Republic of Armenia: Financial System Stability Assessment—Press Release; Staff Report; and Statement by the Executive Director for the Republic of Armenia
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International Monetary Fund. Monetary and Capital Markets Department
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Publication Date:
12 Dec 2018
eISBN:
9781484389737
Language:
English
Keywords:
ISCR; CR; Basel III requirements; financing; CBA; Basel III minimum; CBA judge; CBA assessment; CBA assets; CBA assessment of credit risk management; Armenian bank; Credit
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Financial Sector Assessment Program-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Armenia

Abstract

Financial Sector Assessment Program-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Armenia

Executive Summary

The Armenian banking sector is recovering from the 2014 economic slowdown, aided by additional capital injected by shareholders, several mergers, and improved regulation and supervision. However, banks, including the largest ones, are vulnerable to external shocks because high levels of dollarization expose them to FX-related credit and liquidity risks. These risks can be mitigated with the adoption of a stressed debt service to income ratio limit, the gradual introduction of reserve requirements in foreign currency for liabilities denominated in foreign currency, and the adoption of the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) in domestic currency and in United States dollars (USD). The introduction of the capital surcharge for domestic systemically important banks is also needed.

From a cyclical perspective, with the credit to GDP gap estimated to be closing, the recent pick-up in credit growth warrants close monitoring of bank risks. Banks’ low profitability levels, coupled with the current abundant liquidity, seem to be providing incentives to adopt excessive risk-taking behavior. Moreover, credit quality has not yet fully recovered from the 2014 slowdown. The authorities should implement the planned Basel III’s capital buffers starting from next year, including the framework for the countercyclical capital buffer, and the possibility for supervisors to increase capital requirements for banks with higher risks. Consideration should also be given to remunerating reserve requirements.

The Central Bank of Armenia (CBA) has made significant progress in strengthening banking supervision with the adoption of the Risk-Based Supervision (RBS) framework and addressing gaps in the regulatory framework identified in the previous FSAP. Efforts should now be aimed at refining the risk-based differentiation in capital levels using stress testing and the internal capital adequacy assessment process (ICAAP); consistently enforce large exposure limits; amend the definition of nonperforming and restructured loans to reflect international best practices; and incorporate the understanding of International Financial Reporting Standard (IFRS) 9 methodologies in supervisory practices to enable a more comprehensive assessment of a bank’s credit risk management capabilities.

The crisis management framework is weakened by flaws in the approach to bank resolution; the narrow functions of the Deposit Guarantee Funds (DGF); and the absence of a true interagency high-level crisis management committee. Considering the significant presence of foreign subsidiaries, the supervisory Memoranda of Understanding (MOUs) should be expanded to include resolution planning of foreign subsidiaries in Armenia and, in the absence or inadequate resolution provisions, the authorities should develop contingency plans to deal with stress in foreign banks. Recovery and resolution plans should also be implemented for domestic banks, in particular when they are of systemic importance.

Since the last FSAP in 2012, there have been substantial improvements in the legal framework and key policy decisions that led to further development of the financial sector. However, to fully reap the benefits of these reforms, further efforts are needed.

The bankruptcy law was reformed in 2016 with the objective of increasing the potential for rehabilitation of financially distressed companies and individual debtors. However, further improvements are necessary to ensure that the main function of insolvency proceedings is to maximize return to creditors through reorganization of the debtor, or as a collective debt collection mechanism by pooling together a debtor’s assets for the benefit of all creditors. Due to existing shortcomings in the insolvency law and inefficient individual debt enforcement processes, insolvency in Armenia is often used as a debt collection tool by individual creditors, while the rights of secured creditors in insolvency proceedings are not sufficiently protected.

Access to finance for medium and small enterprises (MSME) remains constrained by informality and unreliable financial reporting, which result in excessive collateral requirements, high costs, and a non-diversified product offering. The efficiency of the fragmented government support programs should be enhanced by consolidation and improved targeting of programs and a better coordination among the various stakeholders.

The full implementation of pension reform in July 2018 was an important step towards the development of capital markets. The administration of the pension system has been set up on a cost-effective basis and is working well. The mandatory pension system should be maintained.

A cross-cutting issue affecting both financial stability and development is the lack of transparency in reporting and accounting by corporations, sub-national entities and state-owned entities (SOEs). Measures to increase transparency, including improved accounting standards and audit requirements, are thus crucial to support financial stability surveillance and financial development, in particular to enable resources from pension funds to be channeled into the real economy.

Table 1.

Armenia: Key Recommendations

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Immediately; ST: short term= less than 1 year; MT: medium term= 1–5 years. When measures require Parliamentary intervention, it is expected that preparations of draft laws are made in the short term.

Financial Sector Structure

1. The financial system has expanded since the 2012 FSAP and remains dominated by banks (Table 2). The banking sector’s assets have risen from 58 percent of GDP in 2012 to 78 percent in 2017, and branch and ATM penetration have also grown rapidly. A large proportion of banking assets are of subsidiaries of foreign banks (Table 3); while nonresidents account for about 20 percent of deposits and 8 percent of loans. Higher capital requirements announced in 2014 and implemented in 2017 have led to the merger/acquisition of four banks since 2015. The nonbank sector is still nascent but growing. The share of nonbank credit sector (non-deposit taking institutions) doubled in 6 years to 8.5 percent of GDP at end of 2017. The insurance sector expanded after third-party auto insurance became mandatory in 2010, but since 2013 its assets have remained broadly constant at about 1 percent of GDP; nonlife insurance premia collected are low by international comparison, and there are no life insurance services. The reform of the pension system, which was launched in 2011 and came into full force on July 1, 2018, has introduced a defined-contribution scheme based on funds run by two private management companies under the CBA supervision. By end-2017, there were six funds, with assets equivalent to 2 percent of GDP.

Table 2.

Armenia: Structure of the Financial System

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Source: Central Bank of Armenia. *Includes payment companies and pawnshops. *Includes net assets.
Table 3.

Armenia: Bank Size and Ownership

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Source: KPMG, Armenian Banking Sector Overview 2017Q4.

2. Markets are growing from a low base but remain shallow (Table 4). Issuances in the primary market are still dominated by government bonds and by three commercial banks, and almost all repo and reverse repo transactions in the secondary market involve government bonds. The interbank market is small but not insignificant for some banks (Figure 1). As of December 2017, interbank transactions in AMD represented 8 percent of banks’ funding.

Table 4.

Armenia: Key Financial Markets

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Source: Central Bank of Armenia; and IMF staff calculations.
Figure 1.
Figure 1.

Interbank Market (November 2017)

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Systemic Risk and Resilience

A. Structural Vulnerabilities

Risks from External Shocks and Dollarization

3. Armenia is highly dollarized (Figure 2), exposing banks to unhedged borrowers. Over 60 percent of household deposits, including most of their saving accounts, are denominated in FX. They are underpinned by remittance inflows, which represented 8.5 percent of GDP in 2017. On the lending side, 80 percent of corporate loans and about 30 percent of household loans (mainly mortgages) are denominated in FX. Competition for market share encourages banks to remunerate FX deposits at rates higher that those consistent with the remuneration of high quality liquid assets (HQLA) holdings; to avoid the negative carry, banks lend to hedged and unhedged customers. Not surprisingly, nonperforming loan (NPL) ratios are higher for dollar-denominated loans and sensitive to currency depreciation.

Figure 2.
Figure 2.

Loans to and Deposits from the Non-Financial Sector

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Source: Financial Stability Department, Central Bank of Armenia
uA01fig01

Armenia: Nonperforming Loans by Currency

(Percent of total gross loans)

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Sources: Central Bank of Armenia; and IMF staff calculations.

4. There are also funding and liquidity risks associated with dollarization. FX funding was about two thirds of total funding between 2012–2017 and the loan to deposit ratio in FX was about 1.4 in 2017 while this ratio was about 1 in AMD. Moreover, as of February 2018, about 30 percent of contractual outflows have a residual maturity of less than 30 days (the bulk of the short-term liabilities is concentrated on corporate demand deposits and retail deposits). Liquidity risks are promoted by the requirement to maintain reserve requirements in AMD for liabilities denominated in foreign currency, which results in lower liquid assets in foreign currency than in domestic currency (about 6 and 18 percent of total assets respectively). Naturally, the central bank has limited capacity to provide emergency liquidity assistance in FX. 1

Low Profitability

5. The rapid expansion of Armenia’s banking sector over the past decade was accompanied by a significant decline in profitability. Between 2007 and 2017, while the total assets of the banking sector increased from 24.3 to 78.2 percent of GDP and banking capital more than doubled, the total profits of Armenian banks remained broadly constant (aside from cyclical fluctuations) in absolute terms (about $60 million per year on average). In 2017, the average return on assets (ROA) of Armenian banks was less than 1 percent and the average return on equity (ROE) was about 6 percent. Low profitability seems to originate from a high volume of nonperforming loans, and declining interest spreads (Figure 3). There are also some indications that profitability could benefit from economies of scale. Armenian banks are generally smaller than banks in comparable countries when using a variety of indicators. These include the average bank assets (which was about $0.53 billion in Armenia in 2017) and the size of their market: the GDP per bank amounted in 2016 to $0.62 billion. With a very moderate concentration index of Herfindahl-Hirschman by assets of 8.7 percent, it appears that additional mergers could be beneficial.

Figure 3.
Figure 3.

Drivers of Profitability of Armenian Banks

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Sources: Central Bank of Armenia; and IMF staff estimates
uA01fig02

Selected Countries: GDP per bank

(average 2016, millions of U.S. dollars)

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Sources: FitchConnect, IMF World Economic Outlook data base; and IMF staff calculations

6. Since 2014, the low profitability trend has been accentuated by the economic downturn and by the increase in minimum capital requirements. The economic slowdown triggered an increase in provisions for nonperforming loans. At the same time, the CBA’s 2014 decision to raise minimum absolute (i.e., not adjusted for risk) capital requirements six-fold from 2017 (to promote mergers) induced an inflow of new capital in the sector that promoted a further expansion of deposits to preserve leverage and thereby returns to shareholders, spurring a competition for loans and deposits that further compressed interest spreads as funding costs increased in real terms.

7. Low profitability may be encouraging excessive risk-taking behavior. The ROE appears to be, on average, below the cost of bank capital (estimated at about 10–16 percent) and compares unfavorably with yields on government bonds.2 Although further recovery from the 2014 slowdown and other prospective developments in the financial sector—such as the expansion of the pension funds, higher use of online services and asset growth—could raise returns somewhat, the risk remains that investors’ expectations of a significant rebound in rates of return may prove optimistic and that investors’ interest may wane if yields remain modest for a protracted period. Protracted low yields could induce bank managers to accept higher risk to improve returns in the short term.

Large Exposures

8. Banks’ large exposures to private counterparties are high and banks tend to breach the local statutory limits. The Armenian regulation of large exposures is more conservative than recommended by the Basel guidance; however, enforcement is poor. Large exposures represent about 25 percent of total exposures. Concentration of banks’ exposure to the sovereign (exempted from the BIS large exposure framework) is low but on the rise while government borrowing is also rising. Total direct exposure to the government (excluding the CBA) amounted to 10 percent of bank assets at end-June 2018, or 65 percent of regulatory capital at end-June 2018, up from 53 percent at end-2015.

B. Cyclical Vulnerabilities

9. The Armenian economy is still recovering from a significant economic slowdown and sharp declines in asset prices that occurred in 2014–15 (Table 7). In 2014, the Armenian economy was hard hit by a fall in price and volume of copper exports, the weakening of Russian economy, and low remittance receipts. The dram depreciated against the U.S. dollar by almost 15 percent in 2014, and monetary policy was tightened to ease the depreciation pressure and contain inflation. With the high level of financial dollarization, depreciation along with lower foreign currency inflows resulted in increased debt burden for unhedged borrowers in foreign currency and high NPLs.

Table 5.

Central Bank of Armenia: Planned Phase-in of Basel III Capital Requirements

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Table 6.

Armenia: Baseline and Adverse Scenarios

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Sources: Central Bank of Armenia; Haver Analytics; and World Economic Outlook database.

Increase equals depreciation.

Table 7.

Armenia: Selected Economic Indicators, 2015–21

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Sources: Armenian authorities; and Fund staff estimates and projections.

For 2018, the authorities’ budget.

Based on public and publicly-guaranteed debt.

Gross international reserves in months of next year’s imports of goods and services, including the SDR holdings.

10. At present, with the credit to GDP gap estimated to be closing, the recent pick-up in credit warrants monitoring, should the trend continue. After two to three years of low growth, both consumption and investment started to revive, supported by rising remittances and monetary easing. Although the credit-to-GDP ratio remains moderate at 45 percent at end-2017, bank credit growth to the private sector started to recover, also as a reaction to the increase in absolute capital requirements (¶6), with total credit expanding over 21 percent (y-o-y) at end-June 2018 and some sectors growing very fast.3 This requires supervisory monitoring as many banks have described this phase as a “borrowers’ market” suggesting inadequate pricing of credit risk and/or some relaxation of credit standards.

Figure 4.
Figure 4.

Monetary and Financial Conditions

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

11. Household and corporate debt appears moderate in aggregate (Figure 5). Loans to households represent about 19 percent of GDP (slightly down from a peak in 2014), of which mortgages and credit card loans account for about 30 percent and 25 percent of total household loans, respectively. The real estate market is picking up thanks to the government’s tax program,4 but market prices of residential apartment buildings in Yerevan remain broadly stable after a fall by 3 percent in 2017. On aggregate, loan-to-value ratios lie in the 60 to 80 percent range, indicating potential risks associated with fluctuations in the real estate price remain restrained; however, there are some high values in the distribution of mortgage loans in foreign currency. At end-2017, nonperforming consumer loans amounted to around 6 percent of total consumer loans, while nonperforming mortgage loans amounted to around 4 percent of total mortgage loans.

Figure 5.
Figure 5.

Households and Corporates’ Balance Sheets

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Source: Central Bank of Armenia

12. Corporate debt is about 25 percent of GDP and dominated by trade credit and loans to the energy and agricultural sectors. Banks generally manage their open currency positions within regulatory limits. Hedging instruments are not widely available on the market so banks seek to balance on-balance sheet positions. The analysis of corporate leverage for financial stability purposes is hampered by the lack of transparency of corporate financial reporting information, which makes it difficult to assess individual corporates’ debt.

C. Risk Assessment

13. Current financial soundness indicators (including from publicly available information) point to high aggregate capitalization of Armenian banks and declining NPL ratios (Figure 6 and Table 8). At end-June 2018, the capital adequacy ratio was about 18 percent (with 16 percent leverage) for the system and all banks had achieved the new CBA-mandated minimum capital (AMD 30 billion, equivalent to $62 million), which came into effect in January 2017. Because the measure was binding for smaller banks, these are the ones with the highest capital to asset ratios, while largest banks are closer to the minimum. At end-June 2018, the system’s NPL ratio had fallen to around 6 percent of total loans, of which about 48 percent were covered by provisions; publicly available information shows that NPL ratios are still high in some banks (above 10 percent) and mainly affect the trade, construction and industry segments, together accounting for 30 percent of loans. Restructured loans are estimated to about 3 percent of total loans but the mission did not have access to detail information about their evolution.

Figure 6.
Figure 6.

Financial Soundness Indicators

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Table 8.

Armenia: Financial Soundness Indicators for the Banking System

(In percent, unless otherwise indicated)

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Source: Central Bank of Armenia

14. The large Armenian banks remain vulnerable to adverse external shocks due to low capital buffers, as signaled by the mission’s solvency stress test.

  • The adverse scenario assumes a sharp oil price fall that prompts a significant downturn in Russia and would affect remittances by about 24 percent. Armenia’s exports are further negatively affected by a decline of copper prices of about 27 percent. The policy reaction features a combination of a 22 percent depreciation of the nominal exchange rate and a large increase in policy rates that doubles to about 12 percent (from the current 6 percent), in line with past developments in late 2014 (see Figure 7 and Table 6). Sovereign yields increase by about 400 basis points. After two years of economic contraction, the economy starts to recover.

  • Under this scenario, bank losses materialize due to higher NPLs, interest rate risk given the prevalence of fixed interest rates on the asset side, and higher capital requirements driven by changes in the nominal exchange rate (Figure 8). Capital shortfalls (relative to the minimum required 12 percent) remain contained at some 1 percent of GDP, although these shortfalls occur in banks with a combined share of 58 percent of the assets of the banking system.

  • The solvency stress testing analysis may underestimate results due to insufficient data on large exposures and restructured loans.

Figure 7.
Figure 7.
Figure 7.

Evolution of Macrofinancial Variables Under the Adverse Scenario

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Source: Central Bank of Armenia; and IMF staff estimates.
Figure 8.
Figure 8.
Figure 8.

Solvency Stress Test (Aggregate) Results

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

Source: IMF staff calculations.Notes: T1 denotes Tier 1 capital and T2 denotes Tier 2 capital.
uA01fig03

Armenia: Capital-Asset Ratio by Total Assets, 2017

Citation: IMF Staff Country Reports 2018, 361; 10.5089/9781484389737.002.A001

15. Liquidity stress tests were based on a standard cash-flow analysis based on time buckets for up to one year under several adverse scenarios featuring funding and market liquidity risks. These scenarios assumed: a 30-day run based on idiosyncratic risks for each bank; three 12-month scenarios characterized by system-wide deteriorating macro-financial conditions; and a combined (idiosyncratic and severe market) 12-month scenario for each bank. The stress-parameters are applied to the respective cash-flows to derive outflow rates for the maturing liabilities, roll-over rates for maturing assets and haircuts on banks liquidity buffers under stressed conditions. The stress tests were undertaken on aggregate liquidity as well as for each currency.

16. While on aggregate (i.e., all currencies) banks seem well positioned to confront liquidity shocks, most banks (including the largest ones) would not have sufficient liquid assets denominated in U.S. dollars to confront U.S. dollar outflows in the adverse scenarios. The result is still valid when all liquid assets in foreign currency are considered (e.g., when euro-denominated foreign assets are allowed to be converted in U.S. dollar). For the most severe scenario, the system’s open funding gaps in foreign currency would amount to 24 percent of the CBA’s international reserves as of May 2018. These results are consistent with banks’ funding structure and low level of counterbalancing capacity in U.S. dollar. A counterfactual assessment conducted at the system level indicates that if reserves for liabilities in foreign currency were required to be held in the currency of the liability, FX buffers would be sufficient to cover the FX gaps in all scenarios.

17. Interconnectedness within the domestic interbank network and within the global network of banking systems is not large enough to threaten the solvency (of individual banks or of the system), even under adverse scenarios. Capital buffers over the regulatory minimum are sufficient to absorb losses in both cases due to thin links. As discussed above, Armenia’s largest direct banking system counterparties are Russia and the United States. Nevertheless, the analyses reveal that the banking systems whose distress could most significantly affect Armenia are France and the United Kingdom, because they are connected to counterparties in Armenia that have large cross-border exposures relative to their capital. Most of the cross-border risk would come from potential credit losses, but losses from potential funding shocks and asset fire-sales would not be negligible.

Financial Stability Policy Framework

A. Systemic Liquidity Management

18. The management of systemic liquidity has improved since the last FSAP; however, there are still in need of improvement. As liquidity forecast errors are largely related to the government cash flows, the Ministry of Finance should improve the quality of its short-term forecasts and provide to the CBA daily cash flow projections at the beginning of each week as well as a 12-month horizon forecasts (with monthly breakdown). The CBA should improve the transparency of its operations by disclosing the formula to determine the allotment of its open market operations, and more liquidity data.5 Finally, CBA should determine the range for the liquidity deficit (i.e., a maximum and a minimum outstanding amount of open market operations), which should be preserved with structural liquidity operations (such as reserve requirements) to maintain a firm grip on short-term interest rates.

19. Reserve requirements in domestic and foreign currencies should be adjusted to reflect their different roles. The role of the reserve requirement in AMD is to create enough refinancing needs in the market to keep the CBA’s control on short-term interest rates (monetary policy implementation tool). The reserve requirement on FX liabilities is primarily a prudential tool.

20. It is recommended to set AMD reserve requirement at the level that provide enough room for averaging to stabilize short-term rates and remunerating it.6 This level should be consistent with the targeted liquidity deficit for monetary policy implementation and should provide enough room for averaging to absorb autonomous factors liquidity shocks. The intertemporal smoothing of liquidity flows over the maintenance period contributes to stabilize short-term interest rates. This criterium would suggest increasing the reserve requirement to at least 5 percent (currently it is 2 percent). It should be fully remunerated at the CBA policy rate to mitigate its impact on banks’ cost of funds.

21. Banks should be gradually required to fulfill the reserve requirement on FX liabilities in FX to correct the distortion arising from the requirement to fulfill it in AMD. Because of this requirement, the stock of banks’ AMD HQLA, which includes the reserve requirement, is disproportionally large, while the stock of FX HQLA is insufficient to mitigate liquidity risks. This situation is costly for banks7 because AMD funding is more expensive than FX funding; it also encourages banks to hold lower liquid buffers in FX, where the central bank cannot act as lender of last resort. The transition should be implemented gradually to avoid destabilizing the FX market as banks will have to convert AMD into U.S. dollar to fulfill the FX requirement in U.S. dollar. The CBA could help via U.S. dollar sales in the market. This sale would not change its gross reserves (as these will remain in its balance sheet), will ensure that the exchange rate is not affected and that any excess liquidity in AMD is absorbed.

22. A few initiatives to support funding and market liquidity should be considered. The government debt strategy should include a market development component, focusing on maintaining AMD-denominated securities for some benchmark maturities. The CBA should encourage the market to develop a reference for short-term interest rate, which is compliant with the international principles for the computation of financial benchmarks. The CBA should also gradually transfer to the market the swap of external funding that it executes for the banks.

23. The CBA is allowed to provide emergency liquidity assistance (ELA) but does not have the operational framework. Its law allows the CBA to provide refinancing for maturities of up to six months and, in exceptional cases, five years, including without collateral (which should be avoided). Making ELA operational includes defining the conditions for access (restricted to solvent banks with temporary liquidity problems), establishing the appropriate collateral framework, monitoring the use of the resources, supervising the steps for prompt reimbursement (remedial measures), and setting criteria for the exit strategy.

24. The CBA collateral framework should be defined clearly. It should be extended beyond government securities to address liquidity stress. A broader collateral framework would provide greater refinancing margin to address the refinancing needs that individual solvent counterparties cannot satisfy in a small market, where pockets of segmentation still prevail. It would also improve the neutrality of the collateral framework across assets classes. Extending the framework requires the introduction of appropriate risk management measures to maintain the same level of residual risk after haircuts across classes of eligible collateral.

25. Financial dollarization raises the issue of what sort of liquidity assistance could be provided in FX. The need for liquidity assistance arises when counterparties have exhausted their FX reserves and government securities denominated in FX that could be sold in the market. Therefore, ELA has to be secured with illiquid FX credit claim. In addition, the CBA could extend ELA in FX with AMD collateral, as it operates a swap facility, which allows banks to access FX funding against AMD reserves at the CBA. ELA in foreign currency should be in place only when and after prudential liquidity regulations ensuring that banks keep prudent buffers of FX HQLA have been adopted.

B. Macroprudential Oversight

26. The financial stability mandate is appropriately one of the CBA’s main objectives. The CBA is an integrated supervisor which oversees all financial sectors. In December 2017, the CBA formally adopted the financial stability mandate as a primary objective in its law in parallel with price stability (based on an inflation targeting framework). The CBA Board adopts macroprudential policies based on assessments and proposals by the Financial Stability and Special Regulation Committee (FSSRC). Given the new mandate, the CBA would benefit from summarizing its macroprudential policy implementation strategy in a public document, setting out policy objectives, instruments and transmissions, decision-making process, communication strategy, and accountability. In addition, the CBA’s financial stability reports should provide more forward-looking perspectives to guide markets’ expectations.

27. Safeguards are needed to counter risks from the CBA’s dual objectives. Although the high degree of financial dollarization strengthens the case for monetary and macroprudential policy coordination, dual mandates can complicate accountability and reduce credibility. Having separate committees on monetary and macroprudential policies, like the CBA does, helps distinguish the two policy functions, and this should be strengthened by clearly assigning policy instruments to the two committees (e.g., by summarizing macroprudential policy implementation strategy in a public document) and improving the communication strategy.

28. The law allows the CBA to select and use from a wide range of known macroprudential instruments including Basel III buffers. At present, tools in use are focused on FX risks. These include higher risk-weights (150–200 percent) and higher loan loss provisions (20 percent higher)—both measures applying to exposures denominated in foreign currency; a prohibition to grant loans to households in foreign currency, except mortgages; and requirements for banks to assess whether borrowers should be considered hedged or unhedged for monitoring purposes.

29. The CBA should proceed with implementation of Basel III capital requirements as planned (Table 5). Current capital adequacy requirements are based on the standardized approach of Basel II with a minimum ratio of 12 percent. In practice, almost all capital of Armenian banks is CET1 as there is only a small market for subordinated or hybrid instruments. A draft regulation addresses the phase-in schedule for three buffers (conservation, countercyclical and systemic). These add-ons are likely to affect larger banks that currently hold capital buffers close to the minimum risk-adjusted ratios as they were not affected by the recent increase in absolute capital requirements. Recent analysis shows the lowest level of the leverage ratio in the banking system (5.3 percent) is still above the Basel minimum, not making the introduction of the ratio a high priority. The framework for setting countercyclical capital buffer (CCyB) should be introduced from January 2019 as planned, and a positive buffer requirement should be adopted if the current credit growth trend continues.

30. Vulnerabilities from dollarization require additional measures to mitigate credit risks from unhedged borrowers and address data gaps related to income information.

  • One option is to introduce a stressed debt service to income (DSTI) limit. For unhedged FX borrowers, the debt-service would be calculated under a stress scenario of a depreciation that matches historical large depreciations (e.g., 20 percent) to ensure sufficient loss absorption capacity.

  • The implementation of the DSTI limit requires borrower income information that needs to be collected by the CBA. If the CBA judges that it is appropriate to include income from informal sources (including remittances) in the calculation, it should provide some guidance to banks on how to include them.

  • The DSTI limit can be first introduced as an indicative limit to allow the CBA to assess the quality of banks’ reporting of their clients’ income, refine the parameters of the limit based on the DSTI distribution, and give time to the banks, as well as their clients, to adjust to the new norm.

  • Until the DSTI limit could become feasible, a stressed loan-to-value (LTV) limit, which similarly assumes certain depreciation for unhedged FX loans, can be imposed to ensure that banks have enough collateral to cover the repayment of the loans if the borrower defaults in a depreciation scenario. The distribution of LTV should be analyzed to determine the threshold.

31. The two prudential liquidity ratios adopted as a follow up to the 2012 FSAP recommendations are not adequate to mitigate liquidity and funding needs in foreign currency. The total liquidity ratio (high liquid assets to total assets); and the current liquidity ratio (high liquid assets to demand liabilities) should be satisfied on aggregate and for individual currencies. However, the requirements for foreign currency are lower8 and neither measure captures stressed assumptions. The Basel III liquidity ratios (LCR and NSFR) have been monitored since 2015 for all banks but are not yet implemented.

32. The CBA should ensure that banks keep not only enough high-quality liquid assets in FX to cover the liquidity risk but also encourage a prudent pricing of FX intermediation:

  • The FX reserve requirement should cover enough of the deposit base, e.g., at least 20 percent (it is 18 percent at present) to ensure that banks keep at the CBA assets of certain quality and liquidity. It would also limit banks’ leverage in term of the loan to deposit ratio.

  • The LCR and NSFR in USD, in addition to those for all currencies should be adopted and set a higher requirement for the LCR in USD than in AMD in the medium term to promote de-dollarization.

  • More generally, the CBA should enhance its methodology for implementing regular liquidity stress tests by using a cash-flow methodology, maturities beyond 30 days, and behavioral components, both in aggregate and in foreign currency.

C. Microprudential Oversight

33. The CBA has made significant progress in its approach to banking supervision by adopting the risk-based supervision (RBS) framework and addressing regulatory gaps identified in the 2012 Basel Core Principles (BCP) assessment. The RBS framework provides a forward-looking assessment of the risk profile of banks and assigns resources more proportionately to risk. The use of risk teams across the banking system also contributes to identification and monitoring of risks arising across the system. In addition, improvements have been made regarding risk management, stress testing, corporate governance, country risk and consolidated supervision.

34. The CBA’s programs still need enhancement in several areas. The RBS program should be refined for more granular assessments of banks’ capital needs. Stress testing and the internal capital adequacy assessment process (ICAAP) conducted by banks are important elements of the RBS program for risk management; however, standardized criteria for their review and evaluation should be developed. Moreover, stress testing and ICAAP processes in banks have not led to a differentiation in capital levels based on risk. This limitation should be addressed.

35. Supervisory resources of the CBA to conduct a RBS program should be re-evaluated annually. Though there is currently no apparent staffing shortage, the CBA should annually conduct resource planning exercises. The number of staff has not changed in five years, while the RBS program has clearly raised expectations regarding the analytical skill sets of the staff. CBA should be commended for its specialized training curriculum and the use of intra-departmental support to fill gaps for stress testing, business plan reviews, and cyber risk reviews; however, resource sharing does not substitute for an adequately trained core group of supervisors. Consideration should also be given to hiring individuals with previous experience/training in risk analytics, stress testing, and risk management.

36. The use of discretionary enforcement powers to address risk management concerns has not been consistent. There has been a pattern since 2013 where several banks have breached large exposure limits regularly. Although sanctions/fines have been levied in some cases, these have apparently not been sufficient to prevent further violations. A plan should be developed to bring down current exposures exceeding limits under the regulatory framework.

37. The definition of nonperforming and restructured loans need to be amended to reflect international best practices. The CBA uses a non-standard definition of NPLs (one day past due); reported NPL ratios are also influenced by the mandatory write-off of loans past due 270 days or more. The definition of restructured loans is not well supported by examples or detailed supervisory explanations. Also, the CBA does not provide detailed guidance on evaluating performance periods for restoring restructured loans to performing status, and instead assesses the adequacy of banks’ internal regulations, where these periods are established, on a case by case basis The CBA should align its definitions for non-performing and forborne (restructured) loans with the BCBS guidance issued in April 2017. More detailed reporting and monitoring of restructured loans by banks should also be initiated.

38. The CBA assessment of credit risk management should incorporate a review of International Financial Reporting Standard (IFRS 9) expected loss estimation practices required for all banks in 2018. As Armenian banks are adapting to the new IFRS 9 methodologies, they will be basing more of their credit risk management activities regarding measuring, monitoring and reporting risk on IFRS 9 techniques. Supervisors will need to enhance their review and understanding of IFRS 9 methodologies if they are to make accurate assessments of a bank’s credit risk management capabilities.

39. The CBA needs to develop a non-discretionary regime of supervisory actions in response to a bank’s deteriorating capital or liquidity position. Such responses may include submission of remediation plans, ceasing dividends and discretionary compensation, and limits on growth, types of activities, or funding sources. Although the CBA has the authority to use these supervisory limits at its discretion, a clearer framework for banks outlining the use of these limits incrementally is missing.

D. Financial Integrity

40. Armenia’s 2015 AML/CFT assessment against the 2012 Financial Action Task Force standard found a broadly sound legal and institutional framework, albeit with some deficiencies. The assessment noted a low level of effectiveness of measures related to criminal sanctions against money launderers and to the confiscation of proceeds of crime. In addition, it recommended to enhance the understanding of money laundering (ML) risks and vulnerabilities with respect to corruption, abuse of legal persons, the shadow economy and the extensive use of cash. It noted that risk-based approach to AML/CFT supervision should be further developed and that domestic politically-exposed persons should be subject to relevant AML/CFT requirements. It also found that the requirements for targeted financial sanctions in relation to proliferation financing needs to be brought more explicitly into the AML/CFT law to avoid legal challenges to sanctions.

41. While improvements have been made since the 2015 AML/CFT assessment, deficiencies remain to be addressed. Armenia has taken steps to address some of its deficiencies, notably by revising some sections of its ML/TF national risks assessment, introducing a risk-based approach to AML/CFT supervision, and amending the AML/CFT law to clarify requirements for targeted financial sanctions in relation to proliferation financing. While these efforts are welcome, further steps should be taken to deepen the understanding of risks and disseminate findings to the private sector and continue to improve risk-based supervision. In addition, measures to detect the laundering of proceeds of corruption should be strengthened, by enacting and implementing enhanced due diligence requirements for domestic politically-exposed persons, and by ensuring that financial institutions and other obliged entities report suspicious transactions

Financial Safety Net and Crisis Management

42. The banking law should be amended to establish a special bank resolution regime (SRR). Although the CBA is the sole authority that can recommend license revocation, there is still the opportunity for the court to reverse the resolution action. The new framework should provide, inter alia, authority for CBA to perform irreversible resolution actions, as well as introduce expanded resolution tools in like with the Key Attributes of Effective Resolution Regimes.

43. The deposit insurance law should also be amended to reflect best practices, in spite of recent enhancements. The timeframe for reimbursing insured depositors has been improved by recent amendments to the Deposit Guarantee Fund (DGF) Law, which specify a gradual reduction to meet international best practices of 7 days by January 1, 2023 (current payout timeframe is 15 days). However, Armenia’s DGF is a pure paybox and doesn’t pay a role in the resolution process. DGF’s mandate should be expanded to permit use of its funds in resolution transactions such as a Purchase and Assumption (P&A). The decision to use funds for resolution transactions will be made by the resolution authority—i.e., the mandate expansion should not confer additional powers to the DGF. The DGF law allows active bankers or members of the banking union (Armenia’s bankers association) to be members of the DGF board, which is not in line with best international practices.9 The DGF covers only individual deposits; however, there is an international trend toward also covering deposits of legal entities (at the same limited level as for individuals), which is recommended, as this may protect spillovers to the broader economy.

44. The Financial Stability and Special Regulation Committee (FSSRC) is an effective coordination platform; however, there should be a true interagency high-level crisis management committee (CMC) comprised of the CBA Governor, Minister of Finance and Director of DGF. The FSSRC is contained within the CBA and representatives from MOF and DGF can attend by invitation only. It is important to formally include the other safety net members in a high-level CMC, which would not be a decision-making body as each member would still retain its statutory responsibilities and obligations: the DGF, since prompt and effective resolution including swift repayment to insured depositors can help prevent contagion and avoid that resolution of a non-systemic bank create a systemic crisis; and MOF, since any systemic crisis will likely require outlays of public funding for recapitalization or guaranteeing certain depositors and creditors. CBA has drafted a Crisis Management Guide, which represents a good start on crisis preparedness and management. Since the 2012 FSAP, the safety net members have conducted several simulations on various subjects, primarily with DGF regarding resolution of a non-systemic bank. The authorities— especially including MOF—are recommended to continue this effort.

45. Recovery and Resolution Planning (RRP) should be implemented. Not all banks have completed their Recovery Plans and those that have are often deficient. CBA has not prepared Resolution Plans for any bank. Every bank should be required to complete adequate and reasonable Recovery Plans, based on proportionality; while CBA should develop Resolution Plans for all systemic banks. RRPs should be updated at least annually.

46. CBA has supervisory MOUs with home regulators for every foreign subsidiary except for the United Kingdom (reportedly there is an informal agreement for coordination and information sharing with U.K. supervisors); however, the extant supervisory MOUs are thin and should be improved. Additionally, Armenia participates in two supervisory colleges. Armenia is not a member of any Crisis Management Group (CMG) for any of the foreign subsidiaries since the foreign subsidiaries are not material for the parent banks.

47. Resolution planning of foreign subsidiaries should be included in the home-host relationship framework. CBA should be proactive in: (i) requesting Resolution Plans from the home supervisory/resolution authority; and (ii) ensuring that the Armenian subsidiary is included and treated equitably in the plan. Moreover, since the parent is the first line of defense for banking problems, the CBA should request letters from foreign parent banks that will commit them to supporting their Armenian subsidiaries, including, but not limited to capital and liquidity support If the Resolution Plan for entities systemic in Armenia is judged inadequate to preserve financial stability in Armenia (e.g., if it discriminates to the favor of home country creditors), or no Resolution Plan is forthcoming, then the authorities should develop national recovery and resolution plans to deal with stress in foreign subsidiaries.

Financial Development

48. Since the last FSAP, there have been substantial improvements notably in the legal and regulatory frameworks that matter for financial development. Armenia has reformed its credit infrastructure, resulting in the establishment and operation of a movable collateral registry, and introduced a new secured transactions regime. Progress has been also made in improving the bankruptcy law. Measures are being taken to address cyber risks in payment systems. The well-designed new pension system has mobilized a growing supply of long-term domestic capital that can be channeled through the local capital market to fund the economy. Support for the pension reform should continue.

49. To fully reap the benefits of these reforms certain shortcomings in the new frameworks need to be addressed:

  • The regime on insolvency of corporate and individual debtors, and related institutional framework need to be strengthened further to create a better balance of creditors rights and strengthen secured creditors rights in the context of insolvency. Further reforms should be aimed at increasing the numbers of successful rehabilitation cases and maximizing creditors recovery within liquidation. Allowing secured creditors to vote on restructuring plans and introducing a time limit for relief from the automatic stay on enforcement for secured creditors, revising the tax authorities’ position in insolvency cases by allowing them to compromise debt and vote on restructuring plans, and extending post-commencement financing beyond approved restructuring plans, are some of recommended steps to achieve this. Reform measures should also be directed toward resorting to insolvency only as a collective proceeding, among multiple creditors, rather than a collection tool by individual creditors against delinquent debtors, as is currently the case. In addition to reforming the insolvency regime, improvements to the effectiveness of the systems of civil enforcement of individual debts, both through formal processes and potentially through the increased use of alternative dispute resolution (ADR) mechanisms should be considered.

  • Corporate transparency, financial capability and the efficiency of government support programs need to be strengthened to provide MSMEs with affordable access to finance. Informality and unreliable financial reporting reduce banks’ ability to overcome information asymmetries and ascertain a company’s ability to generate revenues. As a result, collateral requirements and lending rates for MSMEs are very high. Product diversification is also poor. In a country in which most lending is collateral based, products such factoring, invoice financing, leasing, are key so SMEs can have access to working capital. The introduction of targeted financial capability programs focused on improving MSMEs’ financial reporting and management, as well as the promotion of cash-less payments could help to alleviate some of the demand side constraints. Additionally, the efficiency of the fragmented government support programs should be enhanced by consolidation and improved targeting and a better coordination among the various stakeholders. CBA should also consider creating a new unit to take over tasks related to financial inclusion.

  • A high-level commitment from government is required to create a pipeline of capital markets issuance and demonstration projects. Projects are needed to absorb the inflow of pension contributions. The CBA has been proactive in introducing frameworks for new instruments, and the overall regulatory framework for capital markets is sound. The key constraint to its development is on the supply side due to limited issuance pipeline across issuers and products. Government action is needed promoting municipal, SOE and infrastructure projects.

50. Sustained financial sector development requires improvements in transparency across all sectors of the economy. The lack of transparency in reporting and accounting by corporations, sub-national entities and SOEs hampers not only possible issuances on the capital markets but also inhibits growth of products such as factoring and invoice financing that facilitate trade finance and are key for MSME access to finance. A failure to improve these standards will jeopardize the progress made so far and limit the ability of the financial sector to play an effective role in the economy.

Table 9.

Armenia: Risk Assessment Matrix

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Appendix I. Implementation of 2012 FSAP Recommendations

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Appendix II. Banking Sector Stress Testing Matrix (STeM)

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Annex I. Report on the Observance of Standards and Codes— Basel Core Principles for Effective Banking Supervision

A. Introduction

1. This assessment of the implementation of the BCP in Armenia has been completed as part of the Financial Sector Assessment Program (FSAP), jointly undertaken by the IMF and the World Bank in 2018. The assessment reflects the regulatory and supervisory framework in place as of the completion of the assessment. It requires a review not only of the legal framework, but also a detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. It is not intended to analyze the state of the banking sector or crisis management framework, which are addressed by other assessments conducted in this FSAP.

B. Information and Methodology Used for Assessment

2. This assessment was conducted against the standard issued by the Basel Committee on Banking Supervision (BCBS) in 2012. Since the past BCP assessment, which was carried out in 2012 against the 2006 version of Core Principles, the BCP standards have been revised. The revised Core Principles (CPs) strengthen the requirements for supervisors, the approaches to supervision, and the supervisors’ expectations of banks through a greater focus on effective risk-based supervision and the need for early intervention and timely supervisory actions. Furthermore, the 2012 revision placed increased emphasis on corporate governance and supervisors’ conducting sufficient reviews to determine compliance with regulatory requirements and thoroughly understanding the risk profile of banks and the banking system. This assessment was thus performed according to a significantly revised content and methodological basis compared to the previous BCP assessment.

3. The Armenian authorities opted to be assessed against both the essential criteria (EC) and the additional criteria (AC) but graded on the basis of EC only. To assess compliance, the BCP Methodology uses a set of EC and AC for each principle. The EC set out minimum baseline requirements for sound supervisory practices. The AC are recommended as the best practices against which the authorities of some more complex financial systems may agree to be assessed and graded. Armenian authorities chose to be graded against the EC only.

4. Grading is not an exact science and the CPs can be met in different ways. The assessment of compliance with each principle is made on a qualitative basis. Compliance with some criteria may be more critical for effectiveness of supervision, depending on the situation and circumstances in a given jurisdiction. Emphasis should be placed on the comments that accompany each CP’s grading, rather than on the grading itself.

5. The assessors held extensive meetings with CBA staff, commercial banks and other relevant counterparts who shared their views with the assessors. The team also reviewed the framework of laws, regulations, and supervisory guidelines. The CBA provided a self-assessment of the CPs and answered comprehensively to preparatory questionnaires. The assessment team appreciated the excellent cooperation and would like to thank the CBA staff for their preparation and responsiveness during the assessment period.

C. Preconditions for Effective Bank Supervision

6. Effective supervision is dependent on having the necessary preconditions in place. These include: (i) sound and sustainable macroeconomic policies; (ii) a framework for financial stability including policy formulation, mechanisms for inter-agency coordination, resolution and safety-nets; (iii) a well-developed public infrastructure including a system of business laws, the accounting, auditing and legal professions, judiciary and clearing, payment and settlement systems; and (iv) transparency and market discipline.

D. Main Findings1

Responsibilities, Powers, Independence, Resources, Accountability and Cooperation (Principles 1–3)

7. The CBA’s supervisory responsibilities and powers are well established. Banking supervision in Armenia falls exclusively within the responsibility of the central bank. Accountability could be improved through public reporting of performance of the supervision function relative to its specific objectives. Further, MOUs with foreign supervisors should be revisited to address resolution strategies for large banks.

Ownership, Licensing, and Structure (CPs 4–7)

8. Armenia has a generally high level of compliance with these principles, with appropriate legal requirements and review processes in place. Current laws and regulations cover all the key elements of an effective licensing framework and the approach to assessing the fitness and propriety of major shareholders and senior management of an applicant bank is appropriate. During the interview process, Chief Risk Officers and Heads of the compliance functions are not yet included, but CBA has prepared a draft amendment to be able to do so.

Ongoing Supervision (CPs 8–10)

9. The CBA has made a significant improvement in its approach to banking supervision with adoption of the Risk-Based Supervision framework. The Risk-Based Supervision Framework (RBS) formally adopted in 2017 is designed to provide a more forward-looking assessment of risks and their impact on capital and liquidity; enable supervisory planning to focus resources more proportionately on emerging risks and on firms with more systemic impact; integrate a macroeconomic perspective into supervisory assessments, and strengthen the CBAs understanding of risk management practices. Of particular note is the institution of risk teams in the Supervision Department and focus on conducting thematic inspections and reviews by the latter, which aids better systemic view and risk-based resource allocation. The program is still in its first full cycle of implementation, and while it has identified knowledge gaps to be closed, initial results are promising. Supervisory activities planned for 2018 based on the risk assessment results appear more balanced between off-site analysis and on-site validation activities. Supervisory reporting for off-site analysis and monitoring is a strong point of the CBA regime. In addition to standard financial reports, CBA has access to transactional information on borrowers through a credit registry and a database of all bank internal policies.

10. The CBA is to be commended for implementing this RBS and is encouraged to further enhance its supervisory approach. Areas for further development in supervisory approaches relate to the need for a non-discretionary framework for dealing with weak banks (PCA) and assessing resolvability in larger firms.

Corrective and Sanctioning Powers (Principle 11)

11. The CBA has a wide range of corrective and sanctioning powers, and while there is evidence that they have been effective, there were observed weaknesses in taking enforcement action to address a pattern of large exposure breaches. There were observed inconsistencies in the application of sanctions for all large exposure breaches. The CBA should review its enforcement practices with regard to large exposure limits with an aim towards consistently applying sanctions and having banks operate within prescribed limits. Further, the CBA should consider designing and implementing a Prompt Corrective Action regime to guide decision- making in dealing with banks under stress. The CBA has yet to implement a requirement that larger banks have recovery plans, or to initiate resolution planning in line with the best practices documented in the Financial Stability Board Key Attributes of Effective Resolution Regimes for Financial Institutions.

Consolidated and Cross-Border Supervision (Principles 12, 13)

12. Laws and regulations were enacted to identify affiliated entities as “financial groups” and subject them to consolidated supervision. The regulations give CBA discretion to distinguish its supervisory approaches among complex/not low-risk groups and low-risk groups. All groups are required to file consolidated returns and reports on inter-group transactions, while not low-risk groups are also subject to prudential standards on a consolidated basis. Low-risk groups are supervised on a solo basis, as currently there are no complex/not low-risk groups.

No Armenian banks currently have foreign operations. Subsidiaries of four foreign banks operate locally. Supervisors attend supervisory colleges for two of these foreign banks. For foreign owned large banks, the CBA should contact home supervisors to gain an understanding of their recovery/resolution frameworks. MOUs should be updated as necessary to accommodate sharing of resolution related information.

Corporate Governance Prudential Requirements, Regulatory Framework, Accounting and Disclosure (Principles 14–29)

13. The Corporate Governance regulations for banks are generally adequate; and significant supervisory work has been conducted in this area, in particular with regard to the review of bank strategic planning and role of the risk management function in banks. However, there is a need for more work on the part of supervisors to understand and validate governance practices across firms.

The CBA’s prudential standards and supervisory review of specific risks are generally sound.

  • Capital adequacy requirements are based on Basel II definitions and risk-weightings, while the quality requirements for elements included in regulatory capital are consistent with the Basel III requirements,

  • There have been significant changes in laws and regulations that provide flexibility for the CBA to require good risk management systems in banks. Regulations require banks to have the essential elements for comprehensively identifying and managing risk, including stress testing capabilities and ICAAP processes. Supervisory work to validate risk management systems and fill knowledge gaps is ongoing.

  • Credit risk is monitored closely via on-site reviews and off-site access to borrower information in the credit registry. Unhedged FX borrowers represent significant risk in the loan portfolio and enhancements to credit risk management requirements (e.g., more stringent and targeted DTIs and LTVs) are suggested. Steps were taken recently to provide banks with a common supervisory definition of the risk from unhedged FX borrowers for monitoring purposes.

  • Problem assets are also monitored closely via monthly classification reports and activity observed in the credit registry. The CBA has historically maintained a conservative philosophy with regard to provisioning and charge-offs. Definitions of NPLs and restructured loans are not aligned with BCBS guidance from 2017; it is recommended that these new definitions be adopted to provide investors and other supervisors with data that is comparable with other jurisdictions.

  • The CBA began LCR and NSFR monitoring in 2015 and is intending to adopt these measures pending resolution of a policy matter regarding FX reserve requirements that has resulted in a misbalance between AMD and FX HQLA. The CBA is reviewing options to address this issue and intends to adopt the Basel III standards once this obstacle is addressed.

  • The CBAs regulations provide that only audit firms with broad based experience are eligible to audit banks. IFRS is the accounting standard. Disclosure practices are considered adequate based on IFRS and CBA requirements. Supervisors are in close contact with both internal and external auditors.

  • Measures to detect the laundering of proceeds of corruption should be strengthened. The law should explicitly require the implementation of AML/CFT requirements for domestic politically-exposed persons.

Annex Table 1.

Summary of Compliance with Basel Core Principles

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Annex Table 2.

Recommended Actions to Improve Compliance with the Basel Core Principles and the Effectiveness of Regulatory and Supervisory Frameworks

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Authorities’ Response to the Assessment

The Central Bank of Armenia (CBA) would like to express its appreciation to the International Monetary Fund (IMF), the World Bank (WB), and the Financial Sector Assessment Program (FSAP Program) mission team for the comprehensive and detailed assessment under the FSAP. We believe the latter will promote soundness of the financial system of Armenia and contribute to improving supervisory practices, as was the case with previous Programs.

The CBA would like to specifically acknowledge professionalism shown and hard work performed by the FSAP mission team, which ensured successful completion of the assessment. It is also encouraging to read in the Report that the FSAP mission team emphasizes accomplishments of the CBA in enforcement of compliance with Basel Core Principles and highly evaluates the achievements of the Central Bank in developing and implementing the Risk Based Supervision Framework.

We note that, the FSAP mission team made highly valuable recommendations, which would be addressed in the near future. The Central Bank confirms its strong commitment to undertaking adequate measures for continuous improvement and strengthening of the regulatory and supervisory frameworks of the Armenian banking system.
1

As of end-2017, the CBA’s net international reserves were about $1.7 billion—i.e., about 40 percent of bank liabilities in foreign currency.

2

Yields on one-year bonds were 6.8 percent on average; yields on 10-year bonds were 10.6 percent. Only yields on Treasury bills (with maturities up to 9 months) were, on average, below or equal to the average ROE (6.1 percent).

3

Credit to the manufacturing sector and consumer loans grew by about 40 percent and 25 percent (y-o-y) respectively at end-June 2018. Since the second half of this year, high-frequency data suggest that the growth momentum may have moderated somewhat.

4

Introduction of a tax credit of interest payments on residential mortgages.

5

This includes: the previous day’s balance of banks’ account at the central bank; realized autonomous factors; autonomous factors forecasts; the reserve requirement amount and the average of banks’ accounts at the CBA up to the publication date. Examples can be found at the websites of the ECB, Bank of Albania and National Bank of Serbia.

6

The reserve requirement serves to create a need for the banks to borrow from the central bank. This is the only reason why the central bank has extended loans to the banks in Armenia in the past (besides directed loans for development purposes). Therefore, the CBA will get some compensation to neutralize the cost of remunerating reserves.

7

The cost of the requirement, based on the February 2017 spread between AMD and USD deposit rates of maturities up to 30 days, is estimated more than two times higher than meeting the requirement in foreign currency.

8

Ratios are 15 and 60 percent for the aggregate and 4 and 10 percent in FX.

9

An MOU between DGF, CBA and MOF prohibits active bankers or members of the banking union from being on DGF’s management board; however, this should be included in amendments to the DGF Law.

1

The Detailed Assessment Report has been prepared by Jack Jennings (IMF), and Philippe Aguera (World Bank).

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Cover IMF Staff Country Reports
Republic of Armenia: Financial Sector Assessment Program-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Armenia
Author:
International Monetary Fund. Monetary and Capital Markets Department
Volume/Issue:
Volume 2018: Issue 361
Publisher:
International Monetary Fund
ISBN:
9781484389737
ISSN:
1934-7685
Pages:
66
DOI:
https://doi.org/10.5089/9781484389737.002
Figure 1.

Interbank Market (November 2017)
Figure 2.

Loans to and Deposits from the Non-Financial Sector

Armenia: Nonperforming Loans by Currency

(Percent of total gross loans)
Figure 3.

Drivers of Profitability of Armenian Banks

Selected Countries: GDP per bank

(average 2016, millions of U.S. dollars)
Figure 4.

Monetary and Financial Conditions
Figure 5.

Households and Corporates’ Balance Sheets
Figure 6.

Financial Soundness Indicators
Figure 7.

Evolution of Macrofinancial Variables Under the Adverse Scenario
Figure 7.

Evolution of Macrofinancial Variables Under the Adverse Scenario
Figure 8.

Solvency Stress Test (Aggregate) Results
Figure 8.

Solvency Stress Test (Aggregate) Results

Armenia: Capital-Asset Ratio by Total Assets, 2017