Achieving Sustainable Growth in South Eastern Europe

1. Achieving sustainable growth in SEE:Macroeconomic policies, structural reforms, socio-political support, and a sound financial system Governor Fullani, February 11, 2011

2. Main Messages • There is no conflict between price stability and financial system stability in the long run • Global or even regional financial markets require global or at least regional supervision and crisis resolution mechanisms • The role of anchors in the design and implementation of macro-prudential policies EU integration process

3. Crisis in the region why and how? • Pre-crisis conditions in the region • Absorption-led growth • Based on fast credit growth • Growing trade and current account deficits • Considerable reliance in foreign funds and “cheap” exotic currencies • Foreign made crisis: • Sudden stop of capital flows, among others • Home-grown crisis: • Liquidity shortages • Exchange rate depreciation • Painful adjustments in income, trade and current accounts • Deterioration of the credit portfolio • Credit growth stopped • Economic activity stalled or grew at negative rates • Saved by IMF and EU interventions

4. Focus on Albania Before Crisis • Our economy has been in a solid path of growth for the last decade, with an average annual growth rate of around 6 percent. • Both fiscal and monetary policies have been cautious, consistent and disciplined in the pursuit of • fiscal consolidation Before the crisis, • price stability in a low inflation environment focused on anchoring market participants expectations for price developments in the economy. • This steady economic performance has been supported by a flexible exchange rate regime. • Exchange rate that proved instrumental in encouraging economic adjustments toward a more sustained foreign position

5. Focus on Albania Before Crisis Financial system dominated by the banking sector. • The assets of the banking sector make around 95 percent of the total financial assets in Albania. • Banking system with strong representation of well-known European banking groups from Greece, Austria Italy and France. • Growth in banking sector assets has been financed mainly from internal resources • deposits on average counted for around 80 percent of total assets. • loan to deposit ratio stood at around 50 percent. • Financial performance indicators were very good. • in the previous 4 years, the average return on equity has been above 20 percent while the average return on assets has been around 1.5 percent.

6. Focus on Albania Before Crisis Too many gaps were opening too fast • Most of the credit growth went in the non-tradable sector • Mostly to services and construction • More than 70 percent of total credit was in foreign currency • EURO had the biggest share of the outstanding stock • Fight for market share • Financial illiteracy in the market

7. Focus on Albania Before Crisis Bank of Albania gradually introduced regulatory measures that would: • discourage rapid increase in lending, • encourage banks to lend more in domestic currency • increase transparency toward clients on banks products and services

8. Focus on Albania Before Crisis Bank of Albania gradually introduced regulatory measures that would: • improve the commercial bank’s governance and transparency, • strengthen risk assessment and risk mitigation strategies, • improve the capital adequacy and liquidity ratios,

9. Different story - same results • October 2008 financial sector • fear and contagion resulted in deposits’ withdrawal • liquidity problems emerged (especially in foreign currency) • February 2009, from global events and financial sector to real economy • expected decline in exports, remittances and economic activity • credit growth disappeared • fast but contained exchange rate depreciation • Crisis deepens: From real economy to financial sector and back to real economy • the quality of the loan portfolio started to deteriorate • real economic growth slowed considerably, from 6 to 3 percent • both trade and current account deficits reduced in size. • The flexible exchange rate proved instrumental in encouraging economic adjustments toward a more sustained foreign position.

10. Price Stability Vs. Financial Stability • The overall and most important job for a central bank: ensure the integrity of money and the banking system • the foresight of monetary policy is the size and duration from the trough to the peak of the business cycle • the foresight of banking supervision the size and duration of financial gaps in the banking system • the foresight of financial stability the size and duration of financial gaps in the economy • Price and financial stability do not conflict but complement each other in the long run.

11. Triangle of information sharing and decision making Monetary Policy Banking Supervision Financial stability

12. Defining policy priorities • Central Bank policy shifted its focus toward financial stability • Regain trust in the banking system • Prevent foreign exchange market failures • Fiscal policy provided necessary stimulus in the economy • Increased capital expenditures market a reversal of the consolidation trend in fiscal policy • Monetary policy provides additional stimulus after: • Deposits reversed the declining trend • Fiscal position reached the limit of sustainable behavior

13. Same policy - different results • Albanian economy and banking sector coped relatively well with the impact from the international crisis. • economic growth remains positive in the range between 3 and 4 percent, • inflation has been stable and within the range determined by the Bank of Albania, • exchange rate and non-performing loans developments have stabilized to pre-crisis levels, • banking system remains liquid, well capitalized and profitable.

14. Joint efforts of supervision and crisis response mechanisms Once new products are developed and tested in some markets, they will follow the same pattern of marketing in other markets as well. • Build bridges of continuous communication • supervisors in the SEE region • home-host supervisors • local bank managers • headquarters of the mother institutions

15. Joint efforts of supervision and crisis response mechanisms • Financial systems in SEE are inter-connected, this issue deserves more attention in the future • common problems need common solutions • simultaneous problems need simultaneous actions • Vienna initiative • Financial regulation and regulatory arbitrage was a serious issue before and throughout the crisis. • assess the benefits of more regional approach to regulation

16. Anchors of macro-prudential policies • Good anchors make for good preconditions • IMF programs • EU integration process • Domestic anchors as a long term solution • sustainable fiscal and monetary policies • counter cyclical policy response • policy coordination. • Structural reforms must continue with particular focus on • markets • education • regional model of growth and cooperation

17. Thank You