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IMF Country Report No. 22/248

PARAGUAY

TECHNICAL ASSISTANCE REPORT––BANK RESOLUTION FRAMEWORK AND THE DEPOSIT GUARANTEE FUND

July 2022

This technical assistance report on Paraguay was prepared by a staff team of the International Monetary Fund. It is based on the information available at the time it was completed in July 2022.

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TECHNICAL REPORT

PARAGUAY

Bank Resolution Framework and the Deposit Guarantee Fund

June 2022

Prepared By

Miguel Otero (Mission Chief, MCM), Luis Cortavarría-Checkley (Expert, MCM), Mario Tamez (Senior Legal Counsel, LEG) and Ignacio Caparroso (Expert, LEG)

Authoring Department:

Monetary and Capital Markets and Legal Department

Contents

• Glossary

• Preface

• Executive Summary

• I. Introduction

• II. Overview of the Financial System in Paraguay

• III. Crisis Preparedness and Coordination

• A. Institutional Arrangements in Crisis Situations

• B. Recovery and Resolution Planning

• C. Cross-Border Coordination

• D. Communications

• IV. Bank Resolution Framework

• A. Scope and the Objectives of the Resolution Framework

• B. The Resolution Authority and Its Key Features

• C. Resolution Tools

• D. Legal Safeguards And Judicial Review

• E. Resolution Funding

• V. Deposit Insurance Legal Framework

• A. Legal Mandate, Objectives, and Powers

• B. Coverage and Funding

• C. Role in Crisis Management

• Boxes

• 1. Bridge Banks

• 2. Some Features of Resolution Funds

• Figure

• 1. Overview of the Financial System

• Table

• 1. Key Recommendations

• Appendices

• I. Summaries of Selected Recovery and Resolution Plans

• II. Governance Arrangements in Other Jurisdictions to Host the Resolution Authority within the Central Bank

• III. Bridge Banks in Practice

Glossary

Preface

At the request of the Central Bank of Paraguay (BCP), a joint technical assistance (TA) mission from the IMF’s Monetary and Capital Markets Department (MCM) and the Legal Department (LEG), provided offsite TA between June 15 and July 8, 2021 on options to enhance the existing resolution framework and the Deposit Guarantee Fund (DGF). The mission comprised Miguel Otero (MCM), Luis Cortavarría-Checkley (MCM Expert), Mario Tamez (LEG), and Ignacio Caparroso (LEG Expert).

The mission conducted several participatory workshops on the topics related to the resolution framework and the DGF, each followed by Q&A sessions, and benefitted from constructive discussions with BCP management and staff.

The mission met remotely with Liana Caballero, Diego Duarte Schussmuller, and Fernando Filártiga, all Board members of the BCP; Hernán Colmán, Superintendent of Banks (SB); Edgar Paredes, Director of the Administration Unit of the Deposit Guarantee Fund (UAFGD); Aldo Rodriguez, Director of the Legal Department for Financial Institutions; Antonella Torio, Supervision Manager in the SB; María Elena Acevedo, Intendent of Regulations in the SB; Carlos Ayala, Head of Division in the Department of Supervision; Natalia Valinotti, Head of Division in the Intendency of Regulations; Maria Stael Herrera, Head of Accounting at the UAFGD; Ana Franco, Head of Investments at the UAFGD; Ana Vazquez, Senior Analyst in the Legal Department; and Griselda Figueredo, Senior Analyst in the Legal Department.

The mission would like to express its gratitude to the BCP’s Board for its kind invitation and support to our mission, and to the management and staff of the BCP for their cooperation and productive engagement during this virtual TA mission.

Executive Summary

A joint MCM-LEG mission provided Technical Assistance (TA) to the Paraguayan authorities on their bank resolution framework and the DGF. The mission was carried out remotely and engaged in policy discussions with the authorities, with the view to adopt modern international practices on crisis preparedness and crisis management. It built on the recommendations of the Financial System Stability Review (FSSR), completed by MCM staff in October 2017.

The mission identified several areas where the existing DGF and bank resolution framework could be enhanced. It also provided input on crisis preparedness.

On crisis preparedness and coordination, the mission made recommendations in four areas:

• The institutional arrangements could be usefully enhanced. While a Financial Stability Committee (FSC) and a “Crisis Committee” have been established, the authorities should evaluate the benefits of providing a sound legal regime that includes a clear mandate and better delineation of roles and responsibilities.

• The BCP should consider developing an ongoing process of recovery and resolution planning and underpin it in its regulatory framework, in line with international modern practices. Recovery and resolution plans are a key element of a modern crisis preparedness framework. These plans are living documents that should be regularly updated with robust, credible, and actionable steps. All banks under SB supervision should develop recovery plans, proportional to their size and complexity, which will be assessed by the SB. Once established, the resolution authority (RA) should develop resolution plans for all the systemic banks.

• Cross-border coordination is paramount for Paraguay, given the significant presence of international banking groups in the Paraguayan financial system. Coordination with members of the financial safety net of other jurisdictions is key to ensuring adequate crisis preparedness during normal times and enabling adequate coordination of crisis management measures if there are concerns about the viability of a foreign-owned bank with operations in Paraguay.

• Effective communications are a key element that requires close coordination. A one-voice method of communication with the public should be considered, and advance preparation is paramount to ensure a smooth process for communications in the event of a crisis situation.

On the bank resolution framework, the mission offered recommendations in five areas:

• The current resolution legal framework presents several gaps, including a lack of objectives for the RA. The statutory objectives of the RA should be clearly codified to guide its actions, provide a benchmark for its activities, and ensure predictability.

• The RA should be operationally independent from the supervisory functions of the SB. In line with modern international practices, the operational separation of resolution and supervisory functions would facilitate a more effective implementation of the supervisory and resolution powers by the BCP. Furthermore, the BCP should have governance arrangements to ensure adequate decision making and preparation in relation to its resolution functions, independently from decisions taken in relation to supervisory issues, while maintaining independent reporting lines for both functions.

• The resolution toolkit should be strengthened. In particular, the mission recommends further enhancing the effectiveness of purchase and assumption (P&A) transactions and granting explicit powers to the authorities to create temporary banks (bridge banks). This should allow certain assets (often, performing loans) and eligible liabilities to be transferred with public support, if appropriate, and subject to safeguards, to a temporary “good bank” (to be subsequently divested, as a whole or in parts, to one or more private sector acquirers). Remaining assets and non-eligible liabilities would be left in the failing institution and placed in liquidation. The RA should be granted the power to require banks to hold a certain amount of liabilities that would absorb losses in resolution.

• The resolution regime could be complemented by additional legal safeguards. While several safeguards geared to facilitate the RA’s actions and to protect the rights of shareholders and creditors are already in place, the legal framework should provide for legal protection for the RA and its staff against liability for actions taken and omissions made in good faith while discharging their duties. Indemnities for costs incurred as a result of litigation could also be considered.

• Enhancements to the resolution funding arrangements also need to be considered. The resolution framework should stipulate clear and expeditious access to temporary funding, based on financial stability considerations, in situations where private sector funding has been exhausted or cannot achieve resolution objectives. Losses should be allocated to equity holders and, as appropriate, to unsecured and uninsured creditors, in accordance with the creditor hierarchy and with ex post recovery from the industry of any residual costs. In addition, as part of the contingency planning, the authorities should introduce a framework to guide the use of any public resources, in order to minimize losses and future risks, and ensure that transparent accountability on their use is achieved within a reasonable time.

On the Deposit Insurance Legal Framework, the mission made the following recommendations:

• The DGF’s legal mandate should clearly establish in law a set of powers and objectives. The revised law should specify the DGF’s legal mandate as “pay box plus” and ensure consistency with the powers provided by law to the DGF as a financial contributor to P&A transactions, subject to the least-cost criteria. In addition, the DGF’s legal framework should specify that its two main public policy objectives are protecting depositors and contributing to financial stability.

• The framework for DGF operations (contributions and coverage) should be enhanced. The introduction in the legislation of back-up sources of alternative liquidity funding could be considered. To foster market discipline, it is also recommended to exclude specific types of deposits from DGF coverage (e.g., interbank deposits, deposits of government ministries and departments, and deposits of regional, provincial, and municipal governments, and other public bodies). In addition, the maximum reimbursement period should be shortened to seven working days. Finally, the authorities should consider the removal of the set-off mechanism before payouts (if kept, it should be limited only to past-due claims and matured loans).

• The DGF’s institutional arrangements should be overhauled. The DGF should be operationally independent and protected against external interference, with safeguards in place to avoid and mitigate potential conflicts of interest. In addition, the DGF framework should clarify its role in the preparatory stages of resolution (including contingency planning) and the decision-making process for the resolution of troubled banks.

Table 1 summarizes the mission’s key recommendations.

^{Table 1.}

Paraguay: Key Recommendations

¹Short term = less than one year; Medium term = 1–2 years; Long term = More than two years.

^{Table 1.}

Paraguay: Key Recommendations

Topic/Recommendation	Priority	Timeframe1	Area
1. Consider establishing legal provisions to ground the Financial Stability Committee and ‘Crisis Committee” mandate.	High	Medium term	All
2. Implement a “one-voice” method of communication with the public, whereby all the authorities would use the same set of agreed upon facts and assumptions.	Medium	Short term	All
3. Require all banks to develop recovery plans, focusing first on the largest.	Medium	Short term	Supervision and resolution
4. Elaborate resolution plans for all systemic banks.	Medium	Medium term	Resolution
5. Consider codifying statutory objectives for the RA.	High	Medium term	Resolution
6. Establish an operationally separate unit within the BCP to fulfill the RA functions, with adequate resources to fulfill its mandate and scope to manage any conflict of interests.	High	Medium term	Resolution
7. Revise legal provisions and statutory powers to enhance further the effectiveness of the use of P&A as a resolution tool.	High	Medium term	Resolution
8. Adopt legal provisions and statutory powers for the effective application of new resolution tools, notably, bridge banks.	High	Medium term	Resolution
9. Introduce legal protection for the RA and its staff, supported by indemnifications for litigation costs.	High	Medium term	Resolution
10. Include safeguards in the regime for access to public funding in systemic cases and prepare contingency planning, along with a framework to guide the use of such resources while minimizing moral hazard.	High	Medium term	Resolution
11. Assess the possibility of setting up an ex post resolution funding scheme, comprised of temporary public funding and a recovery mechanism.	High	Medium term	Resolution
12. Establish a “paybox plus” mandate for the DGF in the law, and fully align the powers that the DGF currently has to contribute to a resolution process, subject to the least cost criteria.	High	Medium term	Deposit Insurance
13. Enhance the DGF’s independence and increase its capacity to address potential conflicts of interest.	High	Medium term	Deposit Insurance
14. Remove the automatic setting-off mechanism for debts owed by insured depositors with a failing bank.	High	Medium term	Deposit Insurance
15. Shorten the reimbursement period for insured deposits to seven working days.	Medium	Medium term	Deposit Insurance
16. Exclude specific types of government deposits from DGF coverage.	Medium	Medium term	Deposit Insurance

¹Short term = less than one year; Medium term = 1–2 years; Long term = More than two years.

View Table

^{Table 1.}

Paraguay: Key Recommendations

Topic/Recommendation	Priority	Timeframe1	Area
1. Consider establishing legal provisions to ground the Financial Stability Committee and ‘Crisis Committee” mandate.	High	Medium term	All
2. Implement a “one-voice” method of communication with the public, whereby all the authorities would use the same set of agreed upon facts and assumptions.	Medium	Short term	All
3. Require all banks to develop recovery plans, focusing first on the largest.	Medium	Short term	Supervision and resolution
4. Elaborate resolution plans for all systemic banks.	Medium	Medium term	Resolution
5. Consider codifying statutory objectives for the RA.	High	Medium term	Resolution
6. Establish an operationally separate unit within the BCP to fulfill the RA functions, with adequate resources to fulfill its mandate and scope to manage any conflict of interests.	High	Medium term	Resolution
7. Revise legal provisions and statutory powers to enhance further the effectiveness of the use of P&A as a resolution tool.	High	Medium term	Resolution
8. Adopt legal provisions and statutory powers for the effective application of new resolution tools, notably, bridge banks.	High	Medium term	Resolution
9. Introduce legal protection for the RA and its staff, supported by indemnifications for litigation costs.	High	Medium term	Resolution
10. Include safeguards in the regime for access to public funding in systemic cases and prepare contingency planning, along with a framework to guide the use of such resources while minimizing moral hazard.	High	Medium term	Resolution
11. Assess the possibility of setting up an ex post resolution funding scheme, comprised of temporary public funding and a recovery mechanism.	High	Medium term	Resolution
12. Establish a “paybox plus” mandate for the DGF in the law, and fully align the powers that the DGF currently has to contribute to a resolution process, subject to the least cost criteria.	High	Medium term	Deposit Insurance
13. Enhance the DGF’s independence and increase its capacity to address potential conflicts of interest.	High	Medium term	Deposit Insurance
14. Remove the automatic setting-off mechanism for debts owed by insured depositors with a failing bank.	High	Medium term	Deposit Insurance
15. Shorten the reimbursement period for insured deposits to seven working days.	Medium	Medium term	Deposit Insurance
16. Exclude specific types of government deposits from DGF coverage.	Medium	Medium term	Deposit Insurance

¹Short term = less than one year; Medium term = 1–2 years; Long term = More than two years.