## Botswana FSAP Executive Summary (1bwaea2023004)

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### Background — Macrofinancial Context
- Real GDP growth: 5.8 percent in 2022.
- Private sector credit growth: 5.4 percent (y-o-y, Q2 2022).
- Domestic inflation peak: 14.6 percent (y/y) in August 2022.
- Bank of Botswana monetary policy rate increases: combined 151 basis points between December 2021 to August 2022.
- Bank of Botswana medium-term inflation objective: 3–6 percent.
- Policy priorities: Economic Reform and Transformation Plan (ERTP) for diversification, rebuilding fiscal buffers to ensure sustainability and preserve sovereign credit ratings.

### Financial Sector Structure
- Financial sector size: close to 130 percent of GDP.
- Banking sector: nine commercial banks; three largest banks account for 64 percent of banking sector assets.
- Domestic Systemically Important Banks (D‑SIBs): two banks identified, accounting for 46 percent of banking sector assets.
- Domestic ownership: largest pension fund holds 22 percent of bank shares.
- Retirement funds’ assets: represent 54 percent of GDP.
  - Offshore equities account for 61 percent of retirement funds’ total assets (up to Q3 2022 limits: up to 70 percent offshore; Retirement Fund Act (2022) reduces maximum offshore investments to 50 percent).
  - Of domestic retirement fund investments, 40 percent are in domestic bonds, of which approximately 55 percent is in outstanding government bonds.
- NBFIs share: retirement funds 43 percent of financial system assets; remainder 15 percent (insurance companies, microlenders, brokers).
- Domestic capital markets: small and illiquid.
- Interbank loans: include placements with foreign affiliated banks.

### Systemic Risk Assessment — Key Findings and Scenarios
- Overall resilience:
  - Financial system broadly resilient since 2007 FSAP; banks hold adequate capital, maintain ample liquidity, and show moderate profitability.
- Main risks:
  - High volatility in diamond prices, geopolitical developments, tightening global financial conditions.
  - Realization of risks could delay economic recovery, weaken external position, and depreciate the pula.
- Stress test outcomes:
  - System resilient to a wide range of shocks; most banks withstand severe stress.
  - Two banks would face a mild capital shortfall under an adverse risk scenario.
  - Most banks meet prescribed liquidity ratios under a baseline; some vulnerabilities under an adverse scenario.
  - Insurance companies appear well capitalized and do not face a shortfall under a severe scenario.
- Analytical enhancements recommended:
  - Regular stress testing of large insurers’ and retirement funds’ concentrated bank exposures.
  - Implement data management systems for stress testing and interconnectedness; update and standardize reporting frameworks for banks and NBFIs.
  - Enhance data quality and granularity for credit risk sensitivity tests (household and corporate indebtedness).
  - Develop interbank repo market with legal enforceability and title transfer under relevant Master Agreement.

### Financial Sector Oversight — Supervision and Macroprudential Policy
- Legal and supervisory reforms:
  - Bank of Botswana (Amendment) Act, 2022 (BoBAA) passed in August 2022; effective date February 2023.
  - Draft Revised Banking Act (DRBA) published January 13, 2023.
  - Key Basel III elements at advanced implementation stage; D‑SIBs identified.
  - AML/CFT framework upgraded since 2017 FATF assessment.
  - BoB stress testing capacity enhanced.
- Banking supervision recommendations (selected):
  - Make supervisory framework more risk‑based, forward looking, and consolidated.
  - Strengthen guidance on problem assets, provisioning, liquidity, and interest rate risk.
  - Strengthen operational independence of BoB supervision.
  - Expand oversight of corporate governance to include concentration risk and related‑party transactions.
  - Incorporate Pillar II risk review tools into the Supervisory Review and Evaluation Process (SREP); revise bank rating methodology to be more forward‑looking.
  - Establish legal basis and frameworks for consolidated supervision; augment supervisory resources and risk specialists.
- Macroprudential policy:
  - Enhance toolkit to address liquidity vulnerabilities, consider credit‑based household sector tools, and establish capital buffers.
  - BoBAA to include explicit reference to financial stability and expanded role for Financial Stability Council (FSC).
- Financial integrity:
  - Operationalize AML/CFT risk‑based supervision (RBS) for banks and NBFIs, including virtual assets.
  - Ensure timely availability of beneficial ownership information; accompany measures with public awareness and capacity building.

### Systemic Liquidity Management, Safety Nets, and Crisis Preparedness
- Liquidity management recommendations:
  - Transition to Basel III liquidity standards for systemic liquidity monitoring.
  - Strengthen liquidity management: upgraded forecasting tools, streamlined refinancing access, comprehensive collateral schedule.
  - Develop interbank repo market and ensure legal enforceability and title transfer of securities.
- Safety nets and crisis management:
  - Establish operational framework for Emergency Liquidity Assistance (ELA) once BoBAA effective.
  - Elevate Botswana Deposit Insurance Regulation (BDIS) to law; develop strategic and operational plan for deposit insurance.
  - Operationalize emergency liquidity framework and expand supervisory MOUs to include resolution plans and contingent plans for foreign subsidiaries.
  - Expand FSC remit to coordinate crisis preparedness, recovery and resolution planning, stress testing, contingency planning, and communications.

### Financial Sector Development — Key Issues and Policy Actions
- Key development issues:
  - Need for coordinated financial sector development strategy to deepen markets and channel resources.
  - Development Finance Institutions (DFIs) underperform; high levels of non‑performing assets.
  - Digital financial services advanced inclusion; further progress requires fast payments, open banking, digital ID.
  - Private sector credit to MSMEs limited; deduction-at-source repayment process needs modernization.
  - Data gaps on credit access due to non‑standardized reporting for non‑bank lenders.
  - Long‑term local‑currency financing from retirement funds and insurers underutilized; capital markets small and illiquid.
- Policy actions:
  - Deepen listed and unlisted debt markets and alternative asset classes.
  - Strengthen line‑ministries oversight of DFIs: improve performance monitoring, establish results framework, introduce DFI‑specific regulatory framework.

### FSAP Key Recommendations (selected, timing and lead agencies)
- Systemic Risk Analysis:
  - Introduce Basel III liquidity standards [¶16] — MT–LT — BoB.
  - Regular stress testing of large insurers’ and retirement funds’ concentrated bank exposures [¶18] — MT — NBFIRA, BoB.
  - Implement data management systems and standardized reporting for banks/NBFIs [¶19] — ST — BoB, NBFIRA.
  - Develop data quality and granularity for stress testing [¶19] — ST–MT — BoB.
  - Strengthen liquidity management framework [¶30–31] — ST — BoB.
  - Develop interbank repo market ensuring legal enforceability [¶30] — MT — BoB.
- Financial Sector Oversight:
  - Align corporate governance and risk management with Basel principles; improve offsite/onsite tools [¶25] — ST — BoB.
  - Revise risk‑based supervision and bank rating methodology [¶25] — MT — BoB.
  - Establish legal basis for consolidated supervision [¶25] — MT — BoB, MoF.
  - Enhance supervisory capacity for Pillar 2 risks and SREP; augment resources [¶25] — MT — BoB.
  - Operationalize AML/CFT RBS including virtual assets [¶26] — MT — BoB, NBFIRA.
  - Tailored Pillar II capital buffer requirements for banks with low capital and high dividend payout ratios [¶21] — ST — BoB.
- Safety Nets and Crisis Management:
  - Establish ELA operational framework once BoBAA effective [¶32] — ST–MT — BoB.
  - Elevate BDIS to law and develop operational plan [¶32–33] — ST–MT — BoB, MoF.
  - Expand supervisory MOUs to include resolution plans; prepare contingent plans [¶32] — MT — BoB.
  - Expand FSC remit for crisis preparedness and manage recovery/resolution planning [¶33] — ST–MT — FSC, MoF, BoB.
- Financial Development:
  - Strengthen line‑ministries oversight of DFIs by improving performance monitoring, establishing a results framework, and introducing DFI regulatory framework [¶37] — ST — Ministries responsible for SOFIs.

### Banks' Assets and Liabilities (As of June 2022)
- Total: 77.8 bn.
- BWP 278.2 bn.
- Assets composition:
  - Loans, 62%
  - Cash 6%
  - Interbank loans, 19%
  - Securities 10%
  - Others 3%
- Liabilities composition:
  - Deposits, 77%
  - Balance due to domestic banks 2%
  - Equity 10%
  - Others 8%
- Credit risk:
  - RWAs of credit risk account for 89 percent of total risk-weighted assets.
  - Largest part of total assets comprises loans (83 percent).
  - Loans defined as gross loans, advances, and balances due from other banks.

### Household Loans and Distribution (Percent of total)
- Distribution of household loans:
  - 64.86%
  - 28.32%
  - 6.00%
  - 0.67%
  - 0.14%
- Composition of household loans:
  - Personal loans: 70 percent (mainly unsecured consumer credit).
  - Mortgages: 23 percent.
- Many lenders collect repayments via direct salary deduction, contributing to generally low levels of household NPLs.

### Funding and Liquidity Risks
- Deposits of NBFIs in banking sector: 23 percent of deposits; sizeable deposits from a few large depositors.
- Largest banks hold close to 68 percent of total household and corporate call and savings deposits; smaller banks rely on price‑sensitive fixed deposits or interbank funding.
- Deposits dominated by short-term tenors.
- Peer groups (end-June 2022): Peer 1-2-3 represent 64-22-14 percent of banking system assets, respectively.

### Non-bank Financial Institutions — Exposures and Liquidity Risks
- Retirement Funds Act, 2022 (RFA) changes:
  - Reduce maximum offshore investments from 70 percent to 50 percent of total assets.
  - Allow “early access” to pensions and increase lump sum payout on retirement from 30 percent to 50 percent of accumulated savings; introduce additional lump-sum withdrawal options.
- Deposits of top seven insurance companies account for approximately one third of their capital.
- Deposits from retirement funds account for close to 46 percent of banking sector total capital (NBFIRA 2022 Annual Report and Banking Sector Financial Statistics, 2021).
- Retirement funds’ payouts and investments (as of 2021):
  - Offshore equity: 52 percent of total assets.
  - Offshore alternative investments: almost 9 percent.
  - Contributions growth: around 8 percent per year.
  - Investment income: BWP 17bn in 2021.
  - Payments upon retirement range from 65 to 95 percent of all payouts in surveyed funds; share of payments upon retirement reached 80 percent of all payouts with around 40 percent paid as lump-sum.
  - Survey coverage: select group of retirement funds accounting for 81 percent of market assets.
- Heterogeneity across funds: liquidity risk assessment critical for smaller funds or those with benefits exceeding contributions.

### Interest Rate Risk in the Banking Book (IRRBB)
- Over 65 percent of bank assets are floating rate.
- Approximately 35 percent of liabilities are fixed rate and subject to administered rates that lag policy rate changes.
- Bank assets have shorter maturities than liabilities; in rising rate environment NII may spike and IRRBB exposures may be positive.
- Peer groups: Peer 1-2-3 represent 64-22-14 percent of assets as of end-June 2022.

### Macro Scenarios Used in Stress Testing
- Adverse scenario: sharp decline in real GDP growth in 2024 with recovery by 2025; GDP path more severe than COVID pandemic outcome and less severe than Global Financial Crisis.
- Scenario assumptions:
  - Policy rates continue increasing; assume 1:1 adjustment ratio to prime rates.
  - Long-term bond yields spike then decline as recovery occurs.
  - Pula depreciates against USD due to high domestic inflation.
  - Inflation spikes in 2024 then returns to baseline trend.
- Scenario construction sources: World Economic Outlook; IMF estimates; Flexible System of Global Models.

### Bank Solvency Stress Test Findings
- Aggregate capital depletion in adverse scenario: relatively small (less than 0.02 percent of GDP).
- Rising interest rates contribute positively to capital under both baseline and adverse scenarios due to asset-liability repricing advantages.
- Credit risk increases significantly in 2024 under adverse scenario, but NII increase outweighs impact from rising NPLs.
- Market risk: low given limited securities exposure.
- Pass-through sensitivity:
  - CAR could drop by up to 6 percentage point to 16 percent in 2025 under less favorable pass-through assumptions.
  - Even with pass-through rate of zero, aggregate CAR remains above regulatory thresholds; however three banks would face challenges meeting minimum capital requirements by 2025 (aggregate recapitalization needs reach to 0.4 percent of GDP).
- Concentration risk:
  - If 20 percent of household performing loans transition to NPLs, some banks would face significant capital shortfalls and aggregated CAR could fall below minimum requirements; majority of banks retain robust capital buffers.

### Liquidity Framework and Stress Tests
- Statutory Liquid Assets Ratio (LAR) is an ex‑ante mitigant but does not assess flow‑based liquidity as LCR would.
- LCR stress testing (30‑day horizon) using restrictive HQLA definition aligned with current regulatory liquid assets:
  - All banks were above 100 percent LCR under baseline with current regulatory HQLA definition.
  - Peer 1 banks vulnerable to short-term inflow shocks due to sizeable long‑maturity assets; Peer 3 banks resilient across scenarios.
  - Under extreme aggregated inflow/outflow shocks, Peer 1 and Peer 2 banks fell below 100 percent LCR; Peer 3 banks remained resilient.
  - Expanding eligible liquid assets to include required reserves and government bonds with maturity > one year (with haircuts) improved LCR ratios.
- Recommendation: transition plan to Basel III liquidity framework including revised reporting granularity, guidance, calibration of haircuts/run-off rates and supervisory experience prior to prudential limits.

### Non-bank Stress Test Findings — Insurers and Retirement Funds
- Insurance companies:
  - Asset valuations largely unchanged under adverse scenario; low sensitivity due to large cash holdings and BWP depreciation increasing foreign asset values.
  - No capital shortfalls indicated for insurers.
- Retirement funds (defined contribution schemes):
  - Pension values decline under adverse scenario.
  - Fund members with < 10 years to retirement could face reduction in excess of 15 percent; recommended shift to more conservative allocations for such members.
  - Sample: four life insurers, four short-term insurers, four retirement funds; market coverage 80–95 percent per sector.

### Interconnectedness, Contagion, and Systemic Implications
- Intersectoral linkages significant; common exposures (bank deposits by insurers/retirement funds) could lead to contagion.
- Data limitations: absence of complete bilateral exposure data prevented full spillover measurement.
- Contagion analysis:
  - Interbank positions small relative to banks’ capital; larger banks are major domestic lenders.
  - Failure of any Peer 1 bank could result in up to 12.7 percent potential capital reduction for a counterparty bank.
  - Failure of all Peer 1 banks in simultaneous credit and funding shock: remaining system capital loss of 12 percent.
  - Vulnerability index: Peer 3 banks show capital loss of 11 percent attributed to other banks’ defaults.

### Financial System Oversight — Supervisory Gaps and Recommendations
- Institutional oversight shared: BoB, NBFIRA, Financial Intelligence Agency (FIA).
- Legal frameworks: BoB Act, Banking Act (1995), Bureaus de Change Regulations (2004), Credit Information Act (2021), NBFIRA Act (2022), Financial Intelligence Act (2022).
- Key legal/supervisory gaps:
  - Primary legislation lacks explicit BoB responsibility for banking supervision and powers for consolidated supervision, corporate governance prudential standards, change of control, major acquisitions.
  - Ministerial representation on BoB Board and ministerial involvement in licensing and appeals may undermine operational independence.
  - No enhanced prudential review/reporting for newly licensed banks; no statutory requirement for approval of change of control.
- Supervisory recommendations (selected):
  - Strengthen risk-based, forward-looking supervision and SREP; introduce consolidated supervision powers; develop corrective action framework linked to risk ratings.
  - Institute corporate governance standards: board accountability, codes of conduct, conflict-of-interest policies, regulation of related‑party transactions.
  - Enhance guidance on collateral valuation, problem assets, provisioning requirements, and develop more granular offsite data.
  - Improve liquidity supervision: include flow-based metrics and currency-level assessments; set explicit supervisory limits for intermediation and deposit concentration ratios.
  - Operationalize AML/CFT RBS, clarify reporting for VASPs, and strengthen beneficial ownership systems.

### AML/CFT and Beneficial Ownership
- Findings:
  - Prioritize operationalizing AML/CFT risk‑based supervisory toolkit and oversight framework for VASPs.
  - Clarify reporting requirements under revised AML/CFT framework; accompany with public awareness and capacity building.
  - Ensure beneficial ownership information is adequate, accurate, up-to-date, and timely.
- Recommendations:
  - Implement RBS for AML/CFT with special focus on VASPs.
  - Clarify reporting requirements and carry out public awareness/capacity-building initiatives.
  - Strengthen beneficial ownership information systems.

### Financial Safety Nets, Crisis Management, and Bank Resolution — Findings and Building Blocks
- Findings:
  - Legal reforms (BoBAA and DRBA) needed to empower BoB for safety nets, ELA, deposit insurance, and bank resolution.
  - Botswana Deposit Insurance Regulation (BDISR) drafted; elevating to law required to align with international practices.
  - Operational manuals and procedures for safety nets not yet developed.
- Near- to medium-term actions:
  - Improve DRBA to ensure preemption in bankruptcy; enact promptly.
  - Develop policies, procedures, and manuals for bank intervention and resolution.
  - Enact BDIS law and action plan for operationalization with funding arrangements and public backstop; ensure operational independence.
  - Establish FSC technical working groups for stress testing, simulations, contingency planning, and communication.
  - Expand supervisory MOUs with home countries and develop ELA policies (reserve ELA as funding of last resort for solvent but illiquid banks; require forward-looking solvency assessment and broaden eligible collateral).

### Financial Sector Development — Findings and Recommendations
- Findings:
  - Retirement funds and life insurance assets: 50 percent to GDP.
  - Two‑thirds of retirement/life insurance assets invested off‑shore.
  - Combined asset size of four SOFIs covered by FSAP: BWP 10.4 billion (approximately 8.5 percent of size of banking sector).
  - Repo market inactive due to legal/documentation uncertainty; introducing close-out netting recommended.
  - DFIs weak performance; MSME financing gaps persist.
  - Financial Inclusion Roadmap period: 2022–2027.
- Recommendations:
  - Debt Management Office to provide updated Medium-term Debt Management Strategy and detailed annual borrowing plan; develop investor relations capacity.
  - Clarify legal framework for repo market and introduce close-out netting.
  - Strengthen oversight of SOFIs by government/line ministries; create MoF unit focused on OECD SOE corporate governance.
  - Subject SOFIs to independent oversight by BoB or NBFIRA with proportionality; consider regulatory framework for SOFIs.
  - Modernize deduction at source loan repayment process; develop roadmap and consumer protection elements.
  - Expand MSME lending through credit enhancements, wholesale facilities for NBFIs, and updated regulatory framework for non-bank lenders; implement credit infrastructure reforms.

### Selected Financial Soundness Indicators (2018–Sep-22)
- Capital Adequacy:
  - Capital to assets: 9.4 9.3 9.4 8.9 8.7
  - Regulatory capital to risk weighted assets: 17.9 18.5 20.0 17.3 17.2
  - Regulatory Tier 1 capital to risk-weighted assets: 13.2 13.4 13.8 12.5 12.4
  - Non-performing loans net of provisions to capital: 16.2 14.9 9.2 10.2 7.4
- Asset Quality:
  - Large exposure to capital: 112.7 83.4 72.2 85.1 82.4
  - Non-performing loans to total gross loans: 5.4 4.8 4.3 4.3 3.4
- Earnings and Profitability:
  - Trading income and total income: 3.6 4.2 5.3 6.3 6.3
  - Return on assets: 2.6 5.1 1.8 2.1 2.8
  - Return on equity: 23.3 33.5 17.3 21.3 29.2
  - Interest margin to gross income: 57.2 58.0 55.7 51.8 52.5
  - Non-interest expenses to gross income: 58.5 55.7 61.6 62.0 57.8
  - Personnel expenses to noninterest expenses: 44.4 45.4 45.4 45.2 45.4
- Liquidity:
  - Liquid assets to total assets: 6.1 6.0 5.4 6.1 3.9
  - Liquid assets to short-term liabilities: 7.2 7.0 6.5 7.2 4.6
  - Customer deposits to total (non-interbank) loans: 118.8 120.6 122.9 122.4 125.5
- Exposure to FX Risk:
  - Net open position in FX to capital: 8.1 5.1 4.3 2.4 2.5
  - Foreign currency-denominated loans to total loans: 7.8 6.2 4.9 3.5 4.5
  - Foreign currency-denominated liabilities to total liabilities: 26.1 23.0 12.6 19.4 30.9

### Implementation of 2007 FSAP Recommendations (Appendix I — selected)
- Implemented reforms:
  - 2012–2016 Financial Sector Development Strategy prepared.
  - Abolished 91-day BoBC; introduced 3‑month and 12‑month BoBC; Government Note Program increased from P15 billion to P30 billion.
  - NBFIRA capacity building and prudential framework: multiple prudential rules and strategic plans implemented; manpower grew from 18 to just above 100.
  - Pension sector: Fund administrators regulation and supervision covered in Retirement Funds Act 2022; asset managers licensed under Securities Act 2014.
  - Insurance prudential rules: 13 prudential rules issued from March 2012.
  - Monetary policy/FX regime reforms: crawling band, inflation objective 3–6 percent, adoption of 7‑day BoBC as monetary policy rate and interest rate corridor (reforms from April 28, 2022).
- In progress or not implemented:
  - BoB full supervisory authority over statutory banks: Not Implemented.
  - Consolidated supervision powers in BA: In progress.
  - Supervision of statutory banks’ licensing powers: Not Implemented.
  - Recommendations on securitization, BISS-RTGS penalties, and BISS governance: Not Implemented.

### Risk Assessment Matrix (selected risks and channels)
- Abrupt global slowdown or recession:
  - Overall Level of Concern: Medium; Relative likelihood: High.
- Rising and volatile food and energy prices:
  - Overall Level of Concern: High; Relative likelihood: Medium.
- De-anchoring of inflation expectations and stagflation:
  - Overall Level of Concern: High; Relative likelihood: High.
- Natural disasters related to climate change:
  - Overall Level of Concern: Low; Relative likelihood: Medium.
- Cyber attacks:
  - Overall Level of Concern: Medium; Relative likelihood: High.
- Delays in implementing fiscal consolidation:
  - Overall Level of Concern: Medium; Relative likelihood: Medium.

*Source: IMF Botswana FSAP Executive Summary and selected appendices (1bwaea2023004).*

### EXECUTIVE SUMMARY __________________________________________________________________________ 7

### EXECUTIVE SUMMARY

### BACKGROUND — Macrofinancial Context
- Botswana had a strong post-pandemic economic recovery, with real GDP growth of 5.8 percent in 2022.
- Recovery supported by robust growth in diamond exports enabled a narrowing of the current account deficit and stabilized the import coverage ratio.
- Private sector credit growth was 5.4 percent (y-o-y, Q2 2022).
- Inflation risks are tilted to the upside:
  - Domestic inflation peaked at 14.6 percent (y/y) in August 2022.
  - The Bank of Botswana increased the monetary policy rate by a combined 151 basis points between December 2021 to August 2022.
  - The medium-term inflation objective is 3–6 percent; second-round effects could keep inflation above that objective over the next 12 months.
- Policy context and structural priorities:
  - A comprehensive policy package at the onset of COVID supported recovery.
  - The Economic Reform and Transformation Plan (ERTP) aims to diversify the economy and promote growth across traditional sectors, import substitution, SME support, and digitalization.
  - Rebuilding fiscal buffers remains a priority to ensure sustainability and preserve sovereign credit ratings.

### BACKGROUND — Financial Sector Structure
- Financial sector size and composition:
  - The financial sector accounts for close to 130 percent of GDP.
  - Sector comprises commercial banks and non-bank financial institutions (NBFIs) that are well integrated.
  - The banking sector comprises nine commercial banks; the three largest banks account for 64 percent of banking sector assets.
  - Two banks are identified as Domestic Systemically Important Banks (D-SIBs) and account for 46 percent of banking sector assets.
  - Domestic ownership of banks is mainly through the largest pension fund that holds 22 percent of bank shares.
- Retirement funds and capital markets:
  - Retirement funds’ assets represent 54 percent of GDP.
  - Offshore equities account for 61 percent of retirement funds’ total assets (up to Q3 2022 retirement funds could invest up to 70 percent offshore; Retirement Fund Act (2022) reduces maximum offshore investments to 50 percent).
  - Of domestic retirement fund investments, 40 percent are in domestic bonds, of which approximately 55 percent is in outstanding government bonds.
  - Domestic capital markets are small and illiquid.
- Concentration and linkages:
  - Banks are largely foreign‑owned subsidiaries of pan‑African conglomerates and hold subsidiaries in NBFIs.
  - The bulk of the NBFI sector consists of retirement funds (43 percent of financial system assets); the remainder (15 percent of financial sector assets) comprises insurance companies, microlenders, and brokers.
  - Interbank loans include placements with foreign affiliated banks.

### SYSTEMIC RISK ASSESSMENT — Key findings and scenarios
- Overall resilience:
  - The financial system has remained broadly resilient since the last FSAP (2007); banks hold adequate capital and maintain ample liquidity and show moderate profitability.
  - The financial sector withstood the pandemic well, supported by policy measures and strong sector financial positions.
- Main risks to financial stability:
  - High volatility in diamond prices, geopolitical developments, and tightening global financial conditions.
  - Realization of risks could delay economic recovery and fiscal stability, weaken the external position, and depreciate the pula.
- Stress test outcomes:
  - The system appears resilient to a wide range of shocks; most banks would withstand severe stress.
  - Two banks would face a mild capital shortfall under an adverse risk scenario.
  - Most banks are expected to meet prescribed liquidity ratios under a baseline scenario; some show vulnerabilities under an adverse scenario.
  - For the non-bank financial sector, insurance companies appear well capitalized and do not face a shortfall under a severe scenario.
- Analytical enhancements recommended:
  - Conduct regular stress testing of large insurers’ and retirement funds’ concentrated bank exposures to monitor and detect financial stability risks.
  - Implement data management systems for stress testing and interconnectedness; update and standardize reporting frameworks for both banks and NBFIs.
  - Develop data quality and granularity to enhance stress-testing framework to include sensitivity tests for credit risk, including to household debt and corporate indebtedness.
  - Develop interbank repo market by ensuring legal framework supports enforceability and title transfer of securities under relevant Master Agreement.

### FINANCIAL SECTOR OVERSIGHT — Supervision and macroprudential policy
- Progress and reforms:
  - Legal reforms: Bank of Botswana (Amendment) Act, 2022 (BoBAA) passed by Parliament in August 2022; effective date is February 2023.
  - Draft Revised Banking Act (DRBA) published via the Botswana Government Gazette on January 13, 2023.
  - Key elements of the Basel III Framework are at an advanced stage of implementation; D‑SIBs identified.
  - AML/CFT framework upgraded since the 2017 FATF assessment.
  - Bank of Botswana’s stress testing capacity has been enhanced.
- Recommendations to strengthen oversight:
  - Banking regulation and supervision:
    - Make the supervisory framework more risk‑based and forward looking, and implement on a consolidated basis.
    - Strengthen regulatory guidance for treatment of problem assets and provisioning, and for liquidity and interest rate risk.
    - Strengthen operational independence of BoB supervision.
    - Expand oversight of banks’ corporate governance to include concentration risk and related‑party transactions.
    - Incorporate tools for reviewing and assessing banks’ internal capital adequacy assessment and Pillar II risks into the Supervisory Review and Evaluation Process (SREP).
    - Revise the bank rating methodology to be more forward‑looking and adaptive to emerging risks.
    - Establish legal basis and supervisory frameworks for consolidated supervision for banks and banking groups.
    - Enhance supervisory methodologies and capacity to cover Pillar 2 risks; augment supervisory resources and increase the number of risk specialists.
  - Macroprudential policy:
    - Enhance macroprudential toolkit to address liquidity vulnerabilities, consider credit‑based household sector tools, and establish capital buffers.
    - Once implemented, BoBAA will include an explicit reference to financial stability with an expanded role for the Financial Stability Council (FSC).
  - Financial integrity:
    - Operationalize AML/CFT risk‑based supervision (RBS) for banks and NBFIs, including novel risks from virtual assets.
    - Ensure timely availability of beneficial ownership information and complement AML/CFT measures with public awareness and capacity building.

### SYSTEMIC LIQUIDITY MANAGEMENT, SAFETY NETS, AND CRISIS PREPAREDNESS
- Liquidity management:
  - Recommendation to transition to Basel III liquidity standards to strengthen systemic liquidity monitoring.
  - Strengthen liquidity management framework to include upgraded forecasting tools, streamlined access to refinancing facilities, and a comprehensive collateral schedule.
  - Develop the interbank repo market and ensure legal enforceability and title transfer of securities.
- Financial safety net and crisis management:
  - Establish the operational framework for emergency liquidity assistance once BoBAA comes into effect.
  - Elevate Botswana Deposit Insurance Regulation (BDIS) to law and address gaps to develop a strategic and operational plan for deposit insurance implementation.
  - Operationalize the emergency liquidity framework.
  - Expand supervisory memoranda of understanding with home country regulators to include resolution plans; prepare contingent resolution plans for foreign subsidiaries.
  - Expand the remit of the Financial Stability Council to coordinate crisis preparedness and management, oversee recovery and resolution planning, conduct stress testing and simulations, develop contingency planning, and implement a communications strategy.

### FINANCIAL SECTOR DEVELOPMENT
- Key development issues:
  - A well‑coordinated financial sector development strategy is necessary to deepen the sector and channel resources.
  - Development Finance Institutions (DFIs) have not delivered expected results despite significant financial resources; DFIs currently have high levels of non‑performing assets.
  - Digital financial services have driven financial inclusion; further advancements—fast payment services, open banking, and digital ID—would enable progress.
  - Private sector credit to micro, small, and medium enterprises (MSMEs) remains limited.
  - Data gaps on access to credit exist due to lack of standardization and gaps in the regulatory framework for non‑bank lenders.
  - Substantial long‑term, local currency financing from retirement funds and insurance companies is not being fully utilized; capital markets are small and illiquid.
- Policy actions for development:
  - Deepen listed and unlisted debt markets and support development of alternative asset classes.
  - Strengthen line‑ministries oversight of DFIs by:
    - Improving performance monitoring.
    - Establishing a results framework to track outcomes.
    - Introducing a regulatory framework specifically designed for DFIs.

### FSAP KEY RECOMMENDATIONS (selected, with timing and lead agencies)
- Systemic Risk Analysis:
  - Introduce the Basel III liquidity standards to strengthen systemic liquidity monitoring [¶16] — MT–LT — BoB.
  - Conduct regular stress testing of large insurers’ and retirement funds’ concentrated bank exposures [¶18] — MT — NBFIRA, BoB.
  - Implement data management systems for stress testing and interconnectedness; updated and standardized reporting frameworks for banks and NBFIs [¶19] — ST — BoB, NBFIRA.
  - Develop data quality and granularity to enhance stress testing including sensitivity tests for credit risk [¶19] — ST–MT — BoB.
  - Strengthen liquidity management framework with upgraded forecasting tools and comprehensive collateral schedule [¶30–31] — ST — BoB.
  - Develop interbank repo market by ensuring legal enforceability and title transfer of securities [¶30] — MT — BoB.
- Financial Sector Oversight:
  - Align prudential requirements for corporate governance and risk management with Basel principles, and improve offsite and onsite tools [¶25] — ST — BoB.
  - Revise risk‑based supervision approach and bank rating methodology [¶25] — MT — BoB.
  - Establish legal basis for consolidated supervision for banks and banking groups [¶25] — MT — BoB, MoF.
  - Enhance supervisory methodologies and capacity for Pillar 2 risks and SREP [¶25] — MT — BoB.
  - Augment supervisory resources and increase number of risk specialists [¶25] — MT — BoB.
  - Operationalize AML/CFT risk‑based toolkit for banks and NBFIs, including virtual assets [¶26] — MT — BoB, NBFIRA.
  - Impose tailored Pillar II capital buffer requirements for banks with low capital and high dividend payout ratios [¶21] — ST — BoB.
  - Enhance macroprudential toolkit to address liquidity vulnerabilities and consider household credit tools and capital buffers [¶28] — MT — BoB.
- Financial Safety Net and Crisis Management:
  - Establish operational framework for emergency liquidity assistance once BoBAA is effective [¶32] — ST–MT — BoB.
  - Elevate Botswana Deposit Insurance Regulation to law and develop strategic and operational plan [¶32–33] — ST–MT — BoB, MoF.
  - Expand supervisory MOUs with home country regulators to include resolution plans and prepare contingent resolution plans for foreign subsidiaries [¶32] — MT — BoB.
  - Expand remit of the FSC to coordinate crisis preparedness and management and oversee recovery and resolution planning [¶33] — ST–MT — FSC, MoF, BoB.
- Financial Development Issues:
  - Strengthen line‑ministries oversight of DFIs by: (i) improving performance monitoring, (ii) establishing a results framework, and (iii) introducing a regulatory framework specifically designed for DFIs [¶37] — ST — Ministries responsible for SOFIs.

*Source: IMF Botswana FSAP Executive Summary (selected sections).*

### 77.8 bn

### Banks' Assets and Liabilities Composition (As of June 2022)

### Asset and Liability Breakdown
- Total: 77.8 bn
- BWP 278.2 bn
- Assets composition (percentages as shown):
  - Loans, 62%
  - Cash 6%
  - Interbank loans, 19%
  - Securities 10%
  - Others 3%
- Liabilities composition (percentages as shown):
  - Deposits, 77%
  - Balance due to domestic banks 2%
  - Equity 10%
  - Others 8%
- Graphic axis markers present: 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

### Credit Risk and Asset Quality
- Credit risk is the largest risk in Botswana’s banking system.
- Risk-weighted assets (RWAs) of credit risk account for 89 percent of total risk-weighted assets.
- The largest part of total assets comprises loans (83 percent).
- Loans are defined as gross loans, advances, and balances due from other banks.

### Loan Concentration by Counterparty (2022Q2)
- Loans by counterparty (Percent of total, 2022Q2):
  - Households
  - Real sector
  - NBFIs
  - Public NFCs
  - Non resident loans
  (Specific numerical shares for each category are shown in figures; see Household Loans and Distribution of Household Loans sections below.)

### Household Loans and Distribution
- Household loans (Percent of total) — distribution of household loans:
  - 64.86%
  - 28.32%
  - 6.00%
  - 0.67%
  - 0.14%
- Composition of household loans:
  - Bank loans to households are largely personal loans (70 percent), mainly in the form of unsecured consumer credit.
  - Mortgages comprise 23 percent of household loans.
- Many lenders collect repayments through direct salary deduction, contributing to generally low level of non-performing household loans.

### Funding and Liquidity Risks
- Banks are vulnerable to liquidity and funding risks due to concentrated funding profiles—short-term deposits of corporations and NBFIs.
- Total deposits of NBFIs in the banking sector account for 23 percent of deposits and comprise sizeable deposits from a few large depositors.
- The largest banks hold close to 68 percent of total household and corporate call and savings deposits, leaving smaller banks to rely largely on price-sensitive fixed-deposits or access interbank funding from larger banks.

### Deposits by Maturity and Holder (June 2022)
- Deposits are dominated by short-term tenors.
- The banking system’s deposits are concentrated in Peer 1 banks.
- Peer groups are determined by the banks’ share of total assets to banking system assets; Peer 1-2-3 represent 64-22-14 percent, respectively, as of end-June 2022.

*Source: BOTSWANA — INTERNATIONAL MONETARY FUND (figures and text as of June 2022).*

### 8.      Non-bank financial institutions are increasingly exposed to the banking sector with

### 8.      Non-bank financial institutions are increasingly exposed to the banking sector with related liquidity risks

### Retirement funds, insurance exposures, and liquidity risks
- The new Retirement Funds’ Act, 2022 (RFA) requires retirement funds to reduce the maximum share of offshore investments from 70 percent to 50 percent of total assets.
- The RFA will allow members “early access” to pensions (before retirement) and raise the lump sum payout upon retirement from 30 percent of accumulated savings to 50 percent, and introduce additional (lump-sum) withdrawal options for beneficiaries—transferring liquidity from retirement funds to households and potentially compromising the ability to accumulate long-term retirement savings.
- Deposits of the top seven insurance companies account for approximately one third of their capital and deposits from retirement funds account for close to 46 percent of the banking sector total capital (NBFIRA 2022 Annual Report and Banking Sector Financial Statistics, 2021 data).
- Retirement funds’ liquidity pressures: the share of payments upon retirement have reached 80 percent of all payouts; out of which, around 40 percent are paid as a lump-sum.
- Retirement funds investments and payouts (all data as of 2021):
  - Offshore equity accounts for 52 percent of total assets and is the dominant asset class.
  - Offshore alternative investments account for almost 9 percent.
  - Contributions have increased by around 8 percent per year.
  - Investment income reached BWP 17bn in 2021 (noting extreme volatility due to inclusion of unrealized gains and losses in valuations).
  - Payments upon retirement range from 65 to 95 percent of all payouts in surveyed funds; payouts are generally still considerably lower than contributions.
- Note on survey coverage: statistics on payouts are based on a survey covering a select group of retirement funds that account for 81 percent of market assets.
- Heterogeneity across funds: numbers differ considerably between retirement funds depending on age and salary of members and cyclicality of the employer’s industry. For smaller funds—and those where benefits already exceed contributions—a robust liquidity risk assessment will be critical.

### Interest rate risk in the banking book (IRRBB) and maturity mismatches
- Over 65 percent of bank assets are floating rate, while approximately 35 percent of liabilities are fixed rate and are subject to administered rates that typically lag policy rate changes.
- Bank assets have significantly shorter maturities than liabilities.
- In an environment of rising interest rates, banks may experience a spike in net interest income (NII) and positive IRRBB exposures.
- Peer group definitions used in analysis: Peer 1-2-3 represent 64-22-14 percent of assets, respectively, as of end-June 2022.

### Macro scenarios used in stress testing
- Adverse global and local shocks entail a sharp decline in real GDP growth in 2024 and recovery by 2025; the GDP path is more severe than the COVID pandemic outcome and less severe than the Global Financial Crisis.
- Scenario narratives and model inputs:
  - Policy rates will keep increasing and factor into higher prime rates on credit, assuming a 1:1 adjustment ratio.
  - Long-term bond yields initially spike as the economy goes into recession and government borrowing rises, then gradually decline as the economy recovers.
  - The pula will depreciate against the U.S. dollar due to high domestic inflation relative to trading partners.
  - Inflation spikes in 2024 before returning to the downward baseline trend.
- Sources for scenario construction: World Economic Outlook; IMF estimates. Real GDP path estimated using a “two standard deviations” rule and adjusted with past recessions. Other shocks rely on scenario narratives and The Flexible System of Global Models output. Details in Appendix IV.

### Solvency stress test findings for banks
- Aggregate capital depletion in the adverse scenario is relatively small (less than 0.02 percent of GDP).
- Under both baseline and adverse scenarios, rising interest rates contribute positively to capital due to shorter maturities, a higher share of variable-rate assets, and greater pass-through from policy rate on assets compared to liabilities.
- Credit risk increases significantly under the adverse scenario in 2024, but the increase in NII outweighs the impact on capital from rising non-performing loans (NPLs).
- Banks present low market risk given limited exposure to securities.
- Pass-through sensitivity:
  - Significant NII results from full pass-through assumptions applied to the lending rate.
  - Sensitivity analyses show the sector’s capital adequacy ratio (CAR) could drop by up to 6 percentage point to 16 percent in 2025 under less favorable pass-through assumptions.
  - Even with a pass-through rate of zero, the aggregate CAR would remain above regulatory thresholds; however, three banks would face challenges meeting minimum capital requirements by 2025 (aggregate recapitalization needs reach to 0.4 percent of GDP).
- Note on pass-through assumption: reflects prevailing trend practiced by commercial banks and corroborated from BoB’s feedback.

### Concentration risk from household loans
- A homogenous structure of concentrated exposures to household loans could create pockets of credit risk.
- Assuming 20 percent of household performing loans transit into non-performing loans, some banks would encounter significant capital shortfalls, resulting in the aggregated CAR falling below minimum capital requirements.
- Nevertheless, the majority of banks possess robust total capital buffers and would remain unaffected by severe shocks to household loans.

### Liquidity framework and stress tests
- Botswana’s statutory liquid assets ratio (LAR) is an ex-ante risk mitigant but does not monitor susceptibility to liquidity flows as comprehensively as the liquidity coverage ratio (LCR) estimated under stressed assumptions.
- Liquidity stress testing approach:
  - Compared large and concentrated wholesale deposits against run-off rates and the stock of unencumbered high-quality liquid assets (HQLA) over a 30-day stress period.
  - Applied a restrictive definition of HQLA aligned with current regulatory liquid assets definition, excluding certain Basel III eligible assets and short-term interbank deposits.
  - Note: BoB regulatory framework excludes the primary reserve requirement (PRR) and government bonds with maturities beyond one year from statutory liquid assets; banks have access to the PRR through full averaging and government bonds with more than 1-year to maturity are eligible as collateral.
- LCR stress test results:
  - All banks were well above the 100 percent LCR ratio under the baseline when using the current regulatory definition of HQLA.
  - Peer 1 banks were vulnerable to short-term inflow shocks due to sizeable assets with long-term maturities, and showed lower vulnerability to outflow shocks.
  - Under an extreme scenario of aggregated inflow and outflow shocks, Peer 1 and Peer 2 banks fell below the 100 percent LCR ratio; Peer 3 banks were resilient under all scenarios.
  - LCR ratios remained adequate when expanding eligible liquid assets to include required reserves and government bonds with maturity in excess of one year (with haircuts).
  - The banking system is vulnerable to wholesale deposits run-off but expanding the list of eligible liquid assets improves liquidity metrics.
- Definitions and references:
  - HQLA = high-quality liquid asset; GB = government bonds; LCR = liquidity coverage ratio; RR = reserve requirement.
  - Peer 1-2-3 represent 64-22-14 percent of assets, respectively.

### Recommendations to transition to Basel III liquidity framework
- The Bank of Botswana (BoB) should develop a plan to transition to the Basel III liquidity framework by:
  - Revising statutory reports to permit the reporting granularity required for Basel III liquidity monitoring (e.g., net loans and advances to different counterparties in different maturity buckets).
  - Developing guidance for banks on application of the Basel III liquidity ratios.
  - Appropriately calibrating and setting regulatory weights (haircut rates, run-off rates, and cap ratio of inflows/outflows) relevant for Botswana’s financial sector.
  - Defining a plan for supervisors to gain material experience with the ratios, including on reporting and validating, allowing banks to report ratio calculations for monitoring purposes prior to imposing prudential limits.

### Non-bank risk analysis: insurers and retirement funds
- Insurance sector:
  - Asset valuations of insurance companies were largely unchanged even under an adverse scenario.
  - Low sensitivity to market rates attributed to large cash holdings of short-term insurers and depreciation of the pula increasing the value of foreign assets.
  - Risk analysis did not indicate capital shortfalls for insurers.
- Retirement funds:
  - Pension values of retirement fund members decline under an adverse scenario.
  - Retirement funds are defined contribution schemes.
  - Fund members with less than 10 years to retirement could face a reduction in excess of 15 percent (pre-retirement stage); switching these members to a more conservative asset allocation would be recommended.
  - The non-bank sample comprises four life insurers, four short-term insurers and four retirement funds, with market coverage between 80 percent and 95 percent for each sector, respectively.
  - The retirement funds risk analysis focused on representative members 10 and 30 years to retirement.
  - Findings highlight the need for NBFIRA to monitor vulnerabilities.

### Interconnectedness, contagion, and systemic implications
- Financial system intersectoral linkages are significant; common exposures among financial institutions (banks and NBFIs) could lead to contagion, particularly for insurance companies that place large deposit holdings compared to their capital.
- Data limitations: absence of complete bilateral exposure data prevented full measurement of potential spillovers across the financial sector.
- Recommended actions: BoB and NBFIRA should enhance data quality and granularity to monitor intersectoral contagion risks and set appropriate limits for intermediation and deposit concentration ratios.
- Contagion analysis results:
  - Interbank positions are small relative to banks’ capital; larger banks are major lenders in the domestic interbank market.
  - Dispersion of the contagion index in Peer 1 banks and of the vulnerability index among Peer 3 banks reflect different degrees of bilateral interbank exposures.
  - The failure of any bank in the Peer 1 group would result in a potential capital reduction of up to 12.7 percent for the counterparty bank.
  - In case of a simultaneous credit and funding shock and the failure of all banks in Peer 1, the remaining banking system would experience a total capital loss of 12 percent.
  - The vulnerability index indicates Peer 3 banks are among the most vulnerable, with capital loss of 11 percent attributed to other banks’ defaults.
- Index definitions:
  - Vulnerability index = percentage losses of a bank due to the default of other banks.
  - Contagion index = weighted average percentage losses of other banks due to the failure of a given bank.

### Financial system oversight, supervision, and regulatory reform recommendations
- Institutional landscape:
  - Financial sector oversight is shared across the Bank of Botswana (BoB), NBFIRA, and the Financial Intelligence Agency (FIA).
  - Legal frameworks include the BoB Act, the Banking Act, 1995 (BA), the Bureaus de Change Regulations (2004), the Credit Information Act (CI Act), 2021, the NBFIRA Act, 2022, and the Financial Intelligence Act (FI Act), 2022.
- BoBAA and Banking Act revisions:
  - Implementing the BoB Amendment Act (BoBAA) and prioritizing planned revisions to the BA should strengthen supervision and financial stability by establishing legal bases for emergency liquidity assistance (ELA), deposit insurance, crisis management and resolution.
  - Planned BA revisions are expected to address supervisory gaps identified in graded Basel Core Principles (BCP) and resolve legal limitations on BoB’s powers for crisis preparedness, crisis management, emergency response and resolution.
- Operational independence:
  - Current allowances for Ministerial representatives on BoB’s Board, and Minister involvement in licensing and supervisory appeals could undermine BoB’s operational independence; additional legislative changes may be required to safeguard BoB’s operational independence in supervisory oversight.
- Key supervisory reforms and capacity building (next steps):
  - Strengthen supervisory approach and tools to develop a risk-based, forward-looking framework implemented by supervisors and risk specialists to identify emerging risks among banks and banking groups.
  - Institute an integrated risk management framework: articulate regulatory requirements, limits, supervisory expectations; review banks’ internal risk models for liquidity risk and interest rate risk in the banking book; develop guidance on credit concentration by industry and geographic location, collateral concentrations, and prudential limits for exposure to a single counterparty or group of interconnected counterparties.
  - Establish corporate governance standards: regulations on board accountability, codes of conduct, conflict of interest policies, and enhanced regulation for related-party transactions.
  - Introduce consolidated supervision: legal reforms should give BoB powers for consolidated supervision; circulate Guidelines on Supervision of Financial Conglomerates as a priority once the revised BA is in force.
  - Establish collateral valuation, problem assets, and provisioning requirements: provide clarity on collateral treatment and valuation, enhance supervisory tools/methodologies and more granular offsite data to improve supervisory effectiveness and support periodic system-level analyses of trends and concentrations in problem assets.
  - Develop framework for country and transfer risk: adopt a comprehensive approach to measure these risks.
- AML/CFT efforts: continue efforts to improve effectiveness of the AML/CFT regime following removal from the FATF gray listing in October 2021 and the European Union blacklist of high-risk third countries in January.

*Source: IMF staff report (selected excerpts).*

### 2022. Yet, operationalizing the risk-based supervisory toolkit and implementing a framework to

### 2022. Yet, operationalizing the risk-based supervisory toolkit and implementing a framework to oversee novel AML/CFT risks from virtual asset service providers (VASPs) should be prioritized to improve supervisory effectiveness. Clarifying reporting requirements of the new AML/CFT implementation framework under the revised legal framework should be complemented by increased public awareness and capacity building to ensure consistency in interpretation.

### AML/CFT and Beneficial Ownership
- Findings
  - Operationalizing the risk-based supervisory toolkit and implementing a framework to oversee novel AML/CFT risks from virtual asset service providers (VASPs) should be prioritized to improve supervisory effectiveness.
  - Clarifying reporting requirements of the new AML/CFT implementation framework under the revised legal framework should be complemented by increased public awareness and capacity building to ensure consistency in interpretation.
  - Ensuring that beneficial ownership is adequate, accurate, up-to-date, and available on a timely basis will bolster oversight.

- Recommendations
  - Prioritize implementation of the risk-based supervisory toolkit for AML/CFT, with special focus on VASPs.
  - Clarify reporting requirements under the revised AML/CFT legal framework and accompany with public awareness and capacity-building initiatives.
  - Strengthen beneficial ownership information systems to ensure timely and accurate access.

### Macroprudential Policy
- Findings
  - Steady progress has been made in implementing operational changes; planned legal reforms should complement these to set a good foundation for systemic risk oversight.
  - Once the BoBAA is in force, the status of the Financial Stability Committee (FSC) will be elevated to a statutory committee with a specific legal mandate, enhancing willingness to act using semi-hard powers.
  - The FSC’s membership comprises the chief technical heads for respective regulatory agencies with oversight for the financial sector, facilitating activation of policies.
  - The BoB’s financial stability report consolidates assessment from all FSC members but could benefit from more forward-looking analysis on key systemic risks latent in: the real estate sector; NPLs across business sectors; and homogenous credit exposures to households.
  - Enhancing data quality on full credit exposures through a comprehensive credit information registry can improve granularity for stress testing and macroprudential decision making.
  - Many macroprudential tools are available, although few new measures have been implemented recently.

- Recommendations
  - Publish the memorandum of understanding that sets the scope for collaboration across regulatory agencies and their use of macroprudential tools.
  - Enhance forward-looking analysis in the financial stability report, including risks from real estate, NPLs, and household credit concentrations.
  - Establish a comprehensive credit information registry; streamline reporting of positive and negative information from all credit providers, including micro lenders.
  - Prepare to use macroprudential tools more actively given the uncertain global macroeconomic environment.

### Systemic Liquidity Management
- Findings
  - Banks’ core funding sources are skewed to short-term wholesale deposits; liquidity uncertainty is mainly managed using large liquidity buffers.
  - Volatile excess reserves and limited funding options in the underdeveloped interbank market potentially raise the cost for liquidity shortfalls.
  - Although there is full reserve averaging of the PRR, banks typically front-load or retain fixed reserve balances throughout the reserve maintenance period.
  - Improving liquidity forecasts would enable the BoB to better calibrate liquidity operations and stabilize system-wide liquidity.

- Recommendations on refinancing and collateral
  - Simplify numerous refinancing operations and streamline the refinancing framework.
  - Adjust the penalty rate for shortfalls on the PRR and allow access to the standing credit facility (SCF) after the closure of interbank market trading to better support stable short-term interest rates.
  - Use the credit facility (CF) for daylight credit to support ongoing settlement in the Botswana Interbank Settlement Systems.
  - Publish a comprehensive haircut schedule for eligible collateral and simplify management of collateral pools to avoid permanently pledged securities that cannot be redeployed.
  - Consider a master repurchase agreement to support development of money markets.
  - Avoid punitive rates for under-fulfillment of reserve requirements to prevent reserve hoarding and mixing liquidity management with supervisory objectives.

- Notable charted observations (as described)
  - Structural excess liquidity is defined as the sum of banks’ current account balances at the BoB, net repo position, as well as the access to the standing deposit facility SDF (positive) and credit facilities (negative).
  - The bank rate was discontinued as of April 28, 2022.

### Financial Safety Nets, Crisis Management, and Bank Resolution
- Findings
  - Implementing legal reforms to provide the mandate for the BoB to fully oversee financial safety nets and crisis management is a priority.
  - The revised laws—BoBAA and DRBA—should enable the BoB to operationalize crisis management and bank resolution frameworks through: (i) establishing a special bank resolution regime with expanded resolution powers for the BoB; (ii) instituting the Deposit Insurance Scheme of Botswana (BDIS); and (iii) allowing the BoB to conduct emergency liquidity operations.
  - The BoB has drafted a Botswana Deposit Insurance Regulation (BDISR), but establishing an effective BDIS requires elevating the BDISR to a law to ensure alignment with good international practices.
  - Developing other regulations, manuals, and procedures for operationalizing remaining safety nets has yet to start.

- Key near- to medium-term building blocks and recommendations
  - Improve the DRBA by addressing deficiencies, mainly to ensure preemption in bankruptcy matters, then push for prompt enactment.
  - Develop policies, procedures, and manuals for bank intervention and resolution.
  - Implement a suitable law for the BDIS and prepare an action plan for operationalization, including clear funding arrangements through bank contributions and a public backstop; ensure operational independence by establishing a separate unit reporting directly to the BoB Board.
  - Establish technical working groups within the FSC for crisis preparedness: stress testing, simulations, contingency plans, and communication strategy.
  - Expand supervisory MOUs with all home countries to include alternative options for bank resolution.
  - Develop policies and procedures for the Emergency Liquidity Assistance (ELA) framework: reserve ELA as funding of last resort for solvent but temporarily illiquid banks; require forward-looking solvency assessments accompanied by anticipated funding plans; allow BoB a sufficiently wide range of eligible collateral with suitable risk management.
  - Prioritize FSC work on safety nets and crisis preparedness over the near- to medium-term and develop an effective, comprehensive implementation framework including communication.

### Financial Sector Development
- Findings
  - Retirement funds and life insurance companies’ assets are significant at 50 percent to GDP, and two-thirds of assets are invested off-shore.
  - Domestic capital markets are small; domestic government debt issuance is constrained due to a strong fiscal position and the non-government debt market is less developed.
  - The repo market is inactive, partly due to a lack of legal certainty and documentation; introducing close-out netting and clarifying enforceability and systemic resolution processes would improve market confidence.
  - Weak financial performance by some state-owned financial institutions (SOFIs) is a concern; combined asset size of the four most relevant SOFIs covered by FSAP is BWP 10.4 billion, or approximately 8.5 percent of the size of the banking sector.
  - Financial inclusion slightly lags regional peers with gaps in coverage and usage; the 2022–2027 Financial Inclusion Roadmap has ambitious targets to drive strategic focus.
  - The deduction at source loan repayment process should be modernized to improve accessibility for all credit providers and small businesses.
  - DFIs are the main source of credit for MSMEs but public sector lending is subsidized and unsustainable, competing with non-bank lenders; MSME financing gaps persist.

- Recommendations
  - Debt Management Office should provide an updated Medium-term Debt Management Strategy and a more detailed annual borrowing plan; develop investor relations capacity.
  - Clarify legal framework for repo market and introduce close-out netting.
  - Strengthen oversight of SOFIs by the government and respective line ministries; create a MoF unit with adequate capacity and authority focused on OECD guidelines on corporate governance of SOEs.
  - Subject all SOFIs to independent oversight, with proportionality, by BoB or NBFIRA; consider a regulatory framework for SOFIs (licensing, regulation, supervision).
  - Modernize deduction at source loan repayment process focusing on operational capacity, openness, and consumer protection; develop roadmap.
  - Expand lending to MSMEs through well-designed credit enhancements, wholesale facilities for NBFIs, and updated regulatory framework for non-bank lenders; implement credit infrastructure reforms for effective credit risk assessment.

- Select sector metrics and indicators referenced
  - Retirement funds and life insurance companies’ assets: 50 percent to GDP.
  - Two-thirds of retirement/life insurance assets invested off-shore.
  - Combined asset size of four SOFIs covered by FSAP: BWP 10.4 billion, or approximately 8.5 percent of the size of the banking sector.
  - Financial Inclusion Roadmap period: 2022–2027.

### Authorities’ Views
- Acknowledgements
  - Authorities appreciated open discussions with the FSAP team and found the assessment and recommendations useful.
  - They highlighted enhancements in the financial stability framework since the 2007 FSAP and anticipated benefits of the BoBAA.
  - They emphasized resilience of the domestic financial system to global and regional shocks over the past decade and a half.
  - Authorities agreed with the systemic risk assessment and the need to fill identified data gaps, noting some will require time.
  - They welcomed bank solvency stress test results and noted banks’ high levels of capital, conservative business models, and prudent lending standards focused on households in government employment.
  - Authorities recalled the BoB’s commitment to prudent monetary policy, recent changes to the monetary policy framework, and ongoing plans to implement an LCR-based regime.
  - They welcomed the FSAP’s recognition of progress in financial sector oversight, their commitment to implement Basel III, and the strength of AML/CFT framework since the last FATF assessment.
  - Authorities welcomed the assessment of the non-bank sector and the need to monitor regulatory changes affecting retirement funds.
  - On financial safety nets, authorities acknowledged early steps on resolution planning and highlighted: (i) current high level of solvency in the banking sector; (ii) ability and willingness of main bank shareholders to support institutions if needed; and (iii) high levels of bank capital—all factors reducing probability of crisis and need for public resources.

### Selected Financial Soundness Indicators (from Table 3, 2018–Sep-22)
- Capital Adequacy
  - Capital to assets: 9.4 9.3 9.4 8.9 8.7
  - Regulatory capital to risk weighted assets: 17.9 18.5 20.0 17.3 17.2
  - Regulatory Tier 1 capital to risk-weighted assets: 13.2 13.4 13.8 12.5 12.4
  - Non-performing loans net of provisions to capital: 16.2 14.9 9.2 10.2 7.4

- Asset Quality
  - Large exposure to capital: 112.7 83.4 72.2 85.1 82.4
  - Non-performing loans to total gross loans: 5.4 4.8 4.3 4.3 3.4

- Earnings and Profitability
  - Trading income and total income: 3.6 4.2 5.3 6.3 6.3
  - Return on assets: 2.6 5.1 1.8 2.1 2.8
  - Return on equity: 23.3 33.5 17.3 21.3 29.2
  - Interest margin to gross income: 57.2 58.0 55.7 51.8 52.5
  - Non-interest expenses to gross income: 58.5 55.7 61.6 62.0 57.8
  - Personnel expenses to noninterest expenses: 44.4 45.4 45.4 45.2 45.4

- Liquidity
  - Liquid assets to total assets: 6.1 6.0 5.4 6.1 3.9
  - Liquid assets to short-term liabilities: 7.2 7.0 6.5 7.2 4.6
  - Customer deposits to total (non-interbank) loans: 118.8 120.6 122.9 122.4 125.5

- Exposure to Foreign Exchange (FX) Risk
  - Net open position in FX to capital: 8.1 5.1 4.3 2.4 2.5
  - Foreign currency-denominated loans to total loans: 7.8 6.2 4.9 3.5 4.5
  - Foreign currency-denominated liabilities to total liabilities: 26.1 23.0 12.6 19.4 30.9

*International Monetary Fund — Botswana Financial Sector Assessment (excerpts).*

### Appendix I. Implementation of 2007 FSAP Recommendations

### Appendix I. Implementation of 2007 FSAP Recommendations

### Overview of implementation status
- The appendix lists 26 numbered recommendations from the 2007 FSAP and the implementation status for each recommendation.
- Implementation statuses used: Implemented; Not Implemented; In progress; Partially Implemented.

### Key implemented reforms (selected)
- Recommendation 1: Draw up a comprehensive financial sector strategy reform plan under the guidance of a high-level inter-agency committee.
  - Implemented. A 2012–2016 Financial Sector Development Strategy was prepared under the guidance of a high-level inter-agency coordinating committee.
- Recommendation 2: Develop a strategy for lowering the stock of Bank of Botswana Certificates (BoBCs), consistent with monetary policy and price stability objectives.
  - Implemented. Abolishing of the 91-day BoBC; introduction of the 3-month and 12-month BoBCs and increase in the Government Note Program from P15 billion to P30 billion.
- Recommendation 4: Develop, publish, and implement a strategy for building the capacity of the NBFIRA within the framework of the NBFIRA Act.
  - Implemented. Four strategic plans documented:
    - 2010–2013: development of rules, regulations, operating policies and levy structure approval.
    - 2013–2016: development of legal and regulatory frameworks and introduction of risk based supervisory approach; review of NBFIRA Act (enacted in 2016).
    - 2016–2021: implementation of the new NBFIRA Act; focus on financial stability for non-banking sector and market conduct.
    - 2021–2026: focus on developing and implementing a robust regulatory framework, strengthening NBFIs resilience and Governance, and stakeholder engagement.
  - Manpower growth: from 18 at inception to just above 100.
  - NBFIRA mandate expanded to include virtual assets service providers, capital markets, retirement funds, insurance and lending activities.

### Banking sector reforms and gaps
- Recommendation 5: Give full supervisory authority to BoB for statutory banks and license these institutions.
  - Not Implemented. BoB still does not have full authority over statutory banks and does not have powers to license them; supervision derives from Section 3 of the revised Banking Act (BA).
- Recommendation 6: Give powers to BoB to supervise banking groups on a consolidated basis.
  - In progress. The BA is being revised to empower the Central Bank to supervise a banking group or conglomerate (Section 42 of the revised BA).
- Recommendation 7: Amend the Banking Act so BoB can vet “significant” and “controlling” shareholders.
  - In progress. The BA is being revised to strengthen BoB powers to vet significant and controlling shareholders (Section 21).

### Pension sector reforms
- Recommendation 8: Introduce licensing and on-going supervision of pension fund administrators and asset managers under the new NBFI RA Act.
  - Implemented. Fund administrators regulation and supervision covered in the new Retirement Funds Act 2022. Asset managers specifically licensed and supervised under Securities Act 2014.
- Recommendation 9: Expand information collected by the registrar, such as foreign asset holdings, including “non-traditional” assets.
  - Implemented. PFR2 (2012) – Pension Funds Investment Rule provides the split between traditional and non-traditional assets, off-shore and on-shore split.
- Recommendation 10: Develop and implement broad investment, governance, and custodian guidelines.
  - Implemented. PFR2 and PFR10 implemented from 2012.

### Insurance sector reforms
- Recommendation 11: Develop an on-going supervision plan and prudential requirements (risk assessment and management, liability management).
  - Implemented. Following NBFIRA establishment, 13 prudential rules were issued from March 2012, including:
    - 1. Classes of Business – defined 2012
    - 2. GR2 – Financial Condition Report General Insurance 2012
    - 3. GR3 Approved Person’s Annual Report General Insurance 2012
    - 4. IICR – Intermediary Conduct Rule 2014
    - 5. IPR1G - Prescribed Valuation Method General Insurance Liabilities
    - 6. IPR1L – Prescribed Valuation Method Long Term Insurance Liabilities
    - 7. IPR2G – Prescribed Valuation Method & Admissibility Restrictions General Insurance Assets
    - 8. IPR2L - Prescribed Valuation Method & Admissibility Restrictions for Long-Term Insurance Assets 2012
    - 9. IPR3G Prescribed Capital Target General Insurance 2012
    - 10. IPR3L Prescribed Capital Target for Long Term Insurers 2012
    - 11. LR2 Financial Condition Report 2012
    - 12. LR3 Valuator’s Annual Report Long Term Insurance
    - 13. PPR Policyholder Protection Rules 2012
  - The prudential framework adopted a Risk-Based Supervision (RBS) model replacing compliance-based monitoring.
- Recommendation 12: Collect and analyze statutory returns and analyze relevant information on solvency, re-insurance, claims, and expenses for off-site monitoring.
  - Implemented. Prudential Rules introduced annual and quarterly statutory returns via the online Risk Based Supervision System (RBSS) which are analyzed on the same platform.
- Recommendation 13: Implement regulations on intermediaries and issue guidelines on market conduct.
  - Implemented. Insurance Intermediaries Conduct Rules introduced in 2014 and Policyholder Protection Rules introduced to improve disclosures and protect policyholders.

### Financial and capital markets, financial infrastructure
- Recommendation 14: Establish a group to consider issuance of government and parastatals securities.
  - Implemented. Bond Auction Technical Committee (MoF and BoB) spearheaded reforms. Government Note Issuance Program increased from P15 billion to P30 billion following approval by Parliament in September 2020. Government introduced 3-month Treasury bills in October 2020 and 12-month Treasury bills in January 2021.
- Recommendation 15: Assess costs and benefits of supporting OTC trading in government securities.
  - Implemented. Hybrid model adopted using both OTC and ATS.
- Recommendation 16: Review legislative and regulatory framework to identify reforms to promote securitization.
  - Not Implemented.
- Recommendation 17: Define actions warranting penalties in BISS-RTGS and specifics of penalties.
  - Not Implemented.
- Recommendation 18: Formalize and publicize BISS system governance arrangements.
  - Not Implemented.

### Systemic liquidity and monetary policy
- Recommendation 19: Enhance coordination and transparency of monetary and exchange rate policy.
  - Implemented. Crawling band exchange rate regime implemented through continuous and gradual adjustment (crawling) of the trade weighted NEER of the pula. Rate of crawl based on forecast inflation differential between Botswana and trading partner countries; revised annually using a forward-looking approach. Monetary policy framework adopted in 2008; inflation objective range set at 3–6 percent with a rolling 3-year policy horizon.
- Recommendation 20: Streamline the structure of policy interest rates and further encourage market-determined interest rates.
  - Implemented. Monetary operations reforms introduced April 28, 2022:
    - Adoption of the yield on the main monetary operations instrument (currently the 7-day BoBC) as the anchor policy rate called the Monetary Policy rate.
    - Established an interest rate corridor with a 200-basis points margin.
    - Allowed commercial banks to independently determine their own prime lending rate.
- Recommendation 21: Strengthen systemic liquidity forecasting and undertake and disseminate analytical work on monetary transmission channels.
  - Implemented. New liquidity forecasting unit established and resourced with Assistant Manager and Supervisor; new analytical and forecasting tools developed with IMF TA missions. Monetary Policy Statement is published at the beginning of the year specifying the framework, some instruments and targets.

### Enhancing access to financial services
- Recommendation 22: Update Cooperative Societies Act to ensure safety and soundness.
  - In progress. Revised Cooperative Societies Act undergoing review within the Ministry of Entrepreneurship; expected submission for legal drafting in 2023 and law in 2024. Re-drafted Banking Bill gives BoB powers (Sections 3 and 4) to grant authority to persons to transact banking business or engage in deposit taking, extending to SACOOs.
- Recommendation 23: Proceed with privatization of government-owned financial institutions.
  - Partially Implemented. BBS Limited granted commercial banking licence by BoB in 2022. Botswana Savings Bank (BSB) Lesedi 2022–2025 strategy premised on expected implementation of the BSB (Transition) Act, 2012 or possible review of the BSB Act. National Development Bank being transformed into an Agribank following government pronouncement in April 2022.

### AML/CFT
- Recommendation 24: Intensify implementation of the existing framework including setting up a FIU and active coordination and information sharing.
  - Implemented. The FIA established by Section 3 of the Financial Intelligence Act, 2009 that came into force in March 2010.
- Recommendation 25: Criminalize terrorist financing by law.
  - Implemented. Terrorist financing criminalized under Section 5 of the Counter Terrorism Act, 2014.

### Crisis management and resolution
- Recommendation 26: Issue guidelines for management of problem financial institutions and a framework for emergency liquidity assistance (ELA).
  - In progress. Guidelines on Managing Financial instability at a Macro Level are developed and continuously reviewed. Regarding ELA, Section 38A of BoBAA provides that BoB may act as Lender of Last Resort by providing ELA.

---

### Appendix II. FSAP Risk Assessment Matrix (selected risks and channels)
- Abrupt global slowdown or recession
  - Overall Level of Concern: Medium
  - Relative likelihood: High
  - Impact and transmission channels:
    - Lower demand for diamond and other commodity exports could slow rebound in tourism.
    - A slowdown in neighboring countries could lower SACU revenue, affecting external and fiscal balances, foreign reserves and putting pressure on the pula.
- Rising and volatile food and energy prices
  - Overall Level of Concern: High
  - Relative likelihood: Medium
  - Impact and transmission channels:
    - Higher inflation translates to higher interest rates across the economy.
    - Retirement funds and insurance could suffer loss of premium payments—either through moratoria requests or policy surrenders—impacting institutions’ liquidity.
- De-anchoring of inflation expectations and stagflation
  - Overall Level of Concern: High
  - Relative likelihood: High
  - Impact and transmission channels:
    - Increases in funding costs could impose additional stresses on banks, households and leveraged firms.
    - Tighter financial conditions could leave consumers and businesses with deteriorating balance sheets posing credit risk to banks and underperforming assets.
    - Loan re-pricing due to higher monetary policy rate could impact large share of unsecured household loans, posing credit risks to banks’/financial institutions’ balance sheet.
    - Falling asset prices and valuation losses on retirement funds could erode capital buffers.
    - Non-bank sector heavily invested in offshore equities could face sharp decline in income, large valuation losses and weakened capital positions.
- Natural disasters related to climate change
  - Overall Level of Concern: Low
  - Relative likelihood: Medium
  - Impact and transmission channels:
    - Damage to infrastructure, amplified supply chain disruptions, water and crop production disruptions, slower domestic growth, higher unemployment, increased NPLs, higher loan loss impairment, pressure on banks’ profitability and capital buffers.
- Cyber attacks
  - Overall Level of Concern: Medium
  - Relative likelihood: High
  - Impact and transmission channels:
    - Loss of confidential and critical data, financial losses, business disruption and reputational damage for financial institutions/sector.
- Delays in implementing fiscal consolidation
  - Overall Level of Concern: Medium
  - Relative likelihood: Medium
  - Impact and transmission channels:
    - Effects amplified if coupled with a sovereign credit rating downgrade.
    - Increased demand for the financial sector to finance the government potentially crowding out credit to the private sector; lower growth and higher NPLs.

Note on RAM: The Risk Assessment Matrix reflects staff’s views as of the time of discussions with the authorities and reflects the October 2022 G-RAM.

### Banking Sector: Solvency Test (framework highlights)
- Institutional perimeter
  - Institutions included: Eight commercial banks (including two D-SIBs).
  - Market share: 93.2 percent of assets in the Botswana banking system as of June 2022.
  - Data and baseline date:
    - Supervisory data (balance sheet and income statements).
    - Commercial Bank Survey (bank-level average duration of securities in banking book and trading book, dividend payout ratio by banks in the past 10 years).
    - Starting position: June 2022.
- Channels of risk propagation and methodology
  - Methodology: IMF Solvency Stress Test Workbox (Balance-sheet model).
  - Satellite models for macro-financial linkages:
    - Credit Risk: Satellite models linking credit risk variables with macroeconomic variables by banks to estimate loan losses.
    - Market risk: Mark to Market (MtM) approach used to calculate valuation losses for Held for Trading (HfT) and Available for Sale (AfS) securities when shocks to risk-free rates and credit spread.
    - Repricing risk and Credit spread risk formulae included in the framework text.

*Source: Appendix I and Appendix II, Botswana FSAP implementation matrix and risk assessment.*

### Appendix III. Stress Test Matrix for Banks

### Appendix III. Stress Test Matrix for Banks

### Bank Solvency: Framework and Methodology
- Domain: Top-down by FSAP Team.
- Apply FX shocks on banks open foreign exchange positions.
- Net Interest Income: interest rate risk in the banking book (IRRBB) is assessed by using interest income rate/ interest expense rate satellite models and maturity gap analysis, based on supervisory data on interest sensitive assets and liabilities by repricing buckets.
- Functional specification noted: Y Y = f (macroeconomic variables); (IIR, IER)(inflation, nominal prime rate, exchange rate).
- Stress Test Horizon: 3 years (2022–2024).

### Scenario Analysis
- Two macro scenarios: baseline scenario and adverse scenario.
- Baseline scenario:
  - Follows October 2022 WEO.
  - Botswana continues to recover from the COVID-19 pandemic, growing by approximately 4 percent on average over the medium term.
  - Inflation will remain outside of the target band in 2022, mainly because of higher import prices (particularly fuel and food).
  - The MPR is expected to continue increasing, leading to tighter financial conditions.
  - Portfolio outflows are expected to decline as domestic and global economy recovers; strong demand for diamonds will support replenishing of foreign exchange reserves.
  - Inflation expectations are expected to remain anchored, with inflation falling back towards to the target band over the course of 2023.
- Adverse scenario:
  - Uses IMF’s Flexible System of Global Models for the external context and calibrated based on previous crisis episodes with country team for the domestic impact.
  - Driven by a combination of external shocks amplified by domestic characteristics.
  - Botswana economy experiences a U-shaped growth path with a stagflation scenario, assuming:
    - Lower growth in 2022: 1.52 percent below the baseline.
    - Drop in GDP of -9.47% in 2023.
    - This is equivalent to a shock to 2-year cumulative growth of 2.3 standard deviation from historical mean (estimated from 1990 to 2021).
    - GDP growth returns to its potential in year three.
  - Unemployment rate rising to 25.77 percent, 30.58 percent, and 30.5 percent over the 3-year horizon.
  - Pula depreciates against USD most significantly in year 2, with 13.25 percent depreciation below baseline.
  - Inflation: 14.72 percent (year 1), 12.39 percent (year 2), and 6.03 percent (year 3).
  - Monetary policy will stay high to fight against inflation.
  - Diamond price deterioration: 9 percent, 24.1 percent, and 11.5 percent below baseline over the 3-year horizon.

### Risks, Buffers, and Behavioral Assumptions
- Risks/factors assessed:
  - Credit risk (provision costs): determined by changes in estimated new NPL flows.
  - Market risk: impact of financial variable evolution on sovereign bonds and FX open positions.
  - Interest rate risk in the banking book.
  - Net fee and commission income, other income and non-interest expense evolve with macroeconomic conditions.
- Behavioral adjustments:
  - Balance sheet growth assumption: Static balance sheet assumption (Balance sheet growth is zero).

### Calibration of Risk Parameters and Regulatory Standards
- PDs: proxy based on estimated new NPL flows over performing loans. PD derivation involves changes in NPL volumes and application of α̅ where α̅ = (recoveries+ write-offs)/〖NPL〗_(t-1); α̅ is bank specific. Average alpha is calculated using existing data and applied to historical NPLs to estimate PDs.
- LGDs: proxy based on average historical provision coverage ratio by banks (provisions/ NPLs).
- EADs: proxy as performing loans in t-1.
- Regulatory/Accounting and Market-Based Standards:
  - Basel II standardized approach.
  - The hurdle rates are based on minimum capital requirements: 7.5 percent for Tier1 Capital, 4.5 percent for CET1, and 12.5 percent for total capital.
- RWAs evolve with credit growth, net of increase in provisions.

### Reporting and Outputs
- Output presentation includes:
  - Capital ratios pre- and post-shock and capital shortfall for the aggregate banking system.
  - Decomposition of the key drivers of changes in capital ratios system wide.
  - Distribution of capital ratios system wide over the scenario horizon.

### Bank Liquidity Test (TD by FSAP Team)
- Institutional perimeter:
  - Number of banks: Eight commercial banks (including two D-SIBs).
  - Market share: 93.4 percent of assets in the Botswana banking system as of end-August 2022.
- Methodology:
  - LCR (Liquidity Coverage Ratio) – proxy test, using the bank-level Basel II statutory reports data at end of August 2022.
  - Necessary assumptions to align with Basel III LCR when breakdown data unavailable (e.g., proportions of breakdown items).
  - Banks’ 30-day “Net loans and Advances” (M-LIQGAP) lacks breakdown by counterparties; ratios of “Gross Loans and Advances” of all maturities were applied to proxy breakdown data.
  - Inflow shocks were capped at 75 percent of outflows for smaller banks in all adverse scenarios 0-3 under ST scenarios.
- Scenarios:
  - Baseline: coverage of HQLA close to the BoB’s statutory liquid assets, excluding required reserves and government bonds with maturities beyond one year.
  - Severe scenario: same coverage of HQLA as baseline but with larger haircuts on HQLA, lower inflows from retail and non-financial corporations, and larger run-off on banks’ wholesale and retail deposits funding.

### Insurance and Pensions: Solvency Risk (Appendix IV summary)
- Institutional perimeter:
  - Number of institutions: Life insurance: 4; short-term insurance: 4; retirement funds: 4.
  - Market share: Life insurance: ~93 percent of balance sheet assets; Short-term insurance: ~80 percent of gross written premiums; Retirement funds: ~80 percent based on balance sheet assets.
  - Data: Statutory returns. Reference date: June 30, 2022.
- Channels of risk propagation:
  - Investment assets: market value changes of assets and liabilities after price shocks affecting solvency (future pension values for retirement funds).
  - Sensitivity analysis: effect on available capital and solvency position.
- Time horizon:
  - Instantaneous shock (for insurers).
  - Mid-2022 to mid-2024 (for retirement funds).
- Scenario analysis:
  - Global market and emerging markets stress scenario: interest rates continuing to rise, sovereign bond spreads increasing, and equity prices decline.
  - Shock magnitudes:
    - Share prices: -25.1 percent (domestic, and offshore emerging markets), -28.7 percent (offshore advanced economies).
    - Bond prices: -9.2 percent (domestic short-term), -7.3 percent (domestic long-term), -15.0 percent (offshore).
    - Property prices: -15 percent.
    - Currency: +20.6 percent (BWP appreciation).
  - Sensitivity analysis includes market shocks (increase in domestic interest rates and BWP depreciation) and default of largest bank counterparty.
- Risk factors assessed:
  - Market risks: bond prices, share prices, property prices, FX rates.
  - Credit risks: default of largest bank counterparty.
- Regulatory/accounting standards: National GAAP.
- Reporting formats for results:
  - Impact on valuation of assets.
  - Impact on available capital and solvency position (insurance); impact on future pension values (retirement funds).
  - Dispersion across companies and contribution of individual shocks.

### ROSC: Basel Core Principles — Key Observations (Appendix V excerpts)
- Assessment context:
  - First graded assessment for Botswana’s bank supervision under 2012 BCP standards; previous 2007 FSAP highlighted gaps in independence, corporate governance, consolidated supervision, and bank resolution.
  - Assessment conducted onsite during October 2–November 12, 2022.
- Market structure and indicators:
  - Banking sector assets represent approximately 61.0 percent of GDP in 2021.
  - Access to banking services: ratio of number of depositors to adult population around 78.9 percent (2021).
  - Average financial intermediation ratio: about 81 percent.
- Capital and profitability:
  - All banks reported capital adequacy and common equity Tier 1 capital ratios above prudential minimum limits of 12.5 percent and 4.5 percent respectively.
  - Aggregate unimpaired capital for the banking industry: P13.6 billion in 2021.
  - Net after-tax profit increased by 25 percent (y/y) in 2021.
  - Aggregate return on equity: 16.9 percent; return on average assets: 1.7 percent (2021).
  - Liquid asset holdings generally exceed the minimum 10 percent liquid assets ratio.
- Credit risk:
  - Non-performing loans to total loans and advances in 2021: 4.2 percent.
  - Total past due loans declined in 2021 due to recoveries and loan write-offs.
  - COVID-19 relief measures (including a 6-month loan repayment moratorium) may have delayed deterioration in asset quality; Loans treated under COVID relief measures amounted to P5.6 billion (representing 8.5 percent of total loans) as of December 2020. COVID-relief measures were withdrawn effective January 2023 (instituted in April 2020).
  - Credit information sharing regulated under the Credit Information Act, 2021; BoB regulates credit bureaus.
- Main supervisory deficiencies and recommendations (summary of findings):
  - Material deficiencies in BoB’s responsibilities, objectives and powers within primary legislation for bank supervision; outdated legal framework weakens effective supervision.
  - Banking Act (BA) does not specify BoB’s primary responsibility for promoting safety and soundness of banks and the banking system; lacks prudential requirements for corporate governance, risk management, transactions with related parties, change of control, consolidated supervision, major acquisitions.
  - Ministerial involvement in license appeal cases and representation on BoB Board may impede BoB’s operational independence; legal protection for supervisors against legal costs is absent.
  - Despite BA review and Bank of Botswana Amendment Act (BoBAA), 2022 passage, gaps remain regarding appointments and removal provisions for Governors and Deputy Governors in primary law.
  - Arrangements for domestic cooperation and coordination exist (e.g., FSC with MoUs); cooperation with foreign supervisors via supervisory college. Further legal reform may be warranted to facilitate confidential information sharing among domestic supervisors as banks diversify business models.

*INTERNATIONAL MONETARY FUND — Appendix III. Stress Test Matrix for Banks*

### 16.      The BA empowers the BoB as the sole licensing authority for banks, with permissible

### 1bwaea2023004 - 16.      The BA empowers the BoB as the sole licensing authority for banks, with permissible

### Licensing and permissible activities
- The BA empowers the BoB as the sole licensing authority for banks, with permissible activities clearly defined in legislation.
- The Licensing Policy, issued by the BoB, is strict in terms of what activities can be licensed as a bank, complements the legislation on what constitutes a bank, sets limitations on using the word “bank’ and the activities undertaken by a bank.
- Outside of banks licensed by the BoB, statutory banks derive their mandates from statues established by Acts of Parliament.
- Licensing-process features:
  - BoB demonstrates a structured approach to assessing license applications, including ensuring that banks appoint directors and senior management officials that are fit and proper.
  - The policy specifies the need for applicants to provide suitable operating plans, sound systems of corporate governance and disclose the sources of initial capital as well as the applicant’s ability to provide capital injection as needed.
  - Further analysis of ultimate beneficial ownership should be undertaken to identify the individual shareholder.
- Identified gap:
  - After licensing, there are no requirements for enhanced prudential review and reporting requirements for newly licensees.
  - BoB conducts a pre-operation inspection to ensure adequacy of systems, but newly licensees should be subject to an enhanced supervision plan—ideally within the first 12 months—to verify effective implementation of internal controls, risk management framework and governance functions.

### Transfer of significant ownership and major acquisitions (Principles 6 and 7)
- The BA has no definition of significant ownership.
- There are no requirements to obtain the BoB’s approval for change of control or voting rights in a bank.
- In practice, the BoB relies on the Guidelines on Significant Shareholding (published on BoB’s website) to assess a change of significant shareholding.
- Legal deficiency and practical consequence:
  - The lack of provisions in the primary legislation means there is no direct legal remedy to reject or reverse a change in significant ownership ex-post.
  - A framework for major acquisitions is not provided in legislation; while the BA contains countervailing measures, it is questionable whether the supervisor has the powers to fulfil the specificities of a merger or acquisition.

### Supervisory approach, tools, and reporting (Principles 8–10)
- A risk-based supervision (RBS) framework exists, comprising a mix of onsite and offsite surveillance tools and techniques appropriately embedded in supervisory guidance and procedures.
- Main RBS components:
  - full-scope onsite examinations that are performed on a three-year cycle;
  - statutory returns, submitted at various intervals, to regularly assess financial condition and compliance with prudential requirements;
  - meetings with banks’ senior management held at least annually, and on an ad hoc basis, if necessary.
- Strengthening needed:
  - Consider differentiated supervisory requirements for banks, banking groups and systemically important banks;
  - Conduct ongoing evaluation of the effectiveness of the supervisory methodology;
  - Develop framework for system-wide stress testing and analysis to comprehensively assess risk and capital adequacy.
- Identified reporting gap:
  - No reporting requirements for banks on a solo and group basis.

### Corrective measures and consolidated supervision (Principles 11 and 12)
- Use of sanctioning powers provided for in the BA has been limited; BoB traditionally uses moral suasion to enforce prudential standards.
- Supervisory concerns are typically communicated to management and the Board for action.
- Limited experience in:
  - restricting bank licenses;
  - applying more conservative prudential requirements on individual banks (such as higher minimum capital requirements).
- BoB does not have a formulated corrective action policy framework; the framework to link the risk rating system and approaches to corrective actions is absent.
- The BA does not provide for consolidated supervision.
  - BoB is not legally positioned to evaluate the soundness of an entire group considering risks emanating from the bank and its affiliated entities.
  - Current management of group risks occurs through participation in supervisory colleges and bilateral meetings with host supervisors.

### Home/host relationships (CP 13)
- BoB actively participates in supervisory colleges at the group level with effective two-way sharing of information.
- Given that banks are foreign bank subsidiaries, BoB has signed MoUs with most home supervisors of parent entities and resolution plans exist for parent groups.
- Areas for improvement:
  - Planning and conducting onsite examinations in conjunction with home supervisors could be improved.
  - BoB has not operated as the home supervisor to any bank or banking group.

### Corporate governance, audit, and financial reporting (CP 14, 26–28)
- Material deficiencies in corporate governance regulations:
  - Regulations do not explicitly assign responsibility or hold management and boards accountable for instituting sound corporate governance, including through codes of conduct, and instituting policies to address conflicts of interest.
  - BoB has yet to undertake a formal and structured assessment of a bank’s corporate governance framework, and develop supervisory guidance for such assessments.
  - Laws and regulations do not require key internal committees for effective internal risk oversight (e.g., nomination, remuneration, risk committees).
  - Regulations requiring formal assessment of board members’ effectiveness or the power to address director or board ineffectiveness are absent.
- Regulatory and supervisory frameworks for internal control, internal audit, external audit, financial reporting, and disclosures are well established and effective.
- Possible enhancements:
  - Further align frameworks with BCPs to facilitate greater risk focus for audit functions and integrate audit, internal risk control and compliance oversight.
  - Consider additional legal powers for BoB to ensure suitability of external auditors and oversee their work in rare, extreme situations.

### Capital (CP 16)
- Definition of capital and components are aligned with Basel III requirements.
- Approaches for determining risk weighted assets for the Pillar 1 risks (credit, market and operational) are as per Basel II.
- Capital adequacy framework is proportionate to risks and complexities of the banking industry; all banks maintain capital using:
  - standardized approach for credit risk;
  - standardized maturity method for interest rate risk in trading book;
  - Basic Indicator Approach for operational risk.
- Key statistics:
  - As at end December 2021, the average CET1 and Tier 1 ratios for the banking sector in Botswana was comfortably above the minimum requirements at 12.0 percent and 12.5 percent respectively and the total capital adequacy ratio was 18.5 percent.
- Disclosure and ICAAP:
  - All banks are required to make their Pillar 3 disclosures annually with published financial statements.
  - Annual review of the ICAAP has not resulted in a requirement for a bank to hold additional capital against Pillar 2 risks.

### Risk management (CP 15, 17–25)
- BoB has established regulatory and supervisory frameworks promoting a culture of overall risk management among banks.
- Observed developments:
  - Banks are deploying financial models in increasing numbers, using technology in quantifying risks, conducting stress testing, implementing IFRS-9, and adopting a forward-looking approach to business and capital planning.
  - These developments expose banks to model risks, which should be reviewed more closely by BoB.
- Supervisory approach can be improved in areas including:
  - reviewing the approach for problem assets, provisions and reserves;
  - enhancing guidelines for defining exposures to and transactions with related parties to close significant gaps;
  - establishing appropriate risk management policies, procedures, and arrangements for managing country and transfer risks.
- Need for additional supervisory tools:
  - Development of guidance for supervisors, supervisory tools/methodologies and more granular offsite data to improve effectiveness.
- Liquidity risk management:
  - Need to develop supervisory guidance and methodologies to encourage higher standards of liquidity risk management.
  - Clarification needed on expectations regarding banks’ risk management frameworks; prudential norms could be upgraded for liquidity risk management.

### Abuse of financial services (CP 29)
- AML/CFT enhancements:
  - AML/CFT has received heightened attention with a dedicated team of supervisors undertaking onsite and offsite analysis of bank compliance with AML/CFT obligations as stated in the FI Act.
  - Evidence of greater attention allocated to AML/CFT supervision and integration into risk-based activities to address outstanding issues identified in the most recent FATF follow-up report (April 2021).
- Suggested improvements:
  - Offsite analysis of bank policies and procedures and closer feedback between supervisors would help identify group-wide weaknesses in risk management.

### Summary of key supervisory findings (selected from Table V.1)
- Responsibilities, objectives, and powers:
  - Material deficiencies: primary legislation does not specify BoB’s primary responsibility for banking supervision; legal framework has not been regularly reviewed (last review prior to mission was 1995); deficiencies include absence of provisions for consolidated supervision, major acquisitions, corporate governance standards, risk management standards, and change in significant shareholding.
- Independence, accountability, resourcing:
  - Lack of operational independence from potential ministerial interference; inadequate resources.
- Cooperation and collaboration:
  - Further reform needed to facilitate sharing of confidential information with domestic supervisory agencies.
- Permissible activities:
  - Definition of ‘bank’ clear; the term ‘bank’ is restricted.
- Licensing criteria:
  - Newly licensed banks are not subject to an enhanced supervision plan; analysis of ultimate beneficial ownership is not undertaken to identify the individual shareholder.
- Transfer of significant ownership and major acquisitions:
  - No provision in primary legislation for significant shareholding or legal remedies to reject/modify/reverse transfers or major acquisitions ex ante or ex post.
- Supervisory approach and tools:
  - No internal guidelines for handling distressed or weak banks; system-wide stress tests not conducted; limited engagement with independent non-executive directors on a routine basis.
- Corrective and sanctioning powers:
  - Risk rating methodology is not linked with processes to handle weak and distressed banks and to develop corrective measures.
- Consolidated supervision:
  - No provisions in primary legislation.
- Home-host relationships:
  - Implement MoUs with all home supervisors and increase frequency of information sharing beyond supervisory colleges.
- Corporate governance:
  - Laws/regulations do not explicitly assign corporate governance responsibilities to boards and senior management; BoB has not undertaken formal structured assessments; key committee requirements absent; no power to remove directors or boards that do not perform in interest of bank or depositors.
- Problem assets, provisions, and reserves:
  - Prudential framework for asset classification does not cover all credit exposures; no explicit enforceable prudential provisioning framework that back-stops accounting framework; gaps in supervisory expectations and oversight on individual assessment of significant exposures, eligible collateral valuation and recognition, multiple exposures to same borrower, oversight of rescheduled/restructured loans, and timely write-offs.
- Offsite data and system-wide analysis:
  - Inadequacy of off-site data and lack of periodic assessment of trends and concentrations across banking system for problem assets and risk mitigation.

*Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1bwaea2023004.pdf*

### 19. Concentration risk and large

### 19. Concentration risk and large exposure limits

### Concentration risk: key gaps and findings
- BoB’s prudential requirement for concentration risk management has gaps:
  - (a) the regulatory and supervisory framework cover only limited types of concentrations and do not explicitly cover concentration to industry, geographical regions, collateral, product and markets;
  - (b) definition of exposures is not comprehensive;
  - (c) prudential limit for single counterparty and group of inter-connected counterparties is at significant variance from Basel norm of 25 percent of Tier 1 capital;
  - (d) regulations allow banks to seek exemptions from BoB to exceed the prudential limits and the BoB allows it; and
  - (e) compliance with prudential limits are assessed with reference to net exposures (net of collateral and bilateral netting), but gross exposures are not monitored.

### Transactions with related parties: gaps
- Key divergences from Basel norms:
  - Gaps in the definition of exposure on related parties (these do not include exposure through placements and investment).
  - Gaps in the definition of related parties and absence of an explicit and comprehensive definition of related party transactions for prudential purposes.
  - Absence of prudential limits on aggregate related party exposures and absence of explicit provision for deducting from capital exposures in excess of prudential limits.
  - Gaps in governance requirements.
  - Absence of explicit and comprehensive supervisory (prudential) reporting requirement for transactions with related parties.
- These gaps collectively result in significant weaknesses in the prudential regime for transactions with related parties.

### Country and transfer risks: supervisory gaps
- Laws or regulation do not explicitly require banks to:
  - assess country and transfer risks from both immediate risk and ultimate risk perspectives;
  - grade and provision exposure to country and transfer risks.
- Supervision of banks’ management of country and transfer risks is not explicit in the current onsite and offsite frameworks.

### Market risk: exposures and supervisory capacity
- Banks’ exposures to market risks are not material:
  - "0.01 percent to 2.5 percent of total risk-weighted assets as at end-June 2022; all except two banks were below 0.5 percent".
- Market risk exposures arise mainly through:
  - foreign currency risk and interest rate risk in the trading book (IRR-TB).
- Banks do not engage in trading in commodities or equity.
- Regulatory requirements for management of market risks are broadly in place, but significant gaps exist in supervision due to:
  - knowledge and skills gap specific to these risks and their management;
  - lack of adequate guidance and supervisory tools;
  - inadequate offsite reporting requirements.
- As a result, supervision tends to be less intrusive and supervisors tend to place reliance on banks’ assurance functions.

### Interest rate risk in the banking book (IRRBB)
- Regulations, guidance, and supervision do not explicitly distinguish between IRR-TB and IRRBB.
- Banks are not adequately complying with key regulatory elements:
  - measuring interest rate impacts with reference to impact on economic value of equity;
  - having at least two techniques for measuring interest rate risk (gap analysis, duration, simulation and VaR).
- Supervisors are not systematically encouraging or enforcing compliance.
- Supervisors can review qualitative elements via offsite and onsite mechanisms but lack tools to determine the extent of individual banks’ exposure to IRRBB, hindering validation of banks’ internal measurements for ICAAP and assessment of internal limits.

### Liquidity risk: metric limitations
- BoB’s prudential liquidity requirement LAR is a stock measure of liquidity.
- BoB supplements LAR with the intermediation ratio and the deposit concentration ratio.
- Shortcomings:
  - These measures do not assess liquidity risk from a flow perspective.
  - They do not adopt a nuanced approach to currency-wise liquidity risk.
  - They do not consider liquidity risk from off-balance sheet commitments.
  - The two supplemental metrics lack explicit thresholds (regulatory or supervisory) that would trigger supervisory responses, reducing effectiveness.

### Operational risk, internal control, reporting and disclosure
- Operational risk: legal, regulatory, supervisory frameworks and BoB supervisory practices are largely compliant with the requirements of this CP; however, gaps exist in explicit regulations on outsourcing and supervisory reporting on operational risk events and losses, leading supervisors to rely on banks’ internal sources.
- Internal control and audit: frameworks and practice are generally in compliance with the core principle.
- Financial reporting and external audit: frameworks and practice are generally in compliance with the core principle.
- Disclosure and transparency: frameworks and practice are in compliance with the core principle.
- Abuse of financial services: recommendation for greater sharing of risk information between BSD staff and those responsible for AML/CFT; ambiguity on legal interpretation of the five-day reporting threshold for STRs impairs sanctions.

### Key statistic
- Market risk exposures across banks: "0.01 percent to 2.5 percent of total risk-weighted assets as at end-June 2022; all except two banks were below 0.5 percent."

### Recommended actions (selected, Principles 19–29 and related)
- Principle 19:
  - Review and revise regulations to introduce a more comprehensive approach to supervision of concentration risk management in banks, addressing identified gaps.
  - Review and revise prudential limits on single and group of inter-connected counterparties to comply with the Basel norm of 25 percent of Tier 1 capital; avoid allowing case-by-case exemptions to exceed the prudential limit.
  - Make regulatory requirements and supervisory expectations explicit and detailed for management of other types of concentrations (e.g., industry, geographic, collateral, products).
  - Make corresponding changes to the supervision manual, offsite reporting, and analyses to strengthen SREP with reference to concentration risk management by banks.
- Principle 20:
  - Review and comprehensively revise regulation and supervision of exposures to and transactions with related parties to bring these on par with the specific requirements of this core principle.
  - Improve offsite reporting and analyses, and guidance in supervision manuals for onsite supervision of related party transactions.
- Principle 21:
  - Explicitly establish regulatory requirements and supervisory expectations on identification, measurement, monitoring and management of country and transfer risks from immediate and ultimate risk perspectives, including grading and provisioning.
  - Introduce appropriate prudential reporting requirements and revisions to supervisory manual.
  - Provide training and capacity building to enhance relevant supervisory skills.
- Principle 22:
  - Improve offsite reporting; develop supervisory tools and guidance for assessment of banks’ exposure to market risks and their management.
  - Incorporate these elements in the supervision manual and include an explicit component on management of market risks by banks.
  - Provide appropriate training and capacity building for supervisory skills relevant to market risk.
- Principle 23:
  - Improve offsite reporting; develop supervisory methodologies for assessment of banks’ exposure to IRRBB and the potential impact on banks’ capital to better inform supervision and strengthen SREP.
  - Incorporate IRRBB supervision elements in the supervision manual and provide training and capacity building.
- Principle 24:
  - Include flow-based liquidity measures in BoB toolkit.
  - Introduce explicit regulatory and/or supervisory limits for the intermediation and deposit concentration ratios.
  - Assess liquidity and funding risks at the level of each significant foreign currency in addition to aggregate level.
  - Improve off-site reporting and analyses to better capture liquidity and funding risks.
  - Provide more guidance to supervisors to assess these liquidity dimensions and reflect them in banks’ liquidity risk profiles.
- Principle 25:
  - Review and revise laws, regulations, and supervisory manual/guidance to: (a) issue explicit regulations on outsourcing, cybersecurity (currently in draft stage), and operational resilience; (b) modify offsite framework to systematically obtain periodic and structured and unstructured data/reports on operational risk events (including near-misses) and related losses; (c) incorporate additional guidance to supervisors and (d) supplement with training and capacity building.
- Principle 26:
  - Review and revise laws, regulations, and supervisory manual/guidance to: (a) explicitly require internal audit to adopt a formal risk-based internal audit framework; (b) explicitly review staffing and skills in control functions and back/middle offices; and (c) expand supervisory assessments to include adequacy of compliance staff, their skillsets, experience, and training.
- Principle 27:
  - Seek amendment to the Banking Act (1995) (and other relevant laws) to (i) have explicit powers to reject and rescind appointment of an external auditor deemed to have inadequate expertise or independence or not adhering to professional standards, and (ii) have power to access external auditors’ working papers in rare but extreme situations.
- Principle 28:
  - To supplement disclosures under accounting standards, consider establishing explicit disclosure requirements in corporate governance (CP 14) and related party transactions (CP 21) that reflect prudential requirements and expectations.
- Principle 29:
  - Address legal interpretation of the five-day threshold for suspicious transaction report submission.
  - Increase the frequency of data for inclusion in offsite surveillance (e.g., STRs).

*Source: 19. Concentration risk and large exposure limits.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1bwaea2023004.pdf_