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REALISING BOSNIA AND HERZEGOVINA’S EUROPEAN POTENTIAL: FROM WAR ECONOMY TO CREDITWORTHINESS AND SUSTAINABILITY STRENGTHENING OF THE FINANCIAL SECTOR Mr. Peter Nicholl, Governor of Central Bank of Bosnia and Herzegovina International conference on development of Bosnia and Herzegovina CG Meeting on Bosnia and Herzegovina Sarajevo, September 22 and 23, 2004 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 stateowned payment bureaus In summary, the financial sector was small, fragmented, and played little economic role 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 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. Works well in some other Eastern European 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 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 CBBH FOREIGN RESERVES DATE NET FOREIGN RESERVES DEC 1997 144,1 160,3 - 16,2 DEC 1998 283,3 253,9 29,4 DEC 1999 865,7 836,7 29,0 DEC 2000 1021,2 973,2 48,0 DEC 2001 2666,6 2591,6 75,0 DEC 2002 2463,2 2345,1 118,1 DEC 2003 2.779,6 2.626,3 153,3 JUN 2004 3.167,7 3.007,0 160,8 (end of period – in KM million) MONETARY LIABILITIES FREE RESERVES 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 KM ISSUED FROM AUGUST 11, 1997 UNTIL SEPTEMBER 10, 2004 KM ISSUED TO BH BANKS KM PURCHASED FROM BH BANKS NET KM ISSUED 15,905 13,016 2,889 (in KM billion) 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. INFLATION IN BH YEAR ENDED FEDERATION OF BH REPUBLIKA SRPSKA BH AVERAGE DEC 2000 4,0 16,1 8,0 DEC 2001 0,3 2,2 0,9 DEC 2002 - 0,7 2,4 0,3 DEC 2003 0,3 1,3 0,6 JUN 2004 -0,6 2,0 0,2 (Retail price index, Annual % growth) 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) 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 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 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. 31.12.2000 31.12.2002 30.06.2004 55 40 37 PRIVATE BANKS 36 34 30 STATE-OWNED BANKS 19 6 7 47 10 16 24 19 67 65 TOTAL NUMBER OF BANKS OWNERSHIP: CAPITAL STRUCTURE (%): STATE CAPITAL: DOMESTIC PRIVATE CAPITAL 53* FOREIGN PRIVATE CAPITAL * (1) In 1999, there were 61 banks operating in BH. * Breakup not available BANK LOANS 31.12.200 31.12.2001 31.12.2002 31.12.2003 30.06.2004 Amount Share Amount Share Amount Share Amount Share Amount Share TOTAL LOANS 1652 100% 2101 100% 3213 100% 5122 100% 5318 100% PRIVATE COMPANIES 833 50% 988 47% 1304 41% 1860 36% 2156 40% PUBLIC ENTERPRISES 322 20% 350 16% 361 11% 1167 23% 706 13% CITIZENS 375 23% 647 31% 1415 44% 1966 38% 2318 44% OTHER SECTORS 122 7% 116 6% 133 4% 129 3% 138 3% BANK DEPOSITS 31.12.200 31.12.2001 31.12.2002 31.12.2003 30.06.2004 Amount Share Amount Share Amount Share Amount Share Amount Share 2094 100% 3324 100% 4158 100% 4366 100% 4938 100% DEPOSITS IN KM 895 43% 1214 36% 1749 42% 2274 52% 2671 54% DEPOSITS IN FOREIGN CURRENCY 1199 57% 2110 63% 2409 58% 2092 48% 2266 46% TOTAL DEPOSITS OUT OF IT: INTEREST RATES PRIVATE ENTERPRISES HOUSEHOLDS TIME AND SAVINGS DEPOSITS RATES SHORT-TERM LENDING RATES LONG-TERM LENDING RATES DEMAND DEPOSITS RATES DEC 2002 12,07% 10,59% 1,44% 4,38% DEC 2003 10,54% 9,18% 0,96% 3,40% JUN 2004 10,15% 8,57% 0,84% 3,63% 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 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