## Preface — Mission, context, and sector snapshot ## Source details **Canonical URL:** [Preface — Mission, context, and sector snapshot](https://www.imf.org/-/media/files/publications/tar/2025/english/tarea2025048-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/tar/2025/english/tarea2025048-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/tar/2025/english/tarea2025048-print-pdf.pdf.json) --- ### Mission and meetings - Mission: Monetary and Capital Markets (MCM) Department mission visited Santiago from May 23–June 4, 2024, at the request of the Central Bank of Chile (BCCh). - Purpose: Assist authorities in improving systemic liquidity management covering four areas: collateral policy, emergency liquidity assistance, systemwide measures to support market functioning, and repo market development. - Meetings: Met with BCCh leadership including Governor Rosanna Costa; Vice Governor Stephany Griffith-Jones; Board members Claudio Soto, Luis Felipe Céspedes, and Alberto Naudon; General Manager Luis Oscar Herrera; Heads of the Financial Policy, Financial Markets, and Corporate Risk Divisions—Rosario Celedón, Ricardo Consiglio, Diego Ballivian—and General Counsel Juan Pablo Araya; staff from the Ministry of Finance (MoF), the Financial Markets Commission (CMF), and the Superintendent of Pensions (SP); and private sector representatives from commercial banks, mutual funds, pension funds, and financial market infrastructure providers. - Acknowledgements: Special thanks to Gabriel Aparici and Carlos Fernandez for arrangements that facilitated the mission’s work. ### Context and sector snapshot — key figures and features - Financial sector size: 290 percent of gross domestic product (GDP). - NBFIs: account for almost half of the sector; pension funds dominate. - Banking concentration: six banks account for 87 percent of bank assets (May 2024). - Market features: - Free-floating exchange rate with no restrictions. - Predominance of inflation-indexed products issued by government and private sector. - Active markets in inflation derivatives: short-term inflation forwards and medium-term inflation swaps. --- ### Executive Summary — Main findings and vulnerabilities - Overall assessment: - Responses to recent crises were effective, but gaps remain in BCCh’s ability to deal with idiosyncratic liquidity stress. - The domestic repo market is underdeveloped. - Primary vulnerabilities: - Absence of an active repo market undermines financial resilience. - Need for a coherent collateral framework and a formalized ELA framework. ### Collateral framework — structure, valuation, and risk mitigation ### Components and high-level prescriptions - A coherent collateral framework comprises: - (i) Eligibility criteria; - (ii) Valuation procedures; - (iii) Risk mitigation measures. - Distinction required between collateral eligible for monetary policy operations and collateral eligible for ELA and systemwide support measures (the latter will be lower quality). ### Eligibility and preference order - Recommended process: - Scan bank balance sheets for available collateral, set a priority order considering credit, liquidity, legal, and correlation risks, and assess against potential liquidity needs. - Demarcate eligibility for monetary policy operations from eligibility for ELA/systemwide operations based on steady-state BCCh balance sheet after crisis program maturities. - Specific recommendation: - Remove banks’ bonds and certificates of deposit (CDs) from collateral eligible for monetary policy operations because of high correlation risk. - PWRA versus pledge: - PWRA advantages: upfront legal transfer, minimizes legal transfer risk, contributes to market liquidity through reuse. - Chile-specific note: legal transfer risk is subdued due to a well-functioning central securities depository. ### Valuation methodologies - Three valuation methods currently used: - Market-based pricing for sufficiently liquid securities. - Theoretical models for illiquid securities (external entity calibrates yield curves and prices). - Nominal outstanding amount for nonmarketable collateral (e.g., credit claims used in FCIC). - Recommended valuation developments: - Market-based valuation algorithms using raw market quotes, quote-cleaning parameters, and consensus metrics; use bid prices for market price computation and consider a quote staleness threshold (example: three days). - Theoretical valuation calibrated via yield curves (Nelson-Siegel recommended) for nominal and inflation-indexed instruments; adjust issuer-specific premia for illiquid segments. - Develop methodologies for valuing illiquid and nonmarketable assets; consider external expertise where necessary. ### Risk mitigation, haircuts, and margins — exact current calibrations - Haircut calibration approach: - Haircuts on marketable securities applied as a spread over their yield and calibrated using a conditional value-at-risk (C-VaR) model with a risk tolerance set at 95 percent. - Haircut calculation performed daily based on excess return distribution over the equivalent-maturity government security and calibrated at the issuer level by averaging standalone haircuts. - Liquidity add-on: function of bid-ask spread and turnover calibrated on a 10-day time series. - Table of applicable haircuts (basis points): - Government Bonds: 0 - Bank Bonds: 60 - Term Deposits: 50 - Corporate Bonds: 65 - Commercial Papers: 65 - Credit Claims: 1,000 - Margins and coverage: - Margins calibrated via C-VaR with a 95 percent risk appetite across maturity buckets 1, 2, 3, 4, 5, 7, and 10 years. - Assumed settlement period: 10 days. - Initial margin: 3.5 percent (mobilized collateral value should be higher than 1.035 times the loan amount). - Margin call: 3.5 percent. - Haircuts and margin schemes target a coverage percentage of 98 percent, calibrated on the five-year time series of two-year yields of nominal government bonds. ### FCIC nonmarketable collateral methodology (exact parameters) - Credit risk component: expected losses estimated using CMF standard methodologies; expected loss set at 1.75 percent (corresponds to lowest category of eligible loans). - Duration risk: average monthly amortization rate assumed at 8.5 percent. - Resulting haircut for the collateral portfolio: rounded and set to 10 percent. - Haircuts reviewed monthly; stress scenarios include downgrading a credit claim by three categories. ### Principles and operational guidance - Haircut calibration should aim for risk equivalence across asset classes and be expressed as a percentage of security value. - Haircuts should be recalibrated at a relatively low frequency (recommended every two years; optimally every two to three years). - Use add-ons for additional risks (e.g., exchange-risk-like add-on for inflation-linked bonds, mobilization-modality add-ons). - Complement haircuts with concentration limits and overcollateralization where necessary. - Drop “coverage percentage” in favor of daily margin calls; margins enforced through daily calls. ### Emergency Liquidity Assistance (ELA) — framework, governance, and procedures ### Four-component ELA framework - Components: - (i) Legal Foundation supporting discretionary lending; - (ii) Internal Procedures detailing conditions, policy parameters, and BCCh divisional responsibilities; - (iii) Formalized Arrangements among BCCh, CMF, and MoF clarifying roles and responsibilities; - (iv) Transparency and Communication to condition market behavior and provide ex-post accountability. ### Institutional arrangements and governance - Establish an internal ELA Working Group (EWG) to: - Operationalize the framework, allocate divisional responsibilities, prepare procedures, standardize a request letter, produce an ELA master agreement, and prepare funding templates. - Establish a Crisis Management Group (CMG) with BCCh, CMF, and MoF to: - Clarify roles including solvency and viability assessment, conditions for government indemnities, and information sharing. - BCCh retains ultimate decision on granting ELA; CMF responsible for quick determinations on applicant solvency; MoF potentially provides indemnities when systemic risk and collateral-value uncertainty are high. ### Eligibility, assessments, and timeliness (exact legal and procedural points) - Eligibility criteria: - Institutions must (i) be eligible by law; (ii) be of systemic importance; (iii) have exhausted all other funding sources; and (iv) be solvent on a forward-looking basis and viable. - Legal extensions: - All licensed banks eligible by law (Article 36 LOC). - December 2023 FMRA allows BCCh to provide ELA to CCPs and credit unions meeting comparable regulatory standards. - Systemic importance test: - CMF annual assessment uses four attributes: size, interconnectedness, complexity, substitutability. - Six banks are classified as systemic under Basel III D-SIB methodology. - Timeliness: - CMF must be able to provide, within perhaps 24 hours, its view of an institution’s forward-looking solvency and viability to inform BCCh decision-making. ### Funding, duration, pricing, and conditionality (exact recommendations) - ELA duration and envelope: - Existing law allows providing ELA for a maximum of 180 days (i.e., 90 days with one extension of 90 days). - Disbursements should be provided based on a two-week approved envelope and roll daily. - Pricing recommendations: - ELA priced at a margin above BCCh’s standard lending facility (SLF) rate. - Suggested initial margin: around 200–300 basis points above the SLF rate. - Suggested subsequent reduced margin: 100–150 basis points. - Collateral and mobilization: - ELA-eligible collateral must be integrated into the collateral framework with higher haircuts and tighter risk mitigation. - Credit claims require dedicated procedures; FCIC experience shows mobilization lead times can exceed one month—acceptable for systemwide programs but not for idiosyncratic shocks. - Conditionality and funding plans: - Credible funding plan required; envelope calibrated on forecasted liquidity over a two-week period. - Conditions: prohibit equity buybacks; restrict use for nonessential or risky lending; require exit strategy and quantified milestones. ### Transparency and communication (ex ante and ex post) - Ex ante: prepare an ELA regulation to manage expectations, indicate discretionary nature, list general eligible entities, refer to penalty rate and maximum maturity of 180 days, and describe collateral and conditionality principles. - Ex post: develop communication guidelines to ensure accountability while avoiding disclosures that could spread stress; identifying recipient ideally delayed (suggestion: at least a year after repayment). ### Systemwide market support measures — principles, past programs, and lessons ### Design principles and operational recommendations - Diagnose whether problem is funding liquidity or market liquidity; intervene with targeted programs. - Guiding principles: - Intervention triggers discretionary and guided by market functioning indicators. - Pricing should encourage take-up at launch and facilitate exit. - Prefer temporary or self-liquidating operations (e.g., buy-/sellbacks) over outright transactions to limit BCCh risks and facilitate exit. - Transparency should support effectiveness while ensuring central bank accountability. - Operational recommendations: - Price market support programs to incentivize take-up at launch and facilitate exit while safeguarding BCCh balance sheet. - Minimize balance sheet risks by prioritizing buy-/sellback transactions over outright asset purchases. - Consider publishing more granular data about assets acquired in market support programs. - Consider ex-ante disclosure of FX intervention objectives and ex-post evaluation of effectiveness. ### BCCh past interventions — scale, instruments, and outcomes (exact program figures) - BCCh interventions included spot FX, forwards, bank bond purchases, BCCh bond purchases, and bank bond buy-/sellbacks to address pension-sector redemption pressures. - Money market measures included: - A 30-day funding repo program (later extended to 90 days). - An unsecured credit line limited to the amount of a bank’s reserve requirement (Liquidity Credit Line Facility, LCL). At year-end 2020, amount outstanding: CLP 5.2 trillion against a limit of CLP 5.8 trillion with policy rate at 0.5 percent. - Expansion of collateral eligibility. - Specific programs and amounts: - Bank bond purchase program (launched March 20, 2020): total program amount initially USD four billion, later increased to USD 8 billion; actual use: USD 3.3 billion. - Special asset purchase program (announced June 17): total approved amount USD eight billion; term six months. - Bank bond buy-/sellback (CC-VP) program: amount about USD 16 billion. - Conditional Financing Facility for Increased Loans (FCIC): program volume peaked at around USD 40 billion; completely wound down by July 1, 2024. - Outcomes: - Programs curtailed widening of bank and corporate bond spreads; trading volumes fell and have not recovered fully. - BCCh balance sheet doubled during interventions with bank bonds accounting for around 50 percent of assets at the time, significantly increasing BCCh financial risks. ### Repo market development — diagnosis, constraints, and strategy ### Market size, composition, and activity (exact figures) - Outstanding volume at end-2023: just over USD 12 billion, equivalent to about four percent of GDP. - Comparison: Mexico 10 percent, Brazil 20 percent. - Average daily turnover in 2022: just under USD 2.5 billion (market-based turnover lower because BCCh repos are included). - Transaction profile: - About two-thirds of transactions were for less than USD one million, with an average size around USD 200,000. - Tenors concentrated: overnight to one-week for cash borrowing; up to six months for cash lending. - Repo rates and spreads (2022 averages): - Repo rates substantially above TPM with averages TPM + 405 basis points and TPM + 795 basis points for reverse repo, average spread of 390 basis points. - Market composition: - Brokers accounted for 68 percent of transactions and 44 percent of outstanding value. - Interbank repo outstanding value: USD 850 billion, contributing less than one percent of bank funding and three percent of bank lending. - Cross-border USD repo: - USD repo accounted for 27 percent of outstanding value of repo in 2023 but only three percent of the number of transactions. ### Root causes and constraints - Fundamental drivers for an active repo market are largely absent: - Shallow secondary fixed-income markets and buy-and-hold investor behavior limit liquid collateral supply. - Lack of dealer funding/inventory coverage requirements and significant excess liquidity reduce need for secured transactions. - Legal, regulatory, taxation, accounting, and infrastructure issues identified: - Implementation of close-out netting via FMRA depends on implementing regulation expected later in 2024. - Doubts about transfer of ownership, enforceability, and stay of enforcement under recovery/resolution rules; recommended stay not longer than two days. - Reserve requirement treatment includes interbank transactions in the reservable base, deterring repo and interbank activity; reserve ratios: nine percent for sight deposits and 3.6 percent for term deposits below one year. - Taxation uncertainties (stamp duty, reporting burdens) and accounting treatment uncertainties (reuse of collateral) remain. - Infrastructure: settlement system supports DvP and FoP; CCPs and triparty repo are premature given market size. ### Recommendations — strategy and sequencing (selected, from Table 1 and report) - Leadership and strategy: - Develop a comprehensive medium-term market development strategy; BCCh best placed to lead due to monetary policy and financial stability objectives. - Identify a “champion” (e.g., a senior official in the BCCh) to lead repo market strategy. Authority: BCCh. Timeframe: Short-term. - Legal and regulatory actions: - Publish the implementing regulation for the FMRA related to close-out netting. Authority: BCCh. Timeframe: Short-term. - Ensure the stay of enforcement under the resilience and recovery regime is limited (preferably not longer than two days). Authority: BCCh. Timeframe: Short-term. - Publish a standard master repurchase agreement based on the GMRA (adaptations as annex). Authority: BCCh. Timeframe: Medium-term. - Clarify application of regulatory capital rules to repo and provide worked examples for the Simple Approach and the 10 percent counterparty risk weight. Authority: CMF. Timeframe: Short-term. - Market participation and incentives: - Assess and remove unjustified barriers for NBFI participation in the repo market (e.g., pension funds). Authority: BCCh. Timeframe: Medium-term. - Ensure capital relief for collateralization is attributable to dealers and require monitoring of trading P&L attribution at desk level. Authority: BCCh/CMF. Timeframe: Medium-term. - Confirm that short-selling is neither prohibited nor discouraged. Authority: BCCh/CMF. Timeframe: Short-term. - Taxation, accounting, and infrastructure: - Clarify taxation across the lifecycle of a repo focusing on economic substance. Authority: BCCh/SII. Timeframe: Medium-term. - Develop and disseminate comprehensive local guidance on accounting for repo, including reuse of collateral. Authority: BCCh/CMF. Timeframe: Medium-term. - Facilitate electronic messaging systems for OTC confirmations, reporting, and settlement links; consider low-cost messaging to support quotes and trade confirmation. Authority: BCCh/CMF/MoF. Timeframe: Medium-term. - Market plumbing and reporting: - Continue to drain excessive liquidity through the roll off of crisis-era programs to support repo activity. Authority: BCCh. Timeframe: Medium-term. - Remove interbank (secured and unsecured) transactions from the reservable base for reserve requirement purposes. Authority: BCCh. Timeframe: Short-term. - Develop comprehensive regulatory reporting of unsecured and secured money markets (start with high-level and low frequency). Authority: BCCh/CMF. Timeframe: Medium-term. - Encourage formation of a repo market association to act as a contact point and compile best-practice guidance. Authority: BCCh/CMF. Timeframe: Short-term. ### Selected recommendations summary (from Table 1 — exact text and timeframes) - Collateral Policy - Establish a methodology for determining collateral preference. Authority: BCCh. Timeframe: Short-term. - Demarcate monetary operations’ eligible collateral consistent with an operational framework and transparency requirements. Authority: BCCh. Timeframe: Short-term. - Develop and operationalize valuation methodologies for each eligible collateral. Authority: BCCh. Timeframe: Medium-term. - Monitor potential arbitrage and mispricing between nominal and inflation-index securities. Authority: BCCh. Timeframe: Medium-term. - Adopt haircuts’ calibration models that allow for achieving the risk equivalence principles. Authority: BCCh. Timeframe: Medium-term. - Emergency Liquidity Assistance - Establish an ELA Working Group to allocate divisional responsibilities, establish detailed procedures, and define parameters to ensure operational preparedness. Authority: BCCh. Timeframe: Short-term. - Prepare a standard request letter for institutions requesting ELA. Authority: BCCh. Timeframe: Medium-term. - Prepare an ELA master agreement covering all elements of the lending arrangement (including conditionality). Authority: BCCh. Timeframe: Medium-term. - Prepare funding plan templates. Authority: BCCh. Timeframe: Medium-term. - Establish a Crisis Management Group (BCCh, CMF, MoF) and develop an MoU to define interagency responsibilities. Authority: BCCh/CMF/MoF. Timeframe: Medium-term. - Prepare an ELA regulation to communicate publicly the major elements of the ELA framework. Authority: BCCh. Timeframe: Short-term. - Systemwide Measures - Market support programs should be priced to incentivize take-up at launch and facilitate exit while safeguarding the BCCh’s balance sheet. Authority: BCCh. Timeframe: Medium-term. - Prioritize buy-/sellback transactions over outright asset purchases to minimize BCCh balance sheet risks and facilitate exit. Authority: BCCh. Timeframe: Medium-term. - Consider publishing more granular data about assets acquired in market support programs. Authority: BCCh. Timeframe: Medium-term. - Consider ex-ante disclosure of FX intervention objectives and ex-post disclosure of effectiveness. Authority: BCCh. Timeframe: Medium-term. - Repo Market Development - Ensure policies promote an active domestic market in fixed-income securities. Authority: BCCh/CMF/MoF. Timeframe: Long-term. - Continue to drain excessive liquidity through the roll off the crisis era. Authority: BCCh. Timeframe: Medium-term. - Remove interbank (secured and unsecured) transactions from the reservable base for reserve requirement purposes. Authority: BCCh. Timeframe: Short-term. - Publish the implementing regulation for the FMRA related to close-out netting. Authority: BCCh. Timeframe: Short-term. - Ensure that the stay of enforcement under the resilience and recovery regime is limited (preferably not longer than two days). Authority: BCCh. Timeframe: Short-term. - Publish a standard master repurchase agreement based on the GMRA. Authority: BCCh. Timeframe: Medium-term. - Ensure capital relief for collateralization is attributable to dealers. Authority: BCCh/CMF. Timeframe: Medium-term. - Assess and remove unjustified barriers for NBFI participation in the repo market (e.g., pension funds). Authority: BCCh. Timeframe: Medium-term. - Clarify application of regulatory capital rules to repo. Authority: CMF. Timeframe: Short-term. - Confirm that short-selling is neither prohibited nor discouraged. Authority: BCCh/CMF. Timeframe: Short-term. - Clarify taxation across the life cycle of a repo focusing on economic substance. Authority: BCCh/SII. Timeframe: Medium-term. - Develop and disseminate comprehensive local guidance on accounting for repo, including reuse of collateral. Authority: BCCh/CMF. Timeframe: Medium-term. - Facilitate electronic messaging systems for OTC market confirmations, reporting, and settlement links. Authority: BCCh/CMF/MoF. Timeframe: Medium-term. - Identify a “champion” (e.g., a senior official in the BCCh) to lead repo market strategy. Authority: BCCh. Timeframe: Short-term. - Develop comprehensive regulatory reporting of unsecured and secured money markets (start with high-level and low frequency). Authority: BCCh/CMF. Timeframe: Medium-term. - Encourage formation of a repo market association to act as a contact point and compile best-practice guidance. Authority: BCCh/CMF. Timeframe: Short-term. *IMF Technical Assistance Report — tarea2025048-print-pdf.* ### Preface ................................................................................................................ ### Preface ### Mission and meetings - Mission: Monetary and Capital Markets (MCM) Department mission visited Santiago from May 23–June 4, 2024, at the request of the Central Bank of Chile (BCCh). - Purpose: Assist authorities in improving systemic liquidity management covering four areas: collateral policy, emergency liquidity assistance, systemwide measures to support market functioning, and repo market development. - Meetings: Met with BCCh leadership including Governor Rosanna Costa; Vice Governor Stephany Griffith-Jones; Board members Claudio Soto, Luis Felipe Céspedes, and Alberto Naudon; General Manager Luis Oscar Herrera; Heads of the Financial Policy, Financial Markets, and Corporate Risk Divisions—Rosario Celedón, Ricardo Consiglio, Diego Ballivian—and General Counsel Juan Pablo Araya; staff from the Ministry of Finance (MoF), the Financial Markets Commission (CMF), and the Superintendent of Pensions (SP); and private sector representatives from commercial banks, mutual funds, pension funds, and financial market infrastructure providers. - Acknowledgements: Special thanks to Gabriel Aparici and Carlos Fernandez for arrangements that facilitated the mission’s work. ### Context and sector snapshot - Financial sector size and structure: - Sector size: 290 percent of gross domestic product (GDP). - NBFIs: Nonbank financial institutions account for almost half of the sector; pension funds dominate. - Banking concentration: Six banks account for 87 percent of bank assets (May 2024). - Market features: - Free-floating exchange rate with no restrictions. - Predominance of inflation-indexed products issued by government and private sector. - Active markets in inflation derivatives: short-term inflation forwards and medium-term inflation swaps. ### Recent reforms and prior findings - Financial Markets Resilience Act 2023 (FMRA) expanded BCCh’s ability to respond to liquidity stress by: - Allowing ELA eligibility for central counterparties (CCPs) and credit unions meeting banklike regulations. - Allowing support systemwide or to sectors facing specific liquidity pressures (e.g., the pension sector). - Prior assessments: - IMF FSAP 2021 highlighted lack of ELA preparedness and an underdeveloped repo market. - A 2018 MCM TA mission preceded the FMRA enactment. --- ### Executive Summary — Key findings and analysis ### Main findings on capabilities and gaps - Overall assessment: - Responses to recent crises were effective, but gaps remain in BCCh’s ability to deal with idiosyncratic liquidity stress. - The domestic repo market is underdeveloped. - Primary vulnerabilities: - Absence of an active repo market undermines financial resilience. - Need for a coherent collateral framework and a formalized ELA framework. ### Collateral framework: structure and recommendations - Components of a coherent collateral framework: - (i) Eligibility criteria; - (ii) Valuation procedures; - (iii) Risk mitigation measures. - Distinction required: - Differentiate collateral eligible for monetary policy operations from collateral eligible for ELA and systemwide support measures (the latter will be lower quality). - Eligibility process: - Scan bank balance sheets for available collateral, set a priority order considering credit, liquidity, legal, and correlation risks, and assess against potential liquidity needs. - Demarcate eligibility for monetary policy operations from eligibility for ELA/systemwide operations based on steady-state BCCh balance sheet after crisis program maturities. - Specific recommendation: - Remove banks’ bonds and certificates of deposit (CDs) from collateral eligible for monetary policy operations because of high correlation risk. - Valuation and risk mitigation: - Develop market-based valuation algorithms for marketable securities and theoretical valuations for assets without observable prices. - Develop methodologies for illiquid and nonmarketable assets. - Calibrate haircuts to achieve risk equivalence across collateral with the objective to contain liquidity, market, credit, and other risks within the BCCh’s specified 95 percent tolerance level. - Complement haircuts with concentration limits and provisions for overcollateralization where necessary. - Monitor: - Monitor potential arbitrage and mispricing between nominal and inflation-indexed securities. ### Emergency Liquidity Assistance (ELA): framework and governance - Four components of an ELA framework: - (i) Legal Foundation supporting discretionary lending; - (ii) Internal Procedures detailing conditions, policy parameters, and BCCh divisional responsibilities; - (iii) Formalized Arrangements among BCCh, CMF, and MoF clarifying roles and responsibilities; - (iv) Transparency and Communication to condition market behavior and provide ex-post accountability. - Institutional setup: - Establish an internal ELA Working Group (EWG) to operationalize the framework, allocate divisional responsibilities, prepare procedures, standardize a request letter, produce an ELA master agreement, and prepare funding templates. - Establish a Crisis Management Group (CMG) with BCCh, CMF, and MoF to ensure clarity on respective roles, including solvency and viability assessment, conditions for government indemnities, and information sharing. - BCCh retains ultimate decision on granting ELA; CMF responsible for quick determinations on applicant solvency; MoF potentially provides indemnities when systemic risk and collateral-value uncertainty are high. - Policy parameters to define: - Duration, interest rate, potential conditionality, and funding arrangements. - Transparency: - Prepare an ELA regulation to communicate major elements of the ELA framework publicly. ### Systemwide market support measures: principles and lessons - Past interventions: - BCCh intervened in spot FX and forwards to dampen volatility and alleviate USD funding strains. - In securities markets, BCCh bought bank bonds and BCCh bonds; used bank bond buy-/sellbacks to address pension-sector redemption pressures. - Money markets measures included a 30-day funding repo program, an unsecured credit line limited to the amount of a bank’s reserve requirement, and an expansion of collateral eligibility. - Design principles for future programs: - Diagnose whether the problem is funding liquidity or market liquidity, recognizing interactions between the two. - Intervene with programs targeted to the diagnosed problem. - Guiding principles: - Intervention triggers should be discretionary and guided by market functioning indicators. - Pricing should encourage take-up at launch and facilitate exit. - Prefer temporary or self-liquidating operations (e.g., buy-/sellbacks) over outright transactions to limit BCCh risks and facilitate exit. - Transparency should support effectiveness while ensuring central bank accountability. - Operational recommendations: - Price market support programs to incentivize take-up at launch and facilitate exit while safeguarding BCCh balance sheet. - Minimize balance sheet risks by prioritizing buy-/sellback transactions over outright asset purchases. - Consider publishing more granular data about assets acquired in market support programs. - Consider ex-ante disclosure of FX intervention objectives and ex-post evaluation of effectiveness. ### Repo market development: diagnosis and strategy - Diagnosis of underdevelopment: - Domestic repo market is underdeveloped due to shallow secondary fixed-income markets, absence of dealer funding/inventory coverage requirements, and significant excess liquidity reducing need for secured transactions in normal times. - Constraints identified: - Legal, regulatory, taxation, accounting, and infrastructure issues across government agencies and private sector. - Strategy and leadership: - Develop a comprehensive medium-term market development strategy to identify and address all issues. - BCCh best placed to lead due to both monetary policy and financial stability objectives. - Interim measures and priorities: - Deepening secondary markets and reduction in excess liquidity as crisis-era programs roll off will support repo activity. - Ensure coordination across BCCh, CMF, MoF, tax authority (SII), and market participants. --- ### Recommendations (selected, from Table 1) - Collateral Policy - Establish a methodology for determining collateral preference. Authority: BCCh. Timeframe: Short-term. - Demarcate monetary operations’ eligible collateral consistent with an operational framework and transparency requirements. Authority: BCCh. Timeframe: Short-term. - Develop and operationalize valuation methodologies for each eligible collateral. Authority: BCCh. Timeframe: Medium-term. - Monitor potential arbitrage and mispricing between nominal and inflation-index securities. Authority: BCCh. Timeframe: Medium-term. - Adopt haircuts’ calibration models that allow for achieving the risk equivalence principles. Authority: BCCh. Timeframe: Medium-term. - Emergency Liquidity Assistance - Establish an ELA Working Group to allocate divisional responsibilities, establish detailed procedures, and define parameters to ensure operational preparedness. Authority: BCCh. Timeframe: Short-term. - Prepare a standard request letter for institutions requesting ELA. Authority: BCCh. Timeframe: Medium-term. - Prepare an ELA master agreement covering all elements of the lending arrangement (including conditionality). Authority: BCCh. Timeframe: Medium-term. - Prepare funding plan templates. Authority: BCCh. Timeframe: Medium-term. - Establish a Crisis Management Group (BCCh, CMF, MoF) and develop an MoU to define interagency responsibilities. Authority: BCCh/CMF/MoF. Timeframe: Medium-term. - Prepare an ELA regulation to communicate publicly the major elements of the ELA framework. Authority: BCCh. Timeframe: Short-term. - Systemwide Measures - Market support programs should be priced to incentivize take-up at launch and facilitate exit while safeguarding the BCCh’s balance sheet. Authority: BCCh. Timeframe: Medium-term. - Prioritize buy-/sellback transactions over outright asset purchases to minimize BCCh balance sheet risks and facilitate exit. Authority: BCCh. Timeframe: Medium-term. - Consider publishing more granular data about assets acquired in market support programs. Authority: BCCh. Timeframe: Medium-term. - Consider ex-ante disclosure of FX intervention objectives and ex-post disclosure of effectiveness. Authority: BCCh. Timeframe: Medium-term. - Repo Market Development - Ensure policies promote an active domestic market in fixed-income securities. Authority: BCCh/CMF/MoF. Timeframe: Long-term. - Continue to drain excessive liquidity through the roll off the crisis era. Authority: BCCh. Timeframe: Medium-term. - Remove interbank (secured and unsecured) transactions from the reservable base for reserve requirement purposes. Authority: BCCh. Timeframe: Short-term. - Publish the implementing regulation for the FMRA related to close-out netting. Authority: BCCh. Timeframe: Short-term. - Ensure that the stay of enforcement under the resilience and recovery regime is limited (preferably not longer than two days). Authority: BCCh. Timeframe: Short-term. - Publish a standard master repurchase agreement based on the GMRA. Authority: BCCh. Timeframe: Medium-term. - Ensure capital relief for collateralization is attributable to dealers. Authority: BCCh/CMF. Timeframe: Medium-term. - Assess and remove unjustified barriers for NBFI participation in the repo market (e.g., pension funds). Authority: BCCh. Timeframe: Medium-term. - Clarify application of regulatory capital rules to repo. Authority: CMF. Timeframe: Short-term. - Confirm that short-selling is neither prohibited nor discouraged. Authority: BCCh/CMF. Timeframe: Short-term. - Clarify taxation across the life cycle of a repo focusing on economic substance. Authority: BCCh/SII. Timeframe: Medium-term. - Develop and disseminate comprehensive local guidance on accounting for repo, including reuse of collateral. Authority: BCCh/CMF. Timeframe: Medium-term. - Facilitate electronic messaging systems for OTC market confirmations, reporting, and settlement links. Authority: BCCh/CMF/MoF. Timeframe: Medium-term. - Identify a “champion” (e.g., a senior official in the BCCh) to lead repo market strategy. Authority: BCCh. Timeframe: Short-term. - Develop comprehensive regulatory reporting of unsecured and secured money markets (start with high-level and low frequency). Authority: BCCh/CMF. Timeframe: Medium-term. - Encourage formation of a repo market association to act as a contact point and compile best-practice guidance. Authority: BCCh/CMF. Timeframe: Short-term. - Time horizon definitions: - Near term: < 12 months; - Medium term: 12 to 24 months; - Long term: >24 months. *IMF Technical Assistance Report.* ### Introduction ### Introduction ### Macroeconomic outlook and fiscal/ external context - Real GDP is forecast to grow to about its potential of 2.25–2.5 percent over the medium term. - Inflation fell from a peak of 12.8 percent (December 2023) to 3.4 percent (May 2024), with convergence to the BCCh’s three-percent target set to slow. - The current account deficit (nine percent of GDP in 2022) narrowed substantially in line with the swift rebalancing of the economy and the recent copper price rally. - Fiscal policy aims to reach its deficit target of 1.9 percent of GDP in 2024. ### Institutional framework and financial stability governance - The Financial Stability Council (CEF) is the coordinating body for financial stability and is chaired by the Ministry of Finance (MoF). - Other CEF members: the Pension Superintendency (SP) and the Financial Market Commission (CMF)—the primary financial supervisor and regulator covering banks, large credit unions, insurance, and securities markets. - The BCCh is a permanent invitee and advisor to the CEF; the BCCh’s financial stability mandate focuses on normal functioning of internal and external payments and providing emergency liquidity. - The CEF produces a high-quality semi-annual financial stability report to facilitate identification and containment of financial risks in Chile. ### BCCh emergency liquidity framework developments - A 2018 MCM technical assistance mission assessed NBFIs’ access to BCCh accounts and facilities and eligibility for ELA; recommendations were incorporated in the Financial Markets Resilience Act 2023 (FMRA). - FMRA expanded ELA eligibility to include CCPs and credit unions that meet banklike regulation, and permits the BCCh to provide liquidity through repo transactions to financial sectors (e.g., the pension sector) facing stress even if individual entities are not ELA-eligible. - The BCCh’s ability to respond to liquidity stress was thus expanded following that TA. ### Key FSAP findings on BCCh risk management and market resilience - The 2021 FSAP identified three priority areas: - Upgrade the BCCh’s collateral framework to better manage risks of its lending operations. - Address operational gaps in providing ELA by developing internal procedures and a regulation to publicly communicate key elements of the ELA framework. - Develop a dedicated strategy for the repo (secured lending) market because the lack of an active repo market could amplify financial shocks and undermine system resilience. ### Scope of this report - The report assesses and provides recommendations on four interrelated areas materially affecting Chile’s financial sector efficiency and resilience: - Collateral policy - Emergency lending assistance - Systemwide market support programs - Development of the repo market - The report describes the financial landscape as context—especially the large NBFI sector and the prevalence of inflation-linked products. ### Financial market landscape — monetary policy framework and BCCh balance sheet - The BCCh adopted inflation targeting with a flexible exchange rate in 1999; the last substantial capital controls were removed in 2001. - Operational framework aligns the uncollateralized overnight interbank rate (IRR) with the announced stance communicated by the monetary policy rate (MPR). - Instruments include standing facilities (set at 25 basis points on either side of the MPR), reserve requirements, open market operations, and outright purchases and sales of securities. - The BCCh balance sheet increased from approximately 16 percent of GDP pre-crisis to its peak of 34 percent in 2021; crisis-era programs are rolling off and the balance sheet should be around 20 percent of GDP by end-2024. ### Size and structure of the financial sector - The financial sector is large (290 percent of GDP) and diversified. - The banking sector makes up 41 percent of the financial sector; six banks account for 87 percent of banking assets. - The NBFI segment accounts for 48 percent of the financial sector and is dominated by pension funds with assets equivalent to about 60 percent of GDP (down from over 80 percent before the three extraordinary withdrawals in 2020–21). - The pension sector is concentrated, with the largest fund accounting for around 30 percent of the sector. - Other financial institutions (including mutual funds and other financial auxiliaries) and insurance companies account for about 20 percent and eight percent of financial sector assets, respectively. ### FX, derivatives, and inflation-linked product landscape - The Chilean FX market is liquid and efficient with well-developed hedging markets; the interbank spot market is a continuous electronic OTC market operated by the Bolsa de Comercio de Santiago with market-making agreements including 21 banks licensed by the CMF. - Non-deliverable forwards (NDFs) remain the dominant derivative instrument for hedging CLP risks; domestic NBFIs maintain long USD exposure while NFCs hold the opposite position, both hedging with NDFs. Nonresidents are the most active in NDFs and use them extensively for speculative positions. - Over 75 percent of outstanding debt is inflation linked (including over half of government debt and most bank and corporate debt). - Inflation-linked instruments use the CLF unit of account, linked to the nominal CLP by the UF inflation multiplier. - Government bond stock was equivalent to about 26 percent of GDP in March 2024 (13.5 percent nominal and 12.2 percent inflation-linked), compared with 35 percent in Mexico and 68 percent in Brazil (2022). - A market in inflation derivatives exists (short-term inflation forwards and medium-term inflation swaps). ### Investor and market structure for fixed income - Pension funds hold almost half of all debt and about half of government debt; more conservative pension funds hold more government debt and less equity. - The largest allocation across the pension sector is in equity, particularly foreign equity. - Pension funds use money market mutual funds and short-term bonds for liquidity management. - Banks, insurance companies, mutual funds, and offshore investors hold similar shares of bank and corporate bonds, but banks limit themselves to nominal corporate debt; insurance companies invest entirely in inflation-linked corporate debt and focus on corporate and bank inflation-linked debt and real estate, not large government bond allocations. - Foreign investors prefer nominal government debt (accounting for about 40 percent of nominal government debt holdings) and mainly use derivatives for Chile exposure. ### Market liquidity and anomalies - Secondary trading in fixed-income securities is thin because most investors buy-and-hold. - Turnover on the stock exchange in fixed-income securities is equivalent to about USD 150 billion per month and has fallen from its peak in 2018. - Government bond turnover fell from about 13 percent to under three percent following pension fund withdrawals in 2020–21. - Ten-year swap spreads reached almost 100 basis points against nominal government bonds in May 2024 (up from -40 basis points in September 2022) and 70 basis points against 10-year inflation-linked government bonds (up from -30 in December 2022). - The corporate bond market is illiquid; there is no treasury bill market, and central bank bill issuance is currently limited to 14 days or less. ### Money market and repo market structure - The interbank money market is thin, equivalent to less than three percent of bank assets and under one percent of liabilities. - Interbank trading composition: CDs 42 percent (down from 59 percent in 2018), unsecured deposits 42 percent (up from 21 percent in 2018), and bank bonds 16 percent (down from 20 percent in 2018). - Customer repo is much larger than interbank repo; domestic repo market is small and almost entirely bank-to-customer rather than interbank. - At end-2022, the total repo market was equivalent to about four percent of GDP. ### Collateral Framework ### Current situation — operations and eligibility - The BCCh operates three liquidity-providing operations with varying collateral eligibility: (i) an intraday permanent liquidity facility (FLI); (ii) an overnight liquidity facility (FPL); and (iii) a Repo. - Counterparties can mobilize collateral under Repo, Purchase-With-Resale-Agreement (PWRA) modality, or by pledge (Repo-Prenda), depending on the program. - Repo, and FLI and FLP—both under Repo and pledge—are standard monetary policy operations and are restricted to banks. - The Organic Law of the BCCh prohibits acceptance of government securities in normal times under PWRA, but they can be accepted under pledge. - The FCIC (funding-for-lending scheme) was a systemwide program implemented during the COVID-19 pandemic and expired in July 2024. - There are eight classes of assets currently eligible for BCCh operations (Appendix I). Prior to the GFC, eligible assets were BCCh securities, government securities (pledge only), and mortgage notes issued by banks. Eligibility expanded during the GFC and further during the pandemic to include mortgages, CDs, bank bonds, corporate bonds, and credit claims (under FCIC). ### ELA and special programs eligibility - The BCCh can accept a broader set of assets when providing ELA (Article 36) under its financial stability mandate; legal restrictions for ELA eligibility exclude acquisition of government securities under PWRA, equities, and subordinated and convertible instruments issued by commercial banks. - The BCCh has no established preference order for collateral but can determine one considering the applicant’s balance sheet and crisis severity. - Law prescribes eligible collateral for “special programs” (Article 36 bis): counterparties of special programs are financial institutions supervised by the CMF and SP but not ELA-eligible; collateral eligibility for such programs is restricted to fixed-income securities issued by commercial banks, excluding shares, convertible, and subordinated instruments. ### Valuation methods - Three valuation methods are used: - Market-based pricing for sufficiently liquid securities, using prices from international and local trading platforms. - Theoretical models for illiquid securities; BCCh engages an external entity to calibrate yield curves and price inflation-indexed and other fixed-income securities. - Nominal outstanding amount for nonmarketable collateral (e.g., credit claims used in the FCIC program). ### Risk mitigation: haircuts, margins, and calibration - Haircuts on marketable securities are applied as a spread over their yield and are calibrated using a conditional value-at-risk (C-VaR) model with a risk tolerance set at 95 percent. - Haircut calculation is performed daily based on excess return distribution over the equivalent-maturity government security and calibrated at the issuer level by averaging standalone haircuts of its securities. Haircuts are adjusted for liquidity risk via an add-on that is a function of bid-ask spread and turnover, calibrated on a 10-day time series. - Table of applicable haircuts (basis points): - Government Bonds: 0 - Bank Bonds: 60 - Term Deposits: 50 - Corporate Bonds: 65 - Commercial Papers: 65 - Credit Claims: 1,000 - For marketable securities, margins are applied to the loan amount and supplemented by margin calls; margins are calibrated using a C-VaR approach with a risk appetite of 95 percent for maturity buckets one, two, three, four, five, seven, and 10 years. - A 10-day settlement period is assumed. As of the mission: - Initial margin: 3.5 percent (mobilized collateral value should be higher than 1.035 times the loan amount). - Margin call: 3.5 percent (counterparty might be required to increase mobilized assets by 3.5 percent). - Haircuts and margin schemes target a coverage percentage of 98 percent, calibrated on the five-year time series of two-year yields of nominal government bonds. ### FCIC nonmarketable collateral haircut methodology - The BCCh developed a methodology to calibrate haircuts for nonmarketable collateral used in the FCIC program, capturing credit and duration risks for the counterparty’s portfolio of credit claims. - The credit risk component is based on expected losses estimated according to the CMF’s standard methodologies; this expected loss is set at 1.75 percent, which corresponds to the lowest category of eligible loans. - Duration risk assumes an average monthly amortization rate of 8.5 percent. - The resulting haircut for the collateral portfolio is rounded and set to 10 percent. - Haircuts are reviewed monthly and stress scenarios include downgrading a given credit claim by three categories; the Corporate Risk Division and Division of Financial Market are notified if tests reveal haircuts are too loose. ### Principles for a coherent collateral policy - Collateral policy should be integrated into the central bank’s overall risk management framework. - Central banks in non-dollarized economies have extensive capacity to issue local currency and regulate credit, enabling various forms of support (asset purchases, collateralized lending, foreign exchange interventions). - For collateralized lending, the central bank’s risk is exposure to assets temporarily acquired (purchase or pledge) intended to be returned at contract end or sold in the event of default. - A coherent collateral framework has three main elements: - Eligibility criteria; - Valuation processes—market-based and theoretical; - Risk mitigation measures, including haircuts and margining, concentration limits, and overcollateralization procedures. - Policy parameters for each component should contain financial and operational risks within identified risk tolerances while minimizing price distortions across asset classes and, where possible, facilitate market development through standardized approaches. *IMF Technical Assistance Report — Introduction* ### 26. While the principles underpinning collateral frameworks are similar for monetary ### 26. While the principles underpinning collateral frameworks are similar for monetary ### Monetary operations versus ELA — key differences - Monetary operations involve counterparts that are not under stress, so the risk of lending is lower. - Eligible collateral for monetary operations: - Is predefined, publicly communicated, and generally higher quality. - Valuation methodologies and risk mitigation measures will also be public. - Eligible collateral for ELA: - Counterparty is under stress and will have used all its monetary-operations-eligible collateral—meaning lower credit quality and less liquid collateral must be used. - Valuation and operational details may be nondisclosed to contain moral hazard. - Table 4 summarizes differences: - Objective: Price stability (Monetary Policy Operations) vs Financial stability (ELA) - Eligibility: High-quality liquid assets vs Broader collateral acceptance - Collateral preference: None (asset selection by banks) vs Defined by the central bank - Rule versus Discretion: Rules (might change in systemwide crisis) vs Central bank discretion - Valuation: Disclosure of key methodological elements vs Nondisclosure to the public - Haircuts: Public vs Nonpublic - Concentration Limits: None (generally) vs Applicable - Ancillary numeric detail: "The CMF has 10 debtor categories: A1, ..., A6, B1, ..., B4. 1.75 percent corresponds to the expected losses of the category A4." *Source: IMF staff.* ### Collateral eligibility for systemwide support - Collateral must be targeted to the identified problem; broader than monetary operations but narrower than ELA. - Collateral eligibility would likely be announced with other program modalities; once announced, the central bank commits to accepting collateral under predefined rules. - Valuation, haircuts, margining, concentration limits, and overcollateralization provisions would be at the central bank's discretion and set in context of stress severity. ### Recommendations — Eligibility and preference order - PWRA and Repo-Prenda prohibition had limited effects on BCCh’s capacity to implement monetary policy; ideally central banks could have both pledge and PWRA. - Advantages of PWRA: upfront legal transfer of the underlying asset (minimizes legal transfer risk), contributes to market liquidity through reuse. - Chile-specific point: legal transfer risk is subdued due to a well-functioning central securities depository. - BCCh could issue its own securities in reverse-repo operations to overcome repo market collateral scarcity. - BCCh should establish a methodology for determining the preference order for each collateral: - Assumption: any asset on a bank's balance sheet, unless explicitly prohibited by law, is a priori acceptable as collateral. - Central bank controls risk via a hierarchy of collateral acceptance (highest credit quality and most liquid first) and application of haircuts. - An algorithm (Appendix II) orders collateral based on liquidity, legal certainty, valuation, volatility, total volume on issue, and distribution in the financial sector. The methodology is flexible and scalable. - The established preference order should determine eligibility scope across monetary policy, ELA, and systemwide measures. - Demarcation between collateral accepted in normal times (monetary policy) and in stress (ELA): - Collateral for monetary policy operations should be the most preferred in the ranking. - Depth of the demarcation line balances banks’ refinancing needs and required quality/transparency; material changes in collateral eligibility should be infrequent. - Collateral scanning: - Process comparing banks’ short-term liquidity needs against available collateral (Figure 2). - Informs assessments of banks’ resilience to liquidity stress and adequacy of collateral eligibility breadth. - Standard lending facilities unconditionally backstop counterparts’ liquidity shortfalls subject to terms; ELA may be conditionally provided to potentially cover all runnable liabilities. - Specific eligibility recommendation: - Banks’ bonds and CDs should no longer be eligible for monetary operations. - With the FCIC’s expiry in July 2024, BCCh should roll back part of the post-GFC program. - Rationale: high correlation risks accepting banks’ assets from counterpart banks; bank bonds are a potential source of moral hazard due to hidden own-use risks. - Stylized scanning (Figure 2) shows banks with sizable holdings of these instruments have significantly small runnable liabilities and/or a high share of government securities usable in monetary policy operations. - Enhance capacity to handle nonstandard collateral: - Consider other bank liabilities beyond sight deposits: short-term deposits, issuance of short-term debt securities, interbank borrowings. - Comprehensive assessment plus risk mitigation measures will allow BCCh to quantify potential liquidity demand from bank-specific or systemwide shocks. ### Valuation — market-based and theoretical approaches - Develop market-based valuation algorithms: - Market prices of marketable assets are composite prices aggregated from market quotes. - BCCh should develop a pricing algorithm using market quotes as raw as possible and set quote cleaning parameters (e.g., acceptable bid-ask spread, quote age, quote staleness). - Build its own metric to find consensus across market participants and enable rating of market participants over time (Appendix III). - For the collateral framework, market price computation uses the quote’s bid price. - Quote age: function of last edit; example staleness threshold: three days. - Develop theoretical valuation where no observable prices exist: - Calibrate yield curves based on BCCh-determined market-based price of liquid securities to generate discount factors for coupon payments. - Nelson-Siegel (NS) methodology recommended to inform level, slope, curvature of yield curves (sovereign/corporate; nominal/inflation indexed). - For illiquid segments with no issuer curve, adjust parameters of an already calibrated curve to account for issuer-specific risk premia. - Valuing illiquid and nonmarketable assets: - Efficient use of loans and mortgages as collateral is critical for ELA and systemwide operations. - FCIC program revealed BCCh lacked proper reporting procedures to value such assets; BCCh valued loans at outstanding amount to avoid operational costs. - If necessary, BCCh could solicit external expertise to evaluate nonmarketable assets and establish methodologies with required input data; methodologies should be validated and operationalized within BCCh. - Monitor mispricing and arbitrage between nominal and inflation-indexed securities: - Market participants indicated significant mispricing attributed to liquidity differences across real and nominal yield curves. - Liquidity differential likely driven by “preferred habitat” of international investors (nominal, short-term) vs local investors (long-term inflation-protected). - BCCh should assess arbitrage potential and adjust pricing models as necessary. - Considerations before changes: improve valuation models; note CLP-UF exchange rate is determined by BCCh and clears Equation 1 in Box 1. ### Risk mitigation measures — haircuts, margins, and add-ons - Observations on current BCCh approach: - Assumed settlement date of 10 days is not plausible given market absorptive capacity—liquidation will likely take longer. - BCCh sets haircuts on government securities to zero but applies a 3.5 percent margin; market risk interest-rate volatility is not zero and sovereign credit risk, while low (country rated A+), is not zero. - Recommended development of haircut calibrations to achieve risk equivalence across asset classes: - Risk equivalence: haircuts calibrated so expected losses are the same for all collateral types. - Haircut calibration should follow a model featuring components of financial risks: - Liquidity risk: time-to-liquidation dependent on central bank position size vs market absorptive capacity. - Market risk: price volatility over time-to-liquidation; for marketable securities, interest-rate volatility using discount curve yields. - Credit risk: default of ultimate debtor during time-to-liquidation and related expected losses/shortfalls. - Additional risks: exchange rate risk for foreign-currency collateral; valuation risk for illiquid collateral; residual maturity risk; mobilization risk (e.g., legal risk for assets held abroad). - Analytical frameworks available: - ECB methodology based on expected-shortfall theory provides a closed-form formula for haircuts; parameters can be estimated using Chilean data. - Alternative: VaR models featuring direct modeling of loss functions (Appendix V); applied at sector level so haircuts are calibrated independently from the public sector. - Further haircut-related recommendations: - Haircuts should be expressed as a percentage of the security's value. - Haircuts should be recalibrated at a relatively low frequency—recommended every two years. - Note: optimally, recalibrate every two to three years (as done by the Eurosystem) to provide stability and predictability; recommended frequency is transitory while training the calibration model. - Other risks should be accounted for with add-ons: - Inflation-linked bonds (UF) vs nominal bonds (CLP) are de facto priced in two different currencies—apply an exchange-risk-like add-on to inflation-linked bonds. - Legal requirement to sell back government securities temporarily acquired via PWRA before maturity implies higher liquidation discount—add-ons should differ by mobilization modality. - Margins and coverage percentage: - Margins should be enforced through daily calls; “coverage percentage” can be dropped. - Current coverage percentage mainly captures interest-rate risks related to inflation-indexed curve via CVaR; haircut calibration models account for IRR risk more granularly at sector level. - Nonmarketable collateral haircuts: - Develop new methodology for haircuts on nonmarketable collateral potentially eligible for ELA or systemwide programs. - FCIC approach shortcomings: - Focused solely on sector of credit claims, neglecting cross-sector correlation of default probabilities. - Calibrated PDs collected from banks, reflecting banks’ PDs not BCCh's risk tolerance. - Appendix VI presents a model addressing these caveats. - Expected-loss-based haircut models capture only credit risk; also account for: - Market risk (e.g., value of underlying real estate) - Liquidation risk (market absorptive capacity when collateral sold) - Inflation risk (indexation of nonstandard collateral to inflation) - Complementary tools: - Concentration limits to control exposure to specific asset classes (issuer, debtor, sector, asset type, etc.) and reduce risk via collateral-pool diversification. - Overcollateralization to address ELA counterparty-specific risks or incentivize compliance with ELA conditionality. - Concentration limits applicable for all operations; overcollateralization applicable only in context of ELA. *IMF Technical Assistance Report | 19–25* ### 46. The 2021 FSAP highlighted the need for the BCCh to develop an effective ELA framework, ### 46. The 2021 FSAP highlighted the need for the BCCh to develop an effective ELA framework, ### Overview and four-component ELA framework - The 2021 FSAP recommended the BCCh develop an effective ELA framework with four components: - (i) a Legal Foundation that supports discretionary lending; - (ii) Internal Procedures that detail the conditions and policy parameters under which ELA is provided, and the allocation of divisional responsibilities within the BCCh; - (iii) Formalized Arrangements with the MoF and the CMF covering each party’s responsibilities and obligations, including the circumstances when a government indemnity may be granted; and - (iv) Transparency and Communication measures that publicly communicate the central bank's approach to helping condition market behavior, and central bank accountability, both ex ante and ex post. ### Principles for implementing an ELA framework in Chile - Operational preparation is essential for increasing the chances of ELA’s being successful in mitigating the financial stability risks of idiosyncratic liquidity shocks. - Close monitoring of eligible institutions will allow for the anticipation of liquidity strains, potentially reducing or eliminating the need for ELA. - Financial stability is a shared responsibility requiring cooperation across numerous agencies, with the MoF playing a relevant role in coordination through the FSC. ### Crisis coordination arrangements (Box 2) - Financial Stability Council (CEF): - Statutory body facilitating coordination and information sharing between the MoF, CMF, SP, and BCCh; chaired by the MoF. - BCCh is not a formal member due to autonomous constitutional status, but the BCCh Governor is a permanent invitee and advisor in practice. - Meets monthly; MoU formalizes coordination and information sharing; recommendations nonbinding. - Bilateral MoU: BCCh and CMF: - Specifies responsibilities, communications, and information sharing under stress, including when banks request ELA. - Requires the CMF Board to inform the BCCh of its decision on a bank’s viability; the BCCh Board then decides on ELA provision (Article 36, No. 1, Central Bank Law). - Protocol lacks detail on scope of viability assessments and specific information exchange. _Source attribution: IMF staff, BCCh, CMF._ ### B. Legal Foundation — current status and gaps - Legal basis: - The Constitutional Organic Law (LOC) (Article 36) and the FMRA provide the legal basis for the extension of ELA. - LOC allows discretionary ELA to licensed banks to preserve financial sector stability; BCCh mandate includes lender of last resort role. - FMRA extended ELA eligibility to central counterparties (CCPs) and to credit unions that comply with regulation and supervision standards equivalent to banks. - Gaps in legislation: - Law specifies term limits: ELA can be provided to a viable financial institution for up to 90 days, with the possibility of extension for another 90 days. - Law does not explicitly require that adequate collateral must be provided, that a penal interest rate will be charged, or that conditions may be applied on the requesting institution. ### C. Internal Procedures and Policy Parameters — current situation - ELA assessment process: - Applications are assessed case-by-case with no standard procedures defined or published. - ELA disbursements require BCCh Board approval; bank solvency and viability opinions require CMF Board approval. - A simulation exercise highlighted importance of clarity of roles, operational preparedness, and coordination. - Departmental responsibilities in evaluating ELA requests (summary of Box 3): - Solvency assessment: CMF, BCCh Financial Policy Division (FPD) - Viability assessment: CMF, BCCh FPD, Financial Markets Division (FMD) - Systemic risk assessment: BCCh FPD - Unavailability of alternative funding: CMF, BCCh FMD - Funding plan preparation and conditionality prescription: CMF, BCCh FPD, FMD, General Counsel, Corporate Risk Division (CRD) - Calibration of ELA envelope: CMF, BCCh FPD, FMD, CRD - Preparation of ELA agreements and collateral agreements: CMF, BCCh FMD, CRD, General Counsel - Implications for monetary policy: BCCh FMD, Monetary Policy Division (MPD) - Information exchange with MoF re: indemnities: BCCh Board - Communication strategy and disclosure: BCCh FPD, Institutional Affairs Division (IAD), General Counsel, ATD (including Accounting), CMF, MoF - Proposal and response preparation: ELA Working Group, FPD, FMD ### Recommendations on governance, documentation, and process - Establish an ELA Working Group (EWG): - Lead division: ideally the Financial Policy Division. - Membership: monetary policy, financial stability, legal, back office, communications. - Produce terms of reference focused on preparedness, documented procedures, and clarity of divisional obligations. - EWG should meet regularly and report to a parent committee within the BCCh, which should sign off on key decisions. - Develop standard ELA documentation: - (i) a request letter signed by the requesting institution’s CEO confirming solvency, temporary liquidity stress, reasons, amount, duration, and collateral; - (ii) an ELA master agreement tailored to the Chilean legal environment; and - (iii) funding templates for quick input, institution-specific assessment, and scenario analysis. - Assessment process elements (to be completed to BCCh Board satisfaction before disbursement): - (i) assessing eligibility; - (ii) assigning conditionality; - (iii) determining financial parameters. ### Eligibility: criteria and operational requirements - Institutions must: - (i) be eligible by law; - (ii) be of systemic importance; - (iii) have exhausted all other funding sources; and - (iv) be solvent on a forward-looking basis and viable. - Eligibility and recent legal extensions: - All licensed banks eligible by law (Article 36 LOC). - December 2023 FMRA allows BCCh to provide ELA to CCPs and credit unions meeting comparable regulatory standards. - Systemic importance: - A systemic importance test must be conducted at the time of request; determination can go beyond CMF ex ante D-SIB designations. - CMF annual assessment uses four attributes: size, interconnectedness, complexity, substitutability. - Six banks are classified as systemic under Basel III D-SIB methodology. - Operational preparedness: - BCCh and CMF should prepare a watchlist of potentially systemic institutions, extended to credit unions and CCPs. - CCPs likely systemically important given concentration and substitutability; CCPs may request ELA if markets freeze and their own resources are insufficient. - Exhaustion of other funding sources: - BCCh monitoring of funding and market indicators should assess exhaustion of domestic funding sources (interbank, CDs, bond markets). - CMF should explore parent funding for foreign bank subsidiaries and may request confirmation that parental and market sources are fully used. - Forward-looking solvency and viability tests: - Forward-looking solvency: requires credible prospect of capital being maintained or restored above prudential minimum within a reasonable period (e.g., 12 months). Timeframe should be broadly defined internally by the CMF and not public. - Viability assessment by CMF: covers business operations and outlook, including asset quality, governance and management, earnings, liquidity, and risk management; should identify reforms needed or whether resolution is required. - Timeliness: - CMF must be able to provide, within perhaps 24 hours, its view of an institution’s forward-looking solvency and viability to inform BCCh decision-making; BCCh response should be similarly prompt. ### Conditionality and funding plans - Credible funding plan: - Preparation of an agreed and credible funding plan with CMF and the institution is the most important condition for providing ELA. - Plan should facilitate monitoring of fund use and include a clear exit strategy with quantified milestones. - Calibration of ELA envelope: - ELA envelope should be calibrated on the institution’s forecasted liquidity requirement typically over a two-week period. - Banks should submit a detailed cash flow forecast for the following two weeks distinguishing flows for deposits, loans, securities, interbank operations, and other factors. - Envelope size reflects the difference between current liquidity position and minimum liquidity threshold adjusted by total net cash flows projected for the two following weeks. - Additional conditionality to ensure appropriate use: - Equity buybacks should be prohibited; funds can be used to meet debt repayments as they become due. - Funds should not be used to facilitate nonessential or risky lending practices, distribution of dividends, or bonuses/salary increases for management. - Institution-specific measures should address governance and risk management failures identified in viability assessment. - For foreign subsidiaries, protections against upstreaming of funds to parent and formalized arrangements for prudential information sharing with host supervisor. ### ELA in foreign currency - BCCh should be prepared to provide ELA in foreign currency only under exceptional circumstances and with strict safeguards. - Foreign currency exposures and regulation: - For banking sector loans and deposits as a percentage of the total: loans are 17.5 percent and deposits are 25.1 percent. - Banks’ short foreign exchange positions due in 30 days cannot exceed long positions by more than the bank’s capital. - Risks and safeguards: - FX ELA to foreign-owned branches or subsidiaries could entail additional upstreaming risks. - Preferred solution: foreign-owned bank obtain liquidity from parent, supported by home authorities first. - Constraints on FX ELA highlight the importance of prudential tools to contain buildup of foreign currency-related exposures. *Source: IMF staff, BCCh, CMF.* ### 68. The existing law appropriately allows for providing ELA for a maximum of 180 days ### 68. The existing law appropriately allows for providing ELA for a maximum of 180 days ### ELA duration and operational envelope - Existing law allows providing ELA for a maximum of 180 days (i.e., 90 days with one extension of 90 days). - Disbursements should be provided based on a two-week approved envelope, setting the maximum liquidity that can be extended without requiring further approval. - Within the two-week envelope: - Amounts should follow the funding plan and be based on anticipated cash flows and ELA needs over the next two weeks. - ELA should roll daily, allowing any liquidity surpluses at the start of the next business day. - At the end of each two-week period: - Forecasted ELA need is recalibrated for the forthcoming two weeks. - A new ELA envelope is allocated, which may be larger or smaller than the previous fortnight, in line with funding plan targets. - Rationale: minimizes frequent approvals for ELA extensions when no changes occur in an institution’s financial status or balance sheet composition. ### Pricing and incentives - ELA should be priced at a margin above the BCCh’s standard lending facility (SLF) rate to reduce moral hazard and to incentivize timely repayment. - Suggested initial margin: around 200–300 basis points above the SLF rate. - Suggested subsequent reduced margin as knowledge and compliance increase: 100–150 basis points. - Constraint: while punitive, the ELA rate must not be set at a level that pushes an otherwise viable institution into a nonviable situation. ### Collateral framework and mobilization - ELA-eligible collateral should be considered within the overall collateral framework (Section II) with: - Clearly defined eligibility criteria. - Robust valuation processes. - Adequate risk mitigation measures. - ELA represents an extension of the standard collateral framework with: - Broader eligibility criteria. - Challenges valuing less liquid collateral (e.g., credit claims). - Requirement for more tightly calibrated risk mitigation measures (i.e., higher haircuts). - Credit claims: - BCCh’s acceptance under the FCIC program provided valuable experience. - Credit claims can be material in banks’ assets but require dedicated procedures to assess credit quality and ensure legally robust title transfer. - Operational lead times for the FCIC program were more than a month for identification and mobilization of eligible credit claims — acceptable for systemwide programs but not for idiosyncratic shocks in systemically important institutions. ### Pre-positioning and testing of collateral - To improve crisis preparedness, BCCh should encourage banks to pre-position collateral and conduct regular tests for mobilization. - Pre-positioning includes identifying, verifying eligibility, and validating collateral without transferring legal title. - Once due diligence is satisfactorily completed, collateral is considered pre-positioned and ready to be drawn against, subject to central bank approval. - Testing exercises: - BCCh should conduct testing exercises with key counterparties on identification and mobilization of nonstandard collateral, in particular credit claims. - Initial phase: mandatory tests with the six domestic systemically important banks (D-SIBs). - Next phase: broaden counterparties to include smaller banks and eligible NBFIs. - To shorten lead times and reduce operational risks, BCCh could share minimum procedural and eligibility requirements and conduct exercises built on FCIC experience. - Information sharing on nonbinding eligibility requirements should enable counterparties to identify available and unencumbered assets ahead of time. - BCCh communication must be balanced so that disclosure of eligibility criteria does not diminish BCCh’s discretion when ELA is requested. ### Formalizing arrangements: BCCh / CMF / MoF - Establish a Crisis Management Group (CMG) comprising: - BCCh divisional heads (FPD, FMD, CRD) and the General Counsel. - Representatives of comparable seniority from CMF and MoF. - CMG responsibilities: - Develop a common understanding encapsulated in a MoU of the entire ELA process. - Clarify individual responsibilities, especially regarding forward-looking solvency and viability assessments and potential need for a government indemnity. - Facilitate time-critical assessments conducted effectively and efficiently. - MoF role and institutional coordination: - LOC (s19) allows MoF to attend BCCh Board meetings and to suspend implementation of any decision for a period not to exceed 15 days. - If all BCCh Board Members disagree with the proposed suspension, the Board can unanimously overrule the suspension. - Although the Minister has never exercised the right, coordination is imperative to avoid delays in warranted disbursements. - Government indemnity: - May be required if concerns exist about solvency, viability, or adequacy of collateral due to the magnitude of financial risks relative to BCCh’s balance sheet. - Any indemnity should be unconditional, irrevocable, and callable on demand by the BCCh. - MoF and BCCh should agree on a framework and procedures for granting an indemnity. - Legal constraints: - Under the Chilean constitutional framework, a specific law would have to be passed for MoF to grant such indemnity, making timely availability unlikely in the limited time for an ELA request. - Joint preparatory work: - CMG should initiate work including development of standardized approaches to banks’ funding plans. - Maintain a watchlist of financial institutions generally considered critical for financial stability and hence eligible for ELA. - CMG’s MoU should facilitate exchange of information, market intelligence, assessments on liquidity conditions, and sharing of early warnings among the three members. ### Transparency and communication - Ex ante transparency: - BCCh currently has no public document and should consider developing a publicly available ELA regulation to: - Manage banks’ expectations on conditions for providing ELA. - Highlight that ELA is for solvent and viable institutions. - Ensure central bank accountability. - The ELA regulation should expand the current LOC and outline broad terms and conditions, including: - The discretionary nature of the intervention grounded in BCCh’s financial stability mandate. - Institutional eligibility: the set of entities generally eligible for support. - Conditionality and supervisory intrusion: BCCh/CMF ability to collect, monitor, and assess information and supervisor’s power to adopt early intervention measures. - Requirement for full collateralization. - Discretionary financial parameters, including reference to a penalty rate, the maximum maturity of 180 days, and the broad range of eligible collateral beyond the standard framework with additional risk mitigation measures. - Ex post communication: - Develop ex post communications guidelines to ensure accountability while avoiding disclosures that exacerbate liquidity stress. - Premature disclosure of liquidity support to an individual institution could cause stress to spread. - Identifying the ELA recipient may be required under public disclosure requirements; ideally this should be done at least a year after the ELA has been repaid. - Note: market pricing, contacts, and periodic publication of a central bank’s balance sheet or monetary data may allow deduction of an institution’s stress earlier. ### Systemwide support measures (context and FX market programs) - Systemwide problems can impact one or more segments, creating contagion or asset fire sales and undermining solvency of otherwise viable entities. - Distinction between market liquidity and funding liquidity is critical; their interaction can lead to liquidity spirals. - Box of principles for market support programs (high-level design principles focused on liquidity, triggers, size, pricing, self-liquidation, preparedness, and balance sheet risks). - BCCh experience: - Since 1999, BCCh intervened in FX markets only four times. - In late 2019 and during COVID-19, BCCh implemented FX spot sales, NDFs, and swaps (initial maturities 30 and 90 days, then 180 days) to provide USD liquidity and attenuate exchange rate volatility. - Pricing of USD funding support established facilities as backstops at LIBOR + 400 basis points. - Outcomes: - Spot exchange rate volatility receded to levels typical in emerging market currencies. - Deeply negative basis spreads reversed relatively quickly after NDF and swap programs launched. - Stock of NDF contracts reduced to zero by end-October 2020. - Volume of FX swaps reduced to zero by end-June 2020 (despite availability until January 2021). - Lessons: clear end-dates and pricing facilitated smooth exit and signaled backstop nature of facilities. *Source: tarea2025048-print-pdf - 68. The existing law appropriately allows for providing ELA for a maximum of 180 days* ### 89. Chile has a large bank bond market and nonbank financial sector in comparison with ### 89. Chile has a large bank bond market and nonbank financial sector in comparison with ### Market structure and investor base - Domestic securities issued by banks were almost double those issued by the government at end-2019. - Mutual and pension funds are important providers of funding to the domestic banking system: - Mutual funds provide about half of time deposits. - Pension funds are the largest buyers of bank bonds. - Foreign investors have played a lesser role in recent years despite increasing their holdings, particularly in government securities. - Prior to August 2020 legislative change, the BCCh could not purchase government bonds in the secondary market or accept them under PWRA due to prohibition on buying government debt or financing public spending. The August 2020 change lifted that restriction for exceptional periods. ### Impact of pension fund withdrawals and liquidity shock - Chilean Congress approved three rounds of pension withdrawals: June 2020, December 2020, and April 2021. - Withdrawals exceeded USD 48 billion from pension funds, equivalent to 23 percent of 2020 total assets (nearly 20 percent of GDP). - Nonbank financial institutions (NBFIs) contribute about half of total bank liabilities; withdrawals severely impacted bank funding. - Government bond market liquidity declined but was less concerning because the government used its sovereign wealth fund to finance COVID-19 programs and did not need to suddenly increase government securities issuance. ### BCCh securities market interventions (design and scale) - Bank bond purchase program (launched March 20, 2020): - Eligible assets: nominal or inflation-linked bank bonds with less than five years of remaining maturity. - Operations were in “purchase windows” with preannounced total amount and fixed prices set as spreads over swap rates by rating: - AAA: swap + 250 bps - AA: swap + 260 bps - A: swap + 280 bps - Total program amount initially USD four billion, later increased to USD 8 billion, but only USD 3.3 billion was used. Demand faded after about two months. - Stated objective: curb secondary market volatility. - Special asset purchase program (announced June 17): - Targeted bank bonds and BCCh bonds. - Term: six months. - Total approved amount: USD eight billion. - No information published on allocation mechanism. - Objective: boost banks’ funding liquidity. - Bank bond buy-/sellback (CC-VP) program: - Targeted at pension funds to prevent fire sales after extraordinary withdrawals. - Amount of program: about USD 16 billion. - Stated objective: contain market volatility from forced sales. ### Effectiveness and market outcomes - Programs curtailed widening of bank and corporate bond spreads more than government bond spreads; bank bond spreads receded from peaks significantly faster than government bond spreads. - Trading volumes in the secondary market dropped to less than half of typical pre-pandemic turnover levels and have not since recovered. - Local Stress Index (LSI), particularly its bond market component, showed a relatively persistent increase, suggesting somewhat impaired market functioning. - Exit from bank bond purchase program was prolonged and BCCh financial risks remained elevated: - Bank bond purchases shifted from crisis intervention to quantitative easing to facilitate ongoing pension fund withdrawals. - Purchases were phased out when BCCh halted quantitative easing, but a fixed stock of bank bonds was maintained via a Bank Bond Reinvestment Program in January 2021 (reinvestment of coupons and maturities). - When BCCh raised the policy rate (mid-2021), it stopped reinvesting coupons and redemptions. - BCCh balance sheet doubled, with bank bonds accounting for around 50 percent of assets, significantly increasing its financial risks. ### Money market stress and BCCh liquidity measures - Early 2020: precautionary liquidity demand impaired money markets and monetary policy transmission; higher risk premia threatened transmission to longer-term rates. - Key BCCh measures to underpin funding markets: - Repo program: - Provided funding for 30 days, later 90 days. - Interest rate set at the central bank’s monetary policy rate (TPM). - Liquidity Credit Line Facility (LCL): - Uncollateralized lending limited in size to a bank’s reserve requirement. - At year-end 2020, amount outstanding was CLP 5.2 trillion against a limit of CLP 5.8 trillion with policy rate prevailing at the time of 0.5 percent. - Facility was fully refinanced with the FCIC in March 2022 and completely wound down by August 2022. - Access and use were subject to same loan-growth conditions associated with the FCIC. - Time deposit purchase program: - Announced July 2020 with total amount USD eight billion; only 0.5 billion was purchased; program discontinued October 2020. - Collateral expansion: - Expanded eligibility to (nonbank) corporate bonds and commercial loans for specific programs. - Conditional Financing Facility for Increased Loans (FCIC) — Funding for Lending (Box 5): - Available for up to four years with interest rate set for the whole period at 0.5 percent. - Collateral expanded to include credit claims and corporate bonds. - Program volume peaked at around USD 40 billion and was completely wound down by July 1, 2024. - LCL and three rounds of FCIC indirectly alleviated bank bond market pressures by allowing BCCh funding to substitute for bond issuance and deposits. ### Money market outcomes and interbank activity - Interbank trading: - Average daily interbank trading volume between March 2019 and February 2020: around CLP 400 billion. - After COVID-19 shock, between March 2020 and February 2021: CLP 277 billion. - In the first period, almost all trading days had nonzero trading volume; in the second period, less than 50 percent of days had any market activity. - Banking system liquidity coverage: - Banking system’s LCR remained well above 100 percent throughout the review period. - The weakest bank’s LCR value dropped to 90 percent for only one day. ### Assessment and recommendations (BCCh programs) - Overall assessment: - BCCh acted swiftly and decisively; measures were effective in supporting market functioning but significantly increased financial risk on BCCh balance sheet. - A functioning repo market could have reduced the magnitude of interventions required. - Key recommendations and observations: - Program design should minimize risks to BCCh and facilitate exit: - Buy-/sellbacks (as with CC-VP) are lower risk than outright purchases because (i) counterparty failure and collateral value decline are required for BCCh losses, and (ii) haircuts and margins can be calibrated. - Temporary buy-/sellback transactions simplify exit via self-liquidation at maturity. - Outright purchases may be necessary if the problem is loss of market liquidity with no dealer funding constraint. - Pricing should incentivize market activity resumption and facilitate exit: - Link operations to a floating rate to incentivize take-up and ease rollover without compromising monetary transmission (example: FX swap program). - Low and fixed costs (as in LCL and FCIC) disincentivize early repayment. - Transparency increases effectiveness and mitigates risks: - Ex ante transparency on objectives supports effectiveness and conditions markets for smooth exit. - Ex post transparency enhances credibility and helps manage reputational risks from an expanded balance sheet. - BCCh should consider publishing more granular data on acquired bonds to clarify support to individual entities and credit risk transferred to BCCh balance sheet. - FX intervention transparency: - Infrequent FX intervention increases need for clarity when interventions occur. - BCCh could consider ex ante disclosure of FX intervention objectives and ex post evaluation of effectiveness. ### V. Repo Market Development — Current situation - Domestic repo market size and activity: - Outstanding volume at end-2023: just over USD 12 billion, equivalent to about four percent of GDP. - Comparison: Mexico 10 percent, Brazil 20 percent. - Average daily turnover in 2022: just under USD 2.5 billion (market-based turnover lower because BCCh repos are included). - About two-thirds of transactions were for less than USD one million, with an average size around USD 200,000. - Tenors concentrated: overnight to one-week for cash borrowing; up to six months for cash lending. - Repo rates substantially above TPM with wide spread between repo and reverse repo rates—averaging TPM + 405 basis points and TPM + 795 basis points, respectively, in 2022 (average spread of 390 basis points). - Market composition: - Brokers accounted for 68 percent of transactions and 44 percent of outstanding value. - Interbank repo outstanding value: USD 850 billion, contributing less than one percent of bank funding and three percent of bank lending. - Cross-border USD repo: - Active cross-border USD repo amounts to over one-quarter of outstanding transactions. - USD repo accounted for 27 percent of the outstanding value of repo in 2023 but only three percent of the number of transactions. - USD repo transactions use ICMA GMRA documentation and demonstrate presence of sophisticated repo users. ### V. Repo Market Development — Assessment - Fundamental drivers for an active repo market are absent: - Repo markets rely on active secondary fixed-income markets (collateral motivation) and cash-motivated borrowing. - Chile’s securities market is largely buy-and-hold, producing little supply of liquid collateral and no specialist bond dealers to drive repo. - Banks have alternative funding options and limited incentive to build collateral management until repo offers good liquidity. - Constraints identified by BCCh repo survey: - Volatility of asset prices, illiquidity, and regulatory concerns are perceived as holding back repo market development. - Debt Management Office (DMO) initiative to boost secondary market trading: - DMO proposing official market-makers (primary dealers) supported with a “greenshoe option” and exclusive access to a securities lending facility to lend new securities solely to alleviate temporary acute shortages of particular issues. - DMO has recently been granted necessary legislative approval to amend the Financial Markets Resilience Act. *Source: IMF staff summary of BCCh and related material contained in the provided content.* ### 108. The dominance of inflation-linked securities is unique to Chile but does not seem to be a ### tarea2025048-print-pdf - 108. The dominance of inflation-linked securities is unique to Chile but does not seem to be a ### Inflation-linked securities and use as repo collateral - Chile has a reasonable supply of government securities: "24 percent of GDP at end-2022", with "60 percent being inflation linked (i.e., CPF-denominated securities)". - Comparative figures cited: - "0.7 percent in US Treasury bonds" - "10.7 percent in UK gilts" - The mission evaluated information insensitivity of CPF bonds. Key points: - Collateral acceptability depends on issuer creditworthiness, liquidity, and complexity of cashflow structure. - Complexity of indexed securities complicates valuation and helps explain why they are not widely used as collateral outside Chile. - Exceptions exist: "10.7 percent of repo collateral held by primary dealers in May 2024 were Treasury Inflation-Protected Securities (TIPS)" in the US. - In Chile, CPF bonds are commonplace and "all market participants the mission met believed that government CPFs would among domestic institutions be universally acceptable as collateral." ### Active wholesale cash market and structural liquidity - Central bank balance sheet expansion reduced money market activity by creating structural excess liquidity. - BCCh expanded its balance sheet after social turmoil and COVID-19, removing short-term liquidity risks. - Banks reported having excess liquidity and adequate unsecured interbank lines, reducing need for repo. - Interbank activity composition: - "CDs ... accounted for 42 percent of interbank exposures in Q1 2022, down from 59 percent in Q4 2018." - "Bank bonds accounted for another 22 percent of interbank exposures, up from 16 percent in Q4 2018." - Interbank transactions are included in the reservable base, likely deterring money market and repo activity. - Banking sector concentration may impede money market activity: - "Six banks account for 88 percent of all deposits (May 2024)." - Market segmentation risk if large banks avoid dealing with smaller banks. - The mission lacked transaction-level data to fully assess segmentation. ### Enabling conditions — Diversified financial sector - NBFIs (nonbank financial institutions) are well placed to benefit from and contribute to a repo market: - Repos can serve money market mutual funds for secure short-term investment and liquidity management. - Pension funds can enhance yields by repoing out securities and use repo for portfolio management. - Constraints on NBFI participation: - Pension funds face regulatory constraints and inertia; many managers see little need for repo given defined-contribution structure and use of money market mutual funds. - Pension funds do not engage in securities lending widely. - BCCh survey: absence of pension funds in repo "hindered market development." - Recommendation: remove restrictions on NBFIs dealing in repo as soon as possible, subject to safeguards and a standard domestic legal agreement. ### Legal framework - Close-out netting enforceability: - Recent FMRA provides the right to close-out netting for financial institutions executing repo under a recognized master repurchase agreement (MRAs). - "The necessary implementing regulation, which will formally recognize eligible MRAs, is expected to be published later in 2024." - No widely accepted domestic agreement exists; most parties use bespoke versions of the GMRA. - BCCh survey revealed doubts about transfer of ownership in repo and the right to liquidate collateral. - Outstanding legal risk: - Risk that the regulator's "stay of enforcement" under bank recovery and resolution rules might undermine contractual close-out netting rights under the FMRA. ### Regulation (capital, reserve rules, and perceived costs) - Chile follows the Simple Approach under the Basel Framework for counterparty risk weights. - Market concerns and uncertainties: - Lack of clarity on conditions for a "10 percent counterparty risk weight"—notably the phrase “liquidation of the operation in a proven system for this kind of transaction,” interpreted as settlement on a proven repo settlement system. - Possible misinterpretation: repos treated as commercial loans for loan loss provisioning under Capitulo B7, No.1, Compendio de Normas Contables—collateralization ignored and provisioning against the gross amount of the repo lending. - Banks view Basel leverage ratio (LR), liquidity coverage ratio (LCR), and net stable funding ratio (NSFR) as burdens on repo attractiveness, although LCR favors repos using HQLA such as government bonds. - Reserve requirement specification penalizes repo and interbank borrowings: - Reserve ratios: "nine percent for sight deposits and 3.6 percent for term deposits below one year." - Inclusion of interbank transactions in the reservable base causes double counting and raises effective costs when requirement is unremunerated. ### Boxed rule excerpt — Market-based Approach: Simple Risk Weight Method - Simple Approach substitutes counterparty risk weight with that of collateral issuer subject to a floor of "20 percent", except floor can be reduced to: - "10 percent"—for repo against zero risk-weighted collateral that can be liquidated within five days of a default, has no currency risk, is an overnight transaction or is margined daily, is subject to standard legal documentation, and is settled in a proven repo settlement system; or - "zero"—for repo with a core market participant (e.g., a bank) against zero risk-weighted collateral that has no currency risk and is subject to a collateral haircut of "20 percent" in the capital calculation. ### Taxation and accounting issues - Taxation: - SII abrogated capital gains tax on the purchase and repurchase legs of a repo and confirmed repo interest will be taxed like deposit interest. - Remaining gray areas: application of stamp duty, burdensome reporting for tax refunds, taxation of collateral pools and collateral securities trading special, and repo lifecycle events such as collateral substitution. - Accounting: - Chile follows IFRS, but expertise on application to repo is limited. - Uncertainty around accounting for re-use of collateral (requires creation of a negative asset) may deter reuse and intermediation. - Clarifications: - Variation margining under MRAs does not require change in valuation of securities used as collateral; repo securities remain on the balance sheet of the repo seller. - Variation margin is contractual, must be returned once exposure is eliminated, and does not represent profit. ### Infrastructure and post-trade services - Existing infrastructure supports secure and efficient settlement: - Securities settlement system linked to RTGS offers delivery-versus-payment (DvP) for repo legs and free-of-payment (FoP) for margin and substitution. - Trade repository exists for regulatory transaction reporting (currently derivatives only). - CCPs and triparty repo are premature: - Significant support for a repo CCP exists but concerns about cost and commercial viability; CCPs need volume to be viable and netting-effective. - Clearing repo is more challenging than derivatives due to non-fungibility of securities and difficulty compressing into cash. - Triparty repo requires scale and is likely premature given market size and overheads. - Trading automation: - CLOB automatic trading systems and RFQ platforms are only suited to high-volume markets; both are premature for Chile at this early stage. ### Recommendations — fundamental drivers and enabling actions - Promote an active domestic market in fixed-income securities: - DMO proposal to introduce official market-makers in government bonds may help but design must balance incentives and obligations. - Investigate significant mispricing of securities and barriers preventing arbitrage by domestic and foreign participants. - Support an active wholesale short-term cash market by draining structural excess liquidity: - Conditions expected to be more conducive for short-term money market activity "by the end of 2024" as crisis-related intervention programs are wound back. - BCCh should "closely monitor the distribution of excess reserves and bilateral activity in unsecured and secured interbank markets" to assess segmentation risks. - Assess and remove barriers to broader participation in repo: - Remove restrictions on NBFIs subject to drafting regulations to safeguard end-users and adoption of a standard domestic legal agreement. - Investigate why hedge-fund-type arbitrageurs are not exploiting mispricing—identify potential hidden barriers to entry for unregulated entities. - Legal standardization: - BCCh should publish a version of the GMRA as the domestic standard for use in Chile by the time FMRA implementing regulation is promulgated. - Adaptations likely needed: change governing law from England to Chile, add Acts of Insolvency to GMRA lists, and choose between repurchase transaction and buy-/sellback depending on ability to make manufactured payments without legal or tax issues. *IMF Technical Assistance Report* ### 129. Amendments to the standard GMRA should be attached as an annex. Amendments to the ### 129. Amendments to the standard GMRA should be attached as an annex ### Legal amendments, market consultation, and capacity building - Amendments to the text of the standard agreement should be avoided; amendments should be attached as an annex. - The BCCh should consult legal counsel about necessary changes, possibly involving the firm commissioned by ICMA to produce the legal opinion on enforceability in Chile of the standard GMRA in cross-border transactions. - The BCCh should consult with the market to ensure the draft annex is acceptable; many banks have in-house legal experts familiar with the GMRA from cross-border trades. - For banks without such expertise and for customers, the BCCh should consider capacity-building measures: - Presentations by legal staff from experienced banks. - Provision of background information explaining the purpose and mechanics of the GMRA. - Background information for wider circulation might include clarifying statements about title transfer, the right to re-use collateral, and rights in default. ### Stay of enforcement in recovery and resolution - The stay of enforcement when a systemically important bank is being taken into the recovery and resolution process should be as short as possible. - The CMF should clarify its view on the duration of the stay of enforcement under the bank recovery and resolution rules, at least with respect to repos. - This period should be short, with two days being typical. ### Regulation — redrafting and clarifications - The CMF should redraft its regulations to clarify the treatment of repo transactions, including: - Counterparty risk weights: - Conditions applying under the Basel Simple Approach to lower counterparty risk weights in the calculation of regulatory capital requirements for repo should be clarified and communicated to the market, including with worked examples. - State whether the securities settlement system operated by the CSD (Deposito Central de Valores) has the status of a proven repo settlement system for the purpose of the regulatory capital calculation. - Loan loss provisioning: - It has been suggested there has been a transposition of the method of calculating regulatory limits on large exposures to loan loss provisioning. This needs to be confirmed and, if correct, rectified. ### Collateral rights and short selling - The authorities should explicitly clarify that collateral securities can be reused by repo buyers, including to sell short. - The right to sell short is the essential indicator of a transfer of title to collateral securities. - Authorities must be clear that this exercise of property rights is allowed, while noting: - Short-selling may require additional reporting. - Some institutions (e.g., money market funds) may be subject to short position limits for prudential reasons. ### Capital cost attribution and monitoring - It is essential that the reduced cost of capital is attributed down to the trading desk level. - Relief from regulatory capital requirements is a major driver of migration from unsecured money market transactions into repo. - The CMF should require and monitor trading profit and loss attribution in banks to ensure capital incentives to trade repo are realized. ### Reserve requirement base - All interbank transactions should be exempted from the reserve requirement’s reservable base. - All unsecured and secured (i.e., repo) transactions should be exempted because including them results in double counting of that portion of the deposit base and significantly distorts the costs of activity in the money markets. ### Taxation - The authorities should conduct an audit of the tax treatment of a repo across its lifecycle. - Tax obstacles have derailed attempts to establish active repo markets in many countries. - The BCCh and the CMF should open a dialogue with the tax authorities to: - Inform regarding the functioning of repo operations. - Agree on solutions where taxation could obstruct the use of repo. - The aim should be a neutral taxation framework that treats repo on the basis of its economic substance, not its legal structure, focusing on cashflows and not collateral. ### Accounting - Uncertainty around the accounting treatment of repo must be addressed; banks will not use an instrument for which they cannot account. - The BCCh and the CMF should engage an authoritative source to facilitate guidance to the market on both general principles and day-to-day accounting treatment. - Guidance should address specifics raised in BCCh discussions and its repo survey. - Banks already actively using repos could be engaged to help educate the rest of the market. ### Infrastructure and market plumbing - Post-trade infrastructures such as CCPs and triparty agents are premature at this stage; authorities should adopt a neutral attitude and allow infrastructure providers to make commercial decisions. - The BCCh could facilitate the market’s collective choice of trading infrastructure by: - Bringing in possible providers and moderating discussions with participants. - Promoting a low-cost dedicated electronic messaging system (i.e., chat line) to provide transparency (quotes), automate trade confirmation, reporting to the regulator, and provide the first stage in straight-through processing (STP) through to settlement. - Considering whether posting quotes would be voluntary or subject to some obligation and whether access is restricted to the interbank/interdealer market or includes wholesale customers. - Supplementing platform technology with voice brokers. - Undertaking a comprehensive cost/benefit analysis to avoid overinvestment and distraction from overambitious trading technology. ### Failed deliveries and settlement policy - A policy on failed deliveries should be developed to incentivize efficient settlement as market activity increases. - The BCCh should consider cash penalties calibrated to incentivize efficient settlement practices while not disincentivizing market-making. ### Repo market development strategy — leadership, reporting, and market forum - The BCCh should take the lead in addressing repo market development issues with other authorities (BCCh, MoF, CMF, SP, and SII), because of its price and financial stability mandates. - A senior official (a champion) could be tasked with leading an initiative with a clear strategic objective, milestones, and division of responsibilities. - A starting point could be a detailed scope covering legal, regulatory, tax, accounting, and infrastructure issues included in this report. - The BCCh should establish reporting requirements for repo transactions across the whole money market: - Granular reporting covering turnover, outstanding, and transaction-level data is needed for developmental and financial stability reasons. - Reporting should be automated where possible and limited to essential data at low frequency initially (at least monthly but perhaps starting weekly). - When automated, an expanded array of data can be submitted directly to the trade repository. - A forum of market participants should be formed (an association or permanent working group of repo dealers) to: - Exchange information on market developments. - Identify issues creating friction or disputes. - Formulate consensus solutions and develop conventions and best practices. - Represent the market in discussions with the authorities. - The BCCh should encourage formation of such a forum and may participate as an observer. *IMF Technical Assistance Report | excerpt* --- _Source: https://www.imf.org/-/media/files/publications/tar/2025/english/tarea2025048-print-pdf.pdf_