## Republic of Poland — FSAP Executive Summary (content unit _cr13221)

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### Introduction and financial system snapshot
- Poland avoided recession through 2012 owing to contained inflation, moderate credit growth, a well capitalized banking sector, and moderate public and external debt.
- Policy backstops: floating exchange rate regime, ample international reserves, and the precautionary Flexible Credit Line arrangement with the IMF.
- Recent slowdown and key indicators:
  - GDP growth slowed to 1.1 percent in 2012Q4 (year-on-year).
  - Unemployment rose to 10 percent at end-2012.
  - Credit growth (adjusted for exchange rate ranges) decelerated to 3.4 percent in 2012 from 8.6 percent in 2011.
  - Monetary Policy Council cut policy interest rates by a cumulative 200 percentage point since November 2012 to 2.75 percent.
- Financial system size and structure:
  - Total financial system assets: 86 percent of GDP in 2005 → 124 percent of GDP in 2012.
  - Banks account for about 70 percent of financial assets.
  - Foreign-owned banks control about 63–65 percent of banking sector assets (65 percent noted in sectoral breakdown).
  - State controls four banks accounting for about 22–23 percent of banking sector assets.
  - Top five banks account for about 44 percent of system assets.
  - Nonbanks account for about 30 percent of financial system assets; pension and mutual funds important.

### Financial vulnerabilities and systemic assessment
- Overall assessment: the financial system appears resilient but faces vulnerabilities and some weaknesses.
- Main risk drivers:
  - Slow growth abroad and domestically; uncertainty in the euro area.
  - Rising unemployment.
  - Declining residential real estate prices.
- Key vulnerabilities:
  - Interconnectedness with the euro area.
  - Large stock of FX-denominated loans and exposure to foreign investors and parent bank funding.
  - Impaired assets and pockets of weak institutions (e.g., some SKOKs, small consumer finance firms outside perimeter).
- Banking system performance and indicators (selected Financial Soundness Indicators):
  - Aggregate capital adequacy: 14.7 percent by end-2012 (90 percent Core Tier-1).
  - Regulatory capital to risk-weighted assets: 15 .4 (2013 March), 14 .7 (2012), 13 .1 (2011), 13 .9 (2010), 13 .3 (2009), 11 .1 (2008), 12 .0 (2007).
  - Regulatory Tier1 capital to risk-weighted assets: 13 .8 (2013 March), 13 .1 (2012), 11 .7 (2011), 12 .5 (2010), 12 .0 (2009), 10 .0 (2008), 11 .8 (2007).
  - NPLs to gross loans (nonfinancial sector): 8 .9 (2013 March), 8 .9 (2012), 8 .2 (2011), 8 .8 (2010), 7 .9 (2009), 4 .4 (2008), 5 .2 (2007).
  - Return on average assets (after tax): 1 .1 (2013 March), 1 .2 (2012), 1 .3 (2011), 1 .0 (2010), 0 .8 (2009), 1 .5 (2008), 1 .7 (2007).
  - Liquid assets to total assets: 21 .6 (2013 March), 21 .1 (2012), 19 .5 (2011), 20 .8 (2010), 20 .3 (2009), 17 .0 (2008), 17 .1 (2007).

### Foreign exchange (FX) mortgages, funding, and capital flows
- FX mortgages and exposure:
  - FX mortgages comprise about 22 percent of the total loan portfolio and more than half of mortgages.
  - Impaired FX mortgages increased slightly to 1.8 percent as of year-end 2012.
  - For comparison: PLN loan delinquency was 4 percent and the weighted average for total FX and PLN NPLs 2.8 percent of the overall loan portfolio.
  - One-third of the housing portfolio has high LTVs; 25 percent of the FX housing portfolio has LTV’s over 130 percent.
  - Average LTV for newly originated loans is about 70 percent; some banks continue to offer mortgages at 100 percent LTV.
  - Reserve coverage for impaired housing loans: 48 percent.
  - Supervisory measures: prudential tightening in 2006 and 2011, maximum DTI ratio for new FX loans lowered to 42 percent, risk weights on FX loans increased to 100 percent, new FX lending effectively halted, and new rules prohibit FX loans to clients without adequate FX income.
- Bank funding and hedging:
  - Loan-to-deposit ratio rose to about 120 percent pre-crisis and stabilized since 2008; parent funding is declining in an orderly fashion.
  - On-balance sheet open foreign currency position: about 5 percent of total commercial bank assets.
  - Net stable funding ratios under pressure due to lack of long-term funding; obstacles include shallow domestic investor base, regulatory constraints on pension funds, and near-absence of securitization and covered bond markets.
  - Banks increasingly use long-term CIRS instead of FX swaps to hedge FX risks.
  - Faster deposit growth could mitigate funding pressure.
- Capital flows and market implications:
  - Nonresidents’ share of sovereign bond holdings: 36 percent.
  - Banking sector systemic liquidity surplus absorbed by central bank bills (about 100bn zloty at end-2012).
  - Growing foreign investor demand pushed the 5-year government bond yield below the NBP’s policy rate.
  - Risks from sharp unwinding of foreign investor positions: zloty depreciation → liquidity strains in banks with FX loans; bond price declines → valuation losses; reduced FX swap counterparties → reduced FX liquidity and higher hedging costs.
  - Mitigants: relatively stable and diversified bond investor base, high domestic liquidity, sound hedging practices.

### Asset quality, nonperforming loans, and impediments to resolution
- Asset quality trends:
  - Impaired loan ratio stabilized above 8 percent after 2010; impaired loans increased by 35 percent in 2012 (largest increase across asset classes) driven by construction sector bankruptcies.
  - Overall provisioning coverage for impaired loans: 54 percent; sectoral coverage ranges between 36 and 77 percent.
  - Provisioning may be low for SMEs and housing given long recovery times and falling house prices.
- Barriers to rapid NPL resolution:
  - Tax disincentives limiting deductible provisions.
  - Income accrual practices that may delay write-downs.
  - Obstacles to out-of-court restructurings and limited creditor rights.
  - Legal and social costs of mortgage foreclosure and eviction reducing recovery values.
  - Many loans past due 90 days+ have been past due at least one year; consumer loans comprise almost half of that stock; housing and corporate each roughly 20 percent.
- Recommended actions to improve asset cleanup:
  - Intensify oversight of credit risk management and restructuring; place greater board responsibility for DTI thresholds and risk oversight.
  - Standardize and enhance transparency of accounting practices; review income accrual on impaired loans; KNF to conduct thematic reviews of impaired loan portfolios.
  - Tighten monitoring of restructured loans with more granular and frequent reporting; require Pillar 3 disclosure of restructuring activities.
  - Improve insolvency framework: enhance creditor voice, supervisory oversight of insolvency cases, adopt out-of-court code of conduct, and facilitate transfer of security rights to develop impaired mortgage loan markets.
  - Regulatory proposals: remove uniform DTI thresholds only with tighter oversight; set regulatory LTV ratios below 100 percent; harmonize DTI calculation.

### Stress testing and resilience findings
- Top-down and bottom-up stress-test results:
  - NBP top-down solvency tests covered 20 largest banks (~85 percent of assets); FSAP top-down used six representative banks; KNF bottom-up covered 32 banks (~90 percent of assets).
  - In the most severe scenario, total capital needs: about PLN 10.5 billion (equivalent to less than one percent of banking system assets).
  - Top-down tests without mitigating measures indicate 30 percent of banks may fail to meet minimum capital adequacy ratios under severe macro scenarios; bottom-up KNF tests show no more than two banks (about 1 percent of assets) fall below regulatory minimum in adverse scenarios.
  - Under severe counterparty risk shock, banks representing 14 percent of assets could breach minimum capital requirements.
  - If one out of five performing loans became impaired (credit shock), banks representing 30 percent of assets would not meet minimum CAR.
- Liquidity stress testing:
  - Banking system can withstand liquidity shocks; under simultaneous shocks, four banks (~10 percent of assets) saw coverage of fund outflows by liquid assets fall below 100 percent.
  - Forced liquidation of government bills and bonds could create secondary market turmoil.
- Contagion and interconnectedness:
  - Limited interbank lending reduces contagion risk; affected banks in stress scenarios represent small shares of total assets (most tests affect banks representing less than five percent of assets; none represent more than 10 percent).
- Vulnerable segments:
  - Credit unions (SKOKs) are weak but small; small unregulated consumer finance firms operate outside perimeter.

### Supervisory framework, KNF capacity, and macroprudential arrangements
- Supervisory observance:
  - Poland broadly compliant with Basel Core Principles (BCP), Insurance Core Principles (IAIS), and IADI Core Principles.
- KNF powers and capacity issues:
  - KNF relies heavily on non-legally binding "Recommendations" and “Letters”; constitutional/legal constraints limit powers, independence, and resources.
  - Recommendations: Amend Banking Act to broaden KNF authority to issue binding resolutions; strengthen KNF independence and ability to delegate administrative tasks; obtain powers to apply fit-and-proper criteria and remove supervisory board members; verify external auditors.
  - Inspections planned for 2013: 4 full-scope and 25 targeted inspections covering 86 percent of commercial bank assets.
  - SREP overhaul planned for 2014 to align with EBA templates; KNF should disclose supervisory philosophy and methodologies.
- Macroprudential framework and SRB design:
  - Legislation drafted to establish a Systemic Risk Board (SRB).
  - Recommended SRB features:
    - NBP to take a leading role to shield SRB from political pressures.
    - SRB independence, public recommendations with an “act or explain” mechanism, publication of meeting minutes, and clear accountability.
    - Distinguish macroprudential objectives from monetary and microprudential objectives.
    - Use DTIs and LTVs carefully; prioritize higher risk weights/additional provisioning for FX mortgages as effective tools.
    - Identify instruments for D-SIFIs (surcharges, resolution plans).
  - Enact SRB legislation without delay and develop analytical framework for systemic institution identification and risk indicators.

### Bank resolution framework, BFG (deposit insurer), and crisis management
- Crisis preparedness and safety nets:
  - Poland has a strong ex ante funded safety net, FSC, NBP confidence package for liquidity, increased reserves, contingency plans, and joint crisis simulations.
  - Laws passed in 2009-2010 specify conditions for Treasury support and recapitalization.
- Bank resolution framework:
  - Draft BFG Act expands resolution tools (start resolution pre-insolvency, partial balance-sheet transfers, administrative powers, debt write-down tools).
  - Recommended refinements:
    - Eliminate “open bank” assistance by BFG.
    - If BFG loan instrument used, limit to resolution with least cost test; otherwise solvency support is a MoF responsibility and NBP provides emergency liquidity.
    - Add specific resolution triggers (e.g., a Tier-1 capital trigger) and link “public interest” trigger to financial stability.
    - Grant authorities discretion to recast bank financial statements for prudential adjustments.
    - Explicit creditor claims hierarchy and depositor preference to protect BFG claims.
- Deposit Guarantee Fund (BFG) assessment and capacities:
  - BFG Compliant or Largely Compliant with 16 out of 17 applicable Core Principles; Materially Non-Compliant with one.
  - Coverage: PLN equivalent of EUR 100,000; as of 30 September 2012 membership included 619 domestic banks and cooperative banks.
  - Funding: multiple funds (five) with ex-ante and ex-post elements; emergency back-up funding from NBP and MoF.
  - Ex-ante coverage ratio: 1.87 percent (post-2010 EUR 100,000 increase); target fund ratio: 2.72 percent of covered deposits.
  - Payout capability: reimburse depositors within a maximum of 20 working days; tests indicate often within 7 days; SCV system in use.
  - Governance concerns: Fund Council includes two PBA representatives creating conflict-of-interest risk; recommendation to remove PBA from Council and replace input via an external advisory committee.
  - Recommended actions: reassess fund adequacy given planned expansion (credit unions, expanded resolution powers), rationalize fund multiplicity, extend codes-of-conduct restrictions on employment in member institutions to all BFG employees, and update information-sharing protocols.
- BFG operational recommendations (selected):
  - Remove the PBA from the BFG Council.
  - Ensure adequate funding and capacity; revise and introduce new regulations; enhance protocols in light of expanded mandate.
  - Amend codes of conduct to restrict employment in member institutions to all employees.

### Development of capital markets, pensions, and market structure
- Structural trends and priorities:
  - Competition likely to increase in commercial and cooperative banking, leading to consolidation and exit of weaker institutions.
  - Scarcer foreign funding implies a need to shift financing towards domestic sources and capital markets.
  - Nonbank finance remains embryonic despite growth; mutual and pension funds are more important but domestic capital markets need further development.
- Policy measures to rebalance toward capital markets:
  - Pension system: allow lifecycle strategies in pension funds; measure performance relative to benchmark portfolios; consider requiring minimum duration of fixed-income portfolios to support long-term government securities demand.
  - Capital markets: amend MCB framework to allow broader issuance; adopt legal framework for mortgage securitization; allow universal banks to issue mortgage covered bonds subject to same terms as mortgage banks; eliminate legal and tax obstacles to mortgage rights transfer; establish a modern securitization framework.
  - Strengthen enforcement of security interests and judicial decisions.
  - Address high fees as barrier to voluntary pension saving.

### Key recommendations and time-frames (short-term = within one year; medium term = 1–3 years)
- Addressing impaired loans (Short-term)
  - (i) intensify oversight of credit risk management and restructuring practices;
  - (ii) standardize and enhance transparency of bank accounting practices;
  - (iii) standardize debt-to-income ratio calculation (paras. 17-20).
- Strengthening banking supervision (Short-term/Medium-term)
  - (i) expand scope for KNF to issue legally binding prudential regulations;
  - (ii) allow KNF’s Board to delegate administrative and procedural decisions to its management, increase KNF independence, and address governance issues;
  - (iii) increase KNF flexibility to allocate budgetary and staff resources and enhance analytical capabilities (paras. 27-34).
- Strengthening credit unions (Short-term/Medium-term)
  - (i) eliminate the dual supervision; require a solvency ratio of 8 percent in 5 years; clarify stabilization fund governance;
  - (ii) develop inclusive SKOK regulations and apply financial institution accounting principles to SKOKs;
  - (iii) develop capital rehabilitation plans for weak SKOKs (paras. 36-37).
- Developing macroprudential policies (Short-term)
  - (i) ensure macroprudential supervisory law provides for SRB independence (leading role for NBP), accountability to Parliament, and an “act or explain” mechanism;
  - (ii) develop clear macroprudential objectives distinct from monetary and microprudential policy (paras. 38-41).
- Improving bank resolution framework (Short-term)
  - (i) ensure precedence of administrative powers over corporate insolvency procedures;
  - (ii) ensure creditor claims hierarchy protects BFG’s claims on resources provided for balance sheet “gap filling”;
  - (iii) include a Tier-1 capital trigger and link the “public interest” trigger to financial stability (paras. 48-49).
- Improving deposit insurance (Short-term/Medium-term)
  - (i) remove the PBA from the BFG Council;
  - (ii) ensure adequate funding and capacity, revise/introduce regulations, and enhance protocols for expanded mandate;
  - (iii) amend code of conduct to restrict employment in member institutions to all employees (paras. 50-51).
- Strengthening pensions and capital markets (Short-term)
  - (i) allow lifecycle strategies in pension funds and measure performance relative to benchmark portfolio;
  - (ii) amend MCB framework to allow broader issuance and adopt legal framework for mortgage securitization;
  - (iii) strengthen enforcement of security interests and judicial decisions (para. 53-54).

### Risk Assessment Matrix — selected risks, likelihoods, and policy directions
- Protracted period of slower European growth
  - Relative Likelihood: High
  - Expected Impact if Realized: Medium
  - Policy: further ease monetary policy given limited fiscal space.
- Financial stress in the euro area re-emerges
  - Relative Likelihood: Medium
  - Expected Impact if Realized: Medium
  - Policy: allow exchange rate to float freely; intervene to avoid abrupt movements; NBP to provide liquidity support if needed.
- Excessive pace of parent bank deleveraging
  - Relative Likelihood: Medium
  - Expected Impact if Realized: Medium
  - Policy: NBP liquidity support; monitor deleveraging.
- Emerging markets capital flow reversal
  - Relative Likelihood: Medium
  - Expected Impact if Realized: Medium
  - Policy: allow exchange rate to float; use intervention to avoid abrupt movements; NBP liquidity support.
- Stronger than expected domestic slowdown, higher unemployment, and declining real estate prices
  - Relative Likelihood: Low
  - Expected Impact if Realized: High
  - Policy: further monetary easing, especially as fiscal space is limited.

*Source: IMF staff assessment contained in the provided content unit _cr13221.*

### EXECUTIVE SUMMARY __________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### INTRODUCTION
- Poland’s economy performed well in a challenging environment thanks to strong fundamentals and sound macroeconomic management; the economy avoided recession through 2012.
- At the outset of the global crisis: inflation was contained, credit growth moderate, the banking sector well capitalized, and public and external debt at moderate levels.
- Policy backstops: floating exchange rate regime, ample international reserves, and the precautionary Flexible Credit Line arrangement with the IMF supported confidence.
- Recent slowdown and drivers:
  - GDP growth slowed to 1.1 percent in 2012Q4 (year-on-year).
  - Unemployment rose to 10 percent at end-2012.
  - Credit growth (adjusted for exchange rate ranges) decelerated to 3.4 percent in 2012 from 8.6 percent in 2011.
  - Monetary Policy Council cut policy interest rates by a cumulative 200 percentage point since November 2012 to 2.75 percent.
- Financial system size and structure:
  - Total financial system assets grew from 86 percent of GDP in 2005 to 124 percent of GDP in 2012.
  - Banks account for about 70 percent of financial assets.
  - Foreign-owned banks control about 63 percent of banking sector assets.
  - State controls four banks accounting for about 23 percent of banking sector assets; Poland’s largest commercial bank has a market share of 16 percent.
  - Top five banks account for about 44 percent of system assets.
  - Nonbanks account for about 30 percent of financial system assets, with pension and mutual funds important.

### FINANCIAL VULNERABILITIES
- Overall assessment: Poland’s financial system appears to be resilient; skillful policy management and sound fundamentals helped weather the global crisis and Euro Area turmoil.
- Identified risk drivers:
  - Slow growth abroad and domestically.
  - Rising unemployment.
  - Declining residential real estate prices.
- Key vulnerabilities:
  - Interconnectedness with the euro area.
  - Exposure to foreign exchange (FX) risk and foreign investors, with potential pressure on bank funding if long-term domestic funding sources are absent.
- Banking system performance:
  - System has been profitable and induced to hold high levels of Core Tier-1 capital.
  - Aggregate capital adequacy reached 14.7 percent by end-2012, 90 percent of which is Core Tier 1 capital.
  - Table 1 highlights Financial Soundness Indicators (selected items):
    - Regulatory capital to risk-weighted assets: 15 .4 (2013 March), 14 .7 (2012), 13 .1 (2011), 13 .9 (2010), 13 .3 (2009), 11 .1 (2008), 12 .0 (2007).
    - Regulatory Tier1 capital to risk-weighted assets: 13 .8 (2013 March), 13 .1 (2012), 11 .7 (2011), 12 .5 (2010), 12 .0 (2009), 10 .0 (2008), 11 .8 (2007).
    - NPLs to gross loans (nonfinancial sector): 8 .9 (2013 March), 8 .9 (2012), 8 .2 (2011), 8 .8 (2010), 7 .9 (2009), 4 .4 (2008), 5 .2 (2007).
    - Return on average assets (after tax): 1 .1 (2013 March), 1 .2 (2012), 1 .3 (2011), 1 .0 (2010), 0 .8 (2009), 1 .5 (2008), 1 .7 (2007).
    - Liquid assets to total assets (liquid assets ratio): 21 .6 (2013 March), 21 .1 (2012), 19 .5 (2011), 20 .8 (2010), 20 .3 (2009), 17 .0 (2008), 17 .1 (2007).
    - Net open position in FX to capital: - 0 .1 (2013 March), 0 .1 (2012), - 0 .3 (2011), 0 .3 (2010), 2 .7 (2009), 0 .0 (2008), 0 .6 (2007).

### FOREIGN EXCHANGE LOANS, FUNDING, AND CAPITAL FLOWS
- FX-denominated lending remains a material stock despite being curbed; poses asset-quality and funding risks.
- Bank funding has shifted toward domestic sources as foreign banks retrenched and deleveraged; scarcity of foreign funding anticipated to persist.
- Cross-border exposures create sensitivity to foreign investor behavior; sovereign bond markets and foreign investor activity noted as risk channels (referenced in Figures and text).

### ASSET QUALITY AND NONPERFORMING LOANS
- Persistent nonperforming loans and cyclical deterioration in credit quality moved securing asset quality up the supervisory agenda.
- Actions underway:
  - A thematic supervisory review of impaired assets is getting under way and should lead to updated regulatory guidance if warranted.
- Barriers to rapid resolution of impaired loans:
  - Tax disincentives.
  - Income accrual practices.
  - Obstacles to out-of-court restructurings.
- Recommended improvements:
  - Further improvements in restructuring, accounting practices and the insolvency framework would be helpful.
  - Removal of uniform debt-to-income (DTI) thresholds must be accompanied by tighter oversight of bank risk management practices.
  - Proposed tightening of loan-to-value (LTV) ratios and currency matching of income and borrowing for mortgages are welcome; regulatory LTV ratios should be set below 100 percent.
  - Harmonize calculation of DTI ratios and increase oversight of restructured loans through more granular reporting by banks.

### STRESS TESTING
- Stress tests suggest vulnerabilities are not likely to become systemic, though some pockets of weakness exist.
- Key stress-test findings:
  - Only in the most severe scenarios would some smaller banks fail to meet solvency standards or run into liquidity problems.
  - Contagion risk is limited due to few direct interbank connections.
  - Credit unions are a weak but small segment of the financial system.
- Regulatory arbitrage has pushed some consumer finance transactions outside the regulated system; modifications to the regulation in question, accompanied by better risk management, are likely to stem this phenomenon.

### FINANCIAL SECTOR OVERSIGHT AND SAFETY NETS
- Observance and compliance:
  - Poland is broadly compliant with Basel Core Principles for Effective Banking Supervision (BCP), Insurance Core Principles (IAIS), and International Association of Deposit Insurers (IADI) Core Principles.
- Supervision advances:
  - Banking supervision has improved: increased frequency of targeted inspections and enhanced onsite/offsite coordination.
- Remaining governance and legal constraints:
  - Under the Polish legal system it remains difficult to provide the supervisor with sufficient powers, independence, and resources—of particular concern given an expanding mandate.
  - Consultations with banks and other stakeholders could be further strengthened.
- Deposit Guarantee Fund (BFG):
  - The deposit guarantee fund’s prospective role in bank resolution—when it becomes the designated resolution agency—will fill an important gap.
  - Recommendations (Key Recommendations section) include governance and operational changes for the BFG.

### DEVELOPMENT, MARKET STRUCTURE, AND CAPITAL MARKETS
- Structural outlook:
  - Competition likely to increase in commercial and cooperative banking sectors, leading to consolidation and exit of weaker institutions.
  - Scarcer foreign funding implies financing requirements for economic development must be met more from domestic sources.
- Nonbank finance:
  - Despite growth, nonbank finance remains embryonic; mutual and pension funds have become more important but domestic capital markets need further development.
- Policy initiatives to rebalance toward capital markets:
  - Authorities should consider pension pillar design carefully; pension funds can provide a domestic source of demand for assets.
  - Robust capital market funding frameworks—including mortgage covered bonds and securitization—can address funding needs and mitigate FX and asset quality risks.
  - Recent regulatory initiatives focus on improved asset quality, loan transferability, and reviving mortgage banks.

### KEY RECOMMENDATIONS (WITH TIME-FRAMES)
- Note: "Short-term" = within one year; "Medium term" = 1-3 years.

- Addressing impaired loans (Short-term)
  - (i) intensify oversight of credit risk management and restructuring practices;
  - (ii) standardize and enhance transparency of bank accounting practices;
  - (iii) standardize debt-to-income ratio calculation (paras. 17-20).

- Strengthening banking supervision (Short-term/Medium-term)
  - (i) expand scope for KNF to issue legally binding prudential regulations;
  - (ii) allow KNF’s Board to delegate administrative and procedural decisions to its management, increase KNF independence, and address other governance issues;
  - (iii) increase KNF flexibility to allocate budgetary and staff resources and enhance its analytical capabilities (paras. 27-34).

- Strengthening credit unions (Short-term/Medium-term)
  - (i) eliminate the dual supervision; require a solvency ratio of 8 percent in 5 years; and clarify governance of the stabilization fund;
  - (ii) develop an inclusive set of SKOK regulations and apply accounting principles for financial institutions to SKOKs;
  - (iii) develop capital rehabilitation plans for financially weak SKOKs (paras. 36-37).

- Developing sound macroprudential policies (Short-term)
  - (i) ensure the macroprudential supervisory law provides for SRB’s independence (with a leading role for the NBP), accountability to Parliament, and power to make recommendations coupled with an “act or explain” mechanism;
  - (ii) develop clear macroprudential policy objectives distinct from monetary and microprudential supervisory policy (paras. 38-41).

- Improving the bank resolution framework (Short-term)
  - (i) ensure precedence of administrative powers over corporate insolvency procedures;
  - (ii) ensure that the creditor claims hierarchy protects BFG’s claims on resources provided for balance sheet “gap filling” measures;
  - (iii) include a Tier-1 capital trigger and link the “public interest” trigger to financial stability (paras. 48-49).

- Improving the deposit insurance system (Short-term/Medium-term)
  - (i) remove the PBA from the BFG Council;
  - (ii) ensure adequate funding and capacity, revise and introduce new regulations, and enhance protocols in light of expanded mandate;
  - (iii) amend code of conduct to restrict employment in member institutions to all employees (paras. 50-51).

- Strengthening pension reform and capital markets (Short-term)
  - (i) allow lifecycle strategies in pension funds, and measure performance of pension funds in relation to the benchmark portfolio;
  - (ii) amend MCB framework to allow broader issuance and adopt a legal framework for mortgage securitization;
  - (iii) strengthen enforcement of security interests and judicial decisions (para. 53-54).

### OTHER NOTABLE POINTS
- Credit unions and cooperative banks:
  - Cooperative banks are growing rapidly; commercial banks are expanding into traditional small town and rural territories.
  - Cooperative banks are operationally less efficient but capital ratios appear comparable.
  - Credit unions (SKOKs) reportedly poorly capitalized; regulatory data limited.
- Small unregulated segment:
  - Two main business models: small consumer loans (up to PLN 1,000) at high interest, and installment purchase financing.
  - These firms escape regulatory perimeter because they do not take deposits; risks contained by regulations preventing Polish banks from establishing subsidiaries for such activities (though foreign firms have set up such companies in Poland).

*Source: _cr13221 - EXECUTIVE SUMMARY*

### 7.      The financial system appears to be resilient, though there are vulnerabilities and some

### 7.      The financial system appears to be resilient, though there are vulnerabilities and some weaknesses

### Overview
- Capital adequacy, profitability, and efficiency are high by international standards, though provisioning for residential mortgages is on the low side.
- Main risk drivers: slow economic growth, uncertainty in the euro area, rising unemployment, and falling residential real estate prices (Annex I, Risk Asset Matrix).
- Vulnerabilities: large outstanding portfolio of foreign exchange loans (some with LTVs well above 100 percent), pressure on bank funding, potential volatility of capital flows, and impaired assets.
- Mitigating factors: foreign exchange lending has been extended mainly to higher income households; overall household debt is low by international comparison; the duration of foreign exchange hedging has lengthened; the foreign investor base has become more diversified; banks are relying less on foreign parent funding.
- Stress tests indicate that even under severe scenarios the share of assets at risk is small, liquidity sufficient, and contagion risks limited.

### A. Foreign Exchange Loans
- FX mortgages comprise about 22 percent of the total loan portfolio and more than half of mortgages.
- The proportion of impaired FX mortgages has been decreasing given the decreasing Swiss interest rates and the practice of converting impaired FX mortgages to PLN mortgages.
- The level of impaired FX mortgages has continued to increase slightly to 1.8 percent as of year-end 2012.
- For comparison: PLN loan delinquency was 4 percent and the weighted average for total FX and PLN NPLs 2.8 percent of the overall loan portfolio.
- Inward spillovers from turmoil in the euro area could put pressure on the zloty and adversely affect the loan portfolio, though buffers were built into PLN LTVs; increasing unemployment would be the stronger channel of transmission.
- LTV ratios remain quite high for one-third of the housing portfolio.
- 25 percent of the FX housing portfolio has LTV’s over 130 percent.
- Average LTV for newly originated loans is about 70 percent; some banks reported they are continuing to offer mortgages at 100 percent LTV.
- Reserve coverage for impaired housing loans is 48 percent, which may be low given the lengthy recovery process and falling asset prices.
- Supervisory measures taken: tightening of prudential rules in 2006 and 2011, lowering the maximum DTI ratio for new FX loans to 42 percent, and increasing risk weights on these loans to 100 percent.
- Authorities are tightening regulatory LTV requirements for all mortgage loans; requirements regarding DTI thresholds were removed in recent guidance.
- Changes prohibit FX loans to clients without adequate FX income.
- New foreign exchange lending has ground to a halt, proving the effectiveness of the measures.
- To guard against risk in the remaining outstanding stock of FX loans, capital buffers are being relied upon, which are for the most part sufficient.

### B. Bank Funding
- Funding from parent banks is declining in an orderly fashion; loan-to-deposit ratio rose to about 120 percent in the run up to the global financial crisis and has stabilized since 2008 with signs of some decline in 2012.
- Continued orderly decline of parent funding, increased reliance on domestic deposits and weak credit growth is likely to further reduce the ratio.
- A flare up of euro area turmoil is a downside risk that could precipitate sharper deleveraging.
- On-balance sheet open foreign currency position is about 5 percent of total commercial bank assets.
- Hedging needs are declining as new issuance of FX mortgages has drastically slowed and principal is being repaid faster owing to the low level of Swiss franc interest rates.
- Increased holdings of zloty assets by foreign investors support supply of hedging instruments.
- Net stable funding ratios are under pressure by the lack of available long-term funding.
- Obstacles to lengthening funding duration: shallow domestic investor base, regulatory constraints on pension funds, and virtual absence of securitization and covered bond markets.
- Faster deposit growth could mitigate pressure on funding.

### C. Capital Flows
- Nonresidents’ share of sovereign bond holdings has risen to 36 percent.
- Growing demand from foreign investors has driven the 5-year government bond yield even below the NBP’s policy rate.
- Foreign investors are drawn by a relatively deep and liquid government securities market, enabling positions on Poland and indirectly on the region.
- A sharp and persistent unwinding of foreign investors’ positions would affect the banking system through the exchange rate and bond prices:
  - Zloty depreciation associated with capital outflow would lead to liquidity strains in banks with FX-denominated loan portfolios.
  - Decline in value of government bonds from a sell-off would have negative valuation effects on bank balance sheets subject to mark-to-market valuation.
  - Foreign bond investors are important counterparts for domestic banks in the FX swap markets; unwinding could reduce FX liquidity supply in the FX swap markets and increase FX hedging costs for domestic banks.
- Mitigants: relatively stable and diversified bond investor base; high domestic liquidity; sound hedging practices.
- Banking sector’s systemic liquidity surplus is absorbed by central bank bills (about 100bn zloty at end-2012), providing a cushion against capital withdrawal.
- Banks are increasingly using long-term CIRS instead of FX swaps to hedge FX risks, reducing reliance on foreign investor counterparties.
- Authorities should monitor closely the bond investor base and investors’ funding and hedging behavior.

### D. Asset Quality and Nonperforming Loans
- Asset quality deteriorated rapidly between 2008 and 2009, particularly for consumer loans due to lenient underwriting and increased competition before the 2008-09 financial crisis.
- Corporate sector impairment doubled between 2009 and 2010; impaired loan ratio stabilized at above 8 percent after 2010.
- Overall provisioning coverage for impaired loans is 54 percent; coverage varies across sectors and ranges between 36 and 77 percent.
- The provisioning ratio may be low for certain sectors such as SMEs and housing, given the lengthy recovery process, age of portfolios, and falling house prices.
- With economic slowdown and expected rise in unemployment, asset quality is likely to deteriorate further.
- Impaired loans increased by 35 percent in 2012—the highest increase for all asset classes—driven by financial difficulties and bankruptcy of a few large construction companies.
- The impaired loan ratio is expected to increase in the residential mortgage portfolio as the portfolio ages.
- Obstacles to cleaning up balance sheets:
  - Majority of loans past due 90 days or more have been past due at least one year; consumer loan asset class comprises almost half of this stock; housing and corporate each roughly 20 percent.
  - Keeping impaired loans on balance sheets slows resolution and distorts financial indicators despite high provisions.
  - Banks are legally allowed to accrue high rates of interest on impaired loans for three years after the debtor stops repaying, which may disincentivize swift resolution.
  - Current tax law restricts the amount of provisions or losses that are tax deductible, creating incentives to under-provision.
  - Limited creditor rights protection makes out-of-court restructurings for corporate loans unattractive.
  - Mortgage foreclosures and evictions carry social costs and legal challenges, reducing effective recovery values after expenses.
- Recommended mitigating actions:
  - Tighten oversight over credit risk management practices; place greater responsibility on bank boards for setting DTI thresholds and oversight of risk management; promote nonbank financial institutions’ reporting to the credit bureau.
  - Increase vigilance over restructuring practices: tighten the definition of, and collect more granular data on, restructured loans; collect monthly information on performance, re-aging, sector composition, amount modified year to date, and accruals and cash revenues; require banks to disclose restructuring activities under Pillar 3.
  - Increase standardization and transparency of accounting practices: review practice of accruing income on impaired loans; KNF intends to conduct thematic reviews of impaired loan portfolios to potentially amend guidance on impaired loans and provisions.
  - Improve the insolvency framework to preserve value and lower collection costs: enhance creditors’ voice in insolvency, establish supervisory mechanism over insolvency cases, adopt an out-of-court code of conduct to improve restructurings, and facilitate transfer of security rights to buyers of impaired loans to develop the market for impaired mortgage loans.

### E. Stress Testing
- Stress tests indicate that the banking system is resilient to credit and liquidity shocks, as well as contagion risk.
- Top-down solvency stress tests by the NBP covered the 20 largest banks comprising about 85 percent of total banking system assets.
- Scenarios included a baseline and three adverse scenarios over a 5-year horizon.
- In the most severe scenario, total capital needs are about PLN 10.5 billion, equivalent to less than one percent of banking system assets.
- Top-down tests show that without mitigating measures, 30 percent of banks may fail to meet minimum capital adequacy ratios under severe macroeconomic scenarios.
- 10 percent of banks may not have sufficient liquidity under adverse liquidity shortage scenarios.
- In none of the stress tests did the assets of the affected banks represent more than 10 percent of total banks’ assets, with most tests affecting banks representing less than five percent of assets.
- Limited interbank lending curtails interconnectedness risk and contagion.

*Source: Excerpt from the provided IMF content unit _cr13221.*

### 23.      The FSAP top-down stress tests and single-shock sensitivity tests also show limited

### The FSAP top-down stress tests and single-shock sensitivity tests also show limited capital needs

### Stress test results and sensitivity analysis
- Top-down stress tests were performed using data on six representative banks owing to data confidentiality constraints.
- Sensitivity tests on counterparty, credit, foreign exchange, housing price and interest rate risk suggest the banking system can withstand single adverse shocks.
- Under the most severe counterparty risk shock, a number of banks representing 14 percent of total assets in the system could breach minimum capital requirements.
- In the case of credit risk shocks, if one out of five performing loans became impaired, banks representing 30 percent of assets in the system would not meet the minimum CAR.
- Market risk sensitivity tests had little impact on profits and losses and liquidity.
- No stress tests were conducted on the non-bank financial system because of its small size, lack of interconnectedness with the banking system, and the absence of complex products.

### Bottom-up (KNF) stress test corroboration
- The results of the 2012 bottom-up stress tests of the KNF support the findings of the top-down stress tests.
- No more than two banks, representing about 1 percent of total banking system assets, fall below the regulatory minimum capital ratio in the adverse scenarios.
- The bottom-up tests considered:
  - a baseline scenario based on the NBP’s economic projections;
  - an adverse scenario driven by external shocks;
  - an adverse scenario driven by domestic shocks.
- The bottom-up test covered 32 banks accounting for 90 percent of the assets in the system.
- Adjusting the top-down stress tests for mitigating measures that banks were allowed to adopt in the bottom-up would yield similar outcomes.

### Top-down and market-based testing approach (Box 1)
- Authorities’ tests included the 20 largest banks comprising about 85 percent of total assets; satellite panel data models mapped scenarios into credit losses and net income.
- FSAP team’s balance sheet top-down stress tests were based on six aggregated representative banks. Representative banks were defined by dividing the sample into six percentile buckets based on the CAR test distribution and aggregating banks in each bucket.
- Complementary market-based stress tests were conducted for 13 banks with available market information.
- Top-down tests were compared with the 2012 bottom-up KNF stress test covering 32 banks comprising 90 percent of total assets.

### Liquidity stress testing
- The liquidity stress test found that the banking system can withstand liquidity shocks though asset liquidation could put secondary markets under pressure.
- Under a simultaneous realization of several shocks, only four banks, with about 10 percent of the total assets in the system, saw their ratio of coverage of fund outflows by liquid assets fall below 100 percent.
- The forced liquidation of government bills and bonds could lead to some turmoil in secondary markets.

### Microprudential supervision: institutional powers and capacity
- KNF has limited legal powers imposed by the constitutional framework and relies heavily on non-legally binding "Recommendations" and “Letters.”
- Recommendation: Amend the Banking Act to broaden areas where KNF can issue resolutions, particularly powers to supervise permissible risks in banks’ activities.
- KNF’s independence needs to be strengthened:
  - Having a majority of outside members on the KNF Commission compromises operational independence.
  - Consider modifying commission composition and explicitly stating the primary objective of the KNF in the Financial Market Supervision Act.
  - The prospective Systemic Risk Board (SRB) offers an opportunity to delineate agencies’ responsibilities and instruments.
- Commissioners are overburdened by work typically delegated to management; recommendation that the Commission focus on high-level matters, assess system-wide risks, endorse supervisory practices and methodologies, receive frequent analyses of emerging risks, and approve regulations.
- Regulatory gaps on corporate governance, accounting and external audit should be closed.
- Inspections and coordination:
  - For 2013, KNF planned 4 full-scope and 25 targeted inspections in commercial banks.
  - These consist of 13 horizontal targeted inspections on 7 specific topics and 12 targeted inspections in individual commercial banks.
  - The inspections will cover 86 percent of total assets of commercial banks.
  - KNF practice: inspect the largest commercial banks at least every two years and the others between three and four years.
- KNF should obtain powers to:
  - apply fit-and-proper criteria or remove a member of a bank’s supervisory board;
  - verify the fitness and propriety of all members of the management board;
  - reject or rescind the appointment of an external auditor.
- The Supervisory Review and Evaluation Process (SREP):
  - A full overhaul of the SREP is planned for 2014 to align with EBA risk assessment templates and integrate onsite outcomes.
  - Bank-level information from SREP needs to be analyzed and fed into a bottom-up risk map for regulatory initiatives and systematic prudential supervision.
  - The Commission should approve supervisory methodology and endorse industry-wide SREP outcomes.
  - KNF should disclose its general supervisory philosophy, internal supervisory rating features, principles underpinning supervisory cycles and inspection frequency, impact assessments, and resource allocation.
- Interaction with external auditors has increased since 2011 but should be expanded; auditors expressed concern about limited industry consultation and perceived unrealistic expectations from KNF.
- KNF resource allocation must accommodate an expanding supervisory perimeter and new regulatory challenges, minimize staff turnover, and realign to industry risks.
  - The inclusion of SKOKs in KNF’s perimeter and increased regulatory requirements has delayed allocation of additional resources to commercial banking supervision.
  - In terms of financial assets, cooperative banks and SKOKs represent 7 percent of the financial system.

### Insurance and savings & credit union (SKOK) supervision
- IAIS Core Principles assessment: out of 28 Principles assessed:
  - 14 principles fully observed;
  - 13 largely observed;
  - 1 partially observed (CP3 on Supervisory Authority).
- Weakest areas relate to KNF powers and resources; recommendations include additional staff for insurance supervision, more independence in budgets/salaries/organizational structure, and stronger legal protections for personnel.
- SKOKs:
  - Represent a small but rapidly growing portion of the financial sector and could pose systemic risks if consolidation is not managed prudently.
  - Since 2009, trends have been negative due to rising delinquency and operating expenses, falling interest income and need for additional provisions.
  - SKOKs with weak financial conditions should adopt capital rehabilitation plans to meet the solvency ratio in five years or less—achieving the required 5 percent solvency ratio by January 2014 will be difficult.
- Recent legislation (critical legislation just adopted) strengthens SKOK supervisory framework and boosts statutory capital; further amendments/regulations desirable, including:
  - eliminate confusion between roles of NASCU and KNF;
  - mandate a solvency ratio requirement of 8 percent with a reasonable transition period;
  - include member shares as institutional capital only if available to absorb losses;
  - clarify powers of KNF and NASCU related to the stabilization fund;
  - develop comprehensive implementing regulations and simplified chart of accounts, accounting principles, and reporting formats for SKOKs.

### Macroprudential framework and policy recommendations
- Legislation is being drafted to establish a Systemic Risk Board (SRB) as the macroprudential decision maker responsible for systemic risk identification and analysis, empowered to request that other agencies take action, and endowed with certain tools to control systemic risk.
- Recommendations for the SRB:
  - NBP should take a leading role to shield the SRB from political pressures and leverage central bank expertise.
  - Safeguard SRB independence and endow it with powers to make recommendations regarding the use of tools, but not to individual financial institutions.
  - Make recommendations public and couple them with an “act or explain” mechanism.
  - Require publication of SRB meeting minutes and establish SRB accountability.
  - Enact the legislation without further delay.
- Analytical work:
  - Authorities are developing an analytical framework for systemic issues and identification of systemic institutions.
  - SRB should build on expertise of BGF, KNF, and NBP to produce a list of domestic systemically important financial institutions (D-SIFI’s) and a set of risk indicators.
- Policy tools and objectives:
  - Authorities effectively addressed sectoral systemic risks, including measures to address FX mortgage growth and high leverage in retail credit.
  - Requiring additional capital through higher risk weights for FX mortgages or additional provisioning may be the most effective macroprudential tool to reduce demand and curb sectoral risks.
  - A newly amended regulation will remove the requirement for uniform DTI thresholds and lift income certification requirements for lower loan amounts to facilitate growth of bank credit for certain segments.
  - Other tools have been deployed to increase capital buffers for all banks.
- Need for clarity on policy objectives and roles:
  - Separate macroprudential objectives from monetary and microprudential supervisory objectives.
  - SRB should not use macroprudential policies to manage underwriting quality; use DTIs and LTVs carefully with ceilings for underwriting and reserved macroprudential space below ceilings.
  - KNF should focus on safety and soundness, not manage the credit cycle.
  - SRB should identify policy approach to D-SIFIs, including the use of surcharges, additional supervisory tools, and resolution plans.
  - A complete toolkit of instruments should be identified to pursue macroprudential objectives.

### EU dimension and cross-border considerations
- Poland’s regulatory, supervisory, and resolution frameworks are strongly influenced by EU frameworks undergoing important changes.
- CRD IV/CRR and EU Directives on deposit guarantee schemes and on bank recovery and resolution will need to be transposed into Polish law and regulation.
- With minimum capital standards and risk weights determined by CRD IV/CRR, KNF should focus supervision more intensively on banks’ risk management practices.
- In macroprudential policy, ensure measures apply to EU branches operating in Poland via the “reciprocity” principle agreed with EU institutions (e.g., ESRB) and fully use policy space under CRD IV/CRR to set macroprudential buffers.
- Single Supervisory Mechanism (SSM) and Banking Union (BU) implications:
  - More clarity is needed about SSM arrangements to assess implications and benefits/costs of “opting-in.”
  - Under the SSM, coordination will shift to the ECB and KNF, which could improve cooperation but risk downplaying Polish national concerns.
  - Safeguard cooperation between home and host authorities and strengthen cross-border supervisory and crisis-management colleges.
  - Agreement on governance reform of the European Banking Authority and confirmation of its home-host coordination role should help.
- Opting in could provide benefits:
  - Influence on design of information sharing and cooperation mechanisms within SSM;
  - Enhance credibility and access to supervisory input on parent banks;
  - Potentially enhance investor perception of Poland as part of a pan-European banking union, conditional on SSM effectiveness.

*Source: _cr13221 — Republic of Poland, International Monetary Fund (excerpt).*

### 45.      However, opting in does not appear to provide benefits in terms of liquidity and

### _cr13221 - 45.      However, opting in does not appear to provide benefits in terms of liquidity and

### Crisis management and safety nets — Overview
- Opting in to the BU (Banking Union) could transfer supervisory powers to the ECB without transferring corresponding responsibility for the stability of the national banking system, because access and contributions to a common fiscal safety net and arrangements for access to ECB liquidity remain to be spelled out.
- Poland has built a strong, ex ante funded safety net and a well-tested resolution culture which is being further strengthened.
- Key domestic crisis-prevention and crisis-management steps taken:
  - Creation of a Financial Stability Committee (FSC).
  - Inter-agency cooperation agreements concluded.
  - The NBP adopted a “confidence package” to alleviate liquidity pressures: allowing longer maturity liquidity and offering new foreign exchange refinancing options.
  - International reserves increased and facilities with foreign central banks arranged.
  - Prudential requirements tightened, including through mandatory profit retention.
  - All safety net participants created contingency plans and undertook crisis simulations, including two joint exercises.
  - The NBP worked out details of its emergency liquidity assistance.
  - Poland joined crisis management groups for a number of its larger banks.
  - Laws passed in 2009-2010 specifying conditions for Treasury support and recapitalization of banks.
  - The FSC crisis management contingency plan specifies each institution’s responsibilities in case of a threat to financial stability.

### Bank resolution framework — status and recommendations
- Status:
  - Authorities are adopting a modern bank resolution framework based on the Key Attributes for Effective Banking Resolution.
  - The draft BFG Act includes more flexible tools: starting resolution before full insolvency, allowing partial transfers of a bank’s balance sheet to other banks, applying administrative vs. judicial powers, and deploying new debt write-down tools.
- Recommended revisions to strengthen design and implementation:
  - Eliminate the use of “open bank” assistance by BFG.
  - If a BFG loan instrument is considered, it should only be explicitly part of a resolution process that applies the least cost test; otherwise solvency support should be provided by the MoF or emergency liquidity by the NBP in systemic situations.
  - Add specific resolution triggers (e.g., a tier-1 capital deficit ratio) because the “public interest” trigger is overly general and legally challengeable.
  - Grant authorities discretionary power to recast a bank’s financial statements and reports according to adjustments deemed prudent.
  - Make the new creditor claims hierarchy required for resolution explicit to clarify the seniority of BFG claims for contributions made to fill purchase-and-assumption balance sheet gaps when these do not entail any payments to insured depositors.
  - Add explicit depositor preference to strengthen the deposit guarantee scheme.

### Deposit Insurance — IADI assessment (summary findings)
- Overall assessment:
  - The BFG is Compliant or Largely Compliant with 16 out of 17 applicable Core Principles and Materially Non-Compliant with one Core Principle.
- Institutional and operational features:
  - BFG established as a government legislated and administered agency.
  - Governance: up to five-member Management Board; eight-member Fund Council with two representatives each selected by the minister of finance and the NBP, one representative of the KNF, and two representatives of the PBA.
  - Information sharing and coordination arrangements are extensive; the President of the BFG Management Board attends FSC meetings and will soon become a permanent member.
  - Membership is compulsory for all domestic banks (and foreign banks not covered by their home system); coverage limited to the PLN equivalent of EUR 100,000.
  - As of 30 September 2012, membership included 619 domestic banks and cooperative banks.
  - Under draft legislation, cooperative savings and credit unions will be added to membership.
  - Scope exclusions: professional financial market participants, bank management, shareholders/stakeholders are not covered.
- Mandate expansion and powers under development:
  - BFG responsibilities: collecting deposit insurance premiums; inspecting depositor information; analyzing data on member banks; conducting off-site risk assessment; reimbursing insured depositors; providing financial assistance using a least cost test criteria.
  - Draft legislation would expand BFG resolution powers: act as receiver, transfer assets, undertake purchase-and-assumptions, establish work-out companies, establish bridge institutions, develop resolution plans and resolvability assessments, and include the President of the BFG Management Board on the FSC.
- Funding and payout capacity:
  - Five funds exist: one ex-post (individual bank funds for protection of guaranteed assets), and four ex-ante (assistance fund for restructuring domestic and cooperative banks, a statutory fund, a reserve fund, and a special fund from recoveries).
  - Emergency back-up funding available from the NBP and MoF.
  - A differential “risk-adjusted” premium system is in use.
  - BFG funds are sufficient to cover payout of guaranteed deposits up to the 12th largest bank in Poland (reflecting an ex-ante coverage ratio of 1.87 percent).
  - The target fund ratio is 2.72 percent of covered deposits.
  - Payout capacity: capable of reimbursing depositors within a maximum of 20 working days; tests indicate payouts could often be accomplished within 7 days.
  - Communication: ongoing depositor information via signage, brochures, web sites, print, video and social media; a Single Customer View (SCV) system is in use.
- Governance and adequacy concerns:
  - Governance arrangements could be enhanced: BFG Council includes two representatives of the Polish Bankers Association (PBA), creating potential conflicts of interest.
  - The multiplicity of individual funds (stability, deposit guarantee, resolution, restructuring banks and cooperative banks) should be reviewed.
  - The BFG should reassess fund adequacy in light of EU-mandated coverage increases, the addition of credit unions, and planned expanded resolution powers.
  - Plans are to raise fund adequacy by increasing the coverage ratio back to 2007 levels; and, by 2020 to the EC recommended ratio of 1.5 percent of eligible deposits.
  - Codes of conduct applied to the BFG and its employees have some gaps that need addressing.
- Deposit insurance institutional performance:
  - Depositor reimbursement systems are highly developed; banks required to report depositor data on an ongoing basis; data quality is monitored by the BFG.

### Development and market structure — policy priorities
- Need to shift away from bank-dominated intermediation to meet new demands for financial services and to improve risk-spreading and maturity transformation.
- Pension system:
  - Poland’s pension system is based on three pillars.
  - Recommendations:
    - More efficient organization of the pension fund management industry to ensure lower operational costs and higher expected replacement rates.
    - Lifecycle investment strategies to align mandatory pension fund portfolios with long-term retiree objectives.
    - For voluntary schemes: increase incentives and transparency to address low voluntary private savings and low expected replacement rates.
    - Consider requiring minimum duration of fixed-income portfolios of pension funds to increase demand for longer-term government securities and encourage private sector long-term bond issuance.
    - Address high fees of saving vehicles as a barrier to developing voluntary (third pillar) pension schemes.
- Capital markets and covered bonds:
  - Robust capital market funding frameworks can address banks’ funding needs.
  - Recent regulatory initiatives in mortgage covered bond (MCBs) and securitization focus on improved asset quality, loan transferability, and reviving mortgage banks.
  - Recommendations:
    - Universal banks should be allowed to issue MCBs subject to the same terms and conditions as mortgage banks.
    - Eliminate legal and tax obstacles to mortgage rights transfer.
    - Establish a modern securitization framework.

### Risk Assessment Matrix — selected risks, likelihoods, and expected impacts
- 1. Protracted period of slower European growth
  - Relative Likelihood: High
  - Expected Impact if Realized: Medium
  - Key points:
    - Adverse impact of public and private deleveraging may be larger than expected, leading to sizeable output gaps and potential debt-deflation dynamics.
    - Job skills obsolescence from long unemployment spells and subdued investment could reduce potential output.
    - Channels to Poland: significant trade linkages; monetary policy should be further eased as fiscal space is limited.
- 2. Financial stress in the euro area re-emerges
  - Relative Likelihood: Medium
  - Expected Impact if Realized: Medium
  - Key points:
    - Re-intensification could revive bank-sovereign-real economy links.
    - Significant zloty depreciation could lead to liquidity strains and credit losses in some banks with FX denominated mortgage portfolios.
    - Mitigants: strong, high-quality capital position; FX mortgage stock is 11 percent of GDP.
    - Policy: allow exchange rate to float freely; intervene to avoid abrupt movements; the NBP should provide liquidity support if needed.
- 3. Excessive pace of parent bank deleveraging
  - Relative Likelihood: Medium
  - Expected Impact if Realized: Medium
  - Key points:
    - Could cause a credit squeeze and adverse implications for growth.
    - Mitigants: reduced reliance on parent funding; strong banking balance sheet and liquidity; corporate reliance on retained earnings.
    - Policy: NBP should provide liquidity support.
- 4. Emerging markets capital flow reversal
  - Relative Likelihood: Medium
  - Expected Impact if Realized: Medium
  - Key points:
    - Sudden reversal could raise funding costs and reduce FX derivatives market liquidity, increasing banks’ hedging costs.
    - Mitigants: relatively stable investor base; prudent public debt management; strong banking liquidity.
    - Policy: allow exchange rate to float; use intervention to avoid abrupt movements; NBP liquidity support if needed.
- 5. Stronger than expected domestic slowdown, higher unemployment, and declining real estate prices
  - Relative Likelihood: Low
  - Expected Impact if Realized: High
  - Key points:
    - Could depress domestic demand, raise unemployment, depress housing demand and real estate prices.
    - Potential for larger bank losses and reduced bank profitability.
    - Mitigants: strong capital buffers in banking system.
    - Policy: monetary policy should be further eased, especially as fiscal space is limited.

### Preconditions and macro-financial context
- Economic growth and fiscal stance:
  - After robust growth last year, Poland is feeling headwinds from Europe: growth moderating amid weaker export demand, lower public investment, and weaker confidence affecting private investment and consumption.
  - Economic activity is projected to slow further; rising unemployment and tight credit availability expected to weigh on household spending.
  - GDP growth is projected to slow in 2013; risks are on the downside.
  - Fiscal consolidation: general government deficit projected to drop by 1½ percentage points to about 3½ percent of GDP in 2012.
  - The 2013 budget continues structural consolidation with measures of some ½ percent of GDP while allowing automatic stabilizers to mitigate the slowdown.
- Financial system structure:
  - Total financial system assets grew from 86 percent of GDP in 2005 to 124 percent of GDP in 2012.
  - Banks account for about 70 percent of financial system assets.
  - At end-2012: 70 commercial banks (61 subsidiaries or branches of foreign credit institutions), 573 cooperative banks, and 55 credit unions.

*International Monetary Fund — Poland: selected extracts from the 2013 financial sector assessment content unit*

### 64.      The banking system is dominated by a handful of foreign-owned banks. They control

### _cr13221 - 64.      The banking system is dominated by a handful of foreign-owned banks. They control

### Banking sector structure and concentration
- Foreign-owned banks control about 65 percent of the sector’s assets.
- Foreign ownership share is sizeable but lower than in the Czech Republic, Hungary, and Slovakia.
- Foreign banks have retrenched somewhat; deleveraging by foreign owners has led to some consolidation.
- The state owns controlling shares in four banks, which together account for about 22 percent of banking sector assets.
- The banking system is not highly concentrated; the top five banks account for about 44 percent of system assets.

### Capitalization, liquidity, and asset quality
- In aggregate, capital adequacy reached 14.7 percent, 90 percent of which is tier-1 capital.
- Banks’ profits in 2011 and 2012 were historically high; regulations restricting dividend payouts aided capital building.
- Risks remain from an overhang of FX-denominated mortgages affecting asset quality and funding.
- Deterioration in the construction sector has also affected loan quality.
- Bank capital buffers have remained comfortable and overall liquidity is ample.
- As the economy slowed, NPLs have increased and credit growth has eased.
- Authorities have encouraged voluntary out-of-court restructuring by banks to deal with NPLs.

### Regulatory, supervisory, and macroprudential developments
- The NBP performs financial stability analysis and data collection.
- The KNF is the integrated supervisor for banking, credit unions, insurance, pensions, and securities; responsible for prudential supervision, competition, conduct of business, consumer protection and development issues.
- The BFG manages the deposit guarantee system; under new legislation being developed its role in resolution would be expanded and become more integrated into crisis preparedness and management.
- Safety-net participants exhibit operational independence, accountability, and good transparency and disclosure frameworks; they coordinate closely with the MoF.
- Poland must comply with EU directives; it is expected to be in line with EU Directives on deposit insurance systems and on bank recovery and resolution.
- Work underway: establishing a Systemic Risk Board to implement a macroprudential framework and upgrading the bank resolution toolkit.

### Supervisory challenges and legal framework gaps
- NPLs rose sharply due to the 2008/09 crisis and lenient underwriting standards before 2010.
- Banks face roadblocks from tax disincentives, income accrual practices, and impediments in the legal framework.
- KNF has intensified supervision and is revising underwriting standards.
- Identified supervisory deficiencies:
  - Deficiencies in KNF powers to issue binding resolutions.
  - Need to enhance intensity of on-site supervision.
  - Credit and lending policies need tightening.
  - Need to ensure effective bank board oversight and risk management.
  - Monitoring of loan restructuring should be strengthened.
  - Accounting practices for impaired loans need improvement.
  - KNF would benefit from additional resources, including for planned expanded role in supervising credit unions.
- Legal framework improvement areas:
  - Corporate governance, resolution and insolvency frameworks need enhancement.
  - Banking Act is silent on fit-and-proper criteria for members of banks’ supervisory boards.
  - KNF enforcement actions are relatively low.
  - Major acquisitions by domestic banks require only 30-day ex ante notification to the KNF; agency has inadequate power to influence banking group structures.
  - Resolution framework is underdeveloped; current framework relies mainly on corrective action, reorganization, and liquidation phases using corporate bankruptcy code, which can result in losses of asset value and requires up-front payment to insured depositors.

### Deposit insurer (BFG): role, strengths, and deficiencies
Findings on BFG performance and accomplishments:
- BFG is Compliant or Largely Compliant with 16 out of 17 applicable Core Principles and Materially Non-Compliant with one Core Principle.
- Accomplishments include:
  - Successful reimbursement of depositors in 94 bank failures and provision of financial assistance in 101 bank interventions.
  - Expansion of the deposit insurer mandate from a “paybox” to a “paybox-plus” and recognition as a critical component of Poland’s financial system.
  - Development of a sound governance framework and information sharing and coordination arrangements with other safety-net participants.
  - Creation of a highly developed early warning and risk assessment system complemented by comprehensive depositor data collection and analysis systems.
  - Wide-ranging public awareness activities and innovative tools (e.g., social media) to promote financial literacy and awareness of deposit insurance.
  - A well designed depositor reimbursement system capable of prompt payouts.

Key BFG deficiencies and concerns:
- Governance:
  - BFG governed by up to five-member Management Board and overseen by an eight-member Fund Council.
  - Council membership includes two representatives each from the MoF and NBP, one representative of the KNF, and two representatives of the PBA.
  - Potential conflicts of interest from PBA representation; recommendation to remove PBA representatives and consider involving PBA via an external advisory committee.
- Funding and fund structure:
  - BFG currently has five funds; ex-post fund used first in a failure, followed by BFG’s ex ante funds, and supplementary back-up funding from the NBP and MoF if required.
  - Arrangement is functional but complex; recommendation to rationalize the number of funds.
  - Need to reassess fund adequacy in light of EU-mandated coverage increases, addition of credit unions, and planned expanded resolution powers.
  - EU-mandated coverage limit increased to EUR 100,000 in 2010.
  - In 2007, BFG’s funds sufficient to cover payout of guaranteed deposits up to the 10th largest bank (ex-ante coverage ratio of 2.72 percent).
  - As of 30 September 2012, increase in coverage limit lowered the coverage ratio to 1.87 percent, leaving BFG ex ante funds sufficient to cover payouts only up to the 12th largest bank.
  - Team supports BFG plans to raise fund adequacy by increasing the coverage ratio back to 2007 levels; and, by 2020 to the EC-recommended ratio of 1.5 percent of eligible deposits.
  - Given draft legislation proposals to extend membership to credit unions and add significant new resolution powers, advisable to review and re-assess fund adequacy going forward.
- Codes of conduct and legal protection:
  - BFG, Management Board and employees acting in good faith are not liable for damages in their work; specific limitations of liability are provided in law for Management Board and employees by general labor code rules.
  - Codes of conduct restricting employment in member institutions are applied only to the BFG Council and Management Board.
  - Internal rules require employees to disclose outside employment, but there are no specific statutory prohibitions or restrictions regarding employment in member institutions for BFG employees.
  - Recommendation: extend specific statutory prohibitions or restrictions regarding employment in member institutions to all employees.
- Resolution framework deficiencies:
  - Current framework fragmented and missing important elements: mechanisms for asset transfers, receivership powers, purchase and assumptions, and bridge institutions.
  - Draft legislation under review would expand BFG powers to: act as a receiver, transfer assets and undertake purchase and assumption transactions, establish bridge institutions, develop resolution plans and resolvability assessments, and include the President of the BFG Management Board on the FSC.
  - BFG membership will be expanded to incorporate cooperative savings and credit unions.
  - Implementation will require revising and introducing new regulations, enhancing protocols, and building additional capacity (human resources, IT, public awareness).
  - Information sharing and coordination arrangements with KNF, NBP and MoF may need updating and enhancement.
- Information exchange:
  - Information exchange between safety-net participants is extensive and legally protected; communications are subject to confidentiality provisions.

### Accounting, disclosure, and depositor reimbursement readiness
- Audited financial statements of listed companies, banks and similar financial institutions must be published.
- Accounting and audit profession is self-regulated by the National Chamber of Statutory Auditors and the Commission for Audit Supervision.
- Statutory requirements exist for auditors to have professional liability insurance.
- BFG has developed a comprehensive deposit insurance information system allowing access to detailed information on an ongoing basis.
- BFG has a sound process to examine and verify the quality of data.
- BFG is capable of giving depositors prompt access to insured funds.
- On-site examinations of bank liabilities, standardized data templates and a single customer view data system will help reduce payout speeds further.

### Summary of Core Principles assessment (selected highlights)
- The public policy objectives are formally specified in legislation and integrated into BFG design.
- Coverage is defined in law, credible, limited and meets public policy objectives.
- Membership is compulsory for all domestic banks and foreign bank branches not members of a home country scheme; draft legislation will expand membership to cooperative savings and credit unions.
- The BFG utilizes a hybrid ex-ante and ex-post funding model with access to a wide range of funding sources; funding mechanisms are clearly defined and sufficient, though multiple funds add complexity.
- The BFG is well integrated into early detection and intervention frameworks and plays an important early warning role, but supervisory and resolution framework deficiencies remain.
- Reimbursing depositors: BFG can provide prompt access to insured funds; improvements in data systems will further reduce payout speeds.

### Recommended action plan (major recommendations)
- Moral Hazard (Principle 2): Adopt financial sector oversight recommendations in the FSAP aide memoire (March 2013) to improve moral hazard mitigation.
- Governance (Principle 5): Consider removing PBA representatives from the BFG Council and replace their input with an external advisory committee.
- Funding (Principle 11): Reassess fund adequacy given planned changes (adding credit unions, expanding resolution powers); review and possibly streamline the number of BFG funds.
- Legal protection / Codes of conduct (Principle 13): Extend specific statutory prohibitions or restrictions regarding employment in member institutions to all employees.
- Early detection, intervention and resolution (Principle 15): Adopt FSAP financial sector oversight recommendations and implement the planned resolution regime.
- Effective resolution processes (Principle 16): Implement draft legislation under review; BFG to work with safety-net partners to revise regulations, enhance protocols, and build resolution capacity (human resources, IT, public awareness); review and update information sharing and coordination with KNF, NBP and MoF.

*Source: IMF staff assessment contained in the provided content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13221.pdf_