## Stress Testing the Albanian Banking Sector: A Decade Post-FSAP

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### A. Introduction and Key Context
- Structural changes over the past decade:
  - NPLs declined from almost 25 percent in 2014 to just under 5 percent of total loans in Q1 2024.
  - Share of assets owned by foreign banks fell from 90 percent in 2013 to 65 percent in Q1 2024.
- Banking sector performance and supervision:
  - Average return-on-assets was around 1 percent between 2019 and 2022, rising to an average of 1.7 percent in 2023 and 2024.
  - Average capital adequacy ratio was 19.3 percent in July 2024 (regulatory minimum: 12 percent).
- Remaining vulnerabilities:
  - High sovereign securities holdings relative to peers ("sovereign-bank nexus").
  - Illiquid local-currency government bond and money markets.
  - High euroization and concentration: two-thirds of unhedged FX loans concentrated in the real estate sector, which experienced rapid credit growth in 2024 and continued price increases.
- Stress testing objectives and approach:
  - Two exercises: (1) capital adequacy stress tests (credit and market risks) using bank-by-bank Q1:2024 data following Cihak (2014); (2) liquidity resilience exercise varying haircuts under LCR standard.
  - Horizon for shocks: one year.
  - Banks deemed undercapitalized only if CAR falls below 12 percent.

### B. The Albanian Banking Sector: Snapshot
- Structure and concentration:
  - 11 commercial banks own over 90 percent of overall financial sector assets.
  - Four banks identified as D-SIBs, owning 65 percent of banks’ assets and 66 percent of banks’ capital.
  - Herfindahl-Hirschman Index (HHI) based on Q1:2024 assets: 1428.
- Regulatory framework and requirements:
  - Minimum Pillar 1 capital requirement: 12 percent.
  - Capital conservation buffer: 2.5 percent in 2024.
  - D-SIB buffer: 0.5–1.5 percent for the four D-SIBs.
  - Countercyclical buffer (CCyB): additional 0.25 percent activated, effective by June 2025.
  - Single lending limit: maximum exposure to each counterparty capped at 20 percent of capital (10 percent for a related party).
  - Leverage ratio requirement: at least 5.75 percent of non-risk-weighted assets.
  - Liquidity requirements: LCR and NSFR, differentiated by significant currencies.
- Most banks are compliant with capital and liquidity requirements, though heterogeneity exists.

### C. Stress Testing — Methodology
- Capital adequacy stress tests:
  - Balance-sheet, bottom-up, bank-by-bank using Q1:2024 data; tests capture credit risks (NPL and large exposure) and market risks (interest rate and exchange rate).
  - Banks assessed against 12 percent minimum CAR; time horizon: one year.
- Credit risk channels and scenarios:
  - General credit risk (NPL increase):
    - NPL increase distributed proportional to current share of individual banks’ NPLs.
    - Case A (baseline): 100-percent increase in NPLs.
    - Case B (more severe): 200-percent increase in NPLs.
    - Case C (extreme): 440-percent increase in NPLs (brings NPL ratio to 2014 historical high).
    - Provisioning assumption: 65-percent provisioning rate.
  - Large exposure risk:
    - Top 1: failure of the largest borrower.
    - Top 2: failure of the top two largest borrowers.
- Market risk channels and scenarios:
  - Interest rate risk:
    - Flow channel and stock (MtM) channel.
    - Assumption: 25 percent of bonds MtM; remainder HtM.
    - Baseline: 150-basis point increase.
    - Extreme: 250-basis point increase.
  - Exchange rate risk:
    - Direct and indirect channels.
    - Baseline: 25-percent depreciation of the lek vis-à-vis the euro.
    - Extreme: 40-percent depreciation of the lek vis-à-vis the euro.

### D. Credit Risk Stress Test Results — Findings
- General credit risk (NPL shocks):
  - Case A (100-percent increase in NPLs):
    - All banks have sufficient capital; average CAR around 17 percent.
  - Case B (200-percent increase):
    - Average CAR remains above 12 percent; three banks (including one D-SIB) experience capital shortfalls.
    - Capital injection required: 0.2 percent of GDP.
  - Case C (440-percent increase):
    - Multiple banks, including three D-SIBs, experience significant capital shortfalls.
    - Capital injection required: around 1.5 percent of GDP.
  - Interpretation: sector broadly resilient to realistic NPL shocks; extreme scenario demonstrates how much credit risk has declined since 2014.
- Large exposure risk:
  - Default of largest borrower (Top 1):
    - One bank experiences a capital shortfall.
    - System-wide CAR drops from around 19.07 percent (current) to 15.05 percent (Top 1).
  - Default of top two borrowers (Top 2):
    - Six banks (including one D-SIB) have capital shortfalls.
    - System-wide CAR falls almost below 12 percent (12.02 percent reported for Top 2).
    - Capital injection needed: 0.5 percent of GDP.

### E. Market Risk Stress Test Results — Findings
- Interest rate risk:
  - Under both the 150-bps and 250-bps scenarios, banks’ capital ratios are little affected due to offsetting flow and stock channels given baseline MtM assumption (25 percent MtM).
  - Sensitivity: if a higher share of bonds is MtM (e.g., all bonds MtM), the stock channel amplifies losses and the overall impact of an interest rate rise becomes negative and sizable.
  - Under the baseline 150-bps increase:
    - All banks remain capitalized above the minimum requirement.
    - Two banks (including one D-SIB) experience a mild shortfall despite the system-wide CAR remaining at 15.4 percent.
- Exchange rate risk:
  - Under a 25-percent lek depreciation:
    - System-wide CAR drops by around 3 percentage points.
    - One bank falls short of the required capital ratio; system-wide CAR remains well above 12 percent.
  - Under a 40-percent depreciation:
    - System-wide CAR remains above the minimum requirement.
    - Three banks experience capital shortfalls, although none are systemically important.
  - Decomposition: direct channel accounts for around 60 percent of the reduction in the system-wide capital ratio.

### F. Liquidity Resilience and LCR Results
- Treatment of assets and market context:
  - LCR in lek is the focus; foreign-currency-denominated HQLAs deemed appropriately liquid.
  - Albanian government securities treated as HQLA with a haircut of 0 percent.
  - Large holdings of Albanian government bonds constitute the lion’s share of Albanian banks’ HQLA in lek.
- Haircut scenarios (based on March 2024 LCR dataset):
  - Scenario (i): access to the BoA’s facility with an assumed haircut of 20 percent.
  - Scenario (ii): no access to the BoA’s facility with an assumed haircut of 90 percent (would arise if the bank is experiencing both liquidity and solvency issues).
  - Monthly bond market turnover: around 100 million lek.
  - Median amount assumed to be sold under 90-percent haircut scenario: 2,738 million lek.
- LCR results:
  - Current LCR assumption (zero haircut):
    - Almost all banks (except one outlier) maintain LCR in lek well above 100 percent.
    - System-weighted average LCR: 302.82 (presented as 303 percent).
  - 20-percent haircut (with BoA facility):
    - System-weighted average LCR: 265.89 (presented as 266 percent).
    - No additional bank experiences a liquidity shortfall.
  - 90-percent haircut (no BoA facility):
    - System-weighted average LCR: 75.03 (presented as 75 percent).
    - Eight banks experience a liquidity shortfall, including all four D-SIBs.
- Implication and policy-relevant points:
  - Banks’ ability to meet liquidity needs under stress depends crucially on access to the BoA’s facility.
  - Continued efforts to develop the secondary bond market as well as the secured money market would be important for improving market participants’ resilience to liquidity risks through market-based mechanisms.

### G. Key Figures and Exact Metrics
- System-wide CAR under 150-bps interest rate increase scenario: 15.4 percent.
- Interest rate shock scenarios referenced: 150 bps and 250 bps.
- Exchange rate shock scenarios referenced: 25-percent depreciation and 40-percent depreciation of the lek against the euro.
- LCR benchmark and results:
  - Required minimum LCR: 100 percent.
  - Current (zero haircut) system-weighted average LCR: 302.82.
  - 20% haircut (under BoA's liquidity facility) system-weighted average LCR: 265.89.
  - 90% haircut (no access to BoA's facility) system-weighted average LCR: 75.03.
- Monthly secondary government bond market turnover: around 100 million lek.
- Median amount assumed to be sold under 90-percent haircut scenario: 2,738 million lek.

*Source: sipea2025039 - Section 2 (IMF staff calculations and Bank of Albania data).*

### Section 1

### Stress Testing the Albanian Banking Sector: A Decade Post-FSAP

### A. Introduction and Key Context
- Over the past decade the Albanian banking sector has undergone a remarkable transformation:
  - NPLs declined from almost 25 percent in 2014 to just under 5 percent of total loans in Q1 2024.
  - Share of assets owned by foreign banks fell from 90 percent in 2013 to 65 percent in Q1 2024.
- Banking sector performance and supervision:
  - Average return-on-assets was around 1 percent between 2019 and 2022, rising to an average of 1.7 percent in 2023 and 2024.
  - Average capital adequacy ratio was 19.3 percent in July 2024 (regulatory minimum: 12 percent).
- Remaining vulnerabilities noted:
  - High sovereign securities holdings relative to peers ("sovereign-bank nexus").
  - Illiquid local-currency government bond and money markets.
  - High euroization and concentration: two-thirds of unhedged FX loans concentrated in the real estate sector, which experienced rapid credit growth in 2024 and continued price increases.
- Stress testing objectives and approach:
  - Two sets of exercises: (1) capital adequacy stress tests (credit and market risks) based on Cihak (2014) methodology using bank-by-bank Q1:2024 data; (2) liquidity resilience exercise varying haircuts under LCR standard.

*Horizon for shocks: one year. Banks deemed undercapitalized only if CAR falls below 12 percent.*

### B. The Albanian Banking Sector: Snapshot
- Structure and concentration:
  - 11 commercial banks own over 90 percent of overall financial sector assets.
  - Four banks identified as D-SIBs, owning 65 percent of banks’ assets and 66 percent of banks’ capital.
  - Herfindahl-Hirschman Index (HHI) based on Q1:2024 assets: 1428 (a market with HHI < 1,500 is typically considered competitive).
- Regulatory framework and requirements:
  - Minimum Pillar 1 capital requirement: 12 percent (compared to 8 percent in EU countries).
  - Capital conservation buffer: 2.5 percent in 2024.
  - D-SIB buffer: 0.5–1.5 percent for the four D-SIBs.
  - Countercyclical buffer (CCyB): additional 0.25 percent activated, effective by June 2025.
  - Single lending limit: maximum exposure to each counterparty capped at 20 percent of capital (10 percent for a related party).
  - Leverage ratio requirement: at least 5.75 percent of non-risk-weighted assets (relative to 3 percent in EU regulation).
  - Liquidity requirements: LCR and NSFR, differentiated by significant currencies.
- Most banks are compliant with capital and liquidity requirements, though heterogeneity exists.

### C. Stress Testing Banks’ Capital Adequacy — Methodology
- Approach:
  - Balance-sheet, bottom-up stress testing using bank-by-bank Q1:2024 data following Cihak (2014).
  - Tests capture credit risks (NPL and large exposure) and market risks (interest rate and exchange rate).
  - Banks assessed against 12 percent minimum CAR; time horizon: one year.
- Credit risk channels:
  - General credit risk (NPL increase):
    - NPL increase distributed proportional to current share of individual banks’ NPLs.
    - Three scenarios:
      - Case A (baseline): 100-percent increase in NPLs (in line with 2023 Article IV assumption).
      - Case B (more severe): 200-percent increase in NPLs.
      - Case C (extreme): 440-percent increase in NPLs (brings NPL ratio to 2014 historical high).
    - All scenarios assume a 65-percent provisioning rate.
  - Large exposure risk:
    - Two scenarios:
      - Top 1: failure of the largest borrower.
      - Top 2: failure of the top two largest borrowers.

### D. Credit Risk Stress Test Results — Findings
- General credit risk (NPL shocks):
  - Under Case A (100-percent increase in NPLs):
    - All banks have sufficient capital; average CAR around 17 percent.
  - Under Case B (200-percent increase):
    - Average CAR remains above 12 percent; three banks (including one D-SIB) experience capital shortfalls.
    - Capital injection required: 0.2 percent of GDP.
  - Under Case C (440-percent increase):
    - Multiple banks, including three D-SIBs, experience significant capital shortfalls.
    - Capital injection required: around 1.5 percent of GDP.
  - Interpretation: sector broadly resilient to realistic NPL shocks; extreme scenario demonstrates how much credit risk has declined since 2014.
- Large exposure risk:
  - Default of largest borrower (Top 1):
    - One bank experiences a capital shortfall.
    - System-wide CAR drops from around 19.07 percent (current) to 15.05 percent (Top 1).
  - Default of top two borrowers (Top 2):
    - Six banks (including one D-SIB) have capital shortfalls.
    - System-wide CAR falls almost below 12 percent (12.02 percent reported for Top 2).
    - Capital injection needed: 0.5 percent of GDP.

### E. Market Risk Stress Tests — Methodology and Scenarios
- Interest rate risk:
  - Two channels:
    - Flow channel: changes in interest income and expenses from interest-sensitive asset/liability gaps.
    - Stock channel: mark-to-market (MtM) revaluation of bonds.
  - Assumption: 25 percent of bonds in banks’ portfolios are MtM; remainder are held-to-maturity (HtM).
  - Two scenarios:
    - Baseline: 150-basis point increase in interest rate.
    - Extreme: 250-basis point increase in interest rate.
- Exchange rate risk:
  - Two channels:
    - Direct: change in local-currency value of net FX position.
    - Indirect: exchange rate impact on borrowers’ creditworthiness and NPLs (indirect channel not fully captured in some tests).
  - Two scenarios:
    - Baseline: 25-percent depreciation of the lek vis-à-vis the euro (brings exchange rate roughly to the pandemic-era level).
    - Extreme: 40-percent depreciation of the lek vis-à-vis the euro (brings exchange rate to pre-pandemic level).

### F. Market Risk Stress Test Results — Findings (Interest Rate Risk)
- Net effect of interest rate shocks:
  - Under both the 150-bps and 250-bps scenarios, banks’ capital ratios are little affected.
  - Rationale:
    - Flow channel: banks typically have more interest-sensitive assets than liabilities, so interest rate increases tend to boost net interest income.
    - Stock channel: interest rate increases lower the MtM value of bonds, reducing capital.
    - These two channels act in opposite directions, largely offsetting each other under baseline MtM assumptions.
- Sensitivity to MtM assumption:
  - Vulnerability emerges if the baseline MtM assumption (25 percent of bonds MtM) is relaxed (i.e., higher share MtM would amplify stock-channel losses).

*Prepared by Jakree Koosakul and Eugena Topi; completed on December 17, 2024. This paper is also published separately as IMF Country Report No 25/21.*

*Source: IMF Selected Issues Paper (SIP/2025/039), April 2025.*

### Section 2

### Section 2

### Interest Rate Risk: Bank Capital Impact
- Under the baseline assumption that only 25 percent of banks’ bond portfolio is MtM, the quantitative effects of the two channels almost completely offset each other.
- If all bonds in banks’ portfolio are instead assumed to be MtM, there is a sizable negative effect coming from the repricing channel, such that the overall impact of an interest rate rise is negative and sizable.
- Under the baseline scenario of a 150-bps increase:
  - All banks remain capitalized above the minimum requirement.
  - Two banks (including one D-SIB) are found to experience a mild shortfall despite the system-wide CAR remaining at 15.4 percent.
- Note: In principle, the impact of an interest rate change on the bond market value is a function of the duration of the bonds held. This information is provided by the BoA.

### Exchange Rate Risk: Bank Capital Impact
- Under the baseline scenario of a 25-percent lek depreciation against the euro:
  - The system-wide CAR drops by around 3 percentage points.
  - One bank falls short of the required capital ratio, although the system-wide CAR remains well above the 12-percent requirement.
- Under a 40-percent depreciation scenario:
  - The system-wide CAR remains above the minimum requirement.
  - Three banks experience capital shortfalls, although none of such banks is systemically important.
- Decomposition:
  - The direct channel is responsible for around 60 percent of the reduction in the system-wide capital ratio.

### Liquidity Resilience and the Liquidity Coverage Ratio (LCR)
- LCR in lek is the focus; foreign-currency-denominated HQLAs (for example, euro bonds) are deemed to be appropriately liquid.
- Albanian government securities are treated as HQLA with a haircut of 0 percent (same category as coins, banknotes, and qualifying central bank reserves).
- Due to large holdings of Albanian government bonds amid a lack of other financial instruments, such bonds constitute the lion’s share of Albanian banks’ HQLA in lek.
- Haircut scenarios examined for government bond liquidity (based on March 2024 LCR dataset provided by the BoA):
  - Scenario (i): Access to the BoA’s facility with an assumed haircut of 20 percent.
  - Scenario (ii): No access to the BoA’s facility with an assumed haircut of 90 percent (would arise if the bank is experiencing both liquidity and solvency issues).
  - In the 90-percent haircut scenario, banks are assumed to liquidate securities in the secondary market subject to a 90-percent haircut.
  - Footnote: The monthly bond market turnover stands at around 100 million lek, against the median amount of 2,738 million lek that is assumed to be sold under the 90-percent haircut scenario.
- LCR results under stress scenarios:
  - Under the current LCR assumption of a zero haircut:
    - Almost all banks (except for one outlier) currently maintain a very comfortable LCR in lek well above 100 percent.
    - The system-weighted average LCR is 303 percent.
  - Under a 20-percent haircut (with access to the BoA’s facility):
    - The system-weighted average LCR falls marginally to 266 percent.
    - No additional bank is found to experience a liquidity shortfall.
  - Under a 90-percent haircut (no access to the BoA’s facility):
    - The system-wide average LCR drops to 75 percent, below the minimum requirement.
    - Eight banks are found to experience a liquidity shortfall, including all four D-SIBs.
- Implication:
  - Banks’ ability to meet liquidity needs under stress depends crucially on access to the BoA’s facility.
  - Continued efforts to develop the secondary bond market as well as the secured money market would be important for improving market participants’ resilience to liquidity risks through market-based mechanisms.

### Key Figures and Exact Metrics
- System-wide CAR under 150-bps interest rate increase scenario: 15.4 percent.
- Interest rate shock scenarios referenced: 150 bps and 250 bps.
- Exchange rate shock scenarios referenced: 25-percent depreciation and 40-percent depreciation of the lek against the euro.
- LCR benchmark and results:
  - Required minimum LCR: 100 percent (on an all-currency and all-significant-currency basis).
  - Current (zero haircut) system-weighted average LCR: 302.82 (presented as 303 percent in narrative).
  - 20% haircut (under BoA's liquidity facility) system-weighted average LCR: 265.89 (presented as 266 percent in narrative).
  - 90% haircut (no access to BoA's facility) system-weighted average LCR: 75.03 (presented as 75 percent in narrative).
- Monthly secondary government bond market turnover: around 100 million lek.
- Median amount assumed to be sold under 90-percent haircut scenario: 2,738 million lek.

*Source: sipea2025039 - Section 2 (IMF staff calculations and Bank of Albania data).*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025039.pdf_