Georgia Banking Infrastructure Development II Final Report

Georgia Banking Infrastructure Development II

Final Report

Contract #PCE-I-00-99-00007-00 Task Order #811

Period of Performance: May 2002 – April 2004

Private Sector Officer: Gerald Andersen Cognizant Technical Officer: Revaz Ormotsadze

Submitted by: Chemonics International Inc.

Bankworld Inc. CHEMONICSCHEMONICSCHEMONICSCHEMONICS

National Bank of Georgia Phase II – Final Report

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TABLE OF CONTENTS

GEORGIA BANKING INFRASTRUCTURE DEVELOPMENT II, FINAL REPORT I. Introduction II. Tangible Results A. On-Site Supervision (Inspections) B. Off-Site Supervision (Analytic Systems) C. Problem Bank Resolution (Bank Consolidation) D. Legal and Regulatory Initiatives E. Accounting Procedures Strengthening F. Training Initiatives III. Recommendations for the Future

ATTACHMENTS A. Memorandum of Understanding B. Year 1 - Work Plan Agreement C. Year 1 - Monitoring Report and Schedule of Completion D. Year 2 - Work Plan Agreement E. Year 2 - Monitoring Report and Schedule of Completion


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DETAILED TABLE OF CONTENTS Abbreviations...................................................................................................................... 5 I. Introduction .................................................................................................................... 6 II. Tangible Results............................................................................................................ 7

A. On-Site Supervision (Inspections) ............................................................................ 8 1. Fostering Adequacy of Management Structure and Staffing.................................. 8 2. Assistance in Bank Inspections.............................................................................. 8 3. Upgrade of On-Site Inspection Procedures.......................................................... 10 4. Revise and Update the On-Site Inspection Manual ............................................. 11 5. Completion of Bank Supervision Staff Accreditation Program ........................... 11 6. Development of Anti-Money Laundering Procedures......................................... 12 7. Assist IFIs and Donors on Bank Supervision and Bank Evaluation.................... 13

B. Off-Site Supervision (Analytic Systems)............................................................... 15

1. Fostering Adequacy of Staffing ............................................................................ 15 2. UBPR Seminar and Staff Training ....................................................................... 15 3. Update and Refine CAEL Reporting Format....................................................... 15 4. Refine and Update Off-Site Inspection Manual................................................... 15 5. Develop UBPR Instruction Manual ..................................................................... 15 6. Assist and Instruct Off-Site Division on New Tools & Procedures ..................... 16 7. Develop Licensing Manual ................................................................................... 16 8. Assist in the Review of Applications for New Bank Licenses ............................. 17 9. Assist Licensing Department with IT Database.................................................... 17 10. Assist Methodology Department with IT Major Loan Database........................ 17

C. Problem Bank Resolution (Bank Consolidation) .................................................... 17

1. Review Prompt Corrective Action Regulation ..................................................... 17 2. Identify Institutions Not in Compliance with Capital Regulations or have a composite CAMEL rating of 4 or 5 .......................................................................... 18 3. Enforcement Action and Intervention on Problem Banks .................................... 18 4. Develop and Implement Early Intervention/PCA Program.................................. 20 5. Assist in Development of an Early Warning Program.......................................... 20 6. Develop and Implement Temporary Administrator Operations Manual............. 20 7. Develop Regulatory Review Committee .............................................................. 20 8. Perform Stress Tests Quarterly for Large and Problem Banks............................ 21 9. Develop Liquidation Operations Manual............................................................. 21

D. Legal and Regulatory Reform (Strengthening) Initiatives...................................... 21

1. Amendments to Laws ........................................................................................... 21 2. Issuance of Previously Delivered Regulations .................................................... 23

a. Regulation on Credit Concentration.................................................................. 23 b. Regulation on Fixed Asset Limitations ............................................................ 23 c. Regulation on International Accounting Principals (IFRS and ISA)............... 23


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d. Regulation on Foreign Exchange Management and Limitations..................... 24 e. Regulation on Capital Requirements ............................................................... 24 f. Regulation on Fit and Proper Criteria for Bank Management.......................... 24

3. Design, Discussion, Drafting and Delivery of New Regulations ........................ 24 a. Regulation on Fiduciary Duties of Bank Supervisory Councils ...................... 24 b. Regulation on Prompt Corrective Actions....................................................... 25 c. Regulation on Companies and Other Persons Who Control Banks................. 25 d. Regulation on Liquidity Management ............................................................. 25 e. Regulation on Sanctions and Penalties ............................................................ 25 f. Regulation on Securities Activities of Bank Subsidiaries ................................. 25 g. Regulation on Mergers..................................................................................... 26 h. Regulation on Licensing and Branching.......................................................... 26 i. Regulation on Indirect Ownership.................................................................... 26

E. Accounting Procedures Strengthening .................................................................... 26

1. Assist AMD Staff to Develop and Implement Monitoring Program.................... 26 2. Finalize List of Revisions to Chart of Accounts................................................... 27 3. Assist Accounting Methodology Dept. on Quarterly Large Bank Reviews......... 27 4. Finalize Accounting Regulations and Position Papers ......................................... 29 5. Provide Assistance in On-site Inspections............................................................ 29 6. Offer Opinions and Analysis to AMD and Commercial Bank Staff .................... 30 7. Assist Commercial Banks in Developing Internal Audit Function ...................... 31 8. Provide Assistance to Commercial Banks Through the Help Desk ..................... 32

F. Training Initiatives – Selected Topics for Seminars/Presentations ......................... 32

1. Presentation on External Audits........................................................................... 33 2. Seminar on Banking Laws & Regulations and Supervisory Policies ................... 33 3. Computer Simulation for Banking Operations Presentation ............................... 34 4. UBPR/Ratio Analysis Training Program.............................................................. 34 5. Training at US Regulator for On-Site Supervision Staff Members..................... 34 6. IFRS Seminars for Non-Accountant Commercial Bankers ................................. 35 7. Seminar on Internal Controls and Internal Audit Procedures............................... 35 8. Seminar on Anti-Money Laundering for BDS Staff and Commercial Bankers ... 36 9. Corporate Governance Seminar for BDS Staff and Commercial Bankers .......... 36 10. International Financial Reporting Standard No. 39 Seminar for Banks & BSD36 11. Help NBG take responsibility for BSD Staff Training & Accreditation ........... 37 12. Assist in Providing Anti-Money Laundering Out-of-Country Training............ 39 13. Other Training.................................................................................................... 39

III. Recommendations for the Future............................................................................... 39 Attachment A: Memorandum of Understanding ............................................................. 42 Attachment B: Year 1 - Work Plan Agreement ............................................................... 43 Attachment C: Year 1 - Monitoring report and schedule of completion ......................... 44 Attachment D: Year 2 - Work Plan Agreement............................................................... 45 Attachment E: Year 2 - Monitoring report and schedule of completion ......................... 46


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ABBREVIATIONS NBG – National Bank of Georgia BSD – Bank Supervision Department of NBG AMD – Accounting Methodology Department of NBG SSRAD - Systems and System Risks Analysis Department of NBG FMS – Financial Monitoring Service, monitors possible money laundering activity HRER – Human Resources and External Relations Department of NBG COP – Chief of Party SA – Resident Supervision Advisor AA – Accounting Advisor LAA – Local Georgian Accounting Advisor FA – Local Georgian Financial Analyst EBRD – European Bank for Reconstruction and Development UBPR – Uniform Bank Performance Report AML – Anti-Money Laundering CAMEL – Capital, Assets, Management, Earnings & Liquidity analysis system CAEL - Capital, Assets, Earnings & Liquidity analysis system OTA – US Treasury Department, Office of Technical Assistance USTTA – US Treasury Technical Assistance WL – World Learning GBC – Georgian Business Confederation AMCHAM – Georgian-American Chamber of Commerce GEGI – Georgia Enterprise Growth Initiative GMSE – Georgia Microfinance Stabilization & Enforcement project FSVC – Financial Service Volunteer Corp ISA – International Accounting Standards IFRS – International Financial Accounting Standards (replaced ISA) SAR – Suspicious Activities Report (report of possible AML activity)


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Georgia Banking Infrastructure Development II

I. INTRODUCTION The current Task Order was Phase II of a United States Agency for International Development (USAID) Program to provide technical assistance for strengthening of bank supervision at the National Bank of Georgia (NBG). The Program was developed in accordance with, and operated within the provisions of, the Memorandum of Understanding (MOU) between the Government of the United States of America and the National Bank of Georgia, dated December 16, 1999. A copy of this MOU is included with this report. Phase I of this project started in October 1999 and ended in April 2002. During that phase, substantial progress was made to improve the quality of banking supervision. Specific improvements included the following: • Developed and implemented more sophisticated inspection procedures that required enhancing the technical skills and judgment of the inspectors; • Substantially completed an accreditation program that was intended to develop bank supervision as a professional discipline at the NBG; • Completely overhauled the two key laws that impact the NBG and the commercial banking system; • Developed and implemented several key regulations, including those related to asset classification, internal audit, and restriction on insiders and related parties; • Developed and implemented a new Chart of Accounts that complies with International Accounting Standards; • Completed substantial work in assisting a selected group of commercial banks in the actual implementation and utilization of international accounting standards. Phase II entailed continued implementation of technical assistance (TA) and training for the enhancement of the supervisory process. It was successfully completed during the following two years, and ended on April 30, 2004. It included the following activities: • The refinement of the on-site inspection process so that the inspection reports present a more complete and more accurate assessment of a bank’s financial condition; • Continued development, implementation, and sustainability of the accreditation for the NBG Supervisors;


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• Further implementation of the off-site surveillance system and additional training on how to effectively utilize the system as a management information tool; • Continued development of the legal framework, including regulations that deal with licensing, corporate governance, safety and soundness issues, and other normatives that relate to the adequacy and definition of capital, liquidity, fixed assets, credit concentrations, and auditing standards; • Continued improvement and transparency of the accounting information generated by the commercial banks; • Further development of procedures for dealing with problem banks as well as providing a clear definition of what is a problem bank; • Enhanced surveillance of problem banks, and remedial strategies and actions to be taken to minimize potential disruptions to other healthy banks. At the start of Phase II, the team consisted of Chief of Party (COP) Stroud, Legal Advisor (LA) McCormack and Resident Bank Supervision Advisor (SA) Franson, with Georgian technical and administrative support staff. Mr. McCormack completed his two-year assignment in July 2002 and Accounting Advisor Canfield’s assignment arrived the same month. Mr. Stroud was reassigned at the end of September 2002 and was replaced as Chief of Party by James Satterfield. Mr. Franson’s assignment ended in May 2003, while Mr. Canfield completed his in September 2003.

II. TANGIBLE RESULTS

This report is intended to document the progress made during Phase II. This phase had separate work plans for each of the two years, building upon each other. A copy of the agreed upon work plan covering Year 1 of Phase II, May 2002 to April 2003 is included as Attachment B and the work plan for Year 2, from May 2003 to April 2004, is Attachment D. Overall, our professional judgment is that all the requirements of the Task Order were completed successfully, as also reflected in the responses from the counterparts, USAID officials, and a variety of officials from international organizations, such as IMF and the World Bank. The report is organized to follow the structure of the Work Plan benchmarks. The sections are as follows: A. On-Site Supervision (Inspections) B. Off-Site Supervision (Analytic Systems) C. Problem Bank Resolution (Bank Consolidation) D. Accounting Procedures Strengthening


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E. Legal and Regulatory Initiatives F. Training Initiatives Within each section, there are a number of objectives, and a report on the tangible results achieved on each. They are listed in the order in which they are included in each year’s Work Plan and the Monitoring Report, unless the Year 2 objectives are a continuation of those of Year 1. In that case, the tangible results of both years are combined. The Monitoring Reports provide an excellent overview of the results achieved each year. The Year 1 Monitoring Report forms Attachment C and the Year 2 Monitoring Report is Attachment E. A. ON-SITE SUPERVISION (INSPECTIONS) 1. Fostering Adequacy of Management Structure and Staffing. A review of the duties and objectives of the On-Site Inspection Division was conducted to evaluate the present management structure and staffing for its adequacy given the workload requirements. During the first quarter of Phase II, the COP met with the Director on a regular basis to highlight inadequacies of the On-Site Inspection staff and structure, as identified. In response to the recommendations from Project advisors, NBG appointed a new Bank Supervision Division Director in December 2001, four months before the end of Phase I, which resolved a major issue. However, there were still other staffing issues that needed addressing. The staffing issues included the need to completely staff the Accounting Methodology Department and to replace the Deputy Director of the Policy Division, who was responsible for processing the laws and regulations developed by the resident advisors. On numerous occasions these laws and regulations had been stalled for no reason by the policy division. Both the Policy Division and the Accounting Methodology Departments were not properly staffed, and therefore, not functioning as productive units within the Banking Supervision Department. In July 2002, COP Stroud reviewed the inspection report on a large troubled bank, which the NBG had been reluctant to address for political reasons. The report was lacking in all aspects. The schedules were not filled out properly, the information was confusing and lacked clarity, and the ratings were not properly supported. As a result of these problems, COP and the local consultants prepared additional information and analysis in an attempt to show the senior management of the NBG the impact of staff inadequacies. With the review completed and conclusions confirmed, assistance to the On-Site Inspection Division focused on direct advice and assistance on inspections, on upgrading procedures, codifying them in a revised On-Site Inspection Manual and improving the skills of the inspectors. 2. Assistance in Bank Inspections


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During the first year of Phase II, the Chief of Party and other resident advisors conducted ten inspections of commercial banks with inspectors from NBG. For this purpose, the ten banks selected were banks that were large, risky, or had unusual problems. Initially, these inspections identified significant problems, both at the banks and with the on-site inspection procedures, but by September the inspections required more routine improvements. The first inspection of Phase II, completed in May 2002, was at a bank jointly chartered by a European group and a group of Georgian businessmen. The inspection highlighted major corporate governance issues regarding the working relationship between a commercial bank’s supervisory board and the senior management. Due to the different cultures and ways of conducting the bank’s daily operations, these two groups had been at odds over how to operate this bank since the bank first opened. These disputes later resulted in the kidnapping of the bank’s president, who represented the Europeans, and a severe beating of the chairman of the board, who is Georgian. The NBG’s inspectors were initially hesitant to become involved in what they saw as an internal dispute. In the end, the inspection was completed and recommendations were offered to the Director of the BSD, especially on numerous corporate governance issues concerning the bank. By the fourth inspection in September 2002 no irregularities were found, and in subsequent inspections through February of 2003, the issues addressed were of a more routine nature that included: • Questions about accruals; • Evidence of required improvements; and • Asset quality, branch management, and one bank’s micro-credit portfolio. By April 2003, the COP and SA were engaged in advising the On-Site Inspection team on the need for assigning CAMEL ratings on a consistent basis between the different banks. The positive trend in these inspections continued in Year 2 to such an extent that there was little to note about them. However, by 2004, anti-money laundering had become a topic of increasing importance, resulting in enhanced efforts by the COP to strengthen inspections for Anti-Money Laundering (AML) related issues. A number of inspections to support the project’s anti-money laundering objectives were undertaken. In February 2004, the COP participated in a large commercial bank on-site inspection. During the inspection with BSD Director and FMS Director, the COP consulted with the bank’s senior management and branch managers regarding the bank’s newly-established Anti-Money Laundering program. This was especially critical in light of upcoming recommended changes to the AML law, related software needs, and the necessity of compliance with Suspicious Activity Reporting requirements. The COP also worked with Inspector in Charge on the methods for testing a bank’s AML program. In another situation, the COP met with Internal Audit and IT staff and their resident EBRD Advisor at a large commercial bank during a BSD inspection to discuss their Anti-Money Laundering program. The focus was on their policies and procedures for


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monitoring, analyzing and reporting to the Financial Monitoring Service (FMS). The most significant problem identified was that much of the work has to be done manually as the Internal Audit and IT staff did not have software to assist in analyzing transactions; which made it especially difficult to identify interrelated transactions designed to disguise money laundering activity by keeping each transaction under the legal monitoring threshold requirements. 3. Upgrade of On-Site Inspection Procedures The on-site inspection procedures were revised to increase their effectiveness and to ensure that all new laws and regulations recently adopted are addressed during an on-site inspection. The procedures also included review of the commercial bank compliance with the new International Accounting Standards, asset classification procedures, internal auditing procedures, conflicts of interest procedures, and rules regarding corporate governance procedures for the supervisory councils of commercial banks. The COP and his team were initially disappointed by the performance of the On-Site Division inspectors, and took strong action to improve this performance, both directly with the inspectors and with their management. During June 2002, the COP participated in a workshop for the On-site Inspectors regarding the Uniform Bank Performance Report. The workshop was well received by the staff and the discussions and questions indicated the inspectors were very interested in learning more about how to use this information in their inspections. In August 2002, as the result of an inspection on another large bank, it was the consensus of the resident advisors that the accuracy and reliability of the accounting information being generated by the commercial banks needed to be substantially improved. The COP, AA, and SA met with the inspectors to review the accounting irregularities noted by the project’s accounting advisors. The SA also presented the findings of the latest Capital, Assets, Earning and Liquidity (CAEL) report and the Uniform Bank Performance Report (UBPR). This technical assistance was intended to provide the inspectors with a better and more realistic approach to the assessment of the type and quality of financial information being prepared by the commercial banks. The COP and other team members assessed with a representative from the local PricewaterhouseCoopers accounting office and the Director of the BSD the additional training needed for the on-site and off-site staff to focus on the fundamentals of financial analysis and how this information should be used in the written reports being prepared by each of the departments. The result of these and other efforts from May through October to upgrade on-site inspection procedures was positive. By November, when the COP informed the BSD Director and the Inspector in Charge about the substantial improvement in the most recent inspection report, he was able to conclude that this objective had been met.


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4. Revise and Update the On-Site Inspection Manual Overall, the inspection manual being used by the on-site inspection staff was reviewed and updated to ensure that the new laws and regulations were adequately addressed. In addition, training sessions were conducted to explain the practical aspects of the new regulations to the supervisory staff. In consultation with the Bank Supervision staff and, especially, the Head of Off-Site Division, the SA and FA began work on updating the On-Site Inspection Manual. Our advisors considered that the best approach for updating the NBG On-Site Manual was working directly with inspection teams and with BSD management to determine their perceived needs and reviewing examples of other On-Site Manuals. In response to the Advisors’ recommendation, the BSD Director agreed to establish a BSD working group to be responsible for completing the revision process. The tasks involved were distributed and delegated to the individual members of the working group, according to their responsibilities. The SA and FA prepared a questionnaire to address the shortcomings of the current manual and met with the working group regularly to provide guidance on the structure of the manual. Continuing throughout Phase II, the advisors guided the inspectors, the Head and Deputy Head of Methodology and Licensing Department, BSD economists and others, who were developing individual chapters of the Manual covering Earnings, Liquidity, Asset Quality, Overdue Loans, Capitalization, Securities, Computer Services, Courier Services, Cash Items, Bankers’ Acceptances, Management, and Inspection Administration and Procedures. Regarding the Overdue Loans section, the COP and FA also conferred with the Chairman of the Georgian Federation of Asset Valuers and a partner with the Georgian Audit and Consulting Company on the methods related to real estate valuation. Drafts of each chapter, written to reflect the actual situation in Georgia, were reviewed, discussed and agreed upon by the whole working group. The chapters were translated into English and reviewed by the Advisors so that their advice could also be incorporated in the final drafts. These drafts were submitted to BSD Deputy Director for his review and approval as they were completed. After a complete review of the five CAMEL chapters, the BSD Director sent them to the President of NBG for the issuance of a decree making the manual official. In addition, the SA advised the BSD Director on how the Manual could be used as a management tool to oversee the inspectors’ work. In March 2004, the manual was completed along with the English translations. 5. Completion of Bank Supervision Staff Accreditation Program The implementation of the Accreditation Program for the banking supervision staff started during Phase I was continued during Phase II. The fifth and final course of the accreditation program, the BankExec Seminar was presented from December 16 to 20,


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2003. This program uses a computer simulation model allowing participants to play the roles of bank management. Participant evaluations indicated it as the best received seminar since the beginning of the Bank Supervision project. Duane Stuker, a former head of training for the OCC, was the instructor. He was assisted by a number of the project staff members including one of the financial analysts. The participants were divided into six teams (“Banks”) and competed against each other with the winning team determined by a combination of the bank’s “Stock Price” and its “CAMEL rating.” The finale of the seminar involved each “Bank” presenting its case to a Board of Directors that included the Director and a Deputy Director of BSD, project USAID CTO, project advisors, and the Seminar Instructor on why they should be retained as “Bank” Management. COP and SA assisted throughout the week playing the role of major shareholders. It was the first project seminar to include participants from NBG Bank Supervision and Commercial Banks working together in teams. 6. Development of Anti-Money Laundering Procedures Early in Year 2 of Phase II, the COP joined with advisors from the US Treasury Department’s Office of Technical Assistance (OTA) to help NBG’s President establish the Financial Monitoring Service (FMS) within NBG, as prescribed by the recently passed “Prevention of Illicit Income Legalization Law.” Based on personal acquaintance with a major Greek commercial bank, which was presenting at a Financial Crimes/Money Laundering Seminar, the COP helped organize training of three members of the new FMS at the Greek bank and obtained and distributed copies of its anti-money laundering policy manual to NBG and the Georgian banks. The Accounting Advisor and the COP, in consultation with the FMS Head, an OTA advisor, the BDS On-Site Director and Deputy Director, an EBRD advisor at a large Georgian bank, the management of two other large Georgian banks and an official of the Bankers Association of Georgia, helped establish the AML training needs for both FMS and BDS staff. To further support the AML effort and ensure proper training for the NBG staff, the COP also: • Provided documentation and sample policies from other countries; • Assessed the need for a full-time advisor to the FMS, • Advised the FMS Director and staff on inspection procedures, reporting responsibilities, maintaining databases, coordinating with other monitoring agencies and identifying equipment needs.


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• Helped identify suspicious transaction reporting software for use by FMS, • Assisted NBG’s President, at his request, to meet with the Embassy’s DCM and USAID’s Economic Growth Director about possible software and hardware assistance to the FMS in order to establish a securitized data system to deal with anti-money laundering reports. • Coordinated with OTA on assistance in developing a business plan for the FMS and; • Helped develop plans for a training visit for FMS officials in the US. The COP also collaborated with members of the Georgian Business Confederation (GBC), NBG, FMS, GBC and the U.S. Treasury Advisor to the FMS to review draft NBG Anti-Money Laundering Regulation, changes needed to the Anti-Money Laundering Law, concerns with reporting of Suspicious Activity, and liabilities for non-reporting. This group made the decision to form a small committee representing one member each from the banks, NBG, FMS, and Bankworld/USAID to devise recommendations for changes. 7. Assist IFIs and Donors on Bank Supervision and Bank Evaluation Throughout Phase II, the COP maintained communications with the representatives from IMF, World Bank, EBRD and other donor agencies in their evaluation of the National Bank’s Bank Supervision Department and/or commercial banking sector. Some of the significant events included conferring with the following: • Two representatives of Eurasia Foundation who visited Georgia to assess training needs for bankers as part of their plan to provide grant money to the Georgian Bankers Association for that purpose; • The Director of one of the large commercial banks and the EBRD Advisor to this bank to discuss their concerns about micro-lending program by their bank, the competitive market for such activity and the desire for competition on a level playing field; • A representative from the EBRD Small Enterprise Lending Programme, who is working with two commercial banks in Georgia and wanted to discuss and understand the NBG BSD’s policy of Asset Classification and Provisioning for small enterprise loans; • The International Finance Corporation (IFC) Project Manager and Lawyer for the Georgian Business Development Project to discuss the need to form a workgroup to assist in incorporating good corporate governance into the operations of publicly-held commercial enterprises;


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• The new IMF Mission representative for the NBG to discuss project status and provide a brief summary of project history and objectives. The discussion primarily covered the outcome of stress tests administered using year-end 2003 commercial bank data, the status of use of International Financial Reporting Standards at commercial banks, concern that the NBG has limited authority over quality of commercial bank external audits, and general opinions about the banking sector’s viability. These discussions led to separate meetings to discuss the status of recommended changes still pending in Parliament about NBG’s inability to adequately address the quality of External Audits at commercial banks and a recommendation that the IMF consider making it a “conditionality” for laws to be amended, which would give the NBG the authority to reject poor quality commercial bank audits; • The COP met with the EBRD Small Enterprise Lending Program (SELP) Coordinator, who was working with three commercial banks to establish a viable micro-lending program. They also discussed data collection requirements for transactions in accordance with the Anti-Money Laundering Law and the FMS Regulation; • The new IMF Mission Representative, Geoffrey Heenan, responsible for the NBG, to update him on the results of the Stress Tests, risks in the banking sector, and the strength of the NBG BSD and commercial banking sector. The COP also briefed him on ideas for follow-up during the next year in areas such as Anti-Money Laundering. He highlighted the need of a full time AML advisor, analytical software for the commercial banks, the development of a Deposit Guarantee program, further reduction of the number of banks - primarily through increased capital requirements, an increase in micro-lending in the country, and greater attention to the regulation of the quality of bank audits by independent audit firms; • With the USAID Advisor on the GEGI project, the COP discussed the possibility of a bond issuance by a commercial bank. The anticipated bond offering would be used to assist the energy sector and would potentially be 50 percent guaranteed by USAID. They discussed possible cost of the issue, expected discount and interest cost, and capital requirements for the issuing bank; • With the GEGI Advisor, the COP also discussed the creation of a Credit Bureau in Georgia. They discussed the primary issue of how to get banks to provide both positive and negative information, whether the Bureau should be private or governmental (they leaned heavily toward private), and how to get other users, such as insurance companies, to join; and, • The COP met with Fred Meyers, the IMF Mission’s AML expert, to discuss the status of BSD’s AML inspection and procedures program, the status of the commercial banks’ AML efforts, and needed analytical software and training. The COP apprised Mr. Meyers of latest efforts, working with BSD and FMS, to do On-Site Inspection, develop Inspection Procedures, and provide U.S.-based training for FMS management, and, working with USAID, World Learning, and the GEGI project, to set up training for BSD Inspectors and Commercial Bank staff. Mr. Meyers indicated his belief that, NBG was ahead of other countries and that this project should receive much of the credit.


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B. OFF-SITE SUPERVISION (ANALYTIC SYSTEMS) 1. Fostering Adequacy of Staffing A review of the duties and objectives of the Off-Site Inspection Division was conducted to determine if the present staffing was adequate given their work requirements. SA Franson and a local advisor held discussions with the Off-site Deputy Director and the Head of the Division on the UBPR and the revised CAEL reports. The discussions focused on how the UBPR should be used and what is expected from the off-site inspectors’ analyses. Having agreed on the work requirements of the off-site inspectors, the advisors worked with the department to enhance staff capability to implement the UBPR and CAEL reports, as needed especially during year 1 of Phase II.

2. UBPR Seminar and Staff Training

During June 2002, SA Franson gave a one and a half day seminar to introduce the Off-Site and the Policy and Accounting Divisions to the new Uniform Bank Performance Report. This seminar was followed by a weeklong Uniform Bank Performance Report Seminar presented by Financial Services Volunteer Corp (FSVC) from Monday, September 30 through Friday, October 4, 2002. The seminar focused on the four CAEL components: capital, asset quality, earnings and liquidity. During the seminar, FSVC gave a two-hour lecture on each component and spent the rest of the day working on case studies using the UBPR. The seminar was supplemented by individual coaching on the new UBPR and CAEL format. 3. Update and Refine CAEL Reporting Format In July 2002, Advisors completed a detailed CAEL Executive Summary and an updated and refined CAEL reporting format, which was delivered to NBG senior management for approval. Inspectors found the new format user-friendly and the information practical to their work. 4. Refine and Update Off-Site Inspection Manual The Off-Site Manual was completed in August 2002 and incorporated the newly developed UBPR. During the course of the Manual’s development, the project’s Legal Advisor reviewed it for compliance with local banking laws and regulations. In addition, the project’s Financial Advisor reviewed the Georgian translation of the Manual for accuracy and clarity. Finally, the Off-Site Manual was reviewed and approved by the Head of the Off-Site Division as well as the Deputy Director of Policy and Accounting Methodology. 5. Develop UBPR Instruction Manual


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The User’s Guide for the Uniform Bank Performance Report, detailing the input information for the ratios, was completed in August 2002. The manual also provided guidance on how to interpret the information. The project’s Financial Advisor reviewed the Georgian translation for accuracy and clarity. The Head of the Policy and Accounting Methodology Division, one of the key players in the development of the UBPR, reviewed the User’s Guide for accuracy, ensuring that each ratio description correctly describes the ratios’ components. The User’s Guide was also reviewed by the Head of the Off-Site Division and by the Deputy Director of Policy and Accounting Methodology. 6. Assist and Instruct Off-Site Division on New Tools & Procedures Assistance and instruction on the new tools and procedures were provided to the Off-Site Division and its inspectors. Assistance was also provided in the preparation of Financial Analysis (CAEL) reports using reports submitted by the Commercial Banks and the Uniform Bank Performance Report (UBPR). In March 2004, the COP reviewed, with the Off-Site Inspection staff and the System Risks Analysis Department Head, data analysis methods developed by the project for off-site’ use. The review included the Uniform Bank Performance Report (UBPR) submitted monthly by the commercial banks; monthly Financial Analysis performed by Off-Site Inspection staff using UBPRs; Accounting Analysis performed prior to each large bank inspection, principally to alert on-site inspectors to possible accounting problems; monthly Early Warning Reports, using UBPR data, which incorporate a series of “Triggers” and “Flags” to detect possible problem issues with commercial banks; and “Stress Tests” that are performed at least quarterly to determine how susceptible a commercial bank may be to certain economic changes. The last of these reports is shared with commercial banks for their use in developing policy to deal with drastic changes that could take place in relative short periods of time. The System Risks Analysis Department Head demonstrated an internally developed program, based on the project’s Excel program but less sophisticated. The problems with this Excel-based Accounting Analysis program were also examined. 7. Develop Licensing Manual The Licensing Manual for New Bank applications was completed in March 2004. The Georgian version was being reviewed by the Licensing Department Head and would then be sent to the BSD Director for review and processing for NBG approval. Although the primary focus of the Manual is on new bank applications, many of the components are applicable to other licensing applications, such as the purchase of, or changing of significant ownership of, an existing bank. The Manual includes requirements for meeting the legal “Fit and Proper” conditions for the bank’s significant owners, supervisory council members, and senior management. It also includes provisions for extensive background checks of these administrators to include fingerprinting, law enforcement verifications, and Interpol search.


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8. Assist in the Review of Applications for New Bank Licenses The COP reviewed and analyzed new commercial bank applications with BSD Director and Deputy Director of Licensing. The COP, BSD Director, and Deputy Director of Licensing met with the representative of certain foreign interests that wanted to form a new bank, and discussed the application process, required documents, the amount of capital in cash required, etc. The parties agreed to perform an application process in two phases: First, to obtain documents on the individuals involved to do background and other checks for “Fit and Proper” clearance, and to obtain affidavits from the individuals attesting that they are the ultimate beneficiary and that they are not a front for some other interest; and second, if investors pass the “Fit and Proper” test, then they must furnish a business plan, corporate documents, etc., to complete the BSD’s review. The Accounting Advisor drafted a Certificate of Ultimate Beneficial Ownership and Capitalization to be used in connection with the above-mentioned new bank license application. 9. Assist Licensing Department with IT Database The Licensing Database software shell was completed in March 2004. The COP worked with the Heads of the Licensing Department and the System Risks Analysis Department to review the developed software capabilities. Although this was initially to be only a “Fit and Proper” eligibility database, in connection with developing the Licensing Manual, the database was expanded to include other licensing data. The Licensing Department will proceed to provide information and input into the database. As a first step, all bank administrators were to be recorded on the system once the “Fit and Proper” law and regulations became effective. In its final form, the system is expected to include a search engine to provide name and historical search capability, and to place licensing requirements on the NBG website for automated use by potential licensees. 10. Assist Methodology Department with IT Major Loan Database With the assistance of the COP, software for the Major Loan Database (MLD) was developed with very positive results, as of the end of year 2 of Phase II. The COP recommended specific thresholds for commercial bank reporting, data input, inspector access capability, and future consolidation of the MLD into the existing BSD IT system. The database is suitable for being incorporated into the current FinA system, and it will be easy for commercial banks to provide requested periodic report inputs. The database also meets the need to allow supplemental input from On-Site Inspection findings, and with the search engine provides easy information search capability. The objective is to have credible information on major bank borrowers, especially those that have loans at two or more banks. This will enhance the ability of inspectors to evaluate credit risk, risk classification, and loss reserve requirements on a consistent basis for specific borrowers rather than just doing so for each loan independently. C. PROBLEM BANK RESOLUTION (BANK CONSOLIDATION) 1. Review Prompt Corrective Action Regulation


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Project advisors provided extensive consulting and support for the drafting and delivery of the Prompt Corrective Action Regulation, focusing its ability to best serve the NBG and the commercial banking sector. COP Stroud worked with the Supervisory Counsel on finalizing the draft “Regulation on Prompt Corrective Actions by the National Bank against Problem Banks.” COP Stroud suggested introducing corrective actions only for undercapitalized banks and for banks with Composite Camel Rating “4” and “5” and taking into account specifics of the existing banking environment. Subsequently, the draft regulation was delivered to the NBG Director of Supervision. NBG planned to combine the draft with a few other regulations for an overall Regulation on Problem Bank Management. 2. Identify Institutions Not in Compliance with Capital Regulations or have a composite CAMEL rating of 4 or 5 In July 2002, COP Stroud identified all commercial banks that are either not meeting their capital requirements or have a composite rating of 4 or 5. As a result, he prepared additional analyses on two banks in which he recommended that the NBG take some type of formal enforcement action. The final recommendations were presented to the President of the NBG. 3. Enforcement Action and Intervention on Problem Banks In Phase II, problem bank intervention was generally a much less contentious activity than during Phase I of the project. During both years of Phase II, the Project Advisors assisted NBG with problem bank resolution actions, mostly involving small banks, using a variety of enforcement and remediation procedures. From the period from May through August 2002, the COP worked with NBG’s Vice President to resolve the problems of a small, politically sensitive bank. A temporary administrator was appointed while its financial condition was studied. Also during this period, a second small bank was put under a temporary administration, the license of another was revoked and it was put into liquidation, and a temporary administrator was appointed for a third. Subsequently, in the period from May through January 2004, BSD issued an MOU regarding the merger of two small banks and completed the merger in June. The license of another small bank, previously under temporary administration, was revoked in May, and in August 2003, 60% of the assets and some liabilities of a small bank were transferred to another bank and the remaining assets were liquidated. Finally, in September 2003, the COP advised the BSD Director and the Deputy Directors for Policy and On-Site Supervision regarding placing one small bank in liquidation and another small bank, previously under Temporary Administration, under liquidation when no eligible purchaser came forward with a viable acquisition plan. Two small banks’ licenses were also subsequently revoked.


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Our work involved dealing with some medium-sized and larger banks with problems, as follows: • Prepared analysis and recommendations on enforcement regarding two large, high-profile, problem banks and discussed them with the NBG’s Vice President and Director of the Supervision Department resulting in the buyout, merger and recapitalization of the banks. Recommended that the banks be subject to an international audit and that new professional management be installed to operate the resulting bank. • Consulted with the President of a large commercial bank to discuss the accounting and internal control problems of the bank following discovery of a large defalcation of approximately $700,000 that completely wiped out the bank’s earnings for the previous year. • Participated in inspection of a medium-sized problem bank, inspected some of the bank’s fixed assets at the home and a branch office, including a large piece of commercial real estate owned through foreclosure of a delinquent borrower, and reviewed operations of a profitable electric utility company bank borrower. COP later advised BSD Director and Deputy Director for On-Site Inspection to discuss resolution alternatives for the problem bank. • Assisted NBG in responding to a problem bank inquiry from the Overseas Private Investment Corp. (OPIC) regarding questions raised by Purchase and Assumption of a problem bank by a healthy one. Provided on-going consultation for resolution of issues raised. • Advised the Director of BSD and other management staff in BSD regarding a major issue concerning a large commercial bank not reporting their Off Balance Sheet activity. Specifically, there was a demand for payment under a very large guarantee, which was not previously reported as required, and the bank did not have the funds to honor it. The concern was how to deal with the bank and the effect on the reputation of the Georgian banking system as the result of the bank not honoring its guarantee. • Advised the Director of BSD and other BSD staff concerning NBG response to a situation when the President of Georgia ordered sanctions and the freezing of all bank transactions of the autonomous region of Adjara after he was barred by armed force from entering Adjara to attend an organized parliamentary election political event. Devised plan to suspend bank licenses and freeze all accounts of Batumi-based Maritime Bank, as well as stopping activities of all commercial bank branches located in Adjara. When the impasse was settled, all sanctions against the other commercial bank branches were lifted. However, for other supervisory reasons, Maritime Bank's license remained revoked, so the COP discussed continued procedures for its oversight. • Advised the President of NBG and with the Director of BSD and the On-Site Deputy Director on two other problem banks and made recommendations on possible resolutions.


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4. Develop and Implement Early Intervention/PCA Program Project advisors worked closely with the BSD in its development of an early intervention program for problem banks and finalized a draft “Regulation on Prompt Corrective Actions by the National Bank against Problem Banks,” which focused on corrective actions for undercapitalized banks and banks with Composite Camel Rating “4” and “5.” This draft regulation was delivered to the NBG Director of Supervision in August 2002 and was subsequently used in development of a Regulation on Problem Bank Management. During Year 2, the COP met with the BSD Director and the Regulatory Review Committee periodically to discuss details of procedures needed for a more effective Prompt Corrective Action Program and gave them additional examples of problem bank management programs from the USA and Russia. As the Project was ending, the final version of a revised regulation on a prompt corrective action program was at or near completion. The COP reviewed the document and gave his final comments on it to the BSD Director, who expected the regulation to be issued shortly. 5. Assist in Development of an Early Warning Program The COP worked with the BSD Heads of Off-Site and System Risks Analysis to develop a presentation for Off-Site staff on the new Stress Test and the Early Warning “Triggers” and “Flags” programs, involving certain financial measurements that are periodically calculated. These new programs, along with the UBPR and Accounting Analysis programs, provide substantial tools for Off-Site Inspectors to properly supervise their assigned banks. 6. Develop and Implement Temporary Administrator Operations Manual In preparation for developing a Temporary Administrator Operations Manual, the COP provided the Head of the Liquidation Department with copies of Temporary Administrator and Liquidation manuals from another country and monitored the project status of the Liquidation and Temporary Administrator manuals, which were ultimately combined in one manual, the Liquidation/Temporary Administrator Manual. Once the edit and translation of the Liquidation/Temporary Administrator Manual was completed, Georgian and English versions were provided to the BSD Director and Deputy Director for Policy for review and approval. 7. Develop Regulatory Review Committee The COP advised NBG on the establishment of the Regulatory Review Committee (RRC), so that special supervisory items could be presented to this Committee, which is responsible for review of all banks, with special emphasis on problem banks. RRC


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determines inspection scheduling, supervisory and enforcement actions, and various strategies to resolve problem banks or specific problem bank issues. 8. Perform Stress Tests Quarterly for Large and Problem Banks The COP assisted the BSD System Risks Analysis Department Head to complete Stress Tests for each commercial bank on an on-going basis, using data from the previous quarter. The Stress Test is used by Bank Supervision to assess the impact of economic changes (such as changes in Interest Rates, Foreign Currency rates and Asset Classifications) on the commercial banks’ financial reports. It takes into account the impact of the local currency’s strength against the U.S. dollar and shows the impact of the depreciation on the banks’ “dollarized” portfolios. The goal of performing Stress Tests is to assist the NBG and commercial banks in preparing contingency plans in order to deal effectively with these types of events, should they occur. The COP worked with the BSD Heads of Off-Site and System Risks Analysis to develop a presentation for Off-Site staff on the new Stress Test and the Early Warning “Triggers” and “Flags” programs. The COP also assisted BSD’s System and System Risks Analysis Unit in developing and presenting a short “Stress Test” seminar for commercial banks on the results of their stress tests and on the methodology used in administering these tests. 9. Develop Liquidation Operations Manual The COP oversaw and assisted the Liquidation Department in the development of the Liquidation/Temporary Administrator manuals, which are now combined in one manual. When the edit and translation of the Temporary Administrator and Liquidation Manual was completed, Georgian and English versions were provided to the BSD Director and Deputy Director for Policy for review and approval. D. Legal and Regulatory Reform (Strengthening) Initiatives Legal Advisor Martin McCormack finished two years on the project when he left in July 2002. After he left, the COP and the project’s local Georgian legal staff continued work on legal and regulatory tasks.

1. Amendments to Laws

A major legal and regulatory accomplishment during Phase II was the drafting and successful lobbying support for amendments to the Commercial Bank Law. During Phase II, lobbying of Parliament’s Committee on Budget and Finance continued in connection with the proposed amendments to the Commercial Banking Laws submitted during Phase I. These amendments sought to hold the significant shareholders and the members of Supervisory Councils of banks to international standards of fitness and propriety. This task included analysis and discussion of models from other countries


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and preparation of a paper comparing the provisions of these models, which were sent to the Committee. Specific actions taken in this regard included: • Discussions with the NBG Department of Supervision on the three draft amendments to Georgian Law, i.e. the draft amendments to the Criminal Code, to the Commercial Banking Law, and to the Administrative Violations Code. • Assisted the NBG in its lobbying of the Budget & Finance Committee of Parliament in support of the NBG’s proposed amendments to apply fit and proper standards established for bank managers also to the Supervisory Councils and significant owners of banks. • Prepared comparative analysis of six country model statutes covering “fit and proper” criteria for significant shareholders and Supervisory Councils of banks and delivered it to the NBG Director of Supervision to be forwarded to the Parliamentary Committee. • Met in a closed session of the Budget & Finance Committee to discuss the objections of certain Parliamentarians, and their support staff, to the proposed amendments. • Drafted alternative positions to be used as “back-ups” in the event Parliament did not accept, in the lobbying discussion process, the forfeiture of share voting rights by “Significant Shareholders” of banks who are in violation of the new “fit and proper” requirements to be imposed by the proposed amendments to the CBL. • Amendments to the Law on Commercial Banks concerning “Fit and Proper” provisions to include bank owners was approved by Parliament in December 2002. From May through July 2002, advisors provided substantive support for amendments to the Criminal Code, including the following: • Delivered to the NBG Department of Supervision proposed amendments to the “Criminal Code” providing for imposition of penalties, including ranges of high fines and/or imprisonment, against insiders and their confederates convicted of stealing resources of banks through asset-stripping, defalcation, embezzlement, or other forms of serious inside abuse. The proposed amendments would also establish criminal penalties punishing persons who solicit deposits without a license. • Held discussions with the NBG Department of Supervision on the three draft amendments delivered to it during May, i.e. the draft amendments to the Criminal Code, to the Commercial Banking Law, and to the Administrative Violations Code. • Met with the Deputy Head of the NBG Legal Department and gave arguments for supporting the NBG proposed amendments to the Criminal Code.


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• Prepared a Policy Memorandum to The Deputy Head and to senior officials of the NBG. Project advisors delivered to the NBG Department of Supervision proposed amendments to the “Administrative Violations Code” that would establish civil money penalties against individual bank administrators for various kinds of compliance violations. Subsequently, LA McCormack had discussions with the NBG Department of Supervision on the three draft amendments delivered to it during May 2002, i.e. the draft amendments to the Criminal Code, to the Commercial Banking Law, and to the Administrative Violations Code.

2. Issuance of Previously Delivered Regulations

a. Regulation on Credit Concentration Draft of proposed “Credit Concentration” regulation was reviewed with the Head of BSD Policy Section and BSD Deputy Director of Policy to recommend changes and monitor status of the legislation. When the Regulation on Credit Concentration was issued in December 2003, the project translated and distributed it to USAID. b. Regulation on Fixed Asset Limitations BSD indicated that the draft would be used to update the existing Prudential Regulation rather than issuing a separate regulation on fixed asset limitations. Project advisors deferred to NBG’s Supervision Department on the method it uses, unless the method significantly changed its impact. c. Regulation on International Accounting Principals (IFRS and ISA) Although there were six Accounting Guidelines developed during Phase I of the project, these were not immediately implemented because it was prudent to first issue a general regulation on accounting, internal control, and financial reporting (hereinafter “Accounting Regulation”) prior to issuing any Accounting Guidelines because the Accounting Regulation will be the basis for commercial bank accounting. Therefore, in mid-September of 2002, the AA delivered to the NBG a revised Accounting Regulation. The Vice-President of the NBG, the Head of the Banking Supervision and Regulation Department, and the AMD agreed to the project’s proposal regarding the Accounting Regulation, which included language to satisfy the International Monetary Fund (IMF) assessment regarding consolidated financial reporting.


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Project advisors provided consistent follow up on this regulation throughout Phase II and in February 2004 the completed “Draft” was sent to the Banker’s Association for review and comment. Official passage of the regulation was expected in May 2004. d. Regulation on Foreign Exchange Management and Limitations Although the draft is complete, BSD has indicated that it will likely be issued in conjunction with another regulation or used to update an existing one, possibly the Prudential Regulation, rather than being issued separately. As of April 2004, this regulation was under review by the Monetary Policy department of NBG. e. Regulation on Capital Requirements During Phase II, the recommended regulation on “Capital Adequacy Requirements” was approved by the Ministry of Justice and became effective on October 1 of 2002 and continuous support was given in support of a new regulation on Minimum Capital Requirements for Commercial Banks. This regulation was approved in January of 2004 as Regulation #297 “On Setting Minimum Capital Requirements for Commercial Banks”. The Regulation, effective January 14, 2004, raises the minimum capital requirement from GEL 5 million to GEL 12 million. New banks must meet this requirement at time of licensing, while current operating banks are required to increase their minimum capital in accordance with a schedule over the next several years in order to meet the new requirement by December 31, 2008. Advisors reviewed the regulation, had it translated, discussed its significance at various meetings, and distributed it to USAID, COPs for USAID GEGI and GMSE projects, World Bank, and an EBRD representative to a major commercial bank. f. Regulation on Fit and Proper Criteria for Bank Management During Phase II project advisors provided assistance to the NBG in lobbying Parliament’s Budget and Finance Committee on the proposed amendments to the Commercial Banking Law to raise the fit and proper criteria of bank managers to the levels of Supervisory Councils and significant owners of banks. As a result, the recommended regulation on “Fit and Proper Criteria” was approved by the Ministry of Justice and became effective on October 1, 2002. It covered bank managers, but not bank owners. In December 2002, amendments to the Law on Commercial Banks concerning “Fit and Proper” provisions to include bank owners was approved by Parliament. Included in this amendment was a provision that within 6 months, NBG would draft a Regulation “…defining indirect participation in a commercial bank’s capital.” 3. Design, Discussion, Drafting and Delivery of New Regulations a. Regulation on Fiduciary Duties of Bank Supervisory Councils


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At the beginning of Phase II the draft of the “Regulation on Fiduciary Duties of Bank Supervisory Councils” was substantially completed. It was reviewed by the COP and delivered to the NBG Director of Supervision. b. Regulation on Prompt Corrective Actions Please see Section C-1, above. c. Regulation on Companies and Other Persons Who Control Banks In August of 2002, the draft “Regulation on Persons Who Control Banks” was reviewed, completed, and a final draft was delivered to COP Stroud for his review and then delivered to the NBG Director of Bank Supervision. This draft was subsequently used in the Fit and Proper requirements for owners in the amendment to the Law on Commercial Banks passed in December 2002. d. Regulation on Liquidity Management The “Regulation on Liquidity Management” was delivered to the NBG Director of Supervision in July of 2002. BSD indicated that it might use it to update the existing Prudential Regulations. e. Regulation on Sanctions and Penalties In Phase II, project advisors consulted on the design of the “Regulation on Sanctions and Penalties.” This task was especially complex as the regulation had to be carefully aligned with certain other laws of Georgia and passage was delayed due to priorities relating to the drafting and moving of the approval processes of several other regulations as well as the planning for legislative lobbying matters and the Judicial Training presentations. The regulation, however, was ultimately passed in December of 2003. f. Regulation on Securities Activities of Bank Subsidiaries As of July 2002, the design of “Regulation on Securities Activities of Bank Subsidiaries” was indefinitely put off in view of the need to justify it in the wake of the newly amended Article 59 (8) of the “Organic Law of Georgia on the National Bank” which now requires functional regulation of banks and their securities subsidiaries by the National Bank and the National Securities Commission. In March 2003, the COP discussed the regulation with BSD management and learned that the Securities and Exchange Commission (SEC) is responsible for oversight of operational activities of Security Brokerage firms. The NBG is responsible for oversight of the investments in the subsidiary, for which a regulation already exists.


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g. Regulation on Mergers The Final Report for Phase I of this project states that “The Regulation on Mergers of Banks and on Persons who control them was postponed until August 2002 or beyond for the tactical purposes of both awaiting the specific jurisdiction over persons who control banks conferred by the amended banking laws, and allowing the NBG some experience time in learning to exercise this new power. It was also felt that all mergers in the industry as presently constituted would be rescue mergers rather than voluntary mergers for the foreseeable future.” Continued consultation with NBG in Phase II resulted in a conclusion that this regulation was premature and, therefore, it was not drafted. h. Regulation on Licensing and Branching NBG’s Legal Department insisted that it, not the project’s Legal Advisor, take responsibility for drafting this regulation, and it was taken out of our hands. Many of its provisions are covered by the Licensing Manual, discussed in section B. 7. above. i. Regulation on Indirect Ownership In October 2003 the COP met with BSD Policy staff and reviewed the final version of the Indirect Ownership Regulation. It was approved by NBG and has been sent to Ministry of Justice for final approval and recordation. E. ACCOUNTING PROCEDURES STRENGTHENING 1. Assist AMD Staff to Develop and Implement Monitoring Program Assistance was provided to the staff of the Accounting Methodology Department (AMD) to develop and implement a program to monitor the progress of commercial banks in the completion process of their external audits. It included the following: • Presentation by COP Stroud and the local accounting consultants, to the AMD and off-site staff related to understanding and utilizing an external audit report. The intent of the class was to help the supervisory staff understand how an audit report can be utilized to improve their understanding and analysis of a bank’s operations. The materials, which included case studies, were presented to the off-site and AMD staff to better acquaint them with the requirements of an external audit. • Consultation with the Banking Supervision Department (BSD) regarding staffing to perform the assessment and review of the external audit reports required by law to be provided to the BSD. • Continued consulting with the staff of the AMD to ensure that the commercial banks have booked the annual audit adjustments required by the external auditor.


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• Updating the audit matrix to reflect recent changes. 2. Finalize List of Revisions to Chart of Accounts At the beginning of Phase II work began on the improvements to the Chart of Accounts that was approved for the commercial banks in Phase I, with one of the LAAs reviewing the working files of commercial banks in order to identify problems encountered in previous periods Refinements needed in the Chart of Accounts and Accounts Description Manual, which were issued in 2001, were identified, finalized and consolidated as appropriate and recommended revisions in the form of a memorandum, delivered October 4, 2002. The primary needs identified in the memorandum were summarized as follows: • Some accounts should be eliminated because they were not applicable and were being misused, causing unreliable financial information. • Some accounts needed to be added to identify frequent or important events. For example, there was no separate account for goodwill, only a general account for all categories of intangible assets. • Some account needed to be added to enable the recognition of a provision of contingent liabilities, or an account for the related expense. • The incorrect or unclear descriptions of accounts and inconsistencies in the descriptions of accounts and legal and authoritative documents needed revision and clarification. • The incorrect illustrative or example journal entries for certain accounts needed revision. • The descriptions of certain accounts in which the Georgian terminology needed revision because the current language was misleading and caused accounting misclassifications. The proposed Chart of Accounts changes were presented for review and comment at an accounting seminar. While the memorandum included recommendations that would substantially improve the Chart of Accounts, the Chart of Accounts is a fluid document that will require constant revisions over time to keep in step with continuing changes in the Georgian bank industry. 3. Assist Accounting Methodology Dept. on Quarterly Large Bank Reviews During Phase II the project advisors regularly provided guidance and advice to the AMD, BSD Off-Site Department, and the System Risks Analysis Department (SSRAD) regarding reporting criteria and use of MIS supports. This was not affected when NBG moved the responsibility for reviewing commercial bank accounting data from AMD to


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the Off-Site Department in May 2003. The following are examples of advice and guidance provided by the advisors: • Requirements for consolidated reporting. The COP, AA and LAAs provided guidance to the AMD in its approach to consolidated financial reporting. This advice included a suggestion that the AMD conduct a survey in order to understand the number and nature of commercial bank subsidiaries before issuing a Consolidated Guideline. They also advised the AMD to consider a provision that would require annual consolidated reporting, as opposed to monthly or even quarterly consolidated reporting. Gathering empirical data related to subsidiaries of commercial banks needed to be completed and analyzed to determine the need for and impact of stringent guidelines. The completed analysis showed that few banks had subsidiaries requiring consolidation, so the issue was not a major one. The Head of Policy agreed with the advisors’ recommendation that annual audited financial statements, conducted in accordance with IFRS, which requires consolidated reporting, might satisfy the NBG’s needs in this regard. • Bank Accounting Report MIS Development. The Systems and System Risks Analysis Department (SSRAD) developed an alternative IT program to the project’s MIS software that would provide automatic download of data from call reports rather than having to input data manually. SSRAD designed the program to be integrated with the existing FinA structure. Project advisors advised BSD that it would be a mistake to completely forgo using the project MIS software, which has a proven track record of accuracy and functionality, and that it would be more prudent to continue using the MIS software, while developing the alternative program. Also, when developed, the FinA program should be run in parallel to the project MIS software for a couple of reporting periods to insure accuracy of the new program. The Head of Off-Site subsequently agreed to this idea, but commented that he trusted assurances of the SSRAD and requested the Project to provide training only on the technical aspect of accounting analysis without a primer on data entry for its MIS software. He did agree to have a few Off-Site staff learn the project MIS software and run it parallel to the new FinA program when completed. • The project’s accounting staff provided assistance in this task by: (1) assisting SSRAD staff in their development of an alternative to the project’s MIS Accounting Analysis software by explaining the accounting analysis and its output; (2) providing BSD Off-Site staff with a three-hour training tutorial on performing accounting analysis based on real data of a commercial bank; (3) holding weekly help sessions on issues of accounting analysis and showing how good MIS reports highlighted potential problems and irregularities; and (4) helping key Off-Site staffers learn the MIS software so they could run it in parallel with the FinA program when it was completed. By the end of Phase II, the project advisors had developed a number of data-analysis methods for the Off-Site Department’s use. These included the Uniform Bank Performance Report (UBPR) submitted monthly by the commercial banks; monthly Financial Analysis performed by Off-Site using UBPRs; Accounting Analysis performed


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prior to each large bank inspection - principally to alert On-Site inspectors to possible accounting problems; monthly Early Warning Reports, using UBPR data, that incorporate a series of “Triggers” and “Flags” to detect possible problem issues with commercial banks; and “Stress Tests” that are performed at least quarterly to determine how susceptible a commercial bank may be to certain economic changes. The last of these reports is shared with commercial banks for their use in developing policy to deal with drastic changes that could take place in relative short periods of time. 4. Finalize Accounting Regulations and Position Papers During Phase I, a Regulation on Accounting and Other Records and Internal Controls and a Regulation on Internal Audit Requirements were drafted and delivered. Since then, as the result of evolving international accounting standards and of discussions of the COP and the Accounting Advisor with NBG, these regulations have been modified and accounting guidelines and position papers have been written. This task is closely related to the Year 1 and 2 task of Issuance of a Regulation on International Account Principals discussed above. The Accounting Regulation was finalized when the Accounting Advisor delivered to NBG a revised version. The position papers, Accounting Guidelines for commercial banks, were developed for use by BDS in implementing the Accounting Regulation and International Financial Reporting Standards. The project made use of them in its accounting assistance to commercial banks in training classes, direct assistance and help desk function and in its training and advice to BSD staff and management. Complications, including a major problem with the accounting in the banks, were caused by a poor translation of the 2000 International Accounting Standards and were compounded because the 2000 IAS had been superseded by the International Financial Reporting Standards (IFRS), which made significant changes to the 2000 standards, none of which had been translated into Georgian. The project provided NBG with the most current version of IFRS so that NBG AMD promulgations related to commercial bank accounting and auditing, which include (1) NBG Accounting Instructions; (2) NBG Accounting Guidelines; (3) NBG IFRS Interpretations; and (4) NBG Discussion Papers, are in accordance with the most recent standards. 5. Provide Assistance in On-site Inspections Throughout Phase II project advisors provided assistance for on-site inspections consulting on a variety of issues, including:

• Acquisition accounting; • Mark-to-market valuation and the overall purpose of goodwill; • Impairment testing of assets; • Issues related to accounting for investments; • Establishing reserves for investment valuation; • Accounting for affiliates;


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• Accounting treatment of certain repossessed assets and loans; • Discrepancies between the accounting treatment prescribed in the on-site manual

for accounting for affiliates and IFRS providing the wrong NBG account numbers;

• Assistance in drafting final reports; • Accrual accounting for interest income and expense; • Matching depreciation expense with the related asset in the correct period; • Accounting for cash in outside offices; • Potential misclassification of leases; • Reporting of factoring income; • Accounting for income taxes; • Proper accounting for extraordinary items; • Correct accounting for items in suspense; • Accrual accounting for interest income and expense; • Provision expenses for possible loan losses; • Evaluation of investment accounts; • Proper accounting for income tax expense; and • Potential misclassification of leases.

LAAs held follow-up meetings regarding certain accounting issues and gave a follow-up seminar on external audits to on-site examiners. In addition, to improve the level of analysis performed by on-site inspectors, AA Canfield and COP Stroud developed a bank financial statement analysis concept paper for use by accountants and auditors of Georgian bank financial statements. 6. Offer Opinions and Analysis to AMD and Commercial Bank Staff This task is related to and overlaps with most of the other accounting tasks. Opinions written, and analysis provided, for other accounting tasks also help fulfill this requirement. It should be noted that during Phase II, after extensive discussions with NBG management, the accounting policy function was moved from AMD to the Off-Site Surveillance Department. The Accounting Advisor provided intensive training and advice to the Off-Site staff. Some examples of opinions and analyses provided include: • Written accounting analyses of the largest commercial banks were shared with the AMD on a regular basis. These analyses contained opinions and analyses regarding accounting issues. In addition, the information contained in the analyses was presented to the chief accountants and other accounting staff of the commercial banks. • Advice provided by the AA and LAAs to the AMD regarding year-end financial reporting and specific inquires concerning the proper accounting treatment for the sale of repossessed assets.


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• Advice, which the AA and LAAs continued providing to the AMD, regarding financial reporting in accordance with International Financial Reporting Standards. Specifically, AA and LAAs provided advice regarding audit engagement letters for 2002 year-end audits, which was submitted to the AMD, and consolidated financial reporting. 7. Assist Commercial Banks in Developing Internal Audit Function This function formally started during the first quarter of the Year 2 when two banks were chosen for internal audit function strengthening assistance. This was severely constrained with the departure of the Accounting Advisor and his staff in September of 2003. As on-ongoing effort during Year 1, LAAs responded to direct inquiries from commercial bank accountants regarding the usage of the Internal Audit Manual. Other specific activities undertaken during Phase II included revision of the NBG CAMEL Manual section on “Accounting, Record Keeping and Internal Controls Inspection Procedures.” This section includes procedures for evaluating the internal audit function in commercial banks. These provisions were updated to incorporate recent developments regarding internal auditing, including, but not limited to, the NBG “Regulation on Internal Audit Requirements for Commercial Banks” (which was issued on December 28, 2001), requirements promulgated in International Standards on Audit1 and the “Internal Audit in Banks and the Supervisor’s Relationship with Auditors” 2001 paper issued by the Basel Committee on Banking Supervision. The revised section contains guidelines for assessing the internal audit function of commercial banks. This enabled the project staff to evaluate the internal audit function of selected commercial banks. Analysis of the internal audit function was incorporated into the accounting analyses, which were shared with the AMD and on-site supervisors, as well as with commercial bank accounting staff during on-site inspections and follow-up meetings. Project advisors also developed a seminar on internal auditing that was given in June 2003 to commercial bankers and BSD staff members. Two banks were selected as pilots for development of internal auditing and controls, and the COP signed MOUs with confidentiality agreements allowing the project staff to advise them directly without conflict of interest. The COP and AA met with the General Manager of each bank, discussed the structure and the process in which the bank’s internal audit program is undertaken, planned the work between the project and the bank and executed the MOU. The AA and LAA then held several meetings with internal audit department staff of these commercial banks, for which the project is providing internal audit function strengthening assistance, and drafted Assessment and Recommendations Memoranda for each. 1 ISA 610, Considering the Work of Internal Auditing, contains provisions on scope and objectives of internal auditing as well as methodology for assessment of internal auditing.


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8. Provide Assistance to Commercial Banks Through the Help Desk As an ongoing effort in Phase II, AA Canfield and LAAs provided assistance through the commercial bank help-desk. The subjects of some of the inquiries responded to included:

• The use of and accounting for Nostro and Loro (Vostro) accounts; • The use of corresponding accounts for transferring funds; • The criteria for on-site bank inspections; • Remuneration for audit committee members; • IFRS treatment of contingent liabilities and accounting for regulatory capital: • Recognition and measurement of a foreign currency loan; • External auditors’ requirement for the establishment of loan loss reserves; • A commercial bank’s establishment of special purpose reserves; • The calculation and presentation of deferred taxes in the year-end financial

statements (IAS 12); • The preparation of cash-flow statements (IAS7); • Dividend payment policy; • Contingency accounting (IAS 10); • Whether the accounting for a transaction should be classified as a finance lease

(IAS 17), or as an installment sale; • The equity method of accounting for investments (IAS 28); • Accounting of impairment reserves (IAS 36); • Accounting for accumulated tax losses; • Accounting for investments in foreign currency; • Accounting recognition and measurement for credit card licenses by a commercial

bank; • Classification of an investment and valuation under IAS 39; • Questions regarding cash and cash equivalents; • Accounting for accrued interest income; • An extract from the NBG auditor’s management letter related to IAS 39; and • Accounting for contingent assets under IAS 37.

Inquiries of substance were documented and made the subject of a Discussion Paper or other pronouncement issued by the AMD to assist commercial banks. In support of the commercial banks and to promote the use of the help desk, the AA and LAAs delivered a two-and-a-half day accounting seminar in December of 2002 that was based upon quarterly Accounting Analyses, inspection reports and inquiries by commercial bank accountants. The scope of the seminar included the following topics: (1) accounting basics; (2) accounting for investments, acquisition accounting and consolidated reporting; (3) contingency accounting; (4) deferred tax accounting; (5) accounting events after the balance sheet date; and (6) review and comment session for proposed revisions to the Chart of Accounts. F. TRAINING INITIATIVES – SELECTED TOPICS FOR SEMINARS/PRESENTATIONS


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1. Presentation on External Audits In May 2002, COP Stroud and the local accounting consultants, made a presentation to the AMD and Off-Site Department staff on understanding and utilizing an external audit report. The intent of the class to show the supervisory staff how they can use an audit report to improve their understanding and analysis of a bank’s operations. 2. Seminar on Banking Laws & Regulations and Supervisory Policies With the concurrence and support of the COTR, the limited time available to the Legal Advisor in Phase II was instead used for a Judicial Training Seminar. This seminar was described as follows in the Phase I Final Report: “Project Advisors were invited by ABA/Ceeli and the World Bank funded Judicial Training Center in Tbilisi to teach seminars to judges during Phase II of the Project. The invitation results from the analysis and discussions of Project Advisors with USAID and others with the special need for accurate, impartial and swift enforcement of the NBG’s corrective actions.” LA McCormack discussed the invitation with COP Stroud, the USAID Economic Reform Advisor and the Director of the Judicial Training Center and developed seminar materials. At the Judicial Training Seminar on July 6, COP Stroud spoke about supervisory concerns resulting from legal action taken by banks to defeat NBG corrective actions; LA McCormack gave an overview of NBG mandate, experience in other countries, regulatory concerns and why disputes arising in administrative chambers which involve the banking business should be treated differently from commercial disputes. Local Legal Advisor Beruashvili presented lengthy illustrations of the most important parts of the amended banking legal framework as well as of the five most important NBG regulations. McCormack gave a presentation on the administrative law doctrines of judicial review and due deference to administrative agencies, such as the NBG. He closed with several case study examples of bank litigation in the US and elsewhere challenging regulatory decisions and summaries of the NBG’s authorities and efforts. The Seminar was well received and was very interactive at all stages. In November 2002, the project held a one-day New Capital Regulation Seminar for commercial bankers at the Bank Training Center. Thirty-three participants attended the seminar from 17 banks. After the seminar, the COP met with NBG Vice President and the Director of Bank Supervision to discuss the seminar and give them a copy of the seminar’s presentation and exercises. Overall, the seminar was successful and the participants indicated that they found it useful. Both the Vice President and Director of Bank Supervision indicated that they had received positive feedback concerning the seminar. Later, the Director told the COP that he was pleased with the seminar and had reviewed the materials developed for it and recommended that they be sent to all of the commercial banks.


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3. Computer Simulation for Banking Operations Presentation The fifth and final course of the accreditation program, the BankExec Seminar was presented from December 16 to 20, 2003. This program uses a computer simulation model allowing participants to play the roles of bank management. Participant evaluations indicated it as the best received seminar since the beginning of the Bank Supervision project. The instructor, Duane Stuker, a former head of training for the OCC, is very experienced in using the BankExec model, which is licensed by the American Banker’s Association. He was assisted by a number of the project’s staff including advisors, translators, and a financial analyst. COP and SA assisted throughout the week playing the role of major shareholders. It was the first project seminar to include participants from NBG Bank Supervision and Commercial Banks working together in teams. Participants were divided into six teams (“Banks”) and competed against each other with the winning team determined by a combination of the bank’s “Stock Price” and its “CAMEL rating.” The finale of the seminar involved each “Bank” presenting its’ case to a Board of Directors that included the Director and a Deputy Director of BSD, project USAID CTO, project advisors, and the Seminar Instructor on why they should be retained as “Bank” Management 4. UBPR/Ratio Analysis Training Program During June 2002, SA Franson and the local financial analyst conducted a 1½-day seminar on the recently developed UBPR. The seminar focused on introducing the UBPR to the Off-Site Division and the Policy and Accounting Division, highlighting the additional information the UBPR provides. Specifically, the seminar discussed the trend and peer comparison information that is now available to the analysts. A weeklong seminar on how to analyze a bank using the UBPR will be conducted at a later date. Overall, the seminar was successful. The participants were interested in learning about the UBPR and had numerous questions. In addition, they took the new tool seriously, challenged several aspects of the UBPR, and made recommendations that would be helpful to their work and analysis. 5. Training at US Regulator for On-Site Supervision Staff Members An NBG on-site supervisor was sent to a joint Federal Reserve – World Bank training program in Washington, DC in mid-October 2002. NBG management believed this was sufficient. It was agreed that other supervisors would be sent to the USA or other countries as opportunities arose. In addition, the COP arranged, with the assistance of World Learning and USAID, for three members of BSD’s staff to receive Anti-Money Laundering training in Athens from the National Bank of Greece during September 2003.


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During the final months of Phase II, the COP worked with a US Treasury Department Advisor, World Learning, USAID, and the BSD to arrange training in the U.S. for five member of the Financial Monitor Service. That training was scheduled to take place during May/June 2004, after the completion of our project. 6. IFRS Seminars for Non-Accountant Commercial Bankers In December 2002, AA and LAAs delivered a two-and-a-half day accounting seminar that was based upon quarterly Accounting Analyses, inspection reports and inquiries by commercial bank accountants. The seminar included the following topics: (1) accounting basics; (2) accounting for investments, acquisition accounting and consolidated reporting; (3) Contingency accounting; (4) deferred tax accounting; (5) accounting events after the balance sheet date; and (6) review and comment session for proposed revisions to the Chart of Accounts. Banks in attendance included: Intellect bank, Maritime Bank, Georgian Capital Bank, EA Bank, United Georgian Bank, Bank Credit, Georgian Bank, Basis Bank, Mercury Bank, Kavkasioni Bank, Microfinance Bank, Bank Tetri, Silk Road Bank and People’s Bank (a.k.a. Agroindustrial Bank). Of the 28 scheduled attendees, 25 completed the seminar. Participants and instructors regarded the seminar as highly successful, largely due to its interactive nature and use of IFRS problems and case studies based on Georgian bank transactions. In April 2003, AA and LAAs delivered an “Accounting for Non-Accountants” seminar. The seminar was well attended by thirty-three participants, including twelve from NBG BSD and Licensing Department. There were Twenty-one participants from commercial banks including: (1) Microfinance Bank of Georgia; (2) Bank of Georgia; (3) Tbiluniversal Bank; (4) Tbilbusiness Bank; (5) Intellect Bank; (6) Maritime Bank; (7) People’s Bank of Georgia; (8) Kavkhasioni Bank; (9) Caucasian Development Bank; (10) Georgian Capital Bank; (11) Gamma Bank; (12) United Georgian bank; (13) Republic Bank; (14) Georgian Bank; (15) TBC Bank; and (16) Ea Bank. Guest lecturers from academia, commercial banks, the Georgian accounting and auditing profession, and project COP all delivered seminar modules. Because the seminar completed the accounting portion of the inspector certification curriculum, an exam was given to the bank inspectors. Overall, the seminar was well appreciated by the participants. 7. Seminar on Internal Controls and Internal Audit Procedures An Internal Control/Audit Seminar was delivered during June 23-26, 2003. The seminar was well attended by 33 participants, including 10 individuals from BSD and 23 commercial bankers. In addition to the Advisors and LAAs, the seminar guest lecturers included internal audit heads from commercial banks, representatives from audit firms, BSD Methodology Staff, and three U.S. Treasury anti-money-laundering experts.


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8. Seminar on Anti-Money Laundering for BDS Staff and Commercial Bankers In June 2003, the COP assisted U.S Treasury, Office of Technical Assistance, and advisors to provide a four-day "Financial Crimes/Money Laundering Seminar." Several NBG Inspectors and representatives from commercial banks attended this training seminar. COP worked with the US Treasury Technical Assistance (USTTA) Advisor, the Director of the Financial Monitoring Service of Georgia and the Director of World Learning on Anti-Money Laundering training seminars. Four (4) sessions of two days each, were given by USTTA under USAID/World Learning sponsorship, from October 6 to18. Three sessions were reserved for monitoring entities (Commercial Banks, Insurance Companies, etc.) and one session for Regulatory Authorities (NBG, Securities and Exchange Commission, Ministry of Finance, etc.). During the final months of Phase II, the COP met with US Treasury Advisor, World Learning, FMS, BSD and GEGI to discuss particular Anti-Money Laundering training needs for Bank Supervision and Commercial Banks. Training of a group from FMS in the US was discussed in detail. World Learning and FMS worked directly together to continue this effort, scheduled for May/June 2004, after the end of the project. Additional AML training is envisioned to be in two parts. First an expert will come and work with a few commercial banks to train them on their current IT capabilities in responding to AML law requirements, and assess how their systems could be improved to meet these requirements. The second part of the training would be for BSD, FMS and bank staff to use updated IT capability, which hopefully will be funded at least in part by the USAID GEGI project, in performing AML inspections. A major benefit will be the ability to inspect for “series” interrelated transactions specifically designed to circumvent the law. With US Treasury Advisor assistance, COP developed several training points for inclusion in the RFP and provided to World Learning. 9. Corporate Governance Seminar for BDS Staff and Commercial Bankers The COP assisted World Learning in planning and organizing a Corporate Governance seminar of three sessions, two days each, held in Guadauri during the week of October 20-25, 2003. The US Treasury Advisor presented a segment on the “Geopolitical Consequences of Money Laundering for Georgia” and Bankworld COP presented a segment on “Corporate Governance as it Applies to Governmental and Supervisory Institutions” at all three sessions. Attendees included high-level management from commercial banks, various commercial enterprises, Securities and Exchange Commission, IFC and NBG. The seminar was highly appreciated. 10. International Financial Reporting Standard No. 39 Seminar for Banks & BSD


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In September 2003, COP, AA and LAAs delivered an accounting seminar “IAS 39 Financial Instruments: Recognition and Measurement” of one day each to Commercial Bank Accountants and NBG Bank Supervision staff at the Bank Training Center. The seminar was well received and appreciated by all participants. COP, AA and LAAs discussed IAS 39 treatment of troubled loan restructuring vis-à-vis the NBG draft On-Site Inspection Manual. 11. Help NBG take responsibility for BSD Staff Training & Accreditation During both phases of this project, USAID has provided most of the training for NBG BSD, either directly or by funding training activities. In March and April 2003, as the project was entering its final year, the COP started to discuss the need for the NBG to begin taking responsibility for the training function. During the year, NBG and Georgian instructors were used increasingly in the training seminars organized by the project. The Vice President of NBG, at the COP’s recommendation, signed letters to Commercial Banks and Georgian Professional Associations soliciting instructors for future seminars. The COP introduced the NBG staff to the use of assistance from other arenas, such as USAID’s World Learning, commercial banks, and professional organizations, including independent audit firms and universities, which should enhance the growth and quality of the NBG training effort. As examples of this new training activity, an International Financial Reporting Standards (IFRS) seminar was developed with instructors from internal NBG departments – primarily the Accounting Department; special ongoing English Language training is in progress; and, NBG’s Human Resources and External Relations (HRER) staff members are working with World Learning to arrange participation in its sponsored seminars, the first of which was a Financial Analysis Seminar that fulfills a BSD Accreditation requirements for selected attendees. In April 2003, Project Advisors met with NBG President, discussed the idea of a NBG training center and suggested NBG use the Bank Training Center staff for administrative and logistical support. In December of that year, the COP summarized his recommendations for a BSD training program in a memo to the Department’s Director. In it he pointed out the need for a training coordinator, a sufficient and dedicated training budget, identification of instructors, specialized training for different BSD areas, logistical support, management support, a work plan, a course list and continuation and integration into training of the Bank Supervision Accreditation Program developed by the project. He also gave the Director the project’s training information, including work plans, course lists, and test results. He also met with NBG Human Resource staff on several occasions to discuss training. Discussion focused on requirements for Mission Statement, Goals and Objectives, Action Plan development, training equipment needs list, major issues of budget, dedicated training staff assignments, need to develop cadre of training instructors and providers for


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in-country training, etc. The COP also arranged for representatives of the Human Resources and the External Relations Departments to get a full briefing from the World Learning Center on its process for setting up a training program. On-going discussions revealed that Internal Georgian training was managed by Human Resources, but External Foreign training by the External Relations Department, the workload of which was 90% training-related. The COP advised that this split hurt training effectiveness and increased costs. At the same time, a project-recommended employee training survey form was developed and sent to all NBG employees asking each about their perceived training needs and whether they would volunteer to be a seminar instructor, and if so in what area. The survey forms received back from several NBG departments were especially satisfying as many well-qualified staff expressed interest in serving as a seminar instructor. The use of internal NBG staff as instructors is just one of several ways the project recommended to provide quality training within limited budgetary levels. With the agreement of all, the COP wrote to the Director of Human Resources, with copies to the President and Vice President of NBG, recommending: (1) an NBG Council Resolution to combine all training and associated budget under a Training Director with dedicated staff; (2) an increase in training budget at the mid-year council meeting, as the current 2004 budget did not include local training needs for BSD (primarily since our project has been supplying this training and budget for past 5 years); and (3) formalizing the BSD Accreditation Program and recognition of staff who have completed the program to date. In this memo, the COP recommended appointment of a Training Director responsible for all training activities - with budget responsibility, a significantly increased training budget focused on local training, identification of participants – including some from other NBG departments and commercial banks for some courses, identification of instructors – preferably from NBG itself but also from Georgian Professional organizations and banks, World Learning, other USAID projects and foreign volunteers. Finally, the COP’s letter strongly suggested that the BDS Accreditation Program be formalized and incorporated in the training program. By the end of the project, establishment of an NBG training function to be managed by the NBG Human Resources and External Relations departments, both reporting to the same manager, was essentially complete. This has incorporated the transfer of the BSD training function to HRER. The COP assisted in getting agreement between BSD and HRER on of the content of previously Bank Supervision Project administered BSD Accreditation training program and its place as a key NBG training function. Although insufficient staff and budget constraints continued to be issues, both will be addressed at the mid-year 2004 by the management and council of the NBG.


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All HRER staff, to include the Director, addressed this issue with enthusiasm and commitment. Management support from the President on down has been extremely positive. Although the USAID Bank Supervision Project ended in April 2004, we are confident that a training effort can and will be sustained by the NBG. All at NBG were extremely complimentary about the assistance the project has provided, especially the training, and grateful for helping them to set up a professional training function. 12. Assist in Providing Anti-Money Laundering Out-of-Country Training In June 2003, at the Financial Crimes/Money Laundering Seminar, the COP met with two of the presenters from the National Bank of Greece (a commercial bank in Athens) and proposed the idea of sending several NBG inspectors and some FMS staff to their bank for training in anti-money laundering operation. Subsequent conversations led to the Greek bank agreeing to the training and funding and assistance from USAID/World Learning. Three members from the BSD did go for training at the National Bank of Greece and the Central Bank of Greece in September. All three stated that the training was very valuable and would be very helpful in their efforts to deal with Anti-Money Laundering in their respective roles. During the final months of the project, the COP worked with FMS, the US Treasury Advisor, World Learning, USAID and the US Embassy to make arrangements to send several staff from the FMS to the USA for money laundering training – primarily to FINCEN, Bank Regulatory Agencies, Federal Reserve, etc. The plan is to send 4-5 FMS staff members for 8-12 days to 1-2 cities (Washington DC and New York City). This training trip was scheduled to occur in May, after the end of our project. 13. Other Training In October 2003, the COP Assisted BSD’s System and System Risks Analysis Unit in developing and presenting a short “Stress Test” seminar to commercial bank attendees. The “Stress Test” is used by Bank Supervision to introduce economic changes (such as changes in Interest Rates, Foreign Currency rates and Asset Classifications) into the commercial banks financial reports. This will assist NBG and commercial banks in preparing contingency plans to deal effectively with these type events, should they occur. III. RECOMMENDATIONS FOR THE FUTURE Listed below are recommended areas for follow-up, during the year following project completion, to determine the effectiveness of the Bank Supervision and Enforcement Project’s advisory assistance.

• Accompany On-Site Inspectors on an inspection of a Commercial Bank to review their inspection skills and use of the project-developed On-Site Inspection Procedures.

• Review Commercial Bank monthly reports to the NBG to determine the accuracy

of data and use of appropriate reporting methodology.


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• Perform visitation(s) with Off-Site Inspectors to evaluate their skills in using the

Off-Site Manual in analyzing Bank Financial Reports.

• Perform visitation(s) with Commercial Banks to determine the extent to which International Financial Reporting Standards and International Audit Standards are being used.

• Perform visitation(s) with Off-Site Inspectors to evaluate their skills in analyzing

Commercial Bank Reports and accounting-related issues.

• Meet with NBG Management and discuss BSD’s overall performance as a consequence of skills gained from advisory efforts of the Bank Supervision Project. Discuss areas of expertise and/or skill needs that were not provided by the Bank Supervision Project.

• Meet with NBG Management and determine NBG’s effectiveness in continuance

of a professional BSD Training Program.

• Meet with NBG Management and determine the extent of the NBG’s ability to maintain a BSD dedicated professional accounting staff.

• Meet with NBG Management and determine the effectiveness of Laws,

Regulations, Policy and Procedures generated as a consequence of advisory assistance during the project, as well as the learned ability to generate additional needed legal, policy and procedural structures identified since project completion.

• Perform visitations with selected Commercial Bank Management’s and discuss

their view of BSD performance since gaining skills as a consequence of the advisory efforts of the Bank Supervision Project.

In addition to the above, the following areas may be looked at in the future: 1. Some type of Deposit Guarantee or Insurance system may be considered. We believe that the IMF is also interested in this.) 2. Anti-Money Laundering is going to become a bigger issue as time goes by and there is a real need for some training and advisory work to assist not only the NBG and commercial banks, but other entities, such as insurance companies, casinos, broker dealers, charitable organizations, micro-lending organizations, etc. 3. A Credit Bureau is something another project (GEGI) is working on, aimed primarily at the banking system in its initial stages. Assistance to the banking system will be needed to support this initiative. 4. Hedging transactions are beginning to be used to protect a bank's portfolio from extreme shifts in currency rates, interest rates, etc. Only a few banks, such as TBC, are


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actively involved in setting up such a structure. This is certainly an area the banks need to look at and will need assistance to implement. An example of where the need for hedging already arises is where the banks are so heavy "dollarized" on both sides of the balance sheet that a dramatic decrease in the value of the local currency could cause severe negative consequences to the system. 5. As the larger banks grow and look for capital, they will likely turn for funding to all types of securities transactions, such as different types of stock issues, subordinated debt, bonds, etc. Some of this will likely be coupled with some form of guarantee by organizations such as USAID, EBRD, IFC, or some local governmental group. There is need for assistance in this area to make banks aware of different options and to ensure that they choose one that is appropriate for their particular circumstance. This issue is also something to look at in the micro-lending organizations as well. 6. Corporate Governance is an area that needs pursuing beyond just training. Laws need to be reviewed for change and regulations issued to strengthen the authority of organizations like the NBG to be able to supervise in this area. In giving the seminar on Corporate Governance last year, it was evident that there is not a very good understanding of this issue by high-level leaders in government or private enterprise. 7. Training needs exist and many of them were noted in memoranda to the BSD and NBG Human Resources. Examples include: Corporate Governance, English language, computer skills, communication skills (reading, listening, speaking and writing), instructor training, etc. 8. Organizational Development is an area that is severely needed to provide assistance to organizations, such as NBG and commercial banks. The need is to have an outside party review their organization for functional and organizational compatibility. This review would include organizational alignment, delegations of authority, proper staffing and expertise, salary and benefit structure reflecting education, experience, and responsibility. This could also include an analysis of the internal control structure and establishment of a competent internal audit function. 9. Alternative Dispute Resolution (ADR) is an area of expertise that some assistance is needed to work with commercial banks (and other private enterprises) to learn how to resolve differences in ways other than through the cumbersome, corrupt and time-consuming court system or through violent action. There have been a few seminars on this issue and there is an organization of ADR specialists in Georgia, but it is not very active and there is little understanding of the mechanics of ADR, or the idea of arbitration (binding and non-binding), etc. 10. Marketing is probably one of the least understood skills and programs to enhance skills in the area of how to market your business or product are much needed not only by banks, but also by other commercial enterprises.

Attachments

ATTACHMENT A: MEMORANDUM OF UNDERSTANDING

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Attachments

ATTACHMENT B: YEAR 1 WORK PLAN AGREEMENT

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Attachments

ATTACHMENT C:

YEAR 1 MONITORING REPORT AND SCHEDULE OF COMPLETION

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Attachments

ATTACHMENT D:

YEAR 2 WORK PLAN AGREEMENT

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Attachments

ATTACHMENT E:

YEAR 2 MONITORING REPORT AND SCHEDULE OF COMPLETION

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Attachments

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Georgia Banking Infrastructure Development II Final Report

Documents

Transcript of Georgia Banking Infrastructure Development II Final Report