BANK OF ALBANIA STATEMENT
Financial Stability Statement for 2020 H1

Pursuant to provisions under Article 69 of the Law No. 8269, dated 23 December 1997 “On the Bank of Albania”, as amended, and Article 8 of the Law No.  9962, dated 18.12.2006 “On banks in the Republic of Albania”, as amended, to inform the Assembly of the Republic of Albania and the Council of Ministers, and promote awareness among financial institutions and the public at large of the situation in the Albanian financial system and potential risks to its stability, the Bank of Albania releases this periodic statement.  This statement is an integral part of the Financial Stability Report for the same-stated period.

The Financial Stability Report and the Statement prefacing it assess the exposure of the banking sector to risks arising from its interaction with the external and internal economic environment, real economy agents, financial markets in Albania, as well as operational risks in the activity of the banking sector. Furthermore, these risks are assessed through the stress testing exercise and placed vis-à-vis the financial situation of the banking sector to assess its resilience.

The Bank of Albania deems that in 2020 H1 (hereinafter ‘the period’), banking sector showed a stable activity, notwithstanding the challenges posed by pandemic situation in Albania. The operational measures taken by banks to ensure the continuation of both critical functions and relationships with customers, and the measures taken by public authorities to mitigate the pandemic shock on the economic and financial activity of Albania, provided for the adequate continuation of the intermediation activity and the financial sector indicators remain at good levels. The uncertainty about economic prospects given the pandemic presence is considerable; like the challenges to banking and financial activities. Nevertheless, the assessments by banking industry and the stress tests suggest that currently the banking sector’s ability to withstand these challenges is sufficient. The Bank of Albania remains willing to undertake all the necessary operations in accordance with the Law to support the banking activity and contribute to the stability of the financial system.

This Report, as a rule, analyses the developments in the financial system as at end of 2020 H1.  Overall, these developments showed:

• The impact of pandemic shock on macroeconomic indicators. Data for 2020 Q1 showed the contraction of economy by 2.5%, mainly affected by the drop in investments and consumption. The unemployment rate showed a slight increase after some continuous improving periods. The Government, with the purpose to mitigate the pandemic hit on economy of Albania and notwithstanding the fall in budget income, aimed at safeguarding the level of public expenditure by acting swiftly to finance the increase of both budget deficit and public debt. The comparison with other countries and expectations for a deepening of pandemic shock in the second quarter of the year, show that this action was necessary and unavoidable. The contribution of fiscal policy to tackle the pandemic effects remains crucial, throughout the lifetime of the uncertainty arising from the current pandemic. The maintaining of an adequate flexibility level in the short run, should consider the longer-term objective of fiscal consolidation. Globally but also in the region, many countries experienced an economic contraction. Forecasts about future prospects are pessimistic for 2020 and show that global economy will gradually return to the positive growth rates in 2021.

• Smooth performance of financial markets in Albania. In these markets, notwithstanding the increase in the volume of borrowing from the Government in both lek and foreign currency, the average interest rate on debt securities did not show changes during the period under review. Volume of transactions in the secondary market remained low and concentrated in short-term issues, by reflecting the preference of investors to hold debt securities to maturity. In interbank market, trade volumes increased but the interest rates remained close to the level of the policy interest rate determined by the Bank of Albania.  Lek depreciated against main foreign currencies at the end of 2020 Q1, but it recovered the major part of the value in the second part of the period. In real estate market, the indicators obtained from surveys show an increase of price but expectations on developments in this market, in the short run, are more pessimistic. During the period, the payment systems functioned optimally.

• The impact of pandemic on the activity of households and businesses.  During the period, according to data from banks, the traditional financial position of households as net creditors, and of businesses as net debtors, to the financial system, expanded. The growth of deposits and loans was positive in both sectors, but deposits growth was higher for households, while loan growth was concentrated to businesses. Survey results about the financial situation and debt burden of households showed that the use of debt from them remains limited. The borrowing households showed a fall of their ability to pay.  In the near future, it looks like loan demand will be higher from those households that do not have any debt before.  In terms of enterprises, the responses in the relevant survey report a considerable impact of pandemic, which has posed the main challenge to them, during this period.  Although the major part of enterprises has generated a positive financial result, the level of sales and that of the financial result have shown an extraordinary fall for all groups of enterprises, mostly for small and medium-sized enterprises.  The fall in the level of sales is accompanied with the increase of the support from external funding sources (loans), which is mainly used to afford current expenses and less for investments.  External funding increased to small and large enterprises.  By currency, funding in lek is dominant, particularly to small and medium-sized enterprises.  About ¾ of enterprises, by groups, considers the funding level adequate.  For about 80% of enterprises, the debt value is half of the capital value.  Expectations regarding the growth of funding, increase of investments and improvement of financial performance show more optimistic.

• The stable performance of financial system.  Financial system activity expanded by around 4.4 percentage points during the period, up to 111.6% of Gross Domestic Product.  The contribution of banking system accounts for 3.9 percentage points in this growth. The performance indicators of the financial system, including capitalisation, profitability, liquidity and assets quality, remain at good levels. The interconnection degree among financial institutions remains stable and reflects the importance of banking sector’s stability to the whole financial system.  The activity of the banking sector expanded by 4% during the period or by 7% from the previous year.  The expansion of both investments in securities and lending activity provided the main contribution to the growth of assets.  On liabilities side, deposits grew and in addition to own funds remain the main funding source to the activity of the banking sector.  The statistical effect of the foreign exchange rate provided an upward net effect on the activity of the banking sector in foreign currency.  Banking sector closed the first half of year with a profit, but 32% lower compared with a year earlier.  “Net interest income” and “Income from other activities” were comparable to those of 2019, but the increase of expenses in provisions for loans and in other financial instruments, concentrated in 2020 Q1, provided a negative impact on the financial result of banks.  Banking sector appears well-capitalised and none of the banks results with an adequacy ratio below the regulatory minimum of 12%.  As at end 2020 H1, the capital adequacy ratio fell by 0.4 percentage point, to 18.1%, mainly affected by the growth of risk-weighted assets.  Banks with foreign capital and systemically- important banks show the highest level of Capital Adequacy Ratio.

• Controlled exposure of banking sector to risks. Banks perceived increase of both economic and financial risks during the period but banks’ confidence in the financial system stability remained unchanged driven by the good financial indicators and the measures undertaken to maintain them.  At the end of the period, non-performing loans stock was around ALL 48 billion, almost unchanged throughout the period. The main impact on this stability of the non-performing loans ratio was provided by the definitions in the moratorium on loans payment, which enabled banks to temporarily suspend changes in non-performing loans and within them. Non-performing loans ratio is around 24% lower than the level in the previous year.  This fall of non-performing loans during the last 12 months, concentrated in the second half of 2019, was driven by the write offs, restructuring and repayment of loans. Given the growth of credit, non-performing loans ratio dropped to 8.1%. Liquidity situation of the banking sector appears rather good, notwithstanding the slight fall of liquidity ratios during the period.  In terms of market risks, banking sector remains sensitive to foreign exchange rate risk through the segment of unhedged loans in foreign currency. Exposure to interest rate risk remains present and edged upwards during the period, but it is assessed as limited.  

Risks to banking activity reflect and are intertwined with developments of structural nature.  Such a development is the existence for a long time of a low interest rates environment, which keeps pressure on the financial result of banks, prompts the change of its financing structure towards short-term needs and the need for high liquid assets, and maintains the growth potential for the increase of activity stress in case of a strong and unexpected correction.  The high use of foreign currency in the banking sector is accompanied with the liquidity risk management in foreign currency.  Overall, assessment indices of systemic risks increased during the period.

The Bank of Albania, via regulatory micro-prudential actions and macroprudential policy instruments, has addressed these risks.  The new implemented regulatory acts including liquidity coverage ratio, de-euroisation package of measures, and the regulation on the implementation of macro-prudential capital buffers, aim at mitigating risks and strengthening the banking sector's resilience to these risks.  

In March - June 2020, given the slowdown of the economic activity due to pandemic and the expected difficulties of borrowers to face credit payments, the Bank of Albania undertook some prudential measures and regulatory amendments, which aimed at easing the borrowers’ burden affected by pandemic, increase banks’ financial resilience and support the continuation of lending activity of the banking sector.  These measures consisted in:

• prompting a moratorium, which enables the temporary suspension of credit payments to borrowers affected by pandemic, initially untill June 2020 and then extended untill August 2020;
• approval of regulatory amendments which enable banks to maintain the classification of loans and the levels provisioning for non-performing loans during this situation.  The purpose of these amendments is that, till the end of this year, banks and their borrowing customers find restructuring forms of certain loans which quickly re-establish the creditworthiness of borrowers affected by the pandemic;
• the suspension of banks’ profit allocation till the end of year, with the aim that in any event of financial losses materialisation, capital size be adequate not only to absorb this loss but also to support the new lending.

Given that these measures are temporary and the pandemic development (intensity and duration) remains uncertain, it is not excluded the possibility that the challenges the banking sector may face become deeper.  Stress testing exercises conducted by the Bank of Albania suggest that in case of extreme shocks in macroeconomic framework, it would be necessary that certain banks strengthen their capital position, despite the overall banking sector appearing well-capitalised.

Hence, it is necessary banks use this period to adequately and in transparent manner manage the risks to the activity, being focused on credit risk. Although the preliminary data gathered from banks show that they are actively engaged in these processes, it is considered necessary that banks maintain their focus to:

• guarantee the well- functioning of the institutional activity from operational viewpoint, by providing safe work conditioned to the staff and ensuring the continuation of the critical functions of the activity;
• act with no delay with regard to: assessment of credit risk to their customers; use of the possibilities for credit restructuring pursuant to approaches provided by national and international standards; assessment of added provisions that may be required; the analysis of these costs on capital position and on the ways they will cope with such costs if needed.  It is important to consider that capital position should be sufficient not only to absorb the possible losses but also to boost the new lending that the economy needs;
• use all the ways, including stress tests with extreme but plausible scenarios, in order to regularly and pro-actively assess their resilience degree against unfavourable developments.
• maintain constant and close communication with the Bank of Albania, in order to share in real time their assessment on the economic and financial developments and their impact on the banking activity.

The Bank of Albania, in the framework of its legal functions and in coordination with other public authorities, will be attentive to undertake all the necessary actions in order for the banking sector and financial markets to operate in this period in adequate conditions and stable manner. 

The next chapters present in greater detail the report on financial stability for the first half of 2020.