incorporated in FSM classified as residents per 2008 SNA. - Consolidation basis: - FSIs for DTs compiled on DL basis (resident DTs and branches/subsidiaries resident in domestic economy). - Institutional coverage: - FSIs for DTs cover two commercial banks under FSMBB; credit unions excluded. - Regulatory framework: - Capital adequacy calculation follows a Basel I approach for regulatory capital definition and Basel-III approach for RWAs. - 15 percent Tier-1 capital adequacy ratio and 6 percent leverage ratio required by FSMBB. - Accounting framework: - US GAAP adopted; accrual accounting; accrued interest calculated; interest not accrued on NPLs. - Key data definitions (selected): - Tier 1 capital: equity capital adjusted by deducting goodwill and intangibles, current year operating losses after tax not already deducted, and amount of loans classified as Loss not fully charged off. - Total regulatory capital equals Tier 1 capital (no Tier 2 prescribed). - Risk Weighted Assets calculated per FFIEC Call Report Form 041. - Broad measure of liquid assets: currency, cash items in process of collection, demand/overnight deposits with local and foreign banks, and securities abroad. - NPLs: loans with payments past due for 90 days or more. - ROA: annualized net income before tax divided by average total assets. - ROE: annualized net income after tax divided by average capital and reserves. - Source data and reporting timetable: - Source data include income and expense statements, balance sheets and call reports; banks required to submit quarterly returns by the 30th day after quarter end. *Source: INTRODUCTION; TA Mission; Appendix II–IV, 1fsmea2021001* ### INTRODUCTION ___________________________________________________________________________________ 8 ### INTRODUCTION ### Summary of mission outcomes and priority recommendations - The IMF’s Statistics Department (STA) provided technical assistance (TA) on financial soundness indicators (FSI) to the Federated States of Micronesia Banking Board (FSMBB) during November 2-13, 2020. The mission was conducted remotely via video conferences due to the COVID-19 pandemic and travel restrictions. - Main objectives of the mission: - review the source data, institutional coverage and accounting and regulatory frameworks supporting the compilation of FSIs; - provide guidance for mapping source data for the banking sector to the FSI reporting templates FS2 and FSD and for improving metadata; - agree with the FSMBB the timeline to begin regular reporting of the FSIs for deposit-takers to STA, conditional on the availability and completeness of the source data; - agree on the timeliness of data reporting. - Prior reporting status and outcomes: - The Federated States of Micronesia reported 11 core and 6 encouraged FSIs to STA but stopped reporting via the Integrated Collection System (ICS) in 2016Q2. The FSMBB continued reporting via the National Summary Data Page (NSDP) with a twenty-month lag; these FSIs were not always consistent with the FSI Guide methodology and have not been disseminated by STA in the FSIs database. - As a result of the mission, the FSMBB is now in a position to report quarterly FSIs to STA in line with the 2019 FSI Guide. - The mission compiled, together with FSMBB staff, 18 FSIs for deposit takers (DTs), and two FSIs on the size of OFC’s sector from the available source data. - Coverage of DTs for the compilation includes 2 commercial banks which cover the entire DTs sector other than credit unions. - FSIs compiled cover capital adequacy, asset quality, earnings and profitability, and liquidity for DTs. - Data access and validation: - The mission had access to aggregate data for deposit takers for the period March 2006 to June 2020 and to bank-by-bank data for June 2020; assisted FSMBB in mapping to the FSI workbook and validating aggregated data from bank-by-bank data for June 2020. - Reviewed balance sheet, income statement, and supervisory data from March 2006 to June 2020 and made recommendations to improve source data collection. - Identified discrepancies and necessary corrections: - Series with discrepancies include sectoral distribution of loans, nonperforming loans (NPLs) net of provisions to capital, capital to risk weighted assets ratios, return on equity and liquid assets (Appendix III). - FSMBB was recommended to compile FSIs in line with the 2019 FSI Guide and to address observed data discrepancies before submission to STA. - Shortfalls in source data and validation to be addressed: - i) strengthen the collection of liquid assets, customer deposits, risk weighted assets and regulatory capital series; - ii) strengthen FSMBB validation and reconciliation among different call reports to ensure source data are consistent, accurate and complete; - iii) clarify the definition of capital and reserves and specific provisions in the balance sheet. - Reporting timetable and dissemination: - A timeframe for reporting FSI data and metadata to the IMF was discussed and agreed with FSMBB officials. - FSMBB staff could compile quarterly FSIs for DTs using the mission-developed workbook and agreed to report FSI data and metadata to STA for dissemination on the IMF’s FSI website. - As of November 2020, 143 countries’ FSI data are disseminated on the FSI website. ### Priority recommendations (table summary and detailed action plan highlights) - Agreed target dates and high-priority actions: - January 2021: Implement quality control checks for data submitted by commercial banks and closely work with them to explain reporting requirements and resolve data discrepancies. — Responsible: FSMBB. - February 2021: Finalize and report to STA for review the FSI sectoral financial statements (FS2 template) for DTs (balance sheets, income statements, memorandum series), the sectoral FSIs with underlying series (FSD template) for DTs with quarterly data beginning from 2006: Q1, the FSI institutional coverage (FS1 template) with annual data starting from 2006, and the FSI metadata (FSM template). — Responsible: FSMBB. - March 2021: Start regular reporting to STA for disseminating on the IMF’s FSI website of the FSD and FS2 templates with quarterly data starting from 2006: Q1, and the FS1 template with annual data starting from 2006; also report the FSM template periodically. — Responsible: FSMBB. - Selected additional high-priority milestones with target completion dates: - Align the sectoral classification of deposits (SS 1B form) with the 2019 FSI Guide. — 06/30/2021. - Collect data on the amount of specific provisions set aside for nonperforming loans in the Criticized Assets Call Report (Report No. 5). — 06/30/2021. - Clarify the definition of capital and reserves in the balance sheet and collect additional information on the subcomponents of capital and reserves. — 06/30/2021. - Provide a definition of nonperforming loans in the criticized assets call report in line with the 2019 FSI Guide and eliminate partial reporting of NPLs based on collateralization (Report No. 5). — 06/30/2021. - Calculate the spread between the reference lending and deposit rates using the template provided once the data quality issues are resolved (Report No. 6.A). — 06/30/2021. - Provide clear instructions to banks to properly fill-in their Tier-1 capital in the call report (Report No. 3). — 12/31/2021. - Introduce a comprehensive definition of risk weighted assets and the necessary call report to collect additional information on capital adequacy ratios. — 12/31/2021. - Collect information on the maturity profile of assets and liabilities with a specific call report. — 12/31/2021. - Define liquid assets and collect data in line with the 2019 FSI Guide definition. — 12/31/2021. - Medium priority actions (selected): - Revise the balance sheet call report (Report No. 1) to incorporate financial derivatives on both the asset and liability sides. — 12/31/2021. - Collect memorandum items with detail of accrued interest by instrument. — 12/31/2021. - Collect residential real estate and commercial real estate loans data in line with the definitions provided in the 2019 FSI Guide. — 12/31/2021. - Collect other comprehensive income (OCI) data. — 12/31/2021. - Collect call reports in the electronic format. — 12/31/2021. ### Background (context and institutional setting) - This was the first STA mission on FSIs specifically for the FSMBB. STA previously delivered FSI workshops in Fiji during February 2–6, 2015 and April 4–8, 2016 for Pacific Island countries. - Reporting history: - FSM reported 11 core and 6 encouraged FSIs to STA through ICS until 2016Q2; thereafter FSMBB continued reporting via NSDP with a twenty-month lag but not fully consistent with the FSI Guide. - Supervisory and legal framework: - FSMBB regulates and supervises commercial banks; the Federated States of Micronesia Development Bank (FSMDB) and credit unions are not regulated or supervised by the FSMBB. - A Banking Regulatory Reform project was initiated by the FSMBB in July 2017; PFTAC and IMF’s Legal Department have been providing TA to review the FSM Bank Act and bring FSMDB and credit unions under FSMBB surveillance and develop prudential regulations. - Deposit insurance and reporting ties: - Deposit takers in the FSM are insured by the Federal Deposit Insurance Corporation (FDIC). The Bank of FSM (BFSM) is covered by FDIC insurance under the Compact of Free Association (CFA); Bank of Guam, established in a US territory, is also FDIC insured. - Deposit takers are subject to regulatory reporting to the Federal Financial Institutions Examination Council (FFIEC) as required by the FDIC. - Compact of Free Association (CFA): - The CFA between the FSM and the United States, valid for a period of 20 years, was approved in December 17, 2003. FSMBB is optimistic about renewal in 2023; failure to renew could create important strains on FSM’s banking sector. - COVID-19 impact: - FSM economy was negatively affected by the Covid-19 outbreak; tourism and related industries were most affected by travel restrictions. - FSMBB officials assessed the effect of Covid-19 on the banking sector as manageable; FSIs have not shown financial stability risks stemming from Covid-19. - One commercial bank implemented a voluntary blanket moratorium of consumer loans and personal credit cards between May and July 2020. ### FSM’s financial system: structure and key statistics - Composition and aggregate assets (as of June 2020): - The financial system is comprised of two deposit takers, one development bank, 32 insurers and 5 credit unions. - As of June 2020, total reported assets of the financial system (excluding insurance companies, the pension fund and credit unions) were USD 479,7 million. - Assets of the commercial banks constitute around 85 percent of this total and the government owned development bank, the FSMDB, holds 15 percent share. - There is no central bank in the FSM. - Table 2 highlights (source: FSMBB; Nominal GDP based on end-2018): - Commercial Banks: Number of institutions: 2; Total assets (In Millions USD) June 2020: 411.4; Total assets (Percent of Nominal GDP**): 102. - o/w domestically controlled: 1; 196.8; 49. - o/w branches of foreign banks: 1; 214.6; 53. - Development banks: Number of institutions: 1; Total assets (In Millions USD) June 2020: 68.3; Total assets (Percent of Nominal GDP**): 17. - Other deposit takers: Number of institutions: 5; Total assets (In Millions USD) June 2020: 4.1*; Total assets (Percent of Nominal GDP**): 1. - Insurance: Number of institutions: 32; Total assets: NA. - o/w life and nonlife insurance: 7; NA. - o/w captive insurance: 25; NA. - Pension funds: Number of institutions: 1; Total assets: NA. - Notes: * Data for the largest credit union based on FSMBB survey conducted in 2019. - Deposit taker details: - Commercial banks: 2 licensed deposit taking banks in FSM: - Bank of FSM (BFSM): domestically incorporated; central government owns 24 percent share; provides retail and commercial loans, inward and outward wire transfers and bank guarantees; deposits insured by FDIC under the CFA. - Bank of Guam – FSM Branch (BoG): branch of BoG (headquartered in Guam), not separately incorporated; engages in commercial and retail banking in FSM; as of 2020Q2 holds more than 50 percent of the total assets and total deposits in FSM deposit taker’s sector. - Credit unions: 5 credit unions accept deposits and extend loans only to members; traditionally keep deposits predominantly at savings accounts with commercial banks; credit unions are excluded from Micronesia Bank Act and not subject to oversight by FSMBB or unified supervision by state authorities; work is ongoing to bring credit unions under FSMBB oversight. *Source: INTRODUCTION — 1fsmea2021001* ### 19. Currently there are no DTs in receivership or liquidation in FSM. The FSI Guide ### 1fsmea2021001 - 19. Currently there are no DTs in receivership or liquidation in FSM. The FSI Guide ### Overview and key status - Currently there are no DTs in receivership or liquidation in FSM. The FSI Guide recommends including DTs in distress if they hold significant positions and to compile FSIs both including and excluding these DTs. - FSIs for DTs are compiled using a “domestic location” (DL) basis, appropriate for FSM’s banking system structure. - FSIs for DTs cover 2 domestically incorporated commercial banks. The remainder of the sector not covered includes the five credit unions, which are not under the supervision of the FSMBB. ### Other Financial Corporations (OFC) sector - OFC sector includes development banks, insurance corporations and pension funds. - FSM Development Bank (FSMDB): - Operates as a financial development institution and does not accept deposits. - Provides financing to commercial businesses mainly in the FSM. - Introduced a residential home loan program in 2008 and a consumer lending revolving fund program in 2011. - Currently, FSMDB is not under the oversight of the FSMBB. - Insurance and captive sector: - As of December 2019, there were six registered foreign insurers, 25 licensed captive insurance companies, three licensed insurance agents and two licensed insurance brokers operating in the FSM. - Conventional insurance sector generated a total premium collection of 3.2 million US Dollars for life and non-life during 2019. - Captive Insurance introduced with Public Law 14-88 enacted in 2006. More than $600 million in reinsurance premium were collected by captive insurers during 2019. - Pension funds: - ASC Trust, a Guam based private pension fund, is operating in FSM and is not regulated by FSM authorities. - Note: Definitions from FSMIB: - Insurance agent: person with the authority of an insurer to solicit applications, receive proposals, receive premiums, deliver policies, and make contracts of insurance. - Broker: person who acts on behalf of a prospective customer with authority to arrange insurance business with insurers, including making proposals and paying premiums. ### Consolidation basis and institutional coverage (A) - DL basis used for FSIs; DL includes resident DTs and resident branches of foreign deposit takers. - DL basis is acceptable alternative to the CBCSDI basis where DTs have (i) very few or no foreign branches or subsidiaries, and (ii) very few or no cross-sector subsidiaries. - Recommendation: - The FSMBB to begin regular reporting of FSIs for deposit takers according to the 2019 FSI Guide using the workbook developed during the mission. ### Accounting and regulatory frameworks underlying FSI data (B) - Legal/reporting basis: - Pursuant to sections 604 and 605 of the FSM Bank Act, FSMBB authorized to require banks to submit regular and special reports. - Banking Supervision Policy No.1 (Call Reports) issued August 8, 1995 requires banks to submit certain call reports to the FSMBB. - Accounting standards: - Commercial banks prepare financial statements in accordance with United States Generally Accepted Accounting Principles (US GAAP). - FSM Banking Act does not stipulate a specific accounting standard; Banking Supervision Policy No.1 specifies call reports be prepared in accordance with generally accepted accounting principles. - Nonperforming loans and provisioning: - Loans classified as nonperforming when one or more contractual payments of interest or principal are past due for 90 days or more. - Classification categories: “Standard”, “Special Mention”, “Substandard”, “Doubtful” and “Loss”. - Minimum specific provisioning requirements prescribed: Substandard 20 percent, Doubtful 50 percent, Loss 100 percent. - CoL documents do not specify general provisions for performing asset categories and do not introduce past due date backstops for asset categories. - FSMBB is cooperating with PFTAC and IMF’s Legal Department to update credit classification and provisioning rules. - Financial asset classification: - Commercial banks classify financial assets in accordance with US GAAP: fair value through net income, available for sale (fair value through other comprehensive income), and held to maturity (amortized cost). - Capital adequacy and leverage: - FSMBB has not introduced a regulatory framework for computation of capital adequacy ratios; capital adequacy ratio requirement for the domestic bank is introduced through the Conditions of License (CoL) documents. - Bank is required to maintain a 15 percent Tier-1 Capital Adequacy Ratio. - Risk Weighted Assets (RWA) calculated as required for reporting to the FFIEC Call Report Form 041; bank required to provide a copy of FFIEC Call Report Form 041 to FSMBB. - Tier-1 capital defined in Call Report No.3 as equity capital adjusted by deducting goodwill and other intangible assets, current year’s operating losses after tax where not already deducted from equity capital, and the amount of any loans classified as Loss not fully charged off against specific provisions. - Work ongoing (with TA by PFTAC and IMF Legal) concerning adoption of the Basel-III definition for regulatory capital to introduce Common-Equity Tier-1. - FSMBB call reports do not define Tier 2 capital; therefore Tier-1 capital equals total regulatory capital. Items that would be Tier-2 under Basel-I (undisclosed reserves, asset revaluation reserves) are excluded from total regulatory capital. - CoL documents require a 6 percent minimum leverage ratio to be maintained at all times by the domestic bank. Leverage ratio defined as Tier 1 Capital / Total Assets. Call Report No.3 provides the basis for leverage ratio reporting. Total assets defined as total assets of the bank as of reporting date adjusted by deducting all items required to be deducted from Tier-1 capital. - Risk reporting gaps: - FSMBB has not introduced regulations or reporting requirements for liquidity risk, large exposures, or market risk (net open position in foreign currency). Recommendation to enhance regulatory and reporting framework to measure and supervise liquidity risk, market risk and large exposures. ### Source data and reporting (C) - Source data for compiling FSIs include income and expense statements, balance sheets and other call reports covering capital adequacy, leverage ratio, deposit structure, nonperforming assets, and provisioning. - Data frequency and timeliness: - Data reported on a quarterly basis. - Quarterly call reports are due within 30 days of the end of the reporting period. - Reporting forms used for FSIs (Table 4): - Report No. 1 Consolidated Balance Sheet — Quarterly - Schedule No.1A Loans, Leases and other Extensions of Credit — Quarterly - Schedule No. 1B Deposits — Quarterly - Report No. 2 Off-Balance Sheet Activity — Quarterly - Report No. 3 Capital Adequacy Analysis (Local Bank Only) — Quarterly - Report No. 5 Criticized Assets — Quarterly - Report No. 6 Consolidated Statement of Income and Expenses — Quarterly - Schedule No. 6A Supplemental Detail to Consolidated Statement of Income and Expenses — Quarterly - Data quality issues identified: - Provisioning figures in the criticized assets call reports do not match those in the balance sheets for certain periods. - Weighted average lending rate and weighted average deposit rate data are missing for some banks. - Deposits reported under Supplementary Schedule 1B do not always align with the data provided in the balance sheet. - Recommendations: - The FSMBB to implement quality control checks for data submitted by commercial banks and closely work with them to explain reporting requirements and resolve data discrepancies. - The FSMBB to start collecting call reports electronically. FSMBB has significantly increased capacity to collect and process data in recent years, but still collects data in hard copy format; electronic collection could further enhance timeliness and quality. ### Compilation framework and indicators (D) - Mission developed compilation spreadsheets mapping source data to IMF’s 2019 FSI Guide sectoral financial statement template using bridge tables; spreadsheets and bridge tables provided to FSMBB. - Indicators compiled with mission assistance: - 11 core FSIs and 7 additional FSIs for deposit-takers, plus two additional FSIs relating to the size of OFC subsectors compiled for dissemination based on the 2019 FSIs Guide list. - Core FSIs not compiled include: - common equity tier 1 capital to risk-weighted assets - liquidity coverage ratio - net stable funding ratio - net open position in foreign exchange to capital - liquid assets to short term liabilities - residential and commercial real estate prices - Additional FSIs not available include: - large exposures to capital - spread between reference lending and deposit rates - spread between highest and lowest interbank rate - geographical distribution of loans to total loans - credit growth to the private sector - Note on provisions FSI: - The new core FSI on provisions to nonperforming loans was not compiled, but can be calculated as specific provisions divided by nonperforming loans. - Differences in compiled FSIs vs. existing FSMBB FSIs: - Stem from different compilation methodologies; mission used 2019 FSI Guide recommendations including disaggregation of specific provisions from total loan loss provisions, categorizing claims of one deposit taker from another as interbank loans, annualization of income and expenditure figures, and use of average capital and total assets where appropriate. - Income statement and rate mapping: - Call Report No.6 categorizes dividends on investments under interest income; 2019 FSI Guide recommends dividends declared payable by other corporations or cooperatives in which DTs have an equity stake be covered under non-interest income (“other income”). - Chapter 6 section 618 of FSM Banking Law prohibits domestic banks from investing in the stock of any other corporation. - Annualization and averaging guidance (example for 2019): - Annualizing net income before/after tax reported on a cumulative basis: - 2019Q1 = (2019Q1)*4 - 2019Q2 = (2019Q2)*2 - 2019Q3 = (2019Q3)/3*4 - 2019Q4 = (2019Q4) - Averaging total assets and capital: - 2019Q1 = (2018Q4+2019Q1)/2 - 2019Q2 = (2018Q4+2019Q1+2019Q2)/3 - 2019Q3 = (2018Q4+2019Q1+2019Q2+2019Q3)/4 - 2019Q4 = (2018Q4+2019Q1+2019Q2+2019Q3+2019Q4)/5 - Balance sheet mapping: - Deposits with domestic and foreign banks on asset side mapped to interbank loans per 2019 FSI Guide. - Customer deposits calculated using Supplementary Schedule No.1B. 2019 FSI Guide defines customer deposits as all deposits placed by residents or nonresidents, except those placed by financial corporations, central governments, or central banks. - Deposits from central government excluded from customer deposits and mapped to ‘other currency and deposits.’ - Deposits from domestic and foreign banks mapped to interbank deposits. - Due to absence of disaggregated data on deposits of nonresident non-bank financial corporations, nonresident-nonbank deposits were mapped to customer deposits until more granular data obtained. - Recommendation: - The FSMBB to align the sectoral classification of deposits (SS 1B form) with the 2019 FSI Guide. - Reporting forms mismatch: - Consolidated balance sheet data report form (Report No. 1) requires reporting of investment and securities together; FSI templates require debt securities disaggregated from shares and other equity. Domestic banks are prohibited from investing in the stock of any other corporation. *Source: 1fsmea2021001 - FSI Guide excerpt.* ### 48. Accrual accounting is used by commercial banks to record transactions on their ### Accrual accounting and accrued interest ### Key findings - Accrual accounting is used by commercial banks to record transactions on their balance sheets, but accrued interest is not included with the value of underlying instrument. - In the Consolidated Balance Sheet (Report No. 1), accrued interest is included on the asset side under and on the liability side under Other Liabilities. - These values are not significant; on the asset side 0.1-0.2 percent of total assets and on the liability side 0.2 percent of total liabilities. - The Guide recommends including interest costs that have accrued and are not yet payable as part of the value of the underlying instruments. - Detailed data are unavailable to map accrued interest to underlying instruments. ### Recommendation - The FSMBB to collect memorandum items with detail of accrued interest by instrument (Report No. 1). ### Loan loss provisions and nonperforming loans ### Findings on provisions - Loan loss provisions are reported in the Consolidated Balance Sheet (Report No. 1) but disaggregated information on specific and general provisions are not readily available. - 2019 FSI Guide defines specific provisions as provisions for loan losses that are set aside to cover identified non-performing loans. - The mission estimated specific provisions for non-performing loans by multiplying the amount of substandard, doubtful and loss loans with the corresponding provisioning requirements (i.e., 20, 50 and 100 percent respectively). - The aggregate amount found using this approach is categorized as specific provisions and mapped to (18.ii) Specific Provisions line in the Balance Sheet. - The remaining provisions are categorized as general provisions on performing loans and other assets and are mapped to other liabilities. ### Recommendation - The FSMBB to collect the data on the amount of specific provisions set aside for nonperforming loans in the Criticized Assets Call Report (Report No. 5). ### Nonperforming loans (NPLs) - Non-performing loans are defined in the CoL documents for deposit takers as loans for which one or more contractual payments of interest or principal are past due for 90 days or more. - The Criticized Assets call report (Report No. 5) collects information on non-performing loans according to its subcomponents; substandard, doubtful and loss loans. - The 2019 FSI Guide recommends that nonperforming loans should be the recorded as gross value of the loan on the balance sheet, not just the overdue amount. - Report No. 5 allows loans to be split between the fully secured portion and remaining portion and reporting only the remaining portion under the ‘Loss’ category; this may lead to underreporting of NPLs. - The definition of nonperforming loans was not clearly provided in Report No. 5. ### Recommendation - The FSMBB to provide a definition of nonperforming loans in the criticized assets call report in line with the 2019 FSI Guide and eliminate partial reporting of NPLs based on collateralization (Report No. 5). ### Accumulated depreciation ### Finding - The FSMBB collects data on accumulated depreciation under ‘other liabilities’. - Accumulated depreciation should be considered as a contra asset account, reducing the overall asset value. - Accordingly, accumulated depreciation is mapped to ‘Nonfinancial Assets’ as a contra asset account, which has affected the size of the balance sheet by reducing the reported total assets by 1.3 percent as of 2020Q2. ### Capital and reserves; regulatory capital ### Findings - Capital and reserves data are available through the consolidated balance sheet without additional disaggregation. - The consolidated Balance Sheet call report incorrectly defines capital and reserves to include subordinated debt as an element of Capital and Reserves. - The 2019 FSI Guide defines Capital and reserves as the equity interest of the owners in an enterprise and is the difference between total assets and liabilities and include funds contributed by owners, retained earnings, current year result and general and special reserves. - FSMBB needs to clearly distinguish the balance sheet capital and reserves from regulatory capital which is used for the calculation of regulatory capital requirements. - It is important to collect additional information on the subcomponents of capital and reserves (i.e., paid in capital, retained earnings, current year result, general and specific reserves) to help build internal validation checks with other reporting forms. ### Recommendation - The FSMBB to clarify the definition of capital and reserves in the balance sheet and bring it in line with the definition in the 2019 FSI Guide and collect additional information on the subcomponents of capital and reserves (Report No. 1). ### Financial derivatives ### Finding and recommendation - The balance sheet does not include financial derivatives. Commercial banks in FSM do not engage in financial derivative activities so the omission has no consequences so far. - The mission advised to include the relevant lines in the balance sheet to be ready to capture this activity when it occurs and reflect it in the FSIs. - Recommendation: The FSMBB to revise the balance sheet call report to incorporate financial derivatives on both the asset and liability sides (Report No. 1). ### Supervisory series — Regulatory Capital and Risk Weighted Assets (RWA) ### Findings - Capital adequacy ratios are calculated using the national definition of Tier-1 capital and the FFIEC definition for RWAs. - Regulatory capital comprises Tier-1 capital only and the definition of Tier-1 capital, provided in the capital adequacy analysis call report (Report No. 3), lacks the clear guidance regarding the elements of capital. - Report No. 3 does not specify the calculation of risk weighted assets. - Currently, risk weighted assets are obtained through the report form Schedule RC-R Part I – Regulatory Capital Components and Ratios prepared for the FFIEC. - The FFIEC call report suggests that the Basel-III approach is used in the calculation of capital adequacy ratios. - FSMBB needs to develop its own report forms and preferred methodologies to calculate risk weighted assets given the possibility that the CFA may not continue beyond 2023. ### Recommendations - The FSMBB to provide clear instructions to banks to fill-in Tier-1 capital in the call report (Report No. 3). - The FSMBB to introduce a definition of risk weighted assets and the necessary call report to collect additional data on capital adequacy ratios. ### Liquidity indicators ### Findings - The FSMBB does not have a definition of liquid assets. - The 2019 FSI Guide defines liquid assets as comprised of (i) currency; (ii) deposits and other financial assets that are available either on demand or within three months or less; and (ii) securities that are traded in liquid mar-kets (including repo markets) that can be readily converted into cash, with insignificant risk of change in value under normal business conditions. - Components of liquid assets for the calculation of FSIs are derived from the balance sheet and consist of currency, cash items in the process of collection, demand/overnight deposits with local and foreign banks, and securities abroad. - FSMBB staff and bank officials clarified that securities abroad mainly consists of US Treasury and US Government Agency securities. - There is no local securities market established in the FSM. ### Data gaps and recommendation - Data needs to be collected for short term liabilities; the 2019 FSI Guide defines short term liabilities as short-term element of DTs’ debt liabilities and the net market value of their financial derivatives positions. - Producing this series would require data on the maturity schedule of liabilities; a maturity schedule of assets would be beneficial to analyze the gap structure. - Recommendations: - FSMBB to define liquid assets and collect data in line with the 2019 FSI Guide definition. - The FSMBB to collect information on the maturity profile of assets and liabilities with a specific call report. ### Large exposures ### Findings and status - Large exposures are defined as ones where the sum of all exposures of a DT to a counterparty or to a group of connected counterparties are equal to or above 10 percent of the DT’s eligible capital base. - The FSMBB has not yet introduced a definition for large exposures. - With the support of TA by PFTAC and IMF’s Legal Department, internal work is ongoing concerning the introduction of a definition of large exposures. ### Net open position in foreign currencies ### Findings and recommendation - The FSI on net open position in foreign currencies to capital can be calculated using either on-balance sheet or on- and off-balance sheet measures, with the latter preferred. - The FSMBB does not require the commercial banks to report their net open positions in foreign currency, but data from memorandum items of the consolidated balance sheets suggest that these exposures are insignificant. - The FSMBB should be prepared to require reporting of the relevant data should foreign exposures increase. ### Spread between reference lending and deposit rates ### Findings and recommendation - The FSMBB receives data on average lending and deposits rates through the Supplemental Detail to Consolidated Statement of Income and Expenses call report (Report No. 6.A). - The mission identified that data for one bank is missing in the reports. - A template is provided by the mission to the FSMBB to calculate the spread between lending and deposit rates financial soundness indicator when the data gap is filled. - Recommendation: The FSMBB to calculate the spread between the reference lending and deposit rates using the template provided once the data quality issues are resolved (Report No. 6.A). ### Real estate markets ### Findings - The FSMBB collects data on loans collateralized by real estate. - FSMBB defines real estate credit as any advance for the acquisition and holding of real estate where primary reliance is placed on the real estate as collateral security. - The 2019 FSI Guide defines residential real estate loans as loans collateralized by residential real estate and commercial real estate loans as loans collateralized by commercial real estate, loans to construction companies or loans to companies active in the development of real estate. - FSIs on residential estate loans to gross loans and commercial real estate loans were not compiled as disaggregated data for residential real estate and commercial real estate loans, as defined in the 2019 FSI Guide, is not readily available. ### Recommendation - The FSMBB to collect residential real estate and commercial real estate loans data in line with the definitions provided in the 2019 FSI Guide. ### New FSI report forms and income statement items ### Findings and recommendations - The 2019 FSI Guide recommends that extraordinary income/expenses be mapped to other income, if positive, or other expenses, if negative. Extraordinary items in the income and expense statement (Report No. 6) are mapped accordingly. - Provisions on performing loans and other assets are mapped to other liabilities in the current report forms, consistent with the approach adopted in 2019 FSI Guide; these should be reported under “General and other provisions” on the liability side when the new FSI report forms are introduced. - The 2019 FSI Guide recommends that countries report other comprehensive income (OCI) as an additional line item in their income and expense statements. - Commercial banks in the FSM report other comprehensive income in their financial reports. ### Recommendation - The FSMBB to collect other comprehensive income (OCI) data. ### FSI metadata ### Findings - Metadata reporting is important for interpreting FSIs and to allow for cross-country comparisons. - Any deviations from the recommendations of the 2019 FSI Guide should be explained in the metadata and updated when necessary. - Metadata should contain information on the content and coverage of the FSIs, as well as the accounting conventions and other national guidelines. - The mission developed FSI metadata for DTs and two additional FSIs on the size of OFC subsectors based on information provided by the authorities. - Metadata should be updated whenever changes are observed, for instance, when there are changes to the accounting and regulatory frameworks or to the call report instructions underlying the FSI source data. - Understanding the calculation of key underlying series is important; some national calculations may not fully align with the 2019 FSI Guide due to lack of data or national practices. - Appendix IV presents detailed FSI metadata for deposit takers for reference; the mission prepared the FSI metadata Excel file for reporting together with the FSI data to STA for posting on the IMF’s FSI website. ### FSI data and metadata reporting ### Findings - The FSMBB aims to regularly report the sectoral FSIs to the IMF with quarterly frequency, to be posted on the IMF’s FSI website, upon FSMBB management’s approval. - FSMBB can compile and report all 11 core and 7 additional FSIs for deposit-takers as well as two additional FSIs on the size of OFC subsectors on a quarterly basis. - Underlying data available at the FSMBB for the calculation of FSIs starts from 2006. - The mission worked with FSMBB officials to complete the FSI institutional coverage template (FS1 template) with information on the number of the reporting DTs and their branches, split by ownership, and their respective total assets; the FS1 template should be reported to the IMF for dissemination. ### Recommendations - The FSMBB to finalize and report to STA for review the FSI sectoral financial statements (FS2 template) for DTs, including balance sheet, income statement, and memorandum series, the sectoral FSIs with underlying series (FSD template) for DTs with quarterly data beginning from 2006:Q1, the FSI institutional coverage (FS1 template) with annual data starting from 2006, and the FSI metadata (FSM template). - The FSMBB to start regular reporting to STA, for posting on the IMF’s FSI website, of the FSD and FS2 templates with quarterly data starting from 2006:Q1, and the FS1 template with annual data starting from 2006. Also report the FSM template periodically. ### FSIs for Other Sectors (OFCs and insurance) ### Findings - Two FSIs for OFCs, namely, OFC financial assets to total financial assets and OFC financial assets to gross domestic product, were compiled during the mission. - The OFC sector, solely composed of the FSMDB, currently accounts for 15 percent of the reported assets of the financial system. - Data on total assets for the insurance sector was unavailable to the mission. - The mission advised that developments in the OFC sector be monitored given the importance of the FSMDB in extending credit to the local economy and the importance of the captive insurance sector. ### Resources, training, and technical cooperation ### Recommendation - Support FSMBB officials’ efforts to participate in IMF FSI training courses to improve their methodological knowledge and skills in compilation and interpretation of FSIs. ### Other issues ### Findings - The FSM is one of the few countries still reporting MFS data to STA via non-standardized report forms; FSMBB officials are informed on the importance of sharing MFS data through standardized report forms. - FSM is a timely reporter to the Financial Access Survey (FAS), but has the capacity to report more series. - The FSMBB currently reports 29 series, mainly focused on commercial banks data, out of the 121 series that are part of the FAS. - FSMBB is encouraged to increase coverage by incorporating other financial institutions (i.e., credit unions), data disaggregated by gender, as well as mobile and internet banking. ### Appendix I — Selected Financial Soundness Indicators (Dec-16 to Jun-20) - Core FSIs (In percent) - Regulatory capital to risk-weighted assets: 24.79, 27.03, 35.47, 37.63, 33.27, 33.89, 35.24, 34.22 - Regulatory Tier 1 capital to risk-weighted assets: 24.79, 27.03, 35.47, 37.63, 33.27, 33.89, 35.24, 34.22 - Nonperforming loans net of provisions to capital: 10.35, 7.96, 3.75, 3.77, 3.25, 1.63, 1.93, 1.17 - Nonperforming loans to total gross loans: 1.08, 0.69, 0.35, 0.36, 0.31, 0.17, 0.33, 0.58 - Sectoral distribution of loans — Residents: 17.69, 14.95, 17.16, 15.90, 17.15, 16.06, 17.22, 15.14 - Sectoral distribution of loans — Nonresidents: 82.31, 85.05, 82.84, 84.10, 82.85, 83.94, 82.78, 84.86 - Return on assets: 1.03, 1.06, 1.05, 1.58, 1.80, 1.97, 1.98, 1.19 - Return on equity: 13.91, 15.35, 15.18, 23.07, 25.59, 26.99, 26.23, 15.45 - Interest margin to gross income: 83.01, 84.55, 84.13, 86.35, 86.98, 87.04, 86.59, 86.45 - Noninterest expenses to gross income: 65.28, 58.92, 56.42, 53.03, 49.77, 46.92, 46.95, 57.55 - Liquid assets to total assets: 56.44, 55.24, 58.64, 55.79, 61.12, 59.57, 62.24, 59.10 - Additional FSIs - Capital to assets: 6.29, 5.95, 6.21, 5.84, 6.02, 5.98, 6.11, 5.95 - Gross asset position in financial derivatives to capital: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 - Gross liability position in financial derivatives to capital: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 - Trading income to total income: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 - Personnel expenses to noninterest expenses: 44.49, 46.23, 45.34, 46.22, 45.57, 45.23, 45.88, 48.94 - Customer deposits to total (noninterbank) loans: 376.4, 429.9, 416.3, 456.1, 422.0, 451.0, 418.6, 471.3 - Foreign-currency-denominated loans to total loans: 1.89, 0.71, 0.00, 0.00, 0.00, 0.16, 0.16, 0.14 - Foreign-currency-denominated liabilities to total liabilities: 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00, 0.00 - OFCs - OFC's financial assets to total financial assets: 14.72, 14.73, 15.38, 14.18, 14.38, 13.97, 14.85, 14.44 - OFC's financial assets to gross domestic product: 16.04, 17.77, 14.93 *Source: TA Mission* ### Appendix II. Officials Met During the Mission ### Appendix II. Officials Met During the Mission ### Mission participants and interlocutors - Jesse Giltamag — Banking Commissioner, Federated States of Micronesia, Banking Board - Pilika Palik — Bank Examiner, Federated States of Micronesia, Banking Board - Molleighann Cornelius — Financial Analyst, Federated States of Micronesia, Banking Board - Rose Nakanaga — Vice President, Bank of Federated States of Micronesia - Christopher Schramm — Vice President, Bank of Federated States of Micronesia - Mary Simmering — Assistant Vice President, Bank of Guam - Pohnpei Branch - Christine Quichocho — Vice President, Bank of Guam – Headquarters - Loreta Gabalunos — Assistant Vice President, Bank of Guam – Headquarters - Desiree Iglesias — Accounting Officer II, Bank of Guam – Headquarters - Frank Quitugua III — Accounting Officer, Bank of Guam – Headquarters --- ### Appendix III. Summary of Recommended Amendments to the FSI Definitions ### Objective - Align FSIs with the FSI Guide (including amendments from the 2019 FSI Guide). - Implement most changes during the mission; highlight changes requiring a longer timeframe. ### Recommended methodological and data-collection changes (by indicator) - Total Capital to RWA / Tier 1 Capital to RWA - Provide clear instructions to banks to guide properly fill-in their Tier-1 capital in the call report. - Introduce risk weighted assets definition and necessary call report to collect additional reporting on capital adequacy ratios. (to be implemented). - NPLs net of provisions to capital - Subtract only specific provisions from the numerator. Provisions include only specific provisions on nonperforming loans. - Use regulatory capital as the denominator. - NPLs to total loans - The definition of total loans should be aligned with the FSI Guide definition. - Sectoral distribution of loans - Categorize claims of one deposit taker on another as interbank loans. - Return on Assets (ROA) - Use net income before tax in the numerator. - Aggregate the numerator as indicated in the report. - Average the denominator as indicated in the report. - Return on Equity (ROE) - Use net income after tax in the numerator. - Aggregate the numerator as indicated in the report. - Average the denominator as indicated in the report. - Interest margin to gross income - No change - Noninterest expense to gross income - Update noninterest income definition as suggested in the report. - Liquid assets to total assets - Introduce a liquid assets definition in line with the 2019 FSI Guide and collect liquid assets data. - Use liquid assets derived from the balance sheet until more granular data is available (to be implemented). - Liquid assets to short-term liabilities - Collect information on the maturity profile of assets and liabilities with a specific call report. (to be implemented). - Net open position in foreign exchange to capital - Collect data as recommended by the 2019 FSI Guide (to be implemented). - Capital to Assets - Correct total assets with accumulated depreciation. - Collect specific provisions data. (to be implemented). - Large exposures to capital - Collect data as recommended by the 2019 FSI Guide (to be implemented). - Gross asset/liability position in derivatives to capital - Use regulatory capital as the denominator. - Trading income to total income - No change. - Personnel expenses to noninterest expenses - Update noninterest expenses definition as suggested in the report. - Spread between reference lending and deposit rates (basis points) - Use the template provided during the Mission to calculate the indicator once complete data is available (to be implemented). - Customer deposits to total non-interbank loans - Align the sectoral classification of deposits with that of the 2019 FSI Guide (to be implemented). - FX loans to total loans - No change. - FX liabilities to total liabilities - No change. - Residential real estate loans to total loans - Collect data as recommended by the FSI Guide (to be implemented). - Commercial real estate loans to total loans - Collect data as recommended by the FSI Guide (to be implemented). ### Implementation note - Changes requiring a longer timeframe for implementation are bolded in the original table and are spelled out as individual recommendations in the report. --- ### Appendix III. Table 2 — Comparison of FSIs Before and After the Technical Assistance ### Core FSIs — selected comparisons (Mission vs FSMBB calculation) - Regulatory capital to risk-weighted assets - Dec-17 (Mission): 35.47; Dec-18 (Mission): 33.27 - Dec-17 (FSMBB): 39.10; Dec-18 (FSMBB): 33.30 - Difference: Dec-17: -3.63; Dec-18: -0.03 - Regulatory Tier 1 capital to risk-weighted assets - Dec-17 (Mission): 35.47; Dec-18 (Mission): 33.27 - Dec-17 (FSMBB): 39.14; Dec-18 (FSMBB): 33.27 - Difference: Dec-17: -3.68; Dec-18: 0.00 - Nonperforming loans net of provisions to capital - Dec-17 (Mission): 3.75; Dec-18 (Mission): 3.25 - Dec-17 (FSMBB): -4.18; Dec-18 (FSMBB): -6.29 - Difference: Dec-17: 7.93; Dec-18: 9.54 - Nonperforming loans to total gross loans - Dec-17 (Mission): 0.35; Dec-18 (Mission): 0.31 - Dec-17 (FSMBB): 1.28; Dec-18 (FSMBB): 1.21 - Difference: Dec-17: -0.93; Dec-18: -0.90 - Sectoral distribution of loans — Residents - Dec-17 (Mission): 17.16; Dec-18 (Mission): 17.15 - Dec-17 (FSMBB): 69.66; Dec-18 (FSMBB): 66.52 - Difference: Dec-17: -52.49; Dec-18: -49.37 - Sectoral distribution of loans — Nonresidents - Dec-17 (Mission): 82.84; Dec-18 (Mission): 82.85 - Dec-17 (FSMBB): 30.34; Dec-18 (FSMBB): 33.48 - Difference: Dec-17: 52.49; Dec-18: 49.37 - Return on assets - Dec-17 (Mission): 1.05; Dec-18 (Mission): 1.80 - Dec-17 (FSMBB): 1.30; Dec-18 (FSMBB): 1.82 - Difference: Dec-17: -0.25; Dec-18: -0.02 - Return on equity - Dec-17 (Mission): 15.18; Dec-18 (Mission): 25.59 - Dec-17 (FSMBB): 18.54; Dec-18 (FSMBB): 25.05 - Difference: Dec-17: -3.36; Dec-18: 0.54 - Interest margin to gross income - Dec-17 (Mission): 84.13; Dec-18 (Mission): 86.98 - Dec-17 (FSMBB): 84.13; Dec-18 (FSMBB): 86.98 - Difference: Dec-17: 0.00; Dec-18: 0.00 - Noninterest expenses to gross income - Dec-17 (Mission): 56.42; Dec-18 (Mission): 49.77 - Dec-17 (FSMBB): 53.91; Dec-18 (FSMBB): 47.59 - Difference: Dec-17: 2.51; Dec-18: 2.18 - Liquid assets to total assets - Dec-17 (Mission): 58.64; Dec-18 (Mission): 61.12 - Dec-17 (FSMBB): 66.30; Dec-18 (FSMBB): 61.56 - Difference: Dec-17: -7.67; Dec-18: -0.45 ### Additional FSIs and indicators (selected) - Capital to assets - Dec-17 (Mission): 6.21; Dec-18 (Mission): 6.02 - Dec-17 (FSMBB): 6.79; Dec-18 (FSMBB): 5.97 - Difference: Dec-17: -0.58; Dec-18: 0.05 - Personnel expenses to noninterest expenses - Dec-17 (Mission): 45.34; Dec-18 (Mission): 45.57 - Dec-17 (FSMBB): 47.46; Dec-18 (FSMBB): 47.66 - Difference: Dec-17: -2.11; Dec-18: -2.09 - Customer deposits to total (noninterbank) loans - Dec-17 (Mission): 416.36; Dec-18 (Mission): 422.09 - Dec-17 (FSMBB): 409.26; Dec-18 (FSMBB): 417.01 - Difference: Dec-17: 7.10; Dec-18: 5.08 - OFC's financial assets to total financial assets - Dec-17: 15.38; Dec-18: 14.38 - OFC's financial assets to gross domestic product - Dec-17: 17.77; Dec-18: 14.93 - Other indicators previously submitted to the STA (FSMBB calculations) - Liquid assets to short-term liabilities: 240.04 (Dec-17); 240.35 (Dec-18) - Net open position in foreign exchange to capital: 0.00 (Dec-17); 0.00 (Dec-18) - Large exposures to capital: 126.47 (Dec-17); 132.74 (Dec-18) - Residential real estate loans to total gross loans: 0.00 (Dec-17); 0.00 (Dec-18) - Commercial real estate loans to total gross loans: 27.44 (Dec-17); 25.41 (Dec-18) ### Summary observation - The mission noted significant changes in the capital adequacy ratios, NPL ratios, sectoral distribution of loans, return on equity and liquid assets indicators after applying the recommended methodological and data revisions. --- ### Appendix IV. FSI Metadata for Deposit Takers ### Metadata purpose - Metadata should be disseminated together with FSI data to facilitate interpretation, including data definitions, consolidation basis, supervisory and accounting rules, institutional coverage, and data sources. ### Residence of institutional units - Foreign-owned companies incorporated in FSM are classified as residents in line with System of National Accounts (2008 SNA). ### Consolidation basis - FSIs for deposit takers (DTs) in FSM are compiled on a domestic location (DL) basis. - DL includes resident DTs along with their branches and subsidiaries in the same sector that are also resident in the domestic economy (per the 2019 FSI Guide). ### Consolidation adjustments - Banks in FSM do not have deposit taking subsidiaries. Intra-group consolidation adjustment is not applicable. ### Institutional coverage - FSIs for DTs cover two commercial banks that are under the purview of the FSMBB. - Credit unions (deposit taking institutions) are not regulated by the FSMBB and are not included in the FSI compilation. ### Regulatory framework - Capital adequacy calculation follows a Basel I approach for the definition of regulatory capital and Basel-III approach for the definition of risk weighted assets. - A 15 percent Tier-1 capital adequacy ratio and 6 percent leverage ratio is required by the FSMBB. ### Accounting framework - Commercial banks in FSM have adopted US GAAP for financial statements used in compiling FSIs. - Accrual accounting is adopted; accrued interest is calculated. - Interest is not accrued on nonperforming loans. ### Data definitions (selected) - Tier 1 capital consists of equity capital adjusted by deducting goodwill and other intangible assets, current year’s operating losses after tax, where not already deducted from equity capital and the amount of any loans classified as Loss, to the extent that such loans have not been fully charged off against specific provisions in full. - Total regulatory capital is equal to Tier 1 capital. The FSMBB does not prescribe any element of Tier 2 capital. - Risk Weighted Assets is calculated as required for reporting on the FFIEC Call Report Form 041. - The broad measure of liquid assets include currency, cash items in the process of collection, demand/overnight deposits with local and foreign banks, and securities abroad. - Nonperforming loans (NPLs) is defined as loans for which one or more contractual payments of interest or principal are past due for 90 days or more. - Return on assets (ROA) is calculated as the ratio of annualized net income before tax divided by average total assets. - Return on equity (ROE) is calculated as the ratio of annualized net income after tax divided by average capital and reserves. ### Source data and reporting timetable - Source data include income and expense statements, balance sheets and other call reports relevant for compiling supervisory series (capital, deposit breakdown, nonperforming loans). - Banks are required to submit quarterly returns by the 30th day after the end of each quarter. *Source: Appendix II–IV, 1fsmea2021001 - Appendix II. Officials Met During the Mission* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1fsmea2021001.pdf_