## 1. Summary of Chile FSAP Recommendation ## Source details **Canonical URL:** [1. Summary of Chile FSAP Recommendation](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04269.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04269.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04269.pdf.json) --- ### Overall assessment - Chile’s financial system is large and well diversified, with mandatory private pension funds (AFPs) driving growth across banks, life insurance, mortgage, commercial paper, and corporate bonds. - AFPs and insurance companies hold a substantial fraction of total bank deposits, public securities, corporate and mortgage bonds, and Chile’s external assets. - Other notable structural features: low dollarization, relatively long bond maturities, large corporate external liabilities, and large private assets abroad. - The equity market is large by Latin American standards but illiquid, reflecting a concentrated distribution of wealth and income. - The financial system was judged sound and resilient to shocks: - Banking system remained profitable and well capitalized despite a moderate increase in delinquent loans and a substantial contraction of credit, particularly to smaller enterprises. - Vulnerability to macroeconomic shocks, within a range consistent with recently observed volatilities, was found to be moderate. - Insurance sector requires caution: heightened competition, some under-provisioning of risks, and weaknesses in the resolution framework call for a road map to increase capital and shift to risk-based management and supervision. - Chile’s exposure to external shocks is reduced under the current policy environment (inflation targeting and floating exchange rate) and increasing international financial integration, though export concentration (copper) and potential capital account shocks remain risks. - To preserve BCCh’s capacity to implement effective monetary policy under diverse macroeconomic conditions, BCCh’s financial accounts need strengthening. ### Financial structure and macro environment - The financial sector is large, diversified, and increasingly integrated with the rest of the world; it is the largest (in assets to GDP) and among the deepest in the region. - The core of the system: banking sector and the mandatory, privately-administered pension system (AFPs). - The pension system (switch in 1981 to defined-contribution, fully-funded, privately managed individual accounts) created significant demand for investment assets and helped develop capital markets. - Together with life insurance companies, AFPs hold a substantial fraction of bank deposits, public sector debt securities, corporate and mortgage bonds, and increased external assets as AFPs were allowed rising foreign investment. - Projection: institutional investors will become larger than the banking sector in the next two decades, increasing their systemic importance. - High concentration and conglomeration: - The three largest banks account for 55 percent of bank assets. - The three largest AFPs manage 70 percent of pension fund assets. - A majority of financial institutions are controlled by a handful of financial conglomerates linking banking, securities, mutual and pension fund management, and insurance businesses. - One percent of firms account for 78 percent of sales by enterprises and absorb 79 percent of domestic bank financing and virtually all financing through the capital market. - Market development notes: - Domestic public debt market is moderate and mostly concentrated in instruments issued by the BCCh. - Corporate bond and mortgage markets have grown rapidly; commercial paper markets have grown from a lower base. - Mutual fund industry and the nonbank finance sector are growing but remain relatively small. - Structural features that limit liquidity: high concentration, small economy size, and shortfalls in market infrastructure. ### Market infrastructure and oversight — key findings - Secondary market liquidity lags comparable countries, particularly in equity and corporate debt markets. - Market infrastructure shortfalls identified: - Concepts central to securities clearance and settlement—finality, novation, netting—need firmer embedding in law. - A market for securities lending and borrowing should be organized. - Conditions for eventual introduction of multilateral netting arrangements should be established. - OTC price reporting and disclosure should be enhanced; valuation methods improved; contracts and instruments standardized. - Formalize system of market makers and review financial sector taxation. - Adopt international financial reporting standards for listed corporations after a well-designed transition period. - Oversight framework issues: - Segregation of supervisory responsibility by type of entity among three agencies has worked but shows increasing pitfalls as financial activities converge: gaps in market transparency and surveillance (especially OTC), shortcomings in cross-sectoral and systemic analysis, weaknesses in information systems, undue scope for regulatory arbitrage, and statutory obstacles to fully consolidated supervision of financial conglomerates. - Short-term focus: enhance cooperation among regulators, fill gaps in information/analysis/market surveillance, strengthen coordinating bodies with a permanent technical secretariat. - Medium-term focus: legal changes to support consolidated supervision; shift from rule-based to risk-based supervision; strengthen financial and legal autonomy of supervisory agencies; enhance accountability. ### Main FSAP recommendations — selected items and implementation status indicators - A. Central Bank - Strengthen BCCh’s financial accounts. (Short Term: X) - B. Commercial Banks - Further develop risk-based supervisory approach. (Short Term: X; Medium Term: X) - Clarify SBIF’s powers as regards licenses and expand ‘fit and proper’ tests. (Medium Term: X) - Impose capital requirements for market risk. (Short Term: X; Medium Term: X) - Improve disclosure of risk exposure & management practices by banks. (Short Term: X) - Strengthen bank resolution regime. (Medium Term: X) - C. Corporate Sector - Reform legislation for movable collateral. (Short Term: X) — Already in CMII: Yes - Create national register of pledges. (Short Term: X) — Already in CMII: Yes - Improve quality of SME financial statements. (Medium Term: X) - Eliminate ‘tasa máxima convencional’ or introduce more flexibility. (Medium Term: X) - D. Insurance - Upgrade provisioning requirements and strengthen supervision. (Short Term: X) - Strengthen insurance company failure resolution framework. (Short Term: X) — Already in CMII: Partially - Shift emphasis from rules management to risk management. (Short Term: X; Medium Term: X) - E. AFPs - Judiciously relax investment regime. (Short Term: X) - Move from compliance-based to risk-based supervision. (Short Term: X; Medium Term: X) - Encourage outsourcing and regulate service providers. (Short Term: X) - Enhance attractiveness of voluntary system. (Short Term: X) — Already in CMII: Partially - Develop contingent strategy to enhance competition. (Short Term: X) - Reduce risks faced by workers at retirement. (Short Term: X) - F. Securities Markets - Embed concepts of finality, netting, and novation in the law. (Short Term: X) — Already in CMII: Partially - Promote industry-financed fund for multilateral netting. (Short Term: X; Medium Term: X) - Organize securities lending and borrowing. (Short Term: X) - Establish price reporting for OTC trades and harmonize securities valuation. (Short Term: X) - Introduce international standard contract for repos and derivatives. (Short Term: X) - Enhance standardization of financial instruments. (Short Term: X) - Suitably formalize market-makers for public debt. (Short Term: X) - Increase SVS’s budgetary and staff resources. (Short Term: X) - Introduce minimum standards for securities industry. (Short Term: X) - Require internal compliance programs by brokerage firms. (Short Term: X) - Widen SVS enforcement powers. (Short Term: X) — Already in CMII: Partially - Give SVS power to appoint a conservator or liquidator for brokerage firms. (Short Term: X) - Implement risk based supervision. (Short Term: X; Medium Term: X) - G. Taxation, Financial Reporting Standards, Corporate Governance - Review financial sector taxation. (Short Term: X; Medium Term: X) — Partially - Strengthen financial reporting regime for listed companies. (Short Term: X) - Enhance corporate governance, including training of directors and judges. (Short Term: X) - H. Hedges - Correct deficiencies in information and market infrastructure. (Short Term: X; Medium Term: X) - Relax restrictions on short selling, writing and trading. (Short Term: X) - I. Other Financing Vehicles - Support development of “bridging” vehicles. (Short Term: X) — Already in CMII: Partially - J. Cross-Sectoral Financial Oversight - Embed Committee of Superintendents in the law. (Short Term: X) — Already in CMII: Yes - Establish MOUs and technical secretariat for coordinating committees. (Short Term: X) - Introduce regular staff exchanges. (Short Term: X) - Introduce fully consolidated supervision and relax firewalls. (Short Term: X) - Resolve conflicts of competence and draw contingency plans for failure of financial conglomerates. (Short Term: X; Medium Term: X) - Strengthen the information system. (Short Term: X) - Clarify and strengthen legal protection of supervisors. (Short Term: X) - Allow supervisors control over budget with appropriate accountability. (Short Term: X) - Disconnect timing of Superintendents’ appointments from political cycle. (Short Term: X) - K. Anti-Money Laundering - Strengthen capacity to monitor compliance. (Short Term: X) - Enhance monitoring of securities, insurance, and FX operators. (Short Term: X) - Improve mutual assistance and international cooperation in freezing assets. (Short Term: X) ### Selected statistics and structural numbers - The three largest banks account for 55 percent of bank assets. - The three largest AFPs manage 70 percent of pension fund assets. - One percent of firms account for 78 percent of sales by enterprises and absorb 79 percent of domestic bank financing and virtually all financing through the capital market. - Chile: National Balance Sheet totals (Dec-2003 unless otherwise specified): Total assets/ liabilities aggregate line: 19.7 170.0 44.6 86.9 71.8 67.8 2.1 2.0 465.0 (source tables: BCCh, SBIF, SAFP, SVS, IFS and staff calculations). - The pension sector is among the largest in the world; only 8 OECD countries have comparable pension assets. - Concentration of financial institutions belonging to financial conglomerates (2003): Banking 98 percent, Securities 91 percent, Insurance 40 percent, Pensions 98 percent. ### BCCh financial accounts, profits, and recommended actions - BCCh Summary Balance Sheet, End 2003 (In billions of US dollars) - Liabilities: - Monetary base 3.0 - Currency (2.0) - Bank Reserves (1.0) - BCCh debt 23.0 - Capital -3.0 - Total 23.0 - Assets: - International Reserves 18.0 - BCCh claims on government 5.0 - Total 23.0 - BCCh Structural Income Statement (In millions of US dollars) - Revenues: - Inflation tax on monetary base (3% inflation) 3 x 0.03 90 - Expenditures: - Carrying cost of NIR (140 basis points) 1/ 16 x 0.0014 224 - Carrying cost of claims on government (190 basis points) 2/ 5 x 0.0019 95 - Operating expenditures 50 - Changes in real net worth: -274 - Memorandum item: - Net losses as a fraction of GDP -274/73,000 -0.37 - Footnotes: 1/ Calculated as Chile’s country risk (90 basis points as of Chile EMBIG’s spread of March 4, 2004) plus a premium for currency risk and the duration mismatch between debt and international reserves (50 basis points). 2/ Calculated as the country risk plus the excess average yield of international reserves during 2003 over the yield of BCCh’s claims on government during the same period (Libor plus 50 basis points). - With the current low inflation target, the inflation tax on the money base does not cover the BCCh’s operating expenditures and the carrying cost of its debt-financed foreign and domestic assets. - Options to improve profitability and financial strength: - downsizing the balance sheet (in particular, the carrying cost of claims on government will disappear once this debt is repaid) — but scope is limited by the need to maintain minimum international reserves and domestic public debt; - recapitalizing the BCCh and preferably transferring at least some of its debt to the government. ### Banking system — structure, soundness, and resolution - Total assets of the banking system: US$ 68 billion at end-2003, equivalent to 96 percent of GDP. - Capitalization: the capital ratio exceeds 14 percent. - Asset quality: ratio of nonperforming loans to total loans is 2 percent. - Profitability: historically high; driven by comfortable interest margins and low (albeit rising) fee incomes. - Resilience: stress tests indicate the banking system would only be moderately affected by further shocks affecting market risk or credit risk. - Number of banks: 26 at end-2003 (down from 40 in 1992). - Ownership: - Nineteen banks are privately owned. - One bank (the third largest) is state-owned. - Six banks (40 percent of system assets) are majority owned or controlled by foreign banks. - Safety net and bank resolution: - Current scheme: based on a “narrow banking” concept; untested. - Sight deposits (and term deposits of less than 30 days or whose term to maturity is less than 10 days) are fully guaranteed by the BCCh which requires banks to hold central bank securities against sight deposits in excess of 2.5 times their capital. - If a bank fails, non-sight liabilities are frozen while sight deposits remain fully accessible. - Gaps identified: no current legal provision for rapid transfer of assets and liabilities to a sound financial institution; state cannot transitorily assume bank ownership nor can SBIF grant temporary license to a bridge bank. ### Corporate sector, SME finance, and governance - Corporate leverage: average leverage ratio at end-2003 was 1.3. - Profitability: except in mining and services, return on equity was significantly below estimated cost of capital. - SME finance: - Banks have increased lending to SMEs through leasing and factoring, but room remains to further improve access to finance. - Limited access of firms to local bond market due to high minimum issue size and high issuance fees (stamp tax noted). - Recommendations: - Unify legislation on movable collateral and create a single registry for pledges. - Improve quality of SME financial statements. - Make the ceiling on lending rates (tasa máxima convencional) more flexible. - Consider revenue neutral tax reform that eliminates the stamp tax (or exempts smaller customers). - Strengthen corporate governance: upgrade accounting and auditing system; clarify definitions and improve corporate disclosure of related party transactions; establish clearer standards for appointing directors. ### Insurance sector — vulnerabilities and road map - Size and composition: - 57 companies (domestic and international). - Assets grew to 19 percent of GDP in 2002, up from 7.5 percent in 1992. - Industry dominated by life insurance: 62 percent of total premiums. - Key vulnerabilities: - Under-provisioning of risks; provisions need to be increased to reflect updated mortality tables and other risks. - A major part of the sector could fall below minimum capital requirement once necessary provisioning is made. - Potential government exposure: underprovisioning could expose the government to significant losses (about one percent of GDP), given its annuity performance guarantee. - Road map and supervisory improvements: - Phase-in increases in provisions and changes to regulatory requirements. - Strengthen off-site analysis, develop early warning systems, risk-focused capital assessments. - Strengthen on-site reviews and ensure contagion risks within conglomerates are contained. ### AFPs (pension funds) — holdings, constraints, and recommendations - AFP holdings and market role: - AFPs hold 40 percent of government bonds, 50 percent of mortgage bonds, 38 percent of corporate bonds, and 35 percent of time deposits. - Number of AFPs: 6 at end-2003 (down from 21 in 1994). - Historical returns: real rates of return 7 percent per annum since 1981. - Returns on equity averaged 30 percent in recent years. - Portfolio composition (Chile, 2003): - Cash and Deposits: 15.0 percent - Bills and Bonds: 45.6 percent - Loans: 0.0 percent - Shares: 37.8 percent - Other: 1.6 percent - Foreign Assets/GDP: 23.8 percent - Structural constraints and investment regime issues: - AFPs hold a relatively high level of low-yield, short-term assets, mainly bank certificates of deposits. - Small share of domestic equity; narrow range of equity holdings (90 corporations out of more than 200 listed companies). - Investment regime is overly complex and restrictive with multiplicity of limits and sub-limits and “specific reducing factors” on issuers. - Recommendations: - Preserve main ceilings on major instruments but remove most sub-limits and “specific reducing factors.” - Streamline approval process for eligible investments; permit investment in all listed equities except for a reasonable negative list; allow marginal holdings of below-grade corporate bonds. - Shift from compliance-based to risk-based supervision; require a compliance officer in each AFP reporting directly to the AFP Board. - Allow more instruments to hedge risk (such as currency swaps); increase ceilings on individual foreign shares and mutual funds; permit fees on foreign mutual funds to be netted from gross returns. - Encourage outsourcing of administrative services while regulating service providers. ### Pension reform options and retirement risk management - If gradual reforms fall short, a more radical reform could be introduced later: - Unbundle pension-related services that are subject to economies of scale from asset management. - Introduce a blind quotation system for asset managers as an alternative. - Introduce a long-duration fund and allow workers to purchase fixed annuities gradually in the years before retirement to reduce interest rate risk at retirement. - Note: "The experience of Sweden and its recent adaptation to Latvia is illustrative. Risks of excessive entries could be mitigated through proper licensing criteria." ### Securities markets, derivatives, and market infrastructure - Findings on market structure and liquidity: - "While Chilean securities markets are large, their liquidity remains limited." - Secondary market liquidity lags that in comparable emerging market countries, particularly in corporate paper, mortgages, and equity markets. - Equity market illiquidity reflects concentrated supply and concentrated demand at six AFPs which mostly "buy and hold." - Clearing, settlement, and legal foundations: - Legal voids affecting clearing and settlement need to be filled. - BCCh introduction of a real-time gross-settlement payments system and move toward dematerialization expected to improve transparency and safety. - Legal recommendations: embed finality, netting, and novation in law; introduce netting in bankruptcy code to facilitate future multilateral netting and a central clearing counterparty. - Market trading, valuation, and contract standardization: - Introduce standard contract for repos and possibly an omnibus master agreement for repo and derivatives. - Promote securities lending and borrowing; consider formalization of market making. - Enhance OTC price reporting and harmonize valuation methodologies. - Derivatives and hedging: - Domestic market for nondeliverable foreign-exchange forwards (NDFs) is deep and liquid. - No active interest rate derivatives market; absence of equity derivatives and options. - Recommendations: cautiously relax restrictions (e.g., allow banks to write options after appropriate capital charges and supervisory capacity in place); later extend to AFPs and insurance companies; improve market infrastructure, data, tax and accounting treatment, standardization, and training. - Caution: liquidity limitations of underlying markets increase risks of derivatives; prudent sequencing necessary. ### Cross-sectoral oversight, supervisory structure, and AML/CFT - Supervisory architecture: - Segmented (“silo”) approach with strong firewalls and informal coordination; coordination bodies lack legal basis. - Risks from segmentation: gaps in market transparency (OTC), regulatory arbitrage, statutory obstacles to consolidated supervision of financial conglomerates. - Short-term reforms: - Formalize MOUs, define roles of coordinating bodies, create small permanent technical secretariat, boost analytical capacity, institute staff exchanges. - Medium-term legal reforms: - Define financial conglomerate, financial holding company, and lead regulator in law; establish consolidated supervision alongside relaxation of some firewalls with ring-fencing. - Enhance autonomy and legal protection of supervisors with matching accountability. - Anti-money laundering: - Recent law created a Financial Intelligence Unit (FIU); subsequent Constitutional Court rulings eliminated FIU’s sanctioning powers, limited its discretion in requesting data, and denied access to bank secrecy and other public databases, undermining investigations and international cooperation. - Monitoring of compliance by securities firms, insurance companies, and foreign exchange retail operators needs improvement. ### Regulatory and supervisory recommendations (banking, securities, and insurance) - Banking (selected): - Speed up introduction of market risk capital charges; transition to risk-based supervision; expand consolidated supervision; strengthen SBIF independence and legal protections; extend fit and proper tests. - Securities (selected): - Provide SVS with powers to intervene, appoint receivers/administrators, suspend individuals, finalize disciplinary actions via negotiated settlement, and appoint conservator or liquidator for failing brokerage firms. - Increase SVS staffing and budget; introduce minimum professional standards and internal compliance programs; improve OTC market transparency and settlement; create industry-wide guarantee fund for settlements. - Insurance (selected): - Phase-in higher provisioning, strengthen supervision, improve resolution tools, and prevent spillovers from weak insurers within conglomerates. ### Key macroeconomic and financial statistics (selected figures) - Real GDP growth (percent, selected years): 1997 = 6.6; 1998 = 3.2; 1999 = -0.8; 2000 = 4.2; 2001 = 3.1; 2002 = 2.2; 2003 = 3.2. - Consumer price index (e.o.p.) change: 1997 = 4.7; 1998 = 2.3; 1999 = 4.5; 2000 = 2.6; 2001 = 2.8; 2002 = 3.3. - Total assets of banking system: US$ 68 billion at end-2003 (equivalent to 96 percent of GDP). - Regulatory capital to risk-weighted assets: Dec-98 = 12.5; Dec-99 = 13.5; Dec-00 = 13.3; Dec-01 = 12.7; Dec-02 = 14.0; Sep-03 = 14.5. - NPLs to gross loans: Dec-97 = 1.2; Dec-98 = 1.6; Dec-99 = 1.8; Dec-00 = 1.9; Dec-01 = 1.8; Dec-02 = 2.0; Sep-03 = 2.0. - Pension fund portfolio (Chile, 2003): Cash and Deposits 15.0 percent; Bills and Bonds 45.6 percent; Loans 0.0 percent; Shares 37.8 percent; Other 1.6 percent; Foreign Assets/GDP 23.8 percent. - Export concentration: copper accounting for 36 percent of total exports in the last four years. - Stress-test scenario (10% decrease in TOT) — BCCh macro model implied increases in: (i) short term nom. rate of 180 bp.; (ii) short term real rate of 35 bp.; (iii) long term nom. rate of 160 bp.; (iv) long term real rate of 11 bp.; (v) and unemployment of .4 percentage points + 8.4% depreciation and a decrease in GDP of 1.1 percentage points. - BCCh Structural Income Statement change in real net worth: -274 (millions of US dollars); Memorandum: Net losses as a fraction of GDP -274/73,000 -0.37. *Source: 1. Summary of Chile FSAP Recommendation (IMF FSAP document).* ### 1. Summary of Chile FSAP Recommendation ..........................................................................6 ### 1. Summary of Chile FSAP Recommendation ### Overall assessment - Chile’s financial system is large and well diversified, with mandatory private pension funds (AFPs) driving growth across banks, life insurance, mortgage, commercial paper, and corporate bonds. - AFPs and insurance companies hold a substantial fraction of total bank deposits, public securities, corporate and mortgage bonds, and Chile’s external assets. - Other notable structural features: low dollarization, relatively long bond maturities, large corporate external liabilities, and large private assets abroad. - The equity market is large by Latin American standards but illiquid, reflecting a concentrated distribution of wealth and income. - The financial system was found to be sound and resilient to shocks: - Banking system remained profitable and well capitalized despite a moderate increase in delinquent loans and a substantial contraction of credit, particularly to smaller enterprises. - Vulnerability to macroeconomic shocks, within a range consistent with recently observed volatilities, was found to be moderate. - Insurance sector requires caution: heightened competition, some under-provisioning of risks, and weaknesses in the resolution framework call for a road map to increase capital and shift to risk-based management and supervision. - Chile’s exposure to external shocks is reduced under the current policy environment (inflation targeting and floating exchange rate) and increasing international financial integration, though export concentration (copper) and potential capital account shocks remain risks. - To preserve BCCh’s capacity to implement effective monetary policy under diverse macroeconomic conditions, BCCh’s financial accounts need strengthening. ### Financial structure and macro environment - The financial sector is large, diversified, and increasingly integrated with the rest of the world; it is the largest (in assets to GDP) and among the deepest in the region. - The core of the system: banking sector and the mandatory, privately-administered pension system (AFPs). - The pension system (switch in 1981 to defined-contribution, fully-funded, privately managed individual accounts) created significant demand for investment assets and helped develop capital markets. - Together with life insurance companies, AFPs hold a substantial fraction of bank deposits, public sector debt securities, corporate and mortgage bonds, and increased external assets as AFPs were allowed rising foreign investment. - Projection: institutional investors will become larger than the banking sector in the next two decades, increasing their systemic importance. - High concentration and conglomeration: - The three largest banks account for 55 percent of bank assets. - The three largest AFPs manage 70 percent of pension fund assets. - A majority of financial institutions are controlled by a handful of financial conglomerates linking banking, securities, mutual and pension fund management, and insurance businesses. - One percent of firms account for 78 percent of sales by enterprises and absorb 79 percent of domestic bank financing and virtually all financing through the capital market. - Market development notes: - Domestic public debt market is moderate and mostly concentrated in instruments issued by the BCCh. - Corporate bond and mortgage markets have grown rapidly; commercial paper markets have grown from a lower base. - Mutual fund industry and the nonbank finance sector are growing but remain relatively small. - Structural features that limit liquidity: high concentration, small economy size, and shortfalls in market infrastructure. ### Key findings on market infrastructure and oversight - Secondary market liquidity lags comparable countries, particularly in equity and corporate debt markets. - Market infrastructure shortfalls identified: - Concepts central to securities clearance and settlement—finality, novation, netting—need firmer embedding in law. - A market for securities lending and borrowing should be organized. - Conditions for eventual introduction of multilateral netting arrangements should be established. - OTC price reporting and disclosure should be enhanced; valuation methods improved; contracts and instruments standardized. - Formalize system of market makers and review financial sector taxation. - Adopt international financial reporting standards for listed corporations after a well-designed transition period. - Oversight framework issues: - Segregation of supervisory responsibility by type of entity among three agencies has worked but shows increasing pitfalls as financial activities converge: gaps in market transparency and surveillance (especially OTC), shortcomings in cross-sectoral and systemic analysis, weaknesses in information systems, undue scope for regulatory arbitrage, and statutory obstacles to fully consolidated supervision of financial conglomerates. - Short-term focus: enhance cooperation among regulators, fill gaps in information/analysis/market surveillance, strengthen coordinating bodies with a permanent technical secretariat. - Medium-term focus: legal changes to support consolidated supervision; shift from rule-based to risk-based supervision; strengthen financial and legal autonomy of supervisory agencies; enhance accountability. ### Main FSAP recommendations (Box 1) — selected items and implementation status indicators - A. Central Bank - Strengthen BCCh’s financial accounts. (Short Term: X) - B. Commercial Banks - Further develop risk-based supervisory approach. (Short Term: X; Medium Term: X) - Clarify SBIF’s powers as regards licenses and expand ‘fit and proper’ tests. (Medium Term: X) - Impose capital requirements for market risk. (Short Term: X; Medium Term: X) - Improve disclosure of risk exposure & management practices by banks. (Short Term: X) - Strengthen bank resolution regime. (Medium Term: X) - C. Corporate Sector - Reform legislation for movable collateral. (Short Term: X) — Already in CMII: Yes - Create national register of pledges. (Short Term: X) — Already in CMII: Yes - Improve quality of SME financial statements. (Medium Term: X) - Eliminate ‘tasa máxima convencional’ or introduce more flexibility. (Medium Term: X) - D. Insurance - Upgrade provisioning requirements and strengthen supervision. (Short Term: X) - Strengthen insurance company failure resolution framework. (Short Term: X) — Already in CMII: Partially - Shift emphasis from rules management to risk management. (Short Term: X; Medium Term: X) - E. AFPs - Judiciously relax investment regime. (Short Term: X) - Move from compliance-based to risk-based supervision. (Short Term: X; Medium Term: X) - Encourage outsourcing and regulate service providers. (Short Term: X) - Enhance attractiveness of voluntary system. (Short Term: X) — Already in CMII: Partially - Develop contingent strategy to enhance competition. (Short Term: X) - Reduce risks faced by workers at retirement. (Short Term: X) - F. Securities Markets - Embed concepts of finality, netting, and novation in the law. (Short Term: X) — Already in CMII: Partially - Promote industry-financed fund for multilateral netting. (Short Term: X; Medium Term: X) - Organize securities lending and borrowing. (Short Term: X) - Establish price reporting for OTC trades and harmonize securities valuation. (Short Term: X) - Introduce international standard contract for repos and derivatives. (Short Term: X) - Enhance standardization of financial instruments. (Short Term: X) - Suitably formalize market-makers for public debt. (Short Term: X) - Increase SVS’s budgetary and staff resources. (Short Term: X) - Introduce minimum standards for securities industry. (Short Term: X) - Require internal compliance programs by brokerage firms. (Short Term: X) - Widen SVS enforcement powers. (Short Term: X) — Already in CMII: Partially - Give SVS power to appoint a conservator or liquidator for brokerage firms. (Short Term: X) - Implement risk based supervision. (Short Term: X; Medium Term: X) - G. Taxation, Financial Reporting Standards, Corporate Governance - Review financial sector taxation. (Short Term: X; Medium Term: X) — Partially - Strengthen financial reporting regime for listed companies. (Short Term: X) - Enhance corporate governance, including training of directors and judges. (Short Term: X) - H. Hedges - Correct deficiencies in information and market infrastructure. (Short Term: X; Medium Term: X) - Relax restrictions on short selling, writing and trading. (Short Term: X) - I. Other Financing Vehicles - Support development of “bridging” vehicles. (Short Term: X) — Already in CMII: Partially - J. Cross-Sectoral Financial Oversight - Embed Committee of Superintendents in the law. (Short Term: X) — Already in CMII: Yes - Establish MOUs and technical secretariat for coordinating committees. (Short Term: X) - Introduce regular staff exchanges. (Short Term: X) - Introduce fully consolidated supervision and relax firewalls. (Short Term: X) - Resolve conflicts of competence and draw contingency plans for failure of financial conglomerates. (Short Term: X; Medium Term: X) - Strengthen the information system. (Short Term: X) - Clarify and strengthen legal protection of supervisors. (Short Term: X) - Allow supervisors control over budget with appropriate accountability. (Short Term: X) - Disconnect timing of Superintendents’ appointments from political cycle. (Short Term: X) - K. Anti-Money Laundering - Strengthen capacity to monitor compliance. (Short Term: X) - Enhance monitoring of securities, insurance, and FX operators. (Short Term: X) - Improve mutual assistance and international cooperation in freezing assets. (Short Term: X) ### Selected statistics and structural numbers (as reported) - The three largest banks account for 55 percent of bank assets. - The three largest AFPs manage 70 percent of pension fund assets. - One percent of firms account for 78 percent of sales by enterprises and absorb 79 percent of domestic bank financing and virtually all financing through the capital market. - Chile: National Balance Sheet totals (Dec-2003 unless otherwise specified): Total assets/ liabilities aggregate line: 19.7 170.0 44.6 86.9 71.8 67.8 2.1 2.0 465.0 (source tables: BCCh, SBIF, SAFP, SVS, IFS and staff calculations). - The pension sector is among the largest in the world; only 8 OECD countries have comparable pension assets. - Household and corporate savings composition notes: household savings excluding mandatory pension contributions are small; corporate savings account for a large part of private savings. - Concentration of financial institutions belonging to financial conglomerates (2003): Banking 98 percent, Securities 91 percent, Insurance 40 percent, Pensions 98 percent (detailed breakdowns by foreign, pure domestic, and mixed domestic groups reported). *Source: 1. Summary of Chile FSAP Recommendation (IMF FSAP document).* ### 12. Chile’s strong ### 12. Chile’s strong ### Macroeconomic performance - Boosted by strong productivity gains, average annual real GDP growth rates exceeded 5 percent during 1990-2003, resulting in a doubling of per capita income. - Policy anchors and reforms supporting performance: - steady monetary stabilization to low single digit inflation rates; - long record of prudent fiscal management (consolidated into a structural fiscal balance target rule in 2000); - comprehensive and far reaching program of structural reforms, including the pension reform. - Institutional environment: Chile ranked in the 9th decile in the 2000/2001 index of the “rule of law” (Kaufmann et al., 2002), placing it well above the regional average in reliability and security of the rule of law and property rights. ### Financial sector development and reforms - Key initiatives in the financial area: - consistent promotion of price-indexed financial instruments, which, together with the build up of monetary policy credibility, resulted in a low level of dollarization; - introduction of comprehensive capital market reforms (the 2001 Capital Markets I law, followed by the draft CMII law); - recent review of monetary and public debt management practices (which “nominalized” the conduct of monetary policy and rationalized the issuance of public debt instruments). - Financial integration and market development: - rapid expansion in financial integration in recent years, reflecting in part the strong increase in AFPs’ foreign assets and the 1998 liberalization of the capital account. - Correlation of stock market indices rose from 0.36 before 1998 to 0.58 after 1998, consistent with increased financial integration. ### External vulnerabilities and historical episode (late 1990s) - Despite sound macro framework, Chile was affected by regional financial turmoil in the late 1990s: - rapid output growth in the 1990s accompanied by substantial current account deficits as domestic saving rates remained moderate; - dependence on foreign savings increased vulnerability to international and regional turbulences; - output and credit growth decelerated sharply as the current account deficit swung from a large deficit into a small surplus; contraction of credit particularly strong for smaller enterprises. - Recovery drivers: - favorable external environment; - notable strengthening of copper prices; - supportive monetary policy; - output growth expected to reach around 5 percent in 2004. ### Export concentration and terms-of-trade risk - Export concentration remains high: copper accounting for 36 percent of total exports in the last four years. - Mitigants: - Copper Stabilization Fund (CSF) and structural fiscal balance rule should help mitigate fiscal impact of terms of trade shocks. - Risk transmission channels: - investment, the exchange rate, and capital inflows could remain sensitive to changes in copper prices, contributing to macroeconomic volatility and potential banking system vulnerabilities. - Stress-test finding: - a 10 percent adverse terms of trade shock would have only a marginal impact on banks’ solvency, but could produce liquidity tensions if it induces AFPs and other large depositors to reallocate deposits across banks. ### Stress tests for market and credit risk (summary points from staff estimates) - Exchange rate scenarios: - 25% depreciation, direct effect; - 25% depreciation, direct and indirect effect (includes impact on banks' credit quality); - 7% appreciation, direct effect. - Interest rate scenarios: - Parallel decrease, domestic 160 bp., USD rate 100 bp.; - Parallel increase, domestic 160 bp., USD rate 100 bp.; - Increase and shift in yield curve. - Credit quality scenarios: - Increase in provisions equal to that during 1998; - 5% reduction in firms' operating margin. - Scenario analysis: 10% decrease in TOT (terms of trade) — shocks determined by BCCh's macro model include increases in: (i) short term nom. rate of 180 bp.; (ii) short term real rate of 35 bp.; (iii) long term nom. rate of 160 bp.; (iv) long term real rate of 11 bp.; (v) and unemployment of .4 percentage points + 8.4% depreciation and a decrease in GDP of 1.1 percentage points. - Outcome metric: Banks with CAR <8% / Banks with CAR <10, >8% (table headings provided in source). ### Currency risk and corporates - Banks’ direct exposure to currency risk is negligible due to small open positions. - Corporates have materially increased foreign exchange hedges; about 40 percent of corporate foreign debt is estimated to be currently hedged. - Nearly 60 percent of corporate debt is denominated in US dollars. Among the 50 firms with the largest currency exposure (accounting for 89 percent of total US dollar debt and 64 percent of corporate debt to domestic banks), several would incur debt servicing difficulties under a one-year real exchange rate depreciation of 25 percent; the number of firms in difficulty could increase if depreciation is compounded by adverse changes in other macro variables. ### Capital account exposure and resilience - Chile’s exposure to capital account shocks cannot be dismissed, but vulnerability is diminished under the current monetary policy environment: - full-fledged inflation targeting; - floating exchange rate; - strong fiscal rule. - The 1998-1999 current account reversal was largely exacerbated by domestic portfolio reshuffling following liberalization of the capital account and elimination of the foreign exchange band, rather than a loss of access to international capital markets. - Rising financial integration should increase resilience to sudden stops. ### BCCh (Central Bank) financial accounts and balance sheet (end-2003 figures) - BCCh Summary Balance Sheet, End 2003 (In billions of US dollars) - Liabilities: - Monetary base 3.0 - Currency (2.0) - Bank Reserves (1.0) - BCCh debt 23.0 - Capital -3.0 - Total 23.0 - Assets: - International Reserves 18.0 - BCCh claims on government 5.0 - Total 23.0 - BCCh Structural Income Statement (In millions of US dollars) - Revenues: - Inflation tax on monetary base (3% inflation) 3 x 0.03 90 - Expenditures: - Carrying cost of NIR (140 basis points) 1/ 16 x 0.0014 224 - Carrying cost of claims on government (190 basis points) 2/ 5 x 0.0019 95 - Operating expenditures 50 - Changes in real net worth: -274 - Memorandum item: - Net losses as a fraction of GDP -274/73,000 -0.37 - Footnotes: 1/ Calculated as Chile’s country risk (90 basis points as of Chile EMBIG’s spread of March 4, 2004) plus a premium for currency risk and the duration mismatch between debt and international reserves (50 basis points). 2/ Calculated as the country risk plus the excess average yield of international reserves during 2003 over the yield of BCCh’s claims on government during the same period (Libor plus 50 basis points). ### BCCh financial-account weaknesses and recommended actions - With the current low inflation target, the inflation tax on the money base does not cover the BCCh’s operating expenditures and the carrying cost of its debt-financed foreign and domestic assets. - The central bank’s weak financial accounts could constrain the implementation of monetary policy. - Options to improve profitability and financial strength: - downsizing the balance sheet (in particular, the carrying cost of claims on government will disappear once this debt is repaid) — but scope is limited by the need to maintain minimum international reserves and domestic public debt; - recapitalizing the BCCh and preferably transferring at least some of its debt to the government. *Italic: Source: _cr04269 - 12. Chile’s strong (IMF staff text provided).* ### 19. The Chilean banking system is financially strong, well regulated and ### _cr04269 - 19. The Chilean banking system is financially strong, well regulated and ### Banking system: structure, size, and soundness - Total assets of the banking system: US$ 68 billion at end-2003, equivalent to 96 percent of GDP. - Capitalization: the capital ratio exceeds 14 percent. - Asset quality: ratio of nonperforming loans to total loans is 2 percent. - Profitability: historically high; driven by comfortable interest margins and low (albeit rising) fee incomes. - Resilience: stress tests indicate the banking system would only be moderately affected by further shocks affecting market risk or credit risk. - Operating efficiency: good by regional standards but lags the fastest growing emerging economies. ### Market structure and concentration - Number of banks: 26 at end-2003 (down from 40 in 1992). - Ownership: - Nineteen banks are privately owned. - One bank (the third largest) is state-owned. - Six banks (40 percent of system assets) are majority owned or controlled by foreign banks. - Consolidation drivers: legacy of the 1982-83 banking crisis and a wave of recent mergers; later niche entrants following a lowering of minimum capital requirements in 2001. - Concentration: measured by market share of the three or five largest banks, concentration is high. ### Competition and market segments - Competition trends: - Increasing due to new entrants, foreign bank participation, and local capital market development. - Intense competition for financing very large corporations and in consumer credit (including entry of three department stores into banking). - Limited competition remains: - Middle segment (SMEs) faces limited access to alternative funding and direct institutional investor funding. - Almost no competition in credit markets from nondeposit taking finance institutions until recently. - Limited competition from investment and mutual funds; fastest growing nonbank segments (leasing and factoring) are owned by or integrating into banking groups. - Barriers to entry: exist notably in retail payment services. - Wholesale deposit market: dominated by large, risk averse institutional investors (AFP funding), which may impart conservative bias and favor reputable, well-rated intermediaries. ### Supervision and regulatory framework - Regulatory responsibilities: shared between BCCh and SBIF; supervision entrusted solely to SBIF. - Supervisory strengths: robust, well established, good technical skills and integrity. - Supervisory evolution: moving from compliance-driven to risk-based supervision to give banks more room to manage risks and compete while increasing responsibility of directors and management. - Adaptation needs: - Transition to risk-based supervision increases need for strong analytical and information processing capabilities. - Strengthen and clarify SBIF independence, provided matched with adequate accountability. - Replace risk-specific regulations with a broader capital charge for market risk. - Expand consolidated supervision beyond banks and their subsidiaries. - Extend fit and proper tests to banks’ directors and senior management. - Strengthen banks’ credit risk management practices and disclosure of risk exposures, particularly regarding derivatives and securitization. ### Safety net and bank resolution - Current scheme: based on a “narrow banking” concept; untested. - Design features: - Sight deposits (and term deposits of less than 30 days or whose term to maturity is less than 10 days) are fully guaranteed by the BCCh which requires banks to hold central bank securities against sight deposits in excess of 2.5 times their capital. - If a bank fails, non-sight liabilities are frozen while sight deposits remain fully accessible. - Advantages: good supervision, effective early warning and prompt remedial action; dominance of large institutional depositors could expedite resolution with limited losses if large creditors remain. - Limitations and risks: - Obtaining backing of a majority of creditors needed for resolving a bank could be lengthy if largest creditors have already left. - No current legal provision for rapid transfer of assets and liabilities to a sound financial institution (would entail de facto differential treatment of creditors). - State cannot transitorily assume bank ownership nor can SBIF grant temporary license to a bridge bank. - These options/tools could be usefully integrated into the legal framework to address "too big to fail" and contagion concerns. ### Corporate sector: leverage, profitability, and SME finance - Corporate leverage: average leverage ratio at end-2003 was 1.3 (low), resulting in high debt servicing capacity. - Profitability: except in mining and services, return on equity was significantly below estimated cost of capital; firms’ depressed profitability partly reflects the post-1998 economic slowdown and may have discouraged equity issuance. - SME finance: - Banks have increased lending to SMEs through leasing and factoring, but room remains to further improve access to finance. - Even relatively large firms have limited access to local bond market due to large minimum issue size required to attract AFP investment and cover issue fees. - High issuance fees partly because of the stamp tax. - Recommendations to improve SME access: - Unify legislation on movable collateral and create a single registry for pledges. - Improve quality of SME financial statements. - Make the ceiling on lending rates (tasa máxima convencional) more flexible. - Consider a revenue neutral tax reform that eliminates the stamp tax (or exempts smaller customers) to reduce borrowing costs, especially for smaller firms. - Strengthen corporate governance framework: upgrade accounting and auditing system; clarify definitions and improve corporate disclosure of related party transactions; establish clearer standards for appointing directors. ### Insurance sector: size, provisioning, competition, and resolution - Size and composition: - 57 companies (domestic and international). - Assets grew to 19 percent of GDP in 2002, up from 7.5 percent in 1992. - Industry dominated by life insurance: 62 percent of total premiums (regional average 38 percent). - Annuities dominant for retirees, partly due to availability of inflation-indexed bonds. - Key vulnerabilities: - Under-provisioning of risks; provisions need to be increased to reflect updated mortality tables, allowance for future improvements in life expectancy, and to fully incorporate credit and prepayment risks. - A major part of the sector could fall below minimum capital requirement once necessary provisioning is made. - Potential government exposure: underprovisioning could expose the government to significant losses (about one percent of GDP), given its annuity performance guarantee. - Competition expected to increase due to legal changes allowing banks to distribute insurance products and tightened conditions for early retirement (creating a temporary dip in annuity sales). - Low average returns on equity, aggressive pricing, and large number of players imply need for consolidation. - Resolution framework weaknesses: the 2003 failure of the Inverlink group highlighted need for tools to facilitate orderly transfer of obligations and dealing with asset deficiencies. - Road map and supervisory improvements: - Carefully phase-in increases in provisions and changes to regulatory requirements. - Strengthen off-site analysis (monitor market values and pricing, develop early warning systems, risk-focused capital assessments). - Strengthen on-site reviews to understand companies’ management and strategies. - Ensure weak financial situation of insurance companies within financial conglomerates does not spill over to other group members, particularly banks. ### Pension funds (AFPs): role, portfolio composition, and regulatory suggestions - Market role and holdings: - AFPs are dominant institutional investors: hold 40 percent of government bonds, 50 percent of mortgage bonds, 38 percent of corporate bonds, and 35 percent of time deposits. - Number of AFPs: 6 at end-2003 (down from 21 in 1994). - Historical returns: high; real rates of return 7 percent per annum since 1981 (well above 2 percent average real wage growth). - Returns on equity averaged 30 percent in recent years. - Portfolio composition (Chile, 2003): - Cash and Deposits: 15.0 percent - Bills and Bonds: 45.6 percent - Loans: 0.0 percent - Shares: 37.8 percent - Other: 1.6 percent - Foreign Assets/GDP: 23.8 percent - Structural constraints and investment regime issues: - Despite increase in foreign asset share to almost 30 percent and introduction of multiple funds, AFPs hold a relatively high level of low-yield, short-term assets, mainly bank certificates of deposits. - Small share of domestic equity; narrow range of equity holdings (90 corporations out of more than 200 listed companies). - Corporate bond holdings concentrated in companies rated A and above. - Fast growth of AFPs outstripped availability of investable assets in a small and undiversified economy; fund managers concentrate on a few liquid, reputable securities, then invest residual funds in bank CDs. - Investment regime is overly complex and restrictive with multiplicity of limits and sub-limits and “specific reducing factors” on issuers. - Recommendations for AFP investment regime: - Preserve main ceilings on investment in major instruments and basic issuer limits. - Remove most sub-limits on instruments, all sub-limits on combinations of fixed-income and variable-income instruments, and all “specific reducing factors” linked to concentration, diversification, liquidity, and other factors. - Streamline approval process for eligible investments; permit investment in all listed equities except for a reasonable negative list; allow marginal holdings of below-grade corporate bonds. - Shift from compliance-based to risk-based supervision; train staff on risk management techniques and introduce a compliance officer in each AFP reporting directly to the AFP Board. - Foreign investment and hedging: - Recent increase in ceiling on investments abroad should provide long-term diversification benefits. - Manage large stock of foreign assets better by: - Allowing use of more instruments to hedge risk (such as currency swaps). - Correcting definitional and misclassification problems in mutual fund investments. - Increasing ceilings on individual foreign shares and mutual funds. - Permitting fees on foreign mutual funds to be netted from gross returns. - Competition and administrative reforms: - Enhance competition in asset management to lower fees and broaden diversification of investable funds. - Encourage further outsourcing of administrative services while regulating service providers more effectively. - Implement plans for “decompressing” the mandatory pension system (divert members above a threshold balance to the voluntary pension system) and enhancing the system’s attractiveness. *Italic: Extracted from IMF staff report content unit _cr04269 (pages 19–26) provided in the source PDF.* ### 36. Should this gradual approach fall short of expectations, a more radical reform ### _cr04269 - 36. Should this gradual approach fall short of expectations, a more radical reform ### Pension reform options and retirement risk management - If the gradual approach falls short, a more radical reform could be introduced at a later stage. - The radical reform would: - Unbundle pension-related services that are subject to economies of scale (contributions collection, accounts management, payouts to retirees, etc.) from those services where price competition can thrive (asset management). - Introduce, among other alternatives, a blind quotation system (workers know which asset manager they choose but asset managers do not know the identity of the workers whose pension assets they manage). - Note: "The experience of Sweden and its recent adaptation to Latvia is illustrative. Risks of excessive entries could be mitigated through proper licensing criteria." - Policies to reduce market risks faced by workers at retirement: - The current system separates administration of retirement savings between AFPs and life insurance companies (each operating under different market incentives) and "is not necessarily consistent with maximizing workers’ consumption for a given level of risk." - To protect retiring workers from interest rate risk when switching from the pension fund to annuities, a long-duration fund could be introduced and workers allowed to purchase fixed annuities gradually in the years before retirement. ### Securities markets — state, deficiencies, and reforms (Section VIII) Findings on market structure and liquidity - "While Chilean securities markets are large, their liquidity remains limited." - Secondary market liquidity lags that in comparable emerging market countries, particularly in corporate paper, mortgages, and equity markets. - Equity market illiquidity reflects: - Concentration of supply ("the concentrated firm ownership results in very low “float ratios;”") - Concentration of demand at six AFPs which mostly "buy and hold." - "Enhancing liquidity is essential to securities markets development. Due to incentive problems among the various capital market participants to act collectively, this will require strong leadership and a major coordination effort." - "The significant migration of securities issues and trading abroad has also reduced liquidity in the domestic capital market." Clearing, settlement, and legal foundations - "Legal voids that affect the clearing and settlement of securities need to be filled." - Deficiencies in security transactions and registering became more evident after the Inverlink scandal. - The forthcoming introduction by the BCCh of a real-time gross-settlement payments system and the nearly complete move towards dematerialization of securities will improve transparency and safety. - Legal recommendations: - Embed more clearly in the law the concepts of finality, netting, and novation (the substitution of an old obligation or obligor with a new obligation or obligor). - Introduce the concept of netting as part of a broader reform of the bankruptcy code. - Embedding novation and netting in the law would facilitate later introduction of multilateral netting arrangements and a central clearing counterparty. - Note: "Informal assessments of observance of the CPSS Core Principles for Systemically Important Payment Systems and the CPSS-IOSCO Recommendations for Securities Clearance and Settlement were conducted as part of the FSAP." Market trading, valuation, and contract standardization - Reforms needed to facilitate market trading and enhance liquidity for exchange and OTC securities. - Problems identified: - Securities valuation is undermined by secondary market illiquidity, inadequate price information on OTC trades, and lack of uniformity in valuation methodologies. - Recommendations: - Consider introducing a standard contract for repos (and, possibly, an omnibus master agreement for both repo and derivatives contracts). - Conduct a comprehensive review of shortfalls in contract standardization, including in the highly fragmented mortgage market. - Promote a market for securities lending and borrowing needs and consider suitable formalization of a market making system. - Note: "OTC trading dwarfs the exchange-based trading." Financial reporting and supervision - Financial reporting regime for companies listed on the stock exchange should be strengthened. - Chilean accounting principles differ significantly from International Financial Reporting Standards (IFRS). - They "fail to require disclosure on certain critical areas, and are not as rigorous as IFRS in disclosing the fair value of financial instruments, especially derivatives." - Recommendation: "Chile should adopt IFRS after an adequate period of transition." - External auditing concerns: - Current lack of licensing and quality control mechanisms in the audit profession weakens its role. - Current efforts toward creating a licensing system are welcome. - Securities market regulation: "basically sound, important weaknesses need to be addressed." - SVS would benefit from a significant increase in budgetary and staff resources. - Need to: - (i) introduce minimum professional standards for the securities industry; - (ii) submit brokerage firms to internal compliance programs and ensure their fiduciary duty rule; - (iii) grant the SVS powers to suspend individuals for misconduct, finalize disciplinary action via negotiated settlement rather than court litigation, and intervene (or appoint a conservator or liquidator for) a failing brokerage firm. - Intervention power should be coupled with creation of an industry-wide guarantee fund to facilitate orderly settlement of transactions and limit ripple effects of a failure. ### Derivatives and hedging (Section IX) Findings on derivatives availability and demand - "Notwithstanding increasing hedging needs, the availability of derivatives remains limited." - After removal of the exchange rate band, the domestic market for nondeliverable foreign-exchange forwards (NDFs) expanded rapidly and "has now become quite deep and liquid." - Use of other derivatives remains extremely limited: - No active interest rate derivatives market. - Absence of equity derivatives and options of any kind. - Consequences: - Some sectors, including life insurance, are highly exposed to interest rate risk, reflecting a substantial duration gap and a large exposure to repayment risk. - Lack of derivative instruments hinders capacity of financial intermediaries and corporates to manage and allocate risk effectively. - "New derivatives would help increase trading in assets that are now locked in institutional investors’ portfolios, thereby contributing to market liquidity." Policy and infrastructure recommendations for derivatives - Foster development of new derivatives products by cautious relaxation of current restrictions and enhancements to market infrastructure. - Suggested sequencing and safeguards: - Remove the restriction on banks to write options after a capital charge for market risk has been introduced and supervisors are satisfied that banks have adequate capacity to manage associated risks; this may require capacity building at the SBIF. - Remove restrictions on derivatives trading for AFPs and insurance companies as a logical second step, based on similar requirements. - Market infrastructure and regulatory enhancements needed: - (i) follow intraday market indicators to measure liquidity and ascertain disorderly market conditions; - (ii) increase data available to the public to promote competition and avoid manipulation; - (iii) enable netting and securities lending; - (iv) define a proper tax, accounting, and valuation treatment of derivatives; - (v) promote knowledge building, standardization of contracts, and an industry code of conduct. - Caution: Liquidity limitations of underlying markets (particularly equity) increase risks of derivatives; prudent sequencing is necessary. ### Cross-sectoral issues in financial oversight (Section X) Findings on supervisory architecture - "Supervisory oversight is currently based on a segmented (“silo”) approach, strong firewalls, and mostly informal coordination arrangements." - Supervisory responsibility is segmented by type of financial entity and distributed among three superintendencies (banks, securities and insurance, and pensions). - BCCh retains significant regulatory powers and pre-eminence in systemic stability matters; MoF provides leadership in financial sector development policy. - Silo approach supported by strong firewalls including limits on permissible activities, cross-ownership, and connected lending and investments, and prohibitions on sharing infrastructures and customer bases. - Coordination bodies (Superintendents Committee and Capital Markets Committee) have no legal basis and there is no comprehensive framework describing roles and responsibilities of each participant. - Note: "While CMII would give stronger legal grounding to information sharing, cooperation would remain rather informal and limited in scope." Risks and limitations of segmentation - The segmented approach will become increasingly limiting as financial services integrate and become more complex. - Problems potentially masked by firewalls so far include: - Gaps in market transparency and surveillance (e.g., the opaque OTC market). - Uneven regulatory treatment of similar products promoting regulatory arbitrage. - Statutory obstacles to consolidated supervision of financial conglomerates beyond the bank holding company could impede early recognition of group-wide risks. - The importance of linkages will rise as financial groups exploit synergies and scale economies. Short-term reforms to enhance coordination and capacity - Focus on enhancing cooperation among regulators and filling gaps in information, analysis, and market surveillance. - Many improvements can be achieved in short-term without legal reform: - Redefine functions of the two coordinating bodies and formalize operating principles and protocols via a well-designed MOU. - Consider creation of a small but competent permanent technical secretariat to analyze cross-cutting issues and coordinate efforts to rationalize (and facilitate access to) information. - Boost overall analytical capacity of agencies and broaden scope of analysis, e.g., through a program of regular staff exchanges. Medium-term legal reforms - Legislative reform should define and embed the concepts of financial conglomerate, financial holding company, and lead regulator in the law to underpin full application of consolidated supervision. - Establish consolidated supervision simultaneously with some relaxation of existing firewalls, while ring fencing the financial conglomerate from the rest of the group. - Improve coordination protocols to deal with the possible failure of a complex financial conglomerate. - Enhance autonomy and legal protection of supervisors: - Consider reforms to enshrine political and budgetary autonomy of regulatory agencies and enhance legal protection of supervisors. - Increased autonomy should be matched with increased transparency and accountability. ### Anti-money laundering (Section XI) - Following the 2003 GAFISUD assessment, scope remains for tightening the AML/CFT framework. - Recent law endorsements: - Passage of a law endorsing authority of a Financial Intelligence Unit (FIU) and extending definition of offences and institutions subject to reporting constituted an essential first step. - Subsequent Constitutional Court rulings have: - Eliminated the FIU’s sanctioning powers, - Limited its discretion in requesting data on suspicious transaction records, - Denied its access to information protected by bank secrecy or on other public databases. - Consequences: - These rulings undermine investigations and disclosure of potential offences, precluding effective international cooperation through the FIU, including in freezing assets. - Additional needs: - Monitoring of compliance by securities firms, insurance companies, and foreign exchange retail operators needs improvement. *Source: IMF Financial System Stability Assessment (FSAP) material in the provided content unit.* ### 2000. The assessors benefited from the full cooperation of the Chilean authorities and ### _cr04269 - 2000. The assessors benefited from the full cooperation of the Chilean authorities and ### Introduction and Overall Assessment - The supervisory regime is well established and enjoys a reputation for good technical skills and for integrity. - There has been a conscious policy shift away from a hands-on, compliance-driven style toward placing increasing responsibility for prudent conduct on boards of directors and senior management. - Greater emphasis on corporate governance increases the need for banks to strengthen risk management and for supervisors to further develop a risk-oriented supervisory approach, with appropriate training and IT capacities paramount. - The Superintendency (SBIF) is managing these developments effectively and is reflecting the policy shift in changes to the legal and regulatory framework. - The shift may encourage more active and adventurous bank behavior and pressure for formation of broader financial services groups; a strengthened legal framework should be considered to avoid endangering stability. - Chilean accounting norms for banks depart in several respects from international standards (including accounting for credit limits, other underwritings, NPLs, and reserves for loan losses); prudential supervisory requirements for provisions and write-offs appear prudent and carefully monitored, but differences hinder international comparability. ### Objectives, Autonomy, Powers, and Resources (BCP 1) — Main Findings - The SBIF is legally established by the Banking Act, but the Superintendent is appointed by the President, has no fixed term, may be dismissed without cause, and the Superintendent’s term customarily coincides with that of the President (risk of politicizing the office). - SBIF staff are appointed by the Superintendent and may be dismissed by him personally; they do not enjoy the same job-security as other public servants. Nonetheless, staff numbers are stable and morale is good. - SBIF has little control over its financial resources: funds are derived from a levy on commercial banks, divided equally between the SBIF budget (which requires MoF approval) and the Ministry. In practice, SBIF appears to have sufficient funds, but the arrangement is informal and obscures efficiency. - Legal protection for SBIF officials is limited to protection against physical abuse or defamation; supervisors are subject to civil legal action for negligence and unclear whether they could receive financial support in defenses. This exposure could encourage a compliance-based style and affect ability to attract/retain quality staff. - Greater autonomy and legal protection for SBIF should be accompanied by greater accountability (options include enhanced internal controls and independent professional external scrutiny). - Current division of responsibilities between SBIF and BCCh is untidy: SBIF is sole licensing agency but normally issues licenses after a BCCh opinion; SBIF can withdraw a license only with prior BCCh approval; many prudential regulations are the responsibility of the BCCh; SBIF has adopted mission of ensuring public confidence (often a central bank role). - Recommendation: confine SBIF responsibility to prudential regulation of institutions authorized to conduct banking business and give it powers in all respects: issuing regulations, licensing, supervising, applying sanctions, and withdrawing licenses after consultation with BCCh. - Co-ordination among supervisory/regulatory agencies works effectively via Superintendents’ Committees and the Capital Markets Committee, but as financial activities cross boundaries, new formal arrangements (MOUs, terms of reference, lead regulator/coordinator and small secretariat) should be considered to close gaps and avoid ambiguity. ### Licensing and Structure (BCPs 2-5) - Current framework enables SBIF to assess ownership structure, direct/indirect controlling shareholders, and proposed operations and strategies. - Law empowers SBIF to apply a fit and proper test limited to financial solvency and moral integrity; criteria do not include experience or expertise in banking/financial management. - SBIF checks competence and experience of controllers of banks, but this is done on an informal and therefore legally doubtful basis. ### Prudential Regulation and Requirements (BCPs 6-15) - Chilean financial institutions must maintain minimum capital relative to risk-weighted assets and other commitments in line with the Basel Capital Accord, but are not required to maintain capital against market risks. - On January 2004, a new regulation for grading of loans and determination of provisions for loan losses entered into effect; the new system is inspired by the Basel II model and employs ten loan grades. - Authorities have adopted policy of placing increasing responsibility on management, enhancing managerial practices and internal controls. - AML/CFT legislation has recently been materially strengthened; SBIF efforts to encourage supervised institutions to implement KYC rules are supported. ### Methods of Ongoing Banking Supervision (BCPs 16–20) - SBIF supervisory model is comprehensive but scope needs extension to identify all group risks, including those within affiliated companies. - SBIF can perform on-site examinations on all institutions within a banking group, including subsidiaries at home and abroad. - Off-site supervision relies on financial information and reports submitted by banks, results of on-site inspections, internal and external auditors’ reports, and public information. - Scope of consolidated supervision under current law ends at the level of the bank holding company and fails to capture risks in other parts of a broader group that could endanger the bank. - Other companies outside the banking group but associated through common directors or common name may create risks for the bank; supervisors should have powers to obtain such information through the authorized bank. - Controllers of the bank holding company are requested to provide information on financial position and other interests outside the bank, but they are not obliged to do so even if requested by SBIF. ### Information Requirements (BCP 21) - Audited financial statements of banks do not follow closely internationally accepted practices and standards, hindering comparison with other countries; these differences do not raise particular prudential concerns. ### Formal Powers of Supervisors (BCP 22) - Legal framework grants SBIF sufficient and comprehensive powers for prompt corrective action, through rehabilitation procedures or closure and liquidation. - Supervisors have broad range of powers available to impose graduated remedial actions. ### Cross-Border Banking (BCPs 23–25) - SBIF has authority to perform global consolidated supervision and to share information with foreign supervisors. - SBIF has signed MOUs with relevant foreign supervisory authorities. ### Recommended Action Plan — Summary of Key Recommendations - Objectives, Autonomy, Powers, and Resources (BCP 1) - Establish full operational independence of the SBIF, including new provisions for appointment for a minimum—non coincident with the President’s—term for the Superintendent. - Ensure adequate legal protection for supervisors when discharging their duties in good faith. - Establish a separate budget for the SBIF. - Strengthen employment conditions of SBIF staff to protect them against undue dismissal. - Match reforms with enhanced accountability (e.g., a quality control mechanism for continuous monitoring of supervisors’ work). - Licensing and Structure (BCPs 2-5) - Empower SBIF in licensing and ongoing supervision to reject and withdraw licenses and to prevent appointment of directors, senior managers, and controlling shareholders lacking proper skills and expertise. - Prudential Regulations and Requirements (BCPs 6-15) - Speed up introduction of market risks regulations to include capital charges for these risks. - Expedite provision of means to the FIU to rapidly achieve observance of AML/CFT laws and regulations. - Define the role of financial sector supervisors in AML/CFT matters. - Methods of Ongoing Supervision (BCPs 16-20) - Enlarge scope of consolidated supervision, including clear coordination mechanisms and clear rules for determination of lead supervisor or coordinator for financial conglomerates. - Require a single external auditor for the whole group. - Information Requirements (BCP 21) - Expedite adoption of IASs. - Formal Powers of Supervisors (BCP 22) - Expand bank resolution options available to SBIF. ### Authorities’ Response (selected points) - Chilean authorities assign a high priority to complying with best practices regarding money laundering and consider that the assessment of Principle 15 did not reflect recent improvements. - In December 2003 a law created a specialized agency to prevent Money Laundering, the Financial Analysis Unit (UAF); the UAF is performing its duties normally. - Since May 2004, it is mandatory for banks, their subsidiaries, and the savings and loans cooperatives to report on suspicious transactions and to comply with strict “know-your-customer rules” procedures. ### Implementation of IOSCO Objectives and Principles of Securities Regulation — Overview - Assessment of Chile’s observance of IOSCO Principles benefited from interviews with SVS officials, visits to two of three Chilean stock exchanges, meetings with brokerage community, corporate issuers, money management firms, and academics; post-mission interviews with international accounting and legal community were also conducted. - The primary regulatory agency for Chilean capital markets is the SVS, with jurisdiction over stock exchanges, companies registering securities for public sale, brokerage firms, collective investment funds (including open-end mutual funds, closed-end funds, housing funds, foreign investment funds, and university education funds), accounting industry and private credit rating agencies. - Banks are separately regulated by the SBIF; banks are prohibited from equity trading for own account or clients unless they create a separate registered brokerage subsidiary subject to SVS oversight; banks may engage in other securities activities, including government and corporate debt. - Dominant institutional investors are seven privately operated pension funds controlling assets exceeding US$49 billion, far exceeding approximately US$8.4 billion controlled by mutual funds in Chile. - The SAFP is a separate regulatory agency overseeing pension funds; it has a staff of 141 (more than SVS staff assigned to securities regulation) and greater direct authority over pension funds than SVS has over brokers or mutual funds. - Effectiveness of securities regulation depends on an independent and efficient judiciary; judicial delay in Chile is a serious problem—judicial proceedings and appellate review may continue for as long as ten years—vitiating deterrent effect; capacity of judiciary to adjudicate complex cases should be carefully examined. *Source: IMF assessment text (annex excerpt)._cr04269 - 2000. The assessors benefited from the full cooperation of the Chilean authorities and* ### 76. The Chilean regulatory system lacks sufficient powers and or institutions necessary to ### _cr04269 - 76. The Chilean regulatory system lacks sufficient powers and or institutions necessary to ### Regulatory powers and crisis management (paras. 76–77) - The Chilean regulatory system "lacks sufficient powers and or institutions necessary to respond to major systemic failures if one or more brokerage firms or mutual funds fail." (para. 76) - Recommended powers for the SVS: - "The SVS should have the power to intervene in any failure by a regulated firm, to appoint a receiver or administrator." (para. 76) - "The administrator should be able to immediately assume control of a firm to safeguard customer assets for orderly distribution or transfer and to complete open unsettled transactions so that one firm’s failure does not result in the failure of other firms on the opposite side of open positions." (para. 76) - The SVS "should be provided regulatory jurisdiction over investment advisers, when an adviser is not regulated as a brokerage firm or as a manager of mutual funds." (para. 77) - The SVS "should also have the authority to engage in negotiated settlements to address securities law violations ... and employ a larger number of enforcement staff." (para. 77) - The SVS "must have the authority and the capacity to obtain financial records and other relevant evidence from banks and other entities not directly subject to its regulation." (para. 77) - Suggested systemic liquidity mechanism: - "Ideally, a central insurance or guaranty fund should be created, under the administration of either a stock exchange or the Central Securities Depository (DCV) to provide sufficient liquidity to cover unfilled open positions and ensure an orderly termination of activities." (para. 76) - This approach is stated to be "a more effective and less expensive system than the current system based upon minimum firm capital positions (which may be too low) and each firm obtaining private insurance." (para. 76) - IOSCO Principles referenced: 3, 8, 9, 24, 29, 30 (paras. 76–77) ### OTC debt market, market transparency, and settlement (para. 78) - Legal framework: - "In Chile securities transactions, unless exempted, must be completed on a stock exchange." Exemptions include "government, central bank and other public debt, and non-equity securities issued by a bank or finance company." (para. 78) - Consequences and gaps: - Existence of "a large OTC government debt market that is only partially regulated and partially transparent." (para. 78) - Chilean securities firms "must report their OTC debt trading to a stock exchange on a one day cycle," but "the requirement does not apply to bank trading." (para. 78) - "This gap is significant as Chilean banks are the dominant force in the OTC market." (para. 78) - "The daily composite information published by the Chilean stock exchanges is only a partial summary." (para. 78) - "The largest Chilean banks have developed a private electronic trading system that is not available to Chilean brokerage firms or institutional investors." (para. 78) - Issues raised: "best execution, market transparency and public availability of market prices for asset valuation by intermediaries." (para. 78) - "The lack of an effective standard clearance and settlement system for the OTC market may raise systemic risk issues." (para. 78) - IOSCO Principles referenced: 3, 24, 25, 26, 27, 30 ### Repo market ("pactos") deficiencies (para. 79) - Lack of uniform business practices or regulatory policy in the repo market ("pactos"). (para. 79) - Identified shortcomings: - "There is no standard master agreement governing the terms of a repo and clarifying the rights of the participants in the event of market or credit risks." (para. 79) - "There are also no consistent policies on transfer of collateral and on audit trails for these instruments, making regulatory oversight of the entire OTC market difficult and creating legal uncertainty in the event of a failure." (para. 79) - "While the pactos market is acknowledged to be quite large, there are no accurate figures on the actual size, either in terms of the nominal value of the underlying assets, the cash value of the transactions or the number of transactions daily." (para. 79) - IOSCO Principles referenced: 29, 30 ### Professional standards, internal controls, and investor confidence (paras. 80–81) - Entry and qualification standards: - "The Chilean regulatory system for securities industry professionals ... does not have any meaningful qualification or education standards and no testing program." (para. 80) - "Anyone with a high school degree who has not been convicted of a crime or been bankrupt may work in the securities industry." (para. 80) - Firm-level controls: - "Lack of comprehensive regulatory requirements for firms to have internal control or risk management programs or internal compliance offices to monitor firm personnel." (para. 80) - This results in "the SVS having exclusive responsibility to monitor and enforce compliance with Chilean securities laws without the benefit of access to internal compliance records." (para. 80) - Market liquidity and related risks: - "The Chilean private securities markets (especially equity and corporate debt markets) are widely recognized as illiquid." (para. 81) - Factors increasing risk of illegal market activity: "lack of market intermediaries such as market-makers or specialists, few active professional traders, an inability to borrow securities so as to sell short easily, the lack of derivative instruments needed to hedge market risk, no customer margin regulations and long-standing capital adequacy formulas that may be outdated and insufficient to establish that brokerage firms have sufficient capital to operate." (para. 81) - IOSCO Principles referenced: 8, 23, 26, 28 ### Auditor independence and accounting standard-setting (paras. 82–83) - Auditor independence: - "The Chilean standard for determining an auditor’s independence permits an auditor to own up to 3 percent interest in an audit client." (para. 82) - The assessment states: "This is not consistent with best international practice and should be revised." (para. 82) - Accounting standard-setting: - "Chilean accounting and auditing standards are the responsibility of the College of Accountants of Chile (CCC), a private professional organization." (para. 83) - The CCC "operates the Chilean Accounting Standards Board (CASB) primarily by reliance on a staff of part-time personnel, who are employed by the industry it oversees." (para. 83) - Concern: "This structure should be carefully examined as it affects and may limit the appearance of accounting integrity that a standard setting board must achieve." (para. 83) - Recommendation: "Given the size of the Chilean profession, its close ties to international firms and the increasing convergence of accounting standards worldwide, consideration should be given to adopt worldwide standards, such as IAS/IFRS or U.S. GAAP." (para. 83) - IOSCO Principle referenced: 16 ### Issuers regulation, AFPs, and market access (para. 84) - Hybrid registration system: - "The Chilean system for regulating companies issuing and selling securities to the public is a hybrid of a disclosure-based system with a merit-based system." (para. 84) - Role of the Risk Rating Commission (CCR): - After SVS registration, issuers seeking to offer securities to the AFPs "must submit an application to the Risk Rating Commission (CCR), a quasi-governmental Board ... that determines whether issuers’ securities are suitable for investment by the AFPs." (para. 84) - CCR decision is "based upon a confidential review of a company’s prospectus and rating agency reports submitted by the issuer." (para. 84) - "For equity offerings issuers must submit two rating reports. Only one rating report is required for debt offerings." (para. 84) - CCR decisions are "short letters to the company that do not contain an explanation for the Committee’s decision, and publication of a notice of the decision in the Official Gazette." (para. 84) - Because "the AFPs control most of the available investment capital in Chile, a denial by the CCR may prevent a company from completing a public offering." (para. 84) - Policy question raised: - "Chile should consider whether it is appropriate for a single informal board substantially to control access to the Chilean capital markets." (para. 84) - Alternative suggested: "an approach, in which each AFP would be required to have an internal process for determining the suitability of an investment could achieve the same benefits and, at the same time, provide greater diversification in investment decisions and increased liquidity across the Chilean capital markets." (para. 84) ### Consolidation, regulatory fragmentation, and holding companies (para. 85) - Structural issue: - "The Chilean regulatory structure is premised upon separately registered and regulated independent banks, brokers and investment intermediaries." (para. 85) - "Increasing consolidation into financial holding companies is resulting in something closer to a unified financial services industry." (para. 85) - "Separation of regulatory oversight results in no single regulator being able to examine the financial soundness and capital adequacy of the entire holding company structure." (para. 85) ### Recommended Action Plan (extract) and priority items (Annex summary) - Principles relating to the regulator (CPs 1–5): - "Statutory authority is required to regulate investment advisers and for the SVS to respond to failures by brokerage firms or mutual funds." - "Increased staffing and financial resources for the SVS." - Principles of self-regulation (CPs 6–7): - "Stock exchanges should expand their regulatory inspection and oversight programs." - Principles for the enforcement of securities regulation (CPs 8–10): - "Judicial efficiency and speed must be addressed." - "The SVS should clarify its ability to enter into negotiated settlements of enforcement actions." - Principles for cooperation in regulation (CPs 11–13): - "Existing bank secrecy limits must be eliminated." - "Formal cooperation agreements between regulators should be completed." - Principles for issuers (CPs 14–16): - "The current informal accounting standards process should be reexamined." - "The current auditor independence standard should be amended." - Principles for collective investment schemes (CPs 17–20): - "Mutual fund record keeping, internal controls asset custody and sales practice standards should be established." - Principles for market intermediaries (CPs 21–24): - "Following passage of legal authority, regulation of investment advisers should be initiated." - "Professional competency standards for securities industry professionals should be developed." - "Standards for investment suitability, internal controls and compliance should be developed." - "Improved oversight and transparency in the OTC debt market is required." - Principles for the secondary market (CPs 25–30): - "Current standards for capital adequacy and risk management should be reexamined." - "Clearance and settlement and payment systems must be improved to provide adequate protection for investors and to ensure against systemic failures within the securities markets." - "The SVS or another entity must have the legal authority to respond promptly to failures by regulated entities, such as brokerage firms or mutual funds." ### Authorities' response (paras. 86–87) - The Chilean authorities: - "Agreed on the need to strengthen the compliance programs and suitability standards for mutual funds and intermediaries, and indicated that some reforms have already been included in CMII." (para. 86) - "Disagreed with the assessment that there were no rules in this area," noting that "principles regarding duties for intermediaries and fund managers were well defined in the law and its operational norms." (para. 86) - Noted that "The SVS has units specializing in the surveillance, investigation and enforcement of operations performed by such intermediaries and has taken corrective actions on many occasions." (para. 86) - "Disagreed with the view that the different tax treatment of liquid and illiquid shares as regards the capital gains tax was problematic," arguing instead that "it provided ... an incentive for illiquid firms to float a larger amount of their capital and obtain liquidity and, hence, tax advantages." (para. 87) ### IMF Code of Good Practices on Transparency in Monetary Policy — assessment introduction and main findings (paras. 88–91) - Assessment scope and methodology: - "This assessment examines the observance by the Central Bank of Chile (BCCh) of the IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies (MFP Transparency Code) for monetary policy." (para. 88) - Assessment "was based on pre-mission work; a review of relevant laws, regulations, and policies; documentation provided on the BCCh website and in a variety of official BCCh publications; and on discussions with the BCCh and market participants." (para. 88) - Main findings on central bank roles and clarity (para. 89): - "The assessment reveals a high degree of compliance with the Transparency Code, including in the objectives and responsibilities of the central bank." - Constitutional protections: "The target and instrument autonomy of the Central Bank of Chile is very strong by virtue of being enshrined in the Constitution." (para. 89) - Two areas where further clarification could be useful: - "There is an element of uncertainty in the interpretation of the statutory definition of the monetary policy objective, since currency stability may refer to internal (price) or external (exchange rate) stability." (para. 89) - "The institutional responsibilities of the central bank in determining the exchange rate regime could be more explicitly spelled out." (para. 89) - Transparency of policy process and public information (paras. 90–91): - "The process for monetary policy formulation, implementation and communication is highly transparent." (para. 90) - Practices include publication of resolutions in the Official Gazette, explanations in the Monetary Policy Report, and publication of Board meeting minutes "within a month and a half of the meetings." (para. 90) - Extensive set of publications available on the web-site: "Monetary Policy Report, Economic Policy Papers, the Economic and Financial report, the Monthly Bulletin and the Annual Report." (para. 91) - Two additional helpful documents: "Monetary Policy of the Central Bank of Chile: Objectives and Transmission" and "The Central Bank of Chile and the Economy." (para. 91) *Source: IMF staff report text, paras. 76–91.* ### 92. Accountability for the conduct of monetary policy is ensured by virtue of the fact that ### _cr04269 - 92. Accountability for the conduct of monetary policy is ensured by virtue of the fact that ### Monetary policy accountability and reporting - The Bank is to inform the President of the Republic and the Senate in the performance of its duties, its policies and any regulations having general applicability. - De jure the BCCh is only required to provide information on its policies; in practice it also provides extensive explanations, thereby justifying the appropriateness of its policy decisions. - The central bank is required to consider the general orientation of the Government’s economic policies when passing a resolution through the Board and may obtain any necessary information from other public institutions in the conduct of monetary policy. - The Finance Minister attends Board meetings (including monetary policy meetings) with veto rights subject to detailed procedures and limitations as set out in the law. - The institutional relationship is one of coordination, subject to the primacy of the central bank objectives. - Sharing of information between the monetary and fiscal authority is facilitated by the presence of the Finance Minister in Board meetings. - A number of internal governance provisions will shortly be published on the BCCh web-site, significantly enhancing operational transparency and market perceptions of integrity. ### Legal and institutional framework for foreign exchange policy - The BCCh is a public law (derecho público) institution, which is autonomous and of a technical nature. - As established by its Constitutional Organic Act (COA), the BCCh must "provide for the stability of the currency and the normal functioning of external and internal payments." - The BCCh receives public authorization to regulate the amount of currency and credit in circulation, to perform credit and foreign exchange transactions, and to exclusively issue regulatory provisions regarding monetary, credit, financing and foreign exchange matters. - The exclusiveness to issue foreign exchange regulations derives from the transfer of authority from the Monetary Council to the BCCh in accordance with the 1980 Constitutional Act of Chile (CA). - Judicial pronouncements confirm that: (i) the BCCh is independent from the State of Chile in fulfilling its public duty; (ii) it is subordinated to the 1980 CA and the COA; and (iii) it is the exclusive entity empowered to issue regulatory provisions regarding foreign exchange matters. (Latest decision referenced: Court of Appeals of Santiago dated September 26, 2003, and confirmed by the Supreme Constitutional Court.) - The President of the Republic lacks the authority to regulate matters conferred exclusively to the BCCh; sections 6 and 7 of the 1980 CA penalize infringement with nullity of the corresponding act without prejudice of administrative liabilities. - COA provisions on BCCh’s public duty include: i) to perform in accordance with the general orientation of the government’s economic policy; ii) to inform the President of the Republic and the Senate as provided for in the law; iii) to include the Minister of Finance at Board meetings with the right to be heard and the power to suspend the enforceability of any decision or resolution passed by the Board within a period not to exceed 15 days, plus the right to veto the enforceability of foreign exchange restrictions, in which event the respective restriction may be adopted only with the favorable vote of all the Board members. - The BCCh may purchase and sell foreign currency; issue notes payable in US dollars or denominated in foreign currency; enter into derivative transactions and hedge agreements; and regulate foreign exchange transactions by setting limitations and restrictions. ### Authorities’ response to assessment and transparency actions - The Chilean authorities do not accept the implicit view in Principle 1.1.4 that “...the BCCh statute does not explicitly refer to the institutional responsibility for the choice of the exchange of the exchange rate regime.” They assert the law clearly establishes the BCCh’s responsibility. - The BCCh modified foreign exchange policy using its exclusive and clear legal authority; resolutions were adopted within the prevailing legal framework, with participation of the Executive Power through the Ministry of Finance, published in the Official Gazette, and reported to the Senate as set forth in the COA. - With respect to principles 1.2.4, 4.2.2 and 4.4, steps are being taken to increase transparency: - Short-term: publication of procurement procedures and a set of norms governing the ethical and personal conduct of the staff. - A more detailed description of the functioning of the internal audit unit will be made public as soon as it becomes available. ### Recommended Action Plan (selected items) - Practices 1.2.4 and 4.2.2: Pursue publication of internal norms regarding acquisitions and procurement on the BCCH web-site together with a brief note on internal governance. - Practice 4.4: Pursue the web-site publication of a note on internal rules regarding the personal financial affairs of the staff. ### Key macroeconomic and financial statistics (selected figures from Tables) - Real Sector - GDP (real change) 1/: 1997 = 6.6; 1998 = 3.2; 1999 = -0.8; 2000 = 4.2; 2001 = 3.1; 2002 = 2.2; 2003 = 3.2. - Consumer price index (e.o.p.) change: 1997 = 4.7; 1998 = 2.3; 1999 = 4.5; 2000 = 2.6; 2001 = 2.8; 2002 = 3.3. - Private savings ratio (in percent) 2/: 1997 = 23.1; 1998 = 21.8; 1999 = 21.0; 2000 = 20.6; 2001 = 20.0; 2002 = 21.0; 2003 = n.a. - Monetary and credit data (change in annual averages) - Monetary base: 1997 = 15.8; 1998 = 13.2; 1999 = 4.4; 2000 = 6.1; 2001 = 7.2; 2002 = 7.9; 2003 = 5.5. - Money (M1) 3/: 1997 = 17.0; 1998 = 3.3; 1999 = 5.1; 2000 = 7.8; 2001 = 14.4; 2002 = 14.2; 2003 = 18.3. - Broad money (M3) 4/: 1997 = 20.8; 1998 = 13.3; 1999 = 9.2; 2000 = 8.8; 2001 = 9.0; 2002 = 4.3; 2003 = 3.6. - Domestic credit: 1997 = 11.3; 1998 = -8.1; 1999 = 13.4; 2000 = 23.6; 2001 = -3.6; 2002 = -11.4; 2003 = 8.2. - Reference bank lending rate 6/: 1997 = 20.2; 1998 = 27.4; 1999 = 17.6; 2000 = 18.7; 2001 = 16.7; 2002 = 14.4; 2003 = 13.0. - Public finances (in percent of GDP) - Central government financial balance: 1997 = 1.8; 1998 = 0.4; 1999 = -1.4; 2000 = 0.1; 2001 = -0.3; 2002 = -0.8; 2003 = n.a. - General government financial balance: same series as central government financial balance. - External sector (levels, unless otherwise indicated; Billions of USD, end of period) - Trade balance: 1997 = -1.4; 1998 = -2.0; 1999 = 2.4; 2000 = 2.1; 2001 = 2.1; 2002 = 2.5; 2003 = 2.9. - Current account: 1997 = -3.7; 1998 = -3.9; 1999 = 0.1; 2000 = -0.8; 2001 = -1.2; 2002 = -0.6; 2003 = -0.3. - Foreign direct investment (net): 1997 = 3.8; 1998 = 3.1; 1999 = 6.2; 2000 = -0.3; 2001 = 3.0; 2002 = 1.1; 2003 = n.a. - Portfolio investment (net): 1997 = 1.6; 1998 = -2.5; 1999 = -3.2; 2000 = 0.6; 2001 = 0.0; 2002 = -1.9; 2003 = n.a. - Gross official reserves (billions of US$, end period): 1997 = 18.3; 1998 = 16.3; 1999 = 14.9; 2000 = 15.1; 2001 = 14.4; 2002 = 15.4; 2003 = n.a. - Reserve cover (months of imports) 7/: 1997 = 9.4; 1998 = 8.6; 1999 = 9.3; 2000 = 8.3; 2001 = 8.1; 2002 = 8.9; 2003 = n.a. - Reserve cover (short-term external debt) 8/: 1997 = 2.3; 1998 = 2.1; 1999 = 2.1; 2000 = 1.5; 2001 = 1.4; 2002 = 1.3; 2003 = 1.2. - Total external debt: 1997 = 29.0; 1998 = 32.6; 1999 = 34.8; 2000 = 37.2; 2001 = 38.5; 2002 = 41.0; 2003 = 43.3. - of which: Public sector debt: 1997 = 5.5; 1998 = 5.8; 1999 = 6.0; 2000 = 6.0; 2001 = 6.1; 2002 = 7.5; 2003 = 9.3. - of which: Banking sector debt: 1997 = 2.1; 1998 = 2.5; 1999 = 1.7; 2000 = 1.5; 2001 = 2.5; 2002 = 3.7; 2003 = 5.1. - Central bank short-term foreign liabilities 8/: 1997 = 0.1; 1998 = 0.0; 1999 = 0.1; 2000 = 0.0; 2001 = 0.0; 2002 = 0.0; 2003 = 0.0. - External interest payments to exports (in percent) 9/: 1997 = 6.2; 1998 = 7.1; 1999 = 7.7; 2000 = 8.3; 2001 = 7.9; 2002 = 6.6; 2003 = 4.9. ### Financial soundness indicators (selected) - Regulatory capital to risk-weighted assets2/: Dec-98 = 12.5; Dec-99 = 13.5; Dec-00 = 13.3; Dec-01 = 12.7; Dec-02 = 14.0; Sep-03 = 14.5. - Regulatory Tier I capital to risk-weighted assets3/: Dec-98 = 11.0; Dec-99 = 10.6; Dec-00 = 10.5; Dec-01 = 9.9; Dec-02 = 11.1; Sep-03 = 11.5. - Capital (net worth) to assets: Dec-97 = 7.4; Dec-98 = 7.5; Dec-99 = 7.8; Dec-00 = 7.5; Dec-01 = 7.2; Dec-02 = 7.2; Sep-03 = 7.5. - NPLs to gross loans 4/: Dec-97 = 1.2; Dec-98 = 1.6; Dec-99 = 1.8; Dec-00 = 1.9; Dec-01 = 1.8; Dec-02 = 2.0; Sep-03 = 2.0. - Consumer: Dec-97 = 0.8; Dec-98 = 1.2; Dec-99 = 0.9; Dec-00 = 0.9; Dec-01 = 0.9; Dec-02 = 0.8; Sep-03 = 0.8. - Mortgage: Dec-97 = 0.4; Dec-98 = 0.5; Dec-99 = 0.6; Dec-00 = 0.8; Dec-01 = 0.9; Dec-02 = 1.1; Sep-03 = 1.2. - Commercial: Dec-97 = 1.6; Dec-98 = 1.9; Dec-99 = 2.2; Dec-00 = 2.4; Dec-01 = 2.1; Dec-02 = 2.4; Sep-03 = 2.4. - ROA 7/: Dec-98 = 1.0; Dec-99 = 0.9; Dec-00 = 0.7; Dec-01 = 1.0; Dec-02 = 1.3; Sep-03 = 1.1; (ROA series shows annualized terms in notes). - ROE 7/: Dec-98 = 13.7; Dec-99 = 11.5; Dec-00 = 9.4; Dec-01 = 12.7; Dec-02 = 17.7; Sep-03 = 14.4; Sep-03 final = 16.4. - Liquid assets to total assets: Dec-98 = 16.6; Dec-99 = 15.2; Dec-00 = 17.7; Dec-01 = 16.9; Dec-02 = 17.2; Sep-03 = 18.7; final Sep-03 = 16.9. *Source: Excerpt from IMF staff report text and appended tables (Central Bank of Chile and National Statistics Institute (INE) data).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04269.pdf_