## Preface and Executive Summary — IMF TA Mission to Georgia (1geoea2020005)

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### Mission overview and participants
- Technical assistance mission visited Tbilisi, Georgia, during November 4–13, 2019.
- Mission leader: Ms. Ellen Gaston, Monetary and Capital Markets Department (MCM).
- External experts: Messrs. Ross Henderson and Andrew Poprawa (MCM external experts).
- Meetings with NBG senior leadership and staff: Governor Mr. Koba Gvenetadze; Deputy Governor Mr. Papuna Lezhava; Heads of Nonbanking Institutions Supervision Department, Legal Department, Supervisory Policy Department, and related divisions.
- Industry meetings: Board members and representatives of Micro Financial Institutions (MFIs) Association.

### Key findings on recent reforms and sector composition
- NBG actions since 2017:
  - Amended laws and issued new and revised regulations on registration, capital, and liquidity requirements for MFIs.
  - Expanded supervisory powers and increased supervisory resources for the nonbank sector.
  - Registered 200 LIEs.
  - Implemented consumer protection and responsible lending rules.
- Current nonbank sector composition:
  - MFIs and Loan Issuing Entities (LIEs).
  - Registered entities (as of September 30, 2019): 50 MFIs; 200 LIEs.
  - Total loans outstanding for MFIs and LIEs: about GEL1.5 billion (slightly more than 3 percent of the financial sector’s aggregate loans).
  - MFIs estimated to serve approximately 780,000 Georgians (22 percent of the population).
- Effects of reforms:
  - Enhanced sector resilience, removal of non-viable entities, and improved MFI brand reputation.

### Remaining issues and policy objectives
- Persisting challenges:
  - High funding cost for MFIs.
  - MFIs lack direct access to Georgian GEL from the NBG while lending under a certain threshold is required by the NBG to be in Georgian GEL.
  - MFIs can take repayable funds as a form of deposit, but individuals providing funding are not covered by deposit insurance.
  - Only a few MFIs undertake SME and agricultural lending, contrary to NBG and government objectives.
- NBG objectives:
  - Further strengthen oversight of the nonbank lending sector.
  - Promote financial inclusion on asset and liability sides.
  - Make the sector more attractive to foreign investors.

### Proposed new structure — micro-banks, MFIs, and LIEs (summary)
- Mission supports NBG’s proposed three-tier structure:
  - Top tier: micro-banks
    - Gradually allowed to take deposits.
    - Covered by deposit insurance like banks.
    - Have access to GEL from the NBG.
    - Required to implement capital and liquidity requirements per the Basel framework with proportionality, be subject to enhanced supervision, and establish risk management and corporate governance frameworks.
    - Mandated to lend to underserved individuals, SMEs, and agri-businesses.
  - Existing qualified MFIs may apply to be licensed as micro-banks.
  - Options for current MFIs:
    - Remain MFIs subject to recent measures; apply to be micro-banks; or register as LIEs (no prudential requirements; cannot use name “MFI”).
  - Existing LIEs: continue registration; registration and prudential and nonprudential requirements for new LIEs may be enhanced.

### Transition approach
- Recommended gradual transition over two–three years.
- Rationale:
  - Allows time to assess benefits and risks and to devise prudential and other requirements.
  - Enables qualifying MFIs to gradually adopt deposit-taking business models and meet higher prudential and risk management requirements.
  - Gives NBG nonbank supervision department time to prepare by enhancing supervisory framework and guidance.
  - Minimizes potential negative impacts (e.g., gradual unwinding of MFIs’ deposit taking in the form of repayable funds).

### Main recommendations (highlights)
- Incorporate micro lending strategies into NBG’s three-year strategic plan. (High priority, Short Term)
- Support creation of a new class of bank ("micro-bank") to improve financial inclusion. (High priority, Immediate to Long Term)
- If government approval received, draft amendments to the Banking Law and the Organic Law on National Bank of Georgia to add “micro-bank” to the definition of bank. (High priority, Medium Term)
- Design and implement a licensing regime for micro-banks and enhance Order No. 58/04. (Medium to high priority, Medium to Long Term)
- Establish a clear mandate for micro-banks to lend to underserved individuals, SMEs, and agribusiness. (Medium priority, Short to Medium Term)
- Extend deposit insurance to cover micro-bank deposits; deposits may be restricted for the first two to three years. (High priority, Long Term)
- Allow micro-banks access to GEL by swapping foreign currency for GEL directly with the NBG to reduce funding cost. (Medium priority, Long Term)
- Redefine repayable funds as a conditional deposit within micro-bank regulations as an interim measure prior to MFI migration to micro-banks. (Medium priority, Long Term)
- Introduce transition arrangements for repayable funds over 20 persons for continuing MFIs; no repayable funds allowed for MFIs or LIEs 24 months after government approval of Law changes. (Medium to high priority, Long Term)
- Apply Basel’s framework to micro-banks and MFIs on a proportional basis. (Medium priority, Long Term)
- Complete revisions to the NBG Supervisory Framework for the nonbank and micro-bank sectors. (Medium priority, Medium Term)
- Draft prudential regulations on capital, liquidity, leverage ratio, and large exposure limits for micro-banks. (Medium priority, Medium Term)
- Develop regulations for corporate governance, credit risk, market risk, and operational risk (including business continuity). (Medium priority, Medium Term)
- Consider reviewing and possibly simplifying current liquidity requirements for MFIs. (Medium priority, Long Term)
- Consider further measures to reduce likelihood of fraud and speculation. (Medium priority, Medium Term)
- Revise regulations to provide explicit authority for the NBG to have the power of temporary administration over an MFI. (Medium priority, Long Term)

*Source: Preface and sections I–II of the IMF TA mission report (1geoea2020005 - Preface).*

---

### Sector Structure, Market Statistics, and Business Models

### Market statistics (as of September 30, 2019)
- Registered entities:
  - 50 MFIs
  - 200 LIEs
- Total loans outstanding for MFIs and LIEs: about GEL1.5 billion (slightly more than 3 percent of aggregate loans).
- MFI balance-sheet snapshot (end-Q3 2019):
  - 50 MFIs holding GEL1.3 billion of assets (about 3 percent of total financial sector assets of GEL43 billion).
  - Two largest MFIs constitute 50 percent of total MFI assets.
- Reach: estimated to serve approximately 780,000 Georgians (22 percent of the population).

### MFI funding sources (consolidated basis)
- Loans from commercial banks: 36 percent
- Repayable funds from individuals: 10 percent
- Private foreign investment: 10 percent
- Other debt instruments: 9 percent
- Shareholders: 35 percent

### Evolution and concentration
- Number of MFIs:
  - At end-2016: 80 MFIs.
  - Currently: 50 MFIs.
  - Likelihood that 5 others will fail to meet new requirements by end-2019 and forfeit MFI registration.
- Despite decline in number, total assets remained relatively stable.
- Commercial banks represent 97 percent of the financial sector with high concentration in the top three systemically important banks.
- The smallest bank that transitioned from an MFI in 2018 is roughly the same size as the largest MFI.

### Business models and lending practices
- MFIs employ multiple business models determined by origins, geographic footprint, access to capital, and shareholder/funder aspirations.
- Market opportunity: unmet demand from consumers, small businesses, and farmers.
- Common lending characteristics:
  - Most MFIs lend on collateral with little or no analysis of ability to repay.
  - Significant consumer lending against gold and precious stone jewelry (“pawn shop” operations); in default gold is melted down and sold.
- Consumer protection rules (effective 2019) require responsible lending provisions including assessment of ability to repay, disclosure of cost of borrowing and terms and conditions.

### Segment detail: MFIs focused on SME and agriculture (sample of 12)
- These 12 MFIs have at least 50 percent of loan portfolio for small business and agricultural purposes and account for most SME/agriculture lending.
- Loan Portfolio (Amount in GEL (millions); In percent)
  - Consumer Loans: 153; 35
  - Business Loans: 195; 44
  - Agricultural Loans: 96; 21
  - Total Loans: 444; 100
  - Aggregate Assets: 527
- External Funding (Amount in GEL (millions); In percent)
  - Bank loans: 327; 83
  - Loans from Individuals: 147; 27
  - Loans from Legal Entities: 25; 7
  - Subordinated debt: 14; 3
  - Total External Funding: 393; 100

### Segment detail: Consumer-lending MFIs (sample of 38)
- Provide credit mainly to individuals; represent about 60 percent of aggregate sector assets.
- Loan Portfolio (Amount in GEL (millions); In Percent)
  - Consumer Loans: 627; 96
  - Business Loans: 23; 4
  - Agricultural Loans: 2; 0
  - Total Loans: 652; 100
  - Aggregate Assets: 782
- External Funding (Amount in GEL (millions); In percent)
  - Bank loans: 146; 38
  - Loans from Individuals: 179; 46
  - Loans from Legal Entities: 30; 8
  - Subordinated debt: 32; 8
  - Total External Funding: 393; 100

### Aggregate sector loan composition (selected figures)
- Total Loans: Number of Loans 732,982; Total Amount GEL (millions) 1,097,883; Total Amount (In Percent) 100
- Loans Issued to Individuals: Number of Loans 731,791; Total Amount GEL (millions) 1,068,181; Total Amount (In Percent) 97
- Loans Issued to Legal Entities: Number of Loans 1,191; Total Amount GEL (millions) 29,702; Total Amount (In Percent) 3
- Consumer lending skew: consumer lending represents about 60 percent of the portfolio; the largest MFI represents about 26 percent of aggregate sector assets and focuses on collateralized consumer lending.

---

### Regulatory and Supervisory Reforms, Remaining Risks, and Proposed Prudential Framework

### Legal and supervisory improvements since 2017
- Legal/regulatory amendments include:
  - Requiring lenders with more than 20 clients (other than MFIs) to register as LIEs.
  - Requiring detailed shareholder, governance, and business plan information for MFI registration.
  - Mandatory external audits for MFIs and periodic reporting.
  - Minimum initial capital for MFIs: GEL1 million; ongoing minimum capital requirements of either 18 percent or 24 percent (for deposit takers in the form of repayable funds).
  - Minimum ongoing liquidity requirements for MFIs of either 18 percent or 25 percent.
  - Prudential limits on investments, properties, pawned assets, and loans to connected borrowers.
  - Rules for provisions on delinquent loans; interest accruals and fees halt once a loan is 30 days past due.
  - Reporting of loans in excess of GEL3,000 to the credit bureau.
- Supervisory capacity increases:
  - Nonbank supervisory staff increased from 5 officers in 2016 to 25 in 2019.
  - Five divisions within the nonbank supervisory department for offsite monitoring, onsite inspections, and registration.

### Remaining risks and structural vulnerabilities
- Currency mismatch and cost:
  - About 56 percent of funding from banks and others are denominated in foreign currencies while MFIs are required to make loans up to GEL100,000 in GEL.
  - Exchanging foreign currencies to GEL costs MFIs about 3 percent to 4 percent more (as an interest rate cost) through commercial banks than it does for banks to access GEL for FX through NBG accounts.
- Funding structure and absence of deposit insurance:
  - Approximately 60 percent of aggregate MFI funding is from commercial banks.
  - Concern that secured creditors (commercial banks) would stand ahead of unsecured creditors (individuals with repayable funds) in distress.
  - Approximately 500 individuals have advanced about GEL200 million in funds to MFIs with no deposit insurance protection.
- Interest rate cap and profitability:
  - Effective interest rates for MFIs capped at 50 percent including any additional loan fees (recently reduced from 100 percent).
- Regulatory burden and operating environment:
  - Enhanced regulatory/supervisory framework improved reputation but increased costs (higher capital and liquidity requirements, responsible lending rules, maximum loan sizes, more frequent reporting, investments in technology and training).
  - Significant issues remain regarding access to GEL and reasonably priced funding such as retail deposits.

### Proposal: micro-banks — licensing, safeguards, and proportional Basel application
- Licensing and eligibility:
  - NBG should design and implement a licensing regime for micro-banks.
  - Consider requiring micro-banks to allocate a minimum portion of their loan portfolio (perhaps 50 percent initially) to underserved individuals, SMEs, and agricultural lending.
  - There are currently 12 MFIs exceeding 50 percent SME/agriculture lending; 4 of the largest 5 MFIs meet this basic requirement.
- Capital and leverage:
  - Leverage ratio requires Tier 1 capital divided by on and off-balance sheet exposures.
  - Micro-banks may initially substitute total assets for leverage ratio calculation; must move to proper leverage ratio by the time unrestricted deposit taking begins.
  - Minimum initial capital for micro-banks: an amount in the range of GEL5 million to GEL10 million would be appropriate; commercial banks require GEL50 million.
  - Interim minimum capital adequacy ratio suggested: base capital adequacy ratio of 10.5 percent plus capital conservation buffer of 2.5 percent (i.e., 12 percent overall).
- Sequencing and proportionality:
  - Basel framework applied on a proportional basis; capital-related amendments should be advanced once the transition is underway, potentially about 18 months after the advanced group become micro-banks.
  - Tiered capital structure (Tier 1 and Tier 2) and simplified ICAAP introduced progressively; expectation that simple micro-banks will develop ICAAP capabilities in two to three years.
- Liquidity:
  - Current MFI minimum funding-from-capital proportions: 18 percent and 24 percent (where deposited funds exceed 50 percent of regulatory capital).
  - Recommend simplified liquidity ratio for small institutions; micro-banks must communicate liquidity pressures within 24 hours.
  - Issuance sequencing recommended: capital and liquidity regulations by end-June 2020; market risk development July–December 2020.

### Deposit-taking, repayable funds, and transition arrangements
- Transition and deposit restrictions:
  - All deposit taking by MFIs should cease on a transitional basis over two years.
  - Micro-banks allowed full deposit taking only after demonstration of safety and soundness (perhaps two to three years).
  - NBG may lower current minimum deposit size from GEL100,000 for MFIs to GEL50,000 as incentive to convert.
  - Deposit insurance extended to micro-bank deposits and introduced at licensing; deposits may be restricted for first two to three years.
- Repayable funds:
  - Interim redefinition of repayable funds as a conditional deposit for micro-bank regulations.
  - Category of repayable funds for 1–20 persons should be eliminated when an MFI converts to a micro-bank; 1–20 persons category for continuing MFIs should be eliminated as soon as possible after changes, allowing transition period.
  - Repayable funds over 20 persons: minimum GEL100,000 each; gradual repayment to avoid instability.
- Limits and large exposures:
  - Maximum loan size to remain at GEL100,000 initially; NBG may gradually increase.
  - Introduce large exposures framework with an upper limit of 25 percent of regulatory capital.
  - Loan exposures exceeding 10 percent of regulatory capital should be reported to NBG.
  - At end of transition, large exposure requirements should be based on Tier 1 capital.
  - Examples of higher upper loan limits suggested include GEL500,000 or GEL1 million for flexibility over time.

### Licensing standards and supervisory expectations
- Licensing requirements for micro-banks should include:
  - A strategic plan showing viability and SME/agricultural lending approach.
  - Prudential compliance and three-year financial projections.
  - Risk management framework and governance arrangements.
  - Internal audit program.
- Existing MFIs seeking conversion should engage in consultation and be subject to regular/intensive supervision leading up to conversion.
- Licensing likely to be conditional with transition-period conditions and possible longer-term constraints.
- NBG to allow MFIs to convert to LIEs without liquidation; strengthen registration requirements for new LIEs and consider safeguards (enhanced risk management, governance, and potential capital and liquidity thresholds) for larger LIEs.

### Supervisory framework, proportionality, and enforcement
- NBG should complete revisions to the NBG Supervisory Framework for nonbank and micro-bank sectors by December 2020 and apply it during MFI conversion.
- Supervision should be risk-based and proportional; use a matrix approach with size bands and risk bands to determine supervisory attention and frequency of onsite examinations.
- NBG should move to risk-based onsites and consider a specialist enforcement department for liquidations.
- NBG should review enforcement powers and obtain explicit authority for temporary administration over an MFI.
- Operational risk regulation for micro-banks to be introduced in conjunction with final capital amendments, around six months before micro-banks are licensed; cover IT risk, outsourcing, disaster recovery, business continuity, and pandemic planning on a proportional basis.
- Additional measures:
  - Consider requiring fraud insurance for MFIs and micro-banks.
  - Regulations should prohibit speculation and require hedging of FX positions.

---

*Source: Preface and sections I–II of the IMF TA mission report (1geoea2020005 - Preface).*

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

### Preface

### Mission overview and participants
- A technical assistance (TA) mission visited Tbilisi, Georgia, during November 4–13, 2019.
- Mission leader: Ms. Ellen Gaston, Monetary and Capital Markets Department (MCM).
- External experts: Messrs. Ross Henderson and Andrew Poprawa (MCM external experts specializing in bank and nonbank regulation and supervision).
- Meetings with National Bank of Georgia (NBG) senior leadership and staff:
  - Governor Mr. Koba Gvenetadze
  - Deputy Governor Mr. Papuna Lezhava
  - Ms. Irma Bokuchava, Head of Nonbanking Institutions Supervision Department
  - Ms. Natia Tsotsonava, Head of the First Division of Nonbanking Supervision Department
  - Ms. Natia Gvazava, Head of Legal Department
  - Ms. Teona Kontridze, Head of Supervisory Policy Department
- Meetings with industry stakeholders:
  - Board members of the Micro Financial Institutions (MFIs) Association
  - Representatives from MFIs

### Acknowledgements
- The mission expressed gratitude to the NBG Governor, Deputy Governor, and staff for hospitality, cooperation, and arrangements that facilitated the mission.
- The mission thanked industry participants for generously sharing time and insights.

### Executive summary — key findings
- In the past two years, the NBG adopted measures to strengthen nonbank sector financial regulation, supervision, and oversight, implementing most recommendations from the MCM TA mission in 2017.
- Current nonbank sector composition: Micro Financial Institutions (MFIs) and Loan Issuing Entities (LIEs).
- Measures taken by the NBG include:
  - Amending laws and issuing new and revised regulations on registration, capital, and liquidity requirements for MFIs.
  - Significantly expanding supervisory powers and authorities and increasing supervisory resources for the nonbank sector.
  - Registering 200 LIEs.
  - Implementing consumer protection and responsible lending rules.
- Effects of measures:
  - Enhanced resilience of the nonbank sector.
  - Weeding out non-viable entities.
  - Improved reputation of the MFI brand.

### Executive summary — remaining issues and policy objectives
- Persisting challenges:
  - MFIs have high funding cost.
  - MFIs lack direct access to Georgian GEL from the NBG while lending under a certain threshold is required by the NBG to be in Georgian GEL.
  - MFIs are allowed to take repayable funds as a form of deposit, but individuals providing funding to MFIs are not covered by deposit insurance.
  - Only a few MFIs undertake SME and agricultural lending, contrary to NBG and government policy objectives.
- NBG objectives:
  - Further strengthen oversight of the nonbank lending sector.
  - Promote financial inclusion on asset and liability sides.
  - Make the sector more attractive to foreign investors.

### Proposed new structure — summary of mission support
- Mission supports NBG’s proposed new structure for micro lending:
  - Top tier: micro-banks
    - Gradually allowed to take deposits
    - Covered by deposit insurance like banks
    - Have access to GEL from the NBG
  - Existing qualified MFIs may apply to be licensed as micro-banks.
  - Licensed micro-banks: mandated to lend to underserved individuals, SMEs, and agri-businesses.
  - Micro-banks required to implement capital and liquidity requirements per the Basel framework with proportionality, be subject to enhanced supervision, and establish risk management and corporate governance frameworks.
  - Expected outcomes: promote SME lending, reduce funding cost for micro-banks, and enhance safety and soundness.
- Options for current MFIs:
  - Remain as MFIs and be subject to recent regulatory and supervisory measures.
  - Apply to be micro-banks.
  - Register as LIEs (would not be subject to prudential requirements and could not use the name “MFI”).
- Existing LIEs: no substantial change; registration should continue; registration and prudential and nonprudential requirements for new LIEs may be enhanced.

### Proportionality and supervision
- Recommendation: apply proportionality in implementing Basel prudential requirements for micro-banks:
  - Micro-banks subject to Basel requirements for capital, liquidity, and leverage ratio.
  - Calibration of requirements commensurate with size, complexity, and risk levels.
  - Proportionality applied to supervision and risk management across the micro lending sector.

### Transition approach
- Recommendation: gradual transition over two–three years.
- Rationale and benefits:
  - Provides NBG and government time to assess benefits and risks and devise prudential and other requirements.
  - Allows qualifying MFIs to gradually ease into deposit taking, adopt required business models, and meet higher prudential and risk management requirements.
  - Ensures NBG nonbank supervision department has time to prepare by enhancing supervisory framework and guidance.
  - Minimizes potential negative impacts on the micro lending sector and existing MFIs and LIEs (e.g., gradual unwinding of MFIs’ deposit taking in the form of repayable funds).

### Main recommendations (highlights from Table 1)
- Incorporate policy, regulatory, and supervisory strategies for the micro lending sector into the NBG’s three-year strategic plan. (High priority, Short Term)
- Support creation of a new class of bank ("micro-bank") to improve financial inclusion for underserved individuals, SMEs, and agriculture. (High priority, Immediate to Long Term)
- If government approval received, draft amendments to the Banking Law and the Organic Law on National Bank of Georgia to add “micro-bank” to the definition of bank. (High priority, Medium Term)
- Design and implement a licensing regime for micro-banks and enhance Order No. 58/04 “Procedures and Terms of Registration of Microfinance Organizations”. (Medium to high priority, Medium to Long Term)
- Establish a clear mandate for micro-banks to function as lenders to underserved individuals, SMEs, and agribusinesses. (Medium priority, Short to Medium Term)
- Extend deposit insurance to cover micro-bank deposits; deposits for micro-banks may be restricted for the first two to three years. (High priority, Long Term)
- Allow micro-banks access to GEL by swapping foreign currency for GEL directly with the NBG to reduce funding cost (Medium priority, Long Term).
- Redefine repayable funds as a conditional deposit within micro-bank regulations as an interim measure prior to MFI migration to micro-banks. (Medium priority, Long Term)
- Allow MFIs that wish to convert to LIEs to register as LIEs without liquidation; consider additional safeguards for larger MFIs that become LIEs. (Medium priority, Medium to long Term)
- Introduce transition arrangements for repayable funds over 20 persons for continuing MFIs; no repayable funds allowed for MFIs or LIEs 24 months after government approval of Law changes. (Medium to high priority, Long Term)
- Apply Basel’s framework to micro-banks and MFIs on a proportional basis. (Medium priority, Long Term)
- Complete revisions to the NBG Supervisory Framework for the nonbank and micro-bank sectors (Medium priority, Medium Term).
- Draft prudential regulations on capital, liquidity, leverage ratio, and large exposure limits for micro-banks (Medium priority, Medium Term).
- Develop regulations for corporate governance, credit risk, market risk, and operational risk (including business continuity) management for micro-banks and MFIs (Medium priority, Medium Term).
- Consider reviewing and possibly simplifying current liquidity requirements for MFIs (Medium priority, Long Term).
- Consider further measures to reduce likelihood of fraud and speculation (Medium priority, Medium Term).
- Revise regulations to provide explicit authority for the NBG to have the power of temporary administration over an MFI (Medium priority, Long Term).
- Legend of timelines: Immediate- less than 3 months, short term- 3 to 6 months, medium term- 6 to 12 months, long term- more than 1 year.

### Introduction — context and recent history
- Background:
  - May 2017 MCM TA mission recommended changes for a previously lightly regulated and virtually unsupervised nonbank sector.
  - At that time, the Law of Georgia on Microfinance Organizations was a simple rules-based framework for small entities that did not take deposits and did not require prudential supervision.
- By 2017:
  - MFIs represented about 3 percent of aggregate loans in the system but posed firm and systemic risks due to raising deposit-like funds without supervisory oversight.
- Since 2017:
  - NBG implemented most recommendations from the 2017 mission and has focused on addressing nonbank lending sector vulnerabilities.

### Current structure and market statistics (as of September 30, 2019)
- Registered entities:
  - 50 MFIs
  - 200 LIEs
- Total loans outstanding for MFIs and LIEs: about GEL1.5 billion (slightly more than 3 percent of the financial sector’s aggregate loans).
- Reach: estimated to serve approximately 780,000 Georgians or 22 percent of the population, mostly individuals of modest means and the unbanked.
- MFI balance-sheet snapshot:
  - At end-Q3 2019: 50 MFIs holding GEL1.3 billion of assets (about 3 percent of total financial sector assets of GEL43 billion).
  - Two largest MFIs constitute 50 percent of total MFI assets.
- MFI funding sources (consolidated basis):
  - Loans from commercial banks: 36 percent
  - Repayable funds from individuals: 10 percent
  - Private foreign investment: 10 percent
  - Other debt instruments: 9 percent
  - Shareholders: 35 percent
- Banking sector context:
  - Commercial banks represent 97 percent of the financial sector with high concentration of assets in the top three systemically important banks.
  - The smallest bank that transitioned from an MFI in 2018 is roughly the same size as the largest MFI.

*Source: Preface and sections I–II of the IMF TA mission report (1geoea2020005 - Preface).*

### 7.      MFIs have evolved over the past two years reflecting changing market conditions as

### 7.      MFIs have evolved over the past two years reflecting changing market conditions as

### Evolution and sector overview
- Number of MFIs:
  - At end-2016: 80 MFIs.
  - Currently: 50 MFIs.
  - Likelihood that 5 others will fail to meet new requirements by end-2019 and forfeit MFI registration.
- Despite the decline in number of MFIs, total assets have remained relatively stable over the period.

### Business models, market coverage, and lending practices
- MFIs employ several distinct business models determined by origins, geographic footprint, access to capital, and shareholder/funder aspirations.
- Market opportunity:
  - Demand for credit by consumers, small businesses, and farmers remains significantly unfilled by commercial banks, creating market opportunities for MFIs.
  - Reasons commercial banks avoid the smaller “bottom end” include cost (e.g., opening branches in rural areas) and higher incidence of problem credits.
- Common lending characteristics:
  - Most MFIs lend on the basis of collateral with little or no analysis of ability to repay.
  - Much consumer lending is against collateral of gold and precious stone jewelry; such lenders are classed as “pawn shop” type operations and typically do not undertake substantive borrower repayment analysis.
  - In default, gold is melted down and sold to recover debt.
- Consumer protection:
  - New consumer protection rules implemented in 2018 include responsible lending provisions (including an assessment of ability to repay) and require disclosure of cost of borrowing and terms and conditions.

### MFIs focused on SME and agriculture (sample of 12 MFIs)
- Identification:
  - Based on mission criteria and NBG data, 12 of the current 50 registered MFIs have at least 50 percent of their loan portfolio lent for small business and agricultural purposes.
  - These 12 account for most loans supporting SME business or agriculture and include 4 of the 5 largest MFIs (except the largest MFI).
- Funding sources for the 12 MFIs (Table 2):
  - Loan Portfolio (Amount in GEL (millions); In percent)
    - Consumer Loans: 153; 35
    - Business Loans: 195; 44
    - Agricultural Loans: 96; 21
    - Total Loans: 444; 100
    - Aggregate Assets: 527
  - External Funding (Amount in GEL (millions); In percent)
    - Bank loans: 327; 83
    - Loans from Individuals: 147; 27
    - Loans from Legal Entities: 25; 7
    - Subordinated debt: 14; 3
    - Total External Funding: 393; 100
- External funding sources include local banks, foreign investors (foundations, NGOs, microlending organizations), and Georgian shareholders interested in financial inclusion; these mission-driven MFIs expect a reasonable rate of return consistent with cost of funds and lending risk.

### Consumer-lending MFIs (sample of 38 MFIs)
- Characteristics:
  - Largely provide credit to individuals rather than small businesses or farmers.
  - Represent about 60 percent of aggregate sector assets.
  - Funded primarily by bank loans and repayable funds from individuals (analogous to deposits but not labeled as deposits for regulatory purposes).
- Regulatory requirement:
  - NBG rule requires each repayable fund to be greater than GEL100,000 once number of borrowers exceeds 20 individuals.
- Risks and expectations:
  - Instruments disclaim claims other than ordinary creditor claims, yet individuals expect full redemption; issues arise in realization in liquidation.
- Funding and portfolio details (Table 3):
  - Loan Portfolio (Amount in GEL (millions); In Percent)
    - Consumer Loans: 627; 96
    - Business Loans: 23; 4
    - Agricultural Loans: 2; 0
    - Total Loans: 652; 100
    - Aggregate Assets: 782
  - External Funding (Amount in GEL (millions); In percent)
    - Bank loans: 146; 38
    - Loans from Individuals: 179; 46
    - Loans from Legal Entities: 30; 8
    - Subordinated debt: 32; 8
    - Total External Funding: 393; 100

### Aggregate sector loan composition (Table 4)
- Loan volumes and composition:
  - Business Loans (Trade and Service): Number of Loans 34,498; Total Amount GEL (millions) 193,212; Total Amount (In Percent) 18
  - Agriculture: Number of Loans 19,438; Total Amount GEL (millions) 99,661; Total Amount (In Percent) 9
  - Consumer Loans — Custom Loans: Number of Loans 59,632; Total Amount GEL (millions) 292,270; Total Amount (In Percent) 26
  - Consumer Loans — Online Loans: Number of Loans 115,898; Total Amount GEL (millions) 53,531; Total Amount (In Percent) 5
  - Consumer Loans — “Pawn Shop” Loans: Number of Loans 438,257; Total Amount GEL (millions) 386,388; Total Amount (In Percent) 35
  - Consumer Loans — Installments: Number of Loans 62,745; Total Amount GEL (millions) 29,508; Total Amount (In Percent) 3
  - Consumer Loans — Other: Number of Loans 1,323; Total Amount GEL (millions) 13,611; Total Amount (In Percent) 1
  - Loans Issued to Individuals: Number of Loans 731,791; Total Amount GEL (millions) 1,068,181; Total Amount (In Percent) 97
  - Loans Issued to Legal Entities: Number of Loans 1,191; Total Amount GEL (millions) 29,702; Total Amount (In Percent) 3
  - Total Loans: Number of Loans 732,982; Total Amount GEL (millions) 1,097,883; Total Amount (In Percent) 100
- Sector skew:
  - Aggregate loan portfolio is skewed towards consumer lending representing about 60 percent of the portfolio.
  - The largest MFI represents about 26 percent of aggregate sector assets and is engaged in collateralized consumer lending.

### NBG regulatory and supervisory improvements (since 2017)
- Legal and regulatory amendments include:
  - (a) Requiring all lenders with more than 20 clients (other than MFIs) to register as LIEs and meet registration, reporting, and Consumer Protection Act compliance.
  - (b) Requiring detailed information about shareholders, governance, and business plans for MFI registration.
  - (c) Establishing required information submission by MFIs and LIEs and requirement to obtain an external audit for MFIs.
  - (d) Establishing minimum initial capital requirements for MFIs of GEL1 million and ongoing minimum capital requirements of either 18 percent or 24 percent (for deposit takers in the form of repayable funds).
  - (e) Establishing minimum ongoing liquidity requirements for MFIs of either 18 percent or 25 percent.
  - (f) Enhancing supervisory framework and resources.
  - (g) Establishing prudential limits on investments in securities, properties, pawned assets, and loans to connected borrowers for MFIs.
  - (h) Establishing rules for required provisions for MFI delinquent loans based on arrears, loan-to-value ratios, security, and other relevant factors.
  - (i) Outlining procedures and processes for liquidating an MFI.
- Supervisory capacity and processes:
  - Reporting frequency: All MFIs and LIEs required to submit reports on either a monthly or quarterly basis.
  - Onsite and offsite supervision: NBG implemented improved data collection, offsite monitoring, and onsite inspection processes.
  - Staffing: Nonbank supervisory staff increased from 5 officers in 2016 to a staff complement of 25 in 2019.
  - Organizational structure: Five divisions within the nonbank supervisory department responsible for offsite monitoring, onsite inspections, and registration for MFIs and LIEs.
  - External audit and monthly reporting: MFIs must obtain external audit and report monthly on asset categories and provisions.
- Consumer protection rules (effective 2019):
  - Establish standards for debt service ratios (Payment to Income or PTI), loan to value ratios (LTV), and other measures to encourage healthy lending and reduce debtor over-indebtedness.
  - All loans in excess of GEL3,000 must be reported to the credit bureau.
  - Credit bureau oversight: Borrowers authorize lenders to access credit bureau information; NBG oversees the credit bureau.
- Loan classification and provisioning:
  - Regulations on loan classification and loan loss provisions implemented; interest accruals and fees halted once a loan is 30 days past due.
  - Restrictions on restructured loans to prevent restoring loans to active status without required payments.
  - Aggregate loan loss provisions and NBG continuous monitoring indicate compliance with new rules.

### LIEs (Lenders Identified by the NBG) and registration
- NBG required LIEs to be registered by April 2019.
- Purpose: identify all lenders, ensure minimum standards of consumer protection and operational risk management.
- Characteristics:
  - LIEs almost all owned by resident shareholders and typically provide small loans using collateral such as gold, jewelry, or other valuables.
  - In aggregate, LIEs are funded by bank loans (80 percent) and shareholders (20 percent).
  - LIEs must meet certain security requirements and branch size restrictions; prescribed penalties for non-compliance.
- Limitations and risks:
  - Entities or individuals conducting lending with 20 or less clients remain unregistered and unregulated.
  - Current LIE registration process is limited and does not give NBG sufficient information to determine viability or compliance capacity.
  - NBG continues to monitor LIEs to ensure compliance.

### Remaining issues and challenges
- Currency mismatch and cost:
  - Mismatch: About 56 percent of funding from banks and others are denominated in foreign currencies (typically U.S. dollars or Euros) while MFIs are required to make loans up to GEL100,000 in GEL.
  - Cost implication: Exchanging foreign currencies to GEL costs MFIs about 3 percent to 4 percent more (as an interest rate cost) through commercial banks than it does for banks to access GEL for FX through NBG accounts.
  - MFIs manage currency imbalance via swap arrangements with commercial banks; NBG allows some open positions but monitors exposure, discusses risk management, and conducts stress testing. No currency speculation is allowed.
- Funding structure and absence of deposit insurance:
  - Approximately 60 percent of aggregate funding of MFIs is from commercial banks; larger MFIs borrow at even higher levels.
  - MFIs provide collateral to banks (pledge against fixed assets and loan portfolio); regulations limit security pledged to commercial banks at 90 percent of equity.
  - Concern remains that secured creditors (commercial banks) would stand ahead of unsecured creditors (individuals with repayable funds) in distressed scenarios.
  - Approximately 500 individuals have advanced about GEL200 million in funds to MFIs and have no deposit insurance protection.
- Interest rate cap and profitability:
  - Effective interest rates for MFIs capped at 50 percent including any additional loan fees (recently reduced from 100 percent).
  - Some MFI representatives argue cap is too low for sustainability given weak credit analysis and higher loan loss risk; others say 50 percent provides sufficient latitude to cover costs.
- Regulatory burden and operating environment:
  - MFIs acknowledge enhanced regulatory and supervisory framework has improved sector reputation and weeded out unsuitable entities.
  - Concerns persist that regulatory and supervisory burden has not been sufficiently offset by operational improvements: higher capital and liquidity requirements, responsible lending rules, maximum loan sizes, more frequent reporting, and investments in technology and staff training.
  - Significant issues remain regarding access to GEL and reasonably priced funding sources such as retail deposits.

### Proposed new structure and transition considerations
- Policy objective:
  - NBG should consider steps to promote long-term sustainability and efficacy of nonbank lending to enhance access to credit and financial inclusion.
- Emphasis and targets:
  - Greater emphasis on providing sustainable and reasonably priced credit to small businesses and those engaged in agricultural activities.
  - Current share of MFI loan portfolio focused on these two sectors: 27 percent.
- Measures to promote SME and agricultural lending:
  - More efficient lending processes.
  - Improved access to GEL to increase availability of funds and reduce funding cost, which would over time reduce effective interest rates.
  - Clarify whether individuals should be able to provide savings to MFIs (to enhance financial inclusion for savings and borrowing).
  - Continued improvements in regulation and supervision to rebuild reputation and enhance confidence among domestic and international funders.

*Source: The National Bank of Georgia reports and mission analysis as presented in the IMF chapter.*

### 22.      To further reduce the risks and vulnerabilities of the sector and enhance financial

### 22.      To further reduce the risks and vulnerabilities of the sector and enhance financial inclusion

### Proposal: introduce a new class of bank (micro-banks)
- Support for NBG proposal to establish a three-tier structure: micro-banks, MFIs, and LIEs.
- Micro-banks: a new category of bank specifically designed to serve the micro-finance sector, provide microloans to underserved individuals, small businesses, and agricultural enterprises in rural areas, and be deposit-taking entities prudentially regulated and supervised.
- Expected benefits:
  - Diversify sources of funds by allowing micro-banks to accept deposits from the public.
  - Savers would gain access to deposit insurance through the deposit guarantee scheme once micro-banks meet standards for insurance.
  - Improved reputation with local market and foreign investors to better attract funds at a lower cost, translating to lower interest rates for SME and agricultural borrowers.
- Comparative precedent: other jurisdictions (Mongolia, Papua New Guinea, Serbia, and Uzbekistan) have established similar separate classes of banking institutions for microfinance.

### Licensing and eligibility
- NBG should design and implement a licensing regime for micro-banks.
- Pre-condition proposals:
  - Consider measures to incentivize or require micro-banks to have a minimum portion of their loan portfolio (perhaps 50 percent initially and a higher level over time) allocated to underserved individuals, SME, and agricultural lending in line with a business plan.
  - There are currently 12 MFIs which already exceed 50 percent of their loan portfolios lent out to SMEs and agricultural enterprises.
  - Four of the largest five MFIs currently meet this basic requirement.
- Consultation: NBG should undertake a consultation process to inform MFIs and gather perspectives; new applicants not existing MFIs would face a more vigorous licensing process.

### Regulatory and supervisory safeguards for micro-banks
- Micro-banks should be regulated consistent with the Basel framework applied on a proportional basis and in a gradual manner.
- Key supervisory elements to implement:
  - Appropriate types and levels of capital, liquidity, and risk management requirements.
  - Enhanced governance approaches.
  - Expectation that current staff of the nonbank supervisory department could assume supervisory oversight of micro-banks.
- Possible transitional benefits for MFIs converting to micro-bank status:
  - Transitional provision to allow qualifying MFIs to continue as a micro-bank without winding up and reapplying for a banking license.
  - Access to the NBG’s accounts for local currency to eliminate the need to enter into swaps with commercial banks and reduce funding costs.
  - Deposit insurance protection once requirements are met.

### Implications for MFIs and LIEs
- Phasing out deposit-like repayable funds:
  - Suggested phase-out period: perhaps 24 months.
  - Consumer-focused lending entities reliant on deposit-like funding may choose to re-register as LIEs to avoid higher capital and liquidity costs.
  - NBG should draft regulations to allow MFIs to convert to LIEs without liquidation.
  - Larger LIEs should be subject to enhanced prudential and nonprudential measures as a safeguard.
- Largest MFI:
  - May choose to remain an MFI; business model based primarily on acquiring deposit-like repayable funds (all in excess of GEL100,000), does not lend to SME or agricultural sectors, strictly a consumer lender — therefore would not meet qualifications for a micro-bank.
- LIEs:
  - No substantial change to current entities registered as LIEs.
  - NBG should continue to register “underground” LIEs and strengthen oversight over time to ensure compliance with enhanced registration requirements, consumer protection and responsible lending act, and ongoing viability.

### Legal and implementation timing
- Legislative/regulatory changes required:
  - Some amendments to the Banking Law, regulations for licensing, and potentially revisions to other regulations.
  - Expected implementation period: within a 12–18 month period depending on legislative priorities.
- Proposed new sector structure summary (key points preserved as in source):
  - Micro-banks:
    - A new class of banks called “micro-banks” would be licensed to undertake micro lending.
    - Subject to licensing requirements with possible minimum lending to SMEs and agricultural operations.
    - Subject to enhanced supervision.
    - Capital requirements including a risk weighted approach as well as a leverage ratio in addition to liquidity requirements would be imposed in line with the Basel framework applied on a proportional basis.
    - Expected to meet standards for enterprise risk management (credit, operational, liquidity, and market risk) and sound corporate governance.
    - Would have access to a local currency account at the NBG.
    - Would be able to take deposits which would be covered by deposit insurance.
  - MFIs:
    - Over time required to cease taking repayable funds (deposits) from the public.
    - Permitted to continue to operate in the same market as currently.
    - Permitted to apply for a license as a micro-bank if they meet the requirements.
    - Permitted to apply for a license as a LIE, with larger LIEs subject to enhanced measures.
  - LIEs:
    - Registration requirements for new entrants as a LIE would be strengthened.
    - NBG to ensure unregistered entities become registered.

### Transition plan and sequencing
- NBG should establish a reasonable timeline and proper sequencing in its strategic plan with short, medium, and long term actions.
- Short term:
  - Draft policy proposal for new structure and undertake public consultations on the concept of micro-banks.
  - Obtain government support and draft changes to the Law of Georgia on Commercial Banking to permit micro-banks.
- Medium term:
  - Draft changes to regulations and revise the NBG Supervisory Framework.
- Longer term:
  - Begin licensing micro-banks and provide access to GEL accounts at the NBG along with deposit insurance coverage.

### Regulatory and supervisory measures to support transition
- Approach:
  - Proportional approach based on risk profile and size; allow for gradual transition and account for recent changes already experienced in the MFI sector.
  - Need time to assess MFI compliance with recently introduced prudential requirements before further reforms.
- Transition period specifics:
  - Covers stage until initial intake of micro-banks attain full compliance with interim requirements as micro-banks.
  - Micro-banks will not be allowed to move to full deposit taking status until they attain full compliance — expected to occur within two (but possibly three) years from those initial entities becoming micro-banks; may be delayed if difficulties arise.
- Objectives:
  - Reduce high interest rates on loans driven by high cost of funds and high loan losses.
  - Access to deposit taking should reduce cost of funds over time.
  - Prudential regulation and supervision expected to reduce loan losses over time.

### Expected reduction in cost of funds and loan pricing effects
- Factors expected to reduce cost of funds and loan pricing:
  - Micro-banks eventually able to take deposits from the general public without restrictions on size or number.
  - Micro-banks will have access to GEL from the NBG (by swapping foreign currency for GEL directly with the central bank), which is expected to reduce cost of funds, probably by at least 3 to 4 percent.
  - Reduction in interest rate margins charged by commercial banks on loans to MFIs as these entities are regulated as banks.
  - Lower loan losses over time as weaker credits are weaned out of loan portfolios.

### Applying rules proportionally for micro-banks and capital framework
- Basel Committee guidance allows proportional application of Core Principles commensurate with risk profile and systemic importance.
- Micro-banks will be regulated under the existing Banking Law in Georgia, with minor adjustments to incorporate specific provisions for micro-banks.
- Timing for capital-related amendments:
  - Further amendments in key areas, particularly capital, should be undertaken once the transitional period is underway, potentially at about 18 months after the advanced group of MFIs become micro-banks.
  - Final amendments to the Banking Law and associated proportional regulations should be made; requirements on capital adequacy and risk management expected to be put in place.
  - Capital structure should be developed on a tiered basis (Tier 1 and Tier 2) when final amendments are completed (i.e., six months before the end of the transition period).
  - Components of tiers can be simplified (treated on a proportional basis) while maintaining linkage to fundamental Basel capital requirements.
- Other capital requirements:
  - Tailored approach to risk weighting of assets, ICAAP, buffers, and the leverage ratio treated on a proportional basis, moving more towards full compliance on a proportional basis by six months before full deposit taking is allowed.
- ICAAP:
  - Consider introducing a simplified ICAAP in time.
  - Expectation that simple micro-banks will develop capabilities to perform ICAAP with supervision, perhaps in two to three years.

*Source: IMF mission recommendations and proposed framework for micro-banks, MFIs, and LIEs as presented in the provided content.*

### 47.      The leverage ratio requires Tier 1 capital to be divided by on and off-balance sheet

### 47.      The leverage ratio requires Tier 1 capital to be divided by on and off-balance sheet exposures.

### Capital framework and leverage ratio
- The leverage ratio requires Tier 1 capital to be divided by on and off-balance sheet exposures.
- Micro-banks may initially substitute total assets for the leverage ratio calculation, but amendments must be proportional so micro-banks move to a proper leverage ratio calculation by the time they start taking deposits on an unrestricted basis.
- Public disclosure requirements should commence only after micro-banks have moved to a proper leverage ratio calculation and have become reliable in reporting on it.
- Micro-banks should never be allowed to commence using an internal ratings-based approach for credit risk.

### Minimum initial capital for micro-banks
- The minimum amount of initial capital needs to be higher for micro-banks than for MFIs to recognize their status as a bank.
- For commercial banks the amount is GEL50 million, which would appear beyond the capacity of any current MFI.
- An amount in the range of GEL5 million to GEL10 million would be appropriate.
- While several MFIs could achieve GEL10 million of capital at present, a level somewhat below GEL10 million would seem appropriate considering future capacity and timing.

### Interim capital regime and minimum capital adequacy
- As an interim measure, adoption of the minimum capital requirements and capital adequacy ratio (coefficient) specified in the regulations, along with a leverage ratio, is suitable for micro-banks until they are ready to evolve to Basel requirements on a proportional basis.
- Micro-banks are expected to be in compliance with these interim requirements before the end of the transition period.
- The mission suggests a base capital adequacy ratio of 10.5 percent plus capital conservation buffer of 2.5 percent (i.e., 12 percent overall) as an appropriate minimum capital ratio; the NBG may set a higher ratio if warranted by risk factors.

### Liquidity requirements and simplification
- The NBG should review its current liquidity requirement for MFIs with a view to reduce it over time.
  - Current MFI minimum proportion of funding from capital is set at 18 percent and 24 percent (where deposited funds are over 50 percent of regulatory capital).
  - MFIs mostly raise term debt thus reducing liquidity risk.
- The current liquidity ratio for MFIs is considered overly complex; it requires deduction of longer-term liabilities even though these funds can normally be redeemed early by request.
- For small institutions, a simple ratio setting liquid assets against total liabilities is likely to be more easily understood; the minimum ratio in the regulations for MFIs would need to be readjusted from its current base to one based on a portion of the liabilities.
- A simplified liquidity requirement should be developed for micro-banks, harmonized with proportionality and consistent with revisions to MFI liquidity requirements and those for commercial banks in Georgia.
- Micro-banks should be required to timely communicate liquidity pressures: any micro-bank experiencing or determining it may experience liquidity pressure must contact the NBG within 24 hours.

### Sequencing of prudential regulations
- Issuance sequencing recommended:
  - Capital and liquidity risk regulations issued by end-June 2020.
  - Market risk development to begin in July 2020 and be completed by end-December 2020.
- Regulations should include essential requirements, with further description and expectations provided in guidance.
- Restrictions on loan types (SME and agricultural lending) and strengthened asset classification and reserves regulation should be reviewed and upgraded over time.

### Deposit-taking, transition, and deposit insurance
- The NBG should ensure micro-banks are safe and sound before allowing unrestricted deposit taking.
- Mission suggests all deposit taking by MFIs should cease on a transitional basis over a period of two years so as not to disrupt the market for credit.
- If a transitioned micro-bank is determined safe and sound after a suitable period (perhaps two to three years), full unrestricted deposit taking may be considered; otherwise a minimum deposit size will need to be imposed.
- The NBG may consider lowering the current minimum deposit size from GEL100,000 applying to MFIs to GEL50,000 to provide incentive for MFIs to convert to micro-banks.
- Deposit insurance should be extended to cover micro-bank deposits and should be introduced at licensing.
  - For the first two to three years deposits for micro-banks may be restricted.
  - The NBG would consider term of deposits and potential concentration risk when determining deposit insurance exposure.
- At end of the two to three-year transition period, the license would be changed to either remove all restrictions in relation to deposits or alter them depending on micro-bank advancement.

### Repayable funds and transition arrangements
- As an interim measure redefine the current definition of repayable funds as a conditional deposit within micro-bank regulations before MFIs migrate to micro-banks.
- Current NBG categories for repayable funds by number of individuals (1–20 and greater than 20) can be dispensed with, but requirement for deposit taking by micro-banks should remain at GEL100,000, with possible reduction to GEL50,000 until the transition period expires.
- The category of repayable funds of 1 to 20 persons should be eliminated when an MFI converts to a micro-bank; such funds are often from persons associated with the business and preferably converted to regulatory capital or repaid.
- The 1 to 20 persons category for continuing MFIs should be eliminated as soon as possible after changes are implemented, allowing a transition period for procedural fairness.
- Transition arrangements should apply to the category of repayable funds over 20 persons; minimum repayable funds allowed for this category is GEL100,000 each, and repayment should be gradual to avoid instability.

### Limits on loan and deposit sizes, concentration and large exposures
- While maximum loan size should remain at GEL100,000, the NBG could consider applying a maximum deposit size to micro-banks after the transition period.
- Purpose of maximum loan and deposit size: create a micro-banking model without significant funding concentration.
- Unrestricted deposit taking, or the chosen maximum deposit size, should be allowed up to two to three years after micro-banks are licensed, subject to GRAPE supervisory confidence.
- Initial limits on deposits should be placed to reduce concentration risk; supervisory action when a single deposit or series of deposits from one source, one industry or one sector exceeds a certain percentage of regulatory capital.
- NBG prefers to retain the maximum loan limit of GEL100,000 when MFIs convert to micro-banks, with gradual increases over time.
- Loan size limit may be periodically increased over time; limitations should control large loan or other exposures created by micro-banks.
- A large exposures framework should be introduced with an upper limit of 25 percent of regulatory capital, which cannot be exceeded.
  - Loan exposures exceeding 10 percent of regulatory capital should become classified as large exposures and reported to the NBG.
  - At conclusion of the transition period for the initial group of micro-banks, same large exposure requirements should be based on Tier 1 capital, necessitating further amendment.
- A higher upper loan limit may be considered with the large exposure ratio to capital; examples suggested include GEL500,000 or GEL1 million for flexibility over time.
- Some of the largest MFIs might be able to attract loans of well over GEL5 million under the large exposure formula.

### Licensing of micro-banks and registration of MFIs and LIEs
- New applications to become a micro-bank should go through a licensing process requiring enhancements to Order No. 58/04 “Procedures and Terms of Registration of Microfinance Organizations”.
- Licensing should at least require:
  - A strategic plan showing viability and how the proposed micro-bank will achieve desired growth or maintenance of SME and agricultural lending.
  - Meet prudential requirements.
  - Financial projections (preferably three years) consistent with the strategic plan.
  - Details of risk management framework, including policies and procedures for all risk areas.
  - Governance, including separation of management and supervisory board.
  - Internal audit program.
- A clear mandate should be established for micro-banks to function as lenders to underserved individuals, SMEs, and agribusinesses, with licensing criteria to incentivize or require minimum lending to these segments and publication of such criteria on the NBG’s website.
- Existing MFIs interested in converting should enter consultation with the NBG and be subject to regular/intensive supervision leading up to conversion.
- Licenses for micro-banks are expected to be conditioned, containing transition-period conditions and potentially longer-term constraints on business type, source of deposits, business-plan identified issues, and limits on aspects of business.
- The NBG should draft regulations to allow MFIs wishing to become LIEs to register as LIEs without liquidation; registration requirements for new LIEs should be strengthened over time to include basic information verifying viability, skills and experience of senior management, a basic business plan, financial projections, and capital identification.
- For larger MFIs choosing to become LIEs, appropriate safeguards could include requirements for enhanced risk management and governance and consideration of capital and liquidity thresholds for larger, more complex LIEs.

*Source: 1geoea2020005 - 47.      The leverage ratio requires Tier 1 capital to be divided by on and off-balance sheet exposures.*

### 76.      It is understood that there are still some lending institutions operating within

### 1geoea2020005 - 76.

### Registration and licensing issues
- It is understood that there are still some lending institutions operating within Georgia which have more than 20 loans and are not registered, despite the deadline for registration having expired.
- Registration of these entities should continue as they have the capacity to damage the reputation of the registered MFIs and LIEs; the NBG should allow some of them fail.
- One suggestion the NBG had was to offer a further six-month extension to licensing, with a waiving of the license fee for this period.
- The suggested waiver may cause friction with those that did register within the previous stipulated time period and paid their fee, but it appears to be one way to create an incentive for registration.

### Supervisory Framework for Micro Lending Entities
- The NBG should complete the revisions to the NBG Supervisory Framework for the nonbank and micro-bank sectors incorporating the various elements related to offsite and onsite supervisory processes.
- The NBG is currently developing its supervision framework for MFIs and requested the mission to provide guidance in this area.
- The NBG already has an established supervision framework for banks (GRAPE), however it seeks to tailor a framework that will fit MFIs.
- The mission left some best practice commentary towards enhancing a supervision framework with the NBG.
- Once developed, this framework should become applicable to MFIs and micro-banks.
- Supervisory responses undertaken within the framework will be driven by scale, complexity, and risk issues.
- Changes to regulations to reflect the new supervisory framework would be necessary.
- Completion of the supervisory framework could be done by December 2020 and put into effect during the conversion process of MFIs to micro-banks.
- The NBG’s approach to onsite supervision, which is being developed, encompasses a full suite of onsite supervision activities and tools.
- The NBG has already started undertaking onsite inspections of MFIs on a comprehensive basis covering all key risk areas, though not risk focused on key risk areas, displaying heightened risk or targeted to specific issues within key risk areas.
- The NBG should move to a more risk-based approach to onsites, commensurate with the size and risk of the institutions, so that supervisory resources can be applied more effectively.
- It is considered best practice to have a specialist enforcement department to carry out liquidations, with experts who are well practiced in this field.
- A comprehensive supervisory attention framework structure will assist the “frontline” teams to coordinate transfer of problem institutions to the enforcement area requiring liquidation or other enforcement action, by having a designation in the framework that triggers the transfer.
- In time the remaining MFIs that do not take deposits can move to a supervision approach in tune with proportionality, but some supervision is essential if the remaining MFIs are to move towards becoming micro-banks in a later stage.
- The NBG should consider reviewing the enforcement powers it has for MFIs and ensure it has all the enforcement tools it needs to be effective when dealing with problem institutions.
- Once an MFI transitions to become a micro-bank it will come under the Banking Law (see paragraph 32) and the NBG will then be able to utilize all the enforcement tools currently available for commercial banks also on micro-banks.
- While the mission suggests prudential supervision of LIEs should cease, if the NBG decides LIEs are to continue to be supervised, then a separate minimalist supervision framework should be developed to reflect the ‘light touch’ supervision warranted since no deposit like funds can be accepted by these entities.

### Proportionality in Supervision and Risk Management
- An important component of a supervision framework in a risk-based system is the process for determining the level of supervisory attention and the application of the corresponding framework of supervisory action.
- Supervisory attention should be proportional to the size and risk of the institution, which lends itself to a matrix approach.
- The NBG’s supervision framework should determine frequency of onsite examinations for each institution based on size and the risk of supervised institutions.
- A basic supervision framework helps to mitigate the risk of missing emerging risks under a risk-based approach by setting the minimum core supervision needed, across all onsite and offsite activities, to gain a satisfactory understanding of an institution’s complete risk profile.
- This would be achieved by determining, based on a set risk measure, what supervisory activities must at a minimum be undertaken over a set timeframe.
- In determining the risk categories to decide supervisory action, a matrix involving size bands on one axis and the level of risk on the other, again in bands, should be developed.
- Certain areas of the matrix are delineated as categories of ‘riskiness’ for determining supervisory attention and action.
- This approach allows for consistency of supervisory approach to be maintained across different sized entities, with proportionality in supervision being preserved at the same time.
- For any institution, its position within the matrix can then be readily established from its size and risk rating as determined from the risk measurement calculation within GRAPE.
- Supervisory attention is driven by the category within which an entity falls, which in turn causes certain supervisory actions.
- Under the set risk measure approach, larger institutions, even those with relatively low risk characteristics, will tend to be grouped in the higher supervisory attention band and only very high-risk smaller institutions will be in this same group for supervisory stance.
- The NBG should plan to develop regulations for corporate governance, credit risk management, and operational risk (including business continuity) management for MFIs and micro-banks.
- The mission believes it would be sensible to develop an overarching enterprise wide risk management regulation which includes various individual regulations on risk areas.
- While operational risk will be assessed on a proportional basis for MFIs, the requirements for micro-banks should step up over time.
- At this stage it is considered that the MFIs are not equipped to comply with a full suite of operational risk requirements.
- The mission considers that the aim should be to introduce a final operational risk regulation in conjunction with the final amendments to the capital regulation, around six months before micro-banks are licensed.
- This final version of the operational risk regulation should cover such areas as information technology (IT) risk, outsourcing (if any), disaster recovery planning, business continuity, and pandemic planning, all on a proportional basis.

### Other measures and enforcement tools
- The NBG should consider further measures to reduce the likelihood of fraud and speculation.
- At present MFIs do not, in general, have fraud insurance.
- While MFIs are very simple systems, the potential for fraud appears relatively high.
- Fraud insurance can usually be obtained at reasonable cost and a requirement should be considered, including for micro-banks.
- Some MFIs are currently experiencing pressure on their profitability.
- To reduce their cost of funds there is a real temptation not to hedge their FX positions.
- Regulations should require MFIs and micro-banks not to speculate and hedge all FX positions.
- The regulations should be revised to provide explicit authority for the NBG to have the power of temporary administration over an MFI.
- A full suite of enforcement powers would include temporary administration.
- Temporary administration provides supervisors with an institution to appoint a manger/administrator (who would displace existing management and the supervisory board) where the supervisor(s) believe a viable entity has been poorly managed and the best outcome would be to employ a professional person to clean it up and turn the business around and then remove it from administration.
- The mission was advised the NBG does not have this power; it would be of significant benefit to the NBG in certain circumstances.

*Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1geoea2020005.pdf*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1geoea2020005.pdf_