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Document of
The World Bank
Report No. 52025-ME
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
PROGRAM DOCUMENT
FOR A PROPOSED LOAN
IN THE AMOUNT OF €59.1 MILLION (US$85 MILLION EQUIVALENT)
TO
MONTENEGRO
FOR A
FIRST PROGRAMMATIC FINANCIAL SECTOR DEVELOPMENT POLICY LOAN
July 22, 2011
Finance and Private Sectors Development Unit
South East Europe Country Unit
Europe and Central Asia Region
This document has a restricted distribution and may be used by recipients only in the performance of their official
duties. Its contents may not otherwise be disclosed without World Bank authorization.
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ii
MONTENEGRO – GOVERNMENT FISCAL YEAR
January 1 – December 31
CURRENCY EQUIVALENTS
(Exchange Rate Effective as of May 31, 2011)
Currency Unit EUR
US$1.00 €0.71
Weights and Measures
Metric System
ABBREVIATION AND ACRONYMS
CAMELS
Capital Adequacy, Asset Quality, Management,
Earnings and Liquidity and Sensitivity to market
risk IIA Institute of Internal Auditors
CAR Capital Adequacy Ratio IMF International Monetary Fund
CBCG Central Bank of Montenegro KAP Kombinat Aluminijuma Podgorica
CPS Country Partnership Strategy KfW
Kreditanstalt für Wiederaufbau / German
Development Bank
DPF Deposit Protection Fund LOLR Lender of Last Resort
DPL Development Policy Loan LTD Loan-to-deposit ratio
EBRD
European Bank for Reconstruction and
Development MoF Ministry of Finance
EC European Commission MPBS
Measures for Protection of the Banking
System
ECA Europe and Central Asia NPL Nonperforming Loan
EIB European Investment Bank PEFA
Public Expenditure and Financial
Accountability Assessment
EPCG Elektroprivreda Crne Gore AD PFM Public Financial Management
EU European Union PPI Producer Price Index
FDI Foreign Direct Investment RBN Rudnici Boksita Nikšić
FIRST
Financial Sector Reform and Strengthening
Initiative ROA Return on Assets
FMS Family Material Support ROE Return on Equity
FSAP Financial Sector Assessment Program ROSC
Report on The Observance of Standards
and Codes
FSDPL Financial Sector Development Policy Loan SAC Structural Adjustment Credit
FX Foreign Exchange SAI State Audit Institution
GDP Gross Domestic Product SAP Supervisory Action Plan
GoM Government of Montenegro SEE Southeast Europe
IBRD International Bank for Reconstruction and
Development TA Technical Assistance
IFC International Finance Corporation WB World Bank
Vice President:
Country Director:
Sector Director:
Sector Manager:
Task Team Leader:
Philippe Le Houérou
Jane Armitage
Gerardo Corrochano
Lalit Raina
Alexander Pankov
iii
MONTENEGRO
FIRST PROGRAMMATIC FINANCIAL SECTOR DEVELOPMENT POLICY
LOAN
TABLE OF CONTENTS
LOAN AND PROGRAM SUMMARY ............................................................................ iv I. INTRODUCTION ...................................................................................................1
II. COUNTRY CONTEXT...........................................................................................1 A. Recent Economic Developments ..........................................................1 B. Banking Sector Developments ..............................................................4 C. Macroeconomic Outlook and Debt Sustainability ................................9
III. THE GOVERNMENT’S REFORM PROGRAM .................................................14 A. Overall Reform Program .....................................................................14 B. Financial Sector Reforms ....................................................................15
IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM .............................18 A. Link to the Country Partnership Strategy ............................................18
B. Collaboration with the IMF and other Donors ....................................19 C. Relationship to Other Bank Operations ..............................................19
D. Analytical Underpinnings ...................................................................20 E. Lessons Learned ..................................................................................20
V. THE PROPOSED OPERATION ...........................................................................21
A. Objective and Rationale ......................................................................21 B. Operation Description and Policy Areas .............................................23
C. Expected Outcomes of the Operation .................................................26
VI. OPERATION IMPLEMENTATION ....................................................................27
A. Poverty and Social Impacts .................................................................27 B. Environmental Aspects .......................................................................28
C. Implementation, Monitoring, and Evaluation .....................................28 D. Fiduciary Aspects ................................................................................28 E. Disbursement and Audit Arrangements ..............................................30 F. Risks and Risk Mitigation ...................................................................31
ANNEX 1. Policy Matrix ..................................................................................................35 ANNEX 2. Overview of the Banking Sector .....................................................................37 ANNEX 3. Letter of Development Policy .........................................................................45 ANNEX 4. Fund Relation Note .........................................................................................53 ANNEX 5. Country at a glance .........................................................................................56
ANNEX 6. Country Map ...................................................................................................57
The First Programmatic Financial Sector Development Policy Loan is prepared by a Bank team consisting of Alexander
Pankov (Task Team Leader, ECSPF/EASFP), Aquiles Almansi (FPDPO), Sanja Madzarevic-Sujster (ECSP2), Danijela
Vukajlovic-Grba (ECSP2), Martin Melecky, Aurora Ferrari (ECSF1), Bujana Perolli (ECSF2), Julie Rieger (LEGEM),
Angela Prigozhina (ECSF1), Aleksandar Crnomarkovic (ECSO3), Kenneth Simler (ECSP3), Andrew Lovegrove, Ross
Delston, and Djurdjica Ognjenovic (ECSPF expert consultants). Jan-Peter Olters (WB Resident Representative in
Montenegro) provided critical guidance.
iv
LOAN AND PROGRAM SUMMARY
MONTENEGRO
FIRST PROGRAMMATIC FINANCIAL SECTOR
DEVELOPMENT POLICY LOAN
Borrower The Government of Montenegro
Implementing Agency
The Ministry of Finance (MoF) of Montenegro will be responsible
for overall implementation of the proposed operation. The Central
Bank of Montenegro (CBCG) is closely involved in the work on
most prior actions.
Financing Data
IBRD Loan
Front end fee: 0.25%
Maturity: 20 years
Interest rate: 6 month EURIBOR for EUR plus fixed spread
Amount: €59.1 million
Operation Type
This operation is the first in the series of two Programmatic
Financial Sector Development Policy Loans (FSDPLs).
Main Policy Areas The proposed loan supports a comprehensive program of measures
to strengthen the banking sector, with a view to mitigating the
impact of the global financial crisis and increasing the resilience of
the sector to possible future shocks. The specific reforms proposed
to strengthen the banking sector are in the following areas: (i)
maintaining market confidence; (ii) strengthening the bank liquidity
framework; (iii) assessing and addressing banking sector
vulnerabilities; (iv) enhancing the regulatory framework; and (v)
problem bank restructuring. These reforms are an integral part of
Montenegro’s EU accession strategy insofar as they aim to bring the
supervisory and regulatory framework for the banking sector closer
to EU practices.
Key Outcome
Indicators
The expected outcomes of this operation are: (i) increased
confidence in the banking sector; (ii) enhanced ability of the CBCG
to provide emergency liquidity assistance; (iii) effective supervision
of the banking system consistent with Basel Core Principles; (iv)
strengthened legal authority of the CBCG for resolution of problem
banks according to international and EU good practices; and (v)
Prva Banka no longer poses a systemic and fiscal risk.
v
The key outcome indicators are:
Stabilization of deposits (baseline: -23 percent decline from
September 2008 to March 2011; target: positive growth);
Resumption of prudent lending activities (baseline: -26 percent
decline from September 2008 to March 2011; target: positive
growth);
Adequate liquidity in the banking sector (target: ratio of liquid
assets to due liabilities to remain in compliance with the CBCG
norms at a ratio of 1, calculated as an average for all working
days in a ten-day period);
Improved quality of loan portfolio (baseline: system’s NPL ratio
at 23 percent in March 2011; target: NPLs below 8 percent);
Well-capitalized banks (baseline: average CAR of banking
system at 11.9 percent in June 2009; target: average CAR of
banking system to remain above 12 percent);
Implementation of Supervisory Action Plan for Prva Banka and
withdrawal of central government deposits from this bank.
Program Development
Objective(s) and
Contribution to CAS
The overarching objective of the operation is to strengthen the
banking sector, which is a critical pre-condition for sustainable
economic recovery and balanced private sector-led growth.
The reform program supported by this operation falls under Pillar I
of the Country Partnership Strategy (CPS), namely, to support EU
integration through strengthening institutions and competitiveness in
line with EU accession requirements. The proposed operation
contributes to this strategic priority by supporting reforms in the
legal, regulatory, and supervisory framework for the banking sector
that are in line with international good practices and EU standards.
Risks and Risk
Mitigation
The proposed First Programmatic Financial Sector Development
Policy Loan (FSDPL1) is a high risk operation. The key risks are as
follows:
1. Economic risk. Economic risks are substantial given
Montenegro’s high external vulnerability and the volatile external
environment in which the country operates. Slower than expected
growth in Southeast Europe and the EU could dampen
Montenegro’s recovery, which would further strain the fiscal stance.
Slower recovery would affect the corporate sector performance and
consequently the financial sector. Montenegro’s heavy reliance on
tourism revenues and exports to Europe makes it vulnerable to any
deterioration in regional stability or slowdown of growth in the EU.
This could jeopardize the achievement of planned medium-term
vi
macroeconomic and social outcomes. Furthermore, the country’s
euroization, high level of external debt and large debt service
requirements over the medium term render the Montenegrin
financial sector vulnerable to a slowdown in capital inflows and call
for more prudent fiscal policy. Finally, given the small size of the
country, even a small shock may have a sizeable impact on the
economy.
These risks are partially mitigated by the proposed program of
strengthening the banking sector to enable it to resume lending to
the private sector, and thus encouraging economic growth. In
addition, the Government is committed to tightening fiscal policy
more than provided for in the medium-term fiscal framework for
2012-2015 should macroeconomic conditions turn out to be worse
than currently estimated. Finally, the implementation of the Action
Plan for opening negotiations with the EU, which would lead to a
legal system comparable to that of EU countries, and the
Government’s structural reform program that aims to increase
competitiveness, will contribute to improved investor confidence.
2. Financial instability risk. The banking sector remains
fragile and financial instability can return as a result of external or
internal shocks. Prva Banka in particular remains vulnerable and
lacks the support of a strong strategic investor or a parent foreign
bank, which is provided to the other three systemic banks. This risk
is directly mitigated by the proposed reforms of strengthening the
liquidity framework, the regulatory framework, the deposit
insurance scheme, implementing supervisory action plans, and
dealing with problem banks.
3. Governance risk. EU and domestic observers have raised
concerns in the past about the lack of transparency, and the
influence of the organized crime on politics and the economy. With
encouragement from the EU and other international observers
(including the Bank), Montenegrin authorities are making a
concerted effort to correct this perception. Specifically, the
legislative changes and more robust supervision efforts supported by
this operation are expected to strengthen the regulator’s standing and
improve governance standards in the banking sector.
4. Implementation risk. Implementation of the program is
dependent on consistent collaboration amongst authorities,
especially between the MoF and the CBCG. While there seems to
be broad support for the restoration of banking sector stability and
its relevance for the EU accession agenda, the long preparation
process for the FSDPL1 reflects the politically sensitive and
technically complex nature of the proposed reforms. Going forward,
vii
the CBCG will need to use its strengthened mandate to enforce
prudential norms, require sound capital buffers, and take appropriate
supervisory measures on problem banks. Its actions need to be fully
coordinated with, and supported by the Government, without
jeopardizing its operational independence. To mitigate this risk, the
authorities and the Bank have jointly promoted an inclusive,
consultative approach in designing the program, seeking to foster a
mutual understanding and agreement on the content of the reforms.
The programmatic approach, with the second operation scheduled
for FY13, is also expected to mitigate the implementation risk.
Operation ID P116787
1
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT
PROGRAM DOCUMENT FOR A PROPOSED FIRST PROGRAMMATIC
FINANCIAL SECTOR DEVELOPMENT POLICY LOAN
I. INTRODUCTION
1. This document describes the first in the series of two Programmatic
Financial Sector Development Policy Loans (FSDPLs) to Montenegro in support of
a comprehensive banking sector reform program. The objective of the operation is to
support the authorities’ efforts to strengthen the banking sector, in order to mitigate the
impact of the global financial crisis and increase the resilience of the sector to possible
future shocks. The main areas of reform are: (i) maintaining market confidence; (ii)
strengthening the bank liquidity framework; (iii) assessing and addressing banking sector
vulnerabilities; (iv) enhancing the regulatory framework; and (v) problem bank
restructuring. The program supported by the proposed operation would be implemented
primarily by the Ministry of Finance (MoF) and the Central Bank of Montenegro
(CBCG). The proposed operation is in the amount of €59.1 million (US$85 million
equivalent). The second FSDPL is planned for early FY13 and would be in the amount
of US$20 million equivalent.
II. COUNTRY CONTEXT
A. Recent Economic Developments
Pre-crisis Developments
2. Following the country’s independence in 2006, the Montenegrin economy
grew rapidly averaging nine percent per year, well above the country’s long-term
potential of around 3.5 percent. The growth was largely fuelled by a significant inflow
of foreign direct investment (FDI) and foreign bank loans that amounted to an average of
24 percent of GDP over 2007-2008. Over the same period, a gross fixed investment to
GDP ratio of 37 percent almost doubled compared to the period since 2001, paralleled
with significant rise in household and government consumption.
3. Pro-cyclical fiscal policy contributed to the economic boom. Although the
general government balance was in surplus (four percent of GDP on average in both 2006
and 2007), cyclically adjusted balances point to the existence of a loose fiscal policy
stance. Good revenue performance was driven by high indirect tax revenues collected on
booming imports. High revenues allowed an increase in spending (from 42 percent of
GDP in 2006 to over 50 percent of GDP in 2008), but the Government of Montenegro
(GoM) also took advantage of the additional revenues to prepay some of its debt,
reducing it to 29 percent of GDP by end-2008. The expenditure growth was to a large
extent attributed to a surge in capital expenditure, although current expenditures
increased as well, especially the wage bill and current transfers (at 11 and 19 percent of
GDP in 2008, respectively).
2
4. Domestic demand growth fuelled large macroeconomic imbalances. Given
the limited domestic production of tradables, increased consumption led to a rise in
imports and widening of the current account deficit (from 8.5 percent of GDP in 2005 to
50.7 percent of GDP in 2008)1. The current account deficit was exacerbated by
exponential credit growth, largely financed by lending from foreign parent banks to their
Montenegrin subsidiaries. As a result, the loan to deposit ratio increased to 169 percent
in 2008, contributing to the overheating of the economy. Real gross wages grew by 18
percent on average in the three-year period preceding the crisis, which paralleled
international food and energy price increases, and contributed to an inflation rate of 7.4
percent in 2008.
Crisis Impact and Recent Trends
5. Montenegro was hit hard by the global financial crisis in late 2008. External
demand for Montenegrin exports (in particular for aluminum and steel) declined by
double digits, which coupled with domestic problems in the financial and corporate
sectors, led to an abrupt economic slowdown. A double-digit fall of manufacturing,
construction, transport and tourism in 2009 was only partially compensated by growth in
energy production and agriculture, leading to an estimated economic decline of around
5.7 percent in 20092. The massive drop in production in the heavily indebted and over-
staffed Aluminum Company (KAP) alone, the country’s largest exporter and industrial
producer, accounted for about 1¼ percent decline in GDP.
6. The economic downturn reduced previous gains made in living standards.
Total employment declined by almost seven percent from the second half of 2009 to end-
2010, despite of the moderation of wages and shortened working hours. Unemployment
increased to 13 percent, two percentage points up from its low in 20083. A recent poverty
analysis confirmed that the poverty rate increased to 6.8 percent in 2009, after having
declined from 11.3 percent in 2006 to below five percent in 2008. Almost a quarter of
employees were affected by deteriorating labor market conditions during the crisis,
including 10 percent that experienced wage arrears and another 10 percent that suffered
salary reductions. About 30 percent of crisis-impacted households increased labor
supply, either by having a non-working member seek work or having working members
seek additional work4.
1 However, balance of payments statistics are likely exaggerating these numbers. Namely, the 2009
decision by MONSTAT to change the trade statistics from 2007 to a special regime led to a deterioration of
the current account estimate in 2008 by some 18 percentage points of GDP. Statistics of service exports,
private sector financial and capital transactions also require further strengthening, although some initial
efforts have been made to address the shortcomings. 2 The National Accounts data require further strengthening to produce higher frequency estimates
(quarterly data) and reliable annual data based on the financial reports, which business entities have been
required to submit starting in 2009. The existence of a substantial unofficial or unobserved economy in
Montenegro also affects the accuracy and reliability of statistical information. 3 The biggest factor was the implementation of the social program at KAP and affiliated companies, which
cut the work force by half from the pre-crisis level of more than 4,000 workers. 4 Bank-supported rapid living standard assessment (2009).
3
Figure 1: Montenegro: Crisis and Its Aftermath
Rapid growth following country’s
independence…
…driven by capital inflows and real estate
booms…
…led to enormous build-up of external
vulnerability…
…further amplified by expansionary fiscal
policy.
Source: MONSTAT, CBOM, MOF, staff calculations
7. Owing to an abrupt decline in capital inflows and a large fall in external and
domestic demand, significant external adjustment took place. The current account
deficit was reduced by half between 2008 and 2010 as imports contracted. However, it
remained high at about 26 percent of GDP in 2010, as exports and tourism hardly
recovered. During 2006–2010, net FDI financed on average 70 percent of the current
account deficit, excluding one-off inflows from the recapitalization and partial
privatization of Montenegro’s power utility in 2009. Access to capital was retained
through foreign banks’ increased financial support to their Montenegrin subsidiaries,
which contributed to a rise in external debt to 94 percent of GDP in 2009.
8. Fiscal imbalances widened from late 2008 and fiscal adjustment was
necessary to ensure macro stability. With GDP contracting by about five percent in
2009, the overall fiscal deficit would have risen to above eight percent of GDP without
the budget revision. Revenues declined by around one-fourth in 2009, partially led by
declining tax compliance as liquidity problems of KAP, the state power utility (EPCG)
and other large companies intensified. The budget revision included a downward
adjustment of 4.7 percentage points of GDP on the spending side, resulting in a fiscal
-6
-4
-2
0
2
4
6
8
10
12
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Montenegro
Western Balkans
Central and Eastern Europe
European Union
Real G
DP
gro
wth
, in
perc
en
t
0
500
1,000
1,500
2,000
2,500
3,000
0.0
0.5
1.0
1.5
2.0
2.5
3.0
2010 2011
MO
ST
E s
tock
mark
et in
dex
Billio
ns
of e
uro
MOSTE Index,
monthly averages(left-hand scale)
Stock of bank credits
to the private sector(right-hand scale)
Stock of bank deposits
from the private sector(right-hand scale)
2004 2005 2007 20082006 2009
0
10
20
30
40
50
60
70
80
90
100
2006 2007 2008 2009 2010
Current-
account
deficit
Other credits/debits
Credits/debits (services)
Exports/imports
In p
erc
en
t o
f G
DP
0
5
10
15
20
25
30
35
40
45
50
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
7.5
6.0
4.5
3.0
1.5
0.0
−1.5
−3.0
−4.5
−6.0
−7.5
Overall budget deficit(in percent of GDP, right-hand scale)
Expenditures
Revenues
(both in percent of GDP, left-hand scale)
Tax
Cap.
Cu
rren
t
Oth
er
Overall budget balance
(in percent of GDP, right-hand scale)
4
deficit of 5.3 percent of GDP. Consequently, public debt rose to 42 percent of GDP in
2009. With containment of the wage bill and a decline in capital spending, the fiscal
deficit further declined to 3.7 percent of GDP in 2010, leaving the spending-to-GDP ratio
at a high 47 percent. The Government issued Eurobonds for its financing needs5.
Reflecting the Government’s support to the restructuring efforts by major companies in
the industrial sector (in exchange for an equity position in these companies, including
KAP), public debt with guarantees increased to 54 percent of GDP by 2010.
Table 1: Montenegro: Key Economic Indicators, 2006-2010 (percent of GDP)
Note: Public debt includes publicly guaranteed debt. E.g., the share of public debt to GDP for 2010
includes 11.6 percentage points of publicly guaranteed debt - of which 10.3 and 1.3 percentage points
refer to guarantees of foreign and of domestic debt, respectively. External private debt does not include
any private debt guaranteed by the state.
Source: MONSTAT, CBOM, MOF, staff calculations
B. Banking Sector Developments
9. The rapid expansion of the Montenegrin banking system came to a halt in
late 2008 due to the impact of the global financial crisis on the overheated domestic
economy. The system’s rapid growth was driven by the entry of foreign banks, along
with increased domestic demand coming in particular from the real estate sector6. Total
assets of the banking system increased by more than 100 percent on average in 2006 and
5Its first ever five-year, €200-million Eurobond was issued in September 2010 at a rate of 7.875 percent and
was followed by another issuance of €180-million Eurobonds in April 2011 at a lower rate after receiving
positive outlook by Moody’s. 6 A proportion of increased real estate development financing activity was driven by the development of the
tourism sector.
2006 2007 2008 2009 2010
Real GDP growth (%) 8.6 10.7 6.9 -5.7 1.1
Consumer prices (period average, %) 3.0 4.2 7.4 3.4 0.5
Gross national savings 0.7 -5.8 -10.1 -2.9 -3.6
Gross investment 25.4 33.8 40.6 27.1 22.1
Fiscal sector
Revenues and grants 45.0 49.2 49.9 44.0 43.3
Expenditures 42.0 42.8 50.2 49.3 47.0
Overall balance 3.0 6.4 -0.3 -5.3 -3.7
Primary balance 4.1 7.4 0.5 -4.5 -2.7
Public Debt (gross) 34.2 28.3 29.0 41.8 53.9
External sector
External Debt 52.4 76.2 77.7 93.4 99.7
Private debt, % of total 42.7 67.7 74.4 68.5 59.6
Current account balance -24.7 -39.6 -50.7 -30.1 -25.7
Foreign Direct Investment (net) 21.7 20.8 17.9 30.6 17.7
5
2007, growing from 67 percent of GDP to 111 percent of GDP. Asset growth has slowed
down substantially since 2008 due to the impact of the global financial crisis, with assets
growing by only 11 percent in 2008 (both due to credit controls applied by the CBCG and
the impact of the crisis), and then contracting by eight percent in 2009, a further three
percent in 2010, and by a further one percent in the first three months of 2011 (Table 2).
Table 2: Basic Indicators of the Banking System
2006 2007 2008 2009 2010 Mar-11
Number of Banks 10 10 11 11 11 11
Number of Foreign Banks 7 7 9 9 9 9
Asset/GDP 67 111 107 102 97.3 N/A
Assets Growth y/y 106 108 11 -8 -3 -1
Deposits/GDP 50 78 65 61 59 N/A
Deposit Growth y/y 120 94 -5 -8 -2 -0.4
Credit/GDP 39 84 91 80 73 N/A
Credit Growth y/y 125 165 25 -14 -8 -5 Source: CBCG
Note: Q1 2011 GDP data not available
10. The expansion of the banking system was underpinned by the exceptionally
high rate of credit growth, which was one of the highest in ECA countries, but a
severe credit crunch has followed since late 2008. Total credit grew by 145 percent
annually on average in 2006 and 2007, with credit increasing from 39 percent of GDP to
84 percent of GDP in the same period. Credit growth started to slow down in early 2008
in response to a series of restrictive measures taken by the CBCG to limit the credit boom
(credit growth ceilings and increased minimum solvency requirements). Credit activity
then started to contract in the last quarter of 2008 due to the impact of the crisis, with
total loans outstanding falling by about two percent in Q4 2008, as banks became
concerned about their deteriorating liquidity situation and the ability of their foreign
parent banks to provide additional financing. This declining lending trend continued in
2009, as loans outstanding declined by 14 percent year on year, mainly due to banks’
increasing asset quality problems and a decline in demand for loans from the corporate
sector, which was affected by the weakening economy. In 2010, credit continued to
decline by eight percent in 2010, and by five percent in the first three months of 2011, as
banks have focused on cleaning up their balance sheets.
11. High rates of credit growth were largely financed by foreign parent banks’
lending to their Montenegrin subsidiaries, resulting in high loan-to-deposit ratios
and exposing the banking sector to substantial liquidity shocks. Financing from
parent banks is a critical source of funding for many banks, because the banking sector is
largely foreign-owned (88 percent of system’s assets at end- 2010). Funding from parent
banks (borrowings from parent banks as a share of total liabilities) increased from eight
percent in 2006 to 14 percent in 2007, peaked at 21 percent in 2008, and has since then
decreased to 20 percent in 2009, 17 percent in 2010, and 16 percent in the first three
6
months of 20117. The high loan-to-deposit ratio (LTD) exposed the banking sector to
substantial liquidity shocks. The LTD ratio increased from 87 percent in 2006, to 121
percent in 2007, and further to 169 percent in 2008. The LTD started to decrease in 2009
at 154 percent, and then decreased further to 140 percent at end-2010. The LTD ratio in
Montenegro still remained higher than in many ECA countries at end-2010.
12. As uncertainty increased with the advent of the global financial crisis, banks
lost significant deposits in late 2008, which have not fully recovered yet. The massive
deposit withdrawals were much larger and longer lasting than in neighboring countries.
Over Q4 2008, deposits declined by 18 percent. The anti-crisis measures implemented
by the authorities (see Section III below) helped slow deposit withdrawals, although they
were not successful in stopping the outflow completely. Between September 2008 and
June 2009 there was a loss of about 25 percent of total deposits (with a significant
proportion of this attributed to the depositor run on Prva Banka discussed below). In the
second half of 2009, deposits showed some signs of recovery, signaling a return of
confidence, and the decline in deposits of two percent in 2010 (13 percent increase from
households and 17 percent decline from enterprises) was likely driven by a contracting
GDP rather than by a renewed loss of confidence. In the first three months of 2011,
deposit showed some signs of recovery increasing slightly for both households and
enterprises and mirroring improvements in the overall economy. Overall, between
September 2008 at the onset of the crisis and March 2011, the banking sector lost more
than 23 percent of its total deposits and deposits have not yet recovered to pre-crisis
levels.
13. A massive withdrawal of deposits severely undermined the liquidity of the
system in late 2008, although the situation has improved since then. The system’s
liquid assets to short term liabilities ratio declined from 32 percent in 2007 to 21 percent
in 2008. Since then, system wide liquidity has improved to 26 percent in 2009 and to 33
percent in 2010 and in the first three months of 2011.8 The liquidity situation was helped
by large cash inflows into the banking system as a result of partial privatization of
electricity production and distribution, and by substantial capital injections from the
foreign parents of Montenegrin banks.
14. Asset quality in the banking system has been steadily deteriorating since
2008, although it is expected to stabilize in 2011 as the economy recovers. The
weakened economy (especially the poor performance of the construction sector and the
real estate market) contributed to a rapid increase in non-performing loans (NPLs). NPLs
as a share of total loans increased from seven percent in 2008, to 14 percent in 2009, 21
percent in 2010, and increased again to 23 percent at end-March 2011. At the same time,
past due loans (loans overdue by more than 30 days) increased from 11.5 percent in 2008
to 23 percent in 2009, 24 percent in 2010, and increased again to 30 percent at end-March
7 Loans extended to domestic banks by their parent banks amounted to approximately 24 percent of GDP in
2008 and to 18 percent of GDP in 2009. 8 The minimum level of liquidity is the ratio of liquid assets to due liabilities of 1 when calculated as an
average for all working days in a ten-day period. Due liabilities include: loan payables; interest and fee
payables; due time deposits; 30 percent of demand deposits; 10 percent of liabilities for granted but not-
performed irrevocable loan liabilities (credit lines); other due liabilities.
7
2011. In response to rising NPLs, banks were forced to increase loan loss provisioning,
and draw on their capital buffers. Nine out of 11 banks had to be recapitalized by their
shareholders as a result. The rapid rise in NPLs during 2010 was driven by numerous
factors, including: (i) Prva Banka’s delay in recognizing the extent of its NPLs (which
did not occur until after an onsite inspection in December 2010); (ii) the contraction in
total loans as banks ceased lending (and thus increased NPLs as a proportion of total
loans); and (iii) large banks (particularly CKB and Hypo) ―cleansing of‖ their loan
portfolios in 2010 in anticipation of spinning off large volumes of NPLs to their foreign
parents in the first half of 2011, a process which is now underway. Given an estimated
GDP growth of two percent in 2011 (after an estimated 1.1 percent growth in 2010), the
ending of the cleansing process, and the spin-off of NPLs now underway, NPLs are
expected to stabilize and then decline during 2011, allowing banks to resume lending.
15. As in other countries, the crisis had a rapid and dramatic impact on bank
profitability. The banking sector has incurred heavy losses since December 2008. The
return on assets (ROA) decreased from -0.6 percent in 2008 to -0.7 percent in 2009, to -
2.8 percent in 2010, and improved slightly to -2.4 percent at end-March 2011. The return
on equity (ROE) declined from -6.9 percent in 2008 to -7.8 percent in 2009, declined
dramatically in 2010 reaching -28 percent, and improved to -23 percent in the first three
months of 2011. The banking sector incurred heavy losses throughout 2010, reaching
€82 million at end-2010 mainly due to an increase in provisions by about 69 percent from
end-2009. However, in the first three months of 2011, the rate of losses declined as
banks absorbed €17 million in losses by end-March 2011, reflecting the impact of
tightened bank supervision and banks’ own efforts to clean up their loan portfolios and
complete recording of the required provisions in 2010.
Table 3: Key Prudential Indicators of the Banking System
2007 2008 2009 2010 Mar-11
Liquidity
Liquid assets to short term liabilities 32 21 26 33 33
Liquid assets to total assets 22 11 15 19 19
Liquid assets to total liabilities 24 12 17 21 22
Capital Adequacy
Regulatory capital to risk-weighted assets 17 15 16 16 15
Capital to Assets 8 8 11 11 10
Asset Quality
NPLs / loans 3 7 13 21 23
Past due loans (above 30 days)/ loans 4 12 23 24 30
Provisions/ NPLs 74 56 43 31 24
Provisions/ loans 2 4 6 6 6
NPLs net of provisions, in percent of capital 8 32 52 103 122
Earnings and Profitability
ROA 1 -1 -1 -3 -2
ROE 6 -7 -8 -27 -23 Source: CBCG
8
16. Parent banks have so far supported their Montenegrin subsidiaries with
substantial additional funding and capital injections, thus helping to partially offset
declining domestic deposits and capital erosion. The overwhelming majority of
Montenegrin banks are owned by foreign banking groups, most of which provided some
form of liquidity support throughout the acute stage of the crisis. Equally importantly,
the parent banks provided about €230 million in new capital from Q4 2008 to March
2011. As a result, the capital adequacy ratio (CAR) of the system stood at 15.4 percent at
end- March 2011, above the prudential minimum requirement of 10 percent. Subsidiaries
of foreign banks also had an opportunity to manage their NPLs through transferring them
to the Asset Management Companies (AMCs) of their parent banks. However, domestic
banks have had to maintain their NPLs on their balance sheets.
17. Prva Banka - the largest domestically owned bank - experienced the most
significant outflow of deposits and was the only bank to receive emergency support
from the state. A controlling interest in Prva Banka was acquired in 2006 by a group of
local investors related to the then Prime Minister. Subsequently, the bank’s assets grew
explosively (by 1,600 percent from 2006 to end-2008) to make it the country’s second
largest bank and the only domestically owned bank of systemic importance. Following a
massive outflow of deposits, the bank started to experience severe liquidity problems at
end-2008 that threatened to undermine confidence in the entire banking system. Faced
with chronic asset-liability mismatches and the rapid withdrawal of deposits, Prva Banka
ceased to function as a normal commercial bank as of the fall of 2008, when the CBCG
imposed a freeze on new lending activities. The management of the bank was replaced in
late 2008, at the same time as Prva received a €44 million emergency loan from the GoM.
The loan was repaid in 2009, but underlying asset quality problems remained, with a
negative impact on the bank’s capital position. The bank also continued to rely heavily
on deposits from the Central Government and other majority state-owned entities. The
authorities are now implementing a comprehensive restructuring strategy for Prva Banka
(see Section III and Section V), including a staged withdrawal of Government deposits
and recapitalization of the bank.
18. As of the first quarter of 2011, the priorities for Montenegro’s banking sector
are further improvements in capitalization of banks and their liquidity positions,
amid persistent NPL ratios and fragile depositor confidence. Although increasing
deposits could suggest strengthening confidence in banks, they still remain below their
end-2007 levels. Furthermore, NPLs show some improvement due to loan restructuring
and write-offs, but with new lending still subdued and new NPLs creeping in the situation
remains challenging for banks. Overall, the financial soundness indicators suggest that
the banking sector recovery still has a long way to go. Thus, restoring soundness across
the system remains a priority in order to resurrect new lending to creditworthy enterprises
and projects. In this regard, through the recently strengthened legal framework, the
CBCG is adequately empowered to safeguard financial stability.
9
C. Macroeconomic Outlook and Debt Sustainability
19. The macroeconomic environment has been steadily improving since mid-
2010, although it remains risky given Montenegro’s high external vulnerability and
a volatile external environment (see Risk Section for more detail). Growth resumed
in 2010, and has been accelerating in the first half of 2011. A double-digit rise in
manufacturing, construction, agriculture and retail trade suggests a recovery of around
two percent in the first three months of 2011, despite reductions in energy production,
transport and the financial sector. The CBCG revised upward the 2011 growth projection
to 2.7 percent, as credit activity slowly resumed. From 2011 onwards, economic activity
is projected to be supported by FDI in the construction, energy, and tourism sectors9.
Also, improved terms of trade and the rise in global demand for aluminum and steel are
supporting an upward economic trend. Growth is expected to become more diversified,
and also driven by moderate domestic demand growth. The inflation projection is set at
two percent on average throughout 2011-2013, suggesting a gradual closure of the output
gap.
20. Growth recovery has yet to translate into labor market improvements. Although the tourism sector is on the rise, according to employment statistics as of April
2011 total employment was still eight percent lower than a year ago. However, the
number of newly employed from the unemployment registry almost doubled in the first
quarter of 2011, suggesting a potential decline of unemployment in the second half of
2011.
21. External imbalances are projected to moderate over the medium term. In the
first quarter of 2011, the current account deficit declined to 23 percent of GDP on a four-
quarter rolling basis, led by a surge in exports of goods (60 percent rise led by aluminum
and electricity), transport services (27 percent), and a still moderate rise in imports (7.5
percent). The current account deficit is expected to decline towards 19 percent of GDP
by 2013. Given the important role of FDI in the Montenegrin economy, such level of
external imbalances would be closer to what could be viewed as the country’s debt-
stabilizing level (i.e., 16 percent of GDP). Export growth, which is projected at around
11 percent on average over 2011-2013, will help moderate the current account deficit.
FDI is expected to remain strong at around 15 percent of GDP per year, mostly as a result
of needed recapitalization of the banking sector and the earlier announced investments
taking the form of public-private partnerships. This would cover approximately two-
thirds of the current account deficit and thus reduce financing pressures.
22. Fiscal consolidation efforts have continued despite large tax arrears and
reduced tax collection. The recovery, coupled with a freeze in public sector wages10
and
further expenditure restraints in social transfers and the capital budget, equivalent to three
9 Potential investments at various stages of discussion include a highway connecting the coastline areas to
the Corridor X; hydro-power plants with an undersea energy cable to Italy; and leasing of largely
undeveloped beaches for the construction and management of high-end tourist facilities. 10
Except for the gradual adjustment to gross amounts of integrated meal and holiday bonuses into the basic
wage from December 2010 until end-2012. Given they were not subject to taxes and contributions in 2010,
this will lead to a three percent rise in public sector wage over the two years.
10
percentage points of GDP, cut the accrual-based general government deficit to 3.7
percent of GDP in 2010. This was achieved despite a rise in both unemployment and the
social spending needed for social protection of the vulnerable population, necessitated in
part by restructuring of the metal industry. However, a rise in tax arrears, the bankruptcy
of the steel mill and an immediate call on government guarantees (equivalent to one
percent of GDP), as well as a rush to lock in pensions by the police force that will lose
pension privileges from 2012, are likely to drive the planned 2011 fiscal deficit up to 3.3
percent of GDP as opposed to the planned 2.4 percent of GDP. The tax administration
has stepped up tax collection efforts, in particular in the service sector and for excises.
Following the reprogramming of tax liabilities from January 2011, the authorities expect
additional tax revenues on the order of 0.7 percent of GDP (out of five percent of GDP
total tax arrears) still in 2011.
Table 4: Montenegro: Macroeconomic Outlook (percent of GDP)
Outturn Projected
Indicators 2010 2011 2012 2013
National Accounts
Real GDP growth 1.1% 2.0% 2.0% 3.7%
Total Investment 22.1 22.0 22.5 23.0
Gross National Savings -3.6 -2.4 0.5 3.8
Foreign Savings 25.7 24.4 22.0 19.2
Public Sector
Primary Balance -2.9 -1.8 -1.1 -0.4
Interest payments 1.0 1.6 1.7 1.9
Fiscal Balance (w/o capital revenues) -3.9 -3.4 -2.8 -2.3
Balance of Payments
Trade Balance -43.5 -42.9 -41.7 -40.4
Current Account Balance -25.7 -24.4 -22.0 -19.2
FDI 17.7 15.4 14.4 13.4
Debt
External Debt (private and public) 99.7 98.5 97.0 93.6
Public Debt, gross, (incl. govt
guarantees) 53.9 56.3 55.5 54.2
Gross Internat. Res. (in months of
Imports) 1.7 1.4 1.2 1.2
Memo items:
GDP (US$ millions) 4,007 3,994 4,162 4,354
Inflation (p.a., %) 0.5 3.1 2.0 1.8
Debt service to export ratio 32.1 31.8 28.6 24.7
Exchange rate EUR:US$ (p.a.) 0.75 0.78 0.78 0.79 Note: Fiscal accounts corrected for arrears and assumed slower path of fiscal consolidation than
assumed by the government. Public debt includes publicly guaranteed debt.
Source: MONSTAT, CBCG, MOF, staff calculations
11
23. Recognizing that credit guarantees to ailing industries may be translating
into additional fiscal expenditure, the Government has already endorsed policies for
further spending cuts. These include: (i) accelerated staff downsizing and abolishment
of all benefits and bonuses that will lower the wage bill by 0.2 percent of GDP in 2011;
and (ii) centralized authorization of public procurement, which will prevent budget
arrears’ accumulation. In addition, as possible contingencies, the 2011 budget has the
scope for further spending cuts, should these be needed, to ensure that the fiscal deficit
does not exceed the newly targeted 3.3 percent of GDP, including: (i) recurrent spending
cuts amounting to 0.54 percent of GDP; (ii) a capital spending reduction of 0.15 percent
of GDP, in particular for land acquisition along the future highway Bar–Boljare; and (iii)
subsidies for steel mill redundancies amounting to 0.1 percent of GDP.
24. The Government’s medium-term strategy aims to safeguard stability
through front-loaded expenditure-based fiscal adjustment. The overall spending rise
from an average level of 44 percent of GDP before the crisis to 47 percent during 2009–
2010, driven by social expenditures and the expanding wage bill, is to be reversed. With
its 2011 budget and the Economic and Fiscal Program for 2012–2015, the Government
outlined a gradual adjustment path that aims to ensure the medium-term sustainability of
public finances through:
i. A wage bill reduction of 0.5 percent of GDP by 2013 based on an adopted
Personnel Policy Paper suggesting public sector employment downsizing;
ii. State aid reduction by 0.6 percent of GDP, in particularly for subsidized
electricity to the troubled metal industries that will cease by end 2012;
iii. Rationalization of social security costs and transfers by 0.5 percent of GDP by
2013, to be achieved by capping total health expenditures and imposing central
oversight of the use of budget funds, pension reform, and reduced
intergovernmental transfers;
iv. Moderation of capital spending by 0.5 percent of GDP by 2013 leaving it still at
the relatively high level of 4.5 percent of GDP; and
v. Stepped up efforts in tax collection and gradual increases in property tax and
excise duties (also required as a part of the EU accession program).
25. The ongoing deleveraging process and fiscal consolidation are expected to
reduce external financing needs over the medium term. The large stock of corporate
sector foreign debt (around 60 percent of total) and corresponding large debt obligations
maturing over the medium term continue to create significant external vulnerabilities. In
2011, overall gross external financing needs amount to 31 percent of GDP (or 32 percent
of exports of goods and non-factor services). One-fourth of these are due to principal
repayments, which doubled compared to the pre-crisis period, while the rest is due to a
still unsustainably high current account deficit. Public debt service will decline to around
five percent of GDP in 2011, of which two-thirds is due to domestic creditors.
26. Gross financing needs will slowly decline as external imbalances recede by
2013. Gross financing needs will be on average US$1.2 billion over the 2011-2013
period (or around 28 percent of GDP), half of which are likely to be covered by FDI (in
banking, energy and tourism). The country’s overall borrowing requirements will be in
12
the order of US$600 million per year. With the proposed DPL program and the regular
disbursement profile, the IBRD might cover around 3.8 percent of overall gross financing
needs. Debt service to the IBRD will decline to around eight percent of total public debt
service as the country develops its access to international capital markets.
27. External debt is projected to decline to 93 percent of GDP by 2013, after
reaching its historical high of close to 100 percent of GDP in 2010. The projections
remain highly sensitive to changes in macroeconomic assumptions. Under the
assumption of a moderate export recovery, the debt to exports ratio will decline to below
220 percent by 2013 (from its peak in 2010), indicating the need to diversify export
structure and continue with structural reforms supporting productivity growth. Due to the
relatively short maturity of private external debt, debt service as a share of exports is
expected to decline to below 25 percent by 2013 from over 32 percent in 2010. The
sensitivity analysis suggests that the implicit interest rate of seven percent, real growth at
1.1 percent throughout the observed period (as opposed to 3.3 percent projected in the
baseline scenario) and a non-interest current account deficit at 20 percent (as opposed to
12 percent in the baseline scenario) would widen the external debt by 12 percentage
points of GDP compared to the baseline scenario.
Table 5: External Financing Requirements and Sources (percent of GDP)
Source: MONSTAT, CBCG, MOF, staff calculations
Estimate
Indicators 2010 2011 2012 2013
Requirements 34.6 31.2 29.1 25.2
Current Account Deficit 25.7 24.4 22.0 19.2
(of which scheduled interest payments) 6.2 7.3 7.1 7.0
Principal Repayments 8.3 8.0 7.4 6.3
Official creditors 1.3 1.4 1.6 1.7
o.w. IBRD 0.3 0.3 0.3 0.3
Banks 0.2 2.3 2.1 1.8
Other private 6.9 4.3 3.8 2.8
Increase in net official reserves 0.5 -1.3 -0.3 -0.2
Sources 34.6 31.2 29.1 25.2
Foreign Investment (net) 17.7 15.4 14.4 13.4
Portfolio Investment (net) 6.1 4.7 0.2 0.3
MLT Disbursements 6.1 6.6 10.2 7.4
Official creditors 1.7 3.8 1.7 0.8
o.w. IBRD 0.3 2.4 0.7 0.2
Banks 4.9 2.2 3.7 3.2
Other private -0.5 0.6 4.9 3.4
Short-term & other capital (net) 4.7 4.5 4.3 4.1
Debt and debt service indicators, %
TDO/XGS 272.8 250.1 235.0 217.5
TDO/GDP 99.7 98.5 97.0 93.6
TDS/XGS 32.1 31.8 28.6 24.7
Interest payments/GDP 3.4 4.5 4.4 4.3
IBRD exposure indicators (%)
IBRD DS/public DS 15.9 6.2 7.9 9.3
IBRD DS/XGS 1.0 0.9 1.0 1.1
IBRD TDO (US$m) 237.7 313.6 329.4 320.5
Projected
13
28. As expenditure-led fiscal consolidation advances, overall public debt will
likely decline from 2012 onwards. With a 1.8 percentage points of GDP spending
reduction per year, as envisaged by the medium-term fiscal framework, public debt
(without guarantees) would be reduced to 39 percent of GDP in 2014 after reaching its
peak in 2011. Without planned policy changes, the primary deficit would stay at slightly
above two percent of GDP, and public debt (without guarantees) would remain at about
44 percent of GDP in 2014 (or about 54 percent with public guarantees). Contingent
liabilities in terms of guarantees extended to corporate sector and government overdue
liabilities (arrears) amounted to 13.5 percent of GDP at the end of 2010, one-third of
which is due to guarantees issued to KAP.
29. Non-performing loans and inter-enterprise arrears are posing the biggest
risks to a fragile growth recovery and Government’s fiscal plans. By February 2011,
non-performing loans reached a record high of 23 percent, representing close to 15
percent of GDP. The illiquidity in the private sector is reflected in the overall inter-
enterprise arrears amounting to about 10 percent of GDP, of which the general
government sector arrears amount to about three percent of GDP. Tax arrears, on the
other hand, amounted to five percent of GDP at the end of 2010.
Figure 2: Public Debt Sustainability Figure 3: External Debt Sustainability
Note: Without guarantees. In the historical
averages scenario the key variables include real
GDP growth, real interest rate, and primary
balance as percent of GDP. In the no-policy
change scenario, constant primary balance from
2010 was applied to 2011-2015 period.
Source: IMF calculations.
Note: The key variables in the alternative
scenario include real GDP growth, nominal
interest rate, Euro deflator growth, non-interest
current account, and non-debt inflows in percent
of GDP.
30. The Montenegrin economy needs to strengthen fundamentals to steer
through a volatile external environment. This strategy includes: (i) continuing
restructuring in the financial and real sector; (ii) accelerating structural reforms in social,
labor and education sectors as well as administration to ensure sustainability of public
finances; and (iii) strengthening the enabling environment for private sector growth.
Apart from ensuring macroeconomic stability through fiscal consolidation efforts, the
Historical
averages
Baseline
No policy change
20
25
30
35
40
45
50
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Historical averages
Baseline
60
70
80
90
100
110
120
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
14
Government is proactively addressing competitiveness issues. To that extent, an action
plan for removing administrative burden to investments has been developed, jointly with
the IBRD, implementation of which has been advanced with: (i) the simplification of
business and tax registration under the one-stop-shop concept; (ii) the reduction in
complexity and duration of requesting construction permits; (iii) the adoption of the new
bankruptcy and enforcement laws; and (iv) the reduction in non-tax fees and time for
connection to electricity grids. After amendments to the Pension Insurance Act that
increased the retirement age to 67 over a 20-year period, discussions with social partners
over the amendments to the Labor Law have commenced with a view to reducing
dismissal costs and allow for flexible employment contracts. The Government has also
adopted the 2011 Privatization Plan that targets tourist and transport companies with a
view to unlock unused assets in these companies for more productive use by the private
sector.
31. The overall macroeconomic policy framework, although subject to
significant risks, is considered adequate for the purposes of the proposed DPL. The
set of macroeconomic policies proposed in the Government’s program, if implemented,
should enable sustainable recovery in 2011 and beyond. The public sector deficit is
declining throughout the observed period, which reduces financing risks, but not pursuing
the proposed fiscal strategy makes the medium-term outlook risky, as increased debt
service kicks in from 2015. The country’s euroization, high level of external debt, and
large debt service requirements over the medium term call for a prudent fiscal policy. In
addition, the heavy reliance on tourism revenues and exports to Europe makes the
country vulnerable to any slowdown of growth in the EU. Thus, if any of the risks
materialize and underlying macroeconomic assumptions change, further efforts would be
required to achieve the desired fiscal targets, which the Government is committed to
undertake, as laid out in the Letter of Development Policy (Annex 3).
III. THE GOVERNMENT’S REFORM PROGRAM
A. Overall Reform Program
32. Since the beginning of the crisis in the Fall of 2008, the authorities have
formulated a coherent policy response aimed at restoring long-term macroeconomic
and financial sector stability, and encouraging a sustainable economic recovery. In
the fiscal area, to respond to the crisis and contain the widening fiscal deficit, the
Government undertook politically difficult expenditure cuts to consolidate Government
and expenditure growth, including by privatizing selected state assets and concessions.
In the financial sector, the authorities gave priority to restoring depositor confidence and
stepping up the supervisory effort, including restructuring of problem banks. In parallel,
the authorities pursued a longer term effort towards strengthening the entire regulatory
framework for the banking sector in order to bring it in line with international practices
and EU directives, and thus make the sector and regulatory bodies better prepared for
possible future shocks. These reforms are consistent with the Economic and Fiscal
Program for the three-year period that the Government was obliged to prepare as part of
the EU accession, starting from 2007. The need for a stronger regulatory and institutional
15
framework for the banking sector was also highlighted by the EC in the 2010
Commission Opinion on Montenegro’s Application for Membership of the EU.
B. Financial Sector Reforms
33. To restore consumer confidence in the banking sector, the authorities
adopted an emergency anti-crisis law in October 2008, the Law on Measures for
Protection of the Banking System (MPBS). The provisions of the law were generally
consistent with crisis responses seen in other countries, giving the Government the
authority to: (i) fully guarantee the deposits of all individuals and legal persons; (ii)
facilitate credit guarantees for interbank loans; (iii) provide liquidity support to a bank in
need of additional funds for a period of up to one year; (iv) upon a bank’s request, make a
prepayment of state borrowings from that bank (including loans carrying a government
guarantee); and (v) provide funds for the increase of a bank’s capital, with a view to
protecting and ensuring the stability of the banking system. The law also provided for the
CBCG to: (i) approve the use of funds of the reserve requirements; and (ii) use up to 50
percent of its capital for granting short-term loans to banks. The MPBS has served its
intended purpose and expired at the end of 2009.
34. Confidence in the banking sector was maintained by the MPBS and by
support given by parents of foreign-owned banks to their subsidiaries. Only one
domestic bank (Prva Banka) received emergency loan from the state, which was repaid
within 12 months. A number of banks benefited from state guarantees given by the MoF
for credit lines provided by the European Investment Bank (EIB) and KfW totaling €122
million to support lending to small and medium enterprises (SMEs). In the meantime, the
CBCG has been proactive in introducing a number of temporary changes in prudential
regulations to respond to the special challenges presented by the global financial crisis,
such as lowering reserve requirements to ease liquidity pressures on banks and revising
loan loss provisioning rules to facilitate loan restructuring.
35. In parallel to the emergency anti-crisis measures, the authorities have also
implemented, with support from the World Bank, the following legislative and
institutional reforms in the banking sector, aiming to ensure longer term stability:
(a) maintaining depositor confidence; (b) strengthening the bank liquidity framework; (c)
assessing and addressing vulnerabilities in the banking sector; (d) enhancing the
regulatory framework; and (e) problem bank restructuring. Details of the program in the
different areas are summarized below. These reforms support Montenegro’s EU
accession strategy as they aim to bring the supervisory and regulatory framework for the
banking sector closer to EU practices.
Maintaining market confidence
36. A new Deposit Protection Law was enacted in mid-2010 to replace the
blanket deposit guarantee, which was a temporary measure in the emergency anti-
crisis Law on Measures for Protection of the Banking System. The law aims to
maintain confidence in the banking system by: (i) gradually increasing the ceiling for
deposit insurance coverage in line with regional norms and EU directives; (ii) shortening
16
the timeframe allowed for insured deposit payouts; and (iii) providing a legal instrument
to mobilize external funding sources that would enhance the Deposit Protection Fund’s
(DPF) financial capacity make large deposit insurance payouts. The latter change
allowed an approval later in 2010 of a stand-by credit line from EBRD for the DPF (with
a sovereign guarantee), which can be drawn upon in the event the DPF’s own funds are
not sufficient to deal with a large insured deposit payout.
Strengthening the liquidity framework
37. A new law on the Central Bank of Montenegro (CB Law) was enacted in
mid-2010 that provides the CBCG with expanded powers to act as the lender of last
resort (LOLR). Under the previous CB Law, the CBCG had very limited emergency
liquidity lending capacity. Under the new CB Law, emergency liquidity loans can be
made to solvent banks for 90 days against collateral, extendable to a maximum of 180
days when necessary to preserve the stability of the financial system. The other
important features of the new law include providing legal protection to the CBCG and its
staff from prosecution for acts taken during the performance of their duties, and reflecting
the establishment of a permanent Financial Stability Council (with representation from
the CBCG, MoF, Security and Exchange Commission, and Agency for Insurance
Supervision), a coordination body whose functions are described under a separate law.
The new CB Law has been widely acclaimed as bringing Montenegro closer to the EU’s
sound practices for central bank governance and operations. With one caveat11
, the new
law generally upholds the operational independence of the Central Bank.
Assessing and addressing banking sector vulnerabilities
38. The CBCG has employed a range of supervisory techniques to identify
vulnerabilities in the banking sector and has required bank owners and
management to undertake prompt corrective action as necessary. The supervisory
framework combines full scope on-site examinations, targeted on-site examinations, off-
site monitoring, and quarterly stress testing for credit, liquidity, and market risks. The
CAMELS rating system is in place and is updated for all systemically important banks at
least quarterly. With technical assistance provided by the World Bank, the CBCG has
also now introduced an improved credit assessment and risk rating methodology. The
CBCG conducts periodic on-site examinations of banks, with all of the four largest banks
(Prva Banka, CKB, NLB Montenegro Banka, and Hypo Alpe Adria Banka) and a number
of smaller banks subject to full-scope examinations in both 2009 and 2010. Supervisory
Action Plans (SAPs) were prepared for banks of special concern, approved by CBCG
management, and periodically updated. In the context of SAP implementation, the
CBCG maintains an ongoing dialogue with management and shareholders of the banks to
address specific weaknesses, including requiring capital increases to offset both shortfalls
identified during the inspection process and projected capital needs identified by stress
tests.
11
The new CB Law included a provision, which terminated the mandates of the CBCG Council, including
the CBCG Governor, and required the appointment of a new Council. As communicated by the WB and
the IMF to the authorities, this move could be perceived as an infringement upon the independence of
central bank.
17
Enhancing the regulatory framework
39. In collaboration with the World Bank and IMF, the authorities have taken
steps to bring the Montenegrin regulatory framework for the banking sector in line
with relevant EU Directives and practices in EU member states. A key dimension of
this effort has been to provide the CBCG with the full range of instruments and authority
for effective supervision and, in particular, for dealing with problem banks in a timely
and efficient manner. In mid-2010 a set of amendments to the Law on Banks were
enacted, which enhance the CBCG’s enforcement powers, improve corporate governance
in banks, and strengthen the interim administration process for troubled banks. More
specifically, the deficiencies that were addressed in the amendments to the Law on Banks
included, inter alia: (i) harmonizing fit and proper requirements with the EC directive; (ii)
clarifying the definition of related parties in line with international good practices; (iii)
strengthening the CBCG’s enforcement powers by increasing the types of enforcement
actions available to the CBCG; (iv) limiting the powers of the courts to suspend or revoke
CBCG decisions; and (v) establishing legal protection for the CBCG as a supervisory
authority and its personnel.
40. In parallel, amendments to the Bank Bankruptcy and Liquidation Law were also
enacted to ensure that insolvent banks can be promptly resolved using least cost
solutions. As confirmed in a recent report by the EC12
, the new set of laws has brought
Montenegro substantially closer to compliance with EU countries’ regulatory frameworks
for bank supervision and resolution.
Problem bank restructuring
41. As the only sizeable domestic bank with severe liquidity and asset quality
problems, Prva Banka represented the most critical challenge facing the authorities
during the crisis. Suffering from chronic asset-liability mismatches and rapid
withdrawal of deposits, Prva Banka ceased to function as a normal commercial bank in
the Fall of 2008, when the CBCG imposed a freeze on new lending activities and
subsequently installed a special representative at the bank with the right to attend all
management and board meetings in order to provide close monitoring of its activities.
The management of the bank was replaced in late 2008, when Prva received a €44
million emergency loan from the GoM, which was subsequently repaid. Strong loan
collection efforts by the new management have resulted in a dramatic downsizing of the
bank, with its assets cut almost in half over the past two years, and the bank dropping
from second to fourth largest in Montenegro. By early 2011, the CBCG assessed that
Prva’s condition had stabilized with adequate liquidity, and allowed the bank to resume
limited lending activities, in order to attract new deposits and begin increasing operating
income.
42. Notwithstanding the recent stabilization of Prva Banka, the authorities
recognize that it remains a significant fiscal risk due to its reliance on state-related
deposits, and a potential threat to the stability of the banking system. The bank
12
European Commission Opinion on Montenegro's application for membership of the European Union,
November 2010.
18
continues to rely heavily on deposits from Central Government and majority state-owned
enterprises, primarily EPCG (the second largest shareholder of Prva Banka)13
. The full-
scope examination conducted by the CBCG in late 2010 disclosed that the bank’s asset
quality problems persisted, with the solvency ratio remaining well below the minimum
requirement of 10 percent. In March 2011, the CBCG adopted a new supervisory
strategy (Supervisory Action Plan) for Prva, which, inter alia, required the bank to reach
the minimum solvency ratio of 10 percent by end-April 2011, to reach and maintain
thereafter a minimum solvency ratio of 12 percent by end-December 2011, and develop a
plan to improve the maturity mismatch of its assets and liabilities and excessive
concentration of deposits. Prva met the first of these capital increase targets on time by
means of a new share issue and recovery of NPLs.
43. In parallel, the MoF initiated a gradual withdrawal of central government
deposits from Prva Banka. Total exposure of €28 million was reduced by 25 percent by
end-April 2011. Furthemore, a time-bound schedule was adopted which calls for the
withdrawal, in equal monthly tranches of €1.5 million, of a further 40 percent by end-
December 2011, and all remaining deposits by end-June 2012. This schedule was
coordinated by the MoF with the CBCG in order to ensure that the withdrawal of
government deposits would not destabilize the bank’s liquidity position. Furthermore,
the GoM issued guidance to all majority state-owned enterprises, municipalities and other
state-sponsored institutions to use clearly defined eligibility criteria for procurement of
financial services from commercial banks14
and set a limit for the maximum share of
deposits that should be kept with a single bank. This guidance, whose impact is already
being felt by Prva Banka, should make a major contribution to ensuring that Prva Banka
no longer receives a disproportionate share of state-related financial services business.
IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM
A. Link to the Country Partnership Strategy
44. The objectives of the FSDPL1 are consistent with key priorities and expected
outcomes supported under the current Country Partnership Strategy (CPS). The
FY11-FY14 CPS for Montenegro, endorsed by the Board in January 2011, envisages a
series of two programmatic financial sector DPLs. These operations constitute over half
the CPS lending envelope and fall under the first of the two main priority areas, namely,
―support EU accession through strengthening institutions and competitiveness.‖ The
CPS clearly states that one of the key outcomes of the CPS is expected to be ―a stronger
banking system governed by a modern regulatory framework and central institutions,
which is more resilient to future shocks.‖
13
Following its partial privatization in the Fall of 2009, EPCG is under a management contract with the
private strategic investor (Italy’s A2A utility company), which also has a representative on Prva’s Board of
Directors. 14
Specifically, the document instructs to use bank solvency and profitability as criteria for placement of
deposits, in addition to deposit interest rates.
19
B. Collaboration with the IMF and other Donors
45. This operation has been prepared in close collaboration with the IMF. The
Bank team has maintained close working relations with the Fund team for the purpose of
harmonizing policy recommendations and coordinating technical assistance (TA) efforts.
In general, the IMF has taken the lead on discussing with the authorities the
macroeconomic adjustments needed in view of the changed international and domestic
environment, while the Bank has focused primarily on helping the authorities address the
largest systemic threats to the banking sector. The two institutions have been working
together on improving the legal and regulatory environment for the banking sector, in line
with the joint recommendations recorded in the most recent Financial Sector Assessment
Program (FSAP) Update Report (FY07). Specifically, the Bank and the IMF have jointly
reviewed and provided technical assistance to the authorities on the legal amendments to
the draft Law on Banks and the Bank Bankruptcy and Liquidation Law. The IMF has
taken the lead on reviewing the draft law on the Central Bank, while the Bank has played
the same role for the Law on Deposit Protection Fund. The lack of a formal IMF
program is also contributing to risks albeit the IMF is active on policy matters (mainly
banking and fiscal) and is working closely with the Bank.
46. The Bank is coordinating its policy program under this FSDPL1 with the
European Union, Montenegro’s most important current and future development
partner. The structural and regulatory reforms supported by this operation are essential
for achieving the goals set by the Stabilization and Association Agreement, which aims at
the gradual convergence of Montenegro’s economy with the EU. The ongoing large
twinning project financed by the EU and implemented by Central Bank of Bulgaria
provides extensive TA to the CBCG for further strengthening its supervision capacity.
47. The Bank has also maintained a robust dialogue with other donors active in
Montenegro, in order to avoid the duplication of efforts and leverage support for the
GoM’s reforms. In the context of a joint International Financial Institutions initiative,
the EBRD has been very pro-active in providing additional debt and equity support to the
Montenegrin banking sector since the start of the crisis. Following consultations with the
Bank team and enactment of the law on protection of deposits, the EBRD approved a €30
million stand-by loan to the DPF. Germany’s KfW has also provided several lines of
credit to commercial banks, and is providing a TA program for the DPF.
C. Relationship to Other Bank Operations
48. This loan is not directly related to any recent Bank operation in Montenegro.
However, earlier operations supported the development of Montenegro’s financial and
enterprise sector. The series of Structural Adjustment Credits (SAC 1 approved in 2002
and SAC 2 approved in 2004) supported key structural reforms to enhance fiscal
sustainability and promote private-sector led growth. The SACs supported reforms in a
number of areas including the business environment, financial sector and public
administration. The financial sector component sought to resolve non-performing assets
carved out of the banking sector, and complete the privatization of large banks.
20
D. Analytical Underpinnings
49. The design of this operation is based on considerable analytical and TA
work. The FSAP Update (FY07) assessed overall financial system stability and
vulnerabilities. Some of the main policy issues identified in the FSAP Update have been
addressed in this operation, including improvements in the regulatory environment for the
banking system, strengthening the liquidity management framework, and improving the
crisis management framework. An FY09 Early Warning Toolkit grant funded by FIRST
helped develop and test new methodologies for on-site bank examinations and stress-
testing models for credit risk. The Bank subsequently advised the CBCG on conducting
in-depth on-site examinations and stress-testing of systemic banks, which served as an
analytical foundation for developing bank-specific supervisory action plans (including
that for Prva Banka). The Bank was also closely involved in assisting the Montenegrin
authorities in designing the least-cost restructuring strategies for problem banks. Other
related recent analytical work includes an FY07 Report on Observance of Standards and
Codes (ROSC) analyzing Montenegro’s financial and auditing standards, and an FY10
grant from FIRST to support the development and adoption of a Country Strategy and
Action Plan to enhance the quality of corporate sector financial reporting to comply with
EU standards.
E. Lessons Learned
50. The proposed operation has incorporated lessons from Bank’s experience in
2008-2009 crisis, as well as in previous economic and financial crises. A recent
comprehensive review of the Bank’s responses to financial crises15
underscored the
following lessons:
Early response. The key lesson from the Bank’s responses to previous crises is
the importance of an early response. In this case, the Bank fielded an
identification mission within a few weeks from receiving the request for budget
support, even though the CPS did not foresee a need for a DPL instrument at that
time. Addressing early on the systemic vulnerabilities in the banking sector
helped contain the spread of the crisis and minimize potential fiscal costs.
Need for focus. During crises, it is crucial that operations focus on selected key
areas for good outcomes. The proposed operation incorporates this lesson by
focusing on a main challenge recognized by the Government, namely, addressing
vulnerabilities in the banking sector and making the banking sector more resilient
to cope with possible future shocks.
Government ownership. The proposed reforms need to support the authorities’
priorities and an extensive dialogue is necessary to ensure ownership of the
technically complex and politically sensitive reforms in the banking sector. This
15
―Lessons from Past Financial Crisis‖, Independent Evaluation Group, the World Bank, 2009.
21
FSDPL1 was prepared in direct collaboration with the top leadership of the MoF
and the CBCG.
Communication strategy. The operation should promote the understanding of,
and the appropriate popular support for the reforms through a carefully planned
and implemented communication strategy by the Government and the Bank. The
staff of the World Bank Field Office in Podgorica has played a critical role in this
regard by ensuring consistent and timely communication with key stakeholders.
The Bank also kept civil society and the general public informed of its position on
critical issues through interviews to national media and press releases.
Coordination among development partners. Coordination is critical since a
coordinated approach brings better results. This operation incorporates this
lesson by working closely with the IMF, EC, and EBRD.
V. THE PROPOSED OPERATION
A. Objective and Rationale
51. The objective of the proposed operation is to support the authorities’ reform
program for strengthening the banking sector, which is a critical pre-condition for
sustained economic recovery and balanced private sector-led growth. The operation
supports strengthening the banking sector and increasing its resilience to future shocks,
by undertaking reforms in the following areas: (i) maintaining market confidence; (ii)
strengthening the bank liquidity framework; (iii) assessing and addressing banking sector
vulnerabilities; (iv) enhancing the regulatory framework; and (v) problem bank
restructuring.
52. The negative impact of the crisis on Montenegro’s economy provides a strong
rationale for the operation. The first FSDPL is designed to provide a coherent policy
response to systemic risks in banking sector. It also lays the foundation for healthy future
growth by advancing the regulatory reform agenda in financial sector. The prior actions
proposed under this operation are listed in Box 1 below. The overall structure of the
proposed Program is shown in the attached Policy Matrix (Annex 1).
53. The design of the Government’s reform program and this operation has
benefited from consultations with relevant stakeholders (as required by OP 8.60). The authorities have pro-actively communicated with the public on the objectives of the
program. The MoF and the CBCG representatives made frequent appearances on TV and
in printed media, regularly issued press releases (published on MoF and CBCG websites
in both Montenegrin and English), and organized roundtables to explain the measures
taken by the authorities to boost market confidence and restore healthy financial
intermediation. The changes in legislation had been extensively discussed with industry
stakeholders, and went through an extensive inter-ministerial harmonization process
before their submission for the Parliament’s consideration. The Bank team has also
consulted widely with stakeholders, including banking sector representatives, academic
22
experts, and representatives of the key development partners including the European
Commission
Box 1: Prior Actions for FSDPL 1
The following constitute prior actions for presentation of the Loan to the Bank’s Board of
Directors:
The Borrower has, through enactment of the Law on Protection of Deposits of August 7,
2010 (Official Gazette 44/10), introduced a mechanism for ensuring a smooth transition
from the blanket deposit guarantee by (i) increasing the ceiling for limited deposit
insurance coverage; (ii) enhancing the financial resources of the Deposit Protection Fund
by allowing additional funding sources in case of emergency; and (iii) shortening the
mandatory payout period.
The Borrower has, through enactment of the Law on Central Bank of Montenegro of
July 30, 2010 (Official Gazette 40/10 and 46/10), aligned the legislative framework for
the Central Bank of Montenegro (CBCG) with European Union sound practices,
including, inter alia, expanded powers and instruments for the CBCG’s function as
lender of last resort.
The CBCG has (i) completed onsite examinations and stress-testing of systemic banks to
determine the current and projected level of capital adequacy of such banks; and (ii)
approved, and made progress in implementation of, supervisory action plans for banks of
special concern, in each case applying a satisfactory methodology.
The Borrower has, through enactment of the Law on Amendments to the Law on Banks
of August 7, 2010 (Official Gazette 44/10), enhanced the regulatory framework for the
banking sector, including, inter alia, (i) strengthening ―fit and proper‖ criteria for bank
management and shareholders; (ii) improving the definition of ―related parties‖; (iii)
clarifying the CBCG’s powers for remedial action; (iv) strengthening the interim
administration process for problem banks; and (v) improving the statutory protection of
CBCG employees.
The Borrower has, through enactment of the Law on Amendments to the Law on
Bankruptcy and Liquidation of Banks of August 7, 2010 (Official Gazette 44/10),
provided CBCG with improved instruments for resolution of problem and insolvent
banks in a timely and least costly manner.
The CBCG has approved the time-bound Prva Banka Supervisory Action Plan (PB
Supervisory Action Plan) on the basis of an on-site inspection, and has confirmed that
Prva Banka is in full compliance with minimum regulatory requirements and provisions
of the approved PB Supervisory Action Plan.
The Borrower has (a) withdrawn twenty five (25) per cent of central government
deposits from Prva Banka by April 30, 2011, and (b) adopted, through its Ministry of
Finance, a decision on the complete withdrawal of central government deposits from
Prva Banka by June 30, 2012.
23
B. Operation Description and Policy Areas
54. A sound macroeconomic framework needs to be in place for this budget
support operation. As described in more detail in Section III.B, the macroeconomic
policy mix has, on the whole, been appropriate for addressing the spillovers from the
global economic and financial crisis (also see Annex 4 for the summary of most recent
Article IV Consultation).
Maintaining market confidence
55. Under this operation, the authorities have enacted the new Law on
Protection of Deposits. The law aims to maintain confidence in the banking system by:
(i) gradually increasing the ceiling for deposit insurance coverage; (ii) shortening the
timeframe allowed for insured deposit payouts; and (iii) providing a legal instrument to
mobilize external funding sources that would enhance the DPF’s financial capacity to
respond to large insured deposit payouts in the event of emergency.
Strengthening the liquidity framework
56. Under this operation, the authorities have enacted a new law on the Central
Bank of Montenegro (CB Law) that, inter alia, provides the CBCG with adequate
powers for its function as the LOLR. Under the previous CB Law, the CBCG had very
limited emergency liquidity lending capacity, which was in part the result of its inability
to create money due to the adoption of the Euro. Under the new CB Law, emergency
liquidity loans can be made to solvent banks for 90 days against collateral, extendable to
a maximum of 180 days when necessary to preserve the stability of the financial system.
Assessing and addressing banking sector vulnerabilities
57. Under this operation, the CBCG has employed a range of supervisory
techniques to identify and address vulnerabilities in the banking sector and develop
detailed and time-bound supervisory strategies aiming to correct identified
weaknesses. Starting in the fall of 2009, the CBCG undertook a series of full-scope on-
site inspections in all large and medium-sized banks, and conducted stress tests to
evaluate the likely impact of continued economic downturn. Based on these findings, the
CBCG prepared SAPs for all systemically important banks (CKB, NLB Montenegro
Banka, Hypo Alpe Adria Banka, and, lastly, Prva Banka). The SAPs recorded identified
weaknesses and risks, and included specific targets and deadlines for addressing any non-
compliance with regulations, with the focus on current and projected capital needs. Draft
SAPs were discussed and agreed with bank management and owners, and then officially
enacted by CBCG. The SAP has proven to be a highly effective tool in managing the
impact of the financial crisis and ensuring adequate capitalization of the system. All
systemically important banks have SAPs in effect and are currently in compliance with
key requirements of those plans which were last updated as of end-March 2011.
24
Enhancing the regulatory framework
58. Under this operation, the authorities have enacted improvements in the legal
and regulatory framework for the banking sector aiming at giving the CBCG
expanded powers for proactive and preventive supervision, as well as for efficient
resolution of insolvent banks. Specifically, amendments to the Law on Banks have
been enacted, inter alia, to: (i) clarify the definition of ―related parties‖; (ii) define the
scope of courts’ powers regarding legal action involving the CBCG; (iii) strengthen fit
and proper criteria for bank management and shareholders; (iv) enhance CBCG powers to
impose remedial actions; (v) introduce purchase and assumption (P&A) transactions as a
bank resolution option; (vi) strengthen the interim administration process, including
enabling the interim administrator to undertake open bank purchase and assumption
(P&A) transactions; and (vii) establish statutory protection for the staff of the CBCG in
exercising their supervisory duty. In parallel, amendments to the Bank Bankruptcy and
Liquidation Law have been enacted, that inter alia: (i) clarify the powers of the CBCG to
initiate the bankruptcy and liquidation procedure; (ii) limit the powers of courts to
override technical decisions by the CBCG on bankruptcy and liquidation proceedings;
(iii) improve statutory protection for the bankruptcy administrator; and (iv) align the
Bank Bankruptcy Law and the Law on Deposit Protection in the area of offsetting claims
in a deposit pay out.
Problem bank restructuring
59. Under this operation, the authorities undertook a number of steps aiming at
reducing the fiscal and banking stability risks associated with Prva Banka.
Following the completion of a full-scope on-site inspection using terms of reference
developed jointly with the World Bank, the CBCG adopted a time-bound SAP for Prva in
early 2011, whose most important provision was to require the bank to reach the
minimum solvency ratio of 10 percent by end-April 2011, and reach and maintain a
minimum solvency ratio of 12 percent by end-December 2011. As confirmed by the
CBCG, the first target was met on time by the bank through a combination of raising new
capital, seizure of collateral, and collecting repayments on non-performing loans.
According to the CBCG, as of April 30, 2011, Prva Banka was also in compliance with
provisions related to liquidity listed in its SAP, and with all other minimum regulatory
requirements. Continued compliance of Prva Banka with SAP provisions, including the
exact amount of additional capital needed in order to bring the bank to a minimum 12
percent CAR, will be determined by the next on-site inspection, to be conducted by 4th
quarter of 2011.
60. In parallel, the MoF initiated the process of gradual withdrawal of central
government deposits from Prva Banka. The total exposure of €28 million (end 2010
figure) was reduced by 25 percent by end-April 2011. The MoF adopted a schedule for
complete withdrawal of its deposits from Prva by June 2012, in equal-sized monthly
tranches. Also, as a result of guidance issued in March 2011 to state-owned enterprises
and other Governmental bodies by the MoF, Prva Banka has already received notice of
significant withdrawals of state enterprise deposits. In order not to endanger the bank’s
stability, the schedule for further withdrawals of central government deposits has been
calibrated to ensure that the overall rate of withdrawal of state-related deposits does not
25
jeopardize Prva’s liquidity position. The MoF and CBCG are cooperating with each
other to manage this process.
61. The proposed operation has applied good practice principles for
conditionalities, as described in Box 2.
Box 2. Good Practice Principles for Conditionality
Principle 1: Reinforce Ownership
There is ownership and commitment at the executive and parliamentary level as evidenced by a
number of policy actions to be taken under the package. The Bank’s contribution is based on
analysis conducted during preparation and accepted by the authorities as the basis for further
policy actions to add to and strengthen the set of reforms underway. The Bank team includes
experts with field experience in the country and knowledge of the executive, parliamentary, and
other consultative and consensus building procedures.
Principle 2: Agree up front with the Government and other financial partners on a
coordinated accountability framework
The program is very closely coordinated with the other collaborating partners, namely, the IMF
and the EC. The accountability framework delineated in the policy matrix contains very specific
actions with associated indicators for measuring results to gauge success of the program.
Principle 3: Customize the accountability framework and modalities of Bank support to
country circumstances
The policy measures are specifically geared to support the Government’s reform program and
mitigate future risks generated by the financial crisis. The funding is earmarked for potential
gaps with a view to ensuring a sustainable macro economic framework and financial stability.
Principle 4: Choose only actions critical for achieving results as conditions for disbursement
The policy actions focus only on those that are considered crucial towards maintaining a
sustainable macro economic framework and strengthening the banking sector. The actions are
those which contain key added value features as contributions from the Bank to the policy
agenda.
Principle 5: Conduct transparent progress reviews conducive to predictable and performance-
based financial support
This is a series of two FSDPLs. All the conditions of the first FSDPL will be implemented prior
to Board approval and thus monitoring will take place prior to Board approval. Monitoring will
also take place during loan implementation.
62. The proposed operation is the first in the series of two programmatic DPLs
supporting financial sector reform. FSDPL2, planned for mid-FY13, will continue and
deepen the regulatory and structural reforms initiated under this operation. Box 3 lists
the triggers envisioned for FSDPL2.
26
63. The triggers for FSDPL2 entail implementation of secondary legislation,
which should operationalize the reforms of several primary legislative acts under
the FSDPL1, and support priority areas in working programs of the CBCG and
MoF. Namely, the program will support development and enactment of by-laws under
the Law on Protection of Deposits, the Law on Central Bank, and the Law on Banks. In
addition, other priority areas in the working programs of the CBCG and the MoF will be
supported. These include: (i) full implementation of IFRS for commercial banks; and (ii)
further implementation of government policy on placement of deposits of state owned
companies, state agencies and municipalities with banks with due consideration of the
price, quality and risk aspects.
C. Expected Outcomes of the Operation
64. The main outcome of the operation would be creating the foundation for
economic recovery through maintaining a prudent macroeconomic framework and
strengthening the banking sector. Specifically, the measures supported under this
FSDPL1 would contribute to: (i) increased confidence in the banking sector; (ii)
enhanced ability of the central bank to provide emergency liquidity assistance; (iii)
effective supervision of the banking system consistent with Basel Core Principles; (iv)
strengthened legal authority of the CBCG for resolution of problem banks according to
international and EU good practices; and (v) following implementation of SAP and
withdrawal of central government deposits, Prva Banka no longer poses a systemic and
fiscal risk. Measurable expected outcome indicators for each area are presented in the
Policy Matrix (Annex 1).
Box 3: Indicative Triggers for FSDPL2
The following constitute indicative triggers for FSDPL2:
Adoption of the following regulations by the DPF: (i) regulation on informing depositors
on DI scheme in line with the EU directive; (ii) regulation on guarantee deposit payout
procedure; and (iii) guidelines for DPF's employees during the payout process.
Adoption of the following regulations by the CBCG: (i) by-law on the Lender of Last
Resort function of the CBCG; and, (ii) new Policy for Reserve Requirements.
The CBCG updates and implements SAPs, as evidenced by recapitalization of banks
within the prescribed timetable.
Adoption of the following regulations by the CBCG: (i) capital adequacy; (ii) COREP
(European Banking Agency common regulatory reporting standards) implementation;
and, (iii) credit risk management.
Adoption of CBCG decision on the timetable for harmonization of regulations with IFRS
and associated bank supervision capacity building plan.
Implementation of PB Supervisory Action Plan, including maintenance of CAR above 12
percent, and compliance with regulatory liquidity ratio.
Timely implementation of the MoF decision on withdrawal of central government
deposits from Prva Banka, aiming to reduce the value of deposits from the same source
by (i) further forty (40) percent by December 31, 2011; and (ii) further thirty five (35)
percent by June 30, 2012.
Implementation of a policy requiring all state and state controlled institutions to conduct
price and quality based selection process for banking services.
27
VI. OPERATION IMPLEMENTATION
A. Poverty and Social Impacts
65. The reforms proposed under this operation are expected to have overall
positive poverty and social impact. The deteriorating conditions in the economy,
manifested in the banking sector instability and the near collapse of the aluminum
industry, are very likely to have adverse effects on growth, employment, and poverty (see
Box 4 for more details). This operation would help mitigate the negative effects of the
crisis on poverty as it aims to: (i) increase the capacity of the financial authorities to
anticipate and address risks in the banking sector, thus avoiding a systemic crisis that
could be very costly to depositors; (ii) enhance the capacity of the financial authorities to
deal with troubled banks and thus help preserve taxpayers’ money; and (iii) facilitate a
resumption in credit activities.
Box 4: Recent poverty trends and social protection
Montenegro’s economic growth helped reduce poverty significantly through 2008, but this
trend was interrupted by the crisis. MONSTAT and the World Bank estimate that the share
of the population living below the absolute poverty line decreased from 11.2 percent in 2005 to
4.9 percent in 2008, and then rose to 6.8 percent in 2009 (Table 6). The poverty gap showed a
similar decline from 2005 to 2008, followed by an increase in 2009. Poverty increases were
greater among groups that were already poorer than average, including those living in rural
areas and the north, the unemployed, youth, and those dependent on social transfers. If the
poverty line were 25 percent higher—roughly equivalent to the Eurostat threshold of 60 percent
of national median income in 2009—poverty rates would be twice as high.
Table 6: Poverty and near-poverty in Montenegro, 2005–09 2005 2006 2007 2008 2009
National Poverty Line (in €/month/adult equivalent) 140.47 144.68 150.76 163.57 169.13
Headcount Poverty Rate (%) 11.2 11.3 8.0 4.9 6.8
Poverty Gap (%) 2.1 1.9 1.4 0.9 1.4
Broad Poverty Line = 125% of National Poverty
Line
175.59 180.85 188.45 204.33 211.28
Headcount Poverty Rate (%) 25.2 23.6 16.0 11.2 14.2
Poverty Gap (%) 5.3 5.0 3.6 2.3 3.3
Source: MONSTAT (2009a, 2010) and World Bank staff calculations from Household Budget Survey data
Note: Currency amounts are expressed in current Euros.
The existing social protection programs mitigate some of the negative impacts of the crisis
on poverty. Unemployment insurance was the first line of government social response in 2009,
with unemployment benefit coverage increasing in line with job losses among eligible workers.
For the poorest households, the means-tested last resort social assistance program (FMS/MOP)
also expanded its coverage in response to the crisis. The FMS/MOP is well-targeted, with 84
percent of program benefits going to the poorest quintile, and benefit levels are relatively
generous, among the highest in ECA. The main limitation of FMS/MOP with respect to crisis
mitigation is its low coverage rate: in 2009 only 16 percent of the poorest quintile and 23
percent of all poor received FMS/MOP benefits. Several reforms for improving social
assistance coverage and flexibility in responding to crises may be taken up by the second
FPDPL.
28
B. Environmental Aspects
66. Specific actions under the proposed FSDPL1 are not expected to have any
negative effect on the environment. The specific country policies supported by the
FSDPL1 are not likely to cause effects on the country’s environment and natural
resources. The legal and regulatory changes implemented in the context of the FSDPL1
do not allow the banking sector to circumvent environmental regulations governing
investments, nor modify the existing environmental regulatory framework in any way.
C. Implementation, Monitoring, and Evaluation
67. The MoF will be responsible for the overall implementation of the proposed
operation. The MoF is the main policy counterpart for the Bank team. The CBCG and,
to a lesser extent, the DPF play an important role in the implementation of the banking
sector reforms.
68. The implementation of the policy actions set forth in the policy matrix
(Annex 1) has required technical discussions amongst the Bank and the
implementing institutions. The Bank and the Montenegrin authorities have collaborated
closely in the preparation of this operation. The Bank has provided policy advice and
technical assistance to the authorities on all proposed policies, including design of
macroeconomic framework, drafting of new financial sector legislation, methodology for
enhanced bank supervision, and problem bank restructuring.
69. Specific outcome indicators will be used to monitor the implementation of the
operation. The Bank, in collaboration with the Montenegrin authorities, will monitor,
inter alia, the following: (i) evolution of deposits and of non-deposit funding sources; (ii)
evolution of credit growth; (iii) evolution of NPLs and provisioning levels; (iii) bank
capital adequacy levels; (iv) bank liquidity levels; and (iv) progress with the restructuring
of Prva Banka and of the other large banks. These indicators will serve to evaluate the
impact of the policy changes supported by the proposed operation.
D. Fiduciary Aspects
70. Overall fiduciary risk for the Public Financial Management (PFM) system in
Montenegro is considered to be significant. The findings and conclusions of various
assessments of the Montenegrin public financial management system have been
incorporated within and indeed are integral to the design of the operation. The Public
Expenditure and Financial Accountability Assessment (PEFA) 2009 noted that the
Government has exerted considerable effort to improve its budgeting, reporting, internal
control, and internal auditing. However, despite progress in setting up the central
elements of a sound PFM system, implementation has not been uniform across ministries
and levels of the Government. A number of areas need further strengthening through
effective and continuous reform process. Progress up to date in specific areas, as well as
areas for improvement in the future, are summarized below.
29
71. Accounting data is assessed to be accurate, however the quality of financial
statements should be improved in terms of the standards applied and level of details
presented. Timeliness of submission of financial statements is good with statements
being consistently produced by end-July. The information on national budget is publicly
available, with basic data on revenues and executions published on a monthly basis on
the MoF website. However, financial reporting could be considerably improved by
producing budget revenue and execution reports in sufficient detail so as to enable a
detailed comparison of budget outturn with the original budget, and producing annual
financial statements in accordance with consistently applied and recognized public sector
accounting standards.
72. Capacity of the Internal Audit needs further strengthening. Due to the small
number of internal auditors, it is understood that the internal audit manual and Institute of
Internal Auditors (IIA) standards are not applied in their entirety in every audit including
the application of systems-based audits. Whilst the MoF’s Internal Audit Unit performs
audits of expenditures in the ordinary course of its work, it has not audited revenues since
2004. All internal audit units, as a matter of course always issue a report after every
internal audit assignment, finalize such reports only after discussion and agreement with
the audited entity and distribute the finalized report to the management of the audited
entity. All the internal audit units were of the view that most recommendations and
findings are acted upon by the management of the audited entity. During subsequent
internal audits of an entity, the internal audit units check whether compliance has been
achieved although this is not always documented. However, in view of the small number
of internal auditors, the number and frequency of repeat internal audits is rather low.
Thus, and as acknowledged by the Internal Audit Units, it has not to-date been possible
and indeed was not standard practice for the unit to follow-up on the implementation of
its recommendations in a timely manner.
73. External scrutiny and audit have improved, but require further
strengthening. Significant strides have been made to improve the external audit function
with the constitution of the State Audit Institution (SAI) in 2004 and the recruitment of a
small cadre of auditors who have passed an internally-administered professional
examination. However, the audit methodology requires elaboration and the cadre of audit
staff is small and thus audit coverage is also limited. With the available limited
resources, the SAI performs as well as could reasonably be expected but it does require
considerable further strengthening. Due to time and resource constraints, audit plans are
prepared in order to have all public entities audited at least once in three years.
According to the SAI, in any one year it audits entities that account for around 70 percent
of consolidated public expenditures. Procedurally, external scrutiny is good in that the
Parliamentary Committee on Economy, Finance and Budget receives and is substantially
afforded the opportunity to scrutinize the annual budget law as well as external audit
reports. However, the committee appears very under-staffed and thus unable to perform
its role in as detailed a manner as it would like or could reasonably be expected of it.
Lack of capacity of the external audit function will not have any implications on the
development policy lending since considering the World Bank’s knowledge of the public
finance management systems, the ongoing improvements of these systems and favorable
findings about the Central Bank, no audit of the deposit account will be required.
30
74. The current capacity constraints in the public financial management will not
have direct implications on the development policy lending due to the nature of the
development policy lending. The World Bank has substantial knowledge of the public
finance management systems, and the Government is undertaking significant steps to
improve these systems. There are a number of reform strategies adopted in Montenegro
and currently under implementation. Some of the more recent are: Strategy of Public
Internal Financial Control (2007), Public Internal Financial Control Law (2008), and
Strategy of Management of Public Debt (2008). Other planned PFM reforms relate to
planning of the budget, improvement of functional analysis and structure of the budget,
as well as of the capital budgeting. Considering the favorable findings about the Central
Bank, no audit of the deposit account to be opened in the Central Bank will be required
(please also refer to the next paragraph). Confirmation letter from the MoF will be
required within 30 days after the receipt of the funds with regards to the receipt and
crediting the funds to an acceptable account.
75. Foreign exchange control environment. A deposit account will be opened
and administered in the Central Bank as the Government’s agent for holding and
administering the Single Treasury Account. The auditors expressed clean opinion on
the Central Bank’s financial statements for the years 2007, 2008 and 2009. They have
not identified any weaknesses relating to internal controls system, or any deficiencies,
which would represent risk for foreign exchange environment or flow of funds. The
World Bank’s recent assessment conducted in April 2011, included the review of the
Central Bank, and assessed its systems, procedures and processes as sufficiently sound
and reliable. Walk through test of the accounting cycle and the internal controls, has
been conducted during the assessment and identified no issues. The Central Bank is well
structured organizationally with adequate accounting and financial reporting systems,
appropriate procedures, lines of responsibilities and segregation of duties.
76. Several anticorruption measures have been put in place, including
development of internal and external audit functions, anticorruption laws and
anticorruption council. The fight against corruption is an important feature of the new
Government’s program. Institution building and improvements of standards in the areas
of the judiciary, police, health, and customs is targeted as well as strengthening of
controls and punishments for those who do not respect laws and regulations. Even if
more transparency is introduced and civil society engaged in this fight as planned by the
Government, the level of corruption will remain a challenge. The ongoing reforms and
improvements in the areas of public procurement, internal audit, and strengthening of the
role of the SAI contribute to the fight against corruption.
E. Disbursement and Audit Arrangements
77. The proposed DPL will follow the Bank’s disbursement procedures for
development policy lending. Upon approval of the Loan and notification by the Bank of
Loan effectiveness, the Government will submit a withdrawal application. At the request
of the Government, the Bank will disburse the Loan, less the amount of the front-end fee,
and the net proceeds of the Loan will be deposited in the Treasury’s Euro deposit account
in the Central Bank, this account being available for budget financing and forming part of
31
the official foreign currency reserves of the country. The Borrower shall ensure that
upon deposit of the net proceeds of the Loan into said account, an equivalent amount will
be credited within 30 days of disbursement in the Borrower’s budget management
system, in a manner acceptable to the Bank. If after the proceeds are deposited in the
Central Bank account the proceeds of the Loan are used for ineligible purposes as defined
in the Loan Agreement, the Bank will require the Borrower to promptly, upon notice
from the Bank, refund an amount equal to the amount of said payment to the Bank.
Amounts refunded to the Bank upon such request shall be cancelled.
78. The MoF will be responsible for the DPL’s administration, for preparing the
withdrawal application, and for maintaining the Treasury Euro Account at the
Central Bank. The MoF will provide to the Bank a confirmation that the amount of the
DPL has been credited to an account acceptable to the Bank (the format of the
confirmation letter should be acceptable to the Bank). The confirmation letter needs to
be submitted to the Bank within 30 days after receipt of the amount.
79. No additional fiduciary arrangements including audit are required for the
DPL, given the progress in public financial management reforms, the unqualified audit
opinions provided in the CBCG’s recent audited financial statements (FY 2007, FY 2008,
and FY 2009) and the positive assessment of the capacity of the Central Bank and
functioning of the Treasury. In addition, the nature of the operation does not imply
continuous budgeting, accounting, financial reporting and internal controls for the
Project, which would be applied over an implementation period, therefore fiduciary risk
is limited to the flow of funds through the Treasury system and the Central Bank as the
agent for holding the Single Treasury Account.
F. Risks and Risk Mitigation
80. The proposed FSDPL1 is a high-risk operation. The key risks are as follows:
Economic risks
Financial instability risk
Governance risks
Implementation risks.
Economic risks
81. Economic risks are substantial given Montenegro’s high external
vulnerability and a volatile external environment in which the country operates. Slower than expected growth in Southeast Europe and the EU could dampen
Montenegro’s recovery, which would further strain the fiscal stance. Slower recovery
would affect the corporate sector performance and consequently the financial sector.
Montenegro’s heavy reliance on tourism revenues and exports to Europe makes it
vulnerable to any deterioration in regional stability or a slowdown of growth in the EU.
This could jeopardize the achievement of planned medium-term macroeconomic and
social outcomes. Furthermore, the country’s euroization, high level of external debt and
large debt service requirements over the medium term render the Montenegrin financial
32
sector vulnerable to a slowdown in capital inflows and call for more prudent fiscal policy.
Finally, given the small size of the country, even a small shock may have a sizeable
impact on the economy.
82. These risks are partially mitigated by the proposed program of strengthening
the banking sector to enable it to resume lending to the private sector, and thus
encouraging economic growth. In addition, the Government is committed to tightening
fiscal policy more than provided for in the medium-term fiscal framework for 2012-2015
should macroeconomic conditions turn out to be worse than currently estimated. Finally,
the implementation of the Action Plan for opening negotiations with the EU, which
would lead to a legal system comparable to that of the EU countries, and the
Government’s structural reform program that aims to increase competitiveness will
contribute to improved investor confidence.
Financial instability risk
83. A risk to the proposed operation is that ongoing weaknesses in the banking
sector could increase financial instability. A good tourist season, foreign investments,
and the return of positive rates of economic growth, together with bank recapitalizations,
should help ease the credit squeeze and normalize the situation in the banking sector.
However, currently, the banking sector remains fragile. Banks are struggling to clean up
their balance sheets. Deposits have not recovered to pre-crisis levels. Nonperforming
loans have not yet leveled off and several systemically important banks remain fragile.
Prva Banka in particular remains vulnerable and lacks the support (enjoyed by the other
three systemic banks), which would be provided by a strong strategic investor or foreign
parent.
84. This risk is directly mitigated by the policy reforms supported by the
operation. The operation includes measures that aim to strengthen the liquidity
framework, improve the regulatory framework in the banking sector, strengthen the
deposit insurance scheme, build larger capital buffers, and restructure problem banks.
These reforms, if properly implemented, should enable the authorities to stabilize and
strengthen the banking sector.
Governance risks
85. Lack of progress on governance improvements could undermine
Montenegro’s path toward EU accession and thus threaten its efforts to achieve long
term macroeconomic and financial sector stability. EU and domestic observers have
raised concerns in the past about the lack of transparency, and possible influence
exercised by organized crime. With encouragement from the EU and other international
observers (including the Bank), the Montenegrin authorities are making a concerted effort
to correct this perception (see Box 5 for more detail). Specifically, the legislative
changes and the more robust supervision effort supported under this operation are
expected to strengthen the regulator’s standing and improve governance standards in the
financial sector. For instance, as a result of more stringent application of fit and proper
criteria, the top management of three systemically important banks has been replaced
following the start of the crisis.
33
Implementation risk
86. Implementation of the program is dependent on consistent collaboration
amongst authorities, especially between the MoF and the CBCG. While there is a
broad support for the restoration of banking sector stability, the inability of various
parties to reach consensus on specific policy actions or the wording of legislative changes
has sometimes slowed down progress in the past. With the new legislative framework
now in place, the CBCG will need to use its improved mandate to enforce prudential
norms, encourage higher capital buffers, and take appropriate supervisory measures for
banks of special concern.
87. To mitigate this risk, the Bank has promoted an inclusive, consultative
approach in designing the program. Through a series of technical consultations
involving both the CBCG and MoF, the team has sought to foster a mutual understanding
and agreement on the content of the reforms, especially on the legal reforms that are
necessary to harmonize Montenegrin legislation with EU financial sector legislation.
Going forward, the newly formed Financial Stability Council should provide a permanent
forum for consultation and information sharing between the CBCG, MoF and other
financial sector stakeholders. Judging by the recent progress with the reform program, it
Box 5. Montenegro’s Recent Progress in Governance Reform
In recent years Montenegro has made substantial gains in key international indicators
measuring governance and political and economic performance, and is a strong performer
relative to its SEE neighbors. Montenegro has advanced significantly between 2006 and 2009
on all six of the composite Worldwide Governance Indicators (WGIs) published by the World
Bank Institute (WBI). Notable gains were achieved on political stability, regulatory quality,
rule of law, and government effectiveness. Montenegro’s ranking in Transparency
International’s Corruption Perception Index rose from 85th in 2008 to 69
th in 2010, and
Freedom House upgraded its rating of Montenegro to Free in 2010 from Partially Free in
2007. Montenegro’s formal regulatory framework and implementation practices are fully in
line with the expectation for a country at its income level.
The prior actions for EU membership negotiations define current rule-of-law reform priorities.
The EU stated that membership negotiations could commence once the country had achieved
the necessary degree of compliance with, in particular, the Copenhagen political criteria
―requiring the stability of institutions guaranteeing notably the rule of law‖, pointing inter alia
to public-administration and judiciary-sector reforms aimed at enhancing professionalization,
and fostering de-politicization. The authorities have taken on this challenge. Immediately
following the EU’s awarding of candidate status, the Government underwent a process of
rejuvenation (including the transfer of premiership to the pragmatic and reform-minded
former Finance Minister), with a view to strengthening public institutions in those critical
areas impacting the country’s EU integration perspective. A critical subset of rule-of-law
challenges is congruent with structural reforms required to strengthen Montenegro’s relative
attractiveness as a destination for direct investment—areas in which the Bank has already
provided considerable support, and proposes to continue to do so under the current CPS. The
Bank’s Analytical and Advisory Assistance/Economic Sector Work provides overarching
policy advice on challenges related to public administration, fiscal policy priorities, public
financial management and procurement, statistics, and financial reporting.
34
appears that regulator’s actions are fully coordinated with, and supported by the
Government, without jeopardizing the CBCG’s operational independence.
88. There is also a risk that the implementation of politically sensitive and
technically complex reforms in financial sector may stall or even backtrack
following the approval of this FSDPL1. To mitigate this risk, the prior actions for the
proposed operation entail tangible steps (i.e., enactment of new legislation as opposed to
submission to the Parliament, implementation of supervision action plans by banks as
opposed to approval of SAPs by the CBCG, recapitalization of Prva Banka) that would
be hard to reverse. Furthermore, the reform program supported under this operation will
be continued and deepened under FSDPL2 planned for FY13. Finally, the Loan
Agreement will include, as remedies of last resort, a covenant making disbursement
conditional upon the satisfactory implementation of the Program, and a clause allowing
the Bank to ask for accelerated repayment in case the Program goes off track after
disbursement.
35
ANNEX 1. POLICY MATRIX
POLICY AREA
PRIOR POLICY ACTIONS FOR FSDPL1
INDICATIVE TRIGGERS FOR
FSDPL2
KEY EXPECTED RESULTS AND
OUTCOMES AT THE END OF THE
PROGRAM
1. Maintaining Market
Confidence The Borrower has, through enactment of the Law on Protection
of Deposits of August 7, 2010 (Official Gazette 44/10),
introduced a mechanism for ensuring a smooth transition from
the blanket deposit guarantee by (i) increasing the ceiling for
limited deposit insurance coverage; (ii) enhancing the financial
resources of the Deposit Protection Fund by allowing additional
funding sources in case of emergency; and (iii) shortening the
mandatory payout period.
Adoption of the following regulations by
the DPF: (i) regulation on informing
depositors on DI scheme in line with the
EU directive; (ii) regulation on
guarantee deposit payout procedure; and
(iii) guidelines for DPF's employees
during the payout process.
Increased confidence in the banking
sector leading to stabilization of deposits
(baseline: -23 percent decline from
September 08 to March 2011, target:
positive growth); and resumption of
lending (baseline -26 percent decline
from September 2008 to March 2011,
target: positive growth)
2. Strengthening
Liquidity Framework The Borrower has, through enactment of the Law on Central
Bank of Montenegro of July 30, 2010 (Official Gazette 40/10
and 46/10), aligned the legislative framework for the Central
Bank of Montenegro (CBCG)with European Union sound
practices, including, inter alia, expanded powers and
instruments for the CBCG’s function as lender of last resort.
Adoption of the following regulations by
the CBCG: (i) by-law on the Lender of
Last Resort function of CBCG; and, (ii)
new Policy for Reserve Requirements.
Enhanced ability of the central bank to
provide emergency liquidity assistance.
Adequate liquidity in the banking sector
(target: ratio of liquid assets to due
liabilities to remain in compliance with
the CBCG requirement of minimum ratio
of 1, calculated as an average for all
working days in a ten-day period)
3. Assessing and
Addressing Banking
Sector Vulnerabilities
The CBCG has (i) completed onsite examinations and stress-
testing of systemic banks to determine the current and projected
level of capital adequacy of such banks; and (ii) approved, and
made progress in implementation of, supervisory action plans
for banks of special concern, in each case applying a
satisfactory methodology.
CBCG updates and implements SAPs, as
evidenced by recapitalization of banks
within the prescribed timetable.
Improved quality of loan portfolio
(baseline: system’s NPL ratio at 23
percent in March 2011; target: NPLs
below eight percent).
Well-capitalized banks (baseline: average
CAR of banking system at 11.9 percent in
June 2009; target: average CAR of
banking system to remain above 12
percent)
4. Enhancing
Regulatory Framework
for Banking Sector
The Borrower has, through enactment of the Law on
Amendments to the Law on Banks of August 7, 2010 (Official
Gazette 44/10), enhanced the regulatory framework for the
banking sector, including, inter alia,(i) strengthening ―fit and
proper‖ criteria for bank management and shareholders; (ii)
improving the definition of ―related parties‖; (iii) clarifying the
CBCG’s powers for remedial action; (iv) strengthening the
interim administration process for problem banks; and (v)
improving the statutory protection of CBCG employees
Adoption of the following regulations by
CBCG: (i) capital adequacy; (ii) COREP
(European Banking Agency common
regulatory reporting standards)
implementation; and, (iii) credit risk
management.
Adoption of CBCG decision on the
timetable for harmonization of
Effective supervision of banking system
consistent with Basel Core Principles
Strengthened legal authority of CBCG for
resolution of problem banks according to
international and EU good practices.
36
POLICY AREA
PRIOR POLICY ACTIONS FOR FSDPL1
INDICATIVE TRIGGERS FOR
FSDPL2
KEY EXPECTED RESULTS AND
OUTCOMES AT THE END OF THE
PROGRAM
The Borrower has, through enactment of the Law on
Amendments to the Law on Bankruptcy and Liquidation of
Banks of August 7, 2010 (Official Gazette 44/10), provided
CBCG with improved instruments for resolution of problem
and insolvent banks in a timely and least costly manner.
regulations with IFRS and associated
bank supervision capacity building plan.
5. Restructuring of
Problem Banks The CBCG has approved the time-bound Prva Banka
Supervisory Action Plan (PB Supervisory Action Plan) on the
basis of an on-site inspection, and has confirmed that Prva
Banka is in full compliance with minimum regulatory
requirements and provisions of the approved PB Supervisory
Action Plan.
The Borrower has (a) withdrawn twenty five (25) per cent of
central government deposits from Prva Banka by April 30,
2011, and (b) adopted, through its Ministry of Finance, a
decision on the complete withdrawal of central government
deposits from Prva Banka by June 30, 2012.
Implementation of PB Supervisory
Action Plan, including maintenance of
CAR above 12 percent, and compliance
with regulatory liquidity ratio.
Timely implementation of the MoF
decision on withdrawal of central
government deposits from Prva Banka,
aiming to reduce the value of deposits
from the same source by (i) further forty
(40) percent by December 31, 2011; and
(ii) further thirty five (35) percent by
June 30, 2012.
Implementation of a policy requiring all
state and state controlled institutions to
conduct price and quality based selection
process for banking services.
Following implementation of SAP and
withdrawal of central government
deposits, Prva Banka no longer poses a
systemic and fiscal risk.
37
ANNEX 2. OVERVIEW OF THE BANKING SECTOR
1. The Montenegrin banking sector is dominated by foreign banks. The banking system
comprises 11 banks, nine of which are majority-foreign-owned, and accounting for about 88
percent of banking sector assets (Table 7).
Table 7: Basic Indicators of the Banking System
2006 2007 2008 2009 2010 Mar-11
Number of Banks 10 10 11 11 11 11
Number of Foreign Banks 7 7 9 9 9 9
Asset/GDP 67 111 107 102 97.3 N/A
Assets Growth y/y 106 108 11 -8 -3 -1
Deposits/GDP 50 78 65 61 59 N/A
Deposit Growth y/y 120 94 -5 -8 -2 -0.4
Household Deposits/GDP 23 38 28 28 31 N/A
Household Deposits y/y 184 104 -16 -1 13 0.2
Enterprise Deposits/GDP 17 27 23 20 17 N/A
Enterprise deposits y/y 130 98 -5 -14 -17 1.7
Credit/GDP 39 84 91 80 73 N/A
Credit Growth y/y 125 165 25 -14 -8 -5
Household Credit/GDP 14 30 34 30 29 N/A
Household Credit Growth y/y 198 155 31 -11 -6 -3
Enterprise Credit/GDP 23 52 55 47 42 N/A
Enterprise Credit Growth y/y 102 187 22 -18 -9 -7
Source: CBCG
Note: Q1 2011 GDP data not available.
2. The level of banking system concentration is relatively high. At end-March 2011, the
three largest banks accounted for 56 percent of total assets and 54 percent of deposits. In
particular, the largest bank accounted for 24 percent of assets and 31 percent of deposits (Table
8). Table 8. Concentration of the top banks, end-March 2011
Assets Loans Deposits Equity
1 bank 24 18 31 17
3 banks 56 55 54 40
5 banks 76 76 77 57 Source: CBCG
3. From 2005 to 2007, the Montenegrin banking system expanded very rapidly, but
growth came to a halt since late 2008 due to the impact of the financial crisis. The rapid
growth was driven by the entry of foreign banks, along with increased domestic demand. Total
assets increased by more than 100 percent on average in 2006 and 2007, from 67 percent of GDP
to 111 percent of GDP. Asset growth has slowed down substantially since 2008 due to the
impact of the global financial crisis, with assets growing only by 11 percent in 2008 (both due to
credit controls applied by the CBCG and the impact of the crisis), declining by eight percent in
38
2009, and further by three percent in 2010, and by one percent in the first three months of 2011
(Table 7).
Figure 4. Credit Growth in Montenegro
Source: CBCG
4. The expansion of the banking system was underpinned by the exceptionally high
credit growth, one of the highest in ECA countries, but a severe credit crunch has followed
since 2009. Total credit grew by 145 percent on average in 2006 and 2007, from 39 percent of
GDP to 84 percent of GDP. In early 2008, credit growth started to slow down due to the impact
of the crisis as well as in response to a series of restrictive measures taken by the CBCG to limit
the credit boom (credit growth ceilings and increased minimum solvency requirements). Thus,
in 2008, credit grew by 25 percent. Credit activity started to decline in the last quarter of 2008,
with total loans extended falling by about two percent in Q4 2008, as banks became concerned
about their deteriorating liquidity situation and ability of their parent banks to provide financing.
This declining lending trend continued in 2009, as credit declined by 14 percent year on year,
mainly due to banks’ rising asset quality problems and a decline in demand for loans from the
corporate sector affected by the weakening economy. In 2010, credit continued to decline by
eight percent at end-2010, and by five percent in the first three months of 2011, as banks have
focused on cleaning up their balance sheets.
Figure 5. Credit Growth in ECA countries
Source:IFS
-20
-15
-10
-5
0
5
10
15
20
25
020406080
100120140160180200 ECA countries: Credit growth, y/y
2007 (LHS) 2008 (LHS) 2009 (RHS) Sept 2010 (RHS)
0
20
40
60
80
100
120ECA countries: Credit to private sector/GDP, 2009
-20
-15
-10
-5
0
5
10
15
20
25
020406080
100120140160180200 ECA countries: Credit growth, y/y
2007 (LHS) 2008 (LHS) 2009 (RHS) Sept 2010 (RHS)
0
20
40
60
80
100
120ECA countries: Credit to private sector/GDP, 2009
39
5. The high credit growth was largely financed by external borrowings from foreign
banks, resulting in one of the highest loan-to-deposit ratios in the region, and exposing the
banking sector to substantial liquidity shocks. Financing from parent banks is one of the main
sources of financing for banks, as the banking sector is largely foreign-owned (88 percent of
system’s assets at end-end 2010). Funding from parent banks (borrowings from parent banks as
a share of total non-equity liabilities) increased from eight percent in 2006 to 14 percent in 2007,
21 percent in 2008, and has since then decreased to 20 percent in 2009, 17 percent in 2010, and
16 percent in the first three months of 2011. The high loan-to-deposit ratio exposed the banking
sector to substantial liquidity shocks. The LTD increased from 87 percent in 2006, to 121
percent in 2007, 169 percent in 2008, and has decreased since then to 154 percent at end-2009,
and further to 140 percent as of end- 2010. The LTD ratio in Montenegro still remained higher
than in many ECA countries at end-2010 ( Figure 7).
Figure 6. Funding Structure
Figure 7: Selected ECA countries: LTD, end-2010
Source: IFS
6. Deposits also increased rapidly in the years prior to the 2008 financial crisis, during
which massive deposit withdrawals undermined banks’ liquidity. Deposits increased by an
average of 107 percent in 2006 and 2007, from 50 percent of GDP to 78 percent of GDP.
Significant deposit withdrawals occurred throughout the banking system starting in late
September 2008. As public nervousness increased with the advent of the global financial crisis,
over Q4 2008, deposits declined by 18 percent. The anti-crisis measures implemented by the
authorities helped to slow deposit withdrawals, although they did not stop the outflow
completely. Between September 2008 and June 2009 there was a loss of about 25 percent of
total deposits (about a 33 percent decline of both household and enterprise deposits). In the
second half of 2009, deposits showed some signs of recovery. However, a loss of deposits
continued in 2010, as deposits declined by two percent (13 percent increase from households and
17 percent decline from enterprises) at end-2010. In the first three months of 2011, deposits
declined slightly by -0.4 percent, with a 0.2 percent increase from households and 1.7 percent
increase from enterprises. The decline was mainly due to a decline in financial institutions’
deposits. Overall, between September 2008 and March 2011, the banking sector lost more than
23 percent of total deposits in the system. The withdrawal of deposits was large and persistent,
as deposits have not recovered yet to pre-crisis levels.
40
Figure 8. Deposit growth
Source: CBCG
7. The withdrawal of deposits, particularly in the largest two banks by size of deposits –
CKB and Prva Banka – led to a temporary liquidity crisis in the system. CKB and Prva
Banka lost more than €486 million of deposits (more than a third of deposits respectively) from
September 2008 to June 2009, accounting for 86 percent of total deposit outflow in the system
(CKB accounted for 55 percent of total deposit outflow and Prva Banka for 31 percent of total
outflow). The deposit outflow caused deterioration in liquidity, with the liquidity ratio of liquid
assets to short term liabilities declining from 32 percent at end-2007 to 21 percent at end-2008.
This liquidity ratio was particularly low at Prva Banka at end 2008 with liquid assets to short
term liabilities at seven percent (compared to 21 percent system wide) and liquid assets to total
assets at 5.8 percent (compared to 11 percent system wide). Since then, system wide liquidity
has improved with a liquidity ratio of 26 percent at end-2009, due to the CBCG measures to
improve liquidity in the system by lowering the reserve requirement rate, as well as due to large
inflows as a result of privatization of EPCG. In 2010, the liquidity ratio improved further to
about 33 percent by year-end.
Figure 9. Banking Sector Liquidity
Source: CBCG
8. The banking system entered the crisis with relatively adequate prudential ratios, but
preexisting vulnerabilities were accentuated by the crisis. The banking system reported
adequate capitalization as of end Q2-2008, with a capital adequacy ratio of 27 percent (above the
41
regulatory minimum of 10 percent). NPLs had already been rising from 3.2 percent in 2007 to
3.9 percent at end Q2-2008, but still remained at low levels. The banking system was also
relatively liquid with the liquidity ratio of liquid assets to short term liabilities at about 27
percent at end-Q2 2009. However, funding liquidity risks were high, especially since banks
were heavily reliant on foreign financing.
Table 9. Key Prudential Indicators of the Banking System
2007 2008 2009 2010 Mar-11
Liquidity
Liquid assets to short term liabilities 32 21 26 33 33
Liquid assets to total assets 22 11 15 19 19
Liquid assets to total liabilities 24 12 17 21 22
Capital Adequacy
Regulatory capital to risk-weighted assets 17 15 16 16 15
Capital to Assets 8 8 11 11 10
Asset Quality
NPLs/loans 3 7 13 21 23
Past due loans (above 30 days)/ loans 4 12 23 24 30
Provisions/ NPLs 74 56 43 31 24
Provisions/ loans 2 4 6 6 6
NPLs net of provisions, in percent of capital 8 32 52 103 122
Earnings and Profitability
ROA 1 -1 -1 -3 -2
ROE 6 -7 -8 -27 -23 Source: CBCG
9. The main vulnerability facing the banking sector prior to the crisis was liquidity risk,
due to the high concentration of deposits in the top banks and banks’ reliance on external
borrowings. At end-2008, the top three banks (CKB, Prva, and Hypo Alpe Adria) held 63
percent of total deposits, with the potential to undermine stability in case of a massive deposit
withdrawal. In addition, financing from parent banks constituted 76 percent of total borrowings
at end-2008, exposing the banking sector to liquidity shocks in case parent banks were unable to
sustain financing to their subsidiaries.
10. In addition to the liquidity stress, the asset quality in the banking system has
deteriorated rapidly since the beginning of the crisis on the back of accumulated risk
exposures during the boom. The weakened economy, especially with the declining
performance of the construction sector and the real estate market, contributed to a high rise in
NPLs. NPLs as a share of total loans increased from 7.2 percent at end-2008 to 13.6 percent at
end-2009, to 21 percent at end-2010, and further to 23 percent at end-March 2011. At the same
time, past due loans (loans overdue by more than 30 days) increased from 11.5 percent at end-
2008 to 23 percent at end-2009, to 24 percent at end-2010, and further to 30 percent at end-
March 2011. The rapid rise in NPLs during 2010 was driven in part by Prva Banka’s delay in
recognizing the extent of its NPLs (which did not occur until after an onsite inspection in
December 2010), in part due to the contraction in total loans as banks ceased lending (and thus
42
increased NPLs as a proportion of total loans), and also in part due to other large banks
(particularly CKB and Hypo), which ―cleansed‖ their loan portfolios in 2010 in anticipation of
spinning off large volumes of NPLs to their foreign parents in the first half of 2011, a process
which is now underway. Given estimated GDP growth of two percent in 2011 (after an
estimated 1.1 percent growth in 2010), the ending of the cleansing process, and the spin-off of
NPLs now underway, NPLs are expected to stabilize and then decline during 2011, allowing
banks to resume lending.
11. Provisions coverage of NPLs has been on a declining trend. Provisioning as a share of
total loans increased from four percent at end-2008 to 6.3 percent at end-2009 and to 6.4 percent
as of end-2010. In the first three months of 2011, provisions decreased to 5.5 percent of total
loans (Figure 10). Provision coverage of NPLs has been on a declining trend from 56 percent in
2008 to 47 percent in 2009, to 31 percent as end-2010, and to 24 percent at end-March 2011.
This is partly due to a relaxation in asset classification and provisioning requirements for banks
that the CBCG has undertaken since June 2009. In addition, net NPLs account for a very high
share of banks’ capital, at more than 100 percent at end-March 2011.
Figure 10. NPLs, Loan Loss Provisioning, and Capital at Risk
Source: CBCG
12. Due to the deteriorating asset quality, the system’s capital adequacy was negatively
affected. The banking system’s capital adequacy declined from 15 percent in 2008 to 13 percent
in 2009, increased to 15.9 percent in 2010, and stood at 15.4 at end-March 2011. Parent foreign
banks were able to provide additional capital in the amount of €230 million from Q4 2008 to
March 2011 - to their local subsidiaries to offset the losses caused by the crisis. Prva Banka is
posing the highest risk since, unlike other systemically important banks, it could not rely on
support from a foreign parent.
13. In response to rising NPLs, banks have been restructuring credit. In 2009, total
restructured loans amounted to €205 million (about nine percent of the loan portfolio) and as of
end-March 2011 to €260 million (over 12 percent of the loan portfolio). Loan restructuring
consisted mainly of prolonging repayment of the principal or the interest. On December 23,
2009, the CBCG adopted a temporary regulation allowing creditors to negotiate restructuring
with debtors that have loans of above 180 days overdue loans, a change from the previous
requirement of restructuring loans of up to 90 days overdue.
0
20
40
60
80
100
0
5
10
15
20
25
2006 2007 2008 2009 2010 Mar-11
NPLs/total loans (LHS) Provisions/NPLs (RHS)
0
20
40
60
80
100
120
140
2006 2007 2008 2009 2010 Mar-11
NPLs net of provisions, in percent of capital
43
14. The crisis had a rapid and dramatic impact on bank profitability. The banking sector
has incurred heavy losses since December 2008. The ROA decreased from -0.6 percent in 2008
to -0.7 percent at end-2009, to -2.8 percent at end-2010, and improved slightly at -2.4 percent at
end-March 2011. The ROE declined from -6.9 percent in 2008 to –7.8 percent at end 2009, and
declined dramatically in 2010 reaching -28 percent at end-2010, and stood at -23 percent at end-
March 2011. The banking sector incurred losses throughout 2010 with €82 million in losses at
end-2010. However, in the first three months of 2011, the rate of losses declined as banks
incurred €17 million in losses during this period.
Figure 11. Profitability of the Banking Sector
Source: CBCG
Table 10. Income Statement
2006 2007 2008 2009 2010 Mar-11
Net Interest Income 27,355 33,954 28,313 39,643 -22,578 -8,874
Interest Income 65,157 142,371 245,423 236,833 213,894 49,243
Interest Expenses -27,143 -66,883 -135,336 -116,465 -100,192 -22,466
Provision Expenses for Losses -10,659 -41,534 -81,774 -80,725 -136,280 -35,651
Net Non-Interest Income 36,868 60,529 53,644 42,432 43,403 13,692
Fee Income 36,172 54,816 63,462 49,262 49,708 10,766
Fee Expenses -7,435 -11,692 -15,792 -16,556 -15,275 -3,739
Other Income (net) 8,336 17,590 4,859 9,176 10,680 1,547
Other Extraordinary Income
(net) -205 -185 1,115 550 -1,710 5,118
Overhead and Other Expenses -53,972 -78,101 -99,765 -101,108 -101,676 -22,166
Net Income Before Tax 10,251 16,382 -17,808 -19,033 -80,850 -17,070
Income Taxes and Contributions -1,242 -2,475 -1,879 -2536 -827 -133
Net Profit/Loss 9,009 13,907 -19,687 -21,569 -81,677 -17,203
Source: CBCG
-20
-15
-10
-5
0
5
10
2006 2007 2008 2009 2010 Mar-11
ROA and ROE
ROA
ROE
-100,000
-80,000
-60,000
-40,000
-20,000
0
20,000
2006 2007 2008 2009 2010 Mar-11
In E
UR
00
0's
Profit/Loss
44
15. Parent banks supported their Montenegrin subsidiaries with substantial additional
funding, thus helping to partially offset the decline in deposits. In total, Montenegrin banks
received around €230 million in equity and subordinated debt from Q4 2008 to March 2011, with
most of the funds going to CKB, Hypo Alpe Adria, NLB and Podgoricka. However, there is no
commitment that foreign banks would continue to provide support to their subsidiaries,
especially if parent banks themselves come under additional stress.
Table 11. Balance Sheet
2006 2007 2008 2009 2010 Mar-11
Assets
Cash and deposits 511,902 664,376 473,271 528,707 629,734 626,195
Loans 847,166 2,245,684 2,797,533 2,397,755 2,199,974 2,092,092
Loan loss provisions -19,048 -52,218 -111,928 -150,225 -141,663 -115,361
Net loans 828,117 2,193,467 2,685,605 2,247,530 2,058,311 1,976,731
Securities 26,270 17,667 19,076 82,353 53,297 62,512
Financial derivatives
48 6 3
Factoring and forfeiting
5,446 12,707 31,363
Custody services
19 23 24
Other assets 66,126 101,374 139,925 167,215 202,804 214,250
Provisions for assets other
than loans -1,000 -1,451 -8,216 -6,085 -13,227 -7,565
TOTAL ASSETS 1,431,416 2,975,432 3,309,661 3,025,233 2,943,655 2,903,513
Liabilities
Deposits 1,075,769 2,091,075 1,990,590 1,824,688 1,789,852 1,783,576
Borrowings 172,351 536,249 908,161 741,822 701,386 669,675
Financial derivatives
918 614 406
Custody Services
1,097 340 481
Other liabilities 34,533 111,167 131,533 124,974 140,558 146,770
TOTAL LIABILITIES 1,282,654 2,738,492 3,030,284 2,693,499 2,632,750 2,600,908
TOTAL CAPITAL 148,762 236,940 279,377 331,734 310,905 302,605
TOTAL LIABILITIES
AND CAPITAL 1,431,416 2,975,432 3,309,661 3,025,233 2,943,655 2,903,513 Source: CBCG
45
ANNEX 3. LETTER OF DEVELOPMENT POLICY
46
47
48
49
50
51
52
53
ANNEX 4. FUND RELATION NOTE
IMF Executive Board Concludes 2011 Article IV Consultation with
Montenegro Public Information Notice (PIN) No. 11/51 May 6, 2011
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2011 Article IV Consultation with Montenegro is also available.
On April 29, 2011, the Executive Board of the International Monetary Fund (IMF) concluded
the Article IV consultation with Montenegro.1
Background
A tentative recovery is taking hold, following the global crisis that exerted heavy blows
upon the economy. In 2010, a good tourism season was followed by resumed metal
production, while heavy rains in the region boosted electricity production and exports. After
contracting for almost two years, industry began to grow again in the second half of 2010.
Nevertheless, industrial production at end-2010 was still considerably below its pre-crisis
peak. Expected large-scale infrastructure foreign direct investment has so far not
materialized and construction activity remains depressed. Overall 2010 GDP growth is
estimated at 1.1 percent, keeping output below its 2008 level.
The needed rebalancing of the economy has begun. Inflation and wage growth decelerated
sharply and the current account deficit halved to around 26 percent of GDP in 2010. While
most of the improvement was due to a weather related boost in electricity exports and
rebounding metals production, the nascent adjustment in costs has also improved
competitiveness. The improved fundamentals have also contributed to the September 2010
debut Eurobond issuance of €200 million, subsequent spread tightening, and a further
€180 million issuance in April 2011.
Fiscal consolidation has commenced. Reflecting mainly significant capital expenditure cuts,
the 2010 fiscal deficit is estimated to have declined by 1½ percent of GDP to 3.9 percent,
though, loan guarantees of 3.6 percent were extended to industrial companies. Going
forward, the authorities aim at balancing the budget in 2012 and achieving a sizeable
surplus thereafter in order to bolster sustainability, lower financing risk, and boost the economy’s resilience to shocks.
54
In the banking sector, confidence has begun to return, as evidenced by increasing
deposits, though they are still below their levels in the third quarter of 2007. However,
non-performing loans have not yet leveled off and Financial Soundness Indicators have
continued to deteriorate. Stagnant lending at the current juncture primarily reflects the
dearth of creditworthy projects.
Executive Board Assessment
Executive Directors noted that, although the recovery is gaining momentum, limited policy
space and incomplete reforms pose risks to the outlook. Accordingly, Directors encouraged
the authorities to step up efforts to reconstitute fiscal, external, and financial buffers and to
address rigidities in product and labor markets.
Directors welcomed the start of fiscal consolidation and supported the authorities’ plan to
balance the central government budget by 2012, and run surpluses thereafter. They
considered that a durable fiscal adjustment should encompass both revenue and
expenditure measures, including steps to increase the yield from property taxes and curb
the public sector wage bill. An early implementation of pension reform would also
strengthen the public finances, as would further efforts to avoid expenditure arrears and
direct budget support to private companies.
Directors stressed the importance of restoring the soundness of the banking system to
bolster the resilience of the economy and promote private sector-led growth. They
welcomed recent steps to reinforce the legal and prudential frameworks and encouraged
stronger supervisory practices. In particular, noting that full euroization limits the ability of
the central bank to provide liquidity support to banks, Directors called for conservative
capital and liquidity requirements and an early unwinding of regulatory forbearance.
Noting the importance of strengthened competitiveness for securing external stability,
Directors agreed that structural reforms should remain a top policy priority. Greater
flexibility in wage setting and employment protection would support job creation in the
private sector, while addressing unemployment and poverty traps would boost labor
participation and market attachment. Improvements in the business environment and
investment climate are also part of the unfinished agenda.
Directors cautioned that long-standing weaknesses in economic statistics hamper policy
design and evaluation. They encouraged the authorities to make further progress in
addressing them.
Montenegro: Selected Economic Indicators, 2008–11
(Under current policies)
2008 2009 2010 2011
Est./Prel. Proj.
Real economy
Nominal GDP (millions of €) 3,086 2,981 3,023 3,111
Gross national saving (percent of GDP) -10.0 -3.1 -3.6 -2.5
Gross investment (percent of GDP) 38.2 26.8 22.0 22.0
(Annual per entage chan e)
55
Rea GDP .9 -5 7 1.1 2.0
Industrial production -2.1 -32.2 15.0 ...
Tourism
Arrivals 4.8 1.6 6.0 ...
Nights 6.9 -3.1 5.0 ...
Consumer prices (period average) 1/ 8.5 3.4 0.5 3.1
Consumer prices (end of period) 1/ 7.2 1.5 0.7 3.0
GDP deflator 7.7 2.4 0.3 0.9
Average net wage (12-month) 2/ 23.4 11.3 -1.8 ...
Money and credit (end of period, 12-month)
Bank credit to private sector 24.7 -15.1 -8.9 4.0
Enterprises 20.9 -15.4 -15.0 ...
Households 32.0 -10.9 -7.0 ...
Private sector deposits -14.2 -4.1 6.0 6.0
(In percent of GDP)
General government finances (cash) 3/
Revenue and grants 48.3 42.4 42.2 42.3
Expenditure (incl. discrepancy) 48.6 47.7 46.0 45.7
Overall balance -0.3 -5.3 -3.9 -3.4
Primary balance 0.5 -4.4 -2.8 -1.8
Privatization receipts 1.2 4.4 0.8 0.7
General government gross debt (end of period, stock)
31.9 40.7 44.1 44.0
Balance of payments
Current account balance, excl. grants -50.9 -30.4 -26.2 -25.4
Foreign direct investments 17.9 30.8 17.9 15.4
External debt (end of period, stock) … 93.3 98.9 99.3
REER (CPI-based; annual change; + indicates appreciation)
1.5 5.9 0.2 …
Sources: Ministry of Finance, Central Bank of Montenegro, Monstat, Employment Agency of Montenegro; and IMF staff estimates and projections. 1/ Cost of living index for 2008. 2/ 2008-2009 wage data have been adjusted to reflect a change in the methodology by Monstat starting January 1, 2010. 3/ Includes extra-budgetary funds and local governments, but not public enterprises.
1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.
56
ANNEX 5. COUNTRY AT A GLANCE
Montenegro at a glance 2/25/11
Europe & Upper
Key Development Indicators Central middle
Montenegro Asia income
(2009)
Population, mid-year (millions) 0.62 403 993
Surface area (thousand sq. km) 14 23,549 48,659
Population growth (%) 0.3 0.3 0.9
Urban population (% of total population) 60 64 75
GNI (Atlas method, US$ billions) 4.1 2,772 7,363
GNI per capita (Atlas method, US$) 6,650 6,880 7,415
GNI per capita (PPP, international $) 13,320 13,297 12,800
GDP growth (%) -5.7 4.0 4.1
GDP per capita growth (%) -6.0 3.6 3.2
(most recent estimate, 2003–2008)
Poverty headcount ratio at $1.25 a day (PPP, %) <2 4 ..
Poverty headcount ratio at $2.00 a day (PPP, %) <2 9 ..
Life expectancy at birth (years) 74 69 71
Infant mortality (per 1,000 live births) 8 20 20
Child malnutrition (% of children under 5) 2 .. ..
Adult literacy, male (% of ages 15 and older) .. 99 95
Adult literacy, female (% of ages 15 and older) .. 97 92
Gross primary enrollment, male (% of age group) .. 100 111
Gross primary enrollment, female (% of age group) .. 98 110
Access to an improved water source (% of population) 98 95 95
Access to improved sanitation facilities (% of population) 92 89 84
Net Aid Flows 1980 1990 2000 2009 a
(US$ millions)
Net ODA and official aid .. .. .. 106
Top 3 donors (in 2007):
Germany .. .. .. 15
European Commission .. .. .. 11
France .. .. .. 10
Aid (% of GNI) .. .. .. 2.3
Aid per capita (US$) .. .. .. 171
Long-Term Economic Trends
Consumer prices (annual % change) .. .. 21.9 3.4
GDP implicit deflator (annual % change) .. .. 20.2 2.4
Exchange rate (annual average, local per US$) .. .. 1.1 0.7
Terms of trade index (2000 = 100) .. .. .. ..
1980–90 1990–2000 2000–09
Population, mid-year (millions) 0.6 0.6 0.7 0.6 0.2 1.2 -0.6
GDP (US$ millions) .. .. 984 4,141 .. .. 4.7
Agriculture .. .. 12.5 10.0 .. .. 0.1
Industry .. .. 23.4 20.1 .. .. 4.0
Manufacturing .. .. 10.2 5.9 .. .. -2.4
Services .. .. 64.1 69.9 .. .. 5.8
Household final consumption expenditure .. .. 70.0 89.3 .. .. ..
General gov't final consumption expenditure .. .. 21.9 16.7 .. .. ..
Gross capital formation .. .. 22.4 27.1 .. .. ..
Exports of goods and services .. .. 36.8 32.8 .. .. ..
Imports of goods and services .. .. 51.1 65.9 .. .. ..
Gross savings .. .. 19.6 -2.6
Note: Figures in italics are for years other than those specified. 2009 data are preliminary. .. indicates data are not available.
a. Aid data are for 2008.
Development Economics, Development Data Group (DECDG).
(average annual growth %)
(% of GDP)
6 4 2 0 2 4 6
0-4
15-19
30-34
45-49
60-64
75-79
percent of total population
0
10
20
30
40
50
60
1990 1995 2000 2008
Montenegro Europe & Central Asia
-15
-10
-5
0
5
10
15
95 05
GDP GDP per capita
KapaKapaMorackaMoracka(2227 m)(2227 m)
KomoviKomovi(2656 m)(2656 m)
BiocBioc(2396 m)(2396 m)
LjubisnjaLjubisnja(2238 m)(2238 m)
Sandzak
Durmitor
Sinjajevina
Cijevna
Zeta
Mor
aca
Tara
Cehotina
SvetiSvetiStefanStefanBudvaBudva
Radovi´ciRadovi´ci
Stari BarStari Bar
PlavnicaPlavnica
CetinjeCetinje
KotorKotorTivatTivat
PerastPerast
CrkviceCrkvice
GrahovoGrahovo
BajovoBajovoPoljePolje
RudiniceRudinice
GradacGradacPljevljaPljevlja
Bijelo PoljeBijelo Polje
GoranskoGoransko
VelimljeVelimlje
VilusiVilusi
RisanRisanHerceg-Herceg-NoviNovi
TuziTuzi
MedurijecjeMedurijecjev
ZabljakZabljakv
TomasevoTomasevov
RozajeRozajev
IvangradIvangrad
PlavPlav
GusinjeGusinje
AndrijevicaAndrijevica
MurinoMurino
MojkovacMojkovac
vKolasinKolasin
vMatesevoMatesevo
Lijeva RijekaLijeva Rijeka
PelevPelev
GvozdGvozd
MorakovoMorakovo
DanilovgradDanilovgrad
vBioceBiocevSpuzSpuz
SavnikSavnik˘
NiksicNiksicv ‘PetroviPetrovici
DurdevicaDurdevicaTaraTara
´
PODGORICAPODGORICA
Shkodër
Ulcinj
Sveti Nikola
Bar
Petrovac
SvetiStefanBudva
Radovi´ci
Stari Bar
Plavnica
Cetinje
KotorTivat
Perast
Crkvice
Grahovo
BajovoPolje
Rudinice
GradacPljevlja
Bijelo Polje
Goransko
Velimlje
Vilusi
RisanHerceg-Novi
Tuzi
Virpazar
Medurijecjev
Zabljakv
Tomasevov
Rozajev
Ivangrad
Plav
Gusinje
Andrijevica
Murino
Mojkovac
vKolasin
vMatesevo
Lijeva Rijeka
Pelev
Gvozd
Morakovo
Danilovgrad
vBiocevSpuz
Savnik˘
Niksicv ‘Petrovici
DurdevicaTara
´
PODGORICA
B O S N I A A N DH E R Z E G O V I N A
S E R B I A
KOSOVO
A L B A N I A
Cijevna
Zeta
Mor
aca
Tara
Zeta
Komarinca
Cehotina
Drin
a
Boja
na
- Buna
LakeScutariAdriat ic
Sea
To Foca
To Foca
To Mostar
To Dubrovnik
To Dubrovnik
To Tirane
To Kukes
To Dakovica
To Vucitrn
To Priboj
To Priboj
Sandzak
Durmitor
Sinjajevina
KapaMoracka(2227 m)
Komovi(2656 m)
Bioc(2396 m)
Ljubisnja(2238 m)
19°E
19°E
20°E
42°N
43°N
MONTENEGRO
This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.
0 105 15
0 105 15 20 Miles
20 Kilometers
IBRD 34825R
JULY 2009
MONTENEGROSELECTED CITIES AND TOWNS
NATIONAL CAPITAL
RIVERS
MAIN ROADS
RAILROADS
OPSTINA (MUNICIPALITY) BOUNDARIES
INTERNATIONAL BOUNDARIES
