IMF Issues Report on Financial Sector Stability Review of Costa Rica

Banking, insurance, securities, and pensions are supervised by dedicated agencies under the aegis of the Central Bank of Costa Rica (BCCR) and the authority and coordination of the National Council for the Supervision of the Financial System (CONASSIF). The financial system is highly dollarized and dominated by the banking sector (80% of financial system assets). The insurance sector opened in 2008, produces a premium of nearly USD 1.2 billion, and is dominated by the state-owned Instituto Nacional de Seguros (INS). Securities markets are dominated by the public debt market. The legal framework governing the financial sector is highly fragmented. General laws define the responsibilities for the central bank, the supervisory authorities, and participants in the market. Those laws coexist with a number of organic laws governing financial institutions, such as laws establishing state-owned institutions (banks, the systemic insurer, and some pension funds), financial cooperatives, and several “special regimen entities” in the banking, insurance, and pension sectors. This is a somewhat unbalanced situation, as not all entities are governed by the same rules. The legal framework is deep-rooted and to pass any legal change is not a simple process.

The mission concludes that, despite progress, the financial stability framework in Costa Rica is not well-prepared to handle a potential systemic financial crisis. Supervision of the financial sector is becoming risk-based and intensive, but it lacks key legal powers, tools, and responsibilities for effective oversight of institutions and markets. Serious vulnerabilities in the pension sector, the secondary markets, and financial-crisis safety nets need urgent attention. Key recommendations made by previous missions remain unimplemented. Implementation of the pending 2008 FSAP recommendations and adoption of Basel III standards (gradually introducing capital requirements and liquidity standards) would improve the resilience of the financial system. Although the banking supervisor SUGEF has made progress in its capital adequacy framework on an individual basis, there are still gaps vis-à-vis Basel Committee standards. Regulations on the management of credit risk, country and transfer risks, and concentration risk have not yet been issued. While some progress has been made in several areas, the general framework under which banking supervision is conducted still has serious weaknesses. SUGEF is preparing a draft law on consolidated supervision to be submitted to CONASSIF for approval and subsequent submission to the Legislative Assembly. The draft law that was presented to the mission would address almost all current weaknesses related to consolidated supervision.

The prudential regulation of the insurance and the pension sectors needs further development. The insurance capital regime contains important risk-sensitive elements and goes beyond Solvency I, but its calibration to meet the risk appetite of the insurance supervisor (SUGESE) is lacking. The solvency ratio is calculated using the risk capital that captures investment risk, operation risk, insurance risk, reinsurance risk, and catastrophic risk. The investment risk capital calculation is consistent with the banking sector methodology. The mission recommends that Costa Rica needs to improve its financial safety net by providing an effective lender of last resort process, implementing a deposit insurance fund for all banks, developing effective bank resolution mechanisms, and establishing crisis management protocols. To strengthen banking regulation and supervision, Technical Assistance is primarily directed to support regulatory developments, following the approval of current legislative projects. In the medium term, Technical Assistance can analyze the impact of Basel II/III standards and help implementation planning, depending on the priorities and readiness of the authorities. Furthermore, the development of the prudential regulation and supervision of the insurance and the pension sectors will benefit from external assistance.

Related Link: Technical Assistance Report

Keywords: Americas, Costa Rica, Banking, Insurance, Securities, Pensions, Basel III, Banking Supervision, FSSR, Solvency, Resolution Framework, Technical Assistance, Roadmap, IMF