Appendix I. Highlights Of The Case Studies

Monetary and Financial Policy Transparency (MPT)

1. Turkey: The assessment for Turkey completed in 2007 (based on two FSAP-related missions in 2006), only made an assessment of monetary policy transparency. What makes the Turkish experience interesting is the progress made by the country on monetary policy transparency in the years following the onset of the major fiscal and financial crises that badly battered Turkey early this decade. In fact, that crisis gave impulse, actively supported by the Fund and Bank, to a major macroeconomic reform targeted to correct the country’s serious underlying macro vulnerabilities. In May 2001, in a clear break with failed past economic policies, the Central Bank gained operational independence and was freed from any obligation to finance the fiscal deficit; its primary objective was clearly stated as domestic price stability. The Central Bank used its independence to improve the monetary policy framework, materially enhancing monetary policy transparency with the introduction of inflation targeting and the adoption of clear rules for: influencing interest rates in the Interbank Money Market; reserve maintenance by banks; access by banks to its liquidity facilities; and its own foreign exchange market interventions. Progress did not materialize instantly but came rather gradually over the years. In fact, two years before the 2007 MPT ROSC, the Fund staff still perceived achieving a more transparent monetary framework as the main challenge for the medium term (2004 Article IV Consultations). The staff was encouraging the Central Bank to formally target its ultimate objective, inflation, rather than volatile monetary aggregates such as base money. The staff also saw a greater role for the monetary policy council, better predictability in the timing of interest rate decisions, and a more steady approach to foreign exchange market interventions.¹ When the 2007 MPT ROSC took stock of the situation it reported a high level of monetary policy transparency, both in the text of the laws and regulations and in the way these were being implemented. There was still room for improvement, as three of the core principles were found to be either partially observed or not observed. Some gap filling required amendments to the Central Bank Law—they are still pending, such as the adoption of legal provisions and obligations on capital maintenance by the Central Bank. It is hard to measure the amount of progress since the 2007 ROSC exercise but judging by the most recent surveillance reports, monetary policy transparency issues are no longer central to the Fund agenda with the Central Bank. Moreover, the new macroeconomic framework put in place by Turkey has proven valuable during the recent global turmoil, with the economy showing a smart come back this year on the heels of a robust credit-led rebound.

2. Tajikistan: In August 2007 a Fund assessor carried out both a monetary and financial transparency assessment of the National Bank of Tajikistan (NBT), the country’s monetary authority and the banks’ supervisory and regulatory agency. The Tajik experience with monetary and financial policy transparency is interesting for several reasons. To start with, it shows that appearances can be deceiving when trying to assess transparency. This initial MFPT ROSC found policy transparency at the NBT broadly satisfactory, in part a reflection of the good disposition of the central bank to inform the market on its activities. As a result, the MFPT ROSC gave it relatively generous ratings; most principles were found to be either in observance or broad observance with good transparency standards. In hindsight, the assessor appears to have relied too much on the text of the law without due weight of misaligned practices. For example, since the NBT is required to submit audited financial statements to Parliament the grading of principle 4.2 which deals with this type of disclosure was considered observed, despite the fact that the NBT had not produced audited financial statements for years due to reticence on the part of its auditors to sign off on them. Rather than demanding an immediate reversal of this anomalous and potentially damaging state of affairs, the assessor recommended: “The audited financial statements could be made available on a timely basis on the NBT’s website.” Sadly, a few months later (March 2008) the Fund Board had to meet on five non-complying disbursements by Tajikistan made on the basis of inaccurate net international reserve position reporting—the country was under a three-year Poverty Reduction and Growth Facility. Credibility of the Tajik authorities and its central bank were badly damaged at a time when the country was facing very difficult economic circumstances. In addition, the Fund was put in the position of having to demand a reimbursement.

3. The Tajik experience also illustrates some of the difficulties assessors face with the correct application of the MFP Transparency Code. The focus of this standard often must go beyond mere transparency since it has to be supportive and consistent with other interrelated financial standards. For example, the BCP assessment of February 2007 recommended enhancing transparency and predictability of decision-making at the highest level of the NBT, and that a full up-to-date set of regulations be made available. All the same, the MFPT ROSC assessed principle 6.2 of the MFP Transparency Code, which deals with timely reporting to the public of changes to financial policy, as being observed arguing that financial policies were timely communicated to the public via the media and the NBT’s web site. The Tajik experience also shows how crises can be powerful incentives for financial reform and gatherers of the required political will for rapid implementation. Under a Staff-Monitored Program (SMP), Tajikistan has been addressing governance and management gaps detected at the NBT. With some delays, the most urgent amendments to the laws on Banking Activities (July 2009) and NBT (August 2009) were passed. Also, the NBT’s audited financial statements for FY 2009 were released in April 2010. A new NBT Law is now expected to be enacted by mid-2011. All the same, it will take time to correct organizational shortcomings at the NBT, and in the meantime data and operational integrity at the NBT will continue to lack adequate transparency.

Fiscal Policy Transparency (FPT)

4. Mozambique: This experience shows the long-term value of an accurate and comprehensive FPT ROSC containing a sound list of prioritized recommendations for fiscal reform. Active and sustained follow up has been one of the merits of this ROSC experience (4 ROSCs and updates starting in 2001, with the latest reassessment in 2008). An active Fund-led TA program, well supported by donors and the Bank over the years, has been a main contributor as well as crucial for supplementing the strong commitment and sense of ownership shown by the Mozambican authorities over their comprehensive fiscal reform program, which has been validated by different Administrations. Also, the Fund staff has recognized that gains in FPT have meant easier surveillance and improved compliance over time by Mozambique with Fund-imposed fiscal conditionality. All in all, sustained FPT ROSC engagement by the Fund in Mozambique has enriched fiscal reform, improved coordination of a rich TA program and introduced timely revisions to the long-term FPT agenda.

5. Greece: The Greek experience with FPT ROSCs provided several lessons. One is that country self-assessments (1999, 2001, 2002 and 2003) without the benefit of an initial full-fledged ROSC by a Fund-led team can derive in a false sense of security. A full-fledged FPT ROSC was initiated by a Fund-led team in 2005 and completed in January 2006. In addition, Fund also provided TA related to issues identified in the ROSC. Necessary corrections to the diagnosis were finally introduced once Art. IV consultations finally focused more carefully on the country’s major FPT shortcomings (2005 and 2006). Another crucial lesson is that clear, sustained political will on the part of the authorities is essential. In Greece, the authorities did not take much action on the ROSC and TA reports primarily due to limited political commitment, as well as limited capacity in the Ministry of Finance to implement budget reforms. Further surveillance and EC reviews did not put enough pressure on the authorities to focus on addressing FPT issues. This experience also shows that there is no substitute to sound, broad-based fiscal reform when there is a major shortcoming in FPT. The Greek experience also illustrates the need for comprehensive follow-up on the FPT as a part of the Fund surveillance. In hindsight, it would have been far better to prevent by taking timely corrective action than expose the economy to a serious loss in fiscal credibility. Curative action, as is currently the case of Greece with its now ambitious fiscal reform package under outside-imposed conditionality, is far from ideal and clearly something to be avoided. In retrospect, while prior FPT ROSC tool did not work as preventive medicine, it allowed nonetheless to respond quickly to the emergency by providing a focused list of FPT recommendations for government action and essential material for designing Fund/EU-associated conditionality. In that respect, although the Greek experience has proven to be sour, FPT ROSCs exercises have been helpful to contain further damage following the onset of the macroeconomic crisis. Future FPT ROSCs could also contribute to the slow process ahead of restoring the country’s fiscal credibility.

Data

6. Costa Rica: Costa Rica has been a subscriber of the SDDS since 2001. A lesson from this country experience is that ROSC exercises can be successful even when formal assessments under a ROSC are not repeated for several years (in 2001 and 2010, in the case of Data ROSCs for Costa Rica). However, for that to happen several conditions are probably necessary and which were met in the case of Costa Rica, including strong country ownership of the agenda for macroeconomic statistical reform and close follow up by the Fund via a supportive TA program and periodical Art. IV Consultations. Another important lesson of this Data ROSC experience is the need to engage a country’s commitment by agreeing on a detailed and well-supported action plan as part of the ROSC exercise, which appears to be crucial for moving successfully forward a complex agenda for change, particularly when the reform involves long-term commitment and the need to amend the legal framework—as is currently the situation in Costa Rica for further improvements.

7. Bosnia and Herzegovina: Bosnia and Herzegovina does not participate in the GDDS, and although it meets many of the GDDS recommendations for coverage major deficiencies in its macroeconomic statistics remain. These weaknesses have made it more difficult to deal with the ongoing economic and financial crisis and the country’s sharp fiscal and external imbalances. One lesson is that it is not enough to have a sound, comprehensive assessment; it is also important that this be timely (the first Data ROSC is rather recent, dated February 2008) and that country’s implementing agencies be capable of mustering the political will to apply a cohesive, well coordinated work plan. The four agencies responsible for macroeconomic statistics have had serious difficulties agreeing on clear priorities for a statistical program. There is also a lesson in the relatively abundant but segmented TA from a variety of donors, which has made things more difficult and real reform appear less urgent. The inability to move away from a fragmented, uncoordinated approach in the generation of macroeconomic statistics is a reflection of the pervasive and complex political realities of Bosnia and Herzegovina, which has precluded reaching broad encompassing political agendas. It would have been much better to prevent than to have to implement a real reform in the context of Fund-supported conditionality, as it is currently the case of Bosnia and Herzegovina. In hindsight, delays in improving statistical reporting appear to have added significantly to the current economic burden; this is another case of a missed opportunity for reform and drastically improving the quality of macroeconomic statistics—in particular, when the economic times were good (i.e., during the high growth years that lasted until 2008).

Insolvency and Creditor Rights (ICR)

8. Romania: The Romanian experience with insolvency and debtor/creditor rights issues is particularly interesting given that the ongoing global macroeconomic and financial turmoil has battered Romania particularly hard, resulting in high levels of distressed debtors. Romania made good progress in setting up the legal framework prior to the onset of the crisis. In particular, the country united behind a multidimensional reform effort with the objective of securing membership in NATO and the EU. Once more, the Romanian experience illustrates the importance of strong country ownership of the reform agenda. The ICR ROSC exercise in Romania came rather late (2004) in the process of transforming Romania into a market economy. The detailed assessment produced by a Bank team was for discussion with the authorities only, so unfortunately there was no associated publication of the results, even in a summarized version. The report detected major weaknesses in the implementation and enforcement of the recently modernized legislation. An over ambitious legislative agenda and hastily adopted amendments, ordinances and regulations without meaningful stakeholder participation had undermined transparency and predictability of legal practice and added pressure on the court system. The lesson here is that merely passing laws does not ensure or ingrain reform or a sound legal environment. This ROSC experience also produced a focused and prioritized list of recommendations that enriched the dialogue with the authorities and became integrated into a comprehensive agenda for reform. An impressive package of financial legislation was approved in 2006 as part of the impulse to bring Romania into compliance with the EU directives (Acquis Communautaire). The package also included a new Law on the Insolvency Procedure. Since then the challenge for Romania has been focused on the fair, transparent, expedient and efficient implementation of its new and impressive body of legislative work. The current crisis has accelerated that process. Amendments to the Insolvency Law in 2009 streamlined insolvency proceedings, including the adoption of measures proposed years earlier in the 2004 ICR ROSC (i.e., creation of special divisions within trial courts to deal exclusively with insolvency cases). Renewed recent involvement in Romania by the Fund and Bank also has benefitted the implementation of the reform. The FSAP program (April 2009), for example, made specific recommendations in support of a medium-term ICR structural reform agenda, which is now receiving technical and financial support under the Bank’s DPL series. In particular, assistance is being provided to the Ministry of Justice to remove obstacles to efficient and effective corporate debt restructuring outside the court system, and to the National Bank of Romania on the preparation of guidelines for mortgage debt restructuring. The importance of TA in support of Fund and Bank conditionality is another lesson of this country experience.

9. Guatemala: Guatemala engaged in major financial reform following the economic and banking crisis that badly hit the country in 2001. An impressive long-term effort actively supported by the loans and TA from the Fund, Bank and Inter American Development Bank resulted in major overhauls of the legal, regulatory and supervisory frameworks underpinning the financial system, particularly the dominant banking sector, which has shown appropriate solvency and resilience to market volatility during the current global crisis. Nonetheless, poor private sector access to credit remains a major problem in Guatemala. In this respect, most of the problems with legal practices detected by the 2006 ICR ROSC, which was done in parallel with an FSAP update, still are pending resolution. This is also relevant because it is likely that the high fiscal tag of recurrent bank interventions during the present decade was much augmented by the absence of a modern and agile framework for dealing with distressed credit resolution and collection. Non-financial company restructuring and insolvency in Guatemala is currently left to a fragmented collection of legal provisions regulating different aspects of the process, which often ends up entangled in procedural norms, with proceedings often becoming sluggish, complex and expensive exercises. It is not surprising then that corporate restructuring and insolvency are scarcely used, and that the stigma associated with bankruptcy remains very strong. As made clear by the list of recommendations in the 2006 ICR ROSC, pending financial reform in Guatemala needs to go much further than resolving solely financial issues. It actually implies a broad and in-depth modernization of the civil system of justice, and of its commercial law and procedures in particular. By its nature, this type of effort must engage new agents of change (i.e., in the courts, Ministry of Justice, Congress, etc.) and a wider network of private stakeholders than the one that made possible the banking reform. One of the lessons of this country experience is that sometimes financial reform requires going much beyond the boundaries of the sector, particularly when matters of credit access and appropriate credit risk management are involved. Also, it is likely that better dissemination of the 2006 ICR ROSC (findings remain confidential) could have helped create better awareness of the problems and the development of a more robust agenda for change.

Corporate Governance (CG)

10. Malaysia: The 2005 CG ROSC exercise had good timing. It took place at a crucial moment in the development of Malaysia’s capital market development. Indeed, at the time the Securities Commission (SC) was taking inventory of progress already made in preparation for a major drive by the government to further enhance the capital market’s framework and practices. CG has been part of a broader effort to transform the Malaysian capital market into a more effective and efficient source of long-term funding for the country’s corporate sector. Improving corporate governance is perceived as an important ingredient for increasing capital market transparency and accountability, while benchmarking against best international practices is seen as key to accomplish this task successfully. One of the pillars in this process has been a strong public-private partnership involving key financial players, and which has imprinted the CG Code with a high degree of ownership among stakeholders. Following publication in 2006, the findings and recommendations of the detailed 2005 CG ROSC report were actively and jointly disseminated by the SC and the Bank. Since then most of the recommendations for improving the legal and regulatory framework have been enacted and adopted.

However, the combined presence of weaknesses in enforcement and the CG culture and practices have remained enduring problems detrimental to further advances. Nonetheless, recent surveys indicate that conditions in the area of CG have materially changed for the better since the 2005 CG ROSC. In fact, the Listing Requirements of Bursa Malaysia currently make mandatory the application of important CG principles for companies listing securities in the local market—as opposed to the “comply-or-explain” approach of the SC. As indicated by a recent Article IV report: “Malaysia has withstood the global recession well.” Moreover, Malaysia has met its goal of making its securities market resilient and a dynamic force for meeting the country’s corporate sector financial needs. There are perhaps two important lessons in the country experience. CG should not be left behind in the context of a sweeping and ambitious capital market reform and perseverance in the face of protracted CG issues can pay off handsomely at the end.

11. Argentina: International experience has shown that well-governed companies often are better valued by the market and get access to cheaper credit; and because they tend to be better run outperform their peers. All this should be particularly attractive to publicly traded companies and to those aspiring to a future listing. The question is why, as claimed by the Bank’s 2006 CG ROSC report and others, awareness of the potential benefits of good corporate governance remains low in Argentina, with corporate perceptions that noticeable improvements in the legal and regulatory framework have resulted merely in added costs rather than benefits. Contributing to this lack of corporate culture has been the passive attitude on CG matters by institutional investors. Active preoccupation with CG issues in Argentina is concentrated on the small but important group of large corporations that have looked mainly towards New York in search of new equity funding for expanding their operations. The meager performance of the local equity market probably does not contribute to increasing the interest of the average company in projecting an active and progressive corporate governance image. The poor market performance perhaps gives the impression that no tangible future rewards can be expected in the local capital market, thus focusing the average company attention on other drivers to increase its overall financial return. One of the lessons of the 2006 CG ROSC experience is that the Bank effort to support improvements in corporate governance practices in Argentina would probably have been more fruitful if it had taken a more encompassing approach, directing the effort to addressing issues affecting the vastly larger universe of companies outside the umbrella of the National Securities Commission, including those companies with majority ownership by the state. There might had been more value added in targeting the reform effort on these larger group of companies, particularly if that could have improved corporate governance awareness and standards overall, thus making the future listing of potentially attractive companies more likely. Unfortunately, the 2006 ROSC’s approach was to concentrate its recommendations narrowly around the pending agenda of the NSC. Moreover, there was no dissemination of the work done by the Bank and at the end the report was not made public. Circumstantial changes of staff at the Bank and NSC did not help in this respect.

Accounting and Auditing (A&A)

12. Poland: There have been two A&A ROSCs done in Poland (2002, 2005) and both have been able to report solid progress based on sound structural reform in the financial reporting infrastructure of the country. Central to the reform effort has been the sustained leadership and long-term backing of the Ministry of Finance, which has been ably supported during implementation by financial regulators and professional associations. Besides strong country ownership, another lesson derived from the Polish experience is the importance of solid preparatory work, such as the timely initial self-assessment to the 2002 A&A ROSC exercise. After the 2005 ROSC the country has continued to make steady progress on the basis of a detailed Country Action Plan (CAP). It set out key actions, tasks and allocated responsibilities for implementing necessary reforms. Multidisciplinary working groups have contributed to move the agenda forward, showing the importance of having the right setup for implementing multidimensional and complex reforms. In recent years the emphasis has been focused, as recommended in the 2005 A&A ROSC, on building the monitoring, supervisory and disciplinary regimes required for ensuring effective compliance. The leading challenge has been on quality enforcement of the demanding set of accounting, auditing and ethical standards adopted by Poland. All along, the process of change in financial reporting has been supported by a Bank-led TA program, an effort which has been recognized by the authorities. In this respect, the Bank’s Vienna-based Centre for Financial Reporting Reform and related donor cooperation (i.e., Swiss) have been key contributors to this Polish success.

13. Azerbaijan: The experience of Azerbaijan illustrates some of the difficulties and frustrations encountered by a transition economy trying to adopt and implement internationally recognized financial reporting standards applicable to a modern market economy. The adoption of the new Law on Accounting in 2004 gave a clear signal of the country’s desire for initiating a financial reporting reform. In hindsight, however, it would appear that there was not thorough internalization of the magnitude of the responsibilities and tasks entailed by the passage of that law, which was promoted by the Bank on the basis of a 2003 Country Financial Accountability Assessment. The 2006 A&A ROSC made available the first detailed diagnosis of the situation and summarized the magnitude of the work ahead. It pointed out, for example, serious cultural barriers to the adoption by businesses of general-purpose financial reporting, in particular the adoption of IFRS as required by the new legislation, in a country where different agencies and financial intermediaries had been developing accounting and auditing requirements suited to meet their own specific needs. Basically, the Law on Accounting did not provide basic tools or the financing for an adequate institutional setup for regulating, supervising and enforcing its requirements. The Bank response to the 2006 ROSC and its long list of recommendations was the approval of a Corporate and Public Sector Accountability Project (CAPSAP) in early 2008, a new type of lending for the Bank with the stated objective of supporting implementation of the 2004 Law on Accounting. Project implementation has been minimal so far, principally due to recurrent delays in reaching an agreement on project priorities and the associated Procurement Plan. The lesson here is that the provisioning and financing of TA is not enough to trigger the desire response. Also, perhaps a financial policy lending operation combined with the adoption of a holistic Country Action Plan would have been a more appropriate venue to move the financial reporting agenda forward.

Payment and Settlement (P&S)

14. Uruguay: Under the leadership of the Central Bank of Uruguay, the country’s financial community has been actively engaged in the implementation of a comprehensive program of reform of the payment and settlement systems, which the WB has actively supported since its inception. The first P&S ROSC exercise for Uruguay was carried out in the context of the 2006 FSAP. It provided a useful point of reference early on in the reform process while its holistic list of recommendations assisted in the formulation of the agenda for change, which included the enactment of key legislation, the creation of the P&S oversight function at the Central Bank, and a major upgrade of its real time gross settlement (RTGS) system, the backbone to the country’s payment system. Other program components were the creation of a securities depository and the overhaul of retail payment systems. Solid preparatory work by the Uruguayan team prior to the ROSC exercise under the umbrella of the Western Hemisphere Payments and Securities Clearance Initiative helped with the assessment under the 2006 P&S ROSC. With the publication of the ROSC report came a period of active dissemination of its results jointly by the WB and Central Bank. It culminated with the release by the Central Bank of a comprehensive discussion document (including many of the recommendations in the 2006 ROSC) where it offered its long-term vision for the modernization of Uruguay’s payment and settlement systems. This document, which set an ambitious agenda both in terms of content and timetable, has guided the reform process until today. The agenda was part of a broader effort since Uruguay at the time was engaged in a major overhaul of its financial sector with the support of the Fund, Bank and others. The new law on payment and settlement systems came into effect in September 2009 following the enactment of the Organic Law of the Central Bank and the Securities Market Law. The Bank recognized the work done with the inclusion of a payment and settlement component in its December 2008 Development Policy Loan operation. Implementation is still being actively pursued by the Central Bank and although there has been significant progress this has not been entirely free of hurdles on the way. The oversight function at the Central Bank is already in place and progress continues to be made in upgrading the RTGS system. Also, there is an approved action plan to bring about a new automated clearinghouse for checks and small payments, a central government securities depository and an enhanced securities settlement system. All this has required involving many players and a high degree of consensus supported by private-public partnerships. One of the lessons is that institutions like the Bank and the Fund can play a crucial catalytic role in multifaceted financial endeavors such as the one commented on here.

15. Sudan: These comments do not refer to a ROSC but to the findings summarized in the published 2005 P&S Technical Note (TN) for Sudan, which was one of the outputs of the first FSAP in that country. Part of the interest of commenting on the Sudanese experience is to extract lessons derived from basing a first time assessment on a TN rather than a ROSC, which embodies a more formal, holistic approach. Independently of the reason for a TN, in hindsight the Sudanese experience with the 2005 assessment of the payment and settlement systems appears to have been a case of a missed opportunity since it provided a diagnosis with important shortcomings and a rather shallow list of recommendations, some which were distractive to the Bank of Sudan’s (BOS) efforts to engage in a broad and in-depth reform of the country’s payment, settlement and custodial systems. Lack of adequate and timely information appears to have been the main problem during the preparatory stage and the two FSAP missions. In a marketplace dominated by cash payments, the Sudanese financial sector has been a laggard, with overall financial intermediation remaining low even for Sub-Saharan standards. It is not surprising then that the BOS has been engaged in promoting a comprehensive modernization of the country’s financial system, including payment, settlement and custodial services. The 2005 FSAP actually represented a major opportunity to support the authorities’ efforts for moving the process of financial reform forward. The 2005 P&S TN highlighted that there was much need of outside TA and capacity building support ,which the Bank and Fund are particularly well suited to supply, and that the Bank of Sudan was seeking and willing to finance. The 2005 P&S TN was not of much help (i.e., its list of recommendations was rather shallow and of little help for the preparation of a credible action plan for a far reaching reform). Although earnest, the assessing team did not have sufficient information available or enough time to carry out the comprehensive and formal assessment that the situation in Sudan demanded. There is little information available on recent progress with its payment and settlement systems reform although the Bank’s 2008 Global Payment System Survey reported that Sudan was carrying out a comprehensive reform of its systems, including the legal and regulatory framework; large-value funds transfer systems, retail payment systems; securities settlement systems; foreign exchange settlement mechanisms, and other systems. In the absence of a formal lending program, the Bank continues to provide non-lending TA to the country, but the reform of the payment system is not currently in the agenda. Most of the recent support to the Bank of Sudan in connection with its payment and settlement systems reform apparently has come from the Arab Monetary Fund (AMF). The IMF also provided TA jointly with the AMF after the 2005 FSAP. However, the Fund’s report on the 2009-2010 Staff-Monitored Program did not list structural measures related to the payment and settlement systems reform among its priorities.

Market Integrity (AML/CFT)

16. Mexico: The Mexican authorities have undertaken numerous measures to combat organized crime and drug trafficking including instituting the Integral Strategy against Organized Crime and the 2008 AML/CFT National Strategy. Another sign of the seriousness attached to the AML/CFT agenda by the Mexican government has been its determination to periodically carry out detailed assessments and take corrective measures to improve the country’s AML/CFT framework. There were formal assessments in 2004 and 2008. According to the assessors, the government contribution to these exercises was forceful, contributing to the process with solid self-assessments and well designed action plans to execute the work ahead.

17. The 2008 assessment found important pending issues, despite Mexico’s progress since the previous one in 2004. In particular, the legal framework criminalizing ML and FT offenses, although comprehensive, was still not meeting international standards, especially on laws and procedures that deal with the freezing of terrorist funds. Perhaps more importantly, the effectiveness of the enforcement mechanisms to combat ML activity was not robust enough to meet the challenges faced by Mexico, as illustrated by the relatively weak capacity of law enforcement to adequately and effectively investigate ML activities and prosecutors to secure convictions. Another issue highlighted in the 2008 report was the need to continue strengthening coordination arrangements among intelligence, investigative and prosecution agencies. Also, the Financial Intelligence Unit remained understaffed and had poor access to criminal records. There were also deficiencies in the capacity of the AML/CFT system to prevent ML especially in non-deposit taking institutions, such as the atomized net of exchange bureaus. Another significant gap was detected in the absence of an AML/CFT legal, regulatory and supervisory framework applicable to the so-called FATF designated non-financial businesses and professions, which international experience has shown to be particularly vulnerable to AML/CFT-related criminal and terrorist activity. To be sure, Mexico continues to make steady progress and indications are that some of the shortcomings detected in 2008 have already been addressed or are priorities in the government’s active AML/CFT agenda.

18. Botswana: This middle-income country has shown impressive high economic growth in the past two decades. In particular, the financial sector of Botswana has grown and diversified rapidly anchored around a sound banking system. However, the country is in need of further developing financial services as part of its strategy to increase economic diversification, in an economy which over the years has relied heavily on exports of a maturing diamond mining industry. Managing rapid growth is always a challenge, particularly when financial intermediation is a leading activity. In this general context, ML risk which is limited today in Botswana could easily increase in the future, driven by a domestic financial market that becomes more complex as it expands into new areas of activity, such as capital markets, and as the sector becomes more globally integrated.

19. The authorities were not idle in past years on AML matters. By 2007 Botswana already had put in place the key components of an AML regime. Indeed, the Bank-led team that conducted the detailed 2007 AML/CFT assessment found that the basic elements of the AML legal framework were in place, although it detected some inconsistencies between instruments and several components fell short of the international standards. One important missing component was that financing of terrorism was not criminalized in the law. Despite shortcomings, the Bank assessors saw the potential for significant and rapid gains by just expediting implementation of the existing framework. For example, Botswana was in need of more proactive enforcement as well as better statistics for assessing the country’s vulnerabilities to money laundering and financing of terrorism activities, a long pending task. Important laws such as the Proceeds of Serious Crimes Act (PSCA) were not being properly implemented or enforced, and active coordination and sharing of information between key parties was not taken place. A financial intelligence unit to analyze and disseminate suspicious transactions reports was also missing. Unfortunately, while needed actions were clear there was a sense of frustration in the sense that a promising agenda was not being actively pursued, despite years of waiting (i.e., the PSCA was enacted in 1990). At present, the picture is more encouraging, especially following the activation of the long awaited AML/CFT strategy. In 2008 amendments to the PSCA were approved and, perhaps more importantly, a Financial Intelligence Act was enacted in 2009, containing a new comprehensive legal framework to support AML and the establishment of the Financial Intelligence Agency (FIA). The challenge now is an adequate and timely implementation of the new legal framework. Previous failures with proper follow-up were caused in part by the lack of local experts to adequately carry out AMF/CFT work. While international assistance has been available to Botswana (i.e., from the Bank and Fund targeted AML/CFT TA programs), the country faces some restrictions to obtain outside assistance. Fortunately, Botswana this time has been receiving active support from the US Treasury Department to draft AML legislation and implement the FIA. Hopefully, this will provide another useful lesson on the key importance of international cooperation on AML/CFT matters.

Banking Supervision

20. Australia: Australia has a mature and robust financial system, where commercial banking plays the dominant role. The 2006 BCP ROSC exercise was able to reaffirm Australia’s sound overall regulatory approach to prudential and market conduct regulation, which with the support of good supervisory practices, was contributing to the strength and observed resilience of Australia’s financial system, and that of its banking sector in particular. However, the published report also highlighted banks’ vulnerabilities such as their significant exposure to a highly leveraged household sector (mainly mortgages) and strong reliance on wholesale funding, particularly offshore borrowing. This notwithstanding, supervisors appeared aware of the embedded risk in the banks’ portfolios and were already taking mitigating steps. From the perspective of the 2006 BCP ROSC exercise, an important lesson and crucial factor behind its success was the positive disposition shown by the authorities to participate in the process and try to gain from it. They had produced a detailed self assessment (completed in August 2005) well in advance of the December 2005 FSAP mission. This self assessment contributed to shape the final diagnosis prepared by the two staff assessors and helped them to quickly focus the discussion on the relevant points. Time during FSAP missions is normally quite scarce, so the quality preparatory work done by the Australian authorities as well as their overall disposition to actively participate in the process added value to this ROSC exercise. To be sure, there were some points of contention with the drafted ROSC but in hindsight they appear now to have been minor in the context of the global financial crisis to come. The protracted global financial market turmoil continues to put to a hard test the resilience of Australian banks and so far the system has shown resilience, giving credit to the diagnosis in the 2006 BCP ROSC. While the global slump has made even clearer the need of Australian banks to reduce their funding exposure to rollover risk and dependency on short-term offshore wholesale funding, the overall impact of the global crisis on banks’ asset quality has been limited. In general, financial soundness indicators for the Australian banking system have remained strong, at levels comparable with those of Canadian banks. The Fund recently completed a Basel II Implementation Assessment (published in May 2010) which concluded that there was sufficient evidence of the effectiveness of the Australian supervisory approach in promoting a well-capitalized banking system, both on an ongoing basis and in response to specific events such as the recent global financial market turmoil.

21. Iceland: Iceland can be characterized as a small-sized developed economy with a hyper developed and concentrated commercial banking system. Its BCP ROSC experience is particularly interesting because of the country’s devastating experience with the recent banking crisis that led to widespread insolvency in the industry and a profound contraction in internal demand. There is little doubt that the domestic economy could have fared better had it been able to count on a better legal and regulatory framework and supervision for the financial system, particularly for the dominant banking sector. In retrospect, the question is what went wrong? The first formal BCP ROSC assessment was in 2001. It detected a number of important weaknesses. Unusually for a BCP ROSC, the published document contained the detailed assessment, including ratings of compliance for each Principle. There was material or simply noncompliance in many areas, such as legal protection, investment criteria, loan evaluation, connected lending, country risk and supervision of foreign establishments. Nonetheless, the 2001 BCP ROSC concluded, rather confusedly, that the backbone of Icelandic laws and prudential regulations was fundamentally sound. All the same, this first ROSC exercise was helpful since the Icelandic authorities acted upon the advice given and soon thereafter carried out a major overhaul of the regulatory and supervisory framework. Thus, the 2003 BCP ROSC update reported that the Financial Supervisory Authority (FME) was getting more funding and had additional supervisory powers. Although these were important improvements, in hindsight the 2003 BCP ROSC update gave too-rosy a picture of the situation, perhaps due to excessive reliance on changes in the legal text rather than on a detailed assessment of actual supervisory practices. The lesson here is that unless assessors have prior deep knowledge of the country’s banking sector, the full cooperation of local stakeholders, and a high quality and realistic pre-mission self-assessment, short on-site missions (i.e., in the context of FSAP exercises) have little chance of delivering a comprehensive and sound assessment of the BCP. Curiously, years later in 2008 an FSAP update did not include a formal BCP ROSC exercise among its tasks. Perhaps there was no clear perception at the time that Iceland’s banking sector could pose a serious systemic threat to the international financial market. In hindsight, we now know that that was not the case. Even less fortunate was the fact that the 2008 FSSA report summarized the situation by stating that the banking supervision capacity of FME had been enhanced and that “all issues raised by the 2003 BCP assessment have been addressed.” It should be noted that by June 2008 a profound transformation of the Icelandic banking industry had taken place since 2003, including a quantum leap in banking assets in the in-between years. This does not appear to have merited an in-depth, comprehensive BCP assessment. Unfortunately just a few months later (November 2008) the Fund hastily approved a two-year Stand-By Arrangement (SBA) for Iceland. It followed the enactment of a law giving the FME far-reaching powers to deal with problem banks, which it used days later to swiftly to take control of the three dominant commercial banks. The government had an experienced Finnish bank supervisor assess key areas where changes were needed, such as liquidity management, connected lending, large exposures, cross-ownership, and the “fit and proper” status of owners and managers. The Fund staff in the first review report under the SBA (October 2009) concluded that the recent assessment revealed notable deficiencies in supervisory practices, and that the authorities were determined to correct them by 2011, in particular prudential rules regarding connected lending, large party exposure and the use by banks of consolidated information on borrowers in the FME’s new credit registry. Furthermore, the government is now committed to conduct a detailed BCP assessment by independent and internationally recognized assessors and to publish it at the latest by end-2011.

Securities Regulation

22. Thailand: Thailand has accomplished a lot since the 1997 financial crisis, greatly strengthening the resilience of its economy and financial sector. Major weaknesses in the regulatory and supervisory framework of the financial sector have been addressed, bringing it generally in line with international standards. Improvements in securities regulation and supervision as well as in corporate governance of listed companies have materially helped to bring about the much deeper and broader capital markets observed today. Not least, the financial overhaul has become valuable in the past few years of unsettled domestic politics and global recession. All the same, the 2008 FSAP reported that while the financial regulatory and supervisory structure was generally compliant with international standards, there was still a need to strengthen the legal framework, to which it attached immediate priority. Among other things, this implied amending the Securities Exchange Act to give the Securities and Exchange Commission (SEC) additional legal authority on matters of stock market discipline, SEC’s enforcement powers, enhanced financial and operational independence of the SEC, and an improved toolkit for the SEC to deal with stressed situations and firms’ failures. There were several other recommendations in the 2008 SR ROSC but they could wait until the revised legal framework was in place.² The 2008 FSAP evaluation came at a time when the Thai authorities needed to take stock before finalizing a major drive to enhance once more the legal framework of the financial system. In fact, soon after the FSAP missions, in December 2007, five pieces of legislation of importance to the Thai financial market were enacted by the Legislative Assembly, including amendments to the Securities and Exchange Act which took into account key FSAP recommendations and went into effect in 2008. In summary, this country experience shows the relevance of timely ROSCs when there is country ownership over financial reform and the political will to continue making progress.

23. Qatar: This high-income and extremely fast-growing economy has great appetite for infrastructure financing, both equity and debt, which is clearly in the domain of capital markets to supply. It is not surprising, then, that the government had an active engagement to transform Qatar into an important regional financial center. Mixed results had been achieved by January 2007 when an FSAP mission assessed the securities regulation using the SR standard. The financial legal, regulatory and supervisory structure was complex and rapidly evolving at the time, as the transformation of the financial sector was mid way and there was still a lot of work in progress. The Doha Stock Market (DSM), at the center of Qatar’s capital market activity with a market valuation of roughly US$57 billion, was mainly for trading by domestic retail investors in state-controlled companies. The DSM was basically a self-regulated entity since the Qatar Financial Markets Authority (QFMA), the new securities market overseer created in 2005 was still not operational. There was also the still small but rapidly expanding Qatar Financial Center (QFC) which the authorities had created in 2005, having many of the features of an off-shore center but where local investors also were allowed to do business. The intention was to add a state-of-the-art component to the domestic financial structure and increase competition. With its own legal framework, regulation and oversight of the QFC was in the hands of the QFC Authority (QFCRA).

24. In this environment reminiscent of an active construction site, it is not surprising that the application of the SR standard by the Fund staff found many more gaps than effectively implemented internationally accepted securities regulation principles. The SR ROSC picture taken in early 2007 was perhaps premature and probably came at the wrong time for the DSM. In the absence of an operational QFMA, the DSM was basically still in charge of securities supervision. Moreover, there was much work ahead to fully implement the rapidly evolving vision of the authorities on matters of financial reform. In that environment, it is not clear whether the DSM was the right counterparty to the Fund assessor. In fact, almost in parallel to the FSAP mission the authorities were actively working on significant changes to the financial system framework, having already taken the decision of implementing an integrated financial regulation and supervision approach, in line with the British model. However, all these efforts were going ahead without the benefit of the Fund’s advice, so most of the recommendations made in the context of the SR ROSC exercise came in conflict with the views of the DSM, which opposed most of them across the line, as illustrated by the Authorities’ Response in the detailed SR assessment report.

25. Faced with a complex job, the process of unifying financial regulation and supervision has continued to make progress in Qatar although the practical outcome so far is hard to assess, especially given the scarcity of information available. QFMA has been operational since its law was amended in 2007. More significantly, that year the government formally declared its intention of establishing the new single Financial Regulatory Authority (FRA), a new agency adhering to the highest international standards and expected to draw together the resources of three existing bodies: QFCRA, QFMA and the banking supervision division of the Qatar Central Bank. In the 2009 Article IV Consultation report, the Fund staff commended the authorities’ intention to establish this new unifying entity. However, it urged prompt action to deal with regulatory gaps during the transition period and increased market competition. In the meantime, perhaps it would be worthwhile for the authorities to revisit recommendations on financial and regulatory integration made in the 2008 SR ROSC.

Insurance Supervision

26. Jordan: One important lesson from the Jordanian experience is that it pays off to support reform minded, professionally strong and persistent regulators and supervisors. Perhaps more should have been done in the case of the Insurance Commission, the autonomous financial agency in charge of the sector’s regulation and oversight, which could have benefited from more engaged and active international support, particularly for moving the legislative agenda forward. In that respect, the Bank and Fund could have been more forthcoming by including some of the key IS ROSC recommendations in the dialog with the authorities.³

27. The first detailed assessment of Jordan’s insurance sector was done in the context of the 2004 FSAP evaluation (its findings have not been made public). By then, Jordan had already implemented massive financial modernization, including a major overhaul of the insurance legal and regulatory framework. The new Insurance Law enacted in 1999 gave birth to the new Insurance Commission (IC), the autonomous regulator and supervisor of the insurance industry. This was fully functional—following a major legal overhaul in 2002 that benefited from the accumulated experience with the new framework—by the time of the 2004 IS ROSC. The industry’s new rules entailed internationally compliant licensing and financial solvency criteria based on risk-based capital and solvency ratios. Rules for technical reserves, reinsurance cover, claim settlement procedures and company market conduct also had been established, including the adoption of international accounting standards and actuarial methods. However, despite IC’s great strides much work still lay ahead to fully meet international standards. A shortage of qualified staff was undermining the IC’s capacity for on-site inspections. Other shortcomings required new legislation, including changes to enhance the operational and financial independence of the IC, which was important particularly to reduce undue political pressures. Much work also remained to be done to increase public awareness of the benefits of offering a modern menu of insurance services, given that most insurance was compulsory, with the bulk of premiums coming from automobile insurance. Life insurance business was incipient. All told, insurance penetration was low (equivalent to less than 2 percent of GDP in 2001). The IC, in broad agreement with the 2004 IS ROSC findings and recommendations, was moving ahead with the implementation of its ambitious medium-term action plan. FIRST funded TA needed for strengthening actuarial supervision and later on to take into account ROSC-related recommendations and fund British assistance to develop a supervisory ladder for risk-based supervision. In summary, the IC’s experience shows the importance for a new financial agency to rely on strong and qualified leadership. Despite resource limitations, the agency was able to make much progress in modernizing the insurance industry and expanding its coverage—at a two-digit annual pace in the period 2002-08, when measured by invoiced insurance premiums (insurance penetration of 5.7 percent of GDP in 2007). A factual update of the initial assessment completed in 2009 reported much progress although the increase in premiums was still mainly explained by compulsory auto insurance; life insurance remained a laggard and a major challenge. Ingrained cultural impediments represented a major obstacle to the development of the insurance market. Little success with the finalization of the legal agenda—no fault of the IC— appears today as the major impediment to the IC’ strategic objective of converting Jordan in a regional insurance center.

28. The Philippines: Insurance supervision in the Philippines was found to be largely compliant-oriented by the initial 2002 IS ROSC assessment and the evaluation carried out during recently completed 2010 FSAP exercise. However, the current situation of the insurance sector in the Philippines is far from encouraging. Many of the 2002 IS ROSC recommendations are still pending resolution. More telling, the insurance sector in the Philippines remains small (insurance penetration of 1.05 percent of GDP in 2008) and the non-life segment has shown a sharp contraction since 2002. Paradoxically, there are plenty of private companies and competition. Life insurance business, which represents about two-thirds of gross premiums, has fared somewhat better but it has been negatively impacted by recent volatility in financial markets. This led the 2010 FSAP to conclude that the insurance industry was facing a negative outlook; it was a cause of concern if the present course is not altered.

29. There is a need for decisive corrective action both at the company level and to reform the sector’s legal, regulatory and supervisory framework. For example, low asset yields require that minimum valuation standards for life insurance liabilities be strengthened to meet ICP standards. At the company level, the state-owned Government Services Insurance System (GSIS) continues to introduce major market distortions and if mandatory auto insurance is added to its list of monopolized product lines, it could have serious financial repercussions severely undermining the viability of some private players (the 2002 FSAP recommended the market exit of GSIS). Nonetheless, the technical note produced as part of the 2010 FSAP update highlighted several and wide raging opportunities for the growth of the industry (i.e., micro-insurance, crop insurance, pre-need insurance, flood and earthquake insurance, etc.). This adds to the current frustration with the sector’s performance.

30. The authorities need to embark on a broad-based reform effort for the sector to develop it to its full potential. This would not be the first time that the Philippines tries to modernize its insurance industry. For example, the Asian Development Bank (ADB) has actively supported the Philippines in the context of the Financial Market Regulation and Intermediation Program. Similar previous efforts had some success but weaknesses have remained, in particular with respect to the IC’s independence, scarcity of available resources and the absence of decisive risk-based supervision. The 2010 FSAP highlighted basically the same shortcomings. More specifically on matters of regulation and supervision, the 2010 TN found that while the Insurance Code and associated Regulations and Circulars remained functional they were out of date and should be reformed; in particular, the current framework for insurance companies’ capital requirements and the capacity of the IC to deal with severe financial distress in the industry are in need of a major overhaul. Better IC governance (i.e., financial and operational independence from the central government) and more resources are also a pending issue. In addition, the IC scope should be widened (i.e., to cover pre-need insurance). Ideally, IC should move away from rule-based supervision and become a risk-based supervisor. Finally, the reform agenda is likely to require strong international support.