WORLD BANK GROUP FINANCIAL SECTOR ASSESSMENT REPUBLIC OF POLAND JUNE 2019 FINANCE, COMPETITIVENESS, AND INNOVATION GLOBAL PRACTICE AND EUROPE AND CENTRAL ASIA REGIONAL VICE PRESIDENCY A joint World Bank-IMF Financial Sector Assessment Program (FSAP) mission visited Poland from January 8–19, 2018 and May 7–18, 2018. This report summarizes the main findings of the mission, identifies key financial sector vulnerabilities and development opportunities, and provides policy recommendations. The FSAP team was led by Loïc Chiquier (World Bank) and Michael Moore (IMF), and included deputy mission chiefs Johanna Jaeger (World Bank) and Darryl King (IMF), Juan Buchenau, Ana Carvajal, Pierre-Laurent Chatain, Jose-Antonio Gragnani, Pamela Lintner, Heinz Rudolph (all World Bank); Ran Bi, Ivan Guerra, David Jones, TengTeng Xu (all IMF); and as external IMF experts Jan Brockmeijer, Michel Canta, Johannes Sandahl, Joaquin Gutierrez, David Scott, and Ian Tower. The team met with senior leaders and officials from the Ministry of Finance (MoF), National Bank of Poland (NBP); the Polish Financial Supervisory Agency (PFSA); the Bank Guarantee Fund (BGF) and private sector representatives. This report is based on the information available by the time of the FSAP mission (May 2018), most of subsequent legislative and/or regulatory changes would therefore not be assessed. FSAPs assess the stability of the whole financial system, and not that of individual institutions. FSAPs are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks. Some developmental aspects are studied by this report on themes preselected with authorities. This report also draws from seven FSAP Technical Notes and a Detailed Assessment Report on compliance with Basel Core Principles for Effective Banking Supervision (BCP). CONTENTS Executive Summary .................................................................................................................. 4 I. Macroeconomic Background ................................................................................................. 9 A. Macroeconomic Content ........................................................................................... 9 B. Financial System Structure ........................................................................................ 9 II. Vulnerabilities and Risks ................................................................................................... 11 III. Prudential Oversight ......................................................................................................... 13 A. Independence and resourcing of supervision .......................................................... 13 B. Banking Regulation and Supervision ...................................................................... 16 C. Anti-Money Laundering and Combating Terrorist Financing................................. 16 D. Crisis Management and Safety Nets ........................................................................ 17 E. Insurance and Financial Conglomerate Supervision................................................ 18 F. Capital Markets Supervision and Regulation ........................................................... 18 G. Macroprudential Policies ......................................................................................... 20 IV. Selected Financial Sector Development Themes ............................................................. 21 A. Cooperative Banks and Credit Unions .................................................................... 21 A 1. Cooperative banks ................................................................................................ 21 A 2. Credit Unions........................................................................................................ 23 B. Pension Funds Development ................................................................................... 24 C. Development of Fixed Income Securities Markets ................................................. 26 Appendix I – Tables and Figures ............................................................................................ 31 Table 1. Poland: Selected Economic Indicators, 2015–22 ........................................... 31 Table 2. Poland: Financial Soundness Indicators (Commercial Banks) ...................... 32 Table 3. Poland: Financial Soundness Indicators (Cooperative Banks) ...................... 32 Figure 1. Poland: Macrofinancial Developments ......................................................... 34 Figure 2. Poland: Structure of the Financial System, September 2017 ........................ 35 Figure 3. Poland: Capital .............................................................................................. 35 Figure 4. Poland: Bank Liquidity ................................................................................. 36 Figure 5. Poland: Asset Quality ................................................................................... 36 Figure 6. Poland: Profitability ...................................................................................... 37 Figure 7. Poland: Balance Sheet of Commercial Banks (2017) ................................... 38 Table 4. Poland: Status of FSAP 2013 Recommendations .......................................... 39 Tables Table 1. Poland FSAP: Key Recommendations ....................................................................... 7 Table 2. Poland: Performance of Cooperative Banks by Size ................................................ 22 1 GLOSSARY AML/CFT Anti-Money Laundering/Countering the Financing of Terrorism BCP Basel Core Principles BGF Bank Guarantee Fund BRRD Bank Recovery and Resolution Directive CCP Central Counter Party CET1 Common Equity Tier 1 CRD Capital Requirements Directive CRR Capital Requirements Regulation DAR Detailed assessment report D-SIB Domestic Systemically Important Bank DSTI Debt Service To Income EBA European Banking Authority ELA Emergency Liquidity Assistance ETF Exchange Traded Fund FATF Financial Action Task Force FIAT Financial Institutions Asset Tax FSAP Financial Sector Assessment Program FSC-M Financial Stability Committee—Macroprudential FSR Financial Stability Report FX Foreign Currency GDP Gross Domestic Product GMRA Global Master Refinancing Agreement IMF International Monetary Fund IPS Institutional Protection Scheme IRS Interest Rate Swap LCR Liquidity Coverage Ratio IOSCO International Organization of Securities Commissions LTV Loan-to-value MCM Monetary and Capital Markets Department MiFID Markets in Financial Instruments Directive MoF Ministry of Finance MREL Minimum Requirements for Eligible Securities MTF Multilateral Trade Facility NASCU National Association of Credit Unions NBP National Bank of Poland NSFR Net Stable Funding Ratio NPL Nonperforming loan OFE Open pension fund OSII Other Systematically Important Institution PFR Polish Development Fund PFSA Polish Financial Supervisory Agency 2 PPK Voluntary Funded Pension Scheme RDP Responsible Development Plan Repo Repurchase Agreement ROA Return on Assets ROE Return on Equity RRP Recovery and Resolution Planning RWA Risk-Weighted Assets SRD Strategy for Responsible Development SREP Supervisory Review and Evaluation Process SSB Sell Buy Back TN Technical Note WB World Bank WIBOR Warsaw Interbank Offer Rate WSE Warsaw Stock Exchange ZUS Social Security Agency 3 EXECUTIVE SUMMARY 1. Following several years of strong growth - GDP growth of 4.6 percent in 2017 - the economy is expected to slow to a more sustainable pace. Near-term growth is expected to slow to a still robust 3 to 3½ percent in 2019-20, with low unemployment. 2. The banking system in the aggregate is well-capitalized and resilient to shocks, although a few medium-sized banks are weak. Banks have well managed their non- performing loans (6 percent ratio). Under a stress test scenario, the solvency ratio for the overall banking system (CET1) would decline from 16 to 13 percent of risk-weighted assets, but a few medium-sized banks come under solvency pressure. Similarly, the banking system is largely resilient to liquidity and contagion risks, though cooperative banks are exposed to credit, concentration, and contagion risks through their network affiliations. Credit growth remains in line with GDP growth, even if the composition becomes riskier, with consumer lending growing faster. As foreign-exchange mortgage portfolios represent no systemic threat any longer, any related policy response should be limited to negotiated restructuring, rather through any legislative change which would be costlier to banks and to the overall economy. 3. Sovereign-financial institution linkages have increased, reflecting a recent acquisition of a large bank by the state-controlled insurance company, and changes to the tax regime (an assets tax) that incentivize holdings of government securities. This asset tax should be redesigned on grounds of financial efficiency. Because of the increased state control of financial institutions, it is critical that PFSA is run as a fully independent and well-resourced supervisory agency. 4. Shortcomings were identified in PFSA prudential oversight that reflect budgetary constraints, and a governance framework short of sufficient independence. The consequences of under-resourcing the PFSA will become apparent with the inevitable turn in the economic cycle, but as well in the short run with pressures from dealing with troubled institutions and the oversight of growing capital markets. While there was no observable direct improper influence on the PFSA arising from greater state control, shortcomings in the PFSA budget and organization raise questions whether it has sufficient independence. A new law that will be in force in early 20191 seems to address the budgetary constraints but would further weaken the operational independence of PFSA. In order to limit the future vulnerability of the financial sector, this reform remains incomplete. 5. The macroprudential policy framework is sound, though untested. There is a good range of instruments available. In time, areas of further attention include a rising share of nonbank financial activities, the increase of unsecured consumer lending, pressure on bank profitability and a rising sovereign-bank nexus. 1 This new law was drafted and passed after the FSAP mission. 4 6. Arrangements for crisis management are generally sound, although measures are required to strengthen the independence of the Bank Guarantee Fund (BGF) and powers of the PFSA. Authorities took steps to be prepared to deal with systemic distress and crisis in practice. However, the PFSA should be empowered, notably to dismiss a bank manager without having to dismiss all bank management when imposing receivership; and to undertake insolvency assessments, without the need for a third-party opinion. The bankruptcy framework should also be improved by widening available tools and allowing for timelier action. Exemptions from the requirement to prepare recovery plans for banks subject to rehabilitation plans and for the two OSII affiliating banks are inappropriate. 7. For the cooperative banking sector that plays a useful developmental role through its large membership, the supervisory arrangement is evolving towards a “supplementary” supervision model, by which all cooperative banks below certain thresholds are to join a network that includes an affiliating commercial bank and an Institutional Protection Scheme (IPS) that perform functions of official institutions (internal controls, liquidity and solvency support). However, the model is new and the PFSA needs to intensify its supervision through the transition period. Elevated risks stem from: (i) about 40- 45 cooperatives that still need to affiliate within a network; (ii) 12 cooperatives likely to remain outside of a network (some in need of strengthening); and (iii) for the two existing networks, as their affiliating banks continue to suffer from legacy issues of weak asset quality and capital. 8. For the distinct credit union sector, capital adequacy is weak, reflecting the situation of several large non-viable credit unions. The authorities need to implement a restructuring strategy focused on resolving non-viable entities through exit. Policy-makers will need to determine whether a standalone credit union sector remains appropriate. 9. Poland’s financial system has room for further diversification and access. Authorities have been implementing a Strategy for Responsible Development which includes new risk sharing and equity funds. Most of these initiatives are too recent to assess their overall efficiency upon access to finance for SMEs, but in terms of financial sector diversification, there is a need to develop private bond markets and pension funds. 10. Fixed income markets have developed, but corporate bonds are lagging, and do not sufficiently mobilize local currency funding to finance the economy, which is a missed opportunity. Banks will rather be net issuers of corporate bonds (covered bonds, MREL) than investors. The capacity to mobilize foreign investors is key, in addition to expanding domestic investment and pension funds. A comprehensive action plan is needed to prioritize reforms to develop corporate bond markets that relate to money markets, trading platforms, sounder regulations of private placement, taxation of corporate bonds (also covered bonds), the emergence of project bonds, the development of interest rate futures, and further transparency on government bond markets. 11. The forthcoming private pension scheme (known as PPK) is a welcome step to develop capital markets and to offset the declining replacement rates for pensioners receiving 5 benefits from the social security system, but the system is facing implementation risks due to the short timeline. Authorities are advised to solve operational issues, like IT platforms, the settlement system, the licensing of managers, the setting up of a supervisory framework and adequate investment regulations, and a communication campaign. The system should also be improved by setting up annuities as a default option and improving the payout phase. 6 Table 1. Poland FSAP: Key Recommendations Recommendations Agency Time Risk Analysis Address weaknesses in medium-sized banks and the affiliating banks for cooperatives. PFSA I-NT Replace the asset tax on financial institutions by a tax on their profits or remunerations MoF I-NT Pursue bilateral negotiations to restructure distressed FX loans (but avoid a new law) PFSA, MoF I Financial Sector Oversight Reform and strengthen arrangements for supervision, based on the principles that PFSA should have (i) sufficient staffing and resources, (ii) administrative autonomy, MoF, PFSA, I (iii) effective governance, and (iv) appropriate formal status in the determination of NBP regulatory priorities. Bank oversight Increase sampling of loans across the supervisory and business cycle. PFSA NT Provide enforcement powers (i) ease rigidities constraining prompt corrective action due to the Administrative Code procedures; and (ii) power to dismiss management and MoF, PFSA NT supervisory board members. Crisis Management and Bank Resolution Propose legal amendments for (i) timely petition for bank bankruptcy; (ii) harmonize MOF with resolution triggers; (iii) not always require third-party opinion on solvency; (iv) conduct NT PFSA & BGF P&A transactions in lieu of a deposit payout; and (v) strengthen BGF independence Require recovery plans for affiliating banks, significant credit unions, and banks under MoF, BGF I rehabilitation. Insurance oversight Finalize and implement approach to supervision of the insurance-led financial PFSA I conglomerate. Review approach to insurance conduct of business supervision (preventative work). MoF, PFSA NT Capital Markets oversight Review and clarify regulations on private placements, strengthen market conduct MoF, PFSA I supervision. Conduct periodic assessments of enforcement functions. PFSA I Criminal NT- Strengthen criminal enforcement. authorities MT Macroprudential Policies FSC-M to ascertain the availability of identified macroprudential tools (including LTV, Authorities in I DTI). FSC-M Financial Market Development 7 Recommendations Agency Time Cooperative Banks PFSA, MoF, Strengthen the supplementary internal control and safety net arrangements, address the ABs, IPS, weaknesses of affiliating banks, and develop strategies to promote further I National integration/consolidation Associations Credit Unions PFSA, NBP, Develop and implement a restructuring strategy to (i) resolve non-viable credit unions MoF, NT through exit; (ii) revisit whether a stand-alone credit union sector remains appropriate. NASCU Development of Capital Markets Remove the effect of the Financial Institutions Asset Tax upon corporate bonds MoF I MoF, PFSA, Facilitate the development of money markets by standardizing and simplifying the financial NT repurchase agreement at all levels. institutions Enhance transparency and investors trust, by improving market information on OTC, and MoF, PFSA I for private offers introduce a lock-in period and a notification for investment firms. NT- Reduce market fragmentation by merging the Catalyst platforms. WSE, PFSA MT MoF, NBP, Develop project bonds markets with adequate risk allocation to different stakeholders PFSA, PFR, MT WSE Development of Pension Funds Reduce the implementation risk of PPK reform. MoF, PFR I Design the default option for the payout as an annuity. MoF I Introduce investment limits through secondary regulations (not by law). MoF, PFSA I Agencies: MoF=Ministry of Finance; NBP=National Bank of Poland; PFSA=Polish Financial Supervision Authority; BGF=Bank Guarantee Fund; FSC-M=Financial Stability Committee-Macroprudential; PFR=Polish Development Fund; WSE=Warsaw Stock Exchange; NASCU=National Association of Credit Unions Time Frame: C = continuous; I (immediate) = within one year; NT (near term) = 1-3 years; MT (medium term) = 3-5 years. 8 I. MACROECONOMIC BACKGROUND A. Macroeconomic Content 12. The economy is performing well; real GDP growth accelerated to more than 5 percent during the first three quarters of 2018; and is expected to moderate after several years of strong performance (see Table 1; Appendix). Near-term growth is expected to slow but remain robust at 3½ - 4½ percent in 2018-19. Unemployment reached a historic low of 3.6 percent in August 2018. Wages in the enterprise sector have been growing at around 7 percent per year, while headline inflation (at 1.2 percent in November 2018) remained below the NBP’s inflation target of 2.5 percent. 13. Credit growth remains moderate along low interest rates, but its composition is skewed toward the riskier segment. Credit growth has risen but in line with GDP growth. However, the composition of credit is becoming riskier, with unsecured consumer lending growing faster than other credit components; this sector warrants closer monitoring given its higher 12 percent NPL ratio (twice higher than the average 6 percent) even if household indebtedness remains moderate (below 60 percent of disposable income). Total mortgage growth has been contained following tightened LTV limits. Yet, with nearly all mortgages at floating rates, borrowing costs could rise if global financial conditions tighten. Lending to corporates remains subdued, as banks are reluctant to lend to construction and trade sectors (35 percent of corporate loans) given wage pressures faced by corporates in Poland. 14. Sound policy frameworks and solid macroeconomic fundamentals have shielded Poland from recent market turbulence, but downside risks dominate beyond the near term. Interest rates have been low for three years, yet analysis does not show any overheating in credit growth, housing, or equity prices. Adherence to EU policy frameworks and reductions in fiscal and external vulnerabilities have kept Poland less affected than emerging markets. The zloty has weakened modestly in nominal effective terms since March 2018, and spreads have widened marginally. With accommodative financial conditions, growth in the short run may outperform, if new social programs and tax cuts boost consumption and EU-funded projects accelerate. Yet investor sentiment could be dented by on-going tensions with the EU. B. Financial System Structure 15. A large share of the financial sector by assets is state-controlled or foreign-owned. The overall system remains dominated by banks (figure 2, Appendix). Among the 12 domestic systemically important banks (D-SIBs) designated by the PFSA, 7 are foreign- owned, with 6 of these headquartered in EU. Foreign-owned banks still account for 45.5% of the Polish banking system in 2017, compared to 60% in 2012. Foreign-owned companies, from the EU, USA and Canada, also account for half of the insurance sector. Since the state- controlled large insurer acquired controlling interests in three banks, one from selling foreign owners, the state is now the controlling shareholder of the largest bank (29.4 percent interest) and of the largest insurance company (34.2 percent) as the result of this transaction. So far 9 supervision and enforcement by the PFSA has been carried out in the same way for all institutions regardless of ownership. The WSE-listed status of large state-controlled institutions also contributes to discipline in corporate governance and transparency. Nonetheless, the increasing state control reinforces the need for an independent and well- resourced regulator. Structure of the Financial System, December 2017 16. The Polish financial sector is also characterized by a large number of small cooperative banks and credit unions. While servicing 25 percent of the population, with only 8 percent of financial system assets, they are non-systemic from a risk vulnerability perspective. The 550 cooperative banks rather focus on lending to agriculture (half the total) and SMEs. The 35 credit unions mainly provide consumer finance to retirees and employees; they operate under special regimes. There are known solvency issues and past failures have spilled back onto bank profitability through higher deposit insurance assessments on banks. There are significant interconnections within this sector as most cooperatives are affiliated with one of two networks that each own an affiliating commercial bank. Because of the interconnections, these affiliate banks are designated as Other Systemically Important Institutions (OSII). 17. The insurance sector is small by comparison with most EU markets. The insurance sector is large relative to other CEE countries, but penetration rates, especially in life insurance, remain well below those of more developed EU markets and the product range remains limited. The largest domestic group accounts for one third of total premiums. 18. Among Central and Eastern European countries, Poland has the largest stock markets, and Polish Treasury bond markets are sizeable, but non-sovereign bond markets remain under-developed. Equities are traded through both the regulated Warsaw 10 Stock Exchange and a smaller alternative trading system. Bond markets have been growing, but from a low base for corporate bond markets, which remain modest in size, and with limited liquidity by comparison with larger sovereign debt market. This situation represents a missed opportunity to be remedied by an awaited action plan to develop capital markets, as some of the ingredients for success are present (macro stability, possibility to further mobilize the EU investor base). 19. Poland’s financial system has room for further diversification and access for SMEs. In 2016, Poland’s domestic credit to GDP ratio stood at 55 percent (compared to 89.2 percent in the euro area). Since 2017 authorities have been implementing the Strategy for Responsible Development (SRD), which includes new risk sharing and equity funds (piloted by the Polish Development Fund). But most of these initiatives are too recent for their efficiency to get assessed; the MoF expressed its preference for the FSAP to focus on other priorities of the SRD, such as the needed growth of bond markets and of pension funds. II. VULNERABILITIES AND RISKS 20. Banks’ financial soundness indicators generally improve while profitability is under some pressure. Tier 1 ratio is 16.5 percent of risk weighted assets (RWA) while profitability has been declining (10.4 percent ROE, Appendix I Figure 4) due to slower loan growth and low interest rates, this profitability remains above EU average (6.1 percent ROE). Banks generally managed well their non-performing loans (declining NPL ratio of 6 percent, see Appendix Table 2) and provisioning at about 57 percent. However, a few medium-sized banks have relatively high NPL ratios and lower provisioning coverage. Banks are also generally liquid and mostly funded by low-cost retail deposits (Appendix, figure 4). The system-level loan-to-deposit ratio peaked at 115 percent in 2013 but has improved to 105 percent through 2017. However, some banks show liquidity shortfalls based on the reported Liquidity Coverage Ratio (LCR). 21. Increasing sovereign-financial institution linkages could amplify financial shocks while distorting credit allocation. While government debt levels at about 50 percent of GDP are moderate, and capped at 60 percent by the constitution, sovereign exposures can mutually reinforce fiscal and financial vulnerabilities. Linkages are spurred by the Financial Institution Asset Tax (FIAT), which exempts holdings of government securities. Banks’ related holdings increased from 20 percent of RWA at December 2015 to around 25 percent at December 2017. The FIAT has impacted the profitability and capital of banks, and incentivized them to hold more of government securities, thus steering asset allocation away from more productive private lending and hampering the attractiveness of corporate bonds. The FIAT should be replaced by a less market distortive tax system (for example on the net incomes or on the profits of financial institutions). 11 22. The sovereign –financial institution linkage also stems from the increased state control of financial institutions, while the government has influence over the PFSA (see Box 1 below and the Prudential Oversight section). This situation justifies for the importance of PFSA to remain independent of government and be adequately resourced. Box 1. State Ownership in the Financial Sector: Recent Developments and Implications Policy on state ownership is evolving, while state interest in the financial sector has been increasing. The government is limiting further privatization and focusing on strategic management and maximizing the value of core state assets, including its interests in the largest banks and insurer. State ownership supervision has been reformed, with new arrangements in the Prime Minister’s office for managing key decisions and making appointments to supervisory boards based on skills and expertise. At the same time, the state- controlled large insurer has acquired controlling interests in two banks from foreign owners, furthering a related government objective. State control of financial institutions raises policy challenges, in particular: • Maintaining clarity over objectives. Most entities (including the largest banks and insurer) compete with wholly privately-owned institutions. From FSAP discussions, there is no evidence the government uses state control to direct or to influence the institutions, for example by prescribing lending targets; nor has the state sought the payment of excessive dividends contrary to PFSA recommendations. • Rigorously separating state ownership supervision from other government policy, including regulation and supervision. Centralizing ownership supervision, although the framework is still developing, appears supportive of separation. There are no special provisions in regulation in respect of state-owned institutions and the lead department for regulation (MoF) has no role in ownership supervision. Supervision and the enforcement (by the PFSA), on the evidence of FSAP discussions, is carried out in the same way for all institutions regardless of ownership. • Ensuring that effective governance of the state-controlled institutions is not compromised by government appointments driven by political considerations. The new arrangements for ownership supervision provide a check on political appointments but have not eliminated them (e.g., at least one state-owned financial institution has experienced significant turnover in senior management). Overall risks from significant state ownership were assessed to be mitigated though there are new reasons for concern. The integrity of the regulatory process and empowerment of the supervisor are important checks on potential adverse impacts of state control. The PFSA has evidenced instances where it has resisted the appointment of management board members, imposed financial penalties, and restricted dividend payments by state-controlled banks without interference. The WSE-listed status of all the large state-controlled institutions contributes to discipline in corporate governance and transparency. However, a new law coming into force in early 2019, provides the government with majority voting control over the PFSA, including decisions on enforcement, dividends, capital, and other policies. These changes call into question whether risks from state-ownership will remain sufficiently mitigated. 23. FX mortgage exposures have declined, and do not represent any systemic risk. FX mortgages are no longer offered since 2013 to unhedged borrowers, and the combination of a relatively stable zloty, higher household income, and amortization rates of around 6 percent per year has reduced the risk exposure. The portfolio performance is strong, and the share of outstanding FX mortgages with an LTV ratio above 100 percent declined from 37 percent in 2013 to 30 percent by 2017. In addition, banks and borrowers have been building buffers, and prudential regulations have been tightened. Uncertainties remain, however, as a related 12 consumer protection draft law would - if passed - exacerbate pressure on bank earnings. Negotiations to restructure FX loans for relatively few distressed borrowers would be highly preferable to any new law. 24. The banking system shows resiliency to adverse shocks in the aggregate, however, some Other Systemically Important Institutions (OSIIs) show weakness. Under an adverse case, some of the medium-sized banks would come under pressure, and the necessary recapitalization need would be 0.5 percent of GDP. Cooperative banks are exposed to credit and significant concentration risks. The authorities should sustain supervisory attention towards weaknesses in mediums-sized banks and the affiliating banks of cooperative networks. III. PRUDENTIAL OVERSIGHT 25. Regulatory and supervisory responsibilities are spread over a number of bodies. The PFSA, an agency reporting to the Prime Minister with its board,2 has prudential supervisory responsibility for the financial sector. It also issues recommendations, circulars etc., and enforces regulatory requirements, but only government issues laws and regulations. The NBP has no frontline supervisory responsibilities but has oversight of the overall financial system stability as well as payments system. A. Independence and resourcing of supervision 26. The assessments of the supervision across sectors highlighted resource limitations relative to the high demands on supervisors. Supervisory resources are stretched by high workloads, while the risk-based allocation of resources is not supported by an explicit risk tolerance statement from PFSA or government. Most of the gaps identified, such as broader loan review in banking, the need to increase the oversight of cooperative banks, a comprehensive oversight approach for the new conglomerate, stronger conduct of business supervision in insurance and capital markets, cannot be addressed without more resources3. 27. Under existing law and budgetary procedures by the time of FSAP missions, the PFSA had sought additional resources, but these have proved insufficient. This shortfall has arisen even though the costs of the PFSA’s work are borne by regulated financial institutions through levies, and there is scope to raise more funding from industry without exceeding authorized limits. The PFSA’s expenditure, unlike that of the NBP, must be approved by the Minister of Finance as the PFSA is subject to central government budgetary process. As the financing of the PFSA is from levies and not from taxation revenues, the supervisor should obtain more autonomy from the government’s budgetary process. A recent 2 The PFSA’s “board” in this context refers to the eight-member Authority itself. The Board is supported by PFSA staff, which is managed by the Chairman and the two Vice-Chairmen also sitting at the Board. 3 Its staff slowly increased from 949 to 1017 (from 895 to 958 staff in post) over the five years to end-2017. 13 legislation (adopted since the FSAP Aide Memoire) is establishing the PFSA as a state legal entity along with a stronger budgetary independence. 28. The operational independence of PFSA is raising renewed concerns, given the state’s significant control of the financial system for an effective supervision to be even handed and free from conflicting objectives. The law in force by the time of FSAP makes the PFSA report administratively to the Prime Minister. This gives to the PM powers not only to appoint the Chairman and, on the Chairman’s recommendation, both Vice-Chairmen, but also to set the framework for administrative matters, including the basis for remuneration of the staff and the internal organization of the PFSA. The Board is responsible for the exercise of supervisory powers and Parliament makes the laws, including provisions for regulations issued by government departments. The PFSA can make requests for legislative reform through the MoF, but its requests are not always granted, as views may not be aligned about the priority or the timing of a specific reform, and/or about its chances to get approved by the Parliament. 29. If PFSA’s board was relatively insulated from political influence, the new law may weaken this independence. So far, there have been 8 board members, with 4 representing government4 and 4 others (PFSA’s chairman, two vice chairmen, and a NBP representative) who do not represent government. In the event of a split vote, the chairman decides. The new law expands the PFSA’s board from 8 to 12 by adding (i) one more voting member representing the Prime Minister, which makes the government holding a majority through 5 out of 9 voting members; and (ii) 3 non-voting members, representing security services, consumer protection, and the BGF. While the larger scope of representation facilitates coordination among agencies, the risk is that the enlarged board would increase the sources of political influence as well as broadening access to sensitive information. Supervisory agencies in many countries have similar governing bodies responsible for supervisory decisions, but participation by government, except in narrowly administrative decisions, is rare. Concerns about weakening independence are acute owing to the fact that the three Basel Core Principles For Effective Banking Supervision most relevant to this question (i.e. independence, enforcement and related parties) were found materially non-compliant by the BCP assessors. 30. The PFSA is also limited in taking effective decisions, due to other issues: • Successive changes to the legislation establishing the PFSA5 have restricted the scope of decisions which can be delegated to PFSA Chair and staff. Much of the time of the PFSA board is taken up with a wide range of decisions on the exercise of PFSA powers, that in other countries would be delegated to management and staff (with appropriate ex post reporting and reservation of most significant decisions to the Board). The time for discussion of broader policy on use of powers or strategic issues is thereby limited. 4 One represents the President of the Republic and three represent relevant ministers). 5 2006 Financial Markets Supervision Act. 14 • Furthermore, in the context of the lack of delegation as well as the increasingly technical nature of the supervisory issues with which the PFSA is dealing, the composition of the board is inappropriate: external members lack available time and expertise. As representatives of ministries (or the President), they may not have the skills or experience. • These issues are compounded by the absence of an explicit risk tolerance statement that would enable the PFSA board better to oversee resource allocation, particularly whether the intensity of supervisory activities is proportionate to risks and other priorities such as the implementation of EU Legislation. Notwithstanding the extensive PFSA risk-based supervisory processes, the Board needs to monitor outcomes against risk tolerance. 31. Some aspects of the new law are contrary to FSAP recommendations regarding PFSA governance. Further reforms should be undertaken based on certain principles: • The PFSA should have budgetary autonomy, within an overall framework of accountability for its expenditure and for the levies raised from industry; the authority should be autonomous in the setting of remuneration policy and internal organization; it should remain independent in decision-taking on the use of supervisory and enforcement powers. • The governance arrangements should not include any role for government beyond appointment to the governing body (and dismissal for cause). If it is necessary for government to have oversight of administrative matters, this could be carried out through an advisory or separate oversight body, as in some other countries, with responsibility over the oversight of management and resources, providing strategic direction, assessing supervisory effectiveness against a defined risk tolerance. • In a way consistent with the Constitution, the supervisory authority should be given some formal status in the determination of regulatory needs and priorities; this may be achieved through administrative arrangements for the MoF to work jointly; or potentially by giving the PFSA the right to request regulatory change and to have its requests made public. 32. While under the new law, the PFSA remains a separate supervisory agency, the FSAP also discussed the advantages and shortcomings of another earlier NBP proposal that the PFSA be merged with the NBP. Some advantages could come from NBP’s autonomy on budget and decision making, the complementarity of bank supervision with NBP responsibility over the overall financial stability, and a greater independence of all supervisory functions vis-à-vis government’s ownership positions. However, the enlarged scope of NBP responsibilities would create challenges to manage both price and stability objectives, and the case for NBP oversight expertise of nonbank financial institutions and capital markets is less clear-cut. Central banks with full scope supervisory responsibilities are rare. A “twin peaks” 15 approach (separation of prudential and consumer protection) could be studied, provided that both peaks clearly meet the principles set out above, with a fully empowered peak for market conduct and consumer protection. B. Banking Regulation and Supervision 33. Banking regulation and supervision are largely in line with the Basel Core Principles (BCP) but oversight functions remain insufficient. The EU Single Rule Book including the capital requirement package is in place, and the Single Supervisory Mechanism (SSM) and the European Banking Authority (EBA) are key partners. The PFSA’s supervisory approach is anchored to a robust onsite inspection culture that has evolved to become more risk-based. Yet severe resource constraints have pushed PFSA to give oversight priority to the largest banks at the expense of work on smaller entities, and hampered PFSA ability to deliver the required cycle of bank inspections with adequate coverage of a bank’s loans. 34. There are gaps and undue procedural constraints in the legal framework governing PFSA’s supervisory and enforcement work. The PFSA lacks direct powers to dismiss members of a bank’s management or supervisory boards or require a change in the external auditor. The PFSA may issue recommendations for remediation, but further legal measures are necessary. The PFSA has to send a warning notice to the relevant persons and seek a third-party opinion to support its own assessment. These and other procedural rigidities from the Code of Administrative Procedures, increase the scope for extended litigation and limit the effectiveness of PFSA’s prompt corrective actions. Lastly, its recommendations are not legally binding, even if carrying a lot of weight in practice. 35. There are areas where the supervision by PFSA can be improved: (i) risk assessments should be more forward looking, (ii) the coverage of loan review expanded, and the supervision of credit and concentration risks enhanced (iii) the cycle of inspections should be shorter (if the 15 largest banks are inspected annually, the cycle of inspection for smaller and cooperative banks is too long sometimes exceeding 10 years) and (iv) PFSA is not using often enough financial and administrative penalties on banks and/or managers or shareholders. 36. Off-site supervision is sound and built on well-designed internal processes and information, but further improvements are needed. Risk assessment under the BION (aka Supervisory Review and Evaluation Process (SREP)) needs recalibration to refine its ability to discriminate among different risk profiles.6 BION should be made more forward-looking by including key indicators that anticipate risk. C. Anti-Money Laundering and Combating Terrorist Financing 37. In the area of money laundering and combating terrorist financing, Poland has made recent progress in addressing deficiencies identified through earlier MONEYVAL 6 BION is the Polish acronym for the Supervisory Review and Evaluation Process (SREP) of the PFSA. 16 evaluations. A new AML/CFT law was passed in 2018 to implement the 4th EU AML Directive, which appears to address several recommendations made by MONEYVAL. The law is addressing deficiencies with criminalization of terrorist financing, customer due diligence, and beneficial ownership in line with FAFT standards. The law requires banks to appoint a Money Laundering Risk Officer, provides a clear definition of ultimate beneficial owner, and introduce more dissuasive pecuniary sanctions. 38. There are, however, aspects that merit attention including the need to: (1) increase staffing for both onsite and offsite surveillance to ensure effectiveness; (2) issue-specific KYC/CDD guidelines; and (3) institute a periodic National Risk Assessment (NRA) and (4) develop and implement an action plan to mitigate ML/TF risks as identified by the NRA. D. Crisis Management and Safety Nets 39. Legal and institutional arrangements for recovery and resolution planning, and executing resolutions are generally sound, although legal amendments are needed to ensure Bank Guarantee Fund (BGF) independence. The BRRD measures enhanced the BGF’s and the PFSA’s powers to deal with failing banks.7 The BGF exercises resolution powers along with its responsibilities as deposit insurer. The deposit guarantee payout process is efficient and well-tested, although new resolution tools remain to be tested. Concerns remain however over BGF’s independence which is neither stipulated in law nor assured in practice. 40. Other authorities have broadly sufficient powers and cooperation arrangements are effective, although there is room for progress. The PFSA is responsible for supervising recovery planning, the taking of early intervention measures, and deciding if an entity is considered failing or likely to fail or filing a motion for insolvency to Court. The NBP acts as provider of emergency liquidity assistance. While institutional arrangements among the NBP, PFSA, MoF and BGF provide for adequate information sharing and cooperation in normal and crisis times, there is scope for improved coordination on recovery and resolution planning. 41. Satisfactory progress has been made on recovery and resolution planning. Initial resolution plans have been prepared by the BGF. Preferred resolution strategies have been determined and impediments to execution identified. However, banks subject to rehabilitation plans and affiliating banks should not be waived from preparing recovery plans. 42. The ability to deal effectively with problem and failing banks is well advanced. For smaller cooperative banks and credit unions the deposit guarantee payout process is efficient and well-tested, though new Special Resolution Regime tools remain to be tested. Resolution funding arrangements are in place, including deposit guarantee and resolution funds, although legal conditions for using such funds are set high, in application of EU rules. 7 The new legislation that has passed that gives the PFSA early intervention power to compel the merger of a weak bank upon agreement of an acquiring bank. The new amendments are additional to the existing BRRD powers. The timing of the amendments did not allow for discussion or assessment as part of the FSAP. 17 43. The authorities have taken steps to be prepared to deal with systemic distress and crisis. The FSC is role ensuring interagency cooperation and coordination in the event of a potential threat to stability are well defined. The adopted National Contingency Plan is supported by individual plans in each authority that have been or are being updated. The authorities should consider further addressing cross-border cooperation in the next update to the national plan, and periodically testing the plan by means of crisis simulation exercises. 44. The bankruptcy framework should be improved by widening available tools and allowing for timelier action. The bankruptcy framework should be improved by providing for earlier action by the PFSA and for the purchase of assets and assumption of insured deposit (P&A transactions) if less costly than a deposit payout. The PFSA should have the power to undertake and impose a valuation of assets, including in the context of assessing a bank’s prospective solvency, without the requirement for a third-party opinion/audit. 45. The NBP has a coherent framework to manage liquidity in normal and stressed times, and markets function well. Procedural arrangements for the provision of Emergency Liquidity Assistance (ELA) are well-developed with an MOF backstop in place. However, there are legal constraints to be addressed on the liquidation of collateral in a bank default case. E. Insurance and Financial Conglomerate Supervision 46. Except for issues relating to independence and resources, most recommendations of the prior insurance assessment have been implemented. Implementation of the EU Solvency II Directive in 2016 has strengthened regulation and supervision, including through new risk-based capital standards and comprehensive group supervision. No insurer has had an internal model approved for use under PFSA rules, although several started discussions. 47. The recent emergence of the first Polish financial conglomerate, headed by an insurer, poses new supervisory challenges. Most individual elements of the group are supervised by the PFSA, which already carries out Solvency II-based group supervision. Nonetheless, it also needs to complete the application of comprehensive “supplementary supervision” to the group and strengthen internal coordination amongst supervisor teams. 48. Instances of customer mistreatment have been met by a coordinated response by the authorities and business conduct regulation has been strengthened; however, there is scope to develop a stronger preventative supervisory approach, requiring enhanced processes, cooperation with other agencies, internal organizational change. F. Capital Markets Supervision and Regulation 49. Capital markets arrangements are broadly aligned with IOSCO Principles, despite resource constraints. The program for monitoring of issuers listed in regulated markets is comprehensive. The supervisory program for intermediaries (investment firms, fund managers) is anchored in on-going monitoring based on periodic reporting, and an annual risk 18 assessment process used by the PFSA to calibrate the intensity of supervision. Through an intensive off-site approach, the PFSA also supervises market infrastructure providers. 50. However, conduct supervision needs to be enhanced. The PFSA should (i) strengthen conduct supervision of banks in the performance of MiFID investment services; (ii) make selective improvements to off-site supervision, and (iii) increase the frequency of inspections for the largest participants (iv) make a more extensive use of thematic inspections to address conduct issues in smaller firms. 51. In tandem, the PFSA should continue to strengthen its ability to identify emerging and systemic risk. In the short term, PFSA should add a market trends report (to the sectoral reports already produced) and run market intelligence meetings to strengthen its risk identification process. In the medium term, the PFSA could develop a more structured process for risk identification and monitoring, supported by tools like a risk dashboard. 52. The PFSA should improve regulation and/or supervision vis-à-vis privately placed bonds to rebuild an eroded investor confidence. Clarifications about the use of private placement were recently made, but the PFSA could pursue additional changes, like notification requirements8, or a lock-in period for bondholders.9 After a mediatized case of defaulting bonds (privately placed and resold to retail investors), there is an acute need to rebuild investor trust. 53. The PFSA should supervise more actively the Warsaw Stock Exchange, regarding issuers and secondary markets that the WSE supervises, notably for Multilateral Trade Facilities (MTF) like New Connect where retail investors are active participants. 54. The PFSA should actively use its enforcement authority. The PFSA is willing to use its sanctioning authority when material breaches of conduct obligations are found; however, the experiences leave the question as to whether such tools are being consistently used, and whether enforcement actions are timely enough. 55. Without the strategic use of criminal enforcement, the system lacks a deterrent component. While the PFSA has been actively referring cases to the prosecutor’s office the use of criminal enforcement is limited (especially for crimes different from market manipulation) and when used, the sanctions rarely apply imprisonment, even for the most egregious cases. This challenge is complex and requires actions outside PFSA jurisdiction. 56. Reengineering the processes of authorization of issuances and licensing can make them more efficient, outcomes more consistent and foster capital markets development. The review indicates that the processes are thorough and that PFSA raises substantive issues, but that processes are long, and there are concerns about the consistency of outcomes, 8 Not to regulate the offering, but to allow PFSA monitor whether exemptions are used in a way consistent with regulations. 9 The notification could be imposed on companies and/or intermediaries that facilitate placements. In any event, the possibility for PFSA to act would need to be assessed against EU Directives. 19 impacting efficiency and market development. Thus, processes should also be reviewed with a view to establish deadlines and refusing authorization, licensing or approval, when necessary. 57. The PFSA is encouraged to work on the impact of its regulatory framework on market development. For example, the PFSA could identify areas where more proportionality is needed. To this end, the PFSA and the MoF should hold regular consultation with market participants as a key part of the processes of drafting and issuing regulations. 58. The PFSA needs additional resources to recruit and retain skilled personnel. The PFSA faces limitations in both the number of staff assigned to supervisory activities, as well as the array of expertise available for supervision (in areas such as IT, and risk management). Furthermore, as the market grows in sophistication the PFSA needs to strengthen its analytical tools, including through the use of big data and artificial intelligence. G. Macroprudential Policies 59. The macroprudential mandate is assigned to the Financial Stability Committee Macroprudential (FSC-M), with NBP taking the lead role in systemic risk monitoring. The FSC-M with representation from the NBP, MoF, PFSA, and BGF fosters close collaboration. It does not have direct powers but can issue “comply or explain” recommendations to its members to act. Bi-annually it produces a high-quality analysis of conditions in the financial sector—the Financial Stability Report (FSR)—which should be expanded to cover vulnerabilities emanating from payment and settlement systems. 60. The macroprudential settings are commensurate with the perceived systemic risks, but steps could be taken to underpin the FSC-M’s position in macroprudential policy. Besides EU harmonized instruments, the FSC-M has identified a list of national macroprudential instruments that could be used. Variable rate consumer loans are growing which could cause the FSC-M to consider debt service-to-income (DSTI) limits. The PFSA’s proposal to foster the development of fixed-rate mortgages would help to limit risks for households. The FSC-M should prepare to respond to stability threats that emerge from structural changes, like the rise of non-bank financial activities, or increasing sovereign-bank linkages. FSC-M should also - when needed - take decisions on a majority base10. 10 Even if the unanimity of FSC-M members obviously always remains a preferred solution. 20 IV. SELECTED FINANCIAL SECTOR DEVELOPMENT THEMES A. Cooperative Banks and Credit Unions 61. Despite a consolidation of the cooperative banking sector in the 1990’ , there are still 550 cooperative banks that play an important developmental role. Not much of further consolidation has been taken place over the last 8 years, beyond a few cases of bankruptcy, also as cooperative banks tend to fiercely preserve their independence. 62. Most cooperative banks and credit unions are stable, and the sector does not represent a systemic risk; yet some chronic issues need to be remedied and governance arrangements reinforced. Without efforts to improve capabilities, latent viability issues develop without sufficient early detection. As oversight arrangements develop (i.e., greater reliance on third party networks), there is a need to define the official risk tolerance for failures. 63. For both sectors, the costs of supervision and frequency of failure are higher than for commercial banks. In broad terms, most cooperatives overall achieve social objectives (notably to farmers and SMEs), provide valuable competition to commercial banks, and are financially stable. The credit union sector, however, is more troubled, as being imperiled by the poor situation of its largest members. However, even smaller and healthier credit unions lack critical mass to be viable as a standalone sector, they still need a supportive network structure, and some viable credit union should become or consolidate with banks. 64. Notwithstanding their common nature as member-owned entities, cooperative banks and credit unions have quite different characteristics and perspectives in terms of nature, membership, developmental impact, financial performance and regulatory framework. The cooperative banking sector is more mature and better consolidated. It also provides a wider range of financial services to a more diverse clientele than credit unions that nearly exclusively cater to employees and retirees. A 1. Cooperative banks 65. The Cooperative Bank Act, December 2000, is establishing two tiers of cooperative banks: (i) those with a capital above the equivalent of Euro 5 million and complying with standards applied to commercial banks; and (ii) those with capital between the equivalent Euro of 1 and 5 million. Most cooperative banks remain well capitalized, with moderate NPLs. Cooperative banks smaller towns and rural areas, notably by lending to SMEs and farmers, but where commercial banks are beginning to encroach as they seek domestic expansion. 66. As seen in Table 2, NPLs are higher among larger cooperative banks, reflecting their engagement with enterprises, the impact of the absorption of weaker cooperative banks, and a lower level of connection with local communities. Large cooperative banks represent 65 percent of sector assets but only 40 percent of members. Most of the smaller cooperative banks 21 tend to show stronger financials (except for very small ones), but lack scale for access to technology and third-party services, which affects their current and future competitiveness. Table 2. Poland: Performance of Cooperative Banks by Size (by the end of 2017) Average Number of Regulatory Average Return Average NPL Average of Capital (CET1) entities Capital ratio on Assets ratio Loan Growth < EUR 1 million 4 -1% -2.95% 15.14% -0.21% EUR 1 - 5 million 387 22% 0.59% 4.51% 5.71% EUR 5-10 million 114 18% 0.59% 6.24% 4.61% > EUR 10 million 48 16% 0.68% 9.91% 3.08% Total: 553 21% 0.57% 5.41% 5.21% Source: Staff calculations using NBP and PFSA data 67. Cooperative banks account for 5 percent of overall financial system assets, and do not constitute a systemic risk, yet they keep raising concerns for regulators and policy makers. While the sector is stable, there are pockets of vulnerability among larger cooperative banks due to weaker asset quality and a high concentration. Two cooperative banks including a sizeable one had to be liquidated in 2015-2016. PFSA lacks resources to conduct regular on-site inspections (on average, only every 10-12 years). At the same time, the regulatory regime is applied without much of proportionality, sometimes inducing undue and considerable additional costs for cooperative banks. 68. Cooperative banks also exhibit below-average profitability, with average RoA of 0.6 percent by the end of 2017 (Appendix 1, Table 3). In a low interest rate environment, given the small size of most cooperative banks, the capacity of this cooperative banking sector to expand is limited, within a broader banking sector more competitive and digitalized. 69. The supervisory arrangement is evolving towards a “supplementary” supervision model through Institutional Protection Schemes (IPS). Under EU legislation, Polish authorities decided to promote the IPS model which includes an affiliating commercial bank, owned by participating cooperative banks, that is managing IPS funds and providing services to its affiliates. Currently, there are two IPS networks11 that provide services to most cooperative banks. IPSs perform internal control functions to complement PFSA supervision. They also provide direct liquidity and solvency support to cooperative banks in need before resorting to official institutions. In both cases, the PFSA cooperates with IPS to avoid any turmoil in the sector. Both IPSs have successfully tested the assisted merger of one troubled 11 Respectively the Bank of Polish Cooperatives SA (or BPS) and the Cooperative Banking Group SA (or SGB). A proposal to form a third network using an “Integrated Affiliation” as foreseen in the law instead of an IPS is now unlikely, as the PFSA decided in November 2018 to not license the affiliating bank. 22 cooperative bank with a strong one. The affiliating banks are classified as Other Systemically Important Institutions (O-SIIs) due to their role to manage IPS. But during this transition period, the reliance on PFSA oversight is critical. 70. Elevated risk for the cooperative banks’ sector stems from three sources: (i) about 40-45 cooperative banks that were seeking to establish their own affiliating apex bank and network will now need to affiliate back within an existing network;12 (ii) about 12 cooperative banks remain outside a third cooperative bank network/IPS as they are viewed as either too large, and/or too weak to join an existing IPS; and (iii) for the existing 2 networks, their affiliating banks have legacy issues of weak asset quality and capital that in the past has required that their member cooperative banks provide support. Addressing these areas of risk during this period of transition is a high priority. 71. The two existing IPS’s need to be strengthened to ensure sustainability: (i) the supplementary internal control models need to be robust and aligned with PFSA rules; (ii) the scope of the affiliating bank activities should be reduced to support members and limit further direct lending; (iii) they should promote greater integration of the networks, including through actual and operational consolidation among network cooperative banks; and (iv) ensuring that the liquidity and solvency support arrangements across the schemes are harmonized in relative size, capacity, and accessibility to be viable and promote confidence. 72. Despite the overall improving performance of the sector, the capital position of some individual banks is declining, in some cases below prudential regulatory standards. This will make it necessary that PFSA, the IPSs (as applicable), and the BGF undertake resolution activities that limit spillovers, namely the purchase and assumption technique. A 2. Credit Unions 73. Despite improvements in recent years, the performance of credit unions and the quality of financial information remains unsatisfactory. Since being supervised by PFSA (only since 2012), there has been some improvement in the credit union sector mainly due to the resolution of nonviable credit unions and better performance of the remaining entities. But this progress has not been sufficient to reverse the deterioration in the system this far. 74. Credit unions represent only 0.5 percent of overall financial sector assets in Poland, but they serve 1.76 million members (including many pensioners). The sector is increasingly concentrated (the three largest unions hold 74 percent of this sector’s assets). At 12 The number of banks seeking to establish their own affiliating bank had decreased to 42 entities in August 2018. 23 the end of 2016, the overall portfolio of credit unions was mostly made of consumer loans to individuals (91 percent). Their contribution to finance the economy is therefore limited. 75. The capital adequacy of the credit union sector at end-January 2018 is 2.95 percent, reflecting the troubled situation of larger credit unions. Of the 5 largest credit unions, only 1 has a capital ratio that exceeds the minimum 5 percent requirement established for this sector, while the largest credit union, which is 55 percent of the sector and twice the size of the largest cooperative, is under-capitalized. Losses are due to poor loan underwriting, while the large weak credit union is the result of a series of past mergers that were allowed without addressing viability issues. 76. The sector requires restructuring to consolidate viable entities and resolve non- viable entities through either (i) the merger of weak but solvent credit unions with other viable credit unions or with banks; or (ii) the resolution (and exit) through application of the purchase and assumption tool that will allow the franchise value, which is primarily the depositor base and performing loans, to transfer to a successor entity. As the poor financial performance of credit unions is caused by faulty loan management and collection practices, the restructuring strategy should stress the recovery of overdue loans. 77. Policy-makers need to decide whether a standalone credit union sector remains appropriate and, if not, define a strategy to transition viable credit unions to become or consolidate with banks. Credit unions constitute less than 1 percent of deposit taker assets, but most this sector is in financial trouble. Moreover, credit unions cannot invest into modern retail banking technology, thus losing future market shares and relevancy. While reform could be considered, including further recapitalization of weak entities and changes to the Credit Union Act 2009, the alternative could be phasing out credit unions. For those that have remained viable, there could be a medium-term path towards consolidation and ultimately transformation into one or more cooperative banks (or consolidation with a commercial bank). B. Pension Funds Development 78. The introduction of a voluntary funded pension scheme (PPK) with the proposed automatic enrollment features is a positive initiative. The PPK will help to (i) develop capital markets, (ii) increase long-term contractual savings and (iii) to offset the declining replacement rates for pensioners receiving benefits from the social security system. The PPK is estimated to manage annual flows for about PLN 15 billion starting in 2020.13 In addition, as pension funds managing the OFE scheme (second pillar) start to disinvest from domestic equities, the introduction of the PPK program will help to support the domestic investor base 13 It assumes 75 percent rate of participation. Latest estimates from the PFR suggest a goal of 60 percent. 24 and play a vital role in the development of capital markets, although flows remain below the likely overall demand from multiple issuers (banks, non-banks). 79. The introduction of PPK is also timely from the future evolution of the pensions from the Notional Defined Contribution (NDC) scheme. In a scenario of economic growth and low unemployment, the resistance of social partners should be limited. The proposed contribution rates from the employees, employers and the state through the Labor Fund are in line with international experience, and these levels are supported by favorable conditions. In addition, while the offset of PPK pension benefits to overall pensions will be partial, at least it brings replacement closer to 40 percent (which is a minimum that many countries are aspiring to), with an expected additional impact of 10 percentage points by retirement age, depending on the assumptions, for the generation now in their early 40s. 80. Authorities should not underestimate implementation risks, and an extension of the preparation phase is recommended to 2020. The timeframe is tight for a vast program, as PPK are expected to start running in July 2019, nine months after enacting the law, leaving little room for the preparatory work, in terms of developing and testing the IT systems and platforms (including a portal); putting in place the settlement system at Polish Development Fund (transfer agents, call centers, verification systems); licensing pension fund managers; enacting regulations for participants; setting up the new supervisory framework; and launching a communication campaign through a population apprehensive towards capital markets.14 Any poor implementation or delay would affect the credibility and the opt out rate. 81. Setting up annuities as a default option of the PPK system could improve the welfare of participants and create a new set of institutional investors with long term horizons. Instead of offering a plan with 25 percent conversion factor at retirement and 120 equal installments in the following 10 years, which provide no longevity protection to participants, the government could consider an annuity as a default option. 82. Other areas for improvement can make the PPK system more functional. First, the industrial organization of the fund management industry is based on the OFE model and replicates some of the problems that affected the second pillar in the past. Second, a more precise definition of the areas where the PFR may effectively add value might be necessary. Third, the introduction of performance fees is not helping in defining the long-term asset allocation of the pension funds. Finally, since the PPK is part of the pension system, a stronger payout phase is essential for individuals to effectively receive better pensions. 83. The determination of portfolio benchmarks matters to optimize future pensions. Neither the government nor the PFSA can take this decision alone. Ideally, an agreement 14 This period is short compared with the four years that took the successful implementation of the voluntary pension scheme in the UK. 25 should be reached with experts and social partners that can be sustainable in terms of objectives, and flexible by ensuring that it takes into consideration market changes. 84. Building new asset classes is essential to the success of PPK reforms, but investment limits should rather be set by regulations than being determined in the PPK Law. Since at least 70 percent of PPK portfolios must be invested into the domestic market, it becomes essential to diversify investments to other type of long-term asset classes of fixed income securities, including through infrastructure and/or housing bonds (see chapter C). Investment limits should be set by secondary regulations to ensure that portfolio benchmarks are built with enough flexibility. As the PPK law has been changed and eventually approved on November 28, 2018, the preceding FSAP mission is not in a position to comment any investment rule introduced since in the law but is stressing the need to keep sufficient flexibility to optimize long-term benchmark portfolios when market conditions change. 85. In a next stage, the government is considering submitting to Parliament another pension fund reform. This would move 25 percent of the assets of the OFE scheme to the Demographic Reserve Fund, and to transfer the rest to voluntary pension funds (IKZE/IKE). While the 75/25 ratio is calibrated to avoid fire sales of WSE-listed equities, OFEs will have to sell other assets including corporate bonds and foreign securities. In addition, pension fund management companies (PTE) will be turned into investment fund companies. It would be desirable to conduct simulations about the pattern of outflows from OFEs and compare with the expected inflows from other domestic sources, and to evaluate impact scenarios on the evolution of equity markets. Lastly, OFEs should be authorized to diversify their assets and invest as well into sovereign bonds. C. Development of Fixed Income Securities Markets 86. Poland’s fixed income domestic markets have achieved progress in recent years . The domestic yield curve spans up to 10 years for both fixed-rate and floating rate instruments. The volume of outstanding government and corporate debt grew from PLN543bn to PLN644bn and from PLN38bn to PLN71bn, respectively, between 2013 and 2017. The improvements on market infrastructure have strengthened the market. The growth has been supported by government bond benchmarks15 and an increasing foreign investors’ appetite.16 87. The bond market comprises a significant share of debt issued by government and municipalities (83.8 percent of the overall stock outstanding by the end of 2017). Banks and non-resident investors are the main holders of government bonds, with 39.3 and 32.6 percent of domestic Treasuries in 2017. The non-government bond market has been growing through bank, corporate and covered bonds, however the stock remains incipient. Most corporate bonds have been issued by medium and small entities through private placements. The main non- bank domestic investors are open pension funds (OFE), insurance companies and investment 15 The current benchmark size is PLN25bn 16 Foreign investors increased their allocations in sovereign bonds from PLN128bn in 2010 to PLN203bn in 2017. 26 funds.17 Domestic investors manage assets of PLN 681 billion, as of December 2017. While open pension funds are likely to get further downsized, investment funds have been growing. On the other hand, the insurance sector has shown a small growth during this decade. While open pension funds are largely invested into equities (being prohibited to invest into government bonds), the other two classes of investors hold larger exposures to government securities. Each segment of institutional investors has potential to grow (e.g. investment funds, insurance, existing and upcoming pension funds). 88. Despite progress, corporate bond markets remain small. The corporate sector remains largely financed by retained earnings, bank lending, intracompany financing (external) and equity issuance. Corporate financing via bonds remains small compared with other sources of financing, and largely focused in midsize companies. In the presence of a solid base of local and foreign investors, and a good performance of bonds in past years, the lack of development of this market results from a mix of market practices and regulatory issues. Although this growth reflects a government priority, a comprehensive roadmap of reforms is not ready yet, with different challenges in each segment of the fixed income markets to be addressed.18 89. Market trends and structure are raising challenges. First, the market is dominated by floating-rate bonds, which increase the uncertainties about the final cost for issuers. Secondly, the use of certain exemptions for private placements, with no restrictions on resale nor on the number of times or amount that can be raised through this exemption, does not foster a liquid market, but creates risk for investor protection. The domestic market is also mainly used by medium and small issuers, with issuances too small to foster a deep secondary market, without any external rating. Adverse selection is at play, given the reported high default ratios in smaller issuances. A recent sizable and high visibility case of defaulting bonds – arranged through private placement but resold to retail investors by banks and securities firms - has been further eroding investors’ trust into corporate bond markets. 90. The development of corporate bond markets requires several reforms, to improve efficiency, access, and resiliency, and address several issues, including: (i) the low liquidity of non-government bond market; (ii) a limited capacity of investors to assess credit risk; (iii) a weak presence of domestic institutional investors in some fixed income instruments, (iv) the complexity of trading platforms and excess of customization of transactions; (v) the perverse incentives of the FIAT framework; (vi) the lack of participation of some large institutional investors in the government bond market;19 (vii) the limited development of the derivatives market, and (viii) the quality of information and dissemination to investors. Addressing these issues would involve cross-cutting actions through a comprehensive and sequenced action plan that remains to be elaborated. That plan should include actions in different market 17 It also includes occupational pension funds and voluntary pension funds, but they are currently small. 18 EBRD started advisory for the MoF; but the results of a survey are under study before proposals are drafted. 19 OFE is a crucial segment to increase the liquidity and price discovery of government bonds in the secondary market. Removing OFE prohibition would also help OFE optimize their investment for pensioners and reduce the vulnerability to refinancing risks for the Government under possible stressed times. 27 segments, government and non-government bond markets, repo market, derivatives and investor base. 91. There is scope to improve transparency on government bond markets. While markets offer reasonable liquidity, some features affect price formation. First, the MoF announces five instruments together with a single total amount to be distributed; while this strategy works in normal periods, it may affect transparency and predictability of price formation in periods of volatility. Secondly, 95 percent of the transactions take place in the OTC market, where intermediaries are only required to report volumes and numbers. Reforms are recommended to (i) check if this auction methodology should be revisited (for MoF to announce volumes for each instrument), and (ii) change the requirements for post-trade transparency so that maximum, minimum, average prices are reported. 92. The organized market - only 5 percent of bond transactions - remains fragmented through four platforms of Catalyst, plus one platform dedicated to primary dealers. This situation affects price discovery and liquidity: Catalyst platforms could therefore get merged. 93. Money markets are key to develop capital markets,20 but their current development is limited by two obstacles: • Lack of harmonization of documentation for repo instruments, as two different approaches are used: transactions with local and foreign institutions use the Global Master Repurchase Agreement or GMRA, while Sell Buy Back or SBBs 21 are used between local institutions. The adoption of GMRA in all transactions with non- residents and of the standardized documentation prepared by the Polish Banking Association in all contracts between residents (with similarities to international documentation) would improve legal certainty in fixed income markets and reduce the fragmentation of the instruments. The well-functioning of this market could also increase the investments in medium- and long-term government and non-government assets. • Distortion due to the Financial Institution Asset Tax, which has created temporary falls in money market instruments turnover, affecting the financing of the overall bond market. The estimated cost of this tax as expressed on an annual base is as high as 13.7 percent for O/N deposit, going down to the high level of 1.9 percent for 1-week. More 20 Well-functioning money markets: (i) enhance the effectiveness of liquidity management tools by central banks and market participants; (ii) expand the capacity of market players to finance and hold portfolios of longer-term securities; and (iii) provide price references for the short-term of the yield curve and to create products such as floating-rate bonds. 21 SBB has two different modalities, documented and undocumented. Documented sell-buy-backs are based on standard documentation and are legally more robust than undocumented sell-buy-backs. Both ways are used in Poland. 28 broadly, this tax is also hampering the attractiveness and development of corporate bond markets for investors, as only sovereign bonds are currently waived. 94. The absence of a prime corporate bond market reinforces the need for improving credit risk management practices among institutional investors. In Poland, issuers have rather been smaller companies, as larger corporates either access directly the Euro market or get financing through banks. As corporate bond market might be riskier than other markets, strengthening investor protection and improving default resolution are critical. Reliable credit ratings would build the base for accurate price differentiation. In addition, regulation should encourage investors to adopt high standards of credit risk management. 95. The structure of private placements has been affecting the development of bond markets. Private placements were not supervised, have low requirements, and help issuers speed up the placement. But restrictions to the rule of 149 qualified investors have been circumvented and unqualified retail investors got exposed, as such bonds could be immediately resold to unlimited retail investors through secondary markets. A recent and mediatized case of a resulting defaulting bond has fueled distrust among investors. Some clarifications would have been recently made or considered – since the FSAP mission – regarding the use of private placements (for example to limit cases of multiple issuances by the same issuer within a short period of time) but it is recommended to further strengthen the framework (by a notification requirement for investment firms, by introducing a lock-in period for private offers). 96. Authorities could develop a future contract of interest to anchor the development of fixed rate bond markets. A developed derivatives market improves bond market liquidity and investors’ capacity to manage risks. But the WIBOR three-month future contract has no sufficient liquidity, and derivatives market is now based on interest rate swaps (IRS) through bilateral agreements between banks and non-banks (less efficient in the use of collaterals and to limit counterpart risks). The future contract of interest rate could become a hedging tool against interest rate risks, provided that authorities: (i) safeguard future liquidity of the underlying rate; (ii) increase the availability of liquid instruments maturing at dates coinciding with futures contracts; and (iii) broaden the range of authorized investors (OFEs). 97. Banks have been net issuers (rather than investors) of debt instruments, and this may continue. Banks purchase government bonds (waived from the FIAT). As issuers, they plan to issue more covered bonds - from PLN 10 to 50 billion - to refinance their mortgage portfolio. Banks must also fulfill the requirements of the Minimum Requirements for Eligible Liabilities (MREL), which will imply bank (subordinated) debt issuance for amounts in a range of PLN 60 billion to 80 billion until 2023. Some non-financial large corporates also express a keener interest to issue bonds, in order to diversify their overall funding base. 98. The growth of corporate bond markets depends on the further capacity to mobilize foreign investors, in addition to expand domestic investment and pension funds. This is a not a new situation, as foreign investors already hold 32.6 percent and 39.6 percent 29 of two largest assets classes of Polish capital markets (public debt and equity), but this is exacerbating the need to improve the framework for a healthy development of bond markets. 99. The Polish Development Fund (PFR) should play a catalytic role in engaging domestic institutional investors in the financing of infrastructure. As EU grants start to phase out, domestic capacity should be built among institutional investors to finance infrastructure. A working group to prepare project bonds with adequate risk sharing among stakeholders would help, also to familiarize investors. The WSE has proposed project bonds to finance projects to connect rivers and channels, with a concession granted to a private company that would issue project bonds supported by users’ fees and annual contingent government support, the bonds would be treated by NBP as eligible collateral. But that proposal would unduly expose NBP which has no comparative advantage in assessing project risks, banks would be artificially positioned as long-term investors. The analysis of risk absorption capacity should assign risks to parties that can best manage them. 100. Measures should pursue the promising development of covered bonds. This instrument is recognized by investors as a high-quality asset class of non-sovereign bonds. Three mortgage banks licensed as subsidiaries issued about 4.2 percent of the stock of PLN mortgage loans. Covered bonds could in the long run finance up to 20 percent of the stock. However, the asset tax is crippling this development, given the PLN4bn deduction threshold, the limited margins of lenders, and disincentives for banks and insurance companies to hold such assets. A preferred scenario is the reform of FIAT. A second-best approach would waive covered bonds from the asset base of mortgage banks and waive covered bonds for investors. 101. Competition should be fostered in the investment fund industry (PLN 318 Billion Assets under Management, including PLN 151 billion managed by open funds). The administration fees charged for investments in bond, mixed and equity funds are 1.5, 2.5 and 3.5 percent, respectively. Such levels are higher than in the EU. One factor is the lack of effective competition due to the distributing role of banks. Better disclosure of costs and actual performance matter but may not result in major changes. The effects of solutions such as a cap on fees are difficult to ascertain. The creation of an index based on sovereign bonds to be used as benchmark and an exchange traded fund (ETF) to compete with investment funds would rather be recommended tracks to further explore.22 22 Investors benefit when several investment funds and ETFs track the same index (more competition, reduced fees). 30 APPENDIX I – TABLES AND FIGURES Table 1. Poland: Selected Economic Indicators, 2015–22 31 Table 2. Poland: Financial Soundness Indicators (Commercial Banks) In percent 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2016Q4 2017Q1 2017Q2 2017Q3 2017Q4 Asset Quality NPLs to total loans 6.8 6.6 6.6 6.2 6.4 6.3 6.3 6.0 6.0 6.0 6.0 5.9 Loan loss reserve to NPLs (Coverage) 55.3 55.7 56.2 56.8 57.2 57.7 57.8 56.2 56.8 57.0 57.0 57.7 LLR to total loans 3.7 3.7 3.7 3.5 3.7 3.6 3.6 3.4 3.4 3.4 3.4 3.4 Prov for loan loss to total loans 0.7 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 1.9 1.4 Annualized loan growth 10.3 11.7 11.4 9.2 4.2 3.0 3.0 2.6 5.5 3.2 5.0 3.0 Texas ratio 0.4 0.4 0.4 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.3 Profitability Net Interest Margin 2.5 2.4 2.4 2.5 2.6 2.5 2.6 2.5 2.7 2.7 2.8 2.7 Efficiency (cost/income) 38.6 40.3 41.0 44.8 45.9 42.9 44.2 44.6 50.2 47.4 46.1 46.0 ROAA 1.2 1.1 1.1 0.9 0.9 1.1 1.0 0.9 0.7 0.8 0.9 0.8 ROAE 18.5 16.8 15.8 13.2 12.4 15.7 14.0 13.0 9.3 11.4 11.7 11.3 Trading gains to income 6.1 5.7 5.6 5.8 5.7 5.4 5.7 5.7 4.9 4.6 4.6 4.6 Liquidity and Funding Loan-to-deposit (LTD) 110.4 112.1 109.1 107.0 105.0 105.2 105.1 102.9 104.6 105.1 106.0 102.4 Liquid assets / total assets 20.6 21.3 21.2 21.7 22.6 22.1 21.9 22.6 21.3 21.1 20.9 22.2 Liquid assets / short term liabilities 22.8 23.7 23.6 24.1 25.3 24.8 24.6 25.3 23.9 23.7 23.6 25.0 Wholesale funding 23.7 23.9 22.7 20.5 20.2 19.4 19.1 18.6 18.8 18.3 18.4 17.6 Capital Adequacy Capital adequacy ratio (CAR) 14.8 15.2 15.5 15.9 16.6 17.0 17.2 17.1 17.4 18.0 18.0 18.1 Tier 1 capital ratio (Tier 1 capital to RWA) 13.5 13.9 14.2 14.6 15.1 15.3 15.6 15.5 15.8 16.5 16.5 16.2 Financial Leverage (times) 10.0 9.8 9.8 9.7 9.4 9.3 9.2 9.4 9.2 8.9 8.9 8.8 Foreign currency (FX) FX loans to total loans 31.2 31.3 30.4 30.2 29.4 29.5 28.4 28.7 26.9 25.8 25.0 23.5 FX deposits to total deposits. 10.7 10.8 10.7 10.7 11.1 11.3 11.9 11.8 12.6 13.0 12.7 13.4 Source: NBP Table 3. Poland: Financial Soundness Indicators (Cooperative Banks) Dec-15 Dec-16 Jun-17 Sep-17 Dec-17 Asset Quality NPLs to Loans 6.7 7.7 7.8 8.0 8.3 Prov to NPLs 30.1 31.3 31.5 32.3 42.3 Loan Growth 7.8 4.0 6.2 6.3 3.9 Asset Growth 49.1 11.9 4.5 4.9 7.8 Profitability Return on Avg Assets 0.4 0.5 0.7 0.7 0.6 Liquidity Loan to Deposits 68.8 63.7 65.0 65.2 60.8 Capital Capital to Asset Ratio 9.0 8.4 8.7 8.6 8.3 Source: NBP 32 Figure 1. Poland: Macrofinancial Developments 33 Figure 2. Poland: Structure of the Financial System, September 2017 Figure 3. Poland: Capital Tier 1 Capital and RWA In Percent 1,000 20 Tier 1 in percent of RWA 800 15 PLN Billions 600 10 400 200 5 0 0 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 2016Q3 2017Q1 2017Q3 Tier 1 capital Total RWAs Tier 1 capital ratio (Tier 1 capital to RWA) Source NBP 34 Figure 4. Poland: Bank Liquidity The loan to deposit ratio has declined in recent years… …while the liquidity ratios have been quite stable. Loan-to-deposit ratio Liquidity ratios In Percent In Percent 120 30 25 115 20 110 15 105 10 5 100 0 95 Liquid assets / total assets Liquid assets / short term liabilities Loan-to-deposit (LTD) Source NBP Source NBP Figure 5. Poland: Asset Quality The system shows continuous but slowing And the share of FX mortgages is declining growth Portfolio Composition by Product Portfolio Composition by currency In Percent In Percent 1200 100% 1000 80% 800 PLN billions 60% 600 400 40% 200 20% 0 0% 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 2016Q3 2017Q1 2017Q3 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2015Q3 2016Q1 2016Q3 2017Q1 2017Q3 2008Q1 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 Corporate loans PLN Mortgage loans PLN Other consumer loans PLN Corporate loans Mortgage loans Corporate loans FX Mortgage loans FX Other consumer loans FX Other consumer loans Total loans Source: NBP NPLs continue to moderate and reserve as NPLs are highest in consumer loans, lowest coverage has adjusted. in mortgages NPL ratio and Coverage Non-Performing Loans In Percent of Total Loans Percent of Total Loans 8 20 In percent of Total Loans 7 15 6 10 5 4 5 3 0 2 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 2016Q3 2017Q1 2017Q3 1 0 Corporate loans PLN Mortgage loans PLN Other consumer loans PLN NPLs to total loans LLR to total loans Corporate loans FX Mortgage loans FX Other consumer loans FX Source NBP 35 Figure 6. Poland: Profitability While NIMs, though still sound, show Asset growth has slowed moderation Annualized loan growth Net Interest Margin In Percent In Percent 25 3.5 3.0 20 2.5 15 2.0 10 1.5 1.0 5 0.5 0 0.0 Annualized loan growth Source NBP Net Interest Margin Source NBP And costs have risen, in part due to the bank Affecting profitability asset tax Efficiency ROAA and ROAE In Percent 60 In Percent 30 In percent of Total Loans 50 25 40 20 30 15 20 10 10 5 0 0 ROAA ROAE Source NBP Efficiency (cost/income) Source NBP Though little affected by the crises, the return …with relatively high branch density on assets has declined in recent years 36 Figure 7. Poland: Balance Sheet of Commercial Banks (2017) Balance Sheet Composition Loan Composition by Sector 4% 2% 3% 3% 6% Corporate Loans portfolio, net 3% Mortgage 28% 21% Debt securities, Consumer total 21% Central Bank Non interest- earning assets Government 74% Other assets, 37% Credit including insititutions derivatives Other financial Loan Composition by Currency RWAs by Risk Factors 1% 1% 8% Credit risk 22% Market risk Domestic Foreign Operational risk 78% 89% Others Debt Securities by HFT, AFS and Debt Securities by Exposure HTM 2% Sovereign Debt 9% 2% 4% 11% 5% Non-financial Debt HFT Central Bank AFS Bills HTM Other General 87% Government 80% Financial Institutions • Source: IMF Staff Calculations. • Note: Other loans include loans to the central bank, the government and financial institutions. 37 Table 4. Poland: Status of FSAP 2013 Recommendations Recommendations Status - Addressing impaired loans: (i) intensify Actions included an asset quality review oversight of credit risk management and performed in 2014 and sustained onsite restructuring practices; (ii) standardize and supervisory efforts focusing on credit risk enhance transparency of bank accounting management. These actions along with a practices; and (iii) standardize debt-to- strengthening economy have resulted in income ratio calculation (paras. 17-20). improved asset quality since the last FSAP. - Strengthening banking supervision: There is little redress of recommendations. (i) expand the scope for PFSA to issue The constitution excludes the PFSA from legally binding prudential regulations; (ii) formal rule-making, as this power is allow PFSA’s Board to delegate limited to the MoF and NBP as two key administrative and procedural decisions to agencies for the financial sector. Other its management, increase PFSA recommendations to address issues of independence, and address other PFSA independence, and budgetary and governance issues; and (iii) increase PFSA staff resources remain unaddressed. flexibility to allocate budgetary and staff resources and enhance its analytical capabilities (paras. 27–34). - Strengthening credit unions: (i) eliminate The PFSA, which already had the dual supervision; require a solvency responsibility for banks and cooperatives, ratio of 8 percent in 5 years; and clarify the was appointed as the sole supervisor of governance of the stabilization fund; (ii) credit unions. While it has flexibility to develop an inclusive set of SKOK allocate budgetary and staff resources for regulations and apply accounting the agency, the envelope of available principles for financial institutions to resources is insufficient. The frequency of SKOKs; and (iii) develop capital inspections for small banks, coops and rehabilitation plans for financially weak credit unions has declined since the last SKOKs (paras. 36–37). FSAP. - Developing sound macroprudential In 2015, a law was passed that expanded policies: (i) ensure the macroprudential and formalized the mandate of the supervisory law provides for SRB’s Financial Stability Committee (FSC) to independence (with a leading role for the include macroprudential supervision and NBP), accountability to Parliament, and crisis management. The FSC’s power to make recommendations coupled macroprudential supervision and crisis with an “act or explain” mechanism; and preparedness/ management mandates are (ii) develop clear macroprudential policy undertaken respectively by FSC- objectives that are distinct from those of Macroprudential, meetings of which are 38 monetary and microprudential supervisory chaired by the NBP Governor and policy (paras. 38–41). supported by a secretariat based at the NBP, and by FSC-K (crisis management), meetings of which are chaired by the Minister and supported by a secretariat based at MOF. - Improving the bank resolution The key FSAP recommendations are framework: (i) ensure precedence of addressed particularly with the administrative powers over corporate implementation of the BRRD. insolvency procedures; (ii) ensure that the creditor claims hierarchy protects BGF’s claims on resources provided for balance sheet “gap filling” measures; and (iii) include a Tier-1 capital trigger and link the “public interest” trigger to financial stability (paras. 48-49). - Improving the deposit insurance system: As for bank resolution, key (i) remove the PBA from the BGF Council; recommendations are addressed with the (ii) ensure adequate funding and capacity, implementation of the BRRD. Other revise and introduce new regulations, and actions include the reconstitution of the enhance protocols in light of expanded BGF council to remove the PBA mandate; and (iii) amend code of conduct representative. Funding and capacity seem to restrict employment in member appropriate for the BGF, though resource institutions to all employees (paras. 50– constraints at the PFSA can slow decisions 51). on resolution. - Strengthening pension reform and The legal framework for MCB was capital markets: (i) allow lifecycle amended to facilitate the issuance of strategies in pension funds, and measure covered bonds, but no legal framework for performance of pension funds in relation to mortgage securitization was adopted. the benchmark portfolio; (ii) amend MCB framework to allow broader issuance and Investment decisions for the upcoming adopt a legal framework for mortgage private pension fund system (PPK) will be securitization; (iii) strengthen enforcement guided by portfolio benchmarks through of security interests and judicial decisions targeted funds. (para. 53–54). Source: FSAP team 39