Ardian Fullani: Financial supervision and measures to strengthen
financial stability
Speech by Mr Ardian Fullani, Governor of the Bank of Albania, at the International
Conference for the 10th Anniversary of the Central Bank of the Republic of Kosovo,
Prishtina, 30 October 2009.
* * *
Dear Governor Rexhepi,
Distinguished ladies and gentlemen,
It is a pleasure for me to participate in this Conference which is perfectly organized by the
Central Bank of the Republic of Kosovo, and to witness the amazing progress this institution
has achieved in such a short but intense period of time. The energy and desire of the local
staff to contribute to the history of this institution, has been rightly channeled by the vision
and experience of several managing professionals that have given a valuable contribution in
chairing this institution in the last years. I am sure this story will continue to be a successful
one, based on the commitment of the management of the Central Bank of Kosovo to achieve
and comply with the best work organizational and efficiency standards, by pursuing a clear
long-term policy of investing in the quality of its personnel, and by supporting actions that
contribute to maintaining fruitful inter-institutional cooperation.
In addition, I want to thank the organizers for giving me the honor to speak in front of you
today, regarding a topic that has become so relevant in the last year, following this
unprecedented international financial crisis. Given the fact that the causes and
consequences of this crisis have been broadly identified and discussed, in the first part of my
speech I will focus more on the main findings of the professional discussion that is taking
place nowadays to identify a new financial supervision approach. I am sure you will elaborate
on these issues further during this Conference. In the second part of my speech, I will try to
give you more detailed information on how we at the Bank of Albania are thinking about the
future approach of the public authorities and of the financial industry, in relation to necessary
measures to strengthen financial stability.
Very shortly I want to reiterate what has now become clear to many: the recent crisis was a
consequence of wrong incentives which supported unbalanced financial activity development
and misconception of risk assessment, pricing and management. Such wrong incentives
were present not only to the financial industry and markets, but also to the balance sheet of
households, businesses and entire countries. Given the nature, the size and the impact of
this crisis, not only to the financial industry and markets but also to the real economy, public
authorities in many countries were forced to adopt swift, coordinated and extraordinary
measures, both in the area of monetary and fiscal policies. Central banks abandoned almost
any restriction and even adopted unconventional measures in providing ample and low-cost
liquidity to the financial markets. Governments showed a strong commitment to reduce
systemic risk by saving important financial institutions, by providing guarantees for inter-bank
lending, by raising the level of deposit guarantees for the public etc. Such measures, most of
the times designed as temporary, appear to have been successful in restoring the market
confidence and steering the world economy back in the gradual recovery path.
Focusing on the financial markets and institutions in the aftermath of the crisis, a number of
issues, previously known but many times neglected, have re-appeared forcefully to request a
serious and thorough response by the authorities. Many of these issues relate to the financial
activity itself, others are connected more with the surrounding economic environment.
It can be said now that the supervisory authorities of the financial markets and institutions are
partly responsible for what happened. Despite the rhetoric, they failed to properly and timely
identify and control the risk in the financial industry. Here one can mention the soft-hand on
bank wholesale borrowing that financed the foreign currency credit in a certain jurisdiction,
the neglect for the special purpose entities that were created to by-pass balance sheet
prudential requirements etc. There are many reasons for this weakness and a number of
them, in my opinion, go beyond the legal and resource capabilities of the supervisory
authorities to act. On their own, the supervisory authorities were wrong in basing their work
on the misconception that strong individual financial institutions are sufficient for the entire
financial system stability. By doing so, they missed the negative effects and excesses that
arise from the herd behavior of the financial institutions, many times a consequence of the
pro-cyclicality that is inherent in the financial activity and the regulatory framework itself. The
attention of the supervision was focused on the banking sector, but insufficient attention was
given to its interaction with the non-banking financial sector, that by being much less
regulated, in the meantime was increasing in size and importance. Also, as part of their
general and commending goal to focus their supervisory approach on the most important risk
sources of the financial industry, but also as a sign of their objective difficulty to keep the
pace with the financial markets developments and innovations, the supervisory authorities
relied more and more on the market discipline and on the sophisticated and unclear risk
models of the financial industry, that also proved to be deficient. Some times, the structure of
the supervisory authorities has proven to be fragmented or too complicated, giving rise to
regulatory arbitrage by the market players. Other times, the resources needed to effectively
perform the supervisory role have been limited, negatively affecting the supervisor's
performance.
But this crisis showed that risk came also from other sources, out of the direct control of the
supervisory authorities in a given jurisdiction. For example, the increasing asset prices were
fueled by ample liquidity and credit conditions, which were often affected by international
developments and financial flows. The borrowing in the international markets by the financial
institutions was also affected by increasing fiscal and current accounts deficits, arising due to
wrong policies that created imbalances in the saving-consumption behavior of most
important economic players in the economy, including the households. It is now a question,
whether some of these issues could be addressed by a more powerful role of the monetary
policy. Financial integration, among other things, has also contributed in the rapid expansion
of the financial activity, and many financial institutions have become too big for a single
country. This has occurred at a time when, for the same reason, the "de facto" power of
regulation has shifted away from the local supervisors toward their host counterparties.
Hence, despite a steady trend of convergence between financial legislation in many
countries, there are still marked differences that, particularly at a crisis situation, create
strong tensions between public authorities in different countries.
A very strong effort by the public authorities in the world to address the abovementioned
issues in order to improve the supervisory standards and superstructure is now underway.
Both in the United States of America and in the European Union, the creation of special
institutions is being envisaged, whose role will be to identify and control systemic risk through
a different supervisory approach for financial institutions with systemic importance. At the
same time, such financial institutions are expected to become subject of a more stringent
regulatory framework in terms of capital and liquidity requirements, balance sheet
composition and expansion, and governance relationships. Revising the liquidation
procedures for similar financial institutions with cross-border presence is another area that
will confront the public authorities in the world with a stronger challenge.
The main purpose of the reform of the financial regulatory framework will be to accommodate
new incentives that will create a stronger environment for risk management in the financial
industry. The main principle here is "prevention is the better cure". In this regard, the
perimeter of the supervision regulatory framework will be extended to include other important
non-bank financial institutions and probably the bank holding companies. At the same time,
the approach in the regulatory framework is expected to feature more automatic
requirements (and less discretionary ones), as it tries to move toward more simplicity and
clarity. The move toward simplicity and clarity, will certainly reduce manipulability and
enhance transparency and credibility of the banking and financial activity. These changes will
be complemented by similar ones in the area of customer protection and market
transparency. The regulatory framework of the financial industry is also expected to be less
pro-cyclical, as new interesting proposals are being identified to adopt a countercyclical
approach for capital requirements, provisioning and accounting. Ensuring responsible
governance for the banking and financial institutions is going to be another area of
developments. New regulatory requirements and instruments to seek more involvement and
higher responsibility of boards of directors for risk management and discourage uncontrolled
risk undertaking are being identified. On the other hand, the supervisory authorities will need
to strengthen their macro-prudential risk assessment capacities, by focusing more on
systemic behaviors of the financial institutions. The central bank is expected to take a larger
responsibility in this area, particularly in those countries where it did not use to have a strong
supervisory role. Whatever the approach in this direction, the supervisors will need stronger
legal powers which will ensure their ability to act in a timely and flexible way. As mentioned
also above, procedures for managing distressed financial institutions and for crisis
management will need to be revised to ensure stronger and more effective inter-institutional
and cross-border cooperation, and in general to better address the potential conflict between
ex-ante supervision and ex-post intervention.
This important process of financial regulatory reform is not without risks. I believe that the
public authorities will pay particular attention to control the tendency for over-regulation, and
to avoid a "blind" adoption of the regulatory changes as well as asymmetric/unilateral
approach. Regulating more should mean regulating better. Undertaking risks is a natural
thing for the financial industry in their valuable role of financial intermediation. Such
undertaking of risk, when well identified and properly managed, is useful for increasing
efficiency and returns of the activity, two important elements for a viable and solid on-going
financial performance. Every country should certainly follow with particular attention the
discussion and the changes that are being proposed for the financial regulatory reform, as
this process will affect them for sure. In this regard, it is important for the public authorities to
start a process that would analyze and assess the impact in their financial industry of the
expected and well identified proposed changes. Clearly, the practical adoption of the
proposed changes should be driven by the goal for achieving a higher convergence with
international standards, but it should be determined by the characteristics of the national or
regional financial system, and their development goals. In addition, focusing only at better
regulating the financial industry, without addressing other important and probably
unsustainable economic developments, is an asymmetric approach that will not deal properly
with the risks to financial stability. In this regard, governments, businesses and households,
should identify measures and adopt actions to reduce imbalances in their own balance
sheets, as this will, on the other side, improve the quality of the financial industry and reduce
risk.
Dear participants,
Let me now focus more on how the Albanian economy and our financial system was
challenged by the international crisis, and what are some of the future measures the Bank of
Albania believes are important to strengthen the stability of the financial system and of our
economy.
The recent international crisis showed that at the time of continuing financial integration and
economic globalization, small economies like Albania's or other countries' in the region,
should not count only on some natural protection coming from less developed financial
markets and a much lower level of indebtedness from the households and businesses, to
compensate over time for potential risks coming from less diversified economic growth,
overreliance in remittances, insufficient culture of risk management in financial institutions
and other economic agents - in particular for the exchange rate and liquidity risk, and very
limited space from the public authorities to introduce anti-crisis financial measures similar to
those in the developed countries. Hence, policy measures should address these and other
deficiencies to find a proper solution in the medium-term. Such measures should reflect the
preference for preventive approaches.
In fact, over the last 4 to 5 years the Bank of Albania was vigilant over time to point out areas
of the banking activity that required attention from the industry. We have expressed our
concern regarding the rapid increase in lending, as we believed that this could negatively
affect the credit quality. The composition of the loan portfolio, which is dominated by the
euro-denominated loans, has also been identified as a point of concern. Despite the fact that
this position is supported by a strong presence of foreign currency denominated liabilities in
banks balance sheets and very close economic links to Euro-area countries like Italy and
Greece, Bank of Albania has been consistent in its approach to introduce gradually
regulatory measures that would discourage rapid increase in lending, encourage banks to
lend more in domestic currency and increase transparency toward clients on banks products
and services. On the other side, the monetary policy has successfully anchored expectations
of very moderate growth in the price level and has supported demand for local currency
financial assets by offering sufficient positive real return.
As the crisis hit, the first impact in our economy was shown on the balance of payments,
reflecting the relationships of our economy with the world. The increase of unemployment
and the tightening of financing conditions in the neighboring countries of European Union
were followed by the decline of Albanian emigrants' remittances that live and work in those
countries. While the gap between the domestic and external demand was widened, this was
accompanied with an increase of current account deficit and the mounting pressure on the
exchange rate. At the same time, the banking sector, which heavily dominates the financial
system in Albania, reduced its funding contribution to the domestic economy as a response
to the increasing demand for liquidity, following the deposit withdrawal from the public and an
increasing borrowing demand from the Government. The combined effect of these
developments affected negatively the real sector of the economy, mainly the business sector.
In the first quarter of this year, business confidence index fell under its historic average,
reflecting a more difficult financial situation. The latter was also shown by the
lower-thanplanned realization of fiscal revenues as well as by the decline of loan portfolio quality that
banking sector has encountered throughout the period.
In the short-term, the public authorities took measures to lessen the impact of the global
financial crisis in the economy. Through the significant increase of the fiscal expenditures
share designated for investments, mainly in infrastructure, the government supplied an
important impetus for the support of the real sector of economy to cope with the global crisis
effects. The Bank of Albania has also been active to provide liquidity in the interbank market,
with the aim to preserve the stability of the banking sector and to lessen the expected
decrease of its intermediation role. We removed quantitative limits in the size of the liquidity
injections through our week-long reverse repurchase agreements, and extended the maturity
of our injection operations up to three months. Following a cut of the policy rate by 0.5
percentage points in January and the subdued inflationary pressures at home, the monetary
policy paid an important attention to the financial stability, by keeping the policy interest rate
unchanged throughout the period.1 Through this policy, we intended to maintain strong
incentives that would support the public demand for financial assets denominated in the
national currency, in the short term. At the same time, along with the Ministry of Finance, the
Bank of Albania initiated legislative changes to increase the deposit insurance level, as a
necessary measure to restore the public confidence for the safety of their banking deposits.
From the supervision point of view, the Bank of Albania established a stronger day-to-day
monitoring of the banking sector developments, focusing particularly in the liquidity situation.
This was part of a broader approach that included also changes in the regulatory framework,
better analysis through improving stress-test methodologies, stronger communication with
the banking sector, increasing number of publications and more presence in the media. We
believe that such policies were important for the effective management of the banking sector
liquidity needs, provided an orientation of lending in national currency and maintained strong
capitalization parameters for our banks. The situation entered into a qualitative improvement
phase after the return of public deposits growth in the banking sector. This process, which
was developed gradually and in a stable way in the second quarter of 2009, continues with a
steady pace.
We believe that, after coping with the short-term effects of the international financial crisis
and following the improvement of the international economic situation, it is the time for the
public authorities at home to initiate a process of assessment for the legal and financial
operations framework, with the goal to re-establish appropriate balances in the fiscal,
monetary and banking activity, to further sustain a stable economic growth and maintain
financial stability. In this regard we consider important for the fiscal policy to take respective
correcting measures in order to keep the confidence of the resident and non-resident market
agents and investors. At the same time, the monetary policy should assess the possible
effects on inflation of the financial incentives it provided to the banking sector and to the
economy, and later analyze the possibilities to support the financial intermediation of the
banking sector in the economy at a lower cost. To provide a longer-term response to the
stable economic growth, public authorities should insist on the compilation and
implementation of the strategies for future economic development, which in a medium term
shall provide for:
a) the establishment of a better balance on the contribution that different sectors give
for the economic growth. In this regard, it is important to increase the support for
economic sectors with strong growth potential, like agriculture and tourism;
b) the increase of our economy's competitiveness and its further formalization. In this
regard, the debate should focus on finding the incentives to increase the domestic
production and support domestic savings. Over the time these would improve our
current account balance, and improve the availability of our foreign currency assets;
c) the expansion of the economic agents' funding sources. In this regard the authorities
should implement policies that support the development of the non-banking financial
sector and that sustain the establishment of capital and debt market for private
entities. The accomplishment of these targets shall firstly require the strengthening
of the financial reporting standards; the completion and improvement of the legal
framework for the developments of business relationships and the improvements in
the protection of creditors and consumer rights, regarding the financial institutions
and products. In more practical terms, these measures are expected to improve the
availability of the funding sources for the economic growth, and gradually decrease
its dependence from the banking sector;
d) the improvement and the completion of the legal and operational framework to
strengthen the crisis management capacities of the public authorities. In this regard,
the authorities should identify the necessary measures for the prevention, the
treatment and the elimination of financial crisis consequences. Bank of Albania
believes it is important that each public authority carry out an assessment of its
legal, financial, human and technological capabilities, to perform its role in the
crisisprone situations. Needless to say, throughout this process, the coordination among
the public authorities should be at the highest level.
The banking industry itself is required to carry out a process of re-assessment of its
development objectives and models for the future, so as to ensure consistent and stable
profits. In this regard, the managing structures of the banks are expected to undertake a
process with the purpose of: a) re-assessing the development priorities; b) establishing a
better balance regarding income sources and focus on cost control; c) enabling a higher
specialization of their business and identify competitive priorities; d) achieving a better
balance regarding the composition of their assets and liabilities according to the currency,
maturity structure, etc.; e) implementing more active policies to approach and maintain the
public (customers) close to the institution; f) strengthening the internal audit structure and
risks management and research capacities.
Bank of Albania is now working with the goal that, within the needed time frame and after
properly consulting with the financial industry, to support this process through the
introduction of changes in the regulatory and supervisory framework. With this in mind, we
shall aim at strengthening the internal mechanisms of the banking activity that incentivize its
more controlled and balanced expansion, with adequate characteristics of liquidity and
capitalization. At the same time, Bank of Albania shall assess the need for a new supervisory
approach for the banks with systematic importance. The transparency of banking activity in
its relationships with customers and public in general, shall remain at the centre of our
supervisory activity. In general, in this process the Bank of Albania, shall consider the
alternations that shall occur in the European standards, by supporting the strong
collaboration with other central banks and supervisory authorities.
In conclusion, let me point out that the ultimate goal of the new financial regulatory changes
that is being identified in the international level is to provide the right incentives, which over
time will ensure a more balanced, risk-averse and stable financial markets and institutions
activity in the future. On a global and national level, such changes should be complemented
by other more general economic measures that should enable an adjustment process to
ensure a better alignment of asset and liabilities in the balance sheets of the various
economic agents. All this should be achieved, as we still want the social benefits of economic
and financial integration. This means the path ahead will witness a continuous and
challenging effort to find and strike a new and more appropriate balance between risk
appetite and more stable returns by the economic agents, and between short-term national
concerns and long-term regional economic and political integration objectives.
Once again, I wish to the Central Bank of the Republic of Kosovo, to its management and
staff, a successful future!
Thank you for your attention!