## EXECUTIVE SUMMARY ## Source details **Canonical URL:** [EXECUTIVE SUMMARY](https://www.imf.org/-/media/files/publications/cr/2021/english/1geoea2021003.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1geoea2021003.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1geoea2021003.pdf.json) --- ### Background and macroeconomic impact - Georgia is a small, open economy exposed to recurring macrofinancial and geopolitical shocks, contributing to a highly dollarized banking system. - COVID-19 impact: - Contraction of 6.2 percent in 2020. - Unemployment rose from 16.6 percent at end-2019 to 21.9 percent in 2021Q1. - Government fiscal support: 3.8 percent of GDP in 2020 and a further 2.9 percent of GDP in 2021 (mostly for healthcare). - NBG monetary support: cumulative rate cuts of 100 bps. - Between end-2019 and April 2021, the lari depreciated by about 20 percent against the dollar; net effective exchange rate remained stable due to appreciation versus key trading partners. ### Financial sector resilience and policy actions - Banks remained resilient in capital and liquidity despite increases in non-performing loans and sharp declines in earnings; credit growth remained robust. - NBG early-2020 policy actions: - required banks to take up-front general provisions against loan losses; - restricted capital distributions and released some capital buffers; - lowered the policy rate; - temporarily suspended the LCR requirement in lari; - expanded collateral for central bank liquidity access and allowed banks to swap foreign currency holdings. - Government measures: unemployment compensation, direct transfers, mortgage subsidies, tax relief, credit guarantees, placements of debt issuance proceeds with banks to support liquidity. ### Stress testing, vulnerabilities, and financial stability assessment - FSAP solvency and liquidity analysis covered all 15 banks. - Solvency results: - Under a conservative baseline scenario over a 3-year period, all 15 banks were adequately capitalized. - Under an adverse scenario (extended pandemic through end-2021 coupled with an external disturbance), four banks suffered capital shortfalls in aggregate amounting to 1.5 percent of GDP. - Liquidity results: - All banks were sufficiently liquid across scenarios, including one replicating deposit outflows during the Global Financial Crisis. - Policy implication: - Authorities should encourage banks to retain earnings until pandemic-related uncertainties dissipate and pre-pandemic capital buffers are fully restored. - Proceed with planned implementation of the Basel single party concentration standard for banks. ### Macroprudential policy and dollarization - Toolkit tailored to dollarization includes: - outright ban on FX lending for amounts below 200,000 GEL; - higher capital charges on unhedged FX lending; - borrower-based measures (payment-to-income and loan-to-value requirements by currency); - higher reserve requirements and penalty rates of remuneration on FX versus lari deposits; - differentiation of reserve requirements by individual banks’ deposit dollarization; - differentiated liquidity coverage requirements for FX and lari deposits. - Dollarization metrics: - Banks’ dollarization has declined by about 10 percentage points since 2016. - Deposit dollarization remains above 60 percent. - Loan dollarization remains above 55 percent (the highest in the CCA region). - Recommended approach: - Short term: NBG appropriately focused on restoring de-dollarization related measures released during the pandemic. - Medium term: NBG should consider tightening de-dollarization measures gradually, informed by impact assessments. - NBG should enhance public communication on macroprudential decisions and on foreign exchange intervention policy, and expand and regularly carry out impact assessments. ### Supervisory oversight, capital markets, and AML/CFT - Banking supervision: - Regulatory regime generally consistent with Basel standards and tailored to a highly dollarized system. - Recommendations: formalize supervisory planning and decision-making processes; expand communication with banks on supervisory assessments; follow up on remedial measures; deepen assessments of governance and risk management; require systemic banks to incorporate internal stress tests into capital and liquidity management. - Capital markets oversight: - Framework aligned with IOSCO standards. - Further enhancements: identify emerging risks, assign risk scores, conduct assessments, ensure monetary sanctions for market abuse are sufficiently punitive. - AML/CFT: - Authorities’ views and supervisory details discussed; recommended supervisory strengthening for gaming sector, virtual asset service providers, and real estate agents. ### Financial safety nets and resolution - Progress since last FSAP: - 2019 amendments to NBG and Banking Laws on recovery planning, resolution and liquidation. - Formation of a new Interagency Financial Stability Committee to handle banking resolution. - Remaining actions: - Establish clear procedures for bank resolution and crisis management. - Facilitate swift establishment of a bridge bank when needed. - Prepare formal contingency plans for crisis situations and clarify sources of official financing available during bank resolution. ### Financial sector development and market infrastructure - National Payment System: - Continue improving access and efficiency. - Develop a comprehensive risk management framework for the RTGS and conduct CPMI/IOSCO assessments of the CSDs. - Competition and conduct: - NBG should expand surveillance for anti-competitive conduct, increase penalties, review merger and acquisition activity systematically, and build enforcement capacity. - Capital markets: - Continue efforts to develop legislation for covered bonds to provide investors an additional savings instrument, help lower interest rates on local currency mortgages, and serve as a liquidity management tool. - Access to finance: - Expand credit information on potential borrowers. - Develop an online collateral registry and strengthen the legal framework for secured transactions. - Define a roadmap for fintech development and a National Financial Inclusion Strategy. ### Key recommendations (selected) - Financial Stability Analysis: - Encourage banks to retain earnings until pandemic-related uncertainties subside and pre-pandemic capital buffers are restored. (ST) - Implement Basel regulation on banks’ large exposures as planned. (ST) - Macroprudential Policy and Dollarization: - Review calibration of macroprudential tools aimed at reducing dollarization, including via impact assessments. (ST) - Strengthen communication of the impact and rationale of macroprudential policy decisions. (ST) - Enhance public communication to clarify the objectives of foreign exchange interventions. (I) - Banking Supervisory Oversight: - Formalize and enhance governance of key internal processes for supervisory operations and decisions. (I) - Review the internal GRAPE scoring and weighting methodology. (ST) - Carry out regular in-depth assessments of banks’ governance and risk management practices. (ST) - Require systemic banks and encourage others to incorporate internal stress testing in capital and liquidity planning. (ST) - AML/CFT Supervision: - Strengthen regulation/supervision for gaming sector, virtual asset service providers, and real estate agents. (MoF) (MT) - Consider setting maximum thresholds for use of cash in certain transactions. (ST) - Capital Markets Oversight: - Continue to develop and implement risk-based supervision for all market participants. (ST) - Ensure sanctions for market abuse are sufficiently punitive. (I) - Financial Safety Nets: - Implement a prompt corrective action framework for banks. (I) - Take steps to be able to implement a bridge bank swiftly when needed. (MoF, NBG) (I) - Prepare crisis contingency plans for banks and adopt regular testing programs. (IFSC, NBG) (ST) - Financial Sector Development: - Develop detailed procedures for oversight of payment systems. (I) - Complete self-assessments of the two Central Securities Depositories. (NBG, GCSD) (I) - Develop institutional capacity for competition enforcement and advocacy as a separate function within NBG. (I) - Commit to a predictable schedule of issuance for benchmark government bonds in sizable amounts. (MoF) (I) - Enact relevant legislation for covered bonds as planned. (MoF, NBG) (I) - Establish an online collateral registry and strengthen the legal framework for secured transactions. (NBG, MoJ) (ST) - Define a roadmap for the development of fintech and a National Financial Inclusion Strategy. (ST) *Source: EXECUTIVE SUMMARY, 1geoea2021003.* --- ### 3. A V-shaped recovery, supported by external demand and fiscal stimulus ### Recovery, inflation, and monetary policy - A V-shaped recovery is underway. - CPI inflation rose to about 11.9 percent at end-July 2021, well above the NBG’s target of 3 percent. - The NBG reversed its pandemic monetary policy stance and raised the policy rate by 200 bps cumulatively between March and August 2021. - Authorities have operated an inflation targeting framework with a floating exchange rate regime since 2019. ### Credit growth and credit gap - Credit at constant exchange rates: - slowed to 7.7 percent (y-o-y) in March 2021 compared to about 16 percent before the pandemic; - picked up to 12.6 percent (y-o-y) in June 2021 notwithstanding tightening in rates. - Main drivers shifted from consumer and mortgage lending to large corporates following responsible lending regulation on household credit in 2019. - NBG analysis suggests the credit gap was close to zero before the pandemic and became positive subsequently. ### Macrofinancial vulnerabilities - Corporates, SMEs and households: - Corporate sector debt doubled over the last decade to 69 percent of GDP. - Three-quarters of corporate loans are in FX; only 20 percent are hedged. - 60 percent of SME loans are in FX and almost none are hedged. - Households: - Household sector debt is 38 percent of GDP and has tripled in proportion to disposable income over the past decade. - Over 40 percent of household loans are in FX and almost none are hedged. - Real estate: - Residential prices up about 60 percent in lari terms over the past decade but largely stable in dollar terms; no signs of overvaluation. - Average house price is below 200,000 lari so the outright ban effectively limits mortgage loans in FX. - Sovereign: - Government debt reached 60 percent of GDP, almost 20 percentage points higher than in 2019. - Almost 80 percent of government debt is in foreign currency. - Banks’ holdings of government debt are about 10 percent of banks’ assets and are held to maturity. ### Financial system overview and banking sector performance - Financial sector assets amount to 108 percent of GDP (total assets of about 18 billion USD). - Sector composition: 15 commercial banks (94 percent of assets); microfinance organizations (2 percent); insurers (2 percent); pension funds (2 percent). - Banking system: - 9 domestic banks (3 are D-SIBs) and 6 small banks that are subsidiaries of foreign banks. - Two largest banks make up nearly three-quarters of lending. - Capital, liquidity, asset quality and profitability: - CAR ratios fell by 1.9 ppt during 2020 but rose to 19.2 percent by 2021Q2 (Tier 1 ratio of 14.8 percent). - Liquidity complied with LCR and NSFR requirements during the pandemic; LCR by currency: 100 percent in FX, 75 percent in lari (lary requirement temporarily eased). - NPLs reached 6.7 percent by Q2-2021 compared with 4.4 percent at end-2019 (NBG classification). - NPLs higher on FX loans: about 12 percent on dollar loans, about 8 percent on euro loans, and about 6 percent on lari loans (as of February 2021). - FSI data report NPLs at 2.2 percent at Q2 2021 compared with 1.9 percent at end-2019. - Banks’ external debt increased to 27 percent of GDP in 2020 from about 10 percent in 2010; about three quarters is long-term and nearly half owed to IFIs. ### Policy actions and reforms - Reforms since 2015 include Basel III implementation, Responsible Lending Regulation (2019), new banking resolution regime (end-2019), deposit insurance scheme (2017), Corporate Governance Code (2018), strengthened top-down stress testing framework, and publication of annual Financial Stability Report since 2019. - Pandemic-related measures included moratoria, general provisioning requirements (about 3.5 percentage points of banks’ CET1 ratios), partial releases of buffers, and placement of GEL 600 million of government securities proceeds as long-term deposits with banks. - Transition to IFRS9 prudential provisioning expected by 2022. ### Key vulnerabilities and scenario risks - Key vulnerability: high dollarization of banks’ assets and liabilities. - Risk channels: - Credit risk from unhedged borrowers: about 75 percent of corporates’ liabilities and 40 percent of households’ liabilities are in FX; only about 20 percent of corporate FX borrowers are fully hedged. - Liquidity risk: NBG has limited ability to backstop systemic FX liquidity shocks; banks depend on own FX liquidity buffers. - Scenario risks include extended pandemic, less benign external financing conditions, exchange rate depreciation, residential and commercial real estate adjustments, and external shocks causing capital outflows and higher sovereign borrowing costs. ### Stress-testing approach and results - Stress-testing design: - Baseline used April 2021 WEO forecast. - Two adverse scenarios over a three-year horizon implied negative GDP shocks of 1–1.5 standard-deviations relative to the baseline. - Hurdle rates: Basel CAR 8 percent, T1 6 percent, CT1 4.5 percent. - LCR hurdle rates: 100 percent aggregate, 100 percent in FX, 75 percent in lari. - Results: - Baseline: banks appear well prepared; absorption and replenishment of bank capital buffers likely to take 2–3 years. - Adverse scenarios: - Extended Pandemic: three banks experienced capital shortfalls of 0.5 percent of GDP relative to minimum Tier 1 requirements. - Capital Outflows: four banks suffered capital shortfalls adding up to about 1.5 percent of GDP. - Aggregate shortfalls: - Extended pandemic: 12.7 million lari or 0.03 percent of RWA. - Capital outflows: 149 million lari or 0.4 percent of RWA. - Credit losses expected between 3–6½ percent of gross performing loan exposures. *Source: IMF staff summary of chapter 3 of the Georgia financial system assessment (as provided).* --- ### Banks have sufficient high-quality liquid assets to survive severe shocks to their deposit base ### Solvency and liquidity stress-test findings - All banks were able to endure extreme liability shocks (emulating peak 2008–09 GFC) while sustaining regular operations, even with gross inflows from loans and securities set to zero. - Stress tests indicate banks have sufficient high-quality liquid assets to survive severe deposit-base shocks. ### Sensitivity analysis and other risk channels - Market risk: - A 30 percent lari depreciation would cause a drop in the CAR of about 0.6 percentage points. - Interest rate risk is inconsequential as banks’ assets and liabilities are not marked to market. - Equity price risk is absent. - Interbank contagion: - Small interbank exposures imply interbank contagion is not material. - Bank-sovereign nexus: - Sovereign spreads widening by 600 bps produced a 1.5 percentage point drop in overall CAR, down to a minimum of 11.5 percent across individual banks. - Public bonds can be used as collateral for central bank liquidity. ### Large corporate exposures and provisioning - Analysis of ten largest credit exposures per bank used latest available financial statements. - Companies with less than full coverage of annual debt interest payments accounted for about 12 percent of sampled firms’ assets. - Stress tests indicated a moderate shortage of provisions under adverse scenarios. ### FSAP recommendations (risk management and policy) - Encourage retention of banks’ earnings until credit losses are absorbed and capital buffers fully restored. - Proceed with implementation of the single-party concentration limit as planned; enforcement would have very limited impact on availability of bank credit to large firms. - Data enhancements: refine reporting on large borrowers, expand data on FX risk exposures, add sectoral classification granularity, and implement the ongoing credit registry project. ### Authorities’ views - Authorities largely agreed with FSAP results for solvency and liquidity. - They highlighted that provisions taken in 2020Q1 are still expected to fully cover pandemic losses. - On earnings retention, authorities felt retention should only be required for banks below pre-pandemic capital buffer requirements. - On corporate stress-testing, authorities emphasized using consolidated financials and up-to-date exposure information. ### Macroprudential policy and de-dollarization - Institutional framework broadly meets good design principles; Organic Law grants NBG supervisory powers and financial stability mandate. - Toolkit and measures: - PTI/LTV ratios have slowed household credit growth and shifted lending to corporates. - 200,000 GEL limit on FX lending reduced new FX loan issuance to households. - CICR pillar 2 buffer and higher LCR and reserve requirements in FX bolster resilience. - Policy trade-offs: - Further de-dollarization depends on banks’ ability to raise local currency funding and households’ currency preferences. - Excessive restrictions on FX lending risk financial disintermediation. - Calibration and communication: - NBG should review calibration periodically and carry out impact assessments. - Publish FX intervention strategy and clarify objectives to shape exchange rate expectations. - Improve communication of macroprudential rationale (e.g., heatmaps, policy papers). *Source: IMF staff analysis as presented in the FSAP chapter on Georgia (excerpts provided).* --- ### AML/CFT risks, financial safety nets, and financial sector development ### AML/CFT risks and mitigation - Identified risks: - High use of cash in transactions, including real estate purchases. - Activities of politically exposed persons. - Absence of regulation for providers of virtual assets. - Weak regulations for the gaming sector. - Exemptions from FATF recommendations for some professions. - Recommended actions: - Consider setting maximum cash thresholds for various transactions. - Strengthen analysis of suspicious transactions reported by banks. - Include virtual asset service providers in the AML framework by end-2021 as planned. - Strengthen licensing and supervision for the gaming sector. ### Financial safety nets — assessment and gaps - Legal and operational steps taken: - December 2019 amendments to NBG and Banking Laws upgraded regimes for liquidation and systemic bank resolution, established an ex post funded Resolution Fund, and introduced bank recovery planning. - Deposit insurance coverage expanded in mid-2020 to GEL 15,000 from 5,000 for natural persons on local and FX deposits; now covers 97 percent of resident and non-resident deposits. - Interagency Financial Stability Committee established in mid-2020 (MoF, NBG, Deposit Insurance Agency, Insurance State Supervision Service). - Remaining recommendations: - Simplify creditor hierarchy to align with deposit insurance coverage. - Clarify recovery planning requirements and triggers. - Increase banks’ loss absorbency and resolvability. - Enhance operational capacity of safety net authorities. - Allow DIA to finance purchase and assumption in liquidation if least cost. - Lay operational groundwork for a bridge bank (license, supervisory board, funding). - Implement a formal prompt corrective action framework. - Prepare resolution plans for systemic banks (initial plans for three SIBs to be presented by year-end 2021). - Prepare formal contingency plans and testing programs; clarify modalities for resolution funding and strengthen DIA funding arrangements (MoF backstop line of credit; framework to borrow against NBG investment portfolio). ### Financial sector development — priority areas - Payment systems: - Complete risk management framework for RTGS. - Assess two CSDs against CPMI/IOSCO PFMI standards. - Competition: - Systematic assessment of prudential regulations from a competition perspective. - Enhance monitoring and enforcement capacity for anti-competitive practices. - Capital markets: - Commit to predictable issuance schedule for benchmark government bonds. - Enact legislation for covered bonds to deepen local-currency funding. - Access to finance and fintech: - Define a Fintech roadmap. - Establish an online collateral registry and enhance secured transactions framework. - Improve retail payments interoperability and expand credit-related information on SMEs using alternative data. ### Key statistics and timelines - Deposit insurance coverage: expanded to GEL 15,000 from 5,000 for natural persons in mid-2020; now covers 97 percent of resident and non-resident deposits. - Inclusion of virtual asset service providers in AML framework planned by end-2021. - Resolution plans for the three SIBs: initial plans to be presented by year-end 2021. *Source: IMF staff summarization of the content unit 1geoea2021003 - 41.* --- ### 5. Higher — Climate, COVID support, and regulatory measures ### Climate-related risk - Higher precipitation in Caucasus mountain areas could increase frequency/severity of floods, landslides, mudslides, avalanches, affecting wine and tourism industries. - Financial-sector implications assessed Low / Medium to Medium: - Weaker lari, higher dollarization. - Higher NPLs on banks’ loans to borrowers in related industries. ### Key COVID-19 government support and liquidity measures - Government support: - Credit guarantees scheme: GEL 330 million. - Interest subsidy scheme: GEL 70 million for family-owned SMEs (hotels). - Mortgage subsidy: 4 percentage points on new lari mortgages below GEL 200,000 for purchases of newly built apartments between June 1, 2020 and January 1, 2021. - 600 million GEL in debt issuance for banks’ liquidity support. - Liquidity measures: - MoF issued extra 600 million GEL of government securities in April 2020 and deposited lari proceeds with banks as long-term deposits. - NBG introduced swap lines for up to $400 million with one-month maturity, renewable monthly until April 2022. - NBG activated stand-by swap instrument at a penalty rate. - NBG provided liquidity support against SME loan collateral; mechanism to phase out from 2022 and expire end-2023. - LCR in domestic currency relaxed from 75 percent to zero for one year (May 2020). - NBG reduced policy rate by 50 bps on April 29, 2020; by 25 bps on June 24, and by 25 bps on August 5. - Capital and lending measures: - March 2020: NBG reduced capital requirements by releasing CCB (2.5 percent of RWA) and 2/3 of the CICR pillar 2 buffer. - April 2020: banks instructed not to use capital relief for dividends, buybacks, equity investments, or distributions. - NBG postponed increases in CET1 and Tier 1 requirements from CICR and GRAPE buffers. - Banks offered renewable three-month loan grace periods. - March 2020 guideline on expected credit losses: exposures with temporary liquidity problems on payment holidays should not be regarded as having significant increase in credit risk solely for that reason. - Regulation on Credit Concentration and Large Risks postponed by a year and a half. - NBG suspended on-site inspections except for money laundering (performed remotely) and introduced a moratorium on fines arising from crisis breaches. ### Selected regulatory and borrower-based measures (dates preserved) - Capital: - Increase in minimum regulatory capital to GEL 50 million. (May 2017) - Alignment with Basel III and Pillar 2 introduction. (December 2017) - CCB of 2.5 percent introduced. (December 2017) - CCB released as part of COVID-19 response, to be restored by January 2024. (April 2020) - CICR pillar 2 buffer: 75 percent additional risk weighting for unhedged borrowers; two-thirds released in April 2020, to be restored by January 2023. (December 2017; April 2020) - CCyB introduced but not activated. (December 2017) - DSIB Buffers (between 1.5 and 2.5 percent) phased in through December 2021. (December 2019) - Leverage Ratio minimum 5 percent. (September 2018) - Liquidity: - Reserve requirements and remunerations adjusted (July 2018; March 2019; October 2019; July 2021). - LCR: 100 percent overall, 75 percent domestic currency, 100 percent foreign currency; LCR domestic reduced to zero for one year. (September 2017; May 2020; October 2019) - NSFR requirement of 100 percent. (September 2019) - Borrower-based: - PTI limits and LTV limits set in January 2019 and adjusted in March 2020. - Restriction on FX lending: prohibited below 100,000 GEL (January 2017); limit tightened to 200,000 GEL (January 2019). - Currency-risk: - Limit on net open FX position: 20 percent of regulatory capital. (July 2006) ### Financial sector policy recommendations (Article IV and program reviews) - Monetary policy and exchange rate: - Monetary policy should balance lari depreciation risks and demand weakness, be driven by inflation developments, and maintain exchange rate flexibility as a shock absorber while avoiding excessive lari volatility. - NBG stance deemed adequate and appropriately focused on price stability; continue to build reserves and strengthen transmission mechanism. - Financial stability and institutional: - Providing adequate liquidity and releasing some capital buffers helps sustain stability. - Implement bank resolution and insolvency frameworks; establish funded pension pillar and capital market reforms to mobilize domestic savings. - Adopt insolvency framework for nonfinancial corporations and pursue judiciary reform. ### Status of 2015 FSAP recommendations (selected) - Many recommendations completed (e.g., regulatory provisions, large exposures definition, corporate governance code, macroprudential mandate amendments, CCyB and LCR implementation, D‑SIB buffer introduction, deposit insurance scheme establishment, resolution framework overhaul). - Outstanding/in-progress items: enhance capacity of Banking Supervision Department; financial sector development strategy and capital market development; movable collateral registry operationalization. ### IMF technical assistance (missions listed with counts and dates) - Multiple missions across topics including stress testing, central bank risk management, government securities market, FX policy and communications, nonbank financial institutions, Financial Stability Report, IFRS 9 implementation, resolution framework, financial stability analysis, consolidated supervision, centralized risk management, monetary and FX operations, and macroprudential policy framework (missions and date ranges listed in source). *Source: 5. Higher (chapter/section) — 1geoea2021003* --- ### Appendix I. Central Bank Digital Currency ### Objectives and context - NBG is considering a retail CBDC to enhance payment system efficiencies and financial inclusion. - NBG has developed principles for preferred technical design features and invited technology firms, Fintech companies, and financial institutions to tender proposals. - CBDC design should be aligned with policy objectives and consider macro financial stability implications. ### Preferred design roles and responsibilities - NBG should control issuance and destruction of money; the register/account system; and the rules of operation. - Banks and other third parties should provide end-user services. ### Governance, testing, and safeguards - Consider establishing a joint taskforce with the Ministry of Finance to coordinate exploration, experimental testing, and analysis of CBDC implications. - Taskforce could be supported by private-sector sub-committees focusing on technology and non-technology aspects including monetary policy, financial stability, integrity, and inclusion. - NBG plans a controlled testing environment to identify preferred characteristics of Digital Gel, uncover unintended consequences, and reveal economic and regulatory issues. - NBG may ensure non-bank payment service providers have strong cyber resilience, undertake financial and digital literacy programs, and analyze public law aspects under central bank and monetary law. *International Monetary Fund — Appendix I. Central Bank Digital Currency* ### EXECUTIVE SUMMARY __________________________________________________________________________________ 7 ### EXECUTIVE SUMMARY ### Background and macroeconomic impact - Georgia is a small, open economy exposed to recurring macrofinancial and geopolitical shocks, contributing to a highly dollarized banking system. - The COVID-19 pandemic led to the largest output decline since the 1990s: a contraction of 6.2 percent in 2020. - Unemployment rose from 16.6 percent at end-2019 to 21.9 percent in 2021Q1. - Government fiscal support amounted to 3.8 percent of GDP in 2020 and a further 2.9 percent of GDP in 2021 (mostly for healthcare). - The National Bank of Georgia (NBG) provided monetary support via cumulative rate cuts of 100 bps. - Between end-2019 and April 2021, the lari depreciated by about 20 percent against the dollar, though the net effective exchange rate remained stable due to appreciation versus key trading partners. ### Financial sector resilience and policy actions - Banks remained resilient in terms of capital and liquidity despite increases in non-performing loans and sharp declines in earnings across firms; credit growth remained robust during the pandemic. - NBG policy actions early in 2020 included: - requiring banks to take up-front general provisions against loan losses; - restricting capital distributions and releasing some capital buffers; - lowering the policy rate; - temporarily suspending the LCR requirement in lari; - expanding collateral for central bank liquidity access and allowing banks to swap foreign currency holdings. - Government measures included unemployment compensation, direct transfers, mortgage subsidies, tax relief, credit guarantees, and placements of debt issuance proceeds with banks to support liquidity. ### Stress testing, vulnerabilities, and financial stability assessment - FSAP solvency and liquidity analysis covered all 15 banks. - Solvency: - Under a conservative baseline scenario over a 3-year period, all 15 banks were adequately capitalized. - Under an adverse scenario (extended pandemic through end-2021 coupled with an external disturbance), four banks suffered capital shortfalls relative to minimum Tier 1 requirements, amounting in aggregate to 1.5 percent of GDP. - Liquidity: - All banks were found to be sufficiently liquid in various scenarios, including one replicating deposit outflows during the Global Financial Crisis. - Policy implication: - Authorities should encourage banks to retain earnings until pandemic-related uncertainties dissipate and pre-pandemic capital buffers are fully restored. - Proceed with planned implementation of the Basel single party concentration standard for banks. ### Macroprudential policy and dollarization - The macroprudential toolkit is comprehensive and tailored to the systemic risk of dollarization. Measures include: - outright ban on FX lending for amounts below 200,000 GEL; - higher capital charges on unhedged FX lending; - borrower-based measures such as payment-to-income and loan-to-value requirements by currency; - higher reserve requirements and penalty rates of remuneration on FX versus lari deposits; - differentiation of reserve requirements by individual banks’ deposit dollarization; - differentiated liquidity coverage requirements for FX and lari deposits. - Dollarization metrics: - Banks’ dollarization has declined by about 10 percentage points since 2016. - Deposit dollarization remains above 60 percent. - Loan dollarization remains above 55 percent (the highest in the CCA region). - Recommended approach: - In the short term, the NBG is appropriately focused on restoring de-dollarization related measures released during the pandemic. - Over the medium term, the NBG should consider tightening de-dollarization measures gradually, with choice and calibration informed by impact assessments. - The NBG should enhance public communication on macroprudential decisions and on foreign exchange intervention policy, and expand and regularly carry out impact assessments of macroprudential measures. ### Supervisory oversight, capital markets, and AML/CFT - Banking supervision: - Regulatory regime generally consistent with Basel standards and tailored to a highly dollarized system. - Recommendations include formalizing supervisory planning and decision-making processes, expanding communication with banks on supervisory assessments, following up on remedial measures, deepening assessments of governance and risk management, and requiring systemic banks to incorporate internal stress tests into capital and liquidity management. - Capital markets oversight: - Regulatory and policy framework aligned with IOSCO standards. - Further supervisory enhancements: identification of emerging risks, assignment of risk scores to supervised entities, conduct assessments, and ensuring monetary sanctions for market abuse are sufficiently punitive. - AML/CFT: - Authorities’ views and details on supervision are discussed; specific supervisory strengthening is recommended in areas such as gaming sector, virtual asset service providers, and real estate agents (see Table 1 recommendations). ### Financial safety nets and resolution - Progress since the last FSAP: - 2019 amendments to NBG and Banking Laws on recovery planning, resolution and liquidation. - Formation of a new Interagency Financial Stability Committee to handle banking resolution. - Remaining actions: - Establish clear procedures for bank resolution and crisis management. - Take steps to facilitate swift establishment of a bridge bank when needed. - Prepare formal contingency plans for crisis situations and clarify sources of official financing available during bank resolution. ### Financial sector development and market infrastructure - National Payment System: - Continue improving access and efficiency. - Develop a comprehensive risk management framework for the RTGS and conduct CPMI/IOSCO assessments of the CSDs. - Competition and conduct: - New Competition Law assigns a competition mandate to the NBG; new regulations provide guidance on anti-competitive practices. - The NBG should expand surveillance for anti-competitive conduct, increase penalties, review merger and acquisition activity systematically, and build enforcement capacity. - Capital markets: - Continue efforts to develop legislation for covered bonds to provide investors an additional savings instrument, help lower interest rates on local currency mortgages, and serve as a liquidity management tool. - Access to finance: - Expand credit information on potential borrowers. - Develop an online collateral registry and strengthen the legal framework for secured transactions. - Define a roadmap for fintech development and a National Financial Inclusion Strategy. ### Key recommendations (selected from Table 1) - Financial Stability Analysis: - Encourage banks to retain earnings until pandemic-related uncertainties subside and pre-pandemic capital buffers are restored. (ST) - Implement Basel regulation on banks’ large exposures as planned. (ST) - Macroprudential Policy and Dollarization: - Review calibration of macroprudential tools aimed at reducing dollarization, including via impact assessments. (ST) - Strengthen communication of the impact and rationale of macroprudential policy decisions. (ST) - Enhance public communication to clarify the objectives of foreign exchange interventions. (I) - Banking Supervisory Oversight: - Formalize and enhance governance of key internal processes for supervisory operations and decisions. (I) - Review the internal GRAPE scoring and weighting methodology. (ST) - Carry out regular in-depth assessments of banks’ governance and risk management practices. (ST) - Require systemic banks and encourage others to incorporate internal stress testing in capital and liquidity planning. (ST) - AML/CFT Supervision: - Strengthen regulation/supervision for gaming sector, virtual asset service providers, and real estate agents. (MoF) (MT) - Consider setting maximum thresholds for use of cash in certain transactions. (ST) - Capital Markets Oversight: - Continue to develop and implement risk-based supervision for all market participants. (ST) - Ensure sanctions for market abuse are sufficiently punitive. (I) - Financial Safety Nets: - Implement a prompt corrective action framework for banks. (I) - Take steps to be able to implement a bridge bank swiftly when needed. (MoF, NBG) (I) - Prepare crisis contingency plans for banks and adopt regular testing programs. (IFSC, NBG) (ST) - Financial Sector Development: - Develop detailed procedures for oversight of payment systems. (I) - Complete self-assessments of the two Central Securities Depositories. (NBG, GCSD) (I) - Develop institutional capacity for competition enforcement and advocacy as a separate function within NBG. (I) - Commit to a predictable schedule of issuance for benchmark government bonds in sizable amounts. (MoF) (I) - Enact relevant legislation for covered bonds as planned. (MoF, NBG) (I) - Establish an online collateral registry and strengthen the legal framework for secured transactions. (NBG, MoJ) (ST) - Define a roadmap for the development of fintech and a National Financial Inclusion Strategy. (ST) *Source: EXECUTIVE SUMMARY, 1geoea2021003.* ### 3. A V-shaped recovery, supported by external demand and fiscal stimulus, is now ### 3. A V-shaped recovery, supported by external demand and fiscal stimulus, is now ### Recovery, inflation, and monetary policy - A V-shaped recovery is underway. - CPI inflation rose to about 11.9 percent at end-July 2021, well above the NBG’s target of 3 percent. - The NBG reversed its pandemic monetary policy stance and raised the policy rate by 200 bps cumulatively between March and August 2021. - The authorities have operated an inflation targeting framework with a floating exchange rate regime since 2019. ### Credit growth and credit gap - At constant exchange rates, credit slowed to 7.7 percent (y-o-y) in March 2021 compared to about 16 percent before the pandemic. - Credit picked up to 12.6 percent (y-o-y) in June 2021 notwithstanding tightening in rates. - Main drivers of credit growth have shifted from consumer and mortgage lending to large corporates following responsible lending regulation on household credit in 2019. - NBG analysis suggests the credit gap was close to zero before the pandemic and became positive subsequently. ### Macrofinancial vulnerabilities (summary) - Corporate, SME and household credit risks are elevated; real estate and sovereign-related risks are more muted. - Corporates and SMEs: - Corporate sector debt doubled over the last decade to 69 percent of GDP. - Three-quarters of corporate loans are in FX; only 20 percent are hedged. - 60 percent of SME loans are in FX and almost none are hedged. - Households: - Household sector debt is 38 percent of GDP and has tripled in proportion to disposable income over the past decade. - Households carry significant cash assets at the aggregate level, with likely variation across income groups. - Over 40 percent of household loans are in FX and almost none are hedged. - Real Estate: - Housing market mostly priced in dollars. - Residential real estate prices have increased about 60 percent in lari terms over the past decade but have been largely stable in dollar terms; no signs of overvaluation. - Housing demand has been met by significant pickup in construction over the years. - Limited data on commercial property prices. - Sovereign: - Government debt reached 60 percent of GDP, almost 20 percentage points higher than in 2019. - Almost 80 percent of government debt is in foreign currency. - Government debt is mainly owed to IFIs at concessional rates and is assessed as sustainable (in the 2021 Article IV consultation). - Banks’ holdings of government debt are about 10 percent of banks’ assets and are held to maturity; banks’ net claims on the government have remained broadly unchanged since 2015. ### Financial system overview - Financial sector assets amount to 108 percent of GDP (total assets of about 18 billion USD). - Sector composition: - 15 commercial banks (94 percent of assets); - Microfinance organizations (2 percent); - Insurers (2 percent); - Pension funds (2 percent). - Banking system structure: - 9 domestic banks (3 are D-SIBs) and 6 small banks that are subsidiaries of foreign banks. - No state-owned banks. - Two largest banks make up nearly three-quarters of lending (high concentration). - Banks’ balance-sheet composition and dollarization: - Banks’ assets largely loan portfolios; securities exposure (mainly government bonds) about 11 percent of total assets. - Loan portfolios split almost evenly between corporates and households (latter mainly mortgages). - Funding is deposit-based; debt issuance about 20 percent of total funding. - About 55 percent of banks’ lending portfolios are in foreign currency (mostly U.S. dollar and euro). - 61 percent of deposit funding is in foreign currency. ### Banking sector performance, capital, liquidity, and asset quality - Capital and liquidity: - Banks’ CAR ratios fell by 1.9 ppt during 2020 but rose to 19.2 percent by 2021Q2 (Tier 1 ratio of 14.8 percent). - Liquidity complied with LCR and NSFR requirements during the pandemic. - LCR enforced by currency: 100 percent in foreign currency, 75 percent in lari (lari requirement was temporarily eased during the pandemic). - Profitability: - Profitability was high pre-crisis, dropped sharply during 2020 due to increased provisions and falling interest income, and recovered by early 2021. - Asset quality: - NPLs reached 6.7 percent by Q2-2021 compared with 4.4 percent at end-2019 (NBG asset classification). - NPLs higher on FX loans: about 12 percent on dollar loans, about 8 percent on euro loans, and about 6 percent on lari loans (as of February 2021). - FSI data report NPLs at 2.2 percent at Q2 2021 compared with 1.9 percent at end-2019 (difference reflects NBG forward-looking classification). - Deposits and external debt: - Deposits, including from non-residents, remained stable; non-resident deposits stabilized at 15 percent of total. - Interest rate spread on local versus foreign currency deposits widened during the pandemic. - Banks’ external debt increased to 27 percent of GDP in 2020 (about one fifth of Georgia’s external debt) from about 10 percent in 2010. - About three quarters of external debt is long-term and nearly half owed to IFIs. ### Policy actions and reforms - Reforms since the 2015 FSAP: - Implementation of Basel III framework for capital and liquidity. - Responsible lending regulation (RLR) for household borrowers based on PTI, LTV (2019). - New banking resolution regime (end-2019) and deposit insurance scheme (2017). - Corporate Governance Code (2018). - Strengthened top-down stress testing framework. - Started publication of annual Financial Stability Report (since 2019). - Plans to issue a Central Bank Digital Currency (CBDC) announced in 2020. - Implementation status and adjustments: - Implementation of a limit on banks’ single party concentration delayed to mid-2022 owing to the pandemic. - The countercyclical capital buffer has never been activated given the credit gap close to zero. - Measures aimed at reducing dollarization: - More stringent LTV and PTI requirements for unhedged FX borrowers under RLR. - Introduction of a currency-induced credit risk (CICR) pillar 2 capital buffer with higher capital charges on unhedged FX credit. - Outright ban on FX loans below 200,000 GEL for households, corporates and SMEs. - LCR requirement for banks in FX. - Higher reserve requirements and penalty rates of remuneration for banks on their FX deposits. - Reserve requirements differentiated by bank based on deposit dollarization. - Note: The average house price is below 200,000 lari so the outright ban effectively limits mortgage loans in FX. - COVID-19 related fiscal and central bank measures: - Government interest subsidies to SMEs and households; households received a four-percentage point rate discount on new lari mortgage loans. - Credit guarantees for corporates and SMEs; subsidies applied only to loans for new construction issued between June 1 and January 1, 2021 with subsidy provided for five years. - Banks announced loan moratoria during Q1–Q3, 2020 and offered restructurings: - 63 percent of household loans, 46 percent of SME loans and 30 percent of corporate loans benefited from moratoria at least once in 2020. - NBG provided lari liquidity using swap lines with banks, expanded collateral framework to include SME loans, and partially released the LCR buffer in lari (restored in May 2021). - Government issued an additional 600 million GEL in securities, with lari proceeds placed as long-term deposits in banks. - NBG required banks to take general provisions early in Q1 2020—amounting to about 3.5 percentage points of banks’ CET1 ratios—while restricting shareholder payouts and bonuses. - Simultaneously, NBG lowered banks’ capital requirements by about the same amount by reducing part of pillar 2 buffers (2/3 of CICR buffer) and the capital conservation buffer (CCB); a timeline for restoration has been announced. - NBG is transitioning supervisory reporting to IFRS standards; full transition of prudential provisioning requirements to IFRS9 expected by 2022. ### Key vulnerabilities and risks to financial stability - High dollarization of banks’ assets and liabilities is the key vulnerability. - Channels of risk: - Credit risk from unhedged borrowers: - About 75 percent of corporates’ liabilities and 40 percent of households’ liabilities are in FX. - Only about 20 percent of corporate borrowers in FX are estimated to be fully hedged. - A sufficiently large depreciation could quickly force unhedged borrowers into default. - Historical precedent: during 2015–16, lari depreciation of 15 percent led to a 50 percent increase in NPLs. - Liquidity risk: - NBG has limited ability to backstop systemic FX liquidity shocks; banks depend on own liquidity buffers to weather sudden outflows of FX deposits. - Recent years have not seen a buildup of FX liquidity risk; non-resident deposits stabilized and IFIs make up a large share of banks’ external debtors. - Scenario risks: - Extended pandemic or less benign external financing conditions could: - Lower profits of firms, increase unemployment, weaken debt-servicing capacity of firms and households, erode banks’ asset quality, profitability, and capital buffers. - Lead to further exchange rate depreciation, increasing indebtedness and deteriorating asset quality. - Cause residential real estate price adjustment if unemployment rises; commercial real estate hit by business failures. - An external shock (regional political turmoil or global risk aversion) could trigger capital outflows, weaken the currency and raise sovereign borrowing costs. ### Stress testing approach and scenarios - Stress-testing design: - Baseline used April 2021 WEO forecast. - Two adverse scenarios over a three-year horizon implied negative GDP shocks of 1–1.5 standard-deviations relative to the baseline. - Scenario assumptions: - Baseline: economy starts to recover in mid-2021 with benign external financial conditions. - Adverse Scenario 1, Extended Pandemic: additional lockdowns extend into late 2021; sluggish growth in outer years due to phased withdrawal of support and scarring. - Adverse Scenario 2, Capital Outflows: extended pandemic plus external shock causing higher sovereign spreads, capital outflows and sharp exchange rate depreciation. - Hurdle rates for solvency tests: Basel CAR 8 percent, T1 6 percent, CT1 4.5 percent. - Liquidity hurdle rates based on LCR: 100 percent aggregate, 100 percent in FX, 75 percent in lari. - Key macro variables used: real GDP, exchange rate, CPI inflation, housing prices, unemployment, policy interest rate, EMBI sovereign spread, and 5-year government bond yields. - Stress testing covered all 15 banks as of end-December 2020. - Stress tests included solvency, liquidity, and contagion analyses; other financial institutions excluded due to small size. ### Financial stability assessment results - Baseline outcome: - Banks appear well prepared to absorb pandemic-related losses under the baseline without threatening financial stability. - Systemic resilience driven by solid pre-crisis capital buffers and robust profitability. - Absorption of losses and replenishment of bank capital buffers likely to take 2–3 years. - Adverse scenarios: - Extended Pandemic: three banks experienced capital shortfalls of 0.5 percent of GDP relative to minimum Tier 1 capital requirements. - Capital Outflows: four banks suffered capital shortfalls that add up to about 1.5 percent of GDP. - In aggregate terms: - Extended pandemic scenario aggregate capital shortfall for banks is 12.7 million lari or 0.03 percent of RWA. - Capital outflows scenario aggregate capital shortfall is 149 million lari or 0.4 percent of RWA. - Credit losses: - Expected losses ranged between 3–6½ percent of the gross performing loan exposures, commensurate with current provisioning. *Source: IMF staff summary of chapter 3 of the Georgia financial system assessment (as provided).* ### 19. Banks have sufficient high-quality liquid assets to survive severe shocks to their ### Banks have sufficient high-quality liquid assets to survive severe shocks to their deposit base ### Solvency and liquidity stress-test findings - All banks were able to endure extreme shocks to their liabilities (emulating those at the peak of the 2008‒09 Global Financial Crisis) while sustaining regular operations, even after restricting gross inflows from loans and securities to zero. - Stress tests indicate banks have sufficient high-quality liquid assets to survive severe deposit-base shocks (figures 14,15). ### Other risk channels and sensitivity analysis - Market risk - A 30 percent lari depreciation would cause a drop in the CAR of about 0.6 percentage points. - Interest rate risk is inconsequential as banks’ assets and liabilities are not marked to market. - Equity price risk is absent. - Interbank contagion - Given the small size of interbank exposure, interbank contagion was not found to be material for credit risk exposure of lender banks or liquidity risk for borrower banks. - Bank-sovereign nexus - Sensitivity analysis of sovereign spreads widening by 600 bps produced a 1.5 percentage point drop in overall CAR, down to a minimum of 11.5 percent across individual banks. - Public bonds can be used as collateral for central bank liquidity, making forced liquidation of sovereign bonds under distressed market conditions unlikely. ### Large corporate exposures and provisioning - FSAP detailed analysis of the ten largest credit exposures of each bank (each exposure to a conglomerate group included all loans to companies within that group). - Using latest available financial statements for each company, FSAP estimated impacts of scenarios on corporate vulnerability indicators and derived loan loss provisions under adverse scenarios. - Companies with less than full coverage of their annual debt interest payments with latest available annual earnings accounted for about 12 percent of sampled firms’ assets. - Stress tests indicated a moderate shortage of provisions under the adverse scenarios. ### FSAP recommendations for authorities (risk management and policy) - Earnings retention and capital buffers - Encourage retention of banks’ earnings until credit losses are absorbed and capital buffers fully restored. - The proposed timetable to replenish capital buffers (Table 7) appears reasonable, but uncertain recovery calls for prudence and flexibility. - The NBG should continue close monitoring of banks’ credit risk to evaluate pandemic implications and judge when credit losses are fully absorbed by individual banks. - Single-party concentration limit - Proceed with implementation of the single-party concentration limit as planned. - Enforcement of the Basel concentration limit would have very limited impact on availability of bank credit to large firms (Figure 16). - From a long-term perspective, enforcing the concentration limit should not significantly constrain banks’ capacity to finance large corporations. - Data enhancements - Further refinements to information on large borrowers reported by banks to better reflect consolidated financials and strengthen data validation. - Potential scope to expand data on foreign currency risk exposures of large corporate borrowers. - Sectoral classification of credit could benefit from additional granularity and mapping with standard economic classification. - Implementation of the ongoing credit registry project would complement existing data. ### Authorities’ views (on FSAP findings) - Authorities largely agreed with FSAP results for banks’ solvency and liquidity in baseline and adverse scenarios. - They highlighted that provisions taken by banks in 2020Q1 are still expected to fully cover losses stemming from the pandemic. - On earnings retention, authorities felt retention should only be required for banks that fall below pre-pandemic capital buffer requirements. - On corporate stress-test findings, authorities noted analysis should be based on consolidated financials and emphasized availability of up-to-date information on banks’ exposures to large corporate borrowers, including monthly assessment and validation processes. ### Macroprudential policy and de-dollarization - Institutional framework - Institutional framework broadly meets principles of good design; Organic Law grants NBG supervisory powers and legal mandate to safeguard financial stability. - Financial Stability Committee (FSC) and a dedicated financial stability department support macroprudential policy formulation and analysis. - Toolkit and recent measures - NBG has a comprehensive macroprudential toolkit (see Table 7); tools such as PTI/LTV ratios have slowed credit growth and shifted composition from households to corporates. - Tools have been used to reduce dollarization; borrower-based restrictions and a 200,000 GEL limit on FX lending have reduced new issuance of FX loans, especially to households. - CICR capital buffer enables banks to absorb losses following sharp depreciations; higher LCR and reserve requirements in FX build additional liquidity buffers. - Macroprudential tools targeting dollarization remained in place during the COVID-19 crisis, apart from a temporary, partial release of the CICR buffer. - Policy trade-offs and funding constraints - Further asset de-dollarization depends on banks’ ability to raise local currency funding; households still prefer foreign currency savings. - Introducing excessive restrictions on FX lending risks financial disintermediation as banks may need to adjust lari deposit rates significantly, making lari credit more expensive. - As recovery takes hold, NBG should continue to build a track record of low and stable inflation, supported by government sound fiscal policies. - Development of covered bonds could provide alternative local currency savings instruments and banks’ means to raise lari funding. - Calibration, impact assessment, and data - NBG should review calibration of the macroprudential toolkit periodically and carry out impact assessments of planned measures. - NBG could leverage accumulated income data (including during COVID-19) to reassess PTI thresholds. - Over the medium term, authorities should consider tightening dollarization measures gradually, informed by impact assessments and choice of measures (market-based vs borrower-based vs outright restrictions). - Planned credit registry, collecting income and interest rate data, is a welcome step; income verification in the informal sector remains challenging. - Communication priorities - Foreign exchange intervention policy: publish FX intervention strategy and increase outreach to clarify objectives of reserve accumulation and volatility reduction to shape exchange rate expectations and reduce demand for one-way hedging. - Rationale for macroprudential decisions: adopt new communication tools (e.g., heatmaps), publish policy papers, and increase outreach to banks and the non-financial sector. ### Financial sector oversight: supervision, markets, cyber, and AML/CFT - Banking supervision - Regulatory capital and liquidity framework generally consistent with Basel III, with tailoring due to high dollarization. - Capital surcharge for DSIBs is being phased in; large exposure regulation amended to comply with Basel standards. - Supervisory framework evolving towards risk-based approach: Code of Corporate Governance and General Risk Assessment Program (GRAPE) applied since 2017. - GRAPE assesses risks including corporate governance, group structure, business model, credit, liquidity, market exposure, and operations; scores inform supervisory process and pillar 2 capital charge. - Recommendations to strengthen supervision - Develop and formalize internal supervisory processes for planning, decision making, communications with banks, and timely follow-up on remedial actions. - Reconsider weightings applied to GRAPE elements and develop internal guidelines to support GRAPE scoring, identify important sub-categories, and guide planning and qualitative assessments. - Require banks to develop remediation plans for supervisory concerns and formally review implementation of those plans; formalize supervisory communication practices beyond annual GRAPE letter and Pillar 2 surcharge. - Undertake more in-depth assessments of banks’ risk management and governance beyond compliance. - Require systemic banks to incorporate internal stress testing into capital and liquidity planning and management; use NBG periodic supervisory stress tests to derive Net Stress Buffer capital charge and inform risk assessment. - Capital markets oversight - Authorities aligned oversight with international standards but could enhance methodologies for risk assessment and scoring, strengthen conduct assessments, improve market surveillance framework (including surveillance plan, direct access to audit trail and order flows), and apply sufficiently punitive sanctions for market abuse. - Cybersecurity oversight - Steps taken: cybersecurity framework for banks, dedicated cyber risk supervision division, data governance agency, amendments to 2012 information security law (ongoing); cyber risk included in GRAPE operational component; annual audit requirement and incident reporting; two coordinated cyber exercises held. - Further steps: clarify NBG role in designating critical information systems in information security law amendments; strengthen offsite supervision framework for cyber risk and automate compliance monitoring; enhance frequency and sophistication of testing exercises and develop a testing strategy. - AML/CFT - Progress since last FSAP: 2020 MONEYVAL assessment noted NBG’s adoption of a risk-based approach, reform of legal and regulatory frameworks, and strengthened “fit and proper” checks. - Room for improvement: Georgia scores sufficient ratings for AML/CFT effectiveness on two out of eleven performance benchmarks. *Source: IMF staff analysis as presented in the FSAP chapter on Georgia (excerpts provided).* ### 41. The financial sector faces elevated AML / CFT risks in a number of areas, for which ### 1geoea2021003 - 41. The financial sector faces elevated AML / CFT risks in a number of areas, for which ### AML / CFT risks and recommended mitigation - Findings on money laundering risks: - High use of cash in transactions, including for real estate purchases. - Activities of politically exposed persons. - Absence of regulation for providers of virtual assets. - Weak regulations for the gaming sector. - Risks compounded by various exemptions from FATF recommendations, including for real estate agents, accountants, and virtual asset service providers. - Recommended authorities’ actions: - Consider setting maximum cash thresholds for various transactions. - Strengthen the analysis of suspicious transactions reported by banks. - Include virtual asset service providers in the AML framework by end-2021 as planned. - Further strengthen licensing and supervision for the gaming sector. ### Authorities’ views on supervision - Agreement with need to formalize supervisory oversight procedures. - Supervisory GRAPE methodology: - Should remain an internal procedure, although some aspects could be shared with banks. - NBG commitments: - Dedication to further enhancement of internal operational and decision-making processes, reflected in and communicated through its Supervisory Strategy document. - Plan to communicate material supervisory findings with banks’ supervisory boards on a regular basis. - Would include collecting relevant cyber information like gap assessment, summary of incidents, level of concentration of service providers, technology landscape, key risk indicators, compliance status of action points arising on account of NBG supervisory visits, internal audit, external audit and various tests carried out, on a periodic basis. ### Financial safety nets — assessment and gaps - Recent legal and operational steps: - NBG and Banking Laws amended in December 2019 to upgrade legal regimes for bank liquidation and systemic bank resolution, establish an ex post funded Resolution Fund, and introduce a bank recovery planning regime. - NBG issued regulations and rules to support implementation, including clarification of roles/responsibilities of the NBG and MoF covering coordination in systemic cases, potential emergency liquidity assistance and temporary public financing. - Expansion of deposit insurance coverage during mid-2020 to GEL 15,000 from 5,000 for natural persons on local and FX deposits, and now covers 97 percent of resident and non-resident deposits. - New Interagency Financial Stability Committee established in mid-2020, comprising the MoF, the NBG, the Deposit Insurance Agency and the Insurance State Supervision Service, responsible for coordination of banking resolution issues. - FSAP findings and recommended actions: - Authorities now have most mechanisms needed to resolve banks, but scope remains to: - Simplify the creditor hierarchy to make it consistent with deposit insurance coverage. - Clarify recovery planning requirements and triggers. - Increase banks’ loss absorbency capacity and resolvability. - Enhance operational capacity of financial safety net authorities. - Allow the deposit insurance fund to finance purchase and assumption transactions in liquidation (if lesser cost). - Mitigate potential legal challenges to liquidators and the NBG. - NBG should implement policies encouraging competitive bidding for sale of assets and liabilities of a bank in resolution. - Operational framework for a bridge bank does not yet exist; FSAP recommended laying operational groundwork (e.g., setting up a license, establishing a supervisory board and arranging funding) so it is immediately available when needed. - Need for a formal corrective action framework (prompt corrective action policy) to guide use of NBG's extensive early intervention powers and enable intervention prior to balance sheet insolvency. - NBG should prepare resolution plans for systemic banks and consider prioritizing other banks for resolution planning in 2021. - Resolution planning for the three SIBs is underway; initial plans will be presented to the NBG Resolution Committee by year-end 2021. - Authorities should prepare formal contingency plans for crisis situations along with formal testing programs that dovetail into a national-level plan and testing program. - Clarify modalities for resolution funding, including an MoF-NBG agreement for MoF funding in resolution. - Strengthen DIA funding arrangements by: - Securing a backstop line of credit from the MoF to replenish the insurance fund in time of need. - Agreeing on a framework with the NBG to borrow against its investment portfolio to raise cash if required to make a payout. ### Authorities’ views on financial safety nets and implementation - Authorities largely agreed with FSAP recommendations and focused on operational implementation: - Investigating mechanisms for setting up a bridge bank. - Seeking to amend bank resolution and liquidation frameworks, including creditor hierarchy. - Broadening recovery planning to cover both systemic and selected non-systemic banks. - Updating internal operational processes for bank resolution. - Establishing stand-by cooperation agreements with external parties. - IFSC participants encouraged to collaborate more proactively on crisis preparedness. ### Financial sector development — priority areas and recommendations - Financial Market Infrastructure: - Complete and approve framework for comprehensive risk management for the RTGS. - Assess the two central securities depositories against CPMI/IOSCO PFMI standards. - Establish detailed risk and crisis management procedures, including for defaults of RTGS participants. - Financial Sector Competition: - Provide a systematic assessment of prudential regulations from a competition perspective. - Enhance monitoring of financial sector participants for anticompetitive practices. - Conduct systematized competition review of M&A activity in the financial sector. - Strengthen institutional capacity for enforcement. - Capital Markets Development: - Government should commit to a predictable schedule of issuance for a few benchmark bonds in sizable amounts for yield curve development. - Enact planned legislation for covered bonds to provide additional savings instruments, help lower interest rates on local currency mortgages, and serve as an additional tool for liquidity management by banks and the NBG. - Access to Finance and Fintech: - Define a Fintech roadmap to promote innovation, competition and financial inclusion. - Suggested measures: - An online collateral registry. - Enhancements to the legal framework for secured transactions. - Improved retail payments infrastructure with interoperability between bank and e-money accounts. - Expansion of credit-related information on SMEs to cover alternative data (for example, payments for utilities or other operational liabilities). ### Key statistics and timelines - Deposit insurance coverage expanded during mid-2020 to GEL 15,000 from 5,000 for natural persons on local and FX deposits. - Deposit insurance now covers 97 percent of resident and non-resident deposits. - Inclusion of virtual asset service providers in the AML framework planned by end-2021. - Resolution plans for the three SIBs: initial plans to be presented by year-end 2021. ### Risk Assessment Matrix — selected high-level threats (Table 2 summary) - 1. Prolonged COVID-19 pandemic. - Overall Level of Concern: Medium - Likelihood of Severe Realization of Threat in the Next 1–3 Years: High - Expected Impact on Financial Stability if Threat is Realized: High - Key channels: renewed lockdowns, reduced policy space, repricing of global risk assets, financing difficulties for sovereign, capital outflows, exchange rate depreciation, higher NPLs, weaker credit growth, pressure on real estate, stronger sovereign-bank feedback loops due to financial dollarization. - 2. Regional conflict - Overall Level of Concern: High - Likelihood of Severe Realization of Threat in the Next 1–3 Years: High - Expected Impact on Financial Stability if Threat is Realized: High - Key channels: trade disruption, reduced remittances, deposit outflows (particularly non-residents), higher funding costs, FX pressure, lower asset quality. - 3. Sharp rise in global risk premia exposes financial and fiscal vulnerabilities. - Overall Level of Concern: Medium - Likelihood of Severe Realization of Threat in the Next 1–3 Years: High - Expected Impact on Financial Stability if Threat is Realized: High - Key channels: risk-off events, falls in risk asset prices, sovereign spread increases, FX depreciation, bankruptcies, pressure on public debt to GDP. - 4. Cyber-attacks - Overall Level of Concern: Medium - Likelihood of Severe Realization of Threat in the Next 1–3 Years: High - Expected Impact on Financial Stability if Threat is Realized: High - Key channels: disruption to payment systems, threats to confidence in banking system, increased deposit dollarization and deposit outflows, higher funding costs and FX vulnerability for banks. *Source: IMF staff summarization of the content unit 1geoea2021003 - 41.* ### 5. Higher ### 5. Higher ### Climate-related risk: frequency and severity of natural disasters - Higher precipitation in Caucasus mountain areas could lead to events such as floods, landslides, mudslides, avalanches etc. - Adverse impact on industries of wine and tourism (especially winter sports), which could have a broader impact on growth and external imbalances. - Financial-sector implications (assessed Low / Medium to Medium): - Weaker lari, higher dollarization - Higher NPLs on banks’ loans to borrowers in related industries ### Key Covid-19 government support and liquidity measures - Government support measures: - A credit guarantees scheme amounting to GEL 330 million was introduced to help businesses cope with the pandemic. - An interest subsidy scheme amounting to GEL 70 million was provided to family-owned, small and medium-sized hotels to co‑finance up to 80 percent of the annual interest rate on their loans. - A subsidy scheme covered 4 percentage points of the interest rate for new mortgage loans for 5 years for physical persons. The scheme only applied to lari‑denominated mortgages below GEL200,000 to purchase newly built residential apartments between June 1, 2020 and January 1, 2021. - 600 million GEL in debt issuance for support of banks’ liquidity. - Liquidity measures: - In April 2020, the MoF issued an extra 600 million GEL of government securities and deposited the lari proceeds with commercial banks as long-term deposits. - In April 2020, the NBG introduced swap lines (for up to $400 million) with banks and microfinance institutions in order to provide GEL liquidity to the system. The swaps, which have a one-month maturity, may be renewed on a monthly basis, until April 2022. - The NBG activated the stand-by swap instrument, which enables banks to get GEL liquidity in exchange for foreign currency, at a penalty rate. - In June 2020, the NBG provided commercial banks with the opportunity to receive liquidity support from the NBG against a collateral of SME loans. Microfinance institutions may also seek financing from commercial banks against SME loans, if these meet certain criteria. This mechanism will phase out from 2022 and expire at end-2023. - In May 2020, for a period of one year, banks were allowed to use their foreign currency buffers for GEL liquidity management (LCR in lari relaxed from 75 percent to zero). - The NBG reduced its policy rate by 50 bps on April 29, 2020, by 25 bps on June 24, and again by 25 bps on August 5. - Capital and lending measures: - In March 2020, the NBG reduced capital requirements for commercial banks by reducing their capital conservation buffer (2.5 percent of RWA) and a portion of their pillar 2 buffer (2/3 of their currency-induced credit risk buffer). - In April 2020, the NBG instructed that commercial banks shall not use the relief on capital requirements for dividends, share buybacks, equity investments or other types of distributions and payments that would cause a reduction of bank capital. - In March 2020, the NBG postponed an increase in CET1 and Tier 1 capital requirements that would have come from an increase in banks’ CICR and GRAPE buffers. - Commercial banks offered renewable three-month grace period on loans to customers. - In March 2020, the NBG issued a guideline on the computation of expected credit losses during the Covid-19 crisis. This guideline indicated that banks’ loan exposures to borrowers facing temporary liquidity problems and enjoying payment holidays should not be regarded as exposures with a significant increase in credit risk and should not be provisioned solely for that reason. - The regulation on Credit Concentration and Large Risks in Commercial Banks which should have been enacted from June 2020, was postponed by a year and a half. - The NBG suspended on-site inspections of entities under its supervision, except for money laundering inspections which were performed remotely. - The NBG introduced a moratorium on fines on regulated entities arising from breaches due to the crisis. ### Selected regulatory, liquidity, and borrower-based measures (implementation details and dates) - Capital measures: - Increase in minimum regulatory capital for banks to GEL 50 million. (May 2017) - Alignment of capital ratios with Basel III and introduction of Pillar 2 Capital Requirements. (December 2017) - Capital Conservation Buffer (CCB) of 2.5 percent introduced as part of the Basel III implementation. (December 2017) - CCB released as part of COVID-19 response, to be restored by January 2024. (April 2020) - Unhedged Currency Induced Credit Risk Buffer: Pillar 2 buffer equivalent to 75 percent additional risk weighting for credit exposure to unhedged borrowers. Two-thirds of this buffer was released as part of the NBG response to Covid-19, to be restored by January 2023. (December 2017; April 2020) - Countercyclical Buffer (CCyB) introduced but not activated. (December 2017) - Systemic Buffer DSIB Buffers (between 1.5 and 2.5 percent) introduced for three identified DSIBs to be phased in gradually through December 2021. (December 2019) - Leverage Ratio minimum requirement of 5 percent. (September 2018) - Capital distributions: prohibition on use of relief on capital requirements for dividend payouts, share buybacks, equity investments, increases in variable remuneration for management, or other distributions. (April 2020) - Liquidity-related measures: - Reserve requirements (FX Deposits): remunerated at Fed Funds rate minus 50 bp or ECB deposit facility minus 20 bp; increase in reserve requirement from 20 to 25 percent; further increase from 25 to 30 percent; reduction from 30 to 25 percent; differentiation by bank: 1 ppt reduction for every 2 ppt below 70 percent of deposit dollarization till 40 percent. (July 2018; March 2019; October 2019; July 2021) - Reserve requirements (Lari Deposits): remunerated at policy rate; reduction of reserve requirements from 7 to 5 percent. (July 2018) - LCR: LCR of 100 percent (overall), 75 percent (domestic currency), and 100 percent (foreign currency). LCR in domestic currency reduced to zero for one year. Removal of the 25 percent haircut previously applied to FX required reserves in the calculation of high-quality liquid assets as part of FX liquidity coverage ratio. (September 2017; May 2020; October 2019) - NSFR Net Stable Funding Ratio requirement of 100 percent. (September 2019) - Borrower-based measures: - Payment-to-Income Limit: - Unhedged Borrowers: 20 – 35 percent (January 2019) - Hedged Borrowers: 25 – 60 percent (January 2019) - Unhedged Borrowers: 20 – 30 percent (March 2020) - Hedged Borrowers: 25 – 50 percent (March 2020) - Loan-to-Value Limit: - GEL Loans: 85 percent - Foreign Currency Loans: 70 percent (January 2019) - Restriction on FX lending: - Issuance of FX loans below 100,000 GEL prohibited (January 2017) - Limit tightened to 200,000 GEL (January 2019) - Currency-risk measures: - Limit on net open FX position: 20 percent of regulatory capital. (July 2006) ### Financial sector policy recommendations (recent Article IV consultations and program reviews) - Monetary policy recommendations and exchange rate: - Monetary policy should balance the impact of lari depreciation (which calls for keeping the rate high for longer) with a sharp weakening in demand (which would allow reducing rates) and be driven by inflation developments. Exchange rate flexibility should continue to act as a shock absorber, but excessive lari volatility should be avoided as it could prove disruptive to financial stability. - The stance of monetary policy is adequate and the National Bank of Georgia (NBG) remains committed to the floating exchange rate regime while continuing efforts to build up reserves. - Monetary policy remains adequately focused on price stability. The flexible exchange rate remains a key shock absorber, with interventions only limited to reduce excessive volatility and to build buffers. - Monetary policy remains rightly focused on price stability, supported by the flexible exchange rate and efforts to strengthen the transmission mechanism. The NBG’s monetary policy stance is appropriate, but the authorities need to remain vigilant on monetary and financial developments, including related to credit growth. - Financial stability and institutional recommendations: - Providing adequate liquidity and releasing some capital buffers in financial institutions would help sustain financial stability. The authorities should continue with the implementation of bank resolution and insolvency frameworks. - The planned emergency liquidity assistance and bank resolution framework will strengthen financial stability. Adopting the insolvency framework, developing the local capital market, and judiciary reform will further improve the business environment and support private investment. - Establishing a new insolvency framework for nonfinancial corporations will improve further the business environment. The funded pension pillar, coupled with capital market reforms, should help mobilize domestic savings for investment, supported by the new public private partnership (PPP) framework. - The authorities’ steps to increase the resilience of the financial sector are welcome. Proposed legal amendments would appropriately expand the role of the central bank in regulating and supervising non-banks and credit bureaus, enhance the bank resolution framework, and supervise banks on a consolidated basis. The authorities’ efforts to identify legal amendments to adopt an effective ELA framework are also commendable. ### Status of key recommendations from the Georgia 2015 FSAP (selected outcomes and progress) - Financial Sector Oversight: - Introduce explicit regulatory provisions in areas highlighted in the BCP Assessment rather than rely on the NBG’s broad powers (NBG). Status: Done. Legislative amendments approved by end of 2017 and 2019 strengthened NBG authority to regulate banking groups on a consolidated level, enhance licensing and transfer requirements, exercise risk-based supervision, and create an enhanced resolution framework. - Implement the definition of large exposures consistent with Basel standards (NBG). Status: Done. Regulation approved in November 2019; implementation delayed through June, 2022 owing to the pandemic. - Require Boards to take the lead in developing banks’ risk appetite (NBG). Status: Done. NBG developed a Corporate Governance Code for commercial banks (approved in September 2018). - Enhance capacity of Banking Supervision Department (NBG). Status: Pending. NBG plans remuneration modifications and focuses on recruitment and training. - Financial Stability: - Amend the NBG law to strengthen its macroprudential mandate (NBG). Status: Done. Financial Stability Committee (FSC) now defines NBG’s macroprudential policy strategy. - Implement CCyB and LCR of Basel III (NBG). Status: Done. CCyB and LCR implemented; NSFR implemented as of 2019. Activation of CCyB considered quarterly by FSC. - Implement capital surcharge for systemically important banks (NBG). Status: Done. Regulation implemented in December 2017; D‑SIB buffer to be fully loaded by December 2021. - Employ macroprudential instruments to address FX risks and support larization (NBG). Status: Done. Retail Credit Regulation implemented conservative requirements (PTI, LTV, Loan Maturity) for FX unhedged borrowers; stress test framework includes FX depreciation scenario with impact on regulatory capital. - Crisis Management and Safety Nets: - Revise emergency liquidity assistance policy to mitigate NBG exposure (NBG, MOF). Status: Done. NBG Law amended to require MoF guarantee of any ELA to a bank whose solvency is in doubt. - Overhaul the bank resolution regime (NBG, MOF). Status: Done. New bank resolution and safeguards framework implemented end-2019; all implementing regulations and rules adopted by end-2020. - Introduce a deposit insurance scheme (MOF, NBG). Status: Done. Deposit insurance scheme established in 2017 based on IADI Core Principles. - Set up a Financial Stability Council. Status: Done. 2019 NBG Law amendments established Interagency Financial Stability Committee (NBG, MoF, DIA, Insurance State Supervision Service). - Enhance recovery and resolution plan requirements for SIBs (NBG). Status: Done. 2019 amendments require recovery plans for all banks and resolution plans for SIBs and other systemically relevant banks, updated annually. - Financial Sector Development: - Develop comprehensive financial sector development strategy (MOF, MOE, NBG). Status: Partial and in progress. - Prepare time-bound strategy for capital market development (MOF, MOE). Status: In progress. MoE and NBG preparing new strategy with ADB support; legal/regulatory upgrades advanced. - Designate and empower a capital market regulator (MOF, MOE). Status: Done. Amendments to securities market law approved July 2020. - Complete insurance sector reform (MOF, MOE). Status: Done. Minimum capital requirement raised; regulations on solvency and risk retention put in place; transposition of Solvency II into new Insurance Law ongoing. - Establish credit reporting regulatory framework (MOF, MOE, NBG). Status: Done. NBG given power to supervise credit information bureaus; regulations issued. - Improve secured transaction regime implementation (MOE, MOJ). Status: In Progress. Movable collateral registry yet to be operationalized; legal/regulatory framework for secured lending requires strengthening. ### IMF technical assistance on financial sector issues (recent missions, counts and dates) - Top-down Stress Testing Framework: 3 missions, December 2019 - July 2020 - Central Bank Risk Management: 2 missions, June 2018 - July 2020 - Development of Government Securities Market: 5 missions, June 2017 - June 2020 - FX Policy Framework and Communications: 1 mission, February 2020 - Nonbank Financial Institutions: 1 mission, November 2019 - Financial Stability Report: 3 missions, October 2018 - October 2019 - Implementing IFRS 9 and Accounting Modernization: 3 missions, October 2017 - April 2019 - Eurobond Refinancing: 1 mission, September 2018 - Pillar 2 - Determination of Supervisory Buffers: 1 mission, September 2018 - Resolution Framework: 1 mission, July 2018 - Financial Stability Analysis: 3 missions, December 2017 - May 2018 - Consolidated Supervision: 1 mission, April 2018 - Centralized Risk Management: 1 mission, January 2018 - Monetary and Foreign Exchange Operations/ELA: 1 mission, December 2017 - Macroprudential Policy Framework: 1 mission, June 2017 *Source: 5. Higher (chapter/section) — 1geoea2021003* ### Appendix I. Central Bank Digital Currency ### Appendix I. Central Bank Digital Currency ### Objectives and context - The National Bank of Georgia (NBG) is considering launching a retail Central Bank Digital Currency (CBDC) to enhance payment system efficiencies and financial inclusion. - At this early stage, the NBG has developed principles for its preferred technical design features and has invited technology firms, Fintech companies, and interested financial institutions to tender proposals on how to develop a CBDC that meets the stated principles. - CBDCs can have important macro financial stability implications; therefore the CBDC design should be aligned with policy objectives while allowing innovation by third parties. ### Preferred design roles and responsibilities - NBG should control: - issuance and destruction of money; - the register/account system; and - the rules of operation. - Banks and other third parties should provide end-user services. ### Governance and coordination - Consider establishing a joint taskforce with the Ministry of Finance to: - coordinate exploration of the CBDC; - coordinate experimental testing of technical solutions; and - coordinate further analysis of purposes and consequences of introducing a CBDC. - The taskforce could be supported by sub-committees comprised of private sector individuals to focus on both technology and non-technology aspects, including implications for monetary policy, financial stability, integrity, and inclusion. ### Testing, safeguards, and complementary measures - The NBG plans to provide a controlled environment for testing technical solutions to: - identify preferred characteristics of Digital Gel; - uncover potential unintended consequences; and - reveal relevant economic and regulatory issues. - The NBG may also want to: - ensure that non-bank payment service providers for CBDCs have strong cyber resilient frameworks; - undertake financial and digital literacy programs to support financial inclusion objectives; and - conduct an analysis of the public law aspects of CBDC under central bank and monetary law. *International Monetary Fund — Appendix I. Central Bank Digital Currency* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1geoea2021003.pdf_