## _cr06439 — Executive Summary (IMF FSAP)

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### Financial system recovery and current macro‑financial risks
- Improved liquidity and capital adequacy have increased the Uruguayan banking system’s capacity to withstand shocks.
- Financial sector recovering from the 2002 crisis; banking system is well capitalized and liquid, partly reflecting sharp reduction in lending.
- Key persistent macroeconomic and financial risks:
  - high level of government debt;
  - guarantees to state banks;
  - high dollarization;
  - high share of nonresident deposits.

Key statistics
- Bank assets have halved in dollar terms to about US$12 billion at end-2005.
- 36 percent of bank assets are held in liquid assets.
- Loans to the private sector were 26 percent of GDP.
- Nonresident deposits account for 20 percent of total deposits, down from 50 percent in 2001.
- Depositors continue to utilize mostly sight deposits two years after the crisis.

### Main weaknesses revealed by the crisis
- High dollarization and a large share of nonresident deposits.
- Inadequate oversight, governance, internal controls, and risk management systems in state financial institutions and some private institutions.
- Prudential regulations and policies failed to sufficiently reduce credit and liquidity risks from high financial dollarization and cross‑border activities.
- Government policies and lack of effective supervision of state banks gave rise to large uncovered foreign currency liabilities, nonperforming loans, and contingent liabilities.
- Inadequate bank resolution framework for private banks and difficulties resolving state banks, complicated by rigid employment practices.

### Improvements in regulation and supervision
- Over the last three years, regulation and supervision—particularly of the banking sector—have improved significantly.
- Risk management and internal control systems strengthened across financial institutions.
- The deposit insurance fund became operational in 2005.
- BCU introduced prudential limits to reduce exposures and concentration of risks (especially regarding dollarization) and increased liquidity requirements on nonresident deposits.
- BCU has systematically increased disclosure of financial information, contributing to greater market discipline.

Limitations and continuing challenges in supervision
- Three key problems hinder effective oversight: lack of resources, limits on powers with regard to state institutions, and the quality of data provided by state institutions.
- Amendments to the central bank law to strengthen BCU autonomy were submitted to congress and were expected to be debated later in 2006.
- BROU:
  - accounts for over 40 percent of bank assets and 50 percent of deposits (state guaranteed);
  - remains subject to high liquidity and reserve requirements pending further improvements to risk management, loan approval and recovery processes;
  - lacks adequate procedures to measure and price risks and its information systems are not yet up to standards for a bank that size.
- BHU prohibited from accepting new deposits after its deposits were transferred to BROU; additional restructuring is envisaged.

### State presence, distortions, and contingent risks
- Large state presence creates distortions and challenges for regulation, oversight, and governance.
- BROU owns a majority stake in the largest pension fund (about 57 percent of pension assets) and the state‑owned insurance company accounts for over 60 percent of the insurance market.
- Government guarantees and state bank practices limit financial development and competitive neutrality.
- Contingent and liquidity risks:
  - Improved liquidity position of public banks reduced need for public support in a moderate liquidity shock.
  - In a major shock, emergency liquidity assistance in foreign currency is constrained by international reserves and access to international capital markets.
  - Lack of reinsurance of worker’s compensation and life insurance policies creates a contingent fiscal risk.

### Sector‑specific observations — Banking
- Banking sector accounts for 67 percent of total assets (78 percent of GDP) at end-2005.
- Selected banking figures:
  - Assets: about US$12 billion at end-2005; 36 percent in liquid assets.
  - Loans to private sector: 26 percent of GDP.
  - Nonresident deposits: 20 percent of total deposits (down from 50 percent in 2001).
- Structural changes:
  - Total financial system assets: 2001 — Assets US$25,060 million; 2005 — Assets US$19,280 million.
  - Commercial banks: Dec 31, 2001 — 22 banks, Assets 20,609 (82 percent of total assets); Dec 31, 2005 — 15 banks, Assets 12,951 (67 percent).
  - Public sector‑owned banks: Dec 31, 2001 — 2 banks, Assets 7,457 (30 percent); Dec 31, 2005 — 3 banks, Assets 7,885 (41 percent).
  - Foreign banks: Dec 31, 2001 — 17, Assets 9,980 (40 percent); Dec 31, 2005 — 12, Assets 5,066 (26 percent).
- Dollarization and deposit composition (end-2005):
  - Foreign currency deposits: 85 percent of total nonfinancial resident deposits.
  - Credit denominated in foreign currency: 71 percent of total credit.
  - Deposits of nonresidents: about 23 percent of total nonfinancial sector deposits (declined from over 50 percent at end-2001).
  - Sight deposits remain dominant two years after the crisis.

### Sector‑specific observations — Pension funds and public pensions
- Defined‑contribution pension system assets: 11 percent of GDP (about US$2 billion in individual accounts; about 11 percent of GDP).
- BPS coverage: about 90 percent of active adult population with over one million affiliates; about 670,000 employees affiliates of AFAPs.
- Public pension system deficit:
  - Deficit amounted to 2.6 percent of GDP at end-2005 (after earmarked taxes).
  - Projected deficit of 1.5 percent of GDP for 2010 despite earmarking.
- AFAP concentration and guarantees:
  - Two of four AFAPs account for 74 percent of assets.
  - State‑owned AFAP República accounts for 56 percent of total AFAP assets and government effectively guarantees a minimum investment return for AFAP República (identified as an unrecognized contingent liability).
- Investment profile:
  - Government and central bank debt represent over 80 percent of AFAP portfolios.
  - About 10 percent of AFAP assets held in cash due to unavailability of private sector issues.

### Sector‑specific observations — Insurance
- Insurance sector assets: 3 percent of GDP; state‑owned BSE dominates:
  - BSE: 60 percent of life and 67 percent of nonlife business (over 60 percent market share noted).
- Weaknesses and risks:
  - Need to improve data quality, pricing, internal risk management and control systems of BSE.
  - State effectively acts as reinsurer and guarantor; risks from annuities indexed to wages and workers’ compensation.
- Recommendations:
  - Strengthen oversight, capital, and risk management; improve BSE transparency and pricing.

### Sector‑specific observations — Capital markets
- Capital markets in infancy:
  - Equity market capitalization: 2.2 percent of GDP (2004).
  - Domestic corporate bond market outstanding amount: 0.5 percent of GDP.
  - Only 11 listed firms; trading accounted for 0.5 percent of market capitalization.
- Policy and legal developments:
  - New draft law on capital markets expected to improve legal framework; proposed new tax law envisages major simplifications to make securitization easier.
  - Draft amendments include corporate governance provisions in accordance with IOSCO standards.

### Structural constraints on deepening intermediation
- Obstacles to reducing intermediation costs:
  - High reserve and liquidity requirements (averaging 15 percent on peso deposits and 24 percent on foreign currency deposits).
  - Distortionary taxes (profit tax IRIC 30 percent; net worth tax IPAT 2.8 percent; asset tax IMABA 1/ 2 percent of assets; VAT 23 percent on interest to individuals; credit card tax and supervisory fees as listed).
  - Labor market rigidities: “bolsas de trabajo” hiring expectations; dismissal benefits up to 20 months salaries in banking sector; higher employer contributions to Caja Bancaria.

### Policy priorities and recommended reforms
- Primary challenge: deepen financial intermediation while reducing vulnerabilities.
- Short‑term stability actions:
  - Continue close monitoring of public banks to ensure risk management policies and practices meet standards.
  - Continue to limit lending activities in these banks until improvements are achieved.
- Structural and longer‑term actions:
  - Restructure and downsize state institutions, particularly state banks, to minimize moral hazard.
  - Require directors and managers of public financial institutions to satisfy fit and proper requirements applied to private institutions.
  - Strengthen central bank independence and recapitalize the central bank as envisaged in the draft law submitted to congress.
  - Remove selective employer exemptions from contributions to public pensions as envisaged in the proposed tax law; carry out further reforms to reduce public and sectoral pension funds’ deficits; eliminate government‑guaranteed minimum rate of return in AFAP República.
  - Conduct independent analysis of contingent liabilities from products offered by BSE and any proposals for mortgage insurance.
  - Reform insolvency legislation to allow reorganization of viable firms and faster liquidation of nonviable ones (proposed bankruptcy law envisages Chapter 11–type procedures).
  - Improve corporate governance and disclosure practices to develop local capital markets.
  - Implement upgrade to RTGS (AGATA) and improve legal framework for payment and securities settlement systems.
- Strengthening supervisory and regulatory framework:
  - Increase resources for effective supervision; provide training for staff; improve information systems.
  - Provide legal protection for supervisory staff and deposit insurance agency staff.
  - Enhance AML/CFT legislation and supervision.
  - Improve cooperation and information exchange with foreign supervisors through MOUs.
  - Reduce tax burden and improve legal/regulatory framework for trust funds and securitizations.
  - Enhance regulatory authority over securities intermediaries.

### Stress testing — methodology and results (banking system)
- Coverage: all private banks, cooperative banks, finance companies, offshore banks, and BROU (representing about 80 percent of financial system assets); exposures as of June 2005.
- Sensitivity tests:
  - Interest‑rate shifts and a 30 percent depreciation/appreciation without credit risk did not push CAR below minimum.
  - Very sharp tilt in yield curves (U.S. dollar 163–881 bps; peso 123–861 bps) would cause CAR below minimum for institutions accounting for about 17 percent of banking system assets.
  - Worst‑classification credit risk (each debtor worst rating) and increase of 60 percent in PD would lead to CAR below minimum in institutions accounting for about 13 percent of banking system assets.
- Adverse macro scenarios and CAR impact:
  - Domestic supply shock (drought): CAR below minimum in institutions representing 6 percent of banking system assets.
  - Current account shock (10 percent decline in Argentina’s GDP): institutions representing 28 percent of banking system assets would become undercapitalized.
  - Sudden stop scenario (severe US tightening, world recession, large capital outflows, sudden drop of 8 percent in Uruguayan GDP): banks representing about 80 percent of banking system assets would have CAR below minimum required.
- Liquidity effects:
  - Several institutions would see 30‑ and 90‑day liquidity ratios fall below 50 percent under current and capital account shock scenarios.
- Stress‑test scenario inputs (selected):
  - Scenario 1 (Domestic Supply Shock): GDP −1; Nominal exchange rate 5 to 7; Domestic prices 5 to 7; Real exchange rate 0; Country risk 0.
  - Scenario 2 (Current Account Shock): GDP −4; Nominal exchange rate 17; Domestic prices 5 to 7; Real exchange rate 5; Country risk 500 to 550 bps.
  - Scenario 3 (Capital Account Shock): GDP −8; Nominal exchange rate 48; Domestic prices 15; Real exchange rate 12; Country risk Greater than 600 bps.
- Interest rate shock specifications (bps) used in tests (short/medium/long):
  - Tilt: Peso +160/+110/+90; U.S. dollar +100/+50/+30.
  - Parallel: Peso +160/+160/+160; U.S. dollar +100/+100/+100.
  - Russian crisis: Peso 867/240/123; U.S. dollar 881/243/−163.

### Regulation, supervision, and Basel Core Principles (BCP) assessment
- BCP compliance summary:
  - Out of 30 core principles, 21 assessed as compliant (9 fully compliant, 12 largely compliant); 9 materially noncompliant.
- Main weaknesses:
  1. Operational independence: lack of clear and stable funding; executive branch capacity to overturn BCU decisions; lack of legal protection for supervisors.
  2. Remedial capacity regarding state‑owned banks: inability to remove directors of state banks or apply same remedial powers as for private banks.
  3. Regulation and supervision of market and other risks: not fully implemented; supervisors need additional training.
  4. Accounting norms: differences from IAS; plan to issue new chart of accounts by end-2006 and mandatory IAS compliance by end-2008.
- Selected recommended actions (from Table 2):
  - Channel additional resources to fund personnel, training, and IT systems (CP 1.2).
  - Apply same fit and proper requirements to directors of state banks as for commercial banks (CP 1.4).
  - Provide legal protection for supervisory staff (CP 1.5).
  - SIIF to sign MOUs with home country supervisors of foreign banks (CP 1.6).
  - Ensure implementation of market risk capital requirements and training for supervisors (CPs 6, 12).
  - Issue regulation addressing total risks of an institution and require comprehensive risk control systems (CP 13).
  - Enhance AML supervision and require identification of beneficial owners (CP 15).
  - Ensure banks implement IAS in preparation of 2008 financial statements (CP 21).
  - Issue regulation defining timing and circumstances to implement specific corrective actions (CP 22).

### Payments, securities settlement, accounting, and disclosure
- Payments and clearing:
  - SEDEC (BCU) is main funds transfer system migrating to AGATA (RTGS upgrade).
  - Check clearinghouse (BEVSA) handles large‑value payments and sometimes used for large payments; check clearinghouse presents systemic‑importance elements.
  - Table 3 systemically important payments (2004):
    - SEDEC‑AGATA: Number of Participants 181; Daily Value of Instructions Handled 129 (In millions of U.S. dollars); Average Value per Transaction Settled 204,408 (In U.S. dollars); Daily Volume 633; Yearly Value of Transactions over GDP 236 (In percent).
    - Checks: Number of Participants 15; Daily Value 78 (In millions of U.S. dollars); Average Value per Transaction 1,570 (In U.S. dollars); Daily Volume 49,780; Yearly Value over GDP 143 (In percent).
- Recommended actions for CPSS observance:
  - Formalize BCU oversight function; migrate large‑value payments from check clearinghouse to RTGS; develop secondary processing site, BCP/DRP, and external audit of RTGS after upgrade; clarify legal finality and netting; define access criteria; create system users’ group.
- Securities markets and settlement:
  - Dominated by central bank and government securities; private sector securities activity limited.
  - BEVSA operates an electronic trading system; BVM trading largely on‑floor.
  - Settlement: T+1 for domestic securities; T+3 for foreign securities.
  - Recommendation: strengthen BCU oversight of securities settlement and improve custody arrangements and legal framework.
- Accounting and disclosure:
  - International accounting standards legally required for nonfinancial corporations but compliance uneven.
  - Financial corporations expected to move to international standards by 2008; BCU to issue new chart of accounts by end-2006.

### AML/CFT regime — status and key recommendations
- Regime assessed in November 2005; detailed assessment to be used by GAFISUD and presented July 20–21, 2006.
- Recent measures: passage of new AML/CFT legislation; initial institutional setup.
- Remaining gaps:
  - Legislation should cover broader range of predicate offences.
  - Efficiency of property registries should be enhanced.
  - Deficiencies in supervision/implementation in securities, corporate services, and casinos.
  - Uruguay’s offshore role increases vulnerability to ML/FT.
- Key recommendations:
  - Develop coordinated national AML/CFT strategy (to be implemented in 2006).
  - Improve CFT legislation and regulatory framework for all FIs.
  - Cover missing DNFBP sectors and prioritize company services and casinos.
  - Strengthen and enforce customer due diligence, especially for offshore/cross‑border business and legal entities.
  - Enhance and expand AML/CFT supervision, particularly on‑site inspections of nonbank and offshore institutions.
  - Establish formal cooperation and information exchange with overseas supervisors including AML/CFT elements.
  - Improve registration systems for legal entities and property; strengthen judiciary, prosecution, law enforcement; enhance capacity and resources in FIU and BCU supervisory units.

### Selected financial soundness and macro indicators (selected figures)
- Banking system totals and ratios (selected):
  - Total financial system assets (memorandum, US$ billions): 2002 12.3; 2003 11.6; 2004 11.9; Jun‑05 12.4.
  - Liquid assets to total assets (Jun‑05): 11.9 (percent).
  - Net credit to nonfinancial sector to total assets (Jun‑05): 26.0 (percent).
  - Nonperforming loans to total loans (2005): 8.4 (percent).
  - Capital/assets (percent): 8.0 (2005).
- Macroeconomic indicators:
  - Real GDP growth: −11.0 (2002), 2.2 (2003), 11.8 (2004), 6.6 (2005) (percent).
  - CPI inflation (eop): 25.9 (2002), 10.2 (2003), 7.6 (2004), 4.9 (2005) (percent).
  - Public sector debt (percent of GDP): 96 (2002), 104 (2003), 92 (2004), 69 (2005).
  - Gross official reserves (US$ millions): 772 (2002), 2,087 (2003), 2,512 (2004), 3,438 (2005).
  - Reserves in months of imports: 3.7 (2002), 9.2 (2003), 8.0 (2004), 8.7 (2005).

### Chronology and regulatory measures (selected)
- Key regulatory changes (selected dates and measures):
  - Feb 28, 2002 (Circular 1.773): risk rating requirement.
  - Jan 2, 2003 (Circular 1.837): sharply increased minimum capital requirements.
  - Apr 2, 2003 (Circular 1.850): liquidity requirement on nonresident deposits increased to 30 percent.
  - Oct 2, 2003 (Circulars 1.877/1.878/1.879): prudential limits and information retention requirements.
  - Feb 28, 2004 (Circular 1.901): internal audit and audit committee requirements.
  - Jan 18, 2005 (Comunicación 2005/019): credit classification changes effective January 2006 (increase categories from 5 to 8).
  - May 13, 2005 (Circular 1.933): state bank regulation (sanctions).
  - Aug 30, 2005 (Circular 1.938): new capital requirements announced, effective June 2006; capital requirements established in units indexed to the CPI effective September 2005.
  - Dec 14, 2005 (Comunicación 2005/265): financial flow reporting requirement for 2006 cash flow projections.
- Numerical regulatory note:
  - 0.025 percent of the basic capital requirements (down from 0.15 percent).

*IMF FSAP Executive Summary (content unit: _cr06439 - Executive Summary)*

### Executive Summary ......................................................................................................

### Executive Summary

### Financial system recovery and current macro-financial risks
- Improved liquidity and capital adequacy have increased the Uruguayan banking system’s capacity to withstand shocks.
- The financial sector is recovering from the 2002 crisis; the banking system is well capitalized and liquid, partly reflecting the sharp reduction in lending.
- Key persistent macroeconomic and financial risks:
  - high level of government debt;
  - guarantees to state banks;
  - high dollarization;
  - high share of nonresident deposits.

Key statistics
- Bank assets have halved in dollar terms to about US$12 billion at end-2005.
- 36 percent of bank assets are held in liquid assets.
- Loans to the private sector were 26 percent of GDP.
- Nonresident deposits account for 20 percent of total deposits, down from 50 percent in 2001.
- Depositors continue to utilize mostly sight deposits two years after the crisis.

### Main weaknesses revealed by the crisis
- High dollarization and a large share of nonresident deposits.
- Inadequate oversight, governance, internal controls, and risk management systems in state financial institutions and some private institutions.
- Failure of prudential regulations and policies to reduce credit and liquidity risks arising from high financial dollarization and cross-border activities.
- Government policies on, and lack of effective supervision of, state banks, which gave rise to large uncovered foreign currency liabilities, nonperforming loans, and contingent liabilities.
- An inadequate bank resolution framework for private banks and difficulties in resolving the problems of the state banks, complicated by rigid employment practices.

### Improvements in regulation and supervision
- Over the last three years, regulation and supervision—particularly of the banking sector—have improved significantly.
- Risk management and internal control systems have been strengthened across financial institutions.
- The deposit insurance fund became operational in 2005.
- BCU has introduced prudential limits to reduce exposures and concentration of risks (especially regarding dollarization) and has increased liquidity requirements on nonresident deposits.
- BCU has systematically increased the disclosure of financial information, contributing to greater market discipline.

Limitations and continuing challenges in supervision
- Three key problems hinder effective oversight: lack of resources, limits on powers with regard to state institutions, and the quality of data provided by state institutions.
- Amendments to the central bank law to strengthen BCU autonomy were submitted to congress and were expected to be debated later in 2006.
- BROU (largest state bank) improvements noted, but:
  - remains subject to high liquidity and reserve requirements pending further improvements to risk management, loan approval and recovery processes;
  - lacks adequate procedures to measure and price risks;
  - information systems are not yet up to standards for a bank that size.
- BHU (state housing bank) was prohibited from accepting new deposits after its deposits were transferred to BROU; additional restructuring is envisaged.

### State presence, distortions, and contingent risks
- Large state presence creates distortions and challenges for regulation, oversight, and governance.
- BROU alone accounts for over 40 percent of bank assets and 50 percent of deposits, which are fully guaranteed by the state.
- BROU owns a majority stake in the largest pension fund, which accounts for over half of total pension fund assets and guarantees a minimum return.
- The state-owned insurance company accounts for over 60 percent of the insurance market and, by offering low-cost life insurance to AFAP affiliates, has driven out private competitors.
- Government guarantees and state bank practices limit financial development and competitive neutrality.

Contingent and liquidity risks
- Improved liquidity position of public banks has reduced the need for public support in a moderate liquidity shock.
- In the event of major shocks, emergency liquidity assistance in foreign currency is constrained by the amount of international reserves and access to international capital markets.
- Lack of reinsurance of worker’s compensation and life insurance policies creates a contingent fiscal risk.

### Sector-specific observations
- Banking:
  - Assets: about US$12 billion at end-2005; 36 percent in liquid assets.
  - Loans to private sector: 26 percent of GDP.
  - Nonresident deposits: 20 percent of total deposits (down from 50 percent in 2001).
- Pension funds:
  - Defined-contribution pension system weathered the crisis well and is growing.
  - Public pension system’s deficit, after earmarked taxes, amounted to 2.6 percent of GDP as of end-2004.
  - Some sectoral pension schemes (notably Caja Bancaria) may represent a potential risk to the government.
  - Investment regulations governing the AFAPs need amendment to ensure prudent asset diversification.
- Insurance:
  - State-owned BSE dominates the insurance sector (over 60 percent market share).
  - Need to improve data quality, price policies, and internal risk management and control systems of BSE.
  - Insurance companies need to improve capital and risk management practices; oversight needs strengthening.
- Capital markets:
  - Capital markets are in their infancy.
  - Development would benefit from improvements in corporate governance and disclosure practices.
  - A new draft law on capital markets is expected to improve the legal framework; proposed new tax law envisages major simplifications that would make securitization easier.
  - Draft amendments include corporate governance provisions in accordance with IOSCO standards.

### Structural constraints on deepening intermediation
- Banks’ efforts to reduce intermediation costs constrained by:
  - high reserve and liquidity requirements (with low central bank remuneration effectively acting as an additional tax);
  - distortionary taxes (tax reform submitted to congress in March 2006 should lead to a significant reduction in the tax burden of the financial system);
  - labor market rigidities that hinder cost reductions and have delayed restructuring efforts in intervened banks due to strikes.

### Policy priorities and recommended reforms
- Primary challenge: deepen financial intermediation while reducing vulnerabilities.
- Short-term stability-related actions:
  - Continue close monitoring of public banks to ensure risk management policies and practices are brought up to standard.
  - Continue to limit lending activities in these banks until such improvements are achieved.
- Structural and longer-term actions:
  - Restructure and downsize state institutions, in particular state banks, to minimize moral hazard.
  - Require directors and managers of public financial institutions to satisfy fit and proper requirements applied to private institutions.
  - Strengthen central bank independence and recapitalize the central bank as envisaged in the draft law submitted to congress.
  - Remove selective employer exemptions from contributions to public pensions as envisaged in the proposed tax law; carry out further reforms to reduce public and sectoral pension funds’ deficits; eliminate the government-guaranteed minimum rate of return in AFAP República.
  - Conduct an independent analysis of potential contingent liabilities from products offered by BSE and any proposals for mortgage insurance.
  - Reform insolvency legislation to allow reorganization of viable firms and faster, efficient liquidation of nonviable ones as envisaged in the proposed bankruptcy law.
  - Improve corporate governance and disclosure practices to develop local capital markets.
  - Implement the shift to an upgraded RTGS system and improve the legal framework related to payment and securities settlement systems.
- Strengthening supervisory and regulatory framework:
  - Increase resources for effective supervision and provide training for staff; improve information systems.
  - Provide legal protection for staff of supervisory agencies and deposit insurance agency.
  - Enhance AML/CFT legislation.
  - Improve cooperation and information exchange with foreign supervisors, including through additional MOUs.
  - Reduce the tax burden and improve the legal and regulatory framework for trust funds and securitizations.
  - Enhance regulatory authority over securities intermediaries.

*IMF FSAP Executive Summary (content unit: _cr06439 - Executive Summary)*

### 1.      Uruguay suffered a severe banking crisis in 2002. The withdrawal of nonresident

### _cr06439 - 1.      Uruguay suffered a severe banking crisis in 2002. The withdrawal of nonresident

### Overview of the financial system
- Banking sector accounts for 67 percent of total assets (78 percent of GDP) at end-2005.
- Defined-contribution pension system assets: 11 percent of GDP.
- Insurance sector assets: 3 percent of GDP.
- Other nonbank intermediaries (cooperatives and finance houses): about 2 percent of GDP.
- Offshore banking assets: 17 percent of GDP.
- Equity market capitalization: 2.2 percent of GDP.
- Domestic corporate bond market outstanding amount: 0.5 percent of GDP.
- Domestic public debt: about 16 percent of GDP, of which about 70 percent is denominated in foreign currency; mainly concentrated in short-term instruments.
- External public debt: about 57 percent of GDP and denominated in foreign currency; mainly held by foreign investors.

- State institutions account for more than half of the financial sector:
  - Banco de la República Oriental del Uruguay (BROU) accounts for 41 percent of banking system assets.
  - Banco Hipotecario de Uruguay (BHU) accounts for 11 percent of banking system assets; constrained from taking new deposits; focusing on recovery of nonperforming assets, estimated at nearly 70 percent of the portfolio.
  - Number of private banks declined from 21 to 12 after the 2002 crisis; only foreign-owned banks remain.
  - Largest pension fund accounts for about 57 percent of pension assets and is state-owned.
  - State-owned insurance company has over two thirds of the insurance business.

- Structural table (selected figures):
  - Total financial system assets: December 31, 2001 — 68 institutions, Assets (In millions of U.S. dollars) 25,060, Percent of Total Assets 100; December 31, 2005 — 49 institutions, Assets 19,280, Percent of Total Assets 100.
  - Commercial banks: Dec 31, 2001 — 22 banks, Assets 20,609, 82 percent of total assets; Dec 31, 2005 — 15 banks, Assets 12,951, 67 percent of total assets.
  - Public sector-owned banks: Dec 31, 2001 — 2 banks, Assets 7,457, 30 percent; Dec 31, 2005 — 3 banks, Assets 7,885, 41 percent.
  - Foreign banks: Dec 31, 2001 — 17, Assets 9,980, 40 percent; Dec 31, 2005 — 12, Assets 5,066, 26 percent.
  - Nonbank intermediaries: Dec 31, 2001 — 25, Assets 2,834, 12 percent; Dec 31, 2005 — 15, Assets 3,546, 19 percent.
  - Pension funds (AFPs): Dec 31, 2001 — 4, Assets 1,045, 4 percent; Dec 31, 2005 — 4, Assets 2,164, 11 percent.
  - Insurance companies: Dec 31, 2001 — 17, Assets 572, 2 percent; Dec 31, 2005 — 15, Assets 619, 3 percent.

- Dollarization and deposit composition (end-2005):
  - Foreign currency deposits: 85 percent of total nonfinancial resident deposits.
  - Credit denominated in foreign currency: 71 percent of total credit.
  - Deposits of nonresidents: about 23 percent of total nonfinancial sector deposits (declined from over 50 percent at end-2001).
  - Sight deposits remain dominant two years after the crisis.

- Insurance vs. pension sectors:
  - Life insurance policyholders cashed out policies; sector only now returning to its 2001 size in dollar terms.
  - Defined-contribution pension system grew during the crisis; contributions continued.
  - Insurance and pension institutions suffered capital losses on government debt holdings during the crisis, but losses were more than offset by capital gains from the fall in interest rates on public debt.

### Macroeconomic environment after the crisis
- Stabilization program implemented following the 2002 crisis; a Fund-supported program accompanied the first three years of stabilization and a three-year stand-by arrangement was approved in June 2005.
- Economic growth:
  - 2004: GDP grew by 12.3 percent.
  - 2005: GDP rose by over 6.5 percent, reaching its 1998 levels in real peso terms.
- Inflation: declined to 4.9 percent by end-2005, from 26 percent at end-2002.
- Real effective exchange rate: appreciated since August 2004 but by end-2005 remained about 17 percent more depreciated than in 1998.
- Current account: deficit widened, partly reflecting higher foreign direct investment.
- Public debt:
  - Public sector debt-to-GDP ratio fell from over 105 percent of GDP in 2002 to 69 percent at end-2005.
  - Primary surpluses exceeding 3.5 percent of GDP since 2003 contributed to the reduction.
- Peso interest rates: at their lowest levels in the last 10 years (as of end-2005), reflecting low international rates, improved inflation expectations, continued peso appreciation, and excess liquidity in the banking system.

- Macroeconomic vulnerabilities:
  - Financial liabilities in private and public sectors are largely expressed in foreign currency.
  - Dollar value of domestic income exposed to significant volatility.
  - High public debt; government’s ability to service it depends on continued fiscal discipline, moderate world interest rates, a relatively stable exchange rate, low sovereign risk premia, sustained economic growth, and a proactive debt management strategy.
  - Government carries contingent liabilities from state banks and large public pension and insurance sectors.

### Macro-financial stability analysis
- Main vulnerability: interplay among high government debt, state guarantees to public banks, and high dollarization.
  - State (owner of BROU) offers a full guarantee on deposits, of which 87 percent are in dollars (same as prior to the 2002 crisis).
  - To fulfill guarantees and act as lender of last resort during 2002 crisis, government borrowed bilaterally and from multilateral institutions.
  - Public debt rose from 47 percent of GDP in 2001 to over 105 percent of GDP in 2002 (with most denominated in U.S. dollars).
  - Government accumulated contingent liabilities in the form of a government guarantee on promissory notes to BROU, arising from transfer of deposits from BHU to BROU and nonperforming loans from BROU to trust funds.

- Government capacity constraints:
  - Improved liquidity and capital adequacy of banking system increases resilience, but constraints on government’s ability to act as lender of last resort could amplify external shocks.
  - Stress tests indicate external shock (major distress in Argentina or sharp rise in foreign interest rates) would deteriorate capital adequacy of several financial institutions.
  - Liquidity position of public banks improved, reducing need for public support in a moderate liquidity shock.
  - A major macroeconomic shock (loss of market access or sharp movements in exchange or interest rates; sudden-stop scenario) may trigger liquidity problems as provision of liquidity assistance in foreign currency is constrained by international reserves and access to international capital markets.
  - Recommendation: strong macroeconomic policies and reforms of state financial institutions are critical to increase resiliency.

- Cross-border risks:
  - Uruguay is one of the most financially integrated emerging markets (measured by the sum of external assets and liabilities over GDP), with large gross international transactions reflecting large off-shore activity.
  - Highly liberalized capital account environment gives rise to cross-border risks that need careful management.

- Liquidity requirement recommendation:
  - Authorities raised liquidity requirements to 30 percent of nonresident deposits in 2003.
  - Authorities should assess whether a further increase is appropriate based on higher liquidity risk from these deposits and the cost to financial institutions.

### Stress testing the banking system (summary of Box 2)
- Stress tests conducted on all private banks, cooperative banks, and BROU.
- Tests included movements in exchange and interest rates and deterioration in credit quality; macro scenarios: domestic supply shock (severe weather), current account shock (drop in Argentine GDP of 10 percent), capital account shock (sudden stop scenario; major capital outflows leading to severe recession).
- Minimum capital requirement ratios used for comparison:
  - 10 percent for banks, finance houses, and offshore banks.
  - 15 percent for cooperatives.

- Sensitivity tests:
  - Parallel shift/tilt in U.S. dollar and peso yield curves (ranging between 30–100 and 90–160 basis points, respectively) and a 30 percent depreciation or appreciation of the exchange rate, without credit risk, did not lead to CAR falling below minimum.
  - Very sharp tilt in yield curves to Russian-crisis-like levels (U.S. dollar: 163–881 basis points; peso: 123–861 basis points) would cause CAR to fall below minimum in institutions accounting for about 17 percent of banking system assets.
  - Worst-classification credit risk applied to each debtor across all banks would increase provisioning needs.
  - Increase of 60 percent in probability of default would lead to CAR decline below required minimum in institutions accounting for about 13 percent of banking system assets.

- Adverse macroeconomic event results:
  - Domestic supply shock: CAR below minimum in institutions representing 6 percent of banking system assets.
  - Current account shock (10-percent decline in Argentina’s GDP): institutions representing 28 percent of banking system assets would become undercapitalized.
  - Sudden stop scenario (severe US monetary tightening, world recession, large capital outflows, sudden drop of 8 percent in Uruguayan GDP): banks representing about 80 percent of banking system assets would have CAR below the minimum required.

- Deposit withdrawals / liquidity:
  - Several financial institutions would experience decline in 30- and 90-day liquidity ratios below 50 percent under the current and capital account shock scenarios.

### Strengths and challenges of the financial system — Commercial banks
- State bank distortions and governance:
  - Deposits in state banks have an explicit full government guarantee due to constitutionally based separate charters.
  - Presidents of the two state banks nominated by Uruguay’s president and approved by parliament; can only be removed by parliament.
  - Managers and directors of state banks do not go through the same fit and proper filter as private sector counterparts; superintendency lacks power to remove them.

- Political lending and credit culture:
  - State bank lending has often been politically motivated, fostering poor credit culture.
  - Public banks have distorted market prices under political pressures to provide sectoral subsidies (congress on a few occasions approved a moratorium on agricultural loans).
  - Lax credit evaluation and continued refinancing of nonperforming loans by state-owned banks contributed to sharp increase in nonperforming loans.
  - Public banks underpriced credit risks and failed to enforce lending obligations in segments such as housing and agricultural loans, deterring private banks from participating.

- Need for restructuring:
  - Continued restructuring and downsizing of state-owned banks is needed to minimize moral hazard.
  - Predominance of state-owned institutions raises informational, oversight, and governance issues, challenging regulation and supervision.
  - Supervisory restrictions imposed on these banks have prevented new unsound lending and induced some credit information improvements.
  - Staff recommendation: restructure and downsize public financial institutions and consider a limited public offering by these institutions; even a minority private ownership with proportional board representation may promote transparency and market discipline.
  - State banks should be restricted in deposit and lending activities and should charge rates comparable to private banks.
  - Critical that authorities refrain from political interference in state banks’ lending and loan collection efforts, including loan recovery in the liquidation funds, to change incentives and promote good credit history.

- Risk management:
  - (Text ends at "Risk management" in source.)  

*IMF staff report content (excerpt)._cr06439*

### 17.      Risk management has generally improved, but progress has been uneven. Credit

### 17.      Risk management has generally improved, but progress has been uneven. Credit

### Risk management and supervisory capacity
- Credit risk standards were tightened in the aftermath of the crisis, and regulation and supervision were refocused to address the risks of a dollarized financial system.  
- The central bank credit registry has been improved in recent years and provides essential and timely information for the evaluation of credit risks by banks and supervisors.  
- Most banks have implemented independent risk management structures and involve senior management in the development of a risk culture.  
- Public banks lack adequate systems to assess their risks (such as daily marking to market, use of VARs, backtesting and internal rating systems).

### Managing dollarization risks
- Traditionally, most banks lent in foreign exchange to unhedged borrowers, exposing them to significant credit risk.  
- Post-crisis bank responses:
  - Allocated significant capital as a buffer against FX credit risk.
  - Concentrated lending in dollars to the export sector.
  - BCU introduced prudential limits to reduce exposures and concentration of risks due to dollarization (Statistical Appendix, Table 12).  
- Impact on loan composition:
  - Share in total credit of foreign currency loans to the nontradable sector fell from 46 to 31 percent between 2003 and 2005 (Statistical Appendix, Table 13).

### Costs of financial intermediation
- Three key obstacles constrain banks’ efforts to reduce intermediation costs:
  - High reserve and liquidity requirements.
  - Distortionary taxes.
  - Labor market rigidities.  
- Reserve requirements imposed by BCU:
  - Averaging 15 percent on peso deposits and 24 percent on foreign currency deposits.  
- Central bank pays a low rate on these reserves, effectively becoming an additional tax.  
- Taxation:
  - In addition to profit and net worth taxes, intermediaries are subject to an asset tax and a tax on the credit portfolio (Statistical Appendix, Table 14).  
  - The tax reform submitted to congress in March 2006 envisages elimination of some of these taxes and should lead to a significant reduction in the tax burden of the financial system.

### Labor market rigidities in banking
- Banking sector worker benefits limit banks’ capacity to control labor costs:
  - Under “bolsas de trabajo,” banks are expected to hire workers of liquidated banks.
  - Dismissal benefits: payment of up to 20 months salaries in the banking sector versus a maximum of 6 months salaries in other sectors.
  - Employer contributions under the pay-as-you-go banking pension system (Caja Bancaria) are higher than in other sectors and finance generous benefits.

### Corporate debt vulnerabilities and restructuring
- Corporate sector exposures:
  - Private nonfinancial sector had large stocks of foreign currency-denominated debt prior to the crisis.
  - In 2004, foreign currency debt represented 65 percent of total corporate liabilities.
  - Uruguayan firms have the highest ratios of liability dollarization compared to other firms in Latin America (Statistical Appendix, Table 15).  
- Leverage and solvency:
  - Corporate leverage (debt-equity ratio) has been reduced since the crisis, but the average corporate remains highly indebted and vulnerable to peso depreciation.
  - A substantial number of firms in 2004 exhibited negative net worth as a result of the substantial depreciation of the peso immediately following the crisis.  
- Restructuring practices and recommendations:
  - Financial institutions report a sharp decline in nonperforming loans; some restructured, some written off, some transferred to asset management companies.
  - Evidence suggests restructurings often extended maturities rather than reducing principal burdens.
  - Recommendation: reform insolvency legislation to allow reorganization of viable firms and faster efficient liquidation of unviable ones.
  - Proposed new bankruptcy law envisages major improvements, including procedures similar to the U.S. Chapter 11 approach.

### Pension funds (AFAPs) and public pensions
- System structure:
  - Uruguay has a defined-benefit public pension system (BPS) and a defined-contribution system managed by AFAPs.
  - BPS covers about 90 percent of the active adult population with over one million affiliates.
  - About 670,000 employees are also affiliates of AFAPs, which manage about US$2 billion in individual accounts, equivalent to 11 percent of GDP.
  - Employees with wages above Ur$13,748 are obliged to join AFAPs; lower-wage workers have the option to join.
  - Employers pay 12.5 percent of salaries and employees contribute 15 percent of their salaries to BPS.  
- Public pension deficit:
  - Public pension system’s deficit amounted to 2.6 percent of GDP at end-2005.
  - A deficit of 1.5 percent of GDP is projected for 2010, despite earmarking of a portion of tax revenues (Statistical Appendix, Table 17).
  - Contributions finance about 50 percent of public pension expenditure; central government covers the shortfall.
  - Deficit drivers: population aging, employer contribution exemptions, lingering effects of pre-1995 low retirement ages.
  - Current tax reform proposal envisages removal of sectoral exemptions on social security contributions together with a reduction in the contributions to other sectors; changes improve efficiency but are not expected to alleviate the pension deficit.

### Sectoral pension schemes and AFAP concentration
- Risk from sectoral schemes:
  - Some sectoral schemes outside BPS/AFAP may represent a potential risk to the government, notably Caja Bancaria (bank employees’ scheme).
  - Given bank employees’ economic and political importance, the government may face pressure to inject funds to bail out the system, although no legal obligation exists.
  - Authorities are considering reform options for public sectoral schemes.
- AFAP market concentration and implicit guarantees:
  - Two of the four AFAPs account for 74 percent of assets (Statistical Appendix, Table 18).
  - State-owned AFAP República accounts for 56 percent of total AFAP assets.
  - Government effectively guarantees a minimum investment return for AFAP República, representing an unrecognized contingent liability that should be eliminated.
- AFAP investment profile and recommended adjustments:
  - Government and central bank debt represent over 80 percent of AFAP portfolios.
  - About 10 percent of AFAP assets are held in cash due to unavailability of private sector issues (Statistical Appendix, Table 19).
  - Returns on investment remain low; peso (nominal) and dollar securities earned negative real interest rates in 2005.
  - Possible measures:
    - Allow limited overseas investments in high quality assets.
    - Allow currency and interest hedging instruments to be used by AFAPs to protect against losses.
    - Broaden the range of private sector instruments for AFAP investment by improving the capital market framework.

### Insurance sector findings and recommendations
- Market structure and performance:
  - Insurance sector is small and dominated by state-owned BSE: 60 percent of life and 67 percent of nonlife business.
  - Insurance penetration remains low compared to regional averages (Statistical Appendix, Table 20).
  - Solvency indicators improved since the 2002 crisis; profitability remains poor due to high expense rates and low underwriting profits.
  - Private insurers’ growth constrained by BSE’s dominance and pricing policies.
- Oversight and BSE weaknesses:
  - Government has difficulty overseeing BSE because timeliness and quality of its data are weak; BSE’s transparency, internal controls, and risk management need improvement.
- Contingent liabilities and risks to government:
  - State is effectively BSE’s reinsurer and guarantor.
  - Two particular government risks:
    - BSE’s effective monopoly position as provider of annuities, which legally must be indexed to wages and for which there are no good market hedges.
    - BSE’s legal monopoly as provider of workers’ compensation and disability, a high-risk line of business.
- Recommended strategy:
  - Strengthen oversight, capital, and risk management of the insurance sector.
  - Improve BSE’s data quality, pricing policies, accountability, and transparency.
  - Encourage innovation in insurance products and asset allocations to improve sector profitability, growth, and sustainability.

### Capital markets: size, constraints, and policy priorities
- Market size and liquidity (2004):
  - Equity market capitalization amounted to 2.2 percent of GDP.
  - Trading accounted for 0.5 percent of market capitalization.
  - Only 11 listed firms.
- Historical issuance:
  - Bond and commercial paper issues peaked in late 1990s at US$100–200 million annually but collapsed since 1999.
- Constraints on market development:
  - Country small size, lingering crisis effects, supply constraints, legal and regulatory framework, taxation, and infrastructure issues.
  - Wider use of fideicomisos (trusts) would require lowering and simplifying tax burden, standardization of contracts, and availability of expertise to analyze special contract features.
- Regulatory and tax initiatives:
  - New draft law on capital markets gives more powers to the regulator by allowing supervision of stock exchanges.
  - Proposed new tax law envisages major simplifications in taxation to facilitate securitization.
  - Supervisor’s powers over market agents (e.g., to regulate and directly impose penalties on stock exchange brokers) are not enhanced and remain with the exchanges.
- Policy priorities:
  - Improve corporate governance and disclosure practices; draft amendments include corporate governance provisions in line with IOSCO standards.
  - Foster structured products combining several small issues with credit enhancements to attract pension funds.
  - Support development of markets for hedging instruments by:
    - Establishing a reference yield curve for government debt (task of the Debt Management Unit at the Ministry of Finance).
    - Speedier establishment of necessary legal and regulatory basis for hedging instruments.

### Financial market infrastructure: payments, securities settlement, accounting, and disclosure
- Payments and settlement systems:
  - Main BCU payments system (SEDEC) does not fully comply with several CPSS Core Principles; improvements are underway (CPSS ROSC in Annex).
  - BCU migrating RTGS payment system to a new platform, AGATA.
  - Areas for improvement: develop clear rules and procedures, establish a secondary processing site, and develop business continuity and disaster recovery plans.
  - Recommendation: conduct a comprehensive external audit of the new system once the upgrade is completed.
  - BEVSA-operated check clearinghouse handles some large-value payments but does not observe most CPSS core principles (Annex); shifting large-value payments to RTGS would enhance safety and stability.
  - BEVSA developing an automated clearinghouse (ACH) for electronic credit transfers, direct debits, and other new payment means; BCU should provide oversight and catalyze user agreements to help ACH begin operations at scale with sound legal backing.
- Securities settlement oversight:
  - Oversight currently limited and performed by the stock exchange in self-regulatory capacity.
  - Recommendation: strengthen BCU oversight with adequate resources to increase investor confidence.
- Accounting and disclosure:
  - International accounting standards are legally required for nonfinancial corporations but are poorly understood and compliance is uneven.
  - Financial corporations subject to BCU accounting rules and expected to move to international standards by 2008.
  - Corporate disclosure needs significant improvement:
    - Public disclosure required for most companies but not adequately observed except for banks and market issuers.
    - Quality of information uneven, even among listed companies.
    - Disclosure of ownership is limited.
  - Consequences: weak information complicates lending, enforcement of exposure rules, and capital market development.

### Financial stability policy framework and institutional reforms
- BCU governance and autonomy:
  - Proposed amendments to BCU’s charter aim to improve autonomy and accountability by delinking board appointment cycle from the electoral cycle.
  - Draft law grants BCU operational autonomy but further modifications needed to improve budgetary autonomy.
  - Key amendment: provide legal protection to BCU staff in fulfillment of their duties.
  - Draft law tightens financial reporting standards by requiring publication of audited financial statements in accordance with international accounting standards.
- Institutional reorganization:
  - BCU plans to reorganize financial supervision and regulation as a separate autonomous unit within the central bank.
  - Proposed unification of banking, insurance, securities, and pensions regulation under a newly-created Superintendency of Financial Services to improve supervision of financial conglomerates.

### Regulation and supervision: progress and constraints
- Banking supervision progress since 2002 crisis:
  - Superintendency of Banks improved operational efficiency, increased disclosure of financial information, and introduced prudential limits to reduce exposures and concentration of risks.
  - Overhauled loan classification and capital requirement regulations.
  - Chronology of measures in Statistical Appendix, Table 21; summary of measures presented in Box 3.
- Common problems hindering oversight effectiveness:
  - Lack of resources: superintendencies within BCU lack sufficient resources; staff technically competent but overstretched; limited funding for information systems and training; temporary multilateral assistance alleviates constraints only partially.
  - Limits on powers over state institutions: supervision of public financial institutions limited by legal framework; supervisors cannot require changes in management of public financial institutions.
  - Quality of data from state institutions: timeliness and quality problems hinder oversight of public financial institutions.
  - Result: additional improvements required despite progress (see Annex assessment against Basel Core Principles).
- Insurance sector supervisory gaps:
  - Regulation and supervision of composite companies, annuities, and BSE need improvement.
  - Need to strengthen capital and provisioning rules, financial reporting, and review treatment and transparency of reinsurance.
  - Annuity providers need better supervision on capital and financial reporting before annuity growth accelerates as AFAP retirees increase.

### Box 3 — Measures Taken to Address Liquidity, Market, and Credit Risks (summary)
- Liquidity risk arising from dollarization:
  - Imposed higher reserve requirements on foreign exchange deposits.
- Liquidity risk from cross-border exposure:
  - Increased the 25 percent liquidity requirement on nonresident deposits to 30 percent.
- Credit risk arising from dollarization:
  - Imposed higher capital requirements for foreign currency credit; increased risk weight of FX loans to 125 percent.
  - Overall required capital adequacy ratio reduced from 10 to 8 percent.
  - Amended loan classification and provisioning rules to account for sensitivity of repayment capacity to market conditions, including exchange rate movements.
  - Imposed strict criteria for classification of foreign currency consumption and housing loans (rated 3 if debt service higher than 15 percent and 30 percent of household income for FX loans and domestic currency loans, respectively).
- Credit risk from cross-border exposures:
  - Set limits on country exposures.
- Foreign exchange risks:
  - Imposed capital requirements for FX open positions.
- Market risks:
  - Introduced capital allocation for market risk as of June 2006.
- Cross-border risks, including from cross-border financial conglomerates:
  - Signed MOU with Spain and initiated procedures to sign MOUs with Argentina and other countries.
- Anti-money laundering procedures

*Italic: IMF staff report content unit _cr06439 - 17.*

### 44.      The current AML/CFT regime is largely underdeveloped but there is political

### _cr06439 - 44.      The current AML/CFT regime is largely underdeveloped but there is political

### AML/CFT regime: status and recent steps
- The AML/CFT regime of Uruguay was assessed in November 2005 by a team led by Fund staff. The detailed assessment report will be used by GAFISUD and presented during GAFISUD’s Plenary scheduled for July 20–21, 2006. The detailed assessment report and accompanying ROSC will be finalized after the Plenary discussions, and the ROSC will be submitted to the Executive Board thereafter.
- Recent measures have addressed some weaknesses, including:
  - Passage of new AML/CFT legislation.
  - Initial work to build institutional structures to support implementation.
- Remaining gaps and vulnerabilities:
  - Legislation should be improved, including coverage of a broader range of predicate offences for money laundering.
  - Confiscation provisions are generally sound but the efficiency of property registries should be enhanced to support implementation.
  - Uruguay’s role as a regional offshore financial center increases vulnerability to ML/FT from transnational business operations.
  - Deficiencies in supervision and implementation in key sectors (securities, corporate services, and casinos) add to ML/FT risks.
- Government plans and supervisory needs:
  - The government plans to introduce legislation that would over time discontinue the registration of Uruguayan offshore companies.
  - Improvements in supervisory capacity across all sectors, particularly the nonbanking sector, are required.
- Appendix II (not reproduced here) provides a summary of key recommendations.

### Safety nets and crisis management
- Legislative and institutional changes since the 2002 crisis:
  - In December 2002, congress approved legislation that allowed the BCU to resolve the ongoing crisis and granted it additional powers to supervise banks, impose corrective actions, and resolve problem cases.
  - The draft legislation establishes the deposit insurance agency (COPAB) as an autonomous institution outside of the BCU with responsibility for the resolution and liquidation of problem institutions.
  - The deposit insurance fund became operational in 2005.
- Recommended enhancements:
  - The law should establish a framework for prompt corrective action and clarify the role of the BCU as liquidity provider “under extreme circumstances.”
  - COPAB draft law calls for development of a decision-making and accountability framework for least-cost resolution and includes legal protection for COPAB staff while in fulfillment of their duties.
  - Authorities should develop a comprehensive contingency plan to:
    - Identify probable solutions for alternative crisis scenarios.
    - Test these solutions and implementation arrangements.
    - Identify weaknesses to be addressed.
    - Define roles of parties involved (BCU, COPAB, MoEF and private institutions) and means for effective coordination.

### Basel Core Principles (BCP) assessment: overview and compliance
- Assessment context:
  - Detailed assessments undertaken during missions to Uruguay in October 2005 and January–February 2006.
- Compliance summary:
  - Out of 30 core principles (CPs), 21 are assessed in the compliant category:
    - 9 are fully compliant.
    - 12 are largely compliant.
  - The other 9 CPs are in the materially noncompliant category.
- Progress since 2002 crisis:
  - Law of financial institutions amended at crisis onset to facilitate crisis resolution, empower BCU to conduct consolidated supervision, and require BCU approval for transferring ownership of financial institutions.
  - SIIF internal reorganization to focus on key supervisory processes; moving toward a risk-based approach; implemented consolidated supervision; more proactive corrective actions.
  - Increased disclosure of financial information to foster market discipline.
  - Strengthened prudential regulation: limits to exposures and concentration of risks; tightened loan classification and capital requirements.
  - Measures implemented to mitigate vulnerabilities from dollarization and cross-border contagion.

### Main weaknesses identified
- Four key areas of concern:
  1. Operational independence
     - Restricted by lack of a clear and stable source of funding.
     - Capacity of the executive branch to overturn decisions made by the BCU board.
     - Lack of explicit legal protection for bank supervisors and the BCU board.
  2. Remedial capacity regarding state-owned banks
     - SIIF inability to remove and to establish fit and proper requirements for directors and senior managers of state-owned banks.
     - Lack of authority to impose the most severe sanctions on state-owned banks.
     - Supervisor can impose alternative measures (e.g., high liquidity requirements).
  3. Regulation and supervision of market and other risks
     - Not fully implemented.
  4. Accounting norms
     - Depart in a number of respects from international accounting standards (IAS).
- Authorities’ response and actions:
  - Amendments to the BCU charter submitted to congress to strengthen autonomy by:
    - Extending terms of office of BCU directors so they do not coincide with the election cycle.
    - Establishing only two clear goals for the BCU: price stability and the regulation and supervision of the financial sector.
    - Eliminating the executive branch’s faculty to overturn BCU board decisions and replacing it with a clear accountability mechanism.
  - Regulation requiring capital charges for market risk effective in June 2006.
  - SIIF drafting a new regulation to establish risk management requirements for all risks faced by financial institutions.
  - BCU intends to issue the new chart of accounts by end-2006 to align accounting rules with IAS, with mandatory full compliance by end-2008.

### Selected detailed findings by topic
- Preconditions for effective supervision (CP 1)
  - Constitution grants autonomy to the BCU and legal framework provides adequate basis for prudential regulation.
  - Operational independence affected by absence of clear and stable legal basis for BCU’s financial resources.
  - Executive branch has power to suspend or amend BCU board decisions.
  - Current legal framework does not provide legal protection for supervisory agency and staff for actions taken in good faith.
  - Approval of the draft law submitted to congress in December 2005 would address these drawbacks.
- Removal and remedial powers (CP 1.5 / CP 22)
  - BCU does not have authority to remove directors of state-owned banks; BCU should be able to apply same remedial powers to both private and public banks.
  - BCU and SIIF have range of remedial actions against private banks but limitations regarding state-owned banks; state-owned institutions cannot be intervened or have management changed.
  - Since the crisis, SIIF has imposed stringent remedial measures on state-owned institutions, including special reserve requirements and severe limitations on operations.
- Licensing and structure (CPs 2–5)
  - Framework defines eligibility criteria, enables SIIF to assess ownership structure.
  - Executive branch grants banking licenses based on BCU recommendation; BCU authorization required to start operations.
  - Licensing includes fit and proper assessment of shareholders and managers; acquisitions in certain financial entities require prior authorization from BCU.
- Prudential regulation (CPs 6–15)
  - Capital adequacy rules generally conform to the 1988 Basle Capital Accord.
  - Regulations on capital for market risk effective as of June 2006.
  - Changes effective in June: higher weight to foreign currency loans (125 percent) relative to domestic currency loans (100 percent) while reducing overall capital requirement from 10 percent to 8 percent.
  - Capital adequacy requirements apply equally to all banks.
  - Revised control of credit risks effective January 2006: loan classification categories increased from five to eight.
  - Supervision of market risks and other risks does not conform to international standards; SIIF has policies/procedures and a specialized unit but supervisors need higher understanding of market risk and guidelines on interest rate risk and non-IT operational risks are lacking.
  - Anti-money laundering process assessed as materially noncompliant; supervision of AML compliance should be enhanced in high-risk areas and conducted on a consolidated basis.
  - BCU should consider maximizing use of annual AML compliance reports prepared by external auditors.
- Methods of ongoing supervision (CPs 16–20)
  - SIIF supervision is on a consolidated basis, comprehensive, proactive, risk-focused, emphasizes corporate governance.
  - On-site examinations are full-scale and focused; examiners utilize an in-house rating system (CERT).
  - Reporting system adequate; banks provide considerable information including daily submission of bank statements; SIIF collects monthly consolidated financial information.
- Accounting standards (CP 21)
  - Significant differences between BCU chart of accounts and IAS: accounting of derivatives, accrual of labor benefits and taxes, insufficient information in audited financial statements to estimate divergence from IAS.
  - BCU contracting consultants to align chart of accounts with international standards; process to be completed by end-2006 and full IAS compliance by all banks to commence at end-2008.
- Cross-border banking (CPs 23–25)
  - SIIF has authority and powers to supervise internationally active banks but has not signed MOUs with supervisors of Argentina, Brazil, and the United States.
  - SIIF has power to carry out on-site examinations of overseas activities of branches of local banks and has regular contacts with foreign supervisors.
  - Subsidiaries, branches of foreign banks, and offshore offices are subject to same prudential, inspection, and reporting requirements as domestic banks.
  - BCU can require closing of a foreign bank entity, including offshore offices, if host-country supervision is inadequate.
  - Currently there are six offshore offices owned by large foreign financial institutions.
  - SIIF has signed an MOU with the Bank of Spain and is drafting projects for agreements with Argentina and other interested countries.
- Authorities’ views
  - Uruguayan authorities agreed with most of the assessment and have taken action on several recommendations.
  - Authorities disagree with the assessment on anti-money laundering (CP 15) and accounting (CP 21), noting they assign high priority to AML best practices and that accounting rules in Uruguay are generally consistent with IAS.
  - Recent measures addressing AML/CFT weaknesses include passage of new AML/CFT legislation and initial work to build institutional structures.

### Recommended action plan (selected items from Table 2)
- CP 1.2––Independence and Resources
  - Additional resources should be channeled to fund personnel, training, and IT systems.
- CP 1.4––Enforcement powers
  - Regulations to be adapted to apply the same fit and proper requirements of directors of commercial banks to directors of state banks.
- CP 1.5––Legal protection
  - Legislation to be amended to protect supervisory staff against legal actions for measures taken in carrying out their duties (addressed by pending legislation).
- CP 1.6
  - SIIF to sign MOUs with home country supervisors of foreign banks.
- CP 6––Capital Adequacy
  - Ensure successful implementation by the banks of market risk capital requirements.
- CP 11––Country Risk
  - Ensure financial institutions implement country limits to provide for capital provisioning requirements established by the new Regulation to take effect in January 2006.
- CP 12––Market risks
  - Banking supervisors need additional training to analyze and monitor complexity of banks’ market activities.
- CP 13––Other risks
  - Issue a regulation addressing total risks of an institution and require a comprehensive system of risk control (SIIF preparing a draft).
- CP 15––Money laundering
  - Explicit requirement to identify beneficiary customers is needed; additional training for UIAF analysts to liaise with other authorities (addressed by pending legislation).
- CP 16––On-site and off-site supervision
  - Assign additional data systems specialists permanently to SIIF; focused training in credit analysis and market risks required.
- CP 21––Accounting Standards
  - Take measures to ensure banks implement IAS in the preparation of 2008 financial statements.
- CP 22––Remedial Measures
  - Issue a regulation defining timing and circumstances to implement specific corrective actions listed in the legislation.
- Note: It is assumed that the financial sector law will be enacted as submitted.

*Source: IMF staff assessment text from the provided document.*

### 68.      Cash and checks are the major means of retail payments in Uruguay. There is a single

### _cr06439 - 68.      Cash and checks are the major means of retail payments in Uruguay. There is a single

### Retail payments and check clearing
- Cash and checks are the major means of retail payments in Uruguay.
- There is a single national check clearinghouse in local currency and in U.S. dollars regulated by the central bank and operated by Bolsa Electrónica de Valores del Uruguay (BEVSA), a private sector entity owned by the banking sector.
- BEVSA settles the outgoing balances at the BCU.
- Checks can be endorsed several times without any limit.
- Exchange of physical items takes place between 11:00 p.m. and 11:45 p.m.
- Checks information is sent to BEVSA by banks before 12:30 a.m. on T+1.
- On T+1 between 10:30 a.m. and 11:30 a.m. a rejected items session takes place and new debit positions are settled at BCU accounts.
- The BCU ensured settlement even if no funds were available in the banks’ accounts at BCU until August 2005.
- Since August 2005 the BCU provides collateralized credit for a maximum value of 15 percent of the Responsabilidad Patrimonial Neta (with a cap of two times the minimum amount required to create a bank in Uruguay, Responsabilidad Patrimonial Básica) or the market value of securities available to collateralize, whichever is lower.
- BCU and government securities are accepted as collateral with the application of a haircut.
- See BCU Circulares 1931 of May 2005 and 1934 of August 2005.

### Funds transfer system (SEDEC / AGATA)
- The BCU operates a funds transfer system that affects the accounts financial institutions hold at the central bank through Sistema Electrónico de Comunicaciones (SEDEC).
- In addition to the automated system, participants can move funds with Cartas (paper instructions).
- The great majority of payments are denominated in local currency or U.S. dollars; participants can also request transactions in other currencies like the euro.
- Banks have access to credit from the BCU for payment system purposes; since August 2005 this credit facility is collateralized as described above.
- Reserve requirements can be mobilized throughout the day; although banks must comply with a monthly average, only in four days of the month the reserves could be under the established limit in the case of local currency and never below 90 percent in the case of foreign currency.
- The funds transfer system within SEDEC is migrating to a new platform, AGATA.

### Card payments, ATMs, and retail payment agents
- Debit cards and credit cards use is still very limited.
- There are 5 major credit card issuing companies: OCA, VISA, MASTERCARD, DINERS and AMEX.
- Settlement of card transactions:
  - Local networks for OCA and VISA;
  - Regional networks (Argentina) for MASTERCARD;
  - International networks for the rest.
- Debit cards are used almost exclusively for cash withdrawals.
- There are 4 major ATM networks: BROU, REDBANC, BANCOMAT, and CABAL with more than 575 ATMs.
- REDBANC and BANCOMAT merged in July 2005.
- There is not a national Electronic Funds Transfer at Point of Sale (EFTPOS) switch.
- Two companies provide payment services (payment and collection of utilities and taxes): Abitab and Red Pagos, with about 900 agencies throughout the country.

### Cross-border payments
- The BCU and the commercial banks are connected to SWIFT.
- Normally banks send funds to their foreign correspondents through the BCU.
- In some cases (related to export/import activity), commercial banks and other nonbank financial institutions send payment instructions directly through SWITF (via BEVSA network).
- Remittances are not a very important source of funding for Uruguay: Net Inbound remittances in 2004 represented approximately 0.5 percent of GDP.

### Securities markets and settlement systems
- Securities markets are dominated by central bank and government securities.
- Government securities: treasury bills (letras del tesoro) short-term; treasury bonds (bonos del tesoro) long-term; peso securities indexed to the CPI; securities in foreign currency and foreign markets (“Global Notes and Bonds”).
- BCU issues short term securities for monetary policy (Letras de Regulación Monetaria) denominated in peso and CPI-indexed units.
- Private sector securities: certificates of deposits (CDs), stocks and negotiable bonds; operations of private securities are very limited with trading in only one stock and five negotiable bonds.
- Securities market activities concentrated in two exchanges: Bolsa de Valores de Montevideo (BVM) and Bolsa Electrónica de Valores (BEVSA).
- Total stock exchange operations in 2004 amounted to approximately US$2,203 million:
  - 42 percent through the BVM;
  - 58 percent through the BEVSA.
- Out of total stock exchange operations: 47 percent of the value was primary market activity and 53 percent trading in the secondary market.
- In 2005, the domestic primary market has been almost inexistent as the government has issued in foreign markets (global notes and bonds).
- Most activity is in public securities except trading in CDs.
- Important trading of foreign securities due to lack of domestic securities.
- As of October 2005, there were 74 registered broker-dealers in the BVM although only 35 are active.
- BEVSA ownership and partners:
  - Owned by 17 shareholders including all the banks;
  - Has 9 special partners that do not own the company but are allowed to be direct operators.
  - All the four AFAPs (Administradoras de Fondos de Ahorro Previsional) are special partners.

### Trading and settlement practices
- Securities issued in dematerialized (escriturales) or physical form.
- BVM trading occurs on-floor from 2:00 p.m. to 2:30 p.m. and from 4:15 p.m. to 5:00 p.m.; no electronic trading system at the moment.
- Confirmation process takes place in the 30 minutes following closing of trading.
- Settlement:
  - T+1 for domestic securities and T+3 for securities issued in foreign markets at 5:00 p.m. on a gross basis for securities and multilateral net basis for funds.
- Physical securities and global securities custody held in one private bank (ABN Amro); BVM is reaching agreement to change this arrangement: physical securities under custody of a domestic bank and global securities under custody by a correspondent bank in New York.
- Government and central bank dematerialized securities are deposited in the BCU under the name of the BVM.
- Settlement process: once BVM receives funds through the ABN Amro funds settlement account or in its account at the central bank via SEDEC, BVM transfers ownership (delivers if physical) the securities.
- BVM rules include buy-in and sell-out procedures at the cost of the failing party through its Generic Stock Exchange Guarantee if securities or funds are not delivered at settlement time.
- BEVSA operates an electronic trading system open from 10:00 a.m. to 5:00 p.m. connected on-line with the BCU securities custody system (AGATA).
  - For securities under BCU custody, settlement takes place on a gross basis real-time for both securities and funds.
  - Trading in other securities is settled bilaterally.
  - Global securities settlement takes place bilaterally through international custodians on T+3.
- The OTC market is important although there are no official figures. Broker-dealers can trade through the stock exchange or in the OTC market but must inform on all operations. OTC transactions are settled bilaterally.
- In December 2005 the BVM account will identify the broker-dealer.

### Legal framework
- BCU Charter (Carta Orgánica del Banco Central del Uruguay) dated March 30, 1995:
  - Establishes “to ensure a smooth functioning of the domestic and foreign payments” as a basic function (Article 3b).
  - Articles 6 and 26 regulate issue of currency and its legal tender.
  - Law empowers BCU to establish arrangements with private and public institutions regarding payments and its settlement (Article 29).
  - Regulates reserve requirements (Article 27), open market operations, and financial assistance (Articles 27, 36 and 37).
  - Article 55 refers to securities issues by the central bank.
- Securities markets law (Ley del Mercado de Valores), approved May 2, 1996:
  - Legal basis for immobilization and dematerialization of private securities (Articles 7 to 12).
  - Uncertainty whether SML applies to public securities as Article 1 seems to exclude them.
  - Article 45 regulates approval by the BCU of securities depositories.
  - Stock exchanges are considered self-regulatory-organizations (SROs) in all aspects of their activity (Article 15), including securities settlement.
  - BCU is the entity in charge of securities market regulation and supervision (Article 20).

### Main findings (payment and settlement systems)
- The SEDEC is the main operating system of the BCU; within it, a module allows some institutions holding a current account at the BCU to transfer funds under a RTGS mode.
- Due to the high value settled through it, this funds transfer system is considered systemically important.
- The check clearinghouse operated by BEVSA is also a major funds transfer system; checks are sometimes used as an instrument for exchange of large value payments. The check clearinghouse still presents some elements of systemic importance.

- Table 3. Uruguay: Systemically Important Payments, 2004 (source: BCU)
  - SEDEC-AGATA: Number of Participants 181; Daily Value of Instructions Handled 129 (In millions of U.S. dollars); Average Value per Transaction Settled 204,408 (In U.S. dollars); Daily Volume of Instructions Handled 633; Yearly Value of Transactions over GDP 236 (In percent)
  - Checks: Number of Participants 15; Daily Value of Instructions Handled 78 (In millions of U.S. dollars); Average Value per Transaction Settled 1,570 (In U.S. dollars); Daily Volume of Instructions Handled 49,780; Yearly Value of Transactions over GDP 143 (In percent)

- The BCU does not fully observe some of the CPs and responsibilities in applying the CPSIPS; it needs to establish formally its oversight function over the payment system as a whole and have the ability to exercise its oversight function effectively.
- Important efforts to upgrade the payment system and integrate government securities infrastructure with the large-value system should be put in place soon to guarantee smooth functioning and creation of a more active market for government securities.
- The BCU’s reform program is recognized as addressing many weaknesses; authorities are encouraged to make early implementation of the program a priority.
- Authorities were in agreement with the assessment.

### Recommended actions to improve observance of CPSS Core Principles (summary)
- Legal foundation (CP 1):
  - Address pending legal issues including finality of settlement, protection against bankruptcy procedures, legal basis for netting arrangements, legal basis for public securities, legal definition of the repo, improvement of legal basis for custody arrangements, and legal basis for electronic signatures and documents.
- Understanding and management of risks (CPs 2–3):
  - Develop a clear strategy to effectively migrate all large-value payments from the check clearinghouse to the RTGS system.
- Settlement (CPs 4–6):
  - Amend legislation regarding irrevocability of a settled payment.
- Security and operational reliability, and contingency arrangements (CP 7):
  - Set up a secondary processing site.
  - Define and implement a broader business continuity plan (BCP) and a disaster recovery plan (DRP) and test them regularly.
  - Conduct periodic training and tests of procedures.
  - Re-locate back-up servers to a location with a different risk profile compared to the main site.
  - Strictly enforce security requirements to mitigate participant-borne risks.
  - Implement training programs for participants to increase system security and awareness.
  - Undertake a comprehensive external audit of the RTGS system once the upgrade is completed.
- Criteria for participation (CP 9):
  - Develop clear access criteria and criteria for exclusion of participants from the system.
- Governance of the payment system (CP 10):
  - Create a system users’ group to support the BCU and the Payment System Council and its working groups in initiating new services, accelerating development, and enhancing compliance with user needs.
- Central Bank responsibilities in applying the CPs (Responsibilities A–D):
  - Establish appropriate organizational arrangements and staffing for oversight, including separation of oversight functions from operation where possible.
  - Form a small unit in charge of payment system oversight.
  - Ensure participant cooperation, verify systems satisfy user needs, define actions for non-compliance, and collect/distribute relevant statistical information.
  - Move toward compliance of all systemically important payment systems with international standards and continuously review and improve design and operation.

### Methodological aspects of stress testing (Uruguay FSAP)
- Scope:
  - Stress tests covered main banking institutions: all private banks, cooperative banks, finance companies, offshore banks, and the state-owned Banco de La República Oriental del Uruguay (BROU), representing 80 percent of financial system assets.
  - Stress tests performed on exposures on a bank-by-bank basis as of June 2005.
- Exchange rate risk (sensitivity analysis):
  - Exposure measured by net open position of individual institutions.
  - Net open position stressed against a depreciation and an appreciation of the U.S. dollar-peso exchange rate of 30 percent (equivalent to one standard deviation of changes in the exchange rate) over a year.
- Interest rate risk:
  - Two methods used:
    1. Impact on banks’ trading book: given changes in U.S. dollar, peso, and indexed-unit yield curves, BCU repriced securities in banks’ trading book and marked them to market to quantify effect on capital and risk-weighted assets.
    2. Impact on net present value of banks’ cash flows: asset-liability management framework discounting asset and liability cash flows at spot rates implied by U.S. dollar, peso, and indexed-unit yield curves.
  - BROU excluded from cash-flow exercise as it does not report cash flows on basis of residual maturity.
- Interest rate shocks applied (Table 5):
  - Shock types: Tilt, Parallel, Russian crisis.
  - Peso Rates / U.S. Dollar Rates (in basis points):
    - Tilt: Peso Short Term +160; Medium Term +110; Long Term +90; U.S. Dollar Short Term +100; Medium Term +50; Long Term +30
    - Parallel: Peso Short Term +160; Medium Term +160; Long Term +160; U.S. Dollar Short Term +100; Medium Term +100; Long Term +100
    - Russian crisis: Peso Short Term 867; Medium Term 240; Long Term 123; U.S. Dollar Short Term 881; Medium Term 243; Long Term -163
  - Memorandum items:
    - Brazilian crisis: U.S. Dollar Short Term 80; Medium Term 30; Long Term 0
    - Asian crisis: U.S. Dollar Short Term 270; Medium Term 100; Long Term 20
  - Short-term defined as less than or equal to 3 months; medium-term greater than 3 months and less than or equal to 5 years; long term greater than 5 years.
  - Shifts in the peso and indexed-unit yield curves refer to peso rates; shifts in the U.S. dollar-denominated domestic and foreign yield curves refer to U.S. dollar rates.
  - In the case of the Russian crisis, yield rates were calibrated so that the U.S. dollar 30-year long-term yield would shift by 163 bps while the 10-year index-unit yield would shift by 123 bps.
- Data on U.S. dollar, peso, and indexed-unit yield curves in Uruguay were obtained from BEVSA (Guillermo Mara, 2005, “Curva Uruguay en Dólares de la Bolsa Electrónica de Valores del Uruguay: CUD-BEVSA” unpublished).

*IMF staff report content as provided in the source PDF.*

### 81.      The sensitivity of the banking system to a deterioration in the credit quality was

### _cr06439 - 81.      The sensitivity of the banking system to a deterioration in the credit quality was

### Credit-risk sensitivity tests
- Test 1: Replacing a bank’s debtor ratings with the worst rating assigned to those debtors by any bank in the banking system.
  - Purpose: Identify banks with lax debtor ratings and/or deficient credit evaluation that would require higher provisions.
  - Impact channel: Provisioning shortfall → reduction in capital → lower capital adequacy ratio.
- Test 2: Increase of 60 percent in the probability of default (PD).
  - Methodology: Simplified value-at-risk (VaR) over one year at a five percent confidence level using the Herfindahl-Hirschman concentration index and a normal probability distribution for loan losses, assuming the same PD for all debtors in a bank.9
  - Assumption: Only name concentration exists; no sectoral concentration.
  - Interpretation: Results are the minimum credit losses the banking system can incur when the PD increases by a 60 percent. Expected credit losses (proportional to the mean of the loss distribution) reduce provisions and capital; unexpected credit losses (proportional to the standard deviation of the loss distribution) further affect capital.

### Credit-risk model parameters and assumptions
- Data source: All parameters obtained from the public credit registry.
- Assumptions for expected losses:
  - (a) Loss given default (LGD) = one hundred percent if loans are unsecured; LGD = smaller percentage based on type of collateral and its liquidity if loans are secured.10
  - (b) Exposure at default (EAD) = size of the loan portfolio, which includes credit card lines.
  - (c) Probability of default (PD) proxied by empirical default rates, with a minimum rate equal to 4.5 percent, due to lack of PD information for Uruguayan debtors.

### Macro scenario analysis: design and scenarios
- Purpose: Measure impact on banks’ capital and liquidity of three extreme but plausible scenarios where multiple risk factors change simultaneously.
- Scenarios (defined with BCU):
  - Domestic Supply Shock: Drought
    - Effects:
      - Severe drought → decline in agricultural output and exports; disrupts hydroelectric power supply → intense use of thermoelectric generators.
      - Oil imports increase; current account balance declines.
      - Inflation pressure picks up; monetary policy adjusts to keep inflation within the 5–7 percent target range.
      - Peso depreciates in line with inflation, with no changes in the real exchange rate.
      - GDP falls by 1 percent below the baseline and agribusiness earnings weaken.
  - Current Account Shock: Regional Contagion under Adverse Terms of Trade
    - Effects:
      - Argentine private consumption declines by 10 percent.
      - Argentine peso depreciates in nominal (45 percent) and real terms (30 percent).
      - Brazilian real depreciates by 10 percent in real terms.
      - Terms of trade worsen by 4 percent.
      - Sovereign spreads increase by 500–550 basis points.
      - Government reduces real spending by 2.5 percent.
      - GDP in Uruguay falls by 4 percent below the baseline; real exchange rate depreciates by 5 percent.
      - Central bank adjusts monetary policy to keep inflation within the target range.
  - Capital Account Shock: Capital Outflows under World Recession
    - Effects:
      - Global “hard landing” → sharp increase in international interest rates; capital flows out of emerging markets → emerging market spreads increase by 600 basis points.
      - World output declines and commodity prices collapse.
      - Uruguayan peso depreciates by 48 percent in nominal (12 percent in real) terms, increasing public debt burden.
      - Authorities partly accommodate shocks through an increase in the price level, which rises by 15 percent.
      - GDP falls by 8 percent.

### Scenario inputs (Table 7 inputs, percent change unless otherwise indicated)
- Risk Factor — Scenario 1 — Scenario 2 — Scenario 3
  - Real exchange rate — 0 — 5 — 12
  - Foreign prices — 0 — -5 — -13
  - Domestic prices — 5 to 7 — 5 to 7 — 15
  - Nominal exchange rate — 5 to 7 — 17 — 48
  - GDP1/ — -1 — -4 — -8
  - Country risk (in basis points)2/ — 0 — 500 to 550 — Greater than 600
- Notes:
  - 1/ GDP gap where long-term GDP growth is equal to 3 percent.
  - 2/ The country risk was calibrated according to similar historical episodes.

### Macroeconometric simulation and stress-test implementation
- Model: BCU’s macroeconometric model — a 22-equation structural model covering real and nominal variables of the Uruguayan economy.
  - Data frequency: Quarterly.
  - Blocks:
    - (i) Real sector: behavioral equations for external sector, output, labor market, real exchange rate.
    - (ii) Monetary sector: incorporates inflation forecasts.
  - Sovereign risk premium: Not included as an endogenous equation; risk premium for each macro scenario assigned according to similar historical episodes.
  - Nominal exchange rate: Determined by sum of inflation and real exchange rate forecasts.
- Quantification approach:
  - Each risk factor estimated individually to quantify scenario impact on banks’ capital adequacy.
  - Exchange rate risk: Stress test on banks’ net open position (similar to sensitivity test).
  - Interest rate risk: Focus on effect of a parallel shift in the yield curves on banks’ trading book.
  - Credit risk: Relied on simplified version of the Mexican credit risk model where PDs were stressed according to the different scenarios.11

*Source: _cr06439 - 81.*

### 87.      In the macro scenario analysis, the liquidity stress tests were also scenario-

### _cr06439 - 87.      In the macro scenario analysis, the liquidity stress tests were also scenario-

### Liquidity stress testing (macro scenario analysis)
- The liquidity stress tests were scenario-driven.
- To obtain the effect of deposit withdrawals on the liquidity ratio, the BCU:
  - classified bank deposits into categories based on their estimated probability of being withdrawn; and
  - identified sources of funds that could become illiquid under tight market conditions.
- The tests assumed that changes in deposits would be driven by:
  - banks’ fundamentals; and
  - changes in the exchange rate and country risk.

### Key recommendations to strengthen the AML/CFT regime (SUMMARY OF KEY RECOMMENDATIONS TO STRENGTHEN THE AML/CFT REGIME)
- Develop, as planned, a coordinated national AML/CFT strategy to be implemented in 2006.
- Improve CFT legislation and the regulatory framework for all FIs.
- Cover missing elements of the designated non-financial businesses and professions sectors in the AML/CFT legislation and prioritize implementation in the company services and casino sectors.
- Strengthen and enforce customer due diligence (CDD) requirements in all sectors, and give priority to CDD for offshore/cross-border business and legal entities (e.g., beneficial ownership and control of companies).
- Enhance and expand AML/CFT supervision in all sectors, particularly on-site inspections of nonbank and offshore institutions.
- Establish formal cooperation and information exchange mechanisms with other overseas supervisors that include AML/CFT elements (e.g., Argentina, Brazil, and Paraguay).
- Raise ML/FT risk awareness in all areas particularly for higher-risk sectors.
- Improve the registration system for legal entities, real estate, and other property.
- Strengthen control mechanisms in key sectors (e.g., public sector casinos).
- Improve the efficiency and resources of the judiciary, prosecution, and law enforcement agencies.
- Enhance capacity and resources in the financial intelligence unit and the BCU’s supervisory units.

### Banking system asset and liability structure (Table 8: Uruguay: Banking System Asset and Liability Structure, 2000–05) — selected figures (in percent of total assets unless otherwise indicated)
- Total assets: 100.0 (2000), 100.0 (2001), 100.0 (2002), 100.0 (2003), 100.0 (2004), 100.0 (Jun-05)
- Liquid assets: 5.5 (2000), 7.8 (2001), 7.9 (2002), 11.3 (2003), 10.5 (2004), 11.9 (Jun-05)
- Securitities: 6.2 (2000), 5.6 (2001), 5.4 (2002), 8.1 (2003), 10.7 (2004), 9.9 (Jun-05)
- Net Credit: 79.7 (2000), 78.6 (2001), 78.8 (2002), 72.9 (2003), 70.2 (2004), 69.5 (Jun-05)
  - Performing: 69.3 (2000), 66.9 (2001), 57.1 (2002), 62.1 (2003), 63.7 (2004), 63.2 (Jun-05)
- Financial sector (assets): 24.3 (2000), 25.1 (2001), 26.6 (2002), 36.3 (2003), 36.4 (2004), 37.3 (Jun-05)
  - BCU: 6.2 (2000), 6.6 (2001), 8.4 (2002), 16.5 (2003), 13.7 (2004), 15.7 (Jun-05)
  - Domestic institutions: 1.1 (2000), 0.8 (2001), 7.1 (2002), 5.6 (2003), 4.7 (2004), 4.4 (Jun-05)
  - Foreign institutions: 17.0 (2000), 17.7 (2001), 11.1 (2002), 14.2 (2003), 18.0 (2004), 17.2 (Jun-05)
- Public sector (assets): 2.8 (2000), 3.0 (2001), 5.3 (2002), 2.9 (2003), 2.7 (2004), 1.7 (Jun-05)
- Private sector (assets): 36.2 (2000), 29.8 (2001), 22.3 (2002), 21.7 (2003), 23.5 (2004), 23.3 (Jun-05)
- Nonresidents (assets): 6.0 (2000), 9.1 (2001), 2.8 (2002), 1.2 (2003), 1.1 (2004), 1.0 (Jun-05)
- To be liquidated: 3.0 (2000), 3.1 (2001), 1.5 (2002), 1.0 (2003), 1.2 (2004), 1.0 (Jun-05)
- Nonperforming: 6.8 (2000), 8.0 (2001), 19.4 (2002), 7.1 (2003), 4.2 (2004), 4.0 (Jun-05)
- Other assets: 8.6 (2000), 7.9 (2001), 7.8 (2002), 7.7 (2003), 8.6 (2004), 8.7 (Jun-05)
- Total liabilities: 87.2 (2000), 92.9 (2001), 108.8 (2002), 93.8 (2003), 92.0 (2004), 91.1 (Jun-05)
- Deposits: 84.5 (2000), 88.1 (2001), 104.8 (2002), 90.3 (2003), 87.7 (2004), 87.2 (Jun-05)
  - Financial sector (deposits): 12.1 (2000), 10.7 (2001), 27.6 (2002), 12.0 (2003), 7.9 (2004), 7.1 (Jun-05)
  - Central Bank (of which): 4.2 (2000), 3.8 (2001), 12.4 (2002), 1.7 (2003), 0.8 (2004), 0.6 (Jun-05)
  - Public sector (deposits): 2.0 (2000), 1.8 (2001), 7.5 (2002), 8.0 (2003), 6.5 (2004), 9.1 (Jun-05)
  - Private sector (deposits): 46.5 (2000), 45.7 (2001), 50.6 (2002), 57.7 (2003), 59.7 (2004), 58.2 (Jun-05)
  - Nonresidents (deposits): 23.9 (2000), 29.9 (2001), 19.1 (2002), 12.7 (2003), 13.5 (2004), 12.8 (Jun-05)
- Other liabilities: 4.6 (2000), 4.8 (2001), 4.0 (2002), 3.5 (2003), 4.4 (2004), 4.0 (Jun-05)
- Net worth: 10.9 (2000), 7.1 (2001), -8.8 (2002), 6.2 (2003), 8.0 (2004), 8.9 (Jun-05)
- Memorandum: Total assets (in billions of U.S. dollars): 20.2 (2000), 21.1 (2001), 12.3 (2002), 11.6 (2003), 11.9 (2004), 12.4 (Jun-05)

### Financial Soundness Indicators (Table 9) — selected figures
- Capital adequacy indicators:
  - Capital/assets (percent): 7.3 (2001), -8.8 (2002), 6.2 (2003), 8.0 (2004), 8.9 (Jun-05), 8.0 (2005)
- Asset quality indicators:
  - Nonperforming loans to total loans (percent): 16.1 (2001), 38.6 (2002), 13.6 (2003), 9.2 (2004), 8.9 (Jun-05), 8.4 (2005)
  - Loan provisions to nonperforming loans (percent): 49.9 (2001), 55.0 (2002), 66.1 (2003), 59.3 (2004), 57.4 (Jun-05), 53.4 (2005)
  - Loan provisions to total loans (percent): 8.0 (2001), 2.1 (2002), 2.9 (2003), 0.5 (2004), 5.1 (Jun-05), 4.5 (2005)
- Credit growth (net of provisions, percent): 21.5 (2001), 7.1 (2002), -6.6 (2003), -10.7 (2004), -3.8 (Jun-05), 4.7 (2005)
- Net credit to the nonfinancial sector to total assets (percent): 42.0 (2001), 46.1 (2002), 25.4 (2003), 27.3 (2004), 26.0 (Jun-05), 25.7 (2005)
- Profitability indicators:
  - ROA: -2.0 (2001), -29.8 (2002), -2.8 (2003), 0.7 (2004), 0.9 (Jun-05), 0.5 (2005)
  - ROE: -27.4 (2001), ... (2002), -44.7 (2003), 9.2 (2004), 10.3 (Jun-05), 6.5 (2005)
- Liquidity indicators:
  - Liquid assets to total assets (percent): 7.8 (2001), 7.9 (2002), 11.3 (2003), 10.5 (2004), 11.9 (Jun-05)
  - Liquid assets to total deposits (percent): 8.9 (2001), 7.6 (2002), 12.5 (2003), 12.0 (2004), 13.7 (Jun-05)
  - Foreign currency assets to foreign currency deposits (percent): 8.1 (2001), 7.0 (2002), 12.5 (2003), 11.6 (2004), 12.1 (Jun-05)
  - Domestic currency assets to domestic currency deposits (percent): 16.3 (2001), 14.5 (2002), 12.1 (2003), 14.3 (2004), 22.1 (Jun-05)
  - Net loans to the private sector/total deposits (percent): 47.8 (2001), 29.1 (2002), 28.5 (2003), 31.1 (2004), 29.8 (Jun-05)
- Sensitivity-to-risk indicators (average maturity, years) — Private banks:
  - Assets: 1.7 (2001), 1.3 (2002), 1.2 (2003), 1.1 (2004), 1.2 (Jun-05)
  - Liabilities: 1.0 (2001), 1.7 (2002), 1.0 (2003), 0.7 (2004), 0.6 (Jun-05)
- Net open position (percentage of net worth) for BROU, BHU, private banks and cooperatives: -95.7 (2001), 232.5 (2002), -48.2 (2003), -8.6 (2004), -8.4 (Jun-05), ...

### Selected macro and external indicators (Table 10 and related tables) — selected figures
- Real GDP (percent change): -11.0 (2002), 2.2 (2003), 11.8 (2004), 6.6 (2005)
- GDP (US$ billions): 12.1 (2002), 11.2 (2003), 13.3 (2004), 16.9 (2005)
- CPI inflation (eop): 25.9 (2002), 10.2 (2003), 7.6 (2004), 4.9 (2005)
- Unemployment (in percent): 17.0 (2002), 16.9 (2003), 13.1 (2004), 12.1 (2005)
- Base Money (Program definition, end of period data): 22.1 (2002), 24.9 (2003), 11.1 (2004), 34.1 (2005)
- Credit to the private sector (constant exch. rate): -17.6 (2002), -23.9 (2003), -11.2 (2004), 2.7 (2005)
- Revenue (percent of GDP): 32.1 (2002), 32.0 (2003), 30.9 (2004), 31.8 (2005)
- Primary balance (percent of GDP): 0.0 (2002), 2.7 (2003), 3.8 (2004), 3.9 (2005)
- Overall balance (percent of GDP): -4.6 (2002), -3.2 (2003), -2.2 (2004), -0.7 (2005)
- Public sector debt (percent of GDP): 96 (2002), 104 (2003), 92 (2004), 69 (2005)
- Gross official reserves (US$ millions): 772 (2002), 2,087 (2003), 2,512 (2004), 3,438 (2005)
  - In months of imports of goods and services: 3.7 (2002), 9.2 (2003), 8.0 (2004), 8.7 (2005)
  - In percent of short-term debt plus FX deposits: 7.0 (2002), 20.0 (2003), 27.7 (2004), 32.9 (2005)

### Financial integration and currency-related regulations (selected)
- Financial Integration (total foreign assets plus liabilities in percent of GDP) — Uruguay: 194 (2001), 193 (2002), 280 (2003), 286 (2004)
- Net Foreign Assets (percent of GDP) — Uruguay: -10 (2001), -11 (2002), -13 (2003), -23 (2004)
- Regulations that discriminate by currency composition (Table 12) — selected entries:
  - Reserve requirements (in percent of deposits): Dollar 24 on average; Pesos 15 on average
  - Reserve requirements (rate of remuneration): Dollar 0.5 percent; Pesos None
  - Deposit insurance premiums (in percent of average deposits in the previous year): Dollar 0.2; Pesos 0.1
  - Deposit insurance coverage: Dollar US$5,000 per depositor per bank; Pesos 250,000 units whose peso value is indexed to the CPI—currently about US$15,000 per depositor per bank
  - Capital requirements (in percent of risk-weighted assets, effective June 2006): ... 20 percent lower than for dollar credit
  - Tax on interest income on time deposits exceeding one year (in percent of interest income, proposed tax reform): Dollar 10; Pesos 3
  - Provisioning requirements for consumer loans: Threshold for household exposure that requires upfront 20 percent provisioning (in percent of household income): Dollar 15; Pesos 30
  - Provisioning requirements for individual mortgages: Threshold for household exposure that requires upfront 20 percent provisioning (in percent of household income): Dollar 20; Pesos 35
  - Reclassification of restructured loans: Period of continued loan payment before a restructured loan can be reclassified (in months): Dollar 18; Pesos 9

### Other sectoral and supervisory tables — selected highlights
- Share of foreign currency credit to the nontradable sector in total credit (Table 13):
  - Banking System: 45.9 (2003), 34.3 (2004), 30.7 (2005)
  - Banks (weighted average): 44.9 (2003), 32.7 (2004), 29.7 (2005)
  - Cooperatives (weighted average): 36.4 (2003), 31.8 (2004), 34.2 (2005)
- Financial sector taxes (Table 14):
  - Profit tax (IRIC): 30 percent of profits
  - Net worth tax (IPAT): 2.8 percent of taxable net worth
  - Value-added tax: 23 percent of interest on loans to individuals
  - Asset tax (IMABA): 1/ 2 percent of assets
  - Supervisory tax (ICOSIFI): 0.10 percent of assets
  - Credit card tax: 1/ 0.10 UR (wage-indexed units) per credit card issued
  - Supervisory fee: 4/ 0.10 percent of assets
  - (Notes indicate envisaged changes submitted to congress in March 2006 and December 2005)
- Liabilities of nonfinancial corporate sector denominated or indexed to foreign currency (median values, Table 15):
  - Uruguay: 85.4 (1999), 88.0 (2000), 74.0 (2001), n.a. (2002), 82.1 (2003), 74.1 (2004)

### Chronology of selected prudential regulatory changes (2002–05) — selected entries (Table 21)
- Feb 28, 2002 (Circular 1.773): Risk rating — All banks and cooperatives required to present to the supervisor a report from an independent rating agency at least once a year; local rating scale to be used in addition to agency scale.
- Mar 22, 2002 (Circular 1.778): Fit and proper — Guidelines for supervisory opinion necessary for operation of new financial institutions.
- Dec 20, 2002 (Comunicación 2002/225): Accounting standards — Modifies accounting plan distinguishing trading vs held-to-maturity investment assets, following NIC principles; tradable securities to be valued at market prices.
- Jan 2, 2003 (Circular 1.837): Capital requirements — Sharply increases minimum capital requirements.
- Apr 2, 2003 (Circular 1.850): Nonresident deposits — Imposes a liquidity requirement equivalent to 30 percent of non less than one year maturity nonresident nonfinancial sector deposits and other obligations, to be held in selected asset classes.
- Sep 12, 2003 (Comunicación 2003/179): Information technology — Requires banks to adopt management practices guided by COBIT.
- Sep 15, 2003 (Comunicación 2003/180): Credit classification — Requires financial institutions to write off past due loans from financial institutions; establishes arrastre for nonfinancial sector borrowers with past due loans more than 240 days.
- Oct 2, 2003 (Circulars 1.877/1.878/1.879): Prudential limits, information retention, borrower information — Reduces regulatory exposure limits, requires 20 years retention of information for the central bank, and imposes financial statement/audit requirements for large borrowers.
- Feb 28, 2004 (Circular 1.901): Audit — Requires financial institutions to set up an internal audit unit and an audit committee; audit committee to issue a report at least every six months.
- Mar 3, 2004 (Circular 1.905): Prudential limits — Establishes limits to exposures with foreign governments, positive for those with risk rating equal or higher to AA-.
- Aug 6, 2004 (Comunicación 2004/205): Consolidated supervision — Creates database with information on economic groups including local and foreign entities connected to supervised individuals or enterprises.
- Dec 9 and Dec 10, 2004 (Comunicación 2004/352 and 2004/356): Financial flows and credit bureau — Requires submission of cash flow projections for 2005 and expands credit bureau coverage by requiring banks to submit information of borrowers with outstanding debt exceeding specified thresholds.

*Source: IMF staff report extract and statistical appendices as provided.*

### 0.025 percent of the basic capital requirements (down from 0.15 percent).

### _cr06439 - 0.025 percent of the basic capital requirements (down from 0.15 percent).

### Regulatory changes timeline
- Jan 18, 2005 — Comunicación 2005/019: Credit classification changes effective January 2006.
- May 13, 2005 — Circular 1.933: State bank regulation (sanctions) issued.
- Aug 30, 2005 — Circular 1.938: New capital requirements announced, effective June 2006; capital requirements established in units indexed to the CPI effective September 2005.
- Dec 14, 2005 — Comunicación 2005/265: Financial flow reporting requirement for 2006 cash flow projections.

### Credit classification (Comunicación 2005/019)
- Effective January 2006.
- Increases the number of credit risk categories from 5 to 8 to expand the array of provisioning for credit risk.
- More emphasis on capacity to repay and analysis of risk factors affecting the debtor.
- For nonresident financial institution borrowers the classification is based on reputable international rating institutions.
- For domestic financial institutions, classification is based on actual payment history.

### State bank regulation (Circular 1.933)
- Regulates the sanctions that the BCU can impose on financial institutions.
- Explicitly includes state banks and their senior management within the scope of sanctioning authority.

### Capital requirements (Circular 1.938)
- New capital requirements effective June 2006.
- Establishes capital requirements for market risks.
- Imposes higher capital requirements for credit risk of loans denominated in foreign currency than for those denominated in pesos.
- Effective September 2005, capital requirements are established in units indexed to the CPI.
- Numerical change noted in header: 0.025 percent of the basic capital requirements (down from 0.15 percent).

### Financial flows (Comunicación 2005/265)
- Requires financial institutions to submit cash flow projections for 2006 following central bank guidelines.

*Source: Superintendency of Banks.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06439.pdf_