1

Task Forca për Integrim Evropian Task Forca za Evropske Integracije

Task Force on European Integration

Tavolina e Rrumbullakët “Ekonomi, financa dhe statistika” Okrugli Sto “Ekonomija, financije i statistike”

Thematic Round Table “Economy, Finance and Statistics”

Discussion material on

Kosovo financial services1

October 2012, Pristina

1 This discussion paper has been produced by Shar Kurtishi (an independent local expert), with the financial

assistance of the “Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH” through “Support to European Integration” project. Views presented here are of the consultant and do not necessarily represent the official position of GIZ, MIE or any other TRT participant in any detail.

2

Table of Contents

1. Introduction ............................................................................................................................................ 4

2. Banking Sector in Kosovo ...................................................................................................................... 4

2.1 Legal and Institutional Framework ........................................................................................... 4

2.2 Licence granting from the Central Bank.................................................................................... 5

2.3 Capital requirements ................................................................................................................. 5

2.4 Credit Risk.................................................................................................................................. 6

2.5 Quality of Loan Portfolio ........................................................................................................... 7

2.6 Overall review of the banking sector and loan portfolio ........................................................... 7

2.7 Banking sector sustainability .................................................................................................... 8

2.8 IAIS core principles .................................................................................................................... 9

2.9 Interest Rates ............................................................................................................................ 9

2.10 Electronic Interbank Clearing System ........................................................................................ 9

3. Insurance Sector in Kosovo ................................................................................................................. 10

3.1 Legal and Institutional Framework ......................................................................................... 10

3.2 CBK Licensing........................................................................................................................... 10

3.3 CBK Supervision ....................................................................................................................... 11

3.4 The sustainability of the Insurance System ............................................................................. 11

3.5 Status and challenges ............................................................................................................. 11

4. Financial Market (securities) ............................................................................................................... 12

4.1 Government Treasury Bills ...................................................................................................... 12

4.2 Status and Challenges ............................................................................................................. 12

5. Pension Trust Fund ............................................................................................................................. 13

5.1 FUND – Legal Framework ....................................................................................................... 13

5.2 About FUND ............................................................................... Error! Bookmark not defined.

5.3 Structure of FUND Investments ............................................................................................... 15

3

5.4 Status and Challenges ............................................................................................................. 16

4

1. Introduction

Kosovo’s economy has been one of the fastest growing European economies over the last five years

(together with Albania and Poland). In 2007 and 2008, it averaged about 6.6%, and after a drop in 2009,

it was able to recover in 2010 and 2011 when it reached rates of 4% and 5% respectively. GDP

projections for 2012 and 2013 foresee further economic expansion along a 4% growth trajectory.

This aim of this paper is to analyze Kosovo’s financial sector from the perspective of a possible investor.

Hence, special attention is drawn on the legal infrastructure of the sector, and the regulatory (Central

Bank of the Republic of Kosovo) requirements. The analysis is divided between the major sectors:

Banking Sector

Insurance Sector

Financial Market (securities)

Pension Trust Fund

2. Banking Sector in Kosovo

Kosovo has a considerably stable financial sector. The sector represents the most crucial source of

financing and is one of the most important pillars of stability for the country’s economy. The core of the

financial sector is represented by the banking system which is continuing to perform alike even when

compared to many banking systems with more history in the region and beyond.

As of its establishment, CBK has a licensing, regulatory and supervising authority over all financial

institutions in Kosovo, and as such it contributes towards the development and modernization of

financial sector in Kosovo. Currently, the financial sector in Kosovo consists of banking industry,

insurance industry, pension Funds and other financial institutions (microfinance institutions, non-bank

financial institutions, exchange bureaus for currencies and payments and money transfer institutions).

Very recently, the Government of the Republic of Kosovo started issuing Treasury Bills – a new

important sector added to the financial system.

The financial sector functions well by continuously and increasingly delivering new loans to firms and

households. The average amount of monthly new loans to the total economy has increased between

2007 and 2011 by 35%. In the same period average new investment loans to nonfinancial corporations

have increased by only 13% while average new consumer loans to households have soared by as much

as 84%.

Eight commercial banks continue to operate in Kosovo’s banking system, of which six are foreign owned

and two domestically owned. In June 2011, the foreign owned banks dominated the market with a share

of around 90% of total banking system assets, while domestic banks managed the remainder of 10%.

There are no specific conditions to open branches of/by foreign banks and consequently the foreign

owned banks presence is very high. The CBK applies international practices in the area of licensing,

regulation and supervision of the financial institutions.

2.1 Legal and Institutional Framework

Kosovo’s regulatory and supervisory framework has been gradually improved to meet EU standards,

both for banks and non-bank financial institutions. Very recently, the Law on Commercial Banks,

5

Microfinance Institutions and Non-bank Financial Institutions was passed and its implementation further

strengthens and better regulates the supervisory capacity of the CBK in its role as the financial sector

regulator and it contributes to the reinforcement of the internal governance of financial institutions

themselves. More importantly, the mechanisms of this law enhance the efficiency of licensing,

supervision and financial sector regulation.

Adding to the legal framework of the banking sector in Kosovo is the Law on Deposit Insurance as well.

Its approval has positively contributed to the growth of deposits with longer-term maturity and it has

also set up a very simply guarantee scheme (basically a percentage of the deposit is guaranteed). This

guaranteed percentage is expected to be increased in the near future; the CBK and other relevant

authorities are currently working on modifying the regulations.

The central bank’s capacity to provide emergency liquidity assistance (ELA) to banks is now near-

complete, with a memorandum of understanding between the CBK, the Ministry of Finance, and the

Assembly’s Committee for Budget and Finance governing the provision of ELA taking effect last year.

The Deposit Insurance Law (DIL) is being revised to ensure consistency with the new law. The revised DIL

will allow purchase and assumption transactions and it will maintain the narrow mandate of the deposit

insurance Fund, which limits its involvement in bank resolution, given that the law assigns this role

largely to the CBK.

2.2 Licence granting from the Central Bank

Criteria and conditions to obtain a license for exercising banking and financial activities by banks and

other financial institutions in the Republic of Kosovo are established under Law No. 03/L-209 on Central

Bank of the Republic of Kosovo and other sublegal acts adopted by the CBK. Pursuant to legislation

governing it statutory functions, CBK has authority to set criteria for licensing of financial institutions

and to reject those which do not fulfil these standards.

Licensing criteria established under legislation, aim at ensuring a fair financial market and regulated

through a process based on the principle of justice, honesty and equality. Licensing conditions and

criteria are of supervising character and do not intend creating barriers against investors.

The Central Bank adheres to its rules on granting licences to credit institutions and with the regulations

in place it insures continuous supervision. The credit institutions are to report regularly to their

regulator and adhere to the rules set forth by current regulations in order to sustain their license and

carry on their activities as endorsed when the license was granted. With its continuous supervision the

CBK insures that the credit institutions follow the rules and keep up with the requirements (capital

adequacy, investment policy, credit risk). The CBK has the authority to withdraw the licence at any time

given such rules and requirements are not met.

2.3 Capital requirements

The regulatory framework of the banking system was reformed through the recommendations of Basel

III package. The level of capitalization expressed by the capital adequacy ratio is one of the requirements

set forth from the CBK regulations for the credit institutions to adhere. According to CBK rules, banks are

obliged to maintain a minimum level of 12% of Capital to RWA ratio. Kosovo’s banking system continues

to be characterized with a high level of solvency, with a Capital Adequacy Ratio (CAR) which has

constantly exceeded the required minimum regulatory level.

6

Capital adequacy ratio represents one of the most important indicators of the banking system

sustainability, taking into consideration the fact that capital is considered to be the main pillar for

covering potential losses in case of negative shocks to the banking system. Furthermore, the structure

of capital in banking system contains a considerable level of Tier 1 capital, which shows a good quality of

Kosovo’s banking system capital.2

In addition to changes in calculation of the existing capital components, through Basel III it is

recommended that reporting on the capital indicators should be supplemented with a new ratio, namely

the Leverage Ratio. According to this recommendation, the ratio between Tier 1 capital and the total

amount of assets and off-balance items of a bank should be preserved at a level of 3% at minimum.

Through this ratio, banks will be forced to reduce the balance sheet financing through external debt.3

Although it takes time for these recommendations to be implemented, it is very important that Kosovo

as well is following the international standards for ensuring a sustainable banking system.

The capital of Kosovo’s banking system continues to have the shareholder capital and the profit earned

by banks as the main sources of financing. Banks have also started to use alternative ways to finance the

capital, where we can specify the increase of the use of subordinated debt, which is classified as a

component of Tier 2 capital. In addition to the value, another important element for the banking system

sustainability is the quality of capital possessed by the bank. The quality of capital, among the others,

has an important role to the credit ranking of banks, having direct impact on the external financing cost

as well as on the facilitation of banks to access external financing. The good quality of capital can also be

one of the factors enabling Kosovo’s banking system a constant increase of external financing, where

one of the present instruments is the subordinated debt as well.

2.4 Credit Risk

The high capital adequacy ratio continues to be a distinctive feature of Kosovo’s banking system,

contributing to the reduction of insolvency risk and strengthening the sustainability of this system. On

the other hand, the Central Bank has made important advances in the area of financial supervision.

Going forward, a priority is to build the capacity to provide emergency liquidity assistance to the banking

system.

On the other hand, lending activity of the commercial banks represents one of the main sources of

financing for the consumption and investments in the country. For this reason, the measures to evaluate

the credit risk and loan portfolio are essential. Initially, it shall be noted that CBK as the regulator of the

banking system has insured that the most important international standards in relation to the

recognition of bad debts and provisioning are in place.

Based on Basel Core Principle on effective supervision of banking system, in 2010, steps have been taken

towards capacity building for risk profile-based supervision in banking sector, aiming at a supervising

synergy which is expected to be reflected in a more effective coordination of micro-prudential and

macro-prudential supervision. Also, with purpose to establish as fair as possible the risk-based solvency,

2 CBK – Financial Stability Report Nr. 2, pg. 66

3 CBK – Financial Stability Report Nr. 2, pg. 25

7

good steps have also been taken in the insurance industry towards adoption of basic principles set forth

under Solvency II framework.

CBK reports show that Commercial banks operating in Kosovo in continuity have applied prudent

approach in risk management. In this context, banks proved to be cautious and conservative in the

management of liquidity risk, credit risk and solvency risk. The liquidity indicators, although marking a

slight decline, in continuity have proved to be at satisfactory levels to make the banking system capable

of fulfilling short term liabilities. Regarding the credit risk, deterioration in the credit portfolio quality

was observed, but it should be emphasized that non-performing loans continue to be well covered by

loan provisions. This implies that the current level of non-performing loans does not represent any

serious threat to the banking system sustainability.

2.5 Quality of Loan Portfolio

Kosovo’s banking system continues to be characterized as one of the systems with the best quality of

loan portfolio within the regional countries. The prudent approach applied by the banking system of

Kosovo to maintain its sustainability is also expressed through the persisting high level of capital

adequacy ratio, which kept the insolvency risk at low levels. Liquidity and credit risk are evaluated

through loan to deposit ratio, the ratio between liquid assets and total assets, the ratio between liquid

assets and short term liabilities, through liquidity gap analysis, the level of indebtedness, the share of

non-performing loans. Solvency risk on the other hand is evaluated through the capital adequacy ratio,

Tier I capital, and risk-weighted assets.

Parallel to the analysis of the actual state of banking system exposure to credit risk, liquidity risk, and

solvency risk, the stress-test analysis represents an additional tool through which it is assessed the

sustainability of the sector against potential shocks, both in credit portfolio and in liquid assets.

The superintendence of banks follows a risk-based supervision model under the framework of Basel I,

assessing banks according to CAMELS indicators (capital, asset quality, management, earnings, liquidity,

and risk sensitivity). For subsidiaries of foreign banks this assessment is carried out jointly with home

country supervisors. It contains at least one comprehensive on-site inspection per bank each year as

well as permanent off-site surveillance. Significant advances are also being made in the area of stress-

testing, with an in-house stress-testing model being developed.4

2.6 Overall review of the banking sector and loan portfolio

Kosovo’s financial system has grown rapidly over the past decade. Financial sector assets reached about

73% of GDP by end-2010, from 33% in 2003. The system is dominated by banks. In spite of rapid growth,

banks have managed to maintain a prudent Funding structure. By end 2010, deposits, mostly from

households, accounted for about 87% of banks’ non-equity liabilities. Half of the deposits are long-term.

Private sector credit stood at 35% of GDP in 2010. Reflecting the nascent state of the industrial sector,

about 80% of loans were allocated to retail trade, other services, and households. The international

financial crisis had only limited effects on the banking system, given banks’ low foreign exposures.

4 IMF Country Report No.11/210, pg.13

8

Overall, given Kosovo’s relatively low degree of economic integration in terms of exports and

international finance, economic growth performance over the recent years was only moderately

affected by the global economic crisis and the crisis in the euro zone.

The total value of loans issued by the banking system in Kosovo amounted at euro1.6 billion in June

2011 (34.3% of GDP), which represents an annual growth rate of 15.7% compared with the growth of

9.7% in the same period of the last year. This shows that lending activity of banks in Kosovo returned to

two digit growth rates, after the slowdown period that emerged due to the shocks in the global

economy in the last two years.5

Conclusively, Kosovo’s banking system has remained profitable, liquid, and well-capitalized, although

financial strength varies across banks. Aggregate capital adequacy for the banking system stood at

17.5% at end-January 2012, well above regulatory requirements. 5.9% of loans were non-performing,

down from 6.3% a year earlier.

As regards microfinance institutions, the law assigns the CBK the responsibility for licensing and requires

microfinance institutions to have a clearly defined ownership structure. According to IMF’s Country

Report, microfinance institutions hold less than 5 percent of the financial system’s assets, but play an

important role in reaching parts of the population with limited access to banking services.

2.7 Banking sector sustainability

Referring to World Bank’s Country Partnership Strategy, Kosovo’s financial system has proven quite

resilient to the global financial crisis, and its regulatory and institutional framework has been

substantially strengthened. The financial system is largely deposit-Funded, mostly from large and

relatively stable remittance inflows. However, structural financial sector vulnerabilities exist as bank

assets are highly concentrated, leading to a lack of competition and high interest rates. As a result,

Kosovo’s banking system has one of the lowest loan-to-deposit ratios in the region.

Additionally, banks rely excessively on Government deposits. In recent years, Kosovo’s regulatory and

supervisory framework has been gradually improved to meet EU standards, both for banks and non-

bank financial institutions. In addition to strengthening financial system supervision, there is a need to

improve access to affordable financial services, especially outside the capital city and for small

enterprises. Research indicates that access to credit is seen as a major obstacle by businesses in Kosovo.

Only about 10% of investment is financed by credit, and over 85% of investment is financed from own

resources.

Further strengthening of banks’ risk management practices is a necessary step in order to increase

banks’ willingness to lend. In addition, it is critical to develop and strengthen micro-finance institutions

that have the potential to lend to farmers and other rural entrepreneurs. This would involve, inter alia,

transforming existing non-profit foundations into more sustainable, for-profit financial intermediaries

and raising awareness of the potential roles of small entrepreneurs in mainstream economic activities.6

5 CBK Fiscal Stability Report No.2, pg.46

6 WB - Kosovo Country Partnership Strategy 2012 – 2015

9

2.8 IAIS core principles

Licensing and Methodology Directorate in its licensing and regulating activity for commercial banks,

insurance companies, intermediaries, supplementary pension Funds and other financial and non-

financial institutions, is guided by principles which are in compliance with the European Union directives

and the best international practice, as presented under “Core Principles for Effective Banking

Supervision” published by the Bank for International Settlements (BIS), and Core Principles for Effective

Insurance Supervision published by the International Association of Insurance Supervisors (IAIS). 7

2.9 Interest Rates

Year 2011 was characterized with the decrease of interest rates both in deposits and loans.

Consequently, the interest rate spread declined from 10.9% as it was in 2010 to 10.6% in 2011. With a

further improvement of overall business environment and increase of banks efficiency, loan interest

rates are expected to continue decreasing.

Whereas the CBK is the main institution for financial market regulation and supervision in Kosovo, due

to Kosovo’s use of the euro as official currency, the CBK has only limited policy instruments at its

disposal, such as reserve and liquidity requirements. In the absence of autonomous monetary policy and

given the fully euroised economy, real interest rate and real (effective) exchange rate movements

remain difficult to predict. Uncertainties regarding property rights and weak rule of law continue to be

the main factors for the high risk premiums demanded by the commercial banks.8

According to the same report, while Kosovo’s financial system has evolved rapidly, further progress was

impeded by high risk costs, limited legal capacity, and limited availability of collateral for lending

operations. These constraints keep interest rates high and prevent financial intermediation from

spreading to wider parts of the population. Furthermore, market concentration may also contribute to

elevated lending rates. However, the uneven distribution of profits across banks, relatively low fee

income, aggressive attempts by new entrants to gain market share (notably subsidiaries of Turkish

banks), and substantial increases in deposit rates during the financial crisis suggest insufficient

competition may not be the most important factor.

On the other hand, the legal system continued to suffer from poor accessibility and efficiency. Weak

enforceability of contracts remained one of the main concerns of companies and investors in Kosovo. It

is also one of the factors explaining the relatively high interest rates charged by commercial banks to the

private sector.

2.10 Electronic Interbank Clearing System

Development of an efficient, safe and sustainable national payment system, as a key standard of the

financial infrastructure, is one of the CBK’s primary functions. Electronic Interbank Clearing System

(EICS) operated by the CBK is the only interbank payment system in the Republic of Kosovo. EICS

functions as a hybrid system which enables interbank channelling of a wide range of payment

instruments.

7 CBK 2010 Annual Report, pg. 58

8 Progress Report, 2009, pg. 23

10

During 2011, an increase was marked in the volume and value of EICS transaction ratio and further

advancement of the system was carried out. The constant increase of the volume and amount of EICS

transactions reflects the relative payment increase without cash and the increase of confidence in the

domestic banking system.

There are some specific types of EICS transactions, such as regular (individual and massive, priority

(individual and massive), Kos-Giro and Direct Debit. Regular payments (individual and massive) compose

around 87.5 percent of the EICS transactions volume and around 69% of the EICS transactions value.

Considering the general development of the system and its supervision, it must be noted that the

National Payment Council (NPC) was constituted to support the development and growth of sustainable

efficient clearing and settlement systems to settle payments and securities in Kosovo.

3. Insurance Sector in Kosovo

Developments in other financial sectors in Kosovo, namely insurance companies, microfinance

institutions and financial auxiliaries, have a considerably lower impact on the overall developments in

the financial sector, as a result of their low share in the total financial sector. The main activity of

insurance companies continues to be the Third Party Liability (TPL) insurance, which generates the

largest part of the received premiums.

3.1 Legal and Institutional Framework

In 2011 the Law no. 04/L-018 on Compulsory Motor Insurance liability entered into force. Upon entry

into force of this law, in September 2011, the CBK in coordination with the insurance industry and other

relevant actors established Kosovo Insurance Bureau (KIB).

According to IMF’s latest Technical Memorandum of Understanding, Kosovo is moving ahead with the

reforms of the insurance sector, for which the CBK is the regulator. IMF conducted a full assessment of

the insurance core principles (ICP) with World Bank assistance. A new resident advisor, financed by the

U.S. Treasury, is working with the Insurance Supervision Department of the CBK on reviewing the

statement of duties for the CBK’s insurance supervision department, reviewing prudential requirements

(for current and future reports) as well as the legal framework, and implementing a new on-site

supervision manual for life and non-life insurance, including implementation of key actions as

recommended from a World Bank report. 24.9

Referring to current legal infrastructure, only pension insurance for the employed is compulsory.

3.2 CBK Licensing

The Insurance Supervision Department of the CBK is responsible for the supervision and regulation of

the insurance industry in Kosovo. Licensing criteria are established under the current legislation and

general principles do not differ from the ones described above on the banking sector.

According to CBK Licensing and Regulatory Framework, the duty of the Licensing and Regulation

Department is to complete the legal framework on financial supervision in accordance with the

European Union Directives and the best international practices, as presented under “Core Principles for

9 IMF - Letter of Intent, and Technical Memorandum of Understanding, 12 April 2012, p6-7

11

Effective Banking Supervision” published by the Bank for International Settlement (BIS), and “Core

Principles for Effective Insurance Supervision” published by the International Association of Insurance

Supervisors (IAIS). In accomplishing this mission, the Licensing Department is responsible for receiving,

reviewing and recommending the applications of institutions applying for licensing, respectively

registration to operate in Kosovo, such as commercial banks, insurance companies and insurance

intermediaries, pension Funds and all the other non-bank financial institutions.

3.3 CBK Supervision

Apart from regular reporting designed from the CBK rules, with the aim of in protecting the

policyholders’ interests, the insurance supervisory department actively performed a risk-based

supervision, conducting on-site examinations and off-site examinations.

Monitoring of insurance companies is done through the Reporting and Analysis Division (RAD) in a

systematic way and in standardized forms, issuing regular monthly, quarterly and annual analyses

pursuant to the CBK internal regulations, based on the IFRS standards and IAIS practices. RAD prepares

reports for the CBK Board on regular monthly basis, it monitors the financial performance of insurance

companies, it calculates the minimum margin of solvency, liquidity and the other risk indicators.

3.4 The sustainability of the Insurance System

Solvency for Kosovo insurance industry is regulated under the CBK Regulation No. VIII. Based on the

financial reports as of 31 December 2011, Kosovo insurance industry is solvent by euro 27,957,180 and

compared to 2010 this solvency increased by 32%.

During 2011, the insurance industry in general resulted in sustainable liquidity indicators. Given that

Kosovo insurance market has a growth tendency of voluntary products, the insurance companies

underwrite large risks by transferring the part of the premium and the claim to the reinsurance

companies. During 2011, the part of ceded premium in total gross written premiums is 12% whereas in

2010 it was 9%. This growth trend of ceded premium is a very positive indicator which is mainly a result

of the trend growth of voluntary products.

3.5 Status and challenges

Although the system of insurance companies has continued to expand its activity, the insurance

companies manage only 3.1 percent of total financial sector assets. During 2011 the number of

insurance companies that operated in Kosovo was thirteen, of which ten non-life insurance companies.

The ownership structure is still dominated by companies with foreign-owned capital. Gross written

premiums marked an increase of 4 percent compared with the previous year, with the major part of the

total portfolio of the gross written premiums belonging to the compulsory motor liability insurance. The

ownership structure of insurance companies remains similar with the structure of the previous years,

where 8 insurance companies are foreign-owned, and the rest of three others are of domestically-

owned. Assets of foreign-owned insurance companies represent e 77.5 of total assets of this sector.

The performance ratios of the insurance companies have been generally positive. Payments for TPL

policy holders comprise the largest share of paid claims (68.2% of total paid claims), whereas a share of

28.7% consists of payments for voluntary policies.

12

4. Financial Market (securities)

The financial securities market is barely developed in Kosovo. The activity of financial institutions in

Kosovo continues to be concentrated in the provision of traditional financial services, whereas more

sophisticated financial instruments still have not taken place in the country’s financial sector.

There is no central securities register and one is not expected in the near future, thought it is part of the

CBK’s strategy on the further development of the financial market in Kosovo.

4.1 Government Treasury Bills

Only recently, the Ministry of Finance together with the CBK issued the regulation on the Primary and

Secondary Markets for issuance of Government Securities. Since the beginning of year 2012, the

Government has been issuing T-bills with short term maturity of 91 days.

Government securities are issued on a competitive and non-competitive basis. In competitive tenders,

successful participants are allocated securities at prices quoted, while in non-competitive tenders,

participants are price takers, i.e. government securities are allocated at a pre-determined price.

The following documents, approved by the Central Bank and Ministry of Finance, represent the

Fundamental basis for the start of operation: Regulation for Primary and Secondary Market of

Government Securities, and Agreement on Primary Dealers.

Central Bank of Kosovo has established the Securities Division within Asset Management Department to

implement the Government’s Project on debt issuance. As fiscal agent, Central Bank of Kosovo shall

conduct auctions of government securities. This activity is enabled through CDS system. The Central

Depository Securities (CDS) system will have the following functionalities:

a) issuance, registration, transfer, and management of dematerialized securities;

b) redemption;

c) settlement of transactions;

d) monitoring of participants;

e) payment of interest on government securities worth.

4.2 Status and Challenges

The Government Treasury Bill’s market is on its early development, and is currently functioning on the

primary market only. The Kosovo Pension Trust is the main investor, as regulations regarding its

investment policies were also adjusted with the issuance of Government T-bills in order for this market

to start developing. Commercial banks are the other part of the investors, though with e very small

percentage invested of their total assets.

Consequently, Kosovo faces numerous challenges before its financial sector is fully developed. The

issuance of Government Treasury Bills is a good start; however it remains to be seen on how it will

progress. The biggest challenge is undoubtedly the establishment of the local stock market and then its

cooperation and integration into the EU stock market. The establishment of the legal infrastructure

would be the first step.

13

5. Pension Trust Fund

The pension system in Kosovo is composed of three pillars:

In addition, there is Pillar III - a voluntary pension schemes whereby employers may also provide Supplementary Employer Pensions to their Employees, or individuals may purchase Supplementary Individual Pensions through Pensions providers. Vulnerary pension scheme presents an option for businesses and other financial institutions, and can be funded from employers’ contributions and employees.

Pillar I includes pension schemes financed by the state budget:

a. Basic pensions include the entire population of Kosovo from the age of 65. b. Pension which is based on contribution and age includes former pensioners over 65 years. This is based on payments of contribution made from former pension system of over 15 years experience of contribution. c. Pensions for persons with disabilities. d. Early Pensions of mining of the Complex ―Trepca‖. e. Pensions of former members of the Kosovo Protection Corps (KPC). f. Implementation of international conventions from personal and disability pension based on agreements between the former SFRY and the signatory countries, which partly apply to the renewal of new agreements with the Republic of Kosovo.

Financing of the Pillar I of pension system covers all elderly Kosovars aged over 65. Monthly financial amount offered provides the minimum for the existence of the pensioner. Since this financing is solely made from the Kosovo budget, the amount of pensions depends on the financial sustainability of Kosovo budget, as well as International Monetary Fund and World Bank.

Pillar II:

a. Includes pension savings in individual accounts mandatory for all employees working in Kosovo over the age of 18 years, based on participation with contributions of 5% of gross salaries of employees, 5% of the employer and benefits from the investment (individual savings capitalism). An advantage of this system is that employees take individual responsibility for pension savings. b. Pension savings are administered by an independent institution, Kosovo Pension Savings Trust (KPST), which is responsible for decisions regarding the investment of deposits and provision of individual accounts. Trust is licensed and supervised by the Central Bank of Payments (CBK). The Board of KPST is appointed by the Assembly of Kosovo.

Pillar II provides to future generations a sustainable pension through pension savings in individual accounts mandatory for all employees working in Kosovo over the age of 18. This is based on contributions from 5% of gross salary of employees, 5% of employer and benefits from the investment.

Pillar III:

a. Supplementary pension system (additional voluntary) stimulated by tax concessions from the state. b. Additional voluntary private scheme which may be established by employers as a benefit for their employees, from their pension contributions. c. The third pillar includes formal employees and self-employed. d. Supplementary system in Kosovo that currently operates in the market is the Slovenian – Kosovo Fund.

This pension scheme presents an option for businesses and other financial institutions, and can be funded from employers’ contributions and employees. Stimulated by tax concessions from the

14

state, is foreseen that in the future will complement the first and second pillar.10 According to the Law no. 04/L-101 on Pension Funds of Kosovo, only the Trust and Supplementary Employer Pension Funds or Pensions Providers licensed by CBK for this purpose may provide a Pension in Kosovo under pillar III.

5.1 The Trust – Legal and institutional Framework

The Trust was established in August 2002 in order to manage and administer mandatory and voluntary pension contributions of employees in Kosovo. With purpose of advancing the existing legal infrastructure on licensing, supervision and regulation of Pension Funds, the Law no. 04/L-101 on Pension Funds of Kosovo has been approved by the Assembly and entered into force on 30 March 2012. The Trust is an independent legal entity, under the supervision of the CBK, established according to the model of defined pension contributions, where each contributor has its savings in a personal account. While savings remain a property of pension contributors, savings are to be used only for retirement purposes.11

The new law establishes the competencies of the Pension Savings Trust in the management, administration and investments of participants’ pension assets, and also prescribes licensing, supervision and investment of the additional pension funds of the employer and the additional individual funds. In this light, the Trust ensures a prudent investment and protection of pension assets and paying out flows from individual accounts for purchase of annuities for pension savings, as a trustee management acting on behalf of contributors and its beneficiaries.

The Trust has 5 departments: i) Client Relations, ii) Finance, iii) Public Relations and Training, iv) Human Resources, and v) Information Technology, whose functions are to keep records of the contributions, manage personal accounts, provide client services, and inform the public effectively. The Trust employs 27 professionals who permform functions in receiving and processing contributions and providing advice and support to contributors.12

The pension system in Kosovo is universal and includes all groups living in Kosovo, without discrimination on the basis of gender, race and nationality. Criteria established by legal acts do not exclude and there is no possibility of excluding certain group from the right to pension. However, due to general awareness on the benefits of the system and informal economy inclusion of all employees in the pension system remains a challenge, including the reconciliation of data between the TAK and the Trust.

In May 2010, Tax Administration has launched the electronic declaration service for declaration and payment of income tax and pension contributions. By the end of Q2 around 90% of businesses have moved on to new monthly and electronically reporting system. The Trust has launched an electronic service (eTrusti) improving the desigt, the design and the service as well as enable easier and faster communication between the Trust staff and its contributors.13

The Trust is run by the Governing Board which oversees the functioning of the Trust, provides guidance, has the exclusive responsibilities over policies and investments, and is responsible for making all policy with the input and advice from the Managing Director and staff.14 The Board is composed of 8 members: 4 professional members, 2 representative members (each representing employees and employers), 1 representative of the Government with no voting rights, and 1 representative of ICO (position to be

10

Answers to the Questionnaire of the Feasibility Study, June 2012, pg.363-365 11

Official Trust Website <http://trusti.org/index.php/en/about-the-trust-> 12

Official Trust Website http://trusti.org/index.php/sq/funksionet-dhe-pergjegjesite 13

Official Trust Website http://trusti.org/Dokumentet/Newsletters/Trustorja/TM2_2012_eng.pdf 14

Official Trust Website http://trusti.org/index.php/sq/bordi-

15

filled by the Selection Committee). In June 2012 Kosovo Assembly approved the member’s reappointment and appointment of the Board members, with with a 3-year term starting from August 2012.15 The Board has published the annual report for 2011 and submitted to the Assembly.

The pension contributions are made with the aim of increasing the value of pension savings of contributors, and in the long runenabling the best possible pension on their retirement. The Trust investments are done in different asset classes, markets and industries, to reduce the possible investment risk. It is foreseen that the minimum payment of pension contributions can not be lower than the minimum wage in the country. The Trust has informed the Tax Administration of Kosovo (TAK) and this has been implemented since July 2012, meaning that pension contributions in Kosovo cannot be below the minimum wage levels, i.e. there will be no pension contributions paid for salaries under 130 EUR for employees under 35 years, nor for the salaries of 170 EUR for employees aged between 35 and 65.16

5.2 Structure of the Trust Investments

The Trust is an independent institution, which is vital for the success of its functioning and investments. Decisions on investments are isolated from political influences and are made only on the basis of financial prudence.

The Trust has employed professional asset management firms (Vanguard, AXA GILB, BNY Mellon, Aquila, Schroders, CBK, State Street, European Credit Managment, Raiffeisen Bank, NLB Prishtina), who must themselves meet strict criteria in terms of professionalism, capital strength and independence. These asset managers are responsible for making individual investment decisions, which meet instructions given by the Board. Asset management firms are appointed following a selection process using best international practice.17

The investment structure is set forth by the Investment Policy which is formally reviewed at each Board meeting and the principles outlined are in coherence with the Law on Pension Funds in Kosovo.18 The assets are invested in accordance with the following explicit criteria:

Investing assets in a secure and safe manner;

Investments are in various financial instruments in order to ensure diversification;

Maximum return, consistent with security of Pension Assets;

Maintenance of adequate liquidity, investing assets in easy-to-sell financial instruments.

Pension system is an important component of the financial sector in Kosovo contributing with 17 percent of the total financial sector assets.19 Around 99.4 percent of total pension system assets in the country are managed by the Trust, while the remaining 0.6 percent is managed by the Slovenian-Kosovo Pension Fund. During 2011 pension fund assets recorded an annula growth of 20.2 percent amounting to 593.3 EUR milion.

20

The number of contributors (399,075 participants in second quarter of 2012) and the values of pension contributions continue to grow, followed by the positive rate of return on their investments. According to the Trust Investment Results the second quarter of 2012 was characterised with negative balance due to the debt crisis in several EU countries and large fluctuations in the global financial markets21; however

15

Quarterly Bulletin of Kosovo Pension Savings Trust Year V – Number 17 - Q2 2012 16

Official Trust Website <http://trusti.org/index.php/sq/ndryshim-me-rendesi-ne-ligjin-per-fondet-pensionale> 17

Official Trust Website < http://trusti.org/index.php/en/principles> 18

Official Trust Website < http://trusti.org/index.php/en/investment-policy> 19

Answers to the Questionnaire of the Feasibility Study, June 2012, pg.197 20

CBK Annual Report 2011, pg.33-56 21

Official Trust Website < http://trusti.org/index.php/en/rezultatet-e-gjysmevitit-te-pare-nga-investimet>

16

for the first half of year 2012, there is a positive return in the value of 19 million Euros. Positive investment results, altogether with the new pension contributions made that Trust at the end of this six months period has 654 EUR millions under the management.

During 2011 there was a shift of investments from securities towards stocks and other equities, primarily due to pension funds.22 A significant part of investments are concentrated in investment funds that diversify their portfolio in different instruments and countries. A relatively high share of investments in the foreign markets is represented also by bonds, bonds related to inflation and the money market. In the economy of Kosovo, until the end of 2011, the Trust invested 5.9 percent of its total assets mainly as bank deposits.23 With the issuance of Government Treasury Bills, the pension rules regarding pension asset investments have also been modified. Only recently, the Trust informed the public that they have invested 14 million EUR on these short-term Government T-bills.

Below are assset allocations as of 31.08.201224

Institution Aset class Assets Percentage

Vanguard Equities € 253,053,607.73 35.99%

AXA GILB Inflation Linked Bonds € 102,895,905.03 14.63%

BNY Mellon Mixed € 75,847,575.44 10.79%

Aquila Diversified € 74,670,748.70 10.62%

Schroders Bonds € 63,275,976.58 9%

BQK Not invested € 31,964,065.83 4.55%

State Street Equities € 30,601,584.22 4.35%

European Credit Managment Credit Markets € 21,564,688.89 3.07%

Raiffeisen Bank Certificates of Deposit € 19,162,696.44 2.73%

NLB Prishtina Certificates of Deposit € 16,282,526.26 2.32%

Bonds of the Kosovo Government

Bonds € 13,823,733.72 1.97%

Just for comparison reasons, a positive performance during 2011 was also recorded by the Slovenian Kosovo Pension Fund (SKPF). SKFP is the other pension Fund licenced by the CBK that operates as a Suplementary Pension Fund. The value of the SKPF share in 2011 increased by 4.1 percent while the SKPF investment strucutre is dominated by funds invested in bonds (about 75/5). The remainder of over 20 percent consists of investments in bank deposits. A relatively small part of assets under SKPF management are invested in stock markets and cash.25

5.3 Status and Challenges

The total value of assets under the Trust management has been increasing dramatically. However, the return on investment has been quite low when compared to the region. In addition, the regional countries have chosen a market oriented approach to the mandatory fully funded pillar, whereas Kosovo remains the only country to have not taken the path of opening the market. Hence, Kosovo has

22

CBK Annual Report 2011, pg.55-56 23

CBK Annual Report 2011, pg.56 24

Official Trust Website http://trusti.org/index.php/sq/alokimi-i-mjeteve 25

CBK Annual Report 2011, pg.56

17

not liberalised the market of Pillar II and therefore the market model remains a key challenge. Moreover, the pension annuity payouts remain another challenge, as ones the saver reaches the pension age their assets are not transferred into an annuity fund; rather they are transferred to a commercial bank for a pre-defined phasal withdrawal.

Furthermore the strategic orientation for liberalising the Pillar II, investment policies as well as the annuity payout model choosen remains the key challenges of the mandatory fully funded scheme. In this regard there are plans to standardise the legislation (approximation of legislation with EU directives and international standards), increasing competition in Pillar III, and liberalisation of Pillar II.26

Fondin e Kursimeve Pensionale te Kosovës FKPK(Ish Trusti i Kursimeve

Pensionale i Kosoves)

Raporti Mujor Statistikor për Fondin e Kursimeve Pensionale te Kosovës FKPK per muajn Gusht-Shtator 2012

Investimi i Mjeteve Gjendja e mjeteve me 31/08/2012 Gjendja e mjeteve me 30/09/2012 Ndryshimet e vlerave Pjesëmarrja e aseteve të

menaxherve ne total asetet ne

% për Gusht

Pjesëmarrja e asseteve të

menaxherve ne total asetet ne %

për Shtator

Pasuria Çmimi i njësisë Pasuria Çmimi i njësisë Ndryshimi ne vlera Ndryshimi në % i

çmimit të njësisë

Vanguard 247,901,536 10.3336 253,053,608 10.5462 5,152,071 2.02% 36.04% 35.99%

Schroders 62,762,821 143.1000 63,275,977 144.2700 513,155 0.81% 9.12% 9.00%

ECM DEC 21,516,805 85.1982 21,564,689 85.3878 47,883 0.22% 3.13% 3.07%

BNP Paribas 3,745,349 1.0782 - - - #DIV/0! 0.54% 0.00%

AXA GILB 103,590,499 139.8000 102,895,905 139.2500 (694,594) -0.39% 15.06% 14.63%

Aquila 74,180,178 107.0413 74,670,749 108.9953 490,570 1.79% 10.78% 10.62%

BNY Mellon 75,071,467 1.0991 75,847,575 1.1141 776,108 1.35% 10.91% 10.79%

State Street 29,466,912 17.7865 30,601,584 17.9961 1,134,672 1.16% 4.28% 4.35%

Kosovo T-Bond 12,526,288 13,823,734 32,557 1.82% 1.97%

RBKO 19,127,632 1.1794 19,162,696 1.1799 35,065 0.04% 2.78% 2.73%

NLB 16,235,174 1.0858 16,282,526 1.0863 47,353 0.05% 2.36% 2.32%

BQK 21,766,584 31,964,066 3.16% 4.55%

Totali mjeteve 687,891,245 703,143,109 7,534,842 100.00% 100.00%

Dhe Fondi Slloveno Kosovar I Pensioneve

26

Answers to the Questionnaire of the Feasibility Study, June 2012, pg.168

18

Fondi Sloveno-Kosovar i Pensioneve Vlerat e Kontributeve për shtator 2012

31/08/2012 30/09/2012

Çmimi njësisë Vlera Çmimi njësisë Vlera

Fondi 1 127.71 4,246,743 128.78 4,299,980

Nga burimet e drejtpwrdrejta tw BQK-sw