Government Guarantee Funds9
In several countries, government guarantee funds have been established to ensure DC private pension plans. The goal of such guarantees is to reduce an individual’s exposure to
investment and other risks associated with private plans and to diversify the risk of pension fund failures among the general population of pension plans. In developing countries, especially in Latin America where they have sprouted, government guarantee schemes have helped to ease the transition from government sponsored DB plans to privately run DC plans. It is expected that guarantee funds will grow in importance as more countries shift to greater emphasis on private plans.
Government pension guarantees, as illustrated by the practices in the Latin American region, have commonly been of two forms:
• A guarantee that ensures that each DC fund earns an annual rate of return greater than a pre-specified minimum
• A guarantee that directly ensures each individual return on pension savings, rather than the guarantee on each pension fund (guarantees that participants receive a minimum benefit payment throughout their retirement years, even if their retirement savings are exhausted)
Nonetheless, the structure of government pension guarantees varies across countries. The United States, Germany, and Switzerland have long-standing institutions to insure pension benefits. For example, in the United States, the key role of the Pension Benefit Guarantee Corporation, whose funds are contributed by private firms, is to ensure private pension plans and to protect the retirement benefits of workers whose companies fail or go out of business. In Chile, by contrast, the government has established a minimum pension guarantee that promises to keep pension benefits above a certain level. Only workers who have contributed for at least 20 years are eligible, and the guarantee is intended to reduce the risk that workers will outlive their savings.
The presence of insurance funds is not without inherent risks, including moral hazard and poor design and operation. For example, a fund may carry an investment portfolio similar to that of covered pension funds, which can limit its ability to act in times of crisis. The use of more risk-based elements in the design of guarantee funds, such as risk-based premiums would reduce moral hazard.
1. See Green (2003), Francis (2004), Johnson and Steuerle (2003), and Scheiber (2003), for a discussion of hybrid plans.
2. For a discussion of various types of pension systems, see Yermo (2002) and Carmichael and Pomerleano (2002).
3. Analyzing the regulatory framework depends heavily on the level of government involvement in pension provision.
4. Several recent corporate failures have underlined the importance of transparency and the diversification of pensions fund assets, regardless of type (e. g., the collapse of U. S.-based Enron saw the loss by workers of their entire occupational pension savings, which had been invested largely in company stocks. Losses are estimated between US$5 billion and US$10 billion. The employees were encouraged to buy stocks, which were hugely overpriced and were based on false financial statements that grossly inflated earnings.)
5. This section is based on Carmichael and Pomerleano (2002), pp. 115-17.
6. For an interesting case study in the development of a risk-based capital system, see the IMF (2004) box 3.4 on the Netherlands, p. 104.
7. Investment strategies are typically based on the size and depth of domestic capital markets, as well as access to international capital markets, which is important for diversification and possibly higher rates of return. Size and depth of markets determine the availability of instruments of varying risk, return and maturity, and liquidity characteristics. In many developing countries, shallow capital markets result in heavy investment in government bonds and bank deposits.
8. Chile’s pension fund sector, one of the most developed among emerging markets, is a fully funded system operated by the private sector (which insulates it from political pressures). The Chilean investment regime includes limits specified for each instrument, each class of instrument (variable and fixed income), different combinations of instruments and also sub-limits, depending on risk, liquidity, characteristics, and company age. The limits by issuer are divided into three main categories aimed at (a) portfolio diversification, (b) restricting investments in related companies, and (c) limiting ownership concentration.
9. Section is based on Pennacchi (1998).
Carmichael, Jefferey, and Michael Pomerleano. 2002. The Development and Regulation of Non-Bank Financial Institutions. Washington, DC: World Bank.
Green, L. Bernard. 2003. What Is a Pension Equity Plan? Washington, DC: U. S. Department of Labor.
Francis, David. 2004. “As Pensions Fade, Some Firms Try Hybrid Plans.” Christian Science Monitor, October 25, 2004.
International Monetary Fund. 2004. Global Financial Stability Report. Washington, DC: International Monetary Fund.
Johnson, Richard, and Eugene Steuerle 2003. “Promoting Work at Older Ages: The Role of Hybrid Pension Plans in an Aging Population.” Pension Research Council WP 2003-26. The Wharton School, University of Pennsylvania, Philadelphia, PA. Available at http://rider. wharton. upenn. edu/~prc/PRC/WP/WP2003-26.pdf.
Mitchell, Olivia. 2002. “Redesigning Public Sector Pensions in Developing Countries.” Pension Research Council WP 2002-9, The Wharton School, University of Pennsylvania, Philadelphia, PA.
OECD. 2000. Selected Principles for the Regulation of Investments by Insurance Companies and Pension Funds. OECD: Paris.
— . 2004. Recommendation on Core Principles of Occupational Pension Regulation.
Pennacchi, George. 1998. “Government Guarantees on Pension Fund Returns.” WB Social Protection Discussion Paper No. 9806, World Bank, Washington, DC. Scheiber, Sylvester J. 2003. “The Shift to Hybrid Pensions by US Employers.” Pension Research Council Working Paper 2003-23, The Wharton School, University of
Pennsylvania, Philadelphia, PA. Available at http://rider. wharton. upenn. edu/~prc/ PRC/WP/WP2003-23.pdf.
Whitehouse, Edward. 1999. Pension Reform Primer—Supervision: Building Public Confidence in Mandatory Funded Pensions. Washington, DC: World Bank.
Yermo, Juan. 2002. Revised Taxonomy for Pension Plans, Pension Funds and Pension Entities. A Paper prepared for the OECD Working Party On Private Pensions, OECD (October 2002): Paris.
 Jurisdictions that have relatively large numbers of financial institutions engaged primarily in business with nonresidents
• Financial systems with external assets and liabilities that are out of proportion to domestic financial intermediation designed to finance domestic economies (For most OFCs, the funds that are on the books of the OFC are invested in the major international money-center markets.)
• Centers that provide some or all of the following services: low or zero taxation, moderate or light financial regulation, and banking secrecy and anonymity (Activities of OFCs are centered around international banking and around asset and risk management, including setting up special purpose vehicles and trusts that are aimed at large corporate entities and at high net worth.)
The key defining characteristics of an IFC are (a) the economies of scale and scope in financial activities, (b) the extent of international economic and banking links, (c)
 See Houben, Kakes, and Schinasi (2004, appendix II) and Schinasi (2004) for a discussion of definitions of financial stability.
 For example, if it is found that some services, such as reinsurance or elements of investment banking, are more effectively provided to a particular small country by foreign markets or firms, then there is a presumption that policies blocking access to foreign provision of those services should be dismantled, even though this dismantling may
Given the complexities in conducting effective consolidated supervision, it is critical that the supervisory authorities have the necessary tools to carry out their responsibilities. Some of the preconditions and prerequisites for effective banking supervision, which were discussed earlier (particularly, an appropriate legal framework and operational independence of the supervisory agency or agencies), are especially important in the conduct of effective consolidated supervision.
• The legal framework must grant the supervisor the necessary powers to conduct consolidated supervision over the entire span of institutions under its jurisdiction. Supervisors should have (a) sufficient flexibility in licensing and authorization, (b) the power to request information sufficient to effectively assess the banking group’s risk profile and the adequacy of its risk management, and (c) sufficient enforcement powers to address technical compliance not only with laws and regulations but also with safety and soundness concerns that may arise within the banking group. In addition, they must have the ability to sanction intragroup transactions that, while strictly legal from a groupwide perspective, have undesirable consequences for the regulated group entities.
 Additional important considerations are the agency’s (or agencies’) operational independence and adequacy of resources. Issues to be reconciled include reporting requirements and accountability for the agency, as well as its funding and staffing. A supervisory agency that must report to another ministry may suffer political interference, especially when controversial decisions need to be made. Likewise, an agency that is underfunded or that cannot retain qualified staff members will not be able to maintain an effective supervisory program.
 Typical LOLR instruments are a discount window, or a standing facility, often linked to a payment system.
2. The IMF-Monetary and Financial System Department (MFD), Operational Paper OP/00/01, Emergency Liquidity Support Facilities, provides a detailed discussion of the various elements of LOLR activities.
3. The details of this type of “incentive-compatible” system are discussed in Garcia (1999, 2000, 2001) and in Beck (2003). The adverse impact of deposit insurance on bank soundness is analyzed in Barth, Caprio, and Ross (2004) and in Demirguc-Kunt and Detragiache (2003). Also note that poorly designed deposit insurance could have a negative impact on financial development, as noted in Cull, Senbet, and Sorge (2001).
4. Nearly two-thirds of the schemes established since 2000 cover deposits in foreign currency.
5. Pros and cons of, as well as country experiences with, blanket guarantees are discussed in IMF Occasional Paper 223, “Managing Systemic Banking Crises” (Hoelscher and Quintyn 2003).
6. For further details on protection funds for insurance companies, see Takahiro (2001).
7. See Sundararajan, Marston, and Basu (2001) for a discussion of empirical evidence on the links between stability and observance of the BCP. For a comprehensive analysis of links between bank regulation and banking performance, see Barth, Caprio, and Levine (2005).
8. See IMF and World Bank (2002b). For a more recent update, see IMF (2004a) on issues and gaps in financial sector regulation.
9. See chapter 9 for a discussion. Sequencing and prioritization of reform programs may require technical assistance in some country circumstances.
10. This section is based on Basel Committee on Banking Supervision (1999).
In some circumstances, a separate legal and regulatory framework for leasing companies can be helpful to create a suitable environment for leasing and promote confidence in the industry. Many developed countries, despite their long history of leasing, do not have a separate leasing law (Amembal, Lowder, and Ruga 2000). Those countries usually have well-developed common and civil laws that provide an adequate basis to support leasing transactions. In countries where the leasing industry is still in the very early stages of development, a new legal and regulatory framework could help promote confidence in the efficiency and fairness of the market. Specialized leasing laws may not be necessary, however, provided that existing regulations designed to deal with financial institutions do not discriminate against the industry.5 When the industry develops, however, it will be important that the fundamental elements of an efficient financial leasing law be put in place. Those elements include the following (see International Finance Corporation 1998):
• Freedom of contract
• Recognition of the three-party structure of the modern financial lease
• Duties consistent with party’s role in the transaction
– Lessee’s duty to pay after acceptance
– Lessor’s lack of equipment responsibilities
– Lessee’s recourse against the seller
– Equipment not liable to other creditor’s claims
– Transfer freedom and restraint
• Default remedies, including the right to accelerate the remaining lease payments
 Expedient repossession and recovery
The rights and duties of the lessor as legal owner of the asset and the rights and duties of the lessee as user of the asset should be clearly stated. The legal owner needs a clear, simple, workable, timely process to reclaim an asset if the terms of the lease are breached by the user, including the automatic right of repossession without lengthy court proceedings and the right to claim payments due and other damages. The lessee must have the right to use the asset unimpeded and gain the full productivity of the asset. In some countries, it may be necessary to clarify that the lessee does not have the right to create a lien on leased assets (International Finance Corporation 1996). One advantage of the leasing
 There should be a dedicated focus within the institutional framework to recognize those unique risks of the regulation and supervision of OFIs, whether financial institutions are under a unified or a separate supervisory framework.
 When appropriate, prudential norms ought to be specifically defined for OFIs. The following set of regulations will commonly require reexamination: minimum statutory capital, capital adequacy ratio, asset classification, provisioning, liquidity, acquisition, and investment.
 See IMF (2004a) for the definition of deposit taker and Other Financial Corporation (OFC). This Handbook uses the term Other Financial Intermediary (OFI) instead of OFC to avoid confusion with references to Offshore Financial Centers. IMF (2004a) uses the term deposit takers as units that engage in financial intermediation as a principal activity and that have liabilities in the form of deposits payable on demand, transferable by checks, or otherwise used for making payments. Or they have liabilities in the form of instruments that may not be readily transferable such as certificates of deposits, but that are close substitutes for deposits and are included in measures of broad money.
2. This section is partly drawn from Carmichael and Pomerleano (2002).
Amembal, Sudhir P., Loni L. Lowder, and Jonathan M. Ruga. 2000. International Leasing: The Complete Guide. Salt Lake City, UT: Amembal Associates.
Bakker, Marie H. R., Leora Klapper, and Gregory F. Udell. 2004. Financing Small – and Medium-Size Enterprises with Factoring: Global Growth in Factoring—and Its Potential in Eastern Europe. Washington, DC: World Bank.
Bank for International Settlements, 1997. Core Principles for Effective Banking Supervision. Basel, Switzerland: Bank for International Settlements.
Carmichael, Jeffrey, and Michael Pomerleano. 2002. The Development and Regulation of Non-Bank Financial Institutions. Washington, DC: World Bank.
Herring, Richard, and Anthony Santomero. 1999. “What Is Optimal Financial Regulation.” Financial Institutions Center, The Wharton School, University of Pennsylvania, Philadelphia.
International Finance Corporation. 1996. “Leasing in Emerging Markets.” International Finance Corporation, Washington, DC.
—- . 1998. “Overview of Legislation on Leasing: Recommendations on Legal
Framework.” International Finance Corporation, Russia Leasing Development Group. Available at http://www2.ifc. org/russianleasing/eng/analit/2/2.htm#num5.
IMF (International Monetary Fund). 2004a. Compilation Guide on Financial Soundness Indicators. Washington, DC: International Monetary Fund. Available at http://www. imf. org/external/np/sta/fsi/eng/2004/guide/index. htm.
CGAP published consensus guidelines approved by 29 international donor agencies that support microfinance (Christen, Lyman, and Rosenberg 2003). Those guidelines were approved by CGAP members in September 2002. The consensus guidelines list 21 key policy recommendations on regulation and supervision of microfinance, which create a good checklist of issues to focus on in the assessment of regulatory aspects that pertain to access to financial services. The particular set of key policy recommendations in the checklist that may be applicable to a given situation will vary from one country to another depending, among other things, on the range and variety of institutional providers of rural finance and microfinance services, on the size and relative importance of each type of rural finance and microfinance institution category, and on the size of the rural finance and microfinance sector relative to the formal commercial finance sector. Several of the key policy recommendations are selected for emphasis and are highlighted next:7
• Problems that do not require the government to oversee and attest to the financial soundness of regulated institutions should not be dealt with through prudential regulation. Relevant forms of non-prudential regulation, including regulation under the commercial or criminal codes, tend to be easier to enforce and less costly than prudential regulation.
• Before regulators decide on the timing and design of prudential regulation, they should obtain a competent financial and institutional analysis of the leading MFIs, at least if the existing MFIs are the main candidates for a new licensing window being considered.
• Minimum capital needs to be set high enough so that the supervisory authority is not overwhelmed by more new institutions than it can supervise effectively.
 Where possible, regulatory reform should include adjusting any regulations that would preclude existing financial institutions (banks, finance companies, etc.) from offering microfinance services, or that would make it unreasonably difficult for such [regulated and licensed] institutions to lend to MFIs.
• Prudential regulation should not be imposed on “credit-only” MFIs that merely lend out their own capital, or whose only borrowing is from foreign commercial or non-commercial sources or from prudentially regulated local commercial banks.
• As a corollary to the above principle and] depending on practical costs and benefits, prudential regulation may not be necessary for MFIs taking cash collateral (compulsory savings) only, especially if the MFI is not lending out (i. e., not able to intermediate these funds).
 Example of rapid growth in cooperatives and credit unions include Burkina Faso, Ecuador, Guatemala, and the Philippines.
2. Village banking is a means of delivering financial services such as small loans and savings products to those people who could not otherwise obtain them. While many agencies and organizations provide small loans to low-income families, not all use the village banking method. Developed by FINCA (http://villagebanking. org/), the village banking method is unique in the responsibility and autonomy given to borrowers in running their banks and in the method’s emphasis on community, as well as individual development. The village banking method has been shared widely with 40 voluntary agencies and development organizations that currently operate more than 80 programs worldwide. The village banking method is highly participatory in nature. It gives the beneficiaries a voice and involves them in the development process. Not only do members receive loans, but also they form cohesive groups that manage and collect repayments on those loans, that save diligently, and that decide on ways to invest those savings, and progress together, thus forming networks for mutual support.
3. Data cited as of 2003.
4. See Honohan (2004) for a discussion of this point.
5. In some countries, wholesale borrowings through commercial paper or money market instruments and through medium – to long-term large-value certificates of deposit may require prior authorization from a securities or capital market authority or, where
Barron, John M. and Michael Staten. 2001. “The Value of Comprehensive Credit Reports: Lessons from the U. S. Experience.” In Making Small Business Lending Profitable—Proceedings from the Global Conference on Credit Scoring. International Finance Corporation: Washington, DC.
Boomgard, James, Debra Boyer, and James Dyer. 2003. “The Agricultural Bank of Mongolia: From Insolvent State Bank to Thriving Private Bank.” Case Study presented at the International Conference on Best Practices titled “Paving the Way Forward for Rural Finance,” Washington, DC, June 2003.
Christen, Robert Peck, and Richard Rosenberg. 2000. The Rush to Regulate: Legal Frameworks for Microfinance. Washington, DC: Consultative Group to Assist the Poorest.
Christen, Robert Peck, Timothy R. Lyman, and Richard Rosenberg. 2003. Microfinance Consensus Guidelines. Washington, DC: Consultative Group to Assist the Poorest.
Fiebig, Michael. 2001. Prudential Regulation and Supervision for Agricultural Finance. Rome: Food and Agriculture Organization of the United Nations (FAO) and Deutsche Gesellschaft fur Technische Zusammenarbeit (GTZ), Agriculture Finance Revisited No. 5.
Gallardo, Joselito. 2002. “A Framework for Regulating Microfinance Institutions: The Experience in Ghana and the Philippines” World Bank Policy Research Working Paper No. 2755, World Bank, Washington, DC.
Gallardo, Joselito, Korotoumou Ouattara, Bikki Randhawa, and William F. Steel. 2005. “Comparative Review of Microfinance Regulatory Framework Issues in Benin, Ghana, and Tanzania.” World Bank Policy Research Working Paper WPS3585, World Bank, Washington, DC.
Honohan, Patrick. 2004. “Financial Sector Policy and the Poor: Selected Findings and Issues.” World Bank Working Paper No.43, World Bank, Washington, DC.
Robinson, Marguerite S. 2001. The Microfinance Revolution: Sustainable Finance for the Poor. World Bank: Washington, DC, and Open Society Institute: New York.
Staschen, Stefan. 2003. Regulatory Requirements for Microfinance—A Comparison of Regulatory Frameworks in Eleven Countries Worldwide. Deutsche Gesellschaft fur Technische Zusammenarbeit.
An effective AML-CFT system also requires that certain structural elements and a general policy framework, not covered by the AML-CFT assessment criteria, be in place. The lack of those elements, or significant weaknesses or shortcomings in the general framework, may significantly impair the implementation of an effective AML-CFT framework. The structural elements include in particular
• Sound and sustainable financial sector policies and a well-developed public sector infrastructure
• The respect for principles such as transparency and good governance
 A proper culture of AML-CFT compliance that is shared and reinforced by government, financial institutions, designated nonfinancial businesses and professions, industry trade groups, and self-regulatory organizations (SROs)
• Appropriate measures to combat corruption
• A reasonably efficient court system that ensures that judicial decisions are properly enforced
The 40 recommendations and eight special recommendations on terrorist financing have been endorsed by the Executive Boards of the IMF and the World Bank as the AML-CFT standard for which Reports on Observance of Standards and Codes (ROSCs) are prepared (see IMF and World Bank 2002). Coverage of the AML-CFT standard in Fund-Bank work has progressively widened and now encompasses the full scope of the FATF recommendations. Key dates in this evolution are outlined in the following list:
• In April 2001, the Executive Board directed that AML elements in the relevant supervisory standards for the prudentially regulated financial sector be given particular emphasis. Law enforcement aspects and the broader legal institutional framework for AML policies were excluded.
• In November 2001, the Fund developed an action plan that extended IMF work not only to include terrorist financing elements but also to include, for any jurisdiction, the overall legal and institutional arrangements for AML-CFT. The plan also extended beyond such arrangements to support financial supervision per se, but it excluded involvement in law enforcement issues.
 In July 2002, the Bank, the Fund, and the FATF agreed to an AML-CFT assessment methodology for evaluating compliance with AML-CFT standards, and this agreement was endorsed by the Fund’s and the Bank’s Executive Boards. The methodology delineated those legal, institutional, and supervisory elements of the AML-CFT standard for which the Fund and the Bank would take accountability, as well as those law enforcement and nonfinancial sector elements that should be left to others. A pilot program of assessments that had been based on 2002 methodology was initiated.
• In March 2004, the Fund’s and the Bank’s Executive Boards reviewed the pilot program and determined that Bank-Fund staff members could take accountability for the full scope of the AML-CFT standard, including effective implementation of criminal justice elements and application of the regime beyond the regulated financial sector.4
 The FATF is an intergovernmental body whose purpose is the development and promotion of policies to combat money laundering and terrorist financing. It was established by the G-7 Summit in 1989. See http://www1.oecd. org/fatf/.
2. These are regional anti-money-laundering, task-force-like organizations that have been created in the Caribbean, Asia, Europe, and Southern Africa. Similar regional groupings are planned for Western Africa and Latin America.
3. Definitions of money laundering have been adopted in common vocabulary (see Oxford English Dictionary, 1989, 702). FATF defines money laundering as the processing of criminal proceeds to disguise their illegal origin, and the International Organization of Securities Commissions (IOSCO) defines it as a wide range of activities and processes intended to obscure the source of illegally obtained money and to create the appearance that it has originated from a legitimate source.
4. See IMF and World Bank (2004).
5. See FATF (2004a). In time, the FATF-style regional bodies (FSRBs) are expected also to endorse the revised methodology.
6. The 2002 AML-CFT methodology was organized topically with the legal and institutional framework and effectiveness for criminal justice measures in one part, core preventive measures for all financial institutions in a second part, and sector-specific preventive measures for banking, insurance, and securities in a third part. The organization of the 2002 AML-CFT methodology reflected the evolving nature of its development, beginning with the focus on supervisory measures for prudentially regulated financial institutions, the addition of the legal and institutional framework and CFT, and, finally, the implementation of the criminal justice measures.
7. The designated nonfinancial business and professions are casinos; real estate agents; dealers in precious metals and stones; lawyers, notaries, and other independent legal professions; accountants; and trust and company service providers.
8. Assessments were conducted on the basis of a 2002 assessment methodology. This section is based on the Fund-Bank report titled Twelve-Month Pilot Program of AntiMoney-Laundering and Combating the Financing of Terrorism (AML-CFT) Assessments (IMF and World Bank 2004).
 For a discussion of key elements of central bank autonomy and accountability, see Lybek (1998). Accountability arrangements are also discussed in the Code of Good Practices in Transparency of Monetary and Financial Policy (IMF 1999).
2. The definitions of when a settlement of payment instruction is final in a payment system—settlement finality rules—may come in conflict with the “zero hour rules” in an insolvency regime. In the context of a payment system, zero hour rules make all transactions by a bankrupt participant void from the start (zero hour) of the day of bankruptcy (or similar event). In a real-time system dealing with gross settlements, the effect could be to reverse payments that have apparently already been settled and were thought to be final. In a system with deferred net settlement, such a rule could cause the netting of all transactions to be unwound, with possible systemic consequences. For a discussion of the legal basis of payment systems, see Bank for International Settlement (2001).
 See Litan, Pomerleano, and Sundararajan (2002) for a discussion of financial sector governance and the broader governance nexus.
2. See IMF (1999) for further details.
3. See IMF (2000b), the supporting document of the MFP Code.
4. See IMF (2003b).
5. See Mishkin (2001).
6. This possibility highlights the importance of risk disclosures, an issue addressed in the New Basel Capital Accord. See also section 10.5.
Sovereign debt management is the process of establishing and executing a strategy for managing the government’s debt in order to raise the required amount of funding; achieve its risk and cost objectives, such as ensuring that the government’s financing needs and its payment obligations are met at the lowest possible cost over the medium to long run, which is consistent with a prudent degree of risk; and meet any other sovereign debt management goals that the government may have set, such as developing and maintaining an efficient market for government securities.
A government’s debt portfolio is usually the largest financial portfolio in the country. It often contains complex and risky financial structures, and it can generate substantial risk to the government’s balance sheet and to the country’s financial stability. Sound debt structures help reduce government exposure to interest rate, currency, and other risks.
Risky debt structures are often the consequence of inappropriate economic policies— fiscal, monetary, and exchange rate—but the feedback effects undoubtedly go in both directions. Poor structures in relation to the maturity profile and the interest rate and currency composition of the debt portfolio have often contributed to the severity of an economic and financial crisis. However, if macroeconomic policy settings are poor, sound debt management may not by itself prevent any crisis. The Fund’s balance sheet approach (Allen et al. 2002) has also highlighted the risks involved in inappropriate debt structures that are tilted toward foreign currency and short-term debt and are not matched by assets with similar structure, while underplaying the role of inflation indexed debt (see also IMF
 For example, checks, because of the way they have to be presented and processed, are relatively costly and time-consuming to settle when compared with credit transfer instruments such as payment orders. The credit and liquidity exposures in a check system are substantially more difficult to manage. Although some arrangements can be devised to manage the interbank risks, systemic risk almost inevitably remains in check systems if they are used to channel large-value payments. Therefore, countries with such systems usually establish a dedicated RTGS system to take large-value and time-critical payments out of the check-clearing system. However, an RTGS system might not always be cost-effective in a smaller country.
4. See CPSS (2001, paragraph 3.0.2) for a discussion of what constitutes a SIPS. The definition in the text is based on IMF and World Bank (2001), which provides guidance on how to conduct assessments.
5. When a self-assessment is not available or contains significant information gaps, a questionnaire is sent to the central bank of the country in that bank’s capacity as the payment system overseer.
6. The definitions are from Barth, Remolona, and Woodbridge (2002).
7. The microstructure literature has mostly focused on securities markets. However, there has been recent research on the role of microstructure on exchange rate determination and central bank intervention (see Lyons 2001).
8. See Barth, Remolona, and Woodbridge (2002) for a further discussion of the issues.
9. The section is based on IMF and World Bank (2003a).
10. For more detailed discussions and guidance, see IMF and World Bank (2003a, b).
 For a comprehensive discussion of policy framework to assess reserve adequacy and to manage foreign currency liquidity, see IMF (2004). Also, required reserves on foreign currency deposits in foreign, rather than domestic, currency can help discourage such mismatches in the foreign book.
12. See IMF (2001a). For an elaboration of the guidelines that are based on country practices, see IMF (2003).
13. For more detailed discussions, see IMF (2001b).
14. Definitions of liquidity are discussed in Sarr and Lybek, (2002). For a recent discussion of modeling liquidity, see von Wyss (2004). Many econometric models are available, and none are absolutely conclusive.
Allen, Mark, Christoph Rosenberg, Christian Keller, Brad Setser, and Nouriel Roubini. 2002. “A Balance Sheet Approach to Financial Crisis.” IMF Working Paper 02/210, International Monetary Fund, Washington, DC. Available at http://www. imf. org/ external/pubs/ft/wp/2002/wp02210.pdf.
Balino, Tomas. J, and Lorena M. Zamalloa. 1997. Instruments of Monetary Management: Issues and Country Experiences. International Monetary Fund, Washington, DC.
Barth, Marvin J, Eli M. Remolona, and Phillip D. Wooldridge. 2002. “Changes in Market Functioning and Central Bank Policy: An Overview of the Issues.” BIS Papers No. 120, Bank for International Settlements, Basel, Switzerland.
Borio, Claudio. 1997. Monetary Policy Operating Procedures in Industrial Countries. Basel, Switzerland: Bank for International Settlements.
Committee on Payment and Settlement Systems (CPSS). 2001. “Core Principles for Systemically Important Payment System.” CPSS Publications No. 43, Bank for International Settlements, Basel, Switzerland.
Committee on Payment and Settlement Systems (CPSS) and Technical Committee of the IOSCO (International Organization of Securities Commissions). 2001. “Recommendations for Securities Settlement Systems.” Consultative Report, CPSS Publications No. 42, Bank for International Settlements, Basel, Switzerland. Available at http://www. bis. org/publ/cpss42.pdf.
—- . 2002. “Assessment Methodology for ‘Recommendations for Securities Settlement
Systems’.” CPSS Publications No. 51, Bank for International Settlements and International Organization of Securities Commissions, Basel, Switzerland. Available at http://www. bis. org/publ/cpss51.pdf.
The Financial Sector Assessment Program (FSAP) was launched in May 1999 jointly by the managements of the World Bank and International Monetary Fund (IMF) on a pilot basis. It was a response to calls by the international community for more intense international cooperation (a) to reduce the likelihood, severity, or both of financial sector crises and cross-border contagion and (b) to foster growth by promoting financial system soundness and financial sector diversity. The program aims at contributing to those objectives through the preparation and delivery to national authorities of comprehensive assessments of their financial systems. Those assessments are intended to
• Identify strengths, vulnerabilities, and risks
• Ascertain the sector’s development and technical assistance (TA) needs
• Assess observance and implementation of relevant international standards, codes, and good practices
• Determine whether this observance addresses the key sources of risks and vulnerabilities
• Provide a robust infrastructure for financial development
The operational procedures for carrying out financial sector assessments and updates under the joint Bank-Fund FSAP have been developed by the Bank-Fund Financial Sector Liaison Committee (FSLC). Those procedures have been designed to reflect the following considerations:
• To feed into the IMF’s Article IV consultation process through close linkages with IMF’s surveillance activities
• To serve as input into Bank’s social and structural reviews, country assistance strategies, and other operations of the World Bank
• To serve as a program of peer review of observance of relevant international standards in the financial sector
• To ensure uniform and consistent treatment of countries and economies through adequate quality control and review
• To minimize duplication and overlap when moving from the joint team output of FSAP missions to the separate reporting and accountability requirements of each institution
• To balance the voluntary nature of participation in the FSAP with the need to give priority to some countries and to encourage the countries to participate on the basis of both stability and development considerations
 To ensure adequate consultations within the Fund and the Bank and with the authorities both in country selection and on the scope and focus of work
• To ensure confidentiality of data on individual financial institutions and other market sensitive information provided to the team by the authorities, while facilitating adequate transparency of policy analysis and assessments to the Bank and Fund Boards, as well as to the markets on a voluntary basis
• To facilitate documentation, contacts with authorities, internal review processes, appropriate mission staffing, and adequate Bank-Fund coordination in those areas
One of the key messages of the 2003 FSAP review by Bank and Fund Boards was to exercise greater selectivity in the numbers of standards and topics assessed in detail so as to reduce the average resource costs while tailoring the assessments to country-specific circumstances. The detailed principle-by-principle assessments of international standards and codes is resource intensive for both staff members and authorities. The number and types of standards assessed requires careful consideration of country circumstances, while taking into account their relevance for stability and development concerns and seeking to minimize the risk of missing key vulnerabilities. It was acknowledged that FSAP should remain comprehensive in the coverage of topics spanning both stability and development aspects, but the exercise of selectivity was related to the number of detailed assessments of standards or to the scope of detailed analysis of specific development and stability topics. One idea was to spread out the assessments over time so that some of the standards or topics not initially assessed in the first FSAP engagement could be taken up as part of future FSAP updates. Those assessments could be scheduled as part of a medium-term surveillance program or other work program with the country. Some of the considerations in exercising selectivity of topics and standards in FSAP, drawing on FSAP experience, are outlined as follows:
 When the relevant sector, market, or infrastructure is nascent, or when a high degree of noncompliance is expected, a detailed assessment of the corresponding standard may not be needed. Similarly, when the legal and institutional framework is in its very early stages of being built or implemented, the corresponding standard can be assessed at a later stage—after some experience is gained in implementation.
• In more complex financial systems, a set of interrelated standards may need to be assessed together owing to synergies in the assessment process and interlinkages among the sectors. In such circumstances, the scope for distributing the work on some topics and standards over time, including in the context of either planned future FSAP updates or other Bank-Fund operations, should be considered.
The initiative dealing with International Standards and Codes is one of a series of reforms initiated by the international financial community, including, among other things, the introduction of FSAP, to promote a more stable financial system in the aftermath of the crises of the late 1990s. The initiative aims to promote sound regulation; greater transparency; more efficient and robust markets, institutions, and infrastructure; better informed investment and lending decisions; improved market integrity; accountability and policy credibility; and reduced vulnerability to crises. It seeks to achieve this goal by
• Encouraging the development of internationally recognized standards in the areas enclosed by the Executive Boards of the Fund and Bank as useful to their work
• Encouraging members’ adoption and implementation of standards, including through TA
 Assessing members’ observance of those standards and, with their consent, producing and publishing ROSCs
The Boards of the Fund and Bank have endorsed a list of 12 areas of international standards and codes as useful to their operational work and for which assessments, using ROSCs as the principal tool, will be undertaken as appropriate. The 12 standards are listed in box A.2, and they are grouped into three categories: (a) transparency standards,
 This Appendix draws heavily on chapter 2 of Carmichael, Fleming, and Llewellyn (2004).
2. An important question is how to fit competition issues into the overall institutional structure of regulation and supervision and, in particular, the extent to which competition issues should be the responsibility of a supervisory agency or whether they should fall within the domain of an agency for competition policy for the economy as a whole. This issue has been the subject of much debate, and even controversy, and countries have solved this issue in a range of different ways.
3. For a recent discussion of the effect of regulatory governance on financial soundness, see Das, Quintyn, and Chenard (2004).
4. It may be noted that separation of macroprudential surveillance from microprudential supervision also occurs in some systems, such as Canada’s, that are not explicitly based on a cross-sectoral approach.
5. In dollarized economies, such conflicts of interest are diminished because of the limited room for both lender of last resort and monetary policy operations. This reduced scope for conflicts might favor the case for having the central bank assume supervisory responsibilities.
Despite the fact that systemic banking crises and their resolution are qualitatively different from individual cases of bank insolvency, there are at least two benefits to having in place an adequate legal and institutional framework to address bank insolvency in normal times for managing systemic banking crisis situations:
• First, a good legal and institutional framework could play a mitigating role. A legal framework that comprises many of the critical principles discussed in this report could allow the authorities to ensure that weak-bank problems or insolvency cases are addressed before they can cause systemic problems.
 Second, if the legal and regulatory framework is adequate enough to handle single bank failures, the same framework also could provide a basis for the implementation of most operational aspects of a restructuring strategy, thereby smoothening and expediting the systemic bank restructuring phase.
Nonetheless, modifications to both the legal and institutional framework may still be needed (and in most cases are) to deal with systemic crises. Modifications to the legal framework would help address (a) special institutional arrangements for systemic
 The CCG consisted of 20 country representatives and representatives from all the international financial institutions involved, as well as a few independent experts. Its main task was to review and provide comments on the different versions of the main report to ensure that a basic level of international consensus is reflected in the report. The World Bank Board considered the report at a technical briefing in January 8, 2004.
2. See IMF (2002b).
3. A recent IMF study (IMF 2004a) concluded that insufficient legal basis, ineffective enforcement, forbearance, limited range of measures available, and excessive court intervention have been factors that impede appropriate compliance with BCP 22 by a significant number of countries. This study highlighted the importance of developing a strong bank insolvency framework. The GBII would help in fostering such a framework.
4. An effective bank insolvency framework should enable the resolution of a troubled bank in a way that (a) does not unduly increase moral hazard and, thus, maintains market discipline; (b) does not unduly raise the risk of contagion; and (c) avoids the unnecessary destruction of the value of the bank’s assets.
5. In jurisdictions where the general insolvency legislation is also applied to banks, the law in most cases requires a special role for the banking regulatory authorities in relation to the commencement of the proceedings. In some countries, the special role of the banking regulatory authorities includes the appointment of a trustee or liquidator or other key aspects of the proceedings.
6. Because one of the main arguments for the appropriateness of having a special regime for banks is frequently predicated on the need to give special protection to deposits from the general public, in many jurisdictions, the special insolvency regime is not applied to non-deposit-taking financial entities.
7. For example, the United Kingdom has no special statutory regime to address insolvency of financial institutions. They are subject to the same formal insolvency procedures as unregulated companies, but the law allows for exceptions to grant the Financial Services Authority various rights in insolvency proceedings and does not allow banks certain rescue or rehabilitation procedures that are available to small unregulated companies. Together with other powers of Financial Services Authority and Financial
• Structure and Performance of the Pension Sector: number and types of providers; portfolio compositions; investment regimes; asset growth; gross and net rates of return; fees, costs, and profits; payouts and replacement ratios; coverage of the labor force; and contribution to capital markets development
• Regulatory Framework:3 pension laws, licensing criteria, governance structures, accounting and auditing rules and practices, custodian rules and arrangements, disclosure, investment regulations, outsourcing regulations, and the voluntary pension system
 Supervisory Framework: approach to supervision (proactive vs. reactive), legal status and internal structure of the supervisory agency, regulatory and enforcement powers of supervisor, ability to carry out early interventions, and relationship with other supervisors
Within the assessment of the structure and performance of the pension sector, the focus on the effect on capital markets development is of great importance. Pension systems also have significant effects on poverty alleviation, labor markets, fiscal soundness, fairness and adequacy, and intergenerational and intra-generational redistributive effects, but those issues are typically beyond the scope of the financial sector assessment.