1. Introduction
It is my pleasure to be here and to benefit from the exchange of opinions and experiences. As you may know, pursuant to the Central Bank of Montenegro Law, the Central Bank of Montenegro (CBCG) sets out fostering and maintaining the financial system stability and a sound banking system and safe and efficient payment systems as its main objectives. The financial system in Montenegro is bank-centric. In a dollarized (euroized) and bank-centric systems, such as the one in Montenegro, a stable financial system is a condition for creating and preserving the stability of the economic system.
2. The Context
In response to the global financial crisis and in response to a number of economic and financial events, the ECB, similar to other central banks of major countries, significantly reduced its key interest rates and implemented several nonstandard monetary policy measures, in order to address various risks, including low inflation and dislocation in the liquidity of certain asset markets in the euro area.
South-east European (SEE) countries are small, open economies with very close trading relationships with EU countries. These same countries with which there are close trading ties are a source of capital, foreign direct investments and portfolio investments. Banks in South-east European countries are to a large extent controlled by banking groups headquartered in the euro area. This resulted in sizeable financial flows, mostly within the same banking group, particularly prior to the global crisis.
The very high degree of economic and financial integration between the euro area and SEE countries creates potential monetary policy spillover effects.
Montenegro is a small country with a population of only 620, 000 people. It is a small and open euroized economy, highly exposed to external effects.
According to the Ministry of Finance, the real GDP growth rate for 2016, based on quarterly estimations, has been 2.5 percent and the projections for the next two years, 2017 and 2018, are 3.2 percent and 4.4 percent, respectively. During 2016, annual inflation rates were mostly negative, but the December Consumer Price Index (CPI) was positive at around 1 percent. The CPI rose in March 2017 to 2.7 percent on an annual basis.
3. Risks
The main risks in Montenegro are coming from three sides: fiscal side, financial sector, and real sector. Of the three, the biggest is the fiscal risk, due to high public debt. At the end of December 2016, the public debt of Montenegro amounted to EUR 2,546.1 million, or 67.5 percent of GDP, and was above the Maastricht criterion of a debt-to-GDP ratio of 60 percent. Also, in the period 2019–2021, more than 1 billion euro eurobonds are due to be repaid, while from 2021 onward is planned the repayment over a 14-year period of a loan granted for the construction of the highway Bar—Boljare.
In order to reduce the high level of public debt and reduce the budget deficit, the government has launched a fiscal consolidation plan. This nevertheless, the budget deficit is still high. At the end of 2016, the budget deficit was still 3.4 percent of the GDP.
In the Montenegrin financial sector, the banking sector has a dominant market share of over 90 percent of total financial sector assets. Therefore, the biggest financial risk is credit risk that comes from the banking system. Credit risk is decreasing, but it is still deemed to represent a significant potential risk for the banking system.
In terms of other banking sector vulnerabilities, non-performing loans (NPL) were quite high after the crisis. As a transition economy, we had a boom-bust period, and, after that, in 2011, NPLs amounted to over 24 percent of total loans. Today NPLs have been significantly decreased, to 10.2 percent.
The third risk is coming from the real sector. The real sector was illiquid after the crisis. Nowadays banks are highly liquid while the real sector continues to remain illiquid. After the crisis, banks have tightened lending standards and have become more selective in the loans approval process to the real sector.
4. Central Bank of Montenegro Objectives and Instruments
CBCG is quite a peculiar central bank in terms of objectives and instruments. It operates within a euroized monetary policy regime, in which the monetary policy objectives and instruments are also peculiar to such a regime. Similarly to the Central Bank of Kosovo, the main policy objective of CBCG is to preserve the financial stability. Financial stability in Montenegro is necessary not only to promote internal stability, but also to attract the inflow of FDIs and the development of small and medium-sized enterprises necessary for the economic convergence process with the EU.
Efficient supervision and prudential policy for ensuring and preserving a sound and safe banking sector are at the disposal of CBCG to achieve its primary objective. In light of the weight banks have within the overall financial system, the stability of the banking system is a fundamental determinant of the stability of the entire financial system. Banks are also the primary source of funding for all sectors of the economy.
The banking system in Montenegro consists of 15 banks, 9 of which have a majority stake controlled by foreign owners. Five banks are members of EU banking groups. Stronger competition is the result of new banks entering the domestic market. There has been a positive influence on interest rates from the entry of new banks into the system, contributing to a general downward trend on lending interest rates and narrower spreads between deposit and lending rates.
5. ECB Monetary Policy Spill-Over to Western Balkan Central Banks
All economies in the region are open economies with strong trade and financial linkages with the EU. Therefore, the accommodative monetary policy of the ECB is transmitted to the region.
Despite the heterogeneity of the monetary policy and the exchange rate regimes in the region, the policy rate reaction of the central banks has been mostly in line with the accommodative stance of the ECB.
The low interest rate environment in the euro area provided scope for lower interest rates in the region. The more accommodative monetary stance across the central banks in the region led to a relaxing of financial conditions for the private sector borrowing.
As a result of lower ECB rates, banks in Montenegro decreased lending interest rates both for corporates’ and households’ loans although they remain quite high when compared to euro area levels. Even though lending interest rates are still high compared to the European average, they have exhibited a downward trend. This is evidenced by Figure 1, which shows the weighted average effective lending interest rates (WAELIR) on total loans and for corporates and households. We can see that the WAELIR are decreasing. For example, there is a decrease of WAELIR on total loans from 8.47 percent in January 2016 to 7.42 percent at the end of February 2017. Still, these rates are quite high.
Weighted average effective lending interest rates for period 31.01.2016–28.02.2017.
Source: Central Bank of Montenegro.WAELIR on new businesses on a monthly basis are also on a downward trend, as evidenced by Figure 2. For example, in February 2017 the average effective lending interest rate on new loans was 6.88 percent, which has been one of the lowest in the last periods.
Weighted average effective lending interest rates of banks – new business on a monthly basis
Source: Central Bank of Montenegro.6. Fiscal Policy and Debt Management Strategy
Due to the high public debt and budget deficit, the Government of Montenegro had to search for external financing sources. In 2016, it issued a eurobond. It was the sixth issuance since 2010, for a total issued amount of EUR 300 million for a five-year maturity at a rate of 5.75 percent. In November 2016, Montenegro issued domestic bonds for EUR 80.4 million, with a four-year maturity, at a fixed interest rate of 4 percent, for financing the budget deficit, capital budget, and public debt servicing and fiscal reserve provision.
The Government of Montenegro opted for what was called a growth strategy. There are pros and cons of this strategy: financial sources at lower rates, but increased public debt.
The growth strategy includes an increase in capital investments and the biggest infrastructure project: highway construction. It is actually the biggest capital investment project in the history of Montenegro.
7. Policy Implementation at CBCG
Although CBCG does not have an independent monetary policy, it does have monetary policy instruments it can use in the pursuit of its objective. They include: open market operations, credit operations, lender of last resort, and reserve requirements. Until now, CBCG has actively used only reserve requirements. The CBCG has used the reserve requirements on bank deposits in order to manage credit cycles and liquidity and, to some extent, to achieve macro-prudential goals. Namely, with these instruments, the central bank affects the banks’ lending activity, and indirectly affects the further process of money multiplication (money supply) in the economy.
In the pre-crisis period, CBCG increased the reserve requirement’s rates on bank deposits in order to limit excessive credit growth and limit the excessive leverage of borrowers in the economy. In the post-crisis period, it lowered the reserve requirement’s rates to ease liquidity constraints and encourage further banks’ lending.
In to the period 2006–2008, the CBCG objective was to rein in credit activity and try to strengthen the bank’s resilience to potential risk of a credit boom. In that period, the bank adopted a conservative approach with its regulatory instruments. Banks’ regulations, at that time, was stricter than the international ones, especially the prudential one. CBCG has used reserve requirements on bank deposits in order to manage credit cycles and liquidity and to some extent, to achieve macroprudential goals.
Recently – as of March 2017 – reserve requirements have instead been lowered, with the reserve requirement ratio lowered from 9.5 percent to 7.5 percent for demand deposits and time deposits with a maturity not exceeding one year, and from 8.5 percent to 6.5 percent for time deposits with a maturity exceeding one year.
In the current environment of low inflation and a zero interest rate, the effectiveness of monetary policy instruments has been challenged. The recent global financial crisis has posed new challenges for the monetary policy and demonstrated the need for a more comprehensive approach in the pursuit of objectives. In the absence of monetary policy, CBCG focuses on financial stability. CBCG is currently developing a macro prudential policy framework and instruments. Having the mandate for preserving financial stability, CBCG potentially has a mandate for macro-prudential policy, also.
8. Financial Stability in Montenegro
According to the last statement of the Financial Stability Council, the financial system in Montenegro is stable, systemic risk is moderate, with potential risks arising from the low liquidity of the real sector and its potential insolvency risks. These risks are also exerting pressure in the fiscal domain.
The Financial Stability Council was established in 2010. Its members are: the Governor of the Central Bank of Montenegro, the Minister of Finance, the Director of the Agency for the Supervision of Insurances, and the President of the Securities Commission. The Financial Stability Council was established with a view to monitoring, identifying, preventing, and mitigating potential systemic risks in the financial system of Montenegro as a whole, in order to ensure the maintenance of financial system stability and avoid episodes that may lead to widespread financial distress.
The following figures show recent data about financial stability. They will be published in the financial stability report. The aggregate index of financial stability (AIFS) is a derived index. The AIFS is shown in Figure 3. The AIFS is used to assess the financial stability situation calculating four subindexes, which refer to: external sector (payment system), government (public finance), real sector, and financial sector. The AIFS is used to assess the systemic instabillity trends. At the end of 2016, the AIFS was higher compared to the end of 2015. Below, in Figure 4, there is a financial stability diagram. It shows financial stability developments from 2014 to 2016. Risks emanating from fiscal and external sectors are the predominant ones. Other risks are either stable or have only a minor influence on the overall financial stability.
As for the external sector, risks are very visible and have exhibited a significant increase compared to 2014, primarily due to a widening trade deficit as a result of a drop in export.
Risks referring to non-financial sector have slightly increased compared to 2015, but are almost stable. Fiscal sector risks increased a half point (0.5) due to the increase of public debt, their financing conditions, and the announcement of a higher budget deficit as a result of the investments in infrastructure.
The banking sector risks are stable compared to 2015.
