FINANCIAL STABILITY IN THE REPUBLIC OF BELARUS

NATIONAL BANK OF 1 THE REPUBLIC OF BELARUS FINANCIAL STABILITY IN THE REPUBLIC OF BELARUS 2010 MINSK, 2011

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

3 CONTENTS EXECUTIVE SUMMARY 4 CHAPTER 1. EXTERNAL AND INTERNAL MACROECONOMIC RISKS 6 CHAPTER 2. NON-FINANCIAL SECTOR 13 CHAPTER 3. FINANCIAL SECTOR 20 3.1. BANKING SECTOR 20 3.2. INSURANCE SECTOR 37 CHAPTER 4. FINANCIAL MARKETS 43 CHAPTER 5. PAYMENT SYSTEM OF THE REPUBLIC OF BELARUS 52 APPENDICES 55

4 EXECUTIVE SUMMARY In 2010, the economy of the Republic of Belarus was developing in the environment of recovering global economy and economies of the country s main trade partners. At the same time, an adverse impact of external shocks that manifested themselves in the increased prices for energy for the Republic of Belarus and persisting aftereffects of the global financial and economic crises was still in place. Notwithstanding the gradual recovery of external demand for the products of the Belarusian enterprises and improvement in the conditions of foreign trade, the imbalance of foreign trade operations of the Republic of Belarus expanded in 2010 compared with 2009. External financing was carried out, mainly, at the expense of growing external public debt and foreign credits of the Belarusian banks. As a result, a relative level of the country s gross external debt approached the threshold of economic security. One of the factors contributing to the increase in deficit of foreign trade in goods and services was outstripping growth of domestic demand compared with the rise in labor productivity, resulting from the increase in households incomes and high rates of lending to households and enterprises of the real sector of the economy with a view to speeding up the economic growth under inadequate measures aimed at restructuring the economy. Households credit amounts owed were growing faster than income, with a relative decrease in the propensity to make financial savings, that gave rise to a further increase in the households sector s debt burden. In 2010 compared with 2009, financial condition of the sector of non-financial institutions was characterized, for the most part, by a positive dynamics. The improved situation in the domestic and external markets was conducive to the growth of proceeds from the sale of goods and services, decrease in the finished-goods inventories of industrial enterprises, increase in the profitability of sold products and sales, and decline in the number of loss-making enterprises and amounts of losses. High rates of banks lending to the institutions as well as an increase in the receivables and payables were the most important sources of financing of production and economic activities as well as of monetary funds growth on the economic entities accounts. The debt burden of non-financial enterprises continued to grow. Financial sector of the Republic of Belarus was rather stable in 2010, with the majority of indicators of its stability being within the safe ranges. Additional investments of the state in the authorized capital of core state-owned banks at the end of 2010 increased the banking sector s safety cushion, contributing to the capital adequacy growth and increase in the banking sector s liquidity ratios.

5 The situation in the deposit market during 2010 remained, on the whole, stable, though it was somewhat vulnerable due to the growth of inflationary and devaluation expectations at the end of the year. Maintenance of the stable exchange rate of the Belarusian ruble and attractive interest rates on ruble deposits ensured continuous higher return on ruble savings. In the year under review the development of the securities market of the Republic of Belarus was characterized by decreasing share and volume of government securities in circulation, significantly increasing volume of corporate bonds and bonds of local borrowings, and a debuting issue of government bonds of the Republic of Belarus in foreign markets. Notwithstanding the growing volumes of securities in circulation, the securities market in 2010 was still characterized as being at the initial stage of development due to low functionality and, as a result, non-liquidity of the majority of its segments. In 2010, a sustainable and fail-safe functioning of the payment system was ensured and the work aimed at minimizing the risks in the payment system continued.

CHAPTER 1. EXTERNAL AND INTERNAL MACROECONOMIC RISKS In 2010, the economy of the Republic of Belarus was developing in the environment of recovering global economy and economies of the country s main trade partners. At the same time, an adverse impact of external shocks that manifested themselves in the increased prices for energy for the Republic of Belarus and persisting aftereffects of the global financial and economic crises was still in place. According to the assessment of the International Monetary Fund (IMF) published in the World Economic Outlook in January 2011, the volume of the global economy s output grew in 2010 by 5% after its drop in 2009 by 0.6%. Economic growth recovered in the majority of the industrialized and developing countries. GDP grew in the euro-area countries by 2%, in the USA by 2.8%. In Russia, GDP went up in 2010 by 4%, industrial output by 8.2%, in Ukraine by 4.2% and 11% respectively. The highest rates of economic growth were observed in China and India (110.3% and 109.7% respectively). Recovered demand for the Belarusian products in the external markets along with the economic policy measures designed to stimulate internal demand led to the acceleration of the growth rates of the volumes of output, consumption, and investments. Real growth rates of the GDP amounted in 2010 to 107.6% (100.2% in 2009), of industrial output to 111.3% (98%), and of agricultural output to 102% (101.3%). Investments in fixed capital went up by 16.6% (by 4.7% in 2009). Investments in nonproduction facilities (121.2%) grew faster than investments in production facilities (113.9%), with the trend towards the reduction of the share of investments in the assets component of fixed capital in its total volume continuing. Credit support was the key factor contributing to the growth of investments in fixed capital (accounted for more than two-thirds of growth in this indicator). In the structure of the sources of financing investments in fixed capital the share of banks credits grew by 5.7 percentage points, with the share of budgetary funds and own funds of the organizations being reduced. There was no significant advance in the attraction of direct foreign investments. An increase in the production growth rates against background of active Government measures aimed at stimulating domestic demand led to the accelerated growth of household s income. Real wages and real disposable monetary income grew in 2010 compared with 2009 by 14.9% (in 2009, real wages dropped by 0.4%, with real disposable monetary income growing by 3.7%) resulting in increased consumer demand. Retail turnover grew over 2010 by 17.1% (by 3.2% in 2009); paid services provided to households - by 11.5% (by 2.8% in 2009).

7 Changes in the key macroeconomic indicators of the Republic of Belarus in 2009-2010 in comparable prices (% on the previous year) GDP 17.1 Retail turnover 7.6 Industrial output 3.2 0.2-2.0 11.3-0.4 1.3 2.0 Salaries 14.9 4.7 Agricultural output Source:the Belstat 16.9 Investments 2009 2010 Notwithstanding the fact that in 2010 inflation was at the level of 2009 (in January- December 2010 consumer price index grew by 9.9% against 10.1% in January-December 2009), certain inflationary potential accrued at the year-end. The crucial factors that contributed to the acceleration of inflation processes in 2010 H2 were: an increase in prices for certain foodstuffs in the foreign markets due to the low crop yield in 2010, growth of imported inflation, increasing devaluation and inflationary expectations of households, as well as an outstripped growth of the households real monetary incomes compared with labor productivity. The outstripping growth of industrial producers prices compared with the inflation rates is evidencing the growth of inflation potential. In January-December 2010 they went up by 18.8% against 11.1% in the previous year. In addition to the measures designed to stimulate domestic demand the state was actively involved in liberalizing the economy and improving institutional environment with a view to improving the efficiency of use of the production factors, increasing labor productivity, and razing competitiveness of the economy. A milestone event in this field was drafting and adoption of the Directive of the President of the Republic of Belarus No. 4 On Developing Entrepreneurial Initiative and Stimulating Economic Activity in the Republic of Belarus dated December 31, 2010 that provides for fundamental reforms of economic relations in the country. But the measures that were actually implemented in 2010 proved to be insufficient for creation of the basis for stable and wellbalanced economic growth. The structure of the economy did not undergo significant changes, the forecasted reduction of material consumption, power consumption, and import capacity of industrial output and the economy as a whole was not achieved. Material consumption in

8 industrial output went up in 2010 by 1.1% compared with 2009 (the forecasted decrease being 0.7-1.2%), energy consumption went down by 0.6% (the forecasted decline being 0.7-1.2%), energy consumption in production dropped by 0.6% (the forecasted decline being 8-10%). Besides, inadequate progress in attracting direct foreign investments in the country and low ranking scores assigned to the country s institutional environment in the majority of international social and economic ratings were observed as well. Execution of the state budget in 2010 was characterized by the considerable slowdown of the rates of formation of its revenues side, primarily, due to the decline in revenues from foreign economic activities and non-tax revenues. In 2010, the revenues of the consolidated budget of the Republic of Belarus amounted to 29.9% of GDP (34.0% in 2009) 1, expenditures 32.5% of GDP (35.8% in 2009). As a result, the deficit of the consolidated budget went up from 1.8% of GDP in 2009 to 2.6% of GDP in 2010. Attraction of external financing, including for the purpose of covering the current account deficit and maintaining the country s gold and foreign exchange reserves, contributed to the growth of external public debt from 16.4% of GDP as at early 2010 to 17.8% of GDP (USD9.7 billion) as at January 1, 2011. The ratio of internal government debt (excluding the local governments and self-administration authorities debt) to GDP did not change in 2010 amounting as at January 1, 2011 to 5.7% of GDP. Notwithstanding the gradual recovery of external demand for the products of the Belarusian enterprises and improvement in the conditions of foreign trade as well as implementation of a number of measures aimed at increasing the export and decreasing the import capacity of production, the imbalance of foreign trade operations of the Republic of Belarus expanded in 2010 compared with 2009. In 2010, the balance of payments was under the impact of multidirectional conditions. On the one hand, the impact of external shock related to the global financial and economic crisis was weakening through the trade channel due to the recovery of business activities and prospects for economic growth in the countries - main trade partners of the Republic of Belarus and growing demand for potash fertilizers, that contributed to the increase in physical volumes of non-energy export. 1 Excluding the funds of the state non-budgetary Social Protection Fund of the Ministry of Labour and Social Protection of the Republic of Belarus.

9 On the other hand, the impact of the permanent energy shock related to the change in prices and conditions of energy imports from the Russian Federation intensified. Besides, an active stimulation of domestic demand in 2010 led to the increasing expenditures for domestic consumption and investments and, as a result, contributed to the growing imports of goods and services, external imbalance, and a gap in financing. % 50 40 30 20 10 0-10 -20-30 -40 Individual indicators of the balance of payments of the Republic of Belarus 2002 2003 2004 2005 2006 2007 2008 2009 2010 4 2 0-2 -4-6 -8-10 -12-14 -16-18 % of GDP Source:the National Bank of the Republic of Belarus Icrease in goods and services exports Current account balance (right-hand axis) Icrease in goods and services imports As a result, the deficit of foreign trade in goods and services exceeded in 2010 the forecasted indicator 1.6 times (or by USD2.8 billion) amounting to USD7.4 billion. The imbalance reached the critical level (the negative balance of current account grew from 13% in 2009 to 15.6% in 2010, including in 2010 Q4 the deficit amounted to 20.4% of GDP having reached its historical maximum. The state of the current account worsened due to the growth by 31.1% (or by USD2.2 billion) compared with 2009 in the deficit of foreign trade in goods that amounted to USD9.1 billion. At that, the deficit of foreign trade in energy goods went up by USD1.7 billion to USD5 billion, export of potash fertilizers grew by USD0.9 billion to USD2.2 billion, with the balance of foreign trade in other goods worsening by USD1.4 billion to minus USD6.3 billion. An increase in the expenditures associated with the imports of natural gas (by USD1.4 billion) that was due to the growth in price (by 27% or by USD39.9 per thousand cubic meters) as well as in physical volumes (by 22.4%, or by 4 billion cubic meters) accounted for the major share in the structure of non-energy deficit growth. At the same time, the worsening of the balance of foreign trade in oil and oil products amounted to only USD0.3 billion due to the measures aimed at compensating the negative impact of increase in import duties. The balance of foreign trade in non-energy goods (excluding potash fertilizes) deteriorated due to the accelerated growth of domestic demand (18.9% in 2010 Q4 versus the corresponding quarter of the previous year, compared with 0.8% in 2010 Q1) and, as a result, considerable increase in the demand for imports. These factors contributed to the outstripping growth rates of the physical volumes of non-energy imports (versus the same period of the

10 previous year) compared with those of exports since July 2010. As a result, in December 2010, the physical volumes of non-energy imports exceeded the pre-crises level of June 2008 by 30.9%, while the physical volumes of exports amounted to 95.7% of the level observed in June 2008. The excess of the growth rates of the physical volumes of non-energy imports over those of exports was partially compensated by the favorable conditions of foreign trade in non-energy goods (the ratio of the growth rates of exports prices to the growth rates of imports prices) that improved by 3.4% on a year before (against a 4.4% worsening in 2009). At the same time, the conditions of foreign trade in goods were restored, on the whole, less significantly - by 1.9% after deterioration in 2009 by 11.1% that was due to the further alignment of the conditions of mineral products imports with global ones. Thus, growing foreign economic imbalance was observed over 2010 that was due to the increase in the negative balance of foreign trade in goods and services caused by a permanent external shock related to the changes in the conditions of trade in energy and quick rise in domestic demand. Under the conditions of inadequate advance in the field of structural reforms and declining import capacity, material consumption, and energy consumption in the economy this trend creates risks to the coverage of the gap in financing and ensuring stability of the external position. Notwithstanding further accumulation of the external public debt as well as foreign borrowings by banks, the inflow of foreign capital and financial resources in 2010 was inadequate for covering the needs in financing. Net inflow of capital and financial resources amounted in 2010 to USD7.4 billion, declining by USD0.9 billion compared with 2009. At the same time, the trend of accumulating external public debt for the purpose of financing the balance of payments deficit continued. Notwithstanding a 1.9 times drop compared with 2009, net attraction of foreign capital by the Government agencies and monetary authorities was still making up a considerable sum (USD2.6 billion). Net attraction of foreign capital by the private sector amounted in 2010 to USD4.8 billion, having increased by USD1.5 billion compared with the previous year, mainly, at the expense of accumulating debt liabilities (by USD1.2 billion), with declining attraction of direct foreign investments (by USD0.5 billion). At that, in 2010, the share of short-term borrowings in the growth of the private sector s foreign debt was 54.1%.

11 Net attraction of direct foreign investments dropped due to the decline in net inflows to the equity capital by USD0.5 billion, or 1.6 times. An inflow of net investments to the economy (excluding the funds obtained due to the sale of the shares of OJSC Beltransgas ) amounted to 36.7% of the forecasted indicator (no less than USD2.6 billion). An inflow of funds to the equity capital (excluding the funds obtained due to the sale of the shares of OJSC Beltransgas and investments in the banks equity capital) amounted to USD120.6 million. During 2010, the trend towards the accumulation of external debt by banks, which grew by USD2.2 billion versus USD0.5 billion in 2009, was observed. Short-term liabilities amounted to 48.7% in the growth of the banks foreign debt (29.7% in 2009), evidencing an increasing vulnerability of the banks external position. The non-financial sector attracted foreign capital, mainly, at the expense of commercial credits (USD1.1 billion in 2010 versus USD0.7 billion in 2009). Devaluation expectations, against the background of a relatively inexpensive lending in Belarusian rubles, abated the stimulus for the attraction of foreign capital by the non-financial sector. Thus, net attraction of credits and borrowings by the non-financial sector amounted in 2010 to USD61.1 million, having dropped by USD247.5 million compared with the previous year. Due to the operations involving the financial account of the balance of payments, gross foreign debt amounted as at January 1, 2011 to USD28.5 billion, having increased by 29.2% (by USD 6.5 billion) since January 1, 2010. The relative level of foreign debt reached 52.2% of GDP, having doubled in 2009-2010 and approached the economic security threshold. Therefore, high domestic demand under growing vulnerability of the structure of financing the current account deficit of the balance of payments in 2010 led to the expansion of the gap in financing and growth in foreign economic imbalance, making an adverse impact on the level of international reserve assets and creating the risks of decline in the economy s paying capacity and stability of the Belarusian ruble exchange rate. The growing imbalance of the balance of payments was a key factor of high net demand for foreign exchange in the domestic foreign exchange market of the Republic of Belarus. Against the background of worsening conditions of foreign trade in energy and continuing limited capacities of attracting foreign financial resources by the private sector, net purchase of foreign exchange by the economic entities grew in 2010 amounting to USD6.9 billion compared with USD3.6 billion in 2009. The highest resident economic entities net

12 demand for foreign exchange was in November - December 2010 (USD2.3 billion versus USD4.5 billion in January-October 2010). The growth of the households devaluation and inflationary expectations in 2010 Q4 resulted in the increase in net demand for foreign exchange to USD1.5 billion. However, in January-September 2010, net supply of foreign exchange in the amount of USD8 million was observed in the cash market. In the whole of 2010, the households net demand for foreign exchange was USD1.5 billion against USD0.8 billion in 2009. Net sale of foreign exchange by resident banks amounted in 2010 to USD0.5 billion (versus USD0.8 billion in 2009). With account of external financing attracted by the National Bank and the Government and other factors, international reserve assets of the Republic of Belarus (on the IMF s SDDS definition) dropped in 2010 to USD5,030.7 million, or to 1.6 month of goods and services imports (the recommended threshold indicator being 3 month of imports), reflecting the growing risks for the maintenance of stability in the foreign exchange market.

CHAPTER 2. NON-FINANCIAL SECTOR The financial standing of the sector of non-financial organizations was characterized in 2010 compared with 2009 by the predominantly positive dynamics. Better situation in the internal and external markets contributed to the growth of proceeds from the sale of goods and services, the reduction in the stocks of finished goods in the industrial enterprises warehouses, the increase in the profitability levels of the products sold and sales, and the decrease in the number of loss-making enterprises and the amount of incurred losses 2. 100 Ratio between the stocks of finished goods and the average monthly industrial output 91.8 94.6 90 % 80 70 60 50 53.0 52.9 49.9 49.3 61.1 77.8 67.9 71.2 60.7 54.2 49.5 40 01.01.08 01.04.08 01.07.08 01.10.08 01.01.09 01.04.09 01.07.09 01.10.09 01.01.10 01.04.10 01.07.10 01.10.10 01.01.11 Source:the Belstat In 2010, non-financial organizations (excluding small-sized business entities) increased the sales of products, goods, works, and services in real terms 3 by 16.6% on 2009 (a year earlier the proceeds fell by 3.3%). In 2010, the stocks of finished goods in the industrial enterprises warehouses went down in current prices by 8.1% (a year earlier an increase stood at 10.3%). The stocks share in the average monthly output declined from 67.9% as at January 1, 2010 to 49.5% as at January 1, 2011. Grouping of organizations by the profitability level in2009 Grouping of organizations by the profitability level in 2010 29.4 % 18.2 % 32.2 % 18.7 % 18.0 % 8.1 % 6.5 % 19.8 % 16.0 % 6.8 % 6.0 % 20.3 % Source: thebelstat Source: the Belstat < 0 0-5 5-10 10-20 20-30 > 30 < 0 0-5 5-10 10-20 20-30 > 30 2 Data are presented excluding small-sized business entities. 3 Adjusted for GDP deflator.

14 As a result of the faster growth of the profit on the sale of products, works, and services (131.4%) compared with the cost of products sold (128.5%), the profitability of the products sold grew from 9.9% in 2009 to 10.1% in 2010 and the profitability of sales from 6.1% to 6.3% respectively. At the same time, the share of unprofitable and low-profit enterprises (with the profitability level from 0% to 5%) remains significant: in 2010 it accounted for 48.2% of the country s non-financial sector as a whole (47.4% a year earlier) indicating that the efficiency of the enterprises financial and economic activities is insufficient. The trend set in 2009 towards a decline in the profit was reversed in 2010 and the share of loss-making enterprises and the amount of incurred losses fell. In 2010, the country s economy as a whole saw the growth in both nominal and real amounts of all profit indicators. The amount of real profit 4 on the sale of goods, products, works, and services was up by 19.2%, pre-tax profit by 19.3%, and net profit by 22.6%. The share of organizations that made net loss in 2010 constituted 4.9% of the total number of organizations accounted by the National Statistical Committee (hereinafter the Belstat ) in the regular course of business, against 6.2% a year earlier. Also, the sum of net losses incurred by loss-making enterprises fell to 1 trillion Belarusian rubles, a 20.9% decrease on 2009. Growth, % 45 40 35 30 25 20 15 10 5 0 Non-financial enterprises' accounts payable and receivable 36.4 37.8 26.8 17.9 16.3 16.2 2.3 2.0 Accounts payable Overdue accounts payable Accounts receivable Overdue acconts receivable Source: thebelstat 2009 2010 Given the limited working capital, high rates of banks lending to organizations as well as an increase in accounts payable were the most important source of financing the production and business activities and a significant factor behind the growth of monetary funds in the accounts of economic entities. Debt burden on non-financial enterprises continued to increase. 4 Adjusted for GDP deflator.

15 For example, in 2010 total accounts payable (accounts payable and debt on credits and loans) grew in nominal terms by 24.6% (by 27.2% a year earlier). Debt capacity ratio 5 of nonfinancial organizations increased from 452.4% as at January 1, 2010 to 479.1% as at January 1, 2011. In 2010, non-financial organizations debt on banks credits increased by 33.1%. Debt on banks credits accounted for 48.5% of the total accounts payable (for 45.4% as at January 1, 2010). Credit capacity 6 of non-financial organizations as a whole grew from 205.4% The year 2010 saw an improvement in settlements and an increase of balances in accounts of organizations and current solvency thereof. In 2010, overdue total accounts payable declined by 0.2%, including overdue debt on banks credits by 43.9%. Accounts payable among non-financial organizations accounted for 89.3% of all overdue total accounts payable (for 87.1% as at January 1, 2010). The year 2010 saw a significant deceleration in the growth of overdue accounts payable and receivable compared with an increase in their total amount which led, in its turn, to a reduction in the shares of overdue accounts payable and receivable in their total amounts (from 12.4% as at January 1, 2010 to 10.8% as at January 1, 2011 and from 17% to 14.9% respectively). Also, the share of external overdue accounts payable in the total amount of external accounts payable declined. However, the share of organizations which have overdue debt (as a percentage of the total number of organizations reporting to the Belstat in the regular course of business) is still significant and continues to grow. On January 1, 2011, as many as 59.2% of organizations had overdue accounts payable (56.7% a year earlier) and as many as 69.6% of organizations had overdue accounts receivable (67.2% a year earlier) which may adversely affect non-financial organizations creditworthiness in the future. 5 The ratio between total accounts payable and the average monthly proceeds from the sale of products. 6 The ratio between the debt on banks credits and the average monthly proceeds from the sale of products.

16 % Share of overdue accounts receivable and payable in the total amount thereof 22 19.2 20 18.1 17.7 16.8 17.1 17.0 18 15.8 16.1 16 14.9 14.8 14.9 13.7 13.8 14 15.2 15.1 14.5 14.3 12 13.3 13.5 12.7 12.4 12.1 10 11.4 11.5 11.3 10.8 8 01.01.08 01.04.08 01.07.08 01.10.08 01.01.09 01.04.09 01.07.09 01.10.09 01.01.10 01.04.10 01.07.10 01.10.10 01.01.11 Source: the Belstat Accounts receivable Accounts payable At the same time, the current solvency indicator 7 went up from 188.3% as at January 1, 2010 to 227.3% as at January 1, 2011 due to faster growth rates of balances in accounts of organizations (123.5%) compared with the growth of their overdue accounts payable (102.3%). According to the National Bank s surveys of non-financial enterprises, the dynamics of the main indicators characterizing production, investment, and financial activities in 2010 compared with 2009 was predominantly positive. The economic environment and economic conditions of many enterprises were improved. Enterprises noted that such indicators as physical volumes of output and sales, production capacity utilization, physical volumes of orders in the internal and external markets, demand, net profit, and balances were growing at a faster pace. Also, the growth rates of overdue amounts payable and receivable during 2010 were slower than in 2009. At the same time, enterprises noted faster growth of production costs and prices for finished goods. Terms of lending were improved (as regards credit terms, credit cost and amount) and risks of economic activities associated with changes in laws as well as economic risks were reduced. The extent to which fluctuations in the exchange rate of the Belarusian ruble, risks of economic activities, terms of lending, overdue accounts receivable, and demand affect economic activities of enterprises was reduced. The year 2010 saw a significant acceleration in the growth of households incomes resulting from an increase in the volume of output and measures taken by the Government in the field of salary increases. At the same time, households incomes differentiation remained low and continued to decline and low-income level was brought down. For example, households real monetary incomes grew in 2010 by 15.2%, against 2.7% in 2009. The share of households with per capita disposable resources below minimum subsistence income (low-income level) was reduced from 5% as at year-end 2009 to 3.4% as at year-end 7 The ratio between monetary funds and overdue accounts payable.

17 2010. Low wages in some industries continue to be the factor which constrains households financial possibilities and potential for the growth of banks resource base. Given high growth rates of households real monetary incomes, the year 2010 saw an acceleration of the growth rates of their consumer and investment expenditures with relative decline in propensity to save. Households investment expenditures that are financed by the citizens own funds and by banks loans in particular grew at higher rates. Belarusian rubles, bln 2 500 2 000 1 500 1 000 500 0-500 -1 000-1 500 Change in the balance of households'accounts with banks Source: the National Bankof the Republic of Belarus In Belarusian rubles In foreign exchange In 2010, households nominal expenditures on the purchase of consumer goods and services were up by 24.1%, against a 9.2% increase a year earlier. Investments in real estate at the expense of own and borrowed resources were growing more rapidly than consumer expenditures, however less rapidly than in 2009 (in 2010, nominal increase constituted 37.9% against 43.1% in 2009). At the same time, an absolute growth in households financial savings decelerated by 1.8% 8. In 2010, the dynamics of households ruble and foreign exchange deposits was multidirectional in nature. For example, where in the first half of the year deposits in the national currency were growing at a faster pace, beginning in August 2010 households preferred to build up monetary savings on foreign exchange deposits mainly due to an increase in inflation and devaluation expectations. In the whole of 2010, households balances in accounts with banks grew in nominal terms by 26.5% (by 36.9% a year earlier), including in the national currency by 22.4% (by 3.6% a year earlier) and in foreign exchange by 29.6% (in Belarusian rubles equivalent), or by 23.7% in US dollars equivalent (against a 40.9% increase in 2009). As a result, the share of ruble deposits in the total amount of households funds with banks fell in 2010 from 44.1% to 42.7%. 8 It should be noted that about half of the increase in the amount of households bank deposits in 2009 was associated with revaluation of their foreign exchange component.

18 The credit debt owed by households grew at a higher rate than their incomes thus contributing to further growth of households debt burden. In 2010, households were actively borrowing monetary funds from banks in order to meet growing demand for consumer and investment goods and services at a time of preserving soft budget constraints (first and foremost, as part of soft lending to housing). At the same time, the entire growth of credits was associated with lending in Belarusian rubles due to imposed constraints on lending in foreign exchange 9. Belarusian rubles, bln Credit debt owed by households 24000 20000 16000 12000 8000 4000 0 Jan 2009 Apr 2009 Jul 2009 Oct 2009 Jan 2010 Apr 2010 Jul 2010 Oct 2010 20 18 16 14 12 10 8 6 4 2 0 % Source: the National Bankof the Republic of Belarus In Belarusian rubles In foreign exchange Debt burden (right-hand axis) In 2010, the credit debt owed by natural persons to banks was up by 42.2% (by 26.5% a year earlier), including in Belarusian rubles by 62.9% (by 38.2% a year earlier), and was down in foreign exchange by 46.5% (by 7.2% a year earlier). As a result, households debt burden 10 increased from 17.6% in 2009 to 18.3% in 2010. % Ratio between the credit debt owed by households and households' deposits 220 200 180 160 140 120 100 80 60 40 20 0 01.01.2009 01.04.2009 01.07.2009 01.10.2009 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011 Source: the National Bank of the Republic of Belarus In all currencies In Belarusian rubles In foreign exchange By the end of 2010, the banking sector s and the households sector s reciprocal claims and liabilities became practically equal as a result of the outstripping growth of credits to households compared with the growth in their deposits during last months of 2010. For example, 9 The amounts of debt decreased as a result of the decision to stop lending in foreign exchange to natural persons which was adopted by Resolution No. 105 of the Board of the National Bank dated July 14, 2009 and was conducive to a reduction in banks credit risk and households foreign exchange risk in 2010. 10 The ratio between the average annual credit debt and households disposable incomes earned during the year.

19 the ratio between the credit debt owed by households and households bank deposits rose from 87.9% in early 2010 to 98.8% as at January 1, 2011.

20 CHAPTER 3. FINANCIAL SECTOR Throughout the year 2010, the market for financial intermediation was still dominated by banks and the state s share in the capital structure of the banking sector of the Republic of Belarus was up. No significant institutional changes in the financial sector of the Republic of Belarus took place in 2010. In the year under review, the ratio between the broad money supply and GDP 11 which characterizes the general level of development of the financial sector and the economy as a whole stood at 25.9%, a 1.6 percentage points increase on 2009. In 2010, total assets of the financial sector 12 amounted to 62.1% of GDP 13 (to 55.6% a year earlier), of which banks accounted for 97% and insurance companies for 3%. 3.1. BANKING SECTOR The banking sector of the Republic of Belarus had 31 operating banks as at January 1, 2011 and was still dominated by state-owned banks 14. Following the recapitalization of major state-owned banks as at year-end 2010, the state s share in the aggregate authorized capital of the banking sector rose from 70% to 73.6%, with a simultaneous decline in the foreign capital s shares (from 27.3% to 24.2%) and deposits of residents of non-state ownership (from 2.7% to 2.2%). In 2010, the number of state-owned banks and banks under foreign capital s control did not change and amounted, as at January 1, 2011, to four and 23 respectively. The number of private banks declined from five to four owing to a merger between JSC Belarusian Industrial Bank and OJSC Tekhnobank carried out in 2010 Q2. 11 The average broad money supply over the year as a percentage of nominal GDP. 12 Banks and insurance organizations assets. 13 The chronological average of the sum of banks and insurance organizations assets as a percentage of nominal GDP. 14 Here and hereinafter: state-owned banks (SOBs) a group of banks with a majority interest in the authorized capital belonging to the Government agencies and legal persons of state ownership; foreign banks(fbs) a group of banks with a majority stake in the authorized capital belonging to the foreign capital; private banks (PBs) a group of banks that are not included into SOBs and FBs groups; large banks (LBs) a group of banks whose assets share in the total assets of the banking sector accounts for more than 5%; medium-sized banks (MSBs) a group of banks whose assets share in the assets of the banks that are not included into LBs group accounts for more than 5%; and small banks (SBs) a group of other banks that are not included into LBs and MSBs groups.

21 As many as ten banks had individual international ratings as at January 1, 2011, of which eight banks were assigned ratings by Fitch Ratings, six banks by Moody s Investors Service, and two banks by Standards & Poor s. The concentration of the banking sector s assets in 2010 was somewhat lower and, on the contrary, the concentration of capital was higher. In early 2011, five major banks accounted for 83.1% of assets and 78.7% of the banking sector s capital (84% and 76.9% respectively in early 2010). The Herfindahl-Hirschman index 15 calculated on the basis of assets and capital, as at January 1, 2011, was 0.2403 and 0.2120 respectively (0.2495 and 0.2001 a year earlier). The uniformity in distribution of the banking sector s assets became also higher and in distribution of the banking sector s capital lower. The Gini index 16 calculated on the basis of assets and capital was 0.813 and 0.765 (0.817 and 0.761 as at January 1, 2010). The banking sector s performance was steadily improving during 2010. Positive dynamics of profitability indicators of the banking sector in 2010 Q1-Q3 was mainly due to a low fullness of creation by banks of special provisions for potential losses on assets exposed to credit risk, given the preferences granted by new procedures for classifying assets 17 which were set in October 2009. Also, the trend towards a reduction in the banking sector s bad assets which emerged in 2010 Q3 and became particularly strong in Q4 made it possible to significantly reduce banks net allocations to special provisions and had a positive Profitability of the banking sector (before tax) 16 2.55 15 2.45 2.35 14 2.25 % 13 2.15 2.05 % 12 1.95 11 1.85 1.75 10 1.65 01.01.2009 01.04.2009 01.07.2009 01.10.2009 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011 Source: the National Bank of the Republic of Belarus Return on equity Return on assets (right-hand axis) 15 The Herfindahl-Hirschman index reflects the extent of concentration of the indicator and takes on values from 0 to1. Value 0 corresponds to minimum concentration, less than 0.10 - to low concentration, from 0.10 to 0.18 - to average concentration, and above 0.18 - to high concentration. 16 The Gini index allows estimating the extent of disparity indicating how equally one or another variable is allocated among the participants. Value 1 corresponds to the total concentration and value 0 to the parity with all participants. 17 In compliance with paragraph 3.1 of Resolution of the Board of the National Bank of the Republic of Belarus No.159 dated September 23, 2009 banks have the right to make special provisions in full till December 31, 2010.

22 impact on financial performance of the banking sector. The profit earned by the banking sector (before tax) in 2010 amounted to 2,103.4 billion Belarusian rubles, a 44.8% increase on 2009. In 2010, the return on assets (before tax) was up from 1.96% to 2.14% and the return on equity (before tax) from 11.93% to 14.64%. Singling out constituent elements in the structure 18 of the return on equity shows that an increase in the return on risk-weighted assets as well as an increase in the financial leverage in 2010 H2 were the main factors behind boosting the return on equity in 2010. At the same time, the reduction in the risk level became the main constraining factor. In 2010, the banking sector s capitalization was maintained at a substantially high level, nevertheless the banking sector s protection against assumed risks gradually declined reflecting an increase in banks risky operations. A rise in the Government s contributions made at year-end 2010 to the authorized capital of major banks belonging thereto made it possible to halt the trend towards a gradual reduction in the banking sector s safety cushion. percentage points 6 5 4 3 2 1 0-1 -2-3 -4 Impact of constituent elements on the change in the return on equity 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011 Source: the National Bank of the Republic of Belarus Profit margin Risk level Change in the return on equity Return on assets Financial leverage In 2010 H1, the growth of risk-weighted assets was commensurable with the growth rates in the banks regulatory capital. However, beginning in July 2010, the growth in the banking sector s risky operations experienced a significant acceleration against a background of slow growth rates of the regulatory capital which had a negative impact on the level of protection for the banking sector against assumed risks. During the period from July 1 to December 1, 2010, the banking sector s regulatory capital adequacy ratio fell 1.5 percentage points from 19.76% to 18.25%, the prescribed requirement for individual banks being 8%. 18 Four components may be singled out in the structure of the return on equity: the profit margin; the return on risk-weighted assets; the risk level; and the financial leverage. The profit margin is calculated as the ratio between the profit (before tax) and net revenues from banking; the return on risk-weighted assets as the ratio between net revenues from banking and risk-weighted assets; the risk level as the ratio between risk-weighted assets and total assets; and the financial leverage as the ratio between assets and capital.

23 Additional investments made by the state in December 2010 in major banks belonging thereto led to a material increase, at the end of the year, in the banking sector s regulatory capital by 31.5% (by 18.5% a year earlier). At the turn of 2011, the capital adequacy ratio stood at 20.45%. Indicators of the banking sector's capital adequacy 24 22 20 % 18 16 14 12 10 01.01.2009 01.04.2009 01.07.2009 01.10.2009 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011 Source: the National Bank of the Republic of Belarus Regulatory capital adequacy Core capital adequacy Capital to assets ratio Thus, positive dynamics of the capital adequacy in the banking sector as a whole was achieved in 2010 by increasing the state-owned banks regulatory capital adequacy ratio. At the same time, the extent of protection of foreign and private banks against assumed risks was declining throughout the entire 2010 due to high growth rates of risk-weighted assets (50.2% and 49.9% respectively). The foreign banks capital adequacy ratio fell from 26.2% as at the beginning of 2010 to 21.7% as at January 1, 2011 and the private banks capital adequacy ratio from 34.5% to 28.9%. Along with a significant growth in 2010 of the aggregate amount of the banking sector s core capital, banks were actively increasing the regulatory capital at the expense of other sources that generate additional capital, banks own funds (profit of the current year and previous years as well as funds established at the expense thereof) being the main one. In 2010, the banking sector s additional capital grew by 38.1%, or 955.6 billion Belarusian rubles. As a result, the quality of the banking sector s regulatory capital fell slightly the additional capital to the core capital ratio increased by 1.4 percentage points to 24.5% compared with January1, 2010. Beginning in 2010 Q2, banks were actively increasing the amounts of lending operations as the country s economy was recovering from adverse effects of the global financial and economic crisis. A significant growth in the credit debt along with a decline in bad assets was responsible for a material improvement in the quality of the banking sector s credit portfolio.

24 In 2010 Q1, the country s banking sector continued to operate at a time of persistent negative effect of the global financial crisis. The growth rates of the banking sector s credit portfolio decelerated more than two times on 2009 Q4, amounting to 3.2% only. Growth of assets exposed to credit risk 70 60 % 50 40 30 20 01.01.2009 01.04.2009 01.07.2009 01.10.2009 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011 Source: the National Bank of the Republic of Belarus Total assets Granted to enterprises Granted to households However, beginning in 2010 Q2, the growth of the banking sector s assets exposed to credit risk gathered pace all the time. Where on July1, 2010 an increase in the banking sector s assets exposed to credit risk constituted 28.7% (over 12 months), it was up to 33.8% by January 1, 2011. Also, banks increased the amounts of lending mainly in Belarusian rubles the amount of lending in the national currency to the enterprises of the non-financial sector was up by 47.6% and to households by 62.9%. At the same time, the credit debt in foreign exchange owed by the banking sector, in the US dollars equivalent, was reduced in 2010 by 2.7%, including a 48.9% 19 reduction in households outstanding debt in foreign exchange. In 2010, the structure of assets exposed to credit risk saw a slight decrease in the share of industrial enterprises debt and a simultaneous increase in the share of credits extended to enterprises engaged in agriculture, trade, and construction as well as organizations engaged in real estate transactions. At the same time, the concentration of banks credit portfolio in industry and agriculture remained high enough as at January 1, 2011 debt of industrial enterprises amounted to 38.7% and agricultural enterprises to 23.8% 20. Where the year 2009 saw a continuous acceleration in the growth rates of the credit debt in real terms 21 against a background of growing negative impact of the global financial and 19 A reduction in households outstanding balance was due to the ban on lending in foreign exchange to natural persons imposed by Resolution of the Board of the National Bank of the Republic of Belarus No. 105 dated July 14, 2009. 20 Indicators are calculated based on analytical information provided by banks to the National Bank on the structure of assets exposed to credit risk which are classified under types of activities in compliance with the Nationwide Standard Industrial Classification of Economic Activities (the NSICEA) in the Republic of Belarus. 21 The chronological average of clients and banks credit debt that is 12 months in arrears, adjusted for GDP deflator.

25 economic crisis on financial and economic activities of Belarusian enterprises and a plunge in the growth rates of the economy, a positive trend towards continuous reduction in imbalances between the growth of the credit debt in real terms and the economy growth was noted throughout 2010 which contributed to the reduction in the banking sector s general level of vulnerability to the risk of the borrowers failure to meet their obligations. Where the growth of banks credit investments at the beginning of 2010 exceeded the economy growth by 41.1 percentage points, this gap was narrowed more than three times to 12 percentage points by January 1, 2011. As the state of the country s economy was gradually improving in 2010 H1, the growth rates of the banking sector s bad assets were significantly decelerating and, beginning in July 2010, their amount started to decline giving rise to a significant improvement in the quality of assets exposed to credit risk. Change in the amount of credit debt owed by clients and banks % 45 40 35 30 25 20 15 10 5 0-5 01.01.2009 01.04.2009 01.07.2009 01.10.2009 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011 Source: the National Bank of the Republic of Belarus Growth rates of lending Growth rates of real GDP In the whole of 2010, banks bad assets grew by 12% only, or 362.3 billion Belarusian rubles, a 5.9 times decline on 2009. Also, the growth of legal persons non-performing loans in Belarusian rubles (by 20.4%, or 451.8 billion Belarusian rubles) was entirely responsible for the above-mentioned growth in bad debt. At the same time, the balance of bad debt in foreign exchange of both legal persons and households was down in 2010 by 11.5%, or 23.3 million 4 Factors behind the change in the share of banks' bad assets percentage points 3 2 1 0-1 -2 01.01.2009 01.04.2009 01.07.2009 01.10.2009 01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011 Impact of assets growth Impact of bad assets growth Change in the share of bad assets Source: the National Bank of the Republic of Belarus

26 Belarusian rubles, and by 42.5%, or 14 million Belarusian rubles respectively. In 2010, households bad assets in Belarusian rubles decreased by 5.6%, or 3.6 billion Belarusian rubles. In 2010, non-performing loans of enterprises engaged in agriculture grew 1.8 times, or 499.9 billion Belarusian rubles and in industry by 28%, or 358.1 billion Belarusian rubles. At the same time, the amount of non-performing loans extended to enterprises engaged in construction and trade as well as organizations engaged in real estate transactions decreased by 16.8%, 28.3%, and 76% respectively, or 8.9, 62.9, and 337.6 billion Belarusian rubles. In 2010, the growth rates of assets exposed to credit risk were significantly faster than an increase in bad assets giving rise to a material improvement in the quality of the banking sector s credit portfolio. In early 2011, the amount of bad assets of the banking sector 22 stood at 3.38 trillion Belarusian rubles and the share of bad assets in the total sum of the banking sector s assets exposed to credit risk declined from 4.24% as at January 1, 2010 to 3.55% as at the beginning of 2011. However, the share of bad debt of industrial and agricultural enterprises remained higher than 5%. The indicator characterizing the overall exposure of the banking sector to credit risk 23 decreased in 2010 from 69.7% to 58%, the minimum over the last six years. Structure of bad assets as at January 1, 2010 Structure of bad assets as at January 1, 2011 28.4% 14.5% 14.1 % 3.6 % 57.1% Group III Group IV Group V Source: the National Bank of the Republic of Belarus 82.3 % Group III Group IV Group V Source: the National Bankof the Republic of Belarus In 2010, the structure of bad assets of the banking sector also improved. The share of assets classified under Group III grew significantly compared with the beginning of the year. At the same time, the share of bad assets classified under Groups IV and V declined significantly from 28.4% in early 2010 to 17.7% as at January 1, 2011. By the beginning of 2011, banks ensured that special provisions for potential losses on bad assets were established practically in full. As a result, the banking sector s vulnerability to 22 Assets classified under Groups III, IV, and V with a view to making special provision. 23 The ratio of assets evaluated in terms of credit risk for the purpose of calculating regulatory capital adequacy to assets.