2. REGULATION AND SUPERVISION OF THE BANKING SYSTEM

Transcription

1 2. REGULATION AND SUPERVISION OF THE BANKING SYSTEM

2 32 Annual Report of Central Bank of Montengro for 2002

3 Regulation and supervision of the banking sector The activities of the Bank Supervision Department have been directed towards estimating the coordination of organization and business activities of banks with provisions of the Law on Banks, increasing the efficiency of the banking system, strengthening the financial market and regaining trust in banks. The following activities were undertaken to improve the system framework for bank operations. In the preparation of various rules and regulations, the objective was to achieve full compliance with generally accepted international standards. Furthermore, the previous regulations were continuously amended because their implementation in practice showed some deficiencies. The majority of banks in Montenegro are burdened with historic positions in their balance sheets. Following its strategic commitment to maintain a healthy banking system, the CBM undertook various measures towards insolvent banks. It also made a continued evaluation of the banks organization and operations compliance with provisions of the Law on Banks. Improvement of the existing examination methodologies and procedures, and development of new ones, represents a very important segment of the overall reform process. The training of examiners, the improvement of bank reporting systems and software packages for the data collection and analysis, as well as the organizational and staffing pattern of the department is aimed at accelerating the reform process. For the purpose of establishing control over the establishment and operation of financial entities that operate without any special supervision, the Central Bank undertook a number of activities. It initiated the enactment of certain laws and subordinate legislation and is actively involved in their preparation Bank supervision Results achieved The activity plan prepared for the previous year served as the basis for the activities undertaken during Change of Institutional Framework For the purpose of a more successful implementation of the reform in 2002 the Law on Banks was amended. These amendments are aimed at additional 33

4 Annual Report of Central Bank of Montengro for 2002 adjustment to, and acceptance of international standards. The amended Law prescribes the minimum initial capital for the establishment of a new bank of EUR 5 million and a gradual increase of risk-based capital for banks licensed earlier. The capital requirement also applies to foreign bank affiliations. A new regulation is the obligation of making provisions for losses on all items of assets, and not only loans, as before. Furthermore, International Accounting Standards were fully implemented. With adoption of the amendments to the Law, the following decisions had to be adjusted or adopted anew during last year: Decision on Minimal Standards of Bank Capital, Decision on Criteria and Procedure for Classifying Assets and Forming Asset Loss Reserves, Decision on Minimal Standards of Management of Loan Concentrations and Operations with Bank Related Parties, Decision on Bank Reports to the Central Bank of Montenegro, Decision on Banks and Financial institutions Conduct in case of Suspicious Transactions of Their Clients, Decision on Issuing Licenses, Approvals and Permissions and Amounts of Fees, Decision on Contents and Manner of Maintaining the Bank and Foreign Bank Affiliation Register, Decision on the Contents and Manner of Maintaining the Foreign Bank Representative Office Register, Decision on Credit Unions, Decision on Micro-credit Financial Institutions, Decision on Bank Interim Administration. Beside that, the CBM participated in the preparation of a number of other laws, including: Law on Settlement of Obligations and Claims under Foreign Debt and Frozen Foreign Exchange Savings, Law on Protection of Deposits, 34

5 Regulation and supervision of the banking sector Law on Prevention of Money Laundering, Law on Insurance Companies and Insurance Intermediaries. On-site and off-site examination manuals are in the final stage of preparation. These manuals shall contain criteria for assigning ratings to individual components of the CAMELS system and composite ratings. On-site manuals will be forwarded to banks to make them familiar with the examination techniques and to achieve better transparency of the Bank Supervision Department activities Results of Banking Supervision Within its regular activities, the department conducted 23 on-site and regular off-site examinations during the last year. Also, the software package for bank reporting and studying bank profiles was prepared. Of the total number of examinations conducted, 12 were full-scope examinations, 9 were targeted examinations and 2 were supervisory visits. Full-scope examinations are performed on the basis of risk evaluation in bank operations according to CAMELS methodology. That means that all the components are evaluated: capital, asset quality, management, earnings, liquidity and sensitivity to market risk and ratings from 1 to 5 are assigned, as well as composite ratings for each individual bank. Based on the assigned rating, the strategy for further supervisory actions is being prepared. In the evaluation of asset quality, financial analysis of borrowers and assessment of cash flows are performed Implementation of Measures against Banks In order to remove irregularities and weaknesses observed during on-site examinations, agreements have been signed with banks defining methods and timeframes to remove such deficiencies and obligation to report to the CBM on the steps taken. In addition, the CBM issued orders to commercial banks that have been directed to rectify the deficiencies identified during the examinations, specifying the date by which the orders should be executed. As the result of these measures, and due to its non-compliance with the Law provisions, Beranska Bank was merged with Atlasmont Bank. Bankruptcy proceedings have been initiated in Yugobank, Podgorica and liquidation proceedings in the Bank for Development, Podgorica. Montenegrobank Podgorica was placed under reorganization. 35

6 Annual Report of Central Bank of Montengro for 2002 The reorganization of Montenegrobank At the end of 2001, the CBM Council adopted the Reorganization Plan of Montenegrobank, upon the prior initiative of the Government. The Plan consisted of four stages specifying the future activities, responsible parties and completion deadlines, conclusively with April 9, 2002, i.e., by the end of the interim administration. The main objective of the Plan was to restructure the Bank by mid March 2002 and start a new bank on April 1, In the first stage of the Plan, a new interim administration was appointed and priorities in its work were determined. The priorities included: the establishment of independent internal audit, negotiations with employees about their status, loan rescheduling, sales of collaterals, and so on. The second stage was building normative infrastructure supporting the removal of bank asset and liability items and the assumption of bank ownership by the Government of Montenegro. On March 18, 2002, the Government passed the decision on removal from the Bank s balance sheet. The decision was made in order to increase the capital of the Bank through the conversion of claims originating from the removal of foreign debt and frozen foreign exchange savings accounts into the equity, resulting in the change of the Bank s ownership structure and having the Government of Montenegro as the majority stakeholder. All these amounts represent nominal, non-updated values of the removed foreign debts, assumed from the Bank s balance sheet, i.e., they represent the balance sheet positions recorded in the pre-sanction period. They do not show the changes performed through foreign debt purchase and therefore do not represent a fair basis for making conclusions about the actual debt amount. In accordance with that, the Government of Montenegro assumed the following items from the Bank s balance sheet: Foreign financial loans Bank s claims Bank s liabilities 616,455 thousand 619,977 thousand Frozen FX saving accounts Bank s claims Bank s liabilities 48,177 thousand 48,368 thousand 36

7 Regulation and supervision of the banking sector The difference between claims and liabilities under foreign loans and frozen foreign exchange saving accounts, to the amount of EUR 3,712 thousand, represents the claims of the Republic from the Bank. That claim is converted into the equity capital of the Bank, with the following breakdown: Total capital of the Bank Equity of the Government of RM Equity of other shareholders 4,057 thousand 3,712 thousand 345 thousand The third stage of the Plan comprised the rationalization of the organizational structure, collateral foreclosure, and loan rescheduling and preparing the Bank for sale. Due claims to the amount of EUR 6.2 million have been collected, loans to the amount of EUR 8.7 million have been rescheduled, EUR 2.7 million of the Bank s property was sold and EUR 9.7 million of collateral value have been registered as the Bank s property. All these activities contributed to the improvement in the solvency level from minus 36% before reorganization to 33% after reorganization. Upon completion of measures for the rationalization of the organizational and staffing structure, the total number of employees has been reduced by 56%, so that out of 419 employees, 191 are actively engaged. The fourth stage foresaw the licensing of the new Bank and its privatization. The privatization procedure was finalized with the signing of the privatization agreement with Nova Ljubljanska Bank. Resolution of Other Nonsolid Banks At the beginning of 2002 (February 7), interim administration was introduced in Yugobank Podgorica. It was preceded by 2 on-site examinations and numerous meetings with the Bank management. All the CAMELS components were rated with the lowest grades, with no realistic chances of their improvement. In addition, Yugobank Podgorica was highly dependent on Yugobank Belgrade, which is also under bankruptcy. This dependence was reflected in the payment operations, blocking of accounts and joint and several liability. It was impossible to perform any bank reorganization because of: the absence of a loan portfolio, the great number of litigations with highly uncertain outcome, the high risk of additional loss of property due to joint and several liability, 37

8 Annual Report of Central Bank of Montengro for 2002 so further operation of the bank would further jeopardize its depositors. During the interim administration in the bank it was found that it was not possible for the bank to comply its operations with the provisions of the Law on Banks so that the Central Bank initiated bankruptcy proceedings in Yugobank ad, Podgorica. The total assets on the date of starting the bankruptcy proceedings amounted to EUR 119 million, mostly relating to foreign debt and frozen FX savings. The total off-balance sheet exposure as of the same date amounted to EUR 58 million, and it is also connected to guarantees and other off-balance sheet commitments from the earlier period. The tender documentation for the sale of parts of the bank s assets is under preparation. On February 7, 2002, the Bank for Development, Podgorica was put under liquidation. The liquidation proceedings was initiated because of the impossibility to collect the due claims and lack of interest on the part of management in the further fate of the bank. The total assets on the date of starting the liquidation proceedings were EUR 17,528 thousand. The following items amounting to EUR 11,300 thousand were removed from the initial balance: Long-term loans for employment Short-term loans Claims related to subscribed unpaid capital 3,600 thousand 157 thousand 7,593 thousand The long-term loans originate from a commission deal of the bank with the Employment Bureau. The bank extended long-term employment loans to individuals on its own behalf and for the account of the third party. The liquidation proceedings have not impeded the termination of this contract. The short-term loans refer to claims from the assumed debt challenged in liquidation proceedings. The liquidation pool of assets for the settlement of creditors amounted to EUR 5,815 thousand. During the liquidation, EUR 783 thousand was collected from the bank s debtors and a number of litigations have been undertaken. The creditors and depositors were paid EUR 509 thousand from the liquidation pool of assets and the liquidation expenses were covered. Furthermore, EUR 4,471 thousand was removed from books through offsetting of mutual claims 38

9 Regulation and supervision of the banking sector and liabilities with the bank founders. The liquidation of the Bank for Development is planned to be completed by the end of April Issuing Bank Licenses, Approvals and Permissions In the last year, two new banks were licensed, Opportunity Bank and Atlasmont Bank. Also, based on previous approval to continue their operations and compliance of their organization and acts with the law amendments, ten licenses were issued: Niksicka Bank, Euromarket Bank, Podgoricka Bank, Opportunity Bank Pljevaljska Bank, Hipotekarna Bank, Crnogorska Komercijalna Bank, Montenegrobank, Atlasmont Bank and Ekos Bank. During the previous year, the banks continued to expand their networks, so that the CBM issued approvals for the establishment of 19 branches as well as for the merger between Beranska Bank, Berane and Atlasmont Bank, Podgorica. One license application was rejected due to inadequate and incomplete information on shareholders. Numerous approvals and permissions were issued for the appointment of directors, external auditors, and so on The structure of the banking system in Montenegro Bank number and network During 2002 the banking sector in Montenegro has been significantly changed. At year-end 2002, 10 banks operated in Montenegro. Compared to the previous period the following changes happened: Bankruptcy proceedings commenced in Yugobank a.d. Podgorica. Liquidation proceedings commenced in Development Bank a.d. Podgorica, Montenegrobank became a completely new bank according to many indicators with the interim administration and reorganization, 2 new banks were founded: Opportunity bank a.d. Podgorica and Atlasmont bank a.d. Podgorica, Beranska bank a.d. Berane was merged with Atlasmont bank. The total assets of Montenegrin banks, with frozen foreign savings amounted to EUR million as of 12/31/02, of which the 4 largest banks represent 73% 39

10 Annual Report of Central Bank of Montengro for 2002 Table 14. Business network of banks in Montenegro in 2002 Bank Numbers of units of the total financial potential. The total capital of the banks amount to EUR 77.9 million as of 12/31/02, of which 2 banks with the largest level of capital participate with 37%. 951 employees worked in the banking sector at 2002 yearend. During 2002, 7 branches of banks whose head offices are in Serbia operated in Montenegro. Two branches were able to meet the requirements at the end of 2002, and to continue their performance as affiliations in Regional participation of banks in Montenegro deteriorated compared to the previous year. In 2001, 3 banks had its head offices in the northern part of Montenegro and 8 other in Podgorica; in 2002 this ratio is 2:8. Banks in Montenegro expanded their business network by opening 21 branches in Numbers of units 2002 Towns in which banks have their organizational parts Hipotekarna Bank 0 0 Podgorička Bank 4 7 Podgorica, Danilovgrad, Nikšić, Kolašin,Bijelo Polje, Bar i Budva Crnogorska Kom. Bank 4 8 Rožaje, Bijelo Polje, Nikšić, Bar, Herceg Novi, Budva, Kotor i Ulcin Euromarket Bank 0 5 Rožaje, Herceg Novi, Budva, Kotor i Ulcinj Ekos Bank 9 9 Podgorica, Beograd, Kruševac, Kraljevo, Rožaje Pljevaljska Bank 1 1 Žabljak Nikšićka Bank 3 3 Šavnik, Plužine, Nikšic Atlasmont Bank 0 6 Berane, Herceg Novi, Bar, Nikšić, Budva, Kotor Opportunity Bank 0 3 Bar, Berane i Nikšic Montenegrobank Bar, Beograd, Budva, Ulcinj, Cetinje, Bijelo Polje, Rožaje, Podgorica, Tivat, Herceg Novi, Mojkovac, Pržno, Potkošljun, Petrovac Table 15. Structure of Equities Ownership as of 12/31/02 No. Bank Banks' Ownership Structure State Participation in Capital Participation of Private Sector in Capital Part. of Foreign Individuals in Cap. TOTAL Amount % Amount % Amount % 1 Hipotekarna Bank , , , Podgorička Bank , ,59 0 0, Crnogorska komer. Bank , , , Euromarket Bank 0 0,00 0 0, , Ekos Bank 138 2, ,18 0 0, Pljevaljska Bank , ,67 0 0, Nikšićka Bank , ,15 0 0, Atlasmont Bank , ,73 0 0, Montenegrobank , ,48 0 0, Opportunity Bank 0 0,00 0 0, , TOTAL: , , ,

11 Regulation and supervision of the banking sector At year-end 2002, the state was the owner of 31.13% of share capital of Montenegrin banks, private individuals were owners of 43.55%, and foreign individuals 25.32%. Chart 8. Structure of Equities Ownership Chart 9. Ownership Structure per Banks in 2002 Year State Participation in Capita Particiopation of Private Sect. in Capital Participation of Foreign Individuals in Capital Amount % Amount % Amount % TOTAL Index Table 16. Changes in ownership structure in Montenegrin banks 41

12 Annual Report of Central Bank of Montengro for 2002 State participation in capital of the banks decreased by 12% compared to Participation of private individuals in the capital of banks increased by 3%, and of foreign individuals increased by 9%. Nominally, state capital in banks has decreased by EUR 2.3 million, i.e. 11% compared to Capital of private individuals increased by EUR 6 million 32%, and capital of foreign individuals is increased by EUR 6.9 million or 93%. Three banks are majority state owned (over 50%). The assets of these banks amount to EUR million and represent 30.9% total assets of all banks. Total assets of two banks that are mostly state owned (30 50%) amount to EUR 52.2 million and represent 15.3% of total assets of all banks. In 2001, the assets of the majority state owned banks represented 62% of total assets of all banks. The participation of banks in the total assets of banks in Montenegro in 2001 was 62%. In 2002 this percentage reduced to 46 % Changes in Employment Structure 951 employees were employed in Montenegrin banks at the end of The number of employees decreased by 219 compared to the previous year, which represents a decrease of 19%. The number of employees significantly decreased at Montenegrobank and slightly decreased at Pljevaljska Bank. The number of employees in Niksicka Bank remained the same. The number of employees increased in other banks at year-end It is important to point out that qualification and age structure changed during the previous year. Namely, by expanding their network, banks employed younger staff and with a high education level, and through the proceedings of reorganization, bankruptcy and liquidation the number of older employees and those with lower qualifications decreased through various social programs. 42

13 Regulation and supervision of the banking sector 2.3. Banks' performance in Banks' Total Assets No. Bank Total Assets % Market Share Change Hipotekarna Bank ,03 22,42 23,21 2 Podgorička Bank ,34 16,88 20,63 3 Beranska Bank , Crnogorska Kom. Bank ,26 9,96 18,29 5 Ekos Bank ,99 2,28 2,48 6 Euromarket Bank ,38 3,24 6,40 7 Nikšićka Bank ,61 3,15 3,21 8 Pljevaljska Bank ,45 3,37 4,82 9 Jugobank , Bank for Development , Montenegrobank ,11 12 Atlasmont bank ,52 13 Opportunity bank international ,33 TOTAL ,27 100,00 100,00 The total assets of the banks as of 12/31/02 amounted to EUR million. Total assets decreased by EUR 26.6 million compared to the previous year at the rate of 7.27%. This decrease of total assets is due to the exclusion of Yugobank and Bank for Development from the aggregate balance sheet, which was a consequence of the measures taken against these banks. Assets of these banks represented 1/3 of the total assets of Montenegrin banks, and foreign debts and foreign frozen savings represented 93% of these assets. Foreign frozen savings recorded in the balance sheets of banks totaled EUR million. Table 17. Total Assets of Banks in Montenegro in thousands EUR Table 18. Total Assets of the Banks in Montenegro including Montenegrobank in 2001 No. Bank Total Assets (000 EUR) Market Share (%) % Change Hipotekarna Bank ,03 8,31 23,21 2 Podgorička Bank ,34 6,27 20,63 3 Beranska Bank , Crnogorska Kom. Bank ,26 3,69 18,29 5 Ekos Bank ,99 0,84 2,48 6 Euromarket Bank ,38 1,20 6,40 7 Nikšićka Bank ,61 1,16 3,21 8 Pljevaljska Bank ,45 1,24 4,82 9 Jugobank , Bank for Development , Montenegrobank ,12 62,95 7,11 12 Atlasmont Bank ,52 13 Opportunity international ,33 TOTAL ,65 100,00 100,00 43

14 Annual Report of Central Bank of Montengro for Balance Sheet of Banks with External Debt and Frozen FX Savings Accounts The aggregate balance sheet of the banking sector of Montenegro as of 12/31/ 02 with foreign frozen savings amounted to EUR million. Frozen FX savings, besides Yugobank, is recorded with: Podgoricka bank, Niksicka bank, Pljevaljska bank and Atlasmont bank at the position Other Assets, i.e. Other Liabilities to the amount of EUR 30.7 million. The aggregate balance sheet structure with these positions is shown in the following chart, i.e. as in the Annex 2, Table 11. Chart 10. Aggregated Balance Sheet Liquid Assets Loans Securities Fixed Assets Investments and Acquired Assets Other Assets

15 Regulation and supervision of the banking sector Balance Sheet of Banks without External Debt and Frozen FX Savings Accounts As of year-end 2002,the total assets of the banks amount to EUR 30.8 million. It increased by EUR 70 million compared to 2001, which represents an increase of 29.20%. Total loans represent the most significant nominal increase. They increased by EUR 40.6 million or 48.23%. Cash funds increased by EUR 23.4 million or 20.05%. Fixed assets and acquired assets also significantly increased. Reserves for potential losses on assets items show a slight increase. Other assets decreased by EUR 17.5 million or 61.06%. Assets growth is funded by an increase of total liabilities and capital growth achieved. Total liabilities amount to EUR million. They increased by EUR 46.5 million or 25.08% compared to Liabilities growth is provided by deposits that amount to EUR million. They increased by EUR 57.3 million or 38.70% compared to During 2002, loan leverage of the banking sector decreased, and other liabilities were reduced by half. Total capital of the banks as of 12/31/02 amounted to EUR 77.9 million. It increased by EUR 23.5 million or 43.23% compared with Capital increased by founding new banks, issuing new share capital and achieved operating income in Chart 11. Aggregated Balance Sheet 45

16 Annual Report of Central Bank of Montengro for Market Share Table 19. market Participation of the Banks in Banking Sector in Montenegro as of 12/31/02 Market Share Measured by Total Assets (%) Loans (%) Deposits (%) Capaital (%) 1 bank 23,21 33,96 29,84 18,53 3 banks 62,13 68,96 71,56 46,98 5 banks 79,76 75,94 86,29 69,21 7 banks 90,98 87,27 95,15 81,81 46

17 Regulation and supervision of the banking sector Structure of Loans, Claims under Leasing Operations and Matured Claims Table 20. Structure of Loans, Claims under Leasing Operations and Matured Claims As of 12/ 31/01 and 12/31/02 in 000 EUR No. 1 Description Loans and other receivabl. From the GRM Short term < 1 yr Long term > 1 yr Matured receviables Paid-called for payment OBL TOTAL Government institutions Municipalities Majority state owned 4 enterprises Private enterprises Entrepreneurs Banks Financial institutions Non profit organizations Citizans Credit cards Other TOTAL Note: Total loans are in higher amount that is shown in the balance sheet as of 12/31/02 by euro 27 thousand, which represents paid off balance sheet liabilities that are shown in the balance sheet as other assets. In 2001, 69% of the loan portfolio consisted of short-term loans. The largest borrowers were privately owned enterprises (64.34%), and loans to Government of the Republic of Montenegro (16.85%). Loan activity was concentrated on short-term loans that amounted to EUR 97 million or 77.7% of the loan portfolio at year-end Long term loans amounted to EUR 26 million and represented 20.8% of total loans, and matured receivables amounted to EUR 1.7 million or 1.5 % of total loans. Short-term loans nominally increased by 67% compared to 2001, while matured receivables nominally increased by 214%, and long-term loans decreased by 5.6%. Loans to privately owned enterprises amount to EUR 65.8 million and represent 52.7% of total loans. Short-term loans represent 78.6% of these loans. Loans to citizens amount to EUR 22.2 million representing 17.8% in total loans. Loans to the Government represent 13.2% of total loans, loans to majority state owned 47

18 Annual Report of Central Bank of Montengro for 2002 Table 21. Aggregate Loan Structure By Sectors in 2001 (000 enterprises represent 9%, municipalities represent 2.3%, Government institutions represent 1.6%, entrepreneurs represent 1.5% and other borrowers represent 1.9%. Loans to privately owned enterprises increased by EUR 15.9 million or 34.6% compared to 2001, loans to citizens increased by EUR 15.9 million or 251%. Loans to other borrowers slightly increased. No. Borrowers % % Index 1. Agriculture, hunting, fishing, etc, , ,2% Mining , ,6% Energy , ,7% Civil engineering , ,0% Trade , ,6% Service, tourism, restaurants , ,1% Transport, warehousing, communications , ,7% Finances , ,7% Real Estate trade ,0% Administration , ,4% Other , ,9% 229 TOTAL ,0% ,0% 148 In 2002, loan activity was mainly focused on trade, administration, services and civil engineering. At 2002 year-end loans for transport and mining decreased significantly compared to the previous year-end. Loans to citizens included in category Other had the biggest growth, more than half of the amount. Chart 12. Deposit Structure by Sectors 48

19 Regulation and supervision of the banking sector Banks' Deposits Structure Deposits with the banks increased by 38.7% compared to 2001, and they amounted to EUR million. In 2002 a large dispersion of deposits with banks was present, and new banks had significant growth and market share in total deposits. Table 22. Deposits with Banks as of 12/31/01 and 12/31/02 Dynamic comparison of aggregate deposit structure by maturity (000 EUR) % % Index 1. Demand Deposits % % Up to 3 months % % Up to one year % % Up to 3 years % % Over 3 years 58 0% - 0% - TOTAL % % 139 Chart 13. Deposit structure by maturity in 2001 and 2002 Total deposits in 2001 amounted to EUR million. According to maturity structure, deposits and sight savings represented 70.3% of total deposits, and time deposits represented 29.7%. In the time deposit structure, deposits up to 3 months represented 18.1% of total deposits, deposits up to one year represented 8.4%, deposits up to 3 years 3.2%, and the percentage of the deposits over 3 years was not significant. Total deposits nominally increased by EUR 57.4 million compared to According to the maturity structure, deposits and sight savings represent 70.3% and time deposits are 29.7% of total deposits. This percentage was established even at 2001 year-end. In the time deposit structure, deposits up to 3 months represented 19.3% of total deposits, time deposits up to 1 year were 9.1%, and 49

20 Annual Report of Central Bank of Montengro for 2002 Table 23. Aggregate deposit structure by ownership sectors in 2002 (000 EUR) deposits up to 3 years were 1.3%. Deposits up to 3 months and deposits up to 1 year increased compared to 2001 year-end, and deposits up to 3 years significantly decreased. Depositors % % Index Government of the Republic of Montenegro ,7% ,5% 217 Government institutions 0 0,0% ,8% 0 Municipalities 0 0,0% ,2% 0 Majority state owned enterprises ,2% ,2% 172 Privately owned enterprises ,5% ,9% 79 Entrepreneurs 0 0,0% 380 0,2% 0 Banks ,5% ,5% 96 Financial institutions ,5% ,9% 85 Non profit organizations ,4% ,6% 451 Citizens ,4% ,1% 208 Other ,7% ,0% 82 TOTAL ,0% ,0% 139 According to the depositor structure, deposits of privately owned enterprises represented 54.5% of total deposits, deposits of the Government 15.7%, deposits of majority state owned enterprises 8.2%, deposits of the banks 6.5%, deposits of the citizens 5.4%, and deposits of other depositors 9.7%. According to the depositor structure in 2002, deposits of privately owned enterprises amounted to EUR 63.5 million or 30.9% of total deposits. Deposits of the Government amounted to EUR 50.4 million and represented 24.5% of total deposits. Deposits of majority state owned enterprises represented 10.2% of total deposits, deposits of Government institutions 8.8%, deposits of the citizens were 8.1%, deposits of the banks were 4.5%, deposits of non profit organizations were 4.6%, and deposits of all other depositors were 8.4%. The depositor structure has significantly changed compared to year-end 2001, primarily due to the increase of deposits from government sources. Deposits of the Government increased by EUR 27.2 million, deposits of the Government institutions increased by EUR 18.1 million, deposits of the majority state owned enterprises by EUR 8.8 million and deposits of the municipalities by EUR 6.5 million. Deposits of these four categories of depositors made 46.7% of total deposits (in 2001, the contribution was 24%). Deposits of citizens increased by EUR 8.7 million compared to the previous year, and deposits of non-profit organizations by EUR 7.5 million. Deposits of majority privately owned enterprises decreased by EUR 17.3 million. 50

21 Regulation and supervision of the banking sector Chart 14. Deposit Structure by Sectors in 2001 and Aggregated Banking Industry Income Statement The financial result of banks performances in Montenegro for 2002 was positive. The final net income amounted to EUR 12.1 million. In 2002, all banks show positive result. The result significantly comes from extraordinary items. In 2001, Montenegrin banks operated with losses 3. 3) If we were to include Montenegrobank loss, total amount of loss would exceed EUR 60 million. No. DESCRIPTION Growth in % 1. Interest Income ,8 2. Interest Expenses ,32 3. Net Interest Income/Expenses ,79 4. Provision for Loan Losses ,93 5. Neto prihodi / Rashodi ,24 6. Fee Income ,38 7. Fee Expenses ,44 8. Net Fee Income/Expenses ,78 9. Net Interest and Fee Income/Expenses , Other Operating Income , Operating Expenses , Income/Expenses Before Extraordinary Items , Extraordinary Income , Extraordinary Expenses , Income/Expenses After Extraordinary Items , Taxes , Net Profit/Loss Table 24. Income Statment of Banks (in thousands EUR)

22 Annual Report of Central Bank of Montengro for 2002 Chart 15. Income Structure Table 25. Bank Profitability and Efficiency Ratios No. Ratios Index 1 Return on Average Assets -0.68% 5.29% Return on Average Capital -4.44% 20.92% Net Interest Income/ Average Assets 4.06% 5.38% Net operating Income/Average Asseits 5.18% 5.30% Provision for Loan Losses/Average Assets 4.66% 6.08% Operating Expenses/Average Assets 6.62% 7.49% In 2002, the return on average assets amounted to 5.29%. This ratio was at a high level and was high compared to the previous year when it had been negative. The largest portion of this ratio comes from net extraordinary income at Montenegrobank. The return on average capital amounted to 20.92% and was high due to the same reasons. The interest margin to average assets amounted to 5.38% and had actual growth at the rate of 33% compared to the previous year. This growth was achieved primarily due to the interest income growth in 2002 of 40% compared to 2001 and interest expense at the rate of 10% compared to the previous years. Net operating income to average assets increased modestly. Provisions for loan losses in 2002 represented 6.08% of average assets and compared to the previous year show an increase of 30%, which was similar to the dynamics of interest margin. In 2002, operating (overhead) expenses to average assets were high and amounted to 7.49%. They increased by 13% compared to The increase of these expenses was primarily due to the increase in employees expenses in the current year.

23 Regulation and supervision of the banking sector Chart 16. Rewiev of Banks Perfoemances Through Ratios Source: banks' data 2.4. Risk Exposure of the Montenegro Banking System The risk exposure of the banking system is reduced due to the implementation of new regulations of international standards. Risk management becomes more and more qualitative Credit Risk The primary activity of all banks is credit activity. Loans and lease operations comprise 40% of the total assets of Montenegrin banks. Banks evaluate credit risk that comes from credit activity and from other balance and off balance activities by provisioning the reserves for potential losses pursuant to the relevant classification. The following table shows the amount of formed and required reserves for the period from 12/31/01 to 12/31/02. As of 12/31/02 the banks had 32% more reserves than is required by the Decision on Criteria and Procedure for Classifying Assets and Forming Assets Reserves. The total amount of formed reserves compared to the reviewed period increased by 67%, due to the banks liability to form reserves for potential losses on all assets items, as well as due to increased credit activity that bears higher risk. The structure of balance sheet and off balance sheet items for the period is as follows: 53

24 Annual Report of Central Bank of Montengro for 2002 Table 26. Reaserves according to balance sheet items Clasification % % Pass A 81,71 74,40 Special mention - B 6,37 10,76 Substandard C 3,64 4,87 Doubtful D 7,82 0,15 Loss E 0,46 9,82 T o t a l : 100,00 100,00 One may make a conclusion from the data that the quality of balance sheet and off balance sheet items improved. It was due to the adoption of modern standards in banks performance, a large diversification of loans, modern credit policy and practice of the banks, less credit concentration to bank related parties, more qualitative reserves for potential losses, and better evaluation of financial information of the borrowers Solvency Risk The Central Bank of Montenegro has regulated by legal regulation the manner and criteria for determining the minimal standards of capital, which provides loss coverage originating from credit risks that any bank is exposed to in its performance. Banks in Montenegro are obliged to maintain a solvency ratio as a relative indicator of the exposure of the bank to credit risk at the level of at least 8%. The following table shows the solvency ratios in the banks for the period: All the banks met the legal minimal requirement of solvency ratio of 8%. As of 12/31/02 the solvency ratios for all banks amounted to 42%, and compared to 12/31/02 it increased by 3%. The solvency ratio in some banks declined due to the increase of total risk weighted assets and an increase of credit activities of the banks. Pursuant to this, the banks were obliged to make reserves for potential operating risks, which lead to a growth of provision for potential loan losses and reflected negatively to the earnings of the banks and ultimately to the level of risk based capital of the banks. The reason for the increase of total risk based capital by 61% for the period was the inclusion of two new banks founded in 2002, as well as due to legal requirement for the banks to increase their risk based capital up to EUR 3 million as of 12/31/02. The total risk weighted assets for this one-year period increased by 47%. 54

25 Regulation and supervision of the banking sector Liquidity Risk The Central Bank of Montenegro legally regulated liquidity risk management and determined minimum liquidity requirements. Liquid assets of the banks amounted to 41.17% of total assets and 68.19% of total deposits. Net loans to deposits amounted to 60.74%. Deposits with banks are significantly high to support credit activity growth. According to maturity, the deposit structure is considered stable, since deposits and sight savings of up to one year to time deposits has not been changed in total deposits. The total cumulative gap for all banks was positive as of 12/31/02. The mismatch between financial assets and financial liabilities on the aggregate level are characteristic for a period of 30 days. The cumulative gap amounted to 27.26% of total sources of funds. According to the data from daily cash flow reports, the surplus for December 2002 amounted to million. Based on 10-day reports, the average amount of liquid assets to short-term liabilities for all quarters in 2002 was above the prescribed minimum of 10% Currency Risk Aggregate balance in all foreign currencies for all banks converted to EUR amounts to EUR 12.7 million. First class capital of all banks amounts to EUR 74.6 million. The aggregate position for all foreign currencies represents 17% of total first class capital. The largest total individual position in USD represents 9.61% of first class capital of all banks. The following table shows net long (short) positions as an indicator of foreign currency match of assets and liabilities on aggregate level. Table 27. Foreign cuurency match af assets and liabilities Description Dinar USD GBP CHF Other Total Net long (short) positions % Of first class capital 3,50 9,61-0,05-0,31 0, Operating Risk Operating risk has lately gained more importance, and more institutions in the bank regulatory field and banks themselves have dealt with it. The importance of this risk lies in the fact that in most cases it comes together with other risks. The internal control and audit systems in the banks play an important role in measuring operating risk, the establishment and working of this function is regulqated by law. 55

26 Annual Report of Central Bank of Montengro for 2002 Analyzing bank performance violations of the regulations were noted regarding investments in fixed assets that may not exceed more than 20% of share capital or first class capital. Violations regarding investments in fixed assets were found in four banks Internal Audit in Banks The establishment and functioning of internal audit in banks is prescribed by Law on Banks and Decision on Internal Audit in Banks. All banks appointed internal auditors. A seminar on the manner and functioning of the internal audit system was held in order to train internal auditors. Furthermore, during on-site examination, auditors were provided with suggestions and advice in order to enhance the function and role of internal auditors Information Technology in Banks The Central Bank started with IT examination in banks in July Examiners noted through 8 on-site examinations of the banks conducted in 2002 that the IT Department needs improvement. Areas that need additional attention encompass annual coverage by IT Audit, development of IT policy and adequate contingency plan. Banks have to develop appropriate back-up information systems and written procedures External Audit External Audit of the financial reports for 2001 was performed for all banks in Montenegro. According to the auditors, accounting reports present fairly and correctly the financial position of all banks, except Ekos Bank, as of 12/31/01 as well as operating results and cash flows for the mentioned year in accordance with accounting standards and regulations of the Republic of Montenegro Interest Rate Sensitivity Interest rate risk represents uncertainty regarding its movement and refers to financial condition of banks exposure to unfavorable movements of interest rates. With the introduction of the EURO as the official currency in Montenegro, 56

27 Regulation and supervision of the banking sector and due to its stability, interest rate risk significantly decreased. Available data shows that interest rate variable was low after the introduction of the Deutsche Mark, measured by standard deviation. During 2002 interest rates in the financial market in the Republic of Montenegro, both lending and borrowing rates, slightly decreased compared to previous year. Several factors contributed to this, of which the most important was an established level of competition within the banking system and the increase of foreign investors or creditors as long term foreign lendiers. During 2002, lending interest rates on short-term loans were in the range from 0.12% to 3.10% monthly, and on long-term loans were in the range from 0.16% to 3.0%, while interest rates on securities held to maturity were from 0.60% to 1.27%. Borrowing interest rates on demand deposits were from 0.04% to 0.63% monthly during 2002, time deposits in EUR between 0.11% %, and on time deposits in other foreign currencies between 0.11% %. Changes in interest rates per month are shown in Annex 2, Table P14. The lending rates on short-term loans annually were from 2.00% to 43.20%, for long-term loans from 2.00% to 39.17%, and for securities held to maturity from 7.00% to 16.00%. Annual borrowing rates for demand deposits were in the range from 0.80% to 8.00%, for time deposits in EUR from 1.30% to 30.00%, and for time deposits in other foreign currencies from 1.37% to 13.04%. The range of lending and borrowing rates is largely due to numerous factors both on thedemand and supply of money. When calculating interest rates, a number of risk premiums and the anticipated rate of inflation are added which is still relatively high in the Republic of Montenegro. The level of interest rates in the Republic is influenced also by high operating expenses; the relatively low efficiency of the banking sector, high shareholders premiums and low creditworthiness of the borrowers. The Central Bank will prescribe a uniform methodology for interest accrual in order to remove any differences. The review of lending interest rates show that the increase of the number of banks that approve consumer loans as well as the general stabilization of the conditions in the second half of the year contributed to a decrease in interest rates on consumer loans. These interest rates reacted to the demand for loans, which suddenly increased in November last year. 57

28 Annual Report of Central Bank of Montengro for Main Trends in Banks' Operations 1. Growth of deposits and savings from EUR 148 million to EUR 206 million at the rate of 39% (within the deposits, savings of citizens increased by approximately EUR 17 million compared to EUR 8 million as of 12/31/01), 2. Growth of credit activity (average over 40%), 3. Loans diversification (decrease of participation of private sector from 58.1% to 52.7% and increase of retail sector from 7.5% to 17.8%), 4. Foreign lending to the financial sector, 5. Growth of total capital of the banks (over EUR 23 million), 6. Positive financial result (as of 09/30/02 over EUR 19 million), 7. Profitability return on assets increased by over 300% (from 0.68% to 1.36%) excluding Montenegrobank, 8. Formed reserves for potential losses amounted over EUR 14 million, 9. Decrease of interest rates introducing interest rate on demand deposits, 10. Increased level of implementation of international standards in operations. 11. Participation of the Government in banking sector ownership was 31% and it decreased by 12% compared to The Government is the majority owner in three banks Privatization of Banks The procedure of privatization of Montenegrobank a.d. Podgorica started in 2002 after its reorganization in which the state became the majority owner with 91.5% of shareholder capital. In order to prepare this bank for privatization, an International Trustee has been established consisting mostly of DFID consultants that manage the bank. The privatization procedure is based on privatization legislation, and the sale of the bank via tender has been chosen as the method of privatization. The following chronologically shows the privatization process for the bank:

29 Regulation and supervision of the banking sector May: International Trustee undertakes the management of the bank; June September: Preparation of the necessary documentation for tender: - Preparation of data room, - Preparation of descriptive memorandum, - Preparation of marketing material, - Preparation of contract, etc. September November: additional removal of balance sheet positions by Government of the Republic of Montenegro in order to decrease budget burdening by collection of claims of certain debtors of the bank that are state owned or the Government guaranteed some of their obligations; November: tender announcement, December: gathering initial offers. Nova Ljubljanska Bank was the most serious candidate during the process of gathering offers. It is expected that the process of due diligence, submission of final offers and conclusion of the privatization procedure will be finished by the end of March In case the privatization of this bank fails, the tender will be renewed. In 2002, the Central Bank started with the inclusion of Podgoricka Bank in the Privatization Plan for 2003, in which 56% of capital is state owned. The sales of consolidate equity participation of State and state owned companies in other banks is planned. The participation of the state in banks capital would be 16.98% with the privatization of Montenegrobank and Podgoricka Bank, while the participation of banks in state ownership in total assets would be reduced to 18.54%. 59