Financial Stability Report No1 20 December 2010 - Banka Qendrore ...

Financial Stability ReportNumber 1it is also considered the depreciation of the euro against the U.S. dollar by 20 percent 8 andthe reduction of interest rates by 2.0 pp. The increase of NPL leads to an increase ofprovisions; the depreciation of euro affects the the loss/profit from net open positions; andthe reduction of interest rates affects the loss/profit in net interest income by consideringthe maturity gap between loans and deposits. Apart from the abovementionedassumptions/shocks, the expected profit as a potential for loss absorption from these shocksis also taken into account. In this context, it is assumed that revenues from 'commissionsand similar' and other non-interest revenues in 2010 would be equivalent to 60 percent ofthe level realized in 2009 (because it is assumed that there is no increase of loans), whileother components of the income statement are assumed to be of similar level to those in2009.- The assumed increase of NPL is expressed through the migration of loans fromperforming categories (standard, watch, substandard) towards non-performingcategories (doubtful and loss). NPL growth was proportionally distributed in thetwo non-performing categories, taking into account the initial distribution of NPLin these categories. NPL growth is reflected in the level of provisions based on theCBK regulations for loan provisioning. The assumption for the NPL growth isapplied also to off-balance sheet items, including unused commitments, guaranteesand letters of credit.- Despite the fact that in the scenario it is considered the depreciation of the euroagainst the U.S. dollar in order to assess the exchange rate risk, it must beemphasized that the impact of this risk in the balance sheet of Kosovo’s bankingsystem remains negligible. Net open positions in foreign currencies at the end ofJune 2010 were equivalent to only 11 percent of Tier 1 capital. Lending in foreigncurrency virtually is nonexistent, which minimizes the exchange rate risk.- The assumption on the interest rate risk implies a reduction of interest rates by 2pp(for assets and for liabilities on the balance sheet). The reduction of interest ratesmay affect Net Interest Margin (NIM), taking into account the maturity of loansand deposits. However, the majority of loans and deposits in the banking system inKosovo have fixed interest rate, which makes the banking system less sensitive toshort term interest rate fluctuations.- Sustainability of the banking sector in this analysis is assessed in terms of theimpact of increasing NPL, euro depreciation and interest rate decline on the level ofthe banking sector regulatory capital, risk-weighted assets and, consequently,Capital Adequacy Ratio (CAR).ResultsThe stress-test results based on the scenario explained above suggest that banking sectorwould be sustainable even in the case of this hypothetic scenario. Under the assumptionthat this scenario would occur, only one of the banks operating in Kosovo would have a CARbelow 12 percent, which is the minimum required level by the Central Bank, while the8 This assumption is based on historical data for the volatility of euro – US dollar exhgange rate.| 51