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### I. Introduction — context and main concerns
- Official dollarization since 2000 constrains the central bank’s ability to act as lender of last resort (LOLR) and provide emergency liquidity assistance (ELA).
- This increases the importance of timely and effective regularization and resolution, deposit insurance, and crisis management.
- Key weaknesses identified:
  - BCR lacks legal flexibility and resources to perform limited ELA/LOLR functions.
  - High liquidity requirements for financial institutions (costly and potentially systemic in large shocks).
  - Bank resolution scheme untested; Banking Law contains provisions that could hamper resolution (e.g., requirement for SSF to pre-announce restructuring measures to a problem bank; board of directors may remain in place after intervention).
  - Deposit insurance scheme (IGD) is underfunded and lacks implementing regulation for emergency funding from the BCR.
  - Roles and responsibilities across BCR, SSF, and government are not always consistent with objectives and mandates; no formal measurement or fully specified strategy for systemic risk; limited cross-border contingency planning.

### II. Systemic liquidity management and emergency liquidity assistance (ELA) — Diagnosis
- Main tools and actual levels:
  - Banks required to maintain approximately 22 percent of their liabilities as cash reserves and 3 percent of liabilities as liquid assets.
  - On average, liquid assets equal about 33 percent of deposits (May 2010).
- Reserve access stages for a bank in need:
  - First 25 percent of total reserves at no cost.
  - Second 25 percent at LIBOR plus a penalty.
  - Third 50 percent with SSF approval upon submission of a regularization plan.
- Limitations and structural issues:
  - Reserve and liquid asset requirements were designed before dollarization and do not account for residual term of liabilities or differing liquidity risk characteristics of liabilities.
  - Interbank credit market is effectively non-functioning due to legacy losses (1997), supervisory stance, perceived credit risk, lack of familiarity, missing BCR regulations, and high system liquidity.
  - Legal constraints: LOBCR prohibits BCR from lending or granting guarantees to banks; limited repurchase/purchase options exist (Art. 49 (a) and (b) LOBCR; Art. 49-B BL) but operationalization is inadequate.
  - Lack of implementing regulations for permitted BCR operations.
  - Limited resources: freely available excess net international reserves (NIR) and government deposits at the BCR are very low. The $800 million Stand-By Arrangement approved in March 2010 relaxes this constraint (equivalent to about 34 percent of deposits), but access is conditional on compliance with quarterly fiscal targets.
- Risk asymmetry:
  - Deposit falls affect banks unevenly; a non-systemic aggregate deposit fall can create outsized liquidity needs at individual banks (Figure 2; example: 19 days before elections in 2004).

### III. Recommendations — policy actions to strengthen the safety net
- Provide resources to ensure appropriate systemic liquidity:
  - Government should provide necessary resources so the BCR can act as LOLR to the extent it has available resources (excess international reserves).
  - Consider allocating all the SDRs granted in 2009 (half currently at the Ministry of Finance) to strengthen the BCR balance sheet.
- Modify legal framework to allow BCR to lend to solvent banks in systemic liquidity shocks:
  - Amend Art. 51 of the LOBCR to permit the BCR to act as LOLR with funding from multilateral agencies, other countries, the government, or alternative sources (e.g., a liquidity fund).
  - Proposed FSSRL Article 130 would allow the BCR to lend government or externally borrowed funds to banks in case of systemic liquidity shock.
- Design and implement a Comprehensive Liquidity Policy (CLP), potentially including a Financial System Liquidity Fund (FSLF):
  - CLP should be agreed by MOF, BCR, SSF, and IGD and set medium-term objectives and criteria for use of tools at different stages of liquidity stress.
  - Consider the level of government deposits to be used in systemic shocks and the establishment of an FSLF to pool and distribute liquidity to solvent but illiquid banks.
  - FSLF governed by rules/principles similar to a traditional LOLR (lend only against good collateral and to solvent banks).
  - If FSLF is not created (noting over 95 percent of the Salvadoran financial system is foreign-owned), SSF should at minimum require irrevocable letters of credit from parent companies to local banks.
- Operationalize BCR’s limited LOLR functions under current law by issuing regulations and procedures for:
  - Repurchase operations with government bonds using government deposits at the BCR (Art. 49-B of the LB).
  - Purchase of its own securities (BCR, Article 49 (a) of LOBCR).
  - Purchase of loans and securities of financial institutions (Art. 49 (b) of LOBCR).
- Promote development of the interbank market (SSF and BCR actions):
  - Update rules so interbank market can develop under new RTGS system for large-value payments.
  - Allow use of the third reserve tranche (constituted by securities) as collateral for interbank lending.
  - Communicate supervisory intent to develop a well-functioning interbank market.
  - Explore tasking BMI to actively participate/lead in developing and deepening the interbank market prudently.

### IV. Liquidity risk requirements and Financial System Liquidity Fund (FSLF) — Guidelines
- Liquidity risk requirements (SSF should establish):
  - Take into account the degree of volatility of the different types of liabilities.
  - Take into account the residual term of liabilities (rather than the current contractual basis).
  - Ensure similar treatment of liabilities with similar risk characteristics.
  - Committed credit lines with investment grade foreign banks could be accepted if executable given a certain percentage fall in deposits; regulations should:
    - establish the type of contract that is acceptable; and
    - outline the type of treatment to be given in the case of related entities.
  - Authorities should distinguish when requirements are designed for prudential issues at the individual entity level versus strengthening systemic liquidity (i.e., reserve requirements).
- Guidelines for establishing the FSLF — minimum elements to specify:
  - Objectives, mandate, powers, funding sources, and target amount of fund.
  - Objective: in the context of an officially dollarized economy, provide liquidity assistance to individual banks to preserve financial stability.
  - Mandate: provide funds only to solvent banks facing temporary liquidity shortages, i.e., when the interbank market is not functioning or a bank has used up the non-operational tranches in its required reserve account.
  - Strategic and operational decisions to specify:
    - Institutional Form: separate institution from BCR, an account on the BCR balance sheet, or an intermediate alternative (e.g., a special purpose vehicle).
    - Powers: permissible operations and limitations or prohibitions.
    - Governance: rules governing decision-making and accountability processes.
    - Target amount of resources: a criteria or methodology to determine total resources to be accumulated.
    - Source of funds and contributions scheme: specify sources (for example, banks, government, or IFIs); if contributions come from financial sector, establish methodology for each institution’s contribution.
    - Documents and instruments to operationalize the FSLF.
    - Legal instruments (i.e., law, decree, or resolution) creating the FLSF.
    - Appropriate guarantee policy.
    - Eligibility rules and regulation of terms and conditions (amount, terms, rates, etc).
    - Investment Policy.
    - Procedures Manual.
- Steps to implement the FSLF:
  - Take the political decision to create the FSLF.
  - Make the necessary strategic decisions mentioned above.
  - Develop the documents and instruments needed for the functioning of the FSLF.
  - Formalize the documents and instruments.

### V. Bank resolution and deposit insurance — Diagnosis (selected factual points)
- Regularization and supervisory powers:
  - A bank is placed under regularization if: (i) its capital adequacy ratio (CAR) is less than 10 percent; (ii) it accesses the third required reserve tranche; or (iii) the SBS assesses that the solvency and liquidity of the bank are in danger.
  - Regularization plan should be completed in 90 days, but may be extended up to 180 days.
  - During regularization the SSF may: demand a special report by external auditors; require necessary adjustments; impose limits on lending and investment policies; appoint a special supervisor with veto power over board decisions; or dismiss the board. The SSF does not have the power to limit the distribution of dividends.
  - SSF has not yet issued prudential requirements for credit risk management, market risk, and best practices in corporate governance; nor issued a regulation on the degree of violations and penalties; nor formally defined responsibilities and intensity of follow-up to corrective actions based on risks.
- Suspension and resolution provisions:
  - If a bank fails to submit a regularization plan, fails to remedy shortcomings within the period, or its situation cannot be solved with a regularization plan, shareholders must adequately capitalize the bank within 30 days or the bank should be subject to suspension or resolution (restructuring).
  - The SSF may suspend temporarily the operations of the bank, with the prior favorable opinion of the BCR, when it is not able to pay its liabilities or for ‘social interest reasons.’
  - The initial period of suspension is 30 days, and may be renewed for successive periods of equal time, but should not exceed 90 days.
- Legal framework shortcomings:
  - Requirement to notify the bank three days before suspension of operations or other measures of resolution (BL Section 112B) can increase costs and complicate use of P&A by enabling asset stripping and runs.
  - The cost-benefit criterion is not clearly bounded and may not lead to least-cost resolution of non-systemic financial institutions. Article 175 requires IGD to carry out a cost-benefit estimate including impact on stability and confidence; this qualitative criterion exposes IGD to legal risks and may bias against liquidation even when liquidation is least-cost.
  - Judicially appointed receiver must co-manage with bank’s board of directors (Article 104 of the LB), which may stymie or increase the cost of resolution.
  - IGD internal norms for cost-benefit assessment are complex and not transparent; weights, scores, and ranges lack technical support and include qualitative elements (e.g., moral hazard, financial system image).
  - Requirements and selection criteria for banks participating in resolution have not been established in regulation.
  - Comprehensive procedures, manuals, standard contracts, and training for the resolution mechanism are lacking.
- Cooperative banks and IGD:
  - Amendment to the Cooperative Banks Act (Article 106) makes cooperative banks members of the IGD (as of January 2009) with same obligations and rights as banks; parts four and six of the Banking Law would apply.
  - Second section of the Cooperative Banks Act (dealing with adjustment, special monitoring, intervention, dissolution, and liquidation) was not repealed; cooperative banks could appeal regularization or resolution adopted by SSF citing legal uncertainty.
- Deposit insurance fund and premiums — exact figures:
  - IGD covers deposits of up to $9,000.
  - The annual premium is only 1 dollar per one thousand dollars, increasing 50 percent for entities that do not qualify to accept deposits from pension funds.
  - Once accumulated funds at the IGD exceed 1 percent of total deposits, IGD must transfer to the BCR 50 percent of the premia collected (around US$4.5 million per year) to repay the credit received from the BCR as part of its initial capitalization (US$13.0 million).
  - As of end-March 2010, the IGD fund for banks amounted to US$97 million—about 1.1 percent of total deposits—which would cover fully the insured deposits of 7 small banks (individually).
  - IGD fund for cooperative banks (established January 2009) amounted to US$500,000.
  - Current legal framework does not allow IGD to request or require members to prepay future premiums to increase available resources, although it allows IGD to place securities with financial institutions (including the BCR).
  - Not all IGD funds may be available for cooperative banks: management and accounting of commercial and cooperative bank deposit insurance funds are separate; consolidated balance sheet exists, but governance could result in disputes over use of entire IGD balance sheet for cooperative bank resolution.
- Historical and structural points:
  - Over 95 percent of the Salvadoran financial system is foreign-owned.
  - Historical references: dollarization in 2000; banking losses and interbank decline after 1997; Banking Law changes in 2002; SSF increased liquidity requirements by 3 percent during the 2009 election cycle; Figure 2 example: 19 days before elections in 2004.

### VI. Recommendations — bank resolution and deposit insurance
- Strengthen corrective action framework:
  - Draft law on supervision and regulation of the financial system contains aspects to address weaknesses (e.g., specific regime of sanctions, creation of a Standards Committee). Framework should be reinforced with a broader mandate for the Superintendent to take corrective actions as precursor to regularization.
- Amend legal and regulatory framework to address formal procedures, resources, and deficiencies:
  - Provide legal protection for supervisors and establish a clear capital deficiency threshold for resolution.
    - FSSRL would provide legal protection to the Superintendent but only legal assistance to supervisors involved in resolution; recommendation: law should establish legal protection for all staff, except in case of deliberate malfeasance.
    - Setting a lower bound for capital deficiency would help reduce likelihood for clearance and delay in resolution process.
  - Eliminate requirement to notify the bank three days before suspension of operations or other measures of resolution, and ensure these measures are not reversible.
    - Suspension of bank’s operations (in whole or in part) should only be reversed when problems have been fixed.
    - Resolution measures should not be reversed; they can be subject to compensation following judicial review.
  - Dismiss the bank’s board of directors at the start of the judicial intervention.
  - Clarify the least-cost solution criterion as the limit to IGD’s support for bank resolution; drop qualitative elements in current cost-benefit criterion and issue necessary regulations for least-cost solution.
  - Regulate aspects that would facilitate the bank resolution process under current legal framework.
  - Clarify that resolution framework for cooperative banks is that established in the BL, and that IGD resources are available for resolution of these banks; IGD should seek a legal opinion supporting this ideally before a situation arises.
  - Consider increasing current premiums and contingency funding for IGD.
    - BL allows IGD to place securities with financial institutions (including the BCR), but private institutions may not purchase these securities during stress.
    - IGD could need to require prepayment of premiums; recapitalize IGD through increase of premium charged to financial institutions and target fund for deposit insurance.
    - Issue a regulation on IGD contingency funding through a loan from BCR (as provided for in Article 179 of the BL).
  - Define a strategy and establish a target for the IGD’s reserve fund.
    - Level of reserve fund should consider characteristics and structure of the Salvadoran financial system (officially dollarized and very concentrated), as well as premium and contingency funding available.
    - It should cover expected cost from covering guaranteed deposits of all non-systemic banks.
    - Conduct a study of suitability of current level of coverage, considering percentage of depositors and amount of deposits covered in the region.
    - Strategy for accumulation could include reduction or suspension of premiums once target is reached.
  - Develop a strategy to address systemic banks:
    - Need for tighter supervision and regulation of systemically important financial institutions (SIFIs), including information sharing and coordination with other supervisors.
    - Need for enhanced resolution mechanisms, such as “living wills,” and accumulation of ex-ante resolution funds so SIFIs internalize negative externalities.
    - Given IGD’s deposit insurance reserve funds are insufficient to resolve a systemic bank, consider imposing a special fee on these banks to cover potential fiscal cost of resolution.

### VII. Box 3 — Minimum Requirements for a Bank Resolution Manual (summary)
- Conceptual framework.
- Legal and regulatory framework for bank resolution in El Salvador.
- Scope of bank resolution manual.
- Units and individuals involved in implementation.
- Preparatory work for bank resolution.
- Start of the bank resolution process:
  - Diagnose status of the entity.
  - Develop possible scenarios.
  - Plan the logistics.
  - File necessary documents, including issuing the official resolution that begins the bank resolution process.
  - Designate judicial auditor.
- Operational tasks of bank resolution (selected):
  - Specify the information and data required to assess resolution options and determine the least cost option.
  - Create a data base (assets and liabilities).
  - Establish the residual balance and trust fund where the excluded assets of the failed banks are transferred.
  - Create the business unit (to be transferred to one or several banks).
  - Put together the package information for potential buyers and identify potential buyers.
  - Select banks eligible to participate.
  - Exclude and transfer residual assets and liabilities.
  - Establish a contingency plan in case P&A fails.
- Official resolutions, standard forms and contracts:
  - The transfer of assets.
  - The creation of trust for bank residual assets and liabilities.
  - The administration of the trust.
  - Service to pay the deposit guarantee.
- Process mapping and timing:
  - Process Flow Chart.
  - Deadlines for each stage of the process.

*Source: IMF staff content in the provided PDF chapter/section.*

### Annex I. Core Principles for an Effective Deposit Insurance System .....................................22

### Annex I. Core Principles for an Effective Deposit Insurance System

### I. Introduction — context and main concerns
- Official dollarization since 2000 constrains the central bank’s ability to act as lender of last resort (LOLR) and provide emergency liquidity assistance (ELA).
- This increases the importance of timely and effective regularization and resolution, deposit insurance, and crisis management.
- Key weaknesses identified:
  - BCR lacks legal flexibility and resources to perform limited ELA/LOLR functions.
  - High liquidity requirements for financial institutions (costly and potentially systemic in large shocks).
  - Bank resolution scheme untested; Banking Law contains provisions that could hamper resolution (e.g., requirement for SSF to pre-announce restructuring measures to a problem bank; board of directors may remain in place after intervention).
  - Deposit insurance scheme (IGD) is underfunded and lacks implementing regulation for emergency funding from the BCR.
  - Roles and responsibilities across BCR, SSF, and government are not always consistent with objectives and mandates; no formal measurement or fully specified strategy for systemic risk; limited cross-border contingency planning.

*Authors: Javier Bolzico, Jordi Prat, Jose Rutman.*

### II. Systemic liquidity management and emergency liquidity assistance (ELA) — Diagnosis
- Main tools: reserve and liquid asset requirements.
  - Banks required to maintain approximately 22 percent of their liabilities as cash reserves and 3 percent of liabilities as liquid assets.
  - On average, liquid assets equal about 33 percent of deposits (May 2010).
- Reserve access stages for a bank in need:
  - First 25 percent of total reserves at no cost.
  - Second 25 percent at LIBOR plus a penalty.
  - Third 50 percent with SSF approval upon submission of a regularization plan.
- Limitations and structural issues:
  - Reserve and liquid asset requirements were designed before dollarization and do not account for residual term of liabilities or differing liquidity risk characteristics of liabilities.
  - Interbank credit market is effectively non-functioning due to legacy losses (1997), supervisory stance, perceived credit risk, lack of familiarity, missing BCR regulations, and high system liquidity.
  - Legal constraints: LOBCR prohibits BCR from lending or granting guarantees to banks; limited repurchase/purchase options exist (Art. 49 (a) and (b) LOBCR; Art. 49-B BL) but operationalization is inadequate.
  - Lack of implementing regulations for permitted BCR operations.
  - Limited resources: freely available excess net international reserves (NIR) and government deposits at the BCR are very low (Figure 1). The $800 million Stand-By Arrangement approved in March 2010 relaxes this constraint (equivalent to about 34 percent of deposits), but access is conditional on compliance with quarterly fiscal targets.
- Risk asymmetry: deposit falls affect banks unevenly; a non-systemic aggregate deposit fall can create outsized liquidity needs at individual banks (Figure 2; example: 19 days before elections in 2004).

### III. Recommendations — policy actions to strengthen the safety net
- Provide resources to ensure appropriate systemic liquidity:
  - Government should provide necessary resources so the BCR can act as LOLR to the extent it has available resources (excess international reserves).
  - Consider allocating all the SDRs granted in 2009 (half currently at the Ministry of Finance) to strengthen the BCR balance sheet.
- Modify legal framework to allow BCR to lend to solvent banks in systemic liquidity shocks:
  - Amend Art. 51 of the LOBCR to permit the BCR to act as LOLR with funding from multilateral agencies, other countries, the government, or alternative sources (e.g., a liquidity fund).
  - Proposed FSSRL Article 130 would allow the BCR to lend government or externally borrowed funds to banks in case of systemic liquidity shock.
- Design and implement a Comprehensive Liquidity Policy (CLP), which could include establishing a Financial System Liquidity Fund (FSLF):
  - CLP should be agreed by MOF, BCR, SSF, and IGD and set medium-term objectives and criteria for use of tools at different stages of liquidity stress.
  - Consider the level of government deposits to be used in systemic shocks and the establishment of an FSLF to pool and distribute liquidity to solvent but illiquid banks.
  - FSLF governed by rules/principles similar to a traditional LOLR (lend only against good collateral and to solvent banks).
  - If FSLF is not created (noting over 95 percent of the Salvadoran financial system is foreign-owned), SSF should at minimum require irrevocable letters of credit from parent companies to local banks.
- Elements for CLP (Box 1 — Main Elements of a Comprehensive Liquidity Policy):
  - Define systemic liquidity objectives and key principles consistent with official dollarization.
  - Identify and assign roles/responsibilities, including government deposits to be used in systemic shocks.
  - Define strategy for managing individual and systemic liquidity shocks; identify systemic liquidity needs, sources and uses of funds, and tools (including the FSLF).
  - Develop methodologies and criteria for establishing target government deposits and/or the FSLF and for identifying systemic liquidity risks.
  - Define how tools will be used to implement the CLP.
  - Design communication and coordination mechanisms.
  - Design and implement a system to monitor systemic risk.
- Operationalize BCR’s limited LOLR functions under current law:
  - BCR should issue regulations and define procedures for:
    - Repurchase operations with government bonds using government deposits at the BCR (Art. 49-B of the LB).
    - Purchase of its own securities (BCR, Article 49 (a) of LOBCR).
    - Purchase of loans and securities of financial institutions (Art. 49 (b) of LOBCR).
- Promote development of the interbank market (SSF and BCR actions):
  - Update rules so interbank market can develop under new RTGS system for large-value payments.
  - Allow use of the third reserve tranche (constituted by securities) as collateral for interbank lending.
  - Communicate supervisory intent to develop a well-functioning interbank market.
  - Explore tasking BMI to actively participate/lead in developing and deepening the interbank market prudently.

### IV. Specific quantitative and factual points preserved from the source
- Reserve and liquid asset requirements: approximately 22 percent (cash reserves) and 3 percent (liquid assets) of liabilities.
- Average liquid assets equal about 33 percent of deposits (May 2010).
- Access to required cash reserves in three stages: 25 percent (no cost), 25 percent (LIBOR plus penalty), 50 percent (SSF approval with regularization plan).
- $800 million Stand-By Arrangement approved in March 2010 (equivalent to about 34 percent of deposits).
- Over 95 percent of the Salvadoran financial system is foreign-owned.
- Historical references: dollarization in 2000; banking losses and interbank decline after 1997; Banking Law changes in 2002; SSF increased liquidity requirements by 3 percent during the 2009 election cycle; Figure 2 example: 19 days before elections in 2004.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1446.pdf*

### 16.      The SSF and BCR should review the composition and level of reserve and

### 16.      The SSF and BCR should review the composition and level of reserve and

### Liquidity risk requirements
- The SSF should establish liquidity risk requirements that take into account:
  - the degree of volatility of the different types of liabilities;
  - the residual term of liabilities (rather than the current contractual basis);
  - the similar treatment of liabilities with similar risk characteristics.
- Committed credit lines with investment grade foreign banks could be accepted, if these could be executed given a certain percentage fall in the deposits; the regulation should:
  - establish the type of contract that is acceptable; and
  - outline the type of treatment to be given in the case of related entities.
- Authorities should distinguish when requirements are designed to address:
  - prudential issues related to the individual entity (i.e., its own liquidity risk); or
  - strengthening systemic liquidity (i.e., reserve requirements).

### Guidelines for Establishing the Financial System Liquidity Fund (FSLF)
- Minimum elements authorities should specify for a FSLF: objectives, mandate, powers, funding sources, and target amount of fund.
- Objective: in the context of an officially dollarized economy, provide liquidity assistance to individual banks to preserve financial stability.
- Mandate: provides funds only to solvent banks facing temporary liquidity shortages, i.e., when the interbank market is not functioning or a bank has used up the non-operational tranches in its required reserve account.
- Strategic and operational decisions (items to specify):
  - Institutional Form: separate institution from BCR, an account on the BCR balance sheet, or an intermediate alternative (e.g., a special purpose vehicle).
  - Powers: permissible operations and limitations or prohibitions.
  - Governance: rules governing decision-making and accountability processes.
  - Target amount of resources: a criteria or methodology to determine total resources to be accumulated.
  - Source of funds and contributions scheme: specify sources (for example, banks, government, or IFIs); if contributions come from financial sector, establish methodology for each institution’s contribution.
  - Documents and instruments to operationalize the FSLF.
  - Legal instruments (i.e., law, decree, or resolution) creating the FLSF.
  - Appropriate guarantee policy.
  - Eligibility rules and regulation of terms and conditions (amount, terms, rates, etc).
  - Investment Policy.
  - Procedures Manual.
- Steps to implement the FSLF:
  - Take the political decision to create the FSLF.
  - Make the necessary strategic decisions mentioned above.
  - Develop the documents and instruments needed for the functioning of the FSLF.
  - Formalize the documents and instruments.

### Bank resolution and deposit insurance — Diagnosis
- The Banking Law (BL) establishes criteria, terms, and measures to stabilize a troubled financial institution, but the SSF may be hampered in taking preventive and corrective measures.
  - A bank is placed under regularization if: (i) its capital adequacy ratio (CAR) is less than 10 percent; (ii) it accesses the third required reserve tranche; or (iii) the SBS assesses that the solvency and liquidity of the bank are in danger (e.g., lack of adequate risk management).
  - Regularization plan should be completed in 90 days, but may be extended up to 180 days.
  - During regularization the SSF may: demand a special report by external auditors; require the bank to make necessary adjustments; impose limits on lending and investment policies; appoint a special supervisor (supervisor delegate) with veto power over all board decisions; or dismiss the board. The SSF does not have the power to limit the distribution of dividends.
  - The SSF has not yet issued prudential requirements for credit risk management, market risk, and best practices in corporate governance; nor issued a regulation on the degree of violations and penalties (sanctions); nor formally defined responsibilities and the intensity of follow-up to corrective actions based on risks.
  - The lack of mandatory measures and legal protection for supervisors could lead to forbearance.
- Suspension and resolution provisions:
  - The legal framework establishes situations that might trigger suspension or resolution (restructuring), but lacks specific thresholds or viability criteria.
  - If a bank fails to submit a regularization plan, fails to remedy shortcomings within the period, or its situation cannot be solved with a regularization plan, shareholders must adequately capitalize the bank within 30 days or the bank should be subject to suspension or resolution (restructuring).
  - Although the SSF can resolve a bank if its solvency and the recovery of deposits from the public might be at risk, specific capital or liquidity thresholds (or other characteristics) are not outlined in the law.
- Suspension of operations:
  - The SSF may suspend temporarily the operations of the bank, with the prior favorable opinion of the BCR, when it is not able to pay its liabilities or for ‘social interest reasons.’
  - The initial period of suspension is 30 days, and may be renewed for successive periods of equal time, but should not exceed 90 days.
  - Best practice: suspension should not be lifted until necessary measures to rectify liquidity and solvency problems have been adopted; lack of specific parameters and processes and weak legal protection could delay or reverse adoption of these measures.
- Legal framework for bank resolution — shortcomings:
  - The BL (2002) introduced purchase and assumption of assets and liabilities (P&A) and use of the deposit insurance fund for financial assistance, and requires SSF to notify BCR and IGD and request favorable opinion from IGD when resolution relies on IGD support.
  - Remaining legal deficiencies:
    - Requirement to notify the bank three days before suspension of operations or other measures of resolution (BL Section 112B) can increase costs and complicate use of P&A by enabling asset stripping and runs; P&A is typically carried out quickly (e.g., over a weekend).
    - The cost-benefit criterion is not clearly bounded and may not lead to least-cost resolution of non-systemic financial institutions. Article 175 requires IGD to carry out a cost-benefit estimate including impact on stability and confidence; this qualitative criterion exposes IGD to legal risks and may bias against liquidation even when liquidation is least-cost.
    - Judicially appointed receiver must co-manage with bank’s board of directors (Article 104 of the LB), which may stymie or increase the cost of resolution; potential for conflicting instructions and “gamble for resurrection.”
  - IGD internal norms for cost-benefit assessment are complex and not transparent; weights, scores, and ranges lack technical support and include qualitative elements (e.g., moral hazard, financial system image). In contrast, least-cost solution criterion is clear and objective: maximum contribution of deposit insurer to a bank resolution cannot exceed the cost of paying out deposit insurance minus expected recovery.
  - Requirements and selection criteria for banks participating in resolution have not been established in regulation.
  - Comprehensive procedures, manuals, standard contracts, and training for the resolution mechanism are lacking.
- Resolution process for cooperative banks is unclear:
  - Amendment to the Cooperative Banks Act (Article 106) makes cooperative banks members of the IGD (as of January 2009) with same obligations and rights as banks; parts four and six of the Banking Law would apply.
  - Second section of the Cooperative Banks Act (dealing with adjustment, special monitoring, intervention, dissolution, and liquidation) was not repealed; cooperative banks could appeal regularization or resolution adopted by SSF citing legal uncertainty.
- Deposit insurance fund and premiums:
  - IGD covers deposits of up to $9,000.
  - The annual premium is only 1 dollar per one thousand dollars, increasing 50 percent for entities that do not qualify to accept deposits from pension funds.
  - Once accumulated funds at the IGD exceed 1 percent of total deposits, IGD must transfer to the BCR 50 percent of the premia collected (around US$4.5 million per year) to repay the credit received from the BCR as part of its initial capitalization (US$13.0 million).
  - As of end-March 2010, the IGD fund for banks amounted to US$97 million—about 1.1 percent of total deposits—which would cover fully the insured deposits of 7 small banks (individually).
  - IGD fund for cooperative banks (established January 2009) amounted to US$500,000.
  - Current legal framework does not allow IGD to request or require members to prepay future premiums to increase available resources, although it allows IGD to place securities with financial institutions (including the BCR).
  - Not all IGD funds may be available for cooperative banks: management and accounting of commercial and cooperative bank deposit insurance funds are separate; consolidated balance sheet exists, but governance could result in disputes over use of entire IGD balance sheet for cooperative bank resolution.
- Figure 3 (Minimum Contribution Rate for Deposit Insurance, as of January 2010) referenced source: IADI.

### Recommendations
- Strengthen corrective action framework to ensure compliance and timely implementation of corrective measures prior to regularization:
  - Draft law on supervision and regulation of the financial system has aspects that address weaknesses (e.g., specific regime of sanctions, creation of a Standards Committee to accelerate enactment of regulations related to risk management and corporate governance). Framework should be reinforced with a broader mandate for the Superintendent to take corrective actions as a precursor to regularization.
- Amend legal and regulatory framework to address formal procedures, resources, and legal/regulatory deficiencies, including:
  - Provide legal protection for supervisors and establish a clear capital deficiency threshold for resolution.
    - FSSRL would provide legal protection to the Superintendent but only legal assistance to supervisors involved in resolution; recommendation: law should establish legal protection for all staff, except in case of deliberate malfeasance.
    - Setting a lower bound for capital deficiency would help reduce likelihood for clearance and delay in resolution process.
  - Eliminate requirement to notify the bank three days before suspension of operations or other measures of resolution, and ensure these measures are not reversible.
    - Suspension of bank’s operations (in whole or in part) should only be reversed when problems have been fixed.
    - Resolution measures should not be reversed; they can be subject to compensation following judicial review.
  - Dismiss the bank’s board of directors at the start of the judicial intervention.
  - Clarify the least-cost solution criterion as the limit to IGD’s support for bank resolution; drop qualitative elements in current cost-benefit criterion and issue necessary regulations for least-cost solution.
  - Regulate aspects that would facilitate the bank resolution process under current legal framework.
  - Clarify that resolution framework for cooperative banks is that established in the BL, and that IGD resources are available for resolution of these banks; IGD should seek a legal opinion supporting this ideally before a situation arises.
  - Consider increasing current premiums and contingency funding for IGD.
    - BL allows IGD to place securities with financial institutions (including the BCR), but private institutions may not purchase these securities during stress.
    - IGD could need to require prepayment of premiums; recapitalize IGD through increase of premium charged to financial institutions and target fund for deposit insurance.
    - Issue a regulation on IGD contingency funding through a loan from BCR (as provided for in Article 179 of the BL).
  - Define a strategy and establish a target for the IGD’s reserve fund.
    - Level of reserve fund should consider characteristics and structure of the Salvadoran financial system (officially dollarized and very concentrated), as well as premium and contingency funding available.
    - It should cover expected cost from covering guaranteed deposits of all non-systemic banks.
    - Conduct a study of suitability of current level of coverage, considering percentage of depositors and amount of deposits covered in the region.
    - Strategy for accumulation could include reduction or suspension of premiums once target is reached.
  - Develop a strategy to address systemic banks:
    - Need for tighter supervision and regulation of systemically important financial institutions (SIFIs), including information sharing and coordination with other supervisors.
    - Need for enhanced resolution mechanisms, such as “living wills,” and accumulation of ex-ante resolution funds so SIFIs internalize negative externalities.
    - Given IGD’s deposit insurance reserve funds are insufficient to resolve a systemic bank, consider imposing a special fee on these banks to cover potential fiscal cost of resolution.

*Source: IMF staff content in the provided PDF chapter/section.*

### Box 3. Minimum Requirements for a Bank Resolution Manual

### Box 3. Minimum Requirements for a Bank Resolution Manual

### Conceptual framework
- Conceptual framework

### Legal and regulatory framework
- Legal and regulatory framework for bank resolution in El Salvador.

### Scope
- Scope of bank resolution manual.

### Units and individuals involved
- Units and individuals involved in the implementation of bank resolution manual.

### Preparatory work for bank resolution
- Preparatory work for bank resolution.

### Start of the bank resolution process
- Diagnose status of the entity
- Develop possible scenarios
- Plan the logistics
- File necessary documents, including issuing the official resolution that begins the bank resolution process
- Designate judicial auditor

### Operational tasks of bank resolution
- Specify the information and data required to assess the resolution options and determine the least cost option
- Create a data base (assets and liabilities)
- Establish the residual balance and trust fund where the excluded assets of the failed banks are transferred
- Create the business unit (to be transferred to one or several banks)
- Put together the package information for potential buyers
- Identify potential buyers
- Select banks eligible to participate
- Exclude and transfer residual assets and liabilities
- Establish a contingency plan in case P&A fails
- Other tasks

### Official resolutions, and standard forms and contracts
- The transfer of assets
- The creation of trust for bank is residual assets and liabilities
- The administration of the trust
- Service to pay the deposit guarantee

### Process mapping and timing
- Process Flow Chart.
- Deadlines for each stage of the process.

*Source: _cr1446 - Box 3. Minimum Requirements for a Bank Resolution Manual_*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1446.pdf_