1 Aristomene Varoudakis Armenia Country Manager The World Bank

OUTLINE:  The financial system in Armenia confronts the global financial crisis  World Bank support: Credit Line Facility for SMEs  Some challenges ahead 2

 The Armenian financial sector entered the crisis from a position of strength ◦ Banks not exposed to subprime assets ◦ Overall good quality of loan books (low NPLs) ◦ Bank borrowing at manageable levels and maturities; mostly from IFIs and parent banks ◦ Banks well capitalized and liquid ◦ Strong supervision and prudential regulation ◦ 2007 – Central Bank of Armenia prohibits FX consumer lending 3

 But access to finance for SMEs has been severely restricted ◦ Growing dollarization because of depositor “flight to safety” ◦ Bank AMD liquidity restricted ◦ Higher credit risk perceived by banks ◦ Lack of exchange rate risk hedging (foreign exchange earnings) for foreign currency borrowing by SMEs ◦ Higher AMD interest rates because of exchange rate risk 4

 In December 2008 Government of Armenia established a $50MM credit line facility directed to SME sector development.  Access to Finance for Small and Medium Enterprises (AFSME) – a WB financed Project in effect since April 2009  Another $50 MM credit line was established using KFW SME support program framework out of Russian $500MM stabilization loan proceeds. 5

 FEBRUARY 24, – The World Bank’s Board of Directors approved US$50 million IBRD loan for the Access to Finance for Small and Medium Enterprises (AFSME) Project for Armenia.  The Credit was made to Armenia on IBRD terms, including 26, 5 years maturity and a 5-year grace period.  The credit line to SMEs helps strengthen access to finance for SME borrowers and improve the resiliency of Armenia’s private and financial sectors in the face of the global financial crisis.  SMEs are defined as private firms with less than AMD 500 million (or about US $1.2 million) annual recorded turnover. Thus, virtually all private small and medium enterprises may be eligible for consideration as borrowers on a commercial basis. 6

 The lending instrument is a Financial Intermediary Loan (FIL), providing funds to the Central Bank of Armenia. The CBA in turn enters into subsidiary loan agreements with eligible banks.  Eight banks initially became eligible to participate from the start of the project. The qualification of banks will be an ongoing process, and other banks may meet criteria to participate in the nearest future. The initial ceiling on sub-loans is set at US$150,000. Qualified banks’ on-lending rates will be at market rates.  German-Armenian Fund serves at PMU.  As a revolving facility with an initial five year maturity, banks may provide loans to additional SMEs before the repayment comes. This will enable local banks to finance a large number of loans through the life of this project, increasing Armenian small and medium enterprises’ access to medium-term finance. 7

 Retroactive financing, up to US $ 10 million equivalent, was provided for sub-loans originated after December 1, 2008 which were made in accord with the criteria and procedures set forth in the Operations Manual. By end-Sept. about US $ 7 mln was disbursed to Treasury.  By making medium-term finance available through local banks, the project helps minimize job losses in SMEs, while encouraging investment and firm growth. Enhancing financial support to SMEs is essential for such firms to invest in technology and capacity, thereby raising productivity and improving competitiveness. 8

 Increasing the level of financial intermediation while maintaining a sound banking system ◦ In the wake of the crisis, confidence in the banking sector remains strong and has to be turned into an opportunity for better financial intermediation ◦ Banking system needs to become more internationalized ◦ Promoting opportunities for mergers and acquisitions 9

 Fortifying Armenian financial sector: ◦ strengthening surveillance and liquidity; ◦ undertaking frequent banking system stress tests; ◦ introducing enhanced reporting requirements; ◦ making available liquidity to banks on a temporary basis through accepting a wider range of collateral 10

 Improving access to finance ◦ Strengthening operation of credit bureaus and information on borrower quality. Law on Credit Bureaus is effective as of May 2009 ◦ Improving corporate financial transparency -- helps investors to properly evaluate corporate prospects and results in a lower cost of capital as investors perceive lower risks ◦ Improving the code on corporate governance to strengthen protection of investor rights ◦ Strengthening project appraisal and risk management capacity of commercial banks ◦ Improving the liquidity of the mortgage market: NMC will provide refinancing to commercial banks for mortgage loans; will contribute to lower interest rates 11

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