BANK OF ALBANIA Liquidity Risk Standards and Measurements

BANK OF ALBANIA Liquidity Risk Standards and Measurements during and after the crises Indrit BANKA Ohrid June 15 – 17, 2010

Albanian Banking System q Banks operating in the market: – 14 banks – 2 branches of foreign banks q Major banking operations: – Deposits, Loans, Placements, Treasury Bills Investment, Government Bonds and Other foreign securities q Macro indicators: Year 2008 – Total assets in % of GDP – Credit in % of GDP 76. 68% 36. 47% Year 2009 77. 52% 39. 35% Capital: – Foreign capital – strongly prevailing (92. 3% in Dec. 2009) – State capital – recently totally sold

Liquidity - end of year 2008 q Liquidity situation in Albanian banking sector has been satisfactory till September 2008. Liquid assets to total assets stood at around 46 %. q With regard to the exposure to nonresidents, the asset side consisted in small exposures through investments in securities and placements with foreign banks. Generally, these positions have been taken against governments or well rated banking and financial institutions. q Major reliance from retail funding. However, it has been proven that in the course of time, funding from abroad has been undisputable and has been provided as needed according to liquidity requirements and/or business development and regulatory /supervisory requirements.

International Crisis impacts First impact q Shock of the public confidence in the banking sector. q Deposits withdrawals: Ø From October’ 08, almost all banks have been experiencing deposit withdrawals from customers, especially from households. This trend continued even in the first half of 2009, but at a floating pace. q Liquidity drainage. q Decrease of lending growth rate. q Deterioration of the quality of the loan portfolio.

International Crisis impacts Impact in the real economy Despite the positive economic growth, the analysis of main macro indicators shows that the growth rate was characterized by a progressive slowdown during 2009 determined by: - the reduction of foreign demand; - the slowdown of domestic demand; - constrained liquidity; - limitation of funding; - increased uncertainty.

Measures taken to cope with the changing environment Since mid 2008, the Bank of Albania has intensified its work on various directions to monitor more closely all the developments with implications in the financial sector. Bo. A: q maintained continues contacts with banks, raising their awareness on the challenges/risks, establishing a communication platform to serve the purpose of prompt adequate actions and guiding them in several aspects; q increased contacts with other domestic and international institutions that regulate and monitor the financial markets; q changed and improved the reporting framework of banks, in terms of timeliness and quality of data, in particular regarding their exposure to international markets and deposits movements; q worked very intensively with the Media, to explain the crisis, to clarify the position of our banking sector also toward the potential crisis effects etc; helped maintaining public confidence in the banking sector using its reputation which proved its very important weight; q improved “stress-tests” analysis, in terms of introducing more different assumptions and technicalities that allow for a combination of adverse and relevant scenarios; q in a second phase, a new set of additional information was requested to be reported with the aim to improve the quality of analysis performed not only related to liquidity but also to credit activity and risks.

Measures taken on the improvement of Regulatory Framework The main changes in Regulatory Framework during this period consisted in: q The amendment of the regulation “On risk management arising from the large exposures of banks”. Through these amendments Bo. A reduced the maximum exposure with the mother banks or within the group. q Also, Supervisory Council of Bo. A took the decision to temporally not allow the distribution of dividends. This decision has been taken in order to create a better cushion for banks and especially to bust the public confidence in the strength of the banking sector and the instituions. q In cooperation with the Ministry of Finance, Bo. A prepared proposed the changes in the deposit insurance legislation. The approval of these changes from the parliament, has provided our depositors with a significant and permanent increase in the maximum amount of their deposits that is fully insured as well improvements in the procedures related to the payout.

Measures taken on the improvement of Regulatory Framework New regulation “On Liquidity Risk Management” q A new definition of liquid assets composition was introduced, which basically “narrows” the liquid assets base of banking system. Based on this regulation, the total of the liquid assets as per end of December’ 09 decreased by 33 per cent. q This regulation, also introduced for the first time a regulatory liquidity ratio, that of liquid assets over short term liabilities, which on weekly basis should not be less that 20%. As per December of 2009, this ratio for the banking sector was at around 33%.

Changes in the instruments during the crises Policy changes that were introduced to enlarge the liquidity access were: q Expanding the security base that can be used in repurchase transactions. T-Bond with remaining maturity of not more than 365 days were included in the security base accepted for repurchase transaction with the central bank, instead of only Tbills that were accepted before. q Increasing the daily use of required reserves (under averaging provision) from 20 percent of the required reserve to 40 percent. q Reduction of the interest on the overnight loan, to 75 basis points above the base rate, from 175 basis point above the base rate that was before. q Change the type of the monetary operations offered, from auctions of fixed amount with open interest rate to unlimited amount with fixed price (i. r. )

Retrospective analyses q There has been a restoration of the public confidence on the viability of the banking system as reflected through the continuous inflow of deposits, particularly observed during the second half of 2009 and on. q The liquidity of the banking system (measured by loans to deposits ratio) has been in satisfactory levels, much lower than in other countries. Also the level of the liquid assets to total assets is improved and is relatively high. q The share of loan portfolio to total assets has increased, even though at a much lower pace, thus the exposure of system to credit risk has increased accordingly. q Profitability, although still records positive values, has been adversely impacted due to negative performance of loan portfolio and increased expenses for provisions and loan losses.

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