## _cr1310

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---

### Overview
- Armenia has a relatively small but growing financial system dominated by banks.
- 95 percent of financial assets are held by 21 commercial banks.
- The system was resilient to a GDP contraction of 14.1 percent in 2009 and remains sound.
- Levels of non-performing assets remain low and the system on the aggregate is well capitalized.
- Credit is growing from a relatively low base and dollarization has been deepening, increasing vulnerability to shocks.
- The non-bank market is underdeveloped with a small but growing insurance sector and a tiny capital market.

### Key macroeconomic and financial risks
- Rapid credit growth, especially in foreign currency, is the main systemic risk.
- External and macro vulnerabilities:
  - Possible downturn in the Russian economy and spillovers from the euro area.
  - A drop in commodity prices affecting exports (minerals and metals).
  - Large external current account deficit: 10.9 percent of GDP (2011).
  - Fund staff estimated the real effective exchange rate overvalued by 10–15 percent at Third Review in December 2011.
  - Official exchange rate: 388.69 AMD to the 1USD on Feb 10, 2012.
- Dollarization:
  - Loan dollarization trend: 2008: 38.4 percent; 2009: 52.8 percent; 2010: 55.5 percent; first nine months of 2011: 60 percent.
  - Around 60 to 70% of liabilities and loans held in foreign currency (aggregate statements).
  - CBA measures: increased risk weights and provisioning charges on dollar assets; higher reserve requirements on dollar deposits.

### Banking sector structure and performance
- Market structure and ownership:
  - 21 banks hold 95 percent of financial assets.
  - The largest bank has less than 11 percent of system assets.
  - Approximately half of the banking sector (by assets) consists of subsidiaries of foreign banks.
- Intermediation and product mix:
  - Credit to the private sector less than 32 percent of GDP at end 2011 (other sections note less than 26 percent of GDP in related snapshots).
  - Credit allocation by sector: trade (21.3 percent), manufacturing (11.7 percent), consumer lending (16.7 percent), mortgages (8.5 percent).
- Profitability and capitalization:
  - Banks are profitable relative to comparable banking sectors.
  - Aggregate CAR: declined from 27.5 at end-2008 to 19.6 at end September 2011; elsewhere reported 18.3 percent aggregate at end-December 2011.
  - Tier 1 Capital accounts for about 90 percent of total capital.
  - Leverage increased from 435 percent to 540 percent (period stated).
- Market features:
  - Few inter-linkages between banks and a limited interbank market.
  - Small size of many banks creates concentration risk for some smaller banks.
  - System-level concentration low: HHI index 0.66.

### Asset quality and provisioning
- NPL definitions and levels:
  - CBA definition includes watch, substandard, and doubtful loans, but not loss loans (>270 days past due).
  - As of end-December 2011 NPLs stood at 3.4 percent of gross loans, up from 3.1 percent at end-2010.
  - According to IMF/WB methodology, NPLs reached 5.25 percent at end September 2011 compared to 5.36 percent at end 2010.
  - Nonperforming loans (in billions of drams): 27.9 50.2 64.6 64.5 36.3 43.9 38.5 37.9 28.6 35.7 37.4 56.0 (series provided).
  - Nonperforming loans to gross loans (percent): 4.4 7.6 10.2 9.3 4.8 5.6 4.8 4.5 3.1 3.5 3.4 4.8 (series provided).
- Provisioning and coverage:
  - Provisioning against NPLs (local definition) was 41 percent at end-September 2011.
  - Provisioning was below pre-crises levels but above the low point of 26.5 percent in 2009.
  - Under a more standard definition (excluding watch, including write-offs), provisions covered 103 percent at end-September 2011.
  - Provisions to nonperforming loans (percent) series: 38.2 26.9 26.6 33.1 46.7 36.2 41.4 41.9 56.7 51.0 50.9 41.3.
  - Average loan-to-value for loans registered in the credit registry is 34 percent.
- Bank-specific concerns:
  - As of end-December 2011, NPLs including write-offs in five banks exceeded 10 percent.
  - Ratio of NPLs in foreign currency loans similar to domestic currency NPL ratios.
  - Lack of foreign currency income for many FX borrowers; no systematic collection of natural hedging data.

### Capital adequacy and stress testing
- Capital positions and trends:
  - Banks appear well capitalized in aggregate.
  - CAR: reported declines from 27.5 at end-2008 to 19.6 at end September 2011; other aggregate figures: 28.3/28.9/26.9/22.2/21.3/20.0/19.6 in time series.
  - An analysis suggests all banks would meet Basel III capital levels should those be implemented.
- Stress test framework and results:
  - Coverage: 21 banks (100 percent of sector assets) with horizon 2011-2016; baseline data end-September, 2011.
  - Solvency shocks: FSAP scenarios use 1 (2) standard deviation(s) shock to real GDP in mild (severe) scenarios paired with 15 (30) percent depreciation; authorities’ baseline includes 18 percent exchange rate shock and 2 percentage point interest rate shock.
  - Findings:
    - Only a few banks would face capital strains under scenarios, but banks would be constrained in generating additional capital as higher interest rates would worsen income streams.
    - Fixed interest rate loan portfolios limit pass-through of funding cost increases; banks relying on domestic funding would face negative net interest income margins.
    - Relatively high capital buffers help mitigate risks.
  - Caveat: stress tests may understate vulnerabilities due to recent increased dollarization, competition, and credit growth.

### Concentration, funding, and liquidity
- Concentration risk:
  - Bank-level loan portfolio concentration fairly high; small banks with several big clients especially exposed.
  - Stress tests assuming largest borrower failure show several small and mid-sized banks would need additional capital.
- Funding and liquidity:
  - Banks largely deposit funded; customer deposit to non-interbank loan ratio stable.
  - Banks increased funding from foreign banks (including parents), IFIs, government, and CBA.
  - Interbank market fragmented; not significant source of liquidity.
  - Liquidity metrics (system-level foreign currency): overall foreign currency liquidity ratio 21 percent over total foreign currency assets, and 83 percent over demand liabilities (end-September 2011 HLA/TA (foreign exchange) = 20.8 percent; HLA/DD (foreign exchange) = 83.1 percent).
  - Distribution uneven: 14 out of 21 banks do not meet at least one foreign currency ratio.
  - Liquidity stress tests: banks could cope with large outflows generally, though foreign currency outflows more challenging.
  - Foreign-owned banks expect parent support in systemic event; failure of a foreign parent is a risk.

### Risk management and supervisory framework
- Improvements since crisis:
  - Creation of separate risk management departments in several banks; enhanced role in large loan decisions.
  - Increased bank stress-testing and contingency planning aligned with CBA regulations.
- Remaining gaps and recommendations:
  - CBA regulations regarding risk management (including indirect foreign exchange risk) can be enhanced.
  - Require banks to notify the CBA of any significant changes in operations; currently no legal obligation exists.
  - Make compliance function independent from internal audit; legislative amendment recommended.
  - Implement Pillar 2 supervisory techniques to address institution-specific concentration and risk management weaknesses.
  - Pillar 2 assessments should cover credit concentration risk, interest rate risk in the banking book, indirect FX risk, reputational and strategic risk.
  - Use credit registry data to validate provisioning adequacy periodically.
  - Introduce guidelines for internal validation of banks' internal risk models.
  - Consider mandatory independent risk management division headed by a Chief Risk Officer for larger/riskier banks.

### Macroprudential framework and liquidity requirements by currency
- Institutional setup:
  - Financial System Stability and Development Department (FSSDD) handles macroprudential policy, separate from supervisory units.
  - FSC chaired by the Governor includes Deputy Governor and policy departments; MOF and DGF play minor roles.
- Macroprudential tools applied:
  - Higher risk weight and higher provisioning for FX lending than for dram lending.
  - Restriction on banks’ net open position to 7 percent of capital.
  - Higher reserve requirement ratio for foreign currency liabilities.
- Recommendations:
  - Introduce a liquidity coverage ratio for foreign currency (phased in gradually).
  - Monitor currency mismatch of borrowers: introduce formal procedure to collect data beginning with large borrowers and analyze existing data.
  - Increase public communication: consider issuing press statements after FSC meetings.
- Appendix I findings:
  - CBA liquidity minima: HLA/TA > 15 percent; HLA/DD > 60 percent (monitored monthly).
  - One-time introduction of liquidity regulations by currency at current levels could have non-negligible impacts on a few banks; gradual introduction and lead-time recommended.
  - Ways banks can meet foreign currency HLA/TA and HLA/DD include de-dollarization, asset conversion, or converting demand deposits to time deposits — each with trade-offs.

### Crisis management, emergency liquidity assistance, and resolution
- CBA crisis role and past actions:
  - CBA provided extraordinary support in 2009 crisis using legal powers for short-term and exceptional longer-term loans.
  - CBA law allows short-term liquidity assistance with maturity not exceeding six months with collateral; exceptional unsecured loans up to five years possible.
  - Long-term operations provided in coordination with government:
    - Subordinated loans: ten banks took subordinated loans totaling 30.3 billion AMD (five-year maturity, matched capital replenishment).
    - Merger support: a three-year loan of 7.3 billion AMD provided to banks acquiring a distressed bank.
- Recommendations on ELA and CBA mandates:
  - Introduce liquidity coverage requirement in foreign currency — High — Immediate (planning immediate, implement over time).
  - Limit CBA emergency assistance to secured loans to solvent organizations; more permanent crisis capital assistance should be by government on clear CBA advice.
  - Clarify Emergency Liquidity Assistance (ELA) in law.
  - The CBA should not use its financial resources to recapitalize regulated entities; plan exit of ownership stakes in regulated entities.
- Early intervention and resolution:
  - CBA has a broad range of intrusive powers but law should explicitly authorize instruction to shareholders to raise capital.
  - Triggers for provisional administration should be refined to allow earlier intervention (pre-insolvency quantitative and qualitative triggers proposed).
  - Procedural delays: up to two weeks may elapse between decision to appoint provisional administrator and actual appointment; administrator currently has 6 months to develop resolution plan — shorter period suggested.
- Deposit Guarantee Fund (DGF):
  - Established 2005; ex ante funded; anticipated capacity to cover simultaneous failures of 2–3 medium-sized banks and 8–10 small banks.
  - Funding rules: initial AMD 15 million within ten days of licensure; quarterly contributions equal to 0.5 percent of bank’s average daily balance of deposits in a reporting quarter (but not less than AMD 1 million per year).
  - Recommendations:
    - Consider shortening payout period (currently 3 months) to approximately 20 days.
    - Allow DGF to use funds in resolution/purchase-and-assume transactions and prohibit active bankers from serving on DGF Board.
    - Clarify mechanisms to replenish DGF resources; prefer shortfalls be filled by private sector or government.

### Non-bank financial sector — pensions, insurance, capital markets
- Pension reform:
  - Multi-pillar pension system law approved; pension reform to be introduced beginning in 2014.
  - Prior to implementation authorities should:
    - Put licensing standards for asset managers and rules governing investment policy in place.
    - Conduct a complete analysis of transition costs.
    - Develop regulatory framework: investment policy, fee structure, custody/safekeeping, consumer protection.
    - Develop pension regulation capacity at CBA.
- Capital market:
  - Limited capital market due to small economy.
  - NASDAQ OMX operates Yerevan exchange supporting limited trading; most government bonds traded over-the-counter.
  - Demand for securities could grow with pension reform; corporate issuance likely longer term.
- Insurance sector (non-life dominant):
  - Assets held by insurers: AMD 25.6 billion, accounting for 1.3 percent of total financial sector assets as at end-2010.
  - Gross written premiums: AMD 7.8 billion in 2010 with overall retention 51 percent.
  - No life insurers currently operating in Armenia.
  - Registered agents rose from 65 in 2008 to 5,524 as at end-2011 due to mandatory motor third party liability insurance introduced in 2010.
  - Investments highly liquid, mainly deposits with domestic banks; insurers held only 9 percent of their assets in government securities (end-2010).
  - Key risks: natural catastrophes, credit exposures to reinsurers, FX risks from dollar-denominated deposits.
  - Supervisory framework: CBA took over insurance supervision in 2006; off-site surveillance and on-site inspections comprehensive; solvency regime strengthened in 2010.
- Insurance regulatory findings and ICP-specific recommendations (paragraphs 94–102 summary):
  - Enhance TP computation and require insurers to collate and report claims development triangulation data by lines of business.
  - Update investment and derivative regulations to reflect international best practice; expedite issuance of derivatives regulation.
  - Strengthen solvency regime with solvency control levels and supervisory intervention ladder; address multiple gearing and pledged/encumbered assets supporting technical provisions.
  - Update intermediary/agent regulation given MTPL-driven agent growth; develop consumer protection for life products.
  - Provide legal protections for CBA and staff; broaden information-sharing powers and enforcement toolbox (including conservatorship powers).
  - Develop actuarial and professional standards; improve asset-liability management supports via deeper money and securities markets.
  - Priorities: near-term require granular claims data, expedite derivatives regulation, update agent requirements; medium-term establish solvency control levels and group-wide supervision; longer-term legal protections and market deepening.

### Main recommendations (selected, with priority and timing as in source)
- Introduce liquidity coverage ratio for foreign currency — High — Immediate.
  - Immediate planning should begin, with implementation of new rules over time.
- Amend the law to require banks to immediately report changes to operations that would have a material adverse impact on the bank — High — Immediate.
- Develop a program to gather information and monitor the hedging ability of borrowers — High — Immediate.
- Introduce use of Pillar 2 supervisory techniques — High — Medium-term.
- Amend legislation to establish clearer and earlier triggers for a provisional administrator to conduct resolution operations — Medium — Medium-term.
- Amend Deposit Guarantee Fund legislation to allow funds to be used in resolution operations and to shorten the depositor pay-out period — Medium — Medium-term.
- Revise Deposit Guarantee Fund governance structure to limit the participation of active bankers — Medium — Medium-term.
- Develop sound framework for the investment policy and asset manager regulations for pension funds — High — Medium-term.
- Develop pension regulation capacity at CBA — High — Medium-term.
- Assess reform transition cost of pension reform — High — Medium-term.
- Amend the Civil Code and other relevant laws to simplify and accelerate registration and execution of collateral — Medium — Medium-term.
- Insurance-specific (selected):
  - Require insurers to collate and report claims development triangulation data by lines of business (ICP 20).
  - Expedite issuance of regulations governing insurers’ derivative activities (ICP 22).
  - Establish solvency control levels and supervisory intervention ladder (ICP 23).
  - Update agent regulation and consumer protection to support life insurance market development (ICP 24–25).

### Selected economic and financial indicators (snapshots and series)
- Real GDP (percent change): 6.9 -14.1 2.1 4.6 4.6 3.8 4.0 4.0 4.0 (series 2008–2015).
- GDP (in billions of drams): 3,568 3,142 3,502 3,871 3,819 4,172 4,533 4,903 5,303.
- GDP (in millions of U.S. dollars): 11,662 8,648 9,371 10,126 10,251 10,553 11,055 11,673 12,351.
- CPI (period average; percent change): 9.0 3.5 7.3 7.8 7.7 3.9 4.2 4.0 4.0.
- Current account balance (percent of GDP): -11.8 -15.8 -14.7 -12.2 -10.9 -10.0 -8.7 -7.6 -6.6.
- External debt (percent of GDP): 29.5 57.8 64.6 65.5 65.9 67.6 65.3 62.6 61.0.
- Gross international reserves (in millions of U.S. dollars): 1,407 2,004 1,866 1,806 1,869 1,712 1,613 1,496 1,620.
- Exchange rate examples:
  - End-of-period exchange rate (dram per U.S. dollar): 307 378 363 ... 385.8.
  - Average exchange rate (dram per U.S. dollar): 306 363 374 ... 372.5.
- Financial soundness indicators (selected series highlights):
  - Foreign exchange loans to total loans: 38.7 48.7 51.5 54.3 54.0 54.3 55.4 56.4 58.0 59.6 59.6 60.2.
  - Nonperforming loans to gross loans (percent): 4.4 7.6 10.2 9.3 4.8 5.6 4.8 4.5 3.1 3.5 3.4 4.8.
  - ROA (profits to period average assets): 3.1 -0.1 -0.1 0.0 0.7 1.3 1.8 2.0 2.2 2.0 2.3 1.9.
  - ROE (profits to period average equity): 13.6 -0.7 -0.3 0.1 3.4 6.1 8.5 9.5 10.2 10.0 11.7 9.8.
  - Liquid assets to total assets (percent): 23.8 29.1 32.0 35.2 34.2 33.9 30.1 30.1 29.5 28.9 26.8 28.3.
  - Customer deposits to total (non-interbank) loans (percent): 81.4 92.1 96.3 100.7 96.4 96.5 86.8 86.5 87.2 87.1 85.3 89.3.

*Source: _cr1310 - Executive Summary and IMF staff report content provided in the supplied PDF chapter/section.*

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

### _cr1310 - Executive Summary ......................................................................................................

### Overview
- Armenia has a relatively small but growing financial system dominated by banks.
- 95 percent of financial assets are held by 21 commercial banks.
- The system was resilient to a GDP contraction of 14.1 percent in 2009 and remains sound.
- Levels of non-performing assets remain low and the system on the aggregate is well capitalized.
- Credit is growing from a relatively low base and dollarization has been deepening, increasing vulnerability to shocks.
- The non-bank market is underdeveloped with a small but growing insurance sector and a tiny capital market.

### Key macroeconomic and financial risks
- Rapid credit growth, especially in foreign currency, is the main systemic risk.
- Armenia is vulnerable to: 
  - a possible downturn in the Russian economy and spillovers from the euro area;
  - a drop in commodity prices affecting exports (minerals and metals).
- Dollarization intensified after the 2009 dram devaluation; authorities have increased risk weights and provisioning charges on dollar assets, and higher reserve requirements on dollar deposits.
- Foreign currency lending is largely to corporations and small businesses, and a small mortgage sector.

### Banking sector structure and performance
- Market structure:
  - 95 percent of financial assets are held by 21 commercial banks.
  - The largest bank has less than 11 percent of system assets.
  - Approximately half of the banking sector (by assets) consists of subsidiaries of foreign banks.
- Intermediation and product mix:
  - Credit to the private sector at less than 32 percent of GDP at end 2011.
  - Credit allocation by sector: trade (21.3 percent), manufacturing (11.7 percent), consumer lending (16.7 percent), mortgages (8.5 percent).
- Profitability: banks are profitable relative to comparable banking sectors.
- Market features:
  - Few inter-linkages between banks and a limited interbank market.
  - Small size of many banks creates concentration risk for some smaller banks.

### Vulnerabilities identified and supervisory recommendations
- Foreign currency exposure:
  - Stress tests identified liquidity risk in foreign currency as a vulnerability.
  - The mission recommended a liquidity coverage requirement in foreign currency to address liquidity risk.
  - The CBA has limited ability to extend foreign currency emergency liquidity assistance; foreign currency liquidity requirements would be an important risk mitigant.
- Borrower currency risk and hedging:
  - Recommendation to develop a program to gather information and monitor the hedging ability of borrowers.
  - The CBA should undertake a more systematic analysis of the foreign currency exposure of borrowers, beginning with large borrowers.
- Concentration and institution-specific risks:
  - Use Pillar 2 supervisory techniques to address weaknesses in risk management and institution-specific concentration risk.
- Regulatory framework enhancements:
  - Strengthen definitions of large exposures.
  - Institute a clear responsibility for banks to report any changes in operations that could have a material adverse impact.
  - Establish clear risk management standards.
  - Enhance framework for handling and sharing confidential information with foreign counterparts to meet international standards.
- CBA mandates and governance:
  - The CBA is charged with banking and non-banking supervision as well as financial stability, crisis management, and resolution.
  - The CBA is well resourced with a professional staff, but its broad responsibilities could undermine its credibility.
  - Authorities should limit and manage competing mandates: the CBA should not use its financial resources to recapitalize regulated entities; plan for an exit of ownership stakes in regulated entities; and ensure its development mandate remains secondary to financial stability and monetary objectives.

### Non-bank financial sector and pension reform
- The non-bank market offers very limited alternatives to bank funding or deposits.
- Pension reform will be introduced beginning in 2014, expected to bring additional investments to the market.
- Prior to implementation, the authorities should:
  - Put licensing standards for asset managers and rules governing investment policy in place.
  - Conduct a complete analysis of transition costs.
  - Develop a regulatory framework with a suitable investment policy, fee structure, custody safekeeping, and consumer protection regulation.
- Insurance supervision is comprehensive and thorough, but should be enhanced to reflect international regulatory developments and to tailor prudential and market conduct regulations to support establishment of a life insurance industry.

### Crisis management, liquidity, and resolution
- A crisis management framework exists and allowed the CBA to respond effectively to the 2009 crisis.
- Recommended improvements:
  - Clarify delineation of resolution and liquidation procedures in law.
  - Clearly define Emergency Liquidity Assistance (ELA).
  - Any recapitalization assistance should be undertaken by the government rather than the CBA.

### Main recommendations (Table 1: Armenia FSAP Update: Main Recommendations)
- Introduce liquidity coverage ratio for foreign currency — High — Immediate
  - 1/ Immediate planning should begin, with implementation of new rules over time.
- Amend the law to require banks to immediately report changes to operations that would have a material adverse impact on the bank — High — Immediate
- Develop a program to gather information and monitor the hedging ability of borrowers — High — Immediate
- Introduce use of Pillar 2 supervisory techniques — High — Medium-term
- Amend legislation to establish clearer and earlier triggers for a provisional administrator to conduct resolution operations — Medium — Medium-term
- Amend Deposit Guarantee Fund legislation to allow funds to be used in resolution operations and to shorten the depositor pay-out period — Medium — Medium-term
- Revise Deposit Guarantee Fund governance structure to limit the participation of active bankers — Medium — Medium-term
- Develop sound framework for the investment policy and asset manager regulations for pension funds — High — Medium-term
- Develop pension regulation capacity at CBA — High — Medium-term
- Assess reform transition cost of pension reform — High — Medium-term
- Amend the Civil Code and other relevant laws to simplify and accelerate registration and execution of collateral — Medium — Medium-term

### Background and recent policy context
- A Stand-by Arrangement with the Fund in 2009 to support crisis response was followed by a three-year Extended Fund Facility/Extended Credit Facility-supported program in mid-2010. The Third Review of the EFF/ECF was completed in December 2011.
- Inflation came down rapidly in 2011, and the policy rate was lowered in September 2011, the first time since September 2009.
- Monetary policy is geared to price stability under an inflation targeting framework adopted in 2006.
- The 2005 FSAP Update previously identified foreign currency lending and increased credit growth as sources of risk; many recommendations from that update have been implemented, including greater integration of prudential regulation and macroprudential monitoring, higher standards for bank governance and banking supervision, and an insurance law.

*Source: _cr1310 - Executive Summary ......................................................................................................*

### 10.      Direct spillover effects from any future financial sector distress in the euro area

### _cr1310 - 10.      Direct spillover effects from any future financial sector distress in the euro area

### Direct spillover and macro external vulnerabilities
- Direct spillover effects from any future financial sector distress in the euro area would likely be limited.
- Second-round effects of a downturn in Europe, and in particular Russia, could have greater impact on banks through increased credit risks in the real sector, including through lower remittance inflows, which, however, to a considerable extent are channeled directly into other investments or consumption rather than saved in banks.
- The large external current account deficit is a potential vulnerability:
  - The current account deficit fell by nearly 4 percentage points in 2011, but remains high at 10.9 percent of GDP.
  - Fund staff estimated that the real effective exchange rate was overvalued by 10–15 percent at the time of the Third Review in December 2011.
  - The official exchange rate was 388.69 AMD to the 1USD on Feb 10, 2012.
- Capital inflows (FDI, official financing, banking flows) have remained strong, but risks of pressures on the dram remain.

### Banking sector: summary assessment and evolving vulnerabilities
- Since the onset of the global financial crisis, Armenia’s vulnerabilities have intensified:
  - The shares of foreign currency in both deposits and lending have increased significantly.
  - Policy buffers have been reduced since 2008: public debt to GDP has increased; gross international reserves are on par with pre-crises levels; total external debt to GDP increased from less than 30 percent in 2008 to a projected 65 percent in 2011.
  - The level of credit is higher and growth is accelerating, implying a bigger effect on the economy from similar shocks and more severe feedbacks through weaker balance sheets.
- Some positive factors:
  - Greater awareness of exchange rate risks among banks and borrowers.
  - Some commercial banks have stepped up risk management regarding credit risks from exchange rate volatility.

### Asset quality
- NPLs are moderate though somewhat above pre-crisis levels:
  - NPLs are defined by the CBA to include watch, substandard, and doubtful loans, but not loss loans (i.e., more than 270 days past due).
  - Much of the sudden increase in 2009 was quickly reversed as the economy recovered.
  - Banks did not have much exposure to construction and real estate sectors.
  - Government provided AMD60 billion in guarantees for SME lending oriented to exports or domestic production.
  - As of end-December 2011 NPLs stood at 3.4 percent of gross loans, up from 3.1 percent at end-2010.
  - No significant qualitative difference across sectors; NPLs in agriculture increased less than in other sectors.
- Provisioning and coverage:
  - Provisioning against NPLs, according to the local definition, was 41 percent at end-September 2011.
  - Provisioning was below pre-crises levels but above the low point of 26.5 percent in 2009.
  - Under a more standard definition (excluding watch, including write-offs), provisions covered 103 percent at end-September 2011.
  - Average loan-to-value for loans registered in the credit registry is 34 percent.
- Bank-specific concerns:
  - As of end-December 2011, NPLs including write-offs in five banks exceeded 10 percent; key factor is concentration of credit portfolios with large exposures to a few borrowers. These banks remain adequately capitalized.
  - Ratio of NPLs in foreign currency loans has been similar to domestic currency NPL ratios.
  - Lack of foreign currency income for many FX borrowers adds to credit risk; no systematic collection of natural hedging data and hedging is not taken into account for capital requirements.

### Capital adequacy and stress testing
- Capital positions:
  - Banks appear to be well capitalized.
  - Capital adequacy ratio (CAR) declined from 27.5 at end-2008 to 19.6 at end September 2011.
  - Leverage increased from 435 percent to 540 percent.
  - Tier 1 Capital accounts for about 90 percent of total capital; only a couple of banks have Tier 2 capital > 20 percent of total.
  - An analysis suggests all banks would meet Basel III capital levels should those be implemented.
- Stress test findings:
  - Solvency stress tests simulated a baseline and two recession scenarios: a moderate and a severe slowdown paired with significant AMD depreciation vis-à-vis the USD.
  - Tests suggest only a few banks would face capital strains, but banks would be severely constrained in their ability to generate additional capital as an increase in interest rates would worsen income streams.
  - Armenian banks’ portfolios are dominated by fixed interest rate loans, limiting pass-through of funding cost increases.
  - Banks relying on domestic funding would face negative net interest income margins, which combined with additional loan loss provisions would further erode capital buffers.
  - Relatively high capital buffers help mitigate these risks.
  - CAR would be supported in a downturn relative to the baseline by: (i) slower or negative growth in risk-weighted assets; and (ii) higher pre-provisioning returns on assets.
  - Caveat: stress test results may understate vulnerabilities because historic experiences may not capture more recent vulnerabilities, including increased dollarization, increased competition among banks, and relatively high credit growth.

### Concentration risk
- System-level concentration is low (HHI index is only 0.66).
- Bank-level loan portfolio concentration is fairly high and warrants vigilance:
  - Small banks with small loan portfolios and several big clients are especially exposed.
  - Stress tests assuming the largest borrower fails show several small and mid-sized banks would need additional capital.
  - Failure of the four largest borrowers would have a more significant impact, but recapitalization needs in terms of GDP would still be limited due to the relatively small size of the banking system and the small size of vulnerable banks.

### Profitability and competition
- Profitability has recovered but remains below pre-crisis levels.
- Competition for deposits and to lend has stiffened, visible in tighter lending-to-deposit interest rate spreads, especially in foreign currency.
- Such competition may put pressure on profitability going forward.

### Funding and liquidity
- Funding structure:
  - Armenian banks are largely deposit funded.
  - Customer deposit to non-interbank loan ratio has been fairly stable over the last four years.
  - Banks increased funding from foreign banks (including parents), international organizations, the government, and the CBA.
  - Interbank market is fragmented and not a significant source of liquidity or funding.
- Liquidity metrics:
  - Banks are generally quite liquid, particularly in domestic currency.
  - Foreign currency liquidity is lower than dram liquidity.
  - Overall foreign currency liquidity ratio is 21 percent over total foreign currency assets, and 83 percent over demand liabilities.
  - There are significant differences across banks; several banks have substantially lower ratios.
- Liquidity stress testing and contingent risks:
  - Liquidity stress tests indicate banks could cope with large liquidity outflows, though foreign currency outflows would be more challenging.
  - The CBA imposes strict liquidity requirements, without differentiation among currencies.
  - Main funding sources are domestic deposits and IFI deposits; banks are not exposed to market funding risk.
  - Foreign-owned banks expect support from parents in a systemic liquidity event; the failure of a foreign parent would be a risk for these banks.
  - In a few small banks the largest deposits account for a substantial share of all deposits; banks with high loan concentration tend to have higher funding concentration.

### Risk management
- Risk management has improved since the crisis, with variation across banks:
  - Several banks created separate risk management departments reporting directly to management.
  - Risk departments have an enhanced role in decisions on larger loans.
  - Awareness of exchange rate risk has increased, with intensified loan monitoring including client revenue streams.
  - Stress-testing by banks has increased, aligning with CBA regulations; stress tests are the basis for mandatory contingency plans.
  - Room for improvement remains, especially in smaller banks with lower capacity.
  - CBA regulations regarding risk management (including indirect foreign exchange risk) can be enhanced.
  - Banks emphasize high collateral and internal provisioning in lending.

### Non-bank financial sector: pension and insurance
- Pension sector:
  - Recent approval of a law allowing creation of a multi-pillar pension system is positive.
  - Impact depends on pension regulation and supervision, fiscal sustainability, a sound and diversified financial sector, and labor market growth.
  - Authorities should work quickly to develop a full analysis of reform costs to government and future financing needs.
  - Authorities should increase capacity at the Ministry of Finance for accurate projections and quantify liabilities from guarantees on the real value of contributions.
  - A framework for pension regulation should be developed and implemented by the CBA, covering entry requirements for asset managers, investment policy, limits on abroad investments for diversification, and consideration of a benchmark for such investments.
- Insurance market:
  - The insurance industry is small and has recently consolidated:
    - Assets held by insurers were AMD 25.6 billion, accounting for 1.3 percent of total financial sector assets as at end-2010.
    - There are four insurance brokers and a large number of registered agents, whose numbers rose from 65 in 2008 to 5,524 as at end-2011 due to mandatory motor third party liability insurance introduced in 2010.
    - There are no life insurers currently operating in Armenia.
  - Key risks:
    - Natural catastrophes and credit exposures to reinsurers.
    - Insurers need effective risk management to control retentions of risk accumulations and set prudent risk strategies and tolerance limits.
    - Insurers typically reinsure significant portions of large risks; CBA requires reinsurers to meet eligibility criteria.
    - Insurers’ investments are highly liquid, mainly deposits with domestic banks.
    - Some insurers are exposed to foreign exchange risks from deposits denominated in foreign currencies, mainly US dollars; CBA proposed a standard to become effective July 1, 2012.
    - Insurers held only 9 percent of their assets in government securities.
  - Challenges for life insurance development:
    - Low awareness of life insurance benefits, shallow financial markets, and inadequate local actuarial expertise.
    - Building trust and attracting long-term savings will take time.

*Source: _cr1310 - 10.      Direct spillover effects from any future financial sector distress in the euro area*

### 32.      There is a limited capital market in Armenia, largely due to the small size of the

### _cr1310 - 32.      There is a limited capital market in Armenia, largely due to the small size of the

### Capital market and market conduct
- There is a limited capital market in Armenia, largely due to the small size of the economy.
- NASDAQ OMX operates the Yerevan exchange which supports limited trading in a few stocks as well as government bonds.
- Most government bonds mainly are traded over-the-counter.
- Consumer protection and market conduct regulation are currently carried out by the CBA.
- The regulatory framework in place is adequate to meet the needs of the market.
- If the market further develops, the CBA could consider establishing a separate market conduct unit to address consumer protection issues and eventually securities markets.
- The demand for securities could grow with the implementation pension reform.
- The level of corporate development, and the reluctance of large corporates to meet transparency requirements suggests that equity and corporate bond issuance will be a longer term goal.

### Financial sector oversight — mandate and governance
- The CBA has a broad mandate: monetary policy, financial stability, and the regulation, supervision, and development of the financial sector.
- Financial stability is treated as an equal objective to monetary policy in practice; this could be formally adopted in law.
- Multiple CBA roles can create conflicts of interest (e.g., prudential regulation vs. market development).
- The CBA has some separation of development and prudential regulation but may wish to institute more formal written objection procedures by pertinent departments (e.g., licensing, monetary, stability, regulation) to record dissenting views before final decisions.
- The CBA should consider adding an account of how competing mandates were balanced in its annual report as a measure of accountability.
- The CBA’s credibility and capacity make it the ‘go-to’ agency; it should consider limiting roles where ownership and supervision conflict (it is the main shareholder in both the development bank and mortgage guarantee company which it supervises) and set a careful exit plan.
- The CBA’s involvement in non-standard crisis lending has potential to undermine credibility and flexibility.

### Legal protections and staff liability
- Protection of staff from liability for acts undertaken in the course of duty should be enacted in law.
- Currently such protection is found for all public servants in the civil code but a clear, more robust section should be added to the central bank law.
- International insurance supervision standards require that the CBA itself be protected in law from liability for acts taken in good faith, which it currently is not.

### Cross-border cooperation and information sharing
- Armenia hosts a number of cross-border institutions; the CBA enjoys good relations with foreign counterparts, notably frequent contact with the Central Bank of Russia.
- The CBA has Memoranda of Understanding (MOUs) with a number of countries, with the notable exception of the UK FSA, the home regulator of a large subsidiary in Armenia.
- Under current law, the CBA can only provide information to a foreign regulator where it has an MOU in place.
- Recommendation: The CBA should have greater flexibility to share information where it can satisfy itself that information will be used for supervisory purposes and subject to appropriate confidentiality standards.
- Shortcoming: The CBA currently has no ability to initiate an investigation on behalf of a foreign authority; this must be addressed to meet IOSCO requirements.

### Banking supervision — Pillar 2, risk management, and legal powers
- Basel Core Principles assessment: generally well structured banking supervisory regime; supervisory department appears adequately staffed.
- More work needed for sound and comprehensive implementation of Pillar 2 and its integration in supervisory methodology.
- Recommendation: More frequent (i.e., annual) structured dialogue with banks' Board or Senior Management on capital adequacy assessments.
- Pillar 2 assessments should cover credit concentration risk, interest rate risk in the banking book, indirect foreign exchange risk, and difficult-to-quantify risks such as reputational and strategic risk.
- Stress tests identified vulnerabilities of some small banks to concentration in both assets and liabilities; Pillar 2 assessments should inform supervisory cycles and individual capital ratios.
- CBA regulations should put greater emphasis on risk management instead of control.
- Re-assessment needed of distribution of provisions between mandatory regulations and “comply or explain” guidance.
- Issue guidance for indirect foreign exchange risk assessment and monitoring, revaluation of positions, and internal validation of risk management models.
- The CBA should require banks to notify it of any significant changes in operations; currently no legal obligation exists to notify supervisor of substantial changes or material adverse developments.
- Banking law should be amended to provide explicit powers for consolidated supervision.
- The status of the compliance function in banks should be clearly stated in law; currently internal auditor is specified as responsible for compliance, which conflicts with the auditor’s independent assessment role. Compliance should be carried out by someone other than the internal auditor (e.g., a senior officer or head of legal).

### Insurance supervision
- Updated regulatory framework has a high level of observance with the International Association of Insurance Supervisors' Insurance Core Principles (ICPs); CBA supervision is robust.
- Authorities implemented all recommendations relating to the insurance sector from the 2005 FSAP.
- CBA took over insurance supervision in 2006.
- Off-site surveillance and on-site inspections are comprehensive and facilitated by well-documented internal policies and manuals.
- Solvency regime strengthened in 2010 to adopt a more risk-based and calibrated approach.
- Further enhancements advised to reflect international regulatory developments and the establishment of a life insurance industry.
- Recommendations:
  - Expedite issuance of regulations governing insurers’ derivative activities.
  - Finalize regulatory requirements to combat insurance fraud.
  - Strengthen solvency regime to provide for transparent solvency control levels and supervisory intervention ladder, address group solvency requirements, and regulatory treatment of assets supporting technical provision that are encumbered.
  - Enhance regulatory requirements relating to risk management to better reflect international best practices.
  - Formulate an appropriate group-wide supervision framework in line with the ICPs.
  - Tailor prudential and market conduct requirements to protect long-term financial commitments of life policyholders.

### Payments and settlement systems
- Payment and settlement systems infrastructure for both large value and retail payments is well developed.
- Efficiency could be improved by replacing basic data collection tools with a more organized and automated monitoring system (e.g., data warehousing tools and systems).
- Recommendation: Strengthen human resource capacity of the Payment Systems Oversight Division (PSOD).
- Enhancements to operational reliability of the electronic payment system (EPS) are required to achieve full compliance with the Core Principles for Systemically Important Payment Systems (CPSS).
- Recommendations include developing an information security policy designed for RTGS operational needs and defining acceptable operational reliability/service levels, including recovery time objectives (RTO) for the entire system.

### AML/CFT framework
- A full AML/CFT assessment was undertaken by the IMF and MONEYVAL in February/March 2009.
- Considerable progress since Armenia’s first AML/CFT evaluation in September 2003 by MONEYVAL.
- Remaining deficiencies noted in:
  - Confiscation and provisional measures,
  - Financial secrecy laws,
  - Customer due diligence,
  - Designated non-financial businesses and professions,
  - Criminalization of the financing of terrorism,
  - Freezing and confiscation of terrorist assets pursuant to United Nations Security Council Resolutions 1267 and 1373.

### Macroprudential framework and tools
- The CBA has made progress in monitoring systemic risks.
- The Financial System Stability and Development Department (FSSDD) is in charge of macroprudential policy, separate from supervisory and regulatory units.
- FSSDD assesses banking sector stability using sensitivity analysis, the Banking Stability Index, and monitoring maturity composition of banks’ funding.
- The CBA is developing stress-testing incorporating macroeconomic scenarios such as GDP growth and remittance.
- Macroprudential tools applied to address dollarization risks:
  - Higher risk weight and higher provisioning for FX lending than for dram lending to mitigate credit risks.
  - Restriction on banks’ net open position to 7 percent of the capital to reduce direct currency mismatch risks.
  - Higher reserve requirement ratio for foreign currency liabilities to stave off deposit dollarization and strengthen monetary transmission.
- The CBA plays the lead role in macroprudential policy; MOF and Deposit Guarantee Fund (DGF) play minor roles and participate in the Financial Stability Committee (FSC) at the CBA's request.
- FSC includes the Governor, Deputy Governor and all policy-related departments.
- Areas for further improvement:
  - Monitoring the currency mismatch of borrowers: introduce a formal procedure to collect data on borrowers’ currency mismatch beginning with large borrowers and analyze already collected data.
  - Introduction of liquidity coverage ratios by currency, phased in gradually to avoid disruptive impact on money and credit markets.
  - Increased public communication: consider issuing a press statement after Supervisory Board meetings related to the FSC.

### Integrated systemic risk stress testing
- Macroprudential Analysis Division designs stress testing models and methodology.
- Tools include Vector Autoregression (VAR), simple Probability of Default (PD) based models for credit risk analysis, and a balance sheet stress test tool for calculation of CAR.
- Work is underway to construct PD models for various sectors including households; an interbank contagion matrix is under development.
- Absence of sufficiently long time series of high quality data affects reliability of quantitative results.
- Recommendation: Use hypothetical scenarios based on experiences of other similar countries rather than Armenia’s historical developments.
- The CBA needs to better utilize the existing framework and incorporate results into decision-making.

### Liquidity management, crisis management, and safety nets — Emergency Liquidity Assistance
- The CBA provided extraordinary financial support to banks following the 2009 crisis.
- CBA Law allows short-term liquidity assistance with maturity not exceeding six months with collateral.
- In exceptional cases, the CBA can extend loans with “special lending procedures and conditions,” including unsecured loans with terms up to five years.
- The CBA provided two types of long-term loans in close coordination with the government:
  - Subordinated loans to support capital replenishment of banks — subordinated loans with five year maturity were provided to banks which replenished capital by the matching amount. Ten banks took the subordinated loans in total amount of 30.3 billion AMD.
  - Loans to support bank mergers — a three-year loan of 7.3 billion AMD was provided to banks that acquired a distressed bank.
- Recommendation: Framework for emergency loans beyond short-term collateralized liquidity assistance should be revisited.
- The current CBA Law allows exceptional assistance without coordination with the MOF.
- Recommendation: Limit CBA emergency assistance to secured loans to solvent organizations; more permanent crisis assistance, including capital support, should be provided directly by government on clear advice of the CBA.

### Early intervention and orderly resolution of problem banks
- The CBA has a broadly appropriate range of powers to intervene and resolve problem banks; powers are progressively intrusive.
- Resolution tools include measures to compel remedial action while under private control and measures once private control ceases (appointing an administrator, revoking license, selling assets, bankruptcy and liquidation).
- Improvements could be made to facilitate effective use of these tools.
- The CBA’s power to instruct shareholders to raise capital could be more explicit; current law allows warnings, mandatory instructions, fines, license revocation, or removal of management but does not explicitly state authority to instruct shareholders to raise capital.
- Recommendation: Explicitly state authority in law to issue mandatory instructions for shareholders to raise capital to enable more intrusive action when shareholders fail to act.
- Triggers for provisional administration should be refined to allow for earlier intervention.
- Current triggers include breaching prudential measures and imminent insolvency (e.g., loss of half of core capital or actual insolvency).
- Recommendation: Allow appointment of a provisional administrator well before actual insolvency when pre-insolvency quantitative (e.g., 50–75 percent of CAR) or qualitative triggers (e.g., bank likely to become insolvent or engaging in unsafe/unsound practice posing serious threat to depositors/creditors) are breached.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1310.pdf*

### 58.      Procedural time delays for provisional administration should be reduced.  There

### Procedural time delays for provisional administration should be reduced.

### Provisional administration: timing and powers
- There may be up to a two weeks delay between the CBA’s decision to appoint a provisional administrator and the actual appointment.
- To prevent asset stripping by bank insiders, the administrator should take control of a bank promptly following the decision to appoint.
- Upon appointment, the administrator has 6 months to develop the resolution plan.
- Given that the CBA should be able to obtain a significant amount of information regarding the condition of the bank through the supervisory process, a shorter period should be considered.

### Framework for prompt, orderly liquidation of failed banks
- Current liquidation mechanisms:
  - Extrajudicial involuntary liquidation proceedings (initiated by the CBA).
  - Court-based bankruptcy proceedings (initiated by the CBA).
- Both procedures:
  - May only be initiated by the CBA.
  - Allow for some degree of involvement of the CBA during the proceedings.
  - Are characterized by unique types of delays and lack optimal tools to support financial stability.
- Proposed enhancements to promote financial stability:
  - Allow prompt transfer of viable assets, certain liabilities (including deposits) and essential functions to a healthy institution prior to liquidation of the remainder of the estate.
  - Appoint a provisional administrator early-on, since similar powers are already available to the provisional administrator with respect to open banks; affecting these procedures on a bank under administration could preserve going concern value.
  - Grant the liquidator power to sell the rights of such assets to third parties to speed up the liquidation and bankruptcy process.

### Deposit Insurance Fund (DGF): capacity, funding, and limits
- Institutional development and preparedness:
  - The DGF was established in 2005 and no bank failures requiring payouts have occurred since that time.
  - In 2011 the DGF began conducting payout simulation exercises with the CBA; additional simulations are planned for 2012.
  - The DGF is in the final stages of installing an IT platform for depositor information, which will allow for the submission of internet-based claims.
- Funding design:
  - The DGF is ex ante funded.
  - The Kreditanstalt fur Wiederaufbau (KfW) German Armenian Fund provided seed funding for the establishment of the DGF.
  - Further funding was provided in 2010 by the CBA.
  - Initial contributions: AMD 15 million within ten days of becoming a licensed bank.
  - Quarterly contributions: 0.5 percent of the bank’s average daily balance of deposits in a reporting quarter (but not less than AMD 1 million per year) are mandatory for all banks.
- Coverage capacity:
  - Currently, it is anticipated that the resources of the DGF would be sufficient to cover the simultaneous failures of 2–3 medium-sized banks and 8–10 small banks.
- Recommendations to strengthen the DGF:
  - Consider whether the payout period (currently 3 months) could be shortened to approximately 20 days.
  - Allow the DGF to “fill the balance sheet gap” for good assets and insured deposits and other liabilities transferred to a healthy institution through a purchase and assumption transaction if doing so is less costly to the DGF than a direct payout to insured depositors.
  - Prohibit active bankers from serving on the DGF Board and limit participation of industry representatives to guard against conflicts of interest and misuse of confidential information.
    - Of the DGF’s seven member Board, the CBA, the Government, and the Union of Banks may each appoint two members and the final member is elected by the other members of the Board.
    - In theory, all 7 members could be active bankers; in practice, only one active banker and one industry representative serve on the Board.
    - The DGF should consider prohibiting active bankers and industry representatives from serving on the Board and establishing an advisory committee to the Board where such individuals could freely serve.
  - Clarify mechanisms to replenish the DGF’s resources:
    - The law does not provide a clear mechanism for replenishing resources if resources are low.
    - The DGF requires banks to pay a one-time extra contribution in an amount up to 3 times that paid by the bank in the previous financial year but it is unclear under what circumstances banks would be called upon to make an extra contribution.
    - It would be preferable for shortfalls in resources to be filled by the private sector or the government.

### Inter-institutional arrangements and crisis preparedness
- Coordination arrangements:
  - An interagency MOU has laid out a clear and sound division of labor: the CBA will take the lead in crisis response actions with the MOF coordinating to the extent that budget allocation is required.
  - Coordination primarily occurs through the Boards of the CBA and the DGF.
  - A Deputy Minister of Finance regularly attends open meetings of the CBA Board; representatives from the CBA and MOF serve on Board of the DGF.
  - A tri-party MOU was signed in 2010.
- Institutional practices and recommendations:
  - Coordination appears smooth and also occurs through informal ad hoc channels.
  - In 2011 the CBA established an internal financial stability committee (FSC) which meets regularly.
    - Representatives of the DGF and MOF may participate in FSC meetings by invitation, but there is no clear framework for when such participation would be sought.
  - Authorities should amend relevant legislation to ensure the necessary information to determine whether to provide public solvency support in the event of a systemic crisis can be provided by the CBA and the DGF to the MOF.
  - The CBA publishes a semi-annual financial stability report.
  - The CBA should consider whether it would be beneficial to make public minutes or formal statements from the FSC.

### Insurance sector: overview and supervisory findings (summary)
- Market size and structure:
  - Assets held by insurers: AMD 25.6 billion (accounted for 1.3 percent of total financial sector assets as at end-2010).
  - Gross written premiums by insurers: AMD 7.8 billion in 2010 with an overall retention level of 51 percent.
  - Largest class of business: fire and natural disaster insurance, which accounted for 23 percent of earned premiums.
  - Investment profile: insurers’ investments were mainly in bank deposits with only 9 percent invested in government bonds as at end-2010.
  - Number of registered agents rose from 65 in 2008 to 5,524 as at end-2011 due to the introduction of mandatory motor third party liability insurance in 2010.
- Key risks:
  - Accumulation of exposures arising from natural catastrophes.
  - Credit risks of reinsurers.
- Supervisory framework and findings:
  - The CBA is the integrated supervisor for the financial sector in Armenia under the Law on Central Bank of Armenia (LCBA).
  - The legal framework for insurance is largely based on the Law on Insurance and Insurance Activities (LIIA) and prudential regulations issued by the CBA.
  - The updated regulatory framework has a high level of observance with the ICPs issued by the IAIS in 2003.
  - The authorities have implemented recommendations from the 2005 FSAP review.
  - The CBA’s off-site surveillance and on-site inspections are comprehensive and thorough, with well-documented internal policies and manuals.
- Areas for enhancement:
  - Expedite issuance of regulations governing insurers’ derivative activities and finalize regulatory requirements to combat insurance fraud.
  - Fine-tune the solvency regime to provide for transparent solvency control levels and supervisory intervention ladder, address group solvency requirements and regulatory treatment of assets supporting technical provision that are encumbered.
  - Enhance regulatory requirements relating to risk management to better reflect international best practices, including explicit requirements to monitor risk accumulation from catastrophic events.
  - Provide adequate legal protection to the CBA and its staff and broaden the powers for the CBA to take a fuller range of proportionate enforcement measures.
  - Formulate an appropriate group-wide supervision framework in line with IAIS standards.
  - Tailor prudential and market conduct requirements to support the development of life insurance and protect long-term commitments of life policyholders.
- Specific supervisory observations:
  - The LIIA and LCBA do not provide a robust framework for supervisory cooperation and information exchange including appropriate confidentiality safeguards for insurance supervision.
  - The CBA is empowered to exchange information with other supervisors based on executed memoranda of understanding for supervisory purpose.
  - The CBA has adequate resources for off-site monitoring and conducts both full scale and targeted inspections using the CARAMELS rating system and Assessment Matrix.
  - The CBA is not empowered to impose conservatorship; or take control of an insurer or appoint officials or receivers to protect policyholders’ interests without invoking insolvency proceedings.
  - The LIIA and Law on bankruptcy provide for orderly exits of insurers on voluntary and insolvency grounds; policyholders have priority rights to assets covering technical provisions (TPs), but absence of explicit restrictions on encumbrances of assets covering TPs may weaken policyholders’ priority of claims in insolvency.
  - The CBA has developed a draft law on consolidated supervision to establish a framework for supervising financial groups/conglomerates.
  - The CBA planned to review the minimum requirements for insurers’ risk management framework in 2012.

*Source: IMF staff report content provided in the supplied PDF chapter/section.*

### 94.      The CBA has established a regulatory basis for computing insurers’ TPs and is

### _cr1310 - 94.      The CBA has established a regulatory basis for computing insurers’ TPs and is

### Summary findings (paragraphs 94–102; ICP cross-references)
- 94: The CBA has established a regulatory basis for computing insurers’ TPs and is empowered to require insurers to remedy any shortfall in their TPs. The robustness of the CBA’s analysis of insurers’ TPs could be enhanced through more granular data by requiring insurers to collate and report claims development triangulation data by lines of business.
- 95: The LIIA and regulations issued by the CBA set out high level requirements relating to insurers’ investments covering TPs. The current regime reflects the highly liquid and low risk profiles of insurers’ investments. The CBA should update regulations to reflect international best practice and provide more detailed regulatory guidance to facilitate compliance by insurers and consistency in supervisory assessments.
- 96: Insurers disclose their derivative activities in accordance with the IFRS. The regulatory requirements relating to the use of derivatives by insurers needs to be tightened and the CBA is in the process of drafting the necessary amendments.
- 97: The solvency regime in Armenia takes into consideration underwriting, credit, foreign exchange and operational risks and quality of capital resources. The regime should be strengthened through the establishment of solvency control levels as well as regulatory measures to address multiple gearing of capital by insurance groups and
- 98: The regulatory requirements with respect to the licensing and conduct of business by insurance intermediaries are adequate for general insurance business. The CBA inspects the operations of insurance brokers to check compliance with regulatory requirements. With the sharp increase in the number of agents due to the introduction of MTPL insurance, it is important to update the regulatory requirements for agents to ensure healthy competition and professional conduct.
- 99: The current regulatory regime for consumer protection in Armenia is generally adequate for non-life insurance business. However, the high-level requirements need to be further elaborated to facilitate compliance, especially to support the establishment of a life insurance market to protect the long-term financial commitment of policyholders.
- 100: The public disclosures regime is comprehensive and adequate for the current stage of market development in Armenia.
- 101: There is no explicit legal and regulatory framework for combating insurance fraud. Nonetheless, the CBA and insurance industry cooperates with law enforcement agencies.
- 102: The AML-CFT regime in Armenia has been enhanced, in line with the recommendations of the 2008 joint assessment by the IMF and the MONEYVAL Committee. The current AML-CFT regime is adequate for the insurance industry of Armenia, which only conducts non-life insurance business with a low AML-CFT risk profile.

### Key ICP-specific findings (Table 2 highlights)
- ICP 1: Sound, clearly defined financial sector policy framework; supervisory effectiveness could be enhanced via actuarial standards and development of money and securities markets.
- ICP 3: Operational and financial independence of the CBA provided by LCBA; unclear whether legal protection for CBA and staff meets ICP 3 expectations.
- ICP 5: LIIA and LCBA do not provide a robust framework for supervisory cooperation and information exchange; CBA can only exchange information based on executed MOUs.
- ICP 12: CBA has off-site supervisory manual and CARAMELS rating system; adequate resources for off-site monitoring with minimal reliance on external auditors.
- ICP 15: CBA has broad sanctions powers but cannot impose conservatorship or take control of an insurer without invoking insolvency proceedings.
- ICP 16: LIIA and Law on bankruptcy provide for orderly exits; absence of explicit restrictions on encumbrances of assets covering TPs may weaken policyholders’ priority in insolvency.
- ICP 17: No insurance groups in Armenia; draft law on consolidated supervision developed.
- ICP 19: No explicit requirement for insurers to monitor risk accumulation from catastrophic events.
- ICP 20: CBA has regulatory basis for computation of TPs and powers to require remediation; enhancement possible via more granular claims development triangulation data by lines of business.
- ICP 21: Investment requirements are high-level; current regime assumes highly liquid, low-risk investments; CBA should update regulations to reflect international best practice.
- ICP 22: Derivatives disclosed under IFRS; regulatory requirements need tightening; amendments being drafted.
- ICP 23: Solvency regime considers underwriting, credit, foreign exchange, operational risks and capital quality; should be strengthened with solvency control levels and measures addressing multiple gearing and encumbrances.
- ICP 24–26: Intermediaries and consumer protection regimes adequate for general/non-life business but need elaboration for life insurance and agent regulation following MTPL introduction.
- ICP 27: Public disclosures regime is comprehensive and adequate for current market stage.
- ICP 28: AML-CFT regime enhanced per 2008 joint assessment by IMF and MONEYVAL; adequate for Armenia’s non-life insurance industry with low AML-CFT risk.

### Principal recommendations (Table 3 and text recommendations)
- Enhance TP computation and reporting:
  - Require insurers to collate and report claims development triangulation data by lines of business (paragraph 94; ICP 20).
  - Review TP estimation regime to include an explicit risk margin and submission of more granular claims development data (ICP 20 recommendation).
- Investments and derivatives:
  - Update regulations to reflect international best practice and provide detailed guidance on insurers’ investments covering TPs (paragraph 95; ICP 21 recommendation).
  - Expedite issuance of regulations governing insurers’ derivative activities (paragraph 96; ICP 22 recommendation).
  - Enhance regulatory requirements for asset-liability management, safekeeping of assets, competencies of key investment staff, business continuity plans and stress testing (ICP 21 recommendation).
- Solvency and capital adequacy:
  - Establish solvency control levels and a supervisory intervention ladder to facilitate timely corrective action (paragraph 97; ICP 23 recommendation).
  - Address prohibition of inflation of capital through double/multiple gearing by insurance groups and treatment of pledged assets securing credit facilities (ICP 23 recommendation).
  - Consider solvency requirements for foreign branches operating in Armenia (ICP 23 recommendation).
- Intermediaries, conduct and consumer protection:
  - Update regulatory requirements for insurance agents following the sharp increase in agent numbers due to MTPL insurance to ensure healthy competition and professional conduct (paragraph 98; ICP 24 recommendation).
  - Provide supervisory guidance on fair treatment of consumers and formulate a consumer protection regime to protect long-term financial interests of life policyholders (paragraph 99; ICP 25 recommendation).
  - Review regulatory regime for intermediaries to incorporate elements safeguarding long-term commitments of life policyholders; review agent treatment including underwriting agents and bancassurance parity (ICP 24 recommendations).
- Supervisory framework and enforcement:
  - Consider establishing legal framework to empower CBA to cooperate and share information without requiring international agreements, subject to confidentiality safeguards (ICP 5 recommendation).
  - Broaden range of sanction powers to allow proportionate enforcement, including conservatorship or other measures to protect policyholders without invoking insolvency proceedings (ICP 15 recommendation).
  - Strengthen protection of policyholders and beneficiaries by establishing regulatory and reporting requirements on pledging of assets intended to support TPs and clear rules on asset distribution among classes of policyholders in insolvency (ICP 16 recommendation).
  - Formulate explicit group-wide supervision framework aligned with IAIS October 2011 guidance (ICP 17 recommendation).
  - Update regulatory requirements relating to insurers’ risk management and issue risk management guidelines (ICP 18 recommendation).
  - Require insurers to adopt effective risk management to monitor and manage potential risk accumulation from catastrophic events (ICP 19 recommendation).
- Governance, actuarial and professional standards:
  - Work with industry to address lack of deep and liquid financial markets to facilitate asset-liability management (ICP 1 recommendation).
  - Improve collaboration with actuarial associations to establish actuarial and ethical standards in line with international best practices (ICP 1 recommendation).
  - Provide legal immunity for auditors and actuaries obliged to notify the CBA of pertinent concerns under the LIIA (ICP 1 recommendation).
  - Review corporate governance standards to clarify board accountabilities, establish board committees (e.g., audit and risk), and assess board effectiveness (ICP 9 recommendation).
  - Update Regulations 3/10 to more clearly differentiate supervisory expectations relating to internal controls and risk management (ICP 10 recommendation).
  - Regularly review practice on not requiring audit opinion on insurers’ compliance with prudential requirements and on annual regulatory returns; review use of arithmetic mean in composite risk scoring (ICP 12 recommendation).

### Implementation priorities and sequencing (implied by recommendations)
- Near-term priorities:
  - Require more granular claims development reporting by line of business (ICP 20).
  - Expedite derivatives regulation and update investment rules to international best practice (ICP 21–22).
  - Update agent regulation in response to MTPL-induced agent growth (ICP 24).
  - Strengthen AML-CFT monitoring as relevant to non-life insurance (ICP 28).
- Medium-term priorities:
  - Establish solvency control levels and supervisory intervention ladder (ICP 23).
  - Formulate group-wide supervision framework and enhance risk management guidance (ICP 17–18).
  - Strengthen consumer protection framework for life insurance market development (ICP 25).
- Structural/longer-term priorities:
  - Address legal protections for CBA and staff and legal framework for supervisory cooperation and information sharing (ICP 3 and ICP 5).
  - Develop actuarial standards and deepen money and securities markets to support insurer asset-liability management (ICP 1).

*Source: _cr1310 - 94.      The CBA has established a regulatory basis for computing insurers’ TPs and is*

### 26. Information,

### 26. Information, disclosure and transparency towards markets

### Information, disclosure and transparency
- The CBA is advised to consider enhancing the disclosure regime by incorporating relevant elements from the IAIS public disclosure standards.

### Fraud
- The authorities are advised to expedite the finalization of:
  - the draft regulations requiring insurers and insurance intermediaries to implement effective fraud mitigation measures; and
  - the legal amendments to clarify the treatment of insurance fraud under the Criminal Code.

### Authorities' response to Insurance Core Principles assessment
- The IMF’s Insurance Core Principles assessment conducted in February 2012 was considered of great importance and high priority for Armenia.
- The CBA commits to implementing the assessment team’s recommendations and to developing the Armenian insurance market regulatory and supervisory framework based on international developments and best practices.
- The CBA emphasized the importance of recommendations given the CBA’s steps for the development of life insurance products.
- The CBA thanked the assessment team for their professional, ethical, independent, and impartial assessment.

### Assessment context and methodology (Banking sector ROSC)
- The Basel Core Principles assessment was part of a joint IMF-World Bank ROSC mission conducted from 1 February until 14 February 2012 and reflects CBA banking supervision practices as of end of January 2012.
- The assessment followed the Core Principles (CPs) Methodology, assessed both “essential” and “additional” criteria, and based ratings on the “essential” criteria only.
- Assessors: Michael Deasy (consultant to the IMF) and Katia D'Hulster (World Bank staff).
- Information sources included:
  - a complete self-assessment prepared by the CBA;
  - detailed interviews with CBA staff;
  - review of laws, regulations, and supervisory documentation;
  - meetings with individual banks, an external auditor, a law firm and the association of accountants and auditors.

### Institutional and macro-prudential setting; market structure overview
- Key sector characteristics:
  - The financial sector is dominated by banks, with a small non-banking sector including a nascent insurance sector.
  - Credit to the private sector corresponds to less than 26 percent of GDP.
  - There is a nascent capital market and scarce institutional investors; a funded pension system framework is being completed for future implementation.
  - There are 21 banks; the largest has less than 11 percent of system assets.
  - Approximately half of the banking sector (by assets) consists of subsidiaries of foreign banks (Russian, UK, French).
  - Banks are profitable relative to comparable sectors and concentration is low.
- Capitalization and credit growth:
  - Banks appear relatively well-capitalized at 18.3 percent on aggregate at end-December 2011, declined from 28 percent at end 2008.
  - Overall year on year credit growth of 37 percent as of end-September 2011.
  - Foreign exchange credit growth of 47 percent in the same period.
  - Dollarization: around 60 to 70% of liabilities and loans held in foreign currency.
- Non-performing loans (NPLs):
  - According to IMF/WB methodology, NPLs reached 5.25 percent at end September 2011 compared to 5.36 percent at end 2010.
  - NPLs in the watch category tripled during this period.
  - As of end December 2011, NPLs in 4 banks exceeded 10 percent – including two medium-sized banks and two small banks.
- Loan dollarization trend:
  - 2008: 38.4 percent
  - 2009: 52.8 percent
  - 2010: 55.5 percent
  - first nine months of 2011: 60 percent
  - CBA measures in 2010 and 2011 included assigning a higher risk weight of 50% in capital requirement for FX loans.

### Preconditions for effective banking supervision
- Macroeconomic framework:
  - The CBA operates within an inflation targeting framework.
  - GDP contracted by 14.1 per cent in 2009; economy rebounded but remained in recovery.
  - Armenia has had a three year Extended Fund Facility/Extended credit facility support program from the Fund since 2008 and a financial intermediation loan with the Bank.
- Legal and public infrastructure:
  - Well-developed government, court, and administrative structures.
  - Effective debt recovery regime; laws for liquidation and bankruptcy; body of law on consumer protection.
  - Two credit registries: one managed by the Central Bank and the other by the banks.
  - IFRSs mandatory for all entities regulated by the CBA and major companies; international auditing practices adopted.
- Market discipline and systemic protection:
  - Capital market is nascent with shortage of instruments and lack of trading depth; nascent stock exchange is part of the Nasdaq/OMX Group.
  - CBA exercises lender of last resort authority:
    - to provide unsecured loans to banks for terms up to 5 years; and
    - to guarantee bank liabilities to support development and special projects.
  - Deposit Guarantee Fund (DGF):
    - Established in 2005 and ex ante funded.
    - No bank failures requiring payouts since establishment.
    - In 2011 DGF began conducting payout simulation exercises with the CBA; additional simulations planned for 2012.
    - DGF is final stages of installing an IT platform for depositor information allowing internet-based claims submission.
    - It is anticipated that the resources of the DGF would be sufficient to cover the simultaneous failures of 2-3 medium sized banks and 8-10 small banks.

### Main findings and supervisory recommendations
- CP1 (Objectives, independence, powers, transparency, and cooperation):
  - Broadly met, but weaknesses to address:
    - Reassess position of government representative who is not a director but attends Central Bank board meetings so that he/she becomes subject to confidentiality requirements.
    - Prioritize draft legislation on legal protection for staff.
    - Relax the Law on Banks by allowing exchange of information without an MOU, subject to due diligence requirements.
- Licensing and structure criteria (CP2 to CP5): met.
- Prudential regulation and requirements (CP6 to CP16):
  - Commendation for strict implementation of Pillar 1 of Basel II and introduction of higher risk weights and provisioning percentages for foreign currency exposures.
  - Need further work for sound and comprehensive implementation of Pillar 2 and integration into supervisory methodology.
  - Pillar 2 guidance should cover:
    - credit concentration risk;
    - interest rate risk in the banking book;
    - indirect foreign exchange risk;
    - risks difficult to quantify such as reputational and strategic risk.
  - CBA should use credit registry information to periodically validate adequacy of provisioning requirements.
  - Regulation “Minimum requirements for internal control” should be modernized with greater focus on risk management rather than control; reassess distribution between mandatory regulations and “comply or explain” guidance.
  - Operational risk definition should be part of mandatory regulations.
  - As banks implement internal risk models, CBA should issue guidelines for internal validation of these models.
  - Requirement for an independent risk management division headed by a Chief Risk Officer should be mandatory for larger and more risky banks.
  - Consider stricter collateral requirements (LTV ratios) and lower limits on concentration of large borrowers subject to foreign exchange risk.
  - Regulations should more clearly define and distinguish between indirect foreign exchange risk and FX risk arising from banking activity.
  - Regulation on large exposures deviates from international good practice: exposures to banks and sovereigns are risk weighted; some forms of collateral allowed; participations and other items deducted from capital are not taken into account.
  - Licensing and Supervision department reviewed concept paper on introduction of Basel III liquidity ratios; decided to introduce a 1 year monitoring period of the Basel III liquidity ratios.
  - Recommendation to introduce regulatory requirement for banks to stress test separate foreign currency liquidity strategies and set liquidity ratios by currency.
- Internal control and audit (CP17):
  - Law specifies internal audit function is responsible for compliance; legislation should be amended to ensure compliance function is independent of internal audit.
- Abuse of financial services (CP18):
  - Armenia has yet to introduce legislation to address weaknesses identified in the IMF/MONEYVAL Mutual Assessment exercise of 2009, including prohibition on bearer bank books and bearer certificates of deposit and improvements to ‘know your customer’ procedures.
- Methods of ongoing supervision (CP19 to CP21):
  - No explicit requirement for banks to notify the CBA of any substantive change, including adverse changes, in their circumstances.
- Accounting and disclosure (CP22):
  - Banks required to prepare accounts in accordance with IFRSs and have them audited in accordance with internationally accepted auditing practices and standards.
- Corrective and remedial powers (CP23):
  - The Central Bank of Armenia has a wide range of corrective and remedial powers.
- Consolidation and cross-border supervision (CP24 to CP25):
  - No explicit detailed law on consolidated supervision; current laws allow consolidated supervision over the very limited level of activity at present but would not be sufficient for a financial conglomerate.

### Table 4 — Selected compliance observations (highlights)
- CP1.2: The position of the government representative who is not a director but attends open board meetings should be made subject to confidentiality requirements.
- CP1.5: The law does not provide specific legal protection to the CBA or its staff against lawsuits for actions taken in good faith (amending legislation pending).
- CP1.6: CBA will only exchange information where it has signed an MOU; assessors consider this excessive.
- CP3: Minimum capital requirement for Armenian banks is 5 billion Armenian Drams; can be reduced to 1 billion if an applicant shareholder has a credit A rating and proposes to acquire more than 51 per cent of the bank; assessors recommend a single figure for consistency.
- CP6: Use of initial minimum capital depending on shareholder credit risk is not in compliance with good practice.
- CP7: Recommend more frequent structured dialogue on capital adequacy assessments, more guidance for Pillar 2 implementation, modernization of internal control regulation, mandatory inclusion of risk category definitions in regulations.

*Source: IMF-World Bank ROSC / Central Bank of Armenia assessment material as presented in the provided chapter.*

### 8. Credit risk

### 8. Credit risk

### Credit risk governance and model validation
- As banks implement internal risk management models (credit scoring models, simulation approaches for interest rate risk etc), the CBA should issue guidelines for the internal validation of these models.
- Even if outcomes are not yet used in regulatory capital calculation, poorly validated models will affect banks’ risk management (example: a credit scoring model that does not differentiate between good and bad credits can affect underwriting practices of banks, and hence NPLs in the medium term).
- Make mandatory an independent risk management division headed by a Chief Risk Officer for larger and more risky banks (acknowledging challenges for smaller banks).

### Foreign currency credit exposure — regulatory and supervisory recommendations
- The CBA has introduced higher risk weights and provisioning percentages to address higher risk of foreign currency exposures; however, higher capital and provisioning only address exposures already on the books and should not be the sole regulatory response.
- Recommended complementary measures:
  - Introduce an explicit regulatory requirement for banks to identify, assess and frequently monitor indirect foreign exchange risk as part of credit underwriting and monitoring.
  - Consider stricter collateral requirements (LTV ratios).
  - Consider lower limits on concentration of large borrowers subject to foreign exchange risk.
  - More clearly define and distinguish between:
    - FX risk arising from a mismatch at the level of the borrower (indirect foreign exchange risk), and
    - FX risk arising from the banking activity (FX risk).
  - Apply specific and different mitigation measures for each risk type.

### 9–16: Problem assets, exposures, and risk areas (findings & recommendations)

### Problem assets, provisions, and reserves
- Recommended: the CBA use information in the credit registry to periodically validate the adequacy of provisioning requirements.

### Large exposure limits
- Current regulation on calculation of large exposures deviates from international good practice in several areas:
  - Exposures to banks and sovereigns is risk weighted;
  - Some forms of collateral are allowed to be taken into account;
  - Participations and other items deducted from capital are not taken into account.

### Country and transfer risks
- The CBA does not receive regular offsite reports on a bank’s country risk and transfer risk; exposures are small in Armenia.

### Market risks
- Recommend that the CBA introduce more explicit regulatory requirements to ensure market data used to value positions is independently tested (AC1).
- Introduce specific regulatory requirements on:
  - frequency of revaluation,
  - independent review of processes,
  - verification of consistency, timeliness and reliability of data sources (EC4).
- Reliance solely on IFRS for these matters is not good practice.
- The Regulation “Minimum requirements for internal control” should be enhanced with greater focus on risk management; qualitative market risk management requirements should be more detailed and comprehensive.

### Liquidity risk
- The Licensing and Supervision department reviewed a concept paper on introduction of the Basel III liquidity ratios and decided the CBA will introduce a 1 year monitoring period of the Basel III liquidity ratios.
- Recommend introducing a regulatory requirement for banks to stress test separate foreign currency liquidity strategies and set liquidity ratios by currency.

### Operational risk
- Require banks to inform the CBA of developments affecting operational risk (broader than fraud); reliance on offsite reporting will inform supervisor only after the fact.
- The Regulation “Minimum requirements for internal control” should shift focus toward risk management; some qualitative operational risk management requirements should be mandatory.
- Redistribute provisions between mandatory regulations and “comply or explain” guidance.
- Make the definition of operational risk part of mandatory regulations so banks’ internal legal acts capture all drivers of operational risk.

### Internal control, audit, and compliance
- Legislation currently specifies internal audit function is responsible for compliance function.
- Recommendation: amend legislation to ensure the compliance function is independent of internal audit.
- No explicit requirement for banks to notify the CBA of any substantive change, including adverse changes, in their circumstances—recommend requiring immediate notification.

### 17–25: Supervisory framework and legal gaps (findings & recommendations)

- Abuse of financial services:
  - Armenia has yet to introduce legislation addressing weaknesses identified in IMF/MONEYVAL Mutual Assessment exercise of 2009 (recommend prohibition on bearer bank books, bearer certificates of deposit, other bearer securities; improve ‘know your customer’ procedures).
- Supervisory approach:
  - Require banks to inform the CBA immediately of substantive changes, particularly adverse changes.
  - Adopt a more formal approach to contacts with banks; in addition to ad-hoc contacts, hold a formal meeting, say annually, with senior management to discuss common issues.
- Consolidated supervision:
  - No explicit detailed law on consolidated supervision; current laws suffice only for the very limited consolidated activity in Armenia and would not be sufficient if a financial conglomerate emerges.
- Other supervisory areas listed (supervisory techniques, reporting, accounting and disclosure, corrective powers, home-host relationships) show gaps or scope for enhancement.

### Selected recommended actions (excerpt from Table 5)
- Principle 18. Abuse of financial services: Introduce as a matter of urgency legislation to address weaknesses identified in the IMF/MONEYVAL Mutual Assessment of 2009.
- Principle 19. Supervisory approach: Require banks to inform the CBA immediately of substantive changes, particularly of any adverse change.
- Principle 1.2. Independence, accountancy, transparency: Reassess the position of the government representative who is not a director but attends meetings so that he/she becomes subject to the confidentiality requirements of the Central Bank.
- Principle 17. Internal control and audit: Separate compliance function and the internal audit function, whose function it should be, inter alia, to audit the compliance function.
- Principle 1.5 Legal protection: Prioritize the draft legislation dealing with the issue of legal protection for staff.
- Principle 24. Consolidated supervision: Seek enactment of legislation on consolidated supervision as a matter of urgency.
- Principle 1.6. Cooperation: Relax the Law on Banks by allowing exchange of information without an MOU, subject to specific due diligence requirements (secrecy provisions etc).

### Authorities’ response (summary points)
- The Central Bank of Armenia (CBA) affirms adherence to Core Principles is a high priority and plans improvements to align regulatory and supervisory framework with international standards.
- CBA states the banking system is fully compliant with the majority of Core Principles but accepts FSAP recommendations highlight important issues requiring improvement; some changes and amendments have been initiated.
- CBA believes the 2012 FSAP assessment will play an important role in future development of banking sector regulation and supervision.

### Appendix I — Introduction of liquidity requirements by currency (key findings and data)
- The Armenian banking system is highly liquid; CBA liquidity requirements:
  - highly liquid asset to total asset ratio (HLA/TA) should exceed 15 percent;
  - highly liquid asset to demand liability ratio (HLA/DD) should exceed 60 percent.
- The CBA monitors these ratios monthly and conducts sensitivity analyses.
- Banks tend to have fewer liquid assets in foreign currency because liquidity requirement does not apply by currency.
- System-level foreign exchange HLA ratios at end-September 2011:
  - HLA/TA (foreign exchange) = 20.8 percent;
  - HLA/DD (foreign exchange) = 83.1 percent.
- Distribution of foreign currency liquid assets is uneven: 14 out of 21 banks do not meet at least one ratio in foreign currency, including some large banks.
- Several dollarized economies apply liquidity requirements by major currencies; authorities have limited lender-of-last-resort capacity in foreign currency.
- Funding structure: Armenian banks receive foreign currency via retail deposits and stable funding from IFIs and parent banks; dependence on foreign currency wholesale markets is relatively small.
- In the 2008 shock, deposits shifted between currencies (AMD to USD) rather than leaving banks; a shock causing deposit outflows could create AMD and USD liquidity needs and cause USD liquidity problems in some banks.
- Gradual implementation of a foreign currency liquidity coverage ratio is warranted to avoid disruptive impacts.
- Ways banks can meet foreign currency HLA/TA and HLA/DD:
  - Replacing foreign currency lending and foreign currency demand liabilities with AMD lending and AMD deposits (may de-dollarize);
  - Converting highly liquid AMD assets to highly liquid foreign currency assets (risk violating net open position; limited secondary market liquidity);
  - Converting foreign currency lending to foreign currency HLA (could lead to disintermediation and reduce profits);
  - Converting foreign currency demand deposits to time deposits (could reduce profits due to higher interest on time deposits).
- A simple simulation based on end-September 2011 data indicates one-time introduction of liquidity regulations by currency at current levels could have non-negligible impacts on a few banks; assuming banks adjust by converting demand deposits to time deposits and converting foreign currency lending to foreign currency HLA, the entire system could suffer:
  - a slight decrease in RoE, and
  - a decrease in foreign currency lending.
- Because holdings of foreign currency liquid assets are uneven across banks, impacts would be uneven; gradual introduction and sufficient lead-time between announcement and implementation recommended to avoid disruptive adjustments.

*Source: _cr1310 - 8. Credit risk*

### 3.   Ensure implementation of the compulsory third-

### 3.   Ensure implementation of the compulsory third-party-liability motor insurance

### Insurance law, supervision, and industry development
- The insurance law was implemented and has been reviewed as in keeping with standards for the current industry but would require further amendment to support a life insurance industry.
- The supervisory unit is in place with sufficient technical capacity.
- Mandatory motor vehicle insurance has been adopted.

### Selected economic and financial indicators (Armenia, 2008–2015)
- Real GDP (percent change): 6.9 -14.1 2.1 4.6 4.6 3.8 4.0 4.0 4.0
- Gross domestic product (in billions of drams): 3,568 3,142 3,502 3,871 3,819 4,172 4,533 4,903 5,303
- Gross domestic product (in millions of U.S. dollars): 11,662 8,648 9,371 10,126 10,251 10,553 11,055 11,673 12,351
- Gross domestic product per capita (in U.S. dollars): 3,606 2,647 2,840 3,039 3,076 3,135 3,252 3,400 3,562
- CPI (period average; percent change): 9.0 3.5 7.3 7.8 7.7 3.9 4.2 4.0 4.0
- CPI (end of period; percent change): 5.3 6.7 8.5 4.7 4.7 4.2 4.0 4.0 4.0
- GDP deflator (percent change): 5.9 2.6 9.2 5.7 4.3 5.3 4.5 4.0 4.0
- Poverty rate (in percent) 1/: 27.6 34.1 ..........
- Investment (in percent of GDP): 43.8 33.8 31.3 33.0 30.8 30.7 31.3 31.6 32.3
- National savings (in percent of GDP): 32.0 18.0 16.7 20.8 19.8 20.7 22.6 24.0 25.8
- Reserve money (percent change): 5.3 13.8 -0.8 17.4 32.3 6.2 .........
- Broad money (percent change): 2.4 16.4 10.6 19.0 23.6 15.5 .........
- Velocity of broad money (end of period): 5.0 3.8 3.8 3.6 3.4 3.2 .........
- Commercial banks' 3-month lending rate (in percent): 17.9 19.1 17.7 ..........
- Central government: Revenue and grants (percent of GDP): 20.5 20.9 21.0 21.7 21.9 21.3 21.9 22.1 22.5
  - Of which: tax revenue (percent of GDP): 16.8 16.1 16.2 16.3 16.5 17.1 17.5 17.9 18.3
- Expenditure (percent of GDP): 2/ 22.2 28.6 25.9 25.3 24.7 24.5 24.4 24.4 24.5
- Overall balance on a cash basis (percent of GDP): -1.2 -7.9 -4.5 -3.6 -2.8 -3.1 -2.5 -2.2 -2.0
- Government and government-guaranteed debt (percent of GDP): 16.1 40.2 39.2 42.0 40.6 42.3 42.1 41.5 41.9
- Share of foreign currency debt (percent): 84.0 88.9 87.4 87.5 87.1 87.1 83.2 79.5 76.7
- Exports of goods and services (in millions of U.S. dollars): 1,757 1,336 1,937 2,295 2,405 2,526 2,711 2,899 3,089
- Imports of goods and services (in millions of U.S. dollars): -4,748 -3,683 -4,212 -4,639 -4,790 -4,920 -5,111 -5,290 -5,491
- Current account balance (percent of GDP): -11.8 -15.8 -14.7 -12.2 -10.9 -10.0 -8.7 -7.6 -6.6
- FDI (net, in millions of U.S. dollars): 940 725 562 652 447 498 538 578 624
- External debt (percent of GDP): 29.5 57.8 64.6 65.5 65.9 67.6 65.3 62.6 61.0
  - o.w. public debt (percent of GDP) 3/: 13.6 35.7 34.2 36.7 35.4 36.9 35.0 33.0 32.2
- Debt service ratio (percent of exports of goods and services) 3/: 3.1 5.4 4.7 4.7 4.5 10.2 15.6 10.1 6.4
- Gross international reserves (in millions of U.S. dollars) 4/: 1,407 2,004 1,866 1,806 1,869 1,712 1,613 1,496 1,620
- Import cover (months): 4.6 5.7 4.7 4.5 4.6 4.0 3.7 3.3 3.4
- Nominal effective exchange rate (percent change) 6/: 6.3 -8.4 -2.7 ... 0.3 ............
- Real effective exchange rate (percent change) 6/: 8.6 -7.5 1.5 ... 6.9 ............
- End-of-period exchange rate (dram per U.S. dollar): 307 378 363 ... 385.8 ............
- Average exchange rate (dram per U.S. dollar): 306 363 374 ... 372.5 ............
- Memorandum: Population (in millions): 3.2 3.3 3.3 ... 3.3 ............

Notes:
- Sources: Armenian authorities; and Fund staff estimates and projections.
- 1/ From 2008, the poverty rate is computed using a different methodology based on the new household survey.
- 2/ Including the gas subsidy in 2006–08.
- 3/ Based on government and government-guaranteed debt.
- 4/ Excluding the special privatization account (SPA), but including the Russian project loan.
- 5/ Gross international reserves in months of next year's imports of goods and services, including the SDR holdings.
- 6/ A positive sign denotes appreciation.

### Financial Soundness Indicators for the Banking Sector (2008–11)
- Capital adequacy:
  - Total regulatory capital to risk-weighted assets: 27.5 26.1 28.0 28.3 28.3 28.6 28.9 26.9 22.2 21.3 20.0 19.6
  - Capital (net worth) to assets: 23.0 21.2 22.3 21.0 21.0 20.6 22.1 21.6 20.4 20.2 19.3 18.5
- Sectoral distribution of loans (in billions of drams), selected sectors over time:
  - Industry (excluding energy sector): 66.2 78.0 76.0 89.6 115.3 121.2 127.7 136.7 156.7 164.9 165.6 172.3
  - Trade/commerce: 132.0 140.4 131.0 143.6 145.5 161.0 164.7 174.1 184.8 200.1 222.1 248.0
  - Energy sector: 19.7 17.3 18.6 26.7 31.7 32.0 24.3 37.0 47.2 56.3 65.4 72.7
- Sectoral distribution of loans to total loans (percent of total), selected:
  - Industry (excluding energy sector): 10.7 12.2 12.5 13.7 16.5 16.2 16.9 17.0 17.7 17.1 15.9 14.8
  - Trade/commerce: 21.4 22.0 21.6 22.0 20.8 21.6 21.8 21.6 20.9 20.8 21.3 21.3
- Foreign exchange loans to total loans: 38.7 48.7 51.5 54.3 54.0 54.3 55.4 56.4 58.0 59.6 59.6 60.2
- Asset quality:
  - Nonperforming loans (in billions of drams): 27.9 50.2 64.6 64.5 36.3 43.9 38.5 37.9 28.6 35.7 37.4 56.0
  - Nonperforming loans to gross loans (percent): 4.4 7.6 10.2 9.3 4.8 5.6 4.8 4.5 3.1 3.5 3.4 4.8
  - Provisions to nonperforming loans (percent): 38.2 26.9 26.6 33.1 46.7 36.2 41.4 41.9 56.7 51.0 50.9 41.3
- Earnings and profitability:
  - ROA (profits to period average assets): 3.1 -0.1 -0.1 0.0 0.7 1.3 1.8 2.0 2.2 2.0 2.3 1.9
  - ROE (profits to period average equity): 13.6 -0.7 -0.3 0.1 3.4 6.1 8.5 9.5 10.2 10.0 11.7 9.8
- Liquidity:
  - Liquid assets to total assets (percent): 23.8 29.1 32.0 35.2 34.2 33.9 30.1 30.1 29.5 28.9 26.8 28.3
  - Liquid assets to total short-term liabilities (percent): 103.1 135.4 145.3 146.2 142.1 140.4 128.8 129.3 131.5 137.2 132.0 125.0
  - Customer deposits to total (non-interbank) loans (percent): 81.4 92.1 96.3 100.7 96.4 96.5 86.8 86.5 87.2 87.1 85.3 89.3
  - Foreign exchange liabilities to total liabilities (percent): 55.1 69.4 70.9 68.9 67.6 70.3 67.4 66.2 64.9 65.3 65.5 66.0
- Sensitivity to market risk:
  - Gross open positions in foreign exchange to capital (percent): 11.5 13.8 8.4 7.1 3.4 3.1 3.8 3.6 2.9 3.0 3.2 3.4

(Source: Central Bank of Armenia.)

### Risk Assessment Matrix — main risks, likelihood, and expected impact
- Exchange rate depreciation as a result of current account shock
  - Likelihood of realization: Medium-low
  - Expected impact on financial stability if realized: Medium-high
  - Key points:
    - The system is heavily dollarized, both in terms of assets and liabilities leaving it vulnerable to exchange rate movement.
    - In 2009 a current account shock (contraction of remittances, chiefly from Russia) resulted in a 21 percent devaluation in a single day.
    - Such a shock could occur if the Russian economy or oil prices experienced another such contraction (for example, as a second round effect of a eurozone event).
    - On liabilities, a sharp depreciation accompanied by liquidity shortages could create serious problems for banks with limited official ability to intervene.
    - On assets, depreciation could feed through to credit risk where earners in AMD must repay in dollars creating losses.
    - Banks have capital and liquidity buffers and measures to reduce f/x risk, including higher reserve requirements and net open position limits.
- Asset quality deterioration as a result of global downturn
  - Likelihood of realization: Medium-low
  - Expected impact on financial stability if realized: Medium-low (could be higher for smaller institutions or in combination with confidence shocks)
  - Key points:
    - Recent rapid credit growth could undermine asset quality.
    - A global downturn that depresses economic activity, reduces remittances and FDI would impact asset quality.
    - Provisioning levels are currently reasonable and overall capital levels remain sound.
- Failure of a foreign shareholder/parent
  - Likelihood of realization: Medium
  - Expected impact: Medium
  - Key points:
    - Some subsidiaries rely on parent funding; failure of a foreign parent could be disruptive and create confidence effects.
    - Limited interconnectedness of Armenian banks would limit direct contagion.
- Concentration of liabilities and assets
  - Likelihood of realization: Medium-low
  - Expected impact: Medium-high
  - Key points:
    - Stress testing shows some institutions have concentrations in deposits and loans and are susceptible to outflow or default of a few connected depositors/borrowers.
    - Failure of a few large borrowers or depositors could cause failure of a small or midsized bank and reduce confidence with possible contagion.

### Structure of the financial sector (selected snapshots)
- Banks: Number = 21
  - Dec-09: Total assets (in ARM Ml n) = 1,346,105; % of total assets = 100.0; % of GDP = 42.8
  - Dec-10: Total assets = 1,553,097; % of total assets = 100.0; % of GDP = 44.4
  - Sep-11: Total assets = 1,889,324; % of total assets = 100.0; % of GDP = 48.7
- Of which: Five largest banks*:
  - Dec-09: 5 banks; total assets = 647,424; % of total assets = 48.1; % of GDP = 20.6
  - Dec-10: 5 banks; total assets = 710,402; % of total assets = 46.7; % of GDP = 20.3
  - Sep-11: 5 banks; total assets = 882,305; % of total assets = 46.7; % of GDP = 22.7
- Domestically-controlled banks (Number = 10):
  - Dec-09: total assets = 643,438; % of total assets = 47.8; % of GDP = 20.5
  - Dec-10: total assets = 723,498; % of total assets = 45.8; % of GDP = 20.7
  - Sep-11: total assets = 865,536; % of total assets = 45.8; % of GDP = 22.3
- Foreign-controlled banks (Number = 9):
  - Dec-09: total assets = 617,343; % of total assets = 47.5; % of GDP = 19.7
  - Dec-10: total assets = 755,750; % of total assets = 46.9; % of GDP = 21.6
  - Sep-11: total assets = 928,234; % of total assets = 46.9; % of GDP = 23.9
- State-owned banks (Number = 1):
  - Dec-09: total assets = 21,571; % of total assets = 1.6; % of GDP = 0.7
  - Dec-10: total assets = 22,462; % of total assets = 1.7; % of GDP = 0.6
  - Sep-11: total assets = 32,908; % of total assets = 1.7; % of GDP = 0.8
- Memo: GDP (ARM Millions): 3,141,651 (Dec-09); 3,501,638 (Dec-10); 3,882,690 (Sep-11)

### Stress testing framework and results (banking sector)
- Stress test coverage and horizon:
  - Institutions included: 21 (100 percent of total sector assets and lending).
  - Stress test horizon: 2011-2016.
  - Data and baseline date: Supervisory/consolidated data as of end-September, 2011.
- Solvency stress test assumptions:
  - Shocks (FSAP team): Combined shocks to real GDP growth and nominal exchange rate vis-à-vis the US$.
  - Scenario specifics: 1 (2) standard deviation(s) shock to real GDP in mild (severe) scenario; 15 (30) percent depreciation.
  - Authorities' baseline shocks: exchange rate shocked by 18 percent; interest rates shocked by 2 percentage points; large exposure shocked by assuming default of three largest borrowers for each bank.
  - Regulatory standards: CAR minimum 12 percent (local requirement); definition of capital follows Basel II; RWA follows local standards (moving to Basel II); banks retain profits and do not pay dividends.
- Liquidity stress test assumptions:
  - Risks considered: (a) Parent banks withdraw funding; (b) Rapid withdrawals of resident and nonresident deposits; (c) withdrawal of largest deposits.
  - Methodology: Ad hoc bank-by-bank balance sheet analysis of parent funding and deposit withdrawal shocks.
  - Regulatory liquidity ratios and minima:
    - Highly Liquid Assets (HLA) over Total Assets (TA) with a 15 percent minimum.
    - HLA over Demand Liabilities (DL) with a 60 percent minimum.
- Summary of stress test results (scenarios illustrated):
  - Baseline scenario figures shown for Probability of Default and Loss Given Default over 2011 Q3–2016 (charts included in original).
  - Moderate and Severe scenarios presented with corresponding trajectories for Probability of Default, Loss Given Default, Change in Risk Weighted Assets, Losses (credit), Profit (before losses), Contribution to Capital Adequacy Ratio, and Capital Adequacy Ratio (Minimum, Maximum, and Median) over 2011 Q3–2016 (charts included in original).

*Source: IMF staff and Armenian authorities (as presented in the original PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1310.pdf_