Running Head: NPL IN THE ALBANIAN BANKING SYSTEM

NON-PERFORMING LOANS
IN
THE ALBANIAN BANKING SYSTEM
Armela Hasmuca
EPOKA University

NPL IN THE ALBANIAN BANKING SYSTEM 1

ABSTRACT
This journal aim to give a clear picture of causes and potential actions in cognation to levels of
NPL in the Albanian Banking system and to show some possible opportunities the banks could
have in order to decrement the authentic elevate of non-performing loans. In this journal, certain
variables such as economic conditions, interest rate, inflation rate, regime intervention, and GDP
were utilized, in order to expound the relationship that subsist between those factors with NPLs.
It amasses the condensed ken-how of the frontline departments dealing with the NPL in an
endeavor to analyze and apportion these opinions for the utilization of all bankers and other
parties that are intrigued to ken more about the recent sharp increases in NPL.
For the fulfillment of the journal, different Banks documents were investigated for accumulating
data. The conceptions, which are presented in this paper, have resulted from a qualitative
research and through the reading of research literature.

Keywords: NPL, Albanian Banking system, collateral policy, interest rate, loan monitoring,
property inflation, unemployment, strategy, economic courses.

NPL IN THE ALBANIAN BANKING SYSTEM 2

INTRODUCTION
These last 10 years were characterized by a boom in lending activity fueled by a growing
economy and paramount increase in the caliber of banking intermediation.
But, the issue of non-performing loans (NPLs) has gained incrementing attentions in the last few
decades.
In recent years banks were faced with an extraordinariness increase in the Non Performing Loans
(NPL) by the contribution of the economic crisis but withal accentuated by other internal and
external factors. The efficacious factors in incrementing of NPLs are divided into two sections:
1- Internal factors: these factors are caused by internal functions and activities of bank, and are
due to decisions and practices of officials and staffs functions. These factors are controllable and
manager can obviates them by utilizing congruous method, resoluteness of impuissance and
elimination them and amendment of process.
2- External factors: these factors can be controlled by bank scarcely and are caused by external
environment and its effect on implementation of decisions and additionally regime policies.
Unexpected events, transmuting in rules and obligations, political and economic changes
(inflation and slump) are external factors.
My study is focused in identification of efficacious factors in engendering NPLs and most
paramount of it is, finding ways to avert NPLs, suggestions provided to instauration NPLs.
We are cognizant that the immediate effect of large amount of NPLs in the banking sector means
bank failure. A nonperforming loan in the financial sector is viewed as an facade mirror image of
an poorly unprofitable enterprise. From this perspective, we could say that the purge of nonperforming loans is an mandatory condition to amend the economic position. If the
nonperforming loans are kept subsisting and continually rolled over, the resources are caged in

NPL IN THE ALBANIAN BANKING SYSTEM 3

unprofitable sectors; thus, obstructing the economic magnification and impairing the economic
effectiveness.
Thought this journal I want to raise paramount questions about the quality of credit portfolios in
the Banking system, its root causes and remedial actions. Transcending mere analysis of data and
builds on the experience and knowhow developed by the banks in these recent years of dealing
with the NPL quandary.
We will optically discern that the caliber of cognizance of the banks in cognation to the causes
has incremented significantly with the last years. It is pellucid that banks are taking or are
disposed to take consequential transmutations in the way the lending activity is conducted in
order to adjust for material external events such as the crisis but withal for other quandaries
present in the environment such as: lack of reliable financial information, clients poor business
orchestrating and execution, inefficient collateral amassment processes etc.
I hope that the study of this journal will provide insight into the recent phenomenon of
incrementation in NPLs in the Albanian Banking system as well as share conceptions on taking
preventive or corrective action in regard.
This dissertation was conducted with the support of the Credit Risk Department of BKT Bank
that facilitated the distribution and gathering of questionnaires.
Certain statistical data mentioned in continuing are obtained from the reports and bulletins of
Bank of Albania, Albania Association of Banks and Sweedbank.

NPL IN THE ALBANIAN BANKING SYSTEM 4

Current Size and Concentration Of The NPL In The Albanian Banking System
1. What does Non-performing Loan mean?
A simple definition of non-performing is: A loan that is not earning income and: (1) full
payment of principal and interest is no longer anticipated, (2) principal or interest is 90 days or
more delinquent, or (3) the maturity date has passed and payment in full has not been made.
NPLs according to Basel: Any loan that is past due for more than 90 days, but subject to
national variation.
NPLs according to Central Bank of Albania: Any loan classified in the last three
1.2 According to BIS1, the standard loan classifications are defined as follows:
2. Passed: Solvent loans;
3. Special Mention: Loans to enterprises which may pose some accumulation difficulties,
for instance, because of perpetuating business losses;
4. Substandard: Loans whose interest or principal payments are longer than three months
in arrears and lending conditions are facilitated. The banks make 10% provision for the
unsecured portion of the loans relegated as substandard;
5. Doubtful: Full liquidation of outstanding debts appears dubious and the accounts suggest
that there will be a loss, the exact amount of which cannot be tenacious as yet. Banks
make 50% provision for doubtful loans;
6. Virtual Loss and Loss (Unrecoverable): Outstanding debts are regarded as not
collectable, customarily loans to firms which applied for licit resolution and aegis under
bankruptcy laws. Banks make 100% provision for loss loans

1The details of the loan classifications are collected from various BIS documents.

NPL IN THE ALBANIAN BANKING SYSTEM 5

2. The Albanian Banking Sector In 2012
In last recent years, banks have been working in a difficult atmosphere, characterized by high
uncertainties, sluggish domestic demand and changing domestic and internationally regulatory
agenda. The economic situation in European countries continued to be weak during 2012, while
the policymakers and the regulatory bodies at an international level enforced continuous
regulatory changes and measures on the banking industry aiming at preserving the financial
stability. Albeit the Albanian banking system has had a very low exposure toward problematic
regime securities, the European originated banks were influenced by the imposed rules of their
parent banks and conservative approach toward lending, which conditioned the banking activity
of their subsidiaries not only in the Albania, but withal in the region. The quality of the
subsisting loan portfolio further deteriorated, while the households inclination towards
preserving enabled a good performance of deposits. Overall, banks were remuneratively
lucrative, with vigorous liquidity and well capitalized during 2012. The structure of the banking
sector in Albania remained unchanged in 2012, with 16 banks thoroughly privately owned, while
the remaining peregrine bank branches were converted into subsidiaries.
In 2012, the Albanian banking system grew by6 per cent and its total assets reached 88 per cent
of GDP.Its loan book grew by 2 per cent only, while the non-performing loans reached 22.7 %.
We can verbalize that Albania now has one of the worst NPL ratios in Europe. This translates
into impotent earnings, and the return on equity of the system in 2012 was merely 3.8 per cent2.

2Based on:

Bank Of Albania.(2013). Statistical Report 2013.Tirane: Bank of Albania, pp 50.

NPL IN THE ALBANIAN BANKING SYSTEM 6

Two major issues cognate with the lamentable loans are collateral execution and impairment
methodology. I am jubilant to report progress as of the inditement regarding the former:
Amendments and Integrations to the Civil Procedures Code have been approved by the
Parliament and will be in force from September 2013. They will make the execution of collateral
more efficient. A third issue with regards to deplorable loans is the indite-off procedures as
practiced by the fiscal ascendancy.
3. The expanding credit activity and the recent deterioration in quality
The lending activity optically discerned its consequential increase in Albania in the last 10 years
going from 7.3% of the GDP to about 40%. This represents a nominal magnification of over 10
times. Such magnification was facilitated by the incrementation in credit demand in years of
GDP magnification and the constant increase in the caliber of banking intermediation.

Total loan portfolios and assets (in billions of Lek) from year 2003 to 2012
Loan Portofolios

Assets
1120

743

834

886

991

624
426

374
53

74

2003

2004

497

130
2005

202

2006

293

2007

397

2008

440

2009

1189

483

2010

542

552

2011 3rdQ 2012

re 1: Total loan portfolios and assets (in billions of Lek) from year 2003 to 20123

3Based on:

Deloitte.(2013). Albanian Non performing Loan Report, Seeing beyond the waves.Tirane: Deloitte pp.8.

Figu

NPL IN THE ALBANIAN BANKING SYSTEM 7

Loans and advances to clients represent now about 50% of the total banking assets in Albania
(14% in 2003) and their quality is crucial to the banking system.
The quality of the imprest portfolios in the Albanian Banking System was typically high until
2007. Levels of NPL commenced to visually perceive an incrementation from year 2008. As
such, the caliber of NPL went from 3.3% at the cessation of 2007 to 18.9% at the terminus of
2011 in a virtually steady magnification pattern.

Level of NPL (%) from 2007 to 2012

22.70%
18.90%

13.60%
Level of Non-performing loan (%)
from year 2003 to 2012
10.30%
6.50%
3.30%

2007

2008

2009

2010

2011

3Q 2012

Figure 2: Level of NPL (%) from 2007 to 20124

At the terminus of the third quarter of year 2012, the Bank of Albania published in its statistical
report a caliber of NPL of 22.7%.

4Based on:Bank Of Albania.(2013). Statistical Report 2013.Tirane: Bank of Albania, pp 20-25.

NPL IN THE ALBANIAN BANKING SYSTEM 8

Loan loss reserves have incremented sharply in recent years additionally, going to 13.1% of total
loan portfolios as at the cessation of the third quarter of 2012 to 8.07% as at the cessation of
2007.
4. An overview of the current banking business situation
More than a moiety of the banks believe that the caliber of NPL in the Albanian Banking System
is higher than what reported. This might denote a prospect that NPL level is not going to
decrement organically in the short term.
The NPL seems to have affected more business loans. As such, about 79% of the banks
reported their NPL portfolio to be concentrated in business and corporate loans rather than in
consumer or individuals loans. It should be mentioned that business loans comprise withal
more than 70% of the total lending activity in Albania.

Concentration of NPL
21%
Consumer Loans

Business Loans

79%

Figure 3: Concentration of NPL

I want to accentuate that more sizable voluminous loans are withal most exposed to performance
quandaries. This is consistent with above finding of concentration of non-performance in
business loans. As a result, banks reported their NPL portfolio to be more present in loans

NPL IN THE ALBANIAN BANKING SYSTEM 9

disbursed at amounts of over Euro 200 thousand.

Distribution of NPL over industries

Construction

100%
80%

Manufacturing

60%
40%
20%

Other

0%
Disrbibutoin of NPL over industries

Figure 4: Distribution of NPL over industries5

5Based on:

Bank Of Albania.(2013). Statistical Report 2013.Tirane: Bank of Albania.

NPL IN THE ALBANIAN BANKING SYSTEM 10

It is withal mentioned that, from the group of business loans disbursed, the industry pinpointed
as the most problematic (93% concurred to it) is the Construction Industry. Definitely the
Construction Industry, as reported by several reports, was affected considerably by the economic
downturn of the last years and is currently experiencing a period with quandaries in sales and
liquidity, thus affecting directly repayment capacity.

Key Causes to the Incrementation in NPL in Albania

1. The main factors and causes that have influence NPL magnification.
The astronomical majority of the banks attributed the incrementation of NPL levels to the
external causes.
Certainly, the credit risk models on which the portfolios were developed did not prognosticate
the stringency and longevity of the economic crisis. As such, about 86% referred concretely to
the effect in the economy of the economic crisis as the main external cause6.

External Causes

Internal vs External causes

7%
External Causes

Internal Causes
93%

6Bank Of Albania. (2013).

Statistical Report 2013.Tirane: Bank of Albania.

NPL IN THE ALBANIAN BANKING SYSTEM 11

Figure 5: Internal vs. External causes

1. Economic Condition
The effect of the economic crisis is the predominant external factor. Other paramount secondary
factors are over borrowing from certain industries (i.e. Construction) and poor financial
orchestrating and reporting from clients. To be more detailed, I want to mention some of
economic factors with a consequential impact in banking industry, which had affected the NPL
magnification in indirect way.
2. Interest Rate
Interest is a fee paid on borrowed assets. It is the price paid for the use of borrowed money, or,
money earned by deposited funds (Sullivan Arthur, 2003)7. The longer it takes to make
arrangement, the higher it will be for the interest rate. In the case of BKT the product which gave
them the highest profit is their financing product. It consists of personal financing, housing
financing, car financing, and a few more financing.

7Cited by:

Arthur, S. (2003). In S. M. (2003), Economics: Principles in action (p. 261). Upper Saddle River, New Jersey:
Pearson Prentice Hall.

NPL IN THE ALBANIAN BANKING SYSTEM 12

At a time when interest rate is at its lowest, demand for financing is high by customers. This
shows negative connection among interest rate and authoritatively mandate for loan, while when
interest rate is high, demand for financing is low. People opt to preserve their funds in higher
interest rates, and only apply for financing when the rate is decrementing. By doing so, the
amount that needed to pay for bank as a result for making a loan is marginally lower, contrast to
when the moment when interest rate is high.
By referring to data of BOA interest rate and BKT financial verbalization, we can visually
perceive the positive relationship between interest rate and NPLs. When the interest rate is low,
net NPLs is withal low. And when interest rate is high, the amount of NPLs will additionally
increase. According to all models, NPLs are very sedulously assiduous, which would suggest
that the replication of credit losses to the macroeconomic cycle could take time to materialize,
albeit it would withal implicatively insinuate that NPL would then cumulate to high calibers. For
instance, Fuentes and Maquieira (2003) found, visually examining Chilean banks, that interest
rates had a more preponderant effect on NPLs than the business cycle. Other macroeconomic
variables, in particular the exchange rate, unemployment, and asset and house prices can withal
be paramount.

NPL IN THE ALBANIAN BANKING SYSTEM 13

As we have visually perceived, BOA recently has decremented the norm of interest rate at 3.5%,
the lowest in history, in order to increment the aggregate demand.BOA expects that this
mitigation of monetary policy will engender room for rapid rectification with a lower cost for
public finances.
3. Unemployment
The labour supply of the population has two components: unemployed persons and employed
persons. The labour authoritative ordinance of enterprises and other engenderment units,
additionally, can be broken down in two components: jobs (filled posts) and job vacancies
(unfilled posts). Due to the existence of multiple jobholding, the number of jobs tends to belarger
than the number of employed persons (Ralf Hussmanns)8. Unemployment occurs when people
are without jobs and they have actively probed for work within the past four weeks
(International Labor Organization, 2007).
I want to mention that during unemployment, debtors are incapable to repay it as a consequence
of losing their jobs. Their incomes are reduced sharply without salary. So, they are not able to
pay their imprest obligations. Now we can accentuate the effect, when unemployment rate is
high, the NPLs raise as well. As a consequence of the recession, increasing unemployment is
pushing levels of NPLs even higher.

4. Inflation Rate
Kevin L. Kliesen and Frank A. Schmid (2004) mentioned the surprised in monetary policy
actions bears on both measures of inflation prospects. Monetary policy actions bear on both
8Based on: Ralf Hussmanns (1991), Surveys of Economically Active Population, Employment,
Unemployment and Underemployment (pp.152).International Labour Office, January 1991

NPL IN THE ALBANIAN BANKING SYSTEM 14

measures of inflation prospects. Monetary policy actions that are viewed as tighter than expected
by the market lead the economic agents to revise down the expected rate of inflation9. Further,
one measure designate that federal reserved communication reduces skepticality about the future
rate of inflation, while surprises in monetary policy actions increase about the path the rate of
inflation is going to take. Schwartzman (1992), he verbalized that, the elevate of Inflation that
mundanely occurs as the economy grows betokens that the price of goods and accommodations
raise. The incrementation in inflation ultimately forces interest rates upwards. It signifies that
inflation rates is only profound the impact on the interest rate and not other factors. In Cooley
and Hansen (1989) studies, shot that the caliber of output perpetually falls as the inflation rate
increases.

9Kevin

L. K. and Frank A. S. (2004), Monetary Policy Actions, and Inflation

ExpectationsFederal Reserve Bank of St. Louis Review, May/June 2004, 86(3), pp. 9-21

NPL IN THE ALBANIAN BANKING SYSTEM 15

Internal vs External causes that have contributed in the increase of NPL

Effect in the economy of the crisis

Over-borrowing from certain industries

86

14
Poor financial planning and reporting from clients

Fiscal Policy in practice

29

36

14
6

Corruption and informal economy

Other causes

Fig
ure 1: Internal vs External causes that have contributed in the increase of NPL10
Among the internal causes, one can be pellucidly distinguished from the rest. Looking back at
the expeditious credit magnification over the last years and the more recent increase in NPL,
banks believe they could have been less truculent with their magnification targets.
10Based

on: Bank Of Albania.(2013). Statistical Report 2013.Tirane: Bank of Albania.

NPL IN THE ALBANIAN BANKING SYSTEM 16

Important internal causes that have contributed in the increase of NPL

Aggressive budgeting related to lending activity

50
Poor evaluation of business potential

36

Poor evaluation of financial

situation at time of approval
19

18

29

Poor loan monitoring

6
21

Poor matching of loan product terms with client needs/possibilities

7
5
2

Client and/or Loan officer fraud

Other causes

Figure 2: Important internal causes that have contributed in the increase of NPL

NPL IN THE ALBANIAN BANKING SYSTEM 17

Given poor financial reporting and orchestrating from clients (additionally identified as an
external cause) banks are often put in a position of making decisions with low quality of data.
This in turn results in poor evaluation of business potential, or of the financial situation at the
time of approbation and other factors that are identified as secondary internal causes by the
banks.

Other causes
Client and/or Loan officer fraud
In pre-approval phase poor evaluation of financial situation
Inappropriate loan product terms with client requirements
Poor loan monitoring
Poor evaluation of business prospective
Aggressive budgeting on the lending process

The recent trends in NPL and external events highlighted the paramount connection between low
quality of reporting and orchestrating in the Albanian businesses and the difficulties this
engenders for banks in making quality credit decisions.

Ways to Deal With The NPL Portfolio And Cognate Difficulties

1. Doing the best to amass
It was noted that about a moiety of the banks were focused in reprogramming of loans and the
other half in accumulating the collateral as primary betokens of accumulating assets from the
distressed loans 11. None of the Albanian banks considered the sale of the NPL portfolio as an
alternative they are fixating on at the moment. This stems primarily from the lack of a developed
internal market for distressed assets.

11Albania Assosiation of Banks. (2012). Annual Report 2012. Annual Report , pp. 20.

NPL IN THE ALBANIAN BANKING SYSTEM 18

2. Key difficulties currently faced in the endeavor to reprogram the imprests in NPL
I optate to mention 3 most paramount key difficulties banks here in Albania are facing in the
endeavor to reprogram the NPL loans.

Clients generally are not able to stick to reprogrammed terms

Clients have poor / unreliable financial reporting
Difficult to project cash flows due to consequential fluctuations

As we ken that these elements are evident in Albanian economy system and it is very arduous to
rehabilitate them and need a long run to be developed by the sector. These three factors in
amalgamation make it very arduous to develop a reliable loan restructuring program on which
the Bank can depend on for its credit risk management purposes. Many companies work with
two balance sheets for purport of tax office and are arduous to have formal data that show the
true income of them. Additionally another issue cognate to the retail portfolio customers is that
many of them have a job but are not registered as workers, so they cant provide a document to
the bank to make it reliable. These issues make the work of credit officers very arduous as they
have to consider higher risks when they project the mazuma flows or repayment ability of the
imprest requested by customer.
3. Key difficulties currently faced in amassment of collateral for the imprests in NPL

Difficulties in executing the collateral due to other claims

Execution process is long and costly
Significant collateral accumulated with the bank takes time to convert to cash
Value has decremented significantly due to market conditions or passage of time

Above I have mentioned the primary difficulties faced in accumulation of collateral. Such
quandaries additionally impact the estimates that need to be made in regard to present value of

NPL IN THE ALBANIAN BANKING SYSTEM 19

collateral that can be accumulated; an amount that is crucial in evaluating credit risk reserves for
these imprests.
4. How to achieve our main goal?
Actions to Avert Future Increase of NPL
From the mere analysis of data I bring the conclusion that the three most consequential actions
that the banks are already taking to avert future increase in NPL are as follows:
1. Tighter loan monitoring process
2. Reduce exposure to certain industries that are riskier.
3. Restructure the Bank management processes
Their future priority remedial action includes actions marked as 1 and 3 above and Be more
conservative in credit scoring models being the other top 3rd action. However, we visually
perceive certain actions that the banks seem to believe need to be given higher priority as well.
They are listed below predicated on their incremented paramountcy level:
1. Request immensely colossal clients to get financial verbal expressions audited from
reputable companies
2. Focus lending on more minute loans
3. Amend fraud obviation and detection mechanisms
A paramount fact to descry is that while 71% of the banks seem to be fixating on reducing
exposure to certain industries right now, only 7% optically discern this as a paramount remedial
action for the future.

NPL IN THE ALBANIAN BANKING SYSTEM 20

CONCLUSION
Regarding all the above mentioned points in the journal, nowadays the bank credibility is highly
effect by the external factors such as market conditions, economic conditions, competition, and
regulatory changes. On the other hand, also internal factors are important; the adequacy of credit
risk management processes is the main determinants of the quality of the NPLs portfolio. Some
of the strategies that banks should consider in order to reduce the non-performing loans in their
portfolio were.
1. Conservative lending processes and techniques: a) customer financial analysis, b). collateral
policy, c). client loan repayment
2. Solid risk management structure
3. Effective collection policies
4. Bank expansion/growth policy should be in line with the bank risk appetite
One of the internal processes that bank must be careful was Credit Quality Improvement
-

Diagnose the current state on risk awareness

Check effectiveness of credit control and related policies

Draft guidelines, training proposal

Also during this study, I realized than none of the Banks had taking in consideration the sale of
NPL portfolio. This stems primarily from the lack of a developed internal market for distressed
assets.
From the mere analysis of data, I bring the conclusion that the three most significant actions that
the banks are already taking to prevent future increase in NPL are as follows:
1. Tightening the monitoring process of the loan
2. Reduce lending to the riskier industries such as Construction industry
3. Restructure the risk management processes of the Bank

NPL IN THE ALBANIAN BANKING SYSTEM 21

Their future priority remedial action includes actions marked as 1 and 3 above and Be more
conservative in credit scoring models being the other top 3rd action. However, we see certain
actions that the banks seem to be given higher priority as well. To conclude the above ideas, in
order to deal with bad loans banks have to request large clients to get financial statements
audited from reputable companies, focus lending on smaller loans and improve fraud prevention
and detection mechanisms.

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NPL IN THE ALBANIAN BANKING SYSTEM 22

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