## _cr1509

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### Executive summary — mandate, recent measures, and Basel transition
- The National Bank of Georgia (NBG) has a broad mandate to safeguard financial stability in Georgia in addition to responsibilities for monetary policy and banking supervision; the financial stability mandate is enshrined in the central bank law.
- The legal mandate is general and does not specify the scope of policy instruments the NBG may apply to mitigate systemic risk and ensure financial stability.
- Georgia has applied several measures that may be qualified as macroprudential, including countercyclical adjustments to risk weights for FX loans to unhedged borrowers and countercyclical changes in reserve requirements and the minimum average liquidity ratio.
- Key measures and transitions:
  - Additional risk weight for FX loans to unhedged borrowers: originally 100 percent (2002–2008); reduced to 50 percent (2008–2010); raised to 75 percent (2011); currently 75 percent.
  - Minimum average liquidity ratio: currently 30 percent; reduced to 20 percent in 2008 and raised to 30 percent in 2010.
  - Reserve requirements are higher for FX deposits and other borrowings; additional liquidity requirement for nonresident deposits if they exceed 10 percent of total deposits.
  - Pillar 1 of the Basel II/III capital framework will apply from June 2014 in parallel to current Basel I provisions to be phased out from 2015 to 2017.
  - NBG plans to introduce the Basel III countercyclical capital buffer regime for the banking system in 2015.
  - Banks account for 95 percent of total assets of the Georgian financial system as of end-2013.
  - The capital surcharge for systemically important banks would currently apply at least to the three largest banks by total assets.

### Institutional and governance recommendations
- Revise the legal framework:
  - Make legal basis for macroprudential policy more specific on objective, scope, and range of instruments.
  - Expand the list of available macroprudential instruments beyond risk buffers to include measures that directly influence bank activities (e.g., loan-to-value (LTV) or payment-to-income (PTI) caps).
  - Maintain flexibility for the NBG to take other regulatory actions as new risks emerge.
- Establish governance bodies:
  - Internal advisory Financial Stability Committee at the NBG level to prepare macroprudential policy decisions for the governor; meet at least quarterly or more often if warranted.
  - Separate national-level financial stability council comprising the NBG, MOF, securities and insurance regulators, and other stakeholders to coordinate financial stability policy.
- Strengthen accountability and communication:
  - Require ex-ante communication of macroprudential strategy, detailed communication of considerations behind decisions, and ex-post assessment of effectiveness.
  - Reintroduce Financial Stability Reports (FSRs) regularly (the NBG published FSRs annually from 2006 to 2011 but discontinued in 2012).
- Establish a dedicated financial stability unit with responsibilities to:
  - Perform stress tests of Georgian banks on a regular basis.
  - Incorporate macroeconomic developments and risks from the Macroeconomic and Statistics Department.
  - Prepare macroprudential policy measures for the Financial Stability Committee.
  - Assess impact and effectiveness of macroprudential measures.
  - Exchange views with other policymakers, market participants, rating agencies, analysts, and international financial institutions, and assess international spillover risks.
  - Note: The Financial Risks and Macro Prudential Policy Division currently has a staff of three analysts; the unit needs to be adequately staffed to fulfill tasks.

### Instruments to address indirect FX risks and support dedollarization
- Existing asset- and liability-side measures:
  - Additional risk weights applied to FX loans to unhedged borrowers (additional risk weight is 75 percent).
  - Higher reserve requirements for FX deposits and other borrowings.
  - Banks must hold more liquidity for nonresident deposits (of which 92 percent are in foreign currency as of end-2013) if those deposits exceed 10 percent of total deposits.
  - Minimum average liquidity ratio of 30 percent that does not differentiate by currency.
- Dedollarization via monetary policy and market development:
  - Develop local currency money market via main refinancing operations and standing facilities in GEL.
  - Less conservative local currency reserve requirements compared to FX liabilities (reserve requirements are lower for local-currency liabilities with maturities below two years; NBG applies reserve averaging for local-currency reserve requirements over a two-week maintenance period).
  - Acceptance of local-currency denominated loans as eligible collateral for NBG refinancing operations.
  - Government and market developments supporting dedollarization: increased volume of government securities in circulation; first issuance of a GEL-denominated bond by an international financial institution in March 2014.
- Recommended targeted macroprudential instruments:
  - Asset side:
    - Limit FX lending to unhedged borrowers at minimum for the riskiest forms of lending and for short-term loans for which local-currency alternatives are available and used.
    - These measures would reduce NBG’s need to accept nonmarketable local-currency collateral for refinancing in normal times.
  - Liability side:
    - Reduce reliance on short-term FX funding by lengthening maturity of FX deposits and promoting certificates of deposits (CDs).
    - Consider more differentiated FX reserve requirements for nonwithdrawable CDs with maturities exceeding six months.
    - Consider more favorable treatment of local-currency liabilities in liquidity regulations compared to FX liabilities (e.g., in the minimum average liquidity ratio or the Liquidity Coverage Ratio (LCR), legally binding from September 2014).
  - Funding risk reduction:
    - De-dollarize short-term deposits: almost half of customer deposits with residual maturities of less than a month are denominated in U.S. dollars.
    - Current tight liquidity requirements create a significant negative carry for banks holding liquid assets in foreign currency.
    - Additional instruments summarized in Table 1 (in source) seem warranted to reduce underlying FX funding risk.
- Key statistics and facts:
  - About 62 percent of loans are denominated in foreign currency, mostly U.S. dollars, and by borrowers that are unhedged.
  - The capital adequacy ratio of the banking system stands at 17.2 percent (end-2013), which is more than 5 percentage points above the minimum capital requirement.
  - A large share of FX deposits (about 62 percent) exposes the banking sector to liquidity risk.
  - The average monthly liquidity ratio stood at 41.8 percent in December 2013.
  - No deposit guarantee scheme is in place and systemic liquidity in U.S. dollars is limited.
  - Recommended policy priorities: Lengthen the maturity of FX deposits; De-dollarize very short-term deposits.
  - Recommended measures: (i) More differentiated FX reserve requirements with respect to certificates of deposits with maturities >six months; and (ii) a more favorable treatment of local-currency liabilities in liquidity regulations such as the minimum average liquidity ratio or the LCR (legally binding from September 2014).
  - Complete the safety net (see Technical Note on Crisis Management and Bank Resolution Framework).
- Nonresident deposits:
  - Nonresident deposits amounted to GEL 1.5 billion or 15 percent of customer deposits as of April 2014, concentrated mostly in large banks.
  - Depositors are mostly located in Israel, Russia, United Kingdom, and offshore countries; about two-thirds are individuals with an average deposit of more than US$500,000.
  - Nonresident deposits are largely short-term (59 percent have residual maturities of less than three months) and denominated in foreign currency (92 percent).
  - Since early 2013 the growth of nonresident deposits has slowed; CDs now account for 20 percent of nonresident deposits.
  - Current funding risks appear manageable as shown by the liquidity stress test, but the growth of nonresident deposits deserves continuous and close monitoring.

### Countercyclical capital buffer (CCB) — design, timing, and monitoring
- Planned introduction and scope:
  - NBG intends to establish a CCB regime in line with Basel III standards (BCBS 2010a, 2010b) for application starting in 2015.
  - NBG intends to set the CCB within the range of 0 percent and 2.5 percent, which is in line with the Basel III framework.
  - NBG intends to keep the additional risk weight for unhedged borrowers in a slightly amended version (applicable to all loans to unhedged borrowers) but will no longer adjust it in a countercyclical manner once the CCB is implemented.
  - During the CCB build-up phase, NBG plans to gradually reduce the additional risk weight on unhedged borrowers.
- Purpose and expected effects:
  - Deal more effectively with periods of excessive credit growth and increase system resilience in crisis periods.
  - During boom periods, raise the CCB to increase the cost of capital (reducing credit demand) and induce banks to decelerate growth of risk-weighted assets (reducing credit supply).
  - During periods of stress, release the CCB to allow banks to absorb losses without restraining credit flow.
- Suitability and timing:
  - Current situation provides a good opportunity to introduce CCB given that (i) credit growth is picking up; and (ii) introduction of Basel II/III is expected to release capital for the system over the next few years.
- Assessment techniques and data issues:
  - NBG is developing techniques to assess cyclical risks and guide CCB build-up; buffer decisions should be based on reliable leading indicators and guided discretion by the NBG as macroprudential authority.
  - The credit-to-GDP gap is a useful reference but applying the Drehmann et al (2010) methodology to Georgia suggests it is not particularly suited: the gap would have signaled activation only as late as mid-2007, too late to build buffers before the 2008/09 crisis.
  - Additional indicators need exploration; NBG’s granular credit database helps, but data on real estate prices should be improved (transaction prices rather than offer prices).
- Governance and operational details:
  - Buffer decisions should be made at least quarterly.
  - Financial Stability Committee should recommend buffer decisions to the NBG governor, who takes the final decision.
  - Banks must meet the CCB with Common Equity Tier I or face restrictions on dividend distributions.
  - Following initial build-up, the CCB should be allowed to swing over the cycle (released during stress).
- Supervisory monitoring:
  - NBG should monitor risk-weighted assets (RWA) developments on the system level in light of potential capital release following Basel II/III introduction and phase-out of the Basel I floor.
  - NBG should introduce the Basel III leverage ratio in the medium term to address potential excessive gaming of risk weights by banks.

### Capital surcharge for systemically important banks, concentration, and micro-macro tools
- Capital surcharge and concentration:
  - Planned introduction of a capital surcharge for systemically important banks is particularly important given high market concentration.
  - Based on data as of end-2013, the additional capital requirement would apply at least to the three largest banks by total assets, which together account for more than three quarters of banking sector assets.
  - NBG plans to introduce the capital surcharge within the next few years but has not taken a decision on its scope, level and starting date yet.
- Market shares (end-2013):
  - Bank of Georgia: 34 (percent)
  - TBC Bank: 24 (percent)
  - Liberty Bank: 8 (percent)
  - Procredit Bank: 6 (percent)
  - Bank "Republic": 6 (percent)
  - VTB Bank - (Georgia): 5 (percent)
- Additional macroprudential tools to address concentration and credit risks:
  - Introduce concentration limits for largest borrowers (e.g., limits on Top-5 or Top-10 loan exposures per bank).
  - Consider LTV or DSTI caps, possibly differentiated by currency and segment.
  - Use sectoral risk weights if strong growth in exposures to high-risk market segments occurs.
  - Existing practice: maximum LTV ratios between 40 percent and 75 percent, depending on type of property and location, for loan assets pledged by banks as collateral for monetary policy operations.
  - LTV- or DSTI-limitations are also applied as a microprudential requirement by the NBG for some banks.
  - One-third of retail borrowers in Georgia currently spend more than half of their income on servicing bank loans — consideration should be given to introducing caps to DSTI ratios for retail lending.
- Risk warnings and communication:
  - Public communication and risk warnings can serve as additional “soft” instruments; they can be effective when issued by central banks with strong credibility.
  - Regular financial stability reports and outreach activities provide opportunities to communicate such warnings.
  - If soft measures are not effective, the NBG may apply “hard” tools described above.

### Coordination with monetary policy and concluding assessment
- Coordination and objectives:
  - Coordination at the NBG level between monetary and prudential policies seems to be working well; allocation of both tasks to the NBG facilitates coordination.
  - Decision making, accountability, and communication structures need to be separate for monetary policy and macroprudential policy due to different objectives and instruments.
  - Monetary policy primary objective: price stability; NBG moved to an inflation targeting regime in 2009.
  - NBG targeted annual CPI inflation rates of 6 percent in 2014 and 5 percent for 2015 and 2016.
  - The long-term inflation target of the NBG is 3 percent (as stated in the monetary policy strategy of the NBG).
  - Monetary policy is mainly conducted via refinancing operations; transmission is structurally weak due to high dollarization.
  - NBG committed to a floating exchange rate regime while sometimes intervening to limit short-term exchange rate fluctuations through occasional FX auctions preannounced on the same day of transactions.
- Trade-offs and complementarity:
  - Well-targeted macroprudential policies should allow monetary policy to focus on price stability while preventing the build-up of financial system risks.
  - Conservative limits on LTV or PTI ratios can reduce impact of monetary tightening on borrower defaults.
  - NBG’s independence is crucial for achieving both price stability and financial stability objectives.
  - Interaction of macroprudential policy with microprudential, fiscal, and structural policies may give rise to coordination issues, particularly in crisis situations where perspectives can diverge.

*Source: IMF staff report, content unit _cr1509.*

### EXECUTIVE SUMMARY ______________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### Introduction
- The National Bank of Georgia (NBG) has a broad mandate to safeguard financial stability in Georgia in addition to responsibilities for monetary policy and banking supervision; the financial stability mandate is enshrined in the central bank law.
- The legal mandate is general and does not specify the scope of policy instruments the NBG may apply to mitigate systemic risk and ensure financial stability.
- Georgia has applied several measures that may be qualified as macroprudential, including countercyclical adjustments to risk weights for FX loans to unhedged borrowers and countercyclical changes in reserve requirements and the minimum average liquidity ratio.
- International experience underscores the need for an effective macroprudential policy framework to complement microprudential supervision and address systemic risks not captured at the individual institution level.

### Key findings on recent measures and buffers
- The NBG adjusted risk weights for FX loans to unhedged borrowers in a countercyclical manner:
  - Additional risk weight originally set at 100 percent (2002–2008).
  - Reduced to 50 percent during 2008–2010.
  - Raised to 75 percent when credit growth recovered (2011).
  - The currently applied additional risk weight is 75 percent.
- Reserve requirements and the minimum average liquidity ratio were released following the 2008 shock and increased again in 2010/11:
  - The minimum average liquidity ratio is currently 30 percent; it was reduced to 20 percent in 2008 and raised to its current level in 2010.
- Liability-side measures: reserve requirements are higher for FX deposits and other borrowings; banks must hold more liquidity for nonresident deposits (of which 92 percent are in foreign currency as of end-2013) if those deposits exceed 10 percent of total deposits.
- Combined asset- and liability-side measures, together with general liquidity regulation, increased banks’ capital and liquidity buffers, as shown by FSAP solvency and liquidity stress tests.
- Transition to Basel II/III and Basel III countercyclical capital buffer:
  - Pillar 1 of the Basel II/III capital framework will apply in Georgia from June 2014, in parallel to current provisions under Basel I that will be phased out from 2015 to 2017.
  - The NBG plans to introduce the Basel III countercyclical capital buffer regime for the banking system in 2015.
- Banking sector concentration and systemic bank surcharge:
  - Banks account for 95 percent of total assets of the Georgian financial system as of end-2013.
  - The capital surcharge for systemically important banks would currently apply at least to the three largest banks by total assets.

### Policy recommendations (institutional and governance)
- Revise the legal framework:
  - Make the legal basis for macroprudential policy more specific regarding objective, scope, and range of instruments.
  - Expand the list of available macroprudential instruments beyond risk buffers to allow measures that directly influence bank activities, e.g., loan-to-value (LTV) or payment-to-income (PTI) caps.
  - Maintain flexibility for the NBG to take other regulatory actions as new risks emerge.
- Establish a Financial Stability Committee:
  - Set up an internal advisory Financial Stability Committee at the NBG level to prepare macroprudential policy decisions for the governor; it should meet at least quarterly or more often if warranted.
  - Set up a separate national-level financial stability council comprising the NBG, MOF, securities and insurance regulators, and other stakeholders to coordinate financial stability policy.
- Strengthen accountability and communication:
  - Require ex-ante communication of macroprudential strategy, detailed communication of considerations behind decisions, and ex-post assessment of effectiveness.
  - Reintroduce Financial Stability Reports (FSRs) regularly (the NBG published FSRs annually from 2006 to 2011 but discontinued in 2012).
- Establish a dedicated financial stability unit:
  - The unit should, at minimum:
    - Perform stress tests of Georgian banks on a regular basis.
    - Incorporate macroeconomic developments and risks from the Macroeconomic and Statistics Department.
    - Prepare macroprudential policy measures for the Financial Stability Committee.
    - Assess impact and effectiveness of macroprudential measures.
    - Exchange views with other policymakers, market participants, rating agencies, analysts, and international financial institutions, and assess international spillover risks.
  - The Financial Risks and Macro Prudential Policy Division currently has a staff of three analysts; the unit needs to be adequately staffed to fulfill tasks.

### Selection of macroprudential instruments — targeted measures recommended
- To address FX-induced credit and liquidity risks and support dedollarization:
  - Asset side:
    - Limit FX lending to unhedged borrowers, at 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 exist and are used by parts of the banking sector.
    - These instruments would reduce the NBG’s need to support dedollarization through accepting nonmarketable local-currency collateral for refinancing operations in normal times.
  - Liability side:
    - Reduce reliance on short-term FX funding by lengthening the maturity of FX deposits and promoting certificates of deposits (CDs).
    - Consider more differentiated FX reserve requirements for nonwithdrawable CDs with maturities exceeding six months.
    - Consider more favorable treatment of local-currency liabilities in liquidity regulations compared to FX liabilities (e.g., in the minimum average liquidity ratio or the Liquidity Coverage Ratio (LCR), which is expected to become legally binding for Georgian banks from September 2014).
- To address concentration and credit risks:
  - Introduce concentration limits for the largest borrowers (e.g., limits on Top-5 or Top-10 loan exposures).
  - Consider applying loan-to-value (LTV) or debt-service-to-income (DSTI) caps as macroprudential instruments, possibly differentiated by currency.
  - Consider sectoral risk weights as targeted measures to limit growth in exposures to high-risk market segments.

### Coordination with monetary policy and concluding assessment
- Coordination at the NBG level between monetary and prudential policies seems to be working well.
- Well-targeted macroprudential policies should allow monetary policy to focus on price stability while preventing the build-up of financial system risks.
- The NBG’s independence is crucial for achieving both price stability and financial stability objectives.

*Source: EXECUTIVE SUMMARY, _cr1509.*

### 10.      The NBG needs a well-equipped toolkit to deal with risks to financial stability. A

### _cr1509 - 10.      The NBG needs a well-equipped toolkit to deal with risks to financial stability. A

### Instruments to address indirect FX risks and support dedollarization
- Macroprudential measures for FX-induced credit and liquidity risks have strengthened banks’ risk buffers:
  - Additional risk weights applied to FX loans to unhedged borrowers.
  - Higher reserve requirements for FX deposits and other borrowings.
  - Banks must hold more liquidity for nonresident deposits (of which 92 percent are in foreign currency as of end-2013) if those deposits exceed 10 percent of total deposits.
  - Minimum average liquidity ratio of 30 percent, which does not differentiate by currency.
- Dedollarization promoted through monetary policy measures in three broad groups:
  - Measures to develop the local currency money market, e.g., by main refinancing operations and standing facilities in GEL.
  - Less conservative local currency reserve requirements compared to those for FX liabilities (reserve requirements are lower for local-currency liabilities with maturities below two years; NBG applies reserve averaging for local-currency reserve requirements over a two-week maintenance period).
  - Acceptance of local-currency denominated loans as eligible collateral for NBG refinancing operations.
- Government and market developments supporting dedollarization:
  - Increased volume of government securities in circulation.
  - First issuance of a GEL-denominated bond by an international financial institution in March 2014.
- Status and guidance:
  - The level of dollarization of banks’ loans and deposits has been on a declining trend.
  - Authorities should consider additional policy measures to speed up dedollarization to reduce high indirect exposure of the banking sector to the floating USD-GEL exchange rate.
- Recommended further macroprudential instruments:
  - Asset side:
    - Consider limiting FX lending to unhedged borrowers—at the minimum—for the riskiest forms of lending and for short-term loans for which local-currency alternatives are available and used by parts of the banking sector.
    - Recent reduction in lending rates and relatively stable USD-GEL exchange rate should support the process.
    - These instruments would reduce the NBG’s need to accept nonmarketable local-currency collateral for refinancing in normal times.
  - Liability side:
    - Reduce reliance on short-term FX funding by lengthening the maturity of FX deposits and promoting certificates of deposits (CDs).
    - Support via more differentiated FX reserve requirements with respect to nonwithdrawable CDs with maturities exceeding six months.
    - More favorable treatment of local-currency liabilities in liquidity regulations compared to FX liabilities, e.g., in the minimum average liquidity ratio or in the Liquidity Coverage Ratio (LCR), which becomes legally binding for Georgian banks from September 2014.
    - Similar prudential measures managed to support dedollarization efforts in other countries.
  - Funding risk reduction:
    - De-dollarize short-term deposits: almost half of customer deposits with residual maturities of less than a month are denominated in U.S. dollars.
    - Current tight liquidity requirements create a significant negative carry for banks holding liquid assets in foreign currency.
    - Additional instruments summarized in Table 1 seem warranted to reduce underlying FX funding risk.
- Key statistics and facts from the sector:
  - About 62 percent of loans are denominated in foreign currency, mostly U.S. dollars, and by borrowers that are unhedged.
  - The capital adequacy ratio of the banking system stands at 17.2 percent (end-2013), which is more than 5 percentage points above the minimum capital requirement.
  - The additional risk weight of 75 percent for FX loans to unhedged borrowers is a current measure.
  - A large share of FX deposits (about 62 percent) exposes the banking sector to liquidity risk.
  - The average monthly liquidity ratio stood at 41.8 percent in December 2013.
  - No deposit guarantee scheme is in place and systemic liquidity in U.S. dollars is limited.
  - Current measures include higher reserve requirements for FX deposits and other borrowings; additional liquidity requirement for non-resident deposits if they exceed 10 percent of total deposits; minimum average liquidity ratio of 30 percent without differentiation by currency.
  - Recommended policy priorities: Lengthen the maturity of FX deposits; De-dollarize very short-term deposits.
  - Recommended measures: (i) More differentiated FX reserve requirements with respect to certificates of deposits with maturities >six months; and (ii) a more favorable treatment of local-currency liabilities in liquidity regulations such as the minimum average liquidity ratio or the LCR (legally binding from September 2014).
  - Complete the safety net (see Technical Note on Crisis Management and Bank Resolution Framework).
- Nonresident deposits (Box 1):
  - Nonresident deposits amounted to GEL 1.5 billion or 15 percent of customer deposits as of April 2014, concentrated mostly in large banks.
  - Depositors are mostly located in Israel, Russia, United Kingdom, and offshore countries; about two-thirds are individuals with an average deposit of more than US$500,000.
  - Nonresident deposits are largely short-term (59 percent have residual maturities of less than three months) and denominated in foreign currency (92 percent).
  - Since early 2013 the growth of nonresident deposits has slowed, partly due to NBG policy: 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 (binding end-2014); CDs now account for 20 percent of nonresident deposits.
  - The growth of nonresident deposits deserves continuous and close monitoring; current funding risks appear manageable as shown by the liquidity stress test, but further measures should be considered if the share increases.

### Countercyclical capital buffer (CCB)
- Planned introduction:
  - NBG intends to establish a CCB regime in line with Basel III standards (BCBS 2010a, 2010b) over the next few months for application starting in 2015.
- Purpose and expected effects:
  - Deal more effectively with periods of excessive credit growth and increase system resilience in crisis periods.
  - During boom periods, raise the CCB to increase the cost of capital (reducing credit demand) and induce banks to decelerate growth of risk-weighted assets (reducing credit supply).
  - During periods of stress, release the CCB to allow banks to absorb losses without restraining credit flow.
- Suitability and timing:
  - Current situation provides a good opportunity to introduce CCB given that (i) credit growth is picking up; and (ii) introduction of Basel II/III is expected to release capital for the system over the next few years.
- Assessment techniques and data issues:
  - NBG is developing techniques to assess cyclical risks and guide CCB build-up; buffer decisions should be based on reliable leading indicators and guided discretion by the NBG as macroprudential authority.
  - The credit-to-GDP gap is a useful reference but applying the Drehmann et al (2010) methodology to Georgia suggests it is not particularly suited: the gap would have signaled activation only as late as mid-2007, too late to build buffers before the 2008/09 crisis.
  - Additional indicators need exploration; NBG’s granular credit database helps, but data on real estate prices should be improved (transaction prices rather than offer prices).
- Governance and operational details:
  - Buffer decisions should be made at least quarterly.
  - Financial Stability Committee should recommend buffer decisions to the NBG governor, who takes the final decision.
  - Banks must meet the CCB with Common Equity Tier I or face restrictions on dividend distributions.
  - Following initial build-up, the CCB should be allowed to swing over the cycle (released during stress).
  - NBG intends to keep the additional risk weight for unhedged borrowers in a slightly amended version (applicable to all loans to unhedged borrowers) but will no longer adjust it in a countercyclical manner once the CCB is implemented.
  - During the CCB build-up phase, NBG plans to gradually reduce the additional risk weight on unhedged borrowers.
  - The NBG intends to set the CCB within the range of 0 percent and 2.5 percent, which is in line with the Basel III framework.
- Supervisory monitoring:
  - In light of potential capital release following Basel II/III introduction and phase-out of the Basel I floor, NBG as micro- and macroprudential supervisor should monitor risk-weighted assets (RWA) developments on the system level and introduce the Basel III leverage ratio in the medium term to address potential excessive gaming of risk weights by banks.

### Capital surcharge for systemically important institutions
- Identification and methodology:
  - NBG uses a sound technique to identify systemically important financial institutions (SIFIs) in line with international standards.
  - The BCBS (2012) assessment framework for domestically systemically important banks takes into account four factors: size, interconnectedness, substitutability, and complexity.
  - NBG methodology closely follows this definition and puts most weight on size, which is reasonable given the current state of development of the Georgian banking sector.
- Policy rationale:
  - Identification of SIFIs is a prerequisite for measures to contain negative externalities and reduce the likelihood of their failure or impairment.

*Source: IMF staff report content unit _cr1509 - 10.*

### 18.      The planned introduction of a capital surcharge for systemically important banks is

### _cr1509 - 18.      The planned introduction of a capital surcharge for systemically important banks is

### Capital surcharge and market concentration
- Planned introduction of a capital surcharge for systemically important banks is particularly important in the Georgian context due to high market concentration.
- Based on data as of end-2013, the additional capital requirement would apply at least to the three largest banks by total assets, which together account for more than three quarters of banking sector assets.
- The NBG plans to introduce the capital surcharge within the next few years but has not taken a decision on its scope, level and starting date yet.

### Market shares (end-2013)
- Bank of Georgia: 34 (percent)
- TBC Bank: 24 (percent)
- Liberty Bank: 8 (percent)
- Procredit Bank: 6 (percent)
- Bank "Republic": 6 (percent)
- VTB Bank - (Georgia): 5 (percent)

### Concentration limits, LTV and DSTI measures
- Additional tools to address concentration and credit risks may be needed, including:
  - Introduction of concentration limits for the largest borrowers (e.g., limits on Top-5 or Top-10 loan exposures per bank).
  - Consideration of loan-to-value (LTV) or debt-service-to-income (DSTI) caps, possibly differentiated by currency and segment.
  - Alternatively, use of sectoral risk weights in case of strong growth in banks’ risk exposures to high-risk market segments.
- These risks are currently taken into consideration by the NBG in the context of Pillar 2 of Basel II.
- Maximum LTV ratios are already applied by the NBG in its collateral requirements for floating-rate mortgage loans denominated in GEL in monetary policy operations.
  - The NBG applies maximum LTV ratios between 40 percent and 75 percent, depending on type of property and location, for loan assets pledged by banks as collateral for monetary policy operations.
- LTV- or DSTI-limitations are also applied as a microprudential requirement by the NBG for some banks.
- If deemed necessary from a financial stability perspective, introduction of LTV/DSTI as a macroprudential instrument would:
  - Strengthen the level-playing field.
  - Increase transparency to the general public.
- Consideration should be given to introducing caps to DSTI ratios for retail lending, given that one-third of retail borrowers in Georgia currently spend more than half of their income on servicing bank loans.

### Risk warnings and communication
- Public communication and risk warnings can serve as additional “soft” instruments.
- They can be effective when issued by central banks with strong credibility, as is the case for the NBG, and may restrain banks or market participants from certain activities without further regulatory measures.
- Regular financial stability reports and outreach activities provide opportunities to communicate such warnings.
- If soft measures are not effective, the NBG may need to apply “hard” tools described above.

### Coordination with monetary and other policies
- Monetary policy and macroprudential policy should be coordinated to some extent; allocation of both tasks to the NBG facilitates this coordination.
- Decision making, accountability, and communication structures need to be separate for monetary policy and macroprudential policy due to different objectives and instruments.
- The primary objective of monetary policy in Georgia is to ensure price stability.
  - The NBG moved to an inflation targeting regime in 2009.
  - The NBG targeted annual CPI inflation rates of 6 percent in 2014 and 5 percent for 2015 and 2016.
  - The long-term inflation target of the NBG is 3 percent (as stated in the monetary policy strategy of the NBG).
- Monetary policy is mainly conducted via refinancing operations with the banking sector; transmission is structurally weak due to high dollarization.
- The NBG is committed to a floating exchange rate regime while sometimes intervening to limit short-term exchange rate fluctuations through occasional FX auctions preannounced on the same day of transactions.
- The main objective of macroprudential policy is to safeguard financial stability by reducing incentives to excessive risk taking and providing buffers against unexpected shocks.
- Well-targeted macroprudential policies can complement monetary policy and contain undesirable side effects of monetary policy (e.g., conservative limits on LTV or PTI ratios can reduce impact of monetary tightening on borrower defaults).
- The NBG’s independence is crucial for effective conduct of monetary and macroprudential policy; the NBG should be allowed to focus primarily on financial stability when deciding on macroprudential measures.
- Interaction of macroprudential policy with microprudential, fiscal, and structural policies may give rise to coordination issues, particularly in crisis situations where micro- and macroprudential perspectives can diverge.

### Key regulatory and supervisory practices referenced
- NBG considers concentration limits, LTV/DSTI caps, sectoral risk weights, and applies Pillar 2 of Basel II in assessing risks.
- Existing NBG practice: maximum LTV ratios between 40 percent and 75 percent (by property type and location) for collateral in monetary policy operations.
- One-third of retail borrowers spend more than half of their income on servicing bank loans (payment-to-income distribution noted; PTI distribution may be biased by informal income not reflected in PTI ratios).

*Source: IMF staff report text provided in content unit _cr1509 - 18.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1509.pdf_