Title: Macedonia’s Banking Sector: Confronting Corruption, Instability, and Liquidity Challenges

I. Overview and Sustainability Challenges

A. Background and Economic Constraints

• Macedonia’s banking sector has faced numerous challenges since gaining independence from Yugoslavia.
• Instability and weak institutions have stifled investment opportunities and economic growth.
• The following sections discuss the background, vulnerabilities, and recommendations for addressing the challenges facing Macedonia’s banking sector.

B. Vulnerabilities and Instability

1. Weak Governance and Corruption

   • Systemic corruption and politicization of public institutions weaken the legal framework.
   • Reestablishing confidence in the financial sector and addressing root causes are vital for stability.

2. Vulnerabilities in Smaller Banks and Balance Sheets

   • Weak governance in smaller banks, high nonperforming loans (NPLs), and lack of transparency are concerns.
   • Partnerships with reputable strategic investors can mitigate risks and improve sector standing.

3. Macroeconomic Factors and Interest Rates

   • Gradual economic recovery, high real interest rates, large spreads, and limited lending pose challenges.
   • Sustained macroeconomic stability, improved competition, and effective interest rate strategies are necessary.

4. Euroization and Exchange Rate Risks

   • Widespread euroization of assets and liabilities require vigilance to address credit risks from foreign currency exposures.
   • Strengthened reporting requirements and monitoring mechanisms can help mitigate these risks.

C. Main Recommendations for Banking Sector Reforms

1. Bank Ownership and Governance

• Attract reputable strategic investors to strengthen bank ownership and improve governance.
• Enhance regulatory oversight and stricter reporting requirements for significant bank investments.

2. Regulatory Framework and Supervision

• Focus on market risk, internal risk management, interest rate risk, and strengthening roles of financial regulators.
• Promulgate accounting and disclosure standards and reduce ownership of nonfinancial corporates to foster transparency.
• Encourage banks to monitor borrower foreign exchange exposure.

3. Liquidity Management and Payment Systems

• Improve payment systems with the establishment of remote back-up facilities to increase efficiency and promote financial development.
• Expand instruments eligible for collateral and involve courts in the execution of guarantees to improve liquidity management.

4. Judicial and Legal Framework

• Improvements in the judicial system and implementation and enforcement of laws are essential for rule of law and financial transparency.
• Provide financial sector regulators with legal authority to impose sanctions and cooperate with international initiatives to combat money laundering and terrorist financing.

Long-Term Recommendations

Implemeting the following long-term recommendations diligently can address vulnerabilities in the Macedonian banking sector and contribute to a more stable, vibrant, and integrated financial system that supports the country’s economic growth and development:

1. Bank ownership and governance
2. Regulatory framework and supervision
3. Liquidity management and payment systems
4. Judicial and legal framework