Chapter2. Financial Crises and Behavior of Private Sector Credit in Paraguay
- Jeffrey Franks, Randa Sab, Valerie Mercer-Blackman, and Roberto Benelli
- Published Date:
- September 2005
A series of financial crises have afflicted Paraguay since the financial liberalization in the 1990s and have contributed to the fall in private sector credit. Paraguay did not reap all the benefits associated with financial liberalization because of a lack of adequate banking regulation and supervision; inadequate banking skills, including poor credit and risk assessment; and bad banking practices, such as high levels of insider lending and excessive loan concentration. These weaknesses culminated in the demise of 13 banks and 35 financial companies between 1995 and 1998. In 2002, given the strong link with the Argentine economy, Paraguayans began to hastily withdraw their deposits, bringing about the closure of Banco Alemán and four finance companies. In 2003, the closure of a locally owned private bank and four finance companies, as well as the voluntary withdrawal of three banks, further led to a loss of confidence in the financial system.
This chapter examines the current state of the financial system, the financial crises since the mid–1990s, and the behavior of private sector credit in Paraguay in 2003. First, it assesses the current state of the financial sector, drawing from a comprehensive financial sector survey. It is the only detailed financial sector survey on Paraguay in the literature. Second, the study presents an overview of the financial crises since the 1990s. Third, it analyzes private sector credit in 2003 using detailed data on banks and finance companies. Finally, it draws conclusions and makes policy recommendations.
The waves of financial crises, in a context of political and macroeconomic instability, affected both credit supply and demand, hampering growth prospects. Poor public finances, including the government default on treasury bonds held by banks, affected the liquidity of the latter. In addition, the fall in credit supply can be attributed to the lack of a more flexible liquidity support facility, lack of long–term financing sources, high levels of nonperforming loans (NPLs), lack of hedging instruments against exchange rate volatility, and the relative increase of the informal economy. In parallel, the demand for credit fell because of the recession, the high cost of intermediation, and the unfavorable investment climate, including weak legal institutions and rule of law.
The recurring financial crises in Paraguay point to the need for financial sector reforms. The authorities started implementing the recently approved financial resolution law and new financial regulations. The financial resolution law expedites the resolution process by establishing clear procedures for bank intervention and resolution, and by introducing a deposit insurance fund. The new financial regulations include more stringent rules on asset classification, recognition of credit risk, provision requirements, and imputation of accrued interest. The authorities should press ahead with the approval of the Public Banking Law to consolidate public–lending institutions, and with a comprehensive banking law. Moreover, they should remain vigilant to developments in the financial sector by closely monitoring financial indicators, which serve as early warning signals against potential risks, and by taking prompt corrective action when needed.
B. Current State of the Financial System
The financial system consists of deposit institutions, nondeposit institutions, and other financial institutions.41 The deposit institutions include banks, finance companies, savings and loans associations, cooperatives, an investment fund, and a mutual fund. The nondeposit institutions comprise insurance companies, pensions systems, public financial entities, and warehouses.42 The other financial institutions include the stock market and money exchange houses.
The banking system dominates the financial sector, with about 72 percent of assets (Figure 2.1). It consists of six wholly foreign–owned banks, five majority–owned foreign banks, two locally owned private banks, and a public development bank, Banco Nacional del Fomento (BNF). Wholly foreign–owned banks control the market, followed by the majority–owned foreign banks, and locally owned banks.
Figure 2.1.Financial Institution’s Market Share
Sources: INCOOP; Superintendency of Banks; and IMF staff estimates.
The BNF was created in 1961 to promote various economic sectors. The BNF is the seventh largest bank, with 8 percent of banking assets. The BNF has the largest branch network, with 49 branches covering rural areas, and both retail and wholesale operations. It employs 946 employees, corresponding to 35 percent of the total in the banking system. The bank is the first–largest lender to the agricultural sector, with a market share of about 19 percent, and the second– largest to the manufacturing sector, with a market share of 14 percent. Besides the BNF, there are seven public entities that channel subsidized funds, mainly from the international donor community. Five (CAH, FG, FDC, BANAVI, CONAVI) of these seven entities are first–tier institutions, whereas the other two (UTEP, FDI) are second–tier institutions.
Although overall bank credit supply declined by 17 percent in 2003, credit in some banks increased (Tables 2.1 and 2.2).43, 44 Wholly foreign–owned banks reduced credit supply by 29 percent. Only three (Citibank, Lloyds, and ABN) of the six wholly foreign–owned banks held 43 percent of total assets. Citibank reduced its operations significantly, maintaining only its corporate banking. While its deposits declined by 12 percent, credit fell by 36 percent. ABN reduced credit by 16 percent, and Lloyds by 24 percent. On the contrary, majority–owned foreign banks, with 37 percent of total assets, increased credit by 11 percent. All banks in this group, except for Continental, which has recently merged with a finance company, increased credit supply. Regional, a locally owned private bank expanded by 42 percent, recording the highest growth.
|Branches||Personnel||(In percent)||(In billions of guaranies)|
|Total financial system||248||4,837||100||7,570||10,060|
|Wholly foreign–owned banks||27||839||48||2,838||4,748|
|Lloyds TSB Bank P.L.C.||6||188||10||655||940|
|ABN Amro Bank N.V.||8||246||15||837||1,493|
|Banco do Brasil S.A.||1||62||3||201||285|
|Banco de la Nacion Argentina||3||74||1||79||80|
|I.N.G. Barings N.V.||0||28||2||108||187|
|Chinatrust Commercial Bank||2||41||1||75||68|
|Majority–owned foreign banks||45||849||33||2,284||3,110|
|Banco Asuncion S.A.||1||61||1||62||95|
|Banco Sudameris S.A.E.C.A.||10||188||10||773||879|
|Banco Bilbao Viscaya Argentaria Paraguay S.A.||7||97||9||547||860|
|Banco del Parana S.A.||0||70||1||42||46|
|Banco Integracion S.A.||4||83||2||153||215|
|Banco Continental S.A.E.C.A.||13||177||2||147||228|
|Locally owned private banks||43||572||10||918||906|
|Banco Regional S.A.||11||134||3||220||276|
|Banco Amambay S.A.||4||92||2||124||195|
|Public development bank||49||928||8||749||538|
|Banco Nacional de Fomento||49||928||8||749||538|
|Branches||Personnel||(In percent)||(In billions of guaranies)||Credit||deposits|
|Total financial system||233||4,606||100||6,544||10,947||-13.5||8.8|
|Wholly foreign-owned banks||22||803||47||2,029||4,748||-28.5||0.0|
|Lloyds TSB Bank P.L.C.||6||221||12||498||1,194||-24.0||27.0|
|ABN Amro Bank N.V.||6||236||16||705||1,638||-15.8||9.7|
|Banco do Brasil S.A.||1||61||3||150||266||-25.0||-6.8|
|Banco de la Nacion Argentina||3||74||1||70||114||-10.7||43.2|
|I.N.G. Barings N.V.|
|Chinatrust Commercial Bank||0||32||1||43||46||-42.7||-32.7|
|Majority-owned foreign banks||41||681||37||2,527||3,769||10.7||21.2|
|Banco Asuncion S.A.|
|Banco Sudameris S.A.E.C.A.||9||184||9||1,023||869||32.2||-1.1|
|Banco Bilbao Viscaya Argentaria|
|Banco del Parana S.A.|
|Banco Integracion S.A.||6||89||3||180||283||17.9||32.0|
|Banco Continental S.A.E.C.A.||9||138||2||112||216||-23.9||-5.0|
|Locally owned private banks||15||250||7||436||716||-52.5||-21.0|
|Public development bank||49||946||8||655||654||-12.5||21.4|
|Banco Nacional de Fomento||49||946||8||655||654||-12.5||21.4|
|Market structure Number of banks (units)||35||32||33||23||22||22||20||18||14|
|Locally owned private banks||20||16||13||5||5||4||3||3||2|
|Public development bank||2||2||2||1||1||1||1||1||1|
|Share in assets|
|Locally owned private banks||35.8||37.8||19.7||8.2||9.1||6.8||7.4||10.4||7.4|
|Public development bank||18.3||18.4||18.7||13.0||12.7||11.4||9.2||8.0||8.0|
|Capital-adequacy ratio (percent)||19.5||18.2||21.2||20.7||17.4||17.6||16.9||17.9||20.9|
|NPLs (percent) total loans||7.9||11.1||13.1||11.8||14.8||16.6||16.5||19.7||20.6|
|Provisions (percent) NPLs||…||41.6||41.0||34.9||40.1||38.8||37.0||46.6||54.8|
|Rate of return on assets (ROA)||1.9||2.4||2.8||3.4||2.2||1.4||2.2||1.0||0.4|
|Rate of return on equity (ROE)||13.5||21.0||23.2||28.0||20.1||12.4||21.2||9.0||4.5|
|Current account and sight deposits|
|Term deposits, CDs, and investment|
|titles in total||27.0||28.1||33.8||31.2||33.3||35.5||34.8||32.7||23.1|
|Interest rates Weighted average lending rate in|
|Weighted average lending rate in foreign|
|Holdings at the BCP (billions of PARG)||1,204||1,402||1,457||1,618||1,689||1,772||2,263||2,545||3,684|
|Deposits in the BCP||1,032||1,172||1,187||1,418||1,631||1,734||2,100||2,247||3,083|
|Holdings of LRM||172||230||270||200||58||38||163||298||602|
|Finance companiesMarket structure|
|Number of finance companies (units)||68.0||54.0||50.0||36.0||33.0||28.0||25.0||21.0||17.0|
|Capital adequacy ratio||29.0||27.6||24.1||21.2||27.5||25.1||21.0||19.2||18.6|
|Provisions (percent) nonperforming|
|Returns on assets||1.2||1.9||6.2||6.1||3.6||4.4||5.1||2.3||1.6|
|Returns on equity||4.6||14.6||27.1||24.6||12.6||18.5||24.2||10.7||8.3|
|Sight deposits in total||0.0||1.2||2.3||4.5||6.7||8.4||10.4||13.6||18.3|
|Term deposits, CDs, and investment|
|titles in total||100.0||98.8||97.7||95.5||93.3||91.6||89.6||86.4||81.7|
|Interest rates Weighted average lending rate in local|
|Weighted average lending rate in|
|foreign exchange currency||…||…||18.1||18.5||18.7||15.5||15.6||15.9||14.5|
|Holdings at the BCP (billions of PARG)||48.3||53.0||69.0||76.9||77.9||98.2||107.4||106.7||117.5|
|Deposits in the BCP||47.0||52.6||69.0||73.7||72.8||92.2||105.3||100.7||117.5|
|Holdings of LRM||1.3||0.4||0.0||3.2||5.0||6.0||2.1||5.9||0.0|
|State of the economy|
|Real GDP growth||4.7||1.3||2.6||-0.4||0.5||-0.4||2.7||-2.3||2.3|
|Growth in real investment||7.1||-0.1||-2.0||-4.7||-3.8||-0.7||-17.5||-11.0||-3.6|
|Exchange rate depreciation (-)|
|(US$ per PARG)||-3.1||-5.9||-9.5||-18||-14.3||-6.5||-23.5||-33.8||15.3|
|Central government balance as percent|
|Interest rate on central bank bills||12.7||9.5||15.5||26.2||13.2||5.9||21.0||24.7||12.9|
|International reserves (in millions of|
|Current account as percent of GDP||-1.0||-3.7||-6.8||-1.9||-2.1||-2.1||-4.0||1.7||2.0|
|Terms of trade (deterioration -)||…||0.5||-2.5||-1.0||2.3||-4.6||-0.1||7.4||6.4|
Wholly foreign-owned banks financed mainly wholesale commerce—a stagnant sector in Paraguay now—while majority-owned foreign banks and locally owned private banks financed the booming agricultural sector. Credit to the agricultural sector represented 22 percent of the total, and to the wholesale commerce, 20 percent in 2003. Over the past years, favorable production and prices of soy contributed to the dynamism of banks financing the agricultural sector. In contrast, banks financing other sectors of the economy have stagnated as a result of the economic recession.
Wholly foreign-owned banks performed less favorably than other banks in 2003 (Table 2.3 and Figure 2.2). The NPL ratios in wholly foreign-owned banks were higher than in the majority-owned foreign banks and locally owned private banks. The fall in credit (the denominator) worsened these ratios. The continuous deterioration in NPL ratios in wholly foreign-owned banks weakened profitability. Consequently, returns on assets (ROA) in wholly foreign-owned banks were lower than in majority-owned foreign banks and in locally owned private banks. Wholly foreign-owned banks also had higher administrative costs than majority-owned foreign banks. Among private banks, wholly foreign-owned banks had the highest share of sight deposits to total deposits (80 percent).
|as a Share||as a Share||Spending||Deposits/||Deposits/|
|NPLs||ROA||of NPLs||of Deposits||over Deposits||Total||Total|
|Wholly foreign-owned banks||20.7||0.3||71.9||51.9||5.9||80.4||19.6|
|Lloyds TSB Bank P.L.C.||15.5||1.1||56.6||57.9||4.9||85.4||14.6|
|ABN Amro Bank N.V.||15.1||1.6||105.9||49.3||4.7||86.0||14.0|
|Banco do Brasil S.A.||17.9||1.8||145.6||71.1||6.2||74.0||26.0|
|Banco de la Nacion Argentina||24.8||-1.0||61.7||81.0||9.8||90.8||9.2|
|Chinatrust Commercial Bank||30.4||-6.1||42.2||57.2||20.3||74.2||25.8|
|Majority-owned foreign banks||12.3||1.4||80.6||54.2||4.8||73.1||26.9|
|Banco Sudameris S.A.E.C.A.||29.2||-2.0||63.4||42.6||6.2||69.4||30.6|
|Banco Bilbao Viscaya|
|Argentaria Paraguay S.A.||2.6||4.5||239.0||56.0||2.5||67.2||32.8|
|Banco Integracion S.A.||3.9||1.3||77.9||54.2||6.3||76.8||23.2|
|Banco Continental S.A.E.C.A.||12.7||0.2||66.9||60.7||11.9||77.9||22.1|
|Locally-owned private banks||3.1||1.9||72.8||55.7||6.1||68.2||31.8|
|Banco Regional S.A.||1.2||2.5||135.2||49.2||5.9||67.3||32.7|
|Banco Amambay S.A.||8.5||0.7||48.4||66.8||6.5||69.7||30.3|
|Public development bank||56.2||-2.8||47.7||46.2||14.4||83.6||16.4|
|Banco Nacional de Fomento||56.2||-2.8||47.7||46.2||14.4||83.6||16.4|
|Finance companies||10.4||1.6||45.8||32.6||14.7||18.3||81.7|Figure 2.2.Financial Indicators, 2003
Sources: Superintendency of Banks, and Fund staff estimates.
Banks reduced credit supply and started to build excess liquidity (33 percent of total assets). Since the fall of Banco Alemán, banks began to hold more risk-free assets, such as holdings of central bank bills and unremunerated excess deposits at the Central Bank of Paraguay (BCP) (Figure 2.3). Banks doubled central bank bill holdings to PARG 602 billion in December 2003 and increased excess deposits at the BCP to PARG 500 billion in 2003. Central bank bills during 2002 and 2003 offered attractive interest rates, although they have dropped significantly over the past months. In contrast, excess deposits are unremunerated but are immediately available, causing concerns for monetary policy.
Figure 2.3.Liquid Assets of Banks
Source: Central Bank of Paraguay.
Credit supplied by the BNF also contracted in 2003, partly owing to its new loan limits and high NPL ratios. The authorities imposed loan limits because of the widespread perception of corruption in this bank and of political clientelism.45
One–year loans are limited to PARG 100 million per corporation, three–year loans to PARG 300 million, and five–year loan maturity to PARG 700 million. The NPL ratios are very high (56 percent). Systematic operating losses and poor use of resources caused most of BNF's liquidity problems. Political influence further distorted the bank's operations by affecting loan approvals and by forcing the bank to provide subsidies without the corresponding fiscal resources. BNF loans are concentrated among a few dozen well–connected clients; two–thirds of its loans are to less than 5 percent of clients. Of past–due loans, the 50 largest loans, representing half of all past–due loans in December 1999, were owed by 0.3 percent of total clients. Furthermore, the bank has been unable to prosecute large but influential delinquent borrowers successfully. In the interim, the BNF has been recapitalized and its operations are being modernized and streamlined. So far, the bank has not experienced liquidity problems.
Finance companies, with about 7 percent of assets, extend mainly microcredit. There are 17 finance companies, but 2 are in liquidation, and 1 recently merged with a bank. NPL ratios were 10 percent, compared with 15 percent in private banks, and ROA was 1.6 percent in December 2003. The Superintendency of Banks (SB) regulates and supervises finance companies.
The cooperative sector, with 20 percent of financial assets, plays an important economic and social role in Paraguay. Three types of cooperatives—financial, production, and other cooperatives—exist. Financial cooperatives provide microcredit to 90 percent of its members. The production cooperatives finance agricultural and dairy products, and other cooperatives provide goods, services, and employment. There are about 820 registered cooperatives, out of which 525 are financial cooperatives, and 200 are production cooperatives. However, preliminary data show that more than half of the cooperatives have ceased operations. The cooperative sector helps promote education by funding the Education Development Cooperative Fund, with at least 10 percent of its dividends. In 2002, cooperative sector deposits stood at US$154 million and assets at US$464 million.
The largest 25 financial cooperatives, with 356,000 members, accounted for 80 percent of financial cooperative assets (Gamarra, 2004a and b). Their deposits amounted to about US$82 million and credit to US$110 million. These institutions are highly liquid, with a capital adequacy ratio (CAR) of 34 percent. With the excess liquidity, financial cooperatives intend to finance production cooperatives.
The assets of the largest 25 financial cooperatives have more than doubled since 1998 (Figure 2.4). Because of several banking crises, the public started to shift savings from the banking system to the cooperative sector. Consequently, some cooperatives began to provide services that previously were offered only by banks, except for current accounts and foreign exchange operations. Contrary to banks, cooperatives conduct most of their operations in local currency.
Figure 2.4.Selected Indicators of the Largest 25 Financial Cooperatives
Sources: Superintendency of Banks; and Fund staff estimates.
The supervisory authority of the cooperatives, INCOOP, began taking steps to introduce supervision of the cooperatives by January 2005. It requested assistance from international cooperatives and institutions for (1) implementing prudential norms, (2) designing balance sheets, (3) incorporating the cooperatives into the credit rating agency, (4) providing training, (5) implementing money laundering regulations, and (6) setting a deposit insurance guarantee.
C. Overview of the Financial Crises
During most of the 1980s, policies of financial repression dominated the financial sector in Paraguay.46 These policies included controlled interest rates, high reserve requirement rates (42 percent), fixed exchange rates, and credit controls. Banks had to finance agricultural exports through rediscount papers, which were rediscounted at subsidized rates at the BCP. Moreover, public sector deposits could be located only at the BCP.
By 1989, with a change in government, Paraguay embarked on a process of financial liberalization, which continued through the mid–1990s. The authorities introduced a unified, managed floating exchange rate regime, liberalized interest rates, reduced reserve requirements, gradually eliminated the rediscount papers at the BCP, and issued norms for asset classification. From 1990 to 1993, the authorities further reduced reserve requirements and freed public sector deposits from the BCP to the banking system. In November 1994, financial transactions could be carried out also in foreign currency, allowing banks to extend loans denominated in foreign currency.
Banks started to pursue aggressive accounting practices, exacerbated by poor management.47 Financial institutions recorded in their accounting books nonexistent assets, lent to related parties, and registered only part of their liabilities. Some financial institutions kept unrecorded deposits off balance sheet in a second accounting book system. Unrecorded deposits could be “grey” or “black.” Grey deposits, for which adequate documentation existed, had been recorded off balance sheet, and black deposits, such as promissory notes, were based on inadequate documentation. Most Paraguayan banks and some foreign banks maintained this system of parallel balance sheets before the crisis to avoid the implicit taxation of the high reserve requirement, as well as the taxation on earning, and to circumvent the limits on lending to related parties (Garcia– Herrero, 1997a; and Insfran Pelozo, 2000). Moreover, poor management brought about excessive insider lending and high credit concentration.
Financial liberalization was not accompanied by the strengthening of prudential regulations and supervision, resulting in the rapid expansion in the financial sector. Banking regulations did not determine prudential norms for asset classification and did not specify connected lending.48 The required provisions did not reflect the true risks of banks’ assets. In addition, lax licensing requirements and low required capitalization permitted a proliferation of new financial institutions (Shogo and Habermeier, 2002). Each large company or group of companies owned a bank, which in turn owned a finance company. As a result, the number of banks and finance companies almost doubled to 103 in 1995 from 54 in 1988 (Figure 2.5).
Figure 2.5.Number of Financial Institutions, 1988–2004
Source: Superintendency of Banks.
Furthermore, the SB lacked adequate powers and resources to exercise effective supervision over the growing number of financial institutions and was constrained by political interference (Shogo and Habermeier, 2002). The authorities acknowledged the insolvency of one–third of the banking system as early as 1989 (Garcia–Herrero, 1997a and b). However, the SB could not take swift corrective measures because of a lack of resources, as well as a weak legal framework and financial regulation and supervision, which did not allow for an easy exit and an efficient resolution of the ailing financial institutions. Political pressure and inadequate documentation, hiding the true situation of banks, also hampered adequate supervision.
Financial liberalization brought to light vulnerabilities that precipitated the financial sector crisis of 1995–98. Bad banking practices, including excessive concentration and connected lending without the appropriate credit–risk analysis, inadequate accounting practices, and inefficient supervisory framework, triggered the crisis in 1995. Higher interest rates, brought by the financial liberalization, combined with unfavorable terms of trade, further exacerbated the banks’ deteriorating balance sheets.49
Notwithstanding a new financial law in 1996, about half of the financial institutions failed between 1995 and 1998. The law required that banks’ balance sheets be inspected by external auditors, and authorized banking supervision to intervene in banks that did not comply with prudential regulations or meet the required capital. It also incorporated recommendations set forth by the Basel Committee and created a central risk database. Because the authorities could not take swift measures to clean up the financial sector, the banks’ balance sheets worsened.50 Therefore, the crisis continued in several waves until the end of 1998.
In 2002, fears about the viability of the Argentine–Uruguayan conglomerate Grupo Velox (owners of Banco Alemán, the third–largest bank in Paraguay) led to the closure of the Banco Alemán. The Grupo Velox owned a number of financial and nonfinancial institutions. The Group owned Banco Velox in Argentina; Banco de Montevideo and Banco La Caja Obrera in Uruguay; the Trade and Commercial Bank (TCB), an offshore bank in the Cayman Islands; and several financial institutions in Paraguay, including mutual funds, a finance company, and Banco Alemán, with about 11 percent of banking system assets. The Group had been channeling the deposits captured through its financial institutions in Argentina, Paraguay, and Uruguay to its offshore bank, TCB, which was using them in part to finance the operation of the Group's nonfinancial enterprises. With the financial resources of its Argentine bank frozen and with large exposure to Argentina and Uruguay, the TCB experienced serious liquidity problems and, in mid–May 2002, was unable to satisfy some requests for deposit withdrawals from Paraguayans. The failure to honor TCB commitments intensified the withdrawals from the Group's mutual funds and the Banco Alemán in Paraguay. Between end–2001 and end–July 2002, foreign currency deposits declined by more than US$414 million (33 percent). In June 2002, the authorities intervened and closed Banco Alemán. Because the authorities responded hastily, by end–December 2002 deposits had recovered. Four finance companies also closed in 2002.
The SB intervened in a medium–sized locally owned bank, Multibanco, again in May 2003, after uncovering fraud in this bank. The bank, with around 5 percent of banking system assets, was closed on June 2, 2003. The SB found evidence of irregularities in the bank's lending operations, including connected lending and possible kickbacks paid to attract public sector deposits. As a result of the closure, banking system deposits declined by 7 percent. The authorities moved quickly on Multibanco and began payments under the state deposit guarantee. By August 2003, deposits had recovered. In 2003, three banks, ING, Asunción, and Paraná, and four finance companies closed because of low profitability.
The crisis in the BNF has eased somewhat, owing to a recapitalization in 2003 and new management, but concerns about its long–term viability remain. Until about mid–2003, the bank had problems clearing its outstanding balances in the payments system. The bank's significant losses have continued to consume its capital. The BNF plays an important role in the payment system (particularly in rural areas) and as a tax and payment agent for the government, which could spark wider problems if the BNF were to close.
D. Behavior of Private Sector Credit51
The latest financial crises combined with political and macroeconomic instability caused private sector credit to decline by about 14 percent in 2002–03 (see Table 2.1). Several factors led to the fall in credit: the government's default on treasury bonds held by banks, the lack of a flexible liquidity support facility at the central bank, the lack of longer–term financing sources, high NPL ratios, high dollarization, and the relative increase of the informal economy.
The closure of four banks in 2003 contributed to the decline of available financing sources. ING, Asunción, Paraná, and Multibanco (together equaling 9.4 percent of the banking system assets) had an outstanding stock of credit of PARG 789 billion by end–2002. About 80 percent of the closed banks’ clients have been incorporated in the rest of the banking system.
Credit supply in banks
The de facto default on the treasury bonds held by the government in December 2002 hurt financial system confidence and contributed to the fall in credit by hitting the net worth of banks. The default on some US$22 million in bonds raised banks’ cost of funds. Banks reduced credit lines to both new and current customers as banks started to provision for the defaulted bonds. In October 2003, the new government cleared arrears on domestic bonds through a rollover agreement.
Credit trends started to shift in the region with the onset of the Argentine crisis (Figure 2.6). Credit in Uruguay fell by 25 percent and in Argentina by 15 percent. In Paraguay, wholly foreign–owned banks became more risk averse than local banks as regional uncertainties and the country risk increased after the 2002 crises. According to the Bankers’ Association, some wholly foreign–owned banks began implementing sharper supervision following headquarters’ instructions and tightening their prudential regulations internally. Wholly foreign–owned banks became more conservative in their lending operations and reduced their liabilities by increasing requirements both on collateral and on new deposit accounts. Other banks have changed their strategy by refocusing on more profitable sectors of the economy—the agricultural and livestock sectors—where solid collateral can be claimed.
Figure 2.6.Private Sector Credit as a Share of GDP in the Region
Sources: International Monetary Fund; and Fund staff estimates.
Moreover, the lack of a flexible liquidity support facility led banks to accumulate excess liquidity to hedge against a possible deposit run, thus further reducing available funds for private sector lending.52 The central bank's liquidity support facilities are inadequate. The only facilities available are (1) a short–term liquidity line (call money) for up to 10 days and up to 75 percent of the borrower's capital, collateralized by government bonds, BCP's bills, or first–grade portfolio; and >(2) a repurchase agreement of government bonds in open market operations, with financial characteristics that are decided on an ad hoc basis. In addition, as the Central Bank Board of Directors should approve case–by–case each liquidity request and could be legally prosecuted if banks turn out to be insolvent, this facility cannot be used readily. As this serves more as a lender–of–last resort mechanism, as opposed to a short–term liquidity mechanism, banks use it only when they are facing severe liquidity problems. The banks that use this facility are easily labeled by the BCP and by other financial institutions as unsound, because banks that previously used this facility had to be closed subsequently. The interbank money market, which could serve to meet temporary liquidity problems, is very thin, especially now, when all banks are very liquid.
Another factor hindering medium– and long–term credit is the lack of long–term financing sources (Tables 2.2 and 2.3). Although deposits rose by 6 percent in December 2003, the availability of credit has been limited. After the 2002 banking crisis, depositors feared that the government would pursue interventionist policies similar to those seen in Argentina, such as guaranizationor corralito(freezing of deposits), and shifted their savings from longer– to shorter– term deposits. Sight deposits as a share of total deposits increased to 77 percent in 2003 from 67 percent in 2002. To avoid a high maturity mismatch between assets and liabilities, banks in Paraguay restrained from lending at longer terms.
The high stock of NPLs reduced profitability of banks and contributed to the fall in credit supply. Loan performance deteriorated in 2002 as a result of the economic slowdown and currency depreciation (Figure 2.7). Excluding the BNF, the NPL ratio increased from 12.3 percent in December 2001 to 15 percent in December 2003. Returns on assets and equity declined significantly. In addition, the inefficient judicial system became a barrier to the effective resolution of distressed debts, delaying further the recovery of assets.53
Figure 2.7.Nonperforming Loans for Banks
Sources: Superintendency of Banks; and Fund staff estimates.
The lack of hedging instruments against exchange rate volatility, mainly for long– term loans, also contributed to the fall in credit.54 The high ratio of loans in foreign currency (55 percent), many to borrowers who were not naturally hedged in foreign currency, made the system vulnerable to exchange rate fluctuations. In 2001–03 the total amount of U.S. dollar—denominated credit extended by banks to the private sector contracted by about 40 percent. To avoid exchange rate risks, banks started to lend only to sectors whose revenues were in dollars. Most sectors received their earnings in local currency, except the export–agricultural sector.
The large scale of the informal economy contributed to the fall in credit supply. Banks require fiscal balances and cash flows from borrowers. After the 2002 crisis, more people shifted to the informal economy to evade taxation, thus reducing access to bank financing.
Credit supply in finance companies
Credit supply in finance companies increased in 2003, contrary to the trend in banks (Table 2.1). While deposits increased by 40 percent, credit expanded by 15 percent. In contrast to banks, finance companies hold only 1 percent of the bond stock, leaving the finance companies marginally vulnerable to the bond default. Most of the savings in finance companies are at longer–term maturities (82 percent of total deposits). NPL ratios and profitability are better relative to banks (see Table 2.2). Finance companies are less conservative in lending practices than banks.
Credit supply in cooperatives
The cooperative sector has increased its lending position by attracting clients who fled from the banking system after the Banco Alemán crisis. The cooperatives can pay more attractive interest rates than other financial institutions because they are exempt from value–added tax (VAT) and from legal reserve requirements. While cooperatives pay 4–8 percent in sight deposits, banks pay 2 percent. Moreover, the higher interest rates on fixed–term deposits in the cooperatives encouraged the public to place their financing in longer–term maturities. Only 23 percent of banking deposits are placed at fixed terms, whereas 60 percent of cooperative deposits are at fixed terms.
The recession and exchange rate depreciation in 2002 affected most sectors of the economy. Real GDP declined by 2.3 percent, and the exchange rate depreciated by 34 percent in 2002, leading to the collapse of several firms. All sectors of the economy suffered, except for agriculture, because of a good harvest and favorable international prices (Table 2.4). The agricultural corporate sector (particularly, soybean and cotton), with good credit rating, maintained access to banking finances. The agricultural sector, lacking banking access, financed itself through retained earnings or by selling their products on the futures markets. In 2003, credit allocation fell significantly to wholesale commerce (37 percent), to consumption (26 percent), and to industry (14 percent).
|Total Bank Credit|
|(In billions of guaranies)||Change||(In percent)|
|Total Financial System|
The high cost of bank intermediation contributed to low credit demand. Lending interest rates started to fall in 2003, but real interest rates remained high (see Tables 2.2 and 2.5, and Figure 2.8). The interest rate spread between banks and finance companies has shrunk during 2003. Interest rates vary significantly among banks. Locally owned banks, Banco de la Nación Argentina (a wholly foreign–owned bank), and Continental (a majority–owned foreign bank) tend to charge higher interest rates on loans and pay more attractive interest rates on deposits.
|Commercial Loan >1 Year||Consumption Loan <1 Year||Consumption Loan > 1 Year||Sight Deposits||Term Deposits <90 Days||Term Deposits <365 Days||Certificate of Deposits < 365 Days|
|Wholly foreign-owned banks|
|Lloyds TSB Bank P.L.C.||25.8||34.9||32.4||3.7||5.6||…||7.3|
|ABN Amro Bank N.V.||27.1||29.0||30.1||…||2.0||6.0||6.1|
|Banco do Brasil S.A.||…||30.6||28.1||0.7||…||…||2.8|
|Banco de la Nacion Argentina||…||…||…||7.2||…||10.3|
|Chinatrust Commercial Bank||32.3…||31.5||1.6||…||…||…|
|Majority-owned foreign banks|
|Banco Sudameris S.A.E.C.A.||29.7||23.5||35.0||4.1||6.6||…||12.2|
|Banco Bilbao Viscay|
|Argentaria Paraguay S.A.||31.9||24.4||33.7||3.1||5.7||…||6.4|
|Banco Integracion S.A.||26.8||24.5||29.7||5.1||…||…||…|
|Banco Continental S.A.E.C.A.||52.5||40.2||48.3||5.8||…||…||14.5|
|Locally owned private banks Banco Regional S.A.||45.4||41.2||…||5.9||6.3||7.2||13.4|
|Banco Amambay S.A.||48.6||48.4||37.4||3.1||15.9||…||…|
|Public development bank Banco Nacional de Fomento||29.0||28.5||49.6||5.1||…||…||14.2|Figure 2.8.Lending Interest Rates on Guaraníes
Source: Central Bank of Paraguay.
The unfavorable business environment discourages investment in Paraguay. According to a World Bank business environment report (World Bank 2004), it is more challenging to open a business in Paraguay than elsewhere in the region.55 While entrepreneurs in Paraguay must complete 17 steps to launch a business over 74 days on average at a cost equal to about 158 percent of gross national income (GNI) per capita, entrepreneurs in the region need to take 11 steps over 70 days at a lower cost of 60 percent of GNI per capita. The employment laws index, a measure of rigidity in labor regulations and law, is worse in Paraguay (73) compared with the regional average (61) and the Organization for Economic Co–operation and Development (OECD) (45). However, credit enforcement complexity in Paraguay is lower than in the region but higher than in the OECD. Similarly, it is time consuming and costly to close a business in Paraguay. Moreover, the lack of property rights protection, the weak legal system, and institutionalized corruption further discourage investment (Gwartney and Lawson, 2003).
E. Conclusions and Policy Recommendations
Paraguay has suffered from outbreaks of financial crises since the financial liberalization initiated in the 1990s. The financial crisis that broke out in 1995 did not subside until 1998, after wiping out about half of the banks. The financial sector remained relatively stable until 2002, when a deposit run, caused by the regional outlook, led the authorities to intervene in the third–largest bank and to close four finance companies. In 2003, a locally owned private bank and four more finance companies had to close. Moreover, because of low profit, three banks ceased operations voluntarily.
The origins of the three financial crises can be traced to a weak legal framework and financial supervision. Moreover, the SB has lacked autonomy and resources and has suffered political interference.
The macroeconomic impact of the crises in 1995–98 and 2002 differed from that of the 2003 crisis. In 1998 and 2002, real GDP declined, the exchange rate significantly depreciated, money contracted by about 3 percent, interest rates on central bank bills increased to about 25 percent, and holdings at the BCP grew by about 12 percent (Table 2.1). A better macroeconomic outlook mitigated the spillover effects of the 2003 crisis. The good harvest year and favorable agricultural prices contributed to economic growth and currency appreciation. Money grew by 25 percent, interest rates fell on central bank bills to 13 percent, and holdings at the BCP grew by 44 percent. The risks to the economy from the Multibanco collapse were eased by the bank's relatively small size. Economic agents, foreseeing the bank's fragilities, adjusted their expectations accordingly. Since 2003, however, credit supply has declined significantly.
The authorities have taken key steps to address vulnerabilities in the financial system. By end–2003, a new regulation on asset classification, credit risk, provisioning requirements, and imputation of accrued interest was approved (Resolution 8). This new regulation seeks to bring asset classification and provisioning levels to commonly practiced standards. The gradual implementation of the regulation in 2004–06 will lead to a substantial increase in the level of provisions and thus improve the resilience of financial institutions to shocks. The authorities should coordinate and implement gradually all new and forthcoming financial regulations and laws to avoid a further credit tightening by banks.
The authorities started implementing the financial resolution law, which was approved in 2003. The law expedites the resolution process by addressing some of the difficulties in the financial system. It establishes clear procedures for bank intervention and resolution, and introduces a deposit insurance fund. In particular it (1) creates a permanent deposit insurance fund to protect the general public up to a defined limit per individual; (2) creates a bank recapitalization fund to provide additional public capital support to banks in difficulty and also in case of systemic risk (on a case–by–case basis, within strict guidelines); (3) develops legal tools to allow for the quick transfer of deposits to other financial institutions during bank resolutions; (4) provides adequate legal protection to public officials working in the bank resolution process during the intervention period;56 and (5) delegates to the BCP the authority to issue regulations related to the deposit guarantee and banking resolution.
With the assistance of the World Bank, the authorities have prepared a Comprehensive Banking Law to strengthen further banking supervision. This law is expected to be approved in 2005 and aims at: (1) upgrading regulatory requirements for risk–weighted capital, (2) bringing accounting and prudential standards up to international best practices, and (3) improving the operational capacity of the SB.
To address weaknesses in the public bank, the authorities prepared a Public Banking Law, which is being discussed in Parliament. The law, prepared with the assistance of the IDB, aims at consolidating several public–lending institutions into a retail bank for microenterprises and small farmers, and a small second–tier bank to on–lend resources from bilateral and multilateral development lenders. The SB should monitor closely the evolution of financial indicators of each financial entity to detect any risks in the system at an early stage, and should forcefully take corrective measures. Supervision could also be strengthened by better coordinating off– and on–site inspections. The authorities should allocate more resources to the SB to improve information systems, training, and incentives.
Paraguay will benefit from the thorough assessment of its financial sector through the Financial System Assessment Program (FSAP) that is jointly undertaken by the IMF and the World Bank, and that will be concluded by mid–2005.57 The FSAP identifies strengths, risks, and vulnerabilities of the financial system; assesses observance of financial system standards, codes, and good practices; determines how key sources of risk are being managed; ascertains the financial system's developmental and technical assistance needs; and helps prioritize financial system policies to meet these needs.
The authorities should move forward with the reform agenda, increasing tax and customs efficiency, tackling governance issues, and reforming the judicial system. It is crucial that the government not fall into arrears or default on treasury bonds again. The rollover agreement on the defaulted bonds in 2003 was a stepping– stone to help banks increase their confidence in the government's repayment commitment and accelerate the engine of intermediation in the long run. The authorities should pursue tax and customs reforms to help formalize the informal economy, thus increasing the potential of borrowers with improved conditions to access credit. Better management of the social security institute's (IPS) funds would help finance longer–term projects. The authorities should enhance the BCP's liquidity–support facilities in such a way that they become readily and automatically available if needed, and should deepen the interbank market. They should reform the judicial system to improve the investment climate.
In the long run, political, economic, and financial stability will improve depositors’ and financial institutions’ confidence, helping restart the engine of growth. By pursuing a sound macroeconomic policy, the authorities will give a positive signal to the financial sector and will help reduce the country's risk in the long run, allowing wholly foreign–owned banks to resume lending. Political consensus is of paramount importance to push forward with economic reforms and will contribute to building confidence and credibility. The stability will allow depositors to place their funds at longer–term maturities and to invest in the country. At the same time, financial institutions will facilitate intermediation, stimulating productive investment and growth.
|History of financial liberalization||Before the 1990s, interest rates were subject to administrative controls, the banking law limited banks’ operations, reserve requirements ratios were very high (42 percent), credit allocation was determined by law, the BCP financed agricultural exports through the rediscount papers, the exchange rate was fixed, and public sector funds were deposited at the central bank.|
|Around 1989, the foreign exchange market and interest rates were liberalized. Reserve requirements were reduced, the rediscount papers at the BCP were gradually eliminated, and norms for asset classification were legislated.|
|From 1990 to 1993, more reforms were implemented. Among them were further reductions in reserve requirements and freeing of public sector deposits from the BCP to the banking system.|
|Monetary policy objective||From 1999 to 2003, monetary policy lacked focus. The BCP attempted to pursue multiple targets, sometimes focusing on the exchange rate, at other times pursuing monetary or inflation objectives. Monetary management was complicated in early 2003 by political pressures to extend US$39 million in credit to the government and an attempt by the Ministry of Finance to use public sector deposits to manage monetary policy. In early 2004, the BCP extended a US$33 million advance loan to help the central government pay external arrears. With the approval of a monetary program by end–2003, the monetary authorities have pursued a monetary policy geared mainly toward achieving the inflation target of the program.|
|Commonly used monetary policy tools||Open market operations through central bank bills, which are issued daily at terms ranging upward from 35 days and are fully negotiable up to 360 days, or through call money, with terms from 1 to 15 days. Changes in reserve requirements are used less frequently. This was used more in 2002 after excess liquidity in the system drove the BCP to change its rates.|
|Interest rate liberalization status||Interest rates are liberalized. However, to avoid aggressive competition, banks cannot offer rates higher than 50 percent of the effective weighted average on deposits. In 2003, legislation setting limits on credit card interest rates was approved; however, it was declared unconstitutional.|
|Credit controls||There are no credit controls.|
|Bank–by–bank ceilings||There are no ceilings.|
|Directed credits||The government supports the agricultural system, mainly, the soy, cotton, and wheat campaigns, by taking ad hoc monetary policy measures that benefit these systems; for instance, reducing reserve requirements on banking deposits if banks lend to productive systems.|
|Reserve requirements||Reserve requirement rates remained constant from 1994 until June 2002, when excess liquidity in the banking system drove the BCP to increase the rates, lowering them again in November 2002.|
|Required–reserve ratio (domestic currency)||Demand deposits (less than 30 days): 15 percent. Term deposits (30–180 days): 15 percent. Term deposits (181–360 days): 15 percent. Term deposits (361–540 days): 7 percent. Term deposits (more than 540 days): 0 percent.|
|Required–reserve ratio (foreign currency)||Demand deposits (less than 30 days): 26.5 percent. Term deposits (30–360 days): 26.5 percent. Term deposits (361–540 days): 16.5 percent. Term deposits (541–1,080 days): 6.5 percent. Term deposits (more than 1080 days): 1.5 percent.|
|Discount window||This facility is not very flexible and does not adequately address temporary liquidity problems of banks. It is usually used when the bank is facing severe liquidity problems. However, in most cases, the banks that used this facility ended up being insolvent and had to close. Although the central bank has in the past used medium– term liquidity support facilities to help ailing banks, the legal actions against BCP directors that ensued prevent de facto their use. The only facilities available are (1) a short–term liquidity line (call money) for up to 10 days and 75 percent of the borrower's capital, collateralized by government bonds, BCP's bills, or first–grade portfolio; and (2) a repurchase agreement of government bonds in open market operations, with financial characteristics that are decided on an ad hoc basis. In addition, the process is cumbersome, as the Central Bank Board of Directors on a case–by–case basis should approve each liquidity request.|
|Open market operations||The most widely used monetary policy tools are open market operations through central bank bills, which are issued daily at maturities ranging upward from 35 days and are fully negotiable up to 360 days, or through call money, with maturities from 1 to 15 days. This is the most active instrument, and the BCP has increased its stock of bills significantly during 2003. More recently, owing to the high quasi–fiscal cost, the BCP has been reducing the issuance of the bills by limiting them to longer–term maturities.|
|Treasury bonds market||Treasury bonds exist. However, the placement of these bonds has been very difficult; in particular, they became illiquid owing to the de facto default on the treasury bonds by the government in December 2002. In October 2003, the government cleared arrears on domestic bonds with banks by restructuring the debt. As these bonds are not liquid, they are not traded in a secondary market. Treasury bonds are held by contractuals and suppliers, who in turn negotiate them with banks.|
|Number of banks||14 banks (6 wholly foreign–owned banks; 5 majority–owned foreign banks; 2 locally owned private banks; 1 public bank).|
|Size of banking system||72 percent of financial assets.|
|Number of public banks||One public bank, Banco Nacional del Fomento. Besides the BNF, there are seven public entities that channel subsidized funds, mainly from the international donor community. Five (CAH, FG, FDC, BANAVI, CONAVI) of these seven entities are first–tier institutions, whereas the other two (UTEP, FDI) are second–tier institutions.|
|Public bank assets as a share of total assets in the banking system||8 percent.|
|Strategy for restructuring the public banks||The Public Banking Law aims at consolidating several public lending institutions into a retail bank for microenterprises and small farmers, and a small second–tier bank to on–lend resources from bilateral and multilateral development lenders. In the interim, the National Development Bank has been recapitalized and its operations are being modernized and streamlined.|
|Lending limits on the public bank||There are limits on BNF loans. One–year loans are limited to PARG100 million per corporation, three–year loans to PARG300 million, and loans with maturity greater than five years to PARG700 million.|
|Interbank transactions||There is an interbank money market, but it is very thin, especially now, when all banks are very liquid.|
|Noncash transactions||Cash and ATM cards are widely used. Credit cards are not yet widely used, given the informality of the economy. Moreover, interest rates on credit cards are very high. Although the economy is highly dollarized, dollars are not commonly used in transactions.|
|Financial regulation and supervision||Financial supervision of banks, finance companies, savings and loans associations, exchange houses, warehouses, and public entities is carried out by the Superintendency of Banks (SB), an institution that is part of the BCP, according to the financial law 489/95. The SB is divided into four units: administrative, special supervision, inspection, and financial analysis and regulations. The SB has 160 employees. Nearly 40 percent of the personnel of the SB are devoted to Special Supervision, the unit in charge of liquidation of banks, leaving a reduced group to work in the area of preventive supervision. Supervisors in the SB need additional training in the more sophisticated and forward–looking components of credit risk assessment, such as cash flow analysis and the assessment of borrower's capacity to pay.|
|Banking and finance companies’ average capitalasset ratio||Minimum capital risk–weighted assets ratio is 10 percent.|
|Entry of financial institutions||Entry of banks is easy. The required minimum capital for banks is PARG10 billion and for finance companies, PARG5 billion, which are adjusted annually to the consumer price index (CPI).|
|Exit of financial institutions||Exit of banks is easy. Banks can wind down operations voluntarily.|
|Deposit insurance||Paraguay had a state deposit guarantee. The scheme was not funded and depended on disbursements from the BCP. The level of covered deposits reflected 75 minimum wages. By end–2003, a Bank Resolution Law was approved, which created a deposit insurance fund to protect the public up to a defined limit per individual.|
|Central bank borrower database||Yes.|
|Data collection||Detailed data collected regularly on a monthly basis.|
|Limits on exposure to single borrowers or related borrowers||The limit on the loans is 20 percent of the bank's capital, rising to 30 percent for loans to other financial institutions.|
|Inspection and auditing||Banks and finance companies publish a general balance sheet and income statement, which are audited by external auditors, within 120 days of each fiscal year. The SB publishes the CADEF, a composite rating system that describes the financial situation of each entity, four times a year.|
|Payment system||There is no electronic payment system. Checks play a dominant role as both payment instrument and a way to settle outstanding obligations among banks. The checks are cleared at the Clearing House for checks, which itself settles manually over the banks’ current accounts at the BCP. The Clearing House consists only of a paper–and manual–handling procedure, and it lacks normal safety and efficiency requirements for clearinghouses. The BCP is receiving technical assistance from the IMF in this area.|
|Finance companies||There were 17 finance companies by end–2003, accounting for about 7 percent of financial assets. In 2004, the number dropped to 14.|
|Mortgage market||There is a first–tier public entity for housing, called Banco Nacional de la Vivienda (BNV). Related to the BNV is the Consejo Nacional de la Vivienda (CONAVI), which oversees BNV operations and also acts as a second–tier lender for housing investments.|
|Stock market||Paraguay's first stock market began trading in October 1993. Companies have a minimum paid–up capital of US$50,000. In 2002, trading was only US$12 million, significantly lower than the US$15.5 million traded in 2001.|
|Sovereign/corporate debt||Corporate debt is limited. Sovereign debt is mostly multilateral on a concessional basis.|
|Pension funds||There is a pay–as–you–go social security public pension system, the caja fiscal, for public employees and IPS for private employees.|
|Mutual funds||Mutual funds are very limited.|
|Insurance companies||There are 35 insurance companies. The system is regulated by the Superintendencia de Seguros. Since March 1998, insurance companies must have a minimum paid–up capital of US$500,000, substantially consolidating the insurance market.|
|Money exchange houses||There are 23 money exchange houses, which are supervised by the SB.|
|Cooperatives||Cooperatives account for 20 percent of financial assets.|
|Deposit warehouses||Four deposit warehouses, which are supervised by the SB.|
|Institutional/legal environment||There are serious governance issues in most institutions. In addition, the government sometimes takes ad hoc measures that bring uncertainties to bankers.|
|Loan recovery through judicial system||It takes between three and seven years to conclude a judicial process.|
|Country risk rating (EIU)||Overall Rating: D. Total score: 66 (as of 2/2004), Political Risk: E, Economic Policy: C, Economic Structure: D, Liquidity Risk: D|
|Country's ratings (Standard and Poor's and Moody's)||On February 13, 2003, Standard & Poor's downgraded Paraguayan foreign currency debt to SD (Selective Default), owing to nonpayment of domestic bonds held by banks. On April 29, 2003, Moody's significantly downgraded the country ceiling for foreign currency bonds and notes to Caa1 from B2, and the country ceiling for foreign currency bank deposits to Caa2 from B3. At the time, this rating reflected Moody's concern that a bank deposit run in Paraguay might coincide with or presage a default on the nation's debt. The 2004 Moody's report maintained these ratings.|
|Central bank independence||The charter of the BCP states that it is a technical body endowed with administrative, financial, and regulatory autonomy limited by the constitution and the laws. However, financial autonomy is curtailed by the fact that BCP's budget is part of the national budget and the annual government budget law. This impairs the BCP's actual financial independence and is a potentially severe limitation of its ability to conduct policy independently. In February 2004, the Ministry of Finance and the central bank signed a memorandum of understanding that will grant the bank greater operational autonomy.|
|Information dissemination in the central bank website||Well–maintained website. Monetary and financial data are well disseminated. Financial legislation and resolutions are posted in the BCP website.|
|Fund documents publication||Yes. Fund documents published on the website.|
|IMF programs||Latest Stand–By Arrangement was approved in December 2003. There were also arrangements in 1957, 1958, 1959, 1960, 1961, 1964, 1966, 1968, and 1969.|
|Restrictions on purchase/sale of financial assets by foreigners||Free from restrictions.|
|Restrictions on purchase of foreign currency by residents||Free from restrictions.|
|Repatriation requirements||Free from restrictions.|
|Exchange rate regime||Floating exchange rate; however, to maintain a stable real exchange rate, the authorities sometimes intervene in the market.|
|Article VIII/XIV status||VIII. Date of acceptance: August 23, 1994.|
|Multiple exchange rates||Free from restrictions.|
|Parallel exchange market||Free from restrictions.|
|Forward exchange market||Banks are permitted to enter into forward transactions with respect to trade transactions and on terms that may be negotiated freely with customers.|
|1989–1994||Financial liberalization process.|
|1995, 1997, 1998||Financial crises because of a lack of adequate bank regulation and supervision, inadequate banking skills, poor credit and risk assessment, and high levels of insider lending and loan concentration.|
|June 2002||Intervention in the country's third–largest bank, Banco Alemán, with about 11 percent of banking system assets.|
|December 2002||Default on domestic bonds held by the banking system.|
|January 2003||Decree announcing the transfer of public sector deposits from banks to the BCP.|
|May 2003||Intervention in a medium–sized domestic bank, Multibanco, with around 5 percent of banking system assets.|
|August 2003||New administration.|
|October 2003||The president signed a political agreement with the heads of both houses of Congress and with opposition party leaders to pass a series of economic reform laws, including fiscal adjustment legislation and laws to strengthen the banking system and reorganize public banks, reform the public employees’ pension plan, restructure public enterprises, and pass a new customs code.|
|November 2003||Approval of stricter regulations on asset classification, credit risk, provisioning requirements, and imputation of accrued interest (Resolution 8) seeks to bring asset classification and provisioning levels to standard international practice.|
|November 2003||Approval of a bank resolution law.|
|Approval of a Stand–By Arrangement to help the government create conditions for sustained economic growth and poverty reduction and address long–standing governance problems. The program includes fiscal consolidation, clearance of arrears, the strengthening of the financial system, increased autonomy of the BCP, and structural reforms to address the long–standing governance issues by improving the efficiency and transparency of government operations.|
The tables below provide a snapshot of the business climate in Paraguay by identifying specific regulations and policies that encourage or discourage investment, productivity, and growth. Key indicators are used to help measure the ease or difficulty of operating a business: starting a business, hiring and firing workers, enforcing contracts, getting credit, and closing a business. Regional and OECD averages are provided for each topic for comparison.
Snapshot of Business Environment—Paraguay
Starting a business (2004)
The challenges of launching a business in Paraguay are shown below through four measures: procedures required to establish a business, the associated time, the cost, and the minimum capital requirement. Entrepreneurs can expect to go through 17 steps to launch a business over 74 days on average, at a cost equal to 157.6 percent of gross national income per capita. There is no minimum deposit requirement to obtain a business registration number, compared with the regional average of 32.3 percent of GNI and the OECD average of 47.0 percent of GNI.
|Indicator||Paraguay||Regional Average||OECD Average|
|Number of procedures||17||11||6|
|Cost (percent of GNI per capita)||157.6||60.1||8.4|
|Minimum capital (percent GNI per capita)||0.0||32.3||47.0|
Hiring and firing workers (2003)
The flexibility or rigidity of labor regulations and laws in Paraguay is shown below, using three indices. Conditions covered by the indices include availability of part-time and fixed-term contracts, working-time requirements, minimum wage laws, and minimum conditions of employment. Each index assigns values between 0 and 100, with higher values representing more rigid regulations. The overall Employment Laws Index is an average of the three indices. For Paraguay, the overall index is 73, compared with the regional average of 61 and OECD average of 45.
|Flexibility of hiring index||58||56||49|
|Conditions of employment index||90||79||58|
|Flexibility of firing index||71||48||28|
|Employment laws index||73||61||45|
Enforcing contracts (2003)
The ease or difficulty of enforcing commercial contracts in Paraguay is measured below, using three indicators: the number of procedures counted from the moment the plaintiff files a lawsuit until actual payment, the associated time, and the cost (in court and attorney fees). An overall index of the procedural complexity of contract enforcement is calculated by averaging four subindices related to dispute resolution. The index varies from 0 to 100, with higher values indicating more complexity in enforcing a contract. The procedural complexity index for Paraguay is 67, compared with the regional average of 70 and the OECD average of 49.
|Number of procedures||46||33||18|
|Cost (percent GNI per capita)||34.0||38.0||7.1|
|Procedural complexity index||67||70||49|
Getting credit (2003)
Two sets of measures on getting credit in Paraguay are constructed: indicators on credit information sharing and an indicator of the legal protection of creditor rights. A public credit registry index covers credit information coverage, distribution, access, and quality for public registries. The index ranges from 0 to 100. Higher values indicate that the rules are better designed to support credit transactions. For private credit registries, a coverage indicator is reported. An indicator of creditor rights in insolvency is also provided. A minimum score of 0 represents weak creditor rights and a maximum score of 4 represents strong creditor rights. Paraguay has a score of 2, compared with the regional average of 1 and OECD average of 1.
|Indicator||Paraguay||Regional Average||OECD Average|
|Has public credit registry?||Yes|
|Public credit registry (year est.)||1995|
|Public credit registry coverage (borrowers per 1,000 capita)||—||53.2||43.2|
|Public credit registry index||—||50||58|
|Has private dredit bureau?||Yes|
|Private bureau coverage (borrowers per 1,000 capita)||—||196.6||443.5|
|Creditor rights index||2||1||1|
Closing a business (2003)
The ability of courts to resolve insolvencies in Paraguay is shown below. A goals of insolvency index is calculated by averaging the cost and time associated with resolving an insolvency, the observance of absolute priority of claims, and the outcome (reorganizing viable companies and closing down unviable ones, for example). The goals of insolvency index ranges from 0 to 100. Higher values indicate a more efficient insolvency system. The goals of insolvency index for Paraguay is 46, compared with the regional average of 46 and OECD average of 77. An indicator of the power of the courts during the insolvency process is also provided. A higher value indicates more court involvement in the process, usually an impediment to insolvency resolution. Paraguay has a value of 67, compared with the regional average of 63 and OECD average of 36.
|Actual time (in years)||3.9||3.7||1.8|
|Actual cost (percent of estate)||8||15||7|
|Goals of insolvency index||46||46||77|
|Court powers endex||67||63||36|
AshwellWashington2000 “La Crisis Financiera del Paraguay” Boletin del CEMLA (July–August) pp. 170–74.
CreaneSusanRishiGoyalMushfiqMobarakRandaSab2004 “Financial Sector Development in the Middle East and North Africa” IMF Working Paper 04/201 (Washington: International Monetary Fund).
GwartneyJames and RobertLawson withNeilEmerick2003conomic Freedom of the World: 2003 Annual Report (Vancouver: The Fraser Institute and the Economic Freedom Network).
GamarraRegis2004b “Las Cooperativas Más Grandes” Enfoque Económico (April)
AliciaGarcia-Herrero1997a “Banking Crises in Latin America in the 1990s: Lessons from Argentina, Paraguay, and Venezuela” IMF Working Paper 97/140 (Washington: International Monetary Fund).
AliciaGarcia-Herrero1997b “Monetary Impact of Banking and the Conduct of Monetary Policy” IMF Working Paper 97/124 (Washington: International Monetary Fund).
Insfran PelozoAnibal1999 “Concentración de Depósitos, Tamaño de los Bancos y Sus Efectos Sobre la Oferta de Crédito para las Empresas. El Caso Paraguayo” paper presented at the Catholic University “Nuestra Señora de la Asunción” (July).
Insfran PelozoAnibal2000 “El Sistema Financiero Paraguayo. Evaluando 10 Años de Transición” paper presented at the 22nd International Congress Association of Latin American Studies (Miami) March.
PennerReinaldo1994 “Financial Liberalization in an Agrarian Economy: The Case of Paraguay” in Financial System Reforms Economic Growth and Stability (Washington: World Bank).
ShogoIshii and KarlHabermeier2002Capital Account Liberalization and Financial System Stability IMF Occasional Paper No. 211 (Washington: International Monetary Fund).
StraubStéphane1998 “Evolución Macroeconómica del Paraguay 1989–1997:Burbuja de Consumo y Crisis Financiera” Revista de la Cepal Vol. 65 pp. 119–32
Transparency International2003Available via the Internet:http://www.transparency.org/
World Bank2004 “Doing Business: Benchmarking Business Regulations.” Available via the Internet: http://www.worldbank.org/DoingBusiness/default.aspx.
For a more comprehensive analysis of the financial system in Paraguay see Appendix 1 in this chapter, which contains questions based on a survey by Creane et al. (2004). The survey collects data on a wide range of financial system issues including questions that represent different facets of financial development, such as development of the monetary system and monetary policy, banking system, other financial entities, financial regulation and supervision, financial openness and exchange rate, and institutional and legal environment.
Warehouses and the savings and loans associations account for only 1 percent of financial assets.
Insfran (1999) found a correlation between lower credit supply and a high concentration of deposits in Paraguay, in a sample of 28 banks for 1996–98.s
Data for the first five months of 2004 seem to suggest a rebound in bank credit supply. However, it is early to infer that a reversal of trend is under way, as bank credit continued to decline in the year leading up to May 2004.
Transparency International ranked Paraguay tied for ninety–eighth out of 102 countries in its corruption perception index in 2002, the worst ranking in Latin America. This poor ranking reflects in part the perceived inadequacy of public sector institutions—the country ranked seventy–fourth out of 75 in its public institutions.
Appendix 2 summarizes the major developments in the financial sector in Paraguay.
In 1992, regulations on loan–risk classification and provisioning were approved.
Interest rate spreads increased sharply during the months before the crisis. The large spreads not only reflected the implicit tax arising from relatively high reserve requirements, but also the need to cover losses from NPLs, which increased significantly before the crisis (Garcia–Herrero, 1997a).
The authorities provided liquidity to insolvent banks through a new liquidity–support facility rather than closing them, fearing a systemic financial crisis (Shogo and Habermeier, 2002).
This section was drawn from discussions with members of the Banks’ Association, the private sector, and the authorities, as well as from data analysis.
By end–2003, wholly foreign–owned banks held 44 percent of bonds, majority–owned foreign banks held 49 percent, and local banks held 6 percent.
The recovery of assets can take from three to seven years.
NPL ratio on foreign exchange (23 percent) is higher than on local currency (18 percent).
See Appendix 3 for a comparison of the World Bank Business Environment in Paraguay, the OECD, and the Latin America and Caribbean region.
Public official workers can be prosecuted after the resolution process, precluding them from carrying out their tasks adequately.
The SB has benefited from the numerous technical assistance missions on financial supervision and regulation from the Monetary and Financial Systems Department of the IMF since 1994.