## Executive Summary

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---

### Macroeconomic Performance and Outlook
- Since the 2002 banking crisis Uruguay has rebuilt buffers and strengthened supervision, with landmark legal, regulatory and institutional reforms including laws on insolvency, competition, payments system, capital markets, and deposit insurance.
- High buffers and a buoyant economy helped insulate the financial sector from the global financial crisis.
- Key macroeconomic facts and policy outcomes:
  - Reduced share of central government foreign currency-denominated debt from 95 percent to 48 percent between 2002 to 2011.
  - Lengthened the average maturity to over 12 years by end 2012.
  - Foreign direct investment averaged 5.4 percent of GDP since 2004.
  - Inflation target range: 4 percent to 6 percent; inflation has fallen to single-digit levels but remains above the target range.
  - Recent surge in short-term capital inflows following sovereign upgrades; authorities adopted capital flow management measures aimed at discouraging inflows into central bank monetary policy paper.
  - Nonresident deposits have declined to less than 17 percent of total bank deposits.

### Macrofinancial Risks
- No obvious near-term domestic macrofinancial vulnerability: no credit bubble, households not heavily leveraged, enterprises have reduced FX mismatches, banking system relatively robust and highly liquid.
- Main external risks:
  - Fragile global environment could cause falls in export prices and spillovers from the Eurozone or neighboring countries.
  - Continued links with Argentina (tourism, real estate), though merchandise exports to Argentina have fallen to about 7 percent of total exports.
- Dollarization remains a systemic vulnerability:
  - At end-2011 about 72 percent of total loans and 74 percent of deposits were denominated in U.S. dollars.
  - Prudential measures in place: foreign exchange position limits and higher provisioning for nonhedged loans.

### Financial Sector Structure, Performance, and Vulnerabilities
- Structural features and vulnerabilities:
  - Banking sector indicators broadly sound but challenges persist: small size and high-cost structure affect profitability and Uruguay’s broader development prospects.
  - Significant state presence in banking and other parts of the financial sector may weaken competition.
  - A systemically important publicly owned commercial bank (BROU) is central to transaction processing, affecting operational risk and retail payment system development.
  - Systemic vulnerabilities: high dollarization, uncertainties around foreign parent banks (subsidiaries have placed significant deposits abroad including at parent banks), exposure to commodity prices and regional shocks.
  - Some private banks have buffers close to regulatory minima due to group capital allocation decisions.
- Market structure and competition:
  - Financial sector concentration and segmentation impede competition, efficiency, and economies of scale.
  - BROU: 45 percent of banking system’s assets and more than half of household deposits; almost 80 percent of BROU’s deposits are at zero cost; BROU has 57 percent market share in pensions.
  - Bolsa de Valores de Montevideo: six listed equities with market capitalization of about ½ percent of GDP; total trading in the secondary market in 2011 amounted only to US$600,000.
  - Defined-contribution pension system manages US$8.7 billion in assets, equivalent to 17 percent of GDP at end-2011; nearly 80 percent of their assets are government bonds.
  - Growing nonresident investor base estimated holdings: BCU notes 11 percent of total outstanding; government securities 9 percent of total outstanding.

### Policy Recommendations — Banking, Competition, and Public Bank Reform
- Level the playing field between public and private institutions to inject dynamism:
  - Consider extending the ability to make payroll deductions for debt service to all banks—currently limited to BROU.
  - Consider designating the Central Bank of Uruguay (BCU) as the sole depository of government funds.
- Modernize BROU in governance, information technology, and risk management systems; simplify its oversight and procurement regime to enhance efficiency and responsiveness.

### Supervision, Regulation, and Oversight
- Progress:
  - Superintendency of Financial Services (SSF) progressed in implementing Basel II standards and moved toward risk-based supervision.
  - Improvements against Basel Core Principles (BCP) in capital adequacy, market, liquidity, and operational risks; and in accounting, disclosure, and AML/CFT.
  - AML/CFT: adoption of a National Strategy, amendment of the law, and strengthened surveillance over banks’ compliance.
- Remaining supervisory challenges and priorities:
  - Insufficiency of resources and operational independence, and weak enforcement against state institutions.
  - Expansion of the regulatory perimeter strains SSF capacity.
  - Additional resources would allow SSF to:
    - (i) supervise BROU more intensively;
    - (ii) increase transactional testing to reduce reliance on external auditors;
    - (iii) refine stress testing techniques and strengthen risk analysis;
    - (iv) refine the risk rating system (CERT) and its processes.
  - Specify possible causes for removing the Superintendent to enhance independence and clarify SSF operational and technical autonomy given BCU’s Board role.
  - Strengthen enforcement over public sector banks.
- Supervisory recommendations (selected):
  - Assess and formally approve supervisory and operational strategies, and associated risk assessment and rating systems.
  - Address SSF’s resource gap estimated at about 50 staff.
  - Reduce reliance on external auditors; increase staff capacity and IT/risk specialists.
  - Exploit credit registry information; refine risk matrix and Pillar 2 approaches.
  - Strengthen remedial powers and enforcement, particularly regarding public banks.
  - Introduce prompt corrective action regime, increase sovereign foreign currency risk weights, expand related-party rules, require separate risk management units for systemic and large banks, and extend consolidated/group risk management.

### Safety Net, Crisis Preparedness, and Resolution
- Contingency planning and operational readiness:
  - Financial Stability Council (CEF) should strengthen contingency planning, including simulations, deposit payout exercises, and preparation of Memoranda of Understanding (MoUs) and lender-of-last-resort (LOLR) operations.
  - COPAB should organize operational simulations, including with the industry.
  - CEF should organize “war games,” including, possibly, with foreign supervisors.
  - BCU should develop lender-of-last-resort (LOLR) procedures now that LOLR operations are embedded in the Central Bank law.
  - SSF should consider adoption of a prompt corrective action framework, prepare for solvency testing and resolvability assessments, and integrate recovery and resolution planning into supervision.
- Bank resolution framework shortcomings and recommended fixes:
  - Current features:
    - SSF provides problem bank intervention; COPAB handles suspended bank resolution and has up to 120 days to work out a least-cost solution after BCU Board decision.
    - COPAB can use the deposit guarantee fund, move assets and liabilities, arrange purchase-and-assumption, or propose liquidation.
  - Weaknesses:
    - Allowing suspension of bank activities for up to 120 days can delay depositor payout and destroy value; shortening this period is recommended.
    - Absence of a bridge bank; a time-limited bridge bank option is recommended.
    - Resolution and liquidation decisions are in principle reversible by courts as any administrative act; this can lead to monetary damages and is not good practice.
    - Creditor approval requirement: creditors representing at least 66 percent of the value of liabilities being transferred must consent; removing this requirement would ensure a more seamless resolution process.
    - Civil and criminal legal protection for contractual employees is insufficient.
    - Lack of access to IT systems has impeded supervisors in assessing problem banks and delayed depositor payout.
  - Deposit insurance (COPAB) role and issues:
    - COPAB broadly complies with IADI Core Principles; experienced staff and computerized depositor database (SIDIIF); protects local deposits up to around US$29,000 and foreign currency deposits up to US$5,000.
    - COPAB fully covers 99 percent of all local currency depositors, and about 50 percent of foreign currency depositors.
    - Premiums partly risk-based and differentiated by currency.
    - Funding options include pre-levying premiums (up to three years worth) and a credit line with the government.
    - Payout within 30 days of liquidation.
    - Issues: limited legal protection for contractual employees; state banks BROU and BHU have blanket deposit guarantees mandated by their charters; COPAB should be consulted earlier in licensing/recapitalization processes.

### Macroprudential Framework and Policies
- Active use of tools:
  - Uruguay uses incentives to de-dollarize (prudential norms, monetary policy tools, differential deposit insurance premiums by currency), measures to build countercyclical buffers, and recently introduced a systemic risk capital charge.
  - Dynamic provisioning introduced in 2001 with recalibration in April 2012; bounds between 0 percent and 3 percent of total loans subject to provisions; new factors added to reflect credit ratings, speed of credit growth and to capture cyclical dynamics more closely.
  - Systemic surcharge for systemically important banks will be between 0.5 percent and 2 percent according to size.
- Recommendation:
  - Better coordination of macroprudential tools used by various agencies should form an important part of the CEF agenda, analyzing instrument combinations holistically (reserve requirements, deposit insurance premia, prudential standards differentiated by currency).

### Financial Infrastructure and Development
- Priority measures to deepen domestic-currency markets and financial infrastructure:
  - Anchor inflation and its expectations to encourage long-term savings and lending denominated in local currency.
  - Improve public debt management and monetary operations to build up liquidity in secondary markets:
    - Introduce a primary dealer program.
    - Rationalize the maturities of securities in the market.
    - Use repos for managing liquidity.
  - Broaden pension funds’ scope to invest abroad to reduce reliance on low-yielding government securities.
  - Improve insolvency system with more general out-of-court enforcement of secured claims and accelerate procedural legislation to expedite post-judgment asset execution.
  - Accelerate oversight over retail payment networks and catalyze Automated Clearing House (ACH) development to spur efficiency and foster greater competition.
  - Finalize decisions on Central Securities Depository (CSD) functionalities and efficient interfaces with trading systems, including identification of beneficial owners.
  - Credit reporting: consider sharing the complete Central de Riesgos (CR) database with private credit bureaus; enhance regulation and supervision of credit reporting industry (minimum entry criteria, governance, reliability, positive data collection).
  - Access to finance: priorities include improving services for medium and small enterprises, expanding services to households while lowering costs; note that regulatory interest rate caps preclude development of microfinance for enterprises.

### Stress Testing and Resilience
- SSF quarterly stress tests cover market, liquidity, and credit risk using scenarios with changes in:
  - Inflation: 9 percent to 13 percent.
  - Foreign exchange: 13 percent to 32 percent.
  - Interest rates: 200–750 bps.
  - GDP: decline of 4 percent to 8 percent.
- Adverse and severe scenarios correspond broadly to shocks of one and two standard deviations of historical data including the 2002 crisis.
- FSAP stress tests (assuming steeper depreciation than authorities) found under the adverse scenario the CARs of a few private banks would fall below the 8 percent regulatory floor.
- Capital buffers are slated to increase in 2013 due to new surcharges for operational and systemic risks.
- Stress testing improvements recommended:
  - Use more disaggregated data from the official credit registry (Central de Riesgos) instead of aggregate NPL information to study loan dynamics and estimate impacts on return on assets.
  - Utilize registry data to assess system exposure to large borrowers and/or sectors and simulate losses under extreme scenarios.
  - Strengthen procedures, systems, and staff training for stress testing.

### Key Macro and Financial Indicators (selected figures from Table 2 and other tables)
- Real GDP: 6.5, 7.2, 2.4, 8.9, 5.7, 3.5
- GDP (US$ billions): 23.4, 30.4, 30.5, 39.4, 46.7, 49.2
- CPI inflation (average): 8.1, 7.9, 7.1, 6.7, 8.1, 8.0
- Unemployment (in percent, end of period): 7.7, 6.8, 6.3, 5.4, 5.3, 6.0
- Base Money 1/: 16.4, 29.3, 6.5, 16.2, 17.3, 27.4
- M-1 1/: 29.4, 18.6, 12.2, 28.9, 21.3, 20.4
- M-2 1/: 30.6, 17.1, 15.0, 30.3, 21.4, 17.4
- M-3 1/: 3.8, 28.6, -2.6, 22.1, 17.2, 27.0
- Credit to the private sector (constant exch. rate) 1/: 22.1, 28.0, -7.5, 21.3, 20.3, 20.8
- NPL ratio: 1.1, 1.0, 1.2, 1.0, 1.3, ...
- Bank assets (in percent of GDP): 58.5, 66.1, 58.8, 61.5, 61.5 ...
- Foreign bank market share: 54.5, 56.8, 56.4, 57.6, 56.7 ...
- Revenue 2/: 28.6, 26.9, 28.7, 29.4, 28.9, 29.0
- Non-interest expenditure 2/: 25.3, 25.7, 27.9, 27.7, 27.1, 28.8
- Wage bill: 4.6, 4.6, 5.2, 5.0, 5.0, 5.1
- Primary balance 3/: 3.6, 1.4, 1.1, 1.9, 2.0, 0.5
- Interest 3/: 3.6, 2.9, 2.9, 3.0, 2.9, 2.8
- Overall balance 3/: 0.0, -1.6, -1.8, -1.1, -0.9, -2.3
- Gross public sector debt: 64.4, 63.3, 62.7, 58.0, 57.8, 52.3
- Foreign currency debt: 44.7, 44.2, 40.9, 33.0, 27.9, 23.5
- Net public sector debt 4/: 38.1, 31.6, 32.0, 31.2, 34.4, 31.2
- Merchandise exports, fob (US$ millions): 5,100, 7,095, 6,392, 8,031, 9,307, 9,852
- Merchandise imports, fob (US$ millions): 5,645, 8,810, 6,896, 8,558, 10,690, 11,195
- Terms of trade (percentage change): 2.3, -1.2, 5.7, -3.0, 0.1, 3.1
- Current account balance: -0.9, -5.7, -1.5, -2.2, -3.1, -3.0
- Foreign direct investment: 5.7, 6.9, 5.0, 5.8, 4.7, 6.8
- Overall balance of payments (US$ millions): 1,005, 2,232, 1,588, -361, 2,564, 2,385
- External debt 5/: 48.3, 46.1, 40.4, 35.4, 32.9, 30.5
- Of which: external public debt: 43.7, 41.1, 36.6, 32.4, 29.8, 25.9
- External debt service (percent of exports of goods and services): 26.1, 21.7, 23.8, 29.7, 21.2, 26.9
- Gross official reserves (US$ millions) 6/: 4,124, 6,362, 8,040, 7,655, 10,274, 12,659
- In months of imports of goods and services: 4.8, 9.3, 9.5, 7.2, 9.2, 10.7
- In percent of short-term debt: 471.8, 797.2, 772.3, 517.1, 447.9, 512.8
- In percent of short-term debt plus bank nonresident deposits: 117.2, 151.4, 162.6, 129.5, 151.4, 179.7

Notes:
- 1/ In 2012 corresponds to the change between June 2011 and June 2012.
- 2/ Non-financial public sector, excluding local governments.
- 3/ Total public sector.
- 4/ Public sector debt net of Banco Central del Uruguay' assets.
- 5/ Excludes nonresident deposits.
- 6/ Includes reserve buildup through reserve requirements of resident financial institutions.

### Financial Soundness and Dollarization Indicators (selected)
- Banking system capital adequacy ratio (CAR) as of May 2012: 15.8 percent (10.7 percent for private banks).
- Risk-weighted assets: 60 percent of total assets (54 percent for public banks).
- Nonperforming loans: 1.4 percent of total loans.
- Dollar loans in percent of total loans (series): 79.8, 79.2, 73.9, 72.4, 70.3, 71.6, 22.2 6/
- Dollar deposits in percent of total deposits (series): 78.2, 80.7, 76.8, 74.3, 72.3, 74.2, 18.4 6/
- Private sector credit in percent of GDP (series): 24.1, 22.4, 23.9, 23.4, 20.5, 22.0, 31.8
- Specific loan-loss provisions in percent of non-performing loans (series): 55.1, 63.1, 72.8, 72.2, 74.0, 70.4, 155.0
- Return on assets 3/: 1.8, 1.6, 0.5, 1.2, 1.2, 2.1, 1.6
- Liquidity ratio (maturities up to 30 days) 5/: 53.9, 66.0, 64.4, 56.9, 54.1, 52.1, 30.6
- Implicit exchange rate risk 7/: 35.2, 36.2, 31.6, 31.4, 31.4, 34.0

Notes and data specifics:
- Data excludes Banco Hipotecario del Uruguay.
- 1/ Latest available data.
- 3/ Annualized net income before extraordinary items and taxes from the beginning of the year until the reporting month, in percent of average value of total assets over the same period.
- 4/ Same as footnote 3 but in percent of average value of capital over the same period.
- 5/ Liquid assets with maturity up to 30 days in percent of total liabilities expiring within the same period.
- 6/ Excludes Brazil.
- 7/ Share of foreign currency credit to unhedged borrowers.
- 2/ Median of Brazil, Chile, Colombia, Mexico, and Peru. The official definition of soundness indicators varies by country.

### FSAP Key Recommendations (excerpted)
- Resources and Autonomy of Regulator:
  - Increase supervisory independence via broadening the technical and operational independence of the SSF. (Paragraph 23)
  - Increase financial and human resources for SSF. (Paragraph 24)
- Regulation and Supervision of the Banking Industry:
  - Better discriminate among banks of different risk profiles, including capturing low probability but high impact events. (Paragraph 27)
  - Enhance risk concentration rules to capture linkages among connected borrowers due to financial, commercial, and operational exposures. (Paragraph 27)
  - Provide further guidance to the industry on expected risk measurement, stress testing, contingency planning, risk management, and AML/CFT standards. (Paragraph 27)
  - Require systemic and large banks to operate separate risk management units and integrate risk measures into limits/operations. (Paragraph 27)
- Securities Market:
  - Prepare a comprehensive capital market development strategy, including bringing new issuers to the market. (Paragraph 46)
- Insurance, Pension Funds and Annuities Market:
  - Contract an independent diagnostic of the Banco de Seguros del Estado (BSE), including a review of its strategy, solvency, efficiency, and governance. (Paragraph 31)
  - Liberalize pension fund rules for investing abroad. (Paragraph 48)
  - Provide hedging mechanisms or allow for phased withdrawals to address shortcomings of existing pension indexation requirements. (Paragraph 48)
- Safety Net and Crisis Management:
  - Strengthen contingency planning, develop scenarios, and specify agencies’ roles. (Paragraph 38)
  - Undertake joint and separate crisis preparedness work among the safety net participants. (Paragraph 38)
- Financial Infrastructure:
  - Amend procedural legislation to accelerate the asset execution process, including effective measures to expedite the post-judgment phase. (Paragraph 49)
  - Finalize decisions regarding CSD functionalities (interfaces with trading systems, identification of beneficial owners). (Paragraph 34)
  - Develop and implement the payment system oversight function, including SSS and retail payments. (Paragraph 34)
  - Finalize an agreement on the interbank pricing scheme for the ACH to become operational. (Paragraph 50)

*Source: Executive Summary, IMF Financial Sector Assessment Program — Uruguay (cr13152).*

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

### Executive Summary

### Macroeconomic Performance and Outlook
- Since the 2002 banking crisis Uruguay has rebuilt buffers and strengthened supervision, with landmark legal, regulatory and institutional reforms including laws on insolvency, competition, payments system, capital markets, and deposit insurance.
- High buffers and a buoyant economy helped insulate the financial sector from the global financial crisis.
- Key macroeconomic facts and policy outcomes:
  - Reduced share of central government foreign currency-denominated debt from 95 percent to 48 percent between 2002 to 2011.
  - Lengthened the average maturity to over 12 years by end 2012.
  - Foreign direct investment averaged 5.4 percent of GDP since 2004.
  - Inflation target range: 4 percent to 6 percent; inflation has fallen to single-digit levels but remains above the target range.
  - Recent surge in short-term capital inflows following sovereign upgrades; authorities adopted capital flow management measures aimed at discouraging inflows into central bank monetary policy paper.
  - Nonresident deposits have declined to less than 17 percent of total bank deposits.

### Macrofinancial Risks
- No obvious near-term domestic macrofinancial vulnerability: no credit bubble, households not heavily leveraged, enterprises have reduced FX mismatches, banking system relatively robust and highly liquid.
- Main external risks:
  - Fragile global environment could cause falls in export prices and spillovers from the Eurozone or neighboring countries.
  - Continued links with Argentina (tourism, real estate), though merchandise exports to Argentina have fallen to about 7 percent of total exports.
- Dollarization remains a systemic vulnerability:
  - At end-2011 about 72 percent of total loans and 74 percent of deposits were denominated in U.S. dollars.
  - Prudential measures in place: foreign exchange position limits and higher provisioning for nonhedged loans.

### Financial Sector Structure, Performance, and Vulnerabilities
- Banking sector indicators broadly sound but challenges persist:
  - Small size and high-cost structure affect profitability and Uruguay’s broader development prospects.
  - Significant state presence in banking and other parts of the financial sector may weaken competition.
  - A systemically important publicly owned commercial bank (BROU) is central to transaction processing, affecting operational risk and retail payment system development.
  - Systemic vulnerabilities: high dollarization, uncertainties around foreign parent banks (subsidiaries have placed significant deposits abroad including at parent banks), exposure to commodity prices and regional shocks.
  - Some private banks have buffers close to regulatory minima due to group capital allocation decisions.

### Policy Recommendations — Banking, Competition, and Public Bank Reform
- Level the playing field between public and private institutions to inject dynamism:
  - Consider extending the ability to make payroll deductions for debt service to all banks—currently limited to BROU.
  - Consider designating the Central Bank of Uruguay (BCU) as the sole depository of government funds.
- Modernize BROU in governance, information technology, and risk management systems; simplify its oversight and procurement regime to enhance efficiency and responsiveness.

### Supervision, Regulation, and Oversight
- Supervision has improved significantly:
  - The Superintendency of Financial Services (SSF) progressed in implementing Basel II standards and moved toward risk-based supervision.
  - Improvements against Basel Core Principles (BCP) in capital adequacy, market, liquidity, and operational risks; and in accounting, disclosure, and AML/CFT.
  - AML/CFT: adoption of a National Strategy, amendment of the law, and strengthened surveillance over banks’ compliance.
- Remaining supervisory challenges:
  - Insufficiency of resources and operational independence, and weak enforcement against state institutions.
  - Expansion of the regulatory perimeter strains SSF capacity.
  - Additional resources would allow SSF to:
    - (i) supervise BROU more intensively;
    - (ii) increase transactional testing to reduce reliance on external auditors;
    - (iii) refine stress testing techniques and strengthen risk analysis;
    - (iv) refine the risk rating system (CERT) and its processes.
  - Specify possible causes for removing the Superintendent to enhance independence and clarify SSF operational and technical autonomy given BCU’s Board role.
  - Strengthen enforcement over public sector banks.

### Safety Net, Crisis Preparedness, and Resolution
- Recent improvements require operational follow up:
  - Financial Stability Council should strengthen contingency planning, including simulations, deposit payout exercises, and preparation of Memoranda of Understanding (MoUs) and lender-of-last-resort (LOLR) operations.
- Remaining weaknesses in the bank resolution regime:
  - Allowing suspension of bank activities for up to 120 days.
  - Absence of a bridge bank.
  - Reversibility by courts of bank resolution and liquidation decisions.
- Deposit protection agency (assessed against IADI Core Principles) should be involved earlier in resolution decisions to make purchase-and-assumption by another bank realistic and offer legal protection for contractual employees.

### Financial Infrastructure and Development
- Measures to further develop the financial sector:
  - Broaden pension funds’ scope to invest abroad to reduce reliance on low-yielding government securities.
  - Improve insolvency system with more general out-of-court enforcement of secured claims and accelerate procedural legislation to expedite post-judgment asset execution.
  - Accelerate oversight over retail payment networks and catalyze Automated Clearing House (ACH) development to spur efficiency and foster greater competition.
  - Finalize decisions on Central Securities Depository (CSD) functionalities and efficient interfaces with trading systems, including identification of beneficial owners.

### FSAP Key Recommendations (excerpted)
- Resources and Autonomy of Regulator:
  - Increase supervisory independence via broadening the technical and operational independence of the SSF. (Paragraph 23)
  - Increase financial and human resources for SSF. (Paragraph 24)
- Regulation and Supervision of the Banking Industry:
  - Better discriminate among banks of different risk profiles, including capturing low probability but high impact events. (Paragraph 27)
  - Enhance risk concentration rules to capture linkages among connected borrowers due to financial, commercial, and operational exposures. (Paragraph 27)
  - Provide further guidance to the industry on expected risk measurement, stress testing, contingency planning, risk management, and AML/CFT standards. (Paragraph 27)
  - Require systemic and large banks to operate separate risk management units and integrate risk measures into limits/operations. (Paragraph 27)
- Securities Market:
  - Prepare a comprehensive capital market development strategy, including bringing new issuers to the market. (Paragraph 46)
- Insurance, Pension Funds and Annuities Market:
  - Contract an independent diagnostic of the Banco de Seguros del Estado (BSE), including a review of its strategy, solvency, efficiency, and governance. (Paragraph 31)
  - Liberalize pension fund rules for investing abroad. (Paragraph 48)
  - Provide hedging mechanisms or allow for phased withdrawals to address shortcomings of existing pension indexation requirements. (Paragraph 48)
- Safety Net and Crisis Management:
  - Strengthen contingency planning, develop scenarios, and specify agencies’ roles. (Paragraph 38)
  - Undertake joint and separate crisis preparedness work among the safety net participants. (Paragraph 38)
- Financial Infrastructure:
  - Amend procedural legislation to accelerate the asset execution process, including effective measures to expedite the post-judgment phase. (Paragraph 49)
  - Finalize decisions regarding CSD functionalities (interfaces with trading systems, identification of beneficial owners). (Paragraph 34)
  - Develop and implement the payment system oversight function, including SSS and retail payments. (Paragraph 34)
  - Finalize an agreement on the interbank pricing scheme for the ACH to become operational. (Paragraph 50)

*Source: Executive Summary, IMF Financial Sector Assessment Program — Uruguay.*

### 7.      Policy measures are recommended to reduce dollarization. In particular better

### 7.      Policy measures are recommended to reduce dollarization. In particular better

### Policy recommendations to reduce dollarization and deepen local-currency markets
- Anchor inflation and its expectations to encourage long-term savings and lending denominated in local currency by reducing inflation risk premia.
- Improve public debt management and monetary operations to build up liquidity in secondary markets and promote domestic currency capital market development. Specific measures mentioned:
  - Introducing a primary dealer program.
  - Rationalizing the maturities of securities in the market.
  - Using repos for managing liquidity.
- Continue progress in areas where authorities have already taken steps to help build domestic-currency market depth.

### Macroeconomic and fiscal indicators (selected figures from Table 2)
- Real GDP: 6.5, 7.2, 2.4, 8.9, 5.7, 3.5
- GDP (US$ billions): 23.4, 30.4, 30.5, 39.4, 46.7, 49.2
- CPI inflation (average): 8.1, 7.9, 7.1, 6.7, 8.1, 8.0
- Unemployment (in percent, end of period): 7.7, 6.8, 6.3, 5.4, 5.3, 6.0
- Base Money 1/: 16.4, 29.3, 6.5, 16.2, 17.3, 27.4
- M-1 1/: 29.4, 18.6, 12.2, 28.9, 21.3, 20.4
- M-2 1/: 30.6, 17.1, 15.0, 30.3, 21.4, 17.4
- M-3 1/: 3.8, 28.6, -2.6, 22.1, 17.2, 27.0
- Credit to the private sector (constant exch. rate) 1/: 22.1, 28.0, -7.5, 21.3, 20.3, 20.8
- NPL ratio: 1.1, 1.0, 1.2, 1.0, 1.3, ...
- Bank assets (in percent of GDP): 58.5, 66.1, 58.8, 61.5, 61.5 ...
- Foreign bank market share: 54.5, 56.8, 56.4, 57.6, 56.7 ...
- Revenue 2/: 28.6, 26.9, 28.7, 29.4, 28.9, 29.0
- Non-interest expenditure 2/: 25.3, 25.7, 27.9, 27.7, 27.1, 28.8
- Wage bill: 4.6, 4.6, 5.2, 5.0, 5.0, 5.1
- Primary balance 3/: 3.6, 1.4, 1.1, 1.9, 2.0, 0.5
- Interest 3/: 3.6, 2.9, 2.9, 3.0, 2.9, 2.8
- Overall balance 3/: 0.0, -1.6, -1.8, -1.1, -0.9, -2.3
- Gross public sector debt: 64.4, 63.3, 62.7, 58.0, 57.8, 52.3
- Foreign currency debt: 44.7, 44.2, 40.9, 33.0, 27.9, 23.5
- Net public sector debt 4/: 38.1, 31.6, 32.0, 31.2, 34.4, 31.2
- Merchandise exports, fob (US$ millions): 5,100, 7,095, 6,392, 8,031, 9,307, 9,852
- Merchandise imports, fob (US$ millions): 5,645, 8,810, 6,896, 8,558, 10,690, 11,195
- Terms of trade (percentage change): 2.3, -1.2, 5.7, -3.0, 0.1, 3.1
- Current account balance: -0.9, -5.7, -1.5, -2.2, -3.1, -3.0
- Foreign direct investment: 5.7, 6.9, 5.0, 5.8, 4.7, 6.8
- Overall balance of payments (US$ millions): 1,005, 2,232, 1,588, -361, 2,564, 2,385
- External debt 5/: 48.3, 46.1, 40.4, 35.4, 32.9, 30.5
- Of which: external public debt: 43.7, 41.1, 36.6, 32.4, 29.8, 25.9
- External debt service (percent of exports of goods and services): 26.1, 21.7, 23.8, 29.7, 21.2, 26.9
- Gross official reserves (US$ millions) 6/: 4,124, 6,362, 8,040, 7,655, 10,274, 12,659
- In months of imports of goods and services: 4.8, 9.3, 9.5, 7.2, 9.2, 10.7
- In percent of short-term debt: 471.8, 797.2, 772.3, 517.1, 447.9, 512.8
- In percent of short-term debt plus bank nonresident deposits: 117.2, 151.4, 162.6, 129.5, 151.4, 179.7

Notes:
- 1/ In 2012 corresponds to the change between June 2011 and June 2012.
- 2/ Non-financial public sector, excluding local governments.
- 3/ Total public sector.
- 4/ Public sector debt net of Banco Central del Uruguay' assets.
- 5/ Excludes nonresident deposits.
- 6/ Includes reserve buildup through reserve requirements of resident financial institutions.

### Financial sector structure and dollarization (key findings)
- Uruguay’s banking system is small: private sector credit amounted to 22 percent of GDP at end-2011.
- System characteristics: very liquid, highly dollarized, dominated by a publicly owned bank; largest private banks are foreign-owned branches and subsidiaries engaged in narrowly focused activities.
- Excess of very liquid financial savings and lack of domestic financial assets explain very low cost of deposits; capital market development is at an early stage with virtually nonexistent long-term corporate instruments and little secondary market activity.
- State-owned institutions dominate: a large publicly owned commercial bank (BROU) has 45 percent of banking system’s assets and more than half of household deposits.
- BROU: almost 80 percent of BROU’s deposits are at zero cost; BROU has 57 percent market share in pensions.
- Bolsa de Valores de Montevideo: six listed equities with market capitalization of about ½ percent of GDP; total trading in the secondary market in 2011 amounted only to US$600,000.
- Defined-contribution pension system manages US$8.7 billion in assets, equivalent to 17 percent of GDP at end-2011; nearly 80 percent of their assets are government bonds.
- Growing nonresident investor base estimated holdings: BCU notes 11 percent of total outstanding; government securities 9 percent of total outstanding.

### Financial soundness and dollarization indicators (selected figures)
- Banking system capital adequacy ratio (CAR) as of May 2012: 15.8 percent (10.7 percent for private banks).
- Risk-weighted assets: 60 percent of total assets (54 percent for public banks).
- Nonperforming loans: 1.4 percent of total loans.
- Dollar loans in percent of total loans (series): 79.8, 79.2, 73.9, 72.4, 70.3, 71.6, 22.2 6/
- Dollar deposits in percent of total deposits (series): 78.2, 80.7, 76.8, 74.3, 72.3, 74.2, 18.4 6/
- Private sector credit in percent of GDP (series): 24.1, 22.4, 23.9, 23.4, 20.5, 22.0, 31.8
- Specific loan-loss provisions in percent of non-performing loans (series): 55.1, 63.1, 72.8, 72.2, 74.0, 70.4, 155.0
- Return on assets 3/: 1.8, 1.6, 0.5, 1.2, 1.2, 2.1, 1.6
- Liquidity ratio (maturities up to 30 days) 5/: 53.9, 66.0, 64.4, 56.9, 54.1, 52.1, 30.6
- Implicit exchange rate risk 7/: 35.2, 36.2, 31.6, 31.4, 31.4, 34.0

Notes and data specifics:
- Data excludes Banco Hipotecario del Uruguay.
- 1/ Latest available data.
- 3/ Annualized net income before extraordinary items and taxes from the beginning of the year until the reporting month, in percent of average value of total assets over the same period.
- 4/ Same as footnote 3 but in percent of average value of capital over the same period.
- 5/ Liquid assets with maturity up to 30 days in percent of total liabilities expiring within the same period.
- 6/ Excludes Brazil.
- 7/ Share of foreign currency credit to unhedged borrowers.
- 2/ Median of Brazil, Chile, Colombia, Mexico, and Peru. The official definition of soundness indicators varies by country.

### Market structure, competition, and vulnerabilities
- Financial sector concentration and segmentation impede competition, efficiency, and economies of scale.
- High cost of business for banks due to:
  - High wages and personnel costs.
  - Restrictive negotiated operating conditions (limited hours, high employee separation costs, limits on staff deployment).
  - High employer and employee contributions to the bank pension system (~38 percent of wages for employers and 17.5 percent for employees).
  - Shortcomings in credit enforcement, repossession of collateral, and credit information sharing.
- BROU advantages that affect competition:
  - Monopoly on serving the public sector and public utilities.
  - Privileged access to government employees and state utility workers.
  - Manages 57 percent of workers’ private pension savings assets.
  - Special authorization to directly debit payrolls to service outstanding loans.
  - Dominant branch and ATM network and monopoly on government deposits.
- Market segmentation: private banks lend to large enterprises and higher-income individuals; finance companies and EACs focus on low-income borrowers with high interest rates (typically around 65–70 percent).
- EACs funding and growth: funded largely through securitized loan sales, often to banks in the same group; loan portfolio grew from 0.6 percent of GDP in 2007 to 1.8 percent in 2011.
- Long-term credit commonly priced in U.S. dollars; mortgage market linked to inflation-indexed units providing long-term fixed real interest rates; short-term consumer lending mostly in local currency.

### Stress testing and resilience
- SSF quarterly stress tests cover market, liquidity, and credit risk using scenarios with changes in:
  - Inflation: 9 percent to 13 percent.
  - Foreign exchange: 13 percent to 32 percent.
  - Interest rates: 200–750 bps.
  - GDP: decline of 4 percent to 8 percent.
- Adverse and severe scenarios correspond broadly to shocks of one and two standard deviations of historical data including the 2002 crisis.
- FSAP stress tests (assuming steeper depreciation than authorities) found under the adverse scenario the CARs of a few private banks would fall below the 8 percent regulatory floor.
- Capital buffers are slated to increase in 2013 due to new surcharges for operational and systemic risks.

*Source: IMF staff report content as provided.*

### 20.      Stress testing practices can be fine-tuned by using more granular information

### 20.      Stress testing practices can be fine-tuned by using more granular information

### Stress testing and credit risk
- Use more disaggregated data from the official credit registry instead of aggregate nonperforming loan information to:
  - Study loan dynamics and macroeconomic variables to estimate the impact of stressed scenarios on return on assets.
- To account for concentration risk:
  - Utilize information from the official credit registry to assess system exposure to large borrowers and/or sectors.
  - Use simulation techniques to evaluate losses under extreme scenarios.
- Suggested improvements in work processes:
  - More robust procedures and systems.
  - More staff with appropriate training.

### Box 1 — Competitive advantages and disadvantages of BROU
- Competitive advantages:
  - The right to deduct payments directly from payroll to recover interest and principal on consumer loans.
  - Monopoly on public sector deposits (although subject to 100 percent reserve requirement).
  - Explicit unlimited and permanent deposit guarantee.
  - Scale—BROU is the dominant bank with national coverage through 131 branches; it accounts for 51 percent of household deposits, 44 percent of peso deposits, and 48 percent of peso credit.
  - Payment network effect—in the absence of an Automatic Clearing House (ACH) and given costly interbank transfer fees, the incentives to bank with BROU are strong. BROU has not moved quickly to participate in the development of an ACH that would increase the efficiency of retail transfers and level the playing field.
- Competitive disadvantages:
  - Governance structure that leaves BROU vulnerable to political interference.
  - Multiple layers of public sector oversight in addition to SSF.
  - Subject to public procurement rules.
  - Hiring constraints related to civil service structure.
  - Maintenance of a branch network in unprofitable locations in the public interest, forcing cross-subsidization.
  - No tax exemptions on investment projects, contrary to private firms.

### Banking supervision — progress and challenges (paras 21–26)
- Significant progress has been made in implementing Basel II standards and moving toward risk-based supervision.
- Improvements observed against Basel Core Principles (BCP) in areas including capital adequacy, market, liquidity, and operational risks, as well as accounting, disclosure, and AML/CFT.
- Regulatory perimeter enlargement and SSF integration:
  - SSF responsible for regulating and supervising 486 heterogeneous institutions covering all sectors of financial intermediation (Table 6).
  - Resource constraints in staffing and information technology have challenged supervisory quality.
  - SSF adopted a risk-based approach in 2010 to allocate resources and link supervisory strategy to institutions’ risk profiles.
- Governance and supervisory independence concerns:
  - The BCU Board is responsible for regulating and supervising the financial system and discharges obligations through the SSF, which has technical and operational autonomy but remains subject to BCU Board administrative and financial decisions.
  - The BCU Board appoints and dismisses the Superintendent (dismissal without requirement to specify grounds) and can issue regulations and revoke SSF decisions (powers not yet used).
  - These arrangements may restrict supervisory autonomy.
- Systemic importance of BROU amplifies supervisory challenges:
  - BROU has improved internal governance processes but has no independent directors and some directors are nominated by political parties, complicating oversight (Core Principles 1 and 23).
  - Improvements in risk management and IT systems face public sector contracting and procurement hurdles.
- Implementation moves:
  - Capital charges being introduced for operational, commodity price, equity and systemic risk.
  - By year-end, major banks will submit the results of their first International Capital Adequacy Assessment Process (ICAAP).
  - SSF plans to publish its Supervisory Review and Evaluation Process (SREP), including Pillar 2 capital guidelines, in 2013, and update its road map for implementing Basel III.
  - SSF has implemented risk-based supervisory and operational strategy during the last two supervisory cycles, emphasizing qualitative aspects of internal governance and risk management.

### Supervisory recommendations (para 24–27 and bulleted list)
- BCU Board actions recommended:
  - Assess and formally approve supervisory and operational strategies, and associated risk assessment and rating systems.
  - Address SSF’s resource gap estimated at about 50 staff.
  - Ensure appropriate disclosures regarding the supervisory process and goals.
  - Introduce a rigorous quality assurance process to assess compliance with policies and procedures.
- Further measures to improve banking supervision:
  - Reduce reliance on external auditors for assessing credit quality, internal controls and information systems to achieve a better balance between review of processes and transactions.
  - Increase capacity of staff (including through adopting formal career development, training plans, and hiring IT and risk specialists) and systems (including for work planning, costing and stress testing).
  - Exploit information from the credit registry for supervisory purposes.
  - Refine the risk matrix to better gauge banks’ risks, providing a sounder basis for supervisory response and Pillar 2 capital determination; currently ratings do not differentiate much despite large differences between risk profiles.
  - Strengthen BCU’s remedial powers and enforcement, particularly regarding public banks; publishing sanctions is a good recent step, but BCU’s capacity to impose corrective measures against public banks remains constrained by the inability to make management changes.
  - Improve problem bank toolkit, including adopting formalized procedures detailing the temporary administration process.
  - Other measures include:
    - (i) increase foreign currency sovereign credit risk weights;
    - (ii) introduce a prompt corrective action regime with well-defined thresholds in case of progressive erosion of capital;
    - (iii) enhance risk concentration rules to also cover financial, commercial and operational interlinkages;
    - (iv) expand the scope of related party transactions;
    - (v) reduce the exceptions to lending limits with related financial entities;
    - (vi) provide further guidance on expected risk measurement, stress testing, contingency planning and risk management standards;
    - (vii) require systemic and large banks to operate a separate risk management unit independent from the business areas;
    - (viii) encourage the re-intermediation of the lending done through financial subsidiaries (EAC) of foreign banks when such separation is driven by cost distortions and restrictive labor practices;
    - (ix) extend risk management standards to banking groups to enhance consolidated supervision.

### Financial integrity (AML/CFT) (para 28)
- Progress since 2006 and 2009 assessments:
  - Authorities have adopted a National Strategy against money laundering; amended the AML/CFT law to expand information sharing; created a new registry of owners of bearer securities; and upgraded regulations for money transfers.
- Remaining supervisory improvements needed:
  - Reinforce the Intelligence Unit.
  - Provide further detailed guidance to the industry.
  - Revise the scoring methodology.
  - Adopt stronger and more consistent enforcement measures.
  - Remove legal barriers to international cooperation.

### Securities markets regulation (paras 29–30)
- SSF has powers to regulate securities markets; overall framework largely in place.
- Gaps identified:
  - Missing legal provisions supporting regulator independence.
  - Insufficient resources for effective supervision of intermediaries or stock markets.
  - No risk-based capital requirements and very limited internal control or risk management requirements for brokers.
  - Trades in listed securities may take place over-the-counter and, in that case, do not have to be reported to the exchange, limiting transparency.
- Suggested remedies:
  - (i) Amend the law to give security of tenure to the head of the SSF and allow removal only for stated causes.
  - (ii) Review statutory immunity provisions.
  - (iii) Provide additional resources for capital market activities, particularly supervision of intermediaries and surveillance of markets.
  - (iv) Complete the prudential framework for market intermediaries.
  - (v) Enhance market transparency and the effectiveness of surveillance.

### Insurance and pensions supervision (paras 31–33)
- Insurance sector:
  - Manages assets amounting to about 5 percent of total financial system assets.
  - Dominated by state-owned BSE; government should contract an independent diagnostic including review of strategy, solvency (also actuarial), efficiency and governance.
  - In 2010, SSF approved minimum standards for management of insurance companies used in the integral assessment of two private insurance companies.
- Areas for improvement:
  - No regulation on corporate governance or risk management; only external audit report required for internal controls.
  - Risk management not considered for establishing capital requirements.
  - No license requirements for insurance agents/brokers; they are not supervised.
  - No specific requirements or procedures to ensure customers are treated fairly.
  - Disclosure principle not observed; deficiencies in countering insurance fraud.
  - Draft law presented in 2011 to MEF to address issues including protection of insured customers and annuities contracts.
- Pension funds (AFAPs) supervision:
  - Focused mainly on compliance, efficient in minimizing misuse of pension funds (e.g., compliance of investment limits), but does not promote portfolio optimization.
  - SSF intends to extend risk-based supervision for pension funds.
  - Supervision should emphasize proper risk management systems at AFAPs and ensure AFAPs act in the best interest of contributors.
  - SSF should gradually replace current functions of authorization of securities by drafting regulations ensuring AFAPs have proper procedures for selecting new financial instruments.

### Payment system oversight (para 34)
- BCU progress and plans:
  - Implementation of new Real Time Gross Settlement (RTGS) system scheduled to be launched in the first half of 2013, which includes an integrated Central Securities Depository (CSD).
  - A full assessment against CPSS-IOSCO Principles for Financial Market Infrastructures (FMIs) should be conducted when new systems are launched.
  - Oversight function established by the Payment System Law in 2009 but not yet fully implemented.
  - Retail payment instruments: oversight of “redes de cobranza” should be a priority given their significance for the real sector.

### Financial sector safety net and macroprudential policies (paras 35–37)
- Principal systemic risk addressed: foreign exchange liquidity risk related to the high degree of dollarization—the root of the 2002 crisis.
- Safety net features:
  - BROU guarantees all its deposits fully.
  - Private banks are all foreign owned; larger ones benefit from access to parent bank liquidity and reputation.
  - Protections supplemented by a new deposit insurance agency.
  - Despite significant inflation, most deposits are held as sight deposits—which were paid back in full during the crisis unlike time deposits.
  - Liquidity requirements for nonresident deposits have been increased significantly, and international reserves are sharply up.
- Institutional framework and coordination:
  - Financial Stability Council (Comite de Estabilidad Financiera, CEF) established by decree in 2011 as safety net and macroprudential coordinator.
  - CEF membership: Minister of Economy and Finance, President of the BCU, Superintendent of Financial Services, President of the Deposit Guarantee Corporation (COPAB) which acts as secretariat; a Technical Committee prepares analysis and reports with representation from each body.
  - Interactions guided by a set of MoUs and additional meetings; CEF work program includes reviewing legal framework for inconsistencies and preparing regular forward-looking systemic risk reports for internal discussion.
- Recommended near-term CEF focus:
  - Contingency planning—develop a variety of scenarios specifying agencies’ roles and clarifying interactions.
  - COPAB and SSF have started developing bank intervention and resolution procedures.

*Source: _cr13152 - 20.      Stress testing practices can be fine-tuned by using more granular information*

### 38.      The level of crisis preparedness is still low owing to the recent institutional

### _cr13152 - 38.      The level of crisis preparedness is still low owing to the recent institutional

### Crisis preparedness — overall assessment and recommendations
- The level of crisis preparedness is still low owing to recent institutional changes and the emergence of new (global crisis-related) risk scenarios.
- The legal framework surrounding bank resolution has changed dramatically since the 2002 crisis and should be tested through simulation.
- Specific recommendations:
  - Undertake joint and separate crisis preparation work.
  - COPAB should organize operational simulations, including with the industry.
  - CEF should organize “war games,” including, possibly, with foreign supervisors.
  - BCU should develop lender-of-last-resort (LOLR) procedures, now that LOLR operations are embedded in the Central Bank law.
  - SSF should consider adoption of a prompt corrective action framework, prepare for solvency testing (needed for LOLR operations, since lending is limited to 150 percent of net worth) and resolvability assessments, and integrate recovery and resolution planning into its supervision framework, following FSB guidance on the Key Attributes for Effective Bank Resolution.

### Bank Resolution Framework — structure, powers, and shortcomings
- Institutional roles and timelines:
  - SSF provides (open) problem bank intervention; COPAB handles suspended bank resolution.
  - Once the BCU Board decides to proceed with bank resolution, the suspended bank is passed to COPAB, which has up to 120 days to work out a least-cost solution.
  - COPAB can use the deposit guarantee fund, move assets and liabilities out of the problem institution, arrange a purchase and assumption, or propose liquidation.
  - When breaking contracts, damage claims are paid against the liquidation estate according to creditor priority.
- Identified weaknesses and suggested improvements:
  - The 120-day suspension period can create excessively long delays for depositor payout and may destroy value; shortening this period is recommended.
  - The framework does not provide for a bridge bank; a time-limited bridge bank option would be useful where resolution options require more than 120 days (e.g., to approve a new bank license).
  - Resolution and liquidation decisions are in principle reversible by courts as any administrative act—this is not considered good practice; in practice courts may award monetary damages since reverting to the original state is technically impossible.
  - At liquidation, creditor approval is needed to transfer liabilities to a new owner: creditors representing at least 66 percent of the value of liabilities being transferred must consent (guaranteed deposits are excluded); removing this requirement would ensure a more seamless resolution process.
  - Although COPAB can break contracts and claims directed against the state, it may be useful to explicitly specify administrative limits to damages.
  - The role of unions in past bank resolutions has led to costly delays.
  - Lack of access to IT systems has impeded supervisors in assessing problem banks’ financial situation and delayed depositor payout.
  - Seamless cooperation between SSF and COPAB is required, including through resolvability assessments and resolution planning, to ensure a least-cost resolution.

### Deposit Insurance — design, coverage, and issues
- COPAB is in broad compliance with Core Principles for Effective Deposit Insurance Systems.
- Capabilities and funds:
  - COPAB has experienced staff, an effective computerized system for tracking bank deposits by depositor, and a close working relationship with other safety-net members.
  - COPAB has made impressive progress since its independence from the BCU in 2008.
- Coverage and funding details:
  - Protects local deposits up to around US$29,000 and foreign currency deposits up to US$5,000.
  - Fully covers 99 percent of all local currency depositors, and about 50 percent of foreign currency depositors.
  - Premiums are partly risk-based and differentiated by currency.
  - Funding options include pre-levying premiums from banks (up to three years worth of premiums) and a credit line with the government.
  - Payout is within 30 days of liquidation.
- Remaining issues and recommendations:
  - Civil and criminal legal protection for contractual employees is insufficient.
  - A separate law allows deposits corresponding to recent salary and pension payments to remain accessible during a bank suspension, posing operational difficulties and creating inequality of protection.
  - Public awareness of deposit insurance is low.
  - State banks BROU and BHU have blanket deposit guarantees mandated by their charters, providing them with a competitive advantage.
  - COPAB is consulted before ownership changes and recapitalization plans are approved, but there is no requirement that COPAB be consulted before issuing a new bank license; legal changes/procedures should involve COPAB earlier to accelerate decisions on purchase-and-assumption transactions or liquidation.

### Macroprudential Framework and Policies
- Active use of tools:
  - Uruguay uses incentives to de-dollarize (prudential norms, monetary policy tools, differential deposit insurance premiums by currency), measures to build countercyclical buffers (monetary policy and prudential instruments), and recently introduced a systemic risk capital charge.
  - Dynamic provisioning was introduced in 2001: banks contribute the difference between monthly statistical losses on loans and realized net loan loss in the month, estimated for five categories of loans, bounded between 0 percent and 3 percent of total loans subject to provisions. Over-provisioning led to a recalibration of the parameters in April 2012 and the addition of new factors to reflect credit ratings, the speed of credit growth and to capture more closely provisions and the credit cycle.
  - The systemic surcharge will be between 0.5 percent and 2 percent for systemically important banks according to size.
- Context and coordination:
  - Capital inflows have picked up and measures have been put in place to stem these.
  - Given high dollarization, a thin capital market, and low yields on local currency securities related to the captive demand of pension funds, pressures from capital inflows are relatively less important than in other emerging markets.
  - Recommendation: Better coordination of macroprudential tools used by various agencies should form an important part of the CEF agenda, analyzing instrument combinations (reserve requirements, deposit insurance premia, prudential standards differentiated by currency) holistically to address systemic risk.

### Financial Infrastructure and Development Issues — key priorities
- Securities Market Development:
  - A comprehensive capital market development strategy should improve liquidity and market structure.
  - Proposals for a primary dealer system and a secured interbank repo market are welcome.
  - Policies to expand investor and issuer bases include incentives for private sector issuance for large projects or SOE financing, easing pension fund investment mandates, and rationalizing market structure to encourage consolidation and professionalism of stockbrokers.
- Pension Funds and Annuities Markets:
  - Uruguay’s two-pillar pension system has outgrown the size of the domestic capital market.
  - First pillar: state-owned Banco de Prevision Social (BPS); complementary funded pillar: AFAPs dominated by state-owned AFAP Republica.
  - Each AFAP manages a single fund regardless of contributors’ time to retirement, forcing a sub-optimal risk/return trade-off.
  - Pension funds remain highly concentrated in government securities due to limits on investing abroad, raising concerns about sustaining projected pension increases.
  - Recommendation: consider alternative hedging mechanisms, phased withdrawals, and broadening the scope for investment abroad.
- Insolvency and Creditor Rights:
  - The corporate insolvency system is quite effective, but judicial enforcement is the main legal weakness.
  - Claims secured through trusts and leasing enjoy private execution mechanisms; generally there is no out-of-court enforcement for secured claims.
  - BHU is allowed by law to use an out-of-court enforcement mechanism, typically requiring a four-month period until auction of collateral; other mortgagors or holders of non-possessory pledges must resort to judicial enforcement.
- Retail Payments:
  - BCU should catalyze development and timely launching of the Automated Clearing House (ACH).
  - Uruguay ranks below the Latin American average in deployment of transactional channels and usage of electronic payments.
  - BCU should work with BEVSA (operator of Sistema de Pagos Interbancarios, SPI) and banks to evolve SPI into a full-fledged ACH and help resolve interbank fee issues.
  - As payment system overseer, BCU should ensure appropriate relative pricing of payment instruments and promote government use of electronic payments; consider designating BCU as the sole depository of government funds to promote a level playing field among banks.
- Credit Reporting:
  - Important advances: broadening of BCU’s credit database (Central de Riesgos, CR), strengthening private credit reporting firms, and a new legal framework.
  - Credit bureaus are working to add positive credit data; BCU could consider sharing the complete CR database with private credit bureaus.
  - Regulation and supervision of the credit reporting industry should be enhanced to consider: (i) minimum entry criteria; (ii) governance; (iii) soundness, reliability and efficiency of systems/processes/communication; (iv) ensuring data on individuals is sufficient and balanced (implying collection of positive data) and that data providers report all their loans; (v) product quality; and (vi) appropriate levels of competition.
- Access to Finance:
  - Access to finance is weak across credit, deposits, and account ownership.
  - EACs reach the broad population but offer a narrow range of services at high costs similar to micro-finance.
  - Priorities: improve services for medium and small enterprises, expand services to households while lowering costs.
  - Regulatory interest rate caps introduced to protect borrowers preclude development of microfinance for enterprises.

### Annex I — Basel Core Principles: assessment context and macro background
- The Basel Core Principles assessment reflects banking supervision practices as of end-June 2012.
- Financial system and macro indicators:
  - The 2002–2003 crisis led to a drastic fall in the number of banks and assets under management in U.S. dollars (assets fell almost in half).
  - Pension fund assets increased their market share in total financial assets by a factor of five over the decade.
  - Total financial assets in U.S. dollars rose almost 58 percent in the last decade.
  - Total financial assets to GDP: 83 percent.
  - Bank assets to GDP: 61 percent.
  - Bank credit to GDP is about 27 percent (compared with 60 percent for Brazil and 100 percent for Chile).
  - Annual real GDP growth rates have averaged 5.8 percent since 2004.
  - Share of foreign currency public debt declined from 89 percent to 50 percent; maturity is currently 11.3 years.
  - Nonresident deposits represent today less than 17 percent of total deposits.
  - Merchandise exports to Argentina plunged to about 7 percent of total exports.
- Main systemic risk: the global environment, including potential spillovers from Europe and the region (mainly Argentina), remains the main risk factor to the Uruguayan financial system; authorities have built liquidity buffers including pre-financing debt strategy, international reserves, contingent credit lines, dynamic loan-loss provisions, and high reserve requirements.

*IMF staff summary drawn from the chapter content provided.*

### 6. The following summarizes the main findings of the detailed assessment of

### 6. The following summarizes the main findings of the detailed assessment of

### Objectives, Autonomy, Powers and Resources (CP1)
- Concerns regarding the autonomy of and the resources available to supervision, which impinges on its effectiveness.
- BCU’s Board can revoke the decisions and administrative acts of the SSF and there is no clarity about the scope of its limited “technical and operational autonomy.”
- The SSF does not have all the discretion it needs in terms of its internal organization and personnel selection and management (including promotions).
- SSF is underfunded and its IT capacity is lacking.
- SSF needs means to develop and implement a specialized curriculum and provide its staff with incentives to obtain external accreditation.
- The BCU Law does not specify explicit grounds for the removal from office of Directors and of the Superintendent, nor the need to make public the reasons for such decision.
- BCU’s enforcement powers are limited vis-à-vis public banks; when a public bank fails to comply with the law and regulations, the scope of sanctions and corrective measures is more limited than for private banks.
- Tolerance observed in a certain case of serious and persistent breaches of regulations in state-owned institutions.
- No clear and well articulated regime to deal with problem banks by means of an objective regime of prompt corrective action anchored in a well specified combination of qualitative and quantitative triggers, including addressing progressive levels of undercapitalization.

### Prudential Regulation and Requirements (CPs 6–18)
- Capital adequacy regime:
  - Banking in Uruguay is in transition toward full implementation of the Basel II regime.
  - The BCU will have implemented all the standard charges for Pillar 1 capital by December 2012.
  - Needs to pilot its Pillar 2 approach, adopting a precise protocol to relate the risk assessment of the SSF to the required supervisory capital adequacy above the minimum regulatory capital determined under Pillar 1.
  - Pillar 2 should include use of stress testing to set capital buffers as part of the requirement for banks to operate an internal capital adequacy assessment process (ICAAP).
  - BCU will need to consider the introduction of capital charges for concentration, including collateral and industry sector concentrations.
- Risk management processes:
  - Authorities are advised to communicate explicit standards for bank directors to implement ICAAP governing forward-looking capital planning.
  - Risk management requirements need extension to all entities in a group.
  - Large banks should be required to operate risk management units truly independently from business operations.
  - BCU should develop capacity to assess ICAAP as an essential input to the supervisory review and evaluation process (“SREP”).
  - BCU should specify the response of BCU’s Board to excessive risk accumulation.
  - SREP and the nature and scope of criteria used to exert supervisory judgment should be made public to the institutions.
  - BCU’s Board will need to endow the SSF with sufficient specialized staff and resources to operate under a risk-based approach to supervision.
- Credit risk:
  - Credit risks are much better identified and supervised at present.
  - Suggested enhancements: monitor quality of external auditors’ work, expertise and seniority of audit staff, scope of audit work programs, and sufficiency of audit costs.
  - Increase transactional review by SSF following a formal sampling policy to mitigate excessive reliance on external bank auditors; further onsite efforts to understand credit risk pricing and soundness of credit underwriting standards.
  - BCU’s Board should provide incentives to banks for more diligent remedying of credit risk management gaps assessed by supervisors.
  - Modernize technological infrastructure of the Credit Risk Bureau so SSF can use information flexibly and elaborate quantitative measures of credit risk, including more sophisticated stress testing which considers collateral and concentration risk explicitly and relates credit risk to its fundamental macro-economic drivers.
- Concentration risk:
  - Criteria to identify interconnections among obligors needs broadening to consider common sources of concentration risk such as financial, commercial and operational inter-dependencies among parties not related by control or significant influence.
  - BCU will need to mitigate risks associated with exceptions to large and maximum lending limits that provide liberal space for local subsidiaries of foreign banking groups.
  - Concentration risk should be treated under ICAAPs; BCU’s Board should require SSF to adopt specific procedures to ascertain other dimensions of concentration risk, such as collateral and sector-related risk.
- Related party transactions:
  - All forms of related party transactions need full consideration.
  - BCU should incorporate other forms of related party transactions into its rule book such as all those contemplated under IAS 24.
  - Put in place a more complete regime of ex-post notifications and require interested parties to abstain from participating in decisions where a related party transaction is being evaluated or approved.
- Noncredit financial risks:
  - Assessment has improved substantively but implementation effectiveness can be enhanced.
  - Priority actions: increase number of financial risk specialists aligned to current and anticipated workload; support continuous professional development.
  - Upgrade technological infrastructure for SSF to process data and quantify risk measures.
  - Promote use of stress test and contingency planning as part of banks’ ICAAP.
- Internal controls, information systems, and audit programs:
  - SSF needs to design and compile proxy indicators of capacity, processes and practices to benchmark evaluation of systems and controls among institutions.
  - SSF needs to specify in further detail industry expectations regarding characteristics that attest effectiveness and reliability, including evaluating resources invested in controls and central functions.
  - Capacity, number and skills of supervisors available to assess such systems need reinforcing.
- AML/CFT (CP 18):
  - Progress made and most important flaws in supervisory regime corrected.
  - AML law needs amendment to ease limitations that still hamper international cooperation.
  - Given large scope of entities under supervision, BCU needs to consider increasing resources dedicated to AML/CFT oversight.
  - BCU needs to apply more severe sanctions, more systematically, whenever serious breaches are observed.

### Methods of Ongoing Supervision (CPs 19–21)
- Risk-based supervisory approach has taken root but further development required.
- Supervisory staff, skills, and toolkit need continuous support and development, including re-evaluating workload and properly costing and funding supervision.
- Methodology to assess and rate risk profiles, and criteria used to reach qualitative judgments, are important:
  - Supervisory manuals must provide more granular guidance on risk assessment.
  - Current risk rating system (CERT) needs recalibration to discriminate among different risk profiles, combining proxies of risk of failure and systemic impact.
- Further efforts needed to upgrade response strategy and reinforce its effectiveness based on enforcement regime, including a reasonable, ex-post, quality assurance process.

### Accounting and Disclosure (CP 22)
- Accounting standards continue to differ from IFRS and some differences can have material impact.
- BCU should adopt IFRS according to the current timetable.
- Authorities should carefully consider adapting IAS 39/IFRS 9 to ensure necessary rigor on loan loss provisioning is preserved, including under an expected loss model whose parameters are consistent and prudently applied.
- Need to speed the implementation of Pillar 3 standards.

### Corrective and Remedial Powers (CP 23)
- Response of the BCU continues to be limited by same issues identified in the last 2006 FSAP.
- Legal framework (Financial Institutions Law and BCU Charter) provide valuable powers and mechanisms, but BCU seems reluctant to resort to harsh penalties to achieve better market discipline, particularly regarding public banks.
- Need for a more aggressive approach to respond to gaps in governance and risk management, adopt consistent enforcement policies across all institutions, and design a clear and well-articulated regime to deal with problem banks while limiting unwarranted interferences.
- Recommend a more granular set of quantitative and qualitative prompt corrective actions closely aligned to internal supervisory ratings and its deterioration.

### Consolidated and Cross-Border Banking (CPs 24–25)
- Financial conglomeration subdued except for a very limited number of players and narrow activities.
- Further implementation of regulatory standards and group-wide supervision practice is recommended, including rendering operational a dedicated unit responsible for supervising conglomeration risk.
- SSF should require consolidation of all local credit operations of foreign subsidiaries and develop procedures for consolidated supervision of systemic bank-led groups.
- AML law should be amended to lift barriers hampering home-host cooperation on AML/CFT issues.

### Authorities’ Response
- Authorities are broadly in agreement with the BCP assessment.
- Differences remain regarding:
  - assessment of the independence of supervision (CP1),
  - constraints on sharing information for AML/CFT purposes (CPs 18 and 24),
  - scope of supervision applied to public banks (intensity and response, including enforcement of sanctions),
  - extension of the Supervisor’s Minimum Management Standards (EMG) to public banks.

### Annex: Summary of Compliance and Recommended Action Plan (selected highlights)
- Independence, accountability, transparency:
  - Subordination to BCU’s Board. Limited interpretation of budgetary autonomy of the SSF. Significant budget and resource constraints. Reasons to remove Superintendent not in the law. Decision not public.
- Legal powers:
  - Still limited enforcement and resolution powers.
- AML/CFT cooperation:
  - Legal limitations for information exchange with foreign counterparts for AML/CFT.
- Capital adequacy:
  - Lack of PCA regime. Operational risk in force by end-2012. No Pillar 2 capital regime/concentration risk.
- ICAAP:
  - ICAAP not operational until December 2012.
- External auditors and supervisory reliance:
  - Low sampling and excessive reliance on external auditors.
- Liquidity, operational, and interest rate risk:
  - Lags in stress test development, integration into operations, contingency planning; insufficient resources and guidance.
- Recommended actions (selected):
  - Grant more enforcement power to the BCU vis-à-vis state-owned banks (ME).
  - Provide explicit/public grounds for the removal of the superintendent (ME).
  - Resolve shortage of resources to attract, train and retain valuable staff (BCU).
  - Amend LIF including a PCA regime for response and escalation (ME).
  - Develop procedures to relate the risk profile to Pillar 2 capital add-on (SSF).
  - Require effective risk management units to systemic/large banks (SSF).
  - Increase UIAF and SSF resources to ensure a full coverage of the 486 entities subject to AML/CFT oversight (BCU).
  - Adopt the IFRS according to the timetable (2013) (SSF).
  - Take a more “aggressive” approach against banks displaying persistent weaknesses and not implementing remedial measures (BCU/SSF).
  - Amend art. 7 of the AML law to lift limitation that may hamper international cooperation by the UIAF and the SSF on AML/CFT matters (BCU/ME).

*Source: IMF assessment as summarized in the supplied content unit.*

### ANNEX II. DEPOSIT INSURANCE PRINCIPLES – SUMMARY ASSESSMENT

### ANNEX II. DEPOSIT INSURANCE PRINCIPLES – SUMMARY ASSESSMENT

### A. Introduction and Methodology
- Assessment conducted as part of the FSAP Update in 2012.
- Assessor: Claire McGuire, Senior Financial Sector Specialist with the World Bank.
- Mission dates: September 5 to 19, 2012.
- Assisted by: Inés González del Mazo, Junior Professional Associate.
- Evaluated entity: Corporación de Protección del Ahorro Bancario (“COPAB”).
- Methodology: Methodology for Compliance Assessment adopted in December 2010 by the Bank for International Settlements and the International Association of Deposit Insurers.

### B. Main Findings
- Overall conclusion:
  - The deposit insurance framework in Uruguay, managed by COPAB, broadly conforms to best international practice.
  - COPAB is compliant with most of the Core Principles (one Principle is Not Applicable).
  - COPAB has several strengths and several areas for improvement, most importantly constraints in the resolution framework affecting prompt, cost-effective resolution.

- Institutional origin and mandate:
  - COPAB was established in 2008 pursuant to amendments under Ley No. 18.401 (COPAB Act).
  - COPAB assumed duties of the Superintendencia de Protección del Ahorro Bancario, a unit of the BCU.
  - COPAB administers a Deposit Insurance System (DIS) covering deposits in 13 banks and one financial intermediary cooperative.
  - COPAB has a statutory target ratio of 5 percent of total insured deposits, both in national and foreign currency.
  - As of December 31, 2010, COPAB’s target ratio was approximately 18.3 billion pesos.
  - As of July 31, 2012, the Fund is at 1.17 percent of insured deposits.

- Funding and membership:
  - COPAB is funded by annual premiums collected from members.
  - Membership is compulsory for all on-shore deposit taking financial institutions.
  - Premiums include a flat rate and a risk-based element; rates are differentiated by currency, with higher flat rate premiums for foreign currency-denominated deposits.

- Coverage and payout:
  - Insured amounts:
    - Peso denominated deposits: insured up to the maximum of approximately US$29,000 in peso denominated deposits per person per member institution.
    - Foreign denominated deposits: insured up to US$5,000 per person per member institution.
  - Legal mandate to reimburse depositors within 30 days of the declaration of liquidation of a bank by BCU in the currency of their deposits.
  - COPAB is subrogated to the claims of depositors it pays and also acts as liquidator.

- Strengths:
  - Experienced staff.
  - Computerized data collection system (SIDIIF) providing access to depositor data to enable payout within 30 days if required.
  - Close working relationships and excellent coordination with other members of the safety net, including direct access to member deposit information and supervisory information at SSF, including stress test results.

- Key weaknesses and areas for improvement (detailed by Core Principle themes):
  - Public Policy Objectives; Mitigating Moral Hazard (CP 1, 2)
    - COPAB is a nongovernmental legal entity created under public law; public policy objectives are clearly stated but do not precisely specify financial stability.
    - The deposit insurance system provides a significantly lower level of coverage for dollar-denominated deposits.
  - Mandate and Powers (CP 3, 4)
    - COPAB has an expanded mandate with consistent powers to act both as an insurer of deposits and an implementer of the Bank Resolution Process.
  - Relationship with Other Safety-Net Participants; Cross-Border Issues (CP 6, 7)
    - Excellent coordination between SSF and COPAB.
    - Neither SSF nor COPAB have agreements with foreign deposit insurers; given the importance of foreign banks, COPAB should communicate with other deposit insurers about possible pay-out activities in the bank’s home jurisdictions.
  - Compulsory Membership (CP 8)
    - All onshore deposit-taking institutions are members.
    - COPAB does not have a role in the licensing process and there is no requirement that its views be considered before membership becomes effective.
  - Funding (CP 11)
    - COPAB manages an ex ante fund and has the power to request advance contributions from members and a credit line from the MOF—upon written request and for up to US$40 million from BCU.
    - COPAB cannot assess a special or extraordinary premium in the event that it needs to recapitalize its fund.
  - Public Awareness; Legal Protection (CP 12, 13)
    - Public awareness of the deposit insurance system seems limited.
    - Only COPAB employees have legal protection; legal protection for all people working at COPAB’s direction (e.g., external contractors) is essential.
  - Early Detection and Timely Intervention and Resolution; Effective Resolution Processes (CP 15, 16)
    - No Prompt Corrective Action regime, but good coordination between SSF and COPAB would allow timely intervention.
    - Resolution regime does not allow for early resolution of troubled banks:
      - COPAB is involved in the resolution process once BCU, at its discretion, declares the PRB.
      - COPAB has only 120 days to arrange for a P&A, during which the institution’s activities are suspended and depositors do not have access to their insured accounts.
      - Actions from BCU and COPAB can be challenged, with no limitation on remedies.
      - If a P&A cannot be arranged, COPAB must seek BCU approval to begin liquidation, at which time its obligation to pay insured deposits within 30 days is triggered.
      - Depositors with salary or pension payments from the 30 days preceding the declaration of the PRB are entitled to receive those funds immediately without consideration of their insured accounts.
      - COPAB needs the approval of 66 percent of creditors to transfer liabilities after liquidation.
      - No temporary bridge bank authority exists.
  - Reimbursing Depositors; Recoveries (CP 17, 18)
    - COPAB’s SIDIIF system allows access to depositor data to enable payout within 30 days.
    - COPAB is subrogated to claims of depositors it pays and acts as liquidator, involved in the entire liquidation process.
    - Adequate judicial processes exist for asset recovery, although realizing on collateral can be slow.

- Summary statement:
  - COPAB’s framework broadly conforms to international practice, with strong operational capabilities and coordination, but important legal and resolution-process constraints reduce the ability to execute prompt, cost-effective resolutions and limit some operational flexibilities (e.g., inability to levy extraordinary premiums, limited temporary resolution tools, creditor approval thresholds, and limited legal protection coverage).

*Source: ANNEX II. DEPOSIT INSURANCE PRINCIPLES – SUMMARY ASSESSMENT (extracted from the provided PDF content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13152.pdf_