Recent history

97. Until 1989 the Polish banking system was dominated by the National Bank of Poland (NBP) and four state-owned banks that specialized in foreign trade, currency operations, and foreign currency deposits; agriculture; consumer saving; and mortgages. There were also 1,663 small local cooperative banks that were linked to the state bank dealing with agriculture. In 1989, the four hundred branches of the NBP were converted to nine regional joint stock state-owned banks, leaving central banking and supervisory functions exclusively to the NBP. Subsequent reforms focused on privatizing and consolidating state banks so that they could compete more effectively with foreign banks. As part of these efforts, the NBP arranged the takeover of small private and cooperative banks by regional domestic banks, as well as by allowing foreign banks limited foreign investment in troubled banks. Privatization, together with liberal licensing requirements during the early 1990s, led to a rapid increase in the number of banks. At the end of 1998, there were 83 commercial banks in operation, the majority of which were privately-owned.

98. Favorable macroeconomic conditions played an important role in the development of the banking system. Poland’s real GDP growth has been among the highest in transition countries, and inflation has declined steadily, falling from triple digit levels in the early 1990s to about 9 percent in 1998 (end-of-period). Competition among banks, together with Poland’s prospective membership in the EU, has also helped to rapidly deepen the range of services offered by the banking sector. During the early years of transition, banks focused on servicing corporate customers. With the decline in margins from corporate banking, bank activity has shifted toward retail banking as evidenced in the rapid rise of consumer lending in recent years. Banks are now preparing to offer pension funds, and several banks have established large pension departments in anticipation of the reform of the pension system. Nevertheless, the Polish financial system is still at an early stage of development compared with several other European transition countries as judged by the ratios of bank deposits, broad money (M2), and credit to nongovernment relative to GDP, as well as the number of bank branches per capita (Figure 1).

Poland: Bank Development, 1998

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

Sources: WEO, IPS, OECD and staff estimates.

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Poland: Bank Development, 1998

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

Sources: WEO, IPS, OECD and staff estimates.

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Poland: Bank Development, 1998

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

Sources: WEO, IPS, OECD and staff estimates.

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Concentration and ownership

99. The Polish banking system remains highly concentrated. Over half of bank assets are concentrated in six (out of 83) commercial banks, with 18 percent of assets held by one of the remaining state banks, Bank PKO-BP (the former savings bank). The proportion of bank assets held by state banks fell from 80 percent in 1993 to 48 percent in 1998, and the number of banks with majority public-sector interest declined from 29 to 14 during this period (Table 1). The impending sale of the government’s stake in the second largest bank in Poland (Bank Pekao-SA), which held 11 percent of bank assets at the end of 1997, is expected to reduce significantly the proportion of bank assets held by the public sector. Plans for privatizing the remaining state banks (PKO-BP and BGZ) are not well advanced, however, partly because their privatization is complicated by issues related to asset quality, a need for recapitalization, and some thinking that perhaps these banks should remain domestically owned.

Table 1.

Poland: Structure and Performance of the Banking Sector

Source: General Inspectorate for Banking Supervision.

Table 1.

Poland: Structure and Performance of the Banking Sector

					September
					1993	1994	1995	1996	1997	1998
Number of licensed banks					87	82	81	81	83	83
	Of which:
		Majority state-owned (number)			29	29	27	24	15	14
			As a percent of total assets		80.4	76.1	68.3	66.6	49.3	48.1
		Majority foreign-owned (number)			7	8	15	22	26	28
			As a percent of total assets		2.0	2.2	2.9	11.9	13.8	14.5
		Branches of foreign banks (number)			3	3	3	3	3	3
			As a percent of total assets		0.6	1.0	1.2	1.8	1.4	1.7
Number of banks accounting for
		25 percent of total assets			2	2	2	2	2	2
		75 percent of total assets			12	12	12	13	13	14
Total assets as a percent of GDP					53.3	52.1	51.7	54.4	55.7	59.9
		Foreign currency denominated
			Assets (as a percent of total assets)		29.9	29.0	21.6	20.8	22.0	19.4
			Liabilities (balance sheet/ as a percent of total assets)		27.4	27.0	20.6	19.8	20.3	18.5
				Of which: over 30 days to maturity (as a percent of total assets)	16.1	14.8	10.3	9.6	9.9	10.1
Contingent and off-balance sheet accounts (as a percent of total assets)					19.6	20.1	21.0	30.5	43.3	64.4
		Of which foreign currency denominated (as a percent of total assets)						12	19	32
Total loans (as a percent of GDP)					19.9	17.8	17.7	21.4	23.9	25.6
Credit to private sector (as a percent of GDP)								14.2	16.4	18.1
Total deposits excluding interbank (as a percent of GDP)					31.1	32.7	31.1	32.7	34.4	35.6
Central bank credit to banks (as a percent of GDP)					2.2	1.8	1.6	1.5	1.4	1.1
Average pretax return on total assets					1.1	1.3	3.6	3.7	2.9	1.9
Nonperforming loans, substandard or less (as a percent of total loans)					29.3	28.2	20.9	12.9	10.3	9.3
Provisions for loan losses (as a percent of nonperforming loans)
		Total specific provisions			56	69	67	64	58	52
		Total general provisions			6	7	10	15	21	15
Risk-weighted capital/asset ratio (in percent)					8-15	8-15	8-15	8-15	8-15	8-15

Source: General Inspectorate for Banking Supervision.

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Table 1.

Poland: Structure and Performance of the Banking Sector

					September
					1993	1994	1995	1996	1997	1998
Number of licensed banks					87	82	81	81	83	83
	Of which:
		Majority state-owned (number)			29	29	27	24	15	14
			As a percent of total assets		80.4	76.1	68.3	66.6	49.3	48.1
		Majority foreign-owned (number)			7	8	15	22	26	28
			As a percent of total assets		2.0	2.2	2.9	11.9	13.8	14.5
		Branches of foreign banks (number)			3	3	3	3	3	3
			As a percent of total assets		0.6	1.0	1.2	1.8	1.4	1.7
Number of banks accounting for
		25 percent of total assets			2	2	2	2	2	2
		75 percent of total assets			12	12	12	13	13	14
Total assets as a percent of GDP					53.3	52.1	51.7	54.4	55.7	59.9
		Foreign currency denominated
			Assets (as a percent of total assets)		29.9	29.0	21.6	20.8	22.0	19.4
			Liabilities (balance sheet/ as a percent of total assets)		27.4	27.0	20.6	19.8	20.3	18.5
				Of which: over 30 days to maturity (as a percent of total assets)	16.1	14.8	10.3	9.6	9.9	10.1
Contingent and off-balance sheet accounts (as a percent of total assets)					19.6	20.1	21.0	30.5	43.3	64.4
		Of which foreign currency denominated (as a percent of total assets)						12	19	32
Total loans (as a percent of GDP)					19.9	17.8	17.7	21.4	23.9	25.6
Credit to private sector (as a percent of GDP)								14.2	16.4	18.1
Total deposits excluding interbank (as a percent of GDP)					31.1	32.7	31.1	32.7	34.4	35.6
Central bank credit to banks (as a percent of GDP)					2.2	1.8	1.6	1.5	1.4	1.1
Average pretax return on total assets					1.1	1.3	3.6	3.7	2.9	1.9
Nonperforming loans, substandard or less (as a percent of total loans)					29.3	28.2	20.9	12.9	10.3	9.3
Provisions for loan losses (as a percent of nonperforming loans)
		Total specific provisions			56	69	67	64	58	52
		Total general provisions			6	7	10	15	21	15
Risk-weighted capital/asset ratio (in percent)					8-15	8-15	8-15	8-15	8-15	8-15

Source: General Inspectorate for Banking Supervision.

100. Foreign banks play a significant role in Poland. The number of majority foreign-owned banks rose from 7 in 1993 to 28 in 1998, and the percentage of bank assets held by them increased from 2 percent to 15 percent during these years. Foreign banks also had minor participation in another 14 banks in 1998. German banks are by far the largest foreign investors, accounting for one third of foreign investment in banking; they provided 14 percent of the equity capital of commercial banks at end-1997.

101. There is a large network of cooperative banks in Poland, though their number has fallen from 1,653 to 1,208 during 1993-98. Despite the large number, cooperative banks account for less than 5 percent of banking system assets, as their operations focus on the rural agricultural sector; the rural sector is also served by the extensive branch network of Bank PKO-BP. The cooperative banks are connected to the banking system through the Bank for Food Economy (BGZ), a state bank that provides cooperative banks with clearing, refinancing, and support services. The NBP has placed several hundred cooperative banks ina recovery program (which partially exempts them from meeting their reserve requirements) with a view to facilitating the restructuring and take-over of these cooperatives by other banks (see below).

102. Commercial bank liabilities are dominated by holdings of short-term time deposits by households. Three quarters of all deposits are owned by households, and about one-fifth of deposits are in foreign currencies. Demand deposits accounted for only about one quarter of deposits at end-September 1998, as the high reserve requirement on demand deposits has encouraged banks to offer time deposits with short maturities. Reserve requirements in Poland are high by international standards (11 percent on zloty time deposits, 5 percent on foreign currency deposits, and 20 percent on zloty demand deposits), and are not remunerated.² On the asset side, commercial banks hold about 40 percent of their assets in loans and about 30 percent in securities (Table 2). The composition of bank assets differs between private and state-owned banks. Where as private banks have focused on holdings of Treasury bills and—more recently—consumer loans, a large portion of the portfolio of state-owned and ex-state-owned specialized and regional banks consists of loans to state enterprises for housing, and to agriculture.

Table 2.

Main items in the Consolidated Balance Sheet of Polish Commercial Banks, September 1998

(In millions of zlotys and percent of total)

Source: National Bank of Poland.

Table 2.

Main items in the Consolidated Balance Sheet of Polish Commercial Banks, September 1998

(In millions of zlotys and percent of total)

Reserves	19.3	6.1	Demand deposits	47.2	14.8
Nonreserve claims on NBP	29.5	9.2	Time & saving deposits	125.9	39.5
Foreign assets	15.3	4.8	Money market instruments	0.8	0.2
Claims on government	60.0	18.8	Foreign liabilities	17.8	5.6
Claims on nonfinancial public ent.	29.5	9.2	General government liabilities	13.0	4.1
Claims on private sector	98.9	31.0	Credit from NBP	10.0	3.2
Claims on nonbank financial sector	3.6	1.1	Capital accounts	29.1	9.1
Interbank assets	33.5	10.6	Interbank liabilities	36.6	11.5
Other	29.5	9.2	Other liabilities	38.5	12.0
Total assets	319.0	100.0	Total liabilities	319.0	100.0

Source: National Bank of Poland.

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Table 2.

Main items in the Consolidated Balance Sheet of Polish Commercial Banks, September 1998

(In millions of zlotys and percent of total)

Reserves	19.3	6.1	Demand deposits	47.2	14.8
Nonreserve claims on NBP	29.5	9.2	Time & saving deposits	125.9	39.5
Foreign assets	15.3	4.8	Money market instruments	0.8	0.2
Claims on government	60.0	18.8	Foreign liabilities	17.8	5.6
Claims on nonfinancial public ent.	29.5	9.2	General government liabilities	13.0	4.1
Claims on private sector	98.9	31.0	Credit from NBP	10.0	3.2
Claims on nonbank financial sector	3.6	1.1	Capital accounts	29.1	9.1
Interbank assets	33.5	10.6	Interbank liabilities	36.6	11.5
Other	29.5	9.2	Other liabilities	38.5	12.0
Total assets	319.0	100.0	Total liabilities	319.0	100.0

Source: National Bank of Poland.

Interest rates

103. Interest rates and bank intermediation spreads have fallen in recent years. The decline in interest rates has accompanied the reduction in inflation which, together with greater competition among banks, has resulted in lower interest margins and a lower dispersion of bank deposit rates. On average, three-month deposit rates have fallen from 25 percent at end-1993 to 18 percent in the third quarter of 1998, while their range has narrowed from 20-31 percent to 17-20 percent. At the same time, lending rates on low-risk loans have fallen from 35 percent to 20 percent (Figure 2). Interest margins may be expected to narrow further in 1999, as interest rates continue to fall and as a result of competition among banks.

Poland: Nominal Interest Rates, 1994–98

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

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Poland: Nominal Interest Rates, 1994–98

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

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Poland: Nominal Interest Rates, 1994–98

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

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104. Lending rates on Polish banks’ foreign-currency denominated assets have been significantly lower than the corresponding zloty rates. This led to a rapid expansion in foreign currency and foreign-currency linked lending in 1998, including for residential mortgages.

Deposit insurance

105. Deposit insurance is provided by the Bank Guarantee Fund (BGF). The BGF was established in 1995 and is owned by the NBP, the Treasury, and the commercial banks. The BGF has two fundamental functions: guaranteeing deposits, and supporting the restructuring and rehabilitation of banks (see below). These functions are supported by regular analyses by the BGF staff of the banking sector, which reportedly foster early identification of potential threats. Participation in the system is mandatory for all banks. Most banks are required to allocate 0.4 percent of their deposits to the BGF. The exceptions are Pekao-SA, PKO-BP, and BGZ, which up to end-1999, are obliged to allocate 0.2 percent of their deposits since their deposits (in excess of amounts covered by the BGF) are covered by a state guarantee.³ The contribution rate for these three banks is to be raised to the level applied to the rest of the banking system as of 2000 when the state guarantee will end. Allocations are not collected from banks, and are accessed only in the event there is a need to pay off depositors. Banks are obligated to invest the amounts allocated to the BGF in Treasury or NBP bills. The BGF covers deposits in registered bank accounts of natural persons, legal persons, and organizational units that are not corporate bodies. Amounts not exceeding ECU1,000 are covered fully, and 90 percent of the next ECU5,000 are covered. Plans are for a gradual increase in the coverage of deposits to EU limits: ECU8,000 in 1999, ECU11,000 in 2000, ECU15,000 in 2001, ECU17,500 in 2002, and ECU20,000 thereafter.

Solvency assistance

106. BGF solvency assistance to banks is granted at the request of the concerned bank on the basis of documentation presented by the bank and prepared in keeping with the requirements of the BGF. To access this facility, an institution needs to demonstrate that it is facing solvency difficulties and that the cost of assistance to the BGF would be less than the cost of the bank defaulting and the exercise of the deposit guarantee. Solvency assistance is provided in the form of loans at favorable terms: loan rates are 40 percent of the NBP refinance rate (20 percent for cooperative banks), and maturities are up to ten years, with a grace period of up to five years. Insolvent banks that are undergoing restructuring operations also benefit from reductions in reserve requirements and in tax obligations. Banks contribute 0.4 percent of their risk-weighted balance sheet assets and guarantees to the BGF annually, as well as 0.2 percent of the sum of off-balance sheet liabilities (excluding credit lines). As with deposit insurance, the contribution rate for the three state banks is one half that of other banks until the end of 1999. In January 1998 the NBP began paying 30 percent of the contributions to the BGF (with a corresponding reduction in banks’ fees to the BGF); this percentage was raised to 40 percent at the beginning of 1999, and Parliament is under pressure to increase it further to 50 percent.

107. Since its inception in 1995, the BGF has assisted five commercial banks and 21 cooperative banks to address their solvency difficulties; it has also assisted three commercial banks to take over insolvent commercial banks, and 13 commercial banks and 13 cooperative banks to take over insolvent cooperative banks. The cost of this assistance has amounted to Zl 800 million (compared with Zl 900 million contributed to the facility since its inception). In addition, the NBP has, over time, reduced reserve requirements for 23 commercial banks (of these four or five banks have been exempted altogether from reserve requirements) and for 238 cooperative banks by Zl 542 million and Zl 295 million, respectively. The reductions have been for limited periods, and presently 16 commercial banks and 120 cooperative banks enjoy such reductions (by Zl 512 million and Zl 134 million, respectively). The reduction in requirements is determined by the proportion of assets of insolvent institutions to total assets in merged banks. Since 1995, there have been three commercial banks, and 88 cooperative bank bankruptcies. There were several other banks undergoing bankruptcy procedures or liquidation at the end of 1998.

Capital adequacy

109. The capital adequacy of Polish banks is generally regarded as satisfactory. Polish regulations for capital adequacy conform to the Basle standards, with capital adequacy ratios that exceed the 8 percent risk-weighted ratio and risk weights that are more conservative than those of the Basle Core Principles (BCP). Newly-established banks have to maintain a capital ratio of 15 percent during the first year of operation, 12 percent the second year, and 8 percent there after. The minimum capital requirement is ECU 5 million.

110. Commercial banks in Poland have generally maintained their capital adequacy ratios well above the regulatory minima, with about three quarters of banks maintaining ratios above 12 percent. The median risk-based capital ratio for commercial banks was 15.5 percent at end-September 1998, having declined from 17-18 percent during 1995-97. Meanwhile, the number of banks not meeting the minimum 8 percent standard has fallen from 18 banks to 5. The aggregate solvency ratio for the banking system was at 8.5 percent at end-September 1998, with about 80 percent of capitalization reported to be core capital. Cooperative banks also improved their capital ratios during the period. About half of the cooperative banks maintained ratios of 12 percent or more, and the number of cooperative banks not meeting the minimum 8 percent standard fell from 424 (out of 1612) banks at end-1994 to 93 (out of 1208) cooperative banks at end-September 1998.

Foreign exchange exposure

111. Commercial banks’ direct exposure to foreign exchange risk seems well-managed. The limits on open foreign currency positions were significantly tightened at the beginning of 1999, and are monitored daily by the General Inspectorate for Banking Supervision (GIBS). The new regulations cover on- and off-balance sheet risks, with the latter defined to cover derivative transactions in a comprehensive manner, including swaps and options as well as currency-linked transactions.⁴ In addition, the new regulations have introduced limits on net open positions in nonconvertible currencies (2.5 percent of capital on individual currency exposures, and 5 percent on overall exposures), and have eliminated a 40 percent maximum currency position limit that was defined as the sum of the absolute long and short currency positions. The limit on net open positions in an individual currency (15 percent of capital) and the overall limit on the net open currency position (30 percent of capital) have been retained. The NBP has also developed a system to monitor off-balance sheet risks. All banks are required to report their open currency positions on a daily basis.

112. Banks have recently become increasingly exposed to indirect foreign currency risk as a result of the rapid increase in foreign currency lending and currency-linked lending. Driven by the wide interest differential between zloty and foreign currency loans, the stock of foreign currency loans increased by 71 percent during January-September 1998, boosting the share of foreign currency loans in total loans by 7 percentage points to 24 percent during the period. Part of this lending was to households—including for residential mortgages—suggesting that some of the loans may be to unhedged borrowers. Corporations are also reported to have significant unhedged borrowing in foreign currencies. While borrowers in foreign currencies have gained from the appreciation of the zloty combined with low interest rates on foreign currencies, it is not clear to what extent loan servicing difficulties would result in the event of a sharp depreciation of the zloty. The adoption of inflation targeting in Poland will entail additional exchange rate flexibility, which could increase the riskiness of foreign currency loans.

113. Commercial bank off-balance sheet activity in foreign exchange has also expanded sharply. Off-balance sheet items were 12.6 times the capital of foreign banks, and 6.3 times the capital of domestic banks at the end of the third quarter in 1998, compared to 7.8 times and 4.5 times at the end of 1997, respectively. A large part of this activity is related to operations in foreign exchange. Discussions with commercial bankers indicate that banks plan to expand these activities further in 1999.

Sectoral credit concentration

114. Bank lending in Poland does not seem overly concentrated in any sector. Lending to the booming real estate sector—which was a major factor in banking crises in countries where real estate bubbles burst—has been minimal, and corporations are reported not to be highly leveraged. Exposure to Russia is also reported by the NBP to have been low (less than 0.5 percent of bank assets), and in the summer of 1998 the GIBS acted swiftly to require commercial banks to provision against this exposure. However, with the effects of Russia’s 1998 financial crisis on the Polish economy not yet fully apparent, it is possible that the banking sector could still be affected adversely by the repercussions.

115. Consumer lending—which rose by more than 30 percent in 1998—is also an area with potential risks. Banks do not have long experience in this area, and the collateral system is relatively new and untested. A downturn in economic activity could therefore cause servicing difficulties for some consumer loans.

Security holdings and maturity mismatches

116. Polish banks hold large amounts of securities. The share of securities in commercial bank assets has been around 30 percent in recent years, making the banking system vulnerable to large fluctuations in security prices. Forty-five percent of these securities carry maturities of one month or less, while 35 percent have maturities longer than one year. Given the projected decline in interest rates in Poland, commercial banks are likely to benefit from changes in the value of securities, although the possibility of an un anticipated rise in interest rates cannot be excluded.

117. The maturities of commercial bank assets and liabilities do not seem to be excessively mismatched (Figure 3). The amounts of assets and liabilities with maturities of one month or less—which constitute about one half of commercial banks’ balance sheets—are comparable (such assets were 91 percent of liabilities at end-September 1998). However, there seems to be significant maturity transformation from the 3-12 month maturity to longer term maturities. At end-September 1998, assets with maturities of 3-12 months were only 60 percent of liabilities with the same range of maturities, while assets with maturities longer than one year (which comprise 30 percent of assets) were close to five times the liabilities with the same maturity. This maturity transformation does not necessarily mean additional risks for the banking system, as longer term assets may be quite liquid. Moreover, commercial banks can hedge these risks in forward markets, activities that are not captured by balance sheet entries.

Poland: Maturity Structure of Commercial Bank Assets and Liabilities Sept. 30, 1998

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

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Poland: Maturity Structure of Commercial Bank Assets and Liabilities Sept. 30, 1998

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

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Poland: Maturity Structure of Commercial Bank Assets and Liabilities Sept. 30, 1998

Citation: IMF Staff Country Reports 1999, 032; 10.5089/9781451831818.002.A003

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118. The NBP does not have limits on maturity mismatches in foreign currencies, not with standing the strengthening of controls over banks’ open foreign currency positions. As a result, banks are not discouraged from relying on short-term sources of foreign funding.

Nonperforming assets

119. The ratio of nonperforming loans (NPL) in relation to commercial bank claims has declined sharply in recent years.⁵ NPL were reduced by the government issuance of bank restructuring bonds, which allowed banks to write off loans, increase provisions, and help borrowers to restructure and return to profitability. From 40 percent of total loans in the early 1990s, the proportion of NPL declined to 10.5 percent at the end of 1997, and to 9.7 percent at the end of the third quarter of 1998. The decline in this ratio in 1998 reflected a rapid rise in lending, as the stock of classified loans rose 12 percent during the period. Most of the increase in the stock of NPL was in zloty loans, although in percentage terms, nonperforming foreign currency loans rose at a more rapid pace. The proportion of zloty NPL declined slightly from 10.8 to 10.6 percent, while the proportion of nonperforming foreign currency loans fell from 9.1 percent to 6.8 percent (reflecting the low stock of foreign currency NPL at the beginning of the period combined with the rapid rise in foreign currency lending). Given that the bulk of these loans were made recently, it is too early to assess their repayment performance. A large part of these loans may be unhedged, although the income of some households and enterprises may be connected to the exchange rate.

Profitability

120. Bank profitability declined in 1997-98 from a relatively high level. The average (pretax) return on assets fell from 3.6-3.7 percent in 1995-96 to 2.6 percent in 1997, and to 1.9 percent during the first three quarters of 1998. The return on equity fell from 68 percent in 1996 to 42 percent in 1997, and to about 21 percent in the first three quarters of 1998. The reduction in profitability reflected a contraction in interest margins, an increase in reserve requirements in 1997, and provisioning for loans to Russian entities in 1998. Further pressures on profitability can be expected in 1999 since interest rates and margins are likely to continue falling with the prospective decline in inflation and with increased competition among banks; the GIBS reported that almost 73 percent of net income of core banking operations of commercial banks was derived from interest rate spreads in 1998. The loss of exports to Russia and other eastern markets may also adversely affect profitability in 1999.

The structure of banking supervision

124. The two main pieces of legislation that establish the legal framework for the banking system are the National Bank of Poland Act and the Banking Act, both passed in January 1998. The Banking Act contains a number of prudential provisions and reflects the Polish banking system’s development. It also recognizes the need for further liberalization. Poland’s desire to join the EU is also reflected in the two Acts, and several of the EU directives on financial markets have been incorporated in law.

125. In terms of banking system regulation, the most significant element of the new NBP Act is the establishment of the Commission for Banking Supervision (CBS). The CBS is an operationally independent body, chaired by the President of the NBP. The scope and principles of supervision are set out in the NBP Act and in the Banking Act. The Banking Act specifies the licensing requirements for banks, empowers the CBS to withdraw licenses, and gives the CBS access to relevant information (except for consolidated supervision) through on-site examination of banks and their branches. The CBS also has the obligation to require banks to hold adequate loan provisions, to discourage unsound banking practices, and to impose corrective measures when appropriate. These can include the removal of managers in the event of a breach of prudential regulations or of unsafe and unsound banking activities, as well as calling for conservatorship and/or bank liquidation. The Banking Act requires external auditors of banks to notify the CBS immediately of any facts revealed during the audit that would indicate criminal behavior, a violation of banking regulations or of sound banking practices, circumstances that would endanger the interests of the bank’s customers, or the possibility of a negative or an adverse opinion on the bank’s accounts.

126. The NBP Act stipulates that bank examiners (from the GIBS) shall have appropriate education and professional experience. The GIBS employs a staff of 540, of which 200 are at headquarters in Warsaw and 340 are at NBP branches. Supervision is coordinated at headquarters.

127. Banking supervision focuses on monitoring compliance with prudential requirements. The GIBS conducts on-site examinations and off-site analyses to monitor bank operations and to help identify risks. Its operations have been strengthened by increasing the frequency of on-site comprehensive, specific, and targeted examinations; the development of an on-site examination manual, and the provision of training courses for examiners. A new regulatory reporting system has been developed to utilize a comprehensive system of call reports that should enable the production of analytic financial reports on banks. Donor-funded assistance has been aimed at drafting regulations and reporting forms, and at holding seminars and workshops for bank supervisors.

Accounting and public disclosure

128. The Accounting Act of September 29, 1994 (effective January 1, 1995) improved the accounting standards for Polish banks. Article 81 of the Act gave the NBP the power to regulate bank accounting principles. The NBP accordingly issued Regulation No. 1/1995 on detailed bank accounting principles and on the compilation of notes to financial statements, and Regulation No. 10/1995 on detailed procedures for the compilation by banks of consolidated financial statements. These regulations have now been revised and issued by the GIBS as Regulations No. 1 and 2/1998. The law and regulations are reported to be in conformity with the relevant EU directives, i.e., the Fourth Council Directive 78/660 EEC on the Annual Accounts of Certain Types of Companies; Directive 86/635 EEC on the Annual Accounts and Consolidated Accounts of Banks and Other Financial Institutions, and International Accounting Standards (IAS). Consolidated accounts are now obligatory, and banks have to report their accounting policies, cash flow statements, and detailed notes to the accounts with published statements. In general, the public disclosure requirements for banks appear toi>e in line with international best practice and are transparent. Detailed information on banking sector performance is also issued and published by the GIBS and NBP on a regular basis.

Loan loss classification and provisioning

129. Polish banks are required to classify all loans, other assets and guarantees, and contingent liabilities that could result in a material distortion of a bank’s financial condition. There are four categories: standard, substandard, doubtful, and loss. Classification is based upon the timeliness of payments and the financial condition of the borrower. These criteria work independently, so a borrower will be downgraded if its financial condition deteriorates, even if payments continue to be made on time. Loan charge-offs, however, are carried out when there is no hope of recovery and a lengthy court process is complete. A loan is classified as substandard when principal and interest are past due for one to three months and/or the financial situation of the borrower may jeopardize timely repayment of relevant assets; the provisioning requirement is 20 percent. The classification into doubtful and loss categories isa function of additional specific criteria. For doubtful exposures, the past due criteria are three to six months and the provisioning requirement is 50 percent. For loans classified as loss, the past due criteria are six months or more, and the provisioning requirement for loss is 100 percent.

130. In 1993 the Law on Restructuring Enterprises facilitated the recapitalization of banks through the use of restructuring bonds to provision against nonperforming loans. To be eligible for the bonds, banks had to prove their intention to restructure bad loans. As a result, banks worked with their state-owned customers to restructure loans and return the enterprises to profitability so that debts could be serviced. Subsequently, banks were also allowed to reschedule, sell, and write off bad loans, or swap them for equity. The improvement in the quality of borrowers as a result of restructuring, coupled with favorable economic conditions, an increase in bank equity, a better understanding of customer needs, improved bank lending policies, and strict prudential rules on nonperforming loans and write-offs have resulted in a steady decline in the share of nonperforming loans in the total.

Internal controls and auditing

131. Banks are required to maintain written accounts of their procedures and safeguards for internal risk management. The GIBS assesses each bank’s overall risk management procedures during its on-site inspection. So far, only foreign exchange risk is regulated. Recommendations for the control of interest rate risk are being prepared, but this risk is not reflected in the bank’s required capital; operational risks connected with it are subject to GIBS recommendations.

132. According to the Banking Act, banks must have an internal audit function that verifies the legality and propriety of the activity conducted by the bank and ensures that accounts and reports filed by the bank are true and accurate. The law does not directly require the independence of internal auditing. At present, the internal auditors of the majority of banks are appointed by the management board, and report to it. However, the charters or statutes of some banks make internal auditors accountable to the supervisory board and independent from management; this practice conforms with internationally accepted principles and Basle recommendations.

The implementation of prudential regulations

133. The Banking Act, Chapters 11 and 12, provides the CBS with the legal authority to implement prudential regulation; to obtain necessary information from any institutions under its supervision; to close a bank, penalize a bank and its president, vice president or other members of the management board; and to prescribe various remedial actions. The procedures for bank rehabilitation, liquidations and bankruptcies are directly monitored by the CBS. The Law is fairly detailed on these matters, and provides the CBS with strong legal grounds and with an obligation to act when necessary.

Supervision on a consolidated basis

134. The Polish banking system is based on the universal banking model, where banks are allowed to engage directly in a range of financial activities, including the purchase and sale of securities for their own account. Banks may also own other financial service providers including leasing companies, insurance companies, and securities firms. As a result, universal banks dominate the Polish financial sector, and banks own financial service firms.

135. While this arrangement has advantages, it may also pose risks to the financial system, notably the risk of contagion among financial groups. The authorities are aware that reducing these risks will require that supervision of all financial groups be on a consolidated basis, and that steps should be taken to ensure that no member of any financial group escapes effective supervision.⁶

136. Banks are required to disclose annual accounts on a consolidated basis as well as for each bank subsidiary. However, financial sector supervision in Poland is not currently carried out on a consolidated basis. In fact, some financial institutions, notably leasing companies, are not supervised at all. The legal grounds for conducting consolidated supervision are said to be lacking, but proposed amendments to the Banking Act are expected to allow for consolidated supervision in 1999.

137. The CBS is required by law to provide the Securities and Exchange Commission (SEC), the Agency for Supervision of Pension Funds (ASPF), and the State Agency of Insurance Supervision (SAIS) with information necessary for these agencies to supervise the relevant institutions. These agencies are not required to provide information to the CBS. According to Article 131 of the Banking Act, the principles and procedures applicable to providing such information should be specified in agreements between the Commission for Banking Supervision and the regulatory agencies. No agreements to that effect have yet been signed, but, there is informal cooperation among the agencies as their board members serve on several of these agencies. A draft agreement between the CBS and the SEC has been drawn up, and could serve as a model for agreements with other agencies.

138. Polish banks have subsidiaries, branches, and representative offices in other countries, and foreign banks operate in Poland. The Banking Act regulates the application and licencing procedures for cross-border establishments; authorization is granted by the CBS in agreement with the Ministry of Finance. The Basle Committee has issued four “minimum standards” for a cross-border entity: (a) all international banks and banking groups should be supervised by a home-country authority that capably performs consolidated supervision; (b) the creation of a cross-border banking establishment should receive the prior consent of both the host and home-country supervisory authorities; (c) home-country supervisors should possess the right to gather information for cross-border banking establishments, and (d) if any of the foregoing minimum standards are not met to the satisfaction of the host-country supervisor, it can impose restrictions and prohibit the operation of the foreign banking establishment. The CBS does not conduct on-site supervision of domestic banks operating abroad and, therefore, does not comply with this Basle recommendation. At present, no formal agreement or memorandum of understanding (MoU) exists between the CBS and foreign supervisory authorities, and there are no experiences or procedures for cooperation with banking supervisory agencies from foreign countries with banks in Poland. However, the CBS reportedly intends to sign a MoU with the Financial Services Authority in England, and plans are to enter into agreements with the bank supervisory authorities in the Netherlands, Germany, France, Lithuania, Ukraine, and the United States. The legal framework for agreements with foreign supervisory authorities has been established in the Banking Act.

Compliance with the Basle Core Principle

139. The CBS assessed its compliance with the Basle Core Principles for Effective Banking Supervision (BCP), and submitted its findings to the Basle Committee prior to the ICBS meeting in Sydney, Australia in October 1998. However, fulfillment of the BCP by any country is not, and is not intended to be, an “exact science.” Banking systems differ from one country to another and so do other domestic circumstances. Bank activities are presently changing rapidly around the world. Theories, policies, and best practices of supervision are rapidly evolving. It is internationally acknowledged that the BCP should be seen as minimum standards. Laws and regulations constitute only one aspect of effective supervision. They have limited value if the capacity, competence, and integrity of the supervisory staff are inadequate. That being said, there is a constant need for upgrading supervisory capabilities and skills to keep up with supervisory developments, such as new regulations, the evolution of best practices in banking supervision, and developments in banking operations. According to the self assessment, the CBS concludes that at present it has fulfilled 15 of the BCPs fully, another seven are partly fulfilled, and three are not fulfilled at all. The BCP 1(5) on “legal protection for supervisors,” BCP 20 on “the ability of the supervisors to supervise the banking organization on a consolidated basis,” and BCP 23 on “global consolidated supervision, adequately monitoring and applying appropriate norms to all aspects of the business conducted by banking organizations worldwide, primarily at their foreign branches and subsidiaries” are not implemented.

The year 2000 issue

140. The banking supervisory authorities have requested external auditors to disclose in their auditing statements for 1998 their assessment of the banks’ readiness for the year 2000. The GIBS plans to conduct targeted on-site examinations on this issue, as well as on information technology in general.