## Executive Summary

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---

### Macro-Financial Performance and Structure of the Financial System
- Since the last FSAP in 2002, Brazil’s financial system grew in size, diversification, and sophistication alongside the country’s economic progress.
- Over the last decade, financial sector assets doubled, driven by macroeconomic stabilization, gains in financial inclusion, expansion of securities and derivatives markets, and involvement of institutional investors.
- Structure of public debt more resilient; private bond market more vibrant though still small.
- Banking sector dominated by domestic institutions; public banks have a significant share; international investors play important roles in capital and derivatives markets.
- Policy responses and buffers that helped weather the global crisis:
  - fiscal and monetary policy stimulus, including a significant release of bank reserves to preserve market liquidity;
  - quasi-fiscal stimulus through the national development bank;
  - other public banks expanding lending;
  - foreign exchange intervention and establishment of a swap facility with the U.S. Federal Reserve;
  - measures to channel liquidity to small and medium-sized banks facing stress.
- System-level figures (2011, preserved):
  - Total financial sector assets (2011): R$ 7,389 (Percent of GDP: 178.3).
  - Depository institutions (2011): Number of Institutions 1,603; R$ 4,387 (Percent of total 59.4; Percent of GDP 105.9).
  - Multiple and commercial banks (2011): Number 125; R$ 3,244 (Percent of total 43.9; Percent of GDP 78.3).
  - Large banks (2011): R$ 2,765 (Percent of GDP 66.7).
  - Private banks, domestically-controlled (2011): R$ 1,680 (Percent of total 22.7; Percent of GDP 40.5).
  - Private banks, foreign-control (2011): R$ 375 (Percent of total 10.2; Percent of GDP 18.2).
  - Investment and Asset Managers (2011): R$ 2,815 (Percent of total 36.8; Percent of GDP 67.9).
  - Insurance companies (2011): R$ 469 (Percent of total 6.4; Percent of GDP 10.3).
  - Money and capital markets (2011 memorandum): R$ 6,826 (Percent of GDP 164.7).
  - Nominal GDP entries shown: 2002 = 1,478; 2007 = 2,661; 2011 = 4,143.
- Other structural metrics and concentrations:
  - Total assets in the system around 180 percent of GDP.
  - Asset breakdown: more than half held by depository institutions, one-third by investment and pension funds, about 6 percent by insurance companies.
  - Financial conglomerates control around 75 percent of system’s assets.
  - Government-owned banks account for over 40 percent of total banking assets.
  - Directed credit for low-income housing, agriculture, and infrastructure represents around 35 percent of total credit.
  - Foreign bank participation about 17 percent of banking assets.
- Recent macro-developments:
  - Fiscal stimulus, including quasi-fiscal operations of BNDES, amounted to 3 percent of GDP in response to the 2009 downturn.
  - Economy grew 7½ percent in 2010.
  - BCB started tightening mid-2010; monetary easing began mid-2011.
  - Macroprudential tools deployed to address rapid credit expansion.

### Financial Sector Risks and Resilience
- Overall assessment:
  - Systemic risk currently assessed as low, though exposures to global and domestic risks remain and require monitoring.
  - Financial Stability Map shows risk declined across all dimensions since 2008–09.
- External vulnerabilities:
  - Exposure to volatility in international markets, especially commodities and capital markets.
  - Commodity exports accounted for almost 40 percent of total exports in 2011.
  - Flexible exchange rate and large international reserves provide policy cushion.
  - Extensive use of macroprudential and capital flow management measures; effective for immediate targets but should be embedded in broader macro framework.
- Domestic vulnerabilities:
  - Rapid credit expansion: Credit-to-GDP doubled in the last decade, with annual increases exceeding 3 percentage points during 2007–09 and 2011.
  - Estimated credit-to-GDP gap declined significantly after peaking in 2009.
  - Emerging strains in some sectors and asset classes: indebted households and rapidly rising housing prices in prime locations.
  - Small and medium-size banks reliant on wholesale funding are relatively more vulnerable to liquidity risk.
  - System in a high interest rate–short duration equilibrium:
    - Interest rates well above those in comparable countries.
    - Most debt instruments indexed to the overnight interest rate.
    - Domestic investments concentrated in short-term or indexed instruments.
  - Long-standing fundamentals: legacy of past high and volatile inflation and low level of domestic savings.
  - Continued policy effort beyond the financial sector required: maintaining macroeconomic stability, strengthening domestic savings, improving the business environment.
  - Supporting financial reforms needed to promote longer-term private finance: lengthen duration of financial contracts, reform housing finance, rethink role of state-owned banks.
  - Potential new risks from financial development: search for yield by domestic investors could lead to asset price bubbles and under-pricing of risk.
- Resilience indicators:
  - Banks have significant buffers.
  - Stress tests suggest banking system robust to a variety of severe shocks, though small and medium-size banks show relatively greater liquidity vulnerability.
- Household sector and housing risks:
  - Average household debt service-to-income ratio (DSTI) in Brazil is 23 percent.
  - Indications of rapid real estate price appreciation in prime locations: partial data suggest prices in Sao Paulo and Rio de Janeiro have been growing by about 30 percent annually in recent years, with pace moderating somewhat since 2011.
  - Low proportion of housing loans in banks’ loan portfolios (except for Caixa) mitigates systemic impact of housing price declines.

### Financial Sector Oversight and Infrastructure
- Banking supervision:
  - Strengthened since 2002; high degree of compliance with Basel Core Principles already in 2002 and further improved.
  - Supervision is risk-based, intrusive, and sophisticated, leveraging strong off-site analytics.
  - Average Basel capital adequacy ratio (September 2011): 17.2 percent; Required in Brazil: 11 percent.
  - Leverage ratio: (around 10 percent).
  - Liquidity ratio based on a liquidity buffer/stressed cash flow: (around 1.1).
  - ROE (system-wide): 22.8 percent.
- Capital markets supervision:
  - Transparency standards raised and risk-based supervision implemented.
  - Substantial improvement in compliance with IOSCO principles, with some remaining challenges.
- Insurance supervision:
  - Strengthened, but independence of supervisory agency SUSEP needs improvement.
  - Supervision of brokers and insurance groups should be enhanced.
  - Insurance sector indicators:
    - Life insurers: combined ratio around 75 percent; ROE above 20 percent.
    - Nonlife insurers: combined ratio around 100 percent; ROE between 34 and 47 percent.
    - Life insurance sector margin: average margin of 250 percent above regulatory requirements.
    - Nonlife sector: 90 percent additional solvency margin.
    - Risk ratio (capital plus surplus to underwritten premium): around 1.7.
    - Capital plus surplus to total assets: 8.3 percent.
- Cross-cutting supervisory challenges:
  - Need to keep pace with an evolving system given constraints on budgets and human resources.
  - Need to strengthen legal protection for agencies or employees.

### Financial Sector Safety Nets and Crisis Preparedness
- Authorities’ crisis response was swift, flexible, and successful; safety nets could be further strengthened.
- Emergency Liquidity Assistance (ELA):
  - BCB’s ELA facilities well-designed but could be made more effective in practice; ELA facilities were not used in the recent crisis.
  - Recommendations to ensure prompt ELA disbursement:
    - develop clear internal procedures to approve ELA clarifying roles and accountability;
    - introduce systems to enable quick acceptance of collateral other than government securities, including valuing and determining haircuts;
    - pre-determine haircuts for asset classes, review periodically, and disseminate information;
    - ensure sufficient expertise is readily available and undertake simulation exercises and test transactions.
- Deposit insurer and FGC role:
  - FGC actions included extending guarantees, providing liquidity to small banks, extending deposit insurance coverage, and providing solvency support.
  - FGC’s evolving role from pay-box to providing liquidity and guarantees creates potential conflict of interest.
  - Governance reform removing active bankers from Board was implemented shortly after the FSAP mission.
  - Recommendations on FGC:
    - apply least-cost principle when deciding resolution options;
    - restrict FGC funding beyond least-cost assistance to systemic threats only;
    - cap open bank assistance by FGC at 50 percent of its cash or cash-equivalent resources (except systemic cases);
    - secure backstop access to an unsecured credit line from BCB or government at market rates in systemic crisis.
- Bank resolution framework:
  - Authorities considering new resolution framework with two regimes: systemic and non-systemic.
  - Staff recommendations include maintaining BCB residual powers, removing tax and labor law impediments to P&A and bridge-bank powers, introducing depositor preference, limiting judicial action to suspend resolution proceedings, and enhancing legal protection to gross negligence threshold for supervisors and intervenors.
- Institutional coordination:
  - Consider upgrading multipartite committee for supervisory coordination by giving an explicit mandate for systemic risk monitoring, crisis preparedness, and crisis management, and expand it to include FGC.

### Developmental Issues, Consumer Protection, Corporate Governance, Insolvency and Creditor Rights
- Policies should encourage development of private long-term finance while managing attendant risks.
- Capital markets and BNDES:
  - Shift BNDES towards co-financing with institutional investors and supporting market-based financing, crowding in private sector intermediation.
  - Pricing should be actuarially fair; strengthen governance, transparency, and supervisory oversight.
  - Consider extending tax incentives on infrastructure bonds to infrastructure FIDCs.
  - Measures to improve secondary market liquidity: standardization of issues, market making, liquidity fund, narrow set of benchmark issues, common electronic trading platform, securities lending facility.
- Housing finance:
  - Need to move to longer-term funding linked to market interest rates.
  - System currently based on SBPE and FGTS non-market funding pillars; SBPE’s interest rate floor and short duration contributed to limited mortgage duration.
  - Government eliminated minimum returns on savings deposits (previous floor of 6 percent) in April 2012 enabling mortgage rates to fall without undue spread compression.
  - Introduce regulatory framework for covered bonds and standardization/use of cédulas de crédito imobiliário (CCI).
- Consumer protection and corporate governance:
  - Create a dedicated, adequately staffed consumer financial protection unit.
  - Strengthen broker oversight and consumer disclosures; require pre/during/post purchase information and disclosure of commissions and conflicts of interest.
- Insolvency and creditor rights:
  - Bankruptcy Law (2005) improved framework but shortcomings remain.
  - Recommendations: make tax treatment of debt write-offs neutral; clarify fraud requirement for personal liability; review rules for cooperatives, mixed-capital companies, and health care plan companies; improve judicial enforcement speed and registries for immovables and charges.

### FSAP Key Recommendations (selected, preserved wording and timings)
- Macroprudential Institutional Arrangements and Instruments
  1. Issue regulation on credit bureaus to ensure broad availability of reliable positive information on borrowers (¶11). [CMN] — 6–12 months
  2. Ensure compilation and publishing of a housing price index that is based on purchases, with broad geographic coverage (¶11). [BCB] — 1–2 years
  3. Create a multi-partite, high-level committee, comprising all financial safety net providers, with an explicit mandate for systemic risk monitoring and crisis coordination (¶24–26). [CMN] — 1–2 years
- Safety Nets and Crisis Management
  4. Strengthen the procedures and systems of the BCB to deliver ELA (¶36). [BCB, CMN] — 6–12 months
  5. Revise the composition of the board of the FGC; use the least-cost principle in deciding FGC support for resolution, with OBA provided only when there is a grave systemic threat (capped at 50% of the FGC’s cash resources); and secure adequate funding for the FGC in the event of a systemic crisis (¶37–38). [FGC, BCB, MOF] — 6–12 months
  6. Remove legislative impediments and strengthen the purchase and assumption and bridge bank statutes (¶39). [CMN, BCB, FGC] — 1–2 years
  7. Extend legal protection to all financial sector supervisory agencies, and elevate the threshold for actions against employees of these agencies, BCB-appointed directors, intervenors, or liquidators to gross negligence (¶40). [CMN, MOF] — 1–2 years
- Capital Markets
  8. Extend tax incentives on infrastructure bonds to infrastructure FIDCs (¶40). [MOF] — 6–12 months
  9. Issue stricter market-making rules, e.g., apply a narrow set of the same benchmarks to all market makers, linked to improved incentives, e.g., access to MOF’s securities lending facilities (¶41). [MOF] — 6–12 months
  10. Shift BNDES operations towards co-financing with institutional investors of a broader set of companies and projects to provide market access and facilitate long-term financing (¶42). [MOF, BNDES] — 1–2 years
- Insurance and Pensions
  11. Provide SUSEP and PREVIC with the same legal status as CVM (e.g., fixed-term appointments and clear mandates for board members) (¶30). [MPS, MOF] — 6–12 months
  12. Issue a secondary regulation on brokers’ self-regulation, which should include a mandatory affiliation to the self-regulating entity, and closely supervise its implementation (¶30). [SUSEP] — 6–12 months
  13. Implement the required regulation for consolidated supervision, including the introduction of ERM and capital requirements at group level (¶30). [SUSEP, CNSP] — 1–2 years
- Consumer protection
  14. Establish a dedicated consumer financial protection unit (¶44). [CMN, MOJ] — 1–2 years

### Box 1 — Are Brazilian Households Financially Stressed?
- Definition and prevalence:
  - "Financial stress" defined as DSTI ≥ 40 percent.
  - Only 5 percent of Brazilian households had DSTI > 40 percent (Household Budget Survey, 2008–09).
  - Comparative figures: 15 percent in the US and 17 percent in Spain.
- Drivers of household debt growth and inclusion (2003–2009 survey):
  - number of households with credit cards increased by 7 percent;
  - number of households with bank loans increased by 5 percent;
  - installment credit increased 18 percent.
  - BCB credit registry: number of new individuals borrowing at least R$5000 increased by 50 percent between 2009–2011.
- Evidence of rising stress and delinquency (early 2012):
  - non-performing non-earmarked consumer loans reached 7.6 percent (up by 2 percentage points since December 2010);
  - sharp increase for vehicle loans.
- Distribution and usage highlights (preserved table entries from source):
  - All: 63.4, 57.3, 26.9, 11.4, 4.5 (DSTI distribution summary from survey tables).
  - Brazil: Household Use of Debt — Change 2003-2009 (Percent of Households) — Installment credit 3/: 20.2, 16.5, 18.8, 17.7, 17.9, 19.0, 18.9, 18.3 (income percentiles 5,10,25,50,75,90,95,All).
- Policy and monitoring recommendations:
  - Collect comprehensive transactions-based data to improve monitoring of housing prices.
  - Issue regulation on credit bureaus to ensure broad availability of positive information.
  - Consider targeted macroprudential instruments (limits on LTV or DTI).
  - Introduce countercyclical capital buffers planned under Basel III.

### Box 2 — Stress Test Scenarios and Methodology (highlights)
- Scenario definitions:
  - Scenario 1 (global recession): decline in GDP corresponds to 2.5 standard deviations over 2 years.
  - Scenario 2 (capital flow reversal): exchange and interest rate shocks equivalent to twice the changes observed during the global financial crisis.
  - Scenario 3 (terms-of-trade shock): corresponds to highest current account deficit observed in last 20 years.
- Liquidity test calibration:
  - Retail deposit outflows equivalent: 15 percent.
  - Interbank deposit outflows: 20–90 percent (depending on maturity).
  - Cuts in other sources of funding: 70–95 percent over a 21-day period.
  - Haircuts: 20 percent for foreign currency government bonds and assets; 5–20 percent for interbank claims; 30 percent for investment funds.
- Key stress test findings:
  - All large banks pass liquidity stress test, though some narrowly.
  - Medium-sized banks had the lowest pass rate, followed by small banks.
  - All failing banks together account for less than 3 percent of banking system deposits and non-deposit funding.
  - Direct contagion: failure of any single bank would trigger a maximum loss of 0.8 percent of system’s assets.
  - Indirect contagion: non-linear maximum asset losses around 8 percent for a 25 percent withdrawal rate and 22 percent for a 35 percent withdrawal rate.
  - High level of required reserves is a significant buffer against liquidity shocks.
- Single-factor shock excerpts (preserved):
  - Baseline (end-2011): CAR 17.0; Number of Banks Below Minimum: 3.
  - Foreign exchange rate shock 20: CAR 16.8; Change of CAR -0.23 (Percentage Points); Number of Banks Below Minimum 50.
  - Foreign exchange rate shock 100: CAR 16.0; Change of CAR -1.04 (Percentage Points).
  - Interest rate shock -200: CAR 16.4; Change of CAR -0.64 (Percentage Points).
  - Interest rate shock -600: CAR 15.1; Change of CAR -1.35 (Percentage Points).
  - Securities prices sovereign bonds -20: CAR 14.9; Change of CAR -2.11 (Percentage Points); Number of Banks Below Minimum 19.
  - Credit risk: Default of x largest borrowers: x = 1 → CAR 18.3; Change of CAR -0.13 (Percentage Points); x = 10 → CAR 15.9; Change of CAR -2.528 (Percentage Points).
  - Relative increase in default rates of all credit risk exposures 100 → CAR 17.5; Change of CAR -0.95 (Percentage Points); 200 → CAR 16.5; Change of CAR -1.98 (Percentage Points).

### Insurance Sector and SUSEP Findings
- Market and supervisory findings:
  - Premiums doubled between 2005 and 2010.
  - Average Brazilian spends less than US$350 on insurance per year.
  - Insurance penetration 3.5 percent (around 50 percent of OECD average).
  - SUSEP has strengthened solvency requirements toward a more risk sensitive regime; additional capital surcharge on average 35 percent under new regime.
- Governance, independence, and resources:
  - SUSEP’s operational independence undermined by legal weaknesses; MOF must approve SUSEP’s use of budget; no transparent appointment framework for Superintendent and Directors.
  - Staffing constraints: 55 inspectors inspect 183 insurers on a 3 years cycle; around 138 persons recently recruited but training budget very low.
  - Broker supervision weak: around 88 percent of insurance business sold by 70,000 active brokers (46,000 physical persons); supervision primarily complaint-driven.
- Recommendations:
  - Enact legislation to strengthen SUSEP’s operational independence; require technical input from SUSEP on CNSP regulation; provide autonomy on budget use.
  - Publish missing regulations for brokers’ self-regulation entity and implement mandatory affiliation.
  - Implement consolidated supervision regulation including ERM and group-level capital requirements.
  - Sign IAIS Multilateral MOU and clarify information exchange conditions.
  - Develop macroprudential surveillance unit, periodic top-down stress testing, and public commentary on market developments.

### Regulatory and Supervisory Enhancements (banking focus)
- Supervisory process:
  - BCB conducts rigorous, intrusive risk-based supervision with an annual supervisory plan and SRC methodology.
  - Continuous monitoring leverages transactional registries with one-day lag access.
  - Onsite teams configured by institution and risk type; specialized functions include validation, Basel II/III implementation, corporate governance, AML.
- Enforcement and corrective powers:
  - Resolution 4019 enhances enforcement by allowing correction based on judgmental views.
  - Corporate law constraint: minimum dividend payout rule (usually at least 25 percent of profits to preferred shareholders) may hinder capital preservation; BCB can offset via provisioning or additional capital but permanent exemption recommended.
- Legal and operational recommendations:
  - Enhance de jure independence of BCB (fixed term for Governor, removal for due cause).
  - Grant BCB authority to issue prudential regulations directly.
  - Inject limited flexibility to hire technical experts outside standard civil service entry levels.
  - Exempt non-listed banks from corporate law dividend requirement where necessary.

### Risk Assessment Matrix — Selected Likelihoods and Expected Impacts (preserved characterizations)
- Severe global recession — Likelihood: Medium
  - Impacts: liquidity stress, higher real interest rates, output losses, increased credit and market losses; small- and medium banks reliant on wholesale funding could be severely impacted.
- Sudden stop/reversal or persistent terms of trade shock — Likelihood: Medium
  - Impacts: moderate euro-area contagion effects; generalized sudden stop more severe though ample liquid assets reduce vulnerability; stress tests: all large banks and about 80 percent of medium and small banks would remain liquid (illiquid banks < 4 percent of system’s assets).
- Commodity price shock — Likelihood: Medium
  - Impacts: direct effects on commodity sectors; stress tests show resilience to severe downward pressures for up to two years, solvency effects likelier than liquidity effects.
- Large real estate price shock — Likelihood: Low
  - Impacts: increased default rates on housing loans (10 percent of total loans on average, higher for some banks) and loans to property developers (1½ percent of total); sensitivity tests: even if all mortgages defaulted (no second-round effects) system CAR would decline by about one percentage point.
- Failure of a foreign parent bank — Likelihood: Low/Medium
  - Impacts: contained direct risks due to self-sustainability of foreign banks in Brazil; indirect confidence effects hard to quantify.
- Historical episode highlights:
  - In 2008, equity prices declined about 50 percent and sovereign spreads increased about 400 bps.

*Source: IMF Financial Sector Assessment Program—Executive Summary (document content provided).*

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

### Executive Summary

### Macro-Financial Performance and Structure of the Financial System
- Since the last FSAP in 2002, Brazil’s financial system has grown in size, diversification, and sophistication, hand in hand with the country’s economic progress.
- Over the last decade, financial sector assets doubled, driven by macroeconomic stabilization, significant gains in financial inclusion, the expansion of the securities and derivatives markets, and the considerable involvement of institutional investors.
- The structure of public debt has become more resilient and the private bond market, though still small, more vibrant.
- The banking sector remains dominated by domestic financial institutions, with public banks having a significant share, while international investors play important roles in the capital and derivatives markets.
- Deft policy responses and built-in financial system buffers helped the system weather the global crisis:
  - fiscal and monetary policy stimulus, including a significant release of bank reserves to preserve market liquidity;
  - a quasi-fiscal stimulus through the national development bank;
  - other public banks expanding lending;
  - foreign exchange intervention and the establishment of a swap facility with the U.S. Federal Reserve;
  - measures to channel liquidity to small and medium-sized banks facing stress.

### Financial Sector Risks and Resilience
- Systemic risk is currently assessed as low, but the financial system operates in a challenging environment requiring monitoring for emerging vulnerabilities.
- External vulnerabilities:
  - Exposure to volatility in international markets, especially commodities and capital markets.
  - Flexible exchange rate and large international reserves provide policy cushion, but managing effects of external volatility remains a challenge in an environment of heightened uncertainty.
  - Extensive use of macroprudential and capital flow management measures; effective for immediate targets but should be embedded in a broader policy framework to maintain macroeconomic stability and financial buffers.
- Domestic vulnerabilities:
  - Rapid credit expansion has supported growth and inclusion, but may pose risks: level of credit is still low relative to GDP.
  - Emerging strains in some sectors and asset classes, notably indebted households and rapidly rising housing prices in prime locations.
  - Small and medium-size banks, which rely more on wholesale funding, are relatively more vulnerable to liquidity risk.
  - The system is in a high interest rate–short duration equilibrium:
    - Interest rates are well above those in comparable countries.
    - Most debt instruments are indexed to the overnight interest rate.
    - Domestic investments concentrated in short-term or indexed instruments.
  - Long-standing fundamentals: legacy of past high and volatile inflation and low level of domestic savings.
  - Continued policy effort beyond the financial sector required: maintaining macroeconomic stability, strengthening domestic savings, improving the business environment.
  - Supporting financial reforms needed to promote longer-term private finance: lengthen duration of financial contracts, reform housing finance, rethink role of state-owned banks.
  - Potential new risks from financial development: greater search for yield by domestic investors could lead to asset price bubbles and under-pricing of risk—requires watchful monitoring.
- Resilience indicators:
  - Banks have significant buffers.
  - Stress tests suggest banking system is robust to a variety of severe shocks, though small and medium-size banks show relatively greater liquidity vulnerability.

### Financial Sector Oversight and Infrastructure
- Banking supervision:
  - Strengthened since 2002; high degree of compliance with Basel Core Principles already in 2002 and further improved.
  - Supervision is risk-based, intrusive, and sophisticated, leveraging strong off-site analytics.
- Capital markets supervision:
  - Transparency standards raised and risk-based supervision implemented.
  - Substantial improvement in compliance with IOSCO principles, though a few challenges remain.
- Insurance supervision:
  - Strengthened, but independence of supervisory agency needs improvement.
  - Supervision of brokers and insurance groups should be enhanced.
- Cross-cutting supervisory challenges:
  - Need to keep pace with an evolving system given constraints on budgets and human resources.
  - Need to strengthen legal protection for agencies or employees.

### Financial Sector Safety Nets and Crisis Preparedness
- Handling of the last crisis was swift, flexible, and successful, but safety nets could be further strengthened.
- Authorities are preparing reforms to the resolution framework to align with new international standards.
- Specific gaps and recommended enhancements:
  - Strengthen operational procedures and systems of the BCB to provide emergency liquidity assistance (ELA), including reporting obligations.
  - Protect the financial situation of the Fundo Garantidor de Créditos (FGC) given its evolving role beyond a pay-box; ensure secure and adequate funding in a systemic crisis.
  - Remove tax and labor law impediments to effective implementation of purchase and assumption and bridge-bank powers.
  - Consider upgrading multipartite committee for supervisory coordination by giving it an explicit mandate for systemic risk monitoring, crisis preparedness, and crisis management, and expand it to include the FGC.

### Developmental Issues, Consumer Protection, Corporate Governance, Insolvency and Creditor Rights
- Policies should encourage development of private long-term finance while managing the attendant risks.
- Consumer protection and corporate governance reforms are recommended to keep pace with financial sector development.

### FSAP Key Recommendations (Table 1)
- Macroprudential Institutional Arrangements and Instruments
  1. Issue regulation on credit bureaus to ensure broad availability of reliable positive information on borrowers (¶11). [CMN] — 6–12 months
  2. Ensure compilation and publishing of a housing price index that is based on purchases, with broad geographic coverage (¶11). [BCB] — 1–2 years
  3. Create a multi-partite, high-level committee, comprising all financial safety net providers, with an explicit mandate for systemic risk monitoring and crisis coordination (¶24–26). [CMN] — 1–2 years
- Safety Nets and Crisis Management
  4. Strengthen the procedures and systems of the BCB to deliver ELA (¶36). [BCB, CMN] — 6–12 months
  5. Revise the composition of the board of the FGC; use the least-cost principle in deciding FGC support for resolution, with OBA provided only when there is a grave systemic threat (capped at 50% of the FGC’s cash resources); and secure adequate funding for the FGC in the event of a systemic crisis (¶37–38). [FGC, BCB, MOF] — 6–12 months
  6. Remove legislative impediments and strengthen the purchase and assumption and bridge bank statutes (¶39). [CMN, BCB, FGC] — 1–2 years
  7. Extend legal protection to all financial sector supervisory agencies, and elevate the threshold for actions against employees of these agencies, BCB-appointed directors, intervenors, or liquidators to gross negligence (¶40). [CMN, MOF] — 1–2 years
- Capital Markets
  8. Extend tax incentives on infrastructure bonds to infrastructure FIDCs (¶40). [MOF] — 6–12 months
  9. Issue stricter market-making rules, e.g., apply a narrow set of the same benchmarks to all market makers, linked to improved incentives, e.g., access to MOF’s securities lending facilities (¶41). [MOF] — 6–12 months
  10. Shift BNDES operations towards co-financing with institutional investors of a broader set of companies and projects to provide market access and facilitate long-term financing (¶42). [MOF, BNDES] — 1–2 years
- Insurance and Pensions
  11. Provide SUSEP and PREVIC with the same legal status as CVM (e.g., fixed-term appointments and clear mandates for board members) (¶30). [MPS, MOF] — 6–12 months
  12. Issue a secondary regulation on brokers’ self-regulation, which should include a mandatory affiliation to the self-regulating entity, and closely supervise its implementation (¶30). [SUSEP] — 6–12 months
  13. Implement the required regulation for consolidated supervision, including the introduction of ERM and capital requirements at group level (¶30). [SUSEP, CNSP] — 1–2 years
- Consumer protection
  14. Establish a dedicated consumer financial protection unit (¶44). [CMN, MOJ] — 1–2 years

### Status of Implementation of 2002 FSAP Key Recommendations (Table 2)
- Passage of legislation ensuring the autonomy of the BCB (terms of Board members and price stability objective): Not implemented. Authorities consider that BCB has sufficient operational independence to discharge its functions.
- Tightening of bank licensing requirements: Implemented.
- Improvement of the standards for auditor certification to effectively support bank supervision, and enhance transparency and governance of firms: Implemented.
- Granting of legal protection to financial system supervisors and formalizing criteria for bank intervention: Partially implemented.
- Strengthening bank resolution framework to deal with systemic cases, by developing contingency plans including open bank assistance: Not implemented. Incorporated in recommendation no. 3, Table 1.
- Assessment of possible tax deductibility of provisions and further improvement of quality of banks capital in connection to tax credits, goodwill and Tier I capital: Partially implemented; quality of capital will be further strengthened with the

*Source: IMF Financial Sector Assessment Program—Executive Summary (document content provided).*

### introduction of Basel III.

### introduction of Basel III.

### Implementation status of selected reforms and initiatives
- Improvement of the operations of Federal Banks, particularly their cost structure, and their loan screening, monitoring, and collection practices, and completion of their financial clean-up. — Ongoing.
- Full implementation of the recently agreed MOU between the BCB and the CVM. — Implemented.
- Passage of new Bankruptcy Law. — Implemented.
- Completion of the amendment to Corporate Law regarding accounting, auditing, and reporting to tighten disclosure requirements, in particular with respect to related party transactions. — Implemented.
- Enhancement of the valuation basis and development of a solvency margin for long-term income stream products, and development of local mortality tables. — Implemented.
- Completion of the current project to establish a contingency plan in the event of multiple broker/dealer default. — Not implemented.
- Review of the personnel hiring practices across the different institutions of the public sector involved with the supervision and prudential regulation of the financial system to improve the scope for attracting and retaining highly qualified personnel. — Partially implemented.

### I. MACRO-FINANCIAL PERFORMANCE AND STRUCTURE OF THE FINANCIAL SYSTEM
- Brazil has built a strong macroeconomic framework, increasing its policy credibility and resilience to external shocks through fiscal responsibility legislation, inflation targeting, and a flexible exchange rate.
- Declining debt-to-GDP ratios and an impressive reduction in inflation occurred during the last decade.
- Economic growth has been strong; the economy is estimated to be the sixth largest in the world (just ahead of the United Kingdom).
- Brazil achieved investment grade in 2008 and had ample policy space to mitigate the impact of the global financial crisis. In 2011, Brazil was upgraded further to BBB by Fitch and S&P and Baa2 by Moody’s.

- Financial system structure and concentrations:
  - Total assets in the system are around 180 percent of GDP.
  - Asset breakdown: more than half held by depository institutions, one-third by investment and pension funds, and about 6 percent by insurance companies.
  - Financial conglomerates control around 75 percent of the system’s assets.
  - Government-owned banks account for over 40 percent of total banking assets.
  - Directed credit for low-income housing, agriculture, and infrastructure represents around 35 percent of total credit.
  - Foreign bank participation is about 17 percent of banking assets.

- Policy responses and recent macroeconomic developments:
  - Fiscal stimulus, including quasi-fiscal operations of BNDES, amounted to 3 percent of GDP in response to the 2009 downturn.
  - Economy grew 7½ percent in 2010.
  - BCB started a tightening cycle in mid-2010; a new monetary easing cycle began in mid-2011.
  - Macroprudential tools were deployed to address financial stability concerns linked to rapid credit expansion.

### II. FINANCIAL SECTOR RISKS AND RESILIENCE — Assessment of Systemic Risk and Monitoring and Mitigation Policies
- Overall assessment:
  - Systemic risk has declined since the peak of the recent crisis, but exposures to global and domestic risks remain.
  - A Financial Stability Map shows risk has declined across all dimensions since 2008–09.

- External risk sources:
  - As a major commodity exporter, Brazil is exposed to fluctuations in commodity prices.
  - Commodity exports accounted for almost 40 percent of total exports in 2011.
  - A protracted global recession or a hard landing in China could have a considerable impact.
  - Brazil is exposed to capital flow volatility; equity and derivatives markets are vulnerable due to significant foreign investor participation.
  - Banks have limited external liabilities and a low net foreign exchange position (around 8 percent of capital).
  - Brazil has a large stock of international reserves to mitigate excess volatility.

- Domestic risk sources:
  - Rapid credit growth: Credit-to-GDP doubled in the last decade, with annual increases exceeding 3 percentage points during 2007–09 and 2011.
  - Estimated credit-to-GDP gap has declined significantly after peaking in 2009.
  - Risk mitigants include: overall credit-to-GDP level relatively low by international standards; recent expansion partly from financial inclusion and macroeconomic stabilization; banks hold ample capital and have a strong income position; stress tests suggest resilience; bank supervision is very strong.
  - Vulnerabilities may be emerging in specific sectors: household sector financial distress and real estate price pressures.

- Household sector and housing risks:
  - Average household debt service-to-income ratio (DSTI) in Brazil is 23 percent.
  - Household debt metrics: household debt and indebtedness indicators show Brazil with relatively high DSTI and short maturities versus peers.
  - Lending to households by depository institutions (2005–2011) shows housing and consumer credit expansion.
  - Indications of rapid real estate price appreciation in prime locations: partial data suggest prices in Sao Paulo and Rio de Janeiro have been growing by about 30 percent annually in recent years, with the pace moderating somewhat since 2011.
  - Low proportion of housing loans in banks’ loan portfolios (except for Caixa) mitigates systemic impact of housing price declines.

### Key statistics and table highlights (preserved values from Table 3 and figures)
- Total financial sector assets (2011): R$ 7,389 (Percent of GDP: 178.3).
- Depository institutions (2011): Number of Institutions 1,603; R$ 4,387 (Percent of total 59.4; Percent of GDP 105.9).
- Multiple and commercial banks (2011): Number 125; R$ 3,244 (Percent of total 43.9; Percent of GDP 78.3).
- Large banks (2011): R$ 2,765 (Percent of GDP 66.7).
- Private banks, domestically-controlled (2011): R$ 1,680 (Percent of total 22.7; Percent of GDP 40.5).
- Private banks, foreign-control (2011): R$ 375 (Percent of total 10.2; Percent of GDP 18.2).
- Investment and Asset Managers (2011): R$ 2,815 (Percent of total 36.8; Percent of GDP 67.9).
- Insurance companies (2011): R$ 469 (Percent of total 6.4; Percent of GDP 10.3).
- Money and capital markets (2011 memorandum): R$ 6,826 (Percent of GDP 164.7).
- Nominal GDP entries shown: 2002 = 1,478; 2007 = 2,661; 2011 = 4,143.

*Source: _cr12206 - introduction of Basel III.*

### Box 1. Are Brazilian Households Financially Stressed?

### Box 1. Are Brazilian Households Financially Stressed?

### Definition and comparative prevalence
- "Financial stress" is defined here as a debt service-to-disposable income ratio (DSTI) of 40 percent or more.
- Only 5 percent of Brazilian households had DSTI > 40 percent (Household Budget Survey, 2008–09).
- Comparative figures cited: 15 percent in the US and 17 percent in Spain.
- Caveats: threshold for stress may be lower in an emerging economy due to more limited household wealth and social safety nets; higher share of unsecured loans in Brazil relative to advanced economies where mortgages dominate household bank debt.

### Drivers of household debt growth and financial inclusion
- Between 2003–2009, Household Budget Survey shows:
  - number of households with credit cards increased by 7 percent,
  - number of households with bank loans increased by 5 percent,
  - installment credit increased 18 percent.
- Central Bank of Brazil (BCB) credit registry: number of new individuals borrowing at least R$5000 from the banking sector increased by 50 percent between 2009–2011.

### Evidence of rising stress and delinquency (recent developments)
- Increasing use in 2011 of more expensive lending products (credit cards and overdraft accounts) as an indirect indication of distress.
- Delinquency rates as of early 2012:
  - non-performing non-earmarked consumer loans reached 7.6 percent (up by 2 percentage points since December 2010),
  - particularly sharp increase for vehicle loans.
- Number of bounced checks has increased (reported pickup; chart referenced).

### Distribution of DSTI and debt use (selected figures from survey tables)
- Percentage distribution of household DSTI (by income percentile; "with any debt"):
  - Income percentile "<10": 53.9, 52.1, 21.8, 14.6, 11.5  (columns labeled with DSTI bands "<10 10-20 20-40 >40"? — preserved as in source)
  - Income percentile "10-20": 104, 42.0, 64.3, 20.3, 10.6, 4.8  (table entries preserved exactly as in source)
  - (Full table reproduced in source; summary figure: All: 63.4, 57.3, 26.9, 11.4, 4.5)
- Brazil: Household Use of Debt — Change 2003-2009 (Percent of Households) by income percentiles (selected entries):
  - Mortgage 2/: 0.7, 0.4, 0.5, 0.0, 0.6, 0.9, 0.4, 0.7 (Income percentiles 5,10,25,50,75,90,95,All)
  - Credit Card: 2.8, 2.9, 6.1, 8.9, 9.1, 7.6, 4.5, 7.3
  - Overdraft: 0.4, 0.8, 1.1, 1.7, 1.9, -2.0, -4.2, 0.4
  - Bank loan: 1.0, 2.3, 4.6, 7.0, 6.2, 3.4, 3.6, 5.0
  - Installment credit 3/: 20.2, 16.5, 18.8, 17.7, 17.9, 19.0, 18.9, 18.3
- Brazil: Household Credit Growth (Year-on-Year Percent Change) charts (2006–2011) show sizable growth across categories including total consumer credit, overdraft, personal credit, credit card, vehicles, housing (chart preserved in source).

### Interpretation and implications
- Substantial expansion in access to credit explains much of the increase in household debt and helps account for relatively low observed stress levels in 2008–09.
- However, increasing use of expensive credit instruments, rising delinquency (NPLs), and more bounced checks point to growing stress for at least some households after 2009.
- The composition of household debt (higher share unsecured) and potentially lower informal safety nets imply vulnerability even at lower measured DSTI levels.

### Policy recommendations and monitoring improvements (from source)
- To improve systemic risk monitoring and the macroprudential toolkit, the authorities should consider:
  - Collecting comprehensive transactions-based data to improve monitoring of housing prices.
  - Issuing a regulation on credit bureaus to ensure broad availability of positive information on borrowers.
  - Considering targeted macroprudential policy instruments, such as limits on loan-to-value or debt-to-income ratios, which have been effective elsewhere to contain housing or consumer credit risks.
  - Introducing countercyclical capital buffers planned by the authorities in the context of Basel III.

*Source: Box 1. Are Brazilian Households Financially Stressed? (excerpt from IMF staff report)._

### Box 2. Stress Test Scenarios and Methodology

### Box 2. Stress Test Scenarios and Methodology

### Macroeconomic assumptions
- Trajectories of key macroeconomic variables (GDP, exchange rate, money market rate) were simulated based on historical evidence in VAR or panel models.
- Scenario definitions:
  - Scenario 1 (global recession): the decline in GDP corresponds to 2.5 standard deviations over 2 years.
  - Scenario 2 (capital flow reversal): the exchange and interest rates shocks are equivalent to twice the changes observed during the global financial crisis.
  - Scenario 3 (terms-of-trade shock): the terms-of-trade shock corresponds to the highest current account deficit observed in the last 20 years.

### Bank-specific parameters
- Translation of scenarios into bank-level financial stress used satellite models for:
  - Credit risk—probability of default (PD) and exposure at default (EAD).
  - Pre-impairment profits.
- Loss-given-default (LGD) was projected conditional on PDs (Schmieder, Puhr, and Hasan (2011)).
- Banks’ behavioral responses modeled through:
  - Income and payout ratios varying in line with severity of scenario.
  - Credit growth reflecting limited deleveraging in the stress scenario.
- Stress tests covered public banks as well.

### Solvency tests
- Approach: balance sheet methodology covering all banks.
- Data and horizon: using end-2011 data and a five-year period (2012–16).
- Objectives: assess banks’ ability to cope with a protracted macroeconomic shock and with the introduction of Basel III.
- Concentration and market risks assessed based on single-factor shocks.

### Liquidity tests
- Liquidity stress test calibration:
  - Used historical maximum funding withdrawal rates, accounting for market-wide funding stress and bank-specific vulnerabilities (e.g., concentration and reliance on wholesale funding).
  - Retail deposit outflows equivalent: 15 percent.
  - Interbank deposit outflows: 20–90 percent (depending on maturity).
  - Cuts in other sources of funding: 70–95 percent over a 21-day period.
- Haircuts on liquid assets (based on quality and maturity):
  - 20 percent for foreign currency government bonds and assets.
  - 5–20 percent for interbank claims.
  - 30 percent for investment funds.
- Test metric: BCB’s “liquidity ratio” comparing liquidity inflows (unencumbered liquid assets plus scheduled cash inflows, without recourse to required reserve balances) with potential liquidity outflows (funding losses plus scheduled outflows).

### Contagion tests
- Methodology: BCB and IMF network models simulating default of a bank through bilateral exposures with direct and indirect contagion effects.
- Indirect contagion assumption: default of a large bank triggers deposit withdrawals in all banks, reaching (in the most severe scenario) 35 percent.

### Key findings from liquidity and contagion analysis
- System resilience:
  - All large banks pass the liquidity stress test, though some only by a narrow margin.
  - Medium-sized banks had the lowest pass rate, followed by small banks.
- Deposit and funding concentration of failing banks:
  - All failing banks together account for less than 3 percent of banking system deposits and non-deposit funding.
- Direct contagion:
  - Failure of any single bank would trigger a maximum loss of 0.8 percent of the system’s assets.
- Indirect contagion (deposit-run scenarios):
  - Non-linear maximum asset losses: around 8 percent for a 25 percent withdrawal rate and 22 percent for a 35 percent withdrawal rate.
- Buffer:
  - High level of required reserves is a significant buffer against liquidity shocks.

### Single-factor shock results (high-level summary from Table 5 excerpts)
- Baseline (end-2011): CAR 17.0; Number of Banks Below Minimum: 3.
- Foreign exchange rate shock (percentage change) examples:
  - 20: CAR 16.8; Change of CAR -0.23 (Percentage Points); Number of Banks Below Minimum 50.
  - 100: CAR 16.0; Change of CAR -1.04 (Percentage Points).
- Interest rate shock (change in basis points) examples:
  - -200: CAR 16.4; Change of CAR -0.64 (Percentage Points).
  - -600: CAR 15.1; Change of CAR -1.35 (Percentage Points).
- Securities prices (percent) examples:
  - Sovereign Bonds -20: CAR 14.9; Change of CAR -2.11 (Percentage Points); Number of Banks Below Minimum 19.
  - Equities -50: CAR 16.7; Change of CAR -0.33 (Percentage Points).
- Credit risk examples:
  - Default of x largest borrowers: x = 1 → CAR 18.3; Change of CAR -0.13 (Percentage Points).
  - x = 10 → CAR 15.9; Change of CAR -2.528 (Percentage Points).
  - Relative increase in default rates of all credit risk exposures (percent change): 100 → CAR 17.5; Change of CAR -0.95 (Percentage Points); 200 → CAR 16.5; Change of CAR -1.98 (Percentage Points).
- Note: 2/ Projected end-2012 under baseline macroeconomic scenario. 1/ Impact on all securities in the trading book and available for sale portfolio.

### Capital markets, insurance, and interconnections
- Mutual funds and banks interconnectedness (as of April 2012):
  - Mutual funds’ repo operations with banks: some 20 percent of mutual funds’ total portfolio.
  - Mutual funds’ holdings of bank deposits or CDs: another 15 percent.
  - Repos collateralized by government bonds; mutual funds cannot conduct repos with the BCB.
  - Banks’ reverse repo transactions with the BCB tend to have maturities around 30 days, earning banks around 3–4 basis points.
- Policy consideration for mutual funds:
  - Authorities should consider lowering the 20 percent single exposure limit for mutual funds as availability of financial instruments improves.
- Derivatives market and risk mitigation:
  - Transactions routed through BM&FBOVESPA, a central clearing party with strong intraday controls.
  - Initiatives: contract between the Central Custodian and Settlement of Financial Securities (CETIP) and Clearstream; creation of the Derivatives Exposure Registry by FEBRABAN.
- Reference rate market depth:
  - Market for CDI is shallow: average traded daily volume of CDIs is low (usually less than a hundred trades); top three market participants account for about 85 percent of the volume.
  - CDI used as reference for a very large derivatives market; authorities and market participants studying alternatives to the CDI.
- Insurance sector indicators:
  - Profitability:
    - Combined ratio of life insurers: around 75 percent.
    - Return on equity (ROE) for life insurers: above 20 percent.
    - Combined ratio of nonlife insurers: around 100 percent.
    - ROE for nonlife insurers: between 34 and 47 percent.
    - Investment income: around 25 percent of the premium in both industries.
  - Solvency:
    - Life insurance sector: average margin of 250 percent above Brazilian regulatory requirements (which are about one-third higher than Solvency I requirements).
    - Nonlife sector: 90 percent additional solvency margin.
  - Other indicators:
    - Risk ratio (capital plus surplus to underwritten premium): around 1.7.
    - Capital plus surplus to total assets: 8.3 percent.
    - Foreign currency assets: negligible due to limitation in foreign investments.

### Policy and institutional recommendations (extracted from subsequent discussion)
- Consider establishing a multipartite high-level financial stability committee (upgrade COREMEC or create a new body) including all financial regulators, as well as the FGC and the Ministry of Finance, with responsibilities to:
  - Conduct regular joint-assessments of systemic risks and formulate plans and strategies to address them; consider publishing periodic financial stability assessments or reports complementing the BCB’s Financial Stability Reports.
  - Ensure legal and operational hurdles for information exchange are cleared; consider establishing joint databases to facilitate information sharing.
  - Establish a road map for crisis management, clarify roles and responsibilities consistent with legal mandates, and undertake crisis simulations.
- Consider lowering the 20 percent single exposure limit for mutual funds as financial instruments availability improves.
- Monitor market trends as lower interest rates may spur investors to seek higher returns and take more risk.

*Source: IMF staff calculations and BCB/FSAP analysis as presented in the original document.*

### 33.      However, the highly concentrated financial sector poses regulatory challenges,

### _cr12206 - 33.      However, the highly concentrated financial sector poses regulatory challenges,

### Regulatory challenges from market concentration
- The highly concentrated financial sector poses regulatory challenges, including ensuring adequate resources.
- The CVM should consider whether a single stock exchange operating in the secondary market as a for-profit company warrants regulatory action to promote competition and reduce transaction fees that seem high by international standards.
- High concentration in the CIS sector may partially explain high mutual fund fees, and the preponderance of CIS owned by banks requires continued effective monitoring of related party transactions and the risks associated with high degrees of concentration in portfolios.
- To meet challenges from an increasingly complex and growing industry, the CVM requires:
  - additional resources;
  - an operating budget commensurate with the fees paid by the capital markets; and
  - greater freedom to hire staff with critical skill sets.

### Financial sector safety nets: overview and crisis response
- The Brazilian authorities’ response to spillovers from the global financial crisis was swift, flexible, and effective.
- Central bank actions included:
  - boosting systemic liquidity;
  - intervening in the foreign exchange futures market to accommodate hedging;
  - cutting reserve requirements;
  - expanding eligible assets for the rediscount window; and
  - opening a foreign exchange window to help offset the loss of external credit lines.
- The deposit insurer (FGC) actions included:
  - extending guarantees on deposits;
  - providing liquidity to small banks reliant on wholesale funding;
  - extending deposit insurance coverage; and
  - providing solvency support by lending to firms which invested in undercapitalized banks.
- The prohibition on the state-owned banks buying banks and loan portfolios was temporarily lifted.
- These steps, together with significant capital and liquidity buffers, helped the Brazilian financial system cope with the impact of the crisis.

### Emergency Liquidity Assistance (ELA)
- The BCB’s ELA facilities are well-designed but could be made more effective in practice; ELA facilities were not used in the recent crisis because other sources of liquidity were deployed.
- Alternative crisis measures used included:
  - incentives for large banks to buy small bank loan portfolios;
  - asset purchases by state-owned banks; and
  - funding from the FGC.
- To ensure prompt disbursement of temporary liquidity to solvent but illiquid banks, the BCB should:
  - develop clear internal procedures to approve ELA that clarify roles and accountability and minimize legal challenge risks, e.g., by using the legal protection afforded to the Governor;
  - introduce systems to enable quick acceptance of collateral other than government securities, including valuing and determining haircuts;
  - pre-determine haircuts for asset classes, review these periodically, and disseminate this information regularly to reduce uncertainty; and
  - ensure sufficient expertise is readily available and undertake simulation exercises and test transactions.

### Bank resolution framework and the FGC role
- Authorities are considering a new bank resolution framework with two separate regimes for systemic and non-systemic cases:
  - For systemic cases: expand the resolution toolkit to include bail-in powers and allow for related solvency support.
  - For non-systemic cases: maintain the current intervention regime and convert administrative extrajudicial liquidation to a court-based bankruptcy proceeding under the Bankruptcy Law to accelerate the currently lengthy bank bankruptcy process.
- Staff broadly endorsed the plans but noted that if court-based bankruptcy is pursued, the BCB should retain:
  - residual powers of direction (since the intervenor may not ensure necessary actions within the statutory 120 day-period, including transfer of IT services); and
  - the power to petition the court to replace the liquidator if the liquidator does not comply with directions.
- The FGC’s broader role in the crisis creates potential conflict of interest as it has evolved from a paybox to an institution providing liquidity and guarantees to preserve financial stability.
  - A governance reform removing active bankers from its Board was implemented shortly after the FSAP mission.
  - The least cost principle should be applied when deciding resolution options to mitigate moral hazard and safeguard the fund.
  - The FGC’s authority to provide funding beyond least cost assistance in a P&A or bridge-bank transaction should be restricted to systemic threats, with the determination made at a high level in the government and the BCB to limit moral hazard and risks to the FGC.
  - Open bank assistance, if provided by the FGC, should be capped at 50 percent of its cash or cash-equivalent resources.
  - The FGC should also have access to a backstop unsecured credit line from either the BCB or the government at market rates in case of a systemic crisis.

### Use of public resources and legal/operational reforms for resolution
- The Fiscal Responsibility Law of 2000 bans the use of public funds for solvency support unless Congress passes a specific law to allow this.
- Authorities are considering empowering the BCB in the new resolution regime to provide funds for bank recapitalization after shareholders have been written off using proposed bail-in powers; authorities indicated existing mechanisms would indemnify the BCB for any losses incurred.
- Staff recommended strengthening the resolution regime by:
  - removing impediments in labor and tax legislation and strengthening P&A and bridge bank statutes;
  - clarifying that FGC’s resources can be used to assist in a resolution transaction (P&A or bridge-bank) to facilitate transfer of insured deposits, with its contribution capped (except in systemic cases) at the amount of insured deposits that would have to otherwise be paid in a liquidation;
  - introducing depositor preference, placing depositors above unsecured creditors in the hierarchy of claims in bankruptcy, with the FGC subrogated to the preferred claim if its resources are deployed;
  - expanding the resolution toolkit to include the ability to override the rights of shareholders to carry out a recapitalization or a transfer of shareholding interests;
  - limiting the scope of judicial action to suspend resolution proceedings on appeal, since any delay may jeopardize the effectiveness of the resolution action; and
  - enhancing legal protection by elevating the threshold for civil liability for employees, intervenors, liquidators, and directors during temporary administration to gross negligence, as opposed to mere negligence; and extending a similar level of protection to the BCB.

### Developmental issues: capital markets, housing finance, and BNDES
- Capital Market Reform Package:
  - Offers incentives to increase long-term private finance, including a tax incentive to non-residents investing in long duration investments and infrastructure bonds.
  - ANBIMA’s New Fixed Income Market proposal recommends tax incentives to invest in longer duration instruments; consideration should be given to extending incentives to infrastructure funds (Fundos de Investimento em Direitos Creditório).
- Secondary market liquidity:
  - New Fixed Income Market measures include standardization of issues, market making arrangements, and setting up a liquidity fund.
  - Additional measures that could improve liquidity: a narrower set of benchmark issues for all primary dealers; requiring trading through the same electronic platform; and providing a securities lending facility.
- BNDES role:
  - Should shift towards supporting market-based financing and capital market development by crowding in private sector intermediation (e.g., co-financing projects and securitizing proceeds, placing securities with institutional investors).
  - Should move away from direct financing of large corporations with market access (such as Petrobas and Vale) towards helping develop the long-term corporate debt market through standardization, market making, and signaling (through minority investments).
  - Pricing should be actuarially fair (covering expected losses as well as administrative and funding costs), requiring strengthened governance, transparency, and enhanced supervisory oversight.
- Housing finance:
  - Needs to move to longer-term funding linked to market interest rates.
  - Current system based on two non-market funding pillars: SBPE (Sistema Brasileiro de Poupança e Empréstimo) and FGTS (Fundo de Garantia por Tempo de Serviço); SBPE’s interest rate floor and short duration contributed to lenders limiting mortgage duration.
  - In April 2012, the government eliminated the minimum returns on savings deposits (previous floor of 6 percent), enabling mortgage rates to fall without undue compression of the interest rate spread.
  - Authorities should introduce a regulatory framework for covered bonds and standardization and use of cédulas de crédito imobiliário (CCI) to stimulate private capital participation.

### Consumer protection, corporate governance, insolvency and creditor rights
- Financial consumer protection:
  - Currently the responsibility of the Ministry of Justice but the relevant department is seriously understaffed.
  - A dedicated, adequately staffed unit should be created and establish ties to the BCB and other members of COREMEC.
  - Improvements in consumer education and protection and strengthened broker oversight are needed as first-time insurance buyers enter the market.
- Key findings from assessments on Insolvency and Creditor Rights, Auditing and Accounting, and Corporate Governance:
  - Insolvency framework:
    - The Law on Business Reorganization and Bankruptcy (2005) improved the system, but shortcomings remain.
    - Effectiveness could be improved by: (i) making the tax treatment of debt write-offs neutral; and (ii) reducing legal uncertainty by clarifying that fraud is required to adjudge the creditor personally liable.
    - Rules could be reviewed to encompass sectors lacking access to effective restructuring or insolvency liquidation mechanisms (e.g., cooperatives, mixed-capital companies, and health care plan companies).
  - Judicial enforcement and resources:
    - Lenders prefer movable collateral or real estate under “fiduciary sales” or financial leasing due to out-of-court settlement or abbreviated judicial enforcement procedures.
    - Judicial enforcement of classic mortgages and unsecured claims remains complex and slow, increasing financing costs, especially for SMEs.
    - Specialized courts in Rio de Janeiro and Sao Paulo are generally satisfactory, but backlogs indicate more resources are necessary.
  - Registration systems:
    - Registries for immovable assets and charges over movables are administered at the municipal level, most are not electronic, and reliability varies significantly across municipalities; the system could be significantly upgraded and centralized at the federal level.
  - Corporate governance:
    - CVM introduced new disclosure requirements (e.g., Instruction 480/2009) meeting international standards and stepped up enforcement.
    - Adoption of IFRS accounting standards in 2007 (effective in 2010) improved disclosure and transparency.
    - Remaining issues include difficulty for minority shareholders to influence Board elections; underdeveloped Board committees and lack of independent members (except banks where BCB mandates Board audit committees at institutions of a certain size); and challenging rights of shareholder groups during takeovers and corporate restructurings.

### Risk Assessment Matrix: selected likelihoods and expected impacts
- Severe global recession — Likelihood: Medium
  - Expected impacts include liquidity stress, higher real interest rates, output losses, increased credit and market losses under a multi-year sustained adverse shock, higher unemployment triggering consumer loan losses, and possible severe impact on some small- and medium banks reliant on wholesale funding.
  - Stress tests indicate banking system resilience overall, though some small- and medium banks could be severely impacted.
- Sudden stop/reversal or persistent terms of trade shock — Likelihood: Medium
  - Expected impacts: moderate impact from further euro area bank deleveraging; more substantial impact from generalized sudden stop, though ample liquid assets reduce vulnerability.
  - Stress tests show all large banks and about 80 percent of medium and small banks would remain liquid (with the illiquid banks accounting for less than 4 percent of the system’s assets).
- Commodity price shock — Likelihood: Medium
  - Expected impacts: direct effects on commodity sector and related sectors; stress tests show resilience to severe downward pressures on commodity prices for up to two years, with solvency effects more likely than liquidity effects.
- Large real estate price shock — Likelihood: Low
  - Expected impacts: increased default rates on housing loans (10 percent of total loans on average, but higher for some banks) and loans to property developers (1½ percent of total).
  - Sensitivity tests show that even if all mortgages defaulted (with no second-round effects) system CAR would only decline by about one percentage point.
- Failure of a foreign parent bank — Likelihood: Low/Medium
  - Expected impacts: contained direct risks due to self-sustainability of foreign banks in Brazil; indirect confidence effects could be adverse but are difficult to quantify.
- Additional numeric highlights from stress testing and historical episodes:
  - In 2008, equity prices declined about 50 percent and sovereign spreads increased about 400 bps.
  - Under a more generalized shock, stress tests show large declines in sovereign bond prices could have a more significant impact; however, flexible exchange rate and high international reserves are mitigating factors.

*Source: _cr12206 - 33.      However, the highly concentrated financial sector poses regulatory challenges,*

### Appendix II. Brazil: Stress Testing Matrices

### Appendix II. Brazil: Stress Testing Matrices

### Stress Test Matrix — Solvency
- Domain / Approach:
  - Bottom-Up by Banks: NA
  - Top-Down by Authorities: All banks (137)
  - Top-down by FSAP Team: All banks (137)
- Market share:
  - Percentage of total sector assets: 100
- Data and baseline date:
  - Supervisory
- Methodology:
  - BCB stress testing framework (not reported)
  - Schmieder, Puhr and Hasan (2011)
- Stress test horizon:
  - BCB/authorities: 18 months
  - FSAP Team: Five years
- Shocks:
  - Macro: severe global recession double dip (2.5 standard deviations from trend growth during two years).
  - Other scenarios: Sudden Stop and Terms of Trade Shock; simulation of a commodity price shock and a single factor shock for the real estate sector.
  - The trajectories of the relevant macroeconomic variables were projected based on VAR analysis and econometric models.
  - Market risk shocks for relevant risks (FX Rates, IR, asset prices)
- Risks/factors assessed:
  - Credit losses and pre-impairment income (modeling of components) based on satellite models
  - Market risks
- Calibration of risk parameters:
  - Point in time risk parameters for credit risk parameters or proxies.
- Behavioral adjustments:
  - Credit growth projected by satellite model.
  - Dividend payout depending on scenario.
- Regulatory standards:
  - Hurdle rates based on Basel II/III minimum for Core tier 1, Tier 1, and Total Capital, in line with regulation for Brazil
  - Basel II/III; Standardized Approach; Standardized Approach & quasi-IRB
- Results / Outputs:
  - CAR/shortfall, system-wide and by bank.
  - Pass or fail; percentage of assets that fail.
  - Distribution of capital ratios across the system by bank group/type.
  - Sensitivity tests for concentration risk and market risk.

### Stress Test Matrix — Liquidity
- Domain / Approach:
  - Bottom-Up by Banks: NA
  - Top-Down by Authorities: NA (Framework by Schmieder and others (2012) used for robustness checks and to shed some light on international comparisons, but not reported).
  - Top-down by FSAP Team: All (137)
- Market share:
  - 100
- Data and baseline date:
  - Supervisory data.
- Methodology:
  - Bank-run type test (measured through “Liquidity Ratio”), Basel III ratios (LCR, NSFR);
  - Simulation of funding liquidity & market liquidity (idiosyncratic shock and general market shock), maturity mismatch (NSFR), concentration of funding.
- Risks:
  - Market and funding liquidity risks.
- Regulatory standards:
  - BCB “Liquidity Ratio” is used in Brazil for monitoring purposes; Basel III ratios will become binding according to Basel III schedule.
- Results:
  - Pass Rate (by number of banks and assets).

### Stress Test Matrix — Other Systemic Risks
- Domain / Approach:
  - Bottom-Up by Banks: All (893 financial institutions with interbank exposures (out of a total of 2,000 financial institutions), thereof 137 banks)
  - Top-Down by Authorities: Network model
  - Top-down by FSAP Team: Network model
- Market share:
  - Close to 100 of assets of the financial system
- Data and baseline date:
  - Supervisory
- Methodology:
  - BCB’s network model, simulating the impact direct and indirect contagion (the latter through liquidity)
  - Network model used to analyze direct contagion through interbank exposure.
- Stress test iterations:
  - As many as new equilibrium is found
- Shocks / Scenarios:
  - Simulation of the impact of a default of whatsoever institution(s)
  - Simulation of bilateral knock-on effects; percentage of assets that fail
  - Map of interbank lending (based on tiering)
  - Simulation of bilateral knock-on effects

*Source: IMF staff.*

### Annex I — Basel Core Principles: Introduction and Methodology
- Assessment context:
  - Conducted as part of the 2012 FSAP update against the BCP methodology issued by the Basel Committee on Banking Supervision (BCBS) in October 2006, using both essential and additional criteria.
  - The BCB is the sole supervisor of the banking system and the assessment covers only the BCB.
  - The assessment was performed by Laura Ard (World Bank) and José Tuya (IMF consultant) from February 27 through March 20, 2012.

### Institutional, Macroprudential Setting and Market Structure — Key Facts
- System size and structure:
  - There are 1,475 deposit-taking financial institutions with assets exceeding 100 percent of GDP, including 137 banks, 4 development banks, and one savings bank as of November 2011.
  - The five largest banks account for two-thirds of total assets.
  - Foreign banks control slightly less than 20 percent of total banking assets (down from close to 30 percent in 2002).
- Banks by Ownership (As of September 2011):
  - Public: Number 13; Net Worth 33.5; Total assets 43.3; Deposits 45.9; Loans 41.9
  - Private: Number 124; Net Worth 66.5; Total assets 56.7; Deposits 54.1; Loans 58.1
    - Domestic: Number 67; Net Worth 39.6; Total assets 39.1; Deposits 38.0; Loans 40.2
    - Under foreign control: Number 57; Net Worth 26.9; Total assets 17.7; Deposits 16.1; Loans 18.0
  - Total: Number 137; Net Worth 100.0; Total assets 100.0; Deposits 100.0; Loans 100.0
  - 1/ Public Includes BNDES and the Federal Savings Bank (Caixa).
- System-wide metrics (September 2011):
  - Average Basel capital adequacy ratio: 17.2 percent
  - Required in Brazil: 11 percent
  - Basel I and Basel II requirement: 8 percent
  - Leverage ratio: (around 10 percent)
  - Liquidity ratio based on a liquidity buffer/stressed cash flow: (around 1.1)
  - Return on Equity (ROE): 22.8 percent
- Foreign securities of six largest banks (December 2011):
  - Total securities: R$630 billion
  - Foreign securities: 1.4 percent

### Legal, Accounting, and Oversight Framework
- Legal and operational independence:
  - BCB de facto operates independently and has authority to impose sanctions and preventive or corrective action, and to resolve weak banks.
  - Recommendation: Amendments to Banking Law (Law 4595/1964) could protect operational independence further (codify fixed-term, reasons for removal, allow BCB to issue resolutions directly).
- Accounting and auditing:
  - Federal Accounting Council (CFC) adopted IFAC auditing norms; in process of adopting IASB accounting norms.
  - BCB issues accounting norms for the banking sector; listed banks must also comply with CVM regulations.
  - Since December 31, 2010, listed banks must publish accounting statements in accordance with international standards.
  - Auditors for BCB-supervised institutions subject to stringent independence and professional criteria, including a certification exam.
- Disclosure and reporting:
  - Banks required to disclose accounting, prudential and other types of information to the public and periodically to the BCB.
- Deposit insurance:
  - Provided by the Credit Guarantee Fund (FGC).
  - Maximum value guaranteed by the FGC: R$70,000.

### Main Findings and Supervisory Enhancements
- Progress since 2002 FSAP:
  - Licensing process tightened; MOU between BCB and CVM fully implemented.
  - Improvement of capital quality by excluding goodwill and tax credits being addressed through Basel II (and Basel III).
  - Recommendation to formally ensure BCB autonomy remains unaddressed.
- Supervisory planning and tools:
  - Annual Program of Supervision established.
  - Risk and Control Assessment System (SRC) is a well-structured methodology for identifying and assessing risks and internal controls.
- Corrective actions and enforcement:
  - Timeliness of corrective action improved via regulations enabling judgmental corrective actions.
  - Implementation of Pillar 2 supports preventive enforcement.
  - Constraint: minimum dividend payout rule for preferred stock shareholders (in most cases requires at least 25 percent of profits must be paid) may hinder preserving capital in weak bank situations.
- Independence and staffing:
  - Operational independence strong but not fully codified; recommendation to codify fixed term and removal conditions for the Governor and allow BCB to issue prudential regulations directly.
  - Hiring constrained by civil service rules; recommendation to review employment framework for technical staffing adequacy.
- Licensing:
  - Enhanced licensing process with analysis of strategic plans, capital projections, and fit-and-proper tests.
  - New banks monitored closely for first three years.
  - Resolution 4062 issued (post-mission) requiring prior BCB approval for acquisition of an interest in nonfinancial institutions.
- Prudential regulation:
  - Quality and risk-sensitivity of capital improved; Basel II implementation started in 2007.
  - Phase-out of deferred tax assets in 2012 (ahead of international timetable) as part of Basel III implementation.
  - From June 2010 banks allowed to apply for internal models for market risk; from December 2012 allowed to apply for IRB approach for credit risk.
  - Banks to file first ICAAP report in July 2013.
  - Challenge: deferred tax assets account for about 20–25 percent of Tier 1 capital and are not allowed under Basel III.
- Cross-border exposures and country risk:
  - Collection of country risk data expanded; cross-border exposures not significant.
  - Banks cannot place abroad funds raised in Brazil; majority of transactions by foreign branches relate to Brazilian bonds issued abroad or financing local clients.
- AML/CFT:
  - Comprehensive legal framework and supervisory process; BCB monitors compliance via offsite and onsite activities and horizontal reviews included in SRC.
- Risk management:
  - Requirements comprehensive across eleven risk categories: credit, market, liquidity, corporate (level) operational, business area operational, contagion, legal, reputational, strategic, information technology (IT) and money laundering.
  - Risk monitoring is substantive; controls expected commensurate with size and complexity.
  - Supervision examines banks’ risk metrics and stress tests; capital calculations are prescribed and consistent with or more conservative than Basel II.
  - Contagion risk is rated in context of systemic impact.

*Source: IMF staff.*

### 71.      Banks are required to implement adequate internal controls for their activities and

### _cr12206 - 71.      Banks are required to implement adequate internal controls for their activities and

### Internal controls, supervisory authority, and corrective powers
- Banks are required to implement adequate internal controls for their activities and must be in compliance with the relevant legal norms and regulations.
- The Supervisor can direct additional controls if risk management deficiencies are found, and it can impose more restrictive operational limits when such deficiencies are not corrected on a timely basis.
- Recent regulation has provided the Supervisor with the basis to address risk management and control concerns on a proactive basis rather than waiting for identified concerns to have an impact on the financial condition and performance of the institution.
- Resolution 4019 significantly enhanced enforcement powers by allowing the BCB to require correction based on judgmental views on the adequacy of internal controls or corporate governance, without waiting for quantitative deterioration.
- Enforcement process:
  - Actions are initiated by a letter of issues sent to the bank asking for resolution within a timeframe.
  - Enforcement escalates quickly after the timeframe expires without adequate bank response.
  - Actions are closely tracked and, if needed, intervention takes place to protect the erosion of bank capital.
  - The BCB meets with the Board and management and stresses the significance of its recommendations.
- Corporate law constraint:
  - Brazilian corporate law requires companies to pay a minimum of 25 percent of profits as dividends for preferred shares.
  - The BCB can offset this requirement for weak banks by requiring increased provisioning or additional capital, but a permanent solution would exempt banks from the requirement.

### Supervisory process, risk-based supervision, and monitoring (CPs 19–21)
- The BCB carries out rigorous, intrusive risk based supervision with processes well developed based on extensive information and intensive analysis.
- Supervisory cycle:
  - Each institution is on a 12 or 24-month supervisory cycle, planned and guided by the plan set out by the SRC.
  - The supervisory plan combines continuous monitoring and onsite activities.
  - Systemic banks are considered high priority due to their impact.
- Resources and staffing:
  - Turnover is low at the BCB and the number of existing staff (over 700 supervisors and examiners) supports the number of activities planned in the annual supervisory plan.
- Risk ratings:
  - An overall risk rating is assigned to each institution based on quantitative and qualitative measures.
  - Quantitative rating is based on indicators of asset quality, capital adequacy, liquidity, and profitability.
  - Qualitative rating is based on analysis of:
    - (1) business risks and controls: credit, legal, operational, market, liquidity and contagion risks.
    - (2) corporate functions and controls: strategic, reputation, information technology, money laundering and operational risk.
  - Contagion risk analysis includes risks from nonbanking affiliates and subsidiaries.
  - The bank is assigned a qualitative, quantitative and an overall numerical rating ranging from 1–4 and the frequency and scope of activities reflect the risk of the institution.
  - Frequent discussions with banks take place to discuss performance and these discussions reflect the bank’s risk profile.

### Continuous monitoring and data access
- Continuous monitoring leverages information from banks’ regulatory reporting and data links with clearing houses and registrars.
- Virtually every financial instrument is registered in Brazil, and the supervisor is able to access transactional information for each and every bank with a one day lag.
- Supervisory systems can monitor transactions and reconstruct bank positions such as liquidity positions, funds provider information, and market risk exposures.
- The BCB can stress test certain positions and monitor extraordinary trends; activity outside normal parameters is flagged and followed up.

### Onsite supervision teams and specialized functions
- The onsite department is configured into teams responsible for designated institutions or groups and for specific risks.
- Teams monitor continuous monitoring outputs and conduct monitoring and oversight per supervisory plan and cycle.
- Specialized teams include expertise in:
  - (i) credit, liquidity, market, and operational risks;
  - (ii) legal and fiscal issues;
  - (iii) validation (internal models);
  - (iv) Basel II and III implementation;
  - (v) corporate governance and internal controls;
  - (vi) AML.
- Supervisory cycles begin and end with a full review, evaluation of supervisory activities and results, and development of a subsequent supervisory plan.

### Accounting, disclosure, and external audit (CP 22)
- Banks must comply with BCB established regulatory accounting standards and appoint a director specifically responsible for compliance with the required standards, basic accounting principles, professional ethics and banking secrecy rules.
- Reporting and audit requirements:
  - All banks are required to publish semiannually audited statements according to the accounting plan of national financial system institutions.
  - Conglomerates that include a publicly listed financial institution or financial institutions required to appoint an audit committee must also produce annual statements according to IFRS.
  - Financial conglomerates are required to publish consolidated statements according to IFRS.
  - All financial institutions must receive an external audit according to international audit standards.
- Accounting convergence:
  - Since 2008, the BCB has been conducting an Accounting Convergence Project to evaluate differences between local and international standards with the aim of convergence to IFRS where feasible.
  - In general, national standards for financial institutions result in more conservative figures, particularly regarding provisioning.

### Consolidated and cross-border supervision (CPs 24–25)
- The BCB has broad authority to conduct consolidated supervision on a solo and consolidated basis, including all offices or entities within the group, irrespective of location or legal structure.
- Consolidated supervision is primarily based on information compiled at the parent bank level; parent banks are subject to mandatory detailed regular reporting to the BCB covering internal global risk management and internal controls.
- The BCB coordinates and exchanges information with domestic and foreign supervisors through supervisory colleges and bilateral arrangements.
- As home supervisor the BCB conducts supervisory colleges for Banco do Brasil and Itaú-Unibanco and participates as host in others; the BCB has signed MOUs with a number of countries.

### Insurance sector: market structure, performance, and main findings (Annex II)
- Market growth and penetration:
  - Premiums doubled between 2005 and 2010.
  - Average Brazilian spends less than US$350 on insurance per year.
  - Insurance penetration is 3.5 percent, which is around 50 percent of the average for OECD countries.
- Profitability and solvency indicators:
  - Life insurers: combined ratio around 75 percent and return on equity (ROE) above 20 percent.
  - Nonlife business: combined ratio around 100 percent and ROE between 47 percent and 34 percent.
  - Investment income around 25 percent of the premium in both industries.
  - Under current regulatory solvency requirements life insurance sector has an average margin of 250 percent above the regulatory requirements; nonlife sector is 90 percent above the required solvency margin.
  - Risk ratio (capital and surplus to underwritten premium) around 1.7.
  - Capital plus surplus to total assets is 8.3 percent.
  - Investments are conservative and short term, primarily fixed income instruments.
- Main supervisory findings and developments:
  - SUSEP has been strengthening solvency requirements toward a more risk sensitive regime, incorporating capital risk surcharges for nonlife underwriting risk and for credit risk.
  - As a result, on average, an additional capital surcharge of 35 percent has been required under the new regime.
  - Public disclosure is extensive and timely; audited information is required biannually.
  - SUSEP requires insurers and intermediaries to have controls to deter, prevent, detect, report and remedy fraud; external auditor opinion on internal controls is required per CNSP Resolution 280 of 2004.
  - Licensing, changes in control, portfolio transfers, and suitability requirements largely align with international standards but licensing process could be improved (consultation with home supervisor for foreign participants and a period to grant a license for transparency).
  - Mandatory reinsurance cession rules are complex and should be replaced with risk-based supervision; recommendation to remove limits on type of cessions and move to capital charge recognition based on reinsurer risk.
  - Governance and enterprise risk management for solvency, cooperation and information sharing, cross-border crisis prevention, and macroprudential surveillance need further development; formalized cooperation and signing the IAIS Multilateral MOU are recommended.
  - Consumer protection progress noted (effective ombudsman, claims paid within 30 days) but more work needed: introduce pre/during/post purchase disclosure requirements, disclosure of commissions and conflicts of interest, and design simple microinsurance products with emphasis on simplicity.

### Selected recommended actions from the assessment (excerpted)
- 1(2). Independence, accountability and transparency
  - Enhance the de jure independence of the BCB by providing in the law that the Governor and the Board of the BCB can only be removed for “due cause,” which should be detailed in the law. Also consider establishing a fixed term.
  - Grant the BCB authority to issue prudential regulations directly without having to work through the CMN.
  - Inject limited flexibility to hire technical experts at other than entry level.
- 5. Major acquisitions
  - Adoption of Resolution 4062 on March 29, 2012 addressed the deficiency of the prior regulation, which did not stipulate that banks’ investment in other companies receive the prior approval of the BCB (as required by law). A de minimis level should be established to avoid excessive filings.
- 23. Corrective and remedial powers of supervisors
  - Exempt non-listed banks from the corporate law requirement that 25 percent of net profits must be paid as dividends to preferred shareholders.

*Source: IMF Financial Sector Assessment Program—Brazil (excerpts).*

### 96.      The legal framework should be strengthened to provide SUSEP the independence and

### _cr12206 - 96.      The legal framework should be strengthened to provide SUSEP the independence and

### Legal framework, independence, and governance — findings
- The law contains several weaknesses that undermine SUSEP’s operational independence and capacity to fulfill its mandate and objectives.
- Specific weaknesses identified:
  - The CNSP can and has issued regulation based on limited technical input from SUSEP.
  - The MOF must approve how SUSEP uses its allocated budget, including operational uses such as international travel.
  - There is no framework for the nomination of the Superintendent and Directors and there are no minimal requirements on their qualification. The President of the Republic nominates and can dismiss at any time the Superintendent and the Directors of SUSEP. Similarly, the Superintendent nominates and can dismiss at any time the officers of SUSEP. Dismissal reasons are not published.
  - Legal protection for supervisors provides for defense by the Advocate General, but this may not always be sufficient to prevent intimidation.
  - Legal provisions governing potential liability for officers and employees of SUSEP could be strengthened by clarifying that they will not be held liable while carrying out their duties in good faith.

### Legal framework — recommendations
- Enact legislation to strengthen SUSEP’s operational independence by:
  - Introducing a transparent appointment procedure for the Superintendent and Directors.
  - Requiring technical input from SUSEP on any regulation issued by CNSP.
  - Providing autonomy on the use of the allocated budget.
- Clarify liability protections to ensure officers and employees acting in good faith will not be held liable.
- Establish an ongoing and comprehensive training program for newly incorporated staff.

### Resources, staffing, and supervisory capacity — findings
- SUSEP lacks sufficient financial and staff resources to conduct supervision effectively:
  - 55 inspectors inspect 183 insurers on a 3 years cycle.
  - Around 138 persons were newly recruited, but SUSEP has a very low training budget and does not have an organized, ongoing training program.
- Limitations on budget and staff, and the requirement that all staff be hired through public competition, have led to staff shortages in all departments.
- Inspections frequency is not aligned with size, complexity, and risk profile of insurers; the risk-based approach needs further development and cultural adoption.
- SUSEP’s inspection modules exist for different areas, but a comprehensive Inspection Manual does not exist.

### Brokers, intermediaries, and conduct of business — findings
- Intermediation market structure and supervision:
  - Currently around 88 percent of the insurance business is sold by around 70,000 active brokers, of which 46,000 are physical persons.
  - Supervision and disclosure requirements for brokers are thin.
  - Brokers are inspected primarily in response to complaints; SUSEP does not perform regular onsite inspections of brokers.
  - Brokers are not required to submit financial and operational information demonstrating proper handling of consumer funds.
  - There is no legal requirement that a broker who handles client monies must have safeguards to protect these funds.
  - There are no requirements for insurance intermediaries to apply appropriate corporate governance.
  - SUSEP has not developed specific requirements for the intermediation of insurance.
  - Only reinsurance brokers are required to obtain professional liability insurance.
- Consumer protection and complaints:
  - Requirement to establish an ombudsman by each insurer has increased consumer access: complaints received by the ombudsman rose from 1,756 to 4,114 since 2006.
  - Only 4 percent of cases remain unresolved and only 0.8 percent resulted in a fine.
  - Requirement of having claims paid within 30 days is enforced, with the 30 days stoppable only to request justified additional information.
  - With the exception of open pension plans, there are no requirements on the type of information consumers should receive before, during, and after insurance intermediation, nor disclosure of commissions or conflicts of interest.

### Brokers and intermediaries — recommendations
- SUSEP should urgently publish the missing regulations for the brokers’ self-regulation entity created by CL 137.
- Implement mandatory affiliation of all brokers to the self-regulating entity with strong governance and supervision of the entity by SUSEP.
- Require brokers to submit financial and operational information sufficient to demonstrate that consumer funds are not being misdirected or misused.
- Develop regular onsite inspection protocols for brokers and specific requirements for intermediation and corporate governance.
- Consider legal safeguards for brokers handling client monies.

### Group-wide supervision and consolidated regulation — findings
- The regulatory framework for group supervision is weak and lacks a definition of a financial group or conglomerate for the purposes of insurance supervision.
- The market is dominated by insurers that belong to large financial groups or conglomerates, yet supervision is carried out on a solo basis.
- The lack of consolidated supervision of insurance groups creates supervisory vulnerabilities.
- All capital requirements are at the legal entity level only.

### Group-wide supervision — recommendations
- Develop and implement required regulation for consolidated supervision, including:
  - Introduction of enterprise risk management (ERM) at the insurance group level.
  - Capital requirements at the insurance group level (consolidated capital requirements).
- Enhance regular exchange of information with foreign supervisors, especially given that Brazil is host supervisor of major international insurers and home supervisor of large conglomerates.

### Reinsurance, valuation, and capital — findings
- Reinsurance:
  - The opening of the reinsurance market is recent; participants are still adapting.
  - SUSEP currently does not analyze reinsurance contracts to assess if the intended risk transfer has taken place.
  - Reinsurance contracts lack transparency.
- Valuation:
  - Methods for valuation of assets and liabilities have been specified by SUSEP and basically reflect IFRS 4 rules.
  - The recent introduction of the LAT is a step toward recognizing full economic valuation of liabilities.
- Capital Adequacy:
  - SUSEP has recently incorporated specific capital risk surcharges for the nonlife underwriting risk and for the credit risk.
  - The use by insurers of approved internal models is recognized by SUSEP and can allow a lower capital surcharge in the nonlife underwriting risk.

### Information exchange, cooperation, and macroprudential surveillance — findings and recommendations
- SUSEP has MOUs with the BCB and the CVM used regularly to exchange supervisory information; authority exists to enter agreements with other regulators.
- SUSEP has not yet entered into bilateral agreements with any foreign authorities and has applied to participate in the IAIS Multilateral Memorandum of Understanding but is not yet a signatory.
- Recommendations:
  - Signature of the IAIS MMOU is recommended.
  - Clarify conditions that allow exchanging information in the absence of an MOU to avoid time-consuming case-by-case decisions and enable active exchange with relevant foreign supervisors.
- Macroprudential role:
  - SUSEP’s current involvement in macroprudential surveillance is limited to participation in the Subcommittee to Monitor the Stability of the National Financial System (SUMEF).

### Other key statistics and operational observations
- 55 inspectors inspect 183 insurers on a 3 years cycle.
- Around 88 percent of the insurance business is sold by around 70,000 active brokers, of which 46,000 are physical persons.
- SUSEP recruited around 138 persons recently but lacks an organized ongoing training program.
- Fraud statistics:
  - Proven fraud has been around 1.4 percent of all claims paid throughout the years.
  - The relation between suspected fraud and proven fraud increased from 11 percent in 2008 to 15 percent in 2010.
- Ombudsman statistics:
  - Complaints received rose from 1,756 cases to 4,114 since 2006.
  - 4 percent of cases remain unresolved; 0.8 percent resulted in a fine.

*Source: IMF staff assessment as presented in the provided content.*

### 4.   Licensing Granting licenses with add-ons or limitations can be a way to

### 4. Licensing

### Licensing
- Granting licenses with add-ons or limitations can be a way to increase market participation without endangering the protection of consumers.
- SUSEP should consider having the option to limit or restrict the licenses, at least for a period of time until it feels comfortable with issuing a full license.
- Consultation with the home supervisor should be part of the licensing process of foreign participants.
- A period to grant a license should be introduced to increase transparency in the licensing process.
- Licensing of composite insurers should be banned. The savings elements and long-term duration of the life insurance business as compared with nonlife business warrants a separate legal entity, in particular to increase transparency in winding-up situations with respect to customer investments in saving products.

### Suitability of Persons
- SUSEP should require proactive communication from the insurers in cases the statutory position-holders and significant owners are no longer suitable.
- To gain first-hand information and accelerate the approval process, SUSEP should exchange information with foreign authorities during the approval process of key positions and significant owners.

### Changes in Control and Portfolio Transfers
- (No specific bullets provided in the source beyond the heading.)

### Corporate Governance
- The establishment of corporate governance should be required by regulation, consistent with the standards under this principle, and supervision processes should be created to assess implementation.
- A “duty of skill and care” provision is recommended as a starting point to motivate boards of directors to follow sound business and financial practices and serve as the cornerstone of an effective corporate governance regime.

### Risk Management and Internal Controls
- A general opinion on the completeness and effectiveness of the internal models should be required of the external auditors, or CNSP Resolution 280 should be enhanced with an overarching statement on the effectiveness of the internal controls.

### Supervisory Review and Reporting
- The risk-based approach of supervision needs to be further developed and become part of SUSEP’s culture to optimize use of limited resources with a stronger focus on the more complex and riskier insurers.
- A comprehensive Inspection Manual needs to be created and—ideally—made public to reduce the chances of supervisors missing something during the inspection and to set clear expectations for the insurers.
- SUSEP should be granted the power to conduct onsite inspections directly.

### Preventive and Corrective Measures
- SUSEP should consider formalizing the ladder of intervention by introducing a proactive intervention framework that classifies supervised entities in different stages, each requiring different types of preventive measures.
  - Purposes: support early identification of risks to a firm’s viability and ensure firms take appropriate remedial action; flag actions authorities need to take in advance to prepare for resolution of a firm.

### Enforcement
- The process of recourses needs to be streamlined to avoid any prescription of the sanctions.
- A shorter time between a sanction and a final decision is needed to maintain the effectiveness and timeliness of fines.

### Winding-up and Exit from the Market
- To improve protection of policyholders’ interests, it is recommended that legal segregation be required, at least for assets corresponding to retirement products.
- This should be done without losing the current lien on the assets backing up the technical provisions.

### Reinsurance and Other Forms of Risk Transfer
- SUSEP should remove any limits on the type of cessions that are allowed in dependence of the reinsurer’s license and move to a system based on risk capital.
  - Use of a reinsurer that presents higher risk to the insurer should require a higher capital charge for the insurer or a limited recognition of the reinsurance credit on its balance sheet.
- SUSEP should establish risk transfer requirements to reinsurance contracts and analyze them as part of its supervisory work.
- To enhance the transparency of reinsurance contracts SUSEP should forbid side letters.
- Steps should be taken to require more timely receipt of reinsurance documentation by cedants.

### Valuation
- Further development of the mandatory scenarios to assess the adequacy of the technical provisions is recommended.

### Investment
- To enhance transparency, investment limits should be set for investment funds that take into consideration the quality and nature of their underlying assets.

### Enterprise Risk Management for Solvency Purposes
- SUSEP should establish enterprise risk management requirements for solvency purposes that address all relevant and material risks, consistent with international standards.
- SUSEP should actively supervise the efforts of insurers in this area to help ensure their capabilities are evolving at an appropriate pace.

### Capital Adequacy
- SUSEP is encouraged to further develop the missing risk charges for life underwriting risk, operational risk, and for capitalization of underwriting risk.
- A cautious approach is recommended before internal models can be used for solvency calculation purposes; a few years of experience should pass before internal models can be used for solvency calculation purposes.
- SUSEP should introduce capital requirements at the group level.

### Intermediaries
- Amending the law to make payment of a premium to a broker constitute payment to the insurer would provide an additional measure of protection to customers.
- SUSEP should urgently implement the self-regulation of brokers by publishing the missing regulation for the brokers’ self-regulation entity created by CL 137, to start supporting a tighter supervision of insurance intermediation.
- A mandatory affiliation to the self-regulating entity of all brokers together with strong governance and supervision of the entity by SUSEP is recommended.
- If necessary, legislation supporting this change should be enacted.
- To avoid conflict of interests the self-regulation should not be through any existing trade organization but rather through a separate organization which would carry out the supervisory activities utilizing former brokers that are currently not licensed to practice.

### Conduct of Business
- SUSEP should develop regulation for proper information disclosure by brokers given that the market is basically sold through these intermediaries.
- To enhance consumer protection, transparency requirements need to be introduced (e.g., clear disclosure of conflict of interests; offering a number of similar products together with the disclosure of the product with the highest commission; etc.).
- When introducing microinsurance regulation, particular emphasis on the simplicity of the products should be required.

### Public Disclosure
- (No specific bullets provided in the source beyond the heading.)

### Countering Fraud in Insurance
- (No specific bullets provided in the source beyond the heading.)

### Anti-Money Laundering and Combating the Financing of Terrorism
- SUSEP should consider creating a group of dedicated inspectors for the supervision of AML/CFT matters.
- Circular 380 is in the process of being updated, incorporating requirements to follow up on suspicion of AMF/CFT transactions.
- The updated Circular should also require identification of the ultimate beneficiary on group policies.

### Group-wide Supervision
- The required regulation for consolidated supervision, including the introduction of ERM and capital requirements at group level, needs to be developed and implemented.
- Resources should be allocated to achieve a level of supervisory intensity commensurate with the complexity and relevance of the insurance and financial groups.

### Macroprudential Surveillance and Insurance Supervision
- SUSEP should develop and use a variety of tools as part of its macroprudential surveillance. At a minimum SUSEP should:
  - Create a unit responsible for market analysis, which prepares a timely report on local and international market developments, including quantitative information. The report should be reviewed and commented on by senior supervisors as to the effects of these developments on insurers.
  - Interview senior management of the major insurers annually for their views on industry risks and trends. The results should be fed back to industry.
  - Analyze supervisory financial information by insurer, insurance group, and across the industry. The information analyzed should include solvency margins, reinsurance exposures, and credit exposures.
  - Perform top-down stress testing of the insurance sector each quarter and as necessary with respect to equity-price, exchange-rate, and credit risks. Action should be taken with individual insurers in response to concerns that are identified.
- Senior management of SUSEP should periodically discuss the results of the surveillance and consider whether additional supervisory measures are needed to deal with macroprudential concerns.
- SUSEP should comment publicly on market developments, trends, and its outlook. And the market data should be made publicly available.

### Supervisory Cooperation and Coordination
- SUSEP should sign MOUs with relevant jurisdictions and start to actively exchange information.
- SUSEP should have the ability to participate in international supervisory meetings. Such decisions, including on the necessary budget, should be with SUSEP.
- SUSEP should establish supervisory colleges for Brazilian insurers should their foreign operations become material.

### Cross-border Cooperation and Coordination on Crisis Management
- SUSEP should develop comprehensive plans for dealing with insurers in a crisis and ensure that it has the tools needed to carry out such plans.
- It should ensure that the plans are internationally-coordinated by working with foreign supervisors, for example, through supervisory colleges.

### Authorities’ response to the assessment
- 99. In general terms, the FSAP assessment reflects well the current situation of the regulatory and supervisory regime, as well as that of the industry participants.
- Some points raised by SUSEP could have been addressed in more depth or better had the assessment work been carried out over a longer period of time.
- Some actions are already underway to implement the recommendations, such as the regulation on the establishment, organization, operation and dissolution of self-regulated entities as supporting bodies to SUSEP.

*Source: _cr12206 - 4.   Licensing Granting licenses with add-ons or limitations can be a way to*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12206.pdf_