Abstract
This Selected Issues paper analyzes the developments and determinants of inflation in Romania, and reviews the salient trends in public finance. The study describes the monetary policy issues and the improvements required to clean up the financial sector. The paper chronicles the balance-of-payments crisis in 1999, the external viability trends, reviews the economic and financial implications, and assesses Romania's compliance with EU economic criteria. The paper also provides a statistical appendix for the country.
IV. Financial Sector Issues1
1. Significant progress has been made in restructuring Romania’s financial sector in the past few years. Largely as a result of the privatization and closure of some large state-owned banks in 1999, private banks now own more than half of the total banking sector assets in Romania. The enhanced supervision and stricter rules and regulations, along with the cleaning up of the bad loans of two large state-owned banks, have helped to substantially improve the quality of banks’ loan portfolios. Substantial capital injections into the banking system have also improved the strength of the banks’ financial position. In addition, the government is currently implementing asset classification and provisioning rules that are close to international standards, and is introducing International Accounting Standards in the banking system.
2. In spite of the meaningful progress achieved so far, a large part of the financial system remains weak and much needs to be done to enable Romania’s banking system as a whole to carry out its intermediation function more effectively. The weakness in much of the financial system is reflected in the poor quality of assets even after significant cleaning up, and in the vulnerability of the system. The limited effectiveness of the banking system is revealed by the extremely low level of banking sector credit in the economy, as banks are unable or unwilling to lend. While the financial sector problem fundamentally reflects that of the rest of the economy, it is also attributable to the delay in restructuring the state-owned problem banks, the inadequate regulation and supervision of the banking sector, the unsatisfactory exit mechanism (procedures and legislations) for bankrupt banks, and the lax supervision over the nonbank financial sector.
3. The first three sections below describe recent developments in, and the current status of, the structure, the soundness, and the regulatory and supervisory environment of the banking sector, and the last section deals with the nonbank financial sector.
A. The Structure of Romania’s Banking System
4. Following the establishment of a two-tier system in 1991, Romania’s banking system expanded rapidly but remained dominated by state-owned banks at the end-1998. Romania effectively operated a monobank system until November 1990, when the two-tier banking structure was introduced. Specialized state-owned commercial banks were established in 19902 and developed rapidly, while private banks, including some with foreign ownership, emerged and expanded at an even faster pace. Nonetheless, at the end of 1998, the banking system remained dominated by heavily segmented state-owned banks, none of which had been privatized.
5. The ownership structure of Romania’s banking system has been altered drastically in the last two years with the privatization of two state-owned banks (BRD and Banc Post) and the closure of another, Bancorex(see Table IV.1). At the middle of 2000, Romania’s banking system consisted of 42 banks, of which 7 were branches of foreign banks. Four state-owned or majority state-owned banks remain in the system, and together they account for less than half of the total assets of the banking system. The private sector (majority private-owned) accounts for 56 percent, of which banks with majority foreign participation (majority foreign ownership, and foreign branches and subsidiaries) account for 44 percent of the banking system assets.
The Ownership Structure of the Banking Sector, 1996-2000
The Ownership Structure of the Banking Sector, 1996-2000
| 1996 | 1997 | 1998 | 1999 | June 2000 | ||||
|---|---|---|---|---|---|---|---|---|
| (Number of banks) | ||||||||
| All commercial banks | 35 | 37 | 45 | 41 | 42 | |||
| Of which: | ||||||||
| Romanian incorporated banks | 29 | 31 | 36 | 34 | 35 | |||
| State-owned | 7 | 7 | 7 | 4 | 4 | |||
| Of which: Savings bank | 1 | 1 | 1 | 1 | 1 | |||
| Private | 22 | 24 | 29 | 30 | 31 | |||
| Of which: Joint venture with foreign investors | 8 | 11 | 15 | 19 | 22 | |||
| Branches of foreign banks | 6 | 6 | 9 | 7 | 7 | |||
| Banks under special treatment | ||||||||
| (including: under suspension, in court, etc) | 1 | 1 | 3 | 3 | 3 | |||
| (Share of total banking sector assets) | ||||||||
| All commercial banks | 100 | 100 | 100 | 100 | 100 | |||
| Of which: | ||||||||
| Romanian incorporated banks | 96.1 | 93.4 | 94.3 | 92.9 | 92.5 | |||
| State-owned | 77.8 | 74.7 | 71.0 | 46.8 | 44.3 | |||
| Private | 18.4 | 18.7 | 23.3 | 46.2 | 48.2 | |||
| Of which: Joint venture with foreign investors | 4.3 | 6.4 | 10.4 | 40.5 | 44.1 | |||
| Branches of foreign banks | 3.9 | 6.6 | 5.7 | 7.1 | 7.5 | |||
| Banks under special treatment | ||||||||
| (including: under suspension, in court, etc) | 3.7 | 1.7 | 2.5 | 1.8 | 2.0 | |||
The Ownership Structure of the Banking Sector, 1996-2000
| 1996 | 1997 | 1998 | 1999 | June 2000 | ||||
|---|---|---|---|---|---|---|---|---|
| (Number of banks) | ||||||||
| All commercial banks | 35 | 37 | 45 | 41 | 42 | |||
| Of which: | ||||||||
| Romanian incorporated banks | 29 | 31 | 36 | 34 | 35 | |||
| State-owned | 7 | 7 | 7 | 4 | 4 | |||
| Of which: Savings bank | 1 | 1 | 1 | 1 | 1 | |||
| Private | 22 | 24 | 29 | 30 | 31 | |||
| Of which: Joint venture with foreign investors | 8 | 11 | 15 | 19 | 22 | |||
| Branches of foreign banks | 6 | 6 | 9 | 7 | 7 | |||
| Banks under special treatment | ||||||||
| (including: under suspension, in court, etc) | 1 | 1 | 3 | 3 | 3 | |||
| (Share of total banking sector assets) | ||||||||
| All commercial banks | 100 | 100 | 100 | 100 | 100 | |||
| Of which: | ||||||||
| Romanian incorporated banks | 96.1 | 93.4 | 94.3 | 92.9 | 92.5 | |||
| State-owned | 77.8 | 74.7 | 71.0 | 46.8 | 44.3 | |||
| Private | 18.4 | 18.7 | 23.3 | 46.2 | 48.2 | |||
| Of which: Joint venture with foreign investors | 4.3 | 6.4 | 10.4 | 40.5 | 44.1 | |||
| Branches of foreign banks | 3.9 | 6.6 | 5.7 | 7.1 | 7.5 | |||
| Banks under special treatment | ||||||||
| (including: under suspension, in court, etc) | 3.7 | 1.7 | 2.5 | 1.8 | 2.0 | |||
6. The state-owned banks continue to take a majority share of domestic currency deposits, while the private banks concentrate on foreign currency deposits. The four existing state-owned banks—BCR, BA, EXIMBank, and the Savings Bank (CEC)— accounted for about three-fourths of total lei deposits in the banking system as of June 2000, but only a quarter of total foreign currency deposits by residents. BCR became the largest bank in the system after receiving transfers of assets and liabilities from BX in mid-1999 and the final absorption of BX’s balance sheet in September, and its share in the banking system in terms of total assets rose from 20 percent at the end of 1998 to about 30 percent at the end of 1999. Private banks, especially foreign banks and foreign branches, have concentrated on foreign currency transactions, taking about three quarters of residents’ foreign currency deposits as of end-June 2000. The asset share of foreign banks (some with substantial Romanian participation) almost tripled in 1999 alone, bringing not only technical expertise and competition, but also capital in the form of direct foreign investment.
7. Despite rapid development over the past decade and especially in the last two years, Romania’s banking system as a whole plays a limited role in its intermediation function. Ten years into transition, the overall level of monetization of the economy remains low, and the credit to GDP ratio in Romania ranks the lowest among the EU accession economies in the region.3 (Figure IV.1). The low level of financial intermediation in Romania reflected the lagged progress in restructuring and stabilization in the economy, as well as the weak financial system. Persistently high rates of inflation, variable interest rates (often negative in real terms), and problems at the large state banks all dampened confidence in and demand for the domestic currency and deposits (see previous chapter). Meanwhile, the large amount of nonperforming loans, the less-than-satisfactory enforcement on loan contracts, and the generally weak domestic activity discouraged lending.
Romania: Money and Credit, an International Comparison, 1999
(In percent of GDP)
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A004
Source: EBRD Transition reoort 2000.Romania: Money and Credit, an International Comparison, 1999
(In percent of GDP)
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A004
Source: EBRD Transition reoort 2000.Romania: Money and Credit, an International Comparison, 1999
(In percent of GDP)
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A004
Source: EBRD Transition reoort 2000.B. The Soundness of the Banking Sector
8. The soundness of Romania’s banking system has improved significantly in the last two years, owing to the restructuring of state-owned banks, and the stricter loan loss provisioning and bank supervision. The most visible improvement of Romania’s banking system occurred in 1999, helped by the closure of BX (Box IV.1), and the restructuring of BA (Box IV.2). The AVAB—an Asset Recovery Agency—was established in early 1999 to help recover bad loans from the banking system, especially those of BX. A total of about US$2.3 billion bad assets from BX and BA was transferred to the AVAB during the course of 1999, accounting for about 6 percent of GDP. The closure of BX and the removal of bad loans greatly reduced the presence of problem banks in the whole system (Table IV.2), and the total share of the nonperforming loans in the banking system declined to 35 percent at the end of 1999, compared with 59 percent in 1998 (Table IV.3). In particular, standard loans increased from 12 percent at end-1998 to more than 20 percent at the end of 1999.
The Closing of Bancorex
Bancorex (BX), the former foreign trade bank, was the largest, most troubled state-owned bank in Romania prior to its closure in 1999. Accounting for about one-fourth of total banking sector assets, BX financed a significant portion of Romania’s energy import requirements, as well as imports of capital goods, and was used as a major vehicle to subsidize the energy sector and -energy-intensive industrial sector. The legacies of subsidized loans, years of mismanagement and webbed political connections rendered BX the most troubled bank in the wake of exchange rate and price liberalization in early 1997. As BX was greatly exposed to debtors who traditionally relied on directed credit and the highly subsidized exchange rate, the termination of NBR’s directed credit and exchange rate liberalization in 1997 made it unequivocally evident that the bank was insolvent.
The 1997 rescue effort for BX failed to solve its deep-rooted problems and turn the bank around, and BX collapsed in early 1999. At the end of 1997, BX received an equivalent of US$600 million in government bonds (2 percent of GDP) in order to restructure its nonperforming loans in the portfolio. However, the restructuring of BX, which was to accompany the recapitalization, never took shape. Although a new management team was appointed in April 1998 and a few other steps were taken, a comprehensive restructuring plan was never implemented and the bank’s situation deteriorated further. When BX was again in crisis in late 1998, the authorities considered restructuring measures with a view to privatizing the bank, although international experience would have favored liquidation of the bank. The authorities were concerned about the systemic risk and the cost of liquidation, and contemplated an up-front recapitalization, followed by restructuring and privatization. As the depth of the bank’s problems was investigated, it became clear in early 1999 that BX was in much worse shape than expected, and that privatization with recapitalization would be prohibitively costly. Finally in April 1999, BX collapsed as depositors lined up to withdraw their money.
Realizing the magnitude of BX’s problem, the authorities finalized, in April 2000, a liquidation plan aimed at the orderly removal of BX from the banking system. An estimate at the end of February 1999 put the nonperforming loans of BX at about 85-90 percent of its loan portfolio, or US$1.7 billion (5 percent of GDP; this number increased as more became known about BX during the process of closing the bank), with most of the portfolio being in foreign currency. At that time, Bancorex accounted for one-fourth of total banking system assets and 47 percent of all foreign currency loans. A recapitalization would have required up to US$2 billion from the budget, or almost 6 percent of GDP. It became clear that the only solution was to liquidate the bank in a rapid and orderly fashion. To avoid further runs on the bank and a systemic crisis amid fragile external and economic situations, the liquidation plan included the following key elements: appointment of a special administrator to replace BX’s management (February 1999); transfer of all bad loans classified as such to the newly established Asset Recovery Agency (AVAB) for loan workout and debt recovery; winding down of BX operations, including transferring all liabilities to other banks and reducing staff and subsidiaries; and withdrawal of the banking license of BX before the end of July 1999.
In the event, the final resolution of BX was completed in the following manner:
All bad assets classified as such at the end of 1998 were transferred to AVAB before July 31,1999.
Some of the deposit liabilities and most foreign debt liabilities were transferred to BCR, while a large part of the deposits was withdrawn from BX before July 31, 1999, owing to delays in transfers. The NBR provided special credit to staunch the financial hemorrhage of the bank. Both BCR and the NBR were compensated by government securities in corresponding currencies.
The remainder of BX was merged with BCR, which absorbed the balance sheet of BX, as the authorities considered the actual liquidation politically unacceptable and too lengthy to complete. BCR received government securities to compensate for the gap in BX’s balance sheet, and had the rights of first refusal to any BX assets transferred (on and off the balance sheet).
The government approved the withdrawal of the banking license of BX on July 31 1999 (effective August 2).
The final absorption of BX by BCR was completed only in September 1999, while BCR’s refusal of the BX assets, which were transferred to AVAB in exchange of government securities, continued well into 2000. The Ministry of Finance also agreed to guarantee BX’s off-balance sheet items (more than US$400 million) transferred to BCR.
The closure of BX removed a large destabilizing factor in the financial system, albeit at a heavy cost to the tax-payers. The closure of BX removed some USS2 billion in nonperforming assets from the banking system, which helped to improve the general soundness of the banking system. The removal of a large source of distress borrowing from the system also greatly diminished the level and volatility of market interest rates. In this process, the government took on public debt amounting to US$1.5 billion (net of provisions and other assets), or 4,5 percent of GDP in 1999. This should be added to the 1997 recapitalization of US$600 million, and the future assumption by the government of off-balance-sheet items and litigious liabilities currently with BCR (the exact number is unknown; estimated need for government securities is about US$300 million).
It needs to be noted that the heavy fiscal costs incurred on BX in the last few years are mostly the realization of the losses incurred before 1997, caused both by the use of BX as a quasi-fiscal vehicle and by the mismanagement of the bank. Based on data provided by the authorities, the staff estimate that nonperforming loans before the recapitalization of 1997 amounted to about US$1.5 billion, and much of the off-balance-sheet liabilities and litigious liabilities had been incurred before then as well. The delays in any meaningful restructuring or liquidation of BX in the subsequent two years cost the tax-payers an additional amount of money.
The Restructuring of Banca Agricola
Banca Agricola (BA) was established in 1990 to specialize in financing the agricultural and rural sector on behalf of the state, and became the second largest insolvent bank in 1997. It expanded rapidly its portfolio, branch network, and staff in the first half of the 1990s and had become one of the top three banks in Romania by end-1995, accounting for about 20 percent of total banking system assets. BA lent almost exclusively to the agricultural sector and state-owned agribusiness enterprises, with funding sources primarily from the central bank as part of the government’s directed credit programs, in addition to aggressive mobilization of consumer deposits. As a consequence of lending to nonviable firms and ongoing structural changes in the agricultural sector, BA accumulated large amounts of bad loans over the years. The problems worsened considerably when the directed credit to the agricultural sector was terminated in early 1997. By the middle of 1997, BA’s nonperforming loans and related interests amounted to about 6 trillion lei (equivalent of US$750 million), or 70 percent of its total assets.
The government initiated a restructuring plan in 1997 which succeeded in reducing the number of retail branches and staff, but did not alter fundamentally BA’s financial solvency or its management practice. BA’s rescue package1 consisted of the following elements: A total of 6 trillion lei in nonperforming debts was identified, of which 2.6 trillion lei was removed to an account of “assets in the course of realization,” and the rest was written off against the 3.375 trillion lei five year floating T-bills used to recapitalize the bank. The accompanying restructuring plan called for downsizing of employment and branches, as well as steps toward diversifying loan portfolio, which yielded some marginal improvement of the bank’s situation. The total number of employees was reduced from 10,686 at the end of 1997 to 8,316 at the end of 1998 and 6,000 in August 1999, and one-fourth of the branches were closed down in the meantime. Nonetheless, the bank continued to make losses in part owing to the yield mismatch in assets/liabilities. Moreover, although a restructuring committee was appointed, the previous management still ran the bank and did not improve operational prudence, as it invested in non-market-determined and nontransparent investments such as the recently collapsed investment fund, FNI.
A renewed effort to restructure BA was agreed in 1999, with a view to a final resolution of the bank’s problem by mid-2000 while containing the cost to the budget. BA continued to accumulate non-performing loans after 1997, while losses mounted in part because its performing assets were yielding below market returns. Once again, more than two-thirds of the loans, or about 2.7 trillion lei, were nonperforming as of mid-1999, in addition to about 1 trillion lei in assets in the course of recovery. Rumors in the public domain concerning BA’s liquidity problems triggered heavy cash withdrawals from the bank in mid-1999, which were temporarily met by NBR’s exemption of BA’s minimum reserve requirements, and by heavy borrowing in the interbank market. The government decided to accelerate the restructuring process, which involved; (a) transfer of all bad assets—2.7 trillion lei—and assets in the Danube Fund (1 trillion lei, formerly assets in the course of realization) to AVAB in exchange for government securities; (b) appointment of an administrative board to effectively place BA under the control of the NBR; (c) establishment of a strict time table for restructuring and privatization of the bank; and (d) resolution of the bank if privatization turned out to be unrealistic or too costly to the budget.
In the event, the restructuring and privatization of BA progressed in the following manner:
A consortium of privatization advisors headed by a foreign investment bank was contracted using tendering procedures in October 1999;
All bad assets and assets from the Danube Fund were transferred to AVAB by December 1999;
An Administrative Board was appointed in November 1999 to oversee BA’s day-to-day operations, and the board took more drastic measures in downsizing the bank while cutting operational costs;
The due diligence of BA was completed in February 2000, and the privatization strategy based on the due diligence was approved by the government in April 2000, when BA was publicly offered for sale;
A firm interest letter from a potential investor was received in May 2000 but the investor withdraw its intention later; another interested party emerged in July but requested extension of privatization deadlines to allow time for assessment;
An offer by the second investor was reportedly made in September 2000. Negotiations are reportedly ongoing between the government and potential investors, while the bank is being kept afloat with special credit lines from the NBR.
Recent Developments of Problem Banks, 1998-2000
Recent Developments of Problem Banks, 1998-2000
| Percentage of Total | End-1998 | End-1999 | Mid-2000 | ||
|---|---|---|---|---|---|
| Liabilities - Problem banks | 38.9% | 12.2% | 8.2% | ||
| Problem banks - state-owned | 30.4% | 6.1% | 5.1% | ||
| Bancorex | 22.7% | 0.0% | 0.0% | ||
| Banca Agricola | 7.6% | 6.1% | 5.1% | ||
| Problem banks - private | 8.6% | 6.1% | 3.0% | ||
Recent Developments of Problem Banks, 1998-2000
| Percentage of Total | End-1998 | End-1999 | Mid-2000 | ||
|---|---|---|---|---|---|
| Liabilities - Problem banks | 38.9% | 12.2% | 8.2% | ||
| Problem banks - state-owned | 30.4% | 6.1% | 5.1% | ||
| Bancorex | 22.7% | 0.0% | 0.0% | ||
| Banca Agricola | 7.6% | 6.1% | 5.1% | ||
| Problem banks - private | 8.6% | 6.1% | 3.0% | ||
Evolution of Nonperforming Loans and Provisions, 1996-2000
Evolution of Nonperforming Loans and Provisions, 1996-2000
| 1996 | 1997 | 1998 | 1999 | June 2000 | |||
|---|---|---|---|---|---|---|---|
| (Share of nonperforming loans) | |||||||
| Romanian incorporated commercial banks | 47.2 | 52.6 | 58.5 | 35.4 | 35.4 | ||
| State-owned | 43.0 | 51.1 | 52.9 | 32.3 | 36.2 | ||
| Private | 63.3 | 60.1 | 73.9 | 37.5 | 34.8 | ||
| Of which: Joint venture with foreign investors | 24.1 | 56.2 | 45.1 | 26.0 | 34.2 | ||
| (Share of actual provision/required provision) | |||||||
| Romanian incorporated commercial banks | 64.5 | 73.1 | 73.8 | 102.7 | 94.4 | ||
| State-owned | 59.2 | 74.5 | 72.3 | 114.5 | 91.2 | ||
| Private | 79.0 | 57.0 | 77.4 | 94.6 | 96.9 | ||
| Of which: Joint venture with foreign investors | 40.3 | 56.0 | 57.6 | 90.7 | 97.3 | ||
Evolution of Nonperforming Loans and Provisions, 1996-2000
| 1996 | 1997 | 1998 | 1999 | June 2000 | |||
|---|---|---|---|---|---|---|---|
| (Share of nonperforming loans) | |||||||
| Romanian incorporated commercial banks | 47.2 | 52.6 | 58.5 | 35.4 | 35.4 | ||
| State-owned | 43.0 | 51.1 | 52.9 | 32.3 | 36.2 | ||
| Private | 63.3 | 60.1 | 73.9 | 37.5 | 34.8 | ||
| Of which: Joint venture with foreign investors | 24.1 | 56.2 | 45.1 | 26.0 | 34.2 | ||
| (Share of actual provision/required provision) | |||||||
| Romanian incorporated commercial banks | 64.5 | 73.1 | 73.8 | 102.7 | 94.4 | ||
| State-owned | 59.2 | 74.5 | 72.3 | 114.5 | 91.2 | ||
| Private | 79.0 | 57.0 | 77.4 | 94.6 | 96.9 | ||
| Of which: Joint venture with foreign investors | 40.3 | 56.0 | 57.6 | 90.7 | 97.3 | ||
9. Meanwhile, stricter requirements on loan loss provisions, capital adequacy levels, and enhanced supervision improved the banks’ capital and provisioning levels and their compliance in the last two years (Tables IV.3 and Tables IV.4). Thanks to the increased minimum capital adequacy requirement from 8 percent to 12 percent in 1999, the resolution of a large amount of non-performing loans, and significant capital injection, the ratio of banks’ capital to assets increased markedly in 1999 and 2000. In part owing to stricter supervisory enforcement, the actual provisions for loans improved from about 73 percent in 1997 and 1998 to about 100 percent in 1999.4
Capital Adequacy Ratio of the Banking System: 1996-2000
Capital Adequacy Ratio of the Banking System: 1996-2000
| 1996 | 1997 | 1998 | 1999 | 2000 | |||
|---|---|---|---|---|---|---|---|
| Romanian incorporated commercial banks | 14.0 | 13.6 | 10.3 | 17.5 | 21.4 | ||
| State-owned | 13.2 | 12.0 | 10.3 | 17.5 | 20.4 | ||
| Private | 18.4 | 22.0 | 10.0 | 17.5 | 22.1 | ||
| Of which: Joint venture with foreign investors | 22.2 | 34.7 | 36.6 | 27.0 | 22.2 | ||
Capital Adequacy Ratio of the Banking System: 1996-2000
| 1996 | 1997 | 1998 | 1999 | 2000 | |||
|---|---|---|---|---|---|---|---|
| Romanian incorporated commercial banks | 14.0 | 13.6 | 10.3 | 17.5 | 21.4 | ||
| State-owned | 13.2 | 12.0 | 10.3 | 17.5 | 20.4 | ||
| Private | 18.4 | 22.0 | 10.0 | 17.5 | 22.1 | ||
| Of which: Joint venture with foreign investors | 22.2 | 34.7 | 36.6 | 27.0 | 22.2 | ||
10. Notwithstanding the meaningful progress in improving the underlying health of banks’ balance sheets, a large part of Romania’s banking system is still plagued by poor loan quality and underprovisioning. Nonperforming loans in the banking system still accounted for about 35 percent of the total loan portfolio at end-December 1999 and June 2000, reflecting past legacies of subsidized loans and poor accounting standards, as well as poor banking supervision.5 Economic recession and another large depreciation in 1999 further worsened banks’ balance sheets. In addition, while the restructuring helped to improve indicators of bank soundness, stricter loan classification and provisioning rules contributed to the worsening of the indicators even though the underlying soundness of the banks may have improved.
11. Nonetheless, the official figures presented above show a grim picture of Romania’s banking system. In addition, the official figures understate the true scope of the banking system problems, albeit less so over time, for the following two reasons:
12. First, the current loan loss provisions are insufficient, owing to unsatisfactory asset classification regulations and substandard loan loss provisioning requirements. The current loan classification rules in Romania are based on the financial standing of the borrower as well as the record of debt service, and lax requirements on debt service and the judgment element of the rule sometimes wrongly classify what should be nonperforming loans as standard loans. In addition, because the provisions are made on the basis of the loan classification conducted six months earlier, there is substantial underprovisioning compared with required provisions based on the current loan classification. Moreover, required provisions are based on loan values net of collateral based on its book value, and the book value of collateral is often much higher than the market value. Also, no specific provisions are made against interbank claims.
13. Second, the reported capital adequacy ratio overstates the solvency situation of the banks. Banks’ assets are improperly valued (through, for example, the aforementioned insufficient loan loss provisioning), and insufficient consideration is given to market risks (exchange rate and interest rate risks, for example). Partly because of the problematic measuring of capital and assets in the Romanian system, the NBR increased banks’ minimum capital requirements from 8 percent to 12 percent in 1999 to partially compensate for the problem.
14. The authorities’ new regulations concerning asset classification and provisioning represent a major step forward in addressing these problems and putting Romania’s banking sector on a sounder footing. The new regulations on asset classification and provisioning, introduced in October 2000, bring Romania closer to the international standards. Based on the new regulations, loans are classified solely on the debtors’ debt-service record, for which a more stringent rule on debt-service delays is in place. Moreover, banks are required to classify and provision for their assets every month, and the write-offs of bad assets and related interests are 100 percent tax deductible.6 The authorities are also introducing the International Accounting Standard (IAS) to replace the Romania Accounting Standard (RAS) for all commercial banks, which will improve further the adequacy of asset valuation in the banking system.7
15. Another weakness of Romania’s banking system is its vulnerability in a number of aspects. First, a significant portion of the profits in the profitable banks comes from high returns on the T-bills, which is highly volatile and can not be sustained over the long-run. Second, as the share of nonperforming loans in banks portfolio is high, the banks are particularly vulnerable to economic recession and restructuring at the enterprise level— especially since the major enterprise restructuring still lies ahead. Third, since the banking sector as a whole has significant foreign currency liabilities and foreign currency lending, it is vulnerable to a serious decline of market confidence in the domestic currency, and/or to a sharp un-anticipated exchange rate depreciation.
C. Regulatory and Supervisory Issues in the Banking Sector
The regulatory framework
16. Over the last three years, the regulatory framework for banking has been continuously strengthened. In spite of some remaining weaknesses, it is being progressively brought in line with European and international standards and practices, with technical assistance from various sources, including the Fund, the EU, and USAID.
17. New laws governing the banking sector, including a Central Bank Law, a Commercial Banking Law, and a Bank Insolvency Law were adopted during the first half of 1998. The first two are by and large satisfactory, and have brought Romania close to accepted international practices. On this basis, a number of new and revised prudential regulations have been and continue to be issued to progressively tighten prudential standards, plug loopholes and address remaining shortcomings. By contrast, the legislation on problem banks still suffers from severe shortcomings. In particular, the determination of a bank’s insolvency is made by a Court instead of the central bank in its capacity as banking supervisor, and the procedure to initiate bankruptcy proceedings remains cumbersome and ineffective.
18. The minimum capital requirement was raised to Lei 100 billion in May 2000, and is planned to be raised again to Lei 150 billion in May 2001. Consideration is being given to steeper raises. However, contrary to international practices, there is currently no requirement for banks to permanently feature a surplus of assets over liabilities equal to or larger than the minimum capital. It is the central bank’s intention to address this regulatory shortcoming in the near future.
19. The capital adequacy requirements are consistent with the Basel Committee standards. During 1999, the minimum level was raised from 8-12 percent. This triggered a substantial improvement in the banking sector’s reported equity position. However, capital adequacy is relevant only as far as bank assets are properly appraised. Since Romania’s current loan loss provisioning rules are not strict enough, the banking system’s real solvency position is weaker than the reported one.
20. Thus, the next step in tightening the regulatory framework was to prepare stricter loan classification and provisioning rules. Such rules have been issued, and, at the expiration of a transitory period, came into force in October 2000, forcing the banks to set aside significant amounts of additional provisions. Another major improvement in this field is the tax deductibility of loan loss provisions. In the past, some of the failed banks had paid taxes on accrued interest that they did not receive, exacerbating their insolvency. Banks are striving to comply with the new loan classification and provisioning rules, and significant progress is being achieved, under close monitoring of the central bank.
21. Progress is still underway as regards foreign exchange risk. A new regulation has been prepared, but is not enforced yet. It takes into account the overall position, but fails to set limits on individual currencies, and on intra-day positions. There are still some unsettled issues on the elements to be included in the foreign currency position, in particular the capital when denominated in foreign currency, and on the tax treatment of positive revaluation differences of foreign exchange denominated assets and liabilities. Reporting requirements on foreign exchange positions are also still somewhat below best international standards and practices.
22. The regulation of banks’ liquidity is also a work in progress. Options are currently being considered, and, with outside technical assistance, a draft prudential regulation is being prepared.
Banking supervision
23. Banking supervision has also been significantly strengthened in a number of aspects, although more needs to be done on resolution methods for problem banks, and the Deposit Guarantee Fund is in financial disarray.
24. The improvement in banking supervision is reflected in a more effective organization, the implementation of an early warning system, and the development of on-site inspections. These improvements are summarized in Box IV.3.
25. As concerns the resolution methods of problem banks, several bank closures over the recent past have tested both the central bank’s ability and the applicable laws and regulations’ suitability in dealing with distressed banks. A few insolvent banks have been able to remain open and active for several years, defying the central bank’s efforts to get them closed. As a result, there are still several unresolved problem banks requiring daily attention and waiting for a resolution of some sort.
26. This experience confirms that further improvements in the Bank Insolvency Law are needed. In particular, the central bank needs more discretionary power to take special administrative measures against problem banks and to file for bankruptcy, while appeal possibilities by third parties should not hold up the bankruptcy procedure as easily as they do now. Ways to improve the effectiveness of the Court system also need to be considered. Detailed proposals are being prepared within the central bank and are to be discussed in the near future with the government with a view to introducing amendments to the current Law.
27. As regards the Deposit Insurance Fund, it has been an operational success but a grave financial failure. The Deposit Guarantee Fund was established in 1996, i.e. before the banking system had been cleaned up and stabilized. By the time it had to repay the depositors of a failed bank for the first time in 1999, its reserves were still modest, and two thirds of its resources were soaked up, in spite of that bank’s limited size (0.4 percent of the banking sector). When a second, more sizeable bank (2.4 percent of the banking sector) closed in early 2000, the cost for the Fund represented 6.5 years of ordinary assessments, and the Fund had to be financially supported by the central bank. With the closure of a third bank (1.7 percent of the banking sector) in mid 2000, additional central bank support was unavoidable. For years to come, the Fund will struggle to repay the central bank, even without any new bank closure, and remain unable to accumulate any reserves, defeating the very purpose of its establishment.
Recent Improvements in Banking Supervision
Organization
The NBR’s supervisory function was reorganized in September 1999. On-site and off-site supervision were combined in a new Supervision Department. It consists of four Divisions. Three are in charge of a portfolio of individual banks. There is no separate division for problem banks: they are spread among the Divisions to level off the workload. The fourth Division of the Supervision Department is the Synthesis Division. This division is in charge of the Bank Rating and Early Warning system described below.
As part of the reorganization, a second department was formed: the Financial and Banking Policies Department. This department is responsible for licensing banks and exchange offices, issuing prudential regulations, and managing the Credit Information Bureau.
This new organizational structure appears by and large satisfactory. However, the coordination between the supervisory and policy departments could be improved; there is not yet adequate legal expertise in the Supervision Department and in the Financial and Banking Policies Department, and an efficient division of labor with the central bank’s Legal Department remains to be defined.
Off-site monitoring
Bank Rating and Early Warning system: Since September 1999, the Synthesis Division of the Supervision Department, has been focusing on the development and the implementation of a Bank Rating and Early Warning system based on accepted international standards. This system covers capital adequacy, asset quality, profitability, and liquidity. It is based on 30 internally developed ratios per component, which result in a rating (scale 1 to 5) for each component as well as in a composite rating, which characterizes the overall quality of a bank. The quality of management is not directly included in the system, but taken into account when computing the composite ratio.
Apart from the composite rating per bank, an extensive number of ratios has been defined, which, in combination with the rating system, are used for the monthly analysis of the banking system. The analysis is in principle on an aggregate level, but where necessary details of individual banks are added as an explanation. The analysis, together with the result of the rating system is presented monthly to the Board of Directors. There is a delay of two months in the presentation of the data. The implementation of the rating system as well as the monthly analysis are significant achievements bringing Romania closer to EU and international best practices.
Decision Matrix for Progressive Enforcement Actions: Also since September 1999, a Decision Matrix for Progressive Enforcement Actions has been put in force. It identifies remedial actions appropriate in various situations, based on the Banking Law. After a break-in period of a few months, the matrix has been revised and the measures to be taken have been strengthened. A manual, which contains the procedures for the actions to be taken on the basis of the situation identified in the matrix is currently being drafted.
On-site inspections
Considerable achievements have also been made regarding on-site inspections. Much effort has been made to improve the on-site methodology and to train the staff of the three divisions, also with technical assistance from USAID. Gradually, the coverage of on-site inspections is widened, and the focus moved away from the formal checking of data towards a more risk-oriented approach of understanding the facts behind the figures.
Each bank is now inspected at least once per year. Moreover, the Savings Bank (CEC) has been included in the inspections since September 1999; previously this was not the case, because of the special status of the CEC, of which the deposits are guaranteed by the state.
D. Nonbank Financial Sector Issues
28. The nonbank financial sector is still in the midst of serious unresolved issues and acute problems. While progress has been initiated on bringing credit cooperatives and popular banks under an appropriate supervisory umbrella, the mutual funds sector has been devastated by a high-profile incident and will need to be rebuilt from the ground up, and other nonbank financial institutions’ situation still needs to be comprehensively assessed.
Credit cooperatives
29. A 1996 Law has authorized the introduction of credit cooperatives and popular banks. These are grass-root, unregulated (no licensing, no prudential norms, no required reserves, no reporting requirements) financial intermediaries which compete directly and on uneven terms with regular banks. About 2000 entities of this kind are active in Romania. Most of them are very small, and some organized themselves in networks. Although specific data is missing, their aggregated assets are estimated at ROL 3,000 billion, some 2 percent of the total for the banking system or 0.5 percent of GDP
30. The dangers of this situation were clearly demonstrated when the largest institution of this type, Banca Populara Romana, with assets of Lei 800 billion, appeared unable to repay its depositors in June 2000. This unfortunate incident triggered adverse sentiment about the financial sector as a whole. On the other hand, it provided the impetus to accelerate the completion of a new legislation, already being prepared within the central bank, to regulate these institutions.
31. Under an Emergency Ordinance issued in July 2000, the credit cooperatives and popular banks were given one month to identify themselves with the central bank or wind down their operations. The identified institutions have been given two options. They can become full fledged banks, provided that they meet all prudential requirements imposed on banks. It is not expected that any of the concerned institutions will be able to take this option. The second option is to join a cluster of at least 100 similar institutions and organize a network. Two such networks, and possibly a third one, are in the process of emerging. They will be subjected to specific prudential regulations and requirements, somewhat lighter, but by and large comparable, to those imposed on banks. They will not be allowed to use the word “bank” in their names. The rules are based on the principles of the cooperative banks as applied in a number of European Union countries. Each network will have a central institution, coordinating the activities of the cooperatives and serving as administrative center. The supervision of the individual cooperatives in the group will be delegated to the central institution. The central institution will be supervised by the central bank.
Investment funds
32. The investment fund sector is in deep disarray in Romania at the current juncture, following the May 2000 collapse of the largest mutual fund, Fondul National de Investitii (FNI), which represented 90 percent of the market and had high visibility, with high profile nationwide advertisement campaigns on television and magazines. After the collapse, it became clear that FNI had been little more than a pyramid scheme for years, and that none of the safety measures against fraud had been effective in stopping it. The head of FNI’s management company fled abroad, thereby impeding the investigations. The National Securities Commission (CNVM), in charge of supervising the investment funds, did not play its role, in spite of blatant anomalies, and its former Head has been jailed. Moreover, CEC, the state owned savings bank, developed a complex and unhealthy relationship with the FNI, as a shareholder in the management company; an investor for substantial amounts, generating large profits until the collapse; a provider of a disputed guarantee for the investors; and a close business partner, allowing, through a subsidiary, use of its name and reputation as a state owned bank as a promotion tool in advertisement.
33. Meanwhile the investigations into the affair have taken longer then initially expected. The results of the investigations on FNI as regards the beneficiaries of the fraud and the complexity which made it possible to last for several years have reportedly been concluded but not been announced yet. The incident has now taken a political turn, with the Parliament getting involved, amidst growing controversy. Most recently, the cabinet has initiated legislation that would grant limited compensation to all FNI investors before the fund’s assets are recovered.
34. In the meantime, two courts have decided that CEC be held responsible for the guarantee extended compensate for the losses of the FNI investors. The financial impact is potentially very large, more than CEC’s net equity. An new appeal by the CEC is pending. The authorities, with World Bank assistance, have begun work on the governance issues involved in the FNI incident, and more generally on the regulation and supervision of the non bank financial sector.
This chapter was prepared by Olivier Frecaut and Tao Wang.
Four specialized state banks—Banca Agricola (BA), BANCOREX (BX), Romania Commercial Bank (BCR), and Romania Bank of Development (BRD)—were established at the end of 1990, although Bancorex had existed since 1972, involved exclusively in foreign trade related transactions. Banc Post and the EXIM bank were established in 1991 and 1992, respectively. While the savings bank (CEC) was existed since 1949, it remained a state institution rather than a bank until the late 1990s.
The credit to GDP ratio was understated in 1999 when bad assets from BX and B A were transferred to the Asset Recovery Agency (AVAB), effectively removing credit amounting to 5 percent of GDP from the system.
The write-off of bad loans and transfer of bad assets to AVAB obviously contributed to the decline of required loan loss provisioning.
The state-owned banks were used as a means of quasi-fiscal operations to sustain the inefficient loss-making state enterprises and the agricultural sector prior to 1997, accumulating nonperforming loans on their balance sheets. The problems were aggravated by the elimination of NBR’s directed credit and by the sharp depreciation and high interest rates that followed the exchange rate and price liberalization in early 1997.
One key improvement that is not in the regulation was a rule implemented in 1999—banks are now required to provision 100 percent for interest overdue by more than 90 days (which was previously counted as income), irrespective of the value of collateral.
One main difference between the two standards is that under the RAS, fixed assets (and collateral) are valuated at book value rather than market value, but are not inflation adjusted, whiles the IAS values the fixed assets (and collateral) at market value, but inflation adjusted.
