## cr17107

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### Preface (mission context and scope)
- Mission by the Monetary and Capital Markets Department (MCM) of the IMF visited Tbilisi from October 27–30, 2016 at the request of Mr. Archil Mestvirishvili, Deputy Governor of the National Bank of Georgia (NBG).
- Purpose: gain an understanding of current NBG liquidity management arrangements, interbank market activity, management of liquidity risks within the Georgian banking system, and establish a roadmap for future technical assistance (TA).
- IMF mission team comprised Diarmuid Murphy (Mission Chief) and engaged with NBG staff and management, and four commercial banks (two large banks and two medium-sized banks active in the interbank lending and foreign exchange (FX) markets).
- Main areas of work and sequencing to be discussed further in Washington D.C. during the 2016 Annual Meetings; further engagement between MCM and the NBG agreed for early 2017.
- Accompanying appendices prepared by the IMF team have been removed.

### Executive Summary — Key findings
- NBG is strengthening monetary policy implementation to make actions in normal times credible and predictable; arranging to provide market comfort that it stands ready to respond to systemic events while avoiding undermining the system’s ability to self-ensure.
- NBG strategic framework seeks a balance between:
  - benefits of greater exchange rate flexibility for the inflation targeting (IT) regime, and
  - taking into account relevant macrofinancial features of the Georgian economy.
- Market participants report a high level of credibility enjoyed by the NBG, contributing to anchored inflation expectations.
- Key vulnerability: high level of dollarization in the system — "credit and deposit dollarization levels within the Georgian economy stand at just over 60 percent".
- Authorities pursuing de-dollarization policy via a joint NBG-Government working group.

### Executive Summary — Three broad TA headings agreed
- Financial deepening
  - National financial development plan needed involving NBG, Ministry of Finance (MoF), and other regulatory bodies.
- Liquidity risk monitoring and management
  - NBG implementing a new Liquidity Coverage Ratio (LCR).
  - Current calibration gives more positive treatment to FX deposits than local currency (Georgian lari); recommend revisiting run-off ratios and LCR structure to ensure accurate measurement of liquidity risks, encouragement of term funding, and consistency with de-dollarization policy.
  - Emphasize importance of liquidity forecasting and formalizing Georgian treasury cash-flow projections and timely sharing with the central bank.
  - Suggest formalizing treasury forecasts (potentially via an MoU) and further engagement with MCM before introducing FX swaps and interest rate swaps as standard NBG tools.
  - Recommend creation of a publicly available operational guideline and an internal operational manual covering roles, responsibilities, and contingency arrangements.
- Lender-of-last-resort (LOLR)
  - NBG can provide LOLR liquidity but framework could be made more robust.
  - Recommended elements: eliminate unsecured lending, explicit solvency and viability requirements, internal guidelines on governance, collateral and counterparty policy, risk controls, pricing, and operational processes.

### Summary of recommended actions (timing notation: Short-term means less than one year; medium-term means less than three years)
- Monetary Operations & Collateral (Short-term)
  - Undertake regular forecast of expected liquidity changes and map against NBG collateral expectations.
  - If collateral shortfall identified, identify ex-ante what collateral could be accepted; in systemic need, temporarily accept FX collateral (with haircut "add-ons") or expand criteria for high quality credit claims.
  - Document triggers for different types of systemic responses.
  - Resolve issues around use of collateral that matures within an operation.
  - Committed liquidity facility proposal appears not well grounded; systemic needs should be catered via measures discussed in the note.
  - Move credit claims existence and verification process to NBG operational area.
  - Apply market valuations to treasury bills and bonds accepted as NBG collateral; same methodology for other securities.
  - Consider limits or pricing "add-ons" for credit claims used in monetary policy operations.
  - Move to an internationally recognized Global Master Repurchase Agreement (GMRA) planned next year.
  - Remove any ownership restrictions in NBG certificates of deposit (CDs).
  - Formalize Georgian treasury forecasts; consider establishing a Memorandum of Understanding (MoU).
  - Consider publishing, on a daily basis, net autonomous factors and later NBG forecasts to help market determine system liquidity position.
- Liquidity Coverage Ratio (Short-term)
  - Assess appropriateness of currently proposed FX run-off ratios in the proposed LCR framework given the limited ability of the NBG to meet FX liquidity needs of individual banks or the system.
- Market Deepening (Medium-term)
  - Develop an active primary government bond market; risk-free curve not well defined beyond the very short-end, increasing financial stability risks.
  - Use NBG collateral framework to promote standards (quality, transparency, standardization, simplicity) to help develop term funding markets and groundwork for securitization issuance.
  - Continue regular engagement with market participants and develop a monetary operations manual explaining NBG normal and emergency frameworks.
- Lender-of-Last-Resort (Short-term / Medium-term)
  - Remove the ability to provide unsecured lending under NBG law (Medium-term).
  - Consider publishing a public guideline explaining key elements of NBG LOLR framework (Short-term).
  - Provide for the ability—either through NBG law or public guideline—for NBG to request a government guarantee when necessary to support provision of LOLR (Short-term).
  - Clearly define framework internally, including roles and responsibilities; cover internal governance, liquidity monitoring, collateral and counterparty policy, risk control measures and pricing, and high-level operational processes (Short-term).

### I. More Detailed Assessment — A. Monetary Policy Framework (current status)
- Main NBG objective: maintain price stability; operational target is short-term interbank interest rates (up to seven days).
- Main instrument: one-week refinancing auctions; also uses three and six-month certificates of deposit auctions.
- NBG has a reserve averaging minimum reserve framework and a standing credit and deposit facility.
- In 2015, reserve money position shifted from liquidity surplus to deficit, largely reflecting NBG FX interventions and increased demand for banknotes; NBG FX interventions limited to containing excessive volatility that threatens market functioning, and conducts transactions as opportunities allow to build international reserves.
- Going forward, NBG expects liquidity deficit will most likely increase (mainly driven by cash in circulation).
- In 2010, NBG extended full allotment to seven-day liquidity facilities at fixed spreads above policy rates. In 2015, NBG temporarily introduced internal limits on seven-day auctions to control liquidity volumes; these actions resulted in elevated interbank rates and NBG does not envisage using liquidity limits or guaranteed facilities again.
- NBG has recently incorporated certain loans to small and medium-sized enterprises and residential loans into its collateral framework; operational checks for these loans are conducted in the supervisory area of the NBG. NBG also recently introduced corporate bonds into eligible collateral pool.
- Georgian Treasury deposit is placed with the NBG and is not remunerated. No formal arrangement currently in place with the Georgian Treasury for provision of Treasury liquidity forecasts.
- Minimum reserve framework: reserve ratios are in lari (7 percent requirement) and FX (20 percent requirement). FX requirements are met in FX, with EUR requirements remunerated at the ECB deposit rate (currently negative), and USD currently at zero percent (but linked to FED policy rate (-50 bps)).
- NBG has a formal schedule regarding re-profiling of legacy non-marketable government bonds on its balance sheet to be replaced with tradable government bonds with market interest rates.

### I. More Detailed Assessment — A. Monetary Policy Framework (assessment and recommendations)
- Market perception concerns stem from past depreciation episodes; NBG concerned market may doubt readiness to meet systemic liquidity needs due to past actions/inactions before full adoption of inflation targeting.
- Discussions with market participants indicate market is satisfied with NBG operational framework and its emphasis on price stability over FX, and take comfort from predictability of NBG liquidity provision and sterilization operations.
- If additional comfort is needed, NBG could meet structural liquidity needs via a slightly longer-term standard operation priced at market rates. Structural liquidity is best provided using longer term auctions; NBG could include ability to meet structural liquidity needs (e.g., resulting from previous FX interventions) to minimize rollovers in NBG liquidity-providing operations.
- In such operations, NBG would set and announce a volume (maybe a certain percentage of system liquidity needs) and be a market rate taker in that part of the curve. A suggested useful tenor to start with could be one month.

### Collateral framework — current assessment and suggested work
- At present there does not appear to be a compelling case to expand the collateral accepted under the NBG’s standard monetary policy framework.
- On first inspection, it appears that there is sufficient collateral within the system, because as at September 27, 2016, the total monetary policy borrowings stood at GEL 950 million, while unencumbered monetary policy eligible collateral buffers stood at roughly GEL 2,595 million.
- Recommendation: The NBG should undertake a forecast of expected liquidity changes in the system going forward and compare the results against the expected collateral availability in the system.
  - Such an assessment should be performed on a regular basis, with the goal for the NBG to try and anticipate any expected collateral shortfalls which could require NBG policy actions.
- If the analysis shows a compelling need to expand the collateral framework, the NBG should examine:
  - other types of assets it is prepared to accept, such as additional higher quality credit claims;
  - the possible loosening of current concentration limits so that larger high quality credit claims could be accepted.
- The NBG currently imposes a credit claim limit of 1 million lari per debtor.
- The NBG should continue with the proposed move of the credit claims existence and verification process to the operational area of the NBG (common practice in central banks such as the ECB and the BoE).

### Pre-positioning, eligibility, and operational preparedness
- Counterparties could be asked to pre-position collateral with the NBG so that it can conduct checks and counterparties undertake any required due diligence; pre-positioning is an eligibility and validity check and does not transfer legal title.
- The NBG could hire legal counsel to inspect documentation in the case of credit claims, and also use other agencies for credit assessment.
- Counterparties could update information relating to pre-positioned portfolios on a monthly basis; confidentiality agreements could be helpful.
- Recommendation: The NBG should prepare in advance risk controls that could apply to additional assets—including valuation techniques and haircuts—to avoid rushed decisions at the time of need.
  - When formulating haircuts, the NBG should consider the use of a haircut ‘add-on’—over and above the base haircut applied to the security—to better protect the NBG against adverse FX movements and to discourage further dollarization through acceptance of FX assets.

### Collateral valuation and margining
- Market values should be estimated for Georgian Treasury bills and bonds and applied to collateral taken by the NBG.
  - In the absence of continuous market pricing, use information from the most recent primary auction, market contacts, and pricing from NBG sterilization operations to arrive at the best guess of market value.
  - Ideally, securities would be revalued daily to ensure collateral values cover loan amounts.
  - If there was a shortfall (beyond a pre-specified level), the NBG would be entitled to make a margin call (i.e., request more collateral).
  - The NBG should consider incorporating these commonly used features, bearing in mind the increased operational requirements.

### Inclusion of credit claims and operational eligibility design
- If collateral availability is insufficient, the NBG could consider accepting credit claims (bank loans).
  - The NBG should identify types of credit claims it is prepared to accept in line with its risk tolerance, and formulate eligibility criteria including risk controls.
  - For monetary policy purposes, acceptance of credit claims would normally involve establishment of eligibility criteria and risk controls for performing loans only.
  - For emergency idiosyncratic operations, credit claims with some level of impairment may need to be considered and suitably controlled from a risk perspective if accepted.

### Transparency and flexibility of the monetary policy framework
- Recommendation: Ensure the monetary policy framework is flexible to cater for possible future liquidity shocks, but without disclosing the exact structure of the response so that the system’s ability to self-insure is not undermined.
  - It may be useful for the NBG to publish a monetary operations document that explains its framework in normal times, and discloses certain elements of its framework in emergency times (both during systemic and idiosyncratic cases).

### Systemic response: design principles and the proposed longer-term operation
- Type of NBG response depends on type of market strain; acceptance of assets outside normal framework addresses different demands than lengthening maturities of operations.
- Important principle: If longer term liquidity providing operations are offered, they should be priced at, or even at a small margin to, market rates to be consistent with monetary policy objectives and to ease exit from non-standard arrangements.
- Mission discussion of the NBG’s proposed longer-term operation:
  - If additional term lari liquidity needed, NBG would launch at its initiative a longer-term operation with an envisaged maturity of roughly 6–12 months (modifiable according to market needs).
  - The operation would be priced at market rates and the NBG will accept a wider collateral base, if needed.
  - NBG should prepare how it could accept additional collateral (such as FX collateral) and what additional credit claims could be accepted.
  - If a counterparty cannot pledge collateral that matures within the term of the operation, this issue would need to be addressed first.
- Recommended preparatory actions:
  - Prepare risk controls, valuation techniques and haircuts in advance.
  - Assess definitions of High Quality Liquid Assets (HQLA) in the LCR framework relative to NBG collateral requirements and haircuts.

### Other potential instruments and coordination with fiscal authorities
- NBG discussed introducing FX swaps as part of its standard framework.
  - FX swaps could stabilize FX swap market tension and influence short-term rates; they could be a standing facility priced accordingly, with limits to lend support to the local currency.
  - Further MCM engagement could be useful before establishing FX swaps and other arrangements (such as interest rate swaps currently being considered by the NBG).
  - If FX swaps are used as a monetary policy fine tuning instrument, maturity should be consistent with current monetary policy instruments. If used as market development instruments, FX swaps should be two-way and regularly launched.
- Recommendation: Formally engage with the Georgian Treasury to collect and produce better projections on government expenditure and revenue to support liquidity forecasting.
  - An MoU could be established obligating the Georgian Treasury to provide, at a minimum, weekly information to the NBG in support of its monetary policy role.
  - Cash flow forecasts should, as a start, be weekly and looking two to three months ahead; be regularly updated and rolled forward.
  - Forecasts should be independent of the budget execution process and based on information from large spending ministries, departments and agencies, and from the Revenue Authority.
  - Forecasts should be cross-checked against actual flows and errors discussed with the Georgian Treasury.
- Recommendation: Remove restrictions around acceptance of collateral with a maturity date less than that of the operation, as this could constrain collateral holdings of the system.

### Markets — current status and constraints
- There are 21 banks operating in Georgia (local and foreign owned entities).
- Sector concentration: the two largest banks account for 58 percent of assets.
- Dollarization: credit and deposit dollarization levels standing at roughly 60 percent.
- Lari money market main activity takes place in the unsecured market, and to a lesser extent the FX swap and the developing secured market.
- According to the NBG, roughly five or six banks are active in the interbank market.
- NBG is working with market participants to move to an international Global Master Repurchase Agreement (GMRA) possibly next year.
- Government funds mainly through cheaper international borrowing (international financial institution (IFIs)).
  - Implication (i): requires active (and potentially costly) sterilization by the NBG;
  - Implication (ii): there are no benchmark lari government securities in the local market.
- Limited options for term funding in lari; even where term lari deposits exist they can be converted into FX.
- Market participants expressed concerns about the ability to price risk out the curve.

### Markets — assessment and recommendations
- Assessment:
  - Georgian funding markets appear short-term in focus, with legacy concerns about inflation/depreciation possibly driving this orientation.
  - Combined with government financing mainly through IFIs, there are limited money market instruments in Georgia which increases vulnerability of banks to liquidity shocks.
  - Basic elements for well-functioning money markets are in place, but hindering factors include lack of reliable and market relevant financial benchmarks and a narrow range and insufficient supply of money market instruments.
  - Ownership restrictions on sterilization instruments—only regulated banks—appear to exist; removing such clauses could help market deepening.
- Recommendations to deepen markets:
  - Policies focused on enhancing trading and price discovery out the curve are needed.
  - Add supply of government products beyond the two-year space to better support development of the “risk free” benchmark yield curve.
  - NBG’s plan to term down its six-month sterilization instruments to allow the Georgian Treasury to take this space on the curve is a positive move:
    - Supports transmission of monetary policy;
    - Allows better separation of strategic debt management from short-term liquidity management;
    - Reinforces the Georgian Treasury’s role in developing securities markets.
  - Introduce local currency-denominated securities with credible indexation systems, develop markets for instruments to hedge currency risks, and develop capital markets to help discourage dollarization.
  - Consider development of the securitization market as a longer-term goal; prerequisites include liquidity and accuracy of the yield curve in relevant maturities, availability of efficient hedging instruments, and ability to obtain inexpensive short-term financing through repurchase markets.
- Specific operational suggestion:
  - NBG sterilization should concentrate at the very end of the yield curve, via offerings of fixed volume variable rate tenders, creating space for the MoF to issue further out the curve.
  - NBG issuances should be issued without ownership restrictions; if issuance creates tensions with the MoF, consider working with the MoF to allow use of government securities in sterilization operations with funds raised left with the NBG in a blocked account and remunerated appropriately.

### National Bank of Georgia’s liquidity monitoring — current status
- NBG liquidity metric: an average of month’s liquid assets shall be no less than 30 percent of average of month’s liabilities.
- NBG is planning to implement a LCR that will be stricter than the current ratio.
  - The proposed LCR ratio will be applied to all banks.
  - Differences from Basel’s LCR include:
    - Less liquid assets (e.g., company stocks) that can’t be immediately converted into cash are excluded from high quality asset definitions, while the NBG LCR includes a liquidity requirement by currency;
    - NBG adopts higher outflow rates as levels of deposit concentration increase and based on client residence and account type.
- NBG also noted intention to introduce a ratio on net stable funding requirements in the medium-term.

### Committed Liquidity Facility (CLF) and Liquidity Coverage Ratio (LCR) design
- NBG has discussed internally whether a committed liquidity facility should be implemented to meet shortfalls of high-quality liquid assets in stressed situations when the proposed LCR is introduced.
- Introduction of a committed liquidity facility (CLF) does not appear to be the most appropriate tool in response to a systemic shock.
- CLF mechanics as described:
  - A CLF is a contractual arrangement between a bank and the central bank, through which banks—for a fee—have on-demand access to liquidity.
  - This Facility counts toward high quality liquid assets in LCR ratios.
  - Any access to the CLF should be seen as a last resort and only once all other reasonable steps have been taken to manage their liquidity risks without recourse to the NBG, while a commitment fee should try to equalize incentives between those who have access and those who do not.
- Rationale against CLF introduction in Georgian context:
  - There does not currently appear to be a shortage of HQLA within the Georgian system.
  - Such an arrangement, if introduced, could be more akin to emergency liquidity assistance (but with a commitment rather than being at the NBG’s discretion, and also without safeguards such as possible conditionality), making its objectives less clear.

### LCR run-off rates, FX vulnerability, and supervisory options
- Current run-off treatment noted:
  - FX deposits receive a lower run-off rate (e.g., 18.5 percent) compared with similar lari deposits (e.g., 21.5 percent).
- Concerns:
  - NBG has limited capability to meet FX liquidity needs of the system (as compared to the unlimited capacity to provide lari) should individual banks or the system experience FX outflows beyond existing buffers.
  - Within the LCR framework, FX deposits should be treated as ‘less stable,’ which attracts a higher run-off rate (see paragraph 79 of Basel III: The LCR and liquidity risk monitoring tools, January 2013).
  - Banks and supervisors cannot assume that currencies will remain transferable and convertible in a stress period, even for currencies that in normal times are freely transferable and highly convertible.
  - If the NBG is pursuing a de-dollarizing strategy, preferential treatment for FX is questionable.
- Recommendations:
  - Review the current run-off rates of the proposed LCR arrangement.
  - Reassess the appropriateness of FX run-off assumptions and potentially increase run-off rates for FX deposits.
  - Use prudential tools to reduce the risk that FX liquidity needs arise and outstrip FX resources available.
  - MCM assistance could be helpful in assessing that liquidity risks are being accurately measured and that term funding is being encouraged; MCM can work with the NBG to develop a template to help perform liquidity monitoring.

### Lender-of-Last-Resort (LOLR) — legal status, assessment and recommendations
- Legal basis:
  - NBG’s ability to provide LOLR is set out in Article 33 of the NBG law.
  - Article 33: NBG can extend loans no longer than three months, with an interest rate not be less than the NBG standing facility rate, and against collateral as decided by the NBG Board.
  - Article 33 also states: “in emergencies, where country’s financial system may be threatened, the decision of the Board of the National Bank may permit issuance of loan for longer term, with different interest rate and without security.”
- Assessment and recommendations:
  - The NBG should cease having the ability to provide unsecured lending; this should be supported through the revision of NBG law.
  - Until the NBG Act is amended, the exclusion of unsecured lending should be ratified by the NBG Board and reflected in the published Guidelines.
  - Collateral minimizes potential credit risk to the central bank balance sheet; collateral provides a natural limit to lending as an institution cannot borrow more than its available unencumbered assets accepted by the central bank.
  - In the absence of adequate collateral, the NBG should make explicit the ability to request a government guarantee so that LOLR could be extended.
  - Indemnities should be fully enforceable, irrevocable and unconditional guarantees that rank pari passu with other government obligations.
  - To preserve central bank independence, monetary policy risks are generally not indemnified and covered by central bank capital; risks associated with LOLR are typically covered by government guarantees.
  - NBG should consider publishing a public guideline explaining key elements of the NBG LOLR framework to condition market behavior; elements should include at a minimum requirements for solvency and viability, and supervisory intrusion and conditionality.
  - NBG should monitor lari and FX needs operationally and actively monitor recent liquidity developments across individual counterparties and carry out liquidity projections under different specified stress assumptions.
  - MCM can work with the NBG to develop a template to help perform this liquidity monitoring.

*IMF — Mission report: Preface, Executive Summary, Recommendations, and Section I.A extracted from cr17107 (IMF MCM mission to the National Bank of Georgia).*

### Preface ................................................................................................................

### Preface

### Preface (mission context and scope)
- Mission by the Monetary and Capital Markets Department (MCM) of the IMF visited Tbilisi from October 27–30, 2016 at the request of Mr. Archil Mestvirishvili, Deputy Governor of the National Bank of Georgia (NBG).
- Purpose: gain an understanding of current NBG liquidity management arrangements, interbank market activity, management of liquidity risks within the Georgian banking system, and establish a roadmap for future technical assistance (TA).
- IMF mission team comprised Diarmuid Murphy (Mission Chief) and engaged with NBG staff and management, and four commercial banks (two large banks and two medium-sized banks active in the interbank lending and foreign exchange (FX) markets).
- Main areas of work and sequencing to be discussed further in Washington D.C. during the 2016 Annual Meetings; further engagement between MCM and the NBG agreed for early 2017.
- Accompanying appendices prepared by the IMF team have been removed.

### Executive Summary — Key findings
- NBG is strengthening monetary policy implementation to make actions in normal times credible and predictable; arranging to provide market comfort that it stands ready to respond to systemic events while avoiding undermining the system’s ability to self-ensure.
- NBG strategic framework seeks a balance between:
  - benefits of greater exchange rate flexibility for the inflation targeting (IT) regime, and
  - taking into account relevant macrofinancial features of the Georgian economy.
- Market participants report a high level of credibility enjoyed by the NBG, contributing to anchored inflation expectations.
- Key vulnerability: high level of dollarization in the system — "credit and deposit dollarization levels within the Georgian economy stand at just over 60 percent".
- Authorities pursuing de-dollarization policy via a joint NBG-Government working group.

### Executive Summary — Three broad TA headings agreed
1. Financial deepening
   - National financial development plan needed involving NBG, Ministry of Finance (MoF), and other regulatory bodies.
2. Liquidity risk monitoring and management
   - NBG implementing a new Liquidity Coverage Ratio (LCR).
   - Current calibration gives more positive treatment to FX deposits than local currency (Georgian lari); recommend revisiting run-off ratios and LCR structure to ensure accurate measurement of liquidity risks, encouragement of term funding, and consistency with de-dollarization policy.
   - Emphasize importance of liquidity forecasting and formalizing Georgian treasury cash-flow projections and timely sharing with the central bank.
   - Suggest formalizing treasury forecasts (potentially via an MoU) and further engagement with MCM before introducing FX swaps and interest rate swaps as standard NBG tools.
   - Recommend creation of a publicly available operational guideline and an internal operational manual covering roles, responsibilities, and contingency arrangements.
3. Lender-of-last-resort (LOLR)
   - NBG can provide LOLR liquidity but framework could be made more robust.
   - Recommended elements: eliminate unsecured lending, explicit solvency and viability requirements, internal guidelines on governance, collateral and counterparty policy, risk controls, pricing, and operational processes.

### Table 1 & 2 — Summary of recommendations (timing notation: Short-term means less than one year; medium-term means less than three years)
- Monetary Operations & Collateral (Short-term)
  - Collateral adequacy: undertake regular forecast of expected liquidity changes and map against NBG collateral expectations.
  - If collateral shortfall identified, identify ex-ante what collateral could be accepted; in systemic need, temporarily accept FX collateral (with haircut "add-ons") or expand criteria for high quality credit claims.
  - Document triggers for different types of systemic responses.
  - Resolve issues around use of collateral that matures within an operation.
  - Committed liquidity facility proposal appears not well grounded; systemic needs should be catered via measures discussed in the note.
  - Move credit claims existence and verification process to NBG operational area.
  - Apply market valuations to treasury bills and bonds accepted as NBG collateral; same methodology for other securities.
  - Consider limits or pricing "add-ons" for credit claims used in monetary policy operations.
  - Move to an internationally recognized Global Master Repurchase Agreement (GMRA) planned next year.
  - Remove any ownership restrictions in NBG certificates of deposit (CDs).
  - Formalize Georgian treasury forecasts; consider establishing a Memorandum of Understanding (MoU).
  - Consider publishing, on a daily basis, net autonomous factors and later NBG forecasts to help market determine system liquidity position.

- Liquidity Coverage Ratio (Short-term)
  - Assess appropriateness of currently proposed FX run-off ratios in the proposed LCR framework given the limited ability of the NBG to meet FX liquidity needs of individual banks or the system.

- Market Deepening (Medium-term)
  - Develop an active primary government bond market; risk-free curve not well defined beyond the very short-end, increasing financial stability risks.
  - Use NBG collateral framework to promote standards (quality, transparency, standardization, simplicity) to help develop term funding markets and groundwork for securitization issuance.
  - Continue regular engagement with market participants and develop a monetary operations manual explaining NBG normal and emergency frameworks.

- Lender-of-Last-Resort (Short-term / Medium-term)
  - Remove the ability to provide unsecured lending under NBG law (Medium-term).
  - Consider publishing a public guideline explaining key elements of NBG LOLR framework (Short-term).
  - Provide for the ability—either through NBG law or public guideline—for NBG to request a government guarantee when necessary to support provision of LOLR (Short-term).
  - Clearly define framework internally, including roles and responsibilities; cover internal governance, liquidity monitoring, collateral and counterparty policy, risk control measures and pricing, and high-level operational processes (Short-term).

### I. More Detailed Assessment — A. National Bank of Georgia’s Monetary Policy Framework
- Current status — operational setup and recent developments
  - Main NBG objective: maintain price stability; operational target is short-term interbank interest rates (up to seven days).
  - Main instrument: one-week refinancing auctions; also uses three and six-month certificates of deposit auctions.
  - NBG has a reserve averaging minimum reserve framework and a standing credit and deposit facility.
  - In 2015, reserve money position shifted from liquidity surplus to deficit, largely reflecting NBG FX interventions and increased demand for banknotes; NBG FX interventions limited to containing excessive volatility that threatens market functioning, and conducts transactions as opportunities allow to build international reserves.
  - Going forward, NBG expects liquidity deficit will most likely increase (mainly driven by cash in circulation).
  - In 2010, NBG extended full allotment to seven-day liquidity facilities at fixed spreads above policy rates. In 2015, NBG temporarily introduced internal limits on seven-day auctions to control liquidity volumes; these actions resulted in elevated interbank rates and NBG does not envisage using liquidity limits or guaranteed facilities again.
  - NBG has recently incorporated certain loans to small and medium-sized enterprises and residential loans into its collateral framework; operational checks for these loans are conducted in the supervisory area of the NBG. NBG also recently introduced corporate bonds into eligible collateral pool.
  - Georgian Treasury deposit is placed with the NBG and is not remunerated. No formal arrangement currently in place with the Georgian Treasury for provision of Treasury liquidity forecasts.
  - Minimum reserve framework: reserve ratios are in lari (7 percent requirement) and FX (20 percent requirement). FX requirements are met in FX, with EUR requirements remunerated at the ECB deposit rate (currently negative), and USD currently at zero percent (but linked to FED policy rate (-50 bps)).
  - NBG has a formal schedule regarding re-profiling of legacy non-marketable government bonds on its balance sheet to be replaced with tradable government bonds with market interest rates.

- Assessment and Recommendations — monetary policy framework
  - Market perception concerns stem from past depreciation episodes; NBG concerned market may doubt readiness to meet systemic liquidity needs due to past actions/inactions before full adoption of inflation targeting.
  - Discussions with market participants indicate market is satisfied with NBG operational framework and its emphasis on price stability over FX, and take comfort from predictability of NBG liquidity provision and sterilization operations.
  - If additional comfort is needed, NBG could meet structural liquidity needs via a slightly longer-term standard operation priced at market rates. Structural liquidity is best provided using longer term auctions; NBG could include ability to meet structural liquidity needs (e.g., resulting from previous FX interventions) to minimize rollovers in NBG liquidity-providing operations.
  - In such operations, NBG would set and announce a volume (maybe a certain percentage of system liquidity needs) and be a market rate taker in that part of the curve. A suggested useful tenor to start with could be one month.

*IMF — Mission report: Preface, Executive Summary, Recommendations, and Section I.A extracted from cr17107 (IMF MCM mission to the National Bank of Georgia).*

### 8.      The NBG also raised the question of whether its collateral framework needed to

### 8.      The NBG also raised the question of whether its collateral framework needed to

### Collateral framework — current assessment and suggested work
- At present there does not appear to be a compelling case to expand the collateral accepted under the NBG’s standard monetary policy framework.
- On first inspection, it appears that there is sufficient collateral within the system, because as at September 27, 2016, the total monetary policy borrowings stood at GEL 950 million, while unencumbered monetary policy eligible collateral buffers stood at roughly GEL 2,595 million.
- Recommendation: The NBG should undertake a forecast of expected liquidity changes in the system going forward and compare the results against the expected collateral availability in the system.
  - Such an assessment should be performed on a regular basis, with the goal for the NBG to try and anticipate any expected collateral shortfalls which could require NBG policy actions.
- If the analysis shows a compelling need to expand the collateral framework, the NBG should examine:
  - other types of assets it is prepared to accept, such as additional higher quality credit claims;
  - the possible loosening of current concentration limits so that larger high quality credit claims could be accepted.
- The NBG currently imposes a credit claim limit of 1 million lari per debtor.
- The NBG should continue with the proposed move of the credit claims existence and verification process to the operational area of the NBG (common practice in central banks such as the ECB and the BoE).

### Pre-positioning, eligibility, and operational preparedness
- Even at an early stage counterparties could be asked to pre-position the collateral with the NBG so that it can conduct its checks and the counterparty to undertake any required due diligence.
  - The pre-positioning process is an eligibility and validity check; legal title to the collateral is not transferred to the Bank at the pre-positioning stage.
  - The NBG could hire legal counsel to inspect documentation in the case of credit claims, and also other agencies in terms of credit assessment.
  - It would be helpful if the counterparty updated information relating to pre-positioned portfolios on a monthly basis.
  - Confidentiality agreements with these entities could be helpful.
- Recommendation: The NBG should prepare in advance risk controls that could apply to additional assets—including valuation techniques and haircuts—to avoid rushed decisions at the time of need.
  - When formulating haircuts, the NBG should consider the use of a haircut ‘add-on’—over and above the base haircut applied to the security—to better protect the NBG against adverse FX movements and to discourage further dollarization through acceptance of FX assets.

### Collateral valuation and margining
- Market values should be estimated for Georgian Treasury bills and bonds and applied to collateral taken by the NBG.
  - In the absence of continuous market pricing, use information from the most recent primary auction, market contacts, and pricing from NBG sterilization operations to arrive at the best guess of market value.
  - Ideally, securities would be revalued daily to ensure collateral values cover loan amounts.
  - If there was a shortfall (beyond a pre-specified level), the NBG would be entitled to make a margin call (i.e., request more collateral).
  - The NBG should consider incorporating these commonly used features, bearing in mind the increased operational requirements.

### Inclusion of credit claims and operational eligibility design
- Should the availability of collateral not be considered sufficient, the NBG could consider the acceptance of credit claims (bank loans).
  - The NBG should try to identify as soon as possible the types of credit claims it is prepared to accept in line with its risk tolerance, and formulate eligibility criteria including risk controls.
  - For monetary policy purposes, acceptance of credit claims would normally involve establishment of eligibility criteria and risk controls for performing loans only.
  - For emergency idiosyncratic operations, credit claims with some level of impairment may need to be considered and suitably controlled from a risk perspective if accepted.

### Transparency and flexibility of the monetary policy framework
- Recommendation: The NBG should ensure that its current monetary policy framework is flexible to cater for possible future liquidity shocks, but without disclosing the exact structure of the response so that the system’s ability to self-insure is not undermined.
  - It may be useful for the NBG to publish a monetary operations document that explains its framework in normal times, and discloses certain elements of its framework in emergency times (both during systemic and idiosyncratic cases).

### Systemic response: design principles and the proposed longer-term operation
- The type of NBG response needed during a period of market strain will be largely determined by the type of market strain.
  - Acceptance of assets outside the normal framework would address different demands (need for additional lari liquidity) than lengthening maturities of operations (if demand for term liquidity pressures short-term rates).
- A systemic response often involves an increase in local currency reserves but not necessarily; responses could include sterilization elements.
- Important principle: If longer term liquidity providing operations are offered, they should be priced at, or even at a small margin to, market rates to be consistent with monetary policy objectives and to ease exit from non-standard arrangements.
- Mission discussion of the NBG’s proposed longer-term operation:
  - Should additional term lari liquidity be needed, the NBG would launch at its initiative a longer-term operation with an envisaged maturity of roughly 6–12 months (modifiable according to market needs).
  - The operation would be priced at market rates and the NBG will accept a wider collateral base, if needed.
  - While not necessary at this juncture, the NBG should prepare how it could accept additional collateral (such as FX collateral) and what additional credit claims could be accepted (either existing high quality claims subject to lower debtor concentration limits, or less preferably lower quality credit claims subject to stringent risk controls).
  - Note: If currently a counterparty cannot pledge collateral that matures within the term of the operation, this would need to be addressed first.
- Recommended preparatory actions for the longer-term operation:
  - Prepare risk controls, valuation techniques and haircuts in advance.
  - Assess definitions of High Quality Liquid Assets (HQLA) in the LCR framework relative to NBG collateral requirements and haircuts.

### Other potential instruments and coordination with fiscal authorities
- The NBG discussed introducing FX swaps as part of its standard framework.
  - FX swaps could stabilize FX swap market tension and influence short-term rates; they could be a standing facility priced accordingly, with limits to lend support to the local currency.
  - Further MCM engagement could be useful before establishing FX swaps and other arrangements (such as interest rate swaps currently being considered by the NBG).
  - If FX swaps are used as a monetary policy fine tuning instrument, maturity should be consistent with current monetary policy instruments. If used as market development instruments, FX swaps should be two-way and regularly launched.
- Recommendation: The NBG could formally engage with the Georgian Treasury to collect and produce better projections on government expenditure and revenue to support liquidity forecasting.
  - An MoU could be established obligating the Georgian Treasury to provide, at a minimum, weekly information to the NBG in support of its monetary policy role.
  - Cash flow forecasts should, as a start, be weekly and looking two to three months ahead; be regularly updated and rolled forward.
  - Forecasts should be independent of the budget execution process and based on information from large spending ministries, departments and agencies, and from the Revenue Authority.
  - Forecasts should be cross-checked against actual flows and errors discussed with the Georgian Treasury.
- Recommendation: Remove restrictions around acceptance of collateral with a maturity date less than that of the operation, as this could constrain collateral holdings of the system.

### Markets — current status and constraints
- Current market structure and participants:
  - There are 21 banks operating in Georgia (local and foreign owned entities).
  - The sector is highly concentrated, with the two largest banks accounting for 58 percent of assets.
  - Dollarization: credit and deposit dollarization levels standing at roughly 60 percent.
  - The lari money market main activity takes place in the unsecured market, and to a lesser extent the FX swap and the developing secured market.
  - According to the NBG, roughly five or six banks are active in the interbank market.
  - The NBG is working with market participants to move to an international Global Master Repurchase Agreement (GMRA) possibly next year.
- Implications of government funding choices:
  - The government funds itself mainly through cheaper international borrowing (international financial institution (IFIs)).
    - Implication (i): this requires active (and potentially costly) sterilization by the NBG;
    - Implication (ii): there are no benchmark lari government securities in the local market.
  - Currently, there are limited options for term funding in lari, and even where term lari deposits exist they can be converted into FX.
  - Market participants expressed concerns about the ability to price risk out the curve.

### Markets — assessment and recommendations
- Assessment:
  - Georgian funding markets appear short-term in focus, with legacy concerns about inflation/depreciation possibly driving this orientation.
  - Combined with government financing mainly through IFIs, there are limited money market instruments in Georgia which increases vulnerability of banks to liquidity shocks.
  - Basic elements for well-functioning money markets are in place, but factors hindering deeper markets include lack of reliable and market relevant financial benchmarks and a narrow range and insufficient supply of money market instruments.
  - Ownership restrictions on sterilization instruments—only regulated banks—appear to exist; removing such clauses could help market deepening.
- Recommendations to deepen markets:
  - Policies focused on enhancing trading and price discovery out the curve are needed.
  - Add supply of government products beyond the two-year space to better support development of the “risk free” benchmark yield curve.
  - The NBG’s plan to term down its six-month sterilization instruments to allow the Georgian Treasury to take this space on the curve is a positive move:
    - Supports transmission of monetary policy;
    - Allows better separation of strategic debt management from short-term liquidity management;
    - Reinforces the Georgian Treasury’s role in developing securities markets.
  - More generally, introduce local currency-denominated securities with credible indexation systems, develop markets for instruments to hedge currency risks, and develop capital markets to help discourage dollarization.
  - Consider development of the securitization market as a longer-term goal; prerequisites include liquidity and accuracy of the yield curve in relevant maturities, availability of efficient hedging instruments, and ability to obtain inexpensive short-term financing through repurchase markets.
- Specific operational suggestion:
  - NBG sterilization should concentrate at the very end of the yield curve, via offerings of fixed volume variable rate tenders, creating space for the MoF to issue further out the curve.
  - NBG issuances should be issued without ownership restrictions; if issuance creates tensions with the MoF, consider working with the MoF to allow use of government securities in sterilization operations with funds raised left with the NBG in a blocked account and remunerated appropriately.

### National Bank of Georgia’s liquidity monitoring — current status
- The NBG has in place a liquidity metric where essentially an average of month’s liquid assets shall be no less than 30 percent of average of month’s liabilities.
- The NBG is planning to implement a LCR that will be stricter than the current ratio.
  - The proposed LCR ratio will be applied to all banks.
  - Differences from Basel’s LCR include:
    - Less liquid assets (e.g., company stocks) that can’t be immediately converted into cash are excluded from high quality asset definitions, while the NBG LCR includes a liquidity requirement by currency;
    - NBG adopts higher outflow rates as levels of deposit concentration increase and based on client residence and account type.
- The NBG also noted intention to introduce a ratio on net stable funding requirements in the medium-term.

*IMF staff discussion as provided in the source content.*

### 30.      The NBG has discussed internally whether a committed liquidity facility should

### cr17107 - 30.      The NBG has discussed internally whether a committed liquidity facility should

### Committed Liquidity Facility (CLF) and Liquidity Coverage Ratio (LCR) design
- The NBG has discussed internally whether a committed liquidity facility should be implemented to meet shortfalls of high-quality liquid assets in stressed situations when the proposed LCR is introduced.
- The introduction of a committed liquidity facility (CLF) does not appear to be the most appropriate tool in response to a systemic shock.
- CLF purpose and mechanics as described:
  - A CLF is a contractual arrangement between a bank and the central bank, through which banks—for a fee—have on-demand access to liquidity.
  - This Facility counts toward high quality liquid assets in LCR ratios.
  - Any access to the CLF should be seen as a last resort and only once all other reasonable steps have been taken to manage their liquidity risks without recourse to the NBG, while a commitment fee should try to equalize incentives between those who have access and those who do not.
- Rationale against CLF introduction in the Georgian context:
  - There does not currently appear to be a shortage of HQLA within the Georgian system.
  - Such an arrangement, if introduced, could be more akin to emergency liquidity assistance (but with a commitment rather than being at the NBG’s discretion, and also without safeguards such as possible conditionality), making its objectives less clear.

### LCR run-off rates, FX vulnerability, and supervisory options
- Current run-off treatment noted:
  - FX deposits receive a lower run-off rate (e.g., 18.5 percent) compared with similar lari deposits (e.g., 21.5 percent).
- Concerns highlighted:
  - The NBG has limited capability to meet FX liquidity needs of the system (as compared to the unlimited capacity to provide lari) should individual banks or the system experience FX outflows beyond existing buffers.
  - Within the LCR framework, FX deposits should be treated as ‘less stable,’ which attracts a higher run-off rate (see paragraph 79 of Basel III: The LCR and liquidity risk monitoring tools, January 2013).
  - Banks and supervisors cannot assume that currencies will remain transferable and convertible in a stress period, even for currencies that in normal times are freely transferable and highly convertible.
  - If the NBG is pursuing a de-dollarizing strategy, preferential treatment for FX is questionable.
- Recommendations and options:
  - To avoid having the NBG essentially backstop the market, review the current run-off rates of the proposed LCR arrangement.
  - Consider reassessing the appropriateness of FX run-off assumptions and potentially increasing run-off rates for FX deposits.
  - Prudential tools should be used to reduce the risk that FX liquidity needs arise and outstrip FX resources available.
  - MCM assistance could be helpful in assessing that liquidity risks are being accurately measured and that term funding is being encouraged; MCM can work with the NBG to develop a template to help perform liquidity monitoring.

### Lender-of-Last-Resort (LOLR) — Current legal status
- Legal basis:
  - The NBG’s ability to provide LOLR is set out in Article 33 of the NBG law.
  - According to Article 33, the NBG can extend loans no longer than three months, with an interest rate not be less than the NBG standing facility rate, and against collateral as decided by the NBG Board.
  - Article 33 also states: “in emergencies, where country’s financial system may be threatened, the decision of the Board of the National Bank may permit issuance of loan for longer term, with different interest rate and without security.”

### Lender-of-Last-Resort — Assessment and recommendations
- Collateral and unsecured lending:
  - The NBG should cease having the ability to provide unsecured lending; this should be supported through the revision of NBG law.
  - Until the NBG Act is amended, the exclusion of unsecured lending should be ratified by the NBG Board and reflected in the published Guidelines.
  - The purpose of securing collateral is to minimize the potential credit risk to the central bank balance sheet that may occur in case of default; collateral provides a natural limit to lending as an institution cannot borrow more than its available unencumbered assets accepted by the central bank.
- Government guarantees and indemnities:
  - In the absence of adequate collateral, the NBG should make explicit the ability to request a government guarantee so that LOLR could be extended.
  - Risks associated with LOLR can be extremely large, given the illiquidity of the collateral and the distressed nature of the counterparty.
  - Indemnities should be fully enforceable, irrevocable and unconditional guarantees that rank pari passu with other government obligations.
  - In general, risks associated with monetary policy are generally not indemnified; to preserve the independence of the central bank the ensuing risks are covered by its capital. Risks associated with LOLR are typically covered by government guarantees.
- Transparency and market conditioning:
  - The NBG should consider publishing a public guideline explaining some of the key elements of the NBG LOLR framework in order to condition market behavior.
  - These elements should include at a minimum: requirements for solvency and viability, and supervisory intrusion and conditionality.
  - This guideline could also allow for the NBG to request a government guarantee when necessary.
- Operational monitoring and preparedness:
  - The NBG should monitor lari and FX needs from an operational perspective and should not be taken by surprise by an institution’s need for LOLR.
  - The NBG should actively monitor recent liquidity developments across individual counterparties and carry out liquidity projections under different specified stress assumptions.
  - MCM can work with the NBG with regard to developing a template to help perform this liquidity monitoring.

*IMF staff assessment and recommendations as presented in the source content.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17107.pdf_