## 1. Summary Compliance with the Basel Core Principles—Detailed Assessments (_cr1510)

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### Introduction and Assessment Context
- Assessment completed as part of the Financial Sector Assessment Program (FSAP) undertaken jointly by the IMF and the World Bank.
- Assessment period: between May 15 and June 3, 2014.
- Assessors: Michael Deasy (IMF Consultant) and Marc Schrijver (World Bank).
- Previous assessment: 2007.
- High-level observations:
  - Significant improvements in regulation and supervisory approach since the 2007 FSAP through amendments to existing laws, new laws, and regulations.
  - Identified operational weaknesses within the NBG’s Banking Supervisory Department due to very high staff turnover, over-reliance on key personnel, and need for expanded staff training.
  - NBG often relies on broad supervisory powers in lieu of detailed explicit powers; recent legislative amendments have addressed several shortcomings.

### Macroeconomic Setting and Financial Market Structure
- Key macroeconomic projections and risks:
  - GDP growth: "3.1 percent" for 2013; growth expected to rise to "5 percent" in 2014.
  - Inflation expected to likely approach the NBG’s target of "6 percent" in the coming 12 months (as of assessment).
  - Current account: projected to widen in 2014; over the medium term expected to narrow toward "5 percent of GDP".
  - Lari exchange rate: NBG committed to floating exchange rate; de facto "2 percent" band since early 2011; depreciation by more than "6 percent" in Q3 2013.
- Key vulnerabilities/risks listed:
  - Worsening outlook in Russia, Turkey, Ukraine; oil and gas > "15 percent" of total imports; dollarization with around "60 percent" of lending dollar denominated; short-term nonresident deposits > "15 percent" of commercial banks’ deposits; protracted regional political instability.
- Financial sector structure and statistics:
  - Number of banks: "21".
  - Aggregate banking assets: "GEL 17.9 billion".
  - Market shares: Bank of Georgia (BoG) "34 percent"; TBC Bank "23 percent"; two banks combined over "57 percent".
  - Liberty Bank: less than "8 percent" of total bank assets.
  - Ten smallest banks: each < "1 percent"; aggregate ≈ "5.3 percent".
  - Lending breakdown (aggregate, as of April 2014): corporate loans "37 percent"; SME loans "20 percent"; retail loans "43 percent".
  - Microfinance: over "60" microfinance institutions; fewer than "10" have issued promissory notes; one microfinance reclassified as a qualified credit institution to date.
  - Credit union sector total assets end-December 2013: "GEL 7.6 million"; total current and term deposits: "GEL 5.3 million".
  - Insurance sector size: below "1 to 2 percent of GDP"; health insurance ≈ "75 percent" of total market in 2011.
  - Payment systems: New Law on Payments Systems and Payment Services effective July 2012.
  - Private credit bureau: limit on exchange of positive information "US$500,000"; no limit on exchange of negative information.
  - Deposit insurance: No scheme currently exists; authorities committed to establishing a deposit insurance agency over the next seven years under the EU Association Agreement due to be signed in June.

### Methodology and Scope
- Methodology: Basel Core Principles document (2012) as the assessment basis.
- Grading based on Essential Criteria (EC); additional criteria commented upon but not graded.
- Capital adequacy assessment against Basel I standards; Basel II/III reviewed but not used as grading standard.
- Assessment involved meetings with NBG Specialized Groups, Banking Supervision Department, FMS, MOF, commercial banks, Banking Association, GFPAA, and an external auditing firm.
- NBG staff described as fully transparent and cooperative.

### Supervisory Framework, GRAPE, and Implementation
- GRAPE (General Risk Assessment Program):
  - Forward-looking, risk-based supervisory methodology introduced end-2009; integrates bank supervisors (all risks per bank) and specialist risk supervisors (one risk across banks).
  - GRAPE risk categories include: credit risk, liquidity risk, market risk, operational risk, business model, profitability, macro-economic environment, group structure, corporate governance (AML dealt with separately).
  - Implementation status: new approach "80 percent" implemented; not yet fully formalized.
  - Systemic relevance scoring uses weights: size "55 percent"; interconnectedness "15 percent"; substitutability "25 percent"; complexity "5 percent". Banks divided into five classes; three systemic banks make up "65 percent" of the total sector.
- Supervisory techniques and tools:
  - Powerful supervisory information system enables "online" supervision, including loan-file access.
  - Supervisory cycle: pre-assessment risk identification, risk assessment, post-assessment identification, risk mitigation.
  - Risk: potential under-emphasis on on-site presence because of strong online capabilities; recommendation to increase on-site engagement to assess risk culture.
  - Consolidated prudential reporting framework scheduled to be introduced in November 2014; consolidated supervision significant improvements since 2007.
- Resolvability and crisis framework:
  - NBG has basic powers to take control, appoint temporary administrators, act as resolution authority, and lead liquidation.
  - No explicit operational recovery and resolution framework or systematic resolvability assessments for systemically relevant banks; four banks were required to set up resolution plans and implementation has only recently started.
  - Prompt corrective action matrix abolished in 2010.

### Governance, Independence, Staffing and Resources
- Legal independence:
  - NBG operational independence guaranteed by the Constitution and NBG Law (Article 95, Article 4).
  - Accountability: annual report to Parliament no later than "4 months" after year-end (Article 61).
- Board and appointments:
  - Board size: "seven" members (Article 7); term: "7-year" term.
  - Governor appointment: President appoints governor upon Board nomination; dismissal limited by constitutional provisions.
- Supervisory staff:
  - Total employees involved in banking supervision: approximately "45".
  - Staff evolution and turnover:
    - 2011: average complement "34", "8" resigned ("24 percent").
    - 2012: "37" staff, "13" resignations ("36 percent").
    - 2013: "41" staff, "5" resignations ("12 percent").
  - Salary constraints: salary freeze since 2009; commercial sector wages up to three times NBG supervisors’ salaries; material recruitment/retention difficulty for IFRS specialists, credit risk specialists, and managers.
  - Training and external expertise: internal training, donor-funded secondments (Dutch Central Bank, former FSA Executive Director), World Bank projects; budget constraints limit external training and technology investment.
- Legal protections:
  - Article 68 (6) provides personal liability protection for employees acting in good faith; no explicit statutory protection for the supervisory authority against legal defence costs (NBG states it would pay costs in practice).

### Key Findings and Principal Grades (selected)
- Principle 1 (Responsibilities): Assessment — Largely compliant. Recommendation to remove aspirational wording and make supervisory powers explicit.
- Principle 2 (Independence, resourcing): Assessment — Materially noncompliant. Key concerns: salary uncompetitiveness, high turnover, over-reliance on key staff, training/resource gaps.
- Principle 5 (Licensing): Assessment — Largely compliant. Gaps: no explicit legal requirement for NBG approval of Board/management appointments; recent regulatory amendments address some shortcomings.
- Principle 6 (Transfer of significant ownership): Assessment — Materially noncompliant. Gaps: no obligation for sellers to notify NBG; definition of “significant” should include persons acting in concert.
- Principle 8 (Supervisory approach): Assessment — Largely compliant. Notes: advanced approach; "80 percent" implemented; resolvability framework incomplete.
- Principle 9 (Supervisory techniques and tools): Assessment — Compliant. Strengths: integrated approach, powerful information system; risk of reduced on-site presence.
- Principle 10 (Supervisory reporting): Assessment — Largely compliant. Consolidated reporting to be introduced November 2014.
- Principle 11 (Corrective measures): Assessment — Largely compliant. Range of sanctions comprehensive; practice relies on dialogue and letters; fines ~ "GEL 500.000" in 2013.
- Principle 12 (Consolidated supervision): Assessment — Compliant. Consolidated framework planned (November 2014 / June 2015).
- Principle 14 (Corporate governance): Assessment — Largely compliant. Recommendations to increase Board involvement in risk appetite and consider statutory changes on Board composition/removal powers.
- Principle 15 (Risk management process): Assessment — Materially noncompliant. Several Essential Criteria (EC1, 2, 5, 7, 9, 12, 13, 14) not yet fully met; Basel II/III Pillar 2 implementation central.
- Principle 16 (Capital adequacy): Assessment — Compliant. Transition from Basel I to Basel II/III in progress; RCAR 2013 sets CET1 "7 percent", Tier 1 "8.5 percent", regulatory capital "10.5 percent" including conservation buffer of "2.5 percent".
- Principle 17 (Credit risk): Assessment — LC (Largely compliant). Advanced risk-based approach; not all banks fully implemented lending standards or stress testing for credit risk.

### Capital Adequacy and Transition to Basel II/III
- Current/transition rules and timelines:
  - Minimum regulatory capital: "GEL 12 million".
  - RCAR 2013 capital ratio requirements: Common Equity Tier 1 "7 percent"; Tier 1 "8.5 percent"; Regulatory Capital "10.5 percent" (conservation buffer "2.5 percent").
  - Transition period: "2014–2017" — banks need to comply with both adjusted Basel I minimums and Basel II/III minimums.
  - Banks required to comply with Pillar 1 minimum capital requirements as of "June 30, 2014".
  - Pillar 2 (ICAAP reporting) effective as of "September 30, 2014".
  - NBG to decide Pillar 3 timing before "end-2014".
  - As of "January 2014", banks required to file a parallel run.
- Risk weight and treatment highlights:
  - RCAR 2008 (Basel I style) categories and RCAR 2013 standardized approach detailed in source; examples:
    - Exposures fully secured by residential property: risk weight "35 percent" (RCAR 2013, article 38).
    - Retail exposures meeting criteria: risk weight "75 percent" (RCAR 2013, article 39).
    - Past due loans (> 90 days): weighted "150 percent" when specific provision < "20 percent"; weighted "100 percent" when provision ≥ "20 percent".
  - Currency-induced credit risk: NBG applied an additional "75 percent" risk weight on foreign currency loans where borrower not hedged.
- System indicators:
  - Average regulatory capital ratio end-2013: "17.2 percent".
  - Average tier 1 ratio end-2013: "13 percent".
  - Tier 1 as percent of regulatory capital end-2013: "75 percent".
  - NPL ratio: approximately "3.5 percent" (IMF definition, >90 days) and "7.5 percent" (local definition).
  - Coverage ratio (loan loss reserve to NPL, exclusive of collateral or recovery): "89 percent".
- Recommendations on capital:
  - Introduce guidance and implementation plans for Pillar 2 and Pillar 3; develop SREP guidance before "September 30, 2014".
  - Consider countercyclical buffer and framework for domestic systemically important banks (D-SIBs) to be introduced (Basel D-SIB framework planned around 2016).

### Credit, Concentration, Large Exposures, Related Parties, Country Risk
- Problem assets and provisioning:
  - NBG focused on identifying problem loans and provisioning, especially for large borrowers (representing "40 percent" of total loan portfolio).
  - For SME and retail borrowers NBG uses sampling to ensure provisioning adequacy.
  - NBG intends to facilitate transition toward IFRS and update loan-loss provisioning guidelines accordingly.
- Large exposures and concentration:
  - NBG decreased total large exposure limit from "600 percent" to "200 percent".
  - Regulatory large exposure thresholds:
    - Large loans defined when exceed "5 percent" of bank’s regulatory capital.
    - Total amount to a person shall not exceed "15 percent" of a bank’s regulatory capital.
    - Total amount to a group of interconnected borrowers shall not exceed "25 percent" of a bank’s regulatory capital.
    - Total amount of large exposures cannot exceed "200 percent" of total regulatory capital.
  - NBG receives monthly top-100 borrower databases from every bank.
  - Assessment of Principle 19: Largely compliant.
  - Recommendations: develop regulation/guidelines on concentration risk beyond large exposures; improve identification of economic interdependence; consider limits for top-10 exposures.
- Transactions with related parties (Principle 20):
  - Legal/regulatory framework: LACB article 25 and RCITRP; limits include individual insider exposure ≤ "5 percent" of capital; total related-party exposures ≤ "25 percent"; required collateral "110 percent" for related-party commitments.
  - Reporting: monthly detailed related-party returns; Pricing on loans and deposits reviewed by NBG.
  - Assessment of Principle 20: Compliant.
  - Recommendations: consider explicit statutory power for NBG to determine related-party definition case-by-case; consider explicit requirement for Board approval of write-offs of related-party exposures.
- Country and transfer risk (Principle 21):
  - Total exposures to country/transfer risk as of February 2014: "7.1 percent" of total assets; ≈ "39.8 percent" of system’s regulatory capital.
  - Components: "5.7 percent" gross interbank exposures; "0.9 percent" nonresident exposures; "0.5 percent" investments in foreign subsidiaries; "0.5 percent" investments in foreign securities.
  - NBG guideline on country and transfer risk issued May 2014; NBG can require extra provisioning and used this power for exposures to one country.
  - Assessment of Principle 21: Largely compliant.
  - Recommendations: implement guideline fully, stimulate Board oversight and explicit provisioning for country risk.

### Market Risk, Interest Rate Risk in the Banking Book (IRRBB), Liquidity Risk
- Market risk (Principle 22):
  - Trading book risk immaterial: trading book ≈ "0.2 percent" of total assets system-wide; maximum trading-book ratio "5.1 percent" for a medium-sized bank.
  - Main market risk: foreign exchange risk.
  - Since June 2014, currency risk charged under Pillar 1; Pillar 2 effective September 2014.
  - Assessment of Principle 22: Compliant.
  - Recommendations: continue implementation of new capital regime; consider consolidated market limits.
- Interest rate risk in the banking book (Principle 23):
  - Most banks have limited IRRBB due to short-term balance sheets; contractual maturities: liabilities average "9.2 months" (all deposits) and "11.5 months" (time deposits).
  - One systemic bank has material interest rate position without internal limits and holds earmarked capital buffer.
  - New reporting form (since 2012) and semi-annual detailed report enable standardized GAP/duration-based shock analysis ("4 percent" GEL / "2 percent" USD shock scenarios used).
  - Assessment of Principle 23: Largely compliant.
  - Recommendations: require banks to set internal limits and trigger ratios for IRRBB; consider quarterly reporting; provide more guidance in relation to ICAAP.
- Liquidity risk (Principle 24):
  - Minimum average liquidity ratio: no less than "30 percent"; current system liquidity ratio close to "40 percent"; liquid assets to deposits ratio "50 percent"; liquidity ratio for foreign currency close to "30 percent".
  - NBG moving toward Basel III Liquidity Coverage Ratio (LCR); draft regulation circulated; new liquidity regulation expected to enter into force in September 2014.
  - Only three large banks have contingency funding plans; only a few banks conduct full liquidity stress tests.
  - Assessment of Principle 24: Largely compliant.
  - Recommendations: finalize and implement LCR; ensure all banks have contingency funding planning and proportional stress testing.

### Operational Risk, Internal Control, Audit, Reporting, and Disclosure
- Operational risk (Principle 25):
  - Regulation enacted June 13, 2014 covering operational risk, business continuity, outsourcing, and mandatory prompt notification of "significant" operational risk events.
  - Shortcomings: only "7 out of 21" banks have comprehensive business continuity plans; most banks lack adequate outsourcing policies; internal operational reports should be more analytical; most banks do not perform IT audits.
  - Assessment of Principle 25: Largely compliant.
  - Recommendations: ensure monthly and yearly operational loss reporting, require business continuity plans across banks, mandate IT audits and improved outsourcing governance.
- Internal control and audit (Principle 26):
  - Audit committees required by law (Article 16); internal audit regulation sets responsibilities.
  - Shortcoming: law permits Executive Director to be member of Supervisory Board in some cases; assessors recommend deletion of this provision.
  - Assessment of Principle 26: Compliant.
- Financial reporting and external audit (Principle 27):
  - Banks must prepare annual accounts in IFRS; external audits follow ISAs; auditors mostly from "Big 4".
  - Regulation amended to require auditors to report immediately material matters to NBG (previously up to "five business days").
  - Assessment of Principle 27: Compliant.
- Disclosure and transparency (Principle 28):
  - Quantitative disclosures required; qualitative disclosure limited; NBG plans to enhance qualitative disclosures with IFRS 7 and Pillar 3 requirements.
  - Assessment of Principle 28: Largely compliant.

### Abuse of Financial Services / AML/CFT (Principle 29)
- Institutional framework:
  - Financial Monitoring Service (FMS) is FIU; FMS moving from NBG auspices to Office of the Prime Minister; concerns about continued independence.
  - NBG retains AML supervisory role and has dedicated resources: Money Laundering and Special Inspection Department (16 persons) and Banking Supervision Department AML on-site unit (18 staff).
- Key findings and gaps:
  - No explicit legal obligation on banks to report suspicious activities and incidents of fraud to the NBG where material to safety, soundness, or reputation; banks are required to report STRs to the FMS.
  - Definition of Politically Exposed Person (PEP) refers solely to foreign citizens; recommendation to extend definition to include domestic PEPs in line with FATF (2012) best practice.
  - Record retention: AML Law requires retention for at least "six years".
- Supervision and enforcement:
  - Inspection frequency risk-based: high-risk banks every "2–3 years"; average/low-risk banks every "3–4 years".
  - Fines imposed in recent years: "6" in 2011; "3" in 2012; "7" in 2013; "4" in first quarter 2014.
  - Assessment of Principle 29: Largely compliant.
- Recommended legal changes:
  - Legally require banks to report to the NBG any suspicious activities and incidents of fraud material to safety, soundness, or reputation.
  - Extend the definition of PEP to include domestic and foreign persons.
  - Ensure FMS independence preserved in institutional move.

### Selected Recommendations and Action Points (aggregated)
- Strengthen assessment of banks’ resolvability, particularly for systemically relevant banks, and develop a comprehensive operational recovery and resolution framework.
- Introduce and fully implement the formal consolidated prudential reporting framework as planned (November 2014 / June 2015).
- Ensure adequate on-site supervisory engagement to assess risk culture and avoid over-reliance on online supervision.
- Limit supervisory intrusion into banks’ operational credit risk management; preserve banks’ responsibility for credit approvals.
- Continue implementation of Basel II/III, including:
  - Requiring banks to comply with Pillar 1 minimum capital requirements as of "June 30, 2014".
  - Ensuring Pillar 2 (ICAAP) processes reported as of "September 30, 2014".
  - Determining Pillar 3 compliance timing before "end-2014".
  - Managing the "2014–2017" transition to dual compliance and parallel runs required as of "January 2014".
- Require banks to include credit risk and other material exposures in stress-testing programs and adopt adequate lending standards and contingency arrangements; use ICAAP/SREP to incentivize improvements.
- Address NBG resourcing and remuneration constraints: revisit training policies, consider supervisory charging, and develop staff retention measures.
- Enhance AML/CFT regime: legally require banks to report material suspicious activities to NBG; broaden PEP definition; preserve FMS independence.

*Italic: International Monetary Fund — Detailed assessment summary (Georgia), FSAP chapter: "1. Summary Compliance with the Basel Core Principles—Detailed Assessments" (content unit _cr1510).*

### 1. Summary Compliance with the Basel Core Principles—Detailed Assessments ________________ 11

### 1. Summary Compliance with the Basel Core Principles—Detailed Assessments

### Introduction
- Assessment completed as part of the Financial Sector Assessment Program (FSAP) undertaken jointly by the International Monetary Fund (IMF) and the World Bank.
- Assessment period: between May 15 and June 3, 2014.
- Assessors: Michael Deasy (IMF Consultant) and Marc Schrijver (World Bank).
- Previous assessment: 2007.
- Key high-level observations:
  - Significant improvements in regulation and supervisory approach since the 2007 FSAP through amendments to existing laws, new laws, and regulations.
  - Identified weaknesses include operational risk within the NBG’s Banking Supervisory Department due to very high staff turnover, over-reliance on key personnel, and need for expanded staff training.
  - NBG often relies on broad supervisory powers in lieu of detailed explicit powers; recent legislative amendments have addressed several shortcomings.

### Information on the Methodology Used for Assessment
- Methodology based on the Basel Core Principles document as agreed in 2012.
- Grading for each principle is based on the Essential Criteria (EC); additional criteria commented upon but not reflected in grading.
- Assessment of capital adequacy done against the Basel I standards; Basel II/III were reviewed but not used as the grading standard.
- Assessment involved discussions with:
  - NBG’s Specialized Groups and Supervisory Policy Department and Banking Supervision Department
  - Financial Monitoring Service of Georgia (FMS)
  - Ministry of Finance (MOF)
  - Commercial banks, Banking Association, Georgia Federation for Professional Accountants and Auditors (GFPAA), and a bank external auditing firm
- NBG staff described as fully transparent and cooperative during the visit.

### Institutional and Macroeconomic Setting and Market Structure
- Macroeconomic environment and outlook:
  - GDP growth reached 3.1 percent for 2013.
  - Growth expected to rise to 5 percent in 2014, "in line with potential growth."
  - Inflation expected to likely approach the NBG’s target of 6 percent in the coming 12 months (as of assessment).
  - Current account projected to widen in 2014 as imports pick up; over the medium term current account expected to narrow toward 5 percent of GDP.
  - Lari exchange rate: NBG committed to floating exchange rate but had intervened to prevent appreciation and maintained a de facto 2 percent band since early 2011; depreciation by more than 6 percent in Q3 2013 occurred.
- Risks to the macro-outlook (listed in source):
  - Worsening economic outlook in key trading partners (Russia, Turkey, and Ukraine) could reduce growth through trade and remittances channels.
  - Oil and gas make up more than 15 percent of total imports, raising vulnerability to fuel price shocks.
  - Large dollarization: around 60 percent of lending is dollar denominated, creating balance sheet risks.
  - Protracted regional political instability could undermine depositor confidence and reduce FDI.
  - Short-term nonresident deposits make up over 15 percent of commercial banks’ deposits.
- Financial sector structure and statistics:
  - Number of banks operating: 21.
  - Aggregate banking assets (per balance sheet) of the 21 banks: GEL 17.9 billion.
  - Market shares: Bank of Georgia (BoG) 34 percent; TBC Bank 23 percent; combined two banks over 57 percent of banking activity. Liberty Bank represents 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 total market share.
  - Lending breakdown (aggregate, as of April 2014): corporate loans 37 percent; small and medium enterprise (SME) loans 20 percent; retail loans 43 percent.
  - Microfinance: over 60 microfinance institutions; fewer than 10 have issued promissory notes; one microfinance institution reclassified as a qualified credit institution to date.
  - Credit union sector total assets at end-December 2013: GEL 7.6 million; total current and term deposits: GEL 5.3 million.
  - Insurance sector size: below 1 to 2 percent of GDP; health insurance accounted for nearly 75 percent of the total market in 2011.
  - Securities market: small stock exchange, central securities depository, three independent registrars, nine broker companies.
- Payment systems and credit information:
  - New Law on Payments Systems and Payment Services effective July 2012, providing legal framework for participants and basis for systemic, liquidity and credit risk management.
  - Private credit bureau exists; limit on exchange of positive information is US$500,000; no limit on exchange of negative information.
- Deposit insurance and macroprudential framework:
  - No deposit insurance scheme currently exists; authorities committed to establishing a deposit insurance agency over the next seven years under the EU Association Agreement due to be signed in June.
  - NBG has a broad financial stability mandate and power to issue macroprudential measures, but institutional setting for macroprudential policy should be strengthened; recommendation for NBG to consider setting up a financial stability unit.
  - On dollarization, NBG has undertaken measures to reduce impact and strengthen trust in the GEL.
- Bank resolution:
  - NBG has basic powers to take control of a problem bank, appoint a temporary administrator, act as resolution authority, and lead liquidation; temporary administrator and liquidator accountable to NBG and may arrange sale of assets/liabilities or recapitalization under temporary administration.

### Preconditions for Effective Banking Supervision
- Legal and institutional environment:
  - Georgia has a range of business laws (corporate, bankruptcy, contract, consumer protection, private property) that appear to be upheld and enforced.
  - NBG established a special consumer protection unit to deal with bank customer complaints.
  - Frequent changes in legislation create legal uncertainty: Securities Law amended 19 times since 1999; Companies Law amended 44 times since 1996.
  - Recent amendments to Tax Code and Law on Enforcement Proceedings initially gave Tax Authority priority over registered pledges/mortgages; law later amended in part to reinstate original priorities for specific financial institutions.
- Accounting and audit:
  - Accounting standards based on International Financial Reporting Standards (IFRS); all banks required to prepare annual accounts in IFRS.
  - Audits required to follow best international practice; "Big 4" audit firms present and audit almost all banks.
  - Georgia Federation of Professional Accountants and Auditors (GFPAA) exists but with limited oversight role.

### Main Findings (Selected)
- Principles 1 to 4 (Responsibilities, Powers, Independence, Cooperation):
  - Legislative wording gives secondary status to supervisory role compared to price stability, though no practical examples of compromised supervision found.
  - NBG relies on broad powers in absence of explicit legal provisions.
  - Very high staff turnover in supervisory area due to lack of salary competitiveness; over-reliance on key personnel; external training under-resourced; supervisory staff quality nonetheless described as impressive.
- Principles 5 to 7 (Licensing Criteria, Transfer of Significant Ownership, Major Ownership):
  - Significant legislative gaps: no explicit provisions requiring NBG approval for appointments to Supervisory Board, Directors, and top management and their replacements; no explicit requirement for notification to NBG by existing bank shareholders proposing to dispose of significant shareholdings.
  - No legal requirement for the NBG to assess whether a home supervisor practices global supervision or whether its supervision standards are equivalent to those of the NBG.
  - Several of these shortcomings were recently addressed by strengthening regulations.
- Principles 8, 9, and 11 (Supervisory Approach, Tools, Techniques, Corrective Measures):
  - NBG has developed a comprehensive, forward-looking, risk-based supervisory approach proportionate to systemic relevance of banks.
  - Approach addresses all risks and includes stress tests, business models, corporate governance, capital and contingency planning.
  - Supervisory model combines bank supervisors (responsible for all risks of individual banks) and specialist risk supervisors (responsible for one risk across all banks, including systemic risk).

*International Monetary Fund — Detailed assessment summary (Georgia), FSAP chapter: "1. Summary Compliance with the Basel Core Principles—Detailed Assessments".*

### 28.      Although the NBG developed an advanced supervisory approach, further enhancement is

### _cr1510 - 28.      Although the NBG developed an advanced supervisory approach, further enhancement is

### Supervisory approach and resolvability
- The NBG developed an advanced supervisory approach that is comprehensive, forward looking, and risk-based, proportionate to the systemic relevance of supervised banks.
- The new approach is not yet fully implemented (just for 80 percent) and not fully formalized.
- The assessment of banks’ resolvability should be further strengthened, in particular for systemic relevant banks.
- There is no explicit operational framework or process for handling banks in times of stress to support orderly recovery or resolution, despite having (basic) powers and tools for recovery and resolution.
- During the last period of stress in 2008, the NBG applied a mix of recovery instruments.
- The NBG required four banks to set up resolution plans; the process of implementation has only started recently.

### Supervisory techniques, on-site vs off-site, and risk culture
- The NBG uses a supervisory cycle (risk identification, assessment and mitigation) at the level of each individual risk and integrates bank supervisors and risk supervisors.
- The NBG has a powerful supervisory information system enabling “online” supervision and rigorous data analysis; supervisors can receive loan files online connected to banks’ information systems.
- Risk identified: the NBG runs the risk of not spending enough time on-site because of excellent online possibilities.
- Recommendation: NBG supervisors should consider spending more time on-site to assess risk culture and ensure adequate sensing of bank-level risk culture.

### Supervisory reporting and consolidated supervision
- There is a comprehensive supervisory reporting system, but 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.
- Significant improvement in consolidated supervision since the 2007 FSAP; large exposures are now calculated on a consolidated basis and the NBG has begun to assess capital on the same basis.

### Home-host cooperation and cross-border banking
- The level of cross-border banking is very insignificant in Georgia.
- Legislation providing for cross-border cooperation is adequate, and the actions undertaken by the NBG are commensurate with the level of activity.

### Prudential standards, risk management, and supervisory intrusiveness
- Additional efforts needed to improve banks’ risk management and ensure adequate implementation of regulation and guidelines; focus appropriately on largest and more complex institutions first.
- The intrusive supervisory approach is highly appreciated, but the NBG should avoid being involved in banks’ operational credit risk management or taking over banks’ credit decisions.
- Examples where banks requested NBG views regarding approval of specific credits highlight the fine balance between being intrusive and preserving banks’ responsibility for credit decisions.

### Internal control, financial reporting, disclosure, and AML
- Legislation and practice for internal control and transparency appear adequate.
- Requirements for financial reporting, audit, disclosure and transparency were met, although some minor weaknesses were identified.
- Legislation and practice regarding abuse of financial services appear adequate.
- Weakness identified: there is no legal 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 bank.

### Key Basel Core Principles findings and grades (selected)
- Principle 8 (Supervisory approach): LC — advanced approach; 80 percent implemented; lacks formalized stress/ resolution framework.
- Principle 9 (Supervisory techniques and tools): C — enormous progress; strong online supervision; risk of reduced on-site presence.
- Principle 10 (Supervisory reporting): LC — comprehensive system; formal consolidated prudential reporting framework to be introduced in November 2014.
- Principle 12 (Consolidated supervision): C — significant improvement; main weakness is absence of formal consolidated prudential reporting framework.
- Principle 15 (Risk management process): MNC — intrusive, forward looking, risk-based approach; essential criteria not yet fully met across banks; implementation of Basel II expected to drive improvements.
- Principle 16 (Capital adequacy): C — NBG implementing Basel II and elements of Basel III; conservative applications such as an additional 75 percent risk weight on loans denominated in foreign currencies.
  - Banks required to comply with minimum capital requirements under Pillar 1 as of June 30, 2014.
  - Pillar 2 in force as of September 30, 2014, when banks must report the outcome of their ICAAP.
  - NBG to decide before end-2014 when banks need to comply with Pillar 3 requirements.
  - Transition period: 2014–2017 — banks need to comply with both minimum capital requirements based on adjusted Basel I and minimum capital requirements based on Basel II/III.
  - As of January 2014, banks have been required to file a parallel run.
- Principle 17 (Credit risk): LC — advanced risk-based approach; not all banks have fully implemented lending standards; not all banks include credit risk exposures in stress-testing programs; NBG facilitating implementation of sound stress-testing framework to form part of Pillar 2 by the end of the year.

### Recommendations and action points
- Strengthen assessment of banks’ resolvability, particularly for systemically relevant banks, and develop a comprehensive operational recovery and resolution framework.
- Introduce the formal consolidated prudential reporting framework as planned (November 2014) and ensure full implementation.
- Ensure adequate on-site supervisory engagement to assess risk culture and avoid over-reliance on online supervision.
- Limit supervisory intrusion into banks’ operational credit risk management; maintain clear boundaries so banks remain responsible for credit approvals and risk management decisions.
- Continue implementation of Basel II/III, including:
  - Requiring banks to comply with Pillar 1 minimum capital requirements as of June 30, 2014.
  - Ensuring Pillar 2 processes (ICAAP) are reported as of September 30, 2014.
  - Determining Pillar 3 compliance timing before end-2014.
  - Managing the 2014–2017 transition to dual compliance and parallel runs required as of January 2014.
- Require banks to include credit risk exposures in stress-testing programs and to adopt adequate lending standards and contingency arrangements, with NBG guidance for ICAAP adequacy assessment in SREP.

*IMF staff summary of Georgia: selected excerpts from the Detailed Assessments of Basel Core Principles (text provided).*

### 18. Problem assets,

### 18. Problem assets, provisions, and reserves

### Problem assets and provisioning
- The NBG has focused on identifying problem loans and maintaining adequate provisioning, mostly for the large borrowers (40 percent of total loan portfolio).
- For SME and retail borrowers, the NBG uses sample techniques to ensure adequate provisioning.
- Progress is attributed to comprehensive reporting, enhanced risk assessment skills, an intrusive supervisory approach, and active dialogue with commercial banks.
- The NBG intends to facilitate transition toward the IFRS and, when the IFRS framework is adopted, to update its guidelines on loan-loss provisioning.

### Concentration risk and large exposure limits
- The NBG improved identification of connected borrowers by receiving monthly databases from every bank of the top 100 borrowers, the large exposures and the participations.
- Banks are required by regulation to identify economic interdependence, but there is limited practice within banks, making some large exposures unclear from the perspective of economic interdependence.
- To mitigate uncertainty, the NBG decreased its total large exposure limit from 600 percent to 200 percent.
- The NBG plans to develop guidelines on economic interdependence and has adopted a general regulation on risk management that includes some provisions on concentration risk, but it did not fully implement this regulation.
- The NBG expects implementation to improve with introduction of Pillar 2 of Basel II, which explicitly requires banks to assess all significant sources of concentration risk.
- The NBG prepared to change the definition of large exposures according to the new Basel standard on large exposures and concentration risk (June 2014), to include all claims, including equity (position not material); the amendment is not fully implemented yet.

### Transactions with related parties
- The NBG has made significant efforts to identify related parties and related transactions and to ensure transactions are at arm’s-length.
- The supervisor reviews pricing on both loan and deposit sides to detect irregularities and to cross-check how banks deal with related parties.
- During credit risk assessments, the NBG determines whether a case involves related parties and/or related transactions.

### Country and transfer risks
- The NBG actively monitors country and transfer risk (direct and indirect) based on prudential reports and, since May 2014, has started to stimulate banks to manage these risks through a guideline on country and transfer risk.
- The NBG does not systematically determine whether banks’ strategies, policies, and processes have been approved by the bank’s Board or whether the Board oversees implementation by management.
- Only the largest banks conduct stress tests that 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) to stimulate alignment between risk profile, capital position, and quality of risk management, providing incentives to manage country risk explicitly.
- The NBG does not have a formal provisioning model for country risk and transfer risk; banks have discretion to determine provisioning for country risk as part of standard borrower analysis.
- The NBG can require extra provisioning when not satisfied with provisioning levels or consideration of country/transfer risk and has used this power for bank exposures to one country.

### Market risk
- Market risk in the trading book is not material (including consolidated supervision); the main market risk is foreign exchange risk.
- The NBG assesses whether banks have adequate market risk management processes considering market and macro-economic conditions.
- Since June 2014, currency risk is charged under Pillar 1.
- Pillar 2 will become effective in September 2014.

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

### Liquidity risk
- The NBG’s liquidity risk assessment covers all aspects, analyzing banks’ inherent liquidity risks and their mitigants; systemic and complex banks must have more developed liquidity risk management frameworks.
- The NBG imposes a conservative liquidity requirement and is 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 mainly on the three largest banks, which may leave other banks’ liquidity risk management lagging.
- The assessors expect shortcomings to be resolved as the NBG implements the new liquidity regulation (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: recent regulation and a specialized operational risk unit broadened operational risk supervision into areas not previously covered (business continuity management and outsourcing).
- Areas for improvement recognized by the NBG:
  - Only 7 out of 21 banks have comprehensive business continuity plans (these include the largest banks); other banks have only disaster-recovery plans and should broaden to comprehensive continuity plans.
  - Most banks lack adequate outsourcing policies.
  - Banks have insufficient internal reports that should be more analytical.
  - Most banks do not perform IT audits; new regulation will require incorporation of IT audits in the overall audit plan.

### Internal control and audit
- The law provides that an Executive Director can be appointed to the Supervisory Board, which oversees the executive; 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.
- As CP 14 was rated LC on account of this, there is no downgrade in this Principle.

### Financial reporting and external audit
- Auditors have up to five business days to notify the NBG of any matters of serious significance that come to their attention; that period was considered too long.
- The regulation was recently amended to require 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 regulation on transparency with the introduction of IFRS 7 and Pillar 3 disclosures on the qualitative side and will require banks to publish information on their lending standards.

*IMF staff report excerpt.*

### 29. Abuse of financial

### 29. Abuse of financial services

### Key findings and deficiencies
- LC: 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 safely, soundness, or reputation of the banks.
- The definition of Politically Exposed Person (PEP) refers solely to a foreign citizen and not to both domestic and foreign persons, which is now regarded as best practice.
- The FMS (FIU) is moving from under the auspices of the NBG to the Office of the Prime Minister. There is some concern about its continued independence, including staffing and funding.

### Recommended actions (Principle 29)
- 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.
- Extend the definition of PEP to include domestic and foreign persons.

### Context in supervisory framework
- The assessment rates compliance for Principle 29 as LC and places recommended legal changes alongside broader recommendations across the Basel Core Principles assessment.
- These specific recommendations are presented together with other Principles’ recommended actions in the assessment’s consolidated recommendations table.

*Source: _cr1510 - 29. Abuse of financial*

### 1. Each bank shall prepare and submit to the National Bank, both for the bank itself and

### _cr1510 - 1. Each bank shall prepare and submit to the National Bank, both for the bank itself and

### Reporting and inspection requirements
- Each bank shall prepare and submit to the National Bank, both for the bank itself and separately for each of its subsidiaries, reports concerning organizational-administrative and operational activities and concerning liquidity, solvency, and profitability in order to enable the National Bank to assess their financial conditions both individually and on a consolidated basis. These reports shall be prepared in such form and detail and shall be submitted at such intervals as shall be prescribed by regulation of the National Bank.
- Each bank and each of its subsidiaries shall be subject to inspections by inspectors of the National Bank or by auditors appointed by it. Such auditors may include employees of the monetary or prudential supervision divisions of pertinent foreign regulators in cases where such inspections are to take place with respect to a branch office or subsidiary of a foreign bank.
- In their inspections of banks and their subsidiaries, the NBG and its auditors may:
  - examine all books, records, accounts, funds, and other documents of banks and their subsidiaries;
  - require that administrators and employees of banks and their affiliates submit to review information on the bank's shareholders, controlling persons, and administrators and any information concerning the bank's operation and transactions.

### Supervisor powers and enforcement (EC6)
- EC6 statement of authority: When, in a supervisor’s judgment, a bank is not complying with laws or regulations, or it is or is likely to be engaging in unsafe or unsound practices or actions that have the potential to jeopardize the bank or the banking system, the supervisor has the power to:
  - (a) take (and/or require a bank to take) timely corrective action;
  - (b) impose a range of sanctions;
  - (c) revoke the bank’s license; and
  - (d) cooperate and collaborate with relevant authorities to achieve an orderly resolution of the bank, including triggering resolution where appropriate.
- Description and findings re EC6:
  - Article 30 of the ACB Law sets out a list of infractions whereby the National Bank can impose sanctions (Subsection 2). The list appears comprehensive. Subsection 3 sets out the range of sanctions available to the NBG. They range from issuing written warnings to the cancellation of the bank’s license.
  - Article 30 reads as follows:
    - "1. The penalties provided for infractions described in this Article shall be determined in particular cases by the National Bank. Any aggrieved party may appeal such determination to the courts of law.
    - 2. The National Bank shall be authorized to impose the following actions and sanctions with respect to banks, their administrators and controlling persons if a bank, any of its administrators or controlling persons is guilty of an infraction consisting of:
      a. a violation of a provision of this law or of any regulation, instruction, rule, decree, order or written guidelines of the National Bank;
      b. a violation of any condition or restriction attached to the banking license of a bank or to a regulation issued by the National Bank; and
      c. failure to meet a timeframe for the submission of reports or the submission of incorrect reports or of other inaccurate information.
    - 3. When the above-mentioned violations are revealed, the National Bank has the right, with increasing severity depending on the seriousness of such violation and any actual or potential risk it poses to the assets of the bank, to impose on banks the following sanctions:
      a. issue written warnings;
      b. carry out special actions or issue instructions requiring that a bank must cease certain current practices and desist from future ones and other violations and take measures to eliminate violations within a specified period;
      c. impose fines according to rules and amounts established by the National Bank, but not in excess of a bank's own funds;
      d. impose civil money penalties in such amounts and pursuant to such procedures as are established by the National Bank if action of the bank's administrators caused financial loss to the bank or permitted the violation of regulations and requirements of the National Bank;
      e. suspend the signing authority of the bank's administrators and to require the bank's Supervisory Council to dismiss him or her temporarily or permanently;
      f. require the Supervisory Council and Management Directorate to call a special meeting of the bank's shareholders to discuss the violations and to take necessary measures to eliminate them;
      g. suspend or terminate asset growth, distribution of profits, payment of dividends and bonuses, and salary increases and the reception of deposits;
      h. in special cases, when the interests of the bank's depositors and other creditors are jeopardized, to suspend active operations and to place the bank in Temporary Administration;
      i. request from the controlling persons of a bank to divest or reduce their control in case of failure to provide financial or other information to the National Bank or in cases where a violation has been discovered. Such divestiture or reduction shall be undertaken in accordance with such terms and conditions the National Bank shall deem necessary in the particular circumstances; and
      j. cancel the bank's license."
- Cooperation: On cooperation, etc., there are no provisions in the law for cooperation with other authorities; in practice, the NBG will cooperate where needed (for example, with the Ministry of Finance under a contingency working group framework to achieve an orderly resolution.) Recently, the NBG has signed an MOU with the MOF.

### Group-wide review powers (EC7)
- EC7 summary: The supervisor has the power to review the activities of parent companies and of companies affiliated with parent companies to determine their impact on the safety and soundness of the bank and the banking group.
- Description and findings re EC7:
  - Article 29 of the ACB Law provides that the NBG can require from banks information for review on their shareholders and controlling for the purposes of carrying out its supervisory function.

### Assessment, compliance rating, and recommendations (Principle 1)
- Assessment of Principle 1: Largely compliant.
- Comments and recommended legislative amendments:
  - Reason for ‘largely compliant’: Absence of explicit powers generally in these areas could, at least in theory, leave the NBG open to challenge. The clause in the legislation (Article19 (1) of the CBA Law), which states that where there is no specific banking rule established by the NBG, banks should act pursuant to international banking rules and customs is aspirational only and could not be enforced.
  - Accordingly, it is recommended that the following areas be addressed:
    - EC3: Remove any doubt about the NBG’s ability to set and enforce minimum prudential standards for all banking activities by amending Article 21 of the ACB Law, so that all areas are covered and not just those listed in the Article, notwithstanding the fact that, in practice, these powers seem available under broad general provisions.
    - ECI: Amend legislation to give equal prominence (along with price stability) to the NBG’s supervisory function. This is a very theoretical point. The primacy of price stability in the objectives of any central bank is recognized, as is the fact that many central banks carry out the dual roles of price stability and financial markets regulation and that the fulfillment of these roles do not, as a rule, give rise to conflicts of interest. Nonetheless, any reference to “main tasks” should be deleted from legislation.
    - EC4: Make consultation obligatory before the finalization of draft regulations, although it is recognized that such consultation takes time, as was confirmed by the banks visited.
- Regarding EC6 and supervisor’s ability to revoke a bank’s license:
  - Article 6 of the ACB Law (introduced in 2009) provides that a banking license may only be revoked upon a decision of the National Bank. This was introduced to address one of the findings of the last assessment, namely, that in several instances, the NBG decision to revoke a license was overruled by the courts resulting in technically insolvent banks continuing to operate.
  - Article 68(5) in the NBG Law: “In the event that there is litigation brought to oppose an administrative act of the National Bank the bringing of such litigation shall not suspend the effect of such administrative act until the final decision is made, unless otherwise decided by the National Bank.”

### Independence, accountability, resourcing, and legal protection for supervisors (Principle 2 / EC1)
- Principle 2 summary: Independence, accountability, resourcing, and legal protection for supervisors. The supervisor possesses operational independence, transparent processes, sound governance, and budgetary processes that do not undermine autonomy and adequate resources, and is accountable for the discharge of its duties and use of its resources. The legal framework for banking supervision includes legal protection for the supervisor.
- EC1 Description and findings:
  - The operational independence of the NBG is guaranteed by both the Constitution of Georgia and the NBG Law. Article 95 of the Constitution states that “The National Bank of Georgia shall be independent in its activities. The Organic Law [NBG Law] shall determine the rights and duties, the procedure of activities, and shall guarantee the independence of the National Bank.”
  - Article 4 of the NBG Law states:
    - “1. The National Bank shall be independent in its activity. Legislative, executive and other authorities shall not be entitled to interfere in its activity or to monitor it except in cases as prescribed under the Georgian Constitution and this Organic Law.
    - 2. The National Bank shall be economically independent and shall provide for all its expenses. The National Bank shall not be liable for liabilities of the State of Georgia. Georgia shall not be liable for the liabilities of the National Bank except in cases as envisaged under this Organic Law. (Amended on 23.03.2010 N2828).
    - 3. The National Bank, its assets, property and income, as well as activities and operations carried out by it shall be exempt from all state taxes, duties fees and charges (10.04.2012 N6017).”
  - Article 1 of the NBG Law further states that the NBG is authorized to sign contracts independently, independently purchase real and moveable property and own and dispose of them, act as a plaintiff and a defendant, independently execute the duties imposed on it.
  - Possible constraint: Paragraph 2 of Article 9 of the Law of Georgia on Public Service states that the governor of the National Bank determines the remuneration for employees within the margins determined by the government.
  - Accountability: The NBG is accountable to the parliament of Georgia and presents reports to it annually. According to Article 61 of the NBG Law, “Annually, no later than 4 months after the completion of a financial year, the National Bank shall submit to the parliament of Georgia the report on the progress of monetary-credit, currency and supervision policies. The parliament of Georgia shall approve the submitted report.”  

*Source: Excerpt from the IMF country report PDF content unit _cr1510.*

### Chapter VIII of the NBG Law (Supervision of Financial Sector) supplemented by the provisions

### Chapter VIII of the NBG Law (Supervision of Financial Sector) supplemented by the provisions of the ACB Law

### Governance and appointment of supervisory bodies
- Supreme governing body: Board of NBG consists of seven members (Article 7).
- Board authorities (Article 9) include:
  - review and approve the key principles of management and disposition of international reserves;
  - stipulate the rule for determining the national currency’s official exchange rate against other countries’ currencies;
  - approve the budget of the National Bank’s administrative and capital costs;
  - create special reserves;
  - review, approve, and submit to the President of Georgia the annual report and financial statements of the National Bank;
  - issue legal acts;
  - define the basic trends of supervision and regulation of the activity of financial sector;
  - approve the organizational structure and regulation of the National Bank;
  - perform other duties as prescribed under this Organic Law.
- Appointment/removal process:
  - Board members are appointed by a majority of the parliament on the president’s nomination (Article 7; Article 96 of the Constitution).
  - Board members elected for a 7-year term; a Member of the Board may be re-elected.
  - Dismissal of Board members only via parliamentary decision in accordance with Article 64 of the Constitution (impeachment procedure).
  - The President appoints/dismisses the governor upon nomination by the Board, and vice-governors upon nomination by the governor.
  - Governor dismissal grounds (Article 7): i. is not a member of the Board anymore; ii. deprived of the right to serve as member pursuant to Article 13; iii. unable to perform duties due to health/court finding; iv. dies.
- Publication: Information on Board members is published on the NBG Website. The law provides for public disclosure of reasons for removal of Board members (assessors recommend explicit statutory provision).

### Objectives, accountability and reporting (EC3)
- Statutory objective (Article 47): “The National Bank’s objective shall be to support financial sustainability and transparency of financial sector, protect customers’ and investors rights. To this end, the National Bank shall support stable and effective functioning of the financial system, control of systemic risk, establishment of competitive environment, reduction of potential risks.”
- Current reporting: NBG gives descriptive account of current issues in annual accounts; recommendation to augment with focused strategic plans and targets for the coming year and account for their discharge in the next annual report.

### Internal governance, decision-making and emergency response (EC4)
- Governance of supervisory function delegated to a responsible vice-governor by the governor.
- Decision-making process: bottom-up; divisions under two departments (Specialized Groups and the Supervisory Policy Department, and Banking Supervision Department) perform tasks; heads of departments and vice-governor approve decisions; vice-governor makes significant decisions in agreement with the governor.
- Organizational principles: four-eye principle, clear delegation, trackable decisions.
- Contingency plan (CP) exists to coordinate policy/actions to mitigate systemic risks; special teams mobilized in emergency; NBG has flexibility to respond rapidly.

### Staff professionalism, ethics and confidentiality (EC5)
- Ethical/legal framework:
  - Article 20 sets ethical behavior; subsection 6 restricts supervisory staff from being employees/shareholders/board members of supervised entities and prescribes rules on family/close relatives with >10 percent share.
  - Article 20: confidentiality prohibition for present/former employees and Board members; forbidden to permit access to, disclose or use confidential information for personal gain.
  - Code of conduct supplements Article 20; sanctions range from warning to dismissal.
  - Law of Georgia on Public Servants regulates confidential information, conflicts of interest, permissible activities; sanctions not explicitly stated in that law but employment contract provisions and Article 37 of the Labor Code provide for termination for infringement and firing for disclosure of confidential information.
  - Article 13 restricts NBG Board members (except governor/vice-governors) from simultaneous roles in public service or Georgian financial sector entities; family members restricted from partnership in Georgian financial sector companies.
- Findings: Assessors impressed by professionalism and integrity of supervisory staff.

### Resources, recruitment, training and retention (EC6, EC7)
- Staff and structure:
  - Total number of employees involved in banking supervision: approximately 45.
  - Staff complement evolution: since 2010 staff numbers increased from 33 to 44.
- Salary/remuneration constraints:
  - Article 19 states remuneration shall be commensurate with the level of wages in the Georgian banking system, but Paragraph 2 of Article 9 of the Law of Georgia on Public Service allows governor to determine remuneration within government margins for public servants.
  - In practice, significant salary gap: commercial bankers can earn up to three times what an average NBG supervisor earns; gap larger for managerial positions.
  - Salary levels frozen since 2009; commercial sector salaries rose.
- Turnover statistics:
  - 2011: average staff complement 34, 8 resigned (24 percent).
  - 2012: 37 staff, 13 resignations (36 percent).
  - 2013: 41 staff, 5 resignations (12 percent).
- Skills gaps and dependence:
  - Major recruitment gaps: IFRS specialists, credit risk specialists, and managers.
  - Dependence on short-term staff/interns and potential over-reliance on key staff.
- Training and external expertise:
  - Budget constraints limit external training and technology investment; internal training courses and in-house seminars used (Basel II and III, Pillar II with help of Dutch Central Bank, credit risk, ratio analysis, risk-based pricing).
  - Donor financing enabled commissioning external experts (secondment from Dutch Central Bank; former FSA Executive Director funded by ADB; World Bank projects).
- Resource protection:
  - Article 68 (6) provides personal liability protection for employees acting in good faith in ordinary course of duties; no specific statutory protection for the supervisory authority itself or explicit protection against costs of legal defence—NBG states it would pay such costs in practice.

### Risk-based supervision and allocation of supervisory resources (EC8)
- GRAPE introduced toward end-2009: general risk assessment program determines supervisory programs and allocates resources by bank risk profile and systemic importance.
- Supervisory structure under GRAPE:
  - Banking Supervisors Department: three divisions; banks assigned by systemic importance and scale/size.
  - Specialized Groups (incorporating Supervisory Policy department): six divisions responsible for particular risk categories: retail and corporate credit risk; liquidity risk; market risk; operational risk; business model; profitability; macroeconomic environment; group structure; corporate governance; resources; total risk.
- Supervisory approach: supervisors perform both on-site and off-site style tasks, continuous process throughout year; specialized groups maintain systemic overview and methodologies.
- Software supports risk-based priorities and supervisory plan implementation.

### Cooperation, information sharing and cross-border arrangements (Principle 3, EC1–EC5)
- Domestic collaboration:
  - Until April 2013 NBG was sole regulator; insurance supervision was removed from NBG on that date.
  - MOU signed 25 June 2014 between NBG and new insurance regulator; prior to this there was no effective collaboration framework.
  - Informal collaboration framework exists with the Ministry of Finance on financial stability; proposal to formalize.
  - Formal MOU with Financial Monitoring Service (FMS) on money laundering and illicit income information sharing.
- International cooperation and MOUs:
  - Article 5 requires cooperation with other countries’ competent financial sector supervision authorities and permits exchange of information provided confidentiality is maintained.
  - NBG policy to sign MOUs with authorities in countries where owners of locally systemically important banks operate: Germany, France, Ukraine, United Kingdom; MOU signed in 2012 with BAFIN (Germany). Seeking MOUs with France and Ukraine; U.K. FSA showed no interest previously.
  - NBG member of one supervisory college (ProCredit Bank; BAFIN leads).
  - Additional MOUs with Azerbaijan, Kazakhstan, Turkey, Belarus in relevant cases.
- Confidentiality protections in law and MOUs:
  - Article 20 and MOUs require confidentiality; MOUs generally require prior written consent before releasing information to third parties and use for prudential purposes only. If authority is obliged by law to disclose, it must promptly notify the other authority and seek to preserve confidentiality.
- Support for resolution planning (EC5):
  - NBG is sole authority for bank resolution. No specific statutory cooperation arrangements for resolution, but in practice NBG cooperates with other agencies (e.g., Ministry of Finance). During the financial crisis a contingency working group with Ministry of Finance exchanged information and aligned policies.

### Permissible activities and use of the term “bank” (Principle 4, EC1–EC5)
- Definition of “bank”:
  - ACB Law Article 1: bank is “a juridical [legal] person licensed by the National Bank that attracts deposits and uses them on its own behalf to conduct banking activity pursuant to applicable law.”
  - Article 2 (3): “No one shall use the word ’bank’ or derivatives of the word ‘bank’ without having received a banking license issued pursuant to this law, unless such usage is established or recognized by law or international agreement, or unless it shall be clear from the context in which the word ‘bank’ is used, that the person using it is not engaged in banking activities, as defined by this law or by the “Law on the National Bank of Georgia.””
- Permissible banking activities (ACB Law Article 20):
  - receiving interest-bearing and interest-free deposits; extending consumer, mortgage and other credits; factoring; trade finance including guarantees, letters of credit, forfeiting; trading in monetary instruments and certain securities/futures/options/swaps; cash and non-cash settlement operations; issuing money orders and managing money circulation; securities brokerage; trust operations and funds management; safekeeping and registration of valuables; credit-information services; activities incidental to the above.
- Deposit-taking reserved:
  - Only banks and credit unions are permitted to take deposits from the public; both regulated by the NBG. Credit unions are insignificant at end-2013: total balance sheet GEL 7.6 million and total deposits GEL 5.3 million.
- Microfinance and qualified credit institutions:
  - Loophole identified where microfinance institutions attracted public funds via promissory notes without NBG authorization; over 60 microfinance institutions exist, less than 10 have issued promissory notes.
  - Promissory notes represent about 2 percent of the savings of the Georgian public; banks represent 94 percent; insurance companies 4 percent.
  - Amendment to NBG Law (25 May 2012) introduced “qualified credit institutions” (Article 48 (1)):
    - Defined as legal persons (other than commercial banks) who attract funds from more than four hundred natural persons or the amount of funds attracted exceeds GEL 5 million.
    - Qualified credit institutions must register with NBG and satisfy requirements (fit-and-proper, minimum capital, liquidity, prudential ratios); NBG can inspect, impose restrictions and apply sanctions.
    - NBG can request registration for institutions attracting funds from fewer than four hundred persons or less than GEL 5 million if they play an important role or show expansion.
    - To date, one microfinance institution has been classified as a qualified credit institution.
- Public list of licensed banks: NBG publishes a list of all financial institutions on its website.

### Licensing powers, criteria and fit-and-proper assessments (Principle 5, EC1–EC8)
- Licensing authority and powers:
  - NBG is authorizing and supervisory authority; Article 49.1 (a) authorizes NBG to supervise commercial banks, including issuance and revocation of licenses.
  - ACB Law Chapter II and Regulations set out licensing process, conditions, revocation and fit-and-proper criteria.
  - NBG may attach conditions/restrictions to licenses upon issuance and after issuance for noncompliance.
- Required licensing information (ACB Law Article 3; Regulation on Licensing excerpts):
  - Originals of foundation documents or notarized/apostilled/legalized copies;
  - Information on compliance of administrators with fit-and-proper criteria;
  - Statement of amounts of authorized and paid in capital and information on ownership and origination of capital components; branches of foreign banks to submit financing allocated by Head Office;
  - Fit-and-proper declaration for direct or beneficiary owners exceeding 10percent, 25percent, or 50percent (Article 8(1));
  - Additional information prescribed by NBG regulations (authorized capital, financial resources, head office and branch locations, other requested information);
  - Documentation proving title or right to use real estate for head office/branches.
- Grounds for rejection or revocation:
  - Applications rejected if requirements not satisfied or information inadequate.
  - Article 48(3) authorizes rejection if: issuance can threaten financial stability; does not comply with directives/recommendations of relevant international organizations; does not comply with signed agreements between Georgia and foreign countries; applicant did not present information regarding source of own funds upon request.
  - Article 6 of ACB Law allows license revocation if obtained on grounds of false statements or material irregularities.
- Minimum capital:
  - Regulation on Defining Minimum Capital Requirements: minimum regulatory capital for banks is GEL 12 million.
- Fit-and-proper and ownership scrutiny:
  - Article 8(1) ACB Law: declarer intending to acquire shares (crossing 10percent, 25percent, 50percent thresholds) must submit fit-and-proper declaration with identification, criminal record statements, beneficial owner data, amount of share, and related declarations.
  - Regulation on Licensing details documentary requirements for resident and nonresident shareholders (identification, registration docs, audited financials, bank references, recommendation letter from central bank for foreign banks).
  - NBG assesses ownership structure and transparency and will look through layers to ultimate beneficial owner.
  - Article 49.1 authorizes NBG to require information on source of origination of capital and direct and beneficial owners.
- Assessment of proposed management and governance:
  - Administrators defined: Supervisory Board (non-executive) and Management Board (Directorate, executive).
  - Article 4.1(2) ACB Law sets individual eligibility: not declared incapable by court; not convicted for illicit income legalization or terrorism financing; has respective education and/or experience; not simultaneously administrator of another bank (with limited exception); not convicted for economic crime or crime against entrepreneurial activity.
  - NBG evaluates proposed Board members and Directors’ fitness and propriety commensurate with planned scale and complexity; assesses skills, experience, integrity and criminal records.
  - NBG approval for appointments not directly required by legislation but applied in practice; planned amendments will formalize requirements and information collection (education, qualifications, criminal records, solvency, loans/past due loans, connections with shareholders).
- Strategic, operational and governance plans:
  - Licensing applicants required to provide business plan and organizational structure, internal procedures, and personnel records (Regulation on Licensing Article excerpts).
  - NBG reviews corporate governance, risk management, internal controls, detection/prevention of criminal activities, oversight of outsourced functions and alignment of operational structure with planned activities.
- Gaps and reform plans:
  - No explicit legal provision currently requires proposed legal, managerial, operational and ownership structures to be designed to avoid hindering effective supervision on solo and consolidated basis; planned legislative amendments will address this and align licensing requirements more explicitly with Basel Core Principles and relevant EU Directives.
  - NBG indicates current system works effectively in practice; one application formally rejected and others rejected at inquiry stage.

### Key statistics and exact figures cited
- Board size: seven members (Article 7).
- Board term: 7-year term of office (Article 7).
- Supervisory staff: approximately 45 employees.
- Staff counts and turnover:
  - 2011: average staff complement 34, 8 resigned (24 percent).
  - 2012: 37 staff, 13 resignations (36 percent).
  - 2013: 41 staff, 5 resignations (12 percent).
- Minimum regulatory capital for banks: GEL 12 million.
- Qualified credit institution thresholds:
  - attracts funds from more than four hundred natural persons;
  - or amount of funds attracted exceeds GEL 5 million.
- Public savings distribution (promissory notes / sectors):
  - promissory notes represent about 2 percent of the savings of the Georgian public;
  - banks represent 94 percent;
  - insurance companies represent 4 percent.
- Dates and provisions referenced:
  - Amendment to NBG Law: 25 May 2012 (Article 48 (1) introduction of qualified credit institutions).
  - MOU between NBG and new insurance regulator: 25 June 2014.
  - Salary freeze since 2009 noted in text.

### Assessors’ main findings and recommendations (selected)
- Overall assessment of Principle 2 (supervisory governance and resources): Materially noncompliant.
- Primary concerns:
  - Significant recruitment and retention difficulties due to salary uncompetitiveness and salary freeze since 2009, causing high turnover and gaps in specialist roles (IFRS, credit risk, managers).
  - Over-reliance on key staff and short-term hires; limited external training and technology investment due to budget constraints.
  - Legal gaps: lack of explicit statutory requirement for public disclosure of reasons for removal of Board members (recommendation to amend law); need for explicit legal provision to protect the supervisor and staff against costs of legal defence and to extend personal good-faith protection to the supervisory authority itself (EC9).
  - NBG should publish strategic plans and targets in annual report and account for discharge in following report (EC3).
  - Training policies should be revisited and supervisory training prioritized; consider charging for supervision.
- Licensing and supervisory framework:
  - NBG exercises licensing and supervisory authority effectively in practice, but some licensing powers and requirements are broad rather than explicit; amendments are planned to align more closely with Basel Core Principles and EU Directives and to set clearer information requirements during licensing.
  - No explicit legal provision currently requires group/ownership/operational structures to be designed so as not to hinder effective solo and consolidated supervision; planned amendments will address this.
- Prudential oversight of nonbank deposit-takers:
  - NBG introduced qualified credit institutions regime to close promissory note loophole; recommendation to maintain close watch on microfinance institutions and consider more intensive supervisory regime for qualified credit institutions in areas such as capital, related party lending, and large exposures.

*Source: Chapter VIII of the NBG Law (Supervision of Financial Sector) supplemented by the provisions of the ACB Law (IMF country report content unit _cr1510).*

### 5. Business plan verified by the Board of Directors (management) shall include the following

### _cr1510 - 5. Business plan verified by the Board of Directors (management) shall include the following

### Business plan requirements (ACB Law and licensing)
- The business plan verified by the Board of Directors (management) shall include the following issues:
  - Financial operations and core assets: core financial operations and banking products offered by the bank to its clients;
  - Approximate structure of Assets and Liabilities: approximate structure of assets and liabilities for the first two years; total capital adequacy and its observance, liquidity sources; and credit and investment policies and procedures; and
  - Projected Income Statement: projected income statement for the next two year period, based on market analysis; projected net income allocation; and the structure of expenses.
- Beyond this, the ACB Law gives the NBG the power to require any further information that the National Bank shall reasonably request in the circumstances of each case.
- Amendments projected to licensing provisions (see EC2 above) further specify requirements by explicitly stating submission of:
  - corporate governance policy;
  - organizational structure and job descriptions of management members;
  - credit risk, market risk, operational, and other relevant risk governance frameworks;
  - internal capital adequacy assessment model;
  - calculation of capital adequacy requirement;
  - budgetary plans;
  - accounting policy; and
  - informational technology for initial and advanced periods.

### Licensing authority review and pre-license checks (EC9–EC11)
- EC9: The licensing authority reviews pro forma financial statements and projections of the proposed bank, including an assessment of the adequacy of the financial strength to support the proposed strategic plan and financial information on the principal shareholders of the bank.
  - Findings: NBG requires applicants to provide financial forecasts and calculations of capital adequacy and assesses future financial strength of the shareholder; depth of analysis is commensurate with the scale and complexity of the proposed bank.
- EC10: For foreign banks establishing a branch or subsidiary, before issuing a license, the host supervisor establishes that no objection (or a statement of no objection) from the home supervisor has been received. The host supervisor also determines whether the home supervisor practices global consolidated supervision.
  - Findings:
    - Article 4(e) of the Regulation on Licensing of Banking Institutions requires consent of the home supervisory authority for a foreign bank proposing to establish a branch in Georgia.
    - There is no similar legal requirement where a foreign bank proposes to establish a subsidiary in Georgia; proposal to address this in forthcoming legislation.
    - There is no legal requirement for the NBG to assess whether the home supervisor practices global consolidated supervision or whether its supervision is equivalent to that of the NBG.
    - NBG contends that license applications usually do not require cooperation with third country supervisors; it relies on public information or applicant-provided information and supervises branches and subsidiaries as local banks.
- EC11: The licensing authority or supervisor has policies and processes to monitor the progress of new entrants in meeting business and strategic goals and to determine that supervisory requirements outlined in the license approval are being met.
  - Findings: Since 2011, new license applications are handled by the Supervisory Policy and Corporate Governance Division in collaboration with the Legal And Banking Departments; at a final stage a supervisor from the Banking Supervision Department is dedicated to supervising the new entrant under the general supervisory regime.

### Assessment of Principle 5
- Rating: Largely compliant
- Comments:
  - Licensing process appears to work well in practice despite significant explicit gaps in legislation, based on few authorizations granted recently, several rejections, and no evidence of recently authorized banks subsequently running into difficulties.
  - NBG relies on broad legal principles pending adoption of proposed legislation, and introduced specific rules following the mission; therefore L/C deemed appropriate.
- Identified weaknesses:
  - EC4: No explicit legal provision specifying that proposed legal, managerial, operational, and ownership structures of the bank and its wider group will not hinder effective supervision on both a solo and a consolidated basis, or hinder effective implementation of corrective measures in the future. Regulation recently strengthened to address this.
  - EC5: No reference to “others that may exert significant influence” in the legal definition of significant shareholder, although NBG considers the issue in practice.
  - EC7: NBG approval for appointments to the Supervisory Board, Directors, and top management, and for their replacements, is not directly required by legislation; NBG asserts this authority is indirectly applied and exercised in practice; regulation amended recently to address this.
  - EC10: Consent of the home supervisor required when establishing a branch, but historically not required when establishing a locally incorporated bank in Georgia; addressed recently.
  - EC10: No legal requirement for the NBG to assess whether the home supervisor practices global consolidated supervision or whether its supervision is equivalent to the NBG.

### Banking sector structure and market shares (as reported)
- Current operating banks: 21 banks.
- Aggregate banking assets (per balance sheet) of the 21 banks: GEL 17.9 billion.
- Market concentration:
  - Two banks account for over 57 percent of banking activity:
    - BoG: 34 percent
    - TBC Bank: 23 percent
  - Next largest bank—Liberty Bank—represents less than 8 percent of total activity.
  - 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 share.
- Ownership notes:
  - BoG is widely owned and obtained a listing on the London Stock Exchange in 2006.
  - TBC Bank is owned by a number of financial institutions and obtained a London listing recently.
  - Liberty Bank is owned 70 percent by a Romanian individual.
  - Most remaining banks are subsidiaries or affiliates of foreign banks; a small number, mainly the smaller banks, are owned by individuals, both Georgian and foreign.
- Historical context: The number of banks has remained relatively constant over the last 10 years, hovering around the 20 mark; in the early 1990s there were over 220 banks.

### Principle 6 — Transfer of significant ownership: essential criteria and findings
- Principle summary: The supervisor has the power to review, reject, and impose prudential conditions on proposals to transfer significant ownership or controlling interests held directly or indirectly in existing banks to other parties.

- EC1 — Definitions of “significant ownership” and “controlling interest”
  - Findings:
    - “Significant share” is defined in the ACB Law as “10 percent or higher share in commercial bank’s authorized or paid-in capital, owned by the person through direct or indirect participation in equity capital.”
    - Recommendation: amend definition to include a reference to persons acting in concert to capture circumstances where ownership is held by more than one person but those persons are acting in concert. NBG says banks are aware in practice that they must group related parties together.
    - “Control” is defined as “authority to govern financial and economic policy of an enterprise (organization) for the purpose of deriving economic benefit from such activity.”
    - Clarification in The Regulation on Conflicts of Interest and Transactions between Bank Administrators and Related Parties: “control” is the capability by a person to exercise, directly or indirectly, alone or in concert with others, by using voting shares (stocks) or in any other way, strong influence over the policies or business-related decisions of other person.

- EC2 — Requirements to obtain supervisory approval or provide immediate notification of proposed changes
  - Findings:
    - Article 8 (1) of the ACB Law: a person intending to acquire shares so that his/her or beneficiary owner’s participation exceeds 10 percent, 25 percent, or 50 percent shall submit the fit-and-proper declaration to the NBG, identifying the exact amount of participation to be achieved through the intended transaction.
    - There is no obligation on a significant shareholder to seek the NBG’s consent when disposing of a significant shareholding; NBG proposes forthcoming legislation to require consent where a beneficial owner’s qualifying holding would fall below 10 percent, 25 percent, or 50 percent.

- EC3 — Power to reject or reverse changes in significant ownership
  - Findings:
    - NBG analyzes applications on acquisition of significant shares based on licensing criteria and will reject applications if not satisfied.
    - Article 8.2(4) of the ACB Law: a transaction on acquisition of a significant share shall be nullified if the person has not submitted a fit-and-proper declaration to NBG or if its proposal was rejected by NBG.
    - Article 48.3(1) of the NBG Law authorizes NBG to reject the transfer of significant ownership if:
      - such transaction can threaten the stability of the financial sector;
      - such transaction of a license does not comply with the requirements of the directives or recommendations of international organizations;
      - such transaction of the license does not comply with the signed agreements between Georgia and foreign countries; and
      - upon NBG’s request, the applicant did not present information regarding the source of own funds.
    - NBG considers it has sufficient powers under these broad provisions but seeks more explicit powers under amendments to the licensing provisions project (Principle 5 EC2). If adopted, banks would be required to submit information received during the application process throughout ongoing supervision.

- EC4 — Obtaining names and holdings of significant shareholders (including beneficial owners)
  - Findings:
    - Article 8.3 of the ACB Law requires banks to submit to NBG details of significant shareholders on an annual basis. Precise wording:
      1. Along with the annual report, commercial banks, on the basis of available data, shall provide the National Bank with the information on direct as well as beneficiary owners of 10 percent or more of the share and confirm or not accuracy of such information.
      2. Beneficiary owner, who directly or indirectly holds more than 10 percent of the commercial bank’s share, shall submit a fit-and-proper declaration to the National Bank in April of every year, which should include data as of December of the previous year. (Inter alia, the fit-and-proper declaration requires shareholders to confirm that they have not been convicted of an economic crime.)

*Source: _cr1510 - 5. Business plan verified by the Board of Directors (management) shall include the following*

### 3. Failure to submit requested information to the National Bank on direct as well as

### _cr1510 - 3. Failure to submit requested information to the National Bank on direct as well as

### Beneficial ownership, information requests, and disclosure requirements
- Commercial banks must have full information regarding the identity of every beneficial owner who directly or indirectly owns more than 10 percent of shares (with an indication of the amount), submit this information and any significant changes to the NBG, and publish this information publicly in their annual report (Article 10 of the ACB Law).
- The Regulation on Transparency of a Commercial Bank’s Financial Condition requires banks to disclose and report information on shareholders owning 1 percent or more of shares of the authorized capital and beneficial owners who directly or indirectly own 5 percent or more of shares (with the indication of quotas).
- The NBG has the right to request ownership details from banks if it considers such is necessary.
- Article 8.4 of the ACB Law: in the event of grounded suspicion, the NBG can request submission of declaration on direct, as well as beneficiary, owners of significant shares, suspend voting rights for a certain period and require reduction of an equity share to 10 percent within 60 days, or suspend voting rights for an unlimited period.
- Failure to submit requested information to the NBG on direct as well as beneficiary owners of commercial banks shall result in the respective measures determined under the Georgian legislation.

### Change of control, remedial powers, and notification gaps (EC5 and EC6)
- EC5 findings:
  - Article 8.2 of the ACB Law: any transaction relating to an acquisition of a significant shareholding shall be nullified if the person has not submitted a fit-and-proper declaration to the NBG, or has been refused but still acquired a significant shareholding.
  - In such circumstances, the NBG can:
    - suspend the voting rights of a person for certain periods and request a reduction of an equity share in his/her shareholding to 10 percent within a 60 day period; or
    - suspend voting rights of the person for an unlimited period.
- EC6 findings:
  - There are no explicit laws or regulations that require banks to notify the NBG as soon as they become aware of any material information which may negatively affect the suitability of a major shareholder or a party that has a controlling interest.
  - The standing of major shareholders is periodically (at least once a year) assessed by the NBG under the group structure risk analysis.
  - The NBG checks public information available on shareholders and ultimate beneficial owners to ensure correct identification.
  - Article 10 requires banks to have full information on beneficial owners owning more than 10 percent and to submit significant changes to the NBG; banks must disclose beneficial owners who own more than 5 percent.
  - Per Article 8.4, on grounded suspicion the NBG may request declarations on direct and beneficiary owners, suspend voting rights, and require reduction to 10 percent within 60 days or suspend voting rights indefinitely.

### Assessment of Principle 6 and specific recommendations
- Assessment: Materially noncompliant.
- Comments:
  - Weaknesses arise from lack of explicit statutory specification for certain requirements; the NBG relies on broad general powers.
  - Draft legislation exists to address shortcomings; the NBG hoped enactment during 2014.
- Recommendations and suggested legal amendments (as stated in source):
  - EC1: Amend definition of “significant” in shareholders to include persons acting in concert.
  - EC2: Amend law to require intended sellers of significant shareholdings to inform the NBG (current requirement applies only to proposed acquirers).
  - EC4, EC6: Amend law to refer explicitly to persons that exert controlling influence as well as significant shareholders.
  - EC6: Insert a specific provision in law requiring banks to notify the NBG as soon as they become aware of any material information which may negatively affect the suitability of a major shareholder or a party that has a controlling influence.

### Major acquisitions and investments by banks (Principle 7) — findings and assessments
- Principle summary: Supervisor has power to approve/reject and impose prudential conditions on major acquisitions or investments, including cross-border operations, to ensure corporate affiliations/structures do not expose the bank to undue risks or hinder effective supervision.
- EC1 findings:
  - Commercial banks may acquire holdings in bank and nonbank enterprises subject to limitations.
  - A commercial bank may hold unlimited equity interest in a bank (or brokerage company). If proposed holding would exceed 15 percent of the acquiring bank’s equity capital, prior written consent of the NBG is required.
  - NBG consent is required to establish or acquire subsidiaries engaged in nonbanking activities; authorization defines permissible activities.
  - No consent required for equity interests acquired in exchange for repayment obligations for loans; if aggregate net value of such equity interests exceeds 50 percent of the bank’s equity capital, the bank must dispose of surplus shares within six months (extensions allowed in special circumstances).
  - Aggregate net value of such equity interests shall never exceed 50 percent of the bank’s equity capital.
  - Under Article 21 of the ACB Law, the NBG can set limits on individual banks regarding particular investment types and aggregate amounts.
  - Within the aggregate banking system, total amount of equity investments amounts to about 12 percent of aggregate regulatory capital or 2 percent of the aggregate total assets. This includes both banking and nonbanking investments. Only the three large banks hold investments.
- EC2 findings:
  - Neither law nor regulations set down the criteria the NBG applies when deciding on establishing subsidiaries or acquiring significant shares.
  - The NBG applies internal criteria (publicly disclosed in an article in its periodic journal), including:
    - size of the proposed investment (share of equity and materiality as proportion of regulatory capital);
    - nature of the investment (degree of control/significant influence and potential liability);
    - whether investment undertakes activities on behalf of or connected to bank activities;
    - business case for the investment;
    - risks to the bank and ability to identify, measure, control, and mitigate risks through senior management, systems and controls, and availability of capital, liquidity, and other resources;
    - bank’s ability to prevent the investment from engaging in activities not covered by permission;
    - prospective impact on bank’s ability to meet regulatory requirements;
    - availability to the NBG of full information about each investment;
    - whether the investment is located or operates outside Georgia;
    - amount and nature of the bank’s existing investments.
  - The NBG plans legislative amendments so criteria will have explicit statutory backing.
- EC3 findings:
  - No law, regulation, or internal criteria explicitly provides for:
    - NBG to determine whether new acquisitions/investments will hinder effective implementation of corrective action;
    - prohibition of banks making acquisitions/investments in countries with laws/regulations prohibiting information flows necessary for consolidated supervision;
    - considering effectiveness of supervision in the host country and NBG’s ability to exercise consolidated supervision.
  - In practice, acquisitions/investments by Georgian banks are miniscule. Only two major banks have cross-border interests; levels are not significant and planned for withdrawal in near future. Both investments are subject of MOUs with no impediment to obtaining information.
  - NBG monitors investment value based on consolidated financial statements; currently all investments are deducted from regulatory capital.
- EC4 findings:
  - NBG monitors as part of acquisition assessment:
    - bank’s ability to fund acquisition and impact on capital and regulatory requirements;
    - control function of the investee (senior management quality and systems and controls);
    - extent to which bank may be obliged to provide further financial support and impact on capital, liquidity, and other resources.
- EC5 findings:
  - Commercial banks are not permitted to establish or acquire subsidiaries engaged in nonfinancial business without NBG approval; permissible activities are defined and limited by authorization.
  - NBG strictly monitors banks’ ability to prevent investees from engaging in unauthorized activities.
  - Analyses are more comprehensive for nonfinancial investments; NBG assesses business case, risks posed, and bank’s ability to monitor, manage, and mitigate such risks, including reputation risk and subsidiary strategy/objectives.
  - Post-investment, performance and risks of nonbanking investments are periodically reviewed under group structure risk analysis, including interconnectedness and organizational complexity.
  - Currently all investments in subsidiaries are deducted from regulatory capital; when consolidated supervision is introduced, such investments will require capital cover instead of being deducted from capital.
- Assessment of Principle 7: Largely compliant.
- Comments and legal gaps:
  - NBG’s approach is conservative and investment levels are miniscule.
  - EC2: Criteria used by NBG to judge proposals are not statutorily based.
  - EC3: No explicit legal provisions for NBG to:
    - determine whether new acquisitions/investments will hinder effective implementation of corrective action;
    - prohibit acquisitions/investments in countries with laws/regulations prohibiting necessary information flows for consolidated supervision;
    - take into account effectiveness of supervision in host country and its own ability to exercise consolidated supervision.
  - While NBG would consider these issues in practice, explicit statutory requirements are desirable for transparency and clarity.

### Supervisory approach and GRAPE methodology (Principle 8, EC1)
- Principle summary: Supervisor must develop and maintain a forward-looking assessment of banks’ risk profiles, identify and address risks to banks and system, have early intervention framework, and plans for orderly resolution in partnership with other authorities.
- EC1 findings:
  - The NBG developed methodology GRAPE to assess banks and banking groups, enabling supervisors, with systemic relevance assessment, to form a view of a bank’s probability of failure and impact of failure.
  - GRAPE has not yet addressed resolvability of banks (see EC6).
  - Systemic relevance determination (by Financial Risk and Macro Prudential Policy Division) uses criteria and weights:
    - size (exposure, client deposit) with 55 percent weight;
    - interconnectedness (intra-financial system assets, intra-financial system liabilities; wholesale funding ratio) with 15 percent weight;
    - substitutability (number of branches, agro sector finance) with 25 percent weight;
    - complexity (equity finance) with 5 percent weight.
  - Banks are divided into five classes. Class 1 and 2 consists of, respectively, nine and six of the smallest banks. Class 3 consists of three medium-size banks. Class 1 and 2 consists of three systemic important banks that make up 65 percent of the total banking sector.
  - Currently NBG uses systemic relevance scores for information purposes; staff allocation for banking supervision and risk supervision is based on systemic relevance. NBG plans to develop a framework for domestic systemically important banks in near future.
  - GRAPE risk categories: credit risk, liquidity risk, market risk, operational risk, business model, profitability, macro-economic environment, group structure, and corporate governance. AML is dealt with separately (CP 29).
  - For each risk (except corporate governance), inherent risk, mitigants, and net risk are analyzed. Risk levels scored between one and five on a 0.5 interval. Moderate risk = score equal to three; relatively low risk = scores less than three; relatively high risk = scores more than three.
  - Weights are assigned to each risk category per bank; sum of weights must equal 100 percent. Basis for weights is average weight determined by Specialized Groups and Supervisory Policy Department and Banking Supervision Department.
  - Potential available capital resources (e.g., shareholder support) are analyzed. Combined with internal resources, NBG forms view on bank’s probability of failure and impact of failure.
  - Resolvability is not directly assessed separately, but through various risk assessments NBG forms view on resolvability given simple group structures, minor investments, and low outsourcing.
  - Organizational and task allocation:
    - Bank supervisors (Banking Supervision Department) are responsible for all risks of one bank.
    - Risk supervisors (Specialized Groups and Supervisory Policy Department) are responsible for one risk across banks, including system risk.
    - Work is allocated through task cards prepared by either bank or risk supervisors; reviewer role alternates for quality assurance. Manager and deputy manager approve task cards.
    - One bank can have up to 14 different task cards (credit risk – total, credit risk - corporate, credit risk – SME, credit risk – retail, liquidity risk, market risk, operational risk, business model, profitability, macro-economic, corporate governance, market conduct, group-structure, and total risk). There are also system-wide task cards for specific risks.
    - Each task card contains subtasks: pre-assessment risk identification program, risk assessment summary, post-assessment risk identification program, and risk mitigation program. Task cards have preparation and completion dates and are executed according to frequency.
    - Deadlines of RMP may lie beyond completion date of task card, sometimes freezing planning of next cycle until findings are addressed.
  - Supervisory plan:
    - Execution of task cards follows supervisory plan within cyclical and noncyclical tasks.
    - Supervisory plan is approved by heads of Banking Supervision Division, Specialized Groups and Supervisory Policy Division, the vice-governor and the governor.
    - Implementation in progress: not all task cards uploaded; not all staff planned according to new methodology due to other priorities. Approximately, 80 percent of the task cards are uploaded and explicitly planned according to new methodology.
  - NBG priorities and reporting:
    - Priority to formalize GRAPE documents through official approvals by Supervisory Steering Committee before ICAAP documents (due September 30, 2014) are presented.
    - Reports generated to support senior management include:
      - Risk profile of the bank (total and per risk);
      - Systemic risks;
      - Supervisory plan; and
      - Pending tasks (RIP, RMP).

*Italic: International Monetary Fund — GEORGIA (extracted from the source content).*

### 2010. Before 2010, supervisors were divided into on- and off-site teams and performed bank

### _cr1510 - 2010. Before 2010, supervisors were divided into on- and off-site teams and performed bank

### Supervisory approach (Principle 8; EC1–EC8)
- Transition from CAMEL to GRAPE:
  - Before 2010 supervisors were divided into on- and off-site teams and performed bank risk assessment based on CAMEL methodology.
  - For some small- and medium-size banks the NBG still uses CAMEL (one task card named "total risk assessment" based on CAMEL).
  - CAMEL scoring: supervisors assign scores between one and five on a 1.0 interval.
  - Dual methodology maintained to allow gradual transition; NBG intends to leave CAMEL in the near future (timing not specified).
  - Some supervisors use elements of GRAPE in analysis.
- Risk identification and task-card framework:
  - Work allocation: banking supervisors understand all risks of one bank; risk supervisors understand one risk across all banks.
  - Task cards (per bank or per risk) are prepared by bank or risk supervisors; reviewed by counterpart; approved by manager and deputy.
  - One bank can have 14 different task cards: credit risk – total, credit risk - corporate, credit risk – SME, credit risk – retail, liquidity risk, market risk, operational risk, business model, profitability, macro-economic environment (including stress testing), corporate governance, market conduct, group-structure, and total risk.
  - System-wide task cards exist for credit risk, liquidity risk, market risk, operational risk, profitability, macro economy, and market conduct.
  - Each task card composition: pre-assessment risk identification program, risk assessment summary, post-assessment risk identification program, and risk mitigation program. Every task card has a preparation date, a completion date, and a specified frequency.
  - RMP deadline can lie beyond completion date of total task card, sometimes freezing next-cycle planning until findings addressed.
- Forward-looking components:
  - Methodology components include business model analysis, stress tests, availability of capital, monitoring early warning indicators, and emphasis on risk management (root causes).
- Macroeconomic and cross-sectoral integration:
  - Financial Risk and Macro-Prudential Policy Division analyzes trends (business and credit cycles, international environment, exchange rate, real estate market, interest rates, and other key indicators), revises stress test parameters, runs macro stress tests.
  - Monthly report issued, discussed with Macro Economic Research Division, and shared with supervisors.
  - Specialized groups prepare system-wide reports incorporating macro-economic risks.
  - All financial institutions supervised by NBG except insurance companies; nonbanks supervised include microfinance organizations, credit unions, exchange bureaus, and money transfer offices.
  - Cooperation with insurance supervisor acknowledged as needing establishment; insurance supervisor separated from NBG in 2013.

### Resolvability and crisis framework (EC6–EC7)
- Resolvability:
  - NBG is the resolution authority.
  - No regulation/guidelines require banks to have resolvability plans.
  - Resolvability not assessed as a separate task; assessed via individual risk categories at a high level.
  - NBG view: simple group structures, minor investments, low outsourcing, ring-fencing of subsidiaries/branches and limited cross-border activity reduce resolvability concerns.
  - No detailed assessments identifying resolution barriers and measures; banks required to set up resolution plans but have not implemented them.
  - Four banks were required to set up resolution plans; implementation process has only recently started.
- Crisis handling:
  - NBG lacks an explicit framework/process for handling banks in times of stress to support orderly recovery or resolution.
  - NBG retains basic powers/tools for recovery/resolution.
  - A prompt corrective matrix was abolished in 2010.
  - In 2008 (war against Russia; global financial crisis) NBG applied a mix of recovery instruments; no major failures or orderly resolution/liquidation occurred.
- Assessment and recommendation summary:
  - Assessment of Principle 8: Largely compliant.
  - Key comments: resolvability assessment too high-level for systemic banks (EC1, EC6); no explicit framework for distressed banks (EC7); supervisory approach not fully implemented/formalized (80 percent implemented); insufficient contacts with insurance supervisor (EC2).
  - Recommendations:
    - Finish 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 to identify and mitigate barriers for resolution.
    - Consider doing a crisis simulation exercise.

### Supervisory techniques and tools (Principle 9; EC1–EC12)
- On-site / off-site mix and operational model:
  - Under new risk-based approach supervisors are not separated into on-site and off-site teams; both Banking Supervision Department and Specialized Groups undertake a mixture of on-site and off-site work.
  - Most work is done off-site; NBG can receive complete loan files via an e-line (online supervision).
  - NBG mostly visits on-site to assess IT/data accuracy and to assess liquidity, market, operational, and AML risks.
  - No mandated frequency for inspections; inspections undertaken based on supervisory judgment (risk, systemic relevance, date of last assessment).
- Supervisory cycle and planning:
  - Supervisory cycle: pre-assessment risk identification, risk assessment, post-assessment identification, and risk mitigation.
  - Corrective actions and recommendations communicated in risk-mitigation phase; post-assessment items carried forward.
  - NBG switched promptly to new risk-based framework; formalization followed later.
  - Decree on GRAPE elaborated; supporting software developed; seminars held; risk-assessment methodologies beyond CAMEL analyzed.
  - A coordinator of the supervisory plan (Deputy Head of Banking Supervision Department) periodically prepares reports for vice-governor; vice-governor approves total supervisory plan; tracking functions assigned to risk assessment software.
- Information, tools, and stress testing:
  - NBG uses prudential reports, ad-hoc information, public information, and cross-checks to determine reliability.
  - Tools include financial statement analysis, business model analysis, horizontal peer reviews, review of stress test outcomes, and corporate governance analysis.
  - Specialized teams perform regular stress testing; Financial Risk and Macro-Prudential Policy Division defines parameters, normally revised every six months.
- Internal audit and contacts:
  - NBG receives and reviews internal audit work; communication with heads of internal audit intensified since 2011, including individual and collective meetings.
  - NBG aims to strengthen internal audit through a new decree on internal audit functions.
  - Supervisors maintain frequent contacts with Boards, non-executive members, and management—intensive and ongoing; supervisors in touch almost daily.
  - Board assessments performed mostly through review of Board meeting minutes, correspondences, and inquiries; NBG plans to meet Boards at least every overall risk assessment phase.
- Follow-up, escalation, and information systems:
  - Risk-mitigation program has deadlines and responsible supervisors; one officer oversees planning process.
  - Currently 80 percent of all task cards are recorded in the supervisory information system.
  - Escalation process informal due to deputy governor's hands-on approach.
  - In-house information system provides common storage: FSA-Banks, FSA-Shares, and FSA-SGSP.
  - Reporting software aggregates bank financials for cross-sectional and time-series analysis.
- Assessment and recommendations:
  - Assessment of Principle 9: Compliant.
  - Positive highlights:
    - Supervisory cycle at individual risk level provides flexibility balanced by periodic stock-takes.
    - Balanced integration of bank and risk supervisors; clear responsibilities.
    - Powerful supervisory information system enabling online supervision and granular prudential returns.
    - Implementation of ICAAP in 2014 expected to enhance tools.
  - Noted risk: potential under-emphasis on on-site time affecting ability to sense risk culture.
  - Recommendations:
    - Consider integrating identification of risk culture in the supervisory approach and spending more time on-site to sense banks’ risk culture.
    - Consider greater use of formal letters rather than emails to communicate findings (traceability) (see EC 8).

### Supervisory reporting (Principle 10; EC1–EC12)
- Legal authority and reporting scope:
  - Legislation (Article 29 of ACB Law and Article 48(4) of NBG Law) provides NBG the right to request and receive information for solo and consolidated assessment; in practice prudential reporting is solo-based.
  - NBG is in process of introducing consolidated reporting; will introduce consolidated supervisory regime as from November 2014 (NBG will introduce a consolidated supervisory regime as from November 2014).
- Frequency and coverage:
  - Almost all returns are monthly; some liquidity/treasury reports received daily; operational risk report received annually.
  - Returns cover balance sheet, P&L, liquidity ratios, large exposures, related-party lending, asset quality, etc.
  - Banks prepare consolidated annual accounts based on IFRS.
- Reporting standards and valuation:
  - Prudential reporting currently based on local GAAP (devised in 2000 by NBG with Deloitte & Touche), closely aligned with IFRS; NBG plans to fully converge local GAAP with IFRS and introduce prudential filters.
  - Fair value usage limited; Georgian GAAP uses cost method for loans; real estate valuation monitored and revaluation reserves not part of regulatory capital.
  - Collateral valuation assessed using NBG professional appraiser in Specialized Groups and Supervisory Policy Department.
- Consolidation and group reporting:
  - Formal consolidated prudential reporting not yet implemented; large exposures are calculated on a consolidated basis; NBG has started calculating consolidated capital adequacy ratios for the two banks relevant for consolidated supervision.
  - Investments on banks' balance sheets represent 2 percent of total system assets and 12 percent of total regulatory capital as of December 2013.
- Powers and enforcement:
  - NBG has powers to request information from banks and group entities (Article 48 (4) NBG Law; Article 45 NBG Law).
  - ACB Law (Article 30) authorizes sanctions for late submission or incorrect reports.
  - In practice material errors require immediate correction; material or repeated errors can lead to more severe sanctions including removal of management.
- Verification and use of external experts:
  - NBG relies on on-site/off-site regime, assurance testing by Operational Risk and Information Processing Division, annual comparison between prudential reporting and IFRS-based annual accounts.
  - Although authorized to commission external experts, NBG has not in practice done so for supervisory tasks.
- Assessment:
  - Assessment of Principle 10: Largely compliant.
  - Comments: Absence of consolidated prudential reporting would normally be materially noncompliant but mitigants (planned consolidated regime from November 2014; small size of banking groups; consolidated calculations already for large exposures and some capital adequacy) justify largely compliant rating.

### Corrective and sanctioning powers (Principle 11; EC1–EC7, AC1–AC2)
- Early engagement and follow-up:
  - NBG raises concerns promptly with senior management and, when necessary, with Board or Supervisory Board.
  - Dialogue regime (emails, phone, meetings) is widely used; written instructions and periodic progress reports used for significant corrective measures.
- Range of supervisory tools (Article 30 LACB, September 2009):
  - Possible measures include: written warnings; special actions/instructions to cease practices and eliminate violations within a specified period; fines (not in excess of bank's own funds); require payment of fines if administrators caused loss; suspend signing authority or require dismissal of administrators; require special shareholders meetings; suspend or restrict asset growth, distribution of profits, dividends, bonuses, salary increases, and acceptance of deposits; suspend active operations and place the bank in Temporary Administration; revoke bank's license; request controlling persons to cease control.
  - In practice NBG mostly uses letters and emails; fines used for delayed reporting or AML violations (approximately GEL 500.000 in 2013).
  - Temporary administration has been used in some occasions.
- Powers regarding regulatory thresholds and interventions:
  - NBG can act when banks fall below regulatory thresholds; monitoring occurs on a forward-looking basis.
  - NBG can impose individual prudential ratios and other remedial measures.
- Sanctions on individuals:
  - Sanctions may be applied to banks and to management/Board/individuals (Article 14 LACB, Article 30 LACB; Regulation on Determining and Imposing Pecuniary Penalties Decree N242/01, 25 December 2009).
  - Example: failure to comply with internal control procedures under anti-money laundering law can result in administrator fined GEL 2,000.
- Ring-fencing and group measures:
  - NBG has full power to take ring-fencing measures and has used powers in practice.
  - All foreign bank branches/subsidiaries supervised like local institutions and subject to same prudential requirements.
  - Article 21 of LACB allows individual prudential requirements to assure ring-fencing.
- Resolution cooperation:
  - NBG is sole authority for resolution and liquidation; can appoint temporary administration and liquidator; temporary administrator and liquidator accountable toward NBG and may arrange resolution transactions.
- Assessment and recommendations:
  - Assessment of Principle 11: Largely compliant.
  - Comments: Abolition of prompt corrective action matrix in 2010 replaced by risk-based approach and dialogue; consider formal escalation and clearer escalation framework for prolonged deficiencies.
  - Recommendations:
    - Consider using an escalation framework for safety and soundness issues.
    - Consider whether NBG could have been more effective in addressing deficiencies that linger for a protracted period.
    - Initiate law or regulation giving NBG power to set individual risk governance requirements and to intervene in organizational structure/business model of a bank.

### Consolidated supervision (Principle 12; EC1–EC7, AC1)
- Current status and rationale:
  - No separate reporting forms for consolidated supervision; prudential reporting prepared on a solo basis; annual audited statements prepared on consolidated basis.
  - NBG plans to introduce consolidated supervision concept by June 2015 (expected in place by June 2015, with parallel runs in previous six months) and earlier note: expected to be ready by November 2014 in some sections.
  - Rationale: limited banking group activity; subsidiaries represent minor share: investments on balance sheets represent 2 percent of total system assets and 12 percent of total regulatory capital as of December 2013.
  - Only two main banks lend themselves to consolidated supervision; largest has investments less than 5 percent of its total balance sheet; one subsidiary in Belarus valued about 1 percent and an insurance company in Georgia about 1 percent; second bank owns a small Georgian bank (<10 percent its own size) and a microfinance unit in Azerbaijan (<1 percent).
- Group-structure risk assessment tools:
  - Information on shareholders and beneficial owners; intra-group and related-entity transactions; group-wide large exposures; monthly information on volumes of investments and inquiries on subsidiaries.
- Consolidated analysis and actions:
  - Formal consolidated prudential analyses currently annual; large exposures calculated on consolidated basis; NBG has calculated consolidated capital adequacy ratios for the two relevant banks (consolidated ratios higher since investments are deducted from capital on solo basis).
  - Under GRAPE, consolidated supervision is a risk category enabling corrective action if breach occurs.
- Powers and limits:
  - NBG can set limitations on investments (ownership of equity interests should not exceed 50 percent of bank's own equity; investments deducted from regulatory capital).
  - Approval required for nonfinancial subsidiaries holdings >20 percent of the equity of the target; lower thresholds for other sizes.
  - Power to close foreign offices not explicitly in legislation; Article 21(2) ABC Law allows restricting activities via prudential limits and norms.
- Assessment:
  - Assessment of Principle 12: Compliant.
  - Comments: Significant progress since prior FSAP where Principle rated Materially Noncompliant; main remaining weakness is absence of consolidated supervision reporting framework, but mitigated by minuscule group structures and planned implementation by November 2014/June 2015.

### Home-host relationships (Principle 13; EC1–EC10)
- Cross-border activity:
  - No Georgian bank has material cross-border operations; two major banks have small cross-border subsidiaries (largest: Belarus subsidiary ≈1 percent of parent's assets; second: nonbank subsidiary in Azerbaijan <1 percent).
  - About half of the 21 Georgian banks are foreign-owned; parents located in Germany, France, Turkey, Ukraine, Russia, Azerbaijan, and Kazakhstan.
- Supervisory colleges and MOUs:
  - No supervisory colleges established except participation in BAFIN college for ProCredit Bank.
  - NBG policy to establish MOUs with countries where parents are located or where banks have cross-border operations.
  - MOUs exist with: Azerbaijan; Armenia; Turkey; Belarus; Lithuania; Ukraine (currently securities-focused; banking MOU planned); Kazakhstan; Germany; Moldova; and Qatar.
  - NBG has not performed inspections of cross-border operations due to immateriality and risk-based approach; relies on annual audited consolidated financial statements and MOUs.
- Host requirements and access:
  - Subsidiaries and branches in Georgia subject to same regulatory and reporting requirements as domestic banks; branches required to maintain capital as if locally incorporated.
  - Article 29 of ACB Law provides inspectors/auditors (including home supervisors) access to branches/subsidiaries.
  - Shell banks prohibited under anti-money laundering law; booking/representative offices must register with NBG (only one such operation exists).
- Assessment:
  - Assessment of Principle 13: Compliant.
  - Comments: Cross-border banking activity insignificant; legislative framework for cooperation adequate and actions commensurate with activity level.

### Corporate governance (Principle 14; EC1–EC3, and related regulations)
- Legal and regulatory framework:
  - LACB requires two-tier governance: Supervisory Council (Supervisory Board) and Executive Management (Directors).
  - LACB articles:
    - Article 15.1: Directors in charge of daily governance.
    - Article 14.1: Supervisory Council ensures oversight; Supervisory Board elected by General Meeting of Shareholders (Article 13); Supervisory Board actions to be in bank's best interests and ensure independent, competent Directors and written policy.
    - Article 16: Audit Committee required; reports periodically to Supervisory Board and supports internal/external auditors.
  - Other relevant regulations:
    - Law of Georgia on Entrepreneurs (1994) sets corporate governance basics.
    - Regulation on Fit-and-Proper Criteria for Administrators of Commercial Banks (September 2002): detailed fit-and-proper criteria for senior management, chief accountants, and heads of branches; does not apply to Supervisory Board and audit committee members (draft new regulation extends scope).
    - Regulation on Conflict of Interests and Transactions between Bank Administrators and Related Parties (2001): mechanisms and prohibitions; NBG plans updates and drafting with IFC.
    - Regulation on Internal Audit Requirements for Commercial Banks (December 2011): internal audit requirements; draft update would require regulatory approval for appointment/dismissal of internal audit heads and audit committee members.
    - Regulation on External Audit of Commercial Banks (2010): annual financial statements audited in accordance with IFRS.
    - Regulation on Risk Management in Commercial Banks (2008): sets principles across risk types; practical implementation difficult; some provisions applied case-by-case.
    - Regulation on Transparency of a Commercial Bank Financial Condition (2006): requires IFRS financial statements, ratios, list of shareholders owning 1 percent, beneficiaries with 5 percent or more; NBG preparing amendments for Pillar III.
  - LACB Article 19 permits international practice where NBG has not issued detailed regulations.
- Supervisory assessment and implementation:
  - NBG evaluates corporate governance as part of overall risk profile using GRAPE; criteria include composition, committees, remuneration, internal control, and risk management.
  - Assessments use internal policy review, interviews, and documentation; NBG communicating sound practice expectations to banks.
  - NBG intensifying corporate governance requirements; ICAAP expected to further the process.
- Board composition and nomination:
  - LACB Article 14: Supervisory Board should have odd number of members, at least three and at most 21; majority should be non-executive.
  - NBG determines governance structures/processes for nominating and appointing Board members are appropriate.
- Assessment highlights:
  - Corporate governance expectations set across legislation, regulations, and a Corporate Governance Code (Association of Banks of Georgia, 2009, 11 banks signatories).
  - NBG working to address gaps (fit-and-proper scope, internal audit independence, related-party transaction governance, enhanced transparency).
  - Assessments are commensurate with risk profile and systemic importance; deficiencies prompt recommendations or corrective actions.

*Italic: Content derived solely from the source PDF _cr1510 as provided.*

### part in making decisions on issues related with supervision of Directorate (executive bodies)

### _cr1510 - part in making decisions on issues related with supervision of Directorate (executive bodies)

### EC4 — Board members are suitably qualified, effective, and exercise their “duty of care” and “duty of loyalty.”
- The NBG monitors that Board members are qualified and exercise duties of care and loyalty through individual risk category assessments and corporate governance assessment of bank.
- Paragraph 2 of Article 4 of the LACB: “Members of the bank's Supervisory Board shall conduct the bank's activities in an honest manner and shall exercise their duty of care in the same manner that a reasonable person in the same position and under the same circumstances would exercise, always keeping in mind the stability and best interests of the bank. Members of the Supervisory Council failing to fulfill this responsibility shall be jointly held liable for losses incurred by the bank.”
- The NBG would take corrective actions when it observes that the Board members do not exercise duty of care and loyalty.
- In practice, Boards of the largest banks are composed of non-executive members and are, overall, qualified and independent of ownership and the management function allowing for well-defined roles and responsibilities.
- Fit-and-proper requirements for members of the Supervisory Board are set by legislation. (See for details CP 4 Licensing criteria (EC 7).)

### Board composition and committees
- The law does not directly require the establishment of Board committees except for the Audit Committee (LACB article 16).
- The NBG analyzes how various Board functions are distributed among members, when there are committees in place, and how effective they are.
- Some banks have other Board level committees such as a Remuneration Committee, Risk Committee, and a Nomination Committee.
- Audit Committee:
  - Audit committee membership is composed by independent members (as defined by Law, article 16 LACB) and have a reporting line to a bank’s Supervisory Board.
  - Legally, audit committee members are not held to the same accountability standards as Supervisory Board members.
  - The NBG allows banks to have the same members at Board and audit committee as well in line with its view.
- See CP 15 EC 10 Risk management with regard to risk committee.

### EC5 — Board approves and oversees strategic direction, risk appetite and related policies
- Article 14 of the LACB: the Supervisory Board shall ensure establishment of the commercial bank's business strategy, and formulate in writing the bank's policy governing credit, investment, foreign exchange, assets and liabilities management, assets' evaluation, and their classification and establishment of adequate reserves for loan losses.
- The Regulation on Risk Management in Commercial Banks defines general responsibilities and duties of the Supervisory Board regarding approval of the bank’s risk strategy.
- The NBG assesses:
  - whether banks develop strategy and risk appetite documents;
  - the respective Board role in development of such documents;
  - the extent of the Board’s involvement in supervising executive functions;
  - what reporting is submitted to the Board.
- The NBG has access to all the minutes of Board meetings and makes observations through dialogue with key personnel; it sometimes meets with Boards and in certain instances attends Supervisory Board meetings; the NBG plans to intensify its contact with Supervisory Boards in future.
- The NBG actively monitors the Board’s role in governing conflicts of interest policies and procedures.
  - “Regulation on Conflict of Interests and Transactions Between Bank Administrators and Related Parties” Article 1: “In order to avoid conflict of interests and to cease self-serving and abusive practices, as well as other breaches of fiduciary duties by bank administrators, each commercial bank shall establish, either in its corporate By-Laws or in a Code of Conduct (which is approved by the Supervisory Council) policies and procedures concerning the administrator activities. These policies and procedures would protect and promote good governance of banks and identify and prevent conflict of interests and improper actions.”
- In practice, the banks’ Boards seem to be less involved in setting and overseeing the risk appetite.

### EC6 — Fit-and-proper standards, succession, and oversight of senior management
- The NBG monitors processes in banks for appointing senior management and inquires how new managers were selected and appointed; in some cases conducts interviews with candidates and has rejected approval of candidates to positions.
- The NBG observes whether Supervisory Boards establish performance criteria for Board members and whether succession plans are in place.
- “Regulation on Fit-and-proper Criteria for Administrators (article 1(8))” obliges the Supervisory Board to appoint a person who meets the fit-and-proper criteria; commercial banks are obliged to define in internal regulations fit-and-proper criteria for bank administrators.
- Supervisory Boards must submit the following information to the NBG when appointing administrators:
  - A written statement of the bank’s Supervisory Board with respect to the bank’s Board of Directors, and the written statement of the Board of Directors with respect to the other administrators that they have examined the information regarding the administrator, and he/she is in compliance with the established fit-and-proper criteria, and that the information submitted by them is truthful and accurate.
  - A written statement of the administrator that he/she fully meets the requirements of the fit-and-proper criteria established by this Regulation, and that the information provided by him/her is truthful and accurate.
  - A copy of the document certifying the administrator’s university education.
  - Information certifying the administrator’s qualification and professional experience (revised staff recording document as of appointment date, an extract from the work-book and-or other documents confirming previous places of employment).
  - Information about debts of the administrator.
  - Two recommendation letters (issued by persons, with whom this person worked).
  - Criminal record for residents issued by the Ministry of Internal Affairs, and for nonresidents – by relevant legal authority.

### EC7 — Board oversight of compensation systems and alignment with prudent risk taking
- The NBG assesses corporate governance and how the Board oversees compensation systems as part of the GRAPE risk assessment methodology and follows FSB guidelines in such assessments.
- Banks in Georgia have:
  - fixed salaries and premiums;
  - performance based variable bonuses, some of which are deferred and could include share premiums.
- Variable bonuses include elements of growth and asset quality for both sales officers and credit risk managers; according to the NBG these elements are in balance for both sales officers and credit risk managers.
- The NBG continues individual system assessments and plans supervisory actions case-by-case if necessary:
  - One year deferrals in some cases do not suffice to catch the quality of assets.
  - Some risk and internal control functions are underpaid relative to sector averages, which hinder effective governance.
- The NBG considers that there is greater room for employing diversified compensation schemes to better adjust them to risk and promote long-run performance measures.
- The NBG plans to further intensify oversight over remuneration practice and recently submitted updated reporting requirements on remuneration practice to commercial banks.
- Disclosure of remuneration policies and figures would form part of transparency regulation.

### EC8 — Board and senior management understanding of operational structure and risks
- The NBG from time to time performs meetings with Supervisory Boards to check whether the Board understands operational structures and risks.
- Through ongoing monitoring of the minutes of the Supervisory Board meetings, the NBG can draw understanding on matters of interest.

*Source: _cr1510 - part in making decisions on issues related with supervision of Directorate (executive bodies).*

### conclusions on the Board’s recommendations and actions related to enhancing governance

### conclusions on the Board’s recommendations and actions related to enhancing governance

### EC9 — Supervisor power to require changes in Board composition
- There is no direct and explicit power of the NBG stated in the regulation regarding the ability to require change of the Supervisory Board members; however, such power is implicitly in place.
- Legal bases for NBG action:
  - If a Board member is considered to have a lack of relevant education as per article 41 of LACB, the NBG would require his/her dismissal.
  - If a Board member violates requirements of the legislation, the NBG can suspend the signing authority of the bank's administrators and require the bank's Supervisory Board to dismiss him/her temporarily or permanently (Article 30 of the LACB).
  - Article 4 of the Regulation on Conflicts of Interest states the NBG has the right to require the immediate removal from the Supervisory Board, or the Board of Directors, of any employee or any administrator who, in the documented judgment of the national bank, has violated the regulation of conflicts of interests.
- Practice:
  - The NBG applies such implicit powers in practice, although such cases are very limited.

### AC1 — Notification requirements on fitness and propriety
- Laws/regulations do not require banks to notify the supervisor as soon as they become aware of material and bona fide information affecting fitness and propriety of a Board or senior management member.
- Relevant provisions and practice:
  - Regulation on fit-and-proper criteria (Article 1 sub 7) requires dismissal of any administrator that fails to meet fit-and-proper criteria by decision of the Supervisory Board or Board of Directors.
  - The NBG promptly learns about dismissals of Board members.
  - Supervisory teams update information on Board members and management through different public sources.
  - The NBG has elaborated standard reporting forms on the members of the main governance functions; banks would periodically update information on all administrators.

### Assessment of Principle 14 — Corporate governance
- Overall assessment: Largely compliant
- Key comments and identified areas for improvement:
  - The Board seems to be less involved in setting and overseeing the risk appetite. (See EC5.)
  - Conflict between law and regulation on whether a Director can (LACB 14.1) or can’t (RFP Article 2) be a member of the Supervisory Board; NBG states such practice is very rare and Directors are restricted where participation creates conflict of interest. (See EC1.)
  - Audit Committee exists 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 establishment as subcommittees. (See EC3.)
  - NBG does not have explicit power to change Board composition, but has implicit powers to require dismissal under LACB article 30.3e and article 41. (See EC9.)
- Recommendations:
  - Increase Board involvement in setting and overseeing risk appetite.
  - Align legislation and regulation regarding the role of Directors in a Supervisory Board.
  - Consider making an overseeing risk committee and remuneration committee required by law or regulation.
  - Consider stimulating the sector to make the Supervisory Committee directly responsible for the Audit Committee.
  - Consider initiating a law that gives the power to change the composition of a Board.
- Note: Some findings are also based on assessment of bank governance by the World Bank conducted in May 2014 as part of the FSAP.

### Principle 15 — Risk management process (overview and material conclusion)
- Principle definition (summary): Supervisor determines banks have comprehensive risk-management process (Board and senior management oversight) for identifying, measuring, evaluating, monitoring, reporting, and controlling/mitigating all material risks; assessing adequacy of capital and liquidity; developing contingency arrangements; commensurate with bank risk profile and systemic importance.
- Overall assessment: Materially noncompliant
- General comment: NBG has made significant progress and follows an intrusive, forward-looking, risk-based approach, but several essential criteria are not yet fully met for large, medium, and small banks (EC 1, 2, 5, 7, 9, 12, 13, and 14). Implementation of Basel II/III (Pillar 2) is central to further progress. Caution: the intrusive supervisory approach risks replacing banks’ own risk management in some instances.

### EC1 — Board-approved risk management strategies and risk appetite
- NBG staff assesses inherent risk and mitigants (quality of Supervisory Board, Senior Management, Internal Controls & Systems).
- No direct requirement for Boards to issue a statement on risk appetite; Article 14 of LACB requires Supervisory Boards to ensure establishment of business strategy and approve internal policies governing credit, investment, foreign exchange, assets and liabilities management, assets' evaluation, classification, and loan-loss reserves.
- NBG Regulation on Risk Management in Commercial Banks defines general Supervisory Board responsibilities regarding approval of risk strategy.
- Culture of written risk-appetite policies is not yet established, but most Supervisory Boards demonstrate participation.
- Sources used by NBG: inspections, regulatory reporting, Supervisory Board minutes (required to be sent to supervisor), internal audit reports.
- Basel II/III Pillar 2 guidelines distributed; ICAAP expected to describe Board involvement.

### EC2 — Comprehensive bank-wide risk-management policies and processes
- LACB article 14 and multiple regulations require policies for credit, investment, FX, ALM, asset evaluation/classification, reserves.
- Relevant regulations listed include:
  - Regulation on Calculating and Maintaining Overall Open Foreign Exchange Position Limit of Commercial Banks.
  - Regulation on Supervision and Regulation of the Activities of Commercial Banks (prudential ratios including liquidity ratio).
  - Regulation on Credit Concentration and Large Risks in Commercial Banks.
  - Regulation on Conflict of Interests and Transactions Between Bank Administrators and Related Parties.
  - Regulation on Assets Classification and Loan Loss Provisioning by Commercial Banks.
  - Regulation on operational risk recently approved after the FSAP mission.
- Regulation on Risk Management in Commercial Banks (2008) was detailed and difficult initially; NBG adopted a more gradual/dialogue approach.
- Capital adequacy regulation enforced in 2013 requires effective governance and under Pillar 2 banks identify all material risks and SREP processes are Basel-based.
- Banks to submit ICAAP documents in 2014; dialogue regarding ICAAP has started.

### EC3 — Documentation, review, communication, and exception handling
- NBG determines that strategies, policies, processes, and limits are documented and assesses compliance via individual risk assessments, governance reviews, minutes, and interviews.

### EC4 — Board and senior management understanding of risks and relation to capital/liquidity
- NBG holds intensive meetings and dialogue with bank personnel; assesses soundness of risk estimation and projected losses.
- NBG can impose additional individual capital and liquidity requirements under LACB.
- ICAAP/ILAAP implementation will require banks to calculate capital and liquidity levels aligned with business and risk profiles; assessment of Board understanding will form part of SREP; poor practices may lead to higher capital requirements.

### EC5 — Internal processes for assessing capital and liquidity adequacy; supervisory review
- NBG assesses adequacy of banks’ capital and liquidity relative to risk appetite and profile and can impose incremental capital requirements.
- No direct legislative requirement yet for banks to perform internal capital adequacy (ICAAP) or liquidity adequacy (ILAAP) processes; mitigated by conservative capital and liquidity levels relative to Basel minima.
- Banks adjust capital levels in response to changing risk profiles in many instances.
- As of September 30, 2014, banks will be required to submit their first ICAAP as part of pillar 2 implementation.
  - First ICAAP components: analysis of individual risk categories against capital, future capital, planning, and stress test.
  - So far, only one bank submitted comprehensive documentation; consultations with draft documents received and NBG held meetings with four other banks.

### EC6 — Use and validation of models
- Few banks in Georgia use internal risk models; where they exist they are of limited sophistication.
- Supervisors analyze internal models (e.g., interest rate risk), challenge model validation and management judgment.
- With Basel II/III Pillar II, higher quality internal models are expected; NBG will facilitate adoption where banks have resources and will monitor in Pillar II review.
- For small banks lacking sophistication, NBG expects simpler approach: start from Pillar 1 requirements and adjust for Pillar 2 risks and governance/system weaknesses.

### EC7 — Information systems for risk measurement and reporting
- NBG assesses information systems adequacy in each risk category assessment; analyzes reporting capabilities and reporting lines.
- Operational Risk and Information Processing Division assesses information systems complexity and provides guidance on information security and report-generation ability.
- Regulation on Operational Risk Management by Commercial Banks (adopted after FSAP) requires banks to have information systems commensurate with size/complexity.
- Basel II/III approval processes will rely significantly on sound information systems (ICAAP/ILAAP); such processes/reports are not yet fully in place.

### EC8 — Policies for new products and major initiatives
- Banks usually submit information to NBG on every new product, including business processes, risk assessments, capital implications, risk monitoring/mitigation, pricing, budget forecast, and accounting procedures; quality varies.
- Consumer Protection Division actively monitors new retail products; NBG also tracks product launches in the press.
- Major decisions are generally subject to Supervisory Board approval per banks’ internal guidelines; simple marketing/sales modifications pass through Directorates.

### EC9 — Risk management function resources, independence, and segregation
- NBG assesses adequacy of risk function coverage and segregation during individual risk assessments and governance reviews.
- Observed model in many banks: risk management function and CRO are not fully independent — CRO and credit risk managers often have voting authority in credit committees; no obvious independent second-level surveillance of internal credit ratings.
- Several banks have remuneration policies for credit risk management that incentivize growth and speed, which could provide undesirable incentives.
- Finding corroborated by World Bank governance assessment in May 2014 (FSAP).

### EC10 — CRO requirement for large and complex banks
- Having a CRO is not a formal legal requirement in Georgia, but NBG expects large banks to have CROs.
- All large and complex banks have a dedicated Risk Management Unit overseen by a CRO.
- In practice, liquidity and interest rate risks are often supervised by the CFO rather than the CRO; credit risk is primarily governed by the CRO.
- Boards, especially in largest banks, possess good operational knowledge and have recently established risk committees focused largely on credit risk and large transactions; need to elevate focus to aggregate risk profile, defining risk appetite, and interacting with CRO and Internal Audit.

### EC11 — Standards for credit, market, liquidity, IRRBB, and operational risk
- Credit risk:
  - Regulation on Credit Concentration and Large Risks focuses on large exposures; other gaps addressed under Pillar 2.
  - Regulation on Assets Classification and Loan Loss Provisioning requires written policies aligned with international standards.
  - Regulation on refinancing developed and implemented after FSAP; NBG enacted guidelines on country and transfer risk (May 2014).
- Market risk:
  - Regulation on Calculating and Maintaining Overall Open Foreign Exchange Position Limit prescribes FX position calculation and limits.
  - Trading book regulation defines classification rules and minimum internal standards.
- Liquidity risk:
  - Regulation on Supervision and Regulation of the Activities of Commercial Banks prescribes liquidity ratio and calculation rules.
  - Draft regulation of LCR elaborated based on Basel guidelines; approval under way.
  - NBG has required LCR reporting from commercial banks since 2011.
- Interest Rate Risk in the Banking Book:
  - Incorporated to some extent in risk-based pricing guidelines and stress testing.
- Operational risk:
  - Commercial banks submit monthly operational risk reports based on Basel standardized approach categories.
  - Regulation on Operational Risk Management by Commercial Banks (recently adopted after FSAP) requires operational risk frameworks, information systems, business continuity management, outsourcing standards, defines Supervisory Board/Directorate roles, grants NBG authority to require corrective actions, and requires disclosure of operational risk management frameworks.

### EC12 — Contingency arrangements and recovery plans
- No regulatory requirements for contingency planning at present.
- NBG has evaluated contingency funding plans and their quality for liquidity risk.
- NBG assesses operational risk contingency arrangements (business continuity, disaster recovery).
- Capital contingency plans are being assessed under overall risk assessment but are not yet documented in practice; expected to be incorporated in ICAAP documents.

### EC13 — Stress testing programs
- Stress testing in Georgian banks often limited to credit, liquidity, and interest rate risk.
- NBG promotes enterprise-wide stress testing, assessing impacts across credit, liquidity, market, profitability, and feedback effects.
- Stress scenarios should include systemic, sectoral, and idiosyncratic shocks; key parameters: GDP (and sectoral distribution), household income, unemployment, exchange rate, immovable property prices, interest rates, consumer prices.
- Where statistical time-series are lacking, transaction-level analysis is used.
- NBG expects banks to implement stress-testing frameworks by year-end as part of ICAAP; first ICAAP versions due September 30, 2014.
- Challenge: ensure banks use stress testing to inform risk governance and enable Supervisory Boards to judge capital/resource adequacy under stress; adoption especially challenging for smaller banks.

### EC14 — Risk-based internal pricing and new product approval integration
- Pricing models are assessed by supervisory and financial risk/macroprudential teams under business model and profitability assessment.
- NBG raises concerns with banks and has distributed guidelines on risk-based pricing.

### AC1 (additional) — Policies for other material risks (reputational, strategic)
- Included as part of Pillar II requirements of the new Capital Adequacy Regulation.
- First versions of ICAAP are to be submitted by September 30, 2014.

### Summary of material deficiencies and expected reforms
- Essential criteria not yet fully met: EC 1, 2, 5, 7, 9, 12, 13, and 14.
- Key reform drivers:
  - Implementation of Basel II/III, particularly Pillar 2 (ICAAP/ILAAP) and associated SREP practices.
  - Strengthening Board involvement in risk appetite and aggregate risk oversight.
  - Enhancing independence and second-level surveillance of risk management functions.
  - Formalizing contingency planning and enterprise-wide stress testing.
  - Improving information systems and reporting to support ICAAP/ILAAP and model validation.

*Source: _cr1510 - conclusions on the Board’s recommendations and actions related to enhancing governance*

### 2014. A few banks have already submitted their first draft of their ICAAP. In addition, the NBG

### _cr1510 - 2014. A few banks have already submitted their first draft of their ICAAP. In addition, the NBG

### Implementation of ICAAP, SREP, contingency planning, and stress testing
- A few banks have already submitted their first draft of their ICAAP.
- The NBG has not yet developed guidelines for how to determine the adequacy of the ICAAP in the so called SREP.
- The NBG is required to require banks to have appropriate contingency arrangement (EC 12) and forward looking stress tests (EC 13), but these requirements have not yet been fully implemented by all banks.
- Only the largest banks have capital and liquidity contingency plans (which need further enhancements according to NBG).
- Only 7 out of 21 banks have business continuity plans.
- Not all banks conduct adequate stress tests yet. The 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, internal pricing, and segregation of functions
- The NBG is required to determine the internal pricing of banks (EC 14).
- The NBG requires banks to have comprehensive risk management policies and procedures for all material risks (EC 2).
- Several areas are not yet required by NBG or implemented by banks:
  - Requirements for concentration risk other than large exposures will be implemented with the implementation of Basel II (see CP 19).
  - Identification of economic interdependence should yet be implemented (see CP 19).
  - Country and transfer risk guidelines are not yet implemented by banks (see CP 21).
  - Interest rate risk is not fully taken into account; one systemically relevant bank has a material interest rate risk position without an internal limit (see CP 23).
  - Most banks lack outsourcing policies and do not take local outsourcing into account (see CP 25).
- The NBG is required to determine that the risk management function is clearly segregated from the risk-taking function.
  - Assessment of bank governance in May 2014 by the World Bank observed that the credit risk management function is involved in the credit approval process (see EC 9).
  - Several banks have remuneration policies for their credit risk management which combine elements of growth, volume of analysis, and quality of the loan portfolio.

### Recommendations (as stated)
- Make sure that banks express their risk appetite for the different risk categories.
- Continue implementing Basel II including IAAP, contingency planning, stress testing and SREP.
- Continue implementing the different regulation and guidelines (see CP 17–25).
- Determine the internal pricing of all banks.
- Consider evaluating the role and independence of CRO and (credit) risk management, including the incentive structure.

### Principle 16 — Capital adequacy (overview)
- The supervisor sets prudent and appropriate capital adequacy requirements that reflect risks undertaken by a bank in its market and macroeconomic context.
- Supervisor defines components of capital, bearing in mind their ability to absorb losses.
- At least for internationally active banks, capital requirements are not less than the applicable Basel standards.

### Essential criteria EC1 — Laws, regulations, or the supervisor
- Laws, regulations, or the supervisor require banks to calculate and consistently observe prescribed capital requirements, including thresholds by reference to which a bank might be subject to supervisory action.
- Laws, regulations, or the supervisor define the qualifying components of capital, ensuring emphasis on elements permanently available to absorb losses on a going concern basis.

### Description and findings re EC1 — legal and regulatory authorities
- The banking sector in Georgia is in the process of transition from Basel I to Basel II and III.
- OLNBG, the LACB, and the RCAR give the NBG the authority to prescribe capital requirements and define qualifying components of capital that might be subject to supervisory action.
- Specific statutory provisions (as stated):
  - OLNBG article 49.3: NBG authorized to set minimum capital and rule of its calculation.
  - OLNBG article 49.1d: NBG authorized to prohibit dividend payment, to require additional capital and increase reserve for losses.
  - LACB article 9: NBG periodically defines minimum required amount of reserves, issued capital and regulatory capital and the rules for their creation.
  - LACB articles 19 and 21: require banks to maintain adequate capital in accordance with regulations issued by the NBG.
  - LACB article 30: NBG authorized to impose actions and sanctions if a bank violates any provision of the LOCB or of any regulation, instruction, rule, decree, order or written guidelines of the NBG.
  - RCAR article 9.1: if banks fail to comply with requirements the NBG shall apply actions and sanctions.
  - RCAR article 9.2: NBG shall demand (and review) recapitalization plan, set special requirements and limitations for capital reduction and for carrying out the necessary measures for capital increase.
  - NBG article 9.3: NBG authorized to revoke banking license if tier 1 and regulatory capital ratios equal or are less than 3 percent and 5 percent; or if regulatory capital is less than minimum amount of regulatory capital set by the NBG.
  - Minimum requirement of regulatory capital is GEL 12 million (RDMCR article 1).

### Current regulation on minimum capital requirements (RCAR 2008) — Basel I compliance
- Tier 1 capital ratio (tier 1 to risk-weighted assets) should be no less than 8 percent of the risk-weighted assets (RCAR 2008, article 5).
- Regulatory capital ratio (regulatory capital to risk-weighted assets) should be no less than 12 percent of risk-weighted assets (RCAR 2008, article 7).
- The NBG required some banks with a higher risk profile to have a regulatory capital of up to 24 percent.
- In practice, the average regulatory capital ratio of the banking sector end 2013 is 17.2 percent and average tier 1 ratio of 13 percent.
- Regulatory capital consists of tier 1 and tier 2 capital less deductions (RCAR article 4.3).
- Tier 1 capital components and deductions (RCAR articles 4.6–4.7) and Tier 2 components and limits (RCAR Article 4.8) are defined (details in RCAR 2008).
- Tier 1 shall be no less than 50 percent of regulatory capital (RCAR article 4.10).
- The tier 1 to regulatory capital ratio for the banking sector is 75 percent (end-2013).

### Risk weights and treatment under RCAR 2008 (Basel I style)
- Risk-weighted assets = sum of credit risk-weighted assets and market weighted assets less proportion of general reserves and special reserves (RCAR 2008, article 5.4).
- Asset risk-weight categories (as listed):
  - Assets weighted at zero percent credit risk include: Cash in GEL en currencies of OECD countries; Balances on correspondent and reserve accounts in the NBG; Claims guaranteed by NBG; Claims guaranteed by central governments and/or central banks of OECD countries; Claims secured by deposits pledged in the same bank.
  - Assets weighted at 20 percent credit risk include: Cash equivalent in GEL or currencies of OECD countries; Claims guaranteed by resident banks of OECD countries; Treasury bills (and claims guaranteed by treasury bills) issued by Ministry of Finance of Georgia; Claims secured by deposits in resident banks of OECD countries; Claims guaranteed by international financial institutions (see article 2); Gold or claims guaranteed by gold, which meet international standard.
  - Assets weighted at 50 percent credit risk include: Cash and cash equivalent in currencies of non-OECD countries; Claims guaranteed by resident banks of Georgia; Short term claims guaranteed by resident banks of non-OECD countries; Claims secured by debt securities issued by Ministry of Finance of Georgia; Claims guaranteed by the local government of Georgia, and OECD countries or by debt securities issued by the local government of Georgia and OECD countries.
  - Assets weighted at 100 percent credit risk include: Claims guaranteed by government and central banks of non-OECD countries or guaranteed by debt securities issued by government of government and central bank of non-OECD countries; Long-term claims guaranteed by resident bank of non-OECD countries; Corporate debt securities, investment in legal entities, gold (which not meet international standard), and fixed assets; Loans not reflected in category 20 percent and 50 percent.
- Off balance sheet items: different financial contracts are weighted between 0.5 and 5 percent (interest and FX); different commitments are weighted between 0 and 100 percent depending on their risk profile.
- Market risk-weighted assets defined as foreign exchange risk only; foreign exchange risk-weighted assets are weighted 75 percent (additional to the credit risk weights). This percentage is used as a countercyclical instrument and varies between 0–100 percent.

### Updated regulation (RCAR 2013) — Basel II and III alignment
- Capital ratios (see also minimum requirement in transition period):
  - Common Equity Tier 1 Capital ratio (Common Equity Tier 1 to risk-weighted exposures) is required to be 7 percent (RCAR 2013, article 8.1a).
  - Tier 1 Capital ratio (Tier 1 to risk-weighted exposures) is required to be 8.5 percent (RCAR 2013, article 8.1b).
  - Regulatory Capital ratio (Regulatory Capital to risk-weighted exposures) is required to be 10.5 percent, including a conservation buffer of 2.5 percent (RCAR 2013, article 8.1c).
    - At a later stage, the NBG will segregate the conservation buffer from the regulatory capital ratio by defining the minimum ratio at 8 percent.
  - There is no requirement for a countercyclical buffer, but an additional risk weight of 75 percent for currency-induced credit risk (CICR), which the NBG has been using historically, works as a countercyclical buffer. The NBG plans to decrease the risk weight for CICR and introduce a countercyclical buffer in a later stage. This buffer will range between zero percent and 2.5 percent based on the credit cycle.
  - There is no requirement for a buffer for domestic systemically important banks. At a later stage, the NBG is planning to introduce a framework for dealing with systemically important banks in line with Basel guidelines.
- Qualifying capital components (RCAR 2013):
  - Regulatory capital consist of the sum of Tier 1 capital and Tier 2 capital. Tier 1 capital is going concern capital and consists of common equity tier 1 and additional elements (RCAR 2013, article 3).
  - Common Equity Tier 1 Capital consists of paid in common shares (inclusive premium) and retained profits (see details in RCAR 2013, articles 4 and 28).
  - Additional Tier 1 Capital is equal to Additional Tier 1 Capital components less regulatory adjustments (see details in RCAR 2013, article 5 and 29 and articles 5 and 7).
  - Tier 2 capital consists of Tier 2 Capital components less regulatory adjustments (see details in RCAR 2013, articles 6 and 7).
  - Regulatory adjustments include deductions such as investment in the common shares of unconsolidated banks for the amount above 10 percent of the investment (if the total of all holdings exceeds 10 percent of the bank’s common equity) (RCAR 2013, article 7).

### Pillar 1 — Credit risk (RCAR 2013)
- Banks can only apply a standardized approach according to Basel II.
- The following risk weights are used for different exposures and different credit quality steps, according to Basel II (see details in RCAR 2013 articles 10-14 and articles 32-49). Some risk weights are higher than Basel prescribes.
- Table on Risk Weights per Exposure and Credit Quality Step (in percent) — horizontal: credit quality steps; vertical: exposures
  - Horizontal credit quality steps: 1, 2, 3, 4, 5, 6
  - Vertical exposures:
    1. central government and central bank
    2. regional and local government
    3. banks > 3 months
    4. banks <= 3 months
    5. corporates > 3 months
    6. corporates <= 3 months
  - Table entries (each cell given in percent exactly as in source):
    - Row 1: 0, 20, 50, 100, 100, 150
    - Row 2: 20, 50, 100, 100, 100, 150
    - Row 3: 20, 50, 50, 100, 100, 150
    - Row 4: 20, 20, 20, 50, 50, 150
    - Row 5: 20, 50, 100, 100, 150, 150
    - Row 6: 20, 50, 100, 150, 150, 150
    - Row 7: 20, 50, 100, 100, 150, 150

*GEORGIA — INTERNATIONAL MONETARY FUND*

### 7. collective investment undertaking.

### 7. collective investment undertaking.

### Risk weights and treatment under updated regulation (RCAR 2013)
- Unrated exposures:
  - Georgian government paper in GEL: risk weight of zero percent.
  - Banks: risk weight of 50 percent (unless risk weight of its sovereign is higher).
  - Corporates: risk weight of 100 percent (unless the risk weights of its sovereign is higher).
  - Note: This is applicable to most parts of the corporate portfolio since they are not rated.
- Exposures fully secured by residential property (after assessment by NBG): risk weight of 35 percent (RCAR 2013, article 38). Comment: a release compared to the Basel I based approach (100 percent).
- Retail exposures that comply with certain criteria (after assessment by NBG): risk weight of 75 percent (RCAR 2013, article 39). Comment: a release compared to the Basel I based approach (100 percent).
- Off balance sheet contracts (interest, foreign exchange): weighted depending on maturity between 0.5 percent and 5 percent.
- Past due loans (> 90 days):
  - Weighted 150 percent when a specific provision is less than 20 percent of the outstanding amount of the loan.
  - Weighted 100 percent when specific provisioning is no less than 20 percent.
- Transitional permission: Banks may ask NBG permission to weigh all exposures at 100 percent until December 31, 2014. Seven banks have asked permission.

### Credit risk mitigation, operational and market risk
- Credit risk mitigation: applied for funded and unfunded instruments (see RCAR 2013, articles 51–59).
- Operational risk: banks may use basic indicator approach or standardized approach. Impact: higher capital requirement.
- Market risk: exposures subject to currency induced credit risk shall be assigned a risk weight of 75 percent (on top of credit risk weight).

### Pillar 2 and Pillar 3 requirements and supervisory processes
- Pillar 2:
  - Banks required to have an Internal Capital Adequacy Assessment Process (ICAAP) and have enough capital to cover relevant risks (RCAR 2013, article 23).
  - NBG will evaluate ICAAP through a SREP (RCAR 2013, article 24). Details on conducting SREP planned before September 2014.
- Pillar 3:
  - NBG requires banks to publicly disclose information according to the Regulation on Transparency of a Commercial Bank Financial Condition (RCAR 2013, article 26). This regulation is not yet updated according to Basel II principles.

### Transition from Basel I to Basel II and III (2014–2017)
- Compliance timing:
  - Banks required to comply with minimum capital requirements under Pillar 1 as of June 30, 2014.
  - Banks required to report outcome of their Internal Capital Adequacy Process on September 30, 2014.
  - NBG to decide before end-2014 when banks need to comply with Pillar 3 requirements.
- Transition period (2014–2017): banks need to comply with both:
  - minimum capital requirements based on Basel I multiplied by an adjustment factor (see table in source), and
  - minimum capital requirements under Basel II/III.
- As of January 2014: banks required to file a parallel run.
- NBG impact analysis: showed banks currently already comply with minimum capital requirements based on Basel II and III because of historically held high-quality capital.
- NBG expectation: most banks need 2015 to bring their ICAAP up to standard.
- NBG planned actions: develop Supervisory Review Evaluation Process formally before September 30, 2014.

### Minimum capital requirements in transition period (figures from source)
- Current regulation: 100; 95 (2014) 90 (2015) 80 (2016)
- Updated regulation: 7; 8.5; 10.5
- Additional numbers in table rows: 12; 8 11.4; 7.6 10.26; 6.84 8.21; 5.47
- Note: For explanation of this table, see description of minimum capital requirements in current regulation and updated regulation.

### Assessment against Basel-related essential criteria (EC2–EC6, AC1–AC2)
- EC2: For internationally active banks, definition of capital, risk coverage, method of calculation, and thresholds are not lower than applicable Basel standards. Finding: NBG uses same definition and minimum requirements for all commercial banks; updated regulation is not lower than Basel II and III.
- EC3: Supervisor powers to impose specific capital charges/limits and include both on-balance sheet and off-balance sheet risks. Finding: NBG has power (LACB article 21.3) and has used it in practice; Pillar 2 process to be officially launched September 2014.
- EC4: Prescribed capital requirements reflect risk profile and systemic importance. Findings:
  - Current credit risk based on Basel I weighting (0 percent; 20 percent; 50 percent; and 100 percent); NBG sometimes applies higher weights.
  - Under updated regime, risk weights more granular and in some instances higher than under Basel II.
  - NPL ratio: approximately 3.5 percent based on IMF definition (>90 days past due) and 7.5 percent based on local definition.
  - Coverage ratio (loan loss reserve to NPL, exclusive of collateral or recovery): 89 percent.
  - Operational and market risk not taken into account under current regime; will be under updated regime.
  - Pillar 2 will require banks to consider additional risks: market risk, counterparty risk, sector concentration risk, interest rate risk, liquidity risk, strategic risk, reputational risk.
  - Under current regime, NBG sets higher capital requirements than the 8 percent Basel I minimum: all banks required to have 12 percent capital adequacy and some up to 24 percent.
  - Stress test (May 2014) shows banks relatively resilient.
  - Quality of capital: 25 percent of regulatory capital under current regime consists of tier 2 capital.
  - NBG imposes a capital charge on currency induced credit risk by weighting it an extra 75 percent on top of the credit risk weight for countercyclical purposes.
  - NBG planning to introduce framework for dealing with systemically important banks in 2016.
- EC5: Use of banks’ internal assessments (internal models) not allowed under current regulation and Pillar 1 of updated regulation; banks may only use standardized approach. NBG should approve application of 35 percent and 75 percent preferential risk weights.
- EC6: Supervisor power to require forward-looking capital management and stress testing. Findings:
  - NBG facilitates forward-looking capital planning and communicates with banks on capital buffers.
  - Under updated regime (RCAR article 23) NBG requires banks to maintain sufficient capital on an ongoing basis.
  - G-ICAAP 2013 guideline 3: forward-looking approach to capital planning required; guidelines 7 and 9: stress and scenario tests and contingency planning part of ICAAP.
- AC1: Capital regime does not differentiate between internationally and non-internationally active banks; same regime applied to all banks.
- AC2: NBG does not have specific requirements for distribution of capital within banking group entities (see CP 12 EC 7).

### Overall assessment and comments on Principle 16 (Capital adequacy)
- Assessment: Compliant.
- Comments:
  - NBG compliant with core principle on capital adequacy according to Basel I and in process of implementing Basel II and elements of Basel III.
  - Under updated regime:
    - Credit risk: standardized approach only.
    - Operational risk: basic indicator or standardized approach only.
    - Market risk: simple approach for FX risk.
    - Pillar 2 in force as of September 30, 2014 when banks required to report ICAAP outcome.
    - Transition (2014–2017): parallel run and dual compliance with adjusted Basel I and Basel II/III.
  - Findings:
    - NBG has not yet provided guidance to banks on Pillar 3; plans to update transparency regulation and provide guidance end-2014.
    - NBG has not provided guidance to supervisor on SREP; planned before September 30, 2014.
    - No buffer for D-SIB yet (Basel does not require sooner than 2016).
    - No capital requirements on a consolidated level; unconsolidated investment in capital of subsidiaries deducted (RCAR article 4.9).

### Recommendations (from source)
- Consider introducing a buffer for domestic systemically important banks.
- Consider introducing a framework how to deal with domestic systemically important banks.
- Consider introducing a countercyclical buffer.
- Set up an implementation plan for Pillar 2 and Pillar 3 for banks and supervisors, including deciding who will do the assessment.
- Develop guidance for supervisors on SREP.
- Develop Pillar 3 requirements for banks.

*Source: _cr1510 - 7. collective investment undertaking.*

### 1.76  percent of total banking sector assets (which are deducted from capital), investments in

### _cr1510 - 1.76  percent of total banking sector assets (which are deducted from capital), investments in

### Large exposures and consolidated supervision
- Total participations reported: affiliates – 0.02 percent; investments with less than 20 percent stake – 0.26 percent.
- All participations are reported separately to the supervisor as part of the standard monthly regulatory reporting.
- The supervisor can analyze total gross large exposure using large exposure and participation reports.
- Formal consolidated supervision framework: not yet in place.
- The NBG has started to monitor large exposures on a consolidated level.
- Consolidated large exposures change the overall picture insignificantly because:
  - No major large exposures are extended by bank subsidiaries to their clients.
  - There are no significant and complex groups in Georgia.

### EC7 — Stress testing and concentration impact
- The supervisor requires banks to include the impact of significant risk concentrations into their stress testing programs for risk management purposes.
- Current practice:
  - NBG requires large banks to reflect significant concentrations in their stress-testing.
  - With implementation of Basel II/III, banks are required to conduct stress tests as part of Pillar 2 (see ICAAP guideline under 9).

### Additional criteria AC1 — Single counterparties and groups of connected counterparties
- Regulatory thresholds (as described):
  - Large loans and other liabilities are defined when they exceed 5 percent of the bank’s regulatory capital.
  - Total amount of loans and other liabilities to a person shall not exceed 15 percent of the bank’s regulatory capital.
  - Total amount of loans and other liabilities to a group of interconnected borrowers shall not exceed 25 percent of the bank’s regulatory capital.
  - Total amount of large exposures cannot exceed 200 percent of total regulatory capital.
- NBG is considering setting limits on top borrowers (TOP-5 and TOP-10).

### Assessment of Principle 19
- Assessment: Largely compliant.
- Positive findings:
  - NBG receives monthly database from every bank with top 100 borrowers, large exposures, and participations.
  - NBG can compare bank treatments of groups of borrowers and has identified groups missed by banks; such loans are almost monitored on a daily basis.
- Areas for improvement:
  - Limited practice at banks of identifying economic interdependence despite regulatory requirement to identify it.
  - To mitigate uncertainty, NBG reduced total large exposure limit from 600 percent to 200 percent.
  - Regulation on concentration and large exposures does not prescribe requirements for concentrations beyond single counterparties or groups of connected counterparties.
  - General regulation on risk management includes paragraphs on concentration risk but not fully implemented; Pillar 2 of Basel II expected to address this.
  - NBG preparing to change definition of large exposures per Basel standard (June 2014) to include all claims, including equity (amendment not fully implemented yet).

- Recommendations (from source):
  - 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 (summary of essential criteria EC1–EC7)
- EC1 — Definition and legal/regulatory basis:
  - Transactions with related parties regulated by LACB (article 25) and the RCITRP.
  - LACB article 25 (implemented September 2009) prohibits preferential terms to: Administrators; Controlling persons; Affiliates; and their related parties.
  - LACB and RCITRP provide definitions for: Administrator; Affiliate; Control; Controlling person; Persons related to a bank.
  - RCITRP article 2 and 3 include related-interest definitions with quantitative thresholds:
    - A person owns a significant (5 percent and more) amount of shares.
    - Persons are shareholders of one legal entity where sum of their shares constitutes no less than 20 percent.
    - One person participates directly or indirectly in another person's business where share constitutes no less than 20 percent.
  - Remark: Law wording unclear on explicit inclusion of shareholders/ultimate beneficiary owners; regulation more explicit regarding >5 percent shareholders.
  - No explicit statutory provision that NBG may determine definition of related parties case-by-case; NBG exercises such discretion based on general powers.

- EC2 — Arm’s-length requirement:
  - Legislation and regulation state that transactions with related parties are not to be undertaken on more favorable terms.
  - LACB article 25 and RCITRP article 3 explicitly prohibit preferential terms.

- EC3 — Board approval and conflict exclusion:
  - RCITRP article 3 requires Supervisory Board approval for transactions with administrators, affiliates, or related parties.
  - Related parties must not participate in decision-making on transactions where they expect to benefit; attendance not counted for quorum.
  - NBG receives minutes and can request comprehensive information; Internal Audit Department may study such transactions and report violations.
  - Approval by Board for write-off of related-party transactions is not directly required by legislation; NBG considers facilitating such a practice.

- EC4 — Policies to prevent conflicted persons from participation:
  - Supervisor determines adequacy of banks’ policies and procedures to prevent benefiting persons from participating in granting/managing related transactions via reviewing policies, procedures, transaction reports, and loan files.

- EC5 — Limits, deduction from capital, collateralization:
  - NACB article 21.1d gives NBG authority to impose prudential limits on related-party transactions.
  - Limits in place (RCITRP articles 3.2–3.4; RSR article 5):
    - Commitments to insiders or related interests must not exceed 5 percent of the bank’s capital (RCITRP article 3.2; RSR article 5).
    - Total amount to all related parties must not exceed 25 percent (RCITRP article 3.3; RSR article 5).
    - Banks required to hold 110 percent collateral for commitments to related parties (RCITRP article 3.4; RSR article 5).
  - In practice, waivers sometimes granted (e.g., subsidiaries, small insider loans).

- EC6 — Identification, monitoring, reporting, independent review:
  - NBG determines banks have policies/procedures to identify related-party transactions; exceptions reported to appropriate level; senior management monitors; Supervisory Board provides oversight.
  - NBG reviews internal procedures, minutes, aggregated volumes, terms, identification procedures, loan quality, group structure risks.
  - NBG cross-checks completeness of connected borrower lists (Top-100 borrowers), verifies collateral owners and rental arrangements for related-party links.
  - NBG assesses group-wide structure including shareholders and beneficial owners.

- EC7 — Aggregate information reporting:
  - Monthly reporting forms to NBG include: “Loan Amount,” “The bank's assumed liabilities by off-balance sheet transactions,” “Value of Collateral,“ “Amount of Adversely Classified Assets,” “Loan Loss Reserves on Adversely Classified Assets,” and “Loan Loss Reserves Percent” for specified related-party categories.
  - Related-party categories reported include administrators (Supervisory Board, Audit Committee, Board of Directors), persons related to administrators, bank employees, related enterprises by participation thresholds (20 percent, 20–50 percent, 50 percent), repeated enterprises, related enterprises to shareholders and controlling persons, other shareholders (<5 percent, >5 percent), and related persons to the bank and its administrators.
  - New reporting form introduced including all types of transactions per related party and breakdown by interest rates; NBG monitors low-rate loans and high-rate deposits.

### Assessment of Principle 20
- Assessment: Compliant.
- Comments and positive findings:
  - NBG is compliant with the core principle on related parties.
  - Extensive effort since 2006 to identify related parties and ensure arm’s-length transactions.
  - Monthly prudential return (introduced 2009) is granular and enables cross-checks between banks.
  - Supervisor reviews pricing on loans and deposits to detect irregularities.
- Minor findings:
  - No explicit legal/regulatory provision that NBG could determine definition of related parties case-by-case (NBG uses general powers to do so).
  - No explicit provision requiring write-off of related-party exposures to be subject to prior Board approval.
- Recommendations (from source):
  - Consider initiating legislation that gives the NBG explicit power to determine the definition of related parties on a case-by-case basis.
  - Consider adding a provision that explicitly requires write-off of related party exposures to be subject to prior approval by the bank’s Board.

### Principle 21 — Country and transfer risks (EC1–EC6 summary)
- EC1 — Policies and processes; exposures and monitoring:
  - International activity of Georgian banks is limited.
  - Total exposures exposed to country and transfer risk as of February 2014:
    - 7.1 percent of total assets of the banking sector.
    - Approximately 39.8 percent of the system’s regulatory capital.
  - Composition of 7.1 percent:
    - 5.7 percent gross interbank exposures (of which 2.1 percent is point nostro account).
    - 0.9 percent nonresident exposures.
    - 0.5 percent investments in foreign subsidiaries.
    - 0.5 percent investments in foreign securities.
  - Foreign interbank exposures mainly to parent/sister banks and large international investment grade banks in EU and US; used mainly for liquidity management and addressed under liquidity regulation.
  - Qualifying liquid assets for LCR: only highly rated foreign government bonds and nostro/deposit accounts in investment grade foreign banks.
  - Investments in subsidiaries:
    - Sector-wide 0.5 percent of total assets.
    - Maximum 1.3 percent on an individual level as a percentage of total assets.
    - For prudential purposes, such exposures are deducted from capital and losses do not impact regulatory capital.
  - Investments in foreign securities:
    - 0.2 percent of total assets for the banking system.
    - One bank owns foreign shares equal to 5.1 percent of its total assets (high-quality USA, UK blue chips, exchange traded and index funds).
    - Another bank owns coupon bonds of GEL 1.7 million, which is 3.5 percent of its assets.
  - NBG issued a guideline on country risk (May 2014) requiring banks to have policies and procedures to manage country and transfer risks; banks expected to respond in 10 days.
  - Most banks currently have limits/policies per industry segment and per counterparty; few have country-basis limits or OECD/non-OECD distinctions.
  - NBG expects banks to assess country/transfer risks during ICAAP; banks have not yet implemented the guideline fully.
  - NBG receives monthly prudential returns including total nonresident exposures, investments in foreign subsidiaries, and investments in foreign securities split into foreign government bonds, foreign nongovernment bonds, and foreign shares.
  - Since 2012 NBG introduced special forms allowing review of exposures per country and main segments; reporting is monthly.
  - Supervisory and ad-hoc analyses:
    - Periodic country analysis and transfer risk reviews.
    - Examples of ad-hoc analysis: GIIPS, Cyprus, Baltic countries (2012); Belarusian and Ukrainian exposures; requirement for a bank to withdraw funds from another country; requests for detailed FX swap analyses in politically vulnerable countries.
    - NBG performs bank-by-bank and system-level analyses of indirect country/transfer risk (e.g., borrowers’ exposures against vulnerable countries through trade).

- EC2 — Board oversight:
  - NBG does not yet systematically determine whether bank strategies/policies/processes on country/transfer risk have Board approval and oversight.
  - This is expected to change through implementing the guideline on country and transfer risk and ICAAP regulation.

- EC3 — Information systems and reporting:
  - NBG monitors banks’ information, risk management, and internal control systems to evaluate and report country exposures, using a risk-based approach focused on material exposures.
  - Main focus on interbank exposures system-wide and nonresident exposures where material.
  - NBG checks actual balances for interbank accounts in nonresident banks.

- EC4 — Provisioning oversight:
  - NBG does not impose predefined minimum provisioning for exposures to foreign countries.
  - For provisioning, Georgian banks treat foreign-country exposures similar to domestic exposures; industry/market developments are part of asset classification and provisioning criteria.
  - NBG has power to require extra provisioning and used it in a case of indirect country risk in Ukraine.
  - Foreign investments are deducted from capital.

- EC5 — Stress testing for country/transfer risk:
  - Enterprise-Wide Stress Test guidelines require stress testing of material risk concentrations, including country/transfer risks where relevant.
  - ICAAP requires certain stress tests and adverse scenarios.
  - In practice, only the largest banks conduct stress tests incorporating country and transfer risk.

- EC6 — Timely supervisory information and powers:
  - NBG requires standard regulatory reporting; consolidated reports provided annually or on special request.
  - Detailed information on non-resident, non-banking borrowers obtained via request.
  - NBG has power to request any information necessary for prudential supervision (Organic Law, Article 49).

### Assessment of Principle 21
- Assessment: Largely compliant.
- Comments:
  - NBG actively monitors country and transfer risk using prudential reports and issued guidelines (May 2014) to stimulate bank management of such risks; banks have not yet had time to fully implement guidelines.
  - NBG does not systematically determine Board approval and oversight of bank policies on country/transfer risk.
  - Only the largest banks conduct stress tests incorporating adverse country/transfer scenarios.
  - NBG plans a second-half-2014 review of banks’ ICAAP (SREP) to align risk profile, capital position, and quality of risk management including stress testing (see EC5).
  - No formal provisioning model exists for country/transfer risk; banks have discretion but NBG can require extra provisioning when unsatisfied.
- Recommendations (from source):
  - Continue implementing guidelines on managing country and transfer risk, including stimulating Boards to explicate risk appetite, set country and transfer risk limits, and take responsibility in overseeing the management.
  - Consider implementing an explicit provisioning system for country risk and transfer risk, developed either by the NBG or by the banks themselves.
  - Consider requiring prudential return on country risk on consolidated level on a semi-annual basis.

### Principle 22 — Market risk (EC1–EC5 summary)
- EC1 — Market risk management processes and scope:
  - NBG distinguishes market risk in trading book and banking book.
  - Trading book in Georgia: immaterial.
    - Total trading book: 0.2 percent of total assets system-wide.
    - Maximum trading-book ratio: 5.1 percent for a medium-sized bank.
    - NBG introduced basic trading-book regulation in March 2014.
  - Banking book market risk (more relevant): includes FX risk, real estate (property for own use, investment property, repossessed assets), and indirect market risks (currency-induced credit risk, loans collateralized with commodities or real estate).
  - Foreign currency exposures governed by Regulation on Setting, Calculating, and Maintaining Overall Open Foreign Exchange Position Limit of Commercial Banks (RFX):
    - Current foreign currency limit: 20 percent overall open position to regulatory capital (see article 2 RFX).
  - Fixed assets represent 6.0 percent of total assets of banking system:
    - 0.8 percent point repossessed assets.
    - 5.2 percent point fixed assets for own use and investments in real estate property.
  - NBG transitioning from Basel I to Basel II/III capital adequacy framework:
    - New framework introduces capital requirement for open currency position (OCP) under Pillar I.
    - Banks required to submit their (first) ICAAP in September 2014 (see R-ICAAP).
  - As part of ICAAP, banks must assess exposures to market risks not covered under Pillar I.
  - NBG regularly performs risk assessments of banks, with special attention to FX risk governance.
  - No regulation for market risk on a consolidated level, but NBG monitors consolidated market risk.

- EC2 — Board approval and oversight:
  - LACB article 14b requires policy regarding foreign exchange risk to be approved by the Supervisory Board.
  - ICAAP guidelines require Board involvement in setting strategy, risk appetite, risk governance, and comprehensive review of material risks including market risk.
  - NBG assesses whether high-level policies, procedures, and limits are documented and overseen by the Board.

- EC3 — Systems, limits, controls, and reporting:
  - NBG assesses banks’ policies, procedures, risk management models, internal limits, and reporting; meets bank staff responsible for market risk monitoring.
  - Some banks lack separate FX risk policies, incorporating FX risk into ALM policy or ALCO procedures.
  - Some banks perform stress tests for market shocks.

- EC4 — Valuation, revaluation, and model controls:
  - NBG determines daily open currency position using daily reports from banks.
  - Revaluation of FX-denominated assets and liabilities enters P&L on a daily basis.
  - Trading book present in limited extent in one bank; fair valuation considered appropriate due to highly liquid portfolio constituents.

- EC5 — Capital for market risk:
  - Under current regime there are no capital requirements for market risk.
  - This will change with Basel II/III implementation. Banks will be required to hold 7 percent,

*Italic: Source: IMF staff compilation from the provided document content.*

### 8.5 percent and 10.5 percent of respectively common equity Tier 1, Tier 1 and regulatory capital

### _cr1510 - 8.5 percent and 10.5 percent of respectively common equity Tier 1, Tier 1 and regulatory capital

### Market risk and open foreign exchange position
- Regulatory requirement: 8.5 percent and 10.5 percent of respectively common equity Tier 1, Tier 1 and regulatory capital for their risk weighted open foreign currency position (see R-ICAAP articles 8 and 91).
- Definition: The open foreign exchange position is defined as the largest amount of long and short open foreign exchange positions for all types of foreign currencies. These includes spot, futures, forward, and swap agreements.
- Implementation:
  - Since June 2014, the currency risk is charged for capital under pillar 1.
  - Pillar 2 will be implemented in September 2014.

### Fixed assets revaluation and capital protection
- Revaluation reserve:
  - As of February 2014, the total revaluation reserves of the banks amounts to GEL 133.7 million.
  - This amount functions as a kind of buffer for price decreases; only price decreases beyond GEL 133.7 million would cause losses through P&L.
  - Implication stated: prices of fixed assets can decline by at least 15 percent of the P&L before the regulatory capital of the banks would be affected.
- Assessment: Given the amount and the revaluation buffer, these assets expose the banking system to some risk, but not significant.

### Dollarization and currency-induced credit risk
- High dollarization noted as an issue for currency induced credit risk.
- Regulatory mitigation:
  - Banks are required to hold 75 percent additional capital for foreign currency denominated loans (where the borrower is not hedged), which addresses indirect FX risks.
- Policy development: The NBG is contemplating regulating the structural position and provisioning denomination of the banks given high dollarization of the financial system.

### Enterprise-wide stress testing and EC6 (market risk in stress tests)
- Supervisory requirement: The supervisor requires banks to include market risk exposure into their stress testing programs for risk management purposes.
- ICAAP guideline (under 9) requires banks to conduct plausible but severe stress and scenario tests covering bank-specific risks, jurisdictional risks, macro-economic environment, impact of new legislation, competitor actions, and other factors.
- Practice:
  - Currently, large banks and some of the small banks have developed stress testing tools to include market risk.
  - Currency risk and stress tests on currency devaluation are incorporated in all the banks’ models.
  - The NBG sets minimum stress scenarios, including devaluation of GEL, increase in interest rates, and drop in real estate and gold prices, as well as other market risks specific to the bank.
  - The NBG itself carries out macro stress tests regularly.
- Assessment of Principle 22: Compliant.
- Comment: The market risk in the trading book is not material (including consolidated supervision). The main market risk is exchange risk. The NBG determines sufficiently whether banks have an adequate market risk management process taking into account the market and macro-economic conditions.
- Recommendations:
  - Continue implementing the new capital regime, since this will enhance the risk management, incentivize all banks to conduct stress tests, and allocate capital for unexpected market risk losses.
  - Consider setting market limits on consolidated level (see further CP 12 on consolidated supervision).

### Interest rate risk in the banking book — Principle 23 (EC1–EC3)
- Principle 23 summary: The supervisor determines that banks have adequate systems to identify, measure, evaluate, monitor, report, and control or mitigate interest rate risk in the banking book on a timely basis. These systems take into account the bank’s risk appetite, risk profile, and market and macroeconomic conditions.

EC1 — Strategy and framework
- Legal/regulatory basis:
  - Regulation on risk management (RRM articles 13–17) stipulates that banks are required to have an appropriate interest rate strategy and risk management framework, including policies and procedures to identify, measure, monitor, and control.
  - ICAAP guidelines explicitly require banks to assess their exposure to interest rate risk and link interest rate risk to their risk appetite and economic capital.
- Timing requirement: Banks are required to submit their (first) ICAAP by September 30, 2014.
- Practice:
  - In practice, according to NBG almost all banks (with the exception of a few very small banks) have an interest rate risk management policy and procedures in place, often as a separate document or as part of asset and liability management procedures.
  - NBG is discussing interest rate risk management with one bank that has a material interest rate risk.
- Sector characteristics:
  - The average contractual maturity of the loan book in Georgia is low because the majority of the loans are issued with a maturity of one year.
  - Refinancing of loans is high, resulting in an even lower actual maturity than contractual maturity.
  - Contractual maturities: average contractual maturity of the liability side is 9.2 months for all deposits and 11.5 months for time deposits.
  - Expectation: With financial sector development and economic growth, loan book maturity is expected to increase over time, making interest rate risk management more important.

EC2 — Board approval and senior management oversight
- LACB Article 14 requires the Supervisory Board to approve policies and procedures regarding asset and liability management (broadly covering interest rate risk in the banking book).
- Supervisors receive and review agenda and minutes of the Supervisory Board as part of ongoing supervision.
- ICAAP guidelines require Board involvement in setting strategy, risk appetite, and risk governance and in comprehensive review of material risks, including interest rate risk in the banking book.
- Supervisory approach (GRAPE): bank supervisor together with specialists from the Market Risk and Macro Prudential Policy Division assess the quality of mitigants, including Supervisory Board involvement.

EC3 — Measurement systems, model validation, limits, reporting
- Interest rate measurement:
  - Most banks use the NBG’s standardized GAP analysis (on a one-year horizon) to measure re-pricing risk.
  - Some banks take yield curve risk, basis risk, and option risk into account based upon their own models.
  - Since 2012, the NBG has used duration statistics under a standardized framework to calculate the impact of a 4 percent (GEL) / 2 percent (USD) on the economic value of a bank’s assets and liabilities.
- Model validation:
  - Few banks have interest rate risk models that take into account optionality (prepayment of loans and early termination of deposits); in other banks procedures are not well developed.
  - Supervisor assesses these factors during ongoing supervision, including model assessment.
- Limits:
  - Some banks have detailed procedures with appropriate internal limits and reporting triggers; other banks do not use internal limits.
  - For banks where interest rate risk is not material (except one systemically important bank), they hold extra capital as a buffer according to the NBG.
- Reporting and exception tracking:
  - Many banks provide monthly interest rate risk information to supervisors via a special form (A-G Form) incorporated in financial reporting. The form allocates interest bearing assets and liabilities over time buckets by re-pricing/maturity date and is used to assess effect of interest rate shock on current year P&L.
  - Identified shortcomings of current reporting:
    - Insufficient granularity in time buckets for longer maturities.
    - Does not take into account prepayments and refinancing of loans.
    - Fails to differentiate between currencies and distinguish between on- and off-shore FX funding.
    - Does not allow calculating how economic value or regulatory capital is affected by standard interest rate shocks.
  - NBG actions:
    - A new reporting form has been elaborated covering interest bearing assets and liabilities with detailed currency (distinguishing between on- and off-shore FX funding) and maturity breakdown.
    - Since 2012, collected data is semi-yearly utilized to calculate the impact of interest rate shock on bank’s economic value, according to Basel methodology (using duration statistics under standardized framework).
    - The model needs further calibration for local market characteristics, e.g., assumptions on pre-payment and using actual yield curve for assets/liabilities in GEL.
    - Analogous to the OCP form, the new form will allow calculating interest rate risk position, which may be subject to prudential limit against regulatory capital and/or economic capital requirements under Pillar II.

*International Monetary Fund — Georgia country report excerpt*

### Introduction of the new reporting form for interest rate risk will allow calculating the shock

### Introduction of the new reporting form for interest rate risk will allow calculating the shock

### Interest rate risk — supervisory framework and findings (Principle 23)
- New reporting standard introduced in 2012 enables calculation of shock effects based on more sophisticated scenarios.
- Information systems: Banks are required to have effective information systems for accurate and timely identification and reporting of interest rate risk exposure to the banks’ Boards and senior management.
- EC4 — stress testing requirements:
  - All large banks, and some smaller banks, perform stress tests for interest rate risks on the banking book.
  - Standard stress parameters (per NBG “stress test guidelines”): increase of interest by 4 percent for assets/liabilities denominated in GEL, and by 2 percent for assets/liabilities denominated in foreign currency. Parameters may change if needed.
  - Some banks’ stress testing procedures remain underdeveloped; NBG provides guidance and actively discusses concerns with commercial banks’ management.
  - Commercial banks are required to assess interest rate risk as part of their ICAAPs; stress testing and scenario analysis should be part of ICAAP.
- AC1 — supervisory data collection and system-level modeling:
  - All banks must submit an interest rate GAP report with a time horizon of one year on a monthly basis.
  - Since 2012, banks must submit a more detailed report for the whole interest rate typical balance sheet once every half year.
  - Supervisors are gaining experience calculating economic value impact on system level following Basel guidelines using shocks of 4 percent in GEL and 2 percent in USD.
  - NBG works with industry to calibrate model assumptions (bank specific pre-payment ratios, maturity and duration in long-term buckets, construction of yield curve in GEL, estimation of potential shock level) and to account for basis risk, yield curve risk, and optionality risk.
  - Banks are expected to further elaborate interest rate risk models (including effect on economic value) in the ICAAP.
- AC2 — capital measurement and ICAAP:
  - Banks are required to assess interest rate risk and link it to their risk appetite and economic capital as part of the ICAAP (due September, 30 2014).
  - NBG macro stress test and Enterprise-Wide Stress Test were sent to banks to estimate interest rate risk and its effect on regulatory capital.
  - Impact of interest rate shock on P&L was limited in most cases; in one case a bank will hold capital and is discussing the amount with NBG.
- Assessment of Principle 23: Largely compliant.
- Key comments:
  - Most banks do not have a material interest rate risk position because contractual maturity of loans is approximately the same as maturity of deposits.
  - One systemic bank has a material interest rate position without internal limits and holds earmarked capital as a buffer.
  - Assessors recommend NBG require banks to set up internal limits and take interest rate risk into account relative to capital position (including trigger ratios) as part of Basel II, Pillar 2 implementation.
- Recommendations:
  - Require banks, through regulation, to have internal limits for interest rate risk;
  - Consider providing more guidance to banks on how to deal with interest rate risk in relation to ICAAP;
  - Consider increasing the frequency of reporting to a quarterly basis in order to keep developments abreast.

*Source: _cr1510 - Introduction of the new reporting form for interest rate risk will allow calculating the shock*

### Liquidity risk — supervisory framework and findings (Principle 24)
- Principle summary: Supervisor sets prudent liquidity requirements, requires banks to have strategies and policies to manage liquidity across time horizons; for internationally active banks requirements are at least Basel standards.
- EC1 — legal/regulatory requirements and monitoring:
  - LACB article 19.3 and article 5i of Regulation: minimum average liquidity ratio shall be no less than 30 percent; NBG may impose different ratios (LACB article 21.2a).
  - Three banks have different liquidity ratio requirements (two rewarded for good model; one has an add-on for single concentration).
  - In 2013, liquidity ratio adjusted to penalize banks with a high (>10 percent) share of nonresident deposits.
  - Current system liquidity ratio is close to 40 percent; liquid assets to deposits ratio is 50 percent; liquidity ratio for foreign currency is close to 30 percent.
  - Average liquidity ratio defined as average of month’s liquid assets to average of month’s liabilities; liquid assets include cash, amounts due to banks and central banks, and an investment portfolio (mostly treasury bonds and treasury bills of Ministry of Finance of Georgia and Certificates of Deposit of central banks). Part of investment portfolio is pledged for short-term loans from the NBG.
  - Adjustments:
    - Total amount of government securities and certificates of deposits from the NBG shall not exceed 10 percent of total liabilities.
    - Liquid assets exclude specified accounts (debt securities issued by non-OECD members government or central banks, blocked correspondent accounts, adversely classified inter-bank deposits, or the reserve placed at a central bank or its portion pledged against a credit).
  - NBG launched LCR calculation requirement (not yet an LCR requirement). Draft regulation sent for comments in September 2013. Currently, the LCR is in all currency above 100 percent.
  - Liquidity tools: Macro-Policy Division tracks high-frequency market data on a daily basis (equity prices, FX markets, yield dynamics).
- EC2 — requirements reflect bank risk profile and market conditions:
  - Key market characteristics: very high dollarization (around 60 percent of loans and deposits are denominated in dollars) and deposit concentration (30 largest depositors have 20 percent of total deposits).
  - NBG can impose liquidity requirements and has adjusted requirements based on banks’ risk profiles.
  - Nonresident deposit concentration adjustment: liquid assets in same currency are reduced by X=max[(A-10 percent), 0] percent of nonresident’s deposits (A = share of nonresident deposits).
  - Minimum liquidity ratio not required for every individual foreign currency yet; LCR will be mandatory for every individual currency and in total.
- EC3 — liquidity management framework and contingency planning:
  - LACB article 14.5b requires Supervisory Board to determine and approve internal policy/procedures governing asset and liability management.
  - In practice: room for improvement in contingency planning. Only three large banks have contingency plans; these need significant improvement per NBG. Other banks do not yet have contingency plans.
  - Implementation of Basel II and III will require contingency plans subject to assessment.
- EC4 — liquidity strategy, policies, information systems, board oversight:
  - NBG reviews strategies, policies, procedures, conducts on-site meetings (GRAPE framework), reviews ALCO meeting minutes, and assesses Board expertise via minutes.
  - Day-to-day and intraday liquidity management, information systems and assurance: NBG assesses MIS capability to provide accurate, timely reports; performs assurance of LCR calculation and loan portfolio forms; checks balance verification in resident and nonresident correspondent accounts.
  - Oversight: NBG checks whether Supervisory Board evaluates management reports and periodically reviews liquidity policy.
  - Supervisory focus mainly on a few large banks with on-site inspections; others handled via expert consultations if necessary.
- EC5 — funding strategy, scenarios, liquid asset cushion:
  - NBG requires medium and large banks to establish and review funding structures and scenario analysis.
  - Enterprise-Wide Stress Testing Guidelines provided for analyzing macro deterioration effects (deposit withdrawal, wholesale funding outflow).
  - Georgian banks’ funding in distress is often limited to parent banks or IFIs; NBG imposes a conservative quantitative liquidity ratio requiring banks to hold relatively large liquid assets.
  - Only government bonds and NBG CDs (besides cash, deposits, nostros) are considered liquid.
  - Wholesale funding is rare; 2012 saw one bank issue Eurobonds and introduce Certificates of Deposits.
  - Regular assessment of ability to sell liquid assets is of limited relevance given narrow liquid asset set.
- EC6 — contingency funding plans:
  - NBG asked three large banks to develop contingency funding plans and plans to ask small and medium banks to do the same; so far only a few large banks have set up plans, which need significant improvements.
- EC7 — liquidity stress testing:
  - NBG requires systemic banks to conduct regular liquidity stress testing reviewed by supervisor; banks use historical experience for assumptions.
  - For small banks with high deposit concentration, shock scenario includes 100 percent outflow (in the same currency) of large deposits (e.g., top three, top five, or other depending on concentration).
  - LCR adjustments address overconcentration risk.
- EC8 — foreign currency liquidity:
  - Although significant funding in FX, only a few banks carry out significant currency transformation; maturity transformation in foreign currency is limited.
  - Supervisor monitors FX-induced risks actively and requires monthly form “A-L” giving contractual maturity gap by currency.
  - No quantitative liquidity requirements by currency yet (this will change after LCR implementation).
  - Supervisors review FX cash management procedures and contingency planning.
- Additional criteria AC1:
  - NBG monitors level of pledged assets; largest bank has approximately 4 percent of total assets encumbered (50 percent of its investment portfolio in government and central bank paper).
- Assessment of Principle 24: Largely compliant.
- Comments:
  - NBG’s liquidity risk assessment covers inherent risks and mitigants; NBG imposes conservative liquidity requirement and is moving toward Basel III (LCR). New regulation on liquidity risk expected to enter into force in September 2014.
  - NBG focuses efforts on three largest banks, creating potential lag in quality for other banks; only three largest banks have contingency plans and conduct stress tests; medium and small banks largely do not.
  - Assessors expect shortcomings to be addressed as NBG implements new liquidity regulation.
- Recommendations:
  - Continue with finalization and implementation of draft regulation of LCR.
  - Consider how to ensure all banks have adequate contingency funding planning and conduct stress tests, taking into account proportionality.

### Operational risk — supervisory framework and findings (Principle 25)
- EC1 — regulatory framework and reporting:
  - NBG enacted regulation on operational risk on June 13, 2014 (after FSAP mission) and is implementing it; regulation based largely on Basel II requirements, addresses contingency planning, outsourcing, information security, and mandatory prompt notification of “significant” operational risk events (methodology to be developed by banks and reviewed by NBG).
  - NBG requires banks to report operational risk monthly (number of events and losses per business lines based on Basel II). Yearly voluntary reporting of operational losses over last three years; six banks out of 21 issued this report.
  - Operational Risk and Information Processing Division analyzes reports and works with supervisors and banks.
- EC2 — board approval and oversight:
  - Regulation requires banks’ operational risk strategies/policies/processes to be approved and regularly reviewed by banks’ Boards (articles 7–10 of regulation). NBG interviews management and Board to assess awareness and adequacy.
- EC3 — implementation and integration:
  - NBG conducts interviews and on-site inspections to assess implementation of operational risk policies and processes.
- EC4 — business continuity and disaster recovery:
  - NBG reviews disaster recovery and business continuity plans; seven largest banks have policy and plans in place; other banks have only disaster recovery plans and need to include business continuity plans.
  - NBG has attended tests and inspected server rooms and contingency arrangements.
- EC5 — IT policies and infrastructure:
  - NBG reviewed IT and information security policies; more detailed reviews needed for some banks.
  - NBG supervisory approach based on 4A framework (availability, access, accuracy, agility) and currently focuses on availability, access, and accuracy.
  - NBG cooperating with Cyber Defense Unit; MoU set up but not signed. Six banks experienced card-related data theft and fraud in several countries.
  - NBG asked banks to reduce complexity of information systems and drafted an IT risk management questionnaire in November 2011.
- EC6 — operational risk information systems and reporting:
  - NBG determines banks have appropriate and effective information systems; reconciles prudential reports with internal financial reports and databases.
  - NBG expects banks to make internal operational risk reports more analytical, to develop key risk indicators, scorecards, and risk control self-assessments.
- EC7 — supervisory reporting of operational risk:
  - Two regular operational risk reporting forms based on Basel II introduced in October 2011; monthly report mandatory, annual voluntary; seven out of 21 banks file both.
  - Draft regulation mandates prompt notification of “significant” operational risk events.
  - Several banks created risk cards reflecting material operational risk events.
- EC8 — outsourcing:
  - Draft operational risk regulation includes detailed outsourcing section. NBG maintains catalog of outsourced activities and instructs systemic banks to develop outsourcing policies.
  - One large bank migrated outsourced information systems back to Georgia after outsourcing was deemed in excess of regulatory expectations.
- Additional criteria AC1:
  - NBG regularly identifies common points of exposure to operational risk; 2013 total operational loss for banking was GEL 5 million (without recovery).
  - Overreliance on telecom sector without formal SLAs identified as availability risk.
- Assessment of Principle 25: Largely compliant.
- Comments:
  - Significant progress: specialized operational risk unit created; regulation enacted June 13, 2014.
  - Shortcomings: only seven of 21 banks have business continuity plans; many banks lack adequate outsourcing policies; internal operational reports need to be more analytical; most banks do not perform IT audits.
  - Expect these shortcomings to be resolved in short order given recent regulation.
- Recommendation:
  - Ensure all banks report operational loss both monthly and yearly, set up business continuity plans and outsourcing agreements (taking local environment into account), and conduct mandatory IT audits.

### Internal control and audit — supervisory framework and findings (Principle 26)
- Principle summary: Banks must have adequate internal control frameworks, segregation of duties, safeguarding of assets, and independent internal audit and compliance functions.
- EC1 — legal requirements and governance:
  - Requirements set out in ACB Law and Regulation on Approving Regulation on Risk Management in Commercial Banks.
  - Article 14 ACB Law: Supervisory Council duties include oversight, selection/retention of competent Directors, written policy on banking activities; specific exclusive acts listed (e.g., starting/terminating activities, approving internal policies, determining interest rate ranges).
  - Article 16 ACB Law: Supervisory council must establish an audit committee.
  - Article 12 ACB Law: banks must have charter and internal bylaws addressing organizational structure, duties, audit committee functions, and authority limits.
  - Regulation on Risk Management emphasizes clear powers/liabilities and cooperation among Supervisory Board, Directorate, internal audit, external audit, and risk management units.
  - Shortcoming: Article 14 allows Directors (executive) to be members of Supervisory Board (cannot represent majority nor take part in decision making on executive issues). Two banks have Executive Directors on Supervisory Board; recommendation to delete provision from ACB law.
- EC2 — balance of back office and control functions:
  - NBG reviews effectiveness of back-office and risk-control functions and monitors resourcing and qualifications of internal audit.
- EC3 — compliance function:
  - No regulatory requirement to have a compliance function, but in practice banks have one or assign it to Legal Department. Regulation recently amended to address this.
- EC4 — internal audit function requirements:
  - Article 16 requires Supervisory Board to establish an audit committee of independent members.
  - Regulation on Internal Requirements for Commercial Banks lists main functions of internal audit (review internal controls, verify compliance, inspect transactions, assess efficiency of resource usage, assess reliability of financial information, coordinate with external auditors).
  - NBG assesses independence and effectiveness of internal audit via meetings and report reviews; higher expectations for larger/systemic banks.
- EC5 — internal audit resourcing and powers:
  - NBG assesses independence, resources, quality, and materiality of internal audit reports, including salary levels.
  - NBG checks internal auditor has access to necessary information and that supervisors contact internal auditor when issues arise.
  - Supervisors review internal audit plan and follow-up on recommendations.
- Assessment of Principle 26: Compliant.
- Comments:
  - Shortcoming noted: executive director presence on Supervisory Board is governance concern; recommended deletion from ACB law (also noted under Principle 14).

### Financial reporting and external audit — supervisory findings (Principle 27)
- EC1 — accounting and recordkeeping:
  - Article 26 ACB Law: banks must maintain accurate accounts and prepare annual financial statements in accordance with international accounting standards and NBG-prescribed forms/specifications.
  - For financial accounting and reporting, banks required to use IFRS as issued by IASB. For regulatory reporting, banks apply regulatory accounting issued by Georgian Accounting Standards Committee (based on 1998 IFRS guidelines).
- EC2 — external audit:
  - Article 27 ACB Law: each commercial bank and its subsidiaries shall have books audited annually by an external auditor who shall conduct each audit in accordance with rules established by the National Bank (rules issued by Regulation on the External Audit of Commercial Banks).

*Source: _cr1510 - Introduction of the new reporting form for interest rate risk will allow calculating the shock*

### 2.     Each commercial bank shall submit to the National Bank a complete report of its annual

### _cr1510 - 2.     Each commercial bank shall submit to the National Bank a complete report of its annual

### External audit framework and supervisory oversight (Principle 27)
- Legal and regulatory basis
  - Annual financial statements must be prepared in accordance with IFRS and audited by an independent external auditor under the Regulation on External Audit of Commercial Banks and the Law on Accounting and Auditing.
  - External auditors are licensed by the Georgian Federation of Professional Accountants and Auditors (GFPAA), a member of the IFAC.
  - External audits must comply with the International Standards on Auditing (IAASB/ISAs).
  - Article 27(2) of the ACB Law: banks must submit to the NBG a complete report of their annual external audited report as soon as it is completed, and publish the annual financial statement and external audit report in the Official Gazette in such form as provided by the NBG. Publication must be undertaken within four and a half months after the year’s end.
- Independence and scope
  - Article 4 of the Regulation obliges auditors to refuse services that would compromise independence per the IFAC Code of Ethics.
  - The NBG cannot define auditors’ detailed scope or guidelines but can require banks to request special audits and can require additional explanations from auditors to judge compliance with ISAs and IFRS.
  - The NBG has power to require banks to replace the external auditor if requirements are not met (Article 5 of the Regulation).
- Audit quality and market structure
  - For all but two of the smallest banks, auditors are one of the “Big 4.” Audit teams may comprise local and foreign personnel.
  - Oversight of accounting and auditing in Georgia is underdeveloped; the GFPAA lacks resources for effective quality control. The NBG checks adherence to IFRS rules for banks.
  - The NBG has IFRS-trained staff and performs independent verification and validation of regulatory reporting.
- Valuation and fair-value practices
  - Use of fair valuation is very limited due to little trading activity; assets are largely valued on a hold-to-maturity basis for prudential reporting.
  - New trading book regulations require banks to have internal procedures distinguishing trading vs held-to-maturity securities and relevant measurement principles.
  - Real estate is valued under Georgian GAAP in the same way as under IFRS, but gains from revaluations are not taken into account for regulatory capital calculation.
  - The real estate specialist in the Credit Risk Division checks banks’ IFRS valuations for real estate.
  - The NBG monitors gaps between regulatory and IFRS-based reporting; introduction of IFRS for prudential reporting will eliminate this gap and introduce prudential filters.
- Interaction and reporting timelines
  - NBG has intensified collaboration and meetings with external auditors to signal main risk indicators and influence audit scope and quality.
  - The NBG does not have to, but currently requests bank approval to meet auditors to discuss their reports; this permission has been granted in practice and the issue has been recently addressed.
  - Article 4 of the Regulation requires auditors who identify specified matters to provide the NBG with information no later than five business days after identification; recently this reporting requirement has been changed to require auditors to report immediately.
- Auditor rotation and access
  - No formal rotation requirements are in place; NBG monitors rotation patterns of engagement partners. The current average engagement period is two years.
  - The NBG has the power to access external auditors’ working papers where necessary.
- Assessment: Principle 27 — Compliant.
- Comments highlighted by the assessors:
  - EC8: The NBG should not have to require the permission of the bank to meet with the external auditor; the issue was recently addressed.
  - EC9: The five business day notification period was too long; regulation has been changed to require immediate reporting.

### Disclosure and transparency (Principle 28)
- Legal and regulatory framework
  - Disclosure requirements are contained in: the ACB law; Regulation on Transparency of a Commercial Bank’s True Financial Condition and Performance; and the Regulation on External Audit of Commercial Banks.
  - Annual audited consolidated financial statements must follow IFRS and incorporate IFRS disclosure requirements; these are published on both bank and NBG websites.
  - Banks must publish quarterly unconsolidated accounts based on local GAAP.
- Required disclosures and scope
  - NBG quantitative disclosure requirements in annual accounts include: capital adequacy, liquidity, profitability, nonperforming loans to total loans, loan-loss reserves to total loans, foreign exchange loans to total loans, foreign exchange assets to total assets, and annual loan growth rate.
  - Qualitative disclosure requirements are limited and focus on ownership structures: details on shareholders owning more than 1 percent stake and beneficial owners owning more than 5 percent stake.
  - For qualitative risk disclosures, NBG relies on IFRS 7 requirements and plans to require Pillar III disclosures under Basel II/III, plus additional local disclosures relating to consumer protection.
  - NBG encourages banks to disclose significant risk indicators and lending standards on their websites.
- Supervision and public reporting
  - NBG reviews both quantitative and qualitative information in annual accounts.
  - Aggregated financials and financial soundness indicators of the banking system are published and updated on a monthly basis on the NBG website. The NBG annual report provides additional sectoral insights.
- Assessment: Principle 28 — Largely compliant.
- Comments:
  - Banks publish annual consolidated IFRS accounts and solo quarterly local GAAP accounts with quantitative and qualitative commentary; pending Basel II/Pillar III implementation will expand structured qualitative disclosures (IFRS 7, Pillar III, and consumer protection).

### Abuse of financial services, AML/CFT supervision (Principle 29)
- Legal and institutional framework
  - Under Article 3 (3) (i) of the NBG Law, the NBG supports prevention of illicit income and terrorism financing in cooperation with the Financial Monitoring Service (FMS).
  - The FMS is the national focal point for Suspicious Transaction Reports (STRs) and related information; banks are required under Article 9 of the AML Law to submit STRs to the FMS.
  - The FMS is an independent body under the auspices of the NBG, but legislation is at an advanced stage to transfer the FMS under the Office of the Prime Minister and funding to general government; Transparency International and Moneyval have expressed concerns about the move.
  - Under Article 11(1) of the AML Law and Article 14 (1) of the FMS Regulation on Commercial Banks, the NBG is responsible for supervision and monitoring of commercial banks for AML/CFT purposes.
  - Article 48 of the NBG Act and Article 29 of the ACB Law empower the NBG to examine all books, accounts, files, and documents of banks and subsidiaries.
- NBG AML resources and inspection regime
  - The NBG has a dedicated Money Laundering and Special Inspection Department employing 16 persons.
  - The NBG’s Banking Supervision Department includes a dedicated AML on-site inspection unit with a staff of 18.
  - Inspection frequency (risk-based):
    - High-risk commercial banks: every 2–3 years.
    - Average/low-risk banks: every 3–4 years.
  - Inspection duration and inspector numbers:
    - Large-sized bank – duration: 5–6 weeks with five inspectors.
    - Medium-sized bank – duration: 3–4 weeks with 2–3 inspectors.
    - Small sized banks- duration: 2–3 weeks with two inspectors.
  - Reported AML inspections of banks: 7 in 2011; 3 in 2012; 10 in 2013; 4 in first quarter of 2014.
  - Off-site monitoring: since 2011 the NBG adopted an AML/CFT policy document on supervision and a questionnaire for off-site monitoring under a risk-based approach; supervisory plans of on-site examinations were introduced in 2011.
- Internal controls, CDD and AML requirements for banks
  - Article 8 of the AML Law requires monitoring entities to implement internal control and develop internal regulations covering client identification, beneficial ownership, detection of suspicious transactions, and reporting to the FMS.
  - Banks must designate staff or structural units responsible for implementation and reporting (Articles 8.2, 8.4, 8.5).
  - Banks are required to report transactions above the threshold of GEL 30,000 (automatic reporting) and to report suspicious transactions.
  - The FMS Regulation on Commercial Banks (Article 4(3), Article 6(22–23)) requires written internal procedures and a risk-based identification/verification framework, special procedures for new technologies/products, and enhanced identification for high-risk clients.
  - The NBG adopted Guidelines on a Risk-based Approach for AML/CFT Purposes and Procedures to Identify and Verify Ultimate Beneficial Owners.
- CDD program elements and compliance with EC5 essentials
  - Customer acceptance policies: Article 4.4(a) FMS Regulation requires policies/procedures for identification and verification of clients and beneficial owners.
  - Ongoing customer identification, verification, and due diligence: Article 4.4(d) and Article 6(21) require maintaining current information, periodic updates, and scrutiny of transactions for consistency with client profile.
  - Monitoring and recognizing unusual/suspicious transactions: AML Law defines “unusual transaction” and “suspicious transaction” (Article 5.9; Article 2.h (1)); Article 4.2(d) FMS Regulation requires procedures and electronic databases for identifying suspicious/unusual transactions; banks must ascertain transaction purpose and register results in writing.
  - Enhanced due diligence on high-risk accounts: Article 6(22) requires enhanced due diligence, including:
    - a) Obtain permission from senior management to establish business relationship.
    - b) Take reasonable measures to ascertain origin of funds/property.
    - c) Perform enhanced monitoring over business relations.
  - Enhanced due diligence on PEPs: Article 6(1) requires identification of PEPs; Article 2(v) defines PEP (foreign citizen holding prominent public functions), and Article 6-1(2) and Article 6(3) require management approval and enhanced measures for new and existing PEPs; Article 4.4(b) requires special procedures for ascertaining PEP status and taking measures.
  - Recordkeeping and retention:
    - Note: an international standard referenced in EC5 indicates records have at least a five-year retention period.
    - Georgian law: Article 7(3) of the AML Law requires retention of transaction information, unusual transactions, and transactions with watch/suspicious zones for at least six years from the moment of concluding or implementing the transaction, unless a supervisory authority or Georgian legislation sets a longer period.
    - Article 6.6 and Article 7.4 further specify transaction content, identification data, and that records must be retrievable and usable as evidence in criminal proceedings.
    - Article 4.4(d) and Article 11 of the FMS Regulation require systemizing, recording, filing, and electronic/documentary retention of client identification and monitoring information for not less than six years, unless longer terms are set by the NBG or Georgian legislation.
- Reporting, information sharing, and coordination
  - Banks must report STRs to the FMS; there is no explicit legal obligation for banks to report suspicious activities to the NBG when material to safety, soundness, or reputation—banks report to the FMS only.
  - The NBG consults the FMS before on-site visits and forwards any suspicions to the FMS; an MOU exists between the FMS and the NBG.
  - In the event inspections reveal elements of crime, the NBG forwards information to law-enforcement agencies.
- Enforcement powers
  - Under Article 30 (2) of the ABC Law, the NBG is authorized to impose actions and sanctions with respect to banks, administrators, and controlling persons for infractions (see EC8 in the source for full details).
- Assessment: Principle 29 — (assessment result aggregated in source; detailed findings provided above).

*Source: _cr1510 - 2.     Each commercial bank shall submit to the National Bank a complete report of its annual*

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### EC6 — Correspondent banking policies and requirements
- Supervisor determines banks have, in addition to normal due diligence, specific policies and processes regarding correspondent banking, including:
  - (a) gathering sufficient information about their respondent banks to fully understand the nature of their business and customer base, and how they are supervised; and
  - (b) not establishing or continuing correspondent relationships with those that do not have adequate controls against criminal activities or that are not effectively supervised by the relevant authorities, or with those banks that are considered to be shell banks.
- Legal and regulatory provisions:
  - Article 8 of the FMS Regulation on Commercial Banks: banks shall obtain information from public sources on the reputation of the respondent bank and the quality, adequacy, and efficiency of supervision imposed thereon; ascertain whether the bank represents monitoring entity in light of fighting against ML/TF; request from respondent bank information on exercising internal control with respect to fighting against ML/TR; assess quality of such control; prohibited from establishing correspondent relations with shell banks.
  - Banks must undertake reasonable measures to identify:
    - a) whether the person they have a business relationship with (or the person with whom they are establishing business relations) belongs to the category of the shell bank; and
    - b) whether the person they have a business relationship with (or the person with whom they are establishing business relations) has relations with the shell bank.
  - Article 6.6 of the FMS Decree: Georgian banks must request from respondent banks information on internal controls with respect to ML/FT risks.
  - New FMS Decree No. 4: maintains requirement in Article 8, including obligation to request information regarding degree of internal controls applied to ML/FT risks.
  - Article 8.4.(c) of Instruction 24 NBG: to open a cross-border correspondent account, provide “documentation that reflects the policy of the bank against the legalization of illicit income and financing terrorism, and a standard questionnaire will be developed by the bank where the account is being opened.”
  - Article 8.2 of the new FMS Decree No. 4 and Article 8.6 of Instruction 24 NBG: require “authorization of the bank Directorate (curator Director) of a bank to establish a correspondent relationship.”
- Reporting and oversight:
  - Commercial banks are obliged to present information on every respondent institution to the NBG.
  - NBG receives monthly reporting from each commercial bank, where all correspondent accounts are defined in detail.

### EC7 — Controls and systems to prevent, identify, and report abuses (ML/TF)
- Supervisor determines banks have sufficient controls and systems to prevent, identify, and report potential abuses of financial services, including money laundering and the financing of terrorism.
- Key regulatory requirements:
  - Article 6(22) of the FMS Regulation: banks shall have appropriate risk management system for identification and verification of clients whose activity may pose a high risk of ML/TF; exercise enhanced identification, verification, and enhanced monitoring procedures; identification and verification conducted on a risk sensitive basis depending on type and nature of client, business relationship, product/service risk, or transaction.
  - Article 4.4(a,b,e,f) of the Regulation: banks required to develop an internal regulation containing procedures for identification of clients and beneficial owners, procedure for ascertaining PEPs and exercising measures against them, special procedures for revealing bank transactions subject to monitoring, rules for submission of reporting forms and other relevant materials to the FMS, and terms/procedures for permanent and ongoing monitoring of business relationships.

### EC8 — Supervisory powers and enforcement
- Supervisor has adequate powers to take action against a bank that does not comply with obligations related to AML/CTF laws and regulations.
- Legal bases for sanctions:
  - Article 15(5) of the AML Law; Article 14(2) of the FMS Regulation; Article 1.2(d) of Decree N304 of President of NBG (“Regulation on Determining and Imposing Pecuniary Penalties on Commercial Banks”): NBG authorized to sanction (including fiscal penalties) banks for failure to fulfill duties prescribed by AML Law and Regulation.
  - Articles 30(2)(d) and (3) of the Law on the Activities of Commercial Banks: NBG authorized to impose sanctions for noncompliance with AML Law, Regulation and respective written notices of the FMS regarding prevention of ML/TR.
- Range of sanctions available to NBG:
  - a) issue written warnings;
  - b) carry out special actions or issue instructions requiring cessation of certain practices and measures to eliminate violations within a specified period;
  - c) impose fines according to established rules and amounts, but not in excess of bank's own funds;
  - d) impose fiscal penalties in such amounts and pursuant to such procedures, as established by the NBG, if action of the bank's administrators caused financial loss to the bank or permitted the violation of regulations and requirements of the NBG;
  - e) suspend the signing authority of the bank's administrators and require the bank's Supervisory Council to dismiss him or her temporarily or permanently;
  - f) require the Supervisory Council and Directorate to call a special meeting of the bank's shareholders to discuss the violations and to take necessary measures to eliminate them;
  - g) suspend or restrict asset growth, distribution of profits, payment of dividends and bonuses, and salary increases and the reception of deposits;
  - h) in special cases, when the interests of the bank's depositors and other creditors are jeopardized, suspend active operations, and place the bank in temporary administration;
  - i) in special circumstances, when the bank is not able to pay back deposits and other obligations, revoke the bank’s operations and impose the temporary administration;
  - j) request from the controlling persons of a bank to divest or reduce their control in case of failure to provide financial or other information to the NBG or in cases where a violation has been discovered; such divestiture or reduction shall be undertaken in accordance with such terms and conditions the National Bank shall deem necessary in the particular circumstances;
  - k) revoke the bank's license.
- Fines and enforcement activity:
  - Article 2 (8) of the Regulation on Pecuniary Penalties determines particular amounts of fines that can be imposed.
  - Number of fines imposed on banks in recent years: 6 in 2011; 3 in 2012; 7 in 2013 and 4 in the first quarter of 2014.

### EC9 — Internal audit, compliance officers, screening, and training
- Supervisor determines banks have:
  - (a) requirements for internal audit and/or external experts to independently evaluate relevant risk management policies, processes, and controls; supervisor has access to their reports;
  - (b) established policies/processes to designate compliance officers at management level and a dedicated officer to whom potential abuses (including suspicious transactions) are reported;
  - (c) adequate screening policies/processes to ensure high ethical and professional standards when hiring staff or entering into agency/outsourcing relationships;
  - (d) ongoing training programs for staff, including on CDD and monitoring/detection of criminal and suspicious activities.
- Description and findings:
  - (a) Decree N318 of President of NBG “Regulation on Internal Audit Requirements for Commercial Banks” Article 5.1(b): Internal Audit Department responsible for reviewing internal controls system, assessing adequacy and efficiency, preparing recommendations and ensuring implementation. Article 49.1(c): NBG authorized to request any required information (including reports of the Internal Audit Department). Regulations do not specify AML/CTF processes/policies are subject to internal audit review, but in practice AML/CTF processes and policies are in the audit scope of all Georgian banks.
  - (b) Article 5.1(2) of the Regulation on Commercial Banks: banks must designate an employee as the money laundering officer; officer’s position must correspond to that of a senior manager and report solely to the chief executive.
  - (c) Article 4(6) of the Regulation on Commercial Banks: banks required to have a staff recruitment policy, including provisions for fit-and-proper tests, supplemented by internal rules and procedures.
  - (d) Article 4.5.2(g) of the Regulation on Commercial Banks: the money laundering officer must educate other employees on prevention of money laundering and terrorist financing, including organization of special training programs; training should be on a continuous basis.

### EC10 — Internal reporting and management information systems
- Supervisor determines banks have and follow clear policies and processes for staff to report problems related to abuse of financial services to local management and/or the dedicated officer; banks utilize adequate management information systems to provide Boards, management, and dedicated officers with timely and appropriate information.
- Description and findings:
  - Article 4(4) of the Regulation on Commercial Banks: banks required to have internal regulations setting out procedures for reporting ML/TF problems to the money laundering officer.
  - Article 5.4(d): money laundering officer must submit written reports on his/her activities to bank management.
  - Money Laundering Inspection Division inspections: review adequacy of policies and processes; verify implementation and execution by requiring email, documents, and minutes of meetings; read minutes of the Supervisory Board to verify involvement.

### EC11 — Protection for reporting staff
- Laws provide that a member of a bank’s staff who reports suspicious activity in good faith, internally or directly to the relevant authority, cannot be held liable.
- Description and findings:
  - Article 12(4) of the AML Law: bank employees, when acting within the scope of their powers, who report AML/CTF issues to the money laundering officer, or the latter when reporting to the FMS, shall not be held liable for failure to observe confidentiality of information so reported.

### EC12 — Cooperation with domestic and foreign supervisors
- Supervisor, directly or indirectly, cooperates with relevant domestic and foreign financial sector supervisory authorities or shares information related to suspected or actual criminal activities for supervisory purposes.
- Description and findings:
  - Article 5(2) of the NBG Law: NBG, within scope of its competence, shall cooperate with other country’s competent financial sector supervision authority; cooperation includes exchange of information, provided receiving authority respects confidentiality.
  - Practice: NBG has not to date received a request for information from a foreign supervisor; NBG has requested such information from a foreign supervisor on only two occasions.

### EC13 — In-house specialist expertise and risk communication
- Where not done by another authority, supervisor has in-house resources with specialist expertise for addressing criminal activities and regularly provides information on ML/TF risks to banks.
- Description and findings:
  - This role is carried out by the FMS.
  - The FMS regularly provides the banking sector with updated information on risks of money laundering and the financing of terrorism.

### Assessment of Principle 29 and comments
- Assessment: Largely compliant
- Key observations and recommended legislative changes:
  - Legislative basis for dealing with AML/CTF is quite comprehensive; NBG and FMS seem committed to their respective tasks.
  - Banks visited appear well versed in AML/CTF obligations; each had a dedicated Money Laundering Officer and had been subject to an NBG inspection recently.
  - Identified weakness: EC3 — there is no explicit obligation on banks to report suspicious activities and incidents of fraud to the NBG where such activities/incidents are material to the safety, soundness, or reputation of the banks. NBG indicates banks would report such cases and that FMS would bring them to its attention; nonetheless, legislation should explicitly obligate banks to inform the NBG of any such activities/incidents.
  - Legislation change recommended: bring the definition of PEP in line with the current FATF definition, namely, domestic as well as foreign persons.
  - Institutional note: the move of the FMS from under the auspices of the NBG to the Office of the Prime Minister should not compromise its independence in any way.
  - Resource note: an IMF detailed assessment report on AML undertaken in July 2012 noted significant improvement since 2007 and that the NBG had insufficient AML resources (i.e., five people). This has since been increased to 18.

*Source: IMF country report content provided.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1510.pdf_