## _cr14161 — Algeria FSAP (selected excerpts)

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### EXECUTIVE SUMMARY — context, macro indicators, and main recommendations
- Financial system: "remains stable overall but thoroughly underdeveloped."
- Protective factors: pervasive exchange controls, widespread public ownership, abundant domestic funding.
- Key policy measures since 2008:
  - Minimum capital for banks increased from DA 2.5 billion to DA 10 billion; minimum capital for nonbank credit institutions also increased.
  - Public banks recapitalized, including through NPL purchases.
  - New accounting standards and improved supervisory practices introduced.
  - Consumer lending moratorium imposed.
- Structural constraints:
  - 2014 Doing Business rank: 153rd out of 185 (down from 151st in 2013).
  - Tax compliance rated very low; high use of cash indicates substantial informality.
- Hydrocarbon revenue and monetary complications:
  - Excess liquidity complicates monetary policy, raises credit boom and inflation risks; absence of fiscal withdrawal rule exacerbates risks.
  - "annual average of CPI-adjusted return on BA liquidity facility during 2003-2012 was almost -3 percent."
  - Recommendation: enhanced intertemporal smoothing, including introduction of a sovereign wealth fund (SWF).
- Recent macro indicators (2008–2012 averages and levels):
  - Average growth over 2008–2012: "2½ percent."
  - Current account surpluses averaged "8½ percent of GDP" over 2008–2012.
  - FX reserves exceeded "90 percent of GDP" (or "35 months of imports in 2012").
  - Oil fund (FRR) reached "36 percent of GDP in 2012".
  - Public external debt declined from "4¾ percent" to "2 percent of GDP" between 2006 and 2012.
  - Parallel market premium: "around 40 percent."
  - Non-hydrocarbon exports: "a mere 2 percent of total exports."
- Main cross-cutting recommendations (agent — timing):
  - Improve intergenerational smoothing of hydrocarbon revenue (full-fledged fiscal rule, SWF). — BA/MoF — MT–LT
  - Gradually reduce restrictive measures on foreign exchange transactions. — BA/MoF — MT–LT
  - Allow non-hydrocarbon exporters to sell directly into the foreign exchange market. — BA — ST
  - Create a structural liquidity shortage to facilitate monetary policy implementation. — BA — ST
  - Complete corporate governance reform agenda for SOBs. — MoF — ST–MT
  - Replace consumer lending restrictions with prudential measures; introduce public credit registry for households and personal bankruptcy framework. — BA — MT
  - Facilitate write-off of NPLs; improve supervision framework; continue towards Basel II/III; develop stress-test expertise. — BA — ST–MT
  - Revisit government support programs for microenterprises and SMEs. — MoF — MT
  - Implement payment system council and plan to decrease fiduciary money in M2. — BA — MT
  - Finance budget deficits through issuance of T-bonds along the yield curve to foster liquidity. — MoF — LT
  - Establish special resolution regime, MoUs for crisis management and safety-net coordination. — BA, MoF — LT
  - Implement FATF-related AML/CFT action plan. — BA, MoF, MoJ — ST
- Broader strategy emphasized:
  - Modernize financial sector governance and infrastructure; intertemporal smoothing of hydrocarbon revenues (SWF + withdrawal rule); transform role of the state; phase out exchange controls and liberalize FX gradually.

### 9. State-owned banks (SOBs) — market structure, soundness, and NPL practices
- Market structure:
  - Six SOBs accounted for 86 percent of banking system assets at end-2012.
  - Private banks are foreign-owned and focus on international trade finance.
  - One public bank proposed for stock-exchange listing (authorities published list of 8 SOEs eligible).
- Capital and asset quality:
  - Common equity accounts for 73 percent of regulatory capital.
  - NPLs declined from 21 percent in 2009 to 11½ percent in 2012.
  - Provisions appear to cover 70 percent of NPLs (provisioning rates for NPLs: 2009: 65.4; 2010: 73.5; 2011: 69.9; 2012: 69.5).
- Earnings and liquidity:
  - Interest margins account for 67 percent of operating income.
  - Liquid assets share: 46 percent of total assets at end-2012; retail deposits: 52 percent of liabilities.
  - Liquid Assets/Total Assets: 2009: 51.8; 2010: 53.0; 2011: 50.2; 2012: 45.9.
- Box 1 — Write-off practices and incentives:
  - Current NPL stocks: private banks 4.7 percent; public banks 12.7 percent.
  - NPLs adjusted through swaps for T-bonds (public banks) or rescheduling; NPLs are not written off and remain on balance sheets for years.
  - Barriers for private banks: uncertainty over BA guidelines requiring “every possible means of recovery”; costly and slow enforcement and bankruptcy processes.
  - Barriers for public banks: criminal sanctions risk under Algerian Criminal Code for managers; Treasury bailouts reduce incentives to clean balance sheets.
  - Distorted collateral values where NPLs are routinely purchased by the state.

### Financial stability assessment and stress-testing results
- Overall assessment:
  - Only moderate vulnerability of financial system to shocks, conditional on continued government support and large fiscal/external buffers.
  - Main vulnerabilities: credit risk, hydrocarbon concentration risk, governance weaknesses in SOBs.
- Stress-test methodology:
  - Top-down covering 20 banks and bottom-up for 6 public banks using end-2012 data.
  - Scenarios include global oil shock, protracted European slowdown, and IMF WEO projections; calibrations from NPL historical highs and expert judgment.
- Key stress-test findings (selected):
  - Under credit risk scenario (10 percentage point increase in NPLs):
    - Three public banks (27 percent of banking total assets) fall below regulatory CAR requirement of 8 percent, but remain solvent.
    - Recapitalization cost estimated at 0.5 percent of non-hydrocarbon GDP in similar past interventions.
  - Concentration risks:
    - Top three public sector borrowers account for 38 percent of total loans.
    - Default of the top three borrowers would cause six banks to become insolvent, of which five are public banks.
  - Liquidity stress:
    - Daily deposit withdrawals of 5 to 10 percent per day over five days: banks could withstand substantial deposit runs for five days due to high liquid asset stocks.
    - Total liquid assets were 108 percent of total short-term liabilities in 2012.
  - Interest rate and exchange rate shocks:
    - Little sensitivity to a parallel upward movement of interest rates by 400 basis points.
    - Exchange rate shocks negligible given small open FX positions.
  - Private banks more resilient than public banks under multi-sector shocks.
- Selected system indicators (percent unless stated):
  - Capital Adequacy Ratio: 2009: 26.2; 2010: 23.6; 2011: 23.7; 2012: 23.4.
  - NPL Ratio: 2009: 21.1; 2010: 18.3; 2011: 14.5; 2012: 11.5.
  - Return on Equity: 2009: 26.0; 2010: 26.7; 2011: 24.7; 2012: 23.3.
  - Short-term Assets/Short-term Liabilities: 2009: 114.5; 2010: 114.3; 2011: 103.7; 2012: 107.5.

### 19. Banking supervision, operational reforms, and safety-net gaps
- Supervision progress:
  - New regulations in 2011 on internal control, risk management and liquidity risk.
  - Risk-based methodology developed in 2012; CAMELS-based supervisory approach introduced and pilot-tested; full roll-out pending.
- Remaining gaps and recommendations:
  - Underdeveloped areas: corporate governance framework, consolidated supervision, interest rate risk management.
  - BA should hire specialized professionals (e.g., IT audit) and enhance credit analysis and loan classification training for onsite supervisors.
  - Improve supervisory resource allocation; clarify tasks between off-site/on-site activities and BA/Banking Commission Secretariat.
  - Sign MoUs with foreign supervisors and consider participation in supervisory colleges.
- Public-bank recapitalization and moral hazard:
  - Recapitalization often via purchase of nonperforming claims by the Treasury, releasing provisions and increasing capital.
  - Recommendation: write off fully provisioned losses and recapitalize only if needed to improve transparency; harden budget constraints and consider alternatives (state disengagement, development bank models).
- Insurance supervision:
  - Improvements since 2007; regulator should consider lowering investment limits in government securities and set maximum real estate investment limits.
  - Concern: supervision lacks independence; potential conflict of interest where Insurance Directorate staff serve on boards of public insurers.
- Macroprudential and data needs:
  - BA published first Financial Stability Report; recommendation to establish a permanent unit for financial stability monitoring.
  - Priority: establish real estate price index, increase data coverage on households and corporates, and set up a basic early warning system.
- Safety net, crisis preparedness, and liquidity framework:
  - Coordination among agencies informal; no contingency manual or interagency MoU; recommendation to prepare MoU covering normal and crisis times and data exchange.
  - Suggested maintenance of a structural liquidity deficit to reactivate interbank market and facilitate interest-rate based monetary policy.
  - Absorption instruments exist but reluctance to use them; required reserve rate is already 12 percent.
  - Excess hydrocarbon-related liquidity concentrated in one state bank (BEA), which manages Sonatrach deposits that must be repatriated and converted to DA by law.
- FX market development and ELA:
  - Allow non-hydrocarbon exporters to sell directly into interbank market gradually; liberalize forward contracts in a phased manner linked to trade liabilities/receivables and selected capital flows (mainly FDI).
  - Clarify ELA framework: specify penalty rates, exceptional basis of operations, BA discretion, acceptable collateral terms (six-month maturity renewable up to three years).
- Deposit insurance and payouts:
  - FGDB is a paybox without resolution powers; legal framework prescribes repayment within six months but payouts from 2003–2005 failures remain ongoing; back-up funding not explicitly arranged.
- Bank resolution:
  - Existing corrective powers underused; resolution options limited and reliance on liquidation/public support common.
  - Recommendation: establish a Special Resolution Regime exempting banks from corporate insolvency framework; formalize legal protocol with principles for systemic threat assessment and cost estimation of resolution options.
- AML/CFT:
  - Algeria under FATF monitoring since 2011; identified in October 2013 as not making sufficient progress.
  - Measures: membership of Egmont Group (July 2013), signed 17 MoUs, prepared draft Criminal Code amendments, broadened customer due diligence.
  - FATF called for adequate criminalization of terrorist financing and legal framework for identifying, tracing and freezing terrorist assets.
  - Recommendation: swiftly bring AML/CFT framework in line with standards to exit monitoring.

### 35. Financial-sector reform priorities and measures to deepen finance
- Use hydrocarbon wealth to develop financial markets:
  - Introduce fully-fledged oil saving scheme with binding draw-down rule; SWF recommended to reduce Dutch disease, boost savings, fund counter-cyclical policy and facilitate monetary policy.
  - FRR weaknesses: savings not ring-fenced, withdrawals discretionary.
- Phase out exchange controls and adopt interest-rate based monetary policy:
  - Financial repression demonstrated by negative real interest rates on dinar assets.
  - Exchange controls prevent core markets development and encourage parallel market premium.
  - Gradual liberalization of FX market recommended; forward contracts liberalization phased and initially limited.
- SOB governance weaknesses and reform steps:
  - Government as largest owner, regulator and main client creates conflicts of interest.
  - Weak board independence; chairmen often also Managing Directors.
  - MoF approved a nine-measure action plan in 2012 (implementation pending), including appointment of two independent board members and IPO of at least one SOB.
  - Strategy should clarify privatization and operational objectives; social policy lending should be funded through explicit budget allocations.
- SME finance and access:
  - Credit to private enterprises grew recently driven by government initiatives; interest rate subsidy of up to two percentage points for investment loans capped at 5.5 percent; two partial guarantee funds for SMEs.
  - Distribution of loans to enterprises (by loan size, number and percent in bracket):
    - Loan size 0 - 40 million DA: Public Banks Number 39,962 (89%); Private Banks Number 5,120 (11%).
    - Loan size 40 - 80 million DA: Public Banks Number 624 (55%); Private Banks Number 520 (45%).
    - Loan size 80 - 400 million DA: Public Banks Number 972 (58%); Private Banks Number 710 (42%).
    - Loan size > 400 million DA: Public Banks Number 601 (73%); Private Banks Number 224 (27%).
    - Total: Public Banks 42,159; Private Banks 6,574.
  - Access constraints: high collateral requirements (real estate, personal guarantees); public banks not commercially oriented; private banks have little incentive to focus on SMEs.
- Measures to promote deepening and SME access:
  - Strengthen creditor rights: move away from liquidation culture, introduce conciliation, centralized collateral registry for immovable and unified registry for movable collateral (48 land registries currently).
  - Modernize bankruptcy law: broaden scope to include "personnes libérales, agriculteurs et artisans"; introduce personal bankruptcy law if consumer credit restrictions lifted.
  - Expand role of stock market: current capitalization < 0.1 percent of GDP; COSOB reform program launched in 2011.
  - Relax insurance investment constraints: current rule requires 50 percent of technical provisions in government securities; consider reducing requirement and including other securities.
  - Promote modern payment technologies: leverage mobile-phone use and communications advances; regulatory adjustments needed.
  - Early-stage financing: authorities committed approximately DA 50 billion to finance SMEs via 48 regional funds, one state-owned specialized financial institution and one government-owned specialized private-equity firm.
  - Modernize public credit registry: BA with World Bank and IFC support adopted modernization plan and launched procurement.
- Consumer lending and microfinance:
  - Consumer lending ban (2009) has harmed financial deepening; recommendation to replace ban with prudential rules, improved credit registry, and personal bankruptcy framework.
  - Public microenterprise programs (ANSEJ, CNAC, ANGEM) scaled up rapidly with subsidy and managerial strain; total public support programs (million DA):
    - ANSEJ: 2009 131,491; 2010 176,866; 2011 297,253; 2012 426,795.
    - CNAC: 2009 19,406; 2010 32,558; 2011 88,747; 2012 154,928.
    - ANGEM: 2009 6,381; 2010 8,510; 2011 11,087; 2012 16,054.
    - Total: 2009 157,278; 2010 217,934; 2011 397,087; 2012 597,777.

### Appendices — Risks and supervisory assessment highlights
- Risk Assessment Matrix (selected entries):
  - Euro-Zone: Medium staff assessment for short term; Medium-to-High medium-term risks (protracted European slowdown) with expected negative balance-of-payments and fiscal impacts; impact contained by buffers.
  - Oil price shock: Staff assessment Low (overall) but High (likelihood/impact column); lasting decline in oil prices would worsen fiscal balance and raise NPLs.
  - Algeria-specific risks: Medium overall; notable risk: further demands on hydrocarbon rent (high likelihood/impact).
- Basel Core Principles assessment — main findings:
  - Assessment based on September 2012 methodology; mission conducted September 15–28, 2013 in Algiers.
  - Banking sector dominated by six public banks accounting for 81 percent of assets at end-2012; total credit flow to economy: 15.1 percent of GDP at end-2012.
  - Key deficiencies: insufficient consolidated supervision, hedging of market risk, management of overall interest rate risk, need for improved governance rules, limited crisis management tools and stress-testing coverage, gaps in cooperation with foreign supervisors.
  - Information infrastructure: public credit registry requires upgrading; plan with World Bank support; planned change to monthly frequency of credit transactions early 2014.
  - Legal/judicial issues: bankruptcy law shortcomings; recovery of collateral unpredictable with delays of 2 to 10 years.
  - FGDB lacks full resolution powers and should be modernized; crisis management framework inadequate and coordination informal.
- Stress-testing technical details (selected):
  - Solvency tests: bottom-up for 6 largest banks; top-down for all 20 banks; baseline December 2012 supervisory data; top-down used Cihak (2007) methodology.
  - Solvency shocks: credit deterioration by 10/20/30 percent; sectoral concentration shocks by 10/20/30 percent; restructured loans default 50 percent; largest 1 and top 3 borrowers default.
  - Interest-rate shocks: parallel upward shift of yield curve by 200 bps and 400 bps.
  - Exchange-rate shocks: appreciation/depreciation by 10 percent, 20 percent, 40 percent.
  - Liquidity shocks: 5-day deposit withdrawals of 5 & 10 percent; top-down 5-day withdrawals sequence (5,5,10,10,10 percent); asset daily disposal rates 80 percent for liquid assets, 1 percent for illiquid assets.

_Italicized source attribution: IMF staff report — Content unit: _cr14161 (Algeria FSAP excerpts)._

### EXECUTIVE SUMMARY ___________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Introduction — Context and recent policy measures
- The global crisis has had virtually no impact on Algeria’s financial system; the system "remains stable overall but thoroughly underdeveloped."
- Protective factors: pervasive exchange controls, widespread public ownership, and an abundance of domestic funding have insulated banks from external shocks.
- Policy responses and preventive measures:
  - Amendments in 2008 increased minimum capital for banks from DA 2.5 billion to DA 10 billion; minimum capital for nonbank credit institutions was also increased.
  - Public banks were further recapitalized, including through nonperforming loan (NPL) purchases.
  - New accounting standards and improved supervisory practices were introduced.
  - A consumer lending moratorium was imposed to contain consumer debt and nip an incipient consumer credit boom in the bud.
- Structural reform progress and constraints:
  - Some structural reforms (including in tax and customs administration) were undertaken, but Algeria ranks low on business climate indicators: 2014 Doing Business rank is 153rd out of 185, down from 151st in 2013.
  - Tax compliance is rated very low, hampering private sector borrowers’ ability to use financial statements for bank credit.
  - High use of cash indicates substantial informality.
- Hydrocarbon revenue challenges:
  - Excess liquidity complicates monetary policy, raises risks of credit booms and inflation, and the absence of a fiscal withdrawal rule exacerbates risks.
  - Exchange controls allow negative interest rates on dinar assets to persist: "annual average of CPI-adjusted return on BA liquidity facility during 2003-2012 was almost -3 percent."
  - Recommendation highlighted: enhanced intertemporal smoothing, including the introduction of a sovereign wealth fund (SWF), would help develop financial markets.

### Recent macroeconomic developments — key indicators
- Average growth over 2008–2012: "2½ percent."
- Current account surpluses averaged "8½ percent of GDP" over 2008–2012.
- External and fiscal buffers:
  - FX reserves exceeded "90 percent of GDP" (or "35 months of imports in 2012").
  - Oil fund (FRR) reached "36 percent of GDP in 2012".
  - Public external debt declined from "4¾ percent" to "2 percent of GDP" between 2006 and 2012.
- Parallel market premium: "around 40 percent."
- Non-hydrocarbon exports represent "a mere 2 percent of total exports."

### Overview of the financial system — structure and intermediation
- The financial system is predominantly bank-based with low intermediation: total credit to the economy "stands at a mere 27 percent of GDP at end-2012"—split evenly between SOEs and the private sector.
- Insurance and capital market segments are nascent.
- Constraints on financial deepening include:
  - Slow structural reforms that impede private sector growth.
  - Evolving regulatory environment and poorly developed infrastructure, notably a public credit registry with limited coverage.
  - State-directed lending and government support measures.

### Banking system — vulnerabilities and exposures
- Main banking sector risks identified by stability analysis and stress tests:
  - Credit risk and loan concentration are the main banking sector risks.
  - Public banks are most vulnerable, being highly exposed to large state-owned enterprises in manufacturing, construction, and commerce—leaving them exposed to firm- and sector-specific shocks.
- Stability assessment: the team’s analysis suggests "only moderate vulnerability of the financial system to shocks."
- Buffering factors: Algeria’s substantial external and fiscal buffers, and past state willingness and ability to backstop banks.

### Financial stability framework and outstanding reforms
- Progress since the 2007 FSAP update:
  - Introduction of a risk-based bank rating system.
  - Tightening and adoption of internationally accepted prudential standards.
  - Central bank (BA) has taken on additional responsibilities for financial stability and published its first Financial Stability Report.
- Remaining important 2007 FSAP recommendations:
  - Enhance governance of public banks.
  - Strengthen operations of the judicial system, including extra-judicial procedures for debt workouts.
  - Privatization of public banks remains incomplete.
  - Establish a well-defined yield curve based on an interest rate-centered monetary policy.
  - Improve BA–MoF coordination for better liquidity management.

### Main recommendations (responsible agencies and timing)
- Leverage hydrocarbon revenue for financial sector development: "Improve intergenerational smoothing of hydrocarbon revenue (full-fledged fiscal rule, sovereign wealth fund (SWF))." — BA/MoF — MT–LT
- Exchange controls: "Gradually reduce restrictive measures on foreign exchange transactions." — BA/MoF — MT–LT
- FX market: "Allow non-hydrocarbon exporters to sell directly into the foreign exchange market, to stimulate its development, including for forward contracts." — BA — ST
- Liquidity management: "Create a structural liquidity shortage to facilitate monetary policy implementation." — BA — ST
- SOB reform: "Complete corporate governance reform agenda." — MoF — ST–MT
- Consumer lending: "Replace consumer lending restrictions with prudential measures; introduce an effective public credit registry for households, and personal bankruptcy framework." — BA — MT
- Banking supervision: "Facilitate the write-off of NPLs; improve operational framework for supervision; continue towards Basel II/III; develop stress-test expertise." — BA — ST–MT
- SME lending: "Revisit existing government support programs for microenterprises and SMEs, including partial credit guarantee funds." — MoF — MT
- Insurance: "Adapt MTPL premiums and reduce compulsory reinsurance." — Insurance Dir. — MT
- Insolvency regime: "Modernize the insolvency regime to mitigate risk and strengthen the credit environment." — MoJ, MoF — MT
- Collateral regime: "Improve debt enforcement procedures." — MoJ, MoF — ST–MT
- Criminal sanctions: "Clarify Criminal Code sanctions on mismanagement of funds in state-owned enterprises (SOEs), with judicial training on implementation." — MoJ — ST
- Payment systems: "Set-up a payment system council to monitor the modernization of payment systems and formalize a plan to decrease the proportion of fiduciary money in M2." — BA — MT
- Capital market development: "Finance budget deficits through the issuance of T-bonds along the yield curve and revisit the issuance policy at the MoF to foster liquidity." — MoF — LT
- Stock exchange: "Implement the 2012 COSOB modernization program." — COSOB/MoF — LT
- Crisis management: Establish (i) special resolution regime for failing financial institutions; (ii) memorandum of understanding (MoU) outlining principles for financial crisis management; and (iii) MoU between safety net participants on information exchange and decision-making processes. — BA, MoF — LT
- AML/CFT: "Implement action plan established with the FATF International Cooperative Review Group." — BA, MoF, MoJ — ST

(Note: ST – Short term: within one year; MT – Medium term: 1–3 years; LT – Long term: longer than 3 years.)

### Broader reform strategy emphasized
- Modernizing the financial sector: corporate governance in state banks; public credit registry modernization; improved collateral regime; strengthened insolvency rights; boosted financial sector safety net and dedicated bank resolution regime; enhanced risk-based supervision; strengthened AML/CFT; promote access to finance.
- Intertemporal smoothing of hydrocarbon revenues: establish SWF and withdrawal rule to reduce financial instability risk, ease Dutch disease effects, and develop government securities market and monetary policy transmission.
- Transforming the role of the state: comprehensive reform of business environment (resolution and collateral frameworks; criminal code related to commercial activity) and abolition of restrictive measures to strengthen creditor rights and financial intermediation.
- Phasing out exchange controls: gradual liberalization of the FX market, including for forward contracts, to remove distortions (e.g., persistent negative real returns and underdeveloped core financial markets).

*Source: IMF staff report — EXECUTIVE SUMMARY (Algeria).*

### 9.      State banks continue to play an important role in the financial sector. There are six

### 9. State banks continue to play an important role in the financial sector. There are six

### Role of state-owned banks (SOBs) and market structure
- There are six state-owned banks (SOBs) that accounted for 86 percent of banking system assets at end-2012.
- SOBs continue to play a key role in financing government-prioritized projects.
- Private banks are all foreign-owned and focus more on international trade finance.
- Policy measures that may reorient private banks toward SMEs include:
  - introduction of ceiling on trade credit fees, and
  - introduction of SME interest subsidies.
- One public bank has recently been put forward to be listed on the stock exchange.

### Banking sector soundness: capital, asset quality, earnings, liquidity
- Capital
  - Common equity accounts for 73 percent of regulatory capital.
  - Leverage is rising.
  - For private banks, high capital levels are related to the recent increase in minimum capital.
  - State bank balance sheets have benefitted from capital support from the state, which has contributed to the decline in NPLs from 21 percent in 2009 to 11½ percent in 2012.
- Asset quality
  - Provisions appear to cover 70 percent of NPLs.
  - A more forward-looking provisioning scheme might provide a different picture.
- Earnings
  - Returns on equity and assets are high compared to other countries in the region.
  - NPLs are often reduced not through write-offs but through transfer of the original loans in the context of recurrent government recapitalizations.
  - Interest margins account for 67 percent of operating income and are the most important source of revenues.
- Liquidity
  - On average, banks are highly liquid with little maturity mismatch.
  - 46 percent of total assets at end-2012 are liquid, broadly offsetting retail deposits which account for 52 percent of liabilities.
  - Liquidity at one bank is particularly high given its traditional role in hydrocarbon exports.

### Box 1 — Write-Off of Nonperforming Loans (NPLs): practices and incentives
- Current stock of NPLs:
  - 4.7 percent for private banks.
  - 12.7 percent for public banks.
- NPL adjustment practices:
  - NPLs are adjusted through swaps for T-bonds (in public sector banks) or rescheduling of NPLs.
  - NPLs are not written off and thus remain on banks’ balance sheets for several years.
- Barriers to write-offs for private banks:
  - Uncertainty over Bank of Algeria (BA) prudential guidelines requiring “every possible means of recovery” to be exhausted before write-off.
  - Lack of clarity whether enforcement must reach Court of Appeal or Supreme Court.
  - Enforcement and bankruptcy processes take several years and are costly.
- Barriers to write-offs for public banks:
  - Provisions applying to managers in the public sector create fear of being deemed “mismanagement” under the Algerian Criminal Code, exposing managers to criminal sanctions, including imprisonment.
  - Treasury bailouts (buy-back of loans or restructuring of debts) reduce incentives to clean up balance sheets and encourage lending to public enterprises.
- Impact on provisioning and collateral values:
  - If banks do not seize and dispose of collateral because NPLs are routinely purchased by the state, collateral values may be distorted and may not support loan book values.

### Competition, governance, and market contestability
- Banking sector competition remains low due to:
  - excessive market concentration,
  - frequent bailouts, and
  - insufficient corporate governance for state banks.
- Public sector credit and deposits are highly concentrated in a few banks; private banks face more competition in their segment.
- Policy and structural constraints reducing contestability:
  - Increase in minimum required capital.
  - Introduction of limits on foreign investment (foreign ownership not to exceed 49 percent of capital).
  - Lack of financing alternatives (e.g., through capital market).
- Recapitalizations and weak corporate governance lower incentives for competitive behavior by SOB boards and management.
- Historical note: After the 2003 bankruptcy of a domestic private bank, the Government made it mandatory for SOEs to work exclusively with SOBs; while lifted, SOEs continue to work predominantly with SOBs.

### Nonbank financial sector
- Nonbank system mainly comprises insurance and leasing; occupies a small but growing part of the financial system.
- Stock market:
  - Small, with only four listed companies and almost no trading volume.
  - Authorities published a list of 8 SOEs eligible for stock-exchange listing; the list includes one bank.
- Fixed-income and derivatives:
  - Derivative markets and securitization are nonexistent.
  - Corporate bond market has recently dried up; fixed-income market dominated by government securities.
- Insurance sector:
  - Composed of 23 companies, 10 publicly-owned with a 66 percent market share.
  - Since the 2007 FSAP, six new companies entered the market due to separation of life and non-life business lines.
  - Insurance turnover increased from DA 53.8 billion in 2007 to almost DA 100 billion in 2012.
  - Profitability increased from 5 percent to 6 percent over the period.
  - Third-party automobile liability insurance accounts for 51 percent of premiums; property and casualty 34 percent.

### Financial stability assessment: key risks
- Overall assessment
  - There do not appear to be major financial stability concerns, premised on continued government support.
  - Underlying profitability is weaker than implied by financial soundness indicators.
  - Ample government buffers are available to strengthen state banks in times of need.
- Key vulnerabilities requiring attention
  - Credit risk
    - Remains the most important risk.
    - Corporate sector comprises mostly SOEs; leverage has been reduced via sovereign capital injections.
    - Repeated government interventions have shifted losses from public banks to the government balance sheet.
    - Household debt largely mortgages with tight prudential norms: loan-to-value ratios capped at 70 percent and debt-to-income ratios at 40 percent; ban on consumption credit contains credit risk.
  - Hydrocarbon risk
    - Hydrocarbon exports account for virtually all exports; over two-thirds of direct government revenues originate from that sector.
    - Banking system and sovereign are highly sensitive to hydrocarbon shocks; concentration risk is high.
  - Liquidity risk
    - Mitigated by banks’ recourse to central bank funding facilities.
    - No foreign inflows into the financial system, so sudden outflow risk is currently absent.
  - FX risk
    - Lending in FX is prohibited.
    - Exchange controls require exporters to repatriate all export proceeds, with 50 percent converted into local currency.
    - FX balance sheet risks are negligible.
  - Interest rate risk
    - Currently limited: bonds held to maturity, duration mismatch appears low, policy rates unchanged for years.
    - Needs monitoring as capital markets develop and interest rates take a more prominent role; most credit contracts include variable interest rate clauses.
  - Governance risks
    - Governance of SOBs is a source of concern; high NPLs in public banks reflect weak governance, weak risk-management and IT systems, and misaligned incentive schemes.
    - Expansion into housing and SMEs could surface new governance risks.

### Stress testing: approach and results
- Methodology
  - Stress tests included a top-down analysis covering 20 banks and a bottom-up stress test focusing on 6 public banks using bank-by-bank data for end-2012.
  - Scenarios premised on a global oil shock, a protracted European slowdown, and latest IMF World Economic Outlook projections.
  - Magnitudes calibrated from NPL historical highs, expert judgment, and cross-country experience.
- Data and analytical constraints
  - Lack of information on maturity distribution of assets and liabilities.
  - Limited time series of historical and accurate NPLs.
  - Large fraction of NPLs await periodic government debt buy-backs.
  - Inconsistencies in NPL information and reported financial soundness indicators.
- Key stress-test findings
  - Credit and loan concentration risks are the main sector vulnerabilities; public banks are most vulnerable.
  - Under a credit risk scenario (10 percentage point increase in NPLs):
    - Three public banks (27 percent of banking total assets) fall below the regulatory capital adequacy ratio (CAR) requirement of 8 percent, but remain solvent.
    - Recapitalization cost would fall to the budget and was estimated at 0.5 percent of non-hydrocarbon GDP in similar past interventions.
  - Concentration risks:
    - Top three public sector borrowers account for 38 percent of total loans.
    - Default of the top three borrowers would cause six banks to become insolvent, of which five are public banks.
  - Liquidity stress test:
    - Assessed daily withdrawals of deposits of 5 to 10 percent per day over five days.
    - Banks could withstand substantial deposit runs for five days due to high liquid asset stocks.
    - Total liquid assets were 108 percent of total short-term liabilities in 2012.
  - Interest rate and exchange rate shocks:
    - Banks show little sensitivity to a parallel upward movement of interest rates by 400 basis points.
    - Exchange rate shocks have negligible impact given small open FX positions.
  - Private banks are more resilient than public banks under various multi-sector shocks.

### Stress test scenarios and summarized results (selected points)
- Credit risk scenarios assume a 10 percentage points increase in the respective nonperforming loan ratios.
- Concentration scenarios:
  - Largest borrower defaults and top three borrowers default scenarios showed substantial adverse impacts on CAR and solvency, with public banks disproportionately affected.
- Multi-factor scenarios included combinations of increases in NPLs, DA depreciation, and interest rate increases.
- Summary indicators from Table 2 (selected values, in percent unless otherwise stated):
  - Capital Adequacy Ratio: 2009: 26.2; 2010: 23.6; 2011: 23.7; 2012: 23.4.
  - NPL Ratio: 2009: 21.1; 2010: 18.3; 2011: 14.5; 2012: 11.5.
  - Provisioning Rates for NPLs: 2009: 65.4; 2010: 73.5; 2011: 69.9; 2012: 69.5.
  - Return on Equity: 2009: 26.0; 2010: 26.7; 2011: 24.7; 2012: 23.3.
  - Liquid Assets/Total Assets: 2009: 51.8; 2010: 53.0; 2011: 50.2; 2012: 45.9.
  - Short-term Assets/Short-term Liabilities: 2009: 114.5; 2010: 114.3; 2011: 103.7; 2012: 107.5.

*International Monetary Fund. Content unit: _cr14161 - 9. State banks continue to play an important role in the financial sector.*

### 19.      There has been progress in improving banking supervision, though significant

### _cr14161 - 19.      There has been progress in improving banking supervision, though significant

### Banking supervision: progress and remaining challenges
- Prudential authorities have adequate authority and regulatory powers to establish a sound framework for banking activities.
- The prudential framework was strengthened in 2011 by new regulations on internal control and risk management as well as on liquidity risk.
- Remaining underdeveloped areas: corporate governance framework, consolidated supervision, and interest rate risk management.
- Certain aspects of the Algerian banking legal framework still need follow-up actions from the relevant authorities, including the missing nomination of certain members of the Monetary and Credit Council and the Banking Commission, and the absence of publication of certain implementation decrees.

### Risk-based supervision and CAMELS rollout
- A risk-based methodology was developed in 2012; implementation is not yet complete.
- A new CAMELS-based supervisory approach was introduced at the BA, supported by technical assistance, and tested in two pilot onsite examinations (one public, and one private bank); a full roll-out can now take place.
- To reduce NPLs and avoid repeated government support, improving bank supervision to identify shortcomings in processes that repeatedly led to high NPLs is required.
- Need for better analysis of the credit granting process and the related tools banks use to ensure a more forward-looking perspective on risks by the supervisor.
- BA should hire specialized professionals (for instance in the field of IT audit) to assess high operational risks in the banking sector.
- Recommendation: enhanced credit analysis and loan classification training for onsite supervisors, given apparent weaknesses in loan underwriting.

### Operational framework for supervision: efficiency and tools
- Supervisory efficiency could be improved by:
  - (i) improving the supervisory resource allocation framework;
  - (ii) clarifying tasks between off-site and on-site activities, and between BA and the General Secretariat of the Banking Commission;
  - (iii) strengthening macro-prudential toolkit with horizontal risk analyses and stress testing.
- MoUs need to be signed between the BA and foreign supervisors to secure BA access to critical information from abroad; consider Algerian supervisors participating in supervisory colleges.
- BA should strengthen banks’ internal control layers: ongoing surveillance, internal audit, compliance, external audit.
- Current level of institutions' financial information and transparency practices limit the role of market discipline.
- Prudential norms are based on the Basel I framework; authorities have started preparing the move towards Basel II and certain elements of Basel III, including recent adoption of a regulation on liquidity risk.

### Public banks, recapitalization practices, and moral hazard
- Common form of public sector bank recapitalization has been through the purchase of nonperforming claims by the Treasury, releasing provisions and increasing capital.
- Recommendation: instead of purchasing bad loans, write off losses that have been fully provisioned for and recapitalize public banks only if needed to improve transparency.
- Box 2 findings: repeated recapitalization of SOBs creates a soft budget constraint and moral hazard; alternatives include hardening budget constraints, explicit ex ante budget subsidies for socially useful projects, gradual state disengagement, transforming SOBs into development banks, and improving the bank guarantee framework.

### Insurance supervision
- Since the 2007 FSAP, insurance regulation has improved with new decrees clarifying technical provisions, eligible assets and solvency margin.
- Regulator should consider lowering limits regarding investment in government securities to reduce captive demand for such securities.
- Recommendation: set a maximum limit to real estate investment to avoid concentration risk.
- Concern: insurance sector supervision lacks independence—Commission relies on resources of the Insurance Directorate, several employees of which are also board members of publicly owned insurers, creating potential conflict of interest.

### Macroprudential oversight and data gaps
- 2010 update of the Law on Money and Credit introduced a mandate for financial stability, complementing price stability.
- The BA published its first Financial Stability Report (FSR) and intends to update it annually; the FSR was prepared by an ad hoc working group.
- Recommendation: establish a more permanent small organizational unit for financial stability monitoring.
- Priority work: fill data gaps by establishing a real estate price index and increasing data coverage on household and corporate sectors; set up a basic early warning system to assess credit growth sustainability and asset price bubbles.

### Financial sector safety net, crisis preparedness, and systemic liquidity
- Principal agencies coordinate on an as-needed basis through committees with overlapping memberships (Council of Money and Credit (CMC) and Banking Commission, both presided by BA governor).
- No body currently considers the financial system as a whole, and no contingency manual describes responsibilities and tasks of agencies in times of crisis.
- Recommendation: prepare an interagency MoU covering “normal” and “crisis” times, data exchange, and crisis management modalities; consider overarching principles such as “financial stability at lowest overall cost for the taxpayer.”
- Hydrocarbon revenue volatility poses challenges for liquidity management; mitigation via maintaining a structural liquidity deficit for banks is suggested to reactivate the interbank market and facilitate interest-rate based monetary policy.
- Absorption instruments exist, but reluctance to use them is noted, including the already high required reserve rate of 12 percent.
- Excess hydrocarbon-related liquidity is concentrated in one state bank (BEA), which manages deposits of Sonatrach; law requires these funds be repatriated into Algeria and converted into DA.

### FX market development and emergency liquidity assistance
- To boost FX market development, exporters—starting with non-hydrocarbon exporters—should be enabled to gradually sell directly into the interbank market with the BA present to smooth large fluctuations.
- Liberalization of forward contracts should be gradual and initially limited to underlying trade liabilities and receivables and selected capital transactions (mainly FDI).
- In times of crisis, emergency liquidity needs would be met through the discount window or outright loans, but the ELA framework requires clarification.
  - Discount operations: can be provided on a wider range of collateral, with haircuts proportional to collateral quality, six-month maturity, renewable up to three years.
  - Operational framework needs explicit mention of penalty interest rates, exceptional basis of operations, and explicit BA discretion to decide on individual requests on a case-by-case basis.

### Deposit insurance (FGDB) and payout issues
- The Fonds de Garantie de Dépôts Bancaires (FGDB) was established after the Khalifa bank failure in 2003 as a paybox without resolution powers; it reports collected amounts and makes payouts once instructed by the Banking Commission.
- Legal framework prescribes repayment within six months, but payouts for failed banks Khalifa (2003), BCIA (2003) and CAB (2005) are still ongoing.
- FGDB can only fund pay-outs in liquidation and can initiate payouts only after receiving a verified list of depositors from liquidators; weak information systems in failed banks necessitate account-by-account audits, severely delaying verification and payouts.
- Back-up funding for FGDB is not explicitly arranged.

### Bank resolution framework
- Legal framework provides broad discretionary powers for corrective actions and moral suasion to recapitalize ailing banks, but these powers have not been used consistently.
- Ongoing supervision: BA; sanctions: Banking Commission. Commission can initiate remedial actions including written warnings, “cease and desist” orders, removal of management, and appointment of a temporary administrator.
- Absence of explicit trigger points for supervisory intervention can lead to inconsistent application.
- Resolution options are limited; bank failures are handled under general insolvency framework with practice favoring liquidation or public-sector support.
- Once a bank’s license is revoked, appointment of a liquidator has been slow and disruptive (all debts fall due upon liquidation).
- Recommendation: establish a Special Resolution Regime exempting banks from the corporate insolvency framework to allow continuity of essential functions and facilitate market-based solutions (e.g., rapid transfer of failed institution’s business).
- Suggested: establish a protocol in law with overarching principles for financial crisis management covering assessment of systemic threat, methodology for estimating costs of resolution options, and requirement to choose the lowest cost solution unless systemic concerns justify otherwise.

### Anti-money laundering and combating the financing of terrorism (AML/CFT)
- Algeria is scheduled for a reassessment of its AML/CFT framework; authorities are discussing dates with the World Bank and the Middle East and North Africa Financial Action Task Force; such assessments should be undertaken approximately every five years and, to the extent possible, within 18 months before or after the FSAP mission.
- Algeria has been under FATF monitoring since 2011 and was identified in October 2013 as not making sufficient progress in addressing strategic deficiencies.
- Measures undertaken: Algeria became a member of the Egmont Group in July 2013, signed 17 MoU and exchange of information agreements with counterparts in Africa, the Middle East and Europe, prepared draft amendments to the Criminal Code to align terrorist financing offense with the standard, broadened customer due diligence obligations, and expanded preventive measures to all financial institutions.
- FATF in October 2013 called upon Algeria to take further action, including:
  - (i) adequately criminalizing terrorist financing;
  - (ii) establishing and implementing an adequate legal framework for identifying, tracing and freezing terrorist assets.
- Recommendation: authorities should swiftly bring the AML/CFT framework in line with the standard to protect Algeria’s financial sector and exit the monitoring process.

*Source: IMF staff report content unit _cr14161*

### 35.      Reforms in a number of areas have the

### _cr14161 - 35.      Reforms in a number of areas have the

### Financial-sector reform priorities and rationale
- Leverage hydrocarbon wealth to develop financial sector:
  - Greater intertemporal smoothing of hydrocarbon revenues would reduce volatility in the financial sector, reduce the Dutch disease effect, and carve out a greater role for government securities in deepening financial markets.
  - Long-term smoothing can be achieved through a sovereign wealth fund; a withdrawal rule on the oil savings fund FRR would provide a medium-term buffer that would put greater reliance on issuing public debt to accommodate fluctuations in the fiscal balance (see Box 4).
- Phase out exchange controls and base monetary policy on interest rates:
  - Current financial repression is expressed as negative real interest rates on dinar assets (including on government securities and time deposits) and is held in place by extensive exchange controls.
  - Exchange controls prevent development of core financial markets, exclude the possibility of earning higher returns (including by holding foreign currency assets), and encourage a parallel market premium.
  - Suggested approach: identify appropriate monetary and FX frameworks to establish a coherent operational framework and start gradual liberalization of the FX market, including for forward contracts.
  - Liberalization of forward contracts should be gradual and initially limited to underlying trade liabilities and receivables and selected capital transactions (mainly FDI).
- Transform the role of the state into facilitator:
  - Reforms of the business environment—including resolution and collateral frameworks as well as criminal code related to economic activity—and abolition of various restrictions on economic activity would create conditions for stronger creditor rights and financial intermediation.
  - Revisit strategic positioning of state-owned banks (SOBs): move them away from implementing government objectives; channel institutions’ activities either towards non-commercial development activities or direct competition with private banks on similar terms.
  - Reforms should be accompanied by changes in corporate governance practices.

### State-owned banks (SOBs): governance weaknesses and reform steps
- Key governance weaknesses:
  - Government acts as largest bank owner, regulator, and main client (through SOEs), creating conflicting roles that weaken intermediation.
  - SOBs lack independent and seasoned experts on their boards.
  - Government lacks an ownership function: policies and processes for setting performance contracts, tracking key performance indicators, nominating board members and voting shares are poorly defined or absent.
  - Most SOBs have rudimentary incentive schemes linked to short-term indicators.
  - In all SOBs, the chairman of the board is also the Managing Director, creating potential conflicts of interest between oversight and management functions.
- Reform progress and outstanding actions:
  - The Ministry of Finance approved a comprehensive action plan of nine measures elaborated with World Bank technical support in 2012; the plan remains to be implemented.
  - Plan measures include appointment of two independent board members at SOBs, strengthening the unit monitoring these banks, and the IPO of at least one SOB—one SOB appears on a recently issued list of SOEs to be (partially) privatized.
  - The team urged authorities to clarify the role of the state in the banking sector and to complete the corporate governance reform agenda.
  - Strategy for public banks should clarify further privatization and operational objectives (e.g., specialized vs. universal, profit maximizing vs. required to meet specific social objectives).
  - If banks are asked to meet social policy objectives, these activities should be funded and remunerated through clearly specified budget allocations.

### Credit to private enterprises and SME finance
- Recent trends and drivers:
  - Credit to private enterprises has grown significantly over the past three years, driven by government initiatives.
  - Growth facilitated by abundant liquidity in the banking sector, limited alternative investment opportunities, and incentives including an interest rate subsidy of up to two percentage points for investment loans with interest rates not exceeding 5.5 percent as well as two partial guarantee funds focusing on SMEs.
  - Partial credit guarantee funds likely to boost SME lending; effect of the interest rate subsidy is less clear given the low interest rate cap that may price out younger, less-established SMEs with less collateral.
- Distribution of loans to enterprises by loan size (Table 4: Distribution of Loans to Enterprises (by loan size))
  - Loan size (million DA) 0 - 40:
    - Public Banks: Number 39,962; In percent of bracket 89
    - Private Banks: Number 5,120; In percent of bracket 11
  - Loan size (million DA) 40 - 80:
    - Public Banks: Number 624; In percent of bracket 55
    - Private Banks: Number 520; In percent of bracket 45
  - Loan size (million DA) 80 - 400:
    - Public Banks: Number 972; In percent of bracket 58
    - Private Banks: Number 710; In percent of bracket 42
  - Loan size (million DA) > 400:
    - Public Banks: Number 601; In percent of bracket 73
    - Private Banks: Number 224; In percent of bracket 27
  - Total: Public Banks 42,159; Private Banks 6,574
  - Source: Bank of Algeria.
- Access and constraints:
  - Only a small fraction of enterprises have a loan from a financial institution, with a pronounced gap between small, medium and large firms.
  - Banks require relatively high levels of collateral with emphasis on real estate and personal guarantees.
  - Public sector banks are not commercially oriented and have limited incentives to lend to SMEs beyond directed lending programs.
  - Private banks have comfortable profit margins through trade finance and corporate banking, with little incentive to focus on SMEs.

### Measures to promote financial deepening and SME access
- Strengthening creditor rights:
  - Move away from current liquidation culture to increase recovery rates.
  - Introduce a framework for conciliation to encourage business rescue.
  - Establish a centralized collateral registry for immovable collateral and a unified registry for movable collateral (there are 48 land registries in Algeria with no centralized hub).
  - Strengthen the quality, information, and notice function of collateral registries and streamline debt enforcement procedures.
- Modernizing the bankruptcy framework:
  - Broaden scope of insolvency law beyond current applicability to “commercants et personnes morales de droit privé” to include “personnes libérales, agriculteurs et artisans”.
  - Address limited creditor recovery due to privilege of the Treasury and employees; strengthen insolvency practitioner regulation; add cross-border insolvency provisions.
  - Introduce a law for personal bankruptcy if restrictions on consumer credit are lifted.
- Broadening the role of the stock market:
  - Current capitalization at less than 0.1 percent of GDP; four equity issuers, two bonds issuers listed and a few thousand investors.
  - Market dominated by government securities concentrated on the very short-end of the yield curve.
  - COSOB reform program launched in 2011 to improve legal framework, modernize market infrastructures and professionalize market participants.
- Relaxing insurance investment options:
  - Insurance companies are required to detain 50 percent of technical provisions in government securities.
  - In light of scarce sovereign bonds, consider reducing the level of the requirement and include other securities (such as SOEs’ bonds) to satisfy liquidity requirements.
- Promoting modern payment technologies:
  - Cash use remains prevalent; network reliability issues constrained earlier attempts.
  - Widespread mobile-phone use and advancing communication technologies create potential for rapid growth in modern payment methods if regulatory framework adapted.
- Supporting Early Stage Financing / Venture Capital:
  - Very few private equity-houses serving higher-end market.
  - Authorities committed approximately DA 50 billion to finance SMEs by setting up 48 regional funds (most managed by public banks), one state-owned specialized financial institution and one government-owned specialized private-equity firm.
- Modernizing the public credit registry:
  - Banque d’Algérie, with World Bank and IFC support, adopted a detailed modernization plan and launched procurement to implement the plan.
  - Current public system suffers from limited coverage, insufficient data quality, limited historical track record and an obsolete IT system.

### Consumer lending, microfinance, and public support programs
- Consumer lending ban and effects:
  - Ban on consumer lending introduced in 2009 to contain indebtedness has been harmful for financial deepening.
  - Adverse effects: deprives small firms (many informal) from credit, obstructs households’ consumption smoothing, prevents building of credit history, encourages informal lending and borrowing from friends/families.
  - Recommendation: use better monitoring supported by an improved public credit registry and appropriate prudential rules to prevent excess indebtedness; introduce a personal bankruptcy framework to protect both creditors and consumer debtors.
- Microcredit and public programs:
  - Algeria lacks a conventional microcredit sector comparable to regional peers.
  - Government programs target microenterprises (ANGEM), young self-employed individuals (ANSEJ) and unemployed adults (CNAC), heavily subsidized and partially implemented with public banks, leaving little space for conventional microfinance providers or private banks.
  - Rapid scale-up since 2011 revealed managerial strains and concerns about portfolio quality given heavily subsidized interest rates and reduced beneficiary contributions.
  - No contingent liabilities a priori—the sovereign explicitly only pays the subsidy—but authorities should monitor the potentially higher risk of these programs.
- Public support programs (Table 5: Public Support Programs (Subsidies) for Microenterprises (in million of dinars))
  - Young Entrepreneurs (ANSEJ):
    - 2009 131,491
    - 2010 176,866
    - 2011 297,253
    - 2012 426,795
  - Unemployed Adults (CNAC):
    - 2009 19,406
    - 2010 32,558
    - 2011 88,747
    - 2012 154,928
  - Microenterprises (ANGEM):
    - 2009 6,381
    - 2010 8,510
    - 2011 11,087
    - 2012 16,054
  - Total:
    - 2009 157,278
    - 2010 217,934
    - 2011 397,087
    - 2012 597,777
  - Source: Ministry of Finance.

### Box 4 summary — Intertemporal smoothing and financial development
- Commodity-rich countries can suffer the resource curse through Dutch disease, government revenue volatility, and weak institutional development, which also hampers financial development and raises financial system risk.
- Algeria’s current FRR oil savings fund is designed to save for future generations and smooth short-term volatility but is flawed: savings are not ring-fenced by a withdrawal rule or limit on the primary structural deficit; withdrawals are at authorities’ discretion.
- A fully-fledged oil saving scheme with a binding rule for draw-downs would help disconnect macroeconomic and oil cycles, assign a greater role to public debt management, and potentially boost the fixed-income market.
- A Sovereign Wealth Fund (SWF) could:
  - Reduce Dutch disease by investing overseas;
  - Boost savings and provide higher long-term returns;
  - Fund counter-cyclical policy to smooth resource cycles;
  - Facilitate monetary policy through lower liquidity volatility related to resource revenue;
  - Improve conditions for capital market development and lending in general.

*Source: _cr14161 - 35.      Reforms in a number of areas have the*

### Appendix I. Algeria FSAP—Risk Assessment Matrix

### Appendix I. Algeria FSAP—Risk Assessment Matrix

### 1. Risk to Growth — External shocks and channels
- Staff assessment: Medium (overall for China and euro-zone entries as presented)
- Euro-Zone
  - Short term: Financial stress in the euro area re-emerges, triggered by stalled or incomplete delivery of national and euro area policy commitments (medium)
  - Medium-term: Protracted period of slower European growth, triggered by larger than expected deleveraging or negative surprise on potential growth (high)
  - Expected impact on Algeria:
    - Negative effects on balance of payments via lower hydrocarbon prices and lower demand (Algeria's main gas export partner).
    - Fiscal balance deterioration.
    - Financial sector effects: contraction of liquidity from the hydrocarbon sector and a subsequent rise in NPLs; state-owned banks particularly affected given large concentration ratios.
    - Spillovers through capital markets limited due to Algeria's very limited exposure to international financial markets and widespread capital restrictions.
    - Impact contained by government buffers and limited size of the financial system.
- U.S.
  - Fiscal policy shock in the United States, triggered by failure to raise debt ceiling (low)
  - Expected impact on Algeria: lower global demand with potential impact on oil prices.
- Emerging markets
  - Short/medium term: Protracted economic and financial volatility, especially for emerging markets, triggered by prospective tapering (high)
  - Short/medium term: Lower than anticipated emerging markets growth potential, triggered by earlier maturing of the cycle and incomplete structural reforms with spillovers to low income countries and advanced economies (medium)
  - Expected impact on Algeria: lower global demand and potential effect on oil prices.
- China
  - Medium term: Sharp slowdown in growth in China, triggered by buildup of excess capacity eventually resulting in large financial and fiscal losses (medium)
  - Expected impact on Algeria: lower global demand and potential effect on oil prices.

### 2. Risk to Capital Markets
- Staff assessment: Medium (overall); Staff assessment: Low (likelihood/impact column)
- Key threats identified:
  - Short/medium term: Advanced bond market stress, triggered by lack of fiscal sustainability leading to a sharp rise in sovereign risk premium in advanced economies (medium/low)
  - Medium term: Risks to financial stability from incomplete regulatory reforms, triggered by delays, dilution of reform, or inconsistent approaches (medium)
- Expected impact on Algeria:
  - Algeria's capital account is not very open; risks related to both capital outflows and inflows are marginal.
  - Algeria is a net creditor; large international reserves mainly invested in high-grade sovereign bonds.
  - Stress on international bond market would complicate the reserve investment strategy.
  - Financial sector little exposed to the international environment; second-round effects on the real sector possible.
  - Fiscal buffers and small size of the financial system would limit financial stability threat.

### 3. Other Risks — Oil price shock
- Staff assessment: Low (overall); Staff assessment: High (likelihood/impact column)
- Threat:
  - Short term: Global oil shock, triggered by deceleration of global demand and coming-on-stream of many global excess capacity new projects while global demand remains weak
- Expected impact on Algeria:
  - Fiscal sector heavily reliant on oil revenues; a lasting decline in oil prices would worsen the fiscal balance absent significant efforts to curb current spending and increase non-hydrocarbon revenues.
  - Financial sector effects: reduced liquidity, rise in NPLs.
  - Fiscal backstop for the financial system would be under threat, though small size of the financial system would limit damage to financial instability.

### 4. Algeria-specific Risks
- Staff assessment: Medium (overall); Staff assessment: Low (likelihood/impact column)
- Identified threats and assessed likelihood/impact:
  - Medium term: Shock to food prices (notably wheat), raising pressure on fiscal expenditure (low)
  - Short/medium term: Further demands on the hydrocarbon rent, raising further pressure on fiscal expenditure (high)
  - Short/medium term: Intensification of regional tensions (notably in Mali and Libya), forcing more expenditure to create jobs and for security (medium)
  - Short/medium term: Domestic political instability, driven by the forthcoming Presidential election (low)
- Expected impact on Algeria:
  - Most Algeria-specific risks likely lead to rising fiscal expenditure to contain impact on the population.
  - More government expenditure likely to raise excess liquidity in the system further, which may not translate into much credit growth.
  - Fiscal backstop to the financial system would be weakened, though the small size of the financial system would limit consequences on financial stability.

*Italicized source attribution: Appendix I. Algeria FSAP—Risk Assessment Matrix (extracted content).*

### Appendix III. Basel Core Principles — Summary Assessment and Main Findings

### Information and Methodology
- Assessment scope and context:
  - Banking sector assessment based on revised September 2012 Core Principles Methodology of the Basel Committee on Banking Supervision.
  - Assessment conducted during September 15–28, 2013, in Algiers.
  - Banking sector dominated by six public banks, which accounted for 81 percent of assets of the banking system at end-2012.
  - Total credit flow to the economy: 15.1 percent of GDP at end-2012 (same applies for non-oil GDP).
  - The 14 foreign-owned private banks focused mainly on international activities.
  - Nine financial institutions licensed for carrying out leasing activities, which are expanding rapidly.
  - Stock market plays a minor role in financing the economy.
- Evidence base:
  - Self-assessment and questionnaire by BA; laws and regulations; external auditor reports; meetings and documents from General Secretariat of the Money and Credit Council, General Secretariat of the Banking Commission, BA; interviews with supervisory staff; meetings with Financial Information Processing Unit, Association of Banks and Financial Institutions, credit institutions, external auditors, Association of Chartered Accountants.

### Main Findings — Preconditions and System Vulnerabilities
- Macroeconomic concentration and exposures:
  - Oil sector accounts for 34 percent of GDP, 65 percent of government revenue, and 98 percent of exports.
  - Financial sector exposure to oil revenue volatility could impact credit support policies and increase credit risks if the cycle reverses.
  - Algeria’s financial system minimally affected by the global financial crisis due to limited international exposure, exchange controls, and high oil prices.
- Supervisory structure and challenges:
  - Responsibility for supervising the financial system belongs to the BA; supervision structured around BA, Money and Credit Council (licensing authority), and Banking Commission (supervisor), all chaired by the governor.
  - Governance concerns: too little supervisor cooperation and independence; government’s multiple roles as shareholder, regulator, and client create potential conflicts.
- Prudential framework and supervision capacity:
  - Prudential framework adapted to current low-complexity environment; entry barriers remain due to public sector size and regulatory restrictions (rules on foreign investment and minimum capital).
  - 2011 regulatory bolstering: new regulation on internal control and risk management; instrument on liquidity risk.
  - Deficiencies: insufficient consolidated supervision, hedging of market risk, management of overall interest rate risk, and need to strengthen good governance rules.
  - Risk-based methodology developed in 2012 but implementation lags; tasks of off-site/on-site inspections and Banking Commission Secretariat poorly defined.
  - Tools lacking: crisis management, cross sectional risk analysis, stress testing.
  - Cooperation with foreign supervisors in early stages; lack of cooperation agreement.
- Resourcing and expertise:
  - Workforce stabilized but more resources needed; supervision leans toward regulatory compliance rather than forward-looking institutional risk identification.
  - Limited ability to recruit/train specialists (e.g., IT system auditors); occasional reliance on banks to conduct external audits without specific mandates.
  - Financial reporting and institutional transparency underdeveloped, limiting market discipline.
- Information infrastructure:
  - Public credit registry of business loans managed by BA requires upgrading; currently outdated with limited usefulness for loan origination and monitoring.
  - Plan underway with World Bank support; change to monthly frequency of credit transactions planned for early 2014.
  - Risk centralization project for individuals under consideration.
- Legal and judicial framework issues:
  - Legal framework improved over the last decade, but bankruptcy law has shortcomings in design and application, hampering credit supply development.
  - Inefficiencies in corporate, bankruptcy, contract and private property laws and law enforcement consistency undermine supervision effectiveness.
  - Lack of collective procedure for individuals, artisans, farmers, or liberal professions.
  - Recovery of collateral unpredictable and subject to undue delays (of 2 to 10 years); securities law and scattered registries hinder enforcement; stalling tactics by debtors.
- Accounting and disclosure:
  - 2010 accounting standards revision brought them closer to international standards, but enterprise financial reporting remains insufficient.
  - Consolidated statements remain an exception; disclosure obligations lack rigor, especially for public enterprises.
  - Non-computerization of trade register complicates banks’ risk analysis.
  - Financial reporting on risks (breakdown by risk class, maturity, region, client type, internal control) is lacking.
  - Banking sector underuse of financial markets and lax disclosure obligations prevent market discipline from fully operating.
  - Annual reports of public banks generally not available on their websites.
  - BA publishes annual report on banking supervision, but Banking Commission report for the President of the Republic remains confidential.
- Public safety net, crisis management and resolution:
  - In a liquidity crisis, BA would need to provide liquidity but may lack usual collateral due to poor government and public-sector issuances; BA can implement exceptional facilities based on a broad collateral definition, including certain medium-term loans up to three years, but operational framework needs clarification.
  - FGDB (created after Khalifa Bank bankruptcy in 2003) lacks full resolution powers and should be modernized; repayments from 2003–2005 bank failures remain ongoing.
  - Crisis management framework inadequate; coordination among authorities mostly informal; responsibilities not clearly defined; cooperation agreements not yet developed.

### Summary Assessment of Selected Basel Core Principles (high-level)
- CP1 Responsibilities, objectives and powers
  - Better coordination and communication among stakeholders needed; maintain balance between prudential supervision objectives and other central bank tasks.
- CP2 Independence, accountability, resourcing and legal protection for supervisors
  - Independence of the Governor and supervisors needs to be strengthened further.
- CP3 Cooperation and collaboration
  - Need to put in place cooperation agreements with foreign supervisors.
- CP4 Permissible activities
  - Permissible activities for banks clearly defined but regulatory perimeter should be expanded.
- CP5 Licensing criteria
  - Licensing process satisfactory, but restrictions—including on foreign participation—could be modified.
- CP6 Transfer of significant ownership
  - Strict framework in place to address changes in ownership, but possibly inefficient; need more transparent definition of causes for objection of transfer of ownership.
- CP7 Major acquisitions
  - All cross-border acquisitions occur within a strict framework; no framework for acquisition of non-financial firms in Algeria.
- CP8 Supervisory approach
  - Move to risk-based supervision has made headways; implementation remains a challenge; need to implement stress tests and improve crisis management framework.
- CP9 Supervisory techniques and tools
  - Need to clarify role of off-site and on-site supervision; insufficient coverage of potentially important risks (e.g., operational).
- CP10 Supervisory reporting
  - Reporting requirements satisfactory, but need to introduce consolidated supervision to better follow banking groups.

*Italicized source attribution: Appendix III. Basel Core Principles–Summary Assessment (extracted content).*

### 11. Corrective and sanctioning powers of supervisors

### 11. Corrective and sanctioning powers of supervisors

### Key findings
- Satisfactory accounting and auditing practices in place, but should attempt to better anticipate risks.  
- Sanctions should also be used less sparingly.

### Identified weaknesses and gaps
- Need to deploy a new methodology, taking into account possible risks inherent in institutions.  
- Onsite supervision role needs strengthening to monitor implementation of corrective measures.  
- Prudential information frequency may be insufficient to enable the Bank of Algeria (BA) to have a proper view of banking sector risks and to take preventive measures.  
- Legal ability to impose administrative penalties for officers and directors is lacking.  
- Consideration needed for the Commission Bancaire (CB) to set additional capital requirements based on risk profile of institutions.  

### Recommended actions
- Deploy a new methodology, taking into account possible risks inherent in institutions.  
- Strengthen the role of onsite supervision to monitor the implementation of corrective measures.  
- Consider possibility for the CB to set additional capital requirements based on risk profile of institutions.  
- Consider raising prudential information requirements with a frequency sufficient to enable the BA to have a proper view of the risks of the banking sector and to take the necessary preventive measures.  
- Develop the ability by law to impose administrative penalties for officers and directors.

*Source: _cr14161 - 11. Corrective and sanctioning powers of supervisors_*

### 2008. However, as it is not

### _cr14161 - 2008. However, as it is not

### Improve the transparency and reliability of financial statements
- Main objective: Implement IFRS-accounting standards to financial reporting and the certification of small and medium-sized business accounts.
- Short-Term Actions / Reforms Undertaken:
  - Apply the new IFRS to all banks, insurance companies, and publicly listed companies.
  - Substantially strengthen the professional capacities of accountants and auditors by a better recruitment and training.
  - Strengthen role of the National Accounting Commission to allow effective implementation of the new financial reporting framework.
  - Expand the possibilities of foreign investment in Algerian auditing firms.
  - Implement a quality assurance system to guarantee audit quality of Algerian firms.
- Outcomes and implementation status (as stated):
  - Moved towards IFRS in 2010 for all entities, with banks providing accounts on a quarterly basis. However, there is no consolidation of accounts despite the law (ordonnance 11-03), notably because the CMC should still issue regulation on this. P&L accounts (situation 6001) are on a biannual basis.
  - Implemented the IFRS 2004 rules; may need to consider recent evolutions, notably regarding loan loss provisioning, of IAS 39 as they stood in 2004.
  - Fair Value considered largely irrelevant in the Algerian context, as few financial assets are traded.
  - Capacity of auditors was strengthened, following a decree. However, the exam for chartered accountants has not been organized since 2002.
  - Strengthening of auditors coincided with the move towards IFRS.
  - While there are 6 foreign firms, the level playing field in terms of auditing mandates is still uneven, as external auditors must be Algerian. Some have associated themselves to international firms, especially for specialized audits such as in banks, but certainly not the majority (especially for public banks). The application of international auditing standards remain for this reason quite weak in practice.
  - Not done: certain actions (unspecified) to expand foreign investment and implement a quality assurance system remain undone.

### Increase access to financing — modernization of systems, payment methods, and information centers
- Intermediate objectives and short-term actions:
  - Set up the ACTI (remote clearing system) guarantee fund.
  - Expedite the BA’s on-site inspections to verify whether banks have upgraded to the new payment systems.
  - Encourage the use of new payment methods (bank cards, direct payroll deposit).
  - Strengthen financial information centers by modernizing the existing corporate sector central credit register and extending it to individuals.
- Outcomes and implementation status (as stated):
  - ACTI was put in place in 2006, but there is no guarantee fund in place yet. As sums are small, has not been a high priority.
  - BA on-site inspections to verify upgrades to payment systems: Has not yet taken place.
  - E-banking is developing, notably by private banks. Private banks are also offering internet banking but with a limited offer because of the limited possibilities in terms of secured payment infrastructure.
  - Currently, credit registry in place (not credit bureau yet), to be developed for individuals, and consolidated afterwards with existing one for SME and corporate registry.

### Promote direct financing of businesses — sources of nonbank financing
- Objectives and recommended actions:
  - Increase the volume of Treasury securities issued to encourage the emergence of a “risk-free” rate curve that will be used as a pricing reference for bond issues.
  - Implement a legal framework for commercial paper.
  - Promote investment funds to assist companies to prepare for listing on the stock exchange over time.
  - Review the tax system for real property finance leases and venture capital operations to make these more attractive, and review Article 104 of the Decree on Money and Credit for intra-group loans to allow financing between related parties.
  - Review the legal framework for factoring to allow assignment of receivables.
- Outcomes and implementation status (as stated):
  - Not done: Increase the volume of Treasury securities issued — government focused on financial needs, not sufficiently oriented towards helping develop the financial system.
  - Not done: Implement a legal framework for commercial paper.
  - Not done: Promote investment funds to assist companies to prepare for listing.
  - Double-taxation has been solved.
  - Still no legal framework for factoring in place.

### Banking sector stress testing — Solvency risk (assumptions, methodology, scenarios, reporting)
- Institutional perimeter and data:
  - Institutions included (bottom-up): 6 Largest banks.
  - Institutions included (top-down): All 20 commercial banks.
  - Market share (6 largest): 86 percent of total assets.
  - Market share (20 banks): 100 percent of total assets.
  - Data and baseline date: December 2012 supervisory data.
- Methodology:
  - The FSAP team used the Cihak model (2007), IMF WP/07/59, for the solvency stress tests which is mostly limited to Excel based sensitivity analysis. The FSAP team did the bottom-up tests of 6 public banks.
  - The FSAP team used the Cihak model (2007), IMF WP/07/59, for the solvency stress tests which is mostly limited to Excel based sensitivity analysis. The FSAP team did the Top-down tests.
  - Satellite Models for Macro-Financial linkages: N/A (top-down used expert judgment based on cross country examples due to data limitations).
  - Stress test horizon: Point in time using December 2012 data.
- Tail shocks / Scenario analysis and sensitivity analysis:
  - Top-down: A ‘static scenario’ used because of the inability to construct meaningful macro-stress tests due to data limitations. Expert judgment based on historical events and cross country experiences: Simultaneous shock to loan portfolio, interest rates and depreciation of the Dinar.
  - Bottom-up sensitivity analysis provided to six largest banks:
    i. Credit Risk: deterioration in aggregate loan portfolio by 10 percent, 20 percent, and 30 percent,
    ii. Sectoral concentration by 10 percent, 20 percent, and 30 percent
    iii. One notch shift in all categories and restructured loans default by 50 percent
  - Top-down single factor shocks include:
    i. Credit risk (deterioration in aggregate loan portfolio, sectoral concentration by 10 percent, 20 percent, and 30 percent, category shift - one notch shift in all categories, and restructured loans to loss by 50 percent).
    ii. Concentration risk: Largest 1, and top 3 borrowers default.
    iii. Direct interest rate risk: Parallel upward shift of local yield curve by 200 bps and 400 bps.
    iv. Exchange rate risk: Shock on net open position. Appreciation and depreciation of local currency.
  - Additional top-down shocks:
    iv. Concentration risk: Largest 1, 3, 5, and 10 borrowers default.
    v. Reverse stress testing.
    vi. Interest rate risk: Parallel upward shift in yield curve by 200 and 400 bps.
    vii. Exchange rate risk: appreciation/depreciation of currency by 10 percent, 20 percent, and 40 percent.
    viii. Multi-factor shock: Combination of credit, interest and exchange rate risk by 10 percent, 20 percent, and 40 percent.
    v. Multi-factor shock: Combination of credit, interest and exchange rate risk.
- Risks and buffers:
  - For each risk, the banks’ internal models determine the impact on income and capital.
  - Credit losses: losses are provisioned at the average provisioning ratio and net income loss is estimated. Both are deducted from regulatory capital and Tier I.
  - Interest rate risks: positive or negative changes. Used 2007 methodology on estimating maturity buckets and repricing. Impact on profit and regulatory capital and Tier I.
  - Exchange rate risk: changes due to appreciation/depreciation of local currency. Impact on profit and from regulatory capital and Tier I.
  - Behavioral adjustments: Bank determined; static balance sheet assumption; no profits during stress point in time; no dividends distributed.
- Regulatory and market-based standards and parameters:
  - Calibration of risk parameters: Point in time for both credit and market risks; based on actual point in time (historical highs) or proxies and expert judgment due to data limitations for macro modeling of risk factors.
  - Regulatory/Accounting and Market-Based Standards: Basel I (current standard).
  - Regulatory requirement CAR of 8 percent.
  - Indicators: Tier I / RWA; Tier I / Total Assets.
- Reporting format for results:
  - Output presentation: Capital shortfall below regulatory requirement; Capital shortfall, system wide and by bank type; CAR system wide and by bank type; Number of banks (system wide and by type) with a CAR below the regulatory 8 percent.

### Banking sector stress testing — Liquidity risk (assumptions, methodology, scenarios, reporting)
- Institutional perimeter and data:
  - Institutions included (bottom-up): 6 Largest Banks.
  - Institutions included (top-down): All 20 banks.
  - Market share (6 largest): 86 percent.
  - Market share (20 banks): 100 percent of total assets.
  - Data and baseline date: December 2012 supervisory data.
- Methodology:
  - Bottom-up: Internal models.
  - Top-down: Top down individual bank model based on Cihak (2007), IMF WP/07/59.
- Risks and buffers:
  - Risks: Funding risk; Concentration of funding.
  - Buffers: Bank determined; Counterbalancing capacity (fire sale of assets).
- Tail shocks / Size of the shock:
  - Bottom-up: 5-day withdraw of deposits 5 & 10 percent; Large depositor(s) withdraw all their funds in 1 day.
  - Top-down: 5-day withdraw of deposits (5,5,10,10, & 10 percent); Asset daily disposal rate of 80 percent for liquid assets and 1 percent for illiquid assets; Large depositor(s) withdraw all their funds in 1 day.
- Regulatory and market-based standards and parameters:
  - Note that the Algerian banking sector inter-bank market is inactive due to excess liquidity.
  - Focus on liquidity of banks.
- Reporting format for results:
  - Output presentation: Banks that remain liquid; Number of institutions (system wide and by type of bank) which remain ‘liquid’ after a 5-day period of stress.

*IMF staff report content from the provided document*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14161.pdf_