## _cr11261 - Executive Summary

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### Macrofinancial setting and recent performance
- Real GDP contracted by 1.5 percent in 2009; grew 5.5 percent in 2010; projected to grow by 6.5 percent in 2011.
- Monetary policy: tightening stance since mid-2010.
- Capital flows and asset markets:
  - 2010: strong FDI inflows and all time high portfolio inflows; equity-related inflows largely offset by portfolio outflows as domestic pension funds increased foreign allocation.
  - Corporate bond issuance in 2010: US$ 12.8 billion (flat relative to 2009); share of external issuance rose to 80 percent from 50 percent.
  - Currency mismatches by corporates: limited at 7 percent of assets.
- Financial savings and liabilities:
  - Gross financial savings of Chilean households: about 140 percent of GDP.
  - Nearly half of household gross financial savings placed in pension funds.
  - Gross liabilities of corporates: over one time GDP.
  - Asset managers invest in banks the equivalent of about a quarter of GDP.
- Key risk: strong growth and favorable interest rate differential could intensify capital inflows, raising risk of asset price and credit bubbles.

### Financial system structure, resilience, and sectoral performance
- System characteristics:
  - Financial system: large, well diversified, highly integrated internationally; deepest in the region.
  - High degree of conglomeration; most financial institutions owned by conglomerates operating in two or more financial sectors.
- Banking system soundness:
  - Banks well capitalized; common equity accounts for 44 percent of regulatory capital.
  - Regulatory capital quality: almost 65 percent of Tier 1 capital is common equity.
  - Core capital and total capital above the minimum level agreed under Basel III (implementation horizon 2015–2019).
  - System leverage (Tier 1 capital to assets) has always exceeded 6 percent over the last decade.
  - Liquid assets: 20 percent of total assets at end-2010.
  - Retail deposits account for one third of liabilities.
  - Bond issuance domestically and offshore equivalent to 2 percent of liabilities as of April 2011.
  - Banks’ access to international markets favorable in 2010; hedging keeps FX exposures limited.
  - Pockets of vulnerability: some small banks relying substantially on wholesale funding.
- Insurance sector:
  - Solvency improved since 2004 FSAP due to tighter retirement qualifications and crisis-induced deferred retirements.
  - Life insurance liabilities dominated by annuity obligations (close to 90 percent of liabilities).
  - Insurers shifted into fixed-rate corporate bonds and around 7 percent of portfolios into local real estate-related assets and foreign corporate fixed income.
  - SVS needs closer monitoring of real estate-related asset structures and values.
- Pension funds and asset management:
  - Pension funds better diversified, including internationally; default portfolios follow life cycle criteria.
  - Historic average real return on system portfolio since inception: above 9 percent (12 percent first decade, 9 percent second, 6 percent since 2000).
  - Achieving long-term real returns in the 6 percent range may prove challenging.
  - AFPs charge explicit fees equivalent to 60–70 basis points on assets under management; AFPs‘ profitability is high relative to risk.

### System-wide oversight, regulatory architecture, and consolidation issues
- Sectoral oversight priorities:
  - Strengthen independence and legal protection of regulatory agencies.
  - Complete incorporation of Basel II and III capital standards for banks.
  - Boost relevance and quality of the actuarial profession for insurance market integrity.
  - Augment authority of securities regulator (SVS), especially enforcement powers and ability to regulate all investment advisors.
  - Further enhance the AML/CFT framework.
- Consolidated supervision and conglomerates:
  - Lack of comprehensive framework for consolidated oversight of financial conglomerates (FCs) is an increasingly serious gap.
  - Short-term actions under current legal framework include: sign MoU defining lead and sector supervisors; define information flows; use current powers to improve coverage of unregulated parts of groups; estimate proxies of capital and risk concentrations.
  - Essential building blocks for reformed legal framework (selected):
    - explicit definition of FC common to supervisors;
    - access to information on all operations of the wider financial group, including nonfinancial entities;
    - prior authorization requirement for cross-border establishments belonging to FC;
    - group-level capital adequacy, liquidity, governance, risk management requirements and limits on large/connected exposures.
- Regulatory perimeter and market conduct:
  - Asymmetries in licensing, suitability standards, disclosure, and compliance across institutions offering similar asset management services and investment advice.
  - Custody, clearing, and settlement: recommendation to adopt a comprehensive harmonized approach.
  - Monitor potential emergence of high leverage outside the regulatory perimeter.
  - Retailers’ credit card operations: significant scale and regulatory asymmetry (see Financial infrastructure section).

### Crisis preparedness, resolution, and safety nets
- Institutional arrangements:
  - Financial Stability Committee established by Presidential decree (July 2011); chaired by the ministry of finance; central bank (BCCh) participates as an observer.
  - Recommendation: ensure BCCh can adequately influence deliberations while preserving autonomy; delegate institution-specific issues to a supervisors’ sub-committee in normal times.
- Resolution framework and deposit insurance:
  - Bank resolution framework would benefit from enhancements: powers to dilute existing shareholders before liquidation; enhanced legal protection for regulators and interventors; expanded range of resolution tools.
  - Recommended resolution tools: purchase and assumption (P&A), good bank/bad bank, bridge bank, recapitalization without preemptive shareholder rights, forced bank debt restructuring.
  - SBIF should be granted powers to write down capital as part of restructuring, with an appeal process that does not suspend decisions.
  - Consider establishing a premium-based limited deposit insurance scheme as resolution framework strengthened.
  - Central bank sight deposit guarantee: assess pros and cons of phasing out in context of partial deposit insurance and strengthened resolution framework.
  - Suggested systemic framework elements: (i) credible committee to determine systemic risk; (ii) lift legal obstacles for use of public funds in systemic cases; (iii) authorize use of public funds only after least-cost analysis; (iv) establish ex-post accountability.

### Key policy recommendations (selected high and medium priority items)
- Addressing system-wide risks:
  - Construct and publish standardized house and commercial property price indices to detect price misalignments. Priority: M; Time Frame: M.
  - Proposed consolidated credit registry including banks and other credit providers (including department stores). Priority: M; Time Frame: M.
  - Develop a strategy to ensure adequate replacement rate for retirees. Priority: H; Time Frame: M.
- Financial sector oversight:
  - Strengthen independence and legal protection of regulatory agencies. Priority: H; Time Frame: M.
  - Complete incorporation of Basel bank capital standards. Priority: H; Time Frame: M.
  - Strengthen enforcement powers of securities regulators. Priority: H; Time Frame: S.
  - Establish legal framework for consolidated oversight of financial conglomerates. Priority: H; Time Frame: M.
  - Enhance uniformity in business conduct regulation for asset management services and investment advice. Priority: H; Time Frame: M.
  - Introduce comparable transparency standards for fixed income securities traded outside exchanges. Priority: H; Time Frame: M.
  - Adopt comprehensive approach to custodial, clearing, and settlement infrastructure. Priority: M; Time Frame: M.
  - Further enhance the AML/CFT framework. Priority: M; Time Frame: M.
- Resolution framework:
  - Strengthen legal framework for bank resolution. Priority: H; Time Frame: M.
  - Consider introduction of a premium-based limited deposit insurance system. Priority: M; Time Frame: M.
  - Examine options to establish a framework for dealing with systemic crisis and potential failure of a financial conglomerate. Priority: M; Time Frame: M.

### Stress tests, scenarios, and system resilience
- Scope: stress tests covered all 25 banks for credit, market, and liquidity risk; conducted jointly by BCCh, SBIF, and FSAP team.
- Basel III preparedness:
  - Implementation horizon: Basel III requirements due to be implemented over 2015–2019.
  - LCR: seven banks pass the LCR stress test; average LCR currently stands at 0.66; liquidity shortfall estimated at only 10 percent of total assets.
  - NSFR: 23 banks pass the stress test; the remaining two small banks are around 5 percent of system assets; available stable funding estimated at 91 percent of total assets; required stable funding estimated at 71 percent of total assets; overall liquidity shortfall at only 0.5 percent of total funding liquidity.
- Credit risk stress tests:
  - Under the risk scenario, banking system remains profitable and well capitalized.
  - ROEs would decline by about 10 percent under the risk scenario at the end of a two-year period; capital adequacy remains well above 10 percent for all banks.
- Stress test scenarios and shocks:
  - Baseline Scenario: IMF January 2011 WEO update; GDP growth rises to 5.2 percent in 2011 (authorities’ estimates: 6.6. percent for 2011) from 5.1 percent in 2010, then fluctuates around the 5.0 percent long-term trend; short-term interest rates and unemployment rise gradually to 5.43 and 8.0 percent, respectively, by 2015.
  - Severe Risk Scenario: includes (i) increase in country premium spread by 50 bps; (ii) additional shock in VIX of 40 bps; (iii) negative demand shock in the United States and emerging Asia of 1 and 0.2 percent, respectively; (iv) negative domestic demand shock in consumption and investment. Resulting growth: 1.8 and 3.6 percent in 2011 and 2012 respectively, with permanent shock to long-run growth to 4 percent. The 2011 GDP growth shock corresponds to a three standard deviation (over a 20-year period) decline in GDP growth. Risk horizon: 5 years.
  - Market risk single-factor shocks: exchange rate risk modeled as 20 percent depreciation vis-à-vis the U.S. dollar over 15-day period; interest rate shock modeled as short- and long-term rate increases of 250 and 100 bps respectively, dying out over three years.
  - Liquidity stress tests: modeled sudden withdrawal of funding over five periods (approximately 10 percent on average each period); reverse stress tests assessed withdrawals that would “break” the system.

### Market and liquidity risk assessment (selected results)
- Market risks largely driven by interest rate risk; medium-size and treasury banks most affected by interest rate shocks.
- System-level market risk results (percent of Tier 1 capital):
  - Large Banks (market share 66.7): Baseline 0.60; Risk -0.63 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk 0.60/-0.63.
  - Medium Banks (market share 28.5): Baseline -0.45; Risk -4.17 for Interest Rate; Exchange Rate -0.02/-0.23; Market Risk -0.48/-4.40.
  - Small Banks (market share 1.2): Baseline -0.66; Risk -2.83 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk -0.66/-2.82.
  - Treasury Banks (market share 3.6): Baseline -1.24; Risk -4.98 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk -1.24/-4.98.
  - System (100.0): Baseline 0.27; Risk -2.10 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk 0.27/-2.10.

### Institutional investors — pensions, annuities, and earthquake insurance
- Pension funds:
  - System offers five investment portfolios; most aggressive portfolio holds 80 percent in equities and 70 percent abroad.
  - Hedging requirement: around 45 percent of AFPs‘ foreign positions must be hedged; pension funds must hedge the equivalent of around 15 percent of GDP.
  - Proposed legal change: move hedging regulation from law to the investment regime to provide flexibility; any change should consider implications for the foreign exchange market.
  - Policy implications if returns decline: higher contribution rates, higher retirement age, and pressure on AFPs to reduce costs.
- Insurance sector and earthquake response:
  - Insurance industry settled 98 percent of claims within seven months following the February 2010 earthquake and tsunami.
  - Losses to local insurers limited due to reinsurance transfers to international markets.
  - SVS proactively informed homeowners and monitored claim settlements.
  - SVS has published new reserving standards for non-life business (NCG N° 306 dated April 14, 2011) and is developing risk-based capital factors.

### Securities markets, market infrastructure, and regulatory powers
- Market structure and statistics:
  - Three exchanges: Bolsa de Comercio de Santiago (~80 percent of trading volume), Bolsa Electrónica (slightly less than 20 percent), Bolsa de Valparaiso (smallest).
  - 270 publicly traded companies; total market capitalization of equity shares as of December 2010: US$ 341.5 billion.
  - Average daily trading amount: US$ 190 million; average turnover ratio for all listed equities about 18 percent in 2010.
  - Corporate debt market: 2009 peak 70 issues totaling US$ 7 billion; AFPs and insurance companies purchase over 80 percent of corporate debt issues.
  - Mutual funds: 471 mutual funds, total assets under management approximately US$ 33 billion; mutual fund assets increased from US$ 8.4 billion in 2004 to approximately US$ 33 billion in 2010.
- Market infrastructure:
  - Mandatory use of central counterparty (CCLV) and third-party depository (DCV) for brokers, mutual funds, pension funds, and insurers; voluntary for banks.
  - Recommendation: harmonize trading requirement of securities irrespective of entity trading them to address transparency asymmetry between exchange trading and OTC bank trading.
- Regulatory gaps and recommendations:
  - SVS strengthened since 2004, but needs augmented authority in broker regulation, investigation, and enforcement; SVS lacks authority to compel testimony or documents from persons not subject to its regulation.
  - Investment advisers (except advisers of regulated funds) remain unregulated.
  - Priority actions (selected): appoint Superintendent for fixed term; provide SVS staff legal immunity; complete information sharing agreement among regulators; mandate industry-wide client suitability requirement; grant SVS authority to intervene in failing brokers and compel documents, including bank records when necessary.
  - OTC debt trading transparency and harmonized custody/settlement practices are priorities; fully implementing CCLV and developing robust clearing system with sufficient guaranty fund recommended.

### Financial infrastructure, retailers’ credit cards, and regulatory perimeter
- Credit card scale and structure:
  - Number of credit cards in circulation at end-2010: almost 30 million.
  - Population: 17 million.
  - Number of individual transactions in 2010: 290 million.
  - Total dollar amount of transactions in 2010: US$ 21 billion.
  - Retail credit cards account for almost 70 percent of transactions.
  - Retailers issue over three times as many cards as banks.
- Regulatory asymmetry:
  - Banks and cooperatives issuing cards: included in SBIF Register and subject to prudential regulation.
  - Nonbank issuers (department store conglomerates): required to enroll in Register but subject to lighter regulation; can borrow from banks to fund operations.
  - Current prudential thresholds for nonbank issuers specify capital/reserve minima in UF, limits on obligations, liquidity requirements, reporting, and risk management audits.
- Recommendation: enhanced monitoring of nonbank issuers, close monitoring of potential high leverage outside regulatory perimeter, and careful consideration of bringing retailers’ credit card operations within regulatory perimeter.

### Annexed indicators and risk assessment (selected figures)
- GDP (2010): 103,742
- U.S. dollars (billions): 203.3
- Per capita (U.S. dollars): 11,981
- Poverty rate (2009): 15.1
- Population total (in millions, 2009): 17.0
- Urban population (percent of total): 88.7
- Life expectancy at birth (years): 78.7
- Gini coefficient: 0.55
- Real GDP (selected years): 2006 4.6; 2007 4.6; 2008 3.7; 2009 -1.7; 2010 5.2; 2011 6.5; 2012 5.0
- Current account (percent of GDP, selected years): 2006 4.9; 2007 4.5; 2008 -1.9; 2009 1.6; 2010 1.9; 2011 0.3; 2012 -1.3
- Gross International Reserves (in billions of U.S. dollars): 2006 19.4; 2007 16.9; 2008 23.2; 2009 25.4; 2010 27.9; 2011 39.9; 2012 39.9
- Public sector gross debt (percent of GDP, selected years): 2006 26.9; 2007 19.9; 2008 26.0; 2009 29.3; 2010 27.7; 2011 32.8; 2012 30.3

### Selected risk matrix highlights (threat, likelihood, expected impact)
- Strong capital inflows: Staff assessment: MEDIUM; Expected impact: significant overvaluation of key assets, potential overheating, higher credit/FX/liquidity risk amplified by concentration and conglomerates.
- Slowdown in U.S. and overheating in Emerging Asia: Staff assessment: MEDIUM; Expected impact: weaker external demand, lower terms of trade, higher credit risk and exchange rate correction risk.
- Deterioration in peripheral Europe: Staff assessment: MEDIUM (impact LOW-MEDIUM); Expected impact: higher funding costs, peso depreciation, weaker domestic activity.
- Fast withdrawal of banks’ wholesale deposits: Staff assessment: MEDIUM-HIGH; Expected impact: some wholesale-funded banks could be severely affected; systemic impact limited by small size but interbank disruptions possible.

*Source: IMF staff report excerpt (PDF _cr11261).*

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

### _cr11261 - Executive Summary

### Macrofinancial setting and recent performance
- The Chilean economy recovered strongly after two major shocks (the 2008 global financial crisis and the 2010 earthquake).
- Key growth indicators:
  - Real GDP contracted by 1.5 percent in 2009.
  - Real GDP grew 5.5 percent in 2010.
  - Real GDP is projected to grow by 6.5 percent in 2011.
- Monetary policy moved to a tightening stance since mid-2010.
- Capital inflows and asset markets:
  - Strong growth and a favorable interest rate differential could intensify capital inflows, raising the risk of asset price and credit bubbles.
  - In 2010, domestic investment benefitted from strong FDI inflows and all time high portfolio inflows.
  - Equity-related flows: inflows were largely offset by portfolio outflows as domestic pension funds increased their foreign asset allocation.
- External borrowing and corporate funding:
  - Corporate bond issuance in 2010 was US$ 12.8 billion, flat relative to 2009.
  - The share of external issuance rose to 80 percent from 50 percent.
  - Currency mismatches by corporates are limited at 7 percent of assets.
- Financial savings and liabilities:
  - Gross financial savings of Chilean households are about 140 percent of GDP.
  - Nearly half of household gross financial savings are placed in pension funds.
  - Gross liabilities of corporates are over one time GDP.
  - Interlinkages: asset managers invest in banks the equivalent of about a quarter of GDP; interlinkages among banks are relatively low.

### Financial system structure, resilience, and sectoral performance
- System characteristics:
  - The financial system is large, well diversified, and highly integrated into the global financial system; it is the deepest in the region.
  - A key feature is high degree of conglomeration.
- Banking system:
  - Banks are well capitalized in terms of both quantity and quality of capital.
  - Banks are profitable and significant core deposits substantially limit funding risks.
  - Stress tests indicate banks can withstand severe macroeconomic shocks in terms of solvency and liquidity.
  - Pockets of vulnerability remain among some small banks that rely substantially on wholesale funding.
- Insurance sector:
  - Solvency of insurance companies has improved since the 2004 FSAP.
  - Improvements driven by tighter retirement qualifications and crisis-induced losses in pension portfolios that reduced early retirement.
  - Price formation in the annuity industry improved after introduction of a transparent quotation system, advisor qualification standards, and ceilings on brokers’ commissions.
  - Competitive pressures on profitability could pose challenges going forward.
- Pension funds and asset management:
  - Pension funds’ risks are better diversified, including internationally.
  - Introduction of default portfolios that follow life cycle criteria better aligns investments with long-term interests of contributors.
  - Important steps taken to improve efficiency and competition in the system.
  - Looking ahead, lower returns may require increases in contribution rates and the retirement age.
  - The high profits of pension fund administrators may come under scrutiny in that context.

### System-wide oversight, regulatory architecture, and consolidation issues
- Sectoral oversight:
  - Regulatory framework is robust but there is room for improvement in some areas.
  - Ongoing reforms present an opportunity to enhance independence and legal protection of regulators.
  - Banking priority: complete incorporation of Basel II and III capital standards.
  - Insurance market integrity: boost relevance and quality of the actuarial profession.
  - Securities regulator: augment authority, especially enforcement powers and ability to regulate all investment advisors.
  - Need to further enhance the AML/CFT framework.
- Consolidated supervision and conglomerates:
  - Financial structure dominated by conglomerates creates critical need to strengthen consolidated supervision.
  - Lack of a comprehensive framework for consolidated oversight of financial conglomerates is an increasingly serious gap.
  - Firewalls help limit build-up of intra-group exposures; related-party exposures are strictly limited.
  - Authorities have taken actions to strengthen conglomerate oversight, but major legal reforms are needed to provide regulators with powers to supervise conglomerate risks effectively.
- Regulatory perimeter and market conduct:
  - Asymmetries exist in licensing, suitability standards, disclosure, and compliance across institutions offering similar asset management services and investment advice.
  - A more harmonized approach to custody, clearing, and settlement infrastructure could improve efficiency and reduce systemic risk.
  - The extent to which retailers’ credit card operations should be brought into the perimeter of regulation requires careful consideration.
  - Potential emergence of high leverage outside the regulatory perimeter needs close monitoring.

### Crisis preparedness, resolution, and safety nets
- Institutional arrangements:
  - A Financial Stability Committee has been established to oversee system-wide risks.
  - Caution is advised to ensure the Committee can discharge functions effectively: the central bank is an observer and should be able to adequately influence deliberations while preserving autonomy.
  - Institution-specific issues should be delegated to a supervisors’ sub-committee in normal times to avoid weakening regulatory independence.
- Resolution framework and deposit insurance:
  - The bank resolution framework would benefit from enhancements.
  - Critical reform areas include:
    - Establishing powers to dilute existing shareholders before liquidation.
    - Enhancing legal protection for regulators and interventors.
    - Expanding the range of resolution tools.
  - Authorities are reviewing the bank resolution framework and conducting a crisis simulation exercise.
  - Consideration should be given to establishing a premium-based limited deposit insurance scheme as resolution framework is strengthened.
  - Less urgent: establishing a framework for dealing with systemic cases and potential failure of a conglomerate.

### Key policy recommendations (high and medium priority items from FSAP Update)
- Addressing system-wide risks:
  - Reduce information gaps, including through a consolidated credit registry and standardized residential and commercial property price indices. Priority: M; Time Frame: M.
  - Develop a strategy to ensure adequate replacement rate for retirees. Priority: H; Time Frame: M.
- Financial sector oversight:
  - Strengthen the independence and legal protection of regulatory agencies. Priority: H; Time Frame: M.
  - Complete the incorporation of Basel bank capital standards. Priority: H; Time Frame: M.
  - Strengthen enforcement powers of securities regulators. Priority: H; Time Frame: S.
  - Establish legal framework to enable consolidated oversight of financial conglomerates. Priority: H; Time Frame: M.
  - Enhance uniformity in business conduct regulation for asset management services and investment advice. Priority: H; Time Frame: M.
  - Introduce comparable transparency standards for fixed income securities traded outside exchanges. Priority: H; Time Frame: M.
  - Adopt a comprehensive approach to custodial, clearing, and settlement infrastructure. Priority: M; Time Frame: M.
  - Further enhance the AML/CFT framework. Priority: M; Time Frame: M.
- Resolution framework:
  - Strengthen legal framework for bank resolution. Priority: H; Time Frame: M.
  - Consider introduction of a premium-based limited deposit insurance system. Priority: M; Time Frame: M.
  - Examine options to establish a framework for dealing with a systemic crisis and with the potential failure of a financial conglomerate. Priority: M; Time Frame: M.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11261.pdf*

### 4.      Given potential pressures, efforts to address information gaps to support system-

### 4.      Given potential pressures, efforts to address information gaps to support system-

### Information gaps and recommended actions
- Continue efforts to address information gaps to support system-wide monitoring and the prudent assessment of credit risks.
- Priority: the construction and publication of standardized house and commercial property price indices to help detect price misalignments.
- Proposed consolidated credit registry: include comprehensive information from both banks and other credit providers (including department stores) to improve the assessment and pricing of credit risk for firms and households.

### Overview of the financial system
- As of end-2010, gross financial system assets accounted for over twice GDP.
- Core components of the system:
  - Banks (over half of which are foreign-owned).
  - Mandatory, privately administered pension system.
  - Insurance sector (mainly annuities linked to the pension system).
  - Mutual funds.
- Firms and households are highly integrated, including to global financial markets.
- By international comparison:
  - Gross financial savings of Chilean households are high and invested in a diversified manner (by intermediary and location) across pension funds, insurance policies, bank deposits, and direct claims on local firms.
  - Nonfinancial firms are by far the largest ultimate borrowers and receive sizeable funding from abroad.

### Financial system structure and concentration
- High degree of conglomeration, including mixed conglomerates; most financial institutions are owned by conglomerates operating in two or more financial sectors.
- Market concentration by assets (top 10 conglomerates):
  - Banking industry: 77 percent.
  - Insurance: 65 percent.
  - Investment and mutual funds: 85 percent.
  - Brokers: 91 percent.
  - Pension funds: 42 percent.

### Overall assessment of risks — Soundness and performance of credit institutions
- Banks are well capitalized, highly profitable, and liquid.
  - Common equity accounts for 44 percent of regulatory capital.
  - Capital and leverage are largely within the new Basel III standards.
- Loan quality:
  - Cyclical deterioration in loan quality during the crisis has started to reverse.
  - Provisions are at comfortable levels.
  - Nonperforming loans are more pronounced in the mortgage segment (4.9 percent of total mortgage loans), almost entirely explained by the state-owned bank specializing in low-income borrowers.
- Profitability and earnings drivers:
  - Returns on assets and equity comparable to other countries in the region but relatively high by international standards.
  - Recovery in lending, high margins (especially in retail lending), and relatively low overheads contributed to high profitability.
  - Banks’ long inflation-indexed positions can be an important source of earnings in periods of growing inflation.
- Liquidity and funding:
  - Liquid assets were 20 percent of total assets at end-2010.
  - Retail deposits accounted for one third of liabilities.
  - Decline in wholesale deposits from pension funds observed; lower mutual fund deposits expected as money market funds move to mark-to-market valuations.
  - Some smaller banks relying more on wholesale funding could be vulnerable, though reductions in wholesale funding have been offset by higher retail deposits (partly due to higher policy rates) and bond issuance domestically and offshore (the latter equivalent to 2 percent of liabilities as of April 2011).
  - Banks’ access to international markets was at favorable terms during 2010, resulting in a longer-term borrowing structure; due to hedging, foreign exchange exposures appear limited.

### Preparedness for Basel III capital and liquidity requirements
- Implementation horizon: Basel III requirements due to be implemented over 2015–2019.
- Capital:
  - Regulatory capital mainly consists of high quality capital (almost 65 percent of Tier 1 capital is common equity).
  - Core capital (currently equivalent to Tier 1 capital) and total capital are above the minimum level agreed under Basel III.
  - The leverage ratio proposed under Basel III was introduced by the general banking law some time ago; over the last decade system’s leverage (Tier 1 capital to assets) has always exceeded 6 percent.
  - Chile: Banking System’s Capital Standards (percent of risk-weighted assets) — table indicates comparisons between Basel III, 2019, and Dec. 2010 with figures shown in the source (e.g., Tier 1 6.0 vs. 10.1; Total capital 8.0 vs. 14.1; Total capital + buffer 10.5...; Tier 1 (percent total assets) 3.0 vs. 7.1).
- Liquidity:
  - Chilean regulatory framework establishes 30- and 90-day mismatch limits in domestic and foreign currencies.
  - Liquidity stress tests for the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) show the banking system is well positioned to meet the LCR by 2015 and the NSFR by 2019.
  - LCR: seven banks pass the LCR stress test; the average LCR for the system currently stands at 0.66; the liquidity shortfall is estimated at only 10 percent of the total assets.
  - NSFR: 23 banks pass the stress test; the remaining two small banks (around 5 percent of the system‘s total assets) are in the 75th percentile. Available stable funding is estimated at 91 percent of the total assets; required stable funding is estimated at 71 percent of total assets; the overall liquidity shortfall at only 0.5 percent of the total funding liquidity.

### Stress test results and scenarios
- Scope: stress tests undertaken jointly by the BCCh, SBIF, and the FSAP team, testing all 25 banks for exposure to credit, market, and liquidity risk.
- Credit risk stress tests:
  - Computed using a nonlinear vector auto-regression (VAR) model with banking aggregates (loan loss provision, credit growth, write-offs) and macro variables (output growth, short- and long-term interest rates, unemployment).
  - Under the risk scenario, the banking system remains profitable and well capitalized.
  - ROEs would decline by about 10 percent under the risk scenario at the end of a two-year period. Despite a significant reduction in credit growth, capital adequacy remains well above 10 percent for all banks.
- Stress test scenarios and shocks (Baseline and Severe Risk Scenario):
  - Baseline Scenario: IMF January 2011 World Economic Outlook update; GDP growth rises to 5.2 percent in 2011 (current authorities’ estimates are 6.6. percent for 2011) from 5.1 percent in 2010, then fluctuates around the 5.0 percent long-term trend; short-term interest rates and unemployment rise gradually to 5.43 and 8.0 percent, respectively, by 2015.
  - Severe Risk Scenario: based on BCCh models and the January 2011 WEO risk scenario made adverse via:
    - (i) increase in country premium spread by 50 bps;
    - (ii) additional shock in VIX of 40 bps;
    - (iii) negative demand shock in the United States and emerging Asia of 1 and 0.2 percent, respectively, feeding through lower terms of trade;
    - (iv) a negative domestic demand shock in consumption and investment.
  - Resulting growth: economic growth falters to 1.8 and 3.6 percent in 2011 and 2012 respectively, with a permanent shock resulting in a lower (4 percent) GDP growth in the long run. The 2011 GDP growth shock corresponds to a three standard deviation (over a 20-year period) decline in GDP growth. Risk horizon for macro stress tests is 5 years.
  - Market risk single-factor shocks: exchange rate risk modeled as a 20 percent depreciation of the nominal exchange rate vis-à-vis the U.S. dollar over a 15-day period; interest rate shock modeled as a sharp increase in short-term and long-term interest rates by 250 and 100 bps respectively with the shock dying out gradually over a three-year horizon.
  - Liquidity stress tests: funding or market liquidity stresses modeled as shocks to individual banks’ deposit and wholesale funding base, including a sudden, substantial withdrawal of funding over five periods (approximately 10 percent on average each period). Reverse stress tests tested withdrawals that would “break” the system and preparedness for LCR and NSFR.

### Market and liquidity risk assessment
- Market risks largely driven by interest rate risk.
- VAR-based market risk calculations model each cash flow and the yield curve using dynamic factors.
- Medium-size and treasury banks, active in trading, appear most affected in a stressed scenario where both short- and long-term interest rates increase.
- Large banks are least affected by market risks, reflecting diversified activities.
- System-level market risk results (Table 3, percent of Tier 1 capital) show:
  - Large Banks (market share 66.7): Baseline 0.60; Risk -0.63 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk 0.60/-0.63.
  - Medium Banks (market share 28.5): Baseline -0.45; Risk -4.17 for Interest Rate; Exchange Rate -0.02/-0.23; Market Risk -0.48/-4.40.
  - Small Banks (market share 1.2): Baseline -0.66; Risk -2.83 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk -0.66/-2.82.
  - Treasury Banks (market share 3.6): Baseline -1.24; Risk -4.98 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk -1.24/-4.98.
  - System (100.0): Baseline 0.27; Risk -2.10 for Interest Rate; Exchange Rate 0.00/0.00; Market Risk 0.27/-2.10.

### Institutional investors — Annuities and earthquake insurance
- Solvency of life insurance companies has improved due to:
  - Changes in retirement qualification rules (2004 reforms tightened parameters for early retirement).
  - Effects of recent losses in pension portfolios which reduced the incentive to retire early and deferred retirement, lowering the longevity risk profile of the annuitant pool (now closer to that of the average population).
  - Stricter provisioning rules strengthened financial positions.
- Structure of liabilities:
  - Balance sheets of life insurance companies are dominated by annuity obligations (close to 90 percent of liabilities).
- Investment behavior and risks:
  - Traditional liability matching with long-term government bonds became impractical as the annuity pricing rate has exceeded the bond rate since 2001.
  - Insurers shifted to fixed-rate corporate bonds to capture higher yields, contributing to development of the domestic bond market.
  - More recently, insurers have shifted around 7 percent of their portfolio into local real estate-related assets (perceived to have limited credit risk but highly illiquid) and into foreign corporate fixed income securities to seize higher yields and diversify credit and counterparty risk.
  - The securities and insurance superintendence (SVS) needs to monitor real estate-related asset structures and values more closely due to their bespoke nature.

*Source: IMF staff report excerpt (pages provided).*

### 15.      The performance of insurance companies and the SVS in the context of the

### 15. The performance of insurance companies and the SVS in the context of the

### Insurance industry performance (February 2010 earthquake and tsunami)
- The insurance industry settled 98 percent of the claims within seven months following the earthquake.
- Losses to local insurance companies were limited because associated risk had been transferred to international markets via reinsurance.
- The SVS played a proactive role in:
  - informing homeowners of their insurance coverage; and
  - monitoring the settlement and payment of property claims.

### Pension funds’ asset allocation and returns
- Improvements since 2004:
  - Investment portfolios better diversified following changes in investment limits (including a higher allowance for foreign investments).
  - Investment regulation simplified in the 2008 reform; draft legislation would increase flexibility further (including allowing pension funds to invest directly in foreign currencies and participate in financial restructuring processes).
  - A basic pension safety net (a Pillar 1) was introduced in 2008 to complement the funded pension system.
- System characteristics:
  - The pension fund system offers five different investment portfolios with different risk-return profiles; the most aggressive portfolio for the younger contributors holds 80 percent in equities and 70 percent abroad.
- Historic and projected returns:
  - Average historic real return on the system portfolio since inception: above 9 percent.
  - Trend: 12 percent in the first decade, 9 percent in the second, and 6 percent since 2000.
  - Going forward, achieving long-term real returns in the 6 percent range may prove challenging.
- Implications if returns are lower:
  - Even members with high contribution density may face problems reaching a 70 percent replacement rate with only 10 percent contributions on wages.
  - Potential policy responses: higher contribution rates, higher retirement age, and pressure on AFPs to reduce costs.
- AFPs’ fee and profitability note:
  - AFPs charge explicit fees equivalent to 60–70 basis points on assets under management (after 30 years of operation); AFPs‘ profitability is high relative to the risk they take.

### Hedging and foreign exposure of pension funds
- Current hedging requirement:
  - Around 45 percent of AFPs‘ foreign positions must be hedged.
  - Pension funds must hedge the equivalent of around 15 percent of GDP due to the large size of AFPs and their combined foreign holdings.
- Proposed legal change:
  - Move regulation of hedging from the law to the investment regime, giving more flexibility to SP with inputs from the Technical Investment Committee, the ministry of finance, and the central bank.
- Recommendation:
  - Any change in hedging regulations should consider implications for the foreign exchange market.

### Banks: supervisory framework and provisioning
- Supervisory enhancements:
  - Risk-based supervision grounded on a well defined bank rating system set in law and regulation.
  - Strengthened regulation and supervision of liquidity and market risks: minimum requirements for bank policies; limit for market risks in the trading book; regulation on derivatives; improved measurement of liquidity risks via a financial cash flow model; stress testing requirements; authorization to use internal models; improved disclosure.
  - New provisioning regime in effect since January 2011.
  - New accounting and financial information standards (2009) follow IFRS.
  - SBIF published a draft norm on corporate governance adopting Basel Committee principles.
- New provisioning regime features:
  - One standard model for debtors assessed individually based on explicit parameters on expected losses with a minimum provisioning requirement of 0.5 percent of performing commercial loans.
  - Two options based on banks‘ internal models for debtors assessed as a group.
  - Voluntary countercyclical additional provisions based on internal models intended to enhance protection against unexpected idiosyncratic shocks.
- Suggested future improvements:
  - (i) Introduce two options for loans assessed both individually and as a group—a standard approach based on minimum parameters defined by SBIF, and an internal models approach subject to prior approval by SBIF.
  - (ii) Establish SBIF guidelines for estimating cyclical component provisions, including general criteria for accumulation and draw-down triggers.
  - (iii) Consider countercyclical tools calibrated on the financial cycle to address systemic risks.
- Legal and institutional issues:
  - Recent legal amendments tightened requirements for bank shareholders, improved information sharing, and granted SBIF access to information on bank affiliates.
  - Remaining legal issues: changes to the general banking law to allow full implementation of Basel II and III capital requirements; conglomerates supervision; system-wide oversight; and resolution framework.
  - Fit and proper requirements for bank directors and managers need further specification.

### Institutional independence and capacity of SBIF
- Superintendent appointment and protection:
  - Superintendent appointed by the President of Chile, has no fixed term, and may be dismissed by the President without cause.
  - SBIF budget is part of the general government budget; SBIF relates with government through the ministry of finance.
  - Amendment stipulates SBIF is to provide legal assistance to the Superintendent even after cessation of duties, but this falls short of international best practices for legal protection and indemnity for acts in good faith.
- Staff compensation:
  - SBIF staff salaries are not competitive with the industry and turnover is high.

### Capital adequacy and Basel implementation
- Current regime:
  - Capital adequacy requirements follow Basel I standards, complemented with elements of Basel II and III.
  - No capital charges for market or operational risk; market risk exposures subject to a limit based on the 1996 amendment of the Basel I Capital Accord.
  - SBIF publishes capital adequacy ratios for all banks adjusted by market risk exposures.
  - Elements of Pillars 2 and 3 of Basel II are part of supervisory processes.
  - Legal framework contains elements of Basel III, such as leverage ratio (capital must be higher than 3 percent of total assets) and a systemic capital surcharge.
- Temporary measure:
  - A higher capital adequacy ratio (from 10 to 14 percent) is temporarily required (for no less than one year) when a merger or acquisition would result in a bank with a market share above 15 percent.
- Authorities are working to adopt the main elements of Basel II and III.

### Insurance sector oversight and reforms
- Life insurance improvements:
  - Weaknesses identified in the 2004 FSAP have been reduced significantly.
  - Mortality tables updated and are regularly reviewed to provide for future life expectancy improvements.
  - Change to the profile of annuitants has moderated mortality risk to which life insurance companies are exposed.
  - Recommendation: SVS should take advantage of solvency improvements to shorten the transition (forbearance) period for the upward adjustment in capital required by the updating of mortality tables.
- Risk-based supervision and Solvency II alignment:
  - Draft amendments to the Insurance Law to be presented shortly to Congress will introduce a comprehensive system of risk-based supervision and a new standard of minimum solvency for insurance companies along the lines of Solvency II.
  - SVS has made significant progress preparing risk-based approaches, but approval of the legal amendment is necessary to remove remaining constraints.
  - Effectiveness of a risk-focused approach would be substantially boosted by consolidated oversight of financial conglomerates.
- Actuarial profession:
  - There is considerable room to enhance the relevance of the actuarial profession.
  - Recommendation: Develop a strong independent actuarial profession to lead selection of assumptions for pricing and valuation of annuity liabilities.

### Securities markets regulation
- Progress:
  - Regulation of securities markets has strengthened significantly since 2004.
  - Assessment of implementation of IOSCO Objectives and Principles shows large improvement vs. 2004.
- Remaining needs:
  - Augment authority and powers of the SVS in broker regulation (notably resolution of a failing brokerage firm) and in investigation and enforcement.
  - SVS is promoting legal changes to bypass secrecy provisions when investigating breaches of securities markets law.

### Anti-Money Laundering / Combating the Financing of Terrorism (AML/CFT)
- Evaluation:
  - GAFISUD conducted a mutual evaluation of Chile‘s AML/CFT regime against FATF‘s recommendations in 2010.
- Key findings and needs:
  - Laws criminalizing money laundering and terrorism financing should be amended to be fully consistent with international standards.
  - Scope to improve implementation of these laws.
  - Need for a clear legal obligation for reporting entities to report suspicious transactions related to the financing of terrorism.
- Preventive measures and supervision:
  - Absence of regulation and supervision of currency exchange bureaus is a significant deficiency creating a systemic money laundering and terrorism financing vulnerability.
  - Supervisory agencies can apply sanctions for failures to comply with AML/CFT obligations, but few sanctions have been applied to date.
- International cooperation:
  - Although Chile has signed and ratified relevant international conventions, legal obstacles remain to sharing information subject to secrecy provisions.
  - Need to enact provisions governing requests for mutual legal assistance in asset forfeiture cases where no treaty exists.

### System-wide oversight and consolidated supervision of financial conglomerates (FCs)
- Progress since 2004 FSAP:
  - Amendments to the banking law granted SBIF power to request and access information on subsidiaries of banking institutions.
  - Three financial regulators (SBIF, SP, and SVS) authorized to share information except that subject to banking secrecy.
  - Committee of Superintendents meets monthly (lacks legal basis); technical secretariat established in November 2008.
  - Some cross-sector regulation has been issued.
- Remaining risks and blind spots:
  - Lack of a comprehensive oversight framework for FCs could leave significant risks overlooked, especially from unregulated, nonfinancial, and cross-border parallel entities.
  - Blind spots could facilitate double gearing and hide solvency problems.
  - Resolution framework lacks arrangements suitable for managing the failure of a FC.
- Two-phase approach to consolidated supervision:
  - Phase 1: Intensify efforts under current legal framework.
  - Phase 2: Major legal reform to establish a comprehensive framework for consolidated supervision.
- Essential building blocks for reformed legal framework (listed):
  - (i) explicit definition of FC, common to all domestic supervisors;
  - (ii) clear allocation of powers and responsibilities for consolidated supervision of the FC;
  - (iii) access to information on all operations of the wider financial group on a consolidated and individual basis, and on all nonfinancial entities of the group;
  - (iv) capacity to identify a de facto FC for consolidated supervision purposes (using presumption if needed);
  - (v) prior authorization requirement to establish abroad any financial institution part of the FC and to undertake investments or transfers of ownership that would affect the capacity to conduct effective supervision or entail new material risks;
  - (vi) requirement that the local FC with cross-border parallel operations or with structures not suitable for consolidated supervision take corrective action;
  - (vii) capital adequacy, liquidity, corporate governance, risk management, and disclosure requirements, and limits on large and connected party exposures at the level of the FC;
  - (viii) corrective action framework to address compliance with the above.
- Short-term actions under current legal framework (Box 3 highlights):
  - Sign a new MoU to define roles of lead and sector supervisors; lead supervisor = supervisor of the entity with the largest share in conglomerate assets (or liabilities).
  - Define information flows between lead and sector supervisors.
  - Use current powers to improve coverage of information on unregulated parts of the group.
  - Improve cooperation and information exchange with host supervisors of cross-border parallel establishments.
  - Lead supervisors to estimate proxies of capital and risk concentrations and assemble provisional risk profile reports focusing on solvency, inter-connections, linkages, and concentrations.
  - Identify scope of de facto FC and remaining information gaps; design supervisory strategies and, once Basel II Pillar 2 (and Solvency II) amendments are in place, require additional capital charges reflecting group-wide risks to main supervised members.
  - Effectiveness of capital requirements may be hampered by severe information restrictions.

### Level playing field across financial services oversight
- Observations:
  - Regulation is not uniformly robust across all sectors; gaps and inconsistencies create scope for regulatory arbitrage.
  - Significant differences exist among SBIF, SP, and SVS in regulation of comparable activities (customer investment suitability standards, internal controls, disclosure of fees and expenses, qualification processes).
  - SBIF may take control of a failing bank and SVS may take control of a failing mutual fund or insurer, but SVS (or any other regulator) cannot take action if a broker fails.
- Recommendation:
  - Regulators should use existing powers to improve uniformity; in some cases, legislative initiative might be required to achieve a level playing field.

*Source: _cr11261 - 15.      The performance of insurance companies and the SVS in the context of the*

### 37.      Increased uniformity with respect to financial infrastructure would bring

### _cr11261 - 37.      Increased uniformity with respect to financial infrastructure would bring

### Financial infrastructure and market transparency
- Mandatory use of central counterparty (CCLV) and third-party depository (DCV) for brokers, mutual funds, pension funds, and insurers; use of CCLV and DCV is voluntary for banks.
- Recommendation: Authorities should consider harmonizing the trading requirement of securities irrespective of the entities trading them.
- Current asymmetry noted: when a security is traded by a pension fund, mutual fund, or a brokerage firm it has to be traded in an exchange, but if the same security is traded among banks it can be traded OTC, with less transparency.

### Retailers’ credit card operations and regulatory perimeter
- Key structural facts:
  - Number of credit cards in circulation at end-2010: almost 30 million.
  - Chile‘s population: 17 million.
  - Number of individual transactions in 2010: 290 million.
  - Total dollar amount of transactions in 2010: US$ 21 billion.
  - Retail credit cards account for almost 70 percent of transactions.
  - Retailers issue over three times as many cards as banks.
- Regulatory asymmetry:
  - Banks and cooperatives issuing credit cards: must be included in the Credit Card Issuer and Operator Register maintained by the SBIF and are subject to all relevant prudential regulation.
  - Nonbank issuers (part of mixed department store conglomerates): required to enroll in the Register but are subject to lighter regulation; can leverage and fund operations by borrowing from banks.
- Current prudential thresholds and requirements (as stated in Box 4):
  - Nonbank issuers responsible for payments to non-related businesses exceeding UF 1 million that agree to settle obligations in less than 3 working days must:
    - Include issuance of credit cards in their business purposes.
    - Maintain capital and reserves of no less than UF 100,000.
    - Total obligations cannot exceed 12.5 times capital and reserves.
    - Maintain liquid assets equivalent to obligations maturing within 30 days, with total liquid assets greater than 9 percent of total obligations.
    - Present an annual risk management report to SBIF audited by an entity registered with SBIF.
    - Adhere to operational, informational, and credit and liquidity risk norms established by SBIF; SBIF may require an audited annual report regarding these areas.
  - Nonbank issuers that declare issuance of credit cards and related activities as their sole business purpose and settle obligations in more than 3 working days must:
    - Maintain capital and reserves of no less than UF 200,000.
  - Nonbank issuers not included in the above cases must report yearly total payments to SBIF.
  - Issuers with payments above UF 750,000 can opt, but are not mandated, to enroll in the register and adhere to the norms.
- Policy recommendations:
  - Enhanced monitoring of nonbank issuers to gauge leverage and risks to the conglomerate (credit, contagion, reputational risk).
  - Closely monitor potential emergence of high leverage outside the regulatory perimeter under the current legal framework.
  - Careful consideration of whether retailers’ credit card operations should be brought within the perimeter of regulation.

### Policy coordination, Financial Stability Committee, and institutional roles
- Recent timeline and institutional moves:
  - August 2010: Independent commission tasked to examine structure of financial oversight.
  - April 2011: Commission recommendations published; recommendations include moving toward a "twin peaks" regulatory structure, establishing a Financial Stability Committee, formalizing coordination committees.
  - Ministry of finance endorsed creation of a Financial Stability Committee and conversion of SBIF and SVS into commissions (without moving to twin peaks approach).
  - July 2011: Financial Stability Committee established by Presidential decree.
- Committee design and governance issues:
  - Committee role: monitor system-wide risks, recommend policy measures in support of financial stability, coordinate actions in event of systemic crises.
  - Composition: chaired by the ministry of finance; includes supervisory agencies as members; for legal reasons the central bank (BCCh) participates as an observer.
  - Recommendation: As an observer, BCCh should be able to adequately influence Committee decisions while preserving its independence because BCCh can bring important expertise.
  - To preserve regulatory autonomy, the Financial Stability Committee should delegate institution-specific issues to a sub-committee of supervisors (except in times of systemic crisis).
  - Sub-committee key responsibility: coordinate supervision of financial conglomerates, recognizing that improved coordination does not substitute for the necessary legal framework for consolidated supervision.

### Safety nets, crisis preparedness, and bank resolution
- Observations on crisis management framework:
  - Resolution authority for insurance companies and mutual and pension funds appears adequate.
  - Authority to intervene brokerage firms should be established.
  - Bank resolution priorities:
    - Primary: enhance powers to address idiosyncratic failure of individual banks.
    - Secondary: set up frameworks to address systemic banking problems (could be established when implementing Basel III capital buffers for systemic institutions).
    - Consider introducing arrangements to address the resolution of a FC.
  - Recent crisis simulation exercise seen as an opportunity to review legal framework and design crisis preparedness strategy.
- Recommended legal reforms to enhance bank resolution effectiveness:
  - Broaden the available set of resolution tools, including:
    - Purchase and assumption (P&A) transactions;
    - good bank/bad bank;
    - bridge bank to allow for rapid and lower-cost resolution;
    - ability to undertake a recapitalization without preemptive rights of shareholders;
    - ability to undertake a forced bank debt restructuring.
  - Grant SBIF the powers to write down capital as part of a bank restructuring; law could preserve shareholders‘ rights by establishing an appeal process (without suspension or reversal of the decisions).
  - Strengthen legal protection of officials in charge of resolution (the provisional administrator and the liquidator), similar to protections recommended for supervisors.
- Deposit insurance and central bank sight deposit guarantee:
  - Recommendation: Consider introducing a premium-based partial deposit insurance in lieu of the current partial government guarantee on time deposits.
  - Possible uses of deposit insurance funds: payment of depositors during liquidation and facilitation of resolution options (good bank/bad bank, P&A transactions, bridge bank).
  - Suggestion: Allow use of deposit insurance funds for resolution on a less-cost basis (funds used lower than insured deposits net of estimated asset recoveries during liquidation).
  - Central bank sight deposit guarantee dual purpose: protects payment system and some depositors; authorities could assess pros and cons of phasing out this safety-net feature in the context of partial deposit insurance, strengthened resolution framework, and introducing Basel III systemic capital charges.
- Footnote guidance on systemic framework elements:
  - Such a framework might include:
    - (i) determination of the "systemic risk" by a credible committee (such as the new Financial Stability Committee);
    - (ii) lifting legal obstacles for use of public funds in systemic cases;
    - (iii) making explicit that use of public funds would be authorized after analysis of alternative costs, provided that this represents the least cost for the tax payers; and
    - (iv) establishing a mechanism for ex-post accountability.

### Observance of financial sector standards — insurance sector summary (Annex I / IAIS ICPs)
- Assessment scope and methodology:
  - Benchmarking against the 2007 version of the IAIS Insurance Core Principles (ICPs).
  - Assessment covers all regulated entities licensed by the SVS.
  - Based on study of legal and regulatory framework, SVS self-assessment and questionnaire responses, and discussions with authorities and stakeholders.
- Institutional responsibilities:
  - SVS responsibilities: licensing and supervision of insurance market players (insurance companies, sales personnel, loss adjusters, reinsurance companies, reinsurance brokers).
  - SVS has special partnership with SP for supervision of life annuity business.
  - SVS prepares laws and regulations applicable to insurance but lacks authority to enact regulations (that power rests with the cabinet and the ministry of finance).
- Market structure and metrics:
  - Insurance penetration (premium to GDP) for 2009: total premium to GDP stood at 4 percent for 2009, with 2.6 percent for life insurance and 1.4 percent for non life insurance segments.
  - Growth: insurance penetration has doubled in the last 25 years.
  - Number of insurance companies as of September 2010: 58 insurance companies (32 life and 26 general insurers).
  - Market concentration: Herfindahl index standing below 1,000 in both life and non life segments.
  - Foreign presence and market shares:
    - Currently, 12 of the life insurers and 15 of the general insurers are controlled by foreign insurance groups.
    - Foreign interests provide 36 percent of industry capital in the life sector and 68 percent in the non-life sector.
    - Premium income by foreign insurers represents 50 percent for the life sector and 66 percent of the non-life sector as of September 2010.
- Supervisory development and limitations:
  - SVS has advanced a move toward a more risk-based supervisory approach since the 2004 FSAP recommendations.
  - Actions taken: reorganization of supervisory teams, creation of specialist risk-oriented group, internal ratings approach, training, supervisory manuals, pilot testing.
  - Legislative constraints impede further progress; many initiatives enacted via guidelines risk creating a dual system of laws plus guidelines.
  - The calce rule has been supplemented over time, increasing complexity and opacity of capital and solvency regulation.
- Planned regulatory changes and tools:
  - SVS and the ministry of finance have proposals for legislative amendments to facilitate risk-based supervision.
  - New two-part assessment of financial strength:
    - A company rating based on financial returns, on-site inspections, and industry intelligence.
    - A second ranking from the relationship between available capital-and-surplus and amounts required by a risk-based capital formula.
    - Senior SVS staff would discuss combined results with company management and could demand remedial action or apply sanctions.
  - Corporate governance:
    - SVS issued a draft guideline on corporate governance (expected adoption in 2011) imposing director responsibilities for policy development and oversight, with emphasis on investment risk, underwriting risk, and management risk; supervisor will review management performance and directors’ monitoring.

*Source: _cr11261 - 37. Increased uniformity with respect to financial infrastructure would bring*

### 55.      SVS has also issued a new draft guideline for general (non-life) insurance companies,

### _cr11261 - 55.      SVS has also issued a new draft guideline for general (non-life) insurance companies,

### SVS actions and regulatory developments for insurance
- SVS issued a new draft guideline for general (non-life) insurance companies providing more detailed specifications in the area of reserving; the guideline will shortly be distributed to the industry for discussion.
- Draft legislation to be presented to Congress includes a proposal for the adoption of risk-based capital as a solvency measure.
- SVS is engaged in the development of an appropriate formula for risk-based capital.
- Emphasis that risk weights and other factors adopted for solvency measurement in Chile must be appropriate for conditions in Chile‘s insurance market.

### Main findings on insurance supervision (paragraphs 56)
- SVS carries out supervisory responsibilities effectively; insurer failures and insolvencies are rare.
- The regulatory system requires overhaul; new legislative proposals that lead to a risk-based approach to supervision and enhanced powers of intervention will be of considerable assistance.

### Summary observance of the IAIS Core Principles (ICP) — key observations
- ICP1—conditions for effective insurance supervision:
  - Need to strengthen the role and professionalism of both auditors and actuaries.
  - Local professional bodies should set their own technical and ethical standards.
- ICP2—Supervisory objectives; ICP3—Supervisory authority; ICP4—Supervisory process; ICP5—Supervisory cooperation and information sharing:
  - Improvement required in three areas: intervention powers of supervisor, legal protection for supervisory staff, and information sharing with other supervisors.
- ICP6—Licensing; ICP7—Suitability of Persons; ICP8—Changes in control and portfolio transfers; ICP9—Corporate governance; ICP10—Internal Controls:
  - SVS has limited authority to impose conditions on licenses and to apply “fit and proper” requirements; corporate governance requires strengthening through new legislation and guidelines.
- ICP11—Market Analysis; ICP12—Reporting to supervisors and off-site monitoring; ICP13—On-site inspection; ICP14—Preventive and corrective measures; ICP15—Enforcement or sanctions; ICP16—Winding-up or exit from the market; ICP17—Group-wide supervision:
  - Major weakness: limitations on the supervisor‘s ability to impose sanctions; this should be corrected in new legislation.
  - SVS and Chile must develop a coordinated approach to supervision of financial conglomerates.
- ICP18—Risk assessment and management; ICP19—Insurance activity; ICP20—Liabilities; ICP21—Investments; ICP22—Derivatives and similar commitments; ICP23—Capital adequacy and solvency:
  - Risk management practices among insurers are weak; risk-based approach will promote these via a new corporate governance guideline.
  - Solvency measurement currently resembles European Union Solvency I; adoption of a risk-based capital formula will improve the situation.
- ICP24—Intermediaries; ICP25—Consumer Protection; ICP26—Information, disclosure & transparency towards markets; ICP27—Fraud:
  - Communication with consumers and consumer access to information are excellent.
  - SVS should consider leading efforts against insurance fraud by consumers or intermediaries.
- ICP28—Anti-money-laundering, combating the financing of terrorism (AML/CFT): (no specific comment in excerpt beyond listing)

### Recommended action plan (paragraphs 57–61)
- Amendments to Law 251 governing insurance should be adopted as soon as reasonably possible to facilitate implementation of risk-based capital and the risk-based approach to supervision; strengthening corporate governance is a condition precedent to risk-based supervision.
- Draft guideline on corporate governance should be adopted as soon as possible; companies should be given a reasonable period for full implementation, but the new approach should be established as the desirable standard for all companies.
- Guidelines specifying new standards for reserving of general (non-life) insurance business should be distributed for discussion and adopted as soon as possible.
- Development of risk weights and other factors required to perform the risk-based capital test must be completed in the near future to provide the opportunity for adoption of RBS; SVS should complete the development work as soon as possible.
- Efforts should be directed at establishment of an effective local actuarial association with high standards for admission and a leading role in setting professional and ethical standards; government, SVS, and academic experts may need to work with the local institute over time. Urgent attention required due to actuaries’ role in monitoring reserves for long-term life annuity liabilities.

### Authorities’ response (paragraph 62)
- SVS has published the new standards for reserving of general (non-life) insurance business: the NCG N° 306 dated April 14, 2011 (reference to SVS website provided in original).
- In 2009, SVS hired external consultants to develop the risk-based capital factors; supporting reports were available last year and SVS has continued to study these factors for construction of a standard formula.
- SVS agrees on the need to enhance the actuarial profession’s relevance and has taken measures in this direction; forthcoming corporate governance and risk management rules will reinforce actuaries’ role, especially regarding insurance risks.

### Securities regulation assessment — methodology and fieldwork (paragraphs 63–64)
- Assessment based on the IOSCO Objectives and Principles of Securities Regulation and associated methodology adopted in 2003, updated in 2008; IOSCO revised its principles in 2010 adding eight new principles and associated methodology is under development.
- Fieldwork conducted in March–April 2011, including interviews with SVS staff, visits to two of the three Chilean stock exchanges, and meetings with brokerage community, corporate issuers, money management firms, and academics.
- SVS provided a self-assessment, documentary information, and statistical data; additional information obtained from laws, SVS regulations, and publicly available information.

### Institutional and market structure — overview and key statistics (paragraphs 65–73)
- SVS legal authority: authorized to regulate issuance of securities; mandate initial and periodic corporate disclosure; require registration and continuing oversight of securities markets and market intermediaries, including broker-dealers, mutual funds, and mutual fund operators.
- Banks may underwrite securities offerings directly and trade debt securities, but may not engage in equity trading or service retail accounts other than through an SVS-licensed broker-dealer subsidiary; when securities functions apply to banks, enforcement responsibility is assigned to SBIF, not SVS.
- Investment advisers (except advisers of regulated funds) are unregulated.
- SVS budget and staff growth since 2004 IOSCO assessment:
  - Budget increased from Ch$ 5.8 billion (approximately US$ 15 million) to Ch$ 11.6 billion (approximately US$ 45 million).
  - Staff size increased from 267 to 313 (total including insurance).
  - The Superintendent has full discretion to control allocation of resources within SVS.
- Market structure:
  - Three securities exchanges: Bolsa de Comercio de Santiago (~80 percent of trading volume), Bolsa Electrónica (slightly less than 20 percent), Bolsa de Valparaiso (oldest and smallest).
  - 270 publicly traded companies.
  - Listing requirements: all companies with 500 or more shareholders and all companies with at least 10 percent of shares owned by 100 shareholders must be publicly listed.
  - As of December 2010, total market capitalization of equity shares was US$ 341.5 billion.
  - Average daily trading amount is US$ 190 million.
  - Average turnover ratio for all listed equities was about 18 percent in 2010; five of the ten largest companies had turnover ratios in 2010 under 10 percent.
- Corporate debt market:
  - Peaked in 2009 at 70 issues for a total of US$ 7 billion, more than double the amount issued in 2004.
  - Virtually all corporate debt is investment grade issued in inflation-indexed UF denominations.
  - AFPs and insurance companies purchase over 80 percent of corporate debt issues and tend to hold to maturity.
  - Annual turnover rate for corporate fixed-income rose from less than 10 percent in 2004 to just under 60 percent in 2010.
- Brokers and intermediaries:
  - Two categories: corredoras de bolsa and agente de valores.
  - 44 corredoras (13 owned by banks) and 16 agentes (five owned by banks).
  - Five corredoras account for approximately 55 percent of equity trading and over 80 percent of nonbank fixed income trading.
  - 16 agentes may not trade equity on an exchange and must execute equity trades through a corredora.
  - Intermediaries largely engaged in brokerage for clients; most do not engage in proprietary trading, except in fixed-income.
- Mutual funds:
  - 19 registered fund administrators, of which 11 are bank affiliates.
  - They operate 471 mutual funds with total assets under management of approximately US$ 33 billion.
  - Mutual fund assets increased from US$ 8.4 billion in 2004 to approximately US$ 33 billion in 2010.
  - Number of investors increased from around 400,000 in 2004 to 1.5 million in 2010.
  - Mutual fund assets primarily invested in fixed-income; nearly 50 percent invested in money market funds.

### Preconditions for effective securities regulation (paragraph 74)
- Effectiveness depends on a strong, independent, and efficient judicial system.
- Judicial delay is a serious problem in Chile; judicial proceedings and appellate review may continue for as long as ten years.
- Example: SVS reports three criminal cases filed in 2008 and 2009 that are still in litigation.

### Summary, key findings, and recommendations on securities regulation (paragraphs 75–78)
- SVS has strengthened securities market regulation since the 2004 FSAP, but further improvement requires augmentation of SVS authority and powers in broker regulation and investigative/enforcement ability.
- SVS lacks legal authority to compel testimony or documents from persons not subject to its regulation (e.g., unaffiliated investors, unregulated investment advisers or consultants, banks or bank employees unless working for an SVS-regulated subsidiary, third parties such as telephone or internet service providers).
- Implemented recommendations since 2004:
  - Creation of a central counterparty (CCLV) with legal authority of novation and authority to create a central guaranty fund based on market participant exposures.
  - Requirement for brokers, mutual funds, insurance companies, and pension plans to use the central securities depository as third-party custodian with segregation of customer and entity securities.
  - SVS increased staff and made internal procedure changes to improve staff accountability, regulatory transparency, and fairness in sanctions.
  - Bolsa de Comercio de Santiago and Bolsa Electrónica improved regulatory and disciplinary programs.
  - Adoption and mandatory use of a third-party pricing system by mutual funds and pension funds.
  - Chile adopted IFRS and changed definition of auditor independence.
- Outstanding recommendations from 2004 not implemented:
  - Lack of uniform regulation across banks, brokers, mutual funds, insurance companies, pension funds, and unregulated investment advisers despite comparable products and services.
  - Adoption of an industry-wide customer suitability requirement and mandatory internal controls programs for all intermediaries should be priorities.
  - SVS should utilize existing powers to improve business conduct regulation to be robust and uniform across financial services sectors.
- SVS challenges:
  - Examine and refine procedures to conform to market changes.
  - Improve speed of enforcement program; market credibility requires prompt and decisive action.
  - Review procedures for routine fixed-income securities registrations.

*Source: Excerpts from the assessment contained in the supplied PDF content.*

### Annex B signatory to the IOSCO multilateral MoU.

### _cr11261 - Annex B signatory to the IOSCO multilateral MoU.

### Regulatory cooperation and information sharing
- Completion of the information sharing agreement with SBIF and SP should be a priority.
- Principle 13: The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers.
- SVS requires access to bank secrecy data to meet international standards for information exchange.

### Issuer disclosure and investor protection
- Principle 14: There should be full, timely and accurate disclosure of financial results and other information that is material to investors' decisions.
  - SVS has a sound issuer disclosure regime.
  - Chilean law requires all issuers to file a registration statement for SVS review prior to offering the securities.
  - The registration statement must contain:
    - information on the issuer and its business plan,
    - two years of audited financial statements,
    - a description of the issuer‘s business,
    - information about directors and management,
    - the identity of the twelve largest shareholders,
    - any additional material information.
  - While two years of audited financial statements are required in the registration statement, the prospectus provided to investors contains a shortened summary financial statement.
- Principle 15: Holders of securities in a company should be treated in a fair and equitable manner.
  - The tender offer law provides broad protection for investors in tender offers and other acquisitions.

### Accounting, auditing, and market conduct standards
- Principle 16: Accounting and auditing standards should be of a high and internationally acceptable quality.
  - Chile has adopted IFRS and is completing a multi-year transition.
  - SVS should consider the need for a formal accreditation process for auditors.
- Principle 28: Regulation should be designed to detect and deter manipulation and other unfair trading practices.
  - The law provides SVS with broad legal authority, but limits on the ability to investigate affects its enforcement capacity.

### Collective investment schemes (funds)
- Principle 17: The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme.
  - SVS should establish minimum knowledge and professional standards for senior fund administrators and managers.
  - In Chile, mutual funds operate through a general funds administrator that must be registered with SVS, subject to a range of eligibility criteria.
  - There is no specialized training or experience in mutual fund operations required, no qualification examination or process, and there are no continuing education requirements.
- Principle 18: Rules governing legal form and segregation/protection of client assets.
  - Mutual funds do not have independent legal status, but there is sufficient clarity of form and protections for investors.
  - Law does not require a third-party custodian, but regulatory safeguards exist:
    - Funds must maintain a shareholder registry, updated daily.
    - All fund assets must be kept at DCV (except those that cannot be maintained there, such as foreign securities).
    - Each fund must have a separate account at DCV and assets must be held in the name of the specific fund.
    - Each fund administrator must maintain a separate guarantee account for each fund for the benefit of investors; a bank must be designated as the account beneficiary on behalf of the investor.
- Principle 19: Disclosure necessary to evaluate suitability of a collective investment scheme.
  - Chile‘s system of explicitly defined types of funds enables investor comparison.
  - Mutual funds must file a registration statement with SVS prior to offering fund shares to the public.
  - Legal changes in 2010, to be effective in the near future, will no longer require SVS pre-review prior to operations.
  - SVS can still halt trading and direct the return of investor monies if deficiencies are identified.
  - The elimination of SVS pre-review of mutual fund offering documents is a significant change that should be monitored carefully.
- Principle 20: Proper and disclosed basis for asset valuation, pricing and redemption of units.
  - Development of a uniform pricing model and daily pricing list for debt securities is an important improvement.

### Market intermediaries, licensing, and failure resolution
- Principle 21: Regulation should provide for minimum entry standards for market intermediaries.
  - SVS cannot consider internal controls and operating procedures or professional qualification of key employees in licensing decisions — identified as important deficiencies.
  - Lack of investment adviser authority is a further deficiency.
- Principle 22: Initial and ongoing capital and prudential requirements.
  - SVS has a sound capital adequacy program for licensed brokers.
- Principle 23: Standards for internal organization and operational conduct.
  - Brokers required to have internal control processes; SVS should have client suitability requirement for intermediaries.
  - Law requires firms to adopt procedures to ensure segregation of customer securities with DCV.
  - A 2009 SVS circular establishes internal control requirements for custody of client assets.
  - SVS created in 2009 an office responsible for reviewing customer complaints; it does not have authority to mediate or arbitrate disputes.
  - Intermediaries are not required to have a mechanism for resolution of investor complaints.
- Principle 24: Procedure for dealing with failure of a market intermediary to minimize damage and systemic risk.
  - SVS lacks the authority to take some form of action if an intermediary firm fails: it cannot appoint, or request a court or other body to appoint, a third-party receiver or conservator to assume control of a failing firm and oversee an orderly winding down and transfer of client accounts.
- Principle 29: Ensure proper management of large exposures, default risk and market disruption.
  - Given high concentration and lack of consolidated supervision, issues of excessive concentration within related entities need to be addressed.
  - SVS (and the stock exchanges) does not have capacity to monitor "large exposures" in real time; it may obtain beneficial owner information from the brokerage firm.
  - Development of CCLV as a central counterparty engaging in real-time risk management could enable increased monitoring capability in the future.

### Exchanges, trading transparency and market oversight
- Principle 25: Establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight.
  - SVS has broad authority to license and monitor exchanges.
  - Securities law requires stock exchanges to register with SVS and to regulate trading activity and member firms to ensure a "fair, competitive, orderly, and transparent market."
  - Exchanges must demonstrate capacity to function effectively, have internal governing regulations, and the ability to enforce these laws.
  - SVS can review exchange rules, new products, and new systems of operation.
- Principle 26: Ongoing regulatory supervision of exchanges and trading systems.
  - Chilean law clearly provides SVS with full regulatory authority over Chilean exchanges.
  - SVS reviews proposed changes and has developed an ongoing supervisory inspection process.
- Principle 27: Regulation should promote transparency of trading.
  - Better transparency in the OTC debt market is needed.
  - Debt trading by banks is only available to participating banks; nonbank institutional investors may not obtain a complete picture.
  - Institutional investors can request quotes from a bank, but this is not optimal.
  - The disparity in transparency and access between exchange trading and OTC trading should be studied carefully.

### Clearing, settlement, and systemic risk reduction
- Principle 30: Systems for clearing and settlement should be subject to regulatory oversight and designed to reduce systemic risk.
  - Legal changes creating the CCVL and mandating segregated customer accounts at the DCV are substantial improvements.
  - Fully implementing the CCLV and developing a robust clearing system with a sufficient guaranty fund are priorities.

### Recommended Action Plan (Table 6 — selected recommendations)
- Principles Relating to the Regulator (P 1–5)
  - The Superintendent should be appointed for a fixed term, with removal for good cause.
  - SVS staff should have legal immunity in the performance of official duties.
  - SVS requires expanded authority in several core areas described in the assessment.
  - SBIF authority to enforce the securities market law should be consistent with SVS enforcement.
- Principles of Self-Regulation (P 6–7)
  - The Self-Regulation Committee should have authority to issue binding decisions when it considers customer-broker disputes.
  - The bolsas should adopt rules imposing a customer suitability requirement on its members if SVS cannot adopt such a rule.
- Principles for the Enforcement of Securities Regulation (P 8–10)
  - SVS should be provided comprehensive authority to investigate violations and impose sanctions.
  - It should be exempt from the bank secrecy law when information is necessary to investigate and enforce compliance.
  - SVS should require all intermediaries to develop comprehensive internal control programs.
- Principles for Cooperation in Regulation (P 11–13)
  - Complete the information sharing agreement among regulators as soon as possible.
  - Pursue coordinated examinations of affiliated entities.
  - Legal reform to permit regulators to obtain banking records is a priority.
- Principles for Issuers (P 14–16)
  - Industry development of auditor qualification standards should be supported.
- Principles for Collective Investment Schemes (P 17–20)
  - SVS should establish minimum knowledge and professional standards for senior fund administrators and managers.
  - The elimination of SVS pre-review of mutual fund offering documents is a significant change that should be monitored carefully.
- Principles for Market Intermediaries (P 21–24)
  - SVS should mandate an industry-wide client suitability requirement and require registered intermediaries to have comprehensive internal controls.
  - Rapid implementation of a robust broker employee qualification program by self-regulatory organizations is important.
  - SVS should have authority to intervene and assume control of a failing broker or appoint/seek judicial appointment of a third party to protect client assets and ensure orderly termination.
- Principles for the Secondary Market (P 25–30)
  - OTC debt trading transparency could be improved.
  - SVS should focus on developing systems to closely monitor large market exposures across entire financial conglomerates.
  - Fully implementing the CCLV and developing a robust clearing system with a sufficient guaranty fund should be priorities.

### Authorities' response
- The authorities were in broad agreement with the assessment.

### Selected economic and financial indicators (excerpt)
- GDP (2010): 103,742
- U.S. dollars (billions): 203.3
- Per capita (U.S. dollars): 11,981
- Poverty rate (2009): 15.1
- Indigent: 3.7
- Poor, not indigent: 11.4
- Population total (in millions, 2009): 17.0
- Urban population (percent of total): 88.7
- Life expectancy at birth (years): 78.7
- Gini coefficient: 0.55
- Real GDP (selected years): 2006 4.6; 2007 4.6; 2008 3.7; 2009 -1.7; 2010 5.2; 2011 6.5; 2012 5.0
- Current account (percent of GDP, selected years): 2006 4.9; 2007 4.5; 2008 -1.9; 2009 1.6; 2010 1.9; 2011 0.3; 2012 -1.3
- Gross International Reserves (in billions of U.S. dollars): 2006 19.4; 2007 16.9; 2008 23.2; 2009 25.4; 2010 27.9; 2011 39.9; 2012 39.9
- Public sector gross debt (percent of GDP, selected years): 2006 26.9; 2007 19.9; 2008 26.0; 2009 29.3; 2010 27.7; 2011 32.8; 2012 30.3

*Annex B signatory to the IOSCO multilateral MoU. (Source content provided in the PDF chapter/section.)*

### Appendix 1. Chile: Main Recommendations of the 2004 FSAP

### Appendix 1. Chile: Main Recommendations of the 2004 FSAP

### Central Bank
- Strengthen BCCh‘s financial accounts — PARTLY DONE—The 2006 Fiscal Responsibility Law established a mechanism for the central government to gradually recapitalize BCCh in years of fiscal surplus. These transfers stopped in 2009 when countercyclical fiscal stimulus moved fiscal balance into deficit.

### Commercial Banks
- Further develop risk-based supervisory approach — DONE
- Clarify SBIF‘s powers as regards licenses and expand  ̳fit and proper‘ tests — PARTLY DONE— Fit and proper requirements expanded for shareholders, but not for directors and managers.
- Impose capital requirements for market risk — DONE—Limit on market risks consistent with Basel I
- Improve disclosure of risk exposure, management practices by banks — DONE
- Strengthen bank resolution regime — NOT DONE

### Corporate Sector
- Reform legislation for movable collateral — DONE
- Create national register of pledges — PARTLY DONE—National register created in 2007, but in transition.
- Improve quality of SME financial statements — NOT DONE—Difficult to address as SMEs are typically unregulated.
- Eliminate  ̳tasa máxima convencional‘ or introduce more flexibility — NOT DONE—Current focus of the authorities is to introduce more flexibility, for instance through a less backward-looking rule to address changes in policy rates.

### Insurance
- Upgrade provisioning requirements and strengthen supervision — DONE—Mortality tables for pensions (male and female) updated in 2004 and again in 2010; tables utilized to book the technical provisions of beneficiaries and disabled persons updated in 2007.
- Strengthen insurance company failure resolution framework — PARTLY DONE—The law now allows for the transfer of a portfolio of annuities from one life insurance company to another. It also allows the SVS to take early actions under certain conditions. Legislation to be introduced to Congress will provide SVS with enhanced powers and particularly the authority to intervene at an earlier date and take remedial action in advance of failure.
- Shift emphasis from rules management to risk management — ALMOST DONE—Legislation to be introduced to Congress will mandate a risk classification system based upon solvency and supervisor‘s assessment of riskiness of each company. Rules will include adoption of a risk-based capital formula. Inspection process has been developed to implement fully a risk-based approach to supervision. Over the last four years, all companies have been subjected to a new inspection process, effectively implementing risk-based supervision.

### Pension Funds
- Judiciously relax investment regime — PARTLY DONE— Steps taken to relax the regime; further progress is linked to advances in benchmarking and risk management..
- Move from compliance-based to risk-based supervision — DONE
- Encourage outsourcing and regulate service providers — DONE
- Enhance attractiveness of voluntary system — DONE—Much happened, though results will take time to materialize.
- Develop contingent strategy to enhance competition — PARTLY DONE—Steps include the recent introduction of an auction system on the fees to charge to contributors.
- Reduce risks faced by workers at retirement — PARTLY DONE—Steps include the option to purchase annuities after retiring under the programmed withdrawal option, but not before.

### Securities Markets
- Embed concepts of finality, netting, and novation in the law — DONE
- Promote industry-financed fund for multilateral netting — DONE—CCLV provides multilateral netting of exchange traded securities
- Organize securities lending and borrowing — PARTLY DONE—Securities lending facilities exist, however collateral and margining requirements are too high.
- Establish price reporting for OTC trades, harmonize securities valuation — NOT DONE
- Introduce international standard contract for repos and derivatives — PARTLY DONE—Standard agreement for repos is voluntary, thus benefit of standardization are not certain. No master standard yet for derivatives.
- Enhance standardization of financial instruments — PARTLY DONE—Passage of law amendments needed.
- Suitably formalize market-makers for public debt — PARTLY DONE—Large brokers are now included but no formal standards.
- Increase SVS‘s budgetary and staff resources — DONE
- Introduce minimum standards for securities industry — PARTLY DONE—2010 amendments authorize creation of professional qualifications for broker personnel. Mutual fund, bank and pension sales personnel are not covered.
- Require internal compliance programs by brokerage firms — PARTLY DONE—Brokers are required to have AML internal compliance programs. Other aspects not covered.  
- Widen SVS enforcement powers — NOT DONE—Authority to investigate and sanction persons not associated with securities industry required. SVS should have access to bank records, AML reports, and ability to compel full document production.
- Give SVS power to appoint a conservator or liquidator for brokerage firms — NOT DONE—Legal authority required.
- Implement risk based supervision — DONE

### Taxation, Financial Reporting Standards, Corporate Governance
- Review financial sector taxation — PARTLY DONE—Differential capital gains tax treatment adversely affects market liquidity and development of derivatives market
- Strengthen financial reporting regime for listed companies — DONE
- Enhance corporate governance including training of directors, judges — PARTLY DONE—Corporate Governance Law of 2010 made significant progress.
- Hedges: Correct deficiencies in information and market infrastructure — PARTLY DONE—Creation of CCLV and mandatory custody at DCV are improvements in market infrastructure. Bilateral transaction in OTC debt and derivatives markets should be addressed.
- Relax restrictions on short selling, writing and trading — PARTLY DONE—Progress ongoing with institutional investors.

### Cross-Sectoral Financial Oversight
- Embed Committee of Superintendents in the law — PARTLY DONE
- Establish MOUs and technical secretariat for coordinating committees — DONE—Secretariat created. Work ongoing to refine it further (MoU not completed and signed yet).
- Introduce regular staff exchanges — NOT DONE
- Introduce fully consolidated supervision and relax firewalls — NOT DONE—Law permits exchange of information among regulators; lack of legal framework prevents full implementation.
- Resolve conflicts of competence and draw contingency plans for failure of financial conglomerates — NOT DONE
- Strengthen the information system — PARTLY DONE—Regulators have legal authority to share. MoU required to implement.
- Clarify and strengthen legal protection of supervisors — PARTLY DONE—Superintendent is only SVS person with some limited protection.
- Allow supervisors control over budget with appropriate accountability — NOT DONE—SVS budget determined by ministry of finance and legislature.
- Disconnect timing of Superintendents‘ appointments from political cycle — NOT DONE

### Anti-Money Laundering
- Strengthen capacity to monitor compliance — PARTLY DONE
- Enhance monitoring of securities, insurance, and foreign exchange operators — PARTLY DONE
- Improve mutual assistance / international cooperation in freezing assets — NOT DONE

### Appendix II. Chile: Risk Assessment Matrix — Key Threats, Likelihood, and Expected Impact
- Strong capital inflows  
  - Staff assessment: MEDIUM  
  - Description: Higher growth in Chile and most emerging markets compared to advanced countries, coupled with higher interest rates in emerging markets would continue to attract capital. Continued capital inflow could lead to asset price bubbles in short to medium term. However, at present asset prices are estimated to be close to their equilibrium level, with the stock market being just moderately overpriced.  
  - Staff assessment: MEDIUM  
  - Expected impact: Significant overvaluation of key assets and external funding availability could contribute to an overheating of the economy through increased consumer and corporate lending, potentially resulting in higher credit, foreign exchange, and liquidity risk of financial institutions. The impact on banks‘ books could be magnified by the high concentration of loans and conglomerate structures.

- Slowdown in economic growth in the United States and overheating in Emerging Asia, particularly China  
  - Staff assessment: MEDIUM  
  - Description: Rising inflation in China and other emerging market countries could prompt monetary policy to overshoot and trigger a hard landing with severe consequences on commodity prices and global demand. Consumption spending in the U.S. could remain lower than projected, thus could continue to depress corporate and small business profits, hampering GDP growth.  
  - Staff assessment: MEDIUM  
  - Expected impact: Weaker external demand from main trading partners and lower terms of trade would affect corporate profits and domestic demand, leading to higher credit risk and increased chances of an exchange rate correction, with the attendant foreign exchange risks. In case external demand is affected marginally, some domestic sectors may benefit from the exchange rate correction.

- Significant deterioration in financial conditions in peripheral Europe  
  - Staff assessment: MEDIUM  
  - Description: Deteriorating financial conditions in peripheral Europe could result in rising funding costs in Chile. (Low direct exposure to Europe would limit the impact on banks through this channel.)  
  - Staff assessment: LOW-MEDIUM  
  - Expected impact: Domestic banks and corporates could start experiencing reduced access to external funds and higher borrowing costs, the peso would likely depreciate, and domestic activity weakens. The potential impact on the credit risk of domestic corporates could remain moderate, despite their increasing indebtedness, but households could be more affected.

- Fast withdrawal of banks’ wholesale deposits  
  - Staff assessment: MEDIUM-HIGH  
  - Description: Changes in valuation rules affecting money market mutual funds could lead to further reductions in local bank term wholesale deposits. With increasing interest rates in advanced countries, pension funds could quickly move their wholesale deposits abroad chasing safer returns.  
  - Staff assessment: LOW-MEDIUM  
  - Expected impact: Some banks heavily relying on wholesale funding could be severely affected by fast wholesale deposit withdrawal, The potential systemic impact would not be high due to the small size of these banks, but disruptions could emerge in the interbank market and through elevated liquidity demand.

*Appendix 1. Chile: Main Recommendations of the 2004 FSAP (implementation status and Risk Assessment Matrix).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11261.pdf_