## Surviving Low Interest Rates: Central Banks in Kosovo and Other Western Balkan Countries (SIPEA2023027)

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**Canonical URL:** [Surviving Low Interest Rates: Central Banks in Kosovo and Other Western Balkan Countries (SIPEA2023027)](https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023027.pdf)

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### A. The Central Banks’ Financial Situation: An Overview
- Central banks analyzed: Bosnia and Herzegovina (CBBH), Kosovo (CBK), Montenegro (CBCG).
- Balance sheet composition:
  - Assets mainly comprise foreign reserves (cash, foreign government securities, deposits); CBK and CBCG also hold euro-denominated domestic government securities (not considered foreign reserves).
  - Liabilities mainly include deposits from commercial banks and governments.
- Key empirical observation:
  - Post-GFC decline in global interest rates led to a significant decrease in income for all three central banks; net interest income turned negative for all three central banks in 2021.
- Selected balance sheet aggregates (Percent of GDP; as reported for Year 2007 and 2021):
  - Assets (All): 2007 = 32.85; 2021 = 31.22.
  - Foreign assets 1/: 2007 = 32.54; 2021 = 31.14.
  - Domestic claims on government: 2007 = 0.00; 2021 = 0.01.
  - Other assets 2/: 2007 = 0.30; 2021 = 5.7.
  - Liabilities (All): 2007 = 30.94; 2021 = 30.22.
  - Due to commercial banks: 2007 = 18.32; 2021 = 21.7.
  - Due to government and other public entities: 2007 = 0.44; 2021 = 10.5.
  - Equity and Reserves: 2007 = 1.9; 2021 = 1.6.
- Notes:
  - 1/ Foreign assets include cash, deposits placed at non-resident financial institutions, and foreign securities.
  - 2/ Other assets mainly include fixed assets, intangible assets, and assets related to IMF lending programs.

### B. How Did Central Banks Absorb the Shock of Lower Interest Income?
- Main compensating channels:
  - Increase in fees, commissions, and regulatory income:
    - In 2021, net fees, commissions and other regulatory income represented:
      - More than 100 percent of operating expenses at the CBK and CBCG.
      - About 60 percent of operating expenses at the CBBH.
    - Increases reflected both higher unit rates and financial deepening.
  - Negative remuneration on excess reserves:
    - Remuneration rates aligned with euro area short-term rates (negative between 2014 and mid-2022).
    - Income from negative remuneration offsets negative return on foreign reserves funded by excess reserves, but not those funded by mandatory reserves and government deposits (which the central bank still bears).
  - Interest income from domestic government securities (CBK and CBCG):
    - Interest spreads of these securities over German government bonds averaged:
      - 280 bps (Kosovo) during 2018–22.
      - 420 bps (Montenegro) during 2018–22.
    - CBK began holding Kosovo government securities in 2015; as of end-2021:
      - Government securities represented 13 percent of total assets.
      - These securities generated 2/3 of the CBK’s gross interest income.
- Personnel and operating cost trends:
  - Personnel cost-to-GDP ratios over 2014–19:
    - Broadly flat at the CBK; declined at the CBBH and CBCG.
  - Personnel cost and staffing changes 2014–19:
    - 2014 % GDP: Bosnia and Herzegovina = 0.07; Kosovo = 0.07; Montenegro = 0.19.
    - 2019 % GDP: Bosnia and Herzegovina = 0.05; Kosovo = 0.07; Montenegro = 0.17.
    - Change in Total Personnel Costs 2014-19: Bosnia and Herzegovina = -24%; Kosovo = 0%; Montenegro = 26%.
    - Change in the Number of Employee 2014-19: Bosnia and Herzegovina = 4%; Kosovo = 17%; Montenegro = 5%.
    - Change in Personnel Costs per Employee 2014-19: Bosnia and Herzegovina = -5%; Kosovo = 19%; Montenegro = 20%.
    - Change in Nominal GDP per Capita 2014-19: Bosnia and Herzegovina = 30%; Kosovo = 34%; Montenegro = 43%.
    - Nominal Personnel Costs per Employee 2019: Bosnia and Herzegovina = euro 27,166; Kosovo = euro 21,138; Montenegro = euro 22,618.
    - Nominal GDP per Capita 2019: Bosnia and Herzegovina = euro 5,136; Kosovo = euro 3,959; Montenegro = euro 7,959.
  - Cross-country comparisons:
    - Personnel costs of the CBK and CBBH similar to peers; personnel costs of the CBCG are higher.
- Other Western Balkan economies (Albania, North Macedonia, Serbia):
  - Less-constraining exchange rate regimes mitigated the need to raise fees:
    - Banknotes in circulation act as an “equity” buffer.
    - Albania: interest income from domestic assets mitigated equity decline.
    - North Macedonia: lower interest income cushioned by valuation gains from gold reserves.
    - Serbia: currency depreciation 2008–16 led to valuation gains on international reserves.

### C. Rising Interest Rates in 2022 — Projections and Effects
- Rising euro area interest rates in 2022 expected to increase central bank interest income from foreign reserves.
- CBK-specific projections and rules:
  - CBK charter requires transfer of 50 percent of distributable earnings to the Ministry of Finance when equity exceeds 5 percent of monetary liabilities.
  - Baseline staff assumption: net effective return on the CBK’s assets will be 150–200 bps higher by 2024 relative to that observed in 2021.
  - Projection outcome:
    - Rise in net income earnings projected to bring equity above the 5 percent threshold in late 2023 or early 2024 (up from 4.2 percent in 2021).
    - Assessed profits projected at around €15 million per year (0.2 percent of GDP of 2022).
- Visual projections presented in source (titles preserved):
  - Projected CBK Capital-to-Monetary Liability Ratio (Percent) for 2020–2026 with assumed net effective interest rate and threshold for distributing 50% profit to Government.
  - Projected CBK Equity and Cumulative Profit Distribution (Million Euro) for 2020–2027.
- Additional note:
  - The projection of CBK capital-to-monetary liability ratio follows the projected short-term interest rate path in the euro area in the IMF’s World Economic Outlook published in October 2022.

### D. Policy Implications and Recommendations
- Overarching observation:
  - While central banks should not set positive profits as a policy target, prolonged declines in net interest income required central banks to raise income from other sources to finance operations.
- Cautions on budgetary support:
  - Legislation often allows or requires recapitalization by the budget when equity falls below thresholds — this is positive.
  - However, dependence on budgetary support risks political constraints and policy expectations adverse to central bank goals.
  - Some central banks are required to make transfers to the budget even when they have losses — a problematic feature.
- Guidance on investing in domestic government securities:
  - Investing in domestic government securities should occur only in the context of prudent fiscal policy.
  - Tradeoff: higher interest income versus liquidity risk (domestic securities have lower liquidity than euro area securities).
  - Liquidity risk can be minimized if governments maintain prudent fiscal policy and central bank holdings remain a relatively low share of total assets.
- Fees, commissions, and regulatory income considerations:
  - Montenegro and Kosovo have the highest fees, commissions, and other regulatory income as share of GDP among emerging economies in Europe.
  - Potential distortions:
    - Charges on financial intermediation can be interpreted as taxes on capital income, potentially distorting saving and investment.
    - Lower charges may raise concerns on inequality and financial sector externalities.
  - Whether it is desirable for central banks to rely on such revenues remains an open question.
- Treatment of windfall profits from rising interest rates:
  - Windfall profits from higher interest income should be preserved.
  - For Kosovo:
    - Saving windfall profits will reduce financial pressures in the next low interest rate cycle.
    - Because Kosovo is unilaterally euroized, a strong equity position is important as a buffer for policy interventions (e.g., lending through the emergency liquidity assistance window, ELA).
    - Ideal mechanism: save profits into a designated account managed by the CBK on behalf of the Minister of Finance (including the ELA window), to cover possible fiscal and quasi-fiscal costs from interventions in crisis.
- Additional notes:
  - CBK is prohibited from lending to the government directly.

### Section 1

### Surviving Low Interest Rates: Central Banks in Kosovo and Other Western Balkan Countries — Section 1

### A. The Central Banks’ Financial Situation: An Overview
- Central banks analyzed: Bosnia and Herzegovina (CBBH), Kosovo (CBK), Montenegro (CBCG).
- Balance sheet composition:
  - Assets mainly comprise foreign reserves (cash, foreign government securities, deposits); CBK and CBCG also hold euro-denominated domestic government securities (not considered foreign reserves).
  - Liabilities mainly include deposits from commercial banks and governments.
- Key empirical observations:
  - Post-GFC decline in global interest rates led to a significant decrease in income for all three central banks; net interest income turned negative for all three central banks in 2021.
- Selected balance sheet aggregates (Percent of GDP; as reported for Year 2007 and 2021):
  - Assets (All): 2007 = 32.85; 2021 = 31.22 (Bosnia and Herzegovina / Kosovo / Montenegro table formatting preserved in source).
  - Foreign assets 1/: 2007 = 32.54; 2021 = 31.14.
  - Domestic claims on government: 2007 = 0.00; 2021 = 0.01.
  - Other assets 2/: 2007 = 0.30; 2021 = 5.7.
  - Liabilities (All): 2007 = 30.94; 2021 = 30.22.
  - Due to commercial banks: 2007 = 18.32; 2021 = 21.7.
  - Due to government and other public entities: 2007 = 0.44; 2021 = 10.5.
  - Equity and Reserves: 2007 = 1.9; 2021 = 1.6.
- Notes:
  - 1/ Foreign assets include cash, deposits placed at non-resident financial institutions, and foreign securities.
  - 2/ Other assets mainly include fixed assets, intangible assets, and assets related to IMF lending programs.

### B. How Did Central Banks Absorb the Shock of Lower Interest Income?
- Main compensating channels:
  - Increase in fees, commissions, and regulatory income:
    - In 2021, net fees, commissions and other regulatory income represented:
      - More than 100 percent of operating expenses at the CBK and CBCG.
      - About 60 percent of operating expenses at the CBBH.
    - Increases reflected both higher unit rates and financial deepening.
  - Negative remuneration on excess reserves:
    - Remuneration rates aligned with euro area short-term rates (negative between 2014 and mid-2022).
    - Income from negative remuneration offsets negative return on foreign reserves funded by excess reserves, but not those funded by mandatory reserves and government deposits (which the central bank still bears).
  - Interest income from domestic government securities (CBK and CBCG):
    - Interest spreads of these securities over German government bonds averaged:
      - 280 bps (Kosovo) during 2018–22.
      - 420 bps (Montenegro) during 2018–22.
    - CBK began holding Kosovo government securities in 2015; as of end-2021:
      - Government securities represented 13 percent of total assets.
      - These securities generated 2/3 of the CBK’s gross interest income.
- Personnel and operating cost trends:
  - Personnel cost-to-GDP ratios over 2014–19:
    - Broadly flat at the CBK; declined at the CBBH and CBCG.
  - Personnel cost and staffing changes 2014–19 (percent changes and levels reported):
    - 2014 % GDP: Bosnia and Herzegovina = 0.07; Kosovo = 0.07; Montenegro = 0.19.
    - 2019 % GDP: Bosnia and Herzegovina = 0.05; Kosovo = 0.07; Montenegro = 0.17.
    - Change in Total Personnel Costs 2014-19: Bosnia and Herzegovina = -24%; Kosovo = 0%; Montenegro = 26%.
    - Change in the Number of Employee 2014-19: Bosnia and Herzegovina = 4%; Kosovo = 17%; Montenegro = 5%.
    - Change in Personnel Costs per Employee 2014-19: Bosnia and Herzegovina = -5%; Kosovo = 19%; Montenegro = 20%.
    - Change in Nominal GDP per Capita 2014-19: Bosnia and Herzegovina = 30%; Kosovo = 34%; Montenegro = 43%.
    - Nominal Personnel Costs per Employee 2019: Bosnia and Herzegovina = euro 27,166; Kosovo = euro 21,138; Montenegro = euro 22,618.
    - Nominal GDP per Capita 2019: Bosnia and Herzegovina = euro 5,136; Kosovo = euro 3,959; Montenegro = euro 7,959.
  - Cross-country comparisons:
    - Personnel costs of the CBK and CBBH similar to peers; personnel costs of the CBCG are higher.
- Other Western Balkan economies (Albania, North Macedonia, Serbia):
  - Less-constraining exchange rate regimes mitigated the need to raise fees:
    - Banknotes in circulation act as an “equity” buffer.
    - Albania: interest income from domestic assets mitigated equity decline.
    - North Macedonia: lower interest income cushioned by valuation gains from gold reserves.
    - Serbia: currency depreciation 2008–16 led to valuation gains on international reserves.

### C. Rising Interest Rates in 2022 — Projections and Effects
- Rising euro area interest rates in 2022 expected to increase central bank interest income from foreign reserves.
- CBK-specific projections and rules:
  - CBK charter requires transfer of 50 percent of distributable earnings to the Ministry of Finance when equity exceeds 5 percent of monetary liabilities.
  - Baseline staff assumption: net effective return on the CBK’s assets will be 150–200 bps higher by 2024 relative to that observed in 2021.
  - Projection outcome:
    - Rise in net income earnings projected to bring equity above the 5 percent threshold in late 2023 or early 2024 (up from 4.2 percent in 2021).
    - Assessed profits projected at around €15 million per year (0.2 percent of GDP of 2022).
- Visual projections presented in source:
  - Projected CBK Capital-to-Monetary Liability Ratio (Percent) for 2020–2026 with assumed net effective interest rate and threshold for distributing 50% profit to Government.
  - Projected CBK Equity and Cumulative Profit Distribution (Million Euro) for 2020–2027.

### D. Policy Implications and Recommendations
- Overarching observation:
  - While central banks should not set positive profits as a policy target, prolonged declines in net interest income required central banks to raise income from other sources to finance operations.
- Cautions on budgetary support:
  - Legislation often allows or requires recapitalization by the budget when equity falls below thresholds — this is positive.
  - However, dependence on budgetary support risks political constraints and policy expectations adverse to central bank goals.
  - Some central banks are required to make transfers to the budget even when they have losses — a problematic feature.
- Guidance on investing in domestic government securities:
  - Investing in domestic government securities should occur only in the context of prudent fiscal policy.
  - Tradeoff: higher interest income versus liquidity risk (domestic securities have lower liquidity than euro area securities).
  - Liquidity risk can be minimized if governments maintain prudent fiscal policy and central bank holdings remain a relatively low share of total assets.
- Fees, commissions, and regulatory income considerations:
  - Montenegro and Kosovo have the highest fees, commissions, and other regulatory income as share of GDP among emerging economies in Europe.
  - Potential distortions:
    - Charges on financial intermediation can be interpreted as taxes on capital income, potentially distorting saving and investment.
    - Lower charges may raise concerns on inequality and financial sector externalities.
  - Whether it is desirable for central banks to rely on such revenues remains an open question.
- Treatment of windfall profits from rising interest rates:
  - Windfall profits from higher interest income should be preserved.
  - For Kosovo:
    - Saving windfall profits will reduce financial pressures in the next low interest rate cycle.
    - Because Kosovo is unilaterally euroized, a strong equity position is important as a buffer for policy interventions (e.g., lending through the emergency liquidity assistance window, ELA).
    - Ideal mechanism: save profits into a designated account managed by the CBK on behalf of the Minister of Finance (including the ELA window), to cover possible fiscal and quasi-fiscal costs from interventions in crisis.
- Additional notes:
  - CBK is prohibited from lending to the government directly.
  - The projection of CBK capital-to-monetary liability ratio follows the projected short-term interest rate path in the euro area in the IMF’s World Economic Outlook published in October 2022.

*Source: IMF Selected Issues Paper SIP/2023/027 — Surviving Low Interest Rates: Central Banks in Kosovo and Other Western Balkan Countries (Section 1, completed December 20, 2022).*

### Section 2

### sipea2023027 - Section 2

### Central Bank of Kosovo (CBK) secondary-market purchases
- "However, the CBK is allowed to purchase Kosovo government securities in the secondary market."

### Central Bank fee, commission and other regulatory income (figure data)
- Title as presented: Central Bank Fee, Commission and Other Regualatory Income (Percent of GDP, 2019)
- Numeric axis labels shown exactly: -0.1, 0.0, 0.1, 0.2, 0.3
- Countries listed (in the order shown):
  - Latvia
  - Malta
  - Luxemberg
  - Hungary
  - Poland
  - Georgia
  - Estonia
  - Slovakia
  - Belarus
  - Albania
  - Ukraine
  - Russia
  - Croatia
  - Czech Republic
  - Romania
  - Lithuania
  - Moldova
  - Iceland
  - Turkey
  - Slovenia
  - North Macedonia
  - Bosnia and Herzegovina
  - Cyprus
  - Serbia
  - Kosovo
  - Montenegro
- Data source line exactly as shown: Sources: Central Bankof Kosovo and IMF staff calculations.

### References cited in Section 2
- Alesina, Alberto, and Romain Wacziarg, 1998, "Openness, Country Size and Government." Journal of Public Economics 69.3: 305–321.
- Archer, David, and Paul Moser-Boehm, 2013, "Central Bank Finances." BIS papers.
- Boadway, Robin, and Michael Keen, 2003, "Theoretical Perspectives on the Taxation of Capital Income and Financial Services: a Survey." Taxation of Financial Intermediation: Theory and Practice for Emerging Economies, Oxford University Press, New York.
- Claessens, S., Keen, M., and Pazarbasioglu, C., 2010, "Financial Sector Taxation: The IMF’s Report to the G-20 and Background Material." Washington: International Monetary Fund.
- Galan, Jorge, and Miguel Sarmiento, 2006, "Staff, Functions, and Staff Costs at Central Banks: an International Comparison with a Labor-D emand Model." Borradores de Economía 419: pp. 131–180.
- Goncharov, Igor, Vasso Ioannidou, and Martin C. Schmalz, 2021, "(Why) do central banks care about their profits?" Journal of Finance, Forthcoming.
- IMF, 2019, "Technical Assistance Report --- Report on the Monetary and Financial Statistics Mission." IMF Country Report No. 19/254.
- IMF, 2021, “Central Bank of Kosovo: Safeguards Assessments Report”.
- Ize, Alain, 2006, "Spending Seigniorage: Do Central Banks Have a Governance Problem?" IMF Working Paper 06/58.
- Kiguel, Miguel A. and Pablo A. Neumeyer, 1995, "Seigniorage and Inflation: The Case of Argentina", Journal of Money, Credit and Banking, Vol. 27, No. 3 (Aug.), pp. 672–682.
- Pajdo, Barbara, 2017, "Determinants of central banks’ financial strength: Evidence from Central and Eastern European countries." Economics and Business Review 3.4: pp. 3–27.
- Stella, Peter, 2005, "Central Bank Financial Strength, Transparency, and Policy Credibility." IMF Working Paper 02/13.

*Source: sipea2023027 - Section 2 (PDF).*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023027.pdf_