## _cr11198 ## Source details **Canonical URL:** [_cr11198](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11198.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11198.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11198.pdf.json) --- ### Executive Summary — financial system structure and recent trends - Commercial banks dominate: 15 commercial banks hold assets equivalent to 64 percent of total system assets; the four largest represent about 60 percent of total bank assets. - Ownership: foreign/domestic asset ownership split 50:50, including one state-owned commercial bank. - Other intermediaries: 12 finance companies (FC) and 372 cooperatives holding assets equivalent to 3 percent and 15 percent of GDP respectively. - System growth: total financial system assets grew from 61 percent of GDP in 2005 to 84 percent in June 2010, driven by banks and cooperatives. - Bank balance-sheet composition: - Banks’ loans represent about 57 percent of bank assets; remainder predominantly liquid resources held in central bank accounts. - About 60 percent of bank liabilities are private deposits; the rest are liabilities to the public sector, foreign creditors, and a small amount of subordinated bonds. - Loan concentration: loans concentrated in large agribusiness; FC and cooperatives dominate consumption loans and MSME lending. - Nonbank state-owned financial institutions hold assets of about 2 percent of GDP: Agencia Financiera de Desarrollo (AFD), Fondo Ganadero, Crédito Agrícola de Habilitación (CAH), and SENAVITAT. ### Macroeconomic outcomes (2005–2011) and risks - Growth and shocks: - Between 2005–2008, real GDP rose by 5 percent a year. - 2009 recession driven by global financial crisis and a severe drought. - Real GDP growth was 15.3 percent in 2010 and is expected to remain above potential, at 5.6 percent, in 2011. - Credit growth and inflation risks: - Credit growth peaked at 75 percent (y-o-y) in May 2008. - Decelerated in 2009, rose again in 2010; credit growth stood at over 40 percent (y-o-y) in January 2011. - Price developments suggest inflation could rise to over 10 percent in 2011. - Financial dollarization and funding structure: - Dollarization ratios: about 40 percent for deposits and 45 percent for loans. - Around 70 percent of bank deposits are sight; of sight deposits about 65 percent are large. - High central bank net international reserves: 165 percent of dollar deposits as of end December 2010. - Exposure to macro volatility: - Credit to agribusiness and commerce accounts for almost 65 percent of banks’ loan portfolio. ### Financial soundness, capital, and stress tests - General soundness: - NPL ratio low at 2 percent as of December 2010, but NPLs grew 15.2 percent in 2010. - Specific provisions at 74 percent of NPLs. - Leverage of largest borrowers: median leverage for the largest 10 borrowers was 0.8 as of June 2010; for some large borrowers leverage reached up to 4. - Capital adequacy: - Two systemic banks have CARs below or barely at the 10 percent minimum if Basel I definitions applied. - Adjustments by mission to CARs: revaluation reserves included as Tier 2 after 55 percent discount; Tier 2 limited to 100 percent of Tier 1; subordinated debt limited to 50 percent of Tier 2; certain collateral risk weights adjusted from 50 percent to 100 percent (except household mortgages). - After adjustments: one institution’s CAR falls slightly below the 10 percent adjusted regulatory CAR, two others very close to minimum. - Stress-test scenarios and outcomes: - Main scenarios: (i) GDP decline by 5 percent in 2011 and by 5 percent in 2012 (two droughts/falling commodity prices); (ii) high inflation about 12.5 percent y-o-y with nominal policy rates in the 14-15 percent range for two consecutive years; plus default of largest and two largest borrowers; liquidity run of five days. - Findings: most banks resilient to shocks, but exposure to large borrowers high; some small banks face significant liquidity risk; two systemic banks’ CARs would fall under the 10 percent minimum under most stress tests; a third bank is weak but not systemic. - Stress-test system-wide cost of capitalization examples (percent of GDP): 0.17; 0.24; 0.01; 0.10; 0.25; 0.01; 0.01. ### Cooperatives: soundness, supervision, and recommended sequencing - Cooperatives’ scale and vulnerabilities: - Cooperatives’ assets: 15 percent of GDP. - Loans in cooperatives growing moderately: 11.7 percent y/y by June 2010. - Cooperatives’ NPL ratio about three times the bank ratio. - Deposits growing faster than loans; margins and profitability under pressure. - Cooperatives lack a lender of last resort (LOLR) and a deposit insurance scheme; supervision less stringent than for banks. - Systemic linkages: - Some cooperatives larger than banks; the eleventh largest financial institution is a cooperative with about 3 percent of total system financial assets. - Up to 90 percent of cooperatives’ deposits in the banking sector are located at one of the largest banks (about a fifth of that bank’s total deposits). - At end-2009, banking loans to cooperatives represented 2.5 percent of banks’ loan portfolio; cooperatives’ deposits amounted to 3.3 percent of banks’ deposits. - Stress-test findings and recommendations: - Most cooperatives highly exposed to liquidity risks; urgent need to set up deposit insurance and emergency liquidity funds, supported by stronger supervision. - Recommendations: - INCOOP should strengthen supervisory approach and promote a safety net. - Adopt strong “fit and proper” rules for cooperative managers and board members. - Align prudential framework of large cooperatives with banking standards, especially capital adequacy and provisioning (Table 1: priority H, time frame MT). - Cooperatives should set up a liquidity assistance scheme and deposit insurance for cooperatives following best practices (Table 1: priority H, time frame ST). - Sequencing caution: implement liquidity scheme and deposit insurance only after soundness of largest cooperatives ascertained to avoid exacerbating moral hazard. ### Central Bank recapitalization, monetary policy, and systemic liquidity management - CBP recapitalization: - CBP Capitalization Law approved in April 2010. - Recapitalization benchmark: about 6.25 percent of GDP assessed by a Fund’s TA mission in 2006; ongoing large losses increased recap needs. - Status: CBP submitted proposal to MoF on financial features of bonds; studies underway at MoF; no calendar established for effective implementation. - Immediate implementation stressed because CBP’s negative capital constrains sterilization capacity and ability to act as LOLR. - Recommendation: MoF should start formal discussions with CBP and establish a work calendar to proceed quickly (Table 1: MOF should expedite planned recapitalization of the CBP — priority H, time frame ST). - Monetary policy operations and excess reserves: - Inflation target: 5 percent within a +/-2.5 percent band. - Bank excess reserves chronically high due to structural factors: large proportion of short-term deposits; lack of efficient CBP liquidity-management instruments; unclear repo legal framework; rudimentary payment system. - CBP negative capital limits scope of sterilization; expansionary policy contributed to build up of Guarani-denominated excess reserves. - Consequences: perverse market incentives, inhibited interbank market, weakened monetary transmission, higher interest rate spreads, harder migration toward inflation targeting. - Recommendations: - Tighten monetary policy faster. - Adopt consistent framework for forecasting and managing systemic liquidity; step up efforts to gather timely MoF budget execution and bank reserve demand information. - Clarify repo legal framework and implement a well-designed overnight facility. - Use recapitalization bonds to conduct open market operations. ### Payment systems, market infrastructure, and credit reporting - Payment system status: - Current system based on checks cleared manually at three CBP-sponsored clearing houses and settled the following day on banks’ accounts at the CBP. - Recommendation: obtain congressional approval for draft payment system law (Table 1: priority H, time frame ST); implement new payment system (envisaged October 2011) and develop CBP oversight (priority M, time frame ST). - Money and FX markets: - Recommendations to deepen markets include clarifying legal framework for repo operations, clarifying ownership status of IRM, Treasury adopting a debt management strategy, and using recapitalization bonds in open market operations. - Credit information and collateral registries: - Three credit information systems operate; SB operates public registry Central de Riesgos Crediticios (CRC) with positive and negative information reported monthly. - Registries for property rights and secured transactions unified under a single general direction but inefficient and largely non-computerized. - Recommendations: - CBP should prepare legislation establishing legal framework for the credit reporting industry (CRI) (priority M, time frame MT). - Submit law on organization and coordination of the general registry and cadastre; make electronic registries for immovable assets fully operational and available online (priority M, time frame MT). ### Financial safety net, bank resolution, and deposit insurance - Safety-net features and gaps: - Safety net well developed but needs improvement in early corrective action, resolution regime for systemic crises, and Emergency Liquidity Assistance (ELA). - ELA regulations outdated (not updated since 2002); recommendation: revise and disseminate ELA regulations and consider pre-qualification of collateral. - Systemic crisis regime: “declaration of systemic risk” does not require removal of troubled banks’ managers and lacks options such as temporary administration or bridge bank to override shareholders’ rights. - Recommendation: strengthen coordinating arrangements among supervisors and preserve financial stability through improved legal tools. - Deposit Insurance Fund (FGD): - Coverage level: US$23,800 or 9.6 times GDP per capita — Paraguay has the second largest coverage in America. - About 95 percent of depositors and 19 percent of deposits are fully covered. - Total resources (excluding treasury bonds) of the FGD amounted to 1.6 percent of total deposits and 8.2 percent of insured deposits as of September 2010. - Coverage contributes to moral hazard; recommendation to consider reducing coverage and introduce a risk-adjusted premium. - Recommendation: complete remaining US$24 million capitalization of the FGD by the government and establish a flexible mechanism for adequate contingent funding (Table 1: priority H, time frame ST). - Crisis preparedness: - CBP should undertake a crisis simulation of the resilience of the financial safety net (Table 1: priority M, time frame ST). - Recommendation: implement a system for quick access to effective deposit coverage information to facilitate timely deposit guarantee payments. ### Regulation and supervision of banks — progress, constraints, and reform priorities - Progress since 2005 FSAP: - Risk-based supervision being implemented; regulations on credit, market, and liquidity risks issued. - Strengthened licensing, transfer of ownership requirements, “fit and proper” criteria; supervisors’ qualifications and training improved. - AML-related supervision overhauled; recognized by GAFISUD and FATF. - Legal constraints: - Banking law (LGBFOEC 861/96) and central bank law (LOBC 489/95) are detailed and prescriptive, fixing quantitative limits and limiting CBP’s delegated regulatory capacity. - CBP lacks power to change definition of capital or solvency ratios; has used workarounds (increase minimum paid-in capital, higher general provisioning, ad-hoc monitoring and provisioning add-ons). - Key recommended legal and supervisory changes (selected from Table 1): - Amend banking and central bank laws to state principles and delegate technical prudential regulations to CBP (priority H, time frame MT). - Review numerator and denominator of CAR to align with Basel standards; substantially revise definition of regulatory capital. - Introduce guidance/regulation for all material risks including interest rate risk in the banking book and operational risk. - Amend regulations on renovated, refinanced and restructured (RRR) loans to prevent misreporting and require strict identification and provisioning rules. - Strengthen capacity of Division de Riesgos Financieros to supervise market and liquidity risk (Res. 2/2009). - Implement Reingeniería Informática project (planned Dec 2011) to modernize off-site supervision and reporting. ### INCOOP governance, resources, and supervision capacity - Institutional features and constraints: - INCOOP has adequate regulatory authority but constrained by insufficient resources, limited enforcement power, and governance structure that compromises independence (conflicts of interest). - Example remuneration: examiner’s monthly salary ranges from US$360 to US$540. - Governance and supervisory improvements needed: - INCOOP should issue fit and proper requirements for board members and senior management; board composition should avoid simultaneous managerial responsibilities in cooperatives. - INCOOP should produce an annual report with performance information including financial statements. - Strengthen off-site supervision and ensure quality of reported information; technical assistance received (DGRV) helped develop early warning system for 23 largest S&Ls (first phase active January 2011). - Supervisory delegation for smaller cooperatives could be made to second-level cooperatives or certified external auditors. ### Other financial intermediaries, pensions, and developmental issues - State-owned institutions: - Not a major stability concern but do not intermediate resources efficiently or transparently; one out of five is deposit-taking. - Recommendation: develop a clearly defined strategy for state-owned banks to complement private sector activity. - Pension system: - System remains multiple pay-as-you-go defined benefit regimes; three out of six central government-related regimes have cash flow deficits covered by the government (who does not make employer contributions). - Instituto de Previsión Social (IPS) needs significant parametric adjustments. - Paraguay lacks a comprehensive regulatory framework for pension schemes; recommendation: MoF should prepare legislation establishing a dedicated pension supervisor and undertake actuarial assessments adhering to international standards (Table 1: priority H, time frame MT). - Financial inclusion and infrastructure: - Estimated 70–80 percent of the population only uses cash for transactions. - Recommendations: introduce a basic bank account; speed up branchless banking via nonbank agents and mobile network operators; regulate security standards for branchless/mobile channels. - Credit information industry fragmented; recommendation to launch a major reform program of credit reporting systems per new international standards to be issued in early-2011. ### AML/CFT progress and supervisory gaps - Institutional framework: - Law 1015/1997 assigns SEPRELAD as main authority; enforcement responsibilities divided among SBP/IS, National Securities Commission, and INCOOP. - SEPRELAD Resolution 172/2010 mandates an AML/CFT Manual and CDD measures for each financial institution. - SB established and trained a special unit for AML/CFT supervision with SEPRELAD partnership. - Progress and remaining shortcomings: - Paraguay has made outstanding progress; remaining deficiencies include enactment and procedural implementation relating to Special Recommendation III (SRIII) and Special Recommendation IX (SRIX). - Authorities reported provisions relating to freezing of terrorist assets (SRIII) were submitted to Congress in January 2011. - Resource constraints and limited coordination with INCOOP hamper comprehensive sectoral AML/CFT supervision. ### Key specific findings and statistics (selected, preserved exactly) - Total financial system assets: 61 percent of GDP in 2005 → 84 percent of GDP in June 2010. - Banks’ loans: about 57 percent of bank assets. - Private sector deposits: about 60 percent of bank liabilities. - Institutions: 15 commercial banks; 12 finance companies; 372 cooperatives. - Cooperatives’ assets: 15 percent of GDP. - Nonbank state-owned financial institutions’ assets: about 2 percent of GDP. - Two systemic banks have CARs below or barely at the 10 percent minimum under Basel I definitions. - CBP Capitalization Law approved in April 2010. - Credit growth: peaked at 75 percent (y-o-y) in May 2008; over 40 percent (y-o-y) in January 2011. - NPL ratio: 2 percent as of December 2010; NPLs growing 15.2 percent in 2010. - Dollarization ratios: about 40 percent for deposits and 45 percent for loans. - Central bank net international reserves: 165 percent of dollar deposits as of end December 2010. - Deposit insurance coverage: US$23,800 or 9.6 times GDP per capita. - FGD resources (excluding treasury bonds): 1.6 percent of total deposits and 8.2 percent of insured deposits as of September 2010. - Recapitalization benchmark for CBP: about 6.25 percent of GDP (Fund’s TA mission, 2006). - Cooperatives’ loan growth: 11.7 percent y/y by June 2010. - Population 2008 (millions): 6.2; Gini index (2007/2008): 58.4; Unemployment rate (2009): 6.4; Life expectancy at birth (2007, pro): 71.7; Percentage of population below the poverty line (2009): 37.9; Adult illiteracy rate (2008): 5.2; Rank in UNDP development index (2008): 98 of 179; GDP per capita (US$, 2009): 2,264.9; Estimated share of population using only cash for transactions: 70–80 percent. - Example stress-test system-wide capitalization costs (percent of GDP): 0.17; 0.24; 0.01; 0.10; 0.25; 0.01; 0.01. - Examiner’s monthly salary example: US$360 to US$540. - INCOOP pilot liquidity plan: through initial phase expects to cover 54 percent of the difference between deposits and liquid assets; a credit line of US$50 million would be sufficient. - Tenure/targets and priorities cited throughout: Table 1 entries referenced as priority H, M, or L and time frame ST, MT as indicated in the source text. *Source: IMF staff report, content provided in the source PDF unit.* ### Executive Summary ...................................................................................................... ### Executive Summary ### Financial system structure and recent trends - The financial system is dominated by commercial banks: 15 commercial banks hold assets equivalent to 64 percent of total system assets; the four largest represent about 60 percent of total bank assets. - Foreign/domestic asset ownership is split 50:50, including one state-owned commercial bank. - Other institutions: 12 finance companies (FC) and 372 cooperatives holding assets equivalent to 3 percent and 15 percent of GDP respectively. - Total financial system assets grew from 61 percent of GDP in 2005 to 84 percent in June 2010, mainly due to growth of banks and cooperatives. - Banks’ loans represent about 57 percent of bank assets; the remainder is predominantly liquid resources held in central bank accounts. - About 60 percent of bank liabilities are private deposits; the rest are liabilities to the public sector, foreign creditors, and a small amount of subordinated bonds. - Bank lending concentration: loans concentrated in the large agribusiness sector; FC and cooperatives dominate consumption loans and loans to micro, small, and medium enterprises. - Nonbank state-owned financial institutions hold assets of about 2 percent of GDP: Agencia Financiera de Desarrollo (AFD), Fondo Ganadero, Crédito Agrícola de Habilitación (CAH), and SENAVITAT. ### Macroeconomic risks and financial institutions’ soundness - Progress: regulation and supervision of banks have made major progress since the last FSAP; a risk-based approach is being implemented and several prudential norms strengthened (risk management, licensing, “fit and proper” criteria). - Legal constraint: banking and central bank laws limit the Central Bank of Paraguay (CBP)’s ability to fully implement an effective risk-based supervisory framework; recommendation to overhaul laws so they state principles and delegate specific technical requirements to the CBP. - Capital adequacy and resilience: - Most banks appear resilient to shocks. - Exposure to large borrowers is high. - Some small banks face significant liquidity risk. - Two systemic banks have CARs below or barely at the 10 percent minimum if Basel I definitions were applied. - A third bank is weak but not systemic. - Rapid credit growth: - Very rapid credit growth is creating conditions for a repetition of past boom and bust cycles. - Delays in withdrawing monetary policy stimulus applied in response to the global crisis contributed to excess liquidity and prolonged low interest rates. - Credit quality still appears good; corporate borrowers do not seem excessively leveraged, but competition among financial institutions is intensifying. - Policy recommendations to moderate risks: - Tighten monetary policy faster. - Bring the definition of bank capital closer to international standards. - Ensure adequate provisioning; support for planned introduction of forward-looking provisions. - CBP should enhance classification and provisioning framework and proceed with planned introduction of forward-looking provisions (Table 1: priority L, time frame MT). ### Central Bank recapitalization and systemic liquidity - The CBP recapitalization is a key step to address current and future financial stability challenges. - The CBP Capitalization Law was approved in April 2010; effective implementation is crucial to redress a weak financial situation that limits sterilization capacity and monetary policy effectiveness to moderate credit growth. - Recommendation: MoF should start formal discussions with the CBP and establish a work calendar to proceed quickly (Table 1: MOF should expedite planned recapitalization of the CBP — priority H, time frame ST). - CBP should enhance capacity for systemic liquidity management (Table 1: priority H, time frame MT). ### Financial sector oversight and regulatory gaps - The banking law should be amended so the law states principles while delegating detailed prudential regulations to the CBP (Table 1: priority H, time frame MT). - Improvements noted in risk-based supervision; however, legal constraints limit further progress. - Payment systems: congressional approval should be obtained for the draft payment system law (Table 1: priority H, time frame ST); CBP should expedite implementation of new payment system and develop its oversight (priority M, time frame ST). - Credit information and collateral registries: CBP should prepare legislation establishing a legal framework for the credit reporting industry (CRI) (priority M, time frame MT). Submit to parliament the law on organization and coordination of the registry general and the cadastre; make electronic registries for immovable assets fully operational and available online (priority M, time frame MT). ### Cooperatives: supervision, safety net, and governance - Progress in supervision of cooperatives with focus on largest ones, but regulation and supervision remain less stringent than for banks. - INCOOP is constrained by insufficient resources, limited enforcement power, and governance structure that compromises independence (conflicts of interest). - Recommendations: - INCOOP should strengthen its supervisory approach and promote development of a safety net for cooperatives. - Adopt strong “fit and proper” rules to ensure qualified persons manage members’ savings (integrity, capacity, and independence). - Align cooperative prudential framework with banking standards, in particular capital adequacy and provisioning requirements of large cooperatives (Table 1: priority H, time frame MT). - Cooperatives should set up a liquidity assistance scheme and deposit insurance for cooperatives, following best practices (Table 1: priority H, time frame ST). - Timing: implement liquidity scheme and deposit insurance only after soundness of largest cooperatives has been ascertained to avoid exacerbating moral hazard. - Urgency: take action given liquidity stress test results for cooperatives. ### Financial safety net, crisis management and preparedness - Paraguay’s banking system safety net is well developed but needs improvement in rules for: - Early corrective action. - Resolution regime for systemic crises. - Emergency liquidity assistance (ELA). - Deposit Insurance Fund (FGD): additional contingent funding is necessary given the large size of coverage; MoF should strengthen FGD contingency funding (Table 1: priority H, time frame ST). - CBP should undertake a crisis simulation of the resilience of the financial safety net (Table 1: priority M, time frame ST). - Need to strengthen coordinating arrangements among supervisors and arrangements to preserve financial stability. ### Macro-prudential policy framework and institutional coordination - Recommendation to improve coordination and information sharing among all agencies responsible for financial stability and sector oversight. - Strong encouragement to set up a committee of all regulators at the highest level with: - A clear mandate. - An agenda with concrete deliverables. - Sufficient technical support teams. - Responsibility to report on progress regularly. - Legislative recommendation: set up committee of all regulators at the highest level (Table 1: priority M, time frame MT). ### Financial sector development and other recommendations - Develop and implement a comprehensive agenda to foster financial inclusion in a sustainable manner (Table 1: priority M, time frame MT). - MoF should prepare legislation establishing a dedicated pension supervisor and undertake actuarial assessments of various pension regimes—adhering to international standards—to anchor parametric reform (Table 1: priority H, time frame MT). - CBP should prepare legislation establishing a sound legal framework for the credit reporting industry (CRI) (Table 1: priority M, time frame MT). ### Key specific findings and statistics (selected) - Total financial system assets: 61 percent of GDP in 2005 → 84 percent of GDP in June 2010. - Banks’ loans: about 57 percent of bank assets. - Private sector deposits: about 60 percent of bank liabilities. - Institutions: 15 commercial banks; 12 finance companies; 372 cooperatives. - Cooperatives’ assets: 15 percent of GDP. - Nonbank state-owned financial institutions’ assets: about 2 percent of GDP. - Two systemic banks have CARs below or barely at the 10 percent minimum under Basel I definitions. - CBP Capitalization Law approved in April 2010. *Source: IMF staff report, Executive Summary.* ### 4. Since the 2005 FSAP to the present, Paraguay has experienced very favorable ### 4. Since the 2005 FSAP to the present, Paraguay has experienced very favorable macroeconomic outcomes, and has been only temporarily affected by the global crisis ### Macroeconomic outcomes (2005–2011) - Between 2005–2008, real GDP rose by 5 percent a year. - The CBP’s focus shifted to price stability, while maintaining exchange rate flexibility and inflation in the single digit range for most of the period. - In 2009, the global financial crisis coupled with a severe drought tipped the economy into a recession. - Real GDP growth was 15.3 percent in 2010 and is expected to remain above potential, at 5.6 percent, in 2011. - Recovery in 2010 was driven by a bumper soy crop, buoyant demand from trading partners and a strong monetary stimulus. - Paraguay had several financial crises between 1995–2003. About half of the banks and two thirds of nonbank financial institutions were liquidated. ### Macroeconomic risks and financial institutions’ soundness — overview - Fast credit growth is identified as the most worrisome banking-system vulnerability. - Delays in withdrawing monetary policy stimulus allowed a buildup of excess liquidity and maintained low interest rates for too long. - Credit growth peak and recent trends: - Credit growth peaked at 75 percent (y-o-y) in May 2008. - Decelerated during the 2009 crisis, and rose again in 2010. - Credit growth stood at over 40 percent (y-o-y) in January 2011. - Main drivers of credit growth: consumption and the services sector; credit to agribusiness slowed considerably from its 2010 peak. - Price developments to date suggest that the inflation rate could rise to over 10 percent in 2011, propelled by excess demand pressures and by international oil and food price increases. ### Specific vulnerabilities - Financial dollarization: - Dollarization ratios: about 40 percent for deposits and 45 percent for loans. - Banks’ net open foreign positions are low due to prudential limits, but indirect foreign-exchange risk remains: about a quarter of loans to the service and retail sectors are denominated in foreign currency. - High level of central bank net international reserves: 165 percent of dollar deposits as of end December 2010. - High reserve requirements made in dollars for dollar deposits help mitigate systemic liquidity risk in foreign currency. - Short-term funding: - Around 70 percent of bank deposits are sight. - Of sight deposits, about 65 percent are large. - Depositor confidence has proved sensitive to rumors. - Exposure to macroeconomic volatility: - Paraguay is a small and very open economy, highly dependent on agribusiness and international trade. - Credit to the agribusiness sector and commerce accounts for almost 65 percent of banks’ loan portfolio. - These two sectors have made a significant contribution to the recovery in the credit-to-GDP ratio. ### Financial soundness indicators and stress tests for banks - Methodology: - Stress tests and FSIs used, including an adjusted CAR in line with Basel I. - Main stress tests: - Impact of two extreme macroeconomic scenarios using a macroeconomic model of credit risk: - Scenario (i): a GDP decline by 5 percent in 2011 and by 5 percent in 2012 due to the impact of two droughts and falling commodity prices. - Scenario (ii): high inflation of about 12.5 percent y-o-y, with nominal policy rates in the 14-15 percent range for two consecutive years. - Estimates of the NPL ratio that would bring the CAR to the regulatory minimum of 10 percent or lower. - Failure of the largest and the two largest borrowers. - A stress test on systemic liquidity simulating a five-day run on deposits. - Stress-test results and implications: - Most banks appear resilient to shocks, although exposure to large borrowers is high and some small banks are exposed to significant liquidity risk. - Two systemic banks’ CARs would fall to under the 10 percent minimum under most stress tests. - A third bank is weak but not systemic. - Key financial soundness facts and concerns: - NPL ratio is low: 2 percent as of December 2010. - NPLs are growing quickly: 15.2 percent in 2010. - Leverage of the largest borrowers: median leverage for the largest 10 borrowers was 0.8 as of June 2010; for some large borrowers leverage reached up to 4. - No data available on household leverage; banks expressed concerns that aggressive competition could push smaller borrowers’ and households’ debt to unsustainable levels quickly. - Specific provisions for the system at 74 percent of NPLs appear to be among the lowest in the region. - Mission supported recent increase in general provisions and authorities’ plans to introduce forward-looking provisions; recommended improving the provisioning treatment of refinanced and restructured loans. ### Capital quality and Basel III considerations (Box 1) - CARs in Paraguay are not measured according to Basel recommendations (Basel I differences). - Adjustments made by the mission to reported CARs: - Revaluation reserves included as Tier 2 capital after a 55 percent discount. - Amount of Tier 2 capital limited to 100 percent of Tier 1 capital. - Subordinated debt included in regulatory capital limited to 50 percent of Tier 2 capital. - Risk weights for loans guaranteed by mortgages, warrants, and other collaterals adjusted from 50 percent to 100 percent, except for household mortgages. - After adjustments: - One institution’s CAR falls slightly below the 10 percent adjusted regulatory CAR, while two others are very close to the minimum. - Basel III estimation: - Mission could only calculate equity to risk-weighted assets because regulatory capital definitions do not distinguish common and preferred equity. - Under the optimistic assumption that all stock enjoys Basel III loss-absorbency features, most banks would have enough high-quality capital. - Recent regulatory action: - CBP Board approved an increase of the minimum paid-in capital to obtain or maintain a banking license. - Recommendation: - Review numerator and denominator of capital adequacy ratio to align with Basel standards; consider recent Basel Committee amendments (Basel III). ### Stress test summary results (Table 5 highlights) - Scenarios tested included: Two droughts/falling commodity prices; High inflation/high interest rates; NPL ratio required to bring CAR to 10 percent; default of largest borrower; default of two largest borrowers; 50 percent appreciation of nominal exchange rate; 25 percent depreciation of nominal exchange rate; Liquidity shock: banks illiquid after 5 days. - Cost of capitalization under each scenario (system-wide, percent of GDP) shown for several banks with example values: - 0.17 - 0.24 - 0.01 - 0.10 - 0.25 - 0.01 - 0.01 ### Financial cooperatives (S&L cooperatives) — soundness and stress tests - Vulnerabilities are more significant than in banks: - Loans in cooperative sector growing moderately: 11.7 percent y/y by June 2010. - Deposits are growing faster than loans, putting pressure on cooperative margins and profitability. - NPL ratio in cooperatives is about three times the bank ratio. - Cooperatives lack a lender of last resort (LOLR) and a deposit insurance scheme. - Cooperatives are subject to less stringent supervision, weaker reporting requirements, and lower liquidity buffers than banks. - Systemic considerations: - Some cooperatives are larger than banks (e.g., the eleventh largest financial institution is a cooperative with about 3 percent of total system financial assets). - Up to 90 percent of cooperatives’ deposits in the banking sector are located at one of the largest banks in Paraguay (representing about a fifth of that bank’s total deposits). - At end-2009, banking loans to cooperatives represented 2.5 percent of banks’ loan portfolio; cooperatives’ deposits amounted to 3.3 percent of banks’ deposits, with significant concentration in one bank. - Stress-test findings for cooperatives: - Most cooperatives are highly exposed to liquidity risks. - Urgent need to set up deposit insurance and emergency liquidity funds, supported by stronger supervision. - Capitalization caveats: - Although cooperatives appear well capitalized due to member contributions, there are concerns about the usefulness of reported capital because of shortcomings in definitions of capital and risk-weights, low provisioning requirements, lack of regulations about related parties, adequacy of loan classification, and implementation of classification by cooperatives. ### Monetary policy, market infrastructure, and systemic liquidity management - Bank excess reserves in Paraguay are chronically high. - Structural factors: large proportion of short-term deposits; lack of an efficient CBP liquidity-management instrument; unclear repo legal framework; rudimentary payment system. - The payment system is still based on checks cleared manually at three CBP-sponsored clearing houses and settled the following day on banks’ accounts at the CBP. - Compounding factors: - Expansionary monetary policy in recent years led to substantial build up of Guarani-denominated excess reserves by banks (deposits at the CBP or in bank vaults). - CBP’s negative capital limits the scope of its sterilization operations. - Consequences of large excess reserves: - Perverse market incentives and undermined CBP ability to promote financial stability and conduct monetary policy. - High liquidity buffers impose important costs on banks and drive up interest rate spreads. - Excess reserves inhibit development of an active interbank market, limit the CBP’s ability to control credit growth, weaken monetary transmission mechanisms, and could make migration toward an inflation targeting regime harder. - Recommendations for systemic liquidity management: - Authorities need to step up efforts to withdraw current excess reserves, based on more effective liquidity forecasts. - Adopt a consistent framework for forecasting and managing systemic liquidity. - Step up efforts to gather timely information from the MoF on budget execution and from banks on their demand for reserves. *Source: CBP and IMF staff estimates, as presented in the IMF staff report.* ### 17. To improve systemic liquidity management, it is also critical to implement the ### _cr11198 - 17. To improve systemic liquidity management, it is also critical to implement the ### Recapitalization of the CBP and systemic liquidity management - April 2010: law passed authorizing the MoF to recapitalize the BCP through the transfer of Treasury bonds. - Recapitalization benchmark: about 6.25 percent of GDP assessed by a Fund’s TA mission in 2006, although ongoing large losses have increased the CBP’s recapitalization needs in recent years. - Immediate implementation of the law is key because the CBP’s weak balance sheet constrains its efforts to withdraw excess liquidity out of concern about the effects of monetary tightening on its net worth. - Status: CBP submitted a proposal to the MoF on the financial features of the bonds; studies underway at the MoF; no calendar yet established for effective implementation of the law. - Consequence: CBP’s negative capital could limit its capacity to act as lender of last resort (LOLR) and to sterilize monetary expansion. *Sources: CBP and IMF staff calculations* ### Monetary policy framework and operations - Inflation target: 5 percent within a +/-2.5 percent band (progress in awareness since 2005). - Recommendation: CBP Board should adopt a more pre-emptive approach rather than reacting when observed inflation reaches the midpoint of the target band. - Operational concerns: - Frequent reliance on exchange rate interventions to inject or withdraw liquidity risks signaling an exchange-rate target. - Recommendation: strengthen and clarify operational framework with implementation of a well-designed overnight facility. - Recommendation: adopt more transparent and market-based mechanisms for FX interventions (e.g., auctions) when smoothing excess volatility or acting on government’s behalf. ### Money, FX markets, and payment system reforms - Recommendations to foster deeper and more liquid money and FX markets: - Clarify and disseminate the legal framework governing repo operations. - Clarify the ownership status of the IRM. - Treasury should adopt a well-designed debt management strategy and pursue a constant presence in the market. - CBP could use recapitalization bonds to conduct open market operations. - Payment system: - Critical to seek prompt approval of the draft Law on the Payment Systems, envisaging implementation of a new system in October 2011, to eliminate risks and substantial settlement costs posed by the current payment system. ### Regulation and supervision of banks — progress and constraints - Progress since last FSAP: - Regulations on credit, market, and liquidity risks issued. - More frequent contacts with boards and managers; examinations more risk-based. - Strengthened licensing and transfer of ownership requirements; “fit and proper” criteria imposed for bank board members and managers. - Supervisors’ qualifications strengthened and training programs established. - Purchase by CBP of insurance policy covering legal costs for staff has buttressed supervisors’ de facto operational independence. - Improved enforcement of corrective actions using suasion and regularization plans; punitive measures available but appeal suspends effects. - Complete overhaul of AML-related supervision and regulatory framework recognized by GAFISUD and FATF. - Legal constraints: - Banking and central bank laws are unusually detailed and prescriptive, fixing quantitative limits, risk weights, and fines, with limited delegated capacity to the CBP. - CBP lacks power to change definition of capital or required solvency ratios to reflect bank-specific risk profiles; hence prior FSAP capital adequacy deficiencies remain unaddressed. - Supervisory workarounds: - CBP doubled minimum paid-in capital to obtain/maintain a bank license and raised general provisioning instead of establishing differentiated minimum CARs and provisions by risk profile. - CBP increased monitoring of large borrowers by creating its own monitoring definition and imposed additional general provisions depending on compliance with credit risk management requirements. - Shortcomings addressable within current legal framework: - Salary scales and internal career structure at CBP inadequate; supervisors face retention difficulties. - Regulatory treatment of “renovated, refinanced and restructured (RRR) loans” needs enhancement: banks report revolving and long-term loans as short-term; refinanced/restructured loans may mask deterioration in credit quality and lead to underestimation of required provisions. - Recommendation: strengthen and simplify RRR regulations; require proper identification of transaction terms and credit quality; apply more stringent criteria for loan classification and specific provisions; release of provisions for a refinanced loan should be gradual and conditioned on evidence of improved creditworthiness. ### Regulation and supervision of cooperatives (INCOOP) - Structure: Paraguay has a dual supervisory system — CBP supervises banks; INCOOP regulates and supervises cooperatives. - Findings and weaknesses: - INCOOP has adequate regulatory authority and supervision rightly focused on largest cooperatives, but governance rules urgently needed; supervision is not risk-based; enforcement power limited. - Corporate governance needs enhancement and professionalization, especially in largest S&L cooperatives. INCOOP should issue “fit and proper” requirements for board members and senior management. - Procedures manuals designed for compliance supervision but lack a clear risk-based approach, particularly for credit risks. Prudential regulations for large S&L cooperatives should converge with banks (e.g., definition of capital). - Need to monitor other systemic risks: common exposures of medium-size cooperatives and potential links with banking sector. - Law allows suspension of enforcement of INCOOP corrective actions while appeals are under judicial review, which can undermine supervisors’ capacity and have serious stability consequences. - INCOOP board composition raises independence concerns; recommendation: president of the country should appoint board members based on a list prepared following fit and proper assessment; board members should not hold simultaneous managerial responsibilities in cooperatives. - INCOOP should enhance accountability by producing an annual report with performance information, including financial statements. - Resources and staffing: - INCOOP lacks adequate resources and suffers significant staff turnover because of low salary scale. - Example: an examiner’s monthly salary ranges from US$360 to US$540. - Technical assistance and systems: - INCOOP received technical assistance from DGRV to improve off-site supervision for S&L cooperatives. - First phase of an early warning system put in place in January 2011, automatically capturing monthly financial statements of the 23 largest S&Ls. - For effectiveness INCOOP must ensure quality of received information and provide additional supervisor training to interpret data and detect errors. - Supervisory delegation for smaller cooperatives: - INCOOP could delegate supervisory processes to second-level cooperatives or a cooperative bank, or certify external auditors for auditing tasks. ### Financial safety net — crisis management and preparedness - CBP as LOLR: - CBP’s ability to act as LOLR could be limited by its negative capital; effective implementation of the CBP capitalization law is key to strengthen LOLR capacity. - Emergency Liquidity Assistance (ELA): - Internal procedures for ELA need updating and wide dissemination; regulations for approval and disbursement not updated since 2002 and do not reflect new legal framework for bank resolution and deposit insurance. - Recommendation: revise and disseminate ELA regulations; consider pre-qualification of collateral. - Bank resolution framework: - Adequate for non-systemic crisis situations, but challenges remain in rapid asset valuation and quick asset-to-deposit information due to past fraudulent loans in failed banks. - Supervisors should consider using two options under current law to speed asset valuation: (i) early valuation of assets during regularization plan; and (ii) asset transfer to a trust fund. - Recommendation: implement a system for quick access to effective deposit coverage information to facilitate timely deposit guarantee payments. - Systemic crisis legal features and moral hazard: - “Declaration of systemic risk” includes a contingency plan prepared by CBP but does not require removal of troubled banks’ managers; options like temporary administration by SBP or bridge bank to override shareholders’ rights are not available. - This could hamper timely intervention, threaten financial stability, and create moral hazard. - Crisis simulation: - Recommendation: conduct a crisis simulation exercise to test resilience of financial safety net and identify weaknesses; past bank resolution tests produced poor results and there is no experience declaring systemic risk. ### Deposit insurance system - Coverage level: - Deposit insurance coverage: US$23,800 or 9.6 times GDP per capita — Paraguay has the second largest coverage in America. - About 95 percent of depositors and 19 percent of deposits are fully covered. - Result: high coverage contributes to excessive moral hazard and favors large deposits; increases system risk despite past need to promote confidence after the 1995-2003 banking crisis. - Recommendation: authorities need to consider reducing coverage given improvements in supervision and banks’ soundness indicators; authorities plan to introduce a risk-adjusted premium. - Deposit Insurance Fund (FGD) resources and contingent funding needs: - Total resources (excluding treasury bonds) of the FGD amounted to 1.6 percent of total deposits and 8.2 percent of insured deposits as of September 2010. - This amount covers insured deposits of all financial companies and all banks individually except for the four largest banks. - Recommendation: complete remaining US$24 million capitalization of the FGD by the government and establish a flexible mechanism for adequate contingent funding. ### Cooperatives — liquidity arrangements and LOLR gap - No formal LOLR for cooperatives presently. - INCOOP pilot plan (January 2011): - Pilot liquidity assistance plan prepared and put in place for the largest five cooperatives. - Proposal: INCOOP manage a portfolio of assets provided by cooperatives as collateral to banks, which would then provide credit lines when needed. - This is akin to a collective contingency plan rather than a liquidity facility. - Through initial phase INCOOP expects to cover 54 percent of the difference between deposits and liquid assets; a credit line of US$50 million would be sufficient. - Participation is voluntary. - Recommendation: non-participants should be required to present alternative contingency plans for managing liquidity risk. *Italic: Source — IMF staff assessment and CBP data as presented in the content unit.* ### 38. INCOOP has an adequate range of tools and procedures to deal with troubled ### 38. INCOOP has an adequate range of tools and procedures to deal with troubled ### INCOOP: powers, practice, and governance - INCOOP has an adequate range of tools and procedures to deal with troubled cooperatives but finds it difficult in practice to exercise these powers. - Procedures are divided into four stages according to gravity: - corrective measures, - action plan prepared by the troubled cooperative, - on-site surveillance, - intervention. - If measures are insufficient to restore solvency, the license is removed and the institution liquidated. - INCOOP also has powers to promote mergers, acquisitions and voluntary liquidations as established in the law. - Recommendation: A more independent board would be key to enhance INCOOP’s enforcing powers. ### Deposit insurance proposals and sequencing - Two proposals for a deposit insurance scheme for cooperatives exist: - one prepared by INCOOP, - another by CONPACOOP. - Common features of both proposals: - establishment of a private fund, - capitalization period of around five years during which there would be no deposit coverage, - membership would be compulsory. - Legal implication: Because membership would be compulsory, the deposit insurance scheme requires to be established by law. - Sequencing recommendation: Establishment of any liquidity support and a deposit insurance fund should follow best practices and proceed after: - the soundness of the largest cooperatives has been ascertained, - supervision has improved, - proper procedures to deal with troubled cooperatives can be effectively implemented. ### Coordinating arrangements among supervisors and financial stability - Mission recommendation: create an interagency forum to discuss financial stability issues and harmonize prudential norms. - Suggested structure and mandates: - Committee of all regulators, including INCOOP, with participation at the highest level. - Given that the CBP regulates and supervises systemic financial institutions, the committee should be chaired by the CBP governor. - The committee should have a clear mandate, an agenda with concrete deliverables, sufficient technical support teams and the responsibility to report on progress regularly. - Support structures: - The two existing technical committees at the CBP could be strengthened and serve as support to the council. - Enhanced corporate governance of INCOOP would be key for efficient functioning of the council. - Cross-border cooperation: - Cooperation with international supervisors has been enhanced. - Formal information sharing arrangements are in place with Mercosur countries. - Effective informal arrangements are being formalized with Peru and Spain. - Gap: No crisis management or contingency plan for distress originating at the level of the parent bank. ### Other financial intermediaries: state-owned institutions and pensions - State-owned institutions: - Not a concern for financial stability, but do not intermediate resources efficiently and transparently. - Relatively small compared to regional peers; only one out of five is a deposit-taking institution. - Expected role: provide credit to segments private banks do not reach; in practice, transactions diverge from stated goals. - Recommendation: develop a clearly defined strategy for state-owned banks so they complement private sector activity. - Pension system: - No clear progress since the initial FSAP. - System consists of several pay-as-you-go defined benefits regimes. - Three out of six regimes related to central government employees have a cash flow deficit, which is covered by the government (who does not make employer contributions). - The Instituto de Previsión Social (IPS)—the largest non central government regime—needs important parametric adjustments to maintain long-term financial stability. - Paraguay lacks a comprehensive regulatory framework for pension schemes, including investment guidance, risk-return monitoring and accounting rules. - Current accounting rules mask the system’s fragile actuarial condition; reliable data on assets and liabilities are often missing due to lack of reporting requirement. - Recommendation: create by law a pension supervisor, and conduct actuarial assessments adhering to international standards to help anchor a parametric reform and the harmonization of benefits across regimes. ### Financial infrastructure - Credit information industry: - Lacks comprehensive regulatory and oversight frameworks. - System is fragmented and information sharing is ad-hoc. - Recommendation: launch a major reform program of credit reporting systems in the country taking into account the new international standards to be issued in early-2011 by a task force coordinated by the World Bank in cooperation with the Bank for International Settlements (BIS). - Insolvency and creditor rights: - Mission made recommendations to improve the institutional framework for creditor rights and insolvency. ### Developmental issues and financial inclusion - Financial intermediation: - Paraguay’s level of financial intermediation compares well to other countries in the region and comparator countries worldwide. - Barriers to financial access persist particularly for the informal population. - Ratio of bank credit and deposits to GDP is similar or above many other countries in the region, but the average account value for deposits and the size of credit—scaled by per-capita GDP—remains high for the banking system. - Financial exclusion statistics and behavior: - An estimated 70–80 percent of the population only uses cash for their transactions, as they do not have access to an account or pre-paid card. - Recommendations to foster inclusion: - Introduce a basic bank account. - Speed up current efforts such as branchless banking via nonbank agents and mobile network operators. - Regulate security standards as the industry moves toward branchless/mobile channels. ### Key numerical and contextual indicators cited - Population 2008 (millions): 6.2 - Gini index (2007/2008): 58.4 - Unemployment rate (2009): 6.4 - Life expectancy at birth (2007, pro): 71.7 - Percentage of population below the poverty line (2009): 37.9 - Adult illiteracy rate (2008): 5.2 - Rank in UNDP development index (2008): 98 of 179 - GDP per capita (US$, 2009): 2,264.9 - Estimated share of population using only cash for transactions: 70–80 percent *Source: IMF staff report content provided in the source PDF unit.* ### 52. Paraguay has a dual supervisory system, with the CBP in charge of supervising banks ### Paraguay has a dual supervisory system, with the CBP in charge of supervising banks ### Supervisory structure and mandate - Paraguay has a dual supervisory system: - CBP (Central Bank of Paraguay) is in charge of supervising banks and financing companies. - INCOOP is in charge of regulating and supervising cooperatives. - The SB (Superintendencia de Bancos) is defined as a technical body within the BCP that enjoys functional, administrative and financial autonomy. - Cooperation: - Cooperation with international supervisors has been enhanced, with formal and informal information sharing arrangements in place with all home supervisors. - Internal cooperation and information exchange have increased with the Comision de Valores. - Exchange of information with INCOOP has been very limited so far. ### Financial system composition and recent trends - Commercial banks dominate the financial system: - 15 commercial banks hold assets equivalent to 64 percent of total system assets. - The four largest banks represent about 60 percent of total bank assets. - Foreign/domestic asset ownership is split 50:50, including one state-owned commercial bank. - Other institutions: - 12 finance companies (FC). - 372 cooperatives holding assets equivalent to 3 percent and 15 percent of GDP respectively. - System growth: - Total financial system assets grew from 61 percent of GDP in 2005 to 84 percent in June 2010, mainly due to the growth of banks and cooperatives. - Loan concentration and markets: - Banks’ loans are concentrated in the large agribusiness sector. - FC and cooperatives dominate the market for consumption loans, and loans to micro, small, and medium size enterprises. ### Preconditions and macroeconomic context - Macroeconomic performance: - Between 2005–2008, real GDP rose by 5 percent a year. - In 2009 the economy fell into recession due to the global financial crisis and a severe drought. - Real GDP growth was 15.3 percent in 2010 and is expected to remain above potential, at 5.6 percent, in 2011. - Policy environment: - Between 2005 and 2008 policy and regulatory frameworks were strengthened in several areas, including banking, supported by two IMF arrangements. - CBP focus shifted to price stability, while maintaining exchange rate flexibility and inflation in the single digit range for most of the period. ### Credit information, collateral, and enforcement - Credit information systems: - Three credit information systems operate in Paraguay. - The SB operates the public registry Central de Riesgos Crediticios (CRC), containing positive and negative credit information reported monthly by regulated financial entities; it records all credits on an individual basis and has no minimum floor on loan size. - Two private systems are in operation. - Collateral and registries: - Security interests can be created on real estate or movable assets (mortgages; pledges prendas con registro over movables assets; warrants; cash collateral). - Personal guaranties are widely used. - Registries for property rights, secured transactions, and other charges are unified under a single general direction, but the registration system is inefficient and largely non-computerized. - Enforcement: - Loans secured by warrants, cash collateral and guarantee trusts are enforceable through effective non-judicial procedures. - Enforcement of unsecured and other secured credits using judicial procedures takes very long. ### Bank resolution and deposit insurance - Bank resolution framework: - Adequate for a non-systemic crisis situation, though challenges remain in achieving a rapid valuation of assets. - Triggers for resolution are clearly specified in the law. - Resolution framework is based on the Purchase and Assumption (P&A) process, with support of the Deposit Guarantee Fund FGD under the least-cost solution criterion. - Deposit insurance: - The deposit insurance system broadly complies with international standards. - The deposit insurance agency is a pay-box with the possibility of supporting bank resolution under the least-cost solution. - Administrative Unit of the Deposit Insurance Fund (UAFGD) has adequate information on deposits to comply with its mandate in a timely manner. - Deposit insurance coverage and premium are high and well above the average in the region. ### Main findings on regulation and supervision - Progress since last FSAP: - Major progress in regulation and supervision of banks, reflecting willingness to strengthen CBP technical capacities. - Internal structure and supervisory approach greatly enhanced; IMF technical assistance on adoption of risk-based supervision was helpful. - Supervisory processes improved; on-site examinations increasingly risk-oriented. - Supervisors’ qualifications strengthened and training programs established. - Constraints and challenges: - Banking law (LGBFOEC 861/96) and central bank law (LOBC 489/95) are unusually detailed and prescriptive, limiting CBP’s ability to update prudential requirements. - Detailed legal prescription determines quantitative limits, definitions, and risk weights, limiting delegated capacity to the CBP. - Authorities use alternative tools (e.g., higher absolute minimum paid-in capital, total provisioning, “risk based” and “bank specific” general provisioning add-ons) to offset legal rigidity, which may create complexity and opacity. - Budgetary restrictions hinder retention of trained staff, acquisition of equipment, and modernization of supervisory activities. - Sanctions and fines can be suspended by appeal; “due process” may involve long judicial procedures, limiting supervisor’s ability to enforce sanctions. - Limited internal exchange of information with INCOOP. - Deficiencies in identifying connected lending considered material given business concentration and family-owned firms. ### Licensing, ownership changes, and market entry - Licensing requirements: - Law defines “bank” and permissible activities; sets licensing criteria including constitution and governance, business plan, internal control and audit systems, founding shareholders list, board and management information, and minimum capital. - CBP may deny applications when project, shareholders, board, or management are not suitable. - Ultimate beneficial owners must be identified; 2010 regulations require documentation on criminal records, judicial records, certification of not being under bankruptcy or intervention, proof of financial capacity and origin of capital, and other documentation. - For juridical founding shareholders, chain of shareholders must be established to the physical beneficial owner. - Foreign branches and subsidiaries: - CBP applies same conditions and requirements for foreign branches and subsidiaries as for local institutions. - Applications to open branches must demonstrate home supervisor authorization and board/shareholders minutes authorizing the branch. - Ownership changes: - Supervisor receives information on all changes in ownership; changes involving more than 10 percent of corporate capital must be previously authorized. - Supervisor can reject changes if they do not meet authorization criteria. - Investment limits: - Banks can acquire shares in domestic non-financial entities and in banks and financial entities abroad, subject to limits to regulatory capital. - Investment in non-financial companies and vehicles must be divested before one year or provisions must be set aside equal to the full amount of the participation. - Banks can invest up to 20 percent of their regulatory capital in shares of financial companies abroad, with prior CBP authorization. ### Prudential regulations, capital, and large exposures - Capital requirements: - Minimum capital (patrimonio efectivo) to risk weighted assets of at least 8 percent (consolidated basis). - CBP can increase the Capital Adequacy Ratio (CAR) up to 12 percent without legal change and effectively raised it to 10 percent in 1996. - No distinction between Tier I and Tier II capital in law; subordinated debt limited to 50 percent of paid-up capital and reserves. - Revaluation reserves: CBP established scheduled limitation starting at 100 percent in December 31, 2009 to 70 percent in December 31, 2012. - Minimum CAR calculated using a simplified risk weighting system with risk weights of 0, 20, 50 and 100 percent. - CBP lacks explicit capacity to change regulatory capital definition or prudential capital requirements through regulation; has used alternative tools to reflect bank-specific risk profiles. - Large borrowers and concentration: - Resolution 1/74/2008 defines “large borrowers” as individuals or companies (and their connected counterparties) that represent 3 percent or more of the regulatory capital of the bank. - Large borrowers are also those that have aggregate outstanding loans representing 6 percent or more of the total regulatory capital of the banking system as a whole. - Information on large borrowers is available through CBP’s Central de Riesgo; they are subject to differentiated documentation, risk classification and provisioning requirements. - Since 2005 CBP has progressed in monitoring large borrowers and connected lending; identification relies on on-site verification based on bank-provided (mostly paper) information. - A project to modernize the Central de Riesgos and migrate to electronic form is planned to assist identification of groups. ### Risk management, supervision methods, and reporting - Risk management regulations: - Two central bank regulations: - Resolution 1/74/2008 deals with credit risk management. - Resolution 2/2009 deals with “financial risk” (market risk excluding commodities, and liquidity risk). - Both require banks to have documented risk management policies approved by the board to identify, manage and allocate capital. - Market risk exposures are to be marked to market. - Regulations are recent and supervisory verification of compliance has not yet proceeded. - CBP’s approach emphasizes development of a “risk management culture” before imposing capital requirements; current focus is mostly on credit risk. - Supervision methods: - Control of credit risk is increasingly based on interaction of off-site and on-site supervision; on-site inspections are more risk-oriented and effective in resource use. - Inspectors have direct access to internal documentation and systems and interact with Credit Registries Offices (CRO) and equivalents. - Banks’ senior management maintain fluid exchange of information with SB on strategic matters. - Loan classification and provisioning: - Prudential regulations require reporting of loans whose initial terms have been modified (renovated, refinanced, restructured). - Banks often report revolving credit lines or longer-term loans with predetermined disbursement tranches under “renovated loans.” - “Refinanced and restructured” headings are used for deteriorating credit quality; reclassification to better categories and release of provisions is allowed if conditions met. - Regulations are ambiguous and may be misused to conceal actual impairment, especially in stress periods. - Market, liquidity, operational, and interest rate risks: - New regulation on market and liquidity risks establishes qualitative requirements including separation of front vs. middle office, reinforcement of internal controls, internal models, mandatory back testing and stress tests. - Division de Riesgos Financieros tests efficacy but needs capacity strengthening. - Liquidity typically managed by large buffers of liquid assets; no formal guidance on operational risk except detailed IT guidance. - Initial discussions on qualitative operational risk rule underway. - No specific guidance on interest rate risk in the banking book; no official definition of banking vs. trading book but financial risk resolution assumed to cover interest rate risks in banking book. ### Governance, internal control, and audit - Board and management responsibilities: - Law identifies main responsibilities for Board members and senior management. - Banks are required to have an Internal Control Unit reporting directly to the Board to control accounting, internal processes, and other risks, and to establish an audit committee. - External auditors must make an explicit judgment on the quality of the entity’s internal controls. - Human resources and legal protection: - Supervisors need formal training despite capacity improvements. - Legal protection improved with Law 2334/07 establishing that CBP and SB employees are not to be sued for actions taken while in duty. - CBP purchased in 2009 an insurance policy to cover possible costs of legal defense of a supervisor; the policy remains in effect until legal process is concluded. *Source: _cr11198 - 52. Paraguay has a dual supervisory system, with the CBP in charge of supervising banks* ### 78. Paraguay has made progress in anti-money laundering and combating the financing of ### Paraguay has made progress in anti-money laundering and combating the financing of ### AML/CFT institutional framework and recent actions - Law 1015/1997 defines entities responsible for AML/CFT regulation and supervision. - The Secretariat for the Prevention of Money and Asset Laundering (SEPRELAD), attached to the Office of the President of the Republic, is the main authority responsible for implementing the AML preventive mechanisms established in Law 1015/1997. - Enforcement responsibilities are divided among: - SBP and the IS (technical supervisory bodies within the CBP), - the National Securities Commission, - the INCOOP. - Articles 14 to 16 of Law 1015/1997 require customer due diligence (CDD) measures by financial institutions. - SEPRELAD issued Resolution 172/2010 to regulate compliance with the CDD requirement; Resolution 172/2010 mandates a Manual for AML/CFT Prevention in each financial institution. The Manual must include: - policies and processes to designate compliance officers, - screening policies for professional standards, - mandatory AML/CFT training, - functions of the compliance officer and internal auditor, - staff reporting. - SB has established and trained a special unit for AML/CFT supervision in partnership with SEPRELAD and has started its AML/CFT supervision program. ### Methods of ongoing supervision (CP 19–21): progress and remaining shortcomings - Improvements since the 2005 FSAP: - Reform of SB procedures and processes increased efficiency and promoted coordination. - Establishment of the Division de Estabilidad Financiera introduced a macroeconomic and systemic approach. - Heightened awareness of relevant developments and earlier identification of incipient problems. - Evidence of preemptive actions by the SB on emerging risks. - Remaining constraints: - Insufficiency of resources and minimum coordination with the cooperatives supervisor (INCOOP) hamper effective understanding of exposures and risk in the financial sector as a whole. - Off-site supervision strengthened (improved infrastructure and increased qualification) but still relies too heavily on ad-hoc information. - On-site inspection teams are increasingly respected for technical capabilities and professionalism. - Legal powers for reporting and inspection: - SB inspectors have full access to accounting records and internal information; law establishes mandatory revisions by external auditors. - SB can reject an auditor without indicating cause; quality of auditor work is regularly assessed. - Fraud in information provided in supervisory reports is a ground for initiation of a regularization plan (see CP 23). ### Accounting and disclosure (CP 22) - SB has legal power to establish and modify accounting and valuation regulations. - SB can: - adjust asset valuations to reflect commercial value, - require liability recognition, - write off assets that no longer represent real values, - demand provisions for doubtful operations. - The accounting plan was issued in 1995. - Level of disclosures required is lower than some banks voluntarily provide. - Current accounting framework is commensurate with the lack of complexity of the Paraguayan banking sector and has performed well historically. - Recommendation: a rigorous evaluation of the implications of an eventual migration to international standards seems advisable. ### Corrective and remedial powers of supervisors (CP 23) - Legal framework includes ongoing supervision requiring correction of weaknesses; the most significant mechanism beyond daily suasion is the regularization plan. - Regularization plan can be started for reasons explicitly stated in Law before a bank’s financial situation becomes seriously deteriorated. - Effects when plan initiated: - Distribution of dividends and expansion of activities are automatically suspended. - Plan may involve limits on operations, removal of managers and board members, and establishment of a program to sell or merge the bank with a stronger institution. - Other CBP measures under LOBC 489/95 (including fines) are treated as penalties and undergo the legal procedures sumario administrativo involving due process and appeals, during which their effects are suspended. - Recommendation (from Table 1, CP 23): - Change law to allow the CBP to initiate preventive measures when the situation is not yet warranting a regularization plan. - Change law to allow the CBP more discretion regarding initialization of the regularization plan. ### Consolidated and cross-border supervision (CP 24–25) - No significant banking groups or subgroups—domestic or international—whose parent bank is a Paraguayan entity; practical application of CP24 is limited. - Law 861/96 recognizes important powers for the CBP to deal with formal or de facto banking groups. - SB has authority to issue regulation for consolidating accounting statements for credit institutions deemed to operate as a unified decision-making entity. - CBP has legal powers to establish information sharing arrangements with foreign supervisors; cooperation level is good with relevant home supervisors. - Existing formal agreements with Mercosur countries and Memoranda of Understanding with Peru and Spain (and others in final stages); informal arrangements include participation in training and colleges of supervisors. - Law prescribes confidentiality treatment of all information received by supervisors while in their functions. - Recommendation (from Table 1, CP 24): - Modify prudential regulation to ensure prudential requirements are established, required, reported and supervised on a consolidated basis, as well as on a solo basis. ### Key recommendations from Table 1 (selected principles and actions) - Principle 1 (Objectives, Independence, Powers, Transparency and Cooperation) - Update prudential regulations in a timely manner (requires changes in legislation LGBFOEC 861/96 and LOBC 489/95). - Review salary scale and career structure for supervisory professionals to retain qualified staff. - Amend LGBFOEC 861/96 and LOBC 489/95 to delegate powers to the CBP to issue prudential regulations and apply due discretion. - Amend law to ensure supervisor’s ability to enforce sanctions and penalties and consider reduction in appeal times/levels. - Establish effective information exchange mechanisms with INCOOP. - Principle 6 (Capital Adequacy) - Review numerator and denominator of capital adequacy ratio to align with Basel standards. - Substantially revise definition of regulatory capital—including deductions and limits to computability. - Significantly increase scope of capital requirements to demand capital for all material risks and reconsider current risk-weights. - Enable supervisors to adjust capital requirements to the risk profile of each bank. - Calculate capital requirements on solo and consolidated basis. - Principle 7 (Risk Management Process) - Introduce guidance/regulation regarding risk management requirements for all risks, including assessment of overall capital adequacy relative to overall risk profile. - Principle 8 (Credit Risk) - Require supervised entities to have well-defined criteria for approving renovated, refinanced, and restructured loans and make criteria available to the SB regularly. - Require supervised entities to evaluate borrowers’ capacity and will to pay with documentation for all borrowers. - Principle 9 (Problem Assets, Provisioning, and Reserves) - Amend regulations on credit classification and provisions to require identification of deteriorating assets and reclassification based on early signs of distress in addition to time since first default. - Amend regulations on renovated, refinanced and restructured operations to prevent misreporting. - Principle 10 (Large Exposure Limits) - Legal or regulatory changes to enable supervisor to decide on connected lending case-by-case. - Calculate limits on large exposures on both solo and consolidated basis. - Establish effective exchange of information with INCOOP to identify large borrowers. - Principle 11 (Exposure to Related Parties) - Legal or regulatory changes to ensure supervisor can decide on connected groups and related lending case-by-case. - Principle 13 (Market Risks) - Reinforce capacity of the Division de Riesgos Financieros to supervise implementation of Res. 2/2009 on market risk. - Develop a regulatory framework to require capital requirements for market risk exposures. - Principle 14 (Liquidity Risk) - Reinforce capacity of the Division de Riesgos Financieros to supervise implementation of Res. 2/2009 regarding liquidity risk. - Revise liquidity operational frameworks of systemic private entities identified by the SB to determine development of internal procedures prescribed by Resolution 2/2009. - Principle 15 (Operational Risks) - Issue prudential regulation for operational risk identification, assessment, monitoring and mitigation by banks. - Principle 16 (Interest Rate Risk in the Banking Book) - Develop regulatory framework for identification, monitoring and control of interest rate risk in the banking book. - Expand and reinforce capacity of the Division de Riesgos Financieros to supervise interest rate risk management. - Principle 17 (Internal Control and Audit) - Reinforce SB capacity to require board restructuring in case of serious internal control breaches jeopardizing institutional stability. - Principle 19 (Supervisory Approach) - Establish effective information exchange mechanisms with INCOOP. - Principle 20 (Supervisory Techniques) - Implement the Reingeniería Informática project so it becomes operative as planned in December 2011. - Principle 21 (Supervisory Reporting) - Reinforce off-site supervision so new reported information can be properly analyzed. - Implement the Reingeniería Informática project so it becomes operative as planned in Dec 2011. - Principle 22 (Accounting and Disclosure) - Evaluate rigorously area-by-area the impact of an eventual migration to International Financial Reporting Standards (IFRS) and the desirable timing and sequencing. - Enhance public disclosure requirements to improve comparability, relevance, reliability, and timeliness; include qualitative and quantitative information on financial position and performance, risk management, risk exposures, related-party transactions, accounting policies, and management and governance frameworks. - Principle 23 (Corrective and Remedial Powers) - Change law to allow CBP to initiate preventive measures before regularization plan conditions are met. - Change law to allow CBP more discretion in initializing regularization plans. - Principle 24 (Consolidated Supervision) - Modify prudential regulation to ensure prudential requirements are established, required, reported and supervised on both consolidated and solo bases. ### Authorities’ response and recent actions reported - Authorities agreed with main recommendations, particularly legal changes to grant more regulatory and supervisory powers to the CBP. - Actions reported after the FSAP mission: - Prudential regulations under study (related to increases in capital and general provisions) were approved by the CBP and posted on their website. - Regarding CP 9, regulation modifying Res. 1/2007 and incorporating new criteria for non performing loans was published on November 24, 2010; SB believes establishing non performing loans at 30 days will promote better management by supervised institutions and better payment culture by debtors. - Framework for renovated, refinanced and restructured operations is under study and changes are likely to take place shortly. - On CP 18, FATF statement quoted: - “Paraguay has made an overall outstanding progress to improve its AML/CFT regime. Regarding the key deficiencies outlined in this action plan, Paraguay has taken serious steps pursuant to address them in a timely manner. These remarkable efforts and their high level political commitment have been reflected in the issuance of proper legislation, the authorities’ broader coordination capacity and the strengthening of their institutional framework. All that notwithstanding, a few deficiencies remain, especially in relation to Special Recommendation III (SRIII), where the enactment of proper Bill is pending, as well as the establishment of specific procedures for its effective compliance. For the forthcoming months Paraguayan authorities will have to demonstrate the effectiveness of the legislation in force and of several mechanisms put in place, particularly those addressing Special Recommendation IX (SRIX).” - Authorities informed that provisions relating to the freezing of terrorist assets (SRIII) were submitted to Congress in January 2011. *Source: IMF staff report content from the provided PDF excerpt.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11198.pdf_