## Republic of Serbia Financial System Stability Assessment ## Source details **Canonical URL:** [Republic of Serbia Financial System Stability Assessment](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10147.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10147.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10147.pdf.json) --- ### Executive summary — system-wide findings - Economy shocks and market reaction: - 20 percent depreciation of the dinar vis-à-vis the euro (October 2008–February 2009). - Soaring sovereign spreads, weak export demand, and a plummeting stock market (decline of about 60 percent). - Confidence impact: withdrawal of 18 percent of household deposits from mainly foreign-owned banks. - Banking-system metrics (selected): - Aggregate capital adequacy ratio (CAR): 21 percent (June 2009). - Liquid assets covered 67 percent of short-term liabilities. - Nonperforming loans (NPLs): 16½ percent (June 2009). - System assessment: - Financial system weathered the global crisis to date but faces risks from further economic deterioration. - Key systemic risks: persistent recession, CICR (currency-induced credit risk) from unhedged FX exposures, curtailed external financing to banks, and domestic fiscal policy uncertainty increasing spreads and dinar pressure. ### Banking sector resilience and vulnerabilities - Strengths: - High capitalization and liquidity: CAR 21 percent (June 2009); liquid assets covering 67 percent of short-term liabilities. - Stress tests indicate considerable resilience; even substantial increases in NPLs under severe scenarios do not cause significant undercapitalization for most large banks. - Vulnerabilities: - Very high level of Euroization, weakening monetary policy effectiveness and exposing banks to CICR. - Heavy reliance on foreign funding: 75 percent of the banking system (by funding source) is reliant on foreign funding. - Rising asset quality concerns: NPLs increased to 16½ percent (June 2009). - Potential financial disintermediation driven by high reserve requirements and related distortions. - Performance and ratios (selected): - CAR for entire banking system: 21 percent; all banks maintain CAR above the 12 percent prescribed minimum. - Leverage ratio (total equity/total assets): 23 percent. - NPL ratio: 11.3 percent at end-2008; 16½ percent in June 2009. - Liquid assets: 42 percent of total assets; covered 67 percent of short-term liabilities. - Loan-to-deposit ratio: declined from 104 percent in 2008 to 100 percent in June 2009. - Net open FX position (overall) as percent of Tier I capital: 4.4 (2009-H1). ### Stress-test scenarios and quantitative sensitivities - Coverage and scenarios: - Fifteen largest banks and one small state-owned bank (84 percent of banking sector assets). - Most severe scenario: further widening of the output gap by 6½ percentage points, a 25 percent depreciation of the exchange rate, and an 8 percentage point increase in interest rates over a one-year horizon. - Key stress-test results: - A 25 percent exchange rate depreciation: CICR raised NPLs by almost 6 percentage points. - Severe scenario with 6.5 percentage point lower output gap: NPLs increase by 4.5 percentage points. - In the most severe scenario, an increase in system NPLs of an additional 13½ percentage points did not result in severe undercapitalization for large banks; some banks fell below the 12 percent CAR, most stayed above 8 percent. - Recapitalization needed to restore CAR to 12 percent did not exceed 1.2 percent of GDP in the most severe scenario (excluding net profit buffers). - Liquidity shocks (i) significant deposit withdrawals and (ii) pullback in parent bank funding with maturity of less than one year — in both cases, no bank became illiquid following the shocks. - One state-owned bank exhausts its capital in the most severe scenario and is in the process of restructuring. ### Monetary policy, reserve requirements, and market functioning - NBS actions and issues: - NBS policy rate cut by 825 bps in 2009. - High reserve requirements (RRs), particularly on FX liabilities, used to limit credit expansion and increased banks’ funding costs. - RRs encouraged corporates to borrow directly from parent banks abroad, contributing to financial disintermediation. - Recommendations: - Gradual reassessment and simplification of RRs (eliminating numerous exemptions); any changes to the level should be gradual. - Deepen the money market and promote de-Euroization to improve the inflation-targeting framework. - Reduce number of NBS repo auctions to one per week (Short-term). - Prepare alternative liquidity draining channels to scale down NBS repo auctions (Medium-term). - Start developing a comprehensive debt management strategy (Short-term). - Liquidity management specifics: - Consider lowering FX RRs carefully to reduce FX funding costs while accounting for monetary policy objectives. - Leverage T-Bills market: higher T-Bill issuance and a liquid secondary market to meet structural liquidity needs. - LOLR: broadened acceptable collateral is helpful; ensure margining policy aligns with risk profile and consider automatic recapitalization mechanisms as necessary. ### Crisis management, bank resolution, and deposit insurance - Crisis framework and FSSP: - Financial Sector Stability Package (FSSP) under Vienna Initiative: parent banks committed to maintain end-2008 exposure levels throughout 2009–10 and to keep subsidiaries sufficiently capitalized and liquid. - FSSP incentives: access to new liquidity facilities; softening of some regulatory requirements. - Planned unwind: parent banks’ exposure limits assumed reduced from 100 percent to 80 percent, effective April 2010; recommendation for gradual and coordinated phase-out. - Problem bank resolution design: - Proposed split: NBS to handle restructuring of open banks; DIA to handle liquidation of closed banks. - Need for institutional separation to mitigate conflicts of interest (specialized problem bank resolution unit within NBS reporting to the governor). - Contingent financing mechanisms recommended to channel emergency government assistance to distressed banks through the DIA as part of resolution. - Apply least-cost principle; if public funds required, they should come from MOF with contingency provisions for quick disbursement. - Deposit Insurance Agency (DIA) and DIF capacity: - DIF total financial assets: EUR 98.4 million (as of October 2009). - Total amount of insured deposits: EUR 5.4 billion (end-2009). - DIA financial reserves amount to 1.8 percent of its total exposure. - DIF could approximately cover insured depositors of up to 20 of the smallest banks individually or the sum of the 9 smallest banks in the system (as of October 2009). - Coverage raised from EUR 3,000 to EUR 50,000 per private individual depositor per bank; eligible depositors extended to sole entrepreneurs and SMEs. - Coverage levels: 99 percent of deposits by number and 90 percent by volume are covered by the DIF. - Concerns: DIF funding capacity limited for systemic crises; no contingent government lines of credit in place; high coverage may create moral hazard. - DIA recommendations: - Finalize detailed payout procedures and invest in IT platforms for rapid payout. - Arrange a standby emergency line of credit with GOS to empower timely action in systemic events. - Enhance operational capacity of the DIA to ensure timely payout of insured deposits (Short-Term). - Put in place contingent financing mechanisms between MOF and DIA for emergency drawdown (Short-Term). - Evaluate insured deposit coverage when crisis is over and system stable (Medium Term). - Prepare a comprehensive strategy for the DIA, clarifying role, responsibilities, and funding (Medium Term). ### Corporate and household debt restructuring, insolvency, and enforcement - Corporate sector distress and exposure: - Corporate loans from international banks and capital markets reached 36 percent of GDP, creating significant FX risk and large net open positions. - Corporate financial indicators (highlights): sales growth 2008: 18.7; profit margin 2008: -0.2; ROE (after tax) 2008: -1.0; Interest Coverage Ratio 2008: 0.9. - Household sector vulnerabilities: - FX-linked loans to total loans: 2009 H1: 79.0. - FX-deposits to total deposits: 2009 H1: 91.5 (sample series); FX-deposits to FX- and FX-indexed loans: 2009 H1: 158.4. - Loan-to-value ratio for mortgage loans: 2009 H1: 65.3. - Household exposure to FX partly mitigated by high FX deposits and remittances; approximately 90 percent of home loans insured by the National Mortgage Insurance Corporation (NMIC). - Enforcement and restructuring constraints: - Blocked account process increased by 75 percent over the past year; judicial enforcement can take up to three years. - NBS temporarily relaxed rules: banks can reschedule a borrower’s debt and reclassify it as performing after six months under certain conditions. - Recommended actions: - Establish corporate workout guidelines to facilitate restructuring of NPLs and address corporate distress — Immediate. - Additional incentives for workout procedures (e.g., favorable tax treatment for debt forgiveness, debt-equity swaps, access to priority financing). - Streamline auction and execution procedures; develop regulated profession of execution officers. - Introduce mandatory registration of bills of exchange in a centralized registry — Short term. - Amend pledge law to clarify priority and protection of cash collateral — Short-term. - Exclude creditors whose claims are not affected to accelerate pre-negotiated restructurings. ### Insurance sector — development and regulatory actions - Sector profile and performance: - Insurance consumption: €76 per capita (non-life) and €10 per capita (life). - By mid-2009, 25 insurance companies; industry accounted for 4.6 percent of total assets and 5.6 percent of total capital of the financial sector. - Solvency Ratio close to 200 percent (2005–09). - Premium Leverage Ratio: 1.7–1.9 (Serbia) versus 2.5–3 internationally. - Overall underwriting losses and expenses remain below annual premium intake. - Key regulatory recommendations: - Promote development of life insurance on a level playing field with pension funds. - Separate life and non-life parts of the business for all companies — Short-term. - Liberalize the local reinsurance market — Short-term. - Consider temporarily eliminating the 5 percent tax on non-life insurance premiums given lack of real growth in non-life insurance. ### Risk Assessment Matrix — selected highlights - 1. Reduced external funding of foreign banks and the corporate sector - Assessment: Medium - Likelihood of severe realization sometime in the next 3 years: High - Expected impact: Immediate credit crunch for banks reliant on foreign funding; exchange-rate effects raising CICR and NPLs (see: exchange rate depreciates by 25 percent → CICR raised NPLs by almost 6 percentage points). - 2. Risk of persistent structural fiscal deficits threatening fiscal sustainability - Assessment: Medium; Likelihood: Medium; Expected impact: Higher risk premium and downward pressure on domestic currency, amplified if capital inflows reverse. - 3. Substantial deterioration in the economic outlook - Assessment: Medium; Expected impact: High cumulative impact over a number of years—negative effects on profitability, potential deleveraging, credit crunch, and increases in NPLs (see: severe stress with 6.5 percentage point lower output gap → NPLs +4.5 percentage points). ### Key macroeconomic indicators (selected, as presented in Table 3) - Real GDP: 2006: 5.2; 2007: 6.9; 2008: 5.5; 2009: -2.9; 2010 (Proj.): 2.0 - Consumer prices (average): 2006: 2/12.7; 2007: 6.5; 2008: 12.4; 2009: 8.1; 2010 (Proj.): 4.8 - Consumer prices (end of period): 2006: 2/6.6; 2007: 11.0; 2008: 8.6; 2009: 6.6; 2010 (Proj.): 6.0 - Unemployment rate (in percent): 2006: 21.6; 2007: 18.8; 2008: 14.7; 2009: 17.4; 2010: ... - Nominal GDP (in billions of dinars): 2006: 1,980; 2007: 2,363; 2008: 2,751; 2009: 2,899; 2010 (Proj.): 3,139 - Fiscal balance (cash basis): 2006: -1.6; 2007: -1.9; 2008: -2.6; 2009: -4.2; 2010 (Proj.): -4.1 - Gross debt (% of GDP): 2006: 42.6; 2007: 33.3; 2008: 32.1; 2009: 32.2; 2010 (Proj.): 33.7 - Current account balance (% of GDP): 2006: -10.1; 2007: -15.5; 2008: -17.1; 2009: -5.7; 2010 (Proj.): -8.5 - External debt (end of period; billions of euro): 2006: 14.9; 2007: 17.8; 2008: 21.8; 2009: 23.4; 2010 (Proj.): 25.4 - Gross official reserves (in billions of euro): 2006: 8.7; 2007: 9.5; 2008: 8.2; 2009: 10.6; 2010 (Proj.): 11.3 - Reserves (in months of prospective imports of GNFS): 2006: 6.6; 2007: 6.3; 2008: 7.7; 2009: 7.3; 2010 (Proj.): 9.2 ### Banking supervision, legal framework, and Basel Core Principles (BCP) issues - Legal and supervisory framework: - 2005 Law on Banks (LOB) aligned framework with international standards, EU Directives, and BCPs; introduced two-step licensing and consolidated supervision. - NBS enhanced risk management standards and intensified cooperation with overseas supervisors; participation in supervisory colleges and joint inspections noted. - Remaining supervisory priorities: - Streamline loan classification and provisioning to reduce discretionary interpretation. - Strengthen BSD capacity: more portfolio managers, IT auditors, and experienced team leaders; improve remuneration and career prospects. - Formalize MOUs with important home supervisors by resolving confidentiality issue related to mandatory exchange with tax authority. - Shift onsite supervision toward qualitative assessments and develop a full early warning system. - Prepare specific regulations for market risk, country risk, operational risk, and interest rate risk in the banking book. - BCP assessment highlights and recommended actions: - Serbia largely compliant with BCPs but needs improvements in international cooperation, supervisory skills, consolidated reporting, market risk supervision, and operational/IT capacity. - Recommended actions include clarifying supervisory objectives, enhancing legal protection for supervisors, aligning capital adequacy with EU practice, and requiring consolidated reporting for key indicators. ### Key recommendations (priorities preserved, excerpted) - Banking Regulation and Supervision - Set more precise loan classification criteria and required provisioning — Immediate. - Monitor rescheduled and restructured loans — Immediate. - Relax provisioning and asset classification requirements related to FX loans and reclassification of restructured loans — Immediate. - Ensure adequate staffing in the BSD through competitive salary structures, training, and career prospects — Short-term. - Liquidity and Securities Market Issues - Streamline reserve requirement regulations and reassess levels — Immediate (gradual changes). - Reduce NBS repo auctions to one per week — Short-term. - Prepare alternative liquidity draining channels — Medium-term. - Start developing a comprehensive debt management strategy — Short-term. - Crisis Management and Bank Resolution - Introduce comprehensive crisis management framework and necessary legal amendments — Immediate. - Develop crisis MOUs with relevant home countries — Medium Term. - Introduce broader problem bank restructuring options under the NBS for an open bank — Short-term. - Separate problem bank resolution functions from supervisory functions and set up independent restructuring unit when needed — Short-term. - Consider mechanisms for emergency government financial assistance for bank restructuring costs — Short-term. - Deposit Insurance Scheme - Enhance DIA operational capacity for timely payouts — Short-Term. - Put in place contingent financing mechanisms between MOF and DIA — Short-Term. - Evaluate insured deposit coverage when crisis is over — Medium Term. - Prepare a comprehensive strategy for DIA role and funding — Medium Term. - Corporate and Household Debt - Establish corporate workout guidelines to facilitate restructuring of NPLs — Immediate. - Introduce mandatory registration of bills of exchange — Short-term. - Amend pledge law to clarify priority and protection of cash collateral — Short-term. - Insurance Sector - Separate life and non-life insurance companies in all aspects — Short-term. - Adopt measures to promote the insurance sector and liberalize local reinsurance market — Short-term. *Prepared by the Monetary and Capital Markets and European Departments. Approved by José Viñals and Marek Belka. March 8, 2010.* ### 2010. The views expressed in this document are those of the staff team and do not necessarily reflect ### Republic of Serbia Financial System Stability Assessment ### Executive summary — system-wide findings - The economy suffered from a 20 percent depreciation of the dinar vis-à-vis the euro, soaring sovereign spreads, weak export demand, and a plummeting stock market. - Confidence in the banking sector was affected, reflected in the withdrawal of 18 percent of household deposits from banks. - Aggregate capital adequacy ratio (CAR) was 21 percent in June 2009. - The banking system’s liquid assets covered 67 percent of short-term liabilities. - Nonperforming loans (NPLs) reached 16½ percent in June 2009. - The financial system has weathered the global financial crisis to date, but faces the challenge of a possible further deterioration of the economic environment with attendant effects on asset quality. - Key systemic risks include recession persistence, indirect effects on credit risk due to corporate and household unhedged foreign exchange (FX) exposures, curtailed external financing to banks, and domestic fiscal policy uncertainty leading to higher spreads and pressure on the dinar. ### Banking sector resilience and vulnerabilities - Banking sector strengths: - High capitalization and liquidity: CAR 21 percent (June 2009); liquid assets covering 67 percent of short-term liabilities. - Stress tests indicate considerable resilience; even substantial increases in NPLs under severe scenarios do not cause significant undercapitalization. - Main vulnerabilities: - Very high level of Euroization, weakening monetary policy effectiveness and exposing banks to currency-induced credit risk (CICR). - Heavy reliance on foreign funding: 75 percent of the banking system (by funding source) is reliant on foreign funding. - Rising asset quality concerns: NPLs increased to 16½ percent (June 2009). - Potential for financial disintermediation driven by high reserve requirements and related distortions. ### Stress-test scenarios and quantitative sensitivities - Under a stress test assumption where the exchange rate depreciates by 25 percent, CICR raised NPLs by almost 6 percentage points. - Under severe stress test assumptions with a 6.5 percentage point lower output gap, NPLs increase by 4.5 percentage points. - The assessment highlights that a sudden stop or reversal in capital inflows could produce an immediate credit crunch for banks reliant on foreign funding and affect the exchange rate and valuation of risk-weighted assets. ### Monetary policy, reserve requirements, and market functioning - The National Bank of Serbia (NBS) has improved monetary policy management since the 2005 FSAP, but: - High reserve requirements (RRs), particularly on FX liabilities, have been used to limit credit expansion and increased banks’ funding costs. - These RRs have encouraged corporates to borrow directly from parent banks abroad, contributing to potential financial disintermediation. - Recommendations include gradual reassessment and simplification of RRs (eliminating numerous exemptions), deepening the money market, and promoting de-Euroization to improve the inflation-targeting framework. ### Crisis management, bank resolution, and deposit insurance - Proposed problem bank resolution framework: responsibilities divided between the NBS and the Deposit Insurance Agency (DIA) to allow “least cost restructuring” of problem banks. - Conditions for effectiveness: - Mitigate potential conflicts of interest by institutional separation of NBS supervisory and restructuring enforcement responsibilities. - Contingent financing mechanisms to allow emergency channeling of government assistance to distressed banks through the DIA as part of a resolution process. - The DIA requires a comprehensive review: current insured deposit coverage could lead to excessive risk-taking; DIA performs several tasks that may generate conflicts of interest and weaken institutional focus. ### Corporate and household debt restructuring - Debt restructuring mechanisms are insufficient given increasing corporate distress and rising NPLs. - The NBS temporarily relaxed some rules to encourage debt rescheduling, providing breathing space. - Recommended actions: - Additional incentives to encourage workout procedures. - Further streamlining of auction and execution procedures. - Further development of a regulated profession of execution officers. - Exclude creditors whose claims are not affected to accelerate and simplify pre-negotiated restructurings. ### Insurance sector - The insurance sector is adequately capitalized relative to its overall risk exposure but is underdeveloped and lags most of the region. - Despite some deterioration in asset quality, underwriting losses and expenses remain below annual premium intake. - Key issues to address: - Promote the development of life insurance on a level playing field with pension funds. - Separate life and non-life parts of the business for all companies. - Liberalize the local reinsurance market. ### Risk Assessment Matrix — selected highlights - 1. Reduced external funding of foreign banks and the corporate sector - Assessment: Medium - Likelihood of severe realization sometime in the next 3 years: High - Expected impact: Immediate credit crunch for banks reliant on foreign funding; exchange-rate effects raising CICR and NPLs (see: exchange rate depreciates by 25 percent → CICR raised NPLs by almost 6 percentage points). - 2. Risk of persistent structural fiscal deficits threatening fiscal sustainability - Assessment: Medium; Likelihood: Medium; Expected impact: Higher risk premium and downward pressure on domestic currency, amplified if capital inflows reverse. - 3. Substantial deterioration in the economic outlook - Assessment: Medium; Expected impact: High cumulative impact over a number of years—negative effects on profitability, potential deleveraging, credit crunch, and increases in NPLs (see: severe stress with 6.5 percentage point lower output gap → NPLs +4.5 percentage points). ### Key recommendations (excerpted from Table 2; priorities preserved) - Banking Regulation and Supervision - Set more precise loan classification criteria and required provisioning rather than broad ranges subject to interpretation — Immediate - Monitor rescheduled and restructured loans — Immediate - Relax provisioning and asset classification requirements related to FX loans and the reclassification of restructured loans — Immediate - Ensure adequate staffing in the BSD through competitive salary structures, training opportunities, and career prospects — Short-term - Liquidity and Securities Market Issues - Streamline the reserve requirement regulations and reassess its level, although any changes to the level should be gradual — Immediate - Reduce the number of NBS repo auctions to one per week — Short-term - Prepare alternative liquidity draining channels to allow a scaling down of the NBS repo auctions — Medium-term - Start developing a comprehensive debt management strategy — Short-term - Crisis Management Framework - Introduce a comprehensive crisis management framework by obtaining approval of the necessary legal amendments — Immediate - Develop crisis memoranda of understanding with relevant home countries — Medium Term - Bank Resolution - Introduce broader problem bank restructuring options under the NBS for an open bank — Short-term - Issue NBS regulations to separate problem bank resolution functions from supervisory functions, including setting up an independent problem bank restructuring unit when needed, reporting directly to the governor — Short-term - Consider putting in place mechanisms for emergency government financial assistance for bank restructuring costs — Short-term - Deposit Insurance Scheme - Enhance the operational capacity of the DIA to ensure timely payout of insured deposits — Short-Term - Put in place contingent financing mechanisms between the Ministry of Finance (MOF) and the DIA for emergency drawdown needs — Short-Term - Evaluate the insured deposit coverage when the crisis is over and the system is stable — Medium Term - Prepare a comprehensive strategy for the DIA, including role, responsibilities, and funding — Medium Term - Corporate and Household Debt - Establish corporate workout guidelines to facilitate restructuring of NPLs and address corporate distress — Immediate - Introduce mandatory registration of bills of exchange in a centralized registry — Short term - Amend pledge law to clarify priority and protection of cash collateral (exempt from blocked accounts process) — Short-term - Insurance Sector - Separate life and non-life insurance companies in all aspects — Short-term - Adopt measures to promote the insurance sector — Short-term - Liberalize the local reinsurance market — Short-term *Prepared by the Monetary and Capital Markets and European Departments. Approved by José Viñals and Marek Belka. March 8, 2010.* ### 1. Like most countries in the region, Serbia has been hit hard by the global ### _cr10147 - 1. Like most countries in the region, Serbia has been hit hard by the global ### Crisis impact and immediate developments - October 2008–February 2009: 20 percent depreciation of the dinar vis-à-vis the euro. - Household deposit withdrawal: 18 percent of household savings deposits withdrawn from mainly foreign-owned banks. - Stock market: decline of about 60 percent. - External trade: declined by nearly a third. - GDP: contracted by about 4 percent in the first half of 2009. - CPI inflation: declined to 6.6 percent in December, within the NBS’s end-2009 target. - NBS policy action: policy rate cut by 825 bps in 2009. - Fiscal outcome 2009: fiscal deficit increased to about 4½ percent of GDP in 2009 due to plunging tax collections despite spending cuts and nominal freezes. ### Policy response, Financial Sector Support Program (FSSP), and external financing - Government requested a stand-by arrangement (SBA) with the IMF. - Banking-sector measures: increased deposit insurance coverage; injection of €2 billion into the banking system through direct intervention and changes in RRs; abolishment of the RR on new foreign borrowing (temporarily lifted on new FX external borrowing from September 2008). - Access under the IMF program augmented; additional loans secured from other IFIs and the EU. - FSSP: combination of commitments by banks under the Vienna Initiative and incentives by the NBS (access to new liquidity facilities; softening of some regulatory requirements). - Vienna Initiative commitments: foreign parent banks committed to maintain exposure to Serbia at end-2008 levels throughout 2009–10 and to keep subsidiaries sufficiently capitalized and liquid. - Planned unwind: parent banks’ exposure limits assumed to be reduced from 100 percent to 80 percent, effective in April 2010; recommendation for gradual and coordinated phase-out to avoid disruptive swings in capital flows. ### Key macroeconomic indicators (selected, as presented in Table 3) - Real GDP: 2006: 5.2; 2007: 6.9; 2008: 5.5; 2009: -2.9; 2010 (Proj.): 2.0 - Consumer prices (average): 2006: 2/12.7; 2007: 6.5; 2008: 12.4; 2009: 8.1; 2010 (Proj.): 4.8 - Consumer prices (end of period): 2006: 2/6.6; 2007: 11.0; 2008: 8.6; 2009: 6.6; 2010 (Proj.): 6.0 - Unemployment rate (in percent): 2006: 21.6; 2007: 18.8; 2008: 14.7; 2009: 17.4; 2010: ... - Nominal GDP (in billions of dinars): 2006: 1,980; 2007: 2,363; 2008: 2,751; 2009: 2,899; 2010 (Proj.): 3,139 - General government revenue (% of GDP): 2006: 43.8; 2007: 42.4; 2008: 41.4; 2009: 39.6; 2010 (Proj.): 38.4 - General government expenditure (% of GDP): 2006: 45.4; 2007: 42.2; 2008: 40.0; 2009: 43.7; 2010 (Proj.): 42.5 - Fiscal balance (cash basis): 2006: -1.6; 2007: -1.9; 2008: -2.6; 2009: -4.2; 2010 (Proj.): -4.1 - Structural fiscal balance: 2006: 3/-2.3; 2007: -3.6; 2008: -4.7; 2009: -3.5; 2010: -4.4 - Gross debt (% of GDP): 2006: 42.6; 2007: 33.3; 2008: 32.1; 2009: 32.2; 2010 (Proj.): 33.7 - Money (M1) (end 12-month change, in percent): 2006: 37.1; 2007: 25.3; 2008: -3.8; 2009: -9.7; 2010 (Proj.): 11.7 - Broad money (M2) (end 12-month change, in percent) 4/: 2006: 38.4; 2007: 44.5; 2008: 9.6; 2009: 7.2; 2010 (Proj.): 9.8 - Domestic credit to non-government (end 12-month change, in percent): 2006: 17.1; 2007: 36.9; 2008: 35.0; 2009: 10.0; 2010 (Proj.): 11.9 - Current account balance (% of GDP): 2006: -10.1; 2007: -15.5; 2008: -17.1; 2009: -5.7; 2010 (Proj.): -8.5 - External debt (end of period; billions of euro): 2006: 14.9; 2007: 17.8; 2008: 21.8; 2009: 23.4; 2010 (Proj.): 25.4 - External debt (in percent of GDP): 2006: 63.3; 2007: 60.2; 2008: 63.6; 2009: 76.0; 2010 (Proj.): 79.5 - Gross official reserves (in billions of euro): 2006: 8.7; 2007: 9.5; 2008: 8.2; 2009: 10.6; 2010 (Proj.): 11.3 - Reserves (in months of prospective imports of GNFS): 2006: 6.6; 2007: 6.3; 2008: 7.7; 2009: 7.3; 2010 (Proj.): 9.2 (Note: Table 3 footnotes preserved in source: 1/ Excluding Kosovo (with the exception of external debt). 2/ Retail prices until 2006. 3/ Fiscal balance adjusted …; see IMF Country Report No. 07/390 for details. 4/ Excluding frozen foreign currency deposits.) ### Challenges going forward (three key risks) - Adverse external funding environment: - International financial conditions remain fragile. - Spillovers from regional countries affecting common parent banks, or renewed uncertainty over Serbia’s policy direction, could cause a sudden stop or reversal in capital inflows, leading to a credit crunch, weaker exchange rate, and worsened asset quality due to currency induced credit risk (CICR). - Fiscal risk and investor confidence: - Expectation of modest recovery, high spending needs, and low tax receipts keep fiscal risks elevated, potentially manifesting in a higher risk premium and renewed FX market pressures. - Prolonged real sector weakness and banks’ balance-sheet deterioration: - Low growth persisting over years could raise unemployment and reduce debt servicing capacity, making bank profitability recovery difficult and eroding capital cushions; compounded by protracted corporate loan restructuring for already impaired loans. ### Financial system structure - Financial system assets: reached 71 percent of GDP in mid-2009. - System composition: bank-dominated; NBFIs hold 11 percent of financial sector assets. - Ownership structure (mid-2009): state-owned banks 15 percent of total assets; foreign ownership almost 75 percent of the banking system. - Major foreign banking parents: Austrian subsidiaries 27 percent of system assets; Greek subsidiaries 16 percent; Italian subsidiaries 15.4 percent. ### Banking system assets, liabilities, and exposures - Asset mix (Table 5, in percent of total assets): - Cash and RR: Dec-07: 24.0; Dec-08: 25.9; Jun-09: 24.0 - T bills and NBS repo: Dec-07: 14.1; Dec-08: 5.2; Jun-09: 7.6 - Loans: Dec-07: 54.9; Dec-08: 60.1; Jun-09: 59.4 - Other: Dec-07: 7.1; Dec-08: 8.8; Jun-09: 9.0 - Loans: close to 60 percent of assets; three-quarters of loans are FX-linked. - Loan allocation: over half of loans to enterprises; about a third to households; 16 percent of total loans in mortgages; industry and trade sectors receive almost 20 percent each. - Off-balance-sheet contingent liabilities: about €7.6 billion at end-2008, concentrated in foreign-owned banks; consisting mainly of guarantees by subsidiaries (€4.8 billion) and unutilized credit line commitments; new guarantees have almost stopped since the crisis began. - Funding structure: - Deposits: account for 60 percent of total liabilities; 69 percent of deposits are in FX. - External liabilities: about 20 percent of total liabilities (borrowing and deposits); external borrowing somewhat longer term (over one year maturity) than deposits. - Interbank funding: minimal. ### Corporate and household sectors: vulnerabilities - Corporate sector deterioration: - 2008 outcomes: companies registered considerable losses; manufacturing showed worst results and lowest debt service capacity; financial sector most profitable. - Corporate external debt: corporate loans from international banks and capital markets reached 36 percent of GDP, exposing corporates to significant FX risk and large net open positions. - Corporate sector financial indicators (Table 6 highlights): - Sales growth: 2006: 29.1; 2007: 20.6; 2008: 18.7 - Profit margin: 2006: 2.4; 2007: 1.0; 2008: -0.2 - ROE (after tax): 2006: 3.8; 2007: 1.5; 2008: -1.0 - Equity to Debt: 2006: 1.0; 2007: 0.9; 2008: 0.7 - Liabilities to assets: 2006: 51.1; 2007: 52.8; 2008: 58.1 - Interest Coverage Ratio: 2006: 2.7; 2007: 1.7; 2008: 0.9 - Household sector vulnerabilities (Table 7 highlights): - FX-linked loans to total loans: 2006: 80.1; 2007: 81.5; 2008: 79.6; 2008 H1: 79.4; 2009 H1: 79.0 - FX-deposits to total deposits: 2005: 92.0; 2006: 90.7; 2007: 91.0; 2008: 90.6; 2008 H1: 91.5; 2009 H1: 91.5 - FX-deposits to FX- and FX-indexed loans: 2006: 177.8; 2007: 172.6; 2008: 143.1; 2008 H1: 176.2; 2009 H1: 158.4 - Loan-to-value ratio for mortgage loans: 2005: 60.6; 2006: 61.6; 2007: 64.9; 2008: 65.4; 2008 H1: 65.4; 2009 H1: 65.3 - Short-term loans to total household loans: 2005: 17.7; 2006: 19.6; 2007: 15.0; 2008: 11.6; 2008 H1: 16.2; 2009 H1: 12.1 - Households: exposure to FX risk partly mitigated by high level of FX deposits and remittances; households reportedly hold positive financial net worth in deposits, investments, life insurance, and voluntary pension funds; loan-to-value ratios stable and no significant housing price drops observed through mid-2009. ### Banking sector performance and risks - Capitalization and leverage: - CAR for entire banking system: 21 percent; all banks maintain CAR above the 12 percent prescribed minimum. - Leverage ratio (total equity/total assets): 23 percent. - Asset quality: - NPL ratio: 11.3 percent at end-2008; 16½ percent in June 2009. - NPL concentration: manufacturing, trade, and real estate sectors; higher NPLs at the four majority state-owned banks and at private domestic banks. - Liquidity and resilience: - Liquid assets: 42 percent of total assets; covered 67 percent of short-term liabilities. - System withstood 18 percent withdrawal of household deposits from mainly foreign-owned banks without NBS support (parent banks provided liquidity). - Loan-to-deposit ratio: declined from 104 percent in 2008 to 100 percent in June 2009. - Little interbank activity; limited contagion risk from interbank channel. - FX and interest rate risk: - Direct bank exposure low: overall net open position accounts for 4.4 percent of Tier I capital as of June 2009 (mostly long positions in 2009). - Indirect exposure high: unhedged FX borrowing by households and corporates creates significant indirect FX risk for banks. *Source: Serbian authorities; and IMF staff estimates and projections.* ### 20. Profitability of the Serbian banking system, which is low for the CESE region, ### 20. Profitability of the Serbian banking system, which is low for the CESE region ### Profitability and recent performance - Net income halved in 2009 due to large loan losses. - Return on equity (ROE) dropped to 4.1 percent (annualized) from 9.3 percent in 2008. - Net interest margin remains the main source of banks’ profits and has been relatively stable with respect to total loans. - Some 13 banks (with a total of 16 percent market share) are generating significant losses. - Historically, low profitability reflects high capital and RRs. ### Overall assessment and potential vulnerabilities - Authorities’ measures to curb credit growth: - Created capital and liquidity buffers that help resilience. - Had detrimental effects on financial system development through: - circumvention via direct borrowing abroad (at lower interest cost to corporates); - high costs for the banks because of the RRs; - a complex regulatory framework that leaves significant room for discretion. - These factors contributed to low profitability of Serbian banks relative to other countries in the region. - Key risks going forward: - Prolonged recession and indirect effects on credit risk due to corporate and household unhedged FX exposures. - Further macroeconomic shocks, curtailed external financing to banks (partly mitigated by the FSSP), and fiscal policy uncertainty within Serbia. - Severe scenarios would operate mainly through a loss of confidence, higher spreads, and strong pressure on the dinar. - Profitability restoration risk: - Banks can withstand severe shocks within a one-year horizon per stress tests, but insufficient medium-term profitability would erode capital buffers. - International initiatives to strengthen capital and other requirements could further impair bank profitability if growth opportunities remain subdued. ### Non-performing loans and restructuring - The corporate debt restructuring process needs strengthening to prevent NPLs becoming a long-term burden. - Current mechanisms (e.g., temporary loosening of provisioning for certain restructured loans) are insufficient. - Further measures to strengthen insolvency and enforcement mechanisms are proposed (see Section V.B in source). ### De-Euroization (policy recommendation and rationale) - De-Euroization over the medium-term would be desirable. - Euroization is a key source of vulnerability for borrowers and the banking system. - High euroization impairs the NBS’ ability to affect incentives through dinar interest rate signals, weakening the monetary transmission mechanism. - Even within Serbia’s intention to eventually join the Euro area, de-Euroization is an appropriate systemic risk management policy over the medium term. - Key elements of a de-Euroization strategy would include: - sound macroeconomic policies; - incentives to encourage the Dinarization of banks’ assets. - Measures accompanying a cut in reserve requirements should aim to make dinar lending more appealing, for example: - schemes to induce conversion of FX loans to dinar loans; - remuneration of RRs in dinars. - Objective: even some degree of de-euroization would give the NBS room for maneuver; the aim is not complete elimination of euroization. ### Small banks and state-owned banks - Small banks’ financial condition needs to be addressed. - Authorities should ensure: - capital of majority state-owned banks is sufficiently strengthened before divestment (whether plans involve mergers or not); - risk management at private domestic banks is enhanced. - The National Mortgage Insurance Corporation should be adequately capitalized and its financial status monitored (see Para. 64 in source). ### Key financial soundness indicators (selected figures from Table 8) - Regulatory capital to risk-weighted assets: 26.0 (2005), 24.7 (2006), 27.9 (2007), 21.9 (2008), 21.2 (2009-H1). - Regulatory Tier I capital to risk-weighted assets: 22.2 (2005), 24.2 (2006), 28.5 (2007), 22.8 (2008), 23.7 (2009-H1). - Capital to assets: 16.2 (2005), 18.5 (2006), 21.0 (2007), 23.6 (2008), 23.3 (2009-H1). - Gross non-performing loans to total loans: 11.3 (2008), 16.5 (2009-H1). - Specific Provisions to Gross Non Performing Loans: 56.9 (2008), 46.6 (2009-H1). - Non Performing Loans net of provisions to Tier I capital: 14.8 (2008), 27.1 (2009-H1). - Specific Provisions to gross loans: 10.3 (2005), 11.0 (2006), 8.4 (2007), 7.1 (2008), 9.4 (2009-H1). - Return on Average Assets (ROAA): 1.1 (2005), 1.7 (2006), 1.7 (2007), 2.1 (2008), 1.0 (2009-H1). - Return on Average Equity (ROAE): 6.5 (2005), 9.7 (2006), 8.5 (2007), 9.3 (2008), 4.1 (2009-H1). - Net interest Margin to gross operating income (2009-H1): 61.8. - Non-interest expenses to gross operating income (2009-H1): 88.9. - Core Liquid assets to total assets: 30.5 (2005), 40.7 (2006), 37.3 (2007), 30.3 (2008), 30.3 (2009-H1). - Liquid assets to total assets: 19.8 (2005), 22.9 (2006), 46.7 (2007), 43.3 (2008), 41.8 (2009-H1). - FX-indexed loans to total loans: 66.2 (2008), 71.6 (2009-H1). - FX-deposits to total deposits: 70.7 (2005), 65.9 (2006), 64.2 (2007), 69.0 (2008), 70.1 (2009-H1). - FX-liabilities to total liabilities: 74.7 (2005), 72.4 (2006), 67.8 (2007), 72.1 (2008), 82.0 (2009-H1). - Deposits to assets: 62.5 (2005), 57.0 (2006), 61.4 (2007), 57.7 (2008), 59.2 (2009-H1). - Loans to deposits: 94.9 (2005), 86.7 (2006), 89.3 (2007), 104.3 (2008), 100.3 (2009-H1). - Net open FX position (overall) as percent of Tier I capital: 18.6 (2005), 21.7 (2006), 14.5 (2007), 7.4 (2008), 4.4 (2009-H1). - Off-balance sheet operations as percent of assets: 26.4 (2005), 41.0 (2006), 49.2 (2007), 56.2 (2008), 49.1 (2009-H1). ### Stress tests: coverage, scenarios, and results - Coverage: - Fifteen largest banks and one small state-owned bank, accounting for 84 percent of the banking sector’s assets. - Banks grouped into: (a) local private banks; (b) foreign banks; (c) state-owned banks; (d) consolidated banking sector. - Shocks tested: - Market, credit (including off-balance sheet), and liquidity risks with single and multi-factor shocks. - Shocks calibrated on Serbia’s historical experience and cross-country banking crisis evidence. - Adverse scenarios: - Most severe scenario: further widening of the output gap by 6½ percentage points, a 25 percent depreciation of the exchange rate, and an 8 percentage point increase in interest rates, over a one-year horizon. - Main results: - Banks could largely withstand severe macro shocks thanks to high capital buffers; credit risk showed the most significant impact. - In the most severe scenario, an increase in system NPLs of an additional 13½ percentage points did not result in severe undercapitalization in the large banks. - Some banks fell below the minimum required CAR of 12 percent after the shocks, but most stayed above 8 percent. - Recapitalization needed to restore CAR to 12 percent did not exceed 1.2 percent of GDP in the most severe scenario (excluding net profit buffers). - The main contributor to the increase in the NPL ratio was from CICR. - Liquidity shocks (i) significant deposit withdrawals and (ii) pullback in parent bank funding with maturity of less than one year — in both cases, no bank became illiquid following the shocks. - One state-owned bank exhausts its capital in the most severe scenario and is in the process of restructuring; reportedly a strategic partner has been identified to acquire the bank. - Modeling and capacity: - The NBS has improved stress-testing and modeling capacities. - Current macro-financial models link probabilities of default (PDs) of corporate and household sectors to macro variables but are hampered by short data series. ### Banking supervision: regulatory framework and challenges (selected points) - The 2005 Law on Banks (LOB) aimed to harmonize the legal framework with international standards, EU Directives, and Basel Core Principles on Banking Supervision (BCP). - Introduced a two-step licensing procedure, lowered threshold for regulatory approval for ownership acquisition in banks, and established consolidated supervision. - NBS actions: - Enhanced risk management standards via various regulations. - Intensified cooperation with overseas supervisors, initiated discussions with home-country supervisors of parent banks, participated in supervisory colleges, and undertaken joint inspections. - Supervisory policy: - A relatively strict supervisory policy, including conservative risk weights for some asset categories, has helped the banking sector withstand the financial crisis. *Source: IMF staff report excerpt (provided content).* ### 35. The loan classification criteria are stricter than, but not out of line with, those in ### _cr10147 - 35. The loan classification criteria are stricter than, but not out of line with, those in ### Loan classification and provisioning: regional comparison and features - Finding: The loan classification criteria in Serbia are stricter than, but not out of line with, those in some other countries in the region. - Common regional features: - In addition to timeliness of repayment, all surveyed countries allow classification of loans on the basis of qualitative judgment (e.g., deteriorated financial status of the borrower even when obligations are honored on time). - All countries have contamination clauses: when one loan is classified, other loans to the same delinquent borrower may be automatically given a similar classification. - Serbia-specific features: - Serbia applies a range of possible provisioning levels for each past-due category, with the top of the range among the more conservative within the region. - Serbia requires exposures in foreign currency to be automatically downgraded (noted as a point for reconsideration). - Table 11 (regional comparison) highlights categories and days past-due/provisioning levels across: Bulgaria, Croatia, Czech Republic, Romania, Serbia. (Exact tabular figures are preserved in the source.) ### Supervisory challenges: framework, cooperation, and capacity - Remaining challenges identified: - Streamlining the framework for loan classification and provisioning. - Clearing legal impediments to formalize cooperation agreements with significant home supervisors. - Strengthening the capacity of the BSD (Banking Supervision Department). - Specific issues with loan classification: - Current system is comprehensive and prudent but complex and leaves too much room for judgment. - Discussions indicated fundamental differences in classification standards and approaches between banks and NBS staff; one example showed diverging interpretations on 1/3 of a loan portfolio. - Broad brackets for provisioning increase scope for divergent interpretation of the global risk provisioning framework. - Recommendations (loan classification): - Define a more precise set of loan classification criteria. - Establish a clearer classification framework for days past-due and provisioning levels that balances prudence, clarity, and transparency for supervisors and banks. - Consider whether automatic downgrading of foreign-currency exposures and simultaneous higher CAR weight remains justified. - Revisit the requirement to automatically downgrade duly restructured loans under the normal supervisory regime (not temporary crisis measures). ### Cross-border cooperation and MOUs - Current status: - NBS cooperates fruitfully in practice (supervisory colleges, joint inspections, multilateral MOUs), and participation by parent banks in colleges has been useful for host supervisors. - Obstacle: - Legal obligation of NBS to share banks’ information with the Serbian tax authority raises confidentiality concerns for home supervisors and has suspended finalization of MOUs with France, Austria, and Germany. - Recommendation: - Serbian authorities should resolve the confidentiality/ information-sharing issue swiftly to facilitate formal cooperation agreements with these important home supervisors. ### Capacity building for BSD - Assessment: - Current staffing and budgeting appear adequate overall, but specific competencies are lacking. - Too few portfolio managers, information technology auditors, and sufficiently experienced team leaders for inspection teams. - Onsite examiners’ resources stretched by the recent crisis. - Recommendation: - Prioritize capacity building for the BSD in both quantitative and qualitative terms. - Improve competitiveness of remuneration and career prospects to attract and retain qualified staff. ### Liquidity framework and LOLR - Progress: - Remarkable progress in monetary management since the 2005 FSAP mission; move towards inflation targeting (IT) and reforms strengthened monetary policy-making. - Challenges and findings: - High level of Euroization remains a challenge. - NBS RRs on FX liabilities are high and should be re-assessed given weak asset growth and low bank profitability; RRs are a blunt tool with negative side effects. - Dual role of the 2-week repo (policy signal and de facto standing facility) creates tension as sterilization costs rise. - Recommendations (liquidity management): - Consider lowering FX RRs carefully to reduce banks’ FX funding costs while accounting for monetary policy objectives. - Improve liquidity management by leveraging T-Bills market: higher T-Bill issuance and a liquid secondary market to meet structural liquidity needs. - Consider less frequent NBS repo auctions (once a week instead of two) coupled with a single weekly auction of T-bills to incentivize interbank operations. - LOLR framework: - Recent LOLR broadening of acceptable collateral is helpful. - Strengthening measures recommended: - Ensure margining policy (haircuts) aligns with risk profile of underlying instruments. - Adjust collateral list continuously based on market depth. - Increase legal and institutional options for NBS to collect claims. - Principle: LOLR operations should be carried out under a clear and public commitment of full backing of the central bank by the government. - Recommendation: Consider automatic recapitalization (budgetary transfer to NBS equity) as necessary because NBS capital may not suffice to absorb large collateral losses. ### Crisis management, Banking Stability Law (BSL), and MOUs for crisis - Actions taken after October 2008 crisis: - MOU between MOF, NBS, and DIA for coordinated decision making. - Extension of insured deposit coverage and introduction of loan restructuring framework in context of classification/provisioning rules. - Enhanced liquidity facilities including LOLR, extended dinar liquidity, FX swaps, temporary risk management amendments, potential bank recapitalization measures based on stress testing results under the FSSP. - Proposed BSL features: - Allow NBS and MOF to announce measures for enhanced deposit or liability coverage. - Authorize government financial assistance by an extraordinary session of Parliament. - Require divestment of Government of Serbia’s equity in troubled banks within a year. - Permit NBS to request GOS guarantee to solvent banks with insufficient collateral or significantly undercapitalized systemic banks, against collateral including mortgages, receivables, and acceptable securities. - Provide exit from enhanced emergency measures once stability is restored. - Recommendation: - Enter into crisis MOUs with home country supervisors of largest foreign investors (Austrian, French, German, Greek, Italian) to address crisis-related burden sharing and supervisory issues. ### Problem bank resolution: legal framework and institutional design - Current shortcomings: - Problem bank resolution framework lacks full set of legal tools. - Under Article 117 of the LOB, NBS can appoint receivers for an open bank but cannot restructure without prior consent of depositors and creditors. - DIA can only liquidate banks after license revocation and cannot be directly involved in open bank restructuring. - Institutional approach: - Separation of responsibilities between NBS (restructuring open banks) and DIA (liquidation of closed banks) is pragmatic given current capacities and costs of establishing a separate agency. - Close coordination between NBS and DIA is essential under this split-responsibility approach. - Recommendations: - Establish a specialized problem bank resolution unit within the NBS: - Unit should report to the governor (not to Head of BSD) to avoid conflict of interest. - Activated only when problem banks require resolution; procedures should enable rapid activation. - Ensure separation of functions within NBS while maintaining coordination and information flow between BSD and the resolution unit. - In purchase-and-assumption scenarios, involve supervisory function to verify purchaser’s financial soundness. - Apply least-cost principle in bank restructuring: - If public funds are required, they should come from the MOF with contingency provisions for quick disbursement. - Consider amending law on public debt to permit government issuance of bonds or borrowing to finance bank restructuring and avoid delays from parliamentary approval. ### Deposit Insurance Fund (DIF) and Deposit Insurance Agency (DIA) - Funding and coverage (as of dates in source): - As of October 2009, total financial assets of the DIF stood at EUR 98.4 million. - Total amount of insured deposits as of end-2009 was EUR 5.4 billion. - DIA financial reserves amount to 1.8 percent of its total exposure. - As of October 2009, the DIF could approximately cover insured depositors of up to 20 of the smallest banks individually or the sum of the 9 smallest banks in the system. - Assessment and concerns: - Current reserve level appears adequate and no premium increase seems warranted at this time. - DIF funding capacity in case of a systemic crisis or failure of a systemic bank is limited; no contingent government lines of credit are in place despite legal recognition of GOS backing. - High insured deposit coverage (increase to EUR 50,000 and broadened scope beyond household depositors) results in 99 percent of deposits being covered, which may create moral hazard and excessive risk-taking, especially by smaller banks. - Recommendations: - Put contingent lines of credit with the government in place to bolster DIF funding capacity for systemic events. - Assess future premium coverage using risk weighting of different banks and their likelihood of needing DIF funds. - Gradually narrow scope of deposit coverage to more appropriate levels when the financial system stabilizes, while safeguarding depositor confidence. - Undertake a comprehensive review of DIA functions and prepare a medium-term strategy: - DIA currently administers the DIF, liquidates insolvent banks, manages state-owned and socially-owned bank shares, and collects GOS debt in Paris-London club negotiations. - Multiplicity of functions may dilute institutional focus; a medium-term strategy should ensure clarity and sustainability. *Source: IMF staff report content provided in the input.* ### 57. The DIA has organizational limitations in effectively handling large scale ### _cr10147 - 57. The DIA has organizational limitations in effectively handling large scale ### Deposit Insurance Agency (DIA) — payout capacity and operational readiness - The DIF was created in 2005; the DIA has not undertaken any insured depositor payoff since then. - Development gaps: - Detailed payout procedures have not been finalized. - Investment in adequate software and information technology platforms for rapid deposit payout is lagging. - Legal context: - Introduction of legal amendments aimed at shortening the payout period has increased the need for advanced institutional technical capability. - Recommendation: - The DIA should finalize and approve its internal procedures at the earliest. ### DIA — risk assessment, funding, and contingency arrangements - Capacity needs: - Develop the capacity to assess risks among individual banks covered by the DIF. - Employ actuarial tools to assess the adequacy of the premium charged and of DIF reserves commensurate with the risks. - Develop a risk assessment model of the banking sector. - Use information received from the NBS to monitor risk levels in the sector. - Fund sizing and contingency: - Arrange with the GOS for a standby emergency line of credit that could be activated in times of crisis. - Purpose: reduce the probability that the cost of rescuing a systemically important bank is carried by the central bank and allow the DIA to act quickly to reduce adverse impact on the rest of the banking sector. ### Government securities markets — issuance, market structure, and debt management - Recent developments: - MOF resumed T-Bill issuance; issuance volume has increased steadily due to pressing budgetary needs. - Average duration of T-bills stock increased with issuance of 6-month and one-year bills. - A Debt Management Office (DMO) is being set up within the MOF. - Recommended operational improvements: - Streamline the auction calendar. - Use reopening (assimilation with identical ISIN) to create benchmark series via regular issuance on selected tenor issues. - Move from three weekly auctions to one weekly auction to concentrate volumes, reduce potential market power of largest participants, reduce “squeeze” risk, and allow lifting of the current 15 percent allotment limit for successful bids. - Adopt a multiple rate allotment process to facilitate more efficient price-discovery. - Debt management strategy: - Establish a comprehensive debt management strategy to raise funding and achieve risk and cost objectives (maturity profile, currency denomination) while fostering an efficient market for government securities. - Serbia’s public debt is currently 93 percent FX-denominated. - The expansion of the dinar share of public debt must be gradual. - Cash management of the MOF needs strengthening to reduce reliance on short-term funds, reduce rollover risk, and foster development of a yield curve. - Market development incentives: - Pricing transparency and market-making commitments by key intermediaries could promote secondary market development. - While a Primary Dealership system may be premature, the DMO could design incentives (for example, right to purchase post-auction at the auction cut-off price—Noncompetitive Offers) for participants active in auctions and/or the secondary market. - The DMO should study such measures and consult with market participants. ### Corporate and household debt restructuring — enforcement and insolvency - Collateral and enforcement framework: - Still-evolving and uneven; complicates restructuring and leads to delays and lower recoveries. - Blocked account process can contribute to financial problems; blockages of current accounts increased by 75 percent over the past year and immobilize corporate activity. - Improvements since 2005 FSAP in security and mortgage foreclosure laws and systems, but collective voluntary dissolution and court-supervised insolvency remain costly, ineffective, and unreliable. - Corporate debt restructuring: - Insufficient mechanisms to cope with increasing corporate distress and NPLs. - NBS decision to relax provisioning rules to encourage debt rescheduling: banks can reschedule a borrower’s debt and reclassify it as performing after six months, provided it is a first time rescheduling and the debtor is not delinquent for more than 30 days within a six-month period. - Further incentives suggested: favorable tax treatment for debt forgiveness, debt-equity swaps, access to priority financing, and accelerated approval. - Enforcement and insolvency recommendations: - (a) Streamline auction and execution procedures further. - (b) Introduce an expanded and regulated profession of execution officers. - Judicial enforcement can take up to three years to obtain and enforce a judgment on collateral. - Non-court auction procedures under the new mortgage law have unnecessary restrictions (multiple auctions with minimum bids pegged to prescribed reduction amounts). - Amendments to the bankruptcy law passed in December 2009 should correct some problems (e.g., petitioning creditor not obliged to finance bankruptcy proceeding). - Prepackaged plan of reorganization amendments could be refined by excluding creditors whose claims are not affected. - Household debt restructuring: - Framework improved for real estate and housing, but delays persist for other asset types due to court execution. - Home loans protected by a modern mortgage law, a new cadastre, and relatively swift non-judicial foreclosure procedures. - Transfer of data to the cadastre is mostly complete. - Approximately 90 percent of the home loans are insured by the National Mortgage Insurance Corporation (NMIC), established in 2005. - NMIC is highly profitable and to date has sustained virtually no losses on payout claims. - NMIC is not adequately capitalized according to legal requirements but hopes to achieve adequate capitalization within the next year, possibly by means of an initial public offering or partial privatization. ### Insurance sector — structure, performance, and regulatory recommendations - Sector profile and performance: - Insurance consumption: €76 per capita (non-life) and €10 per capita (life). - By mid-2009, 25 insurance companies, mostly privately owned. - Industry accounted for 4.6 percent of total assets and 5.6 percent of the total capital of the financial sector. - From 2005-09, Solvency Ratio of the sector was close to 200 percent. - Premium Leverage Ratio: 1.7-1.9 in the Serbian market, versus 2.5-3 internationally. - Balance sheet and underwriting: - Growing share of highly liquid assets and declining share of receivables relative to total assets. - Overall underwriting losses and expenses kept below annual premium intake. - Regulation and supervision: - Insurance Supervision Department employs 42 staff. - NBS strategic plan for 2006–09 envisages evolution from compliance-based to risk-based supervision. - Licensing for insurance agents introduced, improved market transparency, proactive onsite and offsite supervision, and a consumer protection unit created. - NBS developing an “early warning system” for intervention before weaknesses become irreversible. - Key indicators (Table 12, selected ratios 2006–2009): - Premium retention ratio (NPW/GPW): 92.0, 92.0, 92.0, 88.0 - Receivables ratio (Receivables/Total Assets): 14.3, 12.7, 11.8 - Liquidity Ratio (Cash and short-term investment/total assets): 36.3, 39.3, 39.1 - Market Solvency Margin Ratio % (Available Surplus Capital/Required Solvency I Capital): 206.0, 211.0, 173.0, 186.0 - Largest 5 companies: 245.0, 252.0, 202.0, 223.0 - Smallest 5 companies: 154.0, 182.0, 116.0, 144.0 - Non-life technical reserves ratio (Technical reserves/NPW): 66.1, 72.8, 78.1 - Regulatory recommendations (three key issues): - Liberalization of the local reinsurance market: review reinsurance requirements to introduce broader competition among local and international reinsurers. - Separation of life and non-life insurance: prevent use of life reserves as substitute for risk capital; consider eliminating temporarily the 5 percent tax on non-life insurance premiums given lack of real growth in non-life insurance. - Development of life insurance: provide tax treatment similar to that allowed under current pension legislation for individual contributions to a voluntary pension scheme. ### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) - Serbia’s progress: - Substantial changes to criminal legislation: amendments to the money laundering offence, criminalization of the terrorist financing offence, changes to the Criminal Procedure Code covering provisional measures and confiscation. - New legislation on liability of legal entities, seizure and confiscation of proceeds from crime, and mutual legal assistance. - Law on the prevention of money laundering and the financing of terrorism entered into force on March 27, 2009. - Findings of the MONEYVAL mutual evaluation of Serbia (conducted May 2009, adopted December 2009) will be used for the FSAP Update to avoid duplication. - Assessment note: - While progress is welcomed, the MONEYVAL report recommends further steps to expand the scope and improve effectiveness of implementation. ### Annex — Basel Core Principles (BCP) assessment — institutional and market overview (selected points) - Assessment timing and methodology: - Assessment conducted October 6 to 21, 2009, using the revised BCP methodology issued in October 2006. - Financial sector structure and concentrations: - Banking industry accounts for 89 percent of the financial sector assets. - Total financial assets amount to 71 percent of GDP. - 34 banks operate in Serbia: - 9 state-controlled banks (representing 18 percent of total financial sector assets) - 6 local private banks (5 percent of total financial sector assets) - 20 foreign-owned banks (66 percent of total financial sector assets) - NBFIs remain small with assets representing only 11 percent of the financial sector. - Supervisory enhancements: - 2005 LOB envisaged harmonization with international standards, EU Directives, and the BCPs. - NBS issued regulations requiring banks to set up risk management systems and specific rules on liquidity risk management, capital adequacy, loan classification and provisioning, external auditing, and know-your-customer procedures. - Cooperation with foreign supervisors intensified but needs formalization via bilateral MOUs with important home supervisors. - Pre-crisis balance-sheet dynamics and regulatory responses: - Run-up to 2008 crisis: rapid expansion of banks’ balance sheets financed by foreign-currency deposits and foreign borrowing. - New loans were predominantly dinar-denominated but indexed to the euro, increasing borrower exchange rate exposure. - NBS measures: - Special 125 percent risk-weight applied to unsecured foreign-currency lending to borrowers with an unmatched foreign currency position. - 75 percent risk-weight applied to foreign-currency lending to borrowers with an unmatched foreign currency position but secured by a mortgage on residential property. - Limits on ratio of gross household loans to core capital lowered from 200 percent to 150 percent in November 2007 and abolished in June 2009. - Market outcomes: - Serbian banks were among the best-capitalized in the region, with capital adequacy in the order of 20 percent. - Liquid assets represented more than 40 percent of total assets. - By 2009H1, average ROE amounted to 4.1 percent, compared to 9.3 percent in 2008. *Source: IMF staff report excerpt (FSAP Update) contained in the supplied PDF content.* ### 8. The global financial turmoil began to spill over to Serbia in late 2008. The turmoil ### _cr10147 - 8. The global financial turmoil began to spill over to Serbia in late 2008. The turmoil ### Crisis transmission and macroeconomic impact - The turmoil first manifested as: sharp corrections in the stock market, rising sovereign spreads, slowing capital inflows, high volatility and frequent NBS interventions, and a depreciation of the dinar. - Credit growth came to a sudden halt and the economy went into a recession. - Headline inflation stood at 6.6 percent y-o-y at end 2009. - Gross public debt currently stands at around 32 percent of GDP. ### Banking sector condition and asset quality - Serbian banking sector entered the crisis with reassuring solvency and liquidity buffers. - Overall, NPLs increased from 11.3 percent of total loans in 2008 to 16.5 percent in 2009H1. - NPLs are more than covered with total provisions. ### Financial Sector Stability Package (FSSP) — design and conditionality - Parent banks of participating foreign subsidiaries commit to: - maintain their exposure to Serbia at their end-2008 level, - provide adequate capital and liquidity support to their subsidiaries, - have their subsidiaries participate in a diagnostic study involving stress tests. - Subsidiaries and local banks participating in the FSSP are required to: - facilitate voluntary conversion of FX and FX-linked loans into local currency loans, - work with the NBS toward developing a common loan workout scheme, - facilitate loan restructuring under a pre-agreed framework (extension of remaining loan maturity by at least 12 months or 20 percent with reduced monthly payments, or any other restructuring that lowers monthly payments by at least 20 percent). - In return, participating banks are granted access to: - an extended dinar liquidity facility, - a foreign exchange swap facility. ### Crisis management measures and safety nets - NBS opened LOLR facilities up to one year at 150 percent of the policy rate to solvent banks against selected liquid collateral. - Deposit insurance changes in response to the deposit run in late-2008: - Coverage raised from EUR 3,000 per private individual depositor per bank to EUR 50,000. - Eligible depositors extended to include sole entrepreneurs and SMEs. - Coverage levels: 99 percent of deposits of the banking system by number and 90 percent by volume are covered by the DIF. - DIF’s total financial assets amount to EUR 98.4 million compared to total insured deposits of EUR 5.4 billion. - The funding capacity of DIF in case of a systemic crisis is limited; no government contingency funding lines of credit are in place. - DIF is prohibited from using its funds for bank resolution actions like mergers or sale of selected liabilities and assets. - A new Banking Stability Law outlining the legal framework for contingency measures is awaiting enactment. ### Preconditions and structural risks affecting banking supervision - Serbia experienced several years of solid economic growth prior to the crisis, mainly driven by buoyant domestic demand and accompanied by increasing external imbalances. - The NBS introduced inflation targeting by end-2006 and now conducts a managed float of the dinar. - Risks relevant to macroeconomic and financial sector stability include weaknesses in enforcement and insolvency mechanisms: - Judicial enforcement may take up to 2–3 years to obtain and to enforce a judgment on collateral. - Parts of the collateral and enforcement framework improved, but collective procedures for voluntary dissolution and court supervised insolvency remain costly and ineffective. - Creditor recoveries in the insolvency process are among the most costly and yield the lowest returns in the region. - Some collection mechanisms, like the blocked account process, can immobilize corporate activity through rapidly escalating blockages. ### Market structure and competition - Market discipline appears well-established. - There are 34 banks operating in a small, bank-dominated financial system. - Stability of net interest margins persisted despite a large drop in profitability in 2009. - Banking regulation and supervisory practices do not discriminate between different categories of banks, ensuring a level playing field. ### Main findings on compliance with Basel Core Principles (BCPs) - Since the previous FSAP, Serbia made considerable progress toward enhanced compliance with the BCPs; overall, Serbia is now largely compliant with the BCPs. - Remaining challenges primarily in: - international cooperation, - strengthening supervision on risk management beyond credit risk. - Key institutional and supervisory observations: - The new LOB (enacted in 2005) enhanced legal powers and legal protection for NBS staff; NBS can be considered functionally independent. - Capacity building and staff retention (competitive compensation, training, promotion) are important with Basel II implementation and financial sector complexity. - Cooperation with several important home supervisors awaits formalization via bilateral MOUs due to mandatory exchange-of-information constraints with the national tax authority. - Licensing improvements: two-stage licensing process and authority to withdraw licenses if initial conditions no longer exist. - Need for rigorous investigation of indirect ownership structures and consideration of requiring periodical declarations about ultimate beneficial ownership. - Capital adequacy framework is conservative by regional standards and broadly aligned with international sound practice. - Further regulatory upgrades needed for market risk, country risk, operational risk and interest rate risk; a new regulation is being prepared as part of Basel II preparations. - Basel II implementation scheduled for 2011 (the NBS is reviewing the possibility to push back Basel II implementation due to the changes in the international environment and legislation). - Asset classification and provisioning framework is clear and prudent regarding overdue days, but qualitative elements and bracket-based practice create scope for differences in interpretation between banks and the NBS. - Onsite supervision should shift more toward qualitative assessments and become more forward looking (e.g., develop a full early warning system). - Opportunities to further formalize sector-level analysis and to enhance cooperation between external auditors and the NBS accounting and finance department; reporting could be further aligned with EU practices. - Accounting: Serbian legislation brought into full compliance with IFRS; external auditors must be recognized by the NBS and are legally obliged to notify the NBS of breaches; further enhancements recommended to meet Pillar III of Basel II. - Corrective and remedial powers are well established, with a wide spectrum of actions (written warnings; ordering letters; formal NBS Decision to eliminate irregularities; appointment of a receiver; removal of license). Framework is being expanded to enhance receivers’ responsibilities including capacity to impose a temporary moratorium. - Consolidated supervision: NBS supervises banks, leasing companies, insurance companies and pension funds and is positioned to conduct consolidated supervision, but does not systematically analyze consolidated risk positions; reporting on a consolidated basis can be improved. - International cooperation: proactive stance with regional and bilateral MOUs, participation in supervisory colleges and joint inspections; main shortcoming is inability to sign MOUs with three important EU home supervisors due to domestic information exchange obligations with tax authorities. ### Table-based core principle highlights (selected) - CP1: Supervisory objectives are not stated explicitly; need for capacity building. - CP3–5: Two-phase licensing introduced; thresholds for transfer of significant ownership aligned with best practices; need to identify ultimate beneficial owners. - CP6: Capital adequacy conservative; scope for aligning with most EU countries. - CP7: Regulation under preparation for non-credit risk categories; scope for stronger qualitative onsite assessments. - CP9: Classification and provisioning rules prudent; loan classification guidance should be made more precise, consistent and transparent. - CP13: Market risk supervision needs advancement beyond procedural checks; scheduled Basel II implementation as of 2011 makes this an urgent issue. - CP14: Liquidity risk regulation is in place and broadly adequate; does not require consideration of impact of other risks on overall liquidity strategy. - CP15: Operational risk supervision impeded by lack of specific IT skills in onsite teams; outsourcing regulation should be upgraded to EU standards. - CP16: Secondary regulation on IRBB management is currently unavailable. - CP17: Internal control and audit scope should be upgraded; ad hoc committee with banks’ boards can be upgraded to Audit Committees per international best practice. *Source: IMF staff assessment as presented in the provided chapter/section.* ### 18. Abuse of financial services The legal framework for AML/CFT is much- ### _cr10147 - 18. Abuse of financial services The legal framework for AML/CFT is much- ### Key findings (BCP 18–25) - Abuse of financial services (BCP 18) - The legal framework for AML/CFT is much-improved and broadly adequate. - There is scope for some further tightening with regard to screenings for new staff. - Supervisory approach (BCP 19) - The analysis on the level of the global banking sector should be enhanced. - The NBS is recommended to perform regular and recurrent stress tests. - Supervisory techniques (BCP 20) - The main challenge facing the NBS is to focus towards more qualitative assessments (onsite), as necessitated by Basel II implementation. - NBS needs to step up capacity building for this effort as a priority. - Supervisory reporting (BCP 21) - NBS is recommended to enquire into the means by which reporting can be enhanced through more systematic certification. - It can also consider further alignment of reporting requirements with EU practices. - Accounting and disclosure (BCP 22) - For disclosure by banks, the law should be fully aligned with EU best practices. - Corrective and remedial powers of supervisors (BCP 23) - Powers appear adequate. - Main priorities: strengthening cooperation with other involved supervisors (both domestically and internationally) and ensuring that internal procedures do not prevent the NBS from acting speedily and decisively in the face of serious irregularities. - Consolidated supervision (BCP 24) - For the future, NBS is recommended to require formal reporting for financial data and risk profiles on a consolidated basis and build proper tools for analysis. - Home-host relationships (BCP 25) - The requirement for the NBS to exchange information with domestic tax authorities needs to be revisited and aligned with European practice. - This would enable the NBS to sign MOUs with all significant home supervisors over Serbian banks. - The NBS is recommended to maintain its proactive attitude with regard to information exchange and in cooperation with home supervisors. ### Recommended action plan (selected BCP recommendations) - Independence (BCP 1.2) - Supervisory objectives should be made more explicit. - Legal protection (BCP 1.5) - Rather than providing ex post compensation for legal expenses, the legal framework should offer compensation up front. Legal protection for receivers needs enhancement. - Cooperation (BCP 1.6) - Clear the way for concluding MOUs with Austria, France, and Germany by reconsidering the mandatory exchange of information with the national tax authority. - Major Acquisitions (BCP 5) - Establish a corresponding body of criteria for the non-banking sector. - Capital Adequacy (BCP 6) - Increase alignment of the capital adequacy framework with the EU. - Risk Management Process (BCP 7) - Extend risk management regulation to risk categories not yet covered; onsite supervision should increasingly focus on the quality and adequacy of risk management policies in banks. - Credit Risk (BCP 8) - NBS is recommended to monitor banks’ strategies and practices with regard to restructuring and/or rescheduling of loans. - Problem assets, provisions and reserves (BCP 9) - Establish a more precise set of criteria for loan classification to reduce differences in interpretation. - Large Exposure Limits (BCP 10) - Enhance reporting requirements to allow monitoring of geographical concentrations. - Exposures to related parties (BCP 11) - Provide additional guidance as to which parties are considered related parties to prevent differences of interpretation. - Country and transfer risks (BCP 12) - Upgrade supervisory framework by issuing secondary legislation specifying minimum requirements for managing country risk. - Market risk (BCP 13) - Issue a specific regulation on market risk and assess appropriateness of limits given institutional characteristics. - Liquidity risk (BCP 14) - Enhance regulation to ensure the impact of other risks is taken into account in the bank’s overall liquidity strategy. - Operational risk (BCP 15) - Upgrade supervisory skills in operational risk, with acute shortages in IT. - Interest rate risk in the banking book (BCP 16) - Provide banks with additional guidance by issuing a specific regulation on IRBB. - Internal control and audit (BCP 17) - Broaden the scope of the compliance function to cover all domains where breaches can expose the bank to reputational risk. - Enhance reporting line of internal audit by requiring an audit committee according to international standards. - Abuse of financial services (BCP 18) - Banks should be required to conduct screenings for new staff as standard routine. - Supervisory approach (BCP 19) - Enhance banking-sector-level analysis and conduct regular stress tests. - Supervisory techniques (BCP 20) - Shift onsite supervision towards qualitative assessments; prioritize capacity building. - Supervisory reporting (BCP 21) - Enhance reliability of reporting through more regular certification requiring cooperation with external auditors and further alignment with EU practices. - Accounting and disclosure (BCP 22) - Fully align disclosure requirements with EU best practices. - Corrective and remedial powers (BCP 23) - Strengthen cooperation with other supervisors and ensure internal procedures allow rapid NBS action in face of serious irregularities. - Consolidated supervision (BCP 24) - Require banks to report on a consolidated basis for key financial indicators (e.g. CAR, provisioning, etc). - Home-host relationships (BCP 25) - Clear the way for concluding MOUs with Austria, France, and Germany by reconsidering mandatory exchange of information with the national tax authority. ### Authorities’ response (NBS) - The National Bank of Serbia (NBS) appreciates the recommendations and considers them in line with its own assessment and priorities. - Highlights from NBS response: - Need to further upgrade supervisory skills in terms of number of supervisors and their expertise, and to provide an adequate framework for retaining experienced staff. - Risk management regulations and internal supervisory tools and manuals need additional improvement to cover all types of risk in more detail. - Devoted to aligning regulation and supervisory practices with internationally recognized best practices in line with Republic of Serbia’s strategic orientation to integration in EU. - During 2007 the NBS adopted the Basel II Implementation Strategy and Action Plan addressing most shortcomings identified in the assessment. - NBS is closely observing developments and changes in international standards triggered by the recent financial crisis and is aligning plans and actions accordingly. - Priorities in developing regulations and supervisory tools for risk management are based on materiality for the Serbian banking sector. - NBS participates in host supervisor initiatives and continuously initiates communication and information sharing, noting that improvement is a two way process. ### Implementation highlights from Appendix I - NBS adopted a corrective action plan to address deficiencies in compliance with BCP. - By-laws on asset classification adopted. - Expand data gathering for foreign currency and foreign currency indexed loans: Done in NBS Decision 51, June 2005. - Require banks to monitor borrower’s exposure to exchange rate risk: Done in NBS Decision 51, June 2005. - Revise criteria for loan loss provisions: Implemented in by-laws pursuant to the LOB. - Two large state-owned banks recapitalized in 2006 by the EBRD and are now under majority ownership of EBRD and the state; plans to merge remaining majority state-owned banks are evolving. - One state bank was sold into foreign ownership; another remains state-controlled with EBRD as shareholder; discussions toward recapitalization continue. - Strengthen state-controlled banks’ reporting requirements: Done. - Revise NBS chart of accounts to conform to IFRS: Done. - Require bank boards to have audit committees with a majority of independent members: The LOB requires an audit committee of at least three members, at least two of which are members of the bank’s board of directors, and with at least one independent member (Articles 79 and 80). - Require banks to disclose FX effects to borrowers: Done in NBS Decision, December 2005. - New LOB extends NBS mandate for consolidated supervision (Articles 2, 122, 123, 125, 126, and 127). - Reduced significant ownership level criterion for prior approval by the NBS from 15 percent to 5 percent in new LOB (Article 95). - Statutory protection for the NBS and its officers when performing supervision in good faith enacted in new LOB (Article 121). - Establish limits for aggregate exposures to related parties: Done in new LOB (Article 33). - Boards required to oversee integrated risk management systems: Done in new LOB (Articles 73 and 141). - Include IT specialists within NBS examinations staff: In progress. - New LOB calls for limits on powers of courts to review NBS decisions (Article 9). - SRR for enterprises raised to 38 percent in December 2005 and unified with SRR for households. - Three lending facilities unified into one linked to the repo rate. - Minimum daily SRR requirement lowered from 80 percent to 50 percent during 2008. - Ceiling of the interest rate corridor linked with the repo rate in November 2005. - Serbia became a participant in the GDDS as of May 2009. - DDOR fully privatized in 2007; privatization of Dunav pending. - New MTPL law became effective on October 12, 2009. - Implement corrective action plan for AML/CFT recommendations put forward in MONEYVAL report: Responsible entity APML. - Accounting legislation brought into full compliance with IFRS standards. *Source: _cr10147 - 18. Abuse of financial services The legal framework for AML/CFT is much-* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10147.pdf_