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Iulia Ruxandra Teodoru and Klakow Akepanidtaworn
The COVID-19 crisis raises the risk of renewed financial sector pressures in the Caucasus and Central Asia (CCA) region in the period ahead. Bank distress and its economic and fiscal fallout have been recurring features of many CCA countries, as seen after the global financial crisis and the 2014–15 oil price shock. Strong policy responses have delayed the full impact of the COVID crisis so far, but financial sector risks will increase once public support is phased out. If these risks are not preemptively addressed, banks’ ability to lend during the recovery phase could be impaired and there may be a need for costly public interventions, as in the past.
Iulia Ruxandra Teodoru and Klakow Akepanidtaworn

. In addition, persistently high dollarization may pose indirect foreign exchange (FX) credit risks, and high loan-to-deposit ratios and reliance on FX funding contribute to liquidity risks. Stress test analysis allows identifying the most significant risk factors in the region’s financial systems at this juncture, especially FX risks. Under adverse macroeconomic scenarios, CCA bank’s capital adequacy ratios could drop significantly but would likely remain above regulatory minimums. However, vulnerabilities due to FX exposures appear substantial: FX-induced credit

International Monetary Fund. Monetary and Capital Markets Department

financial dollarization and growing external imbalances . The banking system operates under substantial—albeit declining—financial dollarization, in the context of an open capital account and a flexible FX regime. Indirect credit risk stemming from FX lending to unhedged borrowers (FX-induced credit risk) is deemed material from the systemic perspective. In addition, a history of persistent current account deficits led to the buildup of foreign liabilities in the corporate sector. The fiscal sector entered the crisis from a relatively sound position, albeit a large share

International Monetary Fund

earnings for fast growing banks Higher charges for loans with FX risk Higher holdings of risk-free securities for excessive credit growth Introduction of special reserves on foreign bond issuance Broadening the base to funding from nonbank intermediaries Lower LTV for housing loans Guidelines to banks on FX-induced credit risk Ceiling on debt service in proportion to earnings Min liquid cover for FX or FX-indexed borrowing Estonia Overheating in 2000s Higher charges on housing loans to residents Higher reserves and broader base Introduction of special

International Monetary Fund. Monetary and Capital Markets Department
This note presents the results of banks’ stress tests carried out jointly by the NBG and the FSAP teams in the context of the 2021 FSAP. It describes the scope, methodology and results of a series of top-down stress tests carried out during January‒April 2021. At the request of the Georgian authorities, complementary bottom-up exercises were not implemented, on account of the operational challenges facing banks because of the COVID-19 pandemic.
International Monetary Fund

policy autonomy is limited. 4 Therefore, under the current exchange rate regime, there may not be much gain in this area even with zero degree of euroization. Box 1. Regulation of FX-Induced Credit Risk in the NBRM’s Supervisory Framework Macedonia has in place a number of prudential regulations that act as incentives against euroization, mitigate risks, or create buffers . Differential reserve requirements . Reserve requirements are 10 percent on denar deposits, 13 percent on FX deposits, and 20 percent on FX-indexed deposits. Net open FX position : A

International Monetary Fund. Monetary and Capital Markets Department

level of financial dollarization, some real assets in Georgia such as land or houses are typically quoted in USD. Nevertheless, most borrowers do not have income in USD and are unhedged against FX fluctuations. The additional FX-induced credit risks have been partly addressed by the additional risk weight for FX-loans to unhedged borrowers mentioned above, which strengthened banks’ risk buffers but did not result in a widespread shift towards lending in local currency ever since the introduction of the measure (see Figure 2 and Annex 1 ). 15

International Monetary Fund. Monetary and Capital Markets Department

macroeconomic environment on FX-induced credit risk, COVID-related credit losses, and concentration risk. Given the domestic orientation of banks, the scenarios focus on domestic macro-financial variables (e.g., GDP, inflation, interest rates, unemployment rate, exchange rate, and property prices). To account for the differential impact of COVID across businesses, the scenarios will simulate the evolution of value added by economic sec tors. These sec tors are grouped in three categories to differentiate their sensitivity to the pandemic. Three scenarios are simulated at the

International Monetary Fund

guidelines on monitoring fx-induced credit risk and household credit risk. 17 The stability of Croatian banks could be further enhanced by improving efficiency . The econometric estimates show that banks with lower cost/income ratio enjoys higher stability. And the ratio of cost to income in Croatia was above average in the EU context. R eferences Borio , Claudio , Craig Furfine , and Philip Lowe , 2001 , “Procyclicality of the financial system and financial stability: issues and policy options,” BIS Papers 1 http

International Monetary Fund. Monetary and Capital Markets Department
The National Bank of Georgia (NBG) has a broad mandate to safeguard financial stability in Georgia and has applied several measures that can be considered macroprudential. For instance, the NBG adjusted risk weights for foreign-currency (FX) loans to unhedged borrowers in a countercyclical manner in recent years. Going forward, it plans to introduce the Basel III countercyclical capital buffer regime for the banking system in 2015, which will require that it sets or releases the buffer on a regular basis, based on assessments of cyclical risks. Policymakers should consider establishing a full-fledged macroprudential policy framework in line with international best practices. The current framework is too broad to support the effective and transparent use of macroprudential policy going forward. An improved system would involve a revised legal framework to cement the use of a broad range of macroprudential instruments, the establishment of a Financial Stability Committee at the NBG level, and strong accountability and communication practices, including by the publication of regular reports on financial stability. The list of available macroprudential instruments should go beyond risk buffers and allow the NBG to set measures that directly influence the banks’ activities, e.g., through the application of loan-to-value (LTV) or payment-to-income (PTI) caps. The introduction of macroprudential measures for FX-induced credit and liquidity risks have led to a strengthening of banks’ risk buffers. On the asset side, additional risk weights are applied to FX loans to unhedged borrowers, while on the liability side, reserve requirements are higher for FX deposits and other borrowings. Furthermore, banks have to hold more liquidity for nonresident deposits (of which 92 percent are in foreign currency as of end-2013), if those deposits exceed 10 percent of total deposits. Combined with the general liquidity regulation, these measures have increased banks’ capital and liquidity buffers, as shown in the results of the FSAP solvency and liquidity stress tests. The planned introduction of buffer requirements to mitigate cyclical and structural risks is a welcome step. The countercyclical capital buffer and the capital surcharge for systemically important banks are planned to be implemented over the next few years. The capital surcharge for systemically important banks, which would currently apply at least to the three largest banks by total assets, is particularly important in the Georgian context due to the high market concentration in the banking sector.