Andorra’s large banking sector (with assets equal to 600 percent of GDP and assets under management—largely off-balance sheet—nearly 23 times the GDP), which is dominated by private banking, is a key feature of the economy. The aim of this paper is to systematically analyze its main features. Building on key stylized facts and cross-country comparisons, the paper discusses the implications of the business model of Andorran banks and the associated vulnerabilities, particularly those related to the reliance on foreign funding, the focus on private banking, and the use of internationalization to grow and remain competitive. These vulnerabilities and the exposure to risks calls for continued vigilance and strong supervision.
Building a stock of international reserve assets for precautionary purposes to cushion against balance of payments risks is especially important for a very open euroized economy. Moreover, Andorra does not have a lender of last resort for its large banking sector with sizeable nonresident deposits. Its reserve assets are currently limited to the reserve tranche position and the SDR holdings at the Fund, which amount to 2 percent of GDP. IMF staff estimate that the government’s liquidity needs are €334 million, equivalent to 12 percent of GDP, assuming that the banks have enough high-quality liquid assets to cover their liquidity needs. The liquidity gap of the government is, thus, 10 percent of GDP, but could be larger if the banking sector has one.