## EXECUTIVE SUMMARY (1geoea2021006) ## Source details **Canonical URL:** [EXECUTIVE SUMMARY (1geoea2021006)](https://www.imf.org/-/media/files/publications/cr/2021/english/1geoea2021006.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1geoea2021006.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1geoea2021006.pdf.json) --- ### Introduction and scope - Prepared for the 2021 FSAP virtual mission to Georgia from January 25 to February 16, 2021. - Focus: findings and recommendations on a select set of banking supervision topics against elements of the Basel Core Principles for Effective Banking Supervision (BCP). - Review concentrated on implementation and effectiveness of recent changes to the Georgian supervisory framework and actions being taken or planned to address challenges from the COVID-19 pandemic. - The review was not intended to result in an assessment of the BCPs. - The last FSAP for Georgia was conducted in 2014 and the detailed assessment published in January 2015. ### Institutional framework and governance - National Bank of Georgia (NBG) is main financial supervisor with broad authority (commercial banks, capital markets, other financial services). - Legal foundations: Law on the Activities of Commercial Banks (ACB Law) and Organic Law on the National Bank of Georgia (NBG Law). - NBG operational independence supported by Constitution of Georgia (Article 68) and structural features (budgetary resources, appointment/removal processes, full supervisory discretion). - Governance observations and recommendations: - Board expanded to nine members (from seven) in June 2020; current vacancies noted with five board members leaving four vacancies. - Recommendation: promptly fill all Board vacancies. - Vice-Governor responsible for supervisory functions; recommendation to develop clear delegations of authority from Vice-Governor to department heads. - Review charter and operations of Financial Sector Supervision Committee (FSSC); clarify role and authority. - Continue to implement NBG Supervisory Strategy (2020-2022). ### Banking sector structure and key statistics (data as of November 2020 / end-2020 / October 31, 2020 as cited) - Number of commercial banks: 15. - Ownership: majority foreign-owned; no state-owned banks. - Two largest banks account for 74 percent of total banking assets. - Three largest banks identified as domestic systemically important banks (D-SIBs). - Loan portfolio composition: - 22.8 percent mortgage - 12.9 percent consumer credit - 14.7 percent other retail - Corporate loan composition: - 25.7 percent trade; remainder across other corporate sectors. - Funding: - non-bank deposits 33.6 billion GEL of 50.2 billion GEL total liabilities. - Loans-to-deposits ratio: 111 percent (Data as of November 2020, NBG Financial Sector Review, January 2021). - Dollarization: - Liabilities dollarization: 61.4 percent as of end-2020 (70.7 percent at end-2016) - Loans dollarization: 55.6 percent as of end-2020 (65.4 percent at end-2016) - CET1 and capital aggregates (as of October 31, 2020 unless otherwise noted): - CET1 ratios range from 9.3 percent to 80 percent (at one small bank). - Aggregate system CET1 ratio: just over 11 percent. - CET1 accounts for over 80 percent of the aggregate total Tier 1 capital 1 ratio of 13 percent. - Aggregate Total Regulatory Capital ratio: approximately 18 percent. - Leverage ratios (as of October 31, 2020 / 2018 reference): - NBG leverage requirement: 5 percent Tier 1 (as of 2018). - Bank leverage ratios ranged from 7.1 percent to over 40 percent. - Liquidity framework: - Local currency LCR requirement: 75 percent (suspended during COVID-19). - Foreign currency LCR requirement: 100 percent. - Total combined required LCR coverage: 100 percent. - NSFR requirement: 100 percent aggregate. - LCR reporting: daily (maximum two-day lag); NSFR: monthly (15 days from end of month). ### NBG response to COVID-19 and system impact - Supervisory actions taken: - Elimination of the capital conservation buffer and two-thirds of the Pillar 2 currency-induced credit risk buffer; temporary relief from local currency LCR. - Prohibited use of released capital for dividends, share buybacks, equity investments, increasing variable remuneration, or other distributions/payments. - Required banks to establish loan loss provisions based on supervisory stress tests. - Issued guidance on provisioning for loans subject to moratoria. - Enhanced liquidity reporting and monitoring; oversaw asset quality reviews. - Postponed or re-scheduled certain new regulatory actions; temporarily suspended on-site examinations emphasizing off-site and virtual examinations. - Developed a capital restoration plan to restore released capital requirements. - Additional fiscal/market measures coordinated with Ministry of Finance (not detailed here). - Impact on banks/system metrics: - Banks’ CAR ratios fell by 1.9 ppt during 2020 to 17.6 percent (Tier 1 ratio of 12.8 percent) against bank-specific capital requirements, amounting to 13.8 percent on total regulatory capital for the overall system (after pandemic-related reduction in buffers). - NPL ratio reached 8.4 percent by end-2020 compared with 4.4 percent at end-2019. - Banks’ liquidity remained in compliance with Basel metrics (LCR and NSFR) during the pandemic. ### Supervisory framework, GRAPE, and supervisory practice - GRAPE (Risk-Based Supervision Framework) overview: - Adopted 2017; center of NBG supervisory process; supports Pillar 2 capital charge — net GRAPE buffer — based on qualitative assessments of risk management, group structure, and corporate governance. - GRAPE operates as a continuous cycle finalized annually; each main GRAPE category assigned a risk weight summing to 100 percent. - Net GRAPE buffer translated from net GRAPE score via predetermined formula; NBG can adjust weights bank-by-bank but has not historically done so. - GRAPE letters sent annually to executive management and copied to supervisory boards; GRAPE letters culminate supervisory findings and determine net GRAPE buffer. - Strengths: - NBG staff knowledgeable and motivated; advanced risk-based supervision and broad regulatory alignment with Basel 3 on capital and liquidity. - Rapid implementation of enhanced rules/regulations; extensive supervisory reporting informs GRAPE. - Substantive and procedural shortcomings: - Heavy reliance on Pillar 2 add-ons can be an inadequate substitute for ensuring strong internal practices; small charges may not incentivize remediation. - No defined internal hierarchy for sub-factors feeding ‘mitigants’ score; lack of formal weighting/prioritization of SB and senior management effectiveness and specific risk processes. - GRAPE guidelines do not serve as an examination manual or set of procedures; NBG chose not to establish an examination manual. - Lack of formal internal procedures for supervisory planning, analysis, internal review, decision-making, timelines, documentation, and tracking of supervisory issues. - Coordination gaps: supervisory function spans three departments without a formal staff-level forum for vetting routine supervisory analysis or reporting dissent. - GRAPE letters often high-level and lack clear remediation directives; follow-up responses and remediation plans by banks are inconsistently documented or approved by NBG. - Recommendations (selected): - Reassess GRAPE scoring weightings; consider greater weight on concentration risk management, liquidity risk management, and board and senior management effectiveness. - Consider greater use of bank-by-bank adjustments to GRAPE weights. - Develop formal internal procedures and documentation (examination processes, roles and responsibilities, timelines). - Establish a staff-level forum to vet supervisory analysis and provide challenge/dissent venue. - Formalize communications with banks’ supervisory boards including annual meetings and improved GRAPE letters. ### Corrective actions, remediation, and enforcement - Legal authority: - 2019 amendments clarified NBG authority to impose supervisory measures, sanctions and directives; authority extended to banking groups. - Identified weaknesses: - No rules-based or qualitative guidelines for issuing corrective actions to ensure early intervention; absence of internal criteria to designate ‘problem bank’ or set prompt corrective action triggers. - No internal management report or database tracking supervisory issues (number, type, status, opening/closing, overdue actions). - Recommendations: - Implement an early remediation framework with prompt corrective action triggers; consider regulatory changes or GRAPE evolution to set early warning indicators and trigger levels. - Require banks to develop formal remediation plans for significant supervisory concerns; such plans should be formally reviewed, approved, and formally accepted/closed out by NBG once remediation validated. - Implement a formal management system (e.g., monitoring software) and procedures to track supervisory directives and remediation. - Hold banks’ SB and internal audit accountable: NBG should generally not accept completion of remediation until internal audit has assessed and validated remediation and reported to the SB (Audit Committee), after which NBG would review and confirm remediation. ### Supervisory communication, external auditors, and transparency - Communication practices: - Continuous supervision with frequent verbal/email communication; meetings with bank management (virtually during COVID-19). - Supervisory directives can take the form of emails, letters, or formal directives. - External auditors: - Auditors must notify NBG “no later than 5 business days after identification” of material adverse changes. - NBG issued Framework for Communication with Auditors; recommendation to fully implement and seek deeper/frequent contact with external auditors. - Transparency and consultation: - NBG Law amended to authorize publishing drafts of normative acts for comments, with exceptions for acts essential for resolution or stability. - Since 2018, NBG consulted on most major normative acts; recommendation to adopt legal requirements establishing due process elements (notice, opportunity to be heard, publication of comments and NBG consideration). ### Supervision of corporate governance, internal audit, and SB effectiveness - Progress: - Issuance of Code of Corporate Governance (2018) and related regulations; recent February 2021 change requires SB chair to be an independent board member. - Observations and recommendations: - NBG should more clearly communicate its view of SB and senior management effectiveness in writing to SBs when significant weaknesses exist (risk management independence/capability, internal audit independence/capability, other internal controls). - Increase emphasis on internal audit and audit committee effectiveness as the third line of defense; supervisory assessments should evaluate whether internal audit identifies and reports weaknesses to the board. - In-depth qualitative assessments (including onsite elements) should be carried out periodically for key functions: credit risk management, CRO independence, internal audit quality, and SB Risk and Audit Committees’ effectiveness. - For D-SIBs, require stronger internal capital and liquidity planning, stress testing, and assess ICAAP effectiveness. ### Capital adequacy, Pillar 2 buffers, and stress testing - Regulatory alignment and identified gaps: - Capital adequacy requirements largely in line with Basel III; NBG self-identified gaps in definitions for certain AT1 and Tier 2 instruments to be addressed over the “medium term”. - Self-identified gaps include: lack of provisions on regulatory and tax events permitting calls on AT1/Tier 2 in first five years; lack of explicit conversion/write-down thresholds; absence of Tier 2 conversion/write-down provisions; lack of threshold deduction provisions for investments in AT1/Tier 2 of financial entities. - Pillar 1 and Pillar 2 specifics: - Pillar 1: Basel 2 standardized approach; no use of banks’ internal models. - Minimum capital ratios: 4.5 percent CET1, 6 percent Tier 1, and 8 percent Total. - Capital conservation buffer: 2.5 percent (currently set to zero as part of COVID-19 response). - Countercyclical buffer: currently set to zero. - Systemic risk capital buffer for the 3 D-SIBs: scheduled to phase in up to as high as 2.5 percent requirement for the two largest banks by year-end 2021. - Pillar 2 buffers currently covered mostly by Tier 2 instruments (not usual international practice); transition plan to increase share of CET1 and Tier 1 to final coverage mix by March 2023 (56 percent CET1, 80 percent Tier 1, 100 percent total capital). - Pillar 2 buffers described: - CICR buffer (Unhedged Currency Induced Credit Risk buffer) — temporarily reduced by 66 percent during COVID-19 response. - HHI buffer (Name and Sectoral Concentration Buffer) — capital charge based on Herfindahl-Hirschman Index. - Net GRAPE Buffer — derived from GRAPE process. - Net Stress Test Buffer — not currently in place. - Stress testing recommendations: - Increase emphasis on scenario-based stress testing for D-SIBs and consider making the Net Stress Buffer a hard Pillar 2 requirement for D-SIBs. - Assess D-SIBs’ stress testing practices and supervisory bottom-up stress tests; determine consequences for failing Net Stress Buffer. - Ensure supervisory and internal stress testing inform Net GRAPE Buffer and overall supervisory assessments. ### Liquidity and concentration risk considerations - Liquidity assumptions and monitoring: - LCR and NSFR implemented consistent with Basel III; local currency LCR suspended during COVID-19. - Recommendation: review inflow/outflow assumptions to account for related party transactions and repayment risks of foreign currency borrowers. - Supervision should increase weighting of qualitative liquidity risk management issues in GRAPE or emphasize ILAAP and liquidity stress testing, especially for D-SIBs. - Concentration and large exposures: - New large exposure regulation effective January 1, 2022; measurement base changes from regulatory capital to Tier 1 capital. - Example limits (new regime): - Single client: <= net exposure of 25 percent of Tier 1 capital; <= gross exposure of 50 percent of Tier 1 capital (excl. mitigation effect). - Resident SIB to another resident SIB: <= net exposure 15 percent of Tier 1 capital; <= gross exposure of 50 percent of Tier 1 capital (excl. mitigation effect). - Related party totals from 2022: total value to one related party must not exceed 5 percent of Tier 1 capital; total value to all related parties must not exceed 25 percent of Tier 1 capital. - Recommendation: increase importance of concentration risk, related party transactions, and connected party definitions in GRAPE scoring and supervisory prioritization. ### Staffing, training, and resourcing - Staffing metrics and concerns: - NBG maintains 66 staff to address 15 supervised banks. - Net decline of 3 positions out of 26 in the Banking Supervision Department over the past 3 years. - Turnover rates: 9 percent (2019) and 8 percent (2020). - Job Evaluation Project (2019) identified compensation gaps; project halted due to pandemic. - NBG analysis shows a –48% to –126% gap for middle management and a –75% to +13% gap for non-managerial positions on average (excluding share-based private sector compensation). - Vacancies at key specialist positions and loss of senior supervisory staff remain a concern. - Recommendations: - Address staffing and human resource challenges; continue compensation review and enhance hiring and retention policies/practices. - Advance recruitment and retention as early as practicable given pandemic pressures. - Improve training program scope/quality; develop internal certification/examiner program and formal examination procedures (GRAPE guidelines partially fill gap). ### Key recommendations (timing legend: I; immediate (<1 year); ST; short term (1–3 years); MT; medium term (3–5 years)) - 1. Improve and clarify NBG Board operations regarding supervisory activities by clarifying the roles and responsibilities of the board, its committees, and senior management. (NBG/Government; ¶13-18, 22-23) — ST - 2. Address staffing and human resource challenges; continue the compensation review and enhance policies and practices supporting effective hiring and retention. (NBG, ¶19-21) — I - 3. Review and enhance the GRAPE scoring and weighting methodology; (NBG; ¶36, 37, 38, 59, 69, 70, 78, and 92) — I - 4. Enhance the supervisory approach and decision-making--ensure that key supervisory processes (planning, analysis, internal review, supervisory determinations, enforcement, and directives for remediation activities) are well-supported by internal procedures and policies. (NBG; ¶39-41, 68). — I - 5. Establish a formal structure for communication with banks’ supervisory boards and senior management, including annual meetings, and upgrade the quality and effectiveness of GRAPE letters in communicating supervisory findings and directives to banks’ supervisory boards and senior management. (NBG; ¶42, 45, 46, 60). — ST - 6. Require banks to develop formal remediation plans to address important supervisory concerns. (NBG; ¶47-48, 50-51). — ST - 7. Enhance expectations from internal audit for assessment and validation of remediation actions taken by banks in response to significant supervisory concerns. (NBG; ¶49, 61). — ST - 8. Conduct internal review to determine the relative importance of specific practices and functions in banks’ key risk management and control frameworks; and carry out in-depth qualitative assessments covering these functions and practices on a periodic basis. (NBG; ¶38, 63, 64) — ST - 9. Further clarify standards to require that material changes in the suitability of significant shareholders or controlling interests, including beneficial owners, are reported in a timely fashion. (NBG; ¶55). — MT - 10. Increase emphasis on D-SIBs’ internal capital and liquidity planning and management; strengthen requirements for stress testing in such planning and consider making the Net Stress Buffer a hard Pillar 2 requirement for D-SIBs. (NBG; ¶65, 66, 87, 93) — ST _Italic: Source: 1geoea2021006 (IMF country report content provided in the supplied PDF excerpt)._ ### EXECUTIVE SUMMARY ___________________________________________________________________________________4 ### EXECUTIVE SUMMARY ### Introduction and scope - Prepared for the 2021 FSAP virtual mission to Georgia from January 25 to February 16, 2021. - Focus: findings and recommendations on a select set of banking supervision topics against elements of the Basel Core Principles for Effective Banking Supervision (BCP). - Review concentrated on implementation and effectiveness of recent changes to the Georgian supervisory framework and actions being taken or planned to address challenges from the COVID-19 pandemic. - The review was not intended to result in an assessment of the BCPs. - The last FSAP for Georgia was conducted in 2014 and the detailed assessment published in January 2015. ### Institutional framework - The National Bank of Georgia (NBG) is the main financial supervisor with broad authority over commercial banks, capital markets, and other financial services providers and intermediaries. - Legal foundations: Law on the Activities of Commercial Banks (ACB Law) and the Organic Law on the National Bank of Georgia (NBG Law). - NBG’s operational independence is supported by the Constitution of Georgia (Article 68) and structural features including adequate budgetary resources, processes for appointment/removal of board members, and full discretion to take supervisory actions. ### Banking sector structure and key statistics - The financial sector is bank-centric and highly concentrated. - Number of commercial banks: 15. - Ownership: majority foreign-owned; no state-owned banks. - The two largest banks account for 74 percent of total banking assets. - Three largest banks identified as domestic systemically important banks (D-SIBs). - Banking model: traditional lending supported by deposits; limited complex trading/derivatives. - Loan portfolio composition: - 22.8 percent mortgage - 12.9 percent consumer credit - 14.7 percent other retail - Corporate loan composition: - 25.7 percent trade; remainder across other corporate sectors. - Funding: non-bank deposits 33.6 billion GEL of 50.2 billion GEL total liabilities. - Loans-to-deposits ratio: 111 percent (Data as of November 2020, NBG Financial Sector Review, January 2021). - Dollarization: - Liabilities dollarization: 61.4 percent as of end-2020 (70.7 percent at end-2016) - Loans dollarization: 55.6 percent as of end-2020 (65.4 percent at end-2016) - Banks manage foreign currency exposure primarily via balance sheet structure rather than hedging instruments; credit exposure to unhedged borrowers is high, raising concerns over Currency Induced Credit Risk (CICR). ### NBG response to COVID-19 - NBG has taken timely actions in response to the COVID-19 pandemic. - NBG is closely monitoring banks’ condition and has exercised discretion and flexibility where necessary. - NBG has developed plans to reinstate pre-COVID requirements that were relaxed during the pandemic; the starting date for reinstatement remains under consideration given uncertainty about timing and further severity of the pandemic. ### Main findings on supervisory framework and practice - NBG continues to strengthen supervision and broaden sophistication of regulatory and supervisory regimes; capital and liquidity standards are broadly in line with Basel 3. - Rapid implementation of enhanced rules and regulations; supervisory framework generally consistent with international practices. - NBG staff are knowledgeable, motivated, and have advanced risk-based supervision. - Supervisory approach remains rooted in a compliance-based emphasis supported by broad discretionary powers and extensive reporting requirements. - Significant progress made in building out banking supervision framework, but further work needed to promote more effective implementation. - Need to formalize supervisory processes: internal governance for supervisory assessments, analyses, decision-making, and communications with banks. - NBG’s evolving risk-based framework should complement compliance-based approach with more comprehensive, periodic qualitative assessments of banks’ internal risk management and governance practices. - Issuance of Code of Corporate Governance (2018) and implementation of GRAPE framework are key steps. - Processes for promoting timely and effective bank remediation should complement Pillar 2 add-on approaches. - Qualitative reviews should increase emphasis on supervisory boards, senior management, and independence/effectiveness of internal audit. - NBG should require banks to submit formal remediation plans for significant weaknesses identified in supervisory reviews. - NBG should reassess GRAPE scoring weightings, considering greater weight on: - concentration risk management, - liquidity risk management, - board and senior management effectiveness (both within specific risk GRAPE elements and overall corporate governance). - Supervision of D-SIBs: increase emphasis on forward-looking processes, internal capital and liquidity planning, and require robust processes incorporating stress impacts; consider making the Net Stress Buffer a hard Pillar 2 requirement for D-SIBs. - NBG recognizes hiring and retention challenges; plans to address human resource challenges are part of NBG’s 2020-2022 strategic plan. ### Key recommendations (Table 1: Summary of Key Recommendations) - Timing legend: I; immediate (<1 year); ST; short term (1–3 years); MT; medium term (3–5 years). - 1. Improve and clarify NBG Board operations regarding supervisory activities by clarifying the roles and responsibilities of the board, its committees, and senior management. (NBG/Government; ¶13-18, 22-23) — ST - 2. Address staffing and human resource challenges; continue the compensation review and enhance policies and practices supporting effective hiring and retention. (NBG, ¶19-21) — I - 3. Review and enhance the GRAPE scoring and weighting methodology; (NBG; ¶36, 37, 38, 59, 69, 70, 78, and 92) — I - 4. Enhance the supervisory approach and decision-making--ensure that key supervisory processes (planning, analysis, internal review, supervisory determinations, enforcement, and directives for remediation activities) are well-supported by internal procedures and policies. (NBG; ¶39-41, 68). — I - 5. Establish a formal structure for communication with banks’ supervisory boards and senior management, including annual meetings, and upgrade the quality and effectiveness of GRAPE letters in communicating supervisory findings and directives to banks’ supervisory boards and senior management. (NBG; ¶42, 45, 46, 60). — ST - 6. Require banks to develop formal remediation plans to address important supervisory concerns. (NBG; ¶47-48, 50-51). — ST - 7. Enhance expectations from internal audit for assessment and validation of remediation actions taken by banks in response to significant supervisory concerns. (NBG; ¶49, 61). — ST - 8. Conduct internal review to determine the relative importance of specific practices and functions in banks’ key risk management and control frameworks; and carry out in-depth qualitative assessments covering these functions and practices on a periodic basis. (NBG; ¶38, 63, 64) — ST - 9. Further clarify standards to require that material changes in the suitability of significant shareholders or controlling interests, including beneficial owners, are reported in a timely fashion. (NBG; ¶55). — MT - 10. Increase emphasis on D-SIBs’ internal capital and liquidity planning and management; strengthen requirements for stress testing in such planning and consider making the Net Stress Buffer a hard Pillar 2 requirement for D-SIBs. (NBG; ¶65, 66, 87, 93) — ST *EXECUTIVE SUMMARY (1geoea2021006)* ### Box 1. NBG Response to the COVID Pandemic ### Box 1. NBG Response to the COVID Pandemic ### NBG supervisory actions during COVID-19 - Release of certain capital and liquidity requirements: elimination of the capital conservation buffer and two-thirds of the Pillar 2 currency-induced credit risk buffer; temporary relief from local currency LCR. NBG prohibited the use of released capital for dividends, share buybacks, equity investments, increasing variable remuneration for management or other types of distributions and payments. - Required, at the onset of the pandemic, that banks establish loan loss provisions adequate to address potential COVID-19-related losses based upon supervisory stress tests. - Issued guidance on provisioning for loans subject to moratoria on payments. - Established enhanced liquidity reporting and monitoring. - Oversaw the conduct of asset quality reviews at banks. - Postponed or re-scheduled the issuance or enforcement of certain new regulatory actions. - Temporarily suspended on-site examinations; emphasized off-site and virtual examinations. - Developed a capital restoration plan that defines the strategy to restore released capital requirements. - Note: NBG, in coordination with the Ministry of Finance, took additional significant actions (support for GEL liquidity, liquidity support facilities, SME and micro-financial support) that are not described here. ### Impact on banks and system metrics - Banks’ CAR ratios fell by 1.9 ppt during 2020 to 17.6 percent (Tier 1 ratio of 12.8 percent) against bank-specific capital requirements, amounting to 13.8 percent on total regulatory capital for the overall system (after the pandemic-related reduction in the capital conservation and pillar 2 buffers). - NPL ratio reached 8.4 percent by end-2020 compared with 4.4 percent at end-2019. - Banks’ liquidity has remained in compliance with standard Basel metrics including the total liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) during the pandemic, due to policy actions taken by the authorities. ### Main findings and supervisory framework recommendations - Overall assessment: - NBG is an effective supervisor with experienced and knowledgeable staff. - NBG has made significant progress updating its supervisory framework via amendments to the ACB Law and the NBG Law in 2017 and 2019 and additional changes through 2020. - A key challenge is absorbing and implementing the many recent changes; NBG is facing this challenge successfully. - Mandate and governance: - NBG has a dual mandate to ensure both price stability and financial stability; price stability is the main objective in the NBG Law. - The operational independence and autonomy of the bank supervisory function is essential; NBG assigns the financial stability mandate to a single Vice-Governor and has established a Financial Stability Committee. - Recommendation: consider raising the importance of the NBG’s financial stability objective to equal that of price stability as part of any future planned amendments to the NBG Organic Law in the long-term. - Legal authority: - NBG Law clearly establishes NBG as the sole authority responsible for supervision of commercial banks (see Articles 48, 49(1) of the NBG Law). ACB Law provides powers to impose supervisory measures and sanctions. - Current assessment finds no evidence that NBG’s dual mandate has adversely impacted its supervisory function. ### Recent legislative and regulatory changes (overview) - Major amendments and regulations implemented (selected items listed in source): - Regulation on the Management of Conflicts of Interest (2015) - Banking Licensing and Transfer of Significant Ownership (2017) - Investments and Group structure related requirements (2017) - NBG empowered to supervise banking groups (2017) - Amendments to equip NBG with resolution powers and set out a preliminary basis for the recovery and resolution framework (2020) - “Capital Adequacy Requirements for Commercial Banks” regulation (2017) — establishment of a conservational capital buffer, countercyclical capital buffer and systemic buffer. - “Identification of Systematically Important Banks and Determining Systemic Buffers” (2017) - “Rule on Additional Capital Buffer Requirements for Commercial Banks within Pillar 2” (2017) — established CICR Buffer, Credit Portfolio Concentration Risk Buffer, GRAPE Buffer, and Net Stress Test Buffer; 5 years phase-in period (postponed by additional one year due to COVID-19). - “Regulation on Disclosure Requirements for Commercial Banks within Pillar 3” (2017) - Liquidity Coverage Ratio (LCR) (2017) - Net Stable Funding Ratio (NSFR) (2019) - “Leverage Ratio Requirements for Commercial Banks” (2018) - “Regulation on Large Exposure and Concentration Risks in Commercial Banks” (2020) (enforcement suspended until 2022 due to supervisory actions taken in response to COVID-19) - “Corporate Governance Code for Commercial Banks” (2018) - “Code of Ethics and Professional Standards” (2018) - “Law Defining Minimum Capital Requirements for Commercial Banks” (Decree N144) (2017) - “Regulation on Interest Rate Risk in the Banking Book (IRRBB)” (2020) - “Instructions on Real Estate Appraisal for Commercial Banks” (2018) ### Governance, staffing, and operational recommendations - Board composition and vacancies: - NBG law (Article 7) expanded the Board to nine members (from seven) in June 2020. Under the law, should the number of members be less than 5, the Board is not authorized to perform its duties; vacancies should be filled within two months. A transitional period until the end of 2020 permitted the Board to perform duties with at least 4 members. At present, there are five board members leaving four vacancies. Recommendation: seek to promptly fill all vacancies on its Board. - Delegation of authority: - A Vice-Governor is responsible for all supervisory functions; heads of supervisory departments report to the Vice-Governor. Recommendation: develop and issue clear delegations of authority to department heads from the Vice-Governor to support timely supervisory decision-making. - Committee charters: - Two committees exist: Financial Stability Committee and Financial Sector Supervision Committee (FSSC). The Governor chairs both; their membership is essentially identical. Recommendation: review the charter and operations of the FSSC to clarify its role and authority in the supervisory process and improve transparency and efficiency. - Supervisory strategic plan: - NBG Supervisory Strategy (2020-2022) commits to strengthening leadership culture, promoting cooperation and information sharing, promotion of working groups and joint decision-making, and increasing the role, responsibilities and accountability of the supervisor in communication with regulated entities. Recommendation: continue to fulfill the 2020-2022 supervisory strategic plan. - Staffing, compensation, retention, and training: - Historical actions: in 2017 NBG raised management salaries by 25 percent and non-managerial positions by 20 percent; it has raised salaries by 3% to align with inflation. A performance management system was implemented. - Staffing metrics and concerns: - NBG maintains 66 staff to address 15 supervised banks. - Net decline of 3 positions out of 26 in the Banking Supervision Department over the past 3 years. - Turnover rates are 9% and 8% for 2019 and 2020, respectively. - Vacancies at key specialist positions and loss of senior supervisory staff remain a concern. - NBG commenced a Job Evaluation Project in 2019 that identified compensation discrepancies; the project is presently halted due to the pandemic. - NBG analysis shows a –48% to –126% gap for middle management and a –75% to +13% gap for non-managerial positions, on average (excluding any share-based compensation for private sector employees). - Recommendations: - Continue to address staffing and human resource challenges. - Regularly review hiring, retention and compensation practices. - Advance recruitment and retention efforts as early as practicable given pandemic pressures. - Training: - A new system of staff evaluation was implemented in 2018; periodic training programs are conducted. - Training materials are somewhat cursory; specialty training and career path development are not fully developed. - Staff have access to FSI Connect and tuition support for industry certifications. - No examiner training program across a determined set of knowledge, skills, and abilities leading to internal certification; lack of an examination manual and formal examination procedures noted. GRAPE guidelines partially fill this gap. - Recommendation: improve training program scope and quality and develop a certification program to enhance employee retention. - Public consultation and transparency: - NBG Law amended to authorize NBG “...to publish drafts of normative acts related to financial sector for the purpose of obtaining comments from stakeholders prior to their approval.” Normative acts considered “essential” for resolution or financial stability and should come into force “immediately” were excluded. - Since 2018, NBG has consulted on most major normative acts; legal acts are generally accompanied by an explanatory note. - Recommendation: adopt legal requirements that clearly establish due process elements (notice, opportunity to be heard, publication requirements) and require that comments received and NBG’s consideration thereof be published to enhance transparency. *Source: 1geoea2021006 - Box 1. NBG Response to the COVID Pandemic* ### 24. The NBG supervisory framework continues to evolve from a rules-based monitoring ### 24. The NBG supervisory framework continues to evolve from a rules-based monitoring ### NBG’s Risk-Based Supervisory Approach (GRAPE) - GRAPE adopted in 2017 is the center of NBG’s supervisory process and supports issuance of a Pillar 2 capital charge — the net GRAPE buffer — based on qualitative assessments of banks’ risk management, group structure and corporate governance. - GRAPE guideline title: “Risk-Based Supervision Framework of the National Bank of Georgia – General Risk Assessment Program (GRAPE)”. - GRAPE pursues a “continuous cycle of risk-based supervision”: supervisory activities are conducted throughout the year and the cycle is finalized annually by grading GRAPE risk categories and translating those scores into the net GRAPE buffer applied as part of a Pillar 2 capital surcharge. - GRAPE principles: - Concentration on material risks; - Forward-looking approach and early interventions; - Dialogue with regulated financial institutions; - Taking account of systemic issues; - Consistency, comparability and compliance; - Efficient use of internal resources. - GRAPE assesses potential impact and risks presented by each commercial bank and establishes risk assessment criteria across risk areas, including considerations for bank group structure complexities when assigning a systemic risk designation and when assessing operational risk and corporate governance. - GRAPE guidelines describe factors to be considered in supervisory reviews but do not constitute an examination manual or set of procedures; NBG has chosen not to establish an examination manual and instead provides staff access to legislation, regulations, international standards, guidance, and examination modules from other jurisdictions. ### GRAPE scoring, net GRAPE buffer, and reporting - GRAPE applies a scoring system evaluating inherent risks and their mitigants (supervisory board, management board, risks management and internal control mechanisms); mitigants are netted against inherent risk for a net score. - Each main GRAPE category is assigned a risk weight; the weights sum to 100 percent. - NBG determines each bank’s net GRAPE score and establishes a net GRAPE buffer as part of Pillar 2. - The net GRAPE score is translated into the GRAPE buffer using a predetermined formula that generally weights each net risk category the same for all banks; NBG has authority to adjust these weights bank-by-bank but has not yet done so in practice. - Under the current GRAPE methodology, risk weights for each of the major categories have been disclosed to banks; the weightings for the sub-factors within each major category are not provided to banks to support supervisory discretion. - Annual GRAPE letters are sent to each bank’s executive management and copied to its supervisory board, providing a broad description of key supervisory findings that determined the score; the process for issuing, monitoring, and resolving supervisory findings is discussed further in Section F (Corrective Actions). - Supervisory reporting required from banks is extensive and informs GRAPE; required reports include organizational structure, financial condition, prudential ratios, LCR, funding, NSFR, loan rejections, top 100 loans, loan concentrations, sectoral risks, related party transactions, and other regular and ad hoc reports. - NBG validates received information by reviewing bank reporting processes during operational risk examinations using automated and manual processes, including staff-level cross-checks and reconciliation to underlying files. - NBG is transitioning supervisory reporting to coordinate with IFRS reporting as part of consolidated supervision guidelines rollout. ### Supervisory communication and on-/off-site examinations - NBG engages in “continuous supervision” with frequent verbal or email communication with bank staff, business line and senior management; responsibility for communicating and addressing supervisory recommendations rests with the employee who carried out the review. - Meetings with bank line managers, risk managers, or senior management are held (currently virtually due to COVID-19; face-to-face meetings were common pre-COVID-19). Communications are often by phone or e-mail, less frequently by letter. - NBG conducts both on- and off-site examinations; on-site examinations were largely suspended during the COVID-19 pandemic. - NBG coordinates all work within a single organizational unit assigned the particular bank rather than separating supervisors into on- or off-site units. - NBG allocates more resources to off-site supervision; example activity levels: 9 on-site examinations were conducted in 2019 vs. 47 off-site examinations. - Most recent on-site examinations focused on operational and credit risk (retail and MSME portfolios). On-site inspections are more rigorous for D-SIBs and targeted and unscheduled examinations have been employed. ### Evolution of GRAPE, resolvability, and recovery & resolution - NBG is reviewing GRAPE to determine needed improvements and continues to conclude actions to address prior recommendations. - NBG intends to incorporate resolvability assessments into its supervisory process (an acknowledged gap). - Recovery planning is a current requirement for commercial banks in its early stages. - In 2019 NBG updated and established a recovery and resolution framework; as the new framework advances, further changes to GRAPE are being considered. ### Areas to improve risk-based supervision under GRAPE — substantive and procedural challenges - Reviewers identified substantive and procedural challenges; NBG acknowledges GRAPE needs enhancements in multiple respects. - Limitations of relying on Pillar 2 add-ons: - For a bank normally operating with capital well in excess of minimum regulatory requirements, an increase due to the pillar 2 charge may not serve as a meaningful incentive. - A relatively small charge in a specific risk area may lead a bank to downplay addressing related weaknesses. - Assessing the amount of increased capital relative to risk-weighted assets that compensates for poor risk management is difficult; a Pillar 2 add-on effectively represents a penalty function and is not an adequate substitute for ensuring strong internal practices. - Lack of defined internal hierarchy for sub-factors feeding the ‘mitigants’ score: - A very broad number of sub-factors can feed into calculating the score of risk ‘mitigants’ but there is no defined internal hierarchy of importance, making it difficult to understand how qualitative assessments inform the GRAPE score. - Relative importance of assessments (e.g., SB and senior management effectiveness, specific risk management and control processes) has not been formalized internally. - Recommendations on weighting and internal analysis: - NBG should consider adjustments to the GRAPE score weighting system and greater use of bank-by-bank adjustments in the weightings because a uniform weighting system may not reflect the importance of different risk attributes across different banks. - NBG should analyze the relative importance of GRAPE element sub-factors for financial stability and direct supervisors’ qualitative assessments toward them; this internal analysis should be documented for internal use in determining GRAPE scores across banks. - Procedural weaknesses and documentation needs: - NBG should establish formal internal procedures to better ensure supervisory plans and implementation are fully developed and executed; supervisory analysis and findings should be fully informed by internal discussions and decisions so staff input is clearly recorded and considered. - Reviewers found the GRAPE process lacked formalized basic procedural elements and substantive requirements: clarity on roles and responsibilities, timelines, review processes, and documentation requirements. - NBG should develop formal internal documentation that sets forth policies, procedures and approaches to its supervisory review and evaluation process and provides requirements for examination processes. - Coordination, vetting, and staff-level forum: - NBG’s supervisory function is conducted across three departments (Banking Supervision, Specialized Risks, and Supervisory Policy); staff communicate frequently but established procedures for coordinating development of supervisory risk assessments and findings are lacking. - There is no clearly established venue or process for challenge and dissent or for staff to report real or perceived distortions to the supervisory process. - The FSSC is focused on high-level, sensitive, and significant supervisory actions requiring Governor and Vice-Governors’ attention; reviewers recommend establishing a staff-level forum to vet more routine supervisory analysis and provide open opportunities to discuss and challenge supervisory findings. - Communication with banks’ supervisory boards: - NBG should establish a more formal structure for communication with banks’ supervisory boards, including an annual meeting to ensure board members understand NBG’s views and remediation expectations (e.g., presenting the GRAPE letter annually and discussing key risks). - More formal and periodic discussions would reinforce SB responsibilities for ensuring effective risk management and controls and oversight of senior management. - External auditors: - External auditors are legally required to notify the NBG “no later than 5 business days after identification” of material adverse changes regarding the bank’s business or risks under the regulation on External Audits of Commercial Banks. - NBG recently issued an updated Framework for Communication with Auditors to establish principles and facilitate communication between NBG and external auditors, encouraging sharing of material information and anticipating detailed procedures to support frequent flow of material information to supervisors. - NBG should fully implement this Framework and seek deeper and more frequent contact with external auditors to leverage their analysis for supervisory oversight and enforcement. ### Corrective Actions, Enforcement of Supervisory Directives, and Early Remediation - Recent legislative amendments provide NBG adequate authority to take and enforce supervisory actions. - In 2019, the NBG Law was amended to clarify NBG’s authority to impose supervisory measures, sanctions and other directives and actions; amendments provide broad authority to impose “…one or several supervisory measures and/or sanctions...” in response to violations of law, standards or instructions, including engaging in “unsafe and unsound banking practices” and where “risks have been identified through the supervisor review and evaluation process (including the General Risk Assessment Program).” (Article 30, ACB Law) - 2017 amendments to the NBG Law extended NBG authority more explicitly to the “banking group.” *Source: 1geoea2021006 - 24. The NBG supervisory framework continues to evolve from a rules-based monitoring* ### 46. As noted above, NBG communicates its supervisory findings and directives through a ### 1geoea2021006 - 46. As noted above, NBG communicates its supervisory findings and directives through a ### GRAPE letter and supervisory communication - The annual GRAPE letter "maintains preeminence in communication with the banks and their supervisory boards." - GRAPE letters: - Reflect the culmination of supervisory findings over an annual period. - Address material weaknesses identified during the examination cycle and reflect determinations ranging from reporting violations to issues demonstrating supervisory judgement and discretion (e.g., large exposure limit violations and issues arising from related party transactions). - Are sent to bank senior management and in certain cases to the supervisory board. - Are discussed with bank management before a final GRAPE score (and surcharge) is settled. - The GRAPE letter and capital surcharge applied is the preeminent if not primary enforcement mechanism to incentivize banks’ remediation of identified supervisory issues. - Supervisory directives can be issued at any time during the “continuous” supervisory cycle and take the form of emails, letters, or formal directives. ### Findings on GRAPE content and remediation clarity - GRAPE letters provide high‑level discussions of key supervisory findings and primarily communicate NBG’s determination of the bank’s net GRAPE buffer. - Shortcomings identified: - GRAPE letters do not clearly set forth details regarding the underlying assessment of specific practices warranting remediation, the prudential objectives, and the expected or required remediation actions (including development of a remediation plan). - In some cases, banks provide a written response and action plan, but these are not consistently fully documented or formally reviewed/approved by NBG. - NBG staff monitor open issues and follow-up as part of continuous supervision, but the process lacks formalization. ### Recommendations on remediation plans and validation - NBG should require banks to develop remediation plans to address identified supervisory concerns; such plans should be: - Formally reviewed and approved by NBG. - Formally accepted/closed out by NBG once remediation is validated. - When remediation is validated, NBG should ‘sign off’ or confirm remediation of the supervisory issue. - Banks’ willingness or capacity to address supervisory concerns in a timely manner should be considered when evaluating effectiveness of supervisory boards (SBs) and senior management. ### Internal procedures, governance and tracking of supervisory directives - Current practice: - NBG follows a ‘continuous supervision’ approach; staff assigned to individual banks maintain listings of open supervisory issues and monitor remediation in day‑to‑day contact with the bank. - Shortcomings identified: - No internal procedures were found surrounding the development, issuance, monitoring, tracking, and closing out of supervisory issues or directives. - There is no management report or database tracking the number, type, status, opening or closing of supervisory issues, or flagging overdue remediation actions. - Difficulty exists in assessing whether ongoing monitoring and the process to issue and monitor open supervisory issues has resulted in an effective and timely supervisory response. - Recommendation: - Implement a formal management system (e.g., monitoring software) and related procedures to enhance management oversight, internal controls, and governance. ### Role of internal audit and supervisory sign‑off - Recommendation: - NBG should consider keeping related supervisory restrictions or actions in place until remediation of a significant deficiency has been evaluated and approved by banks’ internal audit functions. - NBG should generally not accept as complete a bank’s remediation on significant matters until internal audit has assessed, validated and reported to the bank’s SB (Audit Committee) that remediation is complete and appropriate. - Thereafter NBG would review the bank’s response and reach its own determination whether to consider the supervisory issue remediated. - The SB should be held responsible and accountable for ensuring the effectiveness of the internal audit function, including its capacity to serve in this role. ### Early intervention and prompt corrective action framework - Findings: - The rules, guidelines and practice implementing the ACB Law’s flexible framework do not guard against undue delay in taking appropriate corrective actions. - There are no rules‑based or qualitative guidelines for issuing or taking corrective actions to ensure supervisory responses are taken early and to guard against undue delay in enforcement. - No internal criteria exist for identifying or declaring an institution as a ‘problem bank’ subject to early remediation or corrective actions. - Context: - The 2019 amendments to the NBG and ACB laws related to early intervention equip NBG with resolution powers and establish requirements for recovery and resolution planning. - NBG has a broad set of enforcement powers and tools under the ACB Law to intervene early and seek prompt remediation. - Recommendation: - Develop an early remediation framework and pursue regulatory changes (or changes to GRAPE) that would set out prompt corrective action triggers. - GRAPE currently encourages identification of problems “at an early stage and implementing appropriate corrective measures to eradicate them” but does not provide a framework for monitoring or analysis of early warning indicators, trigger levels, or measures to drive early remediation. - Adoption of an early remediation framework could coincide with the evolution of banks’ recovery plans. ### Licensing, transfer of significant ownership, and transparency - Progress: - NBG has addressed most gaps in legal and regulatory standards related to licensing and approvals; legislative and regulatory responses enacted since the 2014 FSAP, with additional amendments in process. - NBG maintains detailed understanding of bank ownership structures; “Pillar 3” reports submitted quarterly must describe current ownership structure and include lists of shareholders owning 1 percent or more and beneficiaries holding indirect and direct holders of 5 percent or more of shares. - Challenges: - Non‑resident ownership is prevalent; as of EOY 2019, just under 90 percent of bank assets and stockholder equity was held by non‑resident beneficial owners. - Assessment and monitoring of ownership and suitability is complicated by foreign/non‑resident ownership and complex group structures. - Recommendation: - Clarify standards to ensure material changes in suitability of significant shareholders or controlling interests, including beneficial owners, are reported in a timely fashion. - Prior amendment (paragraph 6 of Article 8/1) requires a “bank shall immediately notify the National Bank about any change in a fit and proper criteria related” to its shareholders; NBG interprets this as requiring notification of actual changes in suitability, but in practice banks have failed to notify NBG of material events presenting suitability issues. - NBG should issue guidance setting forth its interpretation and supervisory expectations regarding notification obligations. ### Regulatory and definitional enhancements (Box summary) - Legislative/regulatory changes since 2014: - 2014 regulation on “Licensing of Banking Institutions” and 2017 legislative amendments to the ACB Law and NBG Law specify criteria for assessing ownership/group structure and require transparency on ownership including direct shareholders, interim owners and beneficial owners holding “significant share.” - Amendments expanded definition of “significant shareholder” to include persons “acting in concert” and authorized NBG to require banks to change ownership or group structure if such structures hinder effective supervision. - Suitability criteria for significant shareholders are defined by the ACB Law (Articles 5 and 8(1)); Regulation on Fit and Proper Criteria for Administrators of Commercial Bank sets related requirements. - NBG developed a new draft rule “on the acquisition of qualifying holding in commercial bank” to align with EU standards; approval postponed due to temporary moratorium on introducing new supervisory requirements during the Covid‑19 pandemic. - Definitions preserved in source: - “Significant share” defined as “direct or indirect ownership of 10 percent or more of the bank’s authorized or issued capital or/and voting shares by a person or partners (shareholders) acting in concert or an opportunity to have significant influence over commercial bank by a person or partners (shareholders) acting in concert regardless their share in capital or/and voting shares.” - “Significant influence” defined as “as a right to take part in decision‑making process with respect to financial and operational policy, which does not represent control or joint control over such policies. (Article 1 Par. z 5, ACB Law)” ### Supervision of corporate governance and risk management - Progress: - NBG implemented a comprehensive Code of Corporate Governance (CCG) and increased supervisory emphasis on corporate governance. - The CCG and related regulations cover supervisory board and senior management expectations: board structure and composition, required risk and audit committees, minimum number of independent directors, fit and proper criteria, responsibilities for risk management and internal control frameworks, and oversight of senior management. - Recent change: - Changes passed in February 2021 will require that the chair of the SB be an independent board member. - Recommendations: - NBG should consider more heavily weighting its assessment of the effectiveness of the SB and senior management in ensuring an effective risk management framework in its GRAPE process for determining the value of risk “mitigants” and consider increasing the weighting of the broader corporate governance element in GRAPE. - The effectiveness of the SB with respect to the risk management framework should serve as a key element in determining the overall corporate governance GRAPE assessment. - It is currently unclear how assessments of risk management and internal control practices impact GRAPE score components and the GRAPE buffer requirement; clarity and greater emphasis are recommended. *Source: IMF country report content provided in the supplied PDF excerpt.* ### 61. NBG communications with banks’ SB should indicate more clearly the NBG’s view of ### 1geoea2021006 - 61. NBG communications with banks’ SB should indicate more clearly the NBG’s view of ### NBG communications with supervisory boards (SB) and corporate governance (CG) - NBG communications with banks’ SB should indicate more clearly the NBG’s view of the effectiveness of SB and senior management in carrying out their respective roles (see also para. 42). - When significant weaknesses are noted in: - risk management independence, capability or practices; - internal audit independence, capability, or practices; or - other important internal control processes; these should be significant negative factors in assessing SB effectiveness and CG. - The weaknesses identified and their importance in the NBGs’ assessment should be: - communicated in writing directly to the SB; and - used to reinforce that the SB is ultimately accountable for ensuring an effective risk management framework and risk governance and overseeing management’s execution of its responsibilities. ### Role of internal audit and audit committee - Greater supervisory emphasis should be placed on the role of internal audit and the audit committee in supporting the SB mandate of “ensuring compliance with all regulatory and supervisory requirements”, as required by Article 4 of the CCG. - NBG supervisors should explicitly assess whether internal audit functions effectively fulfill their role as the third line of defense, including: - the extent to which internal audit actively identifies risk management and control weaknesses; - reporting of those weaknesses to the board; and - serving as the eyes and ears of the SB. - Where significant internal audit weaknesses exist—demonstrated, for example, by supervisors identifying weaknesses that internal audit did not identify—these should: - be communicated to the SB and audit committee; and - be clearly indicated as an important negative factor in assessing overall CG. ### Supervision of risk management — risk-based approach and resources - NBG supervision uses a risk-based approach with more attention to the largest banks and those with identified concerns. - A significant share of supervisory staff resources is spent on risk assessments and ongoing risk monitoring, including checking positions against regulatory requirements and limits. - The risk assessment framework is generally thorough across key risks, with particular attention to credit and liquidity risks and a notable focus on operational/cyber-related risks. - NBG bank supervisors are deeply knowledgeable about banks and can draw on Risk Specialists and Policy Experts who demonstrate strong understanding of bank-specific and system-wide risks. ### Enhancing qualitative assessments and supervisory reviews - As per the 2020-2022 supervision strategy, NBG supervision should increase focus on qualitative assessments of banks’ important risk management and control practices. - For functions and practices identified as most important in the internal NBG review, supervisors should undertake in-depth qualitative assessments on a regular periodic basis that: - include a significant onsite element; - encompass holistic assessments of frameworks (e.g., entire credit risk management), including effectiveness of SB/Risk Committee, senior management, internal audit, and other control elements; and - assess quality and effectiveness of independent credit risk management functions, the Chief Risk Officer, internal audit independence and quality, and SB Risk and Audit Committees’ effectiveness. - Such reviews should inform broader CG assessments and need not cover every GRAPE element but should focus on the most critical elements. ### D-SIBs: stress testing, ICAAP, and internal capital planning - For D-SIBs, NBG should strengthen requirements for the use of stress testing in internal capital and liquidity management and planning processes to promote greater emphasis on capacity to withstand stressful operating environments. - NBG carries out a periodic supervisory (bottom up) stress testing program which can be used to derive the Net Stress Buffer and to inform the risk assessment process. - Supervisory assessments of banks’ capacity to carry out effective supervisory and internal stress testing should contribute to assessments of banks’ qualitative risk management, internal controls, and corporate governance. - For systemically important banks, a well-run internal stress testing program that informs risk appetite setting frameworks and capital adequacy assessments in a ‘forward-looking’ manner should be a minimum expectation. - At least for D-SIBs, NBG should put more emphasis on ensuring banks have an effective ICAAP, as required by NBG rules, and that supervisors assess banks’ ICAAP practices in the context of Pillar 2-related evaluations. - NBG regulations require an ICAAP to be submitted periodically by banks, but discussions indicate this has not been an area of focus to date. - For D-SIBs, NBG should emphasize robust internal capital planning processes and how effectively risk management and internal controls support capital decisions (including dividend decisions), noting these are key SB responsibilities. ### Credit risk management — reporting, provisioning, and qualitative work - NBG supervision of credit risk is well supported by comprehensive reporting requirements and offsite monitoring; extensive data allow close monitoring of compliance with regulatory requirements, underwriting standards, and portfolio developments. - NBG should focus more on the quality of banks’ internal loan loss classification and provisioning practices, in addition to the adequacy of banks’ actual provisions. - Weak practices should be a clear and important factor in determining the GRAPE score for credit risk. - Loan classification is based on days in arrears and financial performance of the borrower and collateral; capacity to repay and number of days in arrears are key drivers of classification and provisioning. Classification categories include Standard, Watch, Substandard, Doubtful, and Bad. - As supervision evolves, supervisory objectives should move toward banks effectively carrying out classification and provisioning activities on their own, with supervisory requirements serving as a backstop—becoming increasingly important as the transition to IFRS standards for regulatory reporting and accounting proceeds over the next several years. - Qualitative reviews inform the GRAPE process and Net GRAPE Buffer, covering policies and procedures, data checks against credit files, discussions with risk managers, reporting to senior management and the board, and other governance factors. - The process for incorporating qualitative assessments into the GRAPE score should be made clearer internally, including which elements are most important and how responsibilities of SB and senior management, and internal audit, are weighted. ### COVID-19 measures and provisioning guidance - NBG addressed increased credit risk from COVID-19 largely through suspension or reduction of capital requirements: - the CCB has been reset to zero; and - the CICR was reduced by two thirds. - Banks were encouraged to provide borrowers with repayment moratoriums on a voluntary basis. - Loan classification standards continued to require assessments of borrowers’ capacity to repay, though the focus on payment days in arrears was not applied during the pandemic. - Pandemic-related loan-loss provisioning initially involved portfolio-level analysis and general provisions, shifting into loan-specific provisions as banks carried out loan/borrower level assessments. - NBG provided provisioning guidelines during the pandemic that assume a three-year recovery period for corporate and SME sectors. - NBG closely monitors restructured loans, requiring banks to submit internal risk reports and updated financial statements to assess adequacy of provisions for restructured loans. ### Large exposures and concentration risk - In 2019 NBG updated its regulation on concentration of exposures and large exposures; new requirements scheduled to take effect starting January 1, 2022, with details in Appendix 2. - Updates include: - definition of connected parties; - recalibrated large exposure limits, including gross limits and limits net of credit risk mitigation for individual borrowers and connected groups; and - measurement of required limits changing from a percentage of Total Regulatory Capital to Tier 1 capital. - There are no regulatory sectoral concentration limits in place; NBG includes a measure for sectoral concentrations in its Pillar 2 buffers. - Qualitative assessments of large exposure risk management are incorporated into GRAPE credit risk management processes and inform the Net GRAPE score used to derive the Net GRAPE Buffer. - Banks’ SBs are required to set internal thresholds for board approval of large exposures, though thresholds need not match regulatory limits. - Given the importance of concentration risk in Georgia (small number of large banks, limited corporate access to capital markets), consideration should be given to increasing the importance of concentration risk and associated risk management practices in: - GRAPE score calculations; - assessment of inherent risk; and - prioritization of supervisory plans. - Large exposures to firms, corporate groups and sectors are addressed in Pillar 2 requirements that include a specific buffer for concentration risk (see HHI buffer in Capital and Liquidity Frameworks). - Pillar 2 buffer calculations for concentrations address definition of “control” for connected parties and standards for assessing “economic interdependence”. - NBG supervisory stress testing can identify vulnerabilities related to sectoral exposures, but incentives for banks to actively manage or reduce correlated exposures are limited since there is currently no hard requirement to hold capital against supervisory stress test results. ### Related party transactions - NBG was assessed as ‘compliant’ with Basel Core Principles for related party transactions in the 2015 FSAP and maintains well-developed monitoring processes. - NBG issued the “Regulation on the Management of the Conflict of Interests” in 2015, strengthening related party requirements and NBG authority. - Regulation features: - broad definitions of related parties and transactions; - NBG authority to define related parties on a case-by-case basis and require banks to treat them as such; - requirement that transactions with related parties be conducted at “arms-length” and approved by the bank’s SB; and - exceptions noted in the regulation must be collateralized at 110 percent of the value of the loan. - Starting in 2022: - total value of exposures to one related party must not exceed 5 percent of Tier 1 capital; and - total value of exposures to all related parties must not exceed 25 percent of Tier 1 capital. - Under the current rule, related party limits are based on exposures as a percentage of total regulatory capital. Related party transactions are monitored through regulatory reporting requiring banks to report all related party transactions; supervisors analyze monthly reports and other available information, including publicly available sources, to identify related parties. - Given the importance of managing related party transactions and complex group structures, consideration should be given to increasing the importance of this risk and associated practices in the GRAPE score, assessment of inherent risk, and supervisory prioritization. ### Capital adequacy — alignment with Basel III and identified gaps - NBG’s capital adequacy requirements are largely in line with Basel III and international practices, though several self-identified gaps in the definition of capital for certain AT1 and Tier 2 instruments should be addressed over the “medium term”. - Self-identified gaps NBG plans to close: 1. NBG does not include provisions regarding regulatory event and tax events, which permit banks to call AT1 or Tier 2 instruments within first five years of initiation. 2. General provisions regarding conversion and write-down requirement of AT1 instruments are required, but no specific threshold is included. 3. Provisions regarding conversion or write down of Tier 2 instruments are not currently included in capital requirements. After adoption of resolution framework (from 2021), NBG will have the authority to convert or write-off liabilities (bail-in) during resolution. 4. Requirements do not include provisions for threshold deductions (under 10 percent ownership) for investments in AT1 or Tier 2 instruments of banking, insurance or financial entities; they are directly deducted from capital. *Source: IMF country report content unit 1geoea2021006.* ### Appendix 3 for current and pre-COVID-19 regulatory requirements.) ### Appendix 3 for current and pre-COVID-19 regulatory requirements. ### Capital adequacy framework and current metrics - Regulation: "Regulation Setting, Calculating and Maintaining Overall Open Foreign Exchange Position Limit of Commercial Banks" limits open foreign exchange positions, in all currencies and consolidated foreign exchange positions, to a maximum of 20 percent of the total regulatory capital. The limit applies to all on balance sheet and off- balance-sheet positions and must be adhered to on a daily basis. - As of October 31, 2020: - All banks remained above the minimum capital requirements in place as a result of the COVID-19 response. - Most banks remain above the pre-COVID requirements. - CET1 ratios range from a low of 9.3 percent to a high of 80 percent (at one small bank). - Aggregate system CET1 ratio: just over 11 percent. - CET1 accounts for over 80 percent of the aggregate total Tier 1 capital 1 ratio of 13 percent. - Aggregate Total Regulatory Capital ratio: approximately 18 percent. - Pillar 1 capital charges: - Derived using the Basel 2 standardized approach to calculating risk weighted assets. - No use of banks’ internal models for calculating Pillar 1 regulatory capital requirements. - Pillar 1 minimum ratios and buffers: - Minimum capital ratios: 4.5 percent CET1, 6 percent Tier 1, and 8 percent Total. - Capital conservation buffer: 2.5 percent (currently set to zero as part of the COVID-19 pandemic response). - Countercyclical buffer: currently set to zero. - Systemic risk capital buffer for the 3 D-SIBs: scheduled to phase in up to as high as 2.5 percent requirement for the two largest banks by year-end 2021. - Banks will be given two years to restore the CCB with the starting point still yet to be determined. - Leverage ratio: - As of 2018, NBG regulatory capital requirements include a 5 percent Tier 1 leverage ratio. - As of October 31, 2020, all banks exceeded the leverage requirement comfortably. - Leverage ratios across the banks ranged from 7.1 percent to over 40 percent. ### Pillar 2 buffers and capital quality transition - Current composition: - Pillar 2 capital buffers are currently required to be covered mostly by Tier 2 instruments, which is not in line with usual international practice. - Transition plan: - The quality of regulatory capital will shift further towards CET1 and Tier 1 going forward as the Net Grape Buffer and Concentration Buffer (HHI) are scheduled to phase in an increasing share of CET1 and Tier 1 requirements each year to a final coverage mix that is in line with Pillar 1 requirements of 56 percent CET1, 80 percent Tier 1, 100 percent total capital by March 2023. - Specific Pillar 2 buffers (descriptions as provided): - The Unhedged Currency Induced Credit Risk buffer (CICR buffer): measures a capital charge for banks’ exposures to borrowers taking loans in a foreign currency. It is based on Foreign Currency exposures net of a variety of mitigating or ‘hedging’ factors. Under COVID-19 response measures, the CICR buffer has been temporarily reduced by 66 percent. - Name and Sectoral Concentration Buffer (HHI buffer): requires capital to be held against name (including connected groups) and sectoral concentrations through the use of a Herfindahl-Hirschman Index based calculation of concentration and a capital charge based on the HHI score. - Net GRAPE Buffer: represents a significant capital charge for banks and is derived using the GRAPE process discussed elsewhere in this technical Note. - Net Stress Test Buffer: stress test scenario parameters are provided to the banks by NBG and banks calculate the impact of the stress scenario on CET1 capital. The Net Stress Buffer is not currently in place. ### Stress testing, supervisory expectations, and recommendations - Net Stress Buffer status and considerations: - The Net Stress Buffer is not currently in place. - NBG is considering how this buffer interacts with other buffers and if it creates "double-counting" with other buffer requirements. - NBG has not yet decided on the consequences for banks that fail to meet the Net Stress Buffer (i.e., it has yet to be determined if it will become a required buffer under Pillar 2 rules). - Recommendations: - NBG should increase the emphasis placed on scenario-based stress testing for supervisory assessments of capital adequacy at D-SIBs and consideration should be given to making the Net Stress Buffer a hard Pillar 2 requirement for these banks. - Supervisors should assess D-SIBs' stress testing practices including those stress tests designed and run by D-SIBs for risk management and internal capital planning, as well as the NBG supervisory stress test. - Given the importance of systemic banks and the potential challenges associated with their resolution, ensuring these banks are well-capitalized against potentially severely stressful outcomes would help reduce the probability they could default/collapse and disrupt the financial system and economy. ### Liquidity framework and monitoring - Regulatory framework and metrics: - LCR and NSFR rules have both been implemented and are consistent with Basel III standards. - Local currency LCR requirement: 75 percent coverage ratio (suspended during COVID-19 pandemic). - Foreign currency LCR requirement: 100 percent coverage across all foreign currencies. - Total combined required LCR coverage: 100 percent. - NSFR requirement: 100 percent coverage in aggregate; banks are required to monitor positions on a currency-by-currency basis. - Reporting frequency: - LCR: required to be calculated and reported on a daily basis (with a maximum two-day lag). - NSFR: required on a monthly basis (required 15 days from end of month). - Local currency LCR requirement suspension: suspended during COVID-19 pandemic; timing for reimposition not conclusively decided due to uncertainty about the future of the pandemic. - Considerations and recommended reviews of assumptions: - NBG should consider if current inflow and outflow assumptions in regulatory requirements are appropriately calibrated to the Georgian banking environment, focusing on: 1) Related party transactions, particularly for D-SIBs and banks that form part of complex group structures — inflows/outflows from affiliates and other related parties may be especially likely to differ from assumptions in a period of stress as contractual commitments could be subject to loosening or suspension to support these entities. 2) Repayment risks of borrowers in foreign currencies — while the CICR buffer requires capital to be held for the greater potential deterioration of credit worthiness or default for unhedged foreign currency loans, LCR/NSFR assumptions make no distinction between estimated inflows from borrowers in local or foreign currencies. - Supervisory monitoring and reporting: - Supervisory monitoring of liquidity risk and positions is supported by extensive required reporting from the banks, with periodic detailed reviews expected to be carried out by supervisors periodically to ensure data accuracy. - Liquidity positions across the banks are monitored regularly to ensure compliance with the LCR and NSFR. - Required reporting covers maturities of assets and liabilities, sources of interbank and wholesale funding, largest depositors, and positions relative to covenant agreements with major lenders and sources of funding, including international financial institutions. - Supervisory assessment of liquidity risk management: - Supervision is supported by a full set of appropriate elements to be reviewed and assessed in ensuring compliance with liquidity regulations. - In the GRAPE process, the value given to "mitigation" of liquidity risk is substantially defined by qualitative assessments of many different practices at banks, including internal risk management practices and the effectiveness of the SB and senior management. - Recommendations: - NBG should consider increasing the weighting given to qualitative issues related to liquidity risk management in the overall GRAPE score. - Alternatively, NBG should emphasize other processes to create appropriate incentives, for example by requiring banks to have a robust ILAAP framework and making supervisory assessments of ILAAP a key area of focus; such assessment should contribute to views on board and senior management quality and be incorporated into NBG assessments of governance. - For D-SIBs, NBG should emphasize periodic qualitative assessments of liquidity risk stress testing practices in their assessments of liquidity risk management; systemically important banks should conduct their own liquidity stress testing designed to capture idiosyncratic vulnerabilities not well measured in the LCR and NSFR. ### Appendix I — Responses to 2015 FSAP Recommendations (selected items) - Principle 1: Responsibilities, objectives, and powers. - Recommended actions included seeking review of the NBG Law to give banking supervision equal status to price stability; amending Article 21 of the ACB Law to cover all areas when setting and enforcing minimum prudential standards; and amending the law to make public consultation on new laws and regulations statutorily binding. - Reviewers’ assessment and completion status highlights: - The issue of NBG Law review: N (not completed). Rationale: changes have not been made mainly because NBG has not encountered impediments in practice; operationally NBG has two active vice-governors with equal powers, and Financial Stability Committee functionality has increased. - Amendment to ACB Law (Article 21): Y (completed). The ACB Law was amended to expand provisions of setting prudential standards based on risk-based supervision principles to cover all areas (paragraph 3, Article 21). - Amendment to make public consultation statutorily binding: N (not completed). NBG law was amended and paragraph 13 added to Article 48 permitting publication of drafts for comments, with exceptions for acts essential for resolution or stability; practice changed to publish drafts (link referenced in source). - Principle 2: Independence, accountability, resourcing, and legal protection for supervisors. - Recommended actions included reviewing NBG salary levels, increasing training and education budget, considering charging for supervision, publishing a more comprehensive strategic plan and targets in annual accounts, and making legal provisions for protection against defence costs for staff. - Reviewers’ assessment and completion status highlights: - Review of salary levels: P (in progress). Reference to NBG 2020-2022 Supervisory Strategy. - Increase training and education budget: P (in progress). Reference to NBG 2020-2022 Supervisory Strategy. - Consider charging for supervision: N/A (advisory only). - Publish more comprehensive strategic plan and targets: Y (completed). NBG started publishing 3 years supervisory strategy document starting from 2020; annual reports cover upcoming and significant plans in supervision. - Legal protection for supervisor and staff: Y (completed). Annual reports cover reviews and substitute actions (details provided in NBG materials). *Source: Appendix 3 for current and pre-COVID-19 regulatory requirements.* ### Box 6, 7, 8, 9, 10, 11) ### 1geoea2021006 - Box 6, 7, 8, 9, 10, 11) ### Amendments to NBG Law — staff protection - Finding: Article 68 states that no employee of the National Bank shall be personally liable to any party for any action done or not done, as long as such action was done or such person refrained doing it in good faith by such person and in the ordinary course of his or her duties, in accordance with the Georgian legislation. - Recommended action (from reviewers): The protection afforded to staff on a personal level for any action done or not done, as long as such action was done or refrained from in good faith, should be extended to the supervisor itself. - NBG response/actions (completed Y): - With respect to fulfillment of work duties, NBG shall defend the interests of the current or former employee, if disputed action or omission was determined by fulfillment of those duties (except for the case when the dispute is raised by the NBG itself against such employee), which may be expressed in providing legal services to the employee, compensation of dispute related costs and the other measures, which the NBG may deem expedient for protection of an employee’s interests. - Provision also refers to temporary administrator, special manager and liquidator and administrators of bridge bank. ### Principle 5 — Licensing criteria - Recommended actions: - Introduce explicit and specific legal provisions relating to the NBG powers rather than relying on its broad powers to achieve its goals. - Provide explicit powers that foreign banks proposing to establish a locally incorporated bank in Georgia must obtain the prior consent of its home supervisor to do so (as is currently the case for foreign banks proposing to establish a branch bank in Georgia). - Reviewers’ assessment: Completed (Y) - NBG response/actions: - Amendments to the ACB Law introduced explicit and legal provisions on the NBG’s powers regarding the licensing process of commercial banks, harmonizing requirements with Basel Core Principles for Effective Banking Supervision. Enhanced requirements include detailed information on banks’ supervisory boards, audit committees, governance documents, as well as detailed information on ownership structure. - According to amendment to ACB law, in Article 3 “in case of branch and subsidiary of a foreign bank applicant additional information should be submitted in accordance with Paragraph 7 of this Article”. Paragraph 7c requires submitting “approval of supervisory body (home supervisor) of the parent bank on opening a subsidiary or a branch.” ### Principle 6 — Transfer of significant ownership - Recommended actions: - Expand the definition of “significant shareholder” to include persons acting in concert. - Make it legally binding that existing significant shareholders proposing to dispose of their shareholding must notify the NBG in advance. - Make it legally binding for banks to have to notify the NBG as soon as they become aware of any material information that might negatively affect the suitability of a major shareholder or a party with a controlling interest in the bank. - Reviewers’ assessment: Completed (Y) / In Progress (P) / Not completed (N) as noted below. - NBG response/actions: - Definition change (Completed Y): “Significant share – direct or indirect ownership of 10 percent or more of the bank’s authorized or issued capital or / and voting shares by a person or partners (shareholders) acting in concert or an opportunity to have significant influence over commercial bank by a person or partners (shareholders) acting in concert regardless their share in capital or/ and voting stock.” - New paragraph 5 added to Article 8(1) of ACB Law (Completed Y): “direct or indirect owner of the Bank who intends to sell its share in a bank directly or indirectly, as a result of which its share as a beneficial owner becomes less than 10, 25 or 50 per cent, shall notify the NBG in advance on this fact. The notification shall include detailed information about the transaction.” - New paragraph 6 added to Article 8(1) of ACB Law (Completed Y): “Commercial bank is obliged to immediately notify the National Bank about any change related to a fit and proper criteria of significant ownership.” - Status: Expansion to include persons acting in concert — Y. Advance notification requirement — Y. Immediate notification of material information — N (as recorded). ### Principle 7 — Major acquisitions - Recommended actions: - Provide direct statutory backing to the criteria used by the NBG to judge investment proposals by banks. - Effective implementation of corrective action. - Prohibit banks from making acquisitions/investments in countries with laws or regulations prohibiting information flows deemed necessary for adequate consolidated supervision; consider effectiveness of supervision in host country and ability to exercise supervision on a consolidated basis. - Reviewers’ assessment: Completed (Y) / In Progress (P) - NBG response/actions: - In practice, NBG effectively applies such criteria. Amendments made to the Law in December 2017 defined permissible investments and specified restrictions related to investments. NBG has the authority to define the criteria used in decision making regarding investments by a normative act. - Regulation on licensing requires group structure of the bank must not be so complicated that it hinders supervision. NBG can require commercial bank to change ownership or group structure if such structures hinder effective supervision or endanger stable functioning of a bank or financial sector. - For investments outside Georgia, banks are required to prove that the laws or regulations of the country do not prohibit information flows deemed necessary for supervision. NBG effectively applies these criteria in practice. NBG has signed MOUs with countries (Belarus, Azerbaijan) where such investments exist. - NBG collects extensive information about subsidiaries throughout group structure analyses and monitors investment values based on consolidated financial statements. NBG has power to require banks to change group structure. ### Principle 8 — Supervisory approach - Recommended actions: - Complete the implementation of the new supervisory approach and formalize it. - Set up a clear framework for distressed banks and require banks to set up resolution plans to identify and mitigate possible barriers for resolution. - Undertake a crisis-simulation exercise. - Reviewers’ assessment: In Progress (P) / Completed (Y) - NBG response/actions: - New approach implemented. NBG has formalized GRAPE assessment and developed pillar 2 framework. - Changes made to ACB law and NBG law to develop resolution framework. Banks are required to set up recovery plans. - With World Bank assistance, NBG undertook a crisis-simulation exercise involving representatives of commercial banks and relevant government agencies. ### Principle 9 — Supervisory technique and tools - Recommended actions: - Consider how to balance attention for inherent risk and quality of risk management. - Integrate identification of risk culture in the supervisory approach and spend more time on-site to sense the risk culture. - Reviewers’ assessment: Completed (Y) / In Progress (P) - NBG response/actions: - NBG implemented GRAPE which implies assessment of inherent risk as well as mitigants including quality of risk management. - Supervisory staff conducts on-site visits from time to time; meetings with Supervisory Board, management, staff from different divisions are held frequently at NBG building. Based on a report by Federal Reserve Bank of New York Staff, NBG’s approach is quite similar to the one used by FRBNY. ### Principle 10 — Supervisory reporting - Recommended action: - Ensure that a formal consolidated prudential reporting framework is in place by November 2014, as targeted. - Reviewers’ assessment: In Progress (P) - NBG response/actions: - Based on amendments to the NBG Law, NBG has the mandate to supervise banking groups, which includes consolidated prudential reporting framework. NBG is working on implementing IFRS which is an important milestone toward implementing consolidated requirements. ### Principle 11 — Corrective and sanctioning powers of supervisors - Recommended actions: - Employ an escalation framework for safety and soundness issues. - Reflect to what extent NBG could have been more effective with regard to deficiencies that linger for a protracted period of time. - Initiate law or regulation that gives the NBG the power to set individual risk governance requirements, intervene in the organizational structure or business model of a bank. - Reviewers’ assessment: In Progress (P) - NBG response/actions: - The escalation matrix works in practice as NBG acts from a risk-based perspective. According to Article 30 of ACB law, NBG can use its supervisory measures on banks in line with the risk-based approach. Supervisory measures and fines should be imposed either according to prescribed order or without it, in accordance with the severity of the violations and the risks posed by them. - Amendments to ACB law in December 2019 strengthened NBG's early intervention measures and supervisory powers. - Based on amendments to the ACB Law, NBG has an explicit power to set individual requirements on commercial banks based on the principles of risk-based supervision (Article 21, paragraph 3). Status: Completed (Y). ### Principle 12 — Consolidated supervision - Recommended action: - Ensure that a formal consolidated prudential reporting framework is in place by November 2014, as targeted. - Reviewers’ assessment: In Progress (P) - NBG response/actions: - Based on amendments to the NBG Law, NBG has the mandate to supervise banking groups, which includes consolidated prudential reporting framework. NBG is working on implementing IFRS as an important milestone toward consolidated requirements. ### Principle 14 — Corporate governance - Recommended actions: - Increase involvement of Boards in setting and overseeing risk appetite. - Align the legislation and regulation with regard to the role of directors in a Supervisory Board. - Make the overseeing risk committee and remuneration committee a requirement by law or regulation. - Encourage banks to make the Supervisory Committee directly responsible for the Audit committee. - Initiate a law that gives the power to change the composition of a Board. - Reviewers’ assessment: Completed (Y) - NBG response/actions: - Code of corporate governance (2014) requires boards to develop and approve risk appetite statement. - Amendments to the ACB and CCG require independent board members and independent chairs on key committees. - Code of Corporate Governance requires risk committees for each commercial bank. Remuneration committees are mandatory only for systematically important banks as prescribed by Basel Committee of Banking Supervision. For banks without a remuneration committee, the risk committee and board should fulfill remuneration committee responsibilities. - Audit committees are composed with independent supervisory board members. Audit committee is a sub-committee of the supervisory board and is not composed of outsider members. - NBG has the power to change the composition of the Board. According to Article 30.3e of ACB Law NBG has the power to require dismissal of a Board member who lacks experience or education. Regulation on Fit and Proper Criteria for Administrators of Commercial Banks (updated 2014) requires board composition to ensure a variety of experience and skill set corresponding to the scale and complexity of the bank's activities. This requirement is assessed under GRAPE. ### Principle 15 — Risk management - Recommended actions: - Make sure that banks express their risk appetite for the different risk categories. - Continue implementing Basel II including ICAAP, contingency planning, stress testing and SREP. - Determine the internal pricing mechanism of all banks. - Evaluate the role and independence of CRO and (credit) risk management, including the incentive structure. - Reviewers’ assessment: Completed (Y) / In Progress (P) - NBG response/actions: - All banks are required to develop and approve a risk appetite statement according to the code of corporate governance. - NBG implemented Pillar 2 under Basel III. Stress testing methodology was published in 2020. Recovery plans are required starting from 2020. - Banks have basic internal pricing mechanisms. NBG has published a guideline regarding sound pricing principles. - Requirement to separate CRO and its compensation from business line activities is reflected in the code of corporate governance. Risk management framework of commercial banks, including the role and independence of CRO and incentive structure, are assessed under corporate governance assessment throughout GRAPE. ### Principle 16 — Capital adequacy - Note: Text begins but is not completed in the supplied content. *Source: 1geoea2021006 - Box 6, 7, 8, 9, 10, 11)* ### introduction of a capital ### introduction of a capital ### Key recommended actions and implementation status - Consider introducing a countercyclical buffer. - Set up an implementation plan for Pillars 2 and 3 for banks and supervisors, including deciding who will do the assessment. - Develop guidance for supervisors on SREP. - Develop Pillar 3 requirements for banks. - Add legal provisions that explicitly require write-off of related party exposures to be subject to prior approval by the bank’s Board. - Continue implementing the guideline on managing country and transfer risk, including stimulating the Board to explicate their risk appetite, set country and transfer risk limits, take responsibility in overseeing the management. - Develop an explicit provisioning system for country risk and transfer risk. - Require prudential return on country risk on consolidated level on a semi-annual base. - Continue with the finalization and implementation of draft regulation of LCR. - Ensure that all banks have adequate contingency funding planning, taking into account limited opportunities. - Make sure that all banks set up business continuity plans and outsourcing agreements (including taking the local environment into account) and conduct (mandatory) IT audits. - Seek the removal of the legal provision that allows Executive Directors to sit on Supervisory Boards. - Enhance the level of qualitative information, which banks are required to disclose in their annual accounts. - Legally require banks to report to the NBG any suspicious activities and incidents of fraud where such activities/incidents are material to the soundness or reputation of the banks. - Extend the definition of PEP to include domestic and foreign persons. ### Reviewers’ assessment and supervisory actions (selected) - Framework is developed in accordance with Basel principles. 3 banks were identified as D-SIBs and relevant capital requirements are imposed on them. - Basel III countercyclical buffer mechanism was introduced in December 2017. The Financial Stability Committee initiates imposing countercyclical buffer based on its evaluation of financial stability risks. The Financial Stability Committee meets once a quarter in accordance with a pre-announced schedule. Unplanned committee meetings may also be called in special cases. - Pillar 2 and Pillar 3 are successfully implemented in practice. Relevant regulations are also approved. Internal procedures are clear. - GRAPE guideline is developed. It will be updated periodically. - Regulation on Information Disclosure for Commercial Banks within Pillar 3 based on Basel latest documents was adopted in 2017. Banks published their first pillar 3 quarterly reports as of Q2 2017 based on new regulation. - Credit risk management including lending standards is assessed as part of mitigant under GRAPE. In addition, retail credit regulation and risk management standards of CG code are applicable for each commercial bank. Compliance of which is assessed within GRAPE framework. - New regulation on large exposures requires boards to receive information on largest exposures. In addition, NBG is authorized to require risk committees of supervisory board to approve largest exposures. - Detailed guideline for stress testing ensures inclusion of credit risk exposures for all banks in practice. - Pillar 2 reflects recommendation on concentration risk and a separate buffer for credit risk concentration is developed. - The definition of connected parties has been updated and it requires commercial banks to identify groups of connected counterparties by the criteria of control relationship and economic interdependence. - Regulation on the management of conflict of interests updated in 2015 requires banks to have internal policies of conflict of interests which should include the procedure for writing off risk exposures to related parties. Any amendments to contracts with related parties must be approved by the supervisory board. - Country risk guidelines were sent to the banks. Transfer risk is immaterial as exposures are mainly denominated in EURO and US dollars. - According to the country risk guideline banks should develop provisioning system for country risk. - Monthly reporting form includes distribution of exposures by country. - Georgian banks do not have trading books. Existing trading book guidelines require banks to notify NBG if their assets will qualify under trading book definition. - General stress test includes relevant market risk shocks. - The regulation on interest rate risk in the banking book is approved and became effective since September 2020. - The regulation requires limits on IRRBB, requires banks to have risk appetite regarding IRRBB and it must be part of their capital planning process. - Banks are required to submit reporting forms on a monthly basis as defined by NBG. - The Regulation on calculation and preservation of Liquidity Coverage Ratio (LCR) was adopted. LCR requirement is applied under the LCR regulation. - Banks have created business continuity plans and have set up outsourcing agreements. Smaller banks are drafting outsourcing policies. Mandatory IT (IS) audit requirements are already in place based on the new operational risk regulation enacted in 2014 and commercial banks have begun implementing the audits. - According to the amendments to ACB, supervisory members will no longer have the executive functions. - Supervisory reporting form for operational risk includes incidents of fraud and is monitored by the operational risk division at NBG. An additional reporting form for commercial banks is drafted by the Money Laundering and on-site Inspection Department; based on this form commercial banks will be required to report all transactions classified as suspicious. - The law has been updated and the definition of PEP includes foreign as well as domestic persons. ### Large exposure regulations (summary of key changes) - Bases for limits calculation: - Current Regulation (will be abolished in January 2022): Regulatory capital - New Regulation (starts January 2022): Tier 1 capital - Definition of large exposures: - Current: >= 5 percent of regulatory capital - New: >= 10 percent of Tier 1 capital - Exposure value to a single client: - Current: <= 15 percent of regulatory capital - New: <= net exposure of 25 percent of Tier 1 capital; <= gross exposure of 50 percent of Tier 1 capital (excl. mitigation effect) - Exposure value to a group of connected clients: - Current: <= 25 percent of regulatory capital - New: (no explicit percentage line in source beyond single client and other categories) - Exposure value to a bank or group of connected clients containing a bank: - Current: N/A - New: Highest of 25 percent of Tier 1 capital and GEL 200m for net exposures; 50 percent of Tier 1 capital for gross exposures (excl. mitigation effect) - Exposure value to a non-resident bank or group of connected clients containing a non-resident bank w/o an investment grade: - Current: N/A - New: <= net exposures of 25 percent of Tier 1 capital; <= gross exposure of 50 percent of Tier 1 capital (excl. mitigation effect) - Exposure value of resident systemically important bank to another resident systemically important bank: - Current: N/A - New: <= net exposure 15 percent of Tier 1 capital; <= gross exposure of 50 percent of Tier 1 capital (excl. mitigation effect) - Total amount of large exposures: - Current: <= 200 percent of regulatory capital - New: N/A ### Current capital requirements (aggregates across the system) - February 2020 (before Covid-19) — CET1 / Tier 1 / Total - Min. Requirements: 4.5% / 6.0% / 8.0% - Combined Buffer: 3.6% / 3.6% / 3.6% - Conservation Buffer: 2.5% / 2.5% / 2.5% - Countercyclical Buffer: 0.0% / 0.0% / 0.0% - D-SIB Buffer: 1.1% / 1.1% / 1.1% - Pillar 2 Buffers*: 1.8% / 2.4% / 5.7% - CICR Buffer: 1.3% / 1.7% / 2.2% - HHI Buffer: 0.1% / 0.1% / 0.7% - Net GRAPE buffer: 0.4% / 0.5% / 2.7% - Total Requirements: 9.9% / 12.0% / 17.3% - October 2020 — CET1 / Tier 1 / Total - Min. Requirements: 4.5% / 6.0% / 8.0% - Combined Buffer: 1.1% / 1.1% / 1.1% - Conservation Buffer: 0.0% / 0.0% / 0.0% - Countercyclical Buffer: 0.0% / 0.0% / 0.0% - D-SIB Buffer: 1.1% / 1.1% / 1.1% - Pillar 2 Buffers*: 1.0% / 1.3% / 4.1% - CICR Buffer: 0.5% / 0.6% / 0.8% - HHI Buffer: 0.1% / 0.1% / 0.6% - Net GRAPE buffer: 0.4% / 0.5% / 2.7% - Total Requirements: 6.7% / 8.5% / 13.3% - *Pillar 2 buffer requirements are on a bank-specific basis. This table shows aggregates across the system. *Source: introduction of a capital (1geoea2021006)* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1geoea2021006.pdf_