PRESS RELEASE
Governor’s Presentation of the 2010 Annual Report to the Parliamentary Committee on Economy and Finance

Dear Chair,
Dear Committee Members,

It is a pleasure and privilege for me to present to you today the Bank of Albania's Annual Report 2010 key conclusions.

Pursuant to our legal requirements and institutional commitments for enhanced central bank's transparency and responsibility, this year's Annual Report contains a comprehensive analysis of economic and financial developments and reflects faithfully the activity of the Bank of Albania during 2010. This activity, in its entire spectrum, aimed to fulfil our mission and legal obligations, and reflect the Assembly's recommendations for 2010.

Let me begin my presentation with a brief outline of key issues addressed in this Report.

The Albanian economy experienced an overall positive performance during 2010. On the other hand, this year's economic developments underlined the need to continue and intensify structural reforms, which are pre-requisites for stable and long-term economic growth.

Last year, the economy grew reflecting sound foundations of the Albanian economy, dynamism of the private sector, and maintaining and consolidation of macroeconomic stability. Owing to developments in the financial and real sectors of the economy as well as the Bank of Albania's monetary policy, consumer price inflation remained in line with our 2010 target. In this year:

• Inflation was within the target band of the Bank of Albania;
• Budget deficit and public debt dropped in relative terms;
• Financial stability consolidated;
• Financial intermediation expanded further.

In addition, the economy's external position improved, and interest rates and risk premiums in financial markets dropped.

According to INSTAT data, the Albanian economy is estimated to have grown by 3.9 % this year. Compared to 2009, economic growth is more balanced in terms of secotrial distribution and demand components.

During 2010, economic growth relied mostly on foreign demand, as reflected in the rapid growth of Albanian exports and reduction of trade deficit. It has also relied on the increased domestic demand. Significant reduction of the fiscal stimuli, especially in H2, was compensated by positive tendencies in private consumption and investments over this period.

Albeit growing, the Albanian economy was characterised clearly by the existence of free capacities in both the labour and capital market.

Free capacities in the economy, anchored inflationary expectations of economic agents, as well as controlled monetary expansion in response to a prudent policy of the Bank of Albania had a downward impact on inflation.

These factors compensated inflationary effects from increased administered prices, depreciated exchange rate, and global markets prices. Consequently, consumer price inflation recorded an average value of 3.6% during 2010, fully compliant with the Bank of Albania's the policy on price stability.

The above-mentioned developments were supported by a purposeful combination of monetary, macroprudential and fiscal policies. In the presence of controlled actual and expected inflationary pressures, negative output gap, and reestablishment of the public's trust in the financial system, during 2010, macro-economic policies maintained their stimulating trend. The welcomed shift of attention of the fiscal policy towards retaining debt indicators long-term stability was accompanied by the reduction of budget deficit and fiscal stimulus.

This development led to the pursue of a more stimulating monetary policy by the Bank of Albania and paved the way for it to reduce the key interest rate by 0.25 percentage points in July 2010.

In response to continuous liquidity injections by the monetary authority, the easing side of monetary policy was reflected in reduced interest rates for deposits in lek, government bond yields, and, to a lesser extent, lending in lek. Financial markets experienced a quieter year with growing liquidity and downward interest rates. In addition, banking system liquidity and capitalisation indicators improved.

Lending terms applied during 2010by the banking system eased gradually. It was a reflection of not only the Bank of Albania's monetary policy, but also of liquidity indicators improvement, premium risk decline, and public borrowing reduction in the domestic market. Easing of lending terms and increase of credit demand was followed by a rapid surge of crediting in 2010.

In the regional context, financial intermediation expansion during the past year constitutes a prominent development, in contrast to the experience of many other countries witnessing a decline of this indicator. Crediting supported primarily additional investments in services and industry sectors, while consumer credit was subject to moderate growth rates.

At the conclusion of this brief summary outline, I would like to draw your attention to key topics presented in this Report. Economic developments in 2010 are an illustration of economic challenges faced by the Albanian economy.

First, the economic development model pursued until now has room for further improvement. The new agenda of structural reforms should aim to establish the requisites for more balanced and stable growth in the long run.

Greater orientation of Albania's economy on exporting and overall higher competitiveness of our products in international and domestic markets dictate the need for continued structural reforms at macro- and microeconomic levels.

Second, macroeconomic stability consolidation requires more efforts and work in the future.

Maintaining the country's internal and external balances requires decision-making architecture development and macroeconomic coordination, as well as economy and market supervisory and regulatory mechanism. Analytical forecasting and decision-making skills of public and private economic agents need to be improved further. Lessons drawn from the last global crisis should be analysed and implemented with determination by all of us.

Third, ensuring the country's financial stability requires coordinated action by all supervisory and regulatory institutions, and market's private agents. Financial stability serves to channel savings into the most competitive sectors of the economy in the long-term horizon.

***

Following, I would like to address the above-listed topics in more details, focusing on key points of the Bank of Albania's work.

1. Economic and financial developments during 2010

During 2010, the Albanian economy was characterised by gradual improvement of the aggregate demand and further consolidation of the macroeconomic stability. Economic development was followed by price stability, while the public debt and current account deficit narrowed.

Economic growth relied mainly on foreign demand and increased exports, while domestic demand was sluggish. It was decelerated by public finances consolidation and state deficit reduction in 2010, while consumer spending and private investment were affected by insecurity for the future and unutilised capacities.

Private consumption was slow during 2010, as a consequence of the overall economic and financial situation insecurity and future employment expectations. This was reflected in consumers' increased preference for saving, while aggregate data suggest increased available income.
Likewise many other economies, private consumption promotion will be one of the main economic growth determinants and one of the future challenges we may face over the course of the current year.

Private investments provided a low contribution to the 2010 economic growth. Albanian businesses hesitated to make new investments under the impact of low production capacity utilisation and more prudent crediting attitude by banks.

Fiscal policy focused on fiscal consolidation in 2010, subsequent to a countercyclical nature in 2009. Fiscal consolidation accelerated especially during 2010 H2, following the approval of the revised budget. This consolidation was present both on the side of income and on the side of expenditures. Budget income increased by 8.4% y-o-y due to economic growth, expansion of taxpayers' base, and income from privatisations. On the other hand, budgetary expenditures reduced by 4.5%, attributable to reduction of government capital expenditures.

Budget deficit for 2010 settled to around 3.0% of the GDP, reduced by 52% compared to a year earlier. This deficit was funded mainly through the issue of domestic debt ordinary instruments. However, deficit financing was a novelty in 2010 with the issue of the first Albanian Eurobond. Its issue, at EUR 300 million, met a part of the public sector need for foreign currency and was accompanied by the reduction of domestic borrowing. It eased pressures on the national currency, increased the space for private sector borrowing and led to its financing terms improvement.

Current account deficit narrowed by 21.5% in 2010, settling at 11.9% of the GDP. This was reflected in augmented private and public sectors savings. Increased exports as a result of invigorated foreign demand, depreciated exchange rate and improvement of trade terms at this period also contributed to it. Notwithstanding the improvement recorded in 2010, current account deficit remains high. As we have continuously stated, the Bank of Albania deems that formulation of structural policies to dampen the external economy misbalance should be a priority.

Significant narrowing of the goods and services trade deficit came as a result of accelerated goods and services exports increase by about 16.4%, annually. On the other hand, goods and services imports reflected a moderate growth rate by 2.6% on average, with an upward trend in the last months. The difficult economic situation in neighbouring countries is reflected in the annual drop of net remittances by 11.7%, while their share to the GDP was estimated at 7.8%.

Net flows in the capital and financial account recorded a decline by 11.2% in 2010, leading to the financing of the current account deficit to 87.5%. Excluding privatisations, foreign direct investments were estimated to be at 9.3% of the GDP and constituted main foreign financing of the Albanian economy. Foreign reserve increased by about EUR 178.8 million and its stock of EUR 1.9 billion may cover 4.8 months of goods and services import.

Positive developments in the external sector of the economy, primarily owing to the expansion of exports and foreign currency income from the Eurobond, contributed to the generation of contained pressures in the foreign exchange market this year. In  macroeconomic perspective, relative stability of the exchange rate during the year reflected a new equilibrium in foreign currency demand and supply.

In sectorial terms, the Albanian economy development relied chiefly on the industry and services sectors growth, which benefited, largely, by the foreign demand and the structural shift of domestic demand to short-term consumption goods.

In the short- and mid-term horizon, the industry and service sectors are expected to remain the main supporting pillars of the Albanian economy. The construction sector continued to shrink during 2010, reflecting a contraction of public investments, more tightened lending terms, more cautious consumer behaviour vis-à-vis immovable properties, and problems by the relatively high stock of inherited inventory.

Overcoming these problems and correction of price tendencies in some segments of residential markets, will open the way for a more stable development of this sector.
The agricultural sector is deemed to have grown as a consequence of better climacteric conditions and favourable price conjunctures that characterises and will characterise this sector.

Money and financial markets

Broad money was on average up by 10.6% in 2010. This reflects the economic activity and restoration of economic agents trust in the banking system. Expansion of monetary stock complied with the economy's demand for money and did not trigger inflationist tendencies in the economy. Deposit to GDP ratio was 64.2% at end-year, higher than its level prior to deposits withdrawal. In addition, the profile of deposits time structure reflected a higher preference for saving, characterised by a shift to longer maturity-term deposits.

Eased lending terms during 2010 H2, stimulating measures by the Bank of Albania, higher interest of the banking system to support domestic consumption and investment as well as reduced insecurity and risk premiums were followed by a gradual crediting growth during the year. Credit portfolio for the private sector expanded by 10% in 2010, principally due to foreign currency crediting. Nevertheless, crediting continues to suffer from lack of demand and realistic, qualitative and worth crediting business plans.

Restoration of trust in the financial system, stabilised macroeconomic situation, and regulatory and supervisory measures taken by the Bank of Albania led to stabilisation and improvement of banking system capitalisation, liquidity and profitability indicators.

2. Inflation and monetary policy

Annual consumer price inflation was on average 3.6% in 2010, remaining within the target band of the Bank of Albania. Inflationary pressures were more concentrated during 2010 H1, mostly because of a rise in some of the administered prices. Average annual inflation in 2010 H1 was 3.9%. In the following two quarters, relative stabilisation of the exchange rate and low inflationary pressures from the domestic demand side contributed to the average inflation rate convergence around the Bank of Albania target. The generated negative output gap contained inflationary pressures over the entire 2010, thus balancing the depreciation effect of the national currency and international markets price increase.

During 2010, the Bank of Albania's monetary policy was implemented in a macroeconomic environment with positive growth rates, anchored inflationary expectations and contained inflationary pressures. As I highlighted earlier, this environment led to retaining the expansionist monetary policy that had emerged since 2009.

This policy triggered downward interest rates and completed even further stimulating effects from the exchange rate depreciation. Low interest rates favoured domestic consumption and investment increase, while the depreciated exchange rate supported the Albanian exports increase during 2010.

Reduction of the fiscal stimulus expanded even further the space for a stimulating monetary policy. In July 2010, the Bank of Albania reduced the key interest rate by 0.25 percentage points, to its all-time low of 5.0%. Banking system liquidity improvement and public sector's weak demand for monetary assets supported the transmission of a facilitating policy to all financial markets segments during the last months of 2010.

In parallel, the Bank of Albania supplied the financial market with the required liquidity to support financial intermediation. With a view to adopt the most advanced models of central banking, particularly, convergence with Euro-system practices, the Bank of Albania changed the form of its operations objective.

Since June 2010, our liquidity administration operations are oriented on targeting short-term interest rates in the inter-bank market and minimisation of their volatility. This remodelling of our money market interventions boosts the monetary policy effectiveness and triggers the inter-bank market development. Similarly, it marks another step towards the completion of our technical preparations to adopt a targeted inflation regime.

***

Another important aspect of the central bank duties is the banking system supervision.

3. Banking supervision and financial stability

Improvement of Albania's economic activity is reflected also in the performance of the banking activity. Year 2010 was characterised by larger banks assets, improved banking soundness and profitability indicators, as well as system's well capitalisation. On the other hand, the banking system was characterised by a larger non-performing loans portfolio, reflecting also the active policy of the Bank of Albania on banks balances enhanced transparency. The organisational change of banking supervision, in conformity with the challenges of the time, contributed to the further improvement of the regulatory framework and, consequently, strengthening of the financial stability in the country.

Banking system

The banking system continues to remain the main actor of financial intermediation in Albania. At present, this sector consists of 16 banks, two of which are branches of foreign banks. At the end of 2010, banking system assets doubled compared to a year earlier, accounting for about 81% of the GDP. Overall, this ratio expanded by 3.5 percentage points, year-on-year.
The structure of the banking system assets continued to be financed primarily by the public deposits and focused on lending, mainly to the private sector. Banking system investment, in lending, increased in 2010, but its growth rates continued to be moderate. This performance reflects banks prudent policies on their loan portfolio quality and moderate demand for loans by economic agents. The sluggish lending growth and below-potential performance of the economy led to increased non-performing loans indicator to 14%. However, this indicator's growth rate decelerated in 2010.

Capital adequacy ratio remains at satisfactory levels. The system's owners equity increased by 10% in 2010. Albanian banking system is considered as well capitalised, which is also confirmed by the high capital adequacy at 15.4%, clearly higher than the 12% established in the regulatory framework.

Financial leverage ratio settled at 10.6%, almost unchanged compared to 2009. This performance demonstrates a stable support to the banking system intermediation, at same debt levels during the above-mentioned years. Credit risk remains the banking sector's main risk. In response to it, the banking sector has created its own reserve funds to tackle potential losses. At end-2010, credit risk reserve funds (provisions) for lending to residents, were about 33% higher than at end-2009.

Our stress test analysis confirm that, in our banking system, capital is adequate to absorb large shocks, which may lead to reduced borrowers payment capacity or market misbalancing. The Bank of Albania has clearly improved its stress test analysis supported by ever-growing cooperation with the IMF, World Bank, European Central Bank and other central banks. Concerning bank supervision, the Bank of Albania has concluded a number of cooperation agreements with central banks of the region and other European countries, where parent banks have their head offices.

Information exchange both at the licensing phase and on potential financial stability risks to institutions that they supervise, as well as cooperation for controlling financial institutions operating in country and abroad will help the Bank of Albania to ensure banking system stability.

In addition to the banking sector, 2010 was a positive year for non-bank institutions as well, witnessing increased diversity and completion of the financial infrastructure. At end-year, there were 17 non-bank institutions in the financial system compared to 12 ones a year earlier. Overall, their financial and lending activities reflected a good performance and were mainly in compliance with the regulatory framework established by the Bank of Albania.

Banking system supervision

As stated above, at the offset of 2010, the Bank of Albania changed its banking supervision organisational framework, refocusing and connecting it directly to risks that accompany the financial activity.

Moreover, the Bank of Albania re-conceptualised its supervision focus and strategy in accordance with risks faced by the banking and financial system in Albania.

Transparency and publication of information for banking and financial products and services were also at the focus of supervision in 2010. The Bank of Albania provides an orientation to compile business plans both for the public and financial agents through publishing detailed analysis of system-level financial soundness, since 2010 semi-annually. On the other hand, promotion of private financial agents' transparency is reflected in this year's amendments to the regulatory framework. High commission fees for banking products and services was a sensitive issue addressed in 2010 and will continue to be a priority in the upcoming period. The Bank of Albania, through its analysis, played a key role in discussions on this matter, aiming to tackle it in a timely and efficient fashion.

Issues on anti-money laundering, transparency and compliance with supervisory rules were equally important in financial institutions supervision during 2010. Hence, full on-site and two targeted inspections were carried out in two banks and four non-bank financial institutions. Following these inspections, these institutions drafted internal regulations and developed their payment systems, which enable daily cash transactions identification.

Supervisory regulatory framework strengthening

In 2010, the Bank of Albania finalised some new regulations and amended some other regulations on banking supervision. This process aimed at compliance with Basel Committee standards and EU Directives, taking into account international best practices as well as Albanian banking system developments.

New regulatory acts and key amendments to actual acts on banking supervision approved during this year include:

• Regulation 'On management of risk from open foreign exchange positions ' which sets out the rules and criteria for calculation, reporting and supervision of bank's open foreign exchange positions for exchange rate risk management.
• Regulation 'On risk management in the activity of non-bank institutions', whose scope is to set out rules on risk management in the activity of non-bank financial institutions especially with reference to rules on risk management in the activity of micro-credit and financial leasing institutions.
• Guideline 'On conservatorship and liquidation of banks', which sets out the procedures and actions for conservatorship and liquidation, finalising the authority's action framework in cases of conservatorship/liquidation of a bank or a branch of a foreign bank. 

****

Besides some central aspects of the Bank of Albania's work, such as monetary policy and banking sector supervision and regulation, in my presentation I would like to dwell on some other aspects of our work. These activities are compliant to our legal obligations and contribute to the financial system and market economy development in Albania.

4. Other activities of the Bank of Albania

Next, I would like to present a summary of the Bank of Albania's role for the payment systems development, support to the European integration process, public education and communication, statistics, and research capacity building at the Bank of Albania.

Payment systems

In 2010, the payment systems infrastructure improved even further, their security and efficiency increased, by processing high number and volume of payments. The real time gross settlement AIPS) recorded transactions volume up by 44% compared to 2009.

This year marked a further expansion of payment instruments use, reflecting, inter alia, increased public's trust and confidence in the banking system.

Well-functioning of financial markets and strengthening of financial stability in the country may not be realised without effective and developed payment systems. In this regard, the Bank of Albania is working to adopt best practices of other central banks. The Twinning Project with the Bank of Italy and the Bank of France, among other things, will focus on capacity building and approximation of the payment systems regulatory and operational framework in Albania with that of the European Union.

In 2010, we focused on two main aspects: strengthening of the legal framework for the payment systems supervisory role; and, improvement and promotion of changes to the national payment system in the context of the Bank of Albania's reformative role. As concerns improvements to the regulatory framework, in 2010, the draft-law 'On payment systems' was finalised.

This draft-law constitutes a further step that is crucial to the process of ongoing approximation of the Albanian legislation with the EU banking and financial legislation, as envisaged in Articles 70 and 89 of the Stabilisation and Association Agreement (SAA).

In its reformatory capacity, in March 2010, the Bank of Albania realised live communication between the interface of the Treasury system of the Ministry of Finances and the payments systems at the Bank of Albania. This new scheme enables the Ministry of Finance to monitor in real time its accounts activity at the Bank of Albania, contributing to a more efficient funds administration. Moreover, in this year, our work focused in the improvement and extension of the necessary infrastructure to settle electronic payment instruments in Albanian lek for various international cards (MasterCard, Visa) and other projects aiming to reduce the use of cash in the economy.

Support to European Integration process

In light of the SAA implementation, the Bank of Albania contributed to the review of the National Plan for the Implementation of the SAA for 2010 - 2014, identifying and updating priorities and measures taken in the field of macroeconomic stability, free movement of capital, freedom of establishment, and freedom to provide services.

For the questionnaire by the European Commission, the Bank of Albania had a coordinating role for some chapters, and participated actively in further EC fact-finding missions.

During 2010, the Bank of Albania continued to keep regular and fruitful contacts with key financial institutions such as the IMF, World Bank, European Bank for Reconstruction and Development (EBRD), Bank for International Settlements (BIS) and bilateral relations with other central banks.

In 2010, the Bank of Albania continued its work to review the legal and regulatory framework vis-à-vis the EU legislation and latest developments in country by drafting important banking legal, sub-legal and regulatory acts.

Public communication and institutional transparency

Communication with the general public and individual institutions is considered to be one of the most important elements in our work, to which the Bank of Albania dedicates a significant amount of its resources. During 2010, the work of the Bank of Albania, focused mainly on restructuring existing instruments and establishing new communication methods, which contribute to establishing an environment where actors are well-informed and capable to understand central bank's decision-making and make rational decisions on economic and financial issues. In the past year, additional contacts were established with various public groups, targeting especially those that have an impact on the public's educational processes.

Other activities consist in direct communication, periodic and non-periodic publications, presentations and meetings, which have made information on the Bank of Albania's work and decision-making available to the public. Moreover, the official website provides real time information on the Bank of Albania's activities, decisions and statistics.

Improvement of statistics at the Bank of Albania

The Bank of Albania's aim was to not only successfully compile and publish statistical indicators, but also improve continuously its public services by expanding the range of indicators, aligning its methodology and standards with the best international practices, and providing information in the best way. The main developments in 2010, in terms of statistical production, included the first time publication of gross external debt statistics, international investment position statistics and economy crediting detailed statistics, thus concluding the statistics series on the external sector.

With respect to the monetary and financial statistics, the Bank of Albania has worked to improve the methodology, informatise control processes and increase the number of published indicators.

Strengthening of research capacities

The Bank of Albania has long considered economic, financial and social research as a key element in its decision-making assessments and analysis.

Research capacities were strengthened through ongoing staff training, research infrastructure modernisation and establishment of bridges for experience and expertise exchange with various research institutions. Key research aspects in 2010 include monetary and fiscal policies, financial stability issues, new economic growth model, and the external sector of the economy. Support and application of econometric models in studying various economic phenomena led to reliable conclusions and projections.

Our internal future challenge is to improve even further these models and use them in the Bank of Albania's decision-making.

****

In conclusion, I would like to point out that, in addition to the Bank of Albania's Annual Report 2010, financial statements and the balance sheet, certified by auditors, are submitted.

Thanking you for your attention, I remain open to any questions and comments on the activities of the Bank of Albania in 2010.