Page  1
FINANCIAL 
SECTOR 
ASSESSMENT 
COSTA 
RICA 
MARCH 
2003 
LATINAMERICA&THECARIBBEAN 
REGION 
VICEPRESIDENCY 
FINANCIAL 
SECTORVICEPRESIDENCY 
BASEDONTHEJOINT 
IMF-WORLD 
BANK 
FSAP 
REPORT 
1 
This 
Financial 
Sector 
Assessment 
(FSA) 
summarizes 
the 
FSAP 
report 
for 
Costa 
I&a. 
The 
FSAP 
included 
two 
missions 
to 
San 
Jose 
in 
October 
22-29 
and 
December 
5-13, 
2001 
.l 
The 
FSAP 
results 
were 
discussed 
extensively 
with 
the 
authorities 
during 
a 
full-day 
wrap-up 
meeting 
at 
the 
end 
of 
the 
second 
mission. 
They 
were 
also 
discussed 
in 
September 
2002 
with 
relevant 
authorities 
of 
the 
new 
administration 
during 
a 
World 
Bank 
visit 
to 
San 
Jose, 
and 
in 
November 
2002 
in 
the 
context 
of 
the 
IMF 
Article 
IV 
Consultation. 
The 
final 
FSAP 
report 
was 
completed 
in 
August 
2002.2 
The 
diagnosis 
and 
assessment 
in 
the 
FSAP 
report, 
and 
hence 
in 
this 
FSA, 
are 
based 
on 
infomzation 
available 
as 
of 
end-2001. 
However, 
Box 
1 
summarizes 
(without 
evaluating) 
relevant 
reforms 
undertaken 
by 
the 
authorities 
during 
2002. 
I. 
MACRO-FINANCIAL 
VULNERABILITIES 
A. 
Macroeconomic 
Background 
2 
Costa 
Rica 
has 
a 
historical 
record 
of 
substantial 
output 
growth 
with 
low 
macroeconomic 
volatility, 
but 
short 
term 
prospects 
remain 
uncertain. 
Costa 
Rica’s 
average 
yearly 
output 
growth 
(3.5 
percent) 
in 
the 
last 
two 
decades 
exceeded 
that 
of 
most 
of 
its 
neighbors 
while 
inflation 
(23 
percent) 
was 
relatively 
moderate 
by 
Latin 
American 
standards. 
Notwithstanding 
volatile 
terms 
of 
trade, 
output 
and 
real 
exchange 
rate 
volatilities 
in 
Costa 
Rica 
are 
much 
below 
those 
of 
most 
Latin 
countries 
(Figure 
1). 
Costa 
Rica’s 
sovereign 
bond 
ratings 
are 
among 
the 
best 
in 
the 
region 
(Table 
4). 
This 
good 
performance 
has 
been 
anchored 
on 
a 
stable 
policy 
environment 
(with 
fiscal 
and 
monetary 
policies 
having 
avoided 
stop-go 
patterns) 
and 
a 
high 
and 
growing 
integration 
into 
the 
world 
economy 
(Figure 
2). 
A 
stable 
political 
system-with 
a 
long 
democratic 
tradition, 
generally 
effective 
institutions, 
relatively 
low 
’ 
The 
FSAP 
was 
led 
by 
August0 
de 
la 
Torre 
(WBLCR) 
and 
Alain 
Ize 
(IMIVMAE). 
Other 
members 
of 
the 
team 
were 
Jorge 
Cayazzo, 
Armando 
Morales, 
Karl 
Driessen 
(all 
IMFLMAE), 
Sergio 
Martin 
(IMFWHD), 
Katharine 
Christopherson 
(IMF/LEG), 
Yira 
Mascara, 
Mario 
Guadamillas, 
Juan 
Ortiz 
(all 
WB/LCSFP), 
Albert0 
Musalem 
(WBLFSD), 
Joaquin 
Bernal 
(Banco 
de 
la 
Republica, 
Colombia) 
and 
Ruben 
Marasca 
(Banco 
Central 
de 
la 
Republica, 
Argentina). 
Jose 
Benjamin 
Escobar, 
Ross 
Delston 
(both 
U&F/LEG), 
and 
Jose 
Antonio 
Alepuz 
(WB/LEGPS) 
provided 
inputs 
from 
headquarters. 
The 
FSAP 
team 
gratefully 
acknowledges 
the 
excellent 
hospitality, 
cooperation, 
and 
openness 
of 
the 
Costa 
Rican 
authorities 
and 
technical 
counterparts. 
2 
The 
international 
standards 
and 
codes 
formally 
assessed 
under 
the 
Costa 
Rica 
FSAP 
were: 
the 
Code 
of 
Good 
Practices 
on 
Transparency 
in 
Monetary 
and 
Financial 
Policies, 
the 
CPSS 
Core 
Principles 
for 
Systemically 
Important 
Payment 
Systems; 
and 
the 
Basle 
Core 
Principles 
for 
Effective 
Banking 
Supervision. 
Page  2
2 
income 
inequality, 
a 
burgeoning 
middle 
class, 
and 
a 
strong 
education 
system-has 
also 
contributed 
to 
a 
favorable 
environment 
for 
growth. 
However 
trend 
GDP 
growth 
has 
declined 
since 
the 
early 
1990s. 
A 
temporary 
growth 
spurt 
in 
the 
late 
1990s 
was 
associated 
with 
large 
investments 
by 
Intel 
in 
the 
computer 
technology 
sector, 
but 
the 
recent 
world 
downturn 
in 
this 
sector 
accentuated 
the 
output 
decline 
since 
2000 
(Table 
3, 
Figure 
2). 
3 
The 
stable 
macroeconomic 
environment 
masks 
some 
sources 
of 
tension, 
not 
least 
in 
rkspect 
of 
public 
sector 
debt 
but 
also 
with 
regard 
the 
external 
accounts. 
The 
fiscal 
deficit 
widened 
during 
the 
late 
1980s 
and 
mid-1990s 
reflecting 
depressed 
tax 
revenues 
and 
a 
significant 
increase 
in 
pension 
expenditures 
(Table 
3, 
Figure 
2). 
It 
resulted 
in 
a 
steady 
growth 
of 
public 
debt 
to 
a 
current 
level 
of 
around 
40 
percent 
of 
GDP-most 
of 
which 
is 
domestic 
debt. 
In 
turn, 
substantial 
interest 
payments 
on 
public 
debt 
added 
to 
the 
overall 
fiscal 
deficits, 
notwithstanding 
the 
small 
primary 
surplus 
for 
the 
central 
government. 
The 
latter 
(0.7 
percent 
of 
GDP 
during 
1999-2001) 
is 
insufficient 
to 
ensure 
a 
reduction 
over 
time 
of 
the 
debt 
to 
GDP 
ratio, 
even 
under 
the 
assumption 
of 
GDP 
growth 
of 
4.5 
percent, 
equal 
to 
its 
average 
during 
the 
last 
decade 
(Figure 
2). 
Contingent 
pension 
liabilities 
and 
the 
negative 
capital 
of 
the 
central 
bank 
(see 
below) 
shed 
further 
doubts 
on 
the 
sustainability 
of 
public 
debt 
under 
a 
non- 
inflationary 
environment. 
Fiscal 
imbalances 
and 
unfavorable 
terms 
of 
trade 
have 
contributed 
to 
a 
rising 
trend 
in 
the 
external 
current 
account 
deficit 
since 
1996 
which, 
however, 
were 
financed 
during 
the 
late 
1990s 
by 
large 
foreign 
direct 
investments 
(including 
by 
Intel) 
(Figure 
3). 
4 
. 
The 
monetary 
and 
exchange 
rate 
regime 
promotes 
dollarization 
and 
limits 
the 
scope 
for 
relative 
price 
adjustments. 
The 
revealed 
objective 
of 
Costa 
Rica’s 
exchange 
rate 
policy 
has 
been 
to 
preserve 
external 
competitiveness, 
subject 
to 
the 
constraint 
of 
ensuring 
the 
credibility 
of 
the 
crawling 
peg 
through 
an 
adequate 
level 
of 
international 
reserves. 
To 
this 
end, 
Costa 
Rica 
has 
followed 
since 
the 
early 
1980s 
a 
somewhat 
flexible 
exchange 
rate 
crawl, 
in 
the 
sense 
that 
the 
rate 
of 
crawl 
has 
been 
regularly 
adjusted 
(usually 
on 
a 
yearly 
basis) 
to 
compensate 
for 
differentials 
of 
past 
inflation 
between 
Costa 
Rica 
and 
its 
main 
trading 
partners.3 
In 
addition, 
the 
central 
bank 
has 
adjusted 
interest 
rates 
upwards 
to 
defend 
international 
reserves 
in 
times 
of 
turbulence. 
This 
regime 
commands 
considerable 
credibility 
in 
Costa 
Rica 
and 
may 
be 
credited 
for 
having 
avoided 
large 
real 
exchange 
rate 
overvaluations 
and 
currency 
crises. 
However, 
by 
trading 
short-term 
real 
certainty 
against 
long-term 
nominal 
uncertainty 
(through 
the 
systematic 
targeting 
of 
the 
real 
exchange 
rate, 
rather 
than 
inflation), 
the 
current 
regime 
promotes 
dollarization.4 
It 
has 
induced 
agents 
to 
view 
the 
exchange 
rate 
as 
the 
best 
predictor 
of 
inflation 
and 
the 
dollar 
as 
an 
attractive 
store 
of 
value. 
Limits 
to 
transparency 
in 
monetary 
policy 
(which 
partly 
results 
from 
inconsistencies 
between 
the 
central 
bank’s 
de-facto 
policy 
objectives 
and 
their 
legal 
underpinnings5) 
have 
further 
tightened 
the 
link 
between 
inflationary 
expectations 
3 
Since 
August 
1982, 
there 
have 
not 
been 
any 
jumps 
in 
the 
exchange 
rate 
and 
adjustments 
in 
the 
peg 
have 
become 
nearly 
continuous 
since 
January 
1985. 
4 
It 
does 
not 
follow 
that 
some 
dollarization 
would 
not 
have 
obtained 
under 
a 
different 
exchange 
rate 
regime. 
Dollarization 
in 
Costa 
Rica 
also 
appears 
to 
reflect 
other 
factors, 
including 
increasing 
international 
integration 
and 
uncertainties 
about 
public 
sector 
debt 
sustainability 
in 
a 
non-inflationary 
environment-which 
undermines 
the 
role 
of 
the 
colon 
as 
a 
store 
of 
value 
(fostering 
deposit 
dollarization) 
and 
raises 
the 
domestic 
real 
interest 
rate 
(contributing 
to 
loan 
dollarization). 
5 
The 
Central 
Bank’s 
Charter 
specifies 
that 
the 
central 
bank 
should 
stabilize 
the 
internal 
and 
external 
value 
of 
the 
currency, 
neither 
of 
which 
is 
achievable 
under 
the 
current 
monetary 
regime. 
Page  3
3 
and 
the 
exchange 
rate. 
The 
high 
pass 
through 
of 
exchange 
rate 
movements 
to 
prices 
limits 
the 
ability 
to 
induce 
a 
real 
depreciation 
at 
a 
moderate 
cost 
in 
terms 
of 
inflation. 
Box 
1. 
Salient 
Measures 
Adopted 
During 
2002 
Bank 
Supervision 
l 
Joint 
Supervision 
ofO$3zore 
Banks. 
During 
2002 
SUGEF 
made 
considerable 
progress 
in 
signing 
Memoranda 
of 
Understanding 
(MOU) 
with 
the 
supervisory 
authorities 
of 
countries 
where 
Costa 
Rican 
offshore 
banks 
are 
incorporated. 
To 
date, 
MOUs 
have 
been 
signed 
with 
Panama, 
Colombia, 
El 
Salvador, 
Honduras, 
and 
Dominican 
Republic. 
(For 
a 
description 
of 
offshore 
banking 
in 
the 
case 
of 
Costa 
Rica, 
see 
text 
paragraph 
7.) 
Costa 
Rican 
offshore 
banks 
are 
required 
eventually 
to 
move 
to 
jurisdictions 
with 
which 
an 
MOU 
has 
been 
signed. 
Per 
the 
MOUs, 
SUGEF 
can 
conduct 
on-site 
inspections 
of 
Costa 
Rican 
offshore 
banks, 
jointly 
with 
the 
local 
supervisors. 
SUGEF 
can 
do 
the 
same 
with 
respect 
to 
Costa 
Rica 
offshore 
banks 
incorporated 
in 
the 
U.S., 
even 
though 
a 
formal 
MOU 
has 
not 
yet 
been 
signed 
with 
the 
U.S. 
A 
joint 
on-site 
inspection 
of 
a 
Costa 
Rican 
offshore 
bank 
incorporated 
in 
Panama 
was 
conducted 
in 
2002. 
0 
Capital 
Requirements. 
In 
mid-2002, 
CONASSIF 
approved 
a 
Capital 
Adequacy 
Norm 
that 
details 
the 
manner 
in 
which 
financial 
groups, 
included 
public 
bank 
based 
groups, 
are 
to 
calculate 
capital 
adequacy 
on 
a 
solo 
and 
a 
consolidated 
basis. 
SUGEF 
does 
not 
have 
legal 
power 
directly 
to 
regulate 
and 
supervise 
offshore 
banks 
and 
certain 
onshore 
non-bank 
financial 
intermediaries 
(e.g., 
leasing, 
factoring, 
and 
credit 
card 
companies). 
However, 
the 
Capital 
Adequacy 
Norm 
addresses 
part 
of 
this 
limitation 
indirectly. 
It 
requires 
the 
holding 
company 
of 
a 
financial 
group 
to 
hold 
capital 
equivalent 
to 
at 
least 
20 
percent 
of 
the 
assets 
in 
the 
mentioned 
onshore 
non-bank 
intermediaries. 
Such 
capital 
requirement 
can 
be 
reduced 
to 
10 
percent, 
at 
the 
discretion 
of 
SUGEF, 
if 
the 
intermediaries 
voluntarily 
accept 
to 
be 
subject 
to 
SUGEF’s 
onsite 
inspection. 
Risk 
Management. 
The 
Federal 
Reserve 
of 
Atlanta 
and 
the 
Office 
of 
the 
Comptroller 
of 
the 
Currency 
provided 
technical 
assistance 
to 
SUGEF 
to 
strengthen 
its 
capacity 
to 
assess 
risk 
management 
and 
other 
internal 
systems 
in 
financial 
institutions 
(including 
strategic 
planning 
and 
management 
information 
systems). 
In 
addition, 
a 
new 
regulation 
on 
credit 
risk 
deriving 
from 
dollar 
lending 
to 
non-dollar 
earners 
has 
been 
prepared 
and 
is 
expected 
to 
be 
approved 
soon 
by 
CONASSIF. 
I 
l 
Information 
Requirements 
and 
Accounting 
Standards. 
On 
January 
lSt, 
2003, 
a 
new 
chart 
of 
accounts, 
that 
generally 
follows 
International 
Accounting 
Standards, 
came 
into 
effect. 
l 
Anti-Money 
Laundering. 
On 
December 
2001, 
the 
SUGEF 
issued 
new 
guidelines 
for 
“Know 
Your 
Customer” 
rules 
establishing 
the 
minimum 
standards 
that 
are 
to 
be 
complied 
with 
by 
Costa 
Rican 
institutions. 
Securities 
Markets 
l 
Money 
market 
development. 
Procedures 
for 
the 
transfer 
of 
securities 
used 
in 
repos 
were 
simplified 
and 
improvements 
were 
introduced 
to 
facilitate 
information 
availability. 
The 
Stock 
Exchange 
is 
in 
the 
process 
of 
changing 
the 
technological 
platform 
to 
facilitate 
the 
integration 
of 
the 
Mercado 
de 
Liquidez 
and 
the 
MIB. 
l 
Regulation. 
The 
supervisory 
roles 
of 
SUGEVAL 
and 
the 
Stock 
Exchange 
were 
clarified. 
Disclosure 
requirements 
for 
broker-dealers 
were 
enhanced 
and 
mark-to-market 
valuation 
of 
investment 
funds 
introduced. 
5 
The 
exchange 
rate 
crawl, 
together 
with 
the 
central 
bank’s 
negative 
capital, 
cbrnbined 
with 
the 
weak 
fiscal 
situation, 
limit 
the 
capacity 
to 
further 
reduce 
and 
stabilize 
inflation. 
The 
credibility 
cost 
for 
the 
central 
bank 
arising 
from 
its 
negative 
net 
worth,6 
combined 
with 
backward-looking 
nature 
of 
the 
crawl 
and 
the 
high 
pass 
through, 
tends 
to 
perpetuate 
inflation. 
Inflation 
hit 
a 
floor 
of 
about 
10 
percent 
for 
the 
last 
three 
years 
(Figure 
3). 
6 
The 
central 
bank’s 
negative 
capital 
(liabilities 
exceed 
the 
value 
of 
assets) 
arose 
historically 
as 
a 
result 
of 
quasi- 
fiscal 
operations, 
including 
the 
assumption 
of 
impaired 
assets 
in 
the 
context 
of 
certain 
bank 
failures. 
Page  4
4 
Bringing 
inflation 
down 
would 
require 
breaking 
the 
inertia 
of 
the 
current 
exchange 
system 
and 
a 
fiscal 
effort 
to 
replace 
inflationary 
taxation 
by 
sounder 
means 
of 
finance. 
However, 
in 
the 
absence 
of 
the 
central 
bank’s 
recapitalization, 
inflation 
is 
needed 
to 
finance 
central 
bank 
losses 
and, 
thus, 
keep 
its 
negative 
net 
worth 
from 
spiraling 
away.7 
Assuming 
that 
the 
real 
interest 
and 
growth 
rates 
remain 
at 
their 
last 
five-year 
average, 
it 
is 
estimated 
that 
an 
inflation 
rate 
of 
at 
least 
15 
percent 
would 
be 
needed 
to 
stabilize 
the 
ratio 
of 
the 
central 
bank’s 
net 
worth 
to 
GDP. 
B. 
Financial 
System 
Structure 
and 
Trends 
6 
The 
financial 
sector 
is 
deep 
relative 
to 
other 
countries 
in 
the 
region 
and, 
though 
centered 
on 
banking 
intermediation, 
increasingly 
diversified. 
It 
is 
organized 
around 
financial 
groups 
that 
often 
include, 
in 
addition 
to 
an 
onshore 
bank, 
an 
offshore 
bank 
(see 
below), 
a 
stock 
broker, 
an 
investment 
fund, 
an 
insurance 
commercialization 
firm, 
a 
pension 
fund, 
and 
a 
mortgage 
company. 
Gross 
assets 
of 
financial 
institutions 
reached 
72 
percent 
of 
GDP 
in 
June 
2001, 
which 
is 
high 
by 
Latin 
American 
standards 
(Table 
1). 
While 
banks 
account 
for 
the 
lion’s 
share 
of 
financial 
sector 
assets 
(77 
percent), 
investment 
funds 
(mutual 
funds 
and 
pension 
funds) 
have 
grown 
rapidly 
in 
recent 
years 
(to 
10.4 
percent 
of 
financial 
sector 
assets 
and 
to 
the 
equivalent 
of 
34 
percent 
of 
bank 
deposits 
as 
of 
September 
2001) 
as 
a 
result 
of 
reforms 
that 
have 
clarified 
the 
legal 
and 
regulatory 
framework 
for 
mutual 
funds 
and 
created 
a 
privately- 
administered, 
“second 
pillar” 
pension 
system. 
Banks’ 
activity 
has 
increasingly 
focused 
on 
lending 
to 
the 
private 
sector 
(the 
share 
of 
loans 
in 
banks’ 
total 
onshore 
assets 
rose 
from 
43 
percent 
to 
48 
percent 
between 
January 
1998 
and 
June 
2001) 
while 
the 
assets 
of 
investment 
funds 
have 
concentrated 
nearly 
exclusively 
in 
government 
debt 
securities 
(Figure 
4).8 
7 
Offshore 
banking 
(which 
mainly 
serves 
domestic 
residents) 
is 
unusually 
large 
in 
Costa 
Rica, 
but 
its 
growth 
has 
tapered 
off 
during 
the 
last 
few 
years. 
Offshore 
banks 
account 
for 
about 
24 
percent 
total 
banking 
system 
assets 
(Table 
1). 
Unlike 
the 
more 
typical 
offshore 
systems, 
Costa 
Rica’s 
offshore 
banks 
are 
licensed 
in 
foreign 
(mainly 
Caribbean) 
jurisdictions 
but 
conduct 
most 
of 
their 
deposit-taking 
and 
lending 
activities 
with 
Costa 
Rican 
residents 
and 
are, 
therefore, 
fully 
woven 
into 
the 
country’s 
domestic 
financial 
and 
economic 
activity. 
This 
type 
of 
offshore 
operations 
are 
a 
salient 
feature 
among 
private 
financial 
groups 
(assets 
of 
private 
offshore 
banks 
are 
equivalent 
to 
41 
percent 
of 
the 
assets 
of 
private 
onshore 
banks 
and 
to 
100 
percent 
of 
the 
assets 
of 
their 
corresponding 
onshore 
banks, 
as 
against 
11 
percent 
for 
public 
banks). 
As 
onshore 
banks 
are 
legally 
allowed 
to 
take 
dollar 
deposits 
and 
make 
dollar 
loans, 
offshore 
banks 
are 
mainly 
used 
for 
tax 
avoidance 
and 
regulatory 
arbitrage. 
Offshore 
banks 
grew 
rapidly 
in 
the 
initial 
stages 
of 
private 
banking 
(the 
banking 
sector 
was 
a 
state 
monopoly 
until 
the 
mid-1970s), 
in 
response 
to 
high 
unremunerated 
reserve 
requirements 
(over 
28 
percent 
in 
1995) 
and 
reflecting 
private 
banks’ 
search 
for 
a 
competitive 
edge 
against 
public 
banks. 
Offshore 
banks’ 
growth 
is 
tapering 
off 
(information 
on 
offshore 
banks 
is 
limited; 
it 
became 
available 
since 
end-2000), 
following 
a 
substantial 
reduction 
in 
reserve 
requirements 
7 
A 
recent 
effort 
by 
the 
government 
(in 
January 
2001) 
to 
recapitalize 
the 
central 
bank 
brought 
its 
yearly 
losses 
down 
from 
I 
.8 
percent 
of 
GDP 
in 
2000 
to 
1.4 
percent 
of 
GDP 
in 
2001. 
8 
Higher 
yields 
and 
high 
liquidity 
of 
mutual 
funds 
explain 
their 
success. 
However, 
increasing 
competition 
betwee 
banks 
and 
funds 
have 
tended 
to 
depress 
funds’ 
yields 
relative 
to 
those 
of 
term 
deposits 
over 
the 
last 
two 
years, 
suggesting 
that 
funds’ 
growth 
may 
have 
reached 
an 
inflexion 
point. 
,n 
Page  5
5 
(to 
9 
percent 
at 
end-2001), 
concerns 
about 
the 
negative 
connotations 
of 
offshore 
banking, 
and 
aggressive 
competition 
in 
the 
dollar 
funding 
market 
by 
mutual 
funds 
and 
public 
banks. 
8 
The 
already 
high 
degree 
of 
financial 
dollarization 
is 
on 
an 
increasing 
trend. 
At 
present, 
45 
percent 
of 
deposits 
(50 
percent 
of 
loans) 
of 
the 
onshore 
banking 
system 
is 
dollar- 
denominated 
(Figures 
4 
and 
5). 
The 
share 
of 
dollar 
loans 
in 
the 
onshore 
loan 
portfolio 
of 
private 
banks 
is, 
at 
60 
percent, 
higher 
than 
in 
public 
banks 
(40 
percent). 
As 
all 
operations 
of 
offshore 
banks 
are 
in 
dollars, 
about 
60 
percent 
of 
loans 
of 
the 
consolidated 
(onshore 
and 
offshore) 
banking 
system 
are 
dollar 
denominated. 
The 
consolidated 
private 
banking 
system 
(adding 
the 
onshore 
and 
offshore 
segments) 
is 
much 
more 
dollarized 
than 
the 
public 
system- 
over 
75 
percent 
of 
private 
bank 
loans 
are 
in 
dollars, 
compared 
to 
47 
percent 
in 
the 
case 
of 
the 
consolidated 
public 
banks. 
The 
authorities 
estimate 
that 
about 
half 
of 
onshore 
dollar 
loans 
are 
to 
debtors 
whose 
incomes 
are 
not 
in 
dollars 
(Table 
6), 
which 
understates 
the 
problem 
given 
that 
a 
nontrivial 
fraction 
of 
the 
(dollar) 
loans 
of 
offshore 
banks 
is 
likely 
to 
be 
non-dollar 
earners 
(data 
do 
not 
exist 
to 
establish 
that 
proportion). 
Financial 
dollarization 
may 
be 
generally 
fostered 
by 
ongoing 
international 
financial 
integration. 
But, 
as 
mentioned 
earlier, 
it 
is 
accentuated 
by 
the 
exchange 
rate 
regime, 
which 
rises 
nominal 
(colon) 
uncertainty. 
Yield 
curves 
are 
steeper 
for 
the 
colon 
than 
for 
local 
dollars, 
suggesting 
that 
uncertainty 
over 
real 
yields 
rises 
as 
the 
maturity 
of 
colon 
instruments 
rises 
(Figure 
5). 
The 
rapid 
increase 
in 
dollar 
funding 
has 
enabled 
dollar 
loans 
to 
grow 
faster 
than 
dollar 
deposits. 
Deposit 
dollarization 
has 
grown 
despite 
a 
shift 
in 
interest 
rate 
differentials 
in 
favor 
of 
colon 
deposits 
caused 
in 
part 
by 
the 
relative 
abundance 
of 
local 
dollars. 
The 
increase 
in 
the 
funding 
cost 
of 
colon 
loans, 
together 
with 
high 
intermediation 
spreads 
in 
local 
currency 
(see 
below), 
has 
raised 
the 
cost 
of 
colon 
loans, 
inducing 
dollar 
loans 
to 
expand 
across 
the 
board, 
including 
to 
consumer 
loans 
and 
mortgages. 
The 
higher 
debt 
service 
burden 
of 
colon 
loans 
(deriving 
from 
high 
nominal 
interest 
rates 
and 
flat 
amortization 
schedules) 
further 
depresses 
their 
demand. 
9 
The 
capital 
market 
is 
narrow 
and 
centered 
on 
public 
securities 
and 
repo 
operations. 
The 
dominant 
security 
in 
this 
market 
is 
domestic 
public 
debt 
paper 
(issued 
by 
the 
Treasury 
and 
Central 
Bank) 
of 
short 
duration 
(less 
than 
one 
year), 
with 
most 
trading 
(80 
percent) 
consisting 
of 
repo 
operations. 
Partly 
due 
to 
the 
small 
size 
of 
the 
country 
and 
concentrated 
ownership 
patterns, 
the 
market 
for 
private 
securities 
is 
undeveloped. 
There 
is 
only 
a 
handful 
of 
private 
debt 
securities, 
mainly 
issued 
by 
the 
financial 
sector, 
with 
limited 
trading. 
The 
equity 
market 
is 
nearly 
non-existent. 
The 
capital 
market 
has 
performed 
basically 
two 
functions: 
orthodox 
finance 
of 
the 
public 
sector 
and 
money 
market 
activity.’ 
10 
The 
public 
sector 
has 
a 
pervasive 
presence 
in 
Costa 
Rica’s 
highly 
concentrated 
financial 
system, 
limiting 
competition. 
The 
onshore 
banking 
system 
continues 
to 
be 
dominated 
by 
public 
banks, 
which 
include 
three 
state-owned 
commercial 
banks 
(Banco 
National, 
Banco 
de 
Costa 
Rica, 
and 
Banco 
National 
de 
Cartago), 
and 
a 
special-charter 
bank 
(Banco 
Popular) 
in 
principle 
owned 
by 
all 
Costa 
Rican 
workers. 
They 
account 
for 
about 
9 
Money 
market 
activity 
takes 
place 
through 
two 
markets: 
i) 
the 
Mercado 
de 
Liquidez, 
in 
which 
brokerage 
houses 
conduct 
very 
short-term 
repos 
with 
public 
sector 
securities; 
and 
ii) 
the 
MIB 
(Mercado 
Interbancario 
de 
Dinero) 
in 
which 
banks 
and 
the 
central 
bank 
conduct 
inter-bank 
repos, 
also 
with 
public 
securities. 
This 
segmentation 
derives 
historically 
from 
legal 
provisions 
that 
give 
stock 
brokers 
a 
monopoly 
in 
secondary 
market 
trading 
and 
registry 
of 
securities. 
Arbitrage 
between 
the 
money 
markets 
has 
increased 
following 
the 
recent 
introduction 
of 
the 
MIB 
and 
the 
central 
bank’s 
lending 
and 
deposit 
facilities, 
but 
trading 
in 
the 
MIB 
remains 
limited. 
Page  6
6 
Consequently, 
banking 
concentration, 
albeit 
. 
American 
standards 
(Table 
5). 
The 
public 
sector 
75 
percent 
of 
total 
banking 
deposits 
(Table 
1) 
declining, 
continues 
to 
be 
high, 
even 
by 
Latin 
has 
a 
monopoly 
of 
the 
insurance 
sector, 
through 
the 
INS, 
and 
dominates 
the 
pension 
and 
mutual 
fund 
industry 
(for 
instance, 
five 
out 
of 
the 
nine 
pension 
fund 
managers, 
which 
jointly 
account 
for 
about 
75 
percent 
of 
all 
pension 
fund 
assets, 
are 
owned 
by 
public 
sector 
institutions). 
11 
However, 
the 
banking 
system 
has 
become 
more 
diversified 
in 
recent 
years, 
with 
private 
banks 
continuing 
to 
gain 
market 
share 
and 
forcing 
public 
banks 
to 
adjust. 
Onshore 
private 
banks 
include 
17 
banks 
(3 
mergers 
took 
place 
during 
2000 
and 
one 
was 
underway 
in 
2001), 
10 
of 
which 
have 
at 
least 
a 
50 
percent 
share 
of 
foreign 
capital 
(from 
the 
U.S. 
and 
Central 
American 
countries). 
They 
have 
expanded 
their 
share 
in 
onshore 
banking, 
following 
the 
authorization 
(in 
1996) 
to 
open 
sight 
deposits 
(albeit 
conditioned 
to 
depositing 
17 
percent 
of 
such 
deposits 
in 
partially 
remunerated 
accounts 
in 
state-owned 
banks). 
Notwithstanding 
their 
substantially 
higher 
cost 
of 
funding, 
due 
to 
their 
more 
limited 
presence 
in 
the 
retail 
market 
and 
lack 
of 
deposit 
guarantee 
(in 
stark 
contrast 
with 
the 
explicit 
state 
guarantee 
enjoyed 
by 
all 
public 
bank 
deposits), 
the 
private 
banks’ 
share 
of 
onshore 
bank 
lending 
rose 
from 
33 
percent 
in 
early-1998 
to 
42 
percent 
in 
August 
2001 
(Figure 
4), 
as 
they 
countered 
their 
local 
funding 
handicaps 
with 
more 
aggressive 
lending 
in 
dollars, 
a 
rapid 
increase 
in 
funding 
through 
external 
lines 
of 
credit, 
better 
service, 
and 
quicker 
product 
innovation. 
Competition 
from 
private 
banks 
has 
driven 
the 
public 
banks 
to 
expand 
their 
dollar 
lending 
and 
compete 
more 
aggressively 
for 
dollar 
funding. 
As 
a 
result, 
the 
contrast 
between 
the 
asset 
structure 
of 
public 
and 
private 
banks, 
while 
still 
sharp 
(with 
public 
banks 
concentrating 
in 
colon 
lending 
to 
small 
borrowers 
and 
colon-denominated 
public 
securities 
while 
private 
banks 
focus 
on 
dollar 
operations 
with 
the 
larger 
and 
more 
sophisticated 
customers), 
has 
thus 
tended 
to 
become 
less 
pronounced. 
12 
While 
volatile, 
credit 
growth 
has 
accommodated 
demand, 
with 
foreign 
financing 
playing 
a 
buffer 
role. 
Aggregate 
credit 
growth 
has 
incurred 
deep 
fluctuations 
during 
the 
last 
decade, 
mostly 
reflecting 
the 
business 
cycle 
(Figure 
5). 
Setting 
aside 
a 
short 
pause 
in 
1995, 
the 
deposit 
base 
has 
grown 
continuously, 
exceeding 
until 
the 
mid 
1990s 
private 
credit 
by 
a 
comfortable 
margin, 
thereby 
providing 
an 
ample 
liquidity 
buffer 
to 
accommodate 
fluctuations 
in 
credit 
growth. 
While 
the 
growth 
of 
public 
debt 
from 
the 
mid-1990s 
onwards 
started 
to 
crowd 
out 
private 
lending 
and 
exert 
pressures 
on 
funding, 
external 
lines 
of 
credit 
quickly 
filled 
much 
of 
the 
gap. 
Thus, 
credit 
fluctuations 
have 
been 
mostly 
demand-driven, 
with 
funding 
passively 
accommodating 
credit 
needs. 
lo 
13 
The 
high 
colon 
intermediation 
spreads 
reflect 
uneven 
regulatory 
and 
tax 
treatment, 
crowding 
out, 
and 
market 
segmentation. 
High 
spreads 
between 
colon 
deposit 
and 
lending 
interest 
rates 
(at 
about 
12 
percentage 
points, 
on 
average) 
in 
the 
onshore 
banking 
system 
partly 
reflect 
uneven 
taxation 
and 
regulation 
across 
currencies.” 
They 
also 
reflect 
a 
crowding 
out 
of 
colon 
credit 
by 
the 
predominantly 
colon-denominated 
domestic 
public 
debt. 
Finally, 
they 
reflect 
the 
use 
of 
currency 
denomination 
as 
a 
vehicle 
for 
price 
discrimination, 
as 
colon 
lo 
Econometric 
analyses 
of 
the 
relative 
importance 
of 
supply 
and 
demand 
factors 
in 
the 
determination 
of 
credit 
fluctuations 
confirm 
this 
interpretation. 
l1 
Private 
offshore 
(dollar) 
deposits 
are 
not 
subject 
to 
reserve 
requirements 
and 
withholding 
taxes, 
and 
onshore 
dollar 
deposits 
in 
public 
banks 
are 
exempted 
from 
withholding 
taxes. 
Page  7
customers 
are 
generally 
less 
sophisticated 
than 
dollar 
customers 
and 
have 
less 
access 
to 
alternative 
financial 
outlays. 
The 
notable 
differences 
between 
the 
average 
size 
of 
colon 
deposits 
and 
loans 
clearly 
illustrate 
such 
market 
segmentation 
(Figure 
5). 
C. 
Financial 
Sector 
Vulnerabilities 
and 
Risks 
14 
. 
Reported 
prudential 
indicators 
depict 
a 
generally 
healthy 
onshore 
banking 
system 
(Table 
2), 
but 
some 
caution 
is 
needed 
in 
interpreting 
these 
indicators. 
Onshore 
banks 
report 
high 
ratios 
of 
capital 
to 
risk-weighted 
assets 
(CAR), 
14 
percent 
for 
public 
banks 
and 
16 
percent 
for 
private, 
above 
the 
required 
minimum 
CAR 
of 
10 
percent. 
Banks 
have 
remained 
profitable 
over 
the 
last 
years, 
with 
real 
returns 
on 
assets 
around 
2 
percent 
and 
on 
equity 
of 
around 
10 
percent. 
However, 
the 
lack 
of 
on-site 
verification 
of 
the 
financial 
accounts 
and 
asset 
quality 
of 
offshore 
banks 
sheds 
doubts 
on 
the 
related 
onshore 
banks’ 
capital 
adequacy. 
The 
capital 
adequacy 
in 
the 
case 
of 
public 
bank 
based 
groups 
is 
affected 
by 
insufficient 
provisioning 
of 
large 
labor-related 
contingent 
liabilities 
(such 
as 
severance 
payments 
obligations 
to 
employees).‘2 
Non-performing 
loans 
(NPLs)-defined 
as 
loans 
in 
arrears 
for 
90 
days 
or 
more, 
including 
loans 
under 
judicial 
collection 
proceedings- 
have 
oscillated 
around 
5 
percent 
during 
2000-2002 
for 
onshore 
public 
commercial 
banks 
and 
around 
1.5 
percent 
for 
onshore 
private 
banks, 
with 
no 
discernible 
trend.13 
Although 
the 
reported 
provisions 
coverage 
of 
NPLs 
is 
strong 
(around 
80 
percent 
for 
onshore 
public 
banks 
and 
110 
percent 
for 
onshore 
private 
banks), 
the 
high 
percentage 
of 
loans 
reclassified 
as 
a 
result 
of 
on-site 
inspections 
(about 
30 
percent 
of 
revised 
loans) 
suggests 
deficiencies 
in 
banks’ 
own 
risk 
management 
practices, 
particularly 
in 
the 
case 
of 
some 
public 
banks. 
Inconsistencies 
across 
different 
sets 
of 
data 
on 
NPLs 
also 
shed 
some 
doubts 
on 
the 
reliability 
of 
banks’ 
financial 
statements.14 
15 
Dollarization 
raises 
the 
banking 
system’s 
vulnerability 
to 
shocks. 
Financial 
dollarization 
limits 
the 
scope 
for 
using 
monetary 
policy 
to 
moderate 
output 
and 
credit 
cycles. 
The 
reliance 
on 
interest 
rates 
to 
preserve 
the 
exchange 
rate 
regime 
and 
counteract 
adverse 
shocks 
heightens 
interest 
rate 
volatility 
and 
pro-cyclicality 
(interest 
rates 
increase 
during 
downturns), 
thereby 
compounding 
the 
adverse 
effects 
of 
economic 
slumps 
on 
borrowers’ 
debt 
servicing 
capacity. 
Banks’ 
exposure 
to 
liquidity 
risk 
is 
similarly 
enhanced 
by 
the 
high 
dollarization 
of 
bank 
deposits 
and 
the 
fact 
that 
quantity 
adjustments 
(deposits 
and 
international 
reserves), 
rather 
than 
price 
(exchange 
rate) 
adjustments, 
constitute 
the 
first 
line 
of 
defense 
against 
adverse 
systemic 
shocks. 
Finally, 
the 
dollarization 
of 
bank 
loans 
to 
non-dollar 
earners 
exposes 
banks 
to 
credit 
risk 
should 
the 
exchange 
rate 
be 
devalued 
abruptly 
(see 
below). 
16 
Credit 
risk 
could 
rise 
abruptly 
under 
a 
credit 
crunch 
scenario. 
Credit 
fluctuations 
have 
not 
put 
the 
system 
at 
risk 
because, 
as 
noted 
earlier, 
they 
have 
been 
mostly 
demand-driven. 
The 
reported 
soundness 
of 
loan 
portfolios 
is 
not 
independent 
of 
the 
fact 
that 
borrowers 
have 
not 
l2 
In 
mid-2002, 
a 
g-year 
adjustment 
timetable 
was 
introduced 
for 
public 
banks 
to 
gradually 
constitute 
provisions 
for 
these 
labor-related 
liabilities. 
l3 
IVPLs 
excluding 
loans 
under 
judicial 
collection 
proceedings 
are 
significantly 
lower 
(around 
0.4 
percent 
for 
private 
banks 
and 
1 
percent 
for 
public 
banks), 
without 
a 
discernible 
trend 
in 
this 
case 
indicator 
either. 
l4 
For 
example, 
the 
share 
of 
problem 
loans 
reported 
to 
the 
SUGEF 
for 
prudential 
purposes 
by 
banks 
tended 
to 
different 
and 
often 
lower 
than 
that 
reported 
in 
banks’ 
audited 
financial 
statements. 
After 
the 
FSAP 
mission, 
the 
SUGEF 
reports 
to 
have 
addressed 
these 
data 
inconsistencies. 
Page  8
8 
experienced 
a 
contraction 
in 
net 
lending 
flows, 
i.e., 
of 
credit 
flows 
net 
of 
interest 
payments. 
However, 
a 
credit 
crunch 
scenario 
resulting 
from 
an 
abrupt 
contraction 
of 
domestic 
or 
external 
funding 
or 
a 
heightened 
perception 
of 
risk 
by 
local 
bankers, 
could 
result 
in 
a 
sharp 
increase 
in 
NPLs. 
While 
the 
potential 
for 
a 
deterioration 
of 
credit 
portfolios 
is 
difficult 
to 
measure 
econometrically/ 
the 
widespread 
use 
of 
revolving 
credit 
lines 
in 
corporate 
lending 
(whi 
prone 
to 
“ever 
greening”) 
suggests 
that 
a 
scenario 
of 
supply-led 
credit 
contraction 
could 
severe 
impact 
on 
loan 
quality. 
ch 
are 
have 
a 
17 
Banks 
are 
(indirectly) 
exposed 
to 
interest 
rate 
risk 
and, 
particularly, 
to 
exchange 
rate 
risk. 
Banks 
are 
not 
directly 
exposed 
to 
interest 
rate 
risk, 
due 
to 
the 
widespread 
use 
of 
floating 
lending 
rates. 
However, 
this 
shifts 
risk 
to 
borrowers 
(who 
are 
often 
less 
equipped 
to 
bear 
such 
risks 
than 
banks 
or 
investors) 
and 
heightens 
banks’ 
indirect 
exposure 
to 
interest 
rate 
risk 
by 
accentuating 
their 
exposure 
to 
credit 
risk. 
l6 
In 
addition, 
some 
banks 
use 
their 
own 
interest 
rate 
indices 
to 
adjust 
their 
floating 
rates 
on 
loans, 
a 
practice 
that 
lacks 
transparency 
and 
is 
prone 
to 
discretionary 
adjustments. 
Similarly, 
banks’ 
direct 
exposure 
to 
the 
risk 
of 
currency 
depreciation 
is 
not 
significant, 
as 
the 
scope 
for 
holding 
short 
open 
dollar 
positions 
is 
limited 
by 
regulation. 
l7 
However, 
banks 
are 
indirectly 
exposed 
through 
their 
borrowers 
(Table 
6). 
Banks 
are 
aware 
of 
the 
risks 
associated 
with 
lending 
in 
foreign 
currency 
to 
borrowers 
who 
do 
not 
receive 
dollar 
incomes 
and 
have 
taken 
some 
steps 
(in 
terms 
of 
screening 
and 
collateral) 
to 
mitigate 
such 
risks. 
Nonetheless, 
the 
large 
cost 
differentials 
between 
colon 
and 
dollar 
loans 
and 
the 
implicit 
exchange 
rate 
guarantee 
provided 
by 
the 
crawl 
encourage 
a 
systematic 
underestimation 
of 
the 
risks 
associated 
with 
dollar 
contracts. 
18 
Liquidity 
in 
the 
onshore 
banking 
system 
is 
high 
but 
has 
been 
declining 
and 
is 
unevenly 
distributed. 
Both 
systemic 
liquidity 
(hard-currency 
liquid 
assets 
of 
onshore 
banks 
plus 
international 
reserves 
of 
the 
central 
bank) 
and 
idiosyncratic 
liquidity 
(domestic 
or 
external 
liquid 
assets 
held 
by 
individual 
onshore 
commercial 
banks) 
are 
reasonably 
high. 
However, 
liquidity 
has 
declined 
in 
recent 
years 
as 
the 
monetary 
authorities 
reduced 
reserve 
requirements 
and 
banks 
expanded 
their 
lending 
operations 
(Figure 
7). 
Also, 
liquidity 
is 
unevenly 
distributed 
across 
banks. 
While 
public 
banks 
are 
generally 
quite 
liquid, 
reflecting 
their 
large 
holdings 
of 
Costa 
Rican 
government 
securities, 
the 
liquidity 
of 
some 
private 
banks 
lies 
much 
below 
the 
average 
for 
the 
system. 
The 
short 
average 
maturity 
of 
bank 
deposits 
(75 
percent 
of 
deposits 
have 
a 
less 
than 
three-month 
maturity), 
some 
shortcomings 
of 
the 
inter-bank 
money 
market 
(see 
below), 
and 
the 
lack 
of 
deposit 
insurance 
for 
private 
banks 
increase 
the 
risk 
that 
some 
banks 
may 
encounter 
funding 
difficulties 
in 
a 
situation 
of 
turbulence. 
This 
can 
be 
compounded 
by 
the 
adverse 
impact 
of 
interest 
rate 
increases 
(which 
would 
likely 
accompany 
such 
turbulence) 
on 
the 
price 
and 
liquidity 
of 
government 
securities. 
l5 
Stress 
tests 
based 
on 
econometric 
techniques 
(particularly 
to 
estimate 
the 
magnitude 
of 
the 
impact 
of 
shocks 
on 
the 
quality 
of 
bank 
loans) 
could 
not 
be 
reliably 
run 
because 
of 
data 
limitations, 
as 
the 
series 
for 
non-performing 
loans 
was 
inconsistent, 
unavailable 
for 
a 
sufficiently 
long 
period, 
and 
with 
insufficient 
variability. 
l6 
Although 
corporate 
leverage 
in 
Costa 
Rica 
does 
not 
appear 
to 
be 
particularly 
high 
(Figure 
7), 
caution 
is 
needed 
in 
vi 
.ew 
of 
the 
limited 
coverage 
of 
the 
available 
data. 
by 
international 
standards 
l7 
By 
regulation, 
banks 
should 
maintain 
a 
long 
dollar 
position 
of 
between 
zero 
and 
one 
hundred 
percent 
of 
capital. 
However, 
banks 
cannot 
alter 
their 
position 
by 
more 
than 
0.5 
percent 
of 
capital 
per 
day. 
Page  9
9 
19 
Vulnerabilities 
could 
increase 
by 
the 
intensification 
of 
competition. 
Pressures 
banks’ 
profits 
are 
likely 
to 
increase 
due 
to 
greater 
competition 
between 
private 
banks 
and 
on 
public 
banks, 
banks 
and 
mutual 
funds, 
and 
onshore 
and 
offshore 
banks. 
The 
growing 
importance 
of 
institutional 
investors 
and 
the 
shift 
towards 
dollar 
intermediation 
can 
exacerbate 
competitive 
pressures. 
This 
can 
lead 
to 
a 
profit 
squeeze, 
particularly 
for 
public 
banks, 
whose 
franchise 
value 
is 
being 
eroded 
by 
their 
migration 
towards 
dollar 
markets 
(where 
unit 
costs 
are 
higher 
and 
intermediation 
margins 
are 
narrower, 
and 
where 
the 
state 
guarantee 
is 
likely 
to 
be 
less 
relevant) 
and 
the 
envisioned 
introduction 
of 
a 
deposit 
insurance 
for 
private 
banks. 
Profit 
pressures 
could 
induce 
weaker 
institutions 
to 
take 
on 
excessive 
risks, 
particularly 
given 
the 
shortcomings 
in 
the 
bank 
resolution 
framework 
(see 
below). 
II. 
RISK 
MANAGEMENT 
A 
a 
20 
I 
Liquidity 
Management 
The 
segmentation 
of 
the 
money 
market 
and 
somewhat 
opaque 
monetary 
signals 
limit 
the 
effectiveness 
of 
day-to-day 
liquidity 
management. 
The 
money 
market 
is 
segmented 
(see 
footnote 
8), 
its 
depth 
is 
limited, 
and 
interest 
rate 
volatility 
(across 
time 
and 
across 
markets), 
while 
declining, 
continues 
to 
be 
substantial. 
Volatility 
is 
due 
in 
part 
to 
the 
rationing 
of 
liquidity 
injections 
in 
the 
central 
bank’s 
lending 
facility, 
and 
to 
the 
absence 
of 
an 
active 
liquidity 
policy. 
(The 
regulation 
of 
liquidity 
takes 
place 
ex-post 
through 
the 
broad 
corridor 
set 
by 
the 
central 
bank’s 
standing 
facilities.) 
Monetary 
policy 
signals 
are 
focused 
on 
longer 
term 
instruments, 
typically 
six-month 
central 
bank 
bills 
(BEMs), 
sold 
in 
the 
same 
auctions 
as 
treasury 
instruments. 
This 
causes 
the 
yield 
curve 
to 
be 
arbitrarily 
determined 
and 
the 
distinction 
between 
monetary 
policy 
and 
public 
debt 
management 
to 
be 
blurred. 
21 
. 
There 
is 
room 
to 
enhance 
monetary 
management 
under 
the 
current 
crawling-peg 
system. 
A 
lower 
inflation 
would 
facilitate 
monetary 
management 
by 
reducing 
uncertainty 
in 
real 
interest 
rates 
and 
limiting 
incentives 
for 
dollarization. 
An 
essential 
condition 
to 
achieve 
sustainable 
inflation 
stabilization 
is 
that 
the 
central 
bank 
be 
recapitalized, 
so 
as 
to 
eliminate 
its 
operating 
losses. 
The 
strengthening 
of 
the 
primary 
fiscal 
surplus 
would 
be 
necessary 
to 
achieve 
this 
recapitalization 
without 
exacerbating 
problems 
for 
public 
debt 
sustainability. 
This 
recapitalization 
would 
also 
provide 
an 
opportunity 
to 
replace 
the 
central 
bank 
bills 
by 
treasury 
bills 
as 
the 
instrument 
of 
choice 
for 
monetary 
operations, 
thereby 
contributing 
to 
deepen 
the 
market 
for 
short-term 
public 
securities. 
Communications 
between 
the 
central 
bank 
and 
the 
market 
can 
be 
further 
strengthened 
through 
more 
ample 
explanations 
of 
monetary 
goals 
and 
policy 
decisions, 
and 
through 
tools 
(market-based 
or 
survey-based) 
to 
assess 
market 
expectations? 
The 
deepening 
of 
the 
inter-bank 
money 
market 
would 
require 
eliminating 
the 
use 
of 
rationing 
clauses 
in 
the 
day-to-day 
liquidity 
injection 
facility 
as 
well 
as 
measures 
to 
further 
develop 
the 
infrastructure 
for 
trading 
and 
registry 
of 
public 
securities. 
Finally, 
the 
development 
of 
an 
active 
day-to-day 
open 
market 
intervention 
capacity 
(based 
on 
effective 
liquidity 
forecasts) 
would 
be 
needed 
to 
limit 
the 
volatility 
of 
money 
market 
interest 
rates 
and 
gradually 
shift 
the 
focus 
of 
monetary 
policy 
towards 
the 
shorter 
end 
of 
the 
yield 
curve. 
‘* 
Commendable 
efforts 
have 
already 
been 
taken 
to 
strengthen 
central 
communication 
with 
the 
public, 
including 
through 
the 
introduction 
of 
a 
regular 
inflation 
report. 
However, 
the 
authorities 
face 
a 
major 
challenge 
in 
applying 
such 
tools 
to 
a 
regime 
which 
is 
inherently 
much 
less 
transparent 
than 
inflation 
targeting. 
Page  10
10 
22 
Impressive 
progress 
has 
been 
achieved 
as 
regards 
payments 
system 
infrastructure. 
Progress 
was 
notable 
in 
strengthening 
the 
legal 
and 
operational 
underpinnings 
of 
the 
payments 
system, 
including 
through 
the 
introduction 
in 
1999 
of 
a 
real 
time 
gross 
settlement 
system 
(the 
TEF), 
which 
has 
led 
to 
a 
sharp 
reduction 
in 
the 
use 
of 
checks 
for 
large 
payments. 
Costa 
Rica 
fulfills 
most 
of 
the 
Core 
Principles 
for 
Systemically 
Important 
Payments 
Systems. 
However, 
the 
possible 
gradual 
reduction 
in 
reserve 
requirements, 
together 
with 
a 
continuing 
shift 
of 
payments 
towards 
real 
time 
settlements, 
could 
eventually 
constrain 
the 
growth 
of 
the 
TEF 
and 
increase 
the 
risk 
of 
settlement 
failures 
in 
the 
multilateral 
netting 
systems, 
including 
checks. 
Mitigating 
such 
risks 
would 
require 
developing 
liquidity 
enhancing 
arrangements 
(such 
as 
intra-day 
repos) 
and 
increasing 
the 
reserve 
funds 
set 
aside 
for 
the 
check 
clearing 
system. 
B. 
Prudential 
Management 
23 
Some 
features 
of 
the 
organizational 
arrangements 
for 
the 
regulation 
and 
supervision 
of 
the 
financial 
system 
-centered 
around 
CONASSIF-appear 
to 
be 
limiting 
the 
effectiveness 
of 
prudential 
oversight. 
The 
National 
Council 
of 
Financial 
System 
Supervision 
(CONASSIF) 
is 
a 
Board 
that 
oversees 
three 
supervisory 
agencies: 
the 
General 
Superintendency 
of 
Financial 
Entities 
(SUGEF), 
the 
General 
Superintendency 
of 
Securities 
(SUGEVAL), 
and 
the 
Superintendency 
of 
Pensions 
(SUPEN). 
CONASSIF’s 
legal 
mandate 
endows 
it 
with 
broad 
responsibilities 
and 
strong 
powers 
in 
regulation 
and 
supervisory 
enforcement, 
and 
is 
clearly 
of 
an 
“executive” 
nature. 
l9 
However, 
its 
structure 
and 
resources 
are 
more 
congruent 
with 
a 
“consultative” 
role. 
The 
superintendents 
do 
not 
have 
voting 
power, 
nor 
do 
they 
have 
the 
legal 
authority 
to 
set 
priorities 
for 
its 
agenda. 
The 
five 
Board 
members 
with 
voting 
power 
are 
not 
necessarily 
experts 
in 
the 
field 
and 
are 
dedicated 
only 
on 
a 
part-time 
basis.20 
There 
are 
insufficient 
restrictions 
to 
minimize 
potential 
conflicts 
of 
interest.21 
As 
a 
result, 
CONASSIF 
members 
may 
lack 
the 
time, 
and 
potentially 
also 
the 
independence, 
to 
carry 
out 
their 
responsibilities. 
Legally 
unable 
to 
“delegate” 
functions 
to 
the 
superintendents, 
CONASSIF 
constitutes 
an 
additional 
layer 
in 
the 
decision 
making 
process 
that 
can 
hinder 
the 
effectiveness 
of 
key 
decisions, 
particularly 
as 
regards 
supervisory 
enforcement 
and 
troubled 
bank 
resolution. 
Moreover, 
CONASSIF 
is 
naturally 
inclined 
to 
focus 
on 
the 
systemic 
dimensions 
of 
prudential 
oversight 
and, 
hence, 
tends 
to 
pay 
insufficient 
attention 
to 
investor 
protection 
matters, 
which 
are 
central 
to 
the 
responsibilities 
of 
SUPEN 
and 
also, 
to 
a 
lesser 
degree, 
of 
SUGEVAL 
and 
SUGEF. 
24 
Legal 
reform 
is 
recommended 
to 
better 
align 
the 
mandate 
of 
CONASSIF 
with 
its 
capacity 
to 
fulfill 
it. 
Legal 
clauses 
to 
prevent 
conflicts 
of 
interest 
should 
be 
clarified 
and 
tightened. 
As 
regards 
the 
structure 
and 
functions 
of 
CONASSIF, 
one 
alternative 
would 
be 
to 
l9 
CONASSIF 
appoints 
the 
superintendents, 
the 
deputy 
superintendents, 
and 
the 
internal 
auditors 
of 
the 
three 
supervisory 
agencies, 
as 
well 
as 
their 
general 
governing 
rules, 
annual 
budgets, 
internal 
audits, 
and 
annual 
reports. 
CONASSIF 
also 
approves 
prudential 
regulations, 
authorizes 
mergers, 
issues 
cease 
and 
desist 
orders, 
intervenes 
banks 
and 
requests 
the 
liquidation 
of 
banks, 
withdraws 
banking 
licenses, 
etc. 
2o 
CONASSIF 
members 
comprise 
the 
Minister 
of 
Finance, 
the 
President 
of 
the 
Central 
Bank, 
and 
other 
5 
persons 
appointed 
by 
the 
Board 
of 
the 
Central 
Bank. 
They 
are 
typically 
dedicated 
on 
a 
part-time 
basis, 
as 
their 
remuneration 
is 
limited 
to 
a 
maximum 
of 
50 
percent 
of 
the 
salary 
of 
the 
Contralor 
Genera2 
de 
la 
Reptiblica. 
L1 
For 
instance, 
bank 
stockholders 
that 
are 
not 
simultaneously 
members 
of 
a 
bank 
board 
of 
directors 
could 
CONASSIF 
members, 
and 
so 
could 
staff 
members 
of 
external 
. 
auditing 
firms 
that 
audit 
domestic 
banks. 
be 
Page  11
11 
maintain 
its 
current 
composition 
and 
the 
part-time 
dedication 
of 
its 
members 
but 
reduce 
its 
powers 
and 
responsibilities, 
making 
it 
more 
of 
a 
consultative 
or 
coordinating 
Board. 
An 
arguably 
superior 
alternative 
would 
be 
to: 
(i) 
change 
the 
composition 
of 
CONASSIF 
(e.g., 
to 
include 
the 
three 
superintendents, 
the 
president 
of 
the 
central 
bank, 
and 
a 
fifth 
member, 
all 
with 
voting 
power); 
(ii) 
require 
full-time 
dedication 
of 
its 
members, 
and 
(iii) 
focus 
its 
role 
on, 
say, 
four 
main 
functions-approving 
regulations 
that 
are 
consistent 
across 
financial 
sub-sectors, 
granting 
and 
removing 
licenses, 
coordinating 
supervisory 
actions 
by 
different 
agencies 
in 
the 
oversight 
of 
the 
various 
entities 
of 
a 
financial 
conglomerate, 
and 
acting 
as 
an 
appeal 
instance 
with 
regard 
to 
enforcement 
measures. 
Under 
either 
alternative, 
the 
independence 
of 
the 
president 
of 
the 
central 
bank 
and 
the 
superintendents 
should 
be 
maintained 
and 
strengthened. 
25 
. 
Financial 
conglomerates 
are 
not 
supervised 
on 
a 
fully 
consolidated 
basis, 
which 
explains 
the 
under-compliance 
with 
several 
Basle 
Core 
Principles. 
Financial 
conglomerates 
are 
obligated 
by 
law 
to 
adopt 
a 
holding 
company 
structure 
and 
report 
their 
financial 
statements 
on 
a 
consolidated 
basis. 
However, 
important 
entities 
within 
such 
conglomerates 
fall 
legally 
outside 
the 
regulatory 
and 
inspection 
powers 
of 
the 
SUGEF. 
The 
most 
salient 
case 
is 
that 
of 
offshore 
banks, 
which 
are 
not 
regulated 
and 
supervised 
by 
the 
Costa 
Rican 
authorities 
and 
whose 
real 
situation 
can 
be 
known 
only 
through 
agreements 
with 
foreign 
supervisors.22 
Similarly, 
onshore 
entities 
such 
as 
leasing, 
factoring, 
and 
credit 
card 
companies 
are 
not 
legally 
subject 
to 
oversight 
by 
the 
SUGEF. 
The 
legal 
imposition 
of 
a 
holding 
company 
structure 
on 
private 
financial 
conglomerates, 
intended 
to 
provide 
clarity 
to 
company 
organization, 
may 
result 
in 
unnecessary 
rigidities.23 
The 
lack 
of 
fully 
consolidated 
supervision, 
which 
is 
one 
of 
the 
main 
causes 
forCosta 
Rica’s 
under-compliance 
with 
a 
number 
of 
Basle 
Core 
Principles 
for 
Effective 
Banking 
Supervision, 
is 
a 
major 
source 
of 
vulnerability. 
It 
needs 
to 
be 
addressed 
through 
legal 
reform 
as 
a 
matter 
of 
priority.24 
26 
Regulatory 
innovations 
are 
recommended 
to 
address 
other 
risks 
identified 
in 
Section 
I.C. 
Given 
the 
volatility 
of 
credit, 
the 
authorities 
should 
consider 
introducing 
counter 
cyclical 
provisioning 
requirements, 
similar 
to 
those 
recently 
enacted 
by 
the 
Bank 
of 
Spain.25 
Counter 
cyclical 
provisions- 
which 
would 
be 
additional 
to 
generic 
and 
specific 
provisions- 
would 
be 
built 
in 
times 
of 
fast 
credit 
growth, 
enabling 
banks 
to 
convert 
such 
provisions 
into 
specific 
provisions 
as 
loans 
deteriorate 
during 
the 
downswing 
phase 
of 
the 
credit 
cycle. 
In 
view 
of 
the 
high 
(indirect) 
exposure 
of 
banks 
to 
currency 
risk, 
consideration 
should 
also 
be 
given 
to 
establishing 
relatively 
tighter 
loan 
classification 
and 
provisioning 
rules 
for 
dollar 
loans 
to 
the 
non-tradable 
sector. 
At 
the 
same 
time, 
the 
regulation 
on 
open 
foreign 
exchange 
positions 
should 
be 
revised 
to 
limit 
the 
total 
range 
within 
which 
banks 
can 
adjust 
their 
position, 
while 
eliminating 
the 
limit 
on 
the 
daily 
changes 
in 
position. 
As 
reserve 
requirements 
are 
reduced, 
the 
22 
As 
of 
end-2001, 
the 
SUGEF 
had 
agreements 
with 
supervisors 
in 
2 
out 
of 
the 
4 
foreign 
jurisdictions 
in 
which 
Costa 
Rican 
offshore 
banks 
were 
incorporated. 
Such 
agreements 
had 
not 
yet 
been 
implemented 
in 
practice. 
23 
Alternative 
organizational 
structures 
that 
allow 
vertical 
as 
well 
as 
horizontal 
integration 
without 
a 
sacrifice 
of 
transparency 
could 
be 
better 
suited 
to 
the 
business 
strategies 
of 
some 
financial 
groups. 
Until 
September 
2001, 
public 
financial 
groups 
were 
subject 
to 
a 
different 
treatment, 
as 
they 
were 
not 
required 
to 
report 
consolidated 
accounts 
nor 
organize 
themselves 
as 
a 
group 
(via 
a 
holding). 
24 
In 
2001, 
CONASSIF 
created 
a 
Working 
Group 
to 
identify 
the 
legal 
and 
regulatory 
changes 
that 
would 
be 
needed 
to 
ensure 
the 
full 
consolidated 
supervision 
of 
financial 
conglomerates. 
25 
See 
Bank 
of 
Spain, 
Circular 
No. 
9/1999 
of 
December 
17, 
1999. 
Page  12
12 
authorities 
should 
consider 
introducing 
explicit 
liquid 
asset 
requirements 
that 
include, 
at 
least 
in 
part, 
safe 
and 
liquid 
foreign 
assets. 
Finally, 
to 
limit 
banks’ 
exposure 
to 
(indirect) 
interest 
rate 
risk, 
transparency 
standards 
for 
the 
setting 
of 
floating 
rates 
should 
be 
raised. 
The 
effective 
implementation 
of 
all 
of 
these 
regulations 
would 
require 
the 
incorporation 
of 
offshore 
banks 
under 
fully 
consolidated 
supervision. 
27 
. 
While 
competition 
between 
private 
and 
public 
commercial 
banks 
has 
increased, 
significant 
regulatory 
and 
tax 
asymmetries 
remain. 
The 
privileges 
of 
public 
banks 
include 
the 
state 
guarantee 
on 
all 
their 
liabilities 
(no 
explicit 
deposit 
insurance 
exists 
for 
private 
banks), 
the 
tax 
exemption 
of 
their 
dollar 
deposits, 
and 
the 
requirement 
on 
private 
banks 
to 
deposit 
(at 
sub-market 
interest 
rates) 
at 
least 
17 
percent 
of 
their 
short-term 
deposits 
in 
state 
banks 
in 
order 
to 
be 
entitled 
to 
take 
demand 
deposits.26 
One 
special-charter 
public 
bank 
is 
explicitly 
exempted 
from 
the 
legal 
reserve 
requirement, 
and 
benefits 
from 
a 
captive 
source 
of 
almost 
costless 
funding.27 
On 
the 
other 
hand, 
the 
capacity 
of 
state 
banks 
to 
compete 
is 
hindered 
by 
their 
legal 
status 
as 
public 
entities 
(which 
makes 
them 
akin 
to 
a 
government 
ministry) 
and 
by 
their 
governance 
structure 
(politically 
appointed 
boards 
of 
directors). 
As 
a 
result, 
they 
have 
difficulties 
in 
adopting 
profit 
maximization 
as 
the 
objective 
of 
their 
business 
strategy 
and 
the 
role 
of 
their 
boards 
of 
directors 
is 
unclear. 
In 
addition, 
they 
face 
cumbersome 
public 
sector 
procurement 
guidelines 
and 
inflexible 
personnel 
and 
salary 
policies. 
And 
their 
management 
is 
saddled 
with 
the 
restriction 
of 
being 
able 
to 
“do 
only 
what 
is 
permitted 
by 
law” 
(while 
private 
bankers 
can 
“do 
whatever 
is 
not 
prohibited 
in 
the 
law”) 
and 
with 
the 
responsibilities 
attached 
to 
the 
management 
of 
public 
funds 
(which, 
for 
instance, 
makes 
it 
difficult 
to 
recognize 
losses 
in 
securities 
investments). 
These 
asymmetries 
are 
mostly 
grounded 
in 
the 
law 
and 
create 
an 
uneven 
playing 
field 
that 
complicates 
prudential 
oversight 
and 
distorts 
incentives. 
28 
SUGEF 
should 
review 
and 
suitably 
modify 
its 
bank 
rating 
scheme. 
SUGEF’s 
bank 
assessment 
system 
(whose 
results 
are 
not 
disclosed 
to 
the 
public) 
relies 
heavily 
on 
a 
rigid 
weighting 
of 
CAMEL-type 
ratios 
and 
mixes 
two 
distinct 
objectives: 
determining 
differences 
in 
financial 
strength 
between 
viable 
banks 
under 
normal 
conditions 
and 
triggering 
prompt 
correction 
and/or 
intervention 
of 
potentially 
unviable 
banks 
under 
extraordinary 
conditions. 
As 
a 
result, 
it 
performs 
neither 
of 
the 
two 
functions 
well. 
Under 
normal 
banking 
conditions, 
it 
gives 
undue 
weight 
to 
quantitative 
indicators 
and 
does 
not 
discriminate 
between 
banks 
with 
different 
business 
strategies, 
thus 
creating 
incentives 
for 
banks 
to 
“window 
dress” 
their 
balance 
sheets 
in 
order 
to 
display 
“adequate” 
ratios. 
At 
the 
same 
time, 
it 
is 
excessively 
rigid 
and 
unrealistic 
in 
triggering 
correction, 
intervention, 
or 
resolution 
of 
troubled 
banks, 
under 
extraordinary 
conditions.28 
As 
a 
result, 
most 
banks 
end 
up 
being 
classified 
as 
“normal,” 
which 
renders 
the 
rating 
system 
of 
little 
use, 
while 
creating 
the 
false 
impression 
that 
problems 
are 
being 
detected 
and 
corrected 
at 
an 
early 
stage. 
It 
is 
recommended 
that 
SUGEF 
modify 
its 
rating 
26 
Private 
banks 
that 
choose 
not 
to 
raise 
demand 
deposits 
must 
open 
offices 
in 
under-served 
locations. 
27 
A 
part 
(1 
percent 
of 
salaries) 
of 
the 
contributions 
to 
the 
privately-administered 
pension 
funds 
must 
first 
be 
deposited 
for 
18 
months 
in 
that 
special-charter 
bank 
at 
a 
sub-market 
rate 
of 
interest. 
In 
addition, 
employers 
must 
contribute 
l/4 
of 
a 
percent 
of 
their 
wage 
bill 
to 
this 
bank’s 
capital 
in 
an 
unrequited 
manner. 
28 
For 
instance, 
intervention 
of 
a 
bank 
is 
triggered 
if 
its 
capital 
falls 
below 
8 
percent 
of 
risk-weighted 
assets, 
or 
if 
a 
bank 
falls 
in 
category 
3. 
Formal 
rehabilitation 
(saneamiento) 
plans 
are 
automatically 
required 
for 
banks 
in 
categories 
1 
and 
2. 
Only 
banks 
in 
the 
normal 
category 
avoid 
differentiate 
between 
banks 
in 
the 
normal 
category. 
corrective 
actions, 
but 
there 
is 
no 
useful 
system 
to 
Page  13
13 
tools 
to 
better 
handle 
the 
“normal” 
relationship 
with 
regulated 
banks-e.g., 
through 
a 
refinement 
of 
the 
CAMELS 
system 
that 
would 
emphasize 
the 
assessment 
of 
the 
banks’ 
own 
capacity 
to 
manage 
risks 
prudently 
and 
the 
use 
of 
memoranda 
of 
understanding 
to 
correct 
relatively 
minor 
problems. 
Such 
tools 
should 
be 
different 
than 
those 
used 
to 
manage 
the 
“extraordinary” 
relation 
with 
troubled 
banks 
that 
are 
in 
need 
of 
prompt 
correction 
or 
resolution. 
29 
The 
authorities 
should 
also 
redesign 
the 
system 
of 
penalties 
and 
address 
certain 
voids 
in 
prudential 
and 
accounting 
norms. 
Penalties 
consist 
of 
very 
high 
fines 
and/or 
drastic 
actions, 
such 
as 
the 
suspension 
of 
operations 
of 
the 
bank. 
There 
is 
no 
graduated 
system 
that 
matches 
stiffer 
penalties 
with 
graver 
infractions. 
As 
a 
result, 
infractions 
by 
bankers 
tend 
to 
be, 
in 
practice, 
not 
penalized, 
which 
undermines 
enforcement 
and 
supervisory 
credibility. 
Legal 
changes 
should 
be 
introduced 
to 
establish 
a 
graduated, 
realistic 
system 
of 
penalties. 
To 
fost 
discipline, 
the 
authorities 
should 
also 
consider 
disclosing 
penalties 
and 
other 
enforcement 
measures. 
In 
addition, 
there 
is 
room 
for 
improvement 
as 
regards 
some 
accounting 
norms 
(e 
aspects 
of 
consolidation 
of 
financial 
statements, 
the 
treatment 
of 
certain 
off-balance 
sheet 
items, 
securitized 
assets, 
the 
sale 
of 
repossessed 
collateral 
financed 
by 
the 
seller 
bank, 
the 
amortization 
of 
non-financial 
assets, 
and 
loan 
write-offs). 
Also, 
SUGEF 
should 
require 
information 
on 
restructured 
loans 
(to 
better 
detect 
“ever 
greening”). 
:er 
. 
g 
09 
30 
. 
Supervisory 
practices 
have 
strengthened 
considerably 
in 
recent 
years 
(despite 
the 
mentioned 
legal 
and 
institutional 
constraints) 
but 
there 
is 
room 
to 
improve 
banks’ 
own 
risk 
management 
systems 
and 
foster 
greater 
market 
discipline. 
Noticeable 
progress 
has 
taken 
place 
in 
bank 
supervision. 
Further 
progress 
would 
hinge 
not 
only 
on 
the 
intensification 
of 
training 
programs 
but 
also 
on 
greater 
institutional 
support 
for 
supervisors. 
At 
present, 
the 
supervisory 
approach 
is 
insufficiently 
geared 
at 
promoting 
market 
monitoring 
of 
banks 
(which 
is 
fundamentally 
undermined 
by 
the 
state 
guarantee 
of 
public 
banks) 
and 
at 
inducing 
improvements 
in 
banks’ 
own 
risk 
management 
systems. 
The 
authorities 
should 
accelerate 
the 
shift 
to 
a 
risk-based 
supervisory 
approach 
that 
puts 
more 
emphasis 
on 
the 
evaluation 
of 
the 
quality 
of 
bank 
management 
(internal 
controls, 
risk 
management 
policies, 
etc.). 
In 
particular, 
they 
should 
introduce 
incentives 
for 
banks 
to 
correctly 
classify 
and 
provision 
their 
loans 
ahead 
of 
the 
SUGEF 
inspections. 
They 
should 
also 
facilitate 
the 
monitoring 
of 
banks 
by 
the 
private 
sector 
by 
continuing 
to 
enhance 
disclosure 
reporting. 
There 
is 
ample 
room 
to 
strengthen 
the 
oversight 
of 
supervisors 
over 
external 
auditors 
and 
enhance 
the 
complementarity 
of 
their 
work. 
To 
enhance 
debtor 
screening 
and 
monitoring 
while 
strengthening 
supervision, 
the 
debtor 
information 
system 
maintained 
by 
SUGEF 
should 
continue 
to 
improve 
in 
terms 
of 
coverage, 
quantity 
(and 
reliability) 
of 
information, 
and 
ease 
of 
access 
to 
it 
by 
the 
credit 
institutions. 
31 
Prudential 
oversight 
of 
securities 
markets 
has 
registered 
remarkable 
progress, 
but 
the 
division 
of 
functions 
between 
SUGEVAL 
and 
the 
Stock 
Exchange 
should 
be 
clarified 
and 
accounting 
and 
disclosure 
issues 
pertaining 
to 
mutual 
funds 
addressed. 
SUGEVAL 
has 
led 
a 
major 
modernization 
of 
securities 
markets 
regulation 
and 
has 
brought 
under 
its 
oversight 
previously 
unregulated 
funds 
(e.g., 
CAVS 
and 
OPABs) 
that 
grew 
in 
the 
past 
as 
substitutes 
to 
bank 
deposits 
and 
to 
avoid 
legal 
reserve 
requirements. 
However, 
the 
self- 
regulatory 
role 
of 
the 
Stock 
Exchange 
should 
be 
more 
clearly 
defined, 
ensuring 
that 
it 
is 
complementary 
to 
the 
oversight 
function 
of 
SUGEVAL. 
Also, 
stricter 
disclosure 
requirements 
are 
needed 
for 
investors 
to 
better 
understand 
the 
risks 
they 
take, 
including 
through 
the 
so-called 
leveraged 
repos. 
At 
the 
same 
time, 
mark-to-market 
requirements 
need 
to 
be 
introduced 
for 
Page  14
does 
not 
constitute 
at 
present 
a 
in 
fund 
portfolios. 
However, 
its 
14 
mutual 
and 
pension 
funds. 
(The 
absence 
of 
mark 
to 
market 
severe 
practical 
problem, 
given 
the 
short-duration 
of 
assets 
1 
impact 
will 
become 
more 
severe 
as 
longer-duration 
instruments 
become 
available.) 
32 
Important 
progress 
has 
been 
made 
in 
strengthening 
the 
anti 
money 
laundering 
legislation. 
Reforms 
approved 
by 
Congress 
in 
early 
2002 
aligned 
the 
anti-money 
laundering 
law 
closer 
with 
international 
standards. 
However, 
there 
are 
some 
remaining 
areas 
for 
improvement. 
In 
particular, 
the 
power 
granted 
to 
the 
Costa 
Rican 
Drug 
Institute 
(CRDI) 
to 
receive 
the 
proceeds 
of 
its 
investigations 
(all 
assets 
confiscated 
in 
a 
money 
laundering 
case) 
should 
be 
reviewed, 
as 
it 
may 
lead 
to 
conflicts 
of 
interest. 
The 
Financial 
Intelligence 
Unit 
(FIU) 
of 
the 
CDRI 
should 
be 
oriented 
more 
towards 
the 
analysis 
of 
financial 
information 
(it 
is 
presently 
focused 
on 
fighting 
drug 
trafficking). 
C. 
Crisis 
Management: 
Banking 
Safety 
Nets 
33 
The 
lender 
of 
last 
resort 
function 
suffers 
from 
a 
few 
design 
problems 
and 
the 
operational 
arrangements 
for 
its 
implementation 
can 
be 
improved. 
Neither 
of 
the 
two 
LOLR 
facilities 
established 
in 
the 
law 
has 
ever 
been 
used. 
Design 
problems 
with 
the 
first 
LOLR 
facility 
(redescuento 
ordinario) 
include 
an 
arguably 
too 
short 
maturity 
(30 
days), 
too 
high 
an 
access 
limit 
(up 
to 
50 
percent 
of 
the 
bank’s 
financial 
assets, 
net 
of 
provisions 
and 
obligations 
to 
the 
central 
bank), 
and 
lack 
of 
explicit 
provisions 
to 
preclude 
access 
to 
LOLR 
liquidity 
to 
insolvent 
banks. 
Such 
facility 
is 
also 
affected 
by 
operational 
problems. 
A 
ranking 
of 
acceptable 
guarantees 
is 
not 
defined; 
there 
are 
no 
criteria 
to 
determine 
differential 
discounts 
or 
haircuts 
to 
various 
classes 
of 
guarantees; 
and 
there 
is 
no 
role 
defined 
for 
external 
auditors 
or 
the 
SUGEF 
in 
the 
review 
of 
guarantees. 
The 
second 
LOLR 
facility 
(prhtamo 
de 
emergencia) 
is 
available 
only 
to 
intervened 
banks; 
hence, 
it 
carries 
a 
risk 
of 
being 
abused 
to 
support 
clearly 
insolvent 
banks. 
The 
authorities 
should 
eliminate 
this 
latter 
LOLR 
facility 
and 
improve 
the 
design 
and 
operational 
arrangement 
of 
the 
first 
facility. 
34 
. 
The 
current 
framework 
for 
prompt 
correction 
and 
intervention 
of 
troubled 
banks, 
which 
is 
distorted 
by 
the 
large 
presence 
of 
public 
commercial 
banks, 
also 
requires 
reform. 
Enforcement 
of 
prompt 
correction 
on 
public 
banks 
is 
generally 
problematic-i.e., 
vulnerable 
to 
political 
interference. 
With 
regard 
to 
private 
banks, 
simple 
and 
effective 
triggers 
(based 
on 
clear 
indications 
of 
capital 
deficiencies, 
chronic 
illiquidity, 
or 
reckless 
bank 
management) 
for 
prompt 
correction 
should 
be 
established. 
As 
mentioned 
earlier, 
SUGEF’s 
current 
bank 
rating 
system 
is 
impractical 
for 
that 
purpose. 
In 
addition, 
the 
legal 
definition 
of 
intervention, 
which 
requires 
the 
assumption 
of 
the 
bank’s 
management 
by 
a 
SUGEF-appointed 
interventor, 
is 
a 
potentially 
cumbersome 
and 
risky 
process. 
While 
the 
decision 
to 
intervene 
rests 
with 
CONASSIF, 
there 
is 
no 
mechanism 
to 
involve 
its 
members 
at 
an 
early 
stage 
in 
the 
dynamically 
complex 
process 
of 
assessing 
the 
desirability 
and 
monitoring 
the 
application 
of 
an 
intervention. 
Moreover, 
as 
the 
authorities 
perceive 
high 
legal 
risks 
in 
administering 
an 
intervened 
bank, 
they 
have 
in 
all 
past 
cases 
opted 
to 
suspend 
the 
operations 
of 
intervened 
banks. 
Thus, 
interventions 
have 
inexorably 
marked 
the 
beginning 
of 
liquidations. 
For 
prompt 
correction, 
the 
authorities 
should 
rely 
on 
well-defined, 
time-bound, 
and 
tightly 
supervised 
regularization 
plans, 
implemented 
by 
the 
bank’s 
own 
administrators, 
and 
encourage 
private 
sector 
solutions 
(recapitalization, 
mergers, 
acquisitions). 
The 
authorities 
should 
consider 
legal 
reforms 
to 
strengthen 
the 
prompt 
correction 
framework 
and 
suitably 
modify 
the 
definition 
of 
intervention. 
Page  15
15 
35 
The 
system 
of 
bank 
closure 
and 
resolution 
should 
be 
revamped 
and 
linked 
to 
the 
planned 
introduction 
of 
a 
limited 
deposit 
insurance. 
The 
resolution 
of 
any 
public 
bank 
would 
require 
a 
special 
law. 
And 
the 
framework 
for 
private 
bank 
closure 
and 
resolution 
is 
inadequate. 
The 
latter 
consists 
of 
a 
cumbersome 
liquidation 
of 
the 
bank’s 
entire 
balance 
sheet 
(managed 
by 
the 
SUGEF 
under 
the 
same 
legal 
framework 
applicable 
to 
the 
insolvency 
of 
non- 
financial 
corporations), 
which 
fails 
to 
limit 
contagion 
risk 
and 
the 
unnecessary 
destruction 
of 
asset 
value. 
Legal 
reforms 
should 
be 
introduced 
to 
allow 
purchase 
and 
assumption 
(P&A) 
operations 
-i.e., 
the 
transfer 
of 
deposits 
of 
a 
failed 
bank 
(immediately 
upon 
its 
closure) 
to 
existing 
sound 
banks, 
funded 
by 
(i) 
the 
simultaneous 
transfer 
(possibly 
to 
a 
trust) 
of 
the 
good 
assets 
of 
the 
closed 
bank 
plus 
(ii) 
a 
contribution 
from 
the 
deposit 
insurer 
determined 
by 
a 
least- 
cost 
or 
less-cost 
criterion. 
P&A 
techniques 
would 
help 
ensure 
that 
only 
a 
“residual” 
balance 
sheet 
(with 
the 
bad 
assets 
and 
non-deposit 
liabilities29 
of 
the 
failed 
bank) 
is 
sent 
to 
liquidation, 
thereby 
limiting 
the 
contagion 
risk 
of 
a 
bank 
closure. 
3o 
The 
reform 
of 
the 
bank 
resolution 
framework 
should 
be 
linked 
to 
the 
planned 
introduction 
of 
a 
limited 
deposit 
insurance. 
36 
The 
authorities 
should 
introduce 
some 
modifications 
to 
the 
draft 
bill 
that 
proposes 
the 
creation 
of 
separate 
deposit 
insurance 
funds 
for 
private 
and 
public 
banks. 
The 
draft 
law 
does 
not 
propose 
to 
eliminate 
the 
unlimited 
state 
guarantee 
for 
public 
banks, 
reflecting 
the 
authorities’ 
understandable 
concerns 
that 
adverse 
depositor 
reactions 
could 
undermine 
the 
stability 
of 
public 
banks. 
It 
rather 
proposes 
two 
limited 
deposit 
insurance 
schemes 
(with 
separate 
funds) 
for 
private 
and 
public 
banks. 
The 
deposit 
insurance 
fund 
for 
public 
banks, 
although 
redundant, 
would 
ensure 
immediate 
payout 
to 
small 
depositors 
of 
a 
closed 
public 
bank, 
while 
the 
state 
guarantee 
would 
ensure 
that 
the 
rest 
of 
the 
bank’s 
creditors 
are 
made 
whole 
later 
on, 
in 
the 
liquidation 
process.31 
Separate 
insurance 
funds 
for 
public 
and 
private 
banks 
appear 
appropriate 
given 
the 
circumstances, 
but 
the 
draft 
law 
should 
be 
revised 
to 
ensure 
that 
the 
coexistence 
of 
separate 
funds 
would 
be 
transitional. 
That 
is, 
that 
a 
single 
insurance 
scheme 
would 
be 
in 
place 
once 
the 
competitive 
playing 
field 
is 
fully 
leveled. 
During 
the 
transition, 
the 
deposit 
guarantee 
for 
public 
banks 
would 
be 
set 
to 
converge 
to 
the 
same 
coverage 
limit 
applicable 
to 
private 
banks. 
To 
better 
align 
incentives 
and 
foster 
monitoring, 
greater 
participation 
should 
be 
given 
to 
private 
banks 
in 
the 
governance 
and 
administration 
of 
their 
deposit 
insurance 
fund. 
Also, 
the 
draft 
bill 
needs 
to 
provide 
greater 
flexibility 
in 
setting 
premiums 
(including 
scope 
for 
implementing 
risk-based 
premiums 
at 
some 
suitable 
time 
in 
the 
future) 
and 
more 
specific 
guidance 
with 
respect 
to 
the 
insurance 
fund’s 
initial 
capital, 
the 
fund’s 
borrowing 
authority 
(against 
future 
premiums), 
and 
the 
desirable 
(maximum) 
level 
the 
fund. 
Moreover, 
it 
is 
recommended 
that 
the 
draft 
bill 
be 
introduced 
after 
consolidated 
of 
29 
The 
residual 
balance 
sheet 
could 
also 
contain 
some 
fraction 
of 
uninsured 
deposits 
in 
case 
available 
assets 
are 
not 
enough 
to 
fund 
their 
transfer 
under 
a 
purchase 
and 
assumption-type 
operation. 
3o 
Legal 
reforms 
could 
also 
establish 
a 
framework 
for 
managing 
the 
extraordinary 
case 
of 
a 
too-big-to-fail 
bank 
through 
intervention 
cum 
open-bank 
assistance, 
provided 
that 
the 
shareholder’s 
property 
rights 
are 
previously 
written 
down, 
that 
the 
determination 
of 
a 
too-big-to-fail 
a 
case 
is 
made 
by 
authorities 
at 
the 
highest 
level 
(including 
the 
Minister 
of 
Finance), 
and 
that 
any 
open-bank 
assistance 
does 
not 
affect 
the 
deposit 
insurance 
fund 
and 
is, 
instead, 
financed 
through 
government 
debt 
explicitly 
incorporated 
in 
the 
budgetary 
process. 
” 
Under 
current 
legal 
arrangements 
for 
public 
banks, 
the 
state 
guarantee 
on 
these 
banks’ 
liabilities 
is 
explicit 
but 
of 
a 
subsidiary 
nature- 
i.e., 
it 
comes 
into 
effect 
to 
fill 
the 
gap 
only 
after 
the 
liquidation 
of 
the 
failed 
bank’s 
assets 
has 
proven 
insufficient 
to 
meet 
all 
its 
liabilities. 
Page  16
16 
supervision 
is 
fully 
in 
effect 
and 
supervisory 
capacity 
is 
enhanced, 
and 
be 
widened 
to 
include 
a 
simultaneous, 
suitable 
reform 
of 
the 
bank 
exit 
framework 
(see 
above). 
D 
0 
Crisis 
Management: 
Corporate 
Insolvency 
and 
Creditor 
Rights 
31 
Corporate 
reorganization 
and 
liquidation 
proceedings 
are 
hampered 
by 
a 
slow 
judiciary, 
excessive 
protection 
of 
debtors, 
disincentives 
for 
creditor 
participation, 
and 
lack 
of 
effective 
out-of-court 
workouts. 
Corporate 
rehabilitation 
and 
insolvency 
procedures 
are 
fully 
administered 
by 
the 
courts, 
which 
leads 
to 
major 
inefficiencies 
and 
delays, 
given 
that 
judges 
are 
overburdened 
and 
lack 
the 
necessary 
expertise. 
Creditors 
have 
no 
active 
role 
to 
play 
and, 
hence, 
have 
little 
interest 
in 
participating, 
particularly 
considering 
the 
protracted 
nature 
of 
the 
process 
(the 
verification 
of 
claims 
alone 
can 
take 
several 
months). 
While 
undue 
benefits 
are 
provided 
to 
debtors 
that 
file 
for 
rehabilitation 
(including 
reduced 
interest 
payments 
and 
up 
to 
three-year 
stays 
on 
claims 
against 
their 
assets), 
debtors’ 
incentives 
to 
abuse 
these 
benefits 
have 
been 
dampened 
by 
the 
risk 
that 
rehabilitation 
may 
derive 
in 
insolvency 
and 
be 
declared 
fraudulent. 
The 
legal 
framework 
does 
not 
enable 
workable 
out-of-court 
restructurings-only 
unanimously 
approved 
out-of-court 
creditor 
agreements 
are 
accepted 
by 
a 
court. 
And 
there 
are 
technical 
voids 
in 
the 
current 
legislation- 
e.g., 
there 
are 
no 
netting 
rules 
for 
financial 
contracts. 
38 
A 
comprehensive 
legal 
reform 
of 
corporate 
reorganization 
and 
liquidation 
procedures 
is 
thus 
needed. 
A 
reform 
project 
should 
consider 
creating 
specialized 
courts 
for 
corporate 
insolvency/rehabilitation 
-with 
judges 
that 
have 
the 
necessary 
expertise 
in 
economic 
and 
financial 
matters-or 
moving 
substantial 
parts 
of 
the 
process 
outside 
the 
courts. 
(A 
draft 
bill 
under 
preparation 
leans 
in 
the 
latter 
direction; 
it 
would 
enable 
a 
major 
role 
for 
out-of-court 
“conciliators”.) 
The 
scope 
for 
abuse 
by 
debtor 
corporations 
should 
also 
be 
reduced-e.g., 
by 
limiting 
the 
“stay 
of 
payments 
and 
foreclosures” 
only 
to 
the 
period 
until 
a 
reorganization 
plan 
is 
approved. 
The 
process 
of 
verification 
of 
claims 
should 
be 
shortened 
(e.g., 
by 
presuming 
the 
validity 
of 
claims 
in 
the 
debtor’s 
balance 
unless 
otherwise 
proven). 
Creditors 
should 
be 
given 
a 
more 
active 
role 
in 
the 
process 
(e.g., 
by 
being 
allowed 
to 
formulate 
the 
“rehabilitation 
plan”, 
which 
is 
currently 
only 
formulated 
by 
the 
debtor). 
The 
automatic 
investigation 
into 
“fraudulent 
bankruptcy” 
should 
be 
eliminated. 
Netting 
rules 
for 
financial 
contracts 
should 
be 
introduced. 
The 
rapid 
approval 
of 
extra-judicial 
agreements 
should 
be 
facilitated. 
39 
While 
the 
framework 
for 
secured 
lending 
is 
broadly 
adequate, 
operational 
and 
enforcement 
problems 
significantly 
limit 
the 
use 
of 
collateral 
for 
the 
mobilization 
of 
credit. 
As 
a 
result, 
the 
supply 
of 
credit 
is 
lower 
and 
its 
cost 
higher 
than 
otherwise. 
The 
problems 
are 
mainly 
related 
to 
the 
lengthy 
and 
unpredictable 
judicial 
process 
which 
completely 
governs 
the 
execution 
of 
guarantees. 
Delays 
largely 
result 
from 
overburdened 
courts, 
whose 
services 
are 
provided 
free 
of 
cost 
to 
the 
user. 
The 
authorities 
should 
thus 
consider 
creating 
specialized 
courts 
that 
charge 
reasonable 
judicial 
fees, 
or 
moving 
parts 
of 
the 
process 
outside 
the 
court 
system. 
(A 
draft 
bill 
under 
preparation 
proposes 
a 
privately 
administered 
procedure 
for 
the 
auctioning 
of 
collateral.) 
They 
should 
also 
consider 
amending 
the 
civil 
and 
commercial 
codes 
so 
that, 
in 
the 
event 
of 
default, 
the 
creditor 
is 
allowed 
to: 
repossess 
(through 
peaceful 
means) 
the 
collateral, 
sell 
it 
(through 
a 
private 
sale) 
at 
market 
price, 
or 
use 
it 
to 
cancel 
its 
claim 
on 
the 
debtor 
(so 
long 
as 
the 
market 
value 
of 
the 
collateral 
does 
not 
exceed 
the 
value 
of 
the 
claim). 
Suitable 
regulations 
should 
be 
issued 
to 
enhance 
the 
usefulness 
and 
reliability 
of 
the 
Page  17
17 
“guarantee 
trust” 
(fideicomiso 
de 
garantl’a), 
by 
ensuring 
that 
the 
assets 
in 
such 
trusts 
are 
excluded 
from 
the 
bankruptcy 
estate 
in 
case 
of 
liquidation. 
III. 
TOWARDS 
A 
SUSTAINABLE 
FINANCIAL 
SECTOR 
DEVELOPMENT 
A. 
Issues 
in 
Banking 
Structure 
40 
The 
simultaneous 
large 
presence 
of 
public 
banks 
and 
unsupervised 
private 
financial 
activities 
(mainly 
offshore 
banking) 
reflects 
an 
ongoing, 
incomplete, 
and 
potentially 
unstable 
process 
of 
liberalization, 
which 
needs 
a 
permanent 
resolution. 
The 
entry 
of 
the 
private 
sector 
into 
finance 
has 
not 
been 
accompanied 
by 
the 
exit 
of, 
or 
a 
well- 
defined 
exit 
strategy 
for, 
public 
financial 
entities. 
Instead, 
it 
has 
featured 
the 
gradual 
widening 
of 
competition 
through 
incremental 
dismantling 
of 
“privileges” 
enjoyed 
by 
public 
banks 
and 
their 
affiliates. 
As 
a 
result, 
private 
financial 
entities, 
which 
initially 
competed 
among 
themselves 
in 
businesses 
not 
dominated 
by 
public 
banks 
(such 
as 
offshore 
banking 
and 
fund 
management), 
have 
been 
increasingly 
competing 
with 
public 
banks 
in 
common 
markets. 
Complex 
political 
economy 
dynamics 
heighten 
the 
difficulty 
of 
a 
comprehensive 
solution. 
Private 
banks 
profit 
from 
the 
wide 
intermediation 
margins 
of 
public 
banks 
and, 
thus, 
push 
for 
the 
elimination 
of 
remaining 
public 
bank 
“privileges”, 
including 
through 
the 
introduction 
of 
a 
deposit 
insurance 
scheme 
for 
private 
banks. 
In 
response, 
public 
commercial 
bank 
managers 
correctly 
argue 
that 
such 
elimination 
of 
“privileges” 
would 
imply 
a 
slow 
death 
of 
public 
banks 
under 
the 
pressures 
of 
competition 
(which 
may 
destabilize 
financial 
markets 
and 
would 
raise 
the 
ultimate 
fiscal 
cost), 
unless 
the 
governance 
and 
administrative 
constraints 
on 
the 
public 
banks’ 
capacity 
to 
compete 
are 
simultaneously 
lifted. 
The 
large 
presence 
of 
unsupervised 
private 
financial 
activities, 
particularly 
offshore 
banking, 
is 
also 
unsustainable, 
given 
its 
corrosive 
effect 
on 
incentives 
and 
market 
discipline. 
41 
A 
suitable 
reform 
requires 
a 
clear 
medium-term 
objective 
on 
the 
future 
of 
public 
banks 
and 
offshore 
banks, 
to 
be 
achieved 
in 
the 
context 
of 
a 
well-defined 
transition. 
Ways 
should 
be 
found 
to 
bring 
offshore 
banks 
fully 
under 
consolidated 
supervision. 
Given 
the 
strong 
and 
conflicting 
lobbies, 
the 
authorities 
may 
wish 
to 
take 
advantage 
of 
opportunities 
to 
“bundle” 
legal 
reforms. 
For 
instance, 
the 
draft 
legal 
reform 
to 
introduce 
a 
limited 
deposit 
insurance 
for 
private 
banks 
could 
be 
proposed 
jointly 
with 
a 
revamping 
of 
the 
bank 
resolution 
framework 
and 
the 
establishment 
of 
full 
consolidated 
supervision 
of 
financial 
conglomerates. 
The 
medium- 
term 
objective 
should 
be 
the 
complete 
elimination 
of 
obstacles 
to 
a 
level 
playing 
field. 
To 
bring 
offshore 
banks 
fully 
under 
consolidated 
supervision, 
SUGEF 
could, 
for 
instance, 
condition 
the 
maintenance 
of 
the 
onshore 
bank 
license 
to 
the 
signing 
of 
an 
agreement 
whereby 
the 
banker 
accepts 
to 
subject 
her 
offshore 
bank 
fully 
to 
the 
regulation 
and 
supervision 
by 
SUGEF.32 
Beyond 
this, 
the 
authorities 
should 
consider 
introducing 
a 
pre-announced 
timetable 
for 
phasing 
out 
offshore 
banking, 
that 
is, 
for 
the 
full 
establishment 
and 
enforcement 
of 
the 
soundprinciple 
that 
a 
Costa 
Rican 
license 
would 
be 
required 
to 
take 
deposits 
in 
Costa 
Rica. 
As 
regards 
public 
banks, 
converting 
their 
legal 
status 
into 
that 
of 
a 
joint 
stock 
company 
(sociedad 
an6nima) 
appears 
as 
a 
necessary 
step 
to 
free 
public 
commercial 
banks 
from 
the 
administrative 
and 
governance 
constraints 
on 
their 
capacity 
to 
compete, 
as 
well 
as 
to 
explicitly 
unburden 
them 
from 
any 
development 
banking 
function. 
This 
would 
also 
enable 
the 
elimination 
of 
the 
full 
32 
This 
alternative 
has 
the 
risk 
that 
pressures 
would 
mount 
to 
extend 
the 
deposit 
insurance 
to 
offshore 
deposits. 
Page  18
18 
state 
guarantee 
on 
their 
liabilities 
and 
pave 
the 
way 
towards 
these 
banks’ 
eventual 
privatization. 
To 
further 
promote 
competition, 
remaining 
barriers 
to 
the 
entry 
of 
foreign 
banks 
(they 
could 
operate 
in 
Costa 
Rica 
only 
through 
subsidiaries 
but 
not 
branches) 
should 
be 
removed 
at 
a 
suitable 
time. 
B. 
Issues 
in 
the 
Development 
of 
Securities, 
Pensions, 
and 
Insurance 
Markets 
42 
The 
authorities’ 
long-term 
strategy-to 
develop 
a 
liquid 
market 
for 
public 
sector, 
colon-denominated 
debt 
securities, 
as 
a 
precondition 
for 
the 
development 
of 
the 
market 
for 
private 
debt 
and 
equity 
securities- 
faces 
major 
challenges. 
Despite 
advances 
in 
domestic 
public 
debt 
management, 
liquidity 
in 
the 
public-sector 
debt 
market 
is 
hampered 
by 
low 
levels 
of 
standardization 
(55 
percent) 
and 
immobilization 
(68 
percent).33 
Moreover, 
under 
the 
current 
monetary 
and 
exchange 
rate 
arrangement 
that 
favors 
dollarization, 
the 
initial 
cost 
of 
developing 
a 
market 
for 
long-term, 
fixed 
interest 
rate, 
colon-denominated 
public-sector 
debt 
securities 
is 
likely 
to 
be 
high. 
The 
Costa 
Rican 
securities 
markets 
do 
not 
provide 
at 
this 
stage 
an 
alternative 
to 
banks, 
in 
terms 
of 
resource 
mobilization 
for 
private-sector 
companies. 
The 
small 
size 
and 
high 
concentration 
of 
family 
ownership 
in 
the 
corporate 
sector 
undermines 
incentives 
for 
private 
companies 
to 
“go 
public” 
by 
issuing 
tradable 
securities. 
More 
fundamentally, 
a 
small 
country 
like 
Costa 
Rica 
may 
not 
be 
able 
to 
provide 
the 
economies 
of 
scale 
and 
of 
agglomeration 
needed 
for 
a 
self-sustaining 
development 
of 
a 
market 
for 
private 
securities. 
Even 
in 
the 
shorter 
run, 
the 
future 
shape 
of 
Costa 
Rica’s 
centralized 
securities 
market 
is 
uncertain, 
given 
that 
the 
repo-based 
money 
market 
operations 
(which 
account 
for 
the 
bulk 
of 
secondary 
market 
transactions 
in 
the 
Exchange) 
are 
most 
likely 
to 
migrate 
to 
the 
inter-bank 
market 
as 
a 
result 
of 
the 
widening 
use 
of 
the 
real 
time 
gross 
settlement 
system 
and 
of 
soon-to-be-introduced 
reforms 
to 
securities 
clearance 
and 
settlement 
processes. 
43 
Therefore, 
realistic 
objectives 
should 
be 
set 
for 
the 
local 
securities 
markets. 
In 
the 
shorter-term, 
certain 
pressing 
issues 
should 
be 
addressed. 
Greater 
standardization 
and 
de- 
materialization 
of 
public-sector 
debt 
securities 
is 
crucial. 
The 
authorities 
should 
consider 
systematically 
issuing 
(standardized) 
colon 
bonds, 
including 
CPI-indexed, 
with 
a 
view 
to 
develop 
the 
market 
for 
long-duration 
public 
debt 
in 
local 
currency. 
The 
monopoly 
of 
broker- 
dealers 
over 
securities 
transactions 
and 
custody 
should 
be 
broken 
and 
de-mutualization 
of 
the 
Exchange 
considered.34 
As 
regards 
the 
medium-to-long 
term, 
there 
is 
ample 
room 
to 
raise 
corporate 
governance 
standards, 
key 
to 
mobilizing 
long-term 
resources 
in 
pension 
funds 
towards 
private 
sector 
finance. 
Emphasis 
should 
be 
placed 
on 
the 
continuous 
improvement 
of 
the 
enabling 
environment-particularly 
with 
respect 
to 
the 
legal, 
accounting, 
informational, 
and 
contract-enforcement 
infrastructure. 
This 
would 
facilitate 
the 
broadening 
of 
access 
to 
financial 
services 
for 
the 
Costa 
Rican 
population, 
regardless 
of 
whether 
services 
are 
provided 
by 
the 
banking 
system 
or 
by 
securities 
markets, 
by 
domestic 
or 
foreign 
financial 
entities. 
33 
The 
same 
practical 
effect 
of 
de-materialization 
of 
securities 
is 
achieved 
through 
a 
macro-security 
immobilized 
in 
the 
central 
depository. 
The 
de-materialization 
of 
securities 
would 
be 
implemented 
with 
the 
launch 
of 
planned 
reforms 
to 
securities 
clearance 
and 
settlement 
arrangements. 
34 
This 
is 
necessary 
to 
enable 
the 
development 
of 
market 
makers 
and 
appropriate 
risk 
management 
systems 
(i.e., 
a 
securities 
lending 
facility 
and 
a 
guarantee 
fund 
within 
the 
Exchange) 
to 
ensure 
that 
the 
planned 
reforms 
can 
ensure 
delivery-versus-payment 
and 
settlement 
finality 
in 
a 
netting-based 
securities 
clearing 
system. 
Page  19
19 
44 
As 
regards 
pensions, 
the 
reform 
introduced 
in 
2000 
was 
a 
major 
step 
forward, 
but 
needs 
to 
be 
complemented 
by 
further 
actions 
to 
ensure 
the 
viability 
of 
the 
first 
pillar. 
The 
financial 
viability 
of 
the 
first 
(defined-benefit) 
pillar, 
administered 
by 
the 
Costa 
Rican 
National 
Social 
Security 
Administrator 
(CCSS), 
requires 
changes 
in 
its 
over-generous 
benefits 
that, 
fortunately, 
the 
CCSS 
has 
the 
legal 
authority 
to 
make 
on 
its 
own.35 
This 
could 
be 
achieved 
with 
an 
unchanged 
contribution, 
by 
increasing 
the 
minimum 
retirement 
age 
for 
males 
and 
females, 
lowering 
the 
accumulation 
factor 
to 
obtain 
a 
reduced 
pension 
relative 
to 
the 
base 
salary, 
and 
introducing 
an 
actuarially 
fair 
penalty 
for 
early 
retirement.36 
To 
avoid 
opportunistic 
increases 
in 
reported 
earnings 
by 
the 
self-employed 
as 
they 
approach 
retirement 
age, 
the 
base 
salary 
should 
be 
calculated 
as 
the 
average 
of 
salaries 
over 
a 
longer 
period 
of 
time. 
These 
changes 
should 
be 
phased 
in 
as 
pension 
funds 
under 
the 
second 
pillar 
mature. 
The 
CCSS 
should 
outsource 
the 
investment 
of 
its 
funds 
within 
a 
policy 
that 
would 
permit 
diversification 
(including 
internationally), 
consistent 
with 
its 
fiduciary 
responsibilities. 
45 
. 
Reforms 
are 
needed 
to 
enhance 
the 
developmental 
role 
that 
the 
second 
and 
third 
pension 
pillars 
can 
play 
through 
long-term 
financial 
markets.37 
As 
mentioned 
earlier, 
reforms 
to 
CONASSIF 
should 
be 
considered 
to 
ensure 
a 
better 
balance 
between 
systemic 
prudential 
concerns 
and 
investor 
protection 
concerns- 
the 
latter 
being 
crucial 
in 
pension 
markets. 
SUPEN 
should 
be 
legally 
authorized 
to 
play 
a 
role 
in 
the 
determination 
of 
the 
fees 
charged 
by 
the 
CCSS 
for 
the 
centralized 
collection 
of 
contributions 
to 
pension 
funds. 
Private 
pension 
fund 
administrators 
should 
be 
given 
the 
legal 
option 
to 
choose 
a 
collection 
agent 
(currently, 
the 
CCSS 
has 
the 
monopoly 
in 
collection). 
The 
tax 
treatment 
of 
voluntary 
pension 
funds 
should 
be 
simplified, 
and 
the 
double 
taxation 
of 
employees’ 
mandatory 
contributions 
to 
the 
second 
pillar 
eliminated. 
The 
regulations 
on 
the 
investment 
of 
pension 
funds 
(currently 
invested 
mainly 
in 
government 
debt 
securities) 
should 
be 
gradually 
liberalized, 
to 
allow 
risk 
reduction 
through 
diversification, 
including 
internationally, 
as 
suitable 
private 
securities 
become 
available 
domestically. 
Steps 
should 
be 
taken 
to 
reduce 
the 
dominant 
market 
share 
held 
by 
fund 
administrators 
belonging 
to 
public 
commercial 
banks. 
For 
instance, 
public-bank 
related 
pension 
funds 
should 
not 
enjoy 
a 
privilege 
in 
being 
assigned 
undecided 
workers. 
46 
A 
reform 
strategy 
is 
needed 
for 
the 
liberalization 
of 
the 
insurance 
sector, 
which 
at 
present 
constitutes 
a 
state 
monopoly. 
Costa 
Rica 
is 
the 
only 
country 
in 
the 
world 
where 
the 
state 
has 
a 
monopoly 
over 
the 
insurance 
sector 
-through 
the 
National 
Insurance 
Institute 
(INS).38 
This 
has 
stunted 
the 
development 
of 
domestic 
insurance 
markets 
and 
fostered 
inefficiencies, 
limiting 
consumer 
choice. 
(Upper 
income 
households, 
however, 
tend 
to 
satisfy 
their 
demand 
for 
insurance 
products, 
particularly 
life 
insurance, 
in 
international 
markets.) 
A 
reform 
strategy 
is 
needed 
to 
liberalize 
the 
sector 
in 
an 
orderly 
way. 
The 
reform 
should 
revamp 
the 
insurance 
legislation 
to 
allow 
private 
sector 
entry 
into 
the 
industry, 
possibly 
beginning 
with 
35 
In 
the 
absence 
of 
changes, 
the 
first 
pension 
pillar 
would 
begin 
to 
incur 
operational 
losses 
around 
2010 
and 
would 
run 
out 
of 
cash 
reserves 
towards 
2025. 
36 
The 
recommendations 
aim 
at 
ensuring 
the 
a 
redistributional 
instrument, 
if 
so 
desired. 
long-run 
sustainability 
of 
the 
first 
pillar 
and 
do 
not 
rule 
out 
its 
use 
as 
37 
The 
second 
pillar 
is 
a 
mandatory, 
defined-contribution 
s 
ystem 
of 
fully 
capitalized, 
privately 
individual 
retirement 
accounts. 
The 
third 
pillar 
consists 
of 
voluntary 
savings 
in 
pension 
funds. 
38 
Commercial 
banks 
have 
been 
recently 
allowed 
to 
market 
the 
insurance 
products 
of 
the 
INS. 
admini 
stered 
Page  20
20 
the 
life 
insurance 
and 
annuities 
businesses, 
where 
the 
INS 
has 
little 
activity. 
This 
is 
necessary, 
among 
other 
things, 
to 
eliminate 
the 
inconsistency 
that 
arises 
from 
the 
coexistence 
of 
privately 
managed 
pension 
funds, 
on 
the 
one 
hand, 
and 
a 
state 
monopoly 
in 
life 
and 
annuity 
business, 
on 
the 
other. 
Such 
a 
market 
structure 
undermines 
credibility 
in 
the 
pension 
system 
to 
the 
extent 
that 
the 
accumulated 
balances 
in 
privately 
administered 
(mandatory) 
pension 
funds 
become, 
at 
the 
time 
of 
retirement, 
a 
captive 
source 
of 
business 
for 
the 
INS. 
The 
INS 
should 
be 
transformed 
into 
a 
joint 
stock 
company 
(so&dad 
mixta 
del 
Estado), 
whose 
shares 
would 
be 
listed 
and 
subsequently 
sold. 
Efforts 
should 
be 
made 
at 
speeding 
up 
the 
approval 
of 
the 
bill 
currently 
in 
Congress 
to 
create 
a 
regulatory 
agency 
(or 
function 
within 
an 
existing 
agency) 
for 
the 
insurance 
sector, 
and 
consideration 
should 
be 
given 
to 
creating 
the 
Office 
of 
the 
Ombudsman. 
In 
addition, 
INS 
investment 
regulations, 
policies, 
and 
strategies 
should 
be 
amended 
to 
bolster 
its 
role 
as 
institutional 
investor. 
In 
particular, 
it 
should 
avoid 
maturity 
and 
currency 
mismatches 
and 
add 
flexibility 
to 
its 
investment 
policy 
(currently, 
INS 
investments 
are 
concentrated 
on 
government 
paper, 
real 
estate, 
and 
housing 
loans), 
so 
as 
to 
lower 
risk 
through 
diversification, 
including 
internationally. 
It 
should 
adopt 
a 
policy 
of 
greater 
disclosure 
(including 
the 
dissemination 
of 
the 
recently 
completed 
report 
by 
an 
external 
auditing 
firm). 
It 
should 
maintain 
separate 
accounts 
for 
the 
reserves 
associated 
with 
life 
insurance, 
which 
are 
essentially 
the 
property 
of 
the 
insured. 
Finally, 
investment 
income 
on 
these 
reserves 
should 
be 
tax 
exempt, 
in 
line 
with 
better 
international 
practices. 
IV. 
AN 
AGENDAFORREFORM 
47 
. 
The 
authorities 
may 
wish 
to 
incorporate 
the 
recommendations 
in 
this 
FSA 
into 
a 
coherent 
reform 
agenda, 
which 
would 
require 
the 
adoption 
of 
key 
strategic 
decisions. 
Some 
reforms 
can 
and 
should 
proceed 
in 
parallel, 
within 
a 
coherent 
plan 
that 
sets 
out 
priorities, 
identifies 
complementarities, 
allocates 
institutional 
responsibilities, 
provides 
for 
coordination 
mechanisms, 
and 
establishes 
suitable 
timetables. 
Considerable 
technical 
assistance 
may 
be 
required. 
Appendix 
I 
(at 
the 
end 
of 
this 
document) 
summarizes 
the 
recommendations. 
The 
classification 
of 
a 
recommendation 
as 
“medium 
term” 
is 
often 
because 
it 
would 
require 
legal 
changes, 
which 
should 
not 
be 
construed 
to 
imply 
that 
it 
is 
less 
urgent 
or 
of 
lower 
priority. 
Rather, 
priorities 
should 
be 
set 
in 
light 
of 
the 
following 
considerations: 
l 
Certain 
strategic 
policy 
decisions 
constitute 
a 
prerequisite 
to 
an 
internally 
consistent 
structural 
reform 
agenda. 
These 
decisions 
concern, 
importantly, 
the 
possible 
shift 
to 
a 
new 
monetary 
and 
exchange 
rate 
regime, 
the 
future 
of 
offshore 
banks 
and 
public 
banks, 
and 
the 
liberalization 
of 
the 
insurance 
sector. 
In 
all 
cases, 
leveling 
the 
playing 
field 
between 
public 
and 
private 
banks 
appears 
to 
be 
a 
key 
strategic 
priority. 
l 
Regarding 
prudential 
oversight, 
most 
urgent 
are 
reforms 
to 
establish 
fully 
the 
consolidated 
supervision 
of 
financial 
conglomerates 
and 
to 
strengthen 
the 
supervision 
of 
onshore 
banks. 
Suitable 
modifications 
to 
the 
functions 
and/or 
structure 
of 
CONASSIF 
are 
also 
needed, 
albeit 
with 
less 
urgency, 
to 
ensure 
the 
effective 
functioning 
of 
financial 
system 
supervision. 
l 
The 
strengthening 
prudential 
oversight 
should 
also 
include 
prudential 
buffers 
(such 
as 
counter-cyclical 
and 
currency-specific 
provisioning 
requirements, 
and 
liquidity 
requirements) 
to 
limit 
the 
financial 
system’s 
exposure 
to 
systemic 
risk, 
particularly 
if 
the 
current 
monetary 
regime 
is 
maintained. 
Page  21
21 
l 
With 
respect 
to 
the 
financial 
system 
safety 
net, 
it 
is 
essential 
that 
the 
planned 
introduction 
of 
a 
(limited) 
deposit 
insurance 
scheme 
be 
accompanied 
by 
strengthened 
supervision 
and 
the 
establishment 
of 
an 
effective 
bank 
failure 
resolution 
framework. 
Reforms 
to 
ensure 
viability 
of 
the 
defined-benefit 
(first) 
pillar 
of 
the 
pension 
system, 
while 
not 
pressing 
in 
the 
short-run; 
need 
to 
be 
introduced 
to 
ensure 
that 
they 
can 
be 
gradually 
phased 
in, 
in 
time 
to 
keep 
public 
debt 
under 
control. 
Reforms 
to 
improve 
the 
functioning 
of 
securities, 
pensions, 
and 
insurance 
markets 
carry 
relatively 
less 
urgency, 
but 
are 
essential 
for 
development. 
Over 
the 
medium- 
term, 
reforms 
should 
aim 
not 
only 
at 
financial 
stability 
and 
depth, 
but 
also 
at 
broadening 
access 
to 
financial 
services. 
This 
requires 
continuous 
strengthening 
of 
the 
enabling 
environment 
through 
improvements 
in 
the 
legal, 
accounting, 
informational, 
and 
contract-enforcement 
infrastructure, 
and 
in 
tax 
treatment. 
Page  22
22 
Table 
1. 
Costa 
Rica: 
Financial 
System 
Structure, 
June 
2001 
Number 
Assets 
(in 
billions 
of 
colones) 
Percent 
of 
Total 
Assets 
A. 
Banks 
31 
2,945 
Private 
26 
1,233 
Onshore 
17 
731 
Offshore 
9 
502 
State-owned 
and 
special 
charter 
5 
1,712 
Onshore 
4 
1,520 
Offshore 
(BICSA) 
1 
192 
B. 
Other 
45 
324 
Credit 
unions 
and 
co 
30 
177 
Finance 
companies 
13 
32 
Bahnvi, 
Caja 
ANDE 
2 
115 
C. 
Investment 
funds 
34 
557 
Collective 
Investment 
25 
404 
Pension 
funds 
9 
153 
Totaljkancial 
system 
3,827 
As 
a 
percent 
of 
GDP 
71.7 
77.0 
32.2 
19.1 
13.1 
44.7 
39.7 
50 
. 
85 
. 
46 
. 
08 
. 
30 
. 
14.6 
10.6 
40 
. 
100.0 
Sources: 
SUGEF, 
SUGEVAL, 
BCCR, 
and 
staff 
calculations. 
Page  23
23 
Table. 
2. 
Costa 
Rica: 
Indicators 
for 
the 
Banking 
Sector 
1998-2001 
(In 
percent, 
unless 
otherwise 
indicated) 
December 
December 
December 
August 
1998 
1999 
2000 
2001 
Capital 
Adequacy 
Regulatory 
capital 
to 
risk-weighted 
assets 
Public 
banks 
Private 
banks 
Asset 
Composition 
and 
quality 
Loans 
to 
specific 
sectors 
(as 
percent 
of 
total) 
Consumption 
Housing 
Commerce 
Foreign 
exchange 
loans 
to 
total 
loans 
31.0 
37.6 
47.1 
50.3 
NPLs 
to 
gross 
loans11 
17.8 
13.5 
14.4 
11.7 
NPLs 
to 
gross 
loans 
21 
3.1 
4.6 
4.0 
2.9 
NPLs 
net 
of 
provision 
to 
capital 
3/ 
66.8 
52.6 
61.4 
49.2 
Earnings 
and 
Profitability 
ROA 
ROE 
Interest 
margin 
to 
gross 
income 
4/ 
Noninterest 
expenses 
to 
gross 
income 
51 
Personnel 
expenses 
to 
noninterest 
expenses 
6/ 
Spread 
between 
reference 
loan 
and 
deposit 
rates 
71 
Liquidity 
Liquid 
assets 
to 
total 
assets 
81 
13.7 
11.8 
11.1 
10.5 
Liquid 
assets 
to 
total 
short-term 
liabilities 
9/ 
45.2 
38.0 
31.7 
29.4 
Customer 
deposits 
to 
total 
(non-interbank) 
loans 
170.0 
160.0 
150.0 
140.0 
Foreign 
exchange 
liabilities 
to 
total 
liabilities 
44.8 
46.1 
47.2 
51.0 
Sensitivity 
to 
market 
risk 
Duration 
(or 
average 
repricing 
period) 
of 
liabilities 
lO/ 
Net 
open 
position 
in 
foreign 
exchange 
to 
capital 
Sources: 
SUGEF, 
banks’ 
balance 
sheets 
and 
staff 
calculations. 
25.4 
24.0 
22.6 
24.5 
13.4 
15.1 
16.1 
20.6 
17.4 
16.0 
16.6 
16.1 
1.2 
1.6 
1.5 
1.8 
12.3 
17.0 
14.7 
17.1 
29.7 
29.9 
32.4 
35.9 
31.2 
33.3 
33.4 
35.9 
62.1 
60.3 
55.8 
57.1 
9.9 
11.9 
12.2 
11.8 
44.0 
48.0 
58.0 
2 
64.0 
l/ 
Loans 
in 
arrears 
more 
than 
one 
day. 
21 
Loans 
in 
arrears 
more 
than 
90 
days, 
including 
loans 
under 
judicial 
collections 
proceedings. 
The 
figure 
in 
the 
last 
column 
corresponds 
to 
December 
2001. 
3/ 
Based 
on 
loans 
in 
arrears 
more 
than 
one 
day. 
4/ 
Net 
interest 
income/operating 
income. 
5/ 
Noninterest 
expenses/operating 
income. 
6/ 
Personnel 
expenses 
(personnel 
expenses 
plus 
other 
administrative 
costs 
plus 
other 
operating 
expenses 
7/ 
Weighted 
average 
rates 
published 
by 
the 
BCCR 
(includes 
public 
banks). 
8/ 
Cash 
plus 
deposits 
at 
the 
central 
bank 
plus 
remittances 
in 
transit 
plus 
other 
liquid 
assets 
over 
total 
assets. 
9/ 
Core 
liquid 
assets/short-term 
deposits. 
lO/ 
Rough 
estimate 
provided 
by 
the 
BCRD 
(in 
months). 
16.1 
17.4 
17.0 
Page  24
24 
Table 
3. 
Costa 
Rica: 
Selected 
Macroeconomic 
Indicators, 
1996-2001 
(As 
of 
January 
16,2002) 
Total 
population 
(end-2000) 
3,943,204 
GDP 
per 
capita 
(2001) 
US$4,060 
1996 
1997 
1998 
1999 
2000 
Prel. 
2001 
Demand 
and 
supply 
(Constant 
prices) 
GDP 
(percentage 
change) 
GDP 
(in 
US$ 
mln) 
0.9 
5.6 
8.4 
8.2 
2.2 
0.3 
11,846 
12,829 
14,096 
15,797 
15,949 
16,362 
Prices 
and 
incomes 
(percentage 
change) 
GDP 
deflator 
Consumer 
prices 
(end 
of 
period) 
Consumer 
prices 
(average) 
15.8 
14.9 
12.1 
15.0 
6.5 
9.2 
22.4 
11.2 
12.4 
10.1 
10.2 
11.0 
26.3 
13.2 
11.7 
10.0 
11.0 
10.6 
lvlonetary 
ana 
creait 
aata 
Monetary 
base 
Money 
(Ml) 
Broad 
money 
(M2) 
Domestic 
credit 
17.0 
26.8 
12.6 
39.0 
-11.8 
15.1 
19.15 
4U.8 
14.2 
26.4 
16.4 
zw.z 
26.7 
17.9 
24.4 
20.8 
20.6 
13.9 
25.2 
27.5 
51.9 
18.2 
31.3 
19.6 
Merest 
rates 
Y 
ielci 
on 
government 
bonds 
24.5 
1 
/.Y 
z4.w 
II.4 
1s.u 
17.U 
&month 
rate 
24.6 
l&S 
24.5 
l&3 
13.3 
17.U 
Public 
finances 
(in 
percent 
of 
GDP) 
Central 
government 
tinancial 
balance 
Central 
bank 
losses 
(-) 
General 
government 
financial 
balance 
-2.4 
-1.2 
-1.2 
-2.2 
-2.6 
-2.4 
-1.6 
-1.4 
-1.2 
-1.6 
-1.8 
-1.2 
-4.0 
-2.5 
-2.3 
-3.8 
-4.4 
-3.7 
Balance 
of 
payments 
(in 
US$ 
mln) 
Trade 
balance 
Current 
account 
Foreign 
direct 
investment 
_e-‘orttoho 
investment 
-245) 
-4% 
-399 
615 
-205 
-1184 
-3w 
-481 
-522 
-694 
-751 
-816 
421 
402 
607 
614 
404 
442 
-224 
4-w 
16 
244 
-L5 
45’/ 
mternal 
sector 
(in 
USyi 
mm) 
Colones 
per 
US$ 
(end 
of 
period) 
Public 
sector 
external 
debt 
Net 
international 
reserves 
l/ 
Net 
international 
reserves 
(months 
of 
domestic 
imports 
of 
goods 
and 
services) 
Central 
bank 
short-term 
liabilities 
External 
interest 
payments 
to 
exports 
220.1 
244.3 
271.4 
298.2 
318.0 
341.5 
2,859 
2,640 
2,872 
3,057 
3,151 
3,099 
693 
910 
760 
1,240 
1,086 
1,098 
1.8 
2.0 
1.7 
2.7 
2.4 
2.5 
0.8 
0.8 
0.0 
0.0 
0.0 
0.0 
14.0 
15.3 
10.2 
11.6 
13.5 
14.9 
Sources: 
Central 
Bank 
of 
Costa 
Rica; 
Ministry 
of 
Finance; 
and 
Fund 
staff 
estimates. 
l/ 
Excludes 
bilateral 
claims 
under 
negotiation 
with 
neighboring 
countries, 
which 
in 
the 
official 
statistics 
are 
classified 
as 
part 
of 
international 
reserves. 
Page  25
25 
Table 
4. 
Sovereign 
Ratings, 
(October, 
2001). 
Latin 
America 
Moody’s 
S&P 
Rating 
View 
Rating 
View 
Dominican 
Republic 
Guatemala 
Colombia 
Peru 
Jamaica 
Bolivia 
Brazil 
Paraguay 
Venezuela 
Ba2 
Ba2 
Ba2 
Ba3 
Ba3 
Bl 
Bl 
B2 
B2 
B2 
B2 
BB+ 
BB 
BB 
00 
00 
BB- 
B+ 
B+ 
BB- 
00 
B 
00 
B 
nr 
nr 
Honduras 
Nicaragua 
Cuba 
Caal 
- 
Ecuador 
Caa2 
- 
nr 
ccc+ 
00 
Argentina 
Caa3 
- 
SD 
Source: 
J.P. 
Morgan. 
Page  26
26 
Table 
5. 
Market 
Concentration 
in 
the 
Banking 
Sector, 
Selected 
Countries 
Indicator 
Share 
of 
the 
five 
largest 
banks 
in 
total 
assets 
(in 
percent) 
Costa 
Rica* 
January 
1998 
December 
1999 
December 
2000 
August 
200 
1 
85 
81 
77 
74 
El 
Salvador 
(December 
1999)* 
73 
Honduras 
(December 
1999)” 
51 
Mexico** 
82 
Argentina* 
38 
Brazil** 
52 
Chile** 
47 
Germany** 
17 
United 
States** 
35 
Sources: 
* 
Superintendency 
of 
Banks 
of 
Costa 
Rica, 
El 
Salvador, 
and 
Honduras. 
** 
Merrill 
Lynch 
(2001 
Latin 
American 
Bank 
Stock. 
Monthly 
January. 
Data 
as 
of 
December 
2000. 
7 
Table 
6. 
Costa 
Rica: 
Composition 
of 
Foreign 
Currency 
On-Shore 
Loan 
Portfolio, 
March 
2001 
Exporters 
Type 
of 
Borrower 
Other 
Forex 
Revenue 
Non 
Forex 
Revenue 
Earners 
Earners 
Public 
Banks 
21.5 
25.7 
52.8 
Private 
Banks 
29.0 
24.6 
46.4 
Total 
Commercial 
Banks 
26.1 
25.0 
48.9 
Source: 
SUGEF. 
Page  27
27 
Figure 
1. 
Costa 
Rica: 
Macroeconomic 
Volatility 
A. 
Average 
output 
growth 
and 
inflation, 
1980-2000. 
(In 
percent) 
_ 
Argentina 
(435% 
Inf) 
Venezuela 
+ 
Peru 
(630% 
Inf) 
gazil 
(527% 
Inf.) 
Mexico 
El 
Salvador 
+ 
colombt 
Guatewla 
Honduras 
+ 
Costa 
Rica 
Panama 
output 
growth 
B. 
Output 
growth 
and 
real 
bilateral 
exchange 
rate 
volatility, 
1985-2000. 
3 
t-! 
2000 
% 
1800 
- 
* 
iFi 
1600 
- 
Argentina 
$ 
g 
1400- 
a, 
z 
g 
rj; 
1200 
- 
Honduras 
1000 
- 
2 
l 
.z 
Venezuela 
+ 
800 
- 
El 
Salvador 
Peru 
s 
- 
73 
600 
Brazil 
l 
2 
4oo 
- 
Gu&gea 
Panama 
200 
- 
+ 
Costa 
Rica 
$ 
&ile 
Mexico 
l 
0 
1 
I 
v 
I 
I 
I 
I 
I 
I 
1 
I 
0 
5 
10 
15 
20 
25 
30 
35 
40 
45 
50 
Output 
growth 
(%) 
C. 
Fiscal 
sector 
balance 
and 
external 
current 
account 
balance 
volatility, 
19852000. 
2 
g 
50 
+ 
3 
45- 
g 
40- 
Venezuela 
3 
35- 
Panama 
2 
30- 
* 
E 
k 
25- 
2 
20- 
Colombia 
3 
E 
15- 
3 
lo- 
l 
Chile 
Mexico 
83 
5- 
El 
Salvador 
+ 
Honduras 
Argentina 
l 
l 
l 
Brazil 
0 
G&t&& 
@Ma 
Rica 
Peru 
I 
I 
I 
I 
I 
I 
0 
5 
10 
15 
20 
25 
Fiscal 
sector 
balance 
Sources: 
Central 
Bank 
of 
Costa 
Rica, 
National 
Sources, 
IFS 
and 
staff 
calculations. 
30 
35 
Page  28
28 
Figure 
2. 
Costa 
Rica: 
Main 
Macroeconomic 
Indicators 
A. 
Herfindahl 
Index 
of 
Export 
Revenue 
Concentration. 
8 
0.20 
a 
d 
0.15 
Source: 
World 
Bank 
C. 
Risk 
Premium, 
1996-2001. 
4 
, 
1 
Rate 
on 
3-month 
colon 
deposits 
minus 
3- 
3 
- 
month 
CD 
rate 
(US) 
minus 
exchange 
rate 
E. 
Public 
sector 
balance. 
-3 
-4 
0 
Central 
Government 
overall 
balance 
n 
Central 
Government 
primary 
balance 
q 
Combined 
public 
sector 
balance 
B. 
Trade 
openness. 
65 
60 
Ei 
0 
55 
‘“0 
2 
50 
8 
g 
45 
ho 
35 
30 
25 
D. 
GDP 
Growth 
Rates 
with 
and 
without 
Intel, 
1992-2002. 
10 
- 
With 
Intel 
2002 
A- 
-w 
Projected 
. 
I 
F. 
Public 
debt 
sustainability. 
1990s 
average 
GDP 
growth 
0.7 
percent 
of 
GDP. 
0.035 
0.04 
0.045 
Growth 
Sources: 
Central 
Bank 
of 
Costa 
Rica 
(unless 
otherwise 
specified), 
and 
staff 
calculations. 
Page  29
1983 
Dee 
1984 
Dee 
1985 
Dee 
1986 
Dee 
1987 
Dee 
1988 
Dee 
1989 
Dee 
1990 
Dee 
1991 
Dee 
1992 
Dee 
1993 
Dee 
1994 
Dee 
1995 
Dee 
1996 
Dee 
1997 
Dee 
1998 
Dee 
1999 
Dee 
2000 
Dee 
2001 
Dee 
EMBI 
Page  30
30 
Figure 
4. 
Costa 
Rica: 
Financial 
Indicators 
I 
A. 
Money 
and 
Quasi 
money 
over 
GDP. 
5 
ti 
0 
2000 
4000 
6000 
8000 
10000 
Per-capita 
GDP 
in 
US 
dollars 
C. 
Share 
of 
foreign 
currency 
lending 
to 
private 
sector. 
90.0% 
80.0% 
70.0% 
60.0% 
50.0% 
40.0% 
30.0% 
20.0% 
10.0% 
0.0% 
E. 
Onshore 
Banks: 
Asset 
Composition. 
80% 
60% 
Jan-98 
Aug-01 
Public 
Banks 
Jan-98 
Aug-0 
1 
Private 
Banks 
B. 
Short-term 
yields 
of 
Investment 
Funds 
in 
domestic 
currency. 
Dee-99Feb-00 
Apr-00 
Jun-O() 
AW-o(&-00 
Dee-00 
Feb-0 
1 
>. 
Funding 
costs 
in 
US 
dollars 
(90-day 
rate). 
7.0% 
6.0% 
5.0% 
4.0% 
3.0% 
2.0% 
1.0% 
0.0% 
F. 
Onshore 
Banks: 
Loans 
by 
Currency 
(Share 
in 
Total 
Assets). 
80% 
60% 
40% 
20% 
Jan-98 
Aug-01 
Public 
Banks 
q 
loans 
in 
Colones 
Jan-98 
Aug-01 
Private 
Banks 
q 
Loans 
in 
US$ 
Sources: 
Central 
Bank 
of 
Costa 
Rica, 
SUGEF, 
SUGEVAL, 
IFS, 
and 
staff 
calculations. 
Page  31
31 
Figure 
5. 
Costa 
Rica: 
Financial 
Indicators 
II. 
A. 
Real 
credit 
growth 
and 
business 
cycle. 
60 
~,~,--,-,~,---,-~,-~-.~~~ 
14 
12 
lo 
IMAE 
8 
6 
-I 
Annual 
real 
credit 
growth 
~ 
HP-filtered 
IMAE 
growth 
~~~~:~811:~:i:~~:~:~~~:?~~~ 
IR/zAlE;: 
C. 
Deposit 
dollarization, 
Loan 
dollarization, 
and 
share 
of 
foreign 
liabilities. 
E. 
Interest 
rate 
spread 
and 
banks’ 
securities 
holdings. 
$$,r~$$~g$$~~ 
Private 
banks’ 
spread 
-Total 
banks’ 
securities 
over 
total 
banks’ 
assets 
(right- 
hami 
scale) 
B. 
Deposit 
yield 
curves. 
17 
‘Y&P 
15 
14 
13 
12 
11 
10 
One 
month 
One 
year 
D. 
Deposit 
interest 
rates 
and 
exchange 
rate 
depreciation. 
F. 
Average 
size 
of 
loans 
and 
deposits 
in 
thousands 
of 
colones. 
Sight 
deposits 
Savings 
e 
Colones 
#iUS 
dollars 
Sources: 
Central 
Bank 
of 
Costa 
Rica, 
Banco 
de 
Costa 
Rica, 
and 
staff 
calculations. 
Page  32
32 
Figure 
6. 
Costa 
Rica: 
Sources 
of 
Credit 
Growth 
2000.00 
1800.00 
1600.00 
2 
1400.00 
m 
=: 
g 
uj 
1200.00 
5 
B 
tn 
1000.00 
5 
.- 
= 
.- 
a 
800.00 
0.00 
19 
Page  33
33 
Figure 
7. 
Costa 
Rica: 
Financial 
Indicators 
III 
A. 
CAR 
trends 
for 
selected 
banks. 
9% 
Ago-00 
Ago-O 
1 
C. 
Corporate 
Debt-Asset 
ratio. 
10 
5 
0 
Costa 
Rica 
Latin 
America 
G-7 
For 
Costa 
Rica, 
June 
2001, 
for 
others, 
December 
1999 
E. 
Deposit 
money 
banks’ 
liquidity 
over 
deposits 
and 
short-term 
external 
liabilities. 
0.70 
0.60 
0.50 
0.40 
0.30 
0.20 
’ 
z 
0.10 
t 
1 
0.00 
N 
I 
B. 
Credit 
Flows 
(percent 
growth 
net 
of 
interest). 
D. 
Banking 
system 
foreign 
assets 
over 
deposits 
and 
short-term 
external 
liabilities. 
0.70 
0.60 
0.50 
0.40 
0.30 
0.20 
0.10 
0.00 
h 
F. 
Systemically 
Important 
Payment 
Systems. 
1997 
1998 
1999 
2m 
2001 
0 
CHECKS 
q 
RTGS 
Systems 
(TEF, 
MIB 
and 
MONED) 
Sources: 
Central 
Bank 
of 
Costa 
Rica, 
SUGEF, 
SUGEVAL, 
IMF-MAE/TN/Ol-2, 
and 
staff 
calculations. 
Page  34
34 
V. 
APPENDIX 
I 
Costa 
Rica: 
Summary 
of 
FSAP 
Recommendations 
/ 
A. 
Improving 
liquidity 
management 
and 
deepening 
the 
money 
market 
I 
0 
Enhance 
communications 
between 
the 
central 
bank 
and 
the 
market 
X 
0 
Eliminate 
rationing 
clauses 
in 
day-to-day 
liquidity 
injections 
by 
the 
central 
bank 
X 
0 
Develop 
an 
active 
open 
market 
intervention 
capacity 
X 
0 
Increase 
reserve 
funds 
set 
aside 
to 
ensure 
settlement 
finality 
for 
cleared 
checks 
X 
0 
Introduce 
repo-based 
mechanism 
of 
intra-day 
liquidity 
for 
the 
payment 
system 
X 
a 
Introduce 
book 
entry 
system 
and 
associated 
securities 
clearance/settlement 
reforms 
1 
X 
1 
I 
/ 
B. 
Strengthening 
prudential 
management 
0 
Introduce 
prudential 
measures 
to 
limit 
exposure 
to 
systemic 
risk 
X 
0 
Modify 
the 
functions 
and/or 
structure 
of 
CONASSIF 
X 
0 
Clarify 
the 
self-regulatory 
role 
of 
the 
Stock 
Exchange 
X 
0 
Reform 
Law 
to 
establish 
full 
consolidated 
supervision 
of 
financial 
conglomerates 
I 
I 
X 
0 
Eliminate 
asymmetries 
in 
the 
regulatory 
treatment 
of 
public 
and 
private 
banks 
X 
0 
Modify 
the 
current 
SUGEF 
system 
to 
rate 
banks 
X 
0 
Increase 
supervisory 
focus 
on 
banks’ 
own 
risk 
management 
systems, 
in 
part 
through 
incentives 
for 
banks 
to 
classify 
and 
provision 
correctly 
their 
loans 
lx1 
I 
0 
Enhance 
the 
complementarity 
of 
the 
work 
of 
bank 
supervisors 
and 
external 
auditors 
X 
0 
Improve 
the 
coverage 
and 
reliability 
of 
information 
of, 
and 
facilitate 
access 
to, 
the 
debtor 
information 
system 
maintained 
by 
SUGEF 
I 
lx1 
0 
Establish 
a 
graduated 
system 
of 
penalties, 
and 
disclose 
enforcement 
actions 
X 
0 
Address 
certain 
voids 
in 
banking 
system 
prudential 
and 
accounting 
norms 
I 
~ 
~~~~~~ 
X 
I-- 
--I 
l 
Strengthen 
institutional 
support 
for 
mid-level 
supervisory 
decisions 
X 
0 
Bring 
asociaciones 
solidaristas 
under 
the 
oversight 
of 
SUPEN 
X 
/ 
C. 
Strengthening 
crisis 
management 
0 
Eliminate 
the 
pre’stamo 
de 
emergencia 
LOLR 
window 
and 
improve 
design 
and 
operational 
arrangements 
of 
the 
redescuento 
ordinario 
LOLR 
window 
lx1 
I 
0 
Introduce 
a 
simple 
and 
effective 
system 
of 
triggers 
for 
prompt 
correction 
and 
manage 
it 
within 
regularization 
(saneamiento) 
plans 
lx1 
I 
I 
x 
I 
0 
Introduce 
an 
efficient 
system 
of 
bank 
closure 
and 
resolution 
and 
link 
it 
to 
the 
proposed 
establishment 
of 
a 
limited 
deposit 
insurance 
scheme 
0 
Revise 
the 
draft 
deposit 
insurance 
law 
before 
its 
submission 
to 
Congress 
X 
l 
Create 
specialized 
courts 
for 
corporate 
reorganization/insolvency 
process 
or 
move 
substantial 
parts 
of 
the 
process 
out 
of 
the 
judiciary 
I 
I 
X 
0 
Limit 
period 
of 
“stay 
on 
payments”, 
presume 
validity 
of 
balance 
sheets 
in 
verifying 
claims, 
give 
salient 
role 
to 
creditors, 
remove 
presumption 
of 
fraudulent 
bankruptcy 
0 
Enable 
voluntary, 
extra-judicial 
corporate 
restructuring 
agreements 
X 
j 
F. 
Fostering 
sustainable 
financial 
sector 
development 
I 
l 
Convert 
public 
commercial 
banks 
into 
stock-based 
corporations 
X 
0 
Intensify 
efforts 
to 
standardize 
public 
sector 
debt 
securities 
and 
develop 
a 
market 
for 
Page  35
35 
CPI-indexed, 
colon-denominated 
public 
sector 
debt 
securities 
0 
Eliminate 
the 
monopoly 
of 
broker/dealers 
on 
securities 
transactions 
and 
custody, 
and 
consider 
the 
de-mutualization 
of 
the 
Stock 
Exchange 
0 
Raise 
disclosure, 
accounting, 
and 
corporate 
governance 
standards 
X 
0 
Intensify 
efforts 
to 
assess 
the 
feasibility 
of 
regionalization 
of 
securities 
and 
other 
financial 
markets 
across 
Central 
America 
l 
Change 
the 
parameters 
of 
the 
defined-benefit, 
first 
pillar 
of 
the 
pension 
system 
so 
as 
to 
ensure 
its 
financial 
viability 
Ix1 
I 
0 
Give 
SUPEN 
a 
role 
in 
setting 
the 
fees 
charged 
by 
the 
CCSS 
for 
the 
centralized 
collection 
of 
contribution 
to 
pension 
funds, 
and 
give 
the 
latter 
an 
exit 
option 
0 
Simplify 
tax 
treatment 
of 
voluntary 
pension 
funds, 
eliminate 
double 
taxation 
of 
employees’ 
mandatory 
contribution 
to 
second-pillar 
pension 
funds, 
and 
exempt 
from 
taxes 
the 
income 
from 
investment 
of 
reserves 
associated 
with 
life 
insurance 
0 
Gradually 
liberalize 
the 
investment 
policies 
of 
pension 
funds 
X 
0 
Eliminate 
the 
privilege 
that 
pension 
funds 
of 
public 
banks 
have 
vis-a-vis 
undecided 
workers 
X 
0 
Liberalize 
the 
insurance 
sector, 
beginning 
with 
allowing 
the 
entry 
of 
private 
insurance 
companies 
in 
the 
life 
and 
annuities 
businesses 
I 
lx1 
l 
Significantly 
raise 
disclosure 
and 
transparency 
of 
the 
INS, 
increase 
flexibility 
in 
its 
investment 
policy, 
and 
separate 
the 
accounts 
of 
reserves 
for 
life 
insurance 
X 
l 
Convert 
the 
INS 
into 
a 
joint 
stock 
corporation 
and 
then 
list 
it 
in 
the 
Exchange 
X 
0 
Create 
a 
supervisory 
agency 
(or 
a 
function 
within 
an 
existing 
agency) 
for 
insurance 
X 
I 
0 
Create 
specialized 
courts 
that 
charge 
reasonable 
fees 
for 
the 
collateral 
repossession 
process, 
or 
move 
substantial 
parts 
of 
the 
process 
out 
of 
the 
judiciary 
X 
0 
Give 
creditor 
greater 
leeway 
to 
peacefully 
repossess 
or 
sell 
the 
collateral 
X 
0 
Issue 
regulations 
for 
“guarantee 
(or 
collateral) 
trusts” 
X 
wb16313 
L:\WORD\FSAP\Costa 
Rica\Costa 
Rica 
FSA 
- 
(24 
Feb 
03) 
- 
AM 
input.doc 
February 
25,2003 
lo:30 
AM