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June 07, 2018

IMF published its staff report and selected issues report in the context of the Article IV consultation with El Salvador. Directors noted that El Salvador’s banking system is well capitalized and very liquid. Recent credit growth to the productive sectors has been encouraging, but further room for healthy credit expansion remains. Directors acknowledged the recent progress made in risk-based and cross-border supervision. To further improve the resilience of the banking sector, they encouraged the authorities to accelerate the adoption of the crisis management and bank resolution draft law, to strengthen the financing of the lender of last resort facilities, and to create a bank liquidity fund. Directors encouraged continued efforts to strengthen the AML/CFT framework.

The staff report highlights that the banking sector appears solid and credit growth is moderate, but sovereign risk concerns and declining margins are affecting the (mostly foreign-owned) banks. The banking system’s capital adequacy ratio (16.6%) remains well above the required minimum of 12%. The nonperforming loan ratio is 2% and problem loans are amply provisioned. However, abundant liquidity, including due to the lack of viable investment projects, and a declining net interest spread continue to dent bank profitability. Credit growth is moderate at 6% in real terms. The authorities are implementing AML/CFT measures and maintain international cooperation with the U.S. Department of Treasury.

The report also reveals that progress has been made in risk-based supervision and financial inclusion by approving a new law in January 2017. The authorities should continue to strengthen the AML/CFT framework in preparation for the next round of assessment under the CFATF, in 2022. Efforts could be intensified in the areas of systemic liquidity (adequate funding of lender of last resort), banking resolution and crisis management procedures, cross-border supervision, and data availability. These steps would help promote a sound banking system and expansion of credit to productive sectors, including by limiting excessive liquidity holdings.

The selected issues report contains a feature estimating the credit gap, defined as the difference between the credit-to-GDP ratio and its long-term trend. In the case of El Salvador, the estimated threshold is equal to 1.43%, lower than the 2% Basel III micro-prudential rule, which triggers counter-cyclical capital buffers. This is currently positive, but declining and below the critical 2% threshold recommended by Basel III micro-prudential guidelines. The assessment concludes that there is still scope for financial deepening without excessive risks for financial stability. Furthermore, an econometric assessment shows that the recent credit growth is not excessive and is aligned to fundamentals.

 

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Keywords: Americas, El Salvador, Banking, Article IV, Capital Adequacy, Resolution Regime, IMF

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