## cr18346 ## Source details **Canonical URL:** [cr18346](https://www.imf.org/-/media/files/publications/cr/2018/cr18346.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18346.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18346.pdf.json) --- ### MACROECONOMIC CONTEXT - Real GDP growth estimated at about 6 percent in recent years. - Authorities’ inflation target: 5 percent. - Key risks and recent developments: - Constraints in implementing public investments and weak expenditure controls have led to an increase in fiscal arrears. - Sharp increase in nonperforming loans (NPLs) may be linked to fiscal arrears and weaker corporate cash flows. - Credit growth has fallen precipitously; weaker credit demand and tighter credit standards have weighed on credit supply. - External risks include tighter global financial conditions and escalation of trade disputes. - Bank NPL Ratios and Credit Growth (chart period 2011Q4–2017Q4): displays concurrent rise in NPLs and fall in credit growth. ### VULNERABILITIES AFFECTING THE TANZANIAN FINANCIAL SYSTEM - Financial system structure and size: - Financial sector assets: 36 percent of GDP. - Banks account for 72 percent of system assets. - Pension funds account for 26 percent of system assets. - Banking system concentration and composition: - 54 commercial banks classified in Peer groups by asset size (Peer 1: > T Sh 500 billion; Peer 2: T Sh 200–500 billion; Peer 3: T Sh 30–200 billion; Peer 4: < T Sh 30 billion). - 18 domestic and 29 majority foreign-owned banks hold 92 percent of banking assets. - The largest five banks hold 54 percent of assets; the largest ten hold 71 percent of assets. - Commercial banks hold 96 percent of banking assets; remainder comprises two development banks, seven community banks, and five microfinance banks (0.6 percent). - FBME Bank was closed and placed under liquidation in early May 2017; five community banks were closed in January 2018. - Asset and funding composition: - Bank assets: loans 51 percent, government securities 19 percent, deposits at the Bank of Tanzania (BoT) 14 percent, deposits at other banks 9 percent. - Lending concentrated in the corporate sector: three quarters of loan portfolio. - Pension funds hold 4 percent of bank deposits. - Key systemic vulnerabilities and drivers of risk: - Bank asset quality has deteriorated sharply; under-provisioning is significant despite apparently comfortable capital cushions. - Corporate debt loads have risen and corporate cash flows are weak. - Dollarization of bank balance-sheets raises the possibility that solvency stress under shocks could be exacerbated by funding liquidity pressures, especially at smaller banks. - Medium-to-small banks systematically rely more on costlier, short-term interbank financing and institutional deposits and have markedly higher operating costs. - Thin and segmented financial markets complicate systemic liquidity management. - Potential shock amplifiers: - Tighter global financial conditions, lower trading partner growth, prolonged domestic economic uncertainties, and delays in budget execution and infrastructure investment. - Even under a benign baseline, solvency positions of government-owned and smaller private banks could come under pressure; number of undercapitalized institutions may increase. - Confidence spillovers under stress could increase adverse impacts on systemic institutions despite relative resilience of largest banks. ### PORTFOLIO COMPOSITION BY OWNERSHIP AND PEER GROUP - Government-owned banks: - Greater exposure to agriculture and personal loans. - Smaller portfolio share of securities. - Rely more on interbank funding (including through bond issuance) and less on deposits than private banks. - Peer 1 private banks: - Tend to be more deposit funded than other banks. - Credit exposures are more sectorally diversified. - Peer 2–3 private banks: - Higher credit exposure to construction, real estate, and transportation, storage and warehousing—sectors that have experienced greater difficulties. - Dollarization, FX exposure, and funding composition: - For the entire banking system, 30 percent of assets and liabilities are FX denominated. - Peer 2 and Peer 3 banks exhibit higher degrees of dollarization; government-owned banks exhibit lower degrees. - FX liabilities funding sources: - Two-thirds of FX liabilities are sourced from domestic deposits from households, nonfinancial corporates, and pension funds. - Remaining FX liabilities comprise financing from foreign financial institutions, domestic banks, and other sources. - FX assets composition: - Two-thirds of FX assets consist of loans. - Remaining FX assets are claims on foreign banks and domestic interbank loans. - Notwithstanding small net FX positions, liquidity and credit risks may be significant. - Asset-liability maturity transformation: - Private banks: about 70 percent of liabilities mature within 90 days for all Peer groups. - Asset maturity > two years: - Peer 1: 30 percent of assets. - Peer 2: 15 percent of assets. - Peer 3: negligible fraction. ### ASSET QUALITY, PROFITABILITY AND CAPITAL - System-wide NPL ratio: - Increased from 6.8 percent in 2014 to 11.5 percent in 2017. - At end-2017: - 24 banks had NPL ratios exceeding 10 percent. - 17 banks had NPL ratios between five and 10 percent. - Six Peer 2–3 banks have NPL ratios above 30 percent. - Drivers of rising NPLs: - Lower than expected government spending, poor credit underwriting, government payment arrears and policy actions affecting sectors (hotels, transport), drought affecting agriculture, fall in real estate collateral values, prolonged judicial processes. - Forbearance measure (December 2015) extended allowable NPL recognition from one year to three years. - Profitability and capital vulnerabilities: - Many banks show low or negative profitability and high NPLs not covered by provisions, despite appearing adequately capitalized by capital ratios. - Peer 2 private banks: loss making since 2011; vulnerabilities particularly high. - Government-owned banks: low profits since 2015; vulnerabilities particularly high. - Peer 3 private banks: larger capital buffers and higher provisioning ratios but profitability eroded sharply in 2017. - Peer 1 largest banks: diversified income and adequate solvency buffers; for a majority of the ten largest banks, 50 percent to 80 percent of NPLs emanate from 10 corporate accounts. - Operational efficiency: - Significant variation in noninterest expense-to-asset ratios across peer groups. - Several Peer 2 and Peer 3 banks exhibit noninterest expense-to-asset ratios exceeding 10 percent. - Interconnectedness and concentration: - Bilateral exposures between pension funds and banks create interconnectedness. - Peer 1 private banks are central; two-way bilateral exposures between Peer 1 and Peer 3 private banks are most significant. - Government-owned banks are net providers of funding to Peer 1–3 private banks. - Pension fund deposits predominantly allocated to Peer 1 and Peer 3 private banks. - Flight risk from pension fund and MNO deposits due to DB pension shortfalls and poor deposit insurance cover. - Sovereign exposure and fiscal arrears: - Continued unresolved fiscal arrears are a concern given high sovereign exposure of banks and pension funds. - Prompt payment on outstanding government-guaranteed loans and arrears could significantly attenuate banks’ asset quality problems and bolster financial stability. ### STRESS TEST SCENARIOS AND RESULTS - Scenarios used: - Baseline: assumes stable growth of about 6–7 percent under favorable external conditions; improvements in business environment, budget execution and tax collection; scaling up of public investment; decreases in fiscal arrears and bank NPL ratios; gradual recovery in credit growth. - Adverse scenario: recent weaknesses continue unabated, causing persistent slowdown in growth. - Tail risk scenario: extreme combination of external shocks (severe terms-of-trade shock, global financial tightening, slowdown in global growth) and domestic shocks (reduced private and public investment, protracted government payment arrears), triggering sharp domestic slowdown, currency depreciation, spikes in domestic inflation and interest rates, and a credit squeeze. - Capital adequacy and provisioning: - Six banks are currently undercapitalized. - 37 out of 45 banks exhibit varying degrees of under-provisioning at end-2017. - Correcting for under-provisioning reduces the total capital ratio of the system by 2.1 percentage points, to 18.1 percent. - Total capital ratios of six banks representing 10 percent of assets in the system fall below the 12 percent regulatory threshold after adjustment. - Baseline stress test outcomes: - System-wide capital ratio rises to 18.9 percent, driven by profitability of Peer 1 private banks. - Solvency positions of Peer 2–3 private banks and government-owned banks decline; five additional banks become undercapitalized. - The five additional undercapitalized banks represent 1.8 percent of banking assets. - Overall under the baseline, 11 banks representing 12.8 percent of assets in the system are undercapitalized at some point during 2018–20. - Tail risk stress test outcomes: - 22 banks, representing 32 percent of banking assets, would become undercapitalized. - NPL ratios rise from 10.4 percent to 22.7 percent, driven by the economic slowdown. - Slowdown in real GDP growth accounts for about 90 percent of the increase in the aggregate NPL ratio over 2018–20 in the tail risk scenario. - Net open FX positions are small; direct gains/losses from T Sh depreciation play a minor role. - Sharply rising NPLs drive down net interest incomes, significantly affecting solvency. - Contagion and interbank effects: - Interbank exposures exacerbate system vulnerabilities. - In solvency tail risk tests, nine of the 22 undercapitalized banks exhibit negative capital. - Defaults by these banks would trigger knock-on effects: five additional banks representing 5½ percent of system assets ending up with negative capital and an additional bank (1½ percent of system assets) becoming undercapitalized. - Liquidity stress test outcomes: - Cash flow (liquidity ladder) test assumes 25–30 percent of non-equity funding withdrawn within a 90-day period, with 15–20 percent of withdrawals occurring in the first 30 days. - Banks can use cash and excess reserves and liquidate securities with BoT, but beyond a point several would need emergency liquidity assistance (ELA) from BoT to meet shortfalls. - A bank needing ELA to continue operating fails the test. - Funding withdrawal sensitivity: - Withdrawal of funding from pension funds, insurance companies, and/or foreign banks could make at least six banks undercapitalized (assumes asset sales with 30 percent haircuts). - Concentration risk sensitivity: - Default of banks’ five largest credit exposures would drive the system-wide total capital ratio below the 12 percent threshold. ### ENHANCEMENTS TO MANAGING SYSTEMIC LIQUIDITY - Institutional and operational issues: - Volatility in excess reserves and high concentration in liquidity distribution across banks challenge policy transmission. - Clearing balances at the BoT averaged T Sh 734 billion for 2017, relative to T Sh 400 billion for 2016; HHI distribution of 1700 and 1300, respectively. (Note: HHI at or below 1000 shows relatively more unconcentrated distribution.) - FX operations are primary means of managing liquidity; BoT FX operations lack clarity in objectives and contribute to volatile excess reserves. - Net OMOs have not offset FX activity over last two years, increasing uncertainty in liquidity planning. - Recommended operational reforms: - Develop a coherent and transparent operational framework emphasizing attainment of BoT’s price stability mandate. - Re-orient monetary operations to rely on OMOs; design FX operations with distinct objectives. - Establish a policy rate bounded by standing facilities. - Align operating target with monetary policy rate. - Systemically calibrate OMOs to offset autonomous liquidity components including FX operations. - Establish clear accountability framework and enhance BoT–MoFP coordination for liquidity forecasts. - Money market development: - BoT plans: implement a trading system for interbank transactions and introduce the Global Master Repurchase Agreement. - Finalize operational issues for legal basis of repo collateral perfection; establish valuation and repo margining practices to stimulate secondary market trading in Treasury bills and bonds. - Macroprudential tools for FX liquidity: - Introduce a liquidity coverage ratio denominated in FX and, conditional on EAC harmonization, reserve requirements in FX. - Enhance reserve adequacy assessments to include short-term banking sector FX mismatches. - Current gross reserves assessed to be approximately four and a half months of prospective imports (as at March 2018). - Emergency Liquidity Assistance (ELA): - Complete operational framework and tools for ELA; BoTA provides powers for ELA. - Practical gaps: broaden acceptable collateral beyond government securities; pre-arrange government indemnification for ELA under doubtful solvency. - Risk-management practices: test haircuts, pre-screen eligible collateral, ensure overcollateralization, horizon-scanning for D-SIBs. - Consider ELA in FX on bilateral basis with stringent conditions and repayment monitoring. ### BANKING REGULATION, SUPERVISION AND RESOLUTION - Prudential framework: - Capital requirements: current minimum total capital requirement is 12 percent of risk-weighted assets, augmented by a 2½ percent capital conservation buffer. - Capital adequacy based on Basel I definitions with additional charges for market and operational risk; Basel II/III implementation project targeted for end-2018. - Basel III capital standards likely achievable for most banks; Basel III liquidity requirements more challenging due to lack of HQLA. - Loan classification circular (February 19, 2018): - Positive elements: requires banks to devise strategic plans for problem loan reduction, establish permanent recovery functions, and ensure top management for high risk cases. - Risks: allows banks to upgrade classification of NPLs and to capitalize and recognize as income interest on such loans, potentially overstating earnings and capital and masking vulnerabilities. - Recommendation: BoT should follow-up with guidance on criteria for restructuring and upgrade; require capital plans consistent with NPL reduction strategies in preparation for withdrawal of regulatory relief at end-2020. - Banking supervision: - DBS staffing declined since 2015 while number of supervised institutions increased; staff gap amounted to 19 technical staff positions as of February 2018 (actual technical staff 42, excluding ten managers and two advisors). - RBS framework and manual (2010) are significant improvements; recommended revision to introduce a single non-formulaic supervisory risk assessment process and to emphasize offsite analysis. - Recommendations include ensuring final ratings are responsibility of seasoned examiners, increasing offsite guidance, and providing on-the-job training. - Problem bank oversight and resolution: - Legal framework for early intervention and resolution is broadly adequate but could be enhanced to allow Deposit Insurance Fund (DIF) use for lesser-cost resolutions. - Forbearance has delayed intervention (example: five community banks failed in January 2018 after prolonged problems). - Prompt corrective action (PCA) regulations should be operationalized with enforcement policy; require recovery plans for larger banks and BoT resolution plans for D-SIBs once identified. - Deposit Insurance Board (DIB): - No Board appointed since February 2017; operational independence and effectiveness should be enhanced through appointment of a functioning Board. - DIB failed to engage in advance preparation for insured deposit payout and bank liquidation in recent bank failures; recommendation to prepare to make payouts within a seven-day period. - DIB lacks internal capacity for liquidations; procure resources via pre-approved procurement list to avoid up-to-one-year delays. ### FINANCIAL CRISES PREPAREDNESS AND TFSF OPERATIONALIZATION - Tanzania Financial Stability Forum (TFSF) established in 2013; high-level forum for systemic risk surveillance and crisis coordination. - Priority actions to operationalize TFSF: - Undertake contingency planning by member agencies. - Develop checklists and guidelines for departments and individuals in key posts. - Develop clear rules for public support and establish monitoring arrangements. - Test framework via regular crisis simulation exercises. - Prioritize cross-border coordination with home supervisors of foreign banks active in Tanzania. ### AML/CFT AND CYBER RISK - AML/CFT: - National Risk Assessment (NRA) conducted from September 2015 to December 2016 across 19 sectors. - Recommendation: Adopt the NRA report and establish and implement a comprehensive action plan. - Implement risk-based AML/CFT supervision. - Consider amending CFT legislation to explicitly criminalize situations envisaged in UNSC Resolution 2178. - Addressing remaining AML/CFT issues may help preserve correspondent banking relationships. - Cyber risks: - No cyber risk event affected individual banks or the sector to date; threat awareness increased with automation. - BoT actions: stock-taking of IT needs; commissioned separate IT audits for banks for 2016 and 2017; developing regulatory guideline on cyber security (initial draft at commentary stage). - Industry actions: awareness workshops conducted by global banks and major audit firms. ### FINANCIAL SECTOR DEVELOPMENT — MSMEs AND LONG-TERM FINANCE - MSME finance: - MSMEs remain underserved; lending is expensive due to high perceived risk. - Financial infrastructure gaps: secured transaction system, credit bureau improvements, National ID, national Switch. - Multiple non-bank credit providers operate without full regulation; recommendation to regulate and supervise all credit providers. - Introduce financial consumer protection framework and improve financial literacy. - Long-term finance: - Pension funds hold substantial investments in illiquid and unproductive assets. - Actions needed: resolve outstanding government loans to pension funds; devise strategy for high levels of real estate holdings; increase number and size of liquid securities including equities, debt and structured products. - Consider privatizing commercial state-owned enterprises to increase listings on Dar Es Salaam Stock Exchange. - Improve monitoring and oversight of Development Finance Institutions. ### BASEL CORE PRINCIPLES AND SUPERVISORY PRIORITIES - Key supervisory findings and recommendations: - Ensure adequate staffing of the supervision function (CP 2). - Revise the RBS framework to introduce a single non-formulaic risk rating system (CP 1, 9). - Implement consolidated supervision by operationalizing the 2014 supplement to the RBS manual (CP 10, 12). - Enforce existing Prompt Corrective Action regulations and introduce internal guidance to ensure timely action on problem banks (CP 11). - Closely monitor banks’ classification and provisioning to ensure regulatory relief through end-2020 is not abused. - Strengthen consolidated and cross-border supervision, improve offsite analysis, require recovery and resolution plans for systemically important banks, and enhance corporate governance requirements. - Specific prudential details preserved: - Current minimum total capital requirement: 12 percent of risk-weighted assets, plus a 2½ percent capital conservation buffer. - BoT RBS Manual revision and Basel II/III implementation project targeted for completion by end-2018. ### STRESS TESTING FRAMEWORK (STeM) — SUMMARY - Institutional perimeter and data: - Authorities’ solvency perimeter: 40 banks (Top-Down by Authorities); FSAP Team: 45 banks (Peer 1–3 and government-owned). - Market share (Authorities): 98 percent of total banking sector assets (excl. community banks). - Market share (FSAP Team): 100 percent of total banking sector assets (excl. community banks). - Data baseline date: Supervisory data as of December 2017. - Scenarios and calibrations: - Adverse scenario (FSAP Team): real GDP ~1 std. below baseline; cumulative interbank and short rate increase 200 bps; long rate +100 bps; credit expands nominally 7 percent and 1.5 percent real. - Tail risk scenario (FSAP Team): real GDP ~3 std. below baseline; commodity prices decline 30 percent over first two years; currency depreciation about 40 percent; inflation peaks at about 11 percent in 2019; max interest rate increases in 2019: 500 bps for interbank and short rate and 300 bps for long rate; credit contracts real average about 2.5 percent. - Sensitivity and shocks: - Authorities’ credit risk shocks include increases in NPLs by 8 percent and sectoral NPL increases (agriculture 4 percent; manufacturing 12 percent; trade 7.5 percent; personal loans 5.5 percent). - FSAP Team shocks include increases in NPLs proportional to existing NPLs by 25/50 percent in 1 year and 100/150 percent in 2 years; increases in NPLs proportional to total loans by 3, 5 and 7 percent; sectoral 100 percent shocks in key sectors; default of largest 1, 3, 5 borrowers; reverse credit risk tests to find shocks that would bring CAR to 14.5 percent and 12 percent or require capital injections of 0.5/1 percent of GDP. - Liquidity testing: - Authorities’ methodology: bank run (balance sheet-based) including withdrawal scenarios of 10 percent of deposits per day. - FSAP Team methodology: cash-flow-based using maturity buckets; reporting includes number of banks meeting obligations, funding gap, survival period, and number of liquid/illiquid banks. - Contagion: - Authorities and FSAP Team apply interbank network models and balance-sheet models to test defaults and spillovers; FSAP Team assumes LGD 100 percent and asset sales with 30 percent haircut for replacement funding. *Source: Executive Summary and selected chapters and appendices — cr18346 (International Monetary Fund).* ### EXECUTIVE SUMMARY __________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### MACROECONOMIC CONTEXT - Real GDP growth estimated at about 6 percent in recent years. - Authorities’ inflation target: 5 percent. - Risks and recent developments: - Constraints in implementing public investments and weak expenditure controls have led to an increase in fiscal arrears. - Sharp increase in nonperforming loans (NPLs) may be linked to fiscal arrears and weaker corporate cash flows. - Credit growth has fallen precipitously; weaker credit demand and tighter credit standards have weighed on credit supply. - External risks include tighter global financial conditions and escalation of trade disputes. - Bank NPL Ratios and Credit Growth (chart period 2011Q4–2017Q4): displays concurrent rise in NPLs and fall in credit growth. ### CHALLENGES TO FINANCIAL STABILITY — VULNERABILITIES AFFECTING THE TANZANIAN FINANCIAL SYSTEM - Financial system structure and size: - Financial sector assets: 36 percent of GDP. - Banks account for 72 percent of system assets. - Pension funds account for 26 percent of system assets. - Banking system concentration and composition: - 54 commercial banks classified in Peer groups by asset size (Peer 1: > T Sh 500 billion; Peer 2: T Sh 200–500 billion; Peer 3: T Sh 30–200 billion; Peer 4: < T Sh 30 billion). - 18 domestic and 29 majority foreign-owned banks hold 92 percent of banking assets. - The largest five banks hold 54 percent of assets; the largest ten hold 71 percent of assets. - Commercial banks hold 96 percent of banking assets; remainder comprises two development banks, seven community banks, and five microfinance banks (0.6 percent). - FBME Bank was closed and placed under liquidation in early May 2017; five community banks were closed in January 2018. - Asset and funding composition: - Bank assets: loans 51 percent, government securities 19 percent, deposits at the Bank of Tanzania (BoT) 14 percent, deposits at other banks 9 percent. - Lending concentrated in the corporate sector: three quarters of loan portfolio. - Pension funds hold 4 percent of bank deposits. - Key systemic vulnerabilities and drivers of risk: - Bank asset quality has deteriorated sharply; under-provisioning is significant despite apparently comfortable capital cushions. - Corporate debt loads have risen and corporate cash flows are weak. - Dollarization of bank balance-sheets raises the possibility that solvency stress under shocks could be exacerbated by funding liquidity pressures, especially at smaller banks. - Medium-to-small banks systematically rely more on costlier, short-term interbank financing and institutional deposits and have markedly higher operating costs. - Thin and segmented financial markets complicate systemic liquidity management. - Potential shock amplifiers: - Tighter global financial conditions, lower trading partner growth, prolonged domestic economic uncertainties, and delays in budget execution and infrastructure investment. - Even under a benign baseline, solvency positions of government-owned and smaller private banks could come under pressure; number of undercapitalized institutions may increase. - Confidence spillovers under stress could increase adverse impacts on systemic institutions despite relative resilience of largest banks. ### POLICIES AND SUPERVISORY ASSESSMENT - General policy priorities emphasized: - Reduce nonperforming loans and increase provisioning. - Increase institutional and systemic buffers to manage domestic and foreign currency liquidity risks. - Prompt payment on government-guaranteed loans and resolution of government arrears. - Banking supervision and regulatory framework: - Assessment against international standards identified areas for enhancing banking supervision. - Priority supervisory process enhancements: - Ensure adequate staffing of the supervision function. - Revise the risk-based supervision (RBS) framework to introduce a single, non-formulaic risk rating system. - Implement the consolidated supervision regulation. - Adequately and consistently enforce prompt corrective action (PCA) regulations, supported by development and implementation of an enforcement policy to apply early intervention powers. - BoT February 2018 circular on loan classification and restructuring: - Positive elements: requires banks to devise strategic plans for problem loan reduction, establish permanent recovery functions, and ensure top management for high risk cases. - Risks: circular allows banks to upgrade classification of non-performing loans and to capitalize and recognize as income interest on such loans, potentially overstating earnings and capital and masking vulnerabilities. - Recommendation: BoT should follow up with further guidance on criteria for restructuring and upgrade. - Systemic liquidity management: - Institutional liquidity management is costly and uncertain in domestic currency for smaller banks; reliance on BoT is significant for foreign currency liquidity. - BoT plans to develop the repo market and modernize the monetary framework can reduce financial stability risks if completed. - Recommended: clarify objectives, rationalize instrument use, complete changes in secured money markets, promote proactive FX risk management by banks and corporates, and buttress with macroprudential requirements. - Completing operational guidance for Emergency Liquidity Assistance (ELA) is a high priority. - Financial crises management and resolution: - Operationalize existing framework: develop agency-specific contingency plans for members of the Tanzania Financial Stability Forum (TFSF); Ministry of Finance and BoT to prepare plans for extraordinary powers use during systemic crises. - Enhance operational independence and effectiveness of Deposit Insurance Board (DIB) by appointing its Board and increasing planning for payouts and liquidation. - BoT should require recovery plans from banks and prepare resolution plans for Domestic Systemically Important Banks (D-SIBs), once identified. - Financial sector development priorities: - Increase access to formal financial services and provision of long-term finance to micro-, small- and medium-sized firms. - Measures to broaden access and lower costs: address financial infrastructure gaps, bring nonbank credit providers to smaller firms under regulatory/supervisory umbrella, strengthen consumer protection, raise financial literacy. - Revisit pension funds’ investment allocation to contribute to long-term private sector finance; identify measures to increase supply of liquid securities. ### FINANCIAL INTEGRITY AND CYBER RISK - AML/CFT: - Recommendation: Adopt the National Risk Assessment (NRA) report and establish an action plan. - Implement risk-based AML/CFT supervision. - Cyber risks: - Cyber risks flagged as an area of attention (no further numeric specifics in executive summary excerpt). ### KEY RECOMMENDATIONS (Excerpt from Table 1) - Note: Timing codes — 1 = Immediate; ST = Within 1 year; MT = Between 1–3 years. - Financial Stability Surveillance - Expand data collection for liquidity, large exposures, currency, and contagion risk and enhance verification of data quality. Timing: I. Agency: BoT. - Strengthen framework for in-house stress testing and develop framework for constrained, bottom-up stress testing. Timing: ST and MT. Agency: BoT. - Expand in-house capacity for financial stability analysis, including through training and technical assistance. Timing: ST and MT. Agency: BoT. - Banking Supervision - Ensure adequate staffing of the supervision function. Timing: I. Agency: BoT. (¶41) - Follow-up NPL guidance issued to banks in February 2018 to further clarify conditions under which NPLs may be restructured. Timing: I. Agency: BoT. (¶39, ¶40) - Revise the RBS framework to introduce a single non-formulaic risk rating system. Timing: ST. Agency: BoT. (¶42) - Enforce existing Prompt Corrective Action regulations and introduce internal guidance to ensure timely action to deal with identified problem banks. Timing: I. Agency: BoT. (¶45) - Develop and implement an enforcement policy to ensure effective, consistent and timely corrective action. Timing: ST. Agency: BoT. (¶45) - Managing Systemic Liquidity (including ELA) - Develop a coherent and transparent operational strategy emphasizing attainment of BoT’s price stability objective. Timing: ST. Agency: BoT. (¶31) - Enhance surveillance and prudential toolkit for oversight and management of FX liquidity risks and support banks’ risk management. Timing: ST. Agency: BoT. (¶34) - Develop capacity to conduct ELA by compiling comprehensive operational framework. Timing: MT. Agency: BoT. (¶35–37) - Establish arrangements for obtaining government indemnity for ELA operations under uncertainty regarding solvency of borrowing entity. Timing: MT. Agencies: BoT, MoFP. (¶36) - Deposit Insurance and Financial Crises Prevention and Management - Appoint a Board to the DIB. Timing: ST. Agency: MoFP. (¶47) - Operationalize the TFSF MoU for preparing for, and coordinating actions during, a financial crisis. Timing: MT. Agency: TFSF members. (¶49) - Ensure that the legal framework provides government the ability to provide official financial support under strict conditions. Timing: MT. Agency: MoFP. (¶50) - AML-CFT - Adopt the NRA report and establish an action plan. Timing: ST. Agency: Government. (¶54) - Implement risk-based AML/CFT supervision. Timing: MT. Agency: AML/CFT supervisory authorities. (¶53) *Source: EXECUTIVE SUMMARY — cr18346 (International Monetary Fund).* ### 7. Portfolios differ significantly depending on bank size and ownership (Figure 3). ### 7. Portfolios differ significantly depending on bank size and ownership (Figure 3). ### Portfolio composition by ownership and peer group - Government-owned banks: - Greater exposure to agriculture and personal loans. - Smaller portfolio share of securities. - Rely more on interbank funding (including through bond issuance) and less on deposits than private banks. - Peer 1 private banks: - Tend to be more deposit funded than other banks. - Credit exposures are more sectorally diversified. - Peer 2–3 private banks: - Higher credit exposure to sectors that have experienced greater difficulties, including construction, real estate, and transportation, storage and warehousing. ### Dollarization, FX exposure, and funding composition - For the entire banking system, 30 percent of assets and liabilities are FX denominated. - Peer 2 and Peer 3 banks exhibit higher degrees of dollarization; government-owned banks exhibit lower degrees. - FX liabilities funding sources: - Two-thirds of FX liabilities are sourced from domestic deposits from households, nonfinancial corporates, and pension funds. - Remaining FX liabilities comprise financing from foreign financial institutions, domestic banks, and other sources. - FX assets composition: - Two-thirds of FX assets consist of loans. - The remaining FX assets are held as claims on foreign banks and domestic interbank loans. - Notwithstanding small net FX positions, liquidity and credit risks may be significant. ### Asset-liability maturity transformation - Private banks exhibit similar liability maturity profiles across Peer groups—about 70 percent mature within 90 days for all Peer groups. - Peer 1 private banks extend credit and invest at longer maturities than Peer 2–3: - 30 percent of assets of Peer 1 banks are of maturity greater than two years. - 15 percent of assets for Peer 2 banks are of maturity greater than two years. - A negligible fraction for Peer 3 banks. ### Asset quality deterioration and nonperforming loans (NPLs) - System-wide NPL ratio: - Increased from 6.8 percent in 2014 to 11.5 percent in 2017. - At end-2017: - 24 banks had NPL ratios exceeding 10 percent. - 17 banks had NPL ratios between five and 10 percent. - Six Peer 2–3 banks have NPL ratios above 30 percent. - Drivers of rising NPLs include: - Lower than expected government spending, weighing on private sector profits and wage income (most banks). - Poor credit underwriting (large banks and mid-sized banks). - Government actions: rolling over payment arrears to suppliers; firing of certain public sector employees; ban on use of hotels for conferences and meetings; delays on repayment on government guaranteed agricultural loans and Value Added Tax refunds; enforcement of recent changes in the tax administration legislation. - For community banks and microfinance lenders: poor corporate governance, fraud, insider lending, or a higher share of uncollateralized loans. - A forbearance measure introduced by the BoT in December 2015 extended allowable NPL recognition from one year to three years, potentially delaying write-offs. - Fall in real estate collateral values and delays/uncertainty in judicial processes impeded collateral sales and write-offs. - Sectoral loan quality deterioration: - Weak business environment drove NPLs on trade, manufacturing, real estate and personal loans. - Drought adversely impacted agriculture loan quality. - Demand shocks from trading partners hit agriculture and transport. - Government actions impacted loans to hotels and the transport sectors. ### Profitability, capital, and bank vulnerabilities - Many banks show low or negative profitability and high NPLs not covered by provisions, despite appearing adequately capitalized by capital ratios. - Specific vulnerabilities: - Peer 2 private banks: loss making since 2011; vulnerabilities particularly high. - Government-owned banks: low profits since 2015; vulnerabilities particularly high. - Loan loss provisioning has been a significant drag on profitability; capital buffers are weak despite fresh equity infusions in the last two years. - Business model viability issues for some banks. - Peer 3 private banks: - Exhibit larger capital buffers and higher provisioning ratios. - Profitability eroded sharply in 2017 and requires monitoring. - Largest banks (Peer 1), with few exceptions: - Diversified income and adequate solvency buffers. - For a majority of the ten largest banks, 50 percent to 80 percent of NPLs emanate from 10 corporate accounts. - High dollarization and deteriorating solvency heighten vulnerability to funding liquidity shocks, particularly in FX. - August 2, 2018: Bank M was placed under BoT statutory management owing to liquidity difficulties. - Large withdrawals of FX funding would be difficult to meet if FX loans are illiquid. - BoT’s FX reserves adequacy is crucial for managing systemic liquidity. ### Operational efficiency and cost structure - Significant variation in noninterest expense-to-asset ratios across peer groups. - A significant number of Peer 2 and Peer 3 banks, including foreign banks, exhibit noninterest expense-to-asset ratios exceeding 10 percent. - Banks tend to partially offset high noninterest expenses by lending at high interest rates, but many with high cost structures still have negative profitability. ### Interconnectedness and concentration risks - Interconnectedness arises from bilateral balance sheet exposures between pension funds and banks. - Peer 1 banks are central and systemically important; two-way bilateral exposures between Peer 1 private banks and Peer 3 private banks are most significant. - Peer 1 private banks also exhibit interconnections with Peer 2 private banks. - Government-owned banks are net providers of funding to Peer 1–3 private banks. - Pension fund deposits are predominantly allocated to Peer 1 and Peer 3 private banks. - Peer 1 private banks are recipients of funding from both parent and non-parent foreign institutions. - Vulnerability to withdrawal of pension fund and mobile network operators’ (MNO) deposits: - Mandatory social security schemes offer generous defined-benefit (DB) pensions, which have consistently exceeded contributions in recent years, triggering liquidation of assets including bank deposits. - Deposit insurance cover for pension fund and MNO deposits is poor; these sources of funds pose flight risk under stress. ### Sovereign exposure and fiscal arrears - Continued unresolved fiscal arrears are a concern given high sovereign exposure of banks and pension funds. - Non-payment or increases in fiscal arrears would raise banks’ liquidity challenges. - Arrears to pension funds may cause liquidation of bank deposits to meet cashflow needs, adding to liquidity pressures. - Prompt payment on outstanding government-guaranteed loans and arrears could significantly attenuate banks’ asset quality problems and bolster financial stability. ### Stress test scenarios and results - Scenarios used: - Baseline: assumes stable growth of about 6–7 percent under favorable external conditions, improvements in domestic business environment, budget execution and tax collection; scaling up of public investment; decreases in fiscal arrears and bank NPL ratios; gradual recovery in credit growth. - Adverse scenario: recent weaknesses continue unabated, causing persistent slowdown in growth. - Tail risk scenario: extreme combination of external shocks (severe terms-of-trade shock, global financial tightening, slowdown in global growth) and domestic shocks (reduced private and public investment, protracted government payment arrears), triggering sharp domestic slowdown, currency depreciation, spikes in domestic inflation and interest rates, and a credit squeeze. - Capital adequacy and provisioning: - Six banks are currently undercapitalized (Table 6). - 37 out of 45 banks exhibit varying degrees of under-provisioning at end-2017. - Correcting for under-provisioning reduces the total capital ratio of the system by 2.1 percentage points, to 18.1 percent. - Total capital ratios of six banks representing 10 percent of assets in the system fall below the 12 percent regulatory threshold after adjustment. - Baseline stress test outcomes: - System-wide capital ratio rises to 18.9 percent, driven by profitability of Peer 1 private banks. - Solvency positions of Peer 2–3 private banks and government-owned banks decline; five additional banks become undercapitalized. - The five additional undercapitalized banks represent 1.8 percent of banking assets. - Overall under the baseline, 11 banks representing 12.8 percent of assets in the system are undercapitalized at some point during 2018–20. - Tail risk stress test outcomes: - 22 banks, representing 32 percent of banking assets, would become undercapitalized. - NPL ratios rise from 10.4 percent to 22.7 percent, driven by the economic slowdown. - The slowdown in real GDP growth accounts for about 90 percent of the increase in the aggregate NPL ratio over 2018–20 in the tail risk scenario. - Net open FX positions are small; direct gains/losses from T Sh depreciation play a minor role. - Sharply rising NPLs drive down net interest incomes, significantly affecting solvency. - Contagion and interbank effects: - Interbank exposures exacerbate system vulnerabilities. - In the solvency tail risk tests, nine of the 22 undercapitalized banks exhibit negative capital. - Defaults by these banks would trigger knock-on effects, with five additional banks representing 5½ percent of system assets ending up with negative capital and an additional bank (1½ percent of system assets) becoming undercapitalized. - Liquidity stress test outcomes: - Cash flow (liquidity ladder) test assumes 25–30 percent of non-equity funding withdrawn within a 90-day period, with 15–20 percent of withdrawals occurring in the first 30 days. - Banks can use cash and excess reserves and liquidate securities with BoT, but beyond a point several would need emergency liquidity assistance (ELA) from BoT to meet shortfalls. - A bank needing ELA to continue operating fails the test. - Funding withdrawal sensitivity: - Withdrawal of funding from pension funds, insurance companies, and/or foreign banks could make at least six banks undercapitalized (assumes asset sales with 30 percent haircuts). - Concentration risk sensitivity: - Credit concentration amplifies credit risk. - Peer 2 private banks and government-owned banks show higher than average sensitivity to credit deterioration. - Default of banks’ five largest credit exposures would drive the system-wide total capital ratio below the 12 percent threshold. ### Institutional arrangements and macroprudential framework - Tanzania has elements of a framework for monitoring systemic risks and macroprudential policy responses: - Tanzania Financial Stability Forum (TFSF) established in 2013 via MOU among BoT, Social Security Regulatory Authority, Capital Markets Supervisory Authority, Tanzania Insurance Regulatory Authority, DIB, and Ministry of Finance and Planning (MoFP). - TFSF: high-level forum for surveillance of systemic risk and policy responses; coordinates national contingency plans; sectoral authorities committed to crisis management plans. - BoT’s Directorate of Banking Supervision (DBS) participates in TFSF discussions to map broader financial sector risks into banking vulnerabilities. - BoT’s Financial Stability Directorate (DFS), established in 2009, assesses vulnerabilities, issues a bi-annual Financial Stability Report, and collaborates with DBS on scenario-based stress testing. *Source: cr18346 - 7. Portfolios differ significantly depending on bank size and ownership (Figure 3).* ### 28. Enhancements to managing systemic liquidity can provide significant support to ### 28. Enhancements to managing systemic liquidity can provide significant support to ### Improving Policy Transmission and Cost and Access to Liquidity - Institutional liquidity management is challenged by: - Volatility in excess reserves. - Relatively high concentration in the distribution of liquidity across banks. - Recent developments: - Interbank rates and their volatility have declined recently reflecting excess reserves that are high relative to previous cycles of monetary easing. - Banks continue to hoard liquidity and limited access to excess reserves by smaller banks remains a persistent constraint in the interbank market. - Since 2017, banks’ clearing balances at the BoT averaged T Sh 734 billion for 2017, relative to the average of T Sh 400 billion for 2016, with corresponding distribution (as measured by an Herfindahl Index-HHI) of 1700 and 1300, respectively. (Note: HHI at or below 1000 shows relatively more unconcentrated distribution.) - Role of FX operations: - FX operations are the primary means of managing liquidity; passive monetary operations leave a wide range for excess liquidity to fluctuate. - The BoT’s FX operations lack clarity in objectives, are conducted on a daily basis, and are sometimes significant, contributing to volatile excess reserves. - Over the last two years, net open market operations (OMOs) have not offset FX activity, potentially increasing uncertainty in banks’ liquidity planning and resulting in greater volatility in excess reserves and the Interbank Money Market (IBCM) rates. - Recommended institutional and operational reforms to support transition to an interest-rate based operating target: - Develop a coherent and transparent operational framework and strategy that emphasizes attainment of the BoT’s price stability mandate. - Re-orient monetary operations to rely on OMOs to manage liquidity and steer the operational target; design FX operations with distinct objectives. - Establish a policy rate bounded by standing facilities. - Align the operating target with the monetary policy rate. - Systemically calibrate OMOs to adequately offset the liquidity position of autonomous liquidity components, including FX operations. - Develop a clear intervention strategy and distinguish FX operations by underlying objectives to foster two-way volatility of the exchange rate. - Establish a clear accountability framework to address uncertainties about policy decisions and operations. - Enhance coordination between the BoT and the MoFP to improve liquidity forecasts as the BoT seeks greater control over excess reserves. ### Building Resilience to Liquidity Shocks by Fostering Money Market Development - Market structure constraints: - Systemic liquidity management faces thin, segmented and underdeveloped markets. - Secondary market liquidity for government bonds (the main financial asset) is low, potentially increasing the liquidity premium. - Market institutional arrangements limit efficient redistribution of liquidity despite a structural liquidity surplus. - Peer 2 and 3 banks systematically rely more on wholesale funding and face restricted counterparty relationships and limits, sometimes resulting in high IBCM rates or curtailed IBCM access; their only alternative is the BoT’s Lombard facility, priced at punitive rates. - Market development actions under way and needed: - BoT plans to implement a trading system for interbank transactions and introduce the Global Master Repurchase Agreement. - Finalize outstanding operational issues to support the legal basis for perfecting collateral under repo contracts. - Establish market practices for valuation and repo margining, particularly for longer-term repos, to stimulate secondary market trading for government Treasury bills and bonds. ### Macroprudential Tools to Manage FX Liquidity Risk - Priorities and constraints: - Enhancing the prudential framework to reduce FX liquidity vulnerabilities should be a near-term priority. - International reserves will likely remain the primary FX liquidity backstop. - Specific measures recommended: - Build institutional FX liquidity buffers, beginning with increased capacity to identify and anticipate FX liquidity mismatches. - Introduce a liquidity coverage ratio denominated in FX and, conditional on EAC harmonization requirements, reserve requirements in FX. - Enhance reserve adequacy assessments to include short-term banking sector FX mismatches along with import coverage measures to better calibrate buffers. - Current reserve position: - Gross reserves are assessed to be approximately four and a half months of prospective imports (as at March 2018), and their capacity to absorb stress to FX liquidity on their own is unclear. ### ELA (Emergency Liquidity Assistance) - Importance: - Completing the ongoing process of developing an operational framework and tools for ELA is critical. - The 2006 Bank of Tanzania Act (BoTA) provides powers and responsibilities to the BoT for ELA; BoT has begun preparations to develop the corresponding operational framework and tools. - Practical gaps to address: - Determine an appropriate collateral framework to accept a wider class of assets beyond government securities. - Pre-arrange indemnification from the government when extending ELA under doubtful or exceptional circumstances. - Risk-management practices for ELA: - Test haircuts for different assets using rigorous valuation techniques. - Subject eligible collateral to pre-screening and periodic testing of loan pools to establish values and eligibility for ELA. - Ensure adequacy of required levels of overcollateralization. - Adopt a horizon-scanning framework, at least for Domestic Systemically Important Banks (D-SIBs), to anticipate immediate liquidity needs in either T Sh or FX. - ELA in FX: - Consider establishing the possibility of ELA in FX as part of the central bank’s contingency plan for preserving financial stability. - Such FX ELA should be considered on a bilateral basis, supported by horizon-scanning to identify potential FX mismatches. - Apply stringent conditions for ELA in FX, including frequently updated repayment plans, monitoring of banks’ FX liquidity position, and pre-approval of any payments from the local bank to its parent bank to ensure recovery of FX proceeds within a reasonable time. ### Banking Regulations - Prudential framework status: - Prudential regulations are broadly sound and considerable progress has been made since the 2010 FSAP. - The framework includes the 2010 risk management guidelines and a suite of new regulations introduced in 2014. - Capital adequacy requirements are based on Basel I definitions and risk-weightings, with addition of capital charges for market and operational risk. - Current minimum total capital requirement: 12 percent of risk-weighted assets, augmented by a 2½ percent capital conservation buffer. - Meeting Basel III capital standards should not be a challenge for most Tanzanian banks due to capital requirements already exceeding Basel minimums and predominance of common equity Tier 1 capital. - Basel III liquidity requirements will be more challenging due to a dearth of instruments that meet the Basel definition of high quality liquid assets (HQLA). - The BoT has a Basel II/III implementation project with completion targeted for end-2018 in line with EAC harmonization commitments. - Loan classification circular concerns: - A new circular for loan classification and restructuring introduced by the BoT on February 19, 2018 substantially weakens oversight of banks’ problem loan management. - The circular requires banks to devise strategic plans for problem loan reduction, establish permanent recovery functions and ensure top management for high risk cases. - The circular allows banks to upgrade loan classification of NPLs and to capitalize and recognize as income the interest on NPLs, likely resulting in overstated earnings and capital and masking vulnerabilities. - Recommendation: BoT should closely monitor banks to ensure awareness of their true position and require banks to develop capital plans consistent with their NPL reduction strategies in order to be prepared for withdrawal of regulatory relief at the end of 2020. - BoT should follow-up the circular to clarify conditions under which NPLs may be restructured and upgraded, including issuing FAQs and conducting supervisory monitoring of implementation through reporting requirements, targeted onsite examinations, and increased focus on largest non-performing exposures. ### Banking Supervision - Resource constraints: - Effective supervision constrained by lack of adequate resources: staff of DBS has declined since 2015 while the number of supervised institutions has increased. - DBS lacks sufficient resources for effective ongoing supervision, reflected in inability to adhere to annual onsite examination frequency. - Examination process and risk profiling hampered by insufficient focus on, and guidance from, offsite analysis. - Risk-based supervision (RBS) framework: - RBS framework and manual, introduced in 2010, are significant improvements; BoT intends to revise framework and procedures to put in place a single supervisory risk assessment process. - Recommendations for supervisory rating system: - Ensure the new supervisory rating system is appropriately judgmental and avoids pitfalls of a formula-driven approach that can understate risk. - Revise the process for assigning supervisory ratings; treat the management component (CAMELS) as a leading indicator. - Final ratings should be the responsibility of more seasoned examiners and DBS management to ensure appropriate allocation of supervisory resources. - Increase emphasis and provide additional guidance for offsite analysis to support onsite supervision. ### Problem Bank Oversight and Resolution - Legal framework: - Legal framework for early intervention and bank resolution is broadly adequate; early intervention framework is comprehensive and resolution framework establishes a special resolution regime with potential for judicial review. - Introducing legal changes to allow the Deposit Insurance Fund (DIF) to be used for lesser cost resolutions than depositor payout would be desirable; currently DIF can only be utilized for depositor payouts in case of bank liquidations. - Need for decisive action: - BoT should discontinue forbearance practices and opt for early enforcement action to contain losses. - Example: five community banks failed in January 2018 evidenced lengthy forbearance; examinations revealed significant undercapitalization and risk management deficiencies, yet progressively stronger supervisory action was not undertaken; some entities operated with negative capital for a long period. - Delays in early supervisory action resulted in greater losses. - Current vulnerabilities: - Of the 54 banks and financial institutions supervised by the BoT, 20 are CAMELS composite 3-rated and 9 are 4-rated. - These entities together represent 21 percent of the assets in the system. There are no 5-rated institutions, although three entities have negative capital. - Recommendation: Develop and implement an enforcement policy (enforcement manual/intervention policy) and operationalize PCA regulations to ensure effective, consistent, and timely corrective action through-the-cycle. - Ensure adherence to capital triggers in PCA regulations and internal guidance to avoid extended forbearance when recovery is unrealistic. - A formal, consistently administered enforcement policy would strengthen supervisory credibility and influence remedial action. - Require banks to prepare recovery plans and BoT to prepare resolution plans for D-SIBs once identified; ensure recovery plans are rigorously reviewed and detail responses to liquidity shortfalls and asset quality deterioration. ### Deposit Insurance and Financial Crises Management Arrangements - Deposit Insurance Board (DIB) governance: - Operational independence and effectiveness of the DIB should be enhanced through appointment of a functioning Board. - Although law states the Board shall meet not less than once in each quarter, a Board has not been appointed by the MoFP since February 2017, when the terms of the previous directors expired. - A functioning Board is essential to undertake and monitor implementation of planned actions in the DIB strategic plan and to facilitate movement towards operational independence. *UNITED REPUBLIC OF TANZANIA INTERNATIONAL MONETARY FUND* ### 48. Advance preparation needs to be significantly ramped up in order for the DIB to ### cr18346 - 48. Advance preparation needs to be significantly ramped up in order for the DIB to ### Advance preparation for deposit insurance payouts and liquidation - Finding: The DIB did not engage in advance preparation for insured deposit payout and bank liquidation in the case of the five recently failed banks, causing significant delays. - Risk: Delays in liquidation are likely to lead to reduced recoveries. - Recommendation: The DIB should be prepared to make payouts within a seven-day period, in line with international best practice. - Capacity gap: The DIB does not possess the resources or skill set to carry out bank liquidations on its own and needs to procure the required resources. - Procurement recommendation: Because adherence to the government procurement process can take up to a year to obtain resources, a list of resources needed for bank liquidation should be pre-approved through the procurement process and be periodically updated. ### Financial crisis preparedness and operationalizing the TFSF - Finding: Guiding principles for crisis management have been agreed and the TFSF has regular meetings, but an operational coordination mechanism is still pending. - Cause: Some sectoral regulatory authorities have not yet put in place sector-specific plans; e.g., DBS’ assessment of the impact of financial sector risks on the banking sector is not yet comprehensively and consistently applied to derive institutional risk profiles. - Priority actions to operationalize the TFSF: - Undertaking contingency planning by member agencies. - Development of checklists and guidelines for departments and individuals in key posts. - Developing clear rules for public support to be deployed in case of need. - Establishing monitoring arrangements. - Testing: The framework should be tested subsequently with a crisis simulation exercise at regular frequency to detect shortcomings. - Cross-border coordination: High priority should be given to coordination with home supervisors of foreign banks active in Tanzania regarding communication strategies, cross-border crisis management arrangements and resolution plans. ### Extraordinary powers and financial stability legal framework - Finding: Authorities have some resolution powers usable in systemic crisis situations, but a more comprehensive framework for prompt resolution is needed. - Possible powers to include: powers to inject capital, make asset purchases, provide loans or guarantees to weak systemic banks, protect uninsured depositors and creditors, and nationalization. - Recommendation: Consider passing a financial stability law in advance or drafting one for emergency passage when needed to reduce the temptation to misuse emergency powers (for example, providing open bank assistance inappropriately if an existing law permits it). ### Tackling NPLs - Finding: Legal and tax issues decrease the efficiency of enforcement and insolvency processes, impeding NPL resolution despite significant legal modernization. - Recommendations: - Establish a multi-stakeholder working group to identify mechanisms to ensure the legal and tax framework supports efficient NPL resolution. - Channel a larger percentage of corporate NPL cases through the Commercial Division of the High Court. - Ensure proper incentives for banks to pursue enforcement and liquidation claims. - Improve the insolvency law and increase its use to facilitate restructuring of viable enterprises. - Introduce voluntary out-of-court workout guidelines for multi-creditor situations. ### AML/CFT - Progress: Tanzania addressed most deficiencies from the 2009 assessment against the previous standard, amended AML/CFT legislation, and established an FIU, enabling exit from FATF-triggered monitoring. - Recent work: The National Risk Assessment (NRA) was conducted from September 2015 to December 2016, led by the FIU with BoT and other authorities; it assessed risks in 19 sectors of the Tanzanian economy. - Specific actions: 107 bureaux de change were re-licensed (as of March 2018, compared to 297 operating as of June 2017). - Remaining shortcomings: - Some aspects of the current standard are not yet implemented, such as risk-based AML/CFT supervision. - The TF offense may be too general to cover the financing of travel for the purposes of receiving terrorist training. - Recommendations: - Finalize the NRA as a matter of priority by adopting the NRA report and establishing and implementing a comprehensive action plan to mitigate identified risks. - Develop and implement a framework for a risk-based approach to AML/CFT supervision in line with NRA findings. - Consider amending CFT legislation to ensure all situations envisaged in United Nations Security Council Resolution 2178 are explicitly criminalized. - Broader benefit: Addressing remaining AML/CFT issues may help preserve access to correspondent banking relationships. ### Cyber risks - Finding: No cyber risk event has affected individual banks or the sector to date, but threat awareness has increased as banks automate transactions. - BoT actions: - Undertook stock-taking of IT needs. - Commissioned banks’ auditors to conduct separate audits of IT systems for financial years 2016 and 2017 for all commercial banks to identify common issues and enable targeted action. - Developing a regulatory guideline on cyber security; an initial draft is at the commentary stage and will be issued after incorporating industry comments. - Industry actions: Awareness workshops on cyber risks have been conducted by global banks and major audit firms. ### Financial sector development: MSMEs and long-term finance - MSME finance issues: - Large parts of the enterprise sector, particularly Micro, Small and Medium Enterprises (MSMEs), remain underserved by the formal financial sector. - Lending is expensive in part because of high perceived risk by lenders. - Financial infrastructure gaps include the secured transaction system, credit bureau improvements, introducing a National ID, and introducing a national Switch. - Multiple non-bank credit providers (non-deposit taking microfinance, digital finance, invoice discounting providers) operate without full regulation and supervision, undermining data collection and raising legitimacy, AML/CFT reporting and consumer treatment issues. - Recommendations: - Regulate and supervise all credit providers in Tanzania. - Address gaps in financial literacy and consumer protection by introducing a new financial consumer protection framework. - Long-term finance: - Pension funds could be a meaningful source of long-term financing but currently hold substantial investments in illiquid and unproductive assets. - Actions needed include resolving outstanding government loans to pension funds and devising a strategy for high levels of real estate holdings. - Increase the number and size of liquid securities, including equities, debt and structured products. - Consider privatizing commercial state-owned enterprises as a source of new listings on the Dar Es Salaam Stock Exchange. - Improve monitoring and oversight of Development Finance Institutions involved in facilitating increased access to long-term finance. *cr18346 - 48. Advance preparation needs to be significantly ramped up in order for the DIB to* ### Box 1. Bank M ### Box 1. Bank M ### Incident summary and timeline - Due to liquidity problems, Bank M was placed under BoT’s statutory management and its operations suspended for 90 days on August 2, 2018. - While holding a small share of banking system assets (3½ percent), lending (5.2 percent) and deposits (2.8 percent), it is active in the interbank market. - No significant contagion impact on other financial institutions nor on confidence in the banking sector has been reported thus far, despite the deposit freeze. ### Systemic importance and exposures - Bank M’s balance-sheet shares: - Assets: 3½ percent - Lending: 5.2 percent - Deposits: 2.8 percent - Market role: - Active participant in the interbank market. - Observed impacts to date: - No significant contagion to other institutions reported. - No reported material loss of confidence in the banking sector thus far. ### Authorities’ recommended resolution actions - Quickly identify and implement a least cost resolution strategy to minimize systemic risks. - Priority actions: - Provide depositors with swift access to their insured deposits. - Promptly execute a resolution strategy which minimizes systemic risks and resolution costs (including to the deposit insurance scheme). - Loss allocation principle: - Losses should be borne by shareholders in the first instance, and then uninsured creditors (as consistent with preserving financial stability). ### Monitoring and ongoing risk management - The authorities should continue to closely monitor deposit flows at other banks at a high frequency. *Box 1. Bank M, UNITED REPUBLIC OF TANZANIA, INTERNATIONAL MONETARY FUND.* ### Appendix I. Risk Assessment Matrix ### Appendix I. Risk Assessment Matrix ### Domestic Risks - Overall concerns raised: - A deteriorating business environment and delays in addressing key infrastructure bottlenecks. - Impact: Would discourage private sector investment and have adverse impact on economic activity. - Infrastructure development is crucial for reducing costs, attracting investment in the real sector, and sustaining growth; slow execution of infrastructure spending would negatively affect overall investment and growth. - Slower growth would exacerbate the recent rise in NPL ratios, with negative effects on bank profitability, capitalization, and credit growth. Two-way macro-financial feedback loops can amplify banking sector stress. - Sustained overspending and insufficient revenue collection undermine fiscal sustainability in the medium/long term. - A temporary increase in infrastructure spending widens fiscal deficits in the short term. If overspending and deficits become entrenched and cannot be reversed in the medium/long term, financing pressures/costs would rise and fiscal sustainability would be compromised. - Adverse fiscal dynamics would be exacerbated by insufficient revenue mobilization and tighter external funding constraints. - Domestic financing of sustained budget deficits would crowd out credit to the private sector, further deteriorating bank asset quality (NPL ratios). - Deteriorating fundamentals undermine confidence in the banking sector, triggering funding liquidity shocks. - Further deterioration in banks’ balance sheets (NPL ratios and corporate borrower defaults) triggers runs on deposits. - Banks may be unable to meet withdrawals of dollar denominated deposits (if these are sufficiently large) as loans are illiquid, which could drain the BoT’s foreign exchange reserves and put pressure on the exchange rate. - Large capital outflows would exacerbate exchange rate pressures, feeding a vicious cycle of loan defaults — bank deposit/capital outflows — schilling depreciation. - Relative likelihood / impact indicators in the matrix: - Banking confidence/funding liquidity shocks: Low/Medium. - Business environment / infrastructure delays: (relative likelihood/impact not provided as exact cell values in the excerpt). - Sustained overspending / revenue shortfalls: Low (relative likelihood), unspecified impact cell in excerpt. ### External Risks - Key external vulnerabilities and channels: - Adverse and protracted global financial conditions reduce availability of external funding, with adverse impact on public investment. - If tighter global financial conditions are protracted, they would deteriorate macroeconomic conditions in advanced economies, hampering availability of external funding for LICs. This would delay public investment and resolution of infrastructure bottlenecks in Tanzania, constraining growth, and putting pressure on bank revenues and asset quality. - Tighter global financial conditions would complicate budget financing and raise funding costs in government and private sectors—domestic arrears could rise, hitting state owned enterprises and nonfinancial firms with knock-on adverse impact on bank asset quality. - Significant China slowdown. - A China slowdown would reduce Chinese FDI and loans for infrastructure projects, weakening growth prospects. - It would lower commodity prices, reducing revenue from export of metals and external demand from main trading partners—including demand for Tanzania’s port services by neighboring countries. - The Tanzanian schilling would depreciate, triggering defaults of dollar-denominated loans—with adverse impact on bank profitability and capitalization. - Reduced demand for Tanzanian exports of goods and services from main trading partners due to a global slowdown. - Main trading partners potentially affected include Switzerland, India, China, South Africa, Kenya, and DR of Congo. - Reduced exports and tourism demand would lower foreign currency inflows, depreciate the schilling, and trigger defaults of dollar-denominated loans—with adverse impact on bank profitability and capitalization. - Level of concern noted in the matrix: - Adverse/protracted global financial conditions: Medium/High. - Significant China slowdown: Low/Medium. - Reduced external demand from trading partners: Medium. ### Appendix II. Follow-up of 2010 FSAP Recommendations (summary of steps taken and planned) - Financial structure - Consider raising minimum bank capital requirements to promote consolidation. - A study was undertaken; capital levels were increased in 2012. Very little consolidation occurred. - Abolish the loan-to-deposit ceiling (previously set at 80 percent). - Removed from regulatory requirements as part of the 2014 prudential regulations. - Pass regulations for Credit Bureau; create the database for credit information and identification of debtors. - Regulations passed. The Databank was established in 2012; banks submit credit information. Two Credit bureaus licensed and providing services. - Grant exclusive jurisdiction over enforcement of creditor claims to commercial courts. - Not implemented. - Design and implement comprehensive reform of civil procedure to reduce intentional delays by debtors. - Mortgage Finance (Special Provisions) Act, 2008 specified rules; Appellate Jurisdiction Act, Civil Procedure Code Act and Magistrates Court Act 1984 amended to bar appeal/revision/review against decisions that do not finally and exclusively determine a suit. - Safeguarding financial stability — Risks and vulnerabilities in the banking system - Improve timeliness and quality of prudential data; establish consistent dataset for macroprudential analysis. - Ongoing: BoT developed a web-based Electronic Data Interchange system. Relationship Officers conduct “eye-balling” analysis to ascertain accuracy and consistency. Establishing a consistent dataset for macroprudential analysis is part of targeted future actions. BoT currently uses a proxy dataset to assess property, household and corporate sectors. - Be more proactive in ensuring compliance with prudential limits, including on provisioning and large exposures. - Continuous process: offsite surveillance, regular onsite inspections, and regulatory sanctions when noncompliance observed. - Crisis management framework - Establish a systemic crisis management plan and framework for ELA; bolster reserves of the Deposit Insurance Fund. - Remains on the to-do list. A crisis management plan exists but needs improvement and crisis simulation exercises. - Banking sector regulation and supervision - Address capacity and organizational challenges in banking supervision and reduce hierarchy in communication protocol between the BoT and the banks. - BoT implemented Electronic Data Interchange (EDI) and an Onsite Examination System. The BoT meets with senior management on an ad hoc basis; trilateral meetings with senior management and external auditors are scheduled for out of the ordinary issues. - Increase cooperation with home regulators of major international banks and their internal audit services. - MoUs entered with Central Banks of Comoros, Cyprus, the EAC, India, Macao, Nigeria, South Africa, and Zimbabwe. - Seek hands-on technical assistance to implement all aspects of RBS. - Extensive technical assistance received. - Systemic liquidity - Distinguish between sterilization and intervention objectives in FX interventions; limit REPOs to fine-tuning and SMRs for long-term structural sterilization. - BoT participates in FX market selling small amounts of USD on descending order consistent with Average Reserve Money (ARM) objective; may sell more to restore order. Repos conducted through variable rate auctions, usually for 7 and 14-days. SMR used intermittently; SMR unchanged at 10 percent for past decade except change to 8 percent in December 2014 that was reinstated to 10 percent in May 2015. - Expedite movement of government deposits from commercial banks to the BoT. - Various public institutions opened accounts with the BoT. As of March 24, 2016, a total of 158 accounts in T Sh denomination, and 86 accounts in FX denomination were open at the BoT, of which 28 accounts in T Sh denomination and 22 accounts in FX denomination have started to deposit their funds at the BoT. - Promoting Long-Term Finance — Securities markets - Design and implement an effective risk management system for securities settlement. - DSE settlement system connected to TISS and allows custodians to settle on their bonus account. Efforts underway to separate CSD from the DSE. - Confer adequate supervisory powers on the CMSA; adopt legislation requiring demutualization of the DSE and splitting the DSE and the CSD. - Capital Markets and Securities Act 1994 amended in 2010 to confer inspection and investigation powers on CMSA and widen scope of market intermediaries. CMSA admitted to Appendix A in 2011. DSE demutualization commenced; DSE incorporated as a public company limited by share capital and in process of issuing shares to the public with a prospectus submitted to CMSA—expected IPO and listing before the end of June 2016. CMSA amended CMS (Establishment of Stock Exchanges) Regulations, 1996 to allow DSE Limited to be profit-making. DSE commenced process of separating the CSD from the Exchange. - Capital flows and capital account liberalization - Revise capital account liberalization plan to ensure properly sequenced lifting of controls with supporting policies. - BoT, MoFP and CMSA have taken a gradual approach. In May 2014, the capital account was fully opened to EAC residents; plan to open to rest of world in the near-future. A new draft regulation permits capital account transactions to the rest of the world with safeguards for debt inflows. - Pensions - Finalize establishment of Social Security Regulatory Authority and commence operations. - SSRA established and became operational in 2010. - Replace fund-specific laws with single common pension law. - Task of identifying and harmonizing key areas into a single social security law is in-progress. ### Appendix III. Report on the Observance of Standard and Codes — Basel Core Principles for Effective Banking Supervision (selected findings) - Responsibilities, Powers, Independence, Resources, Accountability and Cooperation (Principles 1–3) - The BoT’s supervisory responsibilities and powers are well established. - Accountability could be improved through public reporting of supervision performance relative to objectives. - FSF meets regularly but is not yet operational as a crisis management coordination body because sectoral regulatory authorities have not put in place sector-specific plans. - The DBS is not adequately resourced: staff declined by 10 since 2015 while the number of supervised institutions has increased. - The increase in ongoing projects, EAC commitments, and ad hoc demands (including closure of five small banks in January 2018) exacerbate resource constraints. Even when 20 staff deployed in recently closed banks return to normal duties, DBS will have insufficient resources for effective ongoing supervision. - Ownership, Licensing and Structure (Principles 4–6) - Generally high level of compliance with appropriate legal requirements and review processes. - Vetting processes for proposed directors and senior management rely largely on desk review; recommendation to routinely interview proposed new owners of significant shareholdings and proposed directors and senior managers as part of licensing or transfer-of-ownership processes. - Methods of Ongoing Supervision (Principles 8–10) - The RBS Framework has resulted in generally effective supervisory review of specific risks; BoT intends to revise RBS framework and manual to replace current risk-assessment methodology and CAMELS ratings with a single supervisory risk assessment process. - Revised approach should emphasize offsite analysis and ensure the supervisory rating system is appropriately judgmental to avoid formula-driven outcomes. - CAMELS ratings currently determined with reference to guides specifying ranges for key ratios; in samples the ratings appeared formula-driven and potentially backward-looking, possibly understating material weaknesses identified by examiners. - Planned revision of the RBS Manual should include additional guidance and increased emphasis on offsite analysis; current manual (introduced in 2010) is heavily focused on onsite procedures with limited offsite guidance. - Directorate management should provide additional feedback and on-the-job training to improve breadth and depth of institutional profiles and examination reports; quality currently varies widely and offsite analysis often relies extensively on descriptions of trends in ratios with limited insight into drivers. *Source: cr18346 - Appendix I. Risk Assessment Matrix (excerpts from the provided document).* ### 9. In order to enhance the quality of offsite analysis, the DBS should implement a ### cr18346 - 9. In order to enhance the quality of offsite analysis, the DBS should implement a ### Offsite analysis and supervisory approach (Principle 9) - Finding: Offsite analysis quality is uneven and currently relies extensively on descriptions of trends in ratios, providing limited insight into drivers of trends. - Recommendation: Implement a program of regular bilateral or trilateral meetings with external auditors. - Recommendation: Put in place a regular schedule of meetings with heads of key functions within supervised institutions. - Recommendation: Use insights from additional meetings plus findings from offsite review of banks’ internal policies and procedures to enhance the forward-looking perspective of institutional profiles (IPs) and other supervisory analysis. - Recommendation: DBS management should provide additional feedback and on-the-job training on completion of IPs and examination reports, focusing on increasing breadth and depth of analysis. - Recommendation: New supervisory rating system should be appropriately judgmental; specific guidelines are needed to conduct regular business model analysis as well as peer review and sectoral analysis. - Finding: There are currently no specific internal off-site examination procedures. - Finding: The current supervisory approach prioritizes on-site work; combined with staff shortages this results in too much time devoted to on-site relative to off-site work. ### Corrective and sanctioning powers, timeliness of action (Principle 11) - Finding: The BoT has an appropriately wide/full range of corrective and sanctioning powers and there is evidence these have been used. - Finding: DBS lacks documented procedures such as an enforcement manual or intervention policy, and lacks a policy for operationalizing the Prompt Corrective Action Regulations to guide decision-making for banks under stress. - Finding: The BoT has yet to implement a requirement that larger banks have recovery plans, or to initiate resolution planning in line with the Financial Stability Board Key Elements of Effective Resolution Regimes. - Evidence of delayed action: - Recent cases indicate serious problems had in most instances been uncovered by DBS staff years in advance of bank failures, yet opportunities to resolve problems before reaching the critical stage were missed. - Failure to act when DBS staff correctly identified insolvent banks with no realistic prospect of recovery has led to increased losses for depositors and other creditors. - The five community banks closed in January 2018 had been in a problematic situation for many years before action was taken. - Recommendation: Complement the Prompt Corrective Action Regulations, 2014 with a set of triggers in addition to capital to ensure earlier action. - Recommendation: Develop internal procedures to guide decision-making in dealing with banks under stress; require recovery plans for larger banks and initiate resolution planning. ### Consolidated and cross-border supervision (Principles 12, 13) - Finding: The Consolidated Supervision Regulations and Supplement to the RBS Manual on Consolidated Supervision have provided since 2014 the legal foundation and procedures for consolidated supervision. - Finding: Although the BoT has convened one supervisory college, required consideration of group structures and risks has not been incorporated into ongoing offsite or onsite work; material risks are not being identified and monitored. - Coverage gap: Consolidated supervision procedures need implementation for: - the two Tanzanian banks with international operations, - other domestic banks with financial sector affiliates, - more than 20 banks which are part of foreign groups. - Finding: In practice the BoT is not yet systematically receiving data on all relevant group entities despite Consolidated Supervision Regulations (2014). - Recommendation: Put in place procedures to assess the quality of supervision in home countries of foreign bank subsidiaries in Tanzania. - Recommendation: Develop a formal policy for assessing whether on-site examinations of a banking group’s foreign operations are necessary or whether additional reporting is required; formally assess the quality of supervision conducted by host supervisors. - Finding: There is little coordination of activities with relevant foreign authorities outside EAC Partner States; MOUs were drafted using older Basel guidance and need updating to reflect current best practices on relationships among supervisors. - Recommendation: Amend BFIA to ensure no shell bank would be authorized to operate in Tanzania. ### Corporate governance, prudential requirements, accounting and disclosure (Principles 14–29) - Finding: Planned new Corporate Governance Regulations provide an opportunity to update the Guidelines for Boards of Directors, which are based on previous Basel guidance and do not contain all elements in current Basel standards; current guidelines provide a sufficient foundation. - Recommendation: Include a specific requirement for a code of conduct and conflicts of interest policy, and require bank- or group-wide compensation policies aligned with current Basel guidance to ensure alignment of incentives with long-term interests. - Finding: The BoT’s prudential standards and supervisory review of specific risks are generally sound. - Capital framework and timeline: - The BoT capital adequacy requirements are based on Basel I definitions and risk-weightings, with the addition of capital charges for market and operational risk. - The current minimum requirement is total capital equal to 12 percent of risk-weighted assets, plus a 2.5 percent capital conservation buffer. - The BoT has a Basel II/III implementation project with completion targeted for end-2018 in line with EAC harmonization commitments. - Finding: Meeting Basel III capital standards should not be a challenge for most Tanzanian banks due to capital requirements already exceeding Basel minimums and the predominance of common equity Tier 1 capital. - Finding: Basel III liquidity requirements will be more challenging due in part to the dearth in the Tanzanian market of instruments that meet the Basel definition of high quality liquid assets (HQLA). - Recommendation: Introduce specific requirements for overall capital and liquidity planning in relation to a bank’s risk appetite and risk profile (could be addressed through the Basel II/III implementation project). - Recommendation: Revisions to the RBS manual should include specific guidance on supervisory review and validation of models; consider a specific requirement for Chief Risk Officers (at least for larger banks) and requirements for recovery plans. - Recommendation: Provide more detailed guidance on banks’ stress testing programs and make more use of stress testing results for supervisory purposes; address through revision to Risk Management Guidelines (RMG) and RBS Manual. ### Loan classification and provisioning relief (from February 2018) - Finding: Until February 2018, BoT prudential standards for loan classification and provisioning were consistent with international best practices. - Change: Recently introduced regulatory relief through end-2020 for loan classification and provisioning is a step back. - Elements of the regulatory relief: - Banks will be permitted to capitalize interest when restructuring overdrafts. - Banks will be able to restructure loans up to four times. - Banks will be able to remove the adverse classification of a restructured loan once the debtor has made two (rather than the current four) payments. - Risk: The combination of capitalizing and recognizing as income interest on non-performing loans, and upgrading the classification of non-performing loans, is likely to result in overstated earnings and capital, masking vulnerabilities and overstating resilience of some individual banks and the system overall. - Recommendation: BoT should closely monitor banks to ensure awareness of their true position for effective financial stability analysis notwithstanding the regulatory relief. ### Resourcing, staffing and operational independence (Principles 2, 3, 5, 8) - Staffing gaps and operational impact: - As of February 2018, the gap amounted to 19 technical staff positions according to the DBS’s own evaluation, compared to the actual number of 42 staff members (excluding ten managers and two advisors). - In these circumstances, the BoT is not able to adhere to the internal policy set out by the RBS Manual for an annual bank supervisory cycle. - Relationship officers are responsible for several banks rather than one, stretching their capacity for adequate offsite analysis and onsite participation. - Finding: The circular on “Measures to increase credit to private sector and contain NPLs” issued by the BoT on February 19, 2018 may suggest that prudential standards could be pressured by the BoT’s legal primary objective “to support the general economic policy of the government.” - Finding: Recent requirement to obtain approval of the Office of the President for foreign travel may potentially impinge on BoT operational independence and the DBS’s ability to travel as necessary for consolidated supervision, regional/international meetings and training. - Recommendation: Amend BOTA so that there is a statutory requirement that reasons for removal of the governor or a Board member be publicly disclosed. - Recommendation: BoT should have complete discretion as an autonomous agency to determine international travel necessary to implement effective supervision. *Source: cr18346 - 9. In order to enhance the quality of offsite analysis, the DBS should implement a* ### 2.5 percent capital buffer and in most cases report significantly higher capital, so ### cr18346 - 2.5 percent capital buffer and in most cases report significantly higher capital, so ### Credit risk, problem assets, and provisioning (Principles 17–18) - Principle 17: Credit risk framework generally sound and comprehensive, but: - No requirement that exposures exceeding a certain amount/percentage of the bank’s capital, or especially risky credit exposures, be decided by the bank’s Board or senior management. - The BoT should provide more detailed guidance on stress testing and make greater use of banks’ stress-testing results in its risk analysis. - DBS staff should receive training to credibly challenge banks’ stress-testing assumptions and scenarios. - Principle 18: Concerns on classification/provisioning: - Development finance loans: interest may be accrued on non-performing loans for six months, three months beyond the Basel standard of 90 days. - Circular issued by the BoT on February 19, 2018 grants regulatory relief for a three-year period through end-2020; multiple elements of the relief may be inadequate for prudential purposes and inconsistent with Basel Committee Guidance on Credit Risk and Accounting for Expected Losses (December 2015). - Objective to reduce banks’ NPLs to 5 percent is laudable, but regulatory relief may defer recognition of impairment and expected credit losses. - Restructuring requirements (Circular item #2) do not require assessment of future borrower viability; restructurings may be applied up to four times, effectively deferring impairment recognition. - Circular item #3 permits capitalization of accrued interest on restructuring for overdrafts where bank determines no alternative—this may overstate income versus holding interest in suspense. - Upgrading of facilities after restructuring (Circular item #4) and repeated restructurings allow deferral of impairment recognition; item #5 requires write-off after four quarters in the loss category but loss loans can be restructured and returned to performing status. - Contextual risks: depressed real estate prices, legal processes taking a year or more, and provisions of the Tax Administration Act 2015 that may make seizure of mortgaged property result in additional loss. - Recommendation: DBS must closely monitor banks’ practices to ensure regulatory relief through end-2020 is not abused and BoT is aware of true bank positions. - Supervisory practice recommendations: - Onsite work should devote more attention to assessing the value of risk mitigants even where collateral value is not permitted in provisioning. - Additional focus on classification and provisioning of off-balance sheet items (though typically small other than undrawn facilities). ### Concentration risk, related parties, country/market risks (Principles 19–23) - Principle 19: Concentration risk and large exposure limits: - Delays/failures in Government guarantee programs make exemptions from single borrower limit for Government-guaranteed facilities potentially inappropriate. - Single borrower limit should be applied to foreign exchange placements abroad; current Foreign Exchange Exposure Regulations’ diversification requirement can allow excessive exposures. - Thirteen waivers from risk concentration limits were provided by the BoT between July and November 2017; four relate to diversification requirements for placements abroad. - Existing single borrower limit parameters cited: 25 percent of core capital where exposure is at least 125 percent secured by collateral; 10 percent of core capital where exposure is below 125 percent secured by collateral; and 5 percent of core capital where exposure is unsecured. - Recommendation: Replace current diversification requirement in Foreign Exchange regulations by extending Credit Concentration and Other Exposure Limits Regulations to all exposures including placements abroad. - Principle 20: Transactions with related parties: - BoT should consider aligning related-party definition fully with the Basel definition. - Amend Credit Concentration and Other Exposure Limits Regulations to establish specific write-off requirements for insider exposures. - Require loans and advances to staff to be governed by well-documented policy and that staff beneficiaries do not participate in approvals; address via planned Corporate Governance Regulations. - Principle 21: Country and transfer risks: - Prudential standards introduced in 2014, but supervisory verification process not yet in place; lower priority given low exposures, but RBS Manual should be revised over time to include review procedures, guidance for classification/provisioning and stress testing, and a supervisory return covering country and transfer risks. - Principle 22: Market risks: - Market risk concentrated in foreign exchange risk and interest rate risk; tradable instrument exposure low. - BoT could verify mark-to-market practices and timely capture of trading data more systematically. - Principle 23: Interest rate risk in the banking book: - RMGs discuss interest rate risk descriptively with few prescriptions; examination procedures do not require detailed review. - RMGs and examination procedures should be revised to establish clear supervisory requirements and specific review of policies, measurement tools, reporting, and stress testing for interest rate risk in the banking book. ### Liquidity, operational risk, reporting, disclosure, and AML/CFT (Principles 24–29) - Principle 24: Liquidity risk: - Introducing Basel III liquidity definitions and requirements is challenging due to dearth of HQLA in markets without broad/deep debt markets; this is an EAC-wide issue to address via EAC harmonization. - Supervisors should more consistently consider liquidity impacts of other risks. - More detailed review of banks’ contingency plans in offsite process recommended; RMGs could be more prescriptive on liquidity stress testing. - Introduction of Liquidity Coverage Ratio and Net Stable Funding Ratio in Basel II/III project may address part of this. - Principle 25: Operational risk: - Onsite work shows extensive focus on operational risk; Operational Risk Examination Procedures should be revised to emphasize prudential risks rather than items better suited to internal audit (e.g., physical security, branch inspections). - Principle 27: Financial reporting and external audit: - BoT could enhance onsite review of banks’ valuation practices and institute regular meetings with individual external auditors (e.g., to review year-end adjustments). - Principle 28: Disclosure and transparency: - Need for more specific guidance on contents of banks’ disclosures; Pillar 3 disclosures under Basel II/III implementation could meet this. - Banks should disclose group structures publicly (currently reported to BoT but not required in published disclosures). - Principle 29: Abuse of financial services (AML/CFT): - 2009 ESAAMLG mutual evaluation found AML/CFT regime in early development; since then AML law revised, BoT introduced AML/CFT Examination procedures, and FIU/reporting entity work expanded. - June 2014 FATF recognized significant progress and removed Tanzania from FATF monitoring; Tanzania joined the Egmont Group of FIUs. - Tanzania has not been assessed under the 2012 criteria and revised methodology (amendments in 2013, 2015, 2016, 2017). - Recommendations: FIU should provide statistical data on STRs to BoT regularly; AML legal framework requires revision to align with most recent FATF recommendations; expand definition of Politically Exposed Persons per FATF 2012 (including domestic persons); define business to be refused and require risk-based review of existing customers. ### Recommended priority actions and detailed recommended action plan (summary) - Priority actions highlighted: - Ensure adequate staffing of the supervision function (CP 2). - Revise the RBS framework to introduce a single non-formulaic risk rating system (CP 1, 9). - Implement consolidated supervision by operationalizing the 2014 supplement to the RBS manual (CP 10, 12). - Enforce existing Prompt Corrective Action regulations and introduce internal guidance to ensure timely action on problem banks (EC 11). - Closely monitor banks’ classification and provisioning to ensure regulatory relief through end-2020 is not abused. - Selected recommended actions by Principle (representative items): - Principle 1: Revise RBS Framework and implement consolidated supervision. - Principle 2: Increase DBS staffing to fulfill supervision mandate. - Principle 3: Implement crisis management provisions of Financial Stability Forum; enter into MOUs with home country supervisors and consider publishing MOUs. - Principle 5: Consider revising minimum absolute capital levels at entry; strengthen fit-and-proper processes; early onsite visits and intensive offsite monitoring in first two years after licensing. - Principle 8: Implement regular analysis of banking groups; require recovery and resolution plans for systemically important banks once identified. - Principle 9: Urgently review RBS Manual to replace dual methodologies with a single non-averaging approach; enhance offsite risk analysis; organize formal prudential meetings with banks; strengthen relations with external auditors. - Principle 10: Systematically collect group entity data per Consolidated Supervision Regulations (2014); include valuation practice reviews in working programs. - Principle 11: Strengthen Prompt Corrective Action framework with detailed internal guidelines and triggers beyond capital ratios. - Principle 12: Implement Consolidated Supervision Regulation and 2014 Supplement procedures in ongoing supervision; develop procedures to assess quality of home-country supervision and when foreign on-site examinations are necessary. - Principle 14–16: Introduce codes of conduct and conflict-of-interest rules; require capital and liquidity planning processes tied to risk appetite; require Chief Risk Officers at least in large banks; complete Basel II/III implementation project. - Principle 17–18: Provide detailed guidance on stress testing; closely monitor classification and provisioning practices during regulatory relief through end-2020; assess value of risk mitigants and off-balance sheet classification. - Principle 19: Remove exemptions from concentration limits for government-guaranteed exposures; apply single borrower limit to foreign currency placements abroad. - Principle 20: Introduce high-level approval requirements for write-off of insider exposures; extend conflict-of-interest exclusions to staff. - Principle 21: Revise RBS Manual for country and transfer risk procedures; introduce supervisory return covering country and transfer risk. - Principle 22–24: Systematically verify mark-to-market practices; provide detailed guidance on interest rate risk in the banking book; work with EAC Partner States to consider Basel III liquidity implementation to account for limited HQLA in regional markets. - Principle 25: Revise Operational Risk Examination Procedures to focus on prudential operational risks. - Principle 27–29: Enhance onsite review of valuation practices; regular auditor engagement; Pillar 3 disclosures and public disclosure of group structures; FIU to provide STR statistics to BoT and revise AML legal framework to align with recent FATF recommendations. ### Authorities’ response (BoT) - BoT welcomes assessors’ acknowledgment of progress since 2009 FSAP Update, including RBS Manual review (August 2010) and 2014 regulatory framework review; adopted 2014 supplement for consolidated supervision. - Notes assessment uses Basel Committee methodology issued September 2012 (revised substantially from 2006), so ratings are not directly comparable with earlier assessments. - Specific BoT positions: - Staff shortage: BoT agrees and notes efforts taken to provide additional staff to DBS; will continue to engage qualified staff to fill vacancies. - Supervisory techniques and tools: BoT notes significant efforts since prior FSAP, including RBS Manual review in August 2010, acquisition of onsite examination software and automation of onsite work papers since 2014, leading to generally more effective supervision. - Problem assets, provisions, and reserves: BoT committed to monitoring implementation of temporary regulatory relief granted in February 2018 to ensure it does not undermine adequacy of classification and provisioning for prudential purposes. - BoT agrees with other recommendations and is committed to taking steps to address identified gaps. *Source: cr18346 - 2.5 percent capital buffer and in most cases report significantly higher capital, so (IMF).* ### Appendix IV. Banking Sector Stress Testing Matrix (STeM) ### Appendix IV. Banking Sector Stress Testing Matrix (STeM) ### Banking sector: Solvency risk — institutional perimeter and data - Institutions included (Top-Down by Authorities): 40 banks - Institutions included (Top-down by FSAP Team): 45 banks (Peer 1–3 and government-owned) - Market share (Authorities): 98 percent of total banking sector assets (excl. community banks) - Market share (FSAP Team): 100 percent of total banking sector assets (excl. community banks) - Data and baseline date: Supervisory data as of December 2017 ### Solvency risk — channels of risk propagation and methodology - Methodology (Authorities): Balance sheet model (Čihák, 2007) - Methodology (FSAP Team): IMF stress testing framework (see methodology note) - Satellite models (Authorities): N/A - Satellite models (FSAP Team): Dynamic panel data satellite models for bank-level NPL ratios, credit growth, and pre-impairment profit - Stress test horizon (Authorities): 1 period - Stress test horizon (FSAP Team): 3 years (quarterly frequency) ### Solvency risk — macro scenarios and macro-financial variables - Macro scenarios: baseline, adverse and tail risk scenarios - Macro-financial variables included: real GDP growth, nominal exchange rate change, overnight interbank cash market rate, growth in nominal and real bank credit to the private sector, short and long bond rates, deposit rates, inflation and commodity prices - Baseline: All variables follow the IMF WEO projections - Adverse scenario (FSAP Team description): - Tanzania’s real GDP growth path is about 1 std. lower than the baseline projection - Assumes moderate depreciation and inflation - Cumulative increase in the interbank rate of 200 bps - Cumulative increase in the short rate of 200 bps - Corresponding increase in the long rate of 100 bps - Credit expands moderately at an average rate of 7 percent in nominal terms and 1.5 percent in real terms - Commodity prices remain flat over the period - Tail risk scenario (FSAP Team description): - Tanzania’s real GDP growth path is about 3 std. lower than the baseline projection - Commodity prices decline by 30 percent over the first two years - Trigger a cumulative currency depreciation of about 40 percent - Increase in inflation, which peaks at about 11 percent in 2019 - Maximum interest rate increase attained in 2019: 500 bps for the interbank rate and the short rate and 300 bps for the long rate - Credit barely expands in nominal terms and contracts in real terms at an average rate of about 2.5 percent ### Solvency risk — sensitivity analysis and credit risk shocks - Authorities — Credit Risk shocks: - Increase in NPLs: - a. by 8 percent (proportional to performing loans) - b. by 8 percent (proportional to existing NPLs) - Increase in sectoral NPLs (proportional to sectoral loans): - agriculture: 4 percent - manufacturing: 12 percent - trade: 7.5 percent - personal loans: 5.5 percent - Default of largest 1, 3, 5 borrowers - FSAP Team — Credit Risk shocks: - Increase in NPLs proportional to existing NPLs: - a. by 25 and 50 percent in 1 year - b. by 100 and 150 percent in 2 years - Increase in NPLs proportional to total loans: by 3, 5 and 7 percent of total loans - Increase in NPLs in sectors (100 percent shocks): agriculture, trade, transportation and communication, personal loans - Default of largest 1, 3, 5 borrowers - Shocks to the loan transition matrix: downgrades of a fraction of banks’ loans in each risk class by a notch - Reverse credit risk tests to find the NPL shocks that: - a. would bring the banking system’s CAR down to (i) 14.5 percent and (ii) 12 percent; - b. would cause banks accounting for 25 percent/50 percent of the banking sector assets to fall below the regulatory capital requirement; - c. would require capital injections of 0.5/1 percent of GDP ### Solvency risk — interest rate and currency risk scenarios - Authorities — Interest Rate Risk (Income Effect): - Test assumes an interest rate increase of 200 bps at maturities shorter than 3 years and 400 bps at maturities longer than 3 years - Authorities — Currency Risk: - a. currency depreciation/appreciation of 10 percent - b. mixed currency depreciation and appreciation - Authorities — One period multifactor scenario: shocks to NPLs, interest rates, exchange rates, and profits - FSAP Team — Interest Rate Risk (Income Effect): - Parallel shifts in interest rates in domestic and foreign currency of 300 bps, 600 bps, and 1000 bps - FSAP Team — Currency Risk: - a. currency depreciation of 15 and 25 percent - b. currency appreciation of 15 and 25 percent ### Solvency risk — risks assessed, behavioral adjustments, and calibration - Risks/factors assessed (Authorities): Credit losses, profits, losses from maturity mismatches, counterparty and sectoral concentration risk - Risks/factors assessed (FSAP Team): Credit losses, credit growth, pre-impairment profits, repricing gap, sectoral credit shocks, losses from maturity and currency mismatches, indirect FX risk, counterparty risk, reverse NPL shocks - Behavioral adjustments (Authorities): N/A - Behavioral adjustments (FSAP Team): Assumptions for credit growth in various scenarios as well as dividend payout ratio, repricing gap, NOP, noninterest income, expenses, taxes; dividend payout rule consistent with the aim to build capital conservation buffers - Calibration of risk parameters (Authorities): Changes in sectoral NPLs calibrated on changes in commodity prices and other risk factors - Calibration (FSAP Team): Projections of bank-by-bank NPL ratios, credit growth and pre-impairment profits based on satellite macro-financial models combined with accounting identities and behavioral assumptions; banks’ NPL ratios modeled as a function of real GDP growth, the interest rates, and the exchange rate vis-à-vis the U.S. dollar; credit growth projection based on macro assumptions and impact of interest rate shocks on net interest income assessed in a repricing gap framework for multiple periods ### Solvency risk — regulatory standards - Regulatory/accounting standards: Country-specific regulatory minimum CAR - Newly adopted capital conservation buffer is taken into account ### Banking sector: Liquidity risk — institutional perimeter and data - Institutions included (Authorities): 40 banks - Institutions included (FSAP Team): 43 banks (Peer 1–3 and government-owned banks) - Market share (Authorities): 98 percent of total banking sector assets (excl. community banks) - Market share (FSAP Team): 100 percent of total banking sector assets (excl. community banks) - Data and baseline date: Supervisory data as of December 2017 ### Liquidity risk — channels, methodology and shocks - Methodology (Authorities): Bank run (balance sheet-based) - a. Systemic run - b. Idiosyncratic run - Bank run and haircuts on liquid assets - Methodology (FSAP Team): Cash-flow-based using maturity buckets - Risks assessed: Funding liquidity shock; Market liquidity shock - Buffers (Authorities): Liquid assets - Buffers (FSAP Team): Counterbalancing capacity; Liquid assets ### Liquidity risk — tail shocks and assumptions - Size of the shock (Authorities): - a. a withdrawal of 10 percent of deposits per day - b. lower withdrawals from banks considered strongest: - by size (total assets) - by group (domestic, OECD, non-OECD) - pre-shock CAMEL or core FSI rating - Assumptions: Run-off rates on funding sources and roll-off rates on assets to estimate the funding gap ### Liquidity risk — regulatory standards and reporting - Regulatory standards (Authorities): Hurdle metrics: survival period; Local regulatory requirements - Regulatory standards (FSAP Team): Hurdle metrics: funding gap, survival period, regulatory liquid assets ratio; Local regulatory requirements - Reporting format for results: - Number of banks that can meet their obligations - Funding gap by bank and currency, aggregated - Survival period in days by bank - Number of banks that are liquid/illiquid ### Banking sector: Contagion risk — institutional perimeter and data - Institutions included (Authorities): 31 banks - Institutions included (FSAP Team): 29 banks - Market share (Authorities): 96 percent of total banking sector assets (excl. community banks) - Market share (FSAP Team): 97 percent of total banking sector assets (excl. community banks) - Data and baseline date (Authorities): Supervisory data as of December 2016 - Data and baseline date (FSAP Team): Supervisory data as of December 2017 ### Contagion risk — methodology and tail shocks - Methodology (Authorities): Stress test based on the net interbank exposure matrix (like in Čihák, 2007) - Methodology (FSAP Team): Balance-sheet model; Espinosa-Sole (2010) interbank network model - Tail shocks (Authorities): Default of institutions; sequential defaults on net interbank credit for each of the ten-largest banks and trace effects on other banks - Tail shocks (FSAP Team): Default of institutions; test assumes LGD of 100 percent and that the funding from a failed bank is not rolled over and borrower banks have to replace it by selling assets with a haircut of 30 percent ### Contagion risk — reporting format - Authorities’ outputs: CARs for the system and by ownership groups - FSAP Team outputs: - Tier 1/CARs for the system and by peer groups - For each range of CARs, number of banks and share in the total system by assets - Recapitalization needs in percent of GDP ### Authorities’ statement and policy priorities (excerpt) - Authorities appreciate constructive engagement during the FSAP mission and broadly concur with key policy recommendations - Recognize need to enhance capacity to effectively monitor systemic risks and address macroprudential policy challenges - Note rapid changes from Financial Technology require additional vigilance and intend to draw on Fund Technical Assistance - Reforms and improvements since 2009 FSSA Update include: - Conclusion of Risk-Based Supervision (RBS) Manual and supplement on procedures for consolidated supervision by Bank of Tanzania (BoT) - Recruitment of additional staff into the Directorate of Banking Supervision - Improvements to supervisory techniques, acquisition of onsite examination software, and automation of onsite examination work papers - Authorities’ remarks on methodology: current FSAP methodology revised substantially from 2006; different stress testing model applied versus BoT’s CIHAK model produced different results which staff agreed to reflect in the report - Capital and liquidity framework: - Current capital adequacy ratio: 12 percent of risk-weighted assets, buffered by a 2½ percent capital conservation - Capital adequacy requirements still based on Basel I, supplemented by capital charges for market and operational risks - With higher capital requirements than the Basel minimum and predominance of common equity Tier 1 capital, most Tanzanian banks can meet Basel III capital requirements - BoT working to develop liquidity instruments with high quality liquid assets (HQLA) and transition to a price-based monetary framework - On non-performing loans: - Loan classification and restructuring circular is temporary relief; BoT will monitor implementation and address abuse - BoT committed to scrutiny of bank books and to be more agile in monitoring asset quality with emphasis on provisioning and reserves - On liquidity and FX: - Authorities committed to monitoring systemic liquidity constraints, interconnected risks and vulnerabilities associated with structural liquidity - Priority on repo market development and modernization of the monetary framework to reduce interest rate volatility on domestic currency - Promote a vibrant FX market anchored by sound macroprudential measures to bolster resilience - Despite dollarization, banking sector’s Net Open Position (NOP) remains within regulatory limits - BoT developing operational guidance for emergency liquidity assistance - On crisis prevention, resolution and deposit insurance: - Authorities concur with need to strengthen existing resolution framework - Emphasis on group-wide risk-based supervision of financial corporates and strengthening oversight, crisis and resolution frameworks - Tanzania Financial Stability Forum agrees on use of extraordinary powers through Ministry of Finance and BoT during systemic crisis - Operational independence and effectiveness of Deposit Insurance Board (DIB) to be enhanced with constitution of its Board - BoT will require recovery plans from banks and prepare resolution plans for systemically important banks in the domestic market (D-SIBs) once identified - On financial inclusion and long-term finance: - Authorities view increasing access to formal financial services and boosting long-term finance for micro, small and medium enterprises as urgent - Support measures to broaden access and lower cost of financial services, address financial infrastructure gaps, bring nonbank credit providers under regulatory purview, strengthen consumer protection, and improve financial literacy - Authorities will examine pension funds’ investment allocations to broaden long-term financing and explore modalities for increasing supply of liquid securities - Implementation commitment: - Authorities committed to implementing FSSA recommendations and acknowledge need for significant resources, including Technical Assistance from the Fund *Source: Appendix IV. Banking Sector Stress Testing Matrix (STeM), cr18346 - Appendix IV. Banking Sector Stress Testing Matrix (STeM).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18346.pdf_