Montenegro is a partner country under the Vienna Initiative NPL framework.
As of June 2016, non-performing loans (“NPLs”) amounted to €0.28 billion, for a NPL ratio of 11.7% and a NPL coverage ratio of 51.7%.
The banking system’s health is gradually improving but NPLs continue to be a substantial drag on lending. The “Podgorica Approach” of 2015, under which banks and companies engage in voluntary restructuring and out-of-court work-outs, has been met with limited success. National authorities have undertaken a number of additional measures to strengthen the supervisory, insolvency and debt enforcement framework, including the adoption of a new personal insolvency law (2015) and changes to its debt restructuring and enforcement framework (2014). These reforms are designed to allow for an expedited procedure for debt collection through public enforcement officers, but deficiencies remain.
Assessment of NPL Burden and Corporate Debt Distress
Central Bank of Montenegro, Macroeconomic Report, Monetary Developments, Q3 2016
The implementation of regulation, cleaning of the balance sheet of banks by selling bad loans to factoring companies, together with the approval of new loans during 2016 through refinancing arrangements, restructuring and other forms of lending resulted in the decline in non-performing loans in banks. Thus, non-performing loans were 254.9 million euros at end-September 2016 or 10.2% of total loans, a decline of 15% relative to end-2015 and of 27.5% year-on-year.
World Bank Group, Montenegro Country Snapshot, April 2017
Lending activity recovered slightly, while NPLs declined to 10.3% in 2016. Credits to households grew substantially by close to 11%, thanks to the low base effect, and after reaching a yearly low in September, corporate lending recovered as well, growing by 1.9% in December 2016. Deposits grew by above 9%.
European Commission, Commission Staff Working Documents – Montenegro, November 2016
The share of non-performing loans (NPLs) dropped to 11.7 % in 2015 from 16.5 % a year earlier, with a provision coverage ratio of 72.6 %. Overall, although the crisis preparedness and management framework of the financial system appear well developed, low bank profitability remains a source of vulnerability for some domestic banks, requiring further development of the macroprudential framework.
Lending to the private sector has not yet recovered to the pre-crisis level. The low credit growth is the result of risk aversion among banks due to the high level of NPLs but also poor investment readiness and financial literacy among SMEs. In the first half of 2016, corporate lending recorded some improvement, growing by 3 % y-o-y (compared to 0.7 % a year before), while household loans grew by 5.4 % y-o-y. The reduction of non-performing loans allowed some reduction of financing costs for domestic companies. In June 2016, the average effective interest rate on new loans was 6.72 %, and 6.35 % for business loans, the latter down from 7.82 % a year before.
Economic Reform Programme (ERP) policy guidance: Develop a comprehensive strategy to further foster the disposal of non-performing loans by banks, including participation by all relevant stakeholders, while establishing a bank lending survey to better gauge underlying credit dynamics.
EBRD, Country Assessment: Montenegro, Transition Report 2016
The banking system’s health is gradually improving, but risks remain. Credit to the real economy turned positive again in 2015 and the overall credit activity of the banking sector appears to be improving gradually. However, profitability of the overall sector remains weak. Only four banks managed to generate a return on equity of above 5 per cent. The NPL ratio declined from 25 per cent in 2011 to 11.7 per cent as of the end of June 2016, but many of the bad assets were shifted to factoring companies that are fully owned by the originating banks, making the extent of effective relief for the banks unclear. Also, the “Podgorica approach”, under which banks and companies were supposed to engage in voluntary restructuring and out-of-court work-outs, has proved to be problematic for the banks, has attracted limited interest so far, and is under revision. In its June 2016 report the IMF noted that solvency stress tests strongly indicated inadequate provisioning on NPLs in four Montenegrin banks.
National reforms and support by the international organisations
Highlights of significant measures implemented recently
Supervisory Regime: In 2013, the Central Bank of Montenegro (CBM) introduced a requirement for banks to prepare a multi-year NPL resolution strategy. While a number of supervisory shortcomings remain, CBM has drafted a law to extend its supervisory remit to factoring, leasing, and credit and guarantee operations. The law should be ready by end-March 2017 and adoption by the Parliament is envisioned for 2017.
Insolvency regime for natural persons: Introduced in August 2015 but is considered to require amendments. In November 2016, the government initiated the procedure of constitutionality of the law before the Constitutional Court.
Law on Voluntary Financial Restructuring in line with the “Podgorica Approach”: Prepared by the Central Bank of Montenegro in cooperation with experts from the World Bank and the Ministry of Finance (MoF). Adopted and its application commenced on 1 May 2015 for an initial 2-year validity period. The Law provides a framework for out-of-court restructuring and is supported by tax and loan-provisioning incentives. However, banks have not shown large interest in using this framework in resolving their NPLs. As a result, CBM is working with banks to introduce some changes and extend the validity period of the law.
International Monetary Fund, Financial Sector Assessment Program, Framework for Nonperforming Loans Workout and Insolvency and Creditor Rights – Technical Note, June 2016
As the bulk of NPLs are backed by real estate collateral, the state of the real estate market is one key impediment for reducing NPLs. A second key impediment is some banks’ inability and unwillingness to absorb losses. The absence of sound estimates for the shortfall in provisions relative to actual losses that would be incurred in more rapid NPL resolution impedes effective policy formulation.
Recently strengthened supervisory requirements should be complemented by reversing the loosening of regulatory standards observed over the last several years. In 2013, the CBM introduced a requirement for banks to prepare a multi-year NPL resolution strategy, including annual operational targets and quarterly reporting against those targets. While enhanced supervision and monitoring are expected to positively impact banks’ NPL management practices, it is essential that the CBM also strengthens regulatory standards and enforcement to ensure accurate and timely reporting of nonperforming exposures, and the establishment of loss provisions that better reflect expected losses.
The CBM should consider establishing a specialized NPL team within the Supervision Department, distinct from bank relationship managers and credit risk management.
In order to analyze, regulate, and monitor the NPL problem in its entirety, it is recommended to bring nonbank credit institutions and asset management vehicles under CBM oversight. In addition to the EUR 397 million NPLs on banks’ books, about EUR 720 million has been sold, predominantly to parent banks and affiliated asset management (so-called “factoring”) companies. Reporting these exposures to the credit registry should be made mandatory to comprehensively monitor NPL dynamics, which will likely require some form of CBM oversight of such institutions.
In recent years, Montenegro has undertaken a number of legal and institutional reforms, seeking to improve the framework for NPL enforcement, but certain gaps remain: variability in the speed and quality of enforcing some legal provisions by the courts, undeveloped business rescue culture, lack of use of reorganization procedure (most bankruptcy cases end up in liquidation), or underused out-of-court reorganization (‘workouts’). Land titling and cadastral information has been improving, but gaps remain, especially in rural areas. Finally, the Secured Transaction Register is not interconnected with other databases that are related to movable property (notably, the Registry of Vehicles).
The recently enacted Law on Voluntary Restructuring of Debts should be complemented by additional legal measures, such as removing restriction to a certain type of creditors only and adding a fast-track procedure to confirm workout plans that were previously approved by a legally defined majority of creditors to prevent holdout creditors from blocking the restructuring process.
Finally, the recent Law on Consumer Bankruptcy, which establishes a radical exemption in favor of a bankrupt debtor’s house, could negatively affect both the collection of existing NPLs and the issuance of retail and SME loans secured with mortgages.
IMF, Montenegro 2015 Article IV Consultation, IMF Country Report No. 16/79, March 2016
The authorities have undertaken a number of measures to strengthen the supervisory and debt enforcement framework. The most recent include changes to the enforcement regime and adoption of a personal insolvency law. The former have been generally well received, although their effectiveness remains to be tested. The new personal insolvency law, however, raises a number of concerns. For example:
• In August 2015, Montenegro introduced an insolvency regime for natural persons that, despite some good features, has critical deficiencies. Positive features include provision for a mandatory forum of pre-insolvency debt mediation and court-supervised debt discharge (i.e., “fresh start”) for debtors after a set repayment period. However, the law suffers from a number of critical deficiencies that undermine its ability to achieve the objectives of an effective personal insolvency regime. Among other concerns, the law is ambiguously drafted, which has caused stakeholders to reach inconstant and often contradictory interpretations.
• Montenegro passed a number of changes to its debt restructuring and enforcement framework in 2014. Most notably, the reforms allow an expedited procedure for debt collection through public enforcement officers. Although the public enforcement officer reform shows promise, some strengthened supervision and oversight may be necessary. Overall, weak institutions and inconsistent application of laws appear to be the main obstacles to effective debt resolution and enforcement in Montenegro.