## _cr12325 ## Source details **Canonical URL:** [_cr12325](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12325.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12325.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12325.pdf.json) --- ### Executive summary — overview and macro background - Slovenian financial system severely hit by crisis driven by weak governance in public banks and an externally financed credit boom. - Real GDP decline of about 10 percent from peak to trough; GDP growth 1.4 percent in 2010, -0.2 percent in 2011, recession intensified in 2012. - Unemployment almost doubled since 2008 to 8.4 percent in August 2012. - General government deficit (cash basis) increased from 5.4 percent of GDP in 2010 to 5.7 percent of GDP in 2011. - Total assets of Slovenia’s financial institutions: €65 billion by end 2011 (182 percent of GDP). - Financial depth increased after Euro adoption but was slowed by the crisis. ### Key vulnerabilities and banking sector condition - Credit quality deterioration produced operating losses in the banking sector in 2010–2011. - Deleveraging since 2009 is protracted; banks vulnerable to continued credit deterioration and refinancing risks. - Corporate sector over-indebted; construction and management buy-outs drove NPLs. - Stress test (end-2011 data): under a double-dip adverse scenario, recapitalization of around 5 percent of GDP required to bring system core Tier I to 9 percent. - High exposure to real estate price risk due to large share of loans backed by real estate collateral. - A further sovereign downgrade would impair government ability to recapitalize banks; recent successful bond issuance reduces short-term risk. ### Financial system structure and state control - Banks are dominant; insurers, leasing companies and others make up about a quarter of the system. - Lead companies in the three major financial groups (NLB, NKBM, Triglav) are all at least 50 percent state-controlled. - State-controlled banks account for around 55 percent of the system by assets or capital. - Foreign banks represent 30 percent market share (one of the lowest in Eastern Europe). - NLB Group assets: total €16,445 million; Slovenia assets €12,980 million. ### Corporate, construction, and household sectors - Corporate debt-to-GDP: almost 170 percent in 2008. - Construction sector: worst affected; real estate liquidity declined; two large construction companies bankrupt in 2011. - Household assets excluding real estate: 113 percent of GDP (2010); household liabilities 35 percent of GDP (2010). - Over 50 percent of household financial assets in cash or bank deposits; average mortgage LTV around 60 percent; debt-to-disposable income ratio 53 percent in 2010. - Nonperforming loans for households: 3.5 percent of total household loans at end-2011. ### Bank performance and balance-sheet indicators (selected exact figures) - NPL ratio banking sector: 11.9 percent in 2011; 12.6 percent by June 2012. - Total bank losses (consolidated): €508 million in 2011 (up from €120 million in 2010). - Aggregate capital adequacy ratio (CAR): 12 percent as of December 2011 (11.3 percent in 2010). - As of end-2011, 12 banks fell short of Core Tier I ratio of 9 percent, total shortfall €540 million. - NLB recapitalization: required €320 million by June 2012; recapitalized by €383 million (composed of €320 million contingent convertible instruments and €63 million common equity). - First bucket liquidity ratio: 140 percent at end-2011. - Ratio of liquid assets to short-term liabilities: 40 percent at end-2011. - System loan-to-deposit ratio: 135 percent. - Government deposits: about €2 billion and declining. - Credit to corporate sector declined by 6.2 percent in 2011. - Slovenian banks repaid almost €6 billion in external creditors since 2008 (16 percent of GDP). ### Stress testing — scenarios, assumptions, and outcomes - Coverage: all banks on consolidated and solo basis as of December 2011; horizon 2012–13; zero growth in bank balance sheets assumed. - Major shocks considered: credit losses, sovereign bond mark-to-market, stressed funding costs. - Scenarios: - Baseline: double-dip scenario per BOS projections. - Double-dip adverse: worsening Euro area crisis; Euribor +200 basis points; large export decline; weak 2013 recovery. - Slow-growth: lengthier Euro-zone recession; Euribor +100 basis points; prolonged export weakness. - Single-factor tests: - Real estate shock: commercial real estate -25 percent; residential real estate -15 percent. - Concentration risk: deterioration of three largest exposures. - Refinancing risk: reduction in wholesale external funding. - Bottom-up refinancing assumptions: partial roll-over of maturing foreign loans 20 percent for domestically-owned banks and 40 percent for foreign-owned banks; one-notch sovereign downgrade; ECB funding assumed to finance liquidity shortages. - Top-down refinancing assumption: zero roll-over of maturing wholesale funding; required deleveraging via reduced lending and interest income. ### Stress test results (selected exact figures) - Baseline scenario: several banks’ CAR would fall below required minimum of 8 percent in 2013; total capital shortfall €60 million. - Double-dip adverse scenario: CAR shortfall €518 million. - Core Tier I severe stress outcome: total Core Tier I shortfall €1.9 billion (around 5 percent of GDP). - Top-down and bottom-up results broadly consistent. - Single-factor tests: real estate price shock and concentration risk cause largest impacts, particularly for large domestic banks; refinancing risk affects large domestic and foreign banks most. ### Crisis preparedness, resolution framework, and Deposit Guarantee Scheme (DGS) - Crisis preparedness and management framework requires significant improvement; BOS powers to deal with failing banks need expansion/clarification for least-cost resolution. - Core recommendation: redesign DGS from an ex-post pay-box to an active resolution tool consistent with FSB Key Attributes and EU draft directive. - DGS should be funded ex ante by bank contributions; contributions invested in liquid instruments or deposited at BOS. - DGS allowed to support certain bank-restructuring transactions up to the amount it would have paid in liquidation (cap), with exemptions for systemic cases. - Insured depositors and DGS should have priority rights over the failed bank’s estate. - Asset Management Company (AMC) planned: - Authorities decided early October 2012 to set up an AMC. - AMC intended to issue up to €4 billion of government-guaranteed bonds. - AMC to acquire impaired assets at their “real long-term value,” follow EC State Aid Guidelines, to be wound down after five years and remaining assets transferred to Slovenia Sovereign Holding. - Legal basis for ELA by BOS unclear; recommendation to clarify legal basis for ELA operations. - Solvency support: prior extra-budgetary powers expired end-2010; recommendation to reintroduce standing authorization in Public Finance Act for rapid government support in systemic crises with safeguards (loss attribution, BOS oversight, transparency). ### Restructuring powers and operational crisis arrangements - Administrator powers recommended: full takeover of decision-making bodies (management board, supervisory board, general assembly) and tools including rapid recapitalization without shareholders’ agreement, transfer of assets/liabilities via purchase-and-assume transactions, bridge banks. - Governance risk: appointing an administrator without effective resolution powers can be destabilizing (creditor runs). - Recommendation: prepare and adopt an operational crisis plan defining MOF and supervisory agencies’ roles; conduct periodic crisis simulations (for example, annual). ### Supervisory, regulatory, and macroprudential assessment (BCP findings and recommendations) - BOS assessment: improvements since 2003 but weaknesses remain. - BOS powers to license or remove supervisory board members and to require authorization for banks acquiring non-bank financial companies should be strengthened. - Bank shareholders can currently impede BOS’s requirement to increase capital; legal protection for supervisors inadequate. - Reporting of problem assets lacks granularity; provisioning on NPLs relatively low (provisioning reported as 40–41 percent in several sections). - Macroprudential framework: BOS has well-developed tools for detecting systemic risk and has deployed many policy instruments, but de jure macroprudential mandates are not enshrined in existing legislation. - Recommendation: expand each supervisory agency’s mandate to include macroprudential oversight and designate BOS as lead in systemic risk assessment; make macroprudential decisions and motivations public while respecting confidentiality; macroprudential authority ultimately accountable to parliament. - Supervisory resourcing and approach: - Off-site supervision understaffed; recommendation to considerably expand off-site staff and target hiring for on-site IT and OR expertise. - Strengthen supervisory reporting to include more granular data on related parties and solo reporting from non-bank financial companies. - Empower BOS to reject appointment of external auditors to banks; consider auditor rotation and formal post-audit meetings. - Specific legal and institutional recommendations: - Amend Banking Law to allow BOS to remove supervisory board members and eliminate impediments to require corrective capital measures. - Require banks to obtain authorization prior to acquiring non-bank financial companies. - Ensure ATVP and AZN are not constrained by Public Agencies Act, Public Sector Wage System Act, and Civil Servants Act in respect of wages and incentives. ### Problem assets, provisioning, and recommended supervisory actions - Credit classification system lacks granularity; intermediate class C accounts for about 10 percent of classified assets and is heterogeneous. - Impairment on NPLs reported at around 40 percent; BOS ICAS suggests expected loss 53 percent. - External audits and on-site examinations insufficient in scope; collateral valuation practices weak. - Recommended actions: - Shift to more granular claims classification. - Encourage more critical external audits and larger on-site loan portfolio samples. - Require more conservative collateral valuation and timely supervisory intervention to require higher provisioning and capital where necessary. - Reassess and increase BSD staffing ceiling and supervisory resources. ### Insurance, capital markets, and AML/CFT highlights - Insurance: all insurers solvent as of end-2011; market of 16 insurers and two reinsurers; 75 percent of market written by Slovenian companies; largest life product premiums linked to investment fund units (~48 percent). - Capital market: Blue Chip index of Ljubljana Stock Exchange fell by almost 80 percent between August 2007 and October 2012; LSE trading volume <1 percent of CEESEG group total. - AML/CFT: - OMLP (financial intelligence unit) operates effectively and exchanges information with foreign counterparts. - Deficiencies: criminalization of terrorist financing deficient; shortcomings in confiscation regime; low convictions/confiscations for money laundering-related crimes. - Preventive frameworks broadly sound, but implementation weak among non-bank financial intermediaries and DNFBPs; supervisors not effectively utilizing sanctioning powers; casinos an exception. ### Macro indicators (selected exact series from Table 2) - Real GDP (annual % change): 2008 3.4; 2009 -7.8; 2010 1.2; 2011 0.6; 2012 -2.2; 2013 -1.0; 2014 1.7 - Unemployment rate (ILO): 2008 4.4; 2009 5.9; 2010 7.3; 2011 8.2; 2012 8.8; 2013 9.0; 2014 8.7 - General government balance (percent of GDP): 2009 -5.5; 2010 -5.3; 2011 -5.6; 2012 -3.5; 2013 -3.4; 2014 -3.1 - General government debt (percent of GDP): 2008 22.0; 2009 35.0; 2010 38.6; 2011 46.9; 2012 52.1; 2013 55.6; 2014 57.3 - Gross external debt (percent of GDP, end-period): 2008 105.3; 2009 113.3; 2010 114.4; 2011 111.2; 2012 114.0; 2013 115.9; 2014 116.2 ### Priorities and implementation timetable (selected actions) - Immediate implementation: - Establish AMC with adequate powers, resources, accountability (MOF) — Paragraph 16. - Ensure recapitalization of state-owned banks and strengthen governance (MOF) — Paragraphs 16, 17, 19. - Strengthen legal framework for bank resolution (BOS) — Paragraph 51. - Establish operational crisis management arrangements (BOS, MOF) — Paragraph 54. - Short-term (within 12 months): - Eliminate special tax on banks (MOF) — Paragraph 36. - Expand supervisory mandates for macroprudential oversight and assign BOS leading role in systemic risk assessment — Paragraphs 38, 39. - Strengthen bank legal protection for supervisors and require authorization for bank acquisitions of non-bank financial companies — Paragraph 43. - Redesign DGS to allow funding of bank resolution (BOS) — Paragraph 52. - Strengthen legal framework for official financial support (BOS/MOF) — Paragraph 53. - Medium-term (1–3 years): - Encourage banks to reduce dependence on external and wholesale borrowings (BOS) — Paragraphs 13, 14, 20. - Reduce government ownership in financial institutions (MOF) — Paragraphs 17, 44. - Expand BOS supervisory resources, especially off-site staff — Paragraph 42. - Ensure AZN readiness for Solvency II and adequate staffing/expertise — Paragraph 47. *Source: Executive Summary and selected sections of IMF FSAP report (content unit _cr12325).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Overview and macroeconomic background - The Slovenian financial system has been hard hit by the crisis, driven by weak governance in public banks and an externally financed credit boom directed significantly towards construction companies and management buyouts/corporate takeovers. - Real GDP experienced one of the largest falls in the Euro area (a decline of about 10 percent from peak to trough). - The economy started to recover in 2010, but the escalation of the euro area crisis in the second half of 2011 interrupted the recovery; GDP growth fell by 0.2 percent in 2011 after growth of 1.4 percent in 2010. - The recession intensified in 2012; unemployment almost doubled since 2008 to 8.4 percent in August 2012. - Despite a structural fiscal contraction, the general government deficit on a cash basis increased from 5.4 percent of GDP in 2010 to 5.7 percent of GDP in 2011. - Total assets of Slovenia’s financial institutions stood at €65 billion by end 2011, equivalent to 182 percent of GDP. - Financial depth had been increasing since Euro adoption but was slowed by the financial crisis. ### Key vulnerabilities and banking sector condition - Significant deterioration in credit quality has produced operating losses in the banking sector for the last two years. - The deleveraging process that began in 2009 is proving protracted. - Banks remain highly vulnerable to continued credit deterioration and refinancing risks; the corporate sector is over-indebted and suffers from the double-dip recession. - Stress test (end-2011 data): under a double-dip adverse scenario, the capitalization of the banking system would fall below the prudential minimum, and a recapitalization in the amount of around 5 percent of GDP would be needed to bring the system core Tier I capital ratio to 9 percent. - Exposure to real estate price risk is particularly significant, reflecting the high share of loans backed by real estate collateral. - A further sovereign downgrade would seriously impair the government’s ability to recapitalize troubled banks, though the recent successful bond issuance reduces this risk in the short term. ### Financial system structure and cross-border footprint - Banks are the most important financial institutions; insurers, leasing companies, and other institutions make up about a quarter of the system. - State-owned financial institutions dominate: lead companies in the three major financial groups (NLB, NKBM, and Triglav) are all at least 50 percent directly or indirectly controlled by the government. - State-controlled banks account for around 55 percent of the system in terms of assets or capital. - Slovenia has one of the lowest market shares of foreign banks among Eastern European countries (30 percent of the total). - NLB Group: total NLB Group assets €16,445 million; Slovenia assets €12,980 million; examples of NLB banking activities in ex-Yugoslavia include listed assets and market ranks (e.g., Kosovo assets 386, market share 15, market rank 3). ### Supervisory, regulatory, and macroprudential assessment - Banking supervision: the Basel Core Principles assessment noted improvement since the 2003 assessment but identified weaknesses: - BOS’s powers should be strengthened in several areas, including licensing or removal of bank supervisory board members, and requiring banks to obtain authorization for acquiring non-bank financial companies. - The bank shareholders’ discretion to impede BOS’s requirement to increase capital must be resolved. - Legal protection for bank supervisors should be strengthened. - Reporting of problem assets lacks granularity, and provisioning on NPLs seems relatively low. - Insurance supervision (AZN): effective on-site and off-site monitoring; adequate staff resources but compensation policies need to be more market-oriented; Solvency II implementation in 2014 will be a major challenge requiring adequate staff and expertise. - Securities market regulation (ATVP): generally follows best international practices; appears to have sufficient resources operationally, but compensation scheme should be adjusted for retention/attraction; room to strengthen independence, broaden sanctioning powers, and improve transparency of internal processes. - Macroprudential framework: BOS has well-developed tools for detecting and monitoring systemic risks and many policy instruments have been deployed, but a fully-fledged macro-prudential mandate is not enshrined in existing legislation. ### Crisis preparedness and resolution framework - The crisis preparedness and management framework needs significant improvement. - BOS’s powers to deal with a failing bank need to be substantially expanded or clarified to ensure least-cost bank resolution. - Major changes to the Deposit Guarantee Scheme (DGS) are needed: convert DGS from an ex-post pay-box into an active tool in bank resolution by empowering the DGS to apply its funds for bank resolution purposes. - The framework for official liquidity and solvency support by the government also needs to be strengthened. ### Short-term priorities and key recommendations (selected, preserving original priorities) - Immediate implementation - Proceed with the establishment of an asset management company, ensuring its adequate powers, resources, accountability, and other operational aspects (Ministry of Finance, MOF) — Paragraph 16. - Ensure recapitalization of state-owned banks and strengthen their governance (MOF) — Paragraphs 16, 17, 19. - Strengthen legal framework for bank resolution (BOS) — Paragraph 51. - Establish operational crisis management arrangements (BOS, MOF) — Paragraph 54. - Short-term (Implementation within 12 months) - Eliminate the special tax on banks (MOF) — Paragraph 36. - Expand each supervisory agency’s mandate to include macro-prudential oversight and assign BOS to play a leading role in systemic risk assessment — Paragraphs 38, 39. - Strengthen risk assessment and management in banks (BOS) — Paragraph 41. - Ensure adequate legal protection for bank supervisors (BOS) — Paragraph 43. - Require banks to obtain authorization prior to acquiring a non-bank financial company (BOS) — Paragraph 43. - Ensure that ATVP and AZN are not subject to the Public Agencies Act, Public Sector Wage System Act, and Civil Servants Act (with respect to wages and rewarding of employees) — Paragraphs 46, 49. - Extend the ATVP’s fining power under the Minor Offences Act to banks carrying on investment activities or providing investment services — Paragraph 49. - Redesign DGS to allow funding bank resolution (BOS) — Paragraph 52. - Strengthen legal framework for official financial support (BOS/MOF) — Paragraph 53. - Medium-term (Implementation in 1–3 years) - Encourage banks to reduce dependence on external and wholesale borrowings (BOS) — Paragraphs 13, 14, 20. - Reduce government ownership in financial institutions (MOF) — Paragraphs 17, 44. - Expand BOS’s supervisory resources, especially the off-site staff — Paragraph 42. - Continually monitor Solvency II developments and ensure adequate staffing and expertise are available (AZN) — Paragraph 47. ### Bank balance sheet restructuring and privatization - Strengthening bank capitalization and restructuring balance sheets is the short-term priority: reduce dependence on wholesale or Eurosystem financing, fully recognize problem loans, and write off bad loans. - Authorities are undertaking a comprehensive review of banks’ asset portfolios with third-party participation; this should provide the basis for further restructuring needs. - The asset management company (in process of being established) may help address the overhang of bad debt. - Financial restructuring should be followed by privatization of state-controlled banks to address long-standing governance weaknesses, reduce government influence on day-to-day operations and lending decisions, and improve risk management, efficiency, and stability over the longer term. *Source: Executive Summary of IMF FSAP report (Slovenia).* ### 6. The corporate sector has been substantially affected by the financial crisis of ### _cr12325 - 6. The corporate sector has been substantially affected by the financial crisis of ### Corporate sector: impact and adjustment - Debt-to-GDP ratio of the corporate sector reached almost 170 percent in 2008. - Post-2008-09 shock: plummeting domestic and external demand led to financial difficulties, payment indiscipline, and corporate bankruptcies. - Deleveraging underway due to tightening financing conditions. - Non-export-oriented corporates were especially affected because they could not substitute lost local bank financing with direct financing from the rest of the world. ### Construction sector - Construction has been the worst affected sector and is unlikely to have bottomed out yet. - Real estate market liquidity declined as credit dried up and large construction projects ended in 2008-2009. - Payment arrears of construction companies increased; two large Slovenian construction companies went bankrupt in 2011. ### Household sector: balance sheet and vulnerabilities - Household assets excluding real estate: 113 percent of GDP (2010). - Total household liabilities: 35 percent of GDP (2010). - Over 50 percent of household financial assets were in cash or bank deposits. - Household liabilities are mostly consumer and mortgage loans from banks with an average maturity exceeding 15 years. - Average loan-to-value ratio for housing loans: around 60 percent. - Debt-to-disposable income ratio: 53 percent in 2010 (compared to close to 100 percent in the Euro area). - Mortgage demand declined substantially in 2011 after rapid rates earlier. - Nonperforming loans for households: 3.5 percent of total household loans at end-2011, but may increase given declines in equity and real estate prices. - Note: The data on household assets invested in real estate are not available. ### Risks to financial stability (key channels) - Systemic risks significant due to negative macro outlook and high dependence of Slovenian banks on external funding. - Protracted deleveraging affecting banks and corporates since 2009. - Credit risk identified as the major vulnerability under a double-dip recession, materializing via: - (i) stagnant or shrinking export markets feeding through to the manufacturing sector; - (ii) weak consumer demand associated with increasing levels of unemployment; - (iii) delays in improvement in the financial position of corporates. - Lax pre-crisis credit origination standards increase exposure as the economy worsens. - Real estate price risk: - Residential and commercial real estate prices increased by 40-50 percent from 2005 to 2008. - Real estate prices have fallen by around 10 percent since the peak in 2008. - Refinancing risk: - Aggregate loan-to-deposit ratio climbed to over 160 percent in 2008. - Slovenian banks repaid almost €6 billion in external creditors since 2008 (16 percent of GDP). - Downgrades of the Slovenia’s sovereign rating led to cuts in ratings of several domestic banks. - ECB 3-year LTROs reduced immediate liquidity and refinancing risks, but balance sheet adjustment remains incomplete. - Additional collateral available system-wide, but some individual banks lack eligible collateral. - Loan-to-deposit ratio remains high; reliance on short-term wholesale and Eurosystem financing needs reduction. - Risk of a sharp deleveraging persists. - Other risks: - Market risk: small. - Country and transfer risks: almost negligible; 89 percent of Slovenian banks’ non-consolidated credit exposure is to domestic debtors. - Small exposure to EU peripheral countries; rest-of-world exposure mainly in government securities of core Euro-zone countries. - Interest rate risk on the banking book: relatively small due to variable-rate loans and liabilities indexed to interbank borrowing indices. ### Structural challenges and recommended actions - Determination of bank restructuring needs: - Authorities initiated comprehensive reviews of asset portfolios of largest government-controlled banks with third-party participation. - Due diligence completed for two largest banks; under way for third largest. - Government estimates action needed to manage impaired assets of up to €3 billion. - Cleaning up bank balance sheets: - Options: special loan work-out units or transfer of assets to an asset management company (AMC). - All largest banks established loan work-out units with limited success. - Authorities decided in early October 2012 to set up an AMC. - AMC intended to issue up to €4 billion of government-guaranteed loans. - AMC to acquire impaired assets at their “real long-term value,” following the EC State Aide Guidelines. - AMC will be wound down after five years; remaining assets transferred to the Slovenia Sovereign Holding company. - Successful AMC design elements: clear objective, independence from political interference, adequate legal and funding resources, accountability, and timely disposal of assets. - Bank recapitalization: - Necessary for loss recognition and transfers of assets to the AMC at below book value. - Additional capital margin needed to absorb further losses and support lending. - Corporate balance sheet adjustment: - Corporate sector highly leveraged; needs to reduce reliance on bank funding and seek new sources of equity, especially in construction. - Given lengthy corporate bankruptcy process, AMC should be actively involved in financial restructuring and informal corporate debt workout mechanisms should be explored. - Reforming state-controlled banks: - State-controlled banks’ performance weaker than other groups over last three years. - Return on assets for large domestic banks: 0 in 2009 and -1.3 percent in 2011. - Four state-owned banks account for 80 percent of this group’s market share. - Privatization of state-controlled banks recommended to improve governance and risk management; failure to act would lead to continued misallocation and repeated recapitalization needs. ### Banks — performance and balance-sheet indicators - NPL ratio of the banking sector: 11.9 percent in 2011; 12.6 percent by June 2012. - NPL increase driven essentially by loans to construction companies and loans to management buy-outs. - Total bank losses (consolidated): €508 million in 2011 (up from €120 million in 2010). - Aggregate capital adequacy ratio (CAR): 12 percent as of December 2011 (11.3 percent in 2010). - Fresh capital injections in six banks totaling €458 million contributed to improvement. - As of end-2011, 12 banks fell short of the Core Tier I ratio of 9 percent, with a total shortfall of €540 million. - NLB required to raise €320 million in additional capital by June 2012 (EBA requirements). - NLB was recapitalized by €383 million (composed of €320 million of contingent convertible instruments and €63 million in common equity as approved on a temporary basis by the European Commission in early July 2012). - Short-term liquidity ratios: - First bucket liquidity ratio: 140 percent at end-2011. - Ratio of liquid assets to short-term liabilities: 40 percent at end-2011. - System loan-to-deposit ratio: 135 percent. - Government deposits: about €2 billion and are declining as government draws funds to finance the fiscal deficit. - Credit to the corporate sector declined by 6.2 percent in 2011. - Bank balance sheets contracted in 2011 and continue to contract in 2012 due to deleveraging and divestment of non-core activities. ### Stress tests — assumptions, scenarios, and single-factor tests - Coverage: tests covered all banks operating in Slovenia on consolidated and solo basis as of December 2011; considered credit, sovereign, market, and liquidity risk factors. - Macro stress tests spanned two years (2012-13) and assumed zero growth in bank balance sheets, covering: - (i) direct credit losses from deteriorating loan quality and off-balance sheet commitments; - (ii) increase in bond spreads and mark-to-market losses from sovereign bond holdings; - (iii) effects of stressed funding costs. - Scenarios (three): - Baseline scenario: a double-dip scenario in line with the latest BOS projections (more severe than WEO projections at the time). - Double-dip adverse scenario: simulating a worsening of the Euro area crisis akin to 2008-09; included decline in exports, increased Euribor by 200 basis points, squeezed operating profits, widening Euro area sovereign spreads, and weak recovery in 2013. - Slow-growth scenario: simulating a lengthier Euro-zone recession with prolonged low growth in Slovenian exports and dearth of investment; assumed a similar shock to sovereign spreads as the double-dip adverse scenario and an increase in Euribor by 100 basis points. - Single-factor stress tests included: - Real estate market price shock: decline in commercial real estate prices by 25 percent and residential real estate prices by 15 percent. - Concentration risk: deterioration in the quality of the three largest exposures of each bank. - Refinancing risk: reduction in wholesale external funding of banks. - Bottom-up refinancing risk assumptions: - Partial roll-over of maturing foreign loans: 20 percent for domestically-owned banks and 40 percent for foreign-owned banks. - One notch downgrade of Slovenia’s sovereign rating (decline in eligible collateral for ECB financing). - Liquidity shortage assumed financed by ECB funding; tests aimed to evaluate deficit in eligible collateral. - Top-down refinancing risk assumption: - Zero roll over in maturing wholesale funding; impact assessed on necessary deleveraging via reduced loans and interest income. *Source: _cr12325 - 6. The corporate sector has been substantially affected by the financial crisis of* ### 25. The results of macro scenario stress test highlight the vulnerabilities of banks. ### 25. The results of macro scenario stress test highlight the vulnerabilities of banks. ### Stress test results and capital shortfalls - Baseline scenario: - Several banks’ CAR would fall below the required minimum of 8 percent in 2013. - Total capital shortfall: €60 million (Table 6). - Double-dip adverse scenario: - CAR shortfall: €518 million. - Greatest shortfall seen in the large domestic banks. - Core Tier I outcomes under severe stress: - Many banks would have Core Tier I ratio below 9 percent. - Total Core Tier I shortfall: €1.9 billion (around 5 percent of GDP). - Consistency: - Results of top-down stress tests are broadly consistent with bottom-up tests (Table 7). ### Single-factor stress tests, concentration, and refinancing risks - Real estate price risk: - High vulnerability to real estate price risk (Table 8). - Reflects high share of loans in bank portfolios backed by real estate as collateral. - Impact of real estate price shock is highest for the large banks. - Concentration risk: - Large exposure stress tests indicate exposure to concentration risk. - Refinancing risk: - Large domestic banks and foreign banks are most affected by refinancing risk. - Reflects high reliance on short-term wholesale funding. ### Caveats and data/valuation concerns - Feedback effects: - Analysis does not adequately capture feedback between banking system performance and macroeconomic performance; such feedbacks are especially important in severe turmoil. - AMC and provisioning/valuation uncertainty: - Recent government estimates relating to establishment of the AMC (authorized to issue bonds of up to €4 billion) may raise doubts about the quality of reported loan provisions and/or collateral valuation. - This may result in some over-estimation of the baseline capital position of banks. - General caveat: - Important caveats should be attached to these FSAP stress test results. ### Insurance companies: solvency, market structure, and products - Solvency and profitability: - All insurance companies were solvent as of end-2011. - All but one insurer profitable in a market made up of 16 insurers and two reinsurers. - Market composition: - Market is 75 percent written by Slovenian companies. - Distribution channels: exclusive and independent agents, banks, internet, and direct sales. - Product mix: - Non-life: Motor vehicle liability and motor vehicle land motor account for almost 55 percent of total non-life premium. - Life: Largest life products (in terms of premium) are linked to investment fund units (approximately 48 percent). ### Capital market and intermediaries: size, liquidity, and group affiliation - Market performance: - The capital market (small) has not recovered from the global financial crisis. - Between August 2007 and October 2012, the Blue Chip index of the Ljubljana Stock Exchange (LSE) fell by almost 80 percent. - Causes include weak macroeconomic performance and massive seizure of equities by banks as collateral under management buyout loans. - Liquidity and investor exit: - Many foreign investors have left the market. - Decline in liquidity since 2007 constrains further foreign investment and makes exit planning almost impossible, reducing broker profitability. - Regional exchange group context: - LSE is part of CEESEG, insulating it in short term from income decline pressures. - LSE trading volume is less than 1 percent of the total for the group. - Without medium-term recovery, CEESEG’s controlling shareholders may consider concentrating Slovenian trading on the Vienna Exchange (both share the same trading system). - In practice, listed companies are already moving out, in particular to the Warsaw Stock Exchange. ### Policy implications and supervisory recommendations (high-level) - Supervisory architecture: - Multiple models under discussion (status quo: three separate supervisory agencies BOS, AZN, and ATVP; or fully integrated supervision within BOS). - Team cautioned against changes to supervisory architecture at present due to ongoing challenges: banking system restoration, Basel III implementation, AZN transition to Solvency II, and ATVP’s shrinking securities market. - Recommendation: any change should be meticulously planned and implemented gradually; consider in light of proposed amendment to Euro area supervisory architecture. - Macroprudential framework and systemic risk: - BOS tools for systemic risk detection: aggregate indicators of imbalances, indicators of market conditions, metrics of concentration risk, and stress tests; published in Financial Stability Review and Report on the Stability of the Slovenian Banking System. - Gaps in data: household data lack granularity comparable to corporate sector; insufficient detail on banks’ subsidiaries in the former Yugoslavia; real estate market data could be improved (e.g., coverage of sale of housing from bankruptcy estates). - Recommendation: BOS should proactively cooperate with other statistical agencies to meet financial stability data needs. - Instruments and recent measures: - BOS deployed macroprudential measures during boom and bust (e.g., increased capital requirements on rapidly growing exposures such as management buy-out loans with 150 percent risk weight; prudential provisioning buffer following IFRS introduction in 2006). - Counter-cyclical tax on banks (adopted August 2011) creates distortions and should be abolished: - Intended to encourage lending; banks expanding loans by at least 5 percent annually are exempt. - Risks: may stimulate loans without proper credit risk assessment; may induce circumvention; anti-competitive as it penalizes locally-owned banks with larger share of liquid assets. - Legal and institutional mandates: - Effective cooperation exists among BOS, AZN, and ATVP via the Coordinating Group and a Commission for mutual cooperation. - However, a fully fledged macroprudential mandate is not enshrined in legislation: - None of the agencies’ statutory frameworks include a de jure responsibility for sectoral or systemic stability; existing laws do not require agencies to ensure stability of their sectors—sole responsibility appears to be ensuring regulated institutions follow prudential rules. - Recommendation: expand each financial regulatory agency’s mandate to include macroprudential oversight by ensuring laws include: - (i) responsibility for sectoral stability as the ultimate objective of sectoral supervision; - (ii) responsibility to contribute to stability of the financial system as a whole by identifying, monitoring, and mitigating systemic risk, and cooperating with other agencies with a macro-prudential mandate; - (iii) authority to use existing powers for macroprudential purposes and to propose additional powers where needed. - Recommendation: BOS should be given the leading role in systemic risk assessment. Macroprudential oversight decisions and motivations should be made public in a timely manner (while respecting confidentiality). Macroprudential authority should be ultimately accountable to the national parliament. - Bank supervision improvements: - Regulatory and supervisory frameworks generally align with international standards; BOS has implemented Basel II and is preparing for Basel III. - Areas for improvement: - Strengthen risk management to be more forward looking and proactive in identifying and preventing credit risk buildup. - Improve granularity of problem asset reporting; current provisioning of NPLs at 41 percent seems relatively low and may indicate under-provisioning. - Strengthen off-site supervision: off-site function understaffed; recommend significant increase in off-site staff, targeted hiring of on-site resources, and better leveraging of internal control assessments and audits. - Address specific weaknesses: inadequate legal protection of bank supervisors in civil and criminal court proceedings; insufficient requirements for major acquisitions by banks (no BOS power over acquisition of non-bank financial companies). - Supervise state-controlled banks more effectively: these institutions are least profitable, have greater asset quality problems, require greater capital relative to risk profile; government interference has impeded adoption of appropriate prudential risk management. - Insurance supervision and Solvency II: - AZN has effective on-site and off-site supervision; reporting requirements comprehensive; plans to enhance filing data electronically once legal issues on electronic signatures resolved. - AZN authority to order preventive and corrective measures is present. - Human resources constraints: compensation scheme capped by Public Agencies Act, Civil Servants Act, and Public Sector Wage System Act may impede attraction and retention of talent. - Solvency II adoption (scheduled for January 2014) is a major challenge: will require legislative and IT changes, staffing, and skills to assess potential internal models for capital determination (internal models currently not permitted in Slovenia). - Securities market supervision: - Comprehensive legislative and institutional framework; ATVP adequate human and IT resources relative to small market; effectiveness of law implementation appears high. - Issues to address: - Political independence concerns due to Public Agencies Act provisions detracting from the Market in Financial Instruments Act’s standards. - Limited application of enforcement powers (do not apply to banks despite ATVP supervising banks’ investment activities and services). - Compensation and inflexible career structures impede efficient human resources programs. - Crisis management and resolution toolkit: - BOS powers to deal with failing banks are limited; bank resolution toolkit needs strengthening. - Special administrators’ mandate should be broadened to include design and implementation (after BOS approval) of restructuring plans and, as alternative, preparation for orderly liquidation. - Recommendation: grant special administrators strong and explicit restructuring powers and establish effective restructuring tools. - Given Slovenia’s challenges, merit in moving ahead with such reforms ahead of finalization of EU directives; recommendations align with proposed draft of EU directive. *Source: IMF Financial Sector Assessment content unit _cr12325 - 25. The results of macro scenario stress test highlight the vulnerabilities of banks.* ### 51. The restructuring powers would require the possibility for the administrator to ### _cr12325 - 51. The restructuring powers would require the possibility for the administrator to ### Restructuring powers and tools - Administrator must be able to fully take over the powers of all decision-making bodies of the failing bank: the management board, the supervisory board and the general assembly of shareholders. - Restructuring tools would include, inter alia: - rapid recapitalization of banks without shareholders’ agreement; - transfer of assets (including businesses and subsidiaries), liabilities, and combined portfolios of assets and liabilities (“purchase and assumption transactions”) to third party acquirers; - if such acquirers do not present themselves, chartering bridge banks to transfer assets and liabilities to. - Examples referenced: Article 48, Minister’s right exercise supervision over the agency's affairs; Articles 15 (limiting the protection from legal liability); Articles 23 and 24 (premature dismissal of the Director and Council) Article 36 (limitations to the Agency’s action program). (footnote 14) - Note on governance risk: appointing a special administrator on its own, without application of an effective resolution power shortly thereafter, could be destabilizing as creditors may run. (footnote 15) ### Deposit Guarantee Scheme (DGS) redesign (consistency with FSB Key Attributes and EU draft directive) - Core recommendation: redesign the DGS from a pay-box system into an effective tool for bank resolution, consistent with the FSB’s Key Attributes and the EU’s recent draft directive. - Key features to consider (provided alignment with upcoming EU Directives): (footnote 16) - Ex ante funding: - DGS should be funded ex ante by contributions paid by banks. - Contributions should be invested in liquid instruments or deposited in an account at the BOS. - If DGS funds are insufficient for payouts, the BOS should for the time being continue to be authorized to provide funding, respectful of the conditions for monetary financing. - In the future, responsibilities for supporting the DGS’ financing should be moved from the BOS to the government, which may guarantee the DGS’s financing from markets or provide liquidity directly to the DGS. - Contribution to resolution: - DGS should be allowed to support certain bank-restructuring transactions, with the qualification that its support should not exceed what it would have paid out in a liquidation (i.e. a cap), subject to exemption for systemic cases. - DGS should be authorized to cover the ‘funding gap’ by compensating the acquiring third party in case assets are insufficient to offset insured deposits. - Depositor preference: - Insured depositors and the DGS should be given priority rights over the estate of the failed bank. - Such priority protects contributing banks and ultimately the public purse, and simplifies purchase and assumption transactions. ### Legal framework for official liquidity and solvency support - Liquidity support by the BOS: - The BOS Act does not provide for an explicit legal basis for ELA operations. - Due to legal changes stemming from Slovenia’s accession to the Euro area, it is questionable whether the general provisions on credit operations by the BOS with credit institutions would suffice. - Recommendation: clarify the legal basis for ELA operations for financial stability purposes to enhance legal certainty. - Solvency support by the government: - During the global financial crisis an additional legal basis was created in the Public Finance Act to allow for extra-budgetary bank guarantees, and liquidity and capital support for banks; these provisions expired by end-2010. - Consequently, any state support would require a lengthy appropriation procedure through parliament. - Recommendation: reintroduce in the Public Finance Act a standing authorization for the government to provide rapid financial support to undercapitalized banks in the context of systemic crisis management. - To address moral hazard concerns, ensure: - close interaction with the BOS in determining the need for solvency support from the government; - attribution of losses to existing shareholders by reducing capital; - improvement to the bank’s governance and profitability through the BOS’ approval and follow-up of the bank’s reform plan; - robust ex-post transparency requirements to the parliament. ### Operational arrangements for crisis management - Current gap: a plan for the operation of competent institutions during an unexpected crisis has not yet been prepared and adopted by the Coordinating Group (the plan is referred to in existing rules on mutual cooperation of supervisory authorities). - Recommendation: prepare and adopt a crisis operation plan that defines the respective roles of the MOF and the supervisory agencies—in particular BOS—during a systemic crisis. - The Coordination Group should continue to monitor implementation of the crisis plan in accordance with rules on mutual cooperation of supervisory authorities. (footnote 17) - Additional recommendation: conduct periodic (for example, annual) crisis simulations involving all stakeholders to ensure contingency plans can be executed. ### Anti-Money Laundering and Combating Financing of Terrorism (AML/CFT) - Recent measures: - Slovenia introduced measures since the 2005 MONEYVAL assessment, including amendments to incorporate the Third EU Money Laundering Directive and its Implementing Directive into national law. - Follow-up actions taken to remedy shortcomings identified in the targeted 2010 assessment by MONEVAL. (footnote 19) - Criminalization and enforcement: - Money laundering and financing of terrorism is criminalized largely in accordance with the relevant United Nations Conventions, though a relatively minor deficiency exists. - The seizure and confiscation framework under Slovenian law is comprehensive overall. - Low levels of convictions and confiscations related to money laundering and other proceeds-generating crimes indicate the need to strengthen and facilitate money laundering related investigations, prosecutions and confiscations under the current framework. - Slovenia generally relies on the EU framework for freezing of terrorist assets to implement United Nations Security Council resolution 1267 (1999) and 1373 (2001) and related EU regulations; however, efforts should be made to develop comprehensive domestic procedures and guidance to facilitate implementation of existing measures. - Preventive measures and supervision: - Slovenia has a broadly sound legal structure for major preventive measures against money laundering/terrorist financing in the financial sector and for designated non-financial businesses and professions (DNFBPs), while concerns remain about insufficient implementation by non-banking financial intermediaries and the majority of DNFBPs. - Regulatory and supervisory frameworks for overseeing implementation of preventive measures are generally in place for the financial sector as a whole. - Supervision of non-bank financial intermediaries, notably the insurance sector, should be strengthened, and more sector-specific guidance should be issued. - None of the supervisors appear to be utilizing their sanctioning powers effectively. - Casinos excepted, the majority of DNFBPs lack awareness and the necessary guidance to fulfill their AML/CFT obligations. *Source: _cr12325 - 51. The restructuring powers would require the possibility for the administrator to* ### 58. The Office for Money Laundering Prevention (OMLP), Slovenia’s financial ### _cr12325 - 58. The Office for Money Laundering Prevention (OMLP), Slovenia’s financial ### AML/CFT institutional findings - The Office for Money Laundering Prevention (OMLP), Slovenia’s financial intelligence unit, appears to be operating effectively. - The OMLP and law enforcement agencies appear to be responsive in exchanging information with and providing mutual legal assistance to their foreign counterparts, supported in this by a sound legal framework. - Deficiencies identified: - Criminalization of terrorist financing is deficient and may undermine effectiveness of mutual legal assistance. - Shortcomings in the confiscation regime may undermine effectiveness of mutual legal assistance. - Assessment basis: - Overview draws on the March 2010 MONEYVAL targeted assessment, subsequent follow-up reports, and information obtained by the FSAP mission. - MONEYVAL’s 2010 report addresses only a sub-set of FATF Recommendations, but all 16 Core/Key Recommendations and those rated Non-Compliant or Partially Compliant in the Third Round were reassessed. ### Macroeconomic context and key indicators (selected, Table 2) - Real GDP (annual % change): 2008 3.4; 2009 -7.8; 2010 1.2; 2011 0.6; 2012 -2.2; 2013 -1.0; 2014 1.7 - Domestic demand (annual % change): 2008 3.2; 2009 -10.0; 2010 -0.2; 2011 -0.7; 2012 -4.2; 2013 -1.9; 2014 1.2 - Private consumption: 2008 2.3; 2009 0.1; 2010 1.3; 2011 0.9; 2012 -0.7; 2013 -0.9; 2014 1.5 - Public consumption: 2008 5.9; 2009 2.5; 2010 1.5; 2011 -1.2; 2012 -7.9; 2013 -3.1; 2014 0.1 - Gross capital formation: 2008 3.1; 2009 -33.8; 2010 -5.8; 2011 -4.6; 2012 -9.4; 2013 -3.5; 2014 1.5 - Exports of goods and services (annual % change): 2008 4.0; 2009 -16.7; 2010 10.1; 2011 7.0; 2012 1.4; 2013 2.6; 2014 4.1 - Output gap (percent of potential GDP): 2008 9.2; 2009 -1.0; 2010 -0.9; 2011 -1.3; 2012 -4.1; 2013 -5.5; 2014 -4.3 - Consumer prices (period average): 2008 5.7; 2009 0.9; 2010 1.8; 2011 1.8; 2012 2.2; 2013 1.5; 2014 1.9 - Unemployment rate (ILO definition): 2008 4.4; 2009 5.9; 2010 7.3; 2011 8.2; 2012 8.8; 2013 9.0; 2014 8.7 - General government balance (percent of GDP): 2008 /-0.3; 2009 -5.5; 2010 -5.3; 2011 -5.6; 2012 -3.5; 2013 -3.4; 2014 -3.1 - Primary balance (percent of GDP): 2008 0.5; 2009 -4.6; 2010 -4.1; 2011 -4.3; 2012 -1.8; 2013 -1.2; 2014 -0.5 - General government debt (percent of GDP): 2008 22.0; 2009 35.0; 2010 38.6; 2011 46.9; 2012 52.1; 2013 55.6; 2014 57.3 - Current account balance (percent of GDP): 2008 -6.2; 2009 -0.7; 2010 -0.6; 2011 0.0; 2012 0.8; 2013 1.1; 2014 1.2 - Gross external debt (percent of GDP, end-period): 2008 105.3; 2009 113.3; 2010 114.4; 2011 111.2; 2012 114.0; 2013 115.9; 2014 116.2 - National saving (percent of GDP): 2008 25.6; 2009 21.5; 2010 20.5; 2011 20.1; 2012 19.3; 2013 19.4; 2014 19.7 - Gross capital formation (percent of GDP): 2008 31.8; 2009 22.1; 2010 21.1; 2011 20.1; 2012 18.5; 2013 18.3; 2014 18.4 Sources note: Data provided by the Slovenian authorities; and IMF staff calculations and projections. Eurostat Data for government bond yield (10-year, average). ### Financial system structure (Table 3 highlights) - Total assets (EUR million) for monetary and non-monetary financial institutions combined: - 2006 46,325; 2007 60,769; 2008 62,872; 2009 67,865; 2010 66,903; 2011 64,993 - Monetary financial institutions (EUR million): 2006 34,080; 2007 44,505; 2008 47,948; 2009 52,009; 2010 50,760; 2011 49,283 - Commercial banks (EUR million): 2006 33,868; 2007 44,249; 2008 47,628; 2009 51,612; 2010 50,319; 2011 48,788 - Non-monetary financial institutions (EUR million): 2006 12,245; 2007 16,264; 2008 14,924; 2009 15,856; 2010 16,143; 2011 15,711 - Insurers (EUR million): 2006 3,895; 2007 5,035; 2008 5,151; 2009 5,660; 2010 6,041; 2011 6,108 - Pension companies/funds (EUR million): 2006 893; 2007 1,001; 2008 1,041; 2009 1,287; 2010 1,538; 2011 1,518 Notes: Monetary financial institutions do not include the central bank. The First Pension Fund is included among pension funds. ### Financial soundness indicators (Table 4 highlights) - Regulatory capital to risk-weighted assets (total banking sector): 11.7 (2008); data columns show similar levels across years and bank groups. - Regulatory Tier 1 capital to risk-weighted assets: 9.0 (2008) - Nonperforming loans to total gross loans (total banking sector): 4.2 (2008); increases in later years (table shows elevated NPLs across groups) - Provisions to Non Performing Loans: ... (table indicates missing or ellipses for some entries) - FX-loans to total loans: 6.3 (2008) - Return on assets (total banking sector): 0.5 (2008); later years show declines and negative values in some bank groups - Return on equity (total banking sector): 7.1 (2008); declines in subsequent years with negative values for some groups - Liquid assets to total assets: 13.9 (2008) - Liquid assets to short-term liabilities: 34.8 (2008) Source: Bank of Slovenia. Note: Large domestic banks comprise six banks, of which four banks with a market share of around 80 percent are state-owned. ### Stress testing: scenarios and results (Tables 5–8, summarized) - Macroeconomic scenarios used in stress tests: - Baseline, Adverse scenario 1 (double-dip), Adverse scenario 2 (slow growth). - Example macro variable projections (Table 6, yearly changes): - GDP 2011 -0.2; 2012 -1.2; 2013 0.6; Adverse 1 2012 -8.1; 2013 0.6; Adverse 2 2012 -4.8; 2013 -3.0 - Private consumption 2011 -0.3; 2012 -1.1; 2013 -0.8; Adverse 1 2012 -2.0; 2013 -0.7; Adverse 2 2012 -4.0; 2013 -4.4 - Exports 2011 6.8; 2012 2.3; 2013 4.0; Adverse 1 2012 -18.0; 2013 4.5; Adverse 2 2012 -10.0; 2013 -8.0 - Unemployment 2011 8.1; 2012 9.0; 2013 9.5; Adverse 1 2012 9.6; 2013 11.0; Adverse 2 2012 9.3; 2013 10.4 - EURIBOR 3M 2011 1.4; 2012 1.3; 2013 1.7; Adverse 1 2012 3.3; 2013 3.7; Adverse 2 2012 2.3; 2013 2.7 - Bottom-Up stress test results (Table 6, selected): - Banking system CAR: 2011 11.8; Baseline 2012 11.1; 2013 10.6; Adverse 1 2012 10.7; 2013 8.6 - Banking system capital shortfall (in € m): Baseline 0; Adverse 1 2012 -1; 2013 -60; Adverse 2 2012 -37; 2013 -518 - Core Tier 1 ratio (banking system): 2011 8.7; Baseline 2012 7.9; 2013 7.3; Adverse 1 2012 7.3; 2013 5.3 - Core Tier 1 shortfall (in € m): Baseline -540; Adverse 1 -912; Adverse 2 -1,211 (table shows multiple shortfalls across scenarios and years) - Large domestic banks example: Core Tier 1 ratio 2011 7.9; Baseline 2012 6.9; 2013 6.1; Adverse 1 2012 5.7; 2013 3.8; Core Tier 1 shortfalls: -523, -822, -1,060, -1,102, -1,594 (various scenario-year entries) - Top-Down stress test results (Table 7, selected): - Banking system CAR: 2011 11.7; Baseline 2012 10.7; 2013 10.3; Adverse 1 2012 9.1; 2013 7.7; Adverse 2 2012 9.9; 2013 7.9 - Banking system capital shortfall (in € m): Baseline 0; Adverse 1 2012 -4; 2013 -73; Adverse 2 2012 -3; 2013 -211; additional values shown for other combinations - Core Tier 1 ratio (banking system): 2011 9.0; Baseline 2012 8.0; 2013 7.5; Adverse 1 2012 6.3; 2013 4.9 - Core Tier 1 shortfall (in € m): examples -423; -739; -901; -1,217; -1,662; -993; -1,621 (various entries) - Single-factor stress tests (Table 8, selected): - Real Estate Price Risk (banking system CAR post-shock examples): 2011 CAR 11.8; post-shock 7.9; 11.7; 7.3; 11.5; 9.1; 12.3; 9.0 (table shows multiple group-specific post-shock CARs) - Real Estate: Capital shortfall (in € m) examples: 0.0; -552; 20; -483; 0; -140; -55 (various entries) - Concentration Risk: Capital shortfall (in € m) examples: 0; -250; 0; 0; 0; -25 (table shows multiple entries) - Liquidity Risk (Bottom-Up): Total liabilities (in € m): 48,390; 48,231; 30,533; 30,424; 4,450; 4,423; 13,407; 13,384 - of which liabilities to CB: 1,709; 3,720; 1,036; 1,831; 263; 264; 410; 1,626 - of which liabilities to foreign banks: 9,459; 6,532; 4,239; 2,983; 601; 45; 160; 3,534 - Deficit of eligible financial assets: 0; -643; 0; -110; 0; 0; 0; -533 - Liquidity Risk (Top-Down): Loans to non-banking sectors (in € m): 32,970; 29,178; 18,449; 17,047; 2,595; 2,561; 11,926; 9,577 - Change: -11.5; -7.6; -1.3; -19.7 - Effect on bank profits (in € m): -122; -60; -2; -60 ### Narrative analysis and banking sector dynamics (Figure 1 captions) - Credit to the private sector declined in 2011 reflecting banks' deleveraging, while NPLs continued to rise. - Increased loan loss provisioning, combined with decreased net interest income, led to substantial bank losses. - Capital adequacy improved following fresh capital injections and banks' deleveraging and divestments of non-core activities. - Dependence on wholesale funding subsided owing to challenging capital markets. ### FSAP recommendations status (Appendix I highlights) - Overall supervisory framework: - Promote greater cooperation among the three supervisory agencies: Done - Revisit supervisory model choice after EU accession: Ongoing - Establish arrangements for risk based cross sector supervision: Ongoing - Banking supervision: - Increase risk focus of banking supervision and capacity to assess banks' risk measurement: Done - Strengthen capacity for consolidated supervision and monitoring risk transfer and connected lending: Ongoing - Considerably expand supervisory resources: Ongoing - Insurance supervision: - Strengthen independence of the AZN governance and budget use: Not implemented - Develop technical skills of AZN staff: Done - Provide indemnity or insurance protection for responsible AZN officers: Not implemented ### Risks and contingency observations (Appendix II Risk Assessment Matrix) - Main identified threats and assessments: - More severe double-dip recession triggered by euro area crisis: - Likelihood: Medium - Expected impact on financial stability: High - Notable impacts: Sovereign ratings downgraded; sovereign bond spreads rose sharply in late 2011; largest bank required recapitalization of €320 million by June 2012; additional recapitalization needs and fiscal contingent liabilities possible. - Risk of sharp deleveraging unless capital positions are shored up: - Likelihood: Medium - Expected impact: Medium to High (credit crunch, negative macro feedback) - Sustained period of slow growth: - Likelihood: Medium - Expected impact: High (eroded capital and liquidity buffers; loss-making undercapitalized banks unable to support growth) - Sharp decline in real estate prices: - Likelihood: Medium - Expected impact: High (further losses for banks) ### Stress testing methodology (Appendix III matrices) - Solvency (Bottom-Up and Top-Down): - Institutions included: All banks (100 percent market share) - Data baseline: Audited consolidated/unconsolidated financial statements as of December 2011 - Horizon: 2 years - Shocks: Baseline, Scenario 1 (double-dip, 2 standard deviations for GDP growth), Scenario 2 (slow growth) - Sensitivities: Rating drops of three largest exposures; residential real estate -15 percent; commercial real estate -25 percent - Behavioral adjustments: Zero-growth balance sheet; zero-payout ratio - Regulatory standards: Basel II; hurdle rates: 8 percent regulatory CAR (prudential minimum), 9 percent core Tier 1 capital ratio (EBA requirement) - Results reported as Core Tier 1 and CAR shortfalls in nominal terms - Liquidity: - Methodologies include partial roll-over assumptions (Bottom-Up) and no roll-over (Top-Down) with a one-notch sovereign downgrade - Results focus on liquidity shortfall to be financed by ECB, adequacy of eligible collateral, and impact on deleveraging and profitability *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 59. The assessment of Basel Core Principles for Effective Banking Supervision ### 59. The assessment of Basel Core Principles for Effective Banking Supervision ### Assessment scope and methodology - Assessment reflects regulatory and supervisory frameworks in place as of the date of completion of the assessment. - Conducted in accordance with the Core Principles Methodology published in October 2006 by the Basel Committee on Banking Supervision. - Assessment based on: (i) legal and other documentary evidence; (ii) detailed interviews with staff from BOS and other authorities; and (iii) meetings with the banking industry and others such as academics and representatives of the accounting and audit profession. - Assessors: Bruno Estecahandy (Banque de France) and Joel Shapiro (formerly of the U.S. Federal Reserve). ### B. Institutional and macro-prudential setting and market structure - Banks are the main financial institutions in Slovenia. - Banks account for more than 75 percent of the total financial system assets. - Government controlled banks dominate the system with a market share of around 55 percent in terms of assets or capital. - Foreign institutions operate in Slovenia (mostly from France, Italy and Austria) but their overall market share is comparatively small. - Overseas activities of Slovenian banks are principally in other Balkan countries. - Financial supervision responsibilities are shared: - Banking Supervision Department (BSD) of the BOS supervises banks and is responsible for payments system oversight. - ATVP oversees the securities sector. - AZN mainly deals with the insurance sector. - Cooperation among supervisory agencies: - Occurs from top management to operational levels. - MOF participates with supervisory agencies on macro-relevant issues at top management level. - Operational cooperation appears productive and effective for on-site examinations and routine supervisory issues. - Cooperative efforts governed by multilateral and bilateral MOUs. - Impact of the global crisis: - Affected Slovenia’s economy significantly; most banks were adversely affected by the economic downturn. - Performance deteriorated markedly due to higher levels of non-performing loans in the corporate and real estate sector, particularly construction industry. - Banking system reported operating losses in both 2010 and 2011. - Pre-crisis asset growth was fueled by wholesale funding from abroad, straining capital adequacy and liquidity. - Authorities’ priorities and measures: - Strengthening banking system financial condition is a key priority. - The 3-year LTROs have eased immediate liquidity pressures. - Banks need to reduce dependence on wholesale funding and restructure balance sheets. - Stronger capitalization of some banks would help avoid severe deleveraging and enable provision of credit to the economy. - Further write-downs of non-performing loans will have to be recognized in connection with bank restructuring. - Operations of government controlled banks will have to become more commercially oriented. ### C. Preconditions for effective banking supervision - Institutional macro framework: - Slovenia has a solid institutional framework supporting sound macro-economic policies. - Monetary policy is conducted by the BOS within the ESCB framework. - Budgetary policy is conducted within a fiscal framework based on the EU’s Stability and Growth Pact. - Recent financial crisis has put pressure on financial stability and the budgetary situation; measures taken to ensure budget sustainability but considerable adjustment still needed. - Legal and regulatory framework: - Slovenian legal framework for the financial sector is comprehensive and regularly updated. - EU compendium of laws and regulations has been fully adopted and implemented for the financial sector. - Major legislation includes the Banking Act, attendant regulations, and the Companies Act. - Auditing and accounting: - Auditing and accounting rules applicable to financial institutions comply with international standards. - All banks, insurance companies and listed companies have implemented IFRS. - Disclosure and reporting requirements adhere to EU requirements. - Audit profession rules require internal and external auditors to be independent in both fact and appearance. - Banking Act requires appointment of an internal auditor and an external auditor in a bank; auditors are subject to specific sections of the Audit Act. - Agency for Public Oversight of Audit assures independence of external auditors and serves as a self-regulating body for the audit profession. - Legal and judicial framework: - Judicial system, including bankruptcy and enforcement of property rights, is well developed. - Legal background and regulatory and institutional framework dealing with banks in weak or deteriorating condition (as stipulated in the Banking Act) is inadequate. - BOS needs a more effective set of bank resolution regulations and tools. - Payment systems: - BOS participates in TARGET2 (Trans European Automated Real-Time Gross Settlement Express Transfer 2). - BOS operates the national component of TARGET2; cross-border transactions with TARGET2 outside Slovenia are relatively small in number and value. - Financial reporting and disclosure: - Financial reporting and disclosure requirements for institutions listed on capital market indices in Slovenia or other EU member states are very strict. - BOS requires detailed disclosures in annual and quarterly financial statements, management review, supervisory board’s report, and statements/opinions from directors, management or external auditor. - Corporate governance: - Governed by the Companies Act and the Audit Act; sectoral legislation (e.g., Banking Act) adds sector-specific corporate governance provisions. - Deposit guarantee scheme: - Slovenia has a deposit guaranty scheme insuring depositors with funds on account in a bank aggregating €100,000. - Scheme is administered by BOS and can be utilized if a bank is declared bankrupt under current bankruptcy laws in the Banking Act. - To date, the scheme has not been utilized. - Supervisory legal framework: - Comprised principally of the Banking Act and attendant defining regulations; other important legislation includes the Companies Act, the Conglomerates Act and the Audit Act. - BOS implements prudential requirements via defining regulations on areas ranging from capital adequacy to risk management practices. ### D. Main findings (summary) - Objectives, independence, powers, transparency and cooperation (CP1): - Laws and regulations governing banking supervision are generally comprehensive. - BOS is autonomous de jure and de facto, but government policies and priorities impede robust supervision of government controlled banks. - Legal framework does not indemnify bank supervisors against damages from discharge of responsibilities, nor provide protection against costs of defending acts of commission or omission in good faith. - Banking supervision is understaffed, potentially inhibiting BSD’s ability to perform satisfactorily. - Licensing and structure (CPs 2–5): - Legal framework is clear on permissible banking and non-banking activities. - Infrastructure exists to evaluate bank license applications; few applications are received. - Transfer of ownership is well defined; explicit definitions for controlling interests exist. - Conditions for acquisition of non-bank financial institutions are not contained in the law; banks may acquire such institutions without BOS review or approval at present. - Authorities are contemplating legislation to address this gap. - Prudential regulation and requirements (CPs 6–18): - Capital adequacy framework is based on international standards in accordance with EU directives; Basel II regimen introduced into legal framework. - BOS has established minimum capital requirements and capacity to require additional capital, but legal framework enables shareholders to forestall raising additional capital. - Most major banking risks are subject to scrutiny; risk management evaluation is generally adequate but many banks have not fully developed satisfactory risk management systems in all aspects. - Areas for improvement: certain aspects of credit risk management (reporting of problem assets and loan loss reserves), internal controls, liquidity risk, operational risks, and monitoring of related party exposures. - Reporting of problem assets lacks granularity, and provisioning on NPLs stands at only 41 percent, creating strong possibility that impaired assets are under-reserved. - Methods of ongoing banking supervision (CPs 19–21): - BOS has implemented a risk-based approach; BSD has an ICAAP-SREP program and Risk Assessment System (RAS) methodology. - Good mix of on-site and off-site supervision with extensive communication and cooperation between groups. - Extensive reporting requirements provide wide range of data and risk management information on consolidated and unconsolidated basis. - Gaps: non-bank financial institutions are not required to file financial information on a solo basis; data collected on related parties is incomplete. - Accounting and disclosure (CP22): - Disclosure requirements are very strict; external auditors ensure adherence. - Auditing profession held to high standards in law and practice by BOS, but is self-regulating. - BOS is not empowered to approve external auditing firms retained by banks. - Banking system prepares accounting records and reports financial information in accordance with IFRS. - Corrective and remedial powers (CP23): - BOS has a satisfactory range of enforcement tools. - Tools may be impeded by shareholder rights relative to capital increase requirements and lack of legal power to remove unqualified supervisory board members. - Powers and strategies for resolution of problem banks need strengthening. - Consolidated and cross-border banking supervision (CPs 24–25): - BOS has a generally satisfactory consolidated supervision program. - Supervisors understand banking group organizational structures, have identified risk areas, and maintain contact with foreign supervisors and domestic authorities through supervisory colleges. - Program can be strengthened by: focusing supervisory attention on non-bank financial companies, enhancing understanding of related party interests across banking groups, and monitoring transactions with affiliated companies in mixed activity companies. ### Selected detailed points from Annex Table 1 (principles 1–8 highlights) - CP1 (Objectives, independence, powers, transparency, cooperation): - Laws and regulations relatively comprehensive, but need strengthening to: prohibit potentially unqualified supervisory board candidates, remove unqualified board members, make power to require banks to raise capital more effective, and establish an appropriate and effective bank resolution framework. - BOS has de jure and de facto independence; State policies may impede supervision of government controlled banks (e.g., adequate capitalization). - Protections in law to indemnify bank supervisors against litigation in proper conduct are inadequate. - Satisfactory cooperation and information exchange frameworks exist domestically and abroad; interagency committees have been established. - CP2–CP5 (Permissible activities, Licensing, Transfer of ownership, Major acquisitions): - Legal framework clear on permissible activities; licensing infrastructure effective but BOS lacks power to evaluate/license supervisory board members. - Sanctions on qualifying holders who obtain ownership without BOS authorization are weak; banks not required to inform BOS of material adverse events affecting suitability of qualifying holders. - BOS does not authorize establishment/acquisition of non-bank financial companies by Slovenian banks; banks may acquire such companies without authorization or evaluation of the bank’s financial capacity or risk management plans. - CP6 (Capital adequacy): - Regulatory framework aligned with Basel amendments; supervisors preparing for Basel III. - BOS’s authority to require capital increases is clear but shareholder provisions can frustrate efforts. - Supervisors are not aggressively requiring capital increases from ICAAP/SREP results or moving banks to enhanced capital measurement techniques (e.g., IRB). - Employment of enhanced techniques is expected to result in capital shortfalls for many banks. - For Government controlled institutions, BOS’s powers to ensure additional capital is raised are limited. - CP7 (Risk management process): - Internal RAS/POT methodology provides generally adequate guidance for assessing risk management. - Regulatory guidance on internal control frameworks and organization of risk control functions could be more precise and prescriptive. - BOS has used powers to require banks to strengthen risk management but has not always obtained timely expected improvements. - CP8 (Credit risk): - Regulatory framework and internal guidance on credit risk are relevant. - Credit risk identified as the prominent risk in the Slovenian banking system. - Supervisor’s ability to control banks’ credit policies and practices has not been demonstrated given rise in NPLs and current impact on profitability. - Some evidence credit risk was underestimated and some banks did not follow the supervisor’s prudent approach during high lending growth. - Few banks use foundation IRB; those that do are not the largest credit institutions. - Banks have few incentives to shift to IRB absent regulatory constraint, as IRB would likely result in additional capital requirements. *Source: _cr12325 - 59. The assessment of Basel Core Principles for Effective Banking Supervision* ### 9. Problem assets, ### 9. Problem assets, provisions, and reserves ### Key findings on problem assets and provisioning - Banks report monthly on exposures to debtors using a 5 grade classification system. - The credit classification lacks granularity; the intermediate class C accounts for about 10 percent of the classified assets and is not homogenous. - Impairment on NPLs is only 40 percent. - BOS’s Individual Capital Adequacy Standards (ICAS) methodology for evaluating expected losses indicates 53 percent. - The limited granularity in claims classification contributes to low measured impairment and potential understatement of expected losses. - External audit scrutiny of loan portfolios and on-site examinations of loan portfolios have been insufficient in scope and sample size, contributing to weak collateral valuation practices. ### Supervisory and structural weaknesses affecting problem assets - BOS may not have been proactive or timely enough in supervising credit risk developments, which limits early intervention when credit risk rises. - Off-site supervision is understaffed despite supervisory resources having been expanded by 25% globally since the last FSAP in 2003. - Internal controls and internal audit functions in banks display weaknesses, casting doubt on adequacy of banks’ internal controls, skills, and independence of control functions. - Related party exposures are not adequately gauged on a consolidated basis through supervisory returns or other means, complicating assessment of credit quality. - Supervisory reporting has gaps: non-bank financial companies are not required to file on a solo basis, and data on related party transactions is incomplete. ### Recommended actions specific to problem assets, provisions, and reserves - Consider shifting to a more granular claims classification with more homogenous credit categories. - Encourage external auditors to review banks’ loan portfolios with a more critical bias and require banks to maintain or increase external audit budgeted/fees. - Develop on-site examinations of loan portfolios on larger samples. - Induce banks to take a more conservative stance on collateral valuation. - The supervisor should intervene timely and forcefully when identifying a rise in credit risk and should put more pressure on banks for classifying more appropriately their claims on individual debtors and requiring additional provisioning when needed even if it can result in a deteriorated capital ratio. - BOS should encourage a wider use of IRB approaches. ### Related supervisory recommendations that affect provisioning and problem-asset resolution - Reassess the staffing needs of the Banking Supervision Department; raise the current ceiling on the number of professional staff so further staff additions can be made as appropriate. - Empower BOS to require a bank to increase capital, as a special capital charge or for other reasons, without potential impediments raised by the bank’s shareholders. - Guidance to banks on internal control framework and on risk control functions’ organisation, missions and resources should be more precise and prescriptive; the risk management function should have more power in decision making. - BOS should monitor more closely, on an ongoing basis, the quality and comprehensiveness of internal reports, including audit reports; BOS should have some licensing or veto power for appointments to the supervisory board and the audit committee. *Source: _cr12325 - 9. Problem assets, provisions, and reserves* ### 19. Supervisory ### 19. Supervisory ### 19. Supervisory approach - There is a strong need for more in-depth reviews and ongoing monitoring by off-site supervision (which will require additional staff). - A more forward looking, more proactive rather than reactive approach is required. - A somewhat more intensive implementation of banking supervision is recommended. ### 20. Supervisory techniques - Off-site staff and to a lesser extent on-site staff should be expanded. - A significant increase in resources would allow the off-site section to: - develop meetings with the banks both at the higher level and at more operational level. - better capitalize on banks’ internal audit function production whose reports are not yet systematically used and evaluated. - Targeted hiring of on-site resources (presently short of IT and OR experts) is highly desirable. ### 21. Supervisory reporting - Authorities should consider expanding the amount of data collected through the supervisory reporting process. - More complete information on related party transactions should be required. - To improve the level of consolidated supervision, data on non-bank financial companies should be collected from banks on a solo basis. ### 22. Accounting and disclosure - Authorities should obtain the power to reject the appointment of an auditor by a bank. - This power would allow supervisors to ensure banks select auditors of the highest quality that have been licensed by the governing agency, are not compromised by conflicts of interest, and are not objectionable for other reasons. - Rotation of external auditing firms could create competition in the industry, given the minimal number of firms providing these services at present. - Consideration should be given to having a formal meeting with the external auditor subsequent to the completion of the audit to discuss the auditor’s evaluation of risk management practices and the internal control system. ### 23. Corrective and remedial powers of supervisors - The Banking Law should be amended to enable BOS to remove a member of the supervisory board for the same or similar reasons for which a member of the management board may be removed. - Remove all impediments to BOS’s powers to require corrective measures relative to ensuring that a bank has adequate capital. - Revise and strengthen the authority granted under the Banking Act relative to the resolution of a problem bank to afford the Supervisor of Banks flexibility to apply an appropriate strategy when intervention is warranted. - Revise and strengthen the entire existing regulatory structure, including special administration, liquidation and bankruptcy. ### 24. Consolidated supervision - Consider enhancements to the program of consolidated supervision. - Increase supervisory attention to non-bank financial subsidiaries and monitoring of intercompany transactions in mixed activity companies. - Collect supervisory information on non-bank financial companies and include them in the SREP process more fully to provide insights into risks undertaken by these institutions. - Greater focus on related party interests within a banking group and a mixed activity company is warranted. ### Authorities’ response (paragraphs 83–85) - 83. Bank of Slovenia generally agrees with the key findings and recommendations from the BCP Assessment. - In Bank of Slovenia's view, the assessed consequences of identified weaknesses in implementation of BCP in Slovenia are disproportionate to a certain extent. - Even highly effective banking supervision could not prevent the consequences of the financial crisis facing the Slovenian banking sector and corporate sector. - Bank of Slovenia has reservations towards recommendations requiring regulatory or other activities in areas which are immaterial for Slovenian banks (e.g. requirement to collect data from non-bank financial companies on a solo-basis). - The principle of proportionality is one of the core principles in banking supervision and should be reflected in the recommendations. - 84. Bank of Slovenia has prepared an action plan for implementation of recommendations to improve compliance with the BCP and proposed to the Ministry of finance several amendments of the Banking Act, including provisions on: - (i) legal protection of the Banking Supervision staff, - (ii) Bank of Slovenia's authority to licence supervisory board members and the acquisition of non-financial institutions, - (iii) broader Bank of Slovenia's powers to require a bank to increase its capital, while at the same time not allowing bank's shareholders to impede this procedure, - (iv) introduction of new resolution tools as the basis for the future resolution regime. - Legislative power lies with the Parliament which is empowered to endorse the above-mentioned amendments to the legal acts. - 85. Bank of Slovenia is committed to implement the aforementioned action plan, also in cooperation with other relevant authorities, and will strive for an even more proactive and forward looking approach to banking supervision in the future. - Strengthening the financial condition of the banking system is a key priority of all Slovenian authorities at present. *Source: _cr12325 - 19. Supervisory* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12325.pdf_