Directors noted that the financial sector weathered a period of heightened turbulence and deposit outflows relatively well, and commended the Central Bank of San Marino (CBSM) for its liquidity management. Looking ahead, they encouraged the monetary authorities to address remaining vulnerabilities, including shoring up the financial position of the largest bank, which remains a priority.

Directors recognized progress in response to the 2009 recommendations under the Financial Sector Assessment Program, but called for additional reforms to strengthen the financial system and improve its transparency. Measures taken to enhance the operational autonomy of the CBSM, buttress supervisory functions, and strengthen Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) defenses have been steps in the right direction. However, effective implementation is still lagging in a number of instances. For example, Directors urged the authorities to appoint as soon as possible a Head of Supervision, a position that has remained vacant for over one year.

Directors agreed on the importance of a new business model for San Marino’s financial sector, as the relaxation of bank secrecy and regulations better aligned with international standards undermine the viability of previous business practices. Accordingly, they welcomed strategic reviews underway and looked forward to their recommendations.

Directors welcomed the authorities’ goal to reduce the fiscal deficit, but counseled that the credibility of fiscal plans would be enhanced by a better-articulated consolidation strategy. Cuts in public sector employment through attrition and comprehensive tax reforms could be key elements of such a strategy. Directors also recommended a rapid enactment of the new pension laws to build on progress already made and to safeguard the sustainability of the pension system.

Directors noted the loss in competitiveness of the economy in recent years. In this regard, they considered that easing rigidities in labor markets, in particular impediments to the hiring of skilled non-resident workers, would be desirable.

Directors reiterated their concern about the inadequacy of national account and general government statistics, which hampers policy design and evaluation, and took note of the authorities’ request for technical assistance in this area.

Background

Following two years of economic contraction, led primarily by a sharp decline in fixed investment, the Sammarinese economy remains weak. There were signs of a moderate expansion in manufacturing and commercial activity during the first half of last year, but rising unemployment, stagnant wage growth, and lower confidence have all contributed to a fall in consumption. As a result, real GDP is estimated to have declined by about 1 percent in 2010. This year, the economy could build some momentum, but growth is projected to remain below 1 percent. The fiscal position weakened significantly in 2009-10, mainly due to a sizable decline in revenues, with the deficit rising from 3.4 percent of GDP in 2009 to an estimated 6.1 percent of GDP in 2010.

The financial sector is adjusting to the effects of Italy’s 2009-10 tax amnesty, which led to a significant outflow in bank deposits and, consequently, to a considerable decline in the size of banks’ balance-sheets. The system has shown resilience to the deposit outflow, but liquidity, profitability, and asset quality have deteriorated amid the economic slowdown. Progress has been made on meeting the 2009 Financial Sector Assessment Program (FSAP) recommendations, including strengthening financial regulation, eliminating certain bank-secrecy provisions, and tightening anti money-laundering defenses. Key challenges include the need to shore up the financial position of the largest bank and develop a sustainable new business model for the financial sector.