## _cr05274

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### Executive Summary — financial system and macroeconomic backdrop
- The Albanian financial system "does not appear to be highly vulnerable to immediate macro-economic or financial sector shocks."
- Financial system effect on the real economy is likely small because it "is still in the early stages of development."
- Cash transactions dominate, but trust in government and the formal financial system is increasing after the 1997 pyramid scheme crisis.
- Prudent monetary and fiscal policies have contributed to a stable macroeconomic environment; "much of the core financial sector legislative and regulatory framework is in place."
- Policy continuity by financial institutions and regulatory authorities is needed to build public confidence and keep systemic risks at bay.

### Key macroeconomic statistics and vulnerabilities
- Output growth averaged about "7 percent in 1999–2004."
- Consumer inflation "has generally stayed between 2–4 percent."
- Public debt to GDP "has trended down to 55½ percent at the end of 2004."
- Barring significant changes, growth is expected to remain at "around 6 percent over the medium term."
- Large trade and current account deficits: "some 20 percent and 6 percent of GDP respectively."
- Dependence on migrant remittances is a potential source of risk for consumption, investment, and exchange rate pressure.

### Banking sector — structure, performance, and risks
- System composition and scale:
  - 17 banks (2 Albanian and 15 foreign-owned/or joint ventures).
  - Banking system represents "90 percent of formal financial system assets."
  - Assets as of end-2004 amount to some 52 percent of GDP; total assets/liabilities (in millions of Lek): 339,304.98 (2002), 373,634.54 (2003), 426,440.00 (2004), 454,919.00 (2005-Q1).
  - Privatization in April 2004 moved about 50 percent of banking system assets from public to private hands.
- Liquidity and asset composition:
  - Liquid assets equal a high 75 percent of total assets.
  - Bank credit to the private sector (excluding state-owned enterprises) accounts for about 10½ percent of GDP as of end-April 2005.
  - Low loan/asset ratio: 14.6 percent overall; without Raiffeisen the ratio is 28.4 percent.
  - Of total banking system assets, 76 percent are held in government securities.
  - Treasury bills (percent of assets): 51.6 (2002), 49.6 (2003), 45.8 (2004), 44.5 (2005-Q1).
  - Loans to private sector and households (percent of assets): 10.9 (2002), 12.8 (2003), 15.2 (2004), 16.1 (2005-Q1).
- Currency composition and FX exposure:
  - About 38 percent of assets and nearly 83 percent of loans are denominated in foreign currency (principally the euro and U.S. dollar).
  - Banks maintain net open foreign exchange positions at 8.7 percent as of end-April (within the prescribed limit of 20 to 30 percent of regulatory capital).
  - Net open position in foreign exchange to regulatory capital (selected periods): 2.7, 7.3, 5.1, 9.6, 16.4, 7.4, 3.5, 8.7.
- Profitability and capitalization:
  - Regulatory capital/risk-weighted asset ratios (CARs) have stayed above 20 percent in recent years; CARs by bank range from around 15 percent for the most active lenders to over 200 percent for some small banks.
  - Regulatory capital to risk-weighted assets (selected): 31.6 (2002), 28.5 (2003), 30.1 (2004), 27.0 (Mar. 2005), 25.1 (Jun. 2005), 21.6 (Sep. 2005), 21.0 (Dec. 2005), 20.8 (Mar. 2005 Apr.)
  - Return on assets: 1.2 to 1.4 percent in recent years; selected series: 1.2, 1.2, 1.3, 1.3, 1.4, 1.3, 1.3, 1.3.
  - Return on equity has varied tightly around 20 percent; selected series: 19.1, 19.5, 21.1, 22.2, 23.7, 21.1, 22.1, 22.5.
  - Aggregate NPL ratios declined from over 33 percent in 2000 to less than 5 percent.
- Emerging risks:
  - Credit growth accelerated to 50 percent (y-o-y) in April 2005 and is some 65 percent higher than two years ago.
  - High share of loans in foreign currency raises concern about indirect credit risk from a lek depreciation.
  - Limited financial information on borrowers and unverifiable remittance income increase credit risk.
  - Real estate lending is 2.5 percent of outstanding loans; 95 percent of collateral consists of real estate; typical collateral coverage is over 120–140 percent of the loan.

### Stress tests — methods and main results
- Overall conclusion:
  - Stress tests indicate the banking sector appears fairly resilient to hypothetical shocks to foreign exchange, credit, interest rate, and risk without causing systemic distress; underlying profitability provides a buffer.
- Foreign exchange shocks (Table 3 effects on system CAR and ROA in percentage points):
  - 20 percent lek depreciation (against all currencies): Effect on system CAR +1.72; Effect on system ROA +.06
  - 20 percent lek appreciation: Effect on system CAR -2.31; Effect on system ROA -.06
  - 20 percent USD depreciation: Effect on system CAR -2.63; Effect on system ROA -.06
  - 20 percent USD appreciation: Effect on system CAR +2.30; Effect on system ROA +.05
  - 20 percent Euro appreciation: Effect on system CAR -0.21; Effect on system ROA 0.0
  - 30 percent lek depreciation with indirect credit risk: Effect on system CAR -0.48; Effect on system ROA -.36
- Credit shocks:
  - A 10 percent deterioration in standard loans: Effect on system CAR -1.97; Effect on system ROA -.49
  - Combined 30 percent lek depreciation and 10 percent deterioration of standard foreign currency loans (with provisioning): system CAR decline about -0.48 percentage points and system ROA of -.36; two banks fall below the 12 percent required CAR in this scenario.
- Interest-rate shocks:
  - A 5 percentage point rise in all yield curves: Effect on system CAR -2.44; Effect on system ROA +.10; no bank’s CAR falls below 11 percent.
- Competitiveness shock (Raiffeisen entry assumptions and results):
  - Assumptions include existing total loans grow 35 percent; Raiffeisen Bank loans increase to Euro 100 million (lek 12.5 billion); other banks grow loans proportionally at 15.17 percent; RB loan growth offset by T-bill declines; new T-bill issuance is 23,412 lek billion.
  - 5 pp fall in loan spreads; 3 pp rise in T-bill rates: Effect on system ROA +.47
  - 5 pp fall in loan spreads; no change in T-bill rates: Effect on system ROA -0.79
- Caveat:
  - Stress tests rely on existing balance sheet positions; future balance sheet changes may alter resilience and outcomes.

### Foreign exchange market vulnerability and mitigation
- The formal foreign exchange market appears shallow, creating potential foreign exchange liquidity shock risk.
- Mitigating factors:
  - Banks maintain relatively small net open foreign exchange positions within regulatory limits.
  - Banks hold large foreign exchange assets abroad that could be repatriated quickly.
  - Banks are required to hold reserves on foreign currency deposits in foreign currency, providing a liquidity cushion.
  - The Bank of Albania (BoA) holds a satisfactory level of net international reserves to address a liquidity shock of a reasonable magnitude.
  - Market depth could be enhanced by developing trust and transparent publication of the procedures used by the BoA in choosing counterparties.

### Monetary policy, liquidity management, and government debt market
- BoA responsibilities and regime:
  - BoA is "solely responsible for conducting monetary policy with the primary objective to achieve and maintain price stability, and for foreign exchange policy."
  - Practical inflation objective: "an annual inflation rate within a range of 2 to 4 percent."
  - Exchange rate regime: "fully flexible exchange rate regime" with BoA intervening to smooth excessive volatility.
- Policy instruments and operations:
  - Open market operations (repos, reverse repos, outright transactions) are used to achieve operational targets and manage banks’ liquidity.
  - Reserve requirements are remunerated, uniformly set at "10 percent of deposits and averaged."
  - BoA interventions are generally transparent; procedures and selection criteria for foreign exchange interventions are being clarified.
- Market vulnerabilities:
  - Weak interbank market and shallow domestic foreign exchange market.
  - Banking system is "overly liquid" due to lack of lending opportunities and continuous deposit inflows used to purchase government securities.
  - Transmission of policy rates to credit is limited; "credit extension is still not very responsive to interest rate changes" and transmission to the real sector is "more via the exchange rate than directly via interest rates."
- Government debt market structure:
  - Government debt holdings are "highly concentrated": commercial banks hold about "three-quarters of all Treasury bills and notes"; the newly privately-owned Raiffeisen bank holds "nearly half of the outstandings."
  - Other institutional investors hold "only about 2 percent of outstanding government debt."
  - Recommendations to foster retail demand and market functioning include keeping BoA's retail auction window open and charging for BoA services as issuer of government securities.

### Nonbank sector — size, components, and key issues
- Sector size and development:
  - Nonbank sectors are relatively small and not currently a source of systemic vulnerability.
  - Net open foreign currency position of the non-bank private sector has been falling since early 2003 and is now about 6 3/4 percent of GDP.
- Insurance:
  - Total premium income represents only 0.5 percent of GDP and total assets about 1 percent of GDP.
  - Total premium income increased nearly 2½ times between 1999 and 2004; number of insurance companies doubled from 5 to 10 during 2004.
  - Premium per capita: $9.80 (Albania); next highest regional country Romania at $35.80.
  - Market concentrated in motor vehicle insurance; governance, financial reporting, and asset valuation need strengthening.
  - ISA needs senior qualified finance professionals in leadership and adequate remuneration.
- Pensions:
  - Prudential framework for the private, voluntary funded pension scheme (‘third pillar’) needs acceleration; current law has significant weaknesses and may require a new law.
  - Recommend a well-articulated strategy for the entire pension system, including actuarial studies of the public pension system (the “first pillar”).
- Savings and Credit Unions (SCAs) and micro-credit:
  - Assets amount to less than 1 percent of GDP; assets doubled in the last two years.
  - Growth depends on mobilizing capital, pooling resources, and institutional transformation as donor support diminishes.
  - Recommendation: encourage consolidation/pooling and consider converting MAFF into a rural cooperative bank while removing government equity role.
- Securities markets:
  - ASE has had no listings and no trading over the last eight years; government should consider offering ASE to private financial entities or close it.
  - Institutional impediments include information constraints, weak collateral and contract enforcement, absence of effective property registers, and land registration and titling still in early stages.
  - A well-functioning credit bureau would greatly benefit the system; BoA should take the lead.

### Regulatory, supervisory, and legal framework observations
- Banking supervision:
  - Banking supervision under the Bank of Albania "has been strengthened considerably" and conforms with most Basel Core Principles.
  - BoA operates within a supportive framework and is empowered to issue regulations; supervisory examinations and offsite analysis procedures are well developed.
  - Capital requirements and rules governing credit exposures are subject to adequate supervision.
  - Areas for enhancement include consolidated supervision powers, retention of experienced staff, more legal expertise, and legal protection for supervisors.
- Nonbank supervision:
  - Albania has "too many financial sector regulatory entities" for a very small financial system; four separate bodies: BoA, ISA, ASC, OIPISP.
  - Recommendation: merge insurance, pension, and securities supervisors into one body as a first step; re-examine integration with banking supervision later.
  - ISA recently restructured but lacks sufficient technical expertise and remuneration; needs political support and technical assistance.
- Legal and judicial issues:
  - Legal framework broadly consistent with international best practices but implementation and enforcement are weak.
  - Judicial system is the weakest institutional link; courts perceived as one of the three most corrupt institutions, limiting contract enforcement and commercial activity.
- AML/CFT:
  - AML/CFT implementation beyond banking is limited; a proposed draft AML law will extend measures to insurance, securities, and designated nonfinancial businesses.
  - Full evaluation by MONEYVAL scheduled for September 2005.
  - FIU exists but has insufficient resources; banks must report transactions above lek 2 million; recommendation to refine reporting criteria and consult banks before lowering thresholds.

### Payment systems — AIPS, ACH, retail payments, and oversight
- AIPS (RTGS) role and activity:
  - AIPS is the systemically important RTGS for inter-bank payments in lek (above lek 1 million).
  - 2004 activity: Total number of payments 25,881; Aggregate value settled lek 1,971 billion; Daily average transactions about 120; Daily average value around lek 6.0 billion.
  - ACH completed July 8, 2005; ACH interbank settlement will take place through AIPS.
  - The “Beyond Cash” program aims to increase formal banking usage and de-dollarization.
- Observance gaps and key weaknesses vs. CPSS CPSIPS:
  - AIPS does not fully observe CPSS CPSIPS; specific Principles incompletely observed include I, III, VII, VIII, and X.
  - Issues: legal risk (admissibility of electronic records), enforceability of BoA security interests in ILF collateral, operating hours, operational reliability, contingency planning, efficiency and interoperability, governance and participant engagement.
- Recommended actions (select):
  - Legal foundation: address admissibility of electronic records and enforceability of BoA security interest in treasury bills used as collateral for ILF; consider need for ad hoc payments law or revisions.
  - Oversight: establish BoA oversight function over payments system; create a small separate oversight unit with legal, operational, technical, policy and economics expertise; publicly disclose oversight policy and enforcement mechanisms.
  - Liquidity and settlement: institute controls to remove operational risk of blocking disposal of treasury bills assigned as ILF collateral; re-evaluate the 20 percent ceiling on deployment of required reserves.
  - Operational reliability and contingency: implement robust communication network, strengthen security, upgrade contingency plans and disaster recovery (secondary site outside primary location).
  - Efficiency and governance: convene participants to discuss connectivity and interconnection; create formal user groups (Participants Committee); assign major responsibility to a Payment System Department.
- Summary recommendation:
  - BoA is encouraged to take all actions to ensure AIPS achieves full observance of the CPs; establish oversight, secure legal authority, set organizational arrangements, ensure participant cooperation, define enforcement, and disseminate information publicly.

### Policy implications and supervisory priorities (selected)
- Maintain prudential oversight to keep net open foreign exchange positions small and within prescribed limits.
- Strengthen disclosure and borrower awareness about foreign currency loan risks; encourage or require banks to discuss exchange rate risks explicitly with borrowers before contracts are signed.
- Ensure banks hold adequate capital against potential loan losses, particularly amid rapid credit growth.
- Facilitate creation of a well-functioning credit bureau under BoA leadership.
- Improve land registration, titling systems, and judicial procedures for collateral enforcement.
- Collect and analyze real estate price data; consider guidance on loan-to-value practices.
- Monitor competition effects from privatization and entry of large banks and assess implications for margins, T-bill demand, and systemic liquidity.
- Continue to upgrade ISA, harmonize nonbank supervision, and consider integration of nonbank regulatory bodies.

*Source: _cr05274 - Executive Summary and selected sections*

### Executive Summary ......................................................................................................

### Executive Summary

### Major findings on the financial system and macroeconomic backdrop
- The Albanian financial system "does not appear to be highly vulnerable to immediate macro-economic or financial sector shocks."
- Financial system effect on the real economy is likely small because it "is still in the early stages of development."
- Cash transactions dominate exchanges, but trust in government and the formal financial system is increasing after the 1997 pyramid scheme crisis.
- Prudent monetary and fiscal policies have contributed to a stable macroeconomic environment; "much of the core financial sector legislative and regulatory framework is in place."
- Policy continuity by financial institutions and regulatory authorities is needed to build public confidence and keep systemic risks at bay.

### Key macroeconomic statistics and vulnerabilities
- Output growth averaged about "7 percent in 1999–2004."
- Consumer inflation "has generally stayed between 2–4 percent."
- Public debt to GDP "has trended down to 55½ percent at the end of 2004."
- Barring significant changes, growth is expected to remain at "around 6 percent over the medium term."
- The domestic currency, the lek, has continued to appreciate due to rising external inflows and portfolio shifts.
- Large trade and current account deficits: "some 20 percent and 6 percent of GDP respectively."
- Dependence on migrant remittances is a potential source of risk for consumption, investment, and exchange rate pressure.
- A slowdown in sectors financed with remittances—construction, trade and services—could directly affect growth and loan portfolio quality.

### Banking sector structure, performance, and risks
- The banking system represents "90 percent of formal financial system assets."
- Credit growth reached "50 percent (y-o-y) in April 2005" and loans still amount to "only some 10¼ percent of GDP."
- Credit expansion has been funded by broader deposit-taking and increased remittance intermediation.
- Banks and supervisors have not yet witnessed a full credit cycle and "may not be fully prepared."
- Banking system recent performance: relatively high levels of earnings and capitalization and a low level of NPLs, but "will face significant challenges ahead."
- High share of loans in foreign currency raises concern about indirect credit risk from a lek depreciation.
- Overall net positions: "few Albanian banks suffer serious capital deterioration when foreign exchange rates move" given loans are a small proportion of assets and banks have net overall long positions in foreign exchange.
- Ongoing assessments of vulnerabilities are advised due to rapid sectoral change.

### Nonbank sectors
- Other financial sectors are not large enough to be systemically important yet.
- Insurance sector growth is "quite rapid" and faces risks from poor internal governance, weak financial accounting and reporting, and a technically weak regulator.
- Limited investment opportunities for insurance companies—"government securities and real estate"—constrain diversification.

### Institutional weaknesses hindering financial development
- Weaknesses include inadequate land registration and titling systems, absence of proper accounting standards, money laundering, and corruption (noted as a particular problem in the judicial system).
- Authorities need to assure basic contract enforcement to permit trust for counterparties across banks, non-bank financial institutions, foreign exchange bureaus, and citizens.

### Regulatory and supervisory framework observations
- Banking supervision under the Bank of Albania (BoA) "has been strengthened considerably" and conforms with most Basel Core Principles.
- Other supervisory structures are weak; Albania has "too many financial sector regulatory entities" for a very small financial system.
- Recommendation: merge insurance, pension, and securities supervisors into one body as a first step; re-examine integration with banking supervision later.

### Box 1 — Key FSAP Recommendations (preserved wording)
- Short-term
  - "Pursue efforts to increase the awareness of consumers and other bank borrowers of the risks inherent in foreign currency borrowing, by encouraging or requiring banks to discuss exchange rate risks explicitly with borrowers before contracts are signed."
  - "Discuss with banks means of assessing the risks arising from foreign currency denominated loans and adjust existing loan classification schemes or provisioning if warranted."
  - "Facilitate the creation of a well-functioning credit bureau under the leadership of BoA."
  - "Undertake review of bank exit/receivership provisions and contingency planning arrangements, using 'emergency bank failure scenarios' to assure readiness for such eventualities."
  - "Proceed with the plans to revise AML law in line with the FATF Recommendations 2003."
  - "Offer the Albanian Securities Exchange (ASE) to the private financial sector for a nominal amount to own and operate; failing that, close down the idle ASE."
  - "Improve institutional capacity for public debt management by clearly articulating the objectives, strategies, and decision-making processes for public debt management."
  - "Include senior qualified and experienced finance professionals in the leadership of the Insurance Supervisory Authority (ISA) both at the supervisory board level and management with adequate remuneration."
- Medium term
  - "Begin integration of insurance, securities, and pension fund regulatory bodies into an integrated nonbanking regulator; consider feasibility of integrating banking supervision at a later stage."
  - "Improve land registration, titling systems, and judicial procedures for collateral enforcement."
  - "Ensure effective implementation of proper accounting standards."
  - "Increase capacity of the financial intelligence unit (FIU) to deal with money laundering."
  - "Issue and enforce insurance sector prudential regulations in line with international standards."
  - "Encourage bottom up consolidation or pooling of resources of credit and savings unions."
  - "Harmonize and enhance regulation governing various credit unions and consider introduction of a separate deposit insurance for these institutions."

### Monetary policy and liquidity management: framework, strengths, and vulnerabilities
- BoA responsibilities and regime
  - The BoA is "solely responsible for conducting monetary policy with the primary objective to achieve and maintain price stability, and for foreign exchange policy."
  - Practical inflation objective: "an annual inflation rate within a range of 2 to 4 percent."
  - Exchange rate regime: "fully flexible exchange rate regime" with BoA intervening to smooth excessive volatility.
- Policy instruments and operations
  - Open market operations (repos, reverse repos, outright transactions) are used to achieve operational targets and manage banks’ liquidity.
  - Reserve requirements are remunerated, uniformly set at "10 percent of deposits and averaged," and consistent with good liquidity infrastructure.
  - BoA interventions are generally transparent with clear rules for counterparty participation; procedures and selection criteria for foreign exchange interventions are being clarified.
- Main vulnerabilities to liquidity management and monetary transmission
  - Weak interbank market and shallow domestic foreign exchange market.
  - Banking system is "overly liquid" due to lack of lending opportunities and continuous deposit inflows used to purchase government securities.
  - Comparison between BoA rates and overnight interbank market rates is hampered by the "dearth of transactions."
  - The transmission of policy rates to credit is limited; "credit extension is still not very responsive to interest rate changes" and transmission to the real sector is "more via the exchange rate than directly via interest rates."
  - Central bank should "continue to ensure its pricing of liquidity management operations are not advantageous vis-à-vis other banks and educate banks about the functioning of interbank markets."
- Government debt market structure and retail channel
  - Government debt holdings are "highly concentrated": commercial banks hold about "three-quarters of all Treasury bills and notes"; the newly privately-owned Raiffeisen bank holds "nearly half of the outstandings."
  - Other institutional investors hold "only about 2 percent of outstanding government debt."
  - Recommendations to foster retail demand and market functioning:
    - Keep BoA's retail auction window open and upgrade processes "to allow efficient handling of individuals’ participation."
    - BoA should "charge for its services as the issuer of government securities" to fund system upgrades for retail participation.

### Box 2 — Transparency of Monetary Policy (findings and suggestions)
- Findings on transparency
  - BoA demonstrates "an overall satisfactory degree of transparency" in formulation and reporting of monetary policy, with improved public availability of reports and disclosures.
  - Rules and procedures for BoA foreign exchange interventions "will be finalized and publicly released shortly."
  - Public accountability improved with externally audited BoA financial statements and disclosure of internal governance procedures, though the latter "need to be further strengthened."
  - Lack of general awareness of the BoA's role as fiscal agent "potentially hinders independence." Communication with the public "remains inconsistent."
- Suggestions for improvement (preserved wording)
  - "Establish a separate Monetary Policy Committee made up of qualified members in which only monetary policy discussions and decisions would be taken;"
  - "Facilitate communication with the public by creating a specialized unit responsible for designing and implementing a monetary policy communication strategy and establishing regular meetings with market participants;"
  - "Remove potential doubts about BoA independence by disclosing the rules and procedures of the BoA role as fiscal agent in government debt issuances and the costs incurred thereby; and"
  - "Establish explicit internal control and oversight mechanisms; strengthen code of conduct standards for BoA board members; and disclose the rules and procedures behind the foreign exchange market operations in the domestic market."

*Source: _cr05274 - Executive Summary*

### 8.      The apparent shallowness of the formal foreign exchange market makes the

### _cr05274 - 8.      The apparent shallowness of the formal foreign exchange market makes the

### Foreign exchange market vulnerability and mitigation
- The formal foreign exchange market appears shallow, creating potential foreign exchange liquidity shock risk.
- Mitigating factors:
  - Banks maintain relatively small net open foreign exchange positions within regulatory limits.
  - Banks hold large foreign exchange assets abroad that could be repatriated quickly.
  - Banks are required to hold reserves on foreign currency deposits in foreign currency, providing a liquidity cushion.
  - The Bank of Albania (BoA) holds a satisfactory level of net international reserves to address a liquidity shock of a reasonable magnitude.
  - Market depth could be enhanced by developing trust and transparent publication of the procedures used by the BoA in choosing counterparties.

### Banking sector overview and performance
- Structure and scale:
  - The banking sector accounts for over 90 percent of all financial intermediaries’ assets.
  - The system consists of 17 banks (2 Albanian and 15 foreign-owned/or joint ventures).
  - Assets as of end-2004 amount to some 52 percent of GDP.
  - Privatization in April 2004 moved about 50 percent of banking system assets from public to private hands.
- Liquidity and asset composition:
  - Liquid assets equal a high 75 percent of total assets.
  - Bank credit to the private sector (excluding state-owned enterprises) accounts for about 10½ percent of GDP as of end-April 2005.
  - Low loan/asset ratio: 14.6 percent overall; without Raiffeisen the ratio is 28.4 percent.
  - Of total banking system assets, 76 percent are held in government securities.
- Currency composition:
  - About 38 percent of assets and nearly 83 percent of loans are denominated in foreign currency (principally the euro and U.S. dollar).
  - Banks maintain net open foreign exchange positions at 8.7 percent as of end-April (well within the prescribed limit of 20 to 30 percent of regulatory capital).
- Profitability and capitalization:
  - Regulatory capital/risk-weighted asset ratios (CARs) have stayed above 20 percent in recent years (high averages), driven by concentration in zero risk weighted T-bills.
  - CARs by bank range from around 15 percent for the most active lenders to over 200 percent for some small banks.
  - Return on assets of 1.2 to 1.4 percent in recent years.
  - Return on equity has varied tightly around 20 percent.
  - Aggregate NPL ratios declined from over 33 percent in 2000 to less than 5 percent.

### Key balance-sheet and FSIs (selected figures from Tables)
- From aggregate balance sheet (percent of assets):
  - Treasury bills: 51.6 (2002), 49.6 (2003), 45.8 (2004), 44.5 (2005-Q1)
  - Loans to private sector and households: 10.9 (2002), 12.8 (2003), 15.2 (2004), 16.1 (2005-Q1)
  - Foreign currency assets (memorandum): 37.5 (2002), 36.3 (2003), 37.4 (2004), 38.6 (2005-Q1)
  - Total assets/liabilities (in millions of Lek): 339,304.98 (2002), 373,634.54 (2003), 426,440.00 (2004), 454,919.00 (2005-Q1)
- Financial Soundness Indicators (selected):
  - Regulatory capital to risk-weighted assets: 31.6 (2002), 28.5 (2003), 30.1 (2004), 27.0 (Mar. 2005), 25.1 (Jun. 2005), 21.6 (Sep. 2005), 21.0 (Dec. 2005), 20.8 (Mar. 2005 Apr.)
  - Liquid assets to total assets: 77.9, 73.6, 74.1, 73.2, 73.5, 71.1, 70.3, 69.4 (periods as listed)
  - Net open position in foreign exchange to regulatory capital: 2.7, 7.3, 5.1, 9.6, 16.4, 7.4, 3.5, 8.7 (periods as listed)
  - Return on assets: 1.2, 1.2, 1.3, 1.3, 1.4, 1.3, 1.3, 1.3 (periods as listed)
  - Return on equity: 19.1, 19.5, 21.1, 22.2, 23.7, 21.1, 22.1, 22.5 (periods as listed)

### Vulnerabilities and emerging risks
- Structural and currency risks:
  - Albania is highly dollarized; lek, euro and U.S. dollar all have significant shares of assets and liabilities.
  - Entry of Raiffeisen complicates the risk environment; effects on competition and loan growth are uncertain.
- Credit growth and lending standards:
  - Credit growth accelerated to 50 percent (y-o-y) in April 2005 and is some 65 percent higher than two years ago.
  - Rapid credit expansion could be associated with lower lending standards, higher non-performing loans, and weakened profitability and CARs.
  - Limited financial information on borrowers and unverifiable remittance income increase credit risk.
  - Supervisors and banks should ensure borrowers are aware of foreign currency loan risks and that adequate capital is held against potential loan losses.
- Operational and liquidity risks:
  - Rapid loan processing can lead to mis-estimations of liquidity needs, documentation errors, and customer dissatisfaction.
- Real estate risks:
  - Real estate lending is 2.5 percent of outstanding loans; 95 percent of collateral consists of real estate.
  - Typical collateral coverage is over 120–140 percent of the loan.
  - Lack of prescribed loan-to-value ratios and difficulty/cost of enforcing collateral pose risks if real estate prices fall.

### Stress tests: methods and main results
- Overall conclusion:
  - Stress tests indicate the banking sector appears fairly resilient to hypothetical shocks to foreign exchange, credit, interest rate, and risk without causing systemic distress.
  - Underlying profitability provides a buffer to absorb negative shocks.
- Foreign exchange shocks:
  - A maximum shock of 20 percent was used against all currencies and separately against USD and euro.
  - System generally benefits from lek depreciation and loses from lek appreciation since banks are long in foreign exchange.
  - Exception: lek depreciation against the euro produces significant CAR declines for small highly capitalized banks; in lek appreciation case no bank’s post-shock CAR falls below 11 percent.
  - Table 3 effects on system CAR and ROA (in percentage points):
    - 20 percent lek depreciation (against all currencies on banks’ balance sheets): Effect on system CAR +1.72; Effect on system ROA +.06
    - 20 percent lek appreciation: Effect on system CAR -2.31; Effect on system ROA -.06
    - 20 percent USD depreciation: Effect on system CAR -2.63; Effect on system ROA -.06
    - 20 percent USD appreciation: Effect on system CAR +2.30; Effect on system ROA +.05
    - 20 percent Euro appreciation: Effect on system CAR -0.21; Effect on system ROA 0.0
    - 30 percent lek depreciation with indirect credit risk: Effect on system CAR -0.48; Effect on system ROA -.36
- Credit shocks:
  - A 10 percent deterioration in standard loans: Effect on system CAR -1.97; Effect on system ROA -.49
  - A combined large lek depreciation (30 percent) and indirect credit risk (10 percent deterioration of standard foreign currency loans to lower loan classes, provisioning rules applied) yields system CAR decline of about -0.48 percentage points and system ROA of -.36; two banks fall below the 12 percent required CAR in this scenario.
- Interest-rate shocks:
  - A 5 percentage point rise in yield curves (lek, USD, euro) used; a 5 percentage point rise in all yield curves: Effect on system CAR -2.44; Effect on system ROA +.10
  - Even for a 5 percentage point shift in all yield curves, no bank’s CAR falls below 11 percent.
- Competitiveness shock scenario (reflecting Raiffeisen entry and balance-sheet shifts):
  - Assumptions include: Existing total loans grow 35 percent; Raiffeisen Bank (RB) loans increase to Euro 100 million (lek 12.5 billion); other banks grow loans proportionally at 15.17 percent; RB loan growth offset by T-bill declines; new T-bill issuance is 23,412 lek billion.
  - Results reported in Table 3:
    - 5 pp fall in loan spreads; 3 pp rise in T-bill rates: Effect on system ROA +.47
    - 5 pp fall in loan spreads; no change in T-bill rates: Effect on system ROA -0.79
  - Interpretation: A 5 percentage point drop in loan spreads combined with an instantaneous 3 percentage point increase in T-bill rates produces an improvement in ROA of nearly 50 basis points; without T-bill rate increase, ROA falls by around 80 basis points.
- Caveat:
  - Stress tests rely on existing balance sheet positions; future balance sheet changes may alter resilience and outcomes.

### Policy implications and supervisory priorities
- Maintain prudential oversight to keep net open foreign exchange positions small and within prescribed limits.
- Strengthen disclosure and borrower awareness about foreign currency loan risks.
- Ensure banks hold adequate capital against potential loan losses, particularly amid rapid credit growth.
- Monitor and, where appropriate, improve lending standards and documentation processes to prevent operational missteps during rapid expansion.
- Collect and analyze real estate price data and assess speculative activity; consider guidance on loan-to-value practices.
- Promote transparency by publishing BoA procedures for counterparty selection to enhance market trust and depth.
- Monitor competition effects from privatization and entry of large banks, and assess implications for margins, T-bill demand, and systemic liquidity.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05274.pdf*

### 23.      The nonbank sector remains relatively small and is not current a source of

### The nonbank sector remains relatively small and is not current a source of systemic vulnerability

### Nonbank sector overview
- Small size due to early stage of development, lack of understanding of financial products and services by potential users, and rudimentary basic financial infrastructure.
- Enterprise sector: 91 percent of enterprises have 1–4 employees and extensively use internal funds (e.g., informal, family-generated finance, usually stemming from remittances); little direct access to foreign currency borrowing from abroad.
- Lack of sufficient or reliable financial data and virtually no formal financial reporting—development of nonbank financial entities will take time.
- Net open foreign currency position of the non-bank private sector—proxied by foreign currency deposits less foreign currency loans—has been falling since early 2003 and is now about 6 3/4 percent of GDP.
- FSAP provided a prioritized list of items to help improve nonbank financial intermediaries.

### Insurance companies
- Insurance sector is very underdeveloped relative to potential and to other south eastern European countries.
- Total premium income represents only 0.5 percent of GDP and total assets about 1 percent of GDP.
- Total premium income increased nearly 2½ times between 1999 and 2004; number of insurance companies doubled from 5 to 10 during 2004.
- Premium per capita in Albania is $9.80; the next highest country in the region is Romania at $35.80.
- Market concentrated in motor vehicle insurance; fierce competition and excessive premium discounting may lead to low solvency margins and higher risk of non-payment of claims.
- New updated insurance law enacted; secondary regulations being written, but financial reporting, governance, transparency and asset valuation not yet up to international standards.
- Given limited asset choices (government securities and real estate), attention to prudential norms and asset valuation will be critical.
- Insurance Supervisory Authority (ISA) can use new licensing criteria to ensure higher quality entrants and exit of deficient firms.

### Pension funds (third pillar)
- Prudential framework for a private, voluntary funded pension scheme (‘third pillar’) needs acceleration.
- Key strategic issues to address before finalizing legal framework: take-up potential, cost-efficiency of operational arrangements, safeguards, and impact on the financial system.
- Current law has significant weaknesses in licensing criteria, supervision, governance and profit-sharing arrangements, investment regulations and eligibility for benefits—may require a new law.
- Recommendation: develop a well-articulated strategy for the entire pension system, including actuarial studies assessing long-term sustainability of the public pension system (the “first pillar”).

### Savings and Credit Unions (SCAs) and micro-credit institutions
- Assets amount to less than 1 percent of GDP; assets doubled in the last two years.
- Over the last decade these institutions have serviced about 100,000 urban and rural individuals; demands for more financial services have increased.
- Future growth will depend on mobilizing additional capital and funding, pooling resources, and institutional transformation as donor support diminishes.
- Donor support has aimed to make micro finance institutions financially and operationally autonomous; medium-term donor support could still play a positive role but institutions must grow beyond dependence on government/donor support.
- Consolidation into larger credit unions is a viable method to offer larger loans and banking-like services; reports exist of mergers to finance larger processing plants, warehousing, cold storage or marketing organizations.
- Proposal to convert Mountain Area Finance Fund (MAFF) into a rural cooperative bank; government should eliminate its entire equity role in MAFF to avoid public ownership/control.
- MAFF should not be restricted to agricultural lending but service all rural clients to avoid undiversified loan portfolios.
- Credit unions and micro credit institutions should consider pooling resources into larger cooperative institutions while preserving local ownership benefits.

### Securities markets
- Securities markets are not a likely source of finance for private enterprises in the near future.
- Albanian Stock Exchange (ASE), established in 1997, has had no listings and no trading over the last eight years and has been funded from the state budget without developing equity or corporate debt markets.
- Reasons: enterprises are small; SOEs privatized to strategic investors rather than the general public; larger companies access funding internally or externally; lack of appetite to develop ASE.
- Recommendation: government should consider offering ASE to private financial entities or allow it to close down for want of activity.
- Institutional impediments to public securities development: information constraints, weak collateral and contract enforcement regime, absence of effective property registers, lack of sufficient, reliable and timely data, need for reform of tax administration and judicial system, land registration and titling still in early stages.
- A well-functioning credit bureau would greatly benefit the financial system; initiatives to set one up have been dormant due to competitive concerns—Bank of Albania (BoA) should take the lead with view to future transfer to a private operator.

### Regulatory and supervisory framework
- Recent actions have strengthened regulation and supervision, with many resources focused on banking supervision; compliance with most Basel Core Principles demonstrates progress.
- BoA banking supervision upgraded technical capacity and operating practices with World Bank and IMF assistance; supervisory team trained and competent though limited experience managing difficult enforcement under stress.
- Continuity of skilled staff in the medium term necessary.
- BoA has powers to set prudential regulations; activities permitted by banks and licensing criteria are comprehensive and administered effectively.
- Capital requirements and rules governing credit exposures are subject to adequate supervision despite poor disclosure by borrowers.
- Supervisory examinations and offsite analysis procedures are well developed; corrective measures are effectively implemented.
- BoA needs to continue to improve relationships with home authorities for branches/subsidiaries of foreign banks and assess capacity for effective consolidated supervision.
- Pressure to move BoA salaries toward general civil service pay scale should be strongly resisted to preserve reputation.
- BoA also supervises credit unions and micro-credit institutions (different legal frameworks and licensing requirements); progress made in strengthening BoA’s supervisory capacity and prudential norms for credit unions are being improved.
- Micro-credit institutions have different legal status and supervisory requirements; as they become more “bank-like” their oversight will need to become more rigorous.
- ISA recently restructured but lacks sufficient technical expertise; political support and technical assistance needed to upgrade ISA management and staff, develop prudential regulations and enforcement; remuneration should be closer to market levels to attract professionals.
- Albania has four separate regulatory bodies: BoA (banking), ISA (insurance), ASC (securities) and OIPISP (private pension funds); last two have no market participants to regulate, leading to fragmentation and inefficient use of scarce skills.
- Recommendation: begin integration of all nonbanking regulation and supervision entities in first stage and revisit broader integration later to avoid diluting BoA’s focus on banks.

### Safety nets and liquidity management
- Albania has safety net schemes for bank depositors and some insurance policyholders; coverage for savings deposited in Credit and Savings Associations should be considered.
- Albanian Deposit Insurance agency (ADI) is young and still building its asset base; ADI has not yet needed to pay out claims and is untested.
- Guarantee Fund exists for certain insurance policyholders (third-party motor vehicle) in cases where payment by insurer may be withheld or uncertain.
- Deposits held at savings and credit schemes of credit unions are not insured; safety nets will need introduction after further analysis of implementation issues.
- Legal structure for exit of distressed banks and insurance companies exists but is untested in practice; banking law provides for prompt corrective action and revocation of banking license when warranted—procedures remain untested.
- Emergency preparedness exercise recommended given potential consolidation and bank exits.
- BoA provides lender-of-last-resort facilities to illiquid but solvent institutions through its Lombard credit facility; facility generally meets international best practices and was used effectively several years ago during a “run” on the largest savings bank.
- Recommendation: include Director of Banking Supervision formally in decision-making to determine facility eligibility quickly.
- Albanian Interbank Payment System (AIPS) generally conforms to international standards but is not yet fully compliant with all Core Principles for Systemically Important Payment Systems (CPSIP).
- New retail inter-bank bulk settlement system, the ACH, was completed July 8, 2005; functioning will need evaluation over time.
- Rapid changes in retail payments (growing use of ATM cards and other retail bank checks) require continuous attention; mandatory payment of government employees through banks expected to aid de-dollarization and use of the formal financial system.

### Legal issues
- Legal framework governing regulation and supervision has undergone significant reform and adopted laws and regulations reasonably comprehensive and broadly consistent with international best practices.
- Implementation and enforcement of laws generally weak due to inadequate resources, excessive bureaucracy and corruption, and low respect for the rule of law.
- Judicial system is the weakest institutional link; courts perceived as one of the three most corrupt institutions in Albania, judgments poorly reasoned and biased—authorities are addressing these problems but until confidence in courts increases, ability to enforce contracts will limit commercial and financial activity.

### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- Money laundering remains an ongoing problem due to a large informal economy; formal financial sector involvement likely small given stringent reporting standards on banks and ease of cash-based informal sector operations.
- Banking supervisors have instituted AML/CFT guidelines and enforcement mechanisms; AML law revised in 2003, further improvements needed.
- With IMF assistance in late 2004, a newly revised law is being prepared for parliamentary consideration; Albania recently enacted a law on the financing of terrorism and one to counter organized crime.
- Financial intelligence unit (FIU) exists but has insufficient resources to analyze received data.
- Banks are required to report all transactions above a threshold of lek 2 million, including interbank transactions unlikely linked to money laundering; lack of resources to analyze these reports suggests refinement of reported transaction types to focus on suspicious transactions.
- Recommendation: consult banks on effective means to adjust reporting criteria; postpone lowering the threshold until FIU resources are adequate to avoid wasting additional resources.

*Source: _cr05274 - 23.      The nonbank sector remains relatively small and is not current a source of (PDF).*

### 47.      The implementation of AML/CFT measures beyond the banking sector is

### The implementation of AML/CFT measures beyond the banking sector is

### AML/CFT implementation beyond banking
- The implementation of AML/CFT measures beyond the banking sector is currently limited and appropriate measures need to be put into place.
- A proposed draft AML law will help to deal with the insurance and nascent securities sectors, other financial institutions, and designated nonfinancial businesses and professions, as defined by the FATF.
- A full evaluation of the Albanian AML/CFT regime is scheduled for September 2005 by MONEYVAL, the European regional body on the evaluation of AML/CFT measures.
- As agreed between MONEYVAL and the Bank/Fund, that evaluation will produce a ROSC that will be forwarded to the Boards for information.

### Banking sector structure, performance, and risks
- Banking system composition and market structure:
  - 17 banks (2 domestically-owned banks and 15 foreign-owned or joint ventures).
  - Assets as of end-2004 amounting to some 52 percent of GDP.
  - In April 2004, the government sold its stake in the largest (savings) bank, placing about 50 percent of the banking system assets in private hands.
  - System composition: a large, dominant bank, 5 to 6 medium-sized banks, and a remaining set of small, niche banks.
- Liquidity and performance:
  - Liquid assets at a high 75 percent of total assets.
  - The banking sector has demonstrated strong performance with high levels of earnings and capitalization and a low level of classified or non-performing assets.
- Macroeconomic vulnerability:
  - Financial sector exposed to a moderate amount of macroeconomic risk from declining economic growth and adverse interest rate and exchange rate movements.
  - Over 75 percent of the stock of credit built up in the last four—relatively favorable—years; the system’s reaction to protracted low growth or exchange rate depreciation has yet to be tested.
  - Banks are forecasting aggressive increases in loan volume over the next year and vulnerability of the system will likely rise; rapid credit growth is almost certainly followed by rising loan problems.

### Summary assessment — Basel Core Principles (BCP)
- Assessment context:
  - Carried out by an IMF and World Bank team in the context of a Financial Sector Assessment Program in February 2005, using the methodology recommended by the Basel Committee.
  - The Bank of Albania (BoA) is the sole supervisory authority for banks operating in Albania.
- Supervisory capacity and conduct:
  - The BoA operates within a supportive framework of banking laws and is empowered to issue regulations; the banking law is being revised.
  - Banking supervision in Albania is effective, using periodic offsite analysis and a robust system of onsite supervision.
  - Supervisors operate without political interference and are operationally independent functionally as well as within the budget allocations provided through the BoA’s budget allocation.
  - Senior supervisory staff are highly knowledgeable and have incorporated best international practices, including proactive measures to ensure banks address money laundering processes.
- Key prudential and operational features:
  - Capital requirements are based on the Basel model with a minimum required risk asset ratio of 12 percent.
  - Credit exposures are subject to adequate supervision, though market disclosure by borrowers is poor and lenders rely more on subjective judgment and collateral which is not always easy to realize.
  - Large exposure and connected lending rules are sound; BoA supervision of corporate governance and internal audit and controls is effective.
  - Accounting standards are in transition as banks move over to IFRS.
  - No consolidated supervisory powers currently exist in law, though amendments are planned.
- Main areas for enhancement (grouped by principle references as in the source):
  - CP 1: Retain experienced staff (bonuses or other compensation); strengthen offsite supervision by additional staff; need more staff with legal expertise; legal protection for individual supervisors and inspectors to be incorporated into draft banking law; refine information sharing arrangements; provisions for confidential information adequate.
  - CPs 2–5: Licensing criteria comprehensive and administered effectively; vetting of significant shareholders occurs but additional approval requirements as shareholdings increase are needed; enhance powers to deal with unauthorized banking business; expand supervisory authority over investments in nonbanking business.
  - CPs 6–15: BoA needs power to supervise on a consolidated basis; capital requirements and prudential rules comprehensive; more guidance on valuation of collateral; supervisory powers to deem relationships and consolidate subsidiaries/affiliates exposures would be helpful.
  - CPs 16–20: Examination and offsite analysis procedures well developed; external audit largely by local offices of major international firms to international standards; formalized arrangements for information sharing among Albanian supervisory authorities recommended.
  - CP 21: More guidance on valuation of assets and collateral; adapt supervisory rules as banks move to IFRS.
  - CP 22: Subject to amendment, BoA has adequate enforcement powers; finalize revised manual on corrective action after legal changes.
  - CPs 23–25: No foreign subsidiaries yet; absence of consolidated supervisory powers not problematic so far but will need resolution; BoA to seek improved relationships with home authorities and assess whether home country supervisors practice consolidated supervision.
- Recommended actions (selected entries from the recommended action plan — preserving wording and references):
  - CP 1 (2): BoA should consider means by which to retain experienced staff to minimize the impact of turnover; these could include bonuses or other forms of compensation. Offsite supervision should be strengthened by additional staff given the existing workload and the increase in the number of licensed banks. The supervisory function in general would benefit from more staff with legal expertise.
  - CP 1 (5): The legal coverage and protection of individual supervisors and inspectors performing their duties, who are not protected in law as are administrators and advisors, should be incorporated into the draft banking law.
  - CP 1 (6): There is a need to clarify the responsibilities of the BoA and the securities commission with regard to investments and the investment business of banks.
  - CP 2: The BoA is the legal authority to empowered to address banking activities which are carried on by unlicensed businesses. Its powers should include the ability to examine any unlicensed entities engaged in banking business and it should notify other authorities such as the police and tax authorities of the activity.
  - CP 3: The evaluation of prospective directors and senior management of banks would benefit from conversations with those providing references and recommendations.
  - CP 5: The criteria to judge investments could be expanded to include qualitative judgements by the BoA of the quality of the proposed investment. The BoA should have the authority to deny a bank's request for approval of an investment if, in its judgement, the bank does not have adequate financial or organizational resources to handle the acquisition, even if all other investment criteria are met.
  - CP 6: Currently the BoA has no powers to apply capital requirements on a consolidated basis. The authorities are preparing amendments to the banking law which will, if enacted and applied, remedy this deficiency.
  - CP 7: The supervisory authority should consider requiring banks to provide more training to their staff in financial analysis, including cash flow analysis; require processes and procedures for credits deemed especially risky; require exception processing policies and procedures.
  - CP 9: A more explicit power to group exposures that the BoA may conclude are 'closely related' could be helpful; consolidation of subsidiaries and affiliates' exposures should be provided for.
  - CP 10: It would be helpful if the BoA was also able to deem a relationship to be connected for the purpose of the limits; consider requiring disclosure of exposures to connected parties in the bank's annual audited financial statements.
  - CP 11: Introduce a formal system of monitoring cross-border risk as it arises.
  - CP 15: Supervisory authority should have the authority to share information with foreign financial sector supervisory authorities; require banks to have a policy statement on ethics and professional behavior and communicate it to staff.
  - CP 19: Draft banking law contains a provision enabling the BoA to require that boards of foreign banks meet at least twice a year in Albania and that at least one board member be a resident of Albania during his tenure; BoA could formalize regular post-audit meetings with audit firms.
  - CP 20: The BL, supported by accompanying regulations, should allow supervisors to supervise banking groups on a consolidated basis; formalize arrangements for information sharing among Albanian supervisory authorities.
  - CP 21: Provide more specific guidance to banks on valuation of assets and collateral; more regular meetings with external auditors.
  - CP 24: BoA should continue efforts to formalize agreements with supervisory authorities who have not agreed to do so; ensure draft banking law expands BoA authority to prohibit banks from establishing operations in countries with restrictions on information flows.
  - CP 25: BoA needs to assess whether home country supervisors practice consolidated supervision to ensure active home country supervision over foreign banks’ operations in Albania.
- Authorities’ response:
  - The Authorities thanked the FSAP team and were in broad agreement with findings; most areas identified in the assessment were also identified in the BoA self-assessment and several development projects are underway at the BoA.

### Payment systems — CPSS Core Principles (CPSIPS) summary
- Assessment scope and approach:
  - Summary based on CPSS Core Principles for Systemically Important Payment Systems.
  - One system assessed: the recently launched Real Time Gross settlement (RTGS) system, Albania Interbank Payment System (AIPS).
  - Securities settlement systems were not assessed because securities markets are inactive despite one stock exchange being present.
  - Main counterparty agency for the assessment: Bank of Albania (BoA).
- Market structure and institutions:
  - 17 commercial banks accounting for some 90 percent of all financial intermediary assets.
  - All 17 are majority owned by the private sector (2 Albanian and 15 foreign-owned).
  - Financial sector also includes a small number of insurance companies, credit and savings institutions, and nonbank financial institutions.
- BoA role and objectives:
  - BoA is legally independent, accountable to Parliament, with principal objective the maintenance of price stability.
  - BoA’s primary monetary policy instruments are repo (and reverse repo) operations and outright transactions.
  - To achieve price stability (defined as inflation between 2-4 percent per annum), the BoA is expected to promote liquidity, solvency and proper functioning of a stable, market-oriented banking system.
  - BoA is responsible for supervising banks, issuing domestic currency, and promoting smooth payment system operation.
- AIPS (RTGS) and payment infrastructure:
  - BoA owns and operates the RTGS—Albania Interbank Payment System (AIPS)—for inter-bank payments.
  - AIPS established to provide real time processing and settlement for high value payments in lek (above lek 1 million).
  - AIPS usage includes settlement of netted outcome of retail clearings, payments to/from BoA in its role as banker for the government (including clearing and settling primary market transactions in government securities), and interbank money market transactions.
  - AIPS is located at the BoA with shared departmental responsibilities:
    - IT Department: technical operation.
    - Accounting and Payment Department: business operation.
    - Monetary Operations Department: intraday lending facility.
    - Internal Audit Department: governance and oversight.
    - Supervision Department: enforcement vis-à-vis participants.
- Assessment materials and contacts:
  - Several documents provided, including an assessment of the AIPS performed in June 2004 by the Financial Services Volunteer Corps (FSVC).
  - Mission met Governor and Deputy Governor of the BoA, several BoA departments, and commercial banks.
  - Main tools used: IMF-WB Guidance Note for Assessing Observance of Core Principles for Systemically Important Payment Systems and the CPSS Core Principles for Systemically Important Payment Systems.

*Source: IMF/World Bank FSAP assessment text as provided.*

### 70.      In addition to the AIPS, the BoA offers clearing services for retail payments—

### In addition to the AIPS, the BoA offers clearing services for retail payments—

### Retail payments, ACH, and "Beyond Cash"
- Retail payments currently processed for payment orders and checks; BoA plans to become the settlement agent for card payments.
- Clearing remains largely manual with physical exchange of items during BoA clearing sessions.
- An automated clearing house (ACH) has just been completed, with settlement amounts to be calculated on a multilateral net basis.
- Card payments were insignificant until recently; card infrastructure began to show rapid growth in 2004, mainly in Tirana.
- Card infrastructure is not designed for full interoperability; some individual card facilities are linked to international systems.
- The Post Office provides services for low-value domestic payments; some money transfer operators (e.g., Western Union) specialize in cross-border services (particularly remittances).
- Government-led “Beyond Cash” program, led by the BoA, aims to increase cash entering the formal banking system and promote use of bank accounts for payments.
  - Government employees already paid by direct deposit into banking accounts.
  - A mandatory shift of payments to and from government through banking channels by the end of 2005 is discussed; a voluntary shift is ongoing.
  - Expected accompanying improvements: wider introduction of ATM and POS infrastructure and changes to the business tax regime to encourage formal systems.

### Securities market and delivery-versus-payment
- Securities market in Albania is at a very early stage of development; a well-functioning delivery-versus-payment system is not yet in place.
- Current market:
  - Primary issuance market in government debt.
  - Government securities purchased predominantly by banks; other institutions and individuals increasingly participate.
  - Banks undertake some retail transactions but hold majority of purchases until maturity.
  - Secondary market in government debt is virtually non-existent.
  - No organized market in corporate securities; over-the-counter market nearly inexistent.

### Systemic importance and AIPS performance (2004)
- Only one system considered systemically important in Albania: the recently launched RTGS system, AIPS.
- AIPS 2004 activity:
  - Total number of payments: 25,881 payments.
  - Aggregate value settled: lek 1,971 billion.
  - Daily average transactions: about 120.
  - Daily average value: around lek 6.0 billion.
- Retail payment systems (payment orders, checks, and prospectively VISA card payments) are netted and settled through AIPS.
- ACH interbank settlement will take place through AIPS.
- The “Beyond Cash” initiative and ACH are expected to substantially increase numbers and values of customer payments made through AIPS.
- BoA should consider whether the ACH should be considered a Systemically Important Payments System (SIPS) and, if not, whether it should comply with some or all of the CPs/CPSIPS.

### Observance gaps vs. CPSS CPSIPS and key weaknesses
- AIPS does not fully observe the CPSS CPSIPS; most Principles are observed at least in part.
- Specific Principles with incomplete compliance:
  - Principle I (sound and legal framework)
  - Principle III (managing financial risks)
  - Principle VII (operational reliability and business continuity)
  - Principle VIII (efficiency and practicality)
  - Principle X (governance)
- Identified issues to be addressed and discussed with the financial community:
  - Assessment of legal risk, including admissibility of electronic records and enforceability of BoA security interests in ILF collateral.
  - Extension of operating hours and strict controls on extensions.
  - Improvements in overall efficiency, including full integration of available systems and elimination of manual procedures.
  - Effective interconnection with other systems (e.g., government securities settlement systems).
  - Routines for channeling government payments early in the operating day.
  - More effective governance arrangements, clarification of responsibilities within BoA, and use of the Participants Committee.

### Recommended actions — legal foundation and oversight
- Legal foundation (CP I):
  - Address admissibility of electronic records (including digital signature) as evidence.
  - Clarify enforceability of BoA’s security interest in treasury bills used as collateral for the intraday liquidity facility (ILF); concern that other preferred creditors might rank before BoA in liquidation.
  - BoA is working with the Ministry of Justice and banks; external international expert assistance likely needed.
  - Authorities to consider whether changes require an ad hoc payments system law or revision to overarching law.
- Establishment of oversight (Responsibilities A–D):
  - BoA should establish its oversight function over the payments system as a whole.
  - Implement appropriate secondary legislation (bylaws, circulars, etc.) to complete legal framework urgently.
  - Publicly disclose implementation strategies and a policy statement including objectives, policy stance and instruments of the oversight function; consider broadening policy objectives beyond efficiency and reliability to include promotion of competition in payment services and protection of consumer interests.
  - Create a small, separate oversight unit with legal, operational, technical, policy and economics expertise, distinct from system operations units.
  - Define enforcement mechanisms for non-compliance (pre-determined penalties and sanctions).
  - Collect and distribute relevant statistical information and public policy statements to stakeholders and the public.
  - Enhance cooperation among regulators (BoA overseer, BoA Banking Supervision, Ministry of Finance, securities commission if applicable) and consider joint task forces and memoranda of understanding.
  - BoA encouraged to participate actively in international payment systems fora.

### Recommended actions — liquidity, operational reliability, efficiency, participation, governance
- Liquidity and settlement (CPs II–VI):
  - Institute controls to remove operational risk of failure in blocking disposal of treasury bills assigned as security for ILF advances (work in progress).
  - Consider alternative intraday liquidity provision approaches:
    - Re-evaluate the 20 percent ceiling on deployment of required reserves.
    - Overcome technological/procedural inhibitions preventing more flexible ILF administration to avoid advancing excessive amounts.
  - Keep throughput behavior under review; reconsider throughput guidelines and/or price incentives as experience evolves.
- Operating hours:
  - Ensure strict application of provisions on extensions; put in place controls so BoA internal procedures do not delay payments beyond normal operating hours.
- Security, operational reliability, and contingency (CP VII):
  - Urgent actions required:
    - Implement a more robust and efficient communication network between BoA and participants.
    - Implement and enforce strict security measures for physical and electronic access.
    - Upgrade contingency plans and disaster recovery mechanisms, including placing the secondary site outside the primary site location.
    - Implement very tight measures for business continuity and resilience.
- Efficiency and practicality (CP VIII):
  - Convene system participants to discuss connectivity, operating hours, interconnection with other systems, and routines for channeling government payments early.
  - Address inefficiencies in current intraday liquidity procedure where collateral must be posted before the operating day:
    - Prevent unnecessary immobilization of securities for participants not using intraday credit.
    - Allow access for unexpected payments exceeding morning-posted securities.
  - Formulate pricing policies carefully, discuss with participants, and use pricing to rearrange transactions more efficiently and securely among systems and instruments.
- Participation criteria (CP IX):
  - Periodically reassess access policy and consider inclusion of other institutions into the RTGS system if needs arise (e.g., securities operators if capital markets develop).
- Governance (CP X):
  - Reconsider internal governance: better definition of responsibilities among departments responsible for system operations.
  - Create formal user groups (Participants Committee) convened regularly to address system design and improvement.
  - Assign major responsibility to a Payment System Department to manage RTGS system aspects, business requirements, and monetary policy operations.
  - Use the National Payment System Council, recently established under BoA leadership, as the main forum for dialogue among stakeholders.
  - Clarify and possibly enhance effectiveness of the Supervisory Council to address cross-department payments system issues.
  - BoA should seek as a matter of urgency full observance of all CPSIPS.

### Summary recommendation and authorities' response
- Overall recommendation:
  - BoA is encouraged to take all actions to ensure AIPS achieves full observance of the CPs.
  - Establish oversight function, secure legal authority, set organizational arrangements, ensure participant cooperation, verify system compliance, define enforcement, and disseminate information publicly.
- Authorities’ response:
  - The authorities were in broad agreement with the findings, including that the payment systems framework could be enhanced in some areas.

*Source: IMF staff report excerpt on Albania payment systems (AIPS, ACH, and oversight assessment).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05274.pdf_