78465 FINANCIAL SECTOR ASSESSMENT MOLDOVA 2008 MARCH EUROPE & CENTRALASIAR EGO IN VICE PRESIDENCY FINANCIAL AND PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY ON THE JOINT IMF-WORLD BASED BANKFSAP UPDATE This Financial Sector Assessment (FSA) provides a summary o f the main findings and recommendations o f the work o f the joint IMF-World Bank Financial Sector Assessment Program (FSAP) Update that visited Moldova from October 1 to 12,2007.' The principal objective o f the FSAP Update was to assist the authorities in evaluating development progress and future challenges and assessing the potential vulnerabilities o f the financial system in Moldova. In addition to the Aide Memoire summarizing key findings, the output included detailed assessments o f compliance with the Base1 Core Principles for Banking Supervision and the Core Principles for Systemically Important Payment Systems, Technical Notes o n Securities Markets, the Insurance Sector, Banking Sector and Stress Testing. The FSAP Update team comprised Judit Vadasz (IMF, Mission Chief), Sonja Brajovic-Bratanovic(World Bank, Deputy Mission Chief), Serap Gonulal, Sue Rutledge (all World Bank), Marie-Therese Camilleri, Nikoloz Gigineishvili, Annamaria Kokenyne, Silvia Ramirez (all IMF), Keith Bell (banking supervisions - World Bank expert), Tyge Rasmussen (securities market - World Bank expert), Alexander Shishlov (National Bank o f Kazakhstan, payment systems - World Bank expert), and Walter Zunic (banking supervision - IMF expert). Contents .............................................................................................................. OVERALLASSESSMENT 1 . SUMMARY I OF THE 2004 FSAP RECOMMENDATIONS ............................................................ 4 I1. MACROECONOMIC OUTLOOKAND RISKS............................................................................. 4 I11. THEFINANCIALSECTOR ....................................................................................................... 5 Banking Sector ............................................................................................................. -5 Insurance Sector ............................................................................................................ 6 Securities Sector and Capital Markets........................................................................... 6 Savings and Credit Associations ................................................................................... 7 I V . FINANCIALREGULATION AND SUPERVISION ........................................................................ 8 . . Banking Supervision...................................................................................................... 8 National Commission on Financial Markets ................................................................. 8 Insurance Sector Supervision ........................................................................................ 9 Securities Sector Supervision ....................................................................................... -9 Supervision o f the Savings and Credit Cooperatives Sector ...................................... -10 V . FINANCIALINFRASTRUCTURE ............................................................................................. 10 Payment Systems ......................................................................................................... 10 Payment Infrastructure Supervision ............................................................................ 11 Capital Markets Infrastructure ..................................................................................... 11 Accounting and Auditing . . ............................................................................................. 12 Corporate Governance ................................................................................................. 12 Consumer Protection in Financial Services ................................................................. 13 Financial Integrity ........................................................................................................ 13 ANNEX1. RECOMMENDATIONS OF THE 2004 FSAP ................................................................. 14 ANNEX2. RECOMMENDEDACTIONS TO IMPROVE THE BCP COMPLIANCE ............................... 16 ANNEX3 . RECOMMENDED ACTIONS TO IMPROVE THE CP SIPS COMPLIANCE ......................... 17 ANNEX4 . MOLDOVA-FINANCIAL SECTOR STATISTICS .......................................................... 18 Tables Table 1. Moldova: Regional Comparison. December 2006 .................................................... 18 Table 2 . Moldova: Selected Banking System Indicators ......................................................... 18 Table 3 . Moldova .Financial System Structure ...................................................................... 20 Figures Figure 1. Moldova: Credit Growth .......................................................................................... 19 Figure 2. Moldova: Dollarization Trends ................................................................................ 19 ASSESSMENT OVERALL 1. Overall, the developments in the financial sector, and particularly in the banking sector, have been positive. The 2004 FSAP found that the important risks for the financial system were mostly political and implementation risks, and that significant improvements were needed in the supervisory framework. Since 2004, the banking system withstood major challenges that emanated from serious exogenous shocks and drought. The National Bank o f Moldova (NBM) made successful efforts to improve governance (specifically bank ownership) and build supervisory capacity. The lack o f supervisory capacity in the non- banking sector has been addressed organizationally by creation o f a unified supervisory authority, the National Commission o n Financial Markets (NCFM). 2. Since 2004, the banking sector in Moldova has grown significantly, with major changes in the ownership structure including entry o f reputable foreign investors (Annex 4). Lending to the private sector has increased rapidly without noticeable deterioration o f the loan portfolio, reaching 33 percent o f GDP in 2007. As a result, the sector compares favorably to i t s peers in the former Soviet Union, although it remains well behind the new EU-members. Competition has put pressure o n improving the quality o f financial services and decreasing spreads. 3. The securities markets remain small. In spite o f a number o f initiatives, the basic problem areas mentioned in the 2004 FSAP are, for the most part, s t i l l present. The market suffers from the lack o f instruments, an undeveloped institutional investor base, and complex and inefficient infrastructure. The money market comprises three segments: T-bills, NBM certificates and the direct inter-bank market. The NBM certificates and T-bills with maturities up to one year dominate the market. 4. The insurance sector i s underdeveloped relative to its potential and compared to its peers. With the exception o f motor third party liability (MTPL), all other aspects o f the non-life market and l i f e insurance market are undeveloped. Several factors contribute to l o w insurance penetration, including l o w per capita income, income distribution (the growth o f the l i f e sector i s heavily dependent on the size o f the middle class), poor understanding o f insurance products, the lack o f public confidence in the sector, and the lack o f necessary prudential regulations and inadequate enforcement. 5. Monetary policy credibility and the liquidity overhang that creates inflation pressures are the major, interlinked sources o f vulnerabilities in the financial sector today. In addition, because dependence on remittances i s one o f the highest in the world (more than 30 percent o f GDP), the financial system i s vulnerable to potential volatility in these inflows. Simultaneously with enhancing monetary policy credibility by focusing o n inflation and treating the liquidity overhang, the NBM should make further improvements in i t s liquidity management capacity, tools, and transparency o f monetary policy. 6. Nevertheless, stress tests indicate that the r i s k s are manageable. As mentioned, the banking sector withstood serious exogenous shocks during the past year-and-a-half. Stress tests simulating possible shocks and a number o f extreme scenarios (but s t i l l within 2 historical parameters), show that the banking sector as a whole i s rather robust and can withstand them. 7. The BCP assessment of banking supervision found major improvements since the 2004 FSAP. The purchase o f domestic banks by reputable foreign investors i s an encouraging sign, indicating that the authorities are determined to clean up the sector. Yet, there are s t i l l few areas where further progress i s needed. As a supervisor, the NBM should put stronger emphasis o n analysis o f risks, vulnerabilities and developmental needs o f banks, and improve cooperation with the N C F M taking into account the cross-sectoral linkages. 8. The assessment of Core Principles for Systemically Important Payment Systems (CP SIPS) found significant compliance, with some challenges still remaining in the area o f supervision. Since 2004, the new Interbank Payment System (AIPS) has been completed, including a real time gross payment system (RTGS) and a designated time net settlement system (DNS). Eight o f the ten SIPS core principles are fully observed for the RTGS and the DNS. The key objective for the next period i s to ensure integrity o f the payments infrastructure and to strengthen i t s supervision. 9. Overall, the developmental needs of the financial sector are still substantial. The key priorities are to further improve the NBM supervision capacity and to effectively start operations o f the newly established National Commission on Financial Markets (NFCM). The immediate challenge i s to finalize the legal and regulatory framework for the sub-sectors under N C F M supervision, followed by building up i t s licensing and supervision capacity. Given i t s unstable revenue sources, the N C F M should receive budgetary support, as needed. Better and more effective cooperation between supervisory authorities in the financial sector i s another important priority. Change o f the licensing regime and adequate supervision o f the deposit-taking financial cooperatives sector i s also one o f the critical tasks, as problems in this sector could spill-over and seriously affect the banking markets. 10. Financial infrastructure in all financial sector segments and markets should be further improved. In the banking sector, credit risk registry i s most critical; for securities markets, rationalization o f the registry structure and the stick exchange must receive prompt attention; availability o f better statistical data i s a key issue in the insurance sector. Elements o f the national payment infrastructure that need special attention include, including settlement systems for the securities markets and for electronic payment instruments, as well as for the remittances related payment services. 11. The key recommendations o f the 2007 FSAP Update are provided in B o x 1. 3 Box 1: Moldova - Summary o f Key 2007 Recommendations A. High priority Create theframework for effective cooperation between the supervisors 0 Sign MOU between the NBM and the N C F M and separately between the central bank and all subsectoral supervisors. 0 Develop the joint handling o f some o f the supervisory databases. Improve the effectiveness of bank supervision Issue guidelines for the implementation o f consolidated accounting requirements. 0 Continue to make efforts to identify the beneficial owners o f banks. 0 Improve the capacity in the NBM t o adapt stress testing scenarios to the changing circumstances. Improve liquidity management 0 Develop the capacity to better forecast and manage liquidity. 0 Further increase the transparency o f monetary operations. Start the effective operation of the NCFM 0 Review and redefine, as needed, the licensing process for intermediaries under the N C F M . 0 Ensure the necessary N C F M funding through the government budget, as needed. 0 Upgrade existing staff technical capacity to implement and enforce insurance legislation. 0 M o v e to a modem Central Securities Depository structure, including the registrar functions (and RTGS payments) for at least the listed companies. Implement, with the leadership o f the NBM, the National Net Settlement Service for leu transactions B. Medium term and developmental Upgrade non-bank financial supervision 0 Set new, meaninghl prudential standards for all entities supervised by the N C M F . 0 Develop statutory returns in the insurance sector that provide relevant information o n solvency, reinsurance, claims, and expenses. Build technical capacity in the N C F M to analyze reinsurance programs and produce a set o f minimum reinsurer criteria. 0 Implement risk-based supervision principles for the capital markets sector. 0 Expand the NCFM’s remit to include leasing. Improve financial sector environment 0 Expand the public disclosure statements o f banks and require that the financial statements, bank charters, and statements o f compliance with the Corporate Governance Code be posted o n their websites. e Revise the insurance legislation to reduce the threshold for approval o f shareholders by the supervisor and provide detailed description o f indirect holdings in the capital o f insurers. 4 I. SUMMARY OF THE 2004 FSAP RECOMMENDATIONS 12. The 2004 FSAP concluded that the key issues in the financial sector are due to weaknesses o f the regulatory framework and gaps in its implementation. For the banking sector, the most critical issue was considered to be the privatization o f Banca de Economii, and the implementation o f the “fit and proper� standards for owners o f financial institutions, especially banks. In the insurance sector, the focus was on improving the regulatory environment. The key recommendations for the securities markets aimed to consolidate markets and stimulate market development. Payment system recommendations focused on improving the payment system infrastructure. For governance and accounting, the recommendations focused on development o f the necessary legal framework. 13. Since 2004, many recommendations provided under the 2004 FSAP have been implemented (see Annex 1). While the privatization o f Banca de Economii has been slow, there was major progress in addressing the issue o f ownership structure o f banks, including identifying the nature o f connections between borrowers and stockholders and requiring beneficial shareholders to fully disclose their ownership. The regulatory framework has been improved, but there was little progress in strengthening supervision, except in the banking sector. The payment systems infrastructure has been improved and there were improvements in the legal framework for accounting and auditing practices. 11. MACROECONOMIC OUTLOOK AND R I S K S 14. Economic growth has been robust in recent years, driven by consumer demand and construction activity, themselves fed by remittances and, more recently, by growing foreign direct investment. Due to continuing migration, labor shortages have emerged, indicating that consumption-driven growth i s reaching i t s limits, At the same time, the inflow o f remittances, which amounted to 33 percent o f GDP in 2006, exerts appreciation pressure on the leu and pumps liquidity into the system, fuelling inflation, which at 13.1 percent, remains high for the region. The continued strong growth in credit and broad money suggests that risks to inflation are not yet fully contained. Price stability has become the primary monetary policy objective. 15. The current macroeconomic outlook i s positive, and does not pose immediate risks to financial sector stability. A number o f serious exogenous shocks, including doubling o f import prices for natural gas and ban o n imports o f Moldovan wine in 2006, and drought in 2007 causing food prices were weathered without major impacts. Future risks to the macroeconomic outlook stem from several sources: (i) dependence o n remittances. While they are unlikely to suddenly stop, they could become unstable; (ii) inflationary pressures; and possibly ( iii) rapid credit growth. 5 111. THEFINANCIAL SECTOR Banking Sector 16. While being overwhelmingly dominant in the financial sector and with a high growth trend, the banking sector i s still relatively small. Total assets o f the sector amount to 52 percent o f the GDP, with credit equivalent to about 33 percent o f GDP.* This compares favorably to Moldova’s peers from the former Soviet Union, although it remains well behind the new EU-members (Annex 4, Table 1). The level o f financial intermediation i s partially the consequence o f the widespread use o f cash in the economy, fuelled in large part by remittances. Consequently, the banking sector remains highly dollarized (Annex 4, Figure 2). 17. Foreign participation in the banking sector’s assets i s increasing. It i s currently about 64 percent overall, but widely spread. The majority foreign owned banks account for only 23 percent o f the total banking assets. On the other hand, the bank with the largest branch network accounting for 15 percent o f the total assets i s s t i l l in state ownership. Concentration in the banking sector has not changed significantly since 2004 but compares favorably to Moldova’s peers. 18. Lending to the private sector has increased rapidly without noticeable deterioration o f the loan portfolio, despite the relatively high interest rates (above 18 percent in the past 2-3 years) and sustained high inflation. (Annex 4, Figure 1) Credit to households and to corporate sector increased at about the same pace. Credit to private sector has grown by 18.5 percent in the first 6 months o f 2007. In the retail sector, mortgage and consumer credit expanded most rapidly. 19. The banking sector i s generally in a sound financial condition. (Annex 4, Table 2) The aggregate capital adequacy ratio i s at a very high level o f about 28 percent, in fact, the highest average in the region. Profitability indicators are good, with an overall return on equity in 2006 o f more that 21 percent, which provides an excellent further cushion to absorb any negative shocks. The nonperforming loan ratio was about 4.4 percent at end-2006, partly reflecting overall rapid credit growth but also the implementation o f sound credit risk management practices. 20. Overall, the results o f the stress tests indicate that the banking system in Moldova i s generally stable, but remains somewhat vulnerable to liquidity, credit and macroeconomic shocks. The stress tests were conducted in coordination with the NBM, using bank data as o f end-June 2007. The tests included sensitivity analyses o f the banking sector’s vulnerability to credit, liquidity, interest rate and exchange rate risks, as well as macroeconomic scenarios involving a combination o f shocks. The stress tests were performed at the individual, group, and banking system level and the size o f the each shock was chosen based on both historical and hypothetical changes in key risk factors. Liquidity risk remains the key vulnerability, despite high liquidity ratios and capital buffers. Sensitivity to interest rate shocks i s relatively l o w due to the banking system’s short t e r m asset and 2 In 2004 these figures amounted t o 42 percent and 23 percent, respectively. 6 liability structure. In most scenarios, none o f the larger banks bank falls under the minimum regulatory capital requirements. Insurance Sector 21, Insurance sector i s underdeveloped relative to its potential and compared to neighboring countries. In 2006, total insurance premiums amounted to Moldovan leu (MDL) 560 million (USD 50 million, 1.2 percent o f GDP), o f which non-life accounted for 96.1 percent. Several factors contribute to l o w insurance penetration, including l o w per capita income, income distribution (the growth o f the life sector i s heavily dependent on the size o f the middle class), poor understanding o f insurance products, the lack o f public confidence in the sector, and the lack o f necessary prudential regulations and inadequate enforcement. 22. As of end-2006,33 private insurance companies operated in Moldova, and the presence of foreign investors in the insurance industry was high. The market i s dominated by two companies that collected 53.3 percent o f the premiums in 2006. With the total gross premium income o f MDL 560 million, it i s difficult to see h o w 33 insurers can continue to operate. Measures started in 2003 to stimulate consolidation by increasing minimum capital requirements to MDL 2 million were followed by an increase to MDL 15 million in 2006. However, the deadline for compliance with the new minimum capital has been extended to five years, which will result in continuing undercapitalization. 23. With the exception of motor third party liability (MTPL), other aspects of the insurance market are undeveloped. The market growth in Moldova i s mainly based on the illicit discounting o f M T P L premiums. Household and general liability insurance do not exist, and most industrial enterprises are either uninsured or underinsured. W h i l e recent initiatives have introduced new products, especially in the life and agriculture insurance, such sophisticated products require the development o f a technical infrastructure for the protection o f policyholders and this might take time. 24. I f the Moldovan insurance industry had a national insurance association, it could enforce discipline in the MTPL market and reach consensus on a new rating system to replace the current tariff. Moreover, it could fulfill the responsibility o f bridging the interests o f the supervisor and industry. The establishment o f the Actuarial and Policyholder Protection Associations i s a positive step toward institutional development. Securities Sector and Capital Markets 25. NBM notes and T-bills with maturities up to one year dominate the debt securities market with most activity in the 90 days o r less segment. There were issues with maturities o f up to 3 years, but the outstanding amount i s only MDL 222 million and there is no secondary market activity. There have also been private placements o f a handful o f small corporate bond issues. Price discovery in the active part o f the market has not been effective, so the government and NBM need to focus on developing a well-structured government bond market. The existence o f a yield curve for government bonds o n a liquid 7 secondary market i s the necessary precondition for developing other bond markets, such as corporate or mortgage bonds. 26. The Moldovan equity market i s small. Most o f the basic problem areas mentioned in the 2004 FSAP remain despite o f a number o f initiatives undertaken during the last years. The market suffers from a lack o f some crucial instruments, an undeveloped institutional investor base, and the weak use o f technological infrastructure. 27. The basic legislation concerning trading i s restrictive, and the off-exchange trade volumes are significantly larger that the exchange-based trading. Large trades are traded through tenders at the exchange or as direct over-the-counter trades, smaller trades are done directly at the registrars and there are very few medium-size transactions. The market i s fragmented, the price discovery function i s limited and the exchange i s losing “market share� compared to the off-exchange trading arranged by registrar^.^ 28. The trading patterns reflect an uneven investor base and missing institutional investors. A large number o f very small shareholders (from privatizations) and a few very large shareholders own controlling stakes in the companies. There i s hardly any institutional investor base, but the investment funds from the privatization period are being restructured into joint stock investment companies or liquidated. The MSE i s actively looking for regional cooperation and outsourcing as a survival strategy. Unfortunately, this approach may not work as the current global trend i s clearly one o f mergers and takeovers rather than cooperation. Savings and Credit Associations 29. While the Savings and Credit Association (SCA) sector was not included in the FSAP Update, it warrants mention because o f its high growth and instability. In the 3‘d quarter o f 2007, there were 455 operating SCAs in Moldova - a decrease from the high o f 538 in June 2005. The main cause for the drop appears to be the cancellation o f licenses and/or failure to obtain external funding. Nevertheless, the overall SCA membership continued to grow, reaching more that 111,000 members, indicating that a large number o f rural households maintain a membership in a SCA. The SCA lending portfolio totaled about MDL 445 million in September 2007, o f which about 16 percent was funded by members’ deposits. In fact, about 250 SCAs (over half o f the total number) now take deposits without being supervised. The increasing share o f deposits funding the loan portfolio in an industry that i s not yet regulated or effectively supervised should be a cause o f serious concern. The 1 percent exemption rule allowing registrars to performbrokeddealer functions actually allows by-passing the exchange fro the major part o f the normaltrading flow on a liquid exchange. The r u l e was originally seen as temporary, but it i s included in the new draft Securities Law allowing “operating off-exchange markets.� Trading activity in the off-exchange market i s reported daily to the NCFM and published, but not consolidated with MSE market data. 8 Iv. FINANCIAL REGULATION AND SUPERVISION Banking Supervision 30. T h e essential elements for effective ongoing prudential regulation and supervision o f banks are in place, but there are areas for further improvements. Almost all the 2004 FSAP recommendations from the assessment o f compliance with Base1 Core Principles (BCP) have been implemented either through new regulations, by more forceful and effective use o f supervisory powers, or by improving supervisory practices (see Annex 2). The conclusion o f the BCP assessment under this FSAP Update i s that licensing i s adequate, and previously reported deficiencies in identifying bank shareholders below the significant interest threshold have been largely eliminatedq4 It should be noted, however, that some o f the new regulations might undermine the NBM power^.^ The key issues remaining are the legal protection o f supervisors, the lack o f efficiency in assessing the exposures to connected parties, the consolidated supervision and the home-host relationships. Especially critical i s the cooperation with the newly created National Commission for Financial Markets (NCFM). An information-sharing mechanism has been established by the exchange o f letters between the NBM and the newly created NFMC, but there i s no formal Memorandum o f Understanding (MOU) leaving the issue o f effective cooperation open. Also, to be more effective, the NBM should develop an efficient and effective means to extract useful supervisory information from databases already compiled from on- and off-site supervision. National Commission on Financial Markets 3 1. T h e regulation and supervision o f non-bank financial institutions and the related financial infrastructure has been unified under the National Commission on Financial M a r k e t s (NCFM). This i s a positive step. The N C F M i s an independent body vested with regulatory authority and reporting to Parliament. The N C F M regulation and supervision responsibility specifically includes securities, insurance, pensions and investment funds, microfinance institutions, savings and loans, and possibly other entities active in the financial markets. However, the enforcement power o f the N C F M s t i l l needs to be clearly defined in a manner similar to that o f the NBM in order to be effective. 32. T h e NCFM was set up with the objective o f enhancing the quality o f supervision o f the nonbank financial sector. The task i s complicated, however, by the differences in risk profiles o f various financial intermediaries and in supervisory cultures. For instance, the top priority o f insurance sector o f the N C F M should be o n developing an adequate regulatory and supervisory regime; in the securities sector, the main task i s to develop a strategy to revitalize the securities markets and to extend i t s supervisory activities to cover leasing. In 2005, the threshold defmition o f “significant interest� (i.e,, beneficial interest) was reduced - as recommended in the 2004 FSAP - from 10 to 5 percent o f a bank’s equity or voting rights and the NBM has strived to obtain all necessary information o n the shareholders o f all active banks w i t h reasonable success. “Fit and proper� provisions o f the legislation now approximate the EU standards. The so-called “Guillotine Law,� if implemented unchanged, will limit the NBM’s current powers. W h i l e the NBM will s t i l l be able to issue restrictions, i t s action will be immediately subject to court review. 9 33. Harmonizing the legal framework to ensure a consistent approach to regulation and supervision will be a challenge, as many of the sub-sectors did not have any o r consistent regulations. The transfer o f licensing authority from the Licensing Chamber (planned for October 1, 2008) i s an opportunity to refine the licensing processes. It i s also a challenge as the N C F M needs regulations, staff and back office functions for effective execution. Licensing over 400 savings and loan associations (see below) will be daunting. 34. The NCFM i s envisaged as a self-financing body that will collect taxes and other payments from financial market participants. The sources o f N C F M funding include fees, issuance and trading charges from the securities sector, capital or turnover-based fees o f supervised entities, service fees and penalties. The 100 percent self-financing in shallow and unstable markets, such as those under the N C F M jurisdiction, might not work. A realistically high level o f self-financing should be encouraged as a matter o f principle, but the necessary level o f N C F M funding must be available without putting the institution at risk. Insurance Sector Supervision 35. Insurance supervision problems begin with weaknesses in the licensing procedure and continue through weak ongoing insurance supervision. A non-specialized institution licenses insurance companies. N o on-site supervision. Off-site monitoring, based on analysis o f the financial information submitted by the companies, i s weak and does not provide a good basis to identify potential problems. Supervision does not cover all factors that may affect the performance o f an insurance company such as capital resources (solvency), the formation o f technical provisions, and the existence o f assets (investments) necessary to meet the insured liabilities. 36. Ensuring the solvency of the sector requires publication and enforcement of prudential regulations based on international criteria as soon as possible. This recommendation was made in the 2004 FSAP with l i t t l e progress in upgrading the legal framework noted at the time o f the update. International criteria provided the basis for upgrades in the Insurance and M T P L Laws. However, the absence o f technical regulations i s an important weakness insofar as implementation delays allow companies to be out o f conformity with the current law, despite the clause in the insurance law that establishes that technical regulations should be fully in place as o f October 2007. Securities Sector Supervision 37. The orientation towards risk-based supervision of securities intermediaries i s an important priority. Many laws have been adopted in the last half year or are in the pipeline. A new Joint Stock Company L a w and a new Auditing L a w have been adopted in 2007 and amendments to the Securities L a w are in the parliament. In addition, a Corporate Governance Code has been approved. Implementation o f all these laws implies that many resources will be used for drafting revised regulations. Rather than over-regulating, the N C F M strategy should be to switch from very detailed regulations to focus on regulating the key risk areas. Moreover, focus should be o n collecting data that will support the development o f meaningful risk ratios and early warning signals. Also, calculating sector averages and encouraging s e l f assessments may be a useful strategy. 10 38. The tools and methods for undertaking on- and off-site supervision could be improved. An informal assessment o f IOSCO principles was undertaken on the basis o f a self assessment prepared by the former capital market regulator. A meaningful assessment of a number o f principles was not possible because major changes in the legal and regulatory framework are either not completed or have not been implemented. However, it was clear that the use o f risk-based methods i s very weak. For example, at present intermediaries have only an initial capital requirement; introducing capital requirements based on market risk measures would be a major challenge for the regulator. Supervision ofthe Savings and Credit Cooperatives Sector 39. The capacity to license, regulate and properly supervise the SCA sector i s also a critical challenge for the NSFM. A SCA Law passed by Parliament in July 2007 gives the responsibility for regulation and supervision to the NCFM. An immediate challenge will be to deal with the expiry o f licenses o f about 4 10 SCAs at the end o f 2007, whereby a new licensing procedure, including business classificationY6 should be effectively executed. Capacity and fimding issues o f the NCFM leave it unclear when and how will this exercise be executed. About 250 SCAs have already started to collect members' deposits, making the issue both urgent and serious. Since early 199Os, problems originating in the SCA sector spilled over to the banking sector in a number o f countries triggering banking crises with high costs to the economy. Nevertheless, the NBM has not been actively engaged to help the NCFM. V. FINANCIALINFRASTRUCTURE Payment Systems 40. The two systemically important systems, the Real-Time Gross Settlement System (RTGS) for large value and high priority payments and the Designated-time Net Settlement system (DNS) for low value payments, are owned and operated by the NBM.7The RTGS accounts for about five percent o f total payment transactions and 88 percent o f their total value. The DNS i s a batch system based on multilateral netting. Both systems were assessed for compliance with the SIPS core principles (see Annex 3). Both systems seem fully observant, but a few minor improvements are s t i l l needed. 41, The payment-card base i s growing fast. Twelve commercial banks issue payment cards o f international systems VISA and Mastercard. B y September 2007, just over 700,000 The SCAs are to be classified in three categories: Category "A" SCAs that lend only from their capital and external credit lines. Supervision o f these will be limited and primarily off-site; Category "Blr deposit-taking SCAs, where the deposits need to be deposited into a bank and only a fraction used for lending. The challenge i s to decide exactly how these should be effectively supervised. There are about 250 deposit-taking institutions right now, but that number i s expected to drop to about 40. The rest w i l l have until the end o f 2008 to return the deposit to their members and become Category A again; Category "C" full-fledged credit unions. The plan i s that the C-licenses will start t o be only after the N C F M i s able to exercise the proper supervision. ' There are 17 participants in the AIPS, including the NBM, the 15 commercial banks, the Treasury o f the MOF and the Tiraspol Settlement Center. The NBM could provide liquidity, but in practice prefers that banks obtain the necessary liquidity in the inter-bank market. 11 bank-cards were in circulation, o f which 96 percent were debit cards. Moldova has two processing centers. MoldMediaCard services three commercial banks and Victoria Bank’s in- house processing serves nine banks. The point-of-sale terminals are owned by the banks, unlike in many other countries, and are used as market penetration tools. 42. Clearing and settlement for the electronic payment instruments i s organized by international card system companies through direct correspondent accounts abroad, significantly increasing costs. The Banking Association i s taking the initiative to develop a national settlement service, but the NBM i s resisting due to potential risks in the settlement procedure. Nevertheless, the NBM should do much more than presently to support the development o f cashless payment instruments and reduce the related transaction cost. Payment Infrastructure Supervision 43. T h e NBM has made reasonable progress in developing i t s oversight capacity in the payment system area, but further improvements are needed (see Annex 3). The division in charge o f payment system oversight i s within i t s Payment System Department, as i s the operational division, compromising any arms-length relationship. NBM oversight focuses on individual participants rather than the payment infrastructure. Instead, the NBM should define the minimum measurable requirements that the payment system infrastructure and i t s operators need to comply with to ensure safety and efficiency. 44. I n order to guarantee the integrity of the payment system infrastructure, the NBM should extend its oversight over the Securities Settlement System. In addition, as international remittances and cross-border payments o f corporations are increasingly relevant for MoldovaY9 the NBM should widen the coverage o f following these flows from the traditional areas o f balance o f payments and money laundering to include payment system issues, in particular issues related to efficiency, transparency, risks, and consumer protection. Capital Markets Infrastructure 45. T h e infrastructure for the equities market i s unnecessarily complex and the registrar system i s inefficient; both need to be rationalized. Nearly all the securities are dematerialized, but there i s no central register o f ownerships. Fourteen registrars handle this task, some with joint systems but most with very simple I T solutions. The National Depository Agency mainly functions as a clearing/settlement organization for the Moldova Stock Exchange. I t does not have a registrar’s license and thus does not operate in accordance with usual international practice as a central securities depository. Also contrary to international practice, the NBM i s not involved in the money side o f securities settlement for which the use o f commercial banks introduces credit risk. Discussions about moving the 8 Because o f this, leu transactions are converted into the currency o f an international payment system, USD, for Visa or Euro for Mastercard. 9 The value o f incoming remittances t o the country in 2006 was U S D 1.1 billion that constitutes 33.3 percent o f the GDP. 12 money settlement to the NBM-operated payment systems have been going o n for several years without progress. 46. The Moldova Stock Exchange (MSE) i s the only exchange. Organized as a closed joint stock company (owned in equal portions by all members), the exchange i s recognized as a self-regulatory organization by the capital market regulator. H a l f o f i t s 26 members are independent broker companies; the other half are bank-owned. The number o f broker companies i s decreasing with fewer than 20 listed companies and around 1,000 companies registered for trading. In the post-privatization period, several companies (especially banks) have raised additional capital in the market but none could be called a true initial public offering. 47. Formulation o f revitalization/survival strategy for the equity market and i t s central institutions remains an important priority. The conclusion o f the 2004 FSAP was that reconfiguring the stock market into a cost-effective and operationally-efficient “light stock market� would be essential to revive it. T w o means to achieve this were suggested: (i) establish cost-effective and operationally-efficient supervisoryhegulatory and trading systems and (ii) encourage various forms o f collaboration and outsourcing o f back-office functions with regional markets after study o f different models. These are s t i l l valid recommendations. Accounting and Auditing 48. The regulatory framework for accounting and auditing has been improved with the enactment o f the new Accounting Law and the new Auditing Law in 2007. National accounting standards are to be brought into full compliance with the IFRS within three years. The Accounting L a w demands full access by the general public to information on financial statements. The Auditing L a w stipulates statutory audits o f annual financial reports, including consolidated statements, to be carried out for public interest entities. A specialized body under the MOF will execute the certification process for the auditors and generally oversee the auditing profession. The critical issue now i s the necessary training o f local experts to be able to effectively implement the two laws. Corporate Governance 49. Corporate governance in Moldova has improved. O f the 14 corporate governance recommendations in the 2004 FSAP, over two-thirds have been at least partially implemented, particularly those related to accounting and auditing. A Corporate Governance Code has also been enacted. The use o f international financial reporting standards for all public interest entities, including listed companies and financial institutions, has become mandatory. Annual reports o f pubic interest entities must reflect on compliance with the Corporate Governance Code. The related NBM regulations also have been improved, but could be strengthened further.� The key priority in the next period i s to effectively loThe NBM’s regulations follow the EU Directive o n transparency related to ownership and control, but past legacies make it difficult for the NBM t o identify all ultimate shareholders o f banks. 13 implement the new legislation and provide a functioning central registry where third parties can obtain governance related information, such as ownership, companies’ charters, financial statements, etc. Consumer Protection in Financial Services 50. Consumer protection in financial services received some attention, but more needs to be done. The L a w on Consumer Protection provided the legal framework, followed by regulations requiring banks to disclose effective interest rates for banking products. This has improved the transparency o f banking products. The next steps would be to introduce requirements for non-bank financial products, to more effectively enforce the regulations and to establish (cost-effective) dispute resolution systems. All financial institutions should be obliged to have a complaint department, and consideration could be given to establishing a financial ombudsman with authority to make decisions regarding small claims. Consumer literacy also might be addressed. Financial Integrity 5 1. The anti-money laundering (AML) regime has been strengthened in recent years, but the recent assessment by MONEYVAL found that need to be addressed. The MONEYVAL assessment provides a number o f useful and specific practical recommendations to address the remaining gaps in the A M L / C F T framework in Moldova and the authorities were encouraged to implement these recommendations. 14 ANNEX1. RECOMMENDATIONSOF THE 2004 FSAP 2004 FSAP Recommendations Status of implementation Emphasize inflation as the ultimate policy objective. Implemented, Article 4 o f the NBM Law was amended accordingly. Streamline some of monetary instruments. Implemented. Define more clearly preconditions for LOLR. No progress, the legal framework remains as it was prior to the 2006 amendments. Banking A time-bound corrective action for Banca de Economii to address Implemented. the findings o f the external audit and NBM examination findings. The government to develop a privatization strategy for Banca de Implemented.Growing interest by internationalbanks. Economii. Process slowed down with the selection o f the evaluation consultant. Banks owning stakes in insurance companies to set aside reserves, Implemented. Loan provisioningregulationwas at a minimum equivalent to their equity investments in those amended to stipulate provisioning rules on banks’ companies. equity investments. The Insurance Regulatory Authority to sign MOU with the NBM Implemented. As a result of the establishment o f the on exchange o f financial info. regarding common owners o f banks NCFM, a new Memorandum of Understanding and insurance companies. (MOU) needs to be signed. 15 Payment and settlement systems The NBM to update rules and regulations - for the new system. I Implemented. The legal basis i s comprehensive and covers all aspects in the area o f payment systems. Contingency plans and crisis management to be established. Implemented. BCP has been updated and tested on the regular base. Backup center i s operational and fully redundant, located away from the main building. The net settlement system must have an arrangement in place to Implemented. DNS has two settlements per day in the secure settlement. RTGS system. Elaborate an M O U with the NSCM to ensure oversight o f Not Implemented. Oversight over the securities payments involving the MSE. settlement system involving the NSCM and MSE has not yet been committed. Enact new, modem insurance legislation to upgrade the New laws provide improvements in corporate institutional structure, implementation and enforcement capacity governance, but the prudential regulations o f insurance supervision, and to improve corporate governance o f correspondingto the new Insurance and MTPL Laws the insurance sector. are s t i l l pending. Implementation and enforcement capacity i s s t i l l weak. The regulator to promote the development o f the actuarial N o progress to date profession and to establish a reliable claims database. Capital Markets Develop action plans and carry out public information campaigns Partly implemented. to broaden the investor base and strengthen investor confidence. Rationalize the off-market exchanges in order to integrate the N o progress. equity market. Restructure the current dysfunctional investment fund industry. Underway. Old investment fund industry under liquidation or restructuring into investment JSCs. Microfinance Rationalize the regulations and regulatory framework for Underway. Microfinance Law i s currently discussed in microfinance institutions. the parliament. The NCFM has taken over microfinance regulation and supervision. Strengthen the SCA Law, subject the RFC to appropriate Underway. The NCFM has taken over SCA regulation government supervision, and review and revise the roles of the and supervision. The major progress i s introduction of various stakeholders in the SCA system. A, B and C-type licenses. Prudential requirements are being developed. adopted by the NCFM (2007) but no training progrdinstitute in place. 16 2. RECOMMENDED ACTIONS ANNEX TO IMPROVE THE BCP COMPLIANCE l(2): Separate supervision budget from the overall budget o f the NBM. l(4): see 23 below. l(5): Amend the NBM Law to include legal protection for supervisors. l(6): Set up an agreement for cooperation between the NBM and the NCFM (Le. ve and beyond the exchange of reports). 17 ANNEX3. RECOMMENDED ACTIONS TO IMPROVE THE CP SIPS COMPLIANCE role and discuss the outcomes t o the relevant stakeholders in 18 ANNEX4. MOLDOVA-FINANCIAL SECTOR STATISTICS Table 1. Moldova: Regional Comparison, December 2006 (in percent, unless otherwise indicated) I Albania Georgia 1 FYROM Moldova I Romania i Slovakia ’ Ukraine Number o f banks .-~--._-_.“.I . I Concentration in the banking .__...--__----,..__..._I-_._...--... system . -........___.I.. ..._.__-.l-., ........ 64 ....... 64 48 Total -l-_-l__ -..- assets/GDP banking.-_--..___.I_. I _ 69 ........._.I . .... . .. .. . Out ofwhich credit to GDP 22 kapital !_ .-.---. ._. ... adequacy ratio . . .. .. . ....... I. -“-.I -..-.-..I^ I . . Foreign - ownership % 1/ ~ _. 1 86 ....... ...... � ............... lNon_lperforming/cl I ‘Return on Assets ........... .--I� ...... ........ .... 2j Return on Equity ......... .-.I .... - . I.... ..... ................... . ... . ......... ........ .... ................ I 1 I Source: ECB, FitchRatings, IMF GFSR, and central bank reports, 1/ As a percentage of total capital for Slovakia. Table 2. Moldova: SeIected Banking System Indicators (in percent) I i 200j 2004 200j 2006 2007/1 Depth ofihe banking system - Total beking assetslGDPj2 - I � _ _ - - - - TOG1 Lo-qs/Total_bankingsy_stem Capital-adequacy ratio- I - Dol!%r&&!! -_ .- ___ 1 I_ logs_ Foreign_cunencyloans/_total Source: NBM data and staff calculations 1/ Data as o f June 30, 2007. 2/ For calculating 2007 ratios 2006 GDP was used. 3/ For the three largest banks. 19 Figure 1. Moldova: Credit Growth 160% 3500 -- 160°% 140% 3000 -- 120% 2500 -- 100% 2000 -- 60% 1500 -- 60 O/ o 1000 -- 40 7- ' 500 - - 20 5% o l - 0 2003 2004 2005 2006 06.30.2007 Figure 2. Moldova: Dollarization Trends KZEIratio o f foreign currency deposits in total deposits CZZI ratio o f foreign currency loans in total loans -USD -EUR 20 + T 3 Vl