Current Economic Position

In 1994, the central bank introduced a tight monetary policy. It had the effect of stabilizing the economy and growth resumed. Inflation, running at the rate of 1,884 percent in 1994 declined to 32 percent at the end of 1995. The exchange rate also stabilized and has been floating in a narrow range around dram 400 to $1 since mid-1994. The decline in GDP was reversed and growth of approximately 5 percent was recorded in 1994 and 1995. Fiscal policy has also been tightened, reducing the government deficit from 50 percent of GDP in 1994 to less than 10 percent in 1995.

Despite the dramatic improvements, there is little confidence in the banking system, which is undercapitalized and inefficient, and is thus relegated to a marginal role in savings mobilization and intermediation. A large portion of banks’ assets remain nonperforming, reflecting in part previous policies of directed credit. It is in this light of good news and bad news that reforms within the central bank are reviewed.

In May 1992, the IMF identified the issues to be addressed over the ensuing years and provided a structure for reforms to be developed and implemented. The issues, discussed below, are banking legislation, payments systems accounting, the conduct of monetary policy, foreign exchange operations and financial markets, banking regulation and supervision, and organizational issues.

Banking Legislation

The central bank was established in April 1993 on adoption by Parliament of “The Law About the Central Bank of the Republic of Armenia,” and “The Law About the Banking Activities of the Republic of Armenia.” Prior to that date, the National Bank of Armenia faced the challenges of reforming the entire banking system, not only the central bank, without an appropriate underlying legal framework.

The Law About the Central Bank provided the central bank with independence that had previously been lacking, and under that law all reforms to the banking system have been implemented. As a natural consequence of the rapid changes that have taken place in the financial sector, revisions and amendments to the law have become desirable. A revised law on the central bank, which will give clarity to the independent nature of the bank, is now under discussion in Parliament. It will provide greater transparency to the responsibility of the central bank in formulating and implementing monetary policy and emphasize the accountability it has in reporting progress on monetary policy and financial developments to Parliament.

At this stage of the reform process, opportunity is being taken to revise other legislation, which includes the law on banks and banking, the bank insolvency law, the collateral law, and the bankruptcy law. It is expected that all these will be enacted by the end of 1996.

Accounting

In common with other central banks in the region, the central bank and the commercial banking system in Armenia have been based on the Gosbank system. It has been recognized for several years that there was a need to modify accounting methodology, the plan of accounts, and financial statements to conform more closely with the practices in market economies.

Over the last three years, the central bank has been receiving various forms of technical assistance from the IMF, various international organizations, and participating central banks. This has included assistance to introduce the best international accounting practice in both the central bank and commercial banks. In June 1995, an IMF-appointed resident advisor joined the central bank to further assist in this reform process. At the same time, the central bank set up a separate Accounting Project Team comprising eight young qualified staff from various areas of the bank to work with the advisor. These reforms have also included improvements in internal control processes and the setting up of a separate Internal Audit Department at the central bank.

A number of accounting reforms have been introduced at the central bank, and a new chart of accounts is now being implemented to accommodate accounting practices that conform to International Accounting Standards. This chart of accounts is also currently being expanded to handle a similar transition for commercial banks. The central bank’s 1995 accounts have also been subject to external audit by KPMG, an international auditing firm, on the basis of international accounting and auditing standards.

Associated computer software changes have also been necessary to accommodate this move. Development of cost-center and project-tracking codes has also been necessary to meet the needs of internal central bank budgeting and management information. The software changes have been performed by a local software group with assistance from the Bank’s own Automation Department. It has also been necessary to accommodate a broader range of loan and deposit accounts (in foreign and domestic currency) than those just required for central bank operations so that when the chart of accounts is expanded to the commercial banks, the full range of account possibilities can be accommodated.

Necessary changes in underlying computer software cannot be over-stressed. It is critical to the success of the new chart of accounts implementation that computer software development receives top priority. In particular, moving from the traditional single module approach to a range of modules interfacing with the accounting systems, along the lines of international practice, will be necessary.

It has also been necessary to update the existing account definitions and incorporate new definitions for all accounts. This has been developed in both printed form and as personal computer-based “help screens,” so that users can call up old account numbers and view them linked to new chart of account numbers. End-report users have also been identified, and their existing needs will be met from the new chart of account reports. Any requests for new reports have been viewed as later enhancements to the project so as not to inhibit current development.

The development of a spreadsheet approach linking the old chart of accounts’ daily balances (the existing synthetic accounts transactions) to the new chart of accounts format trial balance has facilitated the transition process. This has been a critical tool for preparing end-1995 accounts on an international accounting standards basis, and for parallel running of old and new approaches with the introduction of a new chart of accounts. The central bank has developed an automatic software linkage to present its daily trial balance on both the old and new bases. Extensive ongoing training and discussion across a number of areas of the central bank remains critical to both successful implementation of accounting reform and ongoing improvements in accounting systems generally.

It has been necessary for the central bank’s board to approve a new set of central bank accounting principles that, when fully implemented, will bring it in line with International Accounting Standards insofar as they can be applied to a central bank.

The new accounting principles relate to market valuation of major central bank assets; for example, gold, foreign and domestic securities investments, and fixed assets such as buildings, as well as the central bank loan portfolio. To adopt a current market valuation for loan assets, it has been necessary to write off nonperforming loans as an expense and to set up adequate provision for doubtful loans, which is then deducted from the assets in the annual financial statements. The introduction of accrual accounting, instead of the essentially cash-flow basis, also provides a better measure of accounting performance and is consistent with international practice.

Internal central bank budget procedures, as well as costing of the central bank’s services to clients, were not very sophisticated in the past. For 1996, an internal operating expenditure budget and a separate capital budget have been developed. Because the necessary computer software coding reforms for the new chart of accounts are being implemented during 1996, a fully computerized budget monitoring system, comparing actual outcomes to budget, will not be possible until next year. In the meantime, manual and personal computer-based monitoring systems are being used. Costing of the central bank’s activities to ensure that client services, for example, government banking and cash distribution, are being performed as efficiently as possible is another aspect of management information systems. The computer software changes being introduced will facilitate this process but more work still needs to be done.

The central bank set up a separate Internal Audit Department in late 1995, which now comprises some eight staff, and an Audit Charter has been approved by the central bank. Also, job descriptions and a broad two-year internal audit program based on areas of perceived risk have been finalized and internal audits commenced. Initial emphasis is being given to potential high-risk activities of the central bank such as those related to foreign exchange activities.

Banking Supervision

Between 1991 and 1993, the absence of adequate legislated authority to properly regulate financial markets resulted in an unsatisfactory beginning for private banking in Armenia. Essentially, given this absence of “restrictions,” a permissive atmosphere quickly developed within the industry. The system suffered from low-capital levels, inadequate economic standards, and an underdeveloped supervisory staff to monitor bank activities. Consequently, a number of banks and financial credit organizations were created, primarily, to exploit the adverse economic and social circumstances.

In April 1993, banking legislation was ratified by the Supreme Council of the Republic of Armenia. Unfortunately, the proper role of the central bank was not fully defined for quite some time after that date, and the Law About the Central Bank of the Republic of Armenia was not implemented until after the appointment of the central bank’s board (i.e., early 1994). This law provides for the appointment of the chairman, the first deputy chairman, and the six other members of the board. Two directors are assigned by the government, two by the Supreme Council of the Republic of Armenia, and two by the chairman of the central bank. The chairman and first deputy chairman are appointed for seven years, and the directors for five years.

By January 1, 1994, 58 banks were operating in the republic. The number included formerly state-owned banks that had acquired the status of shareholders’ banks. The market also included 14 branches of foreign banks.

After a tentative start, a strong evolutionary process of supervision began. The central bank has made great strides toward establishing modern banking supervision and regulation in Armenia. Initially, a committee was formed to monitor the banking system, which was followed by release of the central bank’s first banking regulation on required financial standards. These standards included minimum level of statutory capital; the own-funds-to-assets ratio; balance sheet liquidity indices; required reserves to be kept with the central bank; and loan limits to single borrowers.

The departments of supervision, regulation, and licensing were combined, facilitating information sharing between on-site and off-site users of bank data. Significant progress was made toward developing on-site audit and off-site surveillance programs along international guidelines. At the same time, comprehensive training programs were embarked upon. To this end, an IMF resident advisor joined the central bank in February 1995 to generally assist the department in raising the quality of its regulation and supervision activities.

This early activity has been followed and reinforced by new regulations contained in Resolution 78 of April 1995. The resolution established stronger norms closer to international guidelines in respect of the following prudential standards:

• The minimum total capital and statutory capital: banks were required to achieve their minimum statutory capital by January 1, 1996, that is, dram 50 million, plus dram 5 million for every additional branch. They were then obliged to increase their minimum total capital in annual increments up to the equivalent of $1 million expressed in dram by the year 2,000. Total capital is defined as the sum of fixed capital and other funds and reserves.

• The ratio between total capital and assets effective July 1, 1995 was defined as 1:16.67; and effective July 1, 1996, 1:10 (or 6 percent and 10 percent, respectively).

• The ratio between liquid assets and total assets effective July 1, 1995, was defined as 1:5; from January 1, 1996, as 1:3.33; and from July 1, 1996, as 1:2.85 (or 20 percent, 30 percent, and 35 percent, respectively).

• The maximum exposure to a single borrower should not exceed the following percentage of the capital of the bank—effective July 1, 1995, 50 percent; from January 1, 1996, 35 percent; and from July 1, 1996, 20 percent.

Rules in respect of establishment and licensing of banks are being redefined, the professional integrity of managers of newly established banks was highlighted, and the procedures for suspension of banking activities were strengthened.

During 1995–96, the loan portfolios of 40 commercial banks had been examined. The examination led to a greater appreciation of the extent of nonperforming loans within the commercial banks and establishment of a provisioning procedure to cover losses arising from bad loans.

Introduction of the new system of prudential standards has had a significant effect on banks and several have been obliged to cease operating. By the end of 1995, the number of operating banks had been reduced to 35, and foreign branches to 3.

To raise the efficiency of supervision, a new bank reporting form has been designed. This has led to an improvement in the quality of information received by the central bank and a higher level of off-site supervision. An additional improvement in monitoring standards has followed introduction of the American CAMEL rating system.²⁰

Notwithstanding the substantial reforms in bank supervision implemented by the central bank, the commercial banking system is fragile. It is recognized that if Armenian banks are to compete on an equal footing with international banks, now beginning to be established in Armenia, the banks must be strengthened.

During 1995, the central bank hosted a conference of central banks from Transcaucasian and Central Asian countries under the auspices of the Basle Committee. The objective of the conference was to improve communication and liaison within the region on bank supervision through formation of a regional group.

Organization and Structure of the Central Bank

The central bank has been required to undertake significant organizational changes in its transition from a branch of Gosbank to a fully fledged central bank in an emerging economy. The present structure is based on the recommendations of international financial institutions, as well as studies of functional divisions within prominent European central banks. It has also evolved over three years and has been subjected to fine-tuning based on actual experience.

Changes will continue to be made as the bank’s business develops and staff become more experienced and better trained. To this end, independent departments have been periodically reviewed for efficiency and function. During 1994, for example, licensing, supervision, and regulation departments were merged into a single department, and in 1995 international and foreign exchange operations, monetary and credit, and securities departments were brought into closer proximity. This latest organizational change is important, as it brings closer together the three departments concerned with development and implementation of monetary policy.

Along with structural realignments, human resources are also reviewed for efficiency and function. Staff training has a high priority, and full use is taken of training opportunities both in Armenia and abroad, and of technical assistance. In this connection, the Central Bank of Armenia presently has the benefit of three resident IMF advisors specializing in the areas of accounting, bank supervision, and operations. The central bank continues to experience losses of trained staff to the commercial banking sector that is able to offer more attractive salaries. It is recognized that such losses reflect economic changes taking place in Armenia and are inevitable at this stage. These staff moves are, however, of direct benefit to the financial community as a whole, as skills levels in the commercial banking sector are raised.

The Payments System

The central bank has made remarkable progress in developing payment systems, improving interbank settlements, and reducing the time required for settlement transactions. Only two years ago the need for action was urgent. Initially, the central bank helped develop a “banking mail” service between the central bank and the largest commercial banks. This somewhat basic service nevertheless accelerated interbank mail deliveries, providing deliveries between the banks within one to five days. Previously, these transfers may have taken two weeks or more. From this simple beginning has evolved a new payments procedure in the capital city of Yerevan; a new payments procedure for intraregional payments; and a new procedure for interregional payments.

In April 1994, an Interbank Committee on Payments System Development in Armenia was created with industry-wide representation. In April 1995, a specialized Payments System Development Department was created within the main Payments Department of the central bank. It was these two entities that recognized the need to develop an electronic-delivery system in Armenia for the following reasons: inefficiency in paper delivery by post or courier; the inaccessibility of some regions in winter; the need for reliable and rapid final customer payment to increase the monetary efficiency of the economy; and the need to reduce the risks and costs associated with the buildup of float in the payments system.

Inevitably, a countrywide system would require substantial funding and design expertise, which would take time and be difficult to procure. An interim solution was identified using the existing data telecommunication infrastructure, including the government telegraph network. This telegraph e-mail network was used by the central bank and three major banks. The disadvantages of this somewhat rudimentary system became quickly evident and the need for a countrywide, modern, and secure system was reinforced. The lack of a public service provider of such a system obliged the central bank to take the lead in this new project.

As a result, implementation of a new electronic system named CBANET will begin in May 1996 and is forecast to be fully operational by January 1997. The system will provide a primary e-mail application. It will process credit transfers from the outset, with other instruments to be added at a later date; distribute statements of account and other predefined reports; distribute transaction confirmations; and permit transmission of free format files. It will have the capacity for considerable future development that could include real-time gross settlement for high-value transactions; bulk credit transfers; direct debit; credit and debit cards; and automated teller machines (ATMs).

Development of this system has been achieved through the financial and technical assistance of the U.S. Agency for International Development (USAID), (EC-TACIS²¹), and the IMF, coordinated by the Central Bank of Armenia. Ownership of the system remains with the central bank and users are all commercial banks and their branches in Armenia.

A further development of CBANET will be the ability to make cross-border transactions through links with the SWIFT network. A bank association of SWIFT users has been established in Yerevan, and it is anticipated that this service will be implemented in September 1996.

The absence of an appropriate payments system prevents development of the banking system in a market economy. Full implementation in Armenia of CBANET is therefore of great importance to the banking system and is a significant step in the reform process.

Conduct of Monetary Policy

The development and successful implementation of monetary policy is one of the greatest responsibilities of the central bank. The monetary department of the bank must, therefore, have the necessary resources both human and technological to function efficiently. With these criteria in mind, the bank’s organizational structure has undergone several changes and presently the conduct of monetary policy rests on three departments working closely together: the Monetary Policy Department; the Domestic Operations Department, and the Foreign Operations Department. Very recently, the three departments were formally merged.

The Monetary Policy Department has responsibility for the development of monetary policy and economic research, and achieves this through its five divisions: Economic Research; Budget Relations; Balance of Payments and Foreign Exchange Policy; External Debt Service; and Monetary Policy Implementation. All monetary programming, macro-economic analysis, forecasting and reporting, monitoring links with the budget, and monitoring effective use of monetary instruments are concentrated in this department. It maintains close links with the Ministry of Finance to assess budgetary needs. It also prepares reports and recommendations for the Monetary Policy Committee.

The Domestic Operations Department has responsibility for implementing policy within the domestic markets. It does this through its three divisions: Foreign Exchange Domestic Market; Credit Operations; and Securities. Operational activities include the auctioning of central bank credit, the auctioning of treasury bills as agents of the government, and foreign currency interventions at daily foreign currency auctions.

Credit auctions were introduced during 1994 and sales volumes rose from dram 1 billion a month to dram 4 billion at the end of 1995. To be authorized to participate in the closed, uncollateralized auctions, the commercial banks were subject to prior qualification based on prudential standards and approval of the Monetary Policy Committee. Following the introduction of treasury bills and to halt losses incurred by the central bank from nonrepayment of credits, banks were required to provide full collateral from January 1996. Following introduction of this requirement, demand at the credit auction has ceased, attributable in part to insufficient volumes of treasury bills on issue.

Treasury bills of 28- and 91-day maturities were introduced by the Ministry of Finance in September 1995. The central bank acts as agent for the government and manages treasury bill operations. Regular weekly auctions are held with sales of approximately dram 600 million a month being achieved. In an effort to encourage development of the treasury bill market, the central bank announces daily its selling and buying rates for treasury bills. In addition, the central bank is shortly to begin offering to enter into repurchase agreements.

A Lombard-credit window has been approved by the central bank’s board for provision of short-term fully collateralized credit, and will be opened in the near future.

Over the last two years, the central bank has developed the domestic foreign exchange market through supporting the establishment of three foreign exchange auction centers. The auctions have maintained competition, narrowed margins between buying and selling rates, and reduced commission charges on currency trades.

An interbank foreign exchange market was established at the beginning of 1996 as an evolution of the foreign exchange auctions at which banks had come to rely on the central bank to meet their demands rather than seeking currency within the market. The central bank announces daily its buying and selling rates. Interest in this market is growing while declines in the auction turnover are being seen.

The Foreign Operations Department has responsibility for implementing policy within foreign markets. It does this through two divisions: Correspondent Account Management; and Reserves Management. Reserves Management is overseen by the Investment Committee, which meets on a regular basis and receives daily reports from the division.

Central Bank of Armenia—Current State of Reform

From what has been said above, it is evident that the Central Bank of Armenia has made substantial progress over the last two years in adopting a wide range of reform measures. The organization of the bank allows for efficient use of available human resources. The weaknesses in banking legislation have been addressed, and revised laws are expected to be enacted during 1996. The conduct of monetary policy continues to develop in a satisfactory manner. Banking supervision is in place. Accounting reform is well advanced, and implementation of a modern payments system is on schedule for completion in early 1997. There is reason, therefore, for some satisfaction, although not complacency, over progress made in the central bank. Unfortunately, the picture is not uniformly bright, and serious weaknesses remain in the banking system, as mentioned earlier, that must be addressed in the immediate future.

Banking Sector Weaknesses and Priorities for the Future

The problems faced by the banking system are many and invariably serious. For clarity, they may be listed as follows: high levels of nonperforming debt and the need to implement the new provisioning requirements; low levels of capitalization and the need to implement new capital requirements; the need to mobilize domestic savings and build public confidence in banking services; and the need for commercial banks to expand the range of their services and to adopt international standards of accounting. These problems must be addressed under a comprehensive plan for strengthening the banking system.

There are other issues to be addressed that follow on from reforms presently in progress: the need to develop secondary markets that the central bank is finding difficult to do; new legislation will bring new challenges and the judiciary must be trained to handle concepts previously unknown to them; a deposit insurance scheme to protect bank depositors must be established in the not-too-distant future if confidence in banks is to be restored—the views of the IMF on this subject are well known and we appreciate the necessity of strengthening banks first but the need to give some depositors some reassurance remains. This list is not exhaustive but gives a clear picture of what lies ahead and what the priorities must be. Solutions will be costly, difficult, and time-consuming, but if a strong banking system is to be achieved, corrective action must be taken either by the central bank or the commercial banks, separately or together.

The central bank is grateful to the World Bank for recently assessing the situation in the banking system in Armenia. Their proposals are broadly in line with the central bank’s views, and implementation of the first stage, which will include detailed portfolio assessments of all banks and establishment of a pilot work-out program, is imminent.

Analysis of the portfolio assessments results will determine the central bank’s strategy. It should be emphasized, however, that the objective is to strengthen the system and where possible assist banks to grow. There may be clear evidence in some instances that assistance is not warranted, in which case the bank will be allowed to fail or be closed.

The problems of the banking system in Armenia are clear to the central bank and are being addressed. Fortunately, the central bank is now in a stronger position to face them than three years ago. However, it recognizes that the reform process has several years to run before the full benefits of a market economy can be achieved.

The National Bank

The National Bank of the Republic of Belarus (NBB) determines the direction of monetary policy and regulates and supervises banks’ activities. Objective assessment of trends and processes in the monetary sphere directly and in the country’s economy as a whole is of decisive importance in elaborating a successful strategy for monetary policy, its mechanisms, and realization.

During 1995, the economy developed under conditions of contradictory tendencies. On the one hand, many preconditions for macroeconomic stabilization were formed: (1) enterprises continued to adjust to market conditions; (2) the rate of economic decline slowed down and in some industries business activity increased; (3) the rate of inflation slowed down; (4) the state budget deficit declined and was increasingly covered from noninflationary sources; and (5) the trade balance with the Western countries improved.

In addition, several positive tendencies emerged in the monetary sphere: the confidence in the national currency rose; and the share of rubel savings of the population increased. These developments in the monetary sphere were achieved by means of administrative and economic methods in regulating monetary relations. Among them the most important are the following.

• The rate of growth of the rubel emission of the national bank slowed down in 1995. In 1995, the rubel money supply increased by 3.9 times and the net domestic assets of the national bank in rubels by 2.7 times. The debt of commercial banks on centralized credits declined by 19 percent during the year. The economy was financed mainly by repayments of credits extended earlier.

• A consistent policy aimed at raising reserve requirements to commercial banks’ deposits was pursued. They were increased from 5.5 percent at the beginning of 1995 to 12 percent at the end. Interest rates on deposits and credits approached gradually the rate of inflation and finally became positive in real terms. The national bank established the minimum deposit rates on deposits attracted by commercial banks, thereby helping to stabilize monetary conditions.

• In 1995, the national bank tried to reach a balance between demand and supply by granting increasing amounts of credits through the market mechanism. Their share amounted to 73 percent of the total volume of centralized credits in the fourth quarter of 1995.

• The securities market expanded. It was increasingly used to regulate the liquidity of the banking system and the noninflationary financing of the state budget deficit.

On the other hand, the following factors have had a negative impact on the development of the monetary sphere: (1) the rate of growth of the money supply has remained high and still has a significant influence on the growth of the price level; (2) the rate of term deposits of the monetary resources of the population has declined; (3) it has been difficult to maintain a stable exchange rate for the Belarussian rubel under conditions of high inflation and increasing current account deficit; (4) the gold and hard currency reserves of the country have declined since August 1995; and (5) monetary policy relies increasingly on administrative measures such as credit ceilings and lines, norms of required reserves and restriction of operations on interbank market.

Taking into account the present economic situation, the national bank has defined the main directions of monetary policy for 1996: to strengthen the positive tendencies and processes in the monetary sphere and lower the influence of the negative factors.

The strategic target is to limit the increase of the consumer price index to not more than 2.5 percent a month. The reduction of the inflation rate is expected to be achieved by maintaining the money supply within reasonable limits and positive real interest rates, and conducting flexible exchange rate policy, taking into consideration overall economic conditions.

In order to achieve the inflation target mentioned above, money supply will not be allowed to increase by more than 34 percent and will reach Rbl 23.5 trillion at the end of the year.

The balance of trade and the overall balance of payments are expected to register deficits in 1996. The national bank will therefore be compelled to sell foreign currency. Under such conditions, the growth of the money supply is expected to result from the extension of credit.

To prevent the reduction of commercial banks’ refinancing and to increase it to a certain extent within the proposed credit expansion, it is necessary to cut the national bank’s financing of the budget deficit and to direct these resources to other sectors of the economy. A significant role is assigned to reforming the credit procedure. The use of government securities (obligations of the Ministry of Finance and the national bank) and liquid nongovernment securities (shares, bonds, commodity bills) as collateral for the envisaged expansion of the national bank credit to the commercial banks will increase the reliability of the credits, strengthen the guarantee of their return, and support them as effective instruments of the regulation of money liquidity.

A change of mechanism and conditions for setting the refinancing rates will also serve these purposes. The basic rate will be set on the basis of the interest rate established in the interbank credit market. Differentiated refinancing rates are planned to be established according to the degree of liquidity of the collateral.

To ensure more effective use of credit resources, measures directed toward enlarging the responsibility of the banks and economic agents are envisaged. Credits will be granted to effective programs to increase lost own-capital and to improve profitability.

In 1996, it is planned to give credits to the government and to other sectors of the economy at the refinancing rate. At the same time, the national bank as an agent of the government will deepen the market for government’s securities, thus facilitating increased noninflationary financial resources to the state budget deficit.

In the foreign exchange sector, it is planned to combine market approaches with state regulation. This will be executed under conditions of the balance of payment deficit and an insufficient external financing to cover it. In our estimation, some devaluation of the exchange rate of the national currency (not more than 2 percent a month) is reasonable and possible. We also should account for further reduction of the currency reserves of the country.

The main market tools for regulating the foreign exchange market will be the following:

• currency interventions by the national bank;

• regulating the official exchange rate of the Belarussian rubel to correspond with trading on the interbank currency exchange and interbank exchange market; and

• developing the interbank exchange market to speed up foreign currency settlements and to use currency resources wisely.

To regulate unexpected processes on the foreign exchange market, the following steps are planned:

• concentrate hard currency reserves of the country in the national bank (they are still partly concentrated within the Ministry of Finance);

• speed up decision making concerning the use of external sources of foreign exchange; and

• develop and introduce mechanisms to strengthen state control over foreign exchange inflows and ensure control over import payments to prevent hiding foreign currency abroad.

For interbank settlements, continue efforts to complete the modernization of the payments system so that it will comply with international standards and to achieve settlements on large and urgent payments in a real-time mode (real-time gross settlement system). Creating and enforcing rules on payment obligations remain an acute problem, as well as legalizing electronic payments.

Following the need to solve the main problems of monetary policy mentioned above, the government is now improving the organizational structure of the national bank and the technical aspects of banking transactions to bring them in line with international standards. The National Bank of Belarus has carried out recently the following transformations, based upon the recommendations of the IMF.

The Banking System

The second level of the banking system consists of the commercial banks (state-owned, mixed, and private) that provide credit, settlements, and other banking services to the domestic sector and are independent in their activities and in establishing interest rates. It is likely that activating an investment process in the country will require establishing a specialized bank, working on a nonprofit basis. It would concentrate on investing in projects connected with new technologies.

Too-low interest rates give rise to the possibility of capital outflows. That is why during 1996 the refinancing rate must exceed by one to two points the refinancing rate in neighboring countries. Such an increase would attract additional resources into the country and reduce pressure on the foreign exchange market.

The national bank considers it necessary to take measures directed toward the financial rehabilitation of the banking system—in particular, to restructure the debt of state enterprises to banks into long-term financial obligations with the right to sell or pledge them, to create in the banks a loan-loss reserve for the provisioning of problem loans, and to create an information system on large credits and unreliable clients.

To develop the banking system, the amount of foreign capital in the authorized funds of banks will be regulated in two ways: (1) by limiting the number of foreign banks with 100 percent of foreign capital, and (2) by limiting the number of banks with Belarussian and foreign capital (joint banks).

Recently, as a result of the national bank’s efforts, the growth in the number of banks has ceased and their number is beginning to decline. As of January 1, 1996, 18 commercial banks had formed the required authorized capital in the amount of E C U 2 million. The fulfillment of this requirement by a further 12–15 banks is expected during the first quarter of 1996; 8–10 banks will not be able to raise their initial capital according to the requirement; therefore, a number of them are merging. Some banks will be given a status of credit organization with a limited number of operations on the financial market.

During 1995, the own-capital of banks in the national currency almost tripled. Inflation during this period amounted to 250 percent, so that own capital stayed roughly unchanged in real terms. The assets of the banking system increased during the previous year two- to fivefold and the ratio of own-capital to assets, which is also an indicator of sufficiency, increased by 11.5 percent. Nonetheless, a number of problems remain.

Increased state influence on the credit policy of the commercial banks could help direct, their money resources to support the most important state programs. In the first stage it is necessary to determine which banks can help finance state programs. In the second stage, it is necessary to develop special agreements between the government and specific banks in which will be stipulated the obligations of a bank credit support to and settlement service of a concrete industry. Preference will be given to establishing banks with joint capital and foreign investor contribution of not less than ECU 1–2 million.

In banking supervision, special importance will be given to developing an early warning system. Such a system will help determine potential bankruptcies on early stage, thereby allowing time to take measures to prevent or ease the liquidation of banks.

To regulate the banks in the area of solvency, liquidity, and large risks, all are required to calculate the liquidity ratio (K2) on the first of each month. The ratio is a synthetic parameter of the bank’s liquidity that takes into account the state of the bank’s assets in accordance with a degree of liquidity, the liabilities according to the risk of the simultaneous removal, and the correlation of the assets and the liabilities according to the schedule of repayment.

A table is used to calculate the liquidity ratio by the following periods: “demand,” “up to three months,” “from 3–12 months,” “more than a year.” According to the degree of the liquidity, the following percentage weights of liquidity are used: zero percent, 20 percent, 50 percent, 80 percent, and 100 percent. To evaluate liabilities according to the risk of their simultaneous removal, the following weights are used: zero percent, 20 percent, 60 percent, and 100 percent.

The table permits evaluation of a bank’s liquidity on each of the selected periods as well as a unified synthetic evaluation. Taking into account the changes in the general economic situation in the republic and the peculiarities of the dynamics of the bank’s liquidity, the national bank amends the procedure for its calculation.

The early warning system for “problem situations occurrence” was created with the assistance of experts from the Federal Reserve System of the United States. The short-term liquidity (up to six months) is one of the four factors that are taken into account for obtaining a true evaluation of the bank’s solvency. Supervisory measures are applied to the national bank if it does not comply with the norm of liquidity ratio or if a general negative tendency in the bank’s liquidity is revealed.

In conclusion, it should be noted that the success and positive results of the projected monetary policy will be stronger in a more dynamic economy free of its current problems. To this end, the following are of primary importance:

• create a stable economic base for restraining inflation and stabilize of the exchange rate of the Belarussian rubel on the basis of increasing labor productivity and reducing production costs, thereby minimizing the balance of payments deficit;

• reduce the general tax pressure and lower the ceilings on tax duties;

• establish a mechanism for preserving and enlarging an economic agent’s own working capital, develop and realize for each state enterprise a program for financial recovery, reduce the number of non-payments, and address the situation of bankrupt enterprises through reorganization, liquidation, and sale;

• establish conditions for developing small and medium-sized businesses, especially in services and production of consumer goods; and

• form a legislative, normative, and administrative base that takes into account the interests of all individuals in the country.

Banking Supervision

To support the improvement of the banking industry practices, the national bank is creating new policies and procedures implementing both on- and off-site prudential bank supervision practices that are consistent with or based on international standards. The reforms are undertaken with the goal of moving from a system of supervision based upon determining compliance with supervisory or other normatives to one that focuses on the financial strength or safety and soundness of the institutions. This fundamental change is revolutionary and will result in a much more effective supervisory process. The national bank is providing the infrastructure and training necessary for personnel within the bank to perform the supervisory function according to the new standards.

The modernization of the national bank’s Bank Supervision Department is currently in process as the entire organization is being restructured to enhance the use and effectiveness of the new supervision practices. The reforms cover virtually all areas of commercial banking and supervision, including licensing practices, the adoption of new supervisory policies and procedures, resolution of problems within banks and the banking system, bank restructuring and recapitalization, and bank liquidation. The national bank is also providing the training necessary to implement the new practices in an effective manner. The steps involved are in process and in various stages of completion. The overall plan is outlined below.

To change the strategy for banking supervision it is necessary to rethink the way the work is gathered, processed, evaluated, and acted upon within the Bank Supervision Department. Doing so will achieve the desired level of supervisory capacity, skill, and effectiveness. In January 1996, the national bank underwent restructuring aimed at achieving more solid results from its efforts. The general goal for the reorganization was to gather and evaluate supervisory information in such away as to focus activities where most attention is needed and to provide policymakers with the best tools for making decisions. This would be accomplished by refocusing the work flow toward providing a set of individuals with all the information available and necessary to evaluate and monitor their group or collection of banks. By vesting the responsibility for monitoring specific banks’ activities in one individual, called a Supervision Chief (head of a division), with adequate support from assistants and analysts, we expect to achieve much stronger oversight of individual banks and an enhanced ability to predict systemic problems.

The Supervision Chief is provided all supervisory data developed by the various subgroups under his or her purview and therefore will have a strong overall view of the operations of the banks in their caseload. We basically divided the banks into groups to be supervised full-time by a Supervision Chief. The five groups, one of which comprises nonbanks, contain their own groups of off-site analysts and on-site inspectors, as well as licensing and data management specialists. We divided the different support functions and departments into the same work groups so that the overall team could work together more effectively. The on-site examination reports will provide a means of determining the financial condition of the bank, and the off-site reports will provide interim monitoring between examinations. The structure will allow the Supervision Chief to specialize in the operations and risks of the small group of banks and will provide a better level of bank oversight.

Part of the restructuring included closing the regional offices of the department to increase the staff where it is most needed, in the main office in Almaty. When the finalization of the restructuring was achieved, we had reduced staff countrywide by 157, keeping 112. This also allowed us to realign the compensation structure for the remaining staff and attract some additional talented individuals.

We are currently in the middle of the development and implementation of the national bank’s general bank supervision approach outlined by the Board’s policies regarding the supervision and regulation of commercial banks under an off-site surveillance system coupled with on-site inspection. The group of policies cover the essential guidance to bank and national bank personnel on appropriate banking practices based on international standards and are the same as the principles of banking outlined in our bank improvement program. In addition, there are policies that cover other elements of banking and bank supervision operations, including licensing, on- and off-site inspection, financial performance, enforcement of prudential regulations, problem bank enforcement actions, and liquidation of problem banks.

Work in the licensing area is focused on the implementation of specific policies and procedures governing the application, review, evaluation, and decisions for granting new commercial bank licenses. This will be supported by and consistent with the adoption of new, comprehensive financial and regulatory reporting. The goal of all of the reforms is to bring our system of supervision into line with international practices by implementing an integrated supervision system. For instance, our comprehensive reporting reforms will be used to perform substantive off-site surveillance, as well as provide necessary information for licensing applications and bank liquidation packages. In addition, the national bank is spearheading the adoption of an accrual accounting system consistent with international standards and the domestic business environment. Both the accounting and financial reporting movements are being coordinated to provide banks a framework in which to internally develop the capacity to modernize and improve their own performance and practices.

Internally, the national bank is providing for the computerization of the new financial performance and other information into a supervisory database to facilitate timely and effective identification of potential or emerging problems within individual banks, as well as the system as a whole. The new capability will be supported by regular departmental management reporting on the monthly and quarterly status of individual banks. This will enable the staff to focus efforts where needed and use efficiently the comprehensive new inspection procedures and standardized reporting as a basis for corrective action. In addition, it is expected that the development of a database of statistical information on banks will expand the ability of subsections of the Bank Supervision Department and other departments within the national bank to perform their functions more efficiently and thoroughly. The other departments include Accounting, Statistics and Analysis, and Bank Liquidation.

The national bank is implementing a new, comprehensive career development program designed around a structured, sequenced training program to provide the staffing expertise necessary to perform the new, more complex practices. The program adopted includes formal classroom training, on-the-job training, periodic performance measurement and evaluation, and a certification testing program. This career development path is really built around the restructure of the departmental functions described above. The program is to include written job descriptions and specific performance appraisal criteria. The objective is to bring our own institutional capacity up to the standards we have set for ourselves. The overall development of our supervisory efforts is fully dependent on our ability to support and transform our staff and organization into a more efficient unit. (The training of national bank employees is under way, and the certification of the first group of employees will be in approximately 1.5 to 2 years.)

As detailed above, the national bank has been active in the resolution of weaker banks. This was made more effective through the institution of new bank liquidation policies and procedures. It was the national bank’s desire to make the function more seamless, efficient, and effective. This was achieved by introducing new liquidation regulations and specific procedures designed to facilitate the banks’ resolution.

To continue to improve the effectiveness of current central and commercial banking laws, regulations, and directives of the national bank, we are constantly reviewing and documenting the areas of weakness in the legal framework. This process of constant review and documentation will enable us to provide a more comprehensive and effective regulatory function as we move ahead. The regulatory framework is one of the keys to developing the banking sector, and our ability to effect corrective action on behalf of the national bank and depositors is an important requirement. Some of the areas in which we have made major changes include bank licensing, liquidation, lending limits, and prudential regulations. Our latest revision to the prudential normatives included the adoption of a minimum capital adequacy regulation that is fully consistent with the spirit of the Basle Agreement. In the future, we plan to modify or implement regulations to support many of the changes referred to above, which will support our general goal to promote the development of a stable banking sector.

Review of the Existing Banking System

Eighteen commercial banks with 170 branches have been registered and are operating in the Kyrgyz Republic. Four large commercial banks were established on the basis of the former state banks; the rest of the banks were established with new capital, including foreign capital. The approved Law on Foreign Investments provides a favorable environment for foreign investment. If foreign capital makes up 51 percent or more of the share capital of a bank, such bank is exempted from profit tax for two years.

At the present time, two new banks are in the process of opening. Nearly all the head offices of banks are located in the capital of the country, the city of Bishkek. The commercial banks are owned mainly by non-state organizations and individuals. Thus, out of the total bank share capital som 200 million, there is only one bank, which is totally owned by the state, Kyrgyzelbank (former Savings Bank). In 2 banks, the state holds more than 50 percent of the stock; in 11 banks the share of the state ranges from 4 percent to 32 percent; and 4 banks are entirely privately owned. All the banks, with the exception of Kyrgyzelbank, have licenses to conduct foreign exchange operations. Many commercial banks have established correspondent relations with banks in 15 countries, including Japan, the United States, Germany, the United Kingdom, and France. All the banks, with the exception of Kyrgyzelbank, are universal. They have a legal right to make investments and render a wide range of banking services to individuals and corporations representing different economic sectors.

Most banks have branches in three large regions (oblasts) such as Chu, Osh and Jalal-Abad. In the remaining three regions, the density of bank offices is not high. The overwhelming majority of bank offices belong to the commercial banks, which were established on the basis of state banks. However, those banks that were established during the past several years have achieved certain success and are beginning to compete with the former state banks.

Problems of Commercial Banks and Their Causes

Certain problems became evident in the process of developing the country’s banking system. Thus, according to recent analyses, half of the banks are insolvent. Several factors explain the situation. The most significant one is the direct loans, mainly to the agricultural sector and processing industries, that the government channeled through the state banks in the past. The overall decline in output, as well as the privatization of large farms on conditions that allow new owners not to make commitments to pay off debts to banks, contributed to the accumulation of bad debts at such banks. Problems in the banking system today were also brought about by the very difficult economic situation in 1993 and 1994 and certain shortcomings in management of the banks. This particularly affected the former state banks, which previously implemented governmental programs of financing the economy and are still managed in line with the stereotypes of a centrally planned economy. The banks proved to be unprepared to operate under the conditions of high inflation and have never managed to appropriately adjust their interest rate policy to the subsequent decrease in the rate of inflation that took place in 1994. The high rates of inflation of 1992–93 produced an illusion of huge revenues and ever increasing profitability. The credit policy of the banks relied heavily on high lending rates as a result of high interest rates on deposits. At the same time, they did not take into account the fact that high interest rates on loans increased the risk of nonpayment. Accordingly, when the nonrepayment of loans became overwhelming, the banks suffered a sharp decrease in the interest income accompanied by an increase in the interest expenses. And that, in turn, led to the insolvency of certain banks.

The banking system is in need of skilled staff and management and requires considerable financing for training programs. Those banks that have managed to recruit competent employees, provide training for their staff, and develop advanced managerial methods have fewer problems and, in spite of their short existence, are able to compete with the former state banks and earn a profit.

The increasing credit risk and nonrepayment of the previously made direct loans caused liquidity problems for most banks. Liquidity management was poor. To support liquidity needs and create an impression of well-being, banks paid high interest to attract deposits. The main portion of these new deposits was used to pay interest on the previously received deposits. Costly deposits and nonrepayment of loans increased interest rates on loans, which only exacerbated the situation and caused an increase in losses. As of today, the banks posing systemic risk are mostly paralyzed or verging on collapse. Most banks have ceased to perform the main bank function, that is, to act as financial intermediaries. There is almost no lending to the economy. Radical measures are required to get the banking system out of this situation.

Measures to Strengthen the Banking Sector

Recognizing the necessity to regulate the activities of the banking sector, the national bank at the end of 1993 had established the Banking Supervision Department as part of the central bank. The staff of the Banking Supervision Department has been trained at various international organizations, and from 1994 has been actively developing instructions on bank-licensing activities, bank management, and capital adequacy assessment in compliance with the requirements of the Basle Committee for Banking Supervision. In October 1994, the national bank became a founding member of the Central Asian/Trans-Caucasus Banking Supervisors Group under the auspices of the Basle Committee on Banking Supervision.

To identify and mitigate the risks in the banking system, the national bank has taken a number of measures:

• To improve the quality of bank management, regulatory documents have been issued regulating changes in bank control.

• Recommendations were made with respect to the credit policies of banks requiring that they establish credit committees, maintain credit files, classify loans, and make provisions for loan losses according to classifications.

• Recommendations were made on liquidity management, including the assessment and methods of liquidity management.

• To improve the quality of bank management, changes were made to the bank’s licensing procedures, and requirements were set with respect to the professional suitability of managers of commercial banks.

• To deal with problem banks, certain documents regulating their operating conditions were adopted. In addition, regulations on the introduction of direct bank supervision and temporary administration have also been implemented.

• In accordance with international standards, a system of regulatory reporting has been developed and introduced. It includes, but is not limited to, balance sheet, the structure of capital, off-balance sheet statement, income statement, maturity distribution of assets and liabilities, classification of assets by risk, and calculation of loan-loss reserves, as well as a listing of loans to insiders and related persons.

• Instructions detailing examination planning, conduct, control and report of examination format have been developed and implemented. Inspections are carried out through both external supervision and on-site visits.

The existing accounting system does not allow a quality analysis of a bank’s condition. For example, even if a bank is insolvent, current accounting practices may indicate a profit. The new regulatory documents, as well as reporting forms based on international standards, allow the problems of the banks to be quantified and appropriate measures to be taken. It must also be noted that the improved efficiency of supervisory personnel enabled a much deeper and timelier recognition of bank problems. Thus, in 1994 three banks were closed, and in 1995 licenses of two were suspended. These measures were taken because of the hopeless condition of these banks and the liquidation did not represent a systemic risk. Such actions were possible because the earlier adoption of the Law on Bankruptcy was subsequently supplemented by the Instructions on Aspects of Application of the Law on Bankruptcy to Banks.

Special attention is being paid to the licensing of banks and the exercise of supervisory functions over the activities of commercial banks. There are certain obligatory procedures and requirements that must be met to obtain a bank license. Such procedures decrease the risk resulting from incompetent bank managers and key officers. In addition, the legality of the sources of funds invested in the capital of a bank is investigated, thus reducing the risk of penetration of illegal elements into the banking system. In 1994, the national bank started to enhance its supervisory activities. The supervision over the activities of commercial banks is getting more and more in line with international standards. The bank inspections address all components of the C A M E L system.²² The capital adequacy assessment is performed on the basis of the Basle Agreement. To conduct external (off-site) supervision, banks are required to submit periodic reports using the accounting forms accepted by international practice. This allows considerable improvement in the quality of examinations and assessment of the scale of problems existing in the banking system.

Trends in the Development of New Banks

It must be noted that the existence of systemic risk problems in the banking sector of the country are related to the banks that were established on the basis of the former state banks. At the same time, some banks established with new capital have successfully addressed existing difficulties and endured the competition in the marketplace. These banks are now profitable due to the high professionalism of their managers and staff. In other words, the deterioration in the financial condition of many banks comes not only from the problems in the economy, but to a greater extent, from poor management.

Recently, the volume of foreign investments in the banking system of the country has been increasing. This development was fostered by the fact that foreign investments are legally protected and the law allows for tax exemptions for certain joint-venture banks. In particular, more than 50 percent of the investments in banks in the last year was provided by foreign investors. A further increase in foreign investments will boost competition and the credibility of the banking sector to an appropriate level. The soundness of the system will also be strengthened.

Systemic Banks (Insolvency Crisis)

The main difficulties arise from the former state banks, which pose systemic risk. They have numerous branches in most regions of the country, and in some locations these are the only banks. The deterioration of the capacity to manage numerous branches, the weakening of control over the bank personnel, and an increase in the number of nonperforming loans are the causes of the deterioration in the financial condition of the former state banks. Nonrepayment of loans has led to the liquidity crisis and insolvency of the banks, posing systemic risk.

Structural Reform of the Banking System

Since it is impossible to carry out restructuring of the banking sector without establishing an appropriate legal framework, the Kyrgyz Republic continues to make efforts to ensure improvements in financial legislation. Thus, the national bank has started to prepare bills to amend or add to (1) the Law of the Kyrgyz Republic on Banks and Banking Activities; (2) the Law on the National Bank of the Kyrgyz Republic; and (3) the Law on Deposit Insurance Fund. These bills will further improve the existing legislation on bank supervision and regulation of banking activities.

Proposals have been submitted to the government with respect to the new draft of the Civil Code concerning the legal tender in the Kyrgyz Republic and bank insolvency. Draft instructions concerning prevention of the money laundering activities in the banking system have also been prepared by the national bank.

The government and the national bank are completing the development of a new Law on Collateral. At the present time, banks and other entities have many problems in connection with the registration and repossession of collateral. The existing system of registration is inadequate and cannot exclude the possibility of illegal operations with collateral. The proposed law is expected to solve these problems.

The national bank has done a great deal to improve prudential regulations. Documents for bank supervision that have been developed and adopted include Procedures for the Establishment of Commercial Banks on the Territory of the Kyrgyz Republic; Changes in the Composition of Bank Personnel, Influencing Its Management and Control Over Its Activities; Measures Aimed at Revitalization of the Financial Condition of Commercial Banks; Instructions on Aspects of Application of the Law on Bankruptcy to Banks; Regulations on Interim Administration; and Management of Problem Banks.

The national bank is also working on the transition to a new chart of accounts to be adopted in 1996, which will comply with internationally accepted accounting practices in 1996, and on measures designed to improve and upgrade the bank payments system. At present, the National Bank Clearing System is in five regions of the country and one region is preparing to put it into operation.

The measures that the national bank is taking in cooperation with other organizations, including the foreign institutions, have brought about certain results. However, they have not solved the main problem associated with the financing of a large bad-debt burden. It is necessary to carry out structural banking sector reforms: sell or close some branches, establish several banks on the basis of one bank, merge certain banks, change the administrative structure, and strengthen internal and external controls. These measures will create prerequisites for recapitalization of the banks and allow writing off the remainder of bad debts through loan-loss reserves formed by the banks.

The banking sector of the republic receives technical assistance from various international institutions. However, not all of the country’s banks and the participants in the banking activities receive technical assistance. Additional assistance is needed to provide training to promising employees in new banking methods, accounting, strategic planning, and utilization of new technologies.

At the present time, the National Bank of the Kyrgyz Republic and the World Bank are working on the preparation of the Financial Sector Restructuring Program.

Foreign Exchange Operations

The national bank is carrying out its monetary and foreign exchange policy in accordance with the new Law on the National Bank, which was passed in July 1995. According to the new law, the principal task of the national bank is to achieve and maintain the stability of the national currency.

The currency market in the Republic of Moldova began to take shape as an independent market with the collapse of the rubel area and the first steps toward implementation of an independent economic and emission policy. In 1992–93, serious steps were taken to develop and implement foreign exchange regulation and to create foreign exchange reserves, primarily through borrowing from the IMF and other international organizations, which meant that when the national currency was introduced in late 1993, a full-fledged currency market was created in Moldova that was capable of rapid and successful development. Acceptance of the obligations of Article VIII of the IMF’s Articles of Agreement meant the de facto elimination of restrictions on international operations still in place at that time, complete liberalization of current account operations, and convertibility of the Moldovan leu.

The Department of Foreign Exchange Operations and Foreign Relations, whose structural organization includes front, middle, and back offices, with all of the necessary technical equipment—personal computers, Reuters screens, as well as highly skilled personnel—is responsible for implementing the methodology and strategy for developing the currency market, and also for operations on the domestic currency market and management of the foreign exchange reserves of the national bank.

The existence of sufficient reserves ($250 million at the beginning of 1996, compared with $3 million in 1992) and steady liberalization of exchange control enabled the national bank to pursue a policy on the domestic currency market that led to the stabilization of the national currency (devaluation over the 2.5 years since the introduction of the national currency was just 18 percent), as well as to the elimination of multiple exchange rates and to the development of a currency market. The official exchange rate of the Moldovan leu against foreign currency is a floating rate and is based on the outcome of daily fixing sessions at the Interbank Currency Exchange, depending on supply and demand. The official exchange rate of the national bank is used for statistical and accounting purposes.

Moldova’s commercial banks perform operations with foreign currency on an interbank market that has grown significantly in volume, and they have gradually been giving preference to these operations over participation in the Interbank Currency Exchange. Moldova’s leading banks have joined SWIFT and are on the Reuters network, which enables them to perform operations in accordance with international standards. Banks independently set currency quotations, without any restrictions, governed only by the supply and demand of one currency or another. The fact that the extent of national bank interventions on the domestic market was minimal over the past year and consisted only of evening out fluctuations in the exchange rate indicates that we have managed to saturate the market and that the situation has stabilized. This is also confirmed by the growing interest on the part of banks and economic agents in neighboring countries in our relatively small, but successfully developing currency market.

In determining the volume of interventions by the national bank on the domestic currency market, the Department of Foreign Exchange Operations and Foreign Relations works with the Monetary Policy Department to coordinate basic targets and indicators on a monthly basis, and when necessary, on a weekly basis, which is driven by the need to pursue a coordinated and uniform policy in all areas. It should also be noted that the spot currency market in Moldova is functioning quite successfully as well: the exchange rate on the spot market essentially coincides with the exchange rate on the interbank market, and the difference between the purchase and sale rate is less than 1 percent.

As far as the national bank’s foreign exchange reserves are concerned, as already noted, they have grown by a significant margin, to $250 million in 1996, which at present is sufficient to meet the needs of imports into Moldova for four months. In its management of the reserves, the national bank is guided by the principles of reliable investment of the funds and their liquidity. The strategy and structure of the investment portfolio are determined by the investment committee. The principal investment instruments at this time are repo operations (approximately 25 percent), deposits in first-class foreign banks (about 55 percent), treasury bills of various states (5 percent), funds invested under management contracts (7 percent), and so on. In determining investment strategy and evaluating investment activity, a benchmark is set, the selection criterion for which is based on the status of currency markets. At this particular stage, proceeding from the conditions of liquidity and proper servicing of the country’s foreign debt, the national bank is adhering to a strategy of investing mainly in short-term and reliable instruments. It should be mentioned that despite a fairly conservative and strict approach to managing reserves, income from the management of foreign exchange reserves in 1995 exceeded the national bank’s expenditures on servicing IMF credits, which is a very important outcome, considering the fact that for nine months the national bank had negative net foreign assets.

In light of the fact that management of foreign exchange reserves is a new sphere of activity for the national bank, improving the professional skills of personnel and providing technical equipment are among the priorities that will make it possible in the future to diversify and step up operations on the currency market, moving away from simple deposit operations involving investments in the European capital market to a broader spectrum of investment instruments in Europe.

In 1996, the national bank is faced with the task of further strengthening the entire banking system, thereby creating a foundation for the stable development and strengthening of the currency market, increasing the foreign exchange reserves of the entire country, and turning Moldova into an attractive financial center.

ket, on the other, create a situation in which government securities are becoming the main instrument for solving a broad range of problems.

Although the Russian government securities market appeared nearly three years ago, its volume amounts to nearly $20 billion, or 5 percent of GDP, and its daily turnover is about $500 million, or 2.5–3 percent of the market volume. The annualized yield on rubel transactions during the first two months of 1996 reached nearly 70 percent and the average monthly volume of funds raised on the GKO-OFZ (short-term government bonds and federal loan bonds) market to finance the budget deficit stood at more than $600 million at the end of 1995.

The GKO-OFZ market has already proved its ability to perform the main functions inherent in this instrument. The use of funds raised from the issue of government securities for financing the budget deficit allowed the central bank to considerably reduce the volume of direct credits to the Ministry of Finance and subsequently stop extending such credits altogether. On the other hand, the central bank received a market instrument for implementing its monetary policy, which was repeatedly tested in critical situations on the credit and internal foreign exchange markets. For the banking system, the government securities market has become a major means of maintaining the balance sheets’ liquidity.

The successful implementation of these functions became possible thanks to rapid growth of the market. Qualitative and quantitative expansion within this process has affected such aspects as market volume, the number of participants, the range of the instruments used, and the infrastructure.

At the present stage of development of the government securities market, priority is attached to attracting foreign investments. The financial sector of the Russian economy has reached such a level of maturity that the use of foreign investments cannot become a brake on its further development and will even help improve the infrastructure. From this point of view it is particularly important that investments should be made in the national currency.

At present, nonresidents’ investments in GKO-OFZ are subject to rather stringent regulation both in terms of volumes of transactions and their yields. Securities can only be bought with the rubels purchased from the Bank of Russia in foreign exchange swap operations. The rate of the first part of the transaction is set on the eve of the auction, while the rate of the second part is fixed on the day after the auction. Investments can only be made for the entire maturity of the issue, as a result of which the precise rubel yield becomes known on the day of the auction. Thus, the required final yield of the transaction in foreign currency is established on the day after the auction when the rate of the second part of the transaction is fixed. As for the volumes of transactions, they depend on the volumes of the swap operations transacted by the Bank of Russia.

More than $400 million was invested as a result of the first auction with the participation of nonresidents, and the final annualized yield was set at 25 percent in U.S. dollars. Subsequently, steps were taken to gradually reduce the yields to bring them closer to world levels for similar instruments.

In addition to providing funds for immediate financing of the federal budget deficit and facilitating the implementation of the monetary programs, foreign investments in rubels will help solve some other problems. It is, above all, the problem of creating a vast internal foreign exchange market for both spot and futures transactions. So far, these markets are too small to fulfill the required functions. In other words, an additional impetus needs to be given by regulating authorities. From the financial point of view, the “currency band” introduced in 1995 is nothing else but compensation for the inadequacy of the Russian currency market. In this context, an additional sustained two-way flow of funds will be useful for developing the market as a whole and hedging in particular.

Another important result of the expansion of the rubel investment flow within the framework of the process of de-dollarization of the Russian economy will be an additional impetus to the development of the money market, which, for its part, is the necessary condition of financial stabilization. The circulation of additional instruments on the domestic market will also stimulate development of financial brokerage and consolidation of the corresponding infrastructure. In combination with the aforementioned factors, additional demand for banking services will help strengthen the Russian banking system and increase its reliability.

We regard these processes as closely connected with the further development of the GKO-OFZ market. Despite the hopes laid on the consequences of participation of nonresidents in this market, the main investors and brokers of the Russian government securities market will be Russians and it is the Russians that the central bank has in mind in drafting guidelines for the reform of this market. One can single out here the following basic trends.

Regional trading floors began to participate in the GKO-OFZ market in 1995, and at present government securities are traded in the real-time regime not only in Moscow, but also in St. Petersburg, Novosibirsk, Rostov, Yekaterinburg, and some other cities. The important thing is not that additional funds are attracted to a specific market, but that a national infrastructure has begun to emerge, which in the long run will make it possible to conduct a wide range of financial and stock exchange operations.

Another big step in the development of the market will be the introduction of repo operations, which will not only provide the central bank with a new mobile instrument to regulate banking liquidity, but also open up additional opportunities for the market participants. All these measures should help increase market immunity to external factors.

The introduction by the central bank of Lombard crediting, that is, a mechanism of refinancing based on the use of government securities, confirms the leading role of the GKO-OFZ market from the viewpoint of the share of this sector of the financial market as well as from the viewpoint of the technologies used.

In addition, plans are afoot to make a number of changes inside the market structure, as a result of which private investors will gain access to the market and its efficiency will increase thanks to reorganization of the structure and functions of the authorized dealers.

Such reforms in the government securities market will help further stabilize and improve the performance of the financial system and the economy as a whole during its transition to a market model of development.

Future Priorities

The central bank will continue to press for increasing autonomy over monetary policy and will seek to achieve harmony between fiscal and monetary policies in close cooperation with the Ministry of Economy and Finance. It is expected that the central bank and the ministry will together coordinate public debt management through a joint committee that will examine the mechanisms for the future issue of treasury bills at market-determined interest rates through the auction mechanism. The central bank will continue the struggle against inflation as a priority objective.

Addressing Banking Sector Weaknesses

The central bank regards the financial soundness of the banking system of paramount importance and the availability of timely data a priority. This will require the support of the international community over the medium term. The IMF, the World Bank and the European Bank for Reconstruction and Development (EBRD) are all supporting central bank programs to remedy weaknesses in the financial sector.

Human Resource Development

Bank staff are generally weak in credit and operational matters despite having a good general level of education. The central bank opened a residential interbank training center in 1995 that trains bank staff from the central bank and commercial banks in the capital and in the provincial branches. The center has a fully equipped computer training unit thanks to a World Bank credit. The center cooperates with regional centers like the Kazakstan International Institute of Banking whose trainers have mounted a variety of one-week courses on international banking topics including letters of credit and aspects of lending.

The central bank has engaged a French company, CFPB, that specializes in banking sector education. CFPB is a nonprofit organization. Its shareholders are 13 French commercial banks, and it has long experience in the region. CFPB’s team leader arrived in Ashgabat in April to start the courses for selected commercial and central bank staff, which run throughout 1996. The contract was awarded under the World Bank loan. Senior commercial bankers will spend some weeks in Europe on a study tour of banking institutions; the tour is part of the contract package.

Banking Regulation

The banking sector has a poor record on provisioning for bad and doubtful debt and there is a possibility that write-offs could erode the capital base of the weaker banks. A contract has been awarded under the World Bank loan to experienced consultants with international and regional experience in bank regulation. The consultants will aid the central bank to prepare regulations on a number of essential topics. In the meantime, the central bank has prepared a draft regulation that when introduced will require banks to maintain specific provisions against doubtful and bad loans. The draft provides a method of determining when the quality of a loan has deteriorated to the extent that calls for provisions.

Banking Supervision

The same World Bank loan will provide technical assistance for both off-site and on-site bank supervision. The chosen consultants have the necessary experience in supervisory matters. An experienced Federal Reserve Bank examiner is a frequent visitor to the central bank under an IMF technical assistance program and will continue to assist the development of supervisory standards. Cooperation at the regional level with the Basle committee will ensure that Turkmenistan moves closer to international standards.

International Standards of Accounting

The central bank is using the World Bank loan to explore the introduction of International Accounting Standards in Turkmen banks. So far no contract has been awarded. The central bank will ultimately adopt an accounting plan that the IMF developed in response to requests from a number of central banks in transitional economies.

Settlement System

The central bank will introduce an electronic countrywide settlement system to replace the present arrangements. An initial report by Dutch experts is currently under study. The system will have adequate capacity to take care of peak loads at month ends. It will be sufficient to provide a service to other government users at nonpeak times. Financing of the equipment and the accompanying technical assistance is from the World Bank loan. There will be close cooperation with the Ministry of Communications to ensure system compatibility.

External Audit Approach

Involvement in international trade and relations with foreign correspondent banks require that Turkmen banks are financially sound. One proof of such soundness is the publication of financial statements that have been audited by recognized external auditors. The second phase of an EBRD on-lending project contains preconditions for satisfactory external audit within the foreseeable future.

Project Identification

The business community and the banking sector lack expertise in the identification of projects and their implementation. The EBRD loan project has supplied consultants to work with the banking sector to improve this aspect of the banking business. It is likely to remain an obstacle to major credit proposals at least in the medium term. The associated problems are of banks’ weak analytical capacity and low monitoring ability.

Statistics

The central bank will benefit from the appointment of an IMF regional balance of payments advisor to continue the work of earlier statistical missions. The advisor will share time among three central Asian republics, including Turkmenistan. More timely and more accurate balance of payments data are essential for successful financial programming.

Conclusion

We are confident that the central bank has the will to remedy the weaknesses in the banking sector and that given continued institutional and donor support, it will have the means to do so. The economy of Turkmenistan will improve as we gain wider access to international markets for our gas and other energy products. The central bank intends that the banking sector should be ready to play its part vigorously in a revived and restructured economy.

Payments System

The national bank realizes common national policy in money circulation and credit and exchange regulation; promotes strengthening national currency; arranges interbank settlements; coordinates the operation of the banking system as a whole; and effects supervision over its activity.

Commercial banks of different types and ownership are established by legal entities and individuals as joint-stock or shareholding companies. As of January 1, 1996, 230 commercial banks have been registered in Ukraine.

The strategy for developing the banking system in Ukraine is aimed at providing higher efficiency of commercial bank activities and improving their role in solving economic and social problems of the society.

Developing and implementing the electronic interbank payment system (EPS) in early 1994 was an important achievement in advancing the banking financial sector. In all regions of Ukraine and Crimea, 25 regional settlements houses were established, which were linked into a public common network of settlements houses in Ukraine. The network is a three-linked structure with a central settlement house at the top, located in Kiev. Actually, all Ukrainian banking institutions (over 2,400 commercial banks and their branches) effect payments through correspondent accounts of the national bank institutions and participate in the interbank settlements within the country. EPS operation is controlled by the national bank. EPS incorporates software packages that provide exchange of electronic documents, their verification, analysis, and fraud protection.

The electronic interbank payment system handles payments of legal entities (clients of commercial banks) in the mode close to the real-time mode and maps them in the correspondent accounts of banks with the national bank. Participants receive necessary information on liquidity forecasting. Payments from banks are accepted only within the limits of their correspondent accounts—that is, a bank is entitled to allocate only the actual resources it possesses. Such a procedure minimizes the system risk inherent in similar systems. An opportunity to debit the other participant is given only to the divisions of the national bank. The main operation mode is to transfer electronic documents and preclude use of paper-based technology.

The system handles about 350,000–400,000 payments a day, totaling over krb 150 trillion, which is two or three times higher than the value on current correspondent accounts of the clients using the system. The aver-payment systems and systems of internal automatization of banking activity, in particular, with “client-bank” systems.

With the aim of decreasing domestic currency cash circulation, the national bank together with commercial banks took a decision to implement plastic cards for cashless settlements of individuals. To this end, in September 1995, the 17 largest banks with the participation of the national bank organized “Ukrcard,” a closed-joint-stock company to develop and implement the National Plastic Card Settlement System.

The participants of “Ukrcard” and the national bank have developed the National Settlement System, which takes into account the experience of several European systems available and some systems implemented. The system is based on the use of up-to-date and reliable plastic, smart cards (cards with a microprocessor and a cryptography protection system), and a current electronic interbank payment system. Another payment instrument envisaged by the project is a debit card that guarantees payment for consumer and service transactions.

Implementation of credit and corporate cards is also planned. They are analogous to international cards like Visa, Eurocard, MasterCard, and others. A corporate card will provide services to legal entities performing functions of a debit and payment card. The National Settlement System will also provide payments for Visa, Eurocard, and MasterCard international systems when servicing foreigners in Ukraine and Ukrainians abroad. The pilot project is planned to be realized in at least two regions of Ukraine in 1996.

The pilot-project implementation will be based mainly on the use of the equipment of foreign companies. Simultaneously, preparatory work will be directed at organizing domestic production of the National System elements (through joint ventures, purchasing licenses, and working domestic enterprises).

Prospects of the National Payments System Development

At present the existing system of interbank payments meets the needs of the Ukrainian economy. However, taking into account the increased economic activity in the country, connection to international payment systems, development of the electronic securities market, and implementation of mass payments for consumer goods and services, a new payment system is needed, one that is based on new concepts, technology, and software.

The national bank is developing the new payment system, which will include the following new components:

• a centralized subsystem of operating correspondent accounts of banking institutions within the country;

• a centralized subsystem of urgent money transfers for effecting payments in the real mode (with on-line facilities);

• a subsystem of clearing settlements for effecting interbank payments in a package mode in one day on a regional basis;

• a subsystem of mass payments for consumer goods and services with plastic cards;

• interfaces with the developing electronic systems of the securities market, foreign exchange transactions, and so forth;

• fourth-generation language; SQL, and other modern facilities and technologies, to process and keep data in protected environments, and operate centralized databases in the national bank’s subdivisions;

• on-line money transfers accompanying payments data exchange with banks using “client-server” technology;

• ability to meet in full the future demands; the package mode technology shall remain for banks having no possibility to operate modern technologies and environments for timely payments;

• flexible and reliable means of entering other interbank payment systems, such as SWIFT, payment systems of the Baltics, Russia, and other countries of the former Soviet Union, and so forth;

• back-up systems to secure continuous functioning in case of natural or malicious acts;

• steady improvement of interbank payment systems and their integration in the electronic interbank payment system; and

• enlarged services to the members of the electronic payment system and increased the system reliability and protection.