Ecuador: Financial System Stability Assessment
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Ecuador’s financial system is dominated by banks and credit cooperatives. Its exposure to macrofinancial risks is shaped by its fully dollarized economy and its position as an oil exporter. The institutional framework for financial sector oversight is complex, uncoordinated, and prone to political intervention, which results in sub-optimal policies.

Background

A. Macrofinancial Context

1. The Ecuadorian economy rebounded after the COVID-19 pandemic but has slowed in 2023. Following a sharp contraction in 2020 as Ecuador was hit by the pandemic and a sharp fall in oil prices and export demand, the economy rebounded (Figure 1). High oil prices have supported Ecuador’s external and fiscal balances, with the public sector in 2022 posting the lowest deficit since 2008. However, in the first quarter of 2023 real GDP growth moderated to 0.7 percent; coupled with other indicators, this points to a sharp and broad-based slowdown and an increase in downside risks. Inflation increased in 2022 reaching 3.5 percent (well below regional peers) but has since eased. In December 2022, Ecuador completed a 27-month Extended Fund Facility Arrangement.

2. The financial sector has remained stable but has yet to fully absorb pandemic-related losses. Banks’ average capital ratios were around 15 percent of risk-weighted assets as of end-2022. Reported nonperforming loans (NPLs) are moderate, including on an augmented measure that includes refinanced and restructured loans. The acceleration of credit growth in the wake of the pandemic contributed to mechanical dilution of NPL ratios. Since mid-2022, however, credit growth has slowed, and liquidity conditions have tightened considerably. Competition for deposits between banks and credit cooperatives increased funding costs, which, combined with caps on lending rates, has led to margin compression. Pandemic-era decrees requiring banks to provide financial relief to certain categories of borrowers may have weakened the payment culture and affected the quality of credit data. Cooperatives have higher NPL ratios and lower loan loss provisions than private banks.

B. Financial Sector Structure and Recent Developments

3. Ecuador’s financial sector is dominated by banks and credit cooperatives. The IMF Financial Development Index ranked Ecuador 133 out of 192 countries in 2019, the lowest ranking among peer countries. Financial institutions provide mostly traditional products and there is limited development of services to reach underserved and financially excluded segments. In 2021, 64 percent of adults reported having access to a bank account, below the average for upper middle-income countries (84 percent). Total deposit-takers’ assets are around 78 percent of GDP, of which private banks account for over 50 percent (Figures 2 and 3). Credit cooperatives have become increasingly important over the last decade and have total assets of around 20 percent of GDP. In addition, the funds of the social security administration are managed by the Banco del Instituto Ecuatoriano de Seguridad Social (BIESS), the largest financial institution in the country. While BIESS does not take deposits and has not issued other types of liabilities, its mortgage credit portfolio represents about 6 percent of GDP.

4. Public banks have significantly higher NPLs and have recently undergone an asset quality review (AQR). While public banks have capital ratios above 30 percent covering the substantial gap in loan classification and provisioning found by the AQR in one public bank would trigger supervisory action.

Figure 1.
Figure 1.

Ecuador: Recent Economic Developments

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Sources: Servicio de Rentas Internas; Banco Central del Ecuador; Banco Central de la República Dominicana; Organization of the Petroleum Exporting Countries; Barett and others (2022), “Measuring Social Unrest Using Media Reports”. Journal of Development Economics, 158; IMF staff calculations.Notes: Local sales is based on administrative tax data. For employment, data is missing during the first two quarters of 2020 due to the pandemic. The EMBI spread is the difference between the weighted average Ecuadorian external debt securities yields and the U.S. Treasury securities yields with similar maturity.
Figure 2.
Figure 2.

Ecuador: Financial Sector Structure

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Sources: Superintendency of Banks, Superintendencia de Economia Popular y Solidaria, and staff calculations.1/ Brazil data is as of 2021: Q3; Chile data as of 2021:M12; Mexico data as of 2021:M5.2/ Data does not include BEISS. Private banks data include Banco del Pacifico. Mutualistas are another form of mutual deposit-taker.
Figure 3.
Figure 3.

Ecuador: Financial Soundness Indicators

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Sources: Superintendency of Banks, Superintendencia de Economia Popular y Solidaria, and IMF staff calculations.1/ Loan loss provision requirements are specific provisions mostly determined by the number of past due days.2/ (For charts 1-4): Brazil data is as of 2021: Q3; Chile data as of 2021:M12; Mexico data as of 2021:M5

5. Financial institutions have sizable inter-connections through deposits and investments. The large banks play a pivotal role in the system, taking deposits and investments from other institutions (Figure 4). Cooperatives are net providers of liquidity to the banking sector, as they place deposits with large and medium-size banks.

C. Financial Repression

6. Deposit taking institutions are subject to financial repression measures. Banks and credit cooperatives are subject to ceilings on lending rates. Financial institutions are required to maintain at least 60 percent of their liquid assets in Ecuador, facilitating domestic financing to the government at the expense of risk diversification at the systemic level. Private banks are also required to maintain minimum investments in public banks and public financial institutions. A tax on financial outflows that helped shield the domestic financial system from volatile capital flows is being gradually reduced to 2 percent by end-2023. Banks and investment companies are also subject to a 0.25 percent monthly tax on the stock of funds and investments held abroad.

7. These measures inhibit financial inclusion, distort capital allocation, and elevate financial sector risks. Interest caps prevent lending to new or riskier borrowers and divert resources to consumer lending that is relatively less constrained. Higher international interest rates and competition for deposits have increased funding costs. This, combined with interest rate caps, has led to margin compression and constrained investment. Incomplete credit data, and deficient supervisory practices can also lead to over-indebtedness. Moreover, the requirements for financial institutions to hold liquid assets in Ecuador and public sector securities at non-market prices, limits risk diversification at the systemic level.

D. Liquidity Risk

8. While dollarization provides an important anchor for Ecuador, systemic liquidity risks are high due to the limited capacity of the central bank to provide liquidity. Liquidity shocks affecting banks will ultimately impact the Central Bank balance sheet even though it currently does not offer liquidity facilities, as it will experience an outflow of reserve deposits. This is especially important given the limited size of Ecuador’s FX reserves.1

9. Managing liquidity risk is a critical challenge for Ecuador’s financial system. There are few truly liquid domestic assets, given the lack of secondary market trading. Interbank funding markets are thin and central bank facilities are absent. The strict prohibition on monetary financing is understood to be a legal impediment for the BCE to accept government securities as collateral. There is an industry liquidity fund, but it is limited in size (about 3 percent of members’ assets) and rarely used in part due to its collateralization and operational requirements. Assets that can be reliably monetized are largely limited to cash, central bank reserves, and foreign securities (and bank deposits for some cooperatives and smaller banks).

Figure 4.
Figure 4.

Ecuador: Financial Sector Balance Sheet Structure

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Sources: Superintendency of Banks, Superintendencia de Economia Popular y Solidaria, and IMF staff calculations.1/ Lending volumes for private and public banks.2/ Credit for private banks, public banks and cooperative segments 1-3. Trend calculated using a one-sided HP filter (A=1600) on quarterly data since 2016Q1.3/ The diameter of nodes reflects the total assets of the respective institutions. The thickness of the arrows reflects the size of gross-bilateral exposures. The gross bilateral exposures between banks and cooperatives represent 12 percent of total system assets and 9 percent of GDP. Cooperatives are net providers of liquidity to the banking sector, and the large banks play a pivotal role in the system, taking deposits and investments from other institutions. BIESS is excluded.

10. Financial institutions must largely self-insure against liquidity risk. Liquidity analysis indicates that current regulatory requirements do not prevent banks from facing meaningful liquidity risks. The authorities should ensure that financial institutions manage liquidity risk more conservatively than would be necessary in non-dollarized economies and also take steps to expand the pool of monetizable liquid assets, remove impediments for banks investments in global liquid assets, and ensure that liquid assets held by financial institutions can, in practice, be reliably monetized in time of stress. This objective is reflected in specific recommendations below.

Systemic Risk Assessment

A. Vulnerabilities and Risks

11. Ecuador’s exposure to macrofinancial risks and global spillovers is shaped by its fully dollarized economy and its position as an oil exporter. The corporate and household sectors do not appear overly indebted, and mortgage lending is modest (Figure 4). However, banks and cooperatives have not fully recovered from the impact of the pandemic and now face new challenges stemming from tightening financial conditions and ongoing political uncertainty. Direct exposures to sovereign risk are limited,2 but indirect effects and the presence of public banks and BIESS also entail channels of contagion between the financial and the public sectors. Market risks are immaterial, including interest rate risk in banking book and small trading book. Against this background, an abrupt slowdown in China and the United States accompanied by falling oil prices could substantially affect the financial sector. Political and social discontent is an additional source of systemic risk that could affect private investment and economic activity and possibly lead to sub-optimal financial sector policies.

12. The FSAP assessed the resilience of banks, credit cooperatives and non-financial corporates; the financial system is overall resilient to adverse macro-financial shocks. The analysis comprised all 24 banks, the large credit cooperatives and more than 86,000 registered non-financial companies.

13. The analysis is based on a baseline and an adverse scenario spanning three years (2023-25). Both scenarios are challenging, as their starting point includes the effects of the pandemic and the social turmoil in mid-2022. The baseline scenario follows the April 2023 WEO projections (Table 3). It assumes a weakening external environment, with oil prices easing gradually and global demand slowing down. Financial conditions are affected by the tightening of monetary policy in industrial countries and appreciation of the US dollar. The adverse scenario assumes sharper than expected slowdowns in China and the United States and increases in inflation and policy rates in industrial countries (Figures 5 and 6).

Figure 5.
Figure 5.

Ecuador: Adverse Scenario Benchmark

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Source: IMF staff calculations.
Figure 6.
Figure 6.

Ecuador: Baseline and Stressed Scenarios

(In percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Source: IMF staff calculations.

B. Bank Solvency Stress Tests

14. The solvency analysis integrated credit, sovereign, and interest rate risks. The core methodology entailed a top-down stress test of individual bank solvency, integrated with a corporate stress test of the 100 largest borrowers.3 The cut-off date was December 2022.

15. The solvency ratios of a relatively large number of banks dropped below the minimum capital adequacy ratios (CAR), but the aggregated capital shortfalls were small. The capital ratios of five small banks, which account for two percent of system assets, dropped below 9 percent even under the baseline scenario. These institutions displayed undiversified credit portfolios, with exposure to consumer and small and middle enterprise (SMEs) loans and to agricultural sector micro loans. Under the adverse scenario, nine banks with 11 percent of system assets end up with CAR ratios below the regulatory minimum, but with an aggregate capital shortfall of only 0.2 percent of GDP (Figure 7).

16. At the aggregate level, the banking system appears profitable enough to absorb the losses stemming from the adverse scenario. Aggregate bank profits contribute to material internal capital generation even under the adverse scenario. Credit losses and distributed dividends4 are the main drag on solvency. Large interest rate and sovereign risk shocks in the adverse scenario had only moderate solvency impacts due to short duration assets and already-high spreads, assuming that interest rate caps are adjusted when needed, in line with historic behavior.

C. Cooperatives Stress Tests

17. The solvency stress tests for the cooperative sector followed the same scenario-based approach applied to the banking sector. Expected losses were estimated as the flow of provisions under the baseline and adverse scenarios (Figure 8). The analyses included the larger cooperatives in segments 1 and 2 individually and segment 3 in aggregate.

18. The results suggest that a substantial number of mostly small cooperatives could face solvency challenges. The materialization of the adverse scenario would increase expected losses, particularly for the microcredit portfolio, and reduce profitability and capital adequacy. By 2025, the capital adequacy ratio of 35 cooperatives, representing about 6 percent of system assets could be below the 9 percent minimum requirement. The aggregate capital shortfall, however, is relatively small (0.2 percent of GDP). Several cooperatives could also face solvency challenges under the baseline scenario.

Figure 7.
Figure 7.
Figure 7.

Ecuador: Selected Results of Bank Solvency Analysis

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Source: IMF staff calculations
Figure 8.
Figure 8.

Cooperative Credit Solvency Analysis

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Sources: Superintendencia de Economia Popular y Solidaria and IMF staff calculations.

D. Liquidity Stress Testing

19. The assessment of liquidity risk was constrained by data availability. Liquidity risk at the bank level was therefore assessed using the results of a recent pilot project on the Liquidity Coverage Ratio (LCR) which covers the six largest banks, jointly accounting for about 60 percent of system assets. Parallel analysis was carried out using data from supervisory liquidity gap templates. Considering the shallow domestic secondary markets and the lack of a Lender of Last Resort (LOLR), the analysis differentiated domestic and foreign High Quality Liquid Assets (HQLA), as the latter are more likely to prove truly liquid.

20. Results suggest that banks do not hold enough liquid assets. The core assessment comprised three scenarios that imposed a drawdown of bank liabilities (which are mostly deposits) following the Basel LCR weights. The least severe scenario considered no haircuts on domestic securities and no use of liquidity fund resources. Under this exercise, three of the six banks accounting for about 25 percent of system assets fall below the reference LCR (Figure 10). A more realistic exercise assumed that domestic securities could not be monetized.5 Under these assumptions, five banks accounting for 37 percent of system assets drop below the reference LCR.

Figure 9.
Figure 9.

Ecuador: Structure of Bank Balance Sheets

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Sources: SB, and IMF Staff calculations

21. Systemic liquidity is the main risk to financial stability given the lack of a domestic currency and insufficient foreign assets. A systemic liquidity analysis compared estimated bank liquidity shortages against their claims on the liquidity fund. Half of the sampled banks maintain insufficient claims on the liquidity fund to restore a 100 percent LCR, with one medium-size bank displaying a liquidity deficit 3.7 times larger than its claims. However, two systemically important banks were able to cover their liquidity deficits with resources from the liquidity fund. Extrapolation of the results for the pilot banks suggests a system-wide liquidity deficit of about US$2.9 billion.6

E. Nonfinancial Corporates

22. The corporate stress test indicates that corporate debt-at-risk is not an imminent threat to financial stability. A corporate stress test with the FSAP scenarios translated into sectoral-level impacts was carried out covering the entire population of registered firms with available financial statements. Results show that aggregated debt-at-risk, measured by the debt of companies with an interest coverage ratio (ICR) below 100 percent, is about 6 percent of GDP. Overall, the migration of companies to lower ICRs appears moderate, which is likely due to their relatively low indebtedness (Figure 11).

Figure 10.
Figure 10.

Ecuador: Selected Results of Liquidity Stress Tests

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Source: IMF staff calculations.
Figure 11.
Figure 11.

Ecuador: Selected Results of the Nonfinancial Corporate Stress Test

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Source: IMF staff calculations.

F. Climate-Related Risks

23. Ecuador’s high exposure to natural hazards poses physical risks for banks and credit cooperatives. Ecuador has the 13th largest exposure in the world to natural hazards according to the INFORM Risk index.7 Up to 20 percent of bank loans and 25 percent of cooperative loans are in parts of the country vulnerable to floods, landslides, droughts, and volcanic and seismic risks (see Figure 12). Around 23 percent of system-wide bank loans in Ecuador are also extended to borrowers in sectors that are considered as ‘transition sensitive’ (primarily agriculture).

Figure 12.
Figure 12.

Ecuador: Financial Sector Exposure to Climate Physical and Transition Risk

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Source: Own calculations based on data from SB, SEPS and Thinkhazard.Notes: * The estimates for the share of loans directly exposed to physical risks are obtained by identify sectors that are most directly affected by a certain type of natural hazard and linking them to the canton-level risk classification where these types of loan are located. For banks, these sectors are agriculture (FL, LS, DG, EQ, VA), housing (FL, LS, EQ, VA), transport (FL, LS, EQ, VA), construction (FL, LS, EQ, VA), tourism (FL, LS, EQ, VA) and energy and water (FL, DG). For loans extended by credit cooperatives, exposed loans include only agriculture (FL, LS, DG, EQ, VA), housing (FL, LS, DG, EQ, VA) and transport (FL, LS, DG, EQ, VA) due to data availability and relevance for the sector. The risk classification for each canton is based on data from Thinkhazard.

Financial Sector Oversight

A. Cross-cutting Issues

24. Coordination and information-sharing between the large number of institutions playing a role on financial sector issues is lacking (Table 2). Often, regulatory proposals are developed in isolation, financial stability analysis only considers specific segments of the financial sector, and the information is shared too late to effectively prepare for the failure of weak institutions.

25. Effective micro and macroprudential policies and tools can be built under different oversight architectures. Often, maintaining the stability of existing institutions and focusing on addressing their weaknesses, tend to generate better and faster results than unifying or dismembering agencies, as this process tends to distract from the underlying shortcomings.

26. The superintendencies should play a large and active role in the regulatory process. The Codigo Organico Monetario y Financiero (COMyF) grants comprehensive powers to the Junta of Financial Policy and Regulation (JPRF) to issue regulations. The superintendencies, however, have a direct knowledge of the sectors that they supervise and stronger analytical capacity. The JPRF should solely play the key role of coordinator and ultimate authority on regulatory issues, particularly to harmonize cross-sector regulations and implement timely macroprudential actions. The superintendencies should have an active part in the regulatory process, including by proposing regulations, conducting joint impact analysis, and opining on all regulatory matters applicable to the entities that they supervise.

Table 2.

Ecuador: Institutional Framework for Financial Sector Oversight

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B. Macroprudential Framework

27. Authorities are committed to strengthen the macroprudential framework; it is key that current efforts are expanded as the framework has several shortfalls. Authorities have been discussing a common definition of financial stability, planning to publish a financial stability report, and considering system-wide data collection. These initiatives need to be completed and expanded. First, the current framework is complex and has an unclear distribution of objectives, functions, and powers among authorities. Weak information sharing and coordination arrangements add obstacles to policy making. Second, the authorities lack a systematic process to monitor system-wide financial stability risks. Third, although the legal framework foresees the use of some macroprudential tools, such as additional capital buffers reflecting the phase of the credit cycle and the systemic importance of banks, none have been implemented.

28. To enhance the macroprudential framework the authorities should:

  • Clarify the macroprudential objectives, functions, and powers of each agency. The JPRF should be the overall coordinator of macroprudential policy, and all other agencies should have clear roles and responsibilities in contributing to this goal.

  • Strengthen coordination arrangements and practices between agencies. The authorities also need to urgently establish a systematic process to monitor and evaluate system-wide risks. Authorities could consider the establishment of a Financial Stability Committee in charge of the analysis of systemic risks, the development and monitoring of core indicators, and the preparation of policy proposals to manage systemic risks.

  • Improve data collection, reinforce data sharing among agencies, and enhance analytical capacity. Improvement is needed in areas such as systematic reporting of indices relevant to macroprudential policy, like housing market statistics, indebtedness, and system-wide indicators.

  • Implement the Basel III buffers (conservation, countercyclical and for domestic systemically important banks), and borrower-based measures. The implementation of these measures should follow international standards and Basel guidelines.

  • With appropriate phasing, remove the requirement to hold 60 percent of liquid assets in domestic assets. It is especially important to ensure liquid assets can be sold in deep markets and strengthen system-wide liquidity. The process should be gradual and consider macroeconomic conditions, to avoid triggering an unintended shortfall of domestic financing sources for the public sector.

C. Banking Regulation and Supervision

29. The SB has recently taken several initiatives to enhance banking supervision. These initiatives include efforts to develop and implement a supervisory stress testing program and studies to enhance prudential requirements, including the planned implementation of the LCR.

30. Notwithstanding these efforts, institutional shortcomings impair sound banking supervision.

  • Safety and soundness are not the primary goal of the SB which, in practice, results in the prioritization of SB’s broader responsibilities over prudential goals. The SB has a very broad mandate (including, inter alia, consumer protection, enforcement of interest rate caps, social security oversight, bank resolution etc.). These other duties often disrupt prudential supervisory planning and consume a significant amount of time and resources. The law should recognize safety and soundness as the primary objective and the internal structure should segregate units dedicated to prudential and non-prudential duties.

  • The legal independence of the SB has many practical constraints that have generated substantial institutional instability. The appointment procedure for Superintendents is prone to disputes and the removal procedure is excessively discretional. These characteristics have led to high instability at SB’s senior positions that impair the continuity of work and deviate the attention of senior managers to non-prudential topics. The administrative autonomy of the SB is also undermined by the significant number of requests from other State authorities and the need for consent from the Ministries of Finance and Labor for budget decisions and changes in internal organization. Laws and rules should be reformed to ensure that the SB is able to selforganize and to administer its staff and budget efficiently, stably, and independently. The rules for appointment of the Superintendent need to be strengthened to restrain discretion on removals.

  • Lack of a career plan and a sound training program has significantly hindered the acquisition and retention of talent. The turnover of staff and management of the SB is very high, hindering the accumulation of supervisory knowledge and the implementation of projects.

31. The supervisory approach needs to be substantially strengthened. The SB transitioned to a new risk-based supervision framework which was implemented without being fully developed. Shortcomings include the absence of a supervisory cycle, insufficient guidance to supervisors, an incomplete and fragmented view of banks, absence of modules to directly examine risks and reduced attention to non-credit risks. Overall, examinations and monitoring of individual risks and banks are mostly descriptive, lacking a proper assessment of bank soundness and of risk management and corporate governance processes and policies. The SB still has a strong inclination towards compliance-based supervision, is not well equipped to exercise supervisory judgement and the current methodology does not ensure consistent procedures and comprehensiveness. The SB also lacks a regular program of supervisory stress tests and review of bank’s stress tests.

32. The SB has an adequate range of supervisory tools to impose timely corrective actions, but some supervisory powers are missing and there is a high risk of judicial reversal of supervisory actions. The SB should have the power to increase prudential requirements for individual banks and banking groups based on their risk profile and systemic importance. The SB should also be able to designate temporary administrators, when necessary, instead of requesting the shareholders to replace senior management. In addition, maximum sanctions are too low to function as an effective deterrent. Finally, the legal base for corrective action applied to banks that are not subject to “intensive supervision” could also be enhanced by adding a catalogue of specific measures, in addition to the existing general clause. The regime for the judicial review of the most important supervision and resolution decisions should be reformed to prevent reversal and allow monetary compensation, when justified.

33. The banking supervisory and regulatory framework would also benefit from further progress in several other areas, including:

  • Consolidated supervision should be enhanced by a more comprehensive supervisory perimeter and regular group-wide examinations.

  • Capital and liquidity regulation should gradually align to the Basel Framework, particularly in relation to the definition of capital and Pillar 2 requirements. Banks should also be required to adopt a forward-looking approach to capital and liquidity management.

  • Corporate governance requirements should be strengthened to properly determine the responsibilities and functions of senior management; supervisory procedures should be enhanced in order to better assess the effectiveness of the board’s risk oversight.

  • Corporate exposures classification and provisioning needs further supervisory attention. While non-corporate exposures are classified based on past dues in a conservative way, corporate exposures are classified based on expert models and currently result in less provisioning than IFRS 9, as these models don’t properly account for macroeconomic conditions and shocks.

  • Accounting criteria should be aligned to IFRS. The qualification process applied to external auditors also needs to be strengthened.

  • Supervisory response to climate and environmental risks is at an early stage and should be strengthened.

D. Cooperative Regulation and Supervision

34. Authorities are making an ongoing effort to converge prudential regulatory requirements of large cooperatives with those applied to banks. Prudential regulations have in the past been generally more lenient for cooperatives than for banks, leading to potential regulatory arbitrage. The authorities have been working to level the playing field. Capital, loan classification and provisions, and liquidity requirements of cooperatives have been harmonized with banks. There remain differences in reserve requirements and contributions to the liquidity fund, but convergence is underway, and expected to finish in 2025 and 2027, respectively. The possibility for cooperatives to retain up to 3 percent of the amount of a loan as capital also constitute a meaningful competitive advantage to cooperatives when the interest ceilings are binding.

35. SEPS’s legal powers and autonomy have shortcomings which impair sound supervision. The SEPS cannot remove cooperatives’ Council members for technical breaches and the existing fit and proper requirements are lax. Corrective actions are limited to cooperatives under intensive supervision programs, which limits an early supervisory response. SEPS has similar limitations on its administrative autonomy as the SB.

36. The supervisory approach has weaknesses in scope, risk profile assessments and adoption of early corrective actions. The supervision plan is not based on a comprehensive supervisory cycle and overemphasizes offsite activities. In result, the number of onsite assessments is relatively small. The risk classification methodology is based on quantitative indicators and thresholds that are not risk-sensitive enough; and the scores’ aggregation method underestimates the importance of qualitative indicators. These limitations affect the timely identification of higher-risk cooperatives and the adoption of early corrective actions.

37. The supervision of the largest cooperatives needs substantial improvements. The organizational structure and the practice of assessing the same issues in both offsite and onsite supervision are not conducive to a comprehensive view of their risk profile. The supervisory approach is not forward-looking, and supervisors do not challenge cooperatives’ strategies, policies, and methodologies enough. Core topics such as business model viability and ability to assess debtor payment capacity are not subject to a comprehensive examination. Considering that the operations and business models of the largest credit cooperatives are closer to banks than the other cooperatives, authorities could consider transferring the supervision of the largest cooperatives to the SB. The transfer could enhance the efficiency and effectiveness of supervision by grouping institutions that require a similar supervisory approach under the same superintendency.

38. The cooperative supervisory and regulatory framework would also benefit from closing gaps in several areas, including:

  • Corporate governance and risk management: Supervisors need to set expectations, proportional to the size and risks faced by the cooperative, that foster a comprehensive risk culture and sound risk management practices.

  • Credit risk: The regulation of does not establish minimum requirements for evaluation, approval, and monitoring for each type of loan. SEPS does not have access to consolidated clients’ debt data, which limits its ability to measure and supervise over-indebtedness risk.

  • Classification and provisions: Although in January 2023 loan provision requirements have been raised, there are concerns about the timely disclosure of credit risk in the cooperatives’ balance sheets, due to financial relief measures, weaknesses in internal and external auditors and risk rating agencies, and limited scope and depth of supervisory assessments to detect evergreening practices.

  • Capital and liquidity: As recommended for banks, regulation and supervision should gradually align to the Basel Framework, with proportional simplification of the requirements for small cooperatives. Eventual adjustments, however, should not reduce the stringency of the requirements.

  • Supervisors’ skills: Overcoming the gaps described above necessarily requires a strengthening of the supervisor’s skills, through a comprehensive and specialized training program with the necessary resources for its implementation.

E. Financial Integrity (AML/CFT)

39. Ecuador has started the reform of its AML/CFT framework based on the findings of the latest Mutual Evaluation Report; political commitment is key for further progress. The enactment of the New Organic AML/CFT Law by the forthcoming National Assembly is critical. Although the National AML/CFT Strategy was approved, its publication and the engagement with the private sector are still pending. Furthermore, an updated National Risk Assessment is underway, including additional modules on tax crimes, environmental crimes, assessment of legal entities, state-owned entities, nonprofit organizations, and crypto assets.

40. Resource constraints could overburden the effective AML/CFT supervision of the financial system. Modifications to the AML/CFT framework should apply a risk-based approach and avoid an overly expansive scope. The main AML/CFT coordination body, CONALAFT, is currently operationalizing its mandate, bringing needed collaboration among different authorities. SB, SEPS and SCVS have also started to update their internal regulations and UAFE, the designated supervisory entity of virtual asset service providers, is currently requesting entities to use a selfregistration process. Political commitment to strengthen these areas with adequate budget, technical and human resources is critical.

Financial Crisis Management and Resolution

41. Ecuador has multiple resolution authorities. The SB, SEPS and the deposit insurer (COSEDE) all play a role. The superintendcias implement corrective actions and resolve failing or failed institutions. COSEDE both provides deposit insurance and finances resolution measures. The supervisory authorities do not require member institutions to prepare recovery plans nor do the SB and SEPS prepare resolution plans.

42. The FSAP identified several priority areas for strengthening the resolution framework.

  • The supervision and resolution functions should be separated, either by establishing an independent department within the SB/SEPS or by shifting responsibility for resolution to COSEDE.

  • Existing resolution tools should be strengthened. The superintendents have three instruments: mergers, the “exclusion and transfer of assets and liabilities” (ETAP, a P&A-like power), and liquidation. The ETAP should be converted to a more traditional P&A power, whereby the resolution authority packages assets and deposits for an acquiring institution.

  • The preparation time for resolution should be lengthened and needed data provided in advance of failure. Currently, COSEDE has no access to data before resolution is triggered and, after triggering, the resolution authorities have only 15 days, by law, to determine the resolution plan, conduct the least cost analysis, appoint an Administrator, and begin resolution.

43. Over the medium term, an overhaul of the legal framework for resolution is warranted. The authorities should consider the introduction of a comprehensive financial institution resolution law. That law would establish a resolution agent, separate from the supervisory function. It should establish additional resolution tools and address any remaininglimitations of the current tools. In particular, the law should introduce bridge-bank and bail-in powers. A tighter timeline for the implementation of resolution actions should be established. Legal certainty of resolution actions needs to be enhanced given that judicial review of supervisory actions is very broad and has led to several cases in which closed institutions have been ordered to be reopened with no clarity about the status of their assets, liabilities, or operations. If this occurred for a major financial institution the risk of financial instability would be very high.

44. The deposit insurer has some strong practices but also weaknesses that need to be addressed, especially if it were given a greater role in resolution:

  • The governance of COSEDE should be strengthened to include independent members appointed to the Board.

  • Payout time should be shortened. Payout is limited by a lack of data. COSEDE pays out within 20 days of receiving depositor data from the liquidator. However, the liquidator can take up to 60 days to prepare such data, which should be significantly shortened.

  • COSEDE staffing should be improved. While it has 56 employees, only six are permanent staff, with the remaining seconded on a rotating basis from other institutions. If resolution responsibilities were shifted to COSEDE it would need substantially more resources, staffing and expertise.

  • Funding of COSEDE should be strengthened, despite the substantial ex-ante fund (17 percent of covered bank deposits). Options include giving COSEDE authority to increase premiums on banks and establishing a back-up liquidity facility.

  • Safeguards should be set limiting the use of its resources to the amount it would have paid out to insured depositors in a liquidation.

  • Introduction of clear legal foundation for depositor preference.

45. Given dollarization, Ecuador operates an industry-funded Liquidity Fund in the absence of a standard lender-of-last-resort regime. The BCE does not provide an emergency liquidity facility and may face legal impediments to taking government securities as collateral. The Liquidity Fund is a government-mandated industry support mechanism where institutions deposit their funds and can borrow them back. However, access is limited to the amount of bank equity and is over-collateralized, and the practices for posting collateral are untested. Accordingly, the liquidity fund would only have a limited role during widespread financial distress or a significant deposit run. Consideration should be given to the development of a more flexible lender-of-last resort facility, with possible reforms to governance and information-sharing, ease of collateral posting, size of the fund, relations with the BCE, and terms of lending, although its scope will remain limited by dollarization.

Financial Sector Development

A. Role of the State

46. The State plays an important role in the provision of financial services in Ecuador through SOFIs. Six SOFIs in Ecuador hold 36 percent of total financial sector assets, among the largest in Latin America, operating in asset management, and commercial and development banking. SOFIs are key actors in mortgage and microcredits segments (Figure 13).

Figure 13.
Figure 13.

Ecuador: State-Owned Financial Institutions in Latin America

Citation: IMF Staff Country Reports 2023, 335; 10.5089/9798400254208.002.A001

Sources: National Supervisory Agencies; Challenges of PCG Schemes in Latin America during the Pandemic (2022).Note: In orange: BIESS; In red: 5 SOFIs.

47. SOFIs in Ecuador have operated within a legal, regulatory, governance and organizational frameworks that appear far from international good practices. An ownership policy should be developed including criteria to justify ownership, a centralized unit to exercise ownership/monitoring functions, and strong governance practices. Many SOFIs have deficient credit risk management processes and IT systems that have been long unaddressed. Authorities should focus on restructuring problem SOFIs rather than merging them. The CFN-Banecuador merger should be paused until a viability assessment is conducted. The framework for BIESS could be enhanced to make it more alike to a fund administrator, have it report to credit bureaus, and conduct an AQR of its mortgage and trust investments.

48. Public credit support programs should be redesigned to enhance effectiveness. Public credit programs should be part of broader interventions including business advisory services. Programs should focus on viable but underserved new borrowers and include incentives for loan repayment. Credit subsidies should cover the cost of credit to ensure participation of private credit providers. Expectations of debt forgiveness should be eliminated, and the system of interest rate caps should migrate to a usury rate.

B. Capital Markets Development

49. Government and corporate debt securities are sold through private placements and rarely transacted in the secondary market. The government fixes the interest rates of government securities usually below market rates. Events of default and fraud have damaged the reputation of a rather thin corporate debt market. Issuance requires cumbersome approval processes that do not offer adequate protection to the investor. The infrastructure for transacting government and corporate debt faces operational and reputational risk and requires significant upgrades to comply with international sound practice. Green finance markets are also at a nascent stage. A more active bond market would not only provide a robust financing alternative to the government but will also mitigate the vulnerability of the financial system to liquidity shocks.

50. Capital markets in Ecuador have not developed because the critical preconditions for a local bond market to emerge are still lacking. Recurring external debt defaults, structural macroeconomic imbalances, and the absence of a long-term savings industry suggest that market development should be approached as a gradual, long-term endeavor. However, phased actions to improve the functioning of the government bond market should begin sooner rather than later, starting by replacing private placements with regular auctions, initially for short-term government securities; then looking to expand repo markets and broaden the investor base.

Authorities’ Views

51. Authorities broadly agreed with the FSAP’s assessments and expressed interest in implementation of the recommendations. However, they noted that recommendations that require changes to legislation are challenging in the current political environment, and some could be limited by legal constraints. Recommendations with budgetary or government financing implications would need to be carefully sequenced given fiscal challenges.

52. The authorities pointed to the stability of the financial sector during the pandemic period and the market exit of a significant number of unviable cooperatives as positive signs. However, they agreed that the combination of falling oil prices and tightening global financial conditions in the adverse scenario would be challenging. Authorities agreed with the analysis of the liquidity stress test and noted that the liquidity fund was mostly invested in international liquid assets and would be available in extremis. The implications of a broader move by banks and the deposit insurance fund to holding more international liquid assets for the stability of the dollarized system, which they remain committed to, would need to be considered. In addition, legal limitations on public sector lending to the financial sector could limit some reforms, such as on emergency liquidity assistance.

53. The authorities recognized the challenges for financial sector oversight and crisis management. They highlighted existing initiatives to improve inter-agency coordination and plan to build on these, for example through the forthcoming Financial Stability Report. They agreed with the need to further integrate stress-testing and forward-looking viability analysis into their supervision of banks, mutuals and cooperatives. Addressing shortfalls of resources and recommendations on appointment processes would be more challenging given limited fiscal space. Authorities accepted the case for a reform of the financial institution resolution framework but noted that major financial sector legislation would be politically challenging.

Proposed Decision

The following decision, which may be adopted by a majority of the votes cast, is proposed for adoption by the Executive Board:

The Executive Board takes note of staff’s analysis and recommendations in the report on Ecuador’s Financial System Stability Assessment (SM/23/195, 08/04/2023).

Table 3.

Ecuador: Selected Economic and Financial Indicators, 2020-281/

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Sources: Ministry of Economy and Finance; Central Bank of Ecuador; Haver; World Bank Development Indicators; and Fund staff calculations and estimates.

IMF World Economic Outlook (April, 2023). The projections were finalized before 2022Q4 data were released.

Gross debt consolidated at the level of the NFPS. Includes the outstanding balance for advance oil sales, treasury certificates, central bank loans, other liabilities and the stock of domestic floating debt. The public debt estimates are preliminary and subject to revisions in accordance with the IMF’s Public Sector Debt Statistics: Guide for Compilers and Users

Includes inventories.

GIR excludes non-liquid and encumbered assets.

Net international reserves is equal to gross international reserves less outstanding credit to the IMF, short-term foreign liabilities of the BCE, deposits of other depository institutions and other financial institutions (excl. BIESS) at the central bank, and short-term liabilities of the central government, all derivative positions.

Includes crude and derivatives.

Table 4.

Structure of Financial System, December 2022 1

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Sources: Central Bank of Ecuador, Superintendencia de Economia Popular y Solidaria, and Superintendencia de Bancos.

Data for Segment 4 and 5 of Cooperatives and Mutualistas as of September 2022. Banco del Pacifico classified as a public commercial bank.

Data for 2022 Nominal GDP from IMF Spring 2023 WEO.

Table 5.

Financial Soundness Indicators (2017-22)

(In percent, unless otherwise indicated)

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Source: Superintendency of Banks, Superintendencia de Economia Popular y Solidaria and Fund staff calculations.
Table 6.

Ecuador: Implementation Status of Key Recommendations from the 2004 FSAP

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Table 7.

Ecuador: Risk Assessment Matrix

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In line with the February 2023 G-RAM.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. 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.

Appendix I. Stress Testing Matrix (STeM)

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1

In December 2022, Ecuador’s FX reserves were about 35 percent of the IMF’s Assessment of Reserve Adequacy metric for emerging markets.

2

Investment in public securities represents about 10 percent of bank assets and 85 percent of their capital. The public and medium-sized banks tend to be more exposed to sovereign risk.

3

See Appendix I: Stress Testing Matrix for further details.

4

Healthy banks with a CAR above 12 percent are assumed to distribute two-thirds of their profits.

5

The exercise assumed outflows for each balance sheet item in line with the Basel LCR standard.

6

This estimate was obtained by extrapolating the liquidity deficit of the banks that participated in the LCR pilot project, excluding one outlier.

7

INFORM is a multi-stakeholder forum for developing shared, quantitative analysis relevant to humanitarian crises and disasters. INFORM includes organizations from across the multilateral system, including the humanitarian and development sector, donors, and technical partners.

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Ecuador: Financial System Stability Assessment
Author:
International Monetary Fund. Monetary and Capital Markets Department