BANK OF ALBANIA STATEMENT
On financial system stability in Albania H1 2007

Pursuant to the requirements of the Law No.8269, dated 23.12.1997 "On the Bank of Albania" and the obligation to draw the attention of the country's institutions, the financial market and its operators, and of the public at large, to potential risks that may threaten the country's financial system stability, the Bank of Albania is disclosing this periodic statement.

The country's macroeconomic indicators reflect a stable situation. The Government of the Republic of Albania continues to operate within the parameters specified with relation to the realization of budget deficit indicators at end of the financial year. The operations related to borrowing and public expenditures are reflected more harmonized than in the previous periods, but this feature should gain stability. The Bank of Albania has constantly monitored the liquidity situation of the interbank market, where the government's operations, specifically the borrowing and the public expenditures have a significant impact. Inflation rate is presented close to the target specified by the Bank of Albania.

However, the grave energy situation and the dry weather have livened up inflationary pressures in the economy, particularly on the supply side. The increasing costs for encountering the energy crisis, to businesses, particularlyto small and medium ones, are gradually transmitted to consumer. On the other hand, in spite of a better performance of exports, the trade balance deficit has enlarged. Under these conditions, making a preliminary movement to better orient in time the expectations for future inflationary developments, the Bank of Albania has raised the repurchase agreements/reverse repurchase agreements interest rate. The situation in the foreign exchange market is steady. The value of exchanging the national currency against the foreign ones has moved within the historic bands of the period, reflecting also the situation of the international financial markets.

The concern continues in the international financial markets, about the consequences deriving from the difficult situation in housing loans extended by banks and other specialized institutions to borrowers with doubtful re-payment abilities, mainly in the United States of America. So far, the market has well faced the bankruptcy of some financial institutions, mainly non-banking ones, which were active in this direction. However, to further prevent lack of security for the market liquidity position, the Federal Reserve of the United States of America has astounded market analysts with its fast movement for cutting interest rates on loans extended to commercial banks. The situation is being followed up attentively also in Europe, where the European Central Bank, the Bank of England and relevant market supervision authorities are analyzing exposures of certain financial institutions to these markets.

However, this situation is not expected to have further impact on American and european banks, which are well-capitalized due to high profits earned in the recent years. the American dollar has weakened in the foreign exchange markets, particularly against the common european currency, the euro and the British pound.

The financial system in Albania has continued its growth steadily during the first half of 2007. A very good financial result, particularly in the banking sector has derived from good use of financial resources and relatively from rapid expansion of high return activity from investments, such as lending and investment in securities. As expected, the high pace of activity extension has maintained the pressure for further reduction of its capitalization indicator.

However, the regulatory requirements for higher capital values for banks intending rapid expansion of their activity, the good financial performance of the whole banking system and the shareholders' willingness to inject necessary capital amounts are factors that will impact on maintaining the banking activity capitalization at adequate levels and on mitigating the growth rate of activity in the medium run. On the other hand, the variety of assets composition, good quality of return on investment offered by their portfolio, and the still considerable size of liquid assets of the financial system, particularly of the banking sector, offer a good hedging from the difficulties that may arise from the impact of the grave energy situation on the financial position of the system clients. the inclination for entrance into the market of well-known european financial institutions, particularly in the banking activity and in that of insurances, as well as the headway made towards further consolidation of activity, are important factors that will go on influencing positively on the financial system's ability to manage risks and operate steadily.

The financial indicators of the banking system continued to testify a relatively rapid expansion of activity and a good financial position in the first half of 2007. the active policies of banks in terms of expanding the network and investing in financial resources were associated with increased volume of profit earning assets and deposits. the growth paces of lending to the economy are relatively high, while the credit portfolio quality has remained at satisfactory levels.

At end of June 2007 the capital adequacy indicator for the whole banking system dropped to 16.4 percent, from 18.1 percent at end of 2006. Compared to the same period, the banking system shareholder's equity has increased by about ALL 5.3 billion, climbing in end of June 2007 to ALL 47.4 billion. However, the growth rate of the shareholder's equity and of the regulatory capital has been lower than the growth rate of the banking system assets included in the capital adequacy indicators account. the main impact on the growth of these assets has been given by the relatively rapid growth of lending activity. So, during the first half of the year the credit increased in annual terms by about 52 percent, a lower growth rate than but comparable to the 2006 annual growth. the loan portfolio quality represented by "gross non-performing loan to total loan" ratio has remained satisfactory, at 3.1 percent.

During the first half of 2007 the banking system recorded a positive financial result, at ALL 4.9 billion.
Likewise in the previous period, the commercial banks` inclination to maintain high paces of investment of financial resources that ensure a high return, has influenced the reduction of capital adequacy rate and has maintained unchanged the risk characteristics on the loan portfolio quality. Rapid credit growth impacts statistically in the short run and in an accelerated pace on the standard loan size and artificially creates wrong perceptions on the default risk magnitude. In the meantime, the banking system calculates incomes that are materialized only at the moment of payment effected by the borrower, when the credit quality would be recognized more accurately. Under these conditions, a mechanism is needed to put at a more correct level the risk/ profit indicator that the banking system undertakes during rapid growth of lending, i.e., to duly disseminate the default risk and to extend the necessary financial protection for the banking sector.

To this end, the Bank of Albania will soon establish some new requirements for the regulatory supervisory framework, which will fulfil the relevant regulatory measures adopted in December of the last year. Such measures are intended to directly mitigate risks posed by foreign currency lending, particularly when credit is extended to borrowers that do not generate foreign currency income. the implementation of these measures by banks and the establishment of special structures, as well as the adoption by them of various approaches that intend identification and management of risks posed by main operations of banks will continue to be on the focus of Bank of Albania's supervisory activity.

Alteration and amendment to the supervisory regulatory framework as a result of entry into force of the Law No. 9662, dated 18.12.2006 "On Banks in the Republic of Albania", includes greater requirements in terms of banks' transparency to clients, better regulatory stipulation for the process of banks' merging, more efficient modelling of foreign bank branch supervision, etc. this is a process that will be completed soon enough. On the other hand, the Bank of Albania is under the final stage of preparation for putting into operation the credit register, as an instrument that will significantly support banks' analysis for the borrowers' solvency. the register will be maintained by a specific office at the Bank of Albania, which will commence operation, as scheduled, on January 1, 2008. A broad consultation with commercial banks and other financial institutions has been carried out for this project.

The rest of the financial system, represented mainly by the insurance companies, pension funds and security trading institutions, is supervised by the Financial Supervision Authority. The efforts of this supervisory institution to fulfil and upgrade the legal and regulatory basis are impacting on the standardization of activity of institutions operating in this part of the financial market. Also, an increased interest of foreign non--bank financial institutions to enter and operate in this part of our financial system has been noticed.

The Bank of Albania deems that developments in the financial institutions performance have created, in their composition and in the drafting of the regulatory and supervisory framework, a sound basis for increasing the financial system depth and for making use of it. this process will be accompanied by increased efficiency of the financial institutions through their specialization and competition, increased ability of the financial system to face various risks and enlargement of public access to financial services. these issues related to the country's financial stability in general, require a more focused attendance in dealing with financial stability issues. In this framework, internal procedures foresee encouragement of creating work groups with other state authorities that regulate and supervise the financial activity, as well as close contacts with the financial industry, including banks and other institutions.

In conclusion, the Bank of Albania underlines that the development of the financial system and of the banking system in particular, along with increased possibilities for activity expansion, is objectively associated with the enlivening of various financial risks. the ability of the financial institutions to operate in a well-organized and balanced way and to be correctly oriented under the conditions of increased competition is of primary importance for good management of financial risks. therefore, the Bank of Albania is constantly requiring from commercial banks' management to prudentially follow the market development, strengthen the control system in their institutions, take measures to better diversify financial resources and manage their investments, to constantly develop a well-capitalized activity and monitor their risks. the Bank of Albania will go on treating these issues in the focus of its supervisory policy.

The Bank of Albania is confident that in 2007 it will continue to testify normality in the banking and financial system activity, in the constant development towards its stability and consolidation.