The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) Project Information Document (PID) Appraisal Stage | Date Prepared/Updated: 11-Nov-2019 | Report No: PIDA27644 Oct 22, 2019 Page 1 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) BASIC INFORMATION OPS_TABLE_BASIC_DATA A. Basic Project Data Country Project ID Project Name Parent Project ID (if any) Romania P171039 Romania: Institutional Strengthening and Financial Safety Net Resilience Project Region Estimated Appraisal Date Estimated Board Date Practice Area (Lead) EUROPE AND CENTRAL ASIA 13-Jan-2020 02-Mar-2020 Finance, Competitiveness and Innovation Financing Instrument Borrower(s) Implementing Agency Investment Project Financing Bank Deposit Guarantee Bank Deposit Guarantee Fund (FGDB) Fund (FGDB) Proposed Development Objective(s) The Project Development Objective is to strengthen the institutional capacity and financing mechanism of the deposit guarantee fund to meet its potential deposit insurance and bank resolution obligations. Components PROJECT FINANCING DATA (US$, Millions) SUMMARY -NewFin1 Total Project Cost 452.00 Total Financing 452.00 of which IBRD/IDA 452.00 Financing Gap 0.00 DETAILS -NewFinEnh1 World Bank Group Financing International Bank for Reconstruction and Development (IBRD) 452.00 Oct 22, 2019 Page 2 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) Environmental and Social Risk Classification Low Decision The review did authorize the team to appraise and negotiate B. Introduction and Context 1. Romania’s growth at 4.7 percent in the first half of 2019, was stronger than anticipated. Economic activity was driven by private consumption, supported by an expansionary fiscal policy and a rebound in investment. Unemployment fell to a historical low of 3.8 percent at end-June 2019. Private consumption remained the main driver of growth, up 6.1 percent yoy, supported by increases in public-sector wages, minimum wages and pensions, which boosted disposable incomes. Investment picked up at, 12.4 percent yoy, owing to better than expected performance in construction, retail trade and services. Exports grew by 2.7 percent yoy reflecting weaker demand in the major export markets and a slowdown in industrial exports, while imports remained sturdy (up 6.4 percent) on the back of strong domestic demand. On the production side, Information and Communications Technologies (ICT) (up 9.9 percent yoy) and construction (up 14.9 percent yoy) were the main drivers of growth. Industry stagnated due to a slowdown in manufacturing and the deceleration in the dynamics of exports. High imports of goods and services continued to affect the current account balance, which stood at -4.7 percent of GDP in 2018 compared to -3.2 percent of GDP in 2017. The budget deficit widened to 3.0 percent GDP in 2018, driven by the increases in recurrent expenditure, while continued growth in consumption. Inflation has been trending outside the interval of the National Bank of Romania (NBR), reaching 3.9 percent in August 2019. 2. Deteriorating external environment and weak efforts to implement structural reforms are expected to moderate economic growth over the medium term. Further slowdown in private consumption and exports of goods and services is expected to affect the economic growth in 2019, estimated at 4.2 percent. Higher interest rates on bank credit are expected to slow credit growth in the country. The accommodating fiscal policies will have a negative effect on the government debt and lead to further deterioration in fiscal deficit. General government gross debt remained at a low level of 36.6 percent of GDP in 2018 but is expected to increase to 38.5 percent of GDP in 2019. Furthermore, the general government deficit risks widening to above 3.0 percent of percent of GDP in 2019; thus, increasing the risk of Romania's re-entering the European Union’s (EU) Excessive Deficit Procedure in the coming years. The expected slowdown in Romania's traditional export markets in the EU, mainly Germany and Italy, could exacerbate the domestic risks and increase vulnerability of the Romanian economy in short-term. C. Sectoral and Institutional Context A. Financial Sector Context 3. The financial sector, which is dominated by banks, has been declining as a percentage of GDP. Financial sector assets as a percent of GDP accounted for 61.8 percent in March 2019 compared to 70.8 percent in March 2018. The size of the financial sector relative to the economy continues to decline due to the faster growth of the GDP. The Banking sector accounts for 74.9 percent of financial sector assets, other financial sector players include non-bank financial institutions with a market share of 6.2 percent, investment funds (6.5 percent), private pension fund (8.2 percent), and insurance (4.2 percent) (Figure 1). 4. The banking sector is the majority foreign-owned and competitive. The sector is dominated by foreign-owned banks, with credit institutions with majority foreign capital accounting for 75 percent market share. As of March 2019, Oct 22, 2019 Page 3 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) there are 341 credit institutions operating in the country, 7 of which are foreign bank branches. There are 2 state-owned banks (CEC Bank, Banca de Export-Import a României – Eximbank) with combined share of assets of 8.4 percent. The number of credit institutions has been gradually declining from 43 in 2008. Banking sector consolidation is expected to continue as there are a number of banks with market share below 1 percent. Large banks (more than 5 percent share in assets) hold 73.5 percent of banking sector assets. The concentration of the banking sector is low, with the Herfindahl- Hirschman Index at 963 vs around 1,074 in the EU. Asset concentration for the top five banks at 62.1 percent, which is lower than the EU median of 63.7 percent.2 Despite a healthy competition in the banking sector, the population in the rural areas and Micro, Small & Medium Enterprises (MSMEs) remain underserved by the financial service providers. Figure 1. Composition of financial sector assets, Q1 Figure 2. Total assets of the banking sector as a share of GDP, (Q3 2019 (%) 2018) 300 250 6.5 4.2 8.2 200 150 6.2 100 50 0 74.9 Romania EU-28 Poland Hungary Croatia Bulgaria Euro area Czech Rep Credit Institutions NBFIs Total assets of branches and subsidiaries with majority foreign capital Insurance Private pensions Investment funds Total assets of banks with majority domestic capita Note: NBFIs are Non-Bank Financial Institutions Source: NBR Financial Stability Report, June 2019 5. Banking intermediation in Romania is lower than in other European countries. Total assets of the banking sector as a share of GDP stood at about 49.7 percent in Q3 2018, which is lower than in the peer countries, such as Poland (90 percent), Hungary (93.5 percent), Bulgaria (99.4 percent), and Croatia (113.5 percent), and significantly lower than the Euro area average of 364 percent of GDP (Figure 2).3 The double-digits growth of the banking sector assets that were recorded in the pre-crisis period came to an end in early 2010. Since then, the growth of banking sector assets has been slow and fragile, mainly affected by the weak credit growth, which accounts for about 63 percent of the total assets of the banking sector in Romania (Figure 3). 6. The shallow banking sector is reflected in both low loan and deposit penetration. The total outstanding loans by credit institutions as a share of GDP stood at 32.6 percent in Q2 2019, the majority of which (25 percent of GDP) to private sector. Loans to the private sector were distributed between loans to households at about 14 percent of GDP and loans to enterprises at 11 percent of GDP, which is also low compared to the levels observed in the peer countries.4 1 Credit institutions include banks, branches of foreign banks, and CreditCoop. 2 NBR Financial Stability Report, June 2019. EU median and Herfindahl-Hirschman Index data are as of 2017. 3 Data from NBR 4 Bulgaria, Croatia, Hungary, and Poland Oct 22, 2019 Page 4 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) Figure 3. Evolution of banking sector assets 600 60 Banking sector assets, bln RON, (LHS) 500 Banking sector assets, % change, (RHS) 50 40 400 30 300 20 200 10 100 0 0 -10 Jun. 2014 May. 2010 Apr. 2013 Nov. 2013 May. 2017 Aug. 2008 Dec. 2010 Dec. 2017 Feb. 2019 Jan. 2008 Mar. 2009 Jan. 2015 Aug. 2015 Feb. 2012 Sep. 2012 Mar. 2016 Oct. 2009 Jul. 2011 Oct. 2016 Jul. 2018 Source: Staff calculation based on NBR data 7. Credit to private sector has been growing steadily in recent years, with corporate lending catching up with solid demand by households. Excessive lending in the pre-crisis years resulted in a significant drop in lending activities from about 68 percent year-on-year growth in January 2008 to the negative growth rate in February 2010 (Figure 4). After a brief recovery from July 2010 – July 2012, credit to private sector fell into a prolonged period of negative and weak growth that lasted until 2017. The private sector credit recovery was driven by the strong demand in household lending, with corporate lending picking up the pace in 2019. Household lending accounts for about 53 percent of credit to private sector. Household lending is mainly housing loans and consumer loans in the domestic currency. Lending in foreign currency has been declining from its peak at about 65 percent of total private sector loans in mid-2012 to about 33 percent in Q2 2019. The majority of foreign currency loans (about 58 percent of total FX-loans) are to the corporate sector. 8. The deposit base continues to grow at a moderate pace. The deposit base grew on average by 4.4 percent in the first half of 2019 and by 3.5 percent in 2018. These growth rates are significantly lower than those before the 2008 global financial crisis and the growth rates recorded in 2016 and 2017, at about 6 percent and 7 percent, respectively (Figure 5). Banking sector deposits as a share of GDP stood at 44 percent, with household deposits accounting for 49 percent of total deposits and corporate deposits at 25 percent in Q2 2019. The foreign currency denominated deposits account for 27 percent of total deposits. Household savings account for about 73 percent of total foreign currency denominated deposits and about 41 percent of total household deposits. Oct 22, 2019 Page 5 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) Figure 4. Private sector credit growth, % Figure 5. Deposit base growth, % 80 500,000 40 Total deposits, mln RON (RHS) 70 Total deposits growth, %, y/y (LHS) 400,000 30 60 50 300,000 20 40 30 200,000 10 20 10 100,000 0 0 -10 0 -10 Jan. 2008 Jan. 2009 Jan. 2010 Jan. 2011 Jan. 2012 Jan. 2013 Jan. 2014 Jan. 2015 Jan. 2016 Jan. 2017 Jan. 2018 Jan. 2019 Jul. 2008 Jul. 2009 Jul. 2010 Jul. 2011 Jul. 2012 Jul. 2013 Jul. 2014 Jul. 2015 Jul. 2016 Jul. 2017 Jul. 2018 Jul. 2019 Jan. 2008 Jan. 2009 Jan. 2010 Jan. 2011 Jan. 2012 Jan. 2013 Jan. 2014 Jan. 2015 Jan. 2016 Jan. 2017 Jan. 2018 Jan. 2019 Jul. 2008 Jul. 2009 Jul. 2010 Jul. 2011 Jul. 2012 Jul. 2013 Jul. 2014 Jul. 2015 Jul. 2016 Jul. 2017 Jul. 2018 Jul. 2019 Figure 6. Capital adequacy ratio, % Figure 7. Liquidity Coverage Ratio (LCR), % 25 300 20 250 200 15 150 10 100 5 50 0 0 Dec. 2007 Jun. 2009 Dec. 2010 Jun. 2012 Dec. 2013 Jun. 2015 Dec. 2016 Jun. 2018 Sep. 2008 Sep. 2011 Sep. 2014 Sep. 2017 Mar. 2010 Mar. 2013 Mar. 2016 Mar. 2019 Sep-2017 Sep-2018 Mar-2019 Total Romanian banking sector Minimum requirement for LCR Note: LCR is calculated for credit institutions that are Romanian legal entities (excluding branches) as the ratio of the liquidity buffer to net cash outflows at aggregate level. The minimum requirement for LCR is recalculated periodically. Source: NBR Financial Stability Reports 9. The banking sector is well capitalized, highly liquid, profitable with generally good asset quality. The Capital Adequacy Ratio (CAR) of the banking sector was 19.6 percent in Q2 2019, which is significantly higher than the minimum requirement of 8 percent set by the NBR (Figure 6). The banking sector’s profitability was hit by the 2008 financial sector crisis and measures that were introduced by the NBR to reduce the level of nonperforming loans. However, profitability has been improving since 2015, with Return On Assets (ROA) at 1.2 percent and Return On Equity (ROE) at 11.3 percent, as of June 2019. The banking sector in Romania is highly liquid with the liquidity coverage ratio (LCR) at 256 percent as of March 2019, above the minimum requirement set at 100 percent in 2019 (Figure 7). Furthermore, the loan-to-deposit ratio (LTD) stood at 74.7 percent in June 2019. LTD ratio has been declining since 2008, driven by the stronger growth of deposits than loans (Figure 8). The level of nonperforming Loans (NPLs) s in the banking sector has been declining from about 21 percent of total loans in 2014 to 4.74 percent in Q2 2019 (Figure 9). 10. The banking sector did experience a period of uncertainty in end 2018 following the adoption of a Government Emergency Ordinance (GEO 114/2018) which introduced, inter alia, a tax on bank assets. The emergency ordinance incorporated several measures that would have significantly impacted the banking sector, including: (i) Oct 22, 2019 Page 6 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) calibrating the tax amount depending on the level of ROBOR market rates, (ii) a higher tax rate compared with international practice, (iii) a tax base consisting of all financial assets of credit institutions. There was no consultation with any of the stakeholders of the Romanian financial sector nor with the European Central Bank. Considering the adverse effects on banking sector stability and stability of the investment climate, NBR worked with key stakeholder to amend the initial version of the Ordinance. Consultations were held under the National Committee for Macroprudential Oversight (NCMO) which helped to amend the ordinance via GEO No.19/2019. This resulted in: (i) a lower annual tax rate of 0.2 percent or 0.4 percent, (ii) a tax base consisting of financial assets adjusted for items such as cash, interbank exposures, balances with the central bank, sovereign exposures or exposures secured by central government guarantees, non-performing loans, (iii) a tax reduction mechanism depending on the increase in lending and the narrowing of interest margins, (iv) tax exemption for banks that record losses or that are subject to restrictions on lending. The sector was comfortable with the new Ordinance, however, the episode highlighted the nature of adverse policy making and at the same time offered comfort given the corrective measures taken afterwards. Figure 8: Loan to Deposit ratio, % Figure 9: NPLs to total loans, % 140 25 120 20 100 80 15 60 10 40 20 5 0 0 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Jun-18 Dec-08 Dec-11 Dec-14 Dec-07 Dec-09 Dec-10 Dec-12 Dec-13 Dec-15 Dec-16 Dec-17 Dec-18 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Jun-19 Source: NBR Source: IMF Financial Stability Indicators dataset, June 2019 data point is as reported by NBR 11. Banking sector resilience has improved while authorities have been implementing measures to further strengthen financial stability in line with the recent Financial Sector Assessment Program (FSAP) . An FSAP Update was conducted in Romania 2017-2018 jointly by the IMF and the World Bank (WB) (see Box 1). The FSAP concluded that the Romanian financial sector strengthened significantly since the previous FSAP in 2010, aided by effective supervisory measures which helped reduce the high level of NPLs, while foreign-owned banks’ dependence on parent funding significantly declined and bank deposits from the domestic private sector have increased, reducing liquidity risks. Banks’ capital buffers strengthened, on the back of a slowdown of credit and low interest rates. The FSAP identified several vulnerabilities in the financial sector and made recommendations aimed at reducing risks, improving banking sector oversight, and enhancing crisis management and bank resolution. In the recent 2019 IMF Article IV staff report, it was noted that authorities had made good progress in improving resilience, with the majority of the FSAP 2018 recommendations have been either fully or partially fulfilled including the introduction of a debt-to-income limit for household loans and currency-differentiated liquidity requirements for banks as well as a multi-agency simulation exercise and improvements within the crisis management framework. Annex 2 shows the status of implementation of the FSAP recommendations on financial stability. Oct 22, 2019 Page 7 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) Box 1: Romania FSAP Update 2017/2018 The FSAP is a comprehensive and in-depth analysis of a country’s financial sector and is undertaken jointly by the IMF and WB in developing economies and emerging markets. The goal of FSAP assessments is twofold: to gauge the stability and soundness of the financial sector and to assess its potential contribution to growth and development. An FSAP was undertaken in Romania in 2010 and an FSAP Update took place in 2017/2018 focusing on both financial stability and financial sector development. The FSAP Update 2018 included a Detailed Assessment Report of Observance of the Basel Core Principles for Effective Banking Supervision and Technical Notes on Crisis Preparedness and Safety Net, Macroprudential Policy Framework and Tools, Balance Sheet Analysis, Calibration of a Debt-Service- to-Income Limit, Systemic Risk Analysis and Stress Testing the Financial Sector, Financial Intermediation, and Insurance. As a result of these assessments, it was concluded that Romania’s financial sector has strengthened significantly over the last few years while substantial progress was made since the previous FSAP in 2010. However, some vulnerabilities are emerging. Banks’ holdings of domestic sovereign securities have grown, exposing them to valuation losses in case of an increase in interest rates or sovereign risk spreads. Banks’ indirect exposures to government guarantees on mortgages further exposed banks to sovereign risk. An increase in interest rates or economic shocks may also negatively impact NPLs on mortgage portfolios, which are growing fast and are at variable rates. While the share of foreign exchange (FX) denominated loans and deposits significantly decreased, it remains relatively high, and a large share of corporate borrowers is unhedged. Finally, lending of nonbank financial lenders may lead to loan defaults and reputational risks. As the financial system is small, shocks could further discourage financial intermediation, which is already among the lowest in the EU. These vulnerabilities could have potential significant on banks’ capital in a time of crisis. The FSAP made recommendations on several policy areas to mitigate these risks. Key recommended measures to enhance strengthen stability included: a) a debt-service-to-income limit on mortgages, as well as the gradual scaling back of the government housing loan guarantee program (Prima Casa), b) currency-differentiated bank liquidity requirements to limit FX liquidity risks, c) strengthened monitoring of non-bank lenders, and d) capital buffers to increase resilience and guard against banks’ exposures to sovereign risk. Recommendations to enhance banking supervision included: a) improvements in the offsite monitoring tools and more risk-based analyses, b) stronger expertise in specialized areas such as IT and cybersecurity, and c) enhancements in the Anti-Money Laundering / Combatting the Financing of Terrorism framework. In order to enhance crisis preparedness, it was recommended to: a) conduct inter-agency simulation exercises to further coordination, b) development of an Emergency Liquidity Assistance (ELA) policy that accepts a more diverse asset pool as collateral, c) access to accounts at NBR as well as liquidity facilities for FGDB, and d) diversification of FGDB’s and d) diversification of FGDB’s investment policy aimed at reducing holdings of domestic sovereign bonds and bank deposits. 12. Romania lags its regional and income level peers in terms of financial inclusion. According to the Global Findex database 2017, 58 percent of adults are banked in Romania, unchanged from 2014 data. In a recent WB study on financial inclusion in Romania (see Box 2), linear regression results for account ownership show that poor, unemployed, and uneducated are less likely to have an account. Gender was not found to be a significant variable. Among the unbanked, some commonly cited barriers included high cost and lack of trust in financial institutions (about a quarter of unbanked adults). The majority of the unbanked cite poverty as a barrier (17 percent report it as the only reason) implying that a product suitable to their needs may not be available. About 5-7 percent of unbanked adults cite “no need� and “family member has an account� as the only reason for not having one. Oct 22, 2019 Page 8 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) Box 2: Financial Inclusion in Romania The Technical Note on Financial Intermediation, prepared in the context of the FSAP, analyzed the factors at play explaining the relatively low level of financial intermediation and financial inclusion in Romania and made specific recommendations to support sustainable financial intermediation and inclusion, including the preparation of a national financial inclusion strategy. Following the FSAP, in 2018-19, the WB undertook a detailed study of financial inclusion gaps in Romania in underserved segments of the economy including: a) a geo-spatial mapping of financial inclusion and access to finance, b) a diagnostic assessment for agriculture, c) an overview of the cooperative financial institutions in supporting financial inclusion especially in rural areas and d) an assessment of the policy environment for digital financial inclusion. The report concluded that there is a significant regional disparity in financial inclusion for individuals with Bucharest outperforming all other counties in terms of access to physical banking network, value of deposits, and access to loans. At the same time, small farmers face significant gaps in access to finance despite significant EU and national budget funds for supporting agriculture, as these funds benefit larger farms. While the cooperative sector, including cooperative banks and mutual help houses (MHHs), partially address financial inclusion gaps in rural areas, they could play a larger role. The cooperative bank sector could benefit from further consolidation while MHHs could offer additional services although this would entail legal changes as well as enhanced oversight and a financial safety net (see paragraph 15). Finally, while the policy environment is generally supportive, there are key elements that must be implemented including the enhancing the legal and regulatory framework, promoting a digital approach for payments, expanding the financial services infrastructure system especially in rural areas, and strengthening financial inclusion and literacy programs. Table 1: Financial Inclusion Upper middle Indicator Name (data for 2017) Bulgaria Croatia Hungary Poland Romania Euro area income Account at a financial institution (% age 15+) 72% 86% 75% 87% 58% 95% 73.1% Account at a financial institution, male (% age 15+) 71% 90% 78% 85% 62% 97% 77.0% Account at a financial institution, female (% ages 15+) 74% 83% 72% 88% 54% 94% 69.3% Account at a financial institution, rural (% age 15+) 66% 88% 69% 87% 54% 96% 73% Account at a financial institution, income, poorest 40% (% ages 15+) 55% 81% 68% 84% 38% 94% 62% Account at a financial institution, income, richest 60% (% ages 15+) 84% 90% 80% 88% 71% 96% 80% Account at a financial institution, older adults (% ages 25+) 75% 93% 77% 91% 59% 98% 75% Account at a financial institution, young adults (% ages 15-24) 43% 47% 60% 63% 51% 79% 66% Source: Global Findex 2017 13. Commercial banks have low branch coverage in rural Romania and the alternative financial service delivery mechanisms that exist do not seem to target unbanked populations. As of September 2018, there were 4,515 bank branches in Romania, equivalent to 27 branches per 100,000 adults. While this network penetration is at par with the EU, the commercial branch network has been declining. In addition, the network is very thin in the rural areas, which account for only 621 branches, equivalent to 8 branches per 100,000 adults. Alternative banking delivery mechanisms are being offered. However, these mechanisms do not target the unbanked population. The majority of banks have started to invest substantially in branchless services, including agents, mobile banking vehicles, and virtual branches. As of October 2018, there were 1,429 bank agents. 14. Cooperative banks play an important role in providing financial services in rural areas. There are 40 cooperative banks in Romania that serve around 600,000 members and over 650,000 deposit clients5 through 790 points of service, 500 of which are located in rural areas. Cooperative banks operate under the special provisions of the Oct 22, 2019 Page 9 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) EU Capital Requirements Directive package6 that allows cooperative banks operating with contractual or institutional protection schemes to complete with minimum capital and liquidity requirements as a group and not as individual entities. As is the norm in the cooperative sector worldwide, cooperative banks are structured in a multi-tier system, under a single federation: CreditCoop.7 Cooperative banks date back to the 19th century and have a well-developed network. They are commercially operating and provide a wide range of financial services. They are regulated and supervised by NBR, like other commercial banks. The cooperative bank sector has engaged in a process of consolidation that will allow for more efficient operation. 15. Mutual Help Houses (MHHs), a form of a credit union, also support financial inclusion. Access to financial services is supported by 3,000 MHHs serving employees (about 1.2 million members out of a total estimated of 4-5 million) and pensioners (about 1.4 million members out of a total estimated 5 million). The largest federation of employee MHHs (UNCARSR) estimates that about 20 percent of its affiliated entities are in rural areas. MHHs are non- deposit taking institutions funded through the members’ social funds, a form of saving which cannot be withdrawn at will. MHHs mainly provide short-term small loans to individuals. MHHs are not supervised by the NBR. In fact, supervision does not seem to be exercised by any external authority although according to the law MoPF is tasked with their control. 16. Trust in financial institutions in Romania has been affected by the crisis and has not been fully restored . According to the Life in Transition Survey conducted in 2016, 48.0 percent of surveyed adults in Romania have some or complete mistrust of the banks and financial system compared to 38.1 percent across the region. Trust in the system was shaken during the financial crisis even though no bank needed a bail out in Romania and depositors did not lose any money. While trust has recovered since then, it still remains below pre-crisis levels. In fact, of all European countries included in the survey, Romania expressed the biggest drop in the trust indicator between 2006 and 2010 and while trust has rebounded since then, it still remains well below the pre-crisis level. 17. Low financial literacy hampers access to and use of financial services. Only 22 percent of adults in Romania are financially literate, 8 percentage points lower than the regional ECA average and lowest among the EU countries (average at 53 percent). Unbanked adults were 15 percentage points less likely to be financially literate than banked adults. Low financial literacy is correlated with low trust in financial institutions as well as high preference for holding cash. B. Institutional Context 18. The financial safety net in Romania is composed of four public institutions: NBR, FGDB, MoPF, and the Financial Supervision Authority (ASF). NBR is the monetary authority and lender of last resort, the resolution authority, as well as the supervisor and regulator of the banking system. It is part of the European system of central banks and implements the corresponding European standards and policies in addition to the statutory domestic goal of maintaining price stability. In 2015, Romania transposed EU Bank Recovery and Resolution Directive (BRRD) (2014/59/EU) into the national Law nr. 312/2015 that designates NBR as the resolution authority for the banking sector. FGDB is the deposit guarantee scheme and is mandated to manage two funds: the deposit insurance fund and the resolution fund, newly created in 2015. Romania has transposed the DGSD by enacting Law nr. 311/2015 5 Members of cooperative banks must reside in the defined area of influence of a cooperative bank; clients can reside outside that area. 6 Directive 2103/36/EU and regulation 575/2013/EU 7 CreditCoop represents its affiliates and provides them a variety of services, such as training, and reports their aggregated information to the NBR. In addition, CreditCoop operates 17 own branches that provide financial services to individuals and firms who are not members or clients of the network’s cooperative entities. More importantly, CreditCoop manages a mutualization fund that ensures that, if a cooperative bank fails, the other entities will indemnify the failed entity’s depositors in full . Oct 22, 2019 Page 10 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) on Deposit Guarantee Schemes and the Bank Deposit Guarantee Fund, which is the current legal framework for FGDB. With the enactment of this Law, FGDB acquired additional functions related to resolution procedures. The MoPF is the main liaison of financial oversight agencies with the government; it is in charge of fiscal policy and, in a scenario of need, is also a source of contingent funding to FGDB. The ASF also takes part in the crisis management framework on issues related to its scope of supervisory work, mainly the insurance and private pension industry, asset managers, and capital markets participants. The ASF is also the resolution authority within its scope of supervision. 19. CreditCoop also plays a financial safety net role in relation to the cooperative banks. The cooperative banks rely on CreditCoop’s guarantee and mandate to provide liquidity and solvency support to its affiliates. Any losses suffered by cooperative banks are mutualized by the whole system, which means that if one cooperative bank fails, CreditCoop (using a “mutualization fund� formed by contributions of all other Coop banks in the system) will indemnify depositors in full, without triggering FGDB’s guarantee. Only in case the mutualization fund is not sufficient and CreditCoop cannot mobilize funds from the other cooperative banks (i.e., the system fails as a whole) will FGDB come into play indemnifying depositors, up to the limit of EUR 100,000 set forth in the law. Country Context C. Proposed Development Objective(s) Development Objective(s) (From PAD) The Project Development Objective is to strengthen the institutional capacity and financing mechanism of the deposit guarantee fund to meet its potential deposit insurance and bank resolution obligations. Key Results D. Project Description Note to Task Teams: The following sections are system generated and can only be edited online in the Portal. Please delete this note when finalizing the document. A. Project Development Objective PDO Statement 20. The PDO is to strengthen the institutional capacity and financing mechanism of the deposit guarantee fund to meet its potential deposit insurance and bank resolution obligations. PDO Level Indicators 21. The Proposed Project will strengthen FGDB’s resilience as it will provide it with a reliable source of funds to be accessed in case of a bank crisis. Given the contingent nature of the instrument, both conditional and unconditional results are expected: Oct 22, 2019 Page 11 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) a) PDO Level Indicators conditional on the occurrence of a trigger event. Upon the occurrence of a trigger event, the following results are expected: i. If Trigger 1 occurs, FGDB commences payout of guaranteed depositors within 7 business days from the occurrence of the event. ii. If Trigger 2 occurs, FGDB transfers the requested contribution from the deposit guarantee fund for the financing of resolution within the specified deadline set by the NBR in its decision. b) PDO Level Indicators, not conditional on the occurrence of a trigger event. The following results are expected in order to enhance institutional arrangements and build the long-term financial sustainability of FGDB during Project implementation: i. In the absence of a trigger event, FGDB maintains a minimum reserve ratio in compliance with the Law nr. 311/2015 and not below the minimum level specified in the DGSD.8 ii. In the absence of a trigger event, in the Funding Capability Test portion of the DGS Stress Testing pursuant to Article 4.10 of the DGSD, performed in accordance with Paragraphs 91-95 of the EBA Guidelines on Stress Tests for Deposit Guarantee Schemes, FGDB maintains an “A (Optimal)� rating of adequacy of ex ante funds to cover its funding needs (i20), and obtains at least a “B (Fair)� score in adequacy of ex post and alternative funding means to cover the funding needs not covered by ex ante funds (i22) and quality assessment of arrangements in place for accessing alternative funding means (i23). Regardless of a trigger event, all stakeholders, FGDB, NBR and MoPF sign and maintain an iii. effective Memorandum of Understanding to ensure adequate and timely information exchange regarding institutions at risk and the potential impacts to FGDB’s payout capacity, to allow FGDB to manage its liquidity and be prepared to comply with the 7 day payout obligation set forth in the legislation. B. Project Components 22. The Project Development Objective will be accomplished by a) offering a contingent financing facility to FGDB during the course of the Project b) enhancing the institutional arrangements in Romania to effectively deal with a banking crisis; and c) building the long-term financial sustainability of FGDB 23. The Project will have a single component, with the WB contingent financing to be used solely upon the occurrence of pre-defined trigger events. Pursuant to the Bank Policy and Bank Directive: Investment Project Financing (formerly OP/BP 10), such expenditure meets the productive use requirements as financing of the obligations of a deposit insurance scheme helps increase confidence in the financial system. This, in turn, is likely to lead to increased deposits in the banking sector, which can be utilized for financing investment lending and other forms of productive economic activity. The WB has financed deposit guarantee funds through IPF instruments in the past and the eligibility under the Bank Policy and Bank Directive: Investment Project Financing has already been established. 8 Article 10(2) of the EU Directive on Deposit Guarantee Schemes establishes that Member States shall ensure that, by July 3, 2024, the available financial means of a deposit guarantee scheme shall at least reach a target level of 0.8 percent of the amount of the covered deposits of its members. Oct 22, 2019 Page 12 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) 24. The first trigger for the partial or full drawdown of loan proceeds is the occurrence of events that require a payout of guaranteed depositors from the deposit insurance fund. The natural trigger event for the drawdown of funds would be a bank failure or several bank failures, for which FGDB foresees the need for additional funding to reimburse guaranteed depositors. As Article 65(1) of the Law stipulates that FGDB has 7 business days to pay compensations to guaranteed depositors, if FGDB foresees the need to access WB loan proceeds before that deadline, prompt access should be granted, and certainly, before FGDB exhausts its own resources. Trigger 1: A decision by the NBR that a bank, for reasons directly linked to its financial situation, is unable to repay deposits and has no immediate prospects of being able to do so, or a court decision on the opening of bankruptcy proceedings, which, according to Article 3.6 of Law nr. 311/2015, requires a payout of covered deposits. 25. A second trigger for the drawdown of funds relates to bank resolution actions that require the financing from the deposit insurance fund. In case of resolution of a bank, FGDB can be requested by NBR as the competent Resolution Authority to participate in financing the resolution with cash contribution with the aim to cover losses, provided that depositors continue to have access to their deposits. In accordance with Article 565.2 of Law nr. 312/2015, such contribution could be as much as 50 percent of the target ratio for FGDB, as set out in Article 13 of Law nr. 311/2015 (0.8 percent of covered deposits). Trigger 2: NBR takes resolution action on a bank(s) under its remit and notifies FGDB that it will need to contribute from the deposit guarantee fund to the financing of resolution for a certain amount and by a certain deadline, following Article 565.2 of Law nr. 312/2015. 26. The occurrence of any of the trigger events would give FGDB the right to request withdrawal(s) of WB loan proceeds, for a pre-specified length of time following the occurrence of the event. FGDB may request one or more withdrawals of WB loan proceeds upon the occurrence of any of the pre-defined trigger events, up to 12 months following the date of the trigger event. 27. Relevant documentation shall be furnished by FGDB to the WB for ex-post verification, by pre-specified deadlines after the occurrence of the trigger event, and after FGDB requests disbursement of WB loan proceeds – if it decides to do so. More details on the type of documentation and deadlines for submission are included in Annexes 1 and 2. C. Project Beneficiaries 28. The direct beneficiary of the Project is FGDB. According to Law nr. 311/2015, FGDB is a legal person of public interest whose main objective it to guarantee deposits. 29. Households and enterprises that have deposits in the banking system will also benefit from the Project. FGDB protects depositors, including natural persons and legal entities, up to a guarantee ceiling of the leu equivalent of EUR 100,000, which is the mandatory guarantee ceiling in all EU Member States. Strengthening the financial capacity of FGDB through contingent financing will ensure that the depositors receive prompt compensation in the event of a bank failure. This is of particular importance to individuals and micro, small and medium sized enterprises with small deposit amounts. As of December 31, 2018, guaranteed depositors included 14.1 million natural persons and 1.0 million legal entities.9 The overwhelming majority (99.8 percent) of natural persons have deposits below the guarantee ceiling, hence granted full coverage of their deposits. Half of depositors are women. 30. Finally, the Romanian banking system and the economy as a whole will benefit from the Project. Solid 9 A natural person or legal entity may have deposits at several banks. Oct 22, 2019 Page 13 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) financial footing for FGDB will have a positive impact on strengthening confidence of depositors and increasing the reliance of the banking sector to possible shocks. This supports the growth of domestic savings that can be mobilized and intermediated for more productive uses, which, in turn, can lead to increased growth and job creation. Banks that operate in Romania will also benefit from the increased ability of FGDB to meet its deposit insurance and resolution obligations, as it reduces the chances of a banking failure from becoming a system-wide issue that would negatively impact the operations of all banks. All banks authorized in Romania, 27 in number as of end 2018, are members of FGDB. . . Legal Operational Policies Triggered? Projects on International Waterways OP 7.50 No Projects in Disputed Areas OP 7.60 No Summary of Assessment of Environmental and Social Risks and Impacts . Romania lags its regional and income level peers in terms of financial inclusion. According to Global Findex database 2017, 58 percent of adults are banked in Romania which has remained unchanged since 2014. However, the poor are 33 percent points less likely to have an account in comparison to the rich, which is significantly higher than the income gap for developing countries. Among the unbanked, about one quarter of adults state: some commonly cited barriers include high cost and lack of trust in financial institutions. Majority of the unbanked cite poverty as a barrier implying that a product suitable to their needs may not be available. About 5 to 7 percent of unbanked adults cite 'no need' and 'family member has an account' as the only reason for not utilizing financial institution. E. Implementation 31. FGDB will serve as the Borrower and implementing agency, while MoPF will serve as a representative of the Government of Romania, which will provide a sovereign guarantee for the WB loan. Implementation arrangements for this Project are expected to be fairly straightforward, as i) there may not be any disbursement of funds if no event is triggered, and ii) in case funds are disbursed, they will not be used for procurement of goods or services. FGDB will designate a small team of relevant staff, led by a Project Coordinator, to ensure the Project is properly implemented. The principal activities of the implementing agency will comprise: (i) gathering required documentation for ex-post verification of trigger events- in case they occur - and use of funds - in case withdrawal(s) are requested - in accordance with protocols agreed with the WB; (ii) reporting on the WB transfers - if any - that result in the financing of the deposit guarantee and resolution obligations of FGDB; and (iii) liaising with and reporting to the Romanian authorities and the WB on Project progress. 32. FGDB will be asked to ensure that throughout the Project implementation period it maintains adequate governance and financial management arrangements to reflect the operations, resources and expenditures of the implementing agency, which are acceptable to the WB. 33. NBR and MoPF will be important stakeholders. Both of these entities, in addition to FGDB, play a critical role Oct 22, 2019 Page 14 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) in the financial safety net and are represented on FGDB management board. The director of FGDB also participates in the General Board meetings of the NCMO as an observer. Therefore, the Project design and implementation will require buy-in from both NBR and MoPF in order to ensure that the Project Development Objective is achieved. . CONTACT POINT World Bank Isfandyar Zaman Khan Lead Financial Sector Specialist Natalie Nicolaou Financial Sector Specialist Borrower/Client/Recipient Bank Deposit Guarantee Fund (FGDB) Petre Tulin General Director petre.tulin@fgdb.ro Implementing Agencies Bank Deposit Guarantee Fund (FGDB) Petre Tulin General Director Petre.Tulin@fgdb.ro FOR MORE INFORMATION CONTACT The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 473-1000 Web: http://www.worldbank.org/projects Oct 22, 2019 Page 15 of 16 The World Bank Romania: Institutional Strengthening and Financial Safety Net Resilience Project (P171039) APPROVAL Isfandyar Zaman Khan Task Team Leader(s): Natalie Nicolaou Approved By Environmental and Social Standards Advisor: Practice Manager/Manager: Country Director: Arup Banerji 15-Nov-2019 Oct 22, 2019 Page 16 of 16