41146 FINANCIAL SECTOR ASSESSMENT KYRGYZ REPUBLIC SEPTEMBER 2007 EUROPE CENTRAL ASIAREGIONVICEPRESIDENCY & FINANCIAL ANDPRIVATESECTORDEVELOPMENT PRESIDENCY VICE BASED THEJOINTIMF-WORLDBANKFINANCIAL SECTORASSESSMENT ON PROGRAM This FinancialSectorAssessment (FSA) summarizesthe structuraland developmental aspects of the 2006 FSAPUpdatereportfor the Kyrgyz Republic.The stability and prudentialoversight aspects ofthat report, includingthe factual updates ofROSCsandthe resultsofthe Anti Money LaunderingandCombatingthe FinancingofTerrorism (AML/CFT) assessment, are summarizedinthe FinancialSystemStability Assessment (FSSA) that was discussedby the IMFBoard, as part ofthe Article IV Consultation, inMay 2007. ThisFSA should be read together with the FSSA in order to get afull sense of the findings and recommendationsof the 2006 Kyrgyz Republic FSAP Update. At the requestof the authorities,the 2006 FSAPUpdatehada broadcoverage.The 2002 FSAPidentifieda number of structuralweaknesses anddevelopmentalissues that limitedfinancial intermediationandprivatesector growth. Since then, the authoritieshave made substantialprogress inimplementingtheir financial development plan.' The Update aimedto assess the progress inthat financial sector reform agenda, andidentifyremaining reformgaps andpriorities.2Ajoint IMF-WBteamvisitedthe KyrgyzRepublicfrom October See Appendix Ifor the status o f the keyrecommendations of the 2002 Assessment. * The full FSAPUpdatedocumentonwhichthis FSA is basedincludesthe Aide-MBmoire, summarizingthe Update's findings andrecommendations;TechnicalNotes onthe bankingsector, accessto finance, capital marketdevelopment, the insurancesector andpreconditionsfor a fundedpensionsystem; Factualupdatesofthe observanceofthe Base1CorePrinciplesfor EffectiveBanking Supervisionandofthe CPSS Core Principles for SystemicallyImportant PaymentSystems. .. 11 10-23, 2006.3Its findings and recommendations were thoroughly discussed with the authorities ina wrap-up sessionat the end o f the mission. The diagnosis and assessmento f the FSAP Update, and hence this FSA, are based on information as of October 2006. The key conclusion of the FSAP Update is that key challenges today pertain to the regulation, supervision and development of the non bank finance sector, and to access to finance. The National Bank o f the Kyrgyz Republic (NBKR) licenses, regulates, and supervises credit institutions. The SSSRFM, which was established in2005 to license, regulate, and supervise nonbank financial institutions (NBFIs), is inneed of substantial strengthening and the markets under its purvieware inneed of substantial development so as to facilitate increased intermediationand fastest private sector growth. Inaddition, solutions need to be investigated to increase access to finance, which is currently among the lowest in the world with less than 5 percent o fthe populationwith access to a bank account or borrowing. The Kyrgyz Republic FSAP Update team gratehlly acknowledges the excellent hospitality, cooperation and openness o fthe Kyrgyz authorities and technical counterparts. The FSAP Update mission was comprised o f T. Lybek (Chief, IMF), S. Sirtaine (Deputy Chief, World Bank), F.Kumah, J. Sold, P. Hayward (all IMF), S.O. Gonulal, E.S. Munoz, M.Noel, C. Pardo, H.Rudolph, and C. Segni (all World Bank). ... 111 Contents Acronyms .................................................................................................................................. iv IMacroandInstitutionalSettingforthe2006FSAPUpdate . .................................................. 1 I1.Financingto the Private Sector ............................................................................................. 2 Access to Finance .......................................................................................................... 3 I11 DevelopmentalIssuesinthe Banking Sector . ...................................................................... 4 IV.Special Credit Institutions ................................................................................................... 5 V. Capital Market...................................................................................................................... 6 V I. InsuranceIndustry............................................................................................................... 8 VI1 PensionReform . .................................................................................................................. 8 VI11 Payment Systems . .............................................................................................................. 9 IX.The Supervisory Framework ............................................................................................... 9 X. Conclusions......................................................................................................................... 11 Appendix I Detailed FSAP Update Recommendations. . ........................................................ 12 Appendix I1. Tables andFigures ............................................................................................ 13 Appendix I11 Autonomy. Authority. and Accountability ofthe NBKRandthe SSSRFM . ...17 Tables Table 1: SelectedEconomic Indicators. 2000-06.................................................................... 13 Table 2: Overview ofthe Financial System. 2001-06 ............................................................ 14 Table 3: Capital market development inthe Kyrgyz Republicinsom million(share of GDP); October 2006 ................................................................................................................... 15 Table 4: InsurancePenetrationinSelectedMarkets, 2005 ..................................................... 15 Table 5: Comparing the Institutional Aspects of Financial Sector Regulators ....................... 17 Figures Figure 1:Household access to credit. international comparison. 2005 ................................... 15 Figure 2: PensionCoverageRatio andPer Capita Income ..................................................... 16 iv ACRONYMS AML Anti-Money Laundering BCP Base1Core Principles for Effective Banking Supervision CAMEL Capital, Asset quality, Management, Earnings, andLiquidity CAR Capital Adequacy Ratio CFT Combating the Financingof Terrorism FCSDCU Financial Company for Support andDevelopment of Credit Unions FIU Financial Intelligence Unit FSAP Financial Sector Assessment Program FSSA Financial System Stability Assessment GDP Gross Domestic Product IAS InternationalAccounting Standards IFRS International Financial Reporting Standards (formerly IAS) ISA International StandardsonAuditing KAFC Kyrgyz Agricultural FinanceCorporation MFI Micro Finance Institution MoEF MinistryofEconomy andFinance MoU Memorandumof Understanding NBFI Non-Bank Financial Institution NBKR National Bank of the Kyrgyz Republic NDC Notional DefinedContribution NPL Non-Performing Loans ROSC Report on Observanceof Standardsand Codes RTGS Real-Time Gross Settlement SSSRFM State Service Agency for the Regulationand Supervision of Financial Markets ssc Settlement and Savings Company 1 I.MACRO INSTITUTIONALSETTINGFORTHE2006FSAPUPDATE AND 1. Since the 2002 assessment, the macroeconomicperformanceof the domestic economyhas beenmixedS4 2003-04, real GDP grew on averageby 7 percent per year, In butthe economy contracted in2005, as business sentiment weakened inthe aftermathofthe TulipRevolution andinflationincreased (Table 1). In2006, realGDP grew byjust under 3 percent, dampened by a gold mine accident. Non-gold output, however, grew by 5 percent facilitated by larger-than-expected capital inflows and migrant workers' remittances. Inflation was 4 percent inthe 12 monthsthat ended inMarch 2007. 2. The balanceof paymentshas also posedchallenges.The external current account deficit deteriorated to nearly 17 percent of GDP in2006 affected by a revision inthe statistical series on shuttle trade, buoyant imports, and a shortfall ingold exports but it i s expected to narrow to 12.5 percent o f GDP in2007. Internationalreserves increased to US$823 million (about 3% months o f projected2008 imports o f good and services) at end- March2007, reflectingpersistent capital inflows, which continue to pose challenges for liquidity management. The external public debt declinedfrom 78 percent o f GDP in2005 to 69 percent o f GDP in2006, when domestic public debt amounted to 6 percent o f GDP. Despite largely unsterilizedforeign exchange interventions, the som appreciated by 8 percent against the U.S.dollar during 2006, but the appreciation was only 1.3 percent inreal effective terms. The Kyrgyz Republic maintains a managed floating exchange rate regime. 3. The mainmacroeconomicrisks include: 0 Policyslippages.Recent political difficulties have resulted inpressure to boost sectoral spendingthat could result inunsustainable external borrowing. 0 A sharp deteriorationinthe terms of trade. An abrupt goldprice decline withinthe context o f highoil prices couldresult ina sharp depreciation o f the som and a decline indomestic demand. Lossofaccessto marketsinRussiaandKazakhstan,a decline in workers' remittances, or a reversal o f short-term capital inflows could yield similar effects. 0 Natural disasters.The Kyrgyz Republic is prone to earthquakes that could affect macroeconomic stability. 4. Severalmeasureshavebeentaken to improvethe environmentfor financial institutions,althoughadditionalefforts arewarranted for? 0 Greater consistencyand predictabilityinthe legalframework. The 2006 amendments to the Law on Conservation, Liquidation and Bankruptcy o f Banks, which had been drafted with assistance from internationalfinancial institutions, severely underminethe bank resolution process and could result in: (i) creation o f unlicensed banks; (ii) the rehabilitationprocedure bypassing the bankinglaw; and (iii) rehabilitationprocessbeingusedtobenefitshareholderstothedetrimentof the A three-year PRGF arrangementwiththe IMFwas approvedonFebruary23,2005 (EBS/OS/I19). The World Bank's 2006 DoingBusinessreportrankedthe KyrgyzRepublic in90" position, comparedwith 104 in 2005. 2 small depositors. The NBKRhas issueda regulationto temporarily mitigate the first two concerns. Such changes create uncertainty and can lead to inconsistent court decisions. However, according to market observers, thejudicial system still lacks an understanding ofthe working o f a market-based economy, integrity, and accountability.6 The NBKR should continue to conduct seminars for thejudiciary, ideally incoordinationwith the SSSRFM. A review o f administrativepractices also may be needed. e Improvedeffectivenessof the mortgageand pledgeregistries.Efficacy ofthe newly created registries i s reportedly limited by legal constraints and inefficient judiciary processes. e Strengthenedcreditor rightsand insolvencyprocedures.The authorities have requested a ROSC to identify remaining legal inconsistencies and weaknesses in enforcement. e Improvedimplementationof IFRS andInternationalStandards on Auditing (ISA). While banks follow these standards, the financial statements o ftheir borrowers are not always reliable especially given the shortage o f qualified and certified accountants. This forces banks to rely on collateralrather thanon the financial condition o f the b o r r o ~ e r . ~ e Corporategovernance.A new Law on Joint-stock Companies, adopted in2003 and substantially amendedin2004, had a number o f favorable effects: improved disclosure andtransparency requirements for share depositories, strengthened the role o f the auditing committee, clarified the authority o f the boardo f directors, defined newprocedures for the approval of large transactions, and introducedcumulative voting procedures for the appointment o fthe board. However, market observers claim implementationand enforcement remainweak. e Increasedeffectivenessof the credit informationbureau. The NBKRis already creating an in-house credit register for supervisory purposes, and banks shouldbe givenaccessto informationon clients' aggregated exposure to enhance their risk management, e Corruption.Against the backdrop of low wages anddespitemeasures adopted to curb its incidence, corruption remains an issue.' 11. FINANCING THEPFUVATESECTOR TO 5. The Kyrgyzfinancialsystem comprisesa broadrangeof financialinstitutions (Table 2). There are currently 21 active licensed banks, which are also doing leasing, and a large number o f non-bank credit organizations, mostly pawn offices, credit unions, andmicro finance institutions. The credit unions are supported by the Financial Company for Support 6 Accordingto the Investment Climate Assessment ofthe KyrgyzRepublic, 65 percentof companiessurveyed do not consider that the legal systemwouldupholdcontracts andpropertyrights inlegal disputes. 7 Small-andmedium-sizedenterprisesare givenuntil2009 to apply IFRS. 'In 2006, the KyrgyzRepublicranked 142 out o f 163 countries surveyedby TransparencyInternational. See also footnote 4. 3 and Development o f Credit Unions (FCSDCU). Two state-owned financial institutions providespecialized services: Ayul Bank (agricultural bank) andthe Settlement andSavings Company (SSC). The number o f insurance companies has declined to 13, which includes two newly established reinsurance companies, while there is only one private pensionfund. 6. Commercial banks accountfor the bulk of lending to the private sector, but their activities do not reach all segments of the market. Many corporations rely on their own sources for f~nding.~end-2006, total assets of banks and nonbank credit institutions At (including Ayul Bank) amounted to 25 and above 5 percent o f GDP, respectively. In2006, bank credit grew by 47.5 percent, reaching 11percent o f GDP at year end.Non-bank financial institutions (NBFIs) grew at a lower, although still substantial, rate o f 23 percent (or 32 percent excluding Ayul Bank).They have entered segments previously not catered to by banks, but many segments remainlargely under served (see below). 7. Financial intermediation is increasingbut remains relatively low, while the use of cash is significant. Cash incirculationincreased to 17.5 percent of GDP in2006, from 7 percent in2001. The recent appreciation of the som andthe expansion o f the grey economy, which market observers estimate at 40 percent o f official GDP, are contributing factors. The turnover inthe payment systemi s modest. In2006, som 182.2 billion (1.6 times GDP) cleared the existing payment systems. From 2001 to end-2006, financial deepening, measured by broadmoney inpercent of GDP, increased 2.5 times to 28.5 percent o f GDP, still relatively low compared with countries with similar income per capita. Access to Finance 8. Despite stronggrowth incredit to the private sector, access to the banking system remainsvery limited. Inabsolute terms credit to the private sector has increased four-fold from US$71 million in2002 to US$331million at mid-2006. However, the bank credit market i s still nascent, accounting for only 11percent o f GDP. Furthermore, banking sector loans are highly concentrated insome activities (e.g. trade and services) and segments o f the economy (e.g. large corporate andindividual borrowers), and are largely limitedto larger cities, leaving most o f the financial needs of SMEs and the poor unattended." 9. NBFIs are contributing significantly to increasingaccess to finance by smaller borrowers, but remain small in scale. NBFIsaccounted for 32 percent o f the formal financing providedto the private sector with an aggregate loanportfolio o f 4 percent o f GDP inJune 2006. Their credit outreach has expandedfrom 46,700 borrowersin2002 to 124,800 in2006, with anaverage loansize ofaroundUS$670 (excluding KAFC whichtargets larger borrowers). Over the past few years various types o f non-bank financial institutions (NBFIs) have enteredthe Kyrgyz market, including credit unions and microfinance institutions, and public entities such as the Ayil Bank (former Kyrgyz Agricultural Finance Corporation A 2004 World Bank survey found that internal funds account on average for 77 percent of the financing of fixed investments. loIn2002, agroup ofdonors inceptedthe Micro and SmallEnterpriseFinanceFacility, providingfimding on preferentialterms andtechnical assistanceto banks for the development of SME lending activities. The program has served more than 61,000 borrowerscountry-wide, in lower segments and sectors, including agriculture. However, it is highly donor dependentand does not target the lowest end ofthe Micro and SME segment. 4 KAFC).NBFIs' credit hasbeengrowing very fast, largely underdonor-supported programs, expanding outreach to smaller enterprises, poorer people, the agricultural sector and rural areas. 10. Overall, access to finance remainsamong the lowestinthe world and a central poverty reduction issue. With only 232,900 individual accounts for apopulationo f 5.1 millionpeople inJune 2006 and about only about 5 percent o f households with accessto borrowing, outreach inthe Kyrgyz Republic remains among the lowest inthe world. 11. The authoritieshavedone a lotto improvethe environmentfor NBFIsand encourage smaller scale lending. Inparticular, the financial architecture supporting credit decisions has been strengthened (including with the establishment o f a property registry, a credit bureau, an enhanced business registry, and upgrades increditor rights and insolvency laws - see paragraph 4), andthe legal framework for NBFIshas been improved substantially -butfurtherprogressisstillneededinalltheseareas. 12. Against this background,there is now a need to develop new solutionsto further expand access to finance. The authorities' efforts to increase outreach have beenadversely affected by the mountainous geography of the country, which makes it difficult and largely unprofitable for financial institutionsto reach large segments o f the population inremote areas, even inthe improved lendingenvironment. Since servicing clients through traditional channels (including branches, ATMs, etc) inthese sparsely populated areas i s not profitable, successful experiences inother countries o f alternative methods needto be explored, For example, Brazil uses retail platforms as correspondent bankers and delivers financial services through the post office network, while Southern African countries use o f mobile phone- banking. The use of the Kyrgyz Post office network as a platform for financial institutions to offer financial services inremote areas is worth exploring givenits penetration into all regions o fthe country. 111. DEVELOPMENTAL ISSUES SECTOR INTHE BANKING 13. The banking system is dominatedby foreign-ownedbanks,whichwarrants adequate collaborationwith foreign banking authorities. Foreign-ownedbanks account for about 7lpercent o f total system assets o f which 2.5 percent are subsidiaries o f foreign- mainly Kazakh-banks and 3.3 percent are branches o f foreign banks." The NBKR intends to improve its collaborationwith Kazakhstanwith the signingo f a. Nevertheless, the large share o f foreign owners pose special supervisory challenges, especially regarding due diligence o f the owners. 14. The maturity of the loanportfolio has increasedin recentyears through mortgages. Kazakhbanks' accessto long-term funding has helped develop an importantrole inlendingfor mortgages which nowrepresentsabout 20 percent oftotal loans, compared with only 4 percent in2002.'2The maturity of loans has increasedsignificantly, as 52.5 'IThe Kazakh banking system is much larger than the Kyrgyz one. At end-2006, total assets ofKyrgyz banks amounted to 2% percent o f assets o f Kazakh banks. l2There are no official indices for property prices. Anecdotal information suggests that certain segments o fthe market have increased 10-20 percent since last year. 5 percent o f all loans now have a maturity o f over a year (up from only 22 percent of total loans in2003). However, the maturity o f loans to other sectors remains very short overall. 15. The levelof dollarizationhasdeclinedsomewhatsince 2005, but banksand borrowersare exposed to indirect foreignexchangerisks.At end-2006, almost 70 percent of loans and deposits were denominated inforeign currencies. The indirect exchange rate risk, as experienced inthe aftermath of the Russian crisis in 1998, could be substantial. Some borrowers with foreign currency denominated loans may not have a reliable foreign currency income stream. Thus, the NBKRneeds to pay attentionto this issue andensure that banks adequately take this risk into account intheir credit analysis andpricing. 16. Bank lendingrates are market determined,but the presenceof several credit lines with subsidizedinterestrates introducesdistortions.Inparticular, Ayul Bank benefits from long-term concessional funding that has allowed it to lendat significantly below-market interest rates. Inaddition, consideration i s being givento subsidizing mortgage lendingto certain groups.l3Against this background, the FSAP team suggestedredirecting government policies toward strengtheningthe infrastructure for financial intermediation and ensuring that interest subsidies are targeted to vulnerable groups. Interest rates have declined since 2001,but gross interest rate spreads have remained at highlevels since 2003. This reflects the perceived credit risk, increased demandfor credit, as well as the level o f competition. Further measures to improve the credit culture would improve risk management on the part o f lenders, andtherebytend to reduce lendingrates.14 17. The NBKRis encouragedto continueimprovingitsstress testing. The NBKR, with the assistance ofthe mission, has fbrther developed its stress testingmodel.'' The purposes o f the model, originally built with the support o f the 2002 FSAP team, are to evaluate and monitor credit, market, and liquidity risks. The model complements the NBKR's CAMEL analysis carried out on a regular basis, functioning as an earlywarning system. The model simulates the impact o f single andcombined shocks on the capital adequacy ratio (CAR). Inaddition, a dynamic model, provided by the team, was usedto gauge the sustainability o f weaker banks. The NBKRi s encouraged to continue using both models inits oversight of the bankingsystem. The models could be developed further, including to better assess indirect foreign exchange risk. IV. SPECIAL CREDIT INSTITUTIONS 18. Ayul Bank and SSC fillsome of the intermediationgap, but their planned privatizationsneedcareful preparationbeforepossibly grantingthem full-scale l3The authorities are contemplatingestablishing a "Development Fund"to boosteconomic development.The experiencewith state-owneddevelopmentbanksanddevelopmentfhds hasbeenmixed.Beforeestablishinga developmentfund, the following shouldbe clarified: (i) the criteria for selectingprojectsto finance, including how to prevent subsidizedcredit from distortingthe market; (ii) the funding sources; (iii) the governance framework andaccountabilitystructure; (iv) the prudentialframework to be applied; and(v) the formal responsibilityfor overseeingthe Fund. l4Adverse selection-the fact that moreriskyprojectsable to offer ahigherexpectedreturn crowd out less riskyprojects-would be reduced. l5See Appendix I1for a detailedreview o f the stress testingof the Kyrgyzbankingsystem. 6 banking licenses. This would prevent these institutions from taking on new, riskier business that could detract from their value. Ayul Bank, which specializes inagricultural lending, was givena limitedbanking license at end-2006.l6As part of the agreement with international financial institutions, the government is working on different options for Ayul Bank's privatizationalthough the end-2006 deadline was missed.It i s recommended that Aiyl Bank be privatizedby tendering all, or a majority of, the shares currently heldbythe government to a strategic investor or a consortiumo f investors ledby a strategic investor with a track record inrural development. The SSC was established to provide payment and savings services throughout the country, particularly inremote areas." Its license has been expanded to allow limited lending activities to microfinance institutions. New activities involve new risks that require changes inrisk management systems and strong monitoring by both the management andthe owner. 19. The legalframework for microfinanceinstitutionsis beingimproved. A Law on Microfinance Organizations enacted in2003 formalized microfinance activities, recognizing MFIsas financial institutions under three different legal forms, subject to different regulatory requirements and supervisionprocesses.'* MFIshave grown rapidly over the past few years and currently have a significant position inthe financial system. By mid-2006, MFIs accounted for around 13 percent o f the total credit provided by the financial system. Appropriately, MFIs are allowed to take deposits only when they follow strict prudential req~irements.'~However, a restrictioninthe ownership o f deposit-taking MFIs (requiring them to have at least 5 shareholders, each owning a maximumo f 20 percent o f the MFI's capital) remains an obstacle to further development o f the sector. 20. Credit unionsplay an important role inproviding finance to small borrowers in rural areas but the sector needs consolidatingand strengthening. The sector has been growing at more than 33 percent per annumsince 2003. Its loan portfolio, however, i s still relatively small and accounts for roughly 5 percent o ftotal credit provided by the financial system.Many credit unions are financially weak, and efforts are neededto close, or perhaps merge, unsustainable unions with more viable entities. The credit unions' mother company, the FCSDCU-a subsidiary oftheNBKR-provides credit unions with subsidized funding, centralized services, training, andtechnical assistance. The authorities are appropriately aiming at the mutualizationo fthe FCSDCU only whenthe financial position o f the credit unions i s sufficiently strong and the FCSDCUhas strengthenedits own capacity. V. CAPITALMARKET 21, With the exceptionof a well-functioning rep0 market, the Kyrgyz capital market i s nascent. The market for government securities i s limitedto short maturities and other l6 Its funding has so far beenhighly dependentonconcessionallong-termloans from the WorldBankandthe EuropeanBank for ReconstructionandDevelopment. l7 Withthe widest network(50 branchesand 54 additionalpoints of service), the SSC serves about 75,000 individualdepositors. l8 The three forms are microcredit agencies,microcredit companies, andmicrofinance companies. Licenseto raise depositsrequire minimum capitalrequirements,whichare beyondthe meansofmostmedium andsmallMFIs.At the same time, regulationlimiting shareholdingindeposit-takingMFIsmakesthis option unappealingto largeMFIsthat are ownedandcontrolledby a single entity-foreign donors inall cases. 7 securities markets are insignificant. Government securities outstanding amounted to Som 5.5 billion(US$125 million) or 5.5 percent of GDP on October 1,2006 and secondary market turnover amounted to 5.6 percent o f GDP inthe first nine months of 2006. The treasury bill market has grownrapidly since 2001, reaching som 1.3 billion at end-2006. Yields have declined steadily from 21 percent to 8 percent duringthis period, reflecting increased confidence o f market participants. However, banks are the dominant investors andmarket liquidityis limited.Besidestreasury bills,NBKRholds a portfolio ofde facto non- marketable restructuringgovernment securities amounting to som 4.2 billion Corporate bonds outstanding amounted to 0.2 percent o f GDP on October 1,2006, with no secondary market.There have beenno issues ofmunicipal bonds or asset-backed securities to date. Stock market capitalizationamounted to 1.5 percent o f GDP inOctober 2006, while turnover inthe formal exchanges(excluding over-the-counter (OTC) trades) amounted to 0.1 percent o f GDP inthe first ninemonths o f 2006. The institutional and retail investor base i s insignificant and confidence insecurities i s weak. The assets o f insurance companies reached Som 145 million (US$3 million) at the end of June 2006. Other institutionalinvestors are equally limited, with five active investmentfunds with assets fluctuating betweenSom 10to 11million(US$0.23 to 0.25 million) between2002 and 2005. Only one private pensionfund i s inoperation, with assets under management amounting to Som 7 million (US$ 0.16 million). Public confidence ininstitutional investors i s low as a result o f the fraudulent bankruptcies o f several investment funds and o f an insurance company inthe nineties (see Table 3). 22. The governmentis facingseveralchallengesindevelopingthe capital market. A strategy for the government bond market, while taking into account macroeconomic imbalances, should be developed. For instance, reopeninglonger maturities as they mature andreducing the number of auctions would allow for fewer but larger and more liquidissues. However, volumes are small and creating benchmarks will be difficult. Plans for introducing mortgage bonds require developing the legal and regulatory framework for asset-backed securities. Fiscal decentralization necessitatespreparingthe legal and regulatory framework for municipal borrowing, while ensuring fiscal control. Inaddition, deficiencies inthe legal andregulatory framework for corporate bonds, andtax treatment of income earnedon various financial instrumentsmay create some distortions. As discussed below, priority should be given to strengthenthe prudential framework and its enforcement for nonbank institutional investors as well as the stock exchanges. 23. The modestsize of the three stock exchanges suggeststhat they shouldmerge and consider collaborationwith a regionalexchange.The markets are thinand illiquid, althoughtrading activity i s increasing. Most equity trades take place over-the-counter and are registered ex post, resultinginpoor price discovery. Against this background, the costs and benefits o f developing the local stock exchanges should be considered. 24. International standards shouldbe met before moving the depositoryfor treasury bills from the NBKR to the envisagedcentral depository. The authorities are considering establishing a centralized depository. The NBKR i s currently incharge o f organizingthe weekly auctions oftreasury bills, the trading system, andthe depository. Treasury bills have gained the confidence o f the market. The four depositories o f other securities are relatively small and go largely unsupervisedand unaudited. A merger o f these depositories seems appropriate. Movingthe depository for treasury bills from the NBKRto the envisaged centralized depository, however, entails operational and reputational risksthat could 8 complicate the implementationof monetary policy. This depository should therefore only be moved, when the new depository observes international practices.20 VI. INSURANCE INDUSTRY 25. The insurancesector is underdevelopedrelativeto itspotentialandcompared with neighboringcountries.At end-2006, 13 insurance companies were licensed. Only two companies are engaged inlife insurance andtwo reinsurance companies are newly established. In2006, total insurance premiumsamounted to 0.13 percent o f GDP, o f which non-life accounted for 99.7 percent.21The low insurance penetration reflects low per capita income, the income distribution, limited understanding o f insurance products, low public confidence inthe sector, and supervisory weaknesses. 26. Beforea potentialexpansionof the market,thoughcompulsory insurancefor instance,priority shouldbe givento improvingthe regulatorysupervisory framework. Requests by the industry to make several lines o f insurance compulsory should not be addressedbefore the regulatory framework and supervisory practices have been strengthened. Also, an appropriate reinsurance regulation i s necessary as the Kyrgyz insurance sector has limitedretentioncapacity with a high dependence on reinsurance (in 2006, about 53 percent o ftotal insurance receipts have beenreinsured, of which 51percent abroad). Inaddition, the absence o f financial informationand disclosure to the public preventseffective marketdiscipline and limitscompetition. The SSFRFMshould start building a data base o f information on the insurance sector andpublishtimely annual and quarterly statistical bulletinsso that marketplayers operate withadequate sector information. VII. PENSIONREFORM 27. The "pay-as-you-go" (PAYGO) system couldbe enhancedand avoluntary funded pillar establishedbefore contemplatingthe creationof mandatoryprivatefunds. The 1997 pension reform has broadly achieved its goals, but the level and coverage o f pensions remainlow. The level o f salaries; the fiscal position, which leaves little room to finance the highcost o f a pension reform or to provide adequate tax incentives; the modest size o f the capital market; andthe current legal and regulatory framework as well as market practices for capital market intermediaries do not ensure the prudent operations o f private pensionfunds.22Significant strengtheningo f the SSSRFM would be neededto cope with a further pension reform, the domestic capitalmarketwould also needto bemore developed, andthe fiscal capacity to bearthe cost o fthe reformwould needto be substantially increa~ed.~~ As an interim step, however, consideration could be givento (i) enhancing the 2oSpecifically, the Recommendationsfor Securities Settlement Systems issuedin2001by the Committee on Payments and Settlement Systems and the Technical Committee o f the International Organizations o f Securities Commissions; and the Central Bank Oversight ofpayment and Settlement Systems issued in2005 by the Committee on Payment and Settlement Systems should be used as guidance. 21In2005, insurance penetration(premiums inpercent ofGDP) was 1.03 percent inKazakhstan, 0.40 percent in Uzbekistan and Georgia, and 0.20 percent inArmenia, according to SIGMA and Axco reports - see Table 4. 22The current supervisory framework for private pension funds should be enforced, or the existing private pension fundshould be converted into an investment fund. 23See Appendix IV for preconditions for a fully funded pension system inthe Kyrgyz Republic. 9 current PAYGO system, inparticular by establishing inthe law an indexationmechanism andby reducing the transitionperiod; and (ii) supporting a voluntary fundedpillar; both subject to fiscal constraints. Although it i s possible to make improvements at the margin, the coverage ratios are directly correlated with the degree of economic development (Figure 2). VIII. PAYMENT SYSTEMS 28. Basedon the 2002 FSAP,the NBKR and the governmentlaunchedthe ambitious "NationalPaymentsSystemReform"in2004. The mainobjective was to "build a cashless society" through the implementation of a modern, fully automated, integrated, and secure payment system capable o f handlingthe increasing number o fpayments. The NBKRhas initiatedwork on: (i) a bulk clearing system for small value transactions, which became operational inOctober 2006; (ii) a modernRTGS systemfor large and time-sensitive payments, which i s expectedto be fully operational inearly 2008; (iii) a card production, issuance, and clearing system to support an interoperable bank-shared card system; and (iv) a newNBKRgeneral ledger. Inparallel, the government has initiated the "Treasury Automation Program," which would enable itto process all fiscal and quasi-fiscal payments through the banking system. 29. The reformsledto substantialprogressinpaymenttransactions and to upgrades ina numberof CPSSprinciples.These changeshave eliminatedthe potentialfor delays in the settlement ofpaymenttransactions acceptedfor processing. They also allow for upgrades o f a number of Core Principles for Systemically Important Payment Systems. Implementationo fthe new RTGS systemalong with the related legal andregulatory improvements i s expected to result infull compliance with these principles by early 2008. IX. THESUPERVISORY FRAMEWORK 30. The newlyestablishedagency responsiblefor NBFIregulationand supervision, the State ServiceAgency for Supervisionand Regulationof FinancialMarkets (SSSRFM), is inneedof strengthening.InSeptember 2005, the State Commission on Securities Markets, incharge o f the supervision o f securities markets and investmentfunds, was merged with an agency within the Ministry o f Economy and Finance (MOEF), incharge o f developing and regulatinginsurance andprivate pensions, into a newly established Agency, the SSSRFM (hereafter "the Agency"). The newly established Agency faces significant institutionaland supervisory challenges, which must be addressedto enable the sustainable and sound development o f the markets it regulates and supervises, and which have a key role to play inthe economy. Inparticular, the FSAP Update recommendedthe following main actions: e Strengthenthe Agency's legal authority, ensuringits political independence and securing its financial autonomy and accountability; e Tighten the Agency's licensing criteria and procedures for all financial intermediaries; and strengthen its on-site and off-site supervision capacity; and its enforcement powers; e Improvethe insurance sector regulatory framework and build an insurance sector data base; develop and implementa government debt management and debt market 10 development strategy; develop and implement the legal and regulatory framework for new insurance and capital market products; e Strengthen stock exchange governance and streamline market infrastructure. 31. The legal basis of both regulatory and supervisory authorities should be ~trengthened.~~ The legalbasis o fthe SSSRFM, which is established by a government regulation, i s inneedo f significant strengthening.The SSSRFM should be supported by a law that ensures its authority, independence from political and industryinterests, while giving it some financial autonomy (to be able to pay adequate salaries andattract andretain competent staff), andbeingheld accountable for performing its objectives and tasks effectively and efficiently. But eventhe central bank law should be amended to provide legal immunityto NBKRsupervision stafffor actions takeningoodfaith while discharging their duties.25Bothinstitutions are frequently overruledby courts, inpart due to legal inconsistencies. 32. Scarce supervisory resources should be used to strengthen the current framework instead of considering a new framework. The NBKR licenses, regulates, and supervises credit institutions, payment systems, pawn shops, and exchange bureaus. The SSSRFM licenses, regulates, and supervises insurance companies, pensionfunds, stock exchanges, auditing operations, licenses the gamingindustry, and i s responsible for monitoring accounting and auditing standards. There have beendiscussions on moving banking supervision to the SSSRFM to establish integrated supervision. This would likely detract resources from effective supervision o f the largest segmento fthe financial system in the short run.The NBKR should continue supervising credit institutions, while the SSSRFM should give priority to its immediate supervisory responsibilities, since one failed financial institution could quickly underminethe SSSRFM's well-intendeddevelopment strategies.26 However, a MoUbetween the SSSRFM andthe NBKR should be signed to facilitate collaboration, for instance inthe area o f licensing, information sharing, and establishing guidelines for becoming the lead supervisor when financial conglomerates emerge. 33. The SSSRFM needs to further develop the prudential framework as well as its supervisory practices. The capacity o f the SSSRFM to carry out licensing, supervisory, and enforcement responsibilities needs strengthening. The legal andregulatory framework underpinningthe prudential supervision, good governance andtransparency for NBFIsneeds improvement. Inaddition, the capacity o f the SSSRFM to adequately enforce the regulation needs to be strengthened, starting with licensing criteria, and an adequate of-site and on-site supervision program and strong risk-based analyses o f the financial informationo f intermediaries needto be developed. Technical assistancewill be necessary to upgrade the technical knowledge and skills, bothregardingthe development o f proper prudential 24 See Appendix V for a comparisonof the autonomy andaccountabilityof the NBKR andthe SSSRFM, respectively. 25The central bank law shouldalso be amendedto ensure consistency with IFRS, while ensuringthat only realizedprofits canbe transferredto the government. 26 Iti s expectedthat the responsibility for overseeingpawnshops will be movedfrom the NBKRto the SSSRFM. 11 regulation and implementationand enforcement practices, for instance via amulti-year twinning arrangementwitha supervisory authority from an OECD country. X. CONCLUSIONS 34. A numberof developmentalissues inthe Kyrgyzfinancialsystem resultinlow intermediationand a lackof financialsector support to privatesector growth. The inability o fthe banks and ofNBFIsto increase their outreach to underserved regions and sectors, lower income classes and smaller enterprises needs to be addressedwith innovative solutions enablingto reduce the cost for formal institutions to reach out to these underserved clients. The use of an existing network such as that o f the Kyrgyz post office may be considered. The limited development o f the capital markets and o f insurance further limits the range offinancing andsavings instruments available, anddo notplay the role they could insocial protection. A starting point for their sound development would bethe strengthening ofthe legal, regulatory and supervisory framework for these industries. The government has requested the Bank's assistance to help increase access to finance and strengthen the regulatory and supervisory framework for NBFIs and attract other donors' potential assistance inthese areas. 12 APPENDIXI.DETAILEDFSAPUPDATE RECOMMENDATIONS Measure description Proposed Timing Non bank financial supervision: 0 Develop licensingand supervisory practices, along with enforcement capacities, via increasedAs soon as possible technicalassistance, ideally through atwining arrangement with anexperienced foreign supervisor. 0 Agree on a MoUbetweenthe NBKRandthe SSSRFM. 2007 0 Establishthe SSSRFM by law, clarifying its objectives, authority, autonomy (both political End-2007 and financial), while making it accountable for performing its functions effectively and efficiently. Capital market: 0 MaketheNBKRrestructuringbondsmarketablewithout endangeringthe credibility ofboth 2007 the NBKRandthe Ministry of Finance (MoF). 0 Develop a public debt strategy (MoF andthe NBKR). Mid-2007 0 Establisha centralizeddepository observingbest internationalpractices. 2007-2008 0 Movethe depository for government securities withintheNBKRto the envisagedcentral Ongoing depository only when the necessarypreconditionsare inplace. 0 Promote adequate implementationof IFRSand ISA. Ongoing 0 Encouragethe stock exchangesto merge and consider collaborationwith a regional Ongoing exchange. 0 Developthe legalframework for securitization. Medium term 0 Develop a legal fiamework for municipalbonds. Medium term Insurance market: 0 Issue pendingregulationsto support the insurance legislation. As soon as possible 0 Establishrequirements for reportingand disclosure. As soon as possible 0 Undertakemore active supervisionand implementationofthe prudentialframework. 2007 0 Initiate mandatoryinsuranceonly after the prudentialframework is inplaceandeffectively Only whenready supervised. Private pension funds: A filly fundedmandatorypillar is yet premature, hence: Mediumterm 0 Strengthenthe existingpillar; Medium term 0 Consider developing a voluntary pillar. Privatization of public financial institutions: 0 Address pendingissues for privatization of Ayul Bankwith technical assistance. As soon as possible Do not further expandAyul Bank's bankinglicense prior to its privatization. Ongoing 0 Do not firther expand SSC's bankinglicense prior to its privatization. Ongoing 0 Encourage credit union consolidationand strengthening, and strengthenthe FCSDCU's 2007 capabilities. 0 Mutualize the FCSDCU only when the sector has consolidatedand is self-sustainable. When ready Access to finance: 0 Consider new solutionsto further increase intermediationand financial deepening (such as Ongoing relying on cheaper or existing distribution networks). 13 APPENDIX11. TABLES AND FIGURES Table 1: Selected Economic Indicators, 2000-06 2000 2001 2002 2003 2004 2005 2006 Actual Actual Actual Actual Actual Actual Prel. NominalGDP (inbillionsof soms) 65.4 73.9 75.4 83.9 94.4 100.9 113.2 RealGDP (growth inpercent) 5.4 5.3 0.0 7.0 7.0 -0.2 2.7 GDP per capita (in U.S.dollars) 278 308 322 381 435 477 542 Consumer prices(percent change, eop) 9.6 3.7 2.3 5.6 2.8 4.9 5.1 Unemploymentrate 7.5 7.8 8.6 8.9 9.0 9.7 ... Povertyrate (consumptionapproach) 62.5 56.4 54.8 49.9 45.9 44.0 ... Investmentand savings (in percento f GDP) Investment 20.0 19.6 20.3 20.5 20.8 21.6 23.4 Public 8.1 5.3 6.1 4.8 4.9 4.8 4.5 Private 11.9 14.3 14.3 15.8 16.0 16.8 18.9 Savings 15.7 18.1 15.3 16.4 17.4 19.3 6.6 Public -2.4 -0.5 -0.2 -0.9 -0.1 0.6 2.0 Private 18.1 18.6 15.5 17.3 17.5 18.7 4.6 Savingshnvestmentbalance 4.3 1.5 5.0 4.1 3.5 2.3 16.8 Generalgovernment finances(in percentof GDP) 1/ Overallfiscal balance(cash basis) -9.2 -5.2 -5.6 -4.9 -4.4 -3.7 -2.3 Primaly balanceexcludinggrants -8.5 -4.4 -5.1 -3.9 -3.1 -2.2 -1.4 Bankingsector Netforeignassets (percentchange, eop) 37.9 32.2 42.2 50.0 108.7 20.1 50.6 Netdomestic assets(percentchange, eop) 34.3 -12.7 35.5 5.8 -52.3 54.5 68.7 Creditto privatesector (inpercentof GDP) 4.2 3.8 4.0 4.7 7.0 8.0 11.0 Broad money (percentchange, eop) 11.9 12.2 35.1 34.5 33.6 25.5 54.1 Velocity o fbroadmoney 2/ 8.9 9.4 7.0 6.0 5.6 4.7 3.8 Interestrate 3/ 51.9 33.2 24.8 23.0 24.3 25.7 23.5 External sector Current accountbalance (in percent o f GDP) -4.3 -1.5 -5.0 -4.1 -3.5 -2.3 -16.8 Export o f goods and services (million USD) 573 561 640 745 943 942 1,158 Export growth(percent change) 8.6 -2.1 14.2 16.4 26.0 -0.1 22.9 Import o fgoods and services (million USD) 656 591 756 875 1,127 1,397 2,223 Import growth (percent change) -7.1 -9.9 28.0 15.7 27.6 23.9 59.1 Gross official reserves(million USD)4/ 206 230 317 359 544 609 817 Gross reserves(months of imports, eop) 4.2 3.6 4.3 3.8 4.7 3.3 3.9 External public debtoutstanding(inpercento fGDP) 5/ 111 100 82 92 88 78 69 Debt service-to-exportratio (in percent) 5/ 11.6 12.6 10.2 15.7 6.4 7.3 5.5 Memorandumitems Exchangerate (somsper U.S.dollar, average) 47.8 48.4 46.9 43.7 42.6 41.0 40.1 Realeffectiveexchange rate, Index (1995=100) 6/ 69.0 72.2 74.2 73.7 72.0 72.8 73.6 l/Fundstaffadjustments. 21 12-monthGDP over end-period broad money. 3/ Weighted average interestrate on som- denominated loans. 4/ Gross reservesexclude internationalreserves of the NBKR that are pledgedor blocked. 5/ Excludingobligations of the Kumtor gold mine. 6/ An increasemeansan appreciation. 14 Table 2: Overviewofthe FinancialSystem, 2001-06 End-2001 End-2002 End-2003 End-2004 End-2005 End-2006 Number of institutions Banks 11 21 20 20 20 21 21 22 Non-bank credit institutions and exchangeofices 609 724 746 793 864 886 AyulBank 21 1 1 1 1 1 1 FCSDCU 1 1 1 1 1 1 Exchange ofices 265 288 261 266 265 263 Pawn shops 64 85 108 116 141 148 Credit unions 278 349 303 305 320 305 Micro-finance organizations 72 104 136 168 Securities companies 53 58 62 63 58 Pension funds 31 2 2 2 2 2 2 Insurancecompanies 41 24 23 15 12 12 13 Assets inpercent of GDP Banks: 6.8 10.4 13.5 18.8 21.7 25.0 Locally incorporatedbanks: 21 6.6 10.0 13.0 18.2 21.4 24.2 Private commercial 3.4 2.4 2.6 3.3 4.6 6.3 State-owned 0.9 1.o 1.o 0.8 1.o 0.8 Foreign-ownedbanks 5/ 2.2 6.6 9.5 14.2 15.7 17.0 Branches of foreign banks 0.2 0.4 0.5 0.5 0.4 0.8 Non-bank credit institutions, excl. exchange ofices 1S 2.0 2.7 3.5 4.3 5.3 AyulBank 21 1.o 1.5 1.6 1.6 1.7 2.0 FCSDCU 61 0.2 0.2 0.3 0.3 0.4 0.3 Credit unions 6/ 0.3 0.3 0.3 0.5 0.6 0.6 Micro-finance organizations 61 0.0 0.0 0.5 1.1 1.7 1.8 Insurance companies, gross premium in percentof GDP 7/ 0.18 0.19 0.18 0.20 0.13 0.13 Market capitalization, percent o f GDP ... ... ... 3.0 ... 1.5 Commercial banks ... inpercent of labor force ... Insurance companies ... Trading (value) at the three stock exchangesinpercent of GDP 8/ ... ... ... ... 1.6 3.7 Turnover inpayment systems, times GDP 0.97 1.01 1.15 1.41 1.44 1.61 Currency incirculation, percent of GDP 7.0 9.4 11.1 12.1 13.3 17.6 Broad money, percent of GDP 11.1 14.6 17.5 20.5 21.1 28.5 Sources: National Bankof the Kyrgyz Republic and the StateAgency for Financial Supervision and Reporting. 11 From July 2002 temporary administration was introducedonCABCD Branch from Kazakhstan and from September 2004 Ak Bank was brought under conservator ship. The total number ofbank brancheshas increasedfrom 149 inDecember 2002 to 172 at end-2006. 21 The KAFC was given a limited banking license and changednameto "Ayul Bank" on December 26,2006. It is not included inthe 2006 figures for banks. 31 Including the state pension fund. There i s only one private pension fund, which was establishedin 1994. It has 876 members as o f end-June2006, of which 185 receive apension. 4/ In2006, the number of insurance companiesinclude two newly establishedreinsurance companies. 51 In 2006, the 9 foreign-owned banks included4 subsidiaries of foreign banks. Their assetsamountedto 5.7 percent of GDP or 22.6 percent of total banking assets. 61 Asset figure from end-September2006. 71 In 2006, the share of life insurancepremiums remained low-only 0.3 percent of total premiums. About 53 percent of total premium receipts were reinsured, o f which most-5 1Kpercentagepoints-were reinsured abroad. SI Reported trading at the three stock exchanges: KyrgyzStock Exchange,Exchange TradingSystems,and Central Asian Stock Exchange. 15 Figure 1:Householdaccess to credit, internationalcomparison, 2005 Source: MeasuringFinancial Access, The World Bank, Financial Sector, 2005. Note: Showspercentageof households who reportedborrowedmoney inpast 12months(LSMS surveys concept, cf. Claessens, 2005) plotted against averageliving standards. Table 3: Capital market development inthe Kyrgyz Republic in som million (share of GDP); October 2006 Government Securities Comorate Bonds Eauities Outstanding 5,503 (5.5%) 1/ 234 (0.2%) 1,500 (1.5%) 2/ Volume traded (2006 9 months) 5,651 (5.6%) N a 162(0.1%) 1/ includingrestructuring bonds 2/ based on ADB 2004 estimate o f capitalization ofthe most actively traded companies on the stock exchanges) Sources: NBKR, MOEF, ADB, KSE and ADB Table 4: Insurance Penetration in SelectedMarkets, 2005 Premium Volume Insurancepenetration Insurancedensity Population (US$million) (Premium inpercent (Premiumper capita) (Million) of GDP) 6) Kazakhstan 505.0 1.03 19.28 14.8 Uzbekistan 32.6 0.40 1.25 26.4 Georgia 32.0 0.40 5.25 4.2 Armenia 7.5 0.20 2.28 3.2 Kyrgyz Republic 3.4 0.20 0.80 5.2 Source: SIGMA and Axco reports. 16 Figure 2: PensionCoverageRatio andPer Capita Income CovemgeRatio andPerCapita Income (PPP) 120 100 80 60 40 20 - m Latin America ACentral and EasternEurope+ High IncomeOECD Other 0 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 Source: World Bank staffestimates 17 APPENDIX111. AUTONOMY,AUTHORITY, AND ACCOUNTABILITY OFTHENBKRAND THE SSSRFM Theregulationand supervisionofthe financialsector is carriedout by the NBKRandthe StateAgency for FinancialSupervisionand Reporting(SSSRFM). The NBKRis incharge ofregulatingall deposit taking institutions, as well as Ayul Bank (formerly KAFC), credit unions, microfinance institutions, lombards (pawn-shops), and exchange bureaus. On the other hand, the SSSRFM has the mandate to regulate pension funds, insurance companies, andthe securities market. The SSSRFM is also incharge o f overseeing the introduction and application o f internationalaccounting and reporting standards by legal entities inthe Kyrgyz Republic. It also regulates banks inmatters related to the issuance o f securities. Severalfactors impingeon the independenceand efficacy of the two regulatory agencies, but particularly the SSSRFM. Regarding the NBKR, amendments to the Law on the NBKR are currently stalled inparliament. These amendments would make the Law on the NBKR consistent with IFRS as well as grant its employees legal protectionwhen dischargingtheir duties ingood faith. The SSSRFM does not currently have its own budget - financing i s through the state budget-and the number o f its personnel seems insufficient and inadequately trained giventhe scope o f its mandate (technical staff o f 78 and clerical staff o f 14). These factors severely limit its efficacy. Presently,there is little and infrequentcooperationbetweenthe two agencies. Thetwo institutions have not signeda memorandumofunderstanding (MoU)formalizing the modalities through which cooperation and exchange o f information i s to be carried out. Table 5: Comparingthe Institutional Aspects o f Financial Sector Regulators27 NBKR'~ SSSRFMZg Objectives a) Are they clearly defined a) Yes. Primary objective a) Broadly defined (art. andprioritized? i s to attain and maintain 11.2), such as create price stability (arts. 2, 3) conditions for stable and ensure the growth; improve effectiveness, safety, and investment climate by reliability o fthe banking developingthe financial and payment systems. market; financial reporting and auditing system. Specific functions are defined in art. 111.1* 27Information based on the current Law on the National Bank of the Kyrgyz Republic o f 1997, and the current Regulations of the StateAgencyfor Financial Supervision and Regulation, approved by Government Resolution No. 419 o f September 30,2005. References to legislation is to the Law on the NBKR, unless otherwise indicated. This column mainly focuses on banking supervision, although the NBKR also supervises other non-bank financial institutions. 29References to legislation is to the Government Resolutionon the SSSRFM, unless otherwise indicated. This Resolution was issued following a Presidential Decree. 18 SSSRFM" b) Are they potentially b) Law onNBKR (art. 4 b) Potentialconflict with contradictory? and 30) andLaw on the NBKRregarding Banking (art. 40) clearly supervisionofnon-bank stipulatethat the NBKR institutions(arts. 1.1, will regulate and 111.1.3.6 and 1.3.8). supervisebanks. Law on NBKRstipulatesthat the NBKRshould license pawnshop activities(art. 4) Institutional a) Nominatiodappointment a) Chairman appointed a) Chairman appointed Independence ofboardandmanagement anddismissedby and dismissedby (Refers to the agency's Presidentwith consent of President, members of status as a separate parliament;other 8 board executive council entity from the rest of members appointed by appointedand dismissed the executive, Presidentat Chairman's by Prime Minister (art. legislative, and proposal(art. 39) VI.1) judiciary branches) b) Tendstaggeredterms b) Terms are for 7 years b) Not statedin renewable up to 3 times regulations, but practice (art. 39). is that boardmembers appointedfor an undeterminedperiod. c) Legislation reducing c) Art. 45 limits the c) Agency constitutedby potential conflicts of political activities ofNB's governmentalregulation interest? Boardmembers, but not (not Law), weakening its financial. The NBKRhas legalstatus and making a code of conduct. it susceptibleto government interference. Agency must follow directions of the President, and resolutionsand directions fiom government (arts. 1.2and VI.2.x). Boardmembers cannot belongto political parties(as per Civil Servants Law). There are no financial limitations, but must follow the rules for civil servants. Regulatory a) Refers to the abilityto set a) Yes (arts. 4.5,4.7,7, a) Yes (art. 111) Independence secondary (technical) 30.2.1, and art. 39 on the legislation,rules, and Law on Banking) regulationsindependently. b) Ability to make decisions b) Yes (arts. 30,32, and b) Ineffect no, as it may on individual institutions arts. 39.2,45.1,46, 47,48 follow government without third-party inthe Law onBanking). instructions (arts. 1.2and interference. VI.2.X). c) Do court appeals delay c) Appeals occasionally c) Court appeals are implementationof revokeNBKR often lost due to weak instructions? instructions,evenwhen judiciary system. banks are clearly insolvent. 19 NBKR~~ SSSRFM" Supervisory a) Legal protection for a) Supervisors lack formal a) Supervisors lack legal Independenceand supervisors? legal protection in protection inexecution Authority execution oftheir duties o ftheir duties ingood (Refers to the ability (proposed amendments to faith. to act fteely inmatters the Law onthe NBKR o f licensing, address this issue) ingood supervisiodinspection, faith. sanctioning, and crisis b) License according to b) Yes (arts. 13-17 inLaw b) Not explicitly stated management) objective criteria? onBanking, and inthe Regulations supportive-regulations). c) Check indirect owners? c) Yes (art. 30.2.2, and c) Yes (art. IV.1.ix) art. 14.4 inthe Law on Bankingand Regulations on Licensing). d) Obtain information from d) Yes (art. 30.2.3) and d) Yes (art. IV.1.iito iv, supervised entities art. 43 hLaw on . and IV.1.xiv) Banking. e) Obtain information from e) Partially (art. 30.2.3) e) Yes (art. IV.1.iiiand external auditors and art. 59.2 inLaw on iv) Banking. f) Ability to make on-site f) Yes (art. 30.2.2) and art. f) Yes (art. IV.1.iv and v) inspections? 42 inthe Law on Banking. g) Enforcement powers g) Yes (art. 32) and arts. g) Can impose penalties (impose penalties, sanctions, 39.2'49.6 inthe Law on and sanctions (art. restrict activities, and revoke Banking. IV.1.xxviii); can restrict licenses)? activities and revoke licenses (arts. 111.1.2.6 andIV.1.xv to xx). Budgetary a) Financing o f supervision a) NB has some budgetary a) Agency's budget is Independence (fees, budget, etc.). autonomy (art. 6.1 and determined by the (Refers to the role o f 13.6). Inprocess ofbeing Republican Budget (art. executiveAegislative amended to ensure VIII.7). Agency has the branch indetermining consistency with IFRS. rightto raise agency's budget Regulated entities pay commissions from (including staffing and small licensing fee (som regulated entities, salary levels).) 300). although currently no funds are obtained inthis manner (arts. VIII.5 and 6) b) Salaries at levels o f b) Supervisors' salaries b) Supervisors' salaries supervised institutions? are much lower than those are generally lower than o fregulated institutions. salaries at the NBKR. c) Access to additional c) Accumulated reserves. c) Depending on funds duringcrises. Republican Budget (art. VIII.7) Conflict Resolution There is a clear and open The NBKRis an There is no pre- process to resolve policy autonomous institutions established procedure. Zonflict between supervisor that "shall independently Conflicts would typically mdgovernment arrange and engage in its be resolved inthe regular activities" as stipulated in court. the Law on the NBKR [art. 6) 20 NBKR~' SSSRFM2' Accountability, a) Accountabilityfor a) Yes (art. 11 or 10.2.2). a) Current practice is for Transparency, and policies(reportingto Annual Reportonthe the Agency to report Reporting governmentllegislative, NBKR's activities, policy quarterlyto the executive policystatements,and statements,andworking on policystatementand annual reports andtheir planfor the Boardare strategy. Reportis publication), andtheir published. publishedinthe mass- implementation media. b) Accountabilityfor the b)Yes (arts. 8 to lo). b) Current practice is for financial condition Annually auditedfinancial the Agency to report (accountingstandards, statements, following quarterlyto the executive auditedfinancial statements, IFSR, are published on its fmancial summarybalancesheets) monthly. Summary condition.Report is balance-sheetsare publishedinthe mass- publishedas well. media.