## 1geoea2021004

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### Institutional framework for macroprudential policy — key findings
- NBG has strengthened the institutional framework since the 2015 FSAP and published its Macroprudential Policy Strategy in 2019 with five intermediate objectives:
  - (i) mitigating and preventing excessive credit growth and leverage;
  - (ii) mitigating and preventing excessive maturity mismatch and market illiquidity;
  - (iii) limiting direct and indirect exposure concentrations;
  - (iv) limiting the systemic impact of misaligned incentives with a view to reducing moral hazard; and
  - (v) reducing dollarization of the financial system.
- NBG is effectively the macroprudential authority; mandate rooted in the Organic Law on the NBG.
- Decision-making and governance:
  - Macroprudential policy decisions are made by the Governor based on recommendations of the Financial Stability Committee (FSC).
  - A dedicated financial stability department with a staff of 9 formulates and analyzes macroprudential proposals.
  - The FSC has seventeen ex officio members, is chaired by the Governor, and meets quarterly (with option for extraordinary meetings); minutes are kept but not published.
- Transparency and accountability:
  - Financial Stability Report resumed in 2019 and is published annually around September.
  - FSC recommendations published quarterly since March 2018.
  - Organic Law amended in 2020 to expand the NBG Board from seven to nine positions (four executive and five non-executive); two non-executive vacancies from 2019 recently nominated.
- Areas for further improvement (identified):
  - Strengthen communication (publish heatmap assessments, policy papers on calibration, expand outreach beyond financial sector).
  - Expand impact analysis and cost-benefit assessment of macroprudential measures.
  - Ensure the NBG Board is usually fully staffed to strengthen perception of accountability.

### Macroprudential toolkit — implementation, parameters, and outcomes
- Comprehensive toolkit introduced since 2016 including Basel III elements:
  - Broad-based tools:
    - Counter-cyclical capital buffer (CCyB) — set at zero since introduction in December 2017.
    - Leverage ratio — set at 5 percent since introduction in September 2018.
  - Liquidity tools:
    - Liquidity Coverage Ratio (LCR) — overall 100 percent; 75 percent domestic currency, 100 percent foreign currency (introduced September 2017).
    - Net Stable Funding Ratio (NSFR) — requirement of 100 percent introduced September 2019.
  - Borrower-based tools (introduced January 2019 and revised March 2020):
    - PTI (Payment-to-Income) limits:
      - Unhedged Borrowers: 20 – 35 percent (January 2019), revised to Unhedged: 20 – 30 percent (March 2020).
      - Hedged Borrowers: 25 – 60 percent (January 2019), revised to Hedged: 25 – 50 percent (March 2020).
    - LTV (Loan-to-Value) limits:
      - GEL Loans: 85 percent.
      - Foreign Currency Loans: 70 percent.
    - Minimum FX loan size:
      - Issuance of FX loans below 100,000 GEL prohibited — January 2017.
      - Limit tightened to 200,000 GEL — January 2019.
  - Structural tools:
    - DSIB buffers between 1.5 and 2.5 percent introduced December 2019, to be phased in through December 2021.
  - Capital requirements and buffers:
    - Minimum regulatory capital increased to GEL 50 million — May 2017.
    - Capital Conservation Buffer (CCB) 2.5 percent introduced December 2017; released April 2020 and scheduled to be restored by Jan. 2024.
    - Unhedged Currency Induced Credit Risk Buffer (CICR) equivalent to 75 percent additional risk weighting introduced December 2017; two-thirds released April 2020 and scheduled to be restored by January 1, 2023.
    - CCyB introduced December 2017 but not activated.
- Reserve requirements (selected changes):
  - FX reserve requirement: increase 20 to 25 percent — July 2018; increase 25 to 30 percent — March 2019; reduction 30 to 25 percent — October 2019.
  - Differentiation by bank: 1 ppt reduction for every 2 ppt below 70 percent of deposit dollarization until 40 percent — July 2021.
  - Lari deposit reserve requirement reduced from 7 to 5 percent — July 2018.
  - FX reserve remuneration: Fed Funds rate minus 50 bp or ECB deposit facility minus 20 bp.
- LCR adjustments:
  - LCR in domestic currency reduced to zero for one year — May 2020.
  - Removal of the 25 percent haircut on FX required reserves in HQLA calculation — October 2019.
- Implementation outcomes:
  - PTI and LTV slowed mortgage issuance and improved mortgage quality; newly issued mortgages (lari and FX) declined by 4 percent (y/y) in 2019 compared to average y/y growth of around 40 percent (y/y) in the previous three years.
  - Conservative underwriting contributed to resilience of residential real estate prices after COVID-19 and relatively rare property repossessions.
  - Credit growth at constant exchange rates: peaked at 21.5 percent (y/y) in April 2018; fell to 7.7 percent (y/y) in March 2021; accelerated to 12.6 percent (y/y) in June 2021.
  - Loan dollarization has declined by around 10 percentage points since 2016; deposit dollarization remains higher than loan dollarization.

### Financial dollarization — risks, drivers, and policy direction
- Dollarization identified as the most important risk to the banking system; it limits macroeconomic adjustment and monetary policy transmission.
- Risk channels:
  - Credit risk from unhedged borrowers and liquidity risk from FX deposit volatility.
  - Revaluation effects on bank balance sheets and indirect interest-rate-volatility transmission.
  - High dollarization weakens the interest rate channel and strengthens the exchange rate channel of monetary policy.
- Current magnitudes (early 2021 / recent data):
  - Deposit dollarization hovers just above 60 percent.
  - Loan dollarization about 56 percent.
- Historical drivers:
  - Rooted in macrofinancial instability, hyperinflation, and large exchange rate depreciation in the 1990s.
- Structural and behavioral drivers:
  - Deposit-driven dollarization: FX deposits as savings vehicle, shallow local capital market, housing market and durable goods priced in dollars, remittances, and trade openness.
  - Banks target a closed net open FX position; corporate hedging limited (share of corporate borrowers able to fully hedge estimated at 21 percent).
  - Portfolio choice model: optimal FX allocation rises with relative volatility of inflation vs. real exchange rate depreciation; high exchange rate pass-through and inflation volatility increase insurance value of FX savings.
- Costs and systemic vulnerabilities:
  - Large depreciation can rapidly increase NPLs on FX loans and erode CAR via RWA revaluation (Tier 1 capital held in lari).
  - NBG limited ability to backstop systemic FX liquidity shocks; IFIs provide relatively stable funding.
  - Dollarization associated with greater propensity for financial crises, limited exchange rate policy options, and greater output volatility.

### De-dollarization policy mix and calibration priorities
- NBG toolkit for reducing dollarization:
  - Differentiated reserve requirements, currency-differentiated LCR, borrower-based measures (PTI, LTV, minimum FX loan size), capital buffers against FX credit risk (CICR).
  - Recent reserve differentiation (July 2021): for every two percentage points of deposit dollarization below 70 percent, a bank can lower its FX reserve requirement by one percentage point; reserve requirement floor at 10 percent (for 40 percent or less deposit dollarization).
- Design considerations:
  - Further progress will take time, especially for deposit-driven dollarization.
  - Gradual tightening recommended; choice and calibration informed by impact assessments and cost-benefit analysis.
  - Market-based measures generally avoid credit allocation inefficiencies; borrower-based measures target vulnerabilities but require detailed data; outright restrictions (e.g., raising 200,000 GEL limit) have higher efficiency costs but are easier to communicate and monitor.
- Complementary macroeconomic and structural policies:
  - Strengthen trust in local currency and deliver a track record of low and stable inflation.
  - Publish FX intervention strategy to clarify objectives and enhance perception of two-way exchange rate flexibility.
  - Ministry of Finance actions to deepen local capital markets: regularly issue benchmark local currency bonds, increase share of local currency debt, support development of covered bonds.
  - Monitor potential leakages to entities outside NBG perimeter and be ready to act.

### Data, monitoring, and calibration recommendations
- Data priorities:
  - Implement planned credit registry with detailed loan- and borrower-level information (including interest rates and income) to enable granular risk assessment and calibration.
  - Sign MoUs with the Georgian Revenue Service and Public Registry to formalize data exchange procedures.
  - Expand collection of borrower income and loan terms; PTI and LTV calibration should be reviewed periodically as better data become available.
- Calibration suggestions:
  - Consider moving to a stressed PTI measure that accounts for interest rate shocks in addition to exchange rate and income shocks; example cited: Malta uses a PTI of 40 percent after a 150 bps shock to interest rates.
  - Reassess PTI thresholds that trigger loan deterioration using regular income data and COVID-19 experience.
- Monitoring and leakage assessment:
  - Systematically track and analyze potential leakages (e.g., real estate developers’ in-house USD installment financing) and unintended consequences of de-dollarization measures.
  - Combine credit registry data and more granular sectoral loan classification to monitor hedging status by sector.

### FX market, local capital market, and market infrastructure
- FX market improvements:
  - Electronic FX trading platform based on Bloomberg (bmatch) introduced in 2020 improved liquidity and reduced bid-ask spreads.
  - FX derivatives are expensive; legislative package on collateral, netting, and derivatives aligned with ISDA adopted December 2019.
  - NBG introduced FX swap facilities after COVID-19 shock; only 10 – 15 percent of resources drawn on.
- Constraints to market development:
  - Perception of one-way exchange rate flexibility and limited two-way volatility reduces incentives to hedge.
  - Insufficient IT infrastructure at banks limits use of the FX trading platform; upgrades (potentially shared software) recommended.
- Local government debt market:
  - Over 80 percent of government debt is foreign-currency denominated as of end-2020.
  - MoF began issuing benchmark bonds in 2018; pilot primary dealer system commenced November 2020; non-resident investor share around 10 – 12 percent.
  - COVID-19 led to Eurobond issuance instead of domestic market issuance, temporarily halting domestic debt development.
- Market development recommendations:
  - Publish FX intervention strategy to reduce perception of one-way exchange rate flexibility.
  - Deepen FX derivatives market and local capital market to increase local currency funding and risk-sharing.
  - Develop covered bonds to expand long-term local currency mortgage financing and attract international investors (legislation noted to closely follow EU directives).

### Key consolidated recommendations (timing as in source)
- Institutional framework:
  - Continue to strengthen public communication on rationale and impacts of macroprudential decisions. — NBG — ST
  - Expand impact assessments and cost-benefit analyses of macroprudential measures, including for de-dollarization, and carry these out more regularly. — NBG — ST
  - Ensure NBG Board is usually fully staffed to strengthen perception of accountability. — Parliament, NBG — I
- Data and implementation:
  - Continue to expand and refine data collection on borrowers’ income and debt terms (credit registry, MoF cooperation). — NBG, MoF — ST
  - Review parameterization and calibration of PTI and LTV limits periodically as borrower data expands; consider stressed PTI approaches. — NBG — ST
- De-dollarization measures:
  - Gradually continue to tighten de-dollarization measures, informed by impact assessments and cost-benefit analysis. — NBG — ST
  - Enhance public communication to clarify objectives of FX interventions (publish FX intervention strategy). — NBG — ST
  - Support FX market deepening and IT infrastructure improvements for FX trading. — NBG — MT
  - Continue domestic capital market development: increase share of local currency debt, issue benchmark bonds regularly, and develop covered bonds. — MoF — MT
  - Measure and monitor potential leakages to entities outside NBG regulatory perimeter and stand ready to act. — NBG, MoF — ST
- Capital buffers restoration timeline (announced June 16, 2021):
  - Restore capital buffers starting January 1, 2022, over a two-year period.
  - Banks required to restore the CICR buffer by January 1, 2023, and the capital conservation buffer by January 1, 2024.

*Source: EXECUTIVE SUMMARY and chapters from IMF staff note (IMF staff: Sergejs Saksonovs and Julia Faltermeier) in content unit 1geoea2021004.*

### EXECUTIVE SUMMARY __________________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### Institutional framework for macroprudential policy — key findings
- Since the 2015 FSAP, the NBG has significantly strengthened its institutional framework and put in place a comprehensive toolkit; the NBG published its Macroprudential Policy Strategy in 2019, which sets out five intermediate objectives:
  - (i) mitigating and preventing excessive credit growth and leverage;
  - (ii) mitigating and preventing excessive maturity mismatch and market illiquidity;
  - (iii) limiting direct and indirect exposure concentrations;
  - (iv) limiting the systemic impact of misaligned incentives with a view to reducing moral hazard; and
  - (v) reducing dollarization of the financial system.
- The NBG is effectively the macroprudential policy authority in Georgia; the mandate is rooted in the NBG’s financial stability objective as enshrined in the Organic Law on the NBG.
- Decision-making and governance:
  - Macroprudential policy decisions are made by the Governor of the NBG based on recommendations of the Financial Stability Committee (FSC).
  - A dedicated financial stability department with a staff of 9 people formulates and analyzes macroprudential proposals.
  - The FSC has seventeen ex officio members, is chaired by the Governor, and meets quarterly (with the option of extraordinary meetings).
  - Minutes of FSC meetings are kept (recording opinions and reasons) but are not published; FSC decisions are recommendations to the Governor and become legal acts upon the Governor’s final decision.
- Transparency and accountability:
  - The NBG resumed regular publication of the Financial Stability Report (FSR) in 2019; the report is now published annually usually around September.
  - Recommendations of the FSC have been published quarterly since March 2018.
  - The Organic Law was amended in 2020 to expand the NBG Board from seven to nine positions (four executive and five nonexecutive); two non-executive vacancies from 2019 have been recently nominated to strengthen perception of accountability.
- Areas for further improvement:
  - Strengthen communication (publish heatmap assessments, policy papers on calibration, expand outreach beyond financial sector).
  - Expand impact analysis and cost-benefit assessment of macroprudential measures.
  - Ensure the NBG Board is usually fully staffed to strengthen perception of accountability.

### Implementation of macroprudential tools — outcomes and priorities
- The NBG has implemented a comprehensive toolkit to address systemic risks and to reduce dollarization, with notable measures including:
  - Differentiated reserve requirements and capital buffers against currency-induced credit risk.
  - Borrower-based measures introduced in 2019: limits on payment-to-income (PTI) and loan-to-value (LTV) ratios; a minimum loan size of 200,000 GEL for FX loans (raised from 100,000 GEL introduced in 2017).
  - Gradual tightening of FX reserve requirements and differentiation of the liquidity coverage ratio (LCR) by currency.
- Results:
  - Loan dollarization has declined by around 10 percentage points since 2016.
  - Deposit dollarization remains higher than loan dollarization.
  - Measures have increased interest differentials between lari and USD deposits, making USD deposits less attractive.
- Post-COVID focus:
  - The NBG’s toolkit helped strengthen resilience of the financial sector to the COVID-19 shock; the financial sector remained resilient and profitable despite severe damage from the shock.
  - Much of the toolkit is relatively new; the NBG is focusing on rebuilding buffers and refining implementation rather than expanding the toolkit further.
  - On June 16, 2021, the NBG announced restoration of capital buffers starting on January 1, 2022, over a two-year period:
    - Banks will be required to restore the CICR buffer by January 1, 2023, and the capital conservation buffer by January 1, 2024.
- Data and calibration priorities:
  - Quality of design and implementation depends on quality of data; the planned implementation of a credit registry with detailed loan and borrower information (including interest rates and income) will improve granular risk assessment and calibration.
  - The NBG should review the parameterization and calibration of PTI and LTV limits periodically as more borrower data becomes available; current PTI calibration implies borrower income is stressed for significant exchange rate depreciation.

### Financial dollarization — risks, drivers, and policy direction
- Financial dollarization is identified as the most important risk to the banking system in Georgia and limits the economy’s ability to adjust to shocks:
  - Dollarization increases banking system risks via two channels: (i) credit risk from unhedged borrowers, and (ii) liquidity risk.
  - Revaluation effects of bank balance sheets and indirect interest-rate-volatility transmission also transmit exchange rate fluctuations to the banking system.
  - High dollarization limits the interest rate channel of monetary policy and strengthens the exchange rate channel.
- Historical drivers:
  - Dollarization stems from macrofinancial instability, hyperinflation, and large exchange rate depreciation in the 1990s, which weakened public confidence in the domestic currency and led households to prefer holding dollars as a store of value.
- NBG policy toolkit to limit and reduce dollarization:
  - Differentiated reserve requirements, currency-differentiated LCR, borrower-based measures (PTI, LTV, minimum FX loan size), and capital buffers against FX credit risk.
  - Cross-country evidence: progress on deposit de-dollarization tends to be faster during fiscal consolidation and temporary stable or appreciating exchange rate periods.
- Policy design considerations:
  - Further progress on de-dollarization will take time, especially for deposit-driven dollarization.
  - Gradual tightening of dollarization measures is recommended, with choice of measures and calibration informed by impact assessments and cost-benefit analysis.
  - Market-based measures generally avoid credit allocation inefficiencies; borrower-based measures better target vulnerabilities but require detailed data.
  - Outright restrictions (e.g., increasing the 200,000 GEL limit) have higher efficiency costs but are easier to communicate and implement.
- Complementary macroeconomic and structural measures needed:
  - Strengthen trust in the local currency and build a track record of low and stable inflation.
  - NBG should enhance public perception of two-way exchange rate flexibility by publishing its FX intervention strategy to clarify objectives (no conflict between reserve accumulation and exchange rate flexibility).
  - Ministry of Finance should support local capital market development by regularly issuing benchmark local currency bonds, increasing the share of local currency debt in overall public debt, and supporting development of covered bonds.
  - Monitor and measure potential leakages from macroprudential tools to entities outside the NBG’s perimeter of regulatory coverage and be ready to act.

### Key recommendations (extract from Table 1: Summary of Key Recommendations)
- Institutional Framework for Macroprudential Policy:
  - Continue to strengthen public communication on the rationale for macroprudential policy decisions and their impact. — NBG — ST
  - Expand impact assessments and cost-benefit analyses of macroprudential policy measures, including for de-dollarization, and carry these out more regularly. — NBG — ST
  - Ensure that the NBG Board is usually fully staffed to strengthen perception of accountability. — Parliament, NBG — I
- Implementation of Macroprudential Policy Tools:
  - Continue to expand and refine data collection to improve the basis for macroprudential policy decisions, including on borrowers’ income and on the terms of their debt. — NBG, MoF — ST
  - Review the parameterization and calibration of PTI and LTV ratio limits periodically as available data on borrowers expands. — NBG — ST
- De-dollarization:
  - Gradually continue to tighten de-dollarization measures, with the choice of measures and calibration informed by impact assessments and cost-benefit analysis. — NBG — ST
  - Enhance public communication to clarify the objectives of foreign exchange interventions. — NBG — ST
  - Support deepening of FX markets, including by further development of IT infrastructure for FX trading. — NBG — MT
  - Continue to develop domestic capital markets by increasing the share of local currency debt, issuing benchmark bonds regularly, and developing covered bonds. — MoF — MT
  - Measure and monitor potential leakages from macroprudential tools to entities outside of the NBG’s perimeter of regulatory coverage and stand ready to act. — NBG, MoF — ST
- Timing legend from the source:
  - I–Immediate: within 1 year;
  - ST–short term: 1 to 3 years;
  - MT–medium term: 3–5 years.

*Source: EXECUTIVE SUMMARY (IMF staff note prepared by Sergejs Saksonovs and Julia Faltermeier).*

### 6.      The NBG has implemented all the recommendations of the last FSAP that dealt with

### 6.      The NBG has implemented all the recommendations of the last FSAP that dealt with

### Overview
- The NBG has implemented recommendations from the last FSAP related to macroprudential policy tools, including elements of the Basel III framework: CCyB, LCR, and capital surcharges for systemic banks.
- Momentum for strengthening the macroprudential toolkit accelerated in 2016 after a new government and a new Governor of the NBG were appointed.

### Macroprudential toolkit and key instruments
- The comprehensive toolkit introduced since 2016 includes:
  - Broad-based tools:
    - Counter-cyclical capital buffer (CCyB) — set at zero since its introduction in December 2017.
    - Leverage ratio — set at 5 percent since its introduction in September 2018.
  - Borrower-based tools:
    - Loan-to-value (LTV) and payment-to-income (PTI) ratios — introduced in 2019 and differentiated by currency of the loan.
  - Liquidity tools:
    - Liquidity Coverage Ratio (LCR) — lower for GEL compared to FX liabilities; introduced September 2017 (with later adjustments).
    - Net Stable Funding Ratio (NSFR) — introduced September 2019 with a requirement of 100 percent.
  - Structural tools:
    - Additional capital buffers for domestic systemically important banks (DSIB buffers between 1.5 and 2.5 percent introduced December 2019, to be phased in through December 2021).

- Selected implementation milestones and parameters:
  - 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) 2.5 percent introduced December 2017; CCB released April 2020 as part of COVID-19 response and to be restored by Jan. 2024.
  - Unhedged Currency Induced Credit Risk Buffer (Pillar 2 buffer equivalent to 75 percent additional risk weighting) introduced December 2017; two-thirds of this buffer released April 2020 as part of NBG response to Covid-19 and to be restored by January 2023.
  - CCyB introduced December 2017 but not activated.
  - Leverage Ratio minimum requirement of 5 percent — September 2018.
  - Capital distributions restrictions (dividends, buybacks, equity investments, increases in variable remuneration) imposed April 2020 as part of COVID-19 response.
  - Reserve requirements (FX short-term deposits remunerated at Fed Funds rate minus 50 bp or ECB deposit facility minus 20 bp):
    - Increase from 20 to 25 percent — July 2018.
    - Further increase from 25 to 30 percent — March 2019.
    - Reduction from 30 to 25 percent — October 2019.
    - Differentiation by bank: 1 ppt reduction for every 2 ppt below 70 percent of deposit dollarization until 40 percent — July 2021.
  - Lari deposit reserve requirements remunerated at policy rate: reduction from 7 to 5 percent — July 2018.
  - LCR details:
    - LCR of 100 percent (overall), 75 percent (domestic currency), and 100 percent (foreign currency) — September 2017.
    - LCR in domestic currency reduced to zero for one year — May 2020.
    - Removal of the 25 percent haircut previously applied to FX required reserves in the calculation of high-quality liquid assets — October 2019.
  - Borrower-based measures:
    - PTI limits:
      - Unhedged Borrowers: 20 – 35 percent (January 2019).
      - Hedged Borrowers: 25 – 60 percent (January 2019).
      - Revised in March 2020 to Unhedged: 20 – 30 percent; Hedged: 25 – 50 percent.
    - LTV limits:
      - GEL Loans: 85 percent.
      - Foreign Currency Loans: 70 percent. Implementation 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.
  - Limit on net open FX position: 20 percent of regulatory capital — July 2006.

### Implementation and empirical outcomes
- Use of indicators:
  - The NBG calculates the credit-to-GDP gap using the Hodrick-Prescott filter (sensitivity to short-term fluctuations λ is set to 400,000) and publishes it quarterly alongside FSC decisions; the indicator is affected by exchange rate fluctuations.
  - Credit growth at constant exchange rates is also consistently published alongside FSC decisions.
- Credit growth dynamics:
  - Credit growth at constant exchange rates peaked at 21.5 percent (y/y) in April 2018.
  - It fell to a low of 7.7 percent (y/y) in March 2021 before accelerating to 12.6 percent (y/y) in June 2021.
- Impact of responsible lending regulations (PTI and LTV introduced 2019):
  - PTI and LTV slowed mortgage issuance and improved mortgage quality.
  - Maximum LTV ratios set at 85 percent for lari mortgages and 70 percent for FX mortgages.
  - PTI requirements differentiated by income and hedging status; original four income groups streamlined to two in 2020.
  - PTIs range between 20 and 50 percent depending on whether borrowers’ income is above or below GEL 1000.
  - As a result of the measures and tightening of FX loan limits, newly issued mortgages (lari and FX) declined by 4 percent (y/y) in 2019 compared to average y/y growth of around 40 percent (y/y) in the previous three years.
  - Conservative underwriting contributed to resilience of residential real estate prices after COVID-19 and relatively rare property repossessions.
- Implementation challenges:
  - Income verification under PTI is challenging due to informality; NBG estimates more than 50 percent of borrowers underreport income to tax authorities.
  - The credit bureau provides borrower loan exposure but lacks information on interest rates and borrower income.

### Institutional powers, cooperation, and communication
- Legal and supervisory scope:
  - The organic law grants the NBG supervision powers over the entire financial sector except for the insurance sector, which is very small, providing a broad regulatory perimeter and limiting leakages.
  - Responsibility and legal powers for macroprudential policy rest with the NBG, reducing the need for "comply or explain" mechanisms.
- Interagency cooperation:
  - An interagency committee for financial stability is established by the Organic Law on the NBG to support financial system stability and develop crisis management mechanisms; it includes MoF, NBG, Deposit Guarantee Fund, and Insurance State Supervision Service and convenes at least semi-annually at the NBG’s request.
  - An MoU between MoF and NBG (2014) formalizes cooperation and information sharing to coordinate responses to financial stability risks.
  - Examples of legislative cooperation: introduction of minimum size for foreign currency loans of 200,000 GEL (equivalent to USD 63,000 as of June 2021) and a cap on the annual effective interest rate at 50 percent required changes in the Civil Code of Georgia.
- Consultation and outreach:
  - NBG shares FSC presentation materials with market participants and discusses new tools with the financial sector in advance; feedback is incorporated where possible.
  - During COVID-19 (April–May 2020) the NBG implemented measures (relaxation of LCR in local currency, release of some capital buffers) discussed internally and with the financial sector and implemented quickly; no extraordinary formal FSC meeting took place.

### Assessment and recommendations
- Institutional assessment:
  - The institutional framework for macroprudential policy has been strengthened since the last FSAP and meets broad principles of good design, placing macroprudential powers within the NBG and demonstrating ability to act (including measures taken around COVID-19).
- Recommendations:
  - The NBG should work with Parliament to ensure remaining Board vacancies are filled to provide more oversight and improve perception of accountability over macroprudential and other policies.
  - The NBG should strengthen communication on macroprudential policy decisions, impacts, and rationale to facilitate acceptance and counter biases toward inaction. Specific suggestions include:
    - Use heatmaps to signal assessment of risk levels based on multiple indicators.
    - Gradually publish more policy papers outlining approaches to calibrating instruments such as the CCyB, PTI, and LTV, supported by analysis of the predictive power of various indicators enumerated in the Macroprudential Policy Strategy.
    - Increase outreach beyond the financial sector to large corporate entities (e.g., construction companies, large retailers) whose business models can be significantly affected.
  - The NBG should regularly undertake impact assessments and cost-benefit analyses of macroprudential measures, including ex-ante and ex-post evaluations. The NBG’s Macroprudential Policy Strategy emphasizes monitoring intervention effects and evaluating achievement of intermediate objectives. Example elements to cover in cost-benefit analysis (as practiced in other jurisdictions) include:
    - Impact on risk and severity of a crisis.
    - Efficiency costs of the policy in the absence of a crisis.
    - Compliance costs for registered banks.
    - Potential for unintended consequences.

*Source: IMF staff chapter on Georgia macroprudential framework and implementation.*

### 24.      The NBG  has  not introduced macroprudential  tools targeting specifically the corporate

### 24. The NBG has not introduced macroprudential tools targeting specifically the corporate sector

### Corporate credit patterns and sectoral composition
- Credit growth following responsible lending regulations has been driven by corporate borrowing.
- Increases in corporate indebtedness were more modest than household debt increases prior to responsible lending regulations.
- Sectoral concentration shifted over 2010–2020:
  - The three largest sectors (industry, construction, and trade) accounted for about 80 percent of corporate loans in 2010.
  - Their share declined to around 60 percent in 2020.
  - Lending to the tourism sector rose to around 10 percent of the portfolio by 2020.
- Real estate sales also contributed to portfolio diversification.

### Liquidity and structural measures (Basel III implementation and liquidity support)
- The NBG implemented Basel III liquidity standards:
  - LCR introduced in 2017.
  - NSFR introduced in 2019.
- LCR requirements:
  - Overall LCR requirement of 100 percent.
  - Differentiated LCR by currency: 75 percent for lari and 100 percent for foreign exchange.
- NBG liquidity-enhancing measures:
  - Dedicated FX swap lines with commercial banks and microfinance institutions to exchange foreign currency liquidity for domestic currency.
  - Acceptance of SME loan portfolios as collateral for repo operations until 2023.
  - In April 2021, the NBG extended the stand-by FX swap instrument to operate until May 2022.
- Observations:
  - Overall liquidity has not been a major constraint for the banking system, though episodes of sharp lari liquidity declines occurred (most recently associated with the outbreak of the COVID-19 pandemic).
  - Loan to deposit ratios have remained broadly steady; a higher loan-to-deposit ratio on domestic currency loans suggests local currency funding remains a challenge and that growth in lari lending (due to FX lending restrictions) has been accommodated by the market.
- Nonresident deposits stabilized at about 15 percent of total deposits since 2015.

### Domestic systemically important banks and systemic buffers
- The NBG designated three domestic systemically important banks in line with the Basel framework.
  - Two institutions qualify based on size alone.
  - A third bank is systemic due to an extensive branch network.
- Systemic buffers:
  - Phased in gradually starting in 2017; phase-in expected to be completed by 2021 (despite the COVID-19 shock).
  - Two largest banks have an additional buffer of 2.5 percent of risk-weighted assets.
  - The third bank has an additional buffer of 1.5 percent.
- Georgian regulation requires banks to maintain a net open currency position not exceeding 20 percent of CET1; in practice banks generally keep below that limit.

### Assessment and recommendations on macroprudential toolkit
- The NBG now has a comprehensive macroprudential toolkit that strengthened financial sector resilience to the COVID-19 shock.
- Pre-crisis, tools were broadly effective in slowing credit growth and achieving a more sustainable lending mix.
- Limitations and implementation stage:
  - Much of the toolkit is relatively new.
  - The countercyclical capital buffer has never been activated.
  - PTI and LTV ratios were introduced in 2019.
  - The NBG is focusing on refining implementation rather than expanding the toolkit.
- Data and calibration recommendations:
  - Strengthen data collection: sign memorandums of understanding with the Georgian Revenue Service and the Public Registry to establish formal procedures for data exchanges (currently NBG receives real estate transactions from the public registry and collaborates with the tax authority to obtain detailed income data on a one-off basis).
  - Use medium-term information to consider the need for macroprudential instruments for corporate borrowers.
  - Implement the planned credit registry to compile detailed loan-level data (including interest rates and borrower income) to improve risk assessment (e.g., climate) and calibration of tools.
  - Revisit calibration of PTI and LTV limits and consider moving to a stressed PTI measure as part of recalibration.
    - PTI and LTV values introduced in 2019 and revised in 2020 were chosen based on cross-country comparisons and correlations between PTI/LTV and loan default rates before the regulation, but borrower income data was limited and mortgage defaults were infrequent.
    - With regular income data collection and COVID-19 experience, reassess which PTI thresholds trigger loan deterioration and revisit values if appropriate.
  - Consider pros and cons of a stressed PTI that explicitly accounts for shocks:
    - A stressed PTI imposes a uniform limit on the PTI ratio after a hypothetical shock at underwriting.
    - This re-calibrated PTI would take into account interest rate shocks in addition to exchange rate and income shocks in the current PTI.
    - Such measures are typically used during a low interest rate environment to prepare for eventual interest rate increases (BIS, 2016).
    - Example: in Malta, a PTI of 40 percent is used after a 150 bps shock to interest rates.
    - For Georgia, stressed PTIs could stress domestic currency loans to higher interest rates and foreign currency ones to higher interest rates and depreciation, potentially being more forward-looking, flexible, and transparent.
- Monitoring corporate-specific tools:
  - Over time, richer data (credit registry and formalized data sharing) would enable consideration of macroprudential instruments targeting corporate borrowers.

### De-dollarization policies — context and current status
- Financial dollarization in Georgia:
  - Deposit dollarization hovers just above 60 percent (the highest in the Caucasus and Central Asia).
  - Loan dollarization is about 56 percent as of early 2021.
- Historical and structural context:
  - Dollarization stems from historical extreme instability, hyperinflation, and large exchange rate depreciation in the 1990s, leading households to prefer dollars as a store of value.
  - Georgia introduced inflation targeting in 2009; inflation has been lower and more stable since then, but frequent external shocks (2014 oil price shock, geopolitical tensions in 2019, and COVID-19) and a depreciating trend of the lari against the USD have slowed trust in the local currency.
- COVID-19 effects on de-dollarization:
  - The lari depreciated against the dollar following the COVID-19 shock.
  - NPLs on foreign currency loans increased more than for lari loans.
  - Households entered the crisis in better financial condition due to prudential measures introduced in 2019, especially lower loan issuance in foreign currency.
  - Substitution from lari into dollar deposits after initial March 2020 depreciation was relatively contained, but sustained lari depreciation made saving in lari less attractive and slowed de-dollarization of deposits.
  - Macroprudential tools targeting dollarization stayed in place during COVID-19, apart from a temporary, partial release of the currency-induced credit risk buffer.
  - Support measures such as the local currency mortgage subsidy have helped promote loan larization.
  - Recent change in the reserve requirement incentivizes larization by lowering costs to banks.

### Costs and risks of high dollarization
- High dollarization is the main source of systemic risk to Georgia’s banking system.
- Two main sources of risk from exchange rate volatility:
  - Credit risk from unhedged borrowers:
    - Georgian banks target a closed net open foreign currency position, limiting their exposure.
    - The share of corporate borrowers able to fully hedge is estimated at only 21 percent and concentrated in a few sectors.
    - SMEs and households are generally unhedged; some households may rely on remittance income.
    - Large depreciation could quickly force unhedged borrowers into default; positive correlation exists between exchange rate depreciations and NPL rates.
  - Liquidity risk:
    - The NBG has limited ability to backstop systemic liquidity shocks in foreign currency; banks depend on their own FX liquidity buffers to weather sudden FX deposit outflows.
    - IFIs are another relatively stable source of funding for banks.
    - Concerns about materialization of credit risk can translate into liquidity shocks.
- Balance sheet and interest rate transmission channels:
  - Tier 1 capital is held in lari; depreciation increases the value of risk-weighted assets (RWA), leading to a fall in CAR and forcing banks to hold additional capital buffers to avoid breaching CAR regulations.
  - High exchange rate pass-through to inflation leads to higher domestic interest rates on depreciation, which may increase credit risk even for local currency lending if borrowers cannot service higher monthly payments.
  - Composition shifts: FX lending has shifted more to EUR recently while FX deposits are in USD, exposing banks to interest rate risk in global financial markets.
- Monetary policy transmission limitations:
  - High dollarization may limit the interest rate channel and strengthen the exchange rate channel: central bank has less control over aggregate credit via domestic interest rate; exchange rate becomes more sensitive to policy rate changes.
  - The exchange rate channel may be less expansionary in a highly dollarized economy because the balance sheet channel (increased foreign currency debt burden) can dampen expansionary effects of depreciation.
  - Lower dollarization would curb the balance sheet channel and increase central bank ability to ease credit conditions through policy rate cuts.
- Macro-level consequences:
  - Financial vulnerabilities and limited monetary policy transmission mean dollarization can hinder adjustment to shocks; extreme cases can trigger corporate and banking crises, exacerbate sudden stops, cause output volatility, and even result in self-fulfilling macroeconomic crises.
  - Empirical evidence links dollarization with greater financial crises propensity, limited use of exchange rate flexibility and greater output volatility, and public debt crises.

### Drivers of deposit and loan dollarization
- Nature of dollarization in Georgia:
  - Georgia experiences deposit-driven dollarization rather than carry-trade euroization.
  - FX deposits are widely used as a savings vehicle, supplying banks with ample FX funding; banks extend FX loans to close net open FX positions.
  - Unlike some Eastern European economies with carry-trade euroization that creates long open FX positions, Georgian banks target a closed net open FX position.
  - Banks have started offering EUR lending by swapping USD funding for EUR with correspondent banks, creating some loan euroization; this creates interest rate risk but not exchange rate risk for banks.
- Cross-country perspective:
  - While some dollarization is a natural consequence of trade integration and capital account openness, dollarization in Georgia exceeds cross-country benchmarks, warranting a closer look at drivers specific to Georgia.
- Relevant cross-country and historical notes included in the original analysis:
  - Out of 21 countries with data for 1999–2018, 16 reduced dollarization of term deposits with the average reduction close to 20 percent over twenty years (Levy-Yeyati, 2021).
  - The sample cited includes mostly Latin American countries, where macroeconomic instability period differs slightly from Georgia, affecting the pace of re-establishing trust in the currency.

*Source: 1geoea2021004 — IMF.*

### 43.      Deposit dollarization in Georgia is largely driven by household savings. As the interest

### Deposit dollarization in Georgia is largely driven by household savings

### Drivers of dollarization
- Household savings are the main driver of deposit dollarization; households seek to insure against tail risk and appear less sensitive to the USD/GEL interest rate differential.
- Depreciating trend in recent years has made saving in lari ex-post unattractive even for risk-neutral investors.
- Structural contributors identified (from a cross-country panel regression following Della Valle et. al. (2018)):
  - High trade openness and remittances inflows are associated with higher dollarization and have become more important over time.
  - Low level of financial development contributes to higher dollarization; progress in financial development should lower dollarization going forward.
  - Few restrictions on the financial account (FARI) facilitating capital account openness lead to more dollarization.
  - High current and past inflation and the optimal mean-variance portfolio (MVP) implied by inflation and real exchange rate volatility contribute positively.
- The residual for Georgia in the regression is very high, indicating dollarization is well above that of countries with similar characteristics; persistence from instability in the 90s likely explains some unexplained variation.
- The benchmark level implied by fundamentals is well below current levels exceeding 60 percent, indicating room to lower dollarization.

### Portfolio choice and macroeconomic environment
- A minimum variance portfolio model shows optimal FX allocation rises with relative volatility of inflation versus real exchange rate depreciation: a high volatility in inflation relative to real exchange rate depreciation makes foreign currency more attractive as a store of value.
- High exchange rate pass-through and inflation volatility increase the insurance value of FX savings for households, encouraging FX holdings.
- FX has been used more frequently amid depreciation pressures due to Covid; some depreciation bias observed in 2020.
- Depreciation in 2019 and 2020 made local currency (LC) deposits relatively unattractive.

### Market structure and behavior
- Bank deposits are the main saving vehicle; the shallow local capital market provides no attractive alternative savings instruments in lari.
- Newly created pension fund has increased supply of long-term lari deposits and is expected to grow steadily over the next decades.
- Dollar is the dominant currency for savings, providing banks with ample FX deposit funding and translating into lower interest rates on FX compared to GEL loans.
- Housing market and durable goods are largely priced in dollars; most real estate sales and rental contracts are priced in dollars, increasing pass-through and the exchange rate’s role as the nominal anchor.
- Loan dollarization driven by abundant dollar funding; exacerbated by:
  - Large interest rate differential on loans between GEL and USD (or EUR).
  - Low financial literacy or perception that the central bank will not tolerate significant depreciation, causing borrowers to underestimate exchange rate risk.
  - Credit-constrained borrowers may rationally choose FX loans to backload real interest payments when depreciation is expected (debt limit channel).

### Recent developments in bank funding and liquidity
- Banks increasingly relied on central bank financing for liquidity management: refinancing loans picked up in 2019 and increased further after the COVID-19 shock in March 2020.
- Banks secured about 5.5 billion GEL in new lending via sufficient private GEL funding to accommodate de-dollarization of assets.
- Perceived asymmetric FX intervention and limited two-way exchange rate flexibility have led market participants to misperceive the NBG’s dual objectives of reserve accumulation and volatility reduction, creating a perceived depreciation bias that reduces incentives to hedge against appreciation and hinders FX derivatives market development.

### Policy measures — Data collection and monitoring
- The NBG regularly monitors indicators of dollarization as one of five intermediate objectives of the Macroprudential Policy Strategy; follows monthly data on deposit and loan dollarization, interest rates, and asset quality by currency; updates on the LCR and Financial Stability Report.
- NBG mainly uses supervisory data from banks and has expanded data collection on issuance and pricing of loans by currency, product, and sector.
- Introduction of PTI and LTV ratios in January 2019 led commercial banks to systematically collect borrower income and collateral values; new data will improve assessment of asset quality and retail borrowers’ income sensitivity to exchange rate shocks.

### Policy measures — Resilience of borrowers and FX lending restrictions
- Responsible lending regulation sets different PTI and LTV depending on loan currency and raised the minimum size of FX loans, limiting FX lending.
- An outright ban on FX lending below 200,000 GEL (raised from 100,000 GEL first introduced in 2017) took effect around the same time; the ban covers about 3/4 of household lending including mortgages and since 2019 also applies to legal entities.
- Issuance of new FX loans has fallen markedly; downward trend continued partly because depreciation made FX lending less attractive.
- No robust evidence that macroprudential measures unduly restricted access to finance: consumer credit continued to grow at a more sustainable rate; mortgages grew healthily in Q1 2021 even without a subsidy, and supervisory data show no routine circumvention of the 200,000 GEL limit (no bunching just above the limit).
- Real estate developers’ in-house installment financing (usually in USD) covers about 40 percent of real estate transactions as new construction, of which around 1/4 use in-house financing; if developers extend longer-maturity installments and secure bank financing, this could become a channel to circumvent FX mortgage restrictions.

### Policy measures — Capital buffers and hedging definitions
- The NBG requires additional capital buffers for currency-induced credit risk (CICR); CICR is a Pillar 2 buffer equivalent to 75 percent additional risk weighting for loans to unhedged borrowers.
- The CICR was temporarily reduced to 25 percent during COVID-19 measures; a timeline for rebuilding the buffer over the next two years was announced in June 2021.
- Excluding hedged borrowers from CICR prevents inefficient credit constraints but defining hedged borrowers is difficult; NBG’s definition covers loans such as those exceeding GEL 5 million where repayment depends on income from exports invoiced in foreign currency, hotels with at least 50 percent foreign visitors, or electricity generation.
- Some exporters invoicing in USD may still be exposed to global shocks despite being insured against unilateral lari depreciation.

### Policy measures — Funding, liquidity, and prudential calibration
- Reserve requirements:
  - FX reserve requirement: 25 percent on FX liabilities.
  - GEL reserve requirement: 5 percent.
  - Remuneration: FX reserve remuneration is 50 bp below the Fed Funds rate (20bp below ECB deposit rate for EUR reserves); GEL reserves remunerated at the monetary policy rate.
- In July 2021, NBG differentiated reserve requirements across banks based on deposit dollarization: for every two percentage points of deposit dollarization below 70 percent, a bank can lower its FX reserve requirement by one percentage point; reserve requirement floor at 10 percent (for 40 percent or less of deposit dollarization).
  - The measure releases some FX reserves to banks but aggregate effect expected to be small due to high aggregate deposit dollarization; short-term financial gains for banks are limited, but a signaling effect may increase competition for lari deposits and, combined with recent policy rate tightening, make lari deposits more attractive.
- LCR and NSFR:
  - LCR is differentiated by currency and set higher for foreign currency than for lari.
  - Both LCR and NSFR apply stricter calibration for non-residents to reduce liquidity risk (higher run-off rate for non-resident deposits; lower available stable funding factor under NFSR).
  - Measures are calibrated to mitigate systemic liquidity risks from high volatility of non-resident deposits and to incentivize more stable funding.
- Assessment: liquidity measures appear adequate to limit liquidity risk. The FX reserve requirement is adequate internationally to create a buffer against sudden outflows; penalty remuneration discourages FX intermediation and makes lari deposits more attractive. LCR and NFSR appear adequate to measure, monitor, and limit systemic liquidity risk; share of non-resident deposits has remained stable and FX liquidity appears robust per liquidity stress test.

### Policy measures — Administrative measures and financial literacy
- Since 2017, all prices must be stated in lari to encourage use of the local currency as a unit of account; transactions are mandated to be in local currency, so foreign currency use as medium of exchange is limited.
- To encourage lari in real estate settlements, authorities introduced an escrow account service with the public registry.
- Banks must show borrowers how much monthly payments would increase in response to a 15 percent depreciation to raise awareness of exchange rate risk when borrowing in foreign currency.
- Impact of administrative measures is difficult to measure: US dollar continues widely used in contracts, especially real estate; pricing regulation is easy to circumvent (e.g., real estate websites offer a button to convert prices to USD).
- Experience from other dollarized economies suggests replacing USD with lari as the nominal anchor takes time; small nudges towards using lari may help where dollar usage stems from habit rather than economic incentives.

*Source: IMF staff analysis in the provided content unit.*

### 63.      Recent reforms have supported the functioning of the FX market.

### 63.      Recent reforms have supported the functioning of the FX market.

### FX market reforms and current functioning
- FX spot market:
  - Introduction of an electronic FX trading platform based on Bloomberg (bmatch) in 2020.
  - Improved market liquidity and significantly reduced bid-ask spreads in the FX spot market.
  - Platform allows large corporates with access to a Bloomberg terminal to directly participate in the otherwise relatively concentrated market.
- FX derivatives market:
  - FX derivatives such as FX swaps are expensive in Georgia.
  - In December 2019, the Parliament of Georgia approved the legislative package on financial collateral, netting, and derivatives in line with ISDA international practice.
  - FX swap facilities introduced by the NBG to backstop the market after the COVID-19 shock helped banks and microfinance institutions, even though only 10 – 15 percent of resources were drawn on.

### Constraints on further market development
- Perception and incentives:
  - The perception of lack of two-way volatility in the exchange rate and continuous depreciation provides little incentive to hedge against exchange rate appreciations.
- IT and operational constraints:
  - Insufficient IT infrastructure of commercial banks limits full use of the new FX trading platform and efficient risk management.
  - Upgrades of IT infrastructure, potentially through shared software, would support market functioning.
- NBG actions:
  - The NBG is working on an FX interventions strategy to improve communication and better coordinate the objectives of reserve accumulation and prevention of excessive exchange rate volatility.

### Local government debt market development
- Current constraints:
  - Market size and liquidity are the main constraints for the local market for government debt.
  - Georgia has the highest share of foreign-currency government debt in the region – over 80 percent as of the end of 2020.
- Recent initiatives:
  - The MoF started issuing benchmark bonds in 2018 to develop the local yield curve.
  - In November 2020, a pilot program for a primary dealer system commenced.
    - Primary dealers expected to act as intermediaries between the MoF and investors, diversify the investor base, and enhance secondary market liquidity via regular price quoting and provision of trading and settlement infrastructure.
  - MoF is actively strengthening investor relations to increase the share of non-resident investors (currently around 10 – 12 percent).
- COVID-19 impact:
  - The COVID-19 crisis favored issuance of a Eurobond instead of domestic market issuance, temporarily halting the move to more domestic debt.

### Policy recommendations — overarching strategy
- Embed macroprudential measures in a comprehensive de-dollarization strategy:
  - Macroprudential measures have substantially reduced financial vulnerabilities from unhedged borrowing and increased liquidity buffers.
  - Over the medium term, authorities should consider tightening dollarization measures gradually, with choice and calibration informed by impact assessments.
  - Long-term success depends on:
    - Creating trust in the local currency and building a track record of inflation stability to reduce deposit dollarization.
    - Promoting perception of two-way exchange rate flexibility to deepen the FX derivatives market.
    - Developing local capital markets to attract more local currency funding in the medium term.

### Macroprudential toolkit and calibration
- Periodic review:
  - The NBG should periodically review calibration and implementation of its macroprudential toolkit targeted at dollarization to encourage larization.
  - Re-calibration of some measures may help make them more targeted; NBG needs to monitor potential leakages and develop policy responses.
  - Overall, the toolkit is comprehensive and in line with international practices; no new measures appear necessary at the moment.

### Lessons from cross-country experience for de-dollarization
- Key elements (summary of cross-country guidance):
  - Reduce expectation of continued exchange rate depreciation:
    - Sound and sustainable macroeconomic policies, fiscal discipline, and credible institutions are key prerequisites.
    - Georgia has undertaken substantial reforms; a long enough track record should eventually change expectations.
  - Reduce the insurance value of foreign currency deposits:
    - Central bank reputation for stable and low inflation matters.
    - Prudential measures such as higher FX reserve requirements that reduce the return on FX deposits can incentivize savings in local currency.
  - Develop local capital markets:
    - A more developed capital market creates more investment opportunities in local currency, provides more banks’ term funding in local currency at lower costs, and establishes a yield curve for pricing loans.

### Data collection and monitoring
- NBG actions recommended:
  - Continue to systematically track and analyze potential leakages and unintended consequences of de-dollarization measures.
  - Monitor installment contracts offered by real estate developers (normally denominated in USD) — developers are not under NBG supervision; so far limited in scale but warrants close monitoring for systemic vulnerabilities.
  - Streamline data collection on unhedged credit by sector:
    - Currently NBG receives aggregate data on unhedged credit monthly and sectoral data on a one-off basis.
    - Combine credit registry data and more granular sectoral loan classification to monitor hedging status by sector and re-calibrate macroprudential tools if needed.

### Resilience of borrowers and borrower-based measures
- Cautions on borrower-based measures:
  - Tightening PTI/LTV requirements could limit household borrowing in FX while keeping FX credit available to the most resilient borrowers.
  - Due to the ban on FX lending below 200,000 GEL, changes in ratios may need to be relatively large to reduce FX lending meaningfully.
  - Gradual increases in the 200,000 GEL limit could increase corporate loan dollarization if applied only to physical persons.
  - Large, abrupt changes to asset dollarization could lead to financial disintermediation and create financial instability if liabilities remain highly dollarized.
- Need for careful impact assessments:
  - Assess how much measures lessen crisis severity, efficiency costs (cost of credit, access to finance), compliance cost, and potential unintended consequences (leakages, risk shifting).
  - Market-based measures (e.g., FX reserve requirement, capital requirements) adjust via prices and generally avoid allocation inefficiencies but may have harder-to-control unintended consequences.
  - Borrower-based measures (PTI/LTV limits) allow targeting vulnerable borrowers but rely on additional data and can increase compliance and efficiency costs.
  - Outright restrictions (e.g., increase in 200,000 GEL limit) have higher efficiency costs and are less well targeted but easier to communicate, implement, and monitor.

### Capital buffers and hedged exposure definition
- CICR buffer:
  - The NBG announced in June 2021 the restoration of the CICR buffer by January 2023.
  - The CICR represents a second line of defense against risks from unhedged credit and needs to return to the original level of 75 percent.
  - Re-building expected to happen in coordination with rebuilding of all capital buffers as recovery from the COVID-19 shock takes hold.
- Hedged exposure definition:
  - The NBG should revisit the definition of hedged exposure for the CICR in the medium term to consider export market as well as invoicing currency.
  - Fresh COVID-19 crisis data should inform analysis of exporters exposed to more exchange rate risk than invoicing currency suggests.
  - Current definition appears relatively conservative and the buffer size adequate; additional analysis could help better target regulation if sectoral vulnerabilities build.

### Funding, liquidity, and administrative measures
- Liquidity requirements:
  - Current liquidity requirements (LCR, NSFR, and reserve requirements) appear sufficient.
  - Stress tests found banks sufficiently liquid in local and foreign currency under various plausible deposit outflow scenarios.
  - Continued monitoring necessary due to still-high deposit dollarization and potential risks from increases in non-resident deposits.
- Administrative measures:
  - NBG should continue to clearly communicate risks from FX borrowing to support financial literacy and explore additional incentives for pricing and contracting in GEL.
  - Promotion of local currency pricing and educational programs on FX risks should continue, recognizing the housing market’s salience of the exchange rate as a nominal anchor.

### FX and capital market development recommendations
- FX intervention strategy and communication:
  - NBG should work to reduce the perception of one-way flexibility of the exchange rate, for example by publishing the FX Intervention strategy.
  - When reserves accumulation is required, NBG should seek to minimize impact on the exchange rate by clear communication, emphasizing that reserves accumulation is finite, and considering a pre-announced program of small purchases to complement larger ones.
  - Publishing an FX intervention strategy would help reduce perception of one-way flexibility.
- Deepening FX derivatives and local capital markets:
  - A well-functioning FX derivatives market helps economic agents share risks from exchange rate volatility.
  - A more developed capital market can attract more funding in local currency and help reduce dollarization of public debt.
  - Both risk-sharing and greater availability of lari funding will complement macroprudential tools and help cushion costs associated with high exchange rate volatility.
- Covered bonds development:
  - Plans to develop a covered bonds market could support market development and attract more investment in local currency.
  - Introducing covered bonds could replace non-marketable with marketable collateral and expand long-term mortgage financing.
  - The latest draft legislation on covered bonds closely follows EU directives to attract international investors; legislation expected to be adopted soon but full market development will take time.
  - In the medium-term, covered bonds could increase local currency funding availability and help reduce dollarization.

*Source: 63–79, E. Policy Recommendations, and supporting sections of the provided IMF chapter.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1geoea2021004.pdf_