## _cr1688

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---

### EXECUTIVE SUMMARY
- Post-2008 collapse left a large stock of nonperforming loans (NPLs), weakened bank profitability, and sustained credit contraction.
- Pre-crisis rapid increase in indebtedness adds to banking sector vulnerability and hampers NPL resolution.
- Economic momentum accelerated in 2015 driven by investment-led activity (including the highway project), but downside risks remain.
- System-wide solvency and liquidity indicators appear broadly sound, but significant pockets of vulnerabilities exist among domestically owned banks.
- Several domestically owned banks have very high NPLs and/or very low provisioning levels; some received qualified audited reports.
- Stress tests indicate vulnerability to shocks, including protracted slowdown, even under the moderate stress scenario.
- Immediate recommended actions:
  - Independent Asset Quality Review (AQR) for all banks.
  - Time-bound supervisory action plans including capital injections by shareholders.
  - CBM to prepare bank-specific resolution planning.
- Further regulatory and supervisory improvements recommended: strengthen NPL identification/measurement/management; focus on operational risks; introduce consolidated supervision; amend Law on Consumer Bankruptcy; move insurance oversight to risk-based supervision and gradual Solvency II implementation.

### FINANCIAL SAFETY NET AND LIQUIDITY MANAGEMENT
- Institutional and legal:
  - Confirm CBM as resolution authority for supervised institutions and grant essential resolution powers (e.g., establish a bridge bank).
  - Deposit Protection Fund (DPF) should be authorized to fund resolution measures and integrated into crisis preparedness.
  - A credible and transparent public backstop is needed for systemic cases absent private-sector-funded resolution.
  - Emergency liquidity assistance should be under a single framework following best international practice.
- Constraints and priorities:
  - Euroization limits CBM options to manage liquidity and provide support.
  - Prioritize sound liquidity risk management standards in preparation for Basel III.
- Macroprudential framework:
  - Establish macroprudential framework, make it fully operational over time, and vest the macroprudential mandate in the CBM.
  - Financial Stability Council (FSC) should have expanded powers to issue macroprudential recommendations.

### MACROFINANCIAL SETTING
- Crisis legacy and policy history:
  - Balance-sheet weaknesses and bank deleveraging have hampered growth.
  - By late 2007 CBM tightened asset classification and provisioning (later relaxed), raised CAR by 2 percentage points to 10 percent; early 2008 introduced temporary bank-specific ceilings on credit growth and increased RR on certain deposits; late 2008 government guaranteed all bank private deposits.
- Credit developments (2015):
  - Lending to the private sector increased by 2.3 percent in 2015.
  - Households expanded by 2.7 percent in 2015.
  - Corporate sector expanded by 2.2 percent in 2015.
  - Gross loans to households and the corporate sector have contracted by 10.5 percent and 34 percent of GDP, respectively, since pre-crisis peak in 2008.
- Growth drivers and risks:
  - Highway project equals 23.5 percent of 2014 GDP and should boost growth near- and medium-term, but exacerbates public debt vulnerabilities.
  - Large general government financing needs averaging nearly 10 percent of GDP during 2016–20 are an important macroeconomic risk.
  - Narrow production base, rigid labor market, and rapidly rising public debt constrain policy space.

### FINANCIAL SYSTEM RESILIENCE — STRUCTURE, CONCENTRATION, VULNERABILITIES
- Structure and concentration:
  - Banks account for about 90 percent of system assets.
  - Banking assets equivalent to about 93 percent of GDP as of June 2015.
  - 14 banks operate in Montenegro (up from 11 in 2013).
  - Foreign subsidiaries hold 79 percent of the sector’s assets.
  - Lending composition: trade sector and households each represent about 38 percent of total loans.
  - Loans to nonresidents represent 18 percent of total loans.
- Notable vulnerabilities:
  - Pockets of high NPLs and low provisioning concentrate among domestically owned banks.
  - Cross-border exposures remain notable and warrant strengthened cross-border supervisory and resolution arrangements.
- Payment and settlement systems:
  - CBM-managed payment and settlement systems generally efficient.
  - Suggested operational changes to minimize residual liquidity risks (e.g., facilitate automatic transfer of balances from reserves account to settlement account).
  - CBM oversight should be strengthened via an oversight policy framework and improved interdepartmental communication.

### INSURANCE SECTOR AND NONBANK FINANCIAL SYSTEM
- Insurance sector:
  - Grew at an average annual rate of 3 percent in the past five years.
  - Total premium remains at 2 percent of GDP.
  - Life insurance: 6 life insurers collected EUR 12 million in premiums in 2014, insuring less than 10 percent of the population.
  - Non-life sector is predominantly compulsory motor third-party liability insurance.
  - Nine of the 11 insurers are foreign subsidiaries, writing 95 percent of total premiums.
  - At end-2014, CAR stood at 735 percent for life and 170 percent for non-life; solvency margins calculated on a Solvency I type of fixed factors.
- Other nonbank institutions:
  - Nascent stock exchange has significant market capitalization but very low turnover.
  - Bond market is thin.
  - Total asset size of five micro-credit institutions (MCIs) is 2 percent of GDP.
  - Leasing market is small and declining since the crisis.

### FINANCIAL SOUNDNESS — ASSET QUALITY, PROVISIONING, BALANCE-SHEET REPAIR
- NPLs:
  - Sector NPLs were 14.7 percent of total loans in September 2015, down from 25.3 percent in mid-2011.
  - NPL ratios vary among banks from 5.5 percent to 35 percent.
  - Regulatory provisions were slightly above 70 percent of reported NPLs—having increased slowly since 2010–11.
  - Note: The NPL ratio had declined to 14.75 percent as of end-September 2015.
  - In addition to EUR 397 million NPLs on banks’ books, about EUR 720 million has been sold predominantly to parent banks and affiliated SPVs.
- Corporate and household indebtedness:
  - Corporate sector indebtedness decreased from 2008 by 11.2 percentage points of GDP to 114.5 percent as of 2014.
  - Assuming long-term NPLs fully provisioned extended to non-operational entities, indebtedness would decrease by 6.5 percent of GDP to 108 percent.
  - Household domestic liabilities have declined by about 15 percent relative to the pre-crisis peak.
- Lending conditions:
  - Lending conditions remain tight; credit growth sluggish despite declining lending rates.
  - High NPL levels indicate rigidities in the NPL resolution framework and tightened credit risk management in many banks.
  - Weak credit demand is an important factor.

### CAPITALIZATION, PROFITABILITY, LIQUIDITY, FUNDING STRUCTURE
- Capitalization:
  - Aggregate tier I capital ratio about 14 percent; CAR close to 16 percent, versus regulatory minimum of 10 percent.
  - Wide differences: highest CAR 33 percent; lowest CAR 10 percent.
  - Some banks could have CARs close to or below regulatory minimum after provisioning adjustments (as assumed in stress test).
- Profitability and efficiency:
  - Aggregate ROA 0.5 percent and ROE 3.4 percent in June 2015.
  - Interest rate spreads on new loans declined significantly.
  - Overhead expenses-to-core income ratio 76 percent for sector in June 2015, with five banks above 100 percent.
  - Domestically owned banks: at end-2014 aggregate ROA 0.8 percent (about zero for domestically owned banks; about 1.1 percent for foreign-owned banks).
  - Overhead costs-to-core income ratio: about 75 percent sector-wide; over 90 percent for domestically owned banks and about 70 percent for others.
- Liquidity and funding:
  - Loan-to-deposit (LTD) ratio reduced to just above 100 percent, with wide heterogeneity across banks.
  - High share of liquidity held with CBM above required reserves.
  - Aggregate liquidity coverage ratio (LCR) is 863 percent.
  - Aggregate net stable funding ratio (NSFR) is 124 percent, with two banks below 100 percent; when deposit outflows are assumed, up to seven banks fall below 100 percent NSFR.
  - Some banks hold a high share of liquidity in foreign-government securities and in EU banks.
- Foreign exchange exposure:
  - As of June 2015, loans in foreign currencies EUR 171 million (7.6 percent of total loans); deposits in foreign currencies EUR 152 million (6.3 percent of total deposits).
  - Law on conversion of Swiss franc into euro-denominated loans imposes total cost about EUR 9 million (28 percent of one foreign-owned bank subsidiary’s capital).

### OWNERSHIP, CROSS-BORDER EXPOSURES, CONCENTRATION, INTERCONNECTEDNESS
- Ownership and cross-border:
  - Nine of 11 insurers are foreign subsidiaries; banks show significant foreign ownership.
  - Banks’ foreign claims and liabilities account for over 115 percent and 50 percent of total regulatory capital, respectively, as of end-2014.
  - About 20 percent of deposits belong to nonresidents; over a quarter of nonresident deposits are from Russia.
- Concentration and default-impact metrics:
  - Average largest exposure in system remains below 25 percent of regulatory capital, but some banks have single-debtor exposures above threshold.
  - Default of the largest net exposures would cause total capital shortfall of 0.3 percent of GDP; default of five largest exposures would cause capital shortfalls of 3.2 percent of GDP.
  - Appendix stress tests: default of largest borrower (70% recovery) yields CAR 15.3 and capital shortfall to meet 12 percent CAR 5; default of largest 5 borrowers (70% recovery) yields CAR 13.2 and shortfall 19.

### SUPERVISORY CONCERNS, REMEDIAL ACTIONS, POLICY RECOMMENDATIONS
- Supervisory weaknesses:
  - Slow progress addressing debt overhang due to weak real estate market, banks’ unwillingness to recognize losses, and gaps in debt-resolution framework.
  - Indications of inadequate provisioning; external auditors issued qualified opinions in 2013 and 2014 for several banks that have not been addressed.
  - Supervisors lack proper tools to challenge banks’ real estate collateral valuations.
- Recommended supervisory and resolution measures (selected; authority and term preserved where given):
  - Prepare and implement time-bound supervisory action plans for vulnerable banks (CBM; ¶17). Term: I
  - Conduct an Asset Quality Review for all banks to determine adequacy of provisions (CBM; ¶18). Term: I
  - Introduce a macroprudential mandate and establish policies and toolkit consistent with EU/ESRB framework (MOF/CBM/FSC; ¶38). Term: MT
  - Introduce effective consolidated supervision (CBM; ¶44). Term: NT
  - Improve regulatory and supervisory framework for liquidity and credit risks (CBM; ¶40, ¶45). Term: I
  - Tighten prudential norms for identification, classification, and reclassification of nonperforming assets (CBM; ¶46). Term: NT
  - Adopt risk-based supervision and incrementally implement Solvency II for insurance (ISA; ¶50, ¶51). Term: I/NT
  - Organize a dedicated resolution unit within the CBM and initiate bank-specific resolution planning, prioritizing weakest CAMEL-rated banks (CBM; ¶65, ¶70). Term: I
  - Strengthen DPF operations: implement risk-based contributions and shorten payout term (DPF/MOF; ¶74). Term: NT
  - Streamline ELA policies and strengthen safeguards to protect CBM’s financial autonomy (CBM/MOF; ¶76–¶78). Term: NT
  - Strengthen FSC’s focus on crisis preparedness and management (FSC; ¶64). Term: I

### STRESS TESTS, SCENARIOS, AND TAIL RISKS (one-year horizon)
- Scope and data:
  - Top-down solvency, liquidity, and contagion stress tests for 12 banks active at end-2014; coordinated between mission and CBM using supervisory and bank-submitted data.
- Macroeconomic scenarios applied (one-year):
  - Baseline: IMF staff projections as of August 2015.
  - Adverse scenario 1 (moderate): growth projection of -2.5 percent.
  - Adverse scenario 2 (severe): GDP projected to fall by 5.2 percent.
- Estimated losses and capital shortfalls:
  - Potential loan losses due to credit risk estimated to range from 1.2 percent to 4.8 percent of GDP in the moderate and severe adverse scenarios, respectively.
  - Top-down stress tests suggest potential system-wide capital shortfalls could be 1.0 percent of GDP in adverse scenario 1 and 3.5 percent of GDP in adverse scenario 2 after provisioning adjustments.
  - Parallel solvency stress tests with provisioning adjustments found one bank insolvent before any stress and requiring capital injection of 0.7 percent of GDP to reach minimum regulatory capital.
- Funding and liquidity results:
  - Banks could largely cover deposit outflows using cash and liquid assets, but profitability would be impaired by relatively small deposit rate increases; high share of nonresident deposits increases vulnerability.
  - Aggregate LCR: 863 percent.
  - Aggregate NSFR: 124 percent; some banks below 100 percent and up to seven banks fall below 100 percent under deposit outflow assumptions.
- Market, FX, and concentration risks:
  - Average holdings of fixed income, equities, and real estate equal 3 percent of total assets, but some banks have above 15 percent.
  - Foreign exchange risk limited.
  - Loan concentration default scenarios: largest net exposure default causes capital shortfall 0.3 percent of GDP; five largest exposures cause shortfall 3.2 percent of GDP.

### COMPETITION, LENDING RATES, AND MACROPRUDENTIAL FRAMEWORK
- Authorities’ view and mission assessment:
  - Authorities attribute weak credit growth and high lending rates to banks’ excessive risk aversion and insufficient competition.
  - Mission finds competition not weak: HHI about 0.12 for assets, deposits, and loans at end-2014; share of five largest banks declined from 85 percent at end-2008 to 68 percent.
- Drivers of elevated spreads:
  - High spreads driven predominantly by overheads and provisions (2007–14 decomposition).
  - Profit margins mostly negative.
  - Competition compressed spreads on new lending to levels threatening survival of some smaller banks with higher funding and operating costs.
- Policy advice:
  - Discouraged from imposing lending rate caps and from increasing number of banks without sound business plans and robust capital.
  - Suggested broader structural reform agenda to improve economic flexibility and promote diversification.
- Macroprudential recommendations:
  - Vest the macroprudential mandate in CBM; identify instruments (loan-to-value, debt-service-to-income, debt-to-income ratios, capital buffers) even if not immediately activated.
  - FSC to retain financial stability mandate and expand to issue public macroprudential recommendations; CBM to continue chairing FSC.

### RESOLUTION, FAILURE MITIGATION, DEPOSIT INSURANCE, ELA
- Failure mitigation and resolution:
  - CBM authorized to impose wide early intervention measures; but lacks certain resolution powers (e.g., establish a bridge bank; explicit power to recapitalize and temporarily fund a systemically important bank absent private-sector-funded resolution).
  - Draft lex specialis envisages some powers for systemic crisis but uncertainty complicates planning.
  - Recommendation: start bank-specific resolution planning, establish small full-time Resolution Unit within CBM, prioritize based on CAMEL ratings.
- Resolution funding:
  - Strengthen existing resolution funding powers and arrangements.
  - DPF should be able to finance transfer of insured deposits via P&A and have powers to assist; MOF should have statutory authority in lex specialis to borrow/use budgetary means up to specified limit with ex post parliamentary accountability.
  - Specific recommendations on DPF and MOF contingent financing and MOUs.
- Deposit insurance operational reforms:
  - DPF operates under narrow “pay box” mandate; recommended to amend DPL to enable financing P&A, electronic payments to deposit accounts in other banks, interim/advanced payments, shorten payout from 15 working days to 7, and introduce risk-based premiums.
- Emergency Liquidity Assistance (ELA):
  - CBM cannot create money; limited resources constrain LOLR ability in system-wide shock.
  - Recommendations: bring ELA provisions under CBM Law and lex specialis into single emergency liquidity framework; develop internal list of acceptable collateral with pricing/haircut methodologies; consider MOF subaccount at CBM for ELA; put in place MOF reimbursement arrangements for CBM ELA losses.
  - Suggested ELA safeguards: objective solvency test, cap CBM fund for ELA, require letters of comfort from parents of foreign-owned banks, prohibit upstreaming and require intensive supervision while receiving assistance, temporary beyond-intraday drawdown of reserve requirements for illiquid but solvent banks.

### NPL RESOLUTION AND INSOLVENCY FRAMEWORK
- NPL characterization and risks:
  - NPLs remain a difficult legacy from crisis and lax pre-crisis lending standards.
  - If not reduced, NPLs will continue to burden banks’ balance sheets, undermine profits and capital, and suppress appetite for new lending.
- Structural impediments:
  - Bulk of NPLs backed by real estate collateral; weak real estate market and banks’ unwillingness/inability to absorb losses are key impediments.
  - Absence of sound estimates for provisioning shortfalls relative to actual losses impedes policy formulation.
- Insolvency and creditor rights recommendations:
  - Amend Law on Voluntary Restructuring of Debts to broaden eligibility to debtors in serious distress or insolvency.
  - Complement out-of-court restructuring with fast-track court confirmation procedure binding on all creditors to limit holdouts.
  - Amend/clarify Law on Consumer Bankruptcy through regulation to ensure safeguards for secured creditors’ rights (concern over potential radical exemption for debtor’s house).

### KEY FIGURES, INDICATORS, AND SELECTED PROJECTIONS (preserve exact values)
- NPLs on banks’ books: EUR 397 million.
- NPLs sold predominantly to parent banks and affiliated SPVs: about EUR 720 million.
- Aggregate tier I capital ratio: about 14 percent.
- CAR: close to 16 percent (regulatory minimum 10 percent); range highest 33 percent, lowest 10 percent.
- Aggregate ROA (June 2015): 0.5 percent; aggregate ROE (June 2015): 3.4 percent.
- Overhead expenses-to-core income ratio (June 2015): 76 percent; five banks above 100 percent.
- Aggregate LCR: 863 percent.
- Aggregate NSFR: 124 percent.
- Loans in foreign currencies (June 2015): EUR 171 million (7.6 percent of total loans).
- Deposits in foreign currencies (June 2015): EUR 152 million (6.3 percent of total deposits).
- Cost to one foreign-owned bank subsidiary from CHF-to-euro conversion law: about EUR 9 million (28 percent of its capital).
- Highway project size: 23.5 percent of 2014 GDP.
- General government financing needs averaging nearly 10 percent of GDP during 2016–20.
- Projection highlights (selected):
  - Nominal GDP (millions of euro series): 3,125; 3,265; 3,181; 3,362; 3,458; 3,635; 3,839; 3,988; 4,151; 4,312; 4,549.
  - Real GDP (percent change series): 2.5; 3.2; -2.7; 3.5; 1.8; 3.9; 4.6; 2.5; 2.5; 2.2; 3.8.
  - Overall balance (percent of GDP series): -4.9; -6.7; -5.8; -6.3; -2.6; -8.2; -8.5; -8.2; -4.2; -1.5; -0.7.
  - General government gross debt series: 40.7; 45.6; 53.4; 55.2; 59.9; 67.3; 70.4; 76.0; 77.4; 76.4; 73.4.
  - External debt (end of period, stock series): 141.6; 145.0; 155.9; 151.5; 154.8; 161.5; 164.8; 172.2; 174.6; 175.0; 171.9.
- Appendix financial soundness indicators (selected, percent):
  - Total capital to risk-weighted assets: 16.0 (Sep-15).
  - NPL to total loans: 14.7 (Sep-15).
  - Provisions to NPL (IFRS impairments): 46.2 (Sep-15); ratio based on CBM regulatory provisions was 72.6 percent as of end-June 2015.
  - Return on assets: 0.4 (Sep-15).
  - Liquid assets to total assets: 28.5 (Sep-15).

*Prepared from: EXECUTIVE SUMMARY, MACROFINANCIAL SETTING, FINANCIAL SYSTEM RESILIENCE, and related sections of the provided source content.*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 6

### _cr1688 - EXECUTIVE SUMMARY ___________________________________________________________________________ 6

### EXECUTIVE SUMMARY
- Post-2008 collapse of the lending boom left large stock of nonperforming loans (NPLs), weakened bank profitability, and a sustained contraction in credit.
- Legacy of pre-crisis rapid increase in indebtedness adds to banking sector vulnerability and hampers NPL resolution.
- Economic momentum accelerated in 2015, driven by investment-led activity including the highway project, but downside risks remain.
- System-wide solvency and liquidity indicators appear broadly sound, but significant pockets of vulnerabilities exist among domestically owned banks.
- Several domestically owned banks have very high NPLs and/or very low provisioning levels; some received qualified audited reports. Stress tests indicate vulnerability to shocks, including protracted slowdown, even under the moderate stress scenario.
- Increasing competition and slow recovery compress interest rate spreads, threatening survival of some smaller banks with higher funding and operating costs.
- Recommended immediate actions: independent Asset Quality Review (AQR) for all banks; time-bound supervisory action plans including capital injections by shareholders; CBM to prepare bank-specific resolution planning.
- Bank and insurance legal, regulatory, and supervisory frameworks improved since 2006 FSAP, but further progress needed: strengthen identification, measurement, and management of NPLs; focus on operational risks; introduce consolidated supervision; amend Law on Consumer Bankruptcy; move insurance oversight to risk-based supervision and gradual Solvency II implementation.

### FINANCIAL SAFETY NET AND LIQUIDITY MANAGEMENT
- CBM should be confirmed as resolution authority for supervised institutions and be granted essential resolution powers (e.g., establish a bridge bank).
- Deposit Protection Fund (DPF) should be authorized to fund resolution measures and integrated into crisis preparedness.
- A credible and transparent public backstop is needed for systemic cases absent private-sector-funded resolution.
- Emergency liquidity assistance should be under a single framework following best international practice.
- Euroization limits CBM options to manage liquidity and provide support; sound liquidity risk management standards should be prioritized in preparation for Basel III.
- Macroprudential framework should be established, made fully operational over time, and the macroprudential mandate vested in the CBM. Financial Stability Council (FSC) should have expanded powers to issue macroprudential recommendations.

### MACROFINANCIAL SETTING
- Crisis legacy: balance sheet weaknesses and bank deleveraging have hampered growth.
- Pre-crisis policy actions: by late 2007 CBM tightened asset classification and provisioning (later relaxed), raised CAR by 2 percentage points to 10 percent; early 2008 introduced temporary bank-specific ceilings on credit growth and increased RR on certain deposits; late 2008 government guaranteed all bank private deposits.
- Credit developments:
  - After almost seven years of near uninterrupted contraction, lending to the private sector increased by 2.3 percent in 2015.
  - Households expanded by 2.7 percent in 2015.
  - Corporate sector expanded by 2.2 percent in 2015.
  - Gross loans to households and the corporate sector have contracted by 10.5 percent and 34 percent of GDP, respectively, since their pre-crisis peak in 2008.
- Growth drivers and risks:
  - Highway project equals 23.5 percent of 2014 GDP and should boost growth near- and medium-term, but exacerbates public debt vulnerabilities.
  - Large general government financing needs averaging nearly 10 percent of GDP during 2016–20 are an important macroeconomic risk.
  - Narrow production base, rigid labor market, and rapidly rising public debt constrain policy space.

### FINANCIAL SYSTEM RESILIENCE
- Structure and concentration:
  - Banks account for about 90 percent of system assets.
  - Banking assets equivalent to about 93 percent of GDP as of June 2015.
  - 14 banks operate in Montenegro (up from 11 in 2013).
  - Foreign subsidiaries hold 79 percent of the sector’s assets.
  - Lending composition: trade sector and households each represent about 38 percent of total loans.
  - Loans to nonresidents represent 18 percent of total loans.
- Notable vulnerabilities:
  - Pockets of high NPLs and low provisioning concentrate among domestically owned banks.
  - Cross-border exposures remain notable and warrant strengthened cross-border supervisory and resolution arrangements.
- Payment and settlement systems:
  - CBM-managed payment and settlement systems are generally efficient.
  - Suggested adjustments to minimize residual liquidity risks, e.g., facilitating automatic transfer of balances from reserves account to settlement account.
  - CBM oversight function should be strengthened via an oversight policy framework and improved interdepartmental communication and information exchange.

### FSAP KEY RECOMMENDATIONS (selected; authority and term preserved)
- Prepare and implement time-bound supervisory action plans for vulnerable banks (CBM; ¶17). Term: I
- Conduct an Asset Quality Review for all banks to determine adequacy of provisions (CBM; ¶18). Term: I
- Introduce a macroprudential mandate and establish policies and toolkit consistent with EU/ESRB framework (MOF/CBM/FSC; ¶38). Term: MT
- Introduce effective consolidated supervision (CBM; ¶44). Term: NT
- Improve regulatory and supervisory framework for liquidity and credit risks (CBM; ¶40, ¶45). Term: I
- Tighten prudential norms for identification, classification, and reclassification of nonperforming assets (CBM; ¶46). Term: NT
- Adopt risk-based supervision (ISA; ¶50). Term: I
- Incrementally implement Solvency II (ISA; ¶51). Term: NT
- Strengthen CBM’s oversight function over FMI (CBM; ¶52). Term: NT
- Implement risk mitigation measures to minimize liquidity risks in the RTGS system and eliminate possibility of partial unwinding in the DNS system (CBM; ¶54). Term: I
- Finalize national risk assessment and action plan for AML/CFT (CBM; ¶55). Term: NT
- Strengthen voluntary debt-restructuring framework (MOF; ¶61). Term: I
- Amend personal bankruptcy regime to clarify creditors’ rights for loans secured by mortgages (MOF; ¶62). Term: I
- Set strict and objective criteria for systemic importance to determine eligibility for capital support (CBM/MOF; ¶72). Term: NT
- Strengthen resolution-funding options (MOF; ¶71). Term: NT
- Organize a dedicated resolution unit within the CBM and initiate bank-specific resolution planning, prioritizing weakest CAMEL-rated banks (CBM; ¶65, ¶70). Term: I
- Implement risk-based contributions and shorten payout term for DPF (DPF/MOF; ¶74). Term: NT
- Streamline ELA policies and strengthen safeguards to protect CBM’s financial autonomy (CBM/MOF; ¶76, ¶77, ¶78). Term: NT
- Strengthen FSC’s focus on crisis preparedness and management to complement financial stability mandate (FSC; ¶64). Term: I

*Prepared from: EXECUTIVE SUMMARY, MACROFINANCIAL SETTING, and FINANCIAL SYSTEM RESILIENCE sections of the source content.*

### 6.      The insurance sector grew steadily at an average annual rate of 3 percent in the past

### _cr1688 - 6.      The insurance sector grew steadily at an average annual rate of 3 percent in the past

### Insurance sector and nonbank financial system
- Insurance sector:
  - Grew steadily at an average annual rate of 3 percent in the past five years.
  - Total premium remains at 2 percent of GDP.
  - Life insurance sector: 6 life insurers collected EUR 12 million in premiums in 2014, insuring less than 10 percent of the population.
  - Non-life sector is predominantly compulsory motor third-party liability insurance.
  - Nine of the 11 insurers are foreign subsidiaries, writing 95 percent of total premiums.
  - At end-2014, CAR stood at 735 percent for life and 170 percent for non-life insurers; solvency margins were calculated on a Solvency I type of fixed factors, without taking into account the risk profiles of the assets or liabilities.

- Other nonbank financial institutions:
  - Nascent stock exchange has significant market capitalization but very low turnover.
  - Bond market is thin.
  - Total asset size of the five micro-credit institutions (MCIs) is 2 percent of GDP.
  - Leasing market is small and declining since the crisis.

### Financial soundness — asset quality, provisioning, and balance-sheet repair
- Crisis impact and NPLs:
  - The financial crisis triggered prolonged balance sheet deleveraging and a nearly uninterrupted credit contraction.
  - Sector NPLs were 14.7 percent of total loans in September 2015, down from 25.3 percent in mid-2011.
  - NPL ratios vary among banks from 5.5 percent to 35 percent.
  - Regulatory provisions were slightly above 70 percent of reported NPLs—having increased slowly since 2010–11.
  - Excluding special purpose vehicles (SPVs) established by some foreign-owned banks in Montenegro; SPVs are owned, consolidated, and supervised by the parent banks.
  - Note: The NPL ratio had declined to 14.75 percent as of end-September 2015.

- Corporate and household indebtedness:
  - Corporate sector indebtedness decreased from 2008 only by 11.2 percentage points of GDP to 114.5 percent as of 2014.
  - Assuming long-term NPLs that are fully provisioned are extended to entities that are no longer operational, the level of indebtedness would decrease by 6.5 percent of GDP to 108 percent.
  - Household domestic liabilities have declined by about 15 percent relative to the pre-crisis peak.

- Lending conditions and credit demand:
  - Overall lending conditions remain tight; credit growth has been sluggish despite declining lending rates.
  - High NPL levels indicate rigidities in the NPL resolution framework and tightened credit risk management in many banks.
  - Weak credit demand is an important factor.

### Capitalization, profitability, liquidity, and funding structure
- Capitalization:
  - Aggregate tier I capital ratio is about 14 percent, with the CAR at close to 16 percent, compared to the regulatory minimum of 10 percent.
  - Wide differences: highest CAR being 33 percent and the lowest 10 percent.
  - Some banks could have CARs close to or below the regulatory minimum after provisioning adjustments (as assumed in the stress test).

- Profitability and efficiency:
  - Aggregate return on assets (ROA) was 0.5 percent and return on equity (ROE) 3.4 percent in June 2015.
  - Interest rate spreads on new loans have declined significantly.
  - Overhead expenses-to-core income ratio was 76 percent for the sector in June 2015, with five banks above 100 percent.
  - Domestically owned banks have weaker profitability and higher operating and funding costs than foreign-owned banks.
    - At end-2014, aggregate ROA was 0.8 percent: about zero for domestically owned banks and about 1.1 percent for foreign-owned banks.
    - Overhead costs-to-core income ratio was about 75 percent for the banking sector, with over 90 percent for domestically owned banks and about 70 percent for others.

- Liquidity and funding:
  - Banks have reduced the loan-to-deposit (LTD) ratio since the crisis to just above 100 percent, with wide heterogeneity across banks.
  - Share of liquidity held with the CBM above required reserves is high.
  - Banks’ aggregate liquidity coverage ratio (LCR) is 863 percent.
  - Aggregate net stable funding ratio (NSFR) is 124 percent, with two banks below 100 percent; when deposit outflows are assumed, up to seven banks fall below the 100 percent NSFR threshold.
  - Some banks hold a high share of liquidity in foreign-government securities and in EU banks.

- Foreign exchange exposure:
  - As of June 2015, loans in foreign currencies amounted to EUR 171 million (7.6 percent of total loans); deposits in foreign currencies amounted to EUR 152 million (6.3 percent of total deposits).
  - The recently adopted law on conversion of Swiss franc into euro-denominated loans imposes significant costs on one foreign-owned bank subsidiary (total cost about EUR 9 million, 28 percent of its capital).

### Ownership, cross-border exposures, and interconnectedness
- Ownership and cross-border positions:
  - Nine of 11 insurers are foreign subsidiaries; banks show significant foreign ownership.
  - Banks’ foreign claims and liabilities account for over 115 percent and 50 percent of total regulatory capital, respectively, as of end-2014.
  - On average, about 20 percent of deposits belong to nonresidents; over a quarter of nonresident deposits are from Russia.
  - Domestic interconnectedness among banks is limited: gross claims and liabilities of the banking sector to nonbanks averaged about 2 percent of total assets; domestic interbank transaction volume is 0.2 percent of banking sector total assets.

- Concentration:
  - Average largest exposure in the system remains below 25 percent of regulatory capital, but some banks have single-debtor exposures above the threshold.
  - Default of the largest net exposures would cause a total capital shortfall of 0.3 percent of GDP; default of the five largest exposures would cause capital shortfalls of 3.2 percent of GDP.

### Supervisory concerns, remedial actions, and policy recommendations
- Recognized weaknesses and supervisory actions:
  - Progress to address the debt overhang has been slow due to weak real estate market, banks’ unwillingness to recognize losses, and gaps in the debt-resolution framework.
  - Some banks show indications of inadequate provisioning; external auditors issued qualified opinions related to inadequate provisioning for several banks in 2013 and 2014 that have not been addressed.
  - Supervisors lack proper tools to challenge banks’ real estate collateral valuations.

- Recommended supervisory and resolution measures:
  - Weaker banks should be subject to more intensive supervision and not be allowed to expand by collecting costly deposits.
  - The CBM should adopt bank-specific, time-bound supervisory action plans, including requiring additional capital to cover actual and anticipated losses.
  - In the absence of timely compliance, banks should be resolved on a least-cost basis to avoid market distortions and higher resolution costs.
  - An independent asset quality review (AQR) of banks is needed to estimate the extent of inadequate provisioning and to inform subsequent supervisory action.

### Stress tests, scenarios, and tail risks
- Stress testing framework and broad results:
  - Top-down solvency, liquidity, and contagion risk stress tests were conducted for the 12 banks active at end-2014.
  - Tests were coordinated between the mission and CBM staff using supervisory and bank-submitted data.
  - Tests indicate capital shortfalls in the banking system could be significant in adverse scenarios.
  - Short-term liquidity resilience is strong; longer-term liquidity resilience is weaker and vulnerabilities to elevated funding costs are high.

- Provisioning adjustments and capital needs:
  - Strong indications of inadequate NPL provisioning were found in four banks; for three banks external auditors issued qualified opinions for end-2014 financial statements.
  - Parallel solvency stress tests with adjusted capital adequacy found one bank insolvent before any stress was applied and would require a capital injection of 0.7 percent of GDP to reach the minimum regulatory capital requirement.

- Macroeconomic scenarios applied (one-year):
  - Baseline: IMF staff projections as of August 2015.
  - Adverse scenario 1 (moderate): economic contraction driven by reduced external demand (protracted euro area slowdown and deterioration in Russia); moderate scenario growth projection of -2.5 percent mimics growth in 2012 (EU contracted by -0.5 percent).
  - Adverse scenario 2 (severe): includes adverse scenario 1 shocks plus significant financial market deterioration, reduced investments, elevated funding costs; GDP projected to fall by 5.2 percent (equal to two standard deviations from the historical mean).

- Estimated losses and vulnerabilities:
  - Potential loan losses due to credit risk were estimated to range from 1.2 percent to 4.8 percent of GDP in the moderate and severe adverse scenarios, respectively.
  - Top-down stress tests suggest potential system-wide capital shortfalls could be 1.0 percent of GDP in adverse scenario 1 and 3.5 percent of GDP in adverse scenario 2 after provisioning adjustments.
  - Funding risk: banks could largely cover deposit outflows using cash and liquid assets, but profitability would be impaired even by relatively small deposit rate increases; high share of nonresident deposits increases vulnerability.
  - Market risk: average holdings of fixed income, equities, and real estate equal 3 percent of total assets, but some banks have above 15 percent—creating vulnerability to volatility in credit spreads, equities, and real estate prices.
  - Foreign exchange risk is limited.
  - Loan concentration and potential default of top exposures could generate capital shortfalls (0.3 percent of GDP for largest net exposure; 3.2 percent for five largest exposures).

- Liquidity stress-test outcomes:
  - Aggregate LCR: 863 percent — ample short-term liquidity resilience.
  - Aggregate NSFR: 124 percent — lower long-term resilience with some banks below 100 percent.

- Contagion and external shock channels:
  - A large shock to a country where Montenegro banks have significant exposures could have direct and indirect spillovers; indirect impact can be large due to interconnectedness with countries that have direct exposures to Montenegro.
  - Potential impact of geopolitical events in Ukraine appeared manageable.

*Source: IMF staff report excerpt (Montenegro).*

### 31.      The authorities suggested that weak credit growth and high lending rates are due to

### _cr1688 - 31.      The authorities suggested that weak credit growth and high lending rates are due to

### Causes of weak credit growth and high lending rates
- Authorities' view: banks’ excessive risk aversion and insufficient competition in the banking sector.
- Authorities' actions under consideration or taken:
  - The CBM has looked favorably at applications for new bank licenses.
  - The authorities are also considering imposing lending rate caps to spur credit growth.

### Assessment of competition in the banking sector
- Mission finding: competition in the banking sector not weak, evidenced partly by low concentration and persistent weak profitability.
- Concentration and market power indicators:
  - Herfindahl–Hirschman Index (HHI) was about 0.12 for assets, deposits, and loans at end-2014.
  - The share of the five largest banks declined from 85 percent at end-2008 to 68 percent.

### Drivers of high interest rate spreads
- Staff analysis: banks’ high interest rate spreads are mainly driven by costs.
- Decomposition findings for 2007–14:
  - Spreads on outstanding loans are driven predominantly by overheads and provisions.
  - Profit margins are mostly negative.
- Competitive dynamics:
  - Competition has compressed spreads on new lending to levels threatening the survival of some smaller banks with higher funding and operating costs and a weaker client base.
- Anecdotal pressures:
  - Cost pressures on the funding side, coupled with declining lending rates in the fight for a few good clients, are driving some banks into a high-danger zone.

### Policy advice on lending rate caps and bank entry
- Authorities were discouraged from:
  - Introducing caps on lending rates.
  - Increasing the number of banks without a sound business plan and robust capital base.
- Reasons:
  - Introducing caps may further restrict credit to small- and medium-size enterprises and consumers and lead to undesirable mispricing of risks.
  - International experience suggests interest rate caps have a limited effect on supporting lending while having a negative impact on financial access.
  - Increasing the number of banks without solid business plans and strong capital may lead to costly market disruptions.

### Structural contributors to elevated lending rates
- Factors identified as contributing to elevated lending rates and higher risk aversion:
  - High cost of long-term funding (reflected in high sovereign yields).
  - A sluggish economy.
  - Overall high indebtedness and associated high credit risks.
  - Low rate of recovery on NPLs and other structural rigidities in the economy.
- Additional pressures:
  - Significant competition from foreign intermediaries that directly finance investment.
  - Limited bankable investment opportunities.
- Suggested response: a broader structural reform agenda to improve economic flexibility (including in labor markets) and promote diversification through strengthened competitiveness.

### Financial oversight — macroprudential framework
- Current situation:
  - Responsibilities for financial stability have been assigned, but macroprudential policies or instruments are missing.
  - The CBM has a financial stability objective but lacks the toolkit for mitigating systemic imbalances.
  - The FSC aims to monitor, identify, prevent, and mitigate systemic risks, but lacks a macroprudential toolkit or enabling clause authorizing the CBM to introduce macroprudential tools.
- Recommendation:
  - Vest the macroprudential mandate in the CBM, building on existing regulatory and supervisory powers and including powers over macroprudential instruments.
  - Identify instruments (loan-to-value, debt-service-to-income, debt-to-income ratios, capital buffers) even if not immediately activated.
  - FSC to retain mandate over financial stability, expanded to issue recommendations on macroprudential policy, with recommendations made public.
  - CBM to continue chairing the FSC and perform technical operations.

### Systemic liquidity management
- Constraint: systemic liquidity management is constrained by euroization; CBM cannot create money.
- Implications:
  - High liquidity buffers and strong bank supervision are essential.
- Observations on liquidity:
  - Since 2012, banks’ transactional non-interest-bearing balances have increased from 60 percent of required reserves to 80 percent.
  - A low euro interest environment and sluggish credit demand have increased idle balances with the CBM, weighing on banks’ profitability.
- Regulatory advice:
  - Complement Basel III work with regulatory liquidity ratios to strengthen short-term resilience.
  - Address shortcomings in liquidity ratio design: shallow and illiquid government bond market; limited HQLA; difficulty in assessing stressed outflows due to limited data.
  - Strengthen liquidity risk supervision by focusing on significant currencies, dynamic and structural maturity mismatches, and feasibility of contingency plans, particularly for domestically owned banks.
  - Consider removing treasury bills from the list of eligible securities to meet RRs as the market for government securities is illiquid.

### Banking oversight — supervision and prudential framework
- Progress: laws, regulations, and supervision improved since the 2006 FSAP to align more closely with Basel and EU requirements; CBM adopts a risk-based approach.
- Key supervisory recommendations and findings:
  - Adopt a more conservative approach to evaluation of business plans and issuance of new licenses; three new banks were established in the past year.
  - Consolidated supervision is narrowly defined and applied; focus currently on accounting and reporting rather than group-wide risks; prudential ratios are not calculated on a consolidated basis.
  - Company law does not recognize the concept of a ‘holding company’; recognition would facilitate consolidated supervision.
  - Weaknesses in the operating environment dilute credit risk management and CBM’s supervisory effectiveness (unreliable borrowers’ audited financial statements; inability to independently verify connectedness among counterparties; difficulty in quality evaluation and timely disposal of collateral).
  - Prudential framework for identification and measurement of problem assets is conservative in some respects but has significant gaps leading to inaccurate presentation of NPLs and weak enforcement.
  - CBM’s implementation of prudential limits for related-party transactions and large exposures is weak:
    - Aggregate limit for all related-party exposures is 200 percent of own funds.
    - This compares to a level of 25 percent under the Basel Core Principles (BCP).
    - Significant gaps in definitions of “related party” and “related-party transactions.”
    - Recommendation to expand supervision to address concentration risks, including sector concentration and concentration through collateral.
  - Need for banks to improve governance for risk management and for CBM to address concentration of outsourcing, provide guidance on operational, concentration, funding, and interest rate risk in the banking book, and develop methodologies to supervise these risks.
  - Gaps in measurement of capital and RWA:
    - Framework does not require banks to deduct deferred tax assets and significant investment in the equity of restructured borrowers.
    - Allows fixed asset revaluation reserve at full value without being discounted.
    - Assigns a lower risk weight to nonperforming assets and exposures secured by commercial real estate.

### Insurance oversight
- ISA should transition from compliance-based to risk-based supervision before implementing Solvency II.
- Minimum actions recommended for ISA:
  - Introduce guidelines on corporate governance and requirements on risk management and internal controls.
  - Ensure offsite supervision includes assessments of business risks, effectiveness of risk management policy, and adequacy of capital.
  - Develop a transition strategy to gradually introduce Solvency II with a phased approach.
  - Improve existing solvency regime before Solvency II by:
    - Establishing asset valuation rules for solvency purposes, including treatment of intangible assets, encumbered assets, and provisions for long-outstanding receivables and doubtful debts.
    - Introducing an aggregate limit on investments in and loans to related entities for solvency purposes.
    - Adopting scenario testing to analyze financial resilience in predetermined scenarios as an interim tool to identify vulnerabilities.

### Financial market infrastructure oversight
- Steps since 2006 FSAP are generally conducive, but further improvements needed.
- Recommendations:
  - Strengthen CBM oversight with an oversight policy framework consistent with the Payment System Law and international standards (public policy objectives, CBM standards, scope, activities, tools, and cooperation mechanisms).
  - Implement risk-mitigation measures in CBM payment system (RTGS and DNS):
    - Define priorities for payment orders that could lead to immediate rejection if balances insufficient.
    - Facilitate automatic transfer of balances from reserves account to settlement account for pending transactions.
    - Automate intraday liquidity facility on a collateralized basis.
    - Eliminate partial unwinding of transactions in the DNS system (especially in the final settlement cycle).

### Anti–Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- Progress:
  - Montenegro is taking active steps to enhance AML/CFT framework and understand ML/TF risks.
  - The most recent assessment in 2014 found significant deficiencies.
  - New AML/CFT law rescinded previous versions and strengthened CDD obligations (verification of person acting on behalf of corporate customer) and allowed simplified CDD in instances of “insignificant” ML/TF risk and no suspicion of ML/TF.
  - Practical steps to improve suspicious transaction reporting and to initiate a national ML/TF risk assessment.
- Remaining significant deficiencies:
  - Scope of reporting requirements remains narrow (refers to “transactions” rather than “funds”; “suspicion of ML/TF” rather than “suspicions of funds that are the proceeds of a criminal activity”).
  - Beneficial ownership information of legal persons created in Montenegro does not appear accessible to competent authorities in a timely manner.
  - Beneficial ownership information collected by reporting entities appears inadequate.
  - Enhanced due-diligence measures insufficient:
    - Reporting entities are not required to establish on a risk basis the source of wealth of beneficial owners identified as domestic politically exposed persons (PEPs).
  - No provisions to prevent criminals or their associates from holding or being beneficial owners of a significant or controlling interest, or from holding senior management functions in certain financial sector institutions.
  - These deficiencies and other significant vulnerabilities identified in the national risk assessment should be addressed as a matter of priority.

### Resolution of nonperforming loans (NPLs)
- NPLs characterization:
  - NPLs remain a difficult legacy reflecting the impact of the global financial crisis and subsequent economic slowdown as well as lax pre-crisis lending standards.
- Risks of inaction:
  - If not reduced, NPLs will continue to burden banks’ balance sheets, undermine profits and capital, and suppress banks’ appetite for new lending.
- Structural impediments to NPL reduction:
  - The bulk of NPLs are backed by real estate collateral; the state of the real estate market and some banks’ inability and unwillingness to absorb losses are key impediments.
  - 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.

*IMF staff summary based on the specified content unit.*

### 55.      Regulatory standards have been loosened over the past several years. This should be

### _cr1688 - 55.      Regulatory standards have been loosened over the past several years. This should be

### Nonperforming Loans (NPLs) and Regulatory Standards
- Finding: Regulatory standards have been loosened over the past several years; this should be reversed in accordance with recently strengthened supervisory requirements.
- Actions taken: The CBM has introduced a requirement for banks to prepare a multi-year NPL resolution strategy, including annual operational targets and quarterly reporting against those targets.
- Recommendations:
  - Strengthen regulatory standards and enforcement to establish loss provisions that better reflect expected losses.
  - Where appropriate, require banks to raise additional capital to support these provisions and to create headroom to absorb losses associated with future NPL workouts and write-offs.
  - Establish a specialized team within the Supervision Department to support relationship managers and their teams and to supervise NPL management practices in all banks; this team would be distinct from staff responsible for individual bank relationship management and for supervising the credit risk management function.
  - Consider requiring banks to separate certain NPLs into specialized workout subsidiaries to improve management of transferred NPLs by enabling focused value recovery and independent governance.
- Data and reporting:
  - In addition to the EUR 397 million NPLs on banks’ books, about EUR 720 million has been sold predominantly to parent banks and affiliated SPVs.
  - Recommendation: Make reporting of these exposures to the credit registry mandatory to enhance CBM monitoring of NPL dynamics comprehensively.

### Insolvency and Creditor Rights
- Findings:
  - Legal framework governing bankruptcy is comprehensive and security rights are adequately protected in liquidation, but variability exists in speed and quality of court enforcement.
  - Business rescue culture is not developed; reorganization "workouts" are not common and most bankruptcy cases end in liquidation.
  - Land titling procedures and cadastral information have improved but gaps remain, especially in rural areas.
- Recommendations:
  - Amend the Law on Voluntary Restructuring of Debts to broaden eligibility to loans involving debtors in serious financial distress or insolvency.
  - Complement out-of-court debt-restructuring with a fast-track procedure to confirm workout plans approved by a legally defined majority of creditors, making plans obligatory for all creditors to encourage participation and limit holdouts.
  - Amend or clarify the recent Law on Consumer Bankruptcy through regulation to ensure adequate safeguards for secured creditors’ rights.
    - Concern: The law may establish—depending on interpretation—a radical exemption in favor of a bankrupt debtor’s house, which cannot be sold in bankruptcy, provided it is “commensurate with the basic housing needs of the consumer.” If applied to loans secured by mortgages created before the law’s entry into force, most of those loans would be considered unsecured and collection hampered.
    - Recommendation (footnote): Authorities should clarify through regulation that the law excludes the debtor’s house from sale upon insolvency if the house is not subject to a mortgage or other security right.

### Financial Safety Net — Institutional Arrangements
- Findings:
  - The Financial Stability Council (FSC) establishment and activities are welcome, but several inter-agency Memoranda of Understanding (MOUs) have not been updated since the FSC’s establishment.
  - Overlapping scopes with the FSC Law and absence of MOUs between several institutions raise questions about framework efficiency.
  - The DPF should be an FSC member; currently, the DPF does not get invited to FSC meetings, while the FSC Law does permit this.
  - FSC members should have formal authority to send representatives to meetings to avoid hampering FSC functioning during temporary absences.
- Contingency planning:
  - The FSC adopted the national contingency plan (NCP) to complement institution-specific plans but focuses more on systemic risk monitoring than crisis preparedness and management.
  - Progress toward NCP implementation is rarely discussed by the FSC; no system-wide crisis simulation exercise involving all FSC members and the DPF has been organized.
  - None of the oversight agencies have formal cross-border arrangements with home resolution authorities, and no cross-border crisis management framework is in place.
- Recommendation:
  - Confirm the CBM as the resolution authority for institutions under its supervision; given banking sector size, no new resolution authority is needed.
  - If CBM becomes supervisor of other financial institutions under forthcoming legislation, it should also be the resolution authority for them.
  - Establish a dedicated full-time, small Resolution Unit within the CBM with ready access to resources and a reporting line to the CBM Board separate from the emergency liquidity assistance and Supervision Departments.

### Failure Mitigation Regime
- Authority and tools:
  - The CBM is authorized to impose a wide variety of early intervention measures, including scaling down or ceasing certain operations, establishing adequate reserves for losses, selling assets, restricting or ceasing dividends, increasing capital, and removing executive directors or board members.
  - CBM requires banks to undertake contingency planning for capital and liquidity restoration in stress; banks must prepare liquidity contingency plans and capital plans updated annually.
- Recommendation:
  - While full recovery plans per the EU BRRD/EBA guidance are not yet necessary, current contingency planning requirements should be enforced and evaluated as part of individual bank supervision.

### Failure Resolution Regime
- Current powers and gaps:
  - The CBM can appoint an Interim Administrator (IA) with powers to resolve potentially failing banks, including selling assets and transferring assets and liabilities to another bank; outcomes include recapitalization, transfers, or bankruptcy.
  - Certain desirable resolution powers are not available, including establishing a bridge bank and the explicit power to recapitalize and temporarily fund a systemically important bank in the absence of private-sector-funded resolution.
  - Draft special legislation (the “lex specialis”) envisions some powers for a systemic crisis, but uncertainty about availability complicates resolution planning.
- Recommendations:
  - CBM should immediately start bank-specific resolution planning, including resolvability assessments, executed by the Resolution Unit and prioritized based on banks’ CAMEL ratings and coordinated with home authorities without being dependent on them.
  - If structural impediments to resolvability are identified, CBM should consider using powers under the Banking Law to cause banks to remedy those impediments.
- Resolution funding:
  - Existing resolution funding powers and arrangements are limited and should be strengthened; liquidity and capital support provisions are insufficient.
  - The lex specialis, if adopted, should provide tools (for example, ability to establish a bridge bank) and strong liquidity and capital support provisions with related safeguards.
  - The Deposit Protection Fund (DPF) should be able to finance the transfer of insured deposits to another bank through purchase and assumption (P&A).
  - The Ministry of Finance (MOF) should have statutory authority in the lex specialis to borrow and/or use budgetary means up to a specified limit without requiring ex ante parliamentary approval, though with ex post parliamentary accountability.
  - The MOF could establish a fee-paid (committed) contingent credit line with a reputable foreign bank or an international financial institution.
- Specific procedural recommendations (footnotes consolidated):
  - The amount of DPF assistance should be restricted to costs DPF would have incurred in a payout of insured deposits in liquidation, net of recoveries.
  - DPF should sign an MOU with the MOF to address backup finance from the budget and guarantees for DPF borrowing to cover any shortfall.
  - The MOF has authority to establish contingent lines of credit with two local banks but does not have them in place and they could be unavailable in a crisis.

- Legal and policy guidance on public funding:
  - Rules for use of public funding in a crisis should be clearly defined: shareholders and hybrid capital and subordinated debt holders should fully absorb losses; shareholders should be fully written off prior to government capital support.
  - Introduce the objective to follow a least-cost resolution method explicitly into law.
  - CBM and MOF should adopt explicit policies with strict, objective, quantifiable, and measurable criteria to determine systemic importance warranting public support.
  - Any loss from public funds should be recovered from the banking industry.
  - Provision of public funds should be contingent on, or followed by, formulation of a restructuring plan ensuring long-term viability.

### Deposit Insurance
- Assessment:
  - The deposit insurance system is relatively well developed but needs operational improvements.
  - The DPF operates under a narrow “pay box” mandate.
  - Level of funding by banks is sufficient to cover all insured deposits in all small banks; a standby credit line with the EBRD and a statutory provision for government backup funding are available.
- Recommendations:
  - Amend the Deposit Protection Law (DPL) to enable the DPF to finance P&A transfers of insured deposits to another bank.
  - Allow the DPF to use other payout options: electronic payments to deposit accounts established by depositors in other banks, and interim or advanced payments in case of prolonged delays.
  - Shorten payout timeframe from 15 working days to 7.
  - Introduce risk-based premiums.

### Liquidity Support and Emergency Liquidity Assistance (ELA)
- Constraints and findings:
  - Limited resources to finance ELA constrain the CBM’s lender-of-last-resort (LOLR) ability; CBM cannot create money and would need to provide assistance from its capital.
  - With limited resources, CBM cannot be expected to act effectively as LOLR in a system-wide liquidity shock.
  - Historical note: in 2009 foreign banks facing liquidity outflows obtained assistance from parents, but such credit lines may not be available again.
- Recommendations:
  - Bring ELA provisions under the CBM Law and the lex specialis into a single formalized emergency liquidity support framework, incorporating best international practices (eligible collateral, pricing, haircuts) and essential safeguards (e.g., prohibition on financial transactions between receiving banks and related parties).
  - Develop an internal list of acceptable collateral with pricing and haircut methodologies and build capacity to administer such assets; the internal list might include residential mortgages and corporate loans.
  - Consider alternative options to expand ELA funding envelope, including a dedicated MOF subaccount at the CBM for ELA that the CBM could use at its discretion in addition to its own limited resources.
  - Put arrangements in place for the MOF to reimburse the CBM for losses stemming from ELA.
- Safeguards for ELA:
  - Banks must exhaust all existing sources of liquidity before accessing CBM ELA.
  - Further safeguards could include:
    1. Requiring an objective, predetermined solvency test both at the start and during the duration of ELA.
    2. Capping use of the CBM’s fund for ELA and implementing measures to reimburse the CBM for its ELA-related losses.
    3. Requiring foreign-owned banks’ parents to present a letter of comfort to provide liquidity in times of stress.
    4. Prescribing safeguards for ELA use by the receiving bank and enhancing monitoring to minimize moral hazard (for example, prohibit upstreaming of funds from foreign subsidiaries/branches to their parents during assistance; impose more intensive supervision while receiving assistance).
    5. Allowing banks to draw down required reserves at the CBM below the minimum requirement for a short period.
  - Current arrangement note: CBM allows banks to draw down up to 50 percent of reserve requirement on an intraday basis; reserve requirements must be met by end of day. Recommendation refers to a temporary, beyond-intraday drawdown of reserve requirements—applicable only to illiquid but solvent banks seeking ELA—to relieve liquidity pressure and reduce need for CBM funding.

### Key numeric and fiscal indicators and projections (selected figures from projections and balance sheets)
- NPLs on banks’ books: EUR 397 million.
- NPLs sold predominantly to parent banks and affiliated SPVs: about EUR 720 million.
- Payout timeframe recommendation for DPF: shorten from 15 working days to 7.
- CBM intraday drawdown current practice: up to 50 percent of reserve requirement on an intraday basis.
- Timeline reference: transposition of the BRRD by 2017 is planned (section context).
- Projection table highlights (selected entries as reported):
  - Nominal GDP (millions of euro): 3,125; 3,265; 3,181; 3,362; 3,458; 3,635; 3,839; 3,988; 4,151; 4,312; 4,549.
  - Gross national saving (percent of GDP): -1.0 1.8 2.1 5.1 4.6 9.7 8.5 8.4 5.1 6.7 8.5.
  - Gross investment (percent of GDP): 21.8 19.3 20.6 19.6 19.8 25.4 28.0 28.2 24.4 22.0 21.3.
  - Real GDP (percent change): 2.5 3.2 -2.7 3.5 1.8 3.9 4.6 2.5 2.5 2.2 3.8.
  - Consumer prices (period average): 0.7 3.1 3.6 2.2 -0.7 1.6 1.0 1.3 1.6 1.7 1.7.
  - Overall balance (percent of GDP): -4.9 -6.7 -5.8 -6.3 -2.6 -8.2 -8.5 -8.2 -4.2 -1.5 -0.7.
  - General government gross debt: 40.7 45.6 53.4 55.2 59.9 67.3 70.4 76.0 77.4 76.4 73.4.
  - Current account balance: -22.7 -17.6 -18.5 -14.5 -15.2 -15.8 -19.5 -19.9 -19.3 -15.3 -12.8.
  - External debt (end of period, stock): 141.6 145.0 155.9 151.5 154.8 161.5 164.8 172.2 174.6 175.0 171.9.
  - Of which: Private sector external debt: 112.5 112.4 115.2 111.3 109.6 109.0 108.4 109.6 110.5 111.6 111.0.
- Memorandum:
  - Nominal GDP Growth (in percent): 4.8 4.5 -2.6 5.7 2.8 5.1 5.6 3.9 4.1 3.9 5.5.
  - Aluminum price (€ per tonne): 1,644 1,822 1,542 1,348 1,514 1,514 1,441 1,479 1,524 1,555 1,574.

*Source: IMF staff report as contained in the provided PDF content.*

### Appendix Table 1. Montenegro: Selected Economic Indicators, 2010–20

### Appendix Table 1. Montenegro: Selected Economic Indicators, 2010–20

### Financial system structure (Appendix Table 2)
- Number of banks: 11 (2010), 11 (2011), 11 (2012), 11 (2013), 12 (2014), 14 (2015) 1/
- Domestic-majority owned banks: 2 (2010), 2 (2011), 2 (2012), 2 (2013), 5 (2014), 5 (2015)
- Domestic private banks: 2, 2, 2, 2, 5, 5 (2010–2015)
- Foreign-majority owned banks: 9 (2010), 9 (2011), 9 (2012), 9 (2013), 7 (2014), 7 (2015)
- Subsidiaries of foreign banks: 6 (2010–2015)
- Insurance companies: 11 (total); Life: 6; Non-life: 5
- Leasing companies: 4 (2010), 5 (2011), 5 (2012), 5 (2013), 5 (2014)
- Investment funds (asset management companies): 5; Open-ended funds: 5; Closed-end funds: 5
- Investment intermediaries: 10
- Microcredit organizations: 5 (2010), 6 (2011), 6 (2012), 6 (2013), 5 (2014), 5 (2015)
- Stock exchanges: 1; Central depository agency: 1
- Voluntary pension fund management companies: 2; Voluntary pension funds: 2
- Financial system assets (EUR millions, banks): 2,943.7 (2010), 2,810 (2011), 2,808 (2012), 2,959 (2013), 3,136 (2014), 3,139 (2015)
  - Domestic-majority owned (EUR millions): 341.4 (2010), 289 (2011), 280 (2012), 289 (2013), 646 (2014), 3653 (2015) [preserve exact text as in source]
  - Foreign-majority owned (EUR millions): 2,602.3 (2010), 2,520 (2011), 2,528 (2012), 2,670 (2013), 2,494 (2014), 2,486 (2015)
  - Subsidiaries of foreign banks (EUR millions): 2,271.7 (2010), 2,163 (2011), 2,127 (2012), 2,180 (2013), 2,201 (2014), 2,164 (2015)
  - 5 largest banks (EUR millions): 2,262.7 (2010), 2,073 (2011), 2,030 (2012), 2,082 (2013), 2,139 (2014), 2,132 (2015)
- Leasing companies assets: 203.3 (2010), 171 (2011), 143 (2012), 118 (2013), 76 (2014), 73 (2015)
- Microcredit organizations: 58.7 (2010), 44 (2011), 36 (2012), 35 (2013), 38 (2014), 41 (2015)
- Total assets (memo): 3,580
- Source: CBM. 1/ Latest available.

### Financial soundness indicators (Appendix Table 3, percent; 2009–Sep-15)
- Capital adequacy
  - Total capital to risk-weighted assets: 15.8 (2009), 15.9 (2010), 16.5 (2011), 14.7 (2012), 14.4 (2013), 16.2 (2014), 16.0 (Sep-15)
  - Tier I capital to risk-weighted assets: 15.5 (2009), 15.5 (2010), 15.1 (2011), 15.8 (2012), 13.0 (2013), 14.4 (2014)
  - Total capital to total assets: 11.0 (2009), 10.6 (2010), 10.9 (2011), 10.3 (2012), 13.4 (2013), 14.2 (2014), 13.3 (Sep-15)
- Asset quality
  - NPL to total loans: 13.5 (2009), 21.0 (2010), 15.5 (2011), 17.6 (2012), 18.4 (2013), 16.8 (2014), 14.7 (Sep-15)
  - Provisions to NPL (IFRS impairments): 46.3 (2009), 30.7 (2010), 32.8 (2011), 40.2 (2012), 44.7 (2013), 45.6 (2014), 46.2 (Sep-15)
  - NPL net of provisions to Tier I capital: 59.5 (2009), 115.8 (2010), 71.8 (2011), 77.1 (2012), 101.9 (2013), 77.9 (2014)
  - NPL net of provisions to capital: 52.5 (2009), 102.8 (2010), 66.9 (2011), 68.0 (2012), 62.4 (2013), 49.3 (2014), 43.7 (Sep-15)
  - Top 10 borrowers to Tier I capital: 97.9 (2009), 130.0 (2010), 116.2 (2011), 227.5 (2012), 180.6 (2013), 156.3 (2014)
  - 10 largest credit to net credits: 15.5 (2009), 17.1 (2010), 18.0 (2011), 17.3 (2012), 21.9 (2013), 21.7 (2014)
- Earnings and profitability
  - Return on assets: -0.7 (2009), -2.8 (2010), -0.1 (2011), -2.0 (2012), 0.1 (2013), 0.8 (2014), 0.4 (Sep-15)
  - Return on equity: -7.8 (2009), -27.3 (2010), -1.1 (2011), -18.3 (2012), 0.5 (2013), 5.4 (2014), 2.9 (Sep-15)
  - Net interest margin: 4.9 (2009), 4.9 (2010), 4.8 (2011), 5.0 (2012), 4.2 (2013), 4.5 (2014), 3.4 (Sep-15)
  - Non-interest expenses to gross income: 67.1 (2009), 93.0 (2010), 73.6 (2011), 90.3 (2012), 69.9 (2013), 65.9 (2014)
- Liquidity ratios
  - Liquid assets to total assets: 15.3 (2009), 19.1 (2010), 19.9 (2011), 24.0 (2012), 20.0 (2013), 22.2 (2014), 28.5 (Sep-15)
  - Liquid assets to short-term liabilities: 25.8 (2009), 32.9 (2010), 32.8 (2011), 40.1 (2012), 32.2 (2013), 35.7 (2014), 44.3 (Sep-15)
  - Foreign currency loans to total loans: 4.0 (2009), 4.1 (2010), 2.3 (2011), 1.9 (2012), 3.9 (2013), 3.9 (2014)
  - Foreign currency liabilities to total liabilities: 6.4 (2009), 6.9 (2010), 4.9 (2011), 4.8 (2012), 4.3 (2013), 4.7 (2014)
- Sensitivity to market risk
  - Net long position in foreign exchange to Tier I capital: 0.7 (2009), 0.8 (2010), 1.0 (2011), -0.8 (2012), 0.6 (2013), 0.7 (2014)
- Note: Provisions reflect IFRS impairments. The ratios based on CBM regulatory provisions are higher; the respective ratio was 72.6 percent as of end-June 2015.
- Source: CBM.

### Banking system assets, End-September 2015 (Appendix Table 4; EUR million and % total)
- Bank-level assets (EUR million; % total)
  - Atlas Banka AD: 271.5; 8.4
  - Crnogorska Komercijalna Banka AD: 599.2; 18.6
  - Erste Bank AD Podgorica: 361.7; 11.2
  - Hipotekarna Banka AD: 416.7; 13.0
  - Hypo Alpe-Adria Bank AD: 238.6; 7.4
  - Invest Banka Montenegro AD Podgorica: 46.6; 1.4
  - Komercijalna Banka AD Budva: 124.8; 3.9
  - Lovcen Banka AD: 44.3; 1.4
  - NLB Montenegrobanka AD: 493.3; 15.3
  - Prva Banka CG AD Podgorica: 310.3; 9.6
  - Societe Generale Banka Montenegro AD: 437.2; 13.6
  - Universal Capital Bank AD Podgorica: 97.9; 3.0
  - Zapad Banka AD Podgorica: 34.9; 1.1
  - Ziraat Bank Montenegro AD: 10.2; 0.3
- Total: 3,487.2; 100.0
- Memo items:
  - Assets Domestic-Majority Owned Banks: 770.5; 22.1
    - o/w Public Participation: 356.9; 10.2
  - Assets Foreign-Majority Owned Banks: 2,716.6; 77.9
- Source: CBM.

### Summary of banking system loan portfolio, End-2014 (Appendix Table 5)
- Gross loans and share of total loans; Non-performing loans (NPL) and % of total loans
  - Household loans, residents: Gross loans 880; % of total loans 36.7; Non-performing loans 292; % of total loans 3.8 (preserve original spacing/text)
  - Corporate loans, residents: Gross loans 989; % of total loans 41.3; Non-performing loans 284; % of total loans 11.9
    - Agriculture, forestry and fishing: 28; 1.2; 20.1
    - Manufacturing: 109; 4.5; 54; 2.2
    - Wholesale and retail trade, repair of motor vehicles and motorcycles: 407; 17.0; 120; 5.0
    - Construction: 111; 4.6; 43; 1.8
    - Transport and warehousing: 49; 2.1; 19; 0.8
    - Accommodation, food, arts, recreation and other services: 73; 3.1; 15; 0.6
    - Public administration and defense: 13; 1.5; 12; 0.5
    - Real estate: 2; 41.0; 50.2 (preserve exact source text)
    - Financial and insurance sector: 16; 0.7; 20.1
    - Professional, scientific and technical activities: 40; 1.7; 12; 0.5
  - Loans to non-residents: 434; 18.1; 120; 5.0
  - Other loans: 94; 3.9; 14; 0.6
  - Total: 2,396; 100.0; Non-performing loans total: 402; 16.8
- Source: CBM.

### Risk Assessment Matrix (Appendix Table 6) — Overall level of concern and expected impacts
- 1. Protracted growth slowdown in the euro area and neighboring countries
  - Staff assessment: High (G-RAM, June 2015)
  - Expected impact: High
    - Adverse impact on external demand and internal demand combined with further “lowflation” imported from the euro area.
    - Credit contraction due to low demand and tightened supply resulting from banks’ risk aversion and foreign subsidiaries’ reduced presence in the Montenegro market.
    - Reduced income among banks’ borrowers, leading to further credit quality deterioration.
- 2. Spillovers from a deterioration of global financial market conditions
  - Staff assessment: High (G-RAM, June 2015)
  - Expected impact: High
    - Government external financing needs average around 9 percent of GDP over 2016–2020; stock of debt is large (nearly 70 percent of GDP) and expected to increase absent policy measures.
    - Triggers: loss of confidence in the economic reform program, tightening of U.S. monetary policy, or general reassessment of risk.
    - Banks raise deposit rates, reducing profitability; banks suffer deposit outflows from nonresident and domestic depositors; reliance on market and foreign-parent funding at elevated interest rates due to lack of an LOLR mechanism.
    - Reduction in external and internal demand plus increased funding costs causes deterioration in borrowers’ credit quality.
- 3. Geopolitical and macroeconomic events associated with Russia/Ukraine tensions and Greece’s negotiations with creditors
  - Staff assessment: Medium (G-RAM, June 2015)
  - Expected impact: Medium
    - Reduction in FDI inflows and growth prospects reduces borrowers’ credit quality.
    - Real estate prices decline due to reduced demand from Russia and Ukraine, causing direct and indirect losses.
    - Direct financial links to Greece are negligible, but secondary channels could affect borrowers’ credit quality.

### Stress Test Matrix (Appendix Tables 7 and following) — Banking sector: solvency, liquidity, contagion
- Scope and data
  - Institutions included: All banks (12 banks) as of end-2014 (100 percent of total banking sector assets by end-2014; 99.7 percent by mid-2015).
  - Data: Bank-by-bank supervisory data as of end-2014; data requested from banks; baseline date Dec 31, 2014 for contagion.
  - Consolidation: Consolidated basis stress test of domestic-owned banks and foreign-owned bank subsidiaries active in Montenegro.
- Methodology and models
  - IMF solvency stress testing balance sheet framework.
  - Satellite models: panel model (fixed effects) estimation of logit-transformed bank-specific NPL ratios using up to eight quarterly lags; insufficient significance led to using global rules-of-thumb sensitivities of credit losses to GDP growth.
  - Peer group analysis compared projected NPL ratios to FSAP stress tests in neighboring countries and CBM internal models.
  - Expert judgment used to estimate pre-impairment income sensitivities.
- Stress test horizon: 1-year horizon.
- Scenarios and shocks
  - Baseline: IMF’s macroeconomic projections as of August 2015.
  - Moderate adverse scenario: real GDP growth of -2.5 percent; gross credit growth of -3 percentage points of GDP; funding cost of banks rise by 1.6 percent; general interest rates decrease by 60 basis points; domestic-sovereign bond, foreign-sovereign bond, and corporate bond credit spreads increase by 4.4, 1.3, and 4.7 percentage points, respectively; stock prices fall by 22 percent; real estate prices fall by 10 percent.
  - Severe adverse scenario: real GDP growth of -5.2 percent; gross credit growth of -6 percentage points of GDP; funding cost of banks rises by 3.1 percent; general interest rates decrease by 120 basis points; domestic-sovereign bond, foreign-sovereign bond, and corporate bond credit spreads increase by 8.7, 2.6, and 9.5 percentage points, respectively; stock prices fall by 43 percent; real estate prices fall by 20 percent.
  - Sensitivity analysis: single-factor shocks (haircut on public sector loans and sovereign securities, interest rate hike, exchange rate, equity price decline, real estate price decline); credit concentration risk based on local regulatory standards.
- Risks and buffers assessed
  - Credit risk: household, corporate, public sector loans; domestic-sovereign, foreign-sovereign, corporate bond exposures.
  - Market risk: interest rate risk on net interest income; credit spread risk; FX risk; equity price risk; real estate price risk.
  - Funding risk: Moderate scenario assumed net deposit outflows of 6 percent of domestic deposits and 12 percent of non-resident deposits; severe scenario assumed net outflows of 12 percent of domestic deposits and 23 percent of non-resident deposits.
    - To cover outflows, banks use cash balances and sell liquid assets at haircuts of 15 percent (moderate) and 25 percent (severe).
    - If liquid assets insufficient, domestic banks assumed to meet increased funding cost of 2 and 4 percentage points above the current cost in the two scenarios (approximately a 50 percent and 100 percent increase of the country risk premium).
    - Foreign-owned banks assumed to fund uncovered outflows at half the cost using parent bank funding.
  - Operational risk: Losses set at twice (moderate) and three times (severe) the 2014 level.
- Behavioral adjustments and assumptions
  - Evolution of total assets and liabilities reflected behavioral assumptions to counter deposit outflows.
  - Evolution of risk-weighted assets based on constant balance sheet assumption, adjusting projected RWA by loan loss provisions at a 100 percent risk weight.
  - No other management actions considered.
  - Other net income items, dividends, and taxes evolve in line with economic activity measured as gross credit growth.
- Regulatory and reporting parameters
  - Estimation of expected credit losses using global rules of thumb.
  - Regulatory standard: Basel II; hurdle rates based on local regulatory minimum capital adequacy ratio (CAR) of 10 percent.
  - Output: CAR and capital shortfall under the 10 percent and a 12 percent hurdle rate; system-wide sum of gross capital shortfall (without offsetting); contribution of each source of losses to aggregate capital shortfall.
- Liquidity risk specifics
  - Methodology informed by Basel III LCR setup (short-term) and NSFR setup (long-term).
  - Tail shocks: haircuts and runoff rates as defined in Basel III for LCR and NSFR; additional deposit outflows as in severe adverse scenario; exclusion of required central bank reserves; exclusion of government bonds from HQLA.
  - Regulatory proxies: LCR proxy should exceed 100 percent (not legal requirement); NSFR proxy should exceed 100 percent (not legal requirement).
  - Output: Aggregate LCR and NSFR proxies; aggregate gross liquidity shortfalls (without offsetting); number of banks that fail.
- Contagion risk specifics
  - Institutions included for contagion: All banks (12), 4 insurance companies, 6 investment funds, 1 microcredit institution, 46 other financial institutions (100 percent of sector assets).
  - Methodology: Network analysis using Espinosa-Vega and Solé (2010) methodology.
  - Tail shocks: credit shock (default on all liabilities to domestic institutions or foreign banks); joint credit and funding shock leading to liquidity squeeze for funded institutions.
  - Output: Capital impairment to domestic banking system, number of failed banks, remaining buffers (system and bank level); capital impairment to domestic insurance sector, number of failed insurance companies, remaining buffers (sector and company level).

*Source: IMF staff compilation from CBM and FSAP materials included in the provided content.*

### Appendix II. Progress on 2006 FSAP Recommendations

### Appendix II. Progress on 2006 FSAP Recommendations

### Managing Growing Credit Risk
- Study and evaluate banks’ risk management systems and practices, with a view to identifying best practices and weaknesses.
  - Status: Partially implemented. As a part of the supervision system, the supervisors perform periodic evaluations of banks’ credit risk management system and practices. The supervisory findings are yet to be utilized for disseminating best practices.
- Tailor remedial actions on a bank-by-bank basis.
  - Status: Implemented. The measures against banks are determined depending on the specifics and the risk profile of each individual bank.
- Periodically review the prudential framework to determine potential weaknesses and identify appropriate responses, including bank-specific supplementary capital adequacy levels, provisioning requirements, and assets’ risk weights.
  - Status: Partially implemented. A periodic review of the prudential framework is performed, and the determined weaknesses were corrected through the amendments to the regulation, especially through the adoption of the new Decision on Capital Adequacy of Banks (2010) and the Decision on Minimum Standards for Credit Risk Management at the Banks. CBCG is yet to establish bank-specific prudential requirements, other than for minimum capital adequacy.

### Public Role in Financial Sector
- Public sector to operate on an arm’s-length basis with financial institutions to improve governance and risk management.
  - Status: Partially implemented. Some banks still have a large share of deposits from state-owned enterprises.

### Liquidity Management Framework
- Use a single required reserve ratio (LT). Use liquidity ratio regulations for prudential purposes while reducing the reserve requirement gradually over time (LT). Remove the option of holding required reserves in treasury bills (ST). Gradually remove the limit of 50 percent on maximum usable reserves (MT).
  - Status: Partially implemented. The liquidity ratios are used for prudential purposes and the reserve requirements were reduced. The Treasury bills were removed as an option to meet the reserve requirements after the FSAP, but were reinstated during the global financial crisis.
- Reference the interest rate on liquidity maintenance credits to the relevant ECB rate (ST). Abolish interest charges for intraday credit and use automatic collateral system (MT).
  - Status: Not implemented. The T-bill rate is benchmark for reference interest rate due to the fact that the CBM does not have one. Collateral system procedure is simplified meanwhile.

### Emergency Liquidity Support
- Establish a systemic crisis management framework and a strategy for emergency liquidity provision.
  - Status: Partially implemented. Law on Financial Stability Council was adopted in 2010 and Contingency Plan has been adopted. Refinements are needed.

### Insurance Regulation and Supervision
- Further study supervisory architecture, taking into account the size of the Montenegro economy and financial sector trends.
  - Status: Implemented. The Insurance Supervision Agency (ISA) has been established as an independent legal person, directly responsible to the parliament.

### Payment Systems
- Prepare and enact a Law on Payment and Settlement Systems covering: irrevocability and timing of settlement finality; legal recognition and protection of netting arrangements; use of collateral pledges and admissibility in court of electronic payment instructions; e-based payment instruments.
  - Status: Implemented. The Payment System Law was passed by the parliament in December 2013 and is harmonized with relevant European directives covering the areas outlined in the 2006 FSAP.
- Start oversight of settlement and clearing systems for electronic payment instruments.
  - Status: Partially implemented. An oversight division has been recently established in the CBM. However, the scope of the oversight function, including oversight over electronic payment instruments, is yet to be established.
- Provide leadership to develop national infrastructure for the electronic payment instruments. Establish technical parameters for sharing e-payments related infrastructure (ATMs, PoS).
  - Status: Partially implemented. The retail payment infrastructure includes a network of interoperable ATMs and PoS terminals, owned by the banks. There have been no CBM-led activities for developing any technical parameters for an interoperable infrastructure, as the existing infrastructure is already interoperable.

### Registries
- Broaden access to credit registry (ST). Include additional information in credit registry to better appraise payment discipline (MT). Include statistics and information needed to implement credit models and scoring systems necessary for Basel II implementation (MT).
  - Status: Partially implemented. The Credit Registry has been significantly improved. However, additional improvements could be made to expand the coverage, granularity, and timeliness of information collected and distributed.
- Take credit registry out of offsite supervision and place it in a separate department in the CBM.
  - Status: Implemented. The Credit Registry has been moved from offsite division to a special organizational unit.
- Charge on cost recovery basis for provision of information and services. Broaden the range of services according to market needs.
  - Status: Partially implemented. Services are charged pursuant to the “Decision on Determining Tariffs for Calculating Fees Charged for the CBM Services.” Initiatives to expand the range of services have not been implemented due to limitations on accessing personal information stemming from legislation (Law on Protection of Personal Data, etc.).
- Study options to establish a centralized registry agency, which would include all existing registries.
  - Status: Partially implemented. Discussions are ongoing to improve the exchange of information between different registries (register of commerce, tax authorities, etc.).

### Capital Markets
- Evaluate consequences and needed changes in legislation, regulation, and infrastructure moving from: (1) a “closed/domestic” market to an open market allowing cross-border membership, etc.; (2) an “all on exchange” regime to allowing off-exchange/OTC trading.
  - Status: Partially implemented. The draft Law on Capital Market contains provisions relating to the establishment of OTC trading, and will be followed by the adoption of bylaws to regulate this area in detail. Adoption of the draft law is scheduled for the fourth quarter of 2015.
- Move both stock exchanges to one common trading platform. Reorganize market/listing structure.
  - Status: Implemented. As of January 1, 2011, Montenegro Stock Exchange Podgorica began operating as a single stock exchange by merging Nex Stock Exchange Podgorica with Montenegro Stock Exchange ad Podgorica.

### EU Convergence
- Establish a catalogue for adapting financial sector legislation and market practices and develop action plans in each area.
  - Status: Implemented. The Government of Montenegro adopted “The Montenegro Accession Program 2014–2018,” a strategic document for the process of Montenegro’s accession to the EU. The program includes a plan for the harmonization of national legislation with the EU acquis, including on the financial sector.

### Legal Framework
- Provide legal protection for the CBM, its officers, staff, and agents against liability for damages caused by such persons in the good faith performance of their duties.
  - Status: Partially implemented. Protection is provided for any liability incurred by staff while carrying out their functions in good faith and in the absence of negligence. However, the legislation is silent on coverage for any omission made by staff while discharging their duties in good faith. Also, the legislation is silent on coverage for the CBM itself.
- Empower supervisors to impose appropriate remedial measures in individual situations.
  - Status: Implemented. The Banking Act provides the CBM with a wide range of powers, including written warning notices, requiring the bank to address irregularities, increase own funds, desist from certain activities, remove a director or member of senior management, sell part of its assets and appoint an interim administrator, and revocation of the banking license.
- Authorize the supervisors to impose monetary penalties directly without having to first obtain court approval.
  - Status: Not implemented. The CBM does not have the power to impose monetary fines for misdemeanors; it must go through the Court of Misdemeanors.
- Creating precedent in judicial handling of criminal cases, including regarding insider trading and other market abuses.
  - Status: Not implemented. Abuse of privileged information and manipulation of the securities market and other financial instruments are defined as criminal offenses by the Criminal Procedure Code of Montenegro. No precedents have been created.

### Appendix Table 8. Montenegro: Macroeconomic Projections for Stress Test (selected indicators)
- Note: Exchange rate is expressed in EUR as the equally weighted average price of USD, GBP, and CHF.
- Real GDP growth (%): 2010 2.5; 2011 3.2; 2012 -2.5; 2013 3.3; 2014 1.5; 2015 3.2; 2015 Proj. (Adverse scenario 1) -2.5; 2015 Proj. (Adverse scenario 2) -5.2
- CPI inflation (%): 2010 0.7; 2011 2.8; 2012 5.1; 2013 0.3; 2014 -0.3; 2015 1.7; 2015 Proj. (Adverse scenario 1) -0.3; 2015 Proj. (Adverse scenario 2) -0.6
- Risk-free interest rate: 2010 1.0; 2011 1.4; 2012 0.2; 2013 0.3; 2014 0.1; 2015 0.1; 2015 Proj. (Adverse scenario 1) -0.5; 2015 Proj. (Adverse scenario 2) -1.1
- Exchange rate 1/: 2010 0.90; 2011 0.93; 2012 0.94; 2013 0.91; 2014 0.98; 2015 1.11; 2015 Proj. (Adverse scenario 1) 1.13; 2015 Proj. (Adverse scenario 2) 1.16
- Stock price index (100 = base): 2010 100; 2011 64; 2012 68; 2013 68; 2014 78; 2015 78; 2015 Proj. (Adverse scenario 1) 61; 2015 Proj. (Adverse scenario 2) 44
- Real estate price index (100 = base): 2010 100; 2011 105; 2012 91; 2013 78; 2014 182; 2015 73; 2015 Proj. (Adverse scenario 1) 65

### Appendix Table 9. Montenegro: Financial Projections for Stress Test (selected indicators)
- Non-performing loans, percent of gross loans:
  - 2010 21.0; 2011 15.5; 2012 17.6; 2013 18.4; 2014 16.8; 2015 16.5; 2015 Proj. (Adverse scenario 1) 19.9; 2015 Proj. (Adverse scenario 2) 27.4
- Credit losses, percent of net loans:
  - 2010 -0.4; 2011 -2.3; 2012 1.9; 2013 3.1; 2014 -0.8; 2015 0.3; 2015 Proj. (Adverse scenario 1) 2.0; 2015 Proj. (Adverse scenario 2) 7.8
- Interest-bearing assets, percent of GDP:
  - 2010 76.3; 2011 (blank); 2012 69.8; 2013 70.1; 2014 66.9; 2015 64.1; 2015 Proj. (Adverse scenario 1) 61.9; 2015 Proj. (Adverse scenario 2) 58.1
- Growth rate of non-interest bearing assets, percent:
  - 2015 Proj. (Adverse scenario 1) 16.0; 2015 Proj. (Adverse scenario 2) -28.7; (another column) -56.7
- Growth rate of open position in equity, percent:
  - 2015 Proj. (Adverse scenario 1) 0.0; 2015 Proj. (Adverse scenario 2) 2.5; (another column) 5.1
- Funding cost, spread above Euribor 3M, percent:
  - 2010 2.3; 2011 1.9; 2012 3.0; 2013 2.3; 2014 1.8; 2015 0.0; 2015 Proj. (Adverse scenario 1) 1.6; 2015 Proj. (Adverse scenario 2) 3.1
- Net outflows of deposits, percent of initial total deposits (severe adverse projections):
  - 2015 Proj. (Adverse scenario 1) 0.0; 2015 Proj. (Adverse scenario 2) 7.3; 2015 Proj. (Adverse scenario 2, severe) 14.7
- Net outflows of non-resident deposits, percent of initial deposits:
  - 2015 Proj. (Adverse scenario 1) 0.0; 2015 Proj. (Adverse scenario 2) 11.5; 2015 Proj. (Adverse scenario 2, severe) 23.0
- Haircut on liquid assets sold to cover deposit outflows, percent:
  - 2015 Proj. (Adverse scenario 1) 0.0; 2015 Proj. (Adverse scenario 2) 15.0; 2015 Proj. (Adverse scenario 2, severe) 25.0
- Spread of domestic sovereign bonds above Euribor 3M, percent:
  - 2010 0.4; 2011 0.5; 2012 3.4; 2013 0.2; 2014 -0.8; 2015 -0.8; 2015 Proj. (Adverse scenario 1) 3.6; 2015 Proj. (Adverse scenario 2) 7.9
- Spread of foreign sovereign bonds above Euribor 3M, percent:
  - 2010 4.0; 2011 4.8; 2012 3.9; 2013 3.4; 2014 2.0; 2015 2.0; 2015 Proj. (Adverse scenario 1) 3.3; 2015 Proj. (Adverse scenario 2) 4.6
- Net fee and commission income, annual change, percent:
  - (series includes) 15.0; -11.9; -16.0; 32.4; 4.1; 0.0; -6.0; -11.9
- Other non-interest income, percent:
  - (series includes) 13.8; 649.5; -46.6; -68.1; -48.2; 0.0; -16.0; -32.0
- Non-interest expense, annual change, percent:
  - (series includes) 2.4; 3.3; 6.2; -102.6; -1.4; 0.0; 8.3; 16.4
- Operational risk losses, annual change:
  - (series includes) 17.2; -70.0; 1501.3; -72.6; 0.0; 105.2; 207.8
- Tax rate, percent: 9.0 repeated across series
- Dividends paid/shares issued, percent of net profits:
  - 2015 Proj. (Adverse scenario 1) 0.0; 2015 Proj. (Adverse scenario 2) 0.0

### Appendix Table 10. Results of the Solvency Stress Test without Provisioning Adjustments (All amounts in millions of euro)
- Before stress, 12/31/2014 (Baseline scenario; in % of GDP shown for many items)
  - Regulatory capital 3159.2
    - Tier 1 capital 2707.9
    - Tier 2 capital 451.3
  - Risk-weighted assets (RWAs) 1,947 (56.9)
  - Total assets 3,136 (91.6)
  - Capital Adequacy Ratio (CAR), percent 16.2
  - Capital shortfall to meet 12 percent CAR 40.1
  - Capital shortfall to meet 10 percent CAR 0.0
  - Capital shortfall to meet 0 percent CAR 0.0
- Stress test losses (selected):
  - Credit risk: Baseline -40.1; Adverse scenario 1 -531.5; Adverse scenario 2 -1855.4
  - Loan loss provisions: Baseline -40.1; Adverse scenario 1 -431.3; Adverse scenario 2 -1664.8
  - Credit spread risk on bond holdings: Adverse scenario 1 -100.3; Adverse scenario 2 -190.6
  - Market and liquidity risk: Baseline 10.0; Adverse scenario 1 -411.2; Adverse scenario 2 -752.2
  - Funding risk: Adverse scenario 1 -320.9; Adverse scenario 2 -561.6
    - of which caused by deposit outflows: Adverse scenario 2 10.0
  - Equity price risk: Adverse scenario 1 -30.1; Adverse scenario 2 -60.2
  - Real estate price risk: Baseline 10.0; Adverse scenario 1 -90.3; Adverse scenario 2 -180.5
  - Other net income: Baseline 421.2; Adverse scenario 1 391.1; Adverse scenario 2 250.7
    - of which are operational risk losses: Baseline -20.1; Adverse scenario 1 -40.1; Adverse scenario 2 -60.2
- After stress, 12/31/2015
  - Regulatory capital: Baseline 3541.0 (in % of GDP 36.1); Adverse scenario 1 2607.6; Adverse scenario 2 802.3
    - Tier 1 capital: Baseline 3099.0; Adverse scenario 1 2146.3; Adverse scenario 2 341.0
    - Tier 2 capital: 451.3 (all scenarios)
  - Risk-weighted assets (RWAs): Baseline 1,957 (57.1); Adverse scenario 1 1,808 (52.8); Adverse scenario 2 1,590 (46.4)
  - Total assets: Baseline 3,157 (92.2); Adverse scenario 1 2,755 (80.4); Adverse scenario 2 2,290 (66.9)
  - Capital Adequacy Ratio (CAR), percent: Baseline 18.1; Adverse scenario 1 14.4; Adverse scenario 2 5.0
  - Capital shortfall to meet 12 percent CAR: Baseline 30.1; Adverse scenario 1 170.5; Adverse scenario 2 1223.6
  - Capital shortfall to meet 10 percent CAR: Baseline 0.0; Adverse scenario 1 50.2; Adverse scenario 2 952.8
  - Capital shortfall to meet 0 percent CAR: Baseline 0.0; Adverse scenario 1 0.0; Adverse scenario 2 100.3

### Appendix Table 11. Results of the Solvency Stress Test with Provisioning Adjustments (All amounts in millions of euro)
- Before stress, 12/31/2014
  - Regulatory capital 2808.2
    - Tier 1 capital 2356.9
    - Tier 2 capital 451.3
  - Risk-weighted assets (RWAs) 1,913 (55.8)
  - Total assets 3,136 (91.6)
  - Capital Adequacy Ratio (CAR), percent 14.7
  - Capital shortfall to meet 12 percent CAR 280.8
  - Capital shortfall to meet 10 percent CAR 240.7
  - Capital shortfall to meet 0 percent CAR 80.2
- Stress test losses (selected):
  - Credit risk: Baseline -40.1; Adverse scenario 1 -521.5; Adverse scenario 2 -1825.3
  - Loan loss provisions: Baseline -40.1; Adverse scenario 1 -431.2; Adverse scenario 2 -1634.8
  - Credit spread risk on bond holdings: Adverse scenario 1 -100.3; Adverse scenario 2 -190.6
  - Market and liquidity risk: Baseline 10.0; Adverse scenario 1 -411.2; Adverse scenario 2 -762.2
  - Funding risk: Adverse scenario 1 -320.9; Adverse scenario 2 -571.7
    - of which caused by deposit outflows: Adverse scenario 2 10.0
  - Equity price risk: Adverse scenario 1 -30.1; Adverse scenario 2 -60.2
  - Real estate price risk: Baseline 10.0; Adverse scenario 1 -90.3; Adverse scenario 2 -180.5
  - Other net income: Baseline 421.2; Adverse scenario 1 391.1; Adverse scenario 2 250.7
    - of which are operational risk losses: Baseline -20.1; Adverse scenario 1 -40.1; Adverse scenario 2 -60.2
- After stress, 12/31/2015
  - Regulatory capital: Baseline 3209.3; Adverse scenario 1 2256.6; Adverse scenario 2 471.4
    - Tier 1 capital: Baseline 2748.0; Adverse scenario 1 1805.3; Adverse scenario 2 20.1
    - Tier 2 capital: 451.3 (all scenarios)
  - Risk-weighted assets (RWAs): Baseline 1,922 (56.1); Adverse scenario 1 1,776 (51.9); Adverse scenario 2 1,562 (45.6)
  - Total assets: Baseline 3,121 (91.1); Adverse scenario 1 2,728 (79.6); Adverse scenario 2 2,269 (66.3)
  - Capital Adequacy Ratio (CAR), percent: Baseline 16.6; Adverse scenario 1 12.7; Adverse scenario 2 3.0
  - Capital shortfall to meet 12 percent CAR: Baseline 270.8; Adverse scenario 1 431.2; Adverse scenario 2 1494.3
  - Capital shortfall to meet 10 percent CAR: Baseline 240.7; Adverse scenario 1 331.0; Adverse scenario 2 1223.5
  - Capital shortfall to meet 0 percent CAR: Baseline 70.2; Adverse scenario 1 150.4; Adverse scenario 2 371.1

### Appendix Table 12. Stress Test Results on Credit Concentration Risk
- Note: Large exposure data was only received for 11 out of 12 banks. For three of the banks, fewer than 10 large exposures were reported.
- Before losses:
  - Regulatory capital ratio (CAR), percent 16.2
  - Capital shortfall to meet 12 percent CAR 44
  - Capital shortfall to meet 10 percent CAR 0
  - Capital shortfall to meet 0 percent CAR 0
- Default of the largest borrower (assumed recovery rate of 70 percent):
  - CAR, percent 15.3
  - Capital shortfall to meet 12 percent CAR 5
  - Capital shortfall to meet 10 percent CAR 1
  - Capital shortfall to meet 0 percent CAR 0
- Default of the largest 5 borrowers (assumed recovery rate of 70 percent):
  - CAR, percent 13.2
  - Capital shortfall to meet 12 percent CAR 19
  - Capital shortfall to meet 10 percent CAR 7
- Default of the largest 10 borrowers (assumed recovery rate of 70 percent):
  - CAR, percent 11.6
  - Capital shortfall to meet 12 percent CAR 43
  - Capital shortfall to meet 10 percent CAR 20
- Assumed recovery rate of 35 percent (selected outcomes):
  - Default of largest borrower: CAR 14.3; Capital shortfall to meet 12 percent CAR 13
  - Default of largest 5 borrowers: CAR 9.4; Capital shortfall to meet 12 percent CAR 75
  - Default of largest 10 borrowers: CAR 5.7; Capital shortfall to meet 12 percent CAR 137
- Assumed recovery rate of 0 percent (selected outcomes):
  - Default of largest borrower: CAR 13.2; Capital shortfall to meet 12 percent CAR 21
  - Default of largest 5 borrowers: CAR 5.3; Capital shortfall to meet 12 percent CAR 114
  - Default of largest 10 borrowers: CAR -1.1; Capital shortfall to meet 12 percent CAR 402; Capital shortfall to meet 10 percent CAR 236

### Appendix Table 13. Stress Test Results on Liquidity (Summary)
- Sources: CBM and IMF staff calculations.
- Notes:
  - 1/ The LCR “implied liquidity shortfall” is the amount of system-wide liquidity needs (in terms of HQLA) so that the LCR of each bank is at least 100 percent.
  - 2/ The NSFR “implied liquidity shortfall” is the amount of system-wide liquidity needs (in terms of ASF) so that the NSFR of each bank is at least 100 percent.
- LCR, standard:
  - Total 86; With domestic sovereign bond Level 2 classification 38; Excluding domestic sovereign bonds 28; Excluding domestic sovereign bonds and required reserves 29; LCR, standard 47; (columns in table: 4 values shown) 4
  - Implied liquidity shortfall /10000 (table shows blank)
  - Number of banks below 100 percent 0 0 0 0
- LCR, assuming outflows in severe adverse scenario:
  - Values shown: 52 55 03 38 22 88 (table formatting shows series 525503382288)
  - Implied liquidity shortfall /10000 (table shows blank)
  - Number of banks below 100 percent 0 0 0 0
- NSFR, standard:
  - Values: 124 123 121 -
  - Implied liquidity shortfall 10 10 10 -
  - Number of banks below 100 percent 2 2 2 -
- NSFR, assuming outflows of deposits in severe adverse scenario:
  - Values: 108 107 105 -
  - Implied liquidity shortfall 95 98 109 -
  - Number of banks below 100 percent 7 7 7 -

*Source: IMF staff calculations.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1688.pdf_