FINANCIAL STABILITY IN THE REPUBLIC OF BELARUS

Transcription

1 NATIONAL BANK OF THE REPUBLIC OF BELARUS FINANCIAL STABILITY IN THE REPUBLIC OF BELARUS 2009 MINSK, 2010

2 2 This publication has been prepared by the Banking Supervision Directorate in concert with the Monetary Policy and Economic Analysis Directorate, Banking Operations Regulation Directorate, Monetary Operations Directorate, Balance of Payments and Banking Statistics Directorate, and Payment System Directorate of the National Bank of the Republic of Belarus

3 3 CONTENTS EXECUTIVE SUMMARY 4 CHAPTER 1. EXTERNAL AND INTERNAL MACROECONOMIC RISKS 7 CHAPTER 2. NON-FINANCIAL SECTOR 14 CHAPTER 3. FINANCIAL SECTOR BANKING SECTOR INSURANCE SECTOR 37 CHAPTER 4. FINANCIAL MARKETS 42 CHAPTER 5. PAYMENT SYSTEM OF THE REPUBLIC OF BELARUS 51 APPENDICES 55

4 4 EXECUTIVE SUMMARY In 2009, the economy of the Republic of Belarus was developing in difficult conditions. Global financial and economic crisis had an adverse impact on the Belarusian economy which is actively involved in international financial and economic relations. With a view to minimizing the adverse impact of the global crisis at the time of decreasing external demand and worsening conditions of foreign trade under the limited capacities of attracting foreign capital in the international financial market, the Government and the National Bank of the Republic of Belarus took and implemented a number of measures, including the required adjustment of the exchange rate policy and enhancement of its flexibility. The initial impact of external shock on the economy was compensated to a certain extent at the expense of the stimulating monetary and fiscal policies and attraction of additional emergency financing. Notwithstanding the measures being taken, the foreign trade operations remained unbalanced that was, above all, due to the outstripped pace of growth of internal expanses compared with that of output and insufficient efficiency of the economy. Under limited capacities of attracting capital by the private sector the increased deficit of current account was financed mainly at the expense of the Government agencies and monetary authorities borrowings, that resulted in the significant growth of total external debt. In 2009, the risks related to operations in the domestic financial market of the Republic of Belarus were growing. Devaluation processes of 2009 made a significant impact on the profitability ratio of deposits in Belarusian rubles and foreign exchange. The surge of ruble profitability of the deposits in foreign exchange that followed a one-step devaluation in January 2009 as well as the growing devaluation expectations led to the temporary decrease of the depositors interest to the savings in the national currency. The negative trends in the savings process were observed, primarily, at the beginning of the year. Tightening of the National Bank s monetary policy resulted in the gradual restoration of confidence in the Belarusian ruble as a store of value. Already in 2009 H2, the growth of the deposits in the Belarusian rubles was gradually renewed, with the growth of deposits in foreign exchange simultaneously decreasing. In 2009, profitability of deposits in the Belarusian rubles was higher than ruble profitability of deposits in foreign exchange. Decreasing sustainability of the balance of payments was the main reason for high net demand for foreign exchange in the domestic foreign exchange market of the Republic of Belarus. After considerable worsening in end-2008 the situation in the domestic foreign exchange market of the Republic of Belarus enjoyed certain improvement by mid-2009.

5 5 Worsening economic situation had an adverse effect on the financial standing of the organizations of the non-financial sector in 2009 which was characterized by shrinking real volumes of sale, decreasing profits and profitability, and increasing number of unprofitable organizations and their losses. The trend towards expanding the financing of current and investment activities of the organizations of the non-financial sector at the expense of borrowed funds that had previously emerged continued into 2009, resulting in the continued increase in debt burden in the sector of non-financial enterprises. At the same time, where the situation in the first half of the year was characterized mainly by negative trends in the dynamics of the key indicators of the enterprises financial condition, it started to slightly improve in late Under the conditions of the decelerating growth of the households money incomes in 2009 the increase in consumers expenditure slowed-down, while the growth rates of the households investments financed at the expense of their own funds and banks credits were still high. Households credit amounts owed were growing faster than income, which, in turn, gave rise to a further increase in households debt burden. Growing crisis phenomena in the economy and worsening financial condition and solvency of the organizations of the non-financial sector and households led to the slower growth of the banking sector s credit operations compared with But, the GDP growth rates slowed down to a much higher degree contributing to the increasing imbalance between the growth rates of the banking sector s assets and that of the economy, accumulation of credit risks by the banking sector, and increase in its exposure to the risk of non-fulfillment of obligations by the borrowers. Following recapitalization of the largest state-owned banks at the end of 2008, that made a short-term positive effect on the banking sector, the total level of its exposure to risks was steadily growing. The total level of the banking sector s exposure to risks as at January 1, 2010 was comparable with its level at the beginning of December 2008, even after provision by the Government in December 2009 of support with a view to recovering ruble liquidity. The level of concentration in the insurance sector in 2009 was rather high. The insurance business was concentrated in ten mainly state-owned insurance companies. In 2009, the insurance sector s exposure to major risks was relatively low. The volume of insurance reserves created by the insurance companies at the beginning of 2010 warrants the insurance sector s ability to fulfill its obligations in the long-term. At the same time, the Government s investments in the banking sector at the end of 2008 through the intermediary of the state-owned insurance companies considerably increased the insurance sector s exposure to market risks.

6 saw smooth functioning of the payment system of the Republic of Belarus which ensured continuity of payments for all economic agents. The main risks in the payment system credit risk, liquidity risk, and operational risk were minimized due to the successive activities of the National Bank aimed at streamlining risk management procedures and providing liquidity to banks.

7 7 CHAPTER 1. EXTERNAL AND INTERNAL MACROECONOMIC RISKS In 2009, the economy of the Republic of Belarus was developing in difficult conditions. Global financial and economic crisis had an adverse impact on the Belarusian economy which is actively involved in international financial and economic relations. One of the main channels through which the external crisis developments made an impact on the economy of the country was falling demand for the Belarusian goods in the export markets. It was caused mainly by an overall decline in business and investment activities in the main trading partners of the Republic of Belarus, above all, in the Russian Federation and the European Union (EU). Thus, real GDP in the Russian Federation dropped in 2009 by 7.9% compared with 2008, in the EU by 4.1%. Within the scope of the above-mentioned global trends the macroeconomic situation in the Republic of Belarus in 2009 was characterized by slowing growth rates of the economy, investments in fixed capital, and households money income, as well as by worsening financial condition of enterprises against the background of slowing inflation processes. Owing to the development of adverse foreign economic trends under the continuing growth of internal demand (for the purpose of supporting business activity) outstripping that of income and inadequate flexibility of the Belarusian economy the balance of payments deteriorated and the country s external debt increased to a significant extent, especially, in the Government sector. The initial impact of external shock on the economy was compensated to a certain extent at the expense of the stimulating monetary and fiscal policies and attraction of additional emergency financing. The macroeconomic policy being developed and implemented with the assistance of the International Monetary Fund (IMF) was an important factor of stabilization and adaptation to the new environment. Cooperation with the IMF contributed to the development and implementation of a more well-balanced macroeconomic policy preventing an increase in the potential extent of external imbalance. The funds obtained from the IMF made it possible to close the gap in financing that originated in 2009 and expand the time horizon for taking appropriate measures. However, the monetary policy measures being implemented assured the required macroeconomic adjustment not to the full extent that led to the continuation of and even increase in the external imbalance up to the level threatening macroeconomic and financial stability. Correspondingly, vulnerability of the economy as well as the possibility of materialization of the existing risks in the non-financial and banking sectors grew, with the capacity for further smooth

8 8 adaptation of the economy to the external shocks declining. The pace and depth of the projected and implemented structural reforms which are the key fundamental factor assuring the stable economic growth and well-balancing of the economy continue to be inadequate. Real rates of the GDP growth dropped from 110.2% in 2008 to 100.2% in 2009, of the investments in fixed capital from to 108.6%, and of the households money income from 111.8% to 102.9%. At the beginning of 2009, inflation processes were accelerated due to the one-step devaluation of the Belarusian ruble against foreign currencies, as well as an increase in tariffs for housing and utilities services. In April-November 2009, the inflation rate slowed down amounting in 2009 to 10.1% (13.3% in 2008). The slowing rates of the Belarusian economy growth led to the reduction of revenues of the central and local budgets. In 2009, the revenues of the consolidated budget of the Republic of Belarus dropped by 4.3% compared with With respect to GDP the revenues amounted to 45.9% (in 2008 to 50.6%). With the expenditures side of the consolidated budget being the same as in 2008, it ran a deficit in the amount of 0.7 of GDP (in 2008 it ran a surplus of 1.4% of GDP). A change in the prices for the main Belarusian goods resulted in the worsening conditions of foreign trade. In particular, the prices for the important items of export sank: for mineral fertilizers (including nitrogenous) by 60.6%, compound fertilizers by 52.8%, potash fertilizers by 12.4%, and oil products by 35.6%, with the price of oil import decreasing by 25.7%. At the same time, the prices for imported gas grew by 16.2%. As a result, in 2009 compared with 2008, the average prices, on the whole, dropped by 26.2% for exported goods, while for imported goods they fell by 17%, worsening conditions of foreign trade by 11.1%. Lowering external demand and worsening conditions of foreign trade were accompanied by the limited capacities for attracting foreign capital in the international financial market. In addition, at end-2008-early 2009 the exchange rates of the national currencies to the US dollar in the main trading partners of the Republic of Belarus sank. Thus, in August 1, March 1, 2009, the exchange rate of the Russian ruble 1 to the US dollar dropped by 52%, euro and the currencies pegged to it (Lithuanian lit and Latvian lat) by about 18%, Ukrainian hryvna by 91%, Polish zloty by 79%, British pound sterling by 28%, and Kazakh tenge by 25%. With a view to minimizing the adverse impact of the global crisis the Government and the National Bank of the Republic of Belarus took and implemented a number of 1 Exchange rates of foreign currencies to the US dollar as at the first day of the month were calculated on the basis of the official exchange rates of the Belarusian ruble to the corresponding foreign currency and the US dollar set by the National Bank as of the last business day of the previous month.

9 9 prompt and long-term measures. First of all, the actions aimed at making required adjustment of the exchange rate policy and enhancing its flexibility were taken. With a view to recovering price competitiveness of the Belarusian products against the background of significant worsening of the foreign economic environment a one-step adjustment of the Belarusian ruble exchange rate was made on January 2, The BYR/USD exchange rate fell by 20.5%, the BYR/EUR exchange rate by 20.3%, and BYR/RUR exchange rate by 17.3%. At the same time, with a view to responding to exchange rate shocks in a flexible manner the National Bank switched to a new mechanism of pegging the Belarusian ruble to the currency basket, which incorporated in equal shares the US dollar, the euro, and the Russian ruble. When the currency basket was introduced its value amounted to BYR960. With a view to assuring the required flexibility of the exchange rate response to the changing conditions in external markets, the band of fluctuations of the currency basket value was set within plus/minus 10% of the central parity. As at January 1, 2010, the currency basket value amounted to BYR1,036.27, having increased by 7.9% compared with January 2, Taking into account the mutual exchange rates of foreign currencies, as at January 1, 2010 the exchange rate of the Belarusian ruble versus the US dollar dropped by 8% to BYR2,863/USD1, versus the euro by 10.9% to BYR4,106.11/EUR1, and versus the Russian ruble by 5% to BYR94.66/RUR1. The real effective exchange rate of the Belarusian ruble dropped in December 2009 against December 2008 by 19.4%. Over 2009, the real effective exchange rate decreased by 2.1% compared with 2008, compensating to some extent the adverse impact of a decline in external demand for domestic products and ensuring to a certain degree an improvement of price conditions for carrying out foreign trade operations compared with Notwithstanding the weakening impact of the external shock due to the gradual restoration of external demand and decrease, to a certain extent, in the real effective exchange rate of the Belarusian ruble, the foreign trade operations remained unbalanced in 2009 that was mainly due to the outstripped pace of growth of internal expanses compared with that of output, with high level of imports and insufficient effectiveness and competitiveness of the economy continuing.

10 10 % Individual indicators of the balance of payments of the Republic of Belarus Increase in goods and services exports Increase in goods and services imports Source: Belstat Current account balance (right-hand axis) % of GDP The balance of foreign trade in goods in 2009 was unfavorable amounting to USD7 billion, a rise of 11.8% over the past year. Worsened conditions of trade in energy led to the fall in the foreign trade balance by USD1,378.1 million, while the balance of foreign trade in nonenergy in 2009 improved by USD643.6 million, or 15.2% of the 2008 level. Adverse price conditions of foreign trade with respect to the energy (76.6%) as well as non-energy products (95.6%) continued in At the same time, gross indicators of foreign trade (physical volumes of exports/imports ratio) improved over 2009, amounting at the year-end to 101.3% (99.9% excluding energy products) of the 2008 level. Partial recovery of external demand in combination with the economic policy measures led to the gradual recovery of the physical volumes of foreign trade. Since 2009 Q3 the rates of physical volumes of non-energy exports were exceeding those of imports, contributing to the improvement of gross conditions of foreign trade and the balance of foreign trade in non-energy commodities. 140 Dynamics of physical volumes of foreign trade in non-energy commodities (quarter vis-a-vis the corresponding quarter of the previous year) % % Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4 Source: Belstat Physical volumes of non-energy exports Physical volumes of non-energy imports Change in gross conditions of foreign trade (right-hand axis) Traditionally positive services balance stood in 2009 at USD1.4 billion, a 9.3% decrease on 2008 resulting from the fall in the positive balance of transportation services by 12.2%, or by USD200.5 million, with 20.4% of the trade balance deficit being offset by the services balance (25.2% in 2008).

11 11 In the whole of 2009, the balance of the current account of the balance of payments saw a USD6.4 billion (13.1% of GDP) deficit, increasing by 21.7% compared with the previous year. Growing since 2006 foreign trade deficit has reached the level that created significant risks for the foreign trade imbalance financing and, as a consequence, for the ensuring of the Belarusian ruble exchange rate stability. Due to limited capacities for attracting capital by the private sector the increased deficit of the current account was financed, above all, at the expense of resources borrowed by the Government agencies and monetary authorities 2 that resulted in the significant growth of total external debt. The current account deficit was financed at the expense of the capital and financial resources inflow in the amount of USD8.3 billion, a 1.9 times increase compared with 2008, with emergency financing 3 accounting for 51.9% of net capital inflow. The capital and financial resources inflow (excluding emergency financing) increased by USD1.2 billion, or by 43.5% of the 2008 level. Shrinking net capital inflows were observed under the items of direct investment (by USD316.1 million), while net capital inflows under the other investment item (excluding contingency financing) grew by USD1.5 billion. Shrinking net inflow of direct foreign investment in 2009 was caused, above all, by declining investments in equity capital (by 19.8% or by USD343.7 million). As a result, net attraction of direct foreign investment in the domestic economy amounted to USD1.9 billion, including in equity capital to USD1.4 billion. The sale of shares of JSC Beltransgaz (USD625 million) and investment in the banks equity capital (USD539.1 million) assured 83.8% of investment in equity capital. In 2009, the private sector s access to external credits and loans was, on the whole, limited. Thus, net attraction of the long-term credits by banks considerably reduced compared with 2008 (by USD239.2 million) and net outflow of the banks short-term liabilities (by USD235.3 million) as well as long-term liabilities of the non-financial sector (by USD109.4 million) was observed. At the same time, net redemption of the liabilities under the banks shortterm credits and loans was gradually decreasing over the year and in 2009 Q4 turned into net 2 The National Bank belongs to the monetary authorities in the Republic of Belarus. 3 Emergency financing is financing attracted by the Government agencies and monetary authorities to ensure the covering of the gap in financing resulted from the worsening of the balance of payments and reduction of the international reserve assets (in 2009, the credits of the IMF, Russian Federation, World Bank, allocation of the IMF s SDR, syndicated loan of the Russian banks to the Ministry of Finance of the Republic of Belarus in the total amount of USD4.3 billion).

12 12 inflow in the amount of USD258.6 million. The inflow of the non-financial sector s short-term credits and loans grew in 2009 by USD717.2 million. Net attraction of financial resources in the form of commercial (trade) credits amounted in 2009 to USD656.6 million, having increased by USD367.5 million compared with Growing volumes of emergency financing contributed to the considerable growth of foreign debt of the Republic of Belarus. According to preliminary data, as at January 1, 2010, debt liabilities of the economy grew by 45.4% compared with the beginning of the year, amounting to USD22 billion, or 45% of annual GDP. The share of the Government agencies and monetary policy authorities foreign debt in the total volume of foreign debt increased by 13.3 percentage points to 39.9%. Growing long-term borrowings of the Government agencies and monetary authorities contributed to the increase in the share of the long-term liabilities in the structure of gross foreign debt to 55.1% against 45.4% as at January 1, High growth rates of external debt under high deficit of foreign trade heighten the economy s vulnerability and bear significant risk to the external stability and financial soundness due to the significant growth of expenses associated with its future servicing. Decreased sustainability of the balance of payments was the main reason for high net demand for foreign exchange in the domestic foreign exchange market of the Republic of Belarus. Given decreasing external demand, worsening conditions of foreign trade, including in energy, and continuing limited capacities of the private sector to attract foreign financial resources, net purchase of foreign exchange by the economic entities in 2009 amounted to USD3.6 billion against USD3.8 billion in As an external demand for the Belarusian products was gradually recovered and the exchange rate lowered, the imbalance between the resident economic entities demand and supply for foreign exchange decreased in 2009 H2, amounting to USD1.5 billion against USD2.2 billion in 2009 H1. The highest households net demand for foreign exchange was in January 2009 (USD0.6 billion) due to changes in the National Bank s exchange rate policy. As the negative expectations were declining and due to the maintenance of high interest rates on deposits in the national currency by banks, the households net demand for foreign exchange was decreasing, amounting to USD0.9 billion over 2009 H1 and turning into net supply of foreign exchange in the amount of USD0.1 billion in 2009 H2. In the whole of 2009, the households net demand for foreign exchange amounted to USD0.8 billion against USD0.6 billion in 2008.

13 13 The volumes of foreign exchange purchase/sale operations of the resident banks changed due to the decelerated activities of other foreign exchange market participants as well as a significant deficit of the banking system s ruble liquidity. In the whole of 2009, the volume of net sale of foreign exchange by the resident banks increased 5 times and amounted to USD0.8 billion against USD0.2 billion in After considerable deterioration at the end of 2008 the situation in the domestic foreign exchange market of the Republic of Belarus enjoyed certain improvement by mid Decreasing net demand for foreign exchange was a positive sign of the domestic foreign exchange market stabilization in In 2009 H2, net demand (excluding the operations performed by the Ministry of Finance) amounted to USD1.1 billion against USD2.5 billion in 2009 H1. In the whole of 2009, net demand for foreign exchange stood at USD3.6 billion against USD4.3 billion in With account of external financing attracted by the National Bank and the Government and other factors, international reserve assets of the Republic of Belarus (on the IMF s SDDS definition) grew in 2009 to 5,652.5 million, or to 2.2 month of goods and services imports (the recommended threshold indicator being 3 month of imports), reflecting that certain risks for the maintenance of stability in the foreign exchange market and financial stability as a whole were still in place.

14 14 СHAPTER 2. NON-FINANCIAL SECTOR In 2009 compared with 2008, the financial condition of the non-financial enterprises was characterized by decreasing real volumes of sale, declining profit and profitability, and growing number of loss-making organizations and losses incurred by them. In the year under review, non-financial and services worth trillion Belarusian rubles, up by 2.2% on a organizations (excluding small business entities) sold products, goods, works, year earlier (in 2008 the proceeds grew by 33%). At the same time, a significant decrease in the nominal volumes of all profit indicators was observed: profit from the sale of products, goods, works, and services in the economy as a whole dropped by 21.4%; profit before tax by 25.9%; and net profit by 27.6%. In 2009, the share of organizations suffering net losss in the total number of loss-making organizations amounted to 7.1% compared with 5% in Net loss of loss-making organizations increased 2. 2 times compared with 2008, amounting to 1.3 trillion Belarusian rubles. It should be noted, that in 2009 the number of loss-making organizations decreased, while amounts of their losses grew. As a result of the decreasing profit from the sale of products and growth of the production cost of the sold products (by 6.9%) ), profitability of the sold products, works, and services dropped from 14% in 2008 to 10.3% in The share of non-profitable and low-revenue- producing enterprises (whose profitability ranged from 0% to 5%) remained high 47.4% (42.2% in 2008). It was the highest in agriculture (75%) and the lowest in communications (11.8%). Grouping of organizations by the profitability level in 2008 Grouping of organizations by the profitability level in % 19.6 % 29.4 % 18.2 % 14.7 % 9.0 % 7.3 % Source: developed based on the Belstat data < % > % 19.8 % 8.1 % 6.5 % Source: developed based on the Belstat data < > 30 Of the total volume of the organizations proceeds in 2009 the unpaid proceeds constituted 4.6% and the settlements in the non-monetary form 5.5% (28.8 trillion Belarusian rubles of the proceeds in the monetary form not received in full). This was one of the factors restricting the inflow of monetary funds to economic entities accounts and adversely affecting current settlements in the economy.

15 15 Non-financial enterprises' payables and receivables growth, % Payables Overdue payables Receivables Overdue receivables Source: developed based on the Belstat data Due to a faster growth of enterprises total and overdue receivables, the proportion of enterprises with overdue debt remained high. The share of overdue debt in total debt increased. Growth of payables slowed down and their share reduced. As of end-2009, 56.7% of organizations had overdue payables and 67.2% overdue receivables (of which 81.8% and 88.9% of organizations, respectively, had overdue payables and receivables exceeding three months). The existing trend towards expanding the financing of current and investment activities of the organizations of the non-financial sector at the expense of borrowed funds continued into 2009, resulting in the continued increase in debt burden in the sector of nonfinancial enterprises. In 2009, total payables grew 4 by 39.6%, amounting at the end of the year to trillion Belarusian rubles 5, or 78.4% of GDP. Banks credits which grew by 52.6% accounted for its major share (over 54.3%). The ratio between the average annual credit amounts owed to banks and enterprises proceeds of goods sales over the year increased from 9.5% in 2008 to 14.1% in Such trend (typical of the economy as a whole as well as of the main industries) which has been continuing under deteriorating financial condition of the enterprises evidences the increase in the banking sector s exposure to credit risk. Worsening economic situation which manifested itself, above all, in a significant decrease in the demand and prices for products, works, and services of Belarusian enterprises in the foreign markets had an adverse effect on the financial standing of the organizations of the non-financial sector in Payables and credits and loans debt. 5 Source: Belstat.

16 16 Falling sales of export-oriented enterprises products, shrinking foreign exchange proceeds, and growing non-residents receivables (with the forecasted rates of production growth remaining unchanged) were conducive to an increase in the finished-goods inventories, erosion of working capital, creation of preconditions for the deterioration of the financial standing of enterprises, and the reduction of balances of their accounts with banks. Finished-goods inventories of industrial enterprises BYR bn 8,000. 7,000. 6,000. 5,000. 4,000. 3,000. 2,000. 1,000., Source: developed based on the Belstat data nominal volume to the average monthly volume of production (right-hand axis) % As at January 1, 2010, the finished-goods inventories of industrial enterprises amounted to 5.5 trillion Belarusian rubles, increasing in 2009 by 10.3% (against a 55.5% increase in 2008). With respect to the average monthly output they amounted to 67.9% compared with 61.1% as at January 1, The main reasons for the increase in the finished-goods inventories were the growth of output unsecured by the corresponding increase in demand and competitive weakness of certain types of domestic products. Enterprises monitoring data of the National Bank evidence that in 2009 dynamics of the main indicators of the enterprises production, investment, and financial activities was mostly negative compared with the previous year due to the global financial and economic turmoil. At the same time, since 2009 Q2 (compared with 2008 Q4 early 2009) the economic conditions tended to improve and already in December 2009 dynamics of a number of economic indicators was more positive compared with December Under the conditions of the decelerating growth of the households money income in 2009 the increase in consumers expenditure slowed-down, while the growth rates of the households investments financed at the expense of their own funds and banks credits were still high. Households credit amounts owed were growing faster than income, which, in turn, gave rise to a further increase in households debt burden. The households income growth, though less intensive than in 2008, continued in 2009 (their increment amounted to 16.3% in nominal terms and 2.9% in real terms). On that background, the households reduced the their expenses associated with the consumption of goods and services (growth by 11.8% in 2009 compared with 28.8% in 2008) but continued to

17 17 increase, rather intensively, investments in real estate at the expense of own and borrowed resources (growth by 44.4% in 2009 compared with 30.9% in 2008). The households financial savings and savings in the form of real estate were growing much more faster than their monetary incomes that was mainly due to the devaluation of the exchange rate (exchange rate adjustments accounted for nearly half of the households deposits growth with banks). 2,500. Changes in the balances of households' bank accounts BYR bn 2,000. 1,500. 1,000.,500.,. -, , ,500. Source: NBRB In Belarusian rubles In foreign currency 2009 was also peculiar in that households changed their preferences as to the currency of savings and transferred significant part of their savings in Belarusian rubles in deposits in foreign exchange. The balances of households bank accounts in the national currency increased by a mere 3.6% in nominal value, while foreign exchange deposits grew by 83.4% in Belarusian rubles equivalent and by 40.9% in US dollars equivalent. As a result, the share of the deposits denominated in Belarusian rubles in the total households funds with banks dropped in 2009 from 58.3% to 44.1%. At that, the negative trends in the saving process took place mainly at the beginning of the year. As a result of decreasing devaluation and inflationary expectations in 2009 H2, the growth of deposits in Belarusian rubles was gradually restored, with foreign exchange deposits growth simultaneously slowing down. This fact, on the whole, evidences that the households were still confident in the banking sector and the Belarusian ruble. In 2009, households more actively borrowed from banks in Belarusian rubles in order to meet the increasing demand for consumer and investment goods and services under the remaining soft budget constraints (primarily, within soft loans provided for house construction) as well as due to the imposed restrictions on lending in foreign exchange. Natural persons credit amounts owed to banks increased in 2009 by 26.5% (by 58.6% in 2008), including in Belarusian

18 18 rubles by 38.2% (by 50.5% in 2008) and in foreign exchange dropped by 7.2% (in 2008, grew by 87.4%) 6. As a result, households debt burden 7 rose in 2009 from 14.3% to 17.6%. BYR bn Households' credit amounts owed 18, , , , ,000. 8,000. 6,000. 4,000. 2,000.,. January 2008 April 2008 July 2008 October 2008 January 2009 April 2009 July 2009 October 2009 Source: NBRB In Belarusian rubles In foreign exchange Debt burden (right-hand axis) % Reduction of credit amounts owed in foreign exchange in compliance with the decision on the suspension of provision of credits in foreign exchange to natural persons (Resolution of the Board of the National Bank No. 105 dated July 14, 2009) contributed to the decrease in the banks and households credit risks. In 2009, the households continued to be the net creditor of the banking system, with their deposits with banks exceeding the amounts owed to the banking sector. In the year under review the pace of the households deposits growth outstripped that of credits 8 resulting in a decrease in the ratio between households credit amounts owed to banks and bank deposits from 95.8% as at the end of 2008 to 87.9% as at January 1, Ratio between credit amounts owed and households' deposits % Source: NBRB In all currencies In Belarusian rubles In foreign exchange 6 Source: the NBRB. 7 Ratio of the average annual credit amounts owed to the household s disposable income obtained over a year. 8 In 2009, the total amount of the households deposits with banks grew by 36.9%, including in Belarusian rubles by 3.6% and in foreign exchange by 83.3% (by 40.9% in the dollar equivalent).

19 19 CHAPTER 3. FINANCIAL SECTOR In 2009, banks continued to play a dominant role in financial intermediation. The share of non-residents in the capital of the Belarusian banking system increased to a significant extent. In 2009, the financial sector of the Republic of Belarus did not experience any material institutional changes. As at January 1, 2010, the ratio of the broad money supply to GDP, which characterizes the general level of development of the financial sector and the economy as a whole, was 27.9%, having increased by four percentage points compared with January 1, In 2009, total assets of the financial sector 9 accounted for 55.75% of GDP 10 (41.41% in 2008), with 96.8% belonging to banks and 3.2% to insurance companies BANKING SECTOR As at January 1, 2010, the Republic of Belarus had 32 operating banks. While the stateowned banks 11 were still dominating, the structure of the aggregate authorized capital saw significant changes in the year under review. In 2009, the maintenance of attractiveness of the Belarusian financial sector to foreign investors (including the sale of JSC BPS-Bank to the Savings Bank of the Russian Federation) resulted in a significant growth of the non-residents share in the aggregate authorized capital of the banking sector from 17% to 27.3%, and an increase in the number of banks controlled by foreign investors from 20 to 23, while the share of Government agencies and state entities dropped from 80.5% to 70% and the number of state-owned banks declined from five to four. The share of non-state residents slightly increased (from 2.5% to 2.7%) and the number of private banks decreased from six to five. 9 Banks and insurance companies assets. 10 The chronological mean of banks and insurance companies assets in percentage of nominal GDP. 11 Here and hereinafter: State-owned banks (SOB) - a group of banks with the predominant share of Government agencies and state entities in the authorized capital. Foreign banks (FB) - a group of banks with the predominant share of foreign capital in their authorized capital. Private banks (PB) - a group of banks not included in SOB and FB groups. Large banks (LB) - a group of banks whose share of assets exceeds 5% of total assets of the banking sector. Medium banks (MB) - a group of banks whose share of assets exceeds 5% of assets of banks not included in LB group. Small banks (SB) - a group of other banks not included in LB and MB groups.

20 20 As at January 1, 2010, ten banks had individual international ratings, of which eight had Fitch s ratings, six Moody's Investors Service s ratings, and one Standard & Poor's rating. The level of concentration in the banking sector insignificantly decreased in As at January 1, 2010, five largest banks accounted for 84% of the assets and 76.9% of the banking sector s capital (as at the beginning of 2008, 85.1% and 82.2% respectively). As at January 1, 2009, the Herfindahl-Hirschman 12 index calculated on the basis of data about assets was ( as at January 1, 2008), while the Gini index 13 was (0.821). Individual indicators of the banking sector s efficiency that started to sink in 2008 Q2 continued to worsen in % Banking sector profitability (before tax) Source: NBRB Capital Assets (righ-hand axis) While in 2009 Q1 the main sources of the banks profit growth were incomes from revaluation of funds in foreign exchange in connection with devaluation of the national currency, that had a short-term upward effect on the banking sector s profitability, since April 2009 the banking sector s efficiency indicators were drastically worsening due to the realization of the accumulated credit risk manifesting itself in a significant deterioration of quality of the banks credit portfolio and relevant growth in transfers to special provisions to cover potential losses on assets and off-balance operations. In 2009 Q4, a positive dynamics of the banking sector s profitability indicators was mainly due to the low level of the banks special provisions taking into account the preferences 12 The Herfindahl-Hirschman index reflects the degree of concentration of the indicator. Its value ranges from 0 to 1. Value 0 corresponds to minimum concentration, less than 0.10 to a low level of concentration, from 0.10 to 0.18 to an average level of concentration, and over 0.18 to a high level of concentration. 13 Gini coefficient allows estimating equitability of values of one or other variable among participants. Value 0 of this index indicates that the position of participants is equal, and value 1 corresponds to a full concentration,.i.e. all values in this case fall on one participant.

21 21 given in accordance with new procedures for classifying assets 14 exposed to credit risk that were introduced in October The total profit of the banking sector earned in 2009 amounted to 1,084.2 billion Belarusian rubles, exceeding almost 1.5 times the similar indicator in While return on assets (before tax) increased in 2009 insignificantly from 1.9% to 1.96%, return on equity (before tax) considerably declined from 13.03% to 11.93% that was due to the high growth rates of the banking sector s capital at the end of Impact of components on the change in return on equity percentage points Source: NBRB profit margin return on RWA risk level financial leverage change in ROE Identification of component parts in the structure 15 of return on equity shows that decreasing return on risk-weighted assets and profit margin were the main factors responsible for the decelerating growth of return on equity in Moreover, in 2009 Q4 the decrease in financial leverage became an additional constraint. In 2009, due to the continuing high growth rates of risk transactions carried out by banks the safety cushion of the banking sector was steadily shrinking. The said tendency was successfully suspended only at the end of the year when foreign and private banks were intensively increasing their capital for the purpose of its augmenting to the minimum prescribed amount within the period of time set by legislation. At the beginning of 2009, the banking sector s capitalization was rather high due to the Government investments in the largest state-owned banks. However, over 2009 the growth rate 14 In accordance with paragraph 3.1 of Resolution of the Board of the National Bank of the Republic of Belarus No. 159 dated September 23, 2009, banks were entitled to make special provisions in total volume till December 31, In case of making special provision in 2009 Q4 in total volume, the amount of additional transfers would exceed the volume of the banking sector s profit for the quarter. 15 Four components may be identified in the structure of return on capital: profit margin, return on riskweighted assets, risk level, and financial leverage. Profit margin is the ratio of profit (before tax) to net income from banking activity; return on risk-weighted assets is the ratio of net incomes from banking activity to risk-weighted assets; risk level is the ratio of risk-weighted assets to total assets; and financial leverage is the ratio of assets to capital.

22 22 of the banking sector s regulatory capital was behind the growth rates of the asset-related operations that adversely affected the degree of the banking sector s protection from the assumed risks, creating conditions for decreasing the capital adequacy ratio. This indicator reduced from 21.79% as of January 1, 2009 to 18.99% by October 2009, the requirement for individual banks being 8%. At the end of the year the rates of the banks own capital growth were significantly accelerating 16. In 2009 Q4, the aggregate volume of the banking sector s regulatory capital grew by 9.7%, or by 1.2 trillion Belarusian rubles, increasing 1.3 times compared with the previous three quarters. At the same time, the risk-weighted assets of the banking sector grew by 5.4% only, giving rise to the growth of the banking sector capital adequacy indicator. As at the beginning of the year under review the banking sector s capital adequacy ratio amounted to 19.76%. Indicators of the banking sector capital adequacy % Source: NBRB Regulatory capital adequacy Core capital adequacy Capital to assets ratio It should be noted that in 2009 Q4 a positive dynamics of the capital adequacy in the banking sector as a whole was fully assured at the expense of the intensive growth in the foreign and private banks regulatory capital. At the same time, the degree of protection of the stateowned banks from the assumed risks was declining during the whole of The ratio of capital adequacy of the state-owned banks dropped from 21.5% as at the beginning of 2009 to 17.2% as at January 1, In 2009, the quality of the banking sector s regulatory capital worsened. The ratio of the additional capital and core capital grew from 17.9% as at the beginning of 2009 to 23% as at January 1, High level of banks lending was continuing in But, the intensified crisis phenomena in the economy were conducive to the decelerating growth of the credit 16 In accordance with Resolution of the Board of the National Bank of the Republic of Belarus No. 159 dated October 31, 2008, banks authorized to attract natural persons monetary funds into deposits should have increased regulatory capital up to the minimum prescribed amount equal to EUR25 million till January 1, 2010.

23 23 operations volumes compared with In addition, the growth rates of the credit amounts owed were accelerating in real terms against the background of the declining GDP growth that resulted in a significant worsening of the credit portfolio quality. In 2009, a rather high level of banks lending was safeguarded. The volume of credits granted to the institutions of the non-financial sector increased by 40.3% and to households by 26.5%. However, during the whole year the rates of the credit operations growth were constantly decelerating. For example, where at January 1, 2009 the growth (during 12 months) of the banking sector s assets exposed to credit risk was 53.7%, by January 1, 2010 it dropped to 37%. 70 Growth of assets exposed to credit risk % Source: NBRB Total assets Granted to enterprises Granted to households The growth rates of credit operations in foreign exchange experienced the most drastic deceleration. Over the year they grew in the US dollar equivalent by 0.7% only, including the volume of credits in foreign exchange granted to households that dropped by 28.7% 17 compared with early At the same time, the volumes of banks lending to the economy in Belarusian rubles were rather high the assets in the national currency exposed to credit risk increased by 40% compared with early The structure of assets exposed to credit risk saw an increase in the share of debt of the enterprises operating in the agricultural and industrial sectors. Concentration of banks credit portfolio in the above-mentioned sectors was rather high (as at January 1, 2010, the debt of industrial and agricultural enterprises accounted for 40% and 22.1% respectively). Against the background of the strengthening adverse impact of the global financial and economic turmoil on the Belarusian enterprises financial and economic activities, as well as a sharp decline in economic growth rates by more than 2.5 times, the gap between the rates of the 17 According to Resolution of the National Bank of the Republic of Belarus No. 105 dated July 14, 2009, provision of credits in foreign exchange to natural persons is forbidden.

24 24 economy growth and the volumes of credit amount owed widened in real terms 18, amounting as of January 1, 2010 to 39.2 percentage points. The maintenance of the above-mentioned imbalance at a high level during 2009 stimulated accumulation of credit risks by the banking sector and resulted in a significant deterioration of quality of the banking sector s credit portfolio. During the whole of 2009, the banking sector s bad assets were increasing at the rates considerably exceeding the growth of assets exposed to credit risk. In 2009, the volume of banks bad debt increased 3.5 times, or by 2.14 trillion Belarusian rubles, a more than 9.5 times growth compared with The most drastic deterioration in the quality of the banking sector s credit portfolio occurred in late 2009 following the assessment of the real volume of bad assets by banks in accordance with the new rules of their classification 19. In accordance with the National Bank s calculations made on the basis of information provided by banks, the volume of bad assets in the banking sector increased by 1.54 trillion Belarusian rubles due to the application of new principles of classification, amounting to 39% of its growth in the whole of For this reason the share of bad assets grew by 2.3 percentage points. 4 Factors in the change in the share of banks' bad assets 3 percentage points Source: NBRB impact of assets growth impact of bad assets growth change in the share of bad assets The most drastic deterioration in the quality experienced the credits granted to legal persons, with high growth rates of bad debt being specific to the enterprises and institutions in all sectors of the economy. The most significant growth was experienced by the nonperforming loans granted to industrial enterprises by billion Belarusian rubles (a 3.1 times increase), enterprises carrying out operations with the real estate and providing to the consumers leasing 18 The chronological mean of debt under clients' and banks' credits for 12 months adjusted to the GDP deflator. 19 Changes in the procedures for classifying assets and making special provisions by banks to cover potential losses on assets and off-balance operations are approved by Resolution of the Board of the National Bank of the Republic of Belarus No. 159 dated September 23, 2009.

25 25 and other services by billion Belarusian rubles (a 23.3 times increase), and agricultural enterprises by 396 billion Belarusian rubles (a 3 times increase). The volume of nonperforming loans granted to households grew over 2009 by 78.9 billion Belarusian rubles, or twofold, with the biggest difficulties being experienced by natural persons when servicing loans obtained in foreign exchange. Despite the drastic decrease over 2009 in the balance of the households debt in foreign exchange to banks, bad debt grew at the rates considerably exceeding their growth in Belarusian rubles 190.2% and 36% respectively. As at the beginning of 2010, bad assetss of the banking sector 20 reached 3.01 trillion Belarusian rubles, with their share in the total amount of the banking sector s assets exposed to credit risk increasing from 1.68% as of January 1, 2009 to 4.24% as at the beginning of The share of bad debt of industrial and agricultural enterprises exceededd 5%. In 2009, the indicator characterizing the general level of the banking sector s exposuree to credit risk 21 continued to be rather high, rangingg between 69.3% and 72.1% (59.7% as at the beginning of 2007). While the assets classified under Group III were still dominant in the structure of bad assets as of January 1, 2010, their share significantly declined compared with early At the same time, the share of bad assets under Group IV and Group V considerably grew from 22% to 42.9% (almost a twofold increase) compared with January 1, Structure of bad assets as at January 1, 2009 Structure of bad assets as at January 1, % 14.0 % 28.4 % 14.5 % 78.0 % 57.1 % Source: NBRBB Source: NBRB Group III Group IV Group V Group III Group IV Group V In 2009, as the quality of assets deteriorated, banks were making provisions designedd to cover potential losses on assets exposed to credit risk. As at the beginning of 2010, they grew up to 1,,352.7 billion Belarusian rubles, amounting only to 71.8% of the minimum calculated amount. This was primarily caused by the low level of the banks special provisions on assets under Group I, as well as on bad assets in view of the new procedures for their classification introduced in October Assets classified under Groups III, IV, and V to create special provisions. 21 The ratio of credit risk-weighted assets to calculate regulatory capital adequacy to assets.

26 26 As a result, in 2009 the level of the banking sector s vulnerability to credit risk (the ratio of bad assets less the actual reserve to regulatory capital) significantly increased from 4.52% to 15.39%. The analysis of banks sensitivity to the potential worsening of their credit portfolio quality showed that the vulnerability of the banking sector to credit risk was growing in 2009, despite a certain improvement in the indicator of the banking sector s potential losses to the profit. With the increase in the share of banks bad assets by 15 percentage points (under the assumption that the structure of bad assets would remain in the proportions close to the actual stakes) as well as a corresponding increase in the share of Group II assets, the losses of the banking sector would exceed banks profit over 12 months 5.3 times (according to the data as of January 1, 2009 the losses exceeded the profit 5.5 times). However, despite a certain decline in this indicator, the banks losses in case of realization of the above-mentioned scenario remain considerable. This is evidenced by the growth of the ratio of losses to capital from 35.2% as at January 1, 2009 to 43% as at January 1, The additional capital which is needed to meet the prescribed capital adequacy requirement (8%) by all banks will amount to 1,162.3 billion Belarusian rubles (as of January 1, billion Belarusian rubles). Stress testing results (the worst-case scenario) Indicators over the quarter Change over 12 months Capital adequacy ratio,% Actual value Calculated value Change Losses versus profit over 12 months, times Ratio Losses versus capital, % Ratio Volume of additional investments to capital, billion Belarusian rubles Amount , On the whole, the banking sector would be able to withstand the above-mentioned deterioration in credit portfolio quality: capital adequacy ratio would be more than 8%, at the same time two banks (with the share in total assets of the banking sector amounting to 44.3%) would have the ratio not exceeding 8%. Detailed results of stress testing are shown in the Appendix. Despite additional capitalization by the Government of the largest state-owned banks in late 2008, in 2009, the growth of lending to the economy (mainly, long-term) under the conditions of non-availability of resources matching by term led to a steady growth of the banking sector s exposure to liquidity risk. In 2009, intensification by banks of the asset-related operations resulted in a further increase in maturity mismatch between banks claims and liabilities. The share of the long-term component in the banking sector s time assets during January-November 2009 was at the level of %, with the simultaneous decline in the share of long-term liabilities from 42.3% as at early 2009 to 32.4% as at December 1, 2009.

27 27 As the result, the gap between the long-term assets and liabilities widened during January-November 2009 by more than 1.8 times, amounting to 19 trillion Belarusian rubles as at December 1, 2009 (22.8% of the assets). Indicators of the banking sector's liquidity % Source: NBRB Ratio of liquid assets to total assets Current liquidity (right-hand axis) Short-term liquidity*100 (right-hand axis) The positive effect from recapitalization of core state-owned banks by the Government in late 2008 had a short-term character, while the problems with liquidity were steadily increasing in the banking sector over the whole of The key liquidity indicators (the ratio of liquid assets to total assets and the short-term liquidity ratio) in the banking sector as a whole dropped by December 1, 2009 below the requirements prescribed for a separate bank. After the one-step devaluation of the national currency in early 2009 resulting in a significant reduction of households and economic entities funds attracted in Belarusian rubles, the banks were lacking ruble liquidity to the utmost. Only in 2009 Q1 the total volume of funds in Belarusian rubles on the households and legal persons current, deposit, and other accounts reduced by 19.3%, with the funds attracted in foreign exchange simultaneous growing by 12.7%. Despite the termination during the year of the above-mentioned negative trend towards transferring deposits in Belarusian rubles into savings in foreign exchange, the growth rates of the clients funds attracted in the national currency were significantly decelerating compared with The largest state-owned banks in which the situation with liquidity worsened to the utmost were affected by the above-mentioned processes in the first place. In addition, the stateowned banks expanded lending under dramatic shrinking of the Government s resources support that aggravated their condition. In 2009, the volume of funds in Belarusian rubles placed by the Government agencies with the banks dropped by 1.1 trillion Belarusian rubles, or by 11.1% In 2008, the volume of financial support provided by the Government was quite significant the balance of funds on the accounts of Government agencies grew over the year by 6.4 trillion Belarusian rubles (a 2.8 times increase).

28 28 Therefore, the growth of the banking sector s assets in Belarusian rubles in 2009 was only partially compensated by the increase in the funds attracted from clients that forced the banks to expand the borrowings in the national currency from the National Bank. Share of the National Bank's resources in the total amount of the banking sector'ss liabilities % Source: NBRB In 2009, the volume of resources provided by the National Bank to the banking sector grew more than 2.7 times from 2.96 trillion Belarusian rubles to 8.07 trillion Belarusian rubles. The share of the National Bank in the total amount of ruble liabilities of the banking sector reached 21.6%, having increased 2.3 times compared with early Liabilities structure as at January 1, 2009 Liabilities structure as at January 1, % 4.1 % 13.4 % % 4.7 % 15.2 % 26.0 % Government Households Source: NBRB NBRB Banks 6.4 % Enterprises Non-residents 23.9 % 23.5 % Government Households Source: NBRB NBRB Banks 12.6 % Enterprises Non-residents 16.8 % In 2009, the banking sector s external borrowings were growing at low rates that didn t allow this source of replenishment of the resourcee base to play a significant role in the expansion of internal lending and maintenance of the banking sector s liquidity by banks. The total amount of the banking sector s liabilities to non-residents amounted as at January 1, 2010 to USD3,547.2 million, having increased in 2009 by USD472 million (20.5% less than their growth in 2008). As at January 1, 2010, the funds attracted for a term exceeding one year were dominating in the structure of the banking sector s external debt. However, while over 2009 the share of a long-term component in the total volume of funds attracted from non-residents was within % %, it declined to 52.8% by the beginning of 2010.

29 29 The analysis of banks sensitivity to the outflow of non-residents funds revealed a rather high level of exposure to this type of shock that remained unchanged during the whole year under review. If funds attracted from non-residents outflow in the amount of 50%, all liquidity indicators of the banking sector in foreign exchange (excluding the instant liquidity ratio) would significantly decline that will not allow the banking sector to meet the prescribed liquidity requirements for all types of currencies. At the same time, the general state of liquidity after the shock will considerably deteriorate the shortterm liquidity ratio in foreign exchange for the banking sector as a whole would closely approach zero and amount to Stress-testing results (the worst-case scenario) Indicators over the quarter Change over 12 months Instant liquidity ratio in foreign exchange, % Actual value Calculated value Change Current liquidity ratio in foreign exchange, % Actual value Calculated value Change Short-term liquidity ratio in foreign exchange Actual value Calculated value Change Liquid-to-total assets ratio in foreign exchange, % Actual value Calculated value Change It should be noted that separate banks have problems with liquidity in foreign exchange without occurrence of a shock situation. Thus, as of January 1, 2010, two banks (66% of the total assets) had actual values of current liquidity lower than prescribed requirements, 10 banks (75.5%) of short-term liquidity, 4 banks (29.8%) of liquid-to-total assets ratio. Therefore, with the occurrence of a shock scenario, a significant deterioration in all liquidity indicators in foreign exchange of separate banks would take place 27 banks with the share in total assets of the banking sector amounting to 98.8% will be confronted with liquidity shortage. Detailed results of stress testing are shown in the Appendix. The measures taken by the National Bank in late 2009 made it possible to discontinue the negative tendency of continuous reduction of the main liquidity indicators of the banking sector. Decisions of the National Bank on providing two largest state-owned banks with credits in the form of credit lines, as well as on assuming obligations to grant monetary funds, stimulated the improvement of liquidity indicators both of the above-mentioned banks and the banking sector as a whole. By the early 2010, the short-term liquidity ratio of the banking sector had reached the maximum value over the previous five years 3.01, liquid-to-total assets ratio amounted to 28.41%.

30 30 In 2009, the degree of the banking sector s exposure to the risk of withdrawal by the natural and legal persons of 20% of their monetary funds declined, primarily, due to the significant growth of actual values of all liquidity ratios of the banking sector by January 1, If deposits attracted from households and enterprises outflow in the amount of 20%, nine banks with the share of assets amounting to 38.6% of the total assets of the banking sector would be confronted with liquidity shortage. Thus, four banks (8.3%) would be not able to meet the instant liquidity ratio and seven banks (36.6%) the liquid-to-total assets ratio. Despite the fact that number of banks that are lacking liquidity in case of occurrence of a shock situation remained virtually unchanged compared with early 2009, their share in the total assets of the banking sector would significantly reduce (by 50.3 percentage points). Findings of stress testing (the worst-case scenario) Indicators over the quarter Change over 12 months Instant liquidity ratio, % Actual value Calculated value Change Current liquidity ratio, % Actual value Calculated value change Short-term liquidity ratio Actual value Calculated value Change Liquid-to-total assets ratio, % Actual value Calculated value Change Thus, in 2009, the degree of vulnerability of the banking sector as a whole to the liquidity risk reduced: under the 20%-outflow of deposits only the liquid-to-total assets ratio would be lower than the prescribed requirement. This situation was brought about by the National Bank s measures on providing two largest banks with funds in December 2009, resulting in a significant growth of the actual values of the banking sector liquidity indicators. Detailed results of stress testing are presented in the Appendix. In 2009, a significant growth of the indicators of the banking sector s open foreign exchange position brought about a considerable increase in the level of its vulnerability to the possible fluctuations of exchange rates. Moreover, a multidirectional dynamics of the component shares in foreign exchange in the banks assets and liabilities became an additional reason for their exposure to foreign exchange risk. In the course of 2009, the sale of foreign exchange remained one of the banking sector s sources designed to cover the deficit of funds in Belarusian rubles. Where during January- February 2009 the majority of banks maintained, at a time of devaluation expectations, long foreign exchange position, by the beginning of 2009 Q2 net open foreign exchange position of the banking sector accounted for minus 4.9% of regulatory capital. In 2009 Q2 and Q3, the size of short foreign exchange position of the banking sector continued to grow against the

31 31 background of aggravating ruble liquidity situation and amounted to minus 11.6% by January 1, Open foreign exchange position of the banking sector % Source: NBRB Ratio of total OFEP to capital Ratio of net OFEP to capital The drift to short foreign exchange position of the biggest state-owned banks which continued to sell foreign exchange in an environment of huge deficit of funds in Belarusian rubles was mainly responsible for such situation. Foreign and private banks maintained long foreign exchange position during An increase in negative value of net open foreign exchange position also determined an increase in the ratio between total foreign exchange position and regulatory capital of the banking sector which grew from 8.7% as at January 1, 2009 to 11.7% as at early Credit risks that grew significantly in response to the devaluation of the national currency exerted a restraining influence on the volume of banks issue of foreign exchange credits in Despite significant nominal increase in 2009 of foreign exchange assets exposed to credit risk (by 31%) their volumes in the US dollar equivalent were up by mere 0.7%. Also, the sum of foreign exchange credits granted to the clients virtually did not change during the year and the volume of credit amounts owed by natural persons fell by 28.7%. Accordingly, much lower growth rates of banks credit operations in foreign exchange compared with an increase in volumes of lending in Belarusian rubles called forth a gradual Ratio of foreign exchange components to the total volume % Source: NBRB Clients' funds Households' funds (right-hand axis) Credit amounts owed by clients Enterprises' funds (right-hand axis)

32 32 decline in 2009 in the share of foreign exchange component in the banking sector s assets. By early 2010, the share of foreign exchange claims in the total amount of clients debt on credit and other asset-related operations dropped to 30.7% (to 31.9% as at early 2009), the lowest indicator over the past five years. According to data as at January 1, 2010, the banking sector demonstrated higher degree of vulnerability to the devaluation of the national currency versus the US dollar as evidenced by some deterioration in all key indicators that are analyzed. For example, as a result of 20% depreciation of the Belarusian ruble vis-à-vis the US dollar banks losses will amount to 4.0% of their profit earned over 12 months and 0.36% of capital, with simultaneous decline in banking sector capital adequacy ratio by 0.1 percentage points.. However, all calculated indicators will go into a slight decline. This is due to the fact that the majority of banks (23 banks with the share of assets accounting for 28.1% of total assets in the banking sector as at January 1, 2010) are still in long US dollars position and in the event that the above-mentioned scenario is enacted they will manage to earn, in addition to the profit made, 59.2 billion Belarusian rubles. Results of stress testing (the worst-case scenario) Indicators over the quarter Change over 12 months Capital adequacy ratio, % Actual Calculated Change Losses versus profit over 12 months, times Ratio Losses versus capital, % Ratio Thus, the banking sector demonstrated, on the whole, its ability to withstand direct foreign exchange risk (the capital adequacy ratio remained at high level) with some increase in the degree of vulnerability thereto. Detailed results of stress testing are shown in the Appendix. At the same time, growing inflation and devaluation expectations of households and economic entities were conducive to the process of changing their preferences as to the currency of savings in favor of foreign exchange. In 2009, the share of attracted foreign exchange funds in the total sum of the banking sector s liabilities raised from 32.95% to 41.96%. Such surge in the share of foreign exchange liabilities was due to two factors an increase in the total sum of attracted foreign exchange funds by 14.6% as well as a revaluation of foreign exchange liabilities in connection with the devaluation of the Belarusian ruble. In 2009, the degree of the banking sector s vulnerability to potential changes in interest rates on assets and liabilities raised insignificantly and remained quite substantial. Also, the dynamics of the change in the banking sector s exposure to interest rate risk in Belarusian rubles and in foreign exchange moved in the opposite directions.

33 33 The analysis of key indicators characterizing the banking sector s exposure to interest rate risk testifies to low degree of its vulnerability to the change in interest rates on claims and liabilities in Belarusian rubles saw an improvement in the volume and time structure of the banking sector s interest-bearing claims and liabilities in the national currency. By early 2010, relative cumulative gap between interest-rate sensitive assets and liabilities was positive even at a time when assets and liabilities with days maturities were used in the calculation. Also, the degree of the impact exerted by a change in interest rates on claims and liabilities in Belarusian rubles upon the volume of net interest income of the banking sector was low. Based on the structure of the banking sector s interest-bearing claims and liabilities in the national currency as at January 1, 2010, a change in net interest income of the banking sector will amount, provided that interest rates on assets and liabilities are changed by 1% per annum, to mere 1.4% (to 0.04% as at early 2009). Relative change in the economic capital value will be insignificant too 0.96% (0.9% as at early 2009) Relative gap between interest-rate sensitive assets and liabilities in Belarusian rubles % Up to 30 days days days 181 day-1 year Over 1 year Source: NBRB cumulant curve cumulant curve At the same time, the banking sector s exposure to interest rate risk involving assets and liabilities in foreign exchange remained high and the situation was deteriorating over the year. Relative gap between interest-rate sensitive assets and liabilities in foreign exchange % Up to 30 days days days 181 day-1year Over 1 year Source: NBRB cumulant curve cumulant curve

34 34 The growth in interest rate sensitive liabilities in foreign exchange which is not compensated by the growth in assets with corresponding terms of income revision resulted in significant increase in the banking sector s exposure to interest rate risk. Owing to the deterioration in the volume and time structure of the banking sector s interest-bearing claims and liabilities in foreign exchange the risk of the change in net interest income during 2009 increased substantially. Where the interest rates on foreign exchange assets and liabilities are changed by 1% per annum, potential relative change in net interest income of the banking sector will amount to 13% (to 8.7% as at early 2009) and relative change in the economic value of capital to 0.4% (to 0.3% as at early 2009) showed lower sensitivity of the banking sector to the upward movement of the yield curve both in Belarusian rubles and in foreign exchange. In case of parallel 1,500 basis points upward movement of the yield curve in Belarusian rubles, the banking sector will sustain losses exceeding 1.2 times the profit earned over 12 months, a slight decline in the level existing as at early 2009 (1.7 times). Also, losses versus capital ratio will be reduced from 10.7% as at January 1, 2009 to 9.7% as at January 1, Under the impact of similar shock the banking sector, as a whole, will preserve high degree of stability capital adequacy ratios of all banks as well as of the entire banking sector will remain sufficiently high. Results of stress testing (the worst-case scenario) Indicators Change over the quarter over 12 months Capital adequacy ratio, % Actual Calculated Change Losses versus profit over 12 months, times Ratio Losses versus capital, % Ratio In case of 1,000 basis points upward movement of the yield curve in foreign exchange, 13 banks whose share accounts for 80.6% of the total volume of the banking sector s assets will suffer a decline in capital adequacy ratio, with all analyzed indicators of the banking sector improving, following the impact of the shock on these banks, compared with the results obtained as at January 1, In particular, losses versus profit ratio over 12 months will amount to mere 13.3% (to 23.5% a year earlier), versus capital to 1.1% (to 1.51% a year earlier), and the change in capital adequacy ratio of the entire banking sector will not exceed 0.2 percentage points (0.3 percentage points). Detailed results of stress testing are shown in the Appendix. Risks diagram drawn on the basis of data as at January 1, 2010 shows significant growth, compared with 2008, in the relative level of risks assumed by the banking sector.

35 35 Risks diagram is a comprehensive (aggregated) assessment of the relative level of the banking sector s soundness based on a combination of the analysis of the dynamics of financial stability indicators and the results of the banking sector s stress testing within the observable historic period of time. The scheme for plotting a composite indicator which evaluates the level of risks in the banking sector is based on the principle that a great number of indicators characterizing various factors affecting its stability is used, with the system of weighting coefficients which show the significance of each factor when determining the overall level of risks being employed. The majority of weights in suggested algorithm were attached in an expert manner based on experience and knowledge of the National Bank s specialists. However, an expert survey of banks was conducted with a view to improving the assessments of the main risk factors significance made by the National Bank s specialists as well as for the purpose of enhancing the objectivity of the comprehensive assessment of the level of the banking sector s exposure to risks which made it possible to take into account their point of view when defining the measure of significance of the main characteristics of the banking sector s soundness. By December 1, 2009, the overall level of risks assumed by the banking sector reached its maximum, at that point in time, over the entire observation period (beginning in January 2006) and fell significantly by early 2010 as a result of measures taken by the Government in December 2009 to provide the banking sector with liquidity. 1 Overall level of exposure to risks Source: NBRB However, the banking sector s exposure to the main banking risks increased materially compared with Also, a substantial growth in credit, foreign exchange, and interest rate risks as well as a decline in capital adequacy indicators of the banking sector exerted a raising impact on the dynamics of the overall relative level of risks in At the same time, an improvement in liquidity and efficiency indicators of the banking sector s activities facilitated the reduction in the overall level of risks.

36 36 Diagram of risks as at January 1, 2010 Capital adequacy Overalll level of exposure to risks Credit risk Profitability Liquidity risk Source: NBRBB Interest rate risk Foreign exchange risk A comparative analysis of riskss levels over 2009 gives an obvious idea about the changes that took place in the banking sector during this period. Following the recapitalization of major state-owned banks in late 2008 which had only a short-term positive effect on the overall financial standing of the banking sector, the overall level of its exposure to risks grew steadily. Even after the support provided by the Government in December 2009, the overall level of the banking sector ss exposure to risks turned out to be comparable, as at January 1, 2010, with its values in late Dynamics of the level of the banking sector s risks Overall level of risks Liquidity risk Capital adequacy Credit risk Foreign exchange risk Interest rate risk Profitability

37 INSURANCE SECTOR As at January 1, 2010, the insurance sector of the Republic of Belarus comprised 24 insurance companies, including 4 life insurance companies, and State Unitary Enterprise Belarusian National Reinsurance Organization. In 2009, 8 insurance companies with controlling stakes therein belonging to the state (their number did not change over the year) conducted business in the country s insurance market; the number of companies controlled by foreign capital grew from 7 to 9 owing to the fact that two foreign insurance companies CJSC IC Rosgosstrakh and FIC Zepter Insurance came on the domestic insurance market; and, on the contrary, the number of private insurers 23 declined from 9 to 7. By early 2010, own capital of the insurance sector amounted to 1.87 trillion Belarusian rubles, exceeding more than 3.4 times the 2008 level which was due to a substantial growth in the capitalization of state-owned insurers 24 in As a result, a significant growth, compared with 2008, in the share of the authorized capital of the insurance sector s own capital was registered from 70.2% to 88.4%. Also, a significant growth in the ratio between the insurance sector s own capital and assets was registered from 40.4% to 63.9% 25 which may be deemed as an indication of the excessive capitalization of the domestic insurance sector. As at January 1, 2010, three insurance companies had individual ratings of international rating agencies, two of them were given ratings by Fitch Ratings and one by A.M. Best Co. high. In 2009, the concentration of the domestic insurance sector continued to be rather The bulk of insurance business in 2009 was concentrated in 10 insurance companies (manly state-owned 26 ) which held leading positions in the volumes of insurance premiums and 23 Hereinafter: State-owned insurance companies - a group of state-owned insurance companies with Government agencies and legal persons dominant share in authorized capital. Foreign insurance companies - a group of insurance companies with foreign capital s dominant share in authorized capital. Private insurance companies - a group of banks that are not included in the groups of state-owned and foreign insurance companies. 24 In compliance with Resolution of the Council of Ministers of the Republic of Belarus No dated December 18, 2008 authorized capitals of two state-owned insurers Belgosstrakh and State Unitary Enterprise Belarusian National Reinsurance Organization were increased by 1 trillion Belarusian rubles which were used thereafter to increase capital of the banking sector. 25 The chronological mean of the insurance sector s own capital, aggregate authorized capital, and assets. 26 The state-owned insurers comprising the above-mentioned group of 10 companies raised over 83% of the entire sector s premiums.

38 38 accounted for 94.9% of the sector s revenues as a whole (for 93.8% in 2008). In 2009, the Herfindahl-Hirschman index for the insurance sector, calculated based on the net insurance premiums indicator, stood at 0.31 (at 0.35 in 2008), while the Gini coefficient calculated on the basis of the same indicator was 0.76 (0.75) which suggests that concentration of the insurance market in the Republic of Belarus is still high. In 2009, a decline in financial standing and solvency of the enterprises and decelerating growth rates of households real income had a restraining effect on the growth rates of the insurance industry. In 2009, the total volume of net insurance premiums reached 1.1 trillion Belarusian rubles and the share of voluntary insurance premiums stood at 46.5% (at 44% in 2008). In 2009, the growth rates of net insurance premiums slowed down more than two times compared with previous year (from 43.9% to 18.9%). However, taking into consideration the fact that premiums in foreign exchange (or calculated in compliance with the exchange rate of foreign currency) account for a substantial share (around 30%) in the total volume of insurance premiums, the growth of premiums in 2009 was mainly driven by the devaluation of the Belarusian ruble. Without regard to the devaluation, the growth rates of the domestic insurance market did not exceed 10.8% 27. In 2009, gross insurance premiums as a percentage of GDP stood at 0.81% (at 0.72% in 2008). In terms of this indicator Belarus still falls behind not only developed western economies but Ukraine and Russia Gross insurance premiums as a percentage of GDP Source: Internet data and NBRB Russia Ukraine Republic of Belarus At the same time, a significant growth in the insurance sector s loss ratio was registered in 2009 which resulted in considerable decline of efficiency indicators for insurance business. 27 Based on calculations of the National Bank.

39 39 In 2009, the total amount of net claims grew by 43.7% compared with 2008, exceeding more than two times the growth rates of insurance premiums. As a result, a significant growth, compared with 2008, in the insurance sector s loss ratio (the ratio between net insurance claims and net insurance premiums) was registered from 47.2% to 57.1%. A significant decline, compared with 2008, in the combined loss ratio of non-life insurance companies (the ratio of the sum of net insurance claims, revisions to insurance reserves and policy administration costs to the net insurance premiums) characterizing the efficiency of insurance business was registered. Where in 2008 it was equal to 94.2%, in 2009 this indicator exceeded 100% and amounted to 101.9%. Accordingly, insurance business of non-life insurance companies made a loss in 2009 and investment income was the main source of profit. Pre-tax total profit earned by the insurance sector in 2009 amounted to billion Belarusian rubles, up by 44.8 billion Belarusian rubles or by 60.8% compared with the same indicator in The ratio between the pre-tax profit earned by insurers and average annual value of their own capital in 2009 declined more than two times compared with the year earlier from 16.0% to 7.5% which was largely due to a substantial growth of the insurance sector s capitalization. The return on assets ratio of the insurance sector also fell from 6.5% to 4.8%. Indicators characterizing the adequacy of insurance reserves set up by the insurance sector and its ability to perform obligations in the long-term perspective suggest that there is a slight decline in exposure of the domestic insurance companies to insurance risks. The amount of insurance reserves set up as at January 1, 2010, was 1.81 times higher than the average of net insurance claims paid in last three years (1.83 times as at January 1, 2009). The ratio between the sum of insurance reserves and the average of net insurance premiums received in last three years increased from 92.2% to 96%. The risk of potential significant losses and decrease, through the large claims, in the amount of insurance reserves of the domestic insurance sector may be also assessed as not very high. In 2009, the total amount of large insurance claims paid by the country s insurance companies as compensation for the damages incurred by natural calamities and anthropogenic impacts (transport accidents (wrecks), industrial accidents, and other) amounted to 24.5 billion

40 40 Belarusian rubles or 3.3% of the sum of insurance reserves 28 set up by the insurance sector (in 2008 to 6.8 billion Belarusian rubles and 1.3 % respectively). Government investments in the banking sector made in late 2008 through the agency of state-owned insurers were responsible for the growth in 2009 of exposure of the county s insurance sector to market risks. Where during 2008 the insurance sector s exposure to stock market risk remained at traditionally low level 29 (the total sum of insurance companies investments in legal persons securities amounted, as at October 1, 2008, to mere around 3.4 billion Belarusian rubles or 0.3% of the insurance sector s assets), as early as at the turn of 2009 the insurance sector s investments in authorized capitals of economic entities (including banks) stood at 1 trillion Belarusian rubles (47.1% of assets) and by January 1, 2010 went up to 1.4 trillion Belarusian rubles (48.5% of assets). The Belarusian insurance sector s exposure to the risk of change in real estate prices may be deemed to be low where the prohibition on the investment of funds in real estate by stateowned insurers in conjunction with high level of concentration of the insurance sector are taken into account. As at January 1, 2010, the domestic insurance companies invested in real estate properties only 5.8% of the total amount of assets. The Belarusian insurance sector s exposure to the risk of change in real estate prices may be deemed to be low taking into account the prohibition for state-owned insurers to invest funds in real estate and high level of concentration of the insurance sector. As at January 1, 2010, the domestic insurance companies invested in real estate properties only 5.8% of the total amount of assets. The insurance sector s vulnerability to potential fluctuations in exchange rates of foreign currency is also relatively low. Since insurance policies in respect of which reserves are set up in foreign exchange are mainly of short-term nature and loss ratios of such types of insurance are relatively low, domestic insurer s assets exceed, as a rule, liabilities in relevant currency. This motivates the country s insurance companies to have predominantly long foreign exchange position. 28 The chronological mean of the sum of the set up insurance reserves. 29 In compliance with procedures for investing and placing funds of insurance reserves by insurance companies approved by Resolution of the Council of Ministers of the Republic of Belarus No. 750 dated December 29, 2006, the life insurance company may invest in legal persons securities (save shares and promissory notes) 20% of insurance reserves to the maximum and non-life insurance company 25% to the maximum.

41 41 As at early 2010, the insurance sector s net open foreign exchange position amounted to plus 10.4% of the aggregate amount of its own capital (to plus 8.1% as at January 1, 2009). Low share of life insurance premiums (long-term types of insurance) is responsible for low exposure of the insurance sector to interest rate risk. Exposure to interest rate risk is inherent only in life insurance companies maintaining long-term insurance business that include, along with insurance of various risks associated with natural persons life and health, the investment component which makes it possible to accumulate funds along with the insurance coverage. The key parameter of such insurance products is the guaranteed return rate (guarantee income rate) accrued to the funds accumulated under insurance policies which makes such insurance products sensitive to the change in interest rates. In spite of continuous growth, over the past few years, in the share of life insurance premiums, their share in 2009 continued to be low (5.5%) which makes it possible to draw a conclusion that the level of exposure of the insurance sector as a whole to interest rate risk is low. The degree of the insurance sector s vulnerability to credit risk is also low as the country has no practice of granting credits to the policyholders. Whereas legislation of the Republic of Belarus prohibits the insurance companies from crediting their clients, the risk of counterparties failure to perform their obligations under reinsurance, investment (deposit), and other economic agreements constitutes the insurance sector s credit risk. On January 1, 2010, total receivables of the insurance sector amounted to 60.8 billion Belarusian rubles or 5.5% of the total volume of premiums in 2009 (4.8% in 2008). Liquidity risk is of minor importance for the country s insurance sector. As at January 1, 2010, the domestic insurance companies placed 57.1% of assets 30 on (settlement and deposit) accounts with banks or used them to purchase Government securities. Thus, insurance companies are in position to regulate, without material losses, their liquidity through the purchase/sale of Government securities that are freely traded in the market or early withdrawal of funds from deposit accounts. rubles. 30 Exclusive of investments in authorized capitals of state-owned banks amounting to 1 trillion Belarusian

42 42 CHAPTER 4. FINANCIAL MARKETS In 2009, the majority of operations in the foreign exchange market were conducted in US dollars whose share, together with euros, grew on previous year, while the volume of foreign exchange operations involving the Russian ruble fell significantly. In 2009, the turnover of the domestic foreign exchange market was up by 63.6% compared with 2008, amounting to USD billion, of which the turnover of the over-the- 24.5% (to USD14.11 billion), and the turnover of the cash market declined by 7.5% (to USD12.48 billion). Structure of the foreign exchange market in 2008 Structure of the foreign exchange market in % 14.7% 0.4% 27.9% 6.8% 0.1% 58.4% 65.2% Source: NBRB Source: NBRB The US dollar The Russian ruble The euro Other types of currencies The US dollar The Russian ruble The euro Other types of currencies Transactions involving the US dollar (65.2%) prevailed in the gross volume of foreign exchange operations in the foreign exchange market. The share of this currency grew by 6.8 percentage points compared with 2008, with the share of the euro ncreasing from 26.5% to 27.9% %. The foreign exchange market of the Republic of Belarus saw a significant fall in the share of the Russian ruble, from 14.7% to 6.8%, due to a more vigorous decline in foreign trade operations with the Russian Federation as well as high volatility of the Russian ruble: the cost of the Russian bi-currency basket grew by 7.1% over 2009, its fluctuations ranging from RUR33.7 to RUR40.9. The volume of operations in other currencies remained insignificant with their share accounting for 0.1%, down by 0..3 percentage points compared with the 2008 level. counter market grew by 101.8% (to USD billion), the turnover of the stock market fell by Changes in the exchange rate policy of the National Bank led to a slight mitigation of risks associated with reciprocal fluctuations in the exchange rates of foreign currencies. At the same time, intraday fluctuations in the exchange rate of the Belarusian ruble vis-à- vis the US dollar grew on 2008.