Credit Rating of BH and Perspectives for its Improvement Kemal Kozarić, Ph.D. and Željko Šain, Ph.D. Dubrovnik, December 8 and 9, 2011

2 Macroeconomic indicators for BH Gross Domestic Product (GDP)KM bill.KM bill. GDP per capitaKM 6.233KM Real Growth Rate-3.2%0.7% 2.2% (IMF proj.) 2.0% (other proj. and prognoses) Growth Rate of Industrial Production -3.3% 1.6%4.5% (August 2011/2010) Average Annual Inflation0.0%3.1%3.9% (annual in August) Unemployment Rate in BH24.1%27.1%27.1%27.6 % Average Wage at BH levelKM 790KM 798KM 813 (August) External Debt KM 5.2 bill. (21.7% GDP) KM 6.25 bill. (25.4 % GDP) KM 6.19 bill. (June) Current Account Deficit KM 1.48 bill. (6.2% GDP) KM 1.36 bill. (5.5% GDP) KM 971 mill (first half of the year) Coverage of Import by Export44.8%52.1%54.3% (January – August) DFI (estimate) KM 353 millionsKM 340 millionsKM 193 mill. (first half of the year) Foreign Exchange Reserves KM bill. KM bill. KM bill. (August)

Macroeconomic indicators for BH Rating of the macroeconomic situation in BH “Better than might be expected”? “Better than might be expected”? (evaluation by the part of academic and professional circles, EC, IMF, and other international financial institutions) Worrying... ... Catastrophic? Worrying... ... Catastrophic? (evaluation of the part of academic and professional circles, NGO,...  data on the growth of indebtedness, foreign trade deficit, unemployment rate and overall economic activities in the real sector...) 3

Macroeconomic indicators for BH Rating of the macroeconomic situation in BH Sovereign Credit Rating of BH as an indication of the macroeconomic situation? Formal rating of two reputable rating agencies S&P: rating downgraded from B+ to B, on December 1, 2011, rating status “on watch” Moody's: B2, rating changed from stable to negative since May 2011 Negative outlook this year (mainly political reasons) After recent changes the credit ratings of S&P and Moody’s are on the same level 4

Credit Rating Credit Rating is an assessment of general creditworthiness of a certain debtor or a debt instrument – Securities or other financial obligation, based on relevant risk factors Rating of a certain client is an assessment of its creditworthiness, or “regular” servicing of obligations expressed with the appropriate label Assessment/evaluation of Credit Rating: Internally developed quantitative models; Specialized rating agencies (Moody’s, Fitch, Standard & Poor’s…). Financial institutions using both models of rating development 55

Credit Rating Credit Rating provides internationally harmonized and recognized framework for assessment and comparation of credit quality of individual debtor and debt instruments (securities) Credit Rating in any way does not give an oppinion on how some creditor (for example, a bank, a state) or investment is “good” or “bad”, profitable, successful etc., but only and exclusively the probability of return of “borrowed” funds within agreed time For smaller banks and SMEs there is usually no external rating (not profitable) 66

Rating categories/labels Rating categories/labels Moody’sS&P and FitchDefinitionsDescription AaaAAA Investment grade High investment grade Assets of good quality, great diversification and established size, excellent market positioning, profiled management skills and very good capacity to cover the debt Aa1AA+ Good quality and liquidity of assests, promoted at various places in the market, good quality of management and a good capacity to cover the debt. Aa2AA Aa3AA- A1A+ Medium investment grade Satisfactory quality and liquidity of assets, the average market position and management quality, regular credit standards, the average capacity to cover the debt. A2A A3A- Baa1BBB+ Lower investment grade Acceptable quality and liquidity of assets, but with a noticeable degree of risk, a weaker capacity to cover the debt. Baa2BBB Baa3BBB- Ba1BB+ Non-investment grade Below investment grade Acceptable quality and liquidity of assets, although with a significant degree of risk, low business diversification, limited liquidity and limited margins of debt coverage. Ba2BB Ba3BB- B1B+ Speculative grade The loan under review, assets quality is acceptable, but with temporary difficulties in liquidity level, the high financial “leverage”, some weaknesses in management, positioning and market positioning. B2B B3B- CaaCCC High risk As above, but with evident difficulties, and debt management is sometimes tense and hard. Uncertainty regarding the payment of the interest rates, but not of the principal debt. CaCC 77

Country risk The possibility of non-compliance of obligations to the bank as a result of actions of government or events in the debtors country The determinants of country risk: Political risk Economic risk Risk of transfers Risk of default Risk of guarantee Management of country risk: The adoption of formal policies for management of country risk Internal monitoring The mechanism of reporting to the bank management

The elements that determine country risk Political elements: Political stability The attitude toward foreign investors The issue of privatization/nationalization Monetary inflation Balance of payments The behaviour of bureaucracy Operating elements: Economic growth Currency convertibility Legal effect of contracts Professional services and contractual relations Utility services (fax, phone) Labour/productivity costs Local management and partners Financial elements: Currency convertibility Short-term loans Long-term loans/capital risk Inflation Balance of payments Legal effect of contracts The behaviour of bureaucracy Elements of nationalization: The attitude toward foreign investors and profit Nationalization Currency convertibility Bureaucracy

The structure of strategic risk Risk Time Risk

Macroeconomic indicators for BH Expectation and estimates for the future  How to reach sustainable economic development ? 2012 and short term 2012 and short term  debt crisis in the EU and slowdown in economic growth (recession or crisis with a double bottom) and implications for SE Europe, Western Balkans, Bosnia and Herzegovina “Long” term “Long” term  Is there potential for healthy growth of the real sector based on growth of employment, domestic demand and export?  Is it (only) the capital/money that is missing? 11

Macroeconomic indicators for BH Expectation and estimates for the future  How to reach sustainable economic development? REAL SECTOR  FINANCIAL SECTOR (How and why is the global/financial crisis created and how to resolve it?) 12

The structure of the financial sector in BH Banking sector dominates the financial sector in BH  main source and channel for financing the real sector (and people) High percentage of foreign ownership is a potential risk because strategic decisions are made out of reach of monetary authorities of BH Relatively small share of other financial intermediaries Table: The value of the assets of financial intermediaries Value, KM millions Share, % Value, KM millions Share, % Value, KM millions Share, % Value, KM millions Share, % Banks , , , ,3 Investments funds1.7627, ,88713,58883,7 Leasing companies1.3785, , , ,6 Insurance and reinsurance companies8533,58903,59403,89413,9 Microcredit organisations9463, , ,48563,5 Total

Banking sector in BH The financial sector “bank dominated” : The financial sector “bank dominated” : 84% of total assets of the financial sector (at the end of 2010) The dominance of foreign banking groups: The dominance of foreign banking groups: 95% of total assets and 82% of action/equity capital is concentrated in banks with majority foreign ownership The significance of “Vienna Initiative” (external debt of the banking sector – 29.5% of total liabilities) High liquidity High liquidity Good capital adequacy (16.1% in 2010, 15.5% in Q1, 2011) Good capital adequacy (16.1% in 2010, 15.5% in Q1, 2011) Endangered profitability Endangered profitability Loss in 2010 NPL (non-performing loans) – growth 14

Profitability and level of NPLs. 15

Savings – the other side of the coin? Surveys of Visa company: 33.2% of BH citizens saving 61% do not save or have no money to save 73.1% of citizens borrowing money 75% borrowing money from the banks 17.8% from parents 13.2% from friends 16

Loans The loans to private companies increased by KM 354 millions or 5%, the loans to households increased by KM 98 millions or 1.5%, total loans increased by KM 471 millions or 3.4%. 17 In KM millions Amount Share Amount Share Amount Share Amount Share TOTAL LOANS % % % % Out of these: -Private companies % % % % -Public companies2222 %2372 %3092 %3502 % -Government institutions2311 %3432 %4363 %4453 % -Households % % % % -Other sectors2672 %1501 %1451 %1141 %

The debt crisis in the Euro Zone – a risk of new recession and/or the crisis with a double bottom ? Started and culminated in Greece  threat of bankruptcy, leaving the Euro Zone... Continued in Ireland and Portugal (Countries: “PIGS” – the members of the Euro Zone) Endangered Spain, Italy...? Indicator Indicator  share of public debt in GDP, the level of budget deficit, unemployment rate Consequence Consequence  decline in sovereign credit rating, growth of the loans price, inability in public debt servicing, help from the IMF and the EU, the domino effect, the survival of the euro and the Euro Zone..., 18

The debt crisis in the Euro Zone – a risk of new recession and/or the crisis with a double bottom ? 19

Public debt as % in GDP in the countries of the region 20

The debt crisis in the Euro Zone – a risk of new recession and/or the crisis with a double bottom? 21

The debt crisis in the Euro Zone – a risk of new recession and/or the crisis with a double bottom? 22

The debt crisis in the Euro Zone – a risk of new recession and/or the crisis with a double bottom? The escalation of debt crisis (hesitation and mismatching attitude of the EU?) The escalation of debt crisis (hesitation and mismatching attitude of the EU?)  despite agreed and received assistance, the bankruptcy is threatening to Greece (Portugal and Ireland  slightly better condition)  more and more serious situation in Spain and italy (Franch rating “on watch”)  The exposure of european banks  “trigger” of the banking crisis? Quarterly data Quarterly data  generally slowdown of economic growth and export, threatening inflation, “high unemployment ”  Nouriel Rubini Nouriel Rubini  The chances for new recession bigger than 50% ! 23

How to ensure a better credit rating in the future? For better credit rating in the future, we should: Provide political stability; Create a better macroeconomic environment; Raise awareness of responsibility for credit rating (governments, ministries, regulators, the CBBH, the real sector); Assure budget discipline (reduce the budget deficit and adopt budgets for all levels in time, particularly for BH); Remove the administrative barriers for corporate sector and, the most important, remember that the above items are not one- shot measures, but a continuous process. 24

25 Thank you for your attention 25