©2016 International Monetary Fund IMF Country Report No.16/66 ARGENTINA FINANCIAL SECTOR ASSESSMENT PROGRAM FINANCIAL SAFETY NET — TECHNICAL NOTE The documents related to the Financial Sector Assessment Program for the Republic of Argentina were completed in 2013. The reports were prepared by an IMF team in spring of 2013 and were discussed and finalized by the IMF’s Executive Board on July 12, 2013 . The assessment and recommendations included herein reflect the views of IMF staff at that time and do not apply to developments occurred since then. Copies of this report are available to the public from International Monetary Fund Publication Services PO Box 92780 Washington, D.C. 20090 Telephone: (202) 623-7430 Fax : (202) 623-7201 - mail: publications@imf.org Web: http://www.imf.org Price: $18.00 International Monetary Fund Washington, D.C. February 2016 ARGENTINA FINANCIAL SECTOR ASSESSMENT PROGRAM TECHNICAL NOTE FINANCIAL SAFETY NET Prepared By Monetary and Capital Markets Department This Technical Note was prepared by IMF staff in the context of the Financial Sector Assessment Program in Argentina. It contains technical analysis and detailed information underpinning the Financial Sector Assessment Program’s findings and recommendations. June 1, 2013 ARGENTINA 2 INTERNATIONAL MONETARY FUND CONTENTS GLOSSARY _________________________________________________________________________________________ 3 EXECUTIVE SU MMARY ___________________________________________________________________________ 4 INTRODUCTION __________________________________________________________________________________ 6 CRISIS MANAGEMENT FRAMEWORK ___________________________________________________________ 8 A. Emergency Liquid ity Assistance _________________________________________________________________ 8 B. Bank Resolution Framewor ks __________________________________________________________________ 10 CRISIS PREPAREDNE SS FRAMEWORK _________________________________________________________ 13 A. Legal Framework and Correct ive Action Arr angements _______________________________________ 13 B. Deposit Insur ance Guarant ee __________________________________________________________________ 15 C. Coordinating A rrangemen ts ___________________________________________________________________ 16 LEGAL PROTEC TION ____________________________________________________________________________ 19 BOXES 1. Crédit Agricole Resolution Case _______________________________________________________________ 11 2. Example of Prompt In tervention Trigger ______________________________________________________ 14 3. Crisis Manage ment Gr oup _____________________________________________________________________ 19 ARGENTINA 6 INTERNATIONAL MONETARY FUND Table 1. Argentina: Key Recommendations Recommendations and Authority Responsible for Implementation Timeframe 1 Emergency Liquidity Assistance Maintain surveillance over activities of nonbank financial companies to detect emergence of systemic liquidity risks. (BCRA, in conjunction with CNV). Near Term Bank Resolution Frameworks Clarify in the norms the resolution framework in case of a systemic crisis, formalizing the figure of bridge bank and necessary regulations and manuals (BCRA). Medium Term Set strict conditions to the use of open bank assistance (BCRA). Medium Term Correction Action Arrangements Enhance prompt correction action scheme (BCRA). Medium Term Deposit Insurance Scheme Establish a contingent funding me chanism for the FGD (MECON, FGD). Medium Term Coordinating Arrangements Establish a high-level systemic committee comprising all players of the safety net to monitor and plan for crisis coordination (BCRA, MECON, CNV, SSN, FGD). Medium Term Review liquidation arrangements and crisis management group formation in significant jurisdictions (BCRA). Medium Term Legal Protection Raise the threshold for lawsuits to gross negligence (BCRA). Medium Term Extend legal protecti on to SEDESA (BCRA). Medium Term “I-Immediate” is within one year ; “NT-near-term” is 1–3 years; “MT-medium-term” is 3–5 years. INTRODUCTION 1 1. The uncertainty, as well as the legacy of the 2001 crisis, has kept Argentina’s financial system relatively small (with assets slightly less than 50 percent of GDP). The banking sector accounts for two-thirds of the financial system, and about 43 percent of bank assets are state owned. The banking sector is moderately concentr ated, with the three largest banks representing about 40 percent of banking assets. Insurance se ctor assets represent less than 7 percent and mutual fund assets less than 4 percent of the financ ial system. The equity market is small at about 10 percent of GDP, with 99 listed firms at end-2011. 2. Banks safeguard against risks through stro ng capital and liquidity cushions and conservative funding strategies. As of June 2012, the system-wide capital adequacy ratio reached 16.6 percent, with a leverage ratio of 11 percent. As of October 2012, liquid assets (cash or holdings of central bank securities) amounted to 25 percent of deposits. Banks fund their assets almost entirely through deposits. As of October 2012, deposits from the public and private sector 1 Prepared by José Tuya (IMF consultant), with inputs for the section on ELA from Will iam Allen (IMF consultant). ARGENTINA INTERNATIONAL MONETARY FUND 7 accounted for almost 80 percent of total funding and equity for another 11 percent; less 3 percent of funding came from subordinated debt and foreign credit lines. 3. The banking system is regulated and supervised by the BCRA. Supervision is conducted by the Superintendence of Financial and Foreign Exc hange Institutions (SEFyC) that forms part of the BCRA. Supervision is conducted through a blend of onsite and offsite activities and resources are allocated based on risk. Banking institutions are ra ted by the SEFyC based on eight risk categories: capital, assets, market, earnings, liquidity, business, internal controls and management. Argentina is in the process of implementing Basel II and III. 4. Argentina has a well-developed financial safety net that has provided timely support to stressed institutions. The agencies involved in the financia l safety net are: (i) the BCRA that provides ELA, manages the bank resolution process, implements preventive action, determines least- cost option to be employed, and has inform ation exchange agreements with cross-border supervisors; (ii) the SEDESA that serves as trust ee for the FGD; and (iii) MECON. The system worked well during the most recent crises and the authoriti es demonstrated flexibili ty and innovation in adjusting the practices to reflect the comp lexities of specific resolution cases. 5. The review conducted during the mission fo cused on evaluating current practices and on adjustments that may be required as the Argentine financial system evolves and becomes more complex over time. The options for enhancements outlined below aim at addressing gaps that may develop as the financial system evolves and the recommendations are guided by emerging international best practice.  Systemic liquidity risks outside the banking system. The experience of the United States during the recent financial crisis shows that liqui dity crises can emerge outside the regulatory perimeter. The BCRA should consider how to manage them, and in particular whether the entities concerned should be subject to some fo rm of liquidity regulation, and whether facilities for providing them with ELA should be developed.  Institutional framework and coordination arrangements. The BCRA is the central pillar of the institutional framework and coordination arrang ements, which has worked well during past crises. However, as the financial system gets more complex, and bank organizational structures become more complex, risks may arise in other sectors overseen by other regulators. Currently, the Coordinating Council of Monetary, Financial, and Exchange Policy is composed of the BCRA and MECON officials. It is recommended that a systemic risk committee be instituted that incorporates all financial system regulators, as well as MECON and any ot her government entity that would play a role in cr isis management preparedness.  Prompt corrective action. The BCRA has a prompt correction action program in place requiring banks to respond by specific actions when ce rtain thresholds are breached. The BCRA could consider establishing additional triggers related to capital or liquidity and additional specific actions required of banks. These measures would be implemented automatically when thresholds are breached with exceptions to implementation being fully documented and ARGENTINA 8 INTERNATIONAL MONETARY FUND requiring approval by the BCRA Board. Such automat ic triggers help reduce delays in corrective action and provide additional incentives to m anagers and shareholders to rectify problems. The framework also improves transparency as banks kn ow what to expect when certain thresholds are reached.  FGD liquidity support. Adequate funding should be secured for the FGD in the event of systemic crisis/risks. The funding should be prov ided as a credit line from the government.  Resolution powers. A forward looking review of existing tools and considering possible market growth and diversification of services and financ ial instruments offered would aid the BCRA in maintaining up-to-date resolution tools. Addition ally, while authority to employ the bridge bank and the open bank processes is broadly derived fr om existing legislation, the use of those tools should be formalized in regulation to spec ifically address conditions for their use.  Cross-Border bilateral arrangements. A review of arrangements with home country supervisors and deposit insurance funds to de termine the adequacy of information exchange agreements to develop an effective cross-bo rder resolution and liquidation framework.  Legal protection. Amend legislation or regulation to a ddress legal protection for BCRA staff, currently only BCRA liability is addressed. To lim it filings and frivolous lawsuits, the threshold should require charges of gross negligence, wh en it comes to civil liability of the BCRA employees. CRISIS MANAGEMENT FRAMEWORK A. Emergency Liquidity Assistance 6. The BCRA’s charter designed emergency liqui dity facilities to manage a major bank liquidity crisis. Under these facilities, the BCRA is empo wered to provide peso loans to support distressed financial institutions in a wide range of circumstances. In particular, banks that fall short of liquidity may apply for assistance (rediscounts or loans) using public or private sector assets as collateral—a wider range that accept under normal liquidity facilities. Total assistance is capped at the equivalent of the capital and reserves of the borrower, although the BCRA board can decide to lift this limit in times of systemic stress. 7. The ELA regulation was revised in 2003 to include a more explicit scheme under the same legal framework, included in articles 17 b and c of the BCRA’s charter. The scheme was designed to take into account the lessons of th e 2001–02 crisis and included some new topics such as the introduction of the liquidity ratio (for accessing and paying back the ELA), more limits in terms of the maximum amount available, and autom atic mechanism for paying back the liquidity assistance, among others. The current framework is described in detail in Communication A5304 of May 10, 2012. ARGENTINA INTERNATIONAL MONETARY FUND 9 8. The main features of the framework are as follows:  ELA is available to financial entities that, having exhausted their other opportunities for borrowing from the BCRA, have a liqui dity ratio of less than 20 percent.  The maximum amount that may be borrowed is the lowest of: a. The amount requested by the prospective borrower; b. The amount necessary to get the borr ower’s liquidity ratio up to 30 percent; c. The size of the funding sou rces that the borrower has lost; d. The amount consistent with the BCRA’s monetary policy.  Any bank’s total borrowing from the BCRA is thus lim ited in size to its capital base, and this limit is specified in the BCRA’s Charter (article 17 b and c). However, in the words of the Charter, ‘Where it becomes necessary to provide adequat e liquidity to the financial system, or where general and extraordinary circumstances so warrant at the discretion of an absolute majority of the members of the Board,’ the limit may be exceeded.  The initial term is 180 days but loans may be exte nded for further periods of 180 days. Interest is payable every 30 days.  Loans must be repaid if the borrower’s liqui dity ratio rises above 30 percent, by an amount depending on the excess.  The interest rate is 1.35 times BADLAR for the first 180 days, and 1.70 times thereafter.  A range of private sector assets ar e eligible as collateral. The surplus margin required varies from 25 to 75 percent, depending on th e nature of the collateral.  Assets, such as mortgages, auto loans, consumer loans, post-dated checks and publicly-offered securities can be ‘pre-qualified’ as collateral fo r 90 days in anticipation of the possible need to use them as collateral for a loan. 9. Borrowers are subject to restrictions on th eir activities which become increasingly stringent and intrusive as the ratio of the amount borrowed to the capital base of the bank increases (for instance, because the capital ba se is shrinking because of running losses). When the limit specified by the BCRA Charter (article 17 b and c) is exceeded, borrowers also have to agree to the potential application of article 35 bis of the Law on Financial Institutions. Under this article the BCRA may restructure the borrower in defense of depositors, pending revo cation of its license.  Loans need to be collateralized with surplus margins of 25–75 percent, depending on the nature of the collateral, and loan applications must be accompanied by an independent auditor’s report attesting to the value of the collateral offered. Th is protects the BCRA against loss. It also means ARGENTINA 10 INTERNATIONAL MONETARY FUND that the proprietors of an insolvent bank who w ant funds to keep the business going while they plunder the assets have to give up more value in collateral than they receive in cash, if they use the ELA facility.  Borrowers are required to observe restrictions on their business activities, which become more severe as the amount borrowed increases relative to the bank’s capital base. No borrower can pay dividends, make loans or pay fees to relate d parties. If the loan exceeds 50 percent of the borrower’s capital base, the borrower is required to produce a rationalization plan, which would expose cases of insolvency, or cases in which the bank could be expected to remain solvent only on the basis of implausibly optimistic assumptions about the value of its assets. 10. The BCRA’s facilities have not been te sted since the new ELA regulation was established in 2003. While this framework worked well in the previous crisis, it has not been tested in the current environment, where banks hold fa r less government securiti es than in 2001–02 and may face steeper haircuts on collateral than in the previous crisis. 11. Although the facilities for banks are comprehe nsive, the BCRA should work with other supervisors to monitor potential risk s outside its regulatory perimeter. In particular, the BCRA should review the information about the balance sh eet of stockbrokers, which will become available when the new Capital Markets Act comes into force, and it should monitor the activities of money market mutual funds. The experience of the Unit ed States during the recent financial crisis shows that liquidity crises can emerge outside the regula tory perimeter. In extreme circumstances, central banks and governments may be comp elled to support the liquidity shortfalls in such institutions even though they had given no undertaking to do so and had exercised no regulatory oversight of them. If it concludes that there are systemic liq uidity risks outside the banking system, the BCRA should consider how to manage them, and in partic ular whether the entities concerned should be subject to some form of liquidity regulation, and whether facilities for providing them with ELA should be developed. B. Bank Resolution Frameworks 12. The bank resolution framework is based primarily on P&A model. The P&A process is implemented with the support of the FGD under a le ast-cost criterion. The deposits and the assets with economic value of the failed bank are transfe rred to create a new business unit (good bank). The assets can then be transferred directly to the acquiring bank or to a trust fund that ultimately issues certificates of the participation to the acquiring bank. The bank resolution process of transferring assets and deposits from the failed in stitution: (i) does not require the consent of debtors and creditors, (ii) cannot be challenged in court, and (iii) effectively transmits obligations and rights. Moreover, actions from the Superinten dent of Banks and the Board of the BCRA, in connection with the transfer of assets and privilege d liabilities under a resolution process, do not require any judicial authorization . Moreover, the resolution proce ss cannot be stopped nor subject to judicial appeal. ARGENTINA INTERNATIONAL MONETARY FUND 11 13. Since 1995 the BCRA has been involved in 36 bank resolutions with only one resulting in a depositor payout. In 34 of these cases, the P&A process was successfully employed, with 98.6 percent of deposits being assumed. In 2002 a bridge bank process was developed (Box 1). There was a case of open bank assistance to a systemically important bank and one credit union payout of all insured deposits in 1996. Assist ance available through the FGD was supplemented by assistance from a government contribution throug h the Fiduciary Fund for Bank Capitalization, which was last used in 2002. However, since th en the FGD has been self-sustaining and has not required additional support or an increase in premium. Box 1. Crédit Agricole Resolution Case In 2002, Executive Decree 838/2002 was issued to lice nse Nuevo Banco Bisel S.A., Nuevo Banco Suquía and Nuevo Banco Entre Rios. The three ba nks would serve as bridge banks to resolve Banco Bisel S.A., Banco Entre Rios, and Banco Suquía. The resolution was prompted by the decision of Crédit Agricole, parent of the three banks to exit Argentina and ma rked the first time the authorities used the bridge bank model for a resolution. The process demonstrates the flexibility of the regulatory framework and the crisis collaboration between the authorities. Article 35bis of the Law of Financial Entities does not address the licensing of a bridge bank among the resolution tools. Therefore, an Exec utive Decree was obtained to license bridge banks to be capitalized by Banco de la Nación Argentina. The bridge banks assumed the deposits wh ile the assets were placed in a trust (one for each bank). The trusts then issued ce rtificates “A” and “B” to each bank under resolution representing the assets. Certificate A (good assets) is th en transferred to the bridge banks. Certificate B and unsecured creditors remain with th e banks being resolved as residual value to be liquidated through bankruptcy court. The bridge banks were then sold th rough open solicitation to other banks. Suquía was sold in 2004, Entre Rios in 2005 (FGD purchased ARS$190 million in pref erred shares), and Bisel in 2006 (FGD purchased ARS$132 million in preferred shares). 14. There are currently three banks under recove ry programs and none is receiving FGD assistance. The recovery and resolution processes are administered by the BCRA. Once the SEFyC requires a bank to develop a reco very plan to correct deficiencies under LEF Article 34 or triggers a resolution plan (as directed by the BCRA Board) un der the LEF Article 35bis, the FGD is informed of any contribution that may be required. The SEFyC also prepares the least-cost computations to support liquidation payout or other resolution/recov ery options. Liquidations take place only after the BCRA has revoked the financial institution’s lice nse and are under the purview of the bankruptcy court. There have not been any resolutions since 20 05. The three institutions currently under special supervision for recovery plans are in compliance with the benchmarks imposed by the SEFyC and have returned to profitability. ARGENTINA 12 INTERNATIONAL MONETARY FUND 15. Pursuant to the LEF, the BCRA has the power to adopt, at its sole discretion, corrective or resolution measures, as appropriate, regard ing a financial entity that faces solvency or liquidity problems. Whenever the liquidity and/or solvency de ficiencies of a financial entity are so severe that, in the judgment of the BCRA, the situat ion cannot be normalized by a regularization and stabilization plan, the BCRA may choose between or dering the restructuring of a financial entity to protect its depositors or revoking its license (LEF, articles 35 bis and 44). 16. To implement the restructuring of a financial entity, the BCRA may adopt one or more of several measures contemplated in section 35 bis. The measures include booking of losses against partial or total provisions for doubtful a ssets, capitalization by the shareholders, withdrawal of the BCRA’s approval for all or any of the shareh olders to remain as such and subsequent transfer of the stock by a given deadline, sale of the fi nancial entity or the right to subscribe capital increases, and exclusion of assets se lected by the BCRA and liabilities. 17. The BCRA has broad powers, but liquidations are dealt through the judicial system. The LEF article 34 grants the BCRA the authority to require banks to develop plans to address deficiencies concerning: solvency/liquidity, minimu m reserves, noncompliance with prudential limits and noncompliance with regulatory capital minimu ms. Failure to provide the plan within 30 days authorizes the BCRA to revoke the bank’s license . Article 44 establishes the BCRA authority to resolve a bank when: it has failed to provide or is unable to meet its plan to address deficiencies, or solvency/liquidity deficiencies beyond the bank’s ability to correct. Once the BCRA withdraws the license, the appropriate bankruptcy court assume s responsibility for liquidation and appoints a liquidator. 18. The BCRA is provided with a number of reco very options to protect the value of the assets, and restructure or sell the bank. Under article 49 of the BCRA charter, the Superintendent can suspend the bank’s operations for a period of 30 days (may be extended to 90) during which a determination can be made as to wh ether the bank can be restored. 19. Although the BCRA successfully employed open bank assistance and a bridge bank model in the 2001 crisis; it is recommended that the process be more fully addressed in regulation. During the crisis of 2001/2002 the BCRA utilized open bank assistance and a bridge bank which are not currently specifically defined in the LEF. The LEF could be amended to include those tools and the BCRA should review internal guidelines to ensure they properly capture and address the risks related to those operations. For exam ple, it is important to limit the duration of a bridge bank license so a resolution timetable can be established, de fine activities to be conducted by the bank, establish situations appropriate for a bridge bank (large and/or complex banks), and identify the licensing authority (previous bank was licensed by an executive decree). Open bank assistance is considered controversial for several reasons, including (i) a weak institution remains open and competes with sound institutions; (ii) sh areholders and creditors lo se substantial portions of their investments but not all; and (iii) it rein forces “too-big-to-fail” moral hazard, because this procedure is normally used for large institutions.