BANK OF ALBANIA

BANKA E SHQIPËRISË

BANK OF ALBANIA STATEMENT
Financial Stability Statement for H1 2013

Data e publikimit: 17.11.2013

 

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 December 2006 "On Banks in the Republic of Albania", as amended, to inform the Parliament of the Republic of Albania and the Council of Ministers, and to draw the attention of financial institutions and the public on the Albanian financial system situation and potential risks that may jeopardise its stability, Bank of Albania releases this periodic Statement. This Statement is an integral part of the Financial Stability Report for the same stated period.

The Albanian banking sector and financial system saw stable performance in 2013 H1. Bank capital and liquidity indicators were adequate despite the lower profit figures. Banks' activity volume continued to decelerate due to the lower deposit growth and poor credit growth. Loan portfolio quality continued to deteriorate and a considerable portion of banks' operating income was channelled into reserve funds providing for protection against credit risk. Despite the low growth rates, Albania saw stable macroeconomic framework. It was characterised by low exchange rate volatility and weak inflationary pressures, despite the accommodative monetary policy. Government borrowing cost decreased considerably, notwithstanding the higher budget deficit and public debt. The trading volume and number of transactions in the financial markets were stable. Credit risk remains major risk to the banking sector. The impact of some legal and operating measures taken with a view to ensuring better credit risk management by banks is expected to become more evident in the near future. In the meantime, there is limited banking sector exposure to market and liquidity risks. 

The following provides an overview of developments in the surrounding internal and external economic environment, and the financial system.

Global economy continued to grow in 2013 H1, although the growth rates were uneven across regions. Economic developments in advanced economies were more stable and showed relative improvement in 2013 Q2. The U.S. economy continued to grow, driven by the accommodative monetary policies, positive labour market developments and improved real estate market. Euro area's economy grew in Q2, hence reducing the annual contraction rate. Monetary policies remained deeply accommodative, contributing to stabilising the financial market operations. There was, however, elevated tension in the markets following the U.S. Federal Reserve's announcement of possible monetary stimulus tapering next year. As a result, interest rates on longer-term public and private debt securities increased, raising concerns about their impact on economic growth. Developing economies continued to make dominant, albeit downward, contribution to global economic growth. The lower contribution was also attributable to the government support policies winding down. Central and Eastern European countries did not perform alike, with the countries with more developed exports displaying better performance. The lending conditions in this region remained tight also due to the lower euro area banks' exposure. South-East European countries showed relative improvement of their economic performance, driven primarily by the improved external trade balances. They, however, continued to face increasing difficulties in the labour market, further fall in financial sector lending and deteriorated loan quality. At a global level, the inflationary pressures remained weak, despite the slightly higher pressures in advanced economies, reflected in the rise in food and fuel prices. The persistent output gap, the high unemployment and the performance of primary commodity and food prices are expected to keep the inflationary pressures weak in the foreseeable future.

At a global level, economic growth is expected to remain modest in 2013 H2, and recover slightly in 2014. Fiscal policies will continue to make negative contribution to aggregate demand due to the need for fiscal consolidation in many countries. Private consumption is expected to remain subdued, driven by the still weak labour market conditions, unstable real estate market and tight lending standards. The downtrend in some large emerging economies will affect global economic growth adversely. Against this setting, the inflationary pressures are expected to remain weak.

The Albanian economy continued to grow at rates similar to the previous period, driven primarily by the fiscal stimulus and external demand. In 2013 Q1, Albania's GDP grew by 1.7% on average. Similar to the previous period, industry, agriculture and services made positive contribution to economic growth. Construction continued to impact negatively, albeit more moderately. Transportation and trade also made negative contribution to growth. External demand contributed positively and lowered the current account and trade deficit. Exports performed positively driven by the energy and mineral products. Consumption and private consumption remained weak, whereas the unemployment rate was relatively stable. The Albanian Government pursued an expansionary fiscal policy as a result of the increase in fiscal expenditure beyond the plan and the decrease in revenues. The high budget deficit was mainly financed through domestic resources and at a lower financing cost. The average maturity of debt continued to extend due to the faster increase in debt issues with a maturity of longer than 12 months. Given the weak inflationary pressures, the Bank of Albania pursued an accommodative monetary policy by cutting the interest rate on one-week repurchase agreements. This monetary policy stance aims at creating better conditions for boosting consumption and private investments by lowering the financing costs in the domestic currency. Concerning non-financial assets, the house and rental price index posted simultaneous and similar decrease during the period. This performance was followed by the increase in the relative cost of real estate loan re-payment, despite the downward interest rate on this type of loan. This combined information suggests that house prices will continue to maintain a steadier downward trend in the period ahead.

Households and businesses' financial position and sensitivity to risks moderated at low rates. Households' creditor position deepened at a slower pace given the lower difference between deposit and credit growth. The increase in lending in the Albanian lek provided major contribution in this performance. The quality of household lending deteriorated for almost all types of loans. Households' exposure to unfavourable exchange rate changes was lower than at end-2012 but, however, higher y-o-y. In the meantime, households' exposure to unfavourable interest rate changes did not show significant changes to the previous period. Businesses' debt position remained high; however, it maintained the downtrend begun in the previous period in the face of increased business deposits and absent growth in lending. The debt position is mainly affected by foreign currency operations. Despite the continued downtrend in business non-performing loans, the business non-performing loan ratio increased due to the sluggish lending, the latter being driven by the shrinkage in foreign currency lending. Businesses' exposure to unfavourable exchange rate and interest rate changes, albeit high, was lowered further during the period under review.    

The trading volume in financial markets increased, whereas interest rates sharpened the downward trend. Concerning the Government debt security market, there was a higher preference for debt issues with a maturity of longer than 12 months. Interest rates decreased further across all debt issuance structure as a reflection of the key interest rate cut by the Bank of Albania and the ample liquidity available at banks for this kind of investments, in the face of the considerable slowdown in lending to the private sector. In the secondary market for debt securities, the trading volume increased slightly from the previous period. It, however, remained low and concentrated only in Treasury bills. The trading volume in the interbank market improved markedly, almost doubling y-o-y. Overnight transactions have major share in the number of total transactions. Interest rates on interbank transactions reflected the key interest rate performance, settling below it. In the foreign exchange market, the Albanian lek was relatively stable, depreciating slightly against the euro and appreciating against the U.S. dollar.

The technical infrastructure supporting banking sector operations continued to operate smoothly and the legal basis regulating its activity improved. AIPS and AECH payment systems operated in compliance with the technical conditions to meet the banking sector needs for settling lek payment transactions. The volume and value of transactions in the AIPS increased, alongside with the increase in the value per transaction. By contrast, the number and value of transactions in the AECH system decreased over the same period. In both systems, transactions on behalf of bank customers have the main share in the number and value of total transactions. By banks, the operations carried out by the four largest banks in these systems accounted for about 2/3 of the number and value of processed transactions. The first half of 2013 saw the approval and entry into force of the new Law "On the payment systems", which sets higher standards for the safety, stability and efficiency of the national payment system. These standards shall be applied to the licensing, regulation and surveillance of participants in the national payment system, and the regulation and surveillance of payment instruments. The Law establishes the actions to be followed to limit the impact of situations when a system participant falls insolvent on payment systems and further on financial stability. In this spirit, the law increases the room for using different forms of financial collateral and establishes the rights of the collateral taker to hold/execute it immediately in case the other party to the transaction falls insolvent.
The financial system increased its share in Albania's economic activity further in 2013 H1. Financial intermediation in Albania, as measured by the ratio of financial system assets to Gross Domestic Product (GDP), was estimated at 95.4% at end-June 2013, from 93.9% at end-2012 and 92.8% at end-June 2012. The volume of financial institutions' assets grew 2.1% from end-2012 and around 5.1% from end-June 2012. The banking sector remained the dominant segment of financial intermediation in Albania. Its assets accounted for about 92.6% of total financial system assets and around 88.9% of GDP.

In face of the further slowdown in banking activity, the banking sector saw adequate capital and liquidity levels. Bank profit, however, was lower on a year earlier. Total banking sector assets rose to ALL 1,204 billion, up 1.4% from end-2012 and 3.4% y-o-y. On the asset side, interbank and security transactions registered major increase, reflecting primarily the higher participation in Government debt security auctions. Banking activity was financed through the increase in public deposits, albeit at lower rates. Banking sector exposure to non-resident institutions was similar to the previous period, reflecting low banking sector reliance on foreign financing sources. The annual growth rate of lending slowed down markedly to 1.3%, despite the better performance of mortgage and consumer loans. Due to the ongoing annual contraction in foreign currency lending, only lek-denominated lending contributed to the annual growth in total lending, which grew 9.2%. Credit stock grew ALL 0.8 billion in 2013 H1 from ALL 5.1 billion in 2012 H1. New loans extended by the banking sector were 16% lower than in 2012 H1. As of the end-June 2013, the ratio of non-performing loans to total loans rose to 24.2%, from 22.5% at end-2012 and 21.1% at end-June 2012. The non-performing loan ratio for lek loans was 20.1%, up 2.1 percentage points from June 2012. The same ratio for foreign currency loans was 26.5%, up 3.9 percentage points from June 2012. Deposits totalled ALL 991.4 billion, up 4.9% y-o-y. Lek and foreign currency deposits grew 7.2% and 2.3%, respectively, annually.

At a sector level, banks recorded positive profit, with an accumulated net profit of ALL 1.5 billion, from ALL 2.4 billion at end-June 2012. Net interest income totalled ALL 19 billion, or 3.9% lower y-o-y. Loan-loss provisions increased by around ALL 7.9 billion, or 11.5% lower y-o-y. Paid-in capital rose by around ALL 6.3 billion in 2013 H1. Regulatory capital rose to ALL 105.8 billion, up 1.6%, whereas risk-weighted assets dropped to ALL 622.3 billion, down 3.3%. As a result, the capital adequacy ratio rose to 17.0%. 

Risks to the financial system stem from its interactions with the surrounding economic environment and its activity.

Concerning the impact of macroeconomic developments on banking sector performance, fiscal policy will continue to provide major impact over the period ahead, despite the largest portion of the annual planned deficit being realized and financed. Assuming that the Government will stick to the budget plan for 2013, the need/room for lower borrowing for the remaining of the year may enhance banking sector incentives to lend more to the private sector. On the other hand, the limited room for fiscal policy to take a more active position in relation to settling public liabilities to the private sector during this financial year will restrain businesses' necessary financial resources to pay off their obligations to the banking sector. In any case, it seems like fiscal policy will provide higher impact next year when there will be greater opportunities to address this concern. From this viewpoint, the primary objective of fiscal policy will be to restore economic agents' confidence in the stability of fiscal policy and related indicators. In this context, it is important to adopt a stable fiscal rule in the short-term period, which would establish the public debt ceiling for the medium term and enable its return to stable downtrend. In addition, extending the average maturity of public debt should remain a primary objective, despite the short-term operations aiming at maximising profit and lowering the borrowing cost. As in the previous statement, we note that fiscal policy should cautiously monitor the performance of foreign currency-denominated liabilities. Establishing the actions and the way the foreign currency resources will be provided to deal with these liabilities, at the proper time and at an acceptable cost, contributes to preventing uncertainties in the market and safeguarding financial stability.   

Credit risk represents a major challenge for the banking system activity. The high non-performing loan stock in banks' balance sheets increases banks' costs, impairs their ability to engage in financial intermediation and requires added and inefficient use of their capacities. In this respect, the Bank of Albania has maintained a clear position in relation to the banking industry and other public authorities that may contribute to resolving this issue. In any case, the Bank has underlined the key role the banking sector plays with regard to the policies it implements to know the client, extend and monitor the loans. On the other hand, identifying the needs for amendments to the relevant legal and regulatory framework, the Bank of Albania, in cooperation with the Ministry of Finance and Ministry of Justice drafted some legal amendments that improve the collateral execution process. These amendments are expected to enter into force in September 2013. On the other hand, communication with the banking sector shows that the impact of measures approved by the Bank of Albania in May this year will be more evident in 2013 H2. Lastly, the first transactions that allow the transfer of non-performing loans from banks to non-bank financial institutions have emerged in the market. The Bank of Albania will undertake all the necessary actions to strengthen this instrument further. The banking sector is, therefore, expected to have greater opportunities to manage credit risk in 2013 H2 and beyond. The Bank of Albania will, in the period ahead, assess the need for additional actions that encourage banking industry toward a stable solution to this issue.

The banking sector appeared hedged against direct risk associated with unfavourable exchange rate and interest rate movements; however, the sensitivity is higher. The banking sector's open foreign exchange position was within the historical levels and the values of interest rate-sensitive assets and liabilities were comparable. The banking sector, however, appeared sensitive to the impact of exchange rate and interest rate movements on banking customers. A significant depreciation of the exchange rate or a similar increase in the interest rate may impair the solvency of borrowers, particularly of the business sector. The main transmission channel of this risk is represented by foreign currency loans, when the main source for its settlement is the domestic currency, and variable-rate loans.
Liquidity risk in the banking sector was also moderate. Similar to the previous periods, deposits represent the main financing source for the banking sector. They recorded positive growth, albeit lower than in the previous period. Borrowing from non-residents remained at controlled levels. Banking sector's liquid assets, in lek and major currencies, were above the minimum requirement, and the negative difference between liquid assets and current liabilities with a maturity of up to one year fell over the period. Loan-to-deposit ratio was at optimal levels, driven also by the lower lending.

Capital indicators were at adequate levels; however, banks should cautiously monitor the possible scenarios for the future and their needs for additional capital. The lower growth of risk-weighted assets made major contribution to banks' capitalisation during this period. Concerns relating to loan quality and the lower market rates reduced the banking sector's positive profit further. There is, therefore, less room for the banking sector to generate sufficient income that would support the increase in capital and conduct operations through domestic resources. On the other hand, net non-performing loan coverage ratio fell during 2013 H1. It is, therefore, imperative for banks to continue to make cautious and proactive assessment of needs for additional capital in line with their risk profile. When required, banks should take actions to strengthen their capital position, initially by limiting the profit allocation and later, by injecting additional capital.

The stress test exercise should serve banks as a tool to support the assessment of possible needs for additional capital. The Bank of Albania carries our regular stress test exercises to assess the sensitivity of the main banking sector capital figures to changes in macroeconomic indicators. Baseline and risk scenarios, which extend through the end of 2014, assume assumptions relating to changes in GDP growth rate, exchange rate and interest rate, and lending. The stress test results reveal that the banking sector was generally resilient to assumed shocks. The banking sector capitalization level remained above the minimum requirement in the event of the baseline scenario. In the event of the adverse scenarios, which include the respective assumptions of the decline in GDP growth rate, lower lending and exchange rate depreciation, individual banks may need additional capital. The regulatory and supervisory framework and the international best practices require similar exercises to be carried out by banks themselves on a regular basis in order to assist their decision-making process.

PUBLICATION DATE: 17.11.2013

 

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 December 2006 "On Banks in the Republic of Albania", as amended, to inform the Parliament of the Republic of Albania and the Council of Ministers, and to draw the attention of financial institutions and the public on the Albanian financial system situation and potential risks that may jeopardise its stability, Bank of Albania releases this periodic Statement. This Statement is an integral part of the Financial Stability Report for the same stated period.

The Albanian banking sector and financial system saw stable performance in 2013 H1. Bank capital and liquidity indicators were adequate despite the lower profit figures. Banks' activity volume continued to decelerate due to the lower deposit growth and poor credit growth. Loan portfolio quality continued to deteriorate and a considerable portion of banks' operating income was channelled into reserve funds providing for protection against credit risk. Despite the low growth rates, Albania saw stable macroeconomic framework. It was characterised by low exchange rate volatility and weak inflationary pressures, despite the accommodative monetary policy. Government borrowing cost decreased considerably, notwithstanding the higher budget deficit and public debt. The trading volume and number of transactions in the financial markets were stable. Credit risk remains major risk to the banking sector. The impact of some legal and operating measures taken with a view to ensuring better credit risk management by banks is expected to become more evident in the near future. In the meantime, there is limited banking sector exposure to market and liquidity risks. 

The following provides an overview of developments in the surrounding internal and external economic environment, and the financial system.

Global economy continued to grow in 2013 H1, although the growth rates were uneven across regions. Economic developments in advanced economies were more stable and showed relative improvement in 2013 Q2. The U.S. economy continued to grow, driven by the accommodative monetary policies, positive labour market developments and improved real estate market. Euro area's economy grew in Q2, hence reducing the annual contraction rate. Monetary policies remained deeply accommodative, contributing to stabilising the financial market operations. There was, however, elevated tension in the markets following the U.S. Federal Reserve's announcement of possible monetary stimulus tapering next year. As a result, interest rates on longer-term public and private debt securities increased, raising concerns about their impact on economic growth. Developing economies continued to make dominant, albeit downward, contribution to global economic growth. The lower contribution was also attributable to the government support policies winding down. Central and Eastern European countries did not perform alike, with the countries with more developed exports displaying better performance. The lending conditions in this region remained tight also due to the lower euro area banks' exposure. South-East European countries showed relative improvement of their economic performance, driven primarily by the improved external trade balances. They, however, continued to face increasing difficulties in the labour market, further fall in financial sector lending and deteriorated loan quality. At a global level, the inflationary pressures remained weak, despite the slightly higher pressures in advanced economies, reflected in the rise in food and fuel prices. The persistent output gap, the high unemployment and the performance of primary commodity and food prices are expected to keep the inflationary pressures weak in the foreseeable future.

At a global level, economic growth is expected to remain modest in 2013 H2, and recover slightly in 2014. Fiscal policies will continue to make negative contribution to aggregate demand due to the need for fiscal consolidation in many countries. Private consumption is expected to remain subdued, driven by the still weak labour market conditions, unstable real estate market and tight lending standards. The downtrend in some large emerging economies will affect global economic growth adversely. Against this setting, the inflationary pressures are expected to remain weak.

The Albanian economy continued to grow at rates similar to the previous period, driven primarily by the fiscal stimulus and external demand. In 2013 Q1, Albania's GDP grew by 1.7% on average. Similar to the previous period, industry, agriculture and services made positive contribution to economic growth. Construction continued to impact negatively, albeit more moderately. Transportation and trade also made negative contribution to growth. External demand contributed positively and lowered the current account and trade deficit. Exports performed positively driven by the energy and mineral products. Consumption and private consumption remained weak, whereas the unemployment rate was relatively stable. The Albanian Government pursued an expansionary fiscal policy as a result of the increase in fiscal expenditure beyond the plan and the decrease in revenues. The high budget deficit was mainly financed through domestic resources and at a lower financing cost. The average maturity of debt continued to extend due to the faster increase in debt issues with a maturity of longer than 12 months. Given the weak inflationary pressures, the Bank of Albania pursued an accommodative monetary policy by cutting the interest rate on one-week repurchase agreements. This monetary policy stance aims at creating better conditions for boosting consumption and private investments by lowering the financing costs in the domestic currency. Concerning non-financial assets, the house and rental price index posted simultaneous and similar decrease during the period. This performance was followed by the increase in the relative cost of real estate loan re-payment, despite the downward interest rate on this type of loan. This combined information suggests that house prices will continue to maintain a steadier downward trend in the period ahead.

Households and businesses' financial position and sensitivity to risks moderated at low rates. Households' creditor position deepened at a slower pace given the lower difference between deposit and credit growth. The increase in lending in the Albanian lek provided major contribution in this performance. The quality of household lending deteriorated for almost all types of loans. Households' exposure to unfavourable exchange rate changes was lower than at end-2012 but, however, higher y-o-y. In the meantime, households' exposure to unfavourable interest rate changes did not show significant changes to the previous period. Businesses' debt position remained high; however, it maintained the downtrend begun in the previous period in the face of increased business deposits and absent growth in lending. The debt position is mainly affected by foreign currency operations. Despite the continued downtrend in business non-performing loans, the business non-performing loan ratio increased due to the sluggish lending, the latter being driven by the shrinkage in foreign currency lending. Businesses' exposure to unfavourable exchange rate and interest rate changes, albeit high, was lowered further during the period under review.    

The trading volume in financial markets increased, whereas interest rates sharpened the downward trend. Concerning the Government debt security market, there was a higher preference for debt issues with a maturity of longer than 12 months. Interest rates decreased further across all debt issuance structure as a reflection of the key interest rate cut by the Bank of Albania and the ample liquidity available at banks for this kind of investments, in the face of the considerable slowdown in lending to the private sector. In the secondary market for debt securities, the trading volume increased slightly from the previous period. It, however, remained low and concentrated only in Treasury bills. The trading volume in the interbank market improved markedly, almost doubling y-o-y. Overnight transactions have major share in the number of total transactions. Interest rates on interbank transactions reflected the key interest rate performance, settling below it. In the foreign exchange market, the Albanian lek was relatively stable, depreciating slightly against the euro and appreciating against the U.S. dollar.

The technical infrastructure supporting banking sector operations continued to operate smoothly and the legal basis regulating its activity improved. AIPS and AECH payment systems operated in compliance with the technical conditions to meet the banking sector needs for settling lek payment transactions. The volume and value of transactions in the AIPS increased, alongside with the increase in the value per transaction. By contrast, the number and value of transactions in the AECH system decreased over the same period. In both systems, transactions on behalf of bank customers have the main share in the number and value of total transactions. By banks, the operations carried out by the four largest banks in these systems accounted for about 2/3 of the number and value of processed transactions. The first half of 2013 saw the approval and entry into force of the new Law "On the payment systems", which sets higher standards for the safety, stability and efficiency of the national payment system. These standards shall be applied to the licensing, regulation and surveillance of participants in the national payment system, and the regulation and surveillance of payment instruments. The Law establishes the actions to be followed to limit the impact of situations when a system participant falls insolvent on payment systems and further on financial stability. In this spirit, the law increases the room for using different forms of financial collateral and establishes the rights of the collateral taker to hold/execute it immediately in case the other party to the transaction falls insolvent.
The financial system increased its share in Albania's economic activity further in 2013 H1. Financial intermediation in Albania, as measured by the ratio of financial system assets to Gross Domestic Product (GDP), was estimated at 95.4% at end-June 2013, from 93.9% at end-2012 and 92.8% at end-June 2012. The volume of financial institutions' assets grew 2.1% from end-2012 and around 5.1% from end-June 2012. The banking sector remained the dominant segment of financial intermediation in Albania. Its assets accounted for about 92.6% of total financial system assets and around 88.9% of GDP.

In face of the further slowdown in banking activity, the banking sector saw adequate capital and liquidity levels. Bank profit, however, was lower on a year earlier. Total banking sector assets rose to ALL 1,204 billion, up 1.4% from end-2012 and 3.4% y-o-y. On the asset side, interbank and security transactions registered major increase, reflecting primarily the higher participation in Government debt security auctions. Banking activity was financed through the increase in public deposits, albeit at lower rates. Banking sector exposure to non-resident institutions was similar to the previous period, reflecting low banking sector reliance on foreign financing sources. The annual growth rate of lending slowed down markedly to 1.3%, despite the better performance of mortgage and consumer loans. Due to the ongoing annual contraction in foreign currency lending, only lek-denominated lending contributed to the annual growth in total lending, which grew 9.2%. Credit stock grew ALL 0.8 billion in 2013 H1 from ALL 5.1 billion in 2012 H1. New loans extended by the banking sector were 16% lower than in 2012 H1. As of the end-June 2013, the ratio of non-performing loans to total loans rose to 24.2%, from 22.5% at end-2012 and 21.1% at end-June 2012. The non-performing loan ratio for lek loans was 20.1%, up 2.1 percentage points from June 2012. The same ratio for foreign currency loans was 26.5%, up 3.9 percentage points from June 2012. Deposits totalled ALL 991.4 billion, up 4.9% y-o-y. Lek and foreign currency deposits grew 7.2% and 2.3%, respectively, annually.

At a sector level, banks recorded positive profit, with an accumulated net profit of ALL 1.5 billion, from ALL 2.4 billion at end-June 2012. Net interest income totalled ALL 19 billion, or 3.9% lower y-o-y. Loan-loss provisions increased by around ALL 7.9 billion, or 11.5% lower y-o-y. Paid-in capital rose by around ALL 6.3 billion in 2013 H1. Regulatory capital rose to ALL 105.8 billion, up 1.6%, whereas risk-weighted assets dropped to ALL 622.3 billion, down 3.3%. As a result, the capital adequacy ratio rose to 17.0%. 

Risks to the financial system stem from its interactions with the surrounding economic environment and its activity.

Concerning the impact of macroeconomic developments on banking sector performance, fiscal policy will continue to provide major impact over the period ahead, despite the largest portion of the annual planned deficit being realized and financed. Assuming that the Government will stick to the budget plan for 2013, the need/room for lower borrowing for the remaining of the year may enhance banking sector incentives to lend more to the private sector. On the other hand, the limited room for fiscal policy to take a more active position in relation to settling public liabilities to the private sector during this financial year will restrain businesses' necessary financial resources to pay off their obligations to the banking sector. In any case, it seems like fiscal policy will provide higher impact next year when there will be greater opportunities to address this concern. From this viewpoint, the primary objective of fiscal policy will be to restore economic agents' confidence in the stability of fiscal policy and related indicators. In this context, it is important to adopt a stable fiscal rule in the short-term period, which would establish the public debt ceiling for the medium term and enable its return to stable downtrend. In addition, extending the average maturity of public debt should remain a primary objective, despite the short-term operations aiming at maximising profit and lowering the borrowing cost. As in the previous statement, we note that fiscal policy should cautiously monitor the performance of foreign currency-denominated liabilities. Establishing the actions and the way the foreign currency resources will be provided to deal with these liabilities, at the proper time and at an acceptable cost, contributes to preventing uncertainties in the market and safeguarding financial stability.   

Credit risk represents a major challenge for the banking system activity. The high non-performing loan stock in banks' balance sheets increases banks' costs, impairs their ability to engage in financial intermediation and requires added and inefficient use of their capacities. In this respect, the Bank of Albania has maintained a clear position in relation to the banking industry and other public authorities that may contribute to resolving this issue. In any case, the Bank has underlined the key role the banking sector plays with regard to the policies it implements to know the client, extend and monitor the loans. On the other hand, identifying the needs for amendments to the relevant legal and regulatory framework, the Bank of Albania, in cooperation with the Ministry of Finance and Ministry of Justice drafted some legal amendments that improve the collateral execution process. These amendments are expected to enter into force in September 2013. On the other hand, communication with the banking sector shows that the impact of measures approved by the Bank of Albania in May this year will be more evident in 2013 H2. Lastly, the first transactions that allow the transfer of non-performing loans from banks to non-bank financial institutions have emerged in the market. The Bank of Albania will undertake all the necessary actions to strengthen this instrument further. The banking sector is, therefore, expected to have greater opportunities to manage credit risk in 2013 H2 and beyond. The Bank of Albania will, in the period ahead, assess the need for additional actions that encourage banking industry toward a stable solution to this issue.

The banking sector appeared hedged against direct risk associated with unfavourable exchange rate and interest rate movements; however, the sensitivity is higher. The banking sector's open foreign exchange position was within the historical levels and the values of interest rate-sensitive assets and liabilities were comparable. The banking sector, however, appeared sensitive to the impact of exchange rate and interest rate movements on banking customers. A significant depreciation of the exchange rate or a similar increase in the interest rate may impair the solvency of borrowers, particularly of the business sector. The main transmission channel of this risk is represented by foreign currency loans, when the main source for its settlement is the domestic currency, and variable-rate loans.
Liquidity risk in the banking sector was also moderate. Similar to the previous periods, deposits represent the main financing source for the banking sector. They recorded positive growth, albeit lower than in the previous period. Borrowing from non-residents remained at controlled levels. Banking sector's liquid assets, in lek and major currencies, were above the minimum requirement, and the negative difference between liquid assets and current liabilities with a maturity of up to one year fell over the period. Loan-to-deposit ratio was at optimal levels, driven also by the lower lending.

Capital indicators were at adequate levels; however, banks should cautiously monitor the possible scenarios for the future and their needs for additional capital. The lower growth of risk-weighted assets made major contribution to banks' capitalisation during this period. Concerns relating to loan quality and the lower market rates reduced the banking sector's positive profit further. There is, therefore, less room for the banking sector to generate sufficient income that would support the increase in capital and conduct operations through domestic resources. On the other hand, net non-performing loan coverage ratio fell during 2013 H1. It is, therefore, imperative for banks to continue to make cautious and proactive assessment of needs for additional capital in line with their risk profile. When required, banks should take actions to strengthen their capital position, initially by limiting the profit allocation and later, by injecting additional capital.

The stress test exercise should serve banks as a tool to support the assessment of possible needs for additional capital. The Bank of Albania carries our regular stress test exercises to assess the sensitivity of the main banking sector capital figures to changes in macroeconomic indicators. Baseline and risk scenarios, which extend through the end of 2014, assume assumptions relating to changes in GDP growth rate, exchange rate and interest rate, and lending. The stress test results reveal that the banking sector was generally resilient to assumed shocks. The banking sector capitalization level remained above the minimum requirement in the event of the baseline scenario. In the event of the adverse scenarios, which include the respective assumptions of the decline in GDP growth rate, lower lending and exchange rate depreciation, individual banks may need additional capital. The regulatory and supervisory framework and the international best practices require similar exercises to be carried out by banks themselves on a regular basis in order to assist their decision-making process.