## 1. Main Recommendations

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### Summary and conclusions
- Over the past decade Algeria has attempted to modernize its financial system despite social strife and challenges posed by the large hydrocarbon sector and an inefficient public sector.
- State-owned banks’ lending to public entities still dominates intermediation; financial markets remain in their infancy; implementation of regulatory reforms is lagging.
- Hydrocarbon-funded state support to borrowers and lenders creates an appearance of stability that distorts risk pricing and governance and leads to unsound banking.
- Three mutually reinforcing policy fronts to enhance soundness and finance’s role in development:
  - Privatize public banks over the medium term;
  - Improve banks’ operating environment to cut intermediation costs;
  - Modulate the hydrocarbon-induced liquidity and credit cycles that curtail banks’ risk-taking.

### Context and systemic findings
- Algeria has liberalized foreign trade and most non-energy prices; private sector activity has been trending upward, but exports have barely diversified away from the hydrocarbon sector.
- Although 15 private banks have been licensed since 1998, public banks that have consistently incurred losses overwhelm the small financial sector.
- The authorities have provided unconditional liquidity to public banks, as high as % of bank credit in 1998.
- Public banks have been repeatedly recapitalized (on average, over 4 percent of GDP per year from 199 l-2002) due to public enterprises’ inability to service debts and banks’ low earnings/poor management.
- The failure of the largest private bank in early 2003 exposed gaps in fit-and-proper tests; on that occasion authorities did not provide liquidity support to troubled private banks.
- Bank credit is 34 percent of GDP (60 percent of non-oil GDP), of which 80 percent extended by public banks.
- Before the 2003 failure of the largest private bank, private banks accounted for 26 percent of credit to the private sector.
- The largest public banks’ inspection revealed a provisioning shortfall of 24 percent; if recognized, solvency ratios would be minus 6 percent. In contrast, generally available data put the solvency ratio at 14.8 percent for public banks, and 15 percent for the banking system as a whole.
- 3/4’h of the provisioning shortfall is attributable to loans extended to major SOEs, 14 percent to private sector loans, and the balance to smaller SOE exposures.
- Interest from restructuring bonds represents one-third of bank income, and almost three times reported profits for 2002.
- Public banks’ losses averaged over 4 percent of GDP each year from 1991 to 2002. Although the reported budget was almost balanced, on average, over the same period, repeated bailouts weighed on public finances.

### Financial restructuring, capital needs, and banking costs
- Reported capital ratio after the last (intended final) restructuring: 14 percent.
- BA audit of large exposures at end-2002 revealed public banks still needed another 4 percent of GDP to maintain current capital ratios.
- Actual fiscal cost would be 3 percent of GDP if banks reduced their ratios to the local minimum of eight percent.
- The local minimum (eight percent) is noted as below the "10-l 2 percent" minimum typically imposed on systems with risks comparable to Algeria’s.
- 95 percent of non-internationally active US banks have ratios above 10 percent.
- Repeated public bank bailouts have cost 4 percent of GDP per year for an extended time.
- Cumulative cost of bank distress in comparison: Turkey 40 percent, Thailand 30 percent, Mexico 20 percent.

### Fixed-income and money markets; insurance
- Bonds swapped for SOE loans represent 90 percent of Treasury domestic debt; these bonds were not designed for trading.
- Treasury issues a few tradable series totaling 2.5 percent of GDP of short duration.
- BA’s reference rate is BA’s rediscount rate; BA refinances banks on tap against eligible collateral, and uses deposit auctions and reserve requirements when absorbing liquidity.
- Algeria represented 0.24 percent of the emerging market bond index; tradable debt has virtually no liquidity.
- Insurance sector composition: six state-owned, two mutual, six small private insurers, and one state-owned reinsurer; external reinsurance with reputable firms.
- Premiums: 0.5 percent of GDP (1.5 percent in Tunisia and three in Morocco).
- Non-life insurance accounts for 99 percent of premiums. Life insurance is not yet regulated.
- Insurance sector generally meets local prudential requirements; auto insurance suffers from high expense ratios.

### Housing, CNEP, and microfinance
- Estimated value of Algeria’s housing deficit: 25 percent of GDP.
- Housing loans to households represent 1.5 percent of GDP.
- CNEP’s 2002 portfolio amounted to 97 percent of housing finance.
- By 1997, 75 percent of CNEP’s portfolio was nonperforming; restructured at a cost of 10 percent of GDP.
- Since 1997, management focused on rescheduling old loans while maintaining high provisioning, liquidity, and solvency ratios (18 percent at end-2002).
- One third of CNEP’s credit is extended to a wholly-owned subsidiary that is not consolidated — raising questions on solvency.
- CNEP’s financials were first certified in 2002.
- Microfinance is undeveloped, with only a few programs based on government-run social services.

### Privatize public banks over the medium term (policy recommendations and operational actions)
- Rationale:
  - Financial intermediation will remain bank-based; state banks dominate and impede efficient resource allocation.
  - No system dominated by state banks has avoided large loan losses or contributed effectively to economic development.
- Recommended sequencing and measures:
  - Quickly sell the two healthiest public banks.
  - Give remaining banks five years to prepare for privatization; curtail operations if no bidders.
  - Ceilings on private ownership for Algerian public banks are ill-advised because they may restrict the field of reputable bidders.
- Interim measures for banks remaining in public hands:
  - Make the state shareholder pro-active and enforce performance contracts on public bank managers.
  - Audit public banks by reputable external agencies to reveal underlying value.
  - Replace directed lending to unviable SOEs and financial support under public programs with direct budget support; if banks administer such activities, they should earn fees but not carry subsidized loans on their balance sheets.
  - Supervisor to enforce provisioning rules to clarify profitability.
  - Parallel reform of public enterprises to reduce political pressures for forbearance.
- Privatization operational details and safeguards:
  - Sell banks “as is” may be preferable since investors discount state outlays heavily and will introduce their own systems.
  - State shareholder should be prepared to provide more capital in the interim if needed.
  - If managers cannot make banks attractive to reputable bidders, the shareholder should substantially curtail operations.

### Improve the bank operating environment to cut intermediation costs (policy recommendations)
- Key impediments:
  - Poor implementation of modern laws and regulations inflates intermediation costs.
  - Below-par auditing and accounting practices; local accounting norms and regulations remain vague and sometimes date from the command economy.
  - Payment system inefficiencies.
  - Supervision suffers from crippling delays in banks’ submission of information, weak skills, and blurred lines of responsibility.
- Recommended actions:
  - Forcefully implement existing regulation.
  - Improve accounting and audit standards.
  - Make supervision proactive and strengthen its job content and career prospects.
  - Strictly enforce provisioning rules.
  - Modernize the payment system.
  - Train magistrates in commercial and financial matters.
- Operational issues and data on reporting delays (days late in transmission to supervisor, asset weighted):
  - Public banks: End-Year Statements 31.0; Auditor’s Report 247.8; Prudential Returns 122.2
  - Private banks: End-Year Statements 4.4; Auditor’s Report 170.2; Prudential Returns 17.6
  - o/w domestic: End-Year Statements 6.0; Auditor’s Report 94.8; Prudential Returns 14.5
  - o/w foreign: End-Year Statements 3.1; Auditor’s Report 235.7; Prudential Returns 20.3
  - Banking system: End-Year Statements 29.8; Auditor’s Report 244.5; Prudential Returns 117.7

### Modulate hydrocarbon-induced liquidity and credit cycles that curtail banks’ risk-taking (policy recommendations)
- Problem statement:
  - Financial stability and development are hostage to hydrocarbon-induced liquidity and credit cycles.
  - Procyclical public spending and system liquidity amplify bank liquidity and credit risks despite creation of an oil stabilization fund in 2000.
- Recommended public finance and market actions:
  - Increase “self insurance” reserves as Treasury deposits at the central bank to offset volatile public revenues.
  - Replace the 20-year amortizable bank restructuring bonds with bullet securities staggered between one and ten years to obtain reserves without increasing debt service.
  - Increase dinar issuance by substituting domestic for relatively costly foreign debt; lower external debt ratios could improve prospects for an attractive sovereign rating.
  - Coordinate public debt management with the Bank of Algeria (BA) and strengthen monetary management.
  - Favor Treasury paper over central bank bills for local debt market development.
  - Create the legal infrastructure for an interbank repo market.
  - Once sufficient paper is available to absorb excess bank reserves, support the competitive setting of interest rates along the yield curve.
- Caveat:
  - Competitive markets are unlikely to emerge as long as state banks dominate the financial system.

### Consolidated table of main recommendations (policy fronts and actions)
- Privatize public banks over the medium term:
  - Quickly sell the two healthiest public banks.
  - Give remaining banks five years to prepare for privatization; curtail operations if no bidders.
  - Make shareholder control of managers much tougher.
  - Fully finance unviable public enterprises and programs through budget appropriations; pursue public enterprise reform.
- Improve the bank operating environment to cut intermediation costs:
  - Improve accounting and audit.
  - Make supervision proactive.
  - Strictly enforce provisioning rules.
  - Modernize payment system.
- Modulate hydrocarbon-induced liquidity and credit cycles that curtail banks’ risk-taking:
  - Train magistrates in commercial and financial matters.
  - Increase domestic debt issuance to manage liquidity.
  - Prepay some foreign debt by substituting domestic debt.
  - Create the legal infrastructure for an interbank repo market.

*Source: _cr04138 - 1. Main Recommendations (PDF chapter).*

### 1. Main Recommendations

### 1. Main Recommendations

### Summary and conclusions
- Over the past decade Algeria has attempted to modernize its financial system despite social strife and challenges posed by the large hydrocarbon sector and an inefficient public sector.
- State-owned banks’ lending to public entities still dominates intermediation; financial markets remain in their infancy; implementation of regulatory reforms is lagging.
- Hydrocarbon-funded state support to borrowers and lenders creates an appearance of stability that distorts risk pricing and governance and leads to unsound banking.
- Three mutually reinforcing policy fronts to enhance soundness and finance’s role in development:
  - Privatize public banks over the medium term;
  - Improve banks’ operating environment to cut intermediation costs;
  - Modulate the hydrocarbon-induced liquidity and credit cycles that curtail banks’ risk-taking.

### Context and systemic findings
- Algeria has liberalized foreign trade and most non-energy prices; private sector activity has been trending upward, but exports have barely diversified away from the hydrocarbon sector.
- Although 15 private banks have been licensed since 1998, public banks that have consistently incurred losses overwhelm the small financial sector.
- The authorities have provided unconditional liquidity to public banks, as high as % of bank credit in 1998.
- Public banks have been repeatedly recapitalized (on average, over 4 percent of GDP per year from 199 l-2002) due to public enterprises’ inability to service debts and banks’ low earnings/poor management.
- The failure of the largest private bank in early 2003 exposed gaps in fit-and-proper tests; on that occasion authorities did not provide liquidity support to troubled private banks.
- Bank credit is 34 percent of GDP (60 percent of non-oil GDP), of which 80 percent extended by public banks.
- Before the 2003 failure of the largest private bank, private banks accounted for 26 percent of credit to the private sector.
- The largest public banks’ inspection revealed a provisioning shortfall of 24 percent; if recognized, solvency ratios would be minus 6 percent. In contrast, generally available data put the solvency ratio at 14.8 percent for public banks, and 15 percent for the banking system as a whole.
- 3/4’h of the provisioning shortfall is attributable to loans extended to major SOEs, 14 percent to private sector loans, and the balance to smaller SOE exposures.
- Interest from restructuring bonds represents one-third of bank income, and almost three times reported profits for 2002.
- Public banks’ losses averaged over 4 percent of GDP each year from 1991 to [text truncated in source].

### Privatize public banks over the medium term (policy recommendations and operational actions)
- Rationale:
  - Financial intermediation will remain bank-based; state banks dominate and impede efficient resource allocation.
  - No system dominated by state banks has avoided large loan losses or contributed effectively to economic development.
- Recommended sequencing and measures:
  - Quickly sell the two healthiest public banks.
  - Give remaining banks five years to prepare for privatization; curtail operations if no bidders.
  - Ceilings on private ownership for Algerian public banks are ill-advised because they may restrict the field of reputable bidders.
- Interim measures for banks remaining in public hands:
  - Make the state shareholder pro-active and enforce performance contracts on public bank managers.
  - Audit public banks by reputable external agencies to reveal underlying value.
  - Replace directed lending to unviable SOEs and financial support under public programs with direct budget support; if banks administer such activities, they should earn fees but not carry subsidized loans on their balance sheets.
  - Supervisor to enforce provisioning rules to clarify profitability.
  - Parallel reform of public enterprises to reduce political pressures for forbearance.

### Improve the bank operating environment to cut intermediation costs (policy recommendations)
- Key impediments:
  - Poor implementation of modern laws and regulations inflates intermediation costs.
  - Below-par auditing and accounting practices; local accounting norms and regulations remain vague and sometimes date from the command economy.
  - Payment system inefficiencies.
  - Supervision suffers from crippling delays in banks’ submission of information, weak skills, and blurred lines of responsibility.
- Recommended actions:
  - Forcefully implement existing regulation.
  - Improve accounting and audit standards.
  - Make supervision proactive and strengthen its job content and career prospects.
  - Strictly enforce provisioning rules.
  - Modernize the payment system.
  - Train magistrates in commercial and financial matters.

### Modulate hydrocarbon-induced liquidity and credit cycles that curtail banks’ risk-taking (policy recommendations)
- Problem statement:
  - Financial stability and development are hostage to hydrocarbon-induced liquidity and credit cycles.
  - Procyclical public spending and system liquidity amplify bank liquidity and credit risks despite creation of an oil stabilization fund in 2000.
- Recommended public finance and market actions:
  - Increase “self insurance” reserves as Treasury deposits at the central bank to offset volatile public revenues.
  - Replace the 20-year amortizable bank restructuring bonds with bullet securities staggered between one and ten years to obtain reserves without increasing debt service.
  - Increase dinar issuance by substituting domestic for relatively costly foreign debt; lower external debt ratios could improve prospects for an attractive sovereign rating.
  - Coordinate public debt management with the Bank of Algeria (BA) and strengthen monetary management.
  - Favor Treasury paper over central bank bills for local debt market development.
  - Create the legal infrastructure for an interbank repo market.
  - Once sufficient paper is available to absorb excess bank reserves, support the competitive setting of interest rates along the yield curve.
- Caveat:
  - Competitive markets are unlikely to emerge as long as state banks dominate the financial system.

### Consolidated table of main recommendations (policy fronts and actions)
- Privatize public banks over the medium term:
  - Quickly sell the two healthiest public banks.
  - Give remaining banks five years to prepare for privatization; curtail operations if no bidders.
  - Make shareholder control of managers much tougher.
  - Fully finance unviable public enterprises and programs through budget appropriations; pursue public enterprise reform.
- Improve the bank operating environment to cut intermediation costs:
  - Improve accounting and audit.
  - Make supervision proactive.
  - Strictly enforce provisioning rules.
  - Modernize payment system.
- Modulate hydrocarbon-induced liquidity and credit cycles that curtail banks’ risk-taking:
  - Train magistrates in commercial and financial matters.
  - Increase domestic debt issuance to manage liquidity.
  - Prepay some foreign debt by substituting domestic debt.
  - Create the legal infrastructure for an interbank repo market.

*Source: _cr04138 - 1. Main Recommendations (PDF chapter).*

### 2002. Although the reported budget was almost balanced, on average, over the same period,

### _cr04138 - 2002. Although the reported budget was almost balanced, on average, over the same period,

### Financial restructuring, capital needs, and banking costs
- Reported capital ratio after the last (intended final) restructuring: 14 percent.
- BA audit of large exposures at end-2002 revealed public banks still needed another 4 percent of GDP to maintain current capital ratios.
- Actual fiscal cost would be 3 percent of GDP if banks reduced their ratios to the local minimum of eight percent.
- The local minimum (eight percent) is noted as below the "10-l 2 percent" minimum typically imposed on systems with risks comparable to Algeria’s.
- 95 percent of non-internationally active US banks have ratios above 10 percent.
- Repeated public bank bailouts have cost 4 percent of GDP per year for an extended time.
- Cumulative cost of bank distress in Algeria compared to other crises: Turkey 40 percent, Thailand 30 percent, Mexico 20 percent.

### Fixed-income and money markets; insurance
- Bonds swapped for SOE loans represent 90 percent of Treasury domestic debt; these bonds were not designed for trading.
- Treasury issues a few tradable series totaling 2.5 percent of GDP of short duration.
- BA’s reference rate is BA’s rediscount rate; BA refinances banks on tap against eligible collateral, and uses deposit auctions and reserve requirements when absorbing liquidity.
- Algeria represented 0.24 percent of the emerging market bond index; tradable debt has virtually no liquidity.
- Insurance sector composition: six state-owned, two mutual, six small private insurers, and one state-owned reinsurer; external reinsurance with reputable firms.
- Premiums: 0.5 percent of GDP (1.5 percent in Tunisia and three in Morocco).
- Non-life insurance accounts for 99 percent of premiums. Life insurance is not yet regulated.
- Insurance sector generally meets local prudential requirements; auto insurance suffers from high expense ratios.

### Housing, CNEP, and microfinance
- Estimated value of Algeria’s housing deficit: 25 percent of GDP.
- Housing loans to households represent 1.5 percent of GDP.
- CNEP’s 2002 portfolio amounted to 97 percent of housing finance.
- CNEP history and metrics:
  - By 1997, 75 percent of its portfolio nonperforming; restructured at a cost of 10 percent of GDP.
  - In its first thirty years, housing loans were effectively unsecured by registered collateral.
  - Since 1997, management focused on rescheduling old loans while maintaining high provisioning, liquidity, and solvency ratios (18 percent at end-2002).
  - One third of CNEP’s credit is extended to a wholly-owned subsidiary that is not consolidated — raising questions on solvency.
  - CNEP’s financials were first certified in 2002.
- Microfinance is undeveloped, with only a few programs based on government-run social services.

### Overarching policy objective: financial intermediation rests on banks
- Three mutually reinforcing reform themes:
  - Privatize public banks over the medium term.
  - Improve the operating environment for banking.
  - Modulate hydrocarbon-induced liquidity and credit cycles so banks can gain confidence in macroeconomic stability necessary to extend credit.

### Privatize public banks — findings and recommendations
- Political economy and fiscal risk:
  - Repeated bailouts undermine foreign investor perceptions, including debt sustainability.
  - Bank bailouts were not accompanied by cutting ties to SOEs or operational restructuring.
- Privatization rationale and sequencing:
  - Privatize the healthiest public bank rapidly, followed by a second one soon thereafter to create a "demonstration" effect.
  - Two small public banks identified as in better financial shape: provisioning of remaining impaired assets would push both into loss in 2002 but still leave solvency ratios of 17 and 6 percent.
  - State shareholder should give managers of other state banks a timetable for privatization not to exceed five years.
  - If managers cannot make banks attractive to reputable bidders, the shareholder should substantially curtail operations to remove the possibility of further bailouts.
- Ownership ceilings and investor conditions:
  - Imposition of a 49 percent ceiling in 2002 caused the main suitor for the strongest public bank to withdraw.
  - Reputable investors generally require: full management control; guarantees that the state assumes hidden liabilities materializing within an agreed timeframe; contract obligations for the state to sell remaining shares within an agreed timeframe.
- Sale strategy and pricing:
  - Privatization should not attempt to recoup past budgetary outlays but should prevent future ones and let new owners decide on investments and cost cuts.
  - Sell banks “as is” may be preferable since investors discount state outlays heavily and will introduce their own systems.
- State shareholder responsibilities prior to/alongside privatization:
  - Become proactive: enforce performance contracts, demand frequent and accurate reports, and dismiss managers who fail to inform boards of material developments.
  - Commission audits by reputable firms to reveal intrinsic value and focus management and Ministry of Finance on restoration costs.
  - Be prepared to provide more capital in the interim if needed.
- Operational measures:
  - Replace lending to unviable SOEs and subsidies with direct budgetary support where appropriate; banks should swap remaining credits to unviable SOEs for Treasury paper and not extend new loans.
  - If public banks administer housing or agriculture finance programs, the government should pay management fees and open fees to competitive bidding.

### Improving the bank operating environment — governance, payments, accounting, supervision
- Legal and regulatory modernization:
  - Since the end of the 1980s Algeria modernized many laws and regulations governing financial intermediation; exceptions include bankruptcy and life insurance.
  - Algeria remains in the bottom two quintiles for regulatory quality, rule of law, and control of corruption.
- Implementation and judicial constraints:
  - Poor implementation undermines intermediation cost reduction: court proceedings lengthy; magistrates and attorneys lack commerce/finance training; decisions are costly to enforce; extra-judicial arbitration underutilized.
  - Rights of shareholders and creditors have not been tested; modern bankruptcy framework is lacking.
  - Certain provisions of the central bank law concerning independence do not meet international standards.
- Payment system inefficiencies:
  - Manual procedures and numerous paper-based controls contribute to large suspense accounts.
  - The postal network (6 million accounts in 3000 outlets) offers cheap, reliable centralized payments; could be used to distribute savings or insurance products in the medium term.
- Accounting, auditing, and reporting weaknesses:
  - Sub-par auditing and accounting inflate costs of screening and monitoring borrowers; financial information often concealed for tax reasons.
  - Accounting and audit partnerships fragmented; auditing falls short of international practice; industry association does not effectively enforce local standards.
  - Local accounting norms do not require consolidated financial statements (CNEP is cited) and lack treatment for important transactions/events.
  - Public banks use no less than three methods for computing loan provisions.
  - Prudential returns and other financials are received with long delays and inconsistencies, impeding surveillance.
- Days late in transmission to supervisor (asset weighted) — End-Year Statements; Auditor’s Report; Prudential Returns:
  - Public banks: 31.0; 247.8; 122.2
  - Private banks: 4.4; 170.2; 17.6
  - o/w domestic: 6.0; 94.8; 14.5
  - o/w foreign: 3.1; 235.7; 20.3
  - Banking system: 29.8; 244.5; 117.7
- Anti-money laundering and counter-financing of terrorism (AMUCFT):
  - Algeria lacks an AMUCFT legal framework and has not signed relevant international conventions.
  - A World Bank October 2003 evaluation and a forthcoming ROSC were noted; World Bank technical assistance agreed to strengthen the AMUCFT regime.
- Supervision and licensing:
  - Supervision is entrusted to three institutions, but the central bank provides overall consistency and resources; the Governor of BA chairs the Banking Commission and the Monetary and Credit Board and holds discretionary intervention powers.
  - Extensive state ownership severely undermines regulatory governance.
  - Licensing tightened after prior weaknesses: licenses had been granted to inexperienced individuals, owners’ net worth could not be reliably established, and the 1990 Law on Money and Credit did not require capital to be fully paid-in.
  - These weaknesses culminated in the failure of the largest private bank in 2003 with assets of 3 percent of GDP.
- Operational and systems gaps in banks:
  - Public banks rely on old, decentralized systems that do not deliver timely or reliable accounting (large suspense accounts) and provide poor customer service (processing loans can take up to 18 months).
  - Making a new system operational can take 18 months; banks are advised to consider off-the-shelf solutions.
  - Migration to new information systems and underwriting procedures will require considerable staff training; the state shareholder should account for these costs when deciding whether to continue to run banks or sell them "as is."
- Role of BA (central bank) as supervisor:
  - BA can enforce provisioning rules to gain a firm handle on bank profitability.
  - Supervisory insistence that interest rates charged reflect funding, operating costs, provisions and charge-offs is necessary to reveal underlying profitability.

*Source: IMF country report content (as supplied).*

### Box 3. Standards and Codes

### Box 3. Standards and Codes

### Core Principles for Effective Banking Supervision
- Progress since 1999 in completing the legal and regulatory framework for banking supervision, but authorities need to:
  - Make greater use of all supervisory tools and sanctions to ensure implementation of the rules.
  - Expedite sanctions for banks that fail to meet obligations.
- Remaining implementation delays in:
  - Analysis and monitoring of licenses and bank shareholders.
  - Reliability and punctuality of regulatory reporting.
  - Efficiency of off-site and on-site inspections.
  - Consolidated supervision.

### Code of Good Practices on Transparency in Monetary and Financial Policies
- Two institutional weaknesses identified:
  - BA’s objective for monetary policy should be clarified to improve accountability.
  - BA and the Monetary and Credit Council would strengthen independence by:
    - Specifying clear timeframes for terms in office of the governor and members of the Council.
    - Indicating criteria under which they may be removed from office.

### Supervision needs strengthening
- Findings:
  - BA lacks a permanent system to detect difficulties in individual institutions and to scrutinize prudential returns in a formalized way.
  - Inspections exist and are better focused on material risks but do not systematically assess asset quality, guarantees, provisions, or related party activities.
  - Resources and budgets allocated for supervision are insufficient.
  - Within BA, supervisors should have exclusive responsibility for assessing observance of norms; job content and career prospects should be enhanced.
- Conditional improvement path:
  - If lending to non-viable SOEs is terminated, regulatory governance will have meaning, BA supervisors can become stronger and more responsive, and prescribed remedies can be applied.

### Ordinance on Money and Credit (October 2003)
- Contains some improvements aimed at better coordination between MoF and BA.
- Risks identified:
  - Could give rise to interference by MoF in BA’s day-to-day management.
  - Could undermine BA’s financial autonomy by providing that the Treasury may obtain an “exceptional” advance from BA for external debt management operations.
- Central bank financing of such operations will not address current excess liquidity nor support development of instruments to allow banks to price risk.

### Managing banking crises
- Although laws and regulations to address solvency at individual institutions exist, authorities have hesitated to apply them, notably with certain private banks.
- The recently incorporated Deposit Insurance Corporation lacks functional and budgetary independence.
- Market constraints and BA lending rules:
  - Market may not fund private banks facing liquidity pressures.
  - BA lending is formally constrained by availability of eligible paper.
  - Despite excess systemic liquidity, it is concentrated in public banks; public banks mistrust domestic private banks, making private banks vulnerable to sudden retail deposit withdrawals.
  - BA has provided liquidity to public banks on demand in the past.

### Modulate liquidity and credit cycles that curtail bank risk-taking
- Structural risk environment:
  - Banks face undiversifiable risk factors: hydrocarbon prices and agriculture.
  - In such an environment, banks focus on heavily secured short-term lending (e.g., trade finance); foreign banks specialize in this intermediation.
- Procyclical fiscal policy:
  - Algeria’s procyclical fiscal policy intensifies the business cycle, particularly in bad times, discouraging banks from risk-taking.
  - Expenditure contractions in bad times are two to three times greater than expansions in good times.
- Liquidity volatility and suggested measures:
  - During the 1998 trough in oil prices, BA liquidity provision was about half of banking system credit.
  - Banks have excess liquidity on the order of 30 percent of banking system credit.
  - From 1980-2002, the standard deviation of autonomous factors was 16 percent of BA balance sheet with peak absorption needs of 40 percent.
  - To deal with liquidity swings, authorities could combine:
    - Leaving some oil proceeds abroad (prohibited by law).
    - Smoothing expenditures through the existing oil stabilization fund.
    - Constituting a stock of treasury bills at BA to help liquidity management.
  - Assuming no policy changes and that comfortable absorption capacity requires a buffer of two standard deviations of autonomous factors, BA would need a portfolio of treasury paper of DA 500 billion.
  - Present stock tradable Treasury debt is DA 100 billion, none of which BA holds.

- Fiscal self-insurance and reserves:
  - If oil prices dropped to US$15 per barrel and remained there, Treasury deposits at BA (currently DA 650 billion, or 13 percent of GDP) would sustain expenditures for a year at unchanged policies.
  - Foreign reserves cover almost two years of imports.
  - State oil and gas company has significant term deposits in a public bank to immunize contracted payments.

- Policy recommendation:
  - Specify a sensible medium-term target for the non-oil primary deficit (keyed off permanent income from hydrocarbon resources) and improve transparency of quasi-fiscal activities.

### Quasi-Fiscal Operations and Contingent Liabilities
- Findings:
  - Approximately 12 percent of public expenditure flows through hundreds of special earmarked funds, weakening the budget process.
  - Nearly all domestic public debt (about 20 percent of GDP) comprises swapped public banks’ claims on SOEs.
  - Loans to distressed SOEs from 2001 onward carry more explicit Treasury guarantees or financing arrangements but remain largely extra-budgetary with unclear contingent value.
- PAYG pension funds:
  - Treasury has funded shortfalls of 1 percent of GDP each year since 1999.
  - Contribution rates rose from 7 percent of reported wages in 1985 to 17.5 percent in 2001, increasing under-reporting (partial data suggests two-thirds under-reporting).
  - System threatened by deteriorating dependency ratio, overly generous validation rates and benefits, and ill-advised deposits in private banks.
- Recommendation:
  - Replace directed credit to loss-making SOEs with transparent budget appropriations to better pinpoint Treasury borrowing requirements.

### Increasing public debt issuance to constitute higher Treasury deposits at BA
- Rationale:
  - Best practice debt management objective: meet financing needs at lowest cost over time.
  - Given high likelihood of fiscal “surprises,” increasing issuance across the curve now acts as insurance against higher future financing costs.
- Example:
  - The stock of traded government securities was 2.5 percent of GDP at end-2002.

### Box 6 — Increasing Treasury Domestic Debt: Simulations
- End-2002 public debt: DA 971 billion total; DA 108 billion formally tradable; DA 863 billion bonds issued to public financial institutions to swap impaired assets.
- Of DA 863 billion, DA 498 billion could be transformed into traded government securities.
  - These DA 498 billion are presently amortized in yearly tranches of DA 25 billion until 2019, with a 6 percent coupon.
- Alternative issuance under current yield curve (l-year 2 percent; 2-year 2.5 percent; 5-year 3.5 percent; lo-year 5 percent):
  - Issue DA 290 billion l-year, DA 170 billion 2-year, DA 140 billion 5-year, and DA 50 billion IO-year bullet notes — total DA 650 billion.
  - First-year debt service: DA 17 billion (the two debt structures comparable in net present value terms).
  - Banks would purchase DA 650 billion bullet securities by tendering their restructuring bonds and drawing down deposits at BA by DA 150 billion.
  - Treasury would increase its self-insurance by DA 150 billion.
  - Increasing issuance could raise primary yields, reducing feasible issuance below DA 650 billion; yields would have to almost double for issuance to drop to DA 500 billion.
- Policy implication:
  - Transforming amortizing restructuring bonds into tradable bullet securities improves liquidity management and creates tradable securities for banks.

### Substituting domestic issuance for external debt and other measures
- External debt and prepayment potential:
  - Algeria’s external debt amounted to US$22.6 billion in 2003, of which US$2.7 billion could possibly be pre-paid at par without protracted negotiations or penalties.
- Using reserves to pre-pay some external debt would reduce the import ratio and could improve sovereign rating prospects.
- Treasury buying dollars from BA by issuing new dinar securities on top of previous operations would put banks short liquidity, enabling secondary trading and competitive interest rate setting along the yield curve.

### Strengthening BA’s monetary management and market development
- Lack of Treasuries in BA portfolio has forced BA to use deposit auctions; liquidity absorption is only 60 percent of the amount needed, stifling money and fixed-income markets.
- BA could issue central bank bills (CBB) if financial independence is safeguarded through understanding with Treasury; practical issues:
  - BA would have to issue at least DA 300 billion to absorb current liquidity, making CBB the largest securities market in Algeria only to likely disappear when the oil cycle turns.
  - Stop-and-go issuance would be debilitating for market development and the government yield curve.

### Encourage development of the interbank repo market
- Current practice: BA acts as broker to all trades and sometimes rejects matches for prudential reasons; interest rates bear little relation to counterparty risk.
- Suggestions to revitalize market:
  - Authorize direct dealing among banks.
  - Use screen-based technology to improve price discovery.
  - Set up a legal framework for repurchase operations (repos).
  - Keep the system short liquidity to develop use of BA repos of government securities.
- Expected benefits:
  - Internalization of repo technique by bank treasurers, emergence of market conventions, minimized counter-party risk, and increased demand for treasury paper.

### Key figures and statistics (preserved exactly as in source)
- BA would need a portfolio of treasury paper of DA 500 billion.
- Present stock tradable Treasury debt: DA 100 billion, none of which BA holds.
- Treasury deposits at BA: DA 650 billion, or 13 percent of GDP.
- Excess liquidity on the order of 30 percent of banking system credit.
- From 1980-2002: standard deviation of autonomous factors = 16 percent of BA balance sheet; peak absorption needs = 40 percent.
- DA 150 billion more along the IO-year curve could increase cash reserves at BA by a fourth and halve banks’ excess liquidity.
- Total public debt at end-2002: DA 971 billion; DA 108 billion formally tradable; DA 863 billion swapped to public financial institutions.
- DA 498 billion could be transformed into traded government securities; currently amortized as DA 25 billion yearly until 2019; coupon 6 percent.
- Under simulation issuance: DA 290 billion l-year; DA 170 billion 2-year; DA 140 billion 5-year; DA 50 billion IO-year; total DA 650 billion; first-year debt service DA 17 billion.
- Current yield curve used in simulation: l-year 2 percent; 2-year 2.5 percent; 5-year 3.5 percent; lo-year 5 percent.
- Algeria external debt in 2003: US$22.6 billion; US$2.7 billion potentially pre-payable at par.
- The stock of traded government securities was 2.5 percent of GDP at end-2002.
- About 70 percent of oil and gas export proceeds revert to the budget.
- PAYG pension shortfalls funded by Treasury: 1 percent of GDP each year since 1999.
- Contribution rates increased from 7 percent of reported wages in 1985 to 17.5 percent in 2001 (partial data suggests two-thirds under-reporting).

*Source: _cr04138 - Box 3. Standards and Codes*

### 61.5 N/A

### _cr04138 - 61.5 N/A

### General overview of the banking system
- The Algerian banking system currently has 28 active lending institutions, of which 21 are banks and 7 are financial institutions (there is also one development bank and one offshore bank).
- The total number of lending institutions has increased from end-1999 when there were 21 as a result of private-sector development.
- There are now 15 private banks. However, the public sector remains predominant.
- Public banks represent 86.5 percent of the banking sector’s aggregate balance sheet, 91 percent of loans extended, and 84 percent of deposits taken (as of end-2002).
- The public sector continues to receive a majority of loans extended (some 60 percent), although the proportion has fallen.
- Direct recapitalizations totaled DA 74.4 billion and the outstanding stock of treasury bonds issued to convert bank claims on insolvent public enterprises was DA 672.1 billion at end-2002.
- Progress with privatization is slow; a decision has been made to privatize one of the large public banks (no further detail provided in the source).

### Institutional and macroeconomic setting for banking supervision
- The banking law of April 10, 1990 established surveillance principles and modalities.
- Supervisory functions are entrusted to three institutions:
  - Two collegiate bodies: the Monetary and Credit Board (licenses lending institutions, exercises regulatory authority) and the Banking Commission (off-site and on-site supervision, imposes sanctions).
  - The Bank of Algeria (BA, central bank), which prepares legislation regulating bank regulatory matters and carries out audits—either directly or as delegated by the Banking Commission.
- The Governor of BA chairs the three institutions and assumes ultimate responsibility for policy implementation and consistency.
- On-site supervision has been strengthened and off-site supervision is being expanded, but quantitative and qualitative resource limitations and sometimes unresponsive reactions to regulatory breaches undermine full effectiveness.
- Development of the private banking sector is still modest; some private banks are family businesses with operations and accounts that often lack transparency.
- Collapse of a private bank that had expanded considerably in recent years weakened the private sector and could tarnish the authorities’ image.

### Preconditions and operational weaknesses
- Strengthening supervision requires improving control and surveillance resources and tools, raising operational capacity of public banks, improving the legal and accounting environment, and privatizing one or more large state-owned banks.
- The banking system struggles with inadequacies of payments, collections, and poor quality telecommunications systems.
- Internal weaknesses include inadequate accounting, analysis, risk management, and internal control systems.
- Recent initiatives include procedures for more effective analysis, management, and supervision, and recently issued regulations on internal controls.

### Main findings on Basel Core Principles (BCP)
- The legal framework and implementation of bank supervision appear to observe or largely observe 11 of the 25 Core Principles.
- Shortcomings mainly concern effective implementation of prudential regulations, particularly management standards and risk surveillance.
- Authorities have made significant efforts to improve supervision in the past three years; only one Core Principle was not observed in this assessment, compared with six that occurred in the 1999 assessment.
- Supervision resources and techniques are being developed at the Bank of Algeria; on-site and off-site supervision have improved though off-site audits remain inadequate for regular assessment of financial institutions’ exposures.
- Authorities should continue efforts to correct violations in enforcement of prudential regulations without delay using available legal and regulatory frameworks.

### Comments on implementation of selected Core Principles
- Objectives, autonomy, powers, and resources of the authorities (CP 1):
  - The term of office of the Governor and members of the Monetary and Credit Board are no longer fixed.
  - Grounds for dismissal of the Governor have not been disclosed.
- Licensing and ownership structure (CPs 2–5):
  - Often only a quarter of the minimum capital is paid up when an institution’s license is granted; full payment may take one or more fiscal years.
  - Information on direct and indirect stockholdings is imperfect; data on stockholders are not periodically updated.
- Prudential regulations and requirements (CPs 6–15):
  - Authorities do not routinely verify banks have adequate tools to monitor and evaluate exposures.
  - Lending policies of major banks are not adequately based on sound assessment of nonrecovery risk.
  - Provisions against doubtful claims are not adapted to the real risk of incurring losses.
  - Loans to groups of related borrowers are not clearly defined; reporting requirements are often unmet.
  - Recent prudential regulations on internal controls are too new to be fully implemented and overseen.
  - No practical arrangements yet oblige banks to adopt surveillance procedures against money laundering.
- Methods of ongoing banking supervision (CPs 16–20):
  - Off-site surveillance resources and methods need strengthening; no procedures for consolidated audits; information on direct and indirect owners of bank stock is irregular.
- Accounting standards (CP 21):
  - The chart of accounts needs completion.
  - Banks’ accounting systems have serious flaws making it difficult to determine exact exposure and financial condition.
  - Banks often remit financial statements to authorities with a considerable time lag.
- Corrective measures (CP 22):
  - Authorities do not always take immediate corrective action on numerous institutions failing to observe prudential regulations, in some cases on a routine basis.
- Control of cross-border banking (CPs 23–25):
  - Authorities can strengthen supervision by entering into information-sharing agreements with Algeria’s principal banking sector partners.

### Recommended Action Plan to Improve Observance of the Basel Core Principles (selected items)
- Reference: 1–2 Independence of the authorities
  - Establish a fixed term of office for the Governor and the members of the Monetary and Credit Board. Publish grounds for dismissal of the Governor.
- Reference: 3 Licensing criteria
  - Require that the minimum capital be fully paid up at the time the license is granted.
- Reference: 4 Equity ownership
  - Acquire detailed knowledge of direct and indirect stockholders and keep the information up-to-date.
- Reference: 7–8 Credit policies, loan evaluations
  - Carry out regular on-site supervision to evaluate credit policies, loan portfolio quality, and adequacy of provisions.
- Reference: 10 Loans to related borrowers
  - Clarify what is meant by loans to related parties. Insist that institutions remit the returns required by law.
- Reference: 13–14 Sundry risks, internal controls and audit
  - Verify implementation of the new regulations on internal controls.
- Reference: 15 Money laundering
  - Adopt regulations establishing banks’ obligations under existing legal provisions of a general nature.
- Reference: 18 Off-site surveillance
  - Increase off-site supervision resources in personnel and material. Develop methodology for analyzing banking supervision documents. Introduce early warning systems. Improve coordination between off-site supervision and actions taken by other departments.
- Reference: 29 Consolidated group audits
  - Clarify banks’ obligations concerning consolidation.
- Reference: 21 Accounting standards
  - Insist that documents required by supervisory authorities be delivered on time. Involve outside auditors in accounting controls. Update the chart of accounts.
- Reference: 22 Corrective measures
  - Expedite adoption of corrective measures. Impose appropriate sanctions for breaches of prudential regulations and requirements.
- Reference: 24–25 Cross-border controls
  - Reach exchange-of-information agreements with counterparty countries.

### MFP Transparency Code — Monetary Policy: main findings
- Assessment conducted by Philippe Callier and Laurent Bouscharain as part of the FSAP; based on Law 90-10 of April 14, 1990 (as amended by Ordinance 01-01 of February 27, 2001), BA publications, BA website information, discussions with BA senior staff, and questionnaires to authorities.
- Legal and institutional framework:
  - The Law on Money and Credit is insufficiently precise on ranking of the central bank’s main objectives; Article 55 places equal emphasis on domestic stability, external stability, and orderly development of the national economy.
  - No satisfactory definition of institutional responsibility for exchange policy; sharing of responsibilities between Bank of Algeria and the Council on Money and Credit (CMC) is not clearly defined by law. This is mitigated in practice because the Governor of BA chairs the CMC.
  - BA’s independence may be limited by absence of a fixed term for the Governor and absence of explicit criteria for revocation, except for revocation for gross misconduct.
- Announcement and preparation of monetary policy decisions:
  - Process could be strengthened with press releases providing more thorough explanations of reasons underlying decisions.
  - Recent progress in publication of BA’s annual report might be supplemented with dissemination of more explicit information on monetary policy objectives and developments in relation to those objectives.
- Consultation and publication practices:
  - Before issuing important regulatory texts, BA should more systematically hold prior consultation and explanatory meetings with the financial community.
  - Law requires publication of an annual report; however, there are substantial lags in publishing this report and regulatory texts on the BA website.
  - Publication of central bank debt data has yet to meet the IMF data dissemination standards.
- Accountability and integrity:
  - Disclosure of internal management procedures and a code of good conduct and professional ethics for BA staff would improve accountability and reduce conflicts of interest.

### Recommended Plan of Action — MFP Transparency Code (Monetary Policy)
- I. Clarity of Roles, Responsibilities and Objectives
  - The Law on Money and Credit should clearly and explicitly define the ranking of the Bank of Algeria’s monetary policy objectives.
  - The law should define the sharing of institutional responsibilities for exchange policy.
  - The law should explicitly define the length of the governor’s term to enhance BA’s independence.
- II. Open Process for Formulating and Reporting Monetary Policy Decisions
  - BA should strengthen its process of announcing decisions and providing details; introduce announcement requirements and deadlines for explaining monetary policy decisions.
  - Improve consultation practices with the financial community through systematic prior consultations to explain decisions and ensure feasibility.
- III. Public Availability of Information on Monetary Policy
  - Improve BA publications to permit systematic assessment of monetary policy performance; reduce publication lags.
- IV. Accountability and Assurances of Integrity by Central Bank
  - BA should publish a code of good conduct and professional ethics for its staff, including provisions for penalties.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04138.pdf*

### Introduction

### Introduction

### Mission and basis of assessment
- Assessment conducted by Laurent Bouscharain (IMF) and Michel Svetchine (French Banking Commission) in the framework of the Financial Sector Assessment Program (FSAP) for Algeria.
- Assessment will form an integral part of the FSAP Report.
- Main sources: banking law (Law 90-10 of April 10, 199~Law on Money and Credit), regulations, circulars, reports, data, and other information available in the body of texts of the Council on Money and Credit (CMC), Bank of Algeria (BA), and the Banking Commission (CB), most of which are available at the Bank of Algeria’s website.

### Legal and institutional framework — overview
- The banking law defines principles and modalities for oversight of the Algerian banking system.
- Oversight mission shared among three institutions:
  - The Council on Money and Credit (CMC) is responsible for issuing licenses and regulations.
  - The Banking Commission (CB) is responsible for on- and off-site supervision and is vested with power to issue penalties.
  - The Bank of Algeria (BA), the central bank, is responsible for enforcing current legislation, which it implements directly or by delegation of the Banking Commission for ongoing supervision of banks and financial institutions.
- The Bank of Algeria is responsible for on- and off-site supervision on behalf of the Banking Commission.

### Conclusions — findings
- Clarity of roles, responsibilities and objectives of financial agencies responsible for financial policies:
  - Responsibilities among BA, CMC, and CB are clearly established by legislation.
  - The texts do not indicate the duration of the terms for the governor and members of the CMC, or the criteria for their revocation.
  - There are no arrangements covering the exchange of information between the three authorities (BA, CMC, and CB).
  - The authorities do not engage in periodic comprehensive public reporting on their activities.
- Open process for formulating and reporting of financial policies:
  - Financial communication is substantially based on public access to all prudential texts.
  - The process of preparing texts does not include coordination with the industry.
  - Measures taken are not systematically explained to the institutions to which they apply.
  - The supervision authority does not present measures that it intends to take in exercising its supervision duties.
- Public availability of information on financial policies:
  - Regulatory texts are available to the public.
  - Authorities have not established any communication program.
  - Aggregate data on the banking system and developments are not publicly disclosed according to a regular timetable and are incomplete (no profit and loss accounts).
- Accountability and assurances of integrity by financial agencies:
  - The governor and vice governors are accountable for bank supervision policy.
  - Rules governing the integrity of persons responsible for supervision are identical to those applied to all staff of the BA (see code on transparency in monetary policy).

### Other recommended actions (Table 3)
- V. Clarity of roles, responsibilities, and objectives of financial agencies responsible for financial policies
  - The terms of the Governor and members of the CMC should be defined and the conditions for their revocation should be specified and publicly disclosed.
- VI. Open process for formulating and reporting of financial policies
  - Arrangements should be established and publicly disclosed to specify the modalities for exchanging information between the control authorities.
  - Preparation of prudential texts should include a consultation of the professionals involved; the texts should be systematically explained to those to whom they apply.
- VII. Public availability of information on financial policies
  - According to a predetermined schedule, the authorities responsible for supervising credit institutions should present the information on their supervisory objectives, be accountable for their actions, and regularly publish complete aggregate data on the key features of the financial system and relevant developments (performance of banks, in particular).
- VIII. Accountability and assurances of integrity by financial agencies
  - Information on operating expenditure of the authorities in charge of bank supervision should be disclosed.
  - The BA should publish a code of good conduct and professional ethics for its staff, including the bank supervision authority.

### Authorities’ response
- The authorities discussed this evaluation with the mission, and their comments have been incorporated into the final version of this evaluation.

*Source: _cr04138 - Introduction*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04138.pdf_