Peru
Financial System Stability Assessment
Author:
International Monetary Fund. Monetary and Capital Markets Department
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Publication Date:
25 Jul 2018
eISBN:
9781484370667
Language:
English
Keywords:
ISCR; CR; bank; bank capital requirement; Peruvian bank resolution framework; sensitivity analysis; CFT supervision; capital adequacy; conservation buffer
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Peru’s financial system has developed and become more resilient since the previous FSAP in 2011, but some challenges remain. Peru’s main vulnerabilities are external, especially related to growth in trading partners (due to reliance on commodity exports), and exchange rate depreciation (due to significant dollarization), which were confirmed by the Growth-at-Risk (GaR) analysis. Peru is also vulnerable to domestic headwinds, related to uncertainty and spillovers from the ongoing Lava Jato investigation. The banking sector remains highly concentrated, with the four largest banks accounting for 83 percent of total private banking sector assets. These top four banks are all classified as domestic-systemically important banks (D-SIBs) and hence are subject to elevated supervision. The mission’s stress-test analysis showed that the banking system is largely resilient to adverse shocks, largely because of banks’ initial strong capital buffers and profitability. In the adverse scenario, all large banks experience credit losses, but initial high capital and profitability help them remain above the minimum regulatory capital adequacy ratio (CAR) threshold of 10 percent, while, for a few small banks, the CARs fall below the regulatory threshold. The overall banking system’s profits decline substantially in the adverse scenario, with some banks facing losses, but the aggregate capital shortfall for these banks is modest. The interconnectedness/contagion analysis showed that the joint probability of distress across all banks has fallen since the post-global financial crisis peak level it reached in 2010. However, shocks that affect credit exposures, which are strongly correlated among large banks, have the potential to become systemic events, since the banking system is concentrated.

Abstract

Peru’s financial system has developed and become more resilient since the previous FSAP in 2011, but some challenges remain. Peru’s main vulnerabilities are external, especially related to growth in trading partners (due to reliance on commodity exports), and exchange rate depreciation (due to significant dollarization), which were confirmed by the Growth-at-Risk (GaR) analysis. Peru is also vulnerable to domestic headwinds, related to uncertainty and spillovers from the ongoing Lava Jato investigation. The banking sector remains highly concentrated, with the four largest banks accounting for 83 percent of total private banking sector assets. These top four banks are all classified as domestic-systemically important banks (D-SIBs) and hence are subject to elevated supervision. The mission’s stress-test analysis showed that the banking system is largely resilient to adverse shocks, largely because of banks’ initial strong capital buffers and profitability. In the adverse scenario, all large banks experience credit losses, but initial high capital and profitability help them remain above the minimum regulatory capital adequacy ratio (CAR) threshold of 10 percent, while, for a few small banks, the CARs fall below the regulatory threshold. The overall banking system’s profits decline substantially in the adverse scenario, with some banks facing losses, but the aggregate capital shortfall for these banks is modest. The interconnectedness/contagion analysis showed that the joint probability of distress across all banks has fallen since the post-global financial crisis peak level it reached in 2010. However, shocks that affect credit exposures, which are strongly correlated among large banks, have the potential to become systemic events, since the banking system is concentrated.

Executive Summary

Peru’s financial system has developed and become more resilient since the previous FSAP in 2011, but some challenges remain. Peru’s main vulnerabilities are external, especially related to growth in trading partners (due to reliance on commodity exports), and exchange rate depreciation (due to significant dollarization), which were confirmed by the Growth-at-Risk (GaR) analysis. Peru is also vulnerable to domestic headwinds, related to uncertainty and spillovers from the ongoing Lava Jato investigation. The banking sector remains highly concentrated, with the four largest banks accounting for 83 percent of total private banking sector assets. These top four banks are all classified as domestic-systemically important banks (D-SIBs) and hence are subject to elevated supervision. The mission’s stress-test analysis showed that the banking system is largely resilient to adverse shocks, largely because of banks’ initial strong capital buffers and profitability. In the adverse scenario, all large banks experience credit losses, but initial high capital and profitability help them remain above the minimum regulatory capital adequacy ratio (CAR) threshold of 10 percent, while, for a few small banks, the CARs fall below the regulatory threshold. The overall banking system’s profits decline substantially in the adverse scenario, with some banks facing losses, but the aggregate capital shortfall for these banks is modest. The interconnectedness/contagion analysis showed that the joint probability of distress across all banks has fallen since the post-global financial crisis peak level it reached in 2010. However, shocks that affect credit exposures, which are strongly correlated among large banks, have the potential to become systemic events, since the banking system is concentrated.

Policy action is needed to address these remaining challenges to strengthen financial stability.

  • Increasing the risk weights for foreign currency loans consistent with Basel III requirements would be an important refinement, given the high level of dollarization and its potential risks.

  • Countercyclical provisions should be strengthened to help smaller banks, which are more exposed to the macroeconomic cycle, build buffers against potential shocks.

  • The capital surcharges for systemic banks should be increased to levels in line with the Basel III framework in order to build further resilience against potential losses, given the high level of concentration and the strong correlation of credit risk among banks.

  • The current uncertainty due to the continuing Lava Jato corruption investigation makes continued close monitoring of banks’ off-balance sheet exposures by the Superintendencia de Banca y Seguros del Perú (SBS) a priority.

  • The macroprudential toolkit needs to be continuously reviewed to ensure that the SBS and the Banco Central de Reserva del Peru (BCRP) stand ready—as they have been—with the instruments needed to address potential systemic risks.

Peru’s macroprudential framework functions effectively, but can be improved even further. An enhanced mandate to the BCRP and SBS for macroprudential policy would be desirable to foster the willingness and ability to act. Implementing a memorandum of understanding (MoU) to strengthen coordination between the BCRP and SBS would reduce any tendency toward policy inaction, help improve accountability and safeguard the strong institutional norms currently in place. In doing so, it is also important to preserve the institutional independence of the separate policy functions of the BCRP and SBS. New risk-monitoring tools to help assess systemic risks could also be introduced, such as growth-at-risk, systemic risk models, and monitoring of corporate sector vulnerabilities.

The SBS has made significant progress on the implementation of the Basel III regulatory reform agenda. The implemented approaches for the capital and liquidity regulatory framework in Peru aim to achieve the same objectives and broadly equivalent overall capital levels recommended by the Basel framework. The SBS uses a robust supervisory approach and has been moving toward a more risk-based framework for both banks and insurance companies. While the authorities are currently supervising the activities of financial and mixed conglomerates in Peru, it would be important to amend the law to be able to more effectively regulate and supervise these conglomerates on a consolidated basis. Also, the SBS should make enhancements to the supervisory approach to financial conglomerates, and among others to the supervisory group capital adequacy assessment. Extending the supervisory perimeter of the SBS to include unsupervised cooperatives is important to strengthen financial system oversight.

Although the current legal framework provides for interagency cooperation when dealing with certain crisis situations, a high-level coordinating committee should be formed to assist in preparing for and managing a systemic financial crisis. Besides legislative support for a crisis management coordinating committee (CC), a MoU should be entered into between the members of this CC and other relevant entities. It should be based on each authority’s statutory duties, elaborate on the role of each authority in crisis management, and set out the expectation of cooperation among them toward the shared goal of financial stability.

Strengthening fixed-income markets while fostering financial stability will be an important part of the development agenda. Developing the repo markets would better facilitate liquidity management. The public debt-management strategy should prioritize issuance around benchmark tenors to deepen fixed-income markets. It would also be important to review the taxation of capital-markets instruments to ensure a level playing field with bank savings products. Improvement in infrastructure and trading facilities should further support market development.

Measures are required to improve the pension system to reduce inequities and enhance social protection. While the authorities are evaluating different alternatives for a long-term strategy to improve the pension system, there is an urgent need to repeal the current law that allows for almost a full lump-sum withdrawal when contributors reach minimum retirement age, and to consider incentives to improve replacement rates, including incentives to increase overall contribution rates, and incentives to purchase fixed-term annuities for workers, and to lower overall costs.

Table 1.

Peru: FSAP Key Recommendations

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Financial Structure

1. The financial system is dominated by banks (Table 2). The top four banks (two of which are foreign) are classified as D-SIBs and hence are subject to elevated supervision. The remainder of the financial system is dominated by two large financial conglomerates and by the private defined-contribution pension system, comprised of four fund managers within the Administradora de Fondos de Pensiones (AFP), whose investments comprise about 23 percent of total financial-sector assets. A wide range of microfinance institutions (MFIs) also offer financial services, often in rural areas and for the lower-income urban population.

Table 2.

Peru: Financial Sector Structure

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Sources: BCRP; SBS; BIS Debt Securities Statistics and IMF staff estimates.

2. Domestic capital markets remain shallow and illiquid. Despite an increase in the number of listed companies over the past decade, the local stock market’s capitalization as a share of GDP has increased only marginally, and the turnover ratio has remained mostly unchanged in the past 5 years at around 3.5 percent. Local-currency bond markets in government and private-sector securities remain subdued despite some efforts to increase liquidity. Domestic currency money markets are relatively small, are of short maturity, and are dominated by unsecured interbank transactions. The repo market is at a nascent stage and relies almost uniquely on the certificates of deposit (CDs) issued by the BCRP as underlying instruments. However, this market is still shallow and despite the development of a repo master agreement in 2015, as activity is sporadic, partly due to high transaction and settlement costs.

3. Financial soundness indicators suggest that banks are profitable and well-capitalized with low nonperforming loans (NPLs) and strong provisions (Table 3 and Appendix II). Corporate lending is diversified across industries. Profitability is still high, and return on assets has remained stable at around 2 percent, even in the face of declining commodity prices, exchange-rate depreciation, and the growth slowdowns around 2014 and in late 2016. The Peruvian banking system is also one of the high performers in terms of profitability, among the regional peers (Figure 1).

Table 3.

Peru: Key Financial Soundness Indicators

(Year-end in percent)

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Sources: IMF Financial Soundness Indicators and IMF staff estimates.
Figure 1.
Figure 1.

Peru: Financial Soundness Indicators Amongst Peers

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: IMF, Financial Soundness Indicators database.

4. Banks hold large volumes of very liquid assets, largely due to the high reserve requirements of BCRP. The (marginal) rate of reserve requirement for foreign-currency liabilities stood at 36 percent at the end of March 2018, and it was as high as 70 percent in December 2016. As a result, more than 17 percent of bank assets are very liquid assets, mostly cash and central bank reserves.

5. NPLs have been rising slowly (3.3 percent at end- 2017), mainly in the medium-sized enterprises segments of the marketplace, which are more affected by the economic cycle. They nevertheless account for only a small share of the system (Figure 2). The recent increase in NPLs is largely due to the pick-up in delinquencies among dollar loans to small-to-medium enterprises and individuals (mainly car loans) that have less capacity to protect themselves against exchange-rate risk.1 NPLs have remained at a low and stable level in the segments of corporates loans and mortgages.

Figure 2.
Figure 2.

Peru: Credit Delinquency

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: BCRP.

Vulnerabilities

6. Peru has been one of the top-performing Latin American economies over the past decade, and prospects remain sound. Despite a challenging external environment, Peru’s average GDP growth exceeded 5 percent during the period 2008 to 2016, while inflation remained subdued, averaging 3.25 percent per year. Real GDP growth slowed down in 2017, largely due to the impact of the El Niño flooding and uncertainty caused by the Lava Jato investigation, and is estimated to have closed the year at 2.5 percent (Appendix I). In the coming years, Peru is expected to grow near potential (4.0 percent), driven by increasing investment.

7. The credit cycle shows a negative gap, but may be at a turning point. Estimates of the credit cycle, which featured an expansionary phase until the end of 2015, show a negative gap since late 2016. Private credit growth, which has been robust against a backdrop of firm economic activity and continued financial deepening, moderated in 2016 and the first half of 2017, slowing to around 5 percent year-over-year in both years from 14 percent in 2015. Credit growth has, however, accelerated since the second half of 2017 supported by monetary policy actions, and improved terms of trade. Tighter global monetary conditions could moderate the pace of the credit recovery, but are unlikely to fully offset the impact of the credit drivers mentioned above.

uA01fig01

Bank Credit to Private Sector

(Relative to trend, percent)

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: Haver, IMF staff calculations.

8. Housing prices have remained stable (Figure 3). This resilience is probably the result of the strong improvement in the fundamentals of the housing market over nearly two decades. Furthermore, improved economic conditions led to a significant decline in mortgage interest rates, a substantial de-dollarization of mortgage lending, and an increase in mortgage credit. Although indicators of the price-to-rent ratio show that Peru stands relatively high among Latin American countries, the absolute value of this indicator does not appear excessive, especially when compared to a broader sample of countries. In addition, property price indexes in Peru only reflect the capital, Lima, which has a higher population growth rate and a higher urbanization level than the rest of the country.

Figure 3.
Figure 3.

Peru: Housing Market Indicators

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

9. Although financial dollarization has declined since the early 2000s, it remains high. After the experience of high dollarization during the1990s, a sustained period of macroeconomic stability and reduced exchange rate volatility led to a gradual decline of dollarization in the financial system. The strong exchange rate depreciation between May 2013 and February 2016 led to a partial reversal of the de-dollarization trend in deposits. Credit de-dollarization, however, has continued, supported by policies and actions implemented by BCRP and the SBS during this period, including disincentivizing lending in foreign currencies, such as through using de-dollarization repos, setting FX credit-reduction targets, and instituting additional capital surcharges on dollar lending. At the end of 2017, under one-third of the credit in the banking system consisted of FX credit, while the FX share of deposits was approximately 40 percent.

uA01fig02

Peru: Credit and Deposit Dollarization and the Exchange Rate

(In percent (LHS), Soles per USD (RHS))

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Sources: BCRPand IMF staff calculations.

10. The corporate sector is resilient in general, but domestic-oriented sectors’ debt repayment capacity is relatively more sensitive to shocks than other sectors (Figure 4). Staff sensitivity analysis suggests that, based on an analysis of 93 listed firms, the median interest coverage ratio remains above one when a range of FX, earnings, and interest expense shocks are applied.2 However, this result masks sectoral vulnerabilities. The share of distressed debt in the domestic-oriented sector doubles after the shock. Guarantees to the construction sector pose an indirect risk to banks, an area where the SBS needs to monitor information closely.

Figure 4.
Figure 4.

Peru: Corporate Sector Sensitivity Analysis

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: S&P Capital IQ, Staff calculations.

11. The following vulnerabilities and the risks associated with Peru’s financial system formed the basis of the financial stability analysis of the FSAP (Appendix IV).

  • Peru remains vulnerable to commodity price volatility. Mineral exports—largely copper, also gold, lead, and zinc—correspond to a sizeable portion of the economy, representing about 60 percent of total goods exports and slightly over 11 percent of GDP. Thus, structurally weak growth or a significant slowdown affecting major trading partners can worsen the current account deficit (as in 2014, following a marked drop in metal prices) and weaken growth.

  • High financial dollarization continues to be a source of structural vulnerability. The current levels of credit and deposit dollarization in the financial system are still a source of risk for private sector balance sheets and can exacerbate the contractionary impact of external and domestic shocks. A sharp depreciation can increase defaults among businesses and households that have FX debt, which could lead to higher credit losses for banks.

  • Peru is also vulnerable to domestic headwinds. Uncertainty due to the ongoing Lava Jato corruption investigation is another source of vulnerability. The potential for an extended period of economic and political uncertainty affects the risk appetite of the banking sector, which can reduce investments and infrastructure rebuilding efforts. These factors are accompanied by Peru’s general vulnerability to extreme weather events such as the El Niño phenomenon, which can cause damage to infrastructure and reduce mining and agricultural production.

12. The growth-at-risk (GaR) exercise identified external conditions, leverage, and price of risk in Peru as major risk factors that can lead to tail outcomes in terms of GDP growth, consistent with the vulnerabilities identified above. The GaR framework incorporated almost 30 Peru-specific macroeconomic and financial variables to model the conditional distribution of future GDP growth distribution at different horizons, ranging from one quarter to three years. The three risk factors mentioned above were found to have a statistically significant impact on future GDP growth. External conditions (chart), which are mostly driven by the major trading partner’s economic growth and by foreign exchange developments in Peru, were identified as the most crucial factors that can lead to tail outcomes for GDP growth. The contribution of these two factors to tail risks is twice as high as the contribution of the other factors (leverage and price of risk) identified.

uA01fig03

Variables and Weights Comprising Peruvian External Conditions

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: IMF staff calculations based on data provided from BCRP and Haver.

Systemic Risk Assessment

A. Banking Sector Stress Tests

13. Against this background, the FSAP mission identified the key macrofinancial risks listed below (Appendix III, Risk Assessment Matrix [RAM]). These risks formed the basis of the shocks simulated in the macrofinancial stress scenario, where the shocks are amplified by the vulnerabilities that were identified above.

  • a) A significant slowdown in major export markets and an accompanying decline in the price of minerals, most importantly copper, could adversely affect growth in Peru. Low exports would lead to low growth, low investment, high structural unemployment, and low foreign direct investment, with fiscal pressures for the government. Higher funding needs of the government would lead to higher domestic yields. This would be accompanied by lower profits and less investment for the corporate sector, and lower income for the households. Banks would experience higher NPLs and credit losses due to their direct exposure to the mining sector, but also in their broader credit portfolio due to the overall decline in economic activity with lower investment, lower household income, and higher unemployment.

  • b) Tightening of global financial conditions and higher volatility will be accompanied by Sol depreciation. Tighter financial conditions would lead to capital outflows from Peru, funding pressures for banks, and higher borrowing costs for nonfinancial corporates borrowing from abroad. This would lead to a reduction in credit demand, investments, and employment. The depreciation of the Sol would exacerbate these conditions. Defaults would increase among businesses and households that have unhedged FX debt, which would lead to higher credit losses for banks. In addition to higher defaults, higher debt service costs for FX loans will reduce consumption and investment demand, further reducing growth.

  • c) Homegrown economic weakness related to uncertainty and spillovers from the ongoing Lava Jato investigation and a repeat of the El Niño event. This could undermine confidence in the economy, and reduce the risk appetite of the banking sector and investment by the nonfinancial businesses. Additionally, it could delay investment and infrastructure rebuilding, and lead to lower growth and, eventually, to higher NPLs. Variables and Weights Comprising Peruvian External Conditions

14. The stress tests conducted in collaboration with the SBS used two scenarios, baseline and adverse, over a three-year horizon. The banking sector stress tests included a top-down exercise based on an adverse macroeconomic scenario and sensitivity analyses. The adverse scenario envisions annual GDP growth shocks of -3.6 percent, -5.1 percent, and -0.9 percent, during the three-year scenario period (Figure 5). The cumulative likelihood of the Peruvian GDP growth path characterizing the adverse scenario was estimated via the GaR model. The likelihood of the adverse GDP growth of -1.2 percent (deviation of 5.1 percent from the baseline) in the second year is estimated to be 4.2 percent, indicating that the scenario is harsh but plausible. While the solvency stress test mostly analyzed on-balance-sheet exposures of banks, the FSAP team incorporated in the test assumptions on the off-balance-sheet guarantees to capture the risk of potential losses from these exposures.

uA01fig04

Peru Conditional GDP Distribution

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: IMF staff.
Figure 5.
Figure 5.

Peru: Stress Test Scenarios – Baseline and Adverse

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

15. The banking system overall appears resilient to severe macrofinancial shocks (Table 4 and Figure 6). The mission’s stress test showed that the banking system remains profitable on average, with small declines in system-wide capital levels. The resilience of banks’ solvency positions largely stems from their strong initial capital and profitability buffers, which allow them to absorb most of any potential credit and market losses. At the end of the adverse-scenario simulation, all large banks stay above the minimum regulatory CAR threshold of 10 percent, while a few small banks, which hold approximately 6 percent of the total private banking-sector assets, fall below the regulatory threshold. The total capital shortfall is insignificant, at less than 0.1 percent of GDP. Nevertheless, banks’ credit losses increase and their profits decline substantially in the adverse scenario, which is likely to lead to risk aversion. Losses experienced by any of the large banks have the potential to reduce total credit provision due to the highly concentrated nature of the banking system. Thus, the banking-sector concentration and correlated exposures of large banks are a source of vulnerability that deserves close monitoring.

Table 4.

Peru: Solvency Stress Test Results

(System Wide Averages)

article image
Source: IMF staff estimates
Figure 6.
Figure 6.

Peru: Stress Test Results – Capital Adequacy

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: IMF staff estimates.

16. The largest driver of the change in capital positions in the adverse scenario is loan-loss provisions (Figure 7). As the economic outlook deteriorates in the simulated adverse scenario, defaults increase significantly. With the loan-loss provisioning ratios also increasing from their baseline levels, the increase in defaults leads to large loan-loss provisions, reducing the capital of banks. The compression in net interest income contributes to the losses to a small extent during the scenario.

Figure 7.
Figure 7.

Peru: Stress-Test Results – Drivers of the Change in Capital Levels

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: IMF staff estimates.

17. The FSAP stress test also incorporated assumptions on off-balance-sheet guarantees to capture the risk of potential losses, particularly those due to the construction-sector-related guarantees. The realization of losses from the construction-sector-related guarantees has been near zero in the past, but, given the current environment, there might be higher losses than previously. The notional value of guarantees corresponds to 118 percent of the total capital of banks, on average. The FSAP team used 60 percent of guarantees as the basis for the loss estimation. The assumed triggering of construction-sector-related guarantees contributed to a decline of approximately 0.3 percentage points in the system-wide total capital ratio.

Liquidity Stress Tests

18. The FSAP assessed risks due to the potential volatility that banks’ funding sources might display via a cash-flow-based liquidity stress test, as well as regulatory ratios— the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR). The analysis indicates a limited impact of severe run-off rates of liabilities and haircuts on cash inflows on the overall liquidity position of banks. All banks in the stress test meet the regulatory minimum LCR requirement of 80 percent as of 2017, and in fact they are close to, or above, 100 percent. Similarly, most banks have NSFR well above 100 percent, with only two banks slightly below that level. This metric is currently not binding, and the SBS is working on finalizing the guidance and regulatory requirements related to NSFR.

19. The cash-flow-based liquidity stress test indicated that banks are largely resilient to structural shocks in the simulated scenario. This test used data on the temporal structure of cash flows generated by different liabilities and assets of banks and considered banks’ ability to generate cash from liquid as well as less-liquid assets. All banks maintain positive cash buffers up to one-year horizon, which includes central bank reserves. The results, however, were sensitive to the assumption on the run-off rates applied to the unused credit lines. An increase of the assumed run-off rate from 5 percent to 10 percent would lead three banks to experience cash shortfalls. The analysis also indicated that banks’ FX liquidity risk was rather limited, with the high level of FX reserve requirements providing a significant buffer against FX liquidity shocks.

Financial Interconnectedness and Contagion Analysis

20. There is limited scope for direct contagion across sub-sectors within Peru. The largest positions across sub-sectors are the deposits of pension funds in the banks and the loans of banks to financial companies and microcredit institutions (EDPs). However, these exposures are small in Peru: The banking sector’s reliance on deposits from the non-bank financial sector is limited (pension fund deposits represent less than 3 percent of bank funding), and banking-sector loans to non-bank financial entities remain below 2 percent of banks’ capital.3

uA01fig05

Financial Sector Interconnectedness

(in nominal terms, June 2017)

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Source: SBS

21. The domestic contagion analysis for banks did not find large risks of either direct exposure between the important banks or indirect risks coming from “fire sale” effects. The institutions that hold significant amounts of assets potentially subject to a price decline are also the best-capitalized institutions. A few small banks have large exposures (exceeding 40 percent of their capital) to other banks. Regulating the unsecured total exposure of each bank to the banking system would limit the risk that, were a large bank to default, a second wave of defaults by small banks would hurt the reputation (and thus the liquidity) of other banks.

22. The cross-border contagion analysis indicated that potential spillovers would be limited. Despite a large foreign presence in the banking system, direct cross-border banking exposures appear limited, in part because of the establishment of standalone foreign subsidiaries in Peru and limited cross-border activities of domestic Peruvian banks.

23. Although the risk of joint distress has fallen since 2010, banks’ common exposures have the potential to amplify shocks since the banking system is concentrated. The risk analysis showed that although the joint probability of distress (PoD) is low, if one bank is already in distress, it is likely that another bank would also experience distress (Figure 8). The PoD have come down since 2010, helped by adequate provisions and higher levels of regulatory capital. The large banks have similar loan portfolios, and credit risk is strongly correlated across banks. As a result of these common exposures, systemic risk indicators show that the conditional likelihood of cascades of distress (the likelihood that at least one additional bank is in distress when a first bank is already in distress) is high and could lead to a systemic event.

Figure 8.
Figure 8.

Peru: Sys temic Risk Metrics

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

24. The authorities should continue strengthening their capacity to monitor systemic risk and to strengthen resilience. The capital surcharges for systemic banks could be increased to levels in line with the Basel III framework in order to build further resilience given the concentration in the banking system. Countercyclical provisions could also be strengthened, which would help smaller banks, which are more exposed to the macroeconomic cycle, and build buffers against potential shocks. Increasing prudential requirements on unsecured interbank exposures would also help contain direct contagion risk. The SBS should also enhance its monitoring of banks’ off-balance-sheet exposures, especially exposures to the construction sector. Given the high levels of dollarization and its potential risks, increasing the risk weights for foreign currency loans consistent with Basel III requirements would be an important refinement. The macroprudential toolkit needs to be continuously reviewed to ensure the SBS and the BCRP have the instruments to address potential systemic risks.

Cyber Risk

25. Cyber risk is recognized by the authorities as an important financial stability risk. Cyber risk assessments are part of the operational risk-related regulations. All banks manage cyber risk under their operational risk frameworks, and include incorporating cyber risk in their business impact analysis and stress-testing exercises. They monitor cyber risk regularly, maintain organized cyber risk event databases, and have specific cyber risk insurance coverage. Some would like to see cyber risk standards more specifically included in regulations, aligned with international standards. The SBS has not carried out any cyber-attack simulations so far.

Macroprudential Framework and Policies

26. Peru’s macroprudential framework, albeit less formal than that of many other countries, has several elements that support effective macroprudential policy in line with IMF guidance. A culture and tradition of close coordination between the BCRP and the SBS has made the existing informal arrangement work well for the last several years. Although there is no designated macroprudential authority, policy coordination is achieved via several channels: high-level staff of the Ministerio de Economía y Finanzas (MEF), BCRP, and the SBS meet on a regular informal basis, and the SBS Superintendent attends the quarterly meetings of the BCRP Board of Directors. The BCRP and SBS have organizational structures to operationalize macroprudential policy. Both institutions conduct systemic risk monitoring and prepare separate Financial Stability Reports, although only the BCRP publishes (semiannually).

27. An enhanced mandate to BCRP and the SBS for macroprudential policy would be desirable to foster the willingness and ability to act. In the absence of such a mandate, there could be a tendency toward policy inaction. A mandate would also help improve accountability and safeguard the strong institutional norms currently in place. In establishing the mandate, it will be important to preserve the institutional independence of the separate policy functions of the BCRP and SBS.

28. The authorities have developed an extensive macroprudential toolkit that has served them well. The bulk of these instruments reside with the SBS, and tools include capital surcharges for systemically important financial institutions, capital conservation buffers, countercyclical capital requirements, dynamic provisioning, liquidity requirements, and capital surcharges for a range of risks. In recent years, the BCRP has implemented strong measures (reserve requirements, FX credit limits, and de-dollarization repos) to reduce dollarization, particularly in household borrowing. Nevertheless, the toolkit needs to be continuously reviewed to ensure that the instruments are appropriate to address potential systemic risks. Increasing risk weights for foreign-currency loans in line with Basel III guidelines would be an important refinement.

29. Implementing a MoU between the BCRP and SBS would further strengthen the coordination framework. The BCRP and SBS could more systematically collaborate on stress testing, including on the design of scenarios and the discussion of results and implications. Efforts should be made to close information gaps, particularly regarding corporate sector, financial cooperatives, housing market, and household-income data. New risk-monitoring tools that this FSAP has developed, could also be introduced, such as GaR, systemic risk models, and monitoring of corporate sector vulnerabilities. This would eventually pave the way for establishing a formal coordination mechanism.

Financial Sector Oversight

A. Banking Sector Oversight

30. The SBS followed up on most of the recommendations made in 2011Basel Core Principles (BCP) assessment (Annex 1).4 It expanded its resources and specialized units (for example, information-technology supervision), strengthened consolidated supervision, established continuous monitoring of beneficial ownership, and implemented Pillar 2. In addition, the supervision of more qualitative elements such as governance, management and internal controls, has been improved. One of the few recommendations that has remained unrealized related to the improvement of the legal protection of the SBS staff, for which the General Financial System Law (LGFS) would need to be amended.

31. The SBS has made considerable progress on the implementation of the Basel regulatory reform agenda. While the implemented methodology for the capital conservation buffer, counter-cyclical buffer, and the buffer and framework for D-SIBs is different than that of the Basel framework, the developed approach, tailored to the local characteristics of Peru’s financial system, aims to achieve the same objectives. However, the activation trigger of the counter-cyclical buffer could be enhanced, as well as the systemic and single name risk buffers as these are currently not commensurate with the risk they are supposed to cover. A remaining substantive difference is the use of the Basel II capital definition, which is embedded in the LGFS. The SBS also implemented the LCR, is in process of the implementation (tailored to the local characteristics) of the NSFR, and incorporated in its regulatory framework the Basel guidelines for corporate governance.

32. Notwithstanding the progress that has been made, some areas for improvement remain. These include the SBS’s internal governance, control and accountability framework, which could be strengthened by enhancing the position of the internal audit department and setting up an Audit Committee, its engagement with the Board of Directors of supervised institutions, and establishing recovery and resolution plans for D-SIBs as well as financial groups.

33. Consolidated supervision is a priority for the SBS, albeit impaired by gaps in the legal framework. Given the legal limitations, the SBS has done a remarkable job over recent years of gathering information on Peruvian financial and mixed conglomerates (in terms of shareholders, management and main activities), and requiring (through enforcement over the supervised entities and through moral suasion) prudential requirements and controls on a group level. However, the lack of formal legal powers to bring the holding company and the wider group within the supervisory perimeter is an issue that needs to be addressed. In addition to obtaining the necessary legal powers, the supervisory approach to the group-level assessment (including the establishment of a group rating and lead supervisor) of governance, risk management, capital adequacy and liquidity risk management needs enhancement.

Bank Regulatory Reform Impact

34. The empirical analysis showed that, in the case of Peru, there were no long-lasting effects of increased capital requirements on credit growth. 5 Over the past decade, Peru has significantly raised bank capital requirements, including the imposition of bank-specific capital buffers. The analysis showed that while loan growth was slightly lower in the first three months following a change in requirements, over any period longer than a quarter, loan growth did not significantly differ between periods with and without a change. These results suggest that gradual implementation coupled with high profitability allowed most Peruvian banks to comply with the higher capital requirements through retained earnings. This may have limited both the need and the incentive to reduce lending.

B. Insurance Supervision

35. Insurance supervision has been strengthened over the recent past, but further work needs to be done. Requirements for insurers’ risk management and internal controls have been considerably improved and are expected to be fully implemented during 2018. The SBS has begun the transition from a rules-based supervisory approach to a modern risk-based regime for capital requirements and supervision, but additional changes, including legislative ones, are required. In addition, current regulatory requirements for the valuation of assets and liabilities for solvency purposes need to be updated.

C. Supervision of Cooperatives

36. The FSAP reviewed the effectiveness of the prevailing oversight arrangements and assessed alternative strategies to incorporate the financial cooperatives within the perimeter of supervision by the SBS. The passage of the law that migrates the supervision of the savings and credit cooperatives (Cooperativas de Ahorro y Crédito: COOPAC) directly to the SBS, is important to strengthen financial system oversight and control risks. The law will introduce a three-tiered model of supervision: the SBS will supervise eight to ten of the largest COOPACs, Tier 2 institutions will be supervised by Federación de Cooperativas de Ahorro y Crédito (FENACREP) (as per the current model); and Tier 3 COOPACs will be registered and receive basic monitoring. This tiered system will be phased in over several years, during which FENACREP will play a key role.

37. After formalizing the supervision of cooperatives, there will be new responsibilities for deposit protection and the provision of liquidity in times of stress. The current legislation provides for the establishment of a deposit insurance scheme for cooperatives. Considering their unique challenges, such as their inability to directly participate in payment systems, it will be important to evaluate alternative policy options for managing liquidity in times of stress. In addition, adequate fit and proper tests for cooperative management and the ability to swiftly close problem cooperatives will contribute to the sector’s stability and soundness.

D. Financial Integrity

38. The authorities continue to deepen their understanding of money laundering/terrorism financing (ML/TF) risks. The authorities have completed the ML/TF national risk assessment and several sectoral risk assessments. Drug trafficking, corruption, and environmental crimes were identified as key threats, while the informal economy’s size and the inadequate controls over movement of cash were listed as major vulnerabilities. The acquisition of real estate was recently noted as a significant ML typology. Following the 2017 national policy (an update of 2011 policy), the authorities are finalizing a national plan for anti-money laundering/ combating the financing of terrorism (AML/CFT).

39. Strengthening risk-based AML/CFT supervision of banks and high-risk reporting entities should continue. The SBS assesses key risk factors for each bank and engages compliance officers to strengthen AML/CFT controls. The current low number of effective sanctions demonstrates the need to strengthen the SBS’s sanctioning powers. The financial intelligence unit (FIU) faces operational challenges in supervising more than 6,000 reporting entities (including notaries public). Some financial reporting entities (for example, money exchange businesses and loan companies) should be subject to effective admission licensing or registration frameworks, to facilitate the FIU’s AML/CFT supervision.

40. The effective use of other AML/CFT measures should mitigate ML/TF risks from drug trafficking and corruption and address vulnerabilities in the real estate sector. The FIU should continue engaging with reporting entities (especially high-risk ones) to improve the quality of suspicious transaction reports. Robust exchanges of information, including information now covered by bank and tax secrecy restrictions, should bolster financial investigations. Entity transparency (for example, the registry of the beneficial ownership of companies) and implementing customer due-diligence requirements for politically exposed persons should be enhanced to help detect the laundering of illicit proceeds. A law requiring property transactions above a given threshold to be coursed through the formal financial system would have a positive impact in limiting the ML/TF risks from the real estate sector.

Financial Safety Net and Crisis Management

41. The SBS has in place an effective process for the early identification and supervision of problem financial institutions. The SBS management team is long-tenured, and it possesses significant institutional and financial-industry knowledge. It applies well-seasoned judgment in supervisory actions. In addition, a broad array of internal processes has been established at the SBS’ senior-management level for the consideration of supervisory findings, the assignment of ratings, the development of future supervisory strategy, and a determination of whether and which enforcement actions may be necessary.

42. In addition, Peru’s legal foundation for early intervention and resolution is generally well developed, but the SBS’s available remedies and actions are subject to broad judicial review, reflecting the constitutional power of the judicial system. The LGFS provides for a special resolution regime and an SBS administrative process for failing and liquidating banks. However, the Peruvian courts could reverse SBS decisions on the grounds of illegality (for example, lack of compliance with the legal framework, due process of law). In this regard, it would be preferable for the legal framework to limit the remedies awarded under judicial review to monetary damages (rather than the annulment of the SBS decision).

43. The Peruvian bank resolution framework should be strengthened to deal with systemic cases. Currently, the SBS uses the LGFS-provided surveillance regime to prepare for intervention. In the surveillance regime, the SBS does not have the authority to take control of a problem institution. In the intervention stage, the SBS is allowed to take control but the operations of the entity cease by operation of law. The authorities should consider whether it would be useful in systemic cases for the SBS to have the authority to appoint a special administrator to take control and prepare to quickly resolve a failing bank. The special administrator would work under the supervision of the SBS. This would only be needed in systemic situations and when other remedies are not likely to be effective.

44. The mission recommends enhancing the emergency liquidity assistance (ELA) framework to ensure its effectiveness to respond to the individual and temporary needs of liquidity from certain banks to avoid disturbances to financial stability. This should include clearly defined solvency and collateralization requirements, along with enhanced supervision of recipient entities.

45. Peru’s deposit-insurance program was effective in the most recent failures, but its operational responsibilities may need to be expanded to allow it to carry out its functions in a systemic crisis. The SBS is the resolution authority, and it makes all decisions (with the concurrence of the BCRP and MEF in exceptional cases) as to the form of the resolution. The Fondo de Seguro de Depósitos (FSD) has no decision-making authority, but it funds the resolution decisions of the SBS. However, the challenges to FSD and SBS will increase in the event of a systemic crisis. As such, it would be advisable to enhance information-sharing between the SBS and the FSD to be better prepared to address both idiosyncratic and systemic situations. Ensuring confidence in the FSD and avoiding disruption to insured depositors would require a payout of most deposits within seven working days.

46. A high-level CC should be formed to assist in preparing for and managing a financial crisis. The CC could be comprised of the Minister of the MEF, the governor of the BCRP, the Superintendent of the SBS and the President of the FSD. Besides legislative support for a crisis management CC, a MoU should be entered into among the members of this CC and other relevant entities. It should be based on each authority’s statutory duties, elaborate on the role of each authority in crisis management, and set out the expectation of cooperation among them toward the shared goal of financial stability.

47. There should be one over-arching national contingency plan framework for financial stability based on each individual agency’s contingency plan. The plan can instill confidence that each agency can ensure the orderly management of issues and tasks in its area of responsibility. In addition, an over-arching national plan can ensure that procedures are well coordinated and that there are no gaps or overlaps that could lead to delays or confusion. However, effective

implementation in a crisis relies on the ex-ante creation of subcommittees and working groups, the designation of responsibilities, information collection and analysis, documentation, training, and drilling (simulations). Each member of the CC should create a working group to develop CPs, which could be combined to form a national contingency plan.

48. Extraordinary powers may be required to maintain financial stability in a crisis. Although the authorities have some resolution powers that can be used in systemic crisis situations, there should be a more comprehensive framework for such powers that provide for prompt resolution. During an earlier crisis period, a draft law pertaining to extraordinary powers, and the principles to be employed was developed but was not taken up. The authorities should again consider the proposed law, or a similar initiative.

Developmental Challenges

A. Financial Inclusion

49. Overall, a renewed focus on the implementation of financial inclusion projects is required in order to remain on track to meet the 2021 goals. The National Financial Inclusion Strategy, launched in 2015 and managed by a multisector financial inclusion committee, is working toward six goals (through 65 projects), including increasing the number of people with accounts at a formal financial institution from the current 43 percent level to 75 percent by 2021.6 Many studies and assessments have been completed, and the focus now is on implementation. In this context, Modelo Peru, a mobile-technology platform developed to increase financial inclusion, has had only limited uptake, partly because of lack of interoperability between banks and e-money accounts. It would benefit from a comprehensive review of its technical and business model shortcomings.

B. Pensions

50. It is imperative to implement incentives to retain workers in the private pension system, while also designing reforms to reduce inequities and enhance social protection. The 2016 law allows private pension system contributors that reach the minimum retirement age to withdraw up to 95.5 percent of their capitalized accounts. About 92 percent of contributors that have reached the entitlement age have been withdrawing the maximum allowed. This has led to a short-term expansion of consumption, as also evidenced by a drop in total premiums for annuities of 38 percent over two years as people have not reinvested their capitalized accounts into pension like products. As a result, long-term social protection goals will be undermined if prompt action is not taken. The 2016 law should be repealed, and further reforms should be designed to improve replacement rates and, increase overall contribution rates. Decreasing the overall cost of the system, for example, by lowering pension management fees through introducing caps on commissions would also be desirable. In the meantime, to design incentives for participants to remain in the current system, policy options include requiring employers to participate at the current contribution rates, making the employer-contributed share ineligible for withdrawal; and, providing incentives to purchase fixed-term annuities.

C. Market Conduct

51. Historically, El Instituto Nacional de Defensa de la Competencia y de la Protección de la Propiedad Intelectual (INDECOPI) has been the main body in charge of consumer protection in all sectors of the economy, and the SBS has been in charge of market conduct regarding financial services. In this context and in accordance with its mandate, in 2017 the SBS updated the regulatory framework to establish market conduct as an essential element of the enterprise culture, its institutional policies and incentives, and to ensure fair treatment for consumers throughout the financial product life cycle. The powers to address complaints pertaining to anti-competitive behavior in all areas of financial services remain with INDECOPI. Nevertheless, there have been limited actions taken by INDECOPI with respect to any such behaviors the financial service industry.

52. The authorities should evaluate the legal and institutional framework to improve competition in the financial sector without also compromising financial stability considerations. Currently, the SBS is limited with respect to the type of supervised entities and its scope in business conduct behaviors, which limits the overall spectrum of activities it can undertake. It is important to consider alternatives to enhance the legal and institutional framework to more effectively oversee all aspects of competition, market conduct, and consumer protection in financial services, while taking into consideration the necessary technical expertise in financial sector matters and minimizing potential conflicts between the different mandates.

D. Capital Markets

53. Concerted efforts should be devoted to confronting structural constraints and to further develop fixed-income markets at all tenors. Developing the repo markets would better facilitate liquidity management of the central bank and market participants and thus foster financial stability. The use of repos should be promoted by improving clearing and settlement infrastructure, and by lowering fees. The public debt management strategy should focus on, among other priorities, greater collaboration between BCRP and the government in short-term issuance, and prioritizing issuance in the medium- and long-term around benchmark tenors to deepen fixed-income markets. It would be also important to review taxation of capital-markets instruments to ensure an even playing field with bank savings products.

Appendix I. Selected Economic Indicators

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Sources: National authorities; UNDP Human Development Indicators; and Fund staff estimates/projections.

Defined as the percentage of households with total spending below the cost of a basic consumption basket.

Corresponds to depository corporations.

Foreign currency stocks are valued at end-of-period exchange rates.

Short-term debt is defined on a residual maturity basis and includes amortization of medium and long-term debt.

Adjusted by the economic cycle and commodity prices, and for non-structural commodity revenue. The latter uses as equilibrium commodity prices a moving average estimate that takes 5 years of historical prices and 3 years of forward prices according to IMF

Includes local currency debt held by non-residents and excludes global bonds held by residents.

Includes repayment certificates.

Appendix II. Detailed Financial Soundness Indicators

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Source: National authorities.

These indicators correspond to depository corporations.

Since July 2009, the regulatory capital requirement applied to all risks: credit, market and operational risk.

Since July 2009, Banking Law component establishes that the Tier I capital have to be defined, and Risk-weighted assets include overall risks (credit, market and operational).

Nonperforming loans are overdue loans after 15 days since the due date for commercial loans, and after 30 days for small businesses loans. In the case of mortgage, consumer and leasing loans, they are considered overdue after 30 days since the due date only for the non paid portion and after 90 days for all the credit. The overdue loans include credits under judicial resolution. Figures are net of specific provisions.

Tier I regulatory capital / Total Exposure (on-balance sheet exposures, derivative exposures and off-balance exposures converted into credit exposure equivalents using credit conversion factors).

Includes restructured loans, refinanced loans, and arrears. Refinanced loans refer to those loans subjected to either term and/or principal modifications with respect to the initial debt contract. Restructured loans refer to those loans whose payments have been restructured according to the “Ley General del Sistema Concursal.”

Financing to related parties corresponds to those loans to individuals and firms owning more than 4 percent of the bank.

Nonfinancial expenditures do not consider provisions nor depreciation.

Appendix III. Risk Assessment Matrix (RAM)1

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Appendix IV. Banking Sector Stress Testing Matrix (STeM)

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Appendix V. Implementation of 2011 FSAP Recommendations

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As reported by the authorities.

Risk-based supervision model still being developed.

A macroprudential policy coordination committee has not been established yet.

Appendix VI. The Effect of Higher Bank Capital Requirements on Credit in Peru1

1. The study focuses on banks’ regulatory capital requirements on credit in Peru. This project was undertaken in the broader context of the FSB’s “Post-Implementation Evaluation of the Effects of the G20 Financial Regulatory Reforms,” (FSB, July 2017).

2. In Peru, capital requirements have been raised in two phases. During 2009–2011, uniform minimum requirements were increased from 9.1 percent to 10 percent of risk-weighted assets (RWA). Subsequently, the SBS also introduced bank-specific capital buffers, that come on top of the 10 percent uniform minimum. The buffers were implemented in steps during 2012–2016. (Figure 1.) They consist of a countercyclical component, which can be switched on and off, and a non-cyclical component. At full implementation, buffer requirements typically ranged between 2 percent to 5 percent of RWA. (Figure 2.)

Appendix Figure 1.
Appendix Figure 1.

Actual and Required Capital

(Average, in percent of RWA)

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Notes: The chart plots average actual and required capital for the 14 banks in the sample, weighted by assets,
Appendix Figure 2.
Appendix Figure 2.

Heterogeneity of Capital Requirements

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Notes: The chart plots the distribution of capital requirements across the 14 banks in the sample. Each box shows the inter-quantile range and the horizontal line corresponds to the median. The two values above and below the box correspond to the levels of capital requirements closest to the 75th and 25th percentiles, respectively.

3. The second phase allows for an econometric analysis of the effect of capital requirements on credit that takes advantage of the buffers’ heterogeneity across banks. In the baseline specification, cumulative credit growth has been considered over longer periods “straddled” around jumps in capital requirements. Comparing credit growth across banks and over time reveals by how much, if any, banks faced with higher capital requirements grew their lending vis-à-vis banks with lower requirements. This constitutes a “difference-in-difference” analysis. By looking at increasingly longer straddles, it is possible to see how durable the effect was.

4. The following regression equation is estimated:

For r, s ∈ {0, 1, 2…},

Δ L t + r , t − s i = β r , s Δ K R t , t − 1 i + δ X t − s i + α i + τ t + ϵ t i ( 1 )

Here, the dependent variable is loan growth, while the key explanatory variable is the change in the required capital buffer. Formally, ΔLt+r,t−si is defined as the log-difference in the stock of outstanding gross loans of bank i between the end of quarter t + r and the end of quarter t – s. The change in the required capital buffer, ΔKRt,t−1i is defined as the percentage point difference in bank i’s capital requirement in quarters t versus t – 1. Standard errors are clustered at the bank level to allow for autocorrelation within banks.

5. The regression equation in (1) includes both bank and time fixed effects. Unobserved bank heterogeneity is absorbed by bank fixed effects, αi, while all macroeconomic and policy shocks affecting banks equally (for example, changes in economic growth and monetary policy) are absorbed by time fixed effects, τt. This means that the coefficients of interest, βr,s, are solely estimated off the degree to which an above-average increase in capital requirements leads to an above-average drop in credit growth.

6. To facilitate replicability of the analysis in other contexts, the set of time-varying, bank-specific controls, Xt−si, is parsimonious. It includes: (1) bank size, measured by the logarithm of total assets; (2) liquidity, defined as the ratio of liquid assets over total assets; (3) profitability, measured by the return on assets; (4) the ratio of risk weighted assets over total assets; and (5) “excess capital,” that is, capital adequacy ratio (CAR) minus capital requirement (KR).

7. Table 1 reports ordinary least squares estimates for specification (1) for progressively longer straddles around jumps in buffer requirements. Unweighted and weighted regressions are presented in adjacent columns where, in the latter, observations are weighted by bank assets to allow the largest banks to drive the results. In addition to ΔKRt,t−1i columns (1) and (2) only include bank and time fixed effects as regressors, while columns (3) and (4) add bank-specific controls, Xt−si. Subsequently, the period over which credit growth is calculated is progressively lengthened: columns (5)-(6) show the effect of capital on credit growth over a six-month period, from three months before the jump until three months after, while the effect over a one-year period straddling an increase is reported in columns (7)-(8).

8. Estimates point to a contemporaneous effect of capital on lending that “washes out” very quickly. Columns (1) -(4) reveal that a one percentage point increase in capital requirements is associated with a reduction in loan growth of 4 to 6 percentage points in the same quarter, and that this effect survives the introduction of bank-specific controls. However, columns (5) -(8) show that, for longer periods, the coefficient on ΔKR is not significantly different from zero. This means that, over half a year and more, loan growth does not significantly differ between periods with and without changes in capital requirements. Lengthening the straddle to 6 or 8 quarters— that is, 3 or 4 quarters on either side of a jump—does not change this conclusion.

9. This benign outcome suggests that the cost of raising additional capital was quite low for Peruvian banks. Alternatively, capital requirements may not have been binding and/or credit demand was extremely inelastic, allowing banks to pass on higher costs to borrowers without negatively affecting demand. However, the data reject the former hypothesis (Figure 3), while the literature has shown that, even in the short run, demand for credit tends to be quite elastic (see, for example, Karlan and Zinman, 2013).

Appendix Figure 3.
Appendix Figure 3.

Regressing Actual on Required Capital

Citation: IMF Staff Country Reports 2018, 238; 10.5089/9781484370667.002.A001

Notes: the chart plots average capital requirements and capital held for the 14 banks in the sample, weighted by the assets of each bank.

10. The apparently low cost of adjusting to higher capital levels in Peru may be due to a combination of the early announcement of reforms, the relatively slow speed of implementation, and the high profitability of banks. The reforms were officially announced one year before implementation started, allowing banks time to prepare. Implementation was spread over four years, allowing for a smooth adjustment. Finally, with a weighted average return on equity of around 20 percent (16 percent unweighted), Peruvian banks were highly profitable. While unprofitable banks can improve their capital adequacy only by compressing lending or issuing expensive new equity, highly profitable banks need not resort to either of these options: they can simply retain more earnings, making the transition to higher capital requirements easier, while muting the impact on credit.

Appendix Table 1.

OLS Estimates for Specification (1)

Effect of a jump in required buffers on loan growth, in increasing straddles of up to one year around the jump.

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Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

Appendix VII. Report on the Observance of Standards and Codes—Basel Core Principles for Effective Banking Supervision

1. This assessment of the implementation of the BCP in Peru has been completed as part of the Financial Sector Assessment Program (FSAP), jointly undertaken by the IMF and the World Bank in 2017. The assessment reflects the regulatory and supervisory framework in place as of the completion of the assessment. It requires a review not only of the legal framework, but also a detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. It is not intended to analyze the state of the banking sector or crisis management framework, which are addressed by other assessments conducted in this FSAP.

A. Information and Methodology Used for Assessment

2. This assessment was against the standard issued by the Basel Committee on Banking Supervision (BCBS) in 2012. Since the past BCP assessment, which was conducted in 2011, the BCP standard has been revised. The revised Core Principles (CPs) strengthen the requirements for supervisors, the approaches to supervision, and the supervisors’ expectations of banks through a greater focus on effective risk-based supervision and the need for early intervention and timely supervisory actions. Furthermore, the 2012 revision placed increased emphasis on corporate governance, and supervisors conducting sufficient reviews to determine compliance with regulatory requirements, and having a thorough understanding of the risk profile of banks and the banking system. This assessment for Peru was thus performed according to a significantly revised content and methodology, compared to the previous BCP assessment carried out in 2011.

3. The Peruvian authorities opted to be assessed against both the essential criteria (EC) and the additional criteria (AC), but graded based on EC only. To assess compliance, the BCP Methodology uses a set of EC and AC for each principle. The EC set out minimum baseline requirements for sound supervisory practices. The AC are recommended as the best practices against which the authorities of some more complex financial systems may agree to be assessed and graded. Peruvian authorities chose to be graded against the EC only.

4. Grading is not an exact science and the CPs can be met in different ways. The assessment of compliance with each principle is made on a qualitative basis. Compliance with some criteria may be more critical for effectiveness of supervision, depending on the situation and circumstances in each jurisdiction. Emphasis should be placed on the comments that accompany each CP’s grading, rather than on the grading itself.

5. The team appreciated the very high quality of cooperation received from the Superintendencia de Banca y Seguros del Perú (SBS). The team extends its thanks to the SBS staff who provided excellent cooperation, including extensive provision of documentation and access and for facilitating meetings with other stakeholders. In particular, the team would like to thank the SBS staff who responded to the extensive and detailed requests promptly and accurately during the assessment.

B. Preconditions for Effective Bank Supervision

6. An effective system of banking supervision needs to be able to develop, implement, monitor, and enforce supervisory policies under normal and stressed conditions. There are several elements or preconditions that are necessary for effective supervision:

  • Sound and sustainable macroeconomic policies: See the section ‘The Macrofinancial Context’ in this report.

  • A well-established framework for financial stability policy formulation: See the section ‘Macroprudential Framework and Policies’ in this report.

  • A well-developed public infrastructure: The General Financial System Law (LGSF) provides the SBS the mandate for financial sector supervision. The SBS issues the accounting rules and establishes the structure of the financial statements of financial institutions. The issued accounting standards are based (with some minor deviations) on the International Financial Reporting Standards (IFRS). The SBS also establishes the external audit requirements for supervised institutions, which are based on the International Standards on Auditing and Related Services issued by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC). The Securities Market Superintendence (SMV) is the government entity in charge of regulating and supervising securities market and security settlement systems, while the Central Bank regulates payment systems. The National Institute for the Protection of Competition and Copyright (INDECOPI) is responsible for protecting the rights of consumers and ensuring the adequacy of financial services based on the information provided, amongst other functions. Finally, the SBS, as established by the LGSF, manages a well-established Risk Registry. The Risk Registry is an integrated system for registering financial, credit, commercial and insurance risk, containing information on debtors of the supervised institutions. The Risk Registry provides global and systematised information to third parties, such as the commercial credit registries (thus becoming one of the sources of information of these registries), and individually to information owners, but also plays a key role in SBS’ credit risk supervision.

  • A clear framework for crisis management, recovery and resolution: See the section ‘Financial Safety Net and Crisis Management’ in this report.

  • Appropriate level of systemic protection (or public safety net): See the section ‘Financial Safety Net and Crisis Management’ in this report.

  • Effective market discipline: In addition to the disclosure requirements established by the SBS, the commercial banks (which are by Law required to be listed), are also subject to the disclosure requirements of the SMV, which include also the requirement to publish annually (as an appendix to the annual report) a self-assessment against the Corporate Governance Code. The required disclosures are published and accessible on the SMV website.

C. Main Findings

Responsibilities, Objectives, Powers, Independence, and Accountabilities (CPs 1–2)

7. SBS responsibilities, objectives and powers are clearly defined albeit impaired by legal limitations regarding consolidated supervision. SBS is the banking supervision authority in Peru and it has all the necessary powers to authorize banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns. A significant shortcoming, nevertheless, is that its supervisory powers are limited regarding direct access to parents and affiliates, including non-financial subsidiaries and other affiliates of the parent, all being outside of the direct supervisory perimeter. To redress the absence of this power, the SBS is working through the licensed subsidiaries in Peru and using its powers to put limitations on the licensed institutions if it observes weaknesses on a group level. However, the regulations imposed through this approach on financial groups, for which the SBS has assumed the role of home supervisor, are not as comprehensive (in particular regarding corporate governance and risk management) as the regulations for the licensed entities. These observed weaknesses in the regulatory framework for the supervision of financial groups, for which the SBS is or has assumed the role of home supervisor, have as a root cause the absence of adequate powers to include holding companies and affiliates in the scope of supervision.

8. SBS has operational independence and no budget constraints, however, further enhancements in terms of legal protection and accountability would be beneficial. Legal protection should be enhanced as current provisions extend only to the Superintendent and Deputy Superintendents and even in those cases covering only the first five years after they have left office. Governance and accountability arrangements have further room for improvement, particularly regarding the assessment of the effectiveness of supervisory activities and further disclosure to the public. This will require enhanced transparency of supervisory actions beyond the issuance of annual reports. Allocation of resources within banking supervision does consider the risk profile and systemic importance of individual banks, although the proportion of staff allocated to banks and banking groups, in comparison to the microfinance institutions might need to be reevaluated.

Cooperation, Consolidated Supervision and Home-Host Relationships (CPs 3, 12 and 13)

9. Cooperation and collaboration arrangements with local and foreign authorities are in place. Arrangements currently in place in Peru provide a framework for cooperation and collaboration with relevant domestic and foreign supervisors and do reflect the need to protect confidential information. SBS seems to be actively engaged in cross-border cooperation, including exchanges of information and cooperation on examinations, even beyond its supervisory powers. Particularly regarding domestic authorities, SBS does not seem to feel the need to exchange much information to perform its supervisory duties, although providing information as requested.

10. Consolidated Supervision is a priority for SBS, albeit impaired by the legal framework. Given the legal limitations, SBS has done a remarkable job over recent years in terms of gathering information on the conglomerates, monitoring their activities and requiring, by enforcing through the supervised entities and moral suasion, prudential requirements and controls, and to a certain extent, also acting as a “de facto” home supervisor. The lack of legal enforceability of supervisory requirements directly to the holding company and the existence of non-negligible cross-border operations (and considering that one of the financial groups has the strategy to look for expansion opportunities abroad), outside the direct supervisory perimeter are issues of concern. The fact that the holding company can have all types of investments in non-financial entities and its risk management and controls are not under the formal scrutiny of the SBS are also reasons for concern, even if the investments are deducted from the regulatory capital at the financial group level. Moreover, its supervisory approach to the group-level assessment of governance, risk management, capital adequacy and liquidity risk management needs enhancement.

Permissible activities, Licensing, Transfer of Ownership and Major Acquisitions (CPs 4 to 7)

11. SBS has a thorough authorizations regime, which would benefit from a few enhancements. Market entry is highly controlled and SBS does overall perform a thorough job in reviewing information provided for authorizations purposes. SBS has the power to review, reject and impose prudential conditions on proposals for transfer of significant ownership or controlling interest above 10 percent held directly or indirectly in existing banks to other parties. The legal and regulatory framework falls short in using the concept of significant influence as a qualitative indicator for significant ownership, which would encompass situations where in practice there is significant influence on the management or policies of the bank, even in situations of stakes below 10 percent. The SBS has the power to approve or reject major acquisitions or investments by a bank including establishment of cross-border operations. The limit established for investments in publicly traded companies (no more than 50 percent of the invested company, up to 10 percent of regulatory capital), nevertheless, might result in banks having high stakes and controlling interest/influence in non-financial companies.

Ongoing Supervision (CPs 8–10)

12. The SBS has a robust supervisory approach, moving towards a more risk-based framework. The supervisory approach is supported by a rating methodology that encompasses a forward-looking perspective, assessing and addressing risk emanating from banks and the banking system. Elements related to conglomerates of which a licensed institution is part are taken into account for overriding purposes, but are not embedded into the rating. SBS seems to have a deep knowledge of the operations and risk profile of the major banks operating in Peru, making effective use of a broad range of information sources. Interactions with senior management and board have been enhanced but there is still room for further improvement. Resolvability of banks is a topic yet to be tackled by SBS.

13. A broad range of techniques and tools, supported by a broad set of information and prudential reports, enable the implementation of the supervisory approach. The integration of its on and off-site activities has been beneficial and the split between a specialized risk Deputy Superintendence (SAR) and another one (SABM) in charge of individual banks seems to be working well. In addition to the on-site examinations, SBS produces an array of reports produced by both Superintendences, sometimes with overlap between them. Off-site surveillance is yet to acquire a platform similar as for the on-site activities, facilitating analysis and monitoring of follow up activities.

Corrective and Sanctioning Powers (CP 11)

14. Early action and moral suasion play an important role in SBS effectiveness. The broad powers granted by the legal framework, paired with a moral suasion culture have enabled SBS to successfully tackle supervisory concerns, acting at an early stage to address unsafe and unsound practices or activities that could pose risks to banks or to the banking system. SBS has experienced senior staff that ensure consistency in the application of the corrective actions. SBS would benefit, nevertheless, from written procedures operationalizing its broad legal powers into a range of supervisory tools to be systematically applied depending on the severity of the situation.

Corporate Governance and Risk Management (CPs14–15)

15. The SBS issued in 2017 a new Corporate Governance and Risk Management Regulation incorporating the main elements of the Basel Corporate Governance Principles for Banks. In its regulatory and supervisory framework, the SBS puts significant emphasis on risk management and corporate governance of the licensed institutions and sets clear expectations regarding the role and responsibilities of the Board and the structure of its committees. However, the actual engagement with the Board and individual Board members could be intensified as it is currently mainly limited to an annual meeting with one of the independent Board members.

16. The essential criteria for the evaluation of corporate governance apply explicitly to banks and banking groups. SBS’ governance and risk management regulation does not apply on a group-level for institutions for which the SBS is the home supervisor. As a result, the individual group Board members are not subject to a formal fit and propriety review by the SBS, group Board members are not required to sign-off on their responsibilities as required for Board members of supervised institutions, and the supervisory approach to corporate governance on a group-level is less developed. As mentioned, the root cause of the indirect supervision and less comprehensive regulatory framework for financial groups for which the SBS is the home supervisor, results from its limited powers in this regard.

17. The Consolidated Supervision Regulation to a certain extent redresses the fact that the risk management regulations do not apply on a group-wide basis. The Consolidated Supervision Regulation requires the licensed institution to assure that the group has adequate risk management frameworks in place. This indirect form of regulation and supervision seems currently to work, because the main activities of the Peruvian conglomerates are still taking place in Peru. However, this approach is not optimal and might become ineffective when the cross-border activities of these groups increase.

Capital Adequacy (CP 16)

18. The SBS has made significant progress on the implementation of the Basel III regulatory reform agenda. Although there are differences in the implementation, in particular regarding the different capital buffers, the implemented approaches aim to achieve the same objectives and broadly equivalent overall capital levels. Apart from introducing the Basel III capital definition and formally incorporating the supervisory review of the Internal Capital Adequacy Assessment Process (ICAAP) into account in SBS’ internal rating methodology, there are other elements that could be improved. For example, the countercyclical buffer is activated if GDP growth is above 5 percent, which may be not effective in situations where there is excessive credit growth when GDP growth is still below 5 percent. In addition, the systemic risk and single name risk buffers need to be reviewed as they are currently not commensurate with the risk they are supposed to cover. These issues have already been identified by the SBS and are part of the review of the Additional Capital Requirements Regulation that is currently taking place.

19. The supervisory group capital adequacy assessment needs enhancement. The group capital adequacy assessment could be further enhanced by also taking into account: i) the capital adequacy of the holding company on a solo level (in order to determine if the excess capital is available on a holding company level); ii) the location of capital within the conglomerate, including the risk of ringfencing/non-transferability of capital allocated to entities supervised by authorities abroad; iii) the extent to which excess capital at a group level can be completely allocated to support the financial activities of the conglomerate. The assessment of the consolidated capital adequacy does not take adequately into account the necessary adjustments to account for the change in accounting standards; solo financials based on SBS accounting standards, while consolidated financials might be based on IFRS (which could impact the provisioning levels and therefore the available capital on a consolidated basis).

Prudential Regulations and Requirements (CP17–CP25)

20. The regulatory and supervisory approach and practices regarding the other prudential regulations and requirements are in general sound. As observed in the 2011 BCP assessment, the market risk regulation is outdated. The SBS has recently issued a revised regulation for consultation to the industry, which when issued should bring this regulation again in line with international standards.1 In practice the outdated regulation has not constrained the SBS in conducting effective supervision. With regard to liquidity, the SBS has implemented the LCR (tailored to the local circumstances) and is in the process of implementing the NSFR. With the revised liquidity risk management regulation issued in 2012, the SBS also requires groups for which it acts as the home supervisor, to have liquidity contingency plans on a group level. While the revised regulation requiring liquidity contingency plans on a group level has been issued in 2012, the actual development of these plans is still in their initial phase.

Internal Control, Internal and External Audit, Financial Reporting and Disclosures (CP2628)

21. The regulatory and supervisory frameworks for internal control, audit and financial reporting and disclosures are adequate. Regarding disclosures, the SBS could further improve the qualitative disclosures by implementing the recommendations of Enhanced Disclosure Task Force of the Financial Stability Board and/or the implementation of Pillar 3. The SBS could also improve its engagement with the external auditors. In addition, it could assess more in depth whether the current provisioning requirements are adequate when compared with the new IFRS9 standard, while also considering possible issues as a result of the widening gap in accounting standards between supervised institutions (SBS standards) and consolidated financial groups (might be based on IFRS standards). Overall the frameworks covering these principles are considered adequate taking into account the current state of development and complexity of the financial markets and banking system.

Abuse of Financial Services (CP 29)

22. SBS has a robust AML/CFT framework, but the limited sanctions can potentially curb its effectiveness. The regulatory and supervisory framework has been strengthened in recent years with the issuance of the AML/CFT risk management regulation and continuous enhancements in supervisory procedures. An important limitation in the current framework is the fact that sanctioning for banks is confined to fines up to $ 250,000, not enough to curb behavior.

Appendix Table 1.

Summary of Compliance with Basel Core Principles (continued)

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Appendix Table 2.

Recommended Actions to Improve Compliance with the Basel Core Principles and the Effectiveness of Regulatory and Supervisory Frameworks

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Authorities’ Response to the Assessment

  • The SBS appreciates the opportunity to provide comments for this document. The SBS would like to thank the IMF and WB assessors for their full assessment of Peru’s compliance with the Basel Core Principles for Effective Banking Supervision as part of the comprehensive Financial Stability Assessment Program.

  • The discussions were fruitful with seasoned supervisors. There were many practical ideas and recommendations for improvement, not all of them making their way in this document but all of which will enrich the SBS internal discussion on future developments of the Peruvian banking regulation and supervision.

  • Overall, the assessment adequately reflects the current status of the Peruvian regulatory and supervisory frameworks. There is one point of disagreement regarding the grading of Principle 1. The Peruvian Banking Law defines ample legal powers for the SBS to authorize banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns. The only area where there is some weakness is the limited legal powers for supervising holding companies, which the SBS considers has been overweighted in the assessment of Principle 1.

  • Even though the SBS has not direct powers over holding companies, it has indirect legal powers to require information and impose prudential requirements through the supervised bank. These indirect powers have demonstrated to be effective in the supervision of the two major banking groups. The SBS recognizes there is room for improvement in the legal framework to deal with potential future risks; however, does not consider its current limited legal powers as a major source of risk.

  • Finally, as in previous evaluations, the SBS will carefully evaluate the recommendations and develop a plan to continue strengthening the robust regulatory and supervisory framework of the Peruvian Financial System.
1

The higher dollar credit delinquencies reflect in some part the statistical effect of the substitution of credits in dollars for credits in soles, leading to the corresponding decrease in the denominator of NPLs ratios in dollars.

2

Shocks are calibrated to be consistent with the banking sector stress test assumptions. Scenario 1 assumes an FX shock only (a depreciation of the local currency by 15 percent). Scenario 2 adds on an earnings shock of 15 percent and an interest expense increase of 30 percent. Scenario 3 doubles the FX and earnings shocks (to 30 percent respectively) and maintains an interest expense shock of 30 percent. A natural hedge of 75 percent is applied to export-oriented sectors. Debt includes borrowing from banks and issuance of bonds. The share of FX debt is assumed to be 60 percent, considering the higher dollarization of credit to large companies and the greater outstanding stock of bonds issued abroad.

3

In addition, insurance companies have some exposure to banks (around 10 percent of their investments), and the pension funds have some small exposures to insurance companies.

4

Considering the revisions to the Basel Core Principles (issued in 2012) and the changes to the Basel capital standards since 2011, it was decided to undertake a full graded BCP assessment this time.

5

The study was done by a joint team from MCM and RES (Appendix VI).

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

1

After the completion of the assessment (November 1, 2017) the SBS issued the revised market risk regulation (Resolution SBS No. 4906–2017) on December 20, 2017.

2

The regulation (SBS Resolution No. 4906–2017) has been issued after the assessment and will come into force June 1, 2018.

1

Authors: Xiang Fang (UPenn), David Jutrsa (MCM), Soledad Martinez Peria (RES), Andrea F. Presbitero (RES), Lev Ratnovski (RES), Felix Várdy (MCM).

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Cover IMF Staff Country Reports
Peru: Financial System Stability Assessment
Author:
International Monetary Fund. Monetary and Capital Markets Department
Volume/Issue:
Volume 2018: Issue 238
Publisher:
International Monetary Fund
ISBN:
9781484370667
ISSN:
1934-7685
Pages:
64
DOI:
https://doi.org/10.5089/9781484370667.002
Figure 1.

Peru: Financial Soundness Indicators Amongst Peers
Figure 2.

Peru: Credit Delinquency

Bank Credit to Private Sector

(Relative to trend, percent)
Figure 3.

Peru: Housing Market Indicators

Peru: Credit and Deposit Dollarization and the Exchange Rate

(In percent (LHS), Soles per USD (RHS))
Figure 4.

Peru: Corporate Sector Sensitivity Analysis

Variables and Weights Comprising Peruvian External Conditions

Peru Conditional GDP Distribution
Figure 5.

Peru: Stress Test Scenarios – Baseline and Adverse
Figure 6.

Peru: Stress Test Results – Capital Adequacy
Figure 7.

Peru: Stress-Test Results – Drivers of the Change in Capital Levels

Financial Sector Interconnectedness

(in nominal terms, June 2017)
Figure 8.

Peru: Sys temic Risk Metrics
Appendix Figure 1.

Actual and Required Capital

(Average, in percent of RWA)
Appendix Figure 2.

Heterogeneity of Capital Requirements
Appendix Figure 3.

Regressing Actual on Required Capital