## _cr14355

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### MACROECONOMIC ENVIRONMENT AND FINANCIAL SECTOR STRUCTURE
- Georgia has withstood shocks including the conflict with Russia, the global financial crisis, political uncertainty, and regional tensions.
- Recent positive developments: peaceful democratic transition, signature of the European Union (EU)-Georgia Association Agreement, falling sovereign rates, a falling domestic government yield curve, and the recent listing of the second largest commercial bank on the London Stock Exchange.
- Growth outlook:
  - The economy is expected to grow strongly in 2014 at 5 percent, and maintain trend growth of 5 percent per year thereafter, conditional on strong investment and structural reforms.
- Exchange rate and reserves:
  - In late 2013 the lari depreciated; the NBG sold about 15 percent of total reserves while allowing the dollar exchange rate to depreciate by about 7 percent. The lari has strengthened in 2014.
- Key macro vulnerabilities that would impact the financial sector:
  - Current account deficits and low savings forcing banks to continue relying on external funding.
  - Financial spillovers from geopolitical uncertainty that could choke off wholesale funding and reduce nonresident deposits.
  - External spillovers from a slowdown in Russia and recession in Ukraine that could increase corporate NPLs via trade and remittances channels.
  - Risk of protracted domestic slow-down if fiscal consolidation and structural reforms are delayed.
  - Sudden decline in asset prices risk: more than half of domestic private credit is backed by real estate.

### FINANCIAL SECTOR STRUCTURE AND SIZE
- Banking system:
  - 21 banks, including two branches of foreign banks.
  - Aggregate assets equivalent to 64 percent of GDP.
  - The two largest banks account for 58 percent of assets (elsewhere noted as 60 percent or over 57 percent depending on table/context).
  - Ownership: primarily foreign-owned; only three banks (representing 6 percent of banking sector assets) are domestically owned.
- Nonbank financial sector:
  - Stock market capitalization: 7 percent of GDP at end-2013 (down from 13 percent at end-2007).
  - Market structure: 10 brokerage firms, one corporate securities depository, three registries, and one stock exchange.
  - Insurance: premia per capita €35; market contracted in real terms by 10 percent in 2013; five largest companies control over 80 percent of the market.
  - Other NBFIs: 69 microfinance institutions, 17 credit unions, five leasing companies; sector assets equivalent to 3¼ percent of GDP (up from ½ percent in 2008). MFIs dominate.

### BANKING SYSTEM GROWTH AND PORTFOLIO COMPOSITION
- Bank assets grew at a rate of 20 percent in 2013.
- Portfolio composition:
  - Retail loans: 42 percent of the portfolio (largest and fastest growing segment).
  - Corporate loans: 38 percent of the portfolio.
  - SME loans: 20 percent of the portfolio.
- Financial system asset table highlights (Assets in billions of GEL, 2010–13) quoted as table entries in source (table formatting preserved in source).

### KEY RISKS AND VULNERABILITIES
- Capitalization:
  - Capital adequacy ratio (CAR): 17 percent at end-2013.
  - Tier 1 capital: 13 percent at end-2013.
  - Several banks are near the 12 percent minimum.
- Dollarization:
  - Roughly 60 percent of deposits and loans are in foreign currency (down from around 75 percent in 2008–09).
  - Over 90 percent of foreign currency borrowers rely on income in local currency and are unhedged.
- Funding structure and maturities (end-2013):
  - Nonresident deposits: about 15 percent of bank funding.
  - Wholesale funding: about 25 percent of bank funding.
  - Nearly 60 percent of bank deposits have residual maturities of one month or less.
  - Absence of a deposit guarantee scheme exacerbates risk of deposit runoff.
- Asset quality and provisioning:
  - NPLs (national definition) fell from about 18 percent after 2009 crisis to 8 percent in 2013.
  - Standard 90-day overdue NPLs: slightly above 3 percent in 2013.
  - Loan-loss reserves cover about 90 percent of NPLs, but yearly provisions are diminishing.
  - Three banks exhibited NPLs of 20 percent or higher.
- Profitability:
  - Return on equity close to 15 percent in 2013.
- Concentration and systemic importance:
  - Two largest banks account for 60 percent of banking assets (other statements: over 57 percent / 58 percent in executive summary).
  - A third bank is considered systemically important due to central role in government payments.
  - Recommended special risk-mitigation: more intensive supervision, higher loss absorbency, robust recovery and resolution plans.

### FINANCIAL STABILITY: STRESS TESTS AND RESILIENCE
- Coverage: stress tests covered all banks; nonbank sector excluded due to small size.
- Approaches:
  - Bottom-up by banks (4 largest banks: Bank of Georgia, TBC Bank, ProCredit Bank, Liberty Bank).
  - Top-down by the NBG (all banks).
  - Top-down by the FSAP team (all banks).
- Scenarios used: Baseline, Mild recession, Extreme recession (same scenarios across top-down approaches; differing modeling techniques).
- Solvency stress-test macro assumptions (summary):
  - GDP growth:
    - Baseline: 2014 – 5% ; 2015 – 5% ; 2016 – 5%
    - Mild recession: 2014 – -5% ; 2015 – 0% ; 2016 – +3%
    - Extreme recession: 2014 – -10% ; 2015 – -3% ; 2016 – +1%
  - Interest rates:
    - Baseline: Unchanged (10%)
    - Mild recession: 2014 – +5 p.p. (15 percent); 2015/2016 unchanged relative to prior year
    - Extreme recession: 2014 – +8 p.p. (18 percent); 2015/2016 unchanged relative to prior year
  - Exchange rate:
    - Baseline: Unchanged (10%)
    - Mild recession: Depreciation by 10%
    - Extreme recession: Depreciation by 30%
  - Property prices:
    - Mild recession: 2014 – -10%
    - Extreme recession: 2014 – -35%
  - Credit growth:
    - Baseline: 2014 – 14% ; 2015 – 9% ; 2016 – 9%
    - Mild recession: 2014–2016 – 0%
    - Extreme recession: 2014 – -5% ; 2015 – -5% ; 2016 - -5%
  - Liquidity shock:
    - Mild recession: Increase in average funding costs by 1 p.p.
    - Extreme recession: Run on deposits and increase in average funding costs by 2 p.p.
- Stress test key results:
  - Baseline: system’s Tier I capital would increase by 3 percentage points to a range of 16–24 percent.
  - Mild adverse: four banks would need additional capital close to GEL 120 million (0.4 percent of GDP) to meet minimum CAR.
  - Extreme adverse: total recapitalization needs about GEL 600 million (1.7 percent of GDP); if risk weights for all loans were lowered after Basel II introduction, needs reduced to about GEL 400 million under extreme scenario.
  - Default by the largest three borrowers would require additional capital of GEL 50 million for five banks.
- Liquidity stress tests (scenarios and design):
  - Scenarios included withdrawal of wholesale funding, bank run (deposit withdrawals up to 30 percent; 80 percent for nonresident deposits), closure of foreign funding markets, fire sales with haircuts up to 40 percent, and combination shocks.
  - Specific liability withdrawal assumptions:
    - Scenario 1 examples: (A) 10 percent of liabilities coming due within three months; (B) 10 percent of all liabilities; (C) 50 percent of liabilities coming due within three months.
    - Scenario 2 (Bank Run) examples: (A) withdrawal of 10 percent of resident deposits; 40 percent of nonresident deposits; 100 percent domestic interbank deposits. (B) withdrawal of 30 percent resident deposits; 80 percent nonresident deposits; 100 percent domestic interbank deposits.
    - Scenario 3: combinations of scenarios 1(A/B/C) and 2(A).
  - Asset liquidation assumptions (liquidation value in percent):
    - Cash and funds at central bank, interbank deposits, deposits at foreign banks, foreign government securities, foreign bonds: 100 percent.
    - Deposits at domestic banks, domestic government securities, domestic bonds, other liquid assets: 60 percent.
  - Common assumptions: interbank market closed; 50 percent of committed credit lines drawn down.
- Liquidity stress-test outcomes:
  - Banks can withstand relatively high liquidity shocks overall, but some banks would have difficulty maintaining positive foreign-currency cash flows.
  - One systemically important bank and several small banks need additional liquidity support under severe withdrawal scenarios.
  - Four small banks might not meet minimum CAR if one of the systemically important banks were to fail.
  - Direct contagion risk relatively low due to shallow interbank market, but single counterparty risk for a small bank can exceed 100 percent of its regulatory capital.
- Contagion and market risk:
  - Direct interest and exchange rate sensitivity tests do not reveal significant losses system-wide; market risk limited (small net open FX positions; most debt securities held to maturity).
  - Indirect FX risk captured via GDP decline leading to GEL depreciation and increased NPLs.

### POLICY RECOMMENDATIONS — MACROPRUDENTIAL, LIQUIDITY, FX AND CAPITAL
- Macroprudential and currency/dollarization measures:
  - Implement countercyclical capital buffer regime and Liquidity Coverage Ratio (LCR) of Basel III.
  - Implement capital surcharge for systemically important banks.
  - Employ macroprudential instruments to address indirect FX risks and support larization.
  - Limit FX lending to unhedged borrowers, at minimum for the riskiest forms of lending and for short-term loans where local-currency alternatives exist.
  - Adjust liquidity regulations to provide stronger incentives for attracting local currency deposits.
  - Promote lari-denominated certificates of deposit (CDs) and consider differentiated FX reserve requirements or favorable treatment of FX CDs in reserve/ liquidity calculations.
  - Use liability-side measures to increase deposit maturities and local-currency share of short-term deposits.
  - Introduce concentration limits for largest borrowers (Top-5 or Top-10) and apply loan-to-value (LTV) or debt service to income (DSTI) caps, possibly differentiated by currency or sector risk weights.
  - Consider limiting banks’ ability to pay dividends while foreign currency loans dominate portfolios to build capital buffers.
- Liquidity and funding concentration:
  - Continue requirement: banks hold more than standard 30 percent liquidity if nonresident deposits exceed 10 percent of total deposits.
  - Address funding concentration through LCR and measures such as currency-by-currency limits and differentiated runoff rates on deposits by withdrawability, owner, maturity, and currency.
- Communication and transparency:
  - NBG should publish regular financial stability reports and ensure systemic risk assessments and policy responses are effectively communicated.

### FINANCIAL SECTOR OVERSIGHT, GOVERNANCE, AND LEGAL FRAMEWORK
- Regulatory and supervisory progress:
  - NBG introduced an advanced risk-based supervisory regime; high degree of compliance with international standards in many areas.
  - Supervisory strengths include a comprehensive supervisory information system, forward-looking risk-based approach, and increased consolidated supervision.
- Remaining legal and regulatory gaps:
  - Strengthen legal basis to introduce more explicit regulatory provisions rather than relying on broad implicit powers of the NBG.
  - Licensing and acquisition rules need explicit statutory powers (e.g., definition of “significant” shareholders should include “persons acting in concert”; notification requirements for disposal of significant holdings).
  - Make supervisory powers, staffing protections, and consultation obligations more explicit in law.
- Corporate governance:
  - NBG should encourage Boards to lead in defining banks’ risk appetite and require Audit Committees to be subcommittees of Boards.
  - Encourage formalization of Credit Risk Officer role and stronger Board oversight of large/excessive exposures.
- AML/CFT and financial integrity:
  - November 2013 AML law amendments improved compliance; FMS moved from NBG to PM office.
  - Ensure operational independence and effectiveness of FMS; remediate remaining weaknesses, especially related to nonresident deposits and PEPs.
  - Legally require banks to report suspicious activities to the NBG when material to safety, soundness, or reputation.

### SAFETY NETS, CRISIS MANAGEMENT, AND RESOLUTION
- Emergency Liquidity Assistance (ELA):
  - Current ELA practices allow discretionary extension beyond three months, flexible interest rates, and ELA without collateral—posing fiscal and financial risk.
  - Recommendations:
    - Revise ELA framework to minimize NBG exposure and improve accountability.
    - Provide ELA only to solvent institutions; where solvency uncertainty exists, require government indemnity via guarantees or government securities before ELA.
    - Clearly allocate internal NBG roles and consider public disclosure of ELA operations once confidentiality concerns subside.
- Bank resolution:
  - Strengthen legal powers to resolve banks early on nonviability grounds; provide clear tools and safeguards (independent asset/liability evaluation, “no creditor worse off” principle).
  - Mitigate governance conflicts between supervision and resolution (consider separate problem-bank function reporting to deputy governor or governor).
- Deposit insurance:
  - Authorities must introduce a DIS within seven years under the EU Association Agreement, but a shorter timetable is warranted.
  - DIS design recommendations:
    - Public interest objective to protect insured deposits and support stability.
    - Close cooperation with NBG for information sharing and quick payouts.
    - Ex ante funded scheme with allowance for ex post extraordinary premiums and borrowing authority.
    - Reasonably limited coverage to mitigate moral hazard.
- Crisis preparedness:
  - Create a Financial Stability Council to develop guidelines, crisis communication plans, conduct simulation exercises, and verify operational procedures.
  - Advance recovery and resolution plans (RRPs), integrate stress tests, and enhance legal basis for government interventions and cross-border cooperation.

### FINANCIAL SECTOR DEVELOPMENT: CAPITAL MARKETS, INSURANCE, SME FINANCE, NBFIs
- Capital markets:
  - Almost nonexistent domestic capital markets; no domestic corporate bonds issued since 2009.
  - Recommended actions:
    - Prepare a time-bound capital market development strategy.
    - Identify lead capital market regulator (NBG or new Securities Commission) with independence and powers.
    - Bring Securities Market Law into line with international best practices and EU requirements.
    - Prohibit off-exchange trading of listed securities to improve price discovery.
    - Continue mechanisms to develop government and corporate debt markets and lengthen bank funding maturities in local currency.
- Insurance sector:
  - Constraints: absence of compulsory insurance classes, lack of actuarial expertise, deficient regulatory framework (no general solvency margin regulation since 2010).
  - Recommendations:
    - ISSSG and Georgian Association of Actuaries to develop training/licensing for actuaries.
    - Comprehensive policy and regulatory reforms to stabilize industry, introduce compulsory insurance classes, protect policyholders, and strengthen regulator independence.
- SME finance and NBFIs:
  - SME access to finance limited; banks main source of SME lending but local-currency and long-term lending constrained by funding.
  - NBFIs fragmented, small, and account for about 3.3 percent of GDP and less than 7 percent of banking assets; leasing and factoring underdeveloped.
  - Recommendations:
    - Develop NBFI sector development strategy.
    - Revise Central Bank Law and Law on Microfinance to clarify mandates and definitions.
    - Revise leasing and secured transactions legislation to allow movable property as collateral; implement a modern electronic “notice” registry to protect security interests.
    - Evaluate enforcement and consumer protection frameworks.

### CREDIT REPORTING, PAYMENT SYSTEMS, AND OPERATIONAL FRAMEWORKS
- Credit reporting:
  - No formal oversight framework for Credit Reporting Systems (CRS); legal framework incomplete.
  - Recommendations:
    - Establish legal framework and formal supervisory/oversight function for credit reporting.
    - Existing credit bureau should eliminate thresholds for loan reporting.
    - Facilitate credit registry access to collateral and other registries.
- National Payment System:
  - Core large-value payment infrastructure is sound; retail payments infrastructure fragmented and costly.
  - Recommendation: strengthen oversight framework for the National Payment System.
- Operational risk and internal controls:
  - Operational risk supervision improved; business continuity plans incomplete (7 out of 21 banks have comprehensive plans).
  - Banks generally lack IT audit coverage and comprehensive outsourcing policies; NBG requires improvements.

### BASEL CORE PRINCIPLES (BCP) ASSESSMENT HIGHLIGHTS
- Number of banks: 21; aggregate banking assets GEL 17.9 billion (per balance sheet).
- Market concentration:
  - Bank of Georgia (BOG): 34 percent.
  - TBC Bank: 23 percent.
  - BOG and TBC together over 57 percent of banking activity.
- Supervisory strengths:
  - Advanced risk-based supervisory approach; enhanced consolidated supervision; comprehensive supervisory information system.
- Main supervisory weaknesses and recommended legal actions:
  - High staff turnover, under-resourced external training, reliance on broad legal powers rather than explicit provisions.
  - Need to formalize supervisory approach (completion target noted) and implement a formal consolidated prudential reporting framework by November 2014.
  - Improve legal clarity on licensing, transfer of significant ownership, major acquisitions, and supervisory powers (see Table 8 recommendations).
  - Require banks to express risk appetite, implement ICAAP/ILAAP/Pillar 2/3, stress testing, contingency planning, stronger AML reporting obligations, and enhancements to corporate governance and related-party transaction rules.

### RISK ASSESSMENT MATRIX (MAIN THREATS, LIKELIHOOD, IMPACT)
- Increasing geopolitical tensions — Likelihood: High; Expected impact: Reduced investment and GDP growth, undermined credit quality, reversal of capital inflows including nonresident deposits, funding and liquidity difficulties for banks.
- Global financial conditions — Likelihood: Medium; Expected impact: Funding from parent banks and nonresident deposits could be affected; tight funding and deleveraging risks.
- Slower growth in advanced and emerging economies — Likelihood: Medium; Expected impact: Reduced exports, lower GDP growth, higher NPLs, lower profitability, potential solvency pressures.
- Capital outflow shock — Likelihood: Medium; Expected impact: Sharp drawdown of nonresident deposits could create funding and liquidity problems.
- Foreign exchange shock — Likelihood: Medium; Expected impact: High given dollarized liabilities and lari income leading to higher borrower defaults and NPLs.
- Commodity price shock, asset quality shock, bank concentration risk — Likelihood: Medium; Expected impacts range from medium to high depending on shock specifics.

### SELECTED MACROECONOMIC INDICATORS (HIGHLIGHTS FROM TABLE 4)
- Real GDP: 2008–2016 series in table; 2014–2016 projections: 2014 – 5.0 ; 2015 – 5.0 ; 2016 – 5.0
- Nominal GDP (in billions of laris): 2014 – 29.2 ; 2015 – 32.2
- Nominal GDP (in billions of U.S. dollars): 2014 – 16.1 ; 2015 – 17.5
- GDP per capita (in thousands of U.S. dollars): 2014 – 3.6 ; 2015 – 3.9
- Deposit dollarization (residents and non-residents): 2010 – 74.8 ; 2011 – 71.8 ; 2012 – 68.6 ; 2013 – 63.3 ; 2014 – 66.0 ; 2015 – 62.1 ; 2016 – 63.6 ; 2017 – 61.2 (table lists series through projections)
- Gross international reserves (in billions of U.S. dollars): 2010 – 1.5 ; 2011 – 2.1 ; 2012 – 2.3 ; 2013 – 2.8 ; 2014 – 2.9 ; 2015 – 2.8 ; 2016 – 2.7 ; 2017 – 3.0

### PRIORITY ACTIONS (HIGHLIGHTS)
- Financial Sector Oversight (High priority, Near term — NBG):
  - Introduce explicit regulatory provisions highlighted in the BCP Assessment.
  - Implement definition of large exposures consistent with Basel standards.
  - Require Boards to develop banks’ risk appetite and convey risk-taking parameters to management.
  - Implement countercyclical capital buffer regime and LCR of Basel III.
  - Employ macroprudential instruments to address indirect FX risks and support larization.
  - Ensure banks build adequate capital buffers while FX loans dominate portfolios.
- Financial Stability (Medium/High priority — NBG):
  - Amend NBG law to strengthen macroprudential mandate.
  - Implement capital surcharge for systemically important banks.
  - Develop comprehensive framework for bottom-up stress testing by banks.
  - Publish regular financial stability reports.
- Crisis Management and Safety Nets (High priority, Near term — NBG, MOF):
  - Revise ELA policy to mitigate NBG exposure.
  - Overhaul bank resolution regime and reinforce safeguards.
  - Introduce a deposit insurance scheme aligned with international best practices.
- Financial Sector Development (High priority, Near term — MOF, MOE, NBG):
  - Develop a comprehensive financial sector development strategy and time-bound capital market development plan.
  - Designate and empower a capital market regulator.
  - Complete insurance sector institutional reform and strengthen regulatory framework.

*Source: EXECUTIVE SUMMARY and sections of IMF Financial Sector Assessment — Georgia (content unit _cr14355).*

### EXECUTIVE SUMMARY ___________________________________________________________________________  5

### EXECUTIVE SUMMARY

### MACROECONOMIC ENVIRONMENT AND FINANCIAL SECTOR STRUCTURE
- Georgia has withstood shocks including the conflict with Russia, the global financial crisis, political uncertainty, and regional tensions.
- Recent positive developments: peaceful democratic transition, signature of the European Union (EU)-Georgia Association Agreement, falling sovereign rates, a falling domestic government yield curve, and the recent listing of the second largest commercial bank on the London Stock Exchange.
- Growth outlook:
  - The economy is expected to grow strongly in 2014 at 5 percent, and maintain trend growth of 5 percent per year thereafter, conditional on strong investment and structural reforms.
- Exchange rate and reserves:
  - In late 2013 the lari depreciated; the NBG sold about 15 percent of total reserves while allowing the dollar exchange rate to depreciate by about 7 percent. The lari has strengthened in 2014.
- Key macroeconomic vulnerabilities that would impact the financial sector:
  - Current account deficits and low savings forcing banks to continue relying on external funding.
  - Financial spillovers from geopolitical uncertainty that could choke off wholesale funding and reduce nonresident deposits, leading to liquidity problems for Georgian banks.
  - External spillovers from a slowdown in Russia and recession in Ukraine that could increase corporate NPLs via trade and remittances channels.
  - Risk of protracted domestic slow-down if fiscal consolidation and structural reforms are delayed.
  - Sudden decline in asset prices risk: more than half of domestic private credit is backed by real estate; continued increases in real estate prices toward the pre-collapse level in 2008 could become a source of vulnerability.
- Financial sector structure and concentration:
  - The banking system consists of 21 banks, including two branches of foreign banks, with aggregate assets equivalent to 64 percent of GDP.
  - The sector is highly concentrated: the two largest banks account for 58 percent of assets.
  - Ownership: the banking sector consists primarily of foreign-owned banks; only three banks, representing 6 percent of banking sector assets, are domestically owned.
  - Banks dominate the financial system; the nonbank financial sector is underdeveloped and capital markets are virtually nonexistent.

### FINANCIAL STABILITY
- General assessment:
  - The economy recovered in 2014, but the Russia-Ukraine conflict could weigh on the economy; rapid credit growth and structural banking vulnerabilities (high dollarization, short-term liquidity, concentrated sector) persist.
- Stress tests and resilience:
  - Stress tests suggest that the banking system is resilient and banks could remain adequately capitalized even in the face of severe shocks, given high levels of profitability and conservative provisioning standards.
  - Identified issues: pockets of weakness and a need to further strengthen capital buffers, especially because foreign currency loans dominate loan portfolios.
  - Funding vulnerabilities: banks’ reliance on short-term funding, including nonresident deposits, is an important source of vulnerability and argues for a shift toward longer-term and domestic currency dominated funding.

### FINANCIAL SECTOR OVERSIGHT AND GOVERNANCE
- Regulatory and supervisory progress:
  - The NBG has introduced an advanced risk-based supervisory regime and maintains a conservative approach to detect vulnerabilities early and allocate supervisory resources efficiently and effectively.
  - Compliance with international standards is described as a very high degree of compliance.
- Remaining legal and regulatory gaps:
  - Strengthening of the legal and regulatory framework is warranted to introduce more explicit regulatory provisions rather than relying on the NBG’s implicit broad powers.
- Corporate governance recommendations:
  - The NBG should encourage banks’ Boards to take the lead in developing the institution’s risk appetite and conveying desired risk-taking parameters to management.
  - The NBG should require that the Audit Committee be a subcommittee of the bank’s Board of Directors.
- Anti-Money Laundering:
  - Authorities have taken steps to improve the AML law and to address weaknesses related to the Financial Monitoring Service (FMS).
  - It will be important to ensure the operational independence and effectiveness of the FMS to address risks related to nonresident deposits and to strengthen compliance with the 2012 Financial Action Task Force (FATF) standard.

### MACROPRUDENTIAL POLICIES
- Planned and recommended measures:
  - The NBG’s planned adoption of the Liquidity Coverage Ratio (LCR), the countercyclical capital buffer regime, and the capital surcharge for systemically important banks is welcome.
  - Deploying further macroprudential instruments could address indirect FX risks, liquidity risk, and support dedollarization.
  - Specific suggested measures to address indirect FX risks and support larization:
    - Limit FX lending to unhedged borrowers.
    - Adjust liquidity regulations to provide stronger incentives for attracting local currency deposits.
    - Promote stable long-term funding instruments, through more favorable treatment of FX CDs in reserve requirements.
- Communication and transparency:
  - The NBG should ensure that its systemic risk assessment and policy response are effectively communicated to relevant stakeholders and the general public, including by the publication of financial stability reports.

### SAFETY NETS AND CRISIS MANAGEMENT
- Major shortcomings and recommended reforms:
  - Revise the framework for emergency liquidity assistance (ELA) to mitigate the NBG’s exposure to financial risks.
  - Introduce an effective bank resolution regime and establish a deposit insurance scheme (DIS).
  - Create a Financial Stability Council to coordinate crisis management, remove impediments to possible government interventions in a crisis, and facilitate cross-border cooperation between the NBG and foreign resolution agencies.
  - Enhance requirements for adequate recovery and resolution plans regarding systemically important banks.

### FINANCIAL SECTOR DEVELOPMENT
- Development challenges:
  - The economy lacks sufficient stable and long-term private financing for required investments to enhance productivity.
  - Financial system is dominated by banks; the nonbank financial sector is underdeveloped and capital markets are virtually nonexistent.
- Recommended strategy and reforms:
  - Develop a comprehensive financial sector development strategy to address constraints on SME financing, encourage private investment, strengthen the regulatory framework of the nonbank sector, revive capital markets, and enhance financial infrastructure.
  - Support the insurance sector by introducing several compulsory classes of insurance (such as automotive insurance) and addressing deficiencies in the regulatory framework, including reintroduction of capital adequacy requirements.

### KEY FINDINGS AND RECOMMENDATIONS (HIGHLIGHTS FROM TABLE 1)
- Financial Sector Oversight (High priority, Near term):
  - Introduce more explicit regulatory provisions in areas highlighted in the BCP Assessment rather than rely on the NBG’s broad powers (NBG).
  - Implement the definition of large exposures consistent with Basel standards (NBG).
  - Require Boards to take the lead in developing banks’ risk appetite and conveying desired risk-taking parameters to management (NBG).
  - Implement the countercyclical capital buffer regime and the LCR of Basel III (NBG).
  - Employ macroprudential instruments to address indirect FX risks and support larization (NBG).
  - Ensure that banks continue to build adequate capital buffers as long as foreign currency loans dominate loan portfolios (NBG).
- Financial Stability (Medium/High priority):
  - Amend the NBG law to strengthen its macroprudential mandate (NBG).
  - Implement the capital surcharge for systemically important banks (NBG).
  - Develop a comprehensive framework for bottom-up stress testing by banks (NBG).
  - Ensure systemic risk assessments and policy responses are effectively communicated, including by regular publication of financial stability reports (NBG).
- Crisis Management and Safety Nets (High priority, Near term):
  - Revise emergency liquidity assistance policy to mitigate the NBG’s exposure to financial risk (NBG, MOF).
  - Overhaul the bank resolution regime by implementing effective resolution tools and reinforcing safeguards (NBG, MOF).
  - Introduce a deposit insurance scheme underpinned by features in line with international best practices (MOF, NBG).
- Financial Sector Development (High priority, Near term):
  - Develop a comprehensive financial sector development strategy, revisiting existing government interventions to eliminate inefficiencies (MOF, MOE, and NBG).
  - Prepare a time-bound strategy for capital market development, including regulatory reform, institutional strengthening, and possibly establishing a market maker (MOF, MOE).
  - Designate and empower a capital market regulator for capital markets (MOF, MOE).
  - Complete institutional reform of the insurance sector and strengthen the regulatory framework (MOF, MOE).

*Source: EXECUTIVE SUMMARY, _cr14355*

### 6.      The banking system’s assets are growing strongly. Bank assets grew at a rate of

### _cr14355 - 6.      The banking system’s assets are growing strongly. Bank assets grew at a rate of

### Banking system growth and portfolio composition
- Bank assets grew at a rate of 20 percent in 2013.
- Retail loans account for 42 percent of the portfolio and are the largest and fastest growing segment.
- Corporate loans account for 38 percent of the portfolio.
- SME loans account for 20 percent of the portfolio.

### Nonbank financial sector structure and size
- Stock market capitalization amounted to 7 percent of GDP at end-2013, down from 13 percent at end-2007.
- Market structure: 10 brokerage firms, one corporate securities depository, three registries, and one stock exchange.
- Insurance sector:
  - Premia per capita of €35.
  - Market contracted in real terms by 10 percent in 2013.
  - Five largest companies control over 80 percent of the market.
- Other NBFIs:
  - 69 microfinance (MFI) institutions, 17 credit unions, and five leasing companies.
  - Sector’s assets are equivalent to 3¼ percent of GDP, up from ½ percent in 2008.
  - MFIs play the dominant role.

### Financial system asset table highlights (Assets in billions of GEL, 2010–13)
- Total Banking System: 10.6; 19; 12.7; 19; 14.4; 19; 17.3; 21 (table formatting in source).
- Foreign Controlled: 10.2; 15; 12.2; 16; 13.8; 16; 16.3; 18 (table formatting in source).
- Total Non-Bank Financial: 0.3; 16; 940; 0.5; 160; 50; 0.7; 1114; 0.9; 1181 (table formatting in source).
- Credit Unions: 0.018; 0.018; 0.018; 0.017 (table formatting in source).
- Microfinance Organizations: 0.349; 0.462; 0.762; 0.869 (table formatting in source).
- Exchange Bureaus: 0.01626; 0.01521; 0.01030; 0.01089 (table formatting in source).
- Active leasing companies: 0.00; 0.03; 0.13; 0.15 (table formatting in source).
- Insurance Companies: 160.515; 0.615; 0.514 (table formatting in source).
- Pension Funds: 676; 5 (table formatting in source).
- Total Financial System: 10.9; 1,735; 13.7; 1,646; 15.7; 1,154; 18.7; 1,221 (table formatting in source).
- Source of table: National Bank of Georgia.

### Risks and vulnerabilities: capitalization, dollarization, funding
- Capital adequacy:
  - Banks report a capital adequacy ratio (CAR) of 17 percent at end-2013.
  - Tier 1 capital: 13 percent at end-2013 (Table 3).
  - Several banks are near the 12 percent minimum.
- Dollarization:
  - Roughly 60 percent of deposits and loans are in foreign currency, down from around 75 percent in 2008–09.
  - Over 90 percent of foreign currency borrowers rely on income in local currency and are unhedged against lari depreciation.
- Nonresident and wholesale funding (end-2013):
  - About 15 percent of bank funding came from nonresident deposits.
  - About 25 percent of bank funding came from wholesale funding.
- Deposit maturities and funding risk:
  - Nearly 60 percent of bank deposits have residual maturities of one month or less.
  - Absence of a deposit guarantee scheme exacerbates risk of deposit runoff.

### Asset quality, provisioning, and profitability (Table 3 and figures)
- Nonperforming loans (NPLs):
  - National definition NPLs fell from about 18 percent after 2009 crisis to 8 percent in 2013.
  - Standard 90-day overdue definition: slightly above 3 percent in 2013.
  - Three banks exhibited NPLs of 20 percent or higher.
- Loan-loss reserves now cover about 90 percent of NPLs, but yearly provisions are diminishing.
- Collateral and foreclosed assets remain significant at some banks; NPLs highest in local banks and in foreign currency loans.
- Profitability:
  - Bank returns on equity reached close to 15 percent in 2013.
  - Net Interest Margin and efficiency contributed to strong profitability; profits recovered from a sharp fall in 2012.

### Concentration and systemic importance
- The two largest banks account for 60 percent of banking assets.
- A third bank is considered systemically important due to its central role in government payments via an extensive branch network.
- Special risk-mitigation arrangements recommended: more intensive supervision, higher loss absorbency, and robust recovery and resolution plans.

### Liquidity, maturity profile, and funding composition
- Maturity profile observations:
  - Deposits are mostly of maturity of one month or less.
  - Significant bunching of maturities in the 3–5 year range.
- Liquidity and funding indicators (selected from Table 3, 2010–13):
  - Liquidity ratio: 38.7; 37.3; 39.8; 41.8 (table formatting in source).
  - Deposit dollarization (residents and non-residents): 68.6; 63.3; 66.0; 63.6 (table formatting in source).
  - Deposit dollarization (residents): 65.0; 58.6; 60.4; 57.8 (table formatting in source).
  - Loan-to-deposit ratio: 107.6; 105.3; 106.7; 102.9 (table formatting in source).
  - Loans to resident deposits: 126.4; 129.9; 134.7; 129.0 (table formatting in source).
  - Net open foreign exchange position (in percent of regulatory capital): 8.1; 5.9; 3.3; 2.1 (table formatting in source).
  - Borrowed funds from abroad-to-GDP ratio: 12.2; 9.4; 11.4; 11.1 (table formatting in source).

### Sectoral vulnerabilities and credit growth
- Credit-to-GDP ratio: 29.9; 31.7; 33.2; 38.0 (table formatting in source).
- Rapid credit growth noted as a vulnerability:
  - Credit-to-GDP gap suggests a risk of overheating, though not to 2008 levels.
  - Roughly 50 percent of all loans are secured by real estate.
  - Rapid growth in consumer credit has been focused in riskier products: consumer loans, credit cards, and fast installments.
- Basel Committee guidance referenced: countercyclical capital buffers kick in at a credit gap threshold of 2 percent and reach maximum at 10 percent.

### Box 1 — Nonresident deposits (key facts)
- Nonresident deposits: GEL 1.5 billion or 15 percent of customer deposits as of April 2014.
- Geographic concentration of depositors: Israel 15 percent, Russia 11 percent, United Kingdom 8 percent, Germany 6 percent, Virgin Islands 6 percent, United States 5 percent, Other countries 49 percent.
- Composition: about two-thirds are individuals (many of Georgian origin); average deposit of more than US$500,000.
- Characteristics:
  - 59 percent of nonresident deposits have residual maturities of less than three months.
  - 92 percent are denominated in foreign currency.
  - FX certificates of deposit (CDs) with longer maturity now account for 20 percent of nonresident deposits.
- NBG policy responses since 2013:
  - Banks must hold more liquidity for nonresident deposits if they exceed 10 percent of total deposits.
  - Higher run-off rates for short-term deposits are applied in the LCR calculation, expected to become binding in September 2014.

### Box 2 — Response to the 2008 dual shocks (summary)
- Dual shocks in 2008: August 2008 conflict with Russia followed by the global financial crisis.
- Immediate impacts:
  - Deposit outflows of about 13 percent in August 2008.
  - Interbank lending virtually dried up.
  - External repayment obligations in 2009 amounted to US$700 million (14 percent of liabilities).
- Policy response:
  - NBG declared a one-day bank holiday; provided liquidity by waiving reserve requirements and granting uncollateralized loans.
  - Large lending and equity injections by IFIs and parent banks helped meet external obligations.
  - NBG initially pegged exchange rate, later let the lari depreciate in November 2008 by 16 percent.
- Aftermath:
  - Economy contracted by 4 percent and real estate prices fell by about 25 percent in 2009.
  - NPLs jumped to 19 percent of total loans by mid-2009 (from 3 percent in early 2008).
  - Banking sector recovered in 2010–11 with cyclical recovery, but vulnerabilities remained: large FX lending and dependence on external financing including nonresident deposits.

### Stress testing and resilience (overview)
- Coverage: Stress tests covered all banks; nonbank sector excluded due to small size.
- Risks considered: credit, market, concentration, and liquidity risks; contagion estimated using a simplified network-contagion approach.
- Approaches used for solvency STs:
  - Bottom-up by banks.
  - Top-down by the NBG.
  - Top-down by the FSAP team.
- Scenarios: Baseline, mild, and extreme scenarios were considered; same scenarios used for top-down approaches but with different modeling techniques and models.

*Source: National Bank of Georgia; and IMF staff estimates.*

### 18.      Banks as a whole appear able to withstand even severe shocks, but pockets of

### 18.      Banks as a whole appear able to withstand even severe shocks, but pockets of weakness are evident

### Stress test findings and capital adequacy
- Capital adequacy was assessed against regulatory thresholds: 12 percent of minimum total CAR and 8 percent of Tier I capital. It was also assumed that, following transition to Basel II Tier I, the CAR minimum will increase in 2015 to 8.5 percent.
- Baseline scenario:
  - The system’s Tier I capital would increase by 3 percentage points to 11 percentage points, up to a range of 16–24 percent. This reflects high profitability, capital buffers, moderate credit growth, and declining levels of NPLs.
- Mild adverse scenario:
  - Banking system resilience is unevenly distributed; aggregated system-wide results mask vulnerabilities of some banks.
  - Four banks would need additional capital close to GEL 120 million (0.4 percent of GDP) to meet their minimum CAR.
- Extreme adverse scenario:
  - Reveals vulnerabilities related to indirect foreign exchange shock-related credit risks and a decline in profitability.
  - Several banks would not meet the minimum Tier I CAR and total recapitalization needs would be about GEL 600 million (1.7 percent of GDP).
  - If risk weights for all loans were lowered after the introduction of Basel II (or as a countercyclical measure), recapitalization needs would be reduced to about GEL 400 million under the extreme scenario.
- Credit concentration:
  - Default by the largest three borrowers would require additional capital of GEL 50 million for five banks.
- Single-factor sensitivity tests:
  - Direct interest and exchange rate risk tests do not reveal significant losses to the banking system.
  - Banks’ exposure to market risks is limited: net open position in foreign currencies is small, and almost all debt securities are held to maturity.
- Methodology note:
  - Bottom-up stress tests were conducted using a two-year scenario.
  - Indirect FX risk was captured via decline in GDP: it was assumed that decline in GDP leads to GEL depreciation and increase in NPLs.

### Differences across stress-testing approaches
- IMF top-down stress test:
  - Incorporates more severe assumptions about decline in banks’ profitability after a shock.
  - Assumptions based on downward trend in lending margins and assumed rigidity of operational expenses during one- and two-year horizons.
- Bottom-up stress tests:
  - Limited use due to limited stress-testing experience of banks and inability to fully trace losses and income assumptions.
  - Banks appeared very optimistic about their income before loan-loss provisions; detailed breakdowns were requested but did not fully reveal the optimism drivers.

### Liquidity risk
- Banks can withstand relatively high liquidity shocks, but some banks would have difficulty maintaining positive cash flows in foreign currencies.
- The most severe impact stems from withdrawal of wholesale and retail funding in foreign currency.
  - One systemically important bank and several small banks need additional liquidity support under severe withdrawal scenarios.
- Foreign currency funding risks require close monitoring.
- Liquidity stress test indicators referenced: LCR and LR; foreign-currency liquidity strains are concentrated in some institutions.

### Contagion risk
- Direct contagion risk is relatively low due to a shallow interbank market.
- Limited exposures to other countries and foreign financial institutions reduce impact from foreign financial market shocks.
- Interbank stress test results:
  - Four small banks might not be able to meet their minimum CAR if one of the systemically important banks were to fail.
  - Little balance sheet contagion effect between systemically important banks.
  - In one case, single counterparty risk for a small bank exceeds 100 percent of its regulatory capital.
- Depositor behavior risk:
  - Historical precedent: in 2008, a loss of confidence led to almost 13 percent deposit withdrawal.

### Mitigation of key risks and policy recommendations
- Overall observation:
  - Most banks maintain capital buffers above regulatory minimum, but some have capital only a few percentage points above minimum, limiting loss-absorption capacity.
  - These banks are especially vulnerable to credit risk from economic activity decline, lari depreciation, and wholesale foreign-currency funding risk.
  - High profitability and net interest margins would decline during crisis periods, reducing net interest and other income as assumed in stress tests.

- Recommendations to reduce dollarization and FX risks:
  - NBG should continue to reduce dollarization through a range of measures. Actions already taken in 2013 included accepting, for a period, floating rate mortgages as collateral (encouraging lari lending), imposing higher risk weights on foreign currency loans, and maintaining higher reserve requirements on banks’ foreign currency deposits.
  - NBG should continue to rely on macroprudential measures and build up capital buffers (for example, by limiting banks’ ability to pay out dividends to shareholders) while foreign exchange loans dominate loan portfolios.
  - Asset-side macroprudential measures:
    - Limit FX lending to unhedged borrowers—at the minimum—for the riskiest forms of lending in line with the ESRB recommendation on FX lending and for short-term loans for which local-currency alternatives are available.
    - These instruments would reduce the NBG’s need to support larization by accepting nonmarketable collateral in local currency for refinancing operations in normal times.
  - Liability-side measures to reduce reliance on short-term and FX funding:
    - Increase the maturities of deposits, taking into account the possibility of withdrawals at penalty rates.
    - Increase the local-currency proportion of short-term deposits.
    - Promote lari-denominated certificates of deposit (CDs).
    - Support measures with macroprudential instruments such as differentiated FX reserve requirements for CDs with longer maturities or more favorable treatment of local-currency liabilities in liquidity regulations.
  - Address concentration and credit risks:
    - Introduce concentration limits for the largest borrowers (for example, limits on Top-5 or Top-10 loan exposures) applying to both on- and off-balance sheet exposures.
    - Apply loan-to-value (LTV) or debt service to income (DSTI) caps, possibly differentiated by currency or sectoral risk weights, as targeted measures if banks’ exposures to high-risk market segments grow strongly.

- Liquidity regulation and funding concentration:
  - NBG introduced a liquidity requirement: banks must hold more than the standard 30 percent liquidity if nonresident deposits exceed 10 percent of total deposits.
  - The mission encourages the NBG to address funding concentration through the LCR and other measures such as currency-by-currency limits and differentiated runoff rates on deposits by withdrawability, owner, maturity, and currency.

### Financial sector oversight and governance: supervision issues and recommendations
- Regulatory framework and supervisory responsibilities:
  - NBG is responsible for regulation and supervision of banks, the securities market, MFIs, and credit unions; insurance supervision was transferred to a separate agency in April 2013.
  - Legal framework: Organic Law of Georgia on the National Bank of Georgia and the Law of Georgia on Activities of Commercial Banks.
- Improvements since 2007 FSAP:
  - Strengthened effective supervision, supervisors’ capacity, powers, legal protections, and information sharing.
  - New or amended laws/regulations addressed “beneficial owner” and “significant share,” licensing application details, sanctioning and enforcement, consolidated supervision, AML requirements, bank governance, and NBG governance structure.
- Areas lacking detailed rules or needing improvement:
  - Operational risk within NBG’s Supervision Department:
    - Review salary levels and increase training budget, including specialist training.
    - High staff turnover over the past three years, particularly among specialists; over-reliance on key personnel.
  - Licensing:
    - Gaps in licensing criteria: NBG approval for appointments to Supervisory Board, Directors, and top management, and their replacements, is not required directly by legislation.
    - No legal requirement for NBG to assess whether a home supervisor practices global consolidated supervision or equivalent supervision.
  - Acquisitions:
    - Definition of “significant” does not refer to shareholders acting in concert; no requirement to notify NBG when an existing shareholder proposes to dispose of significant shareholdings.
  - Risk management in banks:
    - Need for improved quality of banks’ risk management beginning with clear articulation of risk appetite.
  - Home/host relationships:
    - Policy to seek MOUs with relevant jurisdictions; MOUs established with most jurisdictions.
  - Regulatory supervisory fees:
    - Authorities should consider charging for regulation and supervision, as in many other jurisdictions.
- Corporate governance in banks:
  - Progressed well, especially in largest banks; Boards have well-defined roles but need to provide strategic guidance on aggregate risk profile.
  - Audit Committees should be enhanced by making them direct subcommittees of Supervisory Boards.
  - NBG should encourage Boards to define risk appetite and formalize the role of the Credit Risk Officer through supervisory process.

### Other sectoral oversight issues
- Capital markets:
  - Regulation needs to strengthen transparency, price discovery mechanisms, and reporting requirements.
  - NBG currently regulates and supervises the securities market; focus has been on licensing and compliance monitoring in the absence of a vibrant capital market.
  - Challenges include aligning regulation and supervision with commitments under the EU Association Agreement.
- Insurance:
  - Oversight weak and requires major overhaul.
  - May 2013: insurance supervision moved from NBG to Insurance State Supervision Service of Georgia (ISSSG).
  - Regulatory framework incomplete and severely deficient:
    - Since repeal in 2010, no general solvency margin regulation in force.
    - No regulatory requirement for actuarial review of reserves adequacy.
    - No regulatory stipulation of maximum or minimum risk retention in any class of business except surety, resulting in very limited reinsurance coverage locally.
- AML/CFT:
  - 2012 detailed assessment identified weaknesses: lack of transparency of legal persons, deficiencies in customer due diligence, risks from offshore ownership with unknown beneficial owners, increase of nonresident deposits, private banking growth including foreign PEPs, and Georgian-led criminal organizations abroad.
  - Remedial actions taken, but risks remain, particularly regarding nonresident deposits.
  - November 2013 AML law amendments improved compliance with international standard, including coverage of lawyers.
  - FMS institutional move from NBG to office of prime minister; authorities report steps taken to address FMS weaknesses.
  - Going forward, authorities encouraged to ensure:
    - Operational independence and effectiveness of the FMS.
    - AML supervision properly addresses risks related to nonresident deposits.
    - Financial institutions adopt reasonable measures as regards domestic PEPs and persons entrusted with a prominent function by an international organization.
    - Compliance with the 2012 FATF standard and effective implementation of the national AML/CFT strategy.

### Macroprudential framework and institutional arrangements
- Institutional strengthening:
  - NBG is legally responsible for financial stability and should establish a full-fledged macroprudential policy framework aligned with international best practices; framework should be more formalized and transparent.
  - NBG should set up a Financial Stability Unit responsible mainly for systemic risk analysis and macroprudential policy.
  - Revised framework should emphasize accountability and communication, including regular financial stability reports.
- Planned instruments:
  - Introduction of countercyclical capital buffer and capital surcharge for systemically important banks is planned.
  - Capital surcharge is especially important given high market concentration in the banking sector.
- Existing FX-related macroprudential measures:
  - Additional risk weights applied to foreign currency loans to unhedged borrowers.
  - Higher reserve requirements for foreign currency deposits and other borrowings.
  - Requirement for banks to hold more liquidity for nonresident deposits when those exceed 10 percent of total deposits.
- Additional recommended instruments (summarized):
  - Limit FX lending to unhedged borrowers for risky and short-term loans.
  - Use liability-side measures to lengthen deposit maturities and increase local-currency share of short-term deposits; promote lari-denominated CDs.
  - Consider differentiated FX reserve requirements and favorable treatment of local-currency liabilities in liquidity rules.
  - Introduce concentration limits (Top-5/Top-10) and LTV/DSTI caps, possibly currency- or sector-differentiated.

*Source: IMF Financial Sector Assessment — Georgia (Section 18 and related paragraphs).*

### 40.      The emergency liquidity assistance (ELA) regime and practices warrant further

### The emergency liquidity assistance (ELA) regime and practices warrant further strengthening

### Emergency Liquidity Assistance (ELA)
- Under special circumstances threatening the financial system:
  - ELA duration can be extended through a discretionary decision by the NBG Board for a term longer than three months.
  - The interest rate can be flexibly determined by the NBG.
  - ELA can be given without collateral.
- Risks and recommended safeguards:
  - The current practices run the risk that ELA would be used for open bank support and long-term funding.
  - Legal and regulatory framework should be revised to minimize the NBG’s exposure to financial risk and to improve accountability.
  - ELA should be provided only to solvent institutions.
  - When there is uncertainty about a bank’s solvency or the adequacy of collateral, the government should indemnify the NBG through guarantees or government securities before providing ELA.
  - Revised procedures for approval of ELA should clearly allocate roles and responsibilities of the various functions within the NBG.
  - The NBG could make public—once confidentiality concerns subside—information on ELA operations to account for the use of public funds.

### Bank Resolution
- Key shortcomings:
  - The bank resolution framework lacks a number of important features despite certain elements being sketched out in legislation.
- Main areas for improvement:
  - Grounds
    - The NBG should be empowered to resolve a bank under a broader, well-defined range of circumstances and at an early stage.
    - Triggers should be based on the nonviability (or likelihood thereof) of a bank.
  - Tools
    - A stronger framework would provide greater legal certainty on the conduct of resolution and remove the need to obtain creditors’ consent when banks’ claims are transferred.
  - Safeguards
    - Elements aimed at ensuring a fair and impartial resolution process could be enshrined in the law, such as the need for an independent evaluation of a failed bank’s assets and liabilities, and the “no creditor worse off” principle.
- Governance arrangements:
  - Conflicts of interest may arise between the supervisory and resolution functions.
  - Consider creating a separate function responsible for problem banks, with different reporting lines to a deputy governor or directly to the NBG governor to mitigate regulatory forbearance.

### Deposit Insurance
- Legal timetable and rationale:
  - The authorities must introduce a deposit insurance scheme (DIS) within seven years under the EU Association Agreement, but a shorter timetable is warranted.
  - A DIS can mitigate the risk of deposit outflows and increase competition by fostering deposits in small- and medium-size banks that lack an implicit state guarantee.
  - The absence of a DIS may encourage the misuse of the ELA for resolution purposes.
  - Introduction of a DIS now while profits are high would be timely.
- Recommended design features (aligned with international best practices):
  - Public interest objective of protecting insured deposits and contributing to financial stability.
  - Close cooperation with the NBG to share information on problem banks and to make quick payouts.
  - An ex ante funded scheme to minimize systemic risk and avoid procyclicality, while allowing for ex post extraordinary premiums and borrowing authority.
  - Coverage of depositors should be reasonably limited to mitigate moral hazard concerns.

### Crisis Preparedness and Management
- Legal and regulatory impediments:
  - The NBG cooperates with foreign supervisors, but does not have legal authority to cooperate with resolution authorities.
  - The government may provide financial assistance in the form of loans.
  - A specific legal provision prohibits the government from owning equity stakes in banks and other financial institutions.
  - State guarantees need to be ratified by the parliament.
- Institutional and operational recommendations:
  - Create a Financial Stability Council to:
    - Develop guidelines and checklists clarifying roles and responsibilities of relevant stakeholders.
    - Draw crisis communication plans and conduct simulation exercises.
    - Verify the adequacy of operational procedures.
    - Elaborate possible policy responses and related legal powers.
  - Advance the NBG’s work on recovery and resolution plans (RRPs), including integrating stress test exercises and enhancing the legal basis.

### Financial Sector Development

#### Capital Markets
- Present situation:
  - Capital markets are almost nonexistent.
  - Corporate debt market is dormant and the government debt market is still relatively small—despite rapid growth of the government’s local currency T-bills issues in 2013.
  - Corporate issuance has mainly taken place overseas, with no domestic corporate bonds issued since 2009.
  - Trade execution is carried out directly by the three share registries or via off-exchange fixings, which undermines confidence in the price discovery mechanism.
- Recommended actions:
  - NBG and MOE should prepare a time-bound strategy for capital market development as a source of stable and long-term private financing, resulting from a comprehensive review of the institutional setting and the regulatory framework.
  - Identify the lead capital market regulator (NBG or a new Securities Commission) with adequate power and necessary independence.
  - MOE should bring the Securities Market Law into line with international best practices and EU requirements.
  - Introduce legal provisions and have Georgia’s Stock Exchange (GSE) revise its charter to create a more transparent and unified market by prohibiting off-exchange trading of listed securities.
  - Continue mechanisms that develop the debt securities market, such as sale of marketable, two- and five-year government bonds to banks and re-depositing proceeds as term deposits to lengthen bank funding maturities in local currency and promote de-dollarization.

#### Insurance Sector
- Constraints and needs:
  - Lack of compulsory classes of insurance business such as automotive insurance severely hampers development.
  - Divestiture of government-mandated investments in hospitals would be a prerequisite for rejuvenating the sector.
  - Lack of consumer protection and limited public awareness of the benefits of insurance.
  - Virtually absence of actuarial expertise prevents market participants from pricing risk and setting reserves.
- Recommendations:
  - ISSSG jointly with the Georgian Association of Actuaries should develop an approach to training and licensing of local actuaries to ensure adequate supply of qualified actuaries.
  - Prepare comprehensive policy and regulatory reforms aiming at:
    - Financial stabilization of the industry.
    - Development and growth of the insurance sector by devising and introducing several compulsory classes of insurance.
    - Adequate protection of policyholders’ rights and consumer education.
    - Institutional strengthening and attainment of true independence for the insurance regulatory agency.

#### SME Finance and NBFIs
- Current limitations:
  - Financial depth and access to finance for SMEs is limited; access to finance is among the main constraints for business growth.
  - Banking sector is the main source of formal finance for the SME sector, and total volume of intermediation in SME lending is considered low by international benchmarks.
- Causes:
  - Banks are unable to supply credit in local currency and at longer terms because of limited access to long-term, local currency funding (only the two larger banks and some foreign banks access wholesale funding).
  - SME assets are largely movable property, while banks typically prefer immovable property as collateral; SMEs therefore mainly borrow using real estate as collateral.
- NBFI sector:
  - NBFIs lack the scale and financial capacity to bridge the SME gap and the capital market is nonexistent.
  - NBFI sector is fragmented into a relatively large number of small institutions that lack capital or access to funding.
  - NBFIs account for about 3.3 percent of GDP and for less than 7 percent of banking sector assets.
  - Factoring is almost nonexistent, while leasing has not taken off.
- Recommendations:
  - Develop a comprehensive NBFI sector development strategy, including:
    - Revise the Central Bank Law and the Law on Microfinance to expand mandate to cover sound development of the financial sector and provide a clear definition of microfinance institutions.
    - Revise leasing legislation and introduce amendments to create a level playing field with the tax treatment of banks.
    - Revise the legal framework governing secured transactions to enable creditors to accept movable property as collateral, in line with international best practice.
    - Establish a modern electronic “notice” registry of a security interest to achieve protection against third party claims.
    - Evaluate the enforcement process in light of the principles of consumer protection.

#### National Payment System
- Assessment and recommendation:
  - The National Payment System is sound and effective; the core infrastructure for large-value payments is highly sophisticated, with appropriate risk mitigation.
  - Retail payments infrastructure is fragmented and costly.
  - Oversight and risk mitigation are uneven, due in part to the lack of a systematic oversight framework.
  - Oversight framework for the National Payment System should be strengthened.

#### Secured Transactions and Use of Movable Property as Collateral
- Recommendation:
  - Facilitating the use of movable property as secured collateral would increase availability of credit for businesses, particularly SMEs.
  - Ministry of Justice should revise the legal framework governing secured transactions in light of international best practices, evaluate the enforcement process to ensure consumer protection and debtor safeguards, and implement a dedicated, fully electronic registry.

*Source: IMF staff report content unit _cr14355 - 40. The emergency liquidity assistance (ELA) regime and practices warrant further*

### 58.      There is no formal oversight framework for the Credit Reporting Systems (CRS) and

### _cr14355 - 58.      There is no formal oversight framework for the Credit Reporting Systems (CRS) and

### Credit reporting: findings and policy recommendations
- Finding: There is no formal oversight framework for the Credit Reporting Systems (CRS) and the existing legal framework is incomplete.
- Recommendations:
  - Establish a legal framework and formal supervisory and oversight function for credit reporting.
  - The sole existing credit bureau should improve current services by eliminating thresholds for loan reporting.
  - The government should facilitate the credit registry’s access to other collateral, companies, and other registries.

### Selected macroeconomic indicators (Table 4: Georgia: Selected Macroeconomic Indicators 2008-15)
- National accounts
  - Real GDP 2.3 -3.8 6.3 7.2 6.2 3.2 5.0 5.0
  - Nominal GDP (in billions of laris) 19.1 18.0 20.7 24.3 26.2 26.8 29.2 32.2
  - Nominal GDP (in billions of U.S. dollars) 12.8 10.8 11.6 14.4 15.8 16.1 16.1 17.5
  - GDP per capita (in thousands of U.S. dollars) 2.9 2.5 2.6 3.2 3.5 3.6 3.6 3.9
  - GDP deflator, period average 9.7 -2.0 8.5 9.5 1.2 -0.7 3.5 5.0
- Investment and saving
  - Gross national saving 4.0 2.5 11.3 13.4 17.3 18.9 17.2 18.5
  - Investment 26.0 13.0 21.6 26.2 28.9 24.8 25.5 26.4
    - Public 8.0 8.0 8.2 7.7 7.5 5.1 5.7 6.5
    - Private 18.0 5.0 13.4 18.5 21.4 19.7 19.8 19.8
- Inflation
  - Period average 10.0 1.7 7.1 8.5 -0.9 -0.5 4.6 4.9
  - End of period 5.5 3.0 11.2 2.0 -1.4 2.4 5.0 5.0
- Consolidated government operations (in percent of GDP)
  - Revenue 30.7 29.3 28.3 28.2 28.8 27.5 27.1 27.3
    - o.w. Tax revenue 24.4 23.5 25.2 25.4 24.8 24.7 25.0
  - Expenditures 37.0 38.4 34.9 31.8 31.8 30.1 30.8 30.3
    - Current expenditures 28.5 30.1 26.0 23.1 23.1 24.3 24.8 23.3
    - Capital spending and net lending 8.6 8.4 8.8 8.8 8.8 7.5 6.0 6.9
  - Overall balance -6.3 -9.2 -6.6 -3.6 -3.0 -2.6 -3.7 -3.0
  - Public debt 27.6 37.4 39.3 33.8 32.3 32.2 34.1 34.2
    - Of which: foreign-currency denominated 23.5 31.7 33.6 28.8 27.6 27.2 27.6 27.5
- Money and credit
  - Credit to the private sector 32.6 -13.5 18.8 24.3 12.8 19.5 21.6 17.7
  - Broad money, including fx deposits 7.9 7.8 23.9 20.3 11.4 24.4 21.5 18.5
  - Deposit dollarization 74.8 71.8 68.6 63.3 66.0 62.1 63.6 61.2
- External sector
  - Gross international reserves (in billions of U.S. dollars) 1.5 2.1 2.3 2.8 2.9 2.8 2.7 3.0
    - In months of next year's imports of goods & services 3.4 4.1 3.4 3.7 3.7 3.3 3.0 3.1
    - In percent of broad money and nonresident deposits 0.10 0.16 2.0 59.3 51.9 42.5 35.5 33.9
  - Current account balance (in billions of U.S. dollars) -2.8 -1.1 -1.2 -1.8 -1.9 -1.0 -1.3 -1.4
    - In percent of GDP -22.0 -10.5 -10.2 -12.8 -11.7 -5.9 -8.4 -7.9
  - Trade balance -30.0 -22.3 -22.3 -24.4 -26.6 -21.7 -25.1 -24.7
  - Foreign direct investment (inflows) 12.2 6.1 7.0 7.3 5.8 6.3 6.4 6.5
  - Gross external debt 44.6 58.8 54.4 78.0 82.2 81.5 84.2 83.1
- Note: Sources: Georgia authorities and IMF staff estimates. Actual Projections (annual percentage change, unless otherwise indicated)

### Risk Assessment Matrix: main threats, likelihood, and expected impacts (Table 5)
- Overall Level of Concern: Assessment categories used include Medium and High across threats.
- Global financial conditions
  - Likelihood: Assessment: Medium
  - Expected impact: The banking system is dominated by foreign banks; higher international market volatility would affect funding from parent banks and nonresident deposits; tight funding could affect banks if parent banks deleverage, hoard liquidity, and cut intergroup lending.
- Slower growth in advanced and emerging economies
  - Likelihood: Assessment: Medium
  - Expected impact: Reduced exports, lower GDP growth, higher NPLs, lower profitability, potential solvency pressures; currency depreciation could widen current account deficit and increase borrower debt burdens and NPLs.
- Increasing geopolitical tensions
  - Likelihood: Assessment: High
  - Expected impact: Reduced investment and GDP growth, undermined credit quality, reversal of capital inflows including nonresident deposits, funding and liquidity difficulties for banks.
- Capital outflow shock
  - Likelihood: Assessment: Medium
  - Expected impact: High concern: a sharp drawdown of nonresident deposits could create funding and liquidity problems; reliance on nonresident deposits is a source of concern.
- Commodity price shock
  - Likelihood: Assessment: Medium
  - Expected impact: High: large oil price increase could affect corporate profitability and lead to higher NPLs.
- Foreign exchange shock
  - Likelihood: Assessment: Medium
  - Expected impact: High: dollarized liabilities versus lari income could cause borrowers to default, increase NPLs, require higher provisioning, reduce bank capital and profitability, and prompt nonresident deposit outflows.
- Asset quality shock
  - Likelihood: Assessment: Medium
  - Expected impact: Medium: uptick in household credit could raise NPLs and adversely affect bank balance sheets.
- Bank concentration risk
  - Likelihood: Assessment: Medium
  - Expected impact: Medium: dominated by three major banks with similar business models; stress could spread quickly; absence of deposit guarantee scheme increases fiscal risk in case of bank failure.

### Status of 2007 FSAP Recommendations (Table 6): selected recommendations and actions taken
- Bank Supervision and Resolution
  - Implement BCP assessment recommendations: The authorities have made a number of legal and regulatory changes as described in the text.
  - Implement consolidated supervision and increase coordination: The NBG now supervises both bank and nonbank financial institutions, although insurance supervision was made separate again in 2013. New regulation is still needed.
  - Start inspections and take actions on weak banks: The NBG has performed inspections and taken a number of actions on weak banks.
  - NBG should draft a decree or internal guideline on principles and rules for use of its LOLR facility: Done; however, the NBG Law and NBG Decree #6 of 2012 still expose the NBG to financial risk.
- Insurance Law and Regulations (multiple items): Most items marked Not done; one item partially done regarding investment in securities of OECD countries (law does not specify minimum credit quality).
- Insurance Supervision
  - Transfer the Pensions Team from NSCG into SISSG as a separate unit: Partially done.
  - SISSG should define minimum skills criteria for future recruits and require that existing staff upgrade their skills: Done.
- Non-State Pensions
  - Allow the central depository to handle pension scheme assets: Done. Assets of pension savings accounts are kept in the Central Depository.
- Capital Markets
  - Amend legislation to allow supervisory authority to enforce rules: Not done.
  - Reduce number of reporting companies: The number has been reduced; change detrimental to transparency and a well functioning securities market.
  - Oblige companies to report off-market trading to the GSE: Most transactions moved away from the GSE; in 2013 94 percent of their value took place in a very nontransparent way in the securities depositories.
  - Reorganize NSCG and improve financial independence of securities supervisor: The NBG continues to be the independent supervisor.
  - Improve coordination with banking and insurance supervisors: Proper coordination with banking supervisors is in place due to NBG’s multiple mandate; an MoU with the new insurance supervisor agency is required.
- Legal recommendations: Mixed progress
  - Limit courts’ review of substantive technical aspects of NBG decisions: No legislative changes implemented, but no further cases where insolvent banks were allowed to operate.
  - Amend Banking Law to strengthen fit and proper criteria for bank administrators and significant shareholders: Done.
  - Consider introducing a Law on Credit Information Bureaus: Not done.
  - Adopt comprehensive Law on Microfinance Institutions: Done, but definition of microfinance institution needs refinement.
  - Consider revising Law on Entrepreneurs: Done; however, no responsible agency for enforcement.
  - Consider introducing a Law on Leasing: Leasing provisions in Civil Code amended in 2011; amendments to VAT treatment pending.
  - Clarify scope of Law on Licenses and Permits: Done.
  - Enact new Law on Bankruptcy Proceedings: Done.
  - Commission study to improve Law on Execution of Judgments: Major changes introduced in various laws to enhance enforcement of judgments.
  - Enact new Law on Public Arbitration based on UNCITRAL Model Law: Done.
- Financial Integrity
  - Supervisory Boards should take greater responsibility for financial statements and have an Audit Committee: Done.
  - Improve transparency of beneficial owners of financial institutions: Done.

### Stress-testing: methodology, scope, and scenarios (Appendix I)
- Limitations and approach
  - Note: Quantitative models used for stress testing are based on relatively short time series and might not capture full effects of extreme shocks.
  - Tests used three different models and approaches: bottom-up by banks, top-down by the NBG, and top-down by the FSAP team.
  - All tests were based on solo data as of December 2013, and simulated shocks for three years ahead.
  - Hurdle rates are in line with current regulatory framework (Basel I); the FSAP mission team made additional calculations to compare results with upcoming Basel II Standardized as well as quasi-IRB frameworks.
- Scenarios considered
  - Three scenarios: one baseline and two adverse (mild and extreme).
  - Baseline: based on the forecast of most likely developments in the Georgian economy for two years ahead; IMF WEO assumptions and projections are used.
  - Mild recession scenario: calibrated to resemble 2008–09 regional geopolitical turmoil; includes reduced trade, lower remittances, lower investment, decline in GDP, depreciation, higher lending interest rates, and fall in real estate prices.
  - Extreme recession scenario: more protracted effects—extreme decline in GDP, higher depreciation, higher shock in interest rates, decline in real estate prices; compounded by liquidity shock based upon a run on nonresident deposits, spillover to resident deposits, sharply increased dollarization, and direct financial spillovers to banks (higher funding costs).
  - In both mild and extreme scenarios banks face increased credit risk, higher NPLs, higher provisioning ratios due to fall in property prices, and higher funding costs from interest rate increases that lower profitability.
- Liquidity stress tests scenarios: (section header present; detailed scenarios follow in source beyond excerpt)

*Italic: Source — _cr14355 - 58.      There is no formal oversight framework for the Credit Reporting Systems (CRS) and*

### 61.      The liquidity stress tests examine banks’ resilience to liquidity shocks, including

### _cr14355 - 61.      The liquidity stress tests examine banks’ resilience to liquidity shocks, including

### Liquidity stress tests — scenarios and shock design
- Scenarios examined:
  - Withdrawal of wholesale funding and closure of foreign funding markets.
    - Wholesale funding based on loans and deposits are not rolled over according to the shock parameters.
  - Bank run:
    - Deposit withdrawals of up to 30 percent (80 percent for nonresident deposits).
    - Wholesale funding withdrawal of up to 30 percent (100 percent for the interbank market).
    - Fire sales of liquid assets with haircuts of up to 40 percent.
    - The initial nominal stock of credit grows according to the baseline scenario.
    - Fifty percent of committed credit lines are drawn down.
    - No net additional intragroup funding is available.
    - Interbank market is closed.
  - Combined shocks:
    - Combines withdrawal of nonresident funding and bank run shocks.

- Specific liability withdrawal assumptions:
  - Scenario 1 — Withdrawal of nonresident funding and closure of foreign funding markets:
    - Overnight withdrawal of wholesale funding.
    - (A) 10 percent of liabilities coming due within three months.
    - (B) 10 percent of all liabilities.
    - (C) 50 percent of liabilities coming due within three months.
    - In all cases, assume no withdrawals of customer deposits.
  - Scenario 2 — Bank Run (withdrawal of resident and nonresident deposits over 5 and 30 days horizon):
    - (A) A withdrawal of 10 percent of residents deposits; 40 percent of nonresidents deposits, including foreign bank deposits; and 100 percent of domestic interbank deposits.
    - (B) A withdrawal of 30 percent of residents deposits; 80 percent of nonresidents deposits, including foreign bank deposits; and 100 percent of domestic interbank deposits.
  - Scenario 3 — Combination scenarios:
    - (A) Combination of scenarios 1A and 2 (A).
    - (B) Combination of scenarios 1B and 2 (A).
    - (C) Combination of scenarios 1C and 2 (A).

### Summary of macroeconomic assumptions for scenario-based solvency stress tests
- Scenarios: Baseline | Mild recession | Extreme recession
- GDP growth:
  - Baseline: 2014 – 5% ; 2015 – 5% ; 2016 – 5%
  - Mild recession: 2014 – -5% ; 2015 – 0% ; 2016 – +3%
  - Extreme recession: 2014 – -10% ; 2015 – -3% ; 2016 – +1%
- Interest rates:
  - Baseline: Unchanged (10%)
  - Mild recession: 2014 – +5 p.p. (15 percent); 2015 – unchanged compared to 2014; 2016 – unchanged compared to 2015
  - Extreme recession: 2014 – +8 p.p. (18 percent); 2015 – unchanged compared to 2014; 2016 – unchanged compared to 2015
- Exchange rate:
  - Baseline: Unchanged (10%)
  - Mild recession: Depreciation by 10%
  - Extreme recession: Depreciation by 30%
- Change in property prices:
  - Baseline: Unchanged
  - Mild recession: 2014 – -10% ; 2015 – unchanged compared to 2014 ; 2016 – unchanged compared to 2015
  - Extreme recession: 2014 – -35% ; 2015 – unchanged compared to 2014 ; 2016 – unchanged compared to 2015
- Credit growth:
  - Baseline: 2014 – 14% ; 2015 – 9% ; 2016 – 9%
  - Mild recession: 2014 – 0% ; 2015 – 0% ; 2016 – 0%
  - Extreme recession: 2014 – -5% ; 2015 – -5% ; 2016 - -5%
- Liquidity shock:
  - Baseline: Not included
  - Mild recession: Not included. Increase in average funding costs by 1 p.p.
  - Extreme recession: Run on deposits and increase in average funding costs by 2 p.p.

### Summary of assumptions for liquidity stress tests — asset liquidation and other parameters
- Assumptions on asset liquidation (liquidation value in percent):
  - Cash and funds held at the central bank, interbank deposits, deposits held at foreign banks, foreign government securities, and foreign bonds: 100 percent
  - Deposits held at domestic banks, domestic government securities, domestic bonds, and other liquid assets: 60 percent
- Other common assumptions for all scenarios:
  - Interbank market is closed.
  - Percent of committed credit lines that are drawn down: 50 percent

### Stress test methodologies — solvency, liquidity, contagion (scope and key features)
- Solvency risk stress tests:
  - Approaches: Bottom-Up by Banks; Top-Down by the NBG; Top-Down by FSAP Team
  - Institutions included:
    - Bottom-Up: 4 largest banks: Bank of Georgia, TBC Bank, ProCredit Bank, and Liberty Bank.
    - Top-Down (NBG and FSAP): All banks.
  - Market share:
    - Bottom-Up: 73 percent.
    - Top-Down: 100 percent.
  - Data:
    - Bottom-Up: Banks’ own data.
    - Top-Down by NBG: Supervisory data.
    - Top-Down by FSAP Team: Supervisory and public data.
  - Stress test horizon:
    - Bottom-Up: 2 years: 2014–2015.
    - Top-Down: 3 years: 2014–2016.
  - Methodologies:
    - Bottom-Up: Bank own methodology for single-factor sensitivity analysis.
    - NBG: NBG’s own balance sheet model; satellite model for credit losses; sensitivity model for net income.
    - FSAP Team: Modified Next Generation Balance Sheet Model; satellite models for credit risk; sensitivity model for net income.
  - Shock scenarios:
    - IMF-defined scenarios including Slowdown in global economic growth and Extreme Recession scenario developed by IMF.
    - Single-factor shocks: Asset quality deterioration (default of up to the three largest borrowers).
  - Market risk scenarios:
    - Impact of 15 percent, 20 percent, and 25 percent sudden devaluation of the Lari against the USD on bank profitability.
  - Risks/factors assessed: Credit quality deterioration; FX shock; Funding risk (Top-Down).
  - Satellite models / transmission:
    - Macro shocks translated into NPLs/PDs via satellite models (dynamic panel OLS and dynamic panel GMM estimation mentioned); sensitivity models for income.
  - Calibration of risk parameters:
    - Actual point-in-time risk parameters for credit risk (NPLs and provisioning ratios); expert judgment for shocks to interest spreads, operational expenditures and other income.
  - Hurdle rates & Basel implementation:
    - Basel I/NBG minimum CAR rates: 12 percent for total CAR and 8 percent for Tier I CAR.
    - For 2015 and 2016: 8.5 percent for Tier I CAR (noted under some top-down approaches).
  - Behavioral adjustments:
    - Bank own strategy based on credit growth and dividend payout (Bottom-Up).
    - Credit growth estimated by a macrofinancial model and expert judgment. No dividend payout policy (Top-Down).

- Liquidity risk stress tests:
  - Scope:
    - Bottom-Up by banks: N/A.
    - Top-Down by NBG (in cooperation with FSAP team and commercial banks): All 21 banks.
  - Market share: 100 percent (Top-Down).
  - Data: Supervisory and public data.
  - Stress test horizon: 5-day and 30-day outflow (Top-Down).
  - Methodology: Implied cash flow based; Bank-run type tests; stress tests separately for GEL and USD.
  - Risks considered:
    - Bank runs: deposit withdrawals of up to 30 percent; wholesale funding withdrawal of up to 30 percent; fire sales with haircuts of up to 40 percent.
    - Withdrawal of nonresident funding and closure of foreign funding markets.
  - Regulatory standards:
    - Liquidity mismatches; maturity mismatches/rollover risks; concentration of funding (LCR). LCR analysis was based on GEL and USD.
  - Presentation of results: Number of banks that fail; liquidity shortage in each currency (GEL and USD).

- Contagion risk stress tests:
  - Scope:
    - Top-Down by NBG: All banks; data on interbank market exposures among banks.
  - Stress test horizon: Immediate.
  - Methodology: Simple sensitivity test based on netting of interbank market exposures; addresses direct contagion risks via balance sheet effects only.
  - Risks: Direct contagion risk due to failure of a bank.

### Annex I — Basel Core Principles for Effective Banking Supervision: key findings and system facts
- System structure and size:
  - Number of banks operating in Georgia: 21 banks.
  - Aggregate banking assets (per balance sheet) of the 21 banks amount to GEL 17.9 billion.
  - Market concentration:
    - Bank of Georgia (BOG): 34 percent.
    - TBC Bank: 23 percent.
    - Together BOG and TBC account for over 57 percent of banking activity.
    - Liberty Bank: less than 8 percent of total bank assets.
    - The 10 smallest banks each have a market share of less than 1 percent and, in aggregate, represent about 5.3 percent of the total market share.
  - Ownership:
    - BOG and TBC have diffuse ownership and are listed on the London Stock Exchange.
    - Most remaining banks are subsidiaries or affiliates of foreign banks; a few smaller banks are owned by individuals, both Georgian and foreign.

- Main supervisory findings (selected):
  - Significant improvements in regulation and supervisory approach since the 2007 FSAP; many amendments to existing laws, new laws, and regulations introduced.
  - Weaknesses identified:
    - Very high level of staff turnover in recent years; over-reliance on key personnel.
    - External training and education is under-resourced.
    - In several areas (notably bank licensing), the NBG relies on broad supervisory powers in the absence of detailed explicit powers; this could leave NBG open to challenge where broad powers are not supported by granular explicit powers.
  - Supervisory approach:
    - NBG developed a comprehensive, forward-looking, risk-based supervisory approach proportionate to systemic relevance.
    - Approach includes stress tests, business models, corporate governance, capital and contingency planning.
    - Uses a mix of bank supervisors (responsible for all risks of one bank) and specialist risk supervisors (responsible for one risk across all banks).
    - Further enhancement needed in assessing banks’ resolvability, particularly for systemically relevant banks; no comprehensive framework for handling banks in distress.
  - Supervisory information systems:
    - Comprehensive supervisory information system enabling “online” supervision and rigorous data analysis off-site.
    - Risk that supervisors may spend insufficient time on-site given strong online capabilities.
  - Supervisory reporting and consolidated supervision:
    - Significant improvement since 2007 FSAP.
    - Group exposures are assessed as part of group structure risk assessment; large exposures calculated on a consolidated basis; NBG has begun to assess capital on consolidated basis.
    - Formal prudential reporting structure not yet in place but expected to be introduced in November 2014.
  - Home-Host supervision:
    - Level of cross-border banking is very insignificant in Georgia.
    - Legislation for cross-border cooperation is adequate and NBG actions commensurate with activity level.
  - Prudential standards and risk management:
    - Additional efforts needed to improve banks’ risk management and ensure adequate implementation of regulation and guidance.
    - NBG focuses first on the largest banks and is generally more demanding toward complex and large institutions.

*Source: _cr14355 - 61.*

### 13.      Though the intrusive supervisory approach is highly appreciated, the NBG should

### _cr14355 - 13.      Though the intrusive supervisory approach is highly appreciated, the NBG should

### Internal Control, Financial Reporting, Audit, Disclosure and Transparency
- Internal Control and Transparency (CP 26):  
  - "The legislation and practice in these areas appear adequate."
- Financial reporting, audit, disclosure and transparency (CPs 27–28):  
  - "The requirements in these areas were met, although some minor weaknesses were identified."

### Anti‑money laundering and Abuse of Financial Services (CP 29)
- Legislation and practice: "appear adequate."
- Identified weakness: "there is no legal obligation for banks to report to the NBG suspicious activities and incidents of fraud where such activities/incidents are material to the bank’s safety, soundness, or reputation."

### Overall supervisory responsibilities and legal framework (Core Principles 1–3)
- Responsibilities, objectives and powers:
  - The supervisory function of the NBG should be given equal status to its "so-called main task of price stability."
  - Recommendation to amend Article 21 of the LACB Law so "all areas are covered and not just those listed in the article."
  - "While public consultation on new laws and regulations takes place in practice, there is no legal obligation on the NBG to do so."
  - Suggestion: give explicit powers in law for certainty, even though current broad powers enable effective supervision.
- Independence, accountability, resourcing and legal protection for supervisors:
  - "The quality of the supervisory staff is impressive."
  - Concerns: "very high level of staff turnover" and "over-reliance on key personnel" and "reliance on short-term staff."
  - "Insufficient resources are put into external training and education. The NBG relies largely on internal training."
  - Observations: "The Georgian authorities do not charge for supervision." (observation, not used for rating)
  - Gaps: "no provision for the public disclosure of reasons for the removal of NBG Board members"; "The NBG does not publish a focused account of its strategic plans and targets or the extent to which these are met."
  - Legal protection: "There is no explicit legal provision that the supervisor will be adequately protected against the cost of defending their actions and/or omissions while discharging their duties in good faith." Protection for staff is unclear; "Temporary administrators and liquidators are protected only if they are NBG Staff."
- Cooperation and collaboration:
  - "A collaborative arrangement (MOU) between the NBG and the recently established insurance regulator has been signed and it should be fully implemented."
  - "A formal arrangement with the MOF to undertake recovery and resolution planning and actions was recently concluded, but it should be fully implemented."

### Licensing, ownership transfers, and major acquisitions (Core Principles 4–7)
- Permissible activities:
  - "The NBG’s policies and procedures are comprehensive and there is an increasing focus on looking through the shareholding and ownership structure above the institution."
- Licensing criteria:
  - Licensing "appears to work well in practice, notwithstanding some explicit gaps in legislation."
  - NBG relies on broad legal principles; "Amendments have recently been introduced to address some of these issues."
  - Gap: "There is no legal requirement for the NBG to assess whether the home supervisor practices global consolidated supervision and/or whether its supervision standards are equivalent to that of the NBG."
- Transfer of significant ownership:
  - NBG relies on broad supervisory powers; progress in identifying beneficial owners noted (correcting a previous major shortcoming).
  - Legislative shortcomings:
    - Definition of "significant" should include "persons acting in concert."
    - "There is no requirement to notify the NBG when an existing shareholder proposes to dispose of his/her significant shareholding."
    - "There is no reference to those that exert controlling influence in the context of transfers of significant ownership."
    - "There is no legal provision that requires banks to notify the supervisor as soon as they become aware of any material information which might negatively affect the suitability of a major shareholder or a party with a controlling interest."
- Major acquisitions:
  - Criteria used are not statutorily based but are established as internal guidelines and "have been published by the NBG under its periodic journal."
  - Missing explicit legal powers for the NBG to:
    - "determine whether new acquisitions/investments will hinder effective implementation of corrective actions;"
    - "prohibit banks from making acquisitions/investments in countries with laws or regulations prohibiting information flows deemed necessary for adequate consolidated supervision; or"
    - "take into consideration the effectiveness of supervision in the host country and its own ability to exercise supervision on a consolidated basis."

### Supervisory approach, techniques and tools (Core Principles 8–9)
- Supervisory approach:
  - NBG developed "an advanced supervisory approach that is comprehensive, forward-looking, and risk-based, proportionate to the systemic relevance of supervised banks."
  - Implementation status: "the new approach is not yet fully implemented (just for 80 percent) and formalized."
  - Recovery/resolution: "The NBG does not have an explicit operational framework or process for handling banks in times of stress that could support orderly recovery or resolution," though it has "(basic) powers and tools" and used a mix of recovery instruments in 2008.
  - "The NBG required four banks to set up resolution plans, but the process of implementation has only started recently."
  - MOU with insurance supervisor exists; insurance sector "relatively small" and the "largest insurance company is a subsidiary of a bank."
  - Cautionary supervisory boundary: "Though the intrusive approach is highly appreciated, the NBG runs the risk of being too involved and taking over the bank’s risk management, in particular, its credit risk management."
- Supervisory techniques and tools:
  - Major strengths:
    - Use of a supervisory cycle (risk identification, assessment and mitigation) at the level of each individual risk, balanced by periodical stock takings.
    - Balanced integration of bank supervisors and risk supervisors: "Bank supervisors are responsible for banks across risks, and risk supervisors are responsible for risks across banks, including systemic risk."
    - Powerful supervisory information system enabling "online" supervision and rigorous data analysis; ability to receive all loan files online connected to banks’ information systems.
  - Risk: "The NBG runs the risk of not spending enough time on-site because of excellent online possibilities." Supervisors should "consider whether they spend enough time on-site to sense the risk culture."

### Supervisory reporting, corrective powers, and consolidated supervision (Core Principles 10–12)
- Supervisory reporting:
  - "The NBG has a comprehensive supervisory reporting system; however, there is no formal consolidated prudential reporting framework in place—to be introduced in November 2014."
  - "Notwithstanding the absence of such a framework, there are sufficient alternatives and mitigants to otherwise address the issue."
- Corrective and sanctioning powers:
  - Since adopting risk-based approach, NBG more focused on underlying factors and forward-looking risks; prefers dialogue via letters, emails, meetings.
  - Recommendation: "consideration should be given to imposing formal actions with clear escalation against banks in cases of safety and soundness issues, especially in cases where these issues linger in banks for a protracted period of time."
  - Mixed record: "examples of successful interventions" and "examples where the NBG could have done better."
  - Importance will increase with Basel II implementation, as banks must upgrade risk management.
- Consolidated supervision:
  - "Significant improvement in consolidated supervision since the last FSAP."
  - Consolidated ratios now calculated and included in the risk assessment program.
  - Main weakness: "absence of a formal consolidated prudential reporting framework" (see Principle 10).

### Home‑host relationships and corporate governance (Core Principles 13–14)
- Home-host relationships:
  - "The level of cross-border banking is insignificant in Georgia."
  - "The legislation providing for cross-border cooperation is adequate and the actions undertaken by the NBG are commensurate with the level of activity."
- Corporate governance:
  - Since Basel II/III announcement, NBG has prioritized robust corporate governance aligned with bank risk profile/systemic importance.
  - Areas for improvement:
    - "Boards seem to be less involved in setting and overseeing the risk appetite."
    - Conflict between law and regulation on whether a Director can be a member of the Supervisory Board; in practice "very rare" and Directors are restricted where conflicts of interest arise.
    - Audit Committees exist in all banks as required by law, but could be enhanced "if made a direct subcommittee of the Supervisory Board."
    - Legally, committee members "are not held to the same accountability standards as Supervisory Board members," though NBG has facilitated committees as subcommittees.
    - NBG lacks explicit power to change Board composition but has implicit power to require dismissal of a Board member (LACB article 30.3e) who lacks experience or education (LACB article 41).

### Risk management process and implementation of Basel frameworks (Core Principles 15–16)
- Risk management process:
  - NBG supervisory approach: "intrusive, forward-looking, and risk-based."
  - Essential criteria not yet fully met across large, medium, and small banks; NBG prioritized largest banks first but should raise standards for small and medium banks (proportionately).
  - Implementation of Basel II is "an important step forward."
  - Specific risks of intrusion: NBG "runs the risk of being too involved and taking over the bank’s risk management, in particular, its credit risk management."
  - Requirements and current gaps:
    - NBG required to determine that banks have a suitable risk appetite; many banks "do not have detailed lending standards or their interest rate risk appetite."
    - NBG required to determine that banks have adequate internal processes for assessing capital and liquidity adequacy (ICAAP, ILAAP) and internal reporting; these requirements "are not (yet) met because banks are in the process of implementing Basel II."
    - "A few banks have already submitted the first draft of their ICAAP."
    - NBG has "not yet developed guidelines for how to determine the adequacy of the ICAAP in the so-called Supervisory Review Evaluation Process (SREP)."
    - NBG required to request banks have contingency arrangements and forward-looking stress tests; "these requirements have not yet been fully implemented by all banks."
    - NBG expects "all banks to have adequate stress tests in place at the end of this year as part of the implementation of Basel II."
    - Risk management segregation: observation that "the credit risk management function/Chief Risk Officer (CRO) is involved in the credit-approval process" and "several banks have remuneration policies for their credit risk management that combine elements of growth, volume of analysis, and quality of the loan portfolio."
- Capital adequacy:
  - NBG "is in the process of implementing Basel II and elements of Basel III."
  - Conservative applications: e.g., "double capital requirements on loans denominated in foreign currencies."
  - Timetables and requirements:
    - "Banks are required to comply with the minimum capital requirements under Pillar 1 as of June 30, 2014."
    - Credit risk: banks can "only apply the standardized approach."
    - Operational risk: banks can "only apply the basic indicator or standardized approach."
    - Market risk: banks required to "use a simple approach to determine a capital requirement for FX risk."
    - "Pillar 2 will be in force as of September 30, 2014, when banks are required to report the outcome of their Internal Capital Adequacy Process (ICAAP)."
    - "The NBG will decide before end-2014 when banks need to comply with the Pillar 3 requirements."
    - Transition period: "2014-2017 banks need to comply with both the minimum capital requirements based on adjusted Basel I capital requirements and the minimum capital requirements based on Basel II/III."
    - "As of January 2014, banks have been required to file a parallel run."

### Credit risk, problem assets, provisioning, and concentration (Core Principles 17–19)
- Credit risk:
  - NBG "has developed a very advanced, risk-based approach to determine whether banks have an adequate credit risk management system," including assessment of credit risk policy/procedures, management information, and loan reviews.
  - Analysis methods: corporate and SME portfolios assessed "mostly on key ratio analysis (derived from Moody’s and S&P) and valuation of collateral."
  - Gaps:
    - "Not all banks have (yet) fully implemented the specific requirements of the credit risk management framework such as adequate lending standards."
    - No specific requirements that "major risks exceeding a certain amount or percentage of the bank’s capital" or other risky exposures "are to be decided by the Board or senior management."
    - "Not all banks include their credit risk exposures into stress testing programs for risk management purposes."
    - NBG "is currently facilitating implementation of a sound stress-testing framework in commercial banks, which would form an essential part of Pillar 2 processes by the end of the year."
- Problem assets, provisions, and reserves:
  - NBG "has put significant effort into identifying problem loans and maintaining adequate levels of provisioning, mostly for the large borrowers (40 percent of total loan portfolio)."
  - For SME and retail borrowers, NBG uses "sample techniques to ensure adequate provisioning."
  - Measures result from "comprehensive reporting, enhanced risk assessment skills, an intrusive supervisory approach, and active dialogue with the commercial banks."
  - NBG intends "to facilitate transition toward the IFRS" and when IFRS is adopted will "update its guidelines on loan-loss provisioning."
- Concentration risk and large exposure limits:
  - NBG improved in identifying connected borrowers; receives monthly database from every bank of "the top 100 borrowers, the large exposures, and the participations."
  - Weakness: banks are required to identify economic interdependence but "there is limited practice at the banks to do this."
  - Mitigant: NBG "decreased its total large exposure limit from 600 percent to 200 percent."
  - Recommendation: "banks should put more effort into identifying economic interdependence" and NBG plans "to develop guidelines on economic interdependence."
  - Regulation gap: "does not prescribe requirements for concentrations other than single counterparties or groups connected counterparties."
  - NBG has a general regulation on risk management that "includes some provisions on concentration risk," but "it did not fully implement this regulation." Implementation to be repaired by the NBG.

*Source: IMF staff assessment text provided in the content unit*

### introduction of Pillar 2 of Basel II, which explicitly requires banks to assess all

### introduction of Pillar 2 of Basel II, which explicitly requires banks to assess all

### Concentration risk and large exposures
- The NBG recently prepared to change the definition of large exposures according to the new Basel standard on large exposures and concentration risk (June 2014).
- The new definition includes all claims, including equity (although the position does not seem to be material).
- This amendment is not fully implemented yet.

### Transactions with related parties
- The NBG has put significant effort into identifying related parties and related transactions and making sure that transactions take place at an arm’s-length basis.
- The supervisor reviews the pricing of both the loan and deposit sides in order to look for irregularities, allowing cross-checks of how different banks deal with related parties.
- During credit risk assessments the NBG determines whether it is a case of related parties and/or related transactions.

### Country and transfer risks
- The NBG very actively monitors the country and transfer risk (direct and indirect) themselves based on prudential reports and recently (May 2014) started to stimulate banks to manage their country and transfer risk through issuing a guideline on country and transfer risk.
- The NBG does not determine systematically whether the bank’s strategies, policies, and processes have been approved by the bank’s Board and whether the Board oversees implementation by management.
- Only the largest banks conduct stress tests and incorporate adverse scenarios of country and transfer risk.
- In the second half of 2014, the NBG will review the ICAAP set up by the banks (SREP) in order to stimulate an alignment between the risk profile, capital position, and the quality of risk management.
- The NBG does not have a formal provisioning model for country risk and transfer risk; banks have the discretion to consider whether provisioning for country risk is deemed necessary as part of standard analysis of a borrower.
- The NBG can require extra provisioning if not satisfied with the level of provisioning or treatment of country or transfer risk and has used this power in the case of bank exposures to one country.

### Market risk
- The market risk in the trading book is not material (including consolidated supervision). The main market risk is foreign exchange risk.
- The NBG determines sufficiently whether banks have an adequate market risk management process, taking into account the market and macro-economic conditions.
- Since June 2014, currency risk is charged under Pillar 1.
- In September 2014, Pillar 2 will become effective.

### Interest rate risk in the banking book
- Banks could receive more guidance from the NBG on improving the quality of interest rate risk management.
- Despite guidelines on risk management introduced in 2008, there is further room for improving the quality of interest rate risk management of banks.
- Based on the new reporting standard, introduced in 2012, most of the banks don’t have a material interest rate risk position because of the basic short-term nature of their balance sheets, although one systemic bank does have a material interest rate position without internal limits.
- This bank holds earmarked capital as a buffer for interest rate risk.
- All banks should take their interest rate risk into account in relation to their capital position, including defining trigger ratios; this will be part of the implementation of Basel II, Pillar 2.

### Liquidity risk
- Liquidity risk assessment by the NBG covers all aspects of liquidity; the NBG analyzes banks’ inherent liquidity risks as well as their mitigants.
- Systemic and complex banks are required to have a more developed liquidity risk management framework.
- The NBG imposes a conservative liquidity requirement and is also in the process of moving toward the Basel III framework (Liquidity Coverage Ratio (LCR)).
- The new regulation on liquidity risk will enter into force in September 2014.
- The NBG focuses efforts on improving liquidity risk management mainly for the three largest banks, which poses a risk that the quality of liquidity risk management of the other banks lags behind.
- The assessors believe these shortcomings will be resolved in the near future since the NBG is in the process of implementing the new regulation on liquidity (including elements of Basel II and III).
- Banks have access to the NBG’s emergency liquidity facility (ELA), pledging as collateral government or NBG debt instruments, and loans, including mortgages, with a 20 percent haircut.

### Operational risk
- The NBG made good progress in operational risk: recent regulation and establishment of a specialized operational risk unit broadened supervision into areas previously not covered directly (business continuity management and outsourcing).
- Areas for improvement identified by the NBG:
  - Only 7 out of 21 banks have comprehensive business continuity plans (though these include the largest banks); the other banks have only disaster-recovery plans and should broaden toward comprehensive continuity plans.
  - Most banks lack adequate outsourcing policies.
  - Banks have insufficient internal reports that should, according to the NBG, be more analytical in nature.
  - Most banks do not perform IT audits; the new regulation requires incorporation of IT audits in the overall audit plan of banks.

### Internal control and audit
- The law provides that an Executive Director can be appointed to the Supervisory Board, the body charged with the oversight of the executive, although Directors are prohibited by law from participating in decision making on issues related to supervision of executive functions activities, approval, and evaluation of its reports.

### Financial reporting and external audit
- The auditor has up to five business days in which to notify the NBG of any matters of serious significance that come to his/her attention, but that period is too long.
- The regulation was recently amended, requiring the auditors to report immediately material changes to NBG supervisors.

### Disclosure and transparency
- The NBG’s current requirements for banks to disclose quantitative and qualitative information are limited on the qualitative side.
- The NBG plans to enhance its regulation on transparency with the introduction of IFRS 7 and Pillar 3 disclosures on the qualitative side.
- The NBG will also require banks to publish information on their lending standards.

*Source: _cr14355 - introduction of Pillar 2 of Basel II, which explicitly requires banks to assess all*

### 29. Abuse of financial services There is no explicit obligation on banks to report to the NBG suspicious activities

### 29. Abuse of financial services There is no explicit obligation on banks to report to the NBG suspicious activities

### Key findings on abuse of financial services
- There is no explicit obligation on banks to report to the NBG suspicious activities and incidents of fraud where such activities/incidents are material to the safety, soundness, or reputation of the banks.
- The definition of Politically Exposed Person (PEP) refers solely to a foreign citizen and does not address domestic PEPs nor persons entrusted with a prominent function by an international organization as is now required by the standard.
- The FMS (FIU) is moving from under the auspices of the NBG to the Office of the Prime Minister. There is concern about its continued independence, including staffing and funding.

### Table 8 — Recommendations to Improve Compliance with the Basel Core Principles (selected principles and recommended actions)
- Principle 1. Responsibilities, objectives and powers.
  - Seek review of the NBG Law, so that banking supervision will be given equal status to price stability as the main task of the National Bank.
  - Amend Article 21 of the ACB Law so that in setting and enforcing minimum prudential standards all areas are covered and not just those listed in the Article.
  - Amend the law to make public consultation on new laws and regulations statutorily binding.
- Principle 2. Independence, accountability, resourcing and legal protection for supervisors.
  - Review NBG salary levels in light of NBG’s legal obligation to maintain effective supervision by maintaining high qualified and experienced staff.
  - The NBG should increase its training and education budget.
  - Consider charging for supervision. (This recommendation is solely advisory — it is not taken into account in determining the rating.)
  - The NBG should publish a more comprehensive and detailed strategic plan and targets in its annual accounts.
  - Make specific legal provisions that the supervisor and its staff will be adequately protected against the cost of defending their actions and/or omissions made while discharging their duties in good faith.
  - The protection afforded to staff on a personal level for any action done or not done, as long as such action was done or refrained from in good faith, should be extended to the supervisor itself.
- Principle 5. Licensing criteria
  - Introduce explicit and specific legal provisions relating to the NBG powers rather than relying on its broad powers to achieve its goals. This seems to work adequately in practice, but, in the interest of certainty and clarity, specific provisions should be introduced.
  - Provide explicit powers that foreign banks proposing to establish a locally incorporated bank in Georgia must obtain the prior consent of its home supervisor to do so (as is currently the case for foreign banks proposing to establish a branch bank in Georgia).
  - In determining the suitability of banks’ shareholders, the NBG should, in addition to approving significant shareholders (owners of 10 percent or more of the share capital of the bank), have regard for others who may exert significant influence on the bank.
- Principle 6. Transfer of significant ownership.
  - Expand the definition of “significant shareholder” to include persons acting in concert.
  - Make it legally binding that existing significant shareholders proposing to dispose of their shareholding must notify the NBG in advance.
  - Make it legally binding for banks to have to notify the NBG as soon as they become aware of any material information that might negatively affect the suitability of a major shareholder or a party with a controlling interest in the bank.
- Principle 7. Major acquisitions
  - Provide direct statutory backing to the criteria used by the NBG to judge investment proposals by banks.
- Principle 8. Supervisory approach
  - Complete the implementation of the new supervisory approach and formalize it.
  - Set up a clear framework for distressed banks and require banks to set up resolution plans in order to identify and mitigate possible barriers for resolution.
  - Undertake a crisis-simulation exercise.
- Principle 9. Supervisory technique and tools
  - Consider how to balance the attention for inherent risk and quality of risk management.
  - Integrate identification of risk culture in the supervisory approach and spending more time on-site to sense the risk culture.
- Principle 11. Corrective and sanctioning powers of supervisors
  - Employ an escalation framework for safety and soundness issues.
  - Reflect to what extent NBG could have been more effective with regard to deficiencies that linger for a protracted period of time.
  - Initiate law or regulation that gives the NBG the power to set individual risk governance requirements, intervene in the organizational structure or business model of a bank.
- Principle 12. Consolidated supervision.
  - Ensure that a formal consolidated prudential reporting framework is in place by November 2014, as targeted.
- Principle 14. Corporate governance
  - Increase involvement of Boards in setting and overseeing risk appetite.
  - Align the legislation and regulation with regard to the role of Directors in a Supervisory Board.
  - Make the Overseeing Risk Committee and Remuneration Committee a requirement by law or regulation.
  - Encourage banks to make the Supervisory Committee directly responsible for the Audit Committee.
  - Initiate a law that gives the NBG power to change the composition of a Board.
- Principle 15. Risk management
  - Make sure that banks express their risk appetite for the different risk categories.
  - Continue implementing Basel II, including ICAAP, contingency planning, stress testing, and SREP.
  - Determine the internal pricing mechanism of all banks.
  - Evaluate the role and independence of CRO and (credit) risk management, including the incentive structure.
- Principle 16. Capital adequacy
  - Introduce a framework on how to deal with domestic systemically important banks, including the introduction of a capital buffer.
  - Consider introducing a countercyclical buffer.
  - Set up an implementation plan for Pillars 2 and 3 for banks and supervisors, including deciding who will do the assessment.
  - Develop guidance for supervisors on SREP.
  - Develop Pillar 3 requirements for banks.
- Principle 17. Credit risk
  - Stay focused on ensuring that all banks implement the credit risk management requirements under which the requirements for lending standards.
  - Require banks to have certain exposures exceeding a certain amount to be decided by the banks’ Board and senior management.
  - Make sure that all, and not only large banks, include credit risk exposures in their stress tests.
- Principle 19. Concentration risk and large exposure limits
  - Develop regulation or guidelines for concentration risk beyond large exposures.
  - Make banks improve their identification of the economic interdependence of borrowers.
  - Consider developing a limit for the 10 largest exposures.
- Principle 20. Transactions with related parties
  - Add legal provisions that explicitly require write-off of related party exposures to be subject to prior approval by the bank’s Board.
- Principle 21. Country and transfer risk
  - Continue implementing the guideline on managing country and transfer risk, including stimulating the Board to explicate their risk appetite, set county and transfer risk limits, and take responsibility in overseeing the management.
  - Develop an explicit provisioning system for country risk and transfer risk.
  - Require prudential return on country risk on consolidated level on a semi-annual base.
- Principle 22. Market risk
  - Continue implementing the new capital regime, since this will enhance risk management.
  - Incentivize all banks to conduct stress tests.
  - Allocate capital for unexpected market risk losses.
- Principle 23. Interest rate risk in the banking book
  - Require banks (through regulation) to have internal limits for interest rate risk.
  - Provide more guidance to banks on how to deal with interest rate risk in relation to ICAAP.
  - Increase the frequency of reporting to a quarterly basis in order to keep abreast of developments.
- Principle 24. Liquidity risk
  - Continue with the finalization and implementation of draft regulation of LCR.
  - Ensure that all banks have adequate contingency funding planning, taking into account limited opportunities.
- Principle 25. Operational risk
  - Make sure that all banks set up business continuity plans and outsourcing agreements (including taking the local environment into account) and conduct (mandatory) IT audits.
- Principle 26. Internal control and audit.
  - Seek the removal of the legal provision that allows Executive Directors to sit on Supervisory Boards.
- Principle 28. Disclosure and transparency.
  - Enhance the level of qualitative information that banks are required to disclose in their annual accounts.
- Principle 29. Abuse of financial services.
  - Legally require banks to report to the NBG any suspicious activities and incidents of fraud where such activities/incidents are material to the soundness or reputation of the banks.
  - Require financial institutions to take the measures required by FATF Recommendation 12 with respect to domestic PEPs and persons entrusted with a prominent function by an international organization.

### Authorities’ response — NBG key positions and comments
- General
  - The NBG expresses appreciation for the FSAP mission team and the assessment, noting observed major improvements and describing the supervisory approach as advanced, forward-looking, intrusive, risk-based, efficient, comprehensive and in several instances even leading.
  - The NBG requests continued importance and credit for FSAP work and calls for enhanced emphasis on qualitative content and comparability of assessments.
- CP2 (Independence, accountability, resourcing and legal protection for supervisors)
  - The NBG notes that the major driver of the “MNC” score is lack of salary competitiveness and junior staff turnover, and argues budget limitations have not compromised professionalism and effectiveness.
  - The NBG considers the assigned grade incompatible with the confirmed quality of supervision staff.
- CP5 (Licensing criteria)
  - The NBG believes it is fully compliant with the principle and disputes the need for legal requirement to assess home supervisor practices as required by the assessors.
  - The NBG notes feedback that presence of legal provisions was important despite not being required by formal BCP guidelines and believes this deviation negatively affected grading of the 1st, 5th, 7th and 15th principles.
- CP6 (Transfer of significant ownership)
  - The NBG states there are no sufficient qualitative observations in the assessment and that essential criteria are satisfied in practice.
  - The NBG commits to eliminating legal gaps such as prescribing “shareholders acting in concert” and introducing obligation to receive supervisory approval for disposal of qualifying holding.
- CP7 (Major acquisitions)
  - The NBG asserts it has a comprehensive practical approach and that identified legal gaps are not stipulated by BCPs.
- CP8 (Supervisory approach)
  - The NBG disputes inconsistencies with Basel core principles given the non-complex, domestic context and limited cross-border activities.
  - Notes that resolvability in Georgia is straightforward and that NBG has taken measures where resolvability posed excessive risks (operational independence, ring-fencing, simplification of group structure).
  - Plans to update regulation on dealing with problem banks in line with the FSB’s key attributes and Basel guidelines.
- CP11 (Corrective and sanctioning powers of supervisors)
  - The NBG agrees some deficiencies could persist but stresses consideration of materiality and lack of concrete feedback from assessors.
  - States it has powers to set individual risk governance requirements and intervene in organizational structures and business models, with an escalation matrix in place, and considers the recommended action plan already implemented.
- CPs 15–25 (Risk management, capital, credit, liquidity, operational, etc.)
  - The NBG reiterates commitment to improve banks’ risk management but argues the assessment was conducted against benchmarks “too high” contrary to proportionality.
  - Defends current ICAAP and Pillar 2 practices, noting legal provisions since 2009 empowered it to impose individual requirements on commercial banks.
  - Contends that recommendations to introduce excessive legislation or requirements to address absent or immaterial risks (e.g., formal provisioning model for country risk) are unnecessary.
  - Emphasizes that intrusive supervision and detailed knowledge of risks in individual banks is appropriate and a good practice.
  - States disagreement with characterization that NBG focuses only on largest banks and asserts monitoring and actions apply to all banks.

*Source: _cr14355 - 29. Abuse of financial services There is no explicit obligation on banks to report to the NBG suspicious activities*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14355.pdf_