## _cr15177 - 2014. The FSSA report was completed on May 20, 2015. ## Source details **Canonical URL:** [_cr15177 - 2014. The FSSA report was completed on May 20, 2015.](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15177.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15177.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15177.pdf.json) --- ### Executive summary — macrofinancial setting and key facts - 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: averaged around 3 percent growth since 2010. - Corporate sector debt: around 69 percent of GDP at end-2013. - Household debt: around 30 percent of disposable income. - CBBH foreign reserve cover: 107 percent of CBBH monetary liabilities as of 2014Q3. - Currency board arrangement (CBA): fixes the convertible marka to Euro and constrains monetary policy and systemic liquidity management. - FSAP mission dates: October 29–November 18, 2014. - FSSA report completion date: May 20, 2015. - IMF Executive Board discussion: June 29, 2015. - Press Release: Press Release No. 15/327; FOR IMMEDIATE RELEASE July 9, 2015. - Price: $18.00 per printed copy. ### Financial system structure, concentration, and ownership - Banks account for about 87 percent of financial system assets, equivalent to 84 percent of GDP. - Banking system composition: - More than 80 percent of banking sector assets held by foreign subsidiaries (also cited as 82 percent in parts of the report). - Domestically-owned banks account for 16 percent; public banks account for 2 percent (as of end-2014 figures cited). - Twenty seven banks operating in the country (17 in FBiH and 10 in RS; shares 70 and 30 percent, respectively). - The five largest banks represent over half of banking sector assets. - Development Bank of Republika Srpska: provides credit lines, deposits, and capital to the banking system. - Capital markets and nonbank financial institutions: small role; insurance penetration about 2 percent of GDP. ### Asset quality, profitability, capital, and liquidity — snapshot and statistics - System-wide NPL ratio: 14 percent at end-2014; about two thirds of which are provisioned (report states "9 percentage points are provisioned" in one passage and gives Provisions to NPLs series: 2013: 66.3; 2014: 65.9). - NPLs trend: rose from 3 percent in 2006 to 14 percent at end-2014. - Aggregate regulatory capital adequacy ratio: exceeded 16 percent as of end 2014; dispersion among banks ranges from about 7 percent to 48 percent. - Regulatory capital (KM million): 2014: 2,784 (series 2005–2014 provided). - Regulatory capital to RWAs: 2014: 16.4 (series 2005–2014 provided). - Profitability: - ROAA: 2014: 0.8 (series 2005–2014 provided). - ROAE: 2014: 6.0 (series 2005–2014 provided). - Gross income to average assets: 2014: 1.4 (series 2005–2014 provided). - Liquidity indicators: - Liquid assets: 26.8 percent of total assets (2014). - Liquid assets to short-term liabilities: 46.1 percent (2014). - Liquid assets stood at 26¾ percent and 46 percent of total assets and short term liabilities, respectively, as of 2014Q4 (textual statement). - Excess reserves: 150 percent of requirements. - Reserve requirements (RR): 10 percent for liabilities with contractual maturity up to one year; 7 percent for other liabilities. - Loan-to-deposit ratio: 120 percent (textual statement); loans to deposits (table) 2014: 108.2. - System-wide LCR: exceeds 250 percent (textual); potential system-wide liquidity shortfall: around ¼ percent of GDP; excluding RRs from HQLA would increase shortfall to just over 1 percent of GDP. - FX exposure and euroization: - Nearly two-thirds of loans are in, or indexed to, a foreign currency, mostly euros. - Foreign-currency-denominated loans to total loans: 2014: 62.4 (series 2005–2014 provided). - Foreign-currency-denominated liabilities to total liabilities: 2014: 62.7 (series 2005–2014 provided). ### Domestically-owned banks — pockets of vulnerability and public links - Domestically-owned banks: lower and declining liquidity and capital ratios; large concentrations; weaker asset quality and profitability relative to foreign banks. - Detailed AQRs of three domestically-owned banks under enhanced supervision revealed capital shortages; only two had been corrected so far. - Public sector links: - In RS, the IRBRS holds sizeable shares and subordinated debt in some domestically-owned banks, has credit lines for on-lending, and deposit placements in four domestically-owned banks. - In FBiH, some public sector entities have stakes in some domestically-owned banks. - Several domestically-owned banks rely on public support with undefined exit plans; public capital support provided in forms that left existing equityholders undiluted, contributing to moral hazard. ### Stress tests, scenarios, tail risks, and key outcomes - Stress test coverage: all 27 banks; 5-year horizon (2015-2019). - Methodology: top-down solvency (supervisory data) and bottom-up (banks’ internal models) with macro scenarios. - Macroeconomic scenarios: three — baseline and two adverse scenarios. - Top-down credit-loss range: 1.9 percent of GDP in the first adverse scenario to 7 percent of GDP in the most severe scenario. - Potential system-wide capital shortfalls (top-down): - Adverse Scenario 1: around 0.1 percent of GDP. - Adverse Scenario 2: 4 percent of GDP. - Sensitivity analysis: up to 11 banks could become insolvent if a few of their largest exposures were to default. - Contagion: domestic interbank exposures among banks are less than 1 percent of total regulatory capital. - Cross-border spillovers: foreign parent funding and correspondent exposures imply potential sizable effects on capital adequacy from external credit and funding shocks. ### Insurance sector: structure, solvency, and vulnerabilities - Insurance sector: dominated by non-life companies; life insurance embryonic. - Insurance penetration: about 2 percent of GDP. - Solvency framework: based on Solvency I; not risk-sensitive; solvency ratios may be overstated. - A number of insurance companies have thin solvency margins; some non-life insurers have combined ratios exceeding 100 percent. - Over 40 percent of insurance sector assets are in bank deposits. - Network analysis: in the severe adverse scenario, the insurance sector would lose about 14 percent of its capital. ### Supervisory, regulatory, and institutional weaknesses - Improvements since 2006 but remaining shortcomings: - Supervisors’ corrective and enforcement powers are weak; limited authority to impose financial penalties and to permanently suspend board members and controlling owners outside provisional administration. - Identifying ultimate beneficial owners and related-party lending problematic. - Fragmented responsibilities for banking, insurance, and capital markets across state and entity levels; Standing Committee on Financial Stability (SCFS) improved coordination but fragmentation delays reforms. - External auditors: concerns about audit quality; auditors often appointed only for one year. - Supervisory data access: FSAP team noted exceptionally good access to supervisory data. - AML/CFT: MONEYVAL 2009 report identified strategic deficiencies; progress includes enactment of a new AML/CFT law and amendments to the Criminal Code; further implementation and a national ML/TF risk assessment recommended. ### Payment systems, RTGS assessment, and operational resilience - RTGS and payment systems: - RTGS launched in 2001; resilient during May 2014 floods. - Contingency arrangements: disaster recovery site ~200 kilometers from primary site; tests three times a year with five-day tests. - Operational risk: well managed, but a recovery time objective needs to be established to ensure resumption within two hours. - Liquidity/reliance: no credit risks due to pre-funding; CBBH prohibited from extending intraday credit. - Concentration: 55 percent of transaction values across five banks, including two settlement banks. - Key legal and oversight weaknesses: - Finality and netting legal certainty insufficient; risk of reversal by court order in participant insolvency; recommendation to eliminate zero-hour rules in insolvency law or adopt explicit settlement finality legislation. - Lack of comprehensive risk-management framework and lack of formal oversight powers in law. - Recommendations include: adopt CPMI-IOSCO PFMIs, strengthen legal basis for finality/netting, establish oversight unit within Payment Systems Department, develop MoUs for oversight cooperation, stress test RTGS (including default of largest participant), and set throughput and recovery time objectives. ### Financial safety net, resolution, deposit insurance, and FSF proposal - Main deficiencies in safety net: lack of a comprehensive remedial action program, inadequacy of resolution powers, and inability to provide temporary emergency liquidity support to soundly capitalized and well managed banks. - Deposit Insurance Agency (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. - Formal assessment: majority of IADI principles compliant or largely compliant. - First DIA deposit pay-out: following liquidation of Bobar Bank (Bobar Bank liquidated on December 22, 2014; DIA started pay-out on January 19, 2015). - Recommended enhancements: establish capacity for prompt pay-outs in line with EU directive; amend legislation to enable prompt pay-out and authorize DIA funds to facilitate P&A under least cost. - Resolution authority and toolkit: - FBA and BARS have some resolution powers but are not formally designated or equipped as resolution authorities. - Proposed: vest resolution powers in FBA and BARS, designate them as resolution authorities, and provide comprehensive resolution powers following FSB Key Attributes and EU BRRD. - DIA/DIF use in resolution: broaden scope to draw on existing DIF for funding bank resolution subject to least-cost solution; DIF should not be used for open bank assistance. - Financial Stability Fund (FSF): - Proposal: establish an FSF under the DIA to provide for open bank resolution and limited and temporary liquidity support in systemic crisis. - FSF design features: limited liquidity support to solvent but illiquid systemic banks; triggers and safeguards; financed by ex-ante levies with capacity for ex-post levies; possible IFI support; administered by DIA and separated from DIF; loss absorption by shareholders and creditors up-front; use under strict conditions to minimize moral hazard. - Suggested Timeframes in recommendations: e.g., Establish FSF — Time: 67 MT (excerpted action plan). ### Key policy recommendations and priorities (Executive Directors’ endorsement) - Immediate priorities: - Adopt a timely, decisive, and well communicated strategy to deal with weak banks. - Consider a credible and transparent backstop for systemic cases. - Streamline collateral execution procedures and facilitate corporate debt restructurings and resolution. - Adopt out-of-court restructuring guidelines. - Enact new banking legislation to strengthen supervisors’ powers and introduce consolidated supervision. - Bolster corporate governance and risk management in banks. - Reinforce the financial safety net by creating an appropriate resolution framework and toolkit, and support establishment of an FSF with limited emergency liquidity assistance within the CBA context. - Improve systemic liquidity management and broaden the macroprudential framework. - Continue implementation of the AML/CFT action plan. - Selected time-bound actions (excerpted): - Conduct additional AQRs in banks with weak solvency and liquidity indicators. Time: 16 I. - Enact new Laws on Banks and amend relevant legislation. Time: 36 I. - Design and implement the LCR, adapted to BiH. Time: 55 MT. - Provide resolution powers to the FBA and BARS on the new Laws on Banks, following the FSB Key Attributes and EU BRRD. Time: 65 I. - Establish an FSF—under the DIA—to provide for open bank resolution and limited and temporary liquidity support in systemic crisis. Time: 67 MT. - Enable prompt depositor pay-out (DIA). Time: 60 I. ### NPL resolution, legal, judicial, and tax impediments - NPL statistics (selected comparisons, In percent): - NPL to total Loans: TOTAL 2012Q4: 13.5; TOTAL 2014Q3: 22.7. - Of which corporates: TOTAL 2012Q4: 8.5; TOTAL 2014Q3: 27.0. - Of which households: TOTAL 2012Q4: 5.0; TOTAL 2014Q3: 4.5. - Memo — Special mention loans (share of total loans): TOTAL 2012Q4: 9.8; TOTAL 2014Q3: 17.2. - Impediments: - Lack of streamlined out-of-court or negotiated restructuring alternatives; insolvency regime does not cover individual debtors; lengthy litigation and execution processes; low recovery rates for pledged assets. - Recommendations: streamline execution (allow final auction at no reserve price if prior rounds fail), specify realistic asset valuation criteria, review tax laws to encourage restructuring and NPL sales (including potential VAT exemptions), hire more commercial court judges, and regulate the insolvency profession. ### Macroprudential framework and systemic liquidity management - Macroprudential toolkit: relatively underdeveloped but being extended to include elements of Basel III (capital conservation buffers, leverage ratio, plans for countercyclical buffers and systemic surcharges). - Main instrument so far: reserve requirements used actively. - Recommendations: - Broaden and focus cooperation among CBBH, FBA, and BARS and add macroprudential analysis to coordination MoU. Time: 52 NT. - Examine LTV and DTI levels, household and corporate indebtedness, and debtors’ currency mismatches. - Consider currency-specific LCRs given high euroization. - Revise reserve requirements, maturity mismatch, and the liquidity ratio. Time: 55 NT. - Calibrate LCR carefully (haircuts on public securities, run-off rates, treatment of prepayment clauses). ### Risk Assessment Matrix — main threats and staff assessments (selected) - Bond market stress (euro area): Staff assessment overall: Low; Likelihood of severe realization: Medium. - Geopolitical tensions Russia/Ukraine: Staff assessment overall: Medium; Likelihood of severe realization: Low. - External funding withdrawal by parent banks: Staff assessment overall: Medium; Likelihood of severe realization: Medium. - Further deterioration in commercial banks and depositor confidence: Staff assessment overall: Medium; Likelihood of severe realization: High. - Unavailability of official budget financing/sov. debt restructuring: Staff assessment overall: Low; Likelihood of severe realization: Low. ### Selected exact numeric facts and dates (as stated) - 87 percent (banks’ share of financial system assets). - 84 percent of GDP (equivalent share). - More than 80 percent (foreign subsidiaries’ share of banking sector assets). - 14 percent (system-wide NPL ratio at end-2014). - FSAP mission dates: October 29–November 18, 2014. - Report completion date: May 20, 2015. - Executive Board discussion: June 29, 2015. - Press release date: July 9, 2015. - Price: $18.00 per printed copy. *International Monetary Fund — Bosnia and Herzegovina Financial System Stability Assessment (FSSA), report completed May 20, 2015 (CR15177).* ### 2014. The FSSA report was completed on May 20, 2015. ### _cr15177 - 2014. The FSSA report was completed on May 20, 2015. ### Executive Board approval and key procedural facts - Press Release No. 15/327; FOR IMMEDIATE RELEASE July 9, 2015. - The IMF Executive Board discussed the Financial System Stability Assessment (FSSA) of Bosnia and Herzegovina on June 29, 2015. - The FSSA report was completed on May 20, 2015. - The FSAP mission visited Bosnia and Herzegovina during October 29–November 18, 2014. ### Financial system structure and concentration - Banks account for about 87 percent of financial system assets, equivalent to 84 percent of GDP. - The banking system comprises mostly foreign subsidiaries, constituting more than 80 percent of the banking sector assets. - Interconnectedness among banks is limited, but linkages between banks and the insurance sector are significant. - The Development Bank of Republika Srpska plays a major role through the provision of credit lines, deposits, and capital to the banking system. - Insurance companies and other nonbank financial institutions play a small role. ### Current condition and legacy problems - A high system-wide non-performing loan (NPL) ratio—14 percent at end-2014—reflects the impact of the crisis, low growth since then, and a history of lax lending policies. - Aggregate solvency and liquidity indicators appear broadly sound, but dispersion among banks is wide; pockets of vulnerability exist within domestically-owned banks. - Several domestically-owned banks are struggling to meet capital requirements; some rely on public support with undefined exit plans. - Stress tests indicate those banks have high loan concentration risks and low liquidity ratios. - A number of insurance companies have thin solvency margins. - Credit to private sector continues to grow only very slowly. ### Supervisory, regulatory, and institutional weaknesses - Banking and insurance oversight have improved since the 2006 FSAP, but supervisors’ corrective and enforcement powers are weak. - Identifying ultimate beneficial owners and related-party lending is problematic. - Regulatory and supervisory responsibilities for banking, insurance, and capital markets are fragmented; the establishment of the Standing Committee on Financial Stability has improved coordination. - Institutional fragmentation is delaying much-needed financial sector reforms. - The current insurance prudential framework is based on Solvency I, is not risk-sensitive, and is ill-suited for supervision as the market develops. - Formal assessment of the real-time gross settlement system suggests many principles are observed, but legal and liquidity risks and lack of oversight powers are weaknesses. ### Liquidity and market functioning constraints - The legal system under the currency board arrangement rules out a standing liquidity facility and emergency liquidity assistance. - The secondary market for government securities is small and illiquid. - Money market and interbank markets are relatively small. - The macroprudential toolkit is relatively underdeveloped but is being extended to include elements of Basel III. ### Financial safety net and crisis preparedness - Important elements of the financial safety net are either missing or not adequately developed. - Main deficiencies: lack of a comprehensive remedial action program, inadequacy of resolution powers, and inability to provide temporary emergency liquidity support to soundly capitalized and well managed banks. - The deposit insurance agency (DIA) is largely compliant with international standards. - Contingency plans were prepared in 2014 by the relevant agencies and a coordinated contingency plan was then developed. - The first ever deposit pay-out of the DIA was efficiently started within a month of the liquidation of a small bank in December (year not specified in the source). ### Executive Directors’ assessment and policy recommendations - Executive Directors concurred with the main findings and recommendations of the second FSSA for Bosnia and Herzegovina. - Directors emphasized that a stronger financial sector is essential to maintain macroeconomic stability and revitalize economic growth. - Key recommendations and policy priorities endorsed by Directors: - Adopt a timely, decisive, and well communicated strategy to deal with weak banks. - Consider a credible and transparent backstop for systemic cases. - Address high level of nonperforming loans by: - Streamlining collateral execution procedures. - Facilitating corporate debt restructurings and resolution. - Adopting out of court restructuring guidelines. - Enhance cooperation among supervisors. - Enact new banking legislation to strengthen supervisors’ powers and introduce consolidated supervision. - Bolster corporate governance and risk management in banks. - Monitor closely thin solvency margins in the insurance sector. - Reinforce the financial safety net by creating an appropriate resolution framework and toolkit. - Support establishment of a financial stability fund (FSF), with limited emergency liquidity assistance, for resolution of systemic banks in the context of Bosnia and Herzegovina’s currency board arrangement. - Improve systemic liquidity management and broaden the macroprudential framework. - Continue to implement the action plan to overcome remaining AML/CFT deficiencies. ### FSAP mission, participants, and scope notes - The FSAP mission team comprised IMF and World Bank staff and consultants (detailed roster in the source). - The mission met with high-level Bosnian authorities, including Governor Kemal Kozarić; Minister of Finance and Treasury Nikola Špirić; Ministers of Finance of the entities; directors of banking, deposit insurance, and insurance agencies; securities commission presidents; directors of development banks; ministries of justice; stock exchanges; and representatives from banks, insurance companies, microfinance organizations, leasing companies, and accounting and auditing firms. - FSAPs assess stability of the financial system as a whole, not individual institutions, and identify key sources of systemic risk and policies to enhance resilience to shocks and contagion. - Certain categories of risk (operational, legal, fraud-related) are not covered in FSAPs. ### Selected exact numeric facts and dates (as stated) - 87 percent (banks’ share of financial system assets). - 84 percent of GDP (equivalent share). - More than 80 percent (foreign subsidiaries’ share of banking sector assets). - 14 percent (system-wide NPL ratio at end-2014). - FSAP mission dates: October 29–November 18, 2014. - Report completion date: May 20, 2015. - Executive Board discussion: June 29, 2015. - Press release date: July 9, 2015. - Price: $18.00 per printed copy (publication information). *International Monetary Fund — Bosnia and Herzegovina Financial System Stability Assessment (FSSA), report completed May 20, 2015.* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Economic and financial activity and macrofinancial setting - Economic and financial activity in Bosnia and Herzegovina (BiH) "remains stuck in a low gear" since the global financial crisis due to weak external demand, tighter funding conditions, and deep seated structural issues. - Real GDP growth is estimated to have slowed to 1 percent in 2014. - Consumer prices fell by 0.9 percent in 2014. - Unemployment rate remains at above 27 percent. - Credit to the private sector has averaged around 3 percent growth since 2010; bank credit to the private sector grew at an average annual rate of around 25 percent over 2003-07. - At end-2013, corporate sector debt stood at around 69 percent of GDP. - Household debt has remained steady at around 30 percent of disposable income. - CBBH foreign reserve cover stands at 107 percent of CBBH monetary liabilities as of 2014Q3. - The currency board arrangement (CBA) fixes the convertible marka to Euro and constrains monetary policy and systemic liquidity management. ### Banking sector performance and vulnerabilities - System-wide NPL ratio: 14 percent at end-2014; about two thirds of which are provisioned. - Banking system ownership: more than 80 percent foreign-owned banks; the banking system comprises mostly foreign subsidiaries—82 percent of the banking sector assets, while domestically-owned and public banks account for 16 and 2 percent respectively. - Number of banks: twenty seven banks operating in the country (17 in FBiH and 10 in RS, with a share of 70 and 30 percent, respectively). - Concentration: the five largest banks represent over half of banking sector assets. - Aggregate solvency and liquidity indicators: average regulatory capital adequacy ratio exceeded 16 percent as of end 2014; dispersion among banks ranges from about 7 percent to 48 percent. - Vulnerabilities concentrated within domestically-owned banks: some struggling to meet capital requirements; some relying on public support. - Stress tests indicate large concentration risks and low liquidity ratios for weaker banks. - Bank governance problems: related-party loans, inadequate corporate resolution and insolvency frameworks, lack of adequate governance and risk management, inadequate administrative powers to sanction supervisory board members and significant owners, problematic identification of ultimate beneficial owners, obscure related-party lending and group exposures. - Need for remedial and decisive actions: strategy to facilitate recovery of weak banks (if practicable) or resolve them cost-effectively while maintaining financial stability and protecting insured depositors; timetable should be spelled out clearly; consider credible and transparent public backstop for potentially systemic cases. ### Supervisory framework, insurance oversight, and financial supervision structure - Banking and insurance oversight improved since the 2006 FSAP but important shortcomings remain. - Institutional fragmentation: oversight responsibilities for banking, insurance, and capital markets lie at the entity level by Constitution; CBBH and Deposit Insurance Authority (DIA) reside at the state level; cooperation among oversight institutions is complex and can have repercussions in stress. - Insurance sector: small; insurance penetration about 2 percent of GDP; nonlife segment collects over 80 percent of insurance premiums; a number of companies have thin solvency margins. - Prudential framework for insurance needs update to improve risk sensitivity; consumer protection and financial literacy in insurance are weak. - Supervisory data access: FSAP team access to supervisory data—at the individual bank level, aggregated along group of banks, and system wide level—was exceptionally good. - Need to strengthen supervisory board selection process and internal audit functions of state banks. ### Financial safety net, NPL resolution, insolvency framework, and liquidity management - Legal framework governing creditor/debtor relationships: comprehensive, but debt resolution and bankruptcy liquidation do not work effectively, impeding NPL resolution. - Need to streamline execution procedures, introduce incentives to facilitate corporate debt restructurings and resolution, and adopt out-of-court restructuring guidelines. - Institutional improvements needed: hire more commercial court judges with appropriate experience and improve regulation of the insolvency profession. - Financial safety net needs strengthening: - Creation of resolution authorities with comprehensive powers, appropriate resolution tools, and temporary and limited emergency liquidity—within the currency board arrangement—are key pillars to support bank resolution and provide liquidity to solvent but illiquid banks. - Deposit insurance system largely compliant with international standards; shortening the payout period in line with the EU relevant directive would be appropriate. - Well-coordinated contingency planning—both domestic and cross-border—is essential. - Establish a macroprudential framework, underpinned by broader and more focused cooperation among relevant agencies. - Liquidity management: revise reserve requirements, maturity mismatch, and the liquidity ratio. ### Payment systems, AML/CFT, and financial market infrastructure - Payment system meets much of the international standard, but liquidity and legal risks exist. - Liquidity risks arise from high concentration of transaction values in the payment systems across a few banks. - Legal basis is relatively sound, but finality and netting arrangements require greater legal certainty at statutory level. - Assessment suggests lack of oversight powers, limited resources and supervisory capacity for payment systems oversight. - RTGS: real-time gross settlement (RTGS) system settles high-value credit funds transfers and net balances submitted by the GIRO clearing system (GCS) and card switching network. - AML/CFT: progress made in enhancing the AML/CFT framework, but further efforts necessary to address remaining deficiencies and implement the AML/CFT law effectively. ### Capital markets, microfinance, and leasing - Capital markets are small and financial sector development in microfinance and leasing is constrained. - Securities market legal and regulatory framework: sound and infrastructure well developed. - Suggested improvements: introduce a ‘passporting’ framework; increase transparency and information disclosures. - Leasing operations: to enhance leasing as an alternative financing option for firms with limited collateral or credit history, revisit collateral requirements and make repossession of assets more effective. ### Key FSAP recommendations and timing (excerpted from Table 1) - Banking Oversight - 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). Time: 40 NT. - Strengthen provisioning under IAS by issuing standards to encourage conservative assumptions on impairment by banks (FBA, BARS). Time: 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). Time: 36 I. - Conduct additional AQRs in banks with weak solvency and liquidity indicators (FBA, BARS). Time: 16 I. - Assure that banks continue implementing IFRS and external auditor implement IAS (FBA, BARS). Time: 41 MT. - Insurance Oversight - The appointment of the FBiH-ISA director should be based on the relevant law (Government). Time: 45 MT. - The new insurance law in the FBiH should be approved if it shows improved convergence towards the EU insurance directives (FBiH-ISA). Time: 44 I. - Introduce a formal channel of information sharing with banking agencies (FBiH-ISA). Time: 46 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). Time: 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). Time: 55 NT. - Design and implement the LCR, adapted to BiH (FBA, BARS). Time: 55 MT. - Revise the consequences to banks for not complying with reserve requirement (CBBH). Time: 54 MT. - Enable prompt depositor pay-out (DIA). Time: 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). Time: 65 I. - Broaden the scope to draw on the existing DIF for funding bank resolution using least-cost solution (DIA). Time: 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). Time: 67 MT. - Strengthen, regularly review, and test bank contingency plans of SCFS members (SCFS). Time: 62 I. - Strengthen the cooperation between DIA and financial safety net players (DIA, CBBH, FBA, BARS). Time: 60 I. - 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). Time: 52 NT. - 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). Time: 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). Time: 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). Time: 35 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). Time: 48 NT. - Develop a comprehensive risk management framework for the RTGS system (CBBH). Time: 47 I. - Stress test the RTGS system, including the default of the largest participant and affiliates (CBBH). Time: 47 NT. - Establish a recovery time objective for the RTGS system following disruptive events (CBBH). Time: 47 I. - Establish a new oversight unit in Payment Systems Department, which is staffed with sufficient resources to carry out oversight responsibilities (CBBH). Time: 48 NT. *Source: IMF staff — EXECUTIVE SUMMARY (CR15177).* ### 10. As elsewhere in the region, the largest foreign banks operating in BiH are from Austria ### _cr15177 - 10. As elsewhere in the region, the largest foreign banks operating in BiH are from Austria ### Financial system resilience — snapshot: asset quality, profitability, and capital - 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; dispersion among banks ranges from about 7 percent to 48 percent. - Banking sector profitability deteriorated following the global financial crisis, reflecting regional effects and past lax lending practices. - Recent natural disaster prompted regulatory forbearance for loan classification but so far has had a mild impact on asset quality. - The development banks in each entity are non-deposit taking institutions supporting investments and export-oriented activities. ### Market structure and foreign ownership / cross-border exposure - The largest foreign banks operating in BiH are from Austria and Italy. - Foreign banks owned by Austria and Italy constitute almost 60 percent of total banking sector assets in BiH (Appendix Table 6). - In terms of 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. - Banks in BiH had exposures at end-March 2014 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. ### Liquidity and funding - Liquid assets stood at 26¾ percent and 46 percent of total assets and short term liabilities, respectively, as of 2014Q4. - Excess reserves were 150 percent of requirements. - The RR is currently set at 10 percent for liabilities with a contractual maturity of up to one year, and 7 percent for other liabilities. - Loan-to-deposit ratio stands at 120 percent, underscoring continued dependence on parent funding. - Relatively higher liquidity in FBiH compared to RS partly explained by different interpretation and enforcement of the regulation on maturity mismatch. - System-wide LCR exceeds 250 percent; system-wide potential liquidity shortfall could be around ¼ percent of GDP; if required reserves were excluded from HQLA in LCR computation, potential system-wide liquidity shortfall would increase to just over 1 percent of GDP. - Most banks exhibit sizeable amounts of deposits at the CBBH; a few banks, mainly domestic-owned, present relatively low liquidity ratios. ### Domestically-owned banks: pockets of vulnerability and public sector links - Domestically-owned banks show lower and declining liquidity and capital ratios and large concentrations; asset quality and profitability of domestically-owned banks are lower than foreign banks. - Detailed AQRs of three domestically-owned banks under enhanced supervision revealed capital shortages; only two had been corrected so far. - In RS, the IRBRS holds sizeable shares and subordinated debt in some domestically-owned banks, has credit lines for on-lending to some banks, and deposit placements in four domestically-owned banks. - In FBiH, some public sector entities have stakes in some domestically-owned banks. - A number of domestically-owned banks rely heavily on public sector support and exit plans are undefined. ### Dealing with weak banks — recommendations and strategy - Strong and timely action is needed to deal with weak banks; a number do not meet prudential capital requirements or only do so via public capital support. - Public capital support has been provided in the form of subordinated debt and preferred shares, leaving existing equityholders undiluted — contributing to moral hazard and lack of transparency. - Unless owners provide significant capital, phase-out related party loans, and address asset quality, weak banks will need restructuring and/or resolution. - Authorities should develop as a high priority a comprehensive bank restructuring strategy that: - Facilitates recovery where practicable or implements cost-effective resolution consistent with stability and protection of insured depositors. - Includes time-bound AQRs of domestically-owned banks and a strategy to address implications. - Explores all options for early action and ensures technical readiness of the DIA to pay-out depositors promptly. - Considers a credible and transparent public backstop for systemic cases. - Bobar Bank was liquidated on December 22, 2014; the DIA started the deposit pay-out on January 19, 2015 (the first deposit pay-out of the DIA). ### Stress tests, scenarios, and tail risks - Stress tests covered all 27 banks; top-down solvency stress tests used supervisory data; bottom-up stress tests used banks’ internal models with macro scenarios provided by the FSAP team. - Three macroeconomic scenarios considered: baseline (based on latest WEO staff projections) and two adverse scenarios; full-fledged five-year macro projections were quantified (Figure 7 and Appendix Table 8). - Top-down stress tests found 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 (Appendix Table 9). - Top-down and bottom-up results broadly consistent; differences reflect larger provisions for impaired loans in top-down and relatively modest macro response in bottom-up. - Aggregate stress losses—mainly increased loan provisions—remain broadly manageable at system level, though important for domestically-owned banks. - 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 (Appendix Table 9). - Sensitivity analysis: up to 11 banks could become insolvent if a few of their largest exposures were to default (Appendix Table 10). - Concentration risks are high in a specific segment: a few domestically-owned banks present very large single (and common) name exposures mainly to large state-owned enterprises. - Direct exchange rate risk and other market risks appear contained: nearly two-thirds of loans are in, or indexed to, a foreign currency, mostly euros; net open FX positions small and regulatory limits met; most banks are “long EUR”. - Indirect FX risk via “unhedged borrowers” warrants closer monitoring; most banks do not collect information on denomination of borrowers’ income or assets — data gaps should be closed. - Liquidity stress tests using Basel III LCR and NSFR proxies show ample system liquidity; system-wide LCR exceeds 250 percent. - Contagion risks through domestic interbank market are small: domestic interbank exposures among banks are less than 1 percent of total regulatory capital. - Cross-border spillovers: several foreign-owned banks benefit from parent credit lines; many banks hold large deposits in correspondent accounts abroad; network analysis suggests potential sizable effects on capital adequacy from credit and funding shocks from abroad. ### Insurance sector - Sector has high sector-wide solvency ratios, but a number of insurance companies have thin solvency margins (Appendix Table 4). - System dominated by non-life companies; life insurance is embryonic; solvency ratios may be overstated due to use of Solvency I. - Some non-life insurers have combined ratios exceeding 100 percent, implying profits dependent on investment performance. - Over 40 percent of insurance sector assets are in bank deposits (Table 2). - Network analysis suggests that in the severe adverse scenario, the insurance sector would lose about 14 percent of its capital. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15177.pdf* ### 28. Resiliency of the interbank payment system was demonstrated during the recent ### 28. Resiliency of the interbank payment system was demonstrated during the recent ### Payment system resilience and contingency arrangements - Resiliency demonstrated during the recent floods. - Contingency arrangements strengthened by development of a disaster recovery site located at a distant location from the primary site to ensure the resumption of critical operations in the event of a wide scale disruption. - Operational risk in payment systems is well managed, but a recovery time objective needs to be established to ensure that operations can resume within two hours following a disruptive event. ### Payment system credit and liquidity risks - No credit risks due to pre-funding requirements in the RTGS. - Prohibiting the CBBH from extending intraday credit and strict rules on the use and replenishment of RR have established strong discipline within the banking system. - Liquidity vulnerabilities arise from the high concentration of payment transaction values: 55 percent of transaction values across five banks, including two settlement banks. - Recommendations and required improvements: - Finality and netting arrangements require greater legal certainty at the statutory level; eliminate zero-hour rules in insolvency law to reduce risk of court-ordered revocation of RTGS transactions. - Develop a comprehensive risk-management framework: formal identification of risks, risk mitigation measures, and monitoring. - Strengthen liquidity risk management (see paragraph 29). - Establish recovery time objective of two hours for resumption of operations. - Enhance efficiency with fee schedule reviews and the setting of minimum service levels. - Strengthen CBBH oversight powers: clearly establish oversight responsibilities (including powers to designate financial market infrastructures and to 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): scope and key statistics - The share of NPLs has increased over recent years; weaknesses in the legal framework have impeded resolution and limited banks’ ability to transfer NPLs to other entities. - Transfers of non-cancelled NPLs from banks to other entities are impeded by inconsistent interpretation of provisions of the Law on Obligations and Laws on Banking as well as legal impediments in the Law on Protection of Users of Financial Services for loans to natural persons. - Tableed NPL statistics (In percent; comparison 2012Q4 and 2014Q3): - NPL to total Loans: 13.5 (TOTAL, 2012Q4); 22.7 (TOTAL, 2014Q3). - FBiH: 13.2 (2012Q4); 15.1 (2014Q3). - RS: 14.1 (2012Q4); 14.6 (2014Q3). - Foreign: 13.2 (2012Q4); 16.2 (2014Q3). - Domestic: 16.5 (2012Q4); 14.5 (2014Q3). - Of which corporates: 8.5 (TOTAL, 2012Q4); 27.0 (TOTAL, 2014Q3). - Of which households: 5.0 (TOTAL, 2012Q4); 4.5 (TOTAL, 2014Q3). - Memo item — Special mention loans (share of total loans): 9.8 (TOTAL, 2012Q4); 17.2 (TOTAL, 2014Q3). ### Legal, insolvency, judicial, and tax impediments to NPL resolution - Absence of an alternative to bankruptcy: no satisfactory streamlined process for company/creditor negotiation of debt restructuring to facilitate least-cost solutions; leads to piecemeal liquidation and lower recovery rates. - Insolvency and judicial framework problems: - Litigation, execution, and bankruptcy cases take too long; additional resources and training in the courts are warranted. - No insolvency regime for individual debtors: insolvency law applies only to legal entities and partners in partnerships; sole traders, craftsmen or entrepreneurs cannot benefit from the insolvency framework. - Legal framework governing creditor/debtor relationships comprehensive but ineffective in practice: - Non-possessory pledges not extensively used because banks do not consider such security as secure. - Recovery rates of loans secured with pledges are very low. - Valuation of assets to be auctioned and reserve prices problematic; execution procedures ineffective. - Tax impediments: - Recommend commissioning a review of relevant tax laws to ensure debt-restructuring, NPL sales, and loan loss provisions encourage restructuring and third-party sales of NPLs. - Consider exempting transfers of NPLs (and associated collateral) from VAT to improve prospects for developing a secondary market for NPLs. - Regulatory and supervisory steps: - 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 status of applicants and maintain incentives for borrowers to service loans. ### Banking supervision, governance, and audit quality - Improvements since 2006, but shortcomings remain; banking agencies preparing a new Law on Banks to address supervisory powers, recovery and resolution, and consolidated supervision. - Coordination among institutions involved in banking oversight is complex; crucial risk information is not always shared, which could be problematic in a crisis. - MOUs: - Banking agencies have signed MOUs with a number of home country supervisors, but no MOUs with home supervisors responsible for several systematically important banks (Austria, Italy and Russia). - Supervisory gaps: - Supervisory agencies do not have a full picture of several domestically-owned banks (ultimate beneficiary owner and holdings not fully identified); related party lending and group exposures not fully identified. - Licensing and approval processes should require more substantive information on direct owners, parent companies, and related parties of parent companies. - Governance and risk management weaknesses at some banks: - Loan concentration levels of some banks exceed regulatory limits. - Moral hazard issues: current owners who cannot meet capital calls are allowed to remain involved in the bank. - Banking agencies have issued regulations on corporate governance and are developing bank-wide risk management guidance; strengthened corrective action powers should improve resiliency if compliance occurs. - Audit quality concerns: - Recent AQRs showed weaknesses that bank audits did not reveal. - Most domestic banks have implemented IFRS 2009, but several auditors refer to the local law instead of IFRS. - External auditors are appointed only for a year, potentially affecting continuity and quality. - Loan loss provisioning: - Based on IAS and prudential requirements; IAS provisioning levels may not be adequate as reflected by adjustments required by inspectors during onsite reviews. - Recommendation: develop supervisory standards to encourage conservative implementation by banks of factors to be considered in determining incurred losses under IAS and move away from the current prudential standard. - Governance of state-owned banks: - Supervisory boards provide little strategic direction and do not hold management accountable. - Rigorous oversight of the government’s bank-related exposures is warranted by the IRBRS. ### Insurance sector: prudential framework and supervision - Prudential framework based on Solvency I is not risk-sensitive and ill-suited for supervising more complex markets. - More than half of insurance premiums are related to mandatory Motor Third Party Liability (MTPL) insurance; framework supporting tariff-compliance needs substantial improvements. - Liberalization of MTPL tariffs underway, but should be preceded by introduction of early warning systems, stress testing, and a risk-based solvency framework with a ladder of interventions. - Supervisory powers and institutional setup issues: - Missing powers: ability to remove members of supervisory board; RS-ISA lacks power to enforce voiding of voting rights of qualified shares acquired without its approval. - FBiH-ISA cannot appoint provisional administration without withdrawing license of the insurer; FBiH-ISA is understaffed and its independence needs safeguarding. - Staff in both agencies should have stronger legal protection. - Merging insurance supervision into respective banking agencies could yield efficiency gains and simplify institutional set-up. - Consumer protection and financial literacy need urgent development. - Group supervision and cooperation with banking supervisors lacking: - Need to strengthen regulation and supervision of insurance groups, supervise holding companies, limit intra-group transactions, and require fit and proper tests for controlling positions at the holding company. - Implement comprehensive group supervision framework. - Strengthen cooperation between insurance and banking supervisors given sizeable exposure of insurance sector to banks. ### Financial market infrastructure oversight and capital markets - Assessment of RTGS: many principles observed but key improvements needed (see Payment system section above). - Assessment of authorities’ responsibilities: lack of oversight powers, limited resources and supervisory capacity, need to broaden and deepen oversight cooperation with other competent authorities. - Capital markets: - Legal and regulatory framework sound due to adoption of EU directives and protocols, but regulators lack resources to supervise large number of listed firms and implement rules. - BiH could benefit from models used within the EU to link national exchanges and harmonize legislation/regulation while preserving national exchanges and regulatory rights (passporting framework mentioned). - Companion FSA report by the WB provides further details. ### AML/CFT - 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; as significant items remained unaddressed, MONEYVAL issued several public statements in 2014 calling for enhanced due diligence. - Progress made: enactment of a new AML/CFT law and amendments to the Criminal Code. - Recommendations: - Timely and effective implementation of the action plan. - Commission a national assessment of ML/TF risks. - Greater coordination and cooperation among State and Entity level agencies in charge of AML/CFT. - Note: Further delay may result in additional scrutiny from the FATF with potentially greater negative repercussions for BiH. ### Macroprudential framework and systemic liquidity management - Macroprudential toolkit underdeveloped but being extended: - Main instrument: reserve requirements, used actively in response to pre-crisis credit boom and subsequent liquidity crunch. - CBBH developing capacity to monitor systemic risks through top-down stress tests; methodology developed with banking agencies to identify systemic domestic banks. - Banking agencies have included elements of Basel III 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. - Insurance sector macroprudential supervision limited to market-wide trend analysis. - Recommendations to broaden macroprudential framework: - Broaden and focus cooperation among CBBH, FBA and BARS; use existing MoU as platform to coordinate systemic risk work and calibration/timing of macroprudential tools. - Examine LTV and DTI levels, household and corporate indebtedness, and debtors’ currency mismatches. - Undertake high-level consultations on systemic risks at least quarterly. - Consider macroprudential supervision framework for insurance sector as it develops. - Systemic liquidity management constraints under the currency board: - Lack of a central bank liquidity window. - Secondary market for government securities is small and illiquid. - Money market and interbank markets are relatively small, reflecting high levels of bank liquidity and foreign banks’ practices to minimize exposures vis-à-vis domestically-owned banks. - Constraints call for conservative liquidity management and liquidity buffers for banks. - Recommendations on reserve requirements (RR): - Use of RRs should be better tailored towards prudential purposes to support systemic liquidity management. - Consider increasing flexibility of RR holdings in times of stress and introducing daily or period-minimum holding thresholds; combine with higher penalty rates and enhanced supervision before sanctions applied. - For 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. - Consider the adequacy of existing RR levels, since they were significantly lowered during the financial crises. *Source: _cr15177 - 28. Resiliency of the interbank payment system was demonstrated during the recent* ### 55. Liquidity regulations should be streamlined and the adoption of the LCR would ### _cr15177 - 55. Liquidity regulations should be streamlined and the adoption of the LCR would ### Liquidity regulations and LCR adoption - Liquidity regulations should be streamlined and the adoption of the LCR would strengthen liquidity management. - For maturity calculations of liquidity ratios, early deposit withdrawal options should be taken into account. - The minimum liquidity ratio should be raised above the RR to ensure that it is binding. - Upon adoption of the LCR, care would be needed in treating RRs as high quality liquid assets (HQLA), given their uncertain availability to meet liquidity pressures. - Calibration issues to consider for the LCR: - Haircut applied to public securities, given the shallow market. - Assumptions for deposits/borrowed funds run-off rates. - Treatment of liabilities maturing after 30 days with a prepayment clause. - Given the high level of euroization, currency-specific LCRs should be considered. - The design and calibration of revised and new liquidity regulations should be reinforced by a quantitative impact study based on historical data with a special emphasis on stress situations. ### Legal constraints on central bank operations - A number of limitations relate to the legal framework underpinning the CBA which requires all CBBH domestic liabilities to be backed by foreign net assets. - The CBBH Law does not allow the CBBH to grant any credit and engage in money market operations “involving securities of any type,” ruling out emergency liquidity assistance and a standing liquidity facility. ### Financial safety net — overall assessment - A number of key elements in the financial safety arrangements are either not present or not adequately developed. - Main deficiencies: lack of a comprehensive remedial action program, inadequacy of resolution powers, and inability to provide temporary emergency liquidity support to soundly capitalized and well managed banks. ### Crisis preparedness framework — corrective action arrangements - Banking agencies have statutory authority to require corrective actions by banks, with guidance including triggers based on breaches of capital, liquidity, and asset quality requirements. - Enforcement powers are limited: - Limited authority to impose financial penalties for noncompliance. - Limited authority to permanently suspend board members and controlling owners, except under provisional administration. - Limited authority for replacing or restricting the powers of controlling owners outside provisional administration. - Consequence: regulatory forbearance, which should be avoided unless based on sound supervisory judgment and satisfactory remedial measures. - Note: “The draft banking laws are expected to provide the banking agencies much more comprehensive powers to facilitate prompt correction and resolution action.” (footnote) ### Deposit Insurance Agency (DIA) — status and enhancements - Current status: - The DIA is 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. - Has infrastructure for effective deposit insurance, including MOUs with banking agencies, regular testing of depositor data, and procedures for pay-outs. - Assessment: - Formal assessment against IADI standards suggests the majority of principles are compliant or largely compliant. - DIA has improved legal framework, capacity, sound governance, and a well-designed depositor reimbursement system capable of payouts. - Recommended enhancements: - Establish capacity for making prompt pay-outs to insured depositors, in line with the EU relevant directive. - Amend legislation to establish the means for prompt pay out of depositors and authorize use of DIA funds to facilitate a purchase and assumption transaction (P&A) under the least cost solution. - Ensure DIA involvement at an early stage in the problem bank resolution process with bank supervision agencies. - Reference: “See companion development FSA by the WB for details on compliance with IADI’s Core Principles for Effective Deposit Insurance Systems.” (footnote) ### Coordination and contingency planning - Need for better coordination among SCFS members: - Inter-agency contingency plan should include guidance on actions required if a bank is closed, including public communications to minimize contagion. - MoU establishing the SCFS sets objectives and principles for bank resolution and coordination procedures. - Recommendation to broaden SCFS focus to include small banks when their distress could have financial stability implications. - Status of contingency plans: - Contingency plans were prepared in 2014 and a coordinated contingency plan was developed by the SCFS. - Plans need revision to incorporate procedures for each crisis stage: systemic impact assessment, diagnostics, resolution option assessment and implementation, cross-border coordination, and communications. - Regular crisis simulation testing is 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. - Given systemic importance of several foreign banks, lack of MoUs poses significant risk to achieving satisfactory whole-of-group resolution. ### Crisis management framework — resolution authority and funding - Need to establish a resolution authority: - FBA and BARS have some resolution powers but are not formally designated or equipped as resolution authorities. - Proposed new banking laws should establish clear responsibility for bank resolution with appropriate accountability and transparency. - Team’s suggestion: vest resolution powers in FBA and BARS and designate them as resolution authorities for banks in their jurisdictions. - This enables synergies between supervision (early intervention) and resolution execution. - Would require governance and accountability arrangements to avoid conflicts of interest. - If pursued, DIA management board should include representatives of the two banking agencies. - Use of deposit insurance fund (DIF) in resolution: - Currently DIF can only pay out insured deposits. - DIF should be allowed to participate in bank resolution subject to least cost solution—i.e., up to 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) proposal: - 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 should be subject to clearly defined criteria to protect the taxpayer. - Loss absorption: all losses in failed banks should be absorbed up-front by existing shareholders and other creditors according to hierarchy of claims in liquidation and subject to financial stability considerations. - Use of FSF should be under strict conditions to minimize moral hazard and allow for ex-post recovery from the banking industry. - Note: “The FSF could be based on the principles of the EU Bank Recovery and Resolution Directive (BRRD) with added limited and temporary liquidity support functions (see below).” (footnote) ### Limited and temporary emergency liquidity assistance under currency board - Constraints on CBBH performing LOLR functions: - CBBH Law does not allow CBBH to grant any credit and engage in money market operations “involving securities of any type.” - Net excess reserves under the currency board are usually very limited, offering little basis for LOLR functions. - FSF as limited liquidity provider: - FSF could be designed to provide very limited liquidity support to solvent banks in acute liquidity stress as an early prompt corrective action tool. - Triggering conditions for limited and temporary liquidity support: - After bank has used all available liquidity management options, including interbank market, parent bank funding if available, and its reserve requirements (reserve framework should be amended per paragraph 54). - Support 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. - Monitoring, supervision, and enforcement: - Emergency liquidity support should be accompanied by enhanced monitoring and supervision to minimize moral hazard. - Compliance with terms and conditions monitored by applicable banking agency; breaches would be grounds for exercise of resolution powers. - FSF financing and safeguards: - FSF could be financed through ex-ante levies on banks and with capacity for ex-post levies to cover costs and losses. - FSF could be supported by possible financing from an international financial institution (IFI). - Scope to support FSF by switching a portion of potential increases in RR into the FSF. - FSF would be administered by the DIA and separated from the DIF. - Safeguards: objectives of the fund, permissible purposes, preconditions for invocation, and governance arrangements. *Source: IMF staff report content from the supplied PDF excerpt.* ### Appendix Table 3. Financial Soundness Indicators of the Banking System ### Appendix Table 3. Financial Soundness Indicators of the Banking System ### Capital adequacy - Regulatory capital (in KM million) - 2005: 1,488 - 2006: 1,861 - 2007: 2,345 - 2008: 2,637 - 2009: 2,642 - 2010: 2,739 - 2011: 2,860 - 2012: 2,821 - 2013: 2,995 - 2014: 2,784 - Regulatory capital to risk-weighted assets (RWAs) - 2005: 17.8 - 2006: 17.7 - 2007: 17.1 - 2008: 16.2 - 2009: 16.1 - 2010: 16.2 - 2011: 17.1 - 2012: 17.0 - 2013: 17.8 - 2014: 16.4 ### Asset quality - Non-performing loans (NPLs) to gross loans - 2005: 5.3 - 2006: 4.0 - 2007: 3.0 - 2008: 3.1 - 2009: 5.9 - 2010: 11.4 - 2011: 11.8 - 2012: 13.5 - 2013: 15.1 - 2014: 14.0 - Provisions to NPLs - 2011: 34.5 - 2012: 43.7 - 2013: 66.3 - 2014: 65.9 - 2015 (implied next columns in table): 66.7 - 2016 (implied next columns in table): 70.2 - NPLs net of provisions to Tier 1 capital - 2011: 25.5 - 2012: 42.0 - 2013: 25.9 - 2014: 30.0 - 2015 (implied): 31.0 - 2016 (implied): 27.0 ### Earnings and profitability - Return on average assets (ROAA) 1/ (Net income as percent of average assets) - 2005: 0.7 - 2006: 0.9 - 2007: 0.8 - 2008: 0.4 - 2009: 0.1 - 2010: -0.6 - 2011: 0.7 - 2012: 0.6 - 2013: -0.2 - 2014: 0.8 - Return on average equity (ROAE) 2/ (Net income as percent of average equity capital) - 2005: 6.2 - 2006: 8.4 - 2007: 8.6 - 2008: 4.2 - 2009: 0.8 - 2010: -5.5 - 2011: 5.8 - 2012: 4.9 - 2013: -1.4 - 2014: 6.0 - Gross income to average assets - 2005: 7.6 - 2006: 7.0 - 2007: 6.4 - 2008: 5.8 - 2009: 5.6 - 2010: 5.8 - 2011: 5.9 - 2012: 5.7 - 2013: 5.6 - 2014: 1.4 - Net interest income to gross income - 2005: 54.1 - 2006: 54.3 - 2007: 59.7 - 2008: 60.6 - 2009: 61.5 - 2010: 60.1 - 2011: 63.9 - 2012: 63.7 - 2013: 62.3 - 2014: 61.5 - Non-interest expenses to gross income - 2005: 90.1 - 2006: 86.5 - 2007: 85.1 - 2008: 90.6 - 2009: 97.4 - 2010: 109.0 - 2011: 86.5 - 2012: 87.4 - 2013: 101.2 - 2014: 83.9 ### Liquidity - Liquid assets to total assets - 2005: 36.1 - 2006: 35.9 - 2007: 37.7 - 2008: 30.0 - 2009: 30.9 - 2010: 29.0 - 2011: 27.2 - 2012: 25.4 - 2013: 26.4 - 2014: 26.8 - Liquid assets to short-term liabilities - 2005: 61.9 - 2006: 60.8 - 2007: 61.3 - 2008: 51.8 - 2009: 53.0 - 2010: 49.7 - 2011: 46.7 - 2012: 44.1 - 2013: 46.2 - 2014: 46.1 - Deposits to assets (excluding interbank deposits) - 2005: 58.0 - 2006: 58.9 - 2007: 60.9 - 2008: 55.1 - 2009: 56.0 - 2010: 58.8 - 2011: 59.1 - 2012: 60.5 - 2013: 62.2 - 2014: 64.4 - Loans to deposits - 2005: 103.8 - 2006: 102.5 - 2007: 97.2 - 2008: 122.3 - 2009: 116.9 - 2010: 116.0 - 2011: 117.9 - 2012: 118.6 - 2013: 114.8 - 2014: 108.2 ### Sensitivity to market risk - Net long position in foreign exchange to Tier 1 capital - 2005: 8.3 - 2006: 9.1 - 2007: 5.9 - 2008: 6.2 - 2009: 1.7 - 2010: 4.4 - 2011: 16.0 - 2012: 5.3 - 2013: 6.7 - 2014: 11.1 - Foreign-currency-denominated loans to total loans - 2005: 68.7 - 2006: 71.0 - 2007: 74.1 - 2008: 73.3 - 2009: 73.9 - 2010: 70.0 - 2011: 66.9 - 2012: 63.1 - 2013: 62.9 - 2014: 62.4 - Foreign-currency-denominated liabilities to total liabilities - 2005: 64.4 - 2006: 62.8 - 2007: 65.1 - 2008: 69.5 - 2009: 69.2 - 2010: 67.0 - 2011: 66.2 - 2012: 65.2 - 2013: 63.8 - 2014: 62.7 *Sources: CBBH; Banking Agency of FBiH; and Banking Agency of RS.* ### Appendix Table 4. Financial Soundness Indicators of the Insurance Sector (selected indicators) Non-life (2009–2013) - Net premium as percent of capital - 2009: 146.9 - 2010: 147.2 - 2011: 141.0 - 2012: 137.3 - 2013: 141.5 - Risk retention ratio (net premium as percent of gross premium) - 2009: 89.2 - 2010: 87.5 - 2011: 80.6 - 2012: 82.6 - 2013: 82.7 - Net technical reserves as percent of average net claims paid in last three years - 2009: 195.7 - 2010: 186.7 - 2011: 191.1 - 2012: 201.9 - 2013: 203.6 - Net technical reserves as percent of average net premium received in last three years - 2009: 92.1 - 2010: 88.2 - 2011: 91.6 - 2012: 96.3 - 2013: 92.5 - Claims outstanding as percent of total claims paid - 2009: 78.6 - 2010: 83.4 - 2011: 84.6 - 2012: 88.7 - 2013: 86.5 - Liquid assets as percent of current liabilities - 2009: 404.3 - 2010: 409.8 - 2011: 443.9 - 2012: 359.3 - 2013: 626.7 Life (selected) - Capital as percent of technical reserves - 2009: 26.3 - 2010: 23.3 - 2011: 21.5 - 2012: 20.7 - 2013: 19.1 - Life and nonlife solvency status (number of institutions by actual solvency margin/minimum) - <100 %: 4, 4, 4, 5, 1 (2009–2013) - 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. (In percent, unless otherwise specified)* ### Appendix Table 5. Risk Assessment Matrix — Main threats, staff assessments, and expected impacts - 1. Bond market stress from reassessment in sovereign risk in the euro area, or protracted slower growth in the euro area. - Staff assessment (overall): Low - Likelihood of severe realization: Medium - Expected impact on financial stability if realized: - Euro area countries are BiH’s largest trading partners; 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, deteriorating BiH’s growth outlook. - Given currency board arrangement, lower availability of FX will constrain base money. - Banks will likely suffer from funding retrenchment and asset quality deterioration due to the increase in NPLs. - Note: Assessment “medium” based on solvency stress test (adverse scenarios 1 and 2). - 2. Geopolitical tensions surrounding Russia/Ukraine. - Staff assessment (overall): Medium - Likelihood of severe realization: Low - Expected impact on financial stability if realized: - Disruptions in commodity production/transport raise oil and gas prices. - Increased uncertainty could reduce global equity prices. - Russian banks own subsidiaries in European countries that are parent companies for banks in BiH; potential funding retrenchment from “grand-parent” banks could affect BiH banks. - Demand for BiH exports from Russia and neighboring countries would fall. - Note: Assessment “low” based on solvency stress test (adverse scenario 1). - 3. External funding: Parent banks remove support of local subsidiaries and/or decide to withdraw from BiH market. - Staff assessment (overall): Medium - Likelihood of severe realization: Medium - Expected impact on financial stability if realized: - BiH banking sector dominated by foreign banks, accounting for 82 percent of the sector’s assets. - Subsidiaries still reliant on parent bank support; parent bank loans and deposits remain sizeable. - Repatriation of parent bank deposits may severely constrain liquidity in some large foreign-owned banks. - Confidence effects of foreign banks withdrawing could be significant; domestic banks too small to compensate for intermediation loss. - Note: Assessment “medium” based on liquidity stress test results using LCR and NSFR proxies. - 4. Further deterioration in the health of commercial banks and confidence loss by bank depositors. - Staff assessment (overall): Medium - Likelihood of severe realization: High - Expected impact on financial stability if realized: - Higher NPLs will call for additional provisioning, negatively affecting banks’ profits. - Bank recapitalization could be problematic without parent bank support. - Authorities unlikely to have the 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 available options. - Note: Assessment “high” based on solvency stress test results (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 (overall): Low - Likelihood of severe realization: Low - Expected impact on financial stability if realized: - Sluggish growth and weak tax revenue may complicate servicing of domestic debt and lead to arrears, austerity measures, and weaker domestic demand. - Banks have accumulated government securities through purchases of entity debt; potential restructure/default of entity government debt would impact bank balance sheets. - Official sector may accelerate withdrawal of their banks’ deposits, compromising banks’ liquidity position. - Note: Assessment “low” based on stress test results from solvency stress test and sensitivity analysis. ### Appendix Table 6. Banking System Assets, end-March 2014 (selected banks and ownership) - Raiffeisen bank d.d. Bosna i Hercegovina - Total Assets (Percent of total banking assets in BiH): 17.4 - Total Assets (Percent of total banking assets in the Entity): 24.9 - Ownership: Foreign bank (Austria) - UniCredit bank d.d. - Total Assets (Percent of total banking assets in BiH): 16.7 - Total Assets (Percent of total banking assets in the Entity): 24.0 - Ownership: Mostly foreign bank (Italy) - Intesa Sanpaolo banka d.d. Sarajevo - Total Assets (Percent of total banking assets in BiH): 6.1 - Total Assets (Percent of total banking assets in the Entity): 8.8 - Ownership: Mostly foreign bank (Italy) - Hypo Alpe-Adria bank d.d. Mostar - Total Assets (Percent of total banking assets in BiH): 5.0 - Total Assets (Percent of total banking assets in the Entity): 7.2 - Ownership: Foreign bank (Austria) - Sparkasse bank d.d. - Total Assets (Percent of total banking assets in BiH): 4.6 - Total Assets (Percent of total banking assets in the Entity): 6.5 - Ownership: Mostly foreign bank (Austria) - Sberbank BH d.d. - Total Assets (Percent of total banking assets in BiH): 4.0 - Total Assets (Percent of total banking assets in the Entity): 5.7 - Ownership: Foreign bank (Russia) - NLB banka d.d. - Total Assets (Percent of total banking assets in BiH): 3.8 - Total Assets (Percent of total banking assets in the Entity): 5.5 - Ownership: Mostly foreign bank (Slovenia) - Nova banka a.d. (Republika Srpske) - Total Assets (Percent of total banking assets in BiH): 6.9 - Total Assets (Percent of total banking assets in the Entity): 22.8 - Ownership: Mostly domestic private bank 1/ - NLB Razvojna banka a.d. - Total Assets (Percent of total banking assets in BiH): 5.5 - Total Assets (Percent of total banking assets in the Entity): 18.2 - Ownership: Mostly foreign bank (Slovenia) - UniCredit bank a.d. - Total Assets (Percent of total banking assets in BiH): 4.1 - Total Assets (Percent of total banking assets in the Entity): 13.5 - Ownership: Mostly foreign bank (Austria) - Sberbank a.d. - Total Assets (Percent of total banking assets in BiH): 2.8 - Total Assets (Percent of total banking assets in the Entity): 9.2 - Ownership: Mostly foreign bank (Russia) *Notes in table: 1/ The ownership of this bank changed in Q3 2014 from a mostly foreign bank to a mostly domestic private bank. 2/ This bank is classified as a mostly domestic private bank because the majority owners of this bank have dual citizenship (BiH and the U.S.) and the other shareholders are mostly domestic.* ### Appendix Table 7. Stress Test Matrix (STeM) for the Banking Sector: Solvency, Liquidity, and Contagion Risks (key assumptions) - Institutional perimeter and market share - All banks (27 banks) included; percentage of total sector assets: 100 percent. - Data and baseline date - Supervisory data; banks’ own data; publicly available data used depending on strand (bottom-up, top-down). - Methodology and satellite models - Combination of banks’ internal models and pre-defined benchmarks; CBBH’s stress testing framework supplemented with the IMF balance sheet stress testing framework; IMF econometric models for credit losses and pre-impairment income. - Stress test horizon - 5 years (2015-2019). - Scenario analysis - 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 - Single-factor shocks: interest rate; exchange rate; sovereign securities loss/haircut. - Credit concentration risk. - Risks assessed - Comprehensive coverage: Credit risk; Market risk; Equity investment-related risk; 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 and regulatory standards - Expected losses or loan migration and changes in provisions based on banks’ internal models and satellite models. - Hurdle rates based on regulatory minimum for total regulatory capital (i.e., CAR of 12 percent). - Basel I rules applied. - Reporting format for results - CAR, shortfall (if applicable); pass or fail; number of “undercapitalized” banks (i.e., with a CAR below 12 percent); system-wide and by entity. *Sources: Banking Agency of FBiH; Banking Agency of RS; CBBH; IMF staff calculations.* *Italic: Content extracted from _cr15177 - Appendix Table 3. Financial Soundness Indicators of the Banking System.* ### 1. Institutional Perimeter ### 1. Institutional Perimeter ### Institutions included and market coverage - All banks (27 banks). - Percentage of total sector assets: 100 percent. - For contagion analysis: All banks (27); All insurance companies (25). - Percentage of total sector assets (contagion domain): 100 percent. ### Data and baseline - Supervisory data. - Banks’ own data. - Publicly available data (for contagion analysis where applicable). ### Channels of risk propagation — methodology - Basel III LCR-type proxy. - Basel III NSFR-type proxy. - Network analysis, using Espinosa-Vega and Solé (2010) methodology (contagion). ### Risks and buffers - Risks: - Market liquidity. - Maturity mismatches. - Buffers: - Counterbalancing capacity (HQLA, ASF). ### Tail shocks — size and scenarios - Haircuts and run-off rates as defined in Basel III for LCR and NSFR. - Contagion stress scenarios: - A severe stress in a bank or a banking system, causing a default on all of its liabilities to domestic institutions or foreign banks. - 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. ### Regulatory and market-based standards and parameters - LCR proxy should exceed 100 percent (not a legal/regulatory requirement). - NFSR proxy should exceed 100 percent (not a legal/regulatory requirement). ### Reporting format and output presentation - Liquidity stress outputs: - Pass rate, remaining buffers, and liquidity shortfall (if applicable). - System-wide and by entity. - Contagion stress outputs: - 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). *Source: _cr15177 - 1. Institutional Perimeter* ### Annex I. Report on the Observance of Standards and Codes: ### Annex I. Report on the Observance of Standards and Codes: CPMI-IOSCO Principles for Financial Market Infrastructure—Summary Assessment ### Introduction - Assessment subject: the RTGS system and authorities’ responsibilities in BiH. - Context: conducted in the context of the IMF’s FSAP to BiH in November 2014. - Objective: identify potential risks related to the RTGS system that may affect financial stability. - Scope: RTGS system and the CBBH (authority responsible for oversight). - Methodology: derived from the CPMI-IOSCO PFMI Disclosure Framework and Assessment Methodology of December 2012; included CBBH self-assessment, Questionnaire on FMIs in BiH, review of national laws, CBBH Annual Reports, CBBH Financial Stability Reports, CBBH RTGS Operational Rules, daily discussions with CBBH, and meetings with relevant public and private-sector representatives. - Assessor: Tanai Khiaonarong, Senior Financial Sector Expert, IMF’s Monetary and Capital Markets Department. ### Main findings — achievements and resilience - Modernization and historical achievements: - Bosnia and Herzegovina was the first country of the former Yugoslavia to dismantle the old payment system, yielding significant efficiency improvements and risk reduction. - CBBH reduced transaction costs and the number of payment agencies. - Development and launch in 2001 of: - a real-time gross settlement system for large-value payments (RTGS), and - a giro clearing system for retail payments. - System resiliency: - Interbank payment system functioned normally since launch in 2001. - Resiliency demonstrated against the severe floods of May 2014. - Contingency arrangements include a disaster recovery site located at a distant location from the primary site. - Plans to adopt the Principles of Financial Market Infrastructures of 2012 into the regulatory framework are at the early stages. - Currency board effects: - Currency board arrangement helped protect the payment system from credit risks. - No credit risk due to pre-funding requirements in the RTGS system. - Central bank prohibited from extending intraday credit; strict rules on use and replenishment of reserve requirements reinforced commercial bank discipline. - Provisional administration and liquidity management issues faced by some banks were contained, helping to prevent potential systemic settlement risks. ### Key areas for improvement (summary from assessment) - Legal certainty and finality: - Finality and netting arrangements require greater legal certainty and protection at the law level. - Risk that a transaction settled in the RTGS system can be revoked by a court order in the event of insolvency of a participant. - International best practice recommendations: - adoption of an explicit law on settlement finality to empower authorities to designate payment systems and fully protect finality and netting, or - elimination of “zero-hour rules” in insolvency. - Comprehensive risk management framework: - No comprehensive risk management framework in place; current CBBH RTGS Operational Rules articulate some mitigation but do not constitute a formal, comprehensive framework covering legal, liquidity, operational risks, and ongoing monitoring. - Liquidity risk management: - Generally effective but could be more robust. - Potential liquidity concentration across five banks, including two commercial banks that act as settlement banks and have a large share of total transaction values. - Liquidity risk sources: - settlement delays from the giro clearing system (GCS), Bam Card, or settlement banks hindering liquidity recycling; - default of the largest participant and its affiliates. - Suggested improvements: - stress testing the RTGS system for potential default of the largest participant and affiliates; - establishment of throughput rules; - monitor each reserve maintenance period of 10 days closely on a daily basis to ensure sufficient liquidity in reserve accounts. - Operational risk and recovery objectives: - Operational risk is well managed with a primary site and a secondary disaster recovery site located around 200 kilometers away. - Secondary site tested regularly three times a year with participants; each test has duration of five days. - Need to establish and document a recovery time objective to ensure operations can resume within two hours following a disruptive event. - Business continuity plan and operational risk management framework should clearly state service availability and recovery time objectives to strengthen cyber resilience. - Efficiency and service levels: - Pricing policy aimed at cost recovery, but fees have not been regularly revised to reflect costs. - RTGS fee schedule has been revised once since its [launch/earlier period]. - Recommended actions: - conduct cost accounting of the payment system on an annual basis; - revise fee schedules to reflect costs where applicable; - establish, monitor, and disclose minimum service levels. - Oversight powers and capacity: - Law of the Central Bank of Bosnia and Herzegovina mainly establishes operational responsibilities but does not give sufficient powers in oversight of payment systems. - Oversight constraints: lack of oversight powers, limited resources and supervisory capacity, need to broaden and deepen oversight cooperation with other competent authorities. - Recommended institutional 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. ### Summary of RTGS compliance with CPMI-IOSCO PFMIs — principal observations - Legal Basis: - Relatively sound overall, but finality and netting legal certainty insufficient; risk of reversal by court order in participant insolvency; lack of loss-sharing arrangements in the GCS; clarification needed whether written statements between CBBH and RTGS participants constitute enforceable contractual agreements and under which law. - Governance: - Arrangements are clear, accountable, and transparent. - Monthly reporting focuses largely on payment flows; risk analysis limited in scope and depth. - Recommendation: report analysis of potential risks and mitigation progress quarterly to the Governing Board. - Framework for comprehensive management of risks: - Lacking a formal, comprehensive framework that identifies risks, mitigation measures, and monitoring processes. - Credit risk: - No credit risk; CBBH does not permit intraday or overnight credit under the currency board arrangement. - All RTGS transaction accounts are prefunded from reserve account balances at the start of a business day; outgoing payments with insufficient funds queue or are returned. - Collateral and Margin: - Not applicable in the institutional set-up (CBBH does not provide intraday credit). - Liquidity risk: - Generally effective but concentration risks across five banks and potential delays from GCS/Bam Card/settlement banks present vulnerabilities. - Reserve maintenance period: 10 days. - Settlement finality: - Legal uncertainty remains for settlement finality in the event of an insolvent participant. - Participant-default rules and procedures: - Clearly defined and available to participants, but need to be established, tested, and reviewed periodically. - General business risk: - RTGS owned and operated by CBBH; CBBH’s mandate covers payment and settlement operations in normal and extreme circumstances. - Requirements to prepare recovery and orderly wind-down plans do not apply to CBBH; likewise, ring-fenced liquid assets and plans to raise additional equity are not required given the CBBH’s inherent financial soundness. - CBBH recorded net profits during 2011 to 2013. - Operational risk: - Well managed with a modern, well staffed secondary site ~200 kilometers from primary; testing three times a year with five-day test durations. - Need to document service availability and recovery time objectives (target: resume operations within two hours). - Access and participation requirements: - Clear, publicly available, fair, objective; rules on suspension, termination, exclusion are defined in CBBH RTGS Operational Rules. - No tiered participation arrangements; recommendation to clarify in operational rules that direct participation is only permitted for commercial banks and the CBBH and to disclose participants. - Efficiency and effectiveness: - Efficiency could be enhanced via regular fee schedule reviews and setting minimum service levels; service level objectives currently appear to be lacking. *Annex I. Report on the Observance of Standards and Codes: CPMI-IOSCO Principles for Financial Market Infrastructure—Summary Assessment* ### introduction in 2001 and was in support of time-zone ### _cr15177 - introduction in 2001 and was in support of time-zone pricing ### RTGS system design, disclosure, and operations - 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. - Disclosure of rules, key procedures, and market data - RTGS rules and procedures are publicly disclosed. - Disclosure 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 understanding of CBBH RTGS Operational Rules, relevant rules and procedures, and potential risks and mitigation measures. - Minimum service levels and efficiency - Minimum service levels do not appear to have been clearly established to monitor efficiency and effectiveness. - 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 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 not directly related to inter-bank settlements (e.g., 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 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 collates operational risk management from different departments on a quarterly basis for reporting to CBBH Management. - 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. - 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 - CBBH 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 objectives, roles, and regulations. - Application of the principles for FMIs - The CBBH has not adopted the CPMI-IOSCO Principles for Financial Market Infrastructures and applied them consistently. - The CBBH plans to do so after 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 under a memorandum of understanding. - Advanced notification and coordination on 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 CBBH and entity securities commissions share interest in promoting safe and efficient FMIs, there is no formal cooperation. - Given systemic importance of CSDs, there is potential role for cooperative oversight by the securities commissions and the CBBH. ### Recommended actions to improve the RTGS system (Compliance with 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 meetings of the Governing Board. - Framework for comprehensive management of risks - Develop a comprehensive risk management framework for the RTGS system covering legal, liquidity, and operational risks. - 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 sufficiency of liquidity in the reserve account of commercial banks on a daily basis. - Operational risk - Establish service availability and recovery time objectives. - Design the business continuity plan to ensure critical information technology systems can resume operations within two hours following disruptive events. - Ensure the plan enables the RTGS system to complete settlement by the end of the day of the disruption, even in extreme circumstances. - Efficiency and effectiveness - Conduct 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 relevant laws, regulations, instructions, decisions, and memorandum of understanding issued by competent agencies in the CBBH Annual Report and web. ### Recommended actions to improve 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 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 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 within different units in the same department to avoid conflicts of interest; ensure 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 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 entity banking agencies to the CBBH to coordinate 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 development and oversight of FMIs, respecting mandates of each competent authority. ### Authorities’ response and official statement - Oversight establishment and internal bodies - Since 2005, there has been a Commission for the Oversight of Payments Systems Operations established by the Governing Board to elaborate the oversight framework in line with “old” principles; in 2012 new principles were released (23 instead of then 10). - The CBBH will publish the translation of new CPMI-IOSCO principles (23 principles) on its web site and work out criteria for identification of FMI mandatory for all participants. - The Governing Board will decide on the recommended variant of oversight optimal for implementation in the CBBH and will publish it in enactments in the Official Gazettes of BH, RS, and FBiH within the set deadline, adhering to CBBH Law provisions. - Internal audit and priorities - Internal audit has assessed oversight of payment systems as a very important business process in the Risk Map and defined it as a priority in internal auditing. - Commitment to implement recommendations - The CBBH will observe all recommendations from the Assessment of Observance of the CPMI/IOSCO Principles for Financial Market Infrastructures as per suggested deadlines. - The CBBH will regularly inform the mission team on implementation of each individual recommendation. - Official statement excerpt - Statement by Mr. Snel, Executive Director for Bosnia and Herzegovina and Mr. Manchev, Advisor to Executive Director: June 29, 2015. - Key points in the statement include: - Continued commitment to the Currency Board Arrangement (CBA) as the cornerstone for domestic policymaking. - Need for strong macro and macroprudential policies to support the CBA. - Recognition that the financial system has navigated the global financial crisis but faces vulnerabilities: sluggish growth, tight macroeconomic conditions, slow credit growth, high NPLs, and weakened profitability. - Creation of a credible, transparent, and effective bank restructuring and resolution mechanism is a pressing issue; consensus option is to establish the resolution mechanism within existing banking supervisors at the entities’ level and a new autonomous resolution fund managed by the state deposit insurer. - Need for an emergency liquidity facility and a Financial Stability Fund supported by IFIs to support resolution and provide liquidity for solvent but illiquid banks. - Commitment to update the 2014 Contingency plan, sign MoUs with remaining home country supervisors of systemically important banks, extend coverage of existing MoUs, and increase institutional capacity and enforcement power of supervisors. - Agreement that debtor-creditor dispute resolution framework needs strengthening and that NPLs must be tackled cost-effectively, with further technical assistance from the Fund for AQRs and methodology development. - Progress on AML/CFT through enactment of a new AML/CFT Law and amendments to the Criminal Code; envisaged improvements in coordination among agencies at state and entity levels. *Source: _cr15177 - introduction in 2001 and was in support of time-zone pricing* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15177.pdf_