IMF published its staff report and selected issues report in the context of the 2018 Article IV consultation with Montenegro. The assessment reveals that conditions in the banking sector continue to strengthen, with improving asset quality, recovering credit growth, and high liquidity. However, the sector appears to be crowded, presenting a challenge for bank profitability.
The staff report recommends that authorities should continue their efforts to improve the health of the financial sector. The authorities have closed supervisory gaps by bringing non-bank financial institutions under the supervision of the central bank. While the overall banking sector is stable, the authorities should steadfastly implement supervisory action plans for weak banks and intervene, if necessary. Asset quality reviews (AQRs) would improve loan classification and provisioning practices and should be implemented as soon as possible. The authorities should also adopt a definition of NPLs that does not exclude impaired assets that have adequate collateral. Provisioning continues to improve with 57% of NPLs provisioned, though further improvements are needed. Non-performing loans (NPLs) fell from 11% of total loans to 8% during 2017. While NPL levels have fallen, CBM should take further steps to strengthen banks’ balance sheets. CBM intends to phase in a new definition for NPLs gradually and implement an AQR in 2019. Capital ratios exceed regulatory minima, though with some variation across institutions. With many banks relative to the size of the market, the authorities should be cautious in granting new banking licenses and promote consolidation. The authorities will consider staff’s proposal to increase the minimum capital of banks, which might facilitate a consolidation.
The report reveals that credit risk is the main risk in the financial sector. Strengthening land ownership registration and improving the credit registry would help banks to better assess borrowers’ eligibility and lower credit risks. Additionally, a Central Bank of Montenegro (CBM) system-level stress test suggests that market risk is currently low. The authorities have improved the legal framework for financial supervision. Laws adopted in 2017 have strengthened the independence of CBM and closed nonbank supervisory gaps by bringing nonbank financial institutions under CBM supervision. The authorities have also drafted laws to align Montenegro with the EU framework for bank resolution and recovery. CBM introduced International Financial Reporting Standards (IFRS) 9 in 2018, which should result in more stringent provisioning practices. Overall, there was progress in the implementation of many FSAP recommendations. The authorities should continue to improve the AML/CFT framework and seek to implement the outstanding recommendations of the 2015 FSAP. The authorities should intervene early and forcefully in nonviable banks or those in substantial non-compliance with supervisory requirements. Three small, non-systemic banks with qualified audits are subject to supervisory action plans, which resulted in significant improvements in two banks but only partial improvements in another. CBM should not delay intervention in any bank that does not comply with supervisory requirements.
The selected issues report highlights that banks are highly liquid, with the share of liquid assets being high at 25% of total assets. While banks are highly liquid, they are cautious in approving new loans, given the legacy of bad loans and impaired balance sheets. The lack of bankable projects also constrains credit growth. Banks’ own liquid assets should be their first line of defense against any liquidity crises. CBM has the authority to grant liquidity loans to banks against adequate collateral and it has defined the conditions for such loans, which may only be granted to solvent banks. While overall liquidity buffers in the banking sector appear to be sufficient, CBM’s own resources for Emergency Liquidity Assistance (ELA) are limited. The overall liquidity buffers in the banking sector consist of banks’ own liquid assets (which include excess reserves and 50% of required reserves at the CBM) and the 50% of banks’ required reserves that they cannot withdraw freely and without penalty. Considering that Montenegro is a unilaterally euroized economy without a lender of last resort, international reserve adequacy should be assessed not only from a balance of payments perspective, but should also take into account considerations such as buffers for fiscal financing and bank ELA. The dominant position of Euro Area banks in Montenegro, however, may overstate the need to cover deposits with international reserves. Banks with Euro Area parents likely have access to ECB liquidity facilities by way of their parent banks and these banks hold two-third of banking system deposits.
Keywords: Europe, Montenegro, Banking, Article IV, FSAP, BRRD, NPLs, IFRS 9, IMF
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