BANK OF ALBANIA STATEMENT
Financial Stability Statement for H1 2010

The Bank of Albania’s Supervisory Council, in its meeting of 13/10/2010, dealt with and approved:

• The Financial Stability Report and the Financial Stability Statement on the first half of 2010

Pursuant to provisions stipulated under Article 69 of the Law No.8269, dated 23/12/1997 "On the Bank of Albania", as amended, and Article 8 of the Law No.9662, dated 18/12/2006 "On Banks in the Republic of Albania", informing the Council of Ministers and the Parliament of the Republic of Albania and drawing the attention of the financial institutions and the public at large on the situation of the Albanian financial system and potential risks that may jeopardize its stability, the Bank of Albania releases the following periodical statement, part of the Financial Stability Report.

Over 2010 H1, Albania’s financial and banking sector has been stable. The need to stabilize and improve credit quality is the main challenge posed to the banking sector. Capitalization level and operational liquidity positions are good. At sectoral level, net operating income has improved. Stress-testing of the banking sector’s resilience to any potential adverse economic or financial scenarios showed robustness.

Financial and banking system risks posed from domestic economic developments over 2010 H1 have subsided. The main positive factors include reining budget and trade deficits, exchange rate stability, moderate inflationary pressures and interest rate cut. Over the said period, the interbank market liquidity was sufficient to meet commercial banks’ short-term liquidity needs. Also, the financial market has operated smoothly. However, these positive developments would have a more lasting impact if they promoted a more rapid improvement of the financial position of both enterprises and individuals/households, thereby stimulating the domestic demand.

In 2010 H1, international economic developments also highlighted a recovered situation. The global economy expanded by 4.7% year on year. Inflationary pressures were moderate. Financial markets were generally steadier and banking groups’ financial position was generally better. However, bank credit availability has remained restricted and public authorities have taken measures for fiscal consolidation. Consequently, new investments in the economy are weak and unemployment rate, especially in Southern countries of the euro area, remains high. Therefore, the growth outlook for the period ahead remains uncertain.

Albania’s financial system expanded over the first half of the year, increasing its share to Gross Domestic Product (GDP), at 84.5%. The banking sector continues to remain the dominant segment of financial intermediation. Banking sector assets rose to ALL 934.7 billion, accounting for 94.4% of the financial system’s total assets.

Smooth functioning of payment systems infrastructure has also contributed to expansion of banking sector activity. The banking activity is well-capitalized and capital adequacy indicator is steady, at 16.2%. Liquid assets account for 27.8% of the banking sector’s total assets. Loans to deposits ratio has amounted to 63.2%. Banking sector’s profit posted a positive figure, ALL 3.6 billion, up substantially from the same period of the previous year. The rise in the financial profit was due to higher net interest income and better control over operating costs. However, the positive financial profit has a high concentration and the banking sector still faces loan quality impairment, with non-performing loans accounting for 12.2% of total loans. Due to high credit risk perception, the banking sector decelerated the annual credit growth rate, cut its average maturity term and further decreased the consumer credit.

Credit risk provisioning increased by about 20%, accounting for 52.5% of non-performing loans at the end of the first half of the year. The Bank of Albania has underscored that banks should continue to cautiously monitor the credit quality performance and timely set aside appropriate provisions. Banks’ relevant structures should assess the nonperforming loan concentration by sector and borrower, and try to increase the loan portfolio diversification. Paying attention to regulatory requirements,

banks should support borrowing entities that incur temporary difficulties but have any worthwhile project that ensures loan repayment. In case this opportunity is small, relevant bank structures should implement contractual rights, in order to recover the loan.

In terms of assessing the banking sector risks, the Bank of Albania consistently performs simulations to test the banking sector’s resilience to adverse scenarios assumed in several macroeconomic and financial indicators, both individually and combined. The analysis of scenarios combining the impact of some macroeconomic and financial indicators, as well as the performance of several banking sector indicators, show that the banking sector’s overall financial position is good and as such, it can withstand an impairment of the situation. The sensitivity analysis of these simulations highlights that the banking sector shows a greater sensitivity to credit risk and indirect credit risk posed from adverse foreign exchange rate movements. Notwithstanding these results, bank management structures should stress-test the viability of institutions they manage by conducting similar exercises and making preliminary and ongoing assessment of their needs for additional capital.

In line with the banking activity challenges and in implementation of the legal objective to ensure a healthy banking sector, the Bank of Albania will assess the need for amendments to the regulatory and supervisory framework. It will constantly monitor the risk spectrum posed to the country’s financial system, in order to take timely preventive measures.

The Bank of Albania’s Supervisory Council, in its meeting of 13/10/2010, dealt with and approved:

• The Financial Stability Report and the Financial Stability Statement on the first half of 2010

Pursuant to provisions stipulated under Article 69 of the Law No.8269, dated 23/12/1997 "On the Bank of Albania", as amended, and Article 8 of the Law No.9662, dated 18/12/2006 "On Banks in the Republic of Albania", informing the Council of Ministers and the Parliament of the Republic of Albania and drawing the attention of the financial institutions and the public at large on the situation of the Albanian financial system and potential risks that may jeopardize its stability, the Bank of Albania releases the following periodical statement, part of the Financial Stability Report.

Over 2010 H1, Albania’s financial and banking sector has been stable. The need to stabilize and improve credit quality is the main challenge posed to the banking sector. Capitalization level and operational liquidity positions are good. At sectoral level, net operating income has improved. Stress-testing of the banking sector’s resilience to any potential adverse economic or financial scenarios showed robustness.

Financial and banking system risks posed from domestic economic developments over 2010 H1 have subsided. The main positive factors include reining budget and trade deficits, exchange rate stability, moderate inflationary pressures and interest rate cut. Over the said period, the interbank market liquidity was sufficient to meet commercial banks’ short-term liquidity needs. Also, the financial market has operated smoothly. However, these positive developments would have a more lasting impact if they promoted a more rapid improvement of the financial position of both enterprises and individuals/households, thereby stimulating the domestic demand.

In 2010 H1, international economic developments also highlighted a recovered situation. The global economy expanded by 4.7% year on year. Inflationary pressures were moderate. Financial markets were generally steadier and banking groups’ financial position was generally better. However, bank credit availability has remained restricted and public authorities have taken measures for fiscal consolidation. Consequently, new investments in the economy are weak and unemployment rate, especially in Southern countries of the euro area, remains high. Therefore, the growth outlook for the period ahead remains uncertain.

Albania’s financial system expanded over the first half of the year, increasing its share to Gross Domestic Product (GDP), at 84.5%. The banking sector continues to remain the dominant segment of financial intermediation. Banking sector assets rose to ALL 934.7 billion, accounting for 94.4% of the financial system’s total assets.

Smooth functioning of payment systems infrastructure has also contributed to expansion of banking sector activity. The banking activity is well-capitalized and capital adequacy indicator is steady, at 16.2%. Liquid assets account for 27.8% of the banking sector’s total assets. Loans to deposits ratio has amounted to 63.2%. Banking sector’s profit posted a positive figure, ALL 3.6 billion, up substantially from the same period of the previous year. The rise in the financial profit was due to higher net interest income and better control over operating costs. However, the positive financial profit has a high concentration and the banking sector still faces loan quality impairment, with non-performing loans accounting for 12.2% of total loans. Due to high credit risk perception, the banking sector decelerated the annual credit growth rate, cut its average maturity term and further decreased the consumer credit.

Credit risk provisioning increased by about 20%, accounting for 52.5% of non-performing loans at the end of the first half of the year. The Bank of Albania has underscored that banks should continue to cautiously monitor the credit quality performance and timely set aside appropriate provisions. Banks’ relevant structures should assess the nonperforming loan concentration by sector and borrower, and try to increase the loan portfolio diversification. Paying attention to regulatory requirements,

banks should support borrowing entities that incur temporary difficulties but have any worthwhile project that ensures loan repayment. In case this opportunity is small, relevant bank structures should implement contractual rights, in order to recover the loan.

In terms of assessing the banking sector risks, the Bank of Albania consistently performs simulations to test the banking sector’s resilience to adverse scenarios assumed in several macroeconomic and financial indicators, both individually and combined. The analysis of scenarios combining the impact of some macroeconomic and financial indicators, as well as the performance of several banking sector indicators, show that the banking sector’s overall financial position is good and as such, it can withstand an impairment of the situation. The sensitivity analysis of these simulations highlights that the banking sector shows a greater sensitivity to credit risk and indirect credit risk posed from adverse foreign exchange rate movements. Notwithstanding these results, bank management structures should stress-test the viability of institutions they manage by conducting similar exercises and making preliminary and ongoing assessment of their needs for additional capital.

In line with the banking activity challenges and in implementation of the legal objective to ensure a healthy banking sector, the Bank of Albania will assess the need for amendments to the regulatory and supervisory framework. It will constantly monitor the risk spectrum posed to the country’s financial system, in order to take timely preventive measures.