Paraguay: Central Bank Statement

Author: | Published: 3 Nov 2015
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Recent studies show that financial crises are commonplace throughout history and across rich and poor countries, with large negative economic and social effects. As pointed out by researchers at the Federal Reserve, "the recent global crisis was associated with a huge loss of economic output and financial wealth, psychological consequences and skill atrophy from extended unemployment, an increase in government intervention, and other significant costs".

Paraguay suffered several financial crises during the nineties, as a byproduct of rapid financial liberalization without adequate safeguards in terms of sound prudential regulations and enforcement. As a consequence, about one third of the banks and two thirds of the nonbank financial institutions were liquidated. Following the event, the legal system for banking supervision and financial intermediation was reformed. The current Central Bank Charter and General Banking Law were conceived under this scenario, as an immediate and desperate attempt to partially alleviate a devastating domino effect triggered by consecutive bank runs.

The picture has changed dramatically over the last twenty years. The size of the banking sector increased three-fold, from a credit level representing only 13% of GDP to 45% of GDP at end-2014. Paraguayan banks are currently placed among the fastest growing and most profitable in the region. Despite strong dynamics, non-performing loan ratios have remained low and banks are well capitalized, above levels recommended by Basel Accords. During the last global financial crisis, financial institutions remained fairly stable and even experienced a credit expansion.

Nevertheless, financial crises are highly unpredictable and authorities must permanently seek opportunities to build up stronger regulatory frameworks. The Central Bank of Paraguay (CBP) recognizes the importance of periodically reviewing and upgrading the legal financial architecture. This is crucial to spur the effectiveness of prudential rules and oversight, while securing a healthy and well-functioning sector.

Banking supervision has seen a major progress during recent years. However, current banking laws have limited further progress in updating prudential requirements towards international standards. At present, laws are unusually detailed and prescriptive, and determine quantitative limits, risk weights, and even the amount of fines, with very limited delegated capacity to the CBP. For that reason, some weaknesses already highlighted by previous sector evaluations cannot be addressed.

Favorable macroeconomic conditions and a vigorous but stable financial system are providing a unique opportunity for reframing current banking laws to migrate towards a more comprehensive risk-based scheme. Existing legislation needs to be overhauled so that they establish principles and general requirements, while leaving to the CBP the responsibility for setting specific requirements and technical details. With the reform, focus will shift to corporate governance issues, adequate solvency ratios that are proportional to risk levels, and strengthening disclosure and transparency requirements.

The Paraguayan economy has been one of the fastest growing in the region during the last decade. The financial sector role was crucial to achieve this success, channeling resources towards the most productive activities and projects. An extensive literature indicates that stronger financial sectors and robust banks are positively correlated with economic performance. By modernizing the regulatory framework, the CBP seeks to develop the sound infrastructure required for adequate financial intermediation and for achieving stronger and more equitable growth rates. This is the right time to do it; after all, no one builds a house on a rainy day.

 

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