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World Bank Document Report No. PID11184 Project Name Guatemala-Guatemala Financial (@) ... Sector Technical Assistance Loan Region Latin America and Caribbean Region Sector Financial Sector Development Public Disclosure Authorized Project ID GTPE76853 Borrower(s) GOVERNMENT OF GUATEMALA Implementing Agency CENTRAL BANK AND SUPERINTENDENCY OF BANKS Banco de Guatemala Address: 7a. Avenida 22-01 Zona 1, Guatemala, Guatemala Contact Person: Mr. Jose Alfredo Blanco, Subgerente, erea Econ6mica Tel: 502-238 1546 Fax: 502-232 8509 Public Disclosure Authorized Email: [email protected] Superintendency of Banks Address: 9a. Avenida 22-00 Zona 1, Guatemala. C.A. 01001 Contact Person: Mr. Hugo Daniel Figueroa Estrada Tel: 502-232-0001 Fax: 502-2325301 Email: [email protected] Environment Category C Date PID Prepared June 3, 2002 Public Disclosure Authorized Auth Appr/Negs Date May 3, 2002 Bank Approval Date July 2, 2002 1. Country and Sector Background The Guatemalan financial system is in a vulnerable situation. A number of banks suffer from liquidity and solvency problems and remain in operation thanks to continuous assistance from the Central Bank of Guatemala (BANGUAT). The real situation of the financial system is obscured by the fact that a large number of institutions, representing approximately 50t of the system in terms of assets, is not regulated. Even in the regulated sector, information is not adequate due to poor accounting practices. Official figures show that non-performing loans (NPLs) in the banking system amounted to 14.9w of all loans by mid-2000. It is presumed that the Public Disclosure Authorized real level of NPLs in the financial system is larger since NPLs may have been transferred to the unregulated off-shore segment. If the NPLs loans were provisioned adequately, a number of banks would present severe capital shortfalls. A recent review of the banking sector shows that six out of 34 regulated banks are affected by chronic liquidity and solvency problems. Five of them (representing about 10t of total deposits) had, at the end of 2000, outstanding liabilities with the BANGUAT that amounted to several times their book capital. The sixth one, a larger bank affected by chronic illiquidity, relies on public sector deposits (including deposits from the Social Security System-IGSS). It is likely that the unregulated financial institutions are suffering more acute problems than their regulated counterparts.The financial problems faced by Guatemalan banks are the result of multiple causes, including political interference in the central bank, poor regulation and supervision, inadequate lending practices, weak risk management capacity within banks, and weak market discipline. Specific weaknesses in the financial system in Guatemala include:Central bankmultiplicity of objectiveslack of political, operational, and financial autonomy of the central banklack of accountability and transparency in the conduction of monetary policyweak financial situationexcessive use of the lender of last resort facilitydeficient payment system Prudential regulation and supervisionlack of political, operational and financial autonomy of the regulatordeficient loan classification and provisioning rulesinadequate accounting and disclosure practicesinsufficient powers of the Superintendency of Banks to supervise and enforce prudential regulationslack of adequate prudential rules for off-shores and non-bank financial institutions (NBFIs).Weak legal, institutional and judicial framework weak legal basis for bank intervention, rehabilitation, restructuring and closurepoor judicial procedures for rapid debt collection.weak credit cultureinadequate legal framework for secured transactionsweak anti-money laundering legislation Authorities are aware of the vulnerabilities of the financial system. With the assistance of the international financial institutions (IMF, IDB, and WB), the current administration has defined a comprehensive program to address the above described problems. The program involves the following: (i) a comprehensive legal and regulatory reforms to improve the framework for monetary and financial policy and recapitalize the central bank; (ii) the strengthening of prudential regulation and supervision; and (iii) the resolution of distressed banks via liquidation, mergers or sales.(i) Framework for monetary policy and financial policy and recapitalization of central bankThe first phase of the Government's efforts in the legislative front have resulted in the presentation to Congress, on September 10, 2001, of four major pieces of monetary and financial sector legislation: (i) Central Bank draft law (Ley Organica del Banco de Guatemala), (ii) Monetary draft law (Ley Monetaria), (iii) Banking and Financial Groups draft law (Ley de Bancos y Grupos Financieros), and (iv) Banking Supervision draft law (Ley de Supervisi6n Bancaria). Approval of these laws is expected for early 2002. The basic norms and regulations to implement the new legislation are expected to be submitted to Congress 30 days prior to the entry into effect of the new legislation. The proposed Central Bank Law grants political and financial autonomy to the central bank and makes the bank more transparent and accountable, requiring central bank's senior officials to inform elected officials and the public about the evolution of monetary policy, as well as exchange and credit policies. Furthermore, it introduces the obligation of the central bank to periodically disclose its financial situation. This law establishes the maintenance of price stability as the main objective of BANGUAT, substituting the "developmental "approach" of existing legislation. It also refines the instruments of monetary policy and establish better mechanisms for the treatment of deficiencies in bank reserves. The law also limits the lender of last resort function of the central bank, while improving the reserve requirement rules. The new Draft Monetary Law guarantees the free convertibility of the currency and the -2 - free movement of capitals, in line with the Law of Free Acceptance of Foreign Currency, approved in December 2000. The central bank will be audited in 2003 by the Superintendency of Banks, assisted, if deemed necessary, by external auditors. The audit will reveal the magnitude of the central bank's accumulated losses as well as the adjustments required in its balance sheet to restore its long term solvency. The central bank is expected to be recapitalized thereafter. As part of the efforts to strengthen the central bank, the payment system will be modernized. Since most of the transactions and payments in Guatemala are made through checks, the authorities have given priority to the automation of the Checks Clearing Center. This involves the purchase of appropriate hardware and software and the issuing of norms that will regulate the electronic clearing and settlement. The expectation is that the electronic clearing of checks will be in place by early 2002. Subsequently, central bank authorities contemplate the implementation of a payment system for high value transactions, which are the most important from the point of view of the systemic risk for the central bank for large transactions. Central bank authorities have requested technical assistance from the World Bank to help it to comply with the disclosure requirements contained in the proposed laws and upgrade the payment system for large transactions, given its systemic importance. (ii) Strengthening of prudential regulation and supervisionThe proposed Banking and Financial Groups draft law and the Banking Supervision draft law strengthen the legal basis for effective financial regulation and supervision. Among other issues, the laws introduce tough licensing requirements for new financial institutions, foster consolidated supervision, adopt international standards on capital requirements and other prudential ratios, improve corporate governance and transparency, create a limited deposit insurance, establish efficient mechanisms for bank resolution, and improve law enforcement by strengthening the powers and autonomy of the Superintendency of Banks. As part of the efforts to strengthen prudential regulation and supervision, a Money Laundering Law was approved by Congress in October 2001 and became effective on December 17, 2001. This new law contains the relevant elements required in a statutory provision to prevent and deter money laundering activities, namely, (i) makes money laundering a crime and provides for appropriate sanctions; (ii) creates a Specific Unit Against Money Laundering within the SB ("Intendencia de Verificaci6n Especial"); (iii) provides for reporting, collection, and analysis of suspicious or unusual transactions (in excess of US$10,000); (iv) authorizes the freezing and seizing of assets reasonably suspected to be proceeds of crime; and (v) authorizes the sharing of such information with other jurisdictions; and cross border legal assistance in prosecuting money laundering crimes, including collecting evidence and extraditing accused criminals. Authorities are aware that additional amendments to financial sector legislation and/or issuance of new laws are needed to strengthen the legal framework of the financial sector. Since more than 50t of Guatemala's financial system remains unregulated, creating serious risks to the overall economy, a new Non-Bank Financial Intermediaries Law is urgently needed. The new law should set the minimum regulatory and supervisory requirements for this type of financial intermediaries, including
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