## _cr16200

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### Executive summary — key findings
- System-wide NPL ratio: 16.5 percent at end-June 2015.
- Bulk of NPLs backed by real estate collateral; weak real estate market impedes resolution.
- Some banks unable or unwilling to absorb losses; absence of sound estimates for provisioning shortfalls impedes policy formulation.
- CBM introduced (2013) requirement for multi-year NPL resolution strategies with annual targets and quarterly reporting.
- Regulatory standards were loosened over recent years; reversing loosening and strengthening enforcement is essential for accurate reporting and provisioning.
- Banks should be required to raise capital where appropriate to support provisions and create headroom for NPL workouts/write-offs.
- CBM should consider a specialized NPL team within the Supervision Department to support supervision, policy, and best practices.
- Nonbank credit institutions and asset management vehicles should be brought under CBM oversight; reporting to the credit registry should be mandatory.
- Montenegro has undertaken legal/institutional reforms but gaps remain: variability of court enforcement, underdeveloped business rescue culture, rare use of reorganization, limited out-of-court workouts, gaps in land titling and cadastral information (notably rural areas), and non-interconnected Secured Transaction Register and Registry of Vehicles.
- Law on Voluntary Restructuring of Debts (LVR, ‘Podgorica Approach’) facilitates out-of-court negotiations but eligibility restricted to creditors holding claims classified as B and C exclusively; needs fast-track confirmation for prepackaged plans to limit minority hold-outs.
- Law on Consumer Bankruptcy (LCB, August 2015) establishes exemption for a bankrupt debtor’s house (cannot be sold if “commensurate with the basic housing needs of the consumer”); if applied to pre-existing mortgages many such loans could be considered unsecured, with adverse effects on enforcement, financial inclusion, and credit access.

### Key statistics and sectoral composition
- System-wide NPL ratio: 16.5 percent at end-June 2015.
- Provision coverage ratio (as a share of NPLs): 72.6 percent at end-June 2016; more than half of NPLs have been 100 percent provisioned (category ‘E’).
- Banks’ loan portfolio: 2.4 billion EUR in mid-2015.
- Composition of loans: 42.7 percent loans to legal persons; 38.4 percent loans to natural persons; 17.9 percent loans to nonresidents.
- Sectoral shares of loans: trade 37.1 percent; construction 11.6 percent.
- Sectoral shares of NPLs (percent of overall portfolio): trade 29.6 percent; manufacturing 13.2 percent; construction 10.6 percent.
- Over 2009–2015, some EUR 720 million in NPLs were sold predominantly to affiliated group asset management companies.
- Two banks had NPL ratios exceeding 30 percent.
- NPL levels for domestic banks: 18.8 percent; for foreign-owned banks: 16.2 percent.
- Regional context: By July 2015, NPLs in the Western Balkans stood on average at 15.8 percent of total loans.
- Montenegro’s NPL decline from a peak of 25 percent in early 2011 to 16.5 percent in mid-2015 came largely as a result of “bulk sales” of bad loans.

### Restructured loans and NPL resolution
- Total gross restructured loans and receivables: Euro 360.7 million at end-Q1 2015 or 14.9 percent of loans and receivables.
- Loans with extended principal or interest repayment: Euro 134 million or 37.2 percent of total restructured loans.
- Banks reluctant to apply debt forgiveness; large share of NPLs collateralized by hard-to-sell real estate.
- Boards/shareholders’ unwillingness to write-down principal and limited capital headroom impede resolution.
- Costs and administrative burden of managing foreclosed real estate deter aggressive foreclosure; few third-party real estate managers exist.
- Very limited sales to third parties to date; discussions with foreign investors ongoing and a market for troubled debts may emerge.

### Regulatory framework, asset classification, and provisioning
- CBM regulation on asset classification and provisioning has been periodically relaxed since 2009, including extending days past due thresholds for conservative categories.
- Regulation permits classification partly based on collateral nature rather than borrower’s repayment ability (examples: treating a loan as performing until 180 days past due if supported by specified financial collateral; preferential treatment for certain collateral types including unlisted debt securities issued by related parties).
- Adoption of IFRS (IAS 39) in 2013 introduced an incurred loss principle, generally resulting in lower provisioning versus regulatory standards and enabling management judgment that can delay NPL resolution; auditors have in some cases issued qualified opinions.
- Regulations on holding foreclosed real estate were relaxed, allowing banks to hold higher shares of own funds in immovable properties and fixed assets for longer periods.

### Standard classification criteria and provisioning requirements (Decision 04/2012-current)
- Classification grades — days past due:
  - A: <=30
  - B1: 31-60
  - B2: 61-90
  - C1: 91-100
  - C2: 151-270
  - D: 271-365
  - E: >365
- Provisioning requirements:
  - A: 0 percent
  - B1: 2 percent
  - B2: 7 percent
  - C1: 20 percent
  - C2: 40 percent
  - D: 70 percent
  - E: 100 percent
- Observations:
  - Current regime conservative for poor-quality grades but zero provisioning for A-rated category is a weakness.
  - Loosening of norms likely understated NPLs and overstated provisioning adequacy and regulatory solvency.
  - Provisioning rules have not been validated against actual resolution outcomes; CBM’s database could be used for validation.

### Supervisory practices and organizational arrangements
- CBM requirement (2013) for 3-year NPL resolution strategies with annual quantified targets and quarterly reporting applies to loans classified C, D, or E.
- Requirement has led to more systematic identification of NPL management practices and pressure for lagging banks to upgrade.
- Banks’ organizational approaches vary: transfers of worst NPLs to parent-owned asset management vehicles (factoring) remove those exposures from supervisory view; retained NPLs often managed by workout units or legal staff with varying involvement of loan originators.
- Structural weaknesses in classification rules lead to under-provisioning and constrain aggressive resolution.
- Tightened standards would require assessment of capital adequacy implications and possible independent asset quality review.

### Policy recommendations (CBM, banks, and other authorities)
- Tighten regulatory standards for asset classification and treatment of rescheduled/restructured exposures:
  - Classify loans based on borrower repayment capacity assessed via quantitative future cash-flow analysis.
  - Collateral type should not influence classification grade.
  - Upgrade rescheduled/restructured loans only after demonstrable repayment capacity and several months of actual debt service under new terms.
- Periodically validate loan-loss provisioning rules against actual NPL resolution outcomes using CBM database (including NPLs transferred to affiliates); revise provisioning where disparities are identified; consider required provision for A-rated loans differentiated across portfolios.
- Require banks to raise additional capital where appropriate to support higher provisions and create headroom for aggressive workouts/write-offs; CBM should estimate capital adequacy consequences and consider an independent asset quality review; use ICAAP assessments to encourage proactive capital raising.
- Consider organizational separation: require transfer of certain NPLs into specialized workout subsidiaries with independent governance, true-sale pricing, loss recognition, and arm’s-length transactions; CBM to scrutinize such transfers and maintain consolidated supervision.
- Bring nonbank credit institutions and asset management vehicles under CBM oversight and mandate reporting of their credit exposures to the credit registry.
- Create a CBM special unit dedicated exclusively to NPLs to formulate system-wide diagnostics, advise on policy, support supervision, and drive NPL resolution; allocate resources to Bank Supervision Department.

### Insolvency and creditor rights — legal and institutional highlights
- Main laws referenced (names and enactment months/years preserved):
  - Law on Obligations –LoO (August 2008)
  - Law on Ownership Rights –LOR (March 2009)
  - Law on Secured Transactions (Movable Property) –LST (January 2003)
  - Law on Enforcement and Securing of Claims –LESC (July 2011)
  - Law on Civil Procedure –LCP (March 2004)
  - Law on Courts –LoC (No. 5/2002)
  - Law on Public Enforcement Officers –LPEO (December 2011)
  - Law on State Surveying and Cadastre of Immovable Property –LSSCIP (May 2007)
  - Law on Mediation –LoM (May 2005)
  - Law on Notaries –LoN (November 2005)
  - Law on Bankruptcy –LoB (December 2010)
  - Law on Voluntary Restructuring of Debts towards Financial Institutions – LVR (April 2015)
  - Law on Consumer Bankruptcy –LCB (August 2015)
- Despite modern laws, implementation weaknesses persist: eviction delays, limited use of reorganization, low use of out-of-court workouts, gaps in cadastral coverage, and fragmented judicial competence in bankruptcy.

### Mortgages and Real Estate Administration (READ)
- Mortgage creation: registration in READ based on contract, pledge statement, law, or court decision; written and authenticated agreement; notarial practice common.
- Priority established by time of registration; mortgages can secure multiple or future obligations; assignment of mortgage requires simultaneous assignment of secured obligation with debtor notification.
- READ: single entity under MoF with main server in Podgorica and 21 local offices; registration flat fee EUR 10; registration typically done in one day.
- Under ongoing surveying project (initiated 2008): some 550,000 hectares surveyed; approximately 250,000 hectares enrolled in registration system.
- Cadastre problematic in 8 percent of territory (~100.000 hectares rural); plans to resolve within five years but funding unavailable.
- In 2014, 3.8 percent of mortgage registrations were rejected (improvement from typical 14 percent).
- Eviction and foreclosure:
  - If default not cured within 15 days from notice of commencement of foreclosure, mortgagee may use extra-judicial foreclosure or court enforcement.
  - Extra-judicial foreclosure timeline: recovery in 6–12 months on average.
  - Sale mechanics: first auction not below appraised value; second auction not below 50 percent of appraised value; third auction price not below creditor’s claim amount.
  - Difficulties in evicting occupants and delays (up to two years reported) may depress auction prices.
- Recovery rates for mortgage loans reported by banks:
  - 90–100 percent in some cases;
  - 50–75 percent in other cases;
  - one bank reported lower than 50 percent.
- IMF assessment: low recovery typically due to under-secured loans or market depreciation rather than legal deficiencies.

### Security rights over movables and Secured Transactions Register (STR)
- Possessory and nonpossessory pledges regulated and used; nonpossessory pledges governed by LST require written agreement and registration.
- STR located at the Commercial Court in Podgorica; started May 2003; electronic public access free; online submission not yet allowed (in-person or fax required).
- Registration fees:
  - EUR 20 for transactions up to EUR 10,000;
  - EUR 50 for EUR 10,000 – 200,000;
  - EUR 100 for above EUR 200,000;
  - EUR 20 for extension/deletion/additions.
- Activity: January 2014–September 2015 filed documents: 11,790; historical total entries (May 2003–September 2015): 67,599.
- STR is not interconnected with related databases (notably Registry of Vehicles); new software to allow electronic filings is being developed.
- Enforcement of registered pledges:
  - Creditor may take possession upon default or seek court order for seizure and delivery; disposition must be “commercially reasonable.”
  - Enforcement typically < six months if uncontested; 12–18 months average if contested.
  - Reported recovery rates for pledge-secured loans vary: some 90–100 percent, others <50 percent; low recovery often due to insufficient collateral or asset depreciation; some difficulties in repossession and lack of police collaboration reported.

### Public Enforcement Officers (PEOs), enforcement timing, and bankruptcy practice
- Since 2014 enforcement petitions for monetary claims are submitted to PEOs rather than courts; PEO must decide within five days.
- PEOs issue writs of enforcement requesting debtor to satisfy claim within three or eight days depending on title; list of enforcement means includes sale of movables/immovables, transfer of claims, blocking bank accounts, sale of shares, etc.
- Debtor complaints limited and time-bound: appeal within five days; court panel to decide within 15 days (practice has seen delays).
- Reported enforcement durations:
  - If debtor does not challenge: 6–12 months.
  - If challenged or converted to civil litigation: 18–24 months (sometimes longer).
- Bank-account blocking:
  - For legal entities: bank holding promissory note may request central bank to block debtor’s accounts; immediate and extended to all accounts, enabling collection or negotiated arrangement.
  - For natural persons: PEO intervention required; blocking not automatically extended and funds often unavailable.
- Bankruptcy (LoB) framework:
  - Liquidation and reorganization available; reorganization infrequently used (less than 10 percent of cases) and tight timelines (plan must be approved within four months or liquidation initiated).
  - Secured creditors: highly protected, not considered “bankruptcy creditors,” not allowed on creditors’ committee, entitled to full satisfaction from proceeds of secured asset; shortfall becomes unsecured claim.
  - Bankruptcy efficiency: liquidation now often less than a year (previously 18–30 months); reorganization rare; no expedited confirmation for prepackaged plans.
- Bankruptcy statistics (as presented):
  - Table: Opened / Pending Resolved
    - 2014 497509
    - Six months 2015 327
    - [12 months projection: 654]
    - 351

### Tax obstacles and out-of-court restructuring (LVR and workouts)
- Tax disincentives where LVR not used:
  - (i) debt reduction (haircut) treated as debtor’s income and taxable;
  - (ii) creditors cannot deduct haircuts as bad debts for income tax without proof of unsuccessful collection as required by tax law;
  - (iii) creditor repossession of immovable collateral subject to 3 percent tax over real market value.
- VAT on NPL assignments: past uncertainty discouraged assignments; current Ministry of Finance interpretation clarified that sale of bad debts to a third party should not be VAT taxable.
- Workouts practice:
  - Voluntary restructuring generally viewed favorably but collective out-of-court agreements infrequent; most restructurings are bilateral (one creditor/one debtor); haircuts and debt-to-equity swaps rarely used.
  - LVR (April 2015) provides tax and provisioning incentives and protection from avoidable-transaction challenges but restricts eligibility to creditors with claims classified as B and C exclusively, potentially excluding plans covering all claims.
- Recommended enhancements to LVR and workout framework:
  - Introduce fast-track court confirmation for prepackaged plans and make such plans obligatory for all creditors.
  - Ensure debt reductions under LVR are not considered debtor’s taxable income.
  - Disseminate benefits via initial successful cases and workshops; strengthen capacity of mediation center, banks, creditors, business community; involve CBM, Association of Banks, Chamber of Commerce.

### Summary of recommended legal and institutional reforms (timing legend: I=Immediate within one year; NT=Near-term 1–3 years; MT=Medium-term 3–5 years)
- Strengthen bank regulatory and supervisory framework for accurate NPE reporting and provisioning. (CBM) — I
- Require banks to raise additional capital to accommodate accurate provisioning and create headroom for NPL resolution. (CBM) — I
- Make special purpose vehicles involved in NPL purchases subject to CBM supervision and mandate reporting to the credit registry. (CBM) — I
- Create a dedicated NPL unit. (CBM) — I
- Require banks to establish specialized workout subsidiaries to transfer certain NPLs. (CBM) — NT
- Specify detailed provisions in the Law on Ownership Rights to expedite eviction of foreclosed residential properties. (MoJ) — NT
- Ensure effective collaboration of officers implementing evictions and repossession of movables. (MoJ) — I
- Provide funding to Real Estate Administration to complete cadastral information and titling of all territory. (MoF) — NT
- Interconnect Registry of Vehicles and Secured Transactions Register. (MoI & Commercial Court) — MT
- Put into operation software for electronic filing of secured transactions at the register. (Commercial Court) — NT
- Introduce uniform standards for appraisers and a centralized website for real estate auctions. (MoF) — NT
- Amend Law on Bankruptcy to allow secured creditors on creditors’ committees and to concentrate bankruptcy-related disputes under a single bankruptcy judge. (MoF) — NT
- Clarify (by regulation or amending LCB) that the debtor’s house exemption should not apply to security rights created before the LCB entered into force; enable liquidation of debtor’s house in bankruptcy in presence of valid mortgage unless safeguards allow mortgage creditor to recover at least the foreclosure value. (MoF) — I
- Improve out-of-court debt restructuring by extending LVR eligibility to all creditors’ claims; create further tax incentives; introduce fast-track court prepack procedure; strengthen stakeholder capacity. (MoF and CBM) — I
- Enhance institutional NPL enforcement and bankruptcy capacity by mandatory continued training and periodic evaluation of PEOs and insolvency administrators and periodic revalidation of insolvency administrators’ licenses. (MoJ) — MT

*Source: IMF Technical Note (EXECUTIVE SUMMARY) and IMF staff text from the supplied content unit.*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### A. Key Findings
- Nonperforming loans (NPLs) remain a difficult legacy, reflecting the local and regional boom-bust cycle as well as lax pre-crisis lending standards. According to CBM data, the system-wide NPL ratio stood at 16.5 percent at end-June 2015, albeit with significant variations among banks. 1
- The bulk of NPLs are backed by real estate collateral; the state of the real estate market is a key impediment for reducing NPLs.
- A second key impediment is some banks’ inability and unwillingness to absorb losses. The absence of sound estimates for the shortfall in provisions relative to actual losses that would be incurred in more rapid NPL resolution impedes effective policy formulation.
- The CBM introduced in 2013 a requirement for banks to prepare a multi-year NPL resolution strategy, including annual operational targets and quarterly reporting against those targets; enhanced supervision and monitoring are expected to positively impact banks’ NPL management practices.
- It is essential to reverse the loosening of regulatory standards observed over the last several years and to strengthen regulatory standards and enforcement to ensure accurate and timely reporting of nonperforming exposures, and the establishment of loss provisions that better reflect expected losses.
- Where appropriate, banks should be required to raise additional capital to support the establishment of needed provisions and create headroom to absorb the losses associated with future NPL workouts and write-offs.
- The CBM should consider establishing a specialized NPL team within the Supervision Department to: serve as a resource to relationship managers, support supervision of NPL management practices in all banks, advise on policy formulation, promote best NPL resolution practices, and help ensure compliance with tightened regulatory standards.
- To analyze, regulate, and monitor the NPL problem in its entirety, nonbank credit institutions and asset management vehicles should be brought under CBM oversight. In addition to the EUR 397 million NPLs on banks’ books, about EUR 720 million has been sold, predominantly to parent banks and affiliated asset management (“factoring”) companies. Reporting these exposures to the credit registry should be made mandatory to comprehensively monitor NPL dynamics, which will likely require some form of CBM oversight of such institutions.
- Montenegro has undertaken legal and institutional reforms to improve NPL enforcement, but gaps remain: variability in speed and quality of court enforcement, underdeveloped business rescue culture, reorganization rarely used with most bankruptcy cases ending in liquidation, limited use of out-of-court reorganization (‘workouts’), and remaining gaps in land titling and cadastral information (notably in rural areas). The Secured Transaction Register is not interconnected with other databases related to movable property (notably, the Registry of Vehicles).
- The Law on Voluntary Restructuring of Debts (the ‘Podgorica Approach’) facilitates out-of-court negotiations with tax and provisioning incentives, but eligibility is restricted to creditors holding claims classified as B and C exclusively, which could prevent adoption of reorganization plans encompassing all claims. The out-of-court mechanism needs a fast-track procedure to confirm ‘prepackaged’ plans and make them obligatory with respect to all creditors to limit minority hold-outs.
- The recently enacted Law on Consumer Bankruptcy establishes a radical exemption in favor of a bankrupt debtor’s house (cannot be sold in bankruptcy if “commensurate with the basic housing needs of the consumer”). If applied to loans secured with mortgages created before the law’s entry into force, most such loans would be considered unsecured, reducing collection prospects. Future mortgage-backed retail and SME lending could disappear if enforcement of a consumer’s house in bankruptcy remains prohibited without safeguards for secured creditors. The impact on financial inclusion, credit access, and cost for households and SMEs should be carefully considered.

Key statistics and sectoral composition (preserve original figures):
- System-wide NPL ratio: 16.5 percent at end-June 2015.
- Provision coverage ratio (as a share of NPLs): 72.6 percent at end-June 2016; more than half of NPLs have been 100 percent provisioned (category ‘E’).
- Banks’ loan portfolio: 2.4 billion EUR in mid-2015.
- Composition of loans: 42.7 percent loans to legal persons; 38.4 percent loans to natural persons; 17.9 percent loans to nonresidents.
- Sectoral shares of loans: trade 37.1 percent; construction 11.6 percent.
- Sectoral shares of NPLs (percent of overall portfolio): trade 29.6 percent; manufacturing 13.2 percent; construction 10.6 percent.
- Over 2009–2015, some EUR 720 million in NPLs were sold predominantly to affiliated group asset management companies.
- Two banks had NPL ratios exceeding 30 percent.
- NPL levels for domestic banks: 18.8 percent; for foreign-owned banks: 16.2 percent.

Notes from regional context:
- By July 2015, NPLs in the Western Balkans stood on average at 15.8 percent of total loans.
- Montenegro’s NPL decline from a peak of 25 percent in early 2011 to 16.5 percent in mid-2015 came largely as a result of “bulk sales” of bad loans.

### B. Summary of Recommendations
- Tighten the bank regulatory and supervisory framework for accurate reporting of nonperforming exposures, and for asset classification and loss-provisioning standards to accurately reflect expected losses. (CBM) — I
- Require banks to raise additional capital to accommodate more accurate loss provisioning and to create headroom to absorb the losses incurred in more rapid NPL resolution. (CBM) — I
- Make special purpose vehicles that are involved in the purchase of NPLs subject to the CBM’s supervision and introduce mandatory reporting to the credit registry to allow for comprehensive NPL monitoring. (CBM) — I
- Create a special unit dedicated exclusively to NPLs. (CBM) — I
- Require banks to establish specialized workout subsidiaries into which to transfer certain of their NPLs. (CBM) — NT

Insolvency and Creditor Rights recommendations:
- Specify detailed provisions in the Law on Ownership Rights to expedite the eviction of foreclosed residential properties. (MoJ) — NT
- Ensure the effective collaboration of the officers in charge of implementing evictions and the repossession of movable assets subject to secured transactions. (MoJ) — I
- Provide adequate funding to the Real Estate Administration to complete cadastral information and titling of all Montenegro territory. (MoF) — NT
- Interconnect the Registry of Vehicles and the Secured Transactions Register. (MoI & Commercial Court) — MT
- Put into operation the software that will allow electronic filing of secured tractions at the register. (Commercial Court) — NT
- Introduce uniform standards for appraisers and appraisals, and establish a centralized website for real estate auctions to ensure greater consistency of valuations across the banking system and to increase transparency and disclosure. (MoF) — NT
- Amend the Law on Bankruptcy to: (1) allow secured creditors to be members of the creditors’ committees; and (2) concentrate under a single judge (bankruptcy judge) the competence over all disputes that may arise in the course of bankruptcy proceedings. (MoF) — NT
- Clarify—by regulation or amending the Law on Consumer Bankruptcy—(1) that the debtor’s house exemption from being sold in bankruptcy shall not apply with respect to security rights created before such law entered into force; and (2) enable liquidation of a debtor’s house in bankruptcy in presence of a valid mortgage agreement, unless adequate safeguards specified by the law allow the mortgage creditor to recover at least the foreclosure value of the property. (MoF) — I
- Improve the out-of-court debt restructuring framework by: (1) extending the Law on Voluntary Restructuring eligibility to all creditors’ claims; (2) creating further tax incentives to out-of-court debt restructuring, whether or not the Law on Voluntary Restructuring mechanism is used in a particular case; (3) introducing in the Law on Bankruptcy a fast-track court procedure for debt restructuring (‘prepacks’); and (4) strengthening the capacity of all stakeholders and disseminating the potential benefits of using the new legislation. (MoF and CBM) — I
- Enhance the institutional framework for NPL enforcement and bankruptcy proceedings by: (1) improving the capacity and skills of Public Enforcement Officers through mandatory continued training and periodic evaluation of their performance; and (2) establishing that insolvency administrators should also receive mandatory continued education and must revalidate their license periodically. (MoJ) — MT

Timing legend:
- I—“Immediate” is within one year;
- NT—“Near-term” is 1–3 years;
- MT—“Medium-term” is 3–5 years.

*Source: IMF Technical Note (EXECUTIVE SUMMARY).*

### 15.      While banks have also taken measures to restructure loan portfolios, the chosen solutions

### _cr16200 - 15.      While banks have also taken measures to restructure loan portfolios, the chosen solutions

### Restructured loans and NPL resolution
- Total gross restructured loans and receivables amounted to Euro 360.7 million at end-Q1 2015 or 14.9 percent of loans and receivables.
- Loans with extended principal or interest repayment accounted for the main share in total restructured loans in the amount of Euro 134 million or 37.2 percent.
- Banks appear unwilling to apply more drastic restructuring measures such as debt forgiveness, in part because a large share of NPLs, or respective collaterals, are related to real estate which are difficult to sell in the current market environment.
- Some banks’ unwillingness to write-down and forgive principal impedes NPL resolution; boards and shareholders were reported unwilling to grant debt forgiveness, reflecting both principle and limited capital headroom to incur more losses.
- Costs and administrative burden of managing foreclosed real estate incentivize banks to be less aggressive in resolving NPLs through foreclosure: few third-party real estate management companies exist, diverting bank management time and operational resources.
- Very limited sales of NPLs to third parties to date, but some market participants are in active discussion with foreign investors; a market for troubled debts may soon emerge creating more opportunities to move NPLs out of banks.

### Regulatory framework: asset classification, provisioning, and accounting
- The CBM regulation on asset classification, treatment of rescheduled and restructured nonperforming exposures, and the establishment of loss provisions has been periodically relaxed since 2009.
- Relaxation included extending the number of days past due that trigger classification into more conservative categories.
- The regulation permits classification partly on the basis of the nature of underlying collateral rather than the borrowers’ ability to repay. Examples:
  - A loan can be treated as performing until it becomes 180 days past due when supported by specified financial collateral.
  - Some collateral types that trigger preferential treatment include unlisted debt securities issued by parties related to the debtor.
- The regulation lacks adequate clarity on rules for restructuring/rescheduling and subsequent reclassification, leading to inconsistent implementation and enforcement.
- Adoption of IFRS accounting starting in 2013 (IFRS IAS 39) introduced an incurred loss principle that has generally resulted in lower levels of provisioning relative to existing regulatory standards; management judgment on future cash flows can create scope to delay NPL resolution and has in some cases led to auditors issuing qualified opinions.
- Regulations applicable to holding foreclosed real estate were relaxed, enabling banks to hold a higher share of their own funds in immovable properties and fixed assets and to hold such assets for a longer period.

### Standard loan classification criteria (since 2008) — days past due (as presented)
- Classification grades and corresponding days past due evolution (table summarized from Decision on Minimum Standards for Credit Risk Management):
  - A: <=30
  - B1: 31-60
  - B2: 61-90
  - C1: 91-100
  - C2: 151-270
  - D: 271-365
  - E: >365
- Note: Table reflects progressive changes across decisions (Original baseline Sept/2008; June/2009; Nov/2010; 04/2012-current).

### Provisioning requirements by classification grades (Decision on Minimum Standards for Credit Risk Management 04/2012-current)
- A: 0 percent
- B1: 2 percent
- B2: 7 percent
- C1: 20 percent
- C2: 40 percent
- D: 70 percent
- E: 100 percent
- Observations:
  - Current provisioning regime considered generally conservative for poor quality grades, but lack of provisioning for A-rated category is a weakness.
  - Loosening of asset classification norms has likely resulted in understatement of NPLs, overstatement of NPL quality and appropriate provisions, and overstatement of banks’ regulatory solvency ratios.
  - Provisioning rules have not been validated against actual outcomes; CBM’s credit database could be leveraged to analyze correlation between actual loss outcomes on resolved NPLs and provisioning rates.

### Supervisory practices
- In 2013 the CBM required banks to prepare problem loan resolution strategies with annual operational targets and quarterly reporting; requirement applies only to loans formally classified as NPLs (rated C, D, or E).
  - Strategy covers a three-year period and must follow CBM guidelines.
  - Each bank defines annual quantified operating targets for NPL recovery and enforcement mechanisms and submits quarterly reports using a prescribed template; CBM monitors progress.
  - Outcome: more systematic identification of better NPL management practices and requirement for lagging banks to upgrade practices.
- Organizational approaches to NPL management vary across banks:
  - Some banks have transferred lowest quality NPLs to special asset management vehicles (e.g., factoring companies) owned by foreign parents; those NPLs may no longer be subject to supervisory attention.
  - For retained NPLs, management is often by designated workout units or legal staff; involvement of originating loan officers varies.
- Structural weaknesses in asset classification rules lead to under-provisioning, constraining more aggressive NPL resolution; several banks are averse to incurring losses beyond regulatory provisions due to limited capital headroom.
- CBM supervises adherence to asset classification and provisioning standards and capital planning, but tightened standards would require assessment of capital adequacy implications.

### Policy recommendations
- Tighten regulatory standards for asset classification and treatment of rescheduled and restructured nonperforming exposures:
  - Loans should be classified based on borrower’s repayment capacity assessed by quantitative analysis of future cash flows.
  - Collateral type should not influence classification grade.
  - Rescheduled/restructured loans should be upgraded only when there is demonstrable improvement in repayment capacity and several months of actual debt service under new terms.
- Periodically validate loan-loss provisioning rules against actual outcomes in NPL resolution:
  - CBM should use its extensive database (supplemented by data on NPLs transferred into affiliates) to analyze appropriateness of provisioning rules.
  - Consider revising required provisioning levels where significant disparities are identified.
  - Consider setting a required provision for A-rated loans (currently exempt), potentially differentiated across portfolios (e.g., loans to real estate developers, consumer loans).
- Require banks to raise additional capital where appropriate to support higher provisions resulting from tightened standards and to create headroom to absorb losses from more aggressive NPL workouts and write-offs:
  - CBM should systematically estimate consequences for capital adequacy in individual banks and consider an independent asset quality review of all banks.
  - CBM should use ICAAP assessments to encourage boards and controlling shareholders to raise capital preemptively.
- Consider requiring organizational separation of certain NPLs into specialized workout subsidiaries:
  - Transfer NPLs with no prospect of profitable relationship to legally separate entities with independent governance, true-sale pricing, recognition of losses, and arm’s-length transactions.
  - CBM should subject all such transfers to thorough scrutiny and maintain consolidated supervision of parent banks.
- Bring nonbank credit institutions and asset management vehicles that hold NPLs under CBM oversight:
  - Make reporting of credit exposures held by these entities to the credit registry mandatory to permit comprehensive analysis of NPL dynamics.
- Create a CBM special unit dedicated exclusively to NPLs:
  - Unit would be distinct from relationship managers and credit risk supervisors.
  - Mandate: formulate system-wide diagnostics of troubled debts, advise on policy formulation, support implementation of strengthened policy and supervisory approach, and drive systematic improvement in NPL resolution.
  - CBM should consider allocating additional resources to the Bank Supervision Department for this purpose.

### Insolvency and creditor rights — legal framework highlights
- Montenegro legislation provides multiple modern laws governing credit life cycle phases; implementation weaknesses remain despite generally up-to-date laws.
- Main laws cited (names and enactment months/years preserved as in source):
  - Law on Obligations –LoO (August 2008)
  - Law on Ownership Rights –LOR (March 2009)
  - Law on Secured Transactions (Movable Property) –LST (January 2003)
  - Law on Enforcement and Securing of Claims –LESC (July 2011)
  - Law on Civil Procedure –LCP (March 2004)
  - Law on Courts –LoC (No. 5/2002)
  - Law on Public Enforcement Officers –LPEO (December 2011)
  - Law on State Surveying and Cadastre of Immovable Property –LSSCIP (May 2007)
  - Law on Mediation –LoM (May 2005)
  - Law on Notaries –LoN (November 2005)
  - Law on Bankruptcy –LoB (December 2010)
  - Law on Voluntary Restructuring of Debts towards Financial Institutions – LVR (April 2015)
  - Law on Consumer Bankruptcy –LCB (August 2015)
- Security rights over immovable assets (mortgages):
  - Montenegrin laws govern mortgages consistent with international best practice; corporate lending is usually secured with real estate and mortgage is the preferred security.
  - A creditor with a mortgage is authorized to demand satisfaction by foreclosing the mortgaged property with priority over unsecured creditors and subsequently registered mortgages.
  - The mortgage secures the entire claim, interests, ancillary claims, and enforced collection costs.
  - In realization of mortgaged property, main and subordinated claims secured by the mortgage are satisfied with priority, except taxes on the mortgaged property and costs of sale.
  - Priority of a mortgage cannot be changed without agreement of all persons whose rights will be affected by the change.

*Source: _cr16200 - 15.      While banks have also taken measures to restructure loan portfolios, the chosen solutions*

### 36.      Creating security rights on immovable assets is not difficult. A mortgage shall be

### _cr16200 - 36.      Creating security rights on immovable assets is not difficult. A mortgage shall be

### Creation and form of mortgages
- A mortgage shall be created by registration in the Real Estate Administration Department (READ) on the basis of: (1) a contract (contractual mortgage); (2) a pledge statement (unilateral mortgage); (3) a law (statutory mortgage); or (4) a court decision (judicial mortgage).
- A mortgage agreement must be concluded in writing and authenticated by a competent body.
- Mortgage contracts are typically drafted and authenticated by notaries; notarial intervention has reduced contract flaws and debtor objections.
- If there are several mortgages on the same immovable property, the priority of each mortgage shall be established according to the moment of submission of the request for its registration.
- Several immovable assets can be subject to a mortgage to secure any or all of a debtor’s obligations, including:
  - individual property or a percentage of that property;
  - future property (such mortgage can be registered only when the property comes into existence);
  - buildings under construction and separate parts (apartments, business premises, garages) provided a valid building permit exists.
- Mortgages can secure conditional or future claims; if the exact amount is unknown at creation, the mortgage agreement must specify the maximum amount secured.
- Immovable property can be mortgaged to secure the debt of a third person.
- A mortgage can be assigned to another person only together with an assignment of the secured obligation; the debtor’s consent is not required, but the debtor must be informed of the assignment.

### Registry for ownership and security rights over immovable assets (READ)
- The READ is responsible for surveying land and keeping cadastral data and all transactions and rights on immovable property; it is a single entity under the MoF, based in Podgorica with 21 local offices.
- Registration of mortgages is subject to a flat fee of EUR 10.
- Registration is done in one day in most cases according to information provided by READ authorities.
- Information is kept in paper and electronically; the main server with a unified database is in Podgorica.
- Basic information is accessible to any citizen registered as a user for free; notaries can search more detailed data. All searches are free.
- Under an ongoing project to survey land initiated in 2008:
  - some 550,000 hectares have been surveyed so far;
  - approximately 250,000 hectares are now enrolled in the real estate registration system.
- In 2014, 3.8 percent of mortgage registrations were rejected, an improvement compared with 14 percent of requests typically rejected in the past.
- Cadastre covers most territory including all towns, but land titling and cadastral information are problematic in 8 percent of Montenegro territory, affecting around 100.000 hectares in rural areas.
- Plans exist to resolve the remaining issues in the next five years, but funding is not available yet.
- User complaints: cadastre not always up-to-date (encumbrances not properly registered), delays in delivery of READ orders/decisions, non-harmonized practices across regional offices, and lack of READ autonomy potentially hindering organization and funding.

### Enforcement of claims secured with mortgages
- If default is not cured within 15 days from delivery of the notice of commencement of foreclosure to the mortgagor, the mortgagee may pursue remedies determined by the agreement: (1) extra-judicial foreclosure; or (2) enforcement according to law regulating enforcement procedures.
- Most secured creditors prefer extra-judicial foreclosure, a brief and not contentious process with limited READ involvement.
- Extra-judicial foreclosure timeline: would allow recovery in 6–12 months (average, excluding exceptional cases where it could take longer).
- Procedure summary:
  - Mortgagee registers a notice of sale in the READ and delivers a copy to the mortgagor.
  - The notice of sale shall be published in two separate daily newspapers and posted in a visible place on the property at least 15 days before the date of sale.
  - Default may be cured at any time before sale by paying amounts stated in the notice.
  - Mortgagor may contest by submitting a complaint to the court within 15 days of receipt of the notice of sale; submission does not postpone foreclosure except where the mortgagor produces evidence that the secured claim has been fulfilled or is not due, that legal procedures were breached, or the mortgage was not duly registered.
  - Courts shall pay special attention to urgency of these disputes.
- Sale mechanics:
  - Extra-judicial sale is by public auction to the highest bidder.
  - At the first auction, the property cannot be sold below the appraised value.
  - If not sold, a second auction may sell at a price not below 50 percent of the appraised value.
  - If not sold at the second auction, a new one can be scheduled at a price not below the amount of the creditor’s claim.
  - The mortgagee may bid and offset its bid to the extent of the full amount of the secured obligation, including unpaid interest, late charges, cost of sale, fees, and other expenses.
  - Upon full payment by the winning bidder, the auctioneer can sign a purchase and sale agreement on behalf of the mortgagor, transferring ownership.

### Appraisal standards, eviction, and practical impediments
- A draft Law on Accounting aims to regulate conditions and manner of property valuation and other accounting/valuation issues.
- Introducing uniform appraisal standards and centralized disclosure of auctioning procedures and prices obtained could increase transparency in valuation processes.
- Eviction of residents in foreclosed residential properties is difficult in practice:
  - The LOR lacks provisions for expedited eviction.
  - The LESC requires intervention of a public enforcement officer who issues a decision ordering eviction and handover to the buyer, but implementation can be slow (up to two years, according to some banks).
  - Difficulty in vacating occupied properties may negatively affect auction prices and buyer interest.

### Recovery rates for mortgage loans
- Banks report varied recovery experiences for loans secured by real estate:
  - 90–100 percent in some cases;
  - 50–75 percent in other banks’ experiences;
  - one bank mentioned a recovery rate lower than 50 percent.
- Legal framework: secured claims enjoy the highest priority vis-à-vis other classes of creditors, both outside and in insolvency proceedings, after costs of sale and taxes related to the collateral have been deducted.
- IMF assessment: low typical recovery rates reported by banks are likely due to loans originally under-secured or market conditions (low demand and depreciation), rather than legal framework deficiencies.

### Security rights over movable assets (pledges)
- Possessory and nonpossessory pledges are adequately regulated and widely used.
- Security rights in movables may be created by delivery of collateral to the pledgee (possessory pledge) or by registration without delivery (registered pledge).
- A pledgee is entitled to satisfaction from sale proceeds prior to other creditors, including claim, interest, and costs.
- Possessory pledge specifics:
  - Pledge contract obliges delivery of movable property to pledgee who acquires security right upon delivery.
  - Pledges may secure future and conditional obligations.
  - If pledgor is a business entity, contract may provide extra-judicial public sale rights upon default.
  - If pledgor is a natural person (not a registered entrepreneur), pledgee may commence extra-judicial public sale through auction if agreed.
  - Pledgor may contest enforcement in the same manner as mortgage foreclosure.
- Registered (nonpossessory) pledge (governed by the Law on Secured Transactions, LST):
  - Any movable legally transferable may serve as collateral.
  - In principle, pledge secures the entire amount of a secured obligation, including unpaid principal, interest, penalties, costs of repossession, maintenance, sale, and other obligations secured.
  - Unless provided in the pledge agreement, a pledge does not secure future advances not advanced or committed at creation.
  - A secured obligation may be identified generally or specifically and need not exist at grant.
  - Nonpossessory pledges must be in writing and registered before a competent registry.
  - Registration is effective upon entry of a notification statement into the registration office records; effective time/date is the time/date the notification statement was presented.

### Registry for security rights over movable assets (STR)
- Pledges and liens over movables are registered at the Secured Transactions Register (STR), a single institution for the whole country, situated at the Commercial Court in Podgorica; STR started operating in May 2003.
- All information is kept electronically and is publicly available online for free; submission of new applications on-line is not allowed at present (registration must be done in person or by fax).
- Only the pledgee (or its agent) may request registration; the pledgor is deemed to have authorized registration by signing the pledge agreement.
- Registration is usually done the same day unless more time is granted for documentation completion.
- Initial registration fees:
  - EUR 20 for a transaction of up to EUR 10,000;
  - EUR 50 if the transaction amount is EUR 10,000 – 200,000;
  - EUR 100 for transactions above EUR 200,000.
- Extension, deletion, or additions to existing files pay a EUR 20 flat fee.
- Searches are possible via internet or at the STR’s office by name of pledgor/pledgee or serial number.
- Activity statistics:
  - From January 2014 to September 2015, the number of filed documents was 11,790.
  - Historical total number of entries (May 2003–September 2015) is 67,599.
- STR is not interconnected with other related databases (notably, the Registry of Vehicles), which may create inconsistent information on the same asset.
- New software is being developed to allow electronic filings in the future.

### Enforcement of claims secured with registered (nonpossessory) pledges
- Enforcement mechanisms:
  - Creditor may take possession of collateral upon default and proceed with realization.
  - Creditor may file an application for execution with the court requesting an order authorizing seizure and delivery of collateral to the creditor; objection against the application for execution is not allowed.
  - Upon such application, the court hearing is limited to: (1) whether there is a perfected pledge; and (2) whether there has been a default. Upon favorable finding, court issues order designating an execution officer to seize collateral and deliver it to the pledgee or authorized agent. Execution officer need not give prior notice of seizure.
  - After lawful possession, pledgee may sell, lease, or otherwise dispose of collateral by public auction or private disposition; disposition must be “commercially reasonable.”
  - Creditor may opt to use enforcement procedure before public enforcement officers contemplated in the LESC.
- Practical performance:
  - Enforcement typically takes less than six months where debtor does not vigorously challenge the claim; otherwise enforcement could take longer (12–18 months, average).
  - Banks report varied recovery rates for pledge-secured nonperforming loans:
    - Some banks’ average recovery rate is 90–100 percent;
    - Others report recoveries lower than 50 percent of the loan amount.
  - Low recovery rates may be due to insufficient collateral or asset value depreciation rather than legal framework deficiencies.
  - Some lenders reported material difficulties in repossession and instances of lack of police collaboration, particularly in small towns.

*Source: _cr16200 - 36.      Creating security rights on immovable assets is not difficult. A mortgage shall be (PDF).*

### 50.      Upon implementation of the Public Enforcement Officers (PEO) in 2014, enforcement

### _cr16200 - 50.      Upon implementation of the Public Enforcement Officers (PEO) in 2014, enforcement

### Enforcement framework under PEOs
- Enforcement petitions of monetary claims shall be submitted to a PEO and not to a court.
- Enforcement of loans shall be ordered on the basis of a number of documents specified by the LESC.
- Creditor must hold either:
  - an “enforceable document” (typically, an enforceable court decision or court settlement) or
  - an “authentic document” (most commonly, promissory note or bill of exchange, and cheque under protest).
- The PEO must decide on an enforcement petition within five days from the day of receiving the petition.
- By way of a writ of enforcement, the PEO shall adopt entirely or partially the enforcement petition.
- The writ of enforcement shall request the debtor to satisfy the claim (within three or eight days, depending on the title) together with the determined costs, and order enforced collection of such claims.
- Means of enforcement to satisfy a monetary claim are: sale of movables, sale of immovables, transfer of monetary claim, transfer of claim for handing over movables or immovables, conversion into cash of other property rights, transfer of funds kept in a bank account, sale of shares, and sale of holdings in business organizations.
- The PEO shall levy enforcement on funds and assets that he/she believes are the most suitable, and that will provide for the most favorable satisfaction of the creditor’s claim.

### Debtor complaints, time limits, and practical delays
- The law restricts the number of complaints a debtor may lodge and establishes tight deadlines for enforcement procedural stages.
- The debtor may file a complaint (‘appeal’) against a writ of enforcement or a PEO’s order within five days from the day the writ/order is serviced.
- The reasons for complaint that a debtor may argue are limited and defined by law.
- When filing a complaint, the debtor must present all reasons for contesting the writ of enforcement and attach all evidences with the filing; otherwise, she shall lose the right to present additional facts and propose evidence.
- A complaint shall not withhold the execution of the writ of enforcement based on a promissory note or an enforceable document.
- A court panel (three judges) shall decide on the complaint within 15 days.
- In practice, legal deadlines have not always been met because:
  - (i) debtors tend to abuse the process; and
  - (ii) until recently, courts have had to deal with an excessive number of cases of different nature.
- Recent institutional and legal reforms: a single judge now hears and decides on a debtor’s complaints in the case of enforceable titles or promissory notes; PEO implementation has alleviated courts’ workload.
- Frequent conversion of enforcement cases into time-consuming civil litigation procedures is reported as a delaying factor.
- Reported average durations:
  - If debtor does not challenge the claim: 6–12 months.
  - If debtor introduces several complaints and appeals, or enforcement procedures are converted to civil litigation cases: 18–24 months (sometimes longer).

### Recovery prospects and bank-account blocking
- Unsecured loan recovery chance and rate are strongly conditioned by availability of funds deposited in debtors’ bank accounts, which can be blocked.
- For legal entities:
  - A bank holding a promissory note issued by the borrower (legal entity) may directly request to the central bank a blockage of the debtor’s bank account, which is immediately implemented and extended to all accounts of such debtor in different banks.
  - This mechanism often allows the creditor to collect its claim (totally or partially) or to force a negotiated debt arrangement.
- For natural persons:
  - Blocking bank account(s) requires PEO’s intervention and is not automatically extended to other accounts.
  - In most cases, there are no funds available in the blocked account(s).
- If there are no funds in blocked accounts, recovery rate of unsecured loans depends on existence of other free assets attachable and realizable in enforcement.
- Most banks report recovery rates lower than 50 percent of unsecured loans in enforcement proceedings.

### Bankruptcy legal framework — enterprises
- The Law on Bankruptcy (LoB) provides for both liquidation and reorganization of legal persons, individual entrepreneurs and business organizations that do not enjoy the status of legal persons.
- Debtors not eligible under the LoB regime are:
  - (i) bodies, organizations, and institutions financed from the budget of Montenegro, budgets of local councils, and state funds;
  - (ii) central bank or independent regulatory bodies; and
  - (iii) legal persons with special bankruptcy proceedings regulated by separate legislation.
- Consumers’ bankruptcy proceedings are governed by a separate law passed in August 2015.
- Both liquidation and reorganization are formal procedures conducted before a specialized court; competent court is where the debtor’s registered office or permanent residence is located.
- At present, there is one Commercial Court, based in Podgorica, with jurisdiction over the whole country.
- The bankruptcy judge’s competence is limited to main decisions; many other disputes arising in bankruptcy (e.g., disputes over creditors’ claims, voidable transactions) are referred to other judges from the Civil Litigation Department—this divided competence contributes to delays and risk of inconsistent interpretation.

### Creditor priority and recovery in bankruptcy
- Secured claims:
  - Secured claims are highly protected, ranking above all other creditor classes.
  - Fully secured creditors are not allowed to be members of the creditors’ committee.
  - Secured creditors are not considered “bankruptcy creditors.”
  - They are entitled to full satisfaction from proceeds of sale of the secured asset, with priority over all other claims.
  - Exercise of security rights may be temporarily postponed by judicial decision during preliminary proceedings, but secured creditor may request adequate protection or cancellation of the enforcement prohibition.
- Order of satisfaction:
  - Costs of bankruptcy (administrative expenses) have priority to collect in full from the bankruptcy estate before all bankruptcy creditors.
  - Bankruptcy creditors are satisfied according to seniority of classes:
    - (1) several labor claims constitute the first tier;
    - (2) obligations with the state that have matured over the three months prior to initiation of bankruptcy proceedings form the second tier;
    - (3) the rest of the unsecured creditors are included in the third tier.
  - Creditors of the same seniority class shall be satisfied proportionally to their claims amount (pro rata).
- If collateral realization proceeds are insufficient to cover a secured claim in full, the unsatisfied amount is treated as unsecured and participates prorated within that class.
- Creditors’ committee shall include three to five creditors who have the largest unsecured or partially secured claims.
- Unsecured claims recovery rates in bankruptcy are usually low: less than 50 percent, per most stakeholders interviewed.

### Bankruptcy process efficiency and reorganization practice
- LoB slightly improved effectiveness of bankruptcy liquidation; most liquidation proceedings would now be completed in less than a year (previously 18–30 months or more).
- Delays typically occur because selling debtor’s assets requires several auctions under current market conditions; disputes arising in bankruptcy proceedings also contribute to delays.
- Reorganization terms are tight: if a plan is not approved and confirmed within four months, liquidation must be initiated.
- Reorganization is infrequently used:
  - Less than 10 percent of bankruptcy cases have a reorganization attempt; very few succeed and avoid liquidation.
  - An enterprise in liquidation may be sold as a functioning unit, enabling rescue where reorganization failed.
- The law does not contemplate an expedited procedure for court confirmation of prepackaged reorganization plans.

### Bankruptcy case statistics (Table 3)
- Table 3. Montenegro: Bankruptcy Cases
  - Opened / Pending Resolved
  - 2014 497509
  - Six months 2015 327
  - [12 months projection: 654]
  - 351
- Source: Podgorica Commercial Court.

### Consumer bankruptcy concerns
- Law on Consumer Bankruptcy (LCB), passed in August 2015, establishes an exemption in favor of a bankrupt debtor’s house, which cannot be sold in bankruptcy—not even to satisfy security rights created over such immovable assets—provided that this is “commensurate with the basic housing needs of the consumer.”
- If applied to loans secured with a mortgage created before the LCB’s entry into force, most such loans would be considered unsecured and their collection prospects could be significantly reduced.
- Potential market effects:
  - Individual loans secured with mortgages may disappear from the market if the prohibition remains in force and no safeguards protect secured creditors’ rights.
  - Impact on financial inclusion, credit access, and cost (particularly for households and SMEs) should be carefully considered.

### Out-of-court debt restructuring (workouts) and legal enhancements
- Workouts practice:
  - Creditors generally view voluntary debt restructuring favorably, but collective out-of-court agreements or plans are not frequent.
  - Some creditors find workouts “satisfactory,” “faster and cheaper than formal proceedings,” while others are skeptical, preferring to rely on individual security rights.
  - In practice, most restructurings are individual (one creditor/one debtor); debt rescheduling and interest reductions are most common.
  - Debt write-off (‘haircuts’) and debt-to-equity swaps are rarely utilized.
- Law on Voluntary Restructuring of Debts (LVR or ‘Podgorica Approach’):
  - Establishes a framework to facilitate out-of-court negotiations and debt restructuring between a debtor and a plurality of creditors, providing tax and loan-provisioning incentives.
  - Protects transactions entered into in a workout from being challenged in bankruptcy under the avoidable transactions regime.
  - Eligibility for LVR is restricted to creditors holding claims classified as B and C exclusively, which may exclude a reorganization plan that encompasses all claims.
- Recommended complements to LVR:
  - Introduce a fast-track procedure to confirm workout plans previously approved by a legally defined majority of creditors (‘prepackaged plans’) and make such plans obligatory for all creditors to limit hold-outs.
  - Ensure debt reductions (‘haircuts’) negotiated under LVR are not considered debtor’s income for tax purposes.
  - Disseminate potential benefits of the new legislation, including presenting one or two initial successful cases and discussing them in a workshop.
  - Strengthen capacity of stakeholders (mediation center, banks, other potential creditors, business community); support and participation of the CBM, the Association of Banks, the Chamber of Commerce, and the mediation center are important.

*Source: IMF staff text as provided in the supplied content unit.*

### 61.      Where LVR mechanism is not used, tax legislation does not provide incentives for the

### _cr16200 - 61.      Where LVR mechanism is not used, tax legislation does not provide incentives for the

### Tax obstacles to debt restructuring and NPL resolution
- Identified tax disincentives where LVR mechanism is not used:
  - (i) debt reduction (haircut) will be considered as debtor’s income and taxed as such.
  - (ii) for income tax purposes, creditors will not be able to deduct haircuts as bad debts because there will be no proof of unsuccessful collection as required by tax law.
  - (iii) creditor repossession of immovable collateral is subject to the same tax applied to any other transfer of real estate property (3 percent over real market value).
- Historical uncertainty:
  - In the past, it was unclear whether or not NPLs assignment was subject to VAT, which acted as a disincentive for such transactions.
  - The current tax law interpretation of the Ministry of Finance has clarified that a sale of bad debts to a third party should not be considered as VAT taxable.

### Institutional framework — Courts system and Public Enforcement Officers (PEOs)
- Reform implemented:
  - The Public Enforcement Officers (‘PEOs’) system was implemented in 2014, transferring monetary claims enforcement competence from the courts to PEOs.
  - The Law on Public Enforcement Officers (‘LPEO’) regulates PEOs’ license requirements (including exams), control and supervision, and contemplates a Chamber of PEOs and a Disciplinary Commission, while the Ministry of Justice (MoJ) retains significant supervisory functions.
- Operational details and impacts:
  - After April 2014, the MoJ licensed 30 PEOs—12 of them are working with territorial jurisdictions in Podgorica.
  - The new system alleviated courts’ workload: Podgorica basic courts used to receive 9,000–12,000 cases per year; those cases are now dealt with by 12 PEOs (in practice, this means multiplying by 6 the number of “courts” in charge of such cases).
  - As a result, the two judges of the Podgorica basic courts received this year only 250 new enforcement cases.
  - PEOs have also reduced the workload of the Commercial Court Enforcement Department.
  - Users consider that some PEOs need to improve capacity and skills, but time for enforcement is now shorter and gains in efficiency are becoming evident.
  - At end-2015, the MoJ will conduct an in-depth evaluation of the PEOs performance.
- Remaining court competence:
  - Courts keep competence only in cases aimed at: (i) restoring an employee’s employment; (ii) implement a child’s custody; and, (iii) forcing a debtor to perform an action that can only be personally performed by him/her.

### Institutional framework — Insolvency administrators
- Regulation and licensing:
  - The MoJ regulates the insolvency administrator profession mainly by issuing the Rulebook for Insolvency Administrators and organizes exams every four months on legal matters and accounting concepts required for certification.
  - At present, there are 203 licensed insolvency administrators.
- Capacity gaps:
  - Stakeholders consider that only a reduced number of such administrators are skilled enough to perform their roles adequately; many others need to improve capacity to handle bankruptcy proceedings more effectively.
  - The law does not establish that insolvency administrators shall receive continued education or revalidate their license periodically.

### Recommendations (summary of proposed legal and institutional reforms)
- Strengthen legal framework for creditor rights:
  - Specify detailed provisions in the Law on Ownership Rights to expedite the eviction of foreclosed residential properties.
  - Ensure effective collaboration of officers implementing eviction and repossession of movable assets subject to secured transactions.
  - Provide adequate funding to the Real Estate Administration to complete cadastral information and titling of all Montenegro territory.
  - Interconnect the Registry of Vehicles and the Secured Transactions Register.
  - Put into operation the software that will allow electronic filing of secured transactions at the register.
- Improve insolvency framework for enterprises:
  - Amend the Law on Bankruptcy to allow secured creditors to be members of the creditors’ committees.
  - Concentrate under a single judge (bankruptcy judge) the competence over all disputes that may arise in the course of bankruptcy proceedings.
- Address Consumer Bankruptcy impacts:
  - Clarify by regulation or by amending the law that the debtor’s house exemption from being sold in bankruptcy shall not apply with respect to security rights created before such law entered into force.
  - Enable liquidation of a debtor’s house in bankruptcy in presence of a valid mortgage agreement, unless adequate safeguards specified by law allow the mortgage creditor to recover at least the foreclosure value of the property.
- Improve out-of-court debt restructuring:
  - Extend the Law on Voluntary Restructuring eligibility to all creditors’ claims.
  - Create further tax incentives to out-of-court debt restructuring, whether or not the Law on Voluntary Restructuring mechanism is used in a particular case.
  - Introduce in the Law on Bankruptcy a fast track court procedure for debt restructuring (‘prepacks’).
  - Strengthen capacity of all stakeholders and disseminate the potential benefits of using the new legislation.
- Enhance institutional capacity for NPL enforcement and bankruptcy proceedings:
  - Improve the capacity and skills of the PEOs through mandatory continued training and periodic evaluation of their performance.
  - Establish that insolvency administrators should receive mandatory continued education and must revalidate their license periodically.

*Source: _cr16200 - 61.      Where LVR mechanism is not used, tax legislation does not provide incentives for the (PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16200.pdf_