IN BOSNIA AND HERZEGOVINA

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Feasibility study FOR THE ESTABLISHMENT OF A FACTORING COMPANY IN BOSNIA AND HERZEGOVINA

2 SEED Southeast Europe Enterprise Development ALBANIA BOSNIA AND HERZEGOVINA FYR MACEDONIA SERBIA AND MONTENEGRO HEADQUARTERS Hamdije Kreševljakovica 19/IV Sarajevo, Bosnia and Herzegovina Tel.:( ) ; Fax: ( ) Acknowledgements: While developing this study with its consultants team, SEED has interviewed a number of organizations and institutions that have provided important input data necessary for the factoring business modeling and analysis of different options of legal status of the Factoring Company. We have interviewed and had very useful discussions with numerous commercial banks representatives, representatives of the Central Bank of BiH, Federal Banking Agency, Investment Guarantee Agency, Banking Association FBiH, and Ministry of Finance both in the Federation of BiH and Republika Srpska. SEED is grateful for the time, inputs and cooperativeness that these organizations and institutions and their representatives have provided during the research phase of the development of this Study. Special thanks goes to our team of consultants; Prof. Milos Trifkovic whose expertise and broad experience in the area of business law provided in-depth analyses of BiH legal framework and recommendations with respect to having factoring business in place, and for adding value to overall Study, assuming the role of consulting editor; Ms. Mejra Juzbasic and her substantive contribution to our better understanding of banking and market potential issues facing factoring business in the country, Mr. Mahir Dzafic, whose input on taxation and accounting standards that influence the establishment and operations of potential factoring companies in Bosnia and Herzegovina was invaluable; and to Dr. Helmut Paris, international consultant on the team, with an expertise in factoring. 2

3 TABLE OF CONTENT 1 EXECUTIVE SUMMARY Country Profile Summary on Banking Sector and Market Potentials for Factoring in BH Summary of the Legal Environment Summary of the Accounting and Taxation Environment COUNTRY PROFILE Political profile Economic Profile BANKING SECTOR AND THE MARKET POTENTIALS FOR FACTORING IN BIH Banking Sector Banking Supervision - Regulatory Bodies Other important laws regulating the banking sector Central Bank of Bosnia and Herzegovina (CBBH) Factoring Economic Trends Exports and SMEs Development of SMEs Risk Coverage Potential Market for Domestic Factoring Market in other CEE countries Recommendations LEGAL ISSUES Sources of Law Subjects Shareholders Insolvency Regulation Civil and Business Law Framework Lending and Credit Contracts Foreign Trade and Exchange Law Framework Recommendations ACCOUNTING AND TAX ISSUES Tax System in BH and Factoring Company Income Tax Sales Tax Accounting Treatment of Factoring Recommendat ions STRATEGY, BUSINESS POLICY AND GENERAL RECOMENDATIONS Strategy Business Policy Final Analysis and General Recommendations

4 SEED Southeast Europe Enterprise Development ALBANIA BOSNIA AND HERZEGOVINA FYR MACEDONIA SERBIA AND MONTENEGRO HEADQUARTERS Hamdije Kreševljakovica 19/IV Sarajevo, Bosnia and Herzegovina Tel.:( ) ; Fax: ( ) Terms of Reference Feasibility Study: Establishing of a factoring company in Bosnia and Herzegovina A. Scope The Project involves a comprehensive review of the environment for establishing factoring companies in Bosnia and Herzegovina. Besides working on a study on possibilities for establishing of factoring companies in Bosnia and Herzegovina, the consultant will look at the possibility to establish a single company that would serve demands of Bosnia and Herzegovina and Serbia. Consultants on the project will research, analyze, and draw conclusions and recommendations related to the legal environment amongst others. In particular, the SME sector will be investigated since the majority of factoring opportunities lies here and not in the moribund state-owned / socially owned sector. SEED will support consultants with on-the-ground legal advisers and through introduction to leading SMEs in the economy. The scope will include but not limited to the following: 1) General information about Bosnia and Herzegovina, esp. at it would relate to Factoring (not to exceed 1/3 of the report) a) Summary of the legal environment b) Summary of the taxation environment c) Summary of the banking environment d) Overview of BiH banking systems i) Are there banks specifically strong in financing exports? ii) BiH Banking Acts (incl. capital requirements, licensing process, F/X-regulations, other important regulations and requirements) e) Other relevant observations about BiH as a business environment* * IFC has made a large investment into the banking sector in BiH. IBRD has concluded negotiations with BiH government on a new credit to improve the business environment. Further respective information may be insufficient to be included here. 2) The Environment for Factoring in BiH a) General i) Basic considerations regarding Factoring within BiH financing system (incl. whether Factoring is considered as banking product, and implications) b) The Market i) Is there a potential market for export factoring in BiH? (1) Exports of consumer goods, with special focus on SME exporters (countries of destination, volume of these exports, current status of refinancing exports, export promotion by guarantees, profile of exporting companies, etc.) 4

5 (2) How are exports being financed now (banks, L/C's, subsidised lending for exports etc)? (3) How are exports guaranteed now (Insurance companies, "IMPEX organisation etc)? ii) Is there a potential market for domestic factoring in BiH? (1) How SMEs finance their receivables right now (prepayments by buyers, bank lending, other)? (2) Can factoring supplant expensive and hard to obtain revolving credits, which currently finance the bulk of SME working capital? (3) Are there mechanisms to secure payments (insurance, bank guarantee, bill of exchange)? iii) The buyers market: (1) What is the structure of buyers for the potential products (consumer good): international chains v. "mama+papa" shop? (2) What are the payment terms in consumer goods in the different buyer groups? (a) How are invoices being collected? (iv) Marketing (1) What is the likelihood for BiH market to accept the Factoring product? (2) How to promote the Factoring product? (v) Describe the development of Factoring markets in comparative countries in the first 3 years, and compare to the outlook for BiH. c) Legal Issues i) What legal requirements are necessary in order to have Factoring in place? Compare to the situation in BiH ii) Legal status of factoring companies (bank versus trading company) iii) Impact of the legal status (different capital requirements, license, management requirements, FX regulations within the financial services industry, etc.) iv) Is there a legal framework that makes the product Factoring possible? v) Is there a legal framework which influences the product Factoring (e.g. FXregulations) vi) Describe the FX-regulations influencing the Factoring business (keeping accounts in FX, refinancing in FX, etc.) vii) How can receivables be assigned? viii) Is there any prohibition of assignment of receivables? ix) How can receivables be collected (general rules, legal procedures, etc.)? x) Other relevant legal issues d) Tax Issues i) Is there a tax framework that influences Factoring? ii) What is the tax treatment of Factoring in BiH? How does this compare to best practices? iii) Describe and analyse any transaction-based and/or other fees iv) Other relevant tax issues e) Accounting Issues i) What accounting regulations are applicable for Factoring? Compare to IAS ii) What is the accounting treatment for the factor? Compare to IAS iii) What is the accounting treatment for the customer? Compare to IAS iv) Other relevant accounting issues. 5

6 f) Other Issues Other relevant issues related to the environment for Factoring in BiH 3) Summary, Comparison, Analysis and Recommendations a) Summary of the current situation (legal, tax, accounting, market) in BiH versus the situation in countries with a developed factoring market. Outline var iances from best practices and provide related recommendation. Recommendations provided will be structured as follows: (1) immediate importance (2) near-term importance (3) long-term importance b) What is necessary to be done in order to create Factoring as a financing opportunity within BiH? B. Deliverables: 1) Periodic written and verbal updates during the whole process (via , facsimile or phone); 2) Summary of recommendations of necessary legal changes; 3) An analysis of the financial sector, legal and regulatory environment, and potential market of the factoring product in BiH that identifies key obstacles to the establishment of a factoring company; 4) A financial forecast for a BiH factoring company; 5) A business plan for a BiH factoring company; 6) A written report containing the information outlined in this proposal (in English language); draft report to be provided to SEED and IFC for comment; 7) Summary Report for BiH government, satisfactory to SEED and IFC, outlining the study s findings, listing needed changes to the regulatory environment (indicating the bases of the recommended changes) 8) One-day workshops in Sarajevo for stakeholders, including preparation of materials. D. Reporting: International consultant and local consultants on the team were reporting to Mr. Davorin Pavelic, Senior Analyst and Ms. Azra Delalic, Program Asst. of Private Sector Development Team (PSD), but they worked with all team staff as appropriate in order to accomplish above-listed tasks. 6

7 1 EXECUTIVE SUMMARY 1.1 Country Profile Bosnia and Herzegovina (BH) is situated in southern Central Europe's Balkan Peninsula, and covers the territory of sqkm inhabited by 4.2 million people (according to the CBBH). Its capital is Sarajevo with a population of about , other major cities are: Banja Luka ; Mostar ; Tuzla ; and Bihac In Bosnia and Herzegovina there live three major ethnic groups: Bosniaks 48.1%, Croats 14.3%, and Serbs 37.1%. Government: Bosnia and Herzegovina consists of two entities: the Federation of Bosnia- Herzegovina (FBiH) and the Republika Srpska (RS) and District Brcko. state architecture in RS and FBiH is not balanced. There are no cantons in RS. BH is the post-war country in transition. That is why in Bosnia -Herzegovina the political situation is more important for the country s economic performance than is usually the case in developed market economies. Post-war-reality was the territory s split into three separate areas, with the leading local players having the intention to limit co-operation among these areas to an absolute minimum. Open support for campaigns propagating a splitting-up has diminished substantially. The governments - now in power in Belgrade and Zagreb - have other priorities. Entities governments also have different priorities than a few years ago. Joining the EU is one of the most important among them. Salient features of the economic policy and regulation are numerous. Most important ones are: stable currency, SMEs as dominant type of enterprise, steady growth of FDI, in banking sector as a champion and foreign trade liberalization 1.2 Summary on Banking Sector and Market Potentials for Factoring in BH During the last few years the banking sector in the BiH has shown a remarkable progress. It is mainly characterized by restructuring efforts to increase capital and capital adequacy, to manage liquidity and maturity mismatch and to introduce modern banking practice. This is the one of rare industries in BiH that experienced a major inflow of foreign direct investment. The bank privatization process has almost been completed and there are only a few remaining state banks to be privatized. One of the major improvements was establishment of the banking supervisory agencies as well. The Agencies were founded in the end of 1996 as independent institutions with the task of supervising the banks and issuing banking licenses, in order to ensure a stable and well-developed-banking sector. In order to protect the depositors of the banks, the Agencies have established numerous standards for banking operations and closely supervise the banks, in accordance with the BIS standards. However this will improve further since shortly both Agencies will come under the umbrella of the Central Bank of BiH (CBBH). The CBBH is apolitical and responsible for the monetary policy. It neither lends money to the government, nor does it provide loans to the commercial banks. It operates as a currency board and it is additionally mandated by the Dayton Peace Accords to safeguard the official domestic currency, the Convertible Mark (KM, Konvertibilna Marka). 7

8 Bank consolidation, driven by the new Law on Banks and other banking regulations, is also taking an important role in the overall improvement of the banking sector. Currently there are 40 banks in the BiH, 28 banks in the Federation of BiH and 12 in the Republika Srpska (RS). The number is still large but in comparison to 54 banks only in the Federation of BiH during , it is inevitable that the bank consolidation and privatization have shown remarkably positive results. Hence, a significant increase of deposits, loan volumes and profits was recorded, but in spite of that the volume of capital in the BiH banks is generally low due to still high volume of non-performing loans, inefficient judiciary system especially in respect of collection of outstanding receivables, and low earnings. Even though assets quality has improved and the liquidity of the BH banks is not a problem, the problem arises when those surpluses have to be invested. Since the assets-liability management (AL M) and risk management are still underdeveloped these surpluses are often kept with foreign banks. Moreover, the lack of long-term funding creates additional problems in respect of ALM Even though the banking sector of the BiH experienced major consolidation and progress, BiH is still "over -banked". The bank consolidation will have to continue with faster pace especially because of the very tough competition and regulations of the banking and financial sector. 1.3 Summary of the Legal Environment There are no specific laws or regulations on factoring in BiH, but the necessary legal framework is existing. The following acts listed below define the legal base for the factoring business: IPL Act autonomy of the parties and collision norms Obligation Code: o Cession (art ) o Sale of rights (art ) o Loan (art ) o Commission and Delcredere (art ) Company Law Company Registration Act Bankruptcy Act Liquidation Act Law on Execution Procedure Law on Foreign Trade Policy Law on the Policy of Direct Foreign Investments Law on Foreign Currency Operations. The Obligation Code (OC) provides comprehensive regulation of general contract law and commercial variations thereto. The Art of the OC provide the framework for the assignment of receivables and for the relationship between assignor, assignee and debtor. There is a new OC Draft which does not regulate factoring, but contains provisions favorable to it The registration of a factoring company has to be applied at the competent court and it will be registered like any other company in BiH. If the company is planning to enter into international business, there are some additional registration requirements. 8

9 Factoring can be offered by: a bank a limited liability company a joint stock company If a Bank intends to be shareholder in a factoring company, it needs prior approval of the Banking Agency, in case the investment is exceeding 5% of the bank s equity and/or the total net value of the banks equity in other companies exceeds 20% of the banks own equity. In case of international factoring the very liberal exchange regulations will affect the business. Foreign exchange payments abroad must be performed by banks. The new Law on Bankruptcy is in force since It is favorable to factoring. Collection of claims against non-performing clients can be difficult and time consuming. Laws on registration of property and mortgages remain underdeveloped and non-registered collateral on movables is not operative as yet. However, laws being important for the business are in place and courts are learning to deal with the overall changes. Legal action starts in the municipal court. Enforced performance on money assets in bank accounts is specifically regulated. According to information from the courts in Sarajevo, execution procedure lasts at most 10 days after the execution request was received. Lawyers consider execution on accounts in thirty days a pretty good outcome. The new Execution procedure act will speed up this procedure. 1.4 Summary of the Accounting and Taxation Environment The two Entities and the Brcko District are fiscally independent. Therefore three tax systems are existing, but it must be mentioned that, with respect to the sales tax, there are only few differences between them. For the time being single phase-tax is applied. Introduction of VAT is expected in The following laws and regulations may effect Factoring in BiH: Laws on Sales Tax Rulebooks on implementation of the Law on Sales Tax Laws on Company Income Tax Rulebooks on implementation of the Law on Company Income Tax In case of non-payment by a debtor, creditor must in the Federation BiH to file a law suit. Non sued receivable, which has been written off, increases the taxable profits. This is not the case in Republic of Srpska. Income-tax is on the level of 30% in the Feder ation BiH, but a broad spectrum of cumulative applicable tax applicable tax reduction possibilities are in use. In Republic of Srpska the rate is only 10% but tax exemptions are much fewer. Export services and credit services for banks only, are exempt of sales service tax. 9

10 A particular problem is the lack of harmonization of taxation of services between the entities. Accounting standards are in line with the International Accounting Standards IAS. There are some parts where they deviate or they were not yet adopted. Most important for Factoring the Standard 39 Financial Instruments: Recognition and Measurement has not been adopted- So, the recognition and valuation of the financial assets and liabilities in BH remain out of IAS reach. 10

11 2 COUNTRY PROFILE 2.1 Political profile Declarations of independence by this and other former republics of the Socialist Federal Republic of Yugoslavia (Croatia and Slovenia) led to the war over BiH territory. On 21 st November 1995 the Dayton Peace Agreement was signed and supported by Western nations. Thus the true independence for BiH was established. The civil implementation of the Dayton Agreement is guided by the Office of the High Representative. The representatives of the International Community are pushing for more responsibilities to be given to the central government as well as for a harmonization of laws and regulations. Bosnia and Herzegovina is a sovereign democratic state, created by public referendum and recognized by the UN. After the war from 1992 to 1995 the Dayton Agreement reinstated the democratic government and split its territory in two multiethnic entities: the Federation of BiH comprises 51 % of the country, the Republika Srpska 49 %. The Dayton Agreement retained BiH s international boundaries, reinstated a joint multi-ethnic and democratic government, and split its territory into two multiethnic entities: the Federation of BiH, with a shared Bosnian Croat (Catholic)-Bosniak (Muslim) post-war majority, comprises 51 % of the country, and the Republika Srpska (RS), with a Bosnian Serb (Orthodox) post-war majority, which comprises 49 %. The territory of Brcko District is under the administration of the BiH state as a separated District according to the arbitration award of the Commission. The Federation is divided into 10 cantons, each with respective Assemblies and Governments, displaying federal state-like features in their administration: 1. Unsko-sanski Canton 2. Posavski Canton 3. Tuzlanski Canton 4. Zenicko-dobojski Canton 5. Bosansko-podrinjski Canton 6. Srednjobosanski Canton 7. Hercegovacko-neretvanski Canton 8. Zapadno-hercegovacki Canton 9. Sarajevo Canton 10. Hercegbosanski Canton The Republika Srpska is administratively divided on 5 regions: 1. Banja Luka region 2. Doboj region 3. Bijeljina region 4. Sarajevsko-romanijska region 5. Trebinje region Cantons and regions are further divided into municipalities. 11

12 The Dayton-mandated BiH Constitution 1 centers around a central government with a bicameral legislature, a joint presidency comprising a Bosniak, a Croat and a Serb, a Council of Ministers (including the Ministry of Foreign Affairs, the Ministry of Economic Development and Foreign Trade, and the Ministry of Communication and Civil Affairs), a Constitutional Court and a Central Bank. In April 2000 the Council of Ministers established three new ministries: the Ministry of European Integration, the Ministry of Human Rights and Refugees and the Treasury. This state government is charged with conducting foreign and economic policy. Currently under the guidance of the High Representative and International Community the political parties are preparing the amendments on the Law on Councils of Ministers i.e. the new Ministries will be introduced on the State level. Additionally, Dayton Agreement grants each entity authority to maintain an army, under the ultimate control of the joint presidency, and it guarantees freedom of movement between entities and the rights of refugees and displaced persons to return to their homes. Civil implementation of Dayton is overseen by the Office of the High Representative (OHR), headed by international officials with broad enforcement powers to further integrate the country. Overall peace is guaranteed by NATO-led troops. The Federation's Central Government and Republika Srpska s Central Government are solely responsible for development of economic policies and all affairs not expressly assigned to the state of Bosnia and Herzegovina. The creation of a Central Bank for the country as a whole was an important first step. In other economic fields, the country de facto continuous to be divided into three ethnically defined areas. The reform discussion has emerged in a situation of shrinking funds for BiH relating activities. The relations between local politicians and representatives of the International Community are a sensitive issue. International donors contributed substantially to last year s political and economic achievements, also financially. The International Community produces regulations, institutions and support schemes every day. The local society has to integrate them into their daily life, otherwise they are of limited use. The Federation s central government and Republika Srpska s central government are responsible for the development of economic policies and all affairs not expressly assigned to the state of Bosnia and Herzegovina. 2.2 Economic Profile Due to the interruption of the economic development caused by the war the quality of statistical data is poor. Currency: 1 Euro = KM 1,95583.GDP per capita 2001: FBiH KM; RS KM The black and gray economy is rather sizably including unrecorded imports and exports. GDP 2001: KM 10.2 billion (FBiH KM 7,2 billion; RS KM 3,0 billion) 1 1. Presidency of Bosnia and Herzegovina 2. Parliamentary Assembly of Bosnia and Herzegovina - House of Representatives - People s House 3. Council of Ministers 4. Constitutional Co urt 12

13 The GDP growth rates are rough estimates lacking a sufficient statistical basis. The IMF estimate for 2001 is 7% for the FBiH and 1,9% for the RS. Possibly these estimates are too optimistic and the same may be true for the estimates up to In a reform scenario the growth rates are 5,1% in 2002 and 6% from 2003 to 2006 whereas in a status quo scenario there are 4% for 2002 and 3,5% for 2003 to The economy s basic problem is the high share of debt-burdened and loss making enterprises in the corporate sector. Preliminary industrial production growth figures indicate a sharp discrepancy between the performances of the two entities. The Federation s industrial output grows while the RS recorded a decline. Generally speaking industrial production is far below pre-war volumes. Another indicator of the still exceptional situation is the extremely high unemployment. The officially reported rate is about 40%. Thanks to the currency board regime implying a fixed peg to the Euro, inflation is not a major problem. Given the huge deficit in the current account (approximately 1 billion Euro) the countries financial problem is obvious. So far, there was enough capital inflow, but it was not a market-generated inflow. In agriculture, forestry, mining, manufacturing and construction production has recovered only partially after the war. The value added, created in the tertiary sector represents a high share in total GDP. This imbalance is putting brakes on overall economic progress. In manufacturing, enterprises often are suffering from lack in working capital. Especially big companies from former times have accumulated debt they can not service. Small and medium-sized enterprises and start-ups are confronted with a hostile business environment. The weakness of the BiH manufacturing sector becomes obvious from the foreign trade data. The trade deficit is still higher than the current account deficit. On local markets they often can not compete with imports, especially if the latter have entered the country illegally and thus free of tax and custom duties. As reg ards foreign markets, companies do not have the funds necessary for gaining market shares abroad. The banking industry has experienced a major inflow of foreign direct investments. Now the major part of commercial banking can be regarded as sound. There are still difficulties with the supply of favorable long-term loans. The market for long-term loans cannot develop because of the lack of adequate infrastructure. Due to institutional shortcomings, lenders have enormous difficulties recovering receivables in the case of default. An inefficient judiciary system is part of the problem. Foreign direct investment could promote production, but foreign direct investment does not flow in just when a country would need it. Conditions for doing profitable business have to be in place. In BiH a foreign investment law was enacted at the state level. In spite of huge efforts towards reforming and harmonizing legal structures barriers are still manifold. Laws and regulations at the state, entity, cantonal and municipality level are often contradictory or duplicative. A study of the Foreign Investment Advisory Service (FIAS) concludes, the existing commercial, legal and regulatory framework is based on a labyrinth of formal and informal rules. The inconsistency and non-transparency of regulations and administrative procedures create opportunities for corruption and abuse of power. Effective and independent mechanisms for appeals are absent. The International Community put much effort into the reconstruction of energy networks and the infrastructure for transports and telecommunication, as a pre-condition for economic recovery and progress. Nevertheless, in many segments of these sectors the degree of utilization and efficiency are low. The reason behind is the still prev ailing split of the country into three areas. In the last two years considerable efforts were made concerning trade liberalization within the South East European region. 13

14 The already existing bilateral free trade agreements will be expanded. When fully implemented, the South East European region will become more attractive to domestic and international investors. This should improve the economic environment fundamentally. It is not likely that the long-lasting downsizing of the industrial and manufacturing part of the economy going together with the high unemployment rate can be interpreted as lack of entrepreneurial spirit of the people. Starting a business of their own, alone or in co-operation with others, is difficult for jobless people everywhere in the world, especially in transition countries. There is not only a lack of own funds, it is also the unwillingness of banks and other financial institutions to finance start-ups. This situation will be substantially improved by the implementation of further para banking instruments - like factoring to the overall benefit of the BiH economy. 14

15 3 BANKING SECTOR AND THE MARKET POTENTIALS FOR FACTORING IN BIH Mejra Juzbašic 3.1 Banking Sector In the recent period the Banking Sector in the BiH has been significantly improved and characterized by efforts to increase capital and capital adequacy, to manage liquidity and maturity mismatch in the way to ensure adequate resources for lending and depositor withdrawals, and to become more competitive. A progress has been recorded in the Federation BiH but in RS banks are significantly behind. Even though these objectives have been partially met the total capital of the banking sector in BiH is still very low, and at 31 st December 2002 amounted to KM 1.2 billion, where the total assets amounted to KM 6.3 billion. This trend of capital increase will continue due to the minimum capital requirement of KM 15 million, which has to be met by 31 st December As many banks will not be able to meet this capital requirement, they will have to be either merged or liquidated. However, given the country's depressed, but improving economic status, BiH is still "over-banked". For the future there are expectations that required equity amount will grow which will contribute to further strengthening the banking sector. The bank consolidation has to continue with faster pace due to the very tough competition and regulations of the banking and financial sector in BiH to qualify for membership in the deposit insurance fund, and to meet minimum capital requirement. Contrary to the apprehensions only 3 banks did not fulfill the 15 mln requirement: Privredna banka Sarajevo, Central profit banka Sarajevo and Post Bank BH. PBS and CPB got an extension up to the to fulfill the requirement. Regarding Post Bank (100% state owned) no measures have been taken, since the Bank is subject to privatization. Currently there are 40 banks in the BiH, 28 banks in the Federation of BiH and 12 in the Republika Srpska (RS). The number is still large but in comparison to 54 banks in the Federation during , the bank consolidation and privatization has shown very positive results. Also, a significant increase of deposits, loan volumes and profits was recorded. In December 2002 the amount of extended loans by banks was KM mil. out of which loans granted to companies amounted KM mil. and to other private sector KM mil. Interest rate range is between 10 14%, and the average interest rate on short-term credits is 12,6% and on long term credit is 10,8%. Average interest rate on demand deposits is 1,4%, and on savings is 4,5 %. The privatization of banks in the Federation has almos t been completed and there are only a few remaining state-owned banks in the process of being privatized (Union Banka d.d. Sarajevo, Postbank BH Poštanska Banka d.d Sarajevo), restructured into a development agency (Federal Investment Bank), or under the provisional administration (Gospodarska banka d.d. Mostar, Mostarska gospodarska banka d.d. Mostar, Hercegovacka banka d.d. Mostar, Una banka d.d. Bihac). Seven banks are 100% and another 10 banks are majority owned by foreign investors. In the Federation BiH the number of banks will continue to decrease since there are further merging plans of existing banks, and also the inability of some banks to meet the capital 15

16 requirement. This will have a positive impact on the overall economy, and it will lead toward strengthening the capital base of BH banks. Among the foreign banks present in the Federation of Bosnia are Raiffeisen, Volksbank, Hypo Alpe Adria Bank, HVB Bank, Unicredito/Zagrebacka Banka (Italy/Croatia), Bosna Bank International, Turkish Ziraat. In Republika Srpska there are three majority foreignowned banks: Balkan Investment Bank/Ukiobankis (Lithuania), Nova banjalucka banka/ Komercijalna banka Beograd, Zepter Commerc Bank / Zepter Holding. Even though the banks in the Republika Srpska banks are very small, they have been slower to consolidate. There was very little new investment that entered the RS market. Total assets in RS in 2002 amounted to KM 1.3 billion, and there are still minority stakes held by the government. This number of banks will have to decrease as well, since this number of banks will not be able to function in this size market in the coming period. 3.2 Banking Supervision - Regulatory Bodies Over the past few years there has been a significant improvement recorded in this area. This was a result of the establishment of Federal Banking Agency (FBA) and Banking Agency in Republika Srpska (BA-RS). The Agencies were founded in the end of 1996 as independent institutions with the task of supervising the banks and issuing banking licenses, in order to ensure a stable and well-developed banking sector. In order to protect the depositors of the banks, the Agencies have established numerous standards for banking operations and closely supervise the banks, in accordance with the BIS standards. The main responsibilities of the Agencies are: Supervision of banks both on- and off-sight Licensing Liquidation A new Law on Banks (Official Gazette of the F BiH 39/98, 32/00, 48/01 and 41/02) contains precise guidelines for FBA activities. There are no major differences in the Law on Banks of the Republika Srpska. Pursuant to this Law banks need to obtain their license from the Banking Agency, and no institution can accept money deposits nor grant loans without having this license. However, the loans granted by the microcredit nonprofit organizations are not subject to these regulations. The request for a banking license has to be submitted to the banking agency in writing and has to contain the following information: The contract on establishing a bank, signed by all founders, draft of statute and other articles of associations Data on qualification of members of Supervisory board and Management of the bank The amount of shareholders capital, total and core capital Plan and projection of business operations, and organization scheme of the bank List of owners. The Agency has to pass a decision regarding the issuance of license within 60 days from the day the request is received, and then the bank has to register at the court within 30 days from 16

17 the day the license is issued. If the court registration is not completed within 90 days, the Agency can revoke the license. Moreover, the Agency will issue the license for establishment of a bank s subsidiary, which is headquartered outside the Federation/Republika Srpska, only if the bank has a license issued by the authorized institution for the supervision of that foreign bank. The branches of foreign banks have to obtain the approval form the Agency as well. The Agency may revoke the license if the bank does not meet the capital requirement, does not accept deposits/grant loans longer than 6 months, does not qualify for membership in the deposit insurance fund, or for some other reasons specified by the Law on Banks. Hence, all banks are obliged to control and to analyze the quality of credit and likelihood of collection. The Agency takes charge of corrective actions that bank management is unable to solve. 3.3 Other important laws regulating the banking sector The Law on Foreign exchange (F/X) This Law regulates payment transactions between persons in the Federation and natural and legal persons abroad, foreign exchange market in the Federation, foreign exchange deals, as well as authorizations of the banks in this process. The foreign payment transactions are executed through banks, and only the Ministry of Finance of the Federation BiH may approve the direct settlement of the domestic companies with abroad. Each domestic legal person is obliged to collect the payment for exported goods within 90 days, if cash payment is contracted, or within the deadline prescribed in the loan agreement if a loan is granted. However, the Ministry of Finance F BiH can approve the collection within a period longer than 90 days, if there is either cash payment or the payment terms determined in the loan agreement. Moreover, a company which exports and imports goods based on the long-term cooperation agreement can contract the payments and collections with person from abroad, through the current account by settlement of receivables and payables. Balance of receivables on the current account cannot exceed 40% of total exports amount for the current year. If that happens the Ministry shall order the settlement or collection within 90 days. Also certain penalties are prescribed in case the Law is not follow ed The Law on Deposit Insurance The Law on Deposit Insurance regulates deposit insurance of natural and legal entities in local and foreign currency in banks that meet the requirements. Also, the Law regulates establishment, status, operations, governance and management of the Deposit Insurance Agency in Federation of Bosnia and Herzegovina. The highest amount of deposit that is insured by the Agency is KM Laws and Regulations in Relation to Capital Markets One of the objectives in the transition process towards market economy is the establishment of capital markets. The following legal framework determines capital markets in the FBiH: Law on Securities Law on the Commission for Securities in FBiH Law on the Securities Registrar Law on Busin ess Companies 17

18 Institutions responsible for the capital markets in FBiH are Securities Commission and Registrar of Securities. Securities Commission The Securities Commission of the Federation of Bosnia and Herzegovina (FBiH) is an independent institution established in 1999 to regulate, approve and supervise issuance and trading of Securities in FBiH. The Commission is the supreme regulatory body in the area of capital markets and is tasked with the establishment and development of the infrastructure of the capital markets. The Commission has five commissioners who serve for a term of five years. Registrar of Securities The Registrar of Securities conducts activities of registration, safekeeping and maintaining information on securities, as well as activities of securities transfer, in accordance with the law regulating the issuance and trading of securities Other Laws Professional appraisers and Real Estate brokers in the BiH do not yet meet western standards, and process servers are unavailable. Collection of claims against non-performing clients can be difficult and time-consuming. Laws on registration of movables and mortgages remain underdeveloped. The Law on registered Pledges has been passed, but its implementation did not start as yet because information system is not finished. However, other laws being important for the banking sector are in place, and courts are learning to deal with the overall changes. Pertinent laws include: Law on Money Laundering Law on Obligations, determining all cond itions of free trade of goods and services. Law on Registrar of Securities, regulating the stock market. Law on Court Registration, regulating the registration of companies. Procedural laws, regulating different legal procedures. 3.4 Central Bank of Bosnia and Herzegovina (CBBH) The Central Bank of Bosnia and Herzegovina (Centralna Banka Bosne i Hercegovine) began to operate as the sole authority for the country's currency and monetary policy on August 11 th, It operates as a currency board and it is additionally mandated by the Dayton Peace Accords to safeguard the official domestic currency, the Convertible Mark (KM, Konvertibilna Marka). Under guidelines drafted with help of the IMF, the CBBH maintained a reserve amount of liquid German Marks, which was backed 1 to 1 with the KM. With the introduction of Euro, CBBH maintains a reserve amount in Euro. CBBH is obliged to maintain foreign currency reserves of at least 1 to 1 of local currency in circulation. Other important facts in relation to CBBiH: The Konvertibilna Marka (KM) is the first nation-wide legal tender in Bosnia and Herzegovina since war broke out in

19 The CBBH controls monetary policy in the country and is apolitical. It does not lend money to the government, it does not provide credits or guaranties, and it is not a lender of last resort to the banking system. Since the DEM s inclusion into the European single currency, assets held by the CBBH are tied to the EURO. The KM is freely convertible at any Bosnian commercial bank (Euro 1 : KM ). Upon liquidation of ZPP 2, the CBBH supports and maintains payment and settlement systems. It also co-ordinates the activities of the banking agencies, of the BiH entities which are in charge of banking licensing and supervision, as well as the Insurance Deposit Agency at the state level. 3.5 Factoring Officially there is no factoring business in BiH. For this type of business activity better financial information systems are required, as well as stronger creditor protection. Also legal support and corresponding laws will be needed to provide framework for implementation of this product. However, due to strong presence of foreign-owned banks on BiH market it is possible that this type of activity will be introduced Potential Market for Development of Factoring A large industrial base and capable companies that produced aircraft and machine tools, and other complex goods characterized the pre-war period in the early nineties. Large-scale industry generated about half the output and employment, ranging from energy and raw material sectors (wood and coke production, coal and bauxite mining), to the production of electrical and machinery equipment, textiles, leather and footwear. Civil engineering and agricultural food processing were equally developed. Unlike other centrally-planned economies, former Yugoslavia's economic system was based on market socialism and self management, allowing for some competition in the product market, but generally restricting competition and mobility in labor and financial markets. State banks supplied the sole source of capital, and bank credit offered the only means for financing ventures. These banks were owned and controlled by large state enterprises, which used them to obtain favorable financing terms. The war destroyed a lot of the country s infrastructure and severely disrupted its economic life. In 1990, BiH had a GDP of US$ 11 bln and a per capita income of US$ 2,400. By 1995, GDP amounted US$ 2 bln, per capita income was estimated at US$ 500 and external debt was US$ 3 bln. Industrial production had fallen to 10% of its pre-war level and unemployment had risen to 80%. With the assistance of the World Bank, the European Commission and other donors, in 1995 a four-to-five-year recovery program was designed to fund reconstruction in infrastructure, social sector, agriculture and other sectors. By the end of 2002, road, telecom, power, water and education services were expected to be at or near pre-war levels. 2 ZPP (former domestic payment bureau) was closed on January 5 th, 2001, when the banks took over the domestic payment system. According to the Federal Banking Agency from that date until September 2001, banks performed KM 13.5 m of payment transactions in total of KM 25.7 bn. 19

20 In May 1998, the authorities embarked on an ambitious economic reform program, supported by adjustment credits form the International Development Association and an International Monetary Fund Stand-By Agreement. The objectives of this program were to create a unified economic space and a functioning banking system, privatize and restructure enterprises, reform the labor market, reshape pension and health systems, implement a simplified customs regime and liberalize the trade regime. Underlying these reforms was an ongoing macroeconomic stabilization program based on a currency board arrangement accompanied by strict fiscal discipline. The most successful achievement over the past few years has been the full establishment of the BIH Central Bank and the launch of its currency - the Konvertibilna Marka that is pegged to the Euro. Other achievements include the adoption of a liberal countrywide customs tariff regime and a substantial increase of inter -entity trade. Unemployment remains the major challenge to economic development. While reconstruction and recovery have brought generalized improvement in welfare with per capita income more than doubling since the end of the war the unemployed and several other vulnerable groups including the internally displaced (refugees) do not benefit from this strong post-war growth. The Bosnian economy has continued to grow relatively rapidly, reflecting the ongoing recovery from the devastating war of Real GDP, however, is still only about half the pre-war level. The high growth rates of the recent years have been sustained by external aid rather than private investment, and a continuation of growth requires the pace of structural reform to be accelerated significantly. There was also a significant imbalance between the two territorial entities, with GDP in the RS estimated at only 75% of the country average. 3.6 Economic Trends 3 Due to the interruption of the social and economic trends caused by the war, the quality of the statistical data is still poor. Another factor not statistically document ed is that the black and gray economy is rather sizable, including large unrecorded imports and exports and cash transfers from emigrants and guest workers abroad. The Gross Domestic Product (GDP) of the BiH in 2000 amounted to KM 9.4 billion (Federation BiH amounted to KM 6.7 billion, RS KM 2.7 billion). GDP per capita in BiH amounted to KM in 2000 (F BiH KM 2.392, RS KM 1.861). This indicator is still very low comparing to other European countries, and shows that BiH is one of the poorest countries in the region. In 2001 the nominal GDP of the BiH amounted to KM 10.2 billion (F BiH KM 7,2 billion, RS KM 3,0 billion). GDP per capita in F BiH was KM and in RS KM. Inflation in December 2000 in the Federation BiH was 4% and fell further in the year 2001, and in first quarter of 2002 was negative, while in RS was 0.6%, as a consequence of the constitution of the currency board and the implementation of tight monetary policy. Therefore, economic growth and exports could only be financed by large amounts of foreign aid and loans. However, this type of capital inflow will most likely decrease in the future. In the first quarter 2002, industrial production in the Federation BiH decreased by 2.3% in comparison to the average production recorded in the year 2001, and compared to the same 3 Data obtained from CBBH 20

21 period of 2001 it is higher by 4.8%. The industrial production in Republika Srpska recorded a downward trend in 2002, decreasing by 11.5%, as compared to the average production in In total year 2002 the industrial production in the F BiH increased by 9,2% as compared to the same period in In the same period the industrial production in RS decreased by 2,5%. In 2002, the total retail price and living cost index in the Federation was lower than the figure recorded in Republika Srpska. Retail prices in the Federation in 2002 decreased by 0.2% as compared to the average retail prices in 2001, while in Republika Srpska in 2002 the total retail prices decreased by 1,7% as compared to the average retail prices given for In the first quarter of 2002, the total living costs in the Federation BiH increased by 1,1% compared to the average living costs in 2001, while in Republika Srpska the total living costs increased by 1,9%. In December 2002, in the BiH the average gross wage amounted to KM 686, and average net wage KM 463. In the Federation the average gross wage amounted to KM 754, and average net wage KM 513. This represented an increase of 15,6% compared to the average net wages paid in 2001, and increase of 12% compared to the average net wages paid in December In the RS in December 2001, the average gross wage amounted to KM 542, and average net wage was KM 356. This represents an increase of 15,2% and by 7,2% compared to the average net wage paid in 2001 and in December 2001 respectively. The unemployment rate in both F BiH and RS remains horrendous about 40%. According to the above the growth patterns indicate that recovery is led by small and medium enterprises in the services and light industry sectors, likely to be leaders of growth in the medium term. 3.7 Exports and SMEs One of the major obstacles to sustainable development is imbalance of exports and imports that has prevailed both in the Federation BiH and in the Republika Srpska. T he value of imports in the Federation BiH was nearly four times that of the exports. The value of imported goods amounted to KM million, while the value of exported goods totaled KM million. The percentage of coverage of imports by exports in 2002 was 26,1%. In Republika Srpska the negative trade balance in the year 2002 amounted to KM million, and the percentage of coverage of imports by exports was 25.9%. BiH is mainly exporting its goods to Yugoslavia, Italy, Germany, Croatia and Switzerland. Switzerland is the only BiH trading partner where BiH had a trade surplus. 21