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IMF: Armenian banking system stable, but dollarisation remains a problem

The International Monetary Fund (IMF) has told Armenia that the country’s financial system remains vulnerable due to high levels of dollarisation and insufficient liquidity cushions in foreign currency.

Discussing the latest Financial System Stability Assessment (FSSA) of Armenia, the bank’s board noted that country’s financial system has expanded further since the 2012 Financial Sector Assessment Programme (FSAP), and that the country’s macroeconomic performance has been satisfactory, and the financial system has been stable. Armenia’s banking sector has weathered the 2014 economic slowdown, aided by additional capital injected by shareholders, several mergers, and improved regulation and supervision. At present, financial soundness indicators show signs of improvement. All banks meet the 12 per cent minimum capital requirement. Bank profitability has gradually recovered, although it is still below pre-crisis levels. Nonperforming loans (NPLs) have fallen, of which a substantial proportion is covered by provisions, although NPL ratios are still high in a few banks.

However, Armenia is a small open highly-dollarised economy subject to external shocks. Against this backdrop, Armenia’s financial system is relatively shallow and dominated by banks. The banking sector’s assets equal about 78 per cent of GDP, and subsidiaries of foreign banks make up a sizable proportion of banking assets. Capital markets are thin, and external financing is important for long-term financing, given a small domestic investor base. As illustrated by the stress tests, risks from a high degree of financial dollarisation are significant, including credit risks and limited liquidity cushions in foreign currency in the event of external shocks.

Since the 2012 FSAP the CBA has made progress in strengthening Armenia’s financial system. The CBA has adopted measures to mitigate risks from dollarization. Higher risk-weights and provisioning were imposed on dollar assets to absorb the credit risk due to unhedged borrowing. Liquidity requirements were introduced in 2012 to mitigate the higher liquidity risk of foreign exchange funding. At the same time, the Central Bank of Armenia (CBA) has pursued an ambitious agenda to strengthen financial oversight, which includes adopting a risk-based supervision framework and addressing gaps in the regulatory framework identified in the previous FSAP.

The IMF’s executive directors welcomed the progress made by the authorities in strengthening financial sector oversight and promoting financial deepening to further enhance financial sector resilience. They commended the CBA for reforms undertaken since the 2012 FSAP review, notably in adopting the prudential measures to mitigate risks from dollarisation and upgrading the risk‑based supervision framework. They encouraged the authorities to prioritise reforms, recognising capacity constraints.

While welcoming the measures already adopted, the IMF’s directors underlined that vulnerabilities remain from high levels of dollarisation and insufficient liquidity cushions in foreign currency. They recommended that the authorities adopt the capital conservation buffer and the surcharge for domestic systemically‑important banks as planned, as well as measures to address credit risk from unhedged foreign exchange exposures, such as the introduction of a stressed debt service to income ratio limit. In addition, the IMF recommended the gradual introduction of the requirement for banks to maintain reserves in foreign currency for liabilities denominated in foreign currency and the liquidity coverage ratio and net stable funding ratio in Armenian dram and in US dollars. They also emphasised the need to be prepared to implement the countercyclical capital buffer, if the current trend in credit growth persists.

The IMF also called on the Armenian authorities to refine the risk‑based supervision framework for a more granular assessment of banks’ capital needs, enforce large exposure limits, and amend the definition of nonperforming and restructured loans in line with international best practices.

Photo: Central Bank of Armenia