Republic of Belarus: Selected Issues

This Selected Issues paper describes labor market trends in Belarus and the role of labor market institutions in the outcome. The paper examines the current status of the tax system in Belarus and assesses recent efforts to reform it. It argues that the current tax system in Belarus is distortionary, and that it weakens the competitiveness of the economy. The paper also provides preliminary estimates of the pass-through from the nominal exchange rate (for the U.S. dollar and the ruble) to inflation in Belarus.

Abstract

This Selected Issues paper describes labor market trends in Belarus and the role of labor market institutions in the outcome. The paper examines the current status of the tax system in Belarus and assesses recent efforts to reform it. It argues that the current tax system in Belarus is distortionary, and that it weakens the competitiveness of the economy. The paper also provides preliminary estimates of the pass-through from the nominal exchange rate (for the U.S. dollar and the ruble) to inflation in Belarus.

IV. Reforming The Banking Sector24

1. Banking sector vulnerability is a serious and possibly growing problem in Belarus. The main issues are the high level of dollarization and asset quality that could well be impaired, given years of directed lending. A currency union with Russia, if established according to the agreed timetable (January 2005), would only increase the vulnerability of the system, as it would require tighter macroeconomic policies, stronger financial sector competition, and limited or no lender of last resort (LOLR) capabilities for the National Bank of Belarus (NBB).25

2. The authorities have undertaken some important measures to reform the banking sector, but the process needs to be accelerated. During 2002–03, they have sought to increase capital requirements and improve banking supervision. However, it will also be important to eliminate directed credits, tighten prudential regulations, and level the playing field for state and nonstate banks. Nonviable banks should be closed as soon as possible whereas viable but undercapitalized banks should be required to come up with credible restructuring plans. While priority should be given to operational restructuring to stop losses from recurring, financial restructuring may become unavoidable. Measures should also be taken to improve the operational environment for banks. An FSAP is expected to be conducted in late 2004; in the mean time, this chapter provides an assessment of the priority areas for banking sector reform. Section A describes the banking system at present; section B summarizes several recent attempts to reform the system; and section C concludes by making preliminary suggestions regarding a more comprehensive reform program.

A. Current Situation

3. The banking sector remains relatively underdeveloped and heavily concentrated. The ratios of M2/GDP and credit to the economy/GDP in Belarus are significantlylower than in advanced transition countries, while the spread between lending and deposit rates and the dollarization ratio are higher (Table 1). The largest six banks, five of which are largely state controlled, make up 85 percent of assets and 87 percent of total capital of the banking system (Table 2).26 The rest of the sector is highly fragmented.

uA04fig01

EBRD index of banking sector reform in 2003

Citation: IMF Staff Country Reports 2004, 139; 10.5089/9781451805086.002.A004

Table 1.

Financial Intermediation Indicators for Belarus and Selected Countries, 1999-2002

(In percent; end of period; unless otherwise specified)

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Sources: Belarus authorities; EBRD Transition Report (2003), De Nicola et. al (2003); and IMF staff estimates.

Includes credit to SOEs.

Credit to the private sector only.

Table 2.

Belarus: Main Indicators of Activities of the Six Largest Banks, 2001-2003

(In millions of rubels unless otherwise specified)

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Sources: The National Bank of Belarus; and IMF staff calculations.

Total assets adjusted for accounts of interbranch settlements and expenditures.

4. State intervention in the operational activities of both enterprises and banks is at the core of problems in the banking sector. About 80 percent of GDP is produced in state enterprises. In the banking sector, at end-2003, the share of the government and the NBB in the capital of the banking system was 79 percent and 3 percent, respectively. Further, for some years the government has used the banking system to stimulate growth in particular sectors and to finance quasi–fiscal activities.27 The four largest SCBs mainly service specific sectors and are often forced to lend without adequately measuring and pricing risk. In 2004, for example, the government has “recommended” that the six largest banks provide credits to specific investment projects amounting to more than 3 percent of GDP.28 In addition, the authorities strongly influence interest rate decisions of commercial banks by “suggesting” deposit and loan interest rates. Very often banks are forced to restructure previous loans, which usually involve issuance of new government guarantees.29 As a result, the financial situation of the SCBs is generally worse than that of the other commercial banks (Table 2).

5. In turn, the SCBs have largely been shielded from competition. The SCBs do not always comply with prudential regulations. Further, they have easy access to central bank and government resources, and often benefit from government guarantees for loans they extend. The SCBs enjoy state insurance on deposits of individuals, while the other banks do not have access to this facility.30 In addition, Belarusbank and Belagroprombank regularly receive substantial capital injections from the government.31

6. Banks face incentives that encourage excessive risk taking and discourage taking corrective measures at an early stage. Governmental pressure to finance particular projects, for example, reduces the incentive for banks to implement adequate procedures for loan screening. The potential for depositors to impose discipline on banks, on the other hand, seems to be limited by the poor quality of the accounting system, weak disclosure practices, deposit insurance, and a lack of alternative investment vehicles. The situation is exacerbated by the lack of skilled labor in the financial sector.

7. Weaknesses in the accounting and disclosure rules and in the legal framework hinder the development of the system. Private investors and depositors as well as bank supervisors need current, accurate, comprehensive, and transparent information on the creditworthiness of banks in order to monitor them and to be able to make adequate investment and supervisory decisions.32 Belarusian banks, however, largely mask their weak financial situation by inadequate accounting and asset classification, and assets are rarely reflected in the balance sheets at market values. Ownership and creditor rights are not well-protected. Banks are often distracted by unwarranted visits by the tax, police, and other control bodies. The legal system makes it difficult and time consuming to trigger bankruptcy procedures and seize collateral for delinquent loans.33

8. The banking system is prone to significant risks, despite good reported vulnerability indicators. Capital adequacy and liquidity ratios are high, and the ratio of NPLs to total loans is fairly low.34 Nevertheless, the key problems would seem to be the following:

  • Senior officials, including President Lukashenko, have become increasingly concerned about NPLs. As a result, in mid-2003 the NBB issued an instruction to banks to reduce them to no more than 5 percent by end-2003. In practice, this target was met, as NPLs were reportedly reduced to less than 4 percent at end-2003 (from about 15 percent of total loans in mid–2002). The authorities attribute the fall to improved payments discipline, but to a large extent it also occurred as a result of: (i) rapid increases in total loans, (ii) “evergreening” (informally rolling over) of loans, and (iii) issuance of government guarantees, which doubled in nominal terms in 2003 (Table 2). Moreover, weak accounting and asset classification practices also mask the vulnerability of the system;

  • Underprovisioning for NPLs is widespread; in 2003, for example, underprovisioning was about 5 percent of total capital;

  • There is a danger of currency mismatches, as the economy remains highly dollarized.35 Banks often lend in foreign currency to borrowers with limited foreign currency revenues, and are not able to hedge the underlying foreign exchange risk. The situation is exacerbated by the fact that the ratio of banking system foreign assets to foreign currency deposits is low;

  • Banking sector profitability is low. With adequate (loan loss) provisioning (see above), the banking sector would have recorded losses in 2000–02 and virtually no profit in 2003;

  • A large part of bank capital has been financed by the NBB, either directly or indirectly through the budget. In 2003, for example, the NBB provided long-term, low-interest loans of Blr 155.6 billion (about ½ percent of GDP) to the government for recapitalizing commercial banks; and

  • With the exception of Priorbank, Belarusian banks largely do not have access to international capital markets. While this factor has limited the financial leverage of banks, it also means that banks will not be able to borrow significant amounts abroad if necessary.

9. The macroeconomic situation is not very conducive for the development of the banking system. While the Belarusian authorities report relatively robust GDP growth rates, the financial situation of enterprises remains difficult. Belarus has a crawling band exchange regime, although its international reserves are low and it continues to have the highest inflation rate among FSU countries.36 The rubel appreciated in real terms against the dollar from September 2001 to end-2002, hurting the competitiveness of Belarusian goods, but depreciated in 2003 as the ruble and euro appreciated against the U.S. dollar. Administrative wage increases and the slow pace of structural reforms have significantly worsened the financial situation of the corporate sector, thereby calling into question the quality of banking system assets. The recent rapid growth in credit to the economy should, therefore, be viewed with caution. Credit to the economy increased by 71 percent in real terms during 2001–03, despite the fact that at least one third of the enterprises were lossmakers.37 Household credit rose rapidly as well.

10. Bank supervision suffers from weak powers to correct problems, as well as the administrative burden of managing the liquidation of bankrupt banks. Bank supervisors do not seem to have sufficient power to force SCBs to comply with prudential regulations. Belarusbank and Belagroprombank, in particular, systematically violate reserve requirements and underprovision for NPLs. Moreover, the NBB’s ownership of large stakes in several banks (Belinvestbank, Poiskbank, Mezhtorgbank, and Belvneshekonombank) creates a conflict of interest with the NBB’s supervisory role. Finally, managing the liquidation of bankrupt banks drains away the limited resources of the NBB.

11. Some state officials are pushing to oblige state-owned enterprises (SOEs) to move their deposits to SCBs. If adopted, this measure would further reduce the efficiency of the banking system to intermediate capital. At present, the authorities are merely studying this proposal, but anecdotal evidence suggests that some SOEs have begun moving their deposits from private commercial banks to SCBs.

B. Previous Reforms

12. A concept paper on development of the banking system was adopted in 2001. It contains several progressive measures, but falls short of proposing a comprehensive reform package. The document aims at reducing the state ownership of banks and opening up the system to foreign competition, both long-overdue measures. However, it fails to identify the state control and quasi-fiscal role of the systemic banks as the main source of banking system vulnerability, stating that “radical changes in respect of the ownership or the structure of Belarusbank, Belagroprombank, and Belinvestbank, including the sale of the NBB shares in these banks is not a priority issue of the system restructuring.”

13. The authorities have been trying to consolidate the system by increasing capital requirements. In 2002, a unified minimum capital of €5 million was introduced, replacing the preferential requirement of €2 million for banks with local capital, and €5 million for banks with foreign capital. While increasing minimum capital requirement was a welcome measure, since it increased the resilience of the system to shocks, doing so in combination with the large capital injections to the SCBs by the government effectively discriminated against small private banks.

14. The authorities have recently adopted a new concept note on banking supervision, prepared by the NBB banking supervision department. The document—which is a step in the right direction—emphasizes the importance of rigorous licensing and proper evaluation of business plans as the first steps to preventing future banking system problems. It also aims at improving self-assessment of banks, removing restrictions on the frequency of on-site inspections, improving the disclosure of information on bank owners, introducing consolidated bank supervision, and expanding power to impose fines and close banks. In line with this concept note, the authorities have already carried out a self-assessment against BIS principles, and are working toward fully realizing these principles.

15. The NBB has recently changed prudential regulations in order to discourage banks from lending in foreign currency to enterprises without regular sources of income in foreign currency. Demand for loans in foreign currency remains very high, however, as borrowing in foreign currency has been much less expensive than borrowing in rubels.

16. On the macroeconomic front, the NBB has announced that starting in 2004 it will stop (inflationary) direct financing of the budget deficit, which was mainly used to finance housing.38 However, the NBB expanded credit to government very substantially in the last days of 2003, effectively “pre-paying” its 2004 contribution to the housing sector. Moreover, the authorities moved the burden of financing the housing construction onto commercial banks. In 2004, for example, Belarusbank alone will provide Blr 500 billion for this purpose.39

C. Moving Forward

17. Stable macroeconomic conditions would do much to reduce uncertainties and volatilities in the economy and contribute to improvement in financial intermediation.40 Bringing inflation down to levels similar to those of neighboring countries is also essential for establishing and retaining investors’ confidence, for which the key measure is stopping direct NBB financing of the budget. This would require downscaling the housing construction program and organizing mortgage lending based on market terms (rather than shifting the fiscal burden of the housing program to the banking sector).

18. Stopping directed credits and leveling the playing field should be the first step in rehabilitation of the banking system. The government needs to stop intervening in the operational management of banks, and all banks should be required to comply with prudential regulations. Exemptions from prudential regulations for SCBs should be abolished and all banks should be treated equally with regard to deposit protection.

19. Prudential regulations may need to be tightened further. Despite the latest changes in prudential regulations, the pace of credit growth, particularly in foreign currency, remains a concern. Divestiture of the NBB’s shares in commercial banks would also eliminate the conflict of interest between the NBB as a shareholder and supervisor of the same institutions.

20. In the rehabilitation of individual banks, priority must be placed on the restructuring the largest SCBs, since they are crucial for the stability of the system. At the same time, one of the most important tasks is to identify loss-making banks, a task that is more difficult than it seems, given the need for adequate information on asset classification and accounting. In this exercise, banks should be classified into three groups: (i) viable and meeting regulatory requirements; (ii) nonviable and insolvent, and (iii) viable but undercapitalized.

21. All viable but undercapitalized banks should be required to present restructuring plans showing how they intend to remain profitable and solvent. All insolvent and nonviable banks, on the other hand, should be closed/resolved as soon as possible to stop their losses. To prevent additional losses from occurring, operational restructuring needs to be given priority. This requires identifying the profitable and unprofitable activities of remaining banks in order to reduce costs through retrenchment of unprofitable branches and by reducing staff. It may also necessitate changes in management, business strategy, and product mix and pricing. In other countries, the key elements of operational restructuring have included implementing new technology; increasing the use of automation; improving accounting, asset valuation, and internal controls and audit; and establishing adequate loan screening, risk management, and loan recovery procedures.

22. Opening up the system to competition would facilitate operational restructuring. Exposing banks to strong competition could have a disciplinary effect on weaker banks, while the entrance of foreign banks could improve competitiveness by weakening the dominant position of the largest banks. Moreover, under the right conditions (including a more favorable environment for FDI), the entry of foreign banks could help diversify the economy and reduce vulnerability.

23. Asset rehabilitation should be a key component of financial restructuring. Best practice typically includes either the creation of a debt recovery unit in banks or the creation of specialized asset management companies (AMC), which can either be private or publicly-owned. The experiences of other countries suggests that handling problems in each bank may help to maximize the recovery value of impaired assets, but at the cost of relatively slow overall progress. Centralized AMCs can be relatively more efficient when the size of the problem assets is large, as asset management may involve economies of scale, and skilled staff is in shortage. However, publicly-owned, centralized AMCs may lack incentives for maximizing recovery values and may be subject to political interference.

24. Bank restructuring will require improving the operational environment for banks. The efficiency of the banking system would largely improve by applying international accounting standards (IAS) to banks and enterprises, enforcing and improving transparency rules, reforming the legal system to strengthen ownership and creditor rights and ease foreclosure and bankruptcy rules, and carrying out land reform.

25. Finally, but most importantly, banking reform needs to be supported by operational and financial restructuring of the corporate sector. Indeed, the poor performance of the unreformed state enterprise sector is the ultimate source of the bad debt problem in the banking sector. Banks will never have good investment choices until reform and privatization of the enterprise sector has been addressed.

References

  • Cottarelli, Carlo, Giovanni Dell’ Ariccia, Ivanna Vladkova-Hollar, 2003, “Early Birds, Late Risers, and Sleeping Beauties: Bank Credit Growth to the Private sector in Central and Eastern Europe and the Balkans, IMF Working Paper 03/213, November, 2003 (Washington, International Monetary Fund).

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  • De Nikolo, Gianni, Sami Geadah, and Dmitriy Rozhkov (2003), “Financial Development in the CIS-7 Countries: Bridging the Great Divide,” IMF Working Paper 03/205, October 2003 (Washington, International Monetary Fund).

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  • Gulde, Anne-Marie, Etibar Jafarov, Vassili Prokopenko, 2004, “Costs and Benefits of a Currency Union Between Belarus and Russia,” IMF Working Paper, forthcoming.

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  • Presidential Ukaz No. 274 “Ob Odobrenii Kontseptsii Razvitiya Bankovskoy Sistemy Respublliki Belarus na 2001-2010,” May 28, 2002 (Concept of banking system development).

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  • Resolution No. 19 of the National Bank of Belarus “Ob Utverzhdeniya Kontseptsii Razvitiya i Sovershenstvovaniya Bankovskogo Nadzora v Respublike Belarus i Plana Meropriyatiy po Vnedireniyu Mezhdunarodnykh Standartov Bankovskogo Nadzora,” January 31, 2003. (Concept of banking supervision).

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24

Prepared by Etibar Jafarov

26

These include four state—controlled banks (SCBs)—Belarusbank, Belagroprombank, Belpromstroibank, and Belinvestbankas well–as Belvneshekonombank (in which the share of the public sector is less than 50 percent of capital), and Priorbank (a subsidiary of Raiffeisen Bank of Austria). Only these banks are “authorized” to carry out state programs.

27

Belarus committed to abolishing directed credits under its 2001 SMP, but directed credits resumed in 2002 when banks were forced to restructure overdue loans to food processing companies and to finance payments for wage and energy arrears. This practice continued in 2003–04.

28

See Government Resolution No. 152 of February 11, 2004 (http://pravo.by/webnpa/text.asp?RN=c20400152).

29

The latest of these initiatives allows investors of loss making farms to defer repayment of bank debts of these enterprises for three years. See Presidential Ukaz No. 138 of March 19, 2004 (http://pravo.by/webnpa/text.asp?RN=P30400138).

30

Belarusbank and Belagroprombank have an unlimited government guarantee on all household deposits, while the other authorized banks have unlimited government guarantees for household deposits in foreign currency and limited guarantees in national currency. Belarusbank and Belagroprombank do not pay premiums.

31

Most of these capital injections were made when the government converted into capital its claims on the banks (which arose when direct NBB credits to the budget were lent to the banks to finance housing construction).

32

Banks themselves need such information about their clients.

33

In 2003, the bankruptcy law was changed to make bankruptcy procedures even more difficult to initiate.

34

See Box 1 in the associated staff report for the 2004 Article IV consultation.

35

There are no sizable markets for hedging instruments.

36

The band is formally identified in terms of the Russian ruble, but de facto the authorities target the dollar.

37

Cottarelli, and others (2003), discuss problems associated with credit booms in Central and Eastern Europe.

38

Elimination of direct NBB financing of the budget in 2004 was a condition under the 2002 Joint Action Plan on creating a monetary union with Russia.

39

Belarusbank will charge 10 percent for housing loans, and will be compensated from the budget for the difference between that rate and the refinance rate, plus 3 percent.

40

While macroeconomic stability is essential for sustainable long-term growth, the authorities need to prepare financial institutions for difficulties stemming from tight policies in the short term.

Republic of Belarus: Selected Issues
Author: International Monetary Fund