## 1ecuea2023001 - 2023. The FSAP findings were discussed with the

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### EXECUTIVE SUMMARY — stability, macrocontext, and immediate concerns
- Financial sector remained stable and credit grew through the pandemic, but tightening global financial conditions present new challenges.
- Since mid-2022 credit growth has slowed, and liquidity conditions have tightened considerably.
- Real GDP growth in the first quarter of 2023 moderated to 0.7 percent.
- Inflation increased in 2022 reaching 3.5 percent and has since eased.
- Ecuador completed a 27-month Extended Fund Facility Arrangement in December 2022.
- Higher international interest rates and competition for deposits increased funding costs; caps on lending rates led to margin compression.
- Institutional framework for financial sector oversight is complex and prone to political intervention; lack of effective coordination results in sub-optimal policies.
- Domestic policy requirements:
  - Financial institutions must maintain liquid assets in Ecuador and minimum investments in government securities and public banks at non-market prices.
  - Interest rate caps hinder financial inclusion and shift credit away from productive purposes.

### SYSTEMIC RISK, STRESS SCENARIOS, AND MAIN RESULTS
- Stress scenarios reflect Ecuador’s full dollarization and oil-exporter status and consider: a sharper-than-expected global slowdown, tightening of US interest rates, and falling oil prices.
- Scenario design:
  - Baseline follows April 2023 WEO projections (weaker external environment, easing oil prices, tightening global financial conditions).
  - Adverse assumes sharper slowdowns in China and the United States, increases in inflation and policy rates in industrial countries, two consecutive years of recession in Ecuador, higher unemployment, elevated lending rates, and a spike in EMBI spreads.
- Bank solvency (selected outcomes):
  - Under the adverse stress, 9 out of the 27 banks, mostly small, would present capital ratios below the 9 percent regulatory minimum.
  - Resulting capital shortfall is 0.2 percent of GDP in 2025.
  - Under the baseline, 5 small banks dropped below 9 percent CAR (accounting for 2 percent of system assets).
  - Bank stress test counts (Number of Banks failing on CAR):
    - Baseline: 2023: 3, 2024: 4, 2025: 5
    - Adverse: 2023: 8, 2024: 9, 2025: 9
  - Failing Bank Assets to System Assets (percent):
    - Baseline: 2023: 0.5, 2024: 0.8, 2025: 2.0
    - Adverse: 2023: 8.0, 2024: 11.4, 2025: 11.4
  - CAR Shortfall (percent of GDP):
    - Baseline: 2023: 0.0, 2024: 0.0, 2025: 0.1
    - Adverse: 2023: 0.1, 2024: 0.1, 2025: 0.2
- Cooperatives:
  - Large cooperative sector comprises 20 percent of financial system assets.
  - By 2025, capital adequacy ratio of 35 cooperatives, representing about 6 percent of system assets, could be below the 9 percent minimum requirement.
  - Aggregate cooperative capital shortfall is 0.2 percent of GDP.
- Liquidity stress testing and aggregate shortfalls:
  - Pilot LCR covered the six largest banks (~60 percent of system assets).
  - Under the least severe LCR scenario, three of six banks (about 25 percent of system assets) fall below the reference LCR.
  - Under a realistic monetization constraint, five banks accounting for 37 percent of system assets drop below the reference LCR.
  - Extrapolation suggests a system-wide liquidity deficit of about US$2.9 billion.
  - Liquidity shortfalls under the severe stress (sample banks, mil. USD):
    - Net Outflows: 5,911
    - HQLA: 4,044
    - Liquidity Needs: 1,916
    - Claims on Liquidity Fund: 1,617
    - Liquidity Deficit: 1,051
- Nonfinancial corporate sector:
  - Aggregated debt-at-risk (debt of companies with ICR below 100 percent) is about 6 percent of GDP.
  - Corporate coverage in sample: Total number of companies: 86,389; Assets to GDP: 135.3; Debt to GDP: 15.4.
- Climate-related exposures:
  - Ecuador ranked 13th largest exposure to natural hazards in the INFORM Risk index.
  - Up to 20 percent of bank loans and 25 percent of cooperative loans are in parts of the country vulnerable to floods, landslides, droughts, volcanic and seismic risks.
  - Around 23 percent of system-wide bank loans are extended to ‘transition sensitive’ sectors (primarily agriculture).

### LIQUIDITY RISKS — implications and recommended priorities
- Dollarization anchors the economy but limits the Central Bank’s capacity to provide liquidity; the Central Bank doesn’t offer liquidity facilities.
- In December 2022, Ecuador’s FX reserves were about 35 percent of the IMF’s Assessment of Reserve Adequacy metric for emerging markets.
- Few domestic assets can be reliably monetized; interbank funding markets are thin; the private Liquidity Fund is small (about 3 percent of members’ assets) and rarely used.
- Priority actions to reduce financial stability risks:
  - Establish sound liquidity requirements and ensure institutions manage liquidity risk more conservatively than in non-dollarized economies.
  - Remove impediments to banks’ investments in global liquid assets.
  - Reform the Liquidity Fund (governance, collateral, size, terms).
  - Further develop interbank and securities markets.
- Reforms should be carefully sequenced with fiscal and macroeconomic actions.

### FINANCIAL SECTOR OVERSIGHT — weaknesses and reform needs
- Institutional fragmentation and weak coordination undermine effective supervision and macroprudential policy.
- Supervisory capacity constraints:
  - Banks’ average capital ratios were around 15 percent of risk-weighted assets as of end-2022.
  - High staff turnover, absence of a career plan and training program, and insufficient technical and analytical capacity.
- Supervisory and legal reforms recommended:
  - Substantially enhance technical and analytical capacity of financial sector authorities; establish career plans and training.
  - Set safety and soundness as the primary goal of supervisory agencies; remove constraints to their independence and enhance powers for preventive action.
  - Develop tools and processes to monitor systemic risks; consider establishing a Financial Stability Committee.
  - Clarify macroprudential objectives and functions across agencies; implement Basel III buffers and borrower-based measures.
  - Shift supervision from descriptive examinations to risk-focused supervision; implement a regular stress testing program and increase attention to climate-related risks.
  - Ensure timely enactment of the New Organic AML/CFT Law and resource the FIU and supervisors.

### FINANCIAL SAFETY NET, RESOLUTION, AND CRISIS PREPAREDNESS
- Reinforce the financial safety net given several weak institutions:
  - Improve coordination, information-sharing, and joint planning between supervisory agencies and the deposit insurer (COSEDE).
  - Update legal framework for bank resolution to expand the toolkit and remove limitations of existing tools (e.g., convert ETAP to P&A powers).
  - Shorten deposit insurance payout times (COSEDE currently pays out within 20 days of receiving depositor data from the liquidator, but the liquidator can take up to 60 days to prepare such data).
  - Reform the Liquidity Fund’s lender-of-last-resort function while noting dollarization constraints on scope.
- COSEDE specifics:
  - Staffing: 56 employees, only six permanent staff.
  - Funding: ex-ante fund equals 17 percent of covered bank deposits.
  - Governance: recommend independent Board members and safeguards limiting use of COSEDE resources to amounts equivalent to insured depositor payouts.

### FINANCIAL SECTOR DEVELOPMENT, PUBLIC INSTITUTIONS, AND MARKET INFRASTRUCTURE
- Financial structure (December 2022 totals; US$ Mil. and percent of total assets):
  - Total assets: 119,410 (100) (103 percent of GDP)
  - Private Banks (23): 49,895 (41.8 percent of total assets) (43.0 percent of GDP)
  - Public Banks (5): 14,881 (12.5 percent of total assets) (12.8 percent of GDP)
  - Cooperatives (467): 23,509 (19.7 percent of total assets) (20.3 percent of GDP)
  - BIESS: 27,806 (23.3 percent of total assets) (24.0 percent of GDP)
- Public credit support and SOFIs:
  - Six SOFIs hold 36 percent of total financial sector assets.
  - Recommend redesigning public credit programs to enhance efficiency, integrate advisory services, remove expectations of debt forgiveness, and migrate interest rate caps to a usury rate.
  - Intensify supervision and enforcement for state-owned financial institutions; address balance-sheet and operational weaknesses.
  - BIESS’s mortgage portfolio represents about 6 percent of GDP; BIESS does not take deposits.
- Capital market findings:
  - Government and corporate debt securities are sold through private placements and rarely transacted in the secondary market; government fixes interest rates usually below market rates.
  - Critical preconditions for a local bond market are lacking (recurring external debt defaults, structural macroeconomic imbalances, absence of a long-term savings industry).
  - Phased market development recommendations: replace private placements with regular auctions (initially short-term securities), expand repo markets, and broaden the investor base.

### SELECTED KEY INDICATORS AND IMPLEMENTATION NOTES
- Selected macro and financial indicators (preserved formatting from source):
  - Real GDP: -7.84.23.02.92.82.82.82.82.8
  - Consumer price index period average: -0.30.13.52.51.51.51.51.51.5
  - Net domestic assets: 3.614.911.05.60.92.02.93.23.8
  - Credit to the private sector: 2.513.613.97.24.03.73.83.83.8
  - Oil price Ecuador mix (US$ per barrel): 35.662.085.170.968.665.962.559.556.8
  - Oil production (millions of barrels): 175.4172.6175.5178.5189.2192.5194.8194.8194.8
  - Nominal GDP (US$ millions): 99,291106,166116,360121,291126,449131,202136,314141,514146,911
  - Gross international reserves (US$ millions): 7,1337,8988,4599,49111,37612,57613,53114,33914,908
- Implementation status of prior FSAP recommendations:
  - Some 2004 FSAP recommendations partially implemented, some implemented (e.g., establishment of a Liquidity Fund and COSEDE), others not implemented.

### 2023 FSAP Key Recommendations (selection, with timing)
- Systemic Risk and Resilience:
  - Enhance capitalization, promptly recognize loan losses, and address unviable financial institutions. (SBs, SEPS) — Time: I
  - Improve credit information: (i) transmit data on BIESS to credit bureaus; (ii) grant access to the credit registry data to BCE and SEPS. (JPRF, SB, SEPS, BCE) — Time: I
  - Gradually remove requirements for banks to hold liquid assets domestically. (MEF, JPRF, JPRM) — Time: NT
- Financial Sector Oversight:
  - Develop processes, organizational arrangements, and tools to monitor, assess and mitigate systemic risks. (MEF, JPRF, JPRM, SB, SEPS, BCE) — Time: I
  - Clarify responsibilities and consider establishing a Financial Stability Committee. (MEF, JPRF, JPRM, SB, SEPS, BCE) — Time: NT
  - Implement Basel III buffers (conservation, countercyclical, D-SIB) and borrower-based measures. (MEF, JPRF, SB, SEPS) — Time: NT
  - Enhance technical and analytical capacity of supervisory agencies. (SB, SEPS, MEF, UAFE, CONALAFT) — Time: I
  - Strengthen independence and mandate of superintendencies to prioritize safety and soundness. (MEF, SB, SEPS) — Time: MT
- Financial Safety Net and Crisis Preparedness:
  - Separate supervisory and resolution functions and overhaul resolution legal framework. (MEF, SB, SEPS, COSEDE) — Time: MT
  - Address operational barriers to deposit insurance payout and strengthen COSEDE governance and resources. (MEF, COSEDE) — Time: MT
  - Reform the Liquidity Fund’s lender-of-last-resort function. (MEF, COSEDE) — Time: NT
- Market Development:
  - Address vulnerabilities in public banks, implement AQR provisioning recommendations, and intensify prudential supervision of SOFIs. (MEF, SB, IESS) — Time: I
  - Redesign credit support programs, remove expectations of debt forgiveness, and migrate interest rate caps to a usury rate. (MEF, JPRM, JPRF) — Time: NT
  - Transition to market mechanisms for placement of government securities and develop repo and secondary markets. (MEF, JPRF, SB, BCE, SCVS) — Time: NT
- Timing notes: I = immediate (less than one year), NT = short term (1–2 years), MT = medium term (3–5 years).

*Source: Ecuador: 2023 FSAP (prepared by Caio Ferreira and Mark Adams with contributions from the FSAP team).*

### 2023. The FSAP findings were discussed with the

### 1ecuea2023001 - 2023. The FSAP findings were discussed with the

### EXECUTIVE SUMMARY — Key findings and context
- The Ecuadorian financial sector has remained stable, and credit continued to grow through the pandemic, but tightening global financial conditions present new challenges.
- Since mid-2022 credit growth has slowed, and liquidity conditions have tightened considerably.
- Real GDP growth in the first quarter of 2023 moderated to 0.7 percent, pointing to a sharp and broad-based slowdown and an increase in downside risks.
- Inflation increased in 2022 reaching 3.5 percent and has since eased.
- Ecuador completed a 27-month Extended Fund Facility Arrangement in December 2022.
- Higher international interest rates and competition for deposits increased funding costs; caps on lending rates led to margin compression.
- Institutional framework for financial sector oversight is complex and prone to political intervention; lack of effective coordination results in sub-optimal policies.
- Requirements for financial institutions to: (i) maintain liquid assets in Ecuador and (ii) maintain minimum investments in government securities and public banks at non-market prices facilitate domestic financing to the government at the expense of risk diversification.
- Interest rate caps hinder financial inclusion and shift credit away from productive purposes.

### SYSTEMIC RISK AND STRESS TEST RESULTS
- FSAP stress tests consider a sharper-than-expected global slowdown, tightening of US interest rates, and falling oil prices — reflecting Ecuador’s full dollarization and oil-exporter status.
- Bank solvency:
  - Under the adverse stress, 9 out of the 27 banks, mostly small, would present capital ratios below the 9 percent regulatory minimum.
  - Resulting capital shortfall is 0.2 percent of GDP in 2025.
  - Losses could be higher if interest caps on loans do not adjust to reflect funding costs.
- Cooperatives:
  - Large cooperative sector comprises 20 percent of financial system assets.
  - A substantial number of cooperatives face asset quality and profitability challenges.
- Liquidity stress tests and analysis:
  - Several important financial institutions currently do not hold enough liquid assets to comply with international liquidity standards.
  - Dollarization anchors the economy but limits the Central Bank’s capacity to provide liquidity.
  - Interbank funding markets are thin; the Central Bank doesn’t offer liquidity facilities.
  - The private liquidity fund offers limited support, is small, and is rarely used.
  - Few domestic assets can be reliably monetized; institutions must largely self-insure against liquidity risk.

### LIQUIDITY RISKS — implications and priorities
- Managing liquidity risk is a critical challenge given dollarization and limited central bank lender-of-last-resort capacity.
- Key actions recommended to reduce financial stability risks:
  - Establish sound liquidity requirements.
  - Remove impediments to banks’ investments in global liquid assets.
  - Reform the Liquidity Fund.
  - Further develop interbank and securities markets.
- Reforms should be carefully sequenced in tandem with addressing ongoing fiscal and macroeconomic conditions.

### FINANCIAL SECTOR OVERSIGHT — weaknesses and needs
- Urgent need to improve financial sector supervision; institutional shortcomings, insufficiently trained staff, and lack of coordination impair sound supervision.
- Required actions include:
  - Substantially enhance technical and analytical capacity of financial sector authorities; address lack of career plan, training program, and high turnover.
  - Set safety and soundness as the primary goal of supervisory agencies; remove constraints to their independence and enhance powers to facilitate preventative supervisory actions.
  - Develop processes, organizational arrangements, and tools to monitor, assess and mitigate systemic risks; consider establishing a Financial Stability Committee.
  - Clarify macroprudential objectives and functions across agencies; implement Basel III buffers and borrower-based measures.
  - Strengthen the supervisory approach: shift from mostly descriptive examinations to risk-focused supervision, enhance supervisory plans and guidance, implement a regular stress testing program, and increase attention to climate-related risks.
  - Ensure timely enactment of the New Organic AML/CFT Law and adequately resource supervisors and the FIU.

### FINANCIAL SAFETY NET AND CRISIS PREPAREDNESS
- Reinforcing the financial sector safety net is a priority due to presence of several weak institutions.
- Immediate needs:
  - Improve coordination, information-sharing, and joint planning between supervisory agencies and the deposit insurer.
  - Update the legal framework for bank resolution to expand the resolution toolkit and remove limitations of existing tools.
  - Shorten deposit insurance payout times.
  - Reform the lender-of-last-resort function (Liquidity Fund) though constraints from dollarization will remain.

### FINANCIAL SECTOR DEVELOPMENT AND PUBLIC INSTITUTIONS
- Public credit support programs should be redesigned to enhance efficiency and impact; expectations of debt forgiveness should be removed.
- Supervision and enforcement for state-owned financial institutions (SOFIs) need intensification; weaknesses in their balance sheets and operations should be addressed.
- Interest rate caps should migrate to a usury rate.
- Capital market development priorities:
  - MEF should transition to market mechanisms for placement of government securities.
  - In subsequent phases, develop repo and secondary markets and broaden the investor base.

### 2023 FSAP Key Recommendations (summary from Table 1)
- Systemic Risk and Financial Sector Resilience:
  - Enhance capitalization, promptly recognize loan losses, and address unviable financial institutions. (SBs, SEPS) — Time: I
  - Improve credit information: (i) transmit data on BIESS to credit bureaus; (ii) grant access to the credit registry data to BCE and SEPS. (JPRF, SB, SEPS, BCE) — Time: I
  - Gradually remove requirements for banks to hold liquid assets domestically. (MEF, JPRF, JPRM) — Time: NT
- Financial Sector Oversight:
  - Develop processes, organizational arrangements, and tools to monitor, assess and mitigate systemic risks. (MEF, JPRF, JPRM, SB, SEPS, BCE) — Time: I
  - Clarify responsibilities, functions, and powers of different agencies, and consider establishment of a Financial Stability Committee. (MEF, JPRF, JPRM, SB, SEPS, BCE) — Time: NT
  - Implement Basel III buffers (conservation, countercyclical, D-SIB) and borrower-based measures. (MEF, JPRF, SB, SEPS) — Time: NT
  - Enhance technical and analytical capacity of supervisory agencies by establishing a career plan, sound training program, and adequate resources. (SB, SEPS, MEF, UAFE, CONALAFT) — Time: I
  - Strengthen institutional framework for supervision by making safety and soundness the primary goal of the superintendencies and enhancing their independence. (MEF, SB, SEPS) — Time: MT
  - Strengthen supervisory approach, consolidated supervision, and corporate governance requirements; ensure convergence of supervisory and regulatory standards for large cooperatives and both public and private banks. (SB, SEPS, JPRF) — Time: NT
  - Align capital and liquidity requirements with Basel III. (SB, SEPS, JPRF) — Time: NT
  - Improve legal basis for corrective actions and sanctioning powers. (SB, SEPS, MEF) — Time: NT
  - Ensure timely enactment of the New Organic AML/CFT Law. (CONALAFT) — Time: I
- Financial Safety Net and Crisis Preparedness:
  - Separate supervisory and resolution functions and overhaul legal framework for resolution. (MEF, SB, SEPS, COSEDE) — Time: MT
  - Address operational barriers to deposit insurance payout and strengthen COSEDE governance and resources. (MEF, COSEDE) — Time: MT
  - Reform the Liquidity Fund’s lender-of-last-resort function: governance and information-sharing, ease of collateral posting, size of the fund, relations with the BCE, and terms of lending. (MEF, COSEDE) — Time: NT
- Market Development:
  - Address vulnerabilities in public banks, implement AQR provisioning recommendations, and intensify prudential supervision of SOFIs. (MEF, SB, IESS) — Time: I
  - Redesign credit support programs, remove expectations of debt forgiveness, and migrate interest rate caps to a usury rate. (MEF, JPRM, JPRF) — Time: NT
  - Streamline supply of government securities and transition to regular auctions; promote repo and secondary market development and broaden investor base. (MEF, JPRF, SB, BCE, SCVS) — Time: NT
- Notes on timing: I = immediate (less than one year), NT = short term (1–2 years), MT = medium term (3–5 years).

### BACKGROUND — Macrofinancial context (high level)
- Post-COVID rebound followed a sharp contraction in 2020; high oil prices supported external and fiscal balances with the public sector posting its lowest deficit since 2008 in 2022.
- By early 2023 indicators point to a broad slowdown and increased downside risks.

*Source: Ecuador: 2023 FSAP (prepared by Caio Ferreira and Mark Adams with contributions from the FSAP team).*

### 2.      The financial sector has remained stable but has yet to fully absorb pandemic-related

### 1ecuea2023001 - 2.      The financial sector has remained stable but has yet to fully absorb pandemic-related

### Financial sector stability and key metrics
- Banks’ average capital ratios were around 15 percent of risk-weighted assets as of end-2022.
- Reported nonperforming loans (NPLs) are moderate, including on an augmented measure that includes refinanced and restructured loans.
- Pandemic-era acceleration of credit growth mechanically diluted NPL ratios; since mid-2022 credit growth has slowed and liquidity conditions have tightened considerably.
- Competition for deposits between banks and credit cooperatives increased funding costs, and caps on lending rates led to margin compression.
- Pandemic-era decrees requiring banks to provide financial relief to certain categories of borrowers may have weakened the payment culture and affected the quality of credit data.
- Cooperatives have higher NPL ratios and lower loan loss provisions than private banks.
- Total deposit-takers’ assets are around 78 percent of GDP, of which private banks account for over 50 percent.
- Credit cooperatives have total assets of around 20 percent of GDP.
- BIESS’s mortgage credit portfolio represents about 6 percent of GDP; BIESS does not take deposits and has not issued other types of liabilities.

### Financial sector structure and interconnections
- The IMF Financial Development Index ranked Ecuador 133 out of 192 countries in 2019.
- Financial institutions provide mostly traditional products with limited development of services to reach underserved and financially excluded segments; in 2021, 64 percent of adults reported having access to a bank account (compared with 84 percent for upper middle-income countries).
- Large banks play a pivotal role, taking deposits and investments from other institutions; cooperatives are net providers of liquidity to the banking sector and place deposits with large and medium-size banks.
- The gross bilateral exposures between banks and cooperatives represent 12 percent of total system assets and 9 percent of GDP.
- Public banks have significantly higher NPLs and have recently undergone an asset quality review (AQR); public banks have capital ratios above 30 percent, but the substantial gap in loan classification and provisioning found by the AQR in one public bank would trigger supervisory action.

### Financial repression and policy measures
- Banks and credit cooperatives are subject to ceilings on lending rates.
- Financial institutions are required to maintain at least 60 percent of their liquid assets in Ecuador.
- Private banks are required to maintain minimum investments in public banks and public financial institutions.
- A tax on financial outflows is being gradually reduced to 2 percent by end-2023.
- Banks and investment companies are subject to a 0.25 percent monthly tax on the stock of funds and investments held abroad.
- These measures inhibit financial inclusion, distort capital allocation, and elevate financial sector risks by:
  - Preventing lending to new or riskier borrowers and diverting resources to consumer lending.
  - Increasing funding costs combined with interest rate caps, leading to margin compression and constrained investment.
  - Limiting risk diversification at the systemic level by requiring holding of liquid assets in Ecuador and public sector securities at non-market prices.
  - Contributing to incomplete credit data and deficient supervisory practices that can lead to over-indebtedness.

### Liquidity risk and constraints
- Dollarization provides an important anchor, but systemic liquidity risks are high due to the limited capacity of the central bank to provide liquidity.
- Liquidity shocks affecting banks will ultimately impact the Central Bank balance sheet even though it currently does not offer liquidity facilities, as it will experience an outflow of reserve deposits.
- In December 2022, Ecuador’s FX reserves were about 35 percent of the IMF’s Assessment of Reserve Adequacy metric for emerging markets.
- There are few truly liquid domestic assets given the lack of secondary market trading; interbank funding markets are thin and central bank facilities are absent.
- The strict prohibition on monetary financing is understood to be a legal impediment for the BCE to accept government securities as collateral.
- An industry liquidity fund exists but is limited in size (about 3 percent of members’ assets) and is rarely used in part due to collateralization and operational requirements.
- Assets that can be reliably monetized are largely limited to cash, central bank reserves, and foreign securities (and bank deposits for some cooperatives and smaller banks).
- Regulatory liquidity requirements currently do not prevent banks from facing meaningful liquidity risks; authorities should ensure financial institutions manage liquidity risk more conservatively than in non-dollarized economies and expand the pool of monetizable liquid assets.

### Systemic risk assessment: scenarios and assumptions
- The FSAP stress testing analysis covered banks, credit cooperatives, and more than 86,000 registered non-financial companies.
- The analysis is based on a baseline and an adverse scenario spanning three years (2023‒25). Both scenarios incorporate the effects of the pandemic and social turmoil in mid-2022.
- The baseline scenario follows the April 2023 WEO projections and assumes:
  - A weakening external environment with oil prices easing gradually and global demand slowing down.
  - Financial conditions affected by tightening monetary policy in industrial countries and appreciation of the US dollar.
- The adverse scenario assumes:
  - Sharper than expected slowdowns in China and the United States.
  - Increases in inflation and policy rates in industrial countries.
- Under the adverse scenario Ecuador experiences two consecutive years of recession and a slow recovery, with:
  - Reduced economic activity from dropping oil prices, weakening global demand, and tightening external financing conditions.
  - Higher unemployment, elevated lending rates, and a spike in EMBI spreads.

### Stress test results: solvency and cooperatives
- Solvency analysis integrated credit, sovereign, and interest rate risks; methodology included a top-down stress test of individual banks integrated with a corporate stress test of the 100 largest borrowers. The cut-off date was December 2022.
- Under the baseline scenario, the capital ratios of five small banks, which account for two percent of system assets, dropped below 9 percent.
- Under the adverse scenario, nine banks with 11 percent of system assets end up with capital adequacy ratio (CAR) ratios below the regulatory minimum, with an aggregate capital shortfall of only 0.2 percent of GDP.
- At the aggregate level, the banking system appears profitable enough to absorb the losses stemming from the adverse scenario; aggregate bank profits contribute to material internal capital generation even under the adverse scenario.
- Credit losses and distributed dividends are the main drag on solvency.
- Large interest rate and sovereign risk shocks in the adverse scenario had only moderate solvency impacts due to short duration assets and already-high spreads, assuming that interest rate caps are adjusted when needed, in line with historic behavior.
- Solvency stress tests for the cooperative sector followed the same scenario-based approach; expected losses were estimated as the flow of provisions under the baseline and adverse scenarios and included larger cooperatives in segments 1 and 2 individually and segment 3 in aggregate.

### Policy recommendations and priorities
- Ensure that financial institutions manage liquidity risk more conservatively than would be necessary in non-dollarized economies.
- Expand the pool of monetizable liquid assets.
- Remove impediments for banks’ investments in global liquid assets.
- Ensure that liquid assets held by financial institutions can, in practice, be reliably monetized in time of stress.
- Address incomplete credit data and deficient supervisory practices to reduce risks of over-indebtedness and impaired borrower assessment.

*Source: IMF staff analysis, "The financial sector has remained stable but has yet to fully absorb pandemic-related losses."*

### 18.      The results suggest that a substantial number of mostly small cooperatives could face

### 18.      The results suggest that a substantial number of mostly small cooperatives could face solvency challenges.

### Cooperative solvency analysis
- The materialization of the adverse scenario would increase expected losses, particularly for the microcredit portfolio, and reduce profitability and capital adequacy.
- By 2025, the capital adequacy ratio of 35 cooperatives, representing about 6 percent of system assets could be below the 9 percent minimum requirement.
- The aggregate capital shortfall is relatively small: 0.2 percent of GDP.
- Several cooperatives could also face solvency challenges under the baseline scenario.
- The stress test assumes cooperatives close the gap between provisions and expected losses.
- Credit composition (2018-25): Commercial, Consumer, Microcredit, Mortgage—consumer and SME (including microcredit) loans dominate coop loan portfolios.
- SME loans have the highest expected loss ratio.
- Profitability for well-capitalized cooperatives returns to pre-pandemic levels in 2024.
- The main contributor to the change in aggregate CAR is increased provision levels in 2023.
- Evolution of ELs by credit types — cooperatives: charts indicate baseline and adverse scenarios for Commercial, Consumer, Microcredit, Mortgages (preserved as presented).

### Bank solvency analysis (selected results)
- A relatively large number of banks fall below the minimum CAR, but aggregate capital shortfalls are small.
- Aggregate bank profits contribute to material internal capital generation even under the adverse scenario, while larger credit losses originate from consumer, corporate and SME loans.
- Interest rate risk is small, reflecting small duration gap and repricing gaps between assets and liabilities.
- Profiles of credit losses differ by bank type:
  - Large and medium-sized banks: more exposed to losses from consumer and commercial lending.
  - Small banks: more exposed to losses from SMEs.
  - Public banks: more exposed to commercial and SME lending, reflecting specialization.
- Ecuador, Selected Results of Bank Stress Testing (Number of Banks failing on CAR):
  - Baseline: 2023: 3, 2024: 4, 2025: 5
  - Adverse: 2023: 8, 2024: 9, 2025: 9
- Failing Bank Assets to System Assets, in percent:
  - Baseline: 2023: 0.5, 2024: 0.8, 2025: 2.0
  - Adverse: 2023: 8.0, 2024: 11.4, 2025: 11.4
- CAR Shortfall, in percent of GDP:
  - Baseline: 2023: 0.0, 2024: 0.0, 2025: 0.1
  - Adverse: 2023: 0.1, 2024: 0.1, 2025: 0.2
- The actual loan-loss provisions of each of the largest 100 corporate borrowers were found broadly appropriate.
- Concentration risk is not prevalent: most individual bank exposures to the largest 100 borrowers were lower than 50 percent of the capital.

### Bank investment, sovereign and interest-rate exposure
- Bank investment portfolios are moderate in size, mostly domestic, marked-to-market and not provisioned.
- Overall exposure of banks to government securities represents 3.7 percent of assets.
- The maturity of government securities is relatively short; thus, the impact of shocks to sovereign spreads on bank solvency is immaterial.
- Interest rate risk is low due to the combination of a relatively high interest rate environment, and small duration and repricing gaps.
- Bank securities portfolios (June 2022): Book value (Mil. USD) — Abroad: 1,940; Ecuador: 5,865; Total: 7,805. Existing provisions (Mil. USD) — Abroad: 171; Ecuador: 321; Total: 48. Percent of Capital — Abroad: 23.9; Ecuador: 72.3; Total: 96.2. Percent of Assets — Abroad: 3.1; Ecuador: 9.5; Total: 12.7.

### Liquidity stress testing
- Data constraints limited the assessment of liquidity risk; bank-level liquidity risk was assessed using a pilot Liquidity Coverage Ratio (LCR) covering the six largest banks (~60 percent of system assets) and supervisory liquidity gap templates.
- Analysis differentiated domestic and foreign High Quality Liquid Assets (HQLA).
- Results suggest banks do not hold enough liquid assets.
- Three LCR scenarios:
  - Baseline: 100 percent weight on domestic securities and 0 percent weight to bank claims on the Liquidity Fund.
  - Stress 1: 0 weight applied to domestic securities and 50 percent weight to bank claims on the Liquidity Fund.
  - Stress 2: 0 weight applied to domestic securities and 0 percent weight to bank claims on the Liquidity Fund.
- Under the least severe scenario (no haircuts on domestic securities and no use of liquidity fund resources), three of the six banks accounting for about 25 percent of system assets fall below the reference LCR.
- Under a more realistic exercise assuming domestic securities could not be monetized, five banks accounting for 37 percent of system assets drop below the reference LCR.
- Systemic liquidity is the main risk to financial stability given the lack of a domestic currency and insufficient foreign assets.
- Half of the sampled banks maintain insufficient claims on the liquidity fund to restore a 100 percent LCR; one medium-size bank displays a liquidity deficit 3.7 times larger than its claims.
- Two systemically important banks were able to cover their liquidity deficits with resources from the liquidity fund.
- Extrapolation of results for the pilot banks suggests a system-wide liquidity deficit of about US$2.9 billion.
- Composition of Bank Liquid Assets (In mil. USD):
  - Reserves and Deposits at BCE — Abroad: 0; Ecuador: 6,015; Total: 6,015
  - Non-Financial Corporations — Abroad: 154; Ecuador: 855; Total: 1,009
  - Sovereign Securities — Abroad: 0; Ecuador: 1,649; Total: 1,649
  - IFIs — Abroad: 1,579; Ecuador: 0; Total: 1,579
  - Private Banks — Abroad: 181; Ecuador: 1,693; Total: 1,711
  - Public Banks — Abroad: 0; Ecuador: 713; Total: 713
  - Credit Cooperatives — Abroad: 0; Ecuador: 96; Total: 96
  - Investment Funds and Escrows — Abroad: 0; Ecuador: 534; Total: 534
  - Total — Abroad: 1,611; Ecuador: 11,186; Total: 12,797
- Liquidity Shortfalls under Stress Scenario (Assumptions: 0 weight applied to domestic securities and 0 percent weight to bank claims on the Liquidity Fund). Aggregate totals (sample banks):
  - Net Outflows: 5,911 (mil. USD)
  - HQLA: 4,044 (mil. USD)
  - Liquidity Needs: 1,916 (mil. USD)
  - Claims on Liquidity Fund: 1,617 (mil. USD)
  - Liquidity Deficit: 1,051 (mil. USD)

### Nonfinancial corporate sector stress test
- Corporate debt-at-risk is not an imminent threat to financial stability.
- Aggregated debt-at-risk, measured by the debt of companies with an interest coverage ratio (ICR) below 100 percent, is about 6 percent of GDP.
- Migration of companies to lower ICRs appears moderate, likely due to relatively low indebtedness.
- Coverage of Corporates:
  - Large: Number of Companies: 3,215; Assets to GDP: 89.7; Debt to GDP: 11.2
  - Medium: Number of Companies: 7,041; Assets to GDP: 16.6; Debt to GDP: 2.1
  - Small: Number of Companies: 21,106; Assets to GDP: 12.5; Debt to GDP: 1.3
  - Micro: Number of Companies: 55,027; Assets to GDP: 16.6; Debt to GDP: 0.8
  - Total: Number of Companies: 86,389; Assets to GDP: 135.3; Debt to GDP: 15.4
- Distribution of ICR in Baseline and Adverse Scenarios (company debt, in percent of GDP, 2024):
  - ICR categories shown: 120<=ICR; 100<=ICR<120; 70<=ICR<100; 50<=ICR<70; 0=ICR<50
- In percent of GDP (2024), ICR>100: Baseline 9.3; Adverse 10.5. ICR<=100: Baseline 6.1; Adverse 4.9. (Preserved as presented.)

### Climate-related risks to the financial sector
- Ecuador’s high exposure to natural hazards poses physical risks for banks and credit cooperatives: Ecuador has the 13th largest exposure in the world to natural hazards according to the INFORM Risk index.
- Up to 20 percent of bank loans and 25 percent of cooperative loans are in parts of the country vulnerable to floods, landslides, droughts, and volcanic and seismic risks.
- Around 23 percent of system-wide bank loans in Ecuador are extended to borrowers in sectors that are considered ‘transition sensitive’ (primarily agriculture).
- Notes on methodology: estimates for share of loans directly exposed to physical risks obtained by identifying sectors most directly affected by a hazard and linking them to canton-level risk classification. For banks, exposed sectors include agriculture (FL, LS, DG, EQ, VA), housing (FL, LS, EQ, VA), transport (FL, LS, EQ, VA), construction (FL, LS, EQ, VA), tourism (FL, LS, EQ, VA) and energy and water (FL, DG). For cooperatives, exposed loans include agriculture (FL, LS, DG, EQ, VA), housing (FL, LS, DG, EQ, VA) and transport (FL, LS, DG, EQ, VA). Risk classification based on Thinkhazard.

### Financial sector oversight, coordination and macroprudential framework
- Coordination and information-sharing between the large number of institutions playing a role on financial sector issues is lacking.
- Regulatory proposals are often developed in isolation; financial stability analysis only considers specific segments; information is shared too late to effectively prepare for failure of weak institutions.
- Effective micro and macroprudential policies and tools can be built under different oversight architectures; focusing on stabilizing existing institutions and addressing weaknesses tends to generate better and faster results than reorganizing agencies.
- The superintendencies should play a large and active role in the regulatory process:
  - The Código Organico Monetario y Financiero (COMyF) grants comprehensive powers to the Junta of Financial Policy and Regulation (JPRF) to issue regulations.
  - Superintendencies have direct knowledge of supervised sectors and stronger analytical capacity.
  - The JPRF should solely play the key role of coordinator and ultimate authority on regulatory issues, particularly to harmonize cross-sector regulations and implement timely macroprudential actions.
  - Superintendencies should propose regulations, conduct joint impact analysis, and opine on all regulatory matters applicable to entities they supervise.
- Institutional roles (summary):
  - Ministry of Economy and Finance (MEF): Responsible for legal framework; Any use of public funds; Governance of public banks.
  - Junta of Financial and Regulatory Policy (JPRF): Prudential rulemaking; Setting of interest rate ceilings; Financial stability report coordination.
  - Junta of Monetary Policy and Regulation (JPRM): Stability of monetary and payment systems, coherence of dollarization; Setting of reserve and liquidity requirements; Oversight of the BCE.
  - Central Bank of Ecuador (BCE): Implementation of JPRM policy; Oversight of payment systems; Supports JPRF stability analysis.
  - Superintendency of Banks (SB): Supervision of banks.
  - Superintendency of Cooperatives (SEPS): Supervision of cooperative deposit-takers (and non-financial cooperatives).
  - Superintendency of Companies, Securities, and Insurance (SCVS): Supervision of financial markets, securities issuance, and insurers.
  - Corporation of Deposit Insurance (COSEDE): Deposit insurance payout; asset & liability transfers in liquidation; Management of the Liquidity Fund.
- Macroprudential framework shortfalls and recommended focus:
  - Authorities committed to strengthen the macroprudential framework; current efforts need expansion.
  - Shortfalls: complex framework with unclear distribution of objectives, functions, and powers; weak information sharing and coordination; lack of a systematic process to monitor system-wide financial stability risks.
  - Although the legal framework foresees some macroprudential tools (e.g., additional capital buffers reflecting the phase of the credit cycle and systemic importance of banks), none have been implemented.
- Suggested priorities: complete and expand initiatives including a common definition of financial stability, publication of a financial stability report, and system-wide data collection.

*Source: IMF staff calculations and material from the IMF Financial Sector Assessment (as presented in the supplied content).*

### 28.      To enhance the macroprudential framework the authorities should:

### 1ecuea2023001 - 28.      To enhance the macroprudential framework the authorities should:

### Macroprudential framework: objectives, coordination, data, and tools
- Clarify the macroprudential objectives, functions, and powers of each agency; designate the JPRF as the overall coordinator of macroprudential policy and assign clear roles and responsibilities to other agencies.
- Strengthen coordination arrangements and establish a systematic process to monitor and evaluate system-wide risks; consider establishing a Financial Stability Committee to:
  - analyze systemic risks;
  - develop and monitor core indicators;
  - prepare policy proposals to manage systemic risks.
- Improve data collection, reinforce data sharing among agencies, and enhance analytical capacity; prioritize systematic reporting of indices relevant to macroprudential policy, such as housing market statistics, indebtedness, and system-wide indicators.
- Implement Basel III buffers (conservation, countercyclical and for domestic systemically important banks) and borrower-based measures in line with international standards and Basel guidelines.
- With appropriate phasing, remove the requirement to hold 60 percent of liquid assets in domestic assets; ensure liquid assets can be sold in deep markets and strengthen system-wide liquidity, with gradual implementation that considers macroeconomic conditions to avoid an unintended shortfall of domestic financing sources for the public sector.

### Banking regulation and supervision: institutional issues and supervisory approach
- Recent SB initiatives:
  - development and implementation of a supervisory stress testing program;
  - studies to enhance prudential requirements, including planned implementation of the LCR.
- Institutional shortcomings impair sound banking supervision:
  - Safety and soundness are not the primary goal of the SB; the law should recognize safety and soundness as the primary objective and internal structure should segregate units dedicated to prudential and non-prudential duties.
  - Legal independence constraints: appointment procedure for Superintendents is prone to disputes; removal procedure is excessively discretional; administrative autonomy undermined by requests from other State authorities and need for consent from the Ministries of Finance and Labor for budget and internal organization changes; laws and rules should be reformed to ensure SB self-organization and strengthen appointment/removal rules.
  - Lack of a career plan and sound training program has hindered acquisition and retention of talent; turnover of staff and management is very high.
- Supervisory approach weaknesses:
  - Transition to a new risk-based supervision framework implemented without being fully developed: absence of a supervisory cycle, insufficient guidance to supervisors, incomplete and fragmented view of banks, absence of modules to directly examine risks, reduced attention to non-credit risks.
  - Examinations and monitoring are mostly descriptive and lack proper assessment of bank soundness, risk management, and corporate governance.
  - Strong inclination towards compliance-based supervision; insufficient supervisory judgement; lack of regular supervisory stress tests and review of banks’ stress tests.
- Supervisory powers and legal framework:
  - SB should have power to increase prudential requirements for individual banks/groups based on risk profile and systemic importance.
  - SB should be able to designate temporary administrators, instead of requesting shareholders to replace senior management.
  - Maximum sanctions are too low to be effective deterrents.
  - Legal base for corrective action on banks not under “intensive supervision” should be enhanced with a catalogue of specific measures.
  - Judicial review regime for major supervision and resolution decisions should be reformed to prevent reversal and allow monetary compensation when justified.
- Additional supervisory and regulatory improvements needed:
  - Enhance consolidated supervision with a more comprehensive supervisory perimeter and regular group-wide examinations.
  - Gradually align capital and liquidity regulation to the Basel Framework, particularly definition of capital and Pillar 2 requirements; require banks to adopt a forward-looking approach to capital and liquidity management.
  - Strengthen corporate governance requirements and supervisory procedures to assess board risk oversight.
  - Address corporate exposures classification and provisioning: corporate exposures rely on expert models that currently result in less provisioning than IFRS 9 because models don’t properly account for macroeconomic conditions and shocks.
  - Align accounting criteria to IFRS and strengthen the external auditor qualification process.
  - Strengthen supervisory response to climate and environmental risks (currently at an early stage).

### Cooperative regulation and supervision
- Convergence efforts:
  - Authorities are converging prudential requirements of large cooperatives with banks; capital, loan classification and provisions, and liquidity requirements have been harmonized.
  - Remaining differences in reserve requirements and contributions to the liquidity fund; convergence expected to finish in 2025 and 2027, respectively.
  - Cooperatives’ ability to retain up to 3 percent of the amount of a loan as capital provides a competitive advantage when interest ceilings are binding.
- SEPS legal and operational shortcomings:
  - SEPS cannot remove cooperatives’ Council members for technical breaches; fit and proper requirements are lax.
  - Corrective actions limited to cooperatives under intensive supervision, limiting early supervisory response.
  - SEPS faces similar limitations on administrative autonomy as the SB.
- Supervisory approach weaknesses:
  - Supervision plan lacks a comprehensive supervisory cycle and overemphasizes offsite activities; relatively small number of onsite assessments.
  - Risk classification methodology is based on quantitative indicators and thresholds that are not risk-sensitive enough; aggregation method underestimates qualitative indicators.
  - These limitations hinder timely identification of higher-risk cooperatives and adoption of early corrective actions.
- Supervision of largest cooperatives needs substantial improvements:
  - Organizational structure and duplicative assessment practices impede a comprehensive view of risk profile.
  - Approach is not forward-looking; supervisors do not sufficiently challenge cooperatives’ strategies, policies, and methodologies.
  - Core topics such as business model viability and debtor payment capacity are not comprehensively examined.
  - Consider transferring supervision of largest cooperatives to the SB to group institutions requiring similar supervisory approaches.
- Remaining gaps to address in cooperative framework:
  - Corporate governance and risk management: set proportional expectations to foster comprehensive risk culture and sound risk management.
  - Credit risk: regulation lacks minimum requirements for evaluation, approval, and monitoring by loan type; SEPS lacks access to consolidated clients’ debt data, limiting supervision of over-indebtedness risk.
  - Classification and provisions: January 2023 loan provision requirements were raised, but concerns remain about timely disclosure of credit risk due to financial relief measures, weaknesses in internal and external auditors and risk rating agencies, and limited supervisory assessment scope to detect evergreening.
  - Capital and liquidity: gradually align regulation and supervision to the Basel Framework with proportional simplification for small cooperatives, ensuring stringency is not reduced.
  - Supervisors’ skills: strengthen through a comprehensive and specialized training program with necessary resources.

### Financial integrity (AML/CFT)
- Ongoing reforms:
  - Reform of AML/CFT framework underway based on the latest Mutual Evaluation Report.
  - Enactment of the New Organic AML/CFT Law by the forthcoming National Assembly is critical.
  - National AML/CFT Strategy approved but publication and engagement with private sector pending.
  - Updated National Risk Assessment underway, including modules on tax crimes, environmental crimes, assessment of legal entities, state-owned entities, nonprofit organizations, and crypto assets.
- Capacity and coordination concerns:
  - Resource constraints could overburden effective AML/CFT supervision; modifications should apply a risk-based approach and avoid overly expansive scope.
  - CONALAFT is operationalizing its mandate to coordinate authorities.
  - SB, SEPS and SCVS updating internal regulations; UAFE (designated supervisory entity of virtual asset service providers) is requesting entities to use a self-registration process.
  - Political commitment with adequate budget, technical, and human resources is critical.

### Financial crisis management and resolution
- Multiple resolution authorities: SB, SEPS and deposit insurer (COSEDE) all play roles; superintendencias implement corrective actions and resolve failing or failed institutions; COSEDE provides deposit insurance and finances resolution measures.
- Gaps identified and priority actions:
  - Separate supervision and resolution functions—either by an independent department within SB/SEPS or by shifting resolution responsibility to COSEDE.
  - Strengthen existing resolution tools: convert ETAP (“exclusion and transfer of assets and liabilities”) to a more traditional P&A power for packaging assets and deposits for an acquiring institution.
  - Lengthen preparation time for resolution and provide needed data in advance of failure; currently COSEDE has no access to data before resolution is triggered and, after triggering, resolution authorities have 15 days, by law, to determine the resolution plan, conduct least cost analysis, appoint an Administrator, and begin resolution.
- Medium-term legal overhaul:
  - Consider a comprehensive financial institution resolution law to establish a resolution agent separate from supervision, introduce additional resolution tools (including bridge-bank and bail-in powers), and address remaining limitations.
  - Establish a tighter timeline for implementation of resolution actions and enhance legal certainty given broad judicial review that has led to reopened closed institutions.
- COSEDE specific strengths and weaknesses (noting potential expanded role):
  - Governance should be strengthened to include independent Board members.
  - Payout time should be shortened: COSEDE pays out within 20 days of receiving depositor data from the liquidator, but the liquidator can take up to 60 days to prepare such data.
  - Staffing: COSEDE has 56 employees, of whom only six are permanent staff; remaining staff are seconded on a rotating basis.
  - Funding: substantial ex-ante fund equals 17 percent of covered bank deposits; options to strengthen funding include authority to increase premiums on banks and establishing a back-up liquidity facility.
  - Implement safeguards limiting use of COSEDE resources to the amount it would have paid out to insured depositors in a liquidation.
  - Introduce a clear legal foundation for depositor preference.
- Liquidity backstop in a dollarized context:
  - Ecuador operates an industry-funded Liquidity Fund in absence of a standard lender-of-last-resort regime; BCE does not provide an emergency liquidity facility and may face legal impediments to taking government securities as collateral.
  - Liquidity Fund: institutions deposit funds and can borrow them back, but access limited to amount of bank equity and is over-collateralized; collateral posting practices are untested.
  - Liquidity Fund would have limited role during widespread distress or a significant deposit run; consider developing a more flexible lender-of-last-resort facility with reforms to governance, information-sharing, collateral posting, fund size, relations with the BCE, and lending terms, while noting scope will remain limited by dollarization.

### Financial sector development: role of the state and SOFIs
- State role:
  - Six SOFIs in Ecuador hold 36 percent of total financial sector assets, among the largest in Latin America; SOFIs operate in asset management, and commercial and development banking; SOFIs are key actors in mortgage and microcredits segments.
- SOFIs governance and operational concerns:
  - Current legal, regulatory, governance and organizational frameworks for SOFIs are far from international good practices.
  - Recommend developing an ownership policy with criteria to justify ownership, a centralized unit for ownership/monitoring functions, and strong governance practices.
  - Many SOFIs have deficient credit risk management processes and outdated IT systems.
  - Authorities should focus on restructuring problem SOFIs rather than merging them; the CFN-Banecuador merger should be paused until a viability assessment is conducted.
  - Enhance BIESS framework to function more like a fund administrator, have it report to credit bureaus, and conduct an AQR of its mortgage and trust investments.
- Public credit support programs:
  - Redesign programs to enhance effectiveness: integrate with business advisory services, focus on viable but underserved new borrowers, include incentives for loan repayment.
  - Credit subsidies should cover cost of credit to ensure private credit provider participation.
  - Eliminate expectations of debt forgiveness and migrate interest rate caps to a usury rate.

*Source: IMF Financial Sector Assessment content unit 1ecuea2023001 (extracted text).*

### 49.      Government and corporate debt securities are sold through private placements and

### 1ecuea2023001 - 49.      Government and corporate debt securities are sold through private placements and

### Government and corporate debt markets: assessment and findings
- Government and corporate debt securities are sold through private placements and rarely transacted in the secondary market.
- The government fixes the interest rates of government securities usually below market rates.
- Events of default and fraud have damaged the reputation of a rather thin corporate debt market.
- Issuance requires cumbersome approval processes that do not offer adequate protection to the investor.
- The infrastructure for transacting government and corporate debt faces operational and reputational risk and requires significant upgrades to comply with international sound practice.
- Green finance markets are also at a nascent stage.
- A more active bond market would not only provide a robust financing alternative to the government but will also mitigate the vulnerability of the financial system to liquidity shocks.

### Capital market preconditions and recommended sequencing
- Capital markets in Ecuador have not developed because the critical preconditions for a local bond market to emerge are still lacking, including:
  - Recurring external debt defaults,
  - Structural macroeconomic imbalances,
  - Absence of a long-term savings industry.
- Market development should be approached as a gradual, long-term endeavor.
- Phased actions recommended to improve the functioning of the government bond market:
  - Replace private placements with regular auctions, initially for short-term government securities.
  - Expand repo markets.
  - Broaden the investor base.

### Authorities’ views and constraints
- Authorities broadly agreed with the FSAP’s assessments and expressed interest in implementation of the recommendations.
- Political and legal constraints:
  - Recommendations that require changes to legislation are challenging in the current political environment, and some could be limited by legal constraints.
  - Recommendations with budgetary or government financing implications would need careful sequencing given fiscal challenges.
- Financial sector stability observations:
  - Authorities pointed to the stability of the financial sector during the pandemic and the market exit of a significant number of unviable cooperatives as positive signs.
  - Authorities agreed that the combination of falling oil prices and tightening global financial conditions in the adverse scenario would be challenging.
  - Authorities agreed with the liquidity stress test analysis and noted that the liquidity fund was mostly invested in international liquid assets and would be available in extremis.
  - They noted implications of a broader move by banks and the deposit insurance fund to holding more international liquid assets for the stability of the dollarized system would need to be considered.
  - Legal limitations on public sector lending to the financial sector could limit some reforms, such as on emergency liquidity assistance.
- Supervision and crisis management:
  - Authorities recognized challenges for financial sector oversight and crisis management.
  - They highlighted initiatives to improve inter-agency coordination and plan to build on these, for example through the forthcoming Financial Stability Report.
  - Authorities agreed on the need to further integrate stress-testing and forward-looking viability analysis into supervision of banks, mutuals and cooperatives.
  - Addressing shortfalls of resources and recommendations on appointment processes would be more challenging given limited fiscal space.
  - Authorities accepted the case for reform of the financial institution resolution framework but noted major financial sector legislation would be politically challenging.

### Proposed Decision
- The Executive Board takes note of staff’s analysis and recommendations in the report on Ecuador’s Financial System Stability Assessment (SM/23/195, 08/04/2023).

### Selected economic and financial indicators (as presented)
- Real GDP: -7.84.23.02.92.82.82.82.82.8
- Domestic demand (contribution to growth): -10.37.95.61.32.92.22.62.72.6
- External Demand (contribution to growth): 2.5-3.7-2.51.5-0.10.50.10.10.2
- Consumer price index period average: -0.30.13.52.51.51.51.51.51.5
- Consumer price index end-of-period: -0.91.93.72.31.31.31.51.51.5
- Net domestic assets: 3.614.911.05.60.92.02.93.23.8
- Credit to the private sector: 2.513.613.97.24.03.73.83.83.8
- Exports: -14.231.021.1-3.23.33.42.21.51.2
- Oil exports and production (selected): Oil-39.563.933.3-14.95.9-1.9-4.1-5.0-4.5; Oil price Ecuador mix (US$ per barrel) 35.662.085.170.968.665.962.559.556.8; Oil production (millions of barrels) 175.4172.6175.5178.5189.2192.5194.8194.8194.8
- Current account balance: 2.72.92.22.02.02.02.02.02.0
- Public debt 2/: 60.962.357.3 (Domestic 16.217.614.9; External 44.744.742.4)
- Nominal GDP (US$ millions): 99,291106,166116,360121,291126,449131,202136,314141,514146,911
- GDP per capita (US$): 5,6705,9796,4626,6436,8296,9887,1597,3297,504
- Gross international reserves (US$ millions) 4/: 7,1337,8988,4599,49111,37612,57613,53114,33914,908
- Net international reserves (US$ millions) 5/: -7,161-5,747-6,413-5,107-2,824-6181,1972,7063,966

### Financial system structure and soundness (selected)
- Table 4: Structure of Financial System, December 2022 (Totals)
  - Total assets (US$ Mil.) Total: 119,410 (100) (103 percent of GDP)
  - Private Banks (23): 49,895 (41.8 percent of total assets) (43.0 percent of GDP)
  - Public Banks (5): 14,881 (12.5 percent of total assets) (12.8 percent of GDP)
  - Cooperatives (467): 23,509 (19.7 percent of total assets) (20.3 percent of GDP)
  - BIESS: 27,806 (23.3 percent of total assets) (24.0 percent of GDP)
- Table 5: Financial Soundness Indicators (selected time series)
  - Private and public commercial banks:
    - Capital adequacy ratio: 13.7 13.4 13.5 14.5 13.9 13.7
    - Non-performing loans / gross loans: 3.0 2.6 2.7 2.6 2.1 2.2
    - Provision / non-performing loans: 234.4 247.7 225.6 293.1 324.4 314.0
    - Gross loans (billions of US dollars): 24.6 27.3 30.0 29.5 33.7 38.6
    - Total credit growth (yoy): 20.7 11.1 9.9 -1.6 14.0 14.6
    - Total deposits (billions of US dollars): 30.7 31.3 33.7 37.5 41.2 43.6
  - Public development banks:
    - Capital adequacy ratio: 39.7 37.5 36.8 35.2 31.7 33.3
    - Non-performing loans / gross loans: 5.4 4.9 5.7 9.6 15.3 16.8
    - Gross loans (billions of US dollars): 4.2 4.7 5.0 4.9 4.6 4.5
  - Cooperatives (Segment 1-3):
    - Capital adequacy ratio (Segment 1 only): 18.0 16.9 17.0 17.2 17.3 15.7
    - Non-performing loans / gross loans: 5.0 3.9 3.9 3.8 4.2 4.0
    - Gross loans (billions of US dollars): 7.5 9.5 10.8 11.3 14.0 17.1
    - Total deposits (billions of US dollars): 8.5 9.7 11.2 12.6 15.8 18.5

### Implementation status of prior FSAP recommendations (high-level)
- Several 2004 FSAP recommendations were partially implemented, some implemented, and others not implemented:
  - Partially implemented items include: strengthening bank supervision, eliminating regulatory forbearance, improving payment system efficiency, promoting development of insurance services, strengthening creditor rights and bankruptcy procedures, and formulating explicit objectives for debt management.
  - Implemented items include: setting up a Liquidity Fund (managed by COSEDE) and establishing COSEDE as deposit insurer and manager of the Liquidity Fund.
  - Not implemented items include: sale of Banco Pacífico at market price; raising minimum capital requirements to 11 percent over three years; liquidation of closed banks by end-2004.

*Source: Excerpts from Ecuador Financial System Stability Assessment (SM/23/195, selected sections).*

### 3. Commodity price

### 3. Commodity price

### Commodity price volatility: nature and drivers
- A succession of supply disruptions (e.g., due to conflicts and export restrictions) and demand fluctuations (e.g., reflecting China reopening) causes recurrent commodity price volatility, external and fiscal pressures, and social and economic instability.

### Likelihood and level of concern
- Medium

### Expected macrofinancial and fiscal impacts if realized
- Uncertainty on commodity prices will affect investment and economic activity. Financial conditions will tighten, leading to higher funding costs for banks and non-financial corporations.
- Credit quality would deteriorate, with potentially adverse consequences on bank solvency.
- Fluctuations in commodity prices would impact the fiscal sector and Ecuador’s balance of payments.

*Source: 1ecuea2023001 - 3. Commodity price*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1ecuea2023001.pdf_