## 1. Bank Concentration

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### I. Introduction and scope
- Analyzes banking sector soundness and identifies vulnerabilities, focusing on balance sheet structure, corporate and household sector performance, and banking sector risk exposures.
- Analysis informed by results of stress tests designed to assess resilience of the banking sector.
- Prepared by Nada Oulidi and Piyabha Kongsamut.

### II. Structure of the financial sector
- Financial sector assets:
  - Grew from 52 percent of GDP in 2005 to over 70 percent of GDP in 2007; crisis halted growth since 2008.
  - Share of banking sector assets in total financial sector assets remained around 89 percent.
- Bank concentration:
  - Herfindahl-Hirschman Index (HHI) for Serbia: 650.
  - Comparative HHIs: Bulgaria 834; Romania (2007) 1041; Croatia 1355.
  - Five largest banks accounted for 46 percent of total banking system assets at mid-2009.
- Ownership:
  - State-controlled banks' share declined from 21 percent of total assets in 2005 to 18 percent in 2009Q2.
  - Nine banks with significant public stake:
    - Four majority state-owned banks: combined market share 2.6 percent.
    - Two banks where EBRD and the state constitute the majority shareholder: combined market share 11.3 percent.
    - Three banks where the state alone holds stakes of around 20-30 percent: combined market share 3.9 percent.
- Foreign ownership and market structure:
  - Foreign ownership rose to almost 75 percent of the banking system.
  - Subsidiaries of Austrian, Greek, and Italian banks are within the top five banks by assets.
  - Banks from Austria, Greece, and Italy combined have close to a 60 percent market share.
  - French and German banks among the top 12 banks.
  - Most local private banks are small; only one fully private Serbian bank among the top 10.
- Nonbank financial institutions (NBFIs):
  - NBFIs account for 11 percent of the financial sector.
  - Composition: leasing companies (almost 60 percent of NBFI sector assets), insurance companies (40 percent), pension funds (less than 1 percent).
  - Leasing companies rely on long-term funding from abroad: 87 percent of liabilities.
  - Top three areas financed by leasing: (a) transportation, warehousing, and communications; (b) manufacturing; (c) trade.
- Financial deepening:
  - Assets relative to GDP remain fairly low compared to peers.
  - Stock market capitalization:
    - 55 percent of GDP in 2007.
    - Plummeted to 25 percent of GDP in early 2009.
    - Recovered to about 30 percent of GDP more recently.
    - Average daily turnover for 2009 was 14 percent of its 2007 levels.
  - Bond trading limited largely to trading in foreign currency savings bonds.

### III. Structure of banking system assets and liabilities
- Euroization and currency composition:
  - Euroization: 80 percent of loans and 70 percent of deposits denominated or indexed to foreign currency.
  - Majority of FX-linked exposure predominantly in euros, but also in Swiss francs.
- Asset composition (June 2009; share of group total):
  - Loans net of provisioning: State 57; Local Private 59; Foreign 60; Total 59.
  - Cash: State 18; Local Private 14; Foreign 11; Total 13.
  - Reserves at the NBS: State 10; Local Private 6; Foreign 12; Total 11.
  - Investments: State 2; Local Private 3; Foreign 2; Total 2.
  - Fixed and other assets: State 13; Local Private 18; Foreign 14; Total 14.
- Loan composition, 2009 (by borrower and sector):
  - Households: 33 percent of loans (16 percent of total loans are in mortgages).
  - Industry: 18 percent of loans.
  - Trade: 19 percent of loans.
  - Construction: 6 percent.
  - Agriculture: 3 percent.
  - Other: 21 percent.
- Credit growth:
  - Euroized credit to the private sector declined from 21 percent at end 2007 (in euro terms) to 4 percent through the first half of 2009.
- Off-balance sheet and cross-border lending:
  - External debt from corporates to non-official creditors grew from €4.6 billion in 2006 to almost €11 billion in August 2009.
  - Guarantees provided by local subsidiaries for cross-border loans:
    - Correspond to 63 percent of off-balance sheet items that are subject to credit risk.
    - Value of these guarantees: € 4.8 billion as of December 2008.
  - Authorities require banks to classify these exposures in the same way as on-balance sheet items.
- Funding structure and liabilities (June 2009, in percent of total):
  - Interbank deposits: Total 4 (State 1; Local private 2; Foreign 5).
  - Non interbank deposits: Total 55 (State 71; Local private 59; Foreign 51).
  - Borrowing: Total 10 (State 3; Local private 4; Foreign 12).
    - o/w due to foreign banks: Total 5 (State 1; Local private 1; Foreign 6).
  - Other liabilities: Total 8 (State 6; Local private 3; Foreign 9).
  - Shareholder equity: Total 23 (State 19; Local private 32; Foreign 23).
  - Deposits account for 59 percent of total liabilities, of which 70 percent are in FX.
  - External liabilities constitute about 20 percent of total liabilities.
  - External borrowing is generally over 1 year maturity; interbank funding is minimal and mostly by foreign-owned banks.
- Liquidity and safe assets:
  - Banks' holdings of T-bills and NBS certificates rose to 7½ percent of total assets in June 2009.
  - Banks hold over 20 percent of assets in cash and unremunerated reserves at the NBS.
  - Share of banks’ holdings of cash in total assets almost doubled from December 2007 levels.
- Parent bank support and foreign group exposure:
  - Share of Serbian bank assets relative to total foreign group assets is small: less than 3.5 percent for each of the ten largest foreign–owned banks, except one with group exposure to Serbia close to 14 percent.
  - Foreign banks participating in the Financial Sector Support Program (FSSP) maintained exposure to Serbia: €8.74 billion at end-July 2009 compared to €8.72 at end-2008.

### IV. Corporate sector performance and risks
- Activity and profitability deterioration:
  - Sales growth: declined to 19 percent in 2008 (from 29 percent in 2006).
  - Aggregate losses: RSD 37 billion in 2008 (versus RSD 50 billion in 2007).
  - Profitability:
    - Profit margin in 2008: -0.2.
    - Return on Equity (ROE) after tax in 2008: -1.0 percent (down from 3.8 percent in 2006).
  - Large companies experienced worse profitability than SMEs.
  - Worst-performing sectors: manufacturing (car industry and basic metals).
  - Most profitable sectors: financial sector and construction.
- Leverage and solvency:
  - Total debt of the corporate sector: 58 percent of total assets.
  - Nearly 70 percent of corporate debt was short-term.
  - Equity to Debt ratios:
    - 2006 overall: 1.0; public 2.9; other 0.7.
    - 2007 overall: 0.9; public 2.8; other 0.7.
    - 2008 overall: 0.7; public 2.5; other 0.6.
  - Liabilities to assets:
    - 2006 overall: 51.1 percent; public 25.4; other 59.0.
    - 2007 overall: 52.8 percent; public 26.1; other 59.3.
    - 2008 overall: 58.1 percent; public 28.9; other 64.3.
  - Interest Coverage Ratio:
    - 2006 overall: 2.7; public 0.1; other 3.1.
    - 2007 overall: 1.7; public -0.5; other 2.0.
    - 2008 overall: 0.9; public -2.5; other 1.2.
- Company size and data coverage:
  - NBS Solvency Unit collects financial information on around 90,000 companies:
    - 925 Large (>250 employees and > €10 million turnover).
    - 3,520 Medium-sized.
    - 85,389 Small Enterprises.

### V. Short-term liquidity (corporates) and household sector vulnerabilities
- Short-term liquidity and liquidity ratios (corporates):
  - Current assets appear largely adequate to cover short-term liabilities.
  - The current ratio hovered around 100 percent over the past three years.
  - The acid-test ratio (quick ratio) is 70 percent.
  - High current and acid-test ratios indicate liquidity risks are manageable and firms would be in a good position to withstand a sudden stop in access to credit, mitigating rollover risk.
- Corporate debt service and FX exposure:
  - Debt service capacity declined, with significant deterioration in 2008.
  - EBIT covered less than 100 percent of interest payments in 2008.
  - Interest coverage for large companies was barely 0.2 versus 4.0 for small enterprises.
  - Corporate external debt contracted directly from international banks and capital markets reached 36 percent of GDP.
  - Total external debt of the corporate sector is almost equal to total banking sector loans.
  - High corporate FX liabilities expose firms to FX and interest rate risks; many borrowers are unhedged.
  - Possible systemic liquidity risk via intercompany debt collection and the blocked account mechanism.
  - Recommendation: strengthen loan workout mechanisms to enhance loan recovery (see para. 48 in source).
- Household sector balance sheets and FX exposure:
  - Unemployment and RSD depreciation have weakened household balance sheets.
  - Most household loans are to unhedged borrowers directly in FX or via FX indexing.
  - Households’ FX exposure partly mitigated by high FX deposits and remittances, but FX depositors do not necessarily match FX borrowers.
  - Under NBS and the FSSP, banks started allowing borrowers to convert FX loans to RSD without penalties.
  - Households have a relatively low debt service burden by regional comparisons and reportedly hold positive net worth including deposits, investments, life insurance, and voluntary pension funds.
  - Liquid assets cover around 78 percent of household loans.
  - Average Loan-To-Value (LTV) ratio for mortgage loans stands at 65.2 percent as of June 2009 (up from 60 percent in 2005).
  - NBS regulatory measures: limits of total allowable monthly debt service payments set between 30 and 50 percent (with mortgage debt) of net monthly income.
  - Selected household ratios (2005–09, values preserved in source):
    - FX-indexed loans to total loans: ...80.1 81.5 79.6 79.3 78.9
    - FX-deposits to total deposits: 92.0 90.7 91.0 90.6 91.5 91.5
    - FX-deposits to FX- and FX-indexed loans: ...177.8 172.6 143.1 176.2 158.4
    - Loan to value ratio for mortgage loans: 60.6 61.6 64.9 65.4 65.4 65.3
    - Short-term loans to total household loans: 17.7 19.6 15.0 11.6 16.2 12.1

### VI. Banking sector capitalization, liquidity, asset quality, and profitability
- Capitalization and liquidity:
  - Banking sector capital adequacy ratio (CAR) is at 21 percent; all systemic banks maintain CARs above the 12 percent prescribed minimum.
  - Leverage ratio (total equity/total assets) stands at 23 percent.
  - Liquid assets accounted for 42 percent of total assets (versus 47 percent in 2007) and covered 67 percent of short-term liabilities.
  - Loans to deposits increased in recent years but declined in the first half of 2009.
  - Liquidity tested in October 2008: 18 percent of savings deposits were withdrawn; authorities increased deposit insurance from EUR 3,000 to 50,000.
  - Half of the withdrawn deposits have reportedly returned to the banking sector.
  - Overall net open FX position as of June 2009: 4.4 percent of Tier 1 capital; regulatory limit is 20 percent of Tier 1 capital.
  - Banks mostly had long FX positions and gained from RSD depreciation.
  - Asset-liability duration match helps contain interest rate sensitivity; most loans are at variable rates and deposits are short-term.
- Asset quality and profitability:
  - Gross NPL ratio reached 16½ percent in June 2009, up from 11.3 percent in 2008.
  - NPLs concentrated in corporate sector—manufacturing, trade, real estate.
  - Loan portfolio diversification: total large exposures account for 41 percent of Tier 1 capital.
  - Private local banks exhibited worse asset quality: NPLs reached 30½ percent in private local banks in June 2009; NPL coverage ratio was 38 percent (lowest among peer groups).
  - Four majority state-owned banks’ NPL ratios ranged between 28 and 55 percent; combined market share is 2.7 percent of banking sector assets.
  - Banking system profitability declined: ROEs halved in June 2009 to 4.1 percent (annualized) versus 9.3 percent in 2008.
  - Large share of non-income generating assets (cash and reserves at NBS) ~25 percent of total banks’ assets, dampening profitability.
  - There are 13 banks with a total of 16 percent market share generating significant aggregate losses.
  - State banks weakest in performance with ROE of 1.1 percent.

### VII. Stress tests: scope, methodology, and key results
- Scope and covered institutions:
  - Stress tests covered market, credit, and liquidity risks through single- and multi-factor shocks.
  - Tests covered 15 largest private banks and one state-owned bank accounting for 84 percent of banking sector assets, plus peer groups: (a) local private banks; (b) foreign banks; (c) state-owned banks; (d) consolidated banking sector.
- Scenario calibrations (Table 10 assumptions):
  - Scenario 1 / Scenario 2
  - Output gap (in percent of potential output): -5.8 / -5.8
  - Nominal euro exchange rate depreciation (%, eop): 12.0 / 25.0
  - Policy rate change (%): 0.1 / 8.0
- Credit risk assumptions and implementation:
  - Credit risk induced by output contraction; currency-induced credit risk (CICR); and higher interest rates.
  - Most loans are to unhedged FX-borrowers bearing variable interest rates.
  - Migration from NBS categories A, B, C to D and E used as proxy for NPLs; mid-points of provisioning rate ranges used to translate additional NPLs into provisions.
  - NBS provisioning ranges by days overdue:
    - <30 days: 1-2 percent
    - 31-60 days: 5-10 percent
    - 61-90 days: 20-35 percent
    - 91-180 days: 40-75 percent
    - > 181 days: 100 percent
  - Exchange rate pass-through: assumed that 40 percent of the exchange rate shock can be passed through to prices in a time of crisis; pass-through reduced by 75 percent in stress tests to account for falling demand.
  - Off-balance sheet: tests applied to classified off-balance sheet items (about a quarter of total off-balance sheet items — payment guarantees and undrawn credit lines).
- Credit risk key results:
  - System NPLs increased by 13½ percentage points from June 2009 levels; over 10 percentage points due to CICR and the widening output gap; interest rate channel contributed around 3 percentage points.
  - In the most severe credit-only scenario (additional 13½ percentage points NPL increase), large banks largely remained capitalized; some banks fell below 12 percent CAR but most stayed above 8 percent; one bank in recapitalization fell below 8 percent.
  - Recapitalization needed to restore CAR to 12 percent did not exceed 0.7 percent of GDP in the credit-risk-only severe scenario.
  - State-owned banks were more strongly affected; one small majority state-owned bank already incurring losses lost its capital in the most severe scenario.
- Market risk (exchange rate and interest rate):
  - FX net open position as of June 2009: 4.4 percent of Tier 1 capital; regulatory limit 20 percent.
  - High risk weights on unhedged FX loans (125 percent) cause RWA to increase significantly in large depreciation, explaining CAR impact of 2-3 percent.
  - Interest rate risk limited due to floating-rate loans and adequate asset-liability management.
- Multi-factor macro scenarios and recap needs:
  - Scenario 1 (program adverse): CAR 18.8 percent (CAR change -2.7 percent), Recapitalization needs 1.0 percent of GDP (with profit buffers); 1.2 percent of GDP without profit buffers.
  - Scenario 2 (crisis): CAR 14.9 percent (CAR change -6.5 percent), Recapitalization needs 0.4 percent of GDP (with profit buffers).
  - Selected single-factor results (based on June 2009 data):
    - Baseline: CAR 21.4 percent; Recapitalization needs 0.0 percent of GDP.
    - Single Factor Credit Risk (Fund program adverse): CAR 17.6 percent (CAR change -3.9 percent); Recapitalization needs 0.2 percent of GDP.
    - Single Factor Credit Risk (crisis): CAR 14.2 percent (CAR change -7.2 percent); Recapitalization needs 0.7 percent of GDP.
    - Market Risk — RSD depreciation 12%: CAR 20.6 percent (CAR change -0.8 percent); Recapitalization needs 0.0 percent of GDP.
    - Market Risk — RSD depreciation 25%: CAR 19.1 percent (CAR change -2.3 percent); Recapitalization needs 0.0 percent of GDP.
- Liquidity stress tests:
  - Deposit-run scenario: daily withdrawals of 7 percent of household deposits and 2 percent of corporate deposits for five consecutive days; liquid assets convertible at 80 percent; illiquid assets at 1 percent; no external financing allowed.
  - Tests showed banks could withstand the shocks due to high liquidity buffers and high reserve requirements.
  - No banks became illiquid in the scenario.
  - Additional tests including withdrawal of parent banks’ short-term exposures showed no major impact.

### VIII. Models, supervisory practices, and capacity
- NBS developments:
  - NBS developed macro-financial models mapping PDs of corporate and household sectors with macro variables and built separate models for unexpected losses for corporate and retail borrowers.
  - Data series availability limited to since 2007; recommendation to build longer series to enhance robustness.
  - Suggested enhancements: refine correlation matrices of risk factors, calibration of shocks, and mapping to macroeconomic scenarios; construct PDs and exposures by economic sector bank by bank covering at least one economic cycle.
- Banks’ stress testing practices:
  - Great divergence across banks; most use sensitivity analyses on parts of the balance sheet.
  - Risk factors used mainly credit and liquidity risks; some large banks do not conduct credit risk stress tests.
  - Macro-financial models rarely used by banks; no bank has a comprehensive and mature stress testing framework per NBS survey.

### IX. Summary findings and policy recommendations
- Key findings:
  - The banking sector is well capitalized and liquid, but weak corporate sector performance poses a risk to NPLs.
  - Corporate activity, profitability, and solvency have significantly declined during the downturn, weakening borrowers’ repayment capacity.
  - FX risk significant for corporate and household sectors due to high unhedged FX borrowing; exchange rate pressures combined with increased unemployment could further weaken balance sheets and debt servicing.
  - NPLs nearly doubled since September 2008 to 16½ percent in June 2009.
  - Banks are resilient to further shocks but remain vulnerable to credit risk, especially FX-induced credit risk and prolonged downturns, which could erode reserves and threaten systemic stability.
- Main recommendations:
  - Monitor NPLs closely, particularly in the manufacturing and processing industries.
  - Monitor restructured loans.
  - Ensure majority state-owned banks are sufficiently strengthened before divestment, given their weak performance.
  - Enhance risk management in small private local banks.
  - Strengthen loan workout mechanisms to enhance loan recovery.

*Source: _cr10149 - 1. Bank Concentration (IMF staff report excerpt, based on June 2009 data).*

### 1. Bank Concentration, .................................................................................................

### Bank Concentration, ..............................................................................................................5

### I. Introduction and scope
- The note analyzes banking sector soundness and identifies vulnerabilities, focusing on balance sheet structure, corporate and household sector performance, and banking sector risk exposures.
- Analysis informed by results of stress tests designed to assess resilience of the banking sector.
- Prepared by Nada Oulidi and Piyabha Kongsamut.

### II. Structure of the financial sector
- Financial sector assets:
  - Grew from 52 percent of GDP in 2005 to over 70 percent of GDP in 2007; crisis halted growth since 2008.
  - Share of banking sector assets in total financial sector assets remained around 89 percent.
- Bank concentration:
  - Herfindahl-Hirschman Index (HHI) for Serbia: 650.
  - Comparative HHIs: Bulgaria 834; Romania (2007) 1041; Croatia 1355.
  - Five largest banks accounted for 46 percent of total banking system assets at mid-2009.
- Ownership:
  - State-controlled banks' share declined from 21 percent of total assets in 2005 to 18 percent in 2009Q2.
  - Nine banks with significant public stake:
    - Four majority state-owned banks: combined market share 2.6 percent.
    - Two banks where EBRD and the state constitute the majority shareholder: combined market share 11.3 percent.
    - Three banks where the state alone holds stakes of around 20-30 percent: combined market share 3.9 percent.
- Foreign ownership and market structure:
  - Foreign ownership rose to almost 75 percent of the banking system.
  - Subsidiaries of Austrian, Greek, and Italian banks are within the top five banks by assets.
  - Banks from Austria, Greece, and Italy combined have close to a 60 percent market share.
  - French and German banks among the top 12 banks.
  - Most local private banks are small; only one fully private Serbian bank among the top 10.
- Nonbank financial institutions (NBFIs):
  - NBFIs account for 11 percent of the financial sector.
  - Composition: leasing companies (almost 60 percent of NBFI sector assets), insurance companies (40 percent), pension funds (less than 1 percent).
  - Leasing companies rely on long-term funding from abroad: 87 percent of liabilities.
  - Top three areas financed by leasing: (a) transportation, warehousing, and communications; (b) manufacturing; (c) trade.
- Financial deepening:
  - Assets relative to GDP remain fairly low compared to peers.
  - Stock market capitalization:
    - 55 percent of GDP in 2007.
    - Plummeted to 25 percent of GDP in early 2009.
    - Recovered to about 30 percent of GDP more recently.
    - Average daily turnover for 2009 was 14 percent of its 2007 levels.
  - Bond trading limited largely to trading in foreign currency savings bonds.

### III. Structure of banking system assets and liabilities
- Euroization and currency composition:
  - Euroization: 80 percent of loans and 70 percent of deposits denominated or indexed to foreign currency.
  - Majority of FX-linked exposure predominantly in euros, but also in Swiss francs.
- Asset composition (Table 3, June 2009; share of group total):
  - Cash: State 18; Local Private 14; Foreign 11; Total 13.
  - Reserves at the NBS: State 10; Local Private 6; Foreign 12; Total 11.
  - Investments: State 2; Local Private 3; Foreign 2; Total 2.
  - Loans net of provisioning: State 57; Local Private 59; Foreign 60; Total 59.
  - Fixed and other assets: State 13; Local Private 18; Foreign 14; Total 14.
- Loan composition, 2009 (by borrower and sector):
  - Households: 33 percent of loans (16 percent of total loans are in mortgages).
  - Industry: 18 percent of loans.
  - Trade: 19 percent of loans.
  - Construction: 6 percent.
  - Agriculture: 3 percent.
  - Other: 21 percent.
- Credit growth:
  - Euroized credit to the private sector declined from 21 percent at end 2007 (in euro terms) to 4 percent through the first half of 2009.
- Off-balance sheet and cross-border lending:
  - External debt from corporates to non-official creditors grew from €4.6 billion in 2006 to almost €11 billion in August 2009.
  - Guarantees provided by local subsidiaries for cross-border loans:
    - Correspond to 63 percent of off-balance sheet items that are subject to credit risk.
    - Value of these guarantees: € 4.8 billion as of December 2008.
  - Authorities require banks to classify these exposures in the same way as on-balance sheet items.
- Funding structure and liabilities (Table 4, June 2009, in percent of total):
  - Interbank deposits: State 1; Local private 2; Foreign 5; Total 4.
  - Non interbank deposits: State 71; Local private 59; Foreign 51; Total 55.
  - Borrowing: State 3; Local private 4; Foreign 12; Total 10.
    - o/w due to foreign banks: State 1; Local private 1; Foreign 6; Total 5.
  - Other liabilities: State 6; Local private 3; Foreign 9; Total 8.
  - Shareholder equity: State 19; Local private 32; Foreign 23; Total 23.
  - Deposits account for 59 percent of total liabilities, of which 70 percent are in FX.
  - External liabilities constitute about 20 percent of total liabilities.
  - External borrowing is generally over 1 year maturity; interbank funding is minimal and mostly by foreign-owned banks.
- Liquidity and safe assets:
  - Banks' holdings of T-bills and NBS certificates rose to 7½ percent of total assets in June 2009.
  - Banks hold over 20 percent of assets in cash and unremunerated reserves at the NBS.
  - Share of banks’ holdings of cash in total assets almost doubled from December 2007 levels.
- Parent bank support and foreign group exposure:
  - Share of Serbian bank assets relative to total foreign group assets is small: less than 3.5 percent for each of the ten largest foreign–owned banks, except one with group exposure to Serbia close to 14 percent.
  - Foreign banks participating in the Financial Sector Support Program (FSSP) maintained exposure to Serbia: €8.74 billion at end-July 2009 compared to €8.72 at end-2008.

### IV. Corporate sector performance and risks
- Activity and profitability deterioration:
  - Sales growth: declined to 19 percent in 2008 (from 29 percent in 2006).
  - Aggregate losses: RSD 37 billion in 2008 (versus RSD 50 billion in 2007).
  - Profitability:
    - Profit margin in 2008: -0.2.
    - Return on Equity (ROE) after tax in 2008: -1.0 percent (down from 3.8 percent in 2006).
  - Large companies experienced worse profitability than SMEs.
  - Worst-performing sectors: manufacturing (car industry and basic metals).
  - Most profitable sectors: financial sector and construction.
- Leverage and solvency:
  - Total debt of the corporate sector: 58 percent of total assets.
  - Nearly 70 percent of corporate debt was short-term.
  - Equity to Debt ratios (Table 5):
    - 2006 overall: 1.0; public 2.9; other 0.7.
    - 2007 overall: 0.9; public 2.8; other 0.7.
    - 2008 overall: 0.7; public 2.5; other 0.6.
  - Liabilities to assets:
    - 2006 overall: 51.1 percent; public 25.4; other 59.0.
    - 2007 overall: 52.8 percent; public 26.1; other 59.3.
    - 2008 overall: 58.1 percent; public 28.9; other 64.3.
  - Interest Coverage Ratio:
    - 2006 overall: 2.7; public 0.1; other 3.1.
    - 2007 overall: 1.7; public -0.5; other 2.0.
    - 2008 overall: 0.9; public -2.5; other 1.2.
- Company size and data coverage:
  - NBS Solvency Unit collects financial information on around 90,000 companies:
    - 925 Large (defined as >250 employees and > €10 million turnover).
    - 3,520 Medium-sized.
    - 85,389 Small Enterprises.

### V. Key findings (summary of vulnerabilities and strengths)
- Strengths and buffers:
  - Banking sector assets remained a dominant share of the financial sector (around 89 percent).
  - Foreign parent banks have provided capital support, including under the FSSP commitments.
  - Banks increased holdings of safe assets (T-bills and NBS certificates at 7½ percent of assets) and cash/reserves (over 20 percent of assets).
- Vulnerabilities:
  - High euroization: 80 percent of loans and 70 percent of deposits expose banks and borrowers to FX risk.
  - Credit growth slowed sharply: euroized credit growth fell from 21 percent (end 2007) to 4 percent (first half 2009).
  - Significant corporate external debt: corporate external debt to non-official creditors nearly €11 billion (August 2009), exceeding banks’ loan portfolio.
  - Off-balance sheet guarantees: €4.8 billion (Dec 2008) in guarantees by local subsidiaries for cross-border loans; these represent 63 percent of off-balance sheet credit-risk items.
  - Corporate sector deterioration: negative aggregate profits (RSD 37 billion in 2008), ROE -1.0 percent, high short-term corporate debt (nearly 70 percent).
  - Concentration remains moderate by HHI but top five banks hold 46 percent of assets.

_Italic: Source: _cr10149 - 1. Bank Concentration, ................................................................................................._

### 16.      Short-term liquidity remains at acceptable levels. Current assets appear largely

### _cr10149 - 16.      Short-term liquidity remains at acceptable levels. Current assets appear largely

### Short-term liquidity and liquidity ratios
- Current assets appear largely adequate to cover short-term liabilities.
- The current ratio hovered around 100 percent over the past three years.
- The acid-test ratio (quick ratio) is 70 percent.
- High current and acid-test ratios indicate liquidity risks are manageable and firms would be in a good position to withstand a sudden stop in access to credit, mitigating rollover risk.

### Corporate sector debt service and FX exposure
- Debt service capacity is modest and declined, with significant deterioration in 2008 due to increased indebtedness, lower profitability, and weaker cash flows.
- Earnings before interest and taxes (EBIT) covered less than 100 percent of interest payments in 2008.
- Interest coverage for large companies was barely 0.2 versus 4.0 for small enterprises.
- Corporate external debt contracted directly from international banks and capital markets reached 36 percent of GDP.
- Total external debt of the corporate sector is almost equal to total banking sector loans.
- High corporate FX liabilities expose firms to FX and interest rate risks; many borrowers are unhedged and depreciation in RSD increases vulnerability.
- Possible systemic liquidity risk: illiquidity contagion through intercompany debt collection and the blocked account mechanism.
- Table 6 (selected sector/size indicators, 2005–08) highlights sectoral and size differences (values preserved in source tables; see source).

### Sector- and size-specific vulnerabilities
- Large corporates, especially public companies, face more financial distress than SMEs: more heavily leveraged, less profitable, and with less debt service capacity.
- Manufacturing sector appears among the most financially distressed in profitability and debt service capacity.
- Construction and financial intermediation sectors appear most profitable.
- High corporate financial distress is a significant vulnerability for the banking sector; potential for further increases in nonperforming loans (NPLs).
- Recommendation from source context: strengthen loan workout mechanisms to enhance loan recovery (see para. 48 in source).

### Household sector balance sheets and FX exposure
- Unemployment and RSD depreciation have weakened household balance sheets.
- Most household loans are to unhedged borrowers either directly in FX or indirectly via FX indexing.
- Households’ FX exposure is partly mitigated by high FX deposits and remittances, but FX depositors do not necessarily match FX borrowers.
- Under NBS and the FSSP, banks started allowing borrowers to convert FX loans to RSD without penalties.
- Households have a relatively low debt service burden by regional comparisons and reportedly hold positive net worth including deposits, investments, life insurance, and voluntary pension funds.
- Liquid assets cover around 78 percent of household loans.
- Average Loan-To-Value (LTV) ratio for mortgage loans stands at 65.2 percent as of June 2009 (up from 60 percent in 2005).
- NBS regulatory measures: limits of total allowable monthly debt service payments set between 30 and 50 percent (with mortgage debt) of net monthly income.
- Table 7 (selected household ratios, 2005–09) shows:
  - FX-indexed loans to total loans: ...80.1 81.5 79.6 79.3 78.9
  - FX-deposits to total deposits: 92.0 90.7 91.0 90.6 91.5 91.5
  - FX-deposits to FX- and FX-indexed loans: ...177.8 172.6 143.1 176.2 158.4
  - Loan to value ratio for mortgage loans: 60.6 61.6 64.9 65.4 65.4 65.3
  - Short-term loans to total household loans: 17.7 19.6 15.0 11.6 16.2 12.1

### Banking sector capitalization and liquidity
- Banking sector capital adequacy ratio (CAR) is at 21 percent; all systemic banks maintain CARs above the 12 percent prescribed minimum.
- Leverage ratio (total equity/total assets) stands at 23 percent.
- Regulatory Tier I capital to risk-weighted assets and other capital metrics (Table 8) preserved in source.
- Liquid assets accounted for 42 percent of total assets (versus 47 percent in 2007) and covered 67 percent of short-term liabilities.
- Loans to deposits increased in recent years but declined in the first half of 2009.
- Liquidity tested in October 2008: 18 percent of savings deposits were withdrawn; authorities increased deposit insurance from EUR 3,000 to 50,000.
- Half of the withdrawn deposits have reportedly returned to the banking sector.
- Overall net open FX position as of June 2009: 4.4 percent of Tier 1 capital; regulatory limit is 20 percent of Tier 1 capital.
- Banks mostly had long FX positions and gained from RSD depreciation.
- Asset-liability duration match helps contain interest rate sensitivity; most loans are at variable rates and deposits are short-term.

### Asset quality, profitability, and peer-group differentials
- Gross NPL ratio reached 16½ percent in June 2009, up from 11.3 percent in 2008.
- NPLs concentrated in corporate sector—manufacturing, trade, real estate.
- Loan portfolio diversification: total large exposures account for 41 percent of Tier 1 capital.
- Private local banks exhibited worse asset quality: NPLs reached 30½ percent in private local banks in June 2009; NPL coverage ratio was 38 percent (lowest among peer groups).
- Four majority state-owned banks’ NPL ratios ranged between 28 and 55 percent; combined market share is 2.7 percent of banking sector assets.
- Banking system profitability declined: ROEs halved in June 2009 to 4.1 percent (annualized) versus 9.3 percent in 2008.
- Large share of non-income generating assets (cash and reserves at NBS) ~25 percent of total banks’ assets, dampening profitability.
- There are 13 banks with a total of 16 percent market share generating significant aggregate losses.
- State banks weakest in performance with ROE of 1.1 percent.
- Selected financial soundness indicators (Table 8) and peer-group comparisons (Table 9) preserved in source.

### Stress tests: scope, methodology, and scenarios
- Stress tests covered market, credit, and liquidity risks through single- and multi-factor shocks.
- Tests covered 15 largest private banks and one state-owned bank accounting for 84 percent of banking sector assets, plus peer groups: (a) local private banks; (b) foreign banks; (c) state-owned banks; (d) consolidated banking sector.
- Credit risk stress-test methodology aligned with FSSP component and CESE regional exercise with key differences noted in source.
- Calibration of macro-to-credit elasticities used cross-country evidence from 51 banking crises in 54 countries (1994–2004), CESE rules of thumb, and expert judgment.
- Macro variables included output gap, exchange rate, and interest rate changes; shocks derived from Fund program downside macro-scenario and an assumed full-blown crisis scenario.
- Table 10: Downside and Crisis Macro Scenario Assumptions for Stress Tests
  - Scenario 1 / Scenario 2
  - Output gap (in percent of potential output): -5.8 / -5.8
  - Nominal euro exchange rate depreciation (%, eop): 12.0 / 25.0
  - Policy rate change (%): 0.1 / 8.0

*Source: _cr10149 (IMF staff report content as provided in the supplied PDF excerpt).*

### 31.      As regards the metrics, the impact was shown on regulatory capital, risk weighted

### _cr10149 - 31.      As regards the metrics, the impact was shown on regulatory capital, risk weighted

### Metrics and methodology
- Impact measured on regulatory capital, risk weighted assets, and CAR.  
- Change in CAR compared to the baseline calculated; necessary capital injection to restore CAR to the minimum 12 percent estimated as a percent of GDP.  
- Credit risk losses treated as increases in provisions; exchange rate stress losses treated as revaluation gain or loss from net open positions and RWA.  
- Macroeconomic scenario shocks expressed as present value of gains or losses charged to capital under two measures: assuming no profit buffers and allowing for profit buffers assuming 100 percent retained earnings.  
- Liquidity stress tests evaluated deposit runs with banks forced to service liabilities through fire-sale of liquid assets with no access to external financing from parent banks or the NBS; calculated number of illiquid banks after each day and their total market share and net cash outflow as a percent of total assets.  
- Collateral treatment: loan base reduced by full amount of prime collateral (mostly cash) and 50 percent of adequate collateral (mortgages) to reflect haircut assumptions.

### A. Credit Risk — assumptions and implementation
- Credit risk assumed induced by: a further contraction in output; pressures on the RSD as currency-induced credit risk (CICR); and an increase in interest rates to support the exchange rate.  
- Most loans in Serbia are to unhedged FX-borrowers bearing variable interest rates.  
- Elasticities linking NPLs with macro variables were taken from cross-country studies using NPL ratios defined as loans 90+ days overdue; Serbian provisioning regulation uses five risk categories A, B, C, D, E. Categories D and E used as proxy for NPLs after adjustments.  
- Migration of loans from A, B, C to D and E distributed proportionally according to banks’ initial shares of NPLs in each category; mid-points of provisioning rate ranges used to translate additional NPLs into additional provisions.  
- NBS provisioning ratio ranges by days overdue:
  - <30 days: 1-2 percent  
  - 31-60 days: 5-10 percent  
  - 61-90 days: 20-35 percent  
  - 91-180 days: 40-75 percent  
  - > 181 days: 100 percent
- Exchange rate pass-through and collateral/price dynamics:
  - Assumed that 40 percent of the exchange rate shock can be passed through to prices in a time of crisis, reducing CICR impact proportionally.  
  - Exchange rate pass-through was reduced by 75 percent in the stress tests to account for falling demand in a crisis.  
  - Three-year average correlation between the RSD/Euro exchange rate and inflation is 0.6; correlation was reduced to account for falling demand.  
  - Formula used for increase in NPL ratio due to CICR: )4.01(NPL, where  is the exchange rate shock,  is the elasticity of the NPL ratio to the exchange rate, and  is the share of corporate loans in total loans.

- Off-balance sheet items: credit risk stress tests applied to classified off-balance sheet items (about a quarter of total off-balance sheet items — payment guarantees and undrawn credit lines) using same migration methodology.

### A. Credit Risk — key results
- System NPLs increased by 13½ percentage points from June 2009 levels; over 10 percentage points due to CICR and the widening output gap; interest rate channel contributed around 3 percentage points.  
- In the most severe scenario (additional 13½ percentage points NPL increase from June 2009), large banks did not experience severe undercapitalization. Some banks fell below minimum CAR of 12 percent but most stayed above 8 percent; one bank in recapitalization fell below 8 percent.  
- Recapitalization needed to restore CAR to 12 percent did not exceed 0.7 percent of GDP in the credit-risk-only severe scenario.  
- State-owned banks were more strongly affected than other groups; one small majority state-owned bank already incurring losses lost its capital in the most severe scenario (reportedly a strategic partner has been identified to acquire the bank).

### B. Market Risks — exchange rate and interest rate
- Exchange rate risk:
  - Direct impact of exchange rate depreciation on banks’ FX net open positions and RWA evaluated.  
  - FX net open position for the banking sector was 4.4 percent of Tier 1 capital as of June 2009.  
  - Regulatory restrictions limit FX-net open positions to 20 percent of Tier I capital; many banks hold long FX-net open positions and thus gain on RSD depreciation.  
  - Largest impact arises from revaluation of FX assets on RWA; high risk weights on unhedged FX loans (125 percent) cause RWA to increase significantly in large depreciation, explaining negative impact on CAR in the range of 2-3 percent.
- Interest rate risk:
  - Market risk impact of interest rates not significant due to adequate asset-liability management and marginal trading portfolios.  
  - Direct impact limited because most loans bear floating rates and reprice with short-term deposits; fixed income securities (excluding repo) are 2 percent of banks’ balance sheets.  
  - Transformation risk mitigated by callability of loans before maturity (standard covenant).

### C. Macro Scenarios — setup and results
- Two adverse macroeconomic multi-factor scenarios:
  - Scenario 1: downside scenario under the Fund program (as of May 2009) — weaker growth, higher output gap, some depreciation pressures, broadly unchanged policy interest rates versus baseline.  
  - Scenario 2: full-blown crisis — same output gap, plunge of the RSD similar to late 2008, significant hike in policy rates. Shock magnitudes guided by historical banking crises (Table 11).  
- Profit buffer treatment:
  - Present-value shocks accounted for projected profits; after-tax pre-provisioning profits assumed at 60 percent of the 2008 level, consistent with CESE and FSSP assumptions.  
  - Net income as of June 2009 included; 100 percent retained earnings assumed when profit buffers allowed.  
- Historical banking crisis indicators (selected values from Table 11; median value):
  - Median value: 28, 33, 58, 8.3 (as reported in the table).  
- Macro-scenarios results:
  - System CAR remains above minimum in both scenarios, excluding or including profit buffers; worst outcome reduces CAR to 13.9 percent.  
  - Capital injection needed to restore CAR of the 15 largest banks and state-owned bank to 12 percent is:
    - 1.2 percent of GDP under the full-blown crisis scenario assuming zero pre-provisioning after-tax projected net income (no profit buffers).  
    - 0.4 percent of GDP allowing for pre-provisioning profits as described above (with profit buffers).  
  - This limited recapitalization need reflects low credit-to-GDP ratio in Serbia and very high pre-crisis capital buffers.  
  - Stress test results of the banking sector mirror foreign banks’ given their predominance.

- Selected summary entries from Table 12 (based on June 2009 data):
  - Baseline (before shocks): CAR 21.4 percent; CAR change in RSD 0.0 billions; Recapitalization needs 0.0 percent of GDP.  
  - Single Factor Credit Risk (Increase in NPLs using Fund program adverse scenario): CAR falls to 17.6 percent (CAR change -3.9 percent), Recapitalization needs 0.2 percent of GDP.  
  - Single Factor Credit Risk (Increase in NPLs using crisis scenario): CAR falls to 14.2 percent (CAR change -7.2 percent), Recapitalization needs 0.7 percent of GDP.  
  - Market Risk — Direct impact RSD depreciation on Net Open Position and RWA (12%): CAR falls to 20.6 percent (CAR change -0.8 percent), Recapitalization needs 0.0 percent of GDP.  
  - Market Risk — Direct impact RSD depreciation on Net Open Position and RWA (25%): CAR falls to 19.1 percent (CAR change -2.3 percent), Recapitalization needs 0.0 percent of GDP.  
  - Multi-factor Scenario 1 (program adverse scenario): CAR 18.8 percent (CAR change -2.7 percent), Recapitalization needs 1.0 percent of GDP (note: multi-factor scenarios take into account profit buffers; without such buffers recap needs would be 1.2 percent of GDP).  
  - Multi-factor Scenario 2 (crisis scenario): CAR 14.9 percent (CAR change -6.5 percent), Recapitalization needs 0.4 percent of GDP.

### D. Liquidity Risk — setup and results
- Liquidity stress test: deposit run over five days without external financing, calibrated to historical evidence.  
  - October 2008 event: 18 percent of savings deposits withdrawn over 1½ months.  
  - Stress test assumed daily withdrawals of 7 percent of household deposits and 2 percent of corporate deposits for five consecutive days.  
  - Liquid assets convertible to cash at 80 percent; illiquid assets at 1 percent; NBS assumed willing to buy back government securities at a discount.  
  - No access to external financing from parent banks, interbank market, or lender of last resort during five days.  
  - Corporate deposits noted as more difficult to withdraw due to documentation requirements.

- Liquidity test results:
  - Banks could withstand the shocks due to high liquidity buffers and high reserve requirements.  
  - No banks became illiquid in the scenario.  
  - Additional test assuming withdrawal of parent banks’ short-term exposures measured against current assets to short-term liabilities ratio showed no major impact.

### VI. Models used by NBS and commercial banks
- NBS progress:
  - NBS developed macro-financial models mapping PDs of corporate and household sectors with macro variables (GDP growth, interest rates, exchange rates, credit growth) and built separate models for unexpected losses for corporate and retail borrowers. Sensitivity analyses are adequate.  
  - Data series availability is limited to since 2007; recommendation to build longer series to enhance robustness.
- Suggested enhancements:
  - Refine correlation matrices of risk factors, calibration of shocks, and mapping to macroeconomic scenarios.  
  - If NBS can forecast macro-variable paths via a macroeconomic model, those could be used to model PD impacts using dynamic panel data regressions; elasticities would feed into credit risk shock calibration.  
  - Construct PDs and exposures by economic sector bank by bank covering at least one economic cycle.
- Banks’ stress testing practices:
  - Great divergence across banks; most use sensitivity analyses on parts of the balance sheet.  
  - Risk factors used are mainly credit and liquidity risks; some large banks do not conduct credit risk stress tests.  
  - Macro-financial models are rarely used by banks; no bank has a comprehensive and mature stress testing framework per NBS survey.

### VII. Summary findings and recommendations
- Key findings:
  - The banking sector is well capitalized and liquid, but weak corporate sector performance poses a risk to NPLs.  
  - Corporate activity, profitability, and solvency have significantly declined during the downturn, weakening borrowers’ repayment capacity.  
  - FX risk significant for corporate and household sectors due to high unhedged FX borrowing; exchange rate pressures combined with increased unemployment could further weaken balance sheets and debt servicing.  
  - NPLs nearly doubled since September 2008 to 16½ percent in June 2009.  
  - Banks are resilient to further shocks but remain vulnerable to credit risk, especially FX-induced credit risk and prolonged downturns, which could erode reserves and threaten systemic stability.
- Main recommendations (from Table 14):
  - Monitor NPLs closely, particularly in the manufacturing and processing industries.  
  - Monitor restructured loans.  
  - Ensure majority state-owned banks are sufficiently strengthened before divestment, given their weak performance.  
  - Enhance risk management in small private local banks.

*Source: IMF staff report excerpt (based on June 2009 data).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10149.pdf_