## _cr08137

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### Executive Summary — Key findings
- Lithuania’s catch-up in per capita income toward the European average accompanied by macroeconomic imbalances, significant credit growth, more than tripling real estate prices, and increased dependence on foreign parent banks’ funding.
- Credit growth slowed since mid-2006 due to tightening of credit standards.
- Dominance of foreign-owned banks (strength and risk) raises regional and global contagion risks.
- Loan portfolio sensitivities:
  - Large share of loans contracted with variable interest rates and in euro; borrowers largely unhedged.
  - Concentration of real estate loans increases vulnerability to a reversal in real estate prices.
- Stress tests: banking system reasonably resilient to macroeconomic shocks but capital buffers may be insufficient for low probability extreme events; strengthening capital advisable.
  - Risk that Basel II standardized and advanced approaches understate loan portfolio risks given limited historical default data.
  - BoL should ensure IRB models capture adequate risk; otherwise apply Pillar 2 capital surcharges as needed.
- Liquidity: banks’ liquidity positions might be inadequate for systemic shocks that combine severe events.
  - BoL LoLR constrained by Currency Board Arrangement (CBA); contingency liquidity plans with banks, parent banks, and foreign authorities recommended.
  - Update internal LoLR procedures; include collateral valuation and approval guidelines (priority: Immediate).
- Crisis management and preparedness: arrangements largely in place but untested; enhance capacity for large collateral executions and corporate insolvencies by making restructuring procedures more flexible and encouraging judge specialization.
- Regulatory and supervisory frameworks broadly conform to international standards; NBFI regulation largely conforms with EU Directives but high LSC staff turnover undermines capacity.
- Pension sector: 2003 reform established a second pillar; supervision requires closer ISC–LSC coordination and stronger governance for pension funds managed by banks and insurers.
- Appendix I: main recommendations; Table 1: priority recommendations; Appendix II: follow-up on 2002 FSAP recommendations.

### I. Macroeconomic environment and risks — selected indicators and observations
- Macroeconomic imbalances: rising inflation and widening external deficit; in 2007 net FDI covered only about one-third of the 2007 deficit.
- Lithuania participates in ERM II with a Currency Board Arrangement (CBA).
- Credit rating changes:
  - Fitch: outlook stable → negative (December 2007).
  - S&P: rating lowered from A to A- with negative outlook (January 2008).
- Credit growth:
  - Credit grew during 2002-08 at an average annual rate close to 50 percent.
  - Year-on-year credit growth eased in 2007; month-on-month rate fell sharply in January 2008.
- Foreign funding of banks:
  - Foreign banks comprise 85 percent of sector assets; Swedish banks account for 61 percent of total assets.
  - Foreign borrowing financed ~50 percent of net new lending in 2006 and ~75 percent in 2007; parent banks provided the majority.
  - Non-parent financing poses refinancing risks for some smaller banks.
- Select macro indicators (In percent unless noted)
  - Real GDP growth: 2002 6.9; 2003 10.3; 2004 7.3; 2005 7.9; 2006 7.7; Est. 2007 8.8
  - General government fiscal balance1/: 2002 –1.9; 2003 –1.4; 2004 –2.7; 2005 –1.3; 2006 –1.5; Est. 2007 –1.9
  - Average CPI (y/y change): 2002 0.3; 2003 –1.1; 2004 1.2; 2005 2.7; 2006 3.8; Est. 2007 5.8
  - Current account balance (share of GDP): 2002 –5.2; 2003 –6.9; 2004 –7.7; 2005 –7.1; 2006 –10.8; Est. 2007 –13.0
  - Gross external debt (share of GDP): 2002 43.9; 2003 44.9; 2004 47.3; 2005 49.3; 2006 64.1; Est. 2007 65.8
  - Short-term debt (original maturity, share of GDP): 2003 17.7; 2004 16.7; 2005 18.9; 2006 19.1; Est. 2007 17.1
  - Reserve cover of short-term debt at remaining maturity: 2003 0.7; 2004 0.5; 2005 0.6; 2006 0.6; Est. 2007 0.6
  - Source: Lithuanian authorities; and staff estimates.
  - 1/ Including restitution payments.

### II. Stability assessment of the banking system — resilience, capital, liquidity, and stress tests
- Resilience and capital
  - Stress tests show reasonable resilience but capital buffers may be insufficient for low probability extreme events.
  - BoL has encouraged prudent credit risk management and strengthening bank capital.
  - Risk that Basel II standardized and advanced approaches understate loan portfolio risks; BoL IRB validation and, if necessary, Pillar 2 surcharges recommended.
- Credit risk stress test (Scenario 1: boom-bust + interest rate rise; CAR in percent)
  - System CAR without and with profits:
    - 2007Q1: 11.46; 13.30
    - 2007Q2: 11.23; 13.07
    - 2007Q3: 11.03; 12.87
    - 2007Q4: 10.59; 12.43
    - 2008Q1: 10.25; 12.10
    - 2008Q2: 9.61; 11.45
    - 2008Q3: 9.06; 10.90
    - 2008Q4: 8.95; 10.79
    - 2009Q1: 8.65; 10.49
    - 2009Q2: 8.13; 9.97
    - 2009Q3: 7.41; 9.25
    - 2009Q4: 7.08; 8.92
  - Interpretation:
    - System average CAR would breach minimum 8 percent after the tenth quarter.
    - Including 2007Q3 profits would prevent system average breach but three banks would still fall below 8 percent.
- Exchange rate shock scenarios (Scenarios 2: -30 percent; 3: +30 percent; CAR percent, without and with profits)
  - Selected outcomes (system unweighted averages):
    - 2007Q1: S2 11.57; 13.41 — S3 11.45; 13.29
    - 2007Q4: S2 9.63; 11.47 — S3 11.36; 13.20
    - 2008Q2: S2 7.32; 9.16 — S3 10.98; 12.82
    - 2009Q4: S2 2.55; 4.40 — S3 10.67; 12.51
  - Interpretation:
    - Scenario 2 (devaluation) is more severe: minimum CAR for three banks and system average breached after the fifth quarter; under Scenario 2, CAR of four banks would fall below 3 percent in the last quarter.
    - Scenario 3 has only mild effect on CARs.
- Market risk
  - Market risk milder than credit risk.
  - Interest rate risk modest due to offsetting variable-rate exposures.
  - Equity and real estate direct exposures small.
  - Exchange rate stress (end-September 2007):
    - CAR before stress 12.3
    - CAR after -30 percent euro/litas change 10.1
    - CAR after +30 percent euro/litas change 14.6
    - In a -30 percent euro/litas change, CARs of two banks (8.5 percent of sector assets) would drop below 8 percent.
- Liquidity risk and funding stress tests
  - Dependence on parent funding significant but stress tests show ability to withstand reductions due to long-term parent funding and high liquidity.
  - Reverse liquidity stress test: banks with foreign parents could withstand parent funding withdrawals up to 43 percent on average (range 18–100 percent).
  - System-Wide Liquidity Ratio actual: 39.7
  - Liquidity stress scenarios (selected results)
    - Scenario 1.A (withdrawal of 10% liabilities to parent due within 3 months): Shock 38.6; Illiquid banks 0; % sector assets 0
    - Scenario 1.C (50% liabilities to parent due within 3 months): Shock 34.0; Illiquid banks 1; % sector assets 1.3
    - Scenario 2 (combined deposit and interbank withdrawals): Shock 8.5; Illiquid banks 4; % sector assets 9.4
    - Scenario 3.A (combination of 1.A and 2): Shock 6.8; Illiquid banks 4; % sector assets 9.4
    - Scenario 3.B (combination of 1.B and 2): Shock 0.0; Illiquid banks 8; % sector assets 69.2
    - Scenario 3.C (combination of 1.C and 2): Shock 0.0; Illiquid banks 6; % sector assets 49.0
  - Interpretation:
    - Resident deposit withdrawals significantly impact liquidity.
    - Combined severe events could overwhelm liquidity; contingency planning recommended given BoL lending limits under the CBA.
  - Recommended BoL actions (priority: Immediate):
    - Discuss contingency liquidity plans with banks, parent banks, and home authorities.
    - Update LoLR internal procedures and include collateral valuation/approval guidelines to expedite emergency support.
  - Key statistics:
    - Reserve cover around 140 percent at end-2007.
    - Excess reserves available for LoLR purposes amounted to 14.4 percent of total banking sector deposits.

### III. Regulatory and supervisory issues — banks, securities, pensions, cross-sectoral
- Banking sector supervision
  - Regulatory and supervisory framework broadly aligns with international standards; BoL conducts effective on-site and off-site supervision.
  - Basel II regulations effective as of January 1, 2008.
  - BoL measures: narrowed residential mortgage definition, 60-percent cap on current year profit counting toward regulatory capital, requests to retain profits for 2005–2007.
  - BoL to validate IRB models carefully; ensure Pillar 2 surcharges where IRB/AMA approaches understate risks.
- Securities markets and intermediaries (LSC)
  - Regulatory framework largely conforms with EU Directives but high staff turnover undermines supervisory capacity.
  - Recommendations (timing indicated):
    - Modify LSC status to enable market-based salaries and sustainable funding including fees from market participants (Short term).
    - Implement staff recruitment, training, and incentive plan; consider cooling-off period after market-based salaries (short term/Immediate).
    - Reform insider trading framework: require disclosure of ultimate controllers on listing and of changes thereafter; require brokers to communicate black lists to LSC; revise Criminal code exclusion (Immediate).
    - Improve market surveillance: complete TRS, extend coverage to First North, request daily SMART reports, enforce SRO responsibilities, make IFRS mandatory for asset managers, staff IFRS supervision.
- Pension sector
  - 2003 reform: second pillar (defined contribution) with individual accounts; participation 55 percent of the labor force.
  - Supervisory fragmentation: pension funds managed by entities supervised by LSC and ISC; databases and reporting fragmented.
  - Governance issues: asset managers linked operationally to parent banks; shared management in insurers; weak corporate governance and control.
  - Recommendations (Immediate):
    - Prepare and enforce a complete regulation on corporate governance and internal control systems for pension fund managers.
    - Conduct assessments of governance and risk management; require external auditors’ periodic assessments.
    - Clarify regulatory precision and reduce administrative obstacles to switching pension fund managers; properly disclose fees to clients.
- Cross-sectoral supervision
  - Review supervisory structure to address cross-sectoral linkages, particularly pension sector supervision by multiple supervisors (Immediate).
  - Parliamentary working group to submit draft new supervision concept to Parliament in 2008.
  - Objectives: strengthen capacity to supervise related-entity relations, unify risk-based approaches, increase information flow, and provide market-based incentives and salaries to supervisory staff.

### IV. Crisis management, safety nets, LoLR, deposit insurance, and cross-border cooperation
- LoLR procedures
  - April 2006 amendment gives BoL flexibility to accept various collateral types.
  - LoLR operations can only be performed in litas; banks can convert to euros via FX standing facility.
  - BoL updating LoLR procedures; should incorporate collateral valuation and approval guidelines to ensure expedited access in emergencies (Immediate).
  - Operational constraints: CBA limits scope of LoLR operations; discount window and open market operations not currently in use.
- Deposit insurance (DIF)
  - Coverage updated on January 1, 2008 to conform with EU Directive.
  - Coverage ratio (coverage limit to GDP per capita) now 2.6 (European average 2; global average 2.9).
  - As of end-September 2007, ~99.5 percent of depositors had coverage of at least 90 percent of deposits.
  - Fund size: around 2.3 percent of insured deposits; target 3–4 percent of insured deposits.
    - At current size, sufficient for a small bank failure; reaching 4 percent would improve coverage but DIF would still need to borrow for large payouts.
    - Expected at least another three years to reach target assuming no payouts.
  - Premiums not risk-based; current annual premium 0.45 percent of deposits.
    - Consider move to risk-based premiums (Medium term) and ensure accelerated accumulation of DIF capital.
- Crisis management and cross-border cooperation
  - Multilateral arrangements: EU trilateral MoU of 2005; MoU among Baltic central banks and Sweden on cross-border bank crisis management.
  - BoL participated in two multilateral crisis simulation exercises; further simulation exercises planned.
  - Priority: contingency planning for emergency liquidity support in cross-border exercises.
- Banking sector resolution and insolvency
  - Legal powers adequate; recommend explicit triggers for intervention (minimum: insolvency defined as zero net worth) and consolidation of insolvency legislation into one comprehensive law (Medium term).
  - Enhance simplified restructuring procedure flexibility and specialize judges handling insolvency; amend Civil Code to allow security interests over future obligations and review bailiffs’ fee structure.
- Main recommendations (selected)
  - Update LoLR emergency procedures; include collateral valuation/approval guidelines (Immediate).
  - Consider risk-based deposit insurance premiums (Medium term).
  - Finalize domestic crisis management arrangements (Short term); enhance cross-border cooperation and exercises (Ongoing).
  - Clarify insolvency triggers and amend restructuring/secured lending laws (Medium term).

### Financial vulnerability indicators, sector structure, and market composition (selected highlights)
- Banking sector soundness (2002–2007, selected series)
  - Regulatory capital to risk-weighted assets: 14.7, 13.2, 12.4, 10.3, 10.7, 10.9
  - Regulatory tier I capital to risk-weighted assets: 12.1, 11.1, 10.2, 8.9, 7.8, 7.7
  - Capital to assets: 10.5, 9.8, 8.8, 7.2, 7.1, 7.4
  - Nonperforming loans to total (non-interbank) loans: 5.3, 2.4, 2.2, 0.6, 1.0, 1.0
  - Residential real estate loans to total (non-interbank) loans: 11.2, 14.3, 18.4, 21.2, 24.7, 27.8
  - Return on equity: 9.1, 11.4, 13.5, 13.8, 21.4, 27.2
  - Return on assets: 0.9, 1.2, 1.3, 1.1, 1.5, 2.0
  - Liquid assets to total assets: 29.3, 27.7, 28.3, 26.9, 24.1, 21.9
  - Customer deposits to total non-interbank loans: 132.1, 101.7, 95.7, 83.3, 72.5, 61.3
  - Foreign-currency loans to total (non-interbank) loans: 51.5, 54.6, 58.3, 65.8, 52.8, 55.6
- Financial sector aggregate indicators (2004–Jan 2008)
  - Private sector credit (y/y change): 40.3, 56.1, 51.4, 45.3, 43.8
  - Total private sector credit (in billions of litai): 16.3, 25.5, 38.5, 56.0, 56.8
  - Total resident deposits (in billions of litai): 17.2, 23.4, 28.6, 35.6, 35.1
  - Share of foreign currency loans in total private sector credit: 58.0, 63.1, 52.3, 54.8, 56.8
  - Short-term private sector credit percent of total private sector credit: 81.1, 84.5, 86.2, 86.2, 86.1
- External and vulnerability indicators (selected Q3 2007 / Jan 2008)
  - Current account balance (percent of GDP): -7.7, -7.1, -10.8, -13.0, -12.3 (2004–Q3 2007)
  - Gross official reserves (in billions US$): 3.6, 3.8, 5.8, 7.0, 6.5 (2004–Q3 2007)
  - Gross official reserves/reserve money: 128.0, 122.8, 140.2, 139.7, 152.0 (2004–Jan 2008)
  - Total gross external debt (in billions US$): 10.6, 12.7, 19.1, 25.2, 25.8 (2004–Q3 2007)
    - in percent of GDP: 47.3, 49.3, 64.1, 65.8, 67.3
  - Total net external debt (in billions US$): 3.3, 4.0, 6.3, 10.9, 10.7
    - in percent of GDP: 14.6, 15.4, 21.1, 28.5, 27.8
- Financial system structure and concentration
  - Nine banks (six subsidiaries) and two branches; foreign entities ~93 percent of sector assets; Swedish banks ~62 percent.
  - Three largest banks account for ~69 percent of banking sector assets and generated three quarters of 2006 credit growth.
  - Total assets of financial market participants (2006, Litas, in millions; percent of total): Banks 52,577 81; UCITS 462 1; Leasing 7,413 11; Investment funds 602 1; Life insurance 1,241 2; Non life insurance 1,506 2; Second pillar pension funds 770 1; Third pillar pension funds 47 1; Stock brokers 143 0; Total 64,761 100.
- State mortgage insurance
  - Premium liabilities ~LTL 65 million (2.2 percent of aggregate exposure); company capital recently LTL 33 million; fund’s capital-to-risk ratio estimated at 2.5–3 percent.

### Stress testing methodology and scenarios (overview)
- Combined top-down and bottom-up approaches; top-down covered five largest banking groups (~83 percent of system assets); bottom-up by three largest banks for market risk.
- Credit stress scenarios (selected mechanics)
  - Scenario 1: litas and euro lending rates increase by 500 bps and 600 bps respectively; housing prices fall by 50 percent.
  - Scenario 2: devaluation of litas by 30 percent; stronger real estate and interest rate shocks than Scenario 1.
  - Scenario 3: revaluation by 30 percent; loss of competitiveness, GDP falls.
- Macro scenario deviations (selected)
  - Scenario 1 deviations example (2008): 3-m Vilibor 5.0; Real GDP (%) –9.6; Unemployment rate 5.0; Private Sector Credit in Percent of GDP (%) –35; Real Estate Price Index (%) –33
  - Scenario 2 deviations example (2009): 3-m Vilibor 13.0; LTL/Euro (%) 30.0; Real GDP (%) –11.2; Unemployment rate 5.5; Private Sector Credit in Percent of GDP (%) –100; Real Estate Price Index (%) –70
  - Scenario 3 deviations example (2008): 3-m Vilibor 5.0; LTL/Euro (%) –30.0; Real GDP (%) –8.1; Unemployment rate 5.2; Private Sector Credit in Percent of GDP (%) –12; Real Estate Price Index (%) –6
- Liquidity test assumptions: immediate shocks, no access to domestic interbank market, parent banks, or central bank support; liquid assets sold at full value for specified asset classes and at 50 percent for other liquid assets.

### Priority recommendations (selected from Table 1 and appendices)
- Banking sector
  - In IRB validation under Basel II ensure internal models capture Lithuanian loan portfolio risk; if not, assess Pillar 2 capital surcharges based on bank-specific risks. (Short term)
  - Discuss contingency liquidity plans with banks, parent banks, and home authorities. (Immediate)
- Safety nets: LoLR
  - Update emergency liquidity support procedures and include collateral valuation and approval guidelines to expedite processes (Immediate).
- Securities markets regulation and supervision
  - Modify LSC status to enable market-based salaries and access to sustainable funding including fees (Short term).
  - Reform insider trading regulatory and enforcement framework: require ultimate controller disclosure on listing and after; require brokers to communicate black lists; revise Criminal code exclusion (Immediate).
- Pension sector
  - Prepare and enforce a complete regulation on corporate governance and internal control systems for pension fund managers (Immediate).
- Cross-sectoral issues
  - Improve supervisory structure to address cross-sectoral linkages, particularly arising from pension fund supervision by multiple supervisors (Immediate).

*Executive Summary — IMF Staff Report _cr08137*

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

### _cr08137 - Executive Summary

### Executive Summary — Key findings
- Lithuania’s catch-up in per capita income toward the European average has been impressive, but this success has been coupled with the emergence of macroeconomic imbalances, a significant rise in credit growth, a more than tripling in real estate prices, and an increased dependence on foreign parent banks’ funding.
- Credit growth has slowed since mid-2006 as a result of tightening of credit standards by banks.
- Dependence on foreign financing coupled with macroeconomic imbalances leaves Lithuania vulnerable. The dominance of foreign-owned banks constitutes both a source of strength and a risk, increasing regional and global contagion risks.
- Loan portfolios are sensitive to the domestic economic cycle:
  - Large share of loans contracted with variable interest rates and in euro increases credit risk related to domestic and foreign interest rate and exchange rate changes because borrowers are not hedged.
  - Concentration of real estate loans increases banks’ vulnerability to a reversal in real estate prices.
- Stress tests indicate the banking system is reasonably resilient to macroeconomic shocks, but existing capital buffers might not be sufficient to cope with low probability extreme events; strengthening capital is advisable.
  - There is significant risk that the standardized and advanced approaches under Basel II might not adequately capture loan portfolio risks given limited historical default data.
  - In validating banks’ Internal Ratings-Based (IRB) models, the BoL should ensure adequate risk capture; otherwise capital surcharges under Pillar 2 should be assessed as needed.
- Banks’ liquidity positions might not be sufficient to cope with systemic shocks involving a combination of low probability severe events.
  - BoL’s lender-of-last-resort (LoLR) operations are limited by the Currency Board Arrangement (CBA); BoL should further discuss liquidity contingency plans with banks, parent banks, and authorities of foreign banks.
  - Contingency planning for emergency liquidity support should take priority in cross-border exercises and discussions; BoL should update internal procedures for emergency liquidity support.
- Crisis management and preparedness: many arrangements largely in place and being strengthened, but untested. Capacity to handle large collateral executions and corporate insolvencies would be enhanced by making restructuring procedures more flexible and encouraging specialization of some judges.
- Banking sector regulatory and supervisory framework is in line with international standards; BoL conducts effective on-site and off-site supervision on all banks operating in Lithuania. The dominance of foreign banks requires continued close cooperation with home supervisors.
- Regulatory framework for non-bank financial institutions (NBFIs) largely conforms with EU Directives, but high staff turnover at Lithuanian Securities Commission (LSC) affects supervisory capacity and may breach implementation of several EU Directives.
  - Status of LSC should be amended to enable market-based salaries and access to an adequate and sustainable source of funding, including fees from market participants.
  - Regulatory and enforcement framework for insider trading should be reformed.
- Pension sector: 2003 reform established an innovative second pillar. Supervision of second pillar pension funds requires closer coordination between the Insurance Supervisory Commission (ISC) and LSC. Governance of pension funds managed by banks and insurance companies should be strengthened to avoid conflicts of interest.
- Appendix I summarizes main recommendations; Table 1 lists priority recommendations. Appendix II follows up on implementation status of the 2002 FSAP recommendations.

### I. Macroeconomic environment and risks — selected indicators and observations
- Macroeconomic imbalances have appeared: inflation rising and external deficit widened. Early 2000s external deficit was financed predominantly by net foreign direct investment; in 2007 net FDI represented only about a third of the 2007 deficit, with external borrowing making up much of the difference.
- Lithuania participates in ERM II with a Currency Board Arrangement (CBA).
- Credit rating developments:
  - Fitch changed outlook from stable to negative in December 2007 citing rising inflationary pressures, prospective delay to euro adoption, deterioration in external imbalances, and uncertainty over gradual adjustment to sustainable growth.
  - In January 2008, S&P lowered Lithuania’s rating from A to A- with a negative outlook.
- Credit growth:
  - Credit grew during 2002-08 at an average annual rate close to 50 percent.
  - Year-on-year credit growth eased in 2007; month-on-month rate fell sharply in January 2008, reflecting tightened lending standards and negative real estate sentiment.
- Foreign funding of banks:
  - Banking sector dominated by foreign banks comprising 85 percent of the sector’s assets; Swedish banks account for 61 percent of total assets.
  - Foreign borrowing financed around half of net new lending in 2006 and around three-quarters in 2007, with parent banks contributing the majority.
  - Non-parent financing, though relatively small, could pose refinancing risks for some smaller banks.

- Table 2. Lithuania: Select Macroeconomic Indicators (In percent)
  - Real GDP growth: 2002 6.9; 2003 10.3; 2004 7.3; 2005 7.9; 2006 7.7; Est. 2007 8.8
  - General government fiscal balance 1/: 2002 –1.9; 2003 –1.4; 2004 –2.7; 2005 –1.3; 2006 –1.5; Est. 2007 –1.9
  - Average CPI (year-on-year change): 2002 0.3; 2003 –1.1; 2004 1.2; 2005 2.7; 2006 3.8; Est. 2007 5.8
  - Current account balance (as share of GDP): 2002 –5.2; 2003 –6.9; 2004 –7.7; 2005 –7.1; 2006 –10.8; Est. 2007 –13.0
  - Gross external debt (as share of GDP): 2002 43.9; 2003 44.9; 2004 47.3; 2005 49.3; 2006 64.1; Est. 2007 65.8
  - Short-term debt (at original maturity, as share of GDP): 2003 17.7; 2004 16.7; 2005 18.9; 2006 19.1; Est. 2007 17.1
  - Reserve cover of short-term debt at remaining maturity: 2003 0.7; 2004 0.5; 2005 0.6; 2006 0.6; Est. 2007 0.6
  - Source: Lithuanian authorities; and staff estimates.
  - 1/ Including restitution payments.

### II. Stability assessment of the banking system — resilience, capital, and liquidity
- Resilience and capital:
  - Stress tests show reasonable resilience to macroeconomic shocks, but capital buffers may be insufficient for low probability extreme events.
  - BoL encouraged prudent credit risk management and strengthened bank capital in recent years.
  - Risk that Basel II standardized and advanced approaches understate loan portfolio risks given limited historical data; IRB validation process must ensure adequate risk capture or apply capital surcharges under Pillar 2.
- Liquidity:
  - Banks’ liquidity positions may be inadequate for systemic shocks combining severe events.
  - BoL LoLR operations constrained by CBA; recommended actions:
    - Discuss contingency liquidity plans with banks, parent banks, and home authorities (priority: Immediate).
    - Update internal procedures for emergency liquidity support and include guidelines for collateral valuation and approval to expedite processes during emergencies (priority: Immediate).
  - Contingency planning for emergency liquidity support should be prioritized in cross-border exercises.

### III. Regulatory and supervisory issues — banks, securities, pensions, cross-sectoral
- Banking sector:
  - Regulatory and supervisory framework broadly aligns with international standards; BoL conducts effective on-site and off-site supervision.
  - EU accession required modification of laws and regulations to conform to EU Directives.
  - Foreign bank dominance presents cross-border cooperation challenges requiring ongoing close cooperation with home supervisors.
- Securities markets and intermediaries:
  - Regulatory framework largely conforms with EU Directives but high staff turnover at LSC undermines supervisory capacity.
  - Recommended reforms:
    - Modify LSC status to enable market-based salaries and access to adequate, sustainable funding, including fees from market participants (short term).
    - Reform insider trading regulatory and enforcement framework by:
      - Requiring companies to disclose their ultimate controllers as part of listing applications and to disclose any change in ultimate controllership following listing.
      - Requiring brokers to communicate black lists to LSC.
      - Revising the Criminal code to exclude information shared by insiders with third parties from the concept of publicly known information. (Immediate)
- Pension sector:
  - 2003 pension reform created an innovative second pillar.
  - Supervision requires closer coordination between ISC and LSC.
  - Governance of pension funds managed by banks and insurance companies should be strengthened to avoid conflicts of interest.
  - Prepare and enforce a new complete regulation on corporate governance and internal control systems for pension fund managers (Immediate).
- Cross-sectoral issues:
  - Multiple supervisors for pension funds mean some aspects escape oversight; supervisory structure should be improved to account for cross-sectoral linkages, particularly those arising from pension fund supervision by multiple supervisors (Immediate).

### IV. Crisis management, safety nets, and cross-border cooperation
- Safety nets: LoLR and deposit insurance framework
  - LoLR constrained by CBA; update emergency liquidity support procedures and include collateral valuation/approval guidelines to ensure expedited processes in crises (Immediate).
- Crisis management and cross-border cooperation
  - Arrangements largely adequate but untested; strengthen cross-border and domestic crisis management, prioritize contingency planning and cross-border exercises.
- Banking sector resolution framework
  - Insolvency and resolution frameworks largely adequate; capacity to handle large collateral executions and corporate insolvencies would be enhanced by more flexible restructuring procedures and specialization of judges.
- Creditors’ rights and corporate insolvency framework
  - Significant progress has been made in creditor rights legislation and related institutions.

### Priority recommendations (from Table 1)
- Banking sector
  - In the process of IRB model validation under Basel II, ensure that banks’ internal models capture the risk characteristics of the Lithuanian loan portfolios adequately. Otherwise, assess capital surcharges under Pillar 2 of Basel II, as needed, based on banks’ individual risks not captured under Pillar 1. (Short term)
  - Discuss further with banks, parent banks, and the home authorities contingency liquidity plans in case of a severe liquidity stress event. (Immediate)
- Safety nets: LoLR
  - Update procedures for emergency liquidity support in case of crisis situations and consider including guidelines for collateral valuation and approval to ensure an expedited process in emergency conditions. (Immediate)
- Securities markets regulation and supervision
  - Modify status of LSC to enable it to pay market-based salaries to its staff and to have access to an adequate and sustainable source of funding, including fees from market participants. (Short term)
  - Reform the regulatory and enforcement framework for insider trading by:
    - Requiring companies to disclose their ultimate controllers as part of their listing application, and to disclose any change in ultimate controllership following their listing.
    - Requiring brokers to communicate black lists to LSC.
    - Revising the Criminal code to exclude information shared by insiders with third parties from the concept of publicly known information. (Immediate)
- Pension sector
  - Prepare a new complete regulation on the corporate governance and internal control systems for pension fund managers and enforce it. (Immediate)
- Cross-sectoral issues
  - Improve supervisory structure to take into account cross-sectoral linkages, particularly those arising as a result of pension fund supervision by multiple supervisors. (Immediate)

*Executive Summary — IMF Staff Report _cr08137*

### 6. At the same time Lithuania’s dependence on foreign financing renders it more

### 6. At the same time Lithuania’s dependence on foreign financing renders it more

### Vulnerability to spillovers and funding risks
- Lithuania’s dependence on foreign financing increases vulnerability to regional and global spillovers, which could manifest as: downgrading of sovereign rating, higher funding costs, and/or reduction or drying up of new lending by parent banks (refinancing risk).
- Recent turbulence in international credit markets has brought mortgage markets in the Baltics and other Central and Eastern European countries under increasing scrutiny from lenders.
- Dominance of Scandinavian banks in Lithuania implies significant and concentrated regional contagion risks across the region.

### Credit growth, concentration, and household vulnerabilities
- Rapid credit growth has increased credit risk, reflected by:
  - rapidly rising indebtedness of households and enterprises;
  - significant concentration of loans in real estate;
  - high share of variable interest rate household mortgage debt—over 90 percent most commonly with 6-month intervals;
  - close to 40 percent of household loans and 50 percent of total loans are in euro, and are not hedged by borrowers.
- Notes and clarifications:
  - On average, exposures to the real estate sector is around 50 percent of banks’ total loan portfolios, of which, around 30 percent is to the household sector.
  - Most foreign exchange loans are in euros with very little lending in other foreign currencies. Consumer loans account for 6.5 percent of total lending.
  - The share of fixed rate loans in new loans have been on the rise in recent years.
  - The majority of mortgage loans have a maturity of more than ten years; typical maturity of new mortgages in recent years has been 20–25 years.

### Real estate market and mitigating factors
- Real estate prices tripled nationwide between 2003 and 2006, reaching levels similar to the Riga and Tallinn markets.
- Constraining factors on housing supply include: land restitution issues, urban planning insufficiencies, lack of resources for infrastructure investments, and institutional inadequacies.
- Yearly constructions cover about half of the estimated required new 15,000 units.
- Risk mitigants:
  - Efficient system for registering property and security rights and expedient mortgage enforcement.
  - State mortgage insurance whose capitalization seems adequate compared to current claim levels and in comparison with similar funds abroad; however, portfolio concentration makes the scheme sensitive to systemic risk.

### Non-bank financial sector and financial market structure
- Lithuania’s small non-bank financial sector does not create systemic concern, although leasing and pension funds are growing rapidly.
- Government opted to develop and support benchmarks on the sovereign Euro-bond market; local bond market is limited.
- Total assets of financial market participants, 2006 (Litas (in millions); In percent of total):
  - Banks: 52,577 81
  - UCITS: 462 1
  - Leasing companies: 7,413 11
  - Investment funds: 602 1
  - Life insurance companies: 1,241 2
  - Non life insurance companies: 1,506 2
  - Second pillar pension funds: 770 1
  - Third pillar pension funds: 47 1
  - Stock brokers: 143 0
  - Total: 64,761 100
- Source of table: Bank of Lithuania, ISC.

### Banking system financial soundness and capital buffers
- Financial soundness indicators (FSIs) are generally satisfactory and compare favorably with other countries in the region:
  - Profitability has been on the rise since the early 2000s; return on assets (RoA) more than doubled since 2002.
  - Nonperforming loans are low.
  - Capital adequacy has increased somewhat in the last two years, thanks to action by the BoL, but remains low relative to the average for the EU and the new member states.
- Cross-country comparisons caveat: Lithuania restricts inclusion of general reserves and hybrid capital instruments into Tier 1 capital, restricts inclusion of interim bank profits in Tier 1 and total regulatory capital, and applies stricter risk weights to certain asset classes.
- Adjustment note: If adjusted for retained profits, the reported CAR for Lithuania increases from 9.8 percent to 11.1 percent.
- Capital buffers (regulatory minus economic capital) remain modest:
  - Average regulatory capital for the five largest banks (as of 2007Q3) surpasses risk-based economic capital estimates (as of 2006Q4) by an average of only 1.6 percentage points.

### Stress testing approach and limitations
- Top-down stress tests on the five largest banks using risk-based methodologies and BoL macroeconomic model:
  - Scenario 1 (central): boom-bust cycle in real estate and credit with strong increase in interest rates; hard landing; run over 12 quarters.
  - Scenario 2 and 3: exchange rate change of +30 percent and -30 percent respectively; considered low probability, extreme events.
  - Tests conducted on non-consolidated bank entity basis.
- Data and methodological limitations that may underestimate credit risk:
  - Lack of macroeconomic data spanning at least one economic cycle required assumptions for downturn behavior.
  - Time series of probabilities of default (PDs) were not available; stock of provisions used as a proxy for PDs.
  - Proxies based on system-wide data may underestimate bank-specific PDs.
  - Cross-country data used to estimate elasticity of NPLs to interest rate movements did not explicitly account for term structure; given high share of variable rate loans this likely underestimates impact of interest rate shocks.
  - BoL’s economic model did not include financial accelerator or asset price effects; decrease in asset prices was exogenously assumed and second-round effects were not incorporated.
  - Stress tests did not account for management action during downturns or adequately estimate operating income that could absorb losses.

### Credit risk stress test results (Scenario 1)
- Credit risk identified as the main source of risk in the banking system.
- Under Scenario 1 (capital adequacy ratio (CAR) in percent), system outcomes without and with inclusion of profits as loss buffer:
  - 2007Q1: Without profits 11.46; With profits 13.30
  - 2007Q2: 11.23; 13.07
  - 2007Q3: 11.03; 12.87
  - 2007Q4: 10.59; 12.43
  - 2008Q1: 10.25; 12.10
  - 2008Q2: 9.61; 11.45
  - 2008Q3: 9.06; 10.90
  - 2008Q4: 8.95; 10.79
  - 2009Q1: 8.65; 10.49
  - 2009Q2: 8.13; 9.97
  - 2009Q3: 7.41; 9.25
  - 2009Q4: 7.08; 8.92
- Interpretation:
  - For three of the five banks, and for the system on average, the minimum CAR of 8 percent would be breached after the tenth quarter.
  - If 2007Q3 profits were sustained and included (not likely in stress), the system average would not breach 8 percent, but CAR of three banks would fall below 8 percent.

### Exchange rate shock scenarios (Scenarios 2 and 3)
- Scenario 2 (exchange rate -30 percent) and Scenario 3 (+30 percent) CAR outcomes (in percent) without and with profits:
  - 2007Q1: S2 Without 11.57; With 13.41 — S3 Without 11.45; With 13.29
  - 2007Q2: S2 10.88; 12.72 — S3 11.36; 13.20
  - 2007Q3: S2 10.48; 12.32 — S3 11.52; 13.37
  - 2007Q4: S2 9.63; 11.47 — S3 11.36; 13.20
  - 2008Q1: S2 8.84; 10.68 — S3 11.19; 13.03
  - 2008Q2: S2 7.32; 9.16 — S3 10.98; 12.82
  - 2008Q3: S2 5.96; 7.80 — S3 10.83; 12.68
  - 2008Q4: S2 6.05; 7.89 — S3 10.78; 12.63
  - 2009Q1: S2 4.77; 6.61 — S3 10.81; 12.65
  - 2009Q2: S2 4.02; 5.86 — S3 10.69; 12.53
  - 2009Q3: S2 2.77; 4.61 — S3 10.46; 12.30
  - 2009Q4: S2 2.55; 4.40 — S3 10.67; 12.51
- Interpretation:
  - Scenario 2 would be more severe: the minimum CAR for three banks and for the system on average would be breached after the fifth quarter, with substantial shortfalls by the last quarter.
  - Under Scenario 2, CAR of four banks would fall below 3 percent in the last quarter.
  - Including 2007Q3 profits would delay breach for system average to after the sixth quarter, but three banks would still fall below 8 percent and two banks below 3 percent in the last quarter.
  - Scenario 3 would have only a mild effect on banks’ CARs.

### Market risk
- Market risk alone has considerably milder implications than credit risk.
- Interest rate risk is modest despite prevalence of variable rates due to offsetting variable rate exposures on both sides of balance sheets.
- Equity and real estate price shocks have small direct effects due to limited direct exposures.
- Exchange rate risk varies significantly across banks; positions shifted from long euro in end-2005 to short by end-September 2007, then shifted back toward long or balanced euro around end-2007.
- Exchange rate stress impact (unweighted average CARs for the system, end-September 2007):
  - CAR before stress 12.3
  - CAR after -30 percent change in euro/litas rate 10.1
  - CAR after +30 percent change in euro/litas rate 14.6
- Based on end-September 2007 data, in a -30 percent euro/litas change, CARs of two banks (comprising 8.5 percent of total sector’s assets) would drop below the 8 percent minimum, although the system as a whole would withstand the shock.
- BoL should continue close monitoring of exposures.

### Liquidity risk and funding stress tests
- Dependence of subsidiaries and branches on parent bank funding is significant, but stress tests indicate ability to withstand reductions in parent financing due to prevalence of long-term parent funding and high liquidity levels.
- Reverse liquidity stress test: on average, banks with foreign parents could withstand parent funding withdrawals up to 43 percent (ranging from 18–100 percent across banks) before becoming illiquid.
- Liquidity stress test results for the system (System-Wide Liquidity Ratio actual 39.7):
  - Scenario 1.A: Withdrawal of 10% of liabilities to parent coming due within 3 months — Actual 39.7; Shock 38.6; Illiquid banks 0; % of sector’s assets 0
  - Scenario 1.B: Withdrawal of 10% of all liabilities to parent — Actual 39.7; Shock 32.3; Illiquid banks 0; % of sector’s assets 0
  - Scenario 1.C: Withdrawal of 50% of liabilities to parent coming due within 3 months — Actual 39.7; Shock 34.0; Illiquid banks 1; % of sector’s assets 1.3
  - Scenario 2.A: Overnight withdrawal of 20% of residents deposits — Actual 39.7; Shock 22.0; Illiquid banks 0; % of sector’s assets 0
  - Scenario 2.B: Overnight withdrawal of 80% of non-residents deposits — Actual 39.7; Shock 31.2; Illiquid banks 0; % of sector’s assets 0
  - Scenario 2.C: Overnight withdrawal of 80% of foreign banks deposits — Actual 39.7; Shock 37.1; Illiquid banks 0; % of sector’s assets 0
  - Scenario 2.D: Overnight withdrawal of 100% of domestic interbank deposits — Actual 39.7; Shock 38.6; Illiquid banks 0; % of sector’s assets 0
  - Scenario 2 (combined withdrawals: 20% resident, 80% non-resident incl. foreign bank, 100% domestic interbank): Actual 39.7; Shock 8.5; Illiquid banks 4; % of sector’s assets 9.4
  - Scenario 3.A (combination of 1.A and 2): Actual 39.7; Shock 6.8; Illiquid banks 4; % of sector’s assets 9.4
  - Scenario 3.B (combination of 1.B and 2): Actual 39.7; Shock 0.0; Illiquid banks 8; % of sector’s assets 69.2
  - Scenario 3.C (combination of 1.C and 2): Actual 39.7; Shock 0.0; Illiquid banks 6; % of sector’s assets 49.0
- Interpretation:
  - Withdrawals of resident deposits have significant impact; withdrawals of nonresident deposits significantly affect a few banks with concentrated exposures.
  - Withdrawals of foreign bank deposits and domestic interbank deposits are less severe.
  - Under the most severe combined scenarios (3.B and 3.C), some systemically important banks would face liquidity problems.
  - While individual severe scenarios show adequate liquidity positions, combined severe events could overwhelm liquidity; probability is low but contingent planning is recommended given BoL’s lending limits under the CBA.
- Recommended actions noted in text:
  - BoL should discuss contingency plans with banks, parent banks, and home authorities for severe combined events.
  - It would be useful to weigh fiscal costs of increased reserve cover against potential benefits.

*Source: IMF mission staff analysis and Bank of Lithuania data as presented in the document.*

### 20. Stress test results indicate that the banking system is reasonably resilient to

### 20. Stress test results indicate that the banking system is reasonably resilient to

### Stress test findings and implications
- Stress test results indicate that the banking system is reasonably resilient to macroeconomic shocks, but existing capital buffers might not be sufficient in low probability extreme events and strengthening the buffers further would be advisable.
- The actual impact on banks is expected to be higher than that indicated by stress tests since, given data limitations, stress tests might have underestimated credit risk.
- The impact on banks’ capital would be more severe if a combination of significant credit, market, and liquidity shocks materialized.
- The Bank of Lithuania (BoL) indicated that they would continue to urge banks to strengthen their capital bases.

### Liquidity stress tests
- Liquidity stress tests suggest liquidity would be broadly adequate under individual stress scenarios but might not be sufficient under a combination of severe events.
- Contingency liquidity planning is advisable.
- Given the limitations imposed by the currency board, the BoL should discuss with banks, parent banks, and the home authorities contingency liquidity plans, including the availability of credit lines.

### Key statistics from stress testing and reserves
- Reserve cover stood at around 140 percent at end-2007.
- Excess reserves available for LoLR purposes amounted to 14.4 percent of total banking sector deposits.

---

### Regulatory and supervisory framework — banking sector
- Lithuania’s regulatory and supervisory framework are in line with international standards.
- The BoL conducts effective on-site and off-site supervision on all banks operating in Lithuania.
- The legal framework affecting banking supervision has been modified to conform to EU Directives.
- Basel II regulations became effective as of January 1, 2008.
- The dominance of foreign banks presents cross-border challenges and requires continued close cooperation with home supervisors.

### BoL actions and prudential measures
- Measures taken by the BoL include:
  - Narrowing the definition of residential mortgage loans, effectively raising the risk weight.
  - Imposition of a 60-percent limit on the part of current year’s profit that may count towards regulatory capital.
  - Requesting banks to fully retain profits made in 2005 and 2006, and intending to do so again with respect to the profits made in 2007.
- Most banks tightened lending standards in 2007 in response to BoL policy and international developments.

### Capital adequacy and Basel II implementation issues
- Stress tests indicate banks’ regulatory capital needs to be strengthened further.
- Where the Capital Requirements Directive allows national discretions, the BoL has chosen the more conservative option.
- Limited historical banking and macroeconomic time series for Lithuania may lead to underestimated loan portfolio risks, especially for banks using advanced Basel II approaches.
- Current LTV ratios reflect steep rises in real estate prices, which might reverse abruptly in a significant slowdown.
- It is expected that most Lithuanian banks will not be allowed to use IRB and AMA approaches before 2009; only one bank was approved for applying these approaches so far.
- In validating banks’ IRB models, the BoL should ensure adequate capture of loan portfolio risks; otherwise risks should be captured under Pillar 2 and capital surcharges based on each bank’s individual risk should be considered.
- The amount of surcharges should be guided by sensitivity and stress test analyses.
- In preparations for the FSAP update, the BoL, together with staff, has developed a stress testing model that could be used for Pillar 2 review once estimations of PDs on a bank-by-bank basis are completed.

### Additional BoL surveillance and risk-reduction measures (recommended)
- Enhance the BoL’s capacity to assess the real estate market and implications for bank lending by:
  - Using more diversified monitoring tools including early warning signals.
  - Identifying the riskiest loans (e.g., developer loans and equity withdrawals) as separate reporting categories.
  - Closer coordination with the state mortgage insurer as defaults on the latter’s loans would provide early-warning signals.
- Promote development of fixed rate loans through BoL surveillance—ensure credit risk from variable rates is accounted for in lending parameters, pricing, and banks’ IRB models.
- Enhance consumer protection and education on risks linked to variable interest, through counseling options and prevention of over indebtedness.
- Improve disclosure to borrowers, including provision of a standardized all-in rate and stress scenarios for variable rates.

### Cross-border supervisory cooperation
- All relevant MoUs on cross-border supervisory cooperation are in place; contacts with home supervisors are effective.
- The BoL has signed bilateral MoUs addressing ongoing supervisory cooperation with all countries having banking establishments in Lithuania and countries where Lithuanian banks are established, and with all neighboring countries.
- The BoL and the Swedish Financial Supervisory Authority are drafting a separate MoU on supervision of financial conglomerates and procedures for Supervisory Review and Evaluation Process (SREP).

### Foreign exchange capital treatment clarification
- The BoL requires open positions in euros to be included in the calculation of the capital requirement for foreign exchange risk.
- There was confusion among banks after the regulatory limit on open euro positions was abolished in 2006; the BoL has clarified that it includes capital charges on euro positions in regulatory capital calculations.

### BoL capacity and stress testing development
- The Financial Stability Division has produced an annual financial stability report since 2005.
- In 2007, the Division received technical assistance from the Fund to develop credit risk measurement and macroeconomic stress testing methodologies.
- Interaction between the Financial Stability Division and the Credit Institutions Supervision Department could be strengthened to leverage supervisory function within the central bank.

---

### Securities markets and intermediaries
- Regulatory framework for NBFIs has improved and is generally in conformity with EU Directives, with a limited number of missing regulations that the LSC is completing.
- LSC’s capacity to supervise securities markets is threatened by high staff turnover and a lack of staff with relevant market experience.
- Recommendations for LSC:
  - Change status to enable payment of market-based salaries and provide adequate, stable funding, including fees from market participants.
  - Implement a comprehensive staff recruitment, training, and incentive plan.
  - Consider imposing a cooling-off period after adopting market-based salaries to prevent departing staff from joining supervised companies immediately.
- Market surveillance deficiencies to address:
  - Complete implementation of the Transaction Reporting System (TRS) and extend coverage to the First North alternative market.
  - Request daily reports from the suspicious transactions detection system (SMART) by Vilnius Stock Exchange.
  - Ensure the Association of Intermediaries of Public Trading in Securities (AIPTS) performs SRO responsibilities and enforce the Code of Ethics.
  - Make adoption of IFRS mandatory for asset management companies and financial brokerages and recruit experienced accountants to supervise IFRS implementation.
- Insider dealing and disclosure issues:
  - Require companies to disclose ultimate controllers as part of listing applications and any changes thereafter.
  - Communicate “black lists” of companies with which brokerage staff maintain business relationships to LSC.
  - Revise the Criminal Code to exclude information shared by an insider with related parties from the concept of publicly known information.
- Cross-border collaboration: seek bilateral MoUs with Russia and Ukraine, as they are not covered by the IOSCO multilateral MoU.

---

### Pension sector
- In 2003, a pension reform established a second pillar allowing voluntary allocation of part of mandatory contributions to fully funded pension funds.
- The second pillar is a defined contribution system with individual accounts.
- Current participation: 55 percent of the labor force participates in the second pillar.
- Pension fund managers offer 32 different pension portfolios.

### Supervisory fragmentation and capacity issues
- Supervision is fragmented: pension funds are managed by investment asset managers and insurance companies, supervised by LSC and ISC respectively.
- Supervision is largely compliance-based, inadequate for flexible organizational structures and limited control over asset management.
- LSC and ISC manage different databases and report pension fund performance separately, complicating comparisons and weakening competition.
- LSC’s low capacity to retain staff has reduced effectiveness in supervising a sophisticated pension industry.

### Corporate governance and market contestability concerns
- Asset managers operate under weak corporate governance standards; operational links with mother banks and use of mother-company depositories/brokers are concerns.
- Pension funds managed by insurance companies may share management teams with other insurance activities.
- Recommended actions:
  - Conduct an assessment of corporate governance and risk management of pension funds.
  - Clarify minimum standards through regulation without sharply increasing administrative costs.
  - Clarify regulatory precision in areas such as corporate governance and sanctions.
  - Require external auditors to conduct periodic assessments of internal control systems of pension fund managers.
  - Address administrative obstacles to switching pension fund managers and streamline information provided to clients.
  - Properly disclose fees that pension funds pay to UCITS-type funds.

---

### Cross-sectoral supervisory framework and other nonbank activities
- A review of the overall supervisory structure is required to take into account cross-sectoral linkages, particularly pension sector weaknesses.
- A parliamentary working group established in December 2006 is expected to submit a draft new supervision concept to Parliament in 2008.
- Objectives for the proposed model include:
  - Strengthening capacity to supervise relations of banks and insurance companies with related entities.
  - Improving systemic risk management by monitoring issues affecting the entire financial sector.
  - Facilitating harmonization of supervisory approaches and regulation across institutions.
  - Developing a unified risk-based approach for various financial institutions.
  - Increasing information flow between regulators and supervisors.
  - Providing supervisory institution(s) with sufficient resources and ability to offer market-based incentives and salaries to staff.

### Leasing sector
- Leasing sector does not present financial stability threats or regulatory arbitrage opportunities vis-à-vis the banking sector at this stage.
- Leasing company assets grew at an annual rate of 48 percent over the last six years, but are still relatively small at around 10 percent of GDP.
- Leasing companies are subject to consolidated supervision of the BoL since all are subsidiaries of domestic banks.
- Leasing exposures are viewed as less risky than banking loans because they are secured with financed assets.
- No obvious impediments to repossession of leased assets; default rate generally low at 0.5 percent of total loans.

### Insurance Supervisory Commission (ISC)
- The status of the ISC should be amended to make it independent from the executive branch.
- Current appointment process: Chairman of ISC appointed by the Prime Minister upon nomination by the Minister of Finance; members appointed by the Prime Minister upon nomination by the Chairman.
- A preferred alternative is for the ISC Chairman to be appointed by Parliament upon nomination by the Prime Minister.

---

### Crisis management, safety nets, and LoLR constraints
- The legal framework for LoLR operations by the BoL is adequate, but the currency board arrangement (CBA) limits the scope of these operations.
- The BoL Law enables open market operations, a discount window, and LoLR operations.
- Staff suggest consideration could be given to increasing the CBA foreign exchange coverage ratio, while carefully weighing the fiscal costs this would imply.

*Source: _cr08137 - 20. Stress test results indicate that the banking system is reasonably resilient to*

### 43. Procedures for a rapid LoLR operations should be updated to ensure an expedited

### 43. Procedures for a rapid LoLR operations should be updated to ensure an expedited

### Lender of Last Resort (LoLR) procedures
- The April 2006 amendment to the BoL Law provides the BoL with the flexibility to accept various types of collateral for BoL lending.
- The BoL is in the process of updating existing procedures for LoLR, in part to reflect its new organizational structure.
- The BoL should consider incorporating guidelines for collateral valuation and approval as part of the LoLR procedure update to ensure expedited access in emergency conditions.
- Operational constraints noted:
  - LoLR operations can only be performed in litas, although banks can convert these into euros through the BoL’s foreign exchange standing facility.
  - The last time the BoL conducted LoLR operations was in December 2002.
  - The BoL does not currently operate a discount window or conduct open market operations (although it did in the past).

### Deposit insurance
- Coverage:
  - Deposit insurance coverage was raised in line with the EU Directive on Deposit Guarantee Schemes on January 1, 2008.
  - The coverage ratio (the ratio of the coverage limit to GDP per capita) is now 2.6, compared with a European average of 2 and a global average of 2.9.
  - As of end-September 2007, around 99.5 percent of depositors had coverage of at least 90 percent of their deposits.
- Fund size and adequacy:
  - The DIF has yet to reach its target fund size of 3-4 percent of insured deposits.
  - At around 2.3 percent of insured deposits, the fund at this stage would have sufficient resources to cover a small bank failure.
  - By moving to a 4 percent coverage ratio, the DIF would be much better placed to cope with stress even among the larger banks, although it would still need to borrow to meet fully its obligations.
  - Assuming no payout in the mean time, it is expected that it will take at least another three years before the fund will reach its target size.
  - Arrangements to ensure speedy pay off to depositors appear to be in place; these arrangements have been tested in two bank failures in the late 1990s.
- Premiums and risk allocation:
  - Insurance premiums are not risk-based.
  - The cost of deposit insurance currently falls disproportionately on the large foreign banks, which are deemed to be of lower risk than some of the smaller banks.
  - Consideration of a risk-based approach to premiums might be warranted; the introduction of a risk-based approach may also help curtail aggressive deposit-gathering behavior by some smaller banks.
  - The introduction of a risk-based approach should be implemented in a way that accelerates the accumulation of capital in the DIF.
  - Appendix IV, Table 15 lists countries in Europe that have introduced premiums that are risk-based.

### Crisis management and cross-border cooperation
- Multilateral arrangements:
  - Multilateral cross-border agreements—including the EU-wide trilateral MoU of 2005 on crisis management cooperation—and an MoU between the central banks of the Baltic countries and Sweden on the management of a financial crisis in banks with cross-border subsidiaries or branches have been concluded.
  - A domestic crisis management plan is currently being discussed by the relevant authorities.
- Exercises and preparedness:
  - The BoL has participated in two multilateral crisis management simulation exercises so far: one EU-wide and the second in 2007 based on the MoU among the five Nordic countries.
  - The 2007 exercise involved Denmark, Finland, Iceland, Norway and Sweden; the Nordic countries participation was trilateral (central banks, banking supervisors, and MoFs), while only the central banks of the Baltic countries participated as observers.
  - These exercises identified areas that need to be strengthened.
- Priorities:
  - Given the riskier external environment, contingency planning for emergency liquidity support should take priority in cross-border exercises and discussions.
  - Further simulation exercises are envisaged in the coming months; the authorities intend to continue actively participating in multilateral cross-border simulation exercises.

### Banking sector resolution framework
- Powers and legislation:
  - The BoL now has adequate powers to perform supervision and apply enforcement measures, with legislation harmonized with EU requirements since accession.
  - Some refinements could strengthen the framework: the law should incorporate explicit triggers for bank intervention, at a minimum at insolvency (which should clearly be defined in the law as a bank having a zero net worth).
  - To avoid potential conflicts in legislation, it would be useful in the medium term to consolidate bank insolvency legislation under one comprehensive law.
  - Currently three main laws apply to enforcement measures, restructuring or liquidation of banks: the law on banks, law on the Bank of Lithuania and law on financial institutions. Other main acts such as the Civil Code apply as well.

### Creditors’ rights and corporate insolvency framework
- Progress achieved:
  - Creation and registration of secured transactions is rather easy and affordable and enforcement is efficient.
  - The Enterprise Bankruptcy Law and the Law on Restructuring of Enterprises are generally consistent with international standards.
- Areas for improvement:
  - Make the simplified restructuring procedure more flexible: under formal reorganization proceedings, restructuring plans can be adopted with the favorable voting of a majority of creditors, whereas plans require unanimity under the simplified procedure—this rigidity makes use of the simplified procedure difficult and rare and would require an amendment to the Law on Restructuring (2001).
  - Specialization of some judges would improve the system’s efficiency.
- Other legal reform recommendations to improve secured lending:
  - Amend the Civil Code to allow the creation of security interests related to any or all of a debtor’s obligations to a creditor, present or future, and in all types of assets and on a global basis.
  - Eliminate the concurrent functions of notaries and judges—mortgage judges should be exclusively dedicated to jurisdictional activities (i.e., enforcement of secured claims) rather than to administrative tasks.
  - Review the current fee structure for executions, as the remuneration of the bailiffs (4 to 20 percent of the amount recovered) is generally considered too high by users of their services.

### Main recommendations (selected, from Appendix I)
- Safety nets: LoLR and deposit insurance
  - Update procedures for emergency liquidity support in crisis conditions and consider including guidelines for collateral valuation and approval to ensure an expedited process in emergency conditions (Immediate).
  - Consider a risk-based approach to deposit insurance premiums (Medium term).
- Cross-border cooperation and crisis management
  - Continue to enhance cross-border cooperation and to participate in cross-border crisis management simulation exercises (Ongoing).
  - Finalize the domestic crisis management arrangements which the authorities are currently working on (Short term).
- Banking sector resolution framework
  - Define the condition for the recognition of a bank as insolvent more precisely in the regulations (at a minimum as zero net worth), and preferably include this into the law (Medium term).
- ICR framework / secured lending and insolvency
  - Amend mortgage legislation to: (1) allow creation of security interests related to future obligations, (2) eliminate the role of judges at registration of mortgage and pledges, and (3) review bailiffs fee structure (Medium term).
  - Amend Law on Restructuring to allow simplified restructuring procedures for out-of-court plans approved by a majority of creditors (Medium term).
  - Specialize a number of judges to deal with insolvency cases (Medium term).

*Source: _cr08137 - 43. Procedures for a rapid LoLR operations should be updated to ensure an expedited*

### APPENDIX III. FINANCIAL VULNERABILITY INDICATORS

### APPENDIX III. FINANCIAL VULNERABILITY INDICATORS

### Banking sector soundness (Table 9: 2002–07)
- Capital adequacy
  - Regulatory capital to risk-weighted assets: 14.7, 13.2, 12.4, 10.3, 10.7, 10.9 (2002–2007)
  - Regulatory tier I capital to risk-weighted assets: 12.1, 11.1, 10.2, 8.9, 7.8, 7.7 (2002–2007)
  - Capital to assets: 10.5, 9.8, 8.8, 7.2, 7.1, 7.4 (2002–2007)
- Asset quality
  - Nonperforming loans net of provisions to capital: 21.1, 11.7, 12.6, 5.7, 9.7, 10.4 (2002–2007)
  - Nonperforming loans to total (non-interbank) loans: 5.3, 2.4, 2.2, 0.6, 1.0, 1.0 (2002–2007)
  - Residential real estate loans to total (non-interbank) loans: 11.2, 14.3, 18.4, 21.2, 24.7, 27.8 (2002–2007)
  - All large exposures to regulatory capital: 194.7, 213.1, 199.6, 239.0, 189.6, 152.5 (2002–2007)
- Earnings and profitability
  - Return on equity (Net income to average capital): 9.1, 11.4, 13.5, 13.8, 21.4, 27.2 (2002–2007)
  - Return on assets (Net income to average total assets): 0.9, 1.2, 1.3, 1.1, 1.5, 2.0 (2002–2007)
  - Interest margin to gross income: 51.3, 49.1, 51.0, 53.8, 54.6, 57.8 (2002–2007)
  - Noninterest expenses to gross income: 82.7, 81.6, 70.9, 66.6, 58.7, 52.6 (2002–2007)
  - Trading and foreign exchange gains (losses) to gross income: 14.1, 10.3, 8.1, 7.8, 8.5, 7.6 (2002–2007)
  - Personnel expenses to noninterest expenses: 42.0, 38.3, 37.3, 37.4, 37.6, 39.3 (2002–2007)
  - Spread between reference lending and reference deposit rate: 5.2, 4.2, 3.6, 3.3, 3.5, 4.1 (2002–2007)
- Liquidity
  - Liquid assets to total assets: 29.3, 27.7, 28.3, 26.9, 24.1, 21.9 (2002–2007)
  - Liquid assets to current liabilities: 42.0, 42.4, 41.7, 42.9, 41.9, 43.5 (2002–2007)
  - Customer deposits to total non-interbank loans: 132.1, 101.7, 95.7, 83.3, 72.5, 61.3 (2002–2007)
- Foreign exchange risk
  - Foreign-currency-denominated loans to total (non-interbank) loans: 51.5, 54.6, 58.3, 65.8, 52.8, 55.6 (2002–2007)
  - Foreign-currency-denominated liabilities to total liabilities: 44.5, 46.1, 45.6, 51.6, 52.0, 56.4 (2002–2007)
  - Net open position in foreign exchange to regulatory capital: -1.5, 10.8, -1.9, -1.0, -1.4, -2.4 (2002–2007)
- Equity risk and exposure to derivatives
  - On balance (assets) position in equities to capital: 11.7, 12.2, 12.2, 14.9, 13.2, 8.6 (2002–2007)
  - Gross assets position in financial derivatives to capital: 0.3, 0.5, 0.8, 1.2, 4.5, 9.7 (2002–2007)
  - Gross liabilities position in financial derivatives to capital: 2.0, 2.1, 0.8, 0.7, 4.9, 7.6 (2002–2007)
- Sectoral distribution of loans to total loans (selected sectors, 2002–2007)
  - Manufacturing: 21.4, 21.8, 17.5, 15.2, 11.9, 9.9
  - Wholesale and retail trade; repair...: 20.2, 19.2, 15.7, 13.0, 12.8, 10.7
  - Financial intermediation: 10.6, 10.7, 10.8, 14.6, 7.3, 5.5
  - Real estate, renting and other business activities: 6.8, 7.6, 9.8, 12.5, 14.5, 16.8
  - Loans not attributed to economic activities: 14.4, 18.9, 24.9, 25.8, 36.4, 42.9
- Notes and definitions (selected)
  - Capital defined as banks shareholders' equity and foreign bank branches funds received from the head office.
  - From end-2005 NPLs defined as loans with payments overdue more than 60 days; until 2004 NPLs are loans in Substandard, Doubtful and Loss categories.
  - Large exposure means loans to a borrower with net value >= 10 per cent of bank capital.
  - From 2005 the major part of foreign currency loans and liabilities are in Euros.
  - FSI cover all banks operating in Lithuania, including foreign bank branches; 1/ Without foreign bank branches.

### Financial sector aggregate indicators (Table 10: 2004–Jan 2008)
- Credit and claims
  - Private sector credit (year-on-year change): 40.3, 56.1, 51.4, 45.3, 43.8 (2004–Jan 2008)
  - Claims on private enterprises (in billions of litas): 11.3, 16.1, 22.7, 31.0, 31.3 (2004–Jan 2008)
    - Share of foreign currency loans to enterprises: 64.8, 67.9, 58.2, 58.8, 60.4
    - Claims on private enterprises (year-on-year change): 24.6, 42.6, 41.1, 36.5, 55.2
    - Share of claims on private enterprises in total private sector credit: 69.2, 63.2, 58.9, 55.3, 55.2
  - Claims on individuals (in billions of litas): 5.0, 9.4, 15.8, 25.0, 25.4
    - Share of foreign currency loans to individuals: 42.8, 54.7, 43.9, 49.8, 52.4
    - Claims on individuals (year-on-year change): 96.0, 86.6, 69.2, 58.0, 55.2
    - Share of claims on individuals in total private sector credit: 30.8, 36.8, 41.1, 44.7, 44.8
- Foreign currency and deposit structure
  - Share of foreign currency loans in total private sector credit: 58.0, 63.1, 52.3, 54.8, 56.8
  - Share of foreign currency deposits in total deposits: 27.0, 28.0, 22.4, 22.5, 23.9
- Other indicators
  - Short-term private sector credit in percent of total private sector credit: 81.1, 84.5, 86.2, 86.2, 86.1
  - Demand deposits in percent of total deposits: 43.3, 38.3, 40.7, 46.7, 50.8
  - Total private sector credit (in billions of litai): 16.3, 25.5, 38.5, 56.0, 56.8
  - Total resident deposits (in billions of litai): 17.2, 23.4, 28.6, 35.6, 35.1
  - Average annual interest rate on litas loans to enterprises: 5.7, 5.0, 5.0, 7.9, 8.6
  - Average annual interest rate on litas loans to households: 6.4, 5.8, 5.2, 8.4, 8.7
  - Average apartment prices in old town Vilnius (average annual growth): 25.6, 49.1, 32.6, 2.6, ... (series incomplete)
- Sources: Bank of Lithuania and National Stock Exchange of Lithuania.
- Notes: Private sector credit includes credit to private enterprises, households, and nonprofit institutions by monetary authorities, deposit money banks, and other banking institutions.

### External and financial vulnerability indicators (Table 11: 2004–Jan 2008 / Q3 2007)
- Financial indicators
  - Broad money (year-on-year change): 21.4, 31.9, 21.5, 22.1, 22.8 (2004–Jan 2008)
  - Broad money in percent of gross official reserves: 249.4, 268.7, 239.7, 242.6, 241.1 (2004–Jan 2008)
  - Private sector credit (year-on-year change): 40.3, 56.1, 51.4, 45.3, 43.8 (Jan. 2008)
- External indicators (Q3 2007 unless specified)
  - Current account balance in percent of GDP: -7.7, -7.1, -10.8, -13.0, -12.3 (2004–Q3 2007)
  - Exports of GNFS (in billions of U.S. dollars): 11.7, 14.9, 17.8, 21.4, 5.7 (2004–Q3 2007)
  - Exports of GNFS (year-on-year change): 23.2, 26.6, 19.5, 20.3, 23.2 (2004–Q3 2007)
  - Imports of GNFS (year-on-year change): 25.3, 25.7, 24.8, 23.5, 21.8 (2004–Q3 2007)
  - Capital and financial account balance in percent of GDP: 6.3, 10.0, 16.8, 18.2, 21.4 (2004–Q3 2007)
  - Gross official reserves (in billions of U.S. dollars): 3.6, 3.8, 5.8, 7.0, 6.5 (2004–Q3 2007)
  - Gross official reserves/short-term debt (remaining maturity basis): ..., 0.6, 0.6, 0.6, 0.4 (2004–Q3 2007)
  - Gross official reserves/short-term debt (original maturity basis): 1.0, 0.8, 1.0, 1.1, 0.9 (2004–Q3 2007)
  - Gross official reserves/reserve money: 128.0, 122.8, 140.2, 139.7, 152.0 (2004–Jan 2008)
  - Gross official reserves in months of imports of GNFS: 2.6, 2.2, 2.7, 2.6, 2.4 (2004–Q3 2007)
  - Total gross external debt (in billions of U.S. dollars): 10.6, 12.7, 19.1, 25.2, 25.8 (2004–Q3 2007)
    - in percent of GDP: 47.3, 49.3, 64.1, 65.8, 67.3
  - Public sector external debt (in billions of U.S. dollars): 3.1, 2.9, 4.0, 4.7, 3.9
    - in percent of GDP: 13.9, 11.2, 13.4, 12.3, 10.2
  - Short-term external debt (original maturity, in billions of U.S. dollars): 3.8, 4.9, 5.7, 6.5, 7.3
    - in percent of GDP: 16.7, 18.9, 19.1, 17.1, 19.0
  - Total net external debt (in billions of U.S. dollars): 3.3, 4.0, 6.3, 10.9, 10.7
    - in percent of GDP: 14.6, 15.4, 21.1, 28.5, 27.8
  - Total net external short-term debt (in billions of U.S. dollars): 1.4, 2.1, 2.5, 3.2, 3.6
    - in percent of GDP: 6.4, 8.4, 8.4, 8.5, 9.4
  - Real effective exchange rate (year-on-year change, "+" = appreciation): -0.2, -1.7, 0.3, 3.4, 3.4 (2004–2007)
- Financial market indicators
  - Stock market index, end of period (VILSE): 289, 449, 493, 514, 490 (2004–March 4, 2008)
  - Foreign currency debt rating (S&P): A-, A, A, AAA- (March 2008)
- Memoranda
  - Nominal exchange rate (litai/U.S. dollar, end-of-period): 2.9, 2.9, 2.6, 2.4, 2.3 (2004–March 5, 2008)
  - Nominal exchange rate (litai/euro, end-of-period): 3.5, 3.5, 3.5, 3.5, 3.5 (2004–March 5, 2008)
- Notes and definitions (selected)
  - Gross official reserves reported differ from the monetary table due to valuation differences.
  - REER is CPI-based against the 17 major trading partners in 2000.
  - Stock index is VILSE. S&P foreign currency sovereign rating provided.

### Structure of the Lithuanian financial system and supervisory framework (Appendix IV)
- Banking sector structure and concentration
  - Banking sector: nine banks (six subsidiaries of foreign banks) and two branches of foreign banks.
  - Foreign entities account for around 93 percent of the sector’s assets; Swedish banks account for around 62 percent of the sector’s assets.
  - The three largest banks (SEB Vilniaus Bankas, Hansabankas, and DnB NORD Bankas) account for around 69 percent of banking sector assets and generated three quarters of the 2006 credit growth.
  - All three largest banks are owned by foreign banks with A+ Standard and Poor’s credit ratings.
- Non-bank financial sector
  - Non-bank sector small but fast-growing; leasing was the largest segment growing at an average rate of 48 percent a year over the last six years (period referenced).
  - Second pillar pension schemes introduced in 2004 accumulated assets rapidly; compulsory motor third-party liability insurance (June 2001) and UCITs (November 2004) also contributed to growth.
  - Rapid growth of mortgage loans spurred growth of mortgage insurance.
- Leasing sector
  - 12 leasing companies operating; total portfolio as of July 1, 2007 was 8.4 billion litas (around 10 percent of GDP).
  - Hansa Leasing and SEB Leasing market shares: 42 percent and 36 percent, respectively.
  - Funding largely in euros and U.S. dollars; 95 percent of leasing contracts are financial leasing and largely to the corporate sector.
  - Leasing companies generally do not finance household mortgages due to taxation differences and shorter maximum maturities (up to 10 years) versus banks (up to 30–40 years).
- Pension sector
  - Major pension reform in 2002 established a three-pillar scheme; second pillar started in 2003, third in late 2004. Participation in second pillar is voluntary.
  - Workers may shift 5.5 percentage points of contribution (out of a total 25 percent) from Pillar 1 to Pillar 2 or keep all in Pillar 1.
  - Approximately 60 percent of the working population of 2.8 million was covered by a second-pillar plan at end-2006.
  - Currently 16 second pillar and six third pillar pension funds operate, with total assets of around 280 million litas (81 million euros).
  - Second pillar is a defined contribution system with individual accounts; no minimum performance guarantee; incentives for international portfolio diversification and portfolio differentiation.
- Supervisory framework
  - Bank of Lithuania (BoL) is the banking sector’s supervisory authority; mandate includes individual and consolidated supervision of banks licensed by the BoL and their financial groups, including domestic banks’ foreign subsidiaries.
  - Leasing companies governed by Law on Financial Institutions and Civil Code but not regulated or supervised except when subsidiaries of banks.
  - Lithuanian Securities Commission regulates and supervises securities market intermediaries, management companies, collective investment undertakings, pension funds, stock exchanges, Central Securities Depository, and public and private issuers; joined IOSCO in 1996.
  - Insurance Supervisory Committee (ISC) supervises insurance companies; for insurance undertakings of other EU member states providing services in Lithuania, supervision is carried out by the competent authority of that EU member state, with coordination by ISC.
- State mortgage insurance
  - Covers mortgages extended under certain riskier conditions (no down payment, overall debt service-to-income ratio above 50 percent, irregular income).
  - NPLs on insured mortgages (20 percent of mortgage loans outstanding) are similar to market average.
  - Premium liabilities amount to about LTL 65 million (2.2 percent of aggregate exposure); company capital recently increased to LTL 33 million.
  - Fund’s capital-to-risk ratio estimated at 2.5–3 percent; compared to American FHA (~4 percent) and Dutch Home Ownership Guarantee Fund (0.5 percent). Private mortgage insurers typically have ratios around 10 percent.
- Deposit insurance
  - Deposit insurance governed by Law on Insurance of Deposits and Liabilities to Investors (entered July 1, 2002); coverage for deposits in litas, US dollars, and EU and EEA currencies.
  - On January 1, 2008, coverage increased to 100 percent up to deposits equivalent to 3,000 euros, and 90 percent for deposits equivalent to 3,000 euros up to 22,000 euros (from previous coverage of 60,000 litas to 77,000 litas), aligning with EU Directive on Deposit Guarantee Schemes.
  - Insurance premiums remain at 0.45 percent of deposits. Premiums paid ex ante into the deposit insurance fund; differ between commercial banks and credit unions.
  - Euro deposits are covered but paid out in litas. Deposit insurance fund covers insured deposits when bankruptcy proceedings are initiated; insolvent banks can be transferred to DIF for restructuring and DIF can become new owner while bank remains open.
  - Annual rate of insurance premiums: 0.45 percent for commercial banks and branches, and 0.2 percent for credit unions.
  - Branches of foreign banks from EU countries covered by deposit insurance in their home countries; branches from non-EU countries required to join Lithuanian scheme if home coverage insufficient; subsidiaries of foreign banks join Lithuanian scheme mandatorily.

### Size and composition of financial sector participants (Tables 12–14)
- Total assets (in millions of LTL, selected entries)
  - Commercial banks: 22,031 (2003), 29,151 (2004), 44,849 (2005), 52,577 (2006); Growth (2005–06): 17.2 percent
  - Credit unions: 155 (2003), 230 (2004), 379 (2005), 462 (2006); Growth (2005–06): 21.8 percent
  - Leasing companies: 2,976 (2003), 4,399 (2004), 5,930 (2005), ... (2006)
  - Second pillar pension funds: 0 (2003), 127 (2004), 410 (2005), 770 (2006); Growth (2005–06): 87.8 percent
  - Third pillar pension funds: 0 (2003), 11 (2004), 37 (2005), 47 (2006); Growth (2005–06): 28.7 percent
  - UCITS: ..., 161 (2004), 398 (2005), 602 (2006); Growth (2005–06): 51.3 percent
  - Life insurance: 401 (2003), 595 (2004), 838 (2005), 1,059 (2006); Growth (2005–06): 26.4 percent
  - Non-life insurance: 1,010 (2003), 1,090 (2004), 1,233 (2005), 1,409 (2006); Growth (2005–06): 14.2 percent
- Number of enterprises (selected, 2003–2006)
  - Commercial banks: 13, 12, 12, 14
  - Credit unions: 58, 62, 65, 68
  - Leasing companies: 20, 18, 15, 16
  - Collective investment undertakings: 0, 10, 19, 24
  - Pension funds: 0, 34, 34, 36
- Ownership of the banking system (end-2007, share in total banking sector assets)
  - SEB Vilniaus Bankas — Skandinaviska Enskilda Banken AB (Sweden), Subsidiary: 30.49 percent
  - Hansabankas — Hansapank (Estonia); ultimate owner: Swedbank AB (Sweden), Subsidiary: 23.94 percent
  - DnB NORD Bankas — DNB NOR Bank ASA (Norway), Subsidiary: 13.13 percent
  - Snoras Bankas — Mr. Vladimiras Antonovas (68.7 percent), Domestic: 7.11 percent
  - Nordea Bank Finland Plc, Lietuvos skyrius — Branch: 6.95 percent
  - Sampo Bankas — Danske Bank (Denmark), Subsidiary: 6.80 percent
  - Ukio Bankas — Mr. Vladimir Romanov (33.0 percent), Domestic: 4.96 percent
  - Siauliu Bankas — EBRD (16.1 percent), Domestic: 2.49 percent
  - Parex Bankas — Parex banka (Latvia), Subsidiary: 1.99 percent
  - AS “UniCredit Bank” Lietuvos skyrius — Branch: 1.13 percent
  - UAB Medicinos Bankas — Mr. Saulius Karosas (85.86 percent), Domestic: 0.87 percent
  - MP Investment Bank hf. filialas Baltijos šalyse — MP Investment Bank hf. (Iceland), Branch: 0.12 percent
  - Balti Investeeringute Grupi Pank AS filialas — Branch: 0.02 percent
- Source: Bank of Lithuania.

*Source: IMF staff report content as provided (Tables and Appendix excerpts).*

### 0.1 to 0.3

### _cr08137 - 0.1 to 0.3

### Deposit Insurance and Coverage (Selected European Countries)
- Belgium: Date Enacted 1974; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 0.79; Co-insurance (in %) 10; Permanent Fund (1=Yes; 0=No) 1; Target Fund Size (% of deposits) 0.42; Annual Premiums (% of base) 0.06
- Bosnia-Herzegovina: Date Enacted 1998; Coverage Limit 5,000 Markas; Coverage Limit to GDP per capita (2002) 1.77; Co-insurance (in %) 0; Permanent Fund 1; Target Fund Size (% of deposits) 0.30
- Bulgaria: Date Enacted 1995; Coverage Limit 15,000 BGL; Coverage Limit to GDP per capita (2002) 2.43; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 5.0
- Croatia: Date Enacted 1997; Coverage Limit 100,000 HRV; Coverage Limit to GDP per capita (2002) 2.48; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 5.0; Annual Premiums (% of base) 0.80
- Cyprus: Date Enacted 2000; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 2.48; Co-insurance (in %) 10; Permanent Fund 1; Annual Premiums (% of base) n.a.
- Czech Rep.: Date Enacted 1994; Coverage Limit 25,000 EUR; Coverage Limit to GDP per capita (2002) 3.55; Co-insurance 10; Permanent Fund 1; Annual Premiums (% of base) 0.10
- Denmark: Date Enacted 1988; Coverage Limit 300,000 DKr; Coverage Limit to GDP per capita (2002) 1.18; Co-insurance 0; Permanent Fund 1; Annual Premiums (% of base) 0.20
- Estonia: Date Enacted 1998; Coverage Limit 100,000 EKK; Coverage Limit to GDP per capita (2002) 0.50; Co-insurance 10; Permanent Fund 1; Target Fund Size (% of deposits) 2.0; Annual Premiums (% of base) 0.28
- Finland: Date Enacted 1969; Coverage Limit 150,000 FIM; Coverage Limit to GDP per capita (2002) 0.93; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 2.0
- France: Date Enacted 1980; Coverage Limit 70,000 EUR; Coverage Limit to GDP per capita (2002) 2.74; Co-insurance 0; Permanent Fund 0; Annual Premiums (% of base) n.a.; Payout Mechanism on demand
- Germany: Date Enacted 1/ 1998; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 0.78; Co-insurance 10; Permanent Fund 1; Target Fund Size (% of deposits) 3.0; Annual Premiums (% of base) 0.03
- Greece: Date Enacted 1993; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 1.51; Co-insurance 0; Permanent Fund 1; Annual Premiums (% of base) 0.025 to 1.25
- Hungary: Date Enacted 1993; Coverage Limit 3,000,000 Ft; Coverage Limit to GDP per capita (2002) 0.60; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 1.5
- Iceland: Date Enacted 1985; Coverage Limit 2,091,000 ISK; Coverage Limit to GDP per capita (2002) 0.72; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 1.0; Annual Premiums (% of base) 0.15
- Ireland: Date Enacted 1989; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 0.60; Co-insurance 10; Permanent Fund 1; Annual Premiums (% of base) 0.2
- Italy: Date Enacted 1987; Coverage Limit 103,291 EUR; Coverage Limit to GDP per capita (2002) 4.75; Co-insurance 0; Permanent Fund 0; Annual Premiums (% of base) n.a.
- Latvia: Date Enacted 1998; Coverage Limit 3,000 Lat; Coverage Limit to GDP per capita (2002) 1.35; Co-insurance 0; Permanent Fund 1; Annual Premiums (% of base) 0.20
- Lithuania (various): Date Enacted 1996; Coverage Limits reported as 45,000 LTL (Coverage Limit to GDP per capita 3.09), 60,000 LTL (Coverage Limit to GDP per capita 2.20) and 70,000 LTL (Coverage Limit to GDP per capita 2.60); All entries show Co-insurance 10; Permanent Fund 1; Target Fund Size (% of deposits) 4.0; Annual Premiums (% of base) 0.45
- Luxembourg: Date Enacted 1989; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 0.40; Co-insurance 10; Permanent Fund 0; Annual Premiums (% of base) n.a.
- Macedonia: Date Enacted 1996; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 10.27; Co-insurance 10; Permanent Fund 1; Target Fund Size (% of deposits) 5.0
- Malta: Date Enacted 2003; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) n.a.; Co-insurance 0; Permanent Fund 1; Annual Premiums (% of base) 0.10
- Netherlands: Date Enacted 1979; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 0.73; Co-insurance 0; Permanent Fund 0; Annual Premiums (% of base) n.a.
- Norway: Date Enacted 1961; Coverage Limit 2,000,000 NOK; Coverage Limit to GDP per capita (2002) 5.97; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 1.5; Annual Premiums (% of base) 0.01 (plus 0.005 of assets)
- Poland: Date Enacted 1995; Coverage Limit 22,500 EUR; Coverage Limit to GDP per capita (2002) 3.63; Co-insurance 10; Permanent Fund 1; Annual Premiums (% of base) 0.4
- Portugal: Date Enacted 1992; Coverage Limit 25,000 EUR; Coverage Limit to GDP per capita (2002) 1.94; Co-insurance 0; Permanent Fund 1; Annual Premiums (% of base) risk-based: 0.08 to 0.12
- Romania: Date Enacted 1996; Coverage Limit 125,222,000 lei; Coverage Limit to GDP per capita (2002) 1.62; Co-insurance 0; Permanent Fund 1; Annual Premiums (% of base) risk-based: 0.3 to 0.6
- Russia: Date Enacted 2003; Coverage Limit 179,600 rubles; Coverage Limit to GDP per capita (2002) n.a.; Co-insurance 50; Permanent Fund 1; Target Fund Size (% of deposits) 5.0; Annual Premiums (% of base) 0.60
- Serbia and Montenegro: Date Enacted 2001; Coverage Limit 5,000 Dinar; Coverage Limit to GDP per capita (2002) 0.05; Co-insurance 0; Permanent Fund 1; Annual Premiums (% of base) n.a.
- Slovak Republic: Date Enacted 1996; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 2.77; Co-insurance 10; Permanent Fund 1; Target Fund Size (% of deposits) 1.5; Annual Premiums (% of base) 0.1 to 0.3
- Slovenia: Date Enacted 2001; Coverage Limit 5,100,000 tolars; Coverage Limit to GDP per capita (2002) 1.59; Co-insurance 0; Permanent Fund 0; Annual Premiums (% of base) n.a.; Payout Mechanism on demand
- Spain: Date Enacted 1977; Coverage Limit 20,000 EUR; Coverage Limit to GDP per capita (2002) 1.19; Co-insurance 10; Permanent Fund 1; Target Fund Size (% of deposits) 1.0; Annual Premiums (% of base) 0.2
- Sweden: Date Enacted 1996; Coverage Limit 250,000 SEK; Coverage Limit to GDP per capita (2002) 0.95; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 2.5; Annual Premiums (% of base) risk-based: 0 to 0.5%
- Switzerland: Date Enacted 1984; Coverage Limit 30,000 SFR; Coverage Limit to GDP per capita (2002) 0.52; Co-insurance 0; Permanent Fund 0; Annual Premiums (% of base) n.a.; Payout Mechanism on demand
- Ukraine: Date Enacted 1998; Coverage Limit 1,500 UAH; Coverage Limit to GDP per capita (2002) 0.26; Co-insurance 0; Permanent Fund 1; Target Fund Size (% of deposits) 10; Annual Premiums (% of base) 0.5
- United Kingdom: Date Enacted 1982; Coverage Limit ₤35,000; Coverage Limit to GDP per capita (2002) 1.97; Co-insurance 10; Permanent Fund 0; Annual Premiums (% of base) n.a.; Payout Mechanism on demand

Notes: Moldova adopted deposit insurance in 2004 but is excluded from the table. N.a. denotes not available.
- Supplementary note on Germany: The 1998 official scheme covers private banks introduced in 1998 to ensure consistency with EU directives. In addition to the official deposit insurance scheme, Germany also has a private deposit insurance scheme funded by the banks with a coverage limit of 30 percent of bank's equity capital per depositor. This scheme was set up in 1966 and revised after the Herstatt bankruptcy in 1974.

*Source: Asli Demirguc-Kunt, Edward Kane and Luc Laeven (forthcoming), Deposit Insurance around the World: Issues of Design and Implementation, Cambridge, MA: MIT Press.*

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### Prudential and Supervisory Measures Implemented by Lithuanian Authorities to Mitigate Credit Risk
Regulatory measures
- Established limits on proportion of retained profits of the current year to be included in banks’ capital base (end-2006):
  - 60 percent of retained profits could be included after confirmation of profit by an independent audit firm;
  - 30 percent could be included after BoL ́s review of the banks’ financial statements.
- Provided guidance to banks to include the cyclical nature of the real estate prices and the potential increase in interest rate in evaluating borrowers credit worthiness (2006).
- Tightened (in 2006) the definition of mortgaged residential property that deserve a 50 percent risk weight by:
  - Excluding loans to legal entities (limiting the definition to loans to individuals);
  - Including only loans that are fully secured by the residential property;
  - Excluding loans that carry a loan-to-value ratio greater than 70 percent of the market value of the property.
  - Excluded loans would generally be attached a risk weight of 100 percent.
- Postponement of planned reduction of reserve requirements (currently remains at 6 percent).
- Higher minimum CARs are imposed on some banks at the discretion of the BoL.

Supervisory measures
- The Bank of Lithuania endorsed General Provisions on Stress-testing in 2001 and recommended banks to apply this risk management method and to include it in general risk management policy. Banks perform these tests periodically, at least once a year and assess risk both on a bank and a banking group level. The Bank of Lithuania analyses banks’ results on stress-testing on the main types of risks (credit, market, liquidity, operational, etc.). The tests assist the authorities in determining the necessary minimum capital requirements.
- Continuous monitoring of bank activities (regular and relatively frequent bank inspections) focusing on banking loan portfolio changes and quality, credit risk management, proper loan insurance, and evaluation of its right value.
- Increasing cooperation with home supervisors of foreign-owned banks; information exchange proceeds regularly and home supervisors assess risks of subsidiaries operating in Lithuania on a group level.
- Strengthen banks’ capital base: a portion of banks’ 2005 profits is allocated to required and other reserves while a large portion is kept with banks as retained earnings.

Market development
- More information on solvency and business categories is collected in the credit registry for risk assessment and management purposes. The Rules for Managing the Loan Risk Database were specified at the end of 2005 to collect additional information on debtors so banks granting new loans can get full information about debtor’s creditworthiness.

Outreach
- Public statements by BoL officials on risks related to the housing boom and a letter to banks emphasizing attention to credit risk management and making enough reserves to amortize expected losses.
- Intensive consultations with banks regarding preparation for implementation of the Basel II, CAD III and internal ratings based risk assessment measures; individual meetings with banks regarding implementation of CAD III are proceeding regularly. Active cooperation with home supervisors on IRB application. The legal basis for the implementation of CAD III is under preparation, in coordination with banks.

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### Banking System Stress Testing (Lithuania) — Methodology and Scenarios
Overview
- Tests combined bottom-up and top-down approaches to assess credit risk, market risk, and liquidity risk.
- Top-down credit risk stress test covered the five largest banking groups representing roughly 83 percent of the system’s assets.
- Bottom-up stress tests were conducted by the three largest banks to measure portfolio credit risk.
- Methodologies used: Fund-developed methodologies based on Segoviano (2006a, b), Segoviano and Padilla (2006), and Segoviano and Goodhart (2007).

Credit risk stress test scenarios
- Scenario 1: Boom-bust in real estate prices and private sector credit plus a strong increase in European interest rates.
  - Key mechanics: litas and euro lending rates increase by 500 bps and 600 bps, respectively; housing prices fall by 50 percent; NPLs and loss-given-default on private sector loans increase significantly.
- Scenario 2: An external financing crisis resulting in exchange rate change of -30 percent.
  - Key mechanics: devaluation of litas by 30 percent; sharper drop in real estate prices and stronger interest rate shock than scenario 1; higher NPLs and stronger adverse effects than scenario 1.
- Scenario 3: Exchange rate revaluation resulting from a desire to reduce inflation leading to a 30 percent revaluation of the currency.
  - Key mechanics: revaluation by 30 percent, loss of external competitiveness, deterioration in trade balance, GDP falls, negative impact on NPLs.

Macro scenarios — baseline and deviations (selected variables preserved verbatim)
- Baseline (selected years):
  - 2006: 3-m Vilibor (In percent) 3.1; LTL/Euro (increase = devaluation) 3.5; Real GDP mln LTL 71,569.31; Unemployment rate (In percent) 5.6; Private Sector Credit in Percent of GDP 50.5; Real Estate Price Index 2,274.6
  - 2007: 3-m Vilibor 4.9; LTL/Euro 3.5; Real GDP 77,670.97; Unemployment rate 4.3; Private Sector Credit in Percent of GDP 50.5; Real Estate Price Index 2,274.6
  - 2008: 3-m Vilibor 5.5; LTL/Euro 3.5; Real GDP 83,434.62; Unemployment rate 4.2; Private Sector Credit in Percent of GDP 50.5; Real Estate Price Index 2,274.6
  - 2009: 3-m Vilibor 5.5; LTL/Euro 3.5; Real GDP 88,027.95; Unemployment rate 4.3; Private Sector Credit in Percent of GDP 50.5; Real Estate Price Index 2,274.6

- Scenario 1: Deviations from Baseline (2007–2009 examples)
  - 2007: 3-m Vilibor (pps) 5.0; LTL/Euro (%) 0.0; Real GDP (%) –6.4; Unemployment rate (pps) 1.7; Private Sector Credit in Percent of GDP (%) –16; Real Estate Price Index (%) –16
  - 2008: 3-m Vilibor 5.0; LTL/Euro 0.0; Real GDP –9.6; Unemployment rate 5.0; Private Sector Credit –35; Real Estate Price Index –33
  - 2009: 3-m Vilibor 5.0; LTL/Euro 0.0; Real GDP –9.6; Unemployment rate 6.9; Private Sector Credit –55; Real Estate Price Index –50

- Scenario 2: Deviations from Baseline (2007–2009 examples)
  - 2007: 3-m Vilibor (pps) 13.0; LTL/Euro (%) 30.0; Real GDP (%) –4.1; Unemployment rate (pps) 1.0; Private Sector Credit in Percent of GDP (%) –35; Real Estate Price Index (%) –23
  - 2008: 3-m Vilibor 13.0; LTL/Euro 30.0; Real GDP –8.9; Unemployment rate 3.3; Private Sector Credit –67; Real Estate Price Index –47
  - 2009: 3-m Vilibor 13.0; LTL/Euro 30.0; Real GDP –11.2; Unemployment rate 5.5; Private Sector Credit –100; Real Estate Price Index –70

- Scenario 3: Deviations from Baseline (2007–2009 examples)
  - 2007: 3-m Vilibor (pps) 5.0; LTL/Euro (%) –30.0; Real GDP (%) –7.8; Unemployment rate (pps) 2.1; Private Sector Credit in Percent of GDP (%) 0; Real Estate Price Index (%) –3
  - 2008: 3-m Vilibor 5.0; LTL/Euro –30.0; Real GDP –8.1; Unemployment rate 5.2; Private Sector Credit –12; Real Estate Price Index –6
  - 2009: 3-m Vilibor 5.0; LTL/Euro –30.0; Real GDP –5.2; Unemployment rate 5.3; Private Sector Credit –22; Real Estate Price Index –10

Market risk stress tests (bottom-up for three largest banks)
- Scenarios and assumptions (Table 17 preserved verbatim):
  - Scenario 1: Positive interest rate shock — Parallel shift in the yield curve of +5 percent
  - Scenario 2: Negative interest rate shock — Parallel shift in the yield curve of -2 percent
  - Scenario 3: Inversion of yield curve — Parallel shift in the yield curve of +5 percent for maturities up to 5 year and parallel shift in the yield curve of -2 percent for maturities over 5 year
  - Scenario 4: Devaluation of currency — Devaluation of the litas against the euro of 30 percent
  - Scenario 5: Revaluation of currency — Revaluation of the litas against the euro of 30 percent
  - Scenario 6: Asset price bubble — Reduction in equity prices by 60 percent
  - Scenario 7: Real estate bust — Reduction in real estate prices by 50 percent

Liquidity stress tests (top-down)
- Main assumptions (Table 18 summary):
  - Liquidity shocks assumed to take place immediately; no access to domestic interbank market, parent banks, or central bank support (tests assumed banks depend solely on existing liquid assets).
  - Liquid assets liquidated at full value: Cash; funds held at the central bank; funds held at Lithuanian and A group countries banks, credit and financial institutions coming due within 1 month; and foreign bonds and debt securities.
  - Other liquid assets, including domestic bonds and government securities, liquidated at 50 percent of their value.
  - Sale of liquid assets proportional to composition at the reference date.
  - Parent bank funding included funding from direct parent banks and ultimate parent banks and other foreign banks belonging to that banking group; subordinated loans excluded due to small share.
  - Average risk weight of sold liquid assets set at 20 percent.
  - Loss from liquidation of assets directly affected banks’ capital.
  - For scenario 2, resident deposits, foreign and nonresident deposits, balances by foreign banks (other than parent banks), and domestic interbank deposits and loans are withdrawn in full irrespective of currency and maturity; deposit runs assumed immediate.

Modeling and methodology notes
- Top-down stress tests used BoL’s macroeconomic model to simulate macro scenarios.
- Bottom-up market risk tests used duration models for interest rate sensitivities and revaluation approaches for trading book and tradable banking book assets; on- and off-balance sheet items were included.
- For interest rate shocks, the impact on bank profits of a change in net interest income arising from interest rate shocks was not taken into account.
- Subordinated loans constitute only 2 percent of total liabilities on average; amount of subordinated loans coming due within 3 months (as of end of September 2007) is only 0.9 percent of total subordinated loans.

*Source: IMF staff compilation from the document _cr08137 - 0.1 to 0.3.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08137.pdf_