## _cr1399 ## Source details **Canonical URL:** [_cr1399](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1399.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1399.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1399.pdf.json) --- ### Executive summary — major vulnerabilities and system-wide findings - Systemic risks appear to be manageable in Kosovo, but pockets of vulnerability exist. - Banks are exposed to macro-financial risks due to openness of the economy, limited scope to diversify, and modest range of tools available to the authorities. - Vulnerabilities are exacerbated because of excessive name concentration. - The Central Bank of the Republic of Kosovo (CBK) has made commendable progress promoting banking sector growth and stability despite legal uncertainty and limited universal recognition of Kosovo’s independence. - CBK supervisory focus to date has been on credit risk; supervisors should adopt a comprehensive risk-based approach including operational and interest rate risks and risks related to subsidiaries of foreign banks and their relations with their parents. - Kosovo’s legal and regulatory framework contains inconsistencies and lacks coherence. - Unilateral adoption of the euro in 2002 supports stability but: - Places a premium on disciplined macroeconomic policies. - Makes fiscal policy the main instrument for domestic demand management. - Limits the central bank’s ability to act as lender of last resort. ### Structural features and key statistics (as of June 2012) - Financial system assets as a share of GDP: about 74 percent (up from 33 percent in 2003). - Financial sector composition (June 2012): - Commercial banks: 8; Assets: 2,652 (euros mn); Percent of total assets: 75. - Foreign banks: 6; Assets: 2,333 (euros mn); Percent of total assets: 66. - Domestic private banks: 2; Assets: 319 (euros mn); Percent of total assets: 9. - Nonbank financial institutions: 33; Assets: 892 (euros mn); Percent of total assets: 25. - Insurance companies: 13; Assets: 120 (euros mn); Percent of total assets: 3. - Pension funds: 2; Assets: 659 (euros mn); Percent of total assets: 19. - Micro-finance institutions: 14; Assets: 79 (euros mn); Percent of total assets: 2. - Total financial system (June 2012): 41 institutions; Assets: 3,544 (euros mn); Percent of total assets: 100. - The three largest locally incorporated banks are subsidiaries of European banks and together account for more than 70 percent of bank assets. - Pension funds represent about 20 percent of total financial assets; microfinance accounts for 4 percent of the total loan portfolio of financial institutions. - Insurance market: - Gross non-life premiums (including personal accident and health): about €67 million; life insurance premiums: about €1 million. - Market penetration rate: about €38 per capita. - 2011 overall real growth of GPW: under 5 percent. - 70 percent of premiums from compulsory third party motor liability insurance (MTPL). - Microfinance sector: - Accounts for 4 percent of total loan portfolio. - Average loan size: €1,400. - Lending to agriculture: 46 percent of sector lending. - Two providers dominate with about 50 percent of assets. ### Macroeconomic developments and outlook - Real GDP growth averaged 4.5 percent during 2010–11, driven primarily by private sector demand. - Consumer prices: deflation of 2.4 percent in 2009 reversed to inflation of 5.4 percent in 2010–11. - Trade deficit: widened from 39.7 percent of GDP in 2009 to 41.1 percent of GDP in 2011. - Remittances from diaspora are significant (equivalent to about 40 percent of GDP). - Early 2012: indications of weakening domestic demand. - Staff projection: real GDP growth of 2.7 percent in 2012. - Consumer price inflation expected to average 2.5 percent in 2012, compared with 7.3 percent in 2011. ### Banking system performance and key indicators (selected, June 2012) - Banking system NPL ratio: 3.3 percent in 2008; 6.5 percent at end June 2012. - Aggregate return on equity: 10 percent as of June 2012 (down from 19 percent at end-2010). - Banking system CAR: 17.2 percent as of June 2012 (down from 18.8 percent at end-2010); most banks above 12 percent regulatory minimum. - Deposit growth: relatively flat in H1 2012; system credit expanded at an annualized rate of around 8 percent. - Liquid assets: 29 percent of total assets covering about 34 percent of total deposits. - Supervisory target: 80 percent loan-to-deposit ratio; banks meet this while investing the remainder abroad. - Key financial soundness indicators (June 2012): - Regulatory capital to risk weighted assets: 17.2. - Regulatory Tier I capital to risk-weighted assets: 14.4. - Nonperforming loans to total gross loans: 6.5. - Return on assets: 1.0. - Return on equity: 9.7. - Liquid asset to total assets: 28.9. - Liquid asset to short-term liabilities: 36.2. - Large exposures to capital: 80.9. ### Stress testing — scenarios, assumptions, and results - Adverse euro-zone scenario channels: decline in remittances and FDI; sovereign bond value declines; higher counterparty risk from exposures to euro-zone banks; reduction in credit due to deleveraging by foreign-owned parents. - Adverse scenario assumptions: - GDP decline of 2 percent. - Yields on European sovereign bonds held by banks increase on average by 130 bps. - Average increase in default probability of European banks to which Kosovo banks are exposed of 140 percent. - Weighted average haircut of about 5 percent on sovereign holdings; European banks’ default probabilities increase from 1.8 to 4.2 percent. - Adverse Kosovo scenario: Real GDP growth of -2.0 percent in 2012 and NPL ratio projected to reach 10.5–11.2 in subsequent years under the adverse path. - Results and vulnerabilities: - Banking system generally resilient to further euro-zone deterioration, but pockets of vulnerability exist among small and medium-sized banks and in one large foreign subsidiary. - Two largest banks would remain above regulatory minimum after shocks. - Four remaining locally incorporated banks more vulnerable; their capital ratios would fall below the 12 percent minimum. Recapitalization needed to restore CARs to minimum: about 0.2 percent of GDP. - One large foreign bank subsidiary more vulnerable; its failure could affect the largest pension fund via a large deposit (~3 percent of the pension fund’s total portfolio). - Stress-test finding: overall impact of the adverse euro-zone scenario on banks’ CAR is on average about 4.5 percentage points. ### Banking sector vulnerabilities and sensitivity tests - Concentration and correlation risk: - CAR of one bank with a 10 percent market share would fall below 12 percent if the five largest common borrowers in the system defaulted. - Supervisory recommendation: enforce new regulation on large exposures on schedule and avoid exceptions. - Interest rate risk: - A parallel shift of 200 basis points in interest rates would bring two banks (representing more than 25 percent of the system) below the 12 percent CAR minimum. - Supervisory recommendation: monitor interest rate risk and impact on earnings and asset values. - Exchange rate risk: low — loans in foreign currency are less than 2 percent of total assets. ### Liquidity stress tests — scenarios, results, and implications - Supervisory moral suasion targeted 80 percent loan-to-deposit ratio; most banks meet it and invest remaining deposits abroad. - Systemic deposit run outcomes (selected): - Cumulative 15 percent outflow with 10 percent haircut: liquid assets to total deposits = 18.4; number of banks with liquidity shortfall = 1; liquidity assistance needed = (0.1). - Cumulative 30 percent outflow with 20 percent haircut: liquid assets to total deposits = (3.9); number of banks with liquidity shortfall = 4; liquidity assistance needed = (2.2). (*) Note: This is approximately the maximum deposit run that could be covered by the ELA and CBK resources, which together amount to around 2 percent of GDP. - Run on a large bank (35 percent outflow of subsidiary's deposits/50 percent haircut): liquid assets to total deposits = 27.2; number of banks with liquidity shortfall = 1; liquidity assistance needed = (0.5). - Withdrawal of ten largest private deposits: liquid assets to total deposits = 26.7; number of banks with a liquidity shortfall = 1; liquidity assistance needed = (0.3). - Total liquidity assistance needed in the 30 percent/20 percent scenario: equivalent to 2.2 percent of GDP. - ELA and CBK resources: - Liquidity assistance of up to 1 percent of GDP can be covered by the ELA fund and up to 2 percent of GDP if CBK equity and reserves are included. - Available ELA funds would be able to fully cover liquidity needs of the two smallest banks (holding 2 and 5 percent of total deposits respectively) in the event of runs on those banks. - Supervisory recommendation: use deposit composition data to identify vulnerabilities from deposit concentration. ### Nonbank financial institutions — pension funds, insurance, MFIs - Pension funds: - Two funds: Kosovo Pension Savings Trust (KPST, mandatory defined contribution) and Slovenia-Kosovo Pension Fund (SKPF, voluntary). - A 20 percent correction in stock market valuations would decline portfolio values by around 14 percent. - Sovereign bond holdings: KPST sovereign bonds about 28 percent of assets (90 percent exposures to Germany, U.S., France, U.K. and Netherlands); SKPF sovereign bonds about 70 percent of assets (about two thirds exposures to Slovenia, Hungary, Netherlands, U.K., Italy, U.S., and Luxembourg); SKPF’s exposure to Slovenian sovereign bonds: about 14 percent of its sovereign bond portfolio. - Market risks borne by pensioners; liquidity risk if redemptions exceed expectations. - Insurance sector: - Four out of 10 nonlife companies are technically insolvent under EU Solvency I rules. - Three nonlife companies have insufficient liquid assets to cover current technical provisions, which appear considerably understated. - MTPL: despite minimum premiums and maximum agent commission, fierce competition yields discounts/rebates; in 2011 most companies recorded negative underwriting income from MTPL; average ROE was 2 percent. - Motor Compensation Fund (MCF) capital: about €2 million; annual collections from “border policies” over €10 million. - Reputational and medium-term solvency risks if “border policy” revenue disappears after joining the Green Card system. - Recommendation: enact out-of-court insurance dispute resolution mechanism (e.g., private arbitration with binding decision powers). - Microfinance institutions (MFIs): - MFI assets about 2 percent of financial system assets (down from 5 percent in 2007). - Drivers of contraction: governance concerns, regulatory uncertainty, fraud cases, refocus on smaller loans. - As of June 2012: - Loan impairment (past due 30 days or more) = 9.2 percent. - ROA = 0.6 percent. - ROE = 0.4 percent. - Annualized profitability: significantly negative. - MFIs hold accounts with commercial banks; most funding from external sources; given MFI size, links do not appear systemic. ### Financial safety nets, crisis management, and supervisory implications - ELA: - Introduced in 2010 for solvent banks and insolvent but systemically important ones. - CBK can provide liquidity assistance up to 100 percent of Tier 1 capital for solvent but illiquid banks; CBL allows ELA to banks that may be insolvent if failure would have adverse implications for financial stability. - Initial ELA grant up to 28 days; extension beyond three months requires a CBK executive board–approved program specifying remedial actions. - Staff does not support ELA for insolvent banks unless subject to strict conditions including prior declaration of systemic crisis and government guarantee securing repayment. - Resources available for ELA operations: approximately €90 million = about 5 percent of bank deposits subject to reserve requirement, or 2 percent of GDP. - Proposal: ELA premium equivalent to 0.3 percent annually of bank deposits subject to reserve requirements (quantified impact: around €5.3 million at current deposit base). - Collateral requirements currently restrictive; consider broadened eligible collateral subject to haircuts. - Operational procedures for ELA (contracts, tasks, solvency analysis, remedial program at grant time, enhanced supervision) need establishment. - Resolution framework: - CBK empowered to appoint official administrators, require resolution plans within 60 days, implement P&A transfers or liquidation, revoke licenses (Article 61), and create bridge banks. - Recommendations: define P&A to include liabilities and assets (articles 68.4 and 73.22); perform P&A after license revocation to minimize litigation; limit bridge bank to systemic banks; introduce least-cost test; formalize intervention and resolution manual. - Deposit Insurance Fund of Kosovo (DIFK): - DIFK operational in 2011; current fund size a little over €13 million and represents approximately 4.6 percent of insured deposits. - DIFK is a narrow mandate “paybox” scheme; may borrow with Government guarantee and issue bonds but no formal emergency back-up funding exists. - Staff recommends raising target reserve level from 5 percent to 8–9 percent of insured deposits. - Deposit coverage: current €2,000 level covers about 90 percent of depositors and about 14 percent of total insured deposit value. - Proposed increase to €5,000 would cover about 93 percent of depositors but increase exposure by about 80 percent (from approximately €300 million to around €529 million). - Recommendation: do not expand coverage now until fund size and back-up funding are adequate. - Compromise agreement (post-mission): coverage to increase to €3,000 on January 1, 2014; €4,000 on January 1, 2016; €5,000 on January 1, 2018. - Banks’ premiums should not be reduced or discontinued even if target reached, except for justified risk-based adjustments; cost of bank failures should be primarily borne by the banking industry. - Recommend Government fast-track limited line of credit to reimburse insured depositors when reserve fund depleted and extraordinary funding arrangements for DIFK. - Institutional coordination and contingency planning: - Tri-party MoU signed end-2011 between CBK, MoF and Assembly Committee on Budget and Finance created Financial Stability and Crisis Management Committee (FSCMC) — consultative only. - Recommendation: create Crisis Management Executive Committee (CMEC) comprising MoF, CBK and DIFK with decision-making power to declare potential systemic crises upon CBK proposal. - Authorities should prepare contingency plans, test via simulations, and require large banks to prepare contingency plans. ### DIFK mandate, premiums, reserve and coverage (detailed) - DIFK operations: - Repayment timeframe: Article 12.1 amended to require repayment “as soon as possible...but not later than 30 days of the insured event” (reduced from 60); practical repayments could start within three to seven days with preparation. - Current fund size: a little over €13 million (including initial disbursements and bank premiums). - Fund size: approximately 4.6 percent of insured deposits. - Reserve fund target and premiums: - Staff calculation: target reserve level should be raised to 8–9 percent of insured deposits. - Banks should continue paying premiums; current law allows DIFK to stop contributions once target reached — amendments before Parliament silent on this. - When target reserve achieves a significant buffer above exposure, DIFK should consider repaying government contributions. - Coverage expansion considerations: - €2,000 covers about 90 percent of depositors (about 14 percent of deposit value). - €5,000 proposed would fully cover about 93 percent of depositors, but increase DIFK exposure from ~€300 million to ~€529 million. - Recommendation: linkage of coverage increases to growth of reserve fund; avoid immediate expansion without emergency funding. ### Payment system, oversight, and implementation timetable - Payment systems: - Electronic Interbank Clearing System (EICS) presently operates as a hybrid interbank system; CBK participants include all commercial banks. - RTGS implementation for large-value transactions initiated with World Bank assistance; expected completion by 2014. - Plan to establish national card switch system to reduce costs and improve efficiency. - Oversight implementation and organization: - Separation of operations and oversight: two divisions established in Payment System Department (Operations; Analysis and Oversight). - Quarterly oversight notes to Governor, publication of oversight summary in Annual Report (first published in Annual Report 2011), inclusion of payment system section in Financial Stability Report No.2. - Hiring of an oversight expert proposed in 2013 budget. - Recommendations: finalize Payment System Law, publish oversight regulation, develop on-site inspection plan for payment service providers, and strengthen cooperation with neighboring countries. - Usage: - Non-cash instruments and payment cards use low but increasing; ATMs and POS networks operated by individual banks with limited sharing. ### Supervisory capacity, legal framework, AML, and Basel Core Principles assessment highlights - Supervisory scope and gaps: - Supervision largely compliance-based; CAMELS used with some risk matrix elements for systemic banks. - Supervisory emphasis strong on credit risk and internal controls; insufficient focus on operational, interest rate, liquidity, and group/parent-related risks. - Off-site reporting: monthly and quarterly reports exist but insufficient analytical depth; technological platform for enhanced reporting not yet available. - Legal and institutional issues: - Rapid institution building and intensive international technical assistance produced extensive legislation but left gaps, inconsistencies and technical weaknesses. - Political/security context and uneven international recognition limit CBK authority in parts of Kosovo (notably Mitrovica/northern Kosovo) and hinder supervision of some banks. - AML/CFT: - Law on the Prevention of Money Laundering and Terrorist Financing (approved 2010) has technical deficiencies: lacks specific provisions giving CBK or FIU authority to carry out compliance inspections in several institution types; insufficient protection for bank officials filing reports to the FIU. - World Bank AML/CFT assessment scheduled by mid-2013. - Basel Core Principles (BCP) assessment (September 18 to October 2, 2012) — selected findings: - CBK responsibilities and objectives generally clear except AML review ability. - Independence, accountability and transparency present; concerns over AML function management and legal expense protection. - Licensing is prescriptive; controls over non-financial investments inadequate. - Prudential requirements: minimum paid-in capital for domestic banks rising from €5 million to €7 million effective October 12, 2012; minimum Tier I to RWA 8 percent and total capital to RWA 12 percent; market and operational risk charges not included in capital calculations. - Supervisory capacity constraints: need to develop staff skills and processes for risk-based, forward-looking supervision and consolidated/group supervision. - Recommended action plan (selected): - Clarify CBK responsibilities vis-à-vis AML and strengthen BSD/AML objectives; consider re-assignment of AML supervisory manager. - Comprehensive review of legal framework to remove gaps and conflicts. - Include market and operational risk charges in capital calculations. - Expand supervisory review beyond loan portfolio; develop regulation and supervisory practices for country and transfer risks; develop liquidity and interest rate risk regulation and staff training. - Improve off-site supervision, supervisory reporting, and technological platform; include consolidated reporting and details on liquidity, interest rate, operational risks, and parent exposures. - Improve MoUs and home-host cooperation for timely information exchange on parent banks and groups. - Address irregularities from non-licensed entities operating in northern Kosovo. ### Policy priorities and key recommendations (selected) - Short term (implementation within 12 months): 1. Ensure legal defense costs for CBK employees sued while carrying out official duties are covered ex-ante (¶39 CBK). 2. Subject ELA granted to potentially insolvent systemically important institutions to very strict conditions (¶55, CBK). 3. DIL should raise DIFK target level to 8–9 percent of insured deposits and clarify that all past and future Government and KfW contributions can be used to repay insured deposits; banks’ premiums should not be reduced except as defined in ¶71 (¶67 and ¶69–71). 4. Amend the Banking Law to address shortcomings in bank resolution framework (¶63) and obstacles to competition and MFI development (¶43, ¶78, ¶79, CBK, Government). 5. Reinstate Solvency I for all insurers; establish investment regulation for life and non-life companies for surplus and reserves; mandatory annual actuarial audit by a certified actuary; retain two in-house actuaries (¶42, CBK). 6. Make initial steps to establish a framework for macroprudential monitoring, analysis, and policy formulation (¶47, CBK). - Medium term (implementation in one to three years): 7. Institute a bank premium to fund ELA needs (¶58, CBK, Government). 8. Put in place extraordinary funding arrangements for DIFK (¶68). Adopt legal framework for crisis management, contingency plans, and perform crisis simulations (¶74–75, Government, CBK). 9. Conduct comprehensive review of financial system legal and regulatory framework to remove inconsistencies and ensure coherence (¶33, MoF/CBK). 10. Revise AML legislation to address technical weaknesses (¶36, MoF). 11. Introduce risk-based supervision focusing on systemic banks and parent-group linkages; enhance CBK supervisory capacity (¶38, CBK). 12. Enact regulation to introduce out-of-court insurance dispute resolution mechanism (¶30, CBK). 13. Enhance stress testing framework to include macro scenario analysis and macrofinancial linkages (¶51, CBK). 14. Develop and implement macroprudential policy using quantifiable indicators and instruments (¶47, CBK). *Source: IMF staff report — Executive Summary and relevant chapters (excerpts from the provided content).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Major vulnerabilities and system-wide findings - Although systemic risks appear to be manageable in Kosovo, there are pockets of vulnerability. - Kosovo banks are exposed to macro-financial risks due to the openness of the economy, limited scope to diversify, and modest range of tools available to the authorities to promote macroeconomic stability. - Vulnerabilities are exacerbated because of excessive name concentration. - Commendable progress has been made by the Central Bank of the Republic of Kosovo (CBK) in promoting the growth and stability of the banking sector; progress was achieved despite legal uncertainty, a challenging security context, and limited universal recognition of Kosovo’s independence which can limit CBK authority in certain areas. - CBK has focused to date on credit risk; going forward supervisors should adopt a comprehensive risk-based approach that includes operational and interest rate risks and risks related to subsidiaries of foreign banks and their relations with their parents. - Kosovo’s legal system was developed afresh since 2000 with intensive international technical assistance; inconsistencies and lack of coherence in the legal and regulatory framework need to be addressed. - Kosovo has unilaterally adopted the euro as its legal tender in 2002, which supports stability but places a premium on disciplined macroeconomic policies, makes fiscal policy the main instrument for domestic demand management, and imposes limitations on the central bank’s ability to act as lender of last resort. ### Structural features and key statistics - Financial system assets as a share of GDP more than doubled from 33 percent in 2003 to about 74 percent as of June 2012. - There are presently eight commercial banks, which account for more than 75 percent of total financial system assets and around 60 percent of GDP. - As of June 2012: - Commercial banks: 8; Assets: 2,652 (euros mn); Percent of total assets: 75. - Foreign banks: 6; Assets: 2,333 (euros mn); Percent of total assets: 66. - Domestic private banks: 2; Assets: 319 (euros mn); Percent of total assets: 9. - Nonbank financial institutions: 33; Assets: 892 (euros mn); Percent of total assets: 25. - Insurance companies: 13; Assets: 120 (euros mn); Percent of total assets: 3. - Pension funds: 2; Assets: 659 (euros mn); Percent of total assets: 19. - Micro-finance institutions: 14; Assets: 79 (euros mn); Percent of total assets: 2. - Total financial system (June 2012): 41 institutions; Assets: 3,544 (euros mn); Percent of total assets: 100. - The three largest locally incorporated banks are subsidiaries of European banks and together account for more than 70 percent of bank assets. - Kosovo’s nonbank sector: pension funds represent about 20 percent of total financial assets; microfinance accounts for 4 percent of the total loan portfolio of financial institutions. - Kosovo is one of the smallest insurance markets in Europe: - Gross non-life premiums, including personal accident and health, amount to about €67 million, of which about €1 million are life insurance premiums. - Market penetration rate: about €38 per capita. - In 2011 the overall real growth of the market measured by gross premium written (GPW) was under 5 percent. - 70 percent of premiums come from the compulsory third party motor liability insurance (MTPL). - Microfinance sector: - Accounts for 4 percent of the total loan portfolio of financial institutions. - Average loan size: €1,400. - Lending to agriculture accounts for 46 percent of total lending to the sector. - Two providers dominate the MFI market, with about 50 percent of assets. - Kosovo’s economy was affected by the global financial crisis of 2008/09: - GDP growth fell to 2.9 percent, from 6.9 percent the year before. ### Policy priorities and recommendations (Table 1: Key Recommendations) Short term (implementation within 12 months) 1. Ensure that costs associated with the legal defense of CBK employees sued while carrying out their official responsibilities are covered ex-ante (¶39 CBK). 2. Subject ELA granted to potentially insolvent systemically important institutions to very strict conditions (¶55, CBK). 3. DIL should raise the DIFK target level to 8–9 percent of insured deposits and should only introduce higher deposit coverage as the fund increases. It should also clarify that all past and future contributions made by the Government and KfW can be used to repay insured deposits. Banks’ premiums should not be reduced or discontinued except as defined in ¶71 (¶67 and ¶69–71). 4. Amend the BL to address the identified shortcomings in the bank resolution framework (¶63) and obstacles to competition and development of the MFI sector (¶43, ¶78, and ¶79, CBK, the Government). 5. Reinstate Solvency I for all insurers; establish an investment regulation for life and non-life companies for their own surplus and reserves, as well mandatory annual actuarial audit of provisions by a certified actuary; and retain two in-house actuaries (¶42, CBK). 6. Make initial steps to establish a framework for macroprudential monitoring, analysis, and policy formulation (¶47, CBK). Medium term (implementation in one to three years) 7. Institute a bank premium to fund ELA needs (¶58, CBK, Government). 8. Put in place extraordinary funding arrangements for the DIFK (¶68). Adopt a legal framework for crisis management, contingency plans, and perform crisis simulations (¶74–75, the Government, CBK). 9. Conduct a comprehensive review of the financial system legal and regulatory framework to remove inconsistencies, close gaps, and ensure coherence (¶33, MoF/CBK). 10. Revise the AML legislation to address its technical weakness (¶36, MoF). 11. Introduce risk-based supervision with attention to those risks resulting from systemic banks and their relation with their parent banks and groups, and enhance further the supervisory capacity of the CBK (¶38, CBK). 12. Enact and implement a regulation to introduce an out-of-court insurance dispute resolution mechanism (e.g., private arbitration with binding decision powers), in order to address the growing volume of consumer complaints against insurers and the lack of technical capacity of local courts to properly address insurance related disputes (¶30, CBK). 13. Enhance the stress testing framework to include macro scenario analysis as well as models specifying macrofinancial linkages (¶51, CBK). 14. Develop and implement macroprudential policy using quantifiable indicators and policy instruments (¶47, CBK). ### Financial safety nets, crisis management, and supervisory implications - The mission commends the authorities for the development of a comprehensive financial safety net. - Recommendations to refine legal and regulatory frameworks: - Ensure the size of the Special Reserve Fund (SRF) will remain adequate and minimize incentives for excessive risk taking. - Amend the banking law to ensure that banks are resolved at the least cost to taxpayers. - For deposit insurance: Government should ensure that the current deposit coverage of €2,000 is only increased as the fund size increases, that banks continue to contribute, and that all past and future contributions are available to be used to repay insured deposits. - Crisis management tools recommended: - Scope for the CBK to obtain appropriate government back stopping when emergency liquidity assistance (ELA) is extended to systemic banks that may be insolvent. - Use of a bridge bank only in the case of systemically important banks. - Clear and sufficient powers to identify a crisis scenario and take actions if necessary. - Contingency plans and crisis simulations. - Supervisory approach to MFIs should be commensurate with risks they pose; legal framework should allow sound growth of the strongest MFIs to reach underserved segments and increase competition. - Regulatory framework for insurance needs complete overhaul; CBK should reinstate the EU Solvency I framework as the main legal basis and strengthen investment regulation and actuarial requirements. *Source: IMF staff report — Executive Summary (pages provided in the source content).* ### 8. While Kosovo’s economy recovered somewhat after 2009, broadly in line with the ### _cr1399 - 8. While Kosovo’s economy recovered somewhat after 2009, broadly in line with the ### Macroeconomic developments - Real GDP grew on average by 4.5 percent during 2010–11, driven primarily by private sector demand. - Consumer prices: reversed from deflation of 2.4 percent in 2009 to inflation of 5.4 percent in 2010–11, triggered by higher prices for imported food. - Trade deficit widened from 39.7 percent of GDP in 2009 to 41.1 percent of GDP in 2011, reflecting mostly higher imports. - Strong current and capital inflows, primarily from the Kosovar diaspora, funded the deficit. - Early 2012 showed indications of a weakening in domestic demand. - Staff projection: real GDP growth of 2.7 percent in 2012. - Consumer price inflation expected to average 2.5 percent in 2012, compared with 7.3 percent in 2011 (Table 3). ### Financial institutions resilience — banks: exposures and channels of risk - External and domestic macro-financial risks affect Kosovo banks due to openness of the economy and cross-border financial exposures. - Transfers from Kosovars living abroad are equivalent to about 40 percent of GDP and are direct determinants of bank credit quality and liquidity. - Inflation is mainly driven by volatility of imported food items, affecting real income and real interest rates. - Credit growth is influenced by developments in foreign countries because the three largest banks are foreign-owned (parent banks in Germany, Austria and Slovenia); two of these parents are undertaking significant deleveraging outside their home markets. - Liquid assets are mainly foreign assets; banks invest around 22 percent of total assets abroad, largely in the euro area. - Placements in parent banks are limited to 15 percent of Tier 1 capital; no limits to placements in other banks. - Sovereign bonds (mostly highly rated) are the equivalent of about 70 percent of Tier 1 capital. - Balances with other banks (including parent banks) are 100 percent of Tier 1 capital. ### Domestic vulnerabilities and market structure - Kosovo is a small and concentrated economy limiting banks’ ability to diversify risks. - Exports remain small (about 7 percent of GDP); imports represent about 52 percent of GDP. - About a third of all bank loans are to the trade sector while another third are loans to households. - High informality and flaws in commercial legislation and judiciary procedures limit acceptable clients and promote name concentration on banks’ asset and liability sides. - Due to unilateral adoption of the euro, authorities have limited macroeconomic stabilization instruments and limited ability to provide a banking safety net. - Local interbank and other financial markets are almost nonexistent; T-bill issuance and market development are at an early stage. ### Banking system performance and indicators (selected) - Banking system NPL ratio: 3.3 percent in 2008, nearly doubled to 6.5 percent at end June 2012. - NPLs appear well provisioned by regional comparisons and based on relatively conservative classification requirements. - Aggregate return on equity: 10 percent as of June 2012, down from 19 percent at end-2010. - Banking system CAR: 17.2 percent as of June 2012, down from 18.8 percent at end-2010; most banks maintained CARs above the 12 percent regulatory minimum. - Deposit growth remained relatively flat during the first half of 2012; system credit expanded at an annualized rate of around 8 percent (higher for small and medium-sized banks). - Liquid assets: 29 percent of total assets covering about 34 percent of total deposits. - Supervisory moral suasion targeted an 80 percent loan-to-deposit ratio; banks meet this while investing the remainder abroad. Key Financial Soundness Indicators (selected, percent unless otherwise noted) - Regulatory capital to risk weighted assets: 17.2 (June 2012). - Regulatory Tier I capital to risk-weighted assets: 14.4 (June 2012). - Nonperforming loans to total gross loans: 6.5 (June 2012). - Return on assets: 1.0 (June 2012). - Return on equity: 9.7 (June 2012). - Liquid asset to total assets: 28.9 (June 2012). - Liquid asset to short-term liabilities: 36.2 (June 2012). - Large exposures to capital: 80.9 (June 2012). ### Stress testing: scenarios, assumptions, and channels - Stress tests assessed impact of further euro-zone deterioration via channels: decline in remittances and FDI; decline in value of European sovereign debt held by banks; higher counterparty risk from exposures to euro-zone banks; reduction in credit due to deleveraging by foreign-owned banks. - Adverse scenario assumptions included: GDP decline of 2 percent; yields on European sovereign bonds held by banks increase on average by 130 bps; average increase in default probability of European banks to which Kosovo banks are exposed of 140 percent. - Under the described adverse euro-zone scenario, the crisis assumptions equate to a weighted average haircut of about 5 percent on sovereign holdings; European banks’ default probabilities would increase from 1.8 to 4.2 percent. - The adverse scenario for Kosovo included: Real GDP growth of -2.0 percent in 2012 (Table 5), and an increase in NPL ratio projected to reach 10.5–11.2 in subsequent years under the adverse path. ### Stress testing: results and vulnerabilities - Overall, the banking system is generally resilient to further euro-zone deterioration, but pockets of vulnerability exist among small and medium-sized banks and in one large foreign subsidiary. - The two largest banks would remain above the regulatory minimum after shocks, partly because of projected reductions in risk-weighted assets from deleveraging and lower credit demand. - The remaining four locally incorporated banks are more vulnerable; their capital ratios would fall below the 12 percent minimum. Recapitalization needed to restore CARs to the minimum would be about 0.2 percent of GDP. - One large foreign bank subsidiary was more vulnerable; failure could affect the largest pension fund via its large deposit in the bank (~3 percent of the pension fund’s total portfolio). - Impact metrics from Table 6 (selected): - Banking system CAR (actual): 17.2. - Under a 50 percent NPL increase/one-notch downgrade: recapitalization needs mapped to percent of GDP show ranges in the table (see Table 6 for full breakdown). - Euro-Zone Recession Scenario: adverse scenario combined with a default of a large bank leads to larger recapitalization needs and an impact on pension fund portfolios percent change in value of -14.2 in the severe adverse case (Table 6). - Stress-test finding: the overall impact of the adverse euro-zone scenario on banks’ CAR is on average about 4.5 percentage points (footnote context). ### Policy implications and supervisory recommendations - Supervisors should monitor credit growth and strengthen provisions in the more vulnerable banks, taking particular account of exposures to parent companies. - Enhanced information exchange and coordination with relevant foreign supervisors may be necessary. - Attention to deposit concentration risks (including large public enterprise deposit movements) and to the pension fund exposure to vulnerable banks is warranted. - Continued development of domestic government securities (T-bills) and planned introduction of repo operations and longer-dated bills may help develop local market cushioning over time. *Source: Kosovo authorities; and IMF staff estimates and projections (excerpts from the provided content).* ### 14. Sensitivity tests found that banks are vulnerable to their highly concentrated ### _cr1399 - 14. Sensitivity tests found that banks are vulnerable to their highly concentrated ### Banking sector vulnerabilities and sensitivity tests - Large concentrations present despite some large corporate clients borrowing from several banks; exposures to common borrowers could induce correlation risk. - Capital adequacy impact: the CAR of one bank with a 10 percent market share would fall below 12 percent if the five largest common borrowers in the system defaulted. - Some banks vulnerable to further deterioration of loan quality in the trade sector. - Recommendation: ensure that the new regulation on large exposures is enforced in the planned schedule, and avoid exceptions to the large exposure limits. - Interest rate risk: - Driven by maturity mismatches between interest-sensitive assets and liabilities. - A parallel shift of 200 basis points in interest rates would bring two banks representing more than 25 percent of the system below the 12 percent CAR minimum. - Recommendation: supervisors should start monitoring interest rate risk and its potential impact on earnings and asset values. - Exchange rate risk: - Direct and indirect exchange rate risks are low because banks on average maintain small open foreign exchange positions and loans in foreign currency are less than 2 percent of total assets. ### Liquidity stress tests — findings and implications - Current liquidity arrangements include a targeted loan-to-deposit ratio of 80 percent imposed by supervisors by moral suasion; most banks meet it while investing most remaining deposits abroad; Emergency Liquidity Assistance (ELA) fund exists. - Systemic deposit run outcomes: - Cumulative deposit outflows of 15 percent of total deposits, combined with a 10 percent haircut on liquid assets, would deplete banks’ excess liquidity and bring the liquid assets of the banking system slightly below 20 percent of total deposits. - A 30 percent outflow, combined with a 20 percent haircut on liquid assets, would nearly deplete the liquid assets of the banking system. - The total liquidity assistance needed in that 30 percent/20 percent scenario would be equivalent to 2.2 percent of GDP. - ELA and CBK resources: - Liquidity assistance of up to 1 percent of GDP can be covered by the ELA fund and up to 2 percent of GDP, if CBK equity and reserves are included. - This assessment does not account for foreign-owned banks borrowing from foreign parents or lower haircuts if runs are locally triggered. - Bank-specific outcomes: - Available ELA funds would be able to fully cover liquidity needs of the two smallest banks (which hold 2 and 5 percent of total deposits respectively) in the event of a run affecting just these banks. - Deposit concentration: - A simultaneous withdrawal of the ten largest private deposits in each bank, which overall account for around 10 percent of total deposits, would reduce the ratio of liquid assets to total deposits of the banking system from 34 percent to around 27 percent. - One small bank would run out of liquid assets and the total amount of liquidity needed to meet the withdrawals would be around 0.3 percent of GDP. - Recommendation: supervisors should use information on deposit composition by size to identify potential vulnerabilities arising from deposit concentration. - Selected table summary (system-wide illustrative positions and stress outcomes): - Initial position (June 2012): Liquid assets to total deposits = 34.0; Number of banks with a liquidity shortfall = 0; Liquidity assistence needed (% of GDP) = 0.0. - Systemic deposit run scenarios (selected rows): - 10 percent outflow/5 percent haircut: Liquid assets to total deposits = 24.8; Number of banks with a liquidity shortfall = 0; Liquidity assistence needed = 0.0. - 15 percent outflow/10 percent haircut: Liquid assets to total deposits = 18.4; Number of banks with a liquidity shortfall = 1; Liquidity assistence needed = (0.1). - 20 percent outflow/15 percent haircut: Liquid assets to total deposits = 11.2; Number of banks with a liquidity shortfall = 2; Liquidity assistence needed = (0.5). - 25 percent outflow/20 percent haircut: Liquid assets to total deposits = 3.0; Number of banks with a liquidity shortfall = 3; Liquidity assistence needed = (1.2). - 30 percent outflow/20 percent haircut *: Liquid assets to total deposits = (3.9); Number of banks with a liquidity shortfall = 4; Liquidity assistence needed = (2.2). Note: (*) indicates approximately the maximum deposit run that could be covered by the emergency liquidity assistance fund (ELA) and the Central Bank's other available resources, which together amount to around 2 percent of GDP. - Run on a large bank (35 percent outflow of subsidiary's deposits/50 percent haircut): Liquid assets to total deposits = 27.2; Number of banks with a liquidity shortfall = 1; Liquidity assistence needed = (0.5). - Withdrawal of ten largest private deposits: Liquid assets to total deposits = 26.7; Number of banks with a liquidity shortfall = 1; Liquidity assistence needed = (0.3). ### Nonbank financial institutions — pension funds, insurance, and MFIs - Pension funds: - Two pension funds: Kosovo Pension Savings Trust (KPST, mandatory defined contribution) and Slovenia-Kosovo Pension Fund (SKPF, voluntary). - A correction in stock market valuations of around 20 percent would result in a decline in the value of the funds’ portfolios of around 14 percent. - Sovereign bond holdings significant: sovereign bonds represent about 28 percent of KPST’s assets (about 90 percent exposures to Germany, U.S., France, U.K. and Netherlands); sovereign bonds represent about 70 percent of SKPF assets (about two thirds exposures to Slovenia, Hungary, Netherlands, U.K., Italy, U.S., and Luxembourg). SKPF’s exposure to Slovenian sovereign bonds is about 14 percent of its total sovereign bond portfolio. - Market risks are borne by pensioners; funds bear liquidity risks if redemptions exceed expectations. Interlinkages with banks limited to deposits with banks, collateralized by pledged securities. - Insurance sector: - Four out of 10 nonlife companies are technically insolvent under EU Solvency I rules. - Three nonlife companies have insufficient liquid assets to cover current technical provisions, which appear considerably understated. - Motor Third Party Liability (MTPL) line: despite minimum MTPL premium and maximum agents’ commission rate, fierce competition leads to discounts/rebates and additional agent compensation; in 2011 most companies recorded negative underwriting income from MTPL and average return on equity (ROE) was 2 percent. - Risks from underestimation of technical provisions and insufficient market liquid assets to support provisions. - Motor Compensation Fund (MCF) currently has about €2 million in capital; the Fund annually collects over €10 million in premiums from “border policies.” The Fund is unlikely to experience financial difficulties covering outstanding claims against one or two bankrupt companies now, but ability to pay could be jeopardized in the medium term with disappearance of “border policy” revenue following Kosovo’s joining the Green Card system. - Reputational risk from poor record of claim payment; recommendation: CBK should enact and implement a regulation to introduce an out-of-court insurance dispute resolution mechanism (e.g., private arbitration with binding decision powers). - Microfinance institutions (MFIs): - After fast growth, MFI assets are now about 2 percent of financial system assets, down from 5 percent in 2007. - Drivers of contraction: governance concerns (largest MFI under official administration and lending frozen), regulatory uncertainty deterring capital increases, fraud cases causing credit losses, refocus on smaller loans. - As of June 2012: - Loan impairment (loans past due 30 days or more) = 9.2 percent. - Returns on assets (ROA) = 0.6 percent. - Returns on equity (ROE) = 0.4 percent. - Annualized profitability was significantly negative. - MFIs hold accounts with commercial banks; some commercial banks grant credit lines to MFIs for onlending, but most MFI funding comes from external sources. Given MFI size, these linkages do not appear to pose systemic risk. ### Financial sector oversight — supervisory capacity and legal framework - Basel Core Principles assessment found an uneven level of compliance, primarily due to resource constraints. - Key areas to address: upgrades to the legal framework; development of a risk-based forward looking supervisory program; consolidated supervision and closer coordination with foreign supervisors; continuation of capacity building in supervision. - CBK responsibilities: regulation and supervision of commercial banks, microfinance companies, insurance companies and other financial service providers (as established in the CBK Law). - Legal and regulatory consistency issues: some banking legislation and regulation need completion or modification to ensure consistency; rapid institution building with intensive international technical assistance may have overburdened local capacity to ensure a fully consistent regulatory framework. - Supervisory challenges due to political/security context: - Declaration of independence of Kosovo not universally recognized poses challenges to CBK authority in some areas; two commercial banks licensed in the Republic of Serbia with operations in northern Kosovo (Mitrovica) are not as intensively supervised as other banks. - One Mitrovica-headquartered institution has not been licensed in Kosovo and does not recognize CBK authority; ad-hoc arrangements have been required for on-site examinations. - Political tensions and lack of regular supervision of banks operating in northern Kosovo reduce CBK effectiveness; ratings for permissible activities, ongoing supervision, and enforcement of corrective actions reflect the supervisory standoff in Mitrovica. - Highlighted risk: potential for escalated tensions if a bank experiences liquidity or other difficulties. - Anti Money Laundering (AML) law: - The Law on the Prevention of Money Laundering and Terrorist Financing (approved 2010) presents technical deficiencies, including lack of specific provisions giving authority to the CBK or the Financial Intelligence Unit to carry out compliance inspections in several institution types, notably banks, and insufficient protection to bank officials filing reports to the FIU. - An AML/CFT assessment is scheduled to be conducted by the World Bank by mid-2013 (as reported in the document). - Supervisory approach and gaps: - Supervision remains largely compliance-based rather than risk-based; CAMELS internal rating system used. - Credit risk assessment receives sufficient attention, especially during on-site exams, but operational, interest rate and liquidity risks have not received necessary supervisory focus. - Recommendation: implement a risk-based supervisory regime, especially for the three systemic banks; enhance supervisory capacity to understand and monitor risks of foreign banks regularly and timely. *Source: Central Bank of Kosovo and IMF staff estimates, as presented in the supplied content.* ### 28. Legal protection for banking supervisors and other CBK employees was found to be ### _cr1399 - 28. Legal protection for banking supervisors and other CBK employees was found to be ### Legal protection for CBK staff and supervisors - Legal framework: members of the Central Bank’s decision-making bodies or its staff “shall not be liable for acts or omissions performed in the course of the duties and responsibilities, unless it has been proven that such acts or omissions constitute intentional wrongful conduct or gross neglect.” - Framework also “indicates the obligation of the CBK to indemnify them for the legal costs they have incurred in these cases.” - Practice and shortcomings: - In practice employees had to cover all costs of their legal defense until being definitively cleared of any wrongdoing; only then were staff entitled to claim reimbursement from the CBK. - Defense costs “may be substantial” and the process of getting definitive acquittal “can take a long time.” - Even if cleared of criminal acts, CBK may challenge expenses and “not reimburse any costs until the claimant gets the official declaration from a Court of Justice compelling the CBK to pay.” - Lack of proper coverage applies to bank and other financial sector supervisors, and to deposit insurance fund employees. ### CBK supervisory actions (banks) - CBK has exercised substantial supervisory authority, including: - Temporarily prohibiting payment of dividends. - Requiring capital injections. - Replacing management in banks. - Closing branches in Kosovo of an unlicensed bank. ### Nonbank Financial Institutions (insurance, MFIs, NBFIs) - Insurance regulation: - Insurance activities governed by UNMIK Regulation No. 2001/25. - Main CBK regulation: Regulation on Deposit of Assets as Security, Capital Adequacy, Financial Reporting, Risk Management, Investment and Liquidation, effective January 1, 2007, which “replaced EU Solvency I.” - MTPL Law No 04/L-018 on Compulsory Motor Liability Insurance passed in 2011. - Assessment: CBK main insurance regulation “suffers from severe technical deficiencies” and its 2007 adoption was a “legislative setback” versus prior regulation. - Recommended legal/structural changes for insurance: - “EU Solvency I framework should be reinstated as the main legal basis for monitoring, supervising and enforcing minimum solvency margin requirements.” - A new insurance law should be approved to supersede all existing UNMIK regulations and provide a comprehensive legal foundation. - Specific regulatory gaps identified: - Minimum requirements for calculating technical provisions missing. - No requirement of mandatory annual actuarial audits by accredited and licensed actuaries. - No requirements for actuarial accreditation. - No specification of potential liabilities for erroneous or misguided opinions. - MFIs and NBFIs: - Both are non deposit taking institutions, regulated and supervised by CBK. - Scope of permitted activities broader for NBFIs; MFIs can only lend to SMEs and low-income households. - NBFIs lack capital and licensing requirements and have fewer activity restrictions, while MFI regulations mimic those of banks. - Recommendation: amend legal framework to create a level playing field between MFIs and NBFIs; develop reporting requirements and supervisory processes appropriate to risks; ensure regulatory requirements promote growth in both sectors. ### Payment System - Single payment system: Electronic Interbank Clearing System (EICS) — a hybrid interbank payment system operated by the CBK that clears priority payments, retail credit transfers, and retail direct debits; all commercial banks and the CBK participate. - CBK initiatives: - Implementation of a Real-Time Gross Settlement (RTGS) payment system for large-value transactions, initiated with World Bank assistance, “expected to be completed by 2014.” - Plan to establish a national card switch system to reduce costs and improve efficiency. - Payment instrument usage: - Non-cash instruments including checks are still not widely used. - Payment card use is low but both number of cards and transactions “has increased significantly.” - All banks operate their own ATM and POS networks; limited cooperation for sharing networks. - Oversight implementation: mixed progress on Fund technical advice; oversight function separated from operation by establishing two divisions in the Payment System Department; hiring an expert to head oversight proposed in 2013 budget; further recommendations depend on passing the Payment System Law. ### Macroprudential oversight - Current state: - CBK “lacks an integrated framework for formulating and implementing policies” to fulfill financial stability responsibility. - Need to counter macro instability from opening of the economy and lack of monetary policy instruments. - Institutional recommendations: - Establish a Macroprudential Policy Advisory Committee (MaPaC) including Executive Board, Financial Stability and Supervision Departments, and other relevant departments; MaPaC to meet quarterly to review indicators and recommend measures to the Executive Board. - Strengthen accountability and transparency: pre-announced schedule of meetings, press releases on decisions, publication of the Financial Stability Report, Governor appearances before the Assembly Budget and Finance Committee, briefings for banks, press and analysts. - Analytical and operational recommendations: - Establish primary indicators for structural and cyclical vulnerabilities and assign instruments to manage those risks. - Cyclical vulnerability indicators suggested: - For leverage/credit: bank leverage ratio or credit/GDP ratio. - For liquidity: bank loan/deposit ratio (LDR). - Use stress testing based on macroeconomic analysis. - Monitor ancillary indicators alongside primary indicators to interpret developments and distinguish system-wide from institution-specific issues. - Data limitations: lack of timely, good quality macroeconomic data complicates indicator determination; priority to improve macroeconomic indicators and research on Kosovo’s business cycle. - Instrument examples: - Limits on loan-to-value or debt- or debt service-to-income ratios for households; analogous measures for firms; countercyclical bank capital elements. - Countercyclical component to reserve requirements for banks. - Advocate a rules-based approach with scope for judgment. ### Financial sector safety nets and crisis management Subsection: Emergency Liquidity Assistance (ELA) - Legal and operational features: - ELA introduced in 2010 for solvent banks and insolvent but systemically important ones. - New Central Bank Law and regulation allow CBK to provide liquidity assistance for solvent but illiquid banks up to 100 percent of Tier 1 capital. - CBL grants CBK power to provide emergency liquidity to banks that may be insolvent if failure would have adverse implications for financial stability. - Initial ELA can be granted for up to 28 days; any extension beyond three months requires a program approved by the CBK’s executive board specifying remedial actions. - Staff view and conditions: - Staff does not support use of ELA for insolvent banks, even if systemically important; if retained, such ELA should be subject to strict conditions including previous declaration of systemic crisis and a government guarantee in writing securing repayment. - Resources and adequacy: - “Resources available for ELA operations amount to approximately €90 million.” - This equals “about 5 percent of bank deposits subject to reserve requirement, or 2 percent of GDP” and “would seem adequate to contain liquidity problems in one or two small banks.” - Footnote details: “Total deposits were about €2 billion as of June 2012. Each of the largest banks holds about 10–30 percent of total deposits, while each of the remaining banks hold about 2–6 percent of total deposits. The Ministry Of Finance (MoF) used the purchase of about €46 million tied to the first program review to fund the central bank’s special reserve fund (SRF) for ELA and the rest is available from the CBK’s own resources. Amendments made in 2012 to the Law on Public Financial Management and Accountability state that only with the consent of the CBK may the Treasury withdraw the SRF assets; and the letter of intent and other program documents indicate that the SRF will remain available for ELA independently of the repayment of the IMF facility.” - Cost-sharing and premiums: - Banks, as ELA beneficiaries, should bear at least part of the costs to limit moral hazard and maturity mismatching. - Proposal: an ELA premium “equivalent to 0.3 percent annually of bank deposits subject to reserve requirements.” - Quantified impact: “A premium of this size applied to the current deposit base subject to reserves, would amount to around €5.3 million and would be consistent with growth of the deposit base by about 6 percent per year.” - Premiums to be pooled in the SRF. - Note: in Ecuador, premium equivalent to 0.25 percent of deposits subject to reserve requirements; Ecuador’s ELA arrangements are entirely funded by banks. - Other operational issues: - Consideration of reserve pooling arrangements if significant ELA funding increase is needed (examples: Ecuador; considered in Panama and El Salvador). - Collateral requirements for ELA currently include government of Kosovo securities, securities of EU countries and banks registered in the EU, and liquidity reserves at CBK; these may be too restrictive and consideration should be given to include certain types of loan portfolio subject to haircuts. - No operational procedures established yet: need for draft contracts, designation of tasks and responsibilities, solvency analysis, remedial program when ELA initially granted (not only upon renewal), and enhanced monitoring by Supervision Department. Subsection: Resolution of problem banks - CBK as resolution authority with new Banking Law tools: - Appointment of an official administrator following triggers who takes over powers of shareholders and management. - Official administrator must prepare a resolution plan within 60 days of appointment. - Official administrator can propose assets/liabilities transfer via Purchase and Assumption (P&A) before license revocation; or initiate liquidation. - If bank not rehabilitated within one year, license revoked (Article 61). - CBK can revoke a license directly and transfer assets/liabilities by initiating receivership; liquidator appointed by CBK. - Payment of insured deposits occurs after license revocation and receivership initiation. - Possibility of creating a bridge bank. - Recommended legal amendments and safeguards: - Amend the banking law to define P&A to include transfer of liabilities and assets (articles 68.4 and 73.22). - To minimize litigation risk, P&A should only be performed after license revocation. - Limit bridge bank option to systemic banks to reduce resolution costs. - Introduce a clearly formulated least-cost test to guide choice among resolution options (including liquidation vs P&A); task CBK with performing this test. - Formalize policies and procedures in a bank intervention and resolution manual. - On judicial challenges: - CBK decisions can be challenged in court but cannot be overturned; they can warrant compensation if actions are found unlawful, arbitrary or capricious. - This feature ensures prompt resolution of problem banks but has consequences for protection of CBK staff as noted earlier. Subsection: Deposit Insurance (DIFK) - Establishment and governance: - DIFK created by Law in 2010 and became operational in 2011. - Several amendments to the Deposit Insurance Law (DIL) were before Parliament (expected to be passed by end-2012) to improve and clarify structure and operations. - DIFK is an independent agency with legislated objectives to protect small depositors and contribute to financial stability. - Management Board appointed by CBK comprises: (i) the CBK Governor; (ii) one representative from the Ministry of Economy and Finance; (iii) the DIFK Managing Director; (iv) a deposit insurance expert; and (v) an expert certified auditor. - The Law is silent on the term of the Managing Director. - Funding and coverage: - DIFK is an ex-ante scheme with initial funding provided by the government (partly from a World Bank loan) and the German donor agency KfW. - Current fund size is “a little over €13 million (including initial disbursements and bank premiums already collected).” - This represents approximately “4.6 percent of insured deposits in the banking sector.” - DIL should clarify whether initial contributions from Government and KfW and funds raised through bonds can be used for insured deposit payouts, as current drafting is unclear. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 57. As a narrow mandate (“paybox”) scheme, DIFK is responsible for collecting ### _cr1399 - 57. As a narrow mandate (“paybox”) scheme, DIFK is responsible for collecting ### DIFK mandate, operations, and emergency funding - DIFK is a narrow mandate (“paybox”) scheme responsible for collecting periodic premiums from banks, accumulating and investing these premiums, and reimbursing insured depositors in the event of a bank failure. - DIFK has no supervisory or resolution powers; it is permitted to (and does) assess risk-based premiums, which, in conjunction with CBK’s supervisory regime, helps mitigate moral hazard. - Amendments to Article 12.1 require DIFK to begin repayment of insured depositors “...as soon as possible...but not later than 30 days of the insured event” (reduced from 60). Given Kosovo’s special bank insolvency regime, and assuming advance preparation by both DIFK and CBK, repayment could easily start within three to seven days. - The law permits DIFK to borrow in the market (but not from member institutions), with Government guarantee, and to issue bonds, but there is no formalized emergency back-up funding arrangement in place. - Recommendation: The Government should put in place a “fast track” limited line of credit to reimburse insured depositors when the reserve fund is depleted. Replenishment of the fund should be made through premiums paid by the banks, using the emergency premium power to the extent permitted. ### Reserve fund size and coverage recommendations - Staff calculations indicate the current target reserve level of 5 percent of total insured deposits should be raised to a range of 8–9 percent. - Typical rules of thumb: for a banking sector comprising 20 to 40 banks, the reserve fund should be adequate to cover 4 to 6 small, or 2 to 3 medium-sized bank failures. The benchmark is inadequate for Kosovo given its relatively small banking sector and composition. - Recommendation: A fund size that could compensate insured depositors in the event of two small or one medium-sized bank failures is recommended. ### Deposit coverage level and implications - Principle: Deposit coverage should grow in line with the growth of the DIFK. - DIFK estimates that the €2,000 level fully covers approximately 90 percent of depositors and around 14 percent of the total value of insured deposits in the banking sector. - Proposed amendment: increase deposit insurance coverage from €2,000 to €5,000. - DIFK staff estimates the proposed €5,000 level would fully cover approximately 93 percent of depositors (coverage of depositors would increase by only 3 percent). - However, it would increase DIFK’s exposure by about 80 percent (from approximately €300 million to around €529 million). - Recommendation: Given current target considered too low and absence of legitimate back-up funding arrangement, it would not be appropriate to introduce coverage expansion now. A higher fund size could support higher coverage and help to gradually close the gap with deposit insurance coverage in the euro area. - Note from staff/authorities: A compromise agreement (reached in program negotiations after the FSAP mission left) was that coverage would increase in line with growth of the target reserve fund, with coverage increasing to €3,000 on January 1, 2014, €4,000 on January 1, 2016, €5,000 on January 1, 2018. ### Premiums, government contributions, and fund governance - Banks’ premiums should not be reduced or discontinued even if the fund’s current target size has been reached, except when a bank becomes less risky justifying adjustment to its risk-based premium. - Current law gives DIFK power to stop contributions once target is reached; amendments before Parliament are silent on this issue. - Core principle: Cost of bank failures should be borne by the banking industry; deposit insurance fund should be funded primarily with bank contributions. - Presently most contributions to DIFK have been made by the government. Recommendation: When the target reserve fund achieves a significant buffer above its exposure, DIFK should consider repaying government contributions. ### Institutional coordination, contingency planning, and crisis management - Existing coordination mechanism between CBK, MoF, and DIFK provides foundation for a comprehensive crisis management framework. - A tri-party MoU on financial stability cooperation was signed end-2011 between the CBK, the MoF and the Assembly Committee on Budget and Finance (ACBF). - The MoU established the Financial Stability and Crisis Management Committee (FSCMC), a consultative forum with no decision power. - Coordination between CBK and DIFK primarily occurs through the Governor of the CBK as a Board Member at DIFK. CBK and DIFK recently signed a MoU for information sharing. - Recommendation: Government should consider creating a Crisis Management Executive Committee (CMEC) comprising the MoF, the CBK and the DIFK with decision making power regarding the declaration of a potential systemic crisis upon proposal by the CBK. - Kosovo has not developed a process for contingency planning. Recommendation: Authorities should prepare a contingency plan, test it through simulation exercises, and require large banks to prepare their own contingency plans for prolonged stress periods. ### Legal framework enhancements for crisis management - Existing framework includes ELA and provisions for creating bridge banks; it should be completed with other legal arrangements: - Extraordinary funding arrangements for the DIFK (¶68). - Option for CBK to avail of government guarantees to extend ELA to systemic banks that may be insolvent (¶55). - Limit use of bridge bank to cases involving a systemically important bank. - A comprehensive framework should: - Name the authority responsible for identification of systemic scenarios. - Provide legal basis for enhanced legal tools. - Identify potential source of funding. - Grant power to: (i) the CMEC to declare a potential systemic crisis upon proposal of the CBK; (ii) the DIFK to increase deposit coverage; and (iii) the Government to issue guarantees as a condition to extend ELA to systemic banks that may be insolvent and to lift the limit of 100 percent of Tier 1 capital in these cases. - Recommendation: Authorities should have power to undertake these actions without getting upfront Parliamentary approval or, if approval is required, obtain it in a single extraordinary session of Parliament the same day of the crisis declaration. ### Financial sector development findings - Access to financial services: - 60 percent of all households (and 52 percent of all low-income households) have access to a bank account. - Use of electronic payment services is limited due to high informality. - ATM and branch penetration is low by regional standards. - Lending is limited except to salaried individuals and established businesses. - Loans of less than €10,000 to small businesses account for under 7 percent of the total loan portfolio. - Loans for up to €30,000 account for about 14 percent. - Loans for agricultural activities account for only 2.4 percent of total loans provided by commercial banks. - Profitability and margins: - Interest rate spreads and margins are high compared with region. - The average weighted differential between deposit and lending rates in Kosovo exceeded 1000 points since 2008. - In 2011, the differential was 1060 basis points, falling to 1016 in 2012. - Regional average spread is less than 400 basis points. - Net interest margin to loans ratio has remained robustly above 8 percent since 2009. - Market structure and regulation: - Profitability and pricing resilience suggest more competition is needed, but the new banking law reduces potential for banks and MFIs to compete. - Legislative thresholds limit MFIs to clients whose income is less than the taxable threshold and cap total annual debt servicing cost, putting most MFIs in violation. - Regulatory uncertainty and complexity of CBK framework constrain MFI sector growth; many MFIs lack the scale/sophistication to implement regulations and are not deposit takers. - Recommendation: CBK should create a Financial Inclusion Task Team comprising Ministry of Trade, Finance and Justice and business associations to address obstacles to MFI growth. ### Risk assessment highlights (from Risk Assessment Matrix) - Major threats and likelihood/impact summaries (selected): - A sharp domestic downturn triggered by a strong intensification of the euro area crisis: Likelihood Medium, Expected Impact Medium. - Sovereign risk from exposure to distressed euro-zone government bonds: Likelihood Medium, Expected Impact Small. - Exposures primarily to euro-zone countries, which account for around 8 percent of total banking system assets. - Credit quality deterioration from portfolio concentrations to trade and single borrowers: Likelihood Medium, Expected Impact High. - Contagion from parent banks: Likelihood Medium/High, Expected Impact Medium/High. - Banks invest about 22 percent of total assets abroad as of June 2012; regulation restricts placements in parent banks to 15 percent of Tier 1 capital. - Failure of a large bank: Likelihood Low/Medium, Expected Impact High. - The three largest banks report CARs well above the 12 percent benchmark; three largest banks account for more than two thirds of banking system assets. ### Stress testing framework (key assumptions and results reporting) - Solvency stress tests (Top-down by FSAP Team): - Institutions included: All banks (eight licensed commercial banks). - Market share: Banks included account for 100 percent of total banking system assets and more than 80 percent of total financial system assets. - Data and baseline date: Balance sheet and income statement supervisory data as of June 2012. - Methodology: Balance sheet and income statement sensitivity analysis and projections conditioned on macroeconomic scenarios based on a regression model estimated by the mission. - Stress test horizon: Five year horizon for macroeconomic scenarios. - Shocks tested: macroeconomic downturns tied to the euro-zone crisis; cross-border contagion; systemic risk scenarios (interbank exposure matrix). - Sensitivity analysis: shocks to loan quality; sovereign bond holdings (haircuts); counterparty interbank exposures; credit concentration/correlation risk (default of large obligors); sectoral loan shocks; failure of a large bank; interest rate and exchange rate shocks. - Risks assessed include credit risk from domestic lending, credit risk from holdings of foreign sovereign bonds, counterparty interbank risk, credit concentration/correlation risk, macroeconomic linkages, cross-border financial contagion risk, interest rate and exchange rate risks, and systemic risk through interbank exposures. - Calibration: regression analysis and historical experience. - Behavioral adjustments: credit growth projections used; profit modeled considering future lost income from NPLs and assuming constant margins and no dividend payout; constant balance sheet allocation assumed in most stress tests. - Regulatory standards: Hurdle rates based on national prudential requirements (12 percent minimum CAR). Basel I definitions of capital and RWA. - Results: Stress test impact measured on bank-by-bank and system CARs. - Liquidity stress tests: - Institutions included: All banks. - Market share and data baseline: same as solvency tests (100 percent of total banking system assets; supervisory data as of June 2012). - Stress test horizon: Five-day horizon. - Scenario analysis: linking solvency and liquidity risks and simulating cross-border contagion effects; systemic deposit run with run-off rates uniform or contingent on parent/subsidiary asset quality. - Sensitivity analysis: deposit concentration risk tests simulated withdrawals of large deposits (e.g., government deposits, top 3, 5, 10 private deposits). - Risks assessed: funding liquidity shock, market liquidity shock, combinations of funding and market liquidity shocks, deposit concentration risk. - Calibration: Historical experience/ad hoc simulations. - Results: Liquidity shortfalls measured as a percentage of GDP and in terms of post-shock liquid assets to total deposits ratios. ### Payment system oversight follow-up (selected actions) - Actions recommended and timing (selected): - Define the legal architecture for the Payment Systems legal provisions: Immediately — Included in the Draft Law on Payment System. - Ensure consistency between the Payment System law and the Banking law: Immediately — Included in the Draft Law on Payment System. - Include reasons for revoking or suspending a payment system operator in the Payment System law: Immediately — Included in the Draft Law on Payment System. - Add possibility for the central bank to ask for specific external audits in the Payment System law: Immediately — Included in the Draft Law on Payment System. - Publish an oversight regulation once the Payment System law enters into force: Included in the Draft on Oversight of Payment System Regulation. - Include systems operated and payment instruments issued by the CBK in the oversight scope: Continuously — Included in the Draft on Oversight of Payment System Regulation. - Develop a three-year annual on-site inspection plan for payment service providers, including non-banks: By end 2011 — Waiting for implementation of the Law on the Payment System. *Source: _cr1399 - 57. As a narrow mandate (“paybox”) scheme, DIFK is responsible for collecting (IMF staff report content as provided).* ### 8. Publish a policy statement ### 8. Publish a policy statement on oversight ### Oversight implementation and timeline - By the time the Payment System law enters into force: Will be fully implemented when the Law on Payment System is implemented. - Producing quarterly oversight written notes, to be communicated to the Governor: - As from September 2011: Weekly and monthly reports have been presented to the CBK Executive Board since September 2011. The format of the Quarterly report is still there to be determined. - Provide a summary of the oversight activities and developments relating to the Kosovo’s payment system in the Annual report: - As from the next Annual report: The summary on oversight activities was published for the first time in the Annual Report for 2011. - Include a section on the national payment system in the Financial Stability Report: - As from the next Financial Stability report: The section on payment systems is included in the Financial Stability Report No.2. ### Oversight organization — recommended actions and status - Implement a strict organizational separation between the oversight function and the operation function: - Time frame: Continuously - Comment: Two divisions in the Payment System Department has been established: (i) Payment System Operations Division and (ii) Analysis and Oversight of Payment Systems Division. - Hire an experienced executive for the oversight unit, with a banking supervision background to be able to organize systems’ assessments and payment service providers’ on-site inspections: - Time frame: Immediately - Comment: Hiring of an expert is proposed in the budget plan for the 2013. - Develop a range of procedures to implement the oversight policy, consistently with the banking supervision ones: - Time frame: Once the Payment System law and the oversight regulation are finalized - Comment: Waiting for the implementation of the Law on the Payment System. - Define an annual oversight working plan: - Time frame: Immediately - Comment: An annual oversight working plan has been prepared. - Submit oversight activities to internal audit: - Time frame: Continuously - Comment: A standard document is being prepared to be sent to the internal audit. - Create an internal CBK committee including all the relevant functions, to meet regularly and form a common position on oversight issues: - Time frame: Immediately - Comment: Not implemented. - Organize a close cooperation with the neighboring countries on oversight issues: - Time frame: To be launched as soon as possible - Comment: Participated at the conferences organized by the National Bank of Macedonia and Turkey in 2012. Plans to visit the Bank of Albania in October 2012. ### Basel Core Principles — assessment context and key findings - Assessment logistics: - The assessment of the Basel Core Principles for Effective Supervision (BCP) was conducted from September 18 to October 2, 2012 as part of an FSAP Assessment. - The supervisory framework was assessed against the BCP methodology issued in October 2006; and the principles were assessed on the essential criteria only. - This is the first BCP assessment for Kosovo under the Financial Sector Assessment Program (FSAP). - Assessors: Diane Mendoza, (IMF, former-OCC) and Martín Vázquez Suárez (World Bank, former-Bank of Spain). - Information and methodology used for assessment: - Sources included: (i) a preliminary self-assessment prepared by CBK; (ii) meetings with the Governor, the Deputy Governor for supervision of financial institutions, Directors and senior staff of CBK; (iii) meetings with the Head and senior officials of the Financial Intelligence Unit (FIU) and the Director of the Deposit Insurance Fund; (iv) review of laws, regulations, advisory letters, and other documentation; (v) reviews of CBK executive orders, inspection manuals and guidelines, offsite and onsite supervision reports, licensing documentation, fines and sanctions, and follow-up documents; and (vi) meetings with senior executives of local and international banks, the Kosovo Financial Reporting Council, the association of certified accountants and auditors, the bankers’ association, and several bank auditors. - Institutional and macroeconomic setting — select points: - Kosovo is in the final stages of transition to full self-governance in economic and financial affairs; since 1999 under UN administration (UN Security Council resolution 1244); declared independence in February 2008; recognition by international community is uneven. - Kosovo’s economy has remained largely shielded from the euro-area crisis, but there are risks from deterioration of labor market conditions in countries where the Kosovo diaspora resides, which could depress remittances and foreign-direct investment. - Banking sector growth: at end-2011 banks held assets that represented almost 60 percent of GDP, compared to 5 percent of GDP in 2000. - Banking sector health indicators: - Average capital adequacy: stood well above the regulatory minimum of 12 percent. - Share of nonperforming loans: 6 percent, largely unchanged since end-2011. - Loan-to-deposit ratios: prudent, averaging about 80 percent across the banking sector. - A small domestic bank was recapitalized by its owners in February after its capital adequacy ratio had temporarily dropped below the regulatory minimum in 2011, as a result of the on-site supervisory work of the CBK. - Preconditions and infrastructure issues: - Challenges: difficulties to enforce contracts; insufficient definition of real estate property rights (partly as a result of the war); reported widespread inefficiency of the judiciary — these present significant difficulties in taking possession of collateral and reduce its value to mobilize credit. - Positive elements: accounting framework based on IFRS (with some differences on provisioning); auditing profession performing well regarding the banking sector; public credit registry operated within the CBK reported to work efficiently. - Institutional responsibilities and market structure: - As established in the CBK Law, the CBK is responsible for regulation and supervision of commercial banks, microfinance companies, insurance companies, and other financial service providers. - Financial sector composition as of June 2012: commercial banks holding about 75 percent of all financial assets; pension funds about 19 percent; the rest held by insurance companies and microfinance institutions. - Macroeconomic snapshot (2011): - Real GDP growth in 2011 is estimated to have reached 5 percent. - Inflation moderated to 3½ percent (y-o-y). - Current account deficit estimated to have widened to about 20 percent of GDP in 2011, from 17½ percent of GDP in 2010. - Main assessment findings and supervisory capacity gaps: - This is the first FSAP in the Republic of Kosovo; previous BCP self-assessments conducted in 2006 and 2008. - Political and social challenges, and uneven international acceptance, affect CBK’s ability to fully execute supervisory mandate (notably inability to conduct on-site supervision in certain areas of Kosovo). - Significant weaknesses in laws and regulations persist despite considerable volume of legislation; technical weaknesses, inconsistencies and gaps noted. - Foreign-owned banks dominate the banking sector, demanding more robust and comprehensive oversight by the CBK and the development of a risk-based, forward-looking supervisory system. - Objectives, Independence, Powers, Transparency, and Cooperation (CP 1): - CBK is a public legal subject with financial and managerial autonomy; primary objective to maintain a stable financial system, achieve and maintain price stability, and support government policies. - Two stated supervisory objectives: (i) evaluate the overall safety and soundness of banking organizations and (ii) protect depositors' funds and maintain a stable financial system. - Governance framework provides accountability and transparency; hiring and termination processes for Governor, Deputy Governors and Central Bank Board members are detailed in Law No. 03/L-209 on Central Bank of the Republic of Kosovo (CBK Law). - CBK has formal arrangements for information sharing with four of the six home supervisors for foreign-owned banks; encouraged to initiate coordination with remaining foreign supervisors. - Supervisors have inadequate coverage of legal expenses in the event of lawsuits; reimbursement process is cumbersome and results in delayed payment. - Licensing and Structure (CPs 2–5): - Since 2008, number of licensed banks steady at eight, with six controlled by foreign owners. - In July 2012, CBK took action to close two locations of an unlicensed bank operating in Kosovo. An unauthorized bank is still operating in a Serbian enclave in the north of Kosovo. - Three applications were denied, withdrawn or rejected since 2008 and two were pending at time of assessment. - Banking Law is very prescriptive regarding licensing; CBK encouraged to consider developing a regulation to guide applicants and update the licensing manual. - Transfer of ownership or control over banks is subject to CBK approval. Effective October 12, 2012, threshold for a significant interest will be decreased from 20 percent to 5 percent. - Inadequate control over investments in non-financial companies; CBK encouraged to require notification by banks regarding such investments and to have authority to unwind transactions deemed excessively risky. - Prudential Regulation and Requirements (CPs 6–18): - Minimum paid in capital requirement for domestic banks of seven million Euros will become effective October 12, 2012, rising from five million euros. - Branches of foreign banks may be required to maintain a capital equivalency deposit with the CBK, if so directed by the CBK. - Minimum risk weighted assets (RWA) to Tier I capital is 8 percent and total capital to RWA is 12 percent. Capital calculations do not include charges for market risk and operational risk. - Definition of capital and asset weights are largely compliant with Basel weighting guidelines. - CBK has used a very “light touch” on risk management processes of banks; banking law and rules address risk management generally. - Guidance provided by the CBK has been limited to credit risk and liquidity risk, with insufficient detail on liquidity. - CAMELS-based review is still the foundation of supervision, although CBK has introduced a risk matrix component into on-site examinations of systemic banks (those holding 10 percent or more of deposits). - CBK faces challenge of developing staff skills and internal processes to implement a risk-based and forward-looking supervisory regime. *Source: _cr1399 - 8. Publish a policy statement* ### 22. Credit risk in the loan portfolio is well-addressed by the supervisory process. ### 22. Credit risk in the loan portfolio is well-addressed by the supervisory process. ### Credit risk and supervisory coverage - Banking Law includes an extensive set of rules and regulations to address credit risk in the loan portfolio and much of on-site examination is dedicated to this component. - Supervisors appear well-informed of loan portfolio exposures to banks’ related parties and such loans are regularly reviewed as part of on-site examinations. - Concern: other sources of credit risk are not being adequately addressed, notably exposures of local banks to their foreign parents and affiliates. - Specific regulatory gaps noted: - No specific regulation regarding country risk and transfer risk. - Transfer risk is potentially significant due to the important presence of foreign-owned institutions and potential restrictions on cross-border flows. ### Supervisory emphasis on governance and internal controls - CBK places emphasis on corporate governance and internal control requirements during on-site examinations. - Guidance issued to banks addresses internal control, audit, and Board of Directors’ responsibilities in designing and implementing risk management systems. - On-site inspections review compliance with risk management requirements; identified deficiencies are explicitly addressed in inspection reports and followed up by CBK when significant. ### Anti–money laundering / Combating the Financing of Terrorism (AML/CTF) weaknesses - Legal framework lacks specific assignment of responsibility to any public authority in Kosovo to conduct on-site AML/CTF compliance reviews in banks and financial institutions. - Weaknesses identified: - Insufficient coordination between the CBK and the FIU. - Limited performance and severe resourcing and leadership deficiencies in CBK’s AML-specialized division (BSD division). - Vacuum in law regarding responsibility to undertake AML/CTF compliance examinations in several institutions, most notably banks. - Consequence: increased perception that obligation to report suspicious activities is not fully met in all cases. ### Ongoing supervision, liquidity, interest rate, and operational risks - Ongoing supervision focuses on adequacy of banks’ management, quality of internal controls, and critical revision of loan portfolios; this approach contributed to sector resilience during the international crisis. - Identified needs: - Regulatory framework for liquidity and interest rate risks is currently too generic. - No specific regulation or supervisory processes yet for operational risk and risks from relationships between Kosovo subsidiaries and their foreign parent banks/group. - Draft regulations pending final approval by the CBK board will be important but must be complemented by enhanced supervisory processes. ### Off-site supervision and supervisory reporting - Off-site supervision prepares monthly and quarterly reports but they provide insufficient analysis to guide supervisory action. - Supervisory reporting must be significantly improved to: - Widen reach, increase depth, and improve level of detail. - Be based on a reliable technological platform (currently not available to the CBK).3 - Receive much more detailed information from banks, including consolidated information and operations subject to country and transfer risk. - Macroprudential analysis is limited; the annual Financial Stability Report could serve as a good base. 3 There is a project in its initial phases to provide the CBK with the necessary technological platform. ### Accounting, disclosure, and remedial powers - Accounting framework for banks is based on IFRS with CBK-established differences in provisioning to reflect enforcement difficulties; banks are generally audited by partners from one of the “Big 4” firms. - Work underway to upgrade status of smaller local accounting firms; much remains to be done for nonbank financial statements. - Legal regime for corrective and remedial actions is clearly addressed and actively used by the CBK; enforcement powers are broad and defined from preventive stage through resolution and liquidation. - Examples of enforcement: restructuring board and senior management, recapitalization, closing an unlicensed foreign branch, and ongoing resolution of a failed bank. - Constraint: lack of unanimous international recognition of Kosovo affects CBK capacity; irregular activity continues in the northern part of the country by at least one unlicensed entity. ### Consolidated and cross-border supervision - Domestic supervisory coordination is informal within the CBK; insurance supervision information is shared with BSD as needed, but the system needs formalization for proper consolidated supervision. - Banks belonging to groups consolidated abroad represent more than 70 percent of the system in both deposit and loan terms. - CBK’s capacity to monitor risks from parent groups is limited; participation in supervisory colleges and MoUs exist (with supervisors of Slovenia, Germany, Turkey, and Albania), and one group’s consolidated supervision has been assigned to BaFin. - Situation requires significant improvement for CBK to obtain necessary and timely knowledge of parent bank and group conditions to mitigate excessive exposures. ### Appendix IV — Summary of Basel Core Principles (selected points) - 1.1 Responsibilities and objectives: Except for ability to review AML/CTF issues, responsibilities are generally clear. - 1.2 Independence, accountability and transparency: Supervisor is independent, accountable and transparent; concern over management of AML supervisory function. - 1.3 Legal framework: Gaps and conflicts exist. - 1.4 Legal powers: Generally present; gap regarding AML/CTF. - 6. Capital adequacy: Include market and operational risks in capital calculation. - 7. Risk management process: Supervisors are not satisfied that banks have a comprehensive risk management process. - 8. Credit risk: Credit risk in loan portfolio appears sufficiently supervised; other credit-risk sources are not. - 11. Exposure to related parties: Loan-portfolio exposures are well-supervised; other related-party exposures are not receiving adequate attention. - 12. Country and transfer risks: Neither regulation nor supervisory processes specifically address these risks. - 14. Liquidity risk: Current regulation is too generic; supervisory practice too dependent on on-site revisions. - 15. Operational risk: No specific regulation or supervisory processes to address operational risk specifically. - 19–21. Supervisory approach, techniques, reporting: Emphasis on loan portfolios and internal controls is strong, but insufficient control, off-site techniques, and reporting regarding liquidity, interest rate, operational risks, and risks from parent entities. ### Appendix IV — Recommended action plan (selected actions) - CBK should clarify responsibilities vis-à-vis AML and BSD should clarify objectives (1.1). - CBK should consider re-assigning the manager of the AML supervisory function (1.2). - CBK should undertake a comprehensive review of the legal framework to remove gaps and conflicts (1.3). - CBK should clarify authority to examine in AML (1.4). - Capital calculations should include market and operational risk charges (6). - BSD should expand credit risk reviews beyond the loan portfolio and supervisory review of problem assets other than those in the loan portfolio (8, 9). - CBK to develop regulation and supervisory practices for country and transfer risks (12). - CBK to develop regulation and supervisory practices, and train staff, to monitor emerging market risk (13). - CBK to develop regulation and supervisory practices to identify and measure liquidity and interest rate risk on individual, group and system-wide basis, including stress tests; train staff in assessing these risks (14, 16). - CBK to develop regulation and supervisory practices and train staff to measure operational risk and to assess operational-risk models in supervised entities (15). - CBK to significantly improve off-site supervision, supervisory reporting, and technological platform; reporting to include consolidated basis and detail on liquidity, interest rate, operational risks, and exposures to parent entities (20, 21). - CBK to improve implementation of MoUs and home-host cooperation to ensure timely information exchange and monitoring of parent banks and groups (25). - CBK to keep addressing irregularities from non-licensed entities operating as banks in the northern part of the country (23). *Source: IMF staff assessment chapter on banking supervision and Basel Core Principles compliance in Kosovo.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1399.pdf_