Bosnia and Herzegovina: Financial Sector Assessment Program-Technical Note-Systemic Liquidity Management, Financial Safety Net, Insolvency Framework, and Macroprudential Policy

EXECUTIVE SUMMARY1 There are constraints on the ability of both banks and the Central Bank of Bosnia and Herzegovina (CBBH) to manage liquidity. The system lacks a central bank liquidity window, and the secondary market for government securities is also small and illiquid. Despite the existing infrastructure, money market and interbank markets are also relatively small, reflecting both high levels of bank liquidity and the fact that foreign banks' internal risk management practices aim to minimize exposures vis-à-vis the domestically-owned banks. Given the currency board arrangement (CBA), the aforementioned limitations call for conservative liquidity management and liquidity buffers for banks. The use of reserve requirements should be better tailored towards prudential purposes. There is scope to amend the system to support systemic liquidity management. First, n times of stress, the CBBH could consider increasing the flexibility of RR holdings and introducing daily or period- minimum holding thresholds. This should be combined with higher penalty rates, accompanied by enhanced supervision, before sanctions are applied. Second, for the RR base, the CBBH should consider residual maturities and set a minimum daily requirement. Lastly, the CBBH should consider the adequacy of existing RR levels, since they were significantly lowered during the financial crises. Liquidity regulations should be streamlined and the adoption of the LCR would strengthen liquidity management. For the purpose of maturity calculations of liquidity ratios, it would important to take into account early deposit withdrawal options. The minimum liquidity ratio should be raised above the RR to ensure that it is binding. Upon adoption of the LCR, care would be needed in treating RRs as high quality liquid assets (HQLA), given their uncertain availability to meet liquidity pressures. Also, there could be a need to calibrate the haircut applied to public securities for the purposes of the LCR, given the shallow market, the assumptions for deposits/borrowed funds run-off rates, and the treatment of liabilities maturing after 30 days with a prepayment clause. Given the high level of euroization, currency-specific LCRs should also be considered. The banking agencies have statutory authority to require corrective actions by banks, but enforcement powers are limited. The agencies have developed guidance on the use of corrective powers, including setting out triggers for corrective actions based on breaches of capital, liquidity, and asset quality requirements. However, their authority to impose financial penalties for noncompliance, or to permanently suspend board members and controlling owners is limited, except under provisional administration. Similarly, the authority for replacing or restricting the powers of controlling owners outside of provisional administration is also limited. The deposit insurance framework is a relatively well developed paybox scheme, but further enhancements of the deposit insurance arrangements would be beneficial.