BANK OF ALBANIA STATEMENT
Financial Stability Statement for 2019 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 test and placed vis-à-vis the financial situation of the banking sector to assess its resilience.

The Bank of Albania deems that in 2019 H1 (hereinafter ‘the period’), following significant structural changes, the banking sector continued to operate amid a stable environment. Indicators of activity, exposure to risks and resilience remain at good levels. As a result, banking sector's ability to withstand risks is assessed as robust. Economic developments and the performance of financial markets supported the overall activity of the financial system.

Highlights in the surrounding economic and financial environment

During the period, expansion in the global economic activity slowed down. Notwithstanding the positive performance in some advanced economies, the escalation of trade tensions between the US and China, prolonged uncertainties surrounding Brexit and economic slowdown in some emerging regions had a deceleration effect on global trade and economic growth. As a result of these developments, conditions in financial markets of advanced regions tightened in the last months and markets' volatility heightened. In emerging economies, financial conditions were tightened mainly in those countries with an uncertain political climate and weak macroeconomic structure. Global inflationary pressures remained contained, reflecting the slowdown in economic and trade activity as well as oil prices. Against this backdrop, central banks of major economies have maintained the accommodative monetary policy stance. In Balkan countries, economic growth slowed down, inflationary pressures remained subdued, but improvements in the labour market continued. Overall, international financial institutions expect global economic activity to continue to further weaken during this year and to stabilise in the next year.

In Albania, the economic growth rate dropped to 2.3% in the second quarter of the year. Aggregate demand was sustained by the expansion of final consumption of the population and private and public investments. In sectorial terms, trade provided positive contribution. Electrical energy production, dictated entirely by unfavourable weather conditions, had a negative impact on Albania’s economic growth rate. In annual terms, the current account deficit expanded at the end of the second quarter, but it was fully covered by the surpluses in the capital and financial accounts. Positive developments in the labour market continued, as confirmed by the decline of the unemployment rate to 11.5%. In an environment with subdued inflationary pressures, during the period, the Bank of Albania maintained the accommodative monetary policy stance. The fiscal policy maintained the fiscal consolidation trend, but at a slower pace.

Financial Markets and Payment Systems

Activity in financial markets was conducted under normal conditions. In the primary market of government debt securities, average yields decreased, but increased slightly in the second part of the period. In the secondary market, the volume of trading increased, bolstered by structural measures that guarantee the tradability of certain benchmark securities, with a long term to maturity.  In the interbank market, transactions’ maturity was up to one week, and rates hovered close to the policy rate of the Bank of Albania. In the foreign exchange market, the Albanian lek appreciated against the euro and the US dollar, but at a slower pace than in the previous year. Indices that monitor the developments of house prices nationwide and for Tirana rose for the period, but at a slower pace than in the previous year. Developments in certain determining factors point to growth of demand and supply in this market. During the period, the operation of payment systems was optimal, with increases in both volume and number of processed payments. 

Households and enterprises

For resident households and enterprises, credit and savings expanded during the period. Credit to resident entities expanded by 3.3% with over 60% of outstanding credit held by enterprises. Overdraft and credit for construction purposes contributed most to credit growth for this segment. For households, credit expanded 3% driven mostly by growth of credit in lek and credit for real estate. Interest rates on new loans granted during the period, both for enterprises and households, declined. At the same time, resident households expanded their investments in deposits, securities, and participation in investment funds. Credit quality improved for households and declined slightly for enterprises. Survey results on the financial and borrowing situation of households and enterprises show that their debt burden overall remains at appropriate levels. Among households, around 1/4 declare that they have a debt to repay and for 3/4 the value of debt amounts up to 30% of their income level. Among enterprises, around 39% have a debt to repay and for almost 76% of borrowing enterprises the debt burden is assessed to amount to almost half the value of their capital. For most indebted enterprises, debt servicing accounts for around  20% of the enterprises activity income. According to respective survey results, households and enterprises’ credit demand for the short-term future is expected to be moderate.

Financial system activity

Activity in the financial system continued amid a stable environment and key performance and resilience indicators remain at good levels. The share of assets of the financial system in the Gross Domestic Product fell by almost 2.1 percentage points. The fall came mainly from the decline in the reported value of banking sector assets, after the finalisation of the transformation of a bank branch abroad into a subsidiary. This reduction effect of this structural break in the data has been observed mainly in the foreign currency activities mostly with non-resident entities. Excluding this effect, banking sector assets would be 1.3% higher for the period. The appreciation of lek's exchange rate, which was stronger in the second half of the period, contributed negatively to the reported values in foreign currency of the banking sector's balance sheet; however, the impact was low. In terms of financial soundness, the banking sector was characterised by good levels of capitalisation and profitability. Liquidity indicators are assessed to be at high levels. The direct exposure of the banking sector to the non-banking sector is estimated as low, whereas the banking sector performance remains a critical factor for the activity and stability of the non-banking sector.

Banking sector's exposure to activity risks

The Bank of Albania assesses activity risks to the banking sector as contained. Thus:

1. Non-performing loans remained overall stable during the period, at ALL 63 billion. The ratio of non-performing loans recorded 11.2%. From a year earlier, non-performing loans fell by 18%, whereas the ratio of non-performing loans stands around 2 percentage points lower. By size of contribution, the annual performance of non-performing loans was determined by repayments, lost loan write offs, and restructuring.  During the period, it is estimated that banks  have written off around ALL 2 billion  lost loans from their balance sheets; this value is smaller compared to the amount of write offs in previous periods. The write offs, restructuring and repayment of loans have been accompanied by the change in the structure of non-performing loans. As a result, the share of lost loans has dropped to 45%. This change in structure has led to the statistical effect of reduction by almost 4.4 percentage points in the coverage ratio of non-performing loans with provisions, to 62%. Similarly, the coverage ratio of net non-performing loans with capital has also declined. On the other hand, the coverage of non-performing loan with collateral remains at high levels. Since the beginning of 2015, when banks began to write off loans classified as lost for more than three years, a total of ALL 57.4 billion have been written off as lost loans from banks’ balance sheets. The amount of write-offs has dropped significantly over the last two years, reflecting the reduction of lost loans classified as such for a period longer than three years. The Bank of Albania deems that the write off process remains necessary to further reduce the non-performing loans ratio and to free resources that banks may better commit to lending. In this light, the Bank of Albania has adopted recently a regulatory change, according to which banks shall write off from their balance sheets lost loans classified as such for longer than two years. The change is expected to bolster the contribution of lost loans write offs to the reduction of non-performing loans. Overall, despite the welcome downtrend in non-performing loans, the Bank of Albania deems that banks should maintain their focus on this process. 
2. Liquidity risk in the banking activity remains low.  The ratios of liquid assets, both in lek and in foreign currency, to short-term liabilities stand significantly above the minimum regulatory requirement. Deposits remain the main source of funding the banking activity. They account for around 80% of liabilities and cover over twice as much the volume of loans. As a result of the considerable share of demand deposits and current accounts, maturity mismatches between short term liabilities and assets are in negative values. However, these mismatches are covered adequately by banks’ liquid assets. The presence of high foreign currency levels in the activity of the banking sector, notwithstanding the relative reduction caused by the effect of the structural break, underscores the need for monitoring the performance of risk indicators and identifying other adjustment measures in response to developments. On the other hand, the high presence points to the wide use of foreign currency in the real sector of the economy, and reinforces the need for a concrete engagement of other public authorities for addressing this phenomenon.
3. The banking sector’s exposure to market risks, despite the decline observed over the period, remains important. Exposures to direct and indirect risk from the exchange rate registered a relative decline, as the values of the open foreign currency position and unhedged loans against the exchange rate risk fell during the period. However, unhedged loans continue to account for around 24% of total outstanding credit, and enterprises hold around 2/3 of the value. Regarding the impact of interest rate fluctuations, the banking sector remains exposed to interest rate fluctuations. Data show that the direct impact is moderate, given that the ratio of open balance sheet positions between rate-sensitive assets and liabilities, to the regulatory capital of the sector, is low. The indirect impact of interest rate risk remains significant. Given the historically low interest rate spreads and the fact that variable interest rate loans represent the majority of loans in the overall bank loans portfolio, a possible correction in the interest rate is expected to have a stronger impact on the borrowers’ ability to pay, over the medium term.  Based on the available information, the probability of this adjustment in the short-term period is assessed as low.
4. The profitability of the financial system is conditioned by a low interest rate environment, for a prolonged period of time; hence, it needs to be constantly monitored. Indicators of productivity in the banking activity are at good levels. At present, it is estimated that the return on equity for the banking sector is higher than the cost of equity. However, compared to the same period in the previous year, the net interest income has declined, reflecting the decline in income from interests in transactions with clients, and in net interest margins. From a longer-term perspective, the downtrend in net income from interests reflects in broader terms the impact from the presence of an internal and external environment with low interest rates for a prolonged period of time. As such, pressure on the financial result of the banking sector, as well as on the overall financial system will persist for as long as economic developments, inflationary pressures and interest rates, at home and abroad, remain close to current levels. Under this scenario, it is necessary for the banking sector to seek ways that keep activity costs in check and allow investments for expanding activities/ products with higher effectiveness and at risk levels that are identified properly and are assessed correctly. For as long as interest rates remain low, the sensitivity of financial institutions’ balance sheet to fluctuations tends to rise. Among financial institutions, this effect varies according to certain elements including the profile of financial activity and composition and average term of the investment portfolio. Overall, it is important for the whole financial system, in particular in the case of the activity of collective investment companies, to monitor with prudence compliance with the regulatory requirements, in order to mitigate risks related to the volatility in the value and quality of these investments as a result of the potential interest rate fluctuations.

Risks to financial stability

To assess systemic risks, the performance of indicators related to the materialization and accumulation of systemic risk is analysed against the stress level in the financial system and the perception of the banking industry regarding its activities’ exposure to systemic risks. Also, the financial stability map provides a consolidated approach for the assessment of these risks.

Overall, the financial stability map, materialisation and accumulation of systemic risks and financial stress indices show that risks to the financial stability are more contained. Indicators related to developments in the real sector of the economy have provided positive contribution to the mitigation of risks, whereas indicators related to the banking sector and the external economic environment show slight volatility in opposing directions. Banks’ responses in the relevant survey show that their perception of political risk and its impact on overall economic developments has increased notably. This response of banks reflects the effect of the tensioned political climate during the period, and evidences the need for relaxing such tensions.   

Macro-prudential policy

During the period, progress was made with regard to definition and operationalisation of macro-prudential policy instruments. Thus, following an extensive consultation process with the banking industry, on 5 June 2019, the Supervisory Council of the Bank of Albania adopted the Regulation No 41 “On macro-prudential capital buffers”, which supports the use of conservative capital buffer, countercyclical capital buffer, capital buffer for systemically-important banks, and capital buffer for systemic risk as macro-prudential policy instruments. Implementation modalities for the countercyclical capital buffer and the capital buffer for systemically-important banks are set out in two specific methodologies attached to the Regulation. This Regulation allows for a period spanning over several years (until 1 January 2024), within which banks shall comply with maximum macro-prudential (eventual) capital buffers and sets out, among others, stipulations related to instruments in which the capital buffer shall be implemented, frequency of assessments for determining them, reporting period by banks, and actions to be taken in the case of failure to comply with the level of the combined macro-prudential capital buffer.

In accordance with the authority stemming from this Regulation, the Governor of the Bank of Albania issued a decision on 28 June 2019 “On determining macro-prudential capital buffers” which specifies: a) level of countercyclical buffer for Albania, set at 0%; b) the list of systemically-important banks and respective capital buffers that they have to comply with for year 2020 (starting 29 March), at least 0.5%. These buffers are added to the conservative capital buffer which is set at 0.5% in the Regulation, for all banks, for the same-stated period. The decision of the Governor is based on conclusions deriving from the analysis of assessment indicators for systemic, cyclical and structural risks, conducted by the Bank of Albania in the last year. This Regulation is a response to the assessments in the Resolution of the Assembly of the Republic of Albania on the activity of the Bank of Albania in 2018 related to the implementation of the macro-prudential policy, and approximates in a comprehensive manner the respective stipulations in EU directives.

Banking sector's ability to withstand risks

The banking sector's ability to withstand risks is assessed by analysing its capitalization and profitability situation, and by testing the adequacy of these indicators through stress-test scenarios.

At the end of the period, the banking sector's capital adequacy ratio was 18.5%, down 0.2 percentage point from the end of 2018 and notably higher than the 12% minimum requirement. The performance of the capital adequacy ratio was dictated by the decline in the values of risk-weighted assets and of regulatory capital. The financial result of the sector was at good levels. Profitability indicators of the sector, Return on Assets (RoA) and Return on Equity (RoE), resulted at 1.5% and 14.3%, standing close to levels recorded in the previous year, and higher than at the end of 2018. During the period, net interest margin fell to 3.4% from 3.8% in the previous year, reflecting the decline in income from interests.

The adequacy of the above indicators was assessed through stress tests, with scenarios that assumed adverse developments in macroeconomic and financial indicators for 2019-2020. Similarly to before, extreme assumptions with a low probability of occurrence in an adverse scenario included a strong contraction of the economy, contraction of credit, rapid growth of average interest rates and strong depreciation of the exchange rate. Overall, test results show that the banking sector remains capitalized and shows good performance in scenarios assuming higher probability of occurrence. In the more extreme scenarios, individual banks and the banking sector would need to increase capital.

Based on this analysis, the Bank of Albania deems that capitalization and profitability of banks is actually adequate to withstand activity risks. As previously, banks should regularly analyse and test their ability to withstand various risks, in compliance with the supervisory and regulatory framework.

A more detailed analysis is presented in the Financial Stability Report for the first half of 2019.