PRESS RELEASE
Interview with Gent Sejko, Governor of the Bank of Albania. Monitor magazine

The Bank of Albania decided to cut its key interest rate again. Specifically, what do you expect to achieve from this latest move, and how do you expect banks and other relevant stakeholders to respond to this move? Governor: The underlying reasons for the further easing of the monetary policy were made public in the latest press conference that followed the decision of the Supervisory Council. However, taking advantage of your question, and in the public interest, let me explain them briefly. The primary objective of the monetary policy of the Bank of Albania is achieving and maintaining price stability. To achieve this objective, we make decisions based on continuous analyses of the current situation and periodic updates of the outlook. The aim of the analyses and projections is to answer three questions: (i) what are the current trends in the economy and financial markets, (ii) what is the outlook for the performance of prices and economic activity and do projections diverge from our targeted objectives; and (iii) against the backdrop of the possible divergence, are the monetary conditions adequate and do we need to change the monetary policy stance. We eased the monetary policy in the form of two key rate cuts in April and May with a cumulative effect of 0.5 percentage point, in response to the conclusions of the analysis and the quarterly monetary policy report. In concrete terms:

- First, the Bank of Albania concluded that the drop in prices in international markets was reflected in a sharp fall of inflation by 1.7 percentage points, during the first quarter of 2016. Moreover, available information suggests that foreign inflationary pressures, over the medium term, will be lower than our previous assessments. The fall in inflation was not an isolated phenomenon in Albania. On the contrary, inflation rates declined similarly in all our trading partners during the first quarter of 2016. For instance, inflation fell by -1 percentage point across the region, and by -0.5 and -1.3 percentage points, in Italy and Greece, respectively. Currently, inflation in the euro area, Italy and Greece and other regional countries stands in negative territory. Disinflation pressures have affected the entire region including Albania, since it has an open economy and is an economically integrated country.

- Second, the Bank of Albania concluded that the economic activity continues to pick up, although it is still characterized by uncertainty and risks. The performance of our trading partner economies remains weak. The prices of some of our main export items in global markets - such as oil and minerals - are low, whilst the hesitation of customers, investors, and financial system remains present. The combination of these factors tends to decelerate the recovery of economic activity in Albania.

- Third, the logical conclusion of the above analyses is that the factors that determine the medium-term inflation performance appear weaker compared to our previous analyses and the uncertainty surrounding them has increased.

Along these lines, the Supervisory Council deemed that the monetary conditions should be further eased. Thus, we have lowered the key interest rate from 1.75% to 1.25%. In terms of the regional context, other central banks in the region have also taken similar steps during this period. The Bank of Hungary and the Bank of Serbia reduced the interest rate by 0.25 and 0.30 percentage point, respectively, whilst the Bank of Croatia and the Bank of Romania have employed other instruments to increase the monetary stimulus.

Let me now explain what we expect from this accommodative monetary policy.

- First, the key rate cut is expected to be followed by the lowering of interest rates across the entire spectrum of the financial system. The cost of funding - firms, consumers and financial system - are expected to be further reduced. This is the first segment of the monetary policy transmission mechanism, which has been effective in the past and will continue to be so in the future.

- Second, the reduction of the cost of funding - both for new loans and servicing existing loans - incentivises consumption and private investments, which together are key components of what is known as the domestic demand. Consumption and private investments were the main contributors to economic growth in the second half of 2015, and are expected to maintain this contribution in 2016 as well. The increase of the monetary stimulus provides the right conditions for the further strengthening of these drivers, while foreign demand remains weak, and the public sector's demand appears limited as a result of the fiscal consolidation strategy.

- Third, and equally important, the monetary policy reaction aims to convey once again the message that the Bank of Albania has always been committed to maintain its price stability objective. Moreover, the Bank of Albania has a complete set of instruments it will not hesitate to use. This is a crucial moment, which I would like to emphasize once again, because the long-term success of the monetary policy depends on its ability to control inflation expectations. In Albania, like in many regional countries, these expectations tend to reflect, to a large extent, the past developments. The decline of inflation due to supply-side shocks may cause a fall in inflation expectations. This implies directly a tightening of monetary conditions, as what matter most are the real interest rates rather than the nominal interest rates. This phenomenon amplifies in time and size the effect of supply-side shocks, which we are facing at the moment. Our quick action and the aggressive forward guidance on the monetary policy stance should be considered in this context as well. Its objective is to convey a strong and clear message regarding the Albanian economy and financial market. The Bank of Albania will take all the necessary measures to comply with its legal objective of price stability, in other words for the return of inflation to 3%.

Thus, this monetary stimulus will give a new incentive to the domestic demand through further easing of financial conditions. Hence, it will help boost economic growth, increase employment and wages, and enable the return of inflation to target by 2018, despite the weakening of inflationary pressures in international markets.

During the last two years, the Bank of Albania has been very aggressive in terms of continuously lowering the key interest rate, but apparently the effect has not been so tangible in the economy, especially in terms of credit growth. What is your explanation on this?

Governor: I would not agree with the implication that the monetary policy has not provided tangible effects in the economy, not because I am the Governor of the Bank of Albania, but because facts and figures prove the opposite of this implication.

Since September 2011, when the Bank of Albania started the accommodative monetary policy cycle, the key interest rate has fallen by 4 percentage points, from 5.25% to 1.25%. This reduction is fully transmitted in the financial market. Thus, for the same time horizon, interest rates of lek loans, reduced by 3.8 percentage points, the yield on the 12-month T-bills reduced by 6.3 percentage points, whilst interest rates of lek deposits reduced by 4.1 percentage points. This implies a complete pass-through of the monetary policy. This also means that the cost of funding for the three main economic agents - private sector, public sector and financial sector - is reduced. Certainly, this reduction has not been always consistent - at times, the speed of its transmission has been uneven - but, overall, we have managed to administer the interest rates in the financial system, and this is what we expect to achieve even after the recent monetary policy easing.

Thanks to the reduction of funding costs lek loans grew. During the cycle of this monetary policy easing, the lek loan portfolio increased on average by 8% a year - with a cumulative growth of 41% - while the foreign currency loan portfolio saw 7% cumulative reduction. The ratio of lek loans to foreign currency loans increased from 33% to 44%. This positive performance would not be possible without the easing monetary policy stance we have adopted.

Related to the credit, let me draw your attention to another argument, which we have emphasised earlier. The majority of loans in Albania are indexed and the accommodative monetary policy helps reducing the servicing costs for existing loans. In a rough estimate, the Albanian enterprises and households in a year benefited around ALL 8 billion because of the reduction of funding costs. This is a considerable support given to them and a figure that is translated in additional annual consumption and investments in the economy.

Beyond the effect in interest rates and credit, I must highlight two other aspects of the monetary policy action.

- First, the accommodative monetary policy is associated with the increased amount of liquidity injected in the banking system. Thus, for 2011- 2015, these injections averaged ALL 24 billion, compared to ALL 18 billion average in the five previous years. The increased injection of liquidity not only enables the banking system to function better, but also contributes to the increase in credit and investments in the economy.

- Second, our accommodative monetary policy creates opportunities for a more convenient exchange rate in the Albanian economy. In its absence, lek exchange rate would be higher and inconvenient for the Albanian economy. It would be a disadvantage for our exporting firms, it would not stimulate the activity of firms that compete with imports and it undoubtedly would result in financial difficulties for a category of firms, and a slower economy growth.

To summarize what I already said and to answer to your question of whether our monetary policy has or has not been effective: It has clearly been effective in all the above introduced channels and dimensions. To reinforce my argument, let me ask you a question: Were it not for this policy stance we have adopted, what would the Albanian economy and financial system be like? Undoubtedly, the answer would be: apparently worse. Both firms and consumers would suffer from high funding costs, trade balance would worsen, and the financial condition of the private and public sectors would be exacerbated. Also, indicators of consumption, investment, economic growth, employment and wages would be certainly lower than what we have today.

To conclude the discussion on monetary policy, I would like to share with you another issue: Is the monetary policy transmission at its optimal levels? The answer to this question is " not completely". There are several reasons for this:

- The high level of uncertainty and perceived risk dictates the demand for consumption, investments and credit, despite the funding cost of these activities. In other words, the reaction the real sector to better funding conditions is somewhat lower than the historical levels.

- The situation in our trading partners' economies and the international financial markets appears problematic and discourages investments and lending in Albania.

- The Albanian economy has to face not only cyclical weaknesses but also structural problems in the form of over-investment in certain sectors or low competitiveness of Albanian products in foreign markets. Restructuring and economic growth are two processes happening at the same time, although the first process does not favour the second.

In the major part, all these obstacles fall outside the ambit of the monetary policy or the central bank mandate. However, the above problems of the transmission mechanism do not render the pursuit of a stimulating monetary policy as undesirable. Instead, they illustrate the need for maintaining or strengthening the monetary stimulus, highlighting the necessity for structural reforms in the economy.

Inflation resulted low for the third consecutive month, according to data published by INSTAT. How would you explain this trend which is becoming more persisting and how is it related to the slowdown of consumption? Does the Bank of Albania consider this low-inflation period as a risk?

Governor: Contrary to the significant and rapid decline of inflation in February, the inflation rate standing at 0.3% in April was not a surprise to the Bank of Albania. Somehow, it reaffirmed our opinion that: the decline of inflation came as a result of external factors; this fall is expected to be temporary; and, the deflationary situation does not threaten Albania.

Since you asked, I would like to clarify that the available information and our analyses suggest that low inflation rates are not related to the decline of consumption. According to INSTAT, consumption grew during the second half of 2015, and we deem this trend will continue in 2016. On the other hand, I think we have strong arguments when we deem that the inflation decline is a result of supply-side shocks, given the performance of this indicator in the region, and disinflationary pressures in two specific categories: food and fuel - whose prices dropped significantly in international markets.

The deceleration of inflation decline may be considered as the first step toward the normalization of the situation. Of course, it is still too early to be certain whether inflation will continue its uptrend from now on. Our projections suggest this trend will crystallise only in the third quarter. However, the stabilization of inflation decline and rise in core inflation confirmed the conclusions of our analysis.

In your last statement you said that this policy stance should be associated with the intensification of the pace of structural reforms in the economy, and constant efforts for improving the business climate and reducing - actual or perceived - risk premiums in the economy. Can you explain what do you mean by it and what specifically do you recommend in terms of structural reforms and improvement of the business climate?

Governor: Thank you for the pertinent question. Opinions on the problems and prospects of the country's development often converge on the need for structural reforms. The Bank of Albania has adopted the call for structural reform as an integral part of its press releases. It aims to draw attention on the fact that these reforms are necessary to increase the potential development of Albania. This potential cannot be expanded through monetary and fiscal policies but it is absolutely necessary in order to accelerate the pace of convergence in the European Union. From the position of the central bank, this appeal aims to point out that certain elements of the structural reform are necessary to improve the monetary policy transmission mechanism.

Considered as a philosophy of action, the structural reform should aim at adopting the best standards from the global experiences. This applies to infrastructure, education, healthcare, legal system, and other fields. If we want to succeed, the final product should be a productive and competitive economy in the global markets, as well as a flexible economy to weather challenges and withstand various shocks.

In practice, three structural reforms are identified, those that: improve the efficiency of the institutions; liberalize and make the real economy more flexible; and, develop the financial sector. In this context, I would like to emphasize that the synthetic indicators of the Doing Business Report and Global Competitiveness Report provide a good guideline, which helps in creating an overview of the needed reforms in Albania in order to unleash the economic potential and accelerate the growth pace.

I would rather not repeat the conclusions of these reports, but I find it necessary to emphasize that Albania still has much to do in terms of: (i) completing the development of infrastructure, which means a modern and efficient network of transport, water, electricity and other basic services supply, as well as a modern information technology infrastructure; (ii) enforcement of contracts and protection of property rights, and this is related directly to the legal framework and the way the law is implemented; (iii) education, especially for a better alignment of our labour force qualification with labour market requirements; (iv) fight against corruption and conflict of interest, in both public and private sectors, in view of fair competition and its promotion; (v) improvement in governance and adoption of modern management methods, in both public and private sectors; and (vi) further expansion of financial system, especially in the capital market segment.

The list I just mentioned is not exhaustive. Many of the mentioned issues are addressed by either partial or complete structural reforms; others require greater commitment of financial resources and cannot be concluded in the short run. However, the need for a coherent reform and development strategy and the good will to boost them is what I want to emphasise.

Bankers have claimed that one of the main reasons for credit slowdown is the lack of demand from large enterprises. According to you, what are the main reasons for the sluggish lending in the economy for 2015, despite the continued easing of the monetary policy stance by the Bank of Albania, and the reduction of interest rates at a record level?

Governor: The Bank of Albania has continuously written and discussed and communicated the reasons of the sluggish growth of the loan portfolio. Let me first make a clarification before I comment on this subject once again: it does not mean that the banking sector does not lend despite the lending portfolio's slow growth. The new loan granted only for investment and house purchase purposes, in 2015, amounts to around EUR 550 billion, or around 6% of the GDP. However, the loan portfolio growth is quite lower, since this portfolio has a relatively short-term maturity.

When I say that the banking system remains active in lending, I do not mean to object to the fact that credit growth is low and far from what we would like it to be.

Regarding the reasons, this performance seems to reflect a low credit demand by the real sector of the economy, as well as a tight credit supply by the banking sector.

The low demand is of course the first main factor, which explains the slow growth of the credit portfolio. This demand has a rational component that relates to the cyclical position of the Albanian economy and the presence of unutilised production capacities that reduce the need for investments to expand the activity. It also has an emotional component related to expected growth and risk perception for the future. I must say that during the past two years demand has naturally tended to be somewhat lower, due to the payment of arrears by the public sector amounting to ALL 54 billion, improving thus the liquidity position of Albanian firms, and reducing their need for bank credit.

Bank credit supply appears somehow subdued and bank's lending policies are conservative. On the one hand, this reflects the high level of non-performing loans and bank's concerns for the enforcement of collateral. We have, therefore, emphasised the major role of the implementation of the action plan to address the non-performing loans, a key instrument for improving the bank credit supply. On the other hand, the subdued credit supply reflects new supervisory and regulatory policies in the European Union, whose effect extends to Albania through the activity of EU-based banking groups that operate in Albania.

Investment opportunities in bank deposits are shrinking (BoA applied negative interest rates on euro deposits, ECB's rates are negative as well, government requirement for treasury bills fell after the issuance of the Euro-bond, credit demand is weak), while the banking system earnings fell significantly in the first quarter. What do you expect the banks reaction to be to this situation? (Some bankers have claimed that they could discourage new deposits and increase loan rates).

Governor: The answer to this question is simple: we expect banks to become more interested and more active in lending. We expect the bank credit supply to improve and better respond to credit demand, which is expected to increase.

Meanwhile, in terms of financial results for the first quarter, the main reasons for the fluctuations in banks profit are associated with the fluctuations in provisioning expenses. The financial performance of the banking sector and the economic situation affect each other mutually. Therefore, I would like to highlight once again the message of the Bank of Albania: the banking sector should be more committed to lending since it benefits both the economy and the sector itself.

Is there a risk for the environment with low interest rates to turn into a boomerang for the banking system and the whole economy?

Governor: The experience in other countries and the theoretical analyses show that low interest rates place banks in front of several alternatives: They can try to anticipate or offset this decline in several ways (often combined), such as: a) expand their investments in longer-terms instruments, with higher yields; b) increase lending; c) increase the income share provided by alternative sources, such as fees or different commissions for operations offered to clients; d) reduce the overall operational costs, such as the case of spending cuts for maintenance of the branches' network, as well as automation of various processes or transactions, or outsourcing a part of them; e) reducing the commitment for the collection of the financial resources that are not justified by the income from their investment through quantitative restrictions or applying different commissions on them.

The Bank of Albania is monitoring the developments to assess the way banks are operating amid low interest rates. It must be noted that the decline of interest rates, which was stronger in the past two years, contributed positively to the profitability of banks, as they were able to preserve the net interest margin so far, and benefited from the revaluation of investments sensitive to interest rate (e.g. long-term securities). As a matter of fact, according to our accounting standards, the banking sector profit was significant in 2015. But, as we point out in our last Financial Stability Report, banks have significantly lowered the expenses for interests on the liabilities side, thus limiting the opportunity for further accommodation, in case of further decline of return rates on investments. Consequently, the pressure on the value of financial performance has increased.

In these terms, we have highlighted that it is necessary that banks use their profit in a better way, aiming to strengthen their capital position. On the other hand, our attention remains focused on the performance of credit portfolio. Our regular on site bank examinations have aimed at the timely identification of non-performing loans, and the strict implementation of the regulatory requirement to write off the loss loans from the balance sheet. For the customers to be well informed, we are also monitoring the implementation of regulatory requirements by the banking sector with regard to the transparency of prices for banking product and services. Within the potential impacts that the environment with low interest rate has on the economy overheating or on certain segments of the market (e.g. real estate market), we assess that the risk we are dealing with is low, as long as credit growth remains low. Regarding the performance of the banking sector deposits', the latest data show that deposits in banks continue to increase, albeit at a moderate pace. There have been cases of savings shifting toward extreme maturities, thus pointing out the need of risk monitoring by the banking sector.

In conclusion, I think that the environment with low interest rates has had an impact on the banking sector activity. So far, in terms of the net financial result of the sector, overall, this impact has been positive. But this environment poses challenges to both the banking sector and the Bank of Albania, in terms of maintaining the sector's financial performance and the management of processes associated with the banking activity and the control of various risks. The Bank of Albania is aware of these challenges and our duty, as the supervisory authority, is to ensure that the banking sector is financially sound and active in supporting the economy with credit.

How is Bank of Albania's plan on lowering non-performing loans progressing? To what extent, has the non-performing loans indicator improved owing to the write offs, restructuring, or repayment of non-performing loans?

Governor: The action plan for reducing non-performing loans is drafted in cooperation with the Albanian government. It is a result of long-standing efforts by the Bank of Albania to raise the stakeholders' awareness on non-performing loans issues, whose treatment requires a coordinated reaction not by the banking system alone, but by all the relevant institutions acting together. We have assessed the right understanding of this phenomenon by the Albanian government and its commitment to addressing several issues in the right direction.

By the end of March, the Bank of Albania fulfilled all its institutional commitments in the framework of this plan, mainly related to the regulatory amendments. In concrete terms:

• Effect of countercyclical measures taken by the Bank of Albania is extended until December 2016.
• Terminology related to loans write off from the balance sheets was changed.
• Several regulatory acts regarding collaterals owned by banks were amended. Their retention period was extended up to seven years, while banks will have to create a provisioning fund for them; on the other hand, the risk level when calculating the capital adequacy will rise to 150%.
• Requirements for licensing companies interested in buying bad debt are eased.
• Credit Registry improved, including the start of the legal process as well as restructured loans.
• Coordinated efforts for the treatment of large exposures in more than one bank, during 2015, contributed to the decrease of non-performing loans.

The projected legal amendments in the action plan for reducing non-performing loans continue. As far as we know, the draft law on bankruptcy is still being discussed by the government, while the rest of legal amendments will be implemented soon. In spite of this, as the majority of tasks in this action plan are of legal nature, their effects are expected to be materialized in the short and medium term.

The ratio of non-performing loans fell to 18.2% at the end of 2015, mainly due to the write off from the balance sheet of loans categorised as loss loans for more than three years, in accordance with the regulatory measures taken by the Bank of Albania. However, the obligation for the repayment of these loans remains and banks continue to pursue legal procedures for recovering them.

The restructuring and the repayment of non-performing loans are dynamic processes with continuous ups and downs, and, have a later effect on the non-performing loans indicator. The restructured loan needs a minimum of six month to be paid regularly and only then it can be reclassified in only one higher category. So these effects will be evident later in time. We had a slight increase of this indicator during the first quarter of 2016, due to the implementation by the banking system of the Bank of Albania's regulations regarding large exposures in the brink of bankruptcy. Although this indicator rose by 1% during the first quarter (predicted by us), we believe that we will achieve the target of reducing this indicator to 15% by mid-next year.

You have stated that the Bank of Albania has a plan for quantitative easing and directly funding private banks. To what extent has this plan developed, what is the plan for its realization in concrete terms and what are the expected results?

Governor: We have stated that in the framework of contingency plans - Bank of Albania is exploring the cost-benefit ratio that alternative instruments of monetary policy present. This does not mean we are preparing to use the quantitative easing instruments. This is only one of the alternative instruments of the monetary policy, and it seems the least useful for the Albanian reality.

Before I further discuss on the above issue, allow me a brief parenthesis.

The Bank of Albania is committed to a long accommodative cycle of the monetary policy. This cycle drove to the reduction of the key interest rates at very low levels.
Our interest rate at the moment seems adequate to meet our inflation target and stimulate economic growth. However, the risks' balance is shifted downward. If these risks materialised, then the Bank of Albania would consider further easing of the monetary policy, hypothetically speaking, if necessary, through other reductions of the key rate.

The Bank of Albania deems that: (i) there is still room for further reduction; and (ii) this instrument remains effective for the monetary stimulus pass-through in the economy.

However, always hypothetically, the use of traditional instruments of monetary policy has a limit. This limit is related to a natural lower bound of the key rate - close but above zero - or to the total lack of effectiveness of this instrument.

Being a forward looking institution, the Bank of Albania has analysed the possible options that can be used if the two following conditions are fulfilled simultaneously:

(i) The space or the effectiveness of conventional monetary policy instruments has been totally exhausted; and

(ii) Monetary stimulus must be further increased.

This is exactly what we mean when we refer to them as contingency plans. These plans are not the Bank of Albania's commitment to take a certain action, but are reaction options conditioned by certain circumstances.

Speaking of alternative instruments, I would like to highlight that our analysis are based on theoretical literature and on the experience of other central banks.

These instruments suggest that the most used non-conventional instruments can be categorised in one of the following categories: (i) quantitative easing; (ii) credit easing; (iii) long-term liquidity injections; and (iv) unconditional commitment of the monetary policy to pursue a certain course.

Quantitative easing implies increased liquidity in the economy through the purchase of securities and debt securities of the government which, have historically been a typical instrument used by central banks to manage liquidity. Central banks of USA, euro area, UK and Japan have undertaken similar operations, when the key interest rate fell close to zero, and the liquidity requirement for financial markets was extremely high. Credit easing once again implies liquidity increase in the economy, but this time changing the structure of the central bank's balance sheet. This means that the central bank buys other instruments of the financial market, thus ensuring liquidity increase in certain segments of the market. This instrument is used by the ECB and the Federal Reserve under the same conditions as before or in addition to quantitative easing, but it is not used as much by other banks. Long-term liquidity injections, as its name indicates, are temporary long-term operations of liquidity increase in the economy. Some operations do not have a particular destination - the case of LTRO operation (Long Term Refinancing Operations used by the ECB) - some others do have a particular destination - the case of TLTRO operation ( Targeted Long Term Refinancing Operations) used by the ECB, and Funding for Lending operation used by the Bank of England and the Bank of Hungary. Unconditional commitment of monetary policy is not a frequently used instrument, mainly used by the Bank of England in the form of strict time limits.

For Albania, I would emphasize that the potential adoption of these instruments should be done in accordance with the Albanian financial market specifications, which is characterized by high short-term liquidity. Because of this, quantitative easing does not seem to be significantly beneficial. Likewise, the lack of alternative financial instruments impedes the use of credit; in addition, the presence of liquidity pressures or problems in certain segments of the market is a prerequisite for the success of this instrument. The unconditional commitment of the monetary policy seems undesirable in Albania's case, as a result of a relatively high volatility of macroeconomic indicators. Thus, the option of long-term liquidity injection- contingent on meeting certain quantitative objectives for the credit portfolio and price growth of this credit-seems the most interesting.

All I can say at the moment is that we are carefully evaluating all the alternatives, and whether their usage will be necessary, and everything will be transparent in due time.

During a special interview for Monitor, some bankers were concerned on whether the intention of quantitative easing was the cancellation and/or the undertaking by the Bank of Albania of debts of big bad borrowers.
What is your opinion on this?

Governor: I'd like to clarify that this option is neither taken nor being taken into consideration by the Bank of Albania. Moreover, this is something we consider to be unnecessary and, why not, even wrong.

It has not happened in any of the world's central banking experiences for the simple reason that this would be a fiscal rather than a monetary operation. Even when central banks have accepted commercial credit as collateral for liquidity injections, these have been performing credits; moreover they have had a market price transparency. Albania's banking system does not suffer from lack of collateral. Albania lacks derivative instruments and a transparent and reliable market price for them. The write-off would be a positive development, but this operation should start as a result of financial market incentives and - in the absence of strategic considerations - there is no need to add burden to the Albanian taxpayers.

The interview