## Financial System Structure, 1998–2002

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### I. Overall assessment of stability and development issues — Context for financial intermediation
- FYR Macedonia has not yet fully recovered from the breakup of Yugoslavia and subsequent upheavals following independence in 1991 (loss of foreign exchange deposits held in the National Bank of Yugoslavia, embargo on Yugoslavia, blockade by Greece, the 1999 Kosovo conflict, and internal civil strife in 2001).
- Intermittent conflicts and disturbances adversely affected development and governance of institutions necessary for transition to a market economy; significant corruption in the public sector reported.
- Judicial system weaknesses: excessive politicization, lack of independence, intimidation of judges, deficiencies in court procedures and operations.
- Consequence: weak institutions and governance have impeded economic development and growth; environment not conducive to attracting investment; financial integrity threatened by corruption and abuse.
- Recommended two-pronged strategy: preserve macroeconomic stability and address governance and corruption; government steps underway in both areas.

### I.B. Vulnerabilities and soundness of banking
- Banking sector characteristics and concentration:
  - Sector small and underdeveloped; deposits and assets concentrated in top three banks forming a core group with improved practices after privatization and entry of foreign strategic investors.
  - Banking system assets at 39 percent of GDP.
  - At end-2002: 21 banks and 17 savings houses licensed.
  - Banks hold 98.9 percent of total bank and savings house assets.
  - The three largest banks managed almost 73 percent of total deposits and 64 percent of total bank assets (end-2002).
  - State ownership of banks: 14 percent.
  - Foreign ownership: almost 45 percent of total bank capital.
- Key vulnerabilities:
  - Weak governance in smaller banks: dispersed ownership with one strong manager, weak management structures, nontransparent ownership.
  - Authorities lack full legal toolkit to address ownership/governance problems; short-term recommendation: attract reputable strategic investors.
  - Balance sheet weaknesses reflected in high percentage of nonperforming loans (NPLs).
- Market features:
  - High real interest rates, large spreads; interest rate spreads above 8 percentage points.
  - Most banks expanding lending only modestly due to weak balance sheets and legal environment not conducive to repayment and loan recovery.
- Euroization:
  - About 64 percent of deposits and 40 percent of banks’ total loans denominated in foreign currency.
  - Foreign currency deposits subject to same reserve requirement as denar deposits.
  - Supervisors monitor open positions; banks adequately hedged against FX risks but exposed to credit risk from borrowers who are not FX earners.
  - NBRM will require banks to set up a reporting system to gauge borrowers’ FX exposure.
- Stress testing and liquidity:
  - Stress tests indicate system relatively resilient to individual shocks; credit risk has greatest impact.
  - Combined exchange and interest rate shocks plus a drop in credit quality could cause significant strain.
  - Larger banks more vulnerable than smaller banks because they lend more actively and have lingering portfolio problems.
  - Liquidity management framework deficiencies: expand eligible instruments for collateral to access central bank; support secondary market development by reducing frequency of central bank bill auctions.
  - Some banks vulnerable due to sizeable individual deposits; interbank market too shallow for larger banks.
- Payment system and supervision:
  - Macedonian Interbank Payment System (MIPS) established; improvements needed in defining NBRM oversight role and establishing a remote back-up facility.
  - Legal requirement that the NBRM execute payment guarantees between commercial bank clients creates legal and liquidity risks and should be revised.
  - Banking supervision quality improving per Basel Core Principles (BCP) assessment; move further toward risk-oriented supervision and include financial soundness in off-site analysis.
  - Regulatory improvements: fit-and-proper rules, stricter reporting of investments in banks and significant bank investments, expanded corrective actions for weak banks.
  - Suggested further regulatory changes: strengthen powers of the administrator of weak banks; enhance supervisors’ role in AML/CFT; adopt internationally accepted accounting standards to improve transparency.

### I.C. Broader framework for finance
- Legal framework:
  - Core legal framework generally sound but implementation and enforcement weak, contributing to noncompliance and nonpayment.
  - Court system improvements crucial to create respect for rule of law and judicial system.
- Corporate governance:
  - Some key elements exist but much remains to be translated into practice.
  - Priority areas: improve protection of shareholder rights and enforcement of directors’ duties; require Macedonian companies to prepare financial statements consistent with International Accounting Standards (IAS); improve auditing practices.
- AML/CFT:
  - Bank supervisors’ integrity efforts must be complemented by enforcement of AML/CFT framework.
  - Newly established financial intelligence unit (FIU) in the MOF should be instrumental, but greater roles for financial sector supervisory agencies are needed; supervisors lack legal authority to enforce compliance.

### I.D. Nonbank financial system
- Securities markets small and present little systemic risk; development of government securities market expected to contribute to financial deepening.
- Equity market development hindered by managerial control over voting rights on shares held by employees.
- Insurance sector insignificant; legal and supervisory frameworks should be strengthened.
- Mandatory second pension pillar legislation passed but poses significant challenges: financing fiscal transition deficits and creating financial instruments for investment.

### Box 1 — Main recommendations (selected)
- Banking:
  - Attract reputable strategic owners to improve quality of bank ownership.
- Banking regulation and supervision:
  - Strengthen regulations in market risk, internal risk management, interest rate risk, corrective actions, and powers for official administrator of weak banks.
  - Promulgate accounting and disclosure standards for banks.
  - Develop strategy to minimize ownership of nonfinancial corporates in banking system.
  - Require banks to monitor and report borrowers’ FX exposure.
  - Establish a list of financial sector soundness indicators.
  - Make supervision more risk-oriented and intensify contacts with bank managers.
  - Give supervisors a more active role in AML/CFT implementation.
  - NBRM should publish a “mission statement” for its banking supervisory function.
- Market development:
  - Prioritize development of government securities market.
  - Improve liquidity management by expanding instruments eligible as collateral to access central bank facilities.
- Payment system:
  - Better define NBRM’s role in payment infrastructure development.
  - Establish a remote back-up facility for MIPS.
  - Remove obligation for NBRM to decide on and execute guarantees between third parties and involve courts.
- Financial safety nets:
  - Establish a framework and procedures for emergency lending by NBRM.
- Legal and judicial framework:
  - Reform judicial system and strengthen law implementation and enforcement.
  - Provide financial sector regulators legal authority to impose sanctions on financial institutions.
- AML/CFT:
  - Strengthen legal framework and expedite implementation.

### Banking system size, structure, and concentration (selected quantitative indicators)
- Banking system assets: 39 percent of GDP.
- End-2002: 21 banks; 17 savings houses.
- Banks hold 98.9 percent of total bank and savings house assets.
- Licensing:
  - 18 banks hold the foreign operations license enabling international payments, credit, and guarantee operations.
  - Minimum capital requirements: EUR 9 million for a foreign operations license; EUR 3.5 million for a domestic operations license.
- System concentration and ownership (end-2002):
  - Three largest banks: almost 73 percent of total deposits; 64 percent of total bank assets.
  - State ownership: 14 percent.
  - Foreign ownership: almost 45 percent of total bank capital.
- Selected asset figures (MKD, as presented):
  - Banks: 1998 MKD 59,093; 1999 MKD 72,279; 2000 MKD 81,999; 2001 MKD 105,623; 2002 MKD 93,213.
  - Largest three banks (assets): 1998 MKD 34,818; 1999 MKD 44,794; 2000 MKD 52,460; 2001 MKD 66,872; 2002 MKD 59,619.
  - Private banks (assets): 1998 MKD 58,254; 1999 MKD 71,375; 2000 MKD 81,067; 2001 MKD 104,214; 2002 MKD 91,362.
  - Savings houses (assets): 1998 MKD 755; 1999 MKD 760; 2000 MKD 1,038; 2001 MKD 676; 2002 MKD 956.
  - Insurance companies (assets): 1998 MKD 8,480; 1999 MKD 10,121; 2000 MKD 11,172; 2001 MKD 11,987; 2002 MKD 11,843.
- Relative asset shares (selected):
  - Banks as percent of total financial system assets: 1998 86.5 percent (30.3 percent of GDP); 1999 86.9 percent (34.6 percent of GDP); 2000 87.0 percent (34.7 percent of GDP); 2001 89.3 percent (45.2 percent of GDP); 2002 87.9 percent (39.0 percent of GDP).
  - Savings houses: around 0.4 percent of total financial system assets across years.
  - Insurance companies: 1998 12.4 percent (4.3 percent of GDP); 2002 11.2 percent (5.0 percent of GDP).

### Comparative indicators (selected, December 31, 2002)
- Number of banks: Albania 13; Bulgaria 34; Czech Republic 37; Hungary 39; FYR Macedonia 21; Poland 62; Slovenia 20.
- Concentration (share of largest three banks in system assets): FYR Macedonia 64.0.
- Total banking assets/GDP: FYR Macedonia 39 (others listed in table).
- Credit to GDP: FYR Macedonia 28.
- Capital adequacy ratio (CAR): FYR Macedonia 28.
- Nonperforming/classified loans: FYR Macedonia 15.9.
- Average ROAA: FYR Macedonia 0.4 percent.
- Average ROAE: FYR Macedonia 2.1 percent.
- Net interest margins: FYR Macedonia 8.2.
- Operating expenses/total assets: FYR Macedonia 4.4.

### Markets, infrastructure, and payments
- Operating short-term markets: interbank money market and foreign exchange market.
- Plans to establish a government securities market starting in early 2004.
- Liquidity and turnover:
  - May 2003 average daily turnover on interbank money market and bilateral deals about MDen 160 million (roughly $2.5 million).
  - Foreign exchange market turnover grew 47 percent in the first four months of 2003 over the same period in the previous year.
  - Since January 2003, bid-ask spread narrowed from around 60 basis points to around 40 basis points.
  - Three banks account for over half of foreign exchange turnover volume.
  - Foreign exchange swaps emerging as main tools for commercial bank liquidity management.
- Cash and noncash usage:
  - Denars on issue are 6 percent of GDP.
  - Noncash payment system concentrated: NBRM initiates about a quarter of total value through the clearing system; the two largest banks account for a further 30 percent of value exchanged.
- Payment system components:
  - MIPS (RTGS) used for all large-value payments (more than Mden 3 million) and urgent/priority payments; 27 participants including all banks, clearinghouses, MOF, and NBRM.
  - MIPS connected to the CSD and provides platform for delivery versus payment securities settlement.
  - KIBS is the clearinghouse for low-value payments.
- MIPS operation follows best international practices; areas for attention: clarify and strengthen NBRM’s oversight role; establish a remote back-up facility.

### Recent economic developments and macroeconomic context (selected indicators)
- Growth and inflation (1998–2002):
  - Real GDP growth (percent change): 1998 3.4; 1999 4.3; 2000 4.5; 2001 -4.5; 2002 0.7.
  - Consumer prices, period average: 1998 -0.1; 1999 -0.7; 2000 5.8; 2001 5.3; 2002 2.4.
  - Real wages, period average: 1998 3.7; 1999 3.6; 2000 -0.3; 2001 -1.7; 2002 4.5.
  - Unemployment rate (average): 1998 34.5; 1999 32.4; 2000 32.2; 2001 30.5; 2002 31.9.
- Public finances and external:
  - General government balance (percent of GDP): 1998 -1.7; 1999 0.0; 2000 1.8; 2001 -7.2; 2002 -5.7.
  - Central government balance (percent of GDP): 1998 -0.8; 1999 0.8; 2000 2.7; 2001 -5.8; 2002 -5.4.
  - Government debt (gross, percent of GDP): 1998 52.0; 1999 57.4; 2000 53.2; 2001 51.6; 2002 50.1.
  - Broad money (M3, percent of GDP): 1998 16.0; 1999 19.4; 2000 21.5; 2001 34.1; 2002 30.3.
  - Total credit to private sector (percent of GDP): 1998 15.7; 1999 14.5; 2000 15.1; 2001 15.5; 2002 16.4.
  - Short-term lending rate: 1998 20.5; 1999 20.0; 2000 19.0; 2001 19.2; 2002 17.7.
  - Official gross reserves (US$ million; end of period): 1998 290; 1999 450; 2000 700; 2001 756; 2002 735.
  - Reserve cover (months of next year's imports): 1998 1.8; 1999 2.4; 2000 4.3; 2001 4.2; 2002 3.6.
- Impact of 2001 security crisis:
  - Growth in 2001 was -4.5 percent.
  - Fiscal balances declined from a surplus of 1.8 percent to a deficit of over 7 percent of GDP, largely due to security-related spending.
- Near-term projections (as presented):
  - Output growth: 0.7 percent in 2002; stronger growth projected for 2003: 2.7 percent.
  - Central government deficit expected to narrow to 1.4 percent of GDP in 2003 from 5.4 percent in 2002.
  - Inflation: average 2.4 percent for 2002; very low inflationary pressures in first half of 2003 (average of 0.3 percent year-on-year).
  - Fiscal pressure easing owing to decline in security-related and pre-election spending and extraordinary inflows of donor finance.

### Vulnerabilities and macroeconomic sources of financial stability risk
- External and exchange regime risks:
  - Current account deficit high: 11.2 percent of GDP excluding grants and 8.6 percent including grants in 2002.
  - Real exchange rate indicators do not suggest an overvaluation.
  - Reliance on remittances, exceptional FDI, and donor finance to maintain reserve position; concern over sustainability if donor inflows decline.
- Exchange rate and fiscal risks for banks:
  - Greatest bank risk: credit risk from borrowers with unhedged exchange rate positions in a highly euroized environment.
  - Mitigating factors: banks’ net long FX position, relatively high capital adequacy ratios, some degree of real euroization.
  - Authorities urging banks to analyze and report clients’ FX exposure.
  - Fiscal vulnerability: budget significantly supported by privatization receipts and donor help; drastic reduction in donor support could make fiscal position unsustainable, forcing domestic borrowing with limited debt management capacity and potentially high interest rates, unsustainable debt levels, and crowding out.

### Banking system soundness: recent improvements and ongoing weaknesses
- Improvements:
  - Stronger supervision, involvement of strategic foreign investors, cleaning up of balance sheets of three largest banks.
  - Emergence of core group accounting for 64 percent of banking system assets and 45 percent of total capital.
- Governance vulnerabilities:
  - Persistent governance problems in smaller banks: nontransparent ownership, dispersed disinterested shareholders, powerful managers.
  - Change-of-ownership approval required only if exceeding 10 percent of equity capital (later lowered to 5 percent in amendments).
  - Constitutional Court rulings (May 2003) invalidated provisions disallowing persons with criminal records as shareholders/board members/managers, creating uncertainty.
  - Existence of “pocket banks” used as treasury or liquidity sources for enterprise groups or individuals.
- Asset quality:
  - NPLs about 15.9 percent of all loans.
  - Provisioning follows international best practices and is strictly enforced with favorable tax treatment; most banks have provisioned at required levels.
  - Supervisors should collect historical recovery rates and proactively change provisioning if warranted.
- Liquidity risks:
  - Deposits largely short term: sight deposits comprise 39 percent of assets; household sight deposits 21 percent of assets.
  - Foreign currency deposits 34 percent of assets; household foreign currency deposits 25 percent of assets.
  - Deposit concentration: single depositor may account for 25 percent to 40 percent of deposit base in some banks.
  - Public deposits shifted abruptly between banks in recent episodes (3 percent to 7 percent of assets in largest banks).
  - Policy recommendation: public funds should be placed in central bank as a sub-account of the Treasury and transferred gradually to minimize liquidity impact.
- Market shallowness:
  - Banks hold precautionary balances domestically and abroad; banks hold substantial short-term deposits in foreign banks (31 percent of assets) to match FX and maturity profile.
  - Buildup of reserves with NBRM before tax and pension payment days.
  - Shallowness constrains ability to extend longer-term domestic credit.

### Financial soundness indicators (selected observations, 1998–2002 as presented)
- Regulatory capital/risk weighted assets: 25.9 28.7 36.7 34.3 28.1
- Tier I capital/risk weighted assets 1/: 28.6 29.8 37.4 35.1 28.3
- Enterprises loans/total loans: 66.4 53.0 47.1 42.1 37.3
- Households loans/total loans: 4.9 4.9 6.1 5.9 7.9
- Foreign currency lending/total credit to private sector: ... 21.3 14.0 13.8 22.2
- Gross nonperforming exposures/total credit exposure 2/: 32.9 41.3 34.8 33.7 15.9
- NPLs net of provision /capital: 70.5 74.6 43.6 52.4 41.6
- Liquid assets/total assets 3/: 37.7 52.6 47.5 54.6 44.8
- Liquid assets/total short-term liabilities 3/: 67.1 86.6 76.6 79.4 69.4
- Customer deposits/total (noninterbank) loans: 55.0 72.0 83.8 163.0 130.2
- Foreign currency deposits/total deposits: 45.9 42.5 49.8 71.9 63.9
- Central bank credit to banks/bank liabilities: 4.3 1.4 0.6 0.2 0.2
- Net FX position /capital: 24.6 79.4 54.0 60.5 56.2
- Notes:
  - 1/ Capital includes common shares, general and revaluation reserves, and undistributed profits, net of specific provisions.
  - 2/ Based on new methodology including interbank loans in total credit exposure.
  - 3/ Liquid assets defined as cash and balances with NBRM, securities rediscounted by NBRM, and short-term bank placements.

### Stress testing results (selected)
- Individual shocks:
  - System-wide CAR could fall by up to 6.5 percentage points in response to individual shocks.
  - Credit shocks are most damaging but manageable for system as a whole.
  - Deterioration in asset quality comparable to Kosovo crisis may cause strain for larger banks.
- Combined shock scenario (specified):
  - 20 percent depreciation of denar,
  - 20 percentage point increase in denar interest rates,
  - 30 percent increase in NPLs.
- Impact of combined scenario:
  - Reduction of system-wide CAR by 13.5 percentage points.
  - Would push three banks below the 8 percent CAR, although those banks would remain solvent.

### Prudential regulation, supervision, and policy recommendations
- Progress and strengths:
  - Substantial progress in legal and supervisory framework; Banking Law in 2000 and subsequent amendments.
  - Improved loan classification and loan loss provisioning practices.
  - Supervisors perceived as professional and proactive; AML monitoring started despite incomplete legal framework.
- Areas needing strengthening:
  - Strengthen role and powers of official administrator in weak banks.
  - Require banks to monitor exchange rate exposure of foreign-currency borrowers.
  - Develop regulations on market risk and frameworks for interest rate risk.
  - Impose accounting and disclosure standards; develop consolidated accounting and supervision.
  - Urgent development of AML policies; legally empower supervisors to enforce AML/CFT.
  - Monitor large exposures, connected lending, loan classification, and provisioning given shaky ownership structures.
  - Assist banks in finding reputable strategic investors and diminish role of nonfinancial corporate owners.
  - Publication of an NBRM supervisory “mission statement” recommended.

### Management of systemic liquidity and market development
- Major issues: shallowness of interbank market and shortage of collateral.
- Interbank market constraints:
  - Development hampered by credit risk and uncertainties in realizing collateral.
  - Interbank transactions not always secured; reliance on bilateral transactions.
  - Central bank should monitor interbank transactions (number, volumes, interest rates by maturities).
- Payment Operations Law (POL) issue:
  - POL stipulation obligating NBRM to execute payment guarantees between commercial bank clients should be revised; creates legal and liquidity risks.
- Monetary instruments and operations:
  - Current instruments: reserve requirements, Lombard facility, central bank bills (CBBs), foreign exchange swaps.
  - Banks hold voluntarily nonremunerated excess reserves of about 20 percent of required reserves.
  - CBBs are most actively used instrument; Lombard facility used only occasionally.
  - Since April 2003, NBRM switched to volume tender format where interest rates announced with upper limit on volume; recommendation to discontinue or accommodate all market demand.
  - Foster secondary market development by reducing frequency of primary auctions and starting repo operations; sign Master Repurchase Agreements with all banks as soon as possible.

### Monetary policy instruments and government paper (selected)
- Recommendation: continue using CBBs as monetary policy instrument to ensure operational autonomy of NBRM.
- Treasury bills to be gradually phased in as NBRM acquires enough treasury bills through secondary market operations.
- Treasury bills design goals: prevent market fragmentation; minimize NBRM’s interest burden; develop a yield curve benchmark.
- Treasury bills should have longer maturities than CBBs; nonbank ownership of CBBs should be limited.
- Develop a registry of pledged collateral to promote and monitor use of existing government bonds.
- CBBs currently constitute only 0.6 percent of larger banks’ assets, limiting collateral availability.
- Reserve requirement reform:
  - Uniform reserve requirements on foreign currency deposits introduced since June 2003; requirements to be met in foreign currency.
  - Expected effect: impose higher cost on foreign exchange deposits to tilt bias toward local deposits.
  - In longer term, averaging provisions should apply to both deposit categories.
  - Footnote: In 2002, this (interest burden) amounted to Mden 568 million (1 percent of central bank assets or 0.2 percent of GDP), an increase of 57 percent from 2001.
  - Note: Unlike reserve requirements on domestic currency deposits, no averaging provisions and reserve accounts frozen during maintenance period for FX deposits.

### Financial safety nets: Deposit insurance and emergency lending
- Deposit Insurance Fund (DIF):
  - Functions as a payout box with no supervisory authority.
  - Insures deposits of natural persons, including foreign currency denominated deposits in commercial banks and savings houses.
  - Coverage: 100 percent of deposits up to EUR 10,000 equivalent and 90 percent of the next EUR 10,000 equivalent, per depositor per institution.
  - Current premium: flat 0.7 percent charged on all household deposits.
  - As of May 2003, DIF reserve fund covered 3.27 percent of the deposit base.
  - Reserve fund targeted to reach 4 percent of the deposit base.
  - Financing sources: initial government capital contribution, premium contributions from member banks, and investment returns; in case of shortfall DIF may receive payments from member banks up to prespecified limit, borrow domestically or externally, and borrow from government.
  - DIF generally transparent; compensation procedures, internal governance, and confidentiality publicly available.
- Emergency lending:
  - No legal provisions for emergency credit facility for systemically important banks.
  - NBRM may extend collateralized short-term liquidity support, but standing facility designed essentially for overnight lending.
  - Recommendation: develop legal provisions and policy framework granting NBRM authority to provide emergency support to systemically important banks specifying decision-making roles, coordination with MOF, eligibility of special collateral, and disclosure policy (balance discretionary authority with ex-post transparency after appropriate delay).

### Market development, pensions, and legal/judicial reforms
- Banking intermediation constraints:
  - Credit expansion noted in 2002; February 2003 annualized growth in banks’ denar placements to nongovernment sector equaled 10.6 percent.
  - Domestic lending has not yet reached pre-2001 internal crisis levels.
  - Constraints: high real rates and spreads, operational inefficiencies, lack of viable projects due to corporate governance and accounting/auditing problems, euroization, weak bank governance.
- Capitalization and profitability (2002):
  - Risk-weighted capital: 28.1 percent (end-2002).
  - Individual bank CARs ranged from 17.1 percent to 156.8 percent (as of December 31, 2002).
  - Required CAR should be higher than 8 percent in Macedonian circumstances.
  - Profitability metrics: ROA 0.4 percent; ROE 2.1 percent; cost-to-income ratio 0.91; operating expenses amounted to 167 percent of net interest income; salaries 91 percent of interest income.
- Pension reform and risks:
  - Two-pillar pension system planned by 2005 poses challenges:
    - Financing transition deficits: if GDP growth below 3 percent annually, transition deficits could amount to 1.5 percent of GDP per year.
    - Shortage of financial instruments for pension fund investment; bank deposits almost the only available financial asset.
    - Too high foreign investment by pension funds could threaten external position.
  - Recommendation: adopt slow and cautious approach; precondition development of government securities market to facilitate financing of transition deficits and provide investment opportunities.
- Legal and judicial framework priorities:
  - Implement new company law and translate corporate governance concepts into practice; improve quality of directors, administrators, accountants, and auditors.
  - Gradual enforcement of IAS compliance; update accounting and auditing laws and standards; establish professional organization to register auditors, set ethical standards, and control audit quality.
  - End practice of employers forcibly removing shareholders’ voting and other rights.
  - Promote arbitration, mediation, and other dispute resolution techniques; consider assigning bankruptcy cases to specialized judges.

### Anti-money laundering (AML) framework
- Vulnerabilities:
  - Macedonia a transit country for trafficking; presence of organized crime facilitates money laundering.
- Legal and institutional steps:
  - UN resolutions on financing of terrorism being implemented; 1998 Declaration Against Terrorism; July 2002 inter-ministerial body established; AML Law enacted in 2001; Law on Prevention of Corruption in 2002.
  - Money laundering defined in Criminal Code with an “all crimes” approach; no convictions for money laundering yet.
- Institutional capacity and recommendations:
  - FIU in MOF lacks capacity to analyze volume of reports, monitor/enforce compliance, and coordinate AML activities.
  - Financial sector supervisory agencies lack legal authority to monitor AML/CFT compliance and impose administrative sanctions without court orders; lack clear authority to share transaction information with foreign counterparts.
  - Law enforcement agencies face limitations (prohibitions against wiretapping, impediments to confiscating/seizing/freezing assets) hindering investigations and mutual legal assistance.
  - Recommendations: amend laws to grant supervisors and law enforcement broader authorities; provide AML/CFT training; allocate enhanced financial and human resources for specialized investigative and prosecutorial staff.

### Observance of standards, codes, and payment systems governance (selected)
- FSAP joint assessments (May–June 2003): FYR Macedonia making considerable progress in observing assessed international standards and codes; authorities willing to implement improvements.
- Payment systems (MIPS) assessment highlights:
  - MIPS is cornerstone of national payments and settlement infrastructure; KIBS carries 22 percent of noncash payments by value.
  - MIPS is RTGS; payments over Mden 3 million must use MIPS.
  - Legal foundation generally supportive but POL contains unusual obligations (NBRM executing payment guarantees) that should be removed.
  - Risks: lack of remote back-up facility for MIPS; NBRM has limited formal role in payment policy formulation.
  - Recommended actions: define and disclose NBRM role in ensuring payment system stability; remove POL obligations compelling NBRM to execute payment guarantees; establish remote back-up site; publish more detailed audited balance sheets and ex post aggregate information on emergency credit facilities with judgment on timing and nature of disclosure.
- MFP Transparency Code (monetary and financial policies):
  - NBRM practices a high degree of transparency on roles, responsibilities, objectives, and policy formulation/disclosure.
  - Areas to enhance disclosure: lender-of-last-resort role, ex post aggregate information on emergency credit facilities, more detailed public financial information, disclosure of internal governance standards and code of conduct, expand conflict of interest statements to all managerial staff, disclose legal protection for staff.
  - Accountability arrangements strengthened: governor required to appear at least every six months before parliament.

*Source: _cr03374 - Financial System Structure, 1998–2002 (IMF).*

### 1.     Financial System Structure, 1998–2002 ..........................................................................1

### Financial System Structure, 1998–2002

### I. Overall assessment of stability and development issues — Context for financial intermediation
- FYR Macedonia has not yet fully recovered from the breakup of Yugoslavia and subsequent upheavals following independence in 1991 (loss of foreign exchange deposits held in the National Bank of Yugoslavia, embargo on Yugoslavia, blockade by Greece, the 1999 Kosovo conflict, and internal civil strife in 2001).
- Intermittent conflicts and disturbances adversely affected the development and governance of institutions necessary for transition to a market economy; significant corruption in the public sector is reported, with use of public office for private gain.
- The judicial system is considered ineffective because of excessive politicization, lack of independence, intimidation of judges, and deficiencies in court procedures and operations.
- Weak institutions and governance have impeded economic development and growth; FYR Macedonia is only midway in the transition to a stable market-oriented economy and does not present an environment conducive to attracting investment.
- Financial integrity has been threatened by corruption and abuse; weak corporate governance and legal uncertainty have constrained banks’ lending activities.
- A two-pronged strategy is needed: preserve macroeconomic stability and address governance and corruption. The government has taken steps in both areas, seen as keystone for building a sound and stable financial system.

### I.B. Vulnerabilities and soundness of banking
- Banking system soundness has been improving but the sector remains small and relatively underdeveloped; deposits and assets are concentrated in the top three banks, which are emerging as a core group with relatively prudent and sound practices after privatization and entry of foreign strategic investors.
- Macedonia’s macroeconomy has been relatively stable despite political and economic upheaval; recovery from the 2001 security situation is very slow. No immediate macroeconomic threats identified, but vigilance is needed for exchange rate instability in a highly euroized environment or a drastic reduction in donor support.
- Key vulnerabilities:
  - Weak governance in smaller banks stemming from early transition practices: dispersed ownership with one strong manager, weak management structures, nontransparent ownership in some banks.
  - Authorities lack the full legal toolkit to address ownership/governance problems; short-term recommendation is to attract reputable strategic investors.
  - Balance sheet weaknesses reflected in high percentage of nonperforming loans (NPLs).
- Market characteristics:
  - High real interest rates, large spreads, and limited appetite for lending. Interest rate spreads are above 8 percentage points, reflecting lack of competition, inefficient operations (overstaffing), and high credit risk.
  - Most banks expanding lending only modestly due to weak balance sheets and a legal environment not conducive to repayment and loan recovery.
- Euroization:
  - About 64 percent of deposits and 40 percent of banks’ total loans are denominated in foreign currency.
  - Foreign currency deposits are subject to the same reserve requirement as denar deposits.
  - Supervisors monitor open positions closely; banks are adequately hedged against foreign exchange risks but exposed to credit risks from borrowers who are not foreign exchange earners.
  - NBRM will require banks to set up a reporting system to gauge their borrowers’ foreign exchange exposure.
- Stress testing and liquidity:
  - Stress tests indicate the banking system is relatively resilient to direct effects of individual shocks; credit risk has the greatest impact.
  - Combined exchange and interest rate shocks plus a drop in credit quality could cause significant strain.
  - Larger banks more vulnerable than smaller banks because they lend more actively and have lingering portfolio problems.
  - Deficiencies in liquidity management framework are developmental but need addressing to avoid systemic problems: expand eligible instruments for collateral to access the central bank; support secondary market development by reducing frequency of central bank bill auctions.
  - Some banks vulnerable due to sizeable individual deposits; interbank market is too shallow for larger banks.
- Payment system and supervision:
  - Establishment of the Macedonian Interbank Payment System (MIPS) is progress; improvements needed in defining central bank oversight role and establishing a remote back-up facility.
  - Legal requirement that the NBRM execute payment guarantees between commercial bank clients should be revised because it creates legal risks for the NBRM and liquidity risks for the payment system.
  - Banking supervision quality continues to improve per Basel Core Principles assessment. Supervisors moving beyond formal rule checking toward risk-oriented supervision are encouraged to further develop risk-oriented techniques and strategic thinking and include financial soundness in off-site analysis.
  - Regulatory framework improvements already include better fit-and-proper regulations, stricter reporting of investments in banks and significant bank investments, and expanded corrective actions for weak banks.
  - Suggested further regulatory changes: strengthen powers of the administrator of weak banks; enhance supervisors’ role in AML/CFT; adopt internationally accepted accounting standards to improve transparency.

### I.C. Broader framework for finance
- Implementation and enforcement of the legal framework must be strengthened for financial intermediation to deepen; core legal framework is generally sound but enforcement is weak, contributing to noncompliance and nonpayment.
- Court system improvements are crucial to create respect for rule of law and judicial system.
- Corporate governance: some key elements exist but much remains to be translated into practice. Priority areas:
  - Improve protection of shareholder rights and enforcement of directors’ duties.
  - Require Macedonian companies to prepare financial statements consistent with International Accounting Standards (IAS) and improve auditing practices.
- AML/CFT: bank supervisors’ integrity efforts must be complemented by enforcement of AML/CFT framework. Newly established financial intelligence unit (FIU) in the MOF should be instrumental, but greater roles for financial sector supervisory agencies are needed; identify ways to overcome supervisors’ lack of legal authority to enforce compliance.

### I.D. Nonbank financial system
- Securities markets are small and present little systemic risk; development of a government securities market is expected to contribute to financial deepening.
- Equity market development hindered by managerial control over voting rights on shares held by employees.
- Insurance sector remains insignificant; legal and supervisory frameworks should be strengthened to allow sector development.
- Mandatory second pension pillar legislation passed but poses significant challenges: financing fiscal transition deficits and creating financial instruments for investment.

### Box 1 — Main recommendations
1. Banking
- The quality of bank ownership could be further improved by continued efforts to attract reputable strategic owners.

2. Banking regulation and supervision
- Regulations should be strengthened in the areas of market risk, internal risk management, interest rate risk, corrective actions, and powers for the official administrator overseeing weak banks. Regulations for accounting and disclosure standards for banks need to be promulgated.
- Supervisors should develop a strategy to minimize the ownership of nonfinancial corporates in the banking system.
- Supervisors should require the banks to monitor and report on their borrowers’ foreign exchange exposure.
- Supervisors should establish a list of financial sector soundness indicators, in order to monitor the aggregate soundness of the banking system.
- Supervision should be more risk-oriented. Contacts with bank managers could be intensified.
- Supervisors should have a more active role in AML/CFT implementation and enforcement.
- The NBRM should publish a “mission statement” for its banking supervisory function.

3. Market development
- The development of government securities market, as a basis for financial market promotion, should be a priority.
- Liquidity management could be improved through the expansion of instruments available for collateral to access the central bank facilities.

4. Payment system
- The NBRM’s role in setting objectives for the development of a payment infrastructure in FYR Macedonia should be better defined.
- A remote back-up facility for MIPS should be established.
- The obligation for the NBRM to decide on, and execute, guarantees between third parties should be removed. A mechanism should be found to involve courts.

5. Financial safety nets
- A framework and procedures for emergency lending by the NBRM should be established.

6. Legal and judicial framework
- The judicial system needs to be reformed and the implementation and enforcement of laws strengthened to create respect for the rule of law and the judicial system.
- Financial sector regulators should be provided legal authority to impose sanctions on financial institutions.

7. AML/CFT
- The legal framework for AML/CFT should be strengthened and implementation expedited.

*Source: _cr03374 - Financial System Structure, 1998–2002 (IMF).*

### 22. The Macedonian banking system remains small compared to the size of the

### 22. The Macedonian banking system remains small compared to the size of the

### Banking system size, structure, and concentration
- Banking system assets at 39 percent of GDP.
- At end-2002: 21 banks and 17 savings houses licensed.
- Banks hold 98.9 percent of total bank and savings house assets.
- Commercial banks operate a two-tier licensing system; 18 banks hold the foreign operations license enabling international payments, credit, and guarantee operations.
- Minimum capital requirements:
  - EUR 9 million for a foreign operations license.
  - EUR 3.5 million for a domestic operations license.
- System concentration and ownership (end-2002):
  - The three largest banks managed almost 73 percent of total deposits and 64 percent of total bank assets.
  - State ownership of banks: 14 percent.
  - Foreign ownership: almost 45 percent of total bank capital.
- Table 1 selected asset figures (years and values preserved as presented):
  - Banks: 1998 MKD 59,093; 1999 MKD 72,279; 2000 MKD 81,999; 2001 MKD 105,623; 2002 MKD 93,213.
  - Largest three banks (assets): 1998 MKD 34,818; 1999 MKD 44,794; 2000 MKD 52,460; 2001 MKD 66,872; 2002 MKD 59,619.
  - Private banks (assets): 1998 MKD 58,254; 1999 MKD 71,375; 2000 MKD 81,067; 2001 MKD 104,214; 2002 MKD 91,362.
  - Savings houses (assets): 1998 MKD 755; 1999 MKD 760; 2000 MKD 1,038; 2001 MKD 676; 2002 MKD 956.
  - Insurance companies (assets): 1998 MKD 8,480; 1999 MKD 10,121; 2000 MKD 11,172; 2001 MKD 11,987; 2002 MKD 11,843.
- Relative asset shares (selected):
  - Banks as percent of total financial system assets: 1998 86.5 percent (30.3 percent of GDP); 1999 86.9 percent (34.6 percent of GDP); 2000 87.0 percent (34.7 percent of GDP); 2001 89.3 percent (45.2 percent of GDP); 2002 87.9 percent (39.0 percent of GDP).
  - Savings houses: around 0.4 percent of total financial system assets across years.
  - Insurance companies: 1998 12.4 percent (4.3 percent of GDP); 2002 11.2 percent (5.0 percent of GDP).

### Comparative indicators with selected Central and Eastern European countries (December 31, 2002)
- Number of banks: Albania 13; Bulgaria 34; Czech Republic 37; Hungary 39; FYR Macedonia 21; Poland 62; Slovenia 20.
- Concentration (share of largest three banks in system assets, country definitions noted in source): FYR Macedonia 64.0.
- Total banking assets/GDP: Albania 52; Bulgaria 46; Czech Republic 110; Hungary 64; FYR Macedonia 39; Poland 61; Slovenia 80.
- Of which: credit to GDP: FYR Macedonia 28 (other countries: Albania 35; Bulgaria 19; Czech Republic 39; Hungary 39; Poland 26; Slovenia 65).
- Capital adequacy ratio (CAR): FYR Macedonia 28 (others: Albania 35; Bulgaria 25; Czech Republic 14; Hungary 13; Poland 15; Slovenia 12).
- Foreign ownership: FYR Macedonia 44 (other values listed as in table).
- Nonperforming/classified loans: FYR Macedonia 15.9 (others: Albania 5.5; Bulgaria 9.8; Czech Republic 16.9; Hungary 3.7; Poland 21.4; Slovenia 7.0).
- Average return on assets (ROAA): FYR Macedonia 0.4 percent.
- Average return on equity (ROAE): FYR Macedonia 2.1 percent.
- Net interest margins: FYR Macedonia 8.2.
- Operating expenses/total assets: FYR Macedonia 4.4.

### Supervisory and central bank practices
- The National Bank of the Republic of Macedonia (NBRM) assessed against the IMF’s Code of Good Practices (Transparency in Monetary and Financial Policies - MFP) as practicing a high degree of transparency on roles, responsibilities, objectives, and policy formulation/disclosure.
- Areas where transparency could be enhanced:
  - Disclose the lender-of-last-resort role and publish, ex post, aggregate information on the use of emergency credit facilities.
  - Provide more detailed financial information to the public.
  - Disclose internal governance standards and the code of conduct; expand conflict of interest statements to all managerial staff; disclose the extent of legal protection of staff.
- Accountability arrangements strengthened post-FSAP by requiring the governor to appear at least every six months before parliament.

### Nonbank financial sectors
- Equity market (2002):
  - Total equity market turnover EUR 26 million.
  - Turnover in other instruments EUR 21 million.
  - Macedonian Stock Exchange (MSE) membership: 12 members (three banks and nine brokerages).
  - Clearing and settlement through the Central Securities Depository (CSD); records maintained in dematerialized form.
  - Securities markets supervised by the Securities and Exchange Commission (SEC), which lacks enforcing capacity.
- Securities Law amendment (2002):
  - Requires all companies meeting MSE listing requirements to list their shares on the MSE.
  - Profit tax reduced by 50 percent for three years for any listed company.
  - About 100 companies were mandated to list their securities; regulations allow voluntary withdrawal after termination of the legal obligation or de-listing.
- Equity market development constraints:
  - Worker/employee role in privatization has effectively blocked trading in many shares; in many companies employees ceded voting rights to management so voting rights may not transfer with sale.
  - By-Law to Foreign Exchange Law imposes higher cost to foreign investors repatriating money before one year by requiring a custodian account.
- Insurance sector:
  - One of the smallest in Europe both absolutely and relative to population.
  - Seven insurance companies licensed and three insurance brokerage houses licensed.
  - Former state-owned insurer dominates the market.
  - Life insurance represents two percent of premiums.
- Regional integration note: Given low activity and equity market size, regional integration should be considered; MSE has an informational link with Slovenia and planned future links with other former Yugoslav countries and Greece.

### Markets, infrastructure, and payments
- Operating short-term markets: interbank money market and foreign exchange market.
- Plans to establish a government securities market starting in early 2004.
- Liquidity and turnover:
  - May 2003 average daily turnover on interbank money market and bilateral deals about MDen 160 million (roughly $2.5 million).
  - Foreign exchange market turnover grew 47 percent in the first four months of 2003 over the same period in the previous year.
  - Since January 2003, bid-ask spread narrowed from around 60 basis points to around 40 basis points.
  - Three banks account for over half of foreign exchange turnover volume.
  - Foreign exchange swaps emerging as main tools for commercial bank liquidity management.
- Cash and noncash usage:
  - Denars on issue are 6 percent of GDP.
  - Noncash payment system concentrated: NBRM initiates about a quarter of total value through the clearing system; the two largest banks account for a further 30 percent of value exchanged.
- Payment system components:
  - MIPS (real-time gross settlement system owned/operated by NBRM) used for all large-value payments (more than Mden 3 million) and urgent/priority payments; 27 participants including all banks, clearinghouses, MOF, and NBRM.
  - MIPS connected to the CSD and provides platform for delivery versus payment securities settlement.
  - KIBS is the clearinghouse for low-value payments.
- MIPS operation follows best international practices; areas for attention:
  - Clarify and strengthen NBRM’s oversight role over the system.
  - Establish a remote back-up facility.

### Recent economic developments and macroeconomic context
- Macroeconomic performance (late 1990s–2002):
  - Economy grew at an average rate of around 4 percent in the late nineties with a low average inflation rate of about 2 percent.
  - Price stability maintained through a de facto exchange rate peg to the euro.
- Table 3 selected indicators (1998–2002 as presented):
  - Real GDP growth (percent change): 1998 3.4; 1999 4.3; 2000 4.5; 2001 -4.5; 2002 0.7.
  - Consumer prices, period average: 1998 -0.1; 1999 -0.7; 2000 5.8; 2001 5.3; 2002 2.4.
  - Real wages, period average: 1998 3.7; 1999 3.6; 2000 -0.3; 2001 -1.7; 2002 4.5.
  - Unemployment rate (average): 1998 34.5; 1999 32.4; 2000 32.2; 2001 30.5; 2002 31.9.
  - General government balance (percent of GDP): 1998 -1.7; 1999 0.0; 2000 1.8; 2001 -7.2; 2002 -5.7.
  - Central government balance (percent of GDP): 1998 -0.8; 1999 0.8; 2000 2.7; 2001 -5.8; 2002 -5.4.
  - Government debt (gross, percent of GDP): 1998 52.0; 1999 57.4; 2000 53.2; 2001 51.6; 2002 50.1.
  - Broad money (M3, percent of GDP): 1998 16.0; 1999 19.4; 2000 21.5; 2001 34.1; 2002 30.3.
  - Total credit to private sector (percent of GDP): 1998 15.7; 1999 14.5; 2000 15.1; 2001 15.5; 2002 16.4.
  - Short-term lending rate: 1998 20.5; 1999 20.0; 2000 19.0; 2001 19.2; 2002 17.7.
  - Official gross reserves (US$ million; end of period): 1998 290; 1999 450; 2000 700; 2001 756; 2002 735.
  - Reserve cover (months of next year's imports): 1998 1.8; 1999 2.4; 2000 4.3; 2001 4.2; 2002 3.6.
- Impact of the 2001 security crisis:
  - Growth in 2001 was negative (-4.5 percent).
  - Fiscal balances declined from a surplus of 1.8 percent to a deficit of over 7 percent of GDP, largely due to security-related spending.
- Recovery and near-term projections (as presented):
  - Output growth remained 0.7 percent in 2002.
  - Stronger growth projected for 2003: 2.7 percent.
  - Central government deficit expected to narrow to 1.4 percent of GDP in 2003 from 5.4 percent in 2002.
  - Inflation: average 2.4 percent for 2002; very low inflationary pressures in first half of 2003 (average of 0.3 percent year-on-year).
  - Fiscal pressure easing owing to decline in security-related and pre-election spending and extraordinary inflows of donor finance.

### Vulnerabilities and macroeconomic sources of financial stability risk
- External competitiveness concerns under the fixed exchange regime:
  - Current account deficit high: 11.2 percent of GDP excluding grants and 8.6 percent including grants in 2002.
  - Real exchange rate indicators do not suggest an overvaluation.
  - Remittances, exceptional FDI, and donor finance have helped maintain international reserve position.
  - Concerns about current account sustainability in the longer run due to heavy reliance on donor inflows.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 36. A potential macroeconomic risk in the banking sector could therefore result

### 36. A potential macroeconomic risk in the banking sector could therefore result

### Exchange rate and macro-fiscal risks
- In Macedonia’s highly euroized environment, the greatest risk for banks is credit risk from borrowers with unhedged exchange rate positions.
- Mitigating factors noted:
  - Banks’ net long position in foreign currency exposure.
  - Relatively high capital adequacy ratios.
  - Some degree of real euroization in the economy.
- Authorities are urging banks to analyze and report clients’ exchange rate exposure.
- Fiscal vulnerability:
  - The budget has been supported significantly through privatization receipts (especially from FDI) and donor help; a drastic reduction in donor support could make the fiscal position unsustainable.
  - If inflows taper off, the government would need to rely on new domestic borrowings despite limited debt management capacity.
  - A large fiscal financing requirement or inability to place government bills could result in high interest rates, unsustainable debt levels, and crowding out of private investment and credit flows.

### Banking system soundness: recent improvements
- Improvements driven by:
  - Stronger supervision.
  - Involvement of a few strategic foreign investors.
  - Ongoing cleaning up of the balance sheets of the three largest banks.
- Emergence of a core group of banks with raised management and internal risk management practices:
  - These banks account for 64 percent of the banking system’s assets and 45 percent of total capital.

### Governance vulnerabilities
- Persistent governance problems, especially in smaller banks, could undermine sector credibility.
- Specific governance concerns:
  - Nontransparent and, in some cases, weak ownership and management structures.
  - Many banks originated in the former Yugoslavia with enterprises retaining shares; some banks have very dispersed and disinterested ownership due to early-1990s “compensating shares” policies.
  - Management can be in a powerful position where ownership is dispersed.
  - Changes in bank ownership only required supervisory approval if they exceed 10 percent of equity capital, limiting vetting.
  - Recent Constitutional Court rulings (May 2003) have invalidated provisions disallowing persons with criminal records as shareholders/board members/managers, creating further uncertainty about ownership quality.
  - New fit and proper articles enacted but remain untested in court.
- Existence of “pocket banks”:
  - Some small banks act as treasury operations or cheap liquidity sources for enterprise groups or individuals.
  - Lack of corporate ownership information makes detection of connected and insider lending difficult.

### Balance sheet weaknesses and asset quality
- Weak internal credit risk systems and limited borrower information raise risk of loan quality erosion.
- Historical shocks exposing vulnerability:
  - 1999 Kosovo crisis and the 2001 security crisis.
- NPLs and provisioning:
  - NPLs are still about 15.9 percent of all loans.
  - Provisioning of NPLs is based on international best practices, strictly enforced, and given favorable tax treatment; most banks have provisioned at required levels.
  - Supervisors should collect information to calculate historical recovery rates and proactively change provisioning requirements if warranted.
  - Monitoring of loan classification is warranted when borrowers’ exchange rate risk leads to credit risk for lenders.
- NPLs remain high also because of problems banks face with the loan recovery process.

### Liquidity risks and market shallowness
- Factors increasing liability volatility and liquidity risk:
  - Bulk of deposits are short term; sight deposits comprise 39 percent of assets, of which household sight deposits are 21 percent of assets.
  - Significant portion of deposits denominated in foreign currency: 34 percent of assets, of which household foreign currency deposits are 25 percent of assets.
  - In some banks, deposit concentration is high: a single depositor may account for 25 percent to 40 percent of the deposit base.
  - In recent episodes public deposits (3 percent to 7 percent of assets in the largest banks) were shifted abruptly between banks.
- Policy recommendation on public funds:
  - Public funds should be placed in the central bank as a sub-account of the Treasury and transferred gradually to minimize impact on bank liquidity positions.
- Market depth issues:
  - Lack of trading volumes leads banks to hold precautionary balances in domestic currency and foreign exchange.
  - Banks hold substantial short-term deposits in foreign banks (31 percent of assets) to match currency and maturity profile of short-term foreign currency liabilities.
  - Significant buildup of reserves with the NBRM before tax and pension payment days.
  - Shallowness constrains ability to extend longer-term domestic credit.

### Financial soundness indicators (selected observations from Table 4, 1998–2002)
- Core metrics and trends (as reported in table format in source):
  - Regulatory capital/risk weighted assets: 25.9 28.7 36.7 34.3 28.1
  - Tier I capital/risk weighted assets 1/: 28.6 29.8 37.4 35.1 28.3
  - Enterprises loans/total loans: 66.4 53.0 47.1 42.1 37.3
  - Households loans/total loans: 4.9 4.9 6.1 5.9 7.9
  - Foreign currency lending/total credit to private sector: ... 21.3 14.0 13.8 22.2
  - Gross nonperforming exposures/total credit exposure 2/: 32.9 41.3 34.8 33.7 15.9
  - NPLs net of provision /capital: 70.5 74.6 43.6 52.4 41.6
  - Liquid assets/total assets 3/: 37.7 52.6 47.5 54.6 44.8
  - Liquid assets/total short-term liabilities 3/: 67.1 86.6 76.6 79.4 69.4
  - Customer deposits/total (noninterbank) loans: 55.0 72.0 83.8 163.0 130.2
  - Foreign currency deposits/total deposits: 45.9 42.5 49.8 71.9 63.9
  - Central bank credit to banks/bank liabilities: 4.3 1.4 0.6 0.2 0.2
  - Net FX position /capital: 24.6 79.4 54.0 60.5 56.2
- Notes (as presented in source):
  - 1/ Capital includes common shares, general and revaluation reserves, and undistributed profits, net of specific provisions.
  - 2/ Based on the new methodology in which interbank loans are included in total credit exposure. The ratio is close to a third of all loans based on the previous methodology.
  - 3/ Liquid assets are defined as cash and balances with the NBRM, securities rediscounted by the NBRM, and short-term bank placements. Short-term liabilities are defined as deposits and other liabilities with a maturity of one year or less.

### Stress testing results
- Individual shocks:
  - System-wide CAR could fall by up to 6.5 percentage points in response to individual shocks.
  - Credit shocks are the most damaging but seem manageable for the system as a whole.
  - Deterioration in asset quality comparable to the Kosovo crisis may cause strain for larger banks.
  - Currency risk matters primarily because it induces credit risk via deterioration of borrowers’ balance sheets.
  - Interest rate risks matter only marginally due to high repricing frequencies.
- Combined shock scenario (specified magnitudes from source):
  - 20 percent depreciation of denar,
  - 20 percentage point increase in denar interest rates,
  - 30 percent increase in NPLs.
- Impact of combined scenario:
  - Reduction of the system-wide CAR by 13.5 percentage points.
  - Would push three banks below the 8 percent CAR, although those banks would remain solvent.

### Prudential regulation, supervision, and policy recommendations
- Progress and strengths:
  - Substantial progress in enhancing legal and supervisory framework; new Banking Law in 2000.
  - Prudential regulations refined; improvements in loan classification and loan loss provisioning practices.
  - Emphasis on improved on-site inspections and off-site monitoring.
  - Supervisors perceived as professional and proactive; example: start of AML monitoring despite incomplete legal framework.
- Areas needing further strengthening:
  - Strengthen role and power of the official administrator in weak banks.
  - Banks should be required to monitor exchange rate exposure of their foreign-currency borrowers.
  - Develop regulations on market risk.
  - Impose accounting and disclosure standards.
  - Urgently develop anti-money laundering (AML) policies beyond infancy.
  - Develop consolidated accounting and supervision standards.
  - Supervisors should monitor large exposure limits, connected lending, loan classification, and loan loss provisioning given shaky ownership structures.
  - Supervisors should assist banks in finding reputable strategic investors and diminish role of nonfinancial corporate owners.
  - Consider publication of a “mission statement” by the NBRM to improve public understanding of supervisors’ work.
- Other financial subsectors:
  - Supervisory framework for securities: recent Securities Law amendments provide greater SEC independence; further improvements recommended, including immunity for securities regulators, strict conflict of interest guidelines, investor complaint systems, and disclosure of legal insider trading.
  - Insurance sector: new insurance supervision law is a step forward but far from EU requirements; insurance supervision housed in MOF is understaffed and inexperienced. Urgent action needed, especially if a second pension pillar is pursued.

### Management of systemic liquidity and market development
- Major issues: shallowness of interbank market and shortage of collateral.
- Interbank market constraints:
  - Development hampered by credit risk from uncertainties in realizing collateral.
  - Interbank transactions are not always secured, increasing reliance on bilateral transactions outside institutional market.
  - Central bank should monitor interbank transactions and ensure sufficient information flows on number of transactions, volumes, and interest rates by maturities.
- Payment Operations Law (POL) issue:
  - POL stipulation obligating the NBRM to execute payment guarantees between commercial bank clients should be revised and handled outside the payment system.
  - Risks: legal risk for NBRM and increased liquidity risks to MIPS participants without a ready management mechanism.
- Monetary instruments and operational recommendations:
  - Current instruments (reserve requirements, Lombard facility, central bank bills (CBBs), foreign exchange swaps) generally adequate for liquidity management.
  - Banks hold voluntarily nonremunerated excess reserves of about 20 percent of required reserves; CBBs are the NBRM’s most actively used instrument; Lombard facility used only occasionally in past two years.
  - Since April 2003, NBRM switched to a volume tender format where interest rates are announced with an upper limit on volume; recommendation to discontinue this practice and, if using volume tenders, stand ready to accommodate all market demand.
  - Foster secondary market development by reducing frequency of primary auctions and starting repo operations to mitigate credit risk via facilitating ownership transfer of underlying collateral in case of default.
  - Master Repurchase Agreements should be signed with all banks as soon as possible.

*Source: IMF staff report excerpt (text provided in the source content).*

### 60. Even after the introduction of treasury bills, CBB issues should be used as a

### _cr03374 - 60. Even after the introduction of treasury bills, CBB issues should be used as a

### Monetary policy instruments and government paper
- Recommendation to continue using CBB issues as a monetary policy instrument to ensure the operational autonomy of the central bank.
- Treasury bills should be gradually phased in as the NBRM acquires enough treasury bills through secondary market operations.
- Treasury bills issuance design goals:
  - Prevent market fragmentation.
  - Minimize the NBRM’s interest burden.11
  - Develop a yield curve that can serve as a benchmark for other instruments.
- Treasury bills should have a longer maturity structure than CBBs.
- Nonbank ownership of CBBs should be limited so CBBs function purely for liquidity management purposes.
- Develop a registry of pledged collateral to promote and monitor use of existing government bonds.
- Collateral and access issues:
  - CBBs currently constitute only 0.6 percent of larger banks’ assets, limiting collateral availability for the Lombard facility.
  - Some government bonds are technically eligible as collateral but ownership transfer is constrained by the stock exchange’s T+3 settlement schedule.
- Reserve requirement reform:
  - Given high euroization, introduction of uniform reserve requirements on foreign currency deposits since June 2003 is a significant stability measure.
  - These requirements are to be met in foreign currency.
  - Expected effect: imposing a higher cost on foreign exchange deposits will tilt the present bias towards local deposits.12
  - In the longer term, averaging provisions should apply to both categories of deposits.

11. In 2002, this amounted to Mden 568 million (1 percent of central bank assets or 0.2 percent of GDP), an increase of 57 percent from 2001.
12. Unlike reserve requirements on domestic currency deposits, there are no averaging provisions and the reserve accounts will be frozen during the maintenance period for required reserves on foreign currency deposits.

### Financial safety nets: Deposit insurance and emergency lending
- Deposit Insurance Fund (DIF) structure and coverage:
  - Functions as a payout box with no supervisory authority.
  - Insures deposits of natural persons (including foreign currency denominated deposits held in commercial banks and savings houses).
  - Coverage: 100 percent of deposits up to EUR 10,000 equivalent and 90 percent of the next EUR 10,000 equivalent, per depositor per institution.
  - Current premium: a flat 0.7 percent charged on all household deposits.
  - As of May 2003, the DIF reserve fund covered 3.27 percent of the deposit base.
  - Reserve fund targeted to reach 4 percent of the deposit base.
  - Financing sources: initial government capital contribution, premium contributions from member banks, and investment returns.
  - In case of shortfall, DIF may receive payments from member banks up to a prespecified limit, borrow domestically or externally, and borrow from the government.
  - DIF is generally transparent; procedures on compensation (payouts), internal governance, and confidentiality are publicly available.
- Emergency lending facility shortcomings and recommendations:
  - No legal provisions for emergency credit facility for systemically important banks.
  - NBRM may extend collateralized short-term liquidity support, but the standing facility is designed essentially for overnight lending (extension of intra-day credit for payments).
  - Recommendation: develop legal provisions and a policy framework granting NBRM authority to provide emergency support to systemically important banks, specifying:
    - Decision-making roles and responsibilities within NBRM.
    - Coordination with the MOF.
    - Eligibility of special collateral.
    - Disclosure policy (policies may be kept internal to prevent moral hazard; balance discretionary authority with ex-post transparency after an appropriate delay).

### Banking intermediation: performance, constraints, and capital
- Recent lending dynamics:
  - Credit expansion noted in 2002 (Table 3) and higher rate in 2003; in February 2003, annualized growth in banks’ denar placements to the nongovernment sector equaled 10.6 percent.
  - Domestic lending has not yet reached pre-2001 internal crisis levels.
- Factors constraining intermediation:
  - High real rates and spreads.
  - Operational inefficiencies.
  - Lack of viable projects due to governance problems in the enterprise sector and problems in accounting and auditing.
  - Euroization of assets and liabilities.
  - Weak bank governance leading to low profitability and limited price competition.
- Capitalization and profitability indicators:
  - Risk-weighted capital was 28.1 percent at end-2002.
  - Individual bank CARs ranged from 17.1 percent to 156.8 percent as of December 31, 2002.
  - In Macedonian circumstances, required capital adequacy ratio should be higher than 8 percent, even in the future.
  - Banks’ profitability and efficiency metrics (2002):
    - Return on assets (ROA): 0.4 percent.
    - Return on equity (ROE): 2.1 percent.
    - Cost-to-income ratio: 0.91.
    - Operating expenses amounted to 167 percent of net interest income (an improvement only slight over previous years).
    - Salaries alone amounted to 91 percent of interest income.
- Lending and interest rate dynamics:
  - Low lending is partly due to high real interest rates and spreads, deterring viable projects and encouraging adverse selection for high risk/high return lending.
  - High nominal interest rates in recent years reflected monetary policy supporting the exchange rate peg; high interest on risk-free CBBs made them attractive investments (particularly to smaller banks) over lending, a situation recently moderated.
- Governance and accounting issues:
  - Corporate governance weaknesses and poor accounting practices impede loan evaluation and early recognition of loan impairment.
  - In practice, corporate sector does not produce financial statements consistent with IAS despite legal requirements.
- Euroization impacts:
  - Euroization of liabilities constrained intermediation: limited opportunities to earn foreign exchange returns forced banks to keep a significant ratio of assets abroad, reducing domestic intermediation funds.

### Market development, pensions, and legal/judicial reforms
- Capital market development:
  - Planned introduction of treasury bills expected to deepen financial markets by increasing investment opportunities and mobilizing savings from households and nonbank financial institutions.
  - Government paper at different maturities will help develop a yield curve to benchmark other instruments.
- Pension system development and risks:
  - Plans to introduce a two-pillar pension system by 2005 pose two major challenges:
    - Financing of transition deficits.14
      - If low GDP growth (i.e., below 3 percent annually) accompanies second-pillar introduction, transition deficits could amount to 1.5 percent of GDP per year, gradually threatening fiscal sustainability.
    - Shortage of financial instruments for pension fund investment; currently bank deposits are almost the only available financial asset.
    - Too high foreign investment by pension funds could threaten Macedonia’s external position.
  - Recommendation: adopt a slow and cautious approach; precondition is development of a government securities market to:
    - Facilitate financing of transition deficits to the extent the fiscal deficit remains sustainable.
    - Provide investment opportunities for pension funds.
    - Stimulate development of other investment opportunities.
14. These are the deficits that will occur during the transition from a one-pillar to a two-pillar system, caused by the transfer of pension contributions to second-pillar assets.
- Legal and judicial framework weaknesses and priorities:
  - Legal framework generally sound, but implementation and enforcement are perceived as weak, fostering corruption, noncompliance, and a weak governance environment that deters financial intermediation.
  - Judicial system weaknesses: lack of staff trained in financial/commercial matters, low funding, poor infrastructure, politicized appointments, perceived lack of independence, weak case management, limited computerization, poor security for judges, frequent intimidation, procedural determinations, and limited training.
  - Areas needing attention:
    - Implement the new company law and translate corporate governance concepts into practice; improve quality of directors, administrators, accountants, and auditors.
    - Gradual enforcement of compliance with IAS; update accounting and auditing laws and standards; establish a professional organization to register auditors, set ethical standards, and control audit quality.
    - End practices of employers forcibly removing shareholders’ voting and other rights.
    - Promote arbitration, mediation, and other dispute resolution techniques to relieve court pressure.
    - Consider assigning bankruptcy cases to specialized judges given complexities; Law on Bankruptcy of 1999 works satisfactorily where private parties are involved but problems arise when the State is involved.
    - Debt recovery framework: efficient for uncontested debts (notaries can resolve cases without courts); where court hearings are required, delays and unpredictability persist due to deficiencies in Civil Procedure and Court Procedure Codes; pledge register is reasonably efficient, cadaster register needs improvement.

### Anti-money laundering (AML) framework
- Vulnerabilities:
  - Macedonia is a natural transit country for trafficking of illicit goods and people; presence of organized crime facilitates money laundering; proceeds of financial crimes believed laundered in country.
- Legal and institutional steps taken:
  - UN resolutions on financing of terrorism being implemented.
  - 1998 parliamentary Declaration Against Terrorism obliges authorities to strengthen detection of terrorist acts.
  - July 2002: government established an inter-ministerial coordinative body for fighting international terrorism; new law against terrorism being prepared.
  - AML Law enacted in 2001; Law on Prevention of Corruption in 2002.
  - Money laundering defined in the Criminal Code with an “all crimes” approach to predicate offenses; allows prosecution of money laundering separate from predicate offense; no convictions for money laundering yet.
  - Amendments to AML Law currently before parliament.
- Institutional capacity and recommendations:
  - Ministry of Finance (MOF) FIU established to receive and analyze suspicious transaction reports; currently lacks capacity to analyze volume of reports, monitor and enforce compliance, and coordinate AML activities across government bodies.
  - Priority: enhance financial and human resources for the FIU.
  - Financial sector supervisory agencies lack appropriate legal authority to monitor AML/CFT compliance and impose administrative sanctions without court orders; they also lack clear authority to share transaction information with foreign counterparts.
  - Law enforcement agencies have legal and constitutional limitations inhibiting effective AML/CFT investigations and prosecutions, including prohibitions against wiretapping and other modern techniques, and impediments to confiscating/seizing/freezing assets of suspects; these limitations also hinder mutual legal assistance with foreign counterparts.
  - Recommendations: amend laws to grant supervisors and law enforcement broader authorities, provide specific AML/CFT capacity training, and allocate enhanced financial and human resources for specialized investigative and prosecutorial staff.

### Summary assessments (observance of standards and codes)
- FSAP joint assessments (May–June 2003) used to gauge risks, vulnerabilities, and developmental needs; authorities willing to implement suggested improvements.
- Overall findings:
  - FYR Macedonia is making considerable progress in observing the assessed international standards and codes.
  - Agencies strive for transparency and openness in policies and procedures.
  - Area needing most effort: AML/CFT.
  - Cross-sector issues requiring attention: legal protection for regulators and supervisors, clearly defined enforcement powers, and publication of mission statements and conflict of interest rules for staff.1
- Specific supervisory and systemic recommendations:
  - Banking supervision:
    - Need to strengthen regulations on the role and power of the official administrator in weak banks.
    - Regulations needed for market and interest rate risk.
    - Develop accounting and disclosure standards for banks and consolidate accounting and supervision.
    - Move supervisory practices toward risk-oriented supervision.
    - Legally empower supervisors to play a more active role in AML issues.
    - Publish a mission statement to support public understanding of supervisory work.
  - Payment systems:
    - MIPS meets most international standards for systemically important payment systems.
    - Improvements suggested to clarify NBRM’s role in policy-setting and oversight of national payments infrastructure.
    - Near-term consideration: build a back-up facility for MIPS at a remote location.
  - Transparency (MFP code):
    - High degree of transparency through publications and websites and presumption in favor of consultation with stakeholders.
    - NBRM could establish a public affairs office to better communicate roles of the NBRM and the financial system.
  - AML/CFT:
    - Need to strengthen legal framework and expedite implementation.
    - Implementation depends on allocating more human resources to involved agencies.
    - Financial supervisors should be given a greater role in monitoring and enforcing compliance with AML/CFT laws.

1. Even though not formally assessed through the respective codes, these shortcomings also apply to the SEC and the insurance supervisors.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 86. The assessment is based on a review of the legal framework governing banking and

### _cr03374 - 86. The assessment is based on a review of the legal framework governing banking and

### Assessment overview
- The assessment is based on a review of the legal framework governing banking and bank supervision and a detailed examination of the policies and practices of the NBRM, the institution in charge of banking regulation and supervision. (Assessment undertaken by Paul J. van Sluijs, the Netherlands Bank, and Marc Quintyn, IMF. A previous BCP assessment was done in 1999.)
- FYR Macedonia has made substantial progress in enhancing its supervisory and legal framework with significant donor help, especially through the Banking Law enacted in 2000.
- Amendments following the BCP assessment have strengthened fit-and-proper rules, regulatory control over significant changes in bank ownership, investments by banks, and the range of corrective actions. Further amendments are planned to strengthen the role and power of an administrator in insolvency proceedings for banks under enhanced monitoring.
- Remaining modification needs include: investments of nonfinancial corporates in banks, assessing market risk, accounting and disclosure standards, money laundering, and consolidated accounting and supervision.
- Emphasis recommended: full implementation of the new legal framework and gradual movement toward a more risk-based supervisory system.

### Institutional and market structure
- Banking Law of 2000 governs commercial banking; savings houses remain under the 1996 Act pending a planned 2004 law on savings houses (until then no new licenses issued to savings houses).
- 2002: Law on Microfinancing Banks came into force; one microfinance bank licensed under the new law.
- According to the Banking Law and the Law on the NBRM, the NBRM supervises banks and savings houses.
- Banking system composition (end of 2002):
  - 21 banks
  - 17 savings houses
  - The three largest banks account for 64 percent of the systems’ total assets.
- Market characteristics:
  - Introduction of foreign strategic owners has improved operations and governance in the largest banks.
  - Some smaller banks have weak management and ownership structures, posing vulnerability.
  - Savings houses are small, making profitable business increasingly difficult.

### Preconditions for effective supervision
- Progress noted in meeting preconditions for effective banking supervision; macroeconomic situation relatively stable despite past disturbances.
- Broader legal framework generally sound; weaker links are implementation and enforcement of laws.
- Issues undermining supervision: excessive delays, questionable court decisions, perceived political interference, and corruption leading to a culture of noncompliance and nonpayment.
- Authorities are strengthening procedures for bank resolution and mechanisms for systemic protection.

### Main findings — banking supervision (by CP clusters)
Objectives, autonomy, powers, and resources (CP 1)
- Legal framework clear regarding objectives of banking supervision and NBRM functions and powers.
- Banking Law clearly regulates bank operations.
- Central bank is an independent agency; supervision department directly responsible to the governor; supervisory decisions taken by the NBRM Council.
- NBRM empowered to take measures to improve banking system conditions; measures and conditions for exercise defined in law.
- Supervisors recently granted legal protection while exercising their profession.
- Suggested improvement: publication of a mission statement to improve public understanding of supervisors’ work.

Licensing and structure (CPs 2–5)
- Legal framework for licensing strengthened following the FSAP assessment.
- Permissible activities clearly defined in the Banking Law.
- Misuse of the word “bank” made a criminal offense by recent amendment.
- New fit-and-proper criteria set following rejection by the Constitutional Court in May 2003 of existing criteria.
- Regulatory control over significant ownership changes strengthened: prior approval threshold lowered to 5 percent of the total amount of voting shares.
- Rules for major acquisitions by banks established.

Prudential regulations and requirements (CPs 6–15)
- Essential prudential regulations specified in the Banking Law with NBRM decisions adding details.
- Loan classification and loan loss provisioning rules are well implemented.
- Regulations on large exposures and connected lending can be hard to implement given shaky ownership in some banks.
- Systems to control and monitor market risk are in a preparatory stage; supervisors trained to develop methodology and reporting system.
- Supervisors have not required banks to develop internal procedures for monitoring clients’ foreign exchange exposures.
- Implementation of the AML law has only started and the law needs strengthening.
- Supervision department might not have enough resources for these new tasks.

Methods of ongoing supervision (CPs 16–20)
- Considerable effort over a few years to establish effective on-site inspections and off-site monitoring.
- Systems now go beyond formal checking based on rules and regulations.
- Contacts with banks are frequent but should be intensified.
- Consolidated supervision and reporting is not practiced but is not an immediate issue.

Information requirements (CP 21)
- No specific accounting standards for banks at present; need limited because balance sheets are relatively simple.
- Government should take initiative in preparing accounting standards.

Formal powers of supervisors (CP 22)
- Supervisors have a fairly broad range of corrective measures, including an article allowing the NBRM to take “any action” when necessary.
- Some measures can only be invoked late in the process.
- In 2002, supervisors took 34 such actions (pressing charges against banks).
- A special unit within the Banking Supervision Department deals with banks under enhanced supervision.

Cross-border banking (CPs 23–25)
- Law empowers supervisors to undertake globally consolidated supervision and to establish contacts with host country supervisors.
- No Macedonian banks currently active abroad.
- Memoranda of Understanding (MOUs) are under preparation with several countries.

### Tabled recommended actions to improve compliance with Basel Core Principles (high-level synthesis of Table A.1)
- CP 1:
  - Further strengthen application of corrective actions; some can only be applied late.
  - Publish a mission statement of the NBRM’s supervisory function.
  - Codify rules and procedures governing supervisors’ work; prioritize this codification.
- CP 2–5:
  - Broaden NBRM powers to investigate suspicions of banking activity without license.
  - Develop strategy to diminish ownership role of nonfinancial corporates in commercial banks (priority).
- CP 6–15:
  - Urgent progress on rules and regulations for market risk and supervisor training in this area.
  - Medium-term: develop framework to control interest rate risk.
  - Expedite implementation of the AML Law as a high priority; increase supervision department resources; adopt a more forceful attitude against money laundering.
- CP 16–20:
  - Move further to risk-oriented on-site inspections and include system-level soundness elements in off-site monitoring.
  - Intensify contacts with bank managers.
  - Medium-term: prepare for consolidated supervision and reporting.
- CP 21:
  - Begin preparation of accounting standards for banks in coming years.

### Authorities’ response (banking)
- Authorities broadly agree with the BCP assessment.
- Several amendments to the Banking Law and the Law on the NBRM were adopted following FSAP missions to correct identified weaknesses.
- Authorities committed to further improve legal framework and supervisory methods.
- On accounting standards for banks, authorities noted this can only happen after the government establishes uniform national accounting standards.

### CPSS core principles for systemically important payment systems — overview
- Assessment focuses on MIPS, the cornerstone of the country’s payments and settlement infrastructure. The other main payment system is KIBS, used for corporate payments and carrying 22 percent of noncash payments by value.
- All payments of more than 3 million denars must be made through MIPS.
- Average value of KIBS transactions: about 22,000 denars (US$420).
- KIBS is not used for securities clearings or to support activity in other organized financial markets.
- Assessment based on review of the Law on the NBRM and the POL, interviews with NBRM staff, and input from the MOF.

Institutional and market structure (payments)
- Legal framework for payments revised over past three years.
- Law on the NBRM specifies central bank objectives in payment systems; POL passed in April 2001 gives greater definition to payment responsibilities of NBRM and MOF and requires banks wishing to conduct payment operations to be licensed by NBRM.
- 21 banks involved in payment clearing and settlement (July 2003).
- System concentration:
  - NBRM initiates about a quarter of total value through the clearing system.
  - The two largest banks account for a further 30 percent.
- Cash remains the major means of payment for individuals.
- Macedonian denars on issue are 6 percent of GDP with an unknown quantity of euros and U.S. dollars in circulation.

### Main findings — payment systems (by CP clusters)
Legal foundation (CP I)
- NBRM Law (January 2002) defines objectives: regulating the system, coordinating interbank settlements, acting as the government’s international banker, and distributing cash.
- POL refines payment system responsibilities and requires NBRM licensing for banks conducting payment operations; conditions for licensed banks are set out in regulation.
- Laws support finality of payments through MIPS but POL includes unusual obligations such as allowing creditors to take funds from debtors’ accounts.
- Current legislation focuses on regulating individual institutions rather than the payment system as a whole; no legal support for a broad policy role for the NBRM in payments.
- MOF also issues regulations affecting payment instruments, cash payment limits for enterprises, and payment processes under court orders.

Understanding and management of risks (CPs II–III)
- MIPS rules and procedures developed in consultation with participants and experts; rules publicly available in hard copy and on NBRM’s website.
- Risks in MIPS are generally transparent and manageable.
- Important liquidity risk: NBRM may unexpectedly debit participants’ accounts if instructed by court orders or to execute payment guarantees at the request of a bank’s client; court orders notify banks at least 15 days before execution but timing remains uncertain; debits related to bank guarantees can be large and arrive without prior notice.

Settlement (CPs IV–VI)
- MIPS is a real time gross settlement (RTGS) system providing prompt settlement throughout the day.
- Once in MIPS, a payment will only fail if a bank has insufficient funds in its central bank account.
- Banks licensed to conduct domestic payment operations are required to hold a central bank account through which interbank payments are settled; hence settlements have no credit or liquidity risks.

Security, operational reliability, and contingency arrangements (CP VII)
- System security in MIPS and the reliability of the primary site is good.
- MIPS lacks a remote back-up site; integrated approach to risk management of the physical environment is lacking.
- MIPS vulnerable to disabling events (e.g., bomb scares, natural disasters) without a remote site or clear rapid reconstruction procedures.

Efficiency and practicality (CP VIII)
- MIPS offers a good basis for efficient liquidity management; well adapted to Macedonia’s payment needs.
- MIPS operates with only three staff and still has ample capacity.
- Transaction costs internationally comparable.

Criteria for participation (CP IX)
- Technical requirements for entry to MIPS are set by the NBRM and publicly available.
- Article 5 of the POL specifies institutions that may open an account at the NBRM and hence participate in MIPS.

Governance of the payment system (CP X)
- Few formal transparency requirements in MIPS governance, a weakness.
- Payments Department keeps the NBRM Council informed and the NBRM Annual Report contains MIPS developments.
- NBRM has conducted follow-up surveys of participants’ experiences with MIPS.

Central bank responsibilities in applying the CPs
- Law defines NBRM oversight responsibility as regulation and supervision of existing institutions but gives it no role in formulating payment policy.
- Recommendation: NBRM should define objectives in formulating payment policy encompassing stability, efficiency, competitiveness, smooth functioning, and development of the payment system.
- No clear separation at NBRM between oversight and operation of MIPS; NBRM should encourage outside scrutiny by publishing material on MIPS and getting input from external assessors.
- MOF has a regulatory role in some payment areas; interaction managed through regular meetings with minutes kept.

### Tabled recommended actions to improve observance of CPSS Core Principles (synthesis of Table A.2)
- CP I (Legal foundation):
  - Make NBRM responsible for ensuring efficient development, smooth running, and stability of payment and settlement system in next legal modifications.
  - Remove unusual obligations for banks from the POL urgently.
- CPs II–III (Understanding and management of risks):
  - Revise obligation on NBRM to execute payment guarantees and court orders immediately.
- CP VII (Security and contingency):
  - Give high priority to establishing a remote site that can be activated quickly.
  - Designate an officer responsible for risk assessment of the physical environment for MIPS.
- CP VIII (Efficiency and practicality):
  - Continuously analyze queuing behavior and reasons for significant payment delays when they occur.
- CP X (Governance):
  - NBRM should commit publicly to reporting on development and operation of MIPS, including publication of follow-up surveys of participants’ assessments.
- Central bank responsibilities (Responsibilities A–D):
  - In the medium term set broader objectives for the central bank covering stability, efficiency, smooth functioning, and development of the payment system in FYR Macedonia.
  - Encourage outside scrutiny by publishing material and seeking input from external assessors (payment experts of other central banks and external auditors).

*Content based on the IMF staff assessment text provided in the source content unit.*

### 120.      The authorities were pleased with the assessment. They stressed that the MIPS has

### _cr03374 - 120.      The authorities were pleased with the assessment. They stressed that the MIPS has

### III. CODE OF GOOD PRACTICES ON TRANSPARENCY IN MONETARY AND FINANCIAL POLICIES—MONETARY POLICY

#### A. General
- Paragraph 121: Assessment of observance by the NBRM of the IMF’s MFP Transparency Code for monetary policy was based on:
  - review of relevant laws, regulations, and policies;
  - documentation provided on the NBRM website and in a variety of official NBRM publications;
  - discussions with various departments of the NBRM.
  - Footnote: The assessment was conducted by Philip Schellekens, IMF.
- Paragraph 122: Legal documents reviewed include the Constitution of the Republic of Macedonia, the Law on the NBRM, the Law on Accountancy, the Banking Law, the Foreign Exchange Law, and the Law on Public Procurement.

#### B. Main findings
- Paragraph 123: In general, the NBRM practices a high degree of transparency in most of its operations. In a number of areas further steps could be taken to improve disclosure and transparency.

#### Clarity of roles, responsibilities, and objectives of central banks for monetary policy
- Paragraph 124:
  - The Law on the NBRM clearly defines the ultimate objective of the NBRM as the maintenance of price stability.
  - The central bank is required to “support the economic policy of the country and the financial stability of the country without jeopardizing the realization of the main objective and adhering to the principles of the market economy.”
  - The Constitution and the Law on the NBRM guarantee the independence of the central bank with respect to the central government and its administrative bodies; only in exceptional circumstances can the central bank be overridden.
  - The finance minister is allowed to attend the meetings of the central bank, but has no voting power. However, up to now he has not been invited.
- Paragraph 125:
  - Responsibilities listed in the central bank law include: design and conduct of monetary policy; licensing banks, savings houses, and exchange offices, and their supervision; management of foreign exchange reserves and the conduct of foreign exchange policy; conduct of payment operations; issuance of banknotes and coins.
  - The main guiding principle for monetary policy is the maintenance of a de facto fixed exchange rate peg of the Macedonian denar to the euro; the main instrument is the issuance of central bank bills.
- Paragraph 126: Until recently, main accountability was the obligation to send its annual report to the government. The only other explicit arrangement, recently put in the Law on the NBRM, is the obligation for the governor to appear before parliament at least twice a year.
- Paragraph 127:
  - The NBRM is governed by the National Bank Council consisting of nine members.
  - The law discloses procedures for appointment, terms of office, and general criteria for removal of the heads and members of the Council.
  - All members are appointed to and relieved from office by parliament, upon proposal of the President of the Republic.
  - Footnote: An amendment to the current legislation provides that the vice-governors be appointed by parliament at the proposal of the governor.
- Paragraph 128:
  - Institutional relationship between monetary and fiscal operations is defined in the Law on the NBRM.
  - Direct lending to the government is restricted to credits or loans with a maturity of one day or less (without any possibility for renewal or extension).
  - Manner of central bank profits allocation and capital maintenance are defined in the law.
- Paragraph 129: The central bank discloses the agency roles it assumes for the government (debt and foreign exchange reserves management, representation in international financial institutions, international payment operations, and certain banking operations).
- Paragraph 130: No information is disclosed on the terms of government deposits with the central bank. They are regulated by an agreement between the NBRM and the MOF and these regulations are not considered by the authorities as information that should be publicly disclosed.

#### Open process for formulating and reporting monetary policy decisions
- Paragraph 131:
  - The process for formulating and reporting monetary policy decisions is transparent.
  - Framework, instruments, and targets are disclosed and explained through the central bank’s annual, semi-annual, and monthly reports and its website.
  - Procedures and practices governing monetary policy instruments and operations are defined in Decisions and Manuals, some available on the central bank’s website.
  - For proposed substantive technical changes to monetary regulations, the NBRM holds consultations with relevant parties within an appropriate period.
- Paragraph 132:
  - Decisions of the National Bank Council are published and explained through often same-day press releases and the central bank’s website.
  - The Council's meeting schedule, however, is not disclosed.
  - Monetary policy decisions are further explained in the central bank’s periodic publications.

#### Public availability of information on monetary policy
- Paragraph 133:
  - The NBRM discloses its balance sheet on a preannounced schedule, information about monetary operations and foreign exchange reserves, maintains an active publications program, and discloses regulations governing monetary policy.
  - A public affairs office would add to accessibility and transparency.
- Paragraph 134:
  - Macedonia does not compile and disseminate the Data Template on International Reserves and Foreign Currency Liquidity.
  - There is no preannounced schedule of reserves data dissemination.

#### Accountability and assurances of integrity by the central bank
- Paragraph 135:
  - Modalities of accountability are disclosed through the Law on the NBRM.
  - Financial statements of the central bank are externally audited and disclosed to the public, as is information on operational expenses and revenues.
- Paragraph 136:
  - Internal governance procedures (including internal control systems) are not disclosed to the public.
  - Some disclosure achieved through recent publication of a Research Memorandum on internal audit practices on the central bank’s website.
  - The Internal Audit Book of Rules is not published.
- Paragraph 137:
  - Certain standards of behavior set by the Law on the NBRM and the Law on Corruption Prevention are disclosed.
  - The Code of Conduct of the Employees of the NBRM is not available to the public, nor are yearly Statements on Conflicts of Interest by members of the National Bank Council.
  - If a Council member declared a conflict of interest prior to an actual vote, the resulting abstention from voting would not be expected to be disclosed to the public (voting records are not disclosed).
- Paragraph 138:
  - Certain waivers of liability apply to the NBRM as an institution and to certain employees (e.g., bank supervisors), but the scope of protection is rather limited in terms of circumstances and coverage of staff.

#### Table A.3. Recommended Actions to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy
- I. Clarity of roles, responsibilities and objectives of payment system oversight agencies
  - Give priority to defining and disclosing more prominently the role of the central bank in providing emergency liquidity support to illiquid but solvent banks.
  - Disclose the terms of government deposits with the central bank.
- II. Open process for formulating and reporting of payment system oversight policies
  - Move to a system of regularly scheduled Council meetings.
  - Disclose the Council meeting schedule and agenda.
- III. Public availability of information on payment system oversight policies
  - Publish more detailed audited balance sheets.
  - Disclose, ex post, aggregate information on emergency credit facilities, exercising judgment on the timing and on the nature of the information disclosed.
  - Establish a public affairs office.
- IV. Accountability and assurance of integrity by payment system oversight agencies
  - Disclose the internal governance standards against which the integrity of operations is evaluated.
  - Disclose the internal code of conduct that applies to the employees of the central bank.
  - Expand the requirement of statements on conflicts of interests to all managerial staff of the central bank and disclose the content and purpose of the standards related to conflicts of interests.
  - Disclose more clearly the modalities of legal protection of NBRM staff. Expand the scope of legal protection to all staff in the discharge of their duties.

#### Authorities’ response
- Paragraph 139: The authorities found this assessment to be very useful and are undertaking several initiatives to fulfill the recommendations made in this assessment.

### IV. CODE OF GOOD PRACTICES ON TRANSPARENCY IN MONETARY AND FINANCIAL POLICIES—FINANCIAL POLICIES (PAYMENT SYSTEM, BANKING SUPERVISION, AND DEPOSIT INSURANCE)

#### A. General
- Paragraph 140:
  - Assessment of observance of the IMF’s MFP Transparency Code for financial policies was carried out for payment system oversight and banking supervision in the NBRM, and for the DIF.
  - Relevant documents consulted include the Law on the NBRM, the Banking Law, the POL and—for the DIF—the Law on the Deposit Insurance Fund and its Charter.
  - Interviews were conducted with representatives of the respective agencies.
  - Footnote: The assessment of the banking supervision function was carried out by Marc Quintyn (IMF), the payment system oversight was assessed by Nicholas Roberts, Reserve Bank of Australia; and the assessment of the DIF was done by Anita Tuladhar and Marc Quintyn (both IMF).

#### B. Main findings
- Paragraph 141:
  - In general, the Macedonian authorities strive for open processes of communication with regard to financial policies and have achieved a great degree of transparency.
  - Roles and responsibilities are defined in laws and regulations available to the public through the Official Gazette and respective websites.
  - New supervisory and payment system developments are communicated through the NBRM’s Annual Report.
  - Reforms in the payment system over the last three years have demonstrated the NBRM’s commitment to transparency, communicated through a well-organized media campaign and regular meetings with the financial community; seminars/workshops were held as reforms were implemented.
- Paragraph 142: Further improvements desirable regarding:
  - (i) the central bank’s emergency lending procedures;
  - (ii) the NBRM’s role as supervisor of the payment system;
  - (iii) the bank’s public information services and the publication of internal governance procedures.
- Paragraph 143:
  - The DIF insures deposits—including foreign currency denominated deposits—of natural persons held in commercial banks and savings houses.
  - The DIF acts as a payout box and does not have any regulatory or oversight function.
  - It is a state-run institution with a five-member Board of Directors: three appointed by the MOF, one by the central bank, the chamber of commerce and the banking industry, each.
- Paragraph 144:
  - Roles, responsibilities and objectives of the NBRM as banking supervisory agency and overseer of payment systems are dealt with in the Law on the NBRM, published in the Official Gazette and on the NBRM’s and MOF’s website.
  - Powers of the NBRM with respect to payment system oversight are defined by the licensing requirement imposed on banks.
  - Recent amendments to the law clarified the relationship between the NBRM and other agencies (including the MOF) with respect to supervision and information exchange.
- Paragraph 145: Functioning and policies of the DIF are spelled out in the DIF Law and Charter; both documents are available through the DIF’s and the MOF’s website, publication in the Gazette, and an information brochure.
- Paragraph 146:
  - Formulating and reporting of financial policies by the NBRM generally occurs in an open manner.
  - For banking supervision, the NBRM uses “Decisions” to specify articles in the law and “Supervisory Circulars” to further explain the purpose of decisions.
  - A consultation process with the banking community precedes major legal changes; following adoption of new laws or amendments, meetings are organized with affected institutions.

*Source: IMF staff assessment text as provided in the content unit.*

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