This paper reassesses Panama's business model based on its abilityto attract international financial, business, and transportation services.


This paper reassesses Panama's business model based on its abilityto attract international financial, business, and transportation services.

Safeguarding Financial Stability in Panama: A Framework for Systemic Risk Oversight and Macroprudential Policy1

This paper assesses potential sources of systemic risk in the Panamanian financial system and recommends a framework for systemic risk oversight and macroprudential policy in Panama. To complement the recommended framework, policies to strengthen the crisis management framework are also considered.

A. Introduction

1. This chapter proposes a framework for systemic risk oversight and macroprudential policy in Panama. To set the context for the proposed framework, the structure of Panama’s financial system and its oversight are first reviewed. Elements of a framework for systemic risk oversight and macroprudential policy are then proposed, taking into consideration the unique structure of the Panamanian financial system and its oversight. Namely, the chapter proposes a framework for systemic risk oversight and macroprudential policy based on three pillars: i) an institutional arrangement, ii) systemic risk oversight, iii) macroprudential policy tools. To complement the recommended framework for systemic risk oversight and macroprudential policy, policies to strengthen the crisis management framework are then considered.

B. Structure of Panama’s Financial System and its Oversight

2. Panama is an important regional financial center. Total financial system assets represent more than 2 times GDP (Table 1). The financial system is the largest in Latin America and is dominated by banks, which represent about 92 percent of total system assets. The banking center encompasses a sizable offshore sector (including 28 banks accounting for 16.5 percent of total banking system assets), with limited connections to the domestic financial system (Table 2).2 Foreign banks have a strong presence in Panama: of the 55 onshore banks, 35 are foreign (representing about 47 percent of onshore banking system assets). Foreign banks originate primarily from Latin America, although a few international banking groups manage their Latin American operations from and sub-consolidate their regional activity in Panama. Several of Central America’s largest regional financial conglomerates also consolidate their banking activity in Panama, although the majority of their assets are located in the country of origin. Banks are closely intertwined with other segments of the financial system through their insurance and broker-dealer subsidiaries.

Table 1.

Structure of Panama’s Financial System

(2016; millions of US dollars)

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Source: SBP; Fund staff calculations.
Table 2.

Overview of Panama’s Regional Banking Center

(end 2016; millions of US dollars unless otherwise stated)

article image
Source: SBP; Fund staff calculations.

3. The onshore banking system maintains a traditional model of lending financed primarily with deposits. Retail deposits account for about three-quarters of banks’ funding, of which about 30 percent are foreign deposits. Wholesale funding is relatively limited (16 percent of onshore banks’ funding), but is concentrated in foreign sources (74 percent). Banks’ assets are concentrated in loans (65 percent of total assets), while securities’ holdings (17 percent of assets) and deposits in other banks (15 percent) account for the bulk of the remainder of banks’ assets. Banks’ lending portfolios are conventional, concentrated in commercial loans (24 percent), mortgages (31 percent) and consumer loans (21 percent). Credit unions also provide financial intermediation, but play a small role compared to banks. As of end-2016, credit unions’ total assets amounted to about 1.5 percent of financial sector assets.3 Their lending is primarily oriented toward consumer loans, including to fund microenterprises, and mortgages.

4. With the strong presence of foreign banks, the Panamanian banking sector maintains important cross-border exposures. In addition to the sector’s exposure to foreign deposits, banks maintain important cross-border asset holdings. Loans to non-residents are about 17 percent of onshore banking system assets or about 29 percent of GDP, while offshore banks’ loans to non-residents account for a further 18 percent of GDP. Over half (55 percent) of the securities in banks’ portfolios are external and banks’ deposits in foreign banks represent over three-quarters of their interbank deposits, as many foreign onshore banks hold deposits at their parent banks or other banks abroad, including their foreign correspondent banks.4

5. Insurers are a growing segment of Panama’s financial system. The sector’s assets account for about 4.7 percent of GDP, with total premiums amounting to about 2.5 percent of GDP.5 Life, health, and automobile insurance account for just under 65 percent of premiums. Use of non-traditional insurance products remains limited. As previously highlighted, many insurers are part of large financial conglomerates with many banks having insurance arms or subsidiaries, some of which are listed on the Panamanian stock exchange. Insurers are also directly connected to the banking system, with some insurers borrowing from onshore banks to finance their investment portfolios, and others holding deposits in the banking system.

6. The domestic capital market is small. Total assets of all firms operating in the securities sector are equivalent to just over 4 percent of GDP. Capital market intermediaries primarily serve international clients with relatively small domestic operations. There are 91 brokerage houses licensed in Panama, of these 26 are either banks with brokerage licenses or subsidiaries of banks. Brokerage houses primarily manage portfolios for non-residents: only about 6 percent of transactions are conducted within Panama.

7. The responsibility for financial sector oversight is decentralized. Responsibility for financial sector oversight falls under eight separate entities (see text figure). To enhance coordination in the decentralized oversight framework, the Financial Coordination Council (FCC) was established in 2011 and consists of six of the financial sector supervisors, Membership includes (i) Superintendency of Banks (SBP), (ii) the Superintendency of the Securities Market (SMV) (iii) the Superintendency of Insurance and Reinsurance of Panama (SSRP), (iv) Panamanian Autonomous Cooperative Institute (IPACOOP) (v) System of Savings and Capitalization of Pensions of Public Servants (SIACAP), and (vi) Ministry of Commerce and Industries (MICI), with the SBP serving as the permanent chair.. The Banco Hipotecario Nacional (BHN), which regulates and supervises savings and loans associations and the Office of the Comptroller, which overseas development banks, are not included in the FCC, although the institutions they oversea represent a relatively small share of total financial system assets.

8. The FCC is an important forum for information exchange across financial sector supervisors. The FCC was primarily established to strengthen supervision and coordinate regulation across supervisors in support of effective supervision of the entire financial sector. The FCC does not have an explicit mandate for systemic risk oversight, although one of its objectives is to enhance confidence in the financial sector.

Figure 1:
Figure 1:

Panama: Financial Sector Oversight

Citation: IMF Staff Country Reports 2017, 106; 10.5089/9781475597721.002.A003

C. Financial Sector Developments

9. Credit growth has been robust, but the credit cycle appears to be at a turning point. Panama has experienced a prolonged expansion of credit, which in recent years has outpaced the growth of deposits. However, more recently, the cost of funding has risen. Banks have responded by raising lending rates and tightening credit supply to realign its expansion with the deposit base. Credit demand has slowed simultaneously, linked to the moderation in economic activity, and consequently credit growth has started to decelerate from the high rates of the past few years. Nevertheless, the credit-to-GDP ratio is elevated at 96 percent of GDP at end-2016. The credit-to-GDP gap, which assesses the increase in the credit-to-GDP ratio relative to its trend, suggests that the ratio has recently evolved in line with its trend. However, in the Panamanian context, the gap may not fully capture overall systemic risks from rapid credit growth given that Panama has experienced a prolonged credit boom since 2000 when credit data became available. Thus, the calculated trend may be distorted and credit risks may be higher than suggested by the gap.

10. Macro-financial stability risks from the prolonged credit expansion remain a concern. The recent deceleration in credit growth has been primarily related to banks cutting exposures to the Colon Free Zone. In contrast, household borrowing continues to fuel credit growth. The increase in household debt has been broad-based with personal loans, particularly for credit cards and automobiles showing rapid growth in addition to residential mortgages. The assessment of macro-financial risks from the rapid increase of household credit is hindered by a lack of available data on property prices, household debt service and loan-to-value (LTV) ratios. However, anecdotal evidence suggests that property prices have risen in tandem with credit. The rapid increase of household debt, which occurred in an environment of very low interest rates, could present a significant risk if the anticipated risk in global interest rates puts pressures on Panamanian interest, particularly as borrowing is primarily on a variable rate basis. Credit risks would rise, particularly in the event of a slowdown in the domestic economy or a correction in property prices, with anecdotal evidence suggestive of oversupply in some segments of property markets. Nonetheless, these risks could be offset by banks’ reportedly conservative lending practices, which have traditionally required low LTV ratios and the existing practice of automatic payroll deductions for household credit which limit debt service to 50 percent of households’ income. While credit to commerce has slowed, there is no data on corporate balance sheets available to assess the build-up of related macro-financial risks.


Panama: Credit to the Private Sector

(Commercial Banks; year-over-year; in percent)

Citation: IMF Staff Country Reports 2017, 106; 10.5089/9781475597721.002.A003

Sources: National authorities; IMF staff calculations.

Credit to Households

(in percent of GDP)

Citation: IMF Staff Country Reports 2017, 106; 10.5089/9781475597721.002.A003

Source: SBP and Fund Staff calculations.

D. A Framework for Systemic Risk Oversight and Macroprudential Policy in Panama: Building on Panama’s Existing Framework

11. An effective framework for systemic risk oversight and macroprudential framework is multifaceted. First, an institutional environment needs to be put in place that will provide a supporting framework from which to assess overall risks to financial stability. Second, a framework for systemic risk oversight, guided by sufficient data, is important to effectively assess existing and emerging risks to financial stability. Finally, a framework for macroprudential policy, embedded in the institutional framework and guided by the systemic risk analysis, can be developed. This section assesses each of these components of Panama’s existing framework and provides recommendations to strengthen these elements in support of Panama’s ongoing efforts to promote financial stability.

Institutional Arrangement

12. A supportive institutional framework is needed to ensure adequate monitoring of systemic risks and enhance the effectiveness of macroprudential policy. Strong macroprudential policy frameworks are typically characterized with clear mandates that encourage a willingness to act by underpinning the legitimacy of policy action to address systemic risks. At the same time, adequate access to information and an effective surveillance capacity, supported by an appropriate set of macroprudential policy instruments, are needed to foster an ability to respond to systemic risks. Particularly in a decentralized supervisory structure, the institutional framework for macroprudential policy also needs to promote effective cooperation across institutions (IMF 2014).

13. The FCC provides a sound starting point for Panama to strengthen its existing framework for systemic risk analysis and macroprudential policy. Internationally, two models for macroprudential policy, differentiated primarily by the institution or committee to which the mandate is assigned, have prevailed. The first model assigns the macroprudential policy mandate to the central bank, while the second assigns it to a committee outside of the central bank, with the central bank participating on the macroprudential committee.6 With no central bank and an existing committee, the FCC, responsible for coordination of financial sector supervision and regulation in the decentralized supervisory environment, the second model is more relevant for Panama.7 Given the importance of the banking sector, the SBP will also need to continue to take a leadership role in systemic risk analysis and macroprudential policy, including through its role as chair of the FCC.

14. The FCC should be given a clear financial stability mandate and be given formal responsibility for macroprudential policy. In its existing state, the FCC does not have a formal role in systemic risk oversight or macroprudential policy. The FCC has a general objective “to recommend any other action that, in the best interests of the national financial sector, requires the exchange of information or coordination among financial supervisory entities”, along with coordination on regulation, licensing and other issues. This objective should facilitate coordination and information exchange. However, existing coordination has focused on microprudential supervision at the institution or group-level (i.e. for financial conglomerates), rather than on systemic oversight. Vesting the FCC with a clear mandate and responsibility can help to strengthen systemic risk oversight by assigning clear responsibility and foster the willingness to act by holding the committee responsible for maintaining overall financial stability. To enhance accountability the objective related to systemic risk oversight could be specified in law. With the SBP maintaining a leadership role in the assessment of systemic risk and implementation of macroprudential policy, consideration could also be given to vesting the SBP with an explicit financial stability mandate and power to conduct macroprudential policy.

15. Ongoing efforts to strengthen coordination through the FCC can facilitate its transition to Panama’s macroprudential authority. The SBP, the SMV and the SSRP have started to enhance cooperation through the FCC for oversight of financial conglomerates to effectively monitor group-wide activities and risks arising from these entities. As a basis for conglomerate supervision, some of the regulatory requirements for banks, including prudential requirements as well as corporate governance and risk management, have been enhanced to cover holding companies within their scope. Moreover, for the first time, the SBP, the SMV and the SSRP in 2017 will undertake joint inspections of financial conglomerates. Memoranda of Understanding (MOUs) are also in the process of being finalized to further strengthen information exchange. These are welcome steps from a microprudential standpoint, and could also be effective in addressing systemic risks since the effects of macroprudential tools targeting banks are partly extended to the non-bank sectors through conglomerate supervision. This enhanced cooperation on microprudential supervision can facilitate a transition toward stronger cooperation on oversight of systemic risks and macroprudential policy.

16. Over the medium-term, it may be useful to move toward an integrated supervisory model. Given the importance of financial conglomerates, coordination amongst supervisory authorities is imperative under the existing decentralized supervisory structure. Integration of supervisory responsibilities into a single organization could be an extension to existing efforts to strengthen coordination and may lower the cost of information exchange and coordination in regulatory and supervisory actions.8 The overall benefits and costs, as well as operational considerations, of the existing decentralized model should be compared to a more integrated model. In the event a more integrated supervisory model is pursued, the responsibility for systemic oversight and macroprudential policy should be vested with the new authority.

Systemic Risk Oversight

17. Macroprudential policy needs to be supported with adequate oversight of systemic risks. Systemic risk is “the risk of widespread disruption to the provision of financial services that is caused by an impairment of all or parts of the financial system and which can cause serious negative consequences for the real economy” (IMF/BIS/FSB 2009). As the objective of macroprudential policy is to limit systemic risk this cannot be accomplished without an understanding of the systemic risks facing an economy. Systemic risk is a multidimensional concept. Conceptually, systemic risk could be classified into two broad dimensions: the “time-dimension”, which refers to the build-up of systemic risk over time, while the “structural dimension” associated with interconnectedness and contagious effects in the financial system. Along the time dimension, systemic risks can arise from economy- wide vulnerabilities from excessive growth in total credit or assets prices, but may also arise from vulnerabilities specific to particular sectors like households and corporates such as growing credit to the household sector or increased exposures to the corporate sector. Systemic risks may also be related to liquidity including maturity mismatches or increased reliance of banks on non-core funding, or structural in nature, due to interconnections between and within classes of financial intermediaries, across borders or from market infrastructure for example.

18. Systemic risk monitoring is at nascent stage of development in Panama. With no single institution responsible for systemic risk oversight, the responsibility has, in practice, fallen primarily to the SBP given the importance of the banking sector. The SBP has made significant progress to strengthen systemic risk oversight. It publishes an annual financial stability report in which it summarizes its assessment of risks at the overall, sectoral, liquidity and structural levels. A multifaceted approach, including monitoring developments in credit and assets prices and conducting stress tests of the resiliency of the banking sector to macroeconomic and financial shocks is used to assess overall risks.9 Data gaps continue to hinder adequate monitoring of sectoral risks, particularly related to households, however, efforts are underway to develop new data on household income and indebtedness as well as property prices. The SBP has also begun to monitor structural risks to financial stability by developing a methodology to identify systemically important banks based on the Basel Committee’s methodology, and plans to begin network analysis of banks’ interconnections.10 The financial stability report also includes basic information on the non-bank segments of the financial sector, such as the number of entities, size of assets, and operational results. However, a more detailed assessment of overall risks requires cooperation of all supervisors.

19. The FCC could play an important role to further strengthen the assessment of systemic risks. Further strengthening the assessment of systemic risks facing the Panamanian financial sector requires enhanced cooperation of other supervisory agencies. Such cooperation will be critical to assess structural risks from interconnections across classes of financial intermediaries and to monitor systemically relevant developments in non-bank sectors. For the latter, primary areas of focus could include, household credits provided by non-bank deposit takers (e.g. credit cooperatives), and developments in capital-market instruments (e.g. asset managers) especially where they entail maturity and/or risk transformations. Vested with an explicit mandate for systemic risk oversight and macroprudential policy, the FCC would be the appropriate venue to cooperate on the assessment of systemic risk. Discussion and analysis of systemic risk should be a standing agenda item for FCC meetings along with regular information exchange between authorities, as an extension of ongoing coordination across supervisors.

20. The capacity for systemic risk oversight needs to be strengthened. Within the SBP there is a distinct unit (the Financial Studies Division), responsible for systemic risk oversight, however the unit is relatively small and would benefit from increased resources to fulfill its function. Enhancing risk-based supervision could be an important precursor for the non-bank sector to begin systemic risk oversight as the SMV and the SSRP remain in the early stages of transiting to risk-based supervision.11

21. Adequate data is needed to support systemic risk oversight. Table 3 provides a list of signals that could be used to strengthen the assessment of systemic risk and the relevance of macroprudential policy measures and indicates which of these signals are currently being monitored by the SBP for the banking sector. With the build-up of household credit presenting the most pressing financial stability risk, the priority should be to continue efforts to collect and analyze data on real estate prices, loan write-offs, LTVs, and leverage indicators for households and corporates and to continue to build capacity to analyze macro-financial linkages. Ongoing efforts to strengthen mechanisms for information exchange across supervisors will also need to continue to ensure that existing data gaps on the interconnections across segments of the financial system are filled to provide a complete overview of safety and soundness in the financial system.

Table 3:

Signals Indicating the Need for Macroprudential Policy1/

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The table focuses on the assessment of risks only from the time dimension. Bolded items are indicators currently being monitored by the SBP. Monitoring of house price growth and house price-to-income ratios is at the development stage as new data on house prices and household income is under development. Source: Adapted from (IMF 2014).

Macroprudential Policy Tools

22. Appropriate macroprudential tools should be employed to different types of systemic risk that are relevant in Panama. Macroprudential policy tools are defined as “the use of primarily prudential tools to limit systemic risk”.12 Different policy tools need to be applied to address different categories of systemic risks. Systemic risks from general credit boom and bust cycle should be addressed by broad-based capital tools such as capital buffers and leverage ratio requirements, while the risks in household or corporate sectors necessitate more targeted tools such as sector specific capital requirements and caps on LTV, DTI or DSTI ratios. Resilience against liquidity stress could be ensured by requiring enough liquid asset buffers and restrictions on funding structure or maturity mismatch. Lastly, the structural vulnerability from systemically important financial institutions (SIFIs) can be addressed by targeted prudential requirements, supervisory framework and enhanced resolvability, while other tools including large exposure limits and risk-weighting could also mitigate such risk. This section analyses the Panama’s current prudential policy framework with respect to each of these areas, and discuss recommended actions.

Broad-Based Macroprudential Policy Tools

23. The financial system needs to build enough capital buffers in stable periods to absorb losses in downturns and avoid procyclical lending. Broad-based macroprudential policy tools are designed to build these capital buffers and can include countercyclical capital buffers (CCBs), dynamic loan loss provisioning requirements (DPRs), leverage ratios, and caps on credit growth. These tools are complementary and aim to enhance the resilience of the financial sector, with a focus on the banking sector, and to reduce the procyclicality of bank lending. Capital buffers are designed to cover unexpected losses that occur in times of financial stress, by providing an additional buffer to be drawn on. Basel III has introduced two types of capital buffers: the capital conservation buffer is fixed at 2.5 percent in common equity Tier 1 (CET1), while the level of CCB is raised when boom in credit cycle is observed and lowered in the bust phase (that is, in a countercyclical manner) within the range of 0 and 2.5 percent.13 Dynamic provisioning (DPR) is complementary to the CCB, it requires loan-loss provisioning to cover expected losses (EL) over an average economic cycle. Provisioning based on DPR is thus more countercyclical compared with provisioning based on incurred losses. While there are several variations in specifications, DPRs typically allow banks to build a countercyclical reserve in boom periods and draw it down in downturn to cover losses.14 Lastly, the leverage ratio, which is also an element of Basel III, complements the risk-based capital requirements by containing the build-up of systemic risk through excessive leverage of financial institutions in a boom period. Finally, caps on credit-growth have been used by some countries to reduce excessive credit growth.

24. Panama has been focused on strengthening microprudential regulation to build appropriate capital buffers, which is an important precursor to macroprudential policy. The focus has primarily been on implementing Basel III capital and liquidity requirements:

  • Capital: The SBP revised its definition of regulatory capital in 2015 to align it with Basel III, introducing the minimum of 4.5 percent for CET1, 6 percent for Tier 1 (T1) and 8 percent for the total risk-based capital.15 Risk-weights for credit risk were revised in March 2016 to incorporate elements of Basel II, which have been implemented from July 2016.16 The scope of these requirements was also extended to bank holding companies, an important step to strengthen consolidated supervision. Basel III consistent capital charges for operational and market risk are expected to be implemented in 2017. Broadening the coverage to these important risk categories, while also strengthening monitoring and requirements for risk management, would further enhance resilience of the sector.17

  • Leverage ratio: A minimum requirement for leverage ratio was introduced together with the new definition of capital in 2015 and application started from the third quarter of 2016. The ratio is defined as CET1 capital over total non-risk-weighted exposures, with a minimum requirement of 3 percent. While aggregate statistics of the leverage ratio is not yet available, Panamanian banks’ RWA density (RWA divided by total non-risk-weighted credit exposure) around 70 percent, suggesting that banks are much less leveraged than the maximum allowed by leverage ratio regulation.18 Nevertheless, the monitoring of the ratio and its historical trend would give an insight on development of systemic risk.

25. As a complement to the strengthening of microprudential regulation, Panama also introduced DPR. The SBP introduced DPR in 2013, with application starting from 2014, as part of a rule for broader credit risk management and provisioning.19 In this system, the level of DPR for each bank is calculated every quarter based on loan outstanding (RWA-based) and the quarterly change in the amount of risk-weighted loan exposures, and quarterly variation in specific provisions.20 It is a capital account item that is disclosed as a stand-alone item and banks are required to maintain the amount of DPR in addition to the 8 percent regulatory minimum capital requirement. This specification resembles the “through-the-cycle accumulation systems” in Wezel et al. (2012), but has some features that are not present the original concept of DPR. For one thing, the draw-down in the downturn phase is restricted and subject to SBP’s decision21 and use of RWA is not a common feature of DPR. Considering these specifications, the Panamanian version of DPR seems to bear some similarities with capital buffers, in addition to the role as loan-loss provisioning. It remains to be seen if the DPR will be work in a countercyclical manner in downturn periods, with its effectiveness subject to the SBP ability to determine the appropriate commencement of the draw-down phase.

26. Additional capital buffers could be considered to further strengthen resilience of the financial system, but would need to be designed in consideration with existing DPRs. The presence of several financial conglomerates and systemically important banks in Panama reinforces the need to have strong capital buffers. The capital adequacy ratio of the national banking system has been hovering around 15 percent even under the updated capital definition, which effectively means banks on average would be able to absorb additional capital requirements.22 To further enhance the resilience of the system, capital conservation and/or counter-cyclical buffers could be introduced when the new minimum capital requirements are fully implemented in 2019. The SBPs recent development of a methodology to identify SIFIs could be the first step toward strengthening resiliency of the system to SIFIs and is an important first step toward consideration of additional capital buffers for these institutions. Given the similarity of the existing DPRs in Panama to capital buffers, the design of additional capital buffers, whether capital conservation of counter-cyclical, would need to consider existing DPRs.

Sector Specific Macroprudential Policy Tools

27. There are several policy options to address the pro-cyclical build-up of risks in specific sectors, usually the household or corporate sector. One of these tools is sectoral capital requirements, either in the form of higher risk weights to exposures to or additional capital requirements on specific economic sectors.23 Increases in the required amount of regulatory capital, would suppress credit provision to the sectors by raising the cost of capital, while also increasing the resilience of the lenders by requiring additional buffers against negative shocks stemming from those sectors. Another approach is to put quantitative caps on new credit provisions using measures on borrowers’ creditworthiness, such as loan-to value (LTV) ratio, debt-to-income (DTI) ratio or debt-service-income ratio (DSTI) in the case of household sector. Each of these tools directly restrict credit supply to excessively leveraged or indebted borrowers, while also enhancing financial resilience by lowering the probability of default (PD) or loss given default (LGD) by restricting high-risk credits. Tools targeting corporate sectors are conceptually the same, typically using LTVs and debt-service coverage (DSC) ratios as metrics.

28. The SBP has recently put in place sectoral risk-weights targeted at the household sector. While these risk-weights were primarily put in place as part of the ongoing strengthening of microprudential regulation, they could also be used as a macroprudential policy tool. The risk-weights introduced in March 2016 became effective in July 2016 and broadly align the treatment of household exposures in regulatory capital requirements with Basel II.24 Risk weights are 35 percent or 50 percent for qualifying residential mortgage exposures with lower LTV ratios and more recent appraisals, and 100 percent risk weight is applied to others.25 The baseline risk weight for personal loans is 100 percent if the term is less than five years and there is no collateral or any other credit risk mitigatory available.26 With banks on average currently operating well above the regulatory minimum capital requirements, the introduction of these sectoral risk weights and resulting overall tightening of risk-weights may not affect banks’ credit underwriting decisions and capital planning. In this context, it is not clear if these risk-weights could be effectively calibrated as a macroprudential tool to actively address the accumulation of sectoral risks and other targeted sectoral measures may be more effective.

29. The use of macroprudential policy tools targeted toward the household sector, particularly risks related to real estate is appropriate. The rapid growth of consumer and residential mortgage exposures in the recent years, as well as property prices, presents the most immediate macro-financial risk to the Panamanian economy. In this context, the existing sectoral risk weights could be complemented with additional measures that may, in the Panamanian context, better target the build-up of these risks such as a cap on LTV ratios and caps of DTI or DSTI ratios.

30. LTV-based macroprudential policy tools could help to mitigate the build-up of systemic risks from residential mortgages in Panama. Restrictions on LTV ratios for the underwriting of new credit, mostly residential mortgage exposures, directly limit or prohibit credit flows to high-risk counterparties, and hence could reduce credit provision as well as housing demand (credit demand channel). Restricting high-risk exposures also means lower PD or LGD on borrowers’ side, which effectively enhance the lenders’ resilience (resilience channel). Lower LTV also means increased down payment, which reduces borrowers’ incentive to default (anti-default channel). Lastly, the introduction of such regulation lowers the expectation on future housing prices, and hence lowers speculative incentives of the borrowers (expectation channel). As part of their risk management practices, Panamanian banks are already monitoring LTV ratios and many report the ratio and its distribution in annual and quarterly financial disclosure documents, suggesting that implementation of an LTV cap would be feasible for the sector. However, an important challenge will be to determine the appropriate calibration of the cap. While some of the large banks report that most their residential mortgage exposures have relatively low LTVs of under 80 percent and LTV is referenced in the capital adequacy regulations, there are no consolidated statistics available on existing LTV ratios and practices. Another consideration in the design of the overall effort to target the build-up of risks the real-estate sector is that it anecdotal evidence suggests that property prices are rising in Panama. In this environment, an LTV cap can become less binding over time, reducing its effectiveness.

31. Implementation of an LTV cap could be tailored to the structure of the Panamanian mortgage market. The simplest way to implement these policy tools is to put a single cap on all relevant exposures, such as a flat 80 percent cap on the LTV ratio, but they could be implemented in a more tailored and nuanced manner. For instance, the residential mortgage market in Panama is diverse and anecdotal evidence suggest that demand for the high-end market is slowing, while the mid-to-low income market still shows robust growth. The segment of under $120,000 are eligible for the government’s interest rate subsidies, which works to limit credit risk even for high LTV loans. The sectoral macroprudential tools could consider these characteristics to specifically target the most important segment in terms of systemic risk, while also minimizing the distortive effects.

32. A DTI or DSTI limit could complement an LTV cap. The channels through which the effect of DTI or DSTI limit is transmitted are similar to the LTV cap. However, household incomes tend to fluctuate less over the credit or economic cycle than property prices, making these indicators more stable. With property prices rising in Panama, these measures could potentially be more binding than an LTV cap at the current stage of the economic cycle and an important complement over the medium-term. In addition, the scope of a DTI or DSTI limit could be broader than an LTV cap limited to collateralized exposures and help to address the broader build-up of risks to the household sector from rapid growth in personal loans. Since DTI or DSTI are not defined or referenced in the current monitoring and regulatory framework, it is imperative to accumulate reliable data on the level and distribution of these ratios for effective implementation. On the other hand, the industry has been practicing automatic payroll deduction for repayment of household sector credit, which effectively limited DSTI to 50%, and the regulatory and monitoring framework could build on it.

Figure 2:
Figure 2:

Transmission Mechanism of Selected Sectoral Macroprudential Instruments

Citation: IMF Staff Country Reports 2017, 106; 10.5089/9781475597721.002.A003

Source: IMF (2014).
Liquidity tools

33. Liquidity tools aim to ensure the resilience of the financial system against systemic liquidity shocks, while also mitigating structural vulnerabilities such as excessive maturity mismatches. Examples include tools developed by Basel Committee of Banking Supervision (BCBS), such as the liquidity coverage ratio which is defined as the ratio of high quality liquid asset over assumed cash outflow in 30 days of severe liquidity stress.27 The Net Stable Funding Ratio (NSFR) aims to act on banks’ funding structure by requiring the amount of stable funding that matches holding of long-term assets. While these BCBS tools are mainly for internationally active banks, simpler measures with the same concepts could also have a similar policy effect. In Panama’s context, the liquid asset buffer is the most important given the lack of central bank and deposit insurance.

34. Current regulations on liquidity buffers could be enhanced. The existing quantitative liquidity regulation is on the legal liquidity index (LLI), defined as the ratio of liquid assets as a share of qualifying deposits. While the ratio has been hovering around 60 percent on average against the minimum of 30 percent, it is inadequate both as a regulatory and monitoring tool. For instance, the range of eligible liquid asset buffer is relatively broad and liquidity risks from non-traditional funding such as short-term inter-bank transactions are not considered, although they are relatively small in Panama as of now.28 The breakdown of the LLI is also used as the primary monitoring indicator for liquidity, but its long assumed horizon of 186 days make it less plausible as a monitoring tool.

35. The planned introduction of the LCR is an important step to strengthening liquidity at the institution-specific and systemic level. While similar conceptually to the LLI, the LCR covers a shorter time horizon of 30 days and the definition of High Quality Liquid Assets (HQLA) is narrower and more conservative. The scenario on cash outflow is calibrated based on the severe liquidity stress around September in 2008 and has comprehensive coverage regarding cash outflows. In fact, Komaromi, Hadzi-Vaskov and Wezel (2016) suggested that many banks could face liquidity shortage if LCR definition is applied. The SBP is expected to finalize the design of its LCR in 2017 for implementation beginning in 2018, which would be an important step to enhance resilience of banks against adverse liquidity shocks.

Structural tools

36. Structural macroprudential policy tools are designed to mitigate systemic risks which arising from interconnections within the financial sector and related spillover effects. The failure of SIFIs, for example, could pose negative externalities to the financial sector and broader economy, due to their size, interconnectedness within the financial system and lack of substitutability. The policy tools identified by the Financial Stability Board (FSB) and BCBS for SIFIs include additional loss absorbency in the form of capital buffers, intensive supervision and improved resolvability. In addition, prudential tools such as limits on large exposures could put disincentives on interbank transactions and thus mitigate excessive interconnectedness within the financial sector.

37. SBP has started designating systemically important banks (SIBs), but no policy measures have been implemented. The SBP has already identified a non-public list of SIBs based on indicators such as size, interconnectedness, cross-jurisdictional activities, complexity and substitutability. The SBP also considers cross-jurisdictional activities as country specific factors in its SIBs identification methodology, which is appropriate considering the importance of regionally active financial conglomerates.29 As for policy options to address risks from these institutions, a flat or bucketed capital surcharge is a possible options. In addition, monitoring of SIBs is currently not distinguished from other banks except as a part of general risk-based supervision, and a more intensive framework could be explicitly developed in the future.

38. The desirability of other policy measures to address interconnectedness should be assessed based on further analysis. To limit the concentration risk which could arise from failure of single counterparty, SBP limits the amount of an exposure to single counterparty (measured at group level) to 25% of T1 capital, in a manner which is broad in line with BCBS standard.30 While interbank transactions in Panama may not be as important as in advanced economies, there exist sizable interbank deposits. Banks maintain clearing account in the Banco Nacional de Panama (BNP), a state-owned bank, which is mandated by Law to provide clearing and settlements to other banks, making the BNP an important player in the interbank network.31 The necessity of further policy tools should be assessed based on further analysis of interconnectedness within the financial market (see paragraph 18).

E. Crisis Management Framework

39. In general, an effective financial safety net to address systemic risks consists of supervisory power with early intervention, a resolution framework, an independent central bank with able to provide emergency liquidity assistance (ELA), and deposit insurance. Supervisors need to identify vulnerabilities in financial institutions early enough so that they can take corrective actions to minimize the negative consequences for the financial system. The resolution framework for the financial sector should be able to resolve financial institutions without causing severe systemic disruption, as occurred during the global financial crisis. When a system-wide liquidity stress is present, discretionary emergency liquidity provision by the central bank might be necessary, while putting in place proper arrangements to mitigate any side effects including moral hazard. A deposit insurance scheme to protect certain amount of deposits could prevent bank runs and contagion to other financial institutions, again with appropriate governance and structure to mitigate moral hazard.

40. While the SBP has a strong track record of early intervention and orderly resolution of small banks, an upgrade of the resolution framework is desirable. The special resolution scheme for banks outside of regular corporate bankruptcy procedure is stipulated in the Banking Law, in which the SBP is considered as the single resolution authority. The scheme consists of three processes: temporary operational control of a bank by the SBP, reorganization of a bank through administrator, and compulsory liquidation. The SBP has resolved several small banks effectively without causing contagion, including the case of BUSA in 2015, which resulted in acquisition by another bank.32 However, the Fund’s TA in 2016 found out that there are still some gaps in the framework, including reorganizer’s lack of power regarding transfer of assets and liability of resolved entity, no rule on establishment of bridge institutions, and lack of power to override shareholders’ rights. These weaknesses resulted in the delayed process some of the recent cases.33 The SBP is now working to address these gaps with follow-up TA anticipated in 2017 to identify the road map for revision of the framework.

41. With no central bank, Panama lacks a lender of last resort (LOLR) and other supportive liquidity mechanisms have yet to be put in place. The Banco Nacional de Panama introduced a $500 million repo facility for local banks in 2016. The structure is a relatively straightforward repo transaction, accepting certain classes of local government and corporate bonds, subject to haircuts, and offering LIBOR plus 200 basis points. While the facility is welcome and could be used by banks to deal with idiosyncratic liquidity shocks, it is not necessarily restricted for LOLR purpose, and some banks have already utilized it for standard repo transactions. The coverage of $500 million is also insufficient for systemic liquidity shocks at less than one percent of the total deposits in the banking system. Importantly, the facility is not separated from the other regular operations of BNP, which could raise a concern for potential conflict of interests when seen as a tool for LOLR. Given these drawbacks, there remains the need to establish a liquidity facility with adequate resources to address systemic shocks with an independent structure.

42. The Panamanian authorities have not yet introduced deposit insurance. Historically, banks have preferred to self-insure against banks runs, rather than to contribute to funding for a public deposit insurance scheme. The only existing depositor protection mechanism is the priority on the repayment up to US$10,000 given in the process of liquidation. The costs and benefits of deposit insurance should be examined along with the upgrade of bank the resolution regime, considering the international best practices.34

43. Crisis management plans should to be created through the FCC. Given the lack of certain elements of an effective financial safety net, the relevant authorities (especially the SBP and the Ministry of Economy and Finance) need to enhance their crisis preparedness. A crisis management plan should be elaborated to coordinate the response of supervisory agencies. The FCC should be tasked with preparing such a plan, including through undertaking hypothetical simulation exercises.

F. Conclusions

44. As a regional financial center, Panama should improve its framework for systemic risk oversight, despite recent positive progress. Given the decentralized supervisory structure with no central bank, and given the backdrop of strong credit growth in recent years, Panama needs to ensure powers, responsibilities and capacities to effectively monitor the entire financial sector and make appropriate decisions regarding macroprudential policy. The FCC is an appropriate coordination body for supervisors and has strengthened its coordination on microprudential supervision of conglomerates, but it could be given an explicit mandate for systemic risk oversight and macroprudential policy, with the SBP continuing to play a leading role as chair of the FCC. The SBP has made significant progress to strengthen monitoring of systemic risk in banking sector, but it is still at nascent stage and data collection, organizational capacity and coordination with other bodies through the FCC could be further improved.

45. Tailored macroprudential policy tools should be developed in Panama, The SBP has already implemented Basel III based capital regulations as a basis for broad-based capital tools, and additional capital buffers could be considered while considering existing DPR. Systemic risks from the household sector are among the most important in Panama’s context, and a combination of LTV and DSTI could be effective to mitigate these risks. Full implementation of LCR is expected to ensure resilience of banking sector against systemic liquidity stresses, which is especially important given the lack of ELA and deposit insurance. The identification of SIFIs is a welcome step to address structural risk in the financial system, and it is recommended to develop regulatory/supervisory tools targeted to them.

46. Panama needs to address gaps in crisis management framework. While the SBP has intervened early and dealt with failure of small banks in the past, an update of the bank resolution framework could ensure orderly resolution even in cases of systemic failures. On the other hand, Panama still lacks appropriate ELA despite the recent introduction of repo facility by BNP, and creation of a liquidity facility to deal with systemic liquidity shock is desirable. Introduction of deposit insurance in line with the international standard would further enhance Panama’s crisis management framework. Lastly, the crisis management plan to coordinate response of authorities could be created, with facilitation through the FCC.


  • Basel Committee on Banking Supervision, 2006, “International Convergence of Capital Measurement and Capital Standards”, June 2006

  • Basel Committee on Banking Supervision, 2010, “Basel III: A global regulatory framework for more resilient banks and banking systems”, December 2010

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  • Basel Committee on Banking Supervision, 2012, “A Framework for Dealing with Domestic Systemically Important Banks”, October 2012

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  • Basel Committee on Banking Supervision, 2013b, “Global Systemically Important Banks: Updated Assessment Methodology and the Higher Loss Absorbency Requirement”, July 2013

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  • Basel Committee on Banking Supervision, 2014, “Supervisory Framework for Measuring and Controlling Large Exposures”, April 2014

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Prepared by Kimberly Beaton and Jun Kusumoto.


Offshore banks offer a wide range of services to non-residents but are not permitted to conduct domestic transactions except for transactions on the local interbank market. Offshore banks deposits in onshore banks are limited at 0.8 percent of their total assets.


Two small development banks, Banco de Desarollo Agropecuario (BDA) and Banco Hipotecario Nacional (BHN), grant medium-and long term credits to the rural sector and mortgage loans to low-income individuals respectively at subsidized rates.


The state-owned Banco Nacional de Panamá accounts for 26 percent of onshore banks’ foreign deposits.


Over 97 percent of premiums are local.


See also IMF (2011), Nier and others (2011) and IMF (2013) and IMF (2013b). IMF (2014) suggests that three models have prevailed as it differentiates between two types of models with the central bank being assigned the macroprudential policy mandate. In one model, the mandate is assigned to the central bank and in the other it is assigned to a dedicated committee within the central bank structure. We consider these models jointly.


IMF (2013b) also evaluates the appropriateness of various institutional models of macroprudential policy for Panama and recommends that the FCC be given a clear financial stability mandate and be given responsibility for macroprudential policy.


While it is not discussed in depth here, information exchange from AML/CFT, such as suspicious financial transactions, customers and their ultimate beneficial owners, is also important in this context.


Stress tests consider the impact of both macroeconomic and interest rate shocks to the banking sector (for baseline, moderate stress and severe stress scenarios) through their impact on nonperforming loans and bank capital adequacy. An early warning indicator system is also in place to monitor credit risks. Financial stability maps and a financial stability index are also used to inform the assessment of overall risks to financial stability.


Panama is also participating in a regional initiative, coordinated through the Central American Council of Superintendents of Banks, Insurers, and other Financial Institutions (CCSBSO), to strengthen the monitoring of systemic risks to regional financial stability.


The SMV have received series of TA on risk-based supervision starting from 2014. The SSRP is also receiving support from outside consultancy.


See BCBS (2010) for Basel III framework. While these capital buffers are not considered “regulatory minimum”, a bank needs to restrict payout of its earning (hence conserving its capital) where there is a breach of required buffer level.


See Wezel, Chan-Lau and Columba (2011) for detailed discussion of the framework.


Regulation No.001–2015. The definitions of capital are consistent with Basel III except for technical features such as loss absorbency at the non-viability of Additional Tier 1 (AT1) and Tier 2 (T2), and the automatic write-down or conversion of AT1. The strengthened minimum capital requirements are being phased-in, starting from 3.75 percent for CET1 and 5.25 percent for T1, and through January 2019.


Regulation No.003–2016.


For instance, investment in securities consist around 15% of the balance sheet of the banking system. While there is no breakdown for purposes of securities holding at the system level, some of the largest banks classify majority of their holding as available-for-sale securities. Even if the size of pure trading operation is relatively small, the interest rate risk in the banking book would be an important risk factor. As for operational risk, compliance issue including AML/CFT could pose certain legal or reputational risks for banks (the latter is not included in the definition of operational risk by the Basel Committee of Banking Supervision (BCBS), it could be important in Panama’s context).


Based on the assumption that the banks’ capital base mostly consists of CET1.


Regulation No. 004–2013.


The amount of DPR in the period t is defined as DPR(t) = αL(t) + βmax{ΔL(t), 0} - SP(t), where α = 1.50%, β = 5.00%, L(t) = risk-weighted assets (RWA) for loans classified under the normal category, SP(t) = variation in the balance of specific reserves. The amount of DPR is capped at 2.5% of qualifying RWA, and is subject to the floor of 1.25% of qualifying RWA. Assuming the second and the third terms are relatively small compared with the first term, this system of DPR could tend to float around 1.50%.


The Article 37 of Regulation No. 004–2013 stipulates that the amount of DPR “cannot be less than the amount established in the previous quarter, unless the decrease is the result of a conversion to specific provisions”, and the SBP “will establish the criteria for the above conversion.


It should be noted that introduction of capital charges for market risk and operational risks could have negative impact on regulatory capital adequacy ratio.


Sectoral requirements can also be imposed on a segment of household or corporate borrowing.


See BCBS (2006) for details of treatments in Basel II.


35% risk-weight is available for mortgage for primary home if the LTV (based on the lowest value in the appraisal report) is less 80% and the appraisal value is less than three years old. The outstanding of qualifying exposures in the national banking system is about $2.7 billion, which is slightly about 20% of the local residential mortgage exposures. This relatively low share could be because of existence of exposures that are related to secondary homes or do not satisfy other criteria such as periods after the last appraisal, even though some of them might have LTV less than 80%.


Basel II allows 75% risk-weight for retail exposures satisfying certain criteria, which is not implemented in Panama.


There are some restrictions or haircuts based on the ratings of the issuers. In addition, the loan inflows within 186- day horizon could be included as liquid assets up to 50%.


It is an element for the methodology for Global SIBs, but not included for Domestic-SIBs. See BCBS 2012 and BCBS 2013b for each methodology.


Article 5, Law No. 4 of 2006.


The BUSA was one of the small banks with the asset size of US$372 million as of May 2015.


For instance, the SBP intervened with the Balboa Bank & Trust on May 5 in 2016, and the reorganization procedures have been extended multiple times.

Panama: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.