## Appendix II — Report on the Observance of Standards and Codes (ROSC) on banking

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### Preface and mission
- An IMF assessment mission visited Andorra from September18–28, 2006 to assess supervision and regulation of the financial sector.
- The mission was a follow up to the 2002 assessment under the Offshore Financial Center (OFC) program and part of periodic assessments every four to five years.
- Assessment team: Socorro Heysen (Mission Chief); Alicia Novoa; Ruben Mendiolaza (Consultant, Superintendency of Banks and Insurance, Peru, Banking); Walter Zunic (Consultant, Banking); Piotr Andrzejewski (Consultant, Insurance and Securities).
- Authorities and stakeholders met: Cap de Govern; Minister of Finance; INAF senior management; UPB head; Deputy Director General (INAF); Director of Supervision (INAF); Director of Tax Administration; financial institutions; industry associations; audit firms; rating agencies.

### Executive summary — key findings
- Overall assessment and scope
  - Financial sector supervision is broadly sound with respect to material activities centered on the banking sector.
  - The AFSSR is a summary report on implementation of indicated financial sector regulatory standards; it is designed to help identify and remedy weaknesses in supervision and regulation and does not directly assess risks associated with asset quality, markets, or fraud.
- Progress since 2002
  - New charter for Institut Nacional Andorrà de Finances (INAF) approved (law 14/2003 superseding the 1989 charter).
  - Draft laws prepared to update regulation of nonbank financial institutions and insurance companies and to strengthen UPB enforcement capacity.
- External auditors and supervision
  - Supervision relies heavily on external auditors; since 2002 auditors are required to prepare complementary reports in addition to annual financial reports.
  - INAF has revised and broadened requirements for complementary reports annually; additional guidance needed to ensure these reports effectively support supervision.
- INAF capacity, powers, and cross-border cooperation
  - INAF independence and cross-border cooperation capacity strengthened by new charter.
  - Charter strengthened remedial powers but INAF cannot yet undertake all sanctions classified as “very serious”; final authority for license revocation remains with the government.
  - Charter permits INAF to sign agreements with foreign supervisors, but a formal agreement with the Bank of Spain (BE) has not been achieved due to restrictions on access to nominative customer information.
  - INAF can facilitate nominative information on large exposures and conduct joint on-site examinations.
  - Recommendation: empower INAF to share with home supervisors information about local operations of foreign banks necessary for effective supervision, provided confidentiality is protected.
- On-site supervision timeline and staffing
  - INAF staff count: 12.
  - Development of INAF’s on-site supervisory capacity under way; full on-site inspections expected to start in late 2007 after training of new staff.
  - Additional hires may be needed to ensure effective on-site oversight and reduce reliance on external auditors.
- Market developments and structural changes
  - Low interest rates shifted customer preferences away from deposits into higher-yield instruments offered by asset managers; bank off-balance sheet items increased.
  - From 2000 to 2005 assets managed by banks grew by 12.8 percent yearly average; collective investment entities’ assets grew by 16.0 percent yearly average.
  - EU Directive 2003/48 (tax retention) effects: retention of EU taxes on savings income applied since July 1, 2005; tax retention is 15 percent from July 1, 2005; increases to 20 percent on July 1, 2008 and to 35 percent on July 1, 2011.
  - Life insurance premiums grew from 61 million euros in 2004 to 1.8 billion euros in 2005 (2005 premiums include transfer of assets into capitalization schemes).
  - Ownership changes: capital of banks with foreign participation represents 2 percent of total bank capital by end-2006 (vs about 70 percent in 2002); another reported figure: foreign capital share fell from 36 percent to 1 percent from 2002 to end-2006.

### Key recommendations (selected) and authorities’ responses
- Cross-sector recommendations
  - Adopt international accounting standards (IFRS) for all the financial sector. Term: ST. Authorities’ response: law is a priority for the MF and should be approved by the General Council in the short run.
  - INAF to develop on-site supervision capacity through training and gradual hires. Term: ST. Authorities’ response: INAF plans to start on-site exams in late 2007.
  - INAF to clarify requests to external auditors and hire independent audit firms to assess audit quality as needed. Term: ST. Authorities’ response: INAF already clarifies requests and comments when not addressed.
  - Integrate all norms for external auditors into a single body of rules. Term: ST. Authorities’ response: INAF will present proposal in October 2006 meeting with banks and external auditors.
- Banking regulation and supervision
  - Grant INAF full authority to grant and revoke bank licenses based on technical elements. Term: MT. Authorities’ response: final authority should remain with the government.
  - Empower INAF to undertake all remedial actions, including orderly resolution and license revocation. Term: MT. Authorities’ response: authorities accept need to balance INAF’s technical decisions with government approval for license revocation.
  - Strengthen rules on connected lending (credits to insiders and related interests). Term: ST. Authorities’ response: INAF is considering issuing a communication.
  - Intensify efforts to enter formal agreements with foreign supervisors and allow INAF to share local operations information with home supervisors subject to confidentiality protections. Term: ST. Authorities’ response: authorities reaffirm intention to enter into formal agreements.
- Collective Investment Schemes (CIS)
  - Review draft CIS law to ensure proper/disclosed asset valuation, pricing and redemption and strengthen disclosure on investor suitability. Term: ST. Authorities’ response: intend to work on this as soon as possible.
  - Government should table the draft CIS law in the General Council with a view to adoption as soon as possible. Term: MT. Authorities’ response: draft laws have been sent to financial sector entities for comments; this law is a priority.
- Insurance sector
  - Require external auditors to produce complementary reports on policies, systems, processes, and internal controls of insurance companies; strengthen oversight capacity. Term: ST. Authorities’ response: efforts will be concentrated to implement this recommendation in the short term.
  - Transfer supervision responsibility for insurance companies to INAF with sufficient staff. Term: MT. Authorities’ response: once new insurance law is approved, responsibility will be carried out by INAF.
  - Table a new insurance law codifying prudential requirements, internal controls, conduct of business, policyholder protection, public disclosure and international cooperation requirements. Term: MT. Authorities’ response: MF will prepare a draft law during 2006 in conformity with IAIS principles; this law is a priority for the MF.

### Assessment scope and methodology
- The mission assessed bank regulation and supervision against the Basel Core Principles for Effective Banking Supervision (BCP).
- Reviewed insurance regulatory and supervisory framework (no formal IAIS compliance assessment due to small sector size).
- Reviewed CIS regulatory and supervisory framework against the IOSCO section (no formal IOSCO compliance assessment).
- Reviewed cross-sector and cross-border cooperation and information exchange arrangements and practices.
- AML/CFT: initial review conducted based on information provided and discussions with UPB and INAF; mission had access to preliminary MONEYVAL mutual evaluation results (October 2005); a ROSC on AML/CFT to be prepared once final MONEYVAL results are issued (authorities expect mid-2007).
- Follow-up: mission evaluated implementation of 2002 Module 2 report recommendations; authorities agreed to participate in the Information Framework—Financial Activities in International and Offshore Financial Centers initiative and expect to submit annual information by early 2007.

### Financial system overview — structure, recent developments, and key statistics
- System structure and employment
  - Financial services sector produces 15 percent of GDP.
  - Sector employs some 1,523 persons, accounting for 3.6 percent of all jobs as of 2005.
  - Average salaries in the sector are above twice the national average.
- Composition (as of December 2005 and 2005 figures)
  - 7 banking institutions.
  - 1 specialized financial credit institution.
  - 7 collective investment entities.
  - 4 wealth management companies.
  - 28 insurance companies (15 branches of foreign insurance companies authorized to operate in Andorra).
  - 7 banks form part of 5 banking groups.
  - Bank-related entities conduct 99 percent of life insurance business (by gross premiums) and 99 percent of collective investment business.
- Banking system size and cross-border links (2005)
  - Banking total assets: 11.3 billion euros in 2005.
  - Customer deposits: 9.3 billion euros in 2005.
  - Total loans in 2005: 8.9 billion euros, of which 2.7 billion euros were loans to nonresidents (mostly Europe and North America).
  - 7 licensed banks offering services through about 55 branches.
  - Banks have branches in Bahamas and Uruguay and a representative office in Panama (very small share of business).
- Ownership and concentration
  - As of early 2006, three of seven banks had Spanish participation, accounting for about 45 percent of assets and deposits (down from around 71 percent in 2001).
  - After reported sales, only one Spanish bank (about 4 percent of assets and deposits) expected to remain operating in Andorra.
  - Ownership totals as of December 2005 (totals): Total banking system assets: 11,328 (millions of euros); Total deposits: 9,289 (millions of euros); Total capital: 1,333 (millions of euros); Total employees: 1,150.
- Structural shifts and product flows (2000–2005)
  - From 2000 to 2005 assets managed by banks grew by 12.8 percent yearly average.
  - Collective investment entities’ assets grew by 16.0 percent yearly average from 2000 to 2005.
  - Life insurance premiums: 61 million euros in 2004; 1.8 billion euros in 2005 (2005 included transfer of assets into capitalization schemes).
- Off-balance sheet and custody activity (2005)
  - Securities in custody: 20.4 billion euros in 2005 (nearly thrice customer deposits).
  - Derivatives operations: 10.8 billion euros in 2005.
  - Securities and other instruments in custody growth: 16.2 percent in 2005.
  - Derivatives growth: 61.1 percent in 2005.
  - Bank-managed third-party assets and assets of investment funds held in custody by banks: 19.2 billion euros.

### Key banking indicators and risk profile (exact figures)
- Capitalization, liquidity, profitability and asset quality (Table 3 indicators, in percent)
  - Capital Adequacy Ratio: 32.3 (2000); 32.4 (2003); 31.7 (2004); 28.8 (2005).
  - Return on Asset: 2.8 (2000); 2.8 (2003); 3.1 (2004); 3.4 (2005).
  - Return on Equity: 26.2 (2000); 19.8 (2003); 20.0 (2004); 21.4 (2005).
  - Liquid assets over total assets (assets maturing in less than one month considered liquid): 45.2 (2000); 46.4 (2003); 40.7 (2004); 36.2 (2005).
  - Liquidity ratio (liquid assets in percent of short term liabilities): 84.0 (2000); 77.0 (2003); 75.1 (2004); 66.2 (2005).
  - Fees and commissions as a percent of total revenue: 25.8 (2000); 38.6 (2003); 44.3 (2004); 45.1 (2005).
- Other key figures
  - Loan-to-deposit ratio reported as 96 percent.
  - 76 percent of total loans granted to Andorran residents.
  - Past due loans: about 0.2 percent of total loans in 2005.
  - Minimum Capital to Risk Weighted Assets (CAR) per Basel 1: 10 percent (minimum).
  - Andorran banks required to hold liquid assets for at least 40 percent of short-term liabilities.

### Legal, institutional, and supervisory framework
- INAF characteristics and powers
  - INAF established as public financial institution (1989) with legal personality; new charter passed in 2003 grants operational and budgetary independence.
  - Directed by a Board of six members appointed by the Consell General at the proposal of the MF for six-year terms (half staggered every three years).
  - Director General appointed by the government; Deputy Director General also six-year term.
  - INAF powers: issue mandatory directives (Comunicats); access necessary information; conduct on-site examinations; impose corrective actions and sanctions (except the most severe and license revocation which remain government functions); enter into agreements with foreign supervisors.
  - Recommendation: empower INAF to make final licensing and sanction decisions to align accountability with supervisory responsibility.
- Legal framework overview
  - Main laws: (i) financial system law (1993); (ii) law governing operational powers of components of the financial system (1996); (iii) law governing the disciplinary system of the financial sector (1997); (iv) law regulating basic administrative rules of banking institutions (1998); (v) INAF charter (2003).
  - INAF Directives (Comunicats) supplement laws with fiduciary, prudential and conduct of business requirements.
  - Draft laws updating regulatory framework for nonbank financial institutions and a CIS draft law elaborated; CIS draft law reported to be Euro-compatible.
- Accounting and reporting
  - Financial institutions (except insurance) follow INAF Chart of Accounts (Pla Comptable) issued in 1999.
  - No accounting standards mandated for insurance companies.
  - Draft accounting law to adopt and implement IFRS being studied; draft expected ready for submission to Parliament in 2007.
- External auditors and complementary reports
  - Communication 157/03 (December 2003) requires expanded complementary audit reports including credit policies, detailed credit risk analysis, evaluation of internal controls, off-balance sheet review, subsidiary details and consolidation methods, and information systems covering concentration limits.
  - Complementary report (IC) in effect since 2001 for banks and since 2005 for nonbank financial institutions.
  - Tripartite annual meetings every October among INAF senior staff, external auditor and bank management discuss the IC and require corrective measures if needed.
  - Observed issues: auditors often need clearer benchmarks and standards to opine effectively on internal controls, risk management, structured products and derivatives; some auditors limit scope to compliance with entity policies; some nonbank auditors provided IC information based solely on annual audit work.
  - Recommendations: integrate audit regulations into a single framework; clarify INAF expectations; define materiality and multi-period work programs; ensure auditor independence, licensing, competence and quality assurance; consider hiring independent audit firms to assess audit quality as needed.

### Sectoral findings and recommendations (selected)
- Banking (BCP compliance)
  - Compliant with 21 principles; largely compliant with 8 principles; materially noncompliant only on Principle 25 (supervision of foreign bank establishments).
  - INAF has not conducted its own on-site examinations since its creation in 1989; relies substantially on external auditors.
  - Recommendations: step up efforts to sign agreements with foreign supervisors; develop on-site supervisory capacities; improve oversight delegated to external auditors; be empowered to make final licensing and sanction decisions; improve disclosure of INAF activities and financial statements.
- Collective Investment Schemes (CIS)
  - No CIS-specific statute yet; INAF Directives govern CIS pending new law.
  - Draft CIS law reportedly Euro-compatible; may need enhancements regarding asset valuation bases, pricing and redemption rules, and retail investor disclosure.
- Insurance
  - Regulation and supervision insufficient relative to sector’s increasing importance; supervision by MF (tax department) with limited prudential and conduct-of-business regulation and no international cooperation provisions.
  - Actions needed: transfer insurance supervision to INAF per charter provisions; increase insurance oversight capacity; prioritize new insurance regulation law consistent with IAIS principles.
- AML/CFT (preliminary)
  - Legal framework largely based on Law on International Criminal Cooperation and Combating Laundering of Money or Valuables Resulting from International Crime (2000).
  - UPB has exclusive jurisdiction over money laundering investigations and supervision; UPB a member of the Egmont Group since 2002.
  - MONEYVAL third-visit preliminary assessment (October 17–21, 2005) found continued progress but noted areas needing improvement.
  - Draft legislation pending to adapt Andorra’s AML/CFT regime to the revised FATF Recommendations (including financing of terrorism, expansion of supervised entities, binding UPB Comunicados Tecnics, and sanctioning powers up to very grave sanctions reserved to central government).

### Cross-border cooperation and information exchange
- Legal provisions and practice
  - Laws include secrecy/confidentiality protections for supervisory information; revealing confidential information penalized (Article 191 of the Penal Code).
  - Both INAF and UPB empowered to enter cooperation agreements with foreign authorities.
  - UPB has signed cooperation agreements with AML authorities in Bahamas, Belgium, Dutch Antilles, France, Luxembourg, Monaco, Peru, Poland, Portugal, Spain, and Thailand.
  - UPB has cooperated closely with Egmont members and conducts on-site inspections and auditor engagement on AML issues.
  - INAF empowered to establish relations and cooperation agreements (Article 9 of its charter) but has not yet signed formal MOUs with foreign supervisors; conversations ongoing with Bahamas authorities.
  - Attempts to sign an agreement with the BE failed due to restrictions on host-country access to nominative customer information and to unannounced on-site examinations.
  - INAF willing to facilitate nominative information on large exposures and to conduct joint on-site inspections.
  - Recommendation: empower INAF to share with home-country supervisors all information about local operations of foreign banks necessary for effective supervision, provided confidentiality is protected.
  - Noted trend: decreasing Spanish participation in Andorran banking system (expected down to some 4 percent of assets and deposits and 2 percent of capital by end-2006) which has reduced urgency for MOUs.

### Preconditions for effective supervision and crisis framework
- Macroeconomic and legal environment
  - No identifiable macroeconomic vulnerabilities with implications for banking industry stability.
  - Public infrastructure supports honoring and enforcement of financial contracts.
- Credit assessment and collateral
  - Small local economy facilitates credit risk assessment.
  - Absence of a credit bureau has not adversely affected loan evaluation; past due loans about 0.2 percent of total loans in 2005.
  - Execution of collateral reportedly takes less than one year.
- Crisis resolution and safety nets
  - No deposit insurance and no lender of last resort.
  - All banks required to participate in a guarantee fund; funds deposited in banks with undefined use for resolution.
  - Authorities foresee implementation, in the medium term, of a fully defined deposit and investments insurance fund.

### Recommended action plan (selected items)
- CP1: Amend INAF’s charter to empower INAF to issue licenses and conduct an orderly resolution of a problem bank; empower INAF to undertake all types of remedial actions including very serious sanctions and revocation of licenses.
- CP10: Ensure credits to insiders and related interests are not granted at preferential rates and require Board approval for such transactions.
- CP14: Members of Boards of Directors should participate in yearly meetings with auditors and INAF.
- CP16: Gradually increase number of INAF supervisors; recruit a system specialist to support on-site and off-site supervision.
- CP20/CP22/CP24–25: Transfer insurance supervision into INAF; enter into MOUs with foreign supervisors (including Uruguay and Spain) and share necessary information about local operations of foreign banks, provided confidentiality is protected.

*IMF assessment mission report on financial sector supervision and regulation in Andorra (September18–28, 2006).*

### Appendix II includes the Report on the Observance of Standards and Codes (ROSC) on banking. The

### Appendix II — Report on the Observance of Standards and Codes (ROSC) on banking

### Preface and Mission
- An IMF assessment mission visited Andorra from September18–28, 2006 to assess supervision and regulation of the financial sector.
- The mission was a follow up to the 2002 assessment under the Offshore Financial Center (OFC) program and part of periodic assessments every four to five years.
- Assessment team composition:
  - Socorro Heysen (Mission Chief)
  - Alicia Novoa
  - Ruben Mendiolaza (Consultant, Superintendency of Banks and Insurance, Peru, Banking)
  - Walter Zunic (Consultant, Banking)
  - Piotr Andrzejewski (Consultant, Insurance and Securities)
- Authorities and stakeholders met included the Cap de Govern, the Minister of Finance, INAF senior management, UPB head, Deputy Director General (INAF), Director of Supervision (INAF), Director of Tax Administration, financial institutions, industry associations, audit firms, and rating agencies.

### Executive summary — Key findings
- Overall assessment:
  - Financial sector supervision is broadly sound with respect to material activities centered on the banking sector.
  - The AFSSR is a summary report on implementation of indicated financial sector regulatory standards; it is designed to help identify and remedy weaknesses in supervision and regulation and does not directly assess risks associated with asset quality, markets, or fraud.
- Progress since 2002:
  - A new charter for the Institut Nacional Andorrà de Finances (INAF) has been approved (law 14/2003 superseding the 1989 charter).
  - Work is under way to address remaining gaps in the regulatory and supervisory framework.
  - Draft laws have been prepared to update regulation of nonbank financial institutions and insurance companies and to strengthen UPB enforcement capacity.
- Role of external auditors:
  - Supervision relies heavily on external auditors. Since 2002 auditors are required to prepare complementary reports in addition to annual financial reports.
  - INAF has revised and broadened requirements for these complementary reports annually, but additional guidance is needed to ensure they effectively support supervision.
  - Clarifying INAF’s requests and reaching an understanding with auditors would enhance supervision in the short term.
- INAF capacity and powers:
  - INAF’s independence and cross-border cooperation capacity have been strengthened by the new charter.
  - The charter strengthened remedial powers but further enhancement is recommended to empower INAF to undertake all sanctions, including those classified as “very serious.”
  - The charter permits INAF to sign agreements with foreign supervisors, but a formal agreement with the Bank of Spain (BE) has not been achieved due to restrictions on access to nominative customer information.
  - INAF can facilitate nominative information on large exposures and conduct joint on-site examinations.
  - Recommendation: empower INAF to share with home supervisors information about local operations of foreign banks necessary for effective supervision, provided confidentiality is protected.
- On-site supervision timeline and staffing:
  - Development of INAF’s on-site supervisory capacity is under way; full on-site inspections are expected to start in late 2007 after training of new staff.
  - INAF staff count is 12; additional hires may be needed to ensure effective on-site oversight and reduce reliance on external auditors.
- Market developments and structural changes:
  - Low interest rates shifted customer preferences away from deposits into higher-yield instruments offered by asset managers; bank off-balance sheet items increased.
  - Starting in 2005, prospects of retention of EU taxes on savings income of EU customers induced switches to savings-linked life insurance policies, increasing the life insurance sector’s significance.
  - Ownership changes: capital of banks with foreign participation represents 2 percent of total bank capital by end-2006, down from about 70 percent in 2002.
  - Additional reported figure: share of foreign capital in the banking system fell from 36 percent to 1 percent from 2002 to end-2006.

### Key recommendations (selected) and authorities’ responses
- Cross-sector recommendations:
  - Adopt international accounting standards for all the financial sector, as proposed in draft legislation to be submitted to Parliament.
    - Term: ST
    - Authorities’ response: This law is a priority for the MF and should be approved by the General Council in the short run.
  - INAF to develop on-site supervision capacity through training and gradual hires.
    - Term: ST
    - Authorities’ response: INAF plans to start on-site exams in late 2007.
  - INAF to clarify requests to external auditors; hire independent audit firms to assess audit quality as needed.
    - Term: ST
    - Authorities’ response: INAF already clarifies requests to auditors when necessary and comments when requests are not addressed as required.
  - Integrate all norms for external auditors into a single body of rules.
    - Term: ST
    - Authorities’ response: INAF will present this proposal in the October 2006 meeting with banks and external auditors.
- Banking regulation and supervision:
  - Grant INAF full authority to grant and revoke bank licenses based on technical elements.
    - Term: MT
    - Authorities’ response: Final authority to grant and revoke licenses should remain with the government.
  - Empower INAF to undertake all remedial actions, including orderly resolution and license revocation.
    - Term: MT
    - Authorities’ response: Authorities accept the need to balance INAF’s technical decisions with government approval for license revocation.
  - Strengthen rules on connected lending (credits to insiders and related interests).
    - Term: ST
    - Authorities’ response: INAF is considering issuing a communication on this matter.
  - Intensify efforts to enter formal agreements with foreign supervisors and allow INAF to share local operations information with home supervisors subject to confidentiality protections.
    - Term: ST
    - Authorities’ response: Authorities reaffirm their intention to enter into formal agreements with banking authorities of foreign banks.
- Collective Investment Schemes (CIS):
  - Review the draft law on CIS to ensure proper/disclosed asset valuation, pricing and redemption and strengthen disclosure provisions on investor suitability.
    - Term: ST
    - Authorities’ response: Authorities intend to work on this as soon as possible.
  - Government should table the draft law on CIS in the General Council with a view to adoption as soon as possible.
    - Term: MT
    - Authorities’ response: Draft laws have been sent to financial sector entities for comments; this law is a priority for the government.
- Insurance sector:
  - Require external auditors to produce a complementary report on policies, systems, processes, and internal controls of insurance companies; strengthen oversight capacity.
    - Term: ST
    - Authorities’ response: Efforts will be concentrated to implement this recommendation in the short term.
  - Transfer supervision responsibility for insurance companies to INAF with sufficient staff.
    - Term: MT
    - Authorities’ response: Once the new insurance law is approved, this responsibility will be carried out by INAF.
  - Table a new insurance law codifying prudential requirements, internal controls, conduct of business, policyholder protection, public disclosure and international cooperation requirements.
    - Term: MT
    - Authorities’ response: MF will prepare a draft law during 2006 in conformity with IAIS principles; this law is a priority for the MF.

### Assessment scope and methodology (Introduction)
- The mission:
  - Assessed bank regulation and supervision against the Basel Core Principles for Effective Banking Supervision (BCP).
  - Reviewed insurance regulatory and supervisory framework (no formal IAIS compliance assessment due to small sector size).
  - Reviewed CIS regulatory and supervisory framework against the IOSCO section (no formal IOSCO compliance assessment).
  - Reviewed cross-sector and cross-border cooperation and information exchange arrangements and practices.
- AML/CFT:
  - An initial review of AML/CFT practices was conducted based on information provided by authorities and discussions with UPB and INAF senior staff.
  - The mission had access to preliminary MONEYVAL mutual evaluation results (October 2005); a ROSC on AML/CFT will be prepared once final MONEYVAL results are issued (authorities expect mid-2007).
- Follow-up and participation:
  - The mission evaluated implementation of 2002 Module 2 report recommendations.
  - The authorities agreed to participate in the Information Framework—Financial Activities in International and Offshore Financial Centers initiative and expect to submit annual information by early 2007.

### Financial system overview — Background and history
- Andorra’s financial system evolution:
  - First bank established in 1930: Banc Agrícoli Comercial d’Andorra, servicing local population and Spanish immigrants.
  - Andorra’s economy was initially dedicated to agriculture and commerce; banking expansion was limited until the 1950s.
  - Andorra emerged as a regional financial center during the 1950s after eliminating all taxes on banking operations (1951), attracting capital inflows mostly from Catalunya.
  - Most existing banks were created during the 1950s (see Appendix I in the assessment).

*Source: IMF assessment mission report on financial sector supervision and regulation in Andorra (September18–28, 2006).*

### 5.      The banking system was self-regulated until 1993, when the financial system law was

### cr0769 - 5.      The banking system was self-regulated until 1993, when the financial system law was

### Historical regulation and establishment of INAF
- The banking system was self-regulated until 1993, when the financial system law was issued and the Institut Nacional Andorrà de Finances (INAF) was established as a technical institution to supervise financial companies and to propose to the government the regulations pertaining to the financial system.
- Until 1993 the Andorran Bankers’ Association (ABA), created in 1960, effectively acted as a self-regulatory body, issuing guidelines followed by Andorran banks.
- Throughout 75 years of banking history, Andorra did not experience a banking crisis; one institution failed in 1968 (Sobanca) and remaining banks honored its liabilities to preserve confidence.
- Andorran banks historically maintained high levels of liquidity and capital as a signal of resilience; this prudent behavior remained generally unchanged after formal regulation and supervision were implemented.

### Previous assessments and recommendations
- The 2002 report assessed compliance with the Basel Core Principles (BCP) and AML/CFT standards, and reviewed insurance and securities sectors:
  - High level of compliance with the BCP, representing around 95 percent of all financial sector activities.
  - Compliance with BCP principles: compliance in 14 principles, large compliance in 13 principles, material noncompliance in 2 principles, and 1 principle deemed not applicable.
  - High level of compliance with international standards for AML.
  - Full IAIS and IOSCO assessments were not carried out given the limited size of insurance and securities systems relative to the overall financial system.
- Key recommendations from the 2002 assessors to improve banking supervision:
  - Clarify responsibilities and strengthen the autonomy of INAF.
  - Improve cooperation and exchange of information with the home supervisor of subsidiaries of foreign banks.
- Identified limits prior to reforms:
  - INAF’s independence was limited by requirements for prior approval/consent of the finance minister and the Comissió Superior de Finances (CSF) for virtually all actions, including approval of regulation, administrative sanctions, and authorization of on-site inspections.
  - Cooperation with home supervisors of foreign banks was restricted by limits on INAF’s ability to enter into agreements with foreign supervisors and on the ability of foreign supervisors to conduct on-site examinations.
- Insurance and securities sector recommendations from 2002:
  - Include insurance supervision within INAF’s functions (requiring modification of the insurance law and enabling legislation).
  - Develop a common chart of accounts for insurance providers.
  - Define complementary audit instructions for external auditors consistent with banking requirements.
  - Strengthen securities legislation to bolster INAF’s mandate for protecting investors and promoting market transparency.

### Implementation of recommendations and INAF’s strengthened independence
- Actions taken by authorities since 2002:
  - INAF charter approved in 2003 strengthened INAF’s independence and capacity for cross-border cooperation and information exchange.
  - INAF issued additional information and evaluation requirements for banks’ external auditors (Informe Complementari d’ Auditoria).
  - Increased supervisory staff with four new hirings.
  - Began training inspectors and commenced some onsite inspections toward the end of 2007.
  - Took steps to seek agreements with foreign supervisors.
  - Drafted legislation for operation of investment funds managers and other asset managers (yet to be submitted to Parliament).
  - Drafted a new insurance law (not tabled in the previous legislature).
- INAF independence strengthened by:
  - Establishing INAF as authority responsible for the Andorran financial system and suppressing the CSF superior authority role.
  - Establishing a clear process for approval by Congress of INAF’s budget.
  - Allowing INAF to conduct on-site examinations as needed without prior approval.
  - Allowing INAF to issue all types of sanctions, except those graded as very serious, which are issued by the MF at INAF’s proposal.
  - Allowing INAF to enter into agreements with foreign supervisors.

### Financial institutions and markets: structure and recent developments
- Financial sector contribution and employment:
  - The financial services sector produces 15 percent of GDP.
  - The sector employs some 1,523 persons, accounting for 3.6 percent of all jobs as of 2005.
  - It is the highest paying sector, with average salaries above twice the national average.
- Composition of the financial system:
  - 7 banking institutions.
  - 1 specialized financial credit institution.
  - 7 collective investment entities.
  - 4 wealth management companies.
  - 28 insurance companies, 15 of which are branches of foreign insurance companies authorized to operate in Andorra.
- Banking groups and market concentration:
  - The 7 banks form part of 5 banking groups.
  - Banking groups generally own 1 collective investment entity and a life insurance company.
  - Bank-related entities conduct 99 percent of the life insurance business (measured by gross premiums) and 99 percent of the collective investment business.
  - The financial system is dominated by banking groups controlling quasi-totality of their markets.

### Structural shifts and market behavior (2000–2005)
- Portfolio shifts driven by low interest rates:
  - Customers shifted away from bank deposits into higher-return financial instruments and asset management (on-balance sheet to off-balance sheet shift).
  - From 2000 to 2005 assets managed by banks grew by 12.8 percent yearly average.
  - Collective investment entities’ assets grew by 16.0 percent yearly average from 2000 to 2005.
- Impact of EU tax retention on savings (EU Directive 2003/48):
  - Since July 1, 2005, retention of EU taxes on savings income earned by EU residents applied.
  - The tax retention is 15 percent from July 1, 2005; the tax rate increases to 20 percent on July 1, 2008 and to 35 percent on July 1, 2011.
  - Prospect of higher taxes induced EU customers to move from savings instruments to other financial instruments, including life policies offered by bank-controlled life insurance companies.
  - Life insurance premiums grew from 61 million euros in 2004 to 1.8 billion euros in 2005 (the 2005 premiums include the transfer of assets into capitalization schemes, an event not likely to be repeated in 2006).

### Banking system: size, concentration, and cross-border links
- System scale and composition (2005):
  - 7 licensed banks offering services through about 55 branches.
  - Banking total assets: 11.3 billion euros in 2005.
  - Customer deposits: 9.3 billion euros in 2005.
  - Total loans in 2005: 8.9 billion euros, of which 2.7 billion euros were loans to nonresidents (mostly Europe and North America).
  - Banks have branches in Bahamas and Uruguay and a representative office in Panama; these represent a very small share of banking groups’ business.
- Universal banking model: banks offer full range of services including credit, asset management, investment counseling, liability operations, stock transactions, financial analysis, and other banking services.
- Ownership changes and Spanish links:
  - Sales of BBVA’s participation in Inter-Mora to Andorran shareholders in early 2006 reduced Spanish participation.
  - As of early 2006, three of seven banks had Spanish participation, accounting for about 45 percent of assets and deposits (down from around 71 percent in 2001).
  - Caixa d’Estalvis i Pensions de Barcelona (la Caixa) announced sale of its shares in Credit Andorra to Andorran shareholders; after finalization, only one Spanish bank (about 4 percent of assets and deposits) would remain operating in Andorra.
  - Since 2005 Credit Andorra owns 100 percent of Caixa Bank.
- Ownership structure (as of December 2005, totals):
  - Total banking system assets: 11,328 (millions of euros).
  - Total deposits: 9,289 (millions of euros).
  - Total capital: 1,333 (millions of euros).
  - Total employees: 1,150.
- Challenges from ownership changes:
  - INAF must be vigilant to ensure banks can manage potential risks, including possible contraction of customer bases after ownership changes; authorities and banks regard this risk as unlikely.

### Key banking indicators and risk profile
- Capitalization and liquidity:
  - Banks are highly capitalized and liquid, well beyond minimum regulatory requirements:
    - Minimum Capital to Risk Weighted Assets (CAR) per Basel 1: 10 percent (minimum).
    - Andorran banks required to hold liquid assets for at least 40 percent of short-term liabilities.
  - Table 3 indicators (In percent):
    - Capital Adequacy Ratio: 32.3 (2000), 32.4 (2003), 31.7 (2004), 28.8 (2005).
    - Return on Asset: 2.8 (2000), 2.8 (2003), 3.1 (2004), 3.4 (2005).
    - Return on Equity: 26.2 (2000), 19.8 (2003), 20.0 (2004), 21.4 (2005).
    - Liquid assets over total assets (assets maturing in less than one month considered liquid): 45.2 (2000), 46.4 (2003), 40.7 (2004), 36.2 (2005).
    - Liquidity ratio (liquid assets in percent of short term liabilities): 84.0 (2000), 77.0 (2003), 75.1 (2004), 66.2 (2005).
    - Fees and commissions as a percent of total revenue: 25.8 (2000), 38.6 (2003), 44.3 (2004), 45.1 (2005).
- Asset quality and lending:
  - Loan-to-deposit ratio reported as high at 96 percent.
  - 76 percent of total loans granted to Andorran residents.
- Profitability:
  - Profits are strong and improved over time, mainly due to higher fees and commissions reflecting the shift to off-balance sheet activities.

### Off-balance sheet growth and custody activity
- Rapid growth in off-balance sheet items:
  - Securities and other instruments in custody: 16.2 percent growth in 2005.
  - Derivatives operations: 61.1 percent growth in 2005.
  - Securities in custody amounted to 20.4 billion euros in 2005, nearly thrice the amount of customer deposits.
  - Derivatives operations amounted to 10.8 billion euros in 2005.
  - Bank-managed third-party assets and assets of investment funds held in custody by banks amounted to 19.2 billion euros.
  - Growth in derivatives corresponds to currency hedging instruments to cover customers’ exposure to currency risk.
  - Parallel slow decline of on-balance sheet items observed.

### Insurance sector: scale, 2005 surge, and market structure
- Size and market characteristics:
  - Insurance sector is small relative to banking; core activity comprises a local market for nonlife business and a life insurance segment.
  - Home market: 70 000 residents; prosperous but small and reportedly close to saturation.
  - Since 2005 a nonresident life insurance segment emerged due to transfers prompted by the EU Directive on Taxation of Savings.
- Aggregate premiums:
  - Aggregate gross premiums (life and nonlife) were over 1.8 billion euros in 2005.
  - 2005 was unusual: large one-time transfers from banks to insurance companies drove life insurance gross premiums to close to 1.8 billion euros in 2005.
  - In 2004 (a “normal” year), life insurers had premiums of 61.5 million euros and nonlife insurers 60.5 million euros.
- Insurance market composition (as of December 2005, In millions of euros):
  - Life Insurance gross premiums (2005): 1,758.1 (mill euros), 100.0 (percent); companies related to Andorran banks: 1,739.8 (99.0 percent), number of companies: 6; other Andorran companies: 12.9 (0.7 percent), number of companies: 1; branches of foreign insurance companies: 5.3 (0.3 percent), number of companies: 1.
  - Nonlife Insurance gross premiums (2005): 50.4 (mill euros), 100.0 (percent); other Andorran companies: 26.3 (52.2 percent), number of companies: 6; branches of foreign insurance companies: 24.1 (47.8 percent), number of companies: 14.
- Market channels and reinsurance:
  - Life insurance products primarily sold through Andorran companies controlled by Andorran banks.
  - Nonlife products sold through nonbank Andorran companies or branches of foreign insurers (primarily France and Spain).
  - Reinsurance is not available locally and is usually contracted with key international reinsurers.
  - In 2005 there were seven life insurance companies (all controlled by Andorran banks) and six nonlife insurers (one controlled by a banking group and its shareholders), plus 15 branches of foreign insurers covering about half of the nonlife market.
  - No insurance groups exist in Andorra.

*Assessment findings and data drawn from the assessors, Institut Nacional Andorrà de Finances, and Ministry of Finance.*

### 24.      Andorra has no stock exchange and its securities activities are highly integrated with

### Andorra: Securities Market, Supervisory Framework, and Financial Sector Findings

### Securities market structure and activity
- Andorra has no stock exchange and its securities activities are highly integrated with the banking activities.
- Activities are limited to funds management and investments carried out by banks and collective investment management firms.
- Most investment services are provided by banks.
- The investment service sector includes seven managers of CIS and four private asset management firms.
- Private asset management firms operate a very low volume: about 274 million euros in 2005.
- These entities are regulated by the financial system law and supervised by INAF; there is no legislation specific to securities—laws of general application and INAF directives apply.

- Table 5. Andorra: Securities Market, as of December 2005 (In millions of euros)
  - Number of Funds 94127142 158
  - Of which,
    - Public 85109113 125
    - Private 91829 33
  - Total Assets of Funds 4,0395,9917,829                8,495
  - Of which,
    - Public                                       3,0494,3825,308                                       6,716
    - Private 9901,6092,521                1,779
  - Source: Institut Nacional Andorrà de Finances.

### Legal and institutional framework
- The Institut Nacional Andorrà de Finances (INAF) is the supervisor for the financial sector, including banks and nonbank financial companies; insurance supervision is the responsibility of the MF.
- The UPB, created in 2001, has exclusive jurisdiction over money laundering investigations and supervision in Andorra.
- INAF characteristics:
  - Public financial institution established in 1989 with legal personality, and operational and budgetary independence under a new charter passed in 2003.
  - Directed by a Consell d’ Administració, a Board of six members appointed by the Consell General at the proposal of the MF for a period of six years, half staggered every three years.
  - Has a Director General—appointed by the government—and a Deputy Director General with six-year terms.
- INAF powers include issuing mandatory directives (Comunicats), accessing necessary information, conducting on-site examinations, imposing corrective actions and sanctions on supervised entities, and entering into agreements with foreign supervisors.
- INAF does not make final decisions on granting/revoking licenses or imposing sanctions graded as very serious—these are responsibilities of the MF. Recommendation: empower INAF to make these decisions to align accountability with supervisory responsibility.

- Legal framework for financial institutions (excluding insurance) is based on five main laws:
  - (i) law regulating the financial system (1993);
  - (ii) law governing operational powers of components of the financial system (1996);
  - (iii) law governing the disciplinary system of the financial sector (1997);
  - (iv) law regulating the basic administrative rules of the banking institutions (1998);
  - (v) the charter of the INAF (2003).
- INAF directives (Comunicats) supplement these laws with fiduciary, prudential and conduct of business requirements.
- Draft laws updating regulatory framework for nonbank financial institutions and a CIS draft law have been elaborated; the CIS draft law appears to be Euro-compatible, in particular as regards the EU Markets in Financial Services Directive and related EU legislation. Reportedly, these bills are to be tabled soon in the General Council.

- Insurance sector:
  - Regulated solely by a 1989 Law (Llei de regulació de l’ actuació de les companyies d’ assegurances al Principat).
  - No prudential or conduct of business regulations have been issued to supplement this law.
  - Charter of INAF mandated presentation in early 2004 to Parliament of regulations for integration of insurance supervision in INAF.
  - A law on regulation of insurance was drafted in late 2003 but requires substantive review to be consistent with IAIS principles before tabling; reportedly among legislative priorities of the new government.

- Accounting and reporting:
  - Financial institutions (except insurance) follow accounting rules issued by INAF: Chart of Accounts -Pla Comptable- issued in 1999 and mandatory for fiscal years ended December 2000.
  - These rules were inspired by Spanish prudential rules in force at the time.
  - Revision merited in the context of IFRS; no accounting standards mandated for insurance companies in Andorra.
  - A draft accounting law to adopt and implement IFRS in all Andorran companies is being studied; a draft law expected to be ready for submission to Parliament in 2007.
  - INAF favors all banks adopting IFRS as soon as draft legislation is passed and adapting prudential regulations to narrow accounting choices available to banks under IFRS.

### Supervisory capacity, external auditors, and recommendations
- INAF is developing on-site supervisory capabilities to be operational by end-2007 once training is completed.
- INAF staff is very lean (12); additional hirings recommended to implement effective on-site oversight and rely less on external audit firms.
- INAF detailed directives require external auditors to evaluate a wide range of areas reported annually in the IC, including:
  - (i) compliance with accounting and prudential rules;
  - (ii) report of significant events;
  - (iii) consolidation of financial statements;
  - (iv) organization and management;
  - (v) internal control processes;
  - (vi) validation of prudential reports filed with the INAF;
  - (vii) management of credit, market, liquidity, country, operational, and legal risks;
  - (viii) follow up of issues raised in previous reports;
  - (ix) general conclusion and recommendations.
- The IC has been in effect since year 2001 for banks, and since 2005 for nonbank financial institutions.
- Tripartite meetings every October among INAF senior staff, external auditor and bank management discuss the IC and require corrective measures if needed.
- Observed issues with external auditors:
  - Supervisory expectations in the IC do not always match auditors’ understanding; auditors state they need benchmarks or best practices defined by the supervisor to opine on themes like internal controls, risk management, market and operational risks, structured products and derivatives, and administrative structure adequacy.
  - Some auditors limited work to verify compliance with entity policies and procedures without assessing adequacy.
  - Some external auditors of nonbank financial entities provided IC information based solely on annual audit work.

- Recommendations to enhance effectiveness of external auditors:
  - (i) integrate dispersed audit regulations into a single norm and framework;
  - (ii) clarify INAF expectations with auditors;
  - (iii) ensure requests are specific, clearly defined, and describe standards against which performance can be measured;
  - (iv) reach understanding with external auditors regarding the concept of materiality;
  - (v) revisit frequency of requests and consider rotation plans or different frequencies and agree on a multi-period work program;
  - (vi) ensure high standards of bank auditing (independence in appearance and fact, proper licensing and good standing, relevant professional experience and competence, subject to quality assurance programs, compliance with ethical requirements);
  - (vii) consider hiring independent audit firms to assess quality of a specific bank audit as needed.

### Sectoral findings: banking, CIS, insurance, and AML/CFT
- Banking:
  - Assessment found a high level of compliance with the BCP and notable improvement since the 2002 assessment.
  - Andorra is compliant with 21 principles and largely compliant with 8 principles.
  - The only principle materially noncompliant is Principle 25, on supervision of foreign bank establishments.
  - INAF can sign agreements for cooperation and information exchange, but efforts have not yet been effective; restrictions on access to nominative customer information impeded an agreement with the BE.
  - Recommendations: INAF should step up efforts to sign agreements with foreign supervisors, develop on-site supervisory capacities, improve oversight delegated to external auditors, be empowered to make final licensing and sanction decisions, and improve disclosure of INAF activities and financial statements.

- Collective Investment Schemes (CIS):
  - No regulations specific to the CIS sector currently; INAF mandatory Directives govern CIS supervision pending a CIS-specific statute.
  - A new CIS regulation law has been drafted and is reportedly a government legislative priority.
  - New law would address CIS creation/modification/termination; fiduciary and prudential obligations; accounting, auditing, regulatory reporting; market disclosure and conduct of business.
  - May need enhancement regarding CIS-specific bases for asset valuation, pricing and redemption of CIS units, and disclosure to retail investors.

- Insurance:
  - Regulation and supervision are insufficient relative to the sector’s increasing importance.
  - Supervision currently by MF with no dedicated insurance supervision area; tasks carried out by the tax department within MF.
  - Supervision mainly consists of analyzing audited financial statements; prudential and conduct of business regulation are limited; no international cooperation provisions or practices.
  - Essential actions: implement INAF charter provision transferring insurance supervision to INAF, increase insurance oversight capacity, and prioritize a new insurance regulation law.

- Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) (preliminary analysis, pending final MONEYVAL report):
  - Andorra’s legal AML/CFT framework is largely based on the Law on International Criminal Cooperation and Combating Laundering of Money or Valuables Resulting from International Crime (2000).
  - Law provides formalized international mutual cooperation, creates and empowers UPB with exclusive jurisdiction over money laundering investigations and supervision, provides comprehensive customer due diligence and record keeping, and sets detailed suspicious transaction reporting requirements.
  - INAF has been divested of a role in AML/CFT.
  - A MONEYVAL third-visit preliminary assessment (October 17–21, 2005) found continued progress but noted areas needing improvement.
  - UPB has conducted on-site inspections in banks, nonbank financial institutions and insurance companies and since end-2002 has requested external auditors to report on procedures and systems to assess fit-and-proper of key staff, internal controls, suspicious transaction reporting by employees, training on money laundering and financing of terrorism, and overall efficiency of procedures to prevent/detect money laundering.
  - Draft legislation pending Parliament would adapt Andorra’s AML/CFT regime to the revised FATF Recommendations by:
    - (i) specifically addressing activities related to financing of terrorism;
    - (ii) expanding the definition of supervised entities and individuals;
    - (iii) making UPB Comunicados Tecnicos binding for supervised entities;
    - (iv) better identifying an entity’s customers and empowering the UPB to impose sanctions, except those considered very grave which should still rest with the central government.
  - UPB does not consider numbered accounts an obstacle given banks’ compliance with know-your-customer requirements; it charges external auditors with specific due diligence requests on these accounts.
  - Draft legislation does not contain particular obligations regarding Politically Exposed Persons, but UPB comunicados tecnicos and INAF’s Ethical Code refer to them.

### Cross-border cooperation and information exchange
- Laws governing financial institutions include provisions to maintain secrecy/confidentiality of information obtained by supervisors and provide gateways for information exchange; revealing confidential information is penalized (Article 191 of the Penal Code).
- Both INAF and UPB are empowered to enter into cooperation agreements with foreign authorities.
- UPB (since 2002) can enter cooperation agreements on criminal matters and AML/CFT and has signed agreements with AML authorities in Bahamas, Belgium, Dutch Antilles, France, Luxembourg, Monaco, Peru, Poland, Portugal, Spain, and Thailand.
- UPB is a member of the Egmont Group since 2002 and has shared information and cooperated closely with other Egmont members.
- INAF (Article 9 of its charter) can establish relations and cooperation agreements with foreign central banks and supervisory authorities; INAF is yet to sign cooperation agreements with foreign supervisors but is in conversations with Bahamas authorities.
- Earlier attempts to sign an agreement with the BE were unsuccessful due to restrictions on foreign supervisors’ access to nominative customer information and ability to conduct on-site examinations without prior notice to INAF.
- INAF indicated willingness to facilitate nominative information of large exposures and to conduct joint on-site inspections with foreign supervisors.
- Recommendation: empower INAF to share with home country supervisors all information about local operations of foreign banks necessary for effective supervision, provided confidentiality is protected.
- Noted trend: decreasing participation of Spanish banks in the Andorran banking system—expected to be down to some 4 percent of assets and deposits and 2 percent of capital by end-2006—which has lowered authorities’ urgency regarding signing cooperation agreements.

*Source: cr0769 (IMF).*

### 48.      While there are no international cooperation provisions in the insurance sector the MF

### While there are no international cooperation provisions in the insurance sector the MF

### International cooperation and information exchange
- The MF can communicate with foreign supervisors if required.
- The MF's ability to exchange useful information has been constrained by the limited scope of the information it collects and reviews under current statute.
- The INAF has made attempts to enter into MOU’s with the Spanish and French bank supervisors; these efforts have not been successful.

### INAF authority, independence, and supervisory powers
- INAF’s charter redefines its functions and grants it more independence.
- The INAF can issue regulations, apply supervisory policy, conduct on-site inspections without prior authorization of the Finance Minister and hire external auditors to independently verify banks’ information.
- INAF has budget independence and licensing decision power.
- INAF has issued Communication 157/03 in December 2003, introducing requirements for the external auditors to include in their mandatory complementary audit report.
- The INAF has the authority to act promptly in enforcement actions, can dismiss temporarily members of management and board of directors, and appoint a temporary management in a bank.
- The authority to issue an orderly resolution that includes removal of a bank’s license is not vested in the INAF.

### Staffing, capacity building, and onsite supervision
- Within the last year the INAF has increased its staff from eight to twelve.
- INAF is developing its capacity to conduct onsite inspections and plans to commence the onsite inspections in late 2007, while continuing to use, for a time, the services of the external auditors.
- Concurrent with this process INAF will carry on an intensive training program and plans to hire additional supervisors.

### External audits and complementary audit scope
- Communication 157/03 of December 2003 instructs external auditors to:
  - Include verification of banks’ credit policies in the complementary audit report.
  - Include a detailed credit risk analysis, including loan loss provisioning.
  - Make an evaluation of internal control processes and review off balance sheet activities.
  - Furnish details in the Complementary report on each subsidiary of a bank including method of consolidation, percentage of participation and financial details of the subsidiaries.
  - Section 6 of Communication 157/03 explicitly requires external auditors to assess information systems covering concentration limits.
- INAF has expanded significantly the scope of the complementary audit and has instructed banks to comply with the five year rotation program of external auditors.
- Communication 126/01 establishes an annual meeting with the member of General Management responsible for internal control and the partner of the audit firm responsible for the preparation of the complementary audits.
- Communication 163/05 issued in February 2006 requires that all staff, including members of the Board of Directors, should avoid conflicts of interest of any type.

### Licensing, fit-and-proper, and related-party lending
- The government retains final authority to approve or deny permits for issuance of new banking licenses; the government has so far always rendered its decisions based on the technical recommendations of the INAF.
- There is no evidence that credits to members of the Board, insiders and related interests are approved by the bank’s Board of Directors.
- There is no clear evidence that credits to insiders and related interests should not be granted at preferential rates.
- UPB requests external auditors to inform what are the procedures and systems that banks have in place to assess fit-and-proper of their key staff.
- Rules for fit-and-proper of directors are specified in a separate law (lack of criminal records, pertinent professional and work history, etc.).
- Banks have procedures to screen new employees for criminal records and auditors are required to inform UPB about such procedures. Fit-and-proper requirements are mandatory for key staff.

### Consolidated supervision and supervision of foreign establishments
- Communication 157/03 requires external auditors to furnish details on subsidiaries and identifies risks emanating from non-banking products or activities in the Complementary Report.
- INAF’s charter includes a provision to incorporate the insurance companies under INAF’s direct supervision.
- Pending legislative modification, efforts to allow INAF to enter into arrangements with foreign supervisors would facilitate consolidated supervision.
- Strengthened INAF capacity would allow home country supervisors greater assurance regarding adequacy of supervision of subsidiaries in Andorra.

### Insurance regulation and supervision
- A draft law to revise the legal framework in line with EU practices has been prepared, but is yet to be submitted to the General Council.
- INAF’s charter mandates that regulations be issued to integrate the supervision of insurance companies into the INAF. These regulations have not been issued.
- An accounting draft law is being studied by the government, with the aim to adopt and implement IFRS in all Andorran companies.

### AML/CFT legal and institutional framework; UPB operations
- Monthly meetings of the Director of the UPB, the INAF, the Ministers of Finance and Interior are held to discuss anti money laundering measures.
- Article 53 of the Law of International Penal Cooperation and the Fight Against Money Laundering requires the exchange of information in this area.
- UPB counts with 2 financial members appointed by the MF, 2 police staff appointed by the Ministry of Interior, a Judge from the High Council of Justice and as many administrative staff as needed. The Director is appointed by both Ministers.
- Since 2005, monthly meetings are informally held with the INAF to discuss common areas of interest.
- Changes to the Penal Code were passed by Parliament in February 2005, including:
  - Increasing the list of offences/crimes that qualify as money-laundering and financing for terrorism activities (a total new 46 such crimes/offences were included).
  - Increasing the severity of sanctions (starting from a minimum 3 years of prison) for violations of the new rules.
- Legislation is pending to introduce financing of terrorism activities in current law and make the UPB’s Comunicados binding for supervised entities.
- Judges may void contracts that are money laundering related if deemed necessary.
- Internal operations of UPB are deemed by the unit as protected. Officers enjoy legal protection and the central government is responsible for paying all claims and suits when resulting from the faithful exercise of their supervisory work.
- UPB has the ability to meet directly with external auditors as much as deemed needed, usually in the presence of the entity’s compliance officer, and has authority to inquire about changes of auditors and require follow-up or special audits/reviews.
- UPB understands that it gets unedited auditor’s reports from banks; preparatory meetings, follow-up meetings or meetings for making special requests to auditors are conducted as deemed needed.

*IMF — Follow up of Implementation of Recommendations Contained in the 2002 Module 2 Report (cr0769)*

### Appendix III. Reports on the Observance of Standards and Codes

### Appendix III. Reports on the Observance of Standards and Codes

### General assessment and methodology
- The assessment of Observance with the Basel Core Principles for Effective Banking Supervision is based on the Core Principles Methodology (Basel Committee on Banking Supervision, October 1999).
- The assessors benefitted from the full cooperation of the authorities and used the following sources:
  - the legal and regulatory framework, mainly four laws applicable to all financial institutions and INAF directives;
  - the INAF self-assessment of compliance with the Core Principles as of August 2006;
  - the 2002 BCP assessment conducted by the IMF in the context of the assessment of Andorra’s financial system;
  - external audit reports, including a sample of Complementary Reports;
  - various INAF reports; and
  - extensive discussions with INAF senior and supervisory staff and meetings with bankers, external auditors and other market participants.

### Preconditions for effective supervision
- Macroeconomic and legal environment:
  - No identifiable macroeconomic vulnerabilities or risks with implications for banking industry structure, financial performance, prudential safeguards, or system stability.
  - Public infrastructure fosters honoring and enforcement of financial contracts.
- Credit assessment and collateral:
  - Small local economy facilitates assessment of credit risk.
  - Absence of a credit bureau has not adversely affected loan evaluation; past due loans were about 0.2 percent of total loans in 2005.
  - Notaries record liens on real estate and other property suitable for collateral.
  - Court system is effective and efficient; execution of collateral reportedly takes less than one year.
- Market information and accounting:
  - Flow of information to market participants considered adequate; disclosure of higher frequency data would be desirable.
  - No official public information on aggregate banking industry strength; banks publish annual audited financial statements; ABA publishes an annual report with financial indicators.
  - No official accounting standards except the INAF Chart of Accounts (1999), inspired by BE accounting standards; updating warranted in context of IFRS.
  - Authorities preparing a draft accounting law for adoption of standards consistent with IFRS, with implementation estimated by 2008; INAF favors IFRS adoption by all banks.
- Crisis resolution and safety nets:
  - Legal and regulatory framework allows flexible government powers to effect resolution of problem banks, but INAF lacks sole empowerment to undertake all remedial actions including license revocation.
  - No deposit insurance and no lender of last resort.
  - All banks required to participate in a guarantee fund; funds deposited in banks and would be available to facilitate resolution though use has not been defined.
  - Authorities foresee implementation, in the medium term, of a fully defined deposit and investments insurance fund.

### Overall compliance with Basel Core Principles
- Compliance summary:
  - Compliant with 21 principles.
  - Largely compliant with 8 principles.
  - Materially noncompliant: only principle 25 (supervision of foreign bank establishments).
- Main assessment sources and reliance:
  - INAF relies substantially on external auditors for on-site verification and complementary reports.
  - INAF has not conducted its own on-site examinations since its creation in 1989.

### Findings by thematic area (selected Core Principles)

Objectives, Autonomy, Powers, and Resources (CP 1)
- INAF is the authority for the Andorran financial system and promotes stability.
- INAF has operational and budgetary independence and authority to issue prudential regulations.
- Disciplinary and sanctioning powers exist, except for the most serious sanctions and license authorization/revocation which are issued by the government with prior opinion of INAF.
- No evidence of government interference; government reportedly follows INAF’s advice.
- INAF funding: revenues from investment income of a government-provided fund and additional government budget resources if needed.
- Recommendation: grant INAF the powers to impose all sanctions and to authorize and revoke banking licenses.

Licensing and Structure (CPs 2–5)
- Term "bank" is clearly defined in law along with permissible operations and services.
- 1998 Law establishes criteria and requirements for new banking licenses; final decision made by the government based on INAF analysis and recommendations.
- Regulation defines qualified ownership and requires INAF approval for ownership changes.
- INAF can obtain information on individuals and legal entities purchasing bank stock at any amount.
- No bearer shares.
- Article 18 of the Bank Administration Law permits INAF to deny authorization to become a shareholder.
- Regulation sets criteria and limits on bank investments relative to their capital and nonfinancial institutions.

Prudential Regulations and Requirements (CPs 6–15)
- Prudential regulations are considered adequate and enforceable by INAF.
- Capital requirements:
  - Consistent with the Basel Capital Accord.
  - Minimum capital ratio of 10 percent required on a solo and a consolidated basis.
  - Capital requirements exist to cover market risks.
- Loan loss provisioning and classification: Chart of Accounts requires charging profit and loss with necessary general or specific loan loss provisions and defines four loan categories.
- Quarterly reporting on loan and investment portfolio quality and collateral information for off-site analysis.
- Definition of "related group" included in the Chart of Accounts.
- Limits and reporting:
  - Limit of 15 percent of bank capital over any kind of exposure with members of the Board of Directors.
  - Banks required to report quarterly on concentration limits and related party exposures on a consolidated basis.
- Ethics and internal controls:
  - Banks must comply with Ethic Code principles and issue internal procedures for staff and representatives.
  - No explicit statutory mention that credits to insiders and related interests should not be granted at preferential rates or require Board approval.
- INAF reliance on external auditors for on-site verification through annual complementary reports.

Methods of Ongoing Supervision (CPs 16–20)
- Off-site supervision:
  - INAF compiles and analyses quarterly data submitted by financial institutions per the Chart of Accounts; information submitted on a solo and consolidated basis.
  - Supervisors conduct a tripartite annual meeting with each bank and the bank’s external auditors to discuss developments, risks, compliance, and scope of complementary audits.
  - INAF officers maintain formal and informal communications with bank managers, directors, and association leaders year-round.
- On-site supervision capacity:
  - INAF staff is very lean: 12 staff members.
  - Recommendation: gradually increase supervisory staff to conduct on-site inspections with its own personnel and reduce reliance on external audit firms.
  - INAF needs to clarify requirements for complementary reports to ensure effective support from external auditors.

Information Requirements (CP 21)
- Accounting standards are satisfactory but require updates for items such as derivatives (currently reported off-balance sheet).
- Proposed legislation to mandate adoption of international accounting standards (IFRS).

Formal Powers of Supervisors (CP 22)
- INAF has a wide range of corrective powers and authority to impose sanctions proportional to transgressions, including:
  - fines applied to the bank or responsible staff;
  - suspension, dismissal, or disqualification of board members or responsible staff;
  - prohibition from distributing dividends; and
  - other disciplinary measures.
- Sanctions categorized as “very severe” related to solvency, liquidity, concentration risk, etc., currently require government action and should be within INAF’s jurisdiction.

Cross-Border Banking (CPs 23–25)
- Cross-border operations are few (Bahamas, Panama, and Uruguay) and represent a very small share of banking group business.
- INAF supervises consolidated condition through quarterly consolidated financial reports and evaluation by external auditors.
- Banks must inform INAF before establishing foreign branches and subsidiaries; INAF can deny constitution of foreign branches or subsidiaries of a local bank.
- INAF can establish cooperation agreements with foreign supervisory authorities but has not yet signed any.
- Efforts to agree on an MOU with the BE were unsuccessful due to host-country restrictions on unannounced on-site examinations and full access to nominative asset information.
- INAF expressed willingness to facilitate nominative information for large exposures and to conduct joint on-site inspections with foreign supervisors.
- Recommendation: empower INAF to share with home-country supervisors all information about local operations of foreign banks, provided confidentiality is protected.

### Key statistics and operational data (exact figures)
- Past due loans: about 0.2 percent of total loans in 2005.
- Minimum capital ratio required: 10 percent (solo and consolidated).
- Limit on exposures with members of the Board of Directors: 15 percent of bank capital.
- INAF staff size at time of assessment: 12 staff members.
- Recent staffing change: increase of four staff members reported by authorities.

### Recommended Action Plan (selected recommendations by principle)
- CP1 (2) Independence: Publish a periodic review of INAF’s performance against its responsibilities and objectives.
- CP1 (3) Legal Framework: Amend INAF’s charter to empower INAF to issue licenses and conduct an orderly resolution of a problem bank; introduce a legal supervisory framework that will cover insurance companies.
- CP1 (4) Enforcement Powers: Amend INAF’s charter to empower INAF to undertake all types of remedial actions, including the very serious sanctions and the revocation of a bank license.
- CP10 Connected Lending: Ensure that credits to insiders and related interests are not granted at preferential rates and that transactions to insiders (e.g., credits to members of the bank’s Board of Directors) require Board approval.
- CP14 Internal Control and Audit: Members of Boards of Directors of financial institutions should participate in yearly meetings with auditors and INAF.
- CP16 On-site and Off-site supervision:
  - Gradually increase the number of INAF supervisors to place less reliance on external audit firms.
  - INAF should have a system specialist on its staff to support on-site and off-site areas.
- CP20 Consolidated Supervision: Activities of insurance companies should come under INAF supervision.
- CP22 Remedial Measures: Amend INAF’s charter to empower INAF to undertake all types of remedial actions, including revocation of a financial institution’s license.
- CP24 Host Country Supervision: Enter into an MOU with the banking supervisory authority of Uruguay and set the scope of information sharing for adequate supervision of foreign subsidiaries.
- CP25 Supervision over Foreign Banks’ Establishments:
  - Intensify efforts to enter into a formal agreement with the banking authorities of Spain to allow full compliance as a host country supervisor.
  - Share with home-country supervisors information about local operations of foreign banks, provided confidentiality is protected.

### Authorities’ response
- The Andorran authorities welcomed the recognition that their supervisory system is broadly sound and noted ongoing efforts to address prior recommendations.
- They agreed with most of the assessment and recommendations but raised observations on CPs 1, 10, 14, 16 and 20.
- On CP1:
  - Authorities highlighted effective cooperation between the Ministry of Finance (MF) and INAF and that government considers INAF opinion when deciding on sanctions.
  - MF is considering empowering INAF to impose “very serious” sanctions but prefers that final authorization and revocation of banking licenses remain with the government to balance technical decisions and government approval.
- On CP10:
  - Communication nº 163/05 of INAF contains provisions on staff and Board behaviour including own operations.
  - Authorities stated banks have mechanisms to prevent preferential insider credits and to require Board approval for insider transactions.
  - INAF will consider issuing communication explicitly requiring Board approval of such credits and stipulating they should not be granted at rates below other customers.
- On CP14:
  - Authorities consider separate meetings with Board members (without external auditors) more useful for matters related to bank management than requiring Board attendance at tripartite meetings.
- On CP16:
  - With a recent increase of four staff members, INAF stated it will be able to conduct on-site inspections with its own staff and acknowledged further increases will be needed when INAF assumes insurance oversight.
  - Authorities emphasized the continued important support role of external auditors and ongoing communication to clarify expectations for complementary reports.
- On CP20:
  - Authorities indicated INAF’s charter includes a provision regarding transfer of insurance supervision responsibility to INAF and that the government commands presentation of a new insurance regulation law to the General Council.
  - Once the new insurance regulation law is approved, responsibility for insurance supervision will be carried out by INAF.
  - Authorities stressed willingness to cooperate with foreign supervisors as mandated in current legal framework and considered that fact was not adequately reflected in the assessment.

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_Source: https://www.imf.org/-/media/files/publications/ofca/english/cr0769.pdf_