Financial System RM vs Different Countries

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2012

ANGAN OLGA FB 10 G

29.11.2012

FINANCIAL SYSTEM IN

REPUBLIC OF MOLDOVA vs

OTHER COUNTRIES



Repub l ic o f Mo ldova

Background

Moldova’s economy grew by an impressive 14 percent cumulatively in 2010–11,

spurred by booming exports and domestic demand, recovering external inflows, and

improved policies. Since January 2010, the authorities’ efforts to restore fiscal,

external, and financial sustainability and promote growth were supported by two

arrangements with the IMF: the Extended Credit Facility and the Extended Fund

Facility, amounting in total to SDR 369.6 million (US$562.5 million at present). Five

reviews have been completed so far, releasing SDR 320 million to support the balance

of payments.

Economic activity slowed markedly in early 2012 due to weakening external

conditions and harsh weather conditions, driving real GDP growth down to 0.8 percent

in 2012 relative to a year ago. The slowdown was reflected in dwindling exports to the

EU and domestic demand in line with weakening remittances. The economy is

expected to pick up in the second half of the year, supported by resilient conditions inthe CIS and investment in infrastructure. However, a severe drought that has hit

Moldova over the summer and a deterioration of conditions in the EU could dampen

this outlook. Twelve-month inflation decelerated to 4.4 percent in August, and is

expected to remain anchored around the National Bank of Moldova (NBM) target of

5 percent during the remainder of 2012 and 2013.

Fiscal consolidation in 2010–11 has been strong, bringing the fiscal deficit down to

2.4 percent of GDP at end-2011. However, revenue shortfalls, due partly to the

slowing economy and partly to increased losses from tax loopholes and collection

problems, and new spending commitments have slowed down fiscal adjustment. The

authorities have implemented corrective measures to safeguard the program’s fiscal

consolidation objective in the context of the fifth program reviews.

Monetary policy was eased aggressively in late 2011 and early 2012 in response to

the rapidly falling inflation, supporting credit growth and thus cushioning the slowing

economic activity.

The banking sector is sound overall. Banks have remained generally liquid, well-

capitalized, and profitable, although their nonperforming loans (NPLs) have risensomewhat as the economy slowed. The euro area debt crisis has had little direct effect

on the financial system owing to limited links with banks in affected countries.

However, risky lending practices and poor governance have significantly weakened

the asset portfolio of the state-controlled Banca de Economii and necessitated a large

increase in provisions. The bank, which accounts for about 13 percent of total assets

in the banking sector, requires urgent measures to repair its balance sheet.



Execut ive Board Assessment

I n concluding the 2012 Article IV consultation with the Republic of Moldova,

Executive Directors endorsed staff’s appraisal, as follows:

Moldova enjoyed vigorous economic growth in 2010–11, supported by appropriate

macroeconomic policies and structural reforms. Implementation of the ECF/EFF-

supported program over that period has been strong.

The economy is slowing down in 2012 due to weakening external conditions, with

serious downside risks. GDP is expected to grow by 3 percent in 2012, and inflation

should settle close to the NBM target of 5 percent. Economic deterioration in the EU

could significantly depress growth. However, with a lower structural fiscal deficit,

improved monetary policy framework, and an overall sound banking sector, Moldova

is in a much better position to withstand shocks than in 2009.

The amended 2012 budget puts fiscal consolidation back on track, while

accommodating cyclical effects and supporting important reforms. Strong corrective

measures have been taken to close tax loopholes and offset unbudgeted expenditure

commitments that emerged in early 2012. Continued improvements in tax and

customs administration, and reforms in the key areas of the pension system,

education, and public administration will be needed to maintain fiscal sustainability in

the medium term as foreign assistance declines.

The current monetary stance is consistent with the NBM’s inflation target, whilethe conduct of monetary policy could be honed further. After the aggressive easing in

early 2012, the financial system has all it currently needs to support credit demand at

advantageous interest rates. Further policy changes could be warranted if the

economic outlook deteriorates or demand-driven inflation pressures re-emerge. To

avoid unnecessary policy volatility, more weight should be given to demand-driven

core inflation trends relative to supply shocks in determining the policy stance and in

communications with the public.

The external position of the economy gives rise to some concerns. The large

current account deficit, rising short-term private debt, and external risks call foraugmentation of the NBM’s international reserves. The real effective exchange rate is

moderately overvalued relative to underlying fundamentals, although it is expected to

self-correct gradually, in light of falling inflation, slowing capital inflows, and a higher

pace of reserve accumulation.

Moldova’s financial system is stable overall, but the deteriorating situation at the

majority state-owned Banca de Economii (BEM) must be promptly addressed. Banks

have generally remained liquid, well-capitalized, and profitable. Swift legislation



amendments to facilitate owner disclosure requirements and introduce fit and proper

criteria for bank managers and board members would further strengthen confidence in

the banking system. However, urgent progress is needed to repair BEM’s balance

sheet and improve its risk management. The new management, the Board of

Directors, and the NBM should ensure that BEM cleans up its portfolio, quickly

disposes of foreclosed collateral, and ends its risky lending practices before seeking

recapitalization.

The authorities’ efforts to improve the business climate and promote exports have

been productive, but important challenges lie ahead. Wide-ranging structural reforms

have enhanced competitiveness and fostered investment. However, further

improvements in several key areas, including protection of property rights, a

transparent and stable policy environment, effective governance, and a reliable

judicial system, are essential to attract investors.

A decisive energy sector reform should finally commence. The authorities shouldpersevere with establishing payment discipline among both households and public

entities, and implement their energy sector restructuring strategy to reduce losses

and resolve historic arrears.

Staff recommends completion of the fifth reviews and approval of the requests for

a waiver of non-observance of the end-March 2012 performance criterion (PC) on the

general government budget deficit and modifications of the end-September 2012 PCs

on the general government budget deficit, the NBM’s net domestic assets, and net

international reserves. Program implementation has been generally good. The

authorities maintain the commitment and the capacity to implement their Fund-

supported program. The slippages in early 2012 have been adequately addressed, and

the policies planned for the remainder of 2012 and beyond, including the requested

new targets, support the program’s objectives. The capacity to repay the Fund

remains strong.

I t a l y Italy's financial system weathered the initial phase of the global credit crisis in 2008-

09 better than those of most other European countries and the US, thanks mainly toItalian banks' traditionally cautious borrowing and lending. Write-downs were

announced by several Italian banks between mid-2007 and early 2009, but these weregenerally smaller than those by US or other large European financial institutions.

According to the Banca d'Italia (the central bank), Italian institutions used fewercomplex credit-risk products than banks in many other countries, and have generallyrelied more heavily on retail deposits and bonds for their funding. Moreover, thecentral bank regards its prudential rules on securitisation and consolidation of off-balance-sheet vehicles as being more conservative than elsewhere. According to Bancad'Italia figures, the ratio of wholesale funding to total outstanding funds at end-2008



was 29%, compared with an average of 41% in the euro area. At end-2009 it was27% in Italy compared with an average of 39.4% in the euro area.

In 2009 Italian banks increased their capital reserves mainly by retaining generatedprofits and raising capital on the markets, rather than through state support. At theend of last year the Tier 1 capital ratio was estimated to be 9% for the entire sector,up from 7.6% at end-2008. This was lower than the average of 11.6% for 12 of thelargest European banking groups, but regular stress testing by the Banca d'Italia hasimplied that the balance sheets of the country's banks remain sufficiently strong tosurvive a period of "unfavourable economic conditions". Investors will be waiting tosee how these results compare to a new round of stress tests currently beingconducted on as many as 100 large financial institutions across Europe by theCommittee of European Banking Supervisors, in a desperate effort by EU policymakersto calm financial market concerns about bank's exposure to rising sovereign debtlevels in the euro zone and EU. It is thought the results of the tests will be publishedon July 15th.

Fee l ing th e p r essure?

Italian banks may have escaped some of the worst effects of the financial turmoil,but they have certainly not been immune, particularly as the crisis triggered a deeprecession in Italy. The level of non-performing loans has increased (albeit from arelatively low level to 4.7% of total bank lending at end-2009), while profits haveshrunk. After falling by 60% in 2008, bank profits declined by a further 15.6% in2009, mainly reflecting a large increase in provisioning for bad loans.

The banking sector will continue to face a more strained business environment,with the prospect of higher funding costs, global regulatory demands to meet tightercapital and liquidity requirements (although recent moves by the G20 suggest a

significant watering-down of earlier proposals) and growing pressure in someEuropean countries to introduce bank levies, transaction taxes or similar measures inorder to build up a fund to finance future bank interventions. The Italian governmenthas underlined its support for tighter regulation and supervision coordinated at the EUlevel or through agreements at international level through bodies such as the G20.

Tensions may also arise as growth disappoints, risking an increase in insolvenciesand loan defaults. After contracting by 5.1% in 2009, the Italian economy is projectedto recover only very sluggishly, expanding by about 0.5% a year in 2010-12 and byabout 1% a year in 2013-14. Moreover, there is a considerable risk of another sharpdip in economic performance over the next year or so, given the likely negative impacton demand of fiscal tightening in Italy, elsewhere in the EU and in the US. Despite the

unprecedented stimulus across the euro area over the past 18 months, there is stillvery little sign of any recovery in employment or money data. Indeed, the latestConference Board leading indicator for the euro area fell 0.5% in May, its first declinein 12 months.

An unavo idab le burden

The trigger is likely to have been rising concerns over levels of debt, both privateand sovereign. There is now a substantial risk of risk of contagion from the Greek



sovereign debt crisis that has spread to several other peripheral euro area countriessince the beginning of 2010. Italy has the second highest government debt in GDPterms in the EU after Greece and the largest debt burden in value terms. At the end of 2009 the stock of Italian public debt amounted to 116% of the country's GDP and one-quarter of total government debt in the euro area. In early May, when the EU and IMFannounced a massive financial support package for Greece, Portugal, Ireland andSpain, Italy appeared to have escaped the worst of the financial market turmoil. But

over the past month markets concerns over Italy's creditworthiness have increased.

Fragile public finances in the EU and concerns about Italy's creditworthiness willaffect the financial system in several ways. For one, it will hurt banks in Italy (andelsewhere) that have large Italian government debt holdings. According to the Bank of International Settlements' June 2010 Quarterly Review, Italian banks have lowexposure to the public sectors in the three countries worst affected by the euro areasovereign debt crisis: Spain, Greece and Portugal. However, the exposure of Italy'stwo main banking groups, Unicredit and Intesa San Paolo, in crisis-hit Hungaryamounts to about Ђ25bn, just under 20% of the total exposure of European banks tothe country's banking system. Exposure to struggling Bulgaria and Romania will also

be of concern.

Moreover, according to the Banca d'Italia, Italian banks have to roll over someЂ800bn in debt by 2012. This means Italian banks will be competing for funds at atime when the Italian state and other cash-strapped governments will be making largedebt issues to meet their financing needs. All this against a backdrop of spreadingfiscal austerity: plans being enacted to address daunting budget deficits across thedeveloped world will continue to weigh on economic growth prospects, restrainingdemand for new loans and challenging borrowers' ability to service existing debts.Italy's financial sector may have weathered the initial deluge, but the storm clouds arestill gathering.

Germay The g loba l f inanc ia l cr is is severe ly a f fected t he Germ an economy ,

especia ll y due t o t he con t r act i on i n w o r ld t rade i n 2008–09 , bu t recen t l y t he

recovery has been s t ron g . Exports initially declined, but have since led the

recovery. Employment was robust in the face of a sharp contraction followed by a

rebound. The fiscal balance deteriorated and the public debt stock jumped due to

financial stability support measures, stimulus measures and cyclical factors. The policy

of the European Central Bank (ECB) allowed interest rates to fall to unprecedentedly

low levels, and also facilitated the availability of liquidity in euros and U.S. dollars.

Germ any ’s f inanc ia l sys tem is com p lex and d ispersed . The banking system is

based on a “three pillar” system (private banks, savings banks and the associated

Landesbanken, and cooperative bank networks) with a relatively high portion of public

banking. The savings bank and cooperative pillars are each bound together through

mutual guarantees, vertical ownership ties, integrated operating systems, the

“regional principle” whereby members do not compete with each other, and legal

restrictions on changing ownership form. The banking sector accounts for the majority



of total financial sector assets, serving as a backbone to the German industry, which is

more reliant on bank financing than that in many other advanced economies. The

smaller banks are domestically oriented, while the major banks, including most apex

organization of cooperative and savings banks, have significant exposures abroad

through branches and subsidiaries, cross-border lending, and market operations, both

in Europe and worldwide. Some German insurance and reinsurance companies are

among the largest in the world. Securities markets are active and wellintegrated into

world markets, and assets under management are large.

The st r uc tu r e o f the system has rema ined b road ly u nchanged over the pas t

decade , w i th som e conso l ida t ion and fo re ign en t r y . Consolidation has continued

in all “pillars,” and some foreign entry has occurred. The privatization of the postal

savings bank reduced the share of government-owned banks, and several of the

Landesbanken were incorporated and/or integrated vertically with Sparkassen from

the respective regions.

Noneth e less , the s t r uc tu r a l i ssues—and indeed t he s tab i l i t y i ssues—

iden t i f ied in the 2003 FSAP rem a in b road ly re levan t . At that time, Germany’s

banking sector and financial system was under strong pressure, but stress tests

suggested that there was no major threat to overall financial stability. Regulation was

assessed to be well-developed, comprehensive, and broadly effective (with the

exception of reinsurance sector). The main recommendations were to (a) enhance

competition and structural development by reducing the rigidity of the “three pillar”

system (with the aim to reform the Landesbanken in particular); (b) increase the

transparency of public banks; and (c) improve specific aspects of the legal framework,

regulation, and, especially, supervision. As summarized in Appendix I, the authorities

have made efforts to enhance supervisory practice. However, the “three pillar” systemand the supporting institutions (such as the mutual guarantees among savings banks

and among cooperatives, respectively, and limits on competition) are largely intact.

Par t s o f Germ any ’s bank ing secto r w ere h i t ha rd du r ing t he f inanc ia l c r is is,

bu t w i t h s t r ong po l i cy suppo r t channe led t h rough excep t i ona l m easu res , t he

cond i t ion o f th e f inanc ia l sec to r h as stab i l i zed . Banks, including some large

banks, suffered market losses and difficult access to, and high costs of financing;

those that were perceived to have lower capitalization or lower quality capital were

most at risk. As the recession deepened, banks exposed to the export sector faced

deteriorating loan quality. Several banks—including certain Landesbanken but also a

major issuer of covered bonds—had to be intervened, at significant costs to the

German taxpayer.

Fo l low ing some in i t ia l ad hoc rescues o f t roub led banks , the au thor i t ies

m oved to a m ore compr ehens ive approach to addr essing th e f inanc ial c r is is. A

new financial stability framework was introduced in October 2008, including the

establishment of the Federal Agency for Financial Market Stabilization (FMSA) to administer

the Special Fund for Financial Market Stabilization (SoFFin). Financial stability support



France



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Financial System RM vs Different Countries