BANKA QENDRORE E REPUBLIKES SË KOSOVËS CENTRALNA BANKA REPUBLIKE KOSOVA CENTRAL BANK OF THE REPUBLIC OF KOSOVO. Financial Stability Report

Transcription

1 BANKA QENDRORE E REPUBLIKES SË KOSOVËS CENTRALNA BANKA REPUBLIKE KOSOVA CENTRAL BANK OF THE REPUBLIC OF KOSOVO Financial Stability Report Number 12 December 2017

2 CBK Working Paper no. 4 Efficiency of Banks in South-East Europe: With Special Reference to Kosovo 2

3 BANKA QENDRORE E REPUBLIKËS SË KOSOVËS CENTRALNA BANKA REPUBLIKE KOSOVA CENTRAL BANK OF THE REPUBLIC OF KOSOVO 1

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5 PUBLISHER Central Bank of the Republic of Kosovo Economic Analysis and Financial Stability Department Garibaldi 33, Prishtinë Tel: Fax: WEBSITE EDITOR-in-CHIEF Zana GJOCAJ EDITOR Krenare MALOKU BAKIJA Authors Arta HASHIMI Arta NUSHI Bejtush KIÇMARI Taulant SYLA TRANSLATOR and TECHNICAL EDITOR Butrint BOJAJ 3

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7 ABBREVIATIONS ACH ATM ATS CAR CBK CEE CIS EBRD ECB FDI GDP HHI IMF IPS KAS KPSF MoF MFI MTA NFA NIM NPISH NPL ODC POS pp PTK RLI ROAA ROAE ROE RWA SDR SEE TPL VAT Automated Clearing House Automated Teller Machines Automated Transfer System Capital Adequacy Ratio Central Bank of the Republic of Kosovo Central and Eastern Europe Commonwealth of Independent States European Bank for Reconstruction and Developments European Central Bank Foreign Direct Investments Gross Domestic Product Herfindahl-Hirschman Index International Monetary Fund Interbank Payment System Kosovo Agency of Statistics Kosovo Pension Saving Fund Ministry of Finance Micro Finance Institutions Money Transfer Agencies Net Foreign Assets Net Interest Margin Non-profitable Institutions Serving Households Nonperforming Loans Other Depository Corporations Point of sales Percentage points Post and Telecommunications of Kosovo J.S.C. Rule of Law Index Return on Average Assets Return on Average Equity Return on Equity Risk Weighted Assets Special Drawing Rights Southeastern Europe Third Party Liability Value Added Tax Note: Users of the data are required to cite the source. Suggested citation: Central Bank of the Republic of Kosovo 2017, No. 12 Prishtina. Any needed correction will be made in the electronic version. 5

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9 CONTENTS 1. Foreword by the Governor Summary Overall assessment of the risks to financial stability Financial stability map Euro area and Western Balkans Kosovo s Economy Securities Market Kosovo s Financial System General Characteristics Exposure to external sector Kosovo s banking sector Structure of the Banking Sector Activity of the Banking Sector Performance of the Banking Sector Risks of the banking sector Stress-test analysis Financial infrastructure in Kosovo Pension Sector Insurance Sector Activity of the Insurance Sector Performance of the Insurance Sector Microfinance Sector and Financial Auxiliaries Activity of Microfinance Sector Performance of the Microfinance Sector Financial Auxiliaries Macro Prudential Policy Identification and assessment of systemic risk Summary of developments in selected macroprudential indicators Decisions and macroprudential CBK measures Statistical Appendix References

10 LIST OF FIGURES Figure 1. Financial stability map Figure 2. Real quarter GDP growth rate in euro area Figure 3. Inflation rate in euro area Figure 4. EURIBOR interbank lending and ECB refinancing rate Figure 5. Annual credit growth and NPL rate in main euro area countries Figure 6. Profitability indicators of the banking sector in some euro area countries Figure 7. Annual growth of loans and deposits in the region countries Figure 8. EUR exchange rate against main currencies Figure 9. Real GDP growth rate and contribution to the growth Figure 10. Annual average change of CPI Figure 11. Imports, exports and trade balance Figure 12. Remittances Figure 13. Structure of foreign direct investments by components Figure 14. Securities market trend Figure 15. Announced and bidding amount Figure 16. Structure of Government securities by maturity Figure 17. Average interest rate on Kosovo s Government securities, by maturity Figure 18. Assets structure of financial system Figure 19. Financial intermediation in Kosovo, by sectors Figure 20. Credit to GDP ratio Figure 21. Credit to GDP gap Figure 22. Net foreign assets, by financial sectors Figure 23. External exposure by financial sectors Figure 24. Structure of assets in external sector Figure 25. Structure of external liabilities Figure 26. Assets structure of the banking sector Figure 27. Concentration level in the banking sector Figure 28. Assets structure of the banking sector Figure 29. Assets of the banking sector Figure 30. Structure of securities Figure 31. Contribution of the sectors to total loans growth Figure 32. Structure of loans by sectors in region countries Figure 33. Structure of loans by economic activity Figure 34. Loans by economic activity Figure 35. Structure of loans by maturity Figure 36. Structure of loans to households and enterprises, by maturity Figure 37. Total loans and new loans Figure 38. New loans

11 Figure 39. New loans by sectors Figure 40. New loans by sectors and purpose of use Figure 41. Bank's credit standards applied when assessing enterprise credit applications Figure 42. Terms and conditions applied for loans to enterprises Figure 43. Household demand for loans Figure 44. Bank's credit standards applied when assessing household credit applications Figure 45. Terms and conditions applied for loans to households Figure 46. Household demand for loans Figure 47. Structure of banking sector deposits Figure 48. Structure of enterprise deposits Figure 49. Non-resident deposits Figure 50. Structure of deposits by maturity Figure 51. Structure of time deposits Figure 52. Average interest rate Figure 53. Interest rates in Kosovo and in region countries Figure 54. Average interest rates on loans to enterprises and households Figure 55. Average interest rate on loans to enterprises, by purpose Figure 56. Average interest rate on loans to enterprises, by maturity Figure 57. Average interest rate on loans to enterprises, by economic activity Figure 58. Average interest rate on loans to households, by purpose Figure 59. Average interest rate on deposits Figure 60. Average interest rate on enterprise deposits Figure 61. Average interest rates on household deposits Figure 62. Financial performance of the banking sector Figure 63. Income structure of the banking sector Figure 64. Expenses of the banking sector Figure 65. Expenses value of the banking sector Figure 66. Profitability indicators of the banking sector Figure 67. Expenses-to-income ratio Figure 68. Loans and deposits of the banking sector Figure 69. Total liquid assets to short-term liabilities ratio Figure 70. Banking sector reserves Figure 71. Liquidity gap Figure 72. NPL to total loans ratio Figure 73. Total loans and NPL Figure 74. NPL to total loans ratio in Kosovo and in some Western Balkan countries Figure 75. NPL rate by activities Figure 76. Structure of loans by classification Figure 77. NPL and provisions Figure 78. Concentration of credit risk

12 Figure 79. Banking sector capitalization Figure 80. Regulatory capital and RWA Figure 81. CAR in Kosovo s banking sector and in region countries Figure 82. Structure of regulatory capital Figure 83. Structure of Tier 1 capital Figure 84. Structure of Tier 2 capital Figure 85. RWAs to total assets ratio of the sector Figure 86. RWA structure by risk weight Figure 87. Opened positions in foreign currency to Tier 1 capital Figure 88. Loans and deposits in foreign currency Figure 89. Assets and liabilities gap sensitive to interest rates Figure 90. General scale of overall systemic importance Figure 91. Criteria of size Figure 92. Criteria of substitutability Figure 93. Criteria of interconnectedness Figure 94. Criteria of interstate activity and complexity Figure 95. Assets of the pension sector Figure 96. Collected contributions received by pension funds Figure 97. Structure of pension sector investments Figure 98. Financial performance of Kosovo Pension Saving Fund Figure 99. Financial performance of Slovenian-Kosovo Pension Fund Figure 100. Assets structure of insurance sector, by ownership Figure 101. Assets of insurance sector Figure 102. Structure of assets of the insurance sector Figure 103. Liabilities and capital of insurance sector Figure 104. Received gross premiums Figure 105. Structure of gross written premiums Figure 106. Premiums received and claims paid Figure 107. Claims paid Figure 108. Assets of microfinance sector Figure 109. Structure of assets of microfinance sector Figure 110. Loans to households, by maturity Figure 111. Loans to enterprises, by maturity Figure 112. Structure of loans to enterprises, by economic sectors Figure 113. Microfinance sector growth rate of loans to enterprises Figure 114. Microfinance sector leasing Figure 115. Structure of leasing Figure 116. Average interest rate on microfinance sector loans Figure 117. Average interest rate on loans, by economic sectors Figure 118. Income and expenses of microfinance sector

13 Figure 119. Profitability indicators of microfinance sector Figure 120. Indicators of credit portfolio quality LIST OF TABLES Table 1. Number of financial institutions Table 2. Assets structure of the banking sector Table 3. Structure of liabilities and own resources of the banking sector Table 4. Key efficiency indicators of the banking sector Table 5. Capacity indicators of the banking sector Table 6. Risk indicators of the banking sector Table 7. Indicators used to assess the systemic importance of banks in Kosovo Table 8. Summary of stress-test results: credit risk Table 9. Summary of stress-test results: liquidity risk Table 10. The share of payment instruments to total transactions of IPS Table 11. Banking sector network Table 12. The share of the value of card transactions by terminals to total value of card transactions Table 13. Structure of pension sector LIST OF BOXES Box 1. Identification of banks with systemic importance in Kosovo

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15 1. Governor s Foreword Global economy during 2017 was characterized by strengthening of the growth of the economic activity, mainly being supported by the economic activity growth in the euro area. Easing quantitative measures taken by the European Central Bank (ECB) were reflected in a strengthened domestic demand, while positive prospects at a global level were translated into an increase of foreign demand. Developments in the euro area were positively reflected in the economies of Western Balkan countries, which in general reported a growth of domestic demand and increased exports. Growth of domestic demand and prices of main products in international markets led to the increase of inflation in the euro area. Similarly, in the Western Balkan countries, unlike the previous year, it was marked an increase in average inflation, mainly as a result of the increase of oil prices, energy and metals in international markets. Kosovo s economy, similar to developments in the euro area and in the region countries, was characterized by a growth in the economic activity during The consumption and investments increase represent the factors with the main contribution, while the exports increase of goods and services had an impact on mitigating the negative contribution of net exports. The inflation rate was characterized with an increase mainly as a result of the increase of prices in international markets, while fiscal position remained stable with low rate of budget deficit and public debt. Kosovo continues to have a sound financial system, which represents a very important source of growth and stability of the domestic economy. All constituent sectors of financial system marked an increase of their activity, thus enabling the country 's economy provide wide range of financial products. Financial intermediation activity of the banking sector marked a sustainable increase. Conditions for funding from banks continued improvement, where in addition to reduction of interest rates, access to bank loans was accompanied with facilities in other aspects. The improvement of lending conditions and the consistent development of new financial products, being supported also by the good soundness of Kosovo s banking sector, was reflected to the continuous growth rate of financial intermediation in Kosovo. Financial soundness indicators of the banking sector in Kosovo reflect a very satisfactory level, where it is worth mentioning the further decline of non-performing loans, which depicts Kosovo against the other region countries as regards to the quality of credit portfolio. Moreover, the banking sector continued to have a high liquidity level and low exposure to market risk. Pension sector recorded an increase of assets resulting from the increase of new contributions and the significant increase of investments return. Also the insurance sector recorded a growth of its activity and an improvement of the performance compared to the previous year. Microfinance institutions continued to accelerate lending activity, thus substantially enriching the lending products offered in Kosovo. The infrastructure of the banking sector continued to enhance, increasing the efficiency of financial services. In addition, the increase of the number of equipment as points of sale and the number of accounts that use the Internet platform, contributed to the increase of volume and value of transactions performed. Central Bank of the Republic of Kosovo (CBK) remains committed to the implementation of its legal objectives, where the financial stability continues to be the primary objective. Financial stability assessment and keeping the public informed continuously regarding important developments for financial stability in the country will continue to be important priorities for the CBK. Fehmi MEHMETI Governor 13

16 2. Summary Economic activity in the euro area is characterized with sustainable growth in the first half of 2017, mainly being supported by domestic demand. Average annual real GDP growth in euro area, in the first half of 2017, is estimated to have been 2.2 percent, mainly being impacted by the further strengthening of the domestic demand in the euro area, as well as the increase of consumers and businesses confidence after the elections in some of the main countries of the euro area. At the same time, Western Balkan countries were characterized with an average increase of GDP with around 2.5 percent, mainly being supported by exports and investments increase. Following the weak inflationary pressures with which was characterized euro area in previous periods, in the first six months of 2017, the average inflation rate reached 0.8 percent (0.1 percent in the first half of 2016). The price increase in the euro, besides expansionary policy of the ECB, is also attributed to the higher commodity prices in international markets during 2017, especially oil prices and energy. Similar with the euro area, countries in the Western Balkans were characterized by an increase in the price level as a result of price increase in the international markets. In the first six months of the year 2017, the Western Balkan countries were characterized with a high degree of average inflation rate of 2.0 percent. Euro area in recent years was characterized with credit recovery activity, supported mainly by eased monetary policy. In the first half of 2017, lending in the euro area was characterized by an average growth rate of 3.1 percent (2.4 percent in 2016). At the same time, the amount of total deposits marked an average growth of 2.4 per cent. Also the indicators of profitability and key indicators of financial soundness indicators marked an improvement. The main countries of the euro area were characterized with a satisfactory level of liquidity in the banking sector, as well as with the improvement of the quality of credit portfolio during the reporting period. Similar to the countries in the euro area, lending in the Western Balkans was characterized with a growth in the first six months of 2017, mainly as a result of the improved lending terms and conditions by banks as well as the increasing demand for loans. Also profitability indicators and key financial soundness indicators marked improvement. Kosovo s economy was characterized with an accelerated economic activity in the first half of According to the Kosovo Agency of Statistics (KAS) estimates, Kosovo s economy marked an average growth of GDP by 4.3 percent in the first two quarters of 2017 (3.4 percent in June 2016), while the nominal value of GDP was around EUR 2.83 billion. The growth of the economic activity in this period was mainly generated by increase of investments and of goods and services export. According to the economic sectors, added-value by the activity in extracting industry, construction sector, financial and trade activities were translated into an increase of real GDP in the country. For the year of 2017, CBK estimates suggest that the real GDP growth rate will be 4.4 percent. In the first half of 2017, similar to the euro area and in the Western Balkans, Kosovo s economy was characterized by an increase in the price level compared to the previous year. Average annual inflation rate, expressed through the consumer price index (CPI), was 1.7 percent (0.0 percent in the first half of 2016), where the increase is attributed mainly to prices increase in international markets and accelerating economic activity. Kosovo continues to have a sustainable fiscal position. In the first half of 2017, Kosovo budget marked a primary balance deficit of around EUR 2.8 million, compared with the balance of around EUR 21.6 million in the same period of The narrowing of the budget surplus was influenced by the growth of the budget expenditures with higher pace against the growth of 14

17 budget revenues. Public debt reached EUR million in June 2017, while as a percentage of GDP, public debt has reached to around 15.5 percent. Meanwhile, the added value of manufacturing sectors remains low, where the increase of domestic demand was translated into an increase of imports, thus impacting on the increase of the current account deficit. The current and capital account deficit reached EUR million until June 2017 (EUR million in the same period of the previous year), mainly due to the increase of the deficit in goods account, while positive balance of services, and primary and secondary income account marked an increase. Within the current account of external sector, remittances received in Kosovo amounted to EUR million, representing an annual increase of 11.8 percent. In the same period Foreign Direct Investments (FDI) received in Kosovo reached the value of EUR million, representing an increase of 75.1 percent compared to the same period of the previous year. FDI in Kosovo continued to remain focused mainly in the economic sectors as real estate, construction, financial services and trade. Until June 2017, a higher increase FDI was marked in financial services sector and construction, whereas regarding the origin of FDI, Germany represents the country with the highest level of FDI, followed by Switzerland, Austria, Great Britain, etc. Kosovo s financial sector during the first half of 2017 was characterized with a sustainable activity in all its constituent sectors. Consequently, the financial intermediation rate in Kosovo, expressed through financial system assets to GDP ratio, which reached 87.8 percent from 84.8 percent as it was in June of previous year. While, as regards to credit activity of the banking sector, credit to GDP ratio stood at 39.8 percent in June 2017, representing a low ratio compared to the average of around 55 percent of the region countries. Loans of the banking sector, as the main contributor to assets growth of the financial system, were characterized with an accelerated annual increase of 10.0 percent (8.4 percent in June 2016), thus reaching the value of EUR 2.39 billion. Lending increase is attributed to the accelerated increase of lending to enterprises, which dominate the structure of total loans, and to the double-digit increase of lending to households with which was characterized the banking sector in the last three years. The improvement of lending conditions by banks and the increase of credit demand were the main factors which influenced the increase of lending by banks. In this context, a positive impact in lending increase was marked by positive developments of non-bank structure factors, as the launch of Kosovo Credit Guarantee Fund in 2016, bailiffs engagement, etc. In the first half of 2017, with an accelerated annual increase of lending were characterized trade and construction sector, while with an annual decline of lending were characterized the sectors of financial services and real estate, energy, and agriculture. Loans with longer maturity continued to increase their share to total loans, which may be attributable to the demand for these loans and the improvement of credit supply conditions by banks through lengthening of maturity for loans. The main source of financing the banking sector activities continue to remain deposits, which in the first half of 2017 amounted to EUR 2.89 billion and marked an annual increase of 7.2 percent. The main contributor to the increase of total deposits were household deposits, which are considered to be a steady source of financing compared to other channels. The average interest rate on loans continued with a declining trend also in the second half of 2017, while the average interest rate on deposits marked a slight increase for the third consecutive year. Average interest rate on new loans declined to 6.8 percent from 7.2 percent as it was in June 2016, whereas average interest rate on deposits increased by 0.1 percentage points reaching 1.1 percent. Average interest rates on loans and deposits in Kosovo s banking sector stand at approximate same average levels of interest rates as in the region countries. Financial sector continued to be characterized with high stability, as assessed by the level of performance of financial soundness indicators. The profit realized by June 2017 reached EUR 15

18 45.6 million, representing a significant annual increase of 20.8 percent, an increase which is mainly attributable to the increase of non-interest income on one hand, and the decline of expenses on loan loss provisions and interest expenses, on the other hand. As a result of the significant profit increase, Return on Average Assets (ROAA) reached 2.6 percent, whereas the Return on Average Equity (ROAE) reached 21.9 percent, representing quite higher levels than those in the region countries. Liquidity position of the banking sector continued to be at a steady level, despite the accelerated increase of lending which had an impact on the increase of loans to deposits ratio reaching 82.8 percent from 80.7 percent as it was in June Liquid assets to short-term liabilities stood at 35.9 percent, which is well above the required regulatory minimum of 25 percent. The capitalization position of the sector continued to reflect sustainability and high capability of the banking sector to cope with potential losses. Capitalization indicator was 18.1 percent in June 2017, while the quality of regulatory capital continued to be characterized with an increase for the third consecutive year as a result of the increase of retained profit which had an impact on the increase of the share of Tier 1 capital to total regulatory capital reaching 89.2 percent from 87.5 percent as it was in the previous year. The exposure to credit risk has continued to decline, reflecting a further decrease of NPL rate to total loans thus falling to 3.9 percent, representing the lowest level since The decline of non-performing loans to total loans was impacted by the higher increase of loans and the significant improvement of credit quality. As regards to economic sectors, NPL rate for households was 1.9 percent, while for the enterprise sector it was 5.0 percent. Besides the quality increase of credit portfolio, it was also marked an increase of coverage level of non-performing loans with loan loss provisions thus reaching percent, showing a satisfactory capability of the sector to withstand any possible losses from loans. NPL rate to total loans continued to remain at lower level compared to the region countries which at an average had an NPL rate of 12.2 percent in June The exposure to market risk continued to remain low. The ratio of net aggregated opened position in foreign currency to Tier 1 capital increased to 2.3 percent from 1.8 percent in June 2016, thus remaining significantly below the required regulatory level of 30 percent. Loans in foreign currency have marked a decline thus reducing their share to total loans to 0.1 percent. Loans and deposits are impacted by interest rate movements primarily in maturity due to their fixed interest rates. The negative gap between assets and liabilities sensitive to interest rates for the short maturity level up to 30 days was widened, increasing the exposure to possible increase of interest rates, while the positive cumulative gap for the period up to 1 year was narrowed, representing a lower exposure to possible decline of interest rate, representing a lower exposure to the risk of possible decrease of interest rates. Banks have created a system, policies and appropriate procedures for managing the operational risk. The management of this risk by June 2017 was appropriate, having no cases of its materialization and by keeping the needed capital for covering this risk in compliance with the regulatory requirements. Stress test analysis with the data for the first half of 2017 suggest high capability of the banking sector to withstand possible shocks to credit portfolio and to the capitalization level, which may appear as a result of certain hypothetic scenario such as: the NPL increase, EUR depreciation against the major currencies; the decline of interest rates for assets and the increase of interest rates on liabilities; and the possible failure of large borrowers. The banking sector has also shown a capability to maintain the liquidity position under the hypothetic assumption of considerable withdrawals of deposits. The banking infrastructure during 2017 continued to enhance and widen. The number and the value of processed transactions by ATS during the first half of 2017 marked a significant 16

19 increase, reaching 8.0 and 43.5 percent, respectively. The number of bank accounts was characterized with a slight annual decline of 1.4 percent, while E-banking accounts marked an increase of 33.8 percent. Credit and debit cards were characterized with an increase as well, the number of which increased by 6.3 percent. The network of POS equipment has marked an increase in the first six months of the year, while the ATM number decreased. Despite the decline of the number of ATMs, the number and the value of processed transactions through them increased. Other constituent sectors of financial system, as pension sector, insurance sector and the one of microfinance institutions, was marked by an activity increase. Assets of the pension sector marked an annual increase of 15.8 percent reaching the value of EUR 1.54 billion in June Annual financial performance of the sector marked an increase as well, mainly as a result of positive return on investments, the increase of new contributions and the increase of price share of both pension funds. Insurance sector expanded its activity, thus increasing their assets to million, corresponding to an annual increase of 3.8 percent. It is worth noting that compared to the previous year, insurance sector was characterized with a significant improvement of its performance, which in June 2017 realized a net profit of EUR 2.0 million against the loss of EUR 11.5 million marked in the previous year. To the positive performance of insurance sector contributed the increase of claims paid by non-life insurance companies, which directly had an impact in reducing technical provisions, thus resulting in reduction of expenditures and consequently in realizing a profit. Microfinance sector was characterized with an accelerated increase of its activity, where the value of assets of the sector reached EUR million in June 2017, corresponding to an annual increase of 24.5 percent. Also, the performance of this sector was improved comparing to three previous years, as a result of the significant increase of the profit which reflected on an improvement of profitability indicators. The Central Bank of the Republic of Kosovo has continued the work on operationalization of Macro prudential Supervision Policy, which was compiled in 2016 in order to maintain the financial stability. In the first half of 2017, the general developments of macro prudential indicators in Kosovo were sustainable, with no threat to financial stability of the country. 17

20 Overall assessment of the risks to financial stability Financial stability map The first half of 2017 was characterized with a slight increase of the risk to financial stability from the internal and external macroeconomic environment (figure 1). 1 The positive developments in enterprise and household sectors suggest for a decline of the risk from the economic agents, with an exception of government sector which has marked a slight increase of the risk. While, internal indicators of the sector sustainability, as capitalization and profitability, liquidity and financing, and the structure of the banking sector, have Figure 1. Financial stability map Capitalization and profitability Liquidity and financing Structure of the banking sector External economy 10 marked a slight increase compared to the same period of As a conclusion, the majority of the indicators continued to stand below or close to the historical average of the risk level. Oil prices in international markets marked a significant increase in the first half of 2017 compared to the decline marked in the previous year, thus contributing to the overall risk increase of the external macroeconomic environment indicator. Developments in other external economic indicators were characterized with a lower risk. The indicator of the economic increase of Kosovo s trading partners was characterized with a slight decline of the risk despite the fact that the average economic growth of these countries was lower in the first half of Unemployment rate marked a decline in the countries from where the most of remittances come into Kosovo. Base interest rates continued to mark a further decline, while the prospects for the economic activity in Europe, according to Organization for Economic Cooperation and Development, marked an improvement. Despite the fact that the risk from the external economy has marked an increase, it still continued to remain quite lower than the historic average level. Kosovo s economy has marked an accelerated economic growth and positive output gap in the first half of However, other domestic economic indicators, with the exception of real effective exchange rate of EUR which marked an increase and contributed to the decline of the risk, were characterized with less positive developments in the context of financial stability. Inflationary pressures increased significantly, where the negative balance of current account to GDP deepened as a result of trade deficit increase, and the stock of external debt to GDP marked a slight increase as well, contributing to the slight increase of the overall risk of internal macroeconomic environment. Risk level of the macroeconomic internal environment continued to stand above the historic average, mainly as a result of structural deepening of current account deficit to GDP, or its higher ratio compared to the historic average trend. Household and enterprise sectors were characterized with positive developments and more significant risk decline. Lending to households and enterprises continued to increase resulting in Government Domestic economy Enterprises Households Historic average June 2016 June Developments of the key risk indicators to Kosovo s Financial Stability are depicted in figure 1, which represents The Map of Kosovo s Financial Stability. This Map graphically represents the movement of the risk level by main risk categories to financial stability and enables the comparison with the historic average scale of the risk for the appropriate categories. The increase of the distance from the center of the map for the indicators reflects an increase of the risk and decline of capability to withstand shocks to financial stability and vice versa. The complete methodology of the Financial Stability Map for Kosovo, including the recent reviews, is represented in the CBK working paper no Economic growth is weighed with Kosovo s exports share to the appropriate countries. The most significant effect on risk decline in this period was marked by weight increase of exports to India to total Kosovo s exports, which had an impact on the increase of the average weighted rate of economic increase due to the relatively higher economic increase of India. 18

21 a positive gap of lending to GDP for these sectors, and consequently an increase of financial intermediation. Credit portfolio quality continued with improvement trend, thus giving a contribution to the decline of financial stability risk. With a positive development for the household sector were characterized remittances which represent an important source for the income of this sector. Whereas, the only indicator with a negative impact to this sector was unemployment which marked an increase in the first half of the year. Enterprise sector was characterized with an improvement in almost all other components. Industry turnover index and the added value of the trade sector to GDP marked an increase. Business confidence, which reflects business expectations for the overall business activity, marked a considerable increase in the firs half of The only component that marked a decline was net balance of registered and closed businesses during this period. The risk from the government sector stands almost at the same level as in the previous year, being characterized with a slight increase. Main developments include narrowing of the fiscal surplus as a result of the faster increase of expenditures compared to income, which has had an impact on the increase of risk scale. Government debt continued to increase thus influencing risk increase, which significantly was neutralized by the cost decline of debt, namely the decline of expenditures for debt in this period. The risk interrelated to the structure of the banking sector has marked an increase during this period as a result of higher decline of capitalization rate of some banks as a ratio to the average decline of the sector, which affected on the increase of the negative deviation of the average capitalization rate of the banking sector. All other components of the banking sector structure, such as assets concentration in three largest banks, the credit concentration for businesses, diversification of credit portfolio and financing sources of banks, have marked an improvement. The other sustainability indicator, namely the internal risk of the sector which involves capitalization and profitability, was characterized with risk increase. The components of this indicator reflect various positive and negative developments in the risk indicator. The capital adequacy ratio has marked a decline along with the decline of interest rate to assets ratio of the sector, while large exposures marked an increase. These developments had an impact on risk increase, while on the other side, profit and shareholders capital increase along with the improvement of credit portfolio gave a positive contribution in mitigating the risk. Despite risk increase of banking sector structure indicator including capitalization and profitability, the risk level remains below the historic average of the appropriate indicators. Liquidity and financing indicator of the sector has marked an increase of the risk as a result of the decline of liquidity ratio, deepening of the liquidity gap for assets and liabilities up to 3 months and an increase of loans-to-deposits ratio. These developments came as a result of credit acceleration and low interest rates which had an impact on the decline of liquid assets and the increase of short-term liabilities. The risk of liquidity and financing indicator was mitigated from positive developments in the financing source which were characterized with an increase of sustainable sources against the decline of the share of less sustainable sources, namely accelerated increase of household deposits and a decline of liabilities to residents to total liabilities ratio. It should be noted that the higher risk level of liquidity and financing indicator alongside with the historic average reflects significantly the nature of components involved in indicators such as household deposits increased rates which was high in the beginning of the operation of the sector and continuously has followed a declining trend with the maturity of deposits increase, and loans-to-deposits ratio which consistently has marked an increasing trend since the beginning of the functioning of the sector. 19

22 Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 3. Euro area and Western Balkans Euro area Euro area was characterized with an increase of the economic activity, in the first half of Real average increase of GDP was 2.2 percent, compared to the average increase of 2.0 percent marked in the same period of 2016 (figure 2). The expansion policies and nonconventional measurements taken by the ECB within the quantitative easing program have had a positive impact on financial conditions in euro area. Moreover, the continuous improvement of conditions in the labor markets and creation of new vacancies, were translated in an increase of disposable income, thus having an impact on the increase of domestic consumption. The increase of the economic activity was mainly concentrated in central economies of the euro area, namely in Germany, France and Spain. Inflation rate marked an increase in euro area, reaching an average of 0.8 percent in the first half of 2017 (0.1 percent in the same period of 2016) (figure 3). In December 2016, the ECB decided to continue with the quantitative easing program measures until at least the end of 2017, with the main focus of returning the inflation rate closer to the target of 2 percent. The impact of expansionary monetary policies on the level of prices in euro area was supported also by price increase of oil and energy during IMF forecasts for the whole year of 2017, suggest that the average inflation rate in euro area is expected to reach 1.5 percent, mainly as a result of price increase of main commodities in international markets, especially energy prices Figure 2. Real quarter GDP growth rate in euro area Source: Eurostat (2017) Figure 3. Inflation rate in euro area, in percent Source: Eurostat (2017) Figure 4. EURIBOR interbank lending and ECB refinancing rate 0.8% 0.6% 0.4% 0.2% 0.0% -0.2% -0.4% -0.6% m 12m ECB refinancing rate Source: Euribor and ECB (2017) The launch of the expanded stimulating program in the recent years has had a direct impact in the further decline of 1-month and 12-month interest rates of Euribor interbank lending, where the ECB has continued to keep interest rate on its main refinancing operations at 0.0 percent (figure 4). 20

23 Euro area in the recent years was characterized with a recovery of credit activity. Accommodating monetary policy has stimulated an expansion of credit activity. In the first half of 2017, lending in the euro area was characterized by an average growth rate of 3.1 percent (2.4 percent in 2016). Credit growth was more significant in Germany (4.1 percent) and in France (3.8 percent), while in Greece the growth rate of lending was negative (figure 5). During this period, also the value of total deposits marked an average increase of 2.4 percent (0.5 percent in 2016), where the highest increase it was marked by Austria (3.9 percent). A more sluggish increase of deposits was marked by Italy (2.0 percent), while Spain and Greece were characterized with a decline 2.2 percent and 14.9 percent, respectively. Profitability indicators, such as Return on Average Assets (ROAA) and Return on Average Equity (ROAE), marked an increase. Also Greece, which in the recent years was characterized with a fragile level of profitability, in Q marked an improvement by realizing a positive return on capital and assets average (figure 6). An increase was marked also by key 0% Germany Spain France Austria Greece financial soundness indicators. The Return on Average Assets (ROAA) Return on Average Equity (ROAE) average of capitalization level of the Source: IMF (2017) banking sector, expressed through the regulatory capital to risk weighted assets ratio, increased at an average of 20.8 percent from 19.6 percent in the previous year. A higher level of capitalization increase was marked by Holland (23.0 percent), while Portugal and Italy marked the lowest level of capitalization (13.9 percent and 13.8 percent, respectively). The capitalization level in Germany, France and Spain was around 19.0 percent, 17.6 percent and 14.8 percent, respectively. With an increase was also characterized the usage level of capital in financing the financial activity, measured by financial leverage, which reached an average increase of 8.6 percent from 8.0 percent in Nonperforming loans reached a level of 6.8 percent representing the same rate as in the previous year. The lowest level of nonperforming loans, in the first half of 2017 was marked by Germany with a rate of 1.7 percent and Austria with 2.5 percent (figure 5). Western Balkans Figure 5. Annual credit growth and NPL rate in main euro area countries, in % 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% Figure 6. Profitability indicators of the banking sector in some euro area countries, in Q % 6% 5% 4% 3% 2% 1% 4.1% 1.7% 2.5% 3.8% 3.9% 1.1% Economic activity in Western Balkans, similar to euro area, was characterized with an increase of domestic demand and improvement of the position of net exports. The increase of investments and exports in Western Balkans was translated in an average GDP increase of 2.5 percent in this region, in the first half of % 5.6% 2.1% 17.1% -3.3% 36.6% Germany Austria France Spain Italy Greece Annual credit growth Source: IMF and ECB (2017) NPL 21

24 The highest economic growth in this period it was marked by Kosovo (4.3 percent) and Montenegro (4.2 percent), followed by Albania (4.0 percent). Bosnia and Herzegovina and Serbia marked a lower rate of increase (2.2 percent and 1.2 percent, respectively) while the only country of Western Balkan region that was marked by an economic decline was Macedonia (a decline of 0.9 percent). IMF forecasts, for the whole year of 2017, suggest that the Western Balkan countries will mark an economic growth rate with an average of 3.0 percent (2.7 percent was the economic growth in 2016). Similarly to the euro area, the Western Balkan countries were characterized with an increase of price level, mainly being attributed to price developments in international markets. In the first half of 2017, Western Balkan countries were characterized with an average of inflation rate of 2.0 percent, while in the same period of 2016 the average inflation rate was 0.3 percent. Figure 7. Annual loans and deposits growth in the region countries in % 10% 8% 6% 4% 2% 0% -2% Kosovo Montenegro B and H Macedonia Serbia Albania During the first half of 2017, credit Loans Deposits activity in the region marked an Source: Central banks of respective countries (2017) increase, primarily being supported by eased credit supply conditions of banks, and the increase for credit demand. The highest increase of lending was marked by Kosovo (10.0 percent), being followed by Montenegro (9.3 percent), and Bosnia and Herzegovina (5.7 percent). The banking sector in the region countries was characterized with a general increase of deposits, where the most annual rapid increase was marked in Montenegro (10.9 percent) and Bosnia and Herzegovina (10.0 percent) (figure 7). Profitability indicators, expressed through return on average assets (ROAA) and return on average equity (ROAE), marked an increase in all the region countries. Also, in the first half of 2017, credit portfolio quality improved, where the average NPL rate decreased at around 12.2 percent (14.1 percent in 2016). The lowest NPL rate was marked by Kosovo (3.9 percent) and Macedonia (6.1 percent), while the highest level it was marked by Albania and Serbia with 15.6 percent. Figure 8. EUR exchange rate against main currencies Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q U.S. dollar British pound Swiss franc Until June 2017, the average of regulatory capital to risk weighted assets ratio marked a slight increase at an average of 17.4 percent (17.3 percent in 2016). Financial leverage, as well, marked a slight increase at an average of 14.0 percent from 13.8 percent as it was in Also the liquidity position, expressed as a ratio of liquidity position to total short-term liabilities stood at high levels, increasing at an average of 45.3 percent until June 2017 from 43.9 percent as it was in the previous year. In the first half of 2017, EUR was depreciated against the American dollar and Swiss franc with 3.0 and 1.8 percent, respectively, while it was appreciated against the British pound with 10.5 percent (figure 8). Within the currencies of the region countries, EUR depreciated against 22

25 Albanian lek and Macedonian denar with 2.3 and 0.1 percent, respectively, while it was appreciated against Serbian dinar with an average of 0.4 percent. 4. Kosovo s Economy Kosovo s economy was characterized with an accelerated activity increase in the first half of Based on KAS estimates, the average increase of GDP for the first quarters of 2017 was 4.3 percent (3.4 percent until June 2016), while the nominal value of GDP amounted to EUR 2.83 billion. This increase of economic activity was mainly generated by investments increase (15.8 percent) and the increase of exports of goods and services (12.4 percent). As depicted in figure 9 investments have contributed to the GDP growth with 4.4 percentage points, while net exports have given a positive contribution with 1.0 percentage points. Factors which have given a contribution to investments increase in the first half of the year, among others are also bank lending (10.0 percent), the increase of public investments (18.7 percent), and Figure 9. Real GDP growth rate and contribution to the growth FDI increase (64.2 percent), etc. The export of goods and services, primarily being impacted by price increase of metals and improvement of external demand, has marked a real growth of 12.4 percent. This increase of goods and services export had an impact on improvement of net exports with 2.8 percent until June In terms of the structure, GDP by expenditures approach is dominated by consumption, which until June 2017 had a share of percent to total GDP of the country. Investments had a share of 30.5 percent, while the component of net export had a share of percent. By production approach, public administration has a higher share to total GDP (13.3 percent), followed by agriculture and trade sectors (10.9 percent each). Considerable share to GDP have also the sectors of the processing industry (9.2 percent) and the real estate business (8.8 percent). Regarding the sectors, the real economic growth of Kosovo during the first half of 2017 was primarily supported by the activity increase of extracting industry sector (22.5 percent), construction sector (20.1 percent), financial activities (11.8 percent) and trade (5.1 percent). Meanwhile, a real decline was assessed to have been marked by agriculture sector (3.3 percent), public administration (2.3 percent) and supply with energy, gas and water (1.8 percent). Based on the CBK estimates, Kosovo s economy in 2017 is expected to mark a real growth of 4.4 percent. In 2017, the main contributors to the growth are expected to be investments, which are forecasted to mark a real growth of 10.0 percent, based on the projections for a considerable increase of public investments (8.7 percent) and private investments (10.4 percent). An important contribution to investments increase is expected to be marked by bank lending, which is expected to be characterized with an accelerated growth pace and low interest rates. Also FDI is expected to give a contribution to the increase of general investments position, which in the previous year marked a considerable increase. Also, the changes in tax policy in the previous years are expected to boost private investments Consumption Investments Net exports Real growth Source: KAS and CBK calculations (2017) 23

26 Consumption, as the main component of domestic demand, is expected to mark a real increase of 1.7 percent, based on expectations that private consumption will increase by 2.2 percent while public consumption by -1.1 percent. Factors which are expected to have an impact on the increase of private consumption growth, among others, are also the increase of remittances and loans. Until the end of 2017, remittances are expected to mark an annual growth of 7.9 percent. Also, loans to households, which in the recent years marked a considerable increase (an average annual increase of 12 percent in the last three years), are expected to continue with the same trend also in Net exports of goods and services are expected to have a lower negative contribution to GDP compared to previous year, an assumption that relies mainly on forecasts on the increase of metal prices which are expected to have an impact on the increase of the value of total exports. Kosovo s economy in the first half of 2017 was characterized with price increase compared to the same period of the previous year. The average annual inflation rate, expressed through the Consumer Price Index (CPI), was 1.7 percent (figure 10). The increase of inflation was impacted by mainly by improvement of economic activity and prices increase in international markets. The highest price increase was marked by electricity, gas and other fuels (4.9 percent), followed by transport Figure 10. Annual average change of CPI, in percent Sheltering, water, electricity, gas Transport Alcoholic beverages and tobacco Footwear and clothing Food and non-alc. beverages Goods and other services Restaurants and hotels Health Furnishing and household Education Communication means Recreation and culture Total CPI Source: KAS (2017) (2.0) prices (4.7 percent). With an increase of 1.4 percent were characterized also food prices, which represent around 33.9 percent of the Kosovar consumer basket. Conversely, a price decline was marked by recreation and culture (1.4 percent) communication means (0.8). In the first half of 2017, Kosovo budget marked a primary balance deficit of around EUR 2.8 million, compared with the balance of around EUR 21.6 million in the same period of In budget surplus reduction the main contribution was marked by a more accelerated increase of budget expenditures than the increase of budget revenues. Budget revenues 3 reached a net value of EUR million, representing an annual increase of 4.1 percent, while budget expenditures 4 reached the value of EUR million, representing an annual increase of 6.9 percent. Regarding the type of taxes, it was observed a higher increase of non-direct tax revenues which reached a value of EUR million (an increase of 5.1 percent), followed by indirect tax revenues which reached a value of EUR million (an increase of 3.9 percent). Non-tax revenues marked even higher increase of budget revenues (an increase of 9.5 percent), which reached a value of EUR 90.9 million. Regarding expenditures, almost all categories were characterized with increase. Government expenditures on wages and salaries marked a slight increase of 0.6 percent and reached a value of EUR million. Goods and services (including also the municipal utilities) marked a decrease of 8.2 percent, reaching a value of EUR 94.9 million. Subsidies and transfers also marked an increase of 9.0 percent and reached the value of EUR million. The highest increase was marked by capital investments which reached the value of euro million, representing an increase of 18.7 percent compared to the same period of the previous year. 3 Within the primary income were not included the revenues from borrowings, income from privatization, receipts of donor defined grants and receipts from deposits in trust. 4 Within budget expenditures are not included debt payments, membership payments at International Financial Organizations (IFO), and returns from deposit funds. 24

27 Public debt reached EUR million in June 2017, presenting an increase of 15.3 percent compared to the same period of the previous year. As a percentage to GDP, public debt reached around 15.5 percent from 13.8 percent. This increase in public debt is attributable to external debt increase of 15.5 percent (its value reached EUR million) and the increase of domestic debt with 15.1 percent (EUR million). External sector was characterized with current and capital account deficit of EUR million in June 2017, compared to the deficit of EUR million in the same period of the previous year. This deficit of current and capital account is mainly attributable to the increase of the deficit of goods account. Conversely, positive balances of services, primary and secondary income accounts marked an increase. The deficit in trade of goods reached the value of EUR 1.2 billion, corresponding with an annual increase of 6.2 percent. In this period, export of goods reached the value of EUR million, corresponding with an annual increase of 17.7 percent (figure 11). The increase of the value of export of goods during this period is mainly attributed to the increase of export of mineral products, base metals, processed food, beverages, vegetables, etc. Conversely, with a decline was characterized the export of textile and articles of it and hides and Figure 11. Imports, Exports and trade balance, in millions of EUR Source: KAS (2017) Import Trade balance Export articles thereof. The value of total imported goods reached EUR 1.4 billion until June 2017, representing an annual increase of 7.6 percent. The growth of import was mainly a result of the increase of the value of imported mineral products, which accounts for import of oil and its derivatives, whose prices had marked an increase in international markets. With an increase was characterized also the import of transport means, machinery, prepared foodstuffs, beverages, etc. Conversely, the import of plastics, articles of stone, ceramic products, glass, etc. marked a decline. In June 2017, the coverage rate of imports by exports stood at 12.8 percent (11.7 percent in June 2016). Figure 12. Remittances 14% % The balance in trade of services marked 10% 11.8% a value of EUR million until June 8% 8.9% , representing a growth of 9.8 6% percent compared to the same period of 6.0% The value of total exported 4% 1.6% 100 2% services marked an annual increase of 50 0% percent, reaching EUR million, while the value of imported services marked an increase of 6.6 percent, reaching a value of EUR million. Excise in tobacco, in euro (right axis) Annual change, in percent Within export of services, pension and insurance services were characterized with an increase, while construction services marked a decline. As regards to import of services, transport services marked a decline, whereas computer services and other business services marked an increase. The primary income account reached the value of EUR 49.2 million, representing a growth of 1.2 percent. The balance of income from the compensation of employees marked an increase of

28 percent, while the negative balance of income realized from investments deteriorated for 21.5 percent. Conversely, the secondary income account reached the value of EUR million, representing an annual growth of 4.6 percent. This increase of secondary income mainly is attributed to the higher level of remittances received in Kosovo, which reached an amount of EUR million, representing an annual increase of 11.8 percent (figure 12). Remittances received in Kosovo mainly come from Germany and Switzerland, which represent the countries with a share of 39.2 percent and 22.6 percent, respectively, of total remittances. A considerable amount of remittances was received from USA, namely 7.3 percent of total remittances received in Kosovo. Foreign Direct Investments (FDI) Figure 13. Structure o foreign direct investments by received in Kosovo reached the value of EUR million, until June 2017, representing an increase of 75.1 percent compared to the same period of the previous year. Within the structure of FDI, with an increase was characterized also the capital and fund of investment in shares and investments in debt components, in millions of EUR instruments. The capital and 0 investments fund in shares, which comprises around 84.4 percent of total FDIs, marked a value of EUR million which is for 99.6 percent more Capital and fund of investment in shares Debt instruments compared to the same period of the previous year. Also, FDI in the form of debt instruments reached a value of EUR 23.2 million which is for 5.4 percent more compared to the same period of the previous year (figure 13). FDI in Kosovo continued to remain focused mainly in the economic sectors as real estate, construction, financial services and trade. A higher increase of FDI was marked in the sector of financial services and in construction (EUR 32.6 percent and EUR 22.6 million more compared to the same period of the previous year), while the trade sector was characterized with a decline of 7.4 percent. Regarding the origin of FDI, Germany represents the country from where came the majority of FDI (EUR 29.9 million), followed by Switzerland with EUR 22.6 million, Austria with EUR 20.5 million, Great Britain with EUR 19.7 million, etc. In June 2017, Kosovo s external debt (the private and public external debt), reached EUR 2.17 billion, which is for 8.5 percent higher than in the same period of As a percentage to GDP, the gross external debt reached 34.0 percent. The public external debt reached a value of EUR million, with a share of 20.4 percent to total external debt. In the structure of external debt, IMF has a share of 11.5 percent followed by the World Bank which has a share of 9.3 percent, and other creditors (around half of the debt to other creditors is intercompany borrowings) which have a significant share of 79.2 percent Securities Market Securities market of the Republic of Kosovo s Government remains an attractive platform to invest in for the banking sector and pension sector as well. Since the commencement of operation of the securities market, financial system in the country has offered adequate liquidity in the auctions organized by the Treasury Department, within the Ministry of Finance of the Republic of Kosovo. 26

29 In millions of EUR In millions of EUR The number and the value of securities auctions in the last year has marked a slight decline compared to the same period of the previous year, thus reflecting a lower demand of the government to finance projects through domestic debt issuance. By June 2017, the number of realized auctions declined to 10 form 11 as realized in the same period of the previous year (figure 14), while the issued amount of securities totaled to EUR million (EUR million in June 2016). According to maturity, the increase of the number of issued bonds with longer maturity was reflected in an increase of the average maturity of securities portfolio. In the end of the first six-month period of 2017, the average maturity term of securities extended to 23.3 months, compared to 20.1 months in the same period of the previous year. 5 The attractiveness of investments in securities of Kosovo s Government reflected through the bidding amount offered by participating entities in auctions, which consistently exceeded the announced amount by the government. However, in the first half of 2017, it was observed a decline of bid to cover ratio in securities auctions at 1.7 from 2.2 in the previous period. This decline may have resulted from the higher concentration of banks in issuing loans and due to the pension investments in external sector. Also, the more favorable interest rates in other instruments such as investment funds abroad may have had an impact in the decline of this ratio. Until June 2017, the announced amount at auctions was for 12.0 percent lower compared to previous period, while the amount bidding amount of participating entities marked a decline of 32.0 percent (figure 15). The issuance structure of securities has changed continuously towards increasing the share of instruments with Figure 14. Securities market trend Figure 16. Structure of Government securities by maturity, in percent 100% 90% 80% 70% 60% 50% 40% 30% longer term of maturity. In the past, the structure was dominated by treasury bills (up to one year), in June 2017 bonds with a maturity over one year accounted for the half of securities (figure 16). 32.2% 43.9% 16.6% 47.6% 6.0% 9.1% 8.0% 9.1% 22.0% 44.0% 31.8% 36.4% 20% 19.1% 12.0% 10% 9.1% 13.8% 9.5% 8.0% 0% 4.5% 91 days 182 days 364 days 2 years 3 years 5 years Amount offered (received) by the Government Number of auctions (right axis) Average until maturity, monthly (right axis) Figure 15. Announced and bidding amount, in millions of EUR Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q Announced amount by MoF Bid-to-cover ratio (right axis) Bidding amount of participants The average maturity was calculated as a simple average of maturity term of securities which have not yet matured at the end of the period mentioned in the analysis. 27

30 3M 6M 12M 2Y 3M 6M 12M 2Y 3Y 3M 6M 12M 2Y 3Y 5Y 3M 6M 12M 2Y 3Y 5Y The overall average interest rate in securities declined to 0.39 percent in first half of 2017, compared to 1.02 percent in the same period of the previous year. Interest rate decline is mainly attributed to the high liquidity level of the banking sector, and the competition in the market to invest in these instruments, which have offered favorable returns in an overall environment of low interest rates in foreign markets. The highest interest rate of 0.9 percent was recorded in treasury bonds with a maturity of 5 Figure 17. Average interest rate on Kosovo s Government securities, by maturity 3.9% 3.3% 2.8% 2.2% years, while the lowest interest rate of 0.1 percent was recorded in treasury bills with a maturity of 91 days (figure 17). All the categories of securities have lower interest rates compared to the same period of the previous year, where 5-year treasury bonds were characterized with a more pronounced annual decline of the interest rate. This development was especially favored by the bid amount for investment in this instrument which was twice higher compared to the amount announced by the government. 2.5% 1.8% 1.7% 1.3% 1.0% 1.1% 0.5% 0.6% 0.7% 0.0% 2.9% 1.6% 3.2% 0.3% 0.3% 1.0% 0.6% 2.4% 3.5% 0.5% 0.2% 0.2% 0.1% 0.9% 0.8% 28

31 2007q1 2007q2 2007q3 2007q4 2008q1 2008q2 2008q3 2008q4 2009q1 2009q2 2009q3 2009q4 2010q1 2010q2 2010q3 2010q4 2011q1 2011q2 2011q3 2011q4 2012q1 2012q2 2012q3 2012q4 2013q1 2013q2 2013q3 2013q4 2014q1 2014q2 2014q3 2014q4 2015q1 2015q2 2015q3 2015q4 2016q1 2016q2 2016q3 2016q4 2017q1 2017q2 5. Kosovo s Financial System 5.1. General Characteristics Kosovo s financial system continues to be characterized with sustainable increase in all its constituent sectors. In June 2017, total value of system assets reached EUR 5.56 billion, representing an annual increase of 9.8 percent. The increase was mainly a result of the expansion of the banking sector activity and positive performance of pension funds. Microfinance and insurance sectors also had a positive contribution to the increase of assets of the system, albeit with a lower rate, while the sector of financial auxiliaries continued to have low share within the financial system in the country. Structure of financial system is dominated by the banking sector, while pension sector continued to expand its share (figure 18). The share of insurance sector, of microfinance institutions and financial auxiliaries remained the same as in the previous year. The rate of financial intermediation in Kosovo continued to increase. Financial system assets to GDP ratio reached 87.8 percent, compared to 84.8 percent in June of the previous year (figure 19). In this period, credit to GDP ratio marked an increase as well, mainly as a result of the accelerated increase of lending activity, albeit remains at lower levels compared to region countries (figure 20). Credit to GDP gap, which shows the current ratio of loans to GDP, along with its long-term potential, in June 2017 continued to stand at a negative territory for Kosovo (figure 21). Figure 18. Assets structure of financial system 0.2% 2.7% 3.2% 100% 26.2% Banks Microfinance Pensions 90% 80% 70% 60% 50% 40% 30% 20% 10% June % It should be noted that credit to GDP Average of the region Source: IMF, Central Banks of the Region (2017) ratio and the negative credit gap suggest a further increase of financial intermediation in the country, despite that the continuous growth of lending, and that with a more accelerated pace in the recent years, has had an impact on Kosovo to move closer towards the region countries. However, the accelerated pace of lending activity may have an impact in deterioration of the credit portfolio in a mid-term period, in case it is not followed by the accelerated increase of the economic activity in the country and a more 67.6% Insurances Financial auxiliaries 0.2% 3.0% 3.1% 27.7% Banks Microfinance Pensions June % Insurances Financial auxiliaries Figure 19. Financial intermediation in Kosovo, by sectors Financial System Banking Sector Pension Sector Insurance Sector Microfinance sector Figure 20. Credit to GDP ratio 120% 100% 80% 60% 40% 20% 0% B and H Montenegro Serbia Kosovo Macedonia Albania 29

32 In millions of EUR 2007q1 2007q2 2007q3 2007q4 2008q1 2008q2 2008q3 2008q4 2009q1 2009q2 2009q3 2009q4 2010q1 2010q2 2010q3 2010q4 2011q1 2011q2 2011q3 2011q4 2012q1 2012q2 2012q3 2012q4 2013q1 2013q2 2013q3 2013q4 2014q1 2014q2 2014q3 2014q4 2015q1 2015q2 2015q3 2015q4 2016q1 2016q2 2016q3 2016q4 2017q1 2017q2 proactive approach of banks to diversify the structure of lending towards the sectors with lower rate of borrowing and which have a strategic importance for the economy of the country. Regarding the number of financial institutions which comprise the financial system, the situation remains almost the same with the previous year. Changes were marked by financial auxiliaries sector and microfinance and non-bank financial institutions. Three new institutions were added to the sector of financial auxiliaries, increasing Figure 21. Credit to GDP gap 14% 10% 6% 2% -2% -6% -10% BH Kosovo Montenegro Macedonia Serbia Albania Average of the region Source: IMF, Central Banks of the Region (2017) their number to 49, whereas the number of microfinance institutions and non-bank financial institutions decreased to 17, as a result of merging of two microfinance institutions into one. Consequently, in June 2017, the number of total licensed financial institutions operating in the country reached 93 (table 1). Table 1. Number of financial institutions 6 Description Commercial banks Insurance companies Pension funds Financial auxiliaries Microfinance institutions and non-bank financial institutions Exposure to external sector 7 The value of net foreign assets (NFA) of Kosovo s financial system, in June 2017, reached EUR 2.5 billion, representing an annual increase of 2.1 percent. In June 2017, foreign assets comprised 43.4 percent of total assets of financial system (45.4 percent in 2016) while external liabilities accounted for 8.9 percent of total liabilities of the system (8.6 percent in 2016). Figure 22. Net foreign assets, by financial sectors 2,900 2,400 1,900 1, CBK Pension Sector Banking Sector Microfinance Sector Insurance Sector Financial auxiliaries NFA of pension funds represent the largest share of total NFA of financial system (52.2 percent), followed by NFA of the CBK (40.3 percent of NFA of financial system). To the positive balance of NFA contributed also the banking sector NFA with a share of 12.0 percent 6 Number of financial institutions represents the institutions which are licensed to operate in Kosovo. Within the category of microfinance institutions were included five financial non-bank institutions licensed for lending activity. 7 In this context, financial system includes the Central Bank of the Republic of Kosovo. 30

33 while, microfinance sector was the only one to mark a negative balance of 4.5 percent of total NFA (figure 22). The exposure of pension funds to external sector remains high, where foreign assets comprise 85.1 percent of 100% 90% total assets of the pension funds, which 80% mainly are in the form of shares and other equities. The CBK remains the 70% 60% 50% 40% second most exposed institution to 30% external sector, where 77.6 percent of 20% 10% assets of the CBK are invested abroad, 0% primarily in the form of deposits in banks outside Kosovo and in securities. While, liabilities to external sector account for 18.9 percent of total External assets/total assets liabilities of the CBK, mainly in the form of the account with the IMF. The banking sector continues to have the lowest exposure to the external sector, while the insurance sector has almost no exposure at all to external sector. In June 2017, foreign assets to total assets ratio of the sector was 14.0 percent, while the external liabilities to total liabilities ratio of the banking sector was 5.8 percent, which reflects the low rate of support of the banking sector from the external financing. Unlike other sectors, microfinance sector has an interaction with the external sector only in the context of liabilities, where 66.9 percent of the activity of this sector is financed from abroad. This is due to the use of microfinance sector of external credit lines to finance its lending activity, given that MFIs have no legal rights to receive deposits (figure 23). The value of assets of the microfinance sector in external sector reached EUR 3.16 billion, corresponding to an annual growth of 4.2 percent (figure 24). 8 The increase of foreign assets was mainly supported by the increase of investments of pension funds sector of 21.3 percent. Also, to the increase of assets of financial system had an impact the increase of 12.5 percent of CBK investments in the external, mainly in the form of securities. Figure 23. External exposure by financial sectors, June 2017 Financial system CBK Banking Sector Pension Sector Microfinance Sector External liabilities/total liabilities Figure 24. Structure of assets in external sector, in percent 100% 80% 60% 40% 20% 0% The main category of assets in the external sector is comprised of shares and other equities, which belong to pension funds, a category which in June 2017 marked an annual increase of 21.4 percent. Investments in securities, as the second category within external assets, marked a more sluggish annual increase of 5.9 percent in June 2017 (an increase of 89.8 percent in June 2016). The largest share of investments in securities belong to the CBK, which during this period have marked a low increase compared to The remainder of investments in this instrument (28.6 percent) belong to commercial banks operating in Kosovo, and were characterized with an annual decline, 8.3% 5.2% 4.9% 4.2% Special drawing rights Securities other than shares Loans Other Deposits Shares and other equities IMF quota Annual change (right axis) 10% 8% 6% 4% 2% 0% 8 In the context of claims of financial system of Kosovo to external sector was not included in the category of cash. In monetary and financial statistics, the category cash, which is held in the treasuries of commercial banks, is treated as an external asset (claims to nonresidents) due to the fact that EUR currency is not the national currency of Kosovo, however in this analysis these assets have not been treated as such because they represent assets held in Kosovo. 31

34 which may have been a result of the change of banks strategy to increase lending. The third category of assets in the external sector are deposits, mainly those of the CBK and of commercial banks. For the second year in a row, deposits continued to mark a decline (16.0 percent in June 2017), which may have resulted from the ECB decision to keep negative interest rate on deposits. The value of total liabilities to external sector, June 2017, reached EUR Figure 25. Structure of external liabilities, in percent million, representing an annual increase 100% 18.0% of 13.3 percent. The increase of external 15.9% 16.0% 80% 14.0% liabilities was impacted by the increase 13.3% 12.0% of the CBK account with the IMF, 60% 10.0% 7.5% followed by the increase of borrowings, 8.0% 40% 4.6% namely the increase of loans which were issued to microfinance institutions in 6.0% 20% 4.0% 2.0% order to finance their operating 0% 0.0% activities in the country. The structure Deposits SDR allocation of external liabilities is dominated by Loans The account at IMF Other Annual change (right axis) the CBK account at the IMF which marked a decelerated annual increase (an increase of 19.3 percent in June 2017 compared to the increase of 35.9 percent in June 2016), followed by loans (an annual increase of 16.0 percent in June 2017, while in June 2016 the increase was 13.9 percent), while the third category of external liabilities is comprised of deposits, which marked an annual increase of 6.2 percent (figure 25). 32

35 In millions of EUR 6. Kosovo s banking sector 6.1 Structure of the Banking Sector Banks with foreign ownership, continued to dominate the structure of the banking sector in the country. In June 2017, foreign banks managed 88.3 percent of total assets and 91.0 percent of the banking sector capital. Three out of eight banks with foreign ownership come from Turkey, while five other banks have their origin in Austria, Germany, Slovenia, Albania and Serbia. The domestic market continued to be represented by two banks (figure 26). The concentration level of the banking sector continued to decline also in the first six months of Expressed as a ratio of the assets of three largest banks of the sector to total assets of the sector, the banking concentration level declined to 61.6 percent form 63.2 percent in June The decline of the market concentration is observed also through the continuous decrease of Herfindahl- Hirschman Index (HHI) (figure 27). the main items on assets and liabilities side, loans and deposits, marked an annual decline of concentration rate with 1.3 and 1.6 percentage points, respectively. The decrease of concentration is mainly attributed to a more accelerated increase of these items at smaller banks. In June 2017, three largest banks marked an annual increase of loans with 7.8 percent, whereas loans of other banks increased by 13.6 percent. As regards to deposits, three largest banks marked an annual increase of 4.0 percent, compared to the growth of 11.5 percent marked by other banks Activity of the Banking Sector Assets Figura 26. Assets structure of the banking sector, by ownership 100% 90% 80% 70% 60% 50% Figure 28. Assets structure of the banking sector 4,000 3,500 3,000 2,500 2,000 1,500 1, % 15.2% 15.8% 15.8% 15.9% 15.0% 14.6% 15.2% 1.9% 1.8% 1.8% 1.7% 9.5% 9.6% 10.2% 11.7% 40% 26.4% 24.7% 22.9% 22.2% 30% 20% 10% 24.9% 25.4% 25.7% 24.3% 0% Austria Germany Kosovo Serbia Slovenia Albania Turkey Figure 27. Concentration level of the banking sector Assets (HHI) Loans (HHI) Deposits (HHI) 9.8% 6.9% 5.0% Cash and balance with the CBK Securities Fixed assets Annual change of total assets (right axis) 7.0% Balance with commercial banks Gross loans Other assets 12% 10% 8% 6% 4% 2% 0% The value of total assets of the banking sector of Kosovo, in June 2017, reached EUR 3.67 billion, representing an annual growth of 7.0 percent (figure 28). The expansion of assets during this period primarily reflects the accelerated lending activity in the country. Also the balance with 33

36 commercial banks and the one of securities had quite a low positive impact on the increase of assets of the banking sector (table 2). Credit portfolio of gross loans increased by 10.0 percent (8.4 percent in June 2016), amounting to EUR 2.39 billion. Net loans marked an increase of 11.1 percent, while the improvement of credit portfolio quality had an impact on the decline of stock reserves for possible loan losses for 6.4 percent. Table 2. Assets structure of the banking sector Description In millions of EUR Share (%) In millions of EUR Share (%) In millions of EUR Share (%) millions of EU Share (%) Cash and balance w ith the CBK % % % % Balance w ith commercial banks % % % % Securities % % % % Gross loans 1, % 2, % 2, % 2, % Fixed assets % % % % Other assets % % % % Total assets 3, % 3, % 3, % 3, % The amount invested by the banking sector in securities, in June 2017, reached EUR million, representing an annual increase of 1.4 percent (2.1 percent in June 2016) (figure 29). The decelerated increase in this category is mainly attributed to investments decline of foreign governments in securities, which marked an annual decline of 7.1 percent (an increase of 10.1 percent in June 2016). In the same period, investments in securities of Kosovo s Government marked an annual increase of 11.7 percent (a decline of 6.2 percent in June 2016). The slowdown of investments increase in securities may be attributable to some extent to the change of investment strategy of banks, taking into account the decline of average interest rate on securities of Kosovo s Government and due to the overall low interest rates in foreign markets. Conversely, the continuous improvement of credit portfolio and higher returns from investments in loans, has had an impact on banks to shift their investments from securities towards lending. Figure 29. Assets of the banking sector, annual change 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% Gross loans Securities Balance with commercial banks Cash and balance with the CBK Figure 30. Structure of securities, in percent 100% 80% 58.9% 50.7% 54.7% 50.1% 60% 40% 20% 41.1% 49.2% 45.2% 49.8% 0% Other financial and nonfinancial corporations Foreign governments Kosovo s Government The balance with commercial banks, in the first six months of 2017 marked an increase, thus expanding for 2.6 percent compared to the sharp annual decline of 16.4 percent recorded in June The only category which marked a decline during this period was cash and balance with 34

37 the CBK, being characterized with a decline of 1.5 percent. The assets shift towards credit portfolio may have had an impact on the decline of this category. Also, the implementation of negative interest rates (-0.40 percent) for bank reserves exceeding the obligatory level of 10.0 percent, as of August 2016, may have had an impact on the level of reserves held at the CBK. Loans Credit activity continued with its increasing trend, thus being characterized with the highest growth rate of 10.0 percent, marked in the last six years. This significant increase of lending, especially in the recent two years is a result of the improved credit supply conditions offered by banks 9, taking into consideration the higher demand for loans. The interest rate decline and the improvement of credit portfolio quality have had an impact on credit activity expansion. Also, the commencement of the Kosovo s Credit Guaranteeing Fund since September of the previous year, which provides collateral insurance for loans issued by banks to small and medium enterprises, and other positive developments in nonbank structural factors may have had an impact on lending increase. With an accelerated increase of lending activity were characterized both economic sectors, namely enterprise and household sectors, which marked a double-digit annual increase in the last Figure 31. Contribution of the sectors to total loans growth, percentage points 12% 10% 8% 6% 4% 2% 0% -2% 100% 80% 60% 40% 20% 0% 48.7% 35.8% 41.6% 45.7% 64.0% 40.6% 49.4% 42.2% 65.9% three years (figure 31). The majority of loans of the banking sector continued to be dominated by loans to enterprises, which account for 64.0 percent of total loans, whereas loans to households represent 35.8 percent of total loans. Other regional countries have similar structure of lending, where enterprises have a higher share to total credit portfolio (figure 32). However, this structure is more present in Kosovo s and Albania s banking sector than in the region countries. The stock of loans to enterprises marked an annual increase of 8.8 percent, while new loans to this sector increased by 29.5 percent. The expansion of new loans to enterprises, designated to non-investment loans followed by investment loans had an impact on the stock increase of loans to enterprises. Loans to households were characterized with an increase of 12.5 percent, representing a decelerated growth rate compared with the previous period (15.2 percent in June 2016). The slight decline of new consumer loans had an impact on the slowdown increase of loans to households, despite the increase of new mortgage loans. 3.5% Figure 32. Structure of loans by sectors in region countries, June % Bosnia and Herzegovina 0.2% 6.1% 17.8% 8.4% 5.4% 24.9% 5.1% 45.3% 32.9% 10.0% Other Enterprises Households Annual change of loans (right axis) 29.0% Kosovo Montenegro Macedonia Serbia Albania Other Households Enterprises Source: Central banks of respective countries (2017) 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% 9 The latest Bank Lending Survey realized by the Central Bank of the Republic of Kosovo. 35

38 Structure of loans to enterprises by activity Loans designated to the trade sector continued to dominated the structure of loans to enterprises, with a share of 51.7 percent (figure 33). Loans intended for the sector of manufacturing industry represent 12.2 percent of total loans, while the sectors of construction and agriculture comprise 7.9 and 3.5 percent, respectively. Mining and energy sector continued to have quite low weight to total loans portfolio of enterprises. Trade sector was characterized with an accelerated annual increase of 7.0 percent in June 2017 (1.1 percent in June 2016), while mining sector marked a slowdown annual increase of 12.1 (48.8 Figure 34. Loans by economic activity, annual change 56% percent in June 2016). It is worth noting 46% that loans to construction sector were 36% characterized with an interruption of declining trend marked in four recent years, marking a significant annual increase of 17.6 percent ( figure 34). Whereas, the only sectors that were 26% 16% 6% -4% -14% -24% characterized with an annual decline of Agriculture Construction Energy Manufacturing lending were the financial services and Mining Trade and real estate, energy and agriculture sector, which marked an annual decline Financial services and real estate Other services of 38.4, 13.4 percent and 5.2 percent, respectively. Banking sector is characterized with high concentration rate of loans by economic sectors, where 60.6 percent of loans to enterprises are concentrated in three largest banks. Consequently, loans classified by economic sectors are characterized with high concentration in three largest banks. In this context, 63.7 percent of total loans to trade were issued by three largest banks. Loans to manufacturing sector have a concentration of 74.1 percent, whereas Figure 35. Structure of loans by maturity, in percent agriculture sector has the highest 100% concentration, where only one bank 25.1% 21.4% 19.4% 19.3% accounts for almost half of agriculture 80% 8.6% 8.8% 7.1% loans portfolio. 7.3% Structure of loans by maturity Figure 33. Structure of loans by economic activity, in percent 100% 80% 60% 40% 20% 60% 40% 0% 3.6% 3.8% 4.0% 3.5% 12.0% 12.6% 11.9% 12.2% 52.2% 54.0% 51.9% 51.7% 8.9% 7.7% 7.2% 7.9% 23.3% 21.9% 25.0% 24.7% Agriculture Manufacturing Trade Construction Other sectors Structure of loans by maturity suffered 20% 29.7% 31.8% 35.2% 37.8% changes, where loans with maturity of over 5 years for the first time 0% dominated loans portfolio with a share of Up to 1 year Over 1 year up to 2 years Over 2 years up to 5 years Over 5 years 37.8 percent. Loans with maturity over 2 up to 5 years, in June 2017 represented 35.8 percent of total loans portfolio (figure 35). Loans with short maturity, namely 37.9% 38.2% 36.6% 35.8% 36

39 up to 1 year and those with maturity of over 1 to 2 years, declined their share to total loans for 0.1 and 1.7 percentage points, Figure 36. Structure of loans to households and respectively. enterprises by maturity Loans to households are dominated mainly by loans with maturity over 5 years, which have a share of 56.0 percent to total loans to households, while concerning enterprises, loans with a maturity of over 2 up to 5 years have the highest share, namely 37.1 percent to total loans to enterprises (figure 36). New loans New loans issued by the banking sector reached a value of EUR million, representing an annual growth of 16.9 percent (a decline of 4.0 percent until June 2016) (figure 37). The main contribution increase of new loans was marked by new loans to enterprises, which marked a significant annual increase of 29.5 percent amounting to EUR million (figure 38). According to Bank Lending Survey, the increase is attributable primarily to eased credit standards for small and medium enterprises, and to the increase of demand. Conversely, new loans designated for households marked an annual increase of 2.3 percent (figure 39). 31.9% 27.6% 26.1% 26.6% 38.0% 38.7% 37.6% 37.1% 22.4% 23.9% 25.9% 27.8% Within new loans to enterprises, 250 investment loans, which represent the majority of these loans (52.3 percent), marked an annual growth of 15.3 percent. Whereas, non-investment loans, which in June 2017 had a share of percent to new loans to enterprises, marked an annual increase of 46.0 percent. The remainder of new loans New loans to enterprises issued to enterprises is comprised of loans with favorable conditions. 100% 80% 60% 40% 20% 0% 43.9% 48.0% 52.9% 56.0% Structure of new loans to households continued to be dominated by consumer loans with 70.9 percent, which marked a slight annual decline of 0.4 percent in the first half of 2017 (an increase of 19.4 percent until June 2016) (figure 40). Whereas, new mortgage loans marked a significant annual increase during this period, for 30.7 percent compared to the increase of 10.6 percent until June % 9.8% 10.5% 8.5% 11.7% 8.5% 7.2% 6.2% 6.2% 5.1% 4.5% 6.8% 37.6% 37.3% 34.8% 33.4% June 2014June 2015June 2016June 2017June 2014June 2015June 2016June % 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% Enterprises Households Up to 1 year Over 1 year up to 2 years Over 2 years up to 5 years Over 5 years Figure 37. Total loans and new loans, annual change 39.4% 8.5% 3.5% 6.1% 8.4% -4.0% Total loans Figure 38. New loans, in millions of EUR New loans New loans to households 16.9% 10.0% 37

40 P P P P P P P P P P P P P P P P P P P P P Tightened Eased Figure 39. New loans by sectors, annual change Figure 40. New loans by sectors and purpose of use 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% 53.9% 18.7% 4.7% The effect of new loans issued during this six-month period to the increase of the stock of loans was declined by the value of write-offs and by returned loans during the period. Since write-offs mitigated the increasing effect of new loans to the increase of total stock of loans for 1.7 percent, returned loans off-set this effect for 63.5 percent. Bank Lending Survey % 18.7% -17.4% New loans to enterprises New loans to households 29.5% 2.3% The latest results of the bank lending survey 11 reflect the developments in bank lending activity during the period of March-August 2017 (referred as P2 2017) 12, and expectations for lending activity for the period of September 2017 to February 2018 (referred as P1 2018). 90% 75% 60% 45% 30% 15% 0% 58.7% 52.3% 38.2% 33.9% 7.5% 9.5% Investment Non-invest. With favor. cond. Loans to enterprises 72.9% 70.9% June 2016 June 2017 Figure 41. Bank's credit standards applied when assessing credit applications of enterprises 14.8% 18.9% 8.7% 6.8% Consumer Mortgage With favor. cond. Loans to households 0.40 Overall SMEs Large enterprises Current value Expected value The dynamic of lending activity to enterprises during this period, based on the bank lending survey, results to be affected positively by credit supply side and demand for loans. Within the credit supply conditions, banks have reported to have eased applied standards during the process of enterprise applications assessment for loans. Within loans to enterprises, credit standards for SMEs eased while credit standards for loans to large enterprises remained unchanged. 10 Bank Lending Survey is conducted by the Central Bank of the Republic of Kosovo with banks that operate in Kosovo. The survey is realized twice a year, conveying the period of March-September and October-February. 11 Replies of individual banks were aggregated by using the appropriate weight of each single bank to total credit portfolio of the banking sector. Positive values of the index of credit standards show ease of lending whereas negative values are characterized with a tightening of lending. Also, positive values of the index of demand show an increase of demand and the negative values show a decline. 12 The period of September-February of each year is referred as the first period -P1, while the period of March-August of each year is referred as the second period -P2. 38

41 P P P P P P P P P P P P P P P P P P Tightened Eased For the period of September 2017 to February 2018, banks stated an expectation for further ease of credit standards for SMEs, while for large enterprises credit standards are expected to further remain unchanged (figure 41). Figure 42. Terms and conditions applied for loans to enterprises Overall SMEs Large enterprises Net interest margin in average loans Amount of loan Maturity Other payments except interest rate Collateral requirements *Lines in dashes represent the respective expected value for the period of September 2017 to February 2018 (P1 2018) Within credit supply side, banks have also reported to have eased terms and conditions of lending to enterprises. Banks have mainly eased credit standard conditions mainly through declining average interest rates, the increase of the size of approved loans and the decrease of collateral requirements for SMEs and large enterprises as well. While, conditions which were tightened to some extent for loans to large enterprises is the shortened of maturity and the increase of other burdens besides the interest rate (figure 42). For the period of September 2017 to February 2018, banks expect an overall ease of lending conditions, albeit slight tightening of some lending conditions for two categories of enterprises. More specifically, banks have stated other increase of burdens except interest rates for SMEs and large enterprises as well. The average interest rate on loans for both of categories is going to follow a declining trend, and furthermore the size of approved loans is expected to mark increase for these categories. The main factor, as banks have declared, which had an effect on easing credit standards it was the increase of competition in credit market in the country, the decline of nonperforming loans and the positive perspective of the bank and of the sector in general. During the reporting period, banks have stated an increase of credit demand by enterprises which comply with the eased credit supply conditions. Credit demand was higher especially by SMEs, while large enterprises marked a demand increase to some extent (figure 43). Within enterprises credit demand, it was marked an increase for financing the inventory and labor capital and to some extent for fixed investments. For the period of September 2017 to February 2018, banks expect a significant higher increase of demand from SMEs unlike the demand marked by large enterprises (figure 43). Within the demand for loans, banks reported a quality increase of applications received from large enterprises, while the applications submitted by SMEs remained almost the same regarding their quality. 39

42 P P P P P P P P P P P P P P P P P P P P P Tightened Eased P P P P P P P P P P P P P P P P P P P P P Decline Increase Figure 43. Household demand for loans 0.5 Overall SMEs Large enterprises Vlera aktuale Vlera e pritur A more sluggish increase of new loans to households during the reporting period compared to new loans to enterprises, based on the bank lending survey, was impacted to some extent by the credit supply conditions while credit demand had marked a significant increase. More specifically, credit standards on consumer loans to some extent marked an ease, while credit standards for loans to households for house purchase remained approximately the same (figure 44). Figure 44. Bank's credit standards applied when assessing household credit applications 0.5 Total loans to households Mortgage loans Consumer loans Current value Expected value Banks expect same trend of credit standards also in the six upcoming months (September February 2018), where an ease is expected to be marked by consumer loans and the same credit standards for loans with the intention for house purchase. An improvement of credit conditions for households during the reporting period was marked for two categories of loans, with a higher emphasis on consumer loans. Conditions for consumer loans were mainly realized through the decline of average interest rates, the reduction of other burdens with the exception of interest rate, the decline of collateral requirements, and lengthening of loans maturity. As regards to house purchase loans, this ease was realized mainly through the decline of non-interest rate charges, and the decline of interest rate on loans (figure 45). In the six upcoming months, banks declared that they expect an ease of lending conditions for households, especially for consumer loans through the decline of interest rate and the decrease of collateral requirements. 40

43 P P P P P P P P P P P P P P P P P P P P P Decline Increase P P P P P P Tightened Eased P P P P P P P P P P P P Figure 45. Terms and conditions applied for loans to households Total loans to households Loans to households for house purchase Consumer loans Net interest margin in average loans Amount of loan Maturity Other payments except interest rate Collateral requirements *Line in dashes represent the respective expected value for the preiod of September 2017 to February 2018 (P1 2018) The increase of competition in the credit market and the favorable access in bank financing were the main factors which affected the ease of credit standards. Figure 46. Household demand for loans 0.70 Total loans to households 0.60 Consumer loans Total loans to households Current value Expected value Banks have reported a significant credit demand for consumer loans and loans for house purchase by households (figure 46). The increased demand from households for consumer loans is attributable to the increase of demand for financing other expenditures besides house purchase costs and the increase of consumer confidence. Whereas, besides the latter above mentioned factor, to the increase of demand for house purchase loans, an impact was marked also by the positive developments in the market of real estate based on the KAS estimates on the increase of the share of construction and real estate business to total GDP during the first six months. Also, the received application forms, for consumer loans and loans for house purchase, results to have been improved. For the period of September 2017 to February 2018, banks expect an increase of demand for loans from both household categories, especially for loans for house purchase. Regarding the maturity, short-term loans and long-term loans have been influenced positively by credit supply conditions. These results are in compliance with the trend of demand for loans by households. Banks declared an increase of total financing in the reporting period, namely as a main financing source were declared to have been transferable deposits, especially household deposits. Banks expect an increase of financing through household and enterprise deposits, and unlike the six previous months it is expected an increase of financing by assets with a longer term of maturity. 41

44 Liabilities and Own Resources Liabilities structure of the banking sector is dominated by deposits, which comprise around 78.7 percent of total liabilities and own resources, and consequently continue to be the main financing source for the banking sector (table 3). Moreover, another quite important source of financing the banking sector continued to be represented by equity (own resources), which in June 2017 marked an increase, mainly as a result of the increase of the accumulated and realized profit during this period. Table 3. Structure of liabilities and own resources of the banking sector The category of the balance with commercial banks, which represents only 2.4 percent of financing activities of the banks operating in Kosovo, marked an annual increase of 2.4 percent in June 2017 (annual increase of 62.2 percent in June 2016). The category of Figure 47. Structure of banking sector deposits subordinated debt, which has quite a 100% 15% low share of 1.0 percent in financing the 90% 20.8% 20.9% 20.8% 22.1% 13% 80% activities of banks, marked a slight 11% 70% annual increase of 0.4 percent. The 60% 10.0% 7.2% 9% 6.3% 50% 7% category of other borrowings and other 40% 4.6% 5% liabilities, which as well have a quite 30% 3% 20% low share in financing the activities of 10% 1% 74.2% 74.0% 74.4% 73.1% the banks, were characterized with an 0% -1% annual decline of 9.9 percent and 3.2 Other deposits Non-resident deposits percent, respectively, in June Enterprise deposits Household deposits Deposits Description Deposits were characterized with an accelerated increased rate unlike the two previous years. The value of total deposits in the Kosovo s banking sector amounted to EUR 2.89 billion in June 2017, representing an annual increase of 7.2 percent (4.6 percent in June 2016). June 2014 June 2015 June 2016 In millions of EUR Share (%) In millions of EUR Share (%) In millions of EUR Share (%) In millions of EUR Share (%) Balance w ith other banks % % % % Deposits 2, % 2, % 2, % 2, % Other borrow ings % % % % Other liabilities % % % % Subordinated debt % % % % Ow n resources % % % % Total liabilities and own resources 3, % 3, % 3, % 3, % Annual change of total Deposits (right axis) Figure 48. Structure of enterprise deposits 100% 90% 80% 70% 60% 50% 40% 30% 20% The main contributor to the increase of 10% 21.8% 15.5% 13.4% 15.0% total deposits were household deposits, 0% which are considered to be a steady Other nonfinancial corporations Other public corporations Other financial corporations source of financing compared to other channels. Household deposits, which comprise 73.1 percent of total deposits, marked an annual increase of 5.4 percent (5.2 percent in 2016) (figure 47). The second category of deposits by importance (22.1 percent of total deposits), 64.4% 13.8% 75.6% 79.8% 77.1% 8.8% June % 7.9% 42

45 In millions of EUR namely enterprise deposits, marked an accelerated annual increase of 14.1 percent (3.7 percent in 2016). In the structure of enterprise deposits, in the first half of 2017, it was observed an increase of the weight of deposits of other financial corporations and public corporations. Conversely, deposits of other nonfinancial corporations (private enterprises) declined their share to total Figure 49. Nonresident deposits enterprise deposits (figure 48). 96 Other financial corporation deposits and public corporation deposits marked an accelerated annual increase of 27.5 percent and 33.5 percent, respectively, whereas other nonfinancial corporation marked an increase of 10.2 percent. The remainder of total deposits is comprised by nonresident deposits with a share of 3.3 percent and other deposits (the government and other nongovernmental organizations) with a share of 1.6 percent. Non-resident deposits marked an annual increase of 1.1 percent compared to 0.5 percent in June of the previous year (figure 49). While, other deposits were characterized with a significant annual increase of 20.6 percent as a result of the increase of deposits of government institutions and non-governmental organizations at commercial banks. Structure of deposits by maturity, in percent The structure of deposits by maturity is dominated by transferable deposits, which in June 2017 increased their share, unlike time deposits and saving deposits which decreased their share to total deposits of the sector (figure 50). These developments in the structure of deposits may be attributable to some extent to the low level of interest rates on deposits that characterized the market In June 2017, transferable deposits marked an annual increase of 12.8 percent, while time deposits interrupted their declining trend with which were characterized in the three previous periods, thus marking an annual increase of 5.0 percent. Conversely, saving deposits declined by 5.7 percent in June 2017 compared to the same period of the previous year. Enterprise time deposits contributed to the increase of deposits, which grew by 20.2 percent, Figure 50. Structure of deposits by maturity 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 18.9% 21.5% 19.6% 17.2% 41.6% 28.4% 24.5% 24.0% 39.6% 50.1% 55.9% 58.8% Saving deposits Time deposits Transferable deposits Figure 51. Structure of time deposits 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 20.7% 20.0% 59.3% 33.4% 28.4% 38.1% 39.2% 37.3% 26.2% 34.6% 17.2% 45.5% Over 2 years Over 1 year up to 2 years Up to 1 year 43

46 while household time deposits marked a growth of 0.2 percent. The increase of business deposits, pension funds and insurance companies deposits had an impact on the significant expansion of enterprise time deposits, which among others were impacted also by the favorable interest rate on this category. Whereas, despite the slight increase of interest rate on household time deposits, the increase of time deposits of this sector was low. It is worth noting that within the structure of time deposits, in June 2017, it was marked a decline of time deposits with longer term of maturity (figure 51). Compared to the same period of the previous year, in June 2017, it was marked a significant increase of 39.2 percent of deposits with short term of maturity up to 1 year, and a slowdown increase of deposits with a maturity of over 2 years (0.7 percent). Whereas, deposits with a maturity of over 1 up to 2 years for the second consecutive year marked a decline (a decline of 30.5 percent in June 2017 and 16.5 percent, in June 2016) Interest Rates Interest rates on loans continued with a declining trend also in the first half of Conversely, average interest rate on deposits marked a slight increase for the third consecutive year. Average interest rate on new loans declined to 6.8 percent from 7.2 percent as it was in June 2016, whereas average interest rate on deposits increased by 0.1 percentage points, reaching 1.1 percent. A more significant decline of interest rate on loans was reflected in narrowing the interest rate spread of loans and deposits which fell at 5.7 percent, from 6.2 percent in June 2016 (figure 52). Figure 52. Average interest rate 14% 12% 10% 8% 6% 4% 2% 0% Interest Rates on Loans Interest Rates on Deposits Loans to deposits ratio (percentage points) Figure 53. Interest rate in Kosovo and in region countries (June 2017) 8% 7% 6% 5% 4% 3% 2% 1% 0% 1.2% 4.4% Bosnia and Herzegovina 6.8% 7.1% 1.1% 0.8% 2.2% 6.2% 1.4% 5.7% 0.8% 6.4% Kosovo Montenegro Macedonia Serbia Albania Interest Rates on Deposits Source: CBK, IMF (2017) Interest Rates on Loans The decline of interest rate on loans of the Kosovo s banking sector during the three recent years, has had an impact on approximating with the interest rates of loans and deposits in the region countries (figure 53). Interest rates on loans The interest rate decline of the banking sector was influenced by the decline of interest rates on loans to enterprises and households as well. The average interest rate on loans to enterprises decreased to 6.6 percent (figure 54). All the categories of new loans to enterprises were characterized with a decline of interest rates. The average interest rate on non-investment loans declined to 6.3 percent, while interest rate on investment loans remained at 6.7 percent, marking a similar level as in the previous period (figure 54). 44

47 Based on maturity, interest rates decreased for mid-term loans, over 1 up to 2 years and over 2 up to 5 years, while interest rates on loans with maturity up to 1 year and over 5 years marked an increase. The category of loans with a maturity over 2 up to 5 years marked a more significant decline, from 7.5 percent at 6.7 percent in June Whereas, the category of loans with a maturity of over 5 up to 10 years marked the highest annual increase, reaching 6.8 percent in June 2017 from 5.6 percent in June 2016 (figure 55). Figure 54. Average interest rate on loans to enterprises and households 13% 12% 11% 10% 9% 8% 7% 6% Enterprises Households With a decline of interest rates were characterized all the categories of loans by economic activity. A more significant decline of interest rates it was marked by loans to agriculture sector which dropped to 6.1 percent, followed by loans to industry sector which in June 2017 had an average interest rate of 6.2 percent. Loans to other services marked a slight decline at 6.7 percent. Whereas, loans to other sectors, was the only category that increased to 6.7 percent in June 2017 (figure 55). Regarding loans to households, the average interest rate decreased to 7.1 percent from 7.8 percent as it was in June The most significant decline of interest rate was marked by consumer loans at 7.4 percent in June Whereas, the interest rate on mortgage loans decreased to 5.8 percent in June 2017 (figure 56). Figure 55. Average interest rate on loans to enterprises, by purpose 14% 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 13% 12% 11% 10% Investment loans Overdrafts Figure 56. Average interest rate on loans to enterprises, by maturity 9% 8% 7% Non-investment loans Credit lines Within mortgage loans, those with 6% 5% longer term of maturity had more favorable interest rates compared to loans with shorter term of maturity. The lower interest rate of 5.0 percent was Up to 1 year Over 2 year up to 5 years Over 1 year up to 2 years Over 5 year up to 10 years registered in mortgage loans with a maturity over 10 years, while the highest interest rate of 7.6 percent was recorded in loans with a maturity of over 1 up to 2 years. 45

48 Figure 57. Average interest rate on loans to enterprises, by economic activity 14% 12% 10% 8% 6% 4% 2% Agriculture Industry Services Figure 58. Average interest rate on loans to households, by purpose 17% 15% 13% 11% 9% 7% 5% 3% Loans to households Mortgage loans to households Consumer loans to households Household overdrafts Interest rates on deposits The average interest rate on deposits increased slightly at 1.1 percent from 1.0 percent a year earlier. The increasing trend of interest rate of total deposits mainly was impacted by the increase of Figure 59. Average interest rate on deposits 1.8% 1.6% 1.4% interest rate on household and 1.2% 1.0% enterprise time deposits (figure 59). Enterprise deposits continued to have 0.8% 0.6% higher interest rates compared to 0.4% household deposits. A more sustainable level of household deposits compared to 0.2% 0.0% enterprise deposits, may have had an impact on banks to offer more favorable Enterprises Households interest rates in order to attract enterprises more and receive deposits from them. Figure 60. Average interest rate on enterprise deposits, by categories 2% 2% 1% 1% 1% 1% 1% 0% 0% 0% Figure 61. Average interest rate on household deposits, by categories 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% Interest rate on transferable deposits Interest rate on saving deposits Interest rate on transferable deposits Interest rate on saving deposits Interest rate on time deposits Interest rate on time deposits The average interest rate on enterprise deposits increased to 1.7 percent. The increase of interest rate, among others, may have been influenced by banks reaction to stimulate an increase of enterprise deposits. The level of interest rates on enterprise deposits was driven by interest rate on time deposits, which in June 2017 marked the highest interest rate of 1.7 percent. The interest rate on saving deposits increased to 0.5 percent (figure 60). Interest rate on household deposits increased to 0.9 percent from 0.7 percent as it was in June 2016 (figure 61). The slight increase of the average interest rates on deposits reflects the increase of interest rate on time deposits, given that other deposits have very low interest rates (figure 61). 46

49 In millions of EUR Within household time deposits, the lowest interest rate of 0.3 percent was recorded by deposits with maturity over 3 up to 6 months, while the highest interest rate of 1.7 percent was recorded by deposits with maturity over 2 years, despite the fact that interest rates for this category of deposits marked the most significant decline of 0.13 percentage points Performance of the Banking Sector Performance of the banking sector continued to be positive, thus contributing in maintaining the financial and economic stability of the country. The profit of the sector, in June 2017, amounted to EUR 45.6 million, representing an annual growth of 20.8 percent (figure 62). Non-interest income marked a more significant increase thus giving the main contribution to profit increase, which at the same time was supported by the decline of loan loss provision expenses and interest expenses. Figure 62. Financial performance of the banking Profit Income Expenses Income Income of the banking sector recorded an increase unlike four recent years when they were characterized with a Figure 63. Income structure of the banking sector, in percent 100% declining trend. The value of income 90% 19.9% 20.6% 21.4% 27.0% accumulated during 2017 was EUR 80% million, corresponding to an 70% 60% annual growth of 5.2 percent. The main impact on the increase of total income was impacted by non-interest income, 50% 40% 30% 78.6% 78.8% 78.6% 72.6% 20% which marked an annual increase of 10% 32.3 percent. Both components of noninterest 2014 June 2015 June 2016 June 2017 June income, more specifically other operating income which almost reached Revaluation income Non-interest income Interest income an increase by five times higher compared to the previous year. Meanwhile, the first category of income, which account for interest income, marked an annual decline of 2.8 percent (figure 63). The continuous decline of interest rates on loans during the recent years have had an impact on interest income from loans to decrease by 1.2 percent. With a decline were characterized also other categories of interest income, such as interest income from placements with banks and from the interest of securities, as a reflection of the entire environment of low interest income which yet have continued to decline. 47

50 Expenses Banking sector expenses marked a decline in the first half of the year unlike the previous year that were characterized with an increase. The total value of expenditures of decreased to EUR 74.1 million, thus representing an decline of 2.5 percent. Interest and noninterest expenses, namely provision expenses on possible loan losses, had an impact on the total decline of expenses. However, the overall administrative expenses, which dominate the structure of expenses, marked an increase (figure 64). Figure 64. Banking sector expenses, in percent 3.2% 6.2% 100% 5.5% 4.0% 90% 80% 70% 51.3% 60% 66.1% 63.4% 68.3% 50% 40% 18.3% 30% 20% 11.5% 18.6% 16.4% 27.2% 10% 0% 16.2% 12.5% 11.3% 2014 June 2015 June 2016 June 2017 June Interest expenses Non-interest expenses General and administrative expenses Losses from revaluation Fees provisions General and administrative expenses increased by 5.0 percent, thus reflecting developments in staff expenses and in general expenses which were characterized with an annual growth of 5.0 percent and 4.8 percent, respectively. Also, non-interest other expenses marked an increase of 6.0 percent, which due to their low weight to total expenses gave little contribution to expenses movement in this period. Non-interest expenses were characterized with an annual decline (figure 65), as a result of the significant decline of 35.7 percent of loan loss provision expenses. The decline of nonperforming loans and the double increase of write-offs during this period had an impact on lowering the amount for loan loss provisions, which was reflected in the decline of expenses of this category. Despite the marginal increase of the annual average interest rate on time deposits, interest expenses continued to decrease as a consequence of significant impact from deposits which dominate the deposits structure of the sector, transferable deposits, whose interest rate declined. Annual decline of 12 percent of interest expenses reflects the decline of interest expenses on deposits of 9.0 percent and for interest on borrowings with 1.0 percent. Profitability and efficiency Figure 65. Expenses value of the banking sector Profitability indicators continued to remain at high levels. As a result of the profit growth, Return on Average Assets (ROAA) reached 2.6 percent, while the Return on Average Equity (ROAE) reached 21.9 percent 13 (figure 66) June 2015 June 2016 June 2017 June Interest expenses General and administrative expenses Non-interest expenses 13 Profit is prior to tax. 48

51 In millions of EUR The general efficiency indicator, expressed through expenses to general income ratio, marked an improvement as well. This ratio decreased to 61.9 percent, as a result of the decline of expenses and the growth of income (figure 67). Table 4, through certain indicators, depicts the measurement of the efficiency of the banking sector in generating income from assets (loans, securities and borrowings to other banks), and management of expenses (of deposits, subordinated debt and other borrowings). Figure 66. Profitability indicators of the banking sector % 29.1% 19.7% 21.9% 2.2% 3.2% 2.3% 2.6% 35% 30% 25% 20% 15% 10% 0% *2017 Profit* Return on Average Assets (right axis) Return on Average Equity (right axis) *Profit for 2017 is annualized 5% The ratio of interest income to the average of assets which bear interest has marked a slight decline of 0.3 Figure 67. Expenses-to-income ratio, in percent 90% percentage points. The base of assets which generate interest increased, albeit 80% 70% 77.9% 66.8% 62.5% 61.9% interest income declined as a 60% consequence of interest rates decline. The ratio of interest expenses to the average of liabilities that bear interest 50% 40% 30% declined for 0.1 percentage points, 20% implying the decline of expenses created 10% 0% by the usage of client assets mainly as a result of the quite low interest expenses on deposits. The decline of interest rates on loans and the slight increase of interest rate on deposits had an impact on the decline of net interest income, thus consequently declining the net interest margin at 2.5 percent from 2.8 percent as it was in the previous year. Table 4. Key efficiency indicators of the banking sector, in percent Description Interest income/average of income-bearing assets 3.7% 3.4% 3.1% 2.8% Interest expenses/average of liabilities-bearing expenses 1.1% 0.5% 0.3% 0.3% Net interest margin (net interest income/average of interest-bearing assets) 2.7% 3.0% 2.8% 2.5% Operational expenses/total assets 1.6% 1.5% 1.4% 1.4% The same trend of annual increase of operational expenses and the increase of assets had an impact on the ratio between them to be almost the same as in the previous period ( table 4). The utilization of the banking sector capacities, expressed through the indicator of the average value of assets managed by an employee, marked an improvement (table 5). This improvement was impacted by the higher increase of the banking sector activities, along with the lower number of employees in this sector compared to the previous year. The ratio of total expenses of the staff and the number of employees in the banking sector recorded an increase as a result of the increase of expenses for employees, while the number of employees downsized slightly, implying an increase of expenses per employee (table 5). 49

52 Table 5. Capacity indicators of the banking sector Description Assets/no. of employees (in thousands of EUR) , ,108.4 Personnel expenses/no. of employees (in thousands of EUR) Risks of the banking sector Main indicators of the banking risks stood at satisfactory level (table 6). The liquidity position of the banking sector remained sustainable, despite the accelerated increase of lending and the growth of transferable deposits, representing developments which had an impact on the decline of liquid assets indicator to short-term liabilities. However, this indicator continued to remain significantly above the minimal level of 25 percent as required by the regulation. Table 6. Risk indicators of the banking sector Description Loan-to-deposit ratio 78.1% 77.9% 80.7% 82.8% Liquid assets to total short-term liabilities ratio 43.7% 41.9% 41.5% 35.9% Capital Adequacy Ratio (CAR) 17.4% 19.0% 18.7% 18.1% Nonperforming loans to total loans ratio 8.2% 7.2% 5.3% 3.9% NPL coverage w ith provisions 116.4% 119.3% 119.9% 136.6% The value of total large exposures to Tier 1 capital ratio 124.0% 81.2% 61.9% 66.7% Opened positions in foreign currency To tier 1 capital 2.6% 0.8% 1.8% 2.3% Also, the indicators of the solvency risk showed high level of sustainability and high capability of the banking sector to endure potential losses. The regulatory capital ratio has marked a slight decline as a result of the decrease of Tier 2 capital, albeit continued to stand quite above the minimum required level and above the average of the region countries. Also, the quality of regulatory capital increased as a result of the increase of Tier 1 capital supported by profit accumulated along the years. The exposure to credit risk continued to decline, being reflected with lower rates of nonperforming loans to total loans. Also, the coverage level of nonperforming loans with loan loss provisions increased, showing a satisfactory coverage level of the sector with loan loss provisions. The concentration of credit risk, until June 2017, marked a significant increase unlike the two previous years as a consequence of a more significant increase of the value of exposures along with the increase of Tier 1 capital. The banking sector continued to have low exposure to market risk. The balance sheet of the banking sector almost entirely was denominated in EUR currency and consequently has low exposure to exchange rate risk. Loans and deposits of the sector mainly have fixed interest rates and have no impact of interest rates movements until maturity. However, there is a risk from interest rate in the context of repricing of assets and liabilities which are sensitive to interest rates. For the short term of maturity up to 30 days there was observed a narrowing of the negative gap compared to the previous year, which declines the exposure of the banking sector to the risk of possible interest rate increase. Whereas, the cumulative gap up to 1 year resulted as positive and narrowed, lowering the exposure to the risk of the possible decline of interest rate. Banks have created a system, policies and appropriate procedures for managing the operational risk. The management of the risk by June 2017 was appropriate, having no cases of its materialization and by keeping the needed capital for covering this risk in compliance with the regulatory requirements. 50

53 6.4.1 Liquidity risk Banking sector continued to have good liquidity position, with the main liquidity indicators standing above the minimal level as a required by the regulation. However, compared to the previous year, liquidity indicators have marked a decline. Despite of the higher increase of deposits compared to the previous year, a more accelerated increase of loans had an impact on loans to deposits ratio to stand at 82.8 percent from 80.7 percent as it was in June 2016 (figure 68). Figure 68. Loans and deposits of the banking sector, in millions of EUR 3,500 3,000 2,500 2,000 1,500 1, Loans Deposits Loan-to-deposit ratio (right axis) 84% 83% 82% 81% 80% 79% 78% 77% 76% 75% Figure 69. Total liquid assets to short-term liabilities ratio 2, , , , % 41.9% 41.5% 35.9% Total liquid assets Short-term liabilities Total liquid assets/short-term liabilities 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% The key liquidity indicator, liquid assets to short-term liabilities ratio decreased to 35.9 percent from 41.5 percent as it was in June The decline of the ratio is attributable to the higher increased rate of short-term liabilities with 6.9 percent, as a result of the shift from time deposits to transferable deposits, compared to the decline of 7.5 percent of liquid assets (figure 69). The decline of liquid assets, along with the expansion of the balance sheet of the sector, had an impact also in the decline of the liquid assets to total assets ratio of the sector at 27.5 percent from 32.0 percent as it was in the previous year. The decline of 13.2 percent of cash marked the highest contribution to the decrease of liquid assets during this period. The cost of assets which exceeded the required reserve (a part of which held in cash), alongside with the general accelerated increasing trend of lending, may have had an impact on shifting liquid assets to longer-term of maturities as more profitable assets. Reserves of the banking sector marked an annual decrease of 0.3 percent, thus continuing to stand above the level of regulatory requirements (figure 70). In Figure 70. Banking sector reserves, in millions of EUR June 2017, the required level of obligatory reserve was EUR million, while the value of total reserves held by banks exceeded the level of 100 obligatory reserve for 34.8 percent 50 compared to 46.7 percent as it was in 0 June The decline of cash and reserves during this period reflects banks discouragement to hold reserves above the required level of the obligatory Obligatory reserve Balance with CBK Cash Total reserves reserve also due to the negative interest rate applied as of August An impact may have been given also by the orientation of assets of banks to more profitable instruments such as loans and securities. 51

54 Banking sector was characterized with an increase of the structural risk of liquidity in June 2017, which is reflected through a maturity mismatch of assets and liabilities of the same maturity term (figure 71). The liquidity gap was expanded for the majority of categories. Negative gap 14 resulted only in the category with a maturity 1-7 days, whose value reached EUR - 1,615.9 million from EUR -1,405.1 million in June The deepening of the negative gap for this category of maturity compared to the previous year came as a result of the decline of assets of 8.4 percent in this category, while liabilities of this category increased by 7.6 percent. Meanwhile, for all other categories of maturity the gap was negative, and the expansion of the gap was mainly a result of the increase of assets in the specific categories. The decline of assets for the category with a maturity of 1-7 days resulted mainly by the decline of securities which have an agreed maturity of 1 to 7 days, the decline of deposits at other banks and the decline of loans. Whereas, the increase of assets in other categories of maturity reflects an increase of long-term lending and a shift of investments in securities with longer term of maturities. Conversely, the increase of deposits with short-term maturity was the main factor that had an impact on the increase of liabilities with maturity of 1-7 days. The increase of deposits was marked also in maturities of 1-3 months, 3-6 months, 6-12 months and 1-5 years, while all other categories of maturity marked a decline. This general shift of assets towards longer terms of maturities and the shift of liabilities towards shorter terms of maturities reflects the developments in interest rates. These developments with a tendency of shifting deposits towards the maturity with short-term, may further expand the liquidity gap for a short-term period, hence may cause problems in managing Figure 72. NPL to total loans ratio, in percent liquidity with longer term of maturity. 9% Credit risk Figure 71. Liquidity gap*, in millions of EUR % 7% 6% 1-7 days 8-30 days 1-3 months 3-6 months 6-12 months 1-5 years Over 5 years *As of 2015 there is a methodological change in calculation; equity not included CBK (2017) 5.3% The NPL rate at the banking sector, 5% which already was low, marked further decline during the first half of 2017 falling at the lowest level since end Nonperforming loans to total loans ratio, dropped to 3.9 percent compared 4% 3% 2% 1% 0% 3.9% to 5.3 percent as it was in the previous year (figure 72). The decline of NPL reflects the annual increase of lending of June 2014 June 2015 June 2016 June percent as well as the significant improvement of credit portfolio quality, where the value of nonperforming loans marked an annual decline of 17.8 percent (figure 73). 8.2% 7.2% 14 The negative gap implies that liabilities for a specific maturity exceed assets and vice versa. 52

55 Figure 73. Total loans and NPL, annual change 15% 9.2% 8.8% 10.0% 10% 6.2% 5% 3.6% 0% -5% -6.2% -10% -15% -17.8% -20% -21.0% -25% Total loans NPL Figure 74. NPL to total loans ratio in Kosovo and in some Western Balkan countries (June 2017) 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 11.5% Bosnia and Herzegovina 3.9% 6.1% 15.6% 15.6% Kosovo Macedonia Serbia Albania NPL rate of the Kosovo s banking sector, which followed a declining trend since November 2014, remains at lower level compared to the region countries, which at an average had an NPL rate of 12.2 percent to total loans, in June 2017 (figure 74). The banking sector exposure to credit risk was more pronounced in loans to enterprises which have an NPL rate of 5.0 percent compared to household loans which have an NPL rate of 1.9 percent. The majority of economic sectors within loans to enterprises were characterized with improvement of credit portfolio quality. A more significant decline of the NPL rate was marked by the category of other loans, which in June 2017 had an NPL rate of 2.5 percent compared to 15.6 percent in June This improvement is attributable more to the decline of NPL value than the trend for this sector. While, loans to manufacturing sector were the second category by credit portfolio improvement, as a result of the higher decline of the value of nonperforming loans along the decline of loans to this sector. The NPL rate for loans to manufacturing decreased to 3.7 percent compared to 8.6 percent in June The highest NPL rate was recorded by energy sector with 12.8 percent (figure 75). The exposure decline to credit risk compared to the previous period is presented also through the analysis of the structure of loans by classification, in which it is observed an increase of loans with no delays, such as standard and observed loans, and a decline of the share of loans classified as nonstandard, doubtful and loss. Figure 75. NPL rate by economic activities 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% June 2015 June 2016 June 2017 Figure 76. Structure of loans by classification 100% 95% 90% 85% 80% 75% 6.2% 6.0% 2.0% 1.2% 2.9% 4.0% 2.3% Alongside with the general improvement Standard Watch Substandard Doubtful Loss of credit portfolio quality, also the level of coverage of NPL with loan loss provisions has marked an improvement rising at percent, in June 2017 (figure 77). The increase of the ratio came as a result of the more significant decline of the value of nonperforming loans, given that the stock value of provisions marked a decline. The decline of the value of provisions, and 3.0% 84.9% 87.6% 3.9% 3.0% 1.3% 0.9% 1.5% 1.6% 2.0% 1.9% 91.3% 92.6% 53

56 In millions of EUR the decline of expenses for provisions, until June 2017, was impacted by the process of write-offs which moved from the balance lost loans and consequently resulted in a lower need for provisions. Banking Figure 77. NPL and provisions % 140% sector also strengthened the capacity for % 140 covering with capital any possible loan losses. This came as a result of the % 125% decline of the value of net % 119.9% nonperforming loans covered by loan % 116.4% loss provisions and the increase of the 40 capital of banks, which had an impact of % 0 110% the net nonperforming loans to capital ratio to decrease at 1.8 percent from 2.7 as it was in June NPL (in millions of EUR) Provisions/NPL (right axis) Concentration of credit risk The rate of credit concentration in Kosovo s banking sector, which is measured as a ratio of total large exposures to Tier 1 capital, has changed the two recent years declining trend increasing it to 70.9 percent in June 2017 (figure 78). This development is attributable to the significant increase of the value of high credit exposures of 58.0 percent, while Tier 1 capital increased by 13.5 percent. Alongside with the increase of the general value of large exposures, there was marked also an increase of the number of large credit exposures 15, thus reaching 40 from 25 as it was in June However, due to the higher increase of the number of exposures than the increase of their value, the average value of large exposures decreased at EUR 7.6 million from EUR 7.7 million as it was in the previous year, thus interrupting the increasing trend of the last three years Solvency risk Figure 78. Concentration of credit risk Kosovo s banking sector continued to have high level of capitalization. Capital Adequacy Ratio (CAR), which represents the ratio of total regulatory capital to risk weighted assets, declined to 18.1 from 18.7 percent as it was in the previous year, which still remains quite higher above the required level of 12 percent (figure 79). 16 The slight decline of the ratio was a result of the higher annual increase of risk weighted assets (RWA) of 14.2 percent, compared to the annual increase of 11.4 percent of the regulatory capital (figure 80). The regulatory capital in this year marked an accelerated increase compared to the previous year, as a consequence of the higher annual increase of Tier 1 capital and the decelerated decline 124.0% 81.2% 61.9% 66.7% Total large exposures Total Tier 1 capital Large exposure to Tier 1 capital ratio (right axis) 140% 120% 100% 80% 60% 40% 20% 0% 15 Large credit exposure is considered any exposure which exceeds 10 percent of Tier 1 capital. 16 According to the CBK regulation on Capital Adequacy, banks are required to have at least 12 percent of total regulatory capital to RWA ratio and at least 8 percent of Tier 1 capital to RWA ratio. 54

57 of Tier 2 capital. The higher increase of risk weighted assets against the Tier 1 capital had an impact on the ratio of Tier 1 capital to risk weighted assets to reduce at 16.2 percent form 16.3 percent in June Figure 79. Banking sector capitalization Figure 80. Regulatory capital and RWAs 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 19.0% 18.7% 17.4% 18.1% 15.9% 16.4% 16.2% 13.5% 11.7% 12.3% 13.0% 10.1% % 18.9% 14.2% 6.2% 11.4% 10.5% 8.3% 2.2% 25% 20% 15% 10% 5% 0% CAR Tier 1 capital / Risk weighted assets Equity to assets ratio Regulatory capital RWA Annual change of regulatory capital increase (right axis) Annual change of RWA increase (right axis) The capitalization level of Kosovo s banking sector remained above the average of 17.5 percent of the region countries (figure 81). Another indicator to assess the level of capitalization is the leverage ratio, which evaluates the coverage level of the banking sector activity with equity. This ratio increased to 13.0 percent from 12.3, continuing to stand above the regulatory requirement of the minimal leverage of 7 percent. 17 The higher increase of 13.4 percent of total equity, compared to the annual increase of 11.9 percent in the previous year, contributed to the increase of this ratio. The current level of the leverage is below the average level of the region countries, which stood at 13.8 percent in June 2017 (figure 81). Figure 81. CAR in Kosovo s banking sector and in region countries (June 2017) 25% 20% 15% 10% 5% 0% Figure 82. Structure of regulatory capital 100% 90% 80% 70% 60% 50% 40% 15.7% 14.7% 30% Regulatory capital 20% The value of regulatory capital of the 10% banking sector reached EUR % million in 2017, exceeding the minimal Tier 1 capital Tier 2 capital capital regulatory requirement for EUR million. The quality of capital, expressed through the share of Tier 1 capital to total regulatory capital, marked an increase for the third consecutive year mainly as a result of the retained profit from the previous year. 22.9% 77.1% 18.1% 13.0% 15.4% 11.1% 22.4% 20.3% 16.3% Bosnia and Herzegovina Kosovo Macedonia Serbia Albania CAR Financial leverage 16.4% 12.5% 10.8% 83.6% 87.5% 89.2% 9.9% 17 CBK regulation on Capital Adequacy, Article 9. 55

58 In June 2017, the value of Tier 1 capital totaled EUR million, representing an annual increase of 13.5 percent, whereas its share to total regulatory capital reached 89.2 percent (figure 82). Figure 83. Structure of Tier 1 capital Investments in equity & and deferred tax Lending to a bank-related person Intangible assets and goodwill Profit for the current year, retained profit, reserve funds Capital (shareholder capital, surplus, preferred shares) Figure 84. Structure of Tier 2 capital, in millions of EUR General reserves for loans (standard and watch) Subordinated debt The structure of Tier 1 capital remained similar to previous periods. Shareholder s capital continued to be the dominant category of Tier 1 capital, despite the decline of its share to 65.1 compared to 72.6 percent as it was in June The decline of the capital share was a result of the increase of the share of retained profit from previous years (figure 83). The value of Tier 2 capital totaled EUR 52.3 million in June 2017, corresponding to an annual decline of 3.4 percent. This was mainly a result of the decline of general provisions held for loans 18 for 6.9 percent and the decline of subordinated of 1.2 percent. The good financial performance of the sector in the recent years has enabled banks to increase their capital through own resources, namely through retained profit, which created a possibility for banks to reduce Tier 2 capital. Subordinated debt, in June 2017, decreased to EUR 32.6 million comprising 62.3 percent of Tier 2 capital (figure 84). The remainder of 37.7 percent of Tier 2 capital is comprised by general provisions for loans. Risk-Weighted assets RWAs accelerated their annual increase to 14.2 percent in June 2017 from 8.3 percent in the previous year. Also, the share of risk assets to total assets of the banking sector 19 increased to 67.0 percent in June 2017 (figure 85). Figure 85. RWAs to total assets ratio of the sector Figure 86. RWA structure by risk weight 110% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 60.6% 62.2% 63.5% 67.0% Operational risk to to total RWAs ratio Total RWAs to assets ratio Credit risk to total RWAs ratio 100% 80% 60% 40% 20% 0% 72.5% 78.9% 82.8% 83.6% 15.1% 9.7% 6.0% 5.1% 9.5% 8.9% 9.3% 8.5% Weight 150 % Weight 20% Operational risk Weight 50 % Weight 75% Weight 100 % 18 The value of provisions allocated by banks for loans classified as standard and watch is calculated as part of Tier 2 capital, limited to 1.25% of risk- weighted assets. 19 Here are included also off-balance sheet assets, as the total value of RWA includes off-balance sheet assets. 56

59 Out of total assets with risk, 91.5 percent are assets with credit risk, while the remainder is represented by assets dedicated for operational risk management. The increase of RWAs came as a result of the increase of assets with risk weight of 100% which represent the dominant category of total RWAs (figure 86). The value of these assets, which account for mortgage and residential loans, equipment and other core assets and other real estates, reached EUR 2.2 billion from EUR 1.9 billion in June Besides assets with risk weight of 75% which marked a decrease, all other categories of risk assets have marked an increase during this period. Disregarding the trend of the category of risk weighted assets, their structure did not suffer any significant change Market risk Exposure of the banking sector to market risk, which implies the exposure to the risk of oscillations in currency exchange rates and movements in interest rates, continued to remain at low level. The ratio of net aggregated opened position in foreign currency to Tier 1 capital increased to 2.3 percent from 1.8 percent in June 2016, albeit continues to be classified as a low level. Loans in foreign currency further declined their share, reaching 0.1 percent in June 2017, to total credit portfolio, which decreases more the exposure to currency risk. Loans and deposits continued to have almost entirely fixed interest rates, being impacted by interest rate movements only in maturity. The negative gap between assets and liabilities sensitive to interest rates for the short-term maturity of up to 30 days narrowed, reducing the exposure to possible increase of interest rates which will reflect more in expenses of refinancing than in reinvestment income. On the contrary, positive cumulative gap for the period up to 1 year declined, which represents a lower exposure to the risk of possible decline of interest rate. Exchange rate risk Net opened position in foreign currency increased to 6.4 from EUR 5.4 million equivalent value in June This came as a result of a more significant increase of EUR 8.6 million equivalent value of assets in currency, whose value reached EUR million. Meanwhile liabilities in foreign currency increased by EUR 7.6 million equivalent value, reaching the value of EUR million equivalent value. The net opened position in foreign currency exposes the sector to changes in currency exchanges depending on the direction of the Figure 87. Opened positions in foreign currency to tier 1 capital 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% 1.8% 1.3% 1.2% currency and type of position (short or long). In June 2017, net opened position was long (assets in foreign currency were longer than liabilities) for two of the major currencies (US dollar and Swiss franc), whereas just the opposite stands for the British pound where liabilities exceeded assets in this period. On the other hand, net aggregated opened position for all currencies 20 increased to EUR 10.0 million equivalent value in June 2017, from EUR 6.9 million value in the same period of the 0.1% 0.0% -0.1% 0.3% 2.3% -1.0% June 2016 June 2017 US$ UK CHF Other Net aggregated opened position/tier 1 capital 20 Aggregated net opened position accounts for the amount of long and short positions in all currencies. For instance, a short net position (-) in dollars equivalent of 1 million equivalent value in EUR and a net long position (+) in Swiss franc with 1 million equivalent value in EUR results in aggregated net position of EUR 2 million, while net opened position currency would be 0. 57

60 previous year. A more significant increase of aggregated position in foreign currency than the increase of Tier 1 capital of the banking sector during this period made their ratio increase at 2.3 percent from 1.8 percent as it was in June 2016, which, however, shows a low sensitivity level of the sector to changes in exchange rates (figure 87). As regards to specific currencies, net disaggregated position to Tier 1 capital, US dollar marked a higher level of 1.2 percent (form 1.3 percent in June 2016), whereas for the Swiss franc this ratio increased to 0.3 percent (from 0.0 percent in June 2016). Meanwhile, for the British pound, this ratio changed direction from 0.07 percent to -0.1 percent in June The ratio of net opened position for each single currency to Tier 1 capital continued to remain quite below the maximum level of 15 percent as required by the regulation. Lending in foreign currency continued to remain at low levels and still marked a further decline. In June 2017, the value of total loans in non-euro currencies it was EUR 3.6 million equivalent value, compared to EUR 4.4 million equivalent value in the previous year. The increase of lending in EUR currency and the decline of lending in non-euro currency made the ratio of loans in noneuro to total credit portfolio to slightly decline at 0.1 percent. Figure 88. Loans and deposits in foreign currency 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 0.3% 0.3% 0.2% 0.1% On the other hand, the value of deposits in foreign currency totaled EUR million from EUR million equivalent value in June However, the share of non-euro deposits to total deposits declined to 4.8 percent from 5.0 percent in June 2016, as a result of the higher increased rate of total deposits. Conversely, the decline of loans in non-euro currency against the increase of deposits in non-euro currency made the ratio of loans in non-euro currency to deposits in non-euro currency to decline at 2.6 percent in June 2017 (figure 88). 5.7% 4.3% 4.6% 5.3% 5.0% 3.3% 4.8% 2.6% The share of foreign currency loans to total credit portfolio The share of deposits in foreign currency to total deposits Loans in foreign currency against deposits in foreign currency The risk of interest rates The Kosovo s banking sector continued to be exposed to the risk of interest rates as regards to the refinancing and reinvestment rates of assets in the period when they mature. However, oscillations in interest rates may have had an impact on the sustainability of the banking sector when taking into account the risk of refinancing and reinvestment of assets, depending on the composition of maturity of assets and liabilities which bear interest (figure 89), and the movement direction of interest rate. Figure 89. Assets and liabilities gap sensitive to interest rates, in millions of EUR days days days 1-5 years Over 5 years The gap between assets and liabilities that bear interest is negative only for the category with a maturity up to 30 days, which exposes the sector to possible increase of interest rate in shortterm basis, since the cost of refinancing from deposits would mark a higher increase than the 58

61 increase of the income from reinvestment of assets. In June 2017, the negative gap for this interval of maturity was expanded to from EUR million in the previous year, increasing the exposure of the sector to this risk. Whereas, cumulative gap for the period of maturity up to 1 year was positive and it was reduced by declining at EUR million from million, which reduces the exposure of the sector to possible decline of interest rate which affects the interest income. For all other maturities beside over 5 years maturity, the gap of assets and liabilities that bear interest is more expanded compared to previous year. The gap for the maturity over 5 years narrowed, whose value declined at EUR million. While the cumulative gap between assets and liabilities for all maturities reached EUR 1.5 billion from EUR 1.4 billion as it was in June The shift of time deposits to transferable deposits in one hand and the accelerated increase of lending on the other hand, had an impact on expanding the positive cumulative gap between assets and liabilities sensitive to interest rates. Stress test results suggest that the sector is able to withstand possible scenarios of the decline of interest rates on assets and the increase of interest rates on liabilities, despite the negative effect that these developments would have on the income of the sector. Box 2. Identification of banks with systemic importance in Kosovo The model for identifying banks with systemic importance represents an important tool for a continuous assessment of the scale of systemic importance of commercial banks in Kosovo. A bank is considered to have a systemic importance if its possible failure is expected to be manifested with a negative severe functions and stability of the whole financial sector and the economy in general. Therefore, the continuous monitoring of the systemic importance is considered to have a special importance for the financial stability. The model as well enables drafting of recommendations for policies and needed measures to ensure appropriate absorbing capacities of possible losses of banks in compliance with their systemic importance scale, thus serving in maintaining the financial stability in the country. 21 Table 7. Indicators used to assess the systemic importance of banks in Kosovo Criteria Indicators Size (weight 25%) Substitutability (weight 25%) Interconnectedness (weight 25%) Interstate activity and complexity (w eight 25%) Assets (w ithout provisions) Value of transactions to total transactions value ratio of the sector through payment system The share to total loans to households The share to total loans to nonfinancial corporations The share to total household deposits The share to total loans to other financial corporations and placements in other banks (excluding parent banks) The share to total financial corporation deposits and other borrow ings (including also deposits of other banks) The share in securities Claims to external sector Liabilities to external sector The share of off-balance items This box represents the assessment of the systemic importance for all banks and branches of foreign banks operating in Kosovo based on data as of June 2017 of the balance sheets of the appropriate banks. This year the model has been enhanced being adopted in compliance with the instructions issued by European Banking Authority (2014), according to which are defined four basic criteria for assessing the systemic importance of banks: criteria of size, substitutability, interconnectedness, and interstate/complexity activity. All four criteria were given equal weight and for each of the criteria were defined specific indicators through which it is measured the systemic importance of individual banks (table 7). The selection of the indicators 21 For the theoretic base and the complete methodology of assessing Banks with Systemic Importance, please refer to the CBK working paper no. 7 Identification of Banks with Systemic Importance and Additional Capital in Kosovo. 59

62 was applied in compliance with certain theories and suggestions of the framework up on which it was developed the model. A bank is considered with a general systemic importance if the average of all criteria for the appropriate bank exceeds the borderline of the systemic importance. The systemic importance line is calculated as an average of the sector for all criteria. Also for other certain criteria, a bank is identified with systemic importance if the weighted average of one criteria for the appropriate bank exceeds the average of the sector in this criteria. The weighted average for the Kosovo s banking sector results to be 1,000 base points, and banks which have higher average than this borderline are considered to be with systemic importance. Below it is presented the description of criteria and the way of measuring them: Criteria of size, is considered a very important criteria in measuring systemic importance of an institution, as the higher the share of a bank to the sector is, the more significant its systemic importance is. This because parties affected by the shock of the bank are more comprehensive and costs for the whole sector and the economy are larger. The criteria of size is measured as a ratio of assets of each institution to total assets of the sector. Figure 90. General scale of systemic importance 3,000 2,500 2,000 1,500 1, A B C D E F G H I J Overall systemic importance Borderline of systemic risk Figure 91. Criteria of size 3,000 2,500 2,000 1,500 1, A B C D E F G H I J General scale of systemic importance Borderline of systemic risk The criteria of substitutability measures the substitutability scale of the products and services offered by the appropriate bank by other banks in the market, in case that bank fails. The higher the share of a bank is in a certain segment of the market or in offering a certain service, the higher are technical capacities and knowledge for the functioning of the appropriate sector (e.g. of the payment system), which makes it more difficult the substitution of its role in offering Figure 92. Criteria of substitutability 3,000 2,500 2,000 these banking services. Therefore, also the systemic importance of one institution 1,500 increases when the difficulties and costs are 1,000 higher for substituting the offered services and products of that bank A B C D E F G H I J Interconnectedness criteria aims to General scale of systemic importance Borderline of systemic risk measure the interconnectedness scale among the banking institutions and interconnectedness with other financial institutions in the country, in order to identify the risk of the spill-over effect crises of one institution to other financial institutions and to the real sector. This criteria is of utmost importance for measuring the systemic risk in countries with developed financial sectors where interconnectedness among the institutions is high and complex. Kosovo s inter-banking market is at quite low level of its activity and interconnectedness between financial institutions mainly are 60

63 limited in deposits and loans that other financial institutions as insurance companies, microfinance institutions and other financial auxiliaries have in commercial banks in Kosovo. Consequently, the interconnectedness of financial institutions is measured through the share of placements in other banks and credit exposure to other financial corporations, and the share of deposits and borrowings from other financial corporations. In this criteria are included also banks investments in securities, which are mainly comprised of investments in Kosovo s Government securities and other foreign governments abroad. Figure 93. Criteria of interconnectedness Criteria of inter-state activity and complexity measures the interactivity scale of one bank with external sector in the context of assets and liabilities as well, and the scale of complexity of the business model and operations of a bank. This criteria aims to present the risk level of a bank against its exposure to external sector and the risk level under the assumption that the higher the complexity of a bank is, the higher are interconnectedness and agreements with third parties, which increase costs and time for addressing problems in case of failure. Kosovo continued to have quite low level of banking interconnectedness with other countries, therefore is more resistant to possible risks which come from the external sector. As an indicator for measuring the inter-state activity were taken into account claims and liabilities to nonresidents whereas as an approximate indicator for measuring the complexity of a bank were taken into consideration the off-balance sheet items to total assets portfolio of that bank. 3,000 2,500 2,000 1,500 1, A B C D E F G H I J General scale of systemic importance Borderline of systemic risk Figure 94. Criteria of interstate activity and complexity 3,000 2,500 2,000 1,500 1, A B C D E F G H I J General scale of systemic importance Borderline of systemic risk Results General results of the model, based on the data of June 2017, suggest that five banks are with the general systemic importance (figure 90). Two out of these banks resulted to have systemic importance in all criteria. Results also show that one bank which has no general systemic importance has shown a systemic importance in interconnectedness criteria. The general scale of systemic importance ranges between 1,136 base points to 2,489 base points, which is lower than in the previous year. This resulted to be as such because in the first half of 2017 in the analysis were involved ten banks operating in Kosovo unlike in the previous year of the same period when it was not included one bank. Also, in this period it was observed a slight decline of the weight of banks with overall systemic importance, which was more sensitive in the interconnectedness and substitutability criteria. This came as a result of investments in securities of the banks with systemic importance, the decline of interbank liabilities and the decrease of credit concentration of these banks in lending to enterprises. Criteria of size - four banks resulted to be with systemic importance in size criteria (figure 91). The scale of systemic importance in this criteria ranges from 1,266 base points to 2,432 base points, representing a decline compared to the previous year. The decline was mainly a result of the inclusion of an 61

64 additional bank which was not included in the previous year because it was considered still on the initial phase of its activity. Also, banks which do not have systemic importance have accelerated their activity more specifically their credit activity, by increasing the share of assets compared to previous year. Criteria of substitutability- in this criteria with a systemic importance resulted to be four banks. The scale of systemic importance in this criteria, in June 2017, ranged from 1,432 base points to 2,364 base points (figure 92). Also in this criteria, the scale of systemic importance marked a decline compared to previous year as a result of the decline of lending to enterprises from banks with higher share of lending for this sector along with the increase of lending of banks with lower share which are not considered to be with systemic importance. Interconnectedness criteria- with systemic importance in the criteria of interconnectedness resulted to be three banks with an overall systemic importance and another bank which is not considered with an overall systemic importance. The scale of systemic importance in this criteria ranged from 1,419 base points to 2,103 base points (figure 93). Compared to the previous year, the scale of systemic importance was decreased as a result of the decline of investments in securities of banks with systemic importance. Also, in the previous year when a bank had systemic importance in this criteria, this year has not resulted as such, albeit stands very close to be of systemic importance. The scale of systemic importance for this bank decreased for base points, as a result of the decline of loans to other financial institutions. Criteria of inter-state and complexity activity - Three out of four banks with overall systemic importance have resulted to be with systemic importance in criteria of inter-state activity. The scale of systemic importance in this criteria ranged from 1,438 base points to 3,055 base points (figure 94). Compared to the previous year, the scale of systemic importance was decreased as a result of the decline of liabilities of banks with systemic importance to the external sector. Also, banks with the overall systemic importance marked a significant increase of off-balance assets thus having an impact on the decline of the complexity scale Stress-test analysis Stress-test analysis present an important tool to assess the sustainability of the banking sector to possible shocks in credit portfolio and the position of liquidity, which may follow unfavorable macroeconomic developments and changes in market conditions. Through this analysis it is assessed the impact of these shocks in the quality of credit portfolio, on the level of capitalization and on the position of liquidity. The analysis presented below is based on the data of the banking sector of Kosovo for 2017, which were used to assess the sustainability of the sector to credit risk, combined with the risk from interest rates and the risk from currency exchange rate (market risk). In the analysis it was tested also the ability of the sector to maintain the liquidity position under the hypothetic assumption of considerable deposits withdrawals (liquidity risk). The results of stress-test analysis continuously suggest satisfactory capability of banks to face extreme situation of the exposure to these risks Sustainability assessment of the banking sector to loans portfolio shocks Methodology Baseline scenario: The analysis is based on the hypothetic scenario when the economic situation in euro area and in the region will be deteriorated, reflecting Kosovo s economy mainly through the decline of remittances and exports, thus discouraging the general demand in the country. As a result, it is supposed to be marked an economic decline, which expands the negative output gap and has an impact on the increase of nonperforming loans. In this scenario it was taken into account an average economic growth rate of 3.2 percent in Kosovo in six recent years, and it was supposed an economic decline of 2.6 percent in In this situation, the 62

65 negative output gap would be 5.8 percent, while the impact on the credit portfolio quality, namely on nonperforming loans, it was assessed by considering an elasticity coefficient of NPL to output gap of implying an increase of 4.7 percentage points of NPL to total loans of the banking sector. As a consequence of the shocks in the real sector, it was supposed that lending would not increase in the following year. In an additional scenario besides the baseline scenario, along with credit risk, were considered also the effects of the market risk in the income of the sector. Therefore, credit risk was combined with the risk of interest rate and with the exchange rate risk. The interest rate for the part of assets were supposed to decline for 2.0pp, while for the part of liabilities interest rates would increase for 1.5pp mainly as a result of the banking competition. Depreciation of EUR currency to other currencies was supposed to be 20 percent. The effects of the above assumption of the banking sector reflects as follows: the increase of the share of NPL to total loans has an impact on the increase of provisions; depreciation of EUR affects the revaluation of loss/profit from net opened position, and the change of interest rates has an impact on the loss/profit of net income from interest taking into account the maturity of assets and liabilities and their reinvestment/refinancing. Besides these assumptions, it was taken into account the expected profit as a loss absorption of these shocks. In this context, it was assumed that the profit, as well, would be impacted by above mentioned shocks, mainly through the decline of ability to generate interest income as a result of no increase of lending activity and failure of loans (NPL increase). Therefore, the expected profit of banks for the following year was calculated taking into account the net profit after the tax realized in the second half 2017, to which it was applied a shock of 40 percent to reflect the effect of no increase of lending activity, and after that were deducted also the income which would be realized if NPLs would not mark an increase. 23 The assumed increase of NPL was expressed through migration of loans from performing category (standard, watch, sub-standard) towards nonperforming category (doubtful and loss). This increase was spread proportionally within the category of doubtful loans and loss loans, taking into account the initial share of these categories to total NPL. The increase of NPL reflects on the level of provisions based on the CBK regulation regarding loans provisioning by classification. The assumption on NPL increase is applied on off-balance items which include unused commitments, guarantees, available credit notes, and commercial credit notes. Despite the fact that to the additional scenario was considered the depreciation of EUR against foreign currencies to assess the risk of exchange rate, it is important to emphasize that the impact of this risk on the balance sheet of banking sector continued to have minor effects due to the low value of net opened positions in foreign currency. The scenario on the risk from interest rate implies the decline of interest rates of 2pp for assets 24 and the increase of 1.5pp for liabilities on the balance sheet. The decrease of interest rate may have an impact on the net interest margin (NIM), primarily taking into account the maturity of loans and deposits since the majority of loans and deposits of the Kosovo s banking sector have fixed interest rates and changes in interest rates are not reflected until maturity. The negative effect on income from the decline of interest rate on the side of assets is further emphasized by the negative effect that has the increase of interest rate of liabilities. 22 Unpublished IMF research paper, "CESE Bank Loss Projection and Stress Testing Exercise", July Assessment of 'lost' income as a result of the NPL increase was initially made by calculating ex-post rate of the overall interest rate on loans for each bank, which was then multiplied by the added value of NPL. 24 The interest rate on loans declined at an average of 1.3pp in 5 recent years. 63

66 Other additional scenarios: Along with the above mentioned base scenarios, additional scenarios in the analysis on credit risk were considered also the failure of largest borrowers in each of the banks, and the capable level of NPL for each of the bank before problems with capitalization would appear. Finally, the sustainability of the banking sector in this analysis was assessed taking into account the impact of hypothetic scenarios on the level of regulatory capital of the banking sector, riskweighted assets and consequently, capital adequacy ratio. Results The state of Kosovo s banking sector as regards to capitalization, until June 2017, was quite favorable, with the capital adequacy ratio standing at 18.1 percent 25 (table 8). The banking sector continued to stand at good position regarding the nonperforming loans to total loans ratio, with 3.9 percent of NPL rate, and the coverage rate of nonperforming loans with loan loss provisions which reached percent. Table 8. Summary of stress-test results: credit risk Description CAR <0 Number of banks 1/ CAR NPL Recapitalization 2/ CAR 0-8% CAR 8-12% Low er level Higher level Sector level Low er level Higher level Sector level In thousands EUR As % to GDP Current levels (prior to shocks) % 74.0% 18.1% 0.6% 6.5% 3.9% Results of macro scenarios Note: 1/ out of ten banks considered in the stress-test analysis, the number of banks which falls under the required regulatory level, broken-down by sectors. Note: 2/ In reporting the minimum and the maximum values of indicators on the level of banks, in some cases were excluded the high values of CAR and the NPL Value of 0 percent, with which are characterized banks in the beginning of their activity. Base scenario % 70.8% 18.1% 4.7% 11.1% 8.6% 8, % Combination of market risk % 70.1% 17.5% 4.7% 11.1% 8.6% 10, % Failure of three borrow ers % 73.0% 17.3% 0.6% 33.8% 10.8% 27, % Failure of five borrow ers % 73.0% 16.5% 0.6% 42.9% 12.7% 37, % Baseline scenario: Under the assumptions of the base scenario to assess the credit risk (including also the off-balance items), in which the share of NPL to credit portfolio would increase for 4.7pp, while the retained profit after the shock would be used to absorb losses, CAR of the banking sector would suffer changes, thus standing at 18.1 percent. The total loss of the banking sector would reach the value of EUR 66.3 million (1.0 percent of the value of GDP forecasted for 2017). However, the whole amount of this value can not be considered as a loss for the sector taking into account that a large amount of this loss would be absorbed by the realized profit. Also, a part of the losses is assumed to be compensated by realization of the collateral or by restructuring loans, albeit this aspect was not taken into account in this analysis. On the level of individual banks, two banks would face with capitalization problems, where CAR would decline at 9.4 percent and 9.8 percent, respectively, which is below the regulatory minimum and additional needed assets for increasing the capital at the minimum required level would amount to EUR total 8.6 million. These two banks have no systemic importance and operate as branches of parent banks, hence the regulatory requirements for the capital are limited based on the capital of the appropriate parent banks. In general, under the assumption of base scenario for assessing the credit risk, banking sector would face an increase of 4.7pp of NPL without risking the capability of banks to fulfill the requirements of capital adequacy ratio as set by the CBK. In these circumstances, the share of NPL to total loans of the banking sector after the shock would reach 8.6 percent, while on the level of individual banks, the highest level of NPL would reach 11.1 percent. 25 In this analysis were involved ten banks operating in Kosovo. 64

67 Additional scenarios: Results of additional scenario, in which the credit risk is combined with the market risk, where besides the 4.7pp increase of NPL is included also the depreciation of EUR and interest rates oscillations at the above assumed levels, CAR of the banking sector would decline at 17.5 percent. In this case, two banks would decline below the minimum required level of CAR at 12 percent, and the needs for recapitalization would amount to EUR 11.0 million (0.17 percent of the nominal value of GDP forecasted for 2017). In this scenario, the effect of EUR depreciation on the income of the sector is presented at low but positive level due to the net opened position that the sector had in June This means that banks have more assets denominated in currency than liabilities, and the possible depreciation of EUR to other currencies would bring higher income since the net equivalent value in EUR would result higher. While the impact of interest rate decline on the income of the sector and the increase of interest rate on expenses will be negative and very high. However, despite additional losses from changes in market conditions - resulting in a change of interest rates, banking sector, though, results to be stable with a capitalization level over 12 percent. Another additional scenario assumes the failure of large credit exposures. Results of the scenario in which it is assumed the failure of the three largest borrowers in each of the banks, suggests that CAR of the sector would drop to 17.3 percent. In these circumstances, in one of the banks CAR would decline below the minimal required level of 12 percent. This would require EUR 28.0 million (equivalent value of 0.44 percent of the nominal value of GDP) additional needed assets for increasing the capital at the minimal required level. Under the assumption of the failure of five largest borrowers in each of the banks, CAR of the sector would decline at 16.5 percent, and two of the banks would result undercapitalized. The needed amount for recapitalization would reach EUR 37.1 million (an equivalent value of 0.59 percent of the Nominal value of GDP in 2017). Banking sector is able to face an NPL ratio to total loans up to 23.3 percent without having a need for additional capital injection in order to keep CAR of the sector at the required regulatory level of 12 percent. Also, the capable level of NPL for each of the bank before capitalization problems would appear is very high for the majority of banks. There is only one bank that would successfully face an NPL rate of only 2.4 percent before becoming undercapitalized. In one of the banks NPL would increase up to 31.1 percent to total credit portfolio of that bank before needing additional capital Sustainability assessment of the banking sector to liquidity shocks Methodology Baseline scenario: The analysis of the banking sector sustainability against the liquidity position is relied on baseline scenario of withdrawing a significant value of deposits from the banking sector, thus assessing the ability of the sector to face with such a shock. More specifically, it was considered an 8 percent withdrawal of deposits on daily basis, for five consecutive days, allocating 5 percent of remained deposits after each day for the purpose of banking operations in the following days. The allocation of 5 percent of deposits for operational purposes, which under the assumed scenarios, the obligatory reserve of 10 percent would decrease for 50 percent. The scenario was also build under the assumption that during this period the possibility of converting liquid assets into cash would be 80 percent of total liquid assets, while the possibility of converting non-liquid assets in cash would only reach 1 percent of these assets within a day. The scenario in which this analysis is based is quite conservative also due to the fact that it was not taken into account the ability of banks to fulfill part of their liquidity needs through their external financing sources. 65

68 Additional scenarios: Along with the above mentioned scenario, additional scenarios in the analysis on liquidity risk were considered also the failure of the largest borrowers in each of the banks, and the capable level of NPL for each of the bank before problems with capitalization would appear. As a conclusion, the banking sector sustainability in this analysis was tested by assessing the adequacy of liquid assets of the banks to face with large deposit withdrawals and the adequacy of liquid assets in order to face possible risks from deposits concentration. Results Kosovo s banking sector was characterized with high liquidity level in 2017, where the key liquidity indicator (liquid assets to short-term liabilities ratio) stood at 35.9 percent. Therefore, as a result of the good liquidity position, the whole banking sector showed satisfactory ability of facing with assumed scenarios of deposit withdrawals. Table 9. Summary of stress-test results: liquidity risk Description Number of banks 1/ Additional needed liquid assets (in thousands of EUR) Loans/Deposits Additional needed liquid assets as % to GDP After the first day % 0.00% After second day % 0.00% After third day % 0.00% After fourth day 4 22, % 0.36% After fifth day 6 76, % 1.20% Note: 1/ Out of ten banks considered in the stress-test analysis, the number of banks which fall under the required regulatory level, broken-down by sectors The baseline scenario results of withdrawing 8 percent of deposits within a day, for five consecutive days, suggest that Kosovo s banking sector would begin to have needs for additional liquidity only in the fourth day, where two of the banks would lack an amount of EUR 22.9 million of liquid assets (table 9). Out of these four banks which would become not liquid, two of them are with overall systemic importance. At the end of the fifth day, problems would appear also in two other banks, which are not with overall systemic importance, thus increasing to six the number of banks which would have lack of liquid assets for facing with assumed deposit withdrawals. The scale of total deposit withdrawals in the fifth day would rise to 34.1 percent, and the amount of additional liquid assets needed for successfully overcoming liquidity problems would amount to EUR 76.3 million (1.20 percent of the GDP Nominal value in 2017). The failure assumption of large depositors in each of the bank results to be not of a concern for the general liquidity statement of the banking sector. Results of this scenario suggest that Kosovo s banking sector has no significant concentration of financing sources (deposits as the main source of liabilities) where none of the banks would have liquidity problems. The capable level of deposits withdrawal for the whole banking sector before liquidity problems would appear results to be 23.6 percent, implying that the banking sector may be able to face the withdrawal of one third (1/4) of total deposits without having a need for liquid assets. In this case, under the assumption that loans value would not increase, loans-to-deposits ratio for the banking sector would reach percent. Also, the capable level of withdrawing deposits for each of the bank before liquidity problems would appear is very high in general. The bank with the lowest threshold stands at 17.2 percent, whereas the one with the highest threshold stands at 41.0 percent. 66

69 6.6. Financial infrastructure in Kosovo Payments system Payments system has an important role in the financial system of a country s economy, taking into account that its efficient and safe operation represents a very important factor in maintaining and promoting financial stability. In Kosovo there is only one payment system for interbank payments, Interbank Payment System (IPS), being operated and supervised by Central Bank of the Republic of Kosovo (CBK). The number of transactions processed by Automated Transfer System, by June 2017, totaled 5.9 million (5.4 million until June 2016), marking an annual increase of 8.0 percent. While, in the same period, the total value of transactions reached euro EUR 5.6 billion (EUR 3.9 billion until June 2016), representing an annual increase of 43.5 percent. Priority massive payments represent the category with the highest share in the number of realized transactions through Automated Clearing House (ACH) component (table 10). These payments represent 2.6 million realized transactions (or 43.4 percent of total number of transactions) and are mainly payments from governmental institutions (such as wages and pensions). Table 10. The share of payment instruments to total transactions of IPS, in percent Number of total transactions Value of total transactions Description June 2016 June 2017 June 2016 June 2017 Prioritized (RTGS) 0.2% 0.8% 8.1% 33.2% Securities 0.01% 0.01% 13.7% 9.3% Bank-to-Bank (RTGS) 0.00% 0.05% 0.0% 23.1% Regular (ACH) 11.8% 10.2% 46.0% 10.3% Regular-massive ( ACH) 36.8% 34.3% 8.2% 5.8% Prioritized-massive ( ACH) 37.7% 43.4% 10.2% 8.2% Giro payments (ACH) 13.2% 10.6% 13.7% 9.8% Direct debiting (ACH) 0.2% 0.3% 0.1% 0.1% After that come regular massive payments, which represent 2.0 million realized transactions (or 34.3 percent of total number of transactions) and are mainly payments received by governmental institutions and account for tax payments, fees, customs etc., while thousands transactions (10.6 percent) account for Giro payments mainly being composed by public utilities (bills of public utility companies, governmental institutions such as Customs Services and Kosovo Property Agency (KPA) (table 10). Regarding the value of transactions, priority payments realized through Real Time Gross Settlement (RTGS) is the category with the highest share of realized transactions, which in the reporting period totaled EUR 1.84 billion. The category of bank-to-bank transactions comprise 23.1 percent of total value of realized transactions. The third category is comprised by regular transactions (credit transfers below the value of EUR 10 thousands which are initiated in the branches of banks with order payment of the payer) 26 which are realized through the component of ACH reached the value of EUR million. 26 Regular payments do not have high priority and are processed through sessions defined by the CBK. They are initiated at a branch of a bank by the payer through a payment in a form of a paper and this payment order is processed by the central system of the commercial bank and is sent for clearance at IPS. The payer either pays in cash or through his bank account. 67

70 Table 11. Banking sector network Description Number of bank branches Number of bank sub-branches ATM number POS number 9,191 9,459 9,785 10,631 Number of E-banking accounts 147, , , ,016 The number of total valid bank accounts 27, in June 2017, was 1.91 million, representing an annual decline of 1.43 percent compared to the previous year. E-banking accounts, by which are processed on-line banking services, have steadily been increased. In June 2017, the number of total e-banking accounts reached thousands, thus marking an annual increase of 33.8 percent (table 11). Also, the volume of transactions processed through E-banking increased. The number of total realized transactions through E-banking accounts by June 2017 reached 1.58 million, corresponding to an annual increase of 18.2 percent, while the value of total transactions realized through E-banking accounts reached EUR 3.84 billion presenting an annual increase of 37.1 percent. The structure of E-banking accounts continued to be dominated by resident accounts with a share of 98.3 percent. Within the resident accounts, individual bank accounts comprise 81.9 percent while the remainder of 18.1 percent consists of business accounts. Similarly, the structure of nonresident accounts is dominated by individual accounts with a share of 91.3 percent, while the remainder of 8.7 percent is comprised by business accounts. The number of total accounts (credit and debit cards) which offer services for cash withdrawals and other payments increased by 6.3 percent in June The number of debit cards reached 856,721 while the number of credit cards rose to 157,295. The number of debit cards was characterized with an annual increase of 6.5 percent, while credit cards marked an annual increase of 5.3 percent. The highest share within debit and credit cards, in June 2017, was marked by Visa Cards (75.8 percent and 84.3 percent, respectively), followed by Master Cards (21.9 percent and 15.0 percent, respectively). Table 12. The share of the value of card transactions by terminals to total value of card transactions, in percent Description ATM cash w ithdraw als 79.7% 74.6% 63.4% 63.5% ATM deposits 0.6% 4.4% 25.4% 27.7% Credit transfers through ATMs 0.1% 0.0% 0.0% 0.0% POS cash w ithdraw als 1.3% 0.9% 0.5% 0.1% Card payments through POS 18.3% 20.1% 10.7% 8.6% Banking infrastructure in the country was expanded in the context of Point-of-Sales (POS) network, whereas the number of Automated Teller Machine (ATM) decreased compared to June 2016 (table 12). Despite the decrease of ATM number, the number of withdrawals through them 27 The number of total bank accounts comprises: the number of current accounts, saving and other accounts at a bank. 68

71 increased to 6.7 million (5.8 million until June 2016), with an amount of EUR million (EUR million until June 2016) (table 12). Consequently, the value of cash withdrawals through ATM to total transactions processed by bank cards reached 63.5 percent until June 2017, showing a high level of cash usage. Despite the fact that the total number of ATM suffered a decline, within them, the number of ATMs which enable clients depositing cash into clients accounts marked an increase, thus having an effect on the depositing value to increase its share to 27.7 percent to total value of card transactions through terminals, from 25.4 percent as it was until June At the same time, the number of payments through points of sales using cards at POSs reached 3.7 million with an amount of EUR million. The value of payments through POSs to total transactions by bank cards reached 8.6 percent (table 12). 69

72 In millions of EUR In millions of EUR In percent 7. Pension Sector The value of assets of pension sector was characterized with an annual increase of 15.8 percent, thus reaching EUR 1.54 billion (figure 95). Kosovo Pension Saving Fund (KPSF) represents the largest share of assets of the sector (99.5 percent), while the remainder is managed by Slovenian- Kosovar Pension Fund (SKPF) (table 13). Table 13. Structure of pension fund Description Kosovo Pension Saving Fund 99.4% 99.5% 99.5% 99.5% Slovenian-Kosovo Pension Fund 0.6% 0.5% 0.5% 0.5% KPSF assets amounted to EUR 1.53 billion, representing an accelerated annual growth of 15.8 percent as it was marked in June 2017 (12.4 percent in 2016). New collected contributions marked an annual increase of 3.9 percent, whose value reached 77.0 million from around 14,632 new contributors (figure 96). Figure 95. Assets of pension sector, in millions of EUR 1,800 1,600 1,400 1,200 1, Structure of assets of KPSF continued 0 0% to be dominated by investments at external markets, which are mainly held in the form of shares and treasury bills Total assets Annual growth (right axis) of foreign governments. In the period until June 2017, KPSF further expanded investment portfolio in foreign markets Figure 96. Collected contributions, by pension funds 80 (figure 97). This trend may be 70 attributable to a better performance of assets of international markets at which the fund invests. Investments abroad increased their share to 85.0 percent (81.1 percent in June 2016), while 20 investments in Kosovo declined their share at 15.0 percent (18.9 percent in 0 June 2016). Within investments in the Jan-Jun 2014 Jan-Jun 2015 Jan-Jun 2016 Jan-Jun 2017 New collected contributions of KPSF New collected contributions of SKPF domestic economy, it was marked a shift of the share from Kosovo s Government securities towards deposits at the CBK and at commercial banks. The weight of securities decreased to 30.0 percent (41.3 percent in June 2016), whereas the weight of deposits at the CBK increased to 61.2 percent (56.2 percent in June 2016) and the weight of deposits at commercial banks increased to 8.8 percent (2.4 percent in the previous year). The level of investments in Kosovo s Government securities depends on the demand and offered amount by the Government along with the competitiveness at auctions. Therefore, depending on these factors and the KPSF investments strategy, to some extent, may be the reason of the decline of investments in Kosovo s Government securities. 24.0% 18.1% 12.4% 30% 25% 20% 15.8% 15% 10% 5% 70

73 In thousands of EUR In millions of EUR In June 2017, the total value of SKPF assets reached EUR 7.0 million, marking an annual increase of 12.1 percent (4.1 percent in June 2016). New collected contributions totaled EUR thousands received from 2,945 new contributors, corresponding to an annual increase of 6.9 percent, albeit at a slower pace than in the previous year when the increase reached 16.4 percent (figure 96). Structure of SKPF assets continued to be dominated by investments abroad, which account for 83.2 percent of total assets, and which are invested primarily in the form of shares (71.0 percent), securities (28.0 percent), commercial notes (0.6 percent) and in cash (0.4 percent). Meanwhile, investments in Kosovo declined their share to 16.8 percent, from 21.1 percent marked in the same period of the previous year. Investments in the domestic market are spread in Kosovo s Government securities (50.4 percent), deposits (20.4 percent) and in cash (29.1 percent) (figure 97). Financial performance of pension sector Pension sector marked a positive financial performance in the first half of 2017, as a result of the positive return in investments and the increase of the share price of two pension funds. Investments return of KPSF, in 2017, reached a value of EUR 56.3 million, which is for EUR 22.8 million higher than in the previous year (figure 98). The higher investments return was a result of the better performance of international stock markets. The higher increase of economic growth in USA, EU, UK and Japan and to some extent the increase of political stability in Europe had an impact on the good performance of shares. While on the other hand the price of debt instruments marked an increase as a result of the increase of demand under the pressure of monetary policy uncertainties in these countries, thus impacting on the decline of these investments return. KPSF closed the Figure 97. Structure of pension sector investments, in percent 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% In the country Abroad In the country Abroad KPSF SKPF Figure 98. Financial performance of Kosovo Pension Saving Fund last day of June 2017 with a higher share price compared to the previous year. More specifically, the share price reached EUR compared to EUR in June Similarly, also SKPF marked positive return on investments. In June 2017, gross return from investments totaled EUR thousands, which is for 44.9 thousands higher than the return Investments return Share price, in EUR (right axis) Figure 99. Financial performance of Slovenian- Kosovo Pension Fund Investments return Share price, in EUR (right axis)

74 In millions of EUR In percent registered in the previous year (EUR in 99). Also, the share price of SKPF in the last day of June 2017 was higher than in the previous year, reaching EURO compared to EUR in June Insurance Sector The structure of insurance sector continued to be dominated by insurance services of non-life insurance, representing 90.0 percent of assets of the insurance market, while the remainder is comprised by assets of life insurance. In the domestic market operate 12 companies which offer products of non-life insurance, while three companies offer products of life insurance. Figure 100. Assets structure of insurance sector, by ownership 100% 0.0% 8.9% 7.7% 7.2% 0 90% 0.0% 5.3% 5.8% 13.9% 26.2% 80% 7.6% 0.0% 16.4% 5.1% 2.3% 70% 14.6% 0.0% 13.5% 14.0% 14.1% 60% 50% 40% 30% 33.6% 27.4% 36.0% 44.6% 20% 30.0% 28.6% 10% 24.3% 12.8% 0% Companies with foreign ownership Austria-Albania Kosovo Slovenia Austria Albania Croatia Turkey continued to dominate the insurance market. In the first half of 2017 it was approved the sale of a company with foreign ownership to domestic owners, which marked a decline of concentration of foreign owned companies. The share of assets managed by foreigners declined at 55.4 percent of total assets from 64.0 percent as it was in the previous year. Regarding the origin of foreign ownership, 26.2 percent of assets of the sector are under management of four institutions which come from Albania. Two companies which come from Slovenia manage 14.1 percent of the sector s assets. Meanwhile with a combined ownership from Austria and Albania operates only one company which manages 12.8 percent of total assets of the sector (figure 100). The concentration level of the market in insurance sector may be considered low, especially comparing to the concentration level of the banking market. Herfindahl-Hirschman Index calculated for assets of the insurance companies results 792 points in June 2017 (798 points in June 2016). Expressed through the share of the three largest companies to total assets of insurance sector, the Figure 101. Assets of insurance sector % concentration level stood at % percent, representing a similar level as % in the previous year % 8.1. Activity of the Insurance Sector 40 Assets of the insurance sector totaled 20 EUR million, corresponding to an 0 annual increase of 3.8 percent (figure Total assets 101). Assets of non-life insurance companies increased by 3.4 percent (8.5 percent in June 2016), while assets of life insurance marked an annual increase of 8.4 percent (6.5 percent in June 2016) % 8.3% 3.8% Annual growth (right axis) 8% 6% 4% 2% 0% 72

75 Structure of assets of insurance sector continued to be dominated by cash and deposits, categories that were characterized with an increase of the share in this period. Their share, in June 2017, increased to 55.6 percent of total assets, from 50.9 percent in June 2016 (figure 102). Conversely, the category of financial assets decreased its share to 10.2 percent from 13.3 percent is it was in June The category of financial assets is comprised of investments in securities of Kosovo s Government, hence as a result of lower returns from securities may have been a shift of investments from these financial instruments to assets held as deposits. Figure 102. Structure of assets of insurance sector, in percent Cash and deposits Premiums debtors Intangible assets Personnel expenses 10.2% 9.6% 12.8% 0.3% 55.6% 6.6% 4.3% 0.6% Financial assets Fixed assets Technical reserves from reinsurance Other assets Figure 103. Liabilities and capital of insurance sector, in percent Within liabilities and own resources, technical reserves dominate the general structure with a share of 69.9 percent, while the remainder is comprised by own capital, other liabilities and loans (figure 103). The category of technical reserves marked an annual increase of 10.7 percent, while other categories of liabilities were characterized with a decline. Loans marked a significant decline of 85.1 percent, while own capital marked a decline of 8.1 percent, mainly being impacted by the loss retained from the previous year The value of total written premiums of the sector, until June, 2017 reached EUR 42.1 million, representing an annual increase of 2.5 percent. The structure of written premiums is led by non-life insurance which comprises percent of total written premiums. In June 2017, these premiums reached a Total gross written premiums Gross premiums "non-life" Gross premiums "life" value of EUR 40.8 million, corresponding to an annual increase of 2.7 percent. The remainder of 3.1 percent of total written premiums accounts for premiums of life insurance, which marked an annual decline of 2.9 percent (figure 104). Within the structure of total written premiums were marked no significant changes. The category of Third Party Liabilities (TPL) continued to be the main category with a share of 50.6 percent of total premiums, albeit marked a slight annual decline of 1.0 percent. While other categories of premiums mainly marked an increase thus expanding their share to total written premiums (figure 105). The highest increase was marked by TPL+ (16.5 percent), while premiums for border insurances marked an increase of 9.0 percent, premiums for property claims from fire 69.9% 22.7% 7.3% 0.1% Loans Own resources Technical reserves Other liabilities Figure 104. Received gross premiums, in millions of EUR

76 In millions of EUR In percent increased by 8.1 percent, personal accidents and health 6.0 percent and Casco insurances for 6.1 percent. Total claims paid by insurance companies and Kosovo Insurance Bureau (KIB), until June 2017, reached the value of EUR 22.6 million, marking an annual increase of 24.4 percent (figure 106). Claims paid for non-life insurances had the main contribution to the increase of claims paid, mainly being impacted by the increase of claims paid for third party liabilities and claims paid for property damages caused by fire and other risks. Claims paid by KIB marked an annual increase of 7.8 percent. Whereas, claims paid for life insurance which have a low base, increased at EUR 295 thousands from 220 thousands, as it was in June 2016 (figure 107). The higher increase of claims paid alongside with the increase of written premiums, resulted in a growth of total claims paid to written premiums ratio. In June 2017, this ratio increased to 53.7 percent compared to 44.3 percent as it was in June Performance of the Insurance Sector The performance of the insurance sector was improved compared to the same period of the previous year. Net income of the insurance sector during the first half of 2017 marked an annual growth of 5.9 percent, while operating and financial expenses marked an annual decline of 7.3 percent, whereas claims incurred, declined by 39.0 percent. As a result of the significant decline of expenses and claims incurred against Figure 106. Premiums received and claims paid, in millions of EUR the increase of income, insurance sector this year registered a net profit of EUR 2.0 million, representing a significant improvement compared to the loss of EUR 11.5 million marked in the previous year. To the positive performance of insurance sector contributed the increase of claims paid by non-life insurance companies, which directly had an impact in reducing technical provisions, thus resulting in reduction of expenses and consequently in realizing a profit. Until June 2017, non-life insurance marked a net profit of EUR 1.9 million (a loss of EUR 11.7 million in June 2016), while life insurance recorded a profit of EUR thousands (EUR 42.4% 49.8% 44.3% 53.7% Figure 105. Structure of gross written premiums 2.5% 60% 50% 40% 30% 20% 10% Received premiums Claims paid Claims/premiums (right axis) % June % 3.1% 6.4% Figure 107. Claims paid, in millions of EUR Claims non-life Claims life Claims KIB 22.6% 5.6% 4.9% Personal accidents and health Border insurances Casco TPL TPL+ Property claims caused by fire and other risks Other Life premiums 2.2% 52.4% June % 3.3% 6.0% 21.9% 0% 5.3% 4.8% Personal accidents and health Border insurances Casco TPL TPL+ Property claims caused by fire and other risks Other Life premiums 74

77 186.2 thousands in June 2016). The annual increase of cash and its equivalent of 13.5 percent, and the increase of 10.7 percent of the insurance sector technical reserves had an impact on the growth of the liquidity level. The ratio of cash and its equivalents to reserves increased to 79.6 percent in June 2017 from 77.6 percent as it was in June Also the accelerated growth of cash and its equivalent had an impact on the latter to total liabilities ratio to increase at 72.0 percent from 68.4 percent as it was in June The increase of the liquidity level, among others, reflects also the change in the structure of assets of insurance companies, where it was observed a shift of part of securities investments towards cash and its equivalents. Capitalization ratio, expressed through the liabilities ratio to total liabilities and the capital of the sector, increased at 77.3 percent in June 2017 from 74.3 percent as it was in the previous year. The increase of this ratio shows a higher support of the sector in financing assets from other liabilities and less from the capital as a more sustainable from of financing. 75

78 In millions of EUR 9. Microfinance Sector and Financial Auxiliaries Microfinance sector was characterized with an accelerated increase of its activity. Assets of the sector reached EUR million in June 2017, corresponding to an annual growth of 24.5 percent (figure 108). In the domestic market operate 17 microfinance institutions, 28 out of which 12 have foreign ownership and represent 94.7 percent of total assets of the sector. Herfindahl-Hirschman Index for assets resulted to be 1,423 points in June 2017 representing an increase of concentration compared to the same of the previous year (1,336 points). Whereas, the share of assets of three largest institutions to total assets of the sector increased to 53.9 percent from 49.6 percent as it was in June 2016, as a result of merging of two institutions into a single microfinance institution Activity of Microfinance Sector Structure of assets of microfinance sector is dominated by loans which comprise 76.1 percent of total assets of the sector (71.8 percent in 2016). The second most important category by weight consists of leasing with has a share of 14.2 percent (16.2 percent in June 2016) (figure 109). During the previous year, it was observed a declining trend of the share of leasing, whereas loans marked an increase of their share to total assets. Regarding liabilities, the activity of the microfinance sector is primarily financed by borrowings which comprise Figure 110. Loans to households, by maturity 73.8 percent of total liabilities and 0.1% 0.2% capital, while only financing from the 100% external sector accounts for 66.9 percent 90% 0.2% 0.2% 0.2% 0.2% 80% 36.7% 40.0% of total liabilities and the capital. During 45.0% 51.6% 70% this year, borrowings from the external 60% sector accelerated significantly their 50% 40% 46.5% 42.7% annual growth reaching 65.9 percent 38.1% 30% 34.6% compared to 9.4 percent in the previous year, and totaled EUR million. 20% 10% 16.5% 17.1% 16.6% 13.4% Loans Figure 108. Assets of microfinance sector, in millions of EUR % Total value of loans of microfinance sector in June 2017 reached EUR million, marking an accelerated annual increase of % % % % June 2013 Total assets Leasing, 14.2% Fixed assets, 2.6% Other assets, 2.4% Balance with commercial banks, 4.2% Gross loans, 76.1% Annual change (right axis) Figure 109. Structure of assets of microfinance sector, June 2017 Cash, 0.4% 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% 0% Up to 1 year Over 1 year up to 2 years Over 2 years up to 5 years Over 5 years up to 10 years Over 10 years 28 Here are included also five financial non-bank institutions which perform credit activities, leasing and factoring. 76

79 percent compared to 25.2 percent in June The accelerated increase of lending was supported by the growth of the financing source of microfinance institutions, mainly of the external sector and the rise of own capital being impacted by the retained Figure 111. Loans to enterprises, by maturity profit. The average amount of approved loans, expressed through the total value of loans to the number of loans ratio, increased at EUR 2,977 compared to the amount of EUR 2,661 as it was in June This was influenced by a faster growth of the approved value of loans compared to the increase of the number of loans, which may suggest an upward absorbing capacity of the borrowers. Similarly to the behavior of the banking sector regarding lending, also MFI loans to enterprises marked a higher increase of 40.2 percent, compared to loans to households which increased by 27.8 percent. However, the higher base of loans to households contributed to the increase of total loans. Loans to households in June 2017 represented 64.9 percent of total loans of the microfinance sector. As regards to maturity, loans to households with a maturity of over 2 up to 5 years consistently have increased their share and in this year represent 33.5 percent of total loans (figure 110). Similar to loans to households, loans issued to enterprises continued to have a maturity of 2 up to 5 years, and this category in the last four years has been marking an increasing trend. (figure 111). 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Figure 113. Microfinance sector growth rate of loans to enterprises, by economic sectors 65% 55% 45% 35% 25% 15% 0.9% 0.5% 0.0% 0.1% 16.1% 12.7% 9.9% 12.4% The structure of lending to enterprises by economic activity remains similar to 5% -5% -15% previous periods. Unlike the banking sector, where loans to agriculture Agriculture Industry Construction represent the category with the lowest Trade Other services share, in microfinance institutions agriculture has a share of 26.8 percent to total loans to enterprises. Other categories which have high access in microfinance financing consists of loans intended for other services and for the construction sector (figure 112). Regarding the lending trend, until June 2017, loans to construction sector registered the highest annual increase. A more significant increase of lending was marked also by the sector of industry 42.0% 41.0% 47.9% 38.8% 56.0% 58.9% 34.1% 28.6% Up to 1 year Over 1 year up to 2 years Over 2 years up to 5 years Over 5 years up to 10 years Figure 112. Structure of loans to enterprises, by economic sectors, June 2017 Other services 31.4% Industry 8.9% Trade 13.7% Agriculture 26.8% Construction 19.2% 77

80 In millions of EUR, trade and other services. Meanwhile, lending to the sector of agriculture marked a slowdown annual increase compared to the previous year (figure 113). Leasing Leasing activity of microfinance institutions marked an increase. The value of leasing of the microfinance sector increased to EUR 24.0 million, corresponding to an annual growth of 8.9 percent (figure 114). The highest contribution to total growth of leasing was marked by leasing to households which increased by 9.2 percent compared to June Leasing to households comprise the main category with a share of 54.2 percent in the general structure of leasing (figure 115). Within leasing to households, mortgage leasing, which comprise the main category, marked an increase of 4.8 percent compared to the decline of 0.1 percent in the previous year. Other leasing also marked an annual increase of 61.7 percent compared to the decline of 0.9 percent in the previous year. Leasing to households continued to be dominated by long-term leasing over 10 years which have a share of 50.0 percent, followed by leasing with maturity over 5 up to 10 years with a share of 34.6 percent. Figure 114. Microfinance sector leasing Total leasing Household leasing Enterprise leasing Figure 115. Structure of leasing, in percent 100% 0.6% 0.3% 0.2% 0.0% 90% 80% 32.1% 70% 51.9% 54.0% 54.2% 60% 50% 40% 67.3% 30% 47.8% 45.8% 45.8% 20% 10% Other Enterprises Households Within leasing to enterprises, leasing for equipment marked a significant decline of 58.9 percent. Also, mortgage leasing marked an annual decline of 15.4 percent. Whereas Figure 116. Average interest rate on microfinance sector loans other leasing were characterized with an 26% increase of 18.8 percent, giving a 25% 24.4% 24.1% contribution to total increase of leasing 24% 23.1% 24.0% to enterprises. As regards to maturity of 23% 23.5% 23.2% 22% 21.9% 22.1% leasing to enterprises, the majority of 21.9% 21% 21.6% them is comprised by mid-term leasing 20% 19.7% over 2 up to 5 years with a share of 19% 19.9% 92.4 percent, followed by leasing with a 18% 17% maturity of over 1 up to 2 years with a share of 5.8 percent. Interest Rates Households Enterprises Average interest rates on loans The average interest rate on loans of microfinance sector marked an increase during the first six months of 2016, reaching 22.1 percent (figure 116). With an average increase of interest rates were characterized household sector, whereas enterprise sector marked a slight decline. 78

81 In millions of EUR In percent In millions of EUR In percent The average interest rate on loans to households increased to 24.0 percent in June 2017, from 23.1 percent as it was in the same period of the previous year. While the average interest rate on loans to enterprises, in June 2017, decreased to 19.7 percent from19.9 percent as it was in June 2016 (figure 116). Within loans to enterprises, services sector has the lowest average interest rate of 15.3 percent. The average interest rate on loans to industry sector marked a decline of 0.9pp, albeit stands at the highest level within loans to enterprises. Whereas, the average interest rate on loans to agriculture sector registered a decline of only 0.5pp (figure 117) Performance of the Microfinance Sector Microfinance sector was characterized with a better financial performance compared to three previous years. In June 2017, the realized profit totaled EUR 3.9 million, compared to the profit of EUR 1.6 million realized in the previous year s first six months. The profit increase was a result of the higher increase of income compared to the increase that was marked by expenses. Income of microfinance sector marked an increase of 28.5 percent compared to 16.0 marked in June 2016, mainly being impacted by the increase of interest income. Also expenditures marked an increase of 10.6 percent, compared to the increase of 13.6 percent until June 2016 (figure 118). All the categories of expenditures were characterized with increase, albeit the highest contribution to the increase of total expenditures was marked by interest expenditures which marked an increase of 35.3 percent. Expenses to income ratio of the microfinance sector has marked an Figure 117. Average interest rate on loans, by economic sectors 26% 24% 22% 20% 18% 16% 14% improvement compared to the previous year, as a result of the higher increase of microfinance sector income compared to the increase of expenses. In June 2017, this indicator decreased at 74.2 percent, from 86.2 percent as it was in the previous year. 25.7% 25.1% 23.6% Figure 118. Microfinance sector income and expenditures 99.9% 88.0% 86.2% 74.2% 26.2% 24.4% 17.8% 25.7% 24.7% 25.1% 24.5% 15.0% 15.3% Agriculture sector Industry sector Services sector 120% 100% 80% 60% 40% 20% Income Expenses Expenses/income (right axis) Figure 119. Profitability indicators of microfinance sector % 0.6% 2.0% 7.3% 2.9% 10.6% 18.7% 4.8% *2017 Net profit ROAA ROAE *For 2017 the profit was annualized based on the performance until June % 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 79

82 March June September December March June September December March June September December March June The profit realized by June 2017 had an impact in improvement of profitability indicators where the Return on Average Assets (ROA) reached 4.8 percent (2.9 percent in 2016), whereas Return on Average Equity (ROAE) reached 18.7 percent (10.6 percent in 2016) (figure 119). The microfinance sector continued to be characterized by a relatively low level of nonperforming loans and satisfactory coverage level of nonperforming loans with loan loss provisions. In June 2017 the share of nonperforming loans to total loans declined to 2.5 percent from 4.3 as it was in June 2016, as a result of the decline of the value of NPL alongside with the increased stock of loans. Also, the coverage by provisions improved considerably at percent compared to the level of percent in June 2016 (figure 120). Figure 120. Indicators of credit portfolio quality 8% 250% 200% 6% 150% 4% 100% 2% 50% 0% 0% NPLs/total loans NPL coverage with loan loss provisions (right axis) 9.3. Financial Auxiliaries The sector of financial auxiliaries is comprised by exchange bureaus and money transferring agencies (MTA). This sector comprises the largest number of financial institutions in the country, albeit manages the lowest share of assets of financial system (0.2 percent in June 2017). The value of assets of financial auxiliaries in June 2017 reached EUR 13.6 million, representing an annual increase of 8.9 percent. Also, the income of financial auxiliaries marked an annual growth of 10.1 percent reaching EUR 3.7 million. The structure of income of financial auxiliaries is dominated by income of transfers (a share of 73.7 percent in June 2017), which were characterized with an annual growth of 12.6 percent. Conversely, expenses marked an annual increase of 12.8 percent reaching the value of EUR 2.2 million. Nevertheless, the higher base of the value of income had an impact on the net profit to increase at EUR 1.5 million from EUR 1.4 million as it was in June

83 10. Macro prudential Policy In 2016, the Central Bank of the Republic of Kosovo, pursuant to the Law No. 03/L-2009 on the Central Bank which empowers the CBK to draft the implementation of the policies to maintain the financial stability in the country, has compiled the Policy on Macro prudential Supervisory. The Policy on Macro prudential Supervisory defines the actions, objectives and instruments as deemed for Macro prudential Supervisory in order to maintain financial stability. The CBK has also set up the Advisory Committee on Macro prudence, as a legal body that has been given a mandate on Macro prudential Policy to assist in its implementation by regularly monitoring systemic risks to the stability of financial system and to recommend policies and appropriate actions. The Macro prudential Policy of the CBK was drafted in compliance with the macro prudential framework of European Systemic Risk Board. The main objective of this Policy is to assist in maintaining the stability of financial system thus declining accumulation of systemic risk and strengthening the resistance of financial system. The intermediary objectives of macro prudential policy are as follows: - Reducing and preventing an excessive increase of loans and leverage; - Reducing and preventing an excessive mismatch of maturity; - Reducing and preventing non-liquidity; - Limitation of large credit exposures; - Limitation of systemic impact of stimulation which aim to reduce moral risk, and - Strengthening of sustainability of financial infrastructure. In order to achieve the above mentioned objectives, the CBK, based on the analysis of the risks on financial system, shall apply a wide range of instruments which will address the systemic risk linked to the business cycle or to the structure of financial sector. Instruments to be used shall have a preventing character in decreasing the possibility of happening and expanding a volatile financial statement, and include many instruments which are currently empowered through the existing regulations, such as regulatory requirements for capital adequacy with risk weight, requirements to maintain and ensure needed liquid funds, limitations on credit concentration, etc. These instruments which initially belong to macro prudential policy, will be as well in the function of macro prudential policy, where the CBK may apply additional requirements for the sector in general or for the specific segments depending on the risk analysis. Other possible instruments of macro prudential character, which are in compliance with laws in power, include additional regulatory requirements for capital adequacy with risk weight in line with the rate of systemic risk and the possibility of risk accumulation in different phases of business cycles, and other limitations to prevent the increase of systemic risk. In order to increase the transparency regarding the Macro prudential Policy and the appropriate decisions, the CBK will regularly publish analysis on systemic risks and the trend of indicators of macro prudential policy Identification and assessment of systemic risk The systemic risk presents the risk if considerable interruptions of offering financial services which are manifested with important negative consequences for financial stability and for the economy in general. Identification and assessment of the systemic risk should be performed in compliance with the two dimensional nature of the systemic risk: the one of time and structure. The dimension of time implies the identification and assessment of the possibility of systemic risk accumulation over time, while structural aspect implies the risk assessment to the system 81

84 which comes from the interconnections between financial concentration in markets and certain sectors. The Central Bank of the Republic of Kosovo steadily monitors general risks to financial stability through different methods and models, which are supplemented through professional judgment. The analysis of systemic risk include developments in main economic sectors to which it is exposed the financial sector, and developments in the financial sector itself and implications for its stability. Besides the analysis of main indicators of developments in certain sectors, the CBK has developed and adopted certain models for assessing risks. The recent developed model of Financial Stability Map analysis developments through eight risk dimensions to financial stability such as: external and internal macroeconomic developments, the statement and developments of main economic agents such as enterprises, households, and government, and the statement and developments in internal risk indicators of the financial sector such as capitalization, liquidity and the structure of the banking sector. Stress-test model is one of the key tools to identify current fragilities of the financial sector and potential systemic risks for the upcoming year. The CBK has developed a model on Identification of Banks with Systemic Importance, which continuously has been enhanced, and recently has also been adopted in compliance with the latest instructions of European Banking Authority (EBA). The model of banks with systemic importance is a typical instrument of macro prudential policy which assesses the spread of the risk and negative effects of a systemic important institution in the whole system. Another typical model of macro prudential policy, which the CBK has started to use, is the identification of the business cycle of the financial sector, in order to assess the systemic cyclic risk and capital adequacy in line with the risk scale. The CBK will work with commitment in enhancing the existing models and developments of other instruments in achieving Macro prudential Policy objectives. Models and instruments shall be calibrated in compliance with international standards and domestic environment, and will be considered as a base for Monetary Policy Summary of developments in selected macro prudential indicators In the second half of 2017, general developments of macro prudential indicators in Kosovo were sustainable, with no threats to financial stability in the country. All the financial indicators were within the certain parameters of the legal framework. Nonperforming loans to total loans continued to follow a declining trend, and were associated with proper coverage. Capitalization indicators for the whole sector, and banks with systemic importance in particular were quite above the regulatory requirements. Similar to the indicator of capital adequacy, the leverage ratio of the whole banking sector stood at 13.0 percent and this ratio of banks which are considered to be with systemic importance stood at 13.9 percent implying that it continued to remain above the minimal level required by the regulation. Loan-to-deposit ratio reached 82.8 percent in June 2017 and it is considered to be of the adequate level, despite the increase from 80.7 percent as it was in the same period of the previous year. In the reporting period, loan-tovalue ratio of the banking sector stood at 30.0 percent, which suggests a lower risk of lending of the banking sector. Similarly, also loan-to-income ratio stood at low level of 41.8 percent, suggesting a good equilibrium between debt and income of the banking sector clients. Liquidity indicators stand at a satisfactory level, especially liquid assets to short-term liabilities which is above the regulatory requirement. The concentration of large exposures in the banking system stands at the adequate level with a declining tendency. Profitability indicators, specifically Return on Average Equity (ROAE), stood at high level with 21.9 percent. Credit to GDP gap gives signals to Kosovo s banking sector that there is room for further expansion of lending activity within macro-financial framework environment in which it 82

85 operates, despite the annual increase of 10.0 percent in the first half of The banking sector continued to have four banks with systemic importance. The results of stress-test analysis continuously suggest satisfactory capability of banks to face extreme situation of the exposure to market or liquidity risks Decisions and macro prudential CBK measures In the second half of 2017, CBK has performed development assessments in macro prudential indicators on quarter basis. Based on the movement of systemic risk indicators which suggest for sustainable developments of the sector in this period, CBK has not evaluated as necessary the implementation of any Macro prudential Policy instrument since the financial stability had already been stable. 83

86 84

87 10. Statistical Appendix 85

88 86

89 Table 1. Financial soundness indicators, in percent Banking sector Core set Capital Adequacy Assets quality Sectoral distribution of loans to total loans Earnings and profitability Liquidity Sensitivity to market risk Regulatory capital to risk-w eighted assets Regulatory Tier I capital to risk-w eighted assets Nonperforming loans net of provisions to capital Nonperforming loans to total gross loans Other financial corporations Public nonfinancial corporations Other nonfinancial corporations Households NPISH Nonresidents Total Return on assets (ROA)* Return on equity (ROE)* Interest margin to gross income Noninterest expenses to gross income Liquid assets (core) to total assets Liquid assets (broad) to total assets Liquid assets (core) to short-term liabilities Liquid assets (broad) to short-term liabilities Net open position in foreign exchange to capital Encouraged set Capital to assets Large exposures to capital Personnel expenses to noninterest expenses Spread betw een reference lending and deposits rates Customer deposits to total (noninterbank) loans Foreign-currency-denominated liabilities to total liabilities *Net income before tax is considered. Guide: Financial Soundness Indicators, Compilation Guide, IMF (2006) 87

90 Table 2. Balance sheets of commercial banks, as of June 2017, in millions of EUR (In millions of EUR) Assets Raiffeisen Bank Liabilities Cash and balances w ith CBK 98.7 Balance from other banks 1.1 Balance w ith commercial banks Deposits Securities 42.3 Other borrow ings - Loans Other liabilities 39.0 Fixed assets 9.4 Subordinated debt 19.3 Other assets 4.2 Ow n resources TOTAL ASSETS T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES (In millions of EUR) Assets Procredit Bank Liabilities Cash and balances w ith CBK 95.3 Balance from other banks 0.6 Balance w ith commercial banks Deposits Securities 80.6 Other borrow ings 10.0 Loans Other liabilities 36.6 Fixed assets 17.2 Subordinated debt 7.5 Other assets 16.7 Ow n resources TOTAL ASSETS T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES (In millions of EUR) Assets NLB Prishtina Liabilities Cash and balances w ith CBK 48.4 Balance from other banks 4.2 Balance w ith commercial banks 63.1 Deposits Securities 29.0 Other borrow ings 0.1 Loans Other liabilities 38.6 Fixed assets 11.9 Subordinated debt - Other assets 2.5 Ow n resources 59.6 TOTAL ASSETS T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES

91 (In millions of EUR) Assets TEB Bank Liabilities Cash and balances w ith CBK 50.4 Balance from other banks 22.3 Balance w ith commercial banks 14.5 Deposits Securities 20.9 Other borrow ings - Loans Other liabilities 19.3 Fixed assets 6.2 Subordinated debt 4.5 Other assets 4.7 Ow n resources 79.2 TOTAL ASSETS T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES (In millions of EUR) Assets Banka Kombëtare Tregtare Liabilities Cash and balances w ith CBK 32.2 Balance from other banks 0.5 Balance w ith commercial banks 42.6 Deposits Securities 44.4 Other borrow ings 6.8 Loans Other liabilities 17.5 Fixed assets 1.7 Subordinated debt - Other assets 6.9 Ow n resources 28.8 TOTAL ASSETS T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES (In millions of EUR) Assets Banka Ekonomike Liabilities Cash and balances w ith CBK 42.1 Balance from other banks 2.2 Balance w ith commercial banks 19.5 Deposits Securities 10.7 Other borrow ings - Loans Other liabilities 9.8 Fixed assets 6.4 Subordinated debt 1.0 Other assets 0.7 Ow n resources 23.6 TOTAL ASSETS T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES

92 Banka për Biznes (In millions of EUR) Assets Liabilities Cash and balances w ith CBK 38.6 Balance from other banks 7.2 Balance w ith commercial banks 9.5 Deposits Securities 8.0 Other borrow ings - Loans Other liabilities 7.5 Fixed assets 1.9 Subordinated debt 6.0 Other assets 1.8 Ow n resources 17.6 TOTAL ASSETS Komercijalna Banka T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES (In millions of EUR) Assets Liabilities Cash and balances w ith CBK 7.1 Balance from other banks - Balance w ith commercial banks - Deposits 55.7 Securities 51.9 Other borrow ings - Loans 2.9 Other liabilities 0.6 Fixed assets - Subordinated debt - Other assets 1.4 Ow n resources 7.1 TOTAL ASSETS 63.3 T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES 63.3 (In millions of EUR) Assets Türkiye İş Bankası Liabilities Cash and balances w ith CBK 12.5 Balance from other banks 43.1 Balance w ith commercial banks 3.2 Deposits 38.4 Securities 5.3 Other borrow ings - Loans 71.1 Other liabilities 2.6 Fixed assets 0.8 Subordinated debt - Other assets 0.3 Ow n resources 9.2 TOTAL ASSETS 93.2 T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES

93 (In millions of EUR) Assets Ziraat Bank Liabilities Cash and balances w ith CBK 1.3 Balance from other banks 6.7 Balance w ith commercial banks 7.0 Deposits 6.5 Securities 0.3 Other borrow ings - Loans 12.2 Other liabilities 0.2 Fixed assets 0.9 Subordinated debt - Other assets 0.1 Ow n resources 8.5 TOTAL ASSETS 21.8 T OT A L LIA B ILIT IES A N D OWN R ESOUR C ES

94 Table 3.1. FC survey net foreign assets and domestic claims (In millions of euro: End of period) Net foreign assets Domestic claims Description Claims on non residents Monetary gold and SDR holdings Deposits Securities other than shares of which: IMF Quota Shares and other equity Liabilities to nonresidents Net claims on central government Claims on central government Liabilities to central governm -ent Claims on other sectors of which: Loans of which: Other non Households financial corporations , , , , , , , , , , , , , , , , , , , , , , , December 2, , , , , , , March 2, , , , , , , June 2, , , , , September 2, , , , , , December 2, , , , , , , March 2, , , , , , , June 2, , , , , , September 2, , , , , , , December 2, , , , , , , , March 2, , , , , , , , June 2, , , , , , , , September 2, , , , , , , , December 2, , , , , , , , March 2, , , , , , , , June 2, , , , , , , September 2, , , , , , , December 2, , , , ,, , , March 2, , , , , , , June 2, , , , , ,

95 Table 3.2. FC survey liabilities (In millions of euro: End of period) Description Deposits Loans Insurance technical reserves Transferable deposits of which: Other deposits Public non -financial corporations Other non financial corporations Households Public non financial corporations of which: Other non financial corpora -tions Households Net equity of households in pension funds Prepay ment of premiu ms&reservs against outstanding claims , , , , , , , , December 2, , , March 2, , , Shares and other equity Other items (net) June 2, , , September 2, , , December 2, , , March 2, , , , June 2, , , , , September 2, , , , , , December 2, , , , , , March 2, , , , , , June 2, , , , , , September 2, , , , , , December 2, , , , , March 2, , , , , , June 2, , , , , September 2, , , , , , , December 2, , , , , , , March 2, , , , , , , June 2, , , , , ,

96 Table 4.1. ODC balance sheet assets (In millions of euro: End of period) Total assets Description Cash and balances with CBK Balances with commercial banks In euro In noneuro currency currencies Securities Gross loans and lease financing Other financial corporations of which in euro: Public non - financial corporations Other non - financial corporations Households Gross loans in noneuro currency Fixed assets Other assets , , , , , , , , , , , , , , , , , , , , September 3, , , October 3, , , November 3, , , December 3, , , January 3, , , February 3, , , March 3, , , April 3, , , May 3, , , June 3, , , July 3, , , August 3, , , September 3, , , October 3, , , November 3, , , December 3, , , January 3, , , February 3, , , March 3, , , April 3, , , May 3, , , June 3, , ,

97 Table 4.2. ODC balance sheet liabilities (In millions of euro: End of period) Total liabilities Description Balances from other banks Deposits Transferable deposits Other deposits: Saving deposits Other borrowings (incl. non neg. CD) Write - downs, provisions Other liabilities Subordinated debt Own resources of which: Share capital , , _ , , ,014.2 _ , , ,229.5 _ , , , , , , , , , , , , , , August 3, , , September 3, , , October 3, , , November 3, , , December 3, , , January 3, , , February 3, , , March 3, , , April 3, , , May 3, , , June 3, , , July 3, , , August 3, , , September 3, , , October 3, , , November 3, , , December 3, , , January 3, , , February 3, , , March 3, , , April 3, , , May 3, , , June 3, , ,

98 Table 5.1. ODC deposits - euro deposits (In millions of euro: End of period) Description Total deposits in euro Governme -nt Finanncial corporations Nonfinancial corporations Other domestic sectors Nonresi -dents Other depository corporations Other financial intermediaries Insurance Pension companies funds Financi al auxilliar -ies Public nonfinancial corporations Other nonfinanci -al corporatio -ns Households , , , , , , , , , , , , , , , , , , September 2, , , October 2, , , November 2, , , December 2, , , January 2, , , February 2, , , March 2, , , April 2, , , May 2, , , June 2, , , July 2, , , August 2, , , September 2, , , October 2, , , November 2, , , December 2, , , January 2, , , February 2, , , March 2, , , April 2, , , May 2, , , June 2, , , NPISH 96

99 Table 5.2. Non euro deposits (In millions of euro: End of period) Description Non-euro deposits Financial corpora tions CBK Other depository corporations of which: Other financial intermedia ries Insurance companies Nonfinancial corporations Public nonfinancial corporations Other nonfinancial corpora -tions Other domestic sectors Households Transferable deposits Saving account Other deposits December September October November December January February March April May June July August September October November December January February March April May June NPISH Nonresidents 97

100 Table 6.1. Deposits at ODC - nonfinancial corporations, euro deposits (In millions of euro: End of period) Non financial corporations Public nonfinancial corporations Other nonfinancial corporations Description Transferable deposits Saving account Other deposits Over 1 month and up to 3 months of which: Over 3 months and up to 6 months Over 2 years Transferable deposits Saving account Other deposits Over 1 month and up to 3 months of which: Over 6 months and up to 1 year Over 1 year and up to 2 years Over2 years July August September October November December January February March April May June July August September October November December January February March April May June

101 Table 6.2. Deposits at ODC - households and NPISH, euro deposits (In millions of euro: End of period) Other domestic sectors Households NPISH Description Transferable deposits Saving account Other deposits Up to 1 month Over 3 months and up to 6 months Over 3 months and up to1 year of which: Transferable deposits Saving account Other deposits , , , , , , , , , , October 1, , November 1, , December 1, , January 1, , February 1, , March 1, , April 1, , May 1, , June 1, , July 1, , August 1, , September 1, , October 1, , November 1, December 2, , , January 2, , , February 2, , , March 2, , , April 2, , , May 2, , , June 2, , , Over 1 year and up to 2 years Over 2 years 99

102 Table 6.3. ODC loans main institutional sectors (Cumulative data, end of period, in millions of euro) Total Description Financial corporations Other financial intermediaries of which: Insurance companies Public nonfinancial corporations of which: Other nonfinancial corporations Up to 1 year Over 1 year Other domestic corporations Households Up to 1 year of which: Over 1 year Nonfinanci -al corporations Nonresidents Loans in Non Euro Currency , , , , , , , , , , , , , , December 1, , , August 1, , , September 1, , , October 2, , , November 2, , , , December 2, , , , January 2, , , February 2, , , , March 2, , , , April 2, , , , May 2, , , , June 2, , , , July 2, , , , August 2, , , , September 2, , , , October 2, , , , November 2, , , , December 2, , , , January 2, , , , February 2, , , , March 2, , , , April 2, , , , May 2, , , June 2, , , ,

103 Table 6.4. ODC loans - main economic sectors, corporates (In millions of euro: End of period) Total Description Agriculture Industry, energy and construction Services Up to 1 year Over 1 year , , , , December 1, August 1, September 1, October 1, November 1, December 1, January 1, , February 1, March 1, April 1, , May 1, , June 1, , July 1, , August 1, , September 1, , October 1, , November 1, , December 1, , January 1, , February 1, , March 1, , April 1, , May 1, , June 1, , Up to 1 year Over 1 year Up to 1 year Over 1 year 101

104 Table 7.1. Interest rates on nonfinancial corporation and household new deposits (New contracts, unless otherwise indicated) Descritpion Interest rates on new time deposits Up to 1 month Over 1 month up to 3 months Over 3 months up to 6 months Over 6 months up to 1 year Over 1 year up to 2 years Over 2 years Saving deposits Transferable deposits August September October November December January February March April May June July August September October November December January February March April May June

105 Table Interest rates on nonfinancial corporation new deposits (New contracts, unless otherwise indicated) Descritpion Interest rates on new time deposits Up to 1 month Over 1 month up to 3 months Over 3 months up to 6 months Over 6 months up to 1 year Over 1 year up to 2 years Over 2 years Saving deposits Transferable deposits August September October November December January February March April May June July August September October November December January February March April May June

106 Table Interest rates on household new deposits (New contracts, unless otherwise indicated) Descritpion Interest rates on new time deposits Up to 1 month Over 1 month up to 3 months Over 3 months up to 6 months Over 6 months up to 1 year Over 1 year up to 2 years Over 2 years Saving deposits Transferable deposits August September October November December January February March April May June July August September October November December January February March April May June

107 Table 7.2. ODC interest rate new loans (New contracts, unless otherwise indicated) Description INTEREST RATE ON NEW LOANS Consumer loans Mortgage loans Loans with favorable conditions New loans, excluding consumer loans, mortgage and loans with favorable conditions Other Agriculture Industry Service sectors OVERDRA- FTS (State as at end of period) CREDIT LINES (State as at end of period) July August September October November December January February March April May June July August September October November December January February March April May June

108 Table ODC interest rates new loans to nonfinancial corporations (New contracts, unless otherwise indicated) Description INTEREST RATE ON LOANS TO NONFINANCIAL CORPORATIONS Loans with favorable conditions New loans, excluding loans with favorable conditions Agriculture Industry Service Other sectors OVERDRAFTS (State as at end of period) CREDIT LINES (State as at end of period) July August September October November December January February March April May June July August September October November December January February March April May June

109 Table ODC interest rates new loans to households (New contracts, unless otherwise indicated) INTEREST RATES ON LOANS TO HOUSEHOLDS Description Consumer loans Mortgage loans Loans with favorable conditions New loans, not including consumer loans, mortgage loans, and loans with favorable conditions OVERDRAFTS (State as at end of period) July August September October November December January February March April May June July August September October November December January February March April May June

110 Table 8.1. ODC income statement - income and expenditures (In millions of euro: Cumulative data during the year) Net profit / loss for period Description Income Interest income Noninterest income Gains from revaluations Expenditures Interest expenditures Non-interest expenditures General and administrative expenditures Losses from revaluations Provision for taxes September October November December January February March April May June July August September October November December January February March April May June

111 11. References Bank of Albania Bank of Slovenia Banking Stability Index: A Cross-Country Study, Kristina Kocisova, Technical University of Kosice, Slovakia Central Bank of Bosnia and Herzegovina Central Bank of Montenegro Croatian National Bank European Central Bank International Monetary Fund Kosovo Agency of Statistics National Bank of Serbia National Bank of the Republic of Macedonia NLB Group: Annual Reports ( ) PCH: Annual Reports ( ) RBI: Annual Reports ( ). 109

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