Regional: Financial Sector Development in Central and West ...€¦ · Abbreviations v Foreword Armenia’s finance sector, dominated by 21 banks and 1 development bank, was largely

Technical Assistance Consultant’s Report Project Number: 43359 September 2013

Regional: Financial Sector Development in Central and West Asia (Financed by the Asian Development Bank’s Technical Assistance Special Fund)

Armenia: Boosting Access and Development

Prepared by Patricia McKean, Geraldine O`Keeffe, and Silke Mueffelmann of Frankfurt School of Finance & Management, and Arup Chatterjee and Lotte Schou-Zibell of Asian Development Bank This consultant’s report does not necessarily reflect the views of ADB or the government concerned, and ADB and the government cannot be held liable for its contents. (For project preparatory technical assistance: All the views expressed herein may not be incorporated into the proposed project’s design.)

finance sector development / 2013

ArmeniA’s FinAnce sector

Boosting Access and Development

By Patricia McKean, Geraldine O’Keeffe,

and Silke Mueffelmann

of the Frankfurt School of Finance & Management

and

Arup Chatterjee and Lotte Schou-Zibell

of the Asian Development Bank

Appendixes i

Contents

Foreword . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ..vAbbreviations.. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . vi

Executive Summary . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ..vii

The Finance Sector: An Overview . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. 1

Macroeconomic Development .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 1

Fiscal Sustainability .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 2

Business Environment: Access to Financial Services.. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 3

Micro, Small and Medium-Sized Enterprise Sector .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 4

Finance Sector: Structure and Development .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 5

Bank Performance .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 7

Credit Organizations . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 8

Insurance Companies. .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 8

Securities Market . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 9

Pensions.. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 9

Leasing Services . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 10

Loan Security . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 11

ACRA Credit Bureau . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 11

Deposit Guarantee Fund . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 11

Challenges and Risks . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 11

Sector Performance, Problems, and Opportunities . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .13

Microfinance.. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 13

Supply . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 13

Banks . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 14

Demand .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 15

Agriculture . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 16

Government Support . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 16

Constraints to Microfinance . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 17

Options to Microfinance . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 17

Electronic Banking and Mobile Financial Services . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 18

Background .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 18

Supply . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 18

Demand .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 22

Government Support . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 23

Constraints to Electronic Banking and Mobile Financial Services . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 25

Road Map for the Development of Electronic Banking and Mobile Financial Services . . .. . .. . .. . .. . .. . .. . .. . .. . .. . 25

ii Armenia’s Finance Sector: Boosting Access and Development

The Insurance Sector . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 27

Market Analysis .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 27

Pension System.. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 32

Regulation, Supervision, and Policy Issues . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 34

Options. .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 35

Government .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 38

Securities Market Development . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 41

Supply of Securities . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 41

Demand for Securities .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 51

Constraints to Securities Market Development . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 52

Road Map for Development of the Securities Market . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 53

Government Sector Strategy .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .57

Status . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 57

Development Goals .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 57

Specific Challenges in Development Goals . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 59

Development of Capital Markets. .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 59

Development of the Insurance Sector . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 60

Development of Mobile and e-Banking . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 60

ADB Sector Experience and Program; Trade Finance; and Micro, Small, and Medium-Sized

Enterprise Development. .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .61

Summary of Experience . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 61

Harmonization of Activities with other Financial Institutions .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 61

Financial Sector Support . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 61

Nonfinancial Sector Support . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 61

Appendixes .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .63

Appendix 1: Development Organization Projects .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 63

Appendix 2: Overview of E-Banking and Mobile Financial Services .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 67

Currency Equivalents (as of 31 December 2012)

Currency Unit - dram (AMD)

AMD1.00 = $0.0025

$1.00 = AMD403.58

Abbreviations v

Foreword

Armenia’s finance sector, dominated by 21 banks and 1 development bank, was largely able to weather the global financial crisis of 2008 on strong capitalization, sound liquidity profiles, and low integration with international financial markets. It did so even though the collapse of remittance-financed construction and lower commodity prices caused gross domestic product to contract 14.1% in 2009.

According to financial market development indicators, the country’s finance sector is competitively disadvantaged, ranking 78th out of 144 countries in one overall financial market development index.

It is considered crucial that Armenia enhance financial support to micro, small, and medium-sized enterprises (MSMEs), particularly providing medium- and long-term funding, to allow them to invest in technology and capital and raise productivity and competitiveness. Bank loans are the dominant source of external financing for MSMEs, and access to financial services remains a concern.

According to the Small and Medium Entrepreneurship Development National Center of Armenia, micro, small, and medium-sized enterprises accounted for a share of about 43% of gross domestic product, up from 41.7% in 2008. The sector contributes significantly to job creation and employs about 42% of the labor force.

Armenia’s 32 credit organizations comprised the second-largest sector in the country’s financial system, with assets of about 6.8% of the total as of December 2012, and rising fast. In addition, seven insurance companies comprised 1.55% of total financial system assets at the end of December 2012. The securities market is developing, but trade in equities and bonds represents only a small portion of finance sector assets.

This report takes a close look at Armenia’s finance sector, presenting the economic context in which it operates and outlining the various approaches the country is taking to improving access to the sector for all Armenians—rural and urban, rich and poor. This includes support for expanding microfinance, electronic and mobile banking services, insurance, and the securities markets.

vi Financial Sector Development in Central and West Asia: Country Assessment Armenia

Abbreviations

ADB – Asian Development Bank

AMD – Armenian dram

APEC – Asia-Pacific Economic Cooperation

ArCa – Armenian Card

CDA – Central Depository of Armenia

CJSC – closed joint stock company

CMTPLI – compulsory motor third-party liability insurance

CPI – consumer price inflation

EBRD – European Bank for Reconstruction and Development

EKENG – e-Governance Infrastructure Implementation Unit

EU – European Union

G2P – government to person

GDP – gross domestic product

GIZ – Gesellschaft für Internationale Zusammenarbeit

IAIS – International Association of Insurance Supervisors

ICPS – Insurance Core Principles, Standards, and Guidance

IFAD – International Fund for Agricultural Development

IFC – International Finance Corporation

IFRS – International Financial Reporting Standards

IMF – International Monetary Fund

MSMEs – micro, small, and medium-sized enterprises

NBFI – nonbank financial institution

OECD – Organisation for Economic Co-operation and Development

OTC – over the counter

P2B – person to business

P2P – person to person

POS – point of sale

PSP – payments system provider

SET – Stock Exchange of Thailand

SMEs – small and medium-sized enterprises

SMS – short messaging service

UCO – universal credit organization

UMCOR – United Methodist Committee on Relief

US – United States

USAID – United States Agency for International Development

WEF – World Economic Forum

The fiscal year of the government ends on 31 December. In this report, “$” refers to US dollars unless otherwise stated.

Executive Summary vii

Executive Summary

Armenia is slowly recovering from an abrupt economic decline triggered by the global financial crisis that started in 2008. While the collapse of remittance-financed construction and lower commodity prices caused gross domestic product (GDP) to contract 14.1% in 2009, the economy picked up, with GDP growing 2.2% in 2010, 4.7% in 2011, and 7.2% in 2012. Growth in 2012 surpassed

earlier projections, based on increased manufacturing, agriculture, mining, and services on one hand, and the combination of budgetary restraints and timely hikes in policy interest rates on the other. Inflation was 2.6% in 2012 and is projected to be 3.6% in 2013, after slowing to 7.7% in 2011 from 8.2% in 2010. Recovery of the Russian Federation economy, the source of most remittances to Armenia, helped inflows rise 14.1% in 2012.

Armenia’s finance sector is dominated by 21 banks (with 479 branch offices), and 1 development bank (Panarmenian Bank), which as of December 2012 accounted for about 92% of financial system assets. Other participants in the financial market, as of 1 January 2013, included 32 credit organizations (with 100 branch offices), 7 insurance companies, 4 insurance brokerages, 143 pawnshops, 238 exchange offices, and 1 legal-entity currency dealer. There were 10 payment organizations in total: 1 processing and clearing organization and 9 money remittance organizations (5 of which also have a processing and clearing organization license). There were also 9 investment companies, as well as NASDAQ OMX Armenia, the Central Depository of Armenia, and 14 reporting issuers.

While the banking sector managed well through the global financial crisis in terms of capitalization and liquidity, nonperforming loans rose, mainly due to an increase in foreign exchange lending. Rapid credit growth and competition, leading to more flexible lending standards, could also be among the factors. Banks need to further improve their risk management systems, concentrate on top borrowers, implement international best practices, and separate management and ownership in decision making.

Micro, small, and medium-sized enterprises (MSMEs) contributed 43.0% of GDP in 2010, compared with 41.7% in 2008, and twice that level in 1999. MSME exports increased to 17.7% in 2009. As of January 2010, MSMEs represented 97.7% of registered legal entities and sole proprietors, reaching 132,923 in number. The SME Development Index, calculated using a United Nations methodology, was 441.8 in 2010, a 7.6-fold increase on 2002. The MSME sector also contributes significantly to job creation, employing 42.2% of the active labor force.

Microfinance in Armenia has expanded quite extensively over the past few years, both by volume and territorial coverage. Presently, microfinance consists primarily of lending activities, although a few banking institutions offer depository and other financial services to micro entrepreneurs. Demand for business, consumer, and housing loans is strong among many self-employed entrepreneurs and micro and small businesses. These are currently underserved by the banking sector and other providers of financial services, which opens a market for rural clients, since most of the financial products are in Yerevan. Armenia also offers great potential for microleasing and microinsurance, especially in the agriculture sector.

Electronic banking (e-banking) exists in the form of plastic cards, internet-based e-banking channels, and payment services provided through terminals, mobile, and online payment systems. With 3.9 million mobile subscribers, Armenia is reaching more than 116% market penetration, a value suggesting that many users have more than one SIM card.

viii Armenia’s Finance Sector: Boosting Access and Development

Even with such a high percentage, mobile banking services are in the initial stages of development, with a few basic services in the market. E-banking services are primarily available to urban customers, with limitations in ATM, point of sale, and payment terminal networks preventing uptake in rural areas.

In remote and rural areas, internet access is low at 37% of households, impeding the uptake of online banking in these areas. Countrywide access to the internet reached 45% by 2013.

Additional constraints preventing greater uptake of e-banking and mobile financial services include (i) the difficulty terminal providers have in profitably serving rural areas given their current pricing structure, (ii) capital requirements to obtain electronic money licenses and limitations on transaction amounts, (iii) cost and dependence on a limited number of suppliers to integrate the core banking systems to e-banking channels, and (iv) the lack of agent banking regulations.

Despite these constraints, the many enabling factors include supportive government regulations and an innovative private sector, which combined have the potential to extend financial services to the unserved or underserved. The insurance penetration rate in Armenia is low, at 0.89% in 2012, as compared with 8.14% in the Organisation for Economic Co-operation and Development countries and 2.62% in central and eastern Europe. The rate is the ratio of the percentage of total insurance premiums in US dollars to GDP. Insurance penetration is primarily the result of demand from large commercial enterprises and compulsory motor third-party liability insurance, rather than voluntary purchases by the private sector and households. Slow development can be attributed to a general lack of trust in the insurance system, regulatory factors, market structure, progress in other segments of the finance sector, social and human development and cultural factors, and generally low salary levels. While the introduction of compulsory motor third-party liability insurance seems to have provided an impetus to nonlife insurers, this has generated limited premium revenue, despite widespread ownership of cars. The transfer of the insurance supervisory authority to the Central Bank of Armenia, and the adoption of new legislation, in tandem with rising incomes, creates potential for the sector to develop more rapidly.

Armenia’s insurance regulatory framework has progressed significantly and is adequate to the current state of development. Yet several challenges remain: (i) the insurance culture remains weak; (ii) while there is support for the insurance market among the middle class, a large percentage of the more affluent have not yet integrated into the insurance system, and many poorer people do not consider purchasing insurance at all; (iii) there is lack of consumer trust, with a legacy going back to the initial years when the insurance market was largely unregulated; and (iv) policy coordination among insurers remains weak. The Association of Insurers has adopted this latter role, but membership is insufficient to be beneficial.

The securities market is developing. The regulatory framework has evolved in the past few years and the required capacity and technology is in place to trade equities and bonds, yet demand is small. A limited investor base due to the absence of institutional investors, the dollarization of the financial market, a lack of confidence in the local currency, and poor liquidity combine to constrain market growth. Strengthening the banking sector, that is, developing interbank lending and money markets will be a critical success factor for securities market development. Meanwhile, although planned reform of the pensions system will address some demand-side challenges, the reforms may create other challenges due to the underdeveloped capacity of the local fixed-income market since fund managers may be forced to continue investing in foreign currency. Given limited availability of hedging tools, and bearing in mind that availability of derivative instruments is likely to require regulatory changes, foreign exchange risks may increase.

To increase access to finance in rural areas, the holistic development of mobile financial services could be pursued via a step-by-step approach to ensure that rural populations have access to affordable, effective, and inclusive financial services using mobile phones. Support could be provided to (i) develop a framework for the delivery of mobile financial services, (ii) review and develop a regulatory framework supportive of mobile financial services, and (iii) implement pilot projects.

Executive Summary ix

To achieve greater outreach of insurance in rural areas, a stronger policy and regulatory environment for insurance needs to be developed. Support can be provided to (i) develop a strategy to enhance access to insurance services, (ii) facilitate development of life insurance and supporting pension reforms, (iii) strengthen the underwriting and claims management system for compulsory motor third-party liability insurance, and (iv) build capacity.

To achieve a deeper and more diversified nonbank finance sector, the development of the domestic capital market could reduce bank dependence and contribute to the maintenance of financial soundness and sustainable economic growth. Support could be provided to develop (i) policy and consensus building, (ii) the primary market for government securities, (iii) the secondary market for government securities, and (iv) the corporate bond market.

The Finance Sector: An Overview 1

The Finance Sector: An Overview

Macroeconomic Development

Armenia’s debt position deteriorated sharply following the global financial crisis in 2008. The local economy shrank in 2009 amid the collapse of remittance-financed construction and lower commodity prices, with gross domestic product (GDP) contracting by 14.1% over the year (Table 1). GDP grew 2.2% in 2010, a more robust 4.7% in 2011, 7.2% in 2012, and is projected to grow 4.5% in 2013.1

The inflation rate increased from 3.4% in 2009 to 8.2% in 2010, slowed to 7.7% in 2011, and further to 2.6% in 2012. It was projected to be 3.6% in 2013 and 3.2% in 2014.2 A pickup in manufacturing, mining, and services, as well as a rebound in agriculture, timely policy rate hikes, budgetary spending restraint, and global price developments contributed to GDP growth. Remittance flows—money transfers from and to Armenians abroad through the country’s commercial banks—also rebounded, after dropping 30.6% in 2009 (Table 2).

Money transfer flows comprised 17.4% of GDP in 2010, with about two-thirds (68.5%) coming from the Russian Federation, 7.6% from the United States (US), and the remainder largely from the European Union (EU) countries (Table 2). Flows from the Russian Federation increased to 73.5% in 2012. The large share of remittances in GDP and the heavy reliance on economic developments in the Russian Federation pose a financial and economic risk. In 2012, a recovery in the Russian Federation stimulated growth in remittance flows, yet these remained slightly below precrisis rates. During January–December 2012, aggregated remittance inflows through commercial banks increased 14.1%, compared with the same period in 2011; 20.5% of the increase came from the Russian Federation and 9.2% from the US.

Net foreign direct investment inflows in 2011 decreased to 4.4% of GDP, from 6.1% in 2010, with estimates at 4.2% of GDP for 2012. As investments in telecommunications and energy projects wind down, mining becomes the primary destination for foreign investors. Reforms to develop a more business-friendly environment are expected to take hold gradually and contribute to an increase in foreign direct investment. Merchandise exports fell 32.7% in US dollar terms in 2009, but increased 57.0% in 2010, 34.4% in 2011, and 7.0% in 2012, with

1 Asian Development Bank (ADB). 2013. Asian Development Outlook 2013: Asia’s Energy Challenge. Manila: ADB.

2 Asian Development Bank (ADB). 2013. Asian Development Outlook 2013: Asia’s Energy Challenge. Manila: ADB.

Table 1: Growth and Price Indicators

2005 2006 2007 2008 2009 2010 2011 2012

GDP ($ million)a 4,900 6,384 9,206 11,662 8,648 9,371 10,248 9,910

Real GDP (% change)b 13.9 13.2 13.7 6.9 –14.1 2.1 4.6 7.2

CPI inflation, end of period (% change)b 0.6 2.9 4.4 9.0 3.4 8.2 7.7 2.6

CPI = consumer price index, GDP = gross domestic product.

Sources: aInternational Monetary Fund (IMF). 2012. World Economic Outlook: Growth Resuming, Dangers Remain. Washington DC: IMF. http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/

text.pdf. bAsian Development Bank (ADB). 2012. Asian Development Outlook 2012. Confronting Rising Inequality in Asia. Manila: ADB.

2 Armenia’s Finance Sector: Boosting Access and Development

projections for 8.0% growth in 2013. Raw materials—minerals and metals—constituted 60% of exports in 2010. High commodity prices and improved macroeconomic conditions in the Russian Federation have contributed to the recovery in exports. The current account deficit, which had increased from 6.4% of GDP in 2007 to 11.8% in 2008 and to 15.8% in 2009, started to improve. It was 14.8% of GDP in 2010, 10.9% in 2011, and 10.4% in 2012. Led by growth in remittances and exports, the current account deficit was projected to be 9.8% in 2013 and to fall to 9.1% of GDP in 2014. In 2012, the real exchange rate depreciated 6.7%.

Fiscal Sustainability

From 1999 to 2008, the government had been moving away from external sources of funding toward domestic funding as the dram appreciated, bringing government and government-guaranteed debt (the public-debt ratio) down to 16.1% of GDP in 2008 (Figure 1). After the global financial crisis, the government borrowed heavily from external sources in 2009 to support the economy, more than doubling the public debt-to-GDP ratio that year to 40.2%. The ratio rose slightly to an estimated 44.5% by the end of 2012, from 40.7% in 2011, still within the 50% ceiling stipulated by the Public Debt Law. About 85% of all public debt is external, with domestic debt held mainly by banks. Much of this borrowing was, and still is, at subsidized rates. The fiscal deficit increased sharply in 2009 to 7.6% of GDP, from a low of 0.7% in 2008, falling back to 2.8% in 2011 and 1.5% in 2012.

The authorities in 2012 implemented comprehensive tax measures and complete a tax strategy paper on reforms for 2013–2015; they are now applying the 2011–2013 strategy. The tax package (excise, income, and mining taxes) aims to raise the relatively low revenue-to-GDP ratio by 0.6 percentage points, improve efficiency and

Table 2: Individual Money Transfers Sent to and Received from Abroad through Armenian Commercial Banks

2004 2005 2006 2007 2008 2009 2010 2011 2012

Total inflow ($ ’000)

Total inflow 760,700 965,287 1,237,597 1,742,205 2,270,615 1,575,678 1,627,056 1,960,033 2,237,468

of which

Russian Federation 435,864 575,927 766,137 1,114,965 1,461,825 949,974 1,114,114 1,364,892 1,644,850

United States 126,341 186,078 217,743 191,764 168,645 115,233 124,426 138,384 127,681

% of total inflow

of which

Russian Federation 57.3 59.7 61.9 64.0 64.4 60.3 68.5 69.6 73.5

United States 16.6 19.3 17.6 11.0 7.4 7.3 7.6 7.1 5.7

% of gross domestic product

Total inflow 21.3 19.7 19.4 18.9 19.5 18.2 17.4 19.1 22.6

of which

Russian Federation 12.2 11.8 12.0 12.1 12.5 11.0 11.9 13.3 16.6

United States 3.5 3.8 3.4 2.1 1.4 1.3 1.3 1.4 1.3

% of gross national income

Total inflow 20.6 19.2 18.8 18.4 18.7 17.9 16.8 18.1 n.a.

of which

Russian Federation 11.8 11.4 11.6 11.8 12.0 10.8 11.5 12.6 n.a.

United States 3.4 3.7 3.3 2.0 1.4 1.3 1.3 1.3 n.a.

n.a. = not available.

Sources: Central Bank of Armenia. 2011. http://www.cba.am. World Bank. World Development Indicators. Washington DC: World Bank. http://data.worldbank.org/data-catalog/world-

development-indicators.


equity, and help ease spending restraints while fiscal consolidation continues.3 The government needs higher tax revenues to safeguard priority social and capital spending; without them, it will need to further restrain spending in 2013 and beyond.

Business Environment: Access to Financial Services

The government is attempting to enhance competitiveness by reducing corruption, enforcing competition, strengthening the civil code and judiciary, and taking steps to diversify the economic base to reduce reliance on minerals and metals.

Over the long run, reforms to improve the economic and business environment should help boost foreign investment, but important reforms so far have yet to translate into decisive improvement in business performance. Reforms include tax administration (such as risk-based approaches for audit, customs, and value-added tax refunds, and improved taxpayer services), easing regulations, inspections, and procedures, and stepping up enforcement of rules against anticompetitive practises.

Further steps were implemented in 2012 to increase transparency and reduce the cost of inspections, registration, tax filing and compliance, customs declaration, legal proceedings, and contract enforcement.

The relative lack of religious or ethnic tensions in Armenia’s highly homogenous society, as well as a relatively well-educated population, benefit its business environment.

According to financial market development indicators, Armenia’s finance sector is considered competitively disadvantaged (Table 3).4 In the overall financial market development index, and relative to other countries in Central and West Asia, it ranks 78th out of 144 countries, before Georgia, Azerbaijan, Kazakhstan, the Kyrgyz Republic, and Tajikistan. Compared with other countries in Central and West Asia, the soundness of Armenia’s banks and the availability and affordability of financial services ranks well for doing business, while the ease of access to loans is viewed less favorably. Financial market development in Estonia ranked 39th and Latvia 52nd.

3 Key measures include a new mining royalty, increased income and payroll taxes on high-income earners, higher excise and presumptive taxes across a range of

goods, transfer pricing and thin capitalization provisions, and gains from ongoing tax administration improvements (approved by parliament).

4 World Economic Forum (WEF). 2012. The Global Competitiveness Report 2012–2013. Geneva: WEF.

Figure 1: Armenian Public Debt—Relative Share, External versus Domestic

Sources: Ministry of Finance of the Republic of Armenia. Various years. “Public Debt of the Republic of Armenia: Annual Report.”

Yerevan. National Statistical Service of the Republic of Armenia. http://www.armstat.am.

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Domestic public debt External public debt


An improvement took place in 2012, when affordability of financial services in Armenia (48th) ranked before both Latvia (58th) and Estonia (59th). In soundness of banks and ease of access to loans, Armenia (51st and 69th, respectively) ranks before Latvia (106th and 72nd) but after Estonia (36th and 67th). Armenia ranks less well in availability of financial services.

On other financial market development indicators, Armenia fares less well, ranking 106th on “regulation of securities market” and 115th on “financing through local equity market.” Estonia ranked 40th and 62nd on these and Latvia 64th and 103rd. This suggests that capital markets in Armenia do not yet make an important contribution to economic growth.

Micro, Small and Medium-Sized Enterprise Sector

Enhancing financial support to MSMEs, particularly medium- and long-term funding, is essential if these enterprises are to invest in the technology and capital needed to raise productivity and competitiveness. Access to affordable finance remains a concern, since bank loans are the dominant source of external financing for MSMEs (Table 3). But such lending has increased as banks look to the MSME sector to diversify lending portfolios and widen interest-rate margins. The growth in MSME financing through banks has been supported by international financial institutions such as KfW, the European Bank for Reconstruction and Development (EBRD), the International Finance Corporation, the World Bank, the United States Agency for International Development (USAID), as well as ADB. All have supported the MSME sector in Armenia through funds to local commercial banks and technical assistance.5

According to the Small and Medium Entrepreneurship Development National Center of Armenia, the contribution of the MSME sector to economic growth is significant. In 2009, MSMEs accounted for about a 42.5% share of GDP, up from 41.7% in 2008 (Table 4). The small and medium-sized enterprise (SME) share of the country’s export volume increased to 17.7% in 2009, down from 17.9% in 2008, but up from 17.4% in 2007.6 As of January 2010, MSMEs comprised 97.7% of registered legal entities and sole proprietors, at a total of 132,923. The SME Development Index, calculated by United Nations methodology, reached 441.8 in 2010, a sevenfold increase on 2002. The MSME sector contributes significantly to job creation, and employs 42.2% of the labor force. However, Armenia lags behind more developed and other emerging countries in the region,

5 ADB. 2011. Report and Recommendation of the President to the Board of Directors on the Proposed Senior Loans for ACBA Credit Agricole Bank, Ameriabank,

Ardshininvestbank, Inecobank: Small and Medium-Sized Enterprise Finance Program (Armenia). Manila: ADB.

6 Small and Medium Entrepreneurship Development National Center of Armenia. “SMEs in Figures.” http://www.smednc.am/?laid=1&com=module&module=me

nu&id=189.

Table 3: Financial Market Development Index 2012–2013

Availability

of Financial

Services

Affordability

of Financial

Services

Financing

through

Local Equity

Market

Ease of

Access

to Loans

Venture

Capital

Availability

Soundness

of banks

Regulation

of

Securities

Exchanges

Financial

Market

Development

Index

Armenia 76 48 115 69 89 51 106 78

Azerbaijan 119 70 63 57 59 133 101 98

Georgia 100 85 126 93 104 92 119 93

Kazakhstan 79 78 109 110 105 120 100 115

Kyrgyz Republic 136 137 139 137 133 131 134 118

Pakistan 95 99 54 65 55 85 55 73

Tajikistan 103 88 88 49 50 100 123 124

Estonia 43 59 62 67 33 36 40 39

Latvia 65 58 103 72 43 106 64 52

Note: Ranked out of 144 countries. For indicators, a rank of 50 and below is a competitive advantage and 51 and above is a competitive disadvantage.

Source: World Economic Forum (WEF). 2012. The Global Competitiveness Report 2012–2013. Geneva: WEF.


particularly those with higher GDP per capita, suggesting that there is a relationship between MSME sector development and income per capita (Table 5).

Finance Sector: Structure and Development

Armenia’s finance sector is small and unsophisticated.7 It is dominated by 21 banks (with 479 branch offices), and 1 development bank (Panarmenian Bank), which account for about 92% of total financial system assets, and therefore have the largest impact on financial stability.8 At the end of 2012, other participants in the sector

7 United States Agency for International Development (USAID). 2011. Armenia High Level Financial Sector Overview - October 2011. Washington DC: USAID.

http://www.pfsprogram.org/armenia-high-level-financial-sector-overview-october-2011.

8 Central Bank of Armenia. 2012. “Financial System and Control. Introduction.” http://www.cba.am/en/sitepages/fscintroduction.aspx.

Table 4: SME Development Index in Armenia

Share of Private

Ownership in the

Economy (%)Share of SMEs

in GDP (%)

Share of the SME

Labor Force in Total

Labor Force (%)GDP Per Capita

($)

SME Development

Index

(GDP per capita)

2002 81.0 34.4 28.2 740 58

2003 83.0 36.5 31.0 873 82

2004 84.0 38.6 32.9 1,104 118

2005 84.0 39.8 34.0 1,513 172

2006 84.0 40.3 35.1 1,996 237

2007 84.0 41.0 40.7 2,844 399

2008 84.0 41.7 42.1 3,689 544

2009 84.0 42.5 42.2 2,686 405

2010 n.a. 43.0 n.a. 3,031 442

2011 n.a. n.a. 43.0 3,305 n.a.

GDP = gross domestic product; SMEs = small and medium-sized enterprises.

Source: Small and Medium Entrepreneurship Development National Center of Armenia. “SMEs in Figures.” http://www.smednc.am/?laid=1&com=module&module=menu&

id=189.

Table 5: Basic Indicators of the SME Sector in Armenia and in Selected Developing Countries

and Countries in Transition (2008)

Share of Private

Ownership in the

Economy (%)

Share of SMEs

in GDP

(%)

Share of the Labor

force of SMEs in

the Total Labor

Force (%)GDP per capita

($)

SME Development

Index

(GDP per capita)

Armenia 84.0 41.7 42.1 3,689 544

Azerbaijan 75.0 40.3 34.0 5,330 548

Bulgaria 75.0 30.0 42.2 6,546 622

Croatia 70.0 56.0 65.0 15,636 3,984

Estonia 75.0 63.0 70.0 14,096 4,662

Georgia 75.0 29.4 32.0 2,931 207

Hungary 80.0 36.9 56.8 15,409 2,584

Latvia 70.0 58.2 69.3 14,909 4,209

Romania 70.0 55.0 21.0 9,300 752

Slovakia 80.0 45.3 66.0 17,565 4,201

Slovenia 70.0 56.5 62.2 26,779 6,630

GDP = gross domestic product; SMEs = small and medium-sized enterprises.

Source: Small and Medium Entrepreneurship Development National Center of Armenia. “SMEs in Figures.” http://www.smednc.am/?laid=1&com=module&module=menu

&id=189.


included 32 credit organizations (with 100 branch offices), 7 insurance companies, 4 insurance brokerages, 143 pawnshops, 238 exchange offices, 1 legal entity currency dealer, 10 money transfer companies, 7 organizations dealing with processing payments, 9 investment companies, as well as NASDAQ OMX Armenia, the Armenian Central Depositary, and 14 reporting issuers. Among a financial system’s key services are opportunities to save and borrow. The mobilization of savings can be ascertained through a number of indicators. One is bank deposits as a percentage of GDP, which in Armenia stood at 24.2% at the end of 2012, after increasing from 2005. Another, broad money, was 33.8% of GDP at the end of 2012. Money outside the banking system as a percentage of dram broad money was 52.0%. As an indicator of trust in the banking sector—a preference to hold cash—the higher the number, the less trust people have in the system.

Credit as a percentage of GDP gauges the level of its provision and the depth of the banking system. Bank credit stood at 47.5% of GDP at the end of 2012, while bank credit to households was 35.0%, of which 66.8% was denominated in dram and 33.2% in foreign exchange.9 Although risks to the financial standing of households are considered manageable given the return to economic growth and the low household debt burden on commercial banks’ books, foreign exchange risk is considered the main exposure for households when dealing with mortgage loans.10

Commercial banks generally have a cautious lending approach, with household liabilities to commercial banks comprising 86.3% of the total household debt burden as of June 2011. Consumer and mortgage lending to households by banks increased 30.1% from December 2010 to December 2011. Mortgage lending, which has slowed markedly since 2009, accounted for 8.0% of the total banking loan portfolio at the end of 2012. At the same time, liabilities to credit organizations grew 36.2% and to pawnshops 34.0%, indicating that households are more easily funded by credit organizations and pawnshops than by banks, albeit at less favorable borrowing rates. The growth of banking system assets is considered largely in line with nominal GDP growth. Banking system assets as a percentage of GDP had increased to 60.0% by December 2012.

In addition, capital market development as measured by equity market capitalization was 1.4% of GDP (Table 6). Private enterprises obtain funding from a range of sources including banks, equity, and bond markets. The metric for capitalization indicates that the equity market in Armenia lags behind those of its regional peers. It appears that neither the banking sector nor the equity markets support economic development to their full potential.

From a regional perspective, by economic activity as measured by GDP, Armenia ranks before Tajikistan and the Kyrgyz Republic (Table 7). Trust in the banking system, as measured by broad money as a percentage of GDP, was about half that in Estonia and about 40% of that in Latvia. Credit in Armenia was only 28.0% of GDP in 2010 (rising to 42.5% in 2012); the same figures are 98.6% in Estonia and 89.6% in Latvia. Likewise, total banking sector assets in Armenia (60.0% of GDP in 2012) lag significantly behind Estonia (135.0%) and Latvia (172.5%).11

9 Central Bank of Armenia. 2013. “Monetary and Financial Statistics.” http://www.cba.am/en/SitePages/statmonetaryfinancial.aspx.

10 The 20% depreciation of the average monthly dram rate in March 2009 did not substantially impact banking stability, yet it was associated with a resurgence

in financial dollarization.

11 European Bank for Reconstruction and Development (EBRD). 2011. Regional Economic Prospects in EBRD Countries of Operation: July 2011. EBRD Office of

the Chief Economist. London: EBRD.


Table 6: Financial Market Size and Level of Development (% of GDP)

2005 2006 2007 2008 2009 2010 2011 2012

Broad money 16.3 18.3 22.0 19.8 25.9 26.0 29.5 33.8

Money in % of dram broad money 64.2 61.8 58.0 58.7 62.6 58.3 53.0 52.0

Credit 8.4 9.1 14.8 19.4 24.6 28.0 34.8 42.5

Deposits 9.9 10.3 11.6 11.0 17.0 17.3 20.4 24.2

Equity market capitalization 0.8 0.8 1.0 1.5 1.7 1.5 1.4 1.3

GDP = gross domestic product.

Sources: Asian Development Bank (ADB). Various years. Key Indicators for Asia and the Pacific. Manila: ADB. National Statistical Service of the Republic of Armenia. http://www.

armstat.am/en/.

Table 7: Financial Market Size and Level of Development, Regional Comparison (2010, % of GDP)

Country

Broad

Money

Money

(% of broad money) Credit Deposits

Bank

Assets

Equity Market

Capitalization

GDP

(current $, million)

GDP Per Capita,

PPP (current international, $)

Armenia 33.8b 52.0b 42.5b 24.2b 60.0b 1.3b 9,910b 5,789

Azerbaijan 31.1b 55.2b 18.0 13.8b 31.2b n.a. 68,731b 10,062

Georgia 30.4 24.3 33.5 24.4 52.3 5.5 15,830b 5,465

Kazahstan 35.7 13.0 36.0 30.7 46.9 23.0 188,050 13,099

Kyrgyz Republic 29.1 59.5a 12.2 10.1 24.4 2.7 6,476b 2,402

Tajikistan 44.2 38.0 14.6 14.7 27.4 n.a. 6,523 2,324

Uzbekistan 32.3 42.0a 17.0a 19.4a 30.5a 2.4a 45,444 3,287

Estonia 56.7 57.7 84.7 60.1 115.3 7.3 22,155 21,997

Latvia 47.0 65.4 82.7 75.5 144.4 3.8 28,253 18,951

aData is for 2010. bData is for 2012. Remaining data is for 2011.

GDP = gross domestic product, n.a. = data not available.

Sources: World Bank. Asian Development Bank. National Statistical Service of the Republic of Armenia. http://www.armstat.am/en/.

Bank Performance

Armenian banks were able to weather the global financial crisis due to their strong capitalization, sound liquidity profiles, and low integration with international financial markets. Banks have generated growth in assets, liabilities, and capital, as well as in net profit (Table 8). The sector remains well capitalized, and profits increased in 2012, although nonperforming loans also rose, albeit within acceptable levels (Table 9). This is mainly attributable to an increase in foreign exchange lending. While high rates of credit growth may not be surprising given the recovery from the crisis and Armenia’s generally low debt-to-GDP ratio, foreign exchange lending could pose risks. Rapid credit growth and competition may also have contributed to lower lending standards. The central bank has taken steps to manage foreign exchange risks, including placing limits on net open positions, higher risk weightings, and provisioning for foreign exchange loans. High capital adequacy ratios are expected to continue to fall as credit portfolios expand, albeit at a slower pace. In addition, weaknesses, such as loan concentration by top borrowers, are a common feature across Armenian banks due to the structure of the economy, and corporate governance does not allow international best practices along some dimensions. Risk management frameworks and processes in most banks are also still evolving.12

12 ADB. 2011. Report and Recommendation of the President to the Board of Directors on the Proposed Senior Loans for ACBA Credit Agricole Bank, Ameriabank,

Ardshininvestbank, Inecobank: Small and Medium-Sized Enterprise Finance Program. Manila: ADB.


Credit Organizations

Credit organizations comprise the second-largest sector in Armenia’s financial system, with assets constituting about 6.8% of total assets as of December 2012. Assets of credit organizations increased 36.1% year-on-year from December 2011 to December 2012, while liabilities rose 37.2% and capital expanded 34.2% (Table 8). Their total liabilities at the end of 2012 were more than AMD105.6 billion ($261.7 million), after increasing by AMD88.6 billion ($71.0 million) in 2012.

As of 31 December 2012, Armenia had 32 credit organizations with 100 branches.13 According to a study by the ARKA News Agency, FINCA, a universal credit organization (UCO), is the leader by volume of total liabilities with AMD10.0 billion ($26.1 million) in liabilities, after an increase of 9.5% in the third quarter 2011. FINCA’s holding of 15.2% of credit organization liabilities is the largest share, followed by Norvik UCO, which holds 14.6% of the total, or AMD9.7 billion ($25.3 million). The next ranked is National Mortgage Company, with more than AMD6.1 billion ($15.9 million), or a 9.3% share; AGBA Leasing, with more than AMD5.6 billion ($14.6 million), or an 8.5% share; and First Mortgage Company, whose AMD4.2 billion ($10.9 million) in liabilities represents 6.4% of the total. Together, these five hold 54.0% of the credit organization liabilities. Insurance Companies

Seven insurance companies comprised just over 1.5% of total financial system assets at the end of December 2012. Recent growth in the insurance sector is mainly attributable to the implementation of compulsory motor third-party liability insurance in 2011, which accounts for the largest share of the nonlife premium. Voluntary purchases by the private sector are rather limited. As of December 2012, contributions decreased about threefold on a year earlier, as did the number of existing contracts (Table 10). In the past, citizens enjoyed comprehensive social cover that guaranteed universal access to health care, retirement benefits and survivors’ pensions. Consumers are therefore unfamiliar with savings products or with buying precautionary cover. Demand for life insurance is insufficient to trigger investments needed to start new life insurance operations.

13 The total liabilities of credit organizations in Armenia in the third quarter of 2011 increased by 5.8% to AMD66.1 billion. ARKA. 2011. “Total liabilities of

credit organizations of Armenia in the third quarter of 2011 increased by 5.8% to 66.1 billion drams.” http://www.armbanks.am/en/2011/11/26/30192/.

Table 8: Assets, Liabilities, Capital and Profit in Banks and Credit Organizations

(Dec 2011–Dec 2012)

Total Assets (y-o-y % change)

Total Liabilities (y-o-y % change)

Total Capital (y-o-y % change)

Current Retained

Profit/Loss ($ million)

Previous Period

Profit/Loss ($ million)

Banks 19.5 21.4 10.6 106,104 164,010

Credit Organizations 36.1 37.2 34.2 11,510 15,700

y-o-y = year on year.

Source: Central Bank of Armenia. www.cba.am (https://www.cba.am/Storage/AM/downloads/stat_data_arm/bank_cuc.xls, https://www.cba.am/Storage/AM/downloads/stat_data_arm/cred_cuc.xls).

Table 9: Financial Soundness Indicators for Banking System

(Dec 2005-Dec 2012, %)

Dec

2005

Dec

2006

Dec

2007

Dec

2008

Dec

2009

Dec

2010

Dec

2011

Dec

2012

Regulatory capital to risk-weighted assets 33.7 34.9 30.1 27.5 28.4 22.2 18.3 16.8

Regulatory Tier 1 capital to risk-weighted assets 31.7 32.7 29.0 26.9 26.7 20.2 16.7 15.2

Nonperforming loans to total gross loans 2.0 2.4 2.4 4.3 4.9 3.0 3.4 3.7

Return on assets 2.9 3.9 3.5 3.5 1.0 2.8 2.4 2.5

Return on equity 13.7 17.2 16.0 15.2 4.8 12.3 12.7 14.7

Liquid assets to total assets 41.8 41.2 33.7 23.8 34.4 29.5 27.9 25.6

Liquid assets to demand deposits 110.5 106.1 98.2 103.1 140.8 131.5 120.8 126.1

Source: Central Bank of Armenia. www.cba.am. https://www.cba.am/Storage/EN/finstability/FSI_eng.xls.


Securities Market

At the end of December 2012, there were 21 banks providing investment services and 9 investment companies offering professional activities in the Armenian securities market. Total equity in the investment companies amounted to AMD3,809.70 million ($9.40 million), with total assets of AMD23,280.50 million ($57.70 million). Two self-regulatory organizations were in operation: the Central Depository of Armenia and NASDAQ OMX Armenia—the latter organizing foreign currency and securities trading. The securities of 14 reporting issuers were listed on NASDAQ OMX Armenia, and, of these, four were banks accounting for 26% of equity shares. The total volume of bonds issued was AMD315.10 million ($1.30 million). The volume of securities traded on the stock exchange was AMD413.10 million ($1.02 million).14

Government bonds comprise the largest share in securities trades and repurchase agreement (repo) transactions. The equity market remains small, with low equity capitalization (Table 6). The corporate bond market is very shallow and became practically nonexistent after March 2009. An active corporate bond market is a significant factor in economic growth as it avoids concentrating intermediation in banks, thereby spreading corporate risk via the capital markets rather than concentrating it in the banking sector.

The volume of domestic debt in Armenia has gradually increased over the past decade (Figure 1). More importantly, although the share of domestic debt relative to GDP fell through to 2005, it has increased steadily since 2007. However, market participants have observed that the government bond market accounts for most of this growth as the corporate market has declined since 2009. Fallout from the devaluation in March 2009 saw only four new corporate bond sales that year, followed by two each in 2010 and 2011. The evaporation of demand for dram-denominated securities after the devaluation caused the collapse of issuance. At present, there are only four corporate bonds on the Secondary List (B) of NASDAQ OMX Armenia—three of these being for one company, Shen Concern—with one bond listed on the Free Market (C).

Pensions

Reform of the pension system began in January 2011. Reforms relating to the voluntary accumulative pension scheme (Pillar III) have been successfully implemented, while the mandatory scheme (Pillar II) is scheduled to be introduced in January 2014 (Figure 2). In the meantime there is a need to develop pension fund management, for which foreign investment is needed. In 2012, amendments to laws were made and legal acts developed to finalize the regulation of laws. In addition, some revisions are needed as insurers operating in the market cannot provide asset (fund) management services. For example, when licensed, life insurers also need to be allowed to operate given the important role they can play in the provision of pension and annuities products for retirement. Life insurance products, especially annuities, provide a convenient way for individuals to make financial provisions for retirement.

14 NASDAQ OMX Armenia. 2012. “Monthly Bulletin”. http://www.nasdaqomx.am/en/bulletins.htm.

Table 10: Insurance Sector Indicators (annual % change)

Insurance

Contribution

Reinsruance

Contribution

Insurance

Payment

Insurance Amounts

for Existing

Contracts

Number of Existing

Contracts

Dec 2007–Dec 2008 61.4 90.9 49.0 112.9 22.3

Jun 2008–Jun 2009 -6.3 -9.0 45.1 29.2 2.8

Dec 2008–Dec 2009 4.3 1.7 38.2 43.8 3.8

Jun 2009–Jun 2010 13.7 5.3 -3.8 13.3 3.7

Dec 2009–Dec 2010 1.9 -0.6 -8.2 -9.9 -0.3

Jun 2010–Jun 2011 227.0 -50.4 306.4 94.4 666.4

Dec 2010–Dec 2011 171.1 -30.1 366.4 21.1 310.5

Jun 2011–Jun 2012 52.3 21.0 87.8 21.4 33.8

Dec 2011–Dec 2012 58.8 13.2 78.0 70.3 96.3

Source: Central Bank of Armenia. http://www.cba.am/Storage/AM/downloads/stat_data_arm/insurance_main.xls [in Armenian].


Pillar II, developing the mandatory contributions program, is the most important element of the reform, but also the most challenging and difficult to implement. To transfer social tax revenue to individual accounts and pay for future rather than current pensions would lead to a temporary budget deficit. According to the World Bank, about 30 countries have so far introduced Pillar II pension systems. They usually share the following characteristics:

(i) mandatory contributions from all salary earners,(ii) investment choices offered to contributors,(iii) access to account information and the option to change investment choices, and(iv) access to funds only after retirement.15

Monthly social pension payments average up to AMD16,500 (about $43) and can be collected at the post office. However, the average age-related pension is much higher. Plastic cards are also increasingly used for pension payments. Preparations are under way to advance postal financial services for payments, including pensions, money transfers, utility payments, and tax collections.

Leasing Services

Armenia’s leasing market is dominated by ACBA Leasing, established in 2003 as the first provider in the very small Armenian leasing sector. In 2011, ACBA operated with 17 employees and 1 head office as well as through 43 branches of ACBA Bank in the regions. It covers equipment and vehicle leasing for all sectors. It introduced real estate leasing in 2010, and at the end of that year the company had an outstanding leasing portfolio of €26 million.16

15 Johan Fredholm. 2009. “Pension reform – opportunities and challenges for governments and markets.” NASDAQ OMX. http://www.nasdaqomx.com/digital-

Assets/71/71131_feas_pension_reform_pdf_without_ad.pdf.

16 Crédit Agricole: Leasing & Factoring. http://www.ca-leasingfactoring.com/en/our-company/our-entities/acba-leasing-armenia.

Figure 2: Overview of the Structure of the Armenian Pension System

Pillar I: Universal basic pensions to all retirees on a pay-as-you-go system; the state pays for today’s pensions from the

current budget.

Pillar II: Mandatory payment scheme established on individual defined contributions.

Pillar III: Voluntary supplemental pension savings; these savings are frequently supported by the state through tax incentives.

Source: Johan Fredholm. 2009. “Pension reform – opportunities and challenges for governments and markets.” NASDAQ OMX. http://

www.nasdaqomx.com/digitalAssets/71/71131_feas_pension_reform_pdf_without_ad.pdf.

0

25

50

75

100

Mandatory savings State pensionVoluntary contribution Pre-retirement income


Loan Security

The Central Bank Credit Registry

The credit registry was established in 2003 to compile data on the credit history of borrowers and provide it to commercial banks, credit organizations, and borrowers. The registry keeps records of loans in excess of about $3,700.0 (AMD1.5 million), as well as loans less than about $3,700.0 that are overdue and classified. In the 12 months to June 2011, 218,700 loans were registered, with the total number of recorded loans reaching 1,196,117. The increase was mainly attributable to more relaxed lending practices. Most reporting by banks and credit organizations to the registry is done on an automated basis. Information is generally provided within a day after a request for information reaches the registry. The increase in information on a borrowers’ credit history makes the registry an integral source of information for the supervision and evaluation of credit risk.

ACRA Credit Bureau

In the first half of 2012, the number of borrowers registered with the ACRA Credit Bureau had increased to 1,289,000, or 7.9% over the previous 6 months. The number of loans registered in the database reached 6,153,000 by June 2012, a 10.0% increase on a year earlier. The bureau started to provide credit reports in 2007. Personal credit history is available upon request.

Deposit Guarantee Fund

The Deposit Guarantee Fund is a noncommercial organization founded the Central Bank of Armenia in accordance with the Law on the Guarantee of Remuneration of Bank Deposits of Physical Persons. The fund guarantees deposits in all banks operating in Armenia and remuneration is effected in case of insolvency of a bank. The maxiumum subject to remuneration of guaranteeed deposits is AMD4 million. If the sum is deposited in foreign currency, the maximum is AMD2 million. The fund guarantees deposits by its own means, which are formed from regular quarterly premiums made by all banks. The central bank supervises operations.

Challenges and Risks

A number of challenges, risks, and pressures confront the developing Armenian financial system, including challenges in (i) foreign exchange risk, (ii) current account deficit and inflationary pressures, and (iii) external pressures.

Foreign exchange risk. The Central Bank of Armenia has attempted to promote the reduction of foreign exchange deposits and bank lending, but these elements remain highly concentrated and continue to pose macroprudential risks. Given the dollarized environment, the objectives of encouraging greater financial deepening may be a cause for concern in the context of safeguarding financial stability.

Current account deficit and inflationary pressures. While macroeconomic performance has improved, factors such as the government’s deteriorating debt profile and persistently high current account deficits are causes for concern.

External pressures. Should the global economic environment deteriorate, the potential reemergence of external pressures would have consequences for remittances, exports, and capital flows. For the public debt ratio, while some space remains, an external shock or slowing of GDP growth could push the debt-to-GDP ratio toward the legislative debt ceiling of 50%, necessitating spending cuts, although the political cycle and recent expenditure compression could make cuts challenging. Continued growth will depend heavily on external demand from Europe and, in particular, on the Russian Federation, Armenia’s main trading partner and source of remittances and foreign direct investment.

Sector Performance, Problems, and Opportunities 13

Sector Performance,Problems, and Opportunities

Microfinance

Microfinance in Armenia is receiving adequate central bank support. Fourteen of 21 commercial banks have entered this market segment, of which ProCredit Bank is the most specialized. Besides the banks, another 32 organizations operate as microfinance institutions. These are the descendants of previous microfinance foundations, which were either branches of foreign nongovernment

organizations or domestic foundations funded by international sources. Among the leading microlenders are Kamurj UCO; FINCA, a member of the international village banking network; and AREGAK UCO, a program started by the United Methodist Committee on Relief (UMCOR), a US nongovernment organization. Several international donors, such as USAID, EBRD,17 KfW, and Gesellschaft für Internationale Zusammenarbeit (GIZ) have contributed substantial funds to Armenia’s microfinance sector. Some of the largest UCOs are encouraged to begin transforming into banks.

Supply

In 2005, the National Assembly of the Republic of Armenia adopted the Law on United Supervision of Financial Systems, creating the legal framework for microcredit programs to formally register and be licensed with the central bank.

As a result of this legislation, UMCOR, with a branch in Armenia in the AREGAK microcredit program, decided to transform the program into a legal entity. In March 2006, the central bank licensed and registered AREGAK, after which AREGAK continued to service those loans, acting as a financial agent for UMCOR. AREGAK extended its first loans in May 2006. Currently, AREGAK has countrywide coverage in Armenia, and has registered 26 branches and 3 representative offices. 18 AREGAK takes part in local and international initiatives such as the first informal Credit Forum of Armenian Microfinance Institutions, the Association of Armenian Credit Organizations, membership with the Microfinance Centre and a member of the leading microfinance institutions group, which was pioneering the adoption of social performance management.19

In 1999, when Armenia’s microfinance market was in the early stages of development, FINCA International, a nonprofit corporation, established FINCA Charitable Foundation to provide financial services to low-income entrepreneurs who lacked access to loans from financial institutions. In 2006, the central bank registered and licensed FINCA, whose founder and sole shareholder was FINCA International. FINCA has a large network of 25 branches and representative offices in most of Armenia, with a portfolio of $43.8 million, an average loan size of $1,152.0, and 52,493 clients. Products include group lending, group lending for agriculture, and individual loans numbering around 5,000, or 45% of the loan portfolio. Individual loans are the only ones requiring fixed collateral.20

17 EBRD supports FINCA with a loan in local currency equivalent to $4 million.

18 Aregak UCO. 2013. www.aregak.am.

19 MIX Market. www.mixmarket.org.

20 FINCA. 2013. “2012 Annual Report. “ Yerevan: FINCA. http://www.finca.am/en/news/2012-annual-report.


Kamurj was founded by the nonprofit organization Microenterprise Development Charitable Fund, which was set up in 2000 after the merger of the Catholic Relief Services and Save the Children programs. It is currently the only shareholder. The Central Bank of Armenia registered and licensed Kamurj in April 2010, when the microfinance program of the Microenterprise Development Charitable Fund was transferred to Kamurj. Kamurj remains committed to the fund’s objectives and continues to provide services that target groups by incorporating appropriate international microfinance practices into the local market. Its goal is to comply with the needs of low-income families in Armenia alongside developing and strengthening institutional capacities; loans are offered to families needing financial services for investing in businesses or for consumer purposes, and to private entrepreneurs and small businesses.21

Banks

Incentives for banks to increase microfinance activities came in the form of dedicated loan funds from international multilateral and bilateral donors, such as grants to INECOBANK from the International Finance Corporation (IFC), a member of the World Bank Group, and loans to ARARATBANK from the European Fund for Southeast Europe. Of the 21 commercial banks, 14 say they offer microfinance products, the largest of which is ACBA-Credit Agricole Bank, with a portfolio of $362 million and 120,600 borrowers in 2011 (Table 11).22

ProCredit Bank in Armenia was serving 11,500 customers at the end of 2010. In 2011, its loan portfolio grew 20%, to $62.4 million, while customer deposits increased by 13% to $29.1 million. The quality of the loan portfolio improved considerably, with portfolio at risk (loans more than 30 days in arrears) coming to 1.61%, compared with 2.34% of the portfolio at the close of 2009. Strong liquidity and a high capital adequacy ratio further attested to the bank’s financial resilience. After expanding the branch network for the first 2 years, in 2010 the bank concentrated on offering additional services and on consolidating its infrastructure. The bank

21 Kamurj UCO. http://www.kamurj.am/en/.

22 Established in 1995, the Agricultural Cooperative Bank of Armenia (ACBA) is a regulated bank founded by the Agricultural Cooperative Regional Unions of

the Armenian provinces of Shirak, Armavir, and Ararat. It obtained a full banking license on 29 March 1996. ACBA was initially created to finance small and

medium-sized agricultural enterprises and individual farmers. In the next few years, the bank began to finance nonagricultural programs. In 2006, Crédit-

Agricole SA France made an investment in ACBA and the bank was reorganized into ACBA-Credit Agricole Bank. See MIX Market. www.mixmarket.org.

Table 11: Major Microfinance Providers in Armenia

Organization

Type of

Institution Year

Gross Loan

Portfolio ($)

Number of Clients

with Outstanding

Loans

ACBA-Credit Agricole Bank Bank 2011 362,336,306 120,596

AREGAK UCO NBFI 2011 25,133,135 26,660

ECLOF UCO NBFI 2011 3,163,554 1,468

Farm Credit Armenia UCO NBFI 2011 6,454,814 1,133

FINCA UCO NBFI 2011 35,162,034 44,989

GFC General Financial Credit Company UCO

NBFI 2011 1,901,066 1,075

Global Credit UCO NBFI 2011 8,026,548 713

GoodCredit UCO NBFI 2011 448,048 69

INECOBANK Bank 2011 162,711,306 72,786

Kamurj UCO NBFI 2011 12,183,504 15,028

Nor Horizon UCO NBFI 2011 5,025,648 3,284

ProCredit Bank Bank 2011 62,393,744 n.a.

SEF International NBFI 2011 11,609,406 12,385

n.a. = not available; NBFI = nonbank financial institution; UCO = universal credit organization.

Source: MIX Market. http://www.mixmarket.org/mfi/country/Armenia/flatstore_mfi_mfdb_data.mix_diamonds__c%2Cbalance_sheet_usd.gross_loan_

portfolio%2Cproducts_and_clients.total_borrowers/2011. Bank and nonbank financial institution websites.


rounded out its product range with facilities for private individuals, introducing utility payment and internet banking and businesses.23

According to analysis by the Microfinance Information Exchange (MIX Market) in 2008, INECOBANK ranked 36th among the 100 best microfinance organizations in developing countries. The bank, registered in 1996, offers bank services for retail clients (169,809 as of September 2011) and corporate customers (5,850 as of September 2011). Microloans in euro are disbursed with interest rates starting at 14% for 1–54 months in an amount of €8.0–€25.0. In 2010, INECOBANK and IFC signed a performance-based grant agreement, according to which IFC will gradually release up to $700,000 of a performance-based grant for INECOBANK, aiming to provide more than 71,000 new microloans to individuals and small entrepreneurs, mostly in rural areas.

Governance standards have noticeably improved since the enactment of laws on credit and financial institutions in 2005 and 2007. The laws increased the central bank’s participation in supervising microfinance institutions. Previously, many microfinance institutions operated as foundations, and as such were outside the scope of financial supervision. Also, the need for external funding has placed more pressure on microfinance institutions to intensify transparency and enhance reporting standards.

Key changes and impacts since 2009 are reported to be in the area of the regulatory emphasis placed on consumer protection, consumer rights, and improving guidelines on prudential regulations. Armenia is one of the first countries in the region to start work on a complete consumer protection framework, and has begun embracing measures to increase transparency.

Both listed and unlisted companies must report in a manner compliant with International Financial Reporting Standards (IFRS) since the passage of the 2008 amendment to the Law on Accounting and Reporting. A greater part of microfinance institutions have followed IFRS since a January 2010 deadline for all nonbank financial institutions, including the UCOs, which comprise much of the market, to adopt these standards.24

Demand

Microfinance in Armenia has been expanding rapidly in the past several years, in both volume and territorial coverage. Presently, microfinance consists primarily of lending, although a few banking institutions offer depository and other financial services to micro entrepreneurs.

The main services from micro providers cover trade, micro and small agricultural businesses, services, and manufacturing. However, demand for microfinance services is high in terms of the variety of services and the client base.

There is strong demand for business as well as consumer and housing loans among many self-employed entrepreneurs and micro and small businesses, which are currently underserved by the banking sector and other providers of financial services. Armenia also offers great potential for microleasing and microinsurance, especially in the agriculture sector.

A microcredit demand survey conducted by the Microenterprise Development Initiative in 2004 showed that Armenia’s financial institutions are meeting less than half of microcredit demand, suggesting a good opportunity for microfinance institutions to increase their scale and outreach. The survey concluded that succeeding in developing internal skills related to market research and product development to meet demand is a challenge. Significant progress has been made in clarifying the legal and regulatory environment for microfinance based on guiding principles established by the Consultative Group to Assist the Poor.25

23 ProCredit Bank. http://www.procreditbank.am/.

24 Economist Intelligence Unit (EIU). 2010. “Global microscope on the microfinance business environment.” London: EIU.

25 Vahe Dalyan and Matt Graham. 2004. “Armenia Benchmarking Report 2004.” Microenterprise Development Initiative. Washington DC: United States Agency

for International Development.


USAID’s Analysis of Micro Credit Demand in Armenia of 2005 estimated the number of potential borrowers among micro and small enterprises at around 50,400.26 Depending on interest rates on loans and the distribution of these enterprises in each income category, the dollar value of demand ranges from $42.4 million to $55.8 million.

Agriculture

The agriculture sector in Armenia is unstable, with interchanging phases of growth and decline during the past decade. The share of agriculture shrank from more than one-third of Armenia’s gross domestic product (GDP) in 1997 to less than one-quarter in 2004. Yet in 2004, the sector grew at an unprecedented 14.5% and contributed 3.1% of the total 10.1% economic growth for that year.27 In 2012, agriculture contributed about 20.0% of GDP, the highest share since 2005.

There are around 340,000 farm households in total, each with 1.4 hectares of land on average and divided into three or four small plots. These account for 97.0% of all agricultural production, while the contribution of commercial agricultural enterprises fluctuated in a range of 0.8%–3.8% during 2003–2006.28 According to the latest Statistical Yearbook of Armenia, commercial organizations contributed 3% to total agricultural output in 2010.29

Given a reduction in the amount of available information, it would be difficult to make up-to-date estimates of current demand for agricultural finance. World Bank estimates that effective demand was more than $100 million from 2005 until 2010, with the average loan size around $300.30 Considering the number of rural households, 340,000 clients seems to be realistic, albeit conservative.31

Based on these considerations, it can be concluded that there is large unmet demand for rural services, which is growing and getting more challenging each year. Demand for sustainable financial services, adjusted to the needs and peculiarities of agricultural production, should therefore be examined in detail.

Government Support

Development of MSMEs has been recognized as a key government development priority. It has set out its commitment through the Concept for Small and Medium Entrepreneurship Development Policy and Strategy in Armenia, and the Law on State Support to Small and Medium Enterprises, both adopted in 2000.32 Annual programs for state support of MSMEs have been implemented since 2001. In 2012, a national strategy for small and medium entrepreneurship development33 was drafted, which specifically promotes entrepreneurship among women and is in line with the government’s On the Approval of the Gender Policy Concept Paper,34 the Gender Policy Strategic Action Plan,35 and the Gender Policy Action Plan for 2012.36 In 2002, the government established

26 United States Agency for International Development (USAID). 2005. “Armenia Micro Enterprise Development Initiative - Analysis of Micro Credit Demand in

Armenia.” Washington DC: USAID. http://pdf.usaid.gov/pdf_docs/PNADK991.pdf.

27 National Statistical Service of the Republic of Armenia. 2004. “Statistical Yearbook of Armenia, 2004.” http://www.armstat.am/en/?nid=45&year=2004.

28 International Fund for Agrcultural Development (IFAD). 2010. “Rural Assets Creation Programme: Program Final Design Report – Main Report.” p. 8.

Rome: IFAD.

29 Statistical Service of Armenia. 2013. “Yearbooks.” http://www.armstat.am/en/?nid=45.

30 World Bank. 2005. “Armenia’s Rural Economy – From Transition to Development.” Washington DC: World Bank.

31 According to the report Armenia’s Rural Economy – From Transition to Development, a conservative assessment of the survey data collected by donor agen-

cies and microfinance operators suggests that there are at least 150,000–200,000 potential small-scale clients. A study conducted by Alpha Plus Consulting in

2001 also concluded that total microcredit demand in Armenia varies between $40 million and $95 million annually.

32 Ministry of Justice. http://www.arlis.am/DocumentView.aspx?docid=64617 (in Armenian).

33 Government of Armenia. 2012. “SME State Support Strategy 2012–2015 (draft).” Yerevan.

34 Government of Armenia. 2010. “On the Approval of the Gender Policy Concept Paper.” Yerevan.

35 Government of Armenia. 2011. “Gender Policy Strategic Action Plan for 2011–2012” Items 19 and 21. Yerevan.

36 Government of Armenia. 2012. “Gender Policy Action Plan for 2012.” Items 11 and 12. Yerevan.


the Small and Medium Entrepreneurship Development National Center to implement annual SME state support programs.

The center provides technical and financial assistance under the umbrella of the Ministry of Economy. The technical assistance comprises information on all the aspects of doing business in Armenia, including training, sales promotion, and support for start-ups. The financial assistance provides loan guarantees, equity financing, seed capital, and partial subsidizing of interest rates for borrowers (Table 12).

Almost 50% of registered MSMEs are located in Yerevan and are particularly active in trade and services. To increase their economic impact, Armenia has taken the following steps:

(i) Government policy is encouraging enterprises with prospective export or import substitution, and looking to diversify the economy and increase the number of SMEs.

(ii) The regional development of the marzes (regions) and reducing the shadow economy are also on the government’s list.

(iii) For the past few years, government emphasis has been placed on the need to simplify the legislative and regulatory framework for SMEs, including tax and customs formalities.37

Constraints to Microfinance

The limited availability of products targeted directly at the microfinance sector constrains the development of microfinance, however, both in terms of credit and other financial services.

Options for Microfinance

The share of agricultural loans, at about 6%, is low compared with the importance of the agriculture sector to Armenia’s economy. This is typically because agricultural finance is considered risky and costly, and lending technologies appropriate for the agricultural activities to be financed are not widely available. Additionally, demand exceeds supply, and infrastructure and technology in rural areas remain underdeveloped. To understand microfinance supply and demand in Armenia, and the constraints, there are several options to consider in supporting the agriculture sector, even from the point of view of making an assessment of the provision of regional technical assistance.

37 Roderick Ackermann. 2010. “Evaluation of SMEDNC/UNDP Joint Project. Support to SME Development in Armenia.” http://erc.undp.org/evaluationadmin/

downloaddocument.html?docid=4275.

Table 12: Regional Distribution of Financial Support Provided in the

Framework of the Start-Up Business Support Program (2010, AMD)

Marz (region) Quantity Loan Amount Guarantee Amount

Aragatsotn 2 3,900,000 4,665,698

Ararat 5 8,373,000 9,909,229

Armavir 1 1,700,000 2,033,766

Gegharkunik 1 2,000,000 2,392,666

Lori 4 6,500,000 7,776,165

Kotayk 3 3,160,000 3,780,415

Shirak 3 4,855,000 5,808,196

Syunik 2 3,300,000 3,945,860

Vayots Dzor 4 5,500,000 6,579,833

Tavush 5 5,563,500 6,655,801

Total 30 44,851,500 53,547,629

Source: Small and Medium Entrepreneurship Development National Center of Armenia. 2010. “Report on

Activities of Small and Medium Entrepreneurship Development National Center of Armenia Fund in 2010”

[in Armenian]. http://smednc.am/download.php?f=1340&fc=smednc%20report%20for%202010.pdf


Develop agricultural lending/value chain finance

i. The development of agricultural lending from banks and UCOs could be enhanced through the development and implementation of new and adequate products such as those for value chain finance.

ii. Beyond the internal capacity of developing banks and UCOs to expand the share of agricultural lending in their total portfolios, a targeted approach to the development of the overall agriculture finance market, especially in remote and rural areas, could benefit from focused initiatives enhancing the value-chain links of different agricultural products or subsectors, including production, processing, and marketing. Many farmers remain economically vulnerable due to the lack of resources and knowledge and poor access to processors and markets. It is necessary to link finance with a broad section of the value chain to develop and strengthen it and to build effective links between stakeholders.

Develop infrastructure and credit technologies for rural areas

i. Conditions for agricultural credit clients, in contrast to urban borrowers, are often characterized by irregular cash flow in terms of date, frequency, and amount. Agriculture is defined by seasonal variables, and agricultural businesses are, naturally, concentrated in rural areas, often implying large distances to travel. Credit expansion to the agriculture sector can therefore be more costly and risky than urban lending. To cope with these challenges, adapted credit technologies could be further developed.

ii. To compensate for the cost factor, better infrastructure for rural areas, including telecommunications, could

be further developed. This would allow financial intermediaries, through technology, to enhance distribution and make it more cost efficient by adding channels such as ATMs, point of sale (POS) terminals, mobile banking, and the internet to the traditional network of branch outlets. This would improve access to financial services for rural populations.

iii. Financial literacy training in rural areas for lending, savings, and insurance services should be provided.

Electronic Banking and Mobile Financial Services

Background

Electronic banking (e-banking) includes plastic cards, internet-based e-banking channels and payment services provided through terminals, and online payment systems. Although the estimated coverage of mobile banking is more than 100%, mobile financial services are in the initial stages of development, with the market offering only a few basic services. E-banking is primarily available to urban customers, with limitations in ATMs, POS, and payment terminal networks preventing uptake in rural areas. Additionally, internet access is still quite low at 45% of households, preventing the uptake of internet banking, especially in remote and rural areas. Many enabling factors, including supportive government regulations and an innovative private sector, together could extend services to people currently not served or underserved by the finance sector.

Supply

E-banking services in Armenia can be classified by type, as outlined in Table 13.

Card channels

Commercial banks first introduced e-banking services through ATMs in the mid-1990s, offering clients the means to transact using a plastic card. In March 2000, the central bank, together with 10 commercial banks, launched Armenian Card (ArCa), a national payment system for card processing. This payment processor provides services to 20 banks, which issue and service either the national ArCa, MasterCard, Visa, or American Express.


The current market for plastic cards consists of an estimated 1,318,010 cards in circulation, of which ArCa (at 37%) and Visa (40%) have the largest share (Figure 3 and Table 14).38

While total penetration of the plastic card market remained limited at 42.5% of the population in 2012 (31.5% in 2011), signs of growth emerged between 2008 and 2010. The ATM network grew 16.0%, alongside POS network growth of 29.5%, which together gave rise to a 29.1% increase in transactions.39 To drive volume through these channels, banks such as ACBA-Credit Agricole have introduced targeted products based on the receipt of remittances directly to plastic card accounts and a utilities payment card to enable payment of household bills through ATMs.

Low uptake of cards is partly attributed to capacity issues at ArCa, which have affected the reliability and availability of the ATM/POS network. In response, ArCa was expected to upgrade to a new payments system, improving availability and security and offering better integration options for partner banks.

Another factor likely affecting the uptake of card channels is the distribution of ATM/POS networks in rural areas. According to central bank statistics, 51.5% of ATMs in 2012 were within Yerevan and the majority of those outside the capital are located in urban centers. Banks appear reluctant to install machines in rural areas due to low transaction volumes and the high cost of transporting cash and servicing ATMs.

Commercial bank branch networks in rural areas are limited, with the 68 branches of VTB Bank (Armenia) providing the largest network. In response to the challenge of providing services to rural villages, the Armenian postal network, HayPost, and Converse Bank have partnered to launch a postal banking model to provide postal financial services through the 250 post offices. These offer banking services including account opening, currency exchange, cash transactions, money transfer, and servicing of plastic cards.

38 Central Bank of Armenia. www.cba.am.

39 Yerevan Report. 2010. “Credit Card Usage in Armenia Up 31 Percent.” 25 August 2010. http://www.yerevanreport.com/28691/credit-card-usage-armenia/.

Table 13: Availability of e-Banking Services (2011)

Service Availability

Remote bank account management • Internet banking (offered by most commercial banks)

• SMS banking, particularly associated with plastic card accounts

• ATM network for cash-out services

Payments for goods/services (person-to-business)

• Third-party payment terminal/dealer networks (Telcell, Mega Pantera, Tandem)

• Bank payment and information terminals (such as those available in Converse Bank halls)

• POS at merchants

• Internet banking (most commercial banks)

• Foreign electronic wallet services (WebMoney, Yandex)

• Local e-money (Idram LLC)

• M-commerce from some banks (Unibank launching first quarter 2012)

• Payment from e-money balance (Mobidram launching first quarter 2012)

Person-to-person remittances Idram LLC e-wallet through a money transfer organization

Card-to-card transfers (ArCa)

Government-to-person payments (salary payment for state-owned companies)

Pension payments via plastic card (provided for example by VTB Bank (Armenia), ARARATBANK, Bank Anelik, Bank Prometey.

Government-to-business Salary payments for state-owned companies

Business-to-business (internet banking) Local e-wallet (Idram LLC)

ArCa = Armenia Card, e-money = electronic money, m-commerce = mobile commerce, POS = point of sale, SMS = short messaging service.

Source: Consultant’s interviews in Armenia.


37%

40%

20%

3%

ArCA Visa MasterCard Other

Note: Percentages as of the third quarter of 2011.Source: Central Bank of Armenia. http://www.cba.am/en/SitePages/

Default.aspx.

Figure 3: Cards Issued by Type (2011)

Table 14: Card Channel Market

2008 2009 2010 2011 2012

Number of ATMs 538 702 819 1,009 1,170

Number of points of sale 2,280 2,720 3,730 5,155 6,674

Of which in bank 410 438 467 554 623

Number of cards issued 454,357 579,431 729,298 974,911 1,318,010

Number of card transactions 6,586,134 8,848,052 11,292,931 14,565,985 18,800,105

Source: Central Bank of Armenia. https://www.cba.am/Storage/AM/downloads/vchar/axes/ax3.xls, https://www.cba.am/Storage/AM/downloads/vchar/axes/ax4.xls, https://www.cba.am/Storage/AM/

downloads/vchar/axes/ax5.xls.

While HayPost and Converse Bank intend to open more branches, the rollout depends on a major systems upgrade by HayPost, which also includes renovation and modernization of all post offices. Commencing in 2011, this has included a modern POS system to provide a platform for the provision of postal and financial services through the post office network. This system, Post POS, was due to be fully implemented by the end of 2012. The options for postal financial services should be fully open and result in a village-based network of banking agents and services.

Payment terminals

While card-based e-banking has grown steadily, terminal-based electronic payments systems have emerged since 2007. These systems consist of networks of physical payment terminals that are spread across the country, receiving cash payments on behalf of service providers such as utility companies, mobile operators, insurance agents, e-money providers, the traffic police, and financial service providers.40 These players process monthly payments of AMD500.0 million (about $1.2 million), of which 65%–70% are payments to mobile operators, 20%–25% to utilities, and the remainder to other service providers.41

40 TelCell in 2011 acquired the Mega Pantera settlement-payment organization and has since operated the terminals Mega Pantera managed.

41 Kiosks RU. 2009. http://www.kiosks.ru/content/rus/628/6288-article.asp?archive=1 (in Russian).


The largest payments system provider is Telcell, which operates about 1,000 terminals. It is also responsible for creating links with the finance sector, offering collections on behalf of nine banks (VTB Bank, Unibank, Artsakhbank, Anelik Bank, Armenian Development Bank, ProCredit Bank, Prometey Bank, BTA Bank, INECOBANK) and one UCO (Norvik). Customers of these institutions can repay either their credit card account or make a direct payment to an outstanding loan via the payment terminals operated by Telcell.42

While commercial banks use payments through the terminal network, UCO participation is less developed. AREGAK, which operates primarily in remote areas, has eliminated the option of collecting loan repayments through the payments system providers due to the cost of these services and limitations on the availability of the machines in their target areas. FINCA also considered using these collection channels, but did not see a match with lending methodologies. So while these payment channels are present, their ability to service the rural finance market remains untapped.

In addition to these third-party cash terminals, several banks, including Converse Bank, have deployed their own terminals within their branches to encourage electronic payments and to help customers access information related to their accounts. These machines allow customers to make direct purchases, such as for mobile phone credits, and pay utility bills directly from bank accounts without needing to go to a bank teller. While avoiding queuing to pay, the reach of these services is still limited by the extent of branch networks.

E-money

Internet-based e-money providers are available from companies including Idram, WebMoney, and Yandex. These providers offer an online system for a range of payments, including utilities and online purchases.

Idram Internet Payment System, which the central bank has regulated as a money transfer organization since 2009, is currently the leading Armenian provider of e-money services. To use this service, customers must register and initially add money, referred to as Idram units, to their wallet by either using a plastic card, depositing via a branch of the participating banks (Unibank, Armbusinessbank, Ardshininvestbank), by direct payment to the Idram office, or via the two larger payment terminal networks (Telcell/Mega Pantera and Tandem). Stored funds can be used to repay loans, pay utilities, buy mobile credit, purchase goods from online shops, pay taxes and fines, or pay internet service providers (Orange, VivaCell-MTS, and Beeline). Person-to-person transactions are also possible with the transfer of Idram units between two wallet holders at a commission of 1%. Unused funds can then be “cashed out” via the nominated banks (Armbusinessbank, Ardshininvestbank), an Idram office, or through a noncash bank transfer. Idram is also accessible via mobile phone, though this method has slightly less functionality than the online version.

Armenians can also access two major foreign providers of e-money, Web Money and Yandex. These can be topped up using the terminal network of Telcell and Mega Pantera, after which funds are available for internet shopping and digital purchases.

While their existing integration with cash in/out providers and payment technology could allow these companies to play a role in extending financial access to rural areas, their market is focused primarily on people who already have internet access and are familiar with e-payments. Web Money and Yandex have initiated studies through the parent company in the Russian Federation to see how they could extend services via mobile phones to promote financial access, especially in rural areas. When they complete a model for the Russian Federation, they are expected to seek to replicate this in other countries of operation, including Armenia.

42 Central Bank of Armenia. “Payment System: Statistical Data and Reports.” http://www.cba.am/EN/SitePages/psstatisticaldatareports.aspx. The second-

largest provider, Tandem, has a network of 43 terminals.


Mobile financial services

For true mobile-based innovations, there are few initiatives, and most are geared more toward providing information, or, at best, account-management services, rather than advanced mobile financial services. VTB Bank allows clients to access account information through short messaging service (SMS). Areximbank also suggests that its internet banking platform can be accessed via mobile phones, which could be considered a type of mobile banking.

While current activity is low, several initiatives have been launched in the payment market to deliver mobile financial services. One is Unibank, which planned to launch a full mobile commerce service in 2012. This product would enable customers to link existing bank accounts with a payment service that could be used for utility payments, and for person-to-person and person-to-business transfers. This would involve Unibank creating its own merchant network to accept payments, with the expectation that all payments will terminate in an account held by Unibank. ARARATBANK has similar plans to launch a mobile service that will enable customers to use mobile phones to make utility payments and person-to-person transfers directly from their bank accounts.

Nonbank players, such as Mobidram (a subsidiary of VivaCell-MTS) that has been licensed as a remittance organization, are also looking to enter the mobile financial services market, and to this end have received central bank approval to provide e-money issuance and servicing. Through this service launched in 2012, customers are able to pay utility bills, buy mobile credit, and repay loans, using their available e-money. Mobidram expects to expand the service to different types of payments and transfers in 2013, although this will be subject to central bank approval.

Demand

Demand for e-banking can be extrapolated based on access to financial services (Table 15). According to a USAID benchmarking study, which measured access based on the number of bank branches, ATMs, and borrowers, Armenia has access equivalent to 50% of the global benchmark and about 20% lower than other central and eastern European countries.43 Access to credit in 2012 was rated as 40th out of 183, according to the World Bank’s Doing Business rating scale.44

Access to bank branches is limited, with only 15.1 commercial bank branches per 1,000 square kilometers, which gives access to 188 people for every 1 million (Table 15).45 ATM access, which is measured both by the number of plastic cards issued and the extent of the ATM/POS network, is only marginally better: 68% of the population, 2.1 million people, are without access to accounts issued with plastic cards, which limits their payment options and access to bank deposits. The ATM network is well below the global benchmark and one of the smallest in the region, with only 33.9 ATMs per 1,000 square kilometers and 312 for every 1 million people (Figure 4).46 Access to POS machines for card-based payments is only slightly more accessible than ATM access, with 1,663 POS per million.

43 USAID. 2011. Partners for Financial Stability. Armenia High Level Financial Sector Overview. USAID. http://www.pfsprogram.org/sites/default/files/files/

Armenia_High_Level_Financial_Sector_Overview_June_2011.pdf. Washington DC: USAID. The report divides the regions into (i) central and eastern Europe

(the northern tier comprising Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia and the southern tier comprising Albania,

Bosnia and Herzegovina, Bulgaria, Croatia, the former Yogoslav Republic of Macedonia, Kosovo, Montenegro, Romania, and Serbia); and (ii) Eurasia,

comprising Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, the Russian Federation, Tajikistan, Turkmenistan, Ukraine, and

Uzbekistan.

44 The World Bank Doing Business ranking system measures the ease of doing business on a scale of 1 to 183, whereby a higher ranking corresponds with a

regulatory environment more conducive to operating a local firm. As part of the assessment, access to credit is rated by two indicators; the depth of credit

information available and the strength of legal rights. World Bank. 2013. Doing Business: Measuring Business Regulation. Washington DC: World Bank.

http://www.doingbusiness.org/methodology/getting-credit.

45 USAID. 2011. Partners for Financial Stability. Armenia High Level Financial Sector Overview. USAID. http://www.pfsprogram.org/sites/default/files/files/

Armenia_High_Level_Financial_Sector_Overview_June_2011.pdf.

46 USAID. 2011. Partners for Financial Stability. Armenia High Level Financial Sector Overview. Washington DC: USAID. http://www.pfsprogram.org/sites/de-

fault/files/files/Armenia_High_Level_Financial_Sector_Overview_June_2011.pdf.


Although the ATM network is growing, the rate has not been rapid, with only a 23% increase in terminals reported between 2010–2011. This implies that at current rates card-based channels will not solve low access to finance. This presents significant opportunity for other technologies, including terminals and mobile, to promote access to finance.

Demand for convenient payments systems using noncard electronic channels is difficult to measure given a lack of volume statistics.47 It is clear that some types of payment, such as purchasing credit for mobile phones and paying utility bills, are relatively well met through existing options, including direct payment to a supplier, the payment terminal network, payments through bank counters or post office outlets, internet banking, and e-wallets.

While options for payments are many, most rely either on access to the internet or the payment terminal network. This network is largely confined to urban centers, however, and is therefore not accessible to rural clients, who represent 36% of the population.48

By contrast, internet access, at 45% of households, is somewhat better than for terminals.49 It is promising that in these statistics, 35% of users are rural villagers and 22% who have internet access use mobile phones for that purpose.50

Mobile phone ownership, as a prerequisite for accessing mobile financial services, is widely available. There are 3.9 million mobile subscribers in Armenia, more than 116% penetration, suggesting that many users have more than one SIM card. 51 VivaCell-MTS is the largest of the three main telecommunication providers, with about 65% of the market; the three largest providers together reportedly cover 90% of the market, suggesting that a mobile network is accessible to most of the population.52

Government Support

The Central Bank of Armenia Strategy 2012–2014 plans to continually introduce institutional and infrastructural reforms to make the finance sector more competitive and modern. More specifically, the central bank intends to ‘‘raise financial intermediation through new financial institutions, financial infrastructures, instruments and

47 The only available statistics refer to internet-based cashless payments. These were reported at AMD2.0 billion in the second quarter of 2010, 17.6% more

than in the first quarter. ArmenianBanks.com. 2010. “Volume of e-commerce in Armenia made 0.5bln AMD in the second quarter, 2010.” http://www.arme-

nianbanks.com/news/2010/08/24/volume-of-e-commerce-in-armenia-made-0-5bln-amd-in-the-second-quarter-2010/.

48 World Bank. 2012. “Armenia at a glance.” Washington DC: World Bank. http://siteresources.worldbank.org/ARMENIAEXTN/Resources/0811_CountryData-

Profile.pdf.

49 Budde.com. “Armenia - Telecoms, Mobile and Internet.” http://www.budde.com.au/Research/Armenia-Telecoms-Mobile-and-Internet.html.

50 New Caucasus. 2011. “Internet Penetration in Armenia Tripled in Past 2 Years: Caucasus Barometer.” 12 April 2011. http://www.epress.am/en/2011/04/12/

internet-penetration-in-armenia-tripled-in-past-2-years-caucasus-barometer.html.

51 Budde.com. “Armenia - Telecoms, Mobile and Internet.” http://www.budde.com.au/Research/Armenia-Telecoms-Mobile-and-Internet.html.

52 VivaCell-MTS. http://mts.am/index.php?lng=2; http://beeline.am/am/index.wbp http://www.orangearmenia.am/en/about-orange-armenia/; and official

websites of mobile operators.

Table 15: Indicators of Access to Financial Services in Armenia

2007 2008 2009 2010 2011

Real interest rate spread (percentage points) 6.87 1.42 6.69 3.45 n.a.

Number of borrowers from commercial banks per 1 million adults 159,900 190,500 162,890 201,880 258,400

Number of commercial bank branches per 1 million population 123.15 134.46 137.79 143.49 188.00

Number of ATMs per 1 million population 112.79 179.50 234.24 263.22 312.30a

n.a. = not available. a Calculated using the population of 3.1 million in 2011 (according to the World Bank). Sources: United States Agency for International Development. 2011. Partners for Financial Stability. Armenia High Level Financial Sector Overview. Washington DC: USAID. http://www.pfsprogram.org/sites/default/files/files/Armenia_High_Level_Financial_Sector_Overview_June_2011.pdf. Central Bank of Armenia. 2013. https://www.cba.am/en/SitePages/Search.aspx?k=ATM. World Bank. “World Development Indicators.” 2012. Washington DC: World Bank.


services, and work on introducing noncash and electronic financial services and their gradual development.’’53 In line with this, it has made several systems and regulations available that together support e-banking. These include:

(i) the BANKMAIL system for interbank electronic payments;(ii) Armenian Card (ArCa) unified card payment and settlement system in compliance with Payment Card

Industry Data Security Standard;(iii) the Law on Payment Systems and Payment Service Organizations (2004);(iv) the Law for Digital Signature (2004);(v) Regulation 16/1 “On Procedure and Conditions for Granting, Suspending and Terminating the Permission

of the Issuance of Electronic Money and the Requirements for Electronic Money Issuers”;(vi) Regulation 16/2 “On Procedure and Conditions of the Issuance and Servicing (Circulation) of Electronic

Money and the Requirements for the Execution of Transactions with Electronic Money”; and(vii) the e-Governance Infrastructure Implementation Unit (EKENG).

Within these regulations and systems, the availability of e-money regulations is of particular importance to the growth of the e-banking environment. Under the regulations, any organization with a money transfer license can issue e-money if they have satisfied central bank criteria. These include a minimum capital requirement of AMD70 million ($173,448.00), starting from April 2012, for a license for all types of payment organizations. This requirement was expected to rise to AMD100 million ($247,722.00) in October 2012. Additionally, e-money that is kept by the issuer in the registration account(s) cannot exceed the equivalent of AMD200,000 ($495.64) for each user at any given moment.

The market response to the introduction of these regulations has been somewhat mixed, with some providers arguing that entry barriers are too high and that the transaction limits will make the service unattractive for many users wanting to purchase goods online. Others are more positive, feeling that the Central Bank of Armenia has provided cautious regulations to guide this new area and will respond to market demands if these

53 Central Bank of Armenia. “Strategy 2012–2014.” Yerevan. http://www.cba.am/Storage/EN/Verluc/CB%20Strateg-2012-2014-eng.pdf.

Figure 4: Number of ATMs (per 1,000 km2)

CEE = central and eastern Europe, km2 = kilometers squared.Northern tier: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia.

Southern tier: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Former Yugoslav Republic of Macedonia, Kosovo, Montenegro, Romania, and Serbia. Eurasia = Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, the Russian Federation, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

Source: United States Agency for International Development (USAID). 2011. Partners for Financial Stability. Armenia High Level Financial Sector Overview. Washington DC: USAID. http://www.pfsprogram.org/sites/default/files/files/Armenia_High_Level_Financial_Sector_Overview_June_2011.pdf.

Armenia CEE northern tier CEE southern tier

Eurasia Eurozone

00

2020

4040

6060

8080

100100

120120

140140

160160

180180

2007 2008 2009 2010 2011


need to be adjusted. So far, no providers have been approved under these regulations, although one provider, Idram, received an e-money license approved at the beginning of March 2012.54

One area relevant to the promotion of e-banking in rural areas is the availability of regulations concerning agent banking. Current legislation governing banks and other financial institutions does not allow these organizations to offer products through agents. This limits the extent to which providers can offer services to rural locations through a bank-agent network, requiring investments in full branch infrastructure to service any location. An exception to these rules has been made for insurance companies, which are permitted to use agency agreements for the sale of insurance products.

The government is also supportive of infrastructure for e-banking through communications networks. A strategy has been implemented to build a secure, high-speed backbone communications network that will help an evolving and diverse range of e-government and e-commerce applications. Alongside these infrastructure developments, EKENG is implementing the e-government strategy. Initial activities are focused on the development and rollout of electronic identification cards, which will provide digital signatures, biometric information, photographs, and other personal information for all cardholders. Launch was in mid-2012 and expected to directly benefit the e-banking sector through the availability of e-signatures, which could be used to improve security.

Other government e-banking initiatives included the launch in February 2011 of pension payments through plastic cards. Through 13 partner banks, pensions are paid directly to plastic cards provided free of charge to pensioners. To promote the use of the funds for noncash purchases, pensioners receive discounts at locations such as health and dental clinics and pharmacies. The project is still being rolled out and as such has considerable progress to make before being available to all 521,000 pensioners in the country.55 However, the uptake appears promising. One of the larger partners, VTB Bank, reported that within the first 3 months of service, 7,444 pensioners had been paid this way and another 30,000 opened bank accounts with the card for the same purpose.56

Constraints to Electronic Banking and Mobile Financial Services

Several constraints have been noted that prevent the uptake of e-banking and mobile financial services by a larger percentage of the population. These include

(i) limited networks of ATM/POS/cash terminals and limited availability of plastic cards;(ii) difficulty for terminal providers to profitably serve rural areas in light of their current pricing structure;57

(iii) limited internet access, especially in rural areas;(iv) cost and dependence on a limited number of suppliers to integrate the core banking systems with an

e-banking channel;(v) capital requirements to obtain an e-money license and limitations on transaction amounts; and(vi) lack of agent banking regulations.

Road Map for the Development of Electronic Banking and Mobile Financial Services

A three-phase intervention is required to deliver e-banking services to rural populations. Through technical assistance and pilot projects, including through the use of mobile phones, rural populations have greater access

54 Idram Payment System. http://www.idram.am/index.php?lang=eng&level_id=538.

55 ARKA News Agency. 2011. “Armenia’s State Pension Service Signs Pension Payment Agreements with 13 Banks.” http://www.armbanks.am/

en/2011/02/01/19234/.

56 ARKA News Agency. 2011. “Bank VTB (Armenia) has paid old-age and retirement pensions to 7,444 senior Armenian citizens.” 11 April 2011. http://www.

armbanks.am/en/tag/pensions/.

57 In Armenia, the average return on one terminal is 18–36 months, and the average payback of the entire business, at a monthly income of $5,000–$10,000

and total investment in its development at an average of $350,000, is about 10 years; whereas, under normal conditions, the return on investment in this

business is 2.5–3 years. Kiosks.ru [in Russian]. http://www.kiosks.ru/content/rus/628/6288-article.asp?archive=1.


to finance. The intervention would provide (i) a supportive regulatory environment and (ii) pilot projects to realize the potential of mobile financial services.

E-banking is available in several forms within Armenia, although most are accessible to urban populations through ATMs, POS, payment terminals, or internet access. This excludes many rural clients from e-banking services, but presents an opportunity to see how other technologies could address this market. Considering the cost and complexity of extending card and internet systems to rural areas, mobile financial services appear to be the most attractive alternative, particularly mobile payment systems such as mobile money transfers. To this end, ADB could pursue the holistic development of mobile financial services through a step-by-step approach that aims to ensure rural populations have access to e-banking channels equal to those in urban centers.

Mobile financial services framework development

Technical support to the Central Bank of Armenia could be provided for the development of a framework for the delivery of financial services through mobile channels in urban and rural areas. This framework or strategy could in turn be available to guide regulations and develop these services. This should consider the normal evolution of mobile services, which starts with information-based systems and evolves to transformative solutions that radically change the way financial services are delivered (Figure 5). Formulation of a plan should also cover the lessons learned from other countries, with careful consideration to various models of mobile financial services that could be well suited to the Armenian market, taking into account existing players.

Finally, the framework will include helping financial providers identify the opportunities available through mobile financial services in Armenia. This will need to consider a cost–benefit analysis that involves detailed analysis of the demand for the types of financial services that can be offered through mobile channels.

Mobile financial services regulatory review and development

While many of the regulations for mobile financial services are available within central bank rules, some topics are not provided for, and others may require review to ensure that they fully support mobile financial services.

Based on the strategy identified, Armenia will need to decide on the relevance and required role for agents within their context. Current regulations do not allow for the provision of banking services through an agent network, which could be a critical limiting factor in the delivery of mobile financial services. Banking or mobile money transfer agents should provide the registration services and cash in and out support for mobile. Agents have been directly associated with improving access to financial services in rural areas, and their availability is generally considered a critical component of mobile financial services delivery. Regulations governing agents should take into account topics such as exclusivity, recruitment and training, assurances of operational integrity, the enforcement of know-your-customer protocols, and other agent business interests.58

Since larger networks will provide a lower unit cost per service and generally enhance the usability of the service, it may also be necessary to review or improve some regulations to cater for interoperability across various mobile financial services providers and between the various e-banking channels in the market. Regulators will need to decide whether only to encourage interconnection, possibly through the definition of standards, or to make it a mandatory element of all services. Both options risk the likelihood that technical standards may well become outdated in the time taken to develop them. To mitigate this, some regulators have sought to provide technically neutral requirements governing areas of authentication, communication, and verification. For regulators preferring to enforce interconnectivity, a judgment call is required to assess how this could hamper innovation and the likelihood that interconnection charges could be agreed upon to the satisfaction of all parties.59

58 Michael Klein and Colin Mayer. 2011. “Mobile Banking and Financial Inclusion: the Regulatory Lessons.” Washington DC: World Bank.

59 Michael Klein and Colin Mayer. 2011. “Mobile Banking and Financial Inclusion: the Regulatory Lessons.” Washington DC: World Bank.


The review of mobile financial services regulation will also need to consider supervision of mobile channels and how this can be catered for within the existing supervisory function.

Support for mobile financial services pilots

Once the framework and regulations are in place, ADB could support the piloting of mobile financial services by qualified providers. The projects should include

(i) product development with pilot partners to design and implement products and services appropriate to mobile channels,

(ii) detailed cost–benefit analysis for the pilot institutions and target clients,(iii) clear evidence of how use of these channels will help expand financial outreach to rural areas,(iv) demonstration of how the services will be interoperable with other e-banking initiatives to help build a

wide network with open access,(v) identification of the agent and service point network for delivering mobile financial services,(vi) client training and awareness campaigns on how mobile channels can be used to access financial services,

and(vii) monitoring and evaluation.

Depending on the Central Bank of Armenia’s preferred model of mobile money transfer (whether led by banks, other financial institutions, or telecommunications providers), this support could be given to players well positioned to extend services to include mobile money transfer. This includes companies such as HayPost, Idram, Telcell, or Mega Pantera, which already have networks and technologies that could be enhanced to support such transfers.

The Insurance Sector

Market Analysis

Armenia’s insurance market is in the early stages of development. Insurance penetration (the value of total premiums as a percentage of GDP) is low at 1.75%,60 compared with 8.14% in Organisation for Economic Co-operation and Development (OECD) countries and 2.62% in central and eastern Europe. Insurance density (the ratio of the value of insurance premiums in US dollars per person) of less than $2.0 compared with $2,847.8 in OECD countries and $272.5 in central and eastern Europe.61 The slow development of the insurance sector can be attributed to regulatory factors, market structure, the development of other segments of the finance sector, social and human development, and cultural factors.

60 In 1997–1999, insurance penetration was about 0.2% of GDP.

61 Swiss Re. 2011. “New Swiss Re sigma study ‘World insurance in 2010’ reveals growth in global premium volume and capital.” 6 July 2011. http://www.

swissre.com/media/news_releases/nr_20110706_World_insurance_in_2010.html.

Figure 5: Evolution of Mobile Financial Services

Source: Government of India. 2011. “Draft Consultation Paper on Mobile Governance Framework.”

http://www.ipeglobal.com/newsletter/May_2011/Draft_Consultation_Paper_on_Mobile_Governance_28311.pdf.

Information Interaction Transaction Transformation


During 2007–2011, legislative reforms pertaining to the operation of the financial system produced a foundation for the implementation of insurance and capital market reforms. The transfer of the insurance supervisory authority to the central bank in 2006, adoption of the new legislation, rising incomes, and projects under way that cover issues such as consumer protection and the financial literacy of households, could lead to more rapid development of this sector.62

As of December 2012, seven insurance companies and four brokerages operated in the country (Table 16). Today, insurance is no longer state-provided and foreign ownership of insurance companies is permitted. Foreign equity participation has taken place in five insurance companies, of which foreign ownership is more than 50% in three, while two have foreign ownership of over 75%.

Although having efficient life insurance is an essential element of systemic pension reform because of the derived demand for annuity products by retiring workers and life and disability insurance by active workers, it is notable that no insurers currently sell these.63

Insurance penetration is primarily driven by large commercial enterprises and compulsory motor third-party liability insurance (CMTPLI), rather than voluntary purchases by the private sector. According to Central Bank of Armenia data, the total premiums for all insurance companies operating in Armenia were over AMD35.5 billion ($88.0 million) at the end of December 2012, 60% higher than a year earlier. The volume of insurance

62 Central Bank of Armenia. “Strategy 2012–2014.” Yerevan. http://www.cba.am/EN/panalyticalmaterialsresearches/CBA%20strategy%202012-2014-eng.pdf.

63 The Law on Insurance and Insurance Activities, passed on 30 September 2007, covers matters such as licensing, registration, and the organization of

information. After passage, the three companies underwriting life insurance business had to surrender their licenses because the law restricted composite

insurance licenses (that is, life and nonlife insurance businesses were segregated). While establishing another subsidiary can accommodate this constraint,

the high capitalization requirements relative to potential business prevent cost-effectiveness in the life insurance segment at present. The new legislation also

permitted nonlife insurers to underwrite some lending activities and some types of creditor insurance, which is the insurance for accidents and deaths.

Table 16: Overview of Insurance Companies in 2012

Name Significant Participants (% shareholding)

Armenia Insurance Region CJSC , Armenia (90%)

E. Abrahamyan, Armenia (10%) (but the person (real name was Edward Arabkhanyan) has recently passed away and no successor has been announced yet)

Garant Insurance M. Yeritsyan, Armenia (28.35%)

Joint Medical Centre Arabkir, Armenia (6.7%)

INGO Armenia Insurance Invest-Polis CJSC, Russian Federation (75%) (Ingosstrakh OJSIC is the owner of 100% shares of Invest-Polis CJSC)

Levon Altunyan, Armenia (25%)

Nairi Insurance Levon Kocharyan, Armenia (30%)

Vahan Gabrielyan, Armenia (22.5%)

Hovik Shahinyan, Armenia (22.5%)

Vahagn Shahinyan, Armenia (12.5%)

Vahagn Khachatryan, Armenia (12.5%)

RESO Insurance Polygraphia (co-owner of Uniastrum Bank, Unibank), Armenia (50%)

CIS Equity Partners Limited (owner of RESO-Garantia Insurance), Russian Federation (50%)

Rosgosstrakh Armenia Rosgosstrakh Ltd., Russian Federation (100%)

SiI Insurance Khachatur Sukiasyan, Armenia (20%)

Saribek Sukiasyan, Armenia (20%)

Eduard Sukiasyan, Armenia (20%)

Robert Sukisayn, Armenia (20%)

Armeconombank, Armenia (20%)

Source: Official websites of the Armenian insurance companies.


compensations at the end of December 2012 was about AMD14.5 billion ($35.9 million), nearly three times more than a year before. Due to its small size, the impact of the insurance sector on financial stability is also estimated to have been low. However, the insurance companies assets have grown 51% thanks to the CMTPLI scheme. 64 While the introduction of the scheme seems to have provided an impetus to nonlife insurers, there is limited premium revenue from car insurance, despite a large fleet of cars relative to the size of the population.

There is an absence of export credit insurance, leaving Armenian exporters unprotected should their foreign counterparts fail to pay due to political or commercial problems.65 This factor contributes significantly to the reluctance of Armenian producers to sell internationally. EBRD, IFC, and ADB cooperate with Armenian banks to provide cover for political and commercial payment risks in international trade transactions. However, in most cases this works only among globally established partner banks. This arrangement provides only a partial solution. Domestic insurers only provide standard marine insurance. However, in November 2012, the Armenian government approved measures to establish a state-sponsored export credit agency to support export finance for small and medium-sized exporters.

The insurance business has so far been profitable despite the small size of the market and limited range of products (Figures 6 and 7). Many transactions may go unrecorded to avoid tax payments and reporting requirements.66

In recent years, there has been a steady decline of the Herfindahl–Hirschman Concentration Index, one of thefinancial indicators for measuring the competiveness of the insurance market (Table 17).67

The Association of Insurance Market Participants of Armenia is a voluntary union of legal entities consisting of representatives of insurers and others, including brokers, adjusters, and surveyors/adjustors. The association cooperates with the Central Bank of Armenia in drafting regulations and will ultimately work as a self-regulatory organization.

64 Central Bank of Armenia. “Strategy 2012–2014.” Yerevan. http://www.cba.am/EN/panalyticalmaterialsresearches/CBA%20strategy%202012-2014-eng.pdf.

65 European Union Advisory Group to the Republic of Armenia. 2011. “The place of financial tools in the creation of a trade pomotion organization. The

European Neighbourhood Partnership Instrument for the Republic of Armenia.” http://www.euadvisorygroup.eu/sites/default/files/Policy%20Paper_%20

The%20place%20of%20financial%20tools%20in%20the%20creation%20of%20a%20Trade%20Promotion%20Organisation_eng.pdf.

66 United States Agency for International Development (USAID). 2006. Armenia Financial Sector Assessment. Washington DC: USAID.

67 Herfindahl–Hirschman Concentration Index is commonly accepted measure of market concentration. The closer a market is to being a monopoly, the higher

the market’s concentration (and the lower its competition).

Figure 6: Insurance Contracts (by type)

Source: Central Bank of Armenia. 2010. “Statistical Bulletin of the Central Bank of Armenia.” http://www.cba.am/en/SitePages/statspannualbulletin.aspx.

0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000

Land vehicle

Fire and natural disaster

Accident

Assistance services

Other damage to property

Health

General liability

Land vehicle

Property (cargo) in transit

Provison of assurance


Table 17: Herfindahl-Hirschman Concentration Index

Indicators 2007 2008 2009 2010 2011

Assets 0.13 0.10 0.09 0.12 0.15

Liabilities 0.19 0.14 0.12 0.15 0.20

Capital 0.11 0.10 0.09 0.11 0.13

Insurance amounts 0.33 0.26 0.28 0.21 0.19

Insurance premiums 0.18 0.16 0.13 0.16 0.18

Note: Figures are as at the end of December in each year. The closer a market is to being a monopoly, the higher the market’s concentration (and the lower its

competition).

Source: Central Bank of the Republic of Armenia. 2011 and 2012. “Armenian Financial System - Development, Regulation and Supervision 2010 and 2011.”

Yerevan. https://www.cba.am/EN/pperiodicals/fin_ham_zarg_11.pdf.

Source: Central Bank of Armenia. 2010. “Statistical Bulletin of the Central Bank of Armenia.” http://www.cba.am/en/SitePages/

statspannualbulletin.statspannualbulletin.aspx.

Figure 7: Gross Insurance Premium and Insurance Indemnity

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000

2007

2008

2009

2010

Insurance indemnity (AMD ‘000) Gross insurance premium (AMD ‘000)

Motor liability insurance, introduced in January 2011, has boosted the development of the insurance sector and is also expected to strengthen the local securities market. The Armenian Motor Insurers’ Bureau (see Box 1) is responsible for administering this scheme. From January through December 2011, Armenia’s insurance companies paid AMD5.6 billion ($14.6 million) in compulsory motor third party liability insurance compensation, of which the eight largest companies paid the equivalent of $14.4 million (Table 18). According to the Armenian Motor Insurers’ Bureau, during the period they satisfied 24,921 applications, while pending payments totaled AMD1.0 billion ($2.6 million). Thus, the loss ratio of CMTPLI in Armenia reached 54% at the beginning of December 2011 (Table 19). The bureau paid AMD78.4 million (in connection with 129 events). CMTPLI policies cover 382,359 Armenian drivers, who paid AMD14.2 billion (about $39.9 million) in premiums to December 2011, of which the eight largest companies received insurance premiums valued at $36.9 million (Table 19). To make the scheme sustainable and administer it efficiently, efforts should focus on the introduction and enforcement of actuarially determined insurance rates with the right mix of incentives and disincentives for errant drivers—that is, a bonus-malus system—and a loss-reserving system that accounts for unpaid or unclaimed liabilities. In addition, bottlenecks related to claims settlement need addressing in a transparent and timely manner. This will require development of dependency factors to compensate death, disability factors for partial and total disability, assessment protocols to assess third-party property damage, and training and developing a cadre of loss assessors.


Box 1: The Armenian Motor Insurers’ Bureau

The Armenian Motor Insurers’ Bureau is a self-regulatory organization—legally recognized by the state and established by the Central Bank of Armenia—whose members provide compulsory motor vehicle third-party liability insurance (CMTPLI). It aims to protect the interests of injured parties and to provide a stable and developing CMTPLI system.

For the stability and development of the system, the bureau ensures that its members follow the rules it adopts. It approves the form of CMTPLI agreements and sets a range for insurance premiums. Cooperation with government and other bodies and motor insurer organizations in other countries is within its sphere, as is participation in events aimed at the prevention of traffic accidents. The bureau’s remit extends to the prevention of forgeries and falsifications, and it investigates disputes between its member insurers, as well as any between insurers, insured persons, and injured parties.

The Guarantee Fund, managed by the bureau, compensates injured parties in cases where the Law on CMTPLI requires it to do so. The bureau is responsible for a common information system about CMTPLI and provides the wider population with assistance and education on motor insurance.

For the direct protection of the injured, the bureau compensates for damages if the driver of the vehicle that has caused the damage or the person having CMTPLI coverage is unknown. In this case the bureau only compensates for personal damages caused to the injured party at the expense of the Guarantee Fund. The bureau also pays out compensation if a vehicle lacking a CMTPLI contract causes the damage and when a hijacked vehicle or one in illegal possession causes the damage. And it pays out in cases where a member insurance company with a CMTPLI agreement becomes bankrupt. It represents an injured party free of charge if that party and the person causing the injury have concluded a CMTPLI agreement with the same insurance company, and if at the moment of the accident the injured party is a passenger or a pedestrian who lacks a CMTPLI agreement with any insurance company in Armenia.

Source: Armenian Motor Insurers’ Bureau. http://www.banks.am/en/motor/Motor_Insurers_Bureau/.

Table 18: Compensation Paid by Insurance Companies

(December 2012)

Insurance Company

Compensation Paid

AMD $ million

Rosgosstrakh Armenia 2,855,681 7.08

INGO Armenia Insurance 2,142,316 5.31

RESO Insurance 1,172,654 2.91

Nairi Insurance 998,414 2.47

Garant Insurance 711,328 1.76

Armenia Insurance 556,916 1.38

Sil Insurance 578,777 1.43

Note: INGO Armenia and Cascade Insurance merged in 2012. RASCO Insurance Company

was renamed Armenia Insurance in 2012.

Source: Armenian Motor Insurers’ Bureau. http://paap.am/datas/zlawdocs/9e5bae71477

492062357df60c2ae04ae.pdf.


Pension system

Armenia’s pension system covers more than 16% of the population. It provides old age, disability and survivorship, and privileged and social benefits on a pay-as-you-go basis. The pension age is 63 for insured men and women, and 65 for social pensions. The pension formula is based on length of service and is not linked to wages. Contributions to the public social security system are 3% of wages for employees, while employers pay from 21% to 28% of payroll (or 23% on average), based on a regressive scale. The agriculture sector, formally almost half of the economically active population, is not required by law to contribute to the social insurance system.

Pensions constituted about 0.4% of GDP and 1.6% of state budget expenses in 2012.68 Despite an increase in 2010, the average pension is still low, and in 2010 amounted to AMD27,107 ($70) per month for all insured persons and AMD13,130 ($34) per month for social pensioners, the average pension is still low, and in 2012 amounted to AMD29,696 ($74) and AMD16,500 ($43) expected. The replacement rate in 2009 amounted to 24.5% for insured pensioners and 13.6% for social pensioners, calculated as a ratio of the national average gross pension to average gross wage. The average insurance pension is less than two-thirds of the minimum consumption basket.69

Because contributors to the pension system are less than the number of pensioners, the effective support ratio of the system is less than one. The constantly rising number of pensioners, comparatively small number of contributors, low wages, and high tax evasion are intensifying fiscal pressure on the pay-as-you-go pension system. A low birth rate, a working-age population outflow, and increased life expectancy are adding to the burden.

Since 2006, to improve the system, the government has explored a number of programs in other countries and, in November 2008, after much debate and deliberation, adopted a pension reform program. By October 2009, the Pension Reform Implementation Managerial Board had developed a legislative package of five draft laws, which the National Assembly adopted in 2010. The government is launching a multipillar pension system from 2011–2014,70 as outlined in the pension reform framework, that includes three components:71

68 Armenia: Global Economic Crisis and Poverty Profile.

69 According to the Economic Development and Research Center in Armenia, the minimum livelihood basket or the “minimum consumption basket”, contains

nonfood products and services and the minimum staple food basket, which consists of food products necessary for a normal life. See http://www.edrc.am/

WP/Prices_and_Vulnerability/Prices_and_Vulnerability_july_eng.pdf.

70 The process of pension reforms started on 1 January 2011 through the introduction of a volunteer accumulative pension system. From 1 January 2014, an

accumulative and mandatory pension system will be introduced that includes citizens born after 1 January 1974.

71 European Commission. 2011. “Armenia: Social Protection and Social Inclusion – Executive Summary of the Country Report.” Brussels: European Union.

http://ec.europa.eu/social/main.jsp?catId=750&langId=en&newsId=1045&furtherNews=yes.

Table 19: Collected Premiums by Insurance Companies

(December 2012)

Insurance Company

Collected Premiums

AMD $ million

Rosgosstrakh Armenia 4,617,904 11.44

INGO Armenia Insurance 3,252,959 8.06

RESO Insurance 2,215,366 5.49

Nairi Insurance 1,859,054 4.61

Garant Insurance 1,081,392 2.68

Armenia Insurance 1,030,132 2.55

Sil Insurance 1,074,051 2.66

Source: Armenian Motor Insurers’ Bureau. http://www.banks.am/en/motor/Motor_Insurers_Bureau/.


(i) Component 1—State Pension (Social Pension/Pillar 0 and Labor Pension/Pillar 1): The state pension system has labor, military, and social components funded from the state budget. Pillar 1, or the labor pension, is for people who do not participate in the mandatory funded pension system and have enough work experience upon reaching retirement age (to be set at 10 years experience beginning in 2016). It is also for people who will participate in the mandatory funded pension system and by the end of 2014 will have had work experience of 10 or more years. In the latter case, an additional amount (premium) for each year of employment will be paid from Pillar 1 only for the years up to 2014. Military pension is provided to military personnel for life, as prescribed by the laws regulating their service. Both labor and pensioners are also entitled to disability pension and survivors’ pension. Pillar 0, or social pension. is for those who were either not employed during their life or were employed fewer than 10 years, or for those employed in the informal economy.

(ii) Component 2—Mandatory Funded Pension (Pillar 2): The mandatory funded pension component ensures the payment of funded pension benefits to individuals as prescribed by law from mandatory funded contributions and return on their investment when these individuals reach the age entitling them to an old-age labor pension. The component was enacted to secure a direct link between the amount of pension contributions made and the pension received, and providing the contributors a choice to select the amount of their funded pensions through the selection of the manager of their pension assets and the management policy of such assets. Depending on their monthly income, hired employees, individual entrepreneurs, or notaries who participate in the scheme receive partial contributions in their pensions account from the state budget, and pay the balance from their income to secure 10% of the required contributions. Participants who voluntarily join the mandatory funded pension scheme contribute at the rate of 5% of the basic income and no additional contributions are made in his or her favor from the state budget. Obligations to make funded contributions are effective until pension age is reached.

Mandatory pension fund assets may be invested in Armenia or foreign countries in accordance with central bank regulations. Each pension fund manager will have to offer at least a conservative fund. In addition they may offer balanced and fixed income funds. The pension fund manager is responsible for rebalancing the pension fund investments to maximize returns.

Funded pensions may be paid in annuities, programmed withdrawals, or as a lump sum. Annuities on offer include a single-life annuity guaranteed for 5 or 10 years and an annuity of married couples, with a guarantee period of 5 or 10 years. An annuity guaranteed for a certain period of time is payable throughout until death. However, if the person dies before the guaranteed period, their legal heirs shall be entitled to receive the remaining sum of the annuity guaranteed. In programmed withdrawals, the pension is paid on a monthly basis at the expense of partial redemption of pension fund shares available in the participant’s pension account. For lump-sum payment, pension payments are made to a participant with an extreme health condition prior to reaching pension age, in a manner prescribed by law.

(iii) Component 3—Voluntary Funded Pension (Pillar 3): The voluntary pension component shall ensure the payment of supplementary pension to individuals from voluntarily funded contributions and return on their investment or insurance fees when these individuals reach the age entitling them to an old age labor pension. Banks may offer only “funded pension deposits” voluntary funded pension schemes. At pension age, individuals may receive the voluntary pension from the bank as a lump-sum payment or periodic payments. Voluntary pension funds (pension fund managers) may offer only “defined pension contributions” schemes. By making voluntary funded contributions, an individual acquires shares of the given voluntary pension fund in quantities in proportion to the contribution, on the basis of the distribution value of the given fund shares. At pension age, a participant may ask to transfer the maturing amount of the funded pension deposit or the redemption amount of the voluntary pension fund shares to the insurance company to conclude an annuity agreement entitling them to pension payment at pension age.

The funds from pillars 2 and 3 will be invested predominantly in locally traded securities according to prescribed rules and regulations, and will take into account the security and profitability of pension assets, diversification of risks, and provision of adequate liquidity. The reform should contribute to the development of


long-term investments and a local capital market.72 At the same time, the government has adopted the program and a schedule for implementation of public awareness, public education, and civil society participation in the reform of the pension system.

Regulation, supervision, and policy issues

The Central Bank of Armenia has adopted a dual role in the development of the finance sector: regulation and supervision, and leadership. Among the development goals outlined in its Strategy 2012–2014, it is bringing the regulatory and supervisory field of the finance sector in compliance with best international practice. For the insurance sector, this would involve compliance, on a gradual basis, with International Association of Insurance Supervisors’ Insurance Core Principles, Standards, and Guidance (IAIS ICPS). The August 2012 Financial Sector Assessment, conducted jointly by the International Monetary Fund (IMF) and World Bank, highlighted the need for fine tuning regulations for improved observance of IAIS ICPs standards in areas related to solvency control levels, supervisory intervention, technical provisioning, groupwide supervision, cross-border cooperation, and information sharing. To raise financial intermediation through new financial institutions, infrastructure, instruments, and services, the central bank envisages a concept of comprehensive financial system development to design and develop collective investment schemes, including a cumulative pension system.

The central bank supports several initiatives: the introduction of Pillar 2 pensions, a plan for development of the capital markets, and attracting strong and reputable international insurers to do business in Armenia. The entry of international players has served as a catalyst for the domestic insurance sector by providing a competitive benchmark for good practice. This has ensured that the serious players remain and develop, and that weaker players either merge or leave the market. This has also provided a platform through which other services can be launched in a sound and sustainable manner—for example, some future compulsory classes of insurance such as workers’ compensation. The central bank’s financial supervision department needs to further strengthen capacity and skills for effective supervision.

Residual restrictions relating to insurance in Armenia’s accession agreement with the World Trade Organization—notably constraints on foreign companies selling life insurance—have already been removed. Apart from general issues of corporate governance and supervision, other key issues include that there are no actuaries in Armenia. As a result, it may not be practical to conduct life insurance business on a large scale. In the absence of underwriting skills and lack of reliable data for actuarial computations, there is also no proper pricing of risk. The Actuarial Society of Armenia has been in place since 2010, and is an associate member of the Institute of Actuaries.

Reinsurance outflows through nonproportional treaties are high, accounting for more than 90% of written premiums. Most of the reinsurance activity is effectively tied to Europe through reinsurance channels. Because Armenia is small, there is potential for an accumulation of risk in the corporate sector and the industry has been insufficiently capitalized to absorb risks. Shortcomings have led to risk management through reinsurance, with industry participants acting more as brokers than as underwriters. The prevalence of “fronting”—a practice that regulators discourage by the imposition of minimum retention requirements—cannot be completely ruled out.73 This accentuates credit exposure to reinsurers.

The number of insurance products is limited. There has been little or no innovation in designing insurance products to meet consumer needs. The main types of policies available are vehicle (collision and compulsory third party liability), property, cargo, transportation, as well as travelers’ accident insurance. With the development of the mortgage and consumer loan markets, the volume of property insurance has increased significantly as most banks seek this as collateral for loans.

There is no market for life insurance. There is a need to tailor the life insurance regulatory regime, both prudential and market conduct, to enable licensing and supervision of life operations. Developing actuarial

72 The USAID-funded Pension and Labor Market Reform Project aims to support pension reform implementation and labor market interventions in Armenia.

73 A practice in which insurance companies act as brokers, rather than as risk carriers that retain a part of the risk on their books.


guidance needs to be considered as a priority to attract life insurers to establish operations. Such guidance should cover, at a minimum, the valuation of liabilities of the life insurance business, the valuation of assets corresponding to liabilities, and the required solvency margin.

Options

Developing the supply side of the insurance market requires development of an integrated industry database and underwriting skills. This can be pursued through industry rationalization, bringing in requisite actuarial and underwriting expertise. Together with supporting regulations, this will contribute to increased risk retention and limit the reliance of local insurers on reinsurance to manage risks.

A lack of confidence in the insurance industry dates back to the Soviet system, when the community regarded insurance as a tax because benefits were not delivered to policyholders (although voluntary life insurance products were prevalent). The development of sectors such as motor vehicle insurance was inhibited by a lack of confidence in the systems and processes for resolving liability following accidents. As a result, growth has been weak. But given that the law on CMTPLI is new, having been enforced only from 1 January 2011, it will take some time yet to realize its impact.

a. Nonlife insurance

The Central Bank of Armenia and the government have been considering the introduction of compulsory classes of insurance. This would take place alongside regulatory reforms, adequate strengthening of market capitalization, and the boosting of skills. CMTPLI was the first compulsory class of insurance introduced and is seen as an important growth area. As newer, western vehicles replace aging Russian stock, comprehensive motor vehicle insurance also has considerable potential. Other compulsory classes, including public liability and workers’ compensation, need to be considered.

Property insurance is another area of potential growth in the nonlife insurance sector (Table 20). Given the current boom in building and construction and mortgage market development (Figure 8), and with the reform of the pension system, demand for investment-grade assets will rise along with the resultant need for legislation to enable securitization of mortgages and other assets.74

b. Health insurance

General tax revenues still largely fund health care. The government has tried to satisfy the need for medical

74 “In 2005, the legislative package had been prepared to assess the existing legal framework for mortgage finance in Armenia, identify gaps and weaknesses

in the laws, and advise the government of Armenia on areas where improvements or additions are needed, both in primary market laws and in the legal

framework necessary for development of a secondary market for mortgage funding. As a result, many laws (including ‘Republic of Armenia Civil and Land

Codes’, the laws ‘On State Registration of Property Rights,’ ‘On Compulsory Enforcement of Court Decrees,’ ‘On Multi-Apartment Building Management,’

‘On Licensing,’ etc.) were amended. In 2007, the new law ‘On Evaluation of Real Property’ was amended. As a result of these amendments, in November

2005, the Housing Code of 1982 was repealed. In 2008, two new laws were adopted: ‘On Covered Mortgage Bonds’ and ‘On Assets Securitization and Assets

Backed Securities.’ This is the new stage of development in housing finance and solving housing problems of the middle-income population.” See Habitat for

Humanity. 2010. “Armenian Housing Study.” http://www.habitat.org/sites/default/files/gov_armenia_housing_study.pdf.

Table 20: Number of Housing Units (by type)

Total Housing Units Number of Units by Type of Housing

Multi-Unit Buildings Single-Family Houses

1989 2009 2010 2011 1989 2009 2010 2011 1989 2009 2010 2011

Total 650,826 822,102 846,001 854,021 361,166 429,512 437,126 434,892 289,660 392,590 408,875 419,129

Urban areas 437,510 536,390 554,744 563,258 329,670 402,036 409,442 410,493 107,840 134,354 145,302 152,765

Rural areas 213,316 285,712 291,257 290,763 31,496 27,476 27,684 24,399 181,820 258,236 263,573 266,364

Source: National Statistical Service of the Republic of Armenia. 2010. “Housing resources and public utility of the Republic of Armenia.” [In Armenian]. http://www.armstat.am/file/article/bf_2010_1,2.pdf.


services, raising the health care budget from 1.0% of GDP in 2000 to 1.6% in 2010, and is planning a further substantial increase with the objective of reaching 2.2% of GDP in 2012. However, in comparison to other public spending, expenditure for health care remains low.

Voluntary private insurance has a limited role and has a supplementary character. Nevertheless, after aviation insurance, the economic segment with the highest growth is health insurance. Large employers, both foreign and local, are beginning to provide health insurance as an employment benefit. In 2011, gross written premiums in health insurance increased 25.1% to AMD1.5 billion. The share of health insurance in total gross written premiums was 6.6%.

The output and quality of the health care system is highly dependent on the human resources and skills of health care staff. Armenia lags behind the European average and many Commonwealth of Independent State (CIS) countries on the number of nurses and midwives per capita, and is above the CIS average by the number of physicians per capita. The number of physicians is also 15% higher than the average for the World Health Organization’s European region.75 However, medical professionals are concentrated in Yerevan.

Health care provision is designed for access for all citizens, without financial, geographic, or other barriers. However, the apparent disparity in access between the capital and regions remains a problem. Patients living in Yerevan, where more than 68% of doctors work, have more opportunity to get care, and health care utilization is low, especially among the poor and those living in rural settlements. In response, national policy prioritizes increased access and quality of health care services, with an emphasis on increasing basic services across the regions and mitigating disparities in the utilization of health care services across income levels.

Discussions about implementing mandatory health insurance are under way. It is expected that the government will start by implementing a social benefits system for civil service employees engaged in state agencies, with benefits to include health insurance, including coverage for families. Indeed, in January 2012, Armenia introduced a social package for 120,000 state employees working at various state organizations consisting of components worth AMD132,000 ($327.0): voluntary health insurance, leisure and/or studies annual leave, and mortgage loans. The first component, voluntary health insurance, has a basic value of AMD52,000 ($128.8), which does not cover full treatment, the reason insurance companies offer individual medical packages.

75 Caucasus Research Resource Centers-Armenia. 2011. “Social Protection and Social Inclusion in Armenia: Country Report.” Executive Summary.

Source: Central Bank of Armenia. “Statistical Bulletin of the Central Bank of Armenia ( 2005-2009).” http://www.cba.am/en/SitePages/

statspannualbulletin.aspx.

Figure 8: Armenian Mortgage Market Development

0

10

20

30

40

50

60

70

80

90

100

31.1

2.0

5

30.0

9.0

6

31.1

2.0

6

31.0

3.0

7

30.0

6.0

7

30.0

9.0

7

31.1

2.0

7

31.0

3.0

8

30.0

6.0

8

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9.0

8

31.1

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8

31.0

1.0

9

28.0

2.0

9

31.0

3.0

9

30.0

4.0

9

Banks Credit organizations Total


c. Agriculture insurance

Agriculture represents one-fifth of GDP in Armenia and is an important source of exports. As the sector is exposed to both production and price shocks for major export crops (such as grapes), Armenia can benefit from broader agricultural insurance coverage. However, the government does not consider the introduction of compulsory agricultural insurance a necessity. After taking the actual income of farmers into consideration, the government’s opinion is that such a mechanism would prove a burden and additional expense. According to the National Statistical Service of the Republic of Armenia, the gross volume of agricultural production reached AMD617 billion ($1.62 billion) in 2010. The average income for each of Armenia’s approximately 340,000 farms is around $4,700 a year,76 without taking into account each farm’s expenses. Nevertheless, commercial insurance coverage for major export crops should continue to be explored to boost exports.

d. Disaster insurance

Multiple natural hazards—earthquakes, floods, hail, landslides, mudflows, drought, erosion, and desertification—have caused substantial social and economic damage over the past few decades. These will continue to absorb scarce resources unless the government takes proactive measures to reduce its fiscal exposure by transferring its implicit financial responsibility for private losses to the private insurance market. Armenia’s citizens can be provided more opportunities to purchase competitively priced low-cost disaster insurance products, where catastrophe insurance could include coverage for earthquakes, floods, mudslides, and others.

In Natural Disasters Hotspot—A Global Risk Analysis of 2005, the World Bank lists Armenia in the top 60 countries exposed to multiple hazards. A 2004 United Nations Development Programme report on reducing natural disaster risk revealed that during 1980–2000 Armenia averaged about 325 deaths per million people due to disasters—ranking third behind the Democratic Republic of Korea and Mozambique.77

The government needs to reduce its fiscal exposure to both common and catastrophic events as Armenia does not have adequate budget to mitigate, respond to, or recover from recurrent crises. At the same time, if Armenia’s citizens can more easily purchase disaster insurance products, it would reduce government financial risk from disasters.

Insurance policies for damage to property and contents from natural hazards, such as earthquakes and floods, could be covered under homeowner policies. Similarly, coverage for financial losses sustained by SMEs due to business interruption from, for example, damaged business equipment and premises, or from earthquakes and floods, could be popularized.

e. Life insurance

The establishment of life insurance operations in Armenia has seen the introduction of savings-linked insurance products, which will reduce precautionary savings, encourage diversification of assets, and allow institutional investors and pension funds to become the engine for the development of domestic capital markets. Death and disability cover and retirement annuities offer significant potential.

f. Compulsory insurance

The introduction of compulsory third-party insurance for automobiles is a good step. While the government may wish to proceed with caution in certain lines of insurance, it may consider introducing compulsory public liability and workers’ compensation/employers’ liability insurance. Public liability originates from the tort law of negligence in common law, under which a person, business, or organization can be sued for acts of negligence

76 xprimm.com. 2012. “ARMENIA: the introduction of the compulsory agricultural insurance considered unnecessary by the government.” http://www.xprimm.

com/ARMENIA-the-introduction-of-the-compulsory-agricultural-insurance-considered-unnecessary-by-the-Government-articol-2,12,46-1386.htm.

77 In 1988, the Spitak earthquake killed more than 25,000 people, injured 19,000, damaged over 515,000 homes, and caused some $15 billion–$20 billion in

damages—as compared with Armenia‘s 2007 GDP of $9.2 billion.


or omission. Public liability insurance is intended to safeguard both small and large businesses and their owners from the financial consequences of property damage or personal injury they cause. In some countries, statutory public liability insurance has been introduced to provide immediate relief to persons affected by accidents occurring while handling hazardous substances during manufacture, processing, treatment, packaging, storage, transportation by vehicle, use, collection, destruction, conversion, offering for sale, transfer, or the like, of such hazardous substances. Workers’ compensation and employers’ liability insurance are required by law in many countries for all business owners who have employees. Its introduction can be seen as part of reinforcing workers’ rights, such as minimum wages and pensions. Employment relationships determine the necessity of having proper workers’ compensation policies to protect both employees and employers. Workers’ compensation insurance provides payments to employees who suffer a work-related injury or occupational illness. Employers’ liability insurance protects businesses against lawsuits due to employment-related injuries or illnesses. The lawsuits can come from the employee, family members, relatives, and third parties. Employers’ liability insurance is among the few types of insurance cover in which employers are legally obliged to provide a safe working environment, and where they are liable to provide financial support to employees injured or assaulted at work.

Government

a. Public awareness

Developing consumer rights protection and a financial literacy framework targeted at various audiences remains a strategic priority, and the Central Bank of Armenia is committed to carrying out explanatory and educational campaigns on pension reforms, types of mandatory insurance, and other financial services and products. A targeted public education campaign should be undertaken to explain the potential advantages and uses of insurance products. While the Association of Insurance Market Participants is best placed to take the lead in organizing such a campaign, the government should support its drive where possible.

b. Constraints

Major issues that confront Armenia’s insurance market include the following:

(i) Lack of an “insurance culture.” Insurance is relatively new and not well understood by the public at large. (ii) Lack of public awareness of the benefits of insurance and of available products. Although the middle class

supports the insurance market, many affluent Armenians have not yet integrated into the insurance system and poorer people generally do not consider buying insurance at all. Therefore, more public awareness is needed of the role of insurance and its limitations in compensating loss.

(iii) Lack of consumer trust. Initial years of a largely unregulated insurance market have undermined consumer trust, which somehow must be regained.

(iv) Weak policy coordination among insurers. While the Association of Insurance Market Participants has adopted the role of policy coordination, membership remains insufficient for developing the market.

c. Road Map

Any plan for the development of the insurance sector needs to recognize the historical context and its current point of evolution. Like many developing countries, the development of the insurance sector has been focused on large commercial risks. Voluntary purchases by the private sector have been limited. Motor third-party liability insurance was made compulsory only recently and accounts for the largest share of nonlife premiums. However, international experience reveals that claims experience feeds directly into the calculation of premium levels, and that any failure in carrying out commensurate periodic adjustment in premium rates can affect the solvency of insurers. Poor validation procedures and misclassification of vehicles contribute to avoidance strategies by drivers, who prefer to “settle in the street,” no matter how expensive that is relative to the formal


insurance process. Proper enforcement of CMTPLI, along with the development of robust architecture for administering the business bonus-malus system, will help in introducing the right incentives and disincentives for making this class of insurance popular and sustainable.78

It is also important to note that there is a strong correlation between pension reforms and financial markets. The manner in which investment activity is accomplished influences overall performance among pension fund managers and insurance companies, and in turn carries over to the economy at large. An efficient life insurance market is an essential element of systemic pension reform because of the derived demand for term life and disability insurance from workers and the purchase of annuity products by retirees. Life insurers therefore need to be encouraged to enter the market without further delay.

Mortgage insurance can be driven by lending and provides security of repayment in the event of the death of the borrower. Borrowers are now covered for accidental death only. Introduction of compulsory mortgage insurance is one way of encouraging growth in this sector. Later, insurance against natural disasters, particularly earthquake damage, may also be considered. The recent boom in building and construction and mortgage market development can contribute towards pension system reforms where there is demand for investment-grade assets, and which could be met through the securitization of mortgages and other assets.

The enhancement of insurance regulatory and supervisory regimes, as well as the expansion of the market, is placing enormous strains on the available skill base. There will be an increasing need to apply actuarial risk management techniques to long-tail claims provisioning (CMTPLI in particular), life and health insurance underwriting and loss reserving, developing mortality and morbidity tables, and developing guidelines for determining solvency control levels and supervisory intervention for both solo and groupwide supervision.

The proposed road map would be expected to enhance the transparency and efficiency of the insurance industry and expand coverage, and ultimately to encourage people to use better insurance products as a risk mitigation tool to manage their lives and assets. Expected outputs (Table 21) are to (i) develop a strategy to enhance access to insurance services, (ii) facilitate development of life insurance and supporting pension reforms, (iii) strengthen CMTPLI architecture, and (iv) build capacity.

As will be shown, outputs 1 and 2 need to be addressed immediately, output 3 will have to commence in 2014, and output 4 is based on the Financial Sector Assessment Program report of 2012 as well as the outcome of the results of components 1 and 2.

Develop a strategy for enhancing access to insurance services.

Develop a strategy in consultation with the central bank and relevant stakeholders. Key aspects of this strategy will include

(i) development and implementation of proportionate regulations compatible and consistent with IAIS ICPs, which support having an enabling regulatory regime for promoting access to insurance;

(ii) introduction of new technology for enabling access to insurance using alternative distribution channels and decreasing administration and operational costs overall;

(iii) recommendations for microinsurance products tailor-made for low-income populations, which can be bundled along with other financial services (for example, microfinance institutions can secure their lending portfolio by offering credit life insurance and thereby improve uptake of credit for productive purposes by people living on low incomes);

78 In insurance, the bonus-malus system means that premiums are adjusted according to claims experience. In practice, bonus-malus systems typically are

mainly for private motor insurance (that is, both for the hull insurance and for the motor third-party liability insurance); bonus systems without malus, which

are also called no-claim discount systems, are more frequent in practice.


(iv) development of transactional platforms and protocols for delivery and servicing of health insurance and pensions to enable delivery of high volume transactions with small individual ticket-size amounts by linking financial institutions with stakeholders in the financial system, including regulators, international payment networks, credit bureaus, and telecommunications service providers;79 and

79 Data availability, costs, and consumer protection issues act as significant barriers to the scaling up of finance sector activities, including health insurance

and pensions. Financial institutions and intermediaries lack access to appropriate “back-end” or “back-office” technologies that enable efficient delivery of a

range of financial services, which are characterized by a high volume of transactions but small individual amounts. Transactional platforms can provide the

much-needed back-end technology platform to financial service providers for overcoming such cost hurdles by acting as “processing hubs”, while meeting the

conditions for maintaining the integrity of the system from the consumer protection point of view. Such processing hubs serve as an interface between the

banking and nonbanking sectors, including health and pensions. It also provides ready-made infrastructure for networking with various elements, including

unified databases for credit and collateral, appropriate accounting frameworks, and access to a wide range of distributors who are crucial for the delivery of

financial services to the last mile. They can also assist in linking financial institutions with other stakeholders in the financial system, including regulators,

international payment networks, credit bureaus, and telecommunications service providers.

Table 21: Outputs and Actions of Insurance Sector Development

Outputs Actions

Develop a strategy to enhance access to insurance services.

■ Conduct a market and regulatory diagnostic study.

■ Identify barriers to accessing insurance products and services.

■ Explore the introduction of new technology, alternate distribution channels, and products tailor-made for low-income segments.

■ Develop and implement proportionate regulations for expanding access to insurance.

Facilitate development of life insurance and supporting pension reforms.

■ Assess market potential for life insurance and its link to systemic pension reform.

■ Estimate the derived demand for

— life and disability insurance (active workers),

— annuity products (retiring workers), and

— mortgage insurance (security of repayment in event of death of borrower).

■ Explore different options for entry of life insurers into the market.

■ Develop a regulatory regime to facilitate the entry of life insurers and the supervision of operations.

■ Study the existing disability insurance regime with a view to integrating and aligning it with the existing pension reform.

■ Develop mortality tables, loss reserving guidelines, health insurance pricing, etc.

■ Train actuaries.

Strengthen compulsory motor third-party liability insurance architecture.

■ Provide assistance in introducing a bonus-malus system for making compulsory motor third-party liability insurance popular and sustainable.

■ Develop systems for proper enforcement of actuarially determined insurance rates and timely and transparent settlement of claims (also useful in inculcating insurance culture).

■ Develop dependency and disability factors for calculating compensation.

■ Develop assessment protocols to assess property damage.

■ Train a cadre of loss assessors.

■ Develop loss reserving system for outstanding claims.

Build capacity. ■ Identify training needs.

■ Provide training to develop the skills of supervisory staff, after the Financial Sector Assessment Program.

■ Provide training for the trainer workshops for supervisory and regulatory staff and actuaries.

■ Collaborate with international institutions for imparting internationally accredited and advanced insurance training and coaching in insurance and actuarial sciences.

Source: Asian Development Bank.


(v) support for public–private partnership arrangements in health insurance and disaster insurance.

Facilitate development of life insurance and supporting pension reforms.

Key aspects will include the following actions:

(i) Assess market potential for life insurance by estimating the derived demand for life and disability insurance for active workers, annuity products for retiring workers, and mortgage insurance for ensuring security of repayment of outstanding loans in the event of death of borrower; and explore the different options for the entry of life insurers into the market. This would include the feasibility of an asset management company, which would gradually be transformed into a life insurance company.

(ii) Develop a regulatory regime to facilitate entry of life insurers and the supervision of operations. This would include a study of the disability insurance regime with a view to integrate and align it with the existing pension reform.

(iii) Develop mortality tables, loss-reserving guidelines, health insurance pricing, and so on.(iv) Develop and train agents in the use of alternative distribution channels.(v) Train actuaries.

Strengthen compulsory motor third-party liability insurance architecture.

This will develop a bonus-malus system and loss reserving guidelines for outstanding claims, which will help in introducing the right system of incentives and disincentives for making CMTPLI popular and sustainable. As CMTPLI was introduced only in 2011, it will take at least 3 years to generate enough data to draw meaningful conclusions about the rating experience.80 Sufficient data will form the basis for the development of a rating system to support underwriting and pricing of CMTPLI on a scientific basis, and, in effect, develop a road map for a tariff regime where premiums are adjusted periodically based on the claims experience. One also needs to address issues related to settlement of claims in a transparent and timely manner. To enable this, dependency factors for the beneficiaries of the deceased, disability factors for partial and total disability, and assessment protocols to assess property damage need to be developed. Also paramount is imparting training to build a cadre of loss assessors.

Output 4: Build capacity.

Capacity development will involve the development of skills among supervisory staff and the implementation of the recommendations of the Financial Sector Assessment Program in the insurance sector based on outcomes as well as collaboration with institutions for imparting advanced insurance training and coaching, and encouraging individuals to take internationally accredited examinations in insurance and actuarial sciences.

Securities Market Development

Supply of Securities

The banking sector and securities market do not support the development of the private sector in Armenia to its full potential. NASDAQ OMX Armenia has the technology and capacity to offer services such as the trading of equities and bonds, but demand is limited and securities represent only a fraction of the finance sector.

80 For many lines of insurance, the ultimate loss associated with a particular exposure (accident or policy) year may not be realized (and hence known) for

many calendar years; instead, these losses develop as time progresses. The actuarial concept of loss development aims at estimating (at the level of the ag-

gregate loss triangle) the ultimate loss by exposure year, given the respective stage of maturity (as defined by the time between the exposure year and the

latest calendar year). While historical information on 5–10 years of development could be regarded as a sufficiently long time for the assessment of reserves

(for instance, the uncertainties of claims reserving are reinforced in emerging countries by the low claim settlement process), still-substantial outstanding

claim payments are reported in past years that remain to be made in emerging countries. This implies greater uncertainty in the estimation of claim reserves,

in particular. The solution is to continue to improve and extend the data gathered so far to dispose of reliable and appropriate databases. Since a statistical

method is based on taking some pattern from past data and projecting it, it will be unreliable if the assumption of a stable pattern is not fulfilled.


The NASDAQ OMX Armenia is the only stock exchange in the country and is the sole, regulated market operator. The Central Bank of Armenia is the supervisory and regulatory authority for the stock exchange as well as for the capital market. As such, the central bank has operational independence. In the view of market participants, the legal and regulatory framework of the securities markets is robust—a development attributable to measures including increasing the capital requirement of investment companies, opening the corporate securities market to banks, and raising the standards of listing and information disclosure requirements for exchange-traded companies.81

The NASDAQ OMX Armenia acquired the Central Depository of Armenia (CDA) in June 2009. The CDA performs the roles of central custodian and centralized registry, and is the sole operator of the securities’ clearing and settlement system.82 As the custodian of securities, it represents the first level of the Armenian two-level custodial system, with other local custodians acting as sub-custodians based on contracts with the CDA.83

The Law on Securities Markets, enacted in March 2008, explicitly provides for the transfer of ownership of securities through book entry (that is, all securities are dematerialized). Adequate securities settlement infrastructure is in the interests of (i) regulators, as it counteracts systemic risk; (ii) market intermediaries, as it provides the lowest cost of execution; and (iii) investors, since it guarantees the most efficient execution. To facilitate securities transfer, it is widely recognized that clearing and settlement should be on a delivery-versus-payment basis. The system should include automated accounts for securities, reliable custody arrangements to allow for tracking securities ownership, and a delivery-versus-payment system that permits same-day settlement.

For government securities and Central Bank of Armenia notes, the central bank acts as a central depository, records transactions, registers rights arising from transactions, and performs final settlement. To carry out these operations, the central bank developed the Government Securities Accounting and Settlement System. This interfaces directly with the central bank real-time gross settlement system and executes transfer orders for securities on the delivery-versus-payment principle using BANKMAIL and book entry (that is, the securities and cash legs of the transaction are settled simultaneously).

Clearing and settlement of corporate bonds via the NASDAQ OMX Armenia uses a pre-deposition mechanism and, as such, is a form of delivery-versus-payment. By 10:30 a.m. on the day, brokers and dealers are required to deposit the necessary cash (if buying) or to block the necessary securities (if selling) in advance of trading. Cash must be transferred to the NASDAQ OMX Armenia’s account, with the pre-funding of cash positions done through commercial banks as they are the only ones permitted to hold a correspondent account with the central bank. Brokers and dealers are required to identify the amounts they are depositing and blocking for their own account and the amounts they are depositing and blocking placed on behalf of their customers. Brokers and dealers inform the CDA of the securities they wish to block on their deposit account with the depository. Commercial banks acting as settlement agents for brokers and dealers, on the other hand, inform the central bank of the payments (position funding) submitted by each broker and dealer. The central bank then sends a confirmation report to the CDA which, in turn, prepares a summary and forwards this information with details about securities that have been blocked. The NASDAQ OMX Armenia uses the statement from the CDA to produce the “original balances” of securities and monetary funds. NASDAQ OMX Armenia participants are only able to trade within the limits of these original balances. This method of clearing and settling transactions was observed to limit the development of fixed income and will deter foreign investors from participating in the domestic market. In addition, although settlement risk is reduced, the system may not be able to function efficiently with high transaction volumes if activity on the NASDAQ OMX Armenia increases.

The accounting framework can play an important role in, among other things, boosting bond market liquidity. Under historic cost accounting, losses or gains are registered only on trading (or maturity), so participants

81 A 2007 EBRD study of the country’s legislative structure observed that there were major shortcomings in the regulation of bonds and derivatives, among

other markets. The market has since developed. EBRD. 2009. Commercial Laws of Armenia: An Assessment by the EBRD. London: EBRD.

82 NASDAQ OMX Armenia. http://www.nasdaqomx.am.

83 Securities issued by the government and the central bank are registered with the Central Bank of Armenia operated Central Securities Depository, with most

secondary market transactions taking place in the over-the-counter market.


often avoid trading for accounting reasons rather than report a loss. Conversely, IFRS International Accounting Standards (IAS39) require initial recognition of financial assets and liabilities, measurement subsequent to initial recognition, impairment, de-recognition, and hedge accounting. Progress has been made in adopting IFRS. All banks have been required to account using those standards since 2008, and enterprises outside the finance sector are gradually switching from local generally accepted accounting principles. For an accounting company to operate an audit practice it is necessary to have three to five auditors and be licensed by the Ministry of Finance. At the same time, it has been observed that, for local participants, other factors—such as qualifications and membership of the Association of Chartered Certified Accountants—are considered more important. Consistent with this, accounting and audit standards are seen as lax, a situation that may undermine investor confidence.84

Supported by EBRD and USAID, a code of corporate governance (with separate internal control) has been adopted for the banking sector and is being rolled out to open joint stock companies and state-owned corporations.

In addition, risk management procedures are being strengthened. Banks tend to have separate risk management departments reporting to the executive committee. Secondary market valuations are based on the yield curve published by the Central Bank of Armenia, and banks are required to report on a monthly basis to the central bank. In the absence of a mark-to-market price, when carrying out valuations of corporate bonds, banks are required to take liquidity risk into account (there is rarely an open market price).

In the area of taxation, there is at present no capital gains tax. Individuals are exempt from tax on dividends, but are liable for 10% tax on interest income derived from government and corporate bonds. Thus, for individuals, there is presently a distortion across asset classes in favor of equities (see Box 2 for a comparative look at the Stock Exchange of Thailand.)

a. Equities

The number of companies listed on the stock exchange in Armenia declined dramatically from 197 in 2005 to 14 by the end of December 2012; 164 companies delisted during 2006–2007 as the regulatory environment was strengthened, capital requirements were raised, and the mandatory listing requirement for a joint stock company with more than 100 shareholders was dropped. Of the 197 companies listed at the end of 2005, only 14 were listed on the medium B listing tier, with 178 listed on the lower C1 tier,85 and 5 on the lower C2 listing tier.86 At the end of 2006, 37 securities were listed on the exchange, with 8 enterprises in the medium B tier, 27 at lower first C1 tier, and 2 at the lower second C2 tier. Finally, by the end of 2012, only 18 securities from 14 issuers were listed and admitted to trading at the NASDAQ OMX Armenia.87

No enterprises have listed shares on the Main List (A) of the NASDAQ OMX Armenia and only three companies have listed shares on the Secondary List (B),88 with a further five companies’ listed on the Free Market (C).89 As of the end of 2012, one company (Pure Iron Plant) accounted for 41.46% of market capitalization. With so few companies listed, the equity market is highly concentrated. The top five enterprises comprise 96.33% of total market capitalization,90 albeit a marginal decrease from more than 98.00% at the end of 2010.91 The

84 USAID said that it was currently working with the Ministry of Finance to improve audit quality standards and complete the implementation of IFRS.

85 There were initially no minimum requirements for lower tier listing.

86 Securities under liquidation or bankruptcy.

87 NASDAQ OMX Armenia. Various years. “Annual Review.” http://www.nasdaqomx.am/en/reports.htm.

88 Requirementsforlistingonthesecondarylistare(i)minimumcapitalofAMD500million,(ii)issueroperating≥3years,(iii)financialstatementsforthelast 3 years audited by an independent auditor, and (iv) minimum free float of 10%.

89 There are no requirements for companies to be admitted to the Free Market (C), but being admitted gives the company a reliable channel for disclosing

financials and other material information to the holders of its stocks. Companies that are under liquidation, including for bankruptcy, cannot be admitted

even to the Free Market.

90 NASDAQ OMX Armenia. 2012. “Monthly Bulletin: December 2012.” http://www.nasdaqomx.am/en/bulletins.htm.

91 NASDAQ OMX Armenia. 2010. “Annual Review, 2010.” http://www.nasdaqomx.am/en/reports.htm.


Box 2: The Thailand Securities Market Experience

Equity market participants in other countries have reacted more positively to tax incentives. For example, in the aftermath of the Asian financial crisis, Thailand announced in 2001 that newly listed firms on the Stock Exchange of Thailand (SET) would qualify for a 25% corporate tax rate,1 effective for 5 years, with no limit on profits. As the local equity market fell in 2008, weighed down by the global financial crisis, as part of its second stimulus package the government introduced further tax incentives in June 2009, effective until the end of 2012. Thus, for companies with an investment promotion from the Thai Board of Investment, listing on the SET will attract a general corporate income tax exemption for 3–8 years during which the exempted amount of tax on net profits is capped at the total investment capital of the company.

As illustrated in Figure B2.1, the number of companies listed on the SET increased steadily from a low point in 2000. Indeed, in the 5 years from 2001 the number of listed companies grew at a compound annual rate in excess of 6%. At the same time, market capitalization increased from 2000 to 2007 before falling off in 2008 as a result of the global financial crisis, although the number of listed enterprises did not decrease at this time. Since 2008, the number of listed

companies has grown at a compound annual rate of slightly more than 1.5%, while market capitalization recovered strongly in 2009. Hence, other things being equal, it would appear that companies promoted by the Board of Investment are not as responsive as local enterprises to tax exemptions.

That said, while tax incentives have been associated with an increase in the number of listed enterprises on the Thai equity market, it has not precluded problems such as market concentration. Of 541 enterprises listed, the top 50 companies

account for around 80% of market capitalization. Conversely, more than 90% of companies listed on the SET account for only 20% of market capitalization. Hence, the issue of market liquidity is as important as boosting the supply side by increasing the number of listed companies. On this matter, it is important to closely monitor the market performance of enterprises benefiting from tax incentives to ensure an adequate free float is maintained;2 the larger the free float, the greater the liquidity, and hence the more attractive the market is to investors. In the early stages of market development, there should be a trade-off between tax incentives and the required free float, with the objective of achieving a free float around 15%, as per the NASDAQ OMX Armenia Main List (A), and the aim of increasing this to 30%–40%.3

Source: Frankfurt School of Finance & Management.

Figure B2.1: Thailand—Equity Market Metrics (as at end of period)

Source: World Federation of Exchanges—Stock Exchange of Thailand.

No. $ million

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1 At the time, the corporate tax rate was 30%.

2 The free float is the proportion of a company’s shares held by investors who are willing to trade; that is, typically investors who do not hold a

controlling interest.

3 Empirical evidence shows that the higher the liquidity in a company’s shares the lower the cost of equity and hence the less leveraged the company. See Southwestern Finance. 2010. “Stock Liquidity and Capital Structure: Evidence from Thailand.”


high market concentration impacts secondary market liquidity, with only 41 trades in 2011 and only 2 trades recorded for the first 2 months of 2012; it reached 254 trades in total by the end of 2012.92

Market participants suggested that factors such as a cultural resistance to “sharing” ownership of an enterprise were to blame for the lack of interest in listing. One intermediary noted that the privatization model adopted in Armenia, specifically an “insider” model, encouraged a concentration of ownership in enterprises’ shareholding structure. This could be contrasted with countries such as Poland and the Czech Republic, where institutional investors played a key role in privatization and, as a result, many enterprises were listed on the respective stock exchanges after privatization.

The government has provided incentives to encourage enterprises to list on the NASDAQ OMX Armenia. For example, companies listing before the end of 2012 were exempted from paying half of the profits tax, with the benefit of the exemption capped at AMD300 million ($743,347). But the absence of enterprises seeking to sell shares appears to indicate that the incentive was insufficient.

b. Government bonds

Armenia set up a domestic debt issuance program in mid-1995, but it was not until reforms initiated in the aftermath of the Russian Federation financial crisis began to take hold in the early 2000s that the focus started to switch to domestic rather than external sources of funding. The development of a robust government bond market starts with an annual borrowing plan based on the forecast budget. It is from this that a debt issuance calendar can be derived, based on relevant auctioning parameters, cash-flow positions, and a policy on building benchmark bonds, as well as liability management operations. For example, buybacks, exchanges, and switches are part of the active management of refinancing risk, all of which can lead to improved liquidity in government securities.

Various factors have impacted bond market development over the past decade. These include variable inflation (Figure 9) and, associated with this, the exchange rate outlook. Having strengthened from 2001 to 2008, the local currency depreciated sharply in early March 2009 as the Central Bank of Armenia announced the return to a floating exchange rate regime. As well as contributing to a loss of confidence in the local currency, the devaluation, of around 22%, was problematic for companies that had borrowed foreign currency because their debt service requirements increased.

A side effect of the devaluation was a return to financial dollarization. Having peaked at close to 50% of total deposits in late 2008, the local currency component now stands at around 30% of total deposits.93 As Figure 10 shows, the local currency share of commercial banks’ deposits grew steadily until September 2008 before declining sharply in the ensuing 9 months. Meanwhile, in the 4 months leading up to the devaluation, the volume of foreign currency deposits almost doubled. Although local currency deposits have again increased since mid-2009, the rate of growth has not been as significant as that of foreign currency deposits, with the exception of mid-2010, when the central bank changed reserve requirements to reduce dollarization in the economy. The central bank in 2011 adjusted reserve requirements again for the same reason.94 A major part of savings that could create capital market demand are denominated in US dollars and most of the dollar deposits are channeled to banks, where some are offering interest rates in the order of 8%–9% for retail call deposits—a distortion of the US dollar yield curve.95 A corollary to this is a reluctance to invest in instruments denominated in dram.

92 NASDAQ OMX Armenia. 2012. ”Monthly Bulletin: December 2012.” http://www.nasdaqomx.am/en/bulletins.htm.

93 Central Bank of Armenia. Ongoing. “Commercial Bank Deposits by Sector of Economy.”

94 Reserve requirements for dram and foreign currency liabilities are 8% and 12%, respectively. Until the second quarter of 2010, the reserve requirement

policy permitted the holding of 25% foreign currency funds attracted by commercial banks in dram and 75% foreign currency funds in a respective foreign

currency. This was changed in the third quarter of 2010 such that 50% of foreign currency funds had to be held in dram and 50% in foreign currency, and

75% in dram and 25% in foreign currency by the the third quarter of 2011.

95 Although these are 1-year time deposits, the law allows retail investors to access the funds at any time, albeit with a loss of interest.


Banks’ liabilities are skewed to foreign currency (Figure 11). While it might be assumed that lending in foreign currency is low-risk given that a considerable volume of deposits is denominated in foreign currency, exchange risk is not eliminated by this matching because a domestic slowdown or exchange rate shock would affect the ability of domestic borrowers to repay in foreign currency. Banks’ balance sheets are therefore exposed to foreign exchange risk.

The growth of the bond market has also been held back by poorly developed money markets. Market intermediaries described the interbank market as thin and illiquid, with repurchase agreements (repos) representing most of the trades. Supply is driven by the Central Bank of Armenia, with repos conducted weekly in 7- and 90-day blocks. There are some interbank repos, but these are limited to a maximum value of AMD10.0 billion (about $24.8 million), although it is understood that the central bank permits the use of reserve

Source: Asian Development Bank (ADB). Various years. Key Indicators. Manila: ADB.

Figure 9: Selected Economic Variables

Consumer price index: Annual change (LHS) AMD/USD: End of period (RHS)

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Figure 10: Commercial Banks’ Deposits

(end of month)

Source: Central Bank of Armenia. http://www.cba.am/EN/SitePages/Default.aspx.

AMD billion

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requirements as collateral for interbank market activities. Banks are reluctant to trade in the interbank market as there is no anonymity, although the NASDAQ OMX Armenia is attempting to develop an overnight interbank market. More importantly, no standard document is available to serve as a contract for repo transactions. It was also noted that dram liquidity was affected by central bank actions in response to things such as IMF targets on inflation and growth of the monetary base.

The success of a government bond market critically depends on the availability of hedging instruments, such as futures and derivatives, to enable primary dealers to manage interest rate risk. For now, the market for hedging instruments in Armenia is not well developed, which will constrain the activities of debt management agents. In cross-currency derivatives, several banks are presently offering forwards and swaps—some as far out as 12 months—but the market is thin.

These factors notwithstanding, the Ministry of Finance has made good progress in building the government securities market over the past 5 years. Government bonds outstanding increased nearly fivefold from 2005 to December 2012 (Figure 12).

Although the Ministry of Finance announces its annual financing program every December, the current approach is to issue securities in excess of the sum announced. The reason for this is the lack of liability management tools to assist the ministry in managing the refinancing risk associated with large benchmark issues. Therefore, depending on market conditions, the ministry issues additional bonds with a view to undertaking buybacks to bring the net issuance in line with proposed volumes. For example, the 2011 program, as announced in December 2010, was for AMD30.0 billion (about $78.4 million). As of mid-November, AMD33.0 billion ($86.2 million) had already been issued, and the Ministry of Finance planned to issue AMD40.0 billion ($103.4 million) in securities by year-end, with the additional proceeds applied to retiring some outstanding bonds. To manage refinancing risks associated with benchmark issuance, subject to liquidity, outstanding bonds will therefore be retired such that 6 months prior to maturity the volume outstanding in any issue is less than AMD12.0 billion (about $31.3 million).

Source: Central Bank of Armenia. http://www.cba.am/EN/SitePages/Default.aspx.

Figure 11: Commercial Banks’ Loans to Residents

(end of period)

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Figure 12: Government Securities Outstanding

(end of period)

Note: Data up to 8 December 2011.

Source: Ministry of Finance of the Republic of Armenia. http://www.minfin.am/main.php?lang=2.

AMD billion

Treasury bills Short-medium term Long term

–25

25

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2005 2006 2007 2008 2009 2010 2011 2012

Areas of progress include the Ministry of Finance’s timely publishing of information about the government debt issuance plans. Government securities are placed by auction using the Central Bank of Armenia as agent. Each December, the ministry publishes an annual calendar setting the auction schedule, including the volume range to be offered. The day of the auction depends on the type of security on offer and the maturity. Treasury bills with a volume range of AMD500.0 million–AMD1.5 billion ($1.24 million–$3.72 million) are auctioned each Monday,96 while medium-term (3–5-year maturity) bonds are auctioned on Tuesdays,97 with a volume range of AMD2.0 billion–AMD5.0 billion ($4.9 million–$12.4 million). Long-term bonds of 7-, 10-, and 20-year maturities are issued quarterly to a specific schedule.98 Further details, such as the actual volumes, are announced at the end of the month preceding the auction. There are also occasional Treasury bill issues (for monetary policy purposes), announced 3 days before the issue.

The Ministry of Finance also offers (non-tradable) savings coupon bonds to retail investors in maturities from 3 months to 25 years. Government securities are offered to retail investors through the “Treasury Direct” facility set up in 1999 to enable the Ministry of Finance to sell Treasury bills and savings coupon bonds directly to individuals.99 As of December 2011, there were 958 depository accounts in Treasury Direct, accounting for AMD1.64 billion ($4.25 million) in government securities.100

Winning bids at each auction are honored at the yield submitted using the Government Securities Accounting and Settlement System.101 Agents and dealers can obtain securities issued by the Ministry of Finance. In October 2011, the Ministry of Finance appointed seven primary dealers, known locally as agents: ARARATBANK, ArdshinInvestbank, ArmSwissBank, Converse Bank, HSBC Bank Armenia, VTB Bank (Armenia), and AMERIABANK. As agents, the banks are required to buy no less than 1% of each issue and to provide simultaneous bid and ask quotes of a specified benchmark government bonds in the NASDAQ OMX Armenia trading system.102 In turn, NASDAQ OMX Armenia has granted agents market-maker status to ensure this

96 The maturity of the Treasury bill depends on the exact day. For example, 180-day Treasury bills are auctioned on the second Monday in the month.

97 3- and 5-year bonds are auctioned in the first and second months of the quarter: 3-year on the third Tuesday and 5-year on the second Tuesday.

98 7- and 10-year bonds are issued every 2 years in odd-numbered years, while 20-year bonds are issued every 4 years in even-numbered years.

99 Treasury Direct provides for direct selling, recording, and (retail) investors’ servicing.

100 Ministry of Finance of the Republic of Armenia. 2012. “The 2011 Annual Report of the Public Debt of the Republic of Armenia.” Yerevan: Ministry of Finance.

http://www.minfin.am/main.php?lang=2.

101 This differs from a Dutch auction, in which all investors receive bonds at the same (highest clearing) price, that is, the lowest yield.

102 The specified bonds are AMGB10072186, AMGB20072283, AMGN36052110, and AMGN60052135.


process is implemented. The requirement for primary dealers to act as market makers does not apply to the over-the-counter (OTC) market.

To increase the volume of securities outstanding with a maturity of more than 1 year, the authorities in early 2008 embarked on an exchange program to consolidate previously issued medium- and long-term bonds, replacing outstanding small issues with large benchmark issues. Associated with this exchange program, the Ministry of Finance started issuing benchmark bonds with maturities of 3, 5, 10, and 20 years. As a result, the volume of securities outstanding with a maturity greater than 1 year increased markedly from 2009 (Figure 13).

As of the end of 2012, AMD249.0 billion ($616.9 million) government securities were outstanding, comprising AMD82.7 billion ($204.9 million) long-term benchmark coupon bonds as well as AMD128.8 billion ($319.2 million) short- to medium-term coupon bonds. In addition, AMD37.4 billion ($92.7 million) of Treasury bills were outstanding.103 Aided by the (large) 20-year bond issued in 2008, the average issue size of benchmark bonds is AMD13.21 billion ($32.73 million), versus AMD335.60 million ($831,557.00) for non-benchmark issues.

Although the government initiated consolidation, there appear to be inconsistencies in the approach the Ministry of Finance has taken.104 The initial focus has been on building benchmark issuance out to 5 years (Figure 14). However, there are two benchmark bonds (issued in February 2008 and 2011) maturing 10 days apart in February 2018, and another two benchmark bonds (issued in February 2008 and March 2010) that have maturities just over 1 month apart in 2013. Other things being equal, in each case, the second benchmark bond should have been issued as a tap on the respective outstanding benchmark bond; that is, the bonds maturing in February 2013 and in February 2018, thereby creating two large benchmark issues. Due to the lack of available data, it was not possible to explore the rationale behind the conflicting maturity schedule. At the same time, the ministry may announce issuance of a benchmark bond, make a few allocations, and then announce issuance of another (comparable maturity) benchmark by removing the former from the list of benchmark bonds—in the process making the bond very illiquid as there is no longer a requirement for the security to be traded on the



104 Artak Kyurumyan. 2009. “Domestically Issued Public Debt as a Sustainable Alternative Instrument for Debt Managers to Meet the Needs of Public Budget

Deficit in Countries of South Caucasus in the Medium to Long Run.” Caucasus Research Resource Centers – Armenia. http://www.crrc.am/upload/Public%20

Debt_Armenia_CRRC.pdf.

T reasury b i l ls (<1 year)

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2007 2008 2009 2010 2011 2012

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Figure 13: Outstanding Government Securities by Maturity Buckets

Source: Ministry of Finance. Various years. “Public Debt of the Republic of Armenia.” http://www.minfin.am/main.php?la

ng=2&mode=ppreports&iseng=1&isarm=1.


NASDAQ OMX Armenia. It appears that more work is required to build understanding of the benchmark yield curve.

c. Corporate bonds

Trading in corporate bonds started in 2006. The most active year for corporate bond sales was 2008, when 12 new issues were listed on the NASDAQ OMX Armenia. Fallout from the devaluation in March 2009 saw activity decline, with only four new issues that year, followed by two each in 2010, 2011, and 2012. The collapse in issuance resulted as demand for dram-denominated securities evaporated after the devaluation. At present there are only four corporate bonds on the Secondary List (B) of NASDAQ OMX Armenia—three of these for one company, ARARATBANK.105

A factor affecting the growth of the corporate bond market is the perceived burdensome process of gaining regulatory approval for a debt sale, in that the approval process can take up to 2 months. In addition, bank loans are readily available and are often priced more cheaply than borrowers can fund through the bond market. That contrasts with developed financial markets where, all other things being equal, bond issues are cheaper than bank loans.

In terms of maturity, it was observed that bond market investors would be unlikely to purchase securities with a maturity of 3 years. Thus, unlike more developed markets, enterprises needing funds for periods longer than

105 C is defined by MASDAQ OMX Armenia as ‘the Free Market’, while B is defined as “the Secondary List.”

Figure 14: Armenia—Outstanding Treasury Bonds by Maturity

(benchmark, mid-, and long-term)

Source: Ministry of Finance. Various years. “Public Debt of the Republic of Armenia.” http://www.minfin.am/main.php?lang=2&mode=ppreports&iseng=1&

isarm=1.

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2012 2014 2016 2018 2020 2022 2024 2026 2028

Outstanding Bonds

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3 years are restricted to (collateralized) bank loans.106 In addition to higher costs and shorter maturities, it is apparently common practice for the corporate bond issuer to provide some form of credit enhancement through bank guarantee or collateral. For example, it is understood that all three bonds issued by the National Mortgage Company provide credit enhancement, in that security to the value of about 120% is “ring-fenced” to support the issue.

While the “concentration rule” has been introduced to concentrate trading on an organized exchange to enhance liquidity, the current law—which requires corporate bonds to be traded on the exchange—is creating distortions between the government and corporate bond markets. At the same time, since trading on-exchange has to be passed through an intermediary, such trades result in additional transaction costs (0.1%). While an impediment to trading, it has also long been acknowledged that, unlike equities, fixed-income instruments trade OTC. That corporate bonds must be traded on-exchange therefore hampers secondary-market activity.

The absence of a deep, liquid government-bond yield curve also has implications for corporate bond market development. For prudential purposes, participants use the Central Bank of Armenia yield curve to mark trading portfolios to market. The central bank has published the formula on which the curve is based, but not the exact details of its construction. In this context, some intermediaries have commented that the central bank’s curve does not reflect market reality. Instead, they have developed an in-house benchmark curve to facilitate price discovery; otherwise, it would not be possible to undertake transparent price discovery when issuing new corporate bonds.

Just as the range of credits in the local fixed-income market is limited, so too is the range of products on offer. For example, while regulations exist to support the sale of covered bonds, other (unidentified) factors prevent the offering of such instruments. The absence of long-term local capital markets means that banks’ mortgage portfolios are funded through a combination of short-term deposits and capital, although more recently it has been possible to access funding for mortgage portfolios from the National Mortgage Company. The markets are also unable to provide the necessary long-dated funding to support infrastructure development.

As for the lack of corporate issues, iinvestors are said to lack confidence in prospective sellers; issues surrounding the lack of confidence in the audit process contribute to this. At the same time, given the nascent state of the corporate bond market, there is as yet no (private) credit rating agency in Armenia.107 Under the Procedure of Rating of Commercial Organizations by the Central Bank of Armenia, the central bank has been rating commercial organizations since April 2006. Possibly associated with this development, prudential regulations allow that any security issued by a nonfinancial enterprise carrying a (central bank) rating above C+ can be used for repurchase agreements.108 While the domestic bond market is unlikely to attain sufficient critical mass to justify the presence of a (private) credit rating agency, it is less than optimal for the Central Bank of Armenia to fulfill this role.

Demand for Securities

As previously noted, banks hold the bulk of assets in the finance sector. To date, the government has had limited success in exploiting the sizable volumes of excess liquidity held in the banking system (primarily in foreign exchange), in the economy, and by individuals, to leverage the country’s economic potential.

Primary dealers are not required to report the take-up of government securities by investor type. However, the Ministry of Finance releases some information about this in its Annual Debt Report.109 As of the end of 2011, Armenian trade banks held 57.8% of outstanding government securities (compared with 78.3% in 2010),

106 It was also observed that banks are unlikely to lend longer than 5 years.

107 It is understood that USAID is presently conducting a viability study on establishing a credit rating agency.

108 The rating grades are given using the letters of the Armenian alphabet. The highest grade is “A+” (Ա+), the lowest “Z” (Զ) (for details, see “Procedure of

Rating of Commercial Organizations” by the Central Bank of Armenia). The ratings from A+ to C– are considered investment ratings, whereas the ratings

from D+ to Z are considered non-investment ratings.




Central Bank of Armenia held 30.8% (12.6% in 2010), other resident investors held 10.8% (8.2% in 2010), and nonbank agents and dealers held 0.4% (0.6% in 2010). Nonresident investors held only 0.2% (0.3% in 2010). Banks therefore play a major role as capital market investors, certainly in government bonds. However, when it comes to the corporate bond market, banks prefer collateralized lending to buying capital market securities.

Various reasons were given for the status of the finance sector. Market players observed that the current prudential regulations of the banking system do not create incentives for fostering capital market activity. Another explanation is the narrowness of the local investor base. The institutional investor base is weak, there is an absence of vehicles for small-scale personal investment, and fixed-income investment culture is lacking among households. In the former, specific legislation on collective investment schemes does not exist in Armenia. The lack of secondary-market liquidity is another factor.

As previously noted, demand for dram securities collapsed after the March 2009 devaluation. The government had already announced pension reform as one way of contributing to the development of the capital markets. While pension reform will go some way to underpinning the growth of the institutional investor base, the country has made little progress in building a life insurance sector—a key component of pension reform, in that life insurers provide the (essential) annuities. Life insurers are also key investors in long-term fixed-income securities, so although beneficiaries will not be drawing pensions for about 2 decades, this shortcoming needs addressing.

The investment guidelines for Pillar 3 funds state that foreign currency investments must not exceed 50% of the total assets of the voluntary pension fund, with no more than 15% of the total assets invested in one specific foreign currency. Since the pension fund liabilities are denominated in dram and no hedging instruments exist, in respect of investment guidelines for Pillar 2 funds, investing in foreign currencies creates foreign exchange risk. Associated with this—due to the lack of available instruments in the local currency—authorities would also have to allow investment in foreign currency assets, compounding problems associated with foreign exchange risk.110

While the Ministry of Finance disseminates information about proposed government bond issuance in a timely manner and NASDAQ OMX Armenia publishes information about transactions conducted on-exchange, it appears that post-trade information from the OTC market is not widely circulated. Since the most recent transaction is, essentially, the current price of a security, in the interests of market transparency and building liquidity, it is essential that information about all trades is readily and publicly available.

Market players identified other factors working against the growth of corporate bond markets. The pre-deposition method of clearing and settlement at NASDAQ OMX Armenia is a cumbersome disincentive to trading, especially for foreign investors, and could lead to failed trades once the market reaches critical mass. At the same time, although there has been a lack confidence in the local securities market, one intermediary stated that it planned to set up an open-end mutual fund with fixed income driving the underlying investment strategy.

Constraints to Securities Market Development

Market intermediaries identified several key issues holding back development of the securities markets. The investor base is narrow—in particular, there is an absence of institutional investors—liquidity is poor, there is a lack of confidence in the local currency, and, associated with this, the financial markets are dollarized.

In time, the authorities’ pension reform strategy will go some way toward addressing problems with the investor base, although the current lack of supply in the local fixed-income market may force fund managers to invest in foreign currency. Meanwhile, continuing to implement a focused debt management strategy combined with benchmark issuance of government bonds will help in secondary market liquidity, albeit further capacity building may be required to facilitate a more streamlined approach to benchmark debt sales.

110 The proposed split for Pillar 2 assets is 60% local and 40% foreign currency.


An issue of concern is the lack of confidence in the local currency and, hence, the trend toward dollarization of the economy. At the same time, the Central Bank of Armenia is constrained by the need to meet IMF targets. In local currency lending, banks are constrained by the lack of dram liquidity and many market players believe that local sales of foreign-currency bonds should be allowed in order to tap banks’ foreign currency deposits.

Road Map for the Development of the Securities Market

Technical assistance would be expected to further develop the securities market by expanding the contribution of the banking sector to economic growth and strengthening the nonbank finance sector to underpin domestic savings. This assistance should support economic growth and achieve a deeper, more diversified nonbank finance sector. The technical assistance would aim to develop policy and consensus building, the primary and secondary markets for government securities, and the corporate bond market. 111

The development of securities markets can be conceptualized as generally occurring in four phases, although activities from different phases can take place simultaneously.112 This is the case for the road map’s four key phases; given the links between public and private sector bond markets, elements of each may proceed in parallel. For example, it is not practical to wait until the primary and secondary markets for government bonds are well established before commencing work on aspects of corporate bond market development, such as corporate governance.

The phases include policy development with an emphasis on consensus and building effective primary and secondary markets for government securities, and thereafter progressing to an efficient corporate bond market. As with any road map, the route will branch out at various points and the relevant authorities will need to make decisions as to which paths to take. These “design” decisions should be based on an assessment of the benefits and drawbacks of possible options and should be made in close consultation with the industry and other stakeholders. Some of the critical design decisions can be made early on and independent of other decisions, while others will need to be sequenced later. It is crucial that measures are carefully sequenced, not just to reflect the hierarchy and complementarities of markets and related institutional structures, but also to mitigate risks in parallel with reforms to expand the market.

The emphasis in the initial phase should be on policy development and consensus building. It seems that the foundations have been laid for policy development and achieving broad concurrence with the strategy to be implemented for development of the securities markets in Armenia. That said, while consensus may have been achieved regarding development of the government bond market, there appear some areas (such as pension reforms) where discussions are ongoing. The consultation process should not end at the first phase; it continues since the market will evolve with the advent of new technologies, products, and services. It is critical that the government remain engaged and in dialogue with market intermediaries and the greater financial community so that it can accurately anticipate needs and continually adjust the environment to enable and encourage the development of the bond markets while controlling risk.

Armenia is progressing with the second phase, during which development of an effective primary market for government securities is emphasized. The focus is on strengthening government cash management capabilities, developing a benchmark yield curve, reliance on indirect monetary policy instruments, widening the range of targeted investors beyond the banking system, and on information dissemination. Authorities have progressed with benchmark issuance, the available data show there are some concerns about implementation of the strategy. It appears that the authorities have achieved consistency between the government’s public debt management program—including issues such as its funding strategy and risk management program—and the Central Bank of Armenia’s policy on open market operations, an area that is crucial for the development of the primary market. The authorities have adopted an auction method for government bonds that enhances

111 This is consistent with the Asia-Pacific Economic Cooperation’s (APEC) guide to the development of domestic bond markets. See APEC. 2009. “Compendium

of Sound Practices. Guidelines to Facilitate the Development of Domestic Bond Markets in APEC Member Economies.” APEC Collaborative Initiative on

Development of Domestic Bond Markets. http://publications.apec.org/userfiles/cover/698-Thumb99_fmp_soundpractice.jpg.

112 This is also consistent with APEC sound practices.


the efficiency of bond issuance, and the recent changes to the primary dealer system indicate that the process continues to be reviewed and amended where appropriate.113 114 The Ministry of Finance is already promoting the timely availability of detailed facts about the government’s debt management strategy and issuing calendar, information that is key to building an effective primary government bond market given its importance to intermediaries’ and investors’ decisions. As a final point, the introduction of Pillar 2 of the pension reform in 2014 will stimulate the investor base, although, based on predictions for the volume of funds generated and the lack of available local currency products, this reform could create other problems, such as foreign currency exposure. Activities would include the following:

(i) Review and, where appropriate, revise incentives for financing through the stock market.(ii) Strengthen and enforce minority shareholder rights.(iii) Establish and enforce adequate corporate governance standards.(iv) Adopt prudential regulations to strengthen market surveillance and enforcement.(v) Review procedures for benchmark government bond issuance.(vi) Promote development of the interbank market, such as through monetary policy implementation and by

introducing an interdealer broker.(vii) Introduce the Global Master Repurchase Agreement with annex to address local market specificities.(viii) Build capacity at financial institutions for risk management and credit analysis.(ix) Promote investor protection and education through awareness programs.

In the third phase (which would often overlap with work in the second phase), the focus is on the development of a secondary market for government securities. To improve market liquidity, three aspects of a work program could be pursued.

Armenia is progressing on this phase. However, issues in the legal and regulatory area are apparent, in that, although regulation exists for covered bonds, impediments preclude their issuance. Problems have also been noted with the procedure for clearing and settling corporate bonds. The repo market is functioning, but it seems that activity is mostly with the Central Bank of Armenia, and the interbank market is lackluster, possibly because there is no broker to ensure anonymity. Standardized documentation in the form of the Global Master Repurchase Agreement has not yet been adopted in the local market with the result that banks negotiate one-off contracts with counterparties. Nor is there yet a facility to support bond borrowing and lending. Just as importantly, it appears that summary details of transactions in the OTC market (such as prices and volumes) are not being widely disseminated. Finally, a distortion exists between the tax treatment of dividends and interest income for individuals, to the disadvantage of fixed-income securities. Activities would include the following:

(i) Establish a system for systemic risk management.(ii) Remove distortions to tax treatment of equities and fixed-income securities.(iii) Address weaknesses in market information dissemination, in particular, those related to the OTC market.(iv) Establish procedures for bond borrowing and lending.(v) Resolve impediments to issuance of covered bonds.(vi) Encourage issuance of equity-related bonds.(vii) Initiate a full disclosure-based framework for corporate bond issuance.(viii) Introduce infrastructure to support shelf registration.(ix) Establish a uniform legal framework for the fund management industry (mutual funds, investment funds,

and others).(x) Develop mutual funds.(xi) Establish a securities industry association as a potential forerunner to a self-regulatory organization.(xii) Develop and enforce trading practices for corporate bonds market intermediaries.(xiii) Streamline clearing and settlement procedures for corporate bonds to allow full delivery-versus-payment.

113 In this regard, it is important to pursue regularity, standardization, and fungibility of bond issuance.

114 Regulations presently only cover primary dealers’ activities in the exchange-traded market. Since most trading of government bonds takes place in the OTC

market, it is imperative that primary dealers’ market-making responsibilities should be extended to the OTC market. There should also be routine monitoring

of compliance with the obligations, and, in the event of non-compliance, sanctions should be imposed.


Finally—and again there is some overlap between this phase and the third phase—the development of an efficient corporate bond market should be emphasized. The appropriate use of credit rating agencies, taxes, and other regulatory issues should be addressed during this stage.115 Another issue relates to the accounting regime, in particular the audit methodology, which is not seen as sufficiently robust.116 This gives rise to a lack of confidence in financial statements that, in turn, impedes growth of the corporate debt market. Associated with this, enterprises outside the finance sector are gradually complying with the IFRS. It also appears that the approval process for new corporate bonds operates on a merit basis rather than full disclosure, which means that it takes about 2 months to obtain approval for a sale. Activities would include the following:

(i) Develop markets for government bond futures and options.(ii) Implement full disclosure framework for corporate bond issuance.(iii) Require all financial institutions to mark to market.(iv) Promulgate an asset securitization law.(v) Develop a framework to support investment funds. (vi) Recognize a self-regulatory organization within the industry.

In preparing the road map, the issue of appropriate sequencing is fundamental. Therefore, the methodology adopted is as set out above, in which key issues are identified in four (sequential) phases.

115 It is understood that USAID is presently working with the Central Bank of Armenia on the credit rating agency.

116 USAID is also apparently working with the Ministry of Finance to improve audit quality standards.

Government Sector Strategy 57

Government Sector Strategy

Status

In 1996, the National Assembly adopted laws to regularize Armenia’s banking sector, including the Law on the Central Bank of the Republic of Armenia, the Law on Banks and Banking, the Law on Bank Bankruptcy, and the Law on Bank Secrecy.

During 1996–2001, the interbank electronic payments system, BANKMAIL, and the government securities accounting and settlements system, BOOKENTRY, were introduced. The SWIFT system started to be widely used for international payments. In the meantime, efforts were made to launch two national payment and settlement systems in compliance with international standards by creating the unified payment and settlement system Armenian Card (ArCa).

During 2002–2004, considerable improvements and innovations were made to banking legislation, introducing, among other things, the guarantee of deposits for individuals.

In 2006, a single framework for risk-based financial regulation and supervision was introduced in compliance with international practice. The central bank was given authority to regulate and supervise the activities of all participants in the finance sector.

From 2007–2011, the central bank initiated legislative reforms pertaining to financial system operations. This laid the ground for reforms to implement in the nonbank finance sector (insurance and capital markets) and paved the way to implement reforms of the financial infrastructure. NASDAQ OMX Group made its entry into Armenia’s market. Further, a consumer interest protection component was established, the office of financial system mediator started operations, and a compulsory motor third-party liability insurance scheme was introduced.

Development Goals

The Central Bank of Armenia, given the authority to be the “mega regulator” of the finance sector, has a vision of how to develop the sector. This includes

■ monetary policy development, ■ financial system stability and development,■ a payment and settlement system and cash money cycle,■ statistics,■ the development of financial system stability, and■ institutional development of the central bank.


The central bank is aiming to champion a solution for capital market development, currently in its nascent stages. The central bank is looking for ways to attract foreign investment and expertise, and, in conjunction with this, has adopted four main areas for further development:

(i) maintaining price stability,(ii) maintaining financial stability,(iii) maintaining national currency cycle stability, and(iv) institutional development.

In the area of maintaining financial stability, the Central Bank of Armenia has the following development goals:

1) Create a sustainable framework of regulation and supervision in line with best international experience and criteria that would best combine risks to the financial system (stability) with the advancement of the financial system. Further align the regulatory field of financial services and products with European Union (EU) directives as part of Armenia’s commitment to integrating with the EU and in the framework of the

EU–Armenia Association Agreement. This includes the following:

(i) Improve the risk-based supervision framework and design and implement consolidated supervision framework.

(ii) Gradually introduce the core principles of Basel II and Basel III frameworks.(iii) Gradually introduce the core principles of Solvency 1 and Solvency 2 frameworks.(iv) Gradually comply with the principles and criteria determined by the Basel Committee on Banking

Supervision, the International Association of Insurance Supervisors, and the International Organization of Securities Commissions.

(v) Create a single information environment for and implement reforms in the area of combating money laundering and terrorism financing.

2) Design a financial stability framework to ensure effective systems are in place for evaluating the risks threatening financial stability and crisis management. This includes the following:

(i) Improve methodology for assessment of risks pertaining to the financial system.(ii) Develop concepts for crisis management.(iii) Organize simulations and develop an emergency plan.(iv) Introduce and develop a system designed to assess risks—through macroprudential analyses—

transmitting to the financial system from nonfinancial areas.

3) Implement reforms in compliance with best international practice and under a single philosophy to ensure balanced development of financial institutions, financial markets, and financial infrastructure alongside raising financial intermediation. This includes the following:

(i) Develop a comprehensive financial system development concept.(ii) Work on introducing noncash and electronic financial services and their gradual development.(iii) Design and gradually introduce “hybrid” and stock exchange trades “T+3” systems.(iv) Work on creating a secondary mortgage market, in particular making mortgage ownership simpler and

less costly, and issue mortgage-backed securities.(v) Work on developing collective investment schemes, including a cumulative pension system.(vi) Take measures to develop the capital market in accordance with the program developed in cooperation

with NASDAQ OMX Armenia.

4) Develop a framework designed to increase consumer protection and financial literacy and awareness levels of households, in compliance with best international practice. This includes the following:

(i) Improve the regulatory and supervisory framework for market conduct, including making a clear distinction between actions for fair financial market and preventive actions.

Government Sector Strategy 59

(ii) Develop and improve the legislative framework for protection of consumer interests.(iii) Develop a national strategy for the financial literacy of households.(iv) Carry out explanatory and educational campaigns on pension reforms, types of mandatory insurance,

and other financial services and products.

Specific Challenges in Development Goals

The Central Bank of Armenia has identified several key areas to ADB that need development and strengthening, including the development of (i) capital markets, (ii) the insurance sector, and (iii) mobile and e-banking.

Development of Capital Markets

Development of the capital markets has been an ongoing process since the late 1990s and has been a major challenge over the past 15 years. High levels of dollarization in the economy and the cultural tendencies of the population have been detrimental.

The Central Bank of Armenia is looking to reinvigorate capital markets with the help of pension reform. Five major laws and 40 bylaws have already been elaborated and approved. The government is working on the annual reporting system and hopes to have it in place very shortly.117 Tax authorities will be linked to information on pension contributions with the treasury and NASDAQ OMX Armenia. The Central Bank of Armenia is willing to fund and house a centralized software system, which will enable fund managers to fulfill reporting requirements to account holders. This is a cost for individual asset managers, and the government hopes to increase the appeal of pension fund management and profitability for private asset managers by eliminating this major administrative obstacle. Overall, the central bank believes that a total of three asset managers should be sufficient for Armenia at this time.

Fund managers will be permitted to offer three strategies with the ratio between equity and fixed income together with deposits as follows: balanced (50:50), conservative (25:75), and fixed income (0:100). Sub-laws will provide further details on investment. The contributions can be channeled into bank deposits, but the government is looking to discourage such actions in order to decrease concentration in the banking system.

Pillar 2, that is, mandatory pension contributions, are slated to start 1 January 2014 and the government has already allocated AMD45.8 million in its 2014 budget forecast for the purposes of contribution. Pillar 3, which is the voluntary portion of pension contributions, began 1 January 2011, and investment guidelines have been enacted.

It is acknowledged that qualified asset managers are lacking. The central bank is keen to attract reputable global fund management institutions to Armenia. The first major step in that direction was the entry of the NASDAQ OMX Armenia exchange operator. It is tasked among other things with managing the stock exchange and the central depository.118

The government is hopeful that pension reforms will create demand for capital market products, which has been absent for many years. In addition, since pension contributions will only be in local currency, it will serve as a major impetus for the development of the dram corporate bond market. The corporate debt market is very shallow and became practically nonexistent after March 2009. By creating demand through pension reforms, the government expects this area of capital markets to pick up significantly.

A National Mortgage Company, Refinancing Credit Organization (RCO) was registered with the central bank on 19 October 2011 to lay the foundation for mortgage-backed securities. The first National Mortgage Company bond was placed in November 2011—an unstructured AMD1 billion issue with a maturity of 6 months.

117 The intention expressed by the Central Bank of Armenia suggested 2012.

118 NASDAQ OMX Armenia. http://www.nasdaqomx.am/en/index.htm.


Development of the Insurance Sector

The insurance sector is a major priority area and the central bank is pleased with the introduction of the compulsory motor third-party liability scheme on 1 January 2011. Mandatory health insurance for government employees is currently being developed. At the same time, central bank officials understand that insurance sector development should hinge less on compulsory products and more on actual insurance products, such as property, casualty, and life.

Actuarial capacity development is another area that needs to be enhanced, along with financial literacy on insurance products and their benefits.

The government is actively involved in bringing in a globally recognized private insurance institution to set up a life insurance company. This also links to the government’s desire to establish more institutional demand in the capital markets, as life insurance companies will be major players in providing long money through purchases of government and corporate bonds.

The government would welcome assistance in sequencing the development of the insurance sector, in particular, a vision paper for the sector.

Development of Mobile and E-Banking

The legislation covering electronic payments, mobile payments, and e-money has been put in place over the past several years. The organizations involved need to have several licenses, such as money transfer and processing. Minimum capital requirements have been put in place for companies engaged in the provision of these services, and minimum standards established for the information technology infrastructure for carrying them out.

The government is also working on creating electronic identification cards, along with developing a framework for e-signatures. EKENG, which the government set up, is the project implementation unit responsible for these activities. The Central Bank of Armenia’s strategy is to limit mobile operators’ entry into the area of mobile banking, or otherwise would also need to regulate their activities. Overall, the government is not particularly keen on establishing branchless banking. However, it is important to ensure high levels of internet penetration in the regions and increase financial literacy there. In that regard, the government is trying to encourage a postal-bank-type institution. The Central Bank of Armenia would welcome ideas and suggestions for the development of supervision and regulation.

ADB Sector Experience and ADB Program 61

ADB Sector Experience and Program; Trade Finance; and Micro, Small and Medium-Sized Enterprise DevelopmentSummary of Experience

Armenia became an ADB member in September 2005 as a “Group B1” country, making it eligible for resources from the Asian Development Fund as well as ADB’s ordinary capital resources. The Board of Directors endorsed ADB’s Economic Report and Interim Operational Strategy for 2006–2009 in October 2006. A new Country Operations Business Plan for 2012–2013, which will supersede the

plan for 2008–2010, was approved in November 2011. In line with the government’s postcrisis development priorities, urban development, regional cooperation, and private sector development have been identified as potentially suitable broad-based goals for ADB’s operational strategy. In December 2010, Armenia subscribed to additional shares under ADB’s fifth general capital increase under the Board of Governors Resolution No. 336.

As of December 2012, ADB had approved projects in transport, municipal infrastructure, and general budget support.

Harmonization of Activities with other Financial Institutions

ADB maintains close partnership with development partners to improve the effectiveness, efficiency, and impact of its programs. ADB collaborates closely with the World Bank, the IMF, EBRD, the United Nations Development Programme, the International Fund for Agricultural Development, the IFC, USAID, the Millennium Challenge Corporation, GIZ, and others. ADB also cooperates with civil society organizations in Armenia to strengthen the effectiveness, quality, and sustainability of the services it provides.

Financial Sector Support

Under ADB’s Trade Finance Facilitation Program, trade-financing agreements were signed with six commercial banks in April 2011, to bolster export and import activities and stimulate job creation and steady economic expansion. Total commitments amounted to $442.6 million, excluding Trade Finance Facilitation Program loans and guarantees.

In November, 2011, ADB’s Board of Directors approved a $65 million loan to four local banks for on-lending to SMEs to promote broad-based growth. In October 2012, it approved the $40 million Women’s Entrepreneurship Support Sector Development program. Using an innovative approach, the program will enable women to build productive businesses in profitable sectors, operate to scale, access finance, and benefit from economic opportunities.

Nonfinancial Sector Support

ADB approved the Rural Roads Rehabilitation Sector Loan ($30.6 million) for rehabilitation of 220 kilometers of rural roads in November 2007. It approved the Water Supply and Sanitation Sector Loan ($36.0 million) for the repair and replacement of water supply infrastructure in small towns and villages in December 2007. And it approved the supplementary loan ($17.3 million) to the Rural Roads Rehabilitation Project in November


2008 to finance an increase in project cost from higher construction materials prices, domestic inflation, and appreciation of the local currency.

The Crisis Recovery Support Program Loan ($80 million), approved in July 2009, played a significant role in helping Armenia to protect budgetary social expenditures and implement anti-crisis measures at a time of economic contraction and declining fiscal revenues.

In 2009, a $500 million multitranche financing facility for financing the North–South Road Corridor Investment Program from ordinary capital resources and Asian Development Fund resources was approved, together with the first tranche amounting to $60 million. The second tranche of the project for rehabilitation of Ashtarak–Talin Road Section ($170 million) was approved in December 2010. The project will contribute to the development of a subregional transport network, promote trade flows, increase the country’s competitiveness, and enhance regional cooperation and integration.

In 2011, ADB approved a $400 million multitranche financing facility for a Sustainable Urban Development Investment Program in Armenia to help the country upgrade its urban transport services to improve living conditions and bolster economic opportunities in 12 of the country’s major and secondary cities. The program is ADB’s first investment in urban transport in Armenia. The first tranche of $48.6 million is earmarked for the construction of a 5.3-kilometer ring road in the capital, Yerevan, which will divert traffic from the center and support increased economic development in outer areas.

The non-lending programs support the government’s pro-poor initiatives with technical assistance focused on capacity building, training, and other related studies, as well as project preparatory technical assistance to prepare for forthcoming lending operations. The Institutional Modernization to Improve the Business Environment project will support the introduction of an online business registry and will make the process of business registration efficient by reducing the time taken to register companies as well as improving the access to and transparency of information about companies. The Transport Sector Development Strategy technical assistance grant, approved in September 2007, helped the government prepare a transport sector strategy (road map) for 2009–2019. Project preparatory technical assistance amounting to $1.0 million and $1.1 million were provided to Armenia for preparation of the Yerevan Sustainable Urban Transport Project (later renamed the Urban Development Investment Program) and the North–South Road Corridor Investment Program, respectively. Small project preparatory technical assistance grants of $150,000 each also support the Rural Roads Rehabilitation Project and Water Supply and Sanitation Project. Active technical assistance grants total $1.7 million.

A major ADB private sector project (approved in 2009) involves the building of a new terminal at the main airport, Zvartnots International Airport in Yerevan. In March 2010, ADB approved a loan of $40 million—the first private sector infrastructure investment in the country.

Appendixes 63

Appendixes

World Bank

Current activities

■ Municipal Water Project■ Social Protection Administration Project■ Yerevan Water and Wastewater Project■ Health System Modernization Project in Support of the Second Phase of the Health Sector Reform■ Judicial Reform Project 2■ Second Foreign Investment and Export Facilitation Project ■ Access to Finance for SMEs ($50 million; financial sector)■ Social Investment Fund III■ Lifeline Roads Investment Project■ Geofund 2: Armenia Geothermal Project■ Second Education Quality and Relevance Project■ Irrigation Rehabilitation Emergency Project■ Transaction advisory support for PPP for solid waste management for Yerevan city■ Social Protection Administration Project ■ Public Sector Modernization Project II■ E-Society and Innovation for Competitiveness Project■ Community Agricultural Resource Management and Competitiveness Project■ Electricity Supply Reliability Project■ Additional Financing to Irrigation Rehabilitation Emergency Project Activities in the pipeline

■ Third Tranche of Social Investment Fund III■ Electricity Supply Reliability and Energy Efficiency Project■ Lifeline Road Network Improvement Project■ Public Expenditure Management and Tax Administration Modernization Project

International Monetary Fund

■ Completed third review under EFF/ECF Arrangement for Armenia and approved $56.1 million disbursement (the original 3-year EFF/ECF program was approved in June 2010 for SDR266.8 million (about $413 million).

■ Last Article IV consultations were in November 2008.■ Providing assistance to the Central Bank of Armenia for inflation targeting.

Appendix 1: Development Organization Projects


International Finance Corporation

■ Promoting sustainable energy finance.■ Supporting Armenia’s banking market development.■ Improving the regulatory environment (regulatory simplification-doing business reform).■ The IFC has two equity investments, both in the financial sector (in Ardshininvestbank and INECOBANK), one

investment in the mining sector (Lydian International), and one in real estate (Narek LLC).■ 18 total projects (80% in the financial sector, that is, term lending/small and medium-sized enterprise

lending/mortgage lending/trade finance).■ Participation in the Currency Exchange Fund (regional currency hedge fund).

European Bank for Reconstruction and Development

■ Total of 101 projects. Overall portfolio €232 million (as of 31 March 2011).■ 95% of all projects are in the private sector.■ Participation in the the Currency Exchange Fund. Providing loans to Armenian financial institutions in dram.■ Equity investments in the financial sector (four banks). Interested in having an equity stake in an asset

management company. Loans to 12 banks, 1 insurance company, 1 leasing company, and 1 microfinance institution.

■ Will do a regional remittance study covering Armenia, Georgia, and Moldova.■ Has projects in other sectors such as transport (Armenia International Airports), municipal and environment

infrastructure (Yerevan Metro, Armenian Small Municipalities Water Project, Kotayk Solid Waste Management Project), energy (Small Hydropower Finance, Electric Networks of Armenia Upgrade of Low-voltage Infrastructure and Installation of Meters), real estate (Artyk Multi-apartment Building Construction), and mining (Lydian International).

United Nations Development Programme

■ Socioeconomic governance — Community development. (i) Global Compact Armenia Phase 2. (ii) Support to SME development in Armenia. (a) Commenced in 2004 with funds of $250,000. (b) Provision of training for startup enterprises. (c) Provision of limited (small) bank guarantees. (d) Support to agriculture and pharmaceutical sectors. — Vocational education and training system.

■ Democratic governance — European Union advisory group. — Live Armenia project marketplace. — Supporting integrated border management in the South Caucasus. — Enhancing dialogue and trust building. — Promoting human rights education. — Mobilizing communities for social contract.

■ Environmental governance — Developing the protected area system. — Improving capacity building and management regime. — The Global Environment Facility small grants program. — Adaptation to climate change impacts in mountain forest ecosystems. — Developing institutional and legal capacity to optimize information and monitoring system for global

environmental management.

Appendixes 65

— Enabling activities for preparing Armenia’s second communication to the United Nations Framework Convention on Climate Change.

— Improving energy efficiency in buildings. — Improving energy efficiency of municipal heating and hot water supply.

■ Crisis Prevention and Recovery — Strengthening of National Disaster Risk Reduction Capacities – Phase 2.

Gesellschaft für Internationale Zusammenarbeit (GIZ)

Sustainable economic development

■ Municipal and economic development — Joint Armenian – German Municipal and Economic Development Program. — Promotes the further development of local government as well as economic and employment sectors in

the context of regional development. — Partnership with the government of the Republic of Armenia; (i) with the Ministry of Territorial Administration of Armenia, (ii) Ministry of Labor and Social Issues, (iii) Ministry of Economy of Armenia, (iv) State Employment Service Agency, (v) state employment agencies, regional governments (marzpetarans), municipalities and chambers of

commerce and industry, and (vi) with local nongovernment organizations and relevant international organizations. — The program promotes local economic development processes by introducing innovative tools in Armenia. — Reducing economic and social disparities in the regions.

■ Local/regional economic development with SME focus — Starting January 2010. — The former GTZ ProSME (Promotion of small and medium-sized enterprises) project was integrated in

GTZ Municipal and Economic Development Program as component 3. — Local/Regional Economic Development with SME Focus supports business support organizations to

expand and improve their business services for small and medium-sized enterprises. — Priority target groups of the component are start-up entrepreneurs, SME owners, employees, and job

seekers. — Closely cooperates with the Ministry of Economy. — The activities implemented within the framework of component 3 can be classified as local economic

development and participatory appraisal of competitive advantages.

■ Private Sector Development in the South Caucasus — Regional program in Armenia, Azerbaijan, and Georgia. This program began in 2008. Mainly private

sector focus on increasing trade and competition. — Vocational trading and labor market development. — Assistance to small enterprises engaged in tourism and trade. — Trade promotion. — Information exchange.

Democracy, municipal development and the rule of law

■ Support for the implementation of program budgeting — procurement, internal budget — accounting and tax policy■ Legal and judicial reform in South Caucasus■ Promotion of Municipal Development in the South Caucasus (supraregional)


Environment and natural resources

■ Sustainable management of biodiversity in protected areas and forests of the South Caucasus (supraregional).

KfW

■ Since establishment total volume of projects exceeds €400 million, with four priority areas.

Financial sector — German-Armenian Fund (SME lending €18 million, mortgage finance €32 million).

Energy sector — Two large transmission line projects. — Two phases of Small Hydro finance (via German Armenia Fund total of €24 million). — One large state-owned Hydro plant renovation (€51 million).

Urban development — Water, sanitation, wastewater management (€73 million). — Environmental protection and resource conservation.

Establishing a private credit bureau — Plans an agricultural lending project for 2012 (€15 million).

International Fund for Agricultural Development

Six projects since 1995 were started. Four have been finished, two are ongoing.

Finished projects■ Rural Areas Economic Development (credit and financial services sector, $15.3 million loan, started in 2004)■ Agricultural Services Project (irrigation, $15.5 million loan, started in 2001)■ North-West Agricultural Services Project (agricultural development, $13 million loan, started in 1997)■ Irrigation Rehabilitation (irrigation, $8 million loan, started in 1995)

Ongoing projects■ Rural Asset Creation Program (rural development, $13.5 million loan, started in 2010)■ Farmer Market Access Program (rural development, $11.9 million loan, started 2007)

United States Agency for International Development

Five areas of interest

■ Democracy and governance — Civil Society and Local Government Support Program — Support to Armenia-Turkey Rapprochement Project — Development of the AAC National Network — Rule of Law Development Program — The Access to Information for Community Involvement Program — Political Process Development in Armenia Program — Election Process Support Program — Monitoring of 2012 Parliamentary and 2013 Presidential Elections, and Monitoring of Elected Bodies’

Activities — The Alternative Resources in Media Project

■ Healthcare

Appendixes 67

— Healthcare System Strengthening in Armenia Project — Armenian-American Wellness Center — Health for Families Program — World Health Organization Grant on Technical Assistance of Tuberculosis Services — The 2010 Armenia Demographic Health Survey

■ Private sector — Enterprise Development and Market Competitiveness to develop more productive enterprises and value

chains by stimulating innovation — Enhance workforce skills and entrepreneurial development — Enhance workforce skills and entrepreneurial development — Facilitate effective financial intermediation — Dates 07/2011–07/2016, funds $17.5 million — Establishment of a Microsoft Innovation Center in Armenia — Partners for Financial Stability (i) Address the financial constraints to enterprise competitiveness through targeted technical assistance

and capacity building for the Central Bank of Armenia, the Union of Armenian Banks, and other key financial sector stakeholders.

(ii) Help the Government of Armenia and the Central Bank of Armenia institute reforms in legal, institutional development and investment promotion areas.

(iii) Financial intermediaries will learn best practices and enhance their capacity for managing risk, reducing transaction costs, and developing new products for value chains.

— Development Credit Authority to First Mortgage — Development Credit Authority Guarantee for Inecobank — Entrepreneurship and Civic Activism for Young People (Junior Achievement of Armenia) — Small-Scale Infrastructure Project

■ Future direction — Innovation Promotion in Armenia — Tax Reform Project

■ Social protection — Pension and Labor Market Reform Project — Stakeholders Acting Together for Strengthened Child Protection in Armenia

■ Water and Energy — Assistance to the Energy Sector to Support Energy Security and Regional Integration — Revive a River — Collection and Recycling of Plastic Refuse — Clean Energy and Water Project

Appendix 2: Overview of E-Banking and Mobile Financial Services

Electronic banking (e-banking) is the delivery of financial services through electronic channels including plastic cards, mobile phones, and the internet. The benefits range from better services for consumers to more cost effective operation for financial service providers. E-banking, as part of a branchless banking strategy, can also promote financial inclusion, particularly in remote and rural areas. Development of electronic channels is generally considered part of a wider branchless banking strategy that involves the provision of financial services beyond a banking network through the use of information and communications technologies and nonbank retail agents.


Mobile Financial Services

Mobile financial services allow e-banking using mobile phones. They range in complexity from the purely informational (texting alerts) to transactional systems that could replace traditional bank deposit accounts (m-payments). Mobile financial services are considered a subset of e-banking.

Mobile money transfers hold the biggest potential for extending access to financial services to populations without adequate access. Mobile money transfer services can be classified by the type of provider, that is, either a bank, a third party provider, or a mobile network operator. Early models focused on services that were either bank-led or nonbank-led. But as markets have evolved variations have emerged involving third parties and partnerships between multiple entities. Each mobile money transfer model has unique characteristics, strengths, and weaknesses.

While bank-led models adhere best to existing regulatory environments, mobile-network-operator-led services offer the most potential in scale and outreach due to their large subscriber base, marketing capabilities, agent networks, and experience with high-volume, low-value transactions (such as sale of airtime).122 But many regulators are uncomfortable with the participation of mobile network operators in the banking sector due to the lack of prudential regulation governing these types of providers. To combine the benefits of both, recent market innovations are using a joint venture or partnership between banks, mobile network operators, or third-party payment service providers.

122 Consultative Group to Assist the Poor. 2008. “The Early Experience with Branchless Banking.” Focus Note 47. http://www.cgap.org/p/site/c/template.

Figure A2.1: Electronic Banking Overview

Appendixes 69

Figure A2.3: Mobile Money Transfer Models

P2P = person to person, G2P = government to person, P2B = person to business

Source: Alliance for Financial Inclusion - Mobile Financial Services: Regulatory Approaches to Enable

Access. November 2010.

Figure A2.2: Mobile Financial Services

M-COMMERCEPurchase of goods and services using mobile service

M-PAYMENTSUse of mobile device

to make payment including m-transfers/

remittances (P2P, G2P, P2B)

M-BANKINGUse of mobile

device for banking transactions

E-BANKINGUse of electronic

channels for banking susch as internet

and ATM

M-FINANCIAL SERVICES(M-money)

Source: mPay Connect Consulting, MMT APAC presentation, 2009.

Mobile Network for Data

Transmission

Hold Deposits, Settlements

Bank-based(e.g., easypaisa

Pakistan)

Non-bank-based(e.g., m-Pesa

Kenya)

Cash In/Cash Out Transfer Money

Mobile Operator

Mobile Operator

Mobile Operator

Bank or third Party Bank

Bank

Bank

Table A2.1: Mobile Financial Systems

Type Description

Mobile Banking Solution provided by financial institution to help customers manage their accounts. Typically supports both information and common transactions between existing bank accounts.

For example: SMS alerts, balance enquiries, statements, inter account transfers, cheque book requests, deposits, loan repayments.

M-payments/ mobile money transfer Payment platform that allows subscribers to effect person-to-person, person-to-business, business-to-business, or government-to-person payments to merchants or partners in the payment network. Commonly known as mobile money transfer.

M-payments may involve either creation of a new e-money payment instrument or use of an existing bank account.

For example: utility payments, merchant purchases, mobile phone top up, payment of pensions.



Table A2.2: Mobile Money Transfer Provider Comparison for Armenia

Bank Led

Mobile Network

Operator Led Third Party Led

Joint Venture/

Partnership Approach

Description ■ Mobile access to existing bank account or creation of a m-wallet as a bank product, likely with link to card or savings account.

■ Payments/transfers (person to person (P2P) and person to business (P2B) initiated by client.

■ Cash is offered either via bank branches, payment terminals, or agent network created by bank.

■ Cash out via branches, automated teller machines (ATM), point of sale (POS) or agent network.

■ Account opening via bank agent network subject to full Know Your Customer regulations by bank branch.

■ M-wallet associated with SIM card

■ Cash in/out services available via existing network of agents for mobile top up.

■ Payments (P2P and P2B) initiated by client and processed via mobile network operator systems interfaces.

■ mobile money transfer service offered by third party company, mostly likely an existing payment system provider (PSP).

■ Could either involve an m-wallet or provide direct linkage to existing bank account held in partner financial institution.

■ If m-wallet option used, can still link to an existing bank accounts to sweep funds to/from m-wallet.

■ Account management via mobile interface operated by client.

■ Cash in/out offered via third party agent network and bank ATMs.

■ Payments (P2P and P2B) initiated by client and processed through PSP interfaces.

■ Partnerships between mobile network operator, PSP and Bank to offer services that utilize the mobile network operator/PSP agent network but is rooted in a bank account held by a bank.

■ Agent network operated by mobile network operator/PSP with optional Cash in/out services available from bank network of ATMs.

■ May not require storage of e-money in a mobile wallet but rather use funds directly from the bank account.

■ Accounts fully protected by prudential regulation of the partner bank.

■ Could be achieved via acquisitions between parties, that is, mobile network operator purchases bank or PSP.

Global Examples XacBank, Mongolia and CAIXA, Brazil

Mpaisa Afghanistan, Mpesa Kenya

Fin Access, Nepal and MPay, Albania

Telenor and Tameer Bank (Pakistan), Orange and BNP Paribas, and Orascom and Ora Bank.

Pros ■ Service covered by prudential regulations.

■ New customers will access not only mobile

money transfer but other range of bank products/services.

■ Telecom network independent.*

■ Mobile network operator subscriber base likely much larger than either bank or

third party so this model has potential for largest impact.

■ Agent network already exists, albeit with a different role.

■ Consumer perception of mobile company likely more positive than that of banks especially with poorer populations.

■ Services offered by specialized payment companies who may already have existing

terminal networks and integrations with service providers.

■ Link to financial institutions means benefits of bank led model would still be realized.

■ Mobile network operator and bank independent gives wider potential client base.

■ Benefits from other models can all be recognized.

■ Potential for largest

impact since all key players would be working toward building the same system.

Continued on next page

Appendixes 71

Cons ■ Development and management of agent network costly and not always successful.

■ limited access to only bank customers so scope to reach scale is limited.

■ Each bank launching this service would have to develop their own integration to service providers (such as business, utility companies).

■ Seen as additive rather than transformative since clients using this model tend to already be existing bank customers.**

■ Mobile network operator will need to comply with both e-money.

■ Limited or no inter-operability to users of different telecom providers.

■ Service will only be as good as the agent network.

■ Could be viewed as competition with the banks who want to launch their own mobile money transfer service.

■ Requires high levels of cooperation and single view between participating parties.

Comments Armenian market ■ Regulatory restrictions on agent banking for both cash in/out transactions would need to be available for this to work.

■ If agent cash in/out not allowed will be fully dependant on the rollout of ATM/cash terminal network.

■ Banks already moving toward this albeit without the agent network.

■ Central Bank of Armenia could consider how to add scale to these projects by reconsidering some levels of branchless banking in areas where branches/ATMs not present and under certain conditions such as cash back on POS up to limit and with purchase.

■ Hay Post Bank/Post POS also fits within this model since it is the Converse bank license that is driving the delivery.

■ In terms of reaching scale this is one of the most viable options but at the same time it presents the largest regulatory barriers.

■ Vivacell appears to be the most logical mobile network operator to launch this service and is already making moves in this direction with their launch of payment services via their subsidiary company.

■ To really reach scale they would still have to build out their network of agents since they appear reliant on the terminals for sales, which is a unique element not present in other countries that have mobile network operator led mobile money transfer.

■ Regulatory restrictions on agent banking for both cash in/out transactions would need to be available for this to work.

■ Existing cash terminal providers are the likely contenders for this model but would need to identify banks to partner with and it is likely that banks may want to enter this market themselves. However, existing trust in these providers could help adoption of the mobile wallet.

■ Could involve Vivacell’s subsidiary partnering with several banks and the largest PSP operators to create a full ecosystem.

*Users of any mobile network can access the service.

** Mary Pickens, David Porteous, Sarah Rotman. 2009. Banking the Poor via G2P Payments. Consultative Group to Assist the Poor. http://www.cgap.org/publications/banking-poor-g2p-payments.


Bank Led Mobile Network

Operator Led

Third Party Led Joint Venture/

Partnership Approach

Table A2.2 continued

Documents

Regional: Financial Sector Development in Central and West ...€¦ · Abbreviations v Foreword Armenia’s finance sector, dominated by 21 banks and 1 development bank, was largely