## _cr08371

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---

### Financial system development and key vulnerabilities
- Financial intermediation has been deepening from a low base with overall growth, greater diversification, and expansion of lending to previously under-served sectors.
- The system remains small and cannot serve all financing needs of the economy.
- Banks generally well capitalized and liquid, but brisk growth is rapidly eroding capital buffers.
- Latest stress test results are considerably weaker than those of a year ago.
- Rapid loan growth could lead to a build-up of unrecognized credit risk.
- Extensive dollarization exposes banks to exchange-rate induced credit risk.
- Exceptionally rapid growth of nonresident deposits without clear knowledge of their sources may expose the banking system to reputational and money laundering (ML) risks in the absence of AML/CFT preventive measures.

### Governance, regulation, and supervisory framework — key findings and needs
- Significant strengthening required in licensing, remedial actions, central bank autonomy and governance, and AML/CFT preventive measures.
- Recent legal changes have added to weaknesses and should be repealed as a matter of priority.
- Insurance sector growing in an unregulated and unsupervised environment; virtually all legal, regulatory, and supervisory areas need upgrading.
- Implementation and enforcement are weak due to limited resources, excessive bureaucracy, and low respect for the rule of law.
- Financial sector governance: absence of conflict-of-interest considerations; lack of public disclosure of significant shareholders; no legal definitions for connected business interests and beneficial ownership.
- Perception of lack of a level playing field, notably in transactions with the NBT; some features suggest weak competition (e.g., extremely high interest rate spreads).

### Cotton debt, KI exposure, and related financial-sector risks
- Fair and transparent resolution of large distressed cotton debt stock is essential to demonstrate commitment to market principles and good governance.
- KI (KreditInvest) exposure and NBT contingent claims:
  - KI balance sheet grew to about $550 million by end-2007; reported capital $1.5 million.
  - KI reportedly recovered about 10 percent of assets; at end-2007 almost all KI’s assets were loans of which 70 percent were restructured; provisions for bad loans were nil.
  - Pledges and guarantees equivalent to about 85 percent of the NBT’s gross foreign assets at end-2007.
- Recommended immediate and key actions:
  - Immediate halt to KI’s activities other than management of its distressed assets, followed by a comprehensive due diligence audit by an internationally recognized audit company.
  - KI may need to be resolved within a comprehensive plan for the cotton sector.
  - Collect on the NBT’s claims on KI to the extent possible.
  - Change the new government-funded cotton sector financing program (somoni 130 million allocated in 2008; allocation equivalent to about 30 percent of the banking system’s capital at end-2007) to preserve banks’ incentives for due diligence and shift credit risk back to the government budget.
- Resolution roadmap: develop a transparent resolution strategy encompassing NBT and the government, foreign lenders, KI, local investors, and farmers; road map foresees development of a resolution strategy by the end of 2009.

### Monetary framework, liquidity management, and NBT solvency
- Systemic liquidity and monetary policy framework require upgrading:
  - Interbank money market virtually nonexistent; no standing central bank facilities; banks maintain excess reserves.
  - Government bond issuance would provide collateral for interbank transactions and instruments for NBT open market operations; issuance should be introduced even without government financing needs.
- NBT financial position and actions:
  - NBT likely deeply insolvent and will need recapitalization.
  - Most recent audit puts NBT’s negative equity at $18 million; estimate likely to grow several times over due to exposure to KI.
  - NBT’s practice of providing direct—substantial and nontransparent at times—credit to financial institutions has been a major concern; NBT should continue to refrain from any new commercial lending operations.
  - Recommendation: recapitalize NBT, including through securitization of government debt it holds.

### Macroeconomic background and selected indicators
- Population: about 7 million.
- Per capita GDP: less than $600.
- World Bank estimated poverty rate: 57 percent in 2004.
- Real GDP average annual expansion during last five years: about 8½ percent.
- Agriculture accounted for about 20 percent of GDP in 2007 and almost 70 percent of employment, primarily in the cotton sector.
- CPI inflation: reached 20 percent at end-2007.
- Worker remittances: about 38 percent of GDP in 2007, mostly from Russia.
- NBT international reserves: fell to very low levels at end-2007 (about ½ month of imports or less than one fifth of dollar-denominated deposits).
- National currency is de-facto pegged to the U.S. dollar.
- Public and publicly guaranteed external debt: 33 percent of GDP in 2007.
- Authorities requested a Staff Monitored Program (SMP) for the second half of 2008.
- First-quarter annual GDP growth estimated at 3.2 percent compared to 5.3 percent in Q1 2007.
- Inflation was around 20 percent in March 2008.
- Low level of international reserves limits options under the conventional peg.

### Main FSAP recommendations (selected short and medium term items)
- Short term (selected):
  - Strengthen surveillance framework to monitor build-up of credit risk.
  - Develop and implement a strategy for resolution of cotton debt; halt KI non-asset-management commercial activities and perform due diligence audit.
  - Strengthen governance and autonomy of the NBT: spell out rules for appointment, dismissal, and terms of office of chairman and Board members; clear conflict-of-interest provisions.
  - Recapitalize the NBT, including through securitization of government debt held by NBT; prohibit resumption of commercial lending operations by NBT.
  - Strengthen legal framework for bank licensing, reintroducing NBT authority to license banks and allowing checks on suitability of beneficial owners.
  - Implement AML/CFT preventive measures.
  - Launch government securities issuance program to develop the bond market and strengthen NBT monetary framework.
  - Continue strengthening bank regulatory and supervisory framework; submit public banks to annual independent external audits.
- Medium term (selected):
  - Eliminate monopoly privileges of state-owned insurance companies on compulsory insurance products.
  - Bring draft laws on insurance, deposit insurance, and credit bureaus into line with international good practice and submit to parliament.
  - Ensure business continuity of the RTGS system and migrate large-value domestic currency payments to the RTGS.

### Rapid growth of banks — scale, composition, and vulnerabilities
- Deposit and lending growth:
  - Bank deposits grew at accelerating annual rates that topped 110 percent in 2007.
  - Net bank loans broadly matched deposit growth in 2007.
  - Between 2004 and 2007, deposits grew by more than 600 percent; one-third of growth accounted for by nonresidents’ foreign currency demand deposits.
- Financial sector size and concentration:
  - Monetization (broad money to GDP) about 21 percent of GDP in 2007.
  - Financial sector assets about 44 percent of GDP in 2007.
  - Banks and KI held 63 and 34 percent respectively of the financial system’s assets in 2007.
  - Three systemically important banks hold about 80 the banking system’s assets; two believed to have strong political connections; the fourth largest bank is state-owned.
- Credit patterns and asset quality:
  - Loans to individuals and SMEs grew fastest (five-fold rise between end-2005 and end-2007).
  - Average loan maturity about six months.
  - Average loan sizes in top three banks range from $10,000 to $60,000 (25 to 150 times GDP per capita).
  - Only about 45 percent of bank assets were loans (net of NPLs) at end-2007.
  - Agriculture lending: 21 percent of loans to agriculture were nonperforming at end-2007.
- Dollarization and deposits:
  - Loan dollarization: 57 percent at end-2004 to 68 percent at end-2007.
  - Foreign currency deposits to total deposits: 2004: 63.5; 2005: 70.9; 2006: 78.4; 2007: 78.9.
  - Bulk of nonresident deposits accrue to a few accounts at the largest bank; largely deposited in correspondent accounts abroad.

### Financial soundness indicators (selected exact figures)
- Capital adequacy (In percent)
  - Tier I capital as percent of risk-weighted assets: 2004: 38.7; 2005: 34.2; 2006: 27.8; 2007: 19.4
  - Reported total capital to risk-weighted assets: 2004: 44.7; 2005: 37.9; 2006: 30.4; 2007: 21.3
  - Reported total capital to total asset: 2004: 28.6; 2005: 27.2; 2006: 20.8; 2007: 16.5
- Asset quality and provisioning
  - Nonperforming loans to gross loans: 2004: 20.6; 2005: 14.3; 2006: 11.3; 2007: 4.8
  - Nonperforming loans net of provisions to regulatory capital: 2004: 19.3; 2005: 16.1; 2006: 18.2; 2007: 13.9
  - Provisions to nonperforming loans: 2004: 47.2; 2005: 36.8; 2006: 27.8; 2007: 40.5
  - Restructured loans were 10 percent of the total at end-2007.
- Profitability and margins
  - Reported return on assets (ROA): 2004: 2.9; 2005: 4.7; 2006: 3.8; 2007: 2.7
  - Reported return on equity (ROE): 2004: 10.2; 2005: 17.2; 2006: 16.1; 2007: 16.8
  - Net interest margin to gross income: 2004: 40.0; 2005: 43.6; 2006: 49.8; 2007: 57.7
  - Net interest margin to earning assets: 2004: 9.1; 2005: 8.9; 2006: 8.5; 2007: 7.4
- Liquidity metrics
  - Liquid assets to total assets: 2004: 36.9; 2005: 30.0; 2006: 39.9; 2007: 39.9
  - Liquid assets to demand and savings deposits: 2004: 113.5; 2005: 80.2; 2006: 84.0; 2007: 112.6
  - Liquid assets to total deposits: 2004: 71.2; 2005: 54.9; 2006: 57.9; 2007: 61.3
- Sensitivity to market risk
  - Net open position in foreign exchange to capital: 2004: 36.3; 2005: 8.8; 2006: 5.9; 2007: 13.4

### Structural and institutional vulnerabilities
- Interest rate spreads above 20 percent in both somoni and foreign currency in recent years.
- High spreads driven by limited credit risk assessment, weak competition, and deficiencies in liquidity-management tools and infrastructure.
- Asset classification and provisioning practices may bias reported profits and capital upward:
  - Reported NPL ratio fell from 21 percent in 2004 to 4.8 percent in 2007, reflecting loan portfolio expansion and a surprising fall in NPLs in 2007.
  - Regulation 139 (July 2005) requires loan classification into four past-due categories and a 2 percent general reserve on performing portfolio, but loopholes remain (e.g., loans can be restructured once with no effect on classification).
  - Provisions relatively low at about 40 percent of NPLs.

### Access to finance, rural lending, and market structure
- About 220 bank branches in 2006 (roughly one branch per 30,000 people).
- Bank lending to agricultural SMEs constrained by inappropriate products, problems using agricultural land as collateral, and maturity mismatches.
- Banking sector highly concentrated; securities markets virtually nonexistent.
- Foreign bank entry likely to increase competition; a bank from Kazakhstan started operations earlier this year.

### Stress testing—approach, scenarios, and key results
- Coverage: detailed balance sheet data for eight commercial banks (95 percent of total banking sector assets); tests based on December 2006, June 2007, and December 2007 data.
- Scenarios assessed: deterioration in credit portfolio quality (migration shocks), deterioration of largest borrower exposures, deterioration of 50 percent of all large exposures, exchange rate shocks, interest rate shocks, and deposit-run liquidity shocks.
- General conclusions:
  - Banking system broadly resilient to a range of extreme but plausible shocks owing to still adequate capitalization and high profits.
  - Tests show limited but rising strain under most scenarios; risk profile deteriorated considerably in the last year largely due to reduction in capital relative to assets.
  - Tajik banks most vulnerable to credit risk, including indirect credit risk related to exchange rate fluctuations.
- Selected stress-test numeric results (preserved as reported):
  - Baseline system CAR (System): December 2006: 26.8; June 2007: 20.8; December 2007: 19.4
  - Two-category migration, 50% collateral coverage — System: December 2006: 23.8 (% change = -11.2); June 2007: 17.6 (% change = -15.4); December 2007: 16.6 (% change = -14.5)
  - Two-category migration, 0% collateral coverage — System: December 2006: 22.2 (% change = -17.2); June 2007: 16.0 (% change = -23.2); December 2007: 15.3 (% change = -21.3)
  - Single largest borrower, 0% collateral coverage — System: December 2006: 20.8 (% change = -22.4); June 2007: 15.2 (% change = -27.0); December 2007: 14.6 (% change = -24.7)
  - All large exposures, 0% collateral coverage — System: December 2006: 16.0 (% change = -40.5); June 2007: 10.9 (% change = -47.5); December 2007: 11.3 (% change = -41.6)
  - Exchange rate appreciation shock — System: December 2006: 22.4 (% change = -16.5); June 2007: 17.6 (% change = -15.2); December 2007: 15.5 (% change = -20.1)
  - Exchange rate depreciation (direct FX impact) — System: December 2006: 30.9 (% change = 15.2); June 2007: 23.8 (% change = 14.3); December 2007: 23.0 (% change = 18.7)
  - Interest rate shock (400 basis points uniform upward shift) — System: December 2006: 21.9 (% change = -18.4); June 2007: 15.0 (% change = -27.6); December 2007: 14.7 (% change = -24.1)
- December 2007 capital and stress outcomes (summary):
  - Based on end-2007 data, banks’ capitalization is adequate but just barely.
  - Two-category downward loan migration, no collateral coverage: two banks breach the 12 percent minimum CAR; worst-case breach is by 2 percentage points; system-wide CAR falls from about 19½ percent to 15 percent.
  - Reclassification of each bank’s largest borrower: three banks see CAR below minimum; worst-case shortfall 6.5 percentage points; result: 70 percent of total banking sector assets would be covered by a CAR below 12 percent; system-wide CAR remains above 14½ percent.
  - Large exposures downgraded simultaneously (50 percent): percent of assets covered by CAR below 12 percent rises to 70 percent; largest bank’s after-shock CAR is 5.5 percent; after-shock system-wide CAR falls below minimum by about one percentage point.
- Liquidity run scenario (somoni deposits run of 10 percent per day for five days; December 2007 results):
  - Domestic deposit run after day 5: Number of illiquid banks = 2; Liquidity shortfall = 0.4 (percent of pre-shock assets); system considered illiquid.
  - FX deposit run after day 5: Number of illiquid banks = 2; Liquidity shortfall = 1.9; system considered illiquid.
  - Overall liquidity shortfall to pay all deposit withdrawals remains very small: less than ½ percent of pre-shock total banking sector assets for domestic run; about 2 percent for FX run.

### Regulatory, supervisory, and payment systems reforms recommended
- Reinstate and strengthen NBT legal powers to license and supervise banks; reverse recent amendments that undermine NBT independence.
- Introduce fit-and-proper checks on shareholders, beneficial owners, board members, and senior management.
- Establish predictable and transparent remedial action and prompt corrective action frameworks in law and practice.
- Strengthen AML/CFT framework: pass the draft anti-money laundering law, implement customer due diligence rules, and establish a FIU.
- Improve asset classification, provisioning, and collateral valuation practices; close regulatory loopholes allowing restructuring without reclassification.
- Enhance transparency and governance: publish names of significant owners, require annual independent external audits for public banks and KI, disclose Board remuneration, and introduce conflict-of-interest rules and disclosures.
- Develop government securities issuance program to provide collateral, facilitate open market operations, and establish a yield curve; consider securitization of NBT-held nonmarketable government bond as first step.
- Strengthen payment system oversight, ensure RTGS business continuity (back-up servers, comprehensive business continuity plan), migrate large-value payments to RTGS, and reduce reliance on bilateral correspondent accounts.
- Improve legal framework for secured lending and creditor information systems: unify title registration, create registries for movable property and land use certificates, and establish a credit registry as transition to a private credit bureau.
- Deposit insurance reforms: make membership mandatory, cap coverage (draft proposes somoni 2,500 per depositor/per bank), improve governance, restrict fund investment policy to highly rated government securities, and authorize emergency government borrowing (not from commercial banks).

### Institutional capacity and transparency assessments
- Basel Core Principles (BCP) assessment flagged:
  - CP 1: NBT objectives and independence undermined by recent revocation of licensing powers and lack of capital to ensure financial independence.
  - CPs 2–5: Licensing and structure shortcomings, lack of probity checks.
  - CPs 6–15: Gaps in prudential regulation (no market risk charges, no consolidated capital requirements), frequent breaches of large exposure limits, weak connected lending rules, and no AML/CFT legal regime in force.
  - CPs 16–20: On-site and off-site supervision developing but consolidated supervision absent.
  - CP 21–22: Weaknesses in accounting/audit profession and supervisory enforcement powers; recent legal changes weaken remedial powers.
- Transparency in Monetary and Financial Policies assessment:
  - Aggregate gradings: Observed (O) – 11; broadly observed (BO) – 4; partly observed (PO) – 1; not observed (NO) – 1.
  - NBT transparency improved but needs further enhancement: clarify monetary policy-making body in law, prohibit government interference, specify dismissal grounds and term limits for chairman and deputies, and formalize consultation processes.
  - Financial agencies transparency aggregate: Observed (O) – 10; broadly observed (BO) – 3; partly observed (PO) – 3; not observed (NO) – 0; not applicable (N/A) – 4.

*Source: Executive Summary and selected chapters (FSAP) — _cr08371._*

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

### Executive Summary

### Financial system development and key vulnerabilities
- Financial intermediation has been deepening in recent years, albeit from a low base, reflected in overall growth, greater diversification, and expansion of lending to previously under-served sectors.  
- The system remains small and is not yet in a position to serve all the financing needs of the economy.  
- While banks remain generally well capitalized and liquid, brisk growth is rapidly eroding capital buffers, raising concern in the context of a weak regulatory and supervisory framework.  
- Latest stress test results are considerably weaker than those of a year ago. Rapid loan growth could lead to a build-up of unrecognized credit risk.  
- Extensive dollarization exposes banks to exchange-rate induced credit risk.  
- Exceptionally rapid growth of nonresident deposits without clear knowledge of their sources may expose the banking system to reputational and money laundering (ML) risks in the absence of AML/CFT preventive measures.

### Governance, regulation, and supervisory framework
- Significant strengthening of the regulatory and supervisory framework is needed to sustain system health amid rapid growth. Specific needs highlighted:
  - Further enhancement of banking regulation and supervision, notably on licensing, remedial actions, central bank autonomy and governance, and AML/CFT preventive measures.
  - Recent legal changes have added to weaknesses in some areas and should be repealed as a matter of priority.
- Insurance sector is growing in an unregulated and unsupervised environment; significant upgrading of legal, regulatory, and supervisory framework needed in virtually all areas.
- Implementation and enforcement of the legal framework remain weak due to limited and inadequate resources, excessive bureaucracy, and a relatively low level of respect for the rule of law.
- Financial sector governance needs significant strengthening: conflict-of-interest considerations appear absent; lack of public disclosure of significant shareholders and no legal definitions for connected business interests and beneficial ownership. Perception of lack of a level playing field among institutions, notably in transactions with the NBT. Some features suggest weak competition (e.g., extremely high interest rate spreads).

### Cotton debt and related financial-sector risks
- Fair and transparent resolution of the large stock of distressed cotton debt is essential to demonstrate the government’s commitment to market principles and good governance.
- Authorities should facilitate private resolution while ensuring measures (e.g., on land use rights, and competition among investors) to minimize recurrence risk.
- Key actions recommended:
  - Immediate halt to KreditInvest’s (KI) activities other than management of its distressed assets, followed by a due diligence audit.
  - KI may need to be resolved within a comprehensive plan for the cotton sector.
  - Every effort should be made to collect on the NBT’s claims on KI.
  - The new government-funded cotton sector financing program threatens liquidity and solvency of participating banks and should be changed at the earliest opportunity.
- Role of government: ensure that further public funds are not used to bail out private interests; ensure the resolution process involves all affected parties.

### Monetary framework, liquidity management, and the NBT
- Systemic liquidity management and the monetary policy framework require upgrading:
  - Interbank money market is virtually nonexistent and there are no standing central bank facilities; banks maintain excess reserves.
  - Government bond issuance would provide collateral for interbank transactions, an instrument for the NBT’s open market operations, and help develop securities markets; issuance should be introduced even in the absence of government financing needs.
- The NBT is likely deeply insolvent and will need to be recapitalized.
  - NBT’s financial position discourages effective use of monetary policy instruments and makes its credibility dependent on government underwriting of current and future losses.
  - Until recently, NBT’s practice of providing direct—substantial and nontransparent at times—credit to financial institutions was a major concern.
  - The NBT should continue to refrain from any new commercial lending operations.

### Macroeconomic background and risks (selected facts and indicators)
- Population: about 7 million.  
- Per capita GDP: less than $600.  
- World Bank estimated poverty rate: 57 percent in 2004.  
- Real GDP average annual expansion during last five years: about 8½ percent.  
- Agriculture accounted for about 20 percent of GDP in 2007 and almost 70 percent of employment, primarily in the cotton sector.  
- CPI inflation: reached 20 percent at end-2007.  
- Worker remittances: about 38 percent of GDP in 2007, mostly from Russia.  
- NBT international reserves: fell to very low levels at end-2007 (about ½ month of imports or less than one fifth of dollar-denominated deposits).  
- The national currency is de-facto pegged to the U.S. dollar.  
- Public and publicly guaranteed external debt: modest 33 percent of GDP in 2007 but both debt and debt-service ratios are set to increase starting this year.  
- Authorities have requested a Staff Monitored Program (SMP) for the second half of 2008 to address emerging macroeconomic risks.  
- First-quarter annual GDP growth is estimated at 3.2 percent compared to 5.3 percent in Q1 2007.  
- Inflation was running at around 20 percent in March 2008.  
- Low level of international reserves limits options under Tajikistan’s conventional peg.

### Main FSAP recommendations (Box 1)
Short term
1. Strengthen the surveillance framework to monitor the build-up of credit risk in the banking system to ensure that problems, if and when they emerge, can be addressed promptly.
2. Develop and implement a strategy for the resolution of cotton debt. Key first steps should be an immediate halt to KI’s non-asset-management-related commercial activities, followed by its comprehensive due diligence audit. KI may need to be resolved in the context of a comprehensive plan for the cotton sector.
3. Strengthen the governance and autonomy of the NBT. In particular, rules for the appointment, dismissal, and terms of office of the chairman and Board members should be spelled out and clear provisions on conflict of interest should be introduced in the law.
4. The NBT should be recapitalized, including through the securitization of the government debt it holds. Further, the NBT must not resume commercial lending operations.
5. Strengthen the legal framework for bank licensing, by reintroducing legal provisions on the NBT’s authority to license banks, and allow the NBT to check on the suitability of beneficial owners of banks.
6. Implement AML/CFT preventive measures.
7. Launch a program of issuance of government securities, which would help develop the bond market and strengthen NBT’s monetary framework.
8. Continue strengthening the bank regulatory and supervisory framework, including by submitting public banks to annual independent external audits.

Medium term
9. Eliminate the monopoly privileges of state-owned insurance companies on compulsory insurance products.
10. Bring the new draft laws on insurance, deposit insurance, and credit bureaus into line with international good practice and submit them to parliament.
11. Ensure the business continuity of the real time gross settlement (RTGS) system and progressively migrate all large-value domestic currency payments from bilateral correspondent accounts to the RTGS.

*Source: Executive Summary (FSAP) — _cr08371 - Executive Summary_.*

### 7.      The rapid growth of Tajik banks has brought new risk exposures to the system.

### 7.      The rapid growth of Tajik banks has brought new risk exposures to the system.

### Rapid growth and broad characteristics
- Bank deposits have grown very rapidly since 2004—at accelerating annual rates that topped 110 percent in 2007.
- Net bank loans have also grown very rapidly, broadly matching the growth of deposits in 2007.
- Monetization (broad money to GDP) was about 21 percent of GDP in 2007.
- Financial sector assets more than doubled in three years to about 44 percent of GDP in 2007.
- Banks and KI held 63 and 34 percent respectively of the financial system’s assets in 2007.
- The three systemically important banks hold about 80 the banking system’s assets; two of these banks are believed to have strong political connections; the fourth largest bank is state-owned.

### Credit growth and sectoral patterns
- Rapid credit growth raises concerns about a build-up of unrecognized credit risk given weak credit risk management, governance, regulatory, and supervisory frameworks.
- Surge in credit to agriculture in 2007 requires careful monitoring:
  - 21 percent of loans to agriculture were nonperforming at end-2007.
- Loans to individuals and SMEs grew fastest (five-fold rise between end-2005 and end-2007).
- Average loan maturity is about six months.
- Average loan sizes in the portfolio of the top three banks range from $10,000 to $60,000 (25 to 150 times GDP per capita).
- Only about 45 percent of bank assets were loans (net of NPLs) at end-2007.
- Table 3 (selected lines) — Bank Credit by Sector, 2004–07 (In percent of total loans)
  - State-owned enterprises: 2004: 6.7; 2005: 5.9; 2006: 13.8; 2007: 9.0
  - Commercial: 2004: 65.7; 2005: 59.7; 2006: 52.6; 2007: 55.6
  - Agriculture: 2004: 14.6; 2005: 14.5; 2006: 8.4; 2007: 8.1
  - Individual1/: 2004: 12.9; 2005: 20.0; 2006: 25.2; 2007: 27.3
- Credit growth by sector (Annual percentage change)
  - State-owned enterprises: 2005: 54.2; 2006: 291.4; 2007: 44.5
  - Commercial: 2005: 60.0; 2006: 48.1; 2007: 133.8
  - Agriculture: 2005: 75.0; 2006: -2.1; 2007: 113.3
  - Individual1/: 2005: 172.1; 2006: 111.3; 2007: 140.0
- NPLs by sector (In percent)
  - State-owned enterprises: 2004: 23.0; 2005: 23.5; 2006: 2.5; 2007: 6.1
  - Commercial: 2004: 24.5; 2005: 11.9; 2006: 11.0; 2007: 3.5
  - Agriculture: 2004: 7.5; 2005: 21.2; 2006: 44.4; 2007: 21.3
  - Individual1/: 2004: 15.1; 2005: 11.2; 2006: 5.3; 2007: 2.2

### Dollarization, deposit composition, and nonresident flows
- Loan dollarization increased from 57 percent at end-2004 to 68 percent at end-2007.
- Foreign currency deposits to total deposits: 2004: 63.5; 2005: 70.9; 2006: 78.4; 2007: 78.9
- Dollarization is increasing partly because banks’ funding is increasingly skewed toward the dollar.
- There appears to be insufficient awareness by borrowers and banks of exchange rate–induced credit risk for unhedged borrowers, though remittance FX inflows could mitigate this risk.
- Between 2004 and 2007, deposits grew by more than 600 percent with one-third of the growth accounted for by nonresidents’ foreign currency demand deposits.
- During 2007 nonresident foreign currency demand deposits displayed a very erratic pattern likely driven by changes to reserve requirement regulations.
- The bulk of nonresident deposits reportedly accrue to a few accounts at the largest bank in the system. These funds are largely deposited in correspondent accounts abroad and do not appear to pose a liquidity risk at this time, but their sources should be investigated for reputational and ML risks.

### National Bank of Tajikistan (NBT) involvement and KI exposure
- The NBT has been an active, indirect, and nontransparent participant in financing the cotton sector, providing guarantees and pledges to foreign lenders and somoni-denominated loans to KI.
- These operations have severely weakened the NBT’s balance sheet and mandates:
  - Pledges and guarantees are equivalent to about 85 percent of the NBT’s gross foreign assets at end-2007 and could be called in the coming months.
  - Most direct loans (accounting for the bulk of the NBT’s rapid NDA expansion since 2004) are nonperforming.
- KI is a nonbank intermediary involved in cotton sector financing, established in 2003 as an asset management company to deal with the bad loans portfolio from the Agroinvestbank (AIB) resolution.
- As supervisor, the NBT allowed continued operation and growth of KI despite serious doubts about its solvency; reportedly the license of KI was suspended last year.

### Financial soundness indicators and bank performance
- Capital adequacy (Table 4, In percent)
  - Tier I capital as percent of risk-weighted assets: 2004: 38.7; 2005: 34.2; 2006: 27.8; 2007: 19.4
  - Reported total capital to risk-weighted assets: 2004: 44.7; 2005: 37.9; 2006: 30.4; 2007: 21.3
  - Reported total capital to total asset: 2004: 28.6; 2005: 27.2; 2006: 20.8; 2007: 16.5
- Asset quality and provisioning
  - Nonperforming loans to gross loans: 2004: 20.6; 2005: 14.3; 2006: 11.3; 2007: 4.8
  - Nonperforming loans net of provisions to regulatory capital: 2004: 19.3; 2005: 16.1; 2006: 18.2; 2007: 13.9
  - Provisions to nonperforming loans: 2004: 47.2; 2005: 36.8; 2006: 27.8; 2007: 40.5
  - Restructured loans were 10 percent of the total at end-2007.
- Profitability and margins
  - Reported return on assets (ROA): 2004: 2.9; 2005: 4.7; 2006: 3.8; 2007: 2.7
  - Reported return on equity (ROE): 2004: 10.2; 2005: 17.2; 2006: 16.1; 2007: 16.8
  - Net interest margin to gross income: 2004: 40.0; 2005: 43.6; 2006: 49.8; 2007: 57.7
  - Net interest margin to earning assets: 2004: 9.1; 2005: 8.9; 2006: 8.5; 2007: 7.4
- Liquidity metrics
  - Liquid assets to total assets: 2004: 36.9; 2005: 30.0; 2006: 39.9; 2007: 39.9
  - Liquid assets to demand and savings deposits: 2004: 113.5; 2005: 80.2; 2006: 84.0; 2007: 112.6
  - Liquid assets to total deposits: 2004: 71.2; 2005: 54.9; 2006: 57.9; 2007: 61.3
- Sensitivity to market risk
  - Net open position in foreign exchange to capital (long is positive): 2004: 36.3; 2005: 8.8; 2006: 5.9; 2007: 13.4

### Structural and institutional vulnerabilities
- Interest rate spreads in Tajikistan remain very high—average ex-ante bank spreads have stayed above 20 percent in both somoni and foreign currency in recent years.
- High spreads driven by:
  - Limited credit risk assessment and mitigation mechanisms;
  - Weak competition;
  - Deficiencies in tools and infrastructure for liquidity management.
- High spreads lead to adverse selection and lending directed to riskier, higher-yielding projects, making loans unaffordable for large sections of the economy.
- Asset classification and provisioning practices may bias reported profits and capital upward:
  - Reported NPL ratio fell from 21 percent in 2004 to just below 5 percent in 2007, reflecting loan portfolio expansion and a surprising fall in the stock of NPLs in 2007.
  - Regulation 139 (July 2005) requires loan classification into four past-due categories with specified provisioning rates and a 2 percent general reserve on performing portfolio, but loopholes remain (e.g., loans can be restructured once with no effect on classification).
  - Provisions are relatively low at about 40 percent of NPLs, reflecting a high share of substandard loans in NPLs, provisioning net of collateral, and weaknesses in collateral valuation.

### Access to finance, rural lending, and market structure
- Access remains constrained: about 220 bank branches in 2006, roughly one branch per 30,000 people.
- Bank lending to agricultural SMEs has been disappointing due to inappropriate products/procedures, problems using agricultural land as collateral, and maturity mismatches (loan maturities shorter than production cycles).
- Banking sector is highly concentrated; securities markets are virtually nonexistent.
- Foreign bank entry is likely to increase competitive pressures; a bank from Kazakhstan started operations earlier this year.

### Policy implications and recommended actions (as implied in text)
- Closely monitor rapid credit growth, particularly to agriculture, given poor repayment records (21 percent NPLs in agriculture at end-2007).
- Strengthen credit risk management capacities and governance, regulatory, and supervisory frameworks (see ROSC for BCP).
- Investigate sources of large nonresident foreign currency demand deposits to guard against reputational and ML risks; consider passing AML/CFT legislation and establishing a FIU (Tajikistan has not yet passed customer due diligence laws nor established a FIU).
- Address dollarization risks by improving awareness of exchange rate–induced credit risk among borrowers and banks; consider measures to manage currency mismatches.
- Improve asset classification, provisioning, and collateral valuation practices; close regulatory loopholes that allow restructuring without reclassification.
- Encourage financial deepening and expanded access outside main urban areas, including relaxing branch licensing requirements in favor of less taxing NBT guidelines.
- Reassess NBT’s direct and contingent exposures (guarantees and pledges) related to cotton financing and KI given the large share (about 85 percent of NBT’s gross foreign assets at end-2007) tied to pledges and guarantees.

*Source: _cr08371 - 7.      The rapid growth of Tajik banks has brought new risk exposures to the system.*

### 20.      The FSAP team conducted stress tests to evaluate the potential vulnerabilities of

### The FSAP team conducted stress tests to evaluate the potential vulnerabilities of

### Banking sector: stress tests and risk profile
- The tests assessed the impact of a deterioration in the quality of credit portfolio, fluctuations in exchange and interest rates, and liquidity withdrawals.
- Reliability of the tests depends on the underlying quality of banks’ financial statements and there are reasons for concerns on this regard.
- Tests suggest the banking system is broadly resilient to a range of extreme but plausible shocks, owing to banks’ still adequate capitalization and high profits.
- Tests revealed limited, but rising, strain for most banks under most scenarios.
- Tajik banks are most vulnerable to credit risk, including indirect credit risk related to exchange rate fluctuations.
- The largest two banks appear vulnerable to a significant simultaneous deterioration in the financial health of their major borrowers.
- The risk profile deteriorated considerably in the last year, largely owing to the reduction in capital relative to assets.
- Review of stress test results based on December 2006, June 2007, and December 2007 data highlights the overall increase in risk-sensitivity of the banks.
- Declining CARs make banks’ risk profile more pronounced.

### Nonbank Financial Institutions (NBFIs)
- NBFIs comprise microfinance organizations (MFOs), insurance firms, leasing companies, and KI.
- As of June 2007: 67 MFOs, 14 insurance firms, and 5 leasing companies.
- Microfinance organizations
  - Lending by MFOs grew by more than 200 percent in 2006 and a further 120 percent in 2007.
  - Aggregate MFO loan portfolio at end-2007: $50 million (roughly equivalent to 10 percent of the commercial banks’ portfolio).
  - MFOs’ client base: more than 50,000 borrowers in 2007.
  - Three types of MFOs licensed under the 2004 law: microcredit funds (38 institutions), microcredit commercial organizations (23), microcredit deposit-taking institutions (6).
  - After commercial banks, MFOs provide 12 percent of all financing for trade.
  - Access to microfinance in Tajikistan: About 1 percent of the active population had access to microcredit in 2005, compared to 2.5 percent in Central and Eastern Europe.
- Insurance
  - Total gross premiums equivalent to 0.3 percent of GDP in 2006.
  - Fourteen insurance companies operating in Tajikistan in 2006, including two state-owned with a monopoly on compulsory classes and all government business.
  - Two companies collected 60 and 25 percent, respectively, of the premiums in 2006.
  - Table 5 (selected figures, 2006):
    - Tajikistan: Premium Volume (USD million) 21.0; Insurance Penetration (Premium in percent of GDP) 0.30; Insurance Density (Premium per capita, USD) 1.18; Population (in millions) 6.5.
  - Factors holding back sector development include limited managerial experience, widespread poverty, skewed income distribution, out-of-date legal framework, and limited use of reinsurance.
- Leasing
  - Volume of leasing negligible: 0.1 percent of GDP.
  - Five leasing companies in operation in mid-2007.
  - Legal framework: governed by the civil code and the 2003 law on leasing; regulated by the NBT.
  - Suggested improvement: include provisions that allow for the re-leasing of equipment.

### Cotton debt: scale, KI, and resolution strategy
- Cotton debt has resulted from falling world cotton prices since the mid-1990s, weather-related bad harvests in 1999 and 2001, and weak record-keeping, producing a steady build-up of bad debts.
- KI involvement and balance sheet
  - Upon inception KI had no capital but received a private capital injection of $300,000 soon thereafter.
  - By end-2004, impaired assets with a book value of somoni 650 million (about $210 million equivalent) had been transferred to KI, along with corresponding liabilities.
  - KI’s balance sheet grew to about $550 million by end-2007.
  - KI reportedly recovered only about 10 percent of assets.
  - At end-2007 almost all KI’s assets were loans, of which 70 percent were restructured.
  - Provisions for bad loans were nil, and reported capital was $1.5 million.
  - The NBT and foreign creditors hold 99 percent of KI’s liabilities.
- KI likely technically insolvent; loans likely booked at highly unrealistic values.
- Road map and resolution
  - With donor assistance, authorities developed a “road map” aiming to improve profitability of the cotton sector and resolve the cotton debt.
  - The road map foresees development of a resolution strategy by the end of 2009.
  - An effective resolution strategy must be transparent and encompass all parties: NBT and the government, foreign lenders, KI, local investors, and farmers.
  - Immediate halt of KI activities other than management of its distressed assets is recommended.
  - A comprehensive due diligence audit of KI should be launched and performed by an internationally recognized audit company.
  - If necessary, KI should be resolved, but in the context of a comprehensive plan for the cotton sector.
- Going forward: access to finance for current cotton farmers requires comprehensive sector reform per the authorities’ road map, including halting practices that restrict farmers’ freedom to select crops and de-linking farmers from cotton investors; also strengthening legal framework on land use and secured lending.
- 2008 government cotton financing scheme risks
  - Government budget allocated somoni 130 million for financing cotton sector in 2008 to be channeled through banks at subsidized interest rates.
  - Allocation equivalent to about 30 percent of the banking system’s capital at end-2007.
  - Government contractually authorized to seize funds banks hold in their correspondent accounts at the NBT if banks fail to repay.
  - Given poor loan repayment track record by cotton farmers, the scheme puts banks’ liquidity and solvency at significant risk.
  - Recommendation: introduce changes to preserve banks’ incentive for due diligence while shifting credit risk back to the government’s budget.

### Strengths and vulnerabilities: National Bank of Tajikistan (NBT) issues
- NBT challenges
  - Significant involvement in commercial lending activities, acceleration of inflation, very rapid credit growth, and erosion of bank capital adequacy.
  - These factors impair NBT’s ability to discharge monetary authority and financial sector supervisory responsibilities.
- NBT autonomy and governance
  - NBT should be capitalized to ensure financial independence.
  - Chairman and deputies should be appointed for fixed terms that do not coincide with the electoral cycle; reasons for dismissal should be explicit in law.
  - The Board should be fully staffed—the three nonexecutive members provided for in the law have never been appointed.
  - Board remuneration parameters should be publicly disclosed.
  - Clear provisions covering conflicts of interest should be introduced in the law and require disclosure of personal holdings and recusal from related decisions.
- NBT solvency and recapitalization
  - Most recent audit puts NBT’s negative equity at $18 million; estimate likely to grow several times over due to exposure to KI.
  - NBT’s limited ability to mop-up excess liquidity is constrained by its financial position and credibility hinges on the government underwriting its current and future losses.
- Policy actions
  - NBT’s decision to stop commercial lending activities is welcomed and should not be resumed; this should be a precondition for recapitalization.
  - NBT funds were allocated in a nontransparent manner, with politically well-connected institutions (including KI) receiving the bulk of these funds.

### Regulatory and supervisory framework: banking supervision shortfalls and reforms
- Progress
  - Two key laws—the NBT law and the law on banks and banking—provide the NBT with adequate authority in most areas.
  - Efforts made to strengthen supervisory capacity: on-site examination, off-site reporting regime, and data analysis capacity.
- Shortcomings
  - Laws and regulations require strengthening in licensing, remedial actions, AML/CFT, and NBT autonomy and governance.
  - Supervisory effectiveness is constrained by perceived or real power of many bank owners.
  - Degree of compliance with the BCP is low.
- Licensing and remedial action weaknesses
  - Licensing: law does not provide for fit and proper assessment of shareholders (including beneficial owners), board members, and senior management, nor for review of proposed corporate governance vis-à-vis best practice.
    - Example: a license was granted where the business plan was weak, no information on shareholders, and the source of capital had not been ascertained.
  - Remedial action: legal and process frameworks require substantial improvement.
    - NBT is not legally required to take action if safety and soundness of an institution is compromised.
    - No prompt corrective action framework in law, regulation, or practice.
    - Recommendation: establish a predictable and transparent remedial action regime to strengthen supervision.

### Box: NBT lending to the private sector (balance sheet items summarized)
- Somoni 154 million government bond issued in 2001 to cover a portfolio of loss loans to state-owned enterprises; in 2006 the NBT provisioned Somoni 83 million against that amount.
- Somoni 24 million portfolio of loss loans to agriculture extended by AIB and guaranteed by the NBT at the time of AIB’s restructuring at end-2003; assumed by the NBT at end-2006 upon expiration of the guarantee.
- Equivalent of $25 million in loans to commercial banks for agricultural development financed through concessional credit lines from the China Development Bank (CDB); funds priced at 2.5 to 5 percent by the CDB and on-lent by the NBT at subsidized interest rates (4, 6, or 14 percent).
- Somoni 14 million loan to KI for food imports, funded by the NBT’s own funds; term of three months, rolled over for another six months, interest rate of 10 percent.
- Guarantees and pledges to foreign creditors of KI for $321 million and a Somoni 874 million loan; operations intended to help mobilize and provide direct funding for the financing of the cotton sector.

*IMF staff report content as provided in the source document.*

### 45.      Recent legal amendments have further weakened the law in those areas and are

### _cr08371 - 45.      Recent legal amendments have further weakened the law in those areas and are

### Banking licensing and supervisory independence
- Recent legal amendments have empowered the government to designate the entity that licenses and de-licenses banks.
- The NBT is no longer entitled to curtail a bank’s activities as part of its corrective action powers.
- The list of allowable bank activities no longer includes taking deposits (described as a parliamentary mistake).
- Despite a government proclamation giving licensing and de-licensing authority to the NBT, the legal changes have created a perception that the NBT’s independence has been undermined.
- Recommendation: It is strongly recommended that the authorities make the necessary amendments to the legal framework for bank licensing to align it with international good practice.

### Supervisory weaknesses and needed reforms
- Areas requiring attention: corporate governance, ethical standards, internal controls and audit; insider lending; application of International Financial Reporting Standards (IFRS) accounting for all banks; legal protection for the NBT and its staff for supervisory actions taken in good faith; consolidated supervision.
- The NBT is aware and has begun drafting regulatory and legal amendments, including on consolidated supervision.
- Prudential regulation measures suggested:
  - Apply higher capital charges to foreign currency-denominated loans to unhedged borrowers to deal with rising dollarization.
  - Strictly enforce prudential rules (e.g., on maximum exposure limits).
  - Increase “haircuts” in the value of loan collateral to address rapid credit growth and falling capital adequacy.
  - Conduct targeted inspections of banks that reported a substantial reduction in the stock of NPLs to verify that reductions are warranted.
- Transparency in banking supervision: broadly satisfactory, but needs improvement in timeliness and extent of dissemination of information on financial policies and system health, and standards of conduct for NBT staff.

### Insurance sector—legal, supervisory, and accounting gaps
- The 1994 insurance law is far from international standards in areas including protection of policyholders and supervisors.
- Ongoing legislative efforts should continue to align the legal framework with good international practice.
- The market supervisor, the State Insurance Supervisory Service (SISS) (a department of the ministry of finance), needs substantial strengthening:
  - Technical staff currently five; knowledge, technical skills, and experience need considerable enhancement in licensing, prudential requirements, and on-going supervision.
  - Staffing decisions constrained by a salary scale well below that of bank supervisors.
  - Authorities should consider alternative institutional structures, including a possible transfer to the NBT.
- Absence of standardized accounting rules across companies hinders proper evaluation of insurers’ condition and performance.

### Deposit insurance—current weaknesses and draft reforms
- The Tajik deposit insurance system (established in 2003) has significant shortcomings:
  - Balances equivalent to less than one percent of insured deposits.
  - No contingency financing arrangements.
  - Participation is voluntary.
  - No cap on insurance coverage (70 percent of eligible deposits are covered independent of their size).
  - Only large shareholders and related parties are excluded from coverage.
- Draft legislation improvements:
  - Makes membership mandatory.
  - Caps coverage to somoni 2,500 per depositor/per bank.
  - Improves governance of the system.
- Additional recommendations for the draft legislation:
  - Exclude bank shareholder and related parties from coverage.
  - Establish a minimum time frame to reimburse deposits.
  - Exclude commercial bank representatives from the fund’s supervisory council to avoid conflict of interest.
  - Restrict the fund’s investment policy to highly rated (domestic and foreign) government securities.
  - Authorize emergency borrowing from the government but not from commercial banks if the fund is insufficient to cover insured deposits of a failed bank.

### Financial infrastructure—legal framework and enforcement
- Over the last decade, the legal framework has undergone significant reform; laws and regulations are often comprehensive and broadly consistent with international best practices but are often conflicting, open to varying interpretations, and not widely disseminated.
- Implementation and enforcement have generally been weak.
- Additional reforms needed:
  - Full implementation of the legal entities registration law (single window principle). Registration for small businesses takes less than a week for individual entrepreneurs but remains complex for larger ones.
  - Overhaul of the 2003 Bankruptcy Law, which is deficient in almost all key areas (lack of reorganization provisions; vague criteria for commencement of insolvency). A new model law on insolvency for the region is under development.
  - Substantial improvement in administration of justice on contract enforcement and property rights: court proceedings are slow, unpredictable, at times biased, with opinions and decisions often secret and not revealed to parties. Efforts underway include establishing a judicial council and a time-bound action plan for judicial sector reform.

### Collateral, creditor information systems, and secured lending
- Problems with secured lending and lack of a creditor information system increase risk to lenders and affect cost and availability of lending.
- Laws governing secured lending are often overlapping and in conflict (example: land code prohibits mortgaging immovable property while the civil code and the mortgage law provide for this possibility).
- Framework weaknesses for registration and property rights enforcement:
  - No uniform system for title registration and related transactions; multiple bodies involved depending on property type. Work is underway on a new law on registration of rights on real estate and a unified registry for movable property.
  - Property registries are not publicly available, failing to protect good faith purchasers during title registration.
  - Judicial foreclosure risks for mortgage lenders include uncertainty on eviction and repossession procedures and lengthy court proceedings; the court may delay sale of foreclosed property through public auction for up to one year, with further appeals possibly delaying an additional year.
  - Out-of-court settlement is possible but depends on voluntary borrower cooperation.
- Creditor information system: authorities drafting legislation to allow establishment of a private credit bureau; as a transition the NBT should consider establishing a credit registry.

### Corporate governance
- Major steps taken: new Law on Joint Stock Companies, establishment of a central share registry for open joint stock companies, privatization of medium and large companies.
- New law improves provisions on related-party transactions, major asset sales, shareholder meetings, election of boards, and fiduciary duties.
- Standard of corporate governance remains weak (2006 EBRD enterprise restructuring and governance indicator rated Tajikistan at “2-” out of “4+”).
- Recommended further actions:
  - Increase transparency of ownership and control by publishing names of significant owners of banks and other financial institutions (immediately for direct owners and over time for beneficial owners); place online the names of company founders and statutes filed with the business registry; establish a central registry of land use certificates with internet access.
  - Subject by law all credit institutions to annual independent audits of their financial statements (extend current requirement applicable to all open joint stock companies to public banks and to KI). Tajikistan also needs to license sufficient professional audit firms capable of auditing financial institutions.

### Systemic liquidity management and monetary policy framework
- Current framework is rudimentary:
  - NBT’s main instruments: unremunerated reserve requirements and outright sales of NBT certificates of deposit.
  - Monetary policy interest rate (the refinancing rate) is not tied to any actual transaction; no standing facilities.
  - Auction volumes small; state-owned bank purchases almost every issue at negative real interest rates.
  - No secondary market for NBT certificates; no market-determined interest rate or yield curve.
- Limited stock of tradable government securities constrains policy and banks’ liquidity management:
  - Ministry of finance has not issued securities since 2001.
  - NBT certificates first issued in 2003; NBT’s insolvency discourages larger placements and market-based pricing.
  - Paucity of transferable collateral limits use of repos and development of an interbank money market.
- Benefits of issuing government bonds:
  - Mop up excess liquidity via open market operations with costs transparently borne by the ministry of finance.
  - Serve as collateral in the banking system.
  - Help establish a reference yield curve, facilitating pricing of credit risk and securities market development.
- Suggested first step: securitization of the nonmarketable government bond on the NBT’s books to replace NBT certificates as main short-term discretionary market instrument; gradually sell longer-maturity bonds and strengthen auctioning procedures.
- Reserve requirements:
  - NBT should ensure reserve requirements remain an effective instrument.
  - NBT changed reserve requirement regulations several times in the last year and a half; it excluded nonresident deposits in January 2007 but later reversed the exclusion.
  - The rate applied to nonresident deposits has at times differed from that applied to resident deposits.
  - Going forward, treatment of both types of deposits should remain unified, compliance strictly enforced, and the NBT should develop other tools including setting up a standing facility.
- NBT transparency in monetary policy has improved but needs enhancement:
  - NBT law lacks provisions for a monetary policy making body, for the central bank’s engagement in commercial lending, and the specific grounds for dismissal of the chairman and deputies, term limits, and required qualifications.
  - No legal guidance on conflict of interest, monitoring, or sanctions.
  - Recent legislative changes on bank licensing powers are a step backwards.
  - NBT informs relevant parties and the public about activities but providing fuller and more future-oriented analysis and formalizing a process for public comments on policy changes would be helpful.

### Payment systems
- Tajikistan is largely a cash-based economy.
- NBT launched an RTGS system in 2002, handling increasing volumes of electronic payment orders; system processes Somoni-denominated orders with the value settled growing by about 30 percent a year since launching.
- Use of other payment instruments (e.g., debit cards) is very limited due to low account ownership.
- The NBT-operated RTGS is the only major interbank payments system and is systemically important; it has improved payment and settlement arrangements and integration between the central bank and banks.
- Tajik banks continue to settle a significant portion of domestic interbank payments through bilateral correspondent accounts, increasing systemic risk:
  - Bilateral correspondent arrangements are not regulated from a payment system perspective; banks are only obliged to report statistics to the NBT on bilateral settlements.
- Business continuity needs:
  - Need for back-up secondary server(s) located in different sites to resume operations quickly without loss of transaction data.
  - Develop a comprehensive business continuity plan covering technical issues, staff availability, and information procedures.
- Legal framework gaps for payments system:
  - Missing concepts include timing of settlement finality, legal protection from insolvency effects, timely seizure of collateral pledges, access rules, and electronic signatures.
  - At minimum, these concepts should be addressed through NBT regulations or equivalent secondary legislation.

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

### 73.      The NBT should play a leading role in promoting the development of electronic

### _cr08371 - 73.      The NBT should play a leading role in promoting the development of electronic

### Payment systems development and NBT role
- The NBT should play a leading role in promoting the development of electronic retail payment instruments and systems.
- Depending on circumstances and the degree of cooperation among banks this role could range from:
  - acting as facilitator,
  - catalyst for change, or
  - even as a direct service provider.
- In the medium term, the NBT needs to develop and fully implement its payment system oversight function.
- Current NBT activities include some basic payment system oversight functions such as the analysis of data and the publication of statistics for the RTGS and card payment systems.
- Shortcomings noted:
  - The NBT has not established specific objectives in payment system oversight.
  - The NBT has not defined requirements that various payment systems must meet nor ways to enforce such requirements.
  - Effective performance will require appropriate organizational arrangements and staffing.

### Liquidity, settlement risk, and interbank practices
- Banks hold deposits with one another, or a group of smaller banks with bigger banks, implying fragmentation of liquidity and potential settlement risks because the settlement agent (a commercial bank) is not a risk-free agent even for the domestic currency.
- The NBT should discuss with the banks involved the risk implications of such practices.

### Remittances, deposit mobilization, and competition
- Banks could help promote the deposit of remittances in the banking system and the NBT could foster competition.
- Current practice: Remittances are paid almost exclusively in cash.
- New products such as payment cards can reduce cash-handling costs and enable remittance beneficiaries to have a deposit account.
- Essential enabling actions:
  - develop awareness campaigns,
  - establish highly concrete education mechanisms, and
  - create specific incentives to encourage remittance recipients to use these products.
- The NBT could foster competition among money transfer operators by increasing market transparency (e.g., publishing comparative data on the various pricing and service alternatives offered by banks and other paying agents).

### Annex — Observance of Financial Sector Standards and Codes: assessment scope
- The annex contains summary assessments of two international standards and codes relevant for the financial sector.
- Assessments undertaken:
  - The BCP, by Ms. Laura Ard (World Bank, formerly U.S. Office of the Comptroller of the Currency), and Mr. Peter Phelan (IMF consultant, formerly Bank of England).
  - Transparency in Monetary and Financial Policies, by Mr. Mariusz Sumlinski (IMF staff).
- Timelines and basis:
  - The BCP assessment was carried out during the February 2007 FSAP mission to Tajikistan, benchmarked against BCP I using both the “essential” and “additional” criteria.
  - The CTMFP assessment was carried out during the August 2007 FSAP mission and was based on the IMF Code of Good Practices on Transparency in Monetary and Financial Policies (MFP Transparency Code).
  - Assessments based on laws, regulations, policies, and practices in place at the time of the assessments and note subsequent legislative changes affecting bank licensing.
- Sources used included:
  - review of legislation, regulations, policies, and other documentation including information on the NBT’s website and in its Annual Reports,
  - self assessments by supervisory authorities and the NBT’s current advisors, USAID-Bearing Point,
  - detailed interviews with NBT officials and other government officials,
  - meetings with financial sector firms.

### Basel Core Principles (BCP) — institutional setting and macroeconomic context
- The NBT is the primary counterpart for the BCP review; banking supervision is part of NBT responsibilities.
- The 1999 Basel Core Principles were used in the review; the revised BCP will be the future goalpost standard, with increased emphasis on governance and risk management.
- Assessment constraints:
  - Comprehensive list of relevant regulation was difficult to obtain.
  - Enforceability of regulations and issuances has not been concretely tested through court cases or formal appeals.
- Institutional and market overview:
  - The central bank regulates and supervises most financial institutions; NBT oversees all deposit-taking institutions and nondeposit-taking microcredit organizations.
  - The banking system has undergone substantial consolidation in recent years against the backdrop of tighter prudential regulations.
- Preconditions for effective supervision — macroeconomic and legal environment:
  - Real GDP has expanded at an average annual rate of about 8½ percent during the last five years.
  - Inflation fell from double digits to 6–7 percent in 2004–05, but accelerated to about 20 percent by end-2007.
  - Fiscal performance: government ran small surpluses (excluding the externally financed public investment program) for the last five years.
  - Legal framework governed by six laws: (i) Law on the NBT (LNBT) (1996, amended 2001–02); (ii) Law on Banks and Banking (LBB) (1998); (iii) Law on Guarantee of the Deposits of Physical Persons (2003); (iv) Law on Securities and Stock Exchange (1992); (v) Law on Insurance (1994); and (vi) Law on Microfinance Organizations (2004).
  - No specific law for nonbank financial institutions; they are governed by NBT Regulation No. 118 “On Credit Companies.”
  - International accounting standards introduced in 1999; IFRS adopted in 2006.
  - Legal framework of the financial system has not been tested in the courts.
  - Local audit industry is shallow; audit firms auditing banks are domiciled in neighboring countries.

### Market discipline and resolution frameworks
- Market discipline:
  - Banks required to disclose financial statements audited annually by firms licensed by the NBT; no interim results disclosed.
  - The NBT sets accounting standards by law; international auditing standards are not required.
  - Incentive structures for hiring and removal of managers and Board members are not concretely established.
  - Tools for market discipline (e.g., deposit mobility, public education about bank soundness) are not evident.
- Systemic protection/resolution:
  - Bank resolution procedures remain ad hoc.
  - In the last 10 years the NBT has withdrawn 21 bank licenses and initiated 1 major bank restructuring (2003–04) involving a “good bank–bad bank” split of Agroinvestbank.
  - Impaired claims amounting to some ¾ of Agroinvestbank’s total assets (7½ percent of GDP) were transferred to a new asset management company, KI.
  - The new asset-management entity has made little subsequent progress in resolving this debt.
  - Deposit insurance scheme is limited in scope and has design flaws:
    - Fund balances equivalent to less than 1 percent of estimated insured deposits,
    - Absence of contingency financing arrangements,
    - Voluntary nature of the scheme,
    - No cap on insurance coverage,
    - Insufficient exclusion of bank shareholders and related parties from coverage.
  - Revisions to the deposit insurance law are under consideration.

### Main findings on Basel Core Principles (selected CPs and key points)
- CP 1 — Objectives, autonomy, powers, and resources:
  - Powers of the NBT to license and supervise banks had been established in law, but these provisions have recently been repealed, leaving supervision based only on a presidential regulation, contrary to best international practice and raising questions on enforceability.
  - Other provisions of the LNBT and the LBB apparently remain in force and provide a reasonable basis for supervision, although the LNBT does not specifically deal with safety and soundness concerns.
  - NBT officially independent, but evidence of interference by the Tajik politico-economic establishment.
  - NBT lacks a capital base to ensure financial independence; chairman appointed for an indefinite term and can only be dismissed for ‘abuse of power.’
  - Staff professionalism is growing, resources are adequate, staff turnover is low.
  - No protection for the NBT or its staff from being sued, nor are costs reimbursed should a lawsuit arise.
  - There are no MOUs with other supervisors.
- CPs 2–5 — Licensing and structure:
  - Recent legal changes have weakened the effectiveness of the law on the use of the term “bank.”
  - Legal shortcomings remain: no requirement to check shareholders, directors and senior management, nor on operational structure of proposed banks.
  - Practice is deficient: decisions not clearly justified nor adequately minuted.
  - Probity checks are not carried out on new shareholders, although holdings >20 percent can be rejected for financial reasons.
  - No system of prior approval for investment holdings of banks, only a limit based on a percentage of capital.
- CPs 6–15 — Prudential regulations and requirements:
  - No capital charges for market risks and no consolidated capital requirements, though many other capital adequacy calculations are consistent with Basel requirements.
  - NBT has taken action against banks in breach of capital requirements, but no formalized forward planning to deal with capital problems before they become critical.
  - No regulation that deals with credit policies (covered in detail during on-site examinations).
  - Adequate past-due based regulation for provisioning; large exposure limits defined in international norms but evidence of frequent breaches.
  - Connected lending rules do not give the NBT power to require decision-making at senior level without the connected person being present.
  - No country risk nor market risk regime (risks minimal at present).
  - Supervision of liquidity and foreign exchange risk is more quantitative through verification of calculations and minimal review of the nature and effectiveness of attendant risk systems.
  - Monitoring of other risks via an ‘internal control unit’ set up in banks at NBT behest; approach more compliance than risk-focused.
  - Need to develop management information systems in banks and effective internal audit functions.
  - No law or regulations setting forth customer diligence requirements and reporting of suspicious transactions for prevention of money laundering or terrorist financing; no FIU established. A draft law is pending before Parliament.
- CPs 16–20 — Methods of ongoing supervision:
  - Comprehensive set of returns developed by the NBT with help of international consultants; consultants also assisted with training for on-site examiners.
  - Annual on-site examination of each bank focusing primarily on credit risk, with some internal control work and validation of off-site returns.
  - Regular contacts with senior management and ad hoc meetings with the chairman, but no regular meetings with the full board.
  - No consolidated supervisory regime at present; NBT drafting a regulation to cover this.
- CP 21 — Information requirements:
  - Banks must have accounts audited in accordance with IFRS and published annually.
  - Audit profession is not well developed in Tajikistan; many audits conducted by staff based in adjacent countries.
  - Effectiveness of IFRS application is in doubt due to issues with timeliness and accuracy of asset classification by banks.
  - International audit standards are not formally applied.
  - Dialogue between NBT and the audit profession is limited; NBT licenses auditors in absence of other capable bodies.
- CP 22 — Formal powers of supervisors:
  - Recent legal changes call into question the foundation for NBT remedial action against banks.
  - NBT’s powers need substantial strengthening despite existing powers to impose fines, staff changes, and business restrictions.
  - A bank cannot be put into liquidation without a prior period of temporary administration.
  - No system of structured remedial action triggered by specific events nor requirement for timely action.
  - NBT actions have not always been consistent and proportionate.
- CPs 23–25 — Cross-border banking:
  - No Tajik banks established outside the country; only one foreign bank operates in Tajikistan with a specialized role serving two embassies.
  - NBT should develop a regime to accommodate more foreign banks, including ability to assess effectiveness of home-country supervision.

### Table 6 — Summary compliance (excerpted comments)
- CP 1.1 Objectives: Banking stability addressed, but not safety and soundness concerns.
- CP 1.2 Independence: Formally present, but vitiated by lack of capital to ensure financial independence and by interference from the Tajik establishment.
- CP 1.3 Legal framework: Inadequate following the recent revocation of NBT’s legal powers to license and supervise banks and their replacement by a Presidential Regulation. Other parts of relevant laws remain in place.
- CP 1.4 Enforcement powers: Laws give the NBT powers to levy sanctions and obtain necessary information; presumably still available based on the Regulation.
- CP 1.5 Legal protection: None for the NBT or its staff; costs of legal action not reimbursed.
- CP 1.6 Information sharing: Laws provide for it, but no formal MOUs in place with other supervisors.
- CP 2 Permissible Activities: Laws were previously satisfactory, but recent changes have watered them down.
- CP 3 Licensing Criteria: Some building blocks in place, but several missing and practice seriously deficient.
- CP 4 Ownership: Only ownership changes in excess of 20 percent require approval; NBT carries out no probity checks nor looks behind nominee shareholders.
- CP 5 Investment Criteria: No system of prior approval of investments; only a limit based on a percentage of capital.
- CP 6 Capital Adequacy: Broadly in line with Basel, no charges for market risks and no consolidated capital requirements; action taken against banks in breach but no forward planning.
- CP 7 Credit Policies: No regulation dealing with credit policies; management information needs improvement.
- CP 8 Loan Evaluation and Loan-Loss Provisioning: Provisioning is on a past due basis; need forward-looking criteria.
- CP 9 Large Exposure Limits: Defined in line with international norms, but frequent breaches of rules.
- CP 10 Connected Lending: Rules do not allow NBT to require senior-level decision-making without the connected person present.
- CP 11 Country Risk: No regime, risks minimal.

*Source: _cr08371 - 73.      The NBT should play a leading role in promoting the development of electronic (IMF staff report content provided in the source PDF).*

### 12. Market Risks There is no regime, although, again, risks are currently minimal.

### _cr08371 - 12. Market Risks There is no regime, although, again, risks are currently minimal.

### Market Risks
- "There is no regime, although, again, risks are currently minimal."
- Recommended action (CP 12): "Commence a training program for supervisors on market risks ahead of their appearance in the Tajikistan market in significant form. Encourage banks to do the same."

### Other Risks
- "Some supervision of Foreign Exchange (FX) and liquidity takes place, and other risks are monitored by an internal control unit in each bank."
- Recommended action (CP 13): "Develop a risk reporting system and the training of staff in the skills needed to assess this."

### Internal Control and Audit
- "The role of the board is not clearly defined, nor that of the internal control unit or internal audit. The approach is compliance rather than risk-based."
- Recommended action (CP 14): "Both the LBB and regulations need amending to incorporate requirements for adequate corporate governance arrangements in banks, including an effective internal audit function."

### Money Laundering
- "No regime is in place, although an anti-money laundering law is in draft."
- Recommended action (CP 15): "The draft law on anti-money laundering and countering the financing of terrorism should be passed and implemented in an effective manner."

### On-Site and Off-Site Supervision
- "A comprehensive set of returns has been developed with the help of international consultants, who have also helped with the training of on-site examiners. Annual on-site visits focus chiefly on credit risk."
- Recommended action (CP 16): "Continue to develop the analytical aspects of the on-site reports."

### Bank Management Contact
- "There are regular contacts with senior management of banks, but only ad hoc meetings with the Chairmen and no regular meetings with the full board."
- Recommended action (CP 17): "The NBT should meet the full board of each bank at least once a year. The line supervisor should be present at all meetings between the NBT and banks (even where it is a chairman to chairman meeting), and all meetings should be minuted."

### Off-Site Supervision
- "A prudential reporting regime is in place and is being regularly improved."

### Validation of Supervisory Information
- "Some validation of data takes place when on-site, but external accountants are not used."
- Recommended action (CP 19): "The NBT should continue to press for enhanced audit standards."

### Consolidated Supervision
- "No regime is currently in place, although a new regulation has recently been drafted."
- Recommended action (CP 20): "The legal and regulatory framework should be established to enable the NBT to undertake consolidated supervision as the Tajikistani financial system develops."

### Accounting Standards
- "Banks’ accounts should be prepared in accordance with IFRS and published annually. The accounting profession is not well developed in Tajikistan, and the effectiveness with which IFRS is applied must be in doubt. International auditing standards are not applied."
- Recommended action (CP 21): "Continue to press for enhanced standards."

### Remedial Measures
- "Substantial improvements are needed, including placing the powers of the NBT again on a firm legal basis. A structured remedial response regime should be developed, as well as the NBT having the right to put a bank into liquidation and being required to act on a timely basis. Recent action has not always been consistent and proportionate."
- Recommended action (CP 22): 
  - "The law should establish a requirement on the NBT to take remedial action against a bank when certain trigger points are breached, and also provide a full range of remedial tools that can be used."
  - "There should be a requirement that action is taken on a timely basis, and is transparent and predictable."
  - From Objectives, Autonomy, Powers, and Resources (CP 1): items include reversing changes to the LBB and LNBT licensing powers, making safety and soundness an explicit objective of the NBT, issuing a full set of regulations, giving the NBT the power to put a bank into immediate liquidation, increasing transparency and predictability at senior levels, appointing the chairman for a fixed term with explicit dismissal reasons in law, appropriate capitalization, amending LNBT so NBT can continue to license a bank in liquidation, legal protection for NBT and staff acting in good faith, confidentiality requirements for supervisory information, and establishing MOUs with other supervisors.

### Globally Consolidated / Host Country Supervision / Foreign Banks’ Establishments
- "There are no Tajikistani banks established outside the country."
- "Ditto"
- Recommended action (CP 25): "Ensure that all necessary licensing techniques and procedures are in place, including, inter alia, the assessment of the quality of the home supervisor’s supervision."
- Also: "The NBT should ensure that it has in place the legal powers and systems to supervise foreign banks established in Tajikistan effectively. This includes comprehensive ‘fit and proper’ tests and an ability to assess the effectiveness of home country supervision."

### Recommended action plan — selected CPs and actions
- CP 1 (Objectives, Autonomy, Powers, and Resources): reverse recent LBB and LNBT changes; make safety and soundness explicit NBT objective; issue and maintain a full set of regulations; give NBT power to liquidate banks; fix chairman appointment term and dismissal grounds; appropriate capitalization; legal protections for staff; confidentiality of supervisory information; MOUs with other supervisors.
- CP 2 (Permissible Activities): "Reverse recent legal changes to re-establish the previously satisfactory situation."
- CP 3 (Licensing Criteria): require checks on shareholders, Board members and senior management; check operational structure for corporate governance; power to check complete criminal records; greater professionalism and vigilance.
- CP 4 (Ownership): right to refuse meaningful acquisitions; staged evaluation including probity and financial strength; power to require unwinding of transactions of between 5 and 20 percent.
- CP 5 (Investment Criteria): system for prior review of all investment plans and regular reporting; establish criteria for suitable investments.
- CP 6 (Capital Adequacy): establish a program to address banks with capital problems starting before capital falls below regulatory minimum.
- CP 7 (Credit Policies): introduce new regulation on credit requiring senior/Board decisions for large/risky credits and comprehensive management information systems.
- CP 10 (Connected Lending): require Board approval for facilities to connected parties exceeding certain amounts or special risks; supervisor able to deduct such lending from capital or require collateralization.
- CP 11 (Country Risk): "A country risk regime should be introduced."

### Authorities’ response
- "The authorities were in broad agreement with the assessment."

### Transparency in Monetary and Financial Policies — summary and key findings
- Paragraphs and findings:
  - 94. "The NBT is the central bank of the country and is responsible for formulation and implementation of monetary policy in Tajikistan, as well as for banking supervision and regulation."
  - 95. "Systemic liquidity management and the monetary policy framework in Tajikistan are rudimentary. The NBT’s main monetary instruments are unremunerated reserve requirements and sales of the NBT certificates of deposit; there are no standing facilities. Auction volumes are small, and there is no secondary market for the NBT certificates or market-determined interest rates or yield curve. The NBT is insolvent. An interbank money market is virtually nonexistent—some of the banks transact among each other on an ad hoc basis. Hence, the banks maintain excess reserves also as insurance as the lender-of-last-resort arrangements are not formalized. A small foreign exchange market serving bilateral exchanges is dominated by the NBT."
  - 96. "The NBT regulates and supervises most financial institutions. The NBT oversees all deposit-taking institutions. The banking system has undergone substantial consolidation in the last few years."
  - 97. "Banking supervision and regulation are governed by the NBT law and the law on banks and banking, which provide the NBT with authority in these areas. However, important shortcomings remain—areas of licensing, remedial actions, and NBT autonomy and governance require strengthening. Also, the effectiveness of the supervisory effort remains restricted as some bank owners rely on (the perceived or real) position of power to resist the recommendations of supervisors."
  - 98. "The NBT’s transparency practices in monetary policy have improved significantly but need further enhancement." Specific omissions include lack of legal provisions for the monetary policy making body, NBT engagement in commercial lending, unspecified grounds for dismissal and term limits for chairman and deputies, lack of legislative guidance on conflict of interest, and recent amendments relating to licensing that constitute a step backwards. Communication improvements recommended: "providing fuller and more future oriented analysis" and formalizing a public comment process on policy changes.
  - 99. "The authorities have put much effort into improving the transparency of financial policies." Key exceptions: clarity of roles/responsibilities and standards of conduct for NBT staff. Independence and institutional authority need increased support; integrity and accountability require strengthening due to lack of effective legislation on conflict of interest and employee protection. Open process for formulating and reporting financial policies and public availability of information are "fairly satisfactory."

### Transparency Code assessment — selected items and aggregate
- Table 8 (Monetary Policy) — sample gradings and descriptions:
  - 1.1 Grading: BO — "The central bank law clearly defines the objectives of monetary policies, but the NBT statements have occasionally mentioned goals that are not specified in the law."
  - 1.2 Grading: BO — "The law broadly defines the institutional relationship between monetary and fiscal operations, but does not regulate extension of the NBT loans and advances to the government."
  - 2.2 Grading: NO — "…function has been delegated to a Monetary Policy Committee that is not formally provided for in the law and whose composition, structure, and functions are not publicly disclosed."
  - 2.3 Grading: BO — "Changes in the setting of monetary policy instruments are disclosed on a quarterly basis. There is no legal requirement for such disclosure, including on a timely basis."
  - 2.5 Grading: BO — "There is an informal presumption in favor of consultations with interested parties … No formal procedures are established for this type of consultations."
  - 3.1 Grading: O — "Tajikistan subscribes to GDDS. The NBT publishes a monthly Bulletin of Banking Statistics …"
  - 4.2 Grading: O — "The NBT is required, by law, to submit after the end of the fiscal year to parliament an audited financial report and a report on its operations. In practice however, this principle has not been observed in the last few years because the auditors could not finalize the audit of NBT’s financial statements."
- Aggregate: "Observed (O) – 11, broadly observed (BO) – 4, partly observed (PO) – 1, not observed (NO) – 1, not applicable (N/A) – 0."

*Source: _cr08371 - 12. Market Risks There is no regime, although, again, risks are currently minimal.*

### 5.4 Where financial agencies have oversight

### 5.4 Where financial agencies have oversight

### Oversight and transparency provisions (principles 5.4–8.4)
- 5.4: Where financial agencies have oversight responsibilities for self-regulatory organizations (e.g., payment systems), the relationship between them should be publicly disclosed — NA. Self-regulatory organizations are not authorized to perform part of the regulatory and supervisory process.
- 5.5: Where self-regulatory organizations are authorized to perform part of the regulatory and supervisory process, they should be guided by the same good transparency practices specified for financial agencies — NA. Self-regulatory organizations are not authorized to perform part of the regulatory and supervisory process.
- 6.1: The conduct of policies by financial agencies should be transparent, compatible with confidentiality considerations and the need to preserve the effectiveness of actions by regulatory and oversight agencies — O.
  - The central bank law provides for transparency of policies by establishing rules governing public accountability of the central bank, its reporting requirements, by setting goals and functions that the central bank is to pursue as well as setting up the regulatory framework for the bank’s supervisory activities.
- 6.2: Significant changes in financial policies should be publicly announced and explained in a timely manner — O. Changes in financial policies are communicated to the interested parties and the public in a timely manner.
- 6.3: Financial agencies should issue periodic public reports on how their overall policy objectives are being pursued — BO.
  - The NBT places on its website assessments of fulfillment of the overall policy objectives in the banking sphere on an irregular basis. The policies are also described in the NBT’s annual report.
- 6.4: For proposed substantive technical changes to the structure of financial regulations, there should be a presumption in favor of public consultations, within an appropriate period — PO.
  - There is no presumption in favor of public consultations for proposed substantive changes, but the changes are usually consulted with the interested parties.
- 7.1: Financial agencies should issue a periodic public report on the major developments of the sector(s) of the financial system for which they carry designated responsibility — BO.
  - The NBT publishes annual report as required by the law as well as a monthly printed periodical “Bulletin of Banking Statistics.” The Banking Bulletins have more information that what is published on the website.
- 7.2: Financial agencies should seek to ensure that, consistent with confidentiality requirements, there is public reporting of aggregate data related to their jurisdictional responsibilities on a timely and regular basis — BO.
  - The NBT publishes annual reports as required by the law as well as a monthly periodical “Bulletin of Banking Statistics.” The NBT publishes on its website limited financial sector data, including numbers of banks, branches, and bank capital.
- 7.3: Where applicable, financial agencies should publicly disclose their balance sheets on a preannounced schedule and, after a predetermined interval, publicly disclose information on aggregate market transactions — O.
  - The NBT submits to parliament an audited report by the end of its fiscal year. The audited financial statements are published in the annual report. Information on monetary operations is available in “Bulletin of Banking Statistics.”
- 7.4: Financial agencies should establish and maintain public information services — O. The NBT has a Press Center which informs the public about the NBT’s activities.
- 7.5: Texts of regulations and any other generally applicable directives and guidelines issued by financial agencies should be readily available to the public — O. All instructions and other banks directives are published by the NBT on its website and in its Journal.
- 7.6: Where there are deposit insurance guarantees, policyholder guarantees, and any other client asset protection schemes, information on the nature and form of such protections, the operating procedures, how the guarantee is financed, and the performance of the arrangement should be publicly disclosed — O.
  - This is disclosed in the deposit insurance law, which is available on the NBT’s website.
- 7.7: Where financial agencies oversee consumer protection arrangements (such as dispute settlement processes), information on such arrangements should be publicly disclosed — NA. The NBT does not oversee consumer protection arrangements.
- 8.1: Officials of financial agencies should be available to appear before a designated public authority to report on the conduct of financial policies, explain the policy objective(s) of their institution, describe their performance in pursuing their objective(s), and, as appropriate, exchange views on the state of the financial system — O.
  - Each year the bank’s performance is reviewed in the government and parliament.
- 8.2: Where applicable, financial agencies should publicly disclose audited financial statements of their operations on a preannounced schedule — O.
  - The NBT is required, by law, to submit after the end of the fiscal year to parliament an audited financial report and a report on its operations.
- 8.3: Where applicable, information on the operating expenses and revenues of financial agencies should be publicly disclosed annually — O. This information is disclosed in the annual report.
- 8.4: Standards for the conduct of personal financial affairs of officials and staff of financial agencies and rules to prevent exploitation of conflicts of interest, including any general fiduciary obligation, should be publicly disclosed — PO.
  - These standards are defined in the law, but there are no provisions on what constitutes conflict of interest (as is also the case for an internal code of conduct that refers to behavior).

- Aggregate: Observed (O) – 10, broadly observed (BO) – 3, partly observed (PO) – 3, not observed (NO) – 0, not applicable (N/A) – 4.

### Recommended action plan — Monetary policies (Table 10 summary)
- 1.1 The ultimate objective(s) and institutional framework of monetary policy should be clearly defined in relevant legislation or regulation, including, where appropriate, a central bank law.
  - There should be consistency between the NBT objectives as spelled out in the law and as discussed by the monetary authorities.
  - The law should explicitly forbid the government from interfering with the policymaking process of the central bank.
  - The three nonNBT Board members should be appointed pursuant to the law.
  - The law should specify grounds for dismissal of the NBT chairman and his deputies, terms of office of appointments, and the qualifications that the appointees should possess.
- 1.2 The institutional relationship between monetary and fiscal operations should be clearly defined.
  - Legislation should regulate extension of central bank advances and overdrafts to the government and required public disclosure of the amounts and terms of advances and overdrafts if such were permitted under the law.
  - Rules governing the NBT participation in the secondary market for government securities and disclosure thereof should be introduced.
  - The law should clarify the NBT’s intermediation function—e.g., by explicitly prohibiting it from extending credit to the private sector or acting as an intermediary in provision of credit to the private sector. Additional provisions could cover the NBT holding of equity in private companies, and procurement processes.
- 2.2 Where a permanent monetary policy making body meets, information on the composition, structure, and functions of that body should be publicly disclosed.
  - The existing Monetary Policy Committee (MPC) should be formally provided for in the law, including its structure and functions; or the NBT should publicly disclose by other means the existence of the MPC and its composition, structure and functions.
- 2.3 Changes in the setting of monetary policy instruments (other than fine-tuning measures) should be publicly announced and explained in a timely manner.
  - Transparency would be enhanced if the minutes of the MPC meetings were made public, including with a maximum delay (e.g., soon after the meeting).
  - Transparency would benefit from a more scheduled, proactive information sharing and more active regular dissemination of monetary policy decisions, including systematic disclosure of the main considerations underlying monetary policy decisions.
- 2.4 The central bank should issue periodic public statements on progress toward achieving its monetary policy objective(s) as well as prospects for achieving them.
  - Transparency would benefit if the NBT published forward-looking analyses on a pre-announced schedule.
- 2.5 For proposed substantive technical changes to the structure of monetary regulations, there should be a presumption in favor of public consultations.
  - Transparency would be enhanced if informal consultations that take place currently were formalized as to their scope and timing.
- 3.2 The central bank should publicly disclose its balance sheet on a preannounced schedule and, after a predetermined interval, publicly disclose selected information on its aggregate market transactions.
  - Transparency would benefit if the NBT posted its annual report on the website on a regular and time-specified basis.
  - A schedule for disclosure of the NBT’s market transactions was established.
- 3.3 The central bank should establish and maintain public information services.
  - Transparency would benefit if the NBT’s publications were made available through its website.
- 4.2 The central bank should publicly disclose audited financial statements of its operations on a preannounced schedule.
  - The audited financial statements could be made available on a timely basis on the NBT’s website.
- 4.4 Standards for the conduct of personal financial affairs of officials and staff of the central bank and rules to prevent exploitation of conflicts of interest should be publicly disclosed.
  - Transparency would be enhanced by including in legislation or guidelines (such an internal code of conduct) provisions on what constitute conflict of interest, how the central bank monitors possible conflict of interest of officials and staff, and sanctions (and procedures for recourse) in the case of violations. Weaknesses in ownership disclosure also need to be addressed.

- Authorities’ response: The authorities were in broad agreement with the assessment. They provided detailed comments on specific items, all of which were incorporated. The authorities also pointed out that a number of revisions to the central bank law and banking law have been drafted that would enhance observance of the transparency code.

### Recommended action plan — Financial policies (Table 11 summary)
- 5.1 The broad objective(s) and institutional framework of financial agencies should be clearly defined, preferably in relevant legislation or regulation.
  - Transparency would benefit from: reversal of recent legislative changes that removed the NBT’s authority to license banks from the NBT Law; clarification of the NBT’s intermediation function—e.g., explicit prohibition from extending credit to the private sector or acting as an intermediary in provision of credit to the private sector. Additional provisions could cover the NBT holding of equity in private companies, and procurement processes.
- 5.3 The role of oversight agencies with regard to payment systems should be publicly disclosed.
  - Transparency would be enhanced if the NBT promoted public disclosure of risk management policies. These are currently nascent but will gain in importance as the system develops.
- 6.2 Significant changes in financial policies should be publicly announced and explained in a timely manner.
  - Transparency would benefit if announcements were accompanied by explanations of changes and new regulations.
- 6.3 Financial agencies should issue periodic public reports on how their overall policy objectives are being pursued.
  - Transparency would be improved if the NBT extended coverage of financial sector issues in its annual report and in other publications.
- 6.4 For proposed substantive technical changes to the structure of financial regulations, there should be a presumption in favor of public consultations.
  - Transparency would be improved if a presumption in favor of public consultation were adopted more formally.
- 7.1 Financial agencies should issue a periodic public report on the major developments of the sector(s) of the financial system for which they carry designated responsibility.
  - Transparency would be enhanced if: the NBT extended coverage of financial sector issues in its annual report and/or other publication; targeted information depending upon the audience addressed—detailed analysis for specialists, periodic and less technical reports could be considered for the public at large.
- 8.4 Standards for the conduct of personal financial affairs of officials and staff of financial agencies and rules to prevent exploitation of conflicts of interest should be publicly disclosed.
  - Transparency would be enhanced by public disclosure of guidelines (such as an internal code of conduct) and provisions on what constitutes conflict of interest, how the central bank monitors possible conflict of interest of officials and staff, and sanctions (and procedures for recourse) in the case of violations. Weaknesses in ownership disclosure also need to be addressed.

- Authorities’ response: The authorities were in broad agreement with the assessment.

### Stress testing of the Tajik banking system (Appendix I, paragraphs 102–105 and Table 12)
- Coverage and data:
  - Stress tests used detailed balance sheet data for eight commercial banks (accounting for 95 percent of total banking sector assets).
  - Initially based on December 2006 data, subsequently updated with June and December 2007 data.
  - Omitted institutions included a foreign bank branch and a newly established small bank.
- Purpose:
  - Examine potential effects of specified changes in risk factors on banks’ financial conditions.
  - Scenarios calibrated using discussions with authorities and FSAP analysis.
  - Shocks evaluated: credit portfolio deterioration, exchange and interest rate fluctuations, liquidity shock in the form of bank runs.
- Main conclusion:
  - The banking system is broadly resilient to a large range of extreme but plausible shocks, but capital buffers are being eroded rapidly.
  - Tajik banks remain most vulnerable to credit risk, including indirect credit risk related to exchange rate fluctuations.
  - Risks are amplified by uncertainties regarding banks’ asset quality, rapid credit growth, and weak credit assessment and monitoring tools.
- Credit risk scenarios (three separate shocks):
  - (i) Two-category downward shift of 20 percent of all loans (migration shock).
  - (ii) Deterioration in the quality of the exposures of the largest borrower (re-classification to the “dangerous” loan category).
  - (iii) Deterioration in the quality of 50 percent of all large exposures (re-classification to the “dangerous” loan category).
  - Tests conducted under two collateral assumptions: 50 percent collateral coverage and 0 percent collateral coverage. The results discussed focus on the more conservative assumption.
- Selected results from Table 12 (preserving provided numeric values and labels):
  - Baseline (before shocks)
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 19.4; Best 2/ = 54.5; System = 26.8
    - June 2007: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 15.5; Best 2/ = 40.7; System = 20.8
    - December 2007: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 13.3; Best 2/ = 35.1; System = 19.4
  - Sensitivity Stress Tests — Credit Risk, 2-category migration, Assuming a 50 % collateral coverage
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 16.1; Best 2/ = 52.4; System = 23.8; % change = -11.2
    - June 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 10.6; Best 2/ = 38.7; System = 17.6; % change = -15.4
    - December 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 11.1; Best 2/ = 32.1; System = 16.6; % change = -14.5
  - Sensitivity Stress Tests — Credit Risk, 2-category migration, Assuming a 0 % collateral coverage
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 14.6; Best 2/ = 51.6; System = 22.2; % change = -17.2
    - June 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 8.5; Best 2/ = 37.6; System = 16.0; % change = -23.2
    - December 2007: No. of banks with CAR below 12% 1/ = 2; Worst 2/ = 10.1; Best 2/ = 30.8; System = 15.3; % change = -21.3
  - Sensitivity Stress Tests — Credit Risk, Single largest borrower, Assuming a 50 % collateral coverage
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 13.5; Best 2/ = 52.4; System = 21.6; % change = -19.3
    - June 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 9.9; Best 2/ = 27.4; System = 15.9; % change = -23.6
    - December 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 10.1; Best 2/ = 30.8; System = 15.6; % change = -19.5
  - Sensitivity Stress Tests — Credit Risk, Single largest borrower, Assuming a 0 % collateral coverage
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 13.5; Best 2/ = 52.4; System = 20.8; % change = -22.4
    - June 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 9.1; Best 2/ = 27.4; System = 15.2; % change = -27.0
    - December 2007: No. of banks with CAR below 12% 1/ = 3; Worst 2/ = 5.5; Best 2/ = 29.0; System = 14.6; % change = -24.7
  - Sensitivity Stress Tests — Credit Risk, All large exposures, Assuming a 50 % collateral coverage
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 1.4; Best 2/ = 52.4; System = 18.3; % change = -31.6
    - June 2007: No. of banks with CAR below 12% 1/ = 2; Worst 2/ = 4.0; Best 2/ = 30.1; System = 13.8; % change = -33.7
    - December 2007: No. of banks with CAR below 12% 1/ = 2; Worst 2/ = 5.6; Best 2/ = 32.1; System = 13.6; % change = -29.8
  - Sensitivity Stress Tests — Credit Risk, All large exposures, Assuming a 0 % collateral coverage
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 0.3; Best 2/ = 52.4; System = 16.0; % change = -40.5
    - June 2007: No. of banks with CAR below 12% 1/ = 2; Worst 2/ = 3.8; Best 2/ = 30.1; System = 10.9; % change = -47.5
    - December 2007: No. of banks with CAR below 12% 1/ = 3; Worst 2/ = 4.1; Best 2/ = 25.2; System = 11.3; % change = -41.6
  - Exchange Rate Risk
    - Appreciation against U.S. dollar
      - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 16.0; Best 2/ = 53.0; System = 22.4; % change = -16.5
      - June 2007: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 13.0; Best 2/ = 38.1; System = 17.6; % change = -15.2
      - December 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 9.0; Best 2/ = 31.6; System = 15.5; % change = -20.1
    - Depreciation against U.S. dollar (plus credit risk)
      - Only direct FX impact
        - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 20.3; Best 2/ = 55.9; System = 30.9; % change = 15.2
        - June 2007: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 17.9; Best 2/ = 43.1; System = 23.8; % change = 14.3
        - December 2007: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 17.2; Best 2/ = 41.2; System = 23.0; % change = 18.7
      - Adding indirect credit risk impact
        - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 13.9; Best 2/ = 55.2; System = 25.6; % change = -4.6
        - June 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 9.2; Best 2/ = 39.6; System = 17.8; % change = -14.1
        - December 2007: No. of banks with CAR below 12% 1/ = 1; Worst 2/ = 10.6; Best 2/ = 33.9; System = 17.7; % change = -8.8
  - Interest Rate Risk (parallel shift of yield curve), Maturity gap
    - December 2006: No. of banks with CAR below 12% 1/ = 0; Worst 2/ = 13.0; Best 2/ = 51.4; System = 21.9; % change = -18.4
    - June 2007: No. of banks with CAR below 12% 1/ = 2; Worst 2/ = 8.4; Best 2/ = 37.2; System = 15.0; % change = -27.6
    - December 2007: No. of banks with CAR below 12% 1/ = 2; Worst 2/ = 8.1; Best 2/ = 31.7; System = 14.7; % change = -24.1

- Caveats and structural sensitivities:
  - Weak accounting and auditing standards, relatively lax implementation of asset classification and provisioning guidelines, limited regulation on connected lending, and lack of reliable data on borrowers’ creditworthiness and on the value of their collateral increase banks’ sensitivity to shocks.
  - Tests account for these uncertainties by using the 50 percent collateral coverage assumption (in line with the Tajik collateral coverage requirement for real estate) and a zero collateral coverage assumption (to account for the possibility that the collateral is unrealizable or unmarketable).

*Source: National Bank of Tajikistan and IMF/World Bank staff estimates (as presented in the assessed content).*

### 106.     Based on data at end-2007, the results indicate that banks’ still have an adequate

### _cr08371 - 106.     Based on data at end-2007, the results indicate that banks’ still have an adequate

### Capital adequacy and credit-quality stress tests
- Based on data at end-2007, banks’ capitalization is adequate but just barely.
- Two-category downward loan “migration”, with no collateral coverage:
  - Two banks breach the 12 percent minimum CAR requirement.
  - Worst-case breach is by 2 percentage points.
  - System-wide CAR falls from about 19½ percent to 15 percent.
  - The two banks breaching are the largest in the system, holding close to 70 percent of assets.
- Reclassification of each bank’s largest borrower to “dangerous” (61 to 180 days past due):
  - Three banks would see their CAR fall below minimum requirement.
  - Worst-case shortfall is 6.5 percentage points (that bank holds a very small fraction of system assets).
  - Other two shortfalls range between 1 and 2 percentage points.
  - Result: 70 percent of total banking sector assets would be covered by a CAR below 12 percent.
  - System-wide CAR remains above 14½ percent.
- When large exposures are downgraded simultaneously:
  - If 50 percent of all large exposures are reclassified to “dangerous”, percent of banking sector assets covered by CAR below 12 percent rises to 70 percent.
  - Largest bank’s after-shock CAR is 5.5 percent.
  - After-shock system-wide CAR falls below minimum requirement by about one percentage point.
  - The degree of interconnectedness of large exposures is difficult to assess; calls for close monitoring of banks’ large exposures, especially absent clear regulation on connected lending.

### Foreign exchange risk
- Most banks are sufficiently well capitalized to withstand a substantial appreciation of the currency.
- On average, banks have a long net open position in foreign exchange (foreign currency denominated assets exceed foreign currency denominated deposits), so an appreciation of the somoni relative to U.S. dollars reduces banks’ CARs.
- Example shocks:
  - A 30 percent appreciation of the somoni lowers system-wide CAR to 15½ percent.
  - Under that shock, the largest bank sees its CAR fall below the 12 percent minimum requirement.
  - A 30 percent depreciation of the somoni combined with a 30 percent deterioration in the quality of foreign currency denominated loans (assuming zero collateral coverage):
    - One bank violates the 12 percent CAR requirement by 1½ percentage points.
    - System-wide CAR remains slightly below 18 percent.
- Robustness caveat:
  - Tests depend on sensitivity of loan portfolios to exchange rate depreciation, a parameter hard to assess given limited information on borrowers’ access to foreign currency income (e.g., remittances).
  - Recommendation: banks should price exchange rate–induced credit risk appropriately, possibly with additional provisions on foreign currency denominated loans.

### Interest rate risk
- Tajik banks appear able to absorb a sizable interest rate shock due to high net interest rate margins and small maturity mismatches.
- Shock applied: uniform 400 basis points upward shift in the deposit interest rate across all maturities (represents a 16 percent decrease in net lending margins).
  - Result: system-wide CAR reduced by five percentage points to about 14½ percent.
  - Two banks, holding about 10 percent of system assets, are particularly vulnerable:
    - One due to relatively longer-term loan portfolio structure.
    - The other due to heavy reliance on nonresident deposits that are deposited abroad.
- Methodology / interpretation:
  - Applied shock is particularly strong and methodology basic; if interest rate rises over time, banks may adjust maturity structure and reduce exposure.

### Liquidity risk
- Deposit-run scenario: somoni deposit run of 10 percent of deposits each day for five consecutive days.
- December 2007 results (summary from Table 13):
  - Run on domestic deposits:
    - After day 3: Number of illiquid banks = 0; Liquidity shortfall = 0.0 (percent of pre-shock assets)
    - After day 4: Number of illiquid banks = 2; Liquidity shortfall = 0.1
    - After day 5: Number of illiquid banks = 2; Liquidity shortfall = 0.4
    - System-wide liquidity after day 5: Yes (system considered illiquid)
  - Run on FX deposits:
    - After day 5: Number of illiquid banks = 2; Liquidity shortfall = 1.9
    - System-wide liquidity after day 5: Yes
- Interpretation:
  - Two banks would not survive daily deposit withdrawal for more than three days without additional liquidity.
  - At end of day 5, all banks would be technically illiquid under the domestic-deposit run in earlier vintages, but December 2007 shows fewer illiquid banks early in the run.
  - Overall liquidity shortfall needed to pay off all deposit withdrawals remains very small: less than ½ percent of pre-shock total banking sector assets for domestic run; about 2 percent of pre-shock total assets for FX run.
  - Banks’ ability to sell liquid assets when needed is a key assumption; simultaneous shocks across banks could prevent such sales.

### Dynamic developments and evolution of risk profile
- Since December 2006:
  - Banks’ total assets rose by about 120 percent, mostly due to lending growth.
  - System-wide CAR fell by 7½ percentage points to about 19½ percent.
- Implication:
  - Increased risk sensitivity of Tajik banks due to a rise in risk-weighted asset base.
  - If fast balance-sheet expansion continues, banks must price risks appropriately, including potential build-up of unrecognized credit risk from weak credit assessment and management tools.

*Source: IMF staff estimates and National Bank of Tajikistan (excerpts from the referenced IMF chapter).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08371.pdf_