## _cr15164 ## Source details **Canonical URL:** [_cr15164](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15164.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15164.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15164.pdf.json) --- ### Major findings: macrofinancial setting and banking sector - Economic and financial activity remains stuck in a low gear since the global financial crisis, reflecting weak external demand, tighter funding conditions, and deep seated structural issues. - System-wide NPL ratio: 14 percent at end-2014, about two thirds of which are provisioned. - Bank ownership and capital: - The banking system is more than 80 percent foreign-owned banks. - Average regulatory capital adequacy ratio exceeded 16 percent as of end 2014. - Dispersion in capital adequacy ranges from about 7 percent to 48 percent across banks. - Historical credit dynamics: - Bank credit to the private sector grew at an average annual rate of around 25 percent over 2003-07. - Credit-to-GDP ratio rose from around 35 percent to 45 percent over 2003-07. - GDP growth averaged around 5 percent over 2001–08, but has remained sluggish since the crisis. - Central bank and safety-net context: - The Currency Board Arrangement (CBA) fixes the convertible marka to Euro and constrains monetary policy and systemic liquidity management. - CBBH foreign reserve cover stands at 107 percent of CBBH monetary liabilities as of 2014Q3. - Key vulnerabilities concentrated in domestically-owned banks, governance problems, related-party lending, small insurance sector with thin solvency margins, payment system legal finality concerns, AML/CFT implementation gaps, and small capital markets constrained by collateral and repossession issues. ### Recent macroeconomic outcomes and household/corporate debt - Real GDP growth: 1 percent in 2014. - Consumer prices: fell by 0.9 percent in 2014. - Unemployment rate: above 27 percent. - Credit to the private sector: averaging around 3 percent growth since 2010. - Corporate sector debt at end-2013: around 69 percent of GDP. - Household debt: around 30 percent of disposable income. - Severe flooding in May 2014 negatively affected the economy. ### Financial sector structure and exposures - BiH entities and oversight: - Federation of Bosnia and Herzegovina (FBiH) and Republika Srpska (RS) hold entity-level regulatory and supervisory responsibilities by Constitution. - CBBH and Deposit Insurance Authority (DIA) reside at the state level. - Banking sector: - Banking sector accounts for 87 percent of financial system assets, equivalent to 84 percent of GDP as of end-2013. - Twenty seven banks: 17 in FBiH (70 percent of system) and 10 in RS (30 percent). - Five largest banks represent over half of banking sector assets. - Ownership composition of banking sector assets: Foreign subsidiaries: 82 percent; Domestically-owned banks: 16 percent; Public banks: 2 percent. - Non-banking financial system small: insurance penetration about 2 percent of GDP; nonlife segment collects over 80 percent of premiums. - Interconnectedness: - Insurance companies’ deposits in banks: about 40 percent of insurers’ total assets. - IRBRS significant in RS banking via credit lines, deposits, capital. - Largest foreign banks mainly from Austria and Italy; Austrian and German exposures account for nearly 50 percent of banks’ total foreign claims and comprise ⅓ of banking sector regulatory capital through correspondent accounts. ### Financial system resilience — banking sector snapshot and liquidity - System-wide NPLs: rose from 3 percent in 2006 to 14 percent at end-2014 (9 percentage points are provisioned). - Average regulatory capital adequacy ratio: exceeded 16 percent as of end 2014; dispersion from about 7 percent to 48 percent. - Liquidity indicators as of 2014Q4: - Liquid assets: 26¾ percent of total assets. - Liquid assets: 46 percent of short term liabilities. - Excess reserves: 150 percent of requirements. - Loan-to-deposit ratio: 120 percent. - Required reserve (RR) rates: - 10 percent for liabilities with a contractual maturity of up to one year. - 7 percent for other liabilities. - Domestically-owned banks exhibit lower and declining liquidity and capital ratios, large concentrations, weaker asset quality and profitability; AQRs of three domestically-owned banks revealed capital shortages, of which only two had been corrected so far. - Bobar Bank liquidated on December 22, 2014; DIA started deposit pay-out on January 19, 2015. ### Resilience and stress-test findings - Aggregate solvency and liquidity indicators broadly sound, but significant pockets of vulnerability exist, notably among domestically-owned banks with concentration risks and low liquidity ratios. - Stress-test coverage and methodology: - Covered all 27 banks; top-down (TD) and bottom-up (BU) approaches; liquidity stress tests using Basel III LCR and NSFR-type proxies; contagion and sensitivity analyses included. - Stress horizon: 5 years (2015-2019). - Three macro scenarios: baseline and two adverse scenarios with five-year macro projections. - Top-down stress test results (selected figures): - Loan losses due to credit risk ranged from 1.9 percent of GDP in Adverse Scenario 1 to 7 percent of GDP in the most severe scenario. - Potential system-wide capital shortfalls: around 0.1 percent of GDP in Adverse Scenario 1 and 4 percent of GDP in Adverse Scenario 2. - System-wide CAR before shock: 17.3 percent. - Total regulatory capital - before shock: 2,938,843 (thousands of KM); Tier 1 capital: 2,624,308 (thousands of KM); Total RWAs: 16,942,976 (thousands of KM); Total assets: 21,783,153 (thousands of KM). - Stress outcomes (CAR after shock, Top-Down / Bottom-Up): Baseline: 18.6 / 19.0; Adverse Scenario 1: 16.3 / 17.2; Adverse Scenario 2: 5.6 / 14.0. - Implied capital shortfall (if any) examples: Adverse Scenario 2 Top-Down: 1,149,405; Adverse Scenario 2 Bottom-Up: 122,731. - Number of banks with CAR below 12 percent: Adverse Scenario 1 Top-Down: 5; Adverse Scenario 2 Top-Down: 22; Adverse Scenario 2 Bottom-Up: 13. - Concentration risk sensitivity: - Up to 11 banks could become insolvent if a few of their largest exposures default. - Credit concentration stress: assumed recovery rates and system-wide CAR and implied capital shortfalls reported for recovery rates 36 percent, zero percent, and 70 percent (detailed figures provided in source). - Liquidity stress-test aggregated results (Appendix Table 11): - LCR (including "required reserves"): System-wide LCR: 291.73 (BiH); FBiH: 348.6; RS: 205.2. - Implied liquidity shortfall (including RR): 70.2 (BiH), 49.7 (FBiH), 20.4 (RS) (in millions of BAM). - Number of banks with LCR below 100 percent (including RR): 5 (BiH), 2 (FBiH), 3 (RS). - LCR (excluding "required reserves"): System-wide LCR: 200.52 (BiH); FBiH: 241.5; RS: 138.1. - Implied liquidity shortfall (excluding RR): 324.6 (BiH), 142.7 (FBiH), 181.9 (RS) (in millions of BAM). - Number of banks with LCR below 100 percent (excluding RR): 11 (BiH), 6 (FBiH), 5 (RS). - NSFR system-wide: 123.0 (BiH); FBiH: 127.4; RS: 114.0. - NSFR implied liquidity shortfall: 322.8 (BiH), 209.9 (FBiH), 112.9 (RS) (in millions of BAM). - Number of banks with NSFR below 100 percent: 7 (BiH), 4 (FBiH), 3 (RS). - Contagion and cross-border spillovers: - Domestic interbank exposures < 1 percent of total regulatory capital. - Network analysis indicates potential sizeable effects on capital adequacy from credit and funding shocks abroad. - At end-March 2014, BiH banks had exposures to banking systems in over 30 named countries; with sovereign exposures included, exposures increase to over 100 countries. ### Insurance sector: solvency, liquidity, and linkages to banks - Sector-wide solvency ratios reported high, but several insurers have thin solvency margins; Solvency I may overstate solvency for life companies. - For some non-life insurers, combined ratios exceed 100 percent. - Over 40 percent of insurance sector assets are in bank deposits. - In a severe adverse stress scenario, the insurance sector would lose about 14 percent of its capital. - Selected insurance-sector figures (2009–2013, In KM million): - Total assets: 1006.9, 1011.3, 1076.8, 1173.8, 1234.2 - Gross premium: 458.9, 470.5, 488.1, 505.1, 527.0 - Investments: 647.1, 667.0, 725.4, 801.7, 892.7 - Cash and bank balances: 347.1, 380.1, 433.8, 495.7, 571.5 - Real estate and related: 162.7, 137.4, 144.2, 154.8, 165.6 - Government securities: 10.7, 19.0, 27.3, 36.7, 56.1 ### Payment system (RTGS) assessment and recommendations - Achievements and resilience: - Modern RTGS and giro clearing system; interbank payment system operated normally during May 2014 floods. - Contingency arrangements include a disaster recovery site ~200 kilometers from primary site; regular tests three times a year. - Weaknesses and recommendations: - Legal finality and netting require greater statutory certainty; transactions settled in RTGS could potentially be revoked by court order in participant insolvency. - Eliminate zero-hour rules in insolvency law; adopt explicit law on settlement finality. - Develop comprehensive risk-management framework for RTGS covering legal, liquidity, and operational risks. - Establish recovery time objective to resume operations within two hours following a disruptive event. - Strengthen liquidity risk management, stress test RTGS for default of largest participant and affiliates, establish throughput rules, monitor intraday liquidity. - Review fee schedules, set minimum service levels, conduct annual cost accounting of payment system. - Strengthen legal framework to designate payment systems and protect finality and netting; adopt Principles for Financial Market Infrastructures. - Establish a new oversight unit in the Payment Systems Department, staffed with sufficient resources and separation from operational duties to avoid conflicts of interest. - Develop MoUs to strengthen oversight of clearing agents, settlement banks, international payment clearing, and cooperation with relevant authorities. - Authorities’ response indicates commitment to observe recommendations and publish plans and translations of CPMI-IOSCO principles. ### Legal, insolvency, and NPL resolution impediments - Legal framework for creditor/debtor relationships is comprehensive but operationally slow: - Execution procedures are slow and need streamlining. - Out-of-court restructuring guidelines and incentives for early initiation of insolvency proceedings are lacking. - Need for more commercial court judges and improved regulation of insolvency profession. - Specific impediments: - Transfer of non-cancelled NPLs impeded by inconsistent interpretation of Law on Obligations and Laws on Banking; Law on Protection of Users of Financial Services creates legal impediments for loans to natural persons. - Non-possessory pledges not widely used; recovery rates on pledged loans are very low. - No insolvency regime for individual debtors; insolvency law applies only to legal entities and partners in partnerships. - Recommended reforms: - Ensure supervisors can monitor NPLs held by AMCs via consolidated supervision. - Maintain NPLs on a credit register. - Establish streamlined insolvency/restructuring framework to facilitate least-cost solutions and preserve jobs. - Speed up litigation, execution, and bankruptcy cases; provide resources and training to courts. - Review tax laws to encourage debt restructuring and sale of NPLs, including consideration of exempting transfers of NPLs from VAT. ### Financial sector oversight, governance, and macroprudential framework - Banking supervision progress since 2006, but shortcomings remain: - Need new Law on Banks to address supervisory powers, recovery/resolution, and consolidated supervision. - Coordination among oversight institutions is complex; information sharing gaps exist. - MOUs with some home supervisors missing for systematically important banks (Austria, Italy, Russia); authorities working on MoUs with Austria and Italy. - Supervisory coverage gaps: incomplete identification of ultimate beneficiary owners and related-party/group exposures. - Governance and audit weaknesses: external audit quality issues; auditors appointed for one year; AQRs revealed weaknesses not caught by external audits. - Loan loss provisioning: - Based on IAS and prudential requirements; IAS provisioning may be inadequate in practice. - Recommendation: develop supervisory standards encouraging conservative implementation of IAS impairment assumptions. - Insurance supervision: - Prudential framework based on Solvency I; tariff-compliance weak, MTPL dominates premiums. - Key supervisory powers missing; FBIH-ISA understaffed and lacks some legal powers. - Recommendation: consider merging insurance supervision into respective banking agencies; strengthen group supervision and cooperation with banking supervisors. - Macroprudential toolkit: - Relatively underdeveloped; main instrument is reserve requirements (RRs). - Authorities plan to introduce countercyclical capital buffers and capital surcharges on systemic banks. - Recommendations: broaden macroprudential framework, underpin cooperation among CBBH, FBA and BARS using existing MoU, examine LTV and DTI levels, and undertake quarterly high-level consultations on systemic risks. ### Financial safety net, resolution framework, and emergency liquidity options - Key deficiencies: lack of comprehensive remedial action program, inadequate resolution powers, inability to provide temporary emergency liquidity support. - Crisis preparedness and DIA: - DIA: reserves about KM 285 million (€ 145 million) representing approximately 4½ percent of insured deposits; supported by a €50 million standby facility with the EBRD. - DIA recommended to establish capacity for prompt pay-outs in line with EU directive, amend legislation to authorize prompt pay out and use funds for P&A under least cost solution, and be involved early in problem bank resolution. - Bank resolution and resolution authority design: - FBA and BARS have some resolution powers but are not formally designated resolution authorities. - Recommended: vest resolution powers in FBA and BARS for banks in their jurisdictions, following FSB Key Attributes and EU BRRD principles, with governance safeguards to avoid conflicts of interest. - Broaden DIF scope to allow funding of bank resolution subject to least-cost solution; DIF should not be used for open bank assistance. - Financial Stability Fund (FSF) and emergency liquidity: - Recommend establishing an FSF under DIA to provide open bank resolution and limited and temporary liquidity support in systemic crisis, subject to strict criteria and safeguards. - FSF financing options: ex-ante levies, ex-post levies, possible IFI financing, and switching a portion of potential RR increases into the FSF. - FSF administration: administered by DIA and separated from DIF with clear governance arrangements. - Limited and temporary emergency liquidity assistance (ELLA) could be provided by FSF given CBBH legal constraints under the CBA, to solvent systemic banks meeting conditions (capital, management, collateral/guarantees). - Emergency liquidity support should be accompanied by enhanced monitoring and enforcement; breach of FSF terms grounds for resolution. ### Immediate strategic priorities (selected) - Decisive and timely actions to deal with weak banks: - Develop a comprehensive strategy with diagnostic assessment to facilitate recovery where practicable or resolve banks cost-effectively while protecting insured depositors. - Spell out and communicate clear timetable for corrective or resolution steps. - Consider credible and transparent public backstop for potentially systemic cases. - Strengthen supervisory capacities and powers: - Enhance cooperation among oversight institutions. - Strengthen governance, risk management, supervisory board selection, and internal audit functions of state banks. - Improve identification of ultimate beneficial owners; increase transparency of related-party lending and group exposures. - Build coordinated financial safety net under the CBA: - Create resolution authorities with comprehensive powers, appropriate resolution tools, and temporary and limited emergency liquidity. - Shorten deposit insurance payout period in line with the EU relevant directive. - Improve contingency planning and cross-border coordination; sign MOUs with home supervisors of systematically important foreign banks. ### Key numerical and macro indicators (selected series and tables) - Nominal GDP (in KM million, selected series): 25,734 26,297 26,500 27,124 28,380 29,913 31,688. - Real GDP (period series): -1.2 2.5 0.8 2.3 3.1 3.6 3.8. - CPI (period average): 2.0 -0.1 -0.9 0.6 1.1 1.2 1.3. - Credit to the private sector (end of period): 2.8 2.3 1.7 2.1 2.8 4.9 6.5. - Total public debt (percent of GDP): 42.7 42.6 45.9 47.3 47.1 46.1 43.7. - Gross official reserves (in EUR million): 3,326 3,613 3,997 4,184 4,410 4,801 4,949. - Foreign-currency-denominated loans to total loans: 68.7 71.0 74.1 73.3 73.9 70.0 66.9 63.1 62.9 62.4. - Financial soundness indicators (selected, 2005–2014): - Regulatory capital to RWAs: 17.8 17.7 17.1 16.2 16.1 16.2 17.1 17.0 17.8 16.4. - NPLs to gross loans: 5.3 4.0 3.0 3.1 5.9 11.4 11.8 13.5 15.1 14.0. - Provisions to NPLs (selected): 34.5 43.7 66.3 65.9 66.7 70.2. - Liquid assets to total assets: 36.1 35.9 37.7 30.0 30.9 29.0 27.2 25.4 26.4 26.8. - System-wide LCR (including required reserves): 291.73 (BiH); excluding required reserves: 200.52 (BiH). - System-wide NSFR: 123.0 (BiH). ### Key policy recommendations (selected from Key FSAP Recommendations) - Banking oversight and remedial actions: - Develop a remedial action program with new tools, earlier enforcement and fines to expedite corrective action (FBA, BARS, relevant Ministries of Finance and Justice). (40) NT - Strengthen provisioning under IAS by issuing standards to encourage conservative assumptions on impairment by banks (FBA, BARS). (42) MT - Enact new Laws on Banks and amend relevant legislation addressing deficiencies in supervisory powers, consolidated supervision, and identification of ultimate beneficiary owners (FBA, BARS, CBBH, Ministries). (36) I - Conduct additional AQRs in banks with weak solvency and liquidity indicators (FBA, BARS). (16) I - Assure continued implementation of IFRS and external auditor implementation of IAS (FBA, BARS). (41) MT - Insurance oversight: - Appoint FBiH-ISA director per relevant law (Government). (45) MT - Approve new insurance law in FBiH if it improves convergence towards EU directives (FBiH-ISA). (44) I - Update solvency regime by gradual incorporation of risk elements and develop an early warning system, including prompt corrective actions (ISAs). (44) I - Financial safety net, NPL resolution, and systemic liquidity: - Revise reserve requirements, maturity mismatch, and liquidity ratio (CBBH, FBA, BARS). (55) NT - Design and implement the LCR, adapted to BiH (FBA, BARS). (55) MT - Enable prompt depositor pay-out (DIA). (60) I - Provide resolution powers to FBA and BARS on new Laws on Banks, following FSB Key Attributes and EU BRRD (FBA, BARS, DIA, relevant Ministries). (65) I - Broaden scope to draw on the existing DIF for funding bank resolution using least-cost solution (DIA). (66) I - Establish a Financial Stability Fund (FSF) under DIA to provide open bank resolution and limited and temporary liquidity support in systemic crisis (DIA, CBBH, FBA, BARS, Governments). (67) MT - Add macroprudential analysis and policy to the coordination MoU and collect additional information for vulnerabilities assessment (CBBH, FBA and BARS). (52) NT - Financial Market Infrastructure: - Strengthen legal framework to designate payment systems and protect settlement finality and netting (CBBH). (48) NT - Develop a comprehensive risk management framework for the RTGS system (CBBH). (47) I - Establish a new oversight unit in Payment Systems Department with sufficient resources (CBBH). (48) NT - Insolvency, restructuring and collateral: - Streamline collateral execution procedures, allow final auction at no reserve price if prior rounds fail, and specify realistic asset market value criteria (RS/FBiH Ministry of Justice). (34) I - Consider tools and incentives to facilitate restructurings and adoption of out-of-court restructuring guidelines (RS/FBiH/BiH MoF, FBA, BARS). (31) I - Revise insolvency framework to incentivize early initiation and expand to cover businesses run by individuals (RS/FBiH MoJ). (35) NT *Source: Excerpts from the IMF staff report content unit _cr15164* ### EXECUTIVE SUMMARY ___________________________________________________________________________ 6 ### EXECUTIVE SUMMARY ### Major findings: macrofinancial setting and banking sector - Economic and financial activity in Bosnia and Herzegovina (BiH) remains stuck in a low gear since the global financial crisis, reflecting weak external demand, tighter funding conditions, and deep seated structural issues. - System-wide NPL ratio: 14 percent at end-2014, about two thirds of which are provisioned. - Bank ownership and capital: - The banking system is more than 80 percent foreign-owned banks. - Average regulatory capital adequacy ratio exceeded 16 percent as of end 2014. - Dispersion in capital adequacy ranges from about 7 percent to 48 percent across banks. - Historical credit dynamics: - Bank credit to the private sector grew at an average annual rate of around 25 percent over 2003-07. - Credit-to-GDP ratio rose from around 35 percent to 45 percent over 2003-07. - GDP growth averaged around 5 percent over 2001–08, but has remained sluggish since the crisis. - Central bank and safety-net context: - The Currency Board Arrangement (CBA) fixes the convertible marka to Euro and constrains monetary policy and systemic liquidity management. - CBBH foreign reserve cover stands at 107 percent of CBBH monetary liabilities as of 2014Q3. - Key vulnerabilities: - Concentration of vulnerabilities in domestically-owned banks: some struggling to meet capital requirements, some relying on public support. - Bank governance problems, related-party lending, inadequate corporate resolution and insolvency frameworks impede NPL resolution and recovery. - Insurance sector small; a number of companies have thin solvency margins. - Payment system: legal finality and netting require greater statutory certainty; liquidity concentrated in a few banks. - AML/CFT framework has improved but remaining deficiencies and implementation gaps persist. - Capital markets are small; microfinance and leasing constrained by collateral and repossession issues. ### Resilience and stress-test findings - Aggregate solvency and liquidity indicators appear broadly sound, but significant pockets of vulnerability exist. - Stress tests indicate domestically-owned weak banks exhibit: - Large concentration risks. - Low liquidity ratios. - FSAP team access to supervisory data was exceptionally good at individual, group, and system-wide levels. ### Legal and institutional impediments to NPL resolution - The legal framework for creditor/debtor relationships is comprehensive but: - Execution procedures are slow and need streamlining. - Out-of-court restructuring guidelines and incentives for early initiation of insolvency proceedings are lacking. - Need for more commercial court judges with appropriate experience and improved regulation of the insolvency profession. ### Policy recommendations and priorities (selected from Key FSAP Recommendations) - Banking oversight and remedial actions: - Develop a remedial action program focusing on new tools, earlier step-up enforcement and heavier fines to expedite corrective action (FBA, BARS, relevant Ministries of Finance and Justice). (40) NT - Strengthen provisioning under IAS by issuing standards to encourage conservative assumptions on impairment by banks (FBA, BARS). (42) MT - Enact new Laws on Banks and amend relevant legislation addressing deficiencies in supervisory powers, consolidated supervision, and identification of ultimate beneficiary owners (FBA, BARS, CBBH, Ministries). (36) I - Conduct additional AQRs in banks with weak solvency and liquidity indicators (FBA, BARS). (16) I - Assure that banks continue implementing IFRS and external auditor implement IAS (FBA, BARS). (41) MT - Insurance oversight: - The appointment of the FBiH-ISA director should be based on the relevant law (Government). (45) MT - The new insurance law in the FBiH should be approved if it shows improved convergence towards the EU insurance directives (FBiH-ISA). (44) I - Update solvency regime by a gradual incorporation of risk elements, develop an early warning system, including prompt corrective actions. Capacity building is required (ISAs). (44) I - Financial safety net, resolution of NPLs, and systemic liquidity management: - Revise the reserve requirements, maturity mismatch, and the liquidity ratio (CBBH, FBA, BARS). (55) NT - Design and implement the LCR, adapted to BiH (FBA, BARS). (55) MT - Enable prompt depositor pay-out (DIA). (60) I - Provide resolution powers to the FBA and BARS for banks in their respective jurisdictions on the new Laws on Banks, following the FSB Key Attributes and EU BRRD (FBA, BARS, DIA, relevant Ministries). (65) I - Broaden the scope to draw on the existing DIF for funding bank resolution using least-cost solution (DIA). (66) I - Establish a Financial Stability Fund (FSF)—under the DIA—to provide for open bank resolution and limited and temporary liquidity support in systemic crisis (DIA, CBBH, FBA, BARS, Governments). (67) MT - Add macroprudential analysis and policy to the coordination MoU. Define and collect additional information for the assessment of vulnerabilities and macroprudential tools (CBBH, FBA and BARS). (52) NT - Financial Market Infrastructure: - Strengthen the legal framework to designate payment systems, and to protect settlement finality and netting in line with international standards (CBBH). (48) NT - Develop a comprehensive risk management framework for the RTGS system (CBBH). (47) I - Establish a new oversight unit in Payment Systems Department, which is staffed with sufficient resources to carry out oversight responsibilities (CBBH). (48) NT - Insolvency, restructuring and collateral: - Streamline collateral execution procedures by allowing a final auction at no reserve price if previous rounds of auctions failed and specify realistic criteria for asset market values (RS/FBiH Ministry of Justice). (34) I - Consider tools and incentives to facilitate restructurings and debt resolution as well as adoption of out-of-court restructuring guidelines. (RS/FBiH/BiH MoF, FBA, BARS). (31) I - Revise the insolvency framework by introducing incentives to initiate proceedings early and expand the insolvency framework to cover businesses run by individuals. (RS/FBiH MoJ). (35) NT ### Immediate strategic priorities highlighted - Decisive and timely actions to deal with weak banks are critical to preserve financial stability: - Develop a comprehensive strategy backed by a credible diagnostic assessment to facilitate recovery where practicable or to resolve banks cost-effectively while protecting insured depositors. - Spell out and communicate a clear timetable for corrective or resolution steps. - Consider a credible and transparent public backstop for potentially systemic cases. - Strengthen supervisory capacities and powers: - Enhance cooperation among oversight institutions to reduce complexity in times of stress. - Strengthen governance, risk management, supervisory board selection, and internal audit functions of state banks. - Improve identification of ultimate beneficial owners; make related-party lending and group exposures more transparent. - Build a stronger, coordinated financial safety net under the CBA: - Create resolution authorities with comprehensive powers, appropriate resolution tools, and temporary and limited emergency liquidity. - Shorten deposit insurance payout period in line with the EU relevant directive. - Improve contingency planning and cross-border coordination. *Source: EXECUTIVE SUMMARY, _cr15164* ### 4. Recent data suggests that the economy still is struggling. Reflecting the effects of severe ### 4. Recent data suggests that the economy still is struggling. Reflecting the effects of severe ### Recent macroeconomic outcomes - Real GDP growth is estimated to have slowed to 1 percent in 2014. - Consumer prices fell by 0.9 percent in 2014. - The unemployment rate remains at above 27 percent. - Credit to the private sector continues to grow slowly (averaging around 3 percent since 2010), although credit expansion is more rapid among some banks that are attempting to gain market share. - Severe flooding in May 2014 negatively affected the economy. ### Credit, corporate and household debt - Corporate sector debt at end-2013 stood at around 69 percent of GDP. - Household debt has remained steady at around 30 percent of disposable income. - There are signs of increased reliance on short-term debt in the form of credit card or general consumption loans, suggesting stretched incomes and increasing debt service liabilities. - Corporates largely rely on bank credit for financing, although intercompany debt has been growing recently. ### Financial sector structure - BiH is divided into two semi-autonomous political entities—the Federation of Bosnia and Herzegovina (FBiH) and the Republika Srpska (RS); regulatory and supervisory responsibilities for banking, insurance, and capital markets lie at the entity level by Constitution. - The CBBH and Deposit Insurance Authority (DIA) reside at the state level. - The banking sector accounts for 87 percent of financial system assets, equivalent to 84 percent of GDP as of end-2013. - There are twenty seven banks operating in the country (17 in FBiH and 10 in RS, with a share of 70 and 30 percent, respectively, of the country’s banking system). - The five largest banks represent over half of banking sector assets. - Ownership composition of banking sector assets: - Foreign subsidiaries: 82 percent - Domestically-owned banks: 16 percent - Public banks: 2 percent - Non-banking financial system is small: - Insurance penetration is low at about 2 percent of GDP. - The nonlife segment collects over 80 percent of insurance premiums. - One stock exchange in each entity; capital markets remain underdeveloped despite advanced infrastructure. - Interconnectedness: - Interconnectedness among banks is limited. - Linkages between banks and the insurance sector, as well as the RS development bank (IRBRS), are significant. - Insurance companies’ deposits in the banking sector amount to about 40 percent of the insurers’ total assets. - IRBRS plays a major role in the RS banking system through credit lines, deposits, and capital. - Largest foreign banks are from Austria and Italy; foreign banks from these two countries constitute almost 60 percent of total banking sector assets in BiH. - Direct exposure: BiH banking sector is mostly exposed to Austria and Germany, accounting for nearly 50 percent of banks’ total foreign claims and comprising ⅓ of banking sector regulatory capital through correspondent accounts. ### Financial system resilience — banking sector snapshot - System-wide NPLs ratio rose from 3 percent in 2006 to 14 percent at end-2014 (9 percentage points are provisioned). - Average regulatory capital adequacy ratio exceeded 16 percent as of end 2014, with dispersion ranging from about 7 percent to 48 percent across banks. - Recent natural disaster prompted regulatory forbearance for loan classification, but had a mild impact on asset quality so far. - Liquidity indicators as of 2014Q4: - Liquid assets stood at 26¾ percent of total assets. - Liquid assets stood at 46 percent of short term liabilities. - Excess reserves were 150 percent of requirements despite high required reserves (RR). - Loan-to-deposit ratio stands at 120 percent. - Required reserve (RR) rates: - 10 percent for liabilities with a contractual maturity of up to one year. - 7 percent for other liabilities. - Domestically-owned banks show pockets of vulnerability: - Lower and declining liquidity and capital ratios. - Large concentrations and weaker asset quality and profitability compared with foreign banks. - Asset quality reviews (AQRs) of three domestically-owned banks under enhanced supervision revealed capital shortages, of which only two had been corrected so far. - Public sector support: - Some domestically-owned banks rely heavily on public sector support and exit plans are undefined. - In RS, IRBRS holds shares and subordinated debt in some domestically-owned banks, provides credit lines for on-lending, and makes deposit placements in four domestically-owned banks. - In FBiH, some public sector entities have stakes in domestically-owned banks. - Bobar Bank was liquidated on December 22, 2014, and the DIA started the deposit pay-out on January 19, 2015 — constituting the first deposit pay-out of the DIA. ### Dealing with weak banks — recommended strategy - Strong and timely action is needed to deal with weak banks; many banks do not meet prudential capital requirements or meet them only due to public capital support. - Public capital support has often been provided as subordinated debt and preferred shares, which: - Does not dilute existing equityholders. - Contributes to moral hazard, lacks transparency, and is not conducive to a level playing field. - Unless owners provide significant capital support, phase-out related party loans, and address asset quality issues, weak banks will need to be restructured and/or resolved. - The team recommended development, as a matter of high priority, of a thorough plan to either facilitate recovery of weak banks (if practicable) or implement cost-effective resolution consistent with maintaining financial stability and protecting insured depositors. The plan should include: - Additional time-bound AQRs of domestically-owned banks and a strategy to address potential implications. - Exploration of all options for early action. - Ensuring technical readiness of the DIA to pay-out depositors promptly. - Consideration of a credible and transparent public backstop may be needed to deal with systemic cases. ### Stress tests and tail risks - Stress tests covered all 27 banks; top-down (TD) solvency stress tests were conducted jointly by the FSAP team and CBBH using supervisory data, complemented by bottom-up (BU) stress tests by individual banks. - Additional tests included liquidity stress tests, contagion risk analysis, and sensitivity analysis such as concentration risks. - Three macroeconomic scenarios were considered: baseline (based on latest WEO staff projections) and two adverse scenarios with full-fledged five-year macroeconomic projections quantified. - Top-down stress test findings: - Potential credit risk losses on the loan book represent the most important risk factor. - Aggregate stress losses—mainly related to increased loan provisions—remain broadly manageable. - Loan losses due to credit risk ranged from 1.9 percent of GDP in the first adverse scenario to 7 percent of GDP in the most severe scenario. - Top-down stress tests suggest potential system-wide capital shortfalls could be around 0.1 percent of GDP in Adverse Scenario 1, and 4 percent of GDP in Adverse Scenario 2. - Top-down and bottom-up results are broadly consistent; differences mainly reflect larger provisions for impaired loans in TD results and relatively modest macroeconomic response in BU results. - Concentration risks: - Average large exposures remain moderate, but a few domestically-owned banks present very large single (and common) name exposures mainly to large state-owned enterprises. - Sensitivity analysis shows potential losses remain broadly manageable at the system level, but up to 11 banks could become insolvent if a few of their largest exposures were to default. - Market and exchange rate risks: - Nearly two-thirds of loans are in, or indexed to a foreign currency, mostly euros. - Parent bank funding and relatively large remittance inflows have contributed to the euroization of deposits. - All banks comply with regulatory limits and exhibit fairly small net open FX positions; net open FX positions across currencies do not necessarily move in the same direction, providing a natural hedge. - Limited securities holdings mean other sources of market risk appear contained. - Indirect FX risks and unhedged borrowers: - Most banks do not collect information on the denomination of their borrowers’ income or assets. - Potential losses related to indirect foreign-exchange risk (through credit risk) could not be appropriately quantified due to lack of data. - Given large issuance of FX-linked loans, the team recommends that banks and supervisors close data gaps and respond as appropriate. *Source: IMF staff report (excerpts).* ### 23. With a few exceptions, bank liquidity positions appear to be sound. Liquidity stress ### With a few exceptions, bank liquidity positions appear to be sound. Liquidity stress ### Bank liquidity positions and stress-test results - System-wide Liquidity Coverage Ratio (LCR) exceeds 250 percent. - Liquidity stress tests use Basel III LCR and NSFR type proxies and show that the system as a whole has ample liquidity. - Most banks hold sizeable amounts of deposits at the CBBH. - A few banks, mainly domestic-owned, present relatively low liquidity ratios (see Appendix Table 11). - Potential system-wide liquidity shortfall could be around ¼ percent of GDP. - If required reserves were excluded from banks’ HQLA in the LCR computation, the potential system-wide liquidity shortfall would increase to just over 1 percent of GDP. - Net Stable Funding Ratio (NSFR) and LCR results reported (Figure 10) support ample liquidity at system level. ### Contagion and interbank market risks - Domestic interbank exposures among banks are less than 1 percent of total regulatory capital. - Some banks engage in overnight over-the-counter transactions of deposits, FX, and cash, but system-wide exposures appear relatively small. - In one particular hypothetical case, the default of a large domestic bank on its interbank obligations would trigger the undercapitalization (CAR below 12 percent) of a small domestic bank in the system. ### Cross-border exposures and spillover analysis - Several foreign-owned banks benefit from credit lines from parent banks; most BiH banks hold large amounts of deposits in correspondent accounts abroad with large global financial institutions. - A few banks, mainly domestically-owned, exhibit “round-tripping” of cross-border exposures where claims and liabilities to a counterparty are roughly the same. - Network analysis using bilateral exposures suggests that the effects (direct and indirect) on capital adequacy of potential credit and funding shocks from abroad could be sizeable (Figure 11). - At end-March 2014, BiH banks had exposures to the banking systems of: Albania, Australia, Austria, Azerbaijan, Bahrain, Belgium, Bulgaria, Canada, Croatia, Denmark, Estonia, France, Germany, Greece, Hungary, Italy, Japan, Kosovo, Kuwait, Liechtenstein, Lithuania, Luxembourg, Macedonia, Montenegro, Netherlands, Norway, Russia, Saudi Arabia, Serbia, Slovakia, Slovenia, Sweden, Switzerland, Turkey, United Arab Emirates (UAE), U.K., and U.S. With sovereign exposures included, the number of countries increases to over 100. ### Insurance sector: solvency, liquidity, and linkages to banks - Sector-wide solvency ratios are reported as high, but a number of insurance companies have thin solvency margins (Appendix Table 4). - The system is dominated by non-life companies; life insurance is in an early stage and solvency ratios may be overstated owing to use of Solvency I. - For some non-life insurers, combined ratios (claims plus expenses over premiums) exceed 100 percent, implying profits depend on investment performance. - Over 40 percent of insurance sector assets are in bank deposits. - Network analysis indicates that in a severe adverse scenario of the stress tests, the insurance sector would lose about 14 percent of its capital. - Selected insurance-sector size and investment figures (2009–2013, In KM million): - Total assets: 1006.9, 1011.3, 1076.8, 1173.8, 1234.2 - Gross premium: 458.9, 470.5, 488.1, 505.1, 527.0 - Investments: 647.1, 667.0, 725.4, 801.7, 892.7 - Cash and bank balances: 347.1, 380.1, 433.8, 495.7, 571.5 - Real estate and related: 162.7, 137.4, 144.2, 154.8, 165.6 - Government securities: 10.7, 19.0, 27.3, 36.7, 56.1 ### Payment system resiliency and risks - Interbank payment system resiliency was demonstrated during recent floods; contingency arrangements include a disaster recovery site at a distant location from the primary site. - RTGS pre-funding eliminates credit risks; CBBH is prohibited from extending intraday credit and strict rules on use and replenishment of RR provide discipline. - Liquidity risks remain due to high concentration of payment transaction values: 55 percent of transaction value is concentrated across five banks, including two settlement banks. - Recommendations and findings on payments infrastructure: - Finality and netting arrangements require greater legal certainty at the statutory level; transactions settled in RTGS could potentially be revoked by court order in participant insolvency. - Eliminate zero-hour rules in insolvency law to increase legal certainty. - Develop a comprehensive risk-management framework that includes formal risk identification, mitigation, and monitoring. - Strengthen liquidity risk management (see paragraph 29). - Establish a recovery time objective to ensure operations can resume within two hours following a disruptive event. - Review fee schedules and set minimum service levels to enhance efficiency. - CBBH Law lacks sufficient oversight powers for payment systems; recommended actions include: - Clearly establish oversight responsibilities and powers to designate financial market infrastructures and protect finality and netting. - Adopt the Principles for Financial Market Infrastructures into the regulatory framework. - Establish a new oversight unit within Payment Systems Department with sufficient staffing. - Develop a MoU to strengthen oversight of clearing agents, settlement banks, international payment clearing, and cooperation with relevant authorities. ### Non-performing loans (NPLs): legacy issues and impediments to resolution - The share of NPLs has increased in recent years; weaknesses in the legal framework impede NPL resolution and limit banks’ ability to transfer NPLs to other entities. - The transfer of non-cancelled NPLs from banks to other entities is impeded by inconsistent interpretation of provisions of the Law on Obligations and Laws on Banking and legal impediments in the Law on Protection of Users of Financial Services for loans to natural persons. - Key impediments and recommended reforms: - Ensure bank supervisors can monitor NPLs held by AMCs within a banking group through consolidated group supervision. - Amend regulations so that NPLs are maintained on a credit register to enable credit providers to identify applicant status and preserve incentives to service loans. - Establish a streamlined insolvency/restructuring framework to allow companies and creditors to negotiate debt restructurings under court oversight to facilitate least-cost solutions and preserve economic activity and jobs. - Speed up litigation, execution, and bankruptcy cases; provide additional resources and training in the courts. - Commission a review of tax laws to ensure tax treatment encourages debt restructuring and the sale of NPLs, including consideration of exempting transfers of NPLs (and associated collateral) from VAT to support a secondary market. - Legal and operational shortcomings: - Non-possessory pledges are not extensively used because banks do not consider them secure; recovery rates on loans secured with pledges are very low. - Ineffectiveness of execution procedures, problematic valuation of assets to be auctioned, and problematic reserve prices reduce recoveries. - No insolvency regime exists for individual debtors; insolvency law applies only to legal entities and partners in partnerships. - Selected NPL distribution statistics (In percent, 2012 and 2014Q3): - NPL to total Loans: TOTAL 13.5, FBiH 13.2, RS 14.1, Foreign 13.2, Domestic 16.5, memo entries include variations by sector - NPL to total Loans (2014Q3): TOTAL 15.1, FBiH 14.6, RS 16.2, Foreign 14.5, Domestic 22.7 - Of which corporates (2012 / 2014Q3): 8.5 / 13.7 - Of which households (2012 / 2014Q3): 5.0 / 2.8 - Special mention loans (share of total loans): 9.8 (2012), 17.2 (2014Q3) ### Financial sector oversight: governance, supervision, and the insurance regulator - Banking supervision has significantly improved since 2006, but shortcomings remain. - Banking agencies are preparing a new Law on Banks to address deficiencies in supervisory powers, recovery and resolution, and consolidated supervision. - Coordination among institutions involved in banking oversight is complex; crucial bank risk-profile information is not always shared with relevant stakeholders. - MOUs: - Banking agencies have signed MOUs with a number of home country supervisors, but there are no MOUs with home supervisors responsible for several systematically important banks (Austria, Italy and Russia). Authorities are working on signing MoUs with Austria and Italy. - Existing MOUs do not cover cross-border cooperation arrangements in times of stress. - Supervisory coverage gaps: - Supervisory agencies lack a full picture of several domestically-owned banks, including identification of ultimate beneficiary owners and their holdings; related party lending and group exposures are not fully identified. - Licensing and approval processes need to provide substantive information on direct owners, parent companies, and related parties. - Governance and audit weaknesses: - Weaknesses in governance and risk management at some banks, coupled with weak supervisory powers, have contributed to problem banks. - Loan concentration levels of some banks exceed regulatory limits. - Current owners unable to meet a capital call may remain involved in the bank, exacerbating moral hazard. - Banking agencies have issued regulations on corporate governance and are developing bank-wide risk management guidance; strengthened corrective action powers are in place. - Financial audit quality needs improvement: AQRs revealed weaknesses not caught by external audits; some auditors reference local law instead of IFRS; external auditors are appointed only for one year. - Loan loss provisioning: - Provisioning is based on International Accounting Standards (IAS) and prudential requirements; IAS provisioning levels may not be adequate as reflected by inspector adjustments during onsite reviews. - Recommendation: develop supervisory standards encouraging conservative implementation by banks of factors for determining incurred losses under IAS and move away from the current prudential standard. - State-owned banks: - Governance is a concern; supervisory boards provide little strategic direction and do not hold management accountable. - Rigorous oversight of government bank-related exposures is warranted by the IRBRS. ### Insurance sector supervision and group supervision gaps - Prudential framework is based on Solvency I, which is not risk-sensitive and is ill-suited for a developing market. - More than half of insurance premiums relate to mandatory Motor Third Party Liability (MTPL) insurance; tariff-compliance framework needs substantial improvements. - Planned liberalization of MTPL tariffs should be preceded by early warning systems, stress testing, and a risk-based solvency framework with a ladder of interventions for prompt corrective action. - Key supervisory powers are missing and institutional complexity requires stronger cooperation: - Powers to remove members of supervisory boards are missing. - RS-ISA lacks power to void voting rights of qualified shares acquired without its approval. - FBiH-ISA cannot appoint provisional administration without withdrawing a license. - FBIH-ISA is understaffed; independence and stronger legal protection for staff are needed. - Merging insurance supervision into respective banking agencies could yield efficiency gains and simplify institutional setup. - Consumer protection and financial literacy need urgent development. - Group supervision is lacking; cooperation with banking supervisors is weak: - Regulation and supervision of insurance groups need strengthening, including supervision of holding companies, limits on intra-group transactions, fit-and-proper tests for controlling positions at holding companies, and a comprehensive group supervision framework. - Given sizeable insurance exposure to banks, strengthen cooperation between insurance and banking supervisors. *Source: IMF staff compilation based on supervisory data, AQRs, and IMF staff calculations.* ### 49. The legal and regulatory framework for the capital market is sound, but more effective ### _cr15164 - 49. The legal and regulatory framework for the capital market is sound, but more effective ### Capital market legal and regulatory framework - Adoption of the EU directives and protocols has improved the legal framework. - Regulators lack the resources necessary to supervise the large number of listed firms and implement existing rules and regulations. - Recommendation: Follow an EU model linking national exchanges and harmonizing legislation and regulation without member states giving up their stock exchanges or their rights to regulate home markets; a “passporting” framework has been implemented to allow issuers, investors and market intermediaries to operate in each other’s national market, creating a vastly larger common market. - Reference: Companion development FSA report by the WB provides further details. ### AML/CFT issues (paragraphs 50) - MONEYVAL 2009 Mutual Evaluation Report identified strategic deficiencies in BiH’s AML/CFT framework, notably criminalization of money laundering and implementation of customer due diligence measures. - BiH agreed to an action plan to remedy shortcomings; as significant items remained unaddressed, MONEYVAL issued several public statements in 2014 calling upon members to apply enhanced due diligence measures to transactions with persons and financial institutions from or in the BiH. - Important progress: enactment of a new AML/CFT law and amendments to the Criminal Code. - Risk: Further delay in addressing remaining deficiencies may result in additional scrutiny from the FATF, with potentially greater negative repercussions for BiH. - Recommendations: Timely and effective implementation of the action plan; a national assessment of ML/TF risks; greater coordination and cooperation amongst State and Entity level agencies in charge of AML/CFT. ### Macroprudential framework (paragraphs 51–52) - Status: - Macroprudential toolkit is relatively underdeveloped, but being extended. - Main instrument: reserve requirements (RRs), used actively during pre-crisis credit boom and subsequent liquidity crunch. - CBBH developing capacity for systemic risk monitoring via top-down stress tests and working with banking agencies on methodology to identify systemic domestic banks. - Banking agencies have included elements of Basel III in capital regulation, such as capital conservation buffers and a leverage ratio; intend to introduce countercyclical capital buffers and capital surcharges on systemic banks. - Limits exist for open FX positions. - In insurance sector, macroprudential supervision limited to market-wide analysis of observed trends. - Recommendations: - Broaden macroprudential framework, considering institutional constraints. - Underpin with broader and more focused cooperation among the CBBH, FBA and BARS using the existing MoU as a coordination platform. - Examine LTV and DTI levels, household and corporate indebtedness, and debtors’ currency mismatches. - Undertake high-level consultations on systemic risks at least quarterly. - When insurance sector develops further, consider introducing a macroprudential supervision framework encompassing the insurance sector. ### Systemic liquidity management under the currency board (paragraphs 53–55) - Constraints and features: - Constraints on banks’ and CBBH’s ability to manage liquidity: no central bank liquidity window; small and illiquid secondary market for government securities; small money and interbank markets; high levels of bank liquidity; foreign banks’ internal risk management minimizes exposures vis-à-vis domestically-owned banks. - Under the Currency Board Arrangement (CBA), limitations call for conservative liquidity management and liquidity buffers for banks. - Reserve requirements (RRs): - Recommendation: Better tailor RRs towards prudential purposes and amend the system to support systemic liquidity management. - Specific proposals: - Consider increasing flexibility of RR holdings in times of stress and introduce daily or period-minimum holding thresholds. - Combine flexibility with higher penalty rates and enhanced supervision before sanctions are applied. - For the RR base, consider residual maturities and set a minimum daily requirement. - Eliminate some exemptions for non-resident deposits introduced during the recent global financial crisis. - Reassess adequacy of existing RR levels, which were significantly lowered during the financial crises. - Liquidity regulations and LCR: - Recommendation: Streamline liquidity regulations and adopt the LCR to strengthen liquidity management. - For maturity calculations, take into account early deposit withdrawal options. - Minimum liquidity ratio should be raised above the RR to ensure it is binding. - Upon adoption of the LCR, exercise care in treating RRs as HQLA given uncertain availability to meet liquidity pressures. - Need to calibrate haircuts applied to public securities for LCR purposes given the shallow market, assumptions for deposits/borrowed funds run-off rates, and treatment of liabilities maturing after 30 days with prepayment clauses. - Given high euroization, consider currency-specific LCRs. - Design and calibration of revised and new liquidity regulations should be reinforced by a quantitative impact study based on historical data with emphasis on stress situations. - Note on legal constraint: CBBH Law requires all CBBH domestic liabilities to be backed by foreign net assets and does not allow CBBH to grant credit or engage in money market operations “involving securities of any type,” ruling out emergency liquidity assistance and a standing liquidity facility. ### Constrained financial safety net (paragraphs 56–71) - Overall assessment: - Several key elements of financial safety arrangements are absent or inadequately developed: lack of a comprehensive remedial action program, inadequacy of resolution powers, inability to provide temporary emergency liquidity support to soundly capitalized and well-managed banks. - A. Crisis preparedness framework - Correction action arrangements (paragraph 57): - Banking agencies have statutory authority to require corrective actions, with guidance on triggers based on breaches of capital, liquidity, and asset quality requirements. - Enforcement powers limited: limited authority to impose financial penalties for noncompliance, or to permanently suspend board members and controlling owners except under provisional administration; limited authority to replace or restrict powers of controlling owners outside provisional administration. - Result: Regulatory forbearance risk; should be avoided unless based on sound supervisory judgment and steps to ensure satisfactory remedial measures. - Note: Draft banking laws expected to provide banking agencies more comprehensive powers to facilitate prompt correction and resolution action. - Deposit Insurance Agency (DIA) (paragraphs 58–60): - DIA is a relatively well-developed paybox scheme. - Funded by member banks with reserves of about KM 285 million (€ 145 million) representing approximately 4½ percent of insured deposits. - Supported by a €50 million standby facility with the EBRD. - DIA has infrastructure for effective deposit insurance, including MOUs with banking agencies, regular testing of depositor data, and procedures for pay-outs. - Formal assessment against IADI standards suggests majority of principles are compliant or largely compliant; DIA improved legal framework and capacity, developed sound governance and a depositor reimbursement system capable of payouts. - Recommendations for enhancements: - Establish capacity for making prompt pay-outs to insured depositors in line with the EU relevant directive. - Amend legislation to authorize prompt pay out of depositors and use of DIA funds to facilitate a purchase and assumption (P&A) transaction under the least cost solution. - Ensure DIA is involved early in problem bank resolution with bank supervision agencies. - Coordination and contingency planning (paragraphs 61–63): - Recommendation: Better coordination among SCFS members; inter-agency contingency plan should include guidance on actions if a bank is closed, including public communications to minimize contagion. - MoU establishing SCFS sets objectives/principles for bank resolution, responsibilities, and coordination procedures. - Recommendation: Broaden SCFS focus to include small banks where distress could have financial stability implications. - Contingency plans prepared in 2014 represent progress but need revision to incorporate procedures for each crisis stage: systemic impact assessment, diagnostics, resolution option assessment and implementation, cross-border coordination, communications. - Regular crisis simulation testing required as part of contingency planning and capacity-building. - Cross-border cooperation: banking agencies and other authorities have no specific crisis resolution arrangements with foreign counterparts; systemic importance of several foreign banks creates risk of inadequate coordination with home authorities; signing of MoUs recommended (see paragraph 38). - B. Crisis management framework - Bank resolution framework (paragraphs 64–66): - Despite recent legal power improvements and contingency plans, significant deficiencies remain: resolution powers, institutional responsibility for resolution, recovery and resolution planning. - Authorities currently not well placed to implement P&A, bridge bank, or bail-in in a manner consistent with maintaining financial stability, avoiding public funding and minimizing moral hazard. - High NPLs and number of banks in stress make addressing financial safety net deficiencies high priority. - Need for a designated resolution authority: - FBA and BARS have some resolution powers but are not formally designated or equipped as resolution authorities. - Proposed new banking laws need to establish clear responsibility with appropriate accountability and transparency. - Ideal: vest resolution powers in DIA (not feasible owing to institutional constraints). - Suggested: vest resolution powers in FBA and BARS and designate them resolution authorities for banks in their jurisdictions, enabling synergies between supervisor and resolution authority; would require governance and accountability arrangements to avoid conflicts of interest and include DIA management board representation from the two banking agencies. - DIF (Deposit Insurance Fund) scope: - Currently DIF can only pay out insured deposits. - Recommendation: Allow DIF to participate in bank resolution subject to least cost solution—i.e., up to the amount that would have been expended for insured depositor reimbursement in a liquidation—including P&A transactions. - DIF resources should not be used to provide open bank assistance. - Financial Stability Fund (FSF) and emergency liquidity (paragraphs 67–71): - Over time, safety net could be broadened by establishing an FSF under the DIA for open bank assistance. - Open bank assistance in a systemic crisis should be provided only if necessary to preserve financial stability and where no new private capital is forthcoming. - FSF backstop option should be subject to clearly defined criteria; losses in failed banks should be absorbed up-front by existing shareholders and other creditors according to hierarchy of claims in liquidation, subject to financial stability considerations. - Use under strict conditions to minimize moral hazard and allow for ex-post recovery from the banking industry. - FSF could be based on principles of the EU Bank Recovery and Resolution Directive (BRRD) with added limited and temporary liquidity support functions. - Limited and temporary emergency liquidity assistance (ELLA) in the context of the currency board: - CBBH is constrained from performing any Lender of Last Resort (LOLR) functions; CBBH Law does not allow granting credit or money market operations “involving securities of any type.” Net excess reserves under CBA usually limited. - FSF could be designed to provide very limited liquidity support to solvent banks in acute liquidity stress as an early prompt corrective action tool, after a bank has used all liquidity options including interbank market, parent funding if available, and its reserve requirements (RR framework should be amended per paragraph 54). - Support should be available only to systemic banks that comply with supervisory capital requirements, are under sound management, and have sufficient collateral or guarantees to cover credit risks for the liquidity provider. - Emergency liquidity support should be accompanied by enhanced monitoring and supervision to minimize moral hazard; banking agency would monitor compliance and take enforcement actions; un-remedied breach of FSF terms would be grounds for resolution. - FSF financing options: ex-ante levies on banks and capacity for ex-post levies to cover costs and losses; possible IFI financing; scope to support FSF by switching a portion of potential increases in RR into the FSF. - Administration: FSF would be administered by the DIA and separated from the DIF. - Safeguards: Objectives, purposes, preconditions for invoking, and governance arrangements should protect the FSF. *Italic line: Source: Excerpt from the IMF staff report content unit _cr15164 - 49.* ### Appendix Figure 3. Monetary and Capital Market Developments ### Appendix Figure 3. Monetary and Capital Market Developments ### Monetary and capital market indicators (charts summary) - Stock Market Index (Index, 2010=100): series presented for Bosnia, Croatia, Serbia, Macedonia from Jan-10 to Jan-15 (chart only). - 5-Year CDS Spreads (Basis Points): series for UniCredit, Intesa, Raiffeisen from Jan-08 to Jul-14 (chart only). - Broad Money and Deposits (Year-on-year percent change): Deposits and M2 series for 2008–2014 (chart only). - Interest Rate on Consumer Loans (In percent): series for House purchase, Consumption, Credit Cards from Jan-12 to Jan-15 (chart only). - House Price Index (Index, 2007 = 100): series from 2007–2013 (chart only). - Foreign Reserves (In EUR million): series Jan-08 to Jul-14 with 2008-2014 Average indicated (chart only). - Source for charts: CBBH. ### Selected economic indicators (Appendix Table 1) - Nominal GDP (in KM million): 25,734 26,297 26,500 27,124 28,380 29,913 31,688 (2012–2018 series with Est./Proj. headings). - Gross national saving (in percent of GDP): 8.9 11.0 11.1 9.8 10.7 11.7 12.5. - Gross investment (in percent of GDP): 18.1 17.0 18.2 18.8 18.9 18.9 18.9. - Real GDP: -1.2 2.5 0.8 2.3 3.1 3.6 3.8. - CPI (period average): 2.0 -0.1 -0.9 0.6 1.1 1.2 1.3. - Broad money (end of period): 3.4 7.9 7.8 4.5 5.3 5.4 5.9. - Credit to the private sector (end of period): 2.8 2.3 1.7 2.1 2.8 4.9 6.5. - Revenue (percent of GDP): 46.3 45.3 46.5 47.1 47.7 47.9 48.0. - Grants (percent of GDP): 2.2 2.4 2.7 2.8 3.0 3.2 3.3. - Expenditure (percent of GDP): 48.9 47.2 49.6 49.6 49.6 49.3 49.0. - Investment expenditure (percent of GDP): 6.3 6.4 7.3 7.7 7.8 8.0 8.1. - Net lending: -2.7 -1.9 -3.1 -2.4 -1.9 -1.3 -1.0. - Net lending, excluding interest payment: -1.9 -1.2 -2.3 -1.5 -0.7 -0.1 0.1. - Total public debt: 42.7 42.6 45.9 47.3 47.1 46.1 43.7. - Domestic public debt: 14.9 14.4 15.3 14.6 14.1 13.6 13.9. - External public debt: 27.8 28.2 30.5 32.7 33.0 32.5 29.8. - Exports of goods and services (in EUR million): 4,062 4,306 4,455 4,663 5,068 5,424 5,767. - Imports of goods and services (in EUR million): 7,278 7,152 7,562 7,984 8,480 8,882 9,290. - Current transfers, net (in EUR million): 1,881 1,879 1,978 1,902 2,028 2,126 2,231. - Current account balance (in EUR million): -1,215 -797 -954 -1,243 -1,184 -1,110 -1,041. - Current account balance (In percent of GDP): -9.2 -5.9 -7.0 -9.0 -8.2 -7.3 -6.4. - Foreign direct investment (in EUR million): 260.3 224.7 280.8 362.9 390.2 419.9 452.0. - FDI (In percent of GDP): 2.0 1.7 2.1 2.6 2.7 2.7 2.8. - Gross official reserves (in EUR million): 3,326 3,613 3,997 4,184 4,410 4,801 4,949. - Reserves (In months of imports): 5.6 5.7 6.0 5.9 6.0 6.2 6.1. - External debt (in percent of GDP): 52.2 51.0 51.7 56.3 56.5 55.6 52.4. - External debt service to GNFS exports (percent): 12.6 13.7 14.5 12.6 12.7 13.6 12.8. - Sources: BiH authorities; and IMF staff estimates and projections. (Values in EUR million unless otherwise indicated.) ### Financial system structure (Appendix Table 2) - Number of banks (Q1 2014): 27 (series 2005–2014 shows 33 in 2005 down to 27 in 2014Q1). - Foreign-majority owned banks (2005–2014 series): 20 22 21 21 21 19 19 19 17 15. - Financial system assets, banks (in KM million, 2005–2014): 11,726 14,683 19,570 20,813 20,608 20,416 20,995 21,186 22,023 21,862. - Foreign-majority owned banks (percent of total bank assets): 90.8 94.0 93.8 95.0 94.5 92.8 92.1 91.9 90.5 82.4. - Domestic private banks (percent of total bank assets): 5.6 2.8 4.3 4.1 4.7 6.4 7.0 7.1 7.4 15.6. - Domestic state-owned banks (percent of total bank assets): 3.6 3.2 1.9 0.9 0.8 0.8 0.9 1.0 2.1 2.1. - Insurance and reinsurance companies (KM million, selected years): 676 708 853 889 933 936 1,080 1,174 1,232 ... . - Investment funds (asset management companies) (KM million, selected years): 1,793 1,553 1,762 1,225 871 888 810 796 762 ... . - Leasing companies (KM million, selected years): 660 1,025 1,378 1,607 1,416 744 767 716 597 ... . - Microcredit organizations (KM million, selected years): 314 488 946 1,213 1,087 853 742 676 667 ... . - Nominal GDP (in KM million, 2005–2014): 17,148 19,567 22,065 24,984 24,307 24,879 25,772 25,734 26,297 6,091 (final entry reflects Q1 2014). - Exchange rate (KM to USD, eop): 1.66 1.49 1.33 1.39 1.36 1.47 1.51 1.48 1.42 1.42. - Sources: Central Bank of Bosnia and Herzegovina (CBBH); Banking Agency of FBiH; Banking Agency of RS; and Agency for Statistics of Bosnia and Herzegovina. ### Financial soundness indicators — banking system (Appendix Table 3) - Regulatory capital (in KM million): 1,488 1,861 2,345 2,637 2,642 2,739 2,860 2,821 2,995 2,784 (2005–2014). - Regulatory capital to risk-weighted assets (RWAs): 17.8 17.7 17.1 16.2 16.1 16.2 17.1 17.0 17.8 16.4. - Non-performing loans (NPLs) to gross loans: 5.3 4.0 3.0 3.1 5.9 11.4 11.8 13.5 15.1 14.0. - Provisions to NPLs (selected years): 34.5 43.7 66.3 65.9 66.7 70.2 (series begins 2009). - NPLs net of provisions to Tier 1 capital (selected years): 25.5 42.0 25.9 30.0 31.0 27.0 (series begins 2009). - Return on average assets (ROAA): 0.7 0.9 0.8 0.4 0.1 -0.6 0.7 0.6 -0.2 0.8. - Return on average equity (ROAE): 6.2 8.4 8.6 4.2 0.8 -5.5 5.8 4.9 -1.4 6.0. - Gross income to average assets: 7.6 7.0 6.4 5.8 5.6 5.8 5.9 5.7 5.6 1.4. - Net interest income to gross income: 54.1 54.3 59.7 60.6 61.5 60.1 63.9 63.7 62.3 61.5. - Non-interest expenses to gross income: 90.1 86.5 85.1 90.6 97.4 109.0 86.5 87.4 101.2 83.9. - Liquid assets to total assets: 36.1 35.9 37.7 30.0 30.9 29.0 27.2 25.4 26.4 26.8. - Liquid assets to short-term liabilities: 61.9 60.8 61.3 51.8 53.0 49.7 46.7 44.1 46.2 46.1. - Deposits to assets (excluding interbank deposits): 58.0 58.9 60.9 55.1 56.0 58.8 59.1 60.5 62.2 64.4. - Loans to deposits: 103.8 102.5 97.2 122.3 116.9 116.0 117.9 118.6 114.8 108.2. - Net long position in foreign exchange to Tier 1 capital: 8.3 9.1 5.9 6.2 1.7 4.4 16.0 5.3 6.7 11.1. - Foreign-currency-denominated loans to total loans: 68.7 71.0 74.1 73.3 73.9 70.0 66.9 63.1 62.9 62.4. - Foreign-currency-denominated liabilities to total liabilities: 64.4 62.8 65.1 69.5 69.2 67.0 66.2 65.2 63.8 62.7. - Sources: CBBH; Banking Agency of FBiH; and Banking Agency of RS. ### Insurance sector indicators (Appendix Table 4) Non-life (2009–2013): - Net premium as percent of capital: 146.9 147.2 141.0 137.3 141.5. - Risk retention ratio (net premium as percent of gross premium): 89.2 87.5 80.6 82.6 82.7. - Net technical reserves as percent of average net claims paid in last three years: 195.7 186.7 191.1 201.9 203.6. - Net technical reserves as percent of average net premium received in last three years: 92.1 88.2 91.6 96.3 92.5. - Claims outstanding as percent of total claims paid: 78.6 83.4 84.6 88.7 86.5. - Liquid assets as percent of current liabilities: 404.3 409.8 443.9 359.3 626.7. Life (2009–2013): - Capital as percent of technical reserves: 26.3 23.3 21.5 20.7 19.1. - Life and nonlife solvency status (number of institutions by margin bands): Actual solvency margin/minimum: <100 %: 4 4 4 5 1; 100-110 %: 5 4 2 7 6; 110-125 %: 5 2 4 3 1; 125-150 %: 5 8 6 2 7; >150 %: 10 11 12 11 11. - Source: Insurance Agency of BiH. ### Risk Assessment Matrix — main threats and assessments (Appendix Table 5) 1. Bond market stress from euro area sovereign reassessment or protracted slower growth. - Staff assessment (overall level of concern): Low. - Likelihood of severe realization of threat in next 1–3 years: Medium. - Expected impact on financial stability if realized: - Export activity and revenues will be severely disrupted. - Remittances from euro area countries are sizeable and a large source of foreign exchange and banks’ liquidity and deposits. - FDI and other capital flows may come to a halt. - Given currency board arrangement, lower availability of FX will constrain base money. - Banks likely to suffer funding retrenchment and asset quality deterioration due to increase in NPLs. - Assessment (“medium”) based on solvency stress test results (adverse scenarios 1 and 2). 2. Geopolitical tensions surrounding Russia/Ukraine. - Staff assessment (overall level of concern): Medium. - Likelihood of severe realization of threat in next 1–3 years: Low. - Expected impact on financial stability if realized: - Disruptions in commodity production or transport raise oil and gas prices. - Increased uncertainty could reduce global equity prices. - Russian banks’ ownership links could produce funding retrenchment for BiH banks via parent/grand-parent banks. - Demand for BiH exports from Russia and neighboring countries would fall. - Assessment (“low”) based on solvency stress test results (adverse scenario 1). 3. External funding: Parent banks remove support or withdraw from BiH market. - Staff assessment: Medium. - Likelihood: Medium. - Expected impact: - BiH banking sector dominated by foreign banks, accounting for 82 percent of sector assets. - Subsidiaries remain reliant on parent bank support despite rising domestic deposits. - Repatriation of parent bank deposits may severely constrain liquidity in large foreign-owned banks. - Confidence effects of foreign banks withdrawing could be significant; domestic banks too small to compensate. - Assessment (“medium”) based on liquidity stress test results using LCR and NSFR proxies. 4. Further deterioration in health of commercial banks and depositor confidence loss. - Staff assessment: Medium. - Likelihood: High. - Expected impact: - Higher NPLs will call for additional provisioning and negatively affect profits. - Bank recapitalization problematic without parent bank support. - Authorities unlikely to have resources/framework to deal with problems in a large bank. - Liquidity strains may turn into solvency problems. - Currency Board Arrangement and lack of LOLR facilities limit options. - Assessment (“high”) based on solvency stress tests (adverse scenarios 1 and 2) and liquidity stress tests using LCR and NSFR proxies. 5. Unavailability of official budget financing and sovereign debt restructuring. - Staff assessment: Low. - Likelihood: Low. - Expected impact: - Sluggish growth and weak tax revenue may complicate servicing of domestic debt and lead to arrears and austerity measures. - Banks have accumulated government securities; restructuring/default of entity government debt would impact bank balance sheets. - Official sector may accelerate withdrawal of banks’ deposits, compromising banks’ liquidity. - Assessment (“low”) based on solvency stress test results and sensitivity analysis. ### Banking system assets — end-March 2014 (Appendix Table 6) - Top banks by Total Assets (Percent of total banking assets in BiH) — Federation of BiH: - Raiffeisen bank d.d. Bosna i Hercegovina: 17.4 (24.9 percent of Entity). - UniCredit bank d.d.: 16.7 (24.0 percent of Entity). - Intesa Sanpaolo banka d.d. Sarajevo: 6.1 (8.8 percent of Entity). - Hypo Alpe-Adria bank d.d. Mostar: 5.0 (7.2 percent of Entity). - Sparkasse bank d.d.: 4.6 (6.5 percent of Entity). - Sberbank BH d.d.: 4.0 (5.7 percent of Entity). - NLB banka d.d.: 3.8 (5.5 percent of Entity). - Bosnia bank international d.d. Sarajevo: 2.5 (3.6 percent of Entity). - Ziraatbank BH d.d.: 1.8 (2.6 percent of Entity). - ProCredit bank d.d.: 1.6 (2.4 percent of Entity). - Vakufska banka d.d. Sarajevo: 1.3 (1.9 percent of Entity). - BOR banka d.d.: 1.1 (1.5 percent of Entity). - UNION banka d.d.: 1.0 (1.5 percent of Entity) — State-owned bank. - Top banks — Republika Srpske (RS): - Nova banka a.d.: 6.9 (22.8 percent of Entity) — Mostly domestic private bank (ownership changed Q3 2014). - NLB Razvojna banka a.d.: 5.5 (18.2 percent of Entity) — Mostly foreign bank (Slovenia). - Hypo Alpe-Adria bank a.d.: 5.2 (17.3 percent of Entity) — Mostly foreign bank (Austria). - UniCredit bank a.d.: 4.1 (13.5 percent of Entity) — Mostly foreign bank (Austria). - Sberbank a.d.: 2.8 (9.2 percent of Entity) — Mostly foreign bank (Russia). - Bobar banka a.d.: 1.6 (5.2 percent of Entity) — Mostly domestic private bank. - Komercijalna banka a.d.: 1.2 (3.8 percent of Entity) — Foreign bank (Serbia). - Pavlovic international bank a.d.: 1.2 (3.8 percent of Entity) — Mostly domestic private bank 2/. - Banka Srpske a.d.: 1.1 (3.5 percent of Entity) — State-owned bank. - MF banka a.d.: 0.8 (2.6 percent of Entity) — Domestic private bank. - Notes: - 1/ Ownership of Nova banka changed in Q3 2014 from mostly foreign to mostly domestic private bank. - 2/ Pavlovic international bank classified as mostly domestic private bank because majority owners have dual citizenship (BiH and U.S.) and other shareholders are mostly domestic. ### Stress testing framework (Appendix Table 7 — STeM) - Banking sector solvency risk perimeter: - Institutions included: All banks (27 banks). - Market share: Percentage of total sector assets: 100 percent. - Data and baseline date: Supervisory data; banks’ own data; publicly available data where applicable. - Stress testing approach: Bottom-Up by banks; Top-Down by authorities; Top-down by FSAP team (as applicable). *Source: _cr15164 - Appendix Figure 3. Monetary and Capital Market Developments (CBBH; IMF staff data as presented in the source content).* ### 2. Channels of Risk Propagation ### _cr15164 - 2. Channels of Risk Propagation ### Methodology and Modeling Framework - Combination of banks’ own internal models and pre-defined benchmarks. - CBBH’s stress testing framework supplemented with the IMF balance sheet stress testing framework. - IMF balance sheet stress testing framework (tailor-made for the Bosnia and Herzegovina FSAP). ### Satellite Models for Macro-Financial Linkages - Banks’ own models for credit losses, pre-impairment income,; expert judgment. - CBBH’s models supplemented with IMF’s econometric models for credit losses, pre-impairment income; expert judgment. - IMF’s econometric models for credit losses, pre-impairment income; expert judgment. ### Stress Test Horizon - 5 years (2015-2019). - 5 years (2015-2019) - 5 years (2015-2019) ### Scenario Analysis / Tail Shocks - Shocks based on GDP trajectories, and translated in a consistent manner to all other variables in the macro-scenarios. - Three scenarios: baseline scenario; moderate external shock scenario; severe external shock scenario (implying output losses larger than those recorded in recent relevant historical crisis). - Sensitivity analysis includes: - Single-factor shocks: interest rate; exchange rate; sovereign securities loss/haircut. - Credit concentration risk. ### Risks and Buffers (Solvency) - Comprehensive coverage of solvency risks: - Credit risk: credit risk on loan book; issuer default risk on government and corporate bond and other debt instrument holdings. - Market risk: interest rate risk impact on net interest income, government and corporate bond and other debt instrument holdings; FX risk. - Equity investment-related risk (includes both credit and market risk components). - Operational risk. - Behavioral adjustments: - Evolution of total assets and RWAs based on constant balance sheet assumption. - No management actions considered. - Other net income items, dividends, and taxes, based on macroeconomic scenarios and pre-determined rules. ### Calibration of Risk Parameters and Regulatory Standards - Calibration: - Expected losses or loan migration (downgrades) and changes in provisions based on banks’ internal models (bottom-up) or satellite models (top-down). - Estimation of expected gains/losses on government and corporate bond holdings, real estate and equity investments based on banks’ internal models or satellite models (including gap and duration analysis). - Regulatory/Accounting and Market-Based Standards: - Hurdle rates based on regulatory minimum for total regulatory capital (i.e., CAR of 12 percent). - Basel I rules. ### Reporting Format for Results (Solvency) - Outputs: CAR, shortfall (if applicable). - Pass or fail; number of “undercapitalized” banks (i.e., with a CAR below 12 percent). - System-wide and by entity. ### Banking Sector: Liquidity Risk - Institutional perimeter: All banks (27 banks). - Market share: Percentage of total sector assets: 100 percent. - Data and baseline date: Supervisory data; Banks’ own data. - Channels of Risk Propagation methodology: - Basel III LCR-type proxy. - Basel III NSFR-type proxy. - Risks: Market liquidity; Maturity mismatches. - Buffers: Counterbalancing capacity (HQLA, ASF). - Tail shocks: Haircuts and run-off rates as defined in Basel III for LCR and NSFR. - Regulatory standards: - LCR proxy should exceed 100 percent (not a legal/regulatory requirement). - NFSR proxy should exceed 100 percent (not a legal/regulatory requirement). - Reporting: Pass rate, remaining buffers, and liquidity shortfall (if applicable); System-wide and by entity. ### Banking Sector: Contagion Risk - Institutional perimeter (top-down FSAP team): All banks (27); All insurance companies (25). - Market share: Percentage of total sector assets: 100 percent. - Data: Supervisory data; Banks’ own data; Publicly available data. - Methodology: Network analysis, using Espinosa-Vega and Solé (2010) methodology. - Tail shocks: - Stress scenario with a credit shock: a severe stress in a bank or a banking system, causing a default on all of its liabilities to domestic institutions or foreign banks. - Stress scenario with a joint credit and funding shock when the default of a bank or a banking system also leads to a liquidity squeeze for those institutions funded by the defaulting bank or banking system. - Reporting (top-down FSAP team): Capital impairment to domestic banking system, number of failed banks, and remaining buffers (at both banking-system level and bank level); Capital impairment to domestic insurance sector, number of failed insurance companies, and remaining buffers (at both sector-wide level and company level). ### Macroeconomic Projections in the Stress Test Scenarios (selected series, period averages) - Note: These scenarios are based on projections made in July 2014. All numbers are period averages. - Baseline scenario (selected years and series): - Real GDP growth: 2010 0.8; 2011 1.0; 2012 -1.2; 2013 2.1; 2014 0.7; 2015 3.5; 2016 3.7; 2017 4.0; 2018 4.0; 2019 4.0 - CPI inflation: 2010 2.2; 2011 3.7; 2012 2.0; 2013 -0.1; 2014 1.1; 2015 1.5; 2016 1.8; 2017 2.0; 2018 2.1; 2019 2.1 - Short-term interest rate: 2010 7.9; 2011 7.5; 2012 6.9; 2013 7.0; 2014 6.7; 2015 7.2; 2016 7.4; 2017 7.6; 2018 7.7; 2019 7.7 - Long-term interest rate: 2010 8.4; 2011 7.5; 2012 7.8; 2013 7.1; 2014 7.3; 2015 7.5; 2016 7.7; 2017 7.8; 2018 7.8; 2019 7.8 - NEER (increase = appreciation): 2010 100.0; 2011 100.5; 2012 99.5; 2013 101.6; 2014 109.2; 2015 109.8; 2016 110.5; 2017 111.2; 2018 111.8; 2019 112.5 - REER (increase = appreciation): 2010 100.0; 2011 100.8; 2012 98.9; 2013 99.9; 2014 100.6; 2015 100.1; 2016 99.8; 2017 99.6; 2018 99.6; 2019 99.5 - House price index (2007=100): 2010 116.2; 2011 111.7; 2012 110.7; 2013 113.0; 2014 110.4; 2015 117.8; 2016 124.4; 2017 130.6; 2018 135.3; 2019 138.7 - Unemployment rate: 2010 44.4; 2011 44.9; 2012 45.5; 2013 44.6; 2014 44.5; 2015 43.2; 2016 41.8; 2017 40.4; 2018 39.0; 2019 37.8 - Alternative scenarios provided (Alternative scenario 1 and Alternative scenario 2) with series for Real GDP growth, CPI inflation, interest rates, exchange rates, house price index, stock price indices, and unemployment rate for 2010–2019 (see full table for values). ### Summary of Solvency Stress Test Results – Entire Banking System (27 banks) (actual data as of 31-March-2014 - before any shock) - Total regulatory capital - before shock: 2,938,843 (thousands of KM) - Tier 1 capital: 2,624,308 (thousands of KM) - Total risk-weighted assets (RWAs): 16,942,976 (thousands of KM) - Total assets: 21,783,153 (thousands of KM) - Total regulatory capital-ratio (CAR; in percent of RWAs) - before shock: 17.3 - Stress test estimated losses after shock (2015) — selected items (Top-Down / Bottom-Up across scenarios): - Credit risk: Increase in provisions due to loan migration: - Baseline Top-Down: (4,067) - Baseline Bottom-Up: (55,062) - Adverse Scenario 1 Top-Down: (545,431) - Adverse Scenario 1 Bottom-Up: (326,040) - Adverse Scenario 2 Top-Down: (2,019,179) - Adverse Scenario 2 Bottom-Up: (829,554) - Expected net losses on BIH government bond holding (HTM) - "issuer default risk": - (1,267); (230); (2,025); (537); (3,127); (1,071) - Risk related to equity instruments: Expected net losses on equity instruments: - 656; 238; (3,161); (4,001); (7,349); (8,717) - Market risk: Expected net interest income: - 743,575; 733,660; 703,600; 709,078; 601,218; 679,485 - Operational risk: Expected operational risk losses: - (1,810); (9,221); (22,343); (10,454); (238,144); (11,651) - Total net expected "stress losses": - 730,724; 668,328; 122,551; 365,411; (1,684,089); (179,600) - Other net income after shock (2015): Total "other net income": - (512,265); (390,860); (307,845); (387,684); (303,081); (384,748) - Stress test estimated capitalization after shock (2015): - Total regulatory capital - after shock: - Baseline Top-Down: 3,157,302 - Baseline Bottom-Up: 3,216,311 - Adverse Scenario 1 Top-Down: 2,753,549 - Adverse Scenario 1 Bottom-Up: 2,916,570 - Adverse Scenario 2 Top-Down: 951,673 - Adverse Scenario 2 Bottom-Up: 2,374,494 - Total regulatory capital-ratio (CAR; in percent of RWAs) - after shock: - 18.6; 19.0; 16.3; 17.2; 5.6; 14.0 - Implied capital shortfall (if any) 1/: - -; 144; 26,147; 2,941; 1,149,405; 122,731 - Number of banks with a CAR below 12 percent: - -; 1; 5; 2; 22; 13 - Number of banks with a CAR below "zero": - -; -; -; -; 5; - ### Stress Test Results on Credit Concentration Risk (summary) - Sample splits: BiH FBiH (27 banks), BiH RS (17 banks), and subset (10 banks) for default of the largest borrower and default of the largest 5 borrowers. - Assumed recovery rates and outcomes: - Assumed recovery rate of 36 percent: - System-wide CAR (in percent of RWAs): 15.3; 16.1; 13.5; 10.3; 12.5; 4.8 - Implied capital shortfall (in millions of BAM) 1/: 91; 28; 63; 516; 168; 348 - Number of banks with a CAR less than 12 percent: 9; 4; 5; 19; 9; 10 - Number of banks with a CAR below "zero": 1; -; 1; 4; 1; 3 - Assumed recovery rate of "zero" percent: - System-wide CAR (in percent of RWAs): 13.9; 14.7; 12.0; 5.7; 7.6; 1.0 - Implied capital shortfall (in millions of BAM) 1/: 166; 60; 106; 1,094; 566; 529 - Number of banks with a CAR less than 12 percent: 10; 5; 5; 24; 14; 10 - Number of banks with a CAR below "zero": 2; 1; 1; 7; 4; 3 - Assumed recovery rate of 70 percent: - System-wide CAR (in percent of RWAs): 16.3; 16.8; 14.9; 13.2; 15.2; 8.3 - Implied capital shortfall (in millions of BAM) 1/: 39; 14; 25; 249; 46; 203 - Number of banks with a CAR less than 12 percent: 6; 3; 3; 11; 4; 7 - Number of banks with a CAR below "zero": -; -; -; 2; -; 2 *Source: _cr15164 - 2. Channels of Risk Propagation (excerpted content).* ### Appendix Table 11. Summary of the Liquidity Stress Test Results ### Appendix Table 11. Summary of the Liquidity Stress Test Results ### Liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) — system and entity breakdown - Population: - BiH (27 banks) - FBiH (17 banks) - RS (10 banks) - LCR (including "required reserves"): - System-wide LCR (in percent): 291.73 (BiH), 348.6 (FBiH), 205.2 (RS) - Implied liquidity shortfall (in millions of BAM) 1/: 70.2 (BiH), 49.7 (FBiH), 20.4 (RS) - Number of banks with a LCR below 100 percent: 5 (BiH), 2 (FBiH), 3 (RS) - LCR (excluding "required reserves"): - System-wide LCR (in percent): 200.52 (BiH), 241.5 (FBiH), 138.1 (RS) - Implied liquidity shortfall (in millions of BAM) 1/: 324.6 (BiH), 142.7 (FBiH), 181.9 (RS) - Number of banks with a LCR below 100 percent: 11 (BiH), 6 (FBiH), 5 (RS) - NSFR: - System-wide NSFR (in percent): 123.0 (BiH), 127.4 (FBiH), 114.0 (RS) - Implied liquidity shortfall (in millions of BAM) 2/: 322.8 (BiH), 209.9 (FBiH), 112.9 (RS) - Number of banks with a NSFR below 100 percent: 7 (BiH), 4 (FBiH), 3 (RS) ### Notes on definitions (as presented) - The LCR “implied liquidity shortfall” is the amount of system wide liquidity needs (in terms of HQLA) so that the LCR of each bank is at least 100 percent. - The NSFR “implied liquidity shortfall” is the amount of system wide liquidity needs (in terms of ASF) so that the NSFR of each bank is at least 100 percent. ### Key takeaways from the liquidity stress-test summary - System-wide liquidity metrics indicate comfortable aggregate LCR and NSFR ratios across BiH, FBiH, and RS, but a non-negligible number of individual banks fall below the 100 percent threshold under different LCR specifications. - Excluding "required reserves" materially reduces system LCRs and increases implied liquidity shortfalls, and raises the count of banks with LCR below 100 percent. --- ### RTGS assessment — major achievements and resilience - Major achievements: - Modernization of the payment system: dismantling of the old payment system led to efficiency improvements and risk reduction. - Launch of a real-time gross settlement system and a giro clearing system for retail payments in 2001. - Resiliency: - The interbank payment system functioned normally during the severe floods of May 2014. - Contingency arrangements include a disaster recovery site located at a distant location from the primary site. - Currency board effects: - The currency board arrangement helped protect the payment system from credit risks by prohibiting intraday credit and enforcing pre-funding requirements. ### RTGS assessment — identified weaknesses and areas for improvement - Legal and finality issues: - The legal basis is relatively sound, but finality and netting arrangements require greater legal certainty and protection at the law level. - It cannot be ruled out that a transaction settled in the real-time gross settlement system can be revoked by a court order in the event of insolvency of a participant. - Recommendation noted: adoption of an explicit law on settlement finality or elimination of “zero-hour rules” in insolvency. - Risk management framework: - A comprehensive risk management framework is lacking; current rules articulate mitigation but do not constitute a formal, comprehensive framework. - The framework should include legal, liquidity, and operational risks among others, with formal identification and ongoing monitoring. - Liquidity risk: - Liquidity risk management is generally effective, but should be more robust given high concentration of transaction values across five banks. - Potential liquidity stress sources include settlement delays from the GCS, clearing agents, or settlement banks, and default of the largest participant and its affiliates. - Suggested improvements include stress testing the RTGS system for the default of the largest participant and affiliates and establishment of throughput rules. - Operational risk and business continuity: - Operational risk is well managed, with a primary and a secondary disaster recovery site located around 200 kilometers apart and regular tests (three times a year, each test lasting five days). - A recovery time objective needs to be established to ensure operations resume within two hours following a disruptive event. - The operational risk management framework and business continuity plan could be improved by clearly establishing in writing the service availability and recovery time objectives. - Efficiency and service levels: - Efficiency could be enhanced with fee schedule reviews and the setting of minimum service levels. - The pricing policy is aimed at recovering cost, but fees have not been regularly revised to reflect costs; the RTGS fee schedule has been revised once since its inception. - Recommended actions include conducting cost accounting of the payment system on an annual basis, revising fee schedules to reflect costs where applicable, and establishing, monitoring, and disclosing minimum service levels. ### Authorities’ responsibilities — shortcomings and recommended actions - Shortcomings: - The Law of the Central Bank of Bosnia and Herzegovina mainly establishes operational responsibilities but does not give sufficient powers in the oversight of payment systems. - Lack of oversight powers, limited resources and supervisory capacity, and need to broaden and deepen oversight cooperation with other competent authorities. - Recommended actions: - Strengthen the legal framework to designate payment systems, and to protect settlement finality and netting in line with international standards. - Adopt the Principles for Financial Market Infrastructures into the regulatory framework. - Establish a new oversight unit within the Payment Systems Department, staffed with sufficient resources to carry out oversight responsibilities. - Develop memoranda of understanding to strengthen oversight of clearing agents, settlement banks, international payment clearing, and cooperation with relevant authorities, respecting mandates of each competent authority. *Source: IMF staff calculations and assessment materials as presented in the Appendix Table 11 and accompanying RTGS assessment.* ### introduction in 2001 and was in support of time-zone ### introduction in 2001 and was in support of time-zone pricing. ### Communication procedures and standards - The RTGS system is based on internationally accepted communication procedures and standards. - SWIFT communication network and messages are used to transmit financial information. - Within SWIFT, a CUG is formed where payments are made within the group in BIH. - Minimum service levels do not appear to have been clearly established to monitor efficiency and effectiveness. ### Disclosure of rules, key procedures, and market data - RTGS rules and procedures are publicly disclosed, but would be more complete with the disclosure of relevant laws, regulations, instructions, decisions, and memorandum of understanding issued by the competent authorities. - Testing and training should increase focus on the understanding of CBBH RTGS Operational Rules, relevant rules and procedures, and potential risks and mitigation measures. - Disclosure of market data by trade repositories: Not applicable. ### Authorities’ Summary — Compliance with the CPMI-IOSCO Responsibilities - Regulation, supervision, and oversight of FMIs: - There are no clearly defined and publicly disclosed criteria to identify FMIs that should be subject to regulation, supervision, and oversight. - The CBBH has plans to establish criteria after the completion of assessment of observance of the RTGS system and authorities’ responsibilities against the CPMI-IOSCO under the IMF-World Bank Financial Sector Assessment Program. - The Law of the CBBH clearly establishes its operational responsibilities, but does not provide sufficient powers for the oversight of payment systems. - Operational responsibilities in the Law of the CBBH include: (i) promoting or establishing and maintaining appropriate payment and settlement systems; (ii) entering into international clearing and payment arrangements; and (iii) organizing facilities for the clearing and settlement of interbank payments. - Powers to discharge oversight responsibilities for FMIs are not clearly established in the Law of the CBBH. - Regulatory, supervisory, and oversight powers and resources: - The Payment Systems Department’s resources are focused on carrying out operational duties and other ancillary services, including maintaining the transaction registry and credit registry. - Staff have not received adequate training on FMI oversight in the past two years, especially on the new CPMI-IOSCO PFMIs, which were released in April 2012. - The CBBH’s Chief Internal Auditor (including 10 staff where two are technology specialists) conducts audits of the payment system every two years and is narrowly focused on information security issues. - The Risk Management Department (including 4 staff) focuses on managing financial risks in foreign currency reserves and, to a lesser extent, operational risk management, collating risks from different departments on a quarterly basis and reporting to CBBH Management. - The establishment of an internal working group to address oversight of payment systems was put on hold since 2007 due to potential conflicts of interest between operational and oversight duties being located within the same organizational unit. - A decision on the appropriate location within the central bank to preserve impartiality is pending at the CBBH Governing Board. - Agreement exists on the need to establish a new oversight unit, but organizational issues have not been resolved. - Disclosure of policies with respect to FMIs: - The CBBH’s responsibilities in the payment system are disclosed through its Annual Report, Financial Stability Report, and website. - There does not appear to be a coherent oversight policy document with respect to the RTGS system that clearly describes its objectives, roles, and regulations. - Application of the principles for FMIs: - The CBBH has not adopted the CPMI-IOSCO Principles for Financial Market Infrastructures and apply them consistently. - The CBBH has plans to do so after the completion of assessment of observance of the RTGS system and authorities’ responsibilities against the CPMI-IOSCO under the IMF-World Bank Financial Sector Assessment Program. - Cooperation with other authorities: - The CBBH and entity banking agencies cooperate on cross-cutting issues between the payment system and banking supervision under a memorandum of understanding. - Advanced notification and coordination between competent authorities on the planned closure of a problem bank and its consequential suspension from the payment system could be further improved to prevent the unwinding of payments following a court order. - Although the CBBH and entity securities commissions have a common interest in promoting safe and efficient FMIs, there is no formal cooperation. - Given the systemic importance of CSDs, there is a potential role for cooperative oversight by the securities commissions and the CBBH. ### Recommended Actions to Improve the RTGS System — Compliance with the CPMI-IOSCO PFMIs - Legal basis and settlement finality: - Strengthen the legal framework to designate payment systems, and to protect settlement finality and netting in line with international standards. - Governance: - Improve risk analysis in the payment system, and report progress on a quarterly basis at the meetings of the Governing Board. - Framework for the comprehensive management of risks: - Develop a comprehensive risk management framework for the RTGS system. This should include legal, liquidity, and operational risks among others. - Monitor risks on an ongoing basis and include periodic reporting to the CBBH Governing Board and Management. - Liquidity risk: - Stress test the RTGS system, including the default of the largest participant and affiliates. - Establish throughput rules, and adopt tools to monitor intraday liquidity flows to assess the sufficiency of liquidity in the reserve account of commercial banks on a daily basis. - Operational risk: - Establish service availability and recovery time objectives. - The business continuity plan should be designed to ensure that critical information technology systems can resume operations within two hours following disruptive events. - The plan should be designed to enable the RTGS system to complete settlement by the end of the day of the disruption, even in case of extreme circumstances. - Efficiency and effectiveness: - Conduct the cost accounting of the payment system on an annual basis and revise fee schedules to reflect costs where applicable. - Establish, monitor, and disclose minimum service levels for RTGS services. - Disclosure of rules, key procedures, and market data: - Develop a description of the design and operations of the RTGS system, and disclose it along with the relevant laws, regulations, instructions, decisions, and memorandum of understanding issued by the competent agencies in the CBBH Annual Report and web. ### Recommended Actions to Improve the Compliance of Authorities’ Responsibilities with the CPMI-IOSCO PFMIs - Regulation, supervision, and oversight of FMIs: - Establish clearly defined and publicly disclosed criteria to identify FMIs that should be subject to regulation, supervision, and oversight by the relevant competent authorities. - Regulatory, supervisory, and oversight powers and resources: - Strengthen the legal framework to designate payment systems, and to protect settlement finality and netting in line with international standards. - Establish memorandum of understanding to strengthen the oversight of clearing agents, settlement banks, international payment clearing, and cooperation with relevant authorities. - Establish a new oversight unit in the Payment Systems Department, staffed with sufficient resources to carry out oversight responsibilities. - Separate oversight and operational duties at either the department level or located within different units in the same department to avoid conflicts of interest, have a clear reporting line, and leverage periodical external assessments for impartiality. - Disclosure of policies with respect to FMIs: - Develop a policy document to clearly define and disclose the regulatory, supervisory, and oversight policies of the CBBH for the RTGS system. - Application of the principles for FMIs: - Adopt the CPMI-IOSCO PFMIs with a time-bound plan and apply them consistently to the RTGS system. - Cooperation with other authorities: - Improve advanced notification from the entity banking agencies to the CBBH to coordinate the timely closure of a bank and its suspension from the payment system. - Develop memorandum of understanding between the CBBH, entity banking agencies, and securities commissions to collaborate on the development and oversight of FMIs, respecting the mandates of each competent authority. ### Authorities’ Response to the Assessment - Paragraph 9: - Since 2005, there has been a Commission for the Oversight of Payments Systems Operations in the CBBH, established by the Governing Board, with the task to elaborate the framework of the oversight in line with the policies and criteria for the FMI according to the “old” principles. - On 2012 new principles were released (23 instead of then 10). - Paragraph 10: - The CBBH is decisive to arrange elaborately the functioning of all its operations via establishment of integrated internal controls system. - The CBBH will publish the translation of new CPMI-IOSCO principles (23 principles) on its web site and work out the criteria for the identification of FMI that will be mandatory for all participants. - The Governing Board will decide on which recommended variant of oversight is optimal for implementation in the CBBH and will publish it in format of enactments in the Official Gazettes of BH, RS, and FBiH, within the set deadline, adhering to the provisions of the CBBH Law. - Paragraph 11: - The internal audit assessed the oversight of payments systems as very important business process in the Risk Map and defined it as the priority in performing the internal auditing process. - Paragraph 12: - Within its authority, the CBBH will observe all recommendations from the Assessment of Observance of the CPMI/IOSCO Principles for Financial Market Infrastructures" as per suggested deadlines. - Paragraph 13: - The CBBH will regularly inform your team on implementation of each individual recommendation. *Source: _cr15164 - introduction in 2001 and was in support of time-zone pricing (PDF chapter/section).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15164.pdf_