Press Release No. 15/327

Press Release: IMF Executive Board Approves Bosnia and Herzegovina’s 2015 Financial System Stability Assessment

July 9, 2015

On June 29, 2015, the Executive Board of the International Monetary Fund (IMF) discussed the Financial System Stability Assessment of Bosnia and Herzegovina (BiH).¹

The financial system in BiH is dominated by the banking sector. Banks account for about 87 percent of financial system assets, equivalent to 84 percent of GDP. The banking system comprises mostly foreign subsidiaries, constituting more than 80 percent of the banking sector assets. Interconnectedness among banks is limited, but linkages between banks and the insurance sector are significant. The Development Bank of Republika Srpska plays a major role through the provision of credit lines, deposits, and capital to the banking system. Banks have notable cross-border exposures. Insurance companies and other nonbank financial institutions play a small role.

The financial system is still dealing with the aftershocks of the global financial crisis as well as deep-seated vulnerabilities. A high system-wide non-performing loan (NPL) ratio—14 percent at end-2014—reflects the impact of the crisis, low growth since then, and a history of lax lending policies. Bank governance problems, weak supervision powers, related-party loans, and inadequate corporate resolution and insolvency frameworks are obstacles to addressing asset quality problems and re-establishing bank profitability. Credit to private sector continues to grow only very slowly.

Aggregate solvency and liquidity indicators appear broadly sound, but dispersion among banks is wide. Pockets of vulnerability exist within domestically-owned banks, a number of which are struggling to meet capital requirements, while some others rely on public support with undefined exit plans. Stress tests indicate that those banks have high loan concentration risks and low liquidity ratios. A number of insurance companies have thin solvency margins.

Banking and insurance oversight have improved since the 2006 Financial Sector Assessment Program (FSAP), but supervisors’ corrective and enforcement powers are weak and identifying ultimate beneficial owners and related-party lending is problematic. Regulatory and supervisory responsibilities for banking, insurance, and capital markets are fragmented;² although the establishment of the Standing Committee on Financial Stability has improved coordination. Cooperation among the various oversight institutions is complex, having potential repercussions in times of stress. Lack of adequate governance and risk management has contributed to the number of banks that warrant close monitoring. The entity Finance Ministries, together with the Banking agencies, are preparing new Laws on Banks that aims to address a number of deficiencies in supervisory powers, recovery and resolution, and consolidated supervision. Harmonization in regulation between the entities has been largely achieved and joint planning continues. The current insurance prudential framework, which is based on Solvency I, is not risk-sensitive and is ill-suited for supervision as the market develops. The formal assessment of the real-time gross settlement system suggests that many of the principles are observed, but legal and liquidity risks as well as lack of oversight powers are weaknesses. Institutional fragmentation is delaying much-needed financial sector reforms.

There are constraints on the ability of both banks and the central bank to manage liquidity. The legal system under the currency board arrangement rules out a standing liquidity facility and emergency liquidity assistance. The secondary market for government securities is also small and illiquid. Money market and interbank markets are also relatively small. The macroprudential toolkit is relatively underdeveloped, but is being extended to include elements of Basel III.

While the authorities have been working to strengthen the financial safety net, more progress is needed. Important elements of the financial safety net are either missing or not adequately developed. The main deficiencies are the lack of a comprehensive remedial action program, the inadequacy of resolution powers, and the inability to provide temporary emergency liquidity support to soundly capitalized and well managed banks. The deposit insurance agency (DIA) is largely compliant with international standards. Contingency plans were prepared in 2014 by the relevant agencies and a coordinated contingency plan was then developed. The first ever deposit pay-out of the DIA was efficiently started within a month of the liquidation of a small bank last December.

Executive Board Assessment³

Executive Directors concurred with the main findings and recommendations of the second Financial System Stability Assessment (FSSA) for Bosnia and Herzegovina. They noted that while the banking system appears broadly sound, vulnerabilities are concentrated among domestically owned banks. More broadly, Directors emphasized that a stronger financial sector is essential to maintain macroeconomic stability and revitalize economic growth.

Directors stressed the importance of a timely, decisive, and well communicated strategy to deal with weak banks. A credible and transparent backstop for systemic cases should be considered. They also called on the authorities to address promptly the high level of non performing loans by streamlining collateral execution procedures, facilitating corporate debt restructurings and resolution, and adopting out of court restructuring guidelines.

Directors commended the improvements in banking and insurance oversight since the 2006 FSSA, but noted that important shortcomings remain. They encouraged the authorities to enhance cooperation among supervisors, enact new banking legislation to strengthen supervisors’ powers and introduce consolidated supervision, and take further steps to bolster corporate governance and risk management. Directors also recommended monitoring closely thin solvency margins in the insurance sector.

Directors recommended reinforcing the financial safety net by creating an appropriate resolution framework and toolkit. Going forward, they supported the establishment of a financial stability fund, with limited emergency liquidity assistance, for resolution of systemic banks in the context of Bosnia and Herzegovina’s currency board arrangement. Directors noted that well coordinated contingency planning—both domestically and cross border—is essential to building an effective financial safety net. Directors also underscored the importance of improving systemic liquidity management and broadening the macroprudential framework.

Directors welcomed the progress made in enhancing the framework for anti money laundering and combating the financing of terrorism, and called on the authorities to implement their action plan aimed at overcoming remaining deficiencies.

¹ The Financial Sector Assessment Program (FSAP), established in 1999, is a comprehensive and in-depth assessment of a country’s financial sector. FSAPs provide input for Article IV consultations and thus enhance Fund surveillance. FSAPs are mandatory for the 29 jurisdictions with systemically important financial sectors and otherwise conducted upon request from member countries. The key findings of an FSAP are summarized in a Financial System Stability Assessment (FSSA), which is discussed by the IMF Executive Board. In cases where the FSSA is discussed separately from the Article IV consultation, at the conclusion of the discussion, the Chairperson of the Board summarizes the views of Executive Directors and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in a summing up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

² BiH is divided into two semi-autonomous political entities. According to the Constitution, financial oversight lies at the entity level.

³ At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.