STRENGTHENING OF THE FINANCIAL SECTOR

1. REALISING BOSNIA AND HERZEGOVINA’S EUROPEAN POTENTIAL: FROM WAR ECONOMY TO CREDITWORTHINESS AND SUSTAINABILITY STRENGTHENING OF THE FINANCIAL SECTOR Mr. Peter Nicholl,Governorof Central Bank of Bosnia and Herzegovina International conference on development of Bosnia and HerzegovinaCG Meeting on Bosnia and Herzegovina Sarajevo, September 22 and 23, 2004

2. THE FINANCIAL SECTOR IN BIH IN 1997 • Four currencies were being used. The only currency used everywhere in the country was the DEM. • There were 76 registered commercial banks • Most were very small • None operated over the whole country • They were mainly state owned • Citizens held very little of their savings in the banks • The non-cash payment system was a monopoly of the state-owned payment bureaus • In summary, the financial sector was small, fragmented, and played little economic role

3. THE CENTRAL BANK OF BiH (CBBH) • Commenced its operations on 11 August, 1997 • A state-level institution • Operates under its own Law • An independent institution • Its strategic direction is set by a Governing Board • It has five offices: • Three Main Units – Banja Luka, Mostar and Sarajevo • Two branch offices – Brčko and Pale

4. MONETARY POLICY • The most important function of CBBH • The CBBH operates monetary policy through a Currency Board arrangement • Choice of a Currency Board: • It Provides a firm nominal anchor in the form of a fixed exchange rate. • It removed discretion in a situation where there was considerable difficulty in establishing institutions and making political decisions. • It had worked well in some other Eastern European countries

5. THE CURRENCY BOARD • The fixed exchange rate is specified in the CBBH Law • Full foreign exchange backing for all the KM liabilities of the Central Bank • Full convertibility of the CBBH’s KM liabilities into the anchor currency

6. THE FIXED EXCHANGE RATE • The fixed exchange rate is 1KM = 0.51129 euro. • Initial exchange rate was 1 KM = 1 DEM • The KM exchange rate has been unchanged since the CBBH commenced its operations in 1997 • Transition from the DEM to the euro as the anchor currency went smoothly

7. CBBH FOREIGN RESERVES (end of period – in KM million)

8. FULL CONVERTIBILITY • The fixed exchange rate is specified in the CBBH Law • Full foreign exchange backing for all the KM liabilities of the Central Bank • Full convertibility of the CBBH’s KM liabilities into the anchor currency (in KM billion)

9. SUCCESS OF THE CURRENCY BOARD • The Currency Board has been a very successful type of monetary policy for BH • The KM has been a stable currency against the DEM and the euro since it was introduced. • Inflation in BH is low and stable. • KM use has risen steadily and the KM is the dominant transactions currency in all parts of the country.

10. INFLATION IN BH (Retail price index, Annual % growth)

11. THE CURRENCY BOARD IN THE FUTURE • Decision of the BH Presidency that the Currency Board will continue, which was stated in the PRSP, which has been endorsed by all levels of government • The Currency Board produced major economic and social benefits • It achieved the main objective – the financial stability through a consistent application of monetary policy • Country is undergoing through very difficult and important political and economic reforms and still required stability • Long term deal – take BH economy closer and into Europe (The exit strategy for BH from Currency Board should be eventual adoption of the euro as in case of some recent members of EU)

12. THE BANKING SECTOR • A rapidly improving banking sector • Return of confidence • Return of depositors • Lending on more reasonable terms • Real competition • High level of foreign investments

13. CHANGES IN THE BANKING SECTOR • Reform of the payment system • Significant increases in a banks’ minimum capital requirements • Inter-entity banking • Deposit insurance • Arrival of foreign banks • Privatization of government owned banks

14. CAPITAL STRUCTURE IN BH BANKING SECTOR • In the end of 2002, 40 banks operated in BH, 8 banks less than in 2001 and 36 less than in 1997. By May 31, 2003, this number has reduced further to 37 • Number of banks, given the ownership structure, is tabled below. * (1) In 1999, there were 61 banks operating in BH. * Breakup not available

15. BANK LOANS (end of period – in KM million)

16. DEPOSITS OF COMPANIES AND CITIZENS (end of period – in KM million)

17. INTEREST RATES

18. OTHER CHANGES IN FINANCIAL MARKETS IN LAST TWO YEARS • BiH received its first formal sovereign credit rating in early 2004: B3 with a positive outlook (Moody’s) • National Capital Markets Council formed in 2003 • Two stock exchanges established • Private investment funds established • Registry of transaction accounts established • Preparations for putting of entity-based banking agencies under the CBBH umbrella almost completed • CBBH started to collect and publish the data on government finances

19. FUTURE INITIATIVES IN THE BIH FINANCIAL SECTOR • Government securities market will be established soon • Leasing Law has to be passed soon • Banking supervision will shift under the CBBH in 2005 • Money market instruments will be developed • Harmonization with EU standards and regulations