Modalities of liquidity management

23. Under its interest rate-based operational framework, the NBS’ key monetary instrument is the interest rate on its weekly tender of two-week repos.² After some adjustment to the system introduced in February 2000, the interest rate of the two-week repo tender³ is now transmitted efficiently to the interbank money market. Standing overnight facilities—deposit, or “sterilization,” and credit⁴, or “refinancing”—are used to cap excessive changes in short-term interest rates. The NBS instruments and their use are quite transparent.

24. As the NBS prepares for the Slovak Republic’s accession to the EU, it intends to further refine its monetary policy instruments to more closely conform with ECB practice. While the NBS plans to raise the rate of remuneration on required reserves to market levels in harmony with the ECB, it has no plans to change the structure of remuneration now in place. Currently the NBS remunerates reserve balances up to the required level each day rather than remunerating average reserve levels for the settlement period (up to the average required level). This practice lowers the remunerated average when reserves balances vary over the period, which discourages the desirable use of reserve averaging as a liquidity management instrument. The FSAP team recommended that the average reserve holding over the settlement period (up to the average required level) be remunerated at market rates.

25. Currently the markets in which banks and others manage their liquidity are small, but growing. The foreign exchange market registered the most growth in the past few years. The infrastructure of the markets is adequate, but would benefit from further technical improvements (e.g., tax distortions in the government securities market should be removed, and the structure and the transparency of the government’s debt issue program should be further improved). The lack of depth in these markets may reflect in part the ease with which bank’s can manage liquidity through the central bank.

26. The payment system is generally efficient and largely observes the CPSS Core Principles. The Slovak Interbank Payment System is owned, operated, and managed by the Slovak National Clearing Center. Only banks participate directly in the system. The legal uncertainties related to the payment system have been recognized and will be addressed by a new Payment System Law, which is expected to come in force in the second half of 2002. Also, in a few years a new RTGS system for large value payments will be introduced, replacing the current net settlement system. In the new system the NBS intends to implement intra-day credit facilities, as in the European Central Bank framework.

Safety nets

27. Slovakia has made significant progress toward putting in place safety net schemes for banks, insurance companies and securities firms. For banks, the NBS’ lender of last resort function is explicitly stated in central and commercial bank legislation. Though the NBS has a good understanding of its appropriate use and the rules specified by its management are clear, it would be helpful to formalize in an internal NBS document the arrangements for lender of last resort support, so that they are easier to implement in difficult times in order to minimize pressures toward regulatory forbearance.

28. Deposit insurance/investor protection is generally in place or planned. Deposit insurance is provided under the Bank Deposit Protection Act. The Deposit Protection Fund (DPF) administers the coverage. The amount insured under the law is roughly equal to Euro 7,700 and is set to rapidly increase to Euro 20,000 to converge with the relevant EU directive immediately upon EU accession. For securities firms, an investor protection scheme is scheduled to become operational by mid 2002. In the insurance sector, a partial safety net exists in the form of a motor vehicle third party liability (TPL) fund created in September 2001, which will pay TPL claims in case of insurance company failure. All three schemes are modeled on applicable EU directives.

29. Banking sector safety net arrangements have functioned effectively to date, although the cost of failure resolution has been fairly high. During 1999–2001 four small/medium sized banks failed⁵ and were put into liquidation under bankruptcy, and the Deposit Protection Fund (DPF) in all four cases paid off the large majority of insured depositors within 3 months of the failure event, at a cost of approximately Sk 20 billion (equivalent to 2 percent of estimated 2001 GDP). As a result, the DPF’s resources have been depleted, and it borrowed from the NBS to honor its legal obligations. This has also placed an undue burden on the solvent banks, which have been subject to high contributions to the DPF. A financial plan that addresses the DPF’s insolvency position and future financial viability is needed.

Banking supervision

30. Banking regulation has been significantly strengthened through the recent adoption of a new banking law. The newly adopted banking law (effective January 2002) provides a stronger framework for corporate governance, risk management, enforcement, and consolidated supervision. The procedures for efficient resolution of problems in banks have also been substantially strengthened in the new law. The supervisor now possesses the explicit authority to require corrective action plans from banks, including requirements for a capital plan, plans for strengthening a bank’s financial position, and other action the NBS determines necessary. Subsequent enforcement actions may be taken if NBS requirements are not met. Supporting regulations must now be drafted in order to further define selected aspects of the new SBA and to implement various provisions. In particular, regulations addressing classification of assets, market risk and risk management, capital adequacy, large exposures, and other areas must be updated or prepared. This process is currently scheduled to be completed by end September 2002.

31. The almost complete foreign ownership of Slovak banks (only two are branches of foreign banks) has implications for supervision. With over 90 percent of banking business in Slovakia conducted by foreign-owned institutions, cooperation and exchange of information between the Slovak authorities and the home country supervisors of the banks are critical aspects of maintaining high-quality supervision. In addition, enhanced cooperation and exchange of information among supervisors in the region can be an effective way to develop capacity to monitor emerging risks in banking. Many of the new bank owners in Slovakia are also strategic investors in banking in neighboring countries, such as Austria, Hungary and the Czech Republic, where they are following similar business strategies. Since the risks from these strategies are likely to emerge at different times in different places, closer supervisory cooperation can give the Slovak authorities a strengthened ability to anticipate emerging problems. Progress has been made on this front; by end-June 2002 the NBS had signed bilateral cooperation agreements with foreign supervisors in the Czech Republic, Germany, and Hungary and was negotiating with 5 other countries.

32. Implementing the new legal framework and achieving effective supervision will not be easy. Overcoming past practices (reflected in the low level of compliance with the Basle Core Principles for Effective Banking Supervision) and achieving fundamental change in the way supervision is implemented will require years of effort. The authorities are committed to such an effort. Early steps were the replacement of the management of the BSD and accepting an IMF-provided resident advisor on banking supervision to assist with the effort. To guide the reform, the NBS Board adopted an ambitious Supervisory Development Plan prepared with the assistance of the World Bank. In accordance with the plan, it adopted and published a new mission statement for banking supervision in December 2001 and a new supervisory strategy in May 2002. In addition to staff training and modernization of manuals, which are essential, prudential regulations will be strengthened and brought into conformity with the new law. With vigorous effort, supervision can be brought up to satisfactory levels in three to five years. The effort needed is considerable, however, and will require the continuous strong commitment of management and staff.

33. Banks’ financial statements, which are still prepared in accordance with inadequate Slovak accounting standards, do not present an accurate picture of their financial condition. The discrepancies that most affect banks are that Slovak standards do not require fair valuation of assets or nonaccrual of interest on distressed assets. These faults may result in misrepresentation of bank income and capital. A principal concern is that these deficiencies overstate the true level of bank capital and correspondingly understate the system’s exposure to risks. While such distortions introduce an unavoidable degree of uncertainty into vulnerability assessments, they do not appear to be so large as to invalidate the process.⁶ One way to compensate for this uncertainty is to utilize relatively demanding shocks in stress tests, as this assessment sought to do. If the system does not then show widespread vulnerability, there can be some confidence that it will remain robust despite accounting errors at more reasonable levels of projected shocks. Nevertheless, adoption and implementation of International Accounting Standards are required to convey needed information to the users of the financial statements, including the supervisors.

Capital markets and insurance supervision

34. The new securities law in force from January 1, 2002 and the new insurance law in force from March 1, 2002 have significantly enhanced the MoF’s and FMA’s authority to regulate and supervise capital markets and the insurance industry. The split between regulatory responsibility of MOF and the supervisory responsibility of FMA imposes a coordination challenge. Since November 2000, capital markets and the insurance industry have been supervised by the FMA, and under the new laws passed in 2002, the FMA has specifically been given wide powers of supervision and can now impose a range of remedial measures and penalties to address violation of laws, regulations or terms and conditions of its permits or licenses. However, the Ministry of Finance (MoF) continues to be responsible for legislation and regulations applicable to these segments of the financial system.

35. The new securities law, as well as a recent amendment to the Commercial Code, have significantly improved shareholder rights. However, there is still room for improvement. Specifically: (i) accounting and auditing standards are not in line with IAS/ISA; (ii) the definition of securities does not cover all products that should be subject to regulation; (iii) information required in issuer prospectus is insufficient; (iv) minority shareholder rights are not fully protected; (v) dealings by officers in the shares of the company, related party dealings, and total benefits received by way of remuneration from the company do not have to be disclosed; and (vi) there are inadequate rules about market manipulation.

36. Regulation of securities firms has been tightened. Before enactment of the new securities law on January 1, 2002 there were approximately 150 securities firms licensed in Slovakia. These firms were not required to limit their activity to trading in securities. Many firms were engaged in a mixture of securities trading, real sector trading and holding/investment company activity. All these firms have until the end of September 2002 to apply for a new license, but the actual re-licensing process is not expected to be completed until mid 2003. It is expected that of the 150 firms, not more than around 30 will be interested in, and able to meet the requirements for (including the minimum capital requirements), obtaining a new license as a securities broker/dealer (more narrowly defined). Of these 30 firms, approximately 20 are likely to be banks (thus, nearly all banks are expected to be also engaged in securities brokerage/dealing activity). Contrary to what was the case under the old securities law, the new securities law contains detailed provisions for the separation of securities firms’ own assets from client assets.

37. Under the new insurance law, external auditors are required to report to the supervisor factors that could impair the ability of the company to meet its obligations. However, the new law does not protect these professionals with immunity from civil suits that might be launched against them as a result of their making reports of this nature. The new law also strengthens corporate governance but does not go far enough. It does not contain specifics regarding the duties of Directors with respect to setting investment policies and general risk management.

38. While supervision and regulation of capital markets and insurance are quite transparent, the FMA’s institutional capacity and enforcement track record still needs to be built up. The FMA as a young agency still needs to develop its internal procedures, manuals and information systems, as well as provide input into the process of reissuing securities markets and insurance regulations to implement the new laws. Due to a lack of experienced supervisors, especially actuaries, the FMA relies heavily on external auditors. The FMA’s independence, funding, and human resources all need to be strengthened.

39. As a result of the above referenced weaknesses, Slovakia still falls short of observing the IOSCO Objectives and Principles of Securities Regulation. Most but not all of the IAIS’s Core Principles are observed. Areas of concern are: (i) the lack of instructions from the supervisor regarding the desired features in a system of internal controls (Boards of Directors should be made responsible for their implementation and monitoring); and (ii) the lack of a program by the supervisor for establishing disclosure standards and other consumer protection measures. The FMA will likely require additional resources if it is to fulfill its mandate.

Payment systems oversight

40. The oversight of the payment system is given to the NBS in the central bank law. Payment systems policy formulation and implementation by the NBS satisfies a very high standard of transparency. The system has functioned well, but the NBS has decided to design and implement a new RTGS under central bank operational control in order to meet the requirements of the EU. A detailed design is now under preparation.

Current condition

50. Financial restructuring has diminished the NPL problem considerably (Table 4). In the process of selling the state-owned banks to private foreign strategic investors, the government cleaned up bank balance sheets by removing about Sk 112 billion of NPLs (13 percent of GDP) and transferred them to consolidation agencies. New capital has been injected as Government bonds, and banks are now generally very well capitalized. NPLs not covered by provision (net NPLs) in the system have fallen from 25 percent of total loans in 1998 to 7–8 percent currently (stronger enforcement of loan loss provisioning rules may bring this figure up). This amount is much more manageable, particularly in light of the doubling in the banking system’s capital ratio that has taken place over the same time period.

Table 4.

Slovak Republic: Financial Soundness Indicators for the Banking Sector, 1997–2001

(In percent, unless otherwise indicated)

Source: National Bank of Slovakia.

^1/Excluding KBB.

^2/Net income to total assets

^3/Net income to book equity

^4/Liquid assets include government securities of all types and maturities, cash and reserve balances at NBS.

^5/Defined as liquid assets to highly volatile liabilities in the NBS Supervisory Information System.

Table 4.

Slovak Republic: Financial Soundness Indicators for the Banking Sector, 1997–2001

(In percent, unless otherwise indicated)

		1997	1998	1999	2000	2001
		December
Capital Adequacy
Regulatory capital to risk-weighted assets 1/		8.0	6.6	12.7	13.1	19.7
Asset Quality
	Sectoral distribution of loans to total loans
Individuals		5.2	6.5	8.7	10.7	15.3
Government		2.0	2.1	2.0	1.7	3.7
Agriculture		4.5	3.8	4.6	3.6	4.2
Mining		0.7	0.9	0.7	0.6	0.7
Manufacturing		29.5	28.7	20.7	18.6	19.7
Transportation		1.8	2.1	1.3	1.2	3.9
Financial services		5.0	2.3	2.7	2.5	3.8
Other services		51.2	53.6	59.3	61.2	48.6
	FX loans to total loans	7.4	8.2	9.1	8.3	7.8
	NPLs to gross loans 1/	27.2	31.6	23.7	15.3	14.0
	NPLs net of provisions to capital	22.5	25.2	15.7	6.9	7.9
Earnings and Profitability
	ROA2/	0.09	-0.48	-2.27	1.41	1.07
	ROE3/	2.81	-13.39	-36.53	25.16	25.26
	Interest margin to gross income	68.6	56.6	50.8	72.0	72.2
	Non-interest expenses to gross income	66.1	66.6	102.7	98.2	102.4
	Personnel expenses to non-interest expenses	33.3	35.4	28.6	25.5	24.6
	Trading and fee income to total income	29.7	39.5	46.1	27.8	28.9
Liquidity
	Liquid assets to total assets 2/	13.5	9.7	12.1	18.1	27.5
	Liquid assets to short term liabilities 3/	47.8	38.6	59.7	90.7	61.4
	Customer deposits to customer loans (ratio)	1.22	1.20	1.34	1.59	2.13
	Customer FX deposits to total deposits	11.6	16.2	16.2	17.4	18.3
Sensitivity to market risk
	Net open positions in FX to capital	59.51	-0.25	11.07	-53.48	-23.03

Source: National Bank of Slovakia.

^1/Excluding KBB.

^2/Net income to total assets

^3/Net income to book equity

^4/Liquid assets include government securities of all types and maturities, cash and reserve balances at NBS.

^5/Defined as liquid assets to highly volatile liabilities in the NBS Supervisory Information System.

View Table

Table 4.

Slovak Republic: Financial Soundness Indicators for the Banking Sector, 1997–2001

(In percent, unless otherwise indicated)

		1997	1998	1999	2000	2001
		December
Capital Adequacy
Regulatory capital to risk-weighted assets 1/		8.0	6.6	12.7	13.1	19.7
Asset Quality
	Sectoral distribution of loans to total loans
Individuals		5.2	6.5	8.7	10.7	15.3
Government		2.0	2.1	2.0	1.7	3.7
Agriculture		4.5	3.8	4.6	3.6	4.2
Mining		0.7	0.9	0.7	0.6	0.7
Manufacturing		29.5	28.7	20.7	18.6	19.7
Transportation		1.8	2.1	1.3	1.2	3.9
Financial services		5.0	2.3	2.7	2.5	3.8
Other services		51.2	53.6	59.3	61.2	48.6
	FX loans to total loans	7.4	8.2	9.1	8.3	7.8
	NPLs to gross loans 1/	27.2	31.6	23.7	15.3	14.0
	NPLs net of provisions to capital	22.5	25.2	15.7	6.9	7.9
Earnings and Profitability
	ROA2/	0.09	-0.48	-2.27	1.41	1.07
	ROE3/	2.81	-13.39	-36.53	25.16	25.26
	Interest margin to gross income	68.6	56.6	50.8	72.0	72.2
	Non-interest expenses to gross income	66.1	66.6	102.7	98.2	102.4
	Personnel expenses to non-interest expenses	33.3	35.4	28.6	25.5	24.6
	Trading and fee income to total income	29.7	39.5	46.1	27.8	28.9
Liquidity
	Liquid assets to total assets 2/	13.5	9.7	12.1	18.1	27.5
	Liquid assets to short term liabilities 3/	47.8	38.6	59.7	90.7	61.4
	Customer deposits to customer loans (ratio)	1.22	1.20	1.34	1.59	2.13
	Customer FX deposits to total deposits	11.6	16.2	16.2	17.4	18.3
Sensitivity to market risk
	Net open positions in FX to capital	59.51	-0.25	11.07	-53.48	-23.03

Source: National Bank of Slovakia.

^1/Excluding KBB.

^2/Net income to total assets

^3/Net income to book equity

^4/Liquid assets include government securities of all types and maturities, cash and reserve balances at NBS.

^5/Defined as liquid assets to highly volatile liabilities in the NBS Supervisory Information System.

51. However, bank profitability is under pressure (Table 5). While net income has improved significantly in recent years, this gain is based in large part on non-recurring items, such as a reversal of funds previously committed to specific provisions or to the general risk reserve. Looking at an operating profitability measure before provisioning, the rate of return on assets shows the system at near-zero profitability for the past three years.

Table 5.

Slovak Republic: Profitability and Cost Indicators in the Slovak Banking System, 1997–2001

(In percent, unless otherwise specified)

Source: National Bank of Slovakia.

Table 5.

Slovak Republic: Profitability and Cost Indicators in the Slovak Banking System, 1997–2001

(In percent, unless otherwise specified)

		1997	1998	1999	2000	2001
Profitability
	Operating profit (ROA)	1.40	1.37	-0.10	0.07	-0.09
	Net income (ROA)	0.09	-0.48	-2.27	1.41	1.17
	Net income (ROE)	2.81	-13.39	-36.53	25.16	25.26
Costs
	Earnings/employee (Sk thousands)	1,322	1,340	1,117	1,485	1,612
	Employees (1,000s)	23.7	23.8	23.6	22.2	21.2
	Operating expense/assets	2.73	2.73	3.67	3.88	3.20

Source: National Bank of Slovakia.

View Table

Table 5.

Slovak Republic: Profitability and Cost Indicators in the Slovak Banking System, 1997–2001

(In percent, unless otherwise specified)

		1997	1998	1999	2000	2001
Profitability
	Operating profit (ROA)	1.40	1.37	-0.10	0.07	-0.09
	Net income (ROA)	0.09	-0.48	-2.27	1.41	1.17
	Net income (ROE)	2.81	-13.39	-36.53	25.16	25.26
Costs
	Earnings/employee (Sk thousands)	1,322	1,340	1,117	1,485	1,612
	Employees (1,000s)	23.7	23.8	23.6	22.2	21.2
	Operating expense/assets	2.73	2.73	3.67	3.88	3.20

Source: National Bank of Slovakia.

52. As banks reduce the overabundance of liquid assets in a seach for higher yields, they will need to venture into new and potentially risky business areas. The new foreign owners are changing the direction of the banking business. Bank strategies now emphasize expanding into retail banking and mortgages. However, the underdeveloped Slovak banking markets, because of their small size, may not be able to generate sufficient profits for all entrants. Competitive pressures in an environment of low operating profitability can also be expected to drive a further round of consolidation. A new capital adequacy regulation, expected to be adopted in the fall of 2002, will introduce a capital charge for exchange rate and interest rate risks.

Stress tests

53. In light of the macroeconomic risks faced by Slovakia, stress tests were administered to individual bank balance sheet data to estimate the result on capital of adverse interest rate, exchange rate, and credit quality shocks. The stress tests carried out were calibrated to reflect various relatively severe macroeconomic shocks: a deterioration in loan quality corresponding to a moderate recession; a large permanent upward shift in the yield curve or a large currency depreciation; and a monetary policy defense against an exchange rate crisis with a corresponding 10 percentage point jump in interest rates that is expected to reverse fully within one year. Because of the large exposure of Slovak enterprises to foreign currency debt, the indirect credit risk effects of a depreciation were also taken into account in the exchange rate test. Scenarios that produce a combination of shocks, e.g., simultaneous high interest rates and depreciation, could result in more severe vulnerabilities, but such scenarios were not explicitly tested because they are difficult to specify with a reasonable degree of likelihood. The sample used for stress tests included 17 banks, accounting for 90 percent of banking system assets. Stress tests indicate that the Slovak banking system can absorb shocks to credit risk, and high interest rate and foreign exchange shocks, without generating systemic distress, although vulnerabilities emerge in all cases (Table 6).

Table 6.

Slovak Republic: Banking System Stress Tests

(Ratio of regulatory capital to risk-weighted assets)

Sources: National Bank of Slovakia; and Fund staff estimates.Note: Sample average is weighted by assets.Interest rate shock: One shock applied was an upward shift in the yield curve equivalent to 3 standard deviations (which represents a 99 percent confidence level) for a 3-month change in the bank deposit rate over the period February 1993 to December 2001. This is equivalent to an upward shift of 248 basis points. Another shock was a severe inversion of the yield curve, given by a 1000 basis point immediate spike in rates expected to reverse completely in one year. This shock would be consistent with a successful monetary policy-based defense of exchange rate levels.Exchange rate shock: Two tests were done for exchanges. The first was to apply to net foreign exchange positions a depreciation of 3 standard deviations (which represents a 99 percent confidence level) for a 3-month change in the exchange rate for the period February 1993 to December 2001. The shock is equivalent to a depreciation of 12.77 percent.The second shock adds to the direct exchange rate shock an estimate of the indirect credit risk effect of me exchange rate change. This estimate was constructed by assuming, in the absence of full information on the distribution of company debt, that debt/asset ratios of firms were step-wise uniformly distributed across the interval [0, 1] and that all firms had the average share of foreign currency debt in total debt. For firms at the extreme debt/asset value of 1, the depreciation shock was applied to the value of foreign currency debt and the resulting percentage increase in the debt/asset ratio was taken as a measure of the percentage of firms that would be pushed into insolvency by the depreciation. This percentage was applied to me end-2001 stock of nonfinancial business loans from banks in Slovakia to obtain an estimate of new NPLs, which was combined with the direct effects of the exchange rate shock to get a total foreign exchange risk effect.Credit risk shock: The Slovak economy has shown a relatively low degree of business cycle volatility. To estimate the credit risk consequences of a potential recession shock, the percentage point increase in the NPL ratio that occurred during the recession of 1997–99 in the Czech Republic (the economy most structurally similar to the Slovak economy) was used. This shock was equivalent to a 65 percent increase in total end-2001 NPLs, and is assumed to reflect a moderate recessionary shock (the Czech real GDP declined about 2.5 percent over me 3-year recession period), although one that would be relatively significant compared to the (limited) economic history of the Slovak Republic.

Table 6.

Slovak Republic: Banking System Stress Tests

(Ratio of regulatory capital to risk-weighted assets)

	Interest rate shock		FX shock
Pre-shock	Shift	Spike	Direct shock	With indirect credit shock	Credit shock
19.5	14.8	19.8	19.0	16.6	15.5

Sources: National Bank of Slovakia; and Fund staff estimates.Note: Sample average is weighted by assets.Interest rate shock: One shock applied was an upward shift in the yield curve equivalent to 3 standard deviations (which represents a 99 percent confidence level) for a 3-month change in the bank deposit rate over the period February 1993 to December 2001. This is equivalent to an upward shift of 248 basis points. Another shock was a severe inversion of the yield curve, given by a 1000 basis point immediate spike in rates expected to reverse completely in one year. This shock would be consistent with a successful monetary policy-based defense of exchange rate levels.Exchange rate shock: Two tests were done for exchanges. The first was to apply to net foreign exchange positions a depreciation of 3 standard deviations (which represents a 99 percent confidence level) for a 3-month change in the exchange rate for the period February 1993 to December 2001. The shock is equivalent to a depreciation of 12.77 percent.The second shock adds to the direct exchange rate shock an estimate of the indirect credit risk effect of me exchange rate change. This estimate was constructed by assuming, in the absence of full information on the distribution of company debt, that debt/asset ratios of firms were step-wise uniformly distributed across the interval [0, 1] and that all firms had the average share of foreign currency debt in total debt. For firms at the extreme debt/asset value of 1, the depreciation shock was applied to the value of foreign currency debt and the resulting percentage increase in the debt/asset ratio was taken as a measure of the percentage of firms that would be pushed into insolvency by the depreciation. This percentage was applied to me end-2001 stock of nonfinancial business loans from banks in Slovakia to obtain an estimate of new NPLs, which was combined with the direct effects of the exchange rate shock to get a total foreign exchange risk effect.Credit risk shock: The Slovak economy has shown a relatively low degree of business cycle volatility. To estimate the credit risk consequences of a potential recession shock, the percentage point increase in the NPL ratio that occurred during the recession of 1997–99 in the Czech Republic (the economy most structurally similar to the Slovak economy) was used. This shock was equivalent to a 65 percent increase in total end-2001 NPLs, and is assumed to reflect a moderate recessionary shock (the Czech real GDP declined about 2.5 percent over me 3-year recession period), although one that would be relatively significant compared to the (limited) economic history of the Slovak Republic.

View Table

Table 6.

Slovak Republic: Banking System Stress Tests

(Ratio of regulatory capital to risk-weighted assets)

	Interest rate shock		FX shock
Pre-shock	Shift	Spike	Direct shock	With indirect credit shock	Credit shock
19.5	14.8	19.8	19.0	16.6	15.5

Sources: National Bank of Slovakia; and Fund staff estimates.Note: Sample average is weighted by assets.Interest rate shock: One shock applied was an upward shift in the yield curve equivalent to 3 standard deviations (which represents a 99 percent confidence level) for a 3-month change in the bank deposit rate over the period February 1993 to December 2001. This is equivalent to an upward shift of 248 basis points. Another shock was a severe inversion of the yield curve, given by a 1000 basis point immediate spike in rates expected to reverse completely in one year. This shock would be consistent with a successful monetary policy-based defense of exchange rate levels.Exchange rate shock: Two tests were done for exchanges. The first was to apply to net foreign exchange positions a depreciation of 3 standard deviations (which represents a 99 percent confidence level) for a 3-month change in the exchange rate for the period February 1993 to December 2001. The shock is equivalent to a depreciation of 12.77 percent.The second shock adds to the direct exchange rate shock an estimate of the indirect credit risk effect of me exchange rate change. This estimate was constructed by assuming, in the absence of full information on the distribution of company debt, that debt/asset ratios of firms were step-wise uniformly distributed across the interval [0, 1] and that all firms had the average share of foreign currency debt in total debt. For firms at the extreme debt/asset value of 1, the depreciation shock was applied to the value of foreign currency debt and the resulting percentage increase in the debt/asset ratio was taken as a measure of the percentage of firms that would be pushed into insolvency by the depreciation. This percentage was applied to me end-2001 stock of nonfinancial business loans from banks in Slovakia to obtain an estimate of new NPLs, which was combined with the direct effects of the exchange rate shock to get a total foreign exchange risk effect.Credit risk shock: The Slovak economy has shown a relatively low degree of business cycle volatility. To estimate the credit risk consequences of a potential recession shock, the percentage point increase in the NPL ratio that occurred during the recession of 1997–99 in the Czech Republic (the economy most structurally similar to the Slovak economy) was used. This shock was equivalent to a 65 percent increase in total end-2001 NPLs, and is assumed to reflect a moderate recessionary shock (the Czech real GDP declined about 2.5 percent over me 3-year recession period), although one that would be relatively significant compared to the (limited) economic history of the Slovak Republic.

54. Stress tests indicate that Slovak banks are now less vulnerable to credit risk. The threat of existing loans turning bad is unlikely to be the focus of vulnerability going forward, because banks are now well-capitalized, borrowers are in an improved financial condition, and more conservative lending rules are being adopted. However, with exports amounting to 70 percent of GDP, a shock to foreign demand and exports, for example, could have significant real economy effects. The impact on the domestic banking system is mitigated because export-oriented firms have accumulated relatively little credit from the domestic banking system. However, the spill-over output losses in other sectors will impact on the quality of banks’ portfolios. For a credit risk shock of a 65 percent increase in NPLs, only one bank drops (modestly) below the 8 percent Basel minimum capital ratio. A qualification to this outcome that was not formally incorporated into stress tests is that Slovak accounting standards, which do not require fair valuation of assets and allow the accrual of interest on distressed loans, may understate the true level of NPLs and overstate capital. Looking forward, improved credit management can be expected to slow the pace of generating any new NPLs.

55. The banking system would be negatively affected, although not to the point of systemic risk, by a large and sustained increase in interest rates, with a few institutions being highly vulnerable. Moreover, it is important to underline that emerging trends in bank behavior are likely to make market risk a greater concern in the future. For example, as the fixed-rate mortgage market grows, bank susceptibility to interest rate mismatches may also grow.⁹ If the pressure of bank competition encourages banks to incorporate conditions friendly to the borrower, new elements of market risk will emerge. The banks’ foreign owners should be relatively well equipped to handle such risks. However, supervisors will need to be vigilant.

56. The banking system is not very sensitive to the direct effects of exchange rate shocks. It is more sensitive to the indirect credit risk of depreciation worsening the balance sheets of its corporate clients whose external debt amounted to Sk 325 billion, or 34 percent of GDP at the end of 2001. Another Sk 53.5 billion, or 5.5 percent of GDP, was borrowed in foreign currency from the domestic banking system. Information on the extent of hedging is incomplete. Traditionally, external borrowing has been largely unhedged. However, after having been hit by the 1998–99 depreciations, there are indications that enterprises with most of their revenues in koruna have increasingly hedged their foreign currency debt. A significant share of external borrowing has been by state-owned enterprises (mainly utilities), which means that there would be fiscal consequences. For most of these state-owned enterprises, revenues are almost exclusively in koruna. Foreign banks have been prepared to lend to these enterprises despite their lack of foreign currency income, because they have been backed by government guarantees. The government’s failure to sufficiently curtail such guarantees is one of the weak points in its fiscal policy.

Going forward

57. NBS and government policies going forward will influence the development of the banking sector through the type of regulatory framework they create. A more efficient banking system will contribute more to economic development and to minimizing vulnerabilities.

58. Ownership restructuring undertaken since 1998 has improved the condition of the Slovak banking system in several ways but further improvements will be needed to eradicate the past weaknesses in credit management practices. When the remaining smaller bank privatizations agreed and anticipated for 2002 are completed, the share of banking system assets controlled by foreigners will rise to over 98 percent. The entry of strong foreign owners is expected to strengthen the credit culture and governance in these banks, as well as bring in new, modern risk management systems, such as credit risk scoring (although this cannot be taken for granted and will need to be reassessed in future).

59. Banks can be expected to respond to low profitability by reaching for yield, improving efficiency, expanding into retail lending, and/or consolidating further. Although labor shedding in the banking sector in the wake of restructuring is apparent, other measures of cost, such as the ratio of operating expenses to assets have not yet shown sustained improvements (see Table 6). The banks—eager to improve returns—have ambitious business plans emphasizing potentially risky areas new to Slovakia like consumer banking, mortgage banking and lending to small and medium sized enterprises. To facilitate the realization of these potential new lines of business, some market infrastructure development and legislative fine tuning will also be required; e.g. support for the creation of credit bureaus and for the development of housing finance. Banks that do not succeed in expanding profitable product lines or reducing costs will merge or exit. Bank exit policies should facilitate such consolidation.

Creditor rights

68. As a general rule, creditor rights remain weak, collateral systems other than for the traditional mortgage are poorly developed, and enforcement procedures are slow and unreliable through the courts. As a result, credit is largely inaccessible to all but the upper echelon of corporate borrowers. To offset the high regulatory risk, lenders have adopted a policy of requiring fully secured loans in nearly all corporate transactions. Similarly, the process of insolvency remains slow, inefficient, and poorly regulated, although recent changes in the law have led to improvements. Legal and regulatory weaknesses have fueled a growing business in lease finance, where ownership resides in the lender or creditor, making asset recovery more efficient and predictable.

69. Court system weaknesses and inefficiencies are the most significant detriment to debt enforcement. While the Foreclosure (Execution) Law has greatly enhanced the ability of creditors to foreclose on assets, mostly real estate, the creditor is unable to avoid court proceedings and continue enforcement without the cooperation of the debtor, which rarely occurs. Another notable deficiency in creditors’ ability to secure their debts is the lack of a registry for pledges on movable property. Currently, possession is required to effect a pledge on movables. A new law and pledge registry for pledge of movables is being developed with assistance from the EBRD and should enhance significantly asset based lending. Bankruptcy presents the worst option for a creditor to recover debt. Though creditors’ rights in a bankruptcy proceeding were strengthened by amendments adopted to the Bankruptcy Law as of August 1, 2000, creditors continue to find that participation in bankruptcy proceedings is not fruitful. Courts are weak as an institution in the Slovak Republic, and bankruptcy courts are no exception. The lack of professional development and regulation of trustees, important players in the bankruptcy process, represents another significant institutional weakness in the bankruptcy system.

Accounting and auditing standards

70. Slovakia’s legislative requirements on accounting and corporate financial reporting seem to be geared toward satisfying the information needs of the tax authorities only; other users, including investors and creditors, have difficulty in making meaningful use of the financial statements for market-oriented decision making. There is a large gap between Slovak accounting requirements and IAS. Although listed companies are required to prepare financial statements in accordance with IAS, in addition to statutory annual financial statements, there is no mechanism to monitor and enforce this requirement. As a result, many of the statements presented as IAS financial statements do not fully comply with IAS.

71. Slovak banks are required to follow Slovak Accounting Standards. International Accounting Standards (IAS) will not be adopted before 2003. There are several differences between the two accounting systems that impact the usefulness of banks’ reporting. For example, Slovak standards do not require fair valuation of assets or non-accrual of interest on distressed assets. These may result in misrepresentation of bank income and capital. Furthermore, the Slovak disclosure requirements fall short of IAS disclosure standards.

72. In the auditing area, too, a number of problems indicate the need for a well-organized reform program: auditors’ failure to comply with internationally comparable independence and ethical requirements, inadequate capacity of the Slovak Chamber of Auditors to properly regulate the profession, shortcomings in educational and training arrangements with regard to the practical application of high-quality accounting and auditing standards and requirements, and absence of effective mechanisms for enforcing established rules and regulations.

73. The authorities, with assistance from the World Bank, have agreed to design and implement a Country Action Plan (CAP) for bringing Slovak accounting and auditing standards and practices in line with IAS and international best practice standards.

Pension funds development

74. The expenditures for benefits and administration costs for the basic social security system or 1st pillar are already exceeding revenues, and a deficit has accumulated. Parliament recently approved reforms to the first pillar aimed at easing the strains on the system, including changes to the benefit formula to link benefits more closely with contributions, the elimination of certain privileged pensions, and a gradual increase in the retirement age for women.

75. The government is looking for alternatives to augment the 1^st pillar pension by creating special privately managed 2^nd pillar funds. These funds would be financed by setting aside a portion of the mandatory contributions that are being collected to finance the 1^st pillar. Such accounts to be established for participants would be invested in securities and other approved investments. One of the difficult questions is to establish the portion of the current mandatory contribution that can be diverted to second pillar funds, and the overall funding pool is still limited. Sk 65 billion in privatization receipts have been set aside in an account at the NBS to finance pension reform, but the details of its use are still undecided.

76. Special legislation was passed in 1996 authorizing the creation of “supplementary pension insurance companies (DDPs)” under the supervision of Ministry of Labor as special purpose legal entities under the civil code to manage a 3^rd Pillar. There are currently 4 DDPs and each one of them has the responsibility for the sales administration and asset management of their fund.

77. Even though supplementary pension insurance companies are financial institutions and have the privilege of collecting contributions from the public, the operations of the DDP and their managed funds are rather non-transparent. The legislation should make clear that the DDP is a pension fund management company with responsibilities for assets management and administration. They should be subject to the same standards of disclosure and transparency as any other type of financial institution. Accounting rules should be specified for them that indicate clearly to their members and to the general public how successful the management company has been in covering the operating expenses and in producing attractive investment returns for the benefit of participants. Since the pension funds could eventually become major players in domestic and regional capital markets, it would be advisable to transfer responsibility for supervision of the DDPs to the FMA.

Credit bureau

78. A functional credit bureau, a necessity for development of consumer finance, does not yet exist. While each bank knows the credit history of its own clients, this information is not shared. Five banks have recently formed an alliance to set up a credit bureau. Once operational, the alliance will be expanded to include all interested banks, and at a later stage other financial institutions as well.

79. Legal changes are needed to overcome the banking law’s secrecy requirements and restrictive provisions of the law on protection of personal data (Law no. 52/1998). Both laws should be amended to allow a Credit Bureau to collect information on credit from banks and other financial institutions without prior client consent, and to allow meaningful bank access to this information, although provisions should be included to protect against the abuse of the personal and financial information collected. Additionally, banks need to agree on organization and technical aspects, such as consumer credit database design, the rules for its use and methods of integration with other information systems, such as collateral registries. Timely reporting to this database should be mandatory for all banks and later for all other types of lending institutions. Access should be open to all participating financial institutions.

Housing finance

80. There are three separate housing finance schemes, all supported by Government subsidies. The first scheme comprises specialized ‘home savings banks’. Borrowers must save a pre-specified amount of money over a pre-specified period of time to become entitled to a housing loan. Savings are subsidized and both savings and loan interest rates are fixed at below market levels and earned interest is tax free. The second scheme comprises an interest rate subsidy for mortgage loans provided by selected commercial banks meeting a higher absolute minimum capital requirement, financed primarily through the issuance of mortgage bonds—tradable fixed income securities collateralized with mortgage loan receivables. Interest on these bonds is tax-exempt. The third scheme consists of an extra budgetary State Housing Development Fund (SHDF) which makes housing loans at subsidized interest rates to low-income individuals, and municipalities for the purchase of newly constructed housing for rental to low income families. These loans, although funded by the budget, are administered by commercial banks under agency contracts. Although the SHDF will cease to exist by end 2002, no decision has been taken on what to do with its existing loan portfolio. There are no linkages between the three schemes, thus individuals can tap into multiple schemes to maximize subsidy receipt.

81. EU accession and the prospect of rapid integration of Slovakia’s financial markets into EU financial markets may warrant adjustments to housing finance support policies. In the short term thought should be given to: (i) linking the ‘home savings bank’ subsidy to taking up a housing loan; (ii) means-testing the ‘home savings bank’ savings subsidy and the mortgage loan interest rate subsidy; and (iii) introduction of a minimum mortgage bond funding ratio to preclude banks from taking on undue interest rate risk. In the medium term, once interest rates converge toward EU levels and per capita income grows, subsidies could be further reduced or abolishing altogether, the minimum absolute capital requirements for regular commercial banks and ‘mortgage banks’ could be unified and ‘home savings banks’ could be transformed into regular commercial banks. The latter two steps would allow a faster consolidation of the banking system and strengthen Slovak banks’ ability to withstand strong cross border competition after EU accession.

Clarity of roles, responsibilities and objectives of central bank for monetary policy

99. The NBS is an independent central bank with the primary objective of maintaining price stability, as specified in the NBA. The NBS’s monetary policy has been predominantly geared to lowering inflation since 1998, without plans to move to a formal inflation targeting framework. The NBS’s monetary policy decisions are taken mainly on the basis of inflation benchmarks set by the NBS. In a context of a floating exchange rate regime, the NBS has adopted a policy of only intervening on the foreign exchange market to avoid sharp oscillations of the exchange rate, and to smooth the assimilation of large, lumpy, and temporary foreign currency inflows resulting from privatization. The NBA assigns the institutional responsibility for foreign exchange to the NBS. In addition, the NBS is responsible for issuing banknotes and coins and controlling, coordinating and ensuring the circulation of money; the payment system and settlement between banks; ensuring the efficient and effective performance of these operations; and supervising the safe functioning of the banking system, as specified in NBA.

100. In pursuance of its monetary policy objective, the NBS uses an operating framework very similar to that used by the ECB. The main instrument used to signal its monetary policy stance is the weekly auction of repos and reverse repos with a maturity of two weeks. The NBS requires commercial banks to maintain minimum required reserves (defined as deposits with the NBS) of 4 percent, and building societies to maintain minimum required reserves of 3 percent. To limit the volatility in the cost of liquidity, the NBS introduced two overnight standing facilities in February 2000, the refinancing facility and the deposit (“sterilization”) facility. The NBS also uses outright sales or purchases of three-month NBS bills with irregular issues.

101. The Bank Board, the governing body of the NBS specified by the NBA, sets the interest rates and the Auction Committee of the NBS decides the amount to be tendered in the weekly two-weeks repo tender. The procedures for appointment and terms of office for the Bank Board is specified in the NBA. The decisions to change the instruments are promptly made public, along with adequate explanations why the changes were necessary, and the NBA provides for instrument independence for the NBS.

102. The government cannot override the NBS decisions, and the NBS is forbidden by law to give credits and overdrafts to the government. There is a clearly defined institutional relationship between monetary and fiscal operations, as well as the procedures for central bank involvement in the rest of the economy (e.g., procurement or provision of services for a fee). The agency roles performed by the central bank for the government are clearly defined and made public. The NBS organizes the primary government securities market for the MoF. Currently the MoF issues mainly nine to twelve months Treasury bills and government bonds with maturities ranging from 1 to 10 years. The NBS also acts as the banker of the government, the manager of the foreign exchange reserves, fiscal agent to the government and advisor on economic and financial policies and in the field of international cooperation, as stipulated in the NBA.

103. The NBS is accountable to the parliament (National Council), as stipulated by the NBA, and to the public. The NBS has to submit to the National Council semi-annual reports on monetary developments, along with audited financial statements, according to international accounting standards. The NBS is required to inform the public of changes in monetary policy and to provide summary balance sheets.

Open process for formulating and reporting monetary policy decisions

104. The NBS formulates and reports monetary policy decisions in an open process. The framework, instruments and targets to pursue the objectives of monetary policy are publicly disclosed and explained, and the responsibility of the Bank Board to assess the underlying economic developments, monitor progress toward achieving the monetary policy objectives and formulate policy is publicly disclosed, as required by the NBA.

105. Although the process in which the NBS formulates and reports monetary policy decisions is open, the NBS should formalize the framework in which advance consultations for technical changes, instructions and guidelines take place. There is a formal requirement for all secondary laws (NBS Decrees) to be submitted to the affected industry for comment before they are adopted. The NBS already consults the public and the affected industry, and incorporates their comments prior to adopting major changes, like the ones included in the secondary laws (NBS Decrees). However, there is no formal procedure for or practice of submitting proposed changes to the industry in advance for comments for changes coming under a legal document lower than a Decree. The NBS sometimes consults informally with the Slovak Bankers’ Association or others for proposed substantive technical changes in NBS rules and regulations. The team recommended that the NBS adopt a similar policy with regard to all operational and regulatory changes. More intensive and formal public consultations for proposed technical changes to the structure of monetary regulations give the public the opportunity to propose changes, including providing an opportunity to present reservations and expected problems in advance, and, therefore, to improve policies.

Public availability of information on monetary policy

106. The NBS subscribes to Special Data Dissemination Standards and it complies with the standards. The NBS publicly discloses a summary balance sheet each ten days within two weeks after the end of the reference period on the website. An advance release calendar, providing the precise release dates is disseminated on the NBS website. Complete and audited financial statements are prepared annually within three months of the end of the calendar year (Article 38 (3) of the NBA). An independent auditor prepares, the “Auditors’ Report and Summarized Statutory Financial Statement” and the “Independent Auditors’ Report and International Financial Statements” published in the Annual Report, according to International Accounting Standards and in accordance with Slovak legal regulations and in a format comparable with the format used for international purposes. A wide range of monetary data and all of the NBS’ monetary operations are published monthly in its Monetary Survey, as well as foreign exchange assets and liabilities.

107. The information on monetary policy is publicly available in a timely manner and of high quality, in various publications and on the website. This is not the case with the emergency credit information, however. Emergency financial support by the NBS has been rare and its details, which on each occasion would involve a single bank, were not published as such. However, on each occasion the fact of the assistance was publicly acknowledged. The results of such credits are reflected, in the aggregate financial statements of the NBS. In addition, the extension of credit by the NBS to the Deposit Insurance Fund was publicly disclosed. The team recommended improving the disclosure of emergency credits. While giving due recognition to concerns relating to stability of the financial markets, confidentiality and moral hazard, the NBS should disclose aggregate information on the emergency credit facilities, exercising judgment on the timing and on the nature of the information disclosed. Such disclosure enhances policy efficiency and accountability of the use of public funds. Information reported could include amounts, terms, follow-up developments, amount outstanding and repayments made, press releases, press communiqués, or other communication vehicles.

108. The public information services of the NBS are carried out by the Public Relations Department. The Department disseminates the publications cited above and also publishes monetary policy decisions and policy announcements in Slovak on the website. Starting with the first half of 2002, it is planning to post them in English as well. Moreover, the NBS operates a website (http://www.nbs.sk), which contains information on the structure, role and organization of the NBS, legislation, data, and research by NBS staff. The English website provides mostly data and legislation governing NBS, as well as a summary of the objectives of the NBS and the Bank Board appointment rules. The website is structured also by function to take account of the multiple functions of the NBS (monetary policy, banking supervision, payment system oversight). The Department also maintains contact with media representatives. All texts of regulations by the NBS are published in Vestnik and on the NBS website in Slovak. The publication is mailed to the commercial banks and can be available by subscription.

109. The NBS issues the Annual Report and the monthly Monetary Survey. They are both posted on the website in Slovak and English and available in hardcopies. In addition, the Annual Report on Monetary Developments in the Slovak Republic that is submitted to the National Council by the NBS is a part of the Annual Report of the NBS and it is available in Slovak and English on the website and in hardcopy.

110. Moreover, the NBS submits to the National Council the Semiannual Report on Monetary Developments in the Slovak Republic. This report, required by the NBA (Article 3), is available only in the Slovak version of the website. The NBS banking journal Biatec was issued in print until January 2002 in both languages and its contents were published on the NBS website (for the English version). Currently only the Slovak version is issued in print, and the English version is on the website. All publications are distributed by mail to interested parties, and are available on the website and as hardcopy at the NBS headquarters. NBS also publishes research working papers on the website in English and Slovak. The NBS has also published information brochures on the Slovak Interbank Payment System, Market for Government Securities and National Bank of Slovakia, (publication, 1999, 2000, 2001; as well as multimedia CD-ROM, 2000). They are both posted on the website in Slovak and English and available in hardcopies. The NBS has also published Documents in the Archives of the NBS and Branch Offices of the NBS, along with promotional leaflets on money issue and other specific activities. In addition, legislation documents (the NBA and the Foreign Exchange Act) are printed in volumes that include both Slovak and English versions, along with explanations. The NBS publications are free of charge, unless otherwise stated above.

Accountability and assurances of integrity by the central bank

111. The NBS Governor appears before the National Council twice annually and upon request. In addition, The Monetary Programme is presented by the Governor to the press and commercial banks in December each year. Moreover, the NBS Governor and or one of her/his Deputies may attend meetings of the National Council and the Government and present the NBS’s views with regard to economic or financial issues. Senior NBS officials also attend meetings of the Committee on European Integration and the Meeting of Economic Ministers (PEM). NBS senior officials very often appear before National Council commissions to present the NBS’s position during legislation work. NBS senior officials give interviews, appear on television, and give speeches on monetary policy and financial sector issues as well as the state of the economy. The NBS Governor and other NBS senior officials regularly give interviews, appear on television, give speeches, attend meetings of the Slovak Bankers’ Association and appear in front of the National Council at request. The speeches of the Governor and other NBS senior officials will be published on the NBS website also in English in the first half of 2002 (so far they have been available only in Slovak).

112. The NBS has very thorough principles and arrangements of internal audit and control in place. An NBS Internal Code of Conduct containing internal rules and regulations with regard to standards for the conduct of personal affairs of officials and staff of the central bank, “Code of Ethics of NBS Employees,” is listed on the Slovak version of the NBS website and it is available upon request. This Code is similar to standards for the conduct of central government employees, but it includes also specific features given by the nature of the NBS work.

113. The information on expenses and revenues is presented in disaggregated form in the audited financial statement in the Annual Report, “Auditors’ Report and Summarized Statutory Financial Statements” and “Independent Auditors’ Report and International Financial Statements.”

114. The NBS intends to improve its transparency further. Currently the efforts of the NBS are concentrated on improving the communication with the public by further developing its website. Both the Slovak and English version have been modified to include more information in a more user friendly format, starting with April 2002. The Public Relations Department efforts will be concentrated during 2002 in this direction.

Recommended actions

Table 7.

Slovak Republic: Recommended Plan of Actions to Improve Transparancy of Monetary Policy

Table 7.

Slovak Republic: Recommended Plan of Actions to Improve Transparancy of Monetary Policy

Reference Practice	Recommended Action
I. Clarity of Roles, Responsibilities and Objectives of Central Banks for Monetary Policy
II. Open Process for Formulating and Reporting Monetary Policy Decisions	Advance consultation for technical changes, instructions and guidelines should be formalized.
III. Public Availability of Information on Monetary Policy	Disclosure of emergency credits should be improved.
IV. Accountability and Assurances of Integrity by the Central Bank

View Table

Table 7.

Slovak Republic: Recommended Plan of Actions to Improve Transparancy of Monetary Policy

Reference Practice	Recommended Action
I. Clarity of Roles, Responsibilities and Objectives of Central Banks for Monetary Policy
II. Open Process for Formulating and Reporting Monetary Policy Decisions	Advance consultation for technical changes, instructions and guidelines should be formalized.
III. Public Availability of Information on Monetary Policy	Disclosure of emergency credits should be improved.
IV. Accountability and Assurances of Integrity by the Central Bank

Authorities’ response

115. The NBS generally agreed with the assessment.

General

116. The Basel Core Principle assessment was performed as a part of the Slovak Financial Sector Assessment Program (FSAP) with the objective of determining the country’s compliance with international best practices in banking supervision as prescribed by the Basle Committee for Effective Banking. A two-member team¹² assessed compliance with the Principles during a visit in late February 2002. Banks in the Slovak Republic are supervised by the Banking Supervision Department (SD) of the National Bank of Slovakia. The documents used for the assessment included relevant laws and regulations, including the Slovak Banking Act, the Act on the Slovak National Bank, Anti-Money Laundering Act, Commercial Code, Act on Auditors, Civil Code, Slovak Accounting Standards, and Decrees of the National Bank of Slovakia. Many aspects of Slovak legislation are undergoing substantial change. However, the assessment is based on those laws, regulations and practices that were in effect at the time of the assessment. Extensive discussions were held with the Chief Executive Director of the NBS Supervision Department (SD), managers, and staff. Visits were made to several commercial banks, major auditing firms, the Chamber of Commerce, and to the Financial Police. The assessment also benefited from information collected by other FSAP team members who assessed compliance with the IAIS Core Principles, IOSCO Core Principles, the IMF MFP Transparency Code and Anti-Money Laundering experts.

117. The team had full access to all information and individuals needed to complete the assessment. The country counterparts were very cooperative, and no impediments to the process were encountered.

118. The assessment was based on the Basel Committee Methodology for assessing the Basel Core Principles. The Slovak Republic’s compliance with the Core Principles (CPs) was assessed against both “essential” criteria and “additional” criteria. This implies that the Slovak Republic, in addition to seeking to fulfil the minimum standard, also strives to apply international best practice.

Institutional and macroprudential setting, market structure—Overview

119. Banking supervision was set up in 1992 as a separate department of the Slovak branch of SBCS, the former central bank of Czechoslovakia. When Slovakia became independent in 1993, it became a part of the National Bank of Slovakia. Today, the SD is responsible for oversight of the banking sector and benefits from the independence of the NBS that is provided under the Constitution. The Financial Market Authority (FMA) oversees the insurance and capital market sectors.

120. Presently, the banking sector in the Slovakia consists of 20 licensed banks. Of these, 5 are currently domestically (state) owned. Fifteen are foreign-affiliated: thirteen are foreign subsidiaries, and 2 are branches. The three largest banks held 55 percent of the market at the end of 2001.

121. The banking sector in the Slovak Republic has undergone a significant change in ownership as a result of the government’s reform efforts and in response to a severely distressed banking sector. As a key part of their restructuring strategy, the authorities pursued rapid privatization of state-owned banks. The strategic investors making direct, controlling investments have been uniformly from outside the country. As a result, the Slovak banking sector is on the threshold of becoming nearly 100 percent foreign-owned.

122. The restructuring of the system involved a carve out of bad assets in selected banks totalling approximately 13 percent of GDP. This, together with privatisation, resulted in a decline of problem assets and a marked increase in the capital ratio. Banks’ restructured balance sheets are now largely deployed in highly liquid assets (cash, central bank accounts, or Treasury bills). As a result of the investment in lower yielding assets, interest rate spreads are relatively tight. No relief in this current yield configuration is immediately apparent due to the existing competitive environment and the perceived lack of quality loan demand. In order to bolster profitability, banks may begin reaching for yield through new products and fee generated business that could, in turn, introduce new risks to the balance sheet.

General preconditions for effective banking supervision

123. While the public infrastructure that supports financial sector oversight is gradually improving, it still presents challenges to effective banking supervision. Recently, a number of changes have been made to the legal framework. However, the legal framework in the area of general court procedures needs strengthening in order to provide increased enforceability of contracts, collateral, and creditor rights (see the assessment of observance of the World Bank’s Principles and Guidelines for Effective Insolvency and Creditor Rights Systems). More specifically, the banking legal framework has been considerably changed in the last two years. The newly adopted Slovak Banking Act (SBA) (effective January, 2002) provides a stronger framework for, in part, bank governance, risk management, enforcement, and corrective actions, particularly in the area of problem bank resolution.

124. The exit policies used to remove a bank from the system should be improved. The experience with the resolution of the four banks that were closed in 2000/2001 highlighted weaknesses in the bankruptcy law and procedures when applied to banks. Amendment of selected provisions in banking, deposit protection and bankruptcy legislation to address these issues is desirable. Additionally, the NBS should consider developing detailed guidelines for temporary administrators directing them to use least cost failure resolution methods rather than as a matter of first choice opting for full insured depositor payoff.

125. Deposit insurance is provided under the Act on Protection of Bank Deposits (BDP Act). The Deposit Protection Fund (DPF) administers the coverage. The amount insured under the law is roughly equal to Euro 7,700 and is set to rapidly converge with the relevant EU directive. The cumulative effect of the four previous bank failures rendered the DPF insolvent. The BDP Act was recently amended to address many of the issues that contributed to this situation. A financial plan that addresses the DPF’s insolvency position and future financial viability is needed.

126. Slovak banks are required to follow Slovak Accounting Standards (SAS). International Accounting Standards (IAS) will not be adopted until 2004. There are several differences between the two accounting systems that impact the usefulness of banks’ reporting. Overall, SAS does not go far enough to present a fully comprehensive picture of banks’ and enterprises’ true economic positions. Banks are audited according to SAS, however, increasingly foreign owned banks are receiving dual audits according to both SAS and IAS. The SBA authorizes the NBS to require additional audit steps in the form of a “long form” report. Upon notification by banks of the appointed external auditor, the SD has the right to veto the selection if certain credible concerns exist.

127. Market discipline is generally weak as the tools used to apply such discipline are not adequate. Corporate governance, accounting and disclosure practices, and auditing standards still lag behind international best practices and hinder the ability of the users of financial information from drawing well-informed opinions on the safety and soundness of the sector. This consequently impacts the level of confidence with which the domestic and international public view the condition and status of the Slovak financial system. Slovakia’s move toward International Accounting and Auditing standards and stronger disclosure practices is essential for improving financial transparency and meaningful use of financial statements.

128. The key source of macroeconomic risk in Slovakia’s open economy is the potential for sustained pressure in the foreign exchange market. With elections in September 2002, increases in perception of political risk are also possible.

Main findings

129. Banking supervision in Slovakia must be further strengthened, both in its practice and its application of the law, in order to ensure that the safety and soundness of the system is safeguarded. Fundamental change in the way supervision is implemented must still be accomplished to be effective and consistent with international best practices. However, the authorities recently have taken significant, meaningful steps to begin a comprehensive development process. Supervisory objectives have been crystallized in the form of a mission statement that has been publicly disclosed. The supervisor’s legal authority has been significantly enhanced through the new Slovak Banking Act (SBA), effective January, 2002. The SBA places stronger governance responsibilities on supervisory boards and management and provides the supervisor with increased authority to require remedial action by these parties. Enforcement capacity has been further enhanced through the provisions of prompt corrective action and through other expanded remedial capacities. However, effective implementation of law must still be accomplished. The supervisory process is still more compliance based, and there is a continuing need to conduct more qualitative assessments on bank safety and soundness, management practice, systems, and risk management. As the supervisor’s capacity to conduct a more proactive supervisory approach develops, its willingness and confidence to carry out its mandate as expressed in its mission statement and operating policy should likewise be enhanced and demonstrated.

130. Objectives, autonomy, powers, and resources (CP 1): Banking supervision enjoys the independence of the central bank provided by the Constitution. The legal framework for banking supervision is also suitable and provides supervisory independence. While the SD enjoys the benefits of this structure, the lack of adequate financial resources and trained personnel inhibits its ability to respond effectively and on a timely basis, thereby de facto, compromising its independence. Recent changes to the SBA have enhanced the supervisor’s authority and ability to act, in part based on certain safety and soundness provisions. However, the ability of the supervisor to address safety and soundness issues in banks is significantly encumbered by its institutional capacity and its reluctance, and restrictions by its legal counsel, to apply qualitative judgement. Now that the SBA allows freer exchange of information among supervisors, an operating mechanism to facilitate the needed communication should be established.

131. Bank licensing and structure (CPs 2–5): The SBA limits the use of the term “bank” and clearly defines permissible activities. However, it does not explicitly provide the NBS with the authority to act against any entity which is, de facto, conducting the business of banking. Due to this and the issue cited above regarding the NBS’ hesitance in interpreting banking legislation, the supervisor has not taken action with entities suspected of deposit gathering activities. The licensing process, as stipulated by law, addresses the key elements critical to prudent authorization. The supervisor has full authority to reject any proposal for ownership, in a de novo bank or in a change of control, if they do not meet the specified criteria. The law conforms to the EU directive, which requires strict investment limits and requires notification of such investments.

132. Prudential regulations and requirements (CPs 6–15): Banks are required to maintain a level of capital adequacy, individually and on a consolidated basis, consistent with international standards. However, the supervisor has not yet introduced a regulation allowing it to require capital based on a bank’s individual risk profile, and there is no capital charge for market risk. The experience in many countries (including Slovakia) is that the integrity of reported financial information is often poor, and therefore, the accuracy of the capital adequacy levels is unreliable (CP6). Banks are required to have internal policies, controls, and monitoring over the credit granting process. However, legislation and guidelines do not specifically cite the importance of bank internal policy to the effective oversight and governance of a bank’s statutory and supervisory boards (CP7). Banks are required to risk rate and classify their loan portfolios, but classification of investments and other assets is not captured. The current regulation requires further implementation (CP8). The SBA limits exposures to large and groups of borrowers. However, the definition of borrower groups is subject to rules for consolidated accounting that hinders effective combination of indebtedness for risk concentration purposes. The rule governing large exposures requires more emphasis on strong governance and the responsibilities of the bank authorities to ensure prudent control over concentrations of risk. It also requires further implementation (CP9). The SBA provides a sufficiently broad definition of “persons having special relationship” to a bank and provides adequate provisions governing such (CP10). The SBA does not specifically address country and transfer risks (CP11), and no market risk management provisions have been provided (CP12). While the SBA requires, generally, that individual banks have appropriate risk management processes, the supervisor’s ability to assess banks’ risk management processes requires strengthening (CP13). The SBA describes the responsibilities of the members of statutory and supervisory boards in the area of safety and soundness, qualifications of internal auditor and head of internal control. More specific definition of what constitutes sound internal controls is needed (CP14). Significant effort in the area of anti-money laundering has been made and legislation is in substantial compliance with international standards. The new legislation and procedures must now be implemented (CP 15).

133. Methods of Ongoing Supervision (CP 16–20): The delivery of supervision to the banking sector is currently weak. The supervisory system consists of both on and offsite supervision. However, at the time of the assessment the objectives and methodology of supervision were ambiguous. The department had just been reorganized and the strategy and approach to examining and conducting off-site monitoring was undefined. Staff continue to need training (CP 16). The off site process does have a means of collecting needed information, but does not yet collect consolidated information (CP 18). Supervisory contact with bank management is not sufficient to establish a regular, fluid exchange of information and convey supervisory concerns. Routine evaluation of the quality of management has not been conducted. (CP 17). The supervisor has a means of independent validation of the supervisory information it receives, through both on-site examinations and external auditors. However, those means are not used in an optimal manner. In the past, material misstatements of financial condition by banks have not been addressed in a timely manner. (CP 19). The supervisor, through the SBA, has the authority to conduct supervision of consolidated entities, however, these provisions must now be implemented (CP 20).

134. Information Requirements (CP 21): The supervisor requires that banks maintain records according to Slovak Accounting Standards (SAS) and NBS regulatory reporting requirements. Implementation of the provisions in the SBA providing the supervisor with substantially improved authorities to ensure accurate regulatory reporting and financial statements is needed. Certain aspects of SAS significantly hinder accurate reporting of banks’ true economic positions, and the supervisor is reluctant to require more conservative regulatory accounting.

135. Formal Powers of Supervisors (CP 22): The SBA provides a range of remedial actions to the supervisor, which, if interpreted properly and effectively applied, offer the supervisor sufficient leverage and actions to oversee the banking sector. In order to accomplish this, the overall practice of supervision must continue to be strengthened. The willingness and capacity of the supervisor to identify issues and to take timely and effective actions must still be demonstrated.

136. Cross-Border Banking (CPs 23–25): The SBA gives the authority to the supervisor to conduct supervision over consolidated entities, both domestically and internationally. Guidelines and processes must be developed in order to implement the requirement (CP 23). The legal framework allows information sharing with other domestic and international supervisors. However, the supervisor must continue to build its operational capacity to allow foreign supervisors to place reasonable confidence in its oversight abilities (CP 24). The SBA allows the supervisor to share information with foreign supervisors once a formal MoU is in place. At the time of assessment, only one MOU was in place for a system that is now 90 percent foreign owned. The supervisor is actively pursuing MOU arrangements with a number of foreign supervisors (CP 25).

Efforts underway to improve compliance

137. Overall compliance with the Core Principles needs improvement. While compliance on a legal basis has substantially improved with the adoption of the SBA (effective January, 2002), the implementation of the law and the application of sound supervisory practices by the supervisor still need improvement. In December, 2001, the NBS Bank Board adopted a Supervisory Development Plan (SDP) that provides time bound objectives for further strengthening bank supervision. This Plan, if fully implemented both through regulation and through practice, should serve to address a number of the issues cited in Core Principles Assessment. Effective implementation of the core elements of the Plan will require at least a 2–3 year time horizon.

138. Objectives, autonomy, powers, and resources (CP1): Supervisory independence would be clearly enhanced if financial and human resources were improved, and increased qualitative judgement was used in interpreting law and regulation. If effectively implemented, the objectives listed in the SDP should help achieve fuller compliance with this section and should enable the supervisor to build its reputation and garner increased respect from the domestic and international public. Within the context of the public infrastructure, the adoption of IAS and the strengthening of governance standards and bank exit procedures will further enhance the NBS’ ability to effectively oversee the banking sector. Compliance with elements CP 1(2) (operational independence and adequate resources), CP 1(3) (suitable legal framework—authorization of banks), CP 1(4) (suitable legal framework—powers to address compliance with laws and safety and soundness), and CP 1(6) (arrangements for information sharing) are in the process of being addressed.

139. Licensing and Bank Structure (CP 2–5): The recent adoption of the SBA has contributed to substantial legal compliance in this area. However, due to the lack of explicit enforcement provisions to take action against institutions conducting de facto banking activities, such institutions, in the past, have been allowed to continue in business. Compliance with CP 2 (defining and enforcing permissible activities) is being addressed through the SDP and through developing more cooperative efforts between the NBS and Financial Markets Authority. Compliance with CP 6 (capital adequacy) will be addressed when the regulation requiring and defining a capital charge for market risk and consolidated capital adequacy calculations is finalized and implemented. As steps are taken to ensure the integrity of reported numbers through financial statements and regulatory reporting, in part accomplished through the eventual adoption of IAS, reliance upon reported capital adequacy ratios should improve.

140. Prudential Regulations and Requirements (CP 6–15): Compliance with these principles is generally adequate, however some strengthening and further implementation are required. The supervisor is in the process of finalizing new prudential regulations in certain specific areas (capital adequacy (CP6), asset classification (CP 8), large exposures (CP 9), persons with “special relationships” to the bank (CP 10), risk management (CP 11, 12, 13), and internal controls (CP 14) as required by the adoption of the SBA. This should improve compliance in many of the cited areas. In particular, increased emphasis on the role of strong governance and the responsibilities of boards and management in these prudential areas is specifically needed. It is through the prudential regulations that the new governance provisions provided in the SBA should be, in part, required. While finalization of these new (or revised) regulations represents a step toward fuller compliance with the respective principles, full compliance cannot be achieved until effective implementation is achieved.

141. Methods of Ongoing Supervision (CP 16–20) is the area of weakest compliance and the area requiring the most attention and work by the authorities. Under the terms of the SDP, the supervisor has begun to make the first changes necessary in order to build banking supervision into an effective process. The goals and objectives of supervision will be clarified and the appropriate mix of on and offsite supervision (CP16), including the extent and nature of management contact (CP 17) and the ability to conduct supervision of consolidated entities (CP 18, 20), will be more fully developed. Compliance with CP 19—validation of supervisory information—should also be improved as the supervisor develops its capacity and willingness to take remedial action against banks who are not reporting financial and regulatory information in an accurate and truthful manner. While the responsibility to strengthen supervisory process rests with the NBS management itself, improving the accounting environment through the adoption of IAS and harnessing market discipline through strengthened governance and disclosure rules will further support the efforts of the supervisor.

142. Compliance with Information Requirements (CP 21) needs improvement. The supervisor has achieved additional authority in requiring accurate accounting records and reporting through the SBA. However, the Slovak accounting law continues to set the standards and procedures. The supervisor should expend further effort to establish regulatory accounting process through which more conservative information is reported and disclosed, better conveying the true economic position of the bank. Fuller compliance with this principle will be achieved when IAS is finally adopted and the supervisor more actively exercises its new authority under the SBA.

143. The Formal Powers of the Supervisor (CP22) have been substantially strengthened, on a legal basis, through the SBA. The capacity of the supervisor must now be strengthened in order for these particular provisions to be properly implemented. The efforts underway to prepare (and implement) a corrective action policy that would guide when and how remedial measures will be taken (as directed by the SDP) will contribute significantly to fuller compliance with this Principle.

144. Compliance with Cross-Border Banking (CP 23–25) has substantially improved as the supervisor has gained the authority, through the SBA, to enter into cooperative agreements with domestic and foreign supervisors (CP 24, 25). The banking sector is now approximately 90 percent foreign-owned, which adds to the importance of dialogue with other supervisors. The supervisor is aggressively pursuing MOU with all pertinent regulators. Following the completion of such agreements and cooperative work relationships established, compliance will be substantially strengthened.

Medium-term challenges

145. The main challenge facing the supervisor is to fundamentally change its supervisory philosophy and its operating practice through evolving the attitudes of and retooling NBS management and staff. The SDP adopted by the NBS Bank Board provides a road map through which to start initiating this change. A new supervisory policy is in the process of preparation that will provide a new standard for conducting supervision on a more risk based approach. This first step in implementing change, if accomplished effectively, will help trigger change at all levels of supervision. This, in turn, will build capacity, improve the willingness of the supervisor to make more qualitative judgements about risk, and take more risk itself in executing its duties. As this occurs, many of the cited concerns in the Core Principle Assessment will be addressed. Specifically, interpretation of legislation, improvement in personnel and financial resources, the method and role of onsite supervision within the overall supervisory process, the manner and timing of effective remedial actions, and stronger governance and accounting standards are all critical components for improving banking supervision within the next 2–5 years. The NBS Bank Supervision Department has recently employed an IMF provided advisor to help with the change and implementation process.

Table 8.

Slovak Republic: Recommended Action Plan to Improve Compliance of the Basel Core Principles

Table 8.

Slovak Republic: Recommended Action Plan to Improve Compliance of the Basel Core Principles

Reference Principle	Recommended Action
Principle 1 1(2) Independence and Resources	Consistent with the SDP. there is a clear need to evaluate and improve both the financial and personnel resources within the SD.
1(3) Legal Framework and Ability to Issue Supporting Legislation	The NBS’ ability to issue prudential rules in the form of decrees that both interpret the SBA and set the standards for safe and sound banking practice is still encumbered through the legislative review process. The ability of the supervisor to provide guidance to the banking industry through rules and decrees must be established.
1(4) Enforcement Powers	Steps must be taken by the NBS’, its supervisors, and its legal department to develop and use the qualitative judgment necessary to effectively interpret and apply the law and to oversee the safety and soundness of the system.
Principle 2 Permissible Activities	The SBA does not provide the explicit authority for the NBS to act when an entity in the market is conducting, de facto, the business of banking without a proper license. While the Act should explicitly provide this power, the NBS must use its authority and its position to responsibly act in such cases, particularly when the interests of the public are at stake.
Principle 3 Licensing	The SBA should be amended to provide a “grandfather” clause that allows a graduated introduction of the university education requirements for bank management. Newly licensed banks should be examined more frequently during their initial years of operations. All supervisory personnel opinions (including onsite examiners) should be elicited when evaluating proposals for licenses, management changes, ownership changes, and changes to the corporate structure of a banking organization.
Principle 6 Capital Adequacy	Decree No. 2/2000, supporting legislation for capital adequacy ratios, should be carefully revised. The impact of a market risk charge should be evaluated through a banking industry survey. The rules for applying capital adequacy on a consolidated basis should be methodically evaluated.
Principle 7 Credit Policies	The supporting Decree No. 3/1995 should be amended to address all forms of borrowers’ exposure, including direct credit extensions, securities, and off-balance sheet exposures. The governance aspect of the Decree should be strengthened to ensure proper emphasis on bank boards’ oversight, internal risk management systems, and responses.
Principle 8 Lone Evaluation and Lone Loss Provisioning	Accurate classification of credit exposures and subsequent provisioning requirements, as specified in Decree No. 3/1995, must be more effectively implemented by the industry and tested by the supervisor. More emphasis on banks’ governance over proper credit granting, monitoring, and classification is required. Changes to the basis for classification of exposures away from the current creditworthiness and paying capacity of the borrower toward a more backward looking approach (based solely on past due status) is inappropriate.
Principle 9 Large Exposures	The definition of “economically linked” borrowers is dependent upon the consolidation rules set by the MOF in accounting standards. This is inadequate for purposes of identifying and managing concentrations of risk and potential unsafe banking practices. The application of “economically linked” borrowers should be expanded to include various scenarios, including legal linkages, common sources of repayment, etc. The supervisor must be provided (or assume) the authority to apply the large exposures limit on a case-by-case basis as situations are so identifie, particularly during on-site examinations.
Principle 11 Country Risk	The supervisor should require that banks’ risk management systems address all sources of risk, including country exposure. It should be provided the authority to address weaknesses in risk management as required by law and as they threaten me safety and soundness of the institution.
Principle 12 Market Risk	See CP 6, 11. Supporting legislation for market risk capital charges should be relative to the level and complexity of such risk taken by the subject bank. Supporting legislation should be issued that describes the requirements for a sound risk management system and management and board oversight.
Principle 13 Other Risks	See CPU, 12.
Principle 14 Internal Control and Audit	The legal provisions require strong internal control and audit oversight. However, there is a need to effectively implement these provisions and to increasingly emphasize the board and management responsibility in the oversight process (governance). The supervisor should issue guidelines on what constitute adequate and effective internal control and internal audit processes.
Principle 15 Money Laundering	Enhanced legislation and examination procedures have been introduced in recent years. These could be expanded to require mat banks appoint a senior officer specifically responsible for AML/CFT activities. Also, the law should explicitly protect bank staff who report suspicious activities in good faith (in addition to the existing confidentiality waiver). Focus on implementation is now necessary.
Principle 16 On-site and Off-site Supervision	Substantial change in this area is required. The purpose and role of the on and off-site supervisory process must be clarified. Strategic policy and procedures must be prepared and adopted by the NBS Bank Board. The organizational structure in the supervisory area should be reevaluated and revamped in order to effectively deliver supervision. Personnel must be further trained. Progress in implementing the SDP must be demonstrated.
Principle 17 Bank Management Contact	Consistent with the SDP, the supervisor should establish minimum requirements for contact with bank management and supervisory boards. This contact should be increased as me significance of the issues grows and the condition of the bank deteriorates.
Principle 18 Off-site Supervision	The regulatory reporting process and on-site analysis should address the consolidated position of bank institutions.
Principle 19 Validation of Supervisory Information	The rigor with which the supervisor addresses inaccuracies and untruthful financial reporting by both the banks and external auditors should increase. Communication and reliance on external auditors should likewise improve.
Principle 20 Consolidated Supervision	The new SBA now provides the authority to conduct consolidated supervision. The supporting legislation and supervisory procedures should now be upgraded to implement the process.
Principle 21 Accounting Standards	The introduction of international accounting standards (IAS) for banks should be expedited. Particularly, requirements for asset valuations and non-accrual of interest on distressed assets are needed. The supervisor should rigorously enforce the requirements for accurate accounting and reporting to both the NBS and the public. Lines of communication with external auditors should be improved.
Principle 22 Remedial Measures	The effectiveness and timeliness of supervisory responses must improve in order to proactively address developing problems before they become costly to the system and to protect the depositor. Enforcement procedures to prevent the misuse of the word “bank” and to prevent de facto banking activities such as deposit taking should be established, in practice and through law. Measures (such as extra judicial actions, purchase and assumption of assets and liabilities, etc.) should be developed to address banks in administration to avoid, to the extent possible, costly liquidation procedures.
Principle 24 Host Country Supervision	The SD must continue to build its operational capacity to supervise overseas activities of domestic banks and to allow foreign supervisors to place reasonable confidence in its oversight capabilities.
Principle 25 Supervision Over Foreign Banks’ Establishments	The NBS should continue the process it is currently pursuing to establish MOU’s with each pertinent foreign supervisor of banks that conduct business in the Slovak Republic.

View Table

Table 8.

Slovak Republic: Recommended Action Plan to Improve Compliance of the Basel Core Principles

Reference Principle	Recommended Action
Principle 1 1(2) Independence and Resources	Consistent with the SDP. there is a clear need to evaluate and improve both the financial and personnel resources within the SD.
1(3) Legal Framework and Ability to Issue Supporting Legislation	The NBS’ ability to issue prudential rules in the form of decrees that both interpret the SBA and set the standards for safe and sound banking practice is still encumbered through the legislative review process. The ability of the supervisor to provide guidance to the banking industry through rules and decrees must be established.
1(4) Enforcement Powers	Steps must be taken by the NBS’, its supervisors, and its legal department to develop and use the qualitative judgment necessary to effectively interpret and apply the law and to oversee the safety and soundness of the system.
Principle 2 Permissible Activities	The SBA does not provide the explicit authority for the NBS to act when an entity in the market is conducting, de facto, the business of banking without a proper license. While the Act should explicitly provide this power, the NBS must use its authority and its position to responsibly act in such cases, particularly when the interests of the public are at stake.
Principle 3 Licensing	The SBA should be amended to provide a “grandfather” clause that allows a graduated introduction of the university education requirements for bank management. Newly licensed banks should be examined more frequently during their initial years of operations. All supervisory personnel opinions (including onsite examiners) should be elicited when evaluating proposals for licenses, management changes, ownership changes, and changes to the corporate structure of a banking organization.
Principle 6 Capital Adequacy	Decree No. 2/2000, supporting legislation for capital adequacy ratios, should be carefully revised. The impact of a market risk charge should be evaluated through a banking industry survey. The rules for applying capital adequacy on a consolidated basis should be methodically evaluated.
Principle 7 Credit Policies	The supporting Decree No. 3/1995 should be amended to address all forms of borrowers’ exposure, including direct credit extensions, securities, and off-balance sheet exposures. The governance aspect of the Decree should be strengthened to ensure proper emphasis on bank boards’ oversight, internal risk management systems, and responses.
Principle 8 Lone Evaluation and Lone Loss Provisioning	Accurate classification of credit exposures and subsequent provisioning requirements, as specified in Decree No. 3/1995, must be more effectively implemented by the industry and tested by the supervisor. More emphasis on banks’ governance over proper credit granting, monitoring, and classification is required. Changes to the basis for classification of exposures away from the current creditworthiness and paying capacity of the borrower toward a more backward looking approach (based solely on past due status) is inappropriate.
Principle 9 Large Exposures	The definition of “economically linked” borrowers is dependent upon the consolidation rules set by the MOF in accounting standards. This is inadequate for purposes of identifying and managing concentrations of risk and potential unsafe banking practices. The application of “economically linked” borrowers should be expanded to include various scenarios, including legal linkages, common sources of repayment, etc. The supervisor must be provided (or assume) the authority to apply the large exposures limit on a case-by-case basis as situations are so identifie, particularly during on-site examinations.
Principle 11 Country Risk	The supervisor should require that banks’ risk management systems address all sources of risk, including country exposure. It should be provided the authority to address weaknesses in risk management as required by law and as they threaten me safety and soundness of the institution.
Principle 12 Market Risk	See CP 6, 11. Supporting legislation for market risk capital charges should be relative to the level and complexity of such risk taken by the subject bank. Supporting legislation should be issued that describes the requirements for a sound risk management system and management and board oversight.
Principle 13 Other Risks	See CPU, 12.
Principle 14 Internal Control and Audit	The legal provisions require strong internal control and audit oversight. However, there is a need to effectively implement these provisions and to increasingly emphasize the board and management responsibility in the oversight process (governance). The supervisor should issue guidelines on what constitute adequate and effective internal control and internal audit processes.
Principle 15 Money Laundering	Enhanced legislation and examination procedures have been introduced in recent years. These could be expanded to require mat banks appoint a senior officer specifically responsible for AML/CFT activities. Also, the law should explicitly protect bank staff who report suspicious activities in good faith (in addition to the existing confidentiality waiver). Focus on implementation is now necessary.
Principle 16 On-site and Off-site Supervision	Substantial change in this area is required. The purpose and role of the on and off-site supervisory process must be clarified. Strategic policy and procedures must be prepared and adopted by the NBS Bank Board. The organizational structure in the supervisory area should be reevaluated and revamped in order to effectively deliver supervision. Personnel must be further trained. Progress in implementing the SDP must be demonstrated.
Principle 17 Bank Management Contact	Consistent with the SDP, the supervisor should establish minimum requirements for contact with bank management and supervisory boards. This contact should be increased as me significance of the issues grows and the condition of the bank deteriorates.
Principle 18 Off-site Supervision	The regulatory reporting process and on-site analysis should address the consolidated position of bank institutions.
Principle 19 Validation of Supervisory Information	The rigor with which the supervisor addresses inaccuracies and untruthful financial reporting by both the banks and external auditors should increase. Communication and reliance on external auditors should likewise improve.
Principle 20 Consolidated Supervision	The new SBA now provides the authority to conduct consolidated supervision. The supporting legislation and supervisory procedures should now be upgraded to implement the process.
Principle 21 Accounting Standards	The introduction of international accounting standards (IAS) for banks should be expedited. Particularly, requirements for asset valuations and non-accrual of interest on distressed assets are needed. The supervisor should rigorously enforce the requirements for accurate accounting and reporting to both the NBS and the public. Lines of communication with external auditors should be improved.
Principle 22 Remedial Measures	The effectiveness and timeliness of supervisory responses must improve in order to proactively address developing problems before they become costly to the system and to protect the depositor. Enforcement procedures to prevent the misuse of the word “bank” and to prevent de facto banking activities such as deposit taking should be established, in practice and through law. Measures (such as extra judicial actions, purchase and assumption of assets and liabilities, etc.) should be developed to address banks in administration to avoid, to the extent possible, costly liquidation procedures.
Principle 24 Host Country Supervision	The SD must continue to build its operational capacity to supervise overseas activities of domestic banks and to allow foreign supervisors to place reasonable confidence in its oversight capabilities.
Principle 25 Supervision Over Foreign Banks’ Establishments	The NBS should continue the process it is currently pursuing to establish MOU’s with each pertinent foreign supervisor of banks that conduct business in the Slovak Republic.

Authorities’ response

146. The authorities did not agree with the assessment for CP 22 (Materially Noncompliant—MNC). They agreed with the assessment that the legal framework in this area is now satisfactory. But they noted that: “it is true that none of the remedial measures have been applied since the new Banking Act has entered into force, but as this is really a too short period of time our position is that to assess this particular principle as MNC is not adequate.”

147. The authorities did not agree with the MNC assessment for CP 16 and 17 (Onsite and Off-site supervision, and Contact with Bank Management). They pointed to the long term Supervisory Development Plan (out to year 2004) mat details current and future action steps designed to address the issues cited in the Core Principles Methodology and the Assessment itself.

148. The authorities did not agree with the MNC assessment for CP 2 (Permissible Activities). They cite that the NBS is not explicitly authorized to take remedial action in cases where entities are conducting non-licensed activities. They also point out that the newly adopted Securities and Investment Services Act provides room for interpretation and possible action against such activities. Otherwise, the law enforcement authorities are responsible for taking action under the Criminal Code.

General

149. Banking supervision policy formulation and implementation by the National Bank of Slovakia (NBS) satisfies a very high standard of transparency practices. The main transparency practices and the areas that deserve further strengthening are described below.

150. The NBS is very eager to be transparent and sees the transparency as an important tool in public participation, in policy formulation, and in oversight of the NBS’ operation.

151. The Slovak authorities cooperated fully with the assessment and provided all the necessary information and clarification.

Main findings

152. Clarity of roles, responsibilities, and objectives of the banking supervisory agency. The objective of the Banking Supervision Division (BSD) is clearly formulated in the NBA and, especially, in the Mission Statement. The NBA, SBA and the Mission Statement are published on the NBS website. A part of the NBS’ Annual Report, which is widely available in hard copy and on the NBS website, is dedicated to its supervisory function conduct. Procedures for appointment and removal of the head of the BSD are not publicly disclosed. Because the MOU between the NBS and the FMA is still to be signed, the scope and the procedures of the cooperation between them is not publicly disclosed.

153. Open process for formulating and reporting of banking supervisory policies. Primary and secondary legislation (which is very detailed) and the overview of the issued supervisory decisions are on the NBS website. That part of supervisory policies which is contained in the secondary legislation (decrees of the NBS) is always discussed within the preparatory period with the banking industry. Significant changes in financial policies are put for discussion to the Board and, after the Board meeting, the NBS issues a press release. The banking supervision development plan is published on the NBS website, allowing the public to comment. The NBS has only one signed MOU with the Czech National Bank and its essential elements are on the NBS website. The annual and semi-annual reports contain a part on Banking Supervision which describes also how the BSD’s overall policy objectives are being pursued.

154. Public availability of information on banking supervision. Quarterly reports on the banking sector performance are published on NBS website. Emergency financial support by the NBS has been rare and its details, which on each occasion would involve a single bank, were not published as such. However, on each occasion the fact of the assistance was publicly acknowledged. The results of such credits are reflected, in the aggregate financial statements of the NBS. The team recommended improving the disclosure of emergency credits. While giving due recognition to concerns relating to stability of the financial markets, confidentiality and moral hazard, the NBS should disclose aggregate information on the emergency credit facilities, exercising judgment on the timing and on the nature of the information disclosed. The NBS has its own Public Information Department and also own speakers. The Department issues information concerning banking supervision. The NBS conducts quarterly meetings, chaired by the Governor with the Vice-Governor responsible for the BSD and the Chief Executive Director of the BSD, with the representatives of all banks. Beyond these regular meetings the Governor and other members of the Bank Board commonly comment on banking sector developments in the media and also publish articles in press. According to the SBA, the banks are obliged to publish on their premises information about the deposit protection system in line with the BDP Act. Moreover, banks must inform depositors about the extent to which each deposit-related product is covered by the deposit protection scheme. The BSD ensures compliance with this requirement.

155. Accountability and assurances of integrity by the banking supervisory agency. The Governor and vice-governors appear in the Parliament to present an Annual Report and Monetary Policy Report (three times a year). They are also very often invited by the Parliament to appear and to answer different questions concerning the banking system. They, and staff of BSD, take part in discussions in parliamentary committees when they are dealing with new banking legislation. The NBS is obliged to present its audited financial statements once a year to the Slovak Parliament. The NBS has very thorough principles and arrangements of internal audit and control in place and they are posted on the NBS website. The Code of Ethics which deals with standards of conduct of the BSD staff (and is separate from the Code of Ethics for other NBS staff) is not publicly disclosed. The SBA states legal protection of BSD staff.

Table 9.

Slovak Republic: Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Banking Supervision

Table 9.

Slovak Republic: Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Banking Supervision

Reference Principle	Recommended Action
V. Clarity of Roles. Responsibilities, and Objective of Financial Agencies Responsible for Financial Policies	The procedures for appointment and removal of the CED of the BSD should be publicly disclosed. The MOU with FMA should be publicly disclosed when signed.
VII. Public Availability of Information on Financial Policies	The disclosure of emergency credits should be improved.
VII. Accountability and Assurance of Integrity by Financial Agencies	The BSD Code of Ethics should be publicly disclosed.

View Table

Table 9.

Slovak Republic: Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Banking Supervision

Reference Principle	Recommended Action
V. Clarity of Roles. Responsibilities, and Objective of Financial Agencies Responsible for Financial Policies	The procedures for appointment and removal of the CED of the BSD should be publicly disclosed. The MOU with FMA should be publicly disclosed when signed.
VII. Public Availability of Information on Financial Policies	The disclosure of emergency credits should be improved.
VII. Accountability and Assurance of Integrity by Financial Agencies	The BSD Code of Ethics should be publicly disclosed.

Authorities’ response

156. No comments provided.

General

157. The assessment of the Slovak Insurance Sector was performed as part of the Financial Sector Assessment Program (FSAP) for the Slovak Republic in February 2002. The main objectives of this assessment are to determine the levels of observance with the International Association of Insurance Supervisor (IAIS) principles, and to suggest areas where further development may be appropriate. The assessment was prepared by Donald McIsaac, Lead Insurance Specialist, Financial Sector Department of the World Bank and was based on a review of the legal framework, and extensive discussions with the supervisory authorities and market participants.

158. The principal counter party for the assessment process is the Insurance Section of the Financial Market Authority. Regulation of the insurance market is based on the Insurance Act of 1991 with amendments in 1992, 1995, 1997 and 2000. This Act is supported by Decree 136, issued in 1996 (with important amendments in 1999 and 2000) and by various supporting memoranda issued under the authority of the Ministry of Finance, including the Order that establishes the means of determining the required minimum solvency margin. The supervisor has also issued specific instructions to licensed companies in order to clarify the application and interpretation of the legal framework. In addition, “Head 15” of the Civil Code that deals with insurance contracts is relevant for the operations of insurance companies. As is the case for all general purpose corporations, insurance companies must be in conformity with the Commercial Code. Financial reporting practices for insurance companies are governed by the Act on Accounting.

159. As of March 1, 2002, a new “Act on Insurance Industry and Amending Some Laws” goes into effect. It will replace the existing insurance legislation. Companies will be given a transition period of one year in order to conform their operations to the requirements of the new law. Some of the provisions in the new law are designed to come into force only at the time of the EU accession for the Slovak Republic.

160. This assessment was performed on the basis of the regulatory system in place prior to the effective date of the new legislation. Supervisory procedures in place are those that support the previous legislation and supporting regulations. At the time of the assessment, necessary decrees to support and make effective the new law were still in the drafting stage. It will take some time before the impact of the new legislation will be felt in the insurance market and in supervisory practices. Where relevant, the assessment identifies those changes that will come from the new legislation that will assist the supervisory system in the Slovak Republic to become more observant of the Core Principles.

161. In making this assessment the FSAP team made use of the Core Principles Methodology Document that was adopted by the IAIS at its annual meeting in October 2000.

Institutional and macroprudential setting—Overview

162. There are 28 licensed insurance companies operating in Slovak Republic, all incorporated locally. As at the end of the year 2000, the majority of the voting shares of 18 companies were foreign owned while the rest are controlled by domestic investors. Four of the companies do only life insurance business, 6 do only non-life business, while there are 18 composite companies. There are no domestic professional reinsurance companies.

163. There are no strategic shareholdings between insurance companies and banks and the only affiliations tend to be of a loose nature. For example, some insurance companies have arrangements to offer mortgage-related insurance products through a bank’s network. However, in general, sale of business through banks is not yet a major part of the operations of insurance companies. ING group has established both a life insurance and a non-life insurance subsidiary in the country. It will be interesting to see whether that leads to significant marketing through the banking arm of the group.

164. As an indicator of the relevance of the insurance industry to the financial sector, it is helpful to compare the total liabilities of insurance companies in respect of their policyholder obligations with the total amount of deposits held by banks. For the year 2000, total liabilities arising under insurance policies issued by Slovak insurance companies amounted to SK 39.0 billion and that amount is approximately 6.4 percent of total bank deposits at the end of 2000. The comparable figures for 1999 were SK 34.7 billion or 6.8 percent of total bank deposits at the end of 1999.

165. Total premiums received by insurance companies operating in the Slovak Republic during 2000 amounted to SK 27.5 billion, of which SK 11.2 billion was for life insurance and SK 16.3 billion for non-life insurance. Total premium income is estimated to represent 3.1 percent of GDP. This level of penetration ranks ahead of that in Poland, Hungary and Croatia, but behind the comparable value for Czech Republic (3.6 percent).

166. The market is somewhat concentrated, since Slovenska Poistovna, a state-owned company, has a 46 percent market share and the top 5 companies collect over 75 percent of premiums written (estimates for 2001 obtained from the Slovak Insurance Association.)

General preconditions for effective insurance supervision

167. The legal system in the Slovak Republic is similar to that prevailing in Germany. Companies, including insurance companies, are incorporated according to the Commercial Code. The Code is to be amended shortly and changes will have an effect on the corporate governance of general purpose corporations. However, the provisions do not go far enough in protecting the interests of policyholders and account-holders in financial institutions. For this reason, laws such as the Insurance Act should include special provisions outlining the responsibilities of Directors and identifying certain key roles they must play. A new Insurance Act has been adopted and will become effective March 1, 2002. This law does give some consideration to the roles and responsibilities of Directors. However, it does not contain specifics regarding their duties with respect to setting investment policies and general risk management. There is no Law on Insurance Contracts in the Slovak Republic although there are relevant provisions contained in Head 15 of the Civil Code. This Code has become outdated.

168. Accounting for all domestic corporations is governed by the Act on Accounting. By virtue of a special supplement to the Act, prepared at the direction of the Ministry of Finance, unique rules prescribe accounting and financial reporting requirements for insurance companies. The rules have the effect of ensuring that Slovak insurance companies prepare their accounts in accordance with the rules established by the EU Insurance Directives for its member countries. Financial returns are to be accompanied by reports and opinions issued by an auditor and an actuary.

169. An important new feature of the new insurance legislation to become effective March 1, 2002 is the requirement for derivative reports. When the actuary or the auditor becomes aware during the course of a regular review that a situation is developing that could impair the ability of the company to meet its obligations, the professional is obliged to make the situation known to the authorities. This provision may cause some difficulties because the law does not appear to provide these professionals with immunity from civil suits that might be launched against them as a result of their making reports of this nature.

170. While an actuary’s opinion is required, and in fact is collected with each annual return, the situation requires some clarification since the Society of Actuaries does not yet have the status of a professional body. In order to deal with this situation, the new legislation will authorize FMA to organize and conduct special qualifying examinations. Persons who have accepted academic credentials in actuarial science and mathematics, will be given the opportunity to attempt a special examination and those who complete it successfully will be registered as “actuaries” by FMA.

Main findings

171. Organization of supervisor: At present, FMA has only 13 persons dedicated to the supervision of insurance companies. This number may be increased in the near future provided the revised plans for funding of FMA are adopted and provided this results in an increase in revenues for the authority. The supervisory team has adopted a reliance approach to their work and look to the external auditor and the actuary to assist with the work of monitoring the financial strength of companies. Unfortunately, none of the supervisory staff has much experience in the insurance field. Efforts have been made to provide training and a commendable job was done by the German supervisory authority that provided technical assistance with financing from the EU PHARE program. However, there is no substitute for experience.

172. The regulation and supervision of the Slovak Insurance sector has been strengthened with the integration of the supervision within FMA. The new legislation just adopted is more closely harmonized with EU legislation, including EU solvency criteria.

173. Licensing and changes in control: In practice, each company must file a business plan when it obtains a license. It must inform the supervisor of any changes to the plan. In the process of inspection and supervision, FMA officials monitor the appropriateness of the elements of the plan and ensure that the company management is adhering to the plan. This process enables the supervisor to ensure, among other things, that Directors and senior managers are always “fit and proper” persons. Since the business plan includes details on the products the company proposes to offer for sale as well as the actuarial and other assumptions upon which prices and technical provisions are based, the supervisor who carefully monitors developments in the plan should be in a position to identify problems at an early date.

174. Corporate governance and internal controls: Corporate governance of insurance companies relies on general provisions of the Commercial Code. Although these provisions have been recently strengthened, they are still insufficient to ensure sound governance of insurance companies. Directors should be made responsible for the establishment of such internal policies as the investment policy, policy on risk retention, policy on transactions with related parties, internal control systems, etc. and for the monitoring of compliance with these policies.

175. The insurance legislation does not impose any particular requirements with respect to internal controls. While company practices in this respect are reviewed at the time of onsite inspections, such inspections are not sufficiently frequent. The supervisor should issue instructions regarding the desired features in a system of internal controls and Boards of Directors should be made responsible for their implementation and monitoring.

176. Prudential rules: The primary focus of insurance supervisory efforts is the monitoring of solvency and capital adequacy. When a company’s net worth falls below the amount that would be required through application of the solvency margin formula, the supervisor makes a formal request for prompt remedial action and the legislation provides considerable powers for intervention in such cases. There have been two insurance company failures in recent years and FMA has advised that there are at present 4 companies that do not meet the minimum solvency requirements and where plans for remedial action formulated by the companies are under consideration.

177. The supervisor should have the authority to order an insurance company to amend its reinsurance program. It would also be desirable if the supervisor collected information on the reinsurance companies with whom the direct writer has made contracts. Additional reserves could then be required if the reinsurers are not highly rated.

178. Market conduct: The existing insurance legislation does not deal directly with issues of consumer protection. There is no Law on Insurance Contracts in the Slovak Republic although there is some reference to insurance contracts under Head 15 of the Civil Code. This code is outdated and it is not apparent that there are any plans for revision. No rules have been set regarding the requirement for codes of conduct for intermediaries and for companies in respect of their relationships with their clients. However, the local associations of companies and of brokers established such codes. The insurance section does not have a program for establishing disclosure standards and other consumer protection measures. It will likely require additional resources if it is to take steps in that direction.

Recommended actions and authorities’ response

Recommended actions

Table 10.

Slovak Republic: Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Table 10.

Slovak Republic: Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Reference Principle	Recommended Action
Organization of an Insurance Supervisor
CP 1	Supervisor requires additional human resources in order to perform its functions adequately. Perhaps this will come with new method of funding for FMA. Care should be taken to ensure optimal coordination between supervisory work at FMA and regulatory functions of MOF
Licensing and Changes in Control
CPs 2–3	Establish requirements and adopt procedures for “fit and proper” testing of all major shareholders of insurance companies
Corporate Governance and Internal Controls
CPs 4–5	Responsibilities for Directors should be defined. The legislation should include the specifics—such as responsibility to establish and monitor investment policy; responsibility to set risk retention limits; responsibility for identifying, limiting and resolving transactions with related parties. Internal control procedures should also receive the scrutiny of the Directors
Prudential Rules
CPs 6–10	Qualification of actuaries should be strengthened. Annual review of adequacy of technical provisions should include a determination whether guarantees promised at the point of sale continue to be sustainable. A practice of collecting comprehensive statistical data should be introduced in order to facilitate the verification of technical provisions. Supervisor should have the authority to review reinsurance arrangements and set minimum standards for retention, and should also have the authority to order changes in the reinsurance program.
Market Conduct
CP 11	Consumer protection responsibilities of the supervisor should be made clear through the legislation. There should be control over disclosure requirements, conflicts of interest, use of misleading information. It would also be wise to provide for some forms of alternate dispute resolution
Monitoring, Inspection, and Sanctions
CPs 12–14	On-site inspections should be conducted at a minimum frequency for all companies. There should be regular communication between the inspectors and the external auditor
Cross-Border Operations, Supervisory Coordination and Cooperation, and Confidentiality
CPs 15–17	No comments

View Table

Table 10.

Slovak Republic: Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Reference Principle	Recommended Action
Organization of an Insurance Supervisor
CP 1	Supervisor requires additional human resources in order to perform its functions adequately. Perhaps this will come with new method of funding for FMA. Care should be taken to ensure optimal coordination between supervisory work at FMA and regulatory functions of MOF
Licensing and Changes in Control
CPs 2–3	Establish requirements and adopt procedures for “fit and proper” testing of all major shareholders of insurance companies
Corporate Governance and Internal Controls
CPs 4–5	Responsibilities for Directors should be defined. The legislation should include the specifics—such as responsibility to establish and monitor investment policy; responsibility to set risk retention limits; responsibility for identifying, limiting and resolving transactions with related parties. Internal control procedures should also receive the scrutiny of the Directors
Prudential Rules
CPs 6–10	Qualification of actuaries should be strengthened. Annual review of adequacy of technical provisions should include a determination whether guarantees promised at the point of sale continue to be sustainable. A practice of collecting comprehensive statistical data should be introduced in order to facilitate the verification of technical provisions. Supervisor should have the authority to review reinsurance arrangements and set minimum standards for retention, and should also have the authority to order changes in the reinsurance program.
Market Conduct
CP 11	Consumer protection responsibilities of the supervisor should be made clear through the legislation. There should be control over disclosure requirements, conflicts of interest, use of misleading information. It would also be wise to provide for some forms of alternate dispute resolution
Monitoring, Inspection, and Sanctions
CPs 12–14	On-site inspections should be conducted at a minimum frequency for all companies. There should be regular communication between the inspectors and the external auditor
Cross-Border Operations, Supervisory Coordination and Cooperation, and Confidentiality
CPs 15–17	No comments

General

182. Insurance supervision policy formulation and implementation of the Financial Markets Authority (FMA) and the Ministry of Finance (MoF) are quite transparent. The main transparency practices and the areas that deserve further strengthening are described below.

183. The FMA and the MoF are very eager to be transparent and see the transparency as an important tool in public participation in policy formulation and in oversight of their operation.

184. The Slovak authorities cooperated fully with the assessment and provided all the necessary information and clarification.

Main findings

185. Clarity of roles, responsibilities, and objectives of the insurance supervisory agencies. The objectives of the FMA are clearly formulated in the ICA. The ICA and the statement of the FMA’s objectives of supervision are publicly disclosed on the MoF website. The FMA Act states that the FMA has the authority to supervise the insurance industry, while according to the Constitution the MoF has the authority to regulate (to issue secondary legislation regarding) the industry. The FMA issues a bulletin that includes reports about its operation, decisions legally in force, professional positions and other important announcements. Under the FMA Act, the FMA may publish an announcement about imposed penalty or a measure to correct found shortcomings in the national daily press. The information is easily available on the FMA website. The procedures for appointment, terms of office, and any general criteria for removal of the Chairman and the members of the council of the FMA are stated in the FMA Act, which is posted on the FMA web. The FMA cooperates with the MoF in formulating financial policy for the insurance industry. On both websites there is information about this cooperation. Because the MOU between the NBS and the FMA is still to be signed, the scope and procedures of the cooperation between them are not publicly disclosed.

186. Open process for formulating and reporting of insurance supervisory policies. Relevant laws and by-laws and the regulatory framework of primary and secondary legislation are posted on the FMA website and on the MoF website. All administration fees of the Slovak Republic, including those charged by the FMA, are set according to the Administration Fee Law and are published in the note to the law, which is posted on the FMA website. Cooperation between the FMA and the MoF, and the NBS is stated in the FMA Act. Under the FMA Act, the FMA can conclude agreements on mutual cooperation with foreign supervisory authorities of the insurance industry. MOUs were signed with the German and Austrian Supervisory Authorities, and its main elements were put on the FMA website. Significant changes in financial policy, which can only be changed through primary and secondary legislation are publicly disclosed on the MoF website. All drafts of new regulations are put on MoF website and the public can comment. The FMA’s Annual Report and an Analysis of Insurance Industry adequately explain how its activities contribute to the overall objectives of supervision, but do not adequately evaluate how the MoF regulations of insurance contribute to those objectives.

187. Public availability of information on insurance supervision. The FMA issues an Annual Report and an Analysis of Insurance Industry. The reports are available on the FMA website. Summaries of quarterly reports of insurance companies sent to the FMA are published on the website of the FMA continuously. The Annual Report includes FMA financial data, balance sheet and income statements. The FMA has a Public Relations Department. The FMA’s chairman and vice chairman appear in public. They give interviews, attend conferences, make speeches and publish articles. The texts of public statements and speeches are released as a matter of course to the public. There is one policyholder guarantee established by law—the Insurance Guarantee Fund—for the case of compulsory contractual insurance of motor vehicles against civil liability (MTPL). Information on the nature and form of the Fund, on the operating procedures, on how the Fund is financed, and on the performance of the arrangement, is contained in the MTPL Law.

188. Accountability and assurances of integrity by the insurance supervisory agency. Standards of accountability differ between the regulatory (the MoF) and supervisory (the FMA) authorities: the Report of the FMA is sent to the Cabinet and the officials of FMA may be requested to attend the meeting of the Cabinet, while under general rules of accountability of Cabinet, the Minister of Finance can be summoned by the Parliament to report on policies in the area of insurance and answer questions. The FMA financial statements are not audited. According to the new FMA Law, the FMA will be required to prepare financial statements that are audited by an external auditor. They will be publicly disclosed. Internal governance procedures are not publicly disclosed. The FMA Act establishes a requirement for the chairman, council and staff of FMA to prevent conflicts of interest, including submitting yearly statements about compliance with legal restrictions.

Table 11.

Slovak Republic: Recommended Action Plan to Improve Transparency of Insurance Supervision

Table 11.

Slovak Republic: Recommended Action Plan to Improve Transparency of Insurance Supervision

Reference Practice	Recommended Action
V. Clarity of Roles. Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	The MOU with NBS should be signed and publicly disclosed.
VI. Open Process for Formulating and Reporting of Financial Policies	One of the reports issued by the FMA should include a section contributed by the MoF explaining how MoF activities contribute to the overall objectives of oversight of insurance industry.
VII. Public Availability of Information on Financial Policies
VIII. Accountability and Assurance of Integrity by Financial Agencies	Officials of the FMA should be available to appear before the Parliament to answer questions on its Annual Report.

View Table

Table 11.

Slovak Republic: Recommended Action Plan to Improve Transparency of Insurance Supervision

Reference Practice	Recommended Action
V. Clarity of Roles. Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	The MOU with NBS should be signed and publicly disclosed.
VI. Open Process for Formulating and Reporting of Financial Policies	One of the reports issued by the FMA should include a section contributed by the MoF explaining how MoF activities contribute to the overall objectives of oversight of insurance industry.
VII. Public Availability of Information on Financial Policies
VIII. Accountability and Assurance of Integrity by Financial Agencies	Officials of the FMA should be available to appear before the Parliament to answer questions on its Annual Report.

Authorities’ response

189. No response provided.

General

190. The assessment of the Slovak securities market was performed during the period February 18-March 1, 2002 as part of the Financial Sector Assessment Program (FSAP) for the Republic of Slovakia. The main objective of the assessment was to determine the effectiveness of securities regulation, soundness of market intermediaries, and development prospects for the capital markets, including observance of the IOSCO Objectives and Principles of Securities Regulation. The assessment was prepared by Euan Abernethy, consultant under the supervision of Lalit Raina, World Bank.

191. The assessment was based on the Objectives and Principles of Securities Regulation, issued September 1998, by the International Organization of Securities Commissions (IOSCO) and the accompanying Methodology. The information used for the assessment included: (i) answers by the Financial Market Authority of the Republic of Slovakia (FMA) to the IOSCO “Questionnaire and Methodologies for Self-Assessment;” (ii) English translation of the Act on Financial Market Authority and the Securities Act No. 566/2001; (iii) English translation of regulations issued by the FMA, and rules issued by the Bratislava Stock Exchange and the Slovak Stock Exchange; (iv) material available on the website for the Financial Market Authority and the Bratislava Stock Exchange; and (v) interviews with the Ministry of Finance and FMA officials and various market representatives, the Bratislava Stock Exchange, the Slovak Stock Exchange, accountants, lawyer and leading market participants.

192. In regard to auditing and accounting standards, the assessment used the research and references in the Report on the Observance of Standards and Codes (Accounting and Auditing) dated November 27, 2001 prepared by a staff team from the World Bank on the basis of information provided by the authorities of the Slovak Republic pursuant to an initiative of the Ministry of Finance and the Slovak Chamber of Auditors.

Information and methodology used for assessment

193. Until November 2000 the regulation and supervision of the capital markets in Slovakia was carried out by the Ministry of Finance (MOF). The FMA was established on November 1, 2000 as the body of state administration responsible for the supervision of the capital markets and insurance sector, which it took over from the MOF. The MOF retains the authority of making regulations.

194. Act the time of the assessment, there are one stock exchange quoting listed shares, the Bratislava Stock Exchange (BSE). The BSE has market segments for shares on the Listed Market and the Free Market. Of a total of 887 stocks listed or registered only 11 were quoted or registered in the Listed Market and the balance (876) on the Free Market. Trading is concentrated in five companies. Even here the volumes are very low. Market capitalization of bonds in the Listed Market on January 31, 2002 was SK 250 billion and on the Free Market was SK 51 billion.

195. It would appear that the efficiency of the capital markets requires significant strengthening to aggregate capital for use in productive enterprises or to provide an efficient platform for trading in securities. Market capitalization of companies listed on the stock exchange is low both in absolute terms (Euro 3.3 billions in year 2000) and when compared with other economies by reference to GDP (17.5 percent in the year 2000). The market is extremely illiquid with low turnover overall and with the majority of stocks trading very rarely.

General preconditions for effective securities regulation

196. The securities market in Slovakia is open to any firm meeting the regulatory requirements. The accounting standards under which the market functions, however, are not adequate. The accounting and financial reporting standards now in place provide accounts relevant for taxation purposes but are not geared to the requirements of capital markets and investors. There are significant differences between Slovakia’s statutory accounting standards and IAS. These include limited disclosure requirements, limited segment reporting, lack of detail on related party transactions, different treatment on recognition, measurement and disclosure of financial instruments and deferred taxation differences. Shortfalls in auditing practice (other than in the international accounting firms) include lack of appreciation of auditors independence, quality control for audit work, lack of strict application of related party transactions and lack of implementation of a going concern standard.

197. The legal foundation of the capital market (corporate governance and securities regulation) is broadly satisfactory but needs to be strengthened in a number of areas. The duties of company directors and managers to the company they manage and to the shareholders of that company need to be clarified and disclosure improved in the areas of dealings by officers in the shares of the company, related party dealings and of total benefits received by way of remuneration from the company. The rights of shareholders, and minority shareholders in particular, are not clearly defined or are non-existent.

Main findings—Summary

198. The securities laws and the constitution of the FMA as a supervisory authority are recent developments in Slovakia and the terms of those laws and the powers and authorities of the FMA generally conform to the good regulatory codes as set out in the IOSCO Objectives and Principles. The powers and authorities of the FMA will be further clarified and improved with new legislation in effect on April 1, 2002 and the new securities laws now in force will apply with more certainty to brokers as they become licensed by the FMA before September 30, 2002.

199. The new securities laws and recent amendments to the Commercial Code have improved shareholder rights but there are still areas where improvements can be made. In particular accounting and auditing standards are not in line with IAS/ISA, the definition of securities does not cover all products that should be covered by securities laws, information required in issuers prospectus’ is insufficient, minority shareholder rights are not fully protected and directors duties and disclosure requirements are not adequate.

200. The FMA is a young agency and is developing its procedures and supervision and enforcement regimes. It will have to ensure that it can offer competitive remuneration and working conditions to attract and retain the skills and experience required to effectively supervise the markets and enforce the laws.

Recommended actions and authorities’ response to the assessment

Recommended actions

Table 12.

Slovak Republic: Recommended Plan of Actions to Improve Securities Regulation

Table 12.

Slovak Republic: Recommended Plan of Actions to Improve Securities Regulation

Reference Principle	Recommended Action
Principle 2	Legislation should grant the FMA the ability to initiate secondary legislation under the Securities Act. The FMA would be more financially independent if it could obtain revenues from market participants.
Principle 3	The FMA should be independent of government salary scales and conditions of employment.
Principle 8	The legislation should clarify the application of the Securities Act to all entities that have offered assets or financial instruments to the public.
Principle 9	Legislation should clarify the application of the powers of the FMA to brokers in the period to September 30, 2002.
Principle 12	There could be more extensive use of MOU’s with foreign regulators.
Principle 14	The legislation or secondary legislation should provide more mandated information in prospectuses.
Principle 15	The Commercial Code should provide more effective protection for minority shareholders. There are inadequate provisions for the duties of directors to the company and shareholders.
Principle 16	Slovakia should adopt accounting and auditing standards which are the same as or equate to international standards.
Principle 22 and 23	Legislation should clarify the application of the Securities Act to those brokers who have not been licensed by the FMA under that Act pending September 30, 2002.
Principle 24	The Securities Act should be amended to clarify the powers of the FMA over brokers pending licensing of all brokers by September 30, 2002.
Principle 27	Important company announcements should be made to the exchange and to members immediately instead of at the end of the days trading.
Principle 28	The laws on market manipulation should be strengthened.

View Table

Table 12.

Slovak Republic: Recommended Plan of Actions to Improve Securities Regulation

Reference Principle	Recommended Action
Principle 2	Legislation should grant the FMA the ability to initiate secondary legislation under the Securities Act. The FMA would be more financially independent if it could obtain revenues from market participants.
Principle 3	The FMA should be independent of government salary scales and conditions of employment.
Principle 8	The legislation should clarify the application of the Securities Act to all entities that have offered assets or financial instruments to the public.
Principle 9	Legislation should clarify the application of the powers of the FMA to brokers in the period to September 30, 2002.
Principle 12	There could be more extensive use of MOU’s with foreign regulators.
Principle 14	The legislation or secondary legislation should provide more mandated information in prospectuses.
Principle 15	The Commercial Code should provide more effective protection for minority shareholders. There are inadequate provisions for the duties of directors to the company and shareholders.
Principle 16	Slovakia should adopt accounting and auditing standards which are the same as or equate to international standards.
Principle 22 and 23	Legislation should clarify the application of the Securities Act to those brokers who have not been licensed by the FMA under that Act pending September 30, 2002.
Principle 24	The Securities Act should be amended to clarify the powers of the FMA over brokers pending licensing of all brokers by September 30, 2002.
Principle 27	Important company announcements should be made to the exchange and to members immediately instead of at the end of the days trading.
Principle 28	The laws on market manipulation should be strengthened.

General

213. Capital markets supervision policy formulation and implementation of the Financial Markets Authority (FMA) and the Ministry of Finance (MoF) are quite transparent. The main transparency practices and the areas that deserve further strengthening are described below.

214. The FMA and the MoF are very eager to be transparent and see the transparency as an important tool in public participation in policy formulation and in oversight of their operation.

215. The Slovak authorities cooperated fully with the assessment and provided all the necessary information and clarification.

Main findings

216. Clarity of roles, responsibilities, and objectives of the supervisory agencies over capital markets. The broad objective of supervision over capital markets, to achieve market efficiency, is not publicly disclosed. Responsibilities and the authority of the FMA to supervise the capital markets is clearly stated in the SIS Act and the SEA. These Acts are on the FMA website. The responsibilities of the MoF as regulator (issues secondary legislation) are stated in the Slovak Constitution. The FMA issues a bulletin, which includes reports about its operation, decisions legally in force, professional positions and other important announcements, and information about economic performance of issuers of publicly tradable securities and asset management companies. The bulletin and other information are easily available on the FMA website. The procedures for appointment, terms of office, and any general criteria for removal of the Chairman and the members of the council of the FMA are stated in the FMA Act, which is posted on the FMA website. The FMA cooperates with the MoF in formulating financial policy for capital markets. On both websites there is information about this cooperation. Because the MOU between the NBS and the FMA is still to be signed, the scope and the procedures of the cooperation between them are not publicly disclosed. Stock exchanges are governed by provisions of the SEA and the Articles of Association (available on their websites).

217. Open process for formulating and reporting of supervisory policies over capital markets. Relevant laws and by-laws and the regulatory framework of primary and secondary legislation are posted on the FMA website and on the MoF website. All administration fees of the Slovak Republic, including those charged by the FMA, are set according to the Administration Fee Law and are published in the note to the law, which is posted on the FMA website. Cooperation among the FMA, the MoF, and the NBS is stated in the FMA Act. Under that Act, FMA can conclude agreements on mutual cooperation with foreign supervisory authorities over capital markets. MOUs were signed with the Czech Supervisory Authority, and their main elements were put on FMA website. Significant changes in financial policy, which can only be changed through primary and secondary legislation, are publicly disclosed on the MoF website. All drafts of new regulations are put on the MoF website and the public can comment. The FMA’s Annual Report and an Analysis of Capital Markets, which are available on the FMA website adequately explain how the FMA’s activities contribute to the overall objectives of supervision, but do not adequately evaluate how the MoF regulations of capital markets contribute to those objectives.

218. Public availability of information on supervision over capital markets. The FMA collects data quarterly and it is published in the Analysis of Capital Markets. The Annual Report includes FMA financial data, balance sheet and income statements. The FMA has a Public Relations Department. The FMA’s chairman and vice chairman appear in public. They give interviews, attend conferences, make speeches and publish articles. The texts of public statements and speeches are released as a matter of course to the public. Under the SIS Act, the Investment Guarantee Fund is established. The Act specifies the nature and form of the protection, how the guarantee shall be financed, and how the arrangement shall be performed.

219. Accountability and assurances of integrity by the supervisory agency over capital markets. Standards of accountability differ between the regulatory (the MoF) and supervisory (the FMA) authorities. The Report of the IMA is sent to the Cabinet and the officials of FMA may be requested to attend the meeting of the Cabinet, while under general rules of accountability of the Cabinet, the Minister of Finance can be summoned by the Parliament to report on policies in the area of capital markets and answer questions. The FMA financial statements are not audited. According to the new FMA Law, the FMA will be required to prepare financial statements that are audited by an external auditor. They will be publicly disclosed. Internal governance procedures are not publicly disclosed. The FMA Act establishes a requirement for the chairman, council and staff of the FMA to prevent conflicts of interest, including submitting yearly statements about compliance with legal restrictions.

Table 13.

Slovak Republic: Recommended Plan of Actions to Improve Transparency in Securities Regulation

Table 13.

Slovak Republic: Recommended Plan of Actions to Improve Transparency in Securities Regulation

Reference Practice	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	The broad objective Lu achieve market efficiency should be publicly disclosed by a Mission Statement. The MOU with the NBS should be signed and publicly disclosed.
VI. Open Process for Formulating and Reporting of Financial Policies	A report issued by the FMA should include a section contributed by the MoF explaining how MoF activities contribute to the overall objectives of oversight of capital markets.
VIII. Accountability and Assurance of Integrity by Financial Agencies	Officials of the FMA should be available to appear before the Parliament to answer questions on its Annual Report.

View Table

Table 13.

Slovak Republic: Recommended Plan of Actions to Improve Transparency in Securities Regulation

Reference Practice	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	The broad objective Lu achieve market efficiency should be publicly disclosed by a Mission Statement. The MOU with the NBS should be signed and publicly disclosed.
VI. Open Process for Formulating and Reporting of Financial Policies	A report issued by the FMA should include a section contributed by the MoF explaining how MoF activities contribute to the overall objectives of oversight of capital markets.
VIII. Accountability and Assurance of Integrity by Financial Agencies	Officials of the FMA should be available to appear before the Parliament to answer questions on its Annual Report.

Authorities’ response

220. No comments received.

General

221. The assessment of the Slovak payment and settlement system was performed during the period February 18-March 1, 2002 as part of the Financial Sector Assessment Program (FSAP) for the Republic of Slovakia. The main objective of the assessment was to determine the level of observance with the Basle Committee on Payment and Settlement Systems (CPSS) Core Principles for Systemically Important Payment Systems, and to suggest areas where further development may be appropriate.

222. The assessment was prepared by Krzysztof Senderowicz, Deputy Director, Payment Systems Department of the National Bank of Poland under the supervision of Warren Coats, International Monetary Fund.

Information and methodology used for assessment

223. The assessment was based on the legislation applying to payment activities including: the National Bank of Slovakia Law, Bankruptcy and Arrangement with Creditors Act, Notice of the National Bank of Slovakia on principles of payment transfers among banks and relevant agreements with banks and operational guidelines for operators and payment systems participants. The assessment also drew on discussions with the representatives of the National Bank of Slovakia (NBS), the Slovak National Clearing Center (SNCC), the Slovak Central Securities Depository, the Bratislava Stock Exchange, the Slovak Stock Exchange and commercial banks, and answers to the IMF questionnaire with regard to payment systems. The staff of the NBS and other institutions cooperated fully with the mission and provided all the necessary clarifications and documents.

224. The assessment was focused on the Slovak Interbank Payment System (SIPS) operated by the Slovak National Clearing Center. The SIPS has been identified as a systemically important payment system as it is the only payment system in the country. The SIPS handles all interbank payments in Slovakia regardless of the value of transaction. The SIPS is used for the settlement of capital market transactions and payment cards transactions.

Institutional and market structure—Overview

225. The banking sector in the Slovak Republic consists of 20 banks. While banks provide most of the payment services to the general public, the NBS plays the principal role in establishing principles and basic rules governing the functioning of the interbank clearing and settlement system. According to Slovak law the National Bank of Slovakia controls, coordinates and ensures the circulation of money, and settlement of the payments within the scope established by the Act on the NBS, and ensures their efficient and economic performance. From operational point of view payments are cleared and settled by the SIPS, which is owned, managed and operated by the Slovak National Clearing Center Inc. established in 1992 in connection with the division of Czechoslovakia into two independent states. The SNCC commenced operations on 8 February 1993 (i.e. the day on which the Slovak currency was introduced) as the sole clearing center for all domestic interbank payments. The SNCC is owned by the NBS (about 40 percent of shares), commercial banks and the Ministry of Finance (one share).

226. Foreign exchange transactions are based on correspondent relations. The Slovak Interbank Payment System operates only in domestic currency.

Payment systems infrastructure

227. According to the Slovak regulations all domestic interbank payments must be carried out through the SNCC. Currently, there are 23 active participants in the system: 21 direct participants (the NBS and 20 commercial banks) and two so called “third parties” (the Bratislava Stock Exchange and the Authorization Center of Slovakia).

228. Direct participants of the SIPS are obliged to hold reserve accounts with the central bank. These accounts are used for final settlement of interbank payments at the end of the clearing day. The SNCC holds technical accounts for all its participants. The initial balances of the banks’ technical accounts in the SNCC equal the initial balances of the reserve balances at the NBS. During the clearing day the SNCC executes all payments on banks’ technical accounts in real time on a gross basis. At the end of the clearing day the SNCC sends the information to the NBS about the balances of technical accounts and the NBS makes final settlement on banks’ reserve accounts.

229. Indirect participants of the SIPS do not keep reserve accounts with the NBS and do not conduct payment transactions “in their own name.” They are authorized to debit or credit the accounts of direct participants. The Bratislava Stock Exchange delivers to the SNCC the results of securities trading and receives the information about financial transfers carried out on banks’ technical accounts. The Authorization Center of Slovakia delivers to the SNCC the net positions of banks arising from processing of card transactions and receives the information about financial transfers carried out on banks’ technical accounts.¹³ The BSE and the ACS have access to the SIPS on the basis of a permit issued by the NBS.

230. The BSE co-ordinates the clearing and settlement of trades concluded by stock exchange members. The transfer of ownership of securities is effected according to the individual trades concluded on BSE. At the end of the trading day, the BSE calculates the net position for each broker. The result can be either a debit or a credit. The obligations are due to be paid on T+2, and the receivables are due to be paid on T+3. Payments to settle trades are made via the SIPS where the BSE assumes a third party role. On T+2 the BSE debits the accounts of debtors and collects the funds on its account at the settlement bank. On T+3 the BSE credits the accounts of creditors. All payments are irrevocable. In order to achieve delivery versus payment, it is necessary to compare the number of securities blocked in favor of the BSE at the Securities Depository and the funds transferred via the SIPS on T+2. If the numbers of securities on the broker’s or its customer’s account at the Securities Depository differ, the BSE will not initiate the respective funds transfer.

231. The BSE settles on multilateral net basis. There are not special risk management solutions in the SNCC to guarantee the settlement. Some inefficiencies in intraday liquidity management and the lack of real time processing in the books of the central bank are the main shortcomings of the system. Therefore, one of the main recommendations for the payment systems is to establish intra-day credit facilities to improve risk management, especially in the context of a new RTGS system.

232. Cash is still the major payment instrument in Slovakia (particularly among individuals) but in recent years, banks have introduced advanced payment instruments. Electronic banking, internet banking and payment cards are widely used. Credit transfers are the major payment instruments particularly among legal entities.

233. The predominance of credit transfers is a distinguishing feature of the payment system in Slovakia. The SIPS also processes direct debits and transactions coming from checks and payment card transactions.

234. The SNCC works on the basis of a 24-hour cycle called “a clearing day.” The data exchange between banks and the SNCC takes place at time intervals set according to a timetable for submitting and processing data at the clearing center. Banks may deliver payment transaction data for processing on a given clearing day from 5:00 p.m. at the previous day to 11:30 a.m. at the clearing day and they are processed in real time on gross basis. The period from 11:30 a.m. to 1:00 p.m. on the clearing day is reserved for large-value interbank funds transfers aimed at balancing the liquidity. From 1:00 p.m. to 4:00 p.m. the final positions of all banks are calculated and the system maintenance is carried out. At 4:00 p.m. books are closed for the current clearing date, daily reports are generated and distributed to all participants and the information about balances of banks’ accounts is sent to the NBS for final settlement. The processing and settlement of credit transfers, from debiting the payer’s account at one bank to crediting the beneficiary’s account at the other bank, takes no more than three days.

235. Banks monitor their current balance on the technical account at the SNCC during the day, either electronically or by telephone. The NBS is authorized to monitor the technical accounts of all banks with the aim to oversee and supervise liquidity in the banking sector.

236. As regards card transactions, the Authorization Center of Slovakia (ACS), a joint stock company, supplies banks (which issue and accept payment cards) with clearing files containing the data on the use of payment cards on a daily basis. At the same time, the ACS prepares data for mutual settlement between banks and submits them to the SNCC for processing on the basis of a third-party order.

237. The settlement of transactions for banks is based on the principle of net settlement. Table 14 shows the number and value of transactions processed in the SIPS in comparison to GDP.

Table 14.

Slovak Republic: The SIPS Transactions

^1/Source: National Bank of Slovakia (1997–1999); and SNCC (2000–2001).

Table 14.

Slovak Republic: The SIPS Transactions

Year	Number of processed transactions (millions)	Value of transactions (SK billions)	Ratio Value/GDP
1997	54.5	12,727	18.5
1998	61.1	11,767	15.7
1999	65.4	9,999	12.3
2000	70.9	12,860	14.5
2001	79.1	15,815	16.5

^1/Source: National Bank of Slovakia (1997–1999); and SNCC (2000–2001).

View Table

Table 14.

Slovak Republic: The SIPS Transactions

Year	Number of processed transactions (millions)	Value of transactions (SK billions)	Ratio Value/GDP
1997	54.5	12,727	18.5
1998	61.1	11,767	15.7
1999	65.4	9,999	12.3
2000	70.9	12,860	14.5
2001	79.1	15,815	16.5

^1/Source: National Bank of Slovakia (1997–1999); and SNCC (2000–2001).

Main findings—Summary

238. Payment system in Slovakia is generally efficient, and the SIPS largely observes the CPSS Core Principles. However, there are a few areas that could be addressed to bring Slovakia with full observance of the CPSS Core Principles.

Recommended actions and authorities’ response to the assessment

Recommended actions

Table 15.

Slovak Republic: Recommended Actions to Improve the Slovak Interbank Payment System

Table 15.

Slovak Republic: Recommended Actions to Improve the Slovak Interbank Payment System

Reference Principle	Recommended Action
Legal foundation-—CP 1	Legislation should protect transfer orders from insolvency law provisions from the moment they enter a designated system, insure that the rights and obligations with the system are protected from retroactive application of insolvency provisions, and insulate collateral from the effect of insolvency proceedings.
Understanding and management of risk—CP 3	Intra-day credit facilities should be established in the context of a new RTGS system.
Criteria for participation—CP 9	These criteria should be applied continuously, not only when an institution makes an initial application. Access and exit criteria should be disclosed.

View Table

Table 15.

Slovak Republic: Recommended Actions to Improve the Slovak Interbank Payment System

Reference Principle	Recommended Action
Legal foundation-—CP 1	Legislation should protect transfer orders from insolvency law provisions from the moment they enter a designated system, insure that the rights and obligations with the system are protected from retroactive application of insolvency provisions, and insulate collateral from the effect of insolvency proceedings.
Understanding and management of risk—CP 3	Intra-day credit facilities should be established in the context of a new RTGS system.
Criteria for participation—CP 9	These criteria should be applied continuously, not only when an institution makes an initial application. Access and exit criteria should be disclosed.

General

258. Payment System policy formulation and implementation by the National Bank of Slovakia (NBS) satisfies a very high standard of transparency practices. The main transparency practices and the areas that deserve further strengthening are described below.

259. The NBS is very eager to be transparent and sees the transparency as an important tool in public participation in policy formulation and in oversight of its operation.

260. The Slovak authorities cooperated fully with the assessment and provided all the necessary information and clarification.

Main findings

261. Clarity of roles, responsibilities, and objectives of the payment system oversight. The objective of the payment system oversight, the means to pursue this objective and the responsibilities of the NBS to direct, coordinate and to secure the payment and settlement system, are all clearly stated in the NBA. The NBA is published on the NBS website. The NBS issues an Annual Report but no part of this report is dedicated to the payment system. The NBS website includes the legislative framework (primary and secondary legislation). The governing body of the NBS is the Bank Board. Procedures for members of the Board appointment, terms of office, and any general criteria for removal and all members by name are available on the NBS website. General policy principles are publicly disclosed in the NBS bulletins and on the NBS website.

262. Open process for formulating and reporting of the payment system oversight. Legislative support for the payment system is provided by the SBA. In the NBA there are also some operating procedures. The operating procedures are described in great detail in the Decrees, which are on the NBS website. Access criteria to the payment system are described in the internal instructions which are not publicly disclosed. Recently, the draft of the Act on payment systems was published on the website of the NBS for comments. Description and explanation of each paragraph was an important part of the draft. Through this the NBS explained its policy. The drafts of substantial technical changes are put on the NBS website for public information and comments. Significant changes in financial policies are placed on the Board’s agenda, and after the Board’s decision, the NBS issues a press release. The NBS overall policy objectives for the payment system are reported in the banking publication BIATEC and on the website of the NBS.

263. Public availability of information on the payment system oversight. The NBS publishes BIATEC (a journal on banking industry), part of which is devoted to major developments of the payment system. BIATEC is also on the NBS website. Aggregate data on payment system are available on the NBS website. The NBS publishes its audited financial accounts in the Annual Report. Emergency financial support by the NBS has been rare and its details, which on each occasion would involve a single bank, were not published as such. However, on each occasion the fact of the assistance was publicly acknowledged. The results of such credits are reflected, in the aggregate financial statements of the NBS. The team recommended improving the disclosure of emergency credits. While giving due recognition to concerns relating to stability of the financial markets, confidentiality and moral hazard, the NBS should disclose aggregate information on the emergency credit facilities, exercising judgment on the timing and on the nature of the information disclosed. The NBS has its own Public Information Department and also own speakers. The Department issues information concerning the payment system. The NBS conducts quarterly meetings, chaired by the Governor with the representatives of all banks. Beyond these regular meetings the Governor and other members of the Bank Board commonly comment on payment system developments in the media and also publish articles in the press.

264. Accountability and assurances of integrity by the NBS. The Governor and vice-governors appear in the Parliament to present an Annual Report and Monetary Policy Report (three times a year). They are also very often invited by the Parliament to appear and to answer different questions concerning the payment system. They and staff of the NBS take part in discussions in parliamentary committees dealing with new banking legislation. The NBS is obliged to present its audited financial statements once a year to the Slovak Parliament. The NBS has very thorough principles and arrangements of internal audit and control in place and they are posted on the NBS website. An NBS Internal Code of Conduct containing internal rules and regulations with regard to standards for the conduct of personal affairs of officials and staff of the central bank, “Code of Ethics of NBS Employees,” is listed on the NBS website. NBS officials and staff have satisfactory legal protection under the Labor and the Civil Code, which are applicable for all employees.

Table 16.

Slovak Republic: Recommended Action Plan to Improve Transparency of Payment Systems Oversight

Table 16.

Slovak Republic: Recommended Action Plan to Improve Transparency of Payment Systems Oversight

Reference Principle	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	A part of an Annual Report should be dedicated to the payment system.
VI. Open Process for Formulating and Reporting of Financial Policies	Access criteria to the payment system should be publicly disclosed.
VII. Public Availability of Information on Financial Policies	The disclosure of emergency credits should be improved.

View Table

Table 16.

Slovak Republic: Recommended Action Plan to Improve Transparency of Payment Systems Oversight

Reference Principle	Recommended Action
V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies	A part of an Annual Report should be dedicated to the payment system.
VI. Open Process for Formulating and Reporting of Financial Policies	Access criteria to the payment system should be publicly disclosed.
VII. Public Availability of Information on Financial Policies	The disclosure of emergency credits should be improved.