PRESS RELEASE
Speech by the Governor of the Bank of Albania, Mr. Ardian Fullani, at the Press Conference on the Financial Stability Report

Dear participants,

On the occasion of approval of the "Financial Stability Report for 2008" by the Supervisory Council of Bank of Albania, I am standing before you today to briefly present the assessment of this report on financial system developments and the factors determining its stability.

Year 2008 will long be remembered as the year when the world economy experienced the greatest financial crisis of the modern times, which culminated in the second half of 2008, upon the bankruptcy of several globally extended financial institutions. Consequently, since that time onwards there is noted a high volatility in the financial markets, investors' flight, liquidity constraints and significant reduction in financial intermediation. The confidence of investors and the public in banks and financial institutions worldwide was shaken, bringing about a general price cut of banks' capital securities, by significantly narrowing their opportunities for refinancing.

The financial crisis magnitude expanded in the real sector of the global economy. The lack of funds and raised financing cost led to the decline of investment and trade, affecting the global domestic demand. Unemployment rate went up in all the developed countries, under the conditions when business enterprises were forced to cut production costs in response to declining demand. Most developed economies entered into a phase of economic recession in the second half of 2008. Slowdown of world economic activity in the demand for raw materials - production and food products - led to price cut of these products.

The deepening and widening of the financial crisis in the second half of the year made necessary the world-wide harmonization of actions, as well as the strengthening of the role of international financial institutions, such as the International Monetary Fund and the World Bank.

In our country, the impact of the international financial crisis increased due to its transformation into a genuine global-wide economic crisis. Initially, the international financial crisis did not provide any significant direct impact on our financial system. The reasons relate to lack of exposure of the banking sector and of the financial system in general to products and financial institutions that were at the centre of the crisis. Another reason is the low exposure to borrowing from foreign markets. However, in the last quarter of 2008, due to the psychological effect that caused the crisis aggravation in international markets, the domestic public reacted by withdrawing a part of banking sector's deposits. Consequently, liquidity conditions were tightened and lending slowdown was evidenced in the banking system. Under these conditions, the Bank of Albania took immediate measures to normalize the situation and restore public confidence in banks. Therefore, the Bank of Albania injected liquidity into the market in various forms, in order to enable an easier access by the banks. These decisions gave a positive effect on reducing the interbank interest rate volatility by the end of the year.

The crisis extension over time led to restricted financing resources and raised price, shrunk foreign currency inflows, increased depreciating pressures on the lek and worsened economic agents' expectations for the future financial health.

This changed financial environment poses several important challenges for the stability of the financial system in general and for the banking sector, as its dominant segment, in particular. These challenges arise from the close relationship of the financial activity with the domestic and international economic developments, as well as their interaction with the internal situation of the financial system itself.

More specifically, the Bank of Albania has assessed that:

1. There is increased the sensitivity of the financial system to domestic macroeconomic developments, where the main risks relate to:

a. Economic activity slowdown at home. Developments over the last quarter of 2008 and first months of 2009 show that the economic growth for 2009, though expected to be positive, will be low. This economic growth slowdown is due to shrinkage of domestic demand, reduced revenues of domestic economic agents that interact with international markets, and significant reduction of banking sector financing in the country. Therefore, the opportunities for expansion of the financial system activity will be more limited and its financial results will be lower during 2009;

b. Financial difficulties of the real sector of the economy. Expectations for slowing down the economy are hampering the financial resources to business enterprises and households. Domestic resources of activity expansion, in the form of income generated from core operation, will be negatively affected by the decline of investments and sales. Foreign financing resources, in the form of borrowing from the banking sector, are still on the downward phase. Various surveys on the business sector state in general confirm the increase of financial difficulties in the current situation and lack of optimism for short-term developments. The difficulties of business enterprises will negatively affect their ability to provide work steadily, causing reduced income for individuals and families. Again, the financial system in general and the banking sector in particular will attend these developments, mainly in the form of loan portfolio quality and slowdown of the public deposits growth rate;

c. Possible fiscal complications. The budget deficit increase in 2008, compared to the previous year, was realized under the conditions of a more favourable situation on deficit financing, in both the domestic and foreign market. The expected economic growth slowdown and the real sector's difficulties exerted pressure on public revenues, raising the difficulties for their realization according to the 2009 budget plan.

On the other hand, a more difficult situation of liquidity in the domestic financial market and in the foreign one is accompanied with increased budget deficit financing cost, bringing about a rise in the fiscal burden over the medium run. On the other hand, public expenditure realization should be adapted to actual income realization level. The Bank of Albania estimates that accomplishment of the target set at the beginning of the year for the budget deficit, would better serve the implementation of its financing at a lower cost and the release of funds for use in the domestic market and for the private sector;

d. High level of current account deficit of the balance of payments. Due to unsteady exports and declining remittances, the current account deficit in the trade balance is aggravated. If this trend goes up, it may steadily affect the foreign currency inflow structure in the domestic market, impacting on the demand and supply for foreign currency and bringing about increased exchange rate volatility of the national currency. The floating exchange rate movement provides an automatic tool to correct these imbalances in the demand and supply for foreign currency in the domestic market. In this framework, all economic agents, public and private, should assess their sensitivity and reliability to possible adverse exchange rate movements and take necessary protective actions.

e. In turn, the banking sector is sensitive to exchange rate movements, particularly in terms of the effect transmitted to foreign currency loan portfolio quality. Therefore, exchange rate developments over the first months of 2009 should give rise to necessary actions by the banking sector, to mitigate any undesirable effects on the financial situation.

2. There is mitigated the financial system sensitivity to developments of international financial markets. In this framework, it is estimated that:

f. Public policies on protecting European banking groups have enhanced the security for their legal and financial stability and the possibility of assistance they can provide for their investments in our country. Financial aid packages approved in Austria, Greece, Italy, France and other countries, and the strong liquidity injection by the European Central Bank have mitigated the difficulties of major European banks to provide liquidity and refinance their liabilities in the market. The positive performance of these banks' shares in stock-exchanges, generally during the first months of 2009, indicates such improvement of the situation.

g. The economic and financial situation in the countries of Central and South-eastern Europe has improved, as a result of financial aid of the International Monetary Fund and the European Commission, thus easing the negative expectations. Actions mitigating investors' uncertainty for economic developments in these countries, improve the perception of our country as well, in terms of the relative similarity that exists, at least in the countries of the region;

h. The signs indicating a gradual stabilization of the global economy are increased. Several relatively optimistic signals are coming from the economies of the developed countries and from the largest developing countries. The perception for an improved global economic climate would positively impact on economic agents in the domestic market, not only economically but also creating more optimistic expectations for a return of their relations with the banking sector to normal behaviour.

3. The financial system sensitivity to the performance of several banking activity indicators has increased. In this framework, it is assessed that:

i. A prudential management of the banking sector demand for liquidity is needed. Specifically, to cope with the deposit decline in the last quarter of 2008, the commercial banks reduced their portfolio of liquid assets, increased borrowing from the dominant banking groups and from the Bank of Albania. The share of public deposits in banking activity financing, though remaining dominant and at high levels, underwent reduction. This process should be prudentially monitored, in order to see how stable it will be in time, as well as to avoid any significant shifting towards wholesale borrowing, particularly in foreign currency. Under the conditions when the foreign-currency financing resources depend on the foreign market, the banking sector is, however, more protected, because foreign currency financing lines are obtained from dominant foreign bank groups. The banking sector's borrowing from the Bank of Albania provides a stable financing source in a specific situation and helps in enhancing the monetary policy transmission mechanism. This development is particularly important for banks that are not part of foreign banking groups. Simultaneously, it allows commercial banks to work out policies that provide a greater support to the national-currency financial activity. From this viewpoint, of importance is also the portfolio management of securities, which serve as collateral for wholesale borrowing. For such transactions in lek, the commercial banks are supported by holding government debt securities, such as treasury bills and bonds. Banks should establish and administer a special portfolio of these securities, for use in case of unexpected liquidity needs. Undertaking actions to further the development of secondary securities market would also be a supporting factor in this regard.

j. In general, to ensure that banks will follow more conservative policies in terms of liquidity risk management, the Bank of Albania is preparing a special regulation that would require banks to improve their capacities in terms of forecasting liquidity needs, and will also establish right and closer relationships between financing resources and banks' investments, in terms of type of currency, change of maturity term, creation of special collateral portfolios, etc;

v. The loan portfolio quality has entered into a downward trend. The difficulties of the real sector of the economy, the slowdown of economic growth and the strong contraction of lending due to unstable situation of liquidity in the latest months, have increased the volume of non-performing loans, notwithstanding the type of currency, the manner of or sector using the funds. The rise in non-performing loans has encouraged a tightening of the lending procedures, leading to reduced volume of credit and of cutting of credit terms. Also, it is associated with increased bank reserve funds, to cope with potential loan losses. This has impacted on reduction of the banking sector's financial result. The banking sector must withstand this situation, aiming at maintaining a sustainable activity in its financial intermediation, a very important function for the development of the economy and for the state of the sector itself.

Therefore, it is the time when the banking sector should give priority to lending in the national currency versus the one in foreign currency, making use of greater opportunities offered by public deposits and borrowing from the Bank of Albania. To this end, the banking sector should follow more appropriate policies in determining the credit price, in order to raise the demand for loans in the national currency. Also, there should be found forms that support the deposit growth and that increase the flexibility of their use by the public, providing faster access through the Internet or other modern communication elements, etc.

The banking sector is sensitive to exchange rate behaviour, particularly due to the impact it passes through the loan portfolio quality. Foreign-currency credit prevails to the total loan portfolio of the banking sector. This growth in years is due to the structure of the banking sector's balance sheet, low interest rates compared to credit in lek, as well as the perception that the lek's exchange rate stability would continue even in the future. It is understandable that the lek's significant depreciation within a short period of time, for those borrowers who do not generate their income in foreign currency, raises the value in Lek of loan instalments paid in foreign currency, thus associating loan repayment with delays and causing its return to non-performing loans. From this viewpoint, both the public and the banks should be more cautious for a better management of risk arising from exchange rate volatility.

l. Even during 2009 the financial result of the banking sector will continue the downward trend it began in 2008. In fact, this is a consequence of reduced operational revenues, due to the decline in the volume of operation with high earning rates and increased costs of operations, particularly due to increased reserve funds, to cope with potential loan losses. The decrease of net financial result means that the banking sector will have fewer domestic resources to support operations and to increase capital. In the case of banks that may experience a financial loss, this will be translated into reduced own funds. Though the decline in the financial result is not expected to have a significant impact on capital values, banks must prudentially monitor the capitalization indicators of operation and increase capital, if necessary. For 2009 capitalization has increased through non-allocation of profits and capital inflows from parent banks.

In conclusion, we stress that the efforts of public authorities should focus on maintaining the stability of macroeconomic and financial indicators. In the framework of fiscal policy, the maintaining of the budget deficit threshold serves to reduce the financing cost, release financing space to the private sector and mitigate the pressure on current account deficit. Simultaneously, this action increases the credibility of fiscal policy to international investors, providing opportunities for financial stability in the future. The prudence for keeping the macro-fiscal indicators on track is automatically translated into stability and credibility of the country against international financial markets. It constitutes the basic ground for a long-term sustainable growth in the country.

In the framework of monetary policy, we will strive for maintaining low inflationary expectations and will manage the liquidity situation in the interbrain market, in order to avoid interest rate volatility.

As the regulatory and supervisory authority of the banking sector, we will seek from banks to take all the necessary actions for maintaining good indicators of capitalization and working liquidity. Showing necessary prudence for the borrowing quality and the sustainability of financing resources, the banking sector will be promoted to find ways to increase national currency financing to the economy.

Based on the financial indicators of the banking sector, and on the size of their volatility according to stress-test analyses, the banking sector remains robust and its resilience to the above-mentioned risks is high.

Latest data speak for a restoring of public confidence, being reflected in the increase of deposits with the banking system. Credit to the economy has also grown, while the lek - foreign currency structure at banks' balance sheets has improved.

The shudder t he system suffered in autumn of 2008 may be regarded as already over.

In conclusion, I would like to emphasize that the Bank of Albania will prudentially attend every economic and financial development with possible impacts on macroeconomic and financial balances of the country. We remain fully committed to taking all the necessary actions in due time and manner, while transmitting them with full transparency to the public.

Thank you!