Annual Report of the Bank of Lithuania 2011

ANNUAL REPORT OF THE BANK OF LITHUANIA 2011

VILNIUS 2012 ISSN 1392-4702 ISSN 1648-9039 (ONLINE)

The Board of the Bank of Lithuania approved the 2011 Report on 10 May 2012. The Annual Report was prepared on the basis of the data from the Bank of Lithuania, Statistics Lithuania, the European Central Bank, Eurostat, the International Monetary Fund and other sources.

© Lietuvos bankas, 2012 Contents Foreword / 7 I. Review of the Economy and Finance / 9 Global Economic Developments / 9 Development of the Economy of Lithuania / 10 Real Sector / 10 Aggregate Demand / 10 Aggregate Supply / 11 External Sector / 12 Foreign Trade / 12 Current Account and Its Financing / 13 External Debt / 14 Box. External Debt Statistics / 15 Labour Market / 19 Employment and Unemployment / 19 Wages / 20 Prices and Costs / 20 Reasons Behind Price Developments / 20 Price Developments / 21 General Government Finances / 22 Revenue, Expenditure and Deficit / 22 Debt / 23 Activities of Non-Financial Corporations / 23 Household Finances / 26 Household Income and Financial Assets / 26 Household Expenses and Financial Liabilities / 27 Households Driven Risk to Credit Institutions / 28 Money and Financial System / 28 Development of Credit Market / 28 Securities Market / 31 Real Estate Market / 33 Ii. Functions of the Bank of Lithuania / 35 Exchange Rate and Monetary Policy / 35 Exchange Rate Policy / 35 Monetary Policy Instruments / 36 Required Reserves and Banking Sector Liquidity Development Factors / 38 Foreign Exchange Operations / 39 Supervision of Credit and Payment Institutions / 40 Institution of Bankruptcy Proceedings Against AB Bankas Snoras / 40 Supervision of Credit Institutions: Main Trends / 41 Work Done After the Global Financial Crisis / 42 Review of Credit Institutions’ Activities / 43 Review of Banking Activities / 43 Bank Capital / 47 Banks by Market Share / 48 Review of Bank Activity Risks / 49 Credit Risk / 49 Liquidity Risk / 50 Market Risk / 51 Operational Risk / 51 Review of Credit Union Activities / 52 Review of Payment Institution Activities / 53 Cash Management / 54 Currency Issue and Withdrawal / 54 Collectors (Commemorative) Coins / 56 Counterfeit Banknotes and Coins / 58 Foreign Reserve Management / 59 Official Foreign Reserves and Key Principles of Their Management / 59 Foreign Reserve Liquidity, Safety and Return on Foreign Reserves / 60 Handling of Statistics / 62 Payment and Securities Settlement Systems / 63 Litas and Euro Payment Systems / 63 Oversight of Payment and Securities Settlement Systems / 64 Non-Cash Payments / 64 SEPA and Target2-Securities Projects / 65 Administration of the Accounts of the State Treasury and Institutions / 66 Participation in the ESCB and International Cooperation / 66 Participation in the ESCB / 67 Participation in the Activities of EU Institutions / 68 Cooperation with the IMF / 68 Relations with Foreign Central Banks and Financial Supervisory Authorities / 69 Cooperation in Other Areas / 70 Iii. Organisation of Activities of the Bank Of Lithuania / 71 Staff and Organizational Structure / 71 Mission, Values and Ethics / 71 Staff / 71 Organizational Development and Social Dialogue / 72 Staff Training / 72 Vladas Jurgutis Award and Scholarship / 74 Transparency of Activities and Public Communication / 74 Accountability and Transparency / 74 Public Communication under Extraordinary Circumstances / 75 Presentation of Activities / 75 Economic Education / 76 Iv. the Annual Financial Statements of the Bank of Lithuania 2011 / 79 Annexes / 102 Resolutions Passed by the Board of the Bank of Lithuania and Published in Valstybės Žinios (Official Gazette) in 2011 / 102 Banknotes and Coins in Circulation / 105 Glossary / 109 List of tables and charts

TABLES Table 1. Real GDP and inflation in the world / 9 Table 2. Key performance indicators of non-financial corporations / 25 Table 3. Development of the bank loan portfolio / 30 Table 4. Monetary policy instruments of the Bank of Lithuania / 37 Table 5. Net purchase of foreign currency from the Bank of Lithuania (–) or net sale to the Bank of Lithuania / 39 Table 6. Loan portfolio quality indicators / 50 Table 7. Net currency issue or withdrawal (–) / 54 Table 8. Banknotes and coins in circulation / 55 Table 9. MD of foreign reserves and their functional parts / 61 Table 10. Return on functional parts of foreign reserves / 61 Table 11. LITAS-RLS and LITAS-MMS transactions / 63 Table 12. TARGET2-LIETUVOS BANKAS transactions / 64 Table 13. Non-cash payments / 65 Table 14. Payments by payment cards / 65 Table 15. Publications of the Bank of Lithuania in 2011 / 76

CHARTS Chart 1. Contributions to real GDP growth by the expenditure approach / 10 Chart 2. Contributions to real GDP growth by production approach / 11 Chart 3. Foreign trade balance / 12 Chart 4. Components of the current account balance / 13 Chart 5. Current account deficit financing sources / 14 Chart 6. Gross external debt by sector / 14 Chart 7. Main indicators of the labour market / 19 Chart 8. Wage developments / 20 Chart 9. Contributions to the annual HICP inflation / 21 Chart 10. General government revenue, expenditure and balance / 22 Chart 11. Contributions determining operating results of non-financial corporations and the number of initiated bankruptcy proceedings / 24 Chart 12. Capacity of non-financial corporations to return debt / 25 Chart 13. Contributions to household financial assets / 26 Chart 14. The ratio of household loans to GDP in Lithuania and selected EU Member States / 27 Chart 15. New loans to households and their interest rates / 28 Chart 16. Annual change of the bank loan portfolio and the nominal GDP in selected EU Member States / 29 Chart 17. Development of the portfolio of loans to households / 30 Chart 18. Contributions to interest rates of new loans to the private sector / 31 Chart 19. Development of stock indexes in the world and Lithuania / 32 Chart 20. Interest rates on five-year credit default swaps / 32 Chart 21. Real estate price developments / 33 Chart 22. Development of residential housing supply and investment indicators / 34 Chart 23. Spreads between sovereign bond yields and interbank interest rates / 36 Chart 24. Bank reserves in litas held at the Bank of Lithuania / 38 Chart 25. Foreign exchange trade of the Bank of Lithuania with banks and other depositors / 39 Chart 26. Dynamics of assets, loans and deposits of the banking sector / 44 Chart 27. Composition of bank assets / 45 Chart 28. Composition of bank liabilities / 46 Chart 29. Net profit of banks / 47 Chart 30. Market share of banks by assets / 49 Chart 31. Key indicators of credit unions / 52 Chart 32. Litas in circulation / 55 Chart 33. 50 litas silver coin dedicated to the 150th birth anniversary of Gabrielė Petkevičaitė-Bitė / 56 Chart 34. 10 litas silver coin dedicated to Theatre (from the series “Lithuanian Culture”) / 56 Chart 35. 50 litas gold coin dedicated to Basketball / 57 Chart 36. 1 litas coin of copper/nickel alloy dedicated to Basketball / 57 Chart 37. 50 litas silver coin dedicated to Vilnius Upper Castle (from the series “Historical and Architectural Monuments of Lithuania”) / 57 Chart 38. 50 litas silver coin dedicated to the XXX Olympic Games in London / 58 Chart 39. Numismatic set of circulation coins of the 2011 issue / 58 Chart 40. Foreign reserves / 59 Chart 41. Breakdown of investment by financial instrument / 60 Chart 42. Breakdown of investment by rating / 60 Chart 43. Number of staff actually employed at the end of the period / 72 Chart 44. Organizational chart of the Bank of Lithuania / 73

Abbreviations and other explanations

AB public limited liability company CCUL Central Credit Union of Lithuania CSDL Central Securities Depository of Lithuania ECB European Central Bank ERM II Exchange Rate Mechanism II ESCB European System of Central Banks EU European Union EUR euro Eurostat Statistical Office of the European Communities GDP gross domestic product HICP harmonised index of consumer prices IMF International Monetary Fund Lt, LTL Lithuanian litas MFI monetary financial institution p.p. percentage point UAB private limited liability company US, USA United States of America USD US dollar VĮ state enterprise

Totals / percentages in some tables and charts may not add up due to rounding (“Total” and 100%). FOREWORD

This Annual Report provides a comprehensive presentation of the work performed by the Bank of Lithuania in 2011 in implementing the central bank’s objectives and performing its functions in the context of the development of domestic and global economy and financial system. In the second half of 2011, the growth of the global economy started to slow down and in a number of developed economies it nearly came to a halt. Economic activity was suppressed by the tension in the financial sector, which transformed into confidence crisis, high unemployment, which restricted consumption, and the tightening of fiscal policy in many countries. In order to stabilise the situation, effective wide-scale measures were taken, however, the situation in the euro area economy remained complicated. The real GDP growth in Lithuania was mostly supported by domestic demand in 2011. In the first half of the year, especially fast growth of investment was observed, however, in the second half investment grew significantly slower due to more cautious assessments of the future. The largest slowdown was registered in investment into vehicles and machine ry and equipment. Private consumption increased throughout the year in line with the improving situation in the labour market. Unemployment rate declined, while the number of employed persons increased the most in the services sector and industry. However, at the end of the year more pessimistic trends became evident: expectations regarding economic development deteriorated and the number of the employed ceased to grow. Contradictory changes and expectations emerged in the credit market. Although the portfolio of loans to the private sector rose in some months, the crediting was still limited in the environment of uncertainty about the economic development of the key foreign trade partners, while the future was assessed more cautiously. On the other hand, the possibilities of both non-financial enterprises and households to fulfil the assumed financial obligations improved considerably. This means that the credit risk of the banking sector, which granted the largest share of loans to the private sector, declined. The largest influence on the annual inflation was made by the prices related to external factors. Approximately one half of inflation in 2011 was determined by food prices, whereas the further two-fifths of inflation were determined by fuel and administered prices. Still, the impact of the increase in food prices on inflation significantly declined in the second half of the year, since the global food commodity prices grew increasingly slower and finally started to fall. The primary objective of the Bank of Lithuania is to maintain price stability, which is implemented using the fixed litas exchange rate strategy. Under the conditions of the fixed litas exchange rate, the Bank ensures free exchange of litas into euro and vice versa, therefore it does not regulate the litas market interest rates and the amount of litas in circulation, as the latter is determined by the demand for litas. The fixed litas exchange rate helps to indirectly attain the primary objective in the long term, i.e. it maintains 7 export and import prices at a more stable level, thereby facilitating international trade, and supports confidence in the economic policy of Lithuania. Monetary policy instruments, which are aimed at maintaining a stable exchange rate of the litas against the euro, help to ensure adequate liquidity in the banking sector. The Bank of Lithuania pursues a conservative foreign reserve investment policy in terms of risk. It was more difficult to implement it in 2011 due to a complicated situation in the euro area government debt securities market. Investment results were determined by especially low yield ratios of the safest euro area countries in terms of credit risk and the increase in the yield spreads of debt securities of these and other euro area countries. The value of cash issued by the Bank of Lithuania in circulation increased in 2011. The rise in the average value of a banknote in circulation shows that the demand for large denomination banknotes increases. The signs of recovery and further strengthening in the country’s banking sector emerged in 2011. The only reason that determined the contraction of the sector at the end of the year, despite its even growth in the course of the year, was the suspension of activity of AB bankas SNORAS, which held around one-tenth of the market. Nevertheless, this shock did not undermine confidence in banks: deposits in some banks declined for a short time, while the majority of deposit insurance compensations remained in the banking sector.

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I. REVIEW OF THE ECONOMY AND FINANCE

GLOBAL ECONOMIC DEVELOPMENTS In the second half of 2011, the recovery in the global economy slowed down markedly and in a number of advanced economies it nearly came to a halt. Economic activity was held back by persisting tensions in international financial markets. The prolonged and outspread euro area sovereign debt crisis posed a particularly serious threat. In the second half of the year it turned into a systemic one and became a confidence crisis. A wide range of measures were undertaken to stabilise the situation in Europe. The European Financial Stability Facility was increased, the European Stability Mechanism was created for the euro area Member States, supervision of the financial sector was tightened, Greek sovereign debt was restructured. In addition, financial sector liquidity maintained by the major central banks of the world and the further implementation of accommodative monetary policy measures eased tensions in the financial sector.

Table 1. Real GDP and inflation in the world (annual percentage changes)

Real GDP Average annual inflation 2010 2011 2012* 2013* 2010 2011 2012* 2013* World 5.3 3.9 3.5 4.1 – – – – Euro area 1.9 1.4 –0.3 0.9 1.6 2.7 2.0 1.6 Central and Eastern Europe 4.5 5.3 1.9 2.9 5.3 5.3 6.2 4.5 USA 3.0 1.7 2.1 2.4 1.6 3.1 2.1 1.9 Japan 4.4 –0.7 2.0 1.7 –0.7 –0.3 0.0 0.0 Russia 4.3 4.3 4.0 3.9 6.9 8.4 4.8 6.4

Sources: Eurostat and IMF. * Forecasts.

Growth in the US economy was weak in 2011, however more signs of recovery appeared towards the end of the year. The economy was fostered by the recovery in domestic demand and the increase in net exports; unemployment declined. An increase in investment and household consumption fostered trade, positive changes also began surfacing in the US real estate market. In Europe, economic activity was suppressed by tensions in financial markets caused by the euro area sovereign debt crisis and the fiscal consolidation implemented in a number of countries. High unemployment limited household consumption. Towards the end of 2011, the euro area economy entered stagnation. In the Nordic countries, cautious public finance policy contributed highly to improved economic performance, however, with the start of an economic downturn in the euro area, the growth in their economies subsided too. In the Baltic States and Poland, the economic expansion was strong. Nevertheless, the rate of growth weakened towards the end of the year. 9  Annual Report of the Bank of Lithuania

In Russia and other CIS commodity exporters, the economic growth was rather strong. High commodity prices and liberalization of international trade contributed positively to 2011 the CIS economies. In October 2011, eight CIS countries signed a free trade agreement, and in December, after 18 years of negotiations, the World Trade Organization decided to accept Russia as a member. Global commodity prices fluctuated in the course of 2011; however, their developments were insignificant. In aggregate terms, the price index for commodities was almost 5 per cent higher at the end of the year than a year ago. The prices for energy commodities rose on the back of geopolitical tensions. Food and other agricultural commodity prices declined in the second half of the year, driven by good harvest and a weak recovery in demand in advanced economies.

DEVELOPMENT OF THE ECONOMY OF LITHUANIA

REAL SECTOR

AGGREGATE DEMAND Recovering domestic demand supported a rapid growth of Lithuania’s economy in 2011. At the end of the year, in the environment of a declining global economy and therefore deteriorating expectations of enterprises in our country, the economic growth slowed down. The effect of slower foreign demand growth was mitigated by a particularly buoyant growth of private consumption in the fourth quarter (8.1% per annum).

Chart 1. Contributions to real GDP growth by the expenditure approach (annual change)

Improving household sentiment and recovering labour market – the rate of unemployment was decreasing, employment and wages were growing – stimulated the growth of private consumption. Household income grew at a more robust rate than inflation, thus strengthening the purchasing power of households. The latter factor and improving expectations about the future reduced household incentives to save, therefore, they 10 allocated a larger portion of income for the acquisition of non-necessities. I. REVIEW OF THE ECONOMY AND FINANCE

In 2011, gross fixed capital formation recovered as well. It was larger than in 2010 by almost one-fifth. A particularly buoyant growth of investment was observed in the first semi-annual period in the context of a recovering economy. At that time, investment into vehicles and production facilities became more intensive, however, in the second half of the year in the context of increased uncertainty about the economic development, this indicator was growing at a slower rate. In the first half of the year, activity of construction of residential buildings increased, most probably due to projects started before the downturn and finished in 2011. Investment into non-residential buildings and constructions was growing at a stable pace throughout the whole year, it was supported most of all by investment projects of the state and state-owned enterprises. In the first half of the year, net exports pushed GDP down, whereas in the second half of the year they pushed it up, as the growth of imports slackened more, compared to exports. These import shifts were determined by unclear global economic prospects. Therefore, Lithuanian enterprises invested less into the development of production and sold more goods from inventories, thus weakening import growth of durable and non-durable goods.

AGGREGATE SUPPLY By the production approach, Lithuania’s economy grew in a balanced manner in 2011 – value added grew in both tradable and non-tradable sectors. The largest increase of value added in the tradable sector was observed in manufacturing and transportation. Enterprises of these economic activities benefited from the earlier gained competitive advantage and increased their foreign market shares. The overall industrial activity was reduced somewhat by a subdued activity of electricity, gas and water supply. Because of expensive raw materials used for the production of energy, the Lithuanian production was substituted by the imported production – primarily it concerns electricity.

Chart 2. Contributions to real GDP growth by production approach (annual change)

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From non-tradable sector activities, the value added created by trade and construction increased most of all. Buoyant growth of construction was determined by new investment 2011 into the production modernisation and development – old constructions were reconstructed or new ones built. Also a strong impact on a recovering construction was made by energy- related projects of the state and state-owned enterprises. The value added created by trade rose due to the growth of private consumption in the environment of improving household sentiment and the recovering labour market. The growth of the value added created by other non-tradable sector activities was slower and the effect on GDP was comparatively weak.

EXTERNAL SECTOR

FOREIGN TRADE Foreign trade deficit expanded in 2011. The largest influence on this indicator was made by a deteriorating balance of the trade of mineral products due to more expensive imported natural gas and oil commodities. However, deficit was increasing at a slow rate and remained smaller by a half than in 2008.

Chart 3. Foreign trade balance (percentage of GDP)

Nominal exports were growing at a decelerating, but fast pace. On an annual basis, exports of all groups of goods, in particular, petroleum products, rose. The overall growth of exports was mostly affected by an increasing domestic demand of Lithuania’s trade partners and higher competitiveness of national exports – market shares of the Lithu- anian exports in the main foreign trade partners went up. Nominal imports advanced at an intensive rate, however, in the second half of the year their 12 development, similar to that of exports, slowed down. Imports were pushed up most of all by I. REVIEW OF THE ECONOMY AND FINANCE

industrial production growth, which supported the demand for the import of intermediate goods. However, in the second half of the year the growth of this group of goods subsided, while the growth of imports of consumer and capital goods shrank even more significantly.

CURRENT ACCOUNT AND ITS FINANCING After being positive in 2009-2010, the current account balance turned again to negative in 2011, with deficit amounting to LTL 1.7 billion or 1.6 per cent of GDP.

Chart 4. Components of the current account balance (percentage of GDP)

The current account balance was negatively influenced by the deficit of trade in goods. It expanded in the context of a continuing increase of prices of natural gas and decreased net exports of machinery, mechanical appliances and transport equipment. However, same as earlier, the current account balance was positively affected by current transfers, mainly by the EU structural support funds and remittances by the Lithuanian emigrants. However, this impact was somewhat smaller in 2011. The current account deficit was curtailed by the services balance surplus, which was larger by one-tenth, compared to 2010. This indicator went up basically due to a better balance of travel services. The income balance deficit continued to grow – this was reflected in an increasing profit of foreign capital enterprises operating in Lithuania. After recovery in the second half of 2010, direct investment in our country remained significant in 2011. However, a major share of direct investment is formed by reinvested profit of foreign capital enterprises rather than investment into new share capital. The surplus of capital account reflecting capital transfers of the EU structural funds was of the same size in 2011 as in 2010. Commercial banks generated the majority of net negative flows from Lithuania – especially because of growing foreign assets of these banks and continuing debt redemption to parent financial institutions. However, bank liabilities were decreasing at a slower rate, compared to 2010, whereas a negative flow generated by them was partly outweighed in the financial account by the borrowing of the Government of the Republic of Lithuania in international markets, determining a rise of portfolio investment at the end of 2011. 13  Annual Report of the Bank of Lithuania

Chart 5. Current account deficit financing sources (percentage of GDP) 2011

EXTERNAL DEBT At the end of 2011, the gross external debt-to-GDP ratio improved year on year and made up about 80.8 per cent. This shift was influenced most of all by the increase of nominal GDP and a large decline in external liabilities of the private sector (particularly commercial banks) over the year.

Chart 6. Gross external debt by sector (compared to four-quarter GDP)

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External debt of the general government calculated as the ratio to GDP remained almost unchanged, however, in terms of an absolute value it grew by more than one-tenth. This development partly determined substantially larger debt redemption costs – the amount of interest paid by the general government in 2011 increased by one-fifth year on year.

Box. EXTERNAL DEBT STATISTICS External debt statistics is an important instrument to assess the economic imbalance and financial vulnerability. It was especially frequently used during economic crises in recent decades. This statistics becomes increasingly more important in the context of global economic shocks of recent years, it is comprehensively discussed by both economists and global financial policy makers. In each case when new statistics is started to be published, some time is needed for users to get acquainted with it and begin to use it in full scope for economic and financial analyses. This box briefly introduces the main external debt elements, breakdowns and presents overall assessments of the Lithuanian statistics.

MAIN MEASUREMENTS OF THE EXTERNAL DEBT STATISTICS Although the need for external debt statistics emerged for countries when they started to borrow economically material amounts in other countries, strange as it may seem, a universal need to agree about external debt definitions and publish debt data appeared very late – only in the 1990’s. After summarising the expertise of countries, the first guide of the international external debt calculation methodology was worked out in 1988. Almost ten years after the South Eastern Asia crisis, the threats of which were possible or would have been possible to be easily identified in the external debt statistics, a more comprehensive External Debt Statistics Guide* was prepared without any delay and published in 2003. The need for external debt statistics was perceived by the euro area and its Member States still later, only after the outbreak of the current economic crisis. Therefore, the external debt statistics of the euro area and its composite countries is relatively poor, compared to the statistics published by Lithuania at the present time. Similar to other statistical areas, the external debt statistics also has two main measurements: in this case – gross and net external debt. Gross external debt is the outstanding amount of actual current indebtedness to foreign entities to be paid by the debtors at some point in the future: principal and interest. Public external debt covers the debt of all domestic economic entities, including the government, i.e. the current value of liabilities to non-residents at the reference date. Net external debt is gross external debt minus resident assets abroad estimated as gross debt of non-residents to residents of Lithuania. The Bank of Lithuania works out and publishes on its website eight sets of external debt data: Gross External Debt, External Debt Service Data, Net External Debt, Gross External Debt (Nominal Value), Gross External Debt Position: Short-Term Remaining Maturity, Debt-Service Payment Schedule, External Debt Position: Foreign/Domestic Currency Composition, Public and Publicity – Guaranteed External Debt. Thus, all external debt datasets recommended by international standards are published. External debt, excluding Gross External Debt Position: Short-Term Remaining Maturity and Debt-Service Payment Schedule, is calculated at market value. Precise, internationally agreed external debt definitions and methodological advices cover several hundreds of pages, therefore this concise box is devoted to the most important aspects.

* External Debt Statistics. Guide for Compilers and Users. International Monetary Fund. 2003. 15  Annual Report of the Bank of Lithuania

The external debt statistics is classified in accordance with these criteria: 2011 n Institutional sector (general government, monetary authorities, MFIs, other sectors). A separate breakdown is made for debt liabilities to affiliated enterprises and debt liabilities to direct investors;

n The maturity of liabilities with regard to the original maturity of liabilities (short-term, long-term). Liabilities with the original maturity of one year and shorter are attributed to short-term liabilities, whereas liabilities with the original maturity of over one year belong to long-term liabilities. Short-term external debt by the remaining maturity is calculated with regard to the remaining maturity of liabilities from a certain reference date;

n Type of a financial instrument (debt securities, loans, currency and deposits, trade credits, other debt liabilities). Equities, financial derivatives and other contingent lia bilities (guarantees, etc.) are not included into gross external debt.

Foreign direct investment liabilities cover debt liabilities to affiliated enterprises and debt liabilities to direct investors. This important aspect is often regarded neither in the external debt statistics nor in the international investment position statistics. Moreover, it is very important to note that foreign direct investment liabilities are not classified by maturity. These liabilities are treated as long-term, irrespective of their actual maturity and are not attributed to short-term debt. The Bank of Lithuania has been publishing the external debt statistics on its website starting with the data of 1996. In the Bank of Lithuania publication External Statistics, the data of the gross external debt and net external debt, as well as external debt service data are published. Beginning with 2002, when publishing gross external debt statistics, the Bank of Lithuania also presents debt distribution of “Other Sectors“ by sub-sectors: a) financial corporations (excluding MFIs), b) other corporations and institutions, and c) households and non-profit institutions serving households (NPISH). It should be noted that no other bank of the ESCB gives such a distribution. Debt of financial corporations (excluding MFIs) covers the external debt of other financial intermediaries, financial auxiliaries and insurance enterprises, and pension and investment funds. Debt of households and NPISH covers the external debt of sole proprietorships (personal enterprises) as well as households and non-profit institutions servicing households. Debt of other corporations and institutions covers the debt of those enterprises and institutions that are not attributable to earlier mentioned sub- sectors. Gross external debt service is the amount of payments (both principal and interest) actually made to satisfy debt obligations over a period. Statistics of the interest paid on the external debt servicing in the picture “Interest paid for Lithuania’s gross external debt” shows very clearly the rapid pace of the change of the position: before the crisis, during it and after the crisis. As far as 2008, more than two-thirds of the interest were paid by MFIs, while in 2011 about a half of the interest was paid by the general government. For the convenience of consumers, the Bank of Lithuania publishes the overall statistics of the external debt in the national currency, euro and dollars. 16 I. REVIEW OF THE ECONOMY AND FINANCE

Interest paid for Lithuania’s gross external debt

NOVELTIES OF THE EXTERNAL DEBT STATISTICS: DRAWING UP OF THE PAYMENT SCHEDULE The external debt payment schedule shows liability amounts to be returned and interest for liabilities payable in the future during specific periods from the reference date. The schedule covers external debt payments during four nearest quarters, two semi-annual sub-periods and other payments payable later than in two years. Immediate payments are singled out. They cover not only debt payable on demand, but also unlimited liabilities or liabilities the redemption period of which has already elapsed. Only payments for current liabilities held at the reference date, irrespective of their possible increase in the future, are included into the schedule. Data of the external debt payment schedule are classified in accordance with these criteria:

n Institutional sector;

n Type of the financial instrument;

n Type of payment (principal and interest). The debt securities payment schedule of the general government, MFIs and other sectors is made on the basis of securities attributes of the data on securities issuers and holders from the registers of securities issuers and holders of the Bank of Lithuania (country and sector of the issuer of security, attribution of securities to an instrument, price). The general government external debt payment schedule worked out by the Bank of Lithuania is compared to the debt schedule presented by the Ministry of Finance of the Republic of Lithuania. When making payment schedules of liabilities of foreign loans of MFIs and other sectors, and direct investment, the statistics of international investment position together with the composition of the loan payment schedule taken from the Foreign Loan Register of the Bank of Lithuania are used. Statistics of Lithuania’s short-term and long-term debts by their remaining maturity shown in the picture “External debts refundable” reveals the attitude of domestic economic 17  Annual Report of the Bank of Lithuania

sectors towards borrowing risk aspects. Lithuania’s debt to be returned in more than 2011 one year was gradually decreasing twice: from mid-2008 to end-2009 and in 2011. It goes without saying that the long-term debt was contracting in part on the account of an increase of the short-term debt. These are particular cycle periods when economic entities are relatively unable or not willing to borrow for longer terms. The debt to be returned in a year reached its peak in 2005 and made up 52 per cent of the total external debt. The said share of the debt decreased most of all in the fourth quarter of 2010 and accounted for 38 per cent of the total external debt. This fact shows that it was exactly that time when Lithuania’s economic entities assessed the threats that emerged during the crisis in the most cautious way.

External debts refundable

The short-term external debt by the remaining maturity covers liabilities of domestic residents to non-residents, the fulfilment term of which expires within four quarters since the reference date. In other words, the short-term debt by its remaining maturity covers not only the short-term gross external debt, but also a part of long-term liabilities of the Lithuanian residents to non-residents. Differently from the above-mentioned external debt statistics, the short-term external debt by the remaining maturity and the external debt payment schedule are calculated at the nominal value. Similar to other data, external debt statistical data are also periodically reviewed after the receipt of new data. Final data of the quarterly external debt statistics of the reporting year are calculated after three months from the end of the reporting year. The comparison of the external debt statistics published by central banks of the EU Member States reveals that the statistics published by the Bank of Lithuania is among the most comprehensive in Europe. Central banks of Belgium, Bulgaria, Greece, Spain, Italy, Cyprus, Poland, Luxembourg, the Netherlands, Portugal, Slovakia, Finland, Sweden and Germany publish only one statistical table – that of Gross External Debt. Central banks of five countries – Austria, Estonia, Latvia, Malta and Slovenia – publish together gross and net external debt. The External Debt Service Data table is published only by Romania, while the Debt-Service Payment Schedule is published by the Czech Republic and Hungary. The Central Bank of Denmark publishes only public sector external debt 18 I. REVIEW OF THE ECONOMY AND FINANCE

statistics. Central banks of three EU Member States – Ireland, United Kingdom and France – provide no statistics on external debt. Almost all EU countries provide quarterly external debt statistical data, while the central banks of Bulgaria and Slovakia publish gross external debt statistics on a monthly basis. Comprehensive Lithuania’s external debt data are published on the website of the Bank of Lithuania under the section External Statistics (http://www.lb.lt/isores_sektoriaus_statistika).

LABOUR MARKET

EMPLOYMENT AND UNEMPLOYMENT Recovering Lithuania’s economy determined an improvement in the labour market situa tion as well. The rate of unemployment increased somewhat in the first quarter, while from the second quarter it was dropping. The average annual unemployment rate was 15.4 per cent (in 2010 – 17.8%). The long-term unemployment rate (unemployment for 1 year and more) in the beginning of the year reached its peak since the beginning of the recent economic downturn. From the second quarter, it was slowly decreasing in line with the total unemployment rate. The number of long-term unemployed still persisted to be very high – in 2011 it made up more than a half of the total number of the unemployed in the country. The youth unemployment was also high, although throughout the whole year it was lower, compared to 2010.

Chart 7. Main indicators of the labour market (annual change)

In 2011, the number of the employed increased by 2 per cent. The largest impact on the growth of employment was made by a rising number of the employed in the private sector. In the second half of the year, the number of the employed was increasing at a particularly slow pace. Worsened expectations about a further economic development determined a more cautious assessment of enterprise expansion possibilities and slowed down the creation of new jobs in the private sector. In addition to this, the number of the employed in the public sector shrank. In this sector, the number of less qualified 19  Annual Report of the Bank of Lithuania

specialists (junior specialists and technicians as well as junior servants) decreased, whereas the number of higher qualification specialists increased. The number of the employed 2011 increased most of all in the services sector, which is the largest by employment, and in industry, whereas in agriculture this number contracted. Flexible forms of work – temporary and part-time employment – stimulated the employment growth in the economy.

WAGES Average gross wage was rising in the economy at a slow rate. With the exception of the beginning of the year, it was increasing in the public sector more intensively than in the private sector. The wage increase in the private sector was mostly influenced by rising wages in the services sector – most of all in trade, information and communication, transport and storage activities. Wages were also rising in other private sector activities – in industry, construction and agriculture. The increase of wages in the private sector was influenced by non-regular payments, such as one-off bonuses, premia, emoluments, etc. At the year-end they determined more than a half of wage increase in the private sector. It is likely that non-regular payments increased substantially more than the fixed part of wages due to the fact that, in the environment of uncertainty surrounding the economic development, enterprises promoted their employees more often by extra pays rather than increasing the fixed part of wages. In the public sector, wages were pushed up more by the fixed part of wages rather than non-regular payments. The largest impact on the wage growth in this sector was made by the wage growth in health care, education, transport and storage, and public administration activities.

Chart 8. Wage developments (annual change)

PRICES AND COSTS

REASONS BEHIND PRICE DEVELOPMENTS In 2011, the average annual HICP inflation made up 4.1 per cent. Approximately a half of this inflation was driven by more expensive food. Increasing prices of fuels and 20 administered prices determined one-fifth of inflation each. Thus, prices rose basically I. REVIEW OF THE ECONOMY AND FINANCE

owing to external factors, mainly due to an increase of global prices of food and energy commodities. Prices of industrial goods and market services related to domestic demand determined only about one-tenth of average inflation. In the beginning of the year, annual inflation decreased after the disappearance of the impact of an earlier increase of electricity price. Later, approximately until the mid-year, it was markedly increasing mainly due to higher prices of food and advancing core infla- tion1. In May, annual inflation reached 5.0 per cent and was the highest in approximately two years. Afterwards it was mainly decreasing.

Chart 9. Contributions to the annual HICP inflation

PRICE DEVELOPMENTS The annual growth of food prices in Lithuania was intensifying approximately to mid-2011. It was stimulated by rising global prices. Afterwards, global food prices together with the prices of food products imported to Lithuania and sold by producers in the domestic market were growing less, therefore, the rise of consumer prices in Lithuania was also slower. Compared to May, when the growth of prices of food products and non-alcoholic beverages in Lithuania over the year was the highest in several recent years, the growth of these prices slowed down considerably afterwards, although prices of food products less important to consumers persisted to be very elevated. Alcoholic beverages and tobacco products exercised an insignificant effect on inflation. The annual growth of administered prices, with the exception of several months, was intensifying approximately from the mid-year. It was pushed up most of all by more expensive heat energy. In December, its price was approximately one-fifth higher year on year.

1 Core inflation is the inflation indicator the calculation of which does not include certain most volatile prices. The Bank of Lithuania calculates the core inflation indicator as the change of the HICP, excluding prices of food, fuels and lubricants, and administered prices. 21  Annual Report of the Bank of Lithuania

In 2011, the price of heat energy was rising almost every month due to more expensive fuels used for heat production, mainly imported natural gas. Fuel prices in Lithuania rose, 2011 compared to 2010, by more than one-tenth, because oil was very expensive in 2011 (about USD 111 per barrel). Compared to 2010, oil prices increased by almost 40 per cent. Almost throughout the whole 2011, the annual growth of fuel prices in Lithuania was large, however, it shrank very much at year-end mainly due to the base effect. Prices related to domestic demand, included in the calculation of the core inflation indicator, rose insignificantly. This reflects that, irrespective of a rapid increase of the turnover of retail trade in non-food goods, the growing domestic demand exercised a feeble effect on prices.

GENERAL GOVERNMENT FINANCES

REVENUE, EXPENDITURE AND DEFICIT In 2011, the situation of public finances improved considerably: the deficit made up 5.5 per cent of GDP and was much smaller year on year. The deficit shrank due to an annual increase of revenue. Public expenditure also rose on an annual basis, but significantly less, compared to revenue. The largest contraction was observed in the deficit of the state budget and social security funds. In 2010, the local government balance was in surplus, whereas in 2011 it was in deficit. As the economic growth was stimulated most of all by consumption expenditure, a substantial increase was registered in the state budget revenue from indirect taxes. The local government balance was mostly influenced by decreased income, when the share of redistributed personal income tax became smaller.

Chart 10. General government revenue, expenditure and balance (four-quarter moving sums, compared to GDP)

The general government revenue-to-GDP ratio contracted by more than 1.5 percentage points. It is likely that this shift is associated with a substantial decline of income elasticity with respect to economic growth since the start of the economic downturn: in 2000-2008 the elasticity made up approximately 1.4, while in 2009-2011 it decreased to about 0.8. General government revenue was mostly pushed up by revenue from indirect taxes, social contributions, higher transfers due to larger income of public institutions, larger support from abroad. Indirect tax income was pushed up most of all by the increase of over one- 22 tenth in income from the value added tax over the year, driven by the growth of one-fifth I. REVIEW OF THE ECONOMY AND FINANCE

in retail trade (including motor vehicles), which pays almost a half of the total value added tax, and the rise of one-sixth in imports of consumer goods. The amount of other indirect taxes – mainly excises – collected in 2011 was also larger because of an increase of tariffs on tobacco and diesel fuels and the sales of goods to which excise duties are imposed. Revenue from direct taxes also grew. This revenue was increased most of all by larger income from the personal income tax. It grew almost by one-tenth per annum due to a decrease of the share of the tax that is returned, wage growth and an increase in the number of the employed. Positive shifts in the labour market had an effect also on larger than a year ago social contributions. The collected amount of the profit tax was smaller by around one-tenth year on year due to a smaller tax rate. In the context of improving profitability expectations, an increasing number of enterprises preferred the advance profit tax based on the operating results in the previous year. Although the tax base of the profit tax paid – the taxable profit in 2010 – grew by more than one-tenth over the year along with an increase in the number of profitably operating companies, the amount of the advance profit tax paid was substantially smaller due to a lower tax rate. In 2011, the general government expenditure-to-GDP ratio contracted to 37.6 per cent, but only due to an increase in GDP. Total general government expenditure was larger than a year ago by 2 per cent. Expenditure was pushed up most of all by an annual one-third increase in the current and capital transfers, one-tenth larger interest payments and almost 2 per cent higher compensation of employees. The interest increase is attributable to a more intensive borrowing of the Government of the Republic of Lithuania in 2010 – the public debt jumped by more than LTL 9 billion. Higher compensation of employees might be related to both supplemental expenditure for the period of service and additional work and higher average wages. In 2011, the general government expenditure for social payments, investments and intermediate consumption decreased. Smaller social payments were the result of a lower number of the unemployed. Smaller investments had already been envisaged by the 2011 national budget law, while intermediate consumption contracted due to a lower amount of funds transferred to receivers of appropriations for performing the functions assigned to them, lower expenditure for the repair of tangible fixed assets, etc.

DEBT The general government debt-to-GDP ratio grew in 2011 by 0.5 percentage point to 38.5 per cent. On an annual basis, the debt expanded by LTL 4.7 billion to LTL 40.8 billion. Approximately one-fifth of this rise is attributed to an increased portfolio of loans received by the general government and the other part was determined by long-term securities. The central government debt was mostly pushed up by the placement of two bond issues in March and November with the total value of USD 1.5 billion. A noticeable rise was also registered in the debt of social security funds – at the year-end it amounted to LTL 7.6 billion or 7.2 per cent of GDP. The debt was mostly driven by long-term loans. The growth rate of the general government debt was substantially slower year on year. This is associated with the decisions of the Government of the Republic of Lithuania reducing the deficit and therefore a weaker demand for borrowing. In 2011, the debt- to-GDP ratio was also reduced by a favourable differential between the average interest rate paid for debt and the growth rate of the economy.

ACTIVITIES OF NON-FINANCIAL CORPORATIONS After a strong recovery in 2010 and the first half of 2011, activities of non-financial corporations operating in Lithuania weakened somewhat in the second half of 2011. 23  Annual Report of the Bank of Lithuania

Some activity indicators approached the level observed before the economic downturn, thus the possibilities for more intensive business expansion were limited and investment 2011 was rising at a slow pace. However, persisting uncertainty surrounding the further development of the main foreign trade partners precluded businesses from a very optimistic assessment of the future, whereas a more rapid domestic consumption recovery was reflected neither in consumer confidence indicators nor in economic assessments of enterprises. However, possibilities of non-financial corporations to return debt improved substantially and the risk to the banking sector decreased.

Chart 11. Contributions determining operating results of non-financial corporations and the number of initiated bankruptcy proceedings

Income from sales received by businesses in 2011 was larger by one-sixth year on year and almost approached the level observed before the economic downturn. Owing to the growth of sales and a less rapid increase in the number of employees and salary and wage fund, which comprises the largest share of costs, non-financial corporations, after incurring losses in 2009, were operating profitably in 2010-2011. In 2011, the average share of profitable enterprises made up two-thirds – about 20 percentage points more than in 2009. In the environment of improving operating results of non-financial corporations, a decreasing number of them faced financial difficulties, the number of initiated bankruptcy proceedings dropped and the ratio of the banking sector’s non-performing loans to total loans to non-financial corporations started to shrink. The largest share of the portfolio of bank loans to non-financial corporations was made up by loans to manufacturing, trade, transport, construction and real estate2 activities. Sales income of manufacturing enterprises in 2011 was the largest from the start of the publication of this indicator in 1998, more than two-thirds of all enterprises were profitable. The number of initiated bankruptcy proceedings against manufacturing enterprises decreased substantially in 2010-2011, whereas their capacity to return debt improved in particular. In the context of a growing economy and increasing consumption expenditure, sales and income of trade enterprises rose. The number of initiated

24 2 Names of some economic activities are abbreviated. I. REVIEW OF THE ECONOMY AND FINANCE

bankruptcy proceedings against non-financial corporations dropped by one-fourth on an annual basis, whereas their capacity to return debt increased, so did the confidence indicator. Enterprises of transport and storage activity, which is closely related with the activity of trade enterprises, started recovering strongly, after a sudden and large slump of income in 2009, when consumption contracted. Sales income received in 2011 was the largest throughout the entire period of the publication of these data since 1998.

Chart 12. Capacity of non-financial corporations to return debt

Table 2. Key performance indicators of non-financial corporations (percentages)

Type of an economic activity* Profitability** Financial Capacity to return Probability of leverage*** debt**** bankruptcy***** 2010 2011 2010 2011 2010 2011 2010 2011 Forestry and fishing 9.2 8.3 33.5 29.8 281.7 416.6 5.3 3.8 Mining and quarrying 19.5 31.1 48.4 108.5 108.9 70.7 0.0 0.0 Manufacturing 3.5 3.7 91.8 93.0 61.0 57.7 3.8 2.6 Energy supply 3.3 0.8 44.8 37.5 80.4 69.8 1.1 0.0 Water supply 7.5 3.0 35.0 36.2 76.3 73.2 3.8 1.9 Construction –0.4 1.3 134.0 148.5 15.3 19.8 5.8 4.4 Wholesale and retail trade 2.3 2.8 149.7 141.6 37.7 45.0 2.8 2.0 Transport and storage 3.9 6.4 60.6 58.5 67.9 87.9 4.1 2.6 Accommodation and catering –3.5 4.4 245.4 201.8 6.8 17.2 3.8 3.8 Information and communication 10.7 10.3 71.1 63.7 75.6 78.9 1.6 1.4 Real estate operations 8.0 16.8 129.6 127.5 10.6 13.2 3.0 2.2 Professional, scientific and technical activities 10.4 32.2 25.8 20.4 15.6 58.7 1.6 1.3 Education 12.8 7.9 36.5 40.6 269.2 177.2 1.3 0.8 Total 3.3 4.4 76.1 71.4 37.8 45.3 3.4 2.5

Sources: Enterprise Bankruptcy Management Department under the Ministry of Economy of the Republic of Lithuania, Statistics Lithuania and Bank of Lithuania calculations. * Names of some economic activities are abbreviated. ** Ratio of profit before taxes to sales over the period. *** Ratio of liabilities to own capital; end-of-period. **** Ratio of profit before taxes, amortisation and depreciation over the period to end-of-period financial debts. ***** Ratio of the number of initiated bankruptcy proceedings during the year to the end-of-period number of corporations. 25  Annual Report of the Bank of Lithuania

After incurring losses in 2009-2010, construction enterprises worked profitably in 2011: almost two-thirds of these enterprises earned profit, whereas the number of such enter- 2011 prises in 2010 was smaller than a half. The number of initiated bankruptcy proceedings shrank, while capacity to return debt increased. After an immense shrinkage of activity and a drop in sales in 2009-2010, real estate enterprises, which are closely related with the construction business, are recovering gradually: the profit earned by these enterprises in 2011 was twice larger than in 2010, whereas the share of profitable enterprises grew. However, the number of initiated bankruptcy proceedings remained large, whereas capacity to return debt still was three times smaller than before the economic downturn.

HOUSEHOLD FINANCES

HOUSEHOLD INCOME AND FINANCIAL ASSETS In the environment of a slow increase of wages and the shrinkage of unemployment from early 2011, the financial position of households was improving and, according to the data of the third quarter, financial assets managed by them were larger by one-tenth year on year. The financial asset structure changed insignificantly over the year. Data of the third quarter of 2011 suggest that the most significant impact on the growth of household financial assets was made by an increase in the value of quoted and unquoted shares, short-term and long-term securities, excluding shares (mainly of other MFIs), net equity in insurance reserves, items of transferable deposits and cash. However, decreased prepayments of insurance premiums and reserves for outstanding claims as well as other accounts receivable made an insignificant, though negative, impact on the value of household financial assets.

Chart 13. Contributions to household financial assets (quarterly data)

Irrespective of the fact that the interest paid for deposits was among the smallest in recent years, in 2011 household deposits shrank insignificantly – by 1.1 per cent. Almost 26 the whole drop was registered in October 2011. I. REVIEW OF THE ECONOMY AND FINANCE

HOUSEHOLD EXPENSES AND FINANCIAL LIABILITIES Net indebtedness of Lithuania’s households to MFIs (26% of GDP), according to the data of 2011, remained to be the smallest not only in the Baltic States (it made up 40% in Latvia and 45% in Estonia), but also one of the smallest in the EU (58% on average). Regardless of the shrinking portfolio of household loans from the banking sector, the share of loans granted to natural persons remained to be stable and made up 44 per cent of loans granted by banks. Similar to previous periods, household loans from financial corporations made up the largest share of financial liabilities assumed by households (76%).

Chart 14. The ratio of household loans to GDP in Lithuania and selected EU Member States (quarterly data)

In the context of the ECB still pursuing an accommodative monetary policy, both the European and the Lithuanian banking sectors holding material liquidity reserves and a gradual easing of risk assessment, the interest rates on new loans remained among the smallest during the period of data collection since 2000, whereas the interest rate spread of new loans with the interest rate fixation period of over 1 year and loans with the interest rate fixation period of up to 1 year narrowed. This encouraged more borrowers to fix rates for a period longer than 1 year. It should be noted that regardless of the fact that the price differential of borrowing in litas and borrowing in euro3 decreased to the pre-crisis level, it is the price that makes the largest effect on households’ decision to borrow, therefore, the share of euro loans to households expanded further and made up 76 per cent at the end of 2011. Results of the Bank Lending Survey of October 2011 conducted by the Bank of Lithu- ania revealed that the majority of banks eased somewhat credit standards not related with interest rates over the six-month period, while lending conditions remained rather conservative.

3 Interest rates on new loans to households. 27  Annual Report of the Bank of Lithuania

Chart 15. New loans to households and their interest rates (monthly data) 2011

HOUSEHOLDS DRIVEN RISK TO CREDIT INSTITUTIONS Interest paid by households for their liabilities to MFIs is determined by the level of indebtedness and the development of interest rates, which are affected by the situation in the interbank market and risk premiums applied by MFIs. In the context of ECB further implementing an accommodative monetary policy, the key interest rates remained low as never before and this fact had an effect on the inter-bank interest rate drop to a level never observed earlier. This compensated an increased MFIs lending margin4. Moreover, smaller household indebtedness also eased the burden of interest paid. However, households usually choose such loan redemption conditions (currency, interest rate fixation period, etc.) that ensure the smallest loan redemption costs, but seldom take risk into account. Many households still preferred loans with the interest rate fixation period of up to 1 year. Thus, a change in the rate would increase household loan repayment costs faster than in 1 year, thereby possibly having a negative impact on households’ solvency. In the context of a gradual improvement of the financial position of households, in 2011 the quality of the portfolio of loans to natural persons was the best compared to other bank debtors.

MONEY AND FINANCIAL SYSTEM

DEVELOPMENT OF CREDIT MARKET The uncertainty surrounding the possibilities of individual states to solve problems related with the public sector debt redemption, which prevailed in 2011, aggravated private sector expectations and the prospect of investment. The EU banking sector loan portfolio was gradually increasing until the end of 2010, while in the second half of 2011 it shrank and in a year stepped up by 0.2 per cent (4.4% a year ago). The financial position of the major debtors of banks improved, however, more intensive growth of the loan portfolio will be restricted by remaining uncertainties whether some

28 4 Spread between interest rates of new loans and the 6-month inter-bank interest rate. I. REVIEW OF THE ECONOMY AND FINANCE

euro area Member States will be able to decrease their budget deficit and what influence it will have on the real economy. Commercial banks have gradually undertaken to implement more stringent capital adequacy requirements and this may hamper lending supply and increase its price.

Chart 16. Annual change of the bank loan portfolio and the nominal GDP in selected EU Member States

In the context of a growing economy, the borrowers’ financial position and expectations were improving in Lithuania, and when credit conditions were eased and interest rates remained low, the borrowing from banks started to increase, especially in the second half of 2011. In July-October, the banking sector loan portfolio stepped up by LTL 0.8 billion, because non-financial corporations and the general government started to borrow more. Over the coresponding period a year ago, this indicator declined by LTL 0.4 billion. In November 2011, the Lithuanian financial system was shocked by an extraordinary event – the revocation of the banking licence of one of its participants – AB bankas SNORAS. The portfolio of loans granted by this bank made up LTL 3.6 billion at the end of October. Because of the suspension of activity of AB bankas SNORAS and the fact that non-financial corporations were reducing liabilities to banks in the last month of several previous years, the loan portfolio of the Lithuanian banking sector shrank in 2011 by 7.6 per cent. Excluding the data of AB bankas SNORAS5, the portfolio decreased by 0.3 per cent. If we assumed that the loan portfolio of that bank did not change in the last two months of 2011, the loan portfolio would have decreased by 1.4 per cent. In 2011, non-financial corporations were more active to use services provided by commercial banks: the banking sector’s portfolio of loans to these corporations remained almost unchanged, although in 2010 it shrank by LTL 4.0 billion. The growing economy pushed up the need of non-financial corporations to update worn out equipment or acquire new equipment. Having sold accumulated stocks of products, the production capacity utilisation level, after increasing for the second year in turn, approached the

5 On 24 November 2011, the Bank of Lithuania revoked the licence of AB bankas SNORAS. To ensure the data comparability and accuracy of the analysis, if not indicated otherwise, the development of credits granted by the banking sector in Lithuania is assessed in this chapter excluding the data of AB bankas SNORAS. 29  Annual Report of the Bank of Lithuania

highest ever level, while the share of enterprises lacking production capacities was increasing. Therefore, the need for investments and funds to finance them was also growing. 2011

Table 3. Development of the bank loan portfolio (the development in brackets is presented excluding AB bankas SNORAS) LTL billions 2009 2010 2011 Total loan portfolio –9.9 (–9.7) –3.2 (–4.2) –4.4 (–0.2) Loans to financial institutions –1.9 (–1.8) 0.9 (0.7) –0.7 (–0.2) Loans to public authorities –0.2 (–0.2) 0.2 (0.1) 0.4 (0.4) Loans to state and municipal enterprises 0.1 (0.1) 0.8 (0.8) 0.3 (0.3) Loans to private enterprises –6.2 (–6.4) –3.3 (–4.0) –2.8 (0.0) Loans to natural persons –1.7 (–1.5) –1.9 (–1.9) –1.5 (–0.8) Housing loans –0.4 (–0.4) –0.5 (–0.5) –0.3 (–0.1) Consumer and other loans –1.2 (–1.0) –1.4 (–1.4) –1.2 (–0.7) Source: Bank of Lithuania calculations.

In the context of business being in a shortage of labour force, the number of the unemployed dropped, while wages rose slightly. In mid-2011, the consumer confidence indicator was the highest in the recent three years, although it remained negative. This was also reflected in a slower reduction of liabilities to the banking sector: in 2011, households reduced them by LTL 0.8 billion (LTL 1.9 billion in 2010).

Chart 17. Development of the portfolio of loans to households (in a month)

Although interest rates on inter-bank loans in euro were shrinking, the average interest rate of new loans to the private sector in Lithuania was higher by 0.1 percentage point in 2011, compared to 2010, and made up 4.7 per cent. Increasing interest rates in 2011 did not exert any large influence on the loan development in Lithuania, because three- fourths of this increase was offset by a decreased margin after the improvement of the financial situation of borrowers. Interest rates of new loans to the private sector in litas were higher by 1.5 percentage points on average, compared to loans in euro (in 2010, this spread made up 1.9 p.p.). In the context of a narrowing spread of interest rates between loans in different currencies, 30 I. REVIEW OF THE ECONOMY AND FINANCE

the structure of the loan portfolio (in particular, loans to households) was changing: irrespective of still more expensive borrowing in litas, the share of liabilities in this currency was rising, whereas that of liabilities in euro was shrinking. A similar trend dominated in 2006-2007. At that time, after a decrease of the spread between interest rates on loans, the population preferred borrowing in the national currency rather than in euro.

Chart 18. Contributions to Interest Rates of New Loans to the Private Sector (12-month moving average)

SECURITIES MARKET In the first quarter of 2011, global and Lithuanian stock markets suffered a short-lived shock caused by a panic related to repercussions of the natural disaster in Japan and the turmoil in the Northern Africa. The Stoxx Europe 600 index reflecting changes in the European stock markets did not change on a quarterly basis, while the S&P 500 index indicating changes in the US stock market rose by 5 per cent. AB “NASDAQ OMX Vilnius” stock exchange index OMX Vilnius (hereinafter referred to as the OMXV index) dropped by 2 per cent. In the second quarter, the stock value of Lithuanian enterprises changed little and investors were inactive. Irrespective of fairly good operating results being announced by enterprises, the attention of global financial markets was captured by renewed warnings concerning the insolvency of Greece; therefore, key stock prices remained almost unchanged. Over the quarter, the Stoxx Europe 600 and OMXV indexes decreased by 1 per cent, while the S&P 500 index remained unchanged. The third quarter stood out by a strong drop of stock prices both in the whole world and in Lithuania. Still prevailing concern about potential insolvency of Greece was strengthened by the concern that the global economy is growing at a slower rate than expected. Affected by a fear of the spill-over of euro area fiscal problems, stock prices of financial institutions decreased substantially. Indexes dropped over the quarter: Stoxx Europe 600 – by 17 per cent, S&P 500 – by 14 per cent, OMXV – by 16 per cent. The last quarter of 2011 was volatile. In expectations of a progress in solving the euro area fiscal crisis and in response to good operating results of enterprises, the key global 31  Annual Report of the Bank of Lithuania

and Lithuanian stock indexes started to rise. However, after the activities of AB bankas 2011 SNORAS were suspended on 16 November, the OMXV index lost 17 per cent of its value within one week and decreased by 10 per cent on a quarterly basis. At the same time, in the context of increasing uncertainty about the Italian debt financing, the yield of the key global stock indexes also dropped. The Stoxx Europe 600 index rose quarter on quarter by 8 per cent, while the S&P 500 index grew by 11 per cent.

Chart 19. Development of stock indexes in the world and Lithuania

In the first half of 2011, the interest rates of the five-year Lithuanian sovereign credit default swaps gradually contracted by 51 basis points. This development suggests a favourable assessment by financial markets of the status of public finances of Lithuania, because the gap from the risky euro zone peripheral countries was evident. For example, over the said period, a respective indicator for Greece increased by 878 basis points and for Portugal – by 245 basis points.

Chart 20. Interest rates on five-year credit default swaps

32 I. REVIEW OF THE ECONOMY AND FINANCE

In the second half of the year, the price of the five-year Lithuanian sovereign credit default swaps rose by 167 basis points. However, regard should be given to the fact that in the context of growing indebtedness of other countries, according to the assessment of market participants, credit risk of other governments and financial institutions was rising even more. This suggests that market participants perceived the main threats to Lithuania as related to potential external impact. After 16 November, interest rates on the five-year Lithuanian sovereign credit default swaps jumped over a week and a half by more than 40 basis points, but already in the beginning of December they returned to the original level. Thus, the suspension of activity of AB bankas SNORAS did not cause a long-term negative reaction of financial markets and did not increase risk premiums of the country.

REAL ESTATE MARKET In 2011, there were no significant changes in the real estate market: prices of residential housing and commercial real estate remained basically unchanged over the year, while market activity, although increasing, remained rather low. Only housing rent prices stood out: in the three summer months they soared by almost one-tenth, but decreased afterwards. Housing rent prices increased over the year by 4 per cent, however, compared to 2010, they went down by 1 per cent.

Chart 21. Real estate price developments (monthly data)

The numbers of the dwellings whose construction was authorized and the new flats built in the fourth quarter of 2011 published by Statistics Lithuania suggest that the supply of new housing in the market will remain insignificant in the near future. In 2011, the number of dwellings whose construction was authorized dropped by more than 12 per cent, compared with 2010. However, as builders finished the constructions that were started earlier, the number of new flats built was higher than in 2010 by nearly 40 per cent. The assessment of the population’s purchasing power shows that the dwelling space (0.6 square meters) that could be bought for one average monthly wage was one of the largest since the beginning of 2000. Moreover, in terms of lending conditions prevailing 33  Annual Report of the Bank of Lithuania

in the market, the capabilities of households to acquire housing (estimated on the basis of the housing affordability index) were also among the largest since the beginning of 2011 the collection of such data in 2000. A household of two working persons earning the average wage at the end of 2011 had to allocate 35 per cent of received monthly income for the acquisition of a typical housing of 60 square metres at the average price. The increase of the household purchasing power was determined by a gradual growth of wages and still the lowest ever interest rates on loans.

Chart 22. Development of residential housing supply and investment indicators (quarterly data)

Regulations for Responsible Lending approved by the Board of the Bank of Lithuania, which entered into effect in November 2011, established new macro-prudential requirements for credits. The application of these regulations reduces the probability of the occurrence of real estate bubbles and large financial problems for borrowers and banks in customer insolvency cases. It is the first case, when the Bank of Lithuania undertakes an active regulation of crediting conditions. The period that passed since the entry into effect of these regulations is too short to comprehensively assess the impact of this ac- tion. However, available data and favourable assessments by market participants suggest that that decision was right and taken in due time.

34 II. FUNCTIONS OF THE BANK OF LITHUANIA

II. functions of the bank of Lithuania

EXCHANGE RATE AND MONETARY POLICY The primary objective of the Bank of Lithuania is to maintain price stability, which is implemented using a fixed exchange rate strategy. The Law of the Republic of Lithuania on the Credibility of the Litas, which came into effect on 1 April 1994, provides legal grounds for the fixed exchange rate of the litas. It sets an obligation for the Bank of Lithuania to ensure that the litas amount in circulation is fully backed by gold and foreign reserves and the anchor currency is exchanged into litas at a fixed exchange rate. As of 2 February 2002, the euro is the anchor currency of Lithuania.

EXCHANGE RATE POLICY In the context of the fixed exchange rate regime, the Bank of Lithuania ensures free exchange of litas into euro and vice versa, therefore, it can not directly regulate the litas market rates and the amount of litas in circulation, as the latter depends on the changing litas demand. For these reasons, the Bank is unable to regulate directly the aggregate demand and the price level. However, the fixed exchange rate means that the primary objective is pursued indirectly, i.e. it helps to keep export and import prices stable and encourages international trade, it also supports confidence in the Lithuanian economic policy. The fixed exchange rate of the national currency therefore helps to ensure relative price stability in a long perspective. Such strategy has been applied since 1994. It is successful because of such features of the Lithuanian economy as its openness and relative flexibility of prices and wages. Price developments in short- and medium-term perspective may deviate from the level which is perceived as relative price stability. This depends on various reasons related both to external and internal factors, such as significant changes in global commodities market (primarily in food and energy prices, which account for a relatively large share in Lithuania’s consumer price index and the cost structure); administrative decisions (change of consumption taxes and administered prices); structural processes (huge differences in labour pro- ductivity within exporting and non-exporting sectors, which lead to price convergence, and improving trade environment), as well as cyclical downturns and upturns of the economy, which sometimes are deepened by the country’s inadequate economic and fiscal policy. The euro, which is a single currency of the EU, is one of the most significant economic policy measures on the way to our country’s prosperity. Lithuania will join the euro area, when it complies with the Maastricht convergence criteria. The introduction of the single currency will allow the country to enjoy the full benefits it can offer, such as no exchange rate risk, cheaper borrowing in the domestic market, no currency exchange costs and cheaper cash transfers for settlement with the key trade partners in the euro area. This will give a boost to Lithuania’s trade and financial integration in the euro area, increase its attractiveness to investors and add to the growth of the welfare of its residents. One of the conditions for the adoption of euro is the country’s participation in the ERM II. Lithuania joined the ERM II on 28 June 2004; since then it has maintained the fixed exchange 35  Annual Report of the Bank of Lithuania

rate regime and a stable exchange rate of the litas against the euro, which is LTL 3.4528 for EUR 1. In its convergence programmes, the Government of the Republic of Lithuania repeat- 2011 edly reaffirmed the country’s plans to continue participation in the ERM II and maintain the fixed exchange rate of the litas against the euro at the current level. The Bank of Lithuania continues to maintain institutional capacities for a smooth and rapid currency changeover in case the EU Council adopts a decision to introduce the euro in the country. In the context of the fixed exchange rate regime, the balance in the currency market is ensured by free floating interest rates in the litas market, which depend on the interest rates of the euro as the anchor currency and the market assessment of additional risk when investing in our country. After a continuous decrease over the last two years, the litas and euro long-term interest rate spread, as measured by the Lithuanian and Ger- man government securities yield spread, increased in the second half of 2011, in the context of the intensification of sovereign debt crisis in some euro area countries and the bankruptcy of AB bankas SNORAS, the country‘s fifth largest bank by assets. The yield spread between the Lithuanian and German government securities redeemable in 2016 grew over the year by 211 basis points to 4.67 per cent, the level recorded at the end of 2009. The money market interest rate spread, calculated as a difference between three-month VILIBOR and EURIBOR, decreased in 2011 by another 19 basis points to 30 basis points, the level observed in mid-2008. This narrow spread between money market interest rates at the end of the year was determined by the improved liquidity of the banking sector after the Government of the Republic of Lithuania used the funds attracted abroad to finance domestic expenditure and transferred to banks the funds for the payment of insurance compensations to depositors of AB bankas SNORAS.

Chart 23. Spreads between sovereign bond yields and interbank interest rates

MONETARY POLICY INSTRUMENTS The Bank of Lithuania uses monetary policy instruments to maintain the fixed exchange rate of the litas against the euro and help to ensure an appropriate amount of liquidity in the banking sector. To implement the fixed litas exchange rate regime, the Bank of Lithuania has assumed a commitment in respect of domestic commercial banks and fo 36 reign bank branches operating in the country (hereinafter referred to as banks) subject II. FUNCTIONS OF THE BANK OF LITHUANIA

to reserve requirements to buy and sell anchor currency without restrictions at the official exchange rate. The net result (the amount of euro purchased or sold by the Bank of Lithuania over a certain period of time) directly depends on the change in the autonomous factors of the banking sector reserves in litas, required reserves and excess reserves6. To ensure stability of settlements between banks, the Bank of Lithuania provides to banks a lending facility in the form of overnight repurchase agreements. In 2011, there was only one case of recourse to the lending facility and the transaction value was LTL 30 million. In December 2011, in response to the interbank volatility triggered by temporary factors (bankruptcy of AB bankas SNORAS), the Bank of Lithuania renewed supplementary monetary policy operations of limited scope, i.e. deposit auctions (which were used between 1997 and 2000) to reduce bank liquidity in litas, debt security redemption auctions (which were used between 1997 and 1998) to boost liquidity and auctions for purchase transactions (operations for purchase of securities were performed between 1995 and 1996). Through these open market operations, banks operating in Lithuania have been offered wider possibilities to manage liquidity and cash flows.

Table 4. Monetary policy instruments of the Bank of Lithuania

Liquidity provision Liquidity absorption Maturity Frequency Procedure Standing facilities for banks Anchor currency Anchor currency – Access at the discretion Bilateral transactions, sale to the Bank of purchase from the of counterparties the Bank of Lithuania purchases euros Lithuania Bank of Lithuania and settles on trade date or the second day following trade date and sells euros and settles on the second day following trade date Overnight repurchase – 24 hours Access at the discretion Bilateral transactions agreements of counterparties Open market operations Fixed-term deposits 7 days Once a week Auctions

Repurchase 7 days Once a week Auctions transactions Purchase of debt – Once a week Auctions securities Reserve requirements Banking sector The required reserve base consists of the liabilities of banks established in Lithuania and foreign bank liquidity stabilisation branches, excluding liabilities to the Bank of Lithuania and other banks (if any), which are subject to reserve requirements applied by the Bank of Lithuania. Zero reserve requirement ratio is applied to the following: 1) deposits with an initial maturity of over two years or with the redemption notice term specified in a relevant agreement of over two years; 2) debt securities issued with an initial maturity of over two years; 3) repurchase agreements. The reserve requirement ratio of 4 per cent is applied to other liabilities of the base. Required reserves are held in litas on settlement accounts of banks with the Bank of Lithuania. Maintenance period: from the 24th calendar day of a month to the 23rd calendar day of the consecutive month, inclusive. Compliance with the reserve requirement is assessed on the basis of the average method.

Source: Bank of Lithuania.

6 Banking sector’s reserves in litas are the funds in litas owned by banks operating in the country, held in settlement accounts at the Bank of Lithuania. Autonomous factors for these reserves are the Bank of Lithuania operations, which have an impact on the amount of reserves in litas of the banking sector, but are conducted to satisfy the needs other than bank liquidity management. The main autonomous factors include the amount of currency in circulation and the transfer of the general government funds from the banking sector to the Bank of Lithuania or from the Bank of Lithuania to the banking sector. 37  Annual Report of the Bank of Lithuania

The Bank of Lithuania was capable to conduct liquidity-providing operations without risk to the fixed exchange rate of the litas, as it had accumulated a huge excess of gold and 2011 foreign exchange coverage for the litas issued into circulation. On 31 December 2011, there were no securities repurchase transactions made by the Bank of Lithuania, however it attracted LTL 78.5 million through a seven-day deposit auction and purchased debt securities with nominal value of LTL 165 million. These amounts accounted respectively for 0.5 and 1.0 per cent of the total amount of litas issued into circulation by the Bank of Lithuania7. The surplus of coverage by net gold and foreign currency reserves made up then LTL 1,693 million or 9.8 per cent of the said litas amount in circulation.

REQUIRED RESERVES AND BANKING SECTOR LIQUIDITY DEVELOPMENT FACTORS Similar to previous years, the autonomous factors of the banking sector’s reserves in litas contributed to the growth in the surplus of its reserves in litas in 2011, whereas the amount of euros purchased from the Bank of Lithuania by banks in the context of the fixed exchange rate of litas and self-regulation of money supply was higher than the amount of euros they sold to the Bank of Lithuania. Over the year, autonomous factors boosted the supply of bank reserves in litas by LTL 8.8 billion: transfers by Lithuanian government institutions when financing the budget expenditure related with the use of the EU structural funds and the payment of insurance compensations to depositors of the bankrupt AB bankas SNORAS contributed to the growth of the banks’ litas reserves by LTL 10.8 billion, whereas the increase in the net demand for litas reduced the banks’ reserves by LTL 2 billion. Required reserves declined by LTL 0.1 billion or 5.6 per cent, as AB bankas SNORAS was no longer subject to the reserve requirement, because the increase (of almost LTL 0.3 billion) in its required reserves exceeded the increase in required reserves in other banks. The open market operations conducted by the Bank of Lithua nia in December 2011 led to a surge of the banking sector’s reserves by LTL 0.1 billion.

Chart 24. Bank reserves in litas held at the Bank of Lithuania

On 31 December 2011, the banking sector’s reserves in litas were unusually high, standing at LTL 6.2 billion, and exceeded required reserves more than three times. This

7 Total amount of litas in circulation: litas banknotes and coins in circulation and balances of litas accounts of banks 38 and other account holders with the Bank of Lithuania. II. FUNCTIONS OF THE BANK OF LITHUANIA

surplus formed due to LTL 4 billion received by banks in December for paying insurance compensations to depositors of the bankrupt bank AB bankas SNORAS. As the process of payment of these compensations and their redistribution among banks began just before 31 December, banks held higher than usual excess reserves.

FOREIGN EXCHANGE OPERATIONS In 2011, the amount of foreign currency in net terms purchased by the Bank of Lithuania was even higher than the amount sold, compared to 2010. In 2011, the sale of foreign currency (mainly euro) to the Bank of Lithuania by the Ministry of Finance of the Republic of Lithuania and other depositors exceeded the foreign currency purchase by LTL 10.5 billion, while the purchase of euros by banks exceeded the sales by LTL 5.7 billion. The net purchase of the foreign currency by the Bank of Lithuania therefore made up LTL 4.8 billion, a significantly higher amount, compared to 2010, when the net purchase was LTL 1.1 billion. This difference formed after the Ministry of Finance of the Republic of Lithuania and VĮ Indėlių ir investicijų draudimas, a deposit insurance fund, purchased in the Bank of Lithuania the amount of approximately LTL 4 billion for the payment of insurance compensations to depositors of AB bankas SNORAS through selected commercial banks.

Table 5. Net purchase of foreign currency from the Bank of Lithuania (–) or net sale to the Bank of Lithuania LTL millions

2010 2011 Q1 Q2 Q3 Q4 Q1–Q4 Domestic banks –7,062.8 –2,525.7 –1,781.2 –228.6 –1,205.6 –5,741.0 Depositors of the Bank of Lithuania 8,165.1 1,201.2 1,984.4 331.7 7,010.4 10,527.7 Total 1,102.3 –1,324.5 203.3 103.1 5,804.9 4,786.7

Source: Bank of Lithuania.

In 2011, the amount of foreign exchange transactions by the Bank of Lithuania with domestic banks and its other depositors totalled LTL 72.8 billion, which comprised an increase of 7.5 per cent from LTL 67.7 billion in 2010.

Chart 25. Foreign exchange trade of the Bank of Lithuania with banks and other depositors

39  Annual Report of the Bank of Lithuania

SUPERVISION OF CREDIT AND PAYMENT INSTITUTIONS

2011 In 2011, the Bank of Lithuania acted within the limits of the powers conferred on it to perform the supervision of credit and payment institutions, which involves monitoring and control of credit and payment institutions’ compliance with the laws and the requirements laid down by the legal acts of the Bank of Lithuania, the International Financial Reporting Standards, and the recommendations of the Basel Committee on Banking Supervision regarding safe and sound banking standards.

INSTITUTION OF BANKRUPTCY PROCEEDINGS AGAINST AB BANKAS SNORAS A significant event occurred in the banking sector in the fourth quarter of 2011: bankruptcy proceedings have been initiated against AB bankas SNORAS, which had 10 per cent of the domestic banking market. When conducting this bank’s supervision, the Bank of Lithuania repeatedly expressed concerns about its activity and ascertained violations of legal acts: insufficient specific provisions were formed for reducing operational risks, the assumed credit risk was assessed inadequately, the bank’s management did not take efficient measures to address the problems referred to in the inspection reports, the main shareholder’s business interests were satisfied, some of the bank’s actions did not comply with the good banking practice standards. Taking into consideration the detected deficiencies and violations, the Board of the Bank of Lithuania continued to apply various sanctions against AB bankas SNORAS, established individual ratios of prudential requirements for it and requested it to reduce the operational risks. However, the bank avoided any constructive cooperation and its shareholders and executives failed to demonstrate their preparedness and possibilities to ensure reliable and prudent bank governance, take timely and proper actions to eliminate the drawbacks in its activities and stop breaching legal acts. Due to these reasons, as well as the results of the bank on-site inspection in the third quarter of 2011 and the deterioration of the bank’s liquidity situation, the Bank of Lithuania decided to take strict measures. The Board of the Bank of Lithuania took the decision on 16 November to declare the suspension of activities (a moratorium) of AB bankas SNORAS and appoint a temporary administrator. This decision was also prompted by suspicions of potential criminal activities at this bank (embezzlement of especially large amounts, fraudulent accounting, etc.), potential insolvency, as well as that the fact that all this can harm the interests of the bank’s depositors, other creditors, customers and the general public. To minimise the negative impact on the financial sector stability and eventual government costs, the Government of the Republic of Lithuania, following the proposal of the central bank, imposed a measure provided for in the Law of the Republic of Lithuania on Financial Sus- tainability. The shares of AB bankas SNORAS were taken over for public needs. However, on 24 November, the Bank of Lithuania received a report by the temporary administrator, according to which the financial situation in AB bankas SNORAS was worse than expected, as the bank’s assets made up LTL 4.4 billion, i.e. they were lower by LTL 3.4 billion than the value estimated by the bank. Consequently, the bank’s liabilities actually exceeded its assets by LTL 2.8 billion. It became clear that further activities of AB bankas SNORAS had no future, therefore the bankruptcy proceedings were initiated against the bank. It should be noted that the case of AB bankas SNORAS was exceptional in the banking sector. Serious deficiencies in its activities are not typical to other banks operating in Lithuania. The domestic banking sector proved it was ready and capable to withstand serious challenges and became even safer and more reliable after AB bankas SNORAS bankruptcy. The banking supervision and decision making system functioning in the 40 II. FUNCTIONS OF THE BANK OF LITHUANIA

Bank of Lithuania ensured the timely identification and quick, professional and effective elimination of the threat posed by AB bankas SNORAS.

SUPERVISION OF CREDIT INSTITUTIONS: MAIN TRENDS The prevention of risks associated with banking activities remained the Bank of Lithua nia’s priority in performing the supervision of credit institutions in 2011, with the major focus on ensuring adequate control of significant risks undertaken by credit institutions, strengthening their capital, which is the main source for absorbing risk-related losses, and improving its quality. Credit risk continues to be among the most significant risks, as it has a direct effect on banks’ operating results. Loan quality was a key determinant of banks’ operating results and their prospects; therefore the issue of strengthening the capital base remained a priority in performing the supervision of credit institutions. In 2011, banks continued implementing the internal capital adequacy assessment process (ICAAP), during which they assessed the underlying risk, calculated the capital requirement to absorb it and informed about capital increase possibilities, taking into account their operational forecasts. On the other hand, the Bank of Lithuania continued the Supervisory Review and Evaluation Process (SREP) to find out whether banks properly managed the risk and their capital was sufficient to absorb the risk, and to identify existing and potential problems, as well as shortcomings in the internal control and risk management systems. Along with the SREP, the central bank continued to organise yearly full-scope and target on-site inspections. During these on-site inspections, a special focus was given to the management of certain types of risks, huge attention was paid to the management of credit and liquidity risks as well as the quality of internal governance. The management of the Bank of Lithuania had regular meetings with heads of banks and credit unions operating in the country. These meetings were held to find out about operational prospects of credit institutions, present to their management the Bank of Lithuania’s position on issues it considers the most urgent, discuss on-site inspection results and other problems related to banks’ activities. Much attention was also paid to the elimination of the shortcomings in the activities of credit institutions, which were revealed during on-site inspections, and the implementation of the instructions prescribed by the Board of the Bank of Lithuania. The liquidity of the banking sector was one of the priorities of the supervision, particularly after suspending the activities of AB bankas SNORAS, owing to fears that its depositors could cause temporary liquidity problems in other banks. The day-to-day information on fluctuations in key bank indicators collected by the Bank of Lithuania was of huge relevance at that time. According to the requirement of the central bank, banks must build up liquidity buffers for at least one-week and one-month survival periods and estimate their liquidity counterbalancing capacity based on the cash-flow forecasts to ensure a constant sufficient level of liquidity. Liquidity buffers formed by banks helped them to withstand a temporary decline in deposits after the activities of AB bankas SNORAS were suspended. To further improve liquidity risk management in banks, the General Provisions for Internal Capital Adequacy Assessment Process and Supervisory Review and Evaluation Process were supplemented. A requirement was set for banks to implement the mechanism for the allocation of liquidity costs, benefits and risks to ensure proper functioning of the liquidity risk management systems and processes. The Bank of Lithuania adopted new requirements and will monitor the preparation and implementation by banks of the 41  Annual Report of the Bank of Lithuania

liquidity cost-benefit allocation mechanism by means of a regular and detailed assessment of the liquidity risk management in banks. 2011 WORK DONE AFTER THE GLOBAL FINANCIAL CRISIS The global financial crisis exposed gaps in the regulation of credit institutions and revealed the need for the systemic regulation of their activities. At the same time, a need emerged to implement new instruments for boosting the banking sector’s capacity to withstand shocks, improve risk management and governance in banks and raise transparency of their activities. In response to the consequences of the financial crisis, the Basel Committee on Banking Supervision has worked out the Basel III framework. The fourth Capital Requirement Directive (CRD IV) establishes the legal regulation of EU credit institutions, which is based on the said framework. In 2011, intensive work on coordinating proposed provisions of this directive took place. Experts of the Bank of Lithuania participated in working (expert) groups of EU institutions, which were discussing the CRD IV, the Capital Requirements Regulation (CRR) and provisions of the technical standards to be issued by the European Banking Authority. Information was prepared along with the country’s position on the main changes in the regulation of credit institution activities to be made in accordance with the CRD IV and CRR requirements, with a major focus on liquidity, leverage indicator, the structure of own funds, the cooperation between home and host countries, enforcement measures, credit risk and counterparty credit risk. In order to encourage responsible lending practices of credit institutions, protect consumers against excessive burden of financial liabilities and form responsible borrowing habits, as well as to reduce the systemic risk of the credit institutions sector and unbalanced changes of real estate prices, the Bank of Lithuania approved the Responsible Lending Regulations. They establish the maximum loan-to-value ratio, which should not exceed 85 per cent, the maximum loan term, which should not exceed 40 years, and the debt- to-income ratio, which should not exceed 40 per cent. To receive sufficient information for monitoring the bank bankruptcy proceedings, the Bank of Lithuania prepared new requirements for information provided by administrators of banks in bankruptcy. Along with the balance sheet, profit (loss) statement and the information on a bank’s credit-related liabilities, financial guarantees and other off-balance sheet items, bank administrators will have to send to the Bank of Lithuania monthly information on decisions adopted by creditor committees and quarterly information on the sale of bank assets, satisfaction of creditor claims and their status, the number of employees, administration expenses and other information. To assess resilience of the financial sector, all banks conducted stress testing exercises in accordance with uniform and quite severe scenarios prepared by the Bank of Lithuania. The findings of the testing on 1 January and 1 July 2011 showed that the Lithuanian banking system is capable to withstand potential financial shocks. The bankruptcy of AB bankas SNORAS was a real challenge for the banking sector, but the latter withstood this testing under extreme circumstances and proved it was ready to counter real shocks. To improve the conditions for operation of electronic money institutions and encourage the development of electronic money in the Lithuanian financial sector, as well as to implement the provisions of the Directive of the European Parliament and of the Council on the taking up, pursuit and prudential supervision of the business of electronic money institutions, experts of the Bank of Lithuania, in cooperation with the work group formed 42 by the Ministry of Finance of the Republic of Lithuania, worked out a draft law of the II. FUNCTIONS OF THE BANK OF LITHUANIA

Republic of Lithuania on electronic money and electronic money institutions. The Seimas (Parliament) of the Republic of Lithuania passed the law in December 2011.The formation of the package of by-laws necessary for electronic money institutions to apply for operational licences and start activities was finalised. The Bank of Lithuania started the supervision of payment institutions at the end of 2011. A legal framework for the supervision of these institutions was built, which regulates licensing, prudential requirements, internal control and risk management, accountability and other issues. Technical measures for receiving supervisory and financial reports and conducting supervision were implemented. The restructuring of the financial sector supervision was completed in the second half of the year by creating the Supervision Service, a new unit of the Bank of Lithuania. It took over the functions of the former Securities Commission and Insurance Supervisory Commission of the Republic of Lithuania, as well as the Credit Institutions Supervision Department of the Bank of Lithuania. A system-wide mechanism has been created for the supervision of the whole financial sector.

REVIEW OF CREDIT INSTITUTIONS’ ACTIVITIES

REVIEW OF BANKING ACTIVITIES On 31 December 2011, there were 8 commercial banks holding the licence issued by the Bank of Lithuania, one bank undergoing bankruptcy proceedings, 12 foreign bank branches and two representative offices of foreign banks. The Bank of Lithuania had received 258 notifications from the supervisory authorities of the EEA countries regarding intentions of the banks licensed by them to provide services without establishing branches. 2011 was an exceptional year for the financial sector. The banking sector encountered a serious challenge at the end of the year, as the activities of AB bankas SNORAS, the country’s fifth largest bank, were suspended. This event received huge attention, as the banking sector had not seen such shocks for more than 10 years. However, it had no systemic consequences for the banking sector, as interbank liabilities of AB bankas SNORAS were modest, while a notable decrease in deposits in some banks was observed only in the first days after suspending the activities of AB bankas SNORAS. Later, the situation stabilised and deposits started climbing again in all banks, as VĮ Indėlių ir investicijų draudimas, a deposit insurance fund, began paying insurance compensations to former depositors of AB bankas SNORAS. As other banks had accumulated large reserves of liquid assets, none of them applied for liquidity loans to the Bank of Lithuania in the first days after the suspension of AB bankas SNORAS, when their deposit holdings declined. Public confidence in the financial sector is the key condition for maintaining its stability. By withstanding the shock of such magnitude, the financial sector revealed not only the competence of banks, but also the society’s maturity. A smooth deposit compensation process had a significant effect on maintaining stability and building up confidence of the population. The message was clear: the government is capable to meet its obligations. The suspension of AB bankas SNORAS activities at the end of 2011 had a significant impact on the banking sector’s indicators. Until then, some positive changes had been observed in the banking sector: the number of operations increased, assets and deposits grew, banks earned profit. The banking sector contracted after the withdrawal of AB bankas SNORAS licence, as this bank’s assets of LTL 8.1 billion, deposits of LTL 5.9 billion and loans of LTL 3.6 billion were no longer included in the data of the banking sector. Such a decrease of the banking sector was mitigated in part by a smooth process of deposit compensation. 43  Annual Report of the Bank of Lithuania

The amount of approximately 4 billion allocated for paying out compensations to AB bankas SNORAS depositors through VĮ Indėlių ir investicijų draudimas reached banks already 2011 in mid-December. The year-end developments however had a more significant effect on the loan portfolio of the banking sector, which shrank by as much as LTL 4.3 billion. The loans issued by AB bankas SNORAS may return to the banking sector after the bankruptcy administrator starts to sell out the assets. As this process may take a long time, the full impact of AB bankas SNORAS collapse on the banking sector’s loan market will be known only in the future. The banking sector lending trends, excluding AB bankas SNORAS, show that the domestic lending volume remained basically unchanged over the year. The amount of liquid assets in banks grew due to the end-2011 events, as funds of the insured depositors of AB bankas SNORAS were transferred to their accounts in a relatively short time. This triggered changes in the composition of banks’ assets. The largest increase was observed in the funds of extremely high liquidity, such as cash and funds held in the central bank and other banks (mainly parent banks), which comprise a part of bank assets. At the end of the year, these liquid funds accounted for over 20 per cent of banks’ assets. Debt securities acquired by banks are also attributed to liquid assets. Banks have invested in debt securities of various issuers, however, the largest share of such investment was made in debt securities of the Government of the Republic of Lithuania. At the end of the year, their value was LTL 3.4 billion, while the value of government debt securities of other countries amounted to only LTL 0.2 billion. In 2011, banks sold nearly all debt securities of some European countries, whose financial stability was doubtful: investments in debt securities of these countries therefore amounted to just a couple dozen million litas.

Chart 26. Dynamics of assets, loans and deposits of the banking sector (end-of-period)

As banks continued to accumulate liquid assets, the share of loans granted decreased in 2011 by 3 percentage points to 68.4 per cent of total assets. Deposits attracted in the country comprise the main source of financing for the banking sector. They account for almost 60 per cent of bank liabilities. As mentioned above, deposits of the banking sector decreased due to the bankruptcy of AB bankas SNORAS, but at the end of the year former depositors of AB bankas SNORAS appeared in some other 44 banks. As a result, deposits in these banks grew by LTL 4 billion or 10.3 per cent during II. FUNCTIONS OF THE BANK OF LITHUANIA

2011. The largest increase was observed in deposits of households (by LTL 3.2 billion) and private enterprises (by LTL 2.6 billion).

Chart 27. Composition of bank assets (end-of-period)

Borrowing from banks, mainly from parent banks, was another important source of finan cing for banks. Unlike in the previous year, when the indebtedness to parent institutions went down notably on account of growing deposits, the banks’ debt share remained broadly unchanged, accounting for 33.5 per cent of total liabilities of banks in 2011, while debt to foreign parent banks decreased only by LTL 0.7 billion. However, bank crediting remained at low level, and cash flows from repaid loans were accumulated by banks largely in parent banks. Therefore, the net debt to parent banks (a difference between the debt to parent banks and funds held with them) decreased by LTL 3.2 billion to LTL 15.2 billion. Other saving instruments such as debt securities were not popular in Lithuania so far, although a slight increase was recorded in their sale last year. These instruments are less attractive, as they are not insured by the government. Banks pay higher interest rates on such debt instruments than on deposits, because they are riskier. The case of AB bankas SNORAS demonstrated that, by receiving higher interest, households also assumed higher risk. Under this situation, alternative borrowing instruments are unlikely to become popular in the Lithuanian banking sector in the nearest future. In 2011, the Lithuanian banking sector became less reliant on the financing from other countries. Funds received from non-residents made up 38.3 per cent of the banking sector’s liabilities at the end of the year, of which, debts to parent banks accounted for more than 30 per cent. The bankruptcy of AB bankas SNORAS led to a notable decrease in non-resident deposits. The decline in debts to parent banks and non-resident deposits in 2011 was followed by the decrease in the share of foreign currency debt from 57.7 to 53.1 per cent of bank liabilities. In 2011, banks earned the profit of LTL 1.1 billion, after incurring losses in 2009 and 2010. It was almost similar to the profit earned by the banking sector during the economic upswing in 2007. However, unlike in 2007, the profit grew largely because of provision reversals (related with the revaluation of loans and investments in subsidiary companies) 45  Annual Report of the Bank of Lithuania

and decreased interest expenses, rather than the income growth. The operating result of banks (their profit before taxes), excluding impairment and provision expenses, remained 2011 actually unchanged in 2011, compared to 2010, making up LTL 856.7 million.

Chart 28. Composition of bank liabilities (end-of-period)

After the annual audit, the operating result of banks slightly declined. Two small domestic banks, AB bankas FINASTA and UAB Medicinos bankas, had made a decision to make 100 per cent provisions against funds held with AB bankas SNORAS. This decision had a significant effect on AB bankas FINASTA. After making the provisions, the need for additional capital emerged for this credit institution. The bank‘s capital therefore was im- mediately restored by an additional contribution to the bank‘s reserve capital. Currently, AB bankas FINASTA complies with all prudential requirements with adequate reserve and started negotiations with potential investors. Net interest income, the main type of banks‘ income in Lithuania, grew in 2011 by 13.8 per cent to LTL 1.3 billion (excluding income of AB bankas SNORAS, net interest income increased by 22.4%). The main reason of its growth was a faster decline of interest expenses, which are incurred by banks when they pay interest for customer deposits and other financing sources, than that of interest income, rather than the increase in interest earned by banks for loans granted and assets invested in other interest-bearing instruments. Net income from services and commissions went down by 11.4 per cent, compared to 2010, to LTL 596.1 million, largely due to the fact that the data for AB bankas SNORAS were no longer recorded in the banking sector’s accounts. The assessment of the annual change shows that net income from services and commissions in other banks, excluding AB bankas SNORAS, went up slightly (by 0.8%), compared to 2010. The growth of income from services and commissions is usually directly related to the economic growth, as the development of the domestic economy triggers activity of its economic entities and thereby the need for banking services. Thus, it is likely that income from services and commissions increased in 2011 due to the growth in the volume of services rather than in their prices. Some banks reduced their fees after the Bank of Lithuania announced an initiative aimed at reducing the price for essential services used by the most socially sensitive groups of people. 46 II. FUNCTIONS OF THE BANK OF LITHUANIA

After the domestic economy strengthened in 2011, some bank customers previously considered insolvent improved their financial situation and began fulfilling their obligations. Moreover, banks carried out the revaluation of pledged assets, therefore, the need for provisions went down. Thus, the reduction of previously formed provisions by banks was bigger than the amount of new provisions made by them, which allowed banks to earn LTL 368 million (LTL 219.6 million from the revaluation of bank investments into subsidiary leasing companies and LTL 158.5 million from the positive effect of the loan impairment). By comparison, in 2010, asset impairment losses incurred by banks made up LTL 1.2 billion. Banks’ operational expenses declined by LTL 27.1 million or 2.5 per cent, compared to 2010, as a result of a decrease in the number of banks; therefore, the real change in operational expenses is reflected by the data without AB bankas SNORAS. Their analysis shows that operational expenses in banks grew by 8.6 per cent in 2011, compared to 2010. They increased mainly due to an annual increase of 11.8 per cent in staff costs.

Chart 29. Net profit of banks (end-of-period)

Contrary to the previous years, return on assets and return on equity indicators of banks were positive on 31 December 2011 due to profitable operation of banks and made up respectively 1.38 and 17.03 per cent. The indicator that reflects business efficiency of banks – the ratio of operating expenses (operational and amortisation costs) to income from the main activity – declined, compared to the previous year, i.e. improved, by 1.9 percentage points to 57.3 per cent. The borrowing and lending costs declined further, as low interest rates continued to pre- vail in the markets. The real interest margin of the banking system rose slightly in 2011 from 1.30 to 1.57 per cent, which had a positive effect on banks’ net interest income.

BANK CAPITAL On 31 December 2011, the foreign investors’ share in the authorised capital of banks made up 87.7 per cent. The capital of investors from the Northern European countries continued to dominate the Lithuanian banking system. In Lithuania, the established capital adequacy ratio is 8 per cent, but for some banks, owing to the specific nature of their operations and risk, a higher ratio of 10 per cent has been set. However, when performing the annual assessment of internal capital adequacy and operational risks specific to them, banks establish their own target capital adequacy ratios, which are substantially higher than the one established by the Bank of Lithuania. In 47  Annual Report of the Bank of Lithuania

2011, the domestic banking sector was well capitalised, with the capital adequacy ratio of 13.92 per cent at the end of the year. A decrease was observed in the gap between 2011 capital adequacy ratios in domestic banks and banks with parent institutions abroad. Several local capital banks increased their capital in 2011. Banks with parent institutions abroad increased their capital in 2009 and 2010; furthermore, these banks planned to reinvest the profits earned into further expansion instead of paying out dividends. Thus, banks will further strengthen their resilience and possibilities to cover potential losses. To avoid financial shocks in the future, the international community has agreed to strengthen banking supervision by setting higher requirements for banks. Banks operating in Lithuania will have to observe much stricter requirements in the future. Under the recommendations of the Basel Committee on Banking Supervision, the Core Tier I capital ratio is to be introduced in all EU countries. The EU Member States have agreed that all the largest banking groups in the EU must have sufficient capital amount to maintain the Core Tier I capital ratio of at least 9 per cent by mid-2012. This ratio will have to be maintained also by foreign parent banking groups, controlling the majority of banks operating in Lithuania: SEB, Swedbank, DNB NOR, Nordea and Danske. The said ratio will not be applied to the Lithuanian subsidiaries of these groups this year, but stricter requirements to parent banks will boost stability in the entire group and eventually will have a positive effect on their subsidiaries operating in our country. It is important that banking groups from the Northern European countries, which have subsidiary banks in Lithuania, unlike banking groups operating in some other EU Member States, should not encounter any larger difficulties in implementing this requirement, as shown by preliminary estimates. As said previously, banks operating in Lithuania will not have to maintain the ratio in 2012 yet, but it is important for the Lithuanian banking sector already today to be prepared for introducing this ratio. By the way, on 31 December 2011 this ratio was 10.7 per cent and well above the minimum target. It is also planned to establish other capital ratios, such as share capital within Tier I capital and financial leverage. According to preliminary estimates, the Lithuanian banking sector is sufficiently capitalised and would be able to comply with the target ratios already today.

BANKS BY MARKET SHARE The suspension of AB bankas SNORAS activities at the end of 2011 prompted some changes in market shares held by banks. The market shares of the three largest banks and foreign bank branches increased in all market segments, whereas the market share of the medium and small bank group, which also included AB bankas SNORAS before the suspension of the latter’s activity, went down. The three largest banks succeeded in boosting significantly their deposits – their share in the deposit market grew over the year by as much as 12.3 percentage points to 71.3 per cent of deposits of the banking sector. This happened because the majority of insurance compensations for deposits held at the bank in bankruptcy AB bankas SNORAS were transferred to the three largest banks in the country. Foreign bank branches also strengthened their positions slightly, as their share in the deposit market grew over the year by 1.1 percentage points to 12.8 per cent. Meanwhile, the deposit market share of medium and small banks shrank by as much as 13.4 percentage points. This happened basically due to AB bankas SNORAS, which had 13.9 per cent of the deposit market in the beginning of 2011. Similar changes were observed over the year in the market share of banks by assets: the 48 market share of the three largest banks significantly increased, the share of foreign bank II. FUNCTIONS OF THE BANK OF LITHUANIA

branches grew at a slower rate, whereas the share of the remaining banks went down. Changes in the loan market were less prominent, as the share of AB bankas SNORAS was just 6.2 per cent. In 2011, the loan market share of the medium and small banks group declined by 6 percentage points to 10 per cent, while the share of the three lar gest banks and foreign bank branches increased respectively to 68.0 and 21.9 per cent.

Chart 30. Market share of banks by assets (end-of-period; percentages)

REVIEW OF BANK ACTIVITY RISKS

CREDIT RISK In 2011, banks remained conservative in their lending, nevertheless, crediting recovered noticeably. The flow of new loans was persistently higher in the second half of the year, albeit only slightly, than the flow of repaid loans. The public sector was credited most actively – loans to government institutions and state and municipal enterprises grew over the year by more than a quarter. The recovery was also observed in the crediting of businesses – in the second half of the year, for the first time since 2009, the amount of new loans to private enterprises exceeded that of earlier loans repaid to banks. In the second half, the amount of loans by banks, excluding AB bankas SNORAS, to private enterprises was higher by LTL 580 million than the amount of earlier loans repaid by these enterprises. This development was driven by the gradual recovery of credit demand, which was prompted by the economic growth and the improvement in the borrowers’ financial situation, and the easing of bank lending conditions. Unfortunately, more active lending in the second half of the year did not offset more passive lending in the beginning of the year. Total loan portfolio contracted in 2011 and amounted to LTL 54 billion on 31 December. Similar to the developments in other data of the banking sector, the bankruptcy of AB bankas SNORAS, whose loan portfolio was LTL 3.6 billion (6.2% of the market), had a huge impact on the changes in lending at the end of 2011. Excluding the loan portfolio of AB bankas SNORAS, only a slight decline in loans issued by the banking sector was observed in 2011: at the end of the year, the loan portfolio was smaller only by 0.2 per cent or LTL 108 million than in the beginning of the year. This is lower by far than in 2009 and 2010, when the loan portfolio decreased respectively by LTL 9.9 billion and LTL 3.2 billion. The loan burden shrank last year largely because of households, as their loan portfolio contracted by LTL 800 million (3.3%) to LTL 23.5 billion. Repayment of consumer and other loans, excluding housing loans, by households contributed materially to the said change. In 2011, the portfolio of housing loans shrank only by 0.7 per cent to LTL 19.6 billion. After the institution of bankruptcy proceedings against AB bankas SNORAS, which had been actively lending to customers from foreign countries, the share of non-resident loans decreased twofold and amounted to LTL 0.7 billion or 1.4 per cent of total loan portfolio at the end of the year. 49  Annual Report of the Bank of Lithuania

Positive changes of the domestic economy in 2011 also contributed to the improvement of the loan portfolio. Banks viewed borrowers as less risky, which prompted them to reduce 2011 provisions made in previous years. Over the year, the provisions decreased by LTL 862 million or 17.8 per cent, but on 31 December they were still high, standing at LTL 4 billion. The decline in provisions was followed by a decline in the ratio of specific provisions to the loan portfolio by 1 percentage point to 6.9 per cent. The quality of the portfolio of housing loans remained good, as specific provisions accounted for 3.3 per cent of the portfolio of such loans. The quality of consumer loans however remained poor. On 31 December 2011, the ratio of specific provisions to these loans was 11.7 per cent. The ratio of loans overdue for more than 60 days8 to the loan portfolio, reflecting partly a potential threat of loan impairment, decreased over the year by 0.5 percentage point to 2.5 per cent on 31 December of 2011. If there are no unexpected economic shocks, the loan portfolio quality is likely to improve in the future.

Table 6. Loan portfolio quality indicators (31 December 2011; share of the loan portfolio, percentages)

Loan impairment Loans overdue for more Impaired loans Non-performing loans (specific provisions) than 60 days Loans to customers: 6.9 2.5 13.8 16.3 of which housing loans 3.3 2.6 6.0 8.6 consumer loans 11.7 5.5 11.0 16.5

Source: Bank of Lithuania.

Improving loan portfolio quality is also reflected by the decline of liabilities to banks by companies against which bankruptcy or restructuring proceedings were instituted. The liabilities to banks by companies which went bankrupt or were under restructuring in 2011 made up around LTL 764 million, which comprised a twofold decrease, compared to 2010. However, the liabilities to banks by all bankrupt companies or companies under restructuring remained significant and on 31 December 2011 made up around LTL 3.3 billion or 12.8 per cent of bank loans to resident enterprises in the private sector. Special provisions against the above loans amounted to LTL 1.6 billion, with loans to companies engaged in real estate and construction activities accounting for the biggest share of these loans (around 65%). On 31 December 2011, banks were able to assume additional credit risk in the amount of LTL 2.6 billion without violating the capital adequacy ratio.

LIQUIDITY RISK Developments at the end of 2011 proved that the banking sector and every participant in it were well prepared for short-term liquidity shocks and capable to withstand them on their own. Although confidence in banks weakened temporarily and deposits declined more than usually in November, none of the banks operating in the country applied to the Bank of Lithuania for liquidity support. On 31 December 2011, all banks maintained the liquidity ratio established by the Bank of Lithuania, whereas the liquidity ratio of the banking sector made up 44.05 per cent and was the highest in the last year and a half (the liquidity ratio set by the Bank of Lithua nia is 30 per cent). Insurance compensations to the depositors of AB bankas SNORAS,

8 Included are only those loans overdue by more than 60 days, for which no specific provisions have been made on 50 an individual basis. II. FUNCTIONS OF THE BANK OF LITHUANIA

which were transferred to the banking sector, contributed significantly to the growth of the banking sector’s liquidity ratio in December 2011. On 31 December 2011, the level of liquidity buffers in banks was sufficient to bridge the net financing gap. Total liquidity buffers formed by banks made up LTL 18.6 billion, while the net financing gap amounted to LTL 6.6 billion, i.e. liquidity buffers in banks were 2.8 times above the minimum requirement for liquidity buffers. This is the amount by which the accumulated reserve of liquid assets exceeded the 1-month net financing gap. The December changes in the composition of liquid assets showed that banks were determined to improve the quality of liquid assets to ensure sufficient amount of highly liquid funds in the turbulent market. On 31 December, the biggest portion of their liquid assets was deposited in the form of funds with banks of EU Member States and other countries holding higher credit ratings, as well as in the form of funds with central banks.

MARKET RISK The debt securities portfolio of the banking sector, which is sensitive to the fluctuations of risk factors, decreased in 2011 almost by one third or LTL 2.5 billion. This steep decrease reflected the suspension of AB bankas SNORAS activities and the sale of debt securities of operating banks. Due to the increasing concerns about financial stability in some European countries, government securities, one of the least risky investment products earlier, became less attractive to banks, which got rid therefore of almost all (over 93%) risky debt securities in November and December. On 31 December 2011, assets and liabilities, which are sensitive to changes in bank interest rates, were balanced by maturity so that the net interest income growth follows the growth in interest rates and vice versa. As in previous periods, banks’ net interest income was most sensitive to changes in interest rates on euro loans, while the changes in interest rates on loans in litas, US dollars and other currencies had only a moderate effect on banks’ profitability. Notwithstanding the decrease in the debt securities portfolio, the capital required to absorb market risk grew in 2011, reaching LTL 502.8 million at the end of the year. The growth of this type of capital was determined by the capital requirement for absorbing foreign exchange risk, which grew following an increase in the open euro position of the banking sector by 2.3 times to 89.5 per cent. The capital requirement for foreign exchange positions, calculated largely for the euro position, made up the largest share in the market risk capital requirement. Other open positions held by banks in other currencies were insignificant, as the banking sector’s open foreign currency position, excluding the euro position, made up 0.7 per cent of banks’ capital (the maximum allowed position is 25%). The equity securities portfolio of banks totalled LTL 1 billion on 31 December 2011. The largest share (96%) of equity securities represented investments into subsidiary companies, while traded equity securities made up only LTL 39.7 million. Banks were less sensitive to changes in the prices of traded equity securities due to insignificant positions of these papers.

OPERATIONAL RISK According to the data in the capital adequacy reports by banks as of 31 December 2011, the capital requirement for absorbing potential operational risk losses arising from people and systems, failed internal processes or from external events, including legal risk, decreased slightly over the year and stood at LTL 222 million. The decrease in operational risk capital requirement was determined by simplified methods for ope 51  Annual Report of the Bank of Lithuania

rational risk assessment, which are applied by many banks in Lithuania and which are directly proportional to the 3-year financial and operational net income, which stopped 2011 declining in the entire banking sector in 2011. The global experience suggests that even one significant operational risk event may be fatal for a bank and all capital of the bank may not be enough to cover the losses; it is therefore very important not only to properly estimate the capital required to absorb operational risk, but also to properly manage the risk to avoid losses. To ensure adequate management of operational risk, the Bank of Lithuania requests banks, including banks that use less sophisticated quantitative methods, to compute the capital requirement for operational risk and continuously improve their operational risk management system: to store internal data on real losses incurred by banks as a result of operational risk; to review information systems to adapt them better to specific needs of information management, storage and analysis; to work out plans for stress-testing and business continuity; to give proper attention to the management of a risk associated with outsourcing of ancillary services, etc.

REVIEW OF CREDIT UNION ACTIVITIES On 31 December 2011, there were 74 credit unions operating in Lithuania. They had over 128,000 members. Six credit unions were founded during the year, whereas the number of credit union members grew by 14,600. As the number of credit union members kept growing and some of credit unions increased minimum share contributions, the share capital of credit unions went up in 2011 by 31 per cent to LTL 177.8 million.

Chart 31. Key indicators of credit unions (end-of-period)

The growing number of credit union members prompted further expansion of credit union operations. Over the year, their assets grew by 27.5 per cent to LTL 1.6 billion, loans surged by 24.1 per cent to LTL 933.5 million and deposits with credit unions increased by 29.7 per cent to LTL 1.4 billion. On 31 December 2011, the assets managed by credit unions made up 2.1 per cent of the assets of the domestic banking sector, which comprised a year-on-year increase of 0.5 percentage point. The quality indicators of the credit unions’ loan portfolio remained better than that of 52 the bank loan portfolio. However, they were affected by risky crediting policy in previous II. FUNCTIONS OF THE BANK OF LITHUANIA

years. It should be noted that in recent two years credit unions in Lithuania’s major cities started issuing loans to legal entities, which are their associated members, by applying to borrowers less tight credit standards than banks and thus assuming higher credit risk. In 2011, specific provisions against loans by credit unions increased twofold to LTL 28.6 million, whereas the ratio of specific provisions to the loan portfolio rose from 1.9 to 3.0 per cent, as a number of members of credit unions failed to meet their obligations on time. The credit unions reported losses of LTL 14 million in 2011, the worst result since the start of their operations (in 2010, the loss was LTL 5.4 million). Profit was reported by 45 credit unions and loss by 27 credit unions. Notwithstanding the growth in their income, the funds held with AB bankas SNORAS and expenses incurred due to the decrease in the value of Greece government securities led to higher losses than in the previous year. The liquidity ratio of credit unions was 44.8 per cent, exceeding the established minimum level (30%) by almost 15 percentage points. The capital adequacy ratio applied to credit unions is higher than for banks – it should be at least 13 per cent. According to the credit union statements for 31 December 2011, the capital adequacy ratio of credit unions was 19.8 per cent and exceeded the established minimum ratio with a relatively large reserve. To ensure sustainable growth of credit unions and proper management of risks assumed by them, it is planned to further strengthen their supervision and gradually make the requirements for them closer to core operational standards applied to banks. Taking the above into consideration, the Guidelines for Credit Union Activities and Supervision were prepared. Upon implementing the measures envisaged in them, a better balance between the expansion of credit union activities and their capabilities to absorb potential losses related with the assumed risks should be achieved, which would help to ensure safe and sound operation of credit unions. At the end of 2011, 62 credit unions were members of the Central Credit Union of Lithuania (CCUL), the assets of which grew over the year by LTL 44.1 million to LTL 354.6 million. The portfolio of loans issued to members of the CCUL surged by 55.9 per cent in 2011 to LTL 47.2 million on 31 December the same year. Under a joint activity (consortium) agreement with UAB Investicijų ir verslo garantijos, the manager of the Entrepreneurship Promotion Fund (INVEGA), loans amounting to LTL 4.7 million were issued by the fund to finance small businesses. The quality of the CCUL’s loan portfolio remained good: no specific provisions were formed and there were no loans with regular payments overdue for more than 60 days. The share capital of the CCUL grew over the year by LTL 18.8 million to LTL 29.1 million on 31 December 2011 (the largest increase amounting to LTL 16.3 million was recorded in the fourth quarter). The increase in their share capital ensured compliance with all prudential requirements. As the CCUL had formed specific provisions against the funds held in AB bankas SNORAS, it was able to help credit unions, members of the CCUL, to solve the above mentioned problems and ensure stability of the credit union sector. In 2011, the CCUL incurred the loss of LTL 15.3 million, after earning the LTL 1.5 million profit in 2010. The specific provisions for the funds held in AB bankas SNORAS, which were formed in the last quarter, made the biggest impact on the negative performance result in 2011.

REVIEW OF PAYMENT INSTITUTION ACTIVITIES After the Republic of Lithuania Law on Payment Institutions, under which legal entities without a payment institution licence were allowed to provide payment services only by 53  Annual Report of the Bank of Lithuania

30 April 2011, entered into effect, an intensive payment institution licensing process took place. During this process, enterprises which used to provide payment services earlier 2011 legalised their activities and new payment institutions were established. In 2011, 21 payment institutions holding licences issued by the Bank of Lithuania to provide payment services were founded. Enterprises providing utility services prevailed among the applicants for a payment institution licence in the second half of the year. Nineteen of them already had such licences (for providing payment services, namely for making money remittances) issued to them earlier. Almost all payment institutions were also engaged in other types of activities. Payment services were the only type of activity only in one institution and core activity in four institutions. In 2011, the payment institutions’ income for their services made up LTL 55 million. It accounted only for 4 per cent of total income of all payment institutions. In 2011, all payment institutions complied with the requirement for the protection of funds of the users of payment services or funds received from another payment services provider under the Law of the Republic of Lithuania on Payment Institutions. On 31 January 2011, all payment institutions complied with the initial capital and own funds requirements established in the Law on Payment Institutions.

CASH MANAGEMENT Implementing its exclusive right to issue currency, the Bank of Lithuania puts into and withdraws from circulation the currency of the Republic of Lithuania, establishes its denominations, organises currency production, transportation and storage, and makes up reserve funds of banknotes and coins according to the procedure established by laws.

CURRENCY ISSUE AND WITHDRAWAL In 2011, the value of currency in circulation, including collectors (commemorative) coins and numismatic sets, increased by LTL 2,003.1 million: the Bank of Lithuania issued into circulation LTL 4,638.6 million and withdrew from circulation LTL 2,635.5 million of unfit banknotes and coins. Over the year, the cash value increased by 22.7 per cent (11.2% in 2010). As at 31 December, the currency in circulation amounted to LTL 10,827.0 million (LTL 8,824.0 million a year ago).

Table 7. Net currency issue or withdrawal (–) LTL millions

Year Quarter I II III IV I–IV 2009 –1,306.4 –316.0 –271.6 196.8 –1,697.3 2010 –105.6 393.2 211.1 393.2 891.8 2011 –143.9 298.3 248.0 1,600.7 2,003.1

Source: Bank of Lithuania.

The value of currency in circulation decreased most notably in January 2011, while the most pronounced increase was observed in December. As at 31 December 2011, banknotes in circulation totalled 88.0 million pieces with their value standing at LTL 10,597.9 million. Since the beginning of the year, the number of banknotes in circulation has grown by 9.7 million (12.4%) and their value by LTL 1,984.9 million (23.0%). With the growing demand for banknotes of higher denominations, the 54 value of an average circulation banknote rose from LTL 109.9 to LTL 120.4 over the year. II. FUNCTIONS OF THE BANK OF LITHUANIA

Chart 32. Litas in circulation

As at 31 December, 1,032.9 million circulation coins were in circulation with their value standing at LTL 215.0 million. Since the beginning of the year the number of coins in circulation has increased by 57.8 million (5.9%) and their value by LTL 16.9 million (8.5%).

Table 8. Banknotes and coins in circulation

Denomination 31 12 2010 31 12 2011 31 12 2010 31 12 2011 LTL Percentage LTL Percentage Million Percentage Million Percentage millions share millions share pcs. share pcs. share Banknotes LTL 1 2.6 0.0 2.6 0.0 2.6 3.4 2.6 3.0 LTL 2 2.6 0.0 2.6 0.0 1.3 1.6 1.3 1.5 LTL 5 2.2 0.0 2.2 0.0 0.4 0.6 0.4 0.5 LTL 10 94.9 1.1 97.4 0.9 9.5 12.1 9.7 11.1 LTL 20 212.5 2.5 214.4 2.0 10.6 13.6 10.7 12.2 LTL 50 420.4 4.9 432.6 4.1 8.4 10.7 8.7 9.8 LTL 100 2,038.9 23.7 2,159.8 20.4 20.4 26.0 21.6 24.5 LTL 200 4,464.1 51.8 5,868.4 55.4 22.3 28.5 29.3 33.3 LTL 500 1,374.9 16.0 1,817.9 17.2 2.7 3.5 3.6 4.1 Total banknotes 8,613.1 100.0 10,597.9 100.0 78.3 100.0 88.0 100.0 Circulation coins LTL 0.01 3.8 1.9 4,0 1.9 379.4 38.9 403.7 39.1 LTL 0.02 4.0 2.0 4.3 2.0 200.6 20.6 214.5 20.8 LTL 0.05 3,9 2.0 4.1 1.9 77.9 8.0 81.6 7.9 LTL 0.1 14.8 7.5 15.3 7.1 147.5 15.1 152.8 14.8 LTL 0.2 14.1 7.1 14.7 6.9 70.4 7.2 73.7 7.1 LTL 0.5 11.1 5.6 11.5 5.4 22.2 2.3 23.0 2.2 LTL 1 40.9 20.6 43.9 20.4 40.9 4.2 43.9 4.3 LTL 2 50.3 25.4 54.4 25.3 25.1 2.6 27.2 2.6 LTL 5 55.3 27.9 62.8 29.2 11.1 1.1 12.6 1.2 Total circulation coins 198.0 100.0 215.0 100.0 975.1 100.0 1,032.9 100.0 Collectors (commemo rative) coins and numismatic sets 12.8 14.1 0.3 0.3

Source: Bank of Lithuania. 55  Annual Report of the Bank of Lithuania

The average number of circulation litas and centas coins per capita in Lithuania increased by 9 per cent to 323 coins, of which 126 coins were 1 centas coins. 2011 COLLECTORS (COMMEMORATIVE) COINS The Bank of Lithuania issued five collectors (commemorative) coins in 2011: one gold (Au 999) and four silver (Ag 925) ones. The coins have a mirror surface with mat relief. The Bank also issued 1 litas circulation collectors (commemorative) coin of copper/nickel alloy. All of them were minted at UAB Lithuanian Mint. 50 litas silver coin dedicated to the 150th birth anniversary of Gabrielė Petkevičaitė-Bitė was issued on 28 February. The coin’s diameter is 38.61 mm, weight 28.28 g, mintage 10,000 pcs. The obverse of the coin features Vytis, the symbol of the coat of arms of the Republic of Lithuania, and the words about Gabrielė Petkevičaitė-Bitė: LIKTI SAVO NAMŲ IR TĖVYNĖS SARGYBOJE (To stay in the guard of one’s home and homeland), the reverse bears a portrait of Gabrielė Petkevičaitė-Bitė and the inscriptions GABRIELĖ PETKEVIČAITĖ-BITĖ, 150, ŽMONĖMS, TAUTAI, VALSTYBEI, KULTŪRAI (To People, Nature, State, Culture). The edge of the coin bears the inscription AD ASTRA. The coin was designed by Rimantas Eidėjus.

Chart 33. 50 litas silver coin dedicated to the 150th birth anniversary of Gabrielė Petkevičaitė-Bitė

On 25 March, the Bank of Lithuania issued 10 litas silver coin dedicated to Theatre. It is the second coin in the series “Lithuanian Culture”. The coin’s diameter is 28.70 mm, weight 12.44 g, mintage 10,000 pcs. The obverse of the coin features Vytis, the symbol of the coat of arms of the Republic of Lithuania, the reverse contains a motif of the work “Theatre” by Stasys Krasauskas. The edge of the coin bears the inscription LIETUVOS KULTŪRA * TEATRAS (Lithuanian Culture * Theatre). The coin was designed by Giedrius Paulauskis.

Chart 34. 10 litas silver coin dedicated to Theatre (from the series “Lithuanian Culture”)

On 21 June, the Bank of Lithuania issued 50 litas gold coin and 1 litas coin of copper/ nickel alloy dedicated to Basketball. 56 II. FUNCTIONS OF THE BANK OF LITHUANIA

The obverse and the reverse of the coins feature a stylized basketball. The obverse also features Vytis, the symbol of the coat of arms of the Republic of Lithuania, the reverse contains the inscription 2011 EUROPOS KREPŠINIO ČEMPIONATAS (The European Bas- ketball Championship 2011). The graphic design of the coin was created by artist Liudas Parulskis, its plaster model by Giedrius Paulauskis. The diameter of the gold coin is 16.25 mm, weight 3.10 g, mintage 5,000 pcs.

Chart 35. 50 litas gold coin dedicated to Basketball

The diameter of 1 litas circulation collectors (commemorative) coin is 22.30 mm, weight 6.25 g, mintage 1 million pcs.

Chart 36. 1 litas coin of copper/nickel alloy dedicated to Basketball

In continuation of the series “Historical and Architectural Monuments of Lithuania”, 50 litas silver coin dedicated to Vilnius Upper Castle was issued on 6 September. It is the tenth coin in this series. Its diameter is 38.61 mm, weight 28.28 g, mintage 5,000 pcs. The obverse of the coin features the coat of arms of the Republic of Lithuania on a shield and an element of the Castle’s brickwork. The reverse bears the stylized Vilnius Upper Castle against the background of the city and the words VILNIAUS AUKŠTUTINĖ PILIS (Vilnius Upper Castle). The edge of the coin bears the inscription ISTORIJOS IR ARCHITEKTŪROS PAMINKLAI (Historical and Architectural Monuments). The coin was designed by Rytas Jonas Belevičius.

Chart 37. 50 litas silver coin dedicated to Vilnius Upper Castle (from the series “Historical and Archi- tectural Monuments of Lithuania”)

On 12 December, the Bank of Lithuania issued 50 litas silver coin dedicated to the XXX Olympic Games in London. Its diameter is 38.61 mm, weight 28.28 g, mintage 5,000 pcs. The obverse of the coin features the coat of arms of the Republic of Lithuania on a shield and symbolical yachts. The reverse depicts an Olympic sport, sailing, and the inscription LONDONAS 2012 (London 2012). The edge of the coin bears the inscription VĖJO (Wind we need) and stylized sails. 57  Annual Report of the Bank of Lithuania

The coin was designed by Rūta Ona Čigriejūtė and Rytas Jonas Belevičius.

2011 Chart 38. 50 litas silver coin dedicated to the XXX Olympic Games in London

On 10 January, the Bank of Lithuania issued a new numismatic set of circulation coins of the 2011 issue with a commemorative medal of copper/nickel alloy (BU quality). Its mintage is 4.5 thousand pcs.

Chart 39. Numismatic set of circulation coins of the 2011 issue

COUNTERFEIT BANKNOTES AND COINS 619 counterfeit banknotes and 12 counterfeit 1 litas coins were identified in Lithuania in 2011. The quantity was 7 per cent above the figure for 2010, when 578 counterfeits were discovered. Like in previous years, counterfeit 100 litas banknotes of the 2000 issue were detected for the most part, accounting for 65 per cent of total counterfeits. Coun- terfeit 50 litas banknotes of the 2003 issue accounted for 17 per cent of the counterfeits. The counterfeit banknotes were mostly printed using inkjet printers, sometimes imitat- ing banknote security features (watermark, security thread, security features fluorescent under UV light, etc.). The counterfeits were of poor quality, thus they could be easily distinguished from the genuine currency by doing a “feel-look-tilt” test and comparing them with genuine banknotes and coins. In 2011, identified counterfeits accounted for around 0.0007 per cent of total banknotes in circulation: one counterfeit banknote per 142 thousand pcs. of banknotes in 58 II. FUNCTIONS OF THE BANK OF LITHUANIA

circulation (24 thousand pcs. in the euro area). In Lithuania, the overall level of currency counterfeiting was significantly lower, compared to the euro area countries.

FOREIGN RESERVE MANAGEMENT One of the functions of the Bank of Lithuania is the management, use and disposal of the foreign reserves of the Bank of Lithuania. The Bank aims to invest its foreign reserves in safe, liquid and return generating assets and thus ensure a smooth functioning of the fixed exchange rate regime. Acting as a State Treasury agent, the Bank of Lithuania manages accounts of the State Treasury, Lithuanian and EU institutions, foreign banks and international financial institutions.

OFFICIAL FOREIGN RESERVES AND KEY PRINCIPLES OF THEIR MANAGEMENT In 2011, official foreign reserve assets (hereinafter referred to as “foreign reserves”) increased by EUR 1,360.4 million (LTL 4,697.1) or 27.3 per cent. On 31 December, they amounted to EUR 6,347.4 million (LTL 21,918.0 million).

Chart 40. Foreign reserves

Foreign reserves increased on account of an increase in MFI deposits by EUR 784.3 million (LTL 2,708.0 million), currency in circulation by EUR 579.7 million (LTL 2,001.7 million) and other factors by EUR 212.5 million (LTL 733.7 million). Central government deposits reduced foreign reserves by EUR 216.2 million (LTL 746.4 million). The main objective of the Bank of Lithuania in managing foreign reserves is to ensure such an amount of liquid financial resources that is sufficient to maintain the fixed exchange rate of the litas against the anchor currency at any time. Therefore, foreign reserve management is based primarily following the principles of liquidity and safety. In the management of foreign reserves, the Bank of Lithuania seeks the highest return over a one-year horizon, adhering to tight liquidity and safety requirements. Foreign reserves have been divided into four functional parts according to their purpose: current operations, investment, held-to-maturity and gold portfolios. Foreign reserves within the current operations portfolio are primarily aimed to ensure urgent liquidity needs of the Bank of Lithuania. Investment portfolio funds can be used for this purpose as well; however, with little probability that this will ever be needed, it 59  Annual Report of the Bank of Lithuania

is aimed at investing them more profitably than current operations portfolio funds. Part of long-term securities, for which high liquidity requirements are not raised and which 2011 are to be held to maturity, can be attributed to the held-to-maturity portfolio. Given the purpose of gold and the specificity of its management, gold investment is attributed to a separate portfolio.

FOREIGN RESERVE LIQUIDITY, SAFETY AND RETURN ON FOREIGN RESERVES Following the principle of liquidity, the Bank of Lithuania manages its foreign reserves so as to ensure that they can be liquidated quickly and without significant costs, if needed. On 31 December 2011, investment in highly liquid government bonds and funds on the accounts with other central banks and international financial institutions accounted for 38 per cent of investment.

Chart 41. Breakdown of investment by financial instrument (31 December 2011)

The Bank of Lithuania applies operational liquidity requirements, which ensure that regular-scope interventions in the domestic foreign exchange market are made and liabilities vis-à-vis depositors can be met without liquidating any investment. Following the principle of safety, the Bank of Lithuania limits and actively manages all types of financial risk faced in the process of investment of foreign reserves. Credit risk is limited by compiling lists of eligible counterparties and issuers of securities with particularly low probability of default. As at 31 December 2011, investment in financial instruments of highest security accounted for 36 per cent of foreign reserves.

Chart 42. Breakdown of investment by rating (31 December 2011)

60 II. FUNCTIONS OF THE BANK OF LITHUANIA

To reduce credit risk, the principle of diversification is widely used. To implement it, investment limits are set for financial instruments, issuers, counterparties and their groups as well as to issuers and counterparties of one particular country. As at 31 December 2011, investments were made in debt securities issued by 35 issuers. Like most other central banks, the Bank of Lithuania faces foreign exchange rate risk and gold price risk. As our country has a fixed exchange rate of the litas against the euro, to reduce currency risk, the Bank of Lithuania invests almost all its foreign assets (excluding gold), net of liabilities in foreign currencies, in euro, whereas the assets that correspond to liabilities are invested in the currency of liabilities. As at 31 December, gold accounted for 4.1 per cent of foreign reserves net of liabilities in foreign currencies. The amount of gold remained unchanged over the year at 5.8 tons. Its price in euro rose by 11.4 per cent over the year. Implementing the principle of safety, the Bank of Lithuania manages interest rate risk in addition to credit and exchange rate risks. Developments in market interest rates bring about developments in the market value of Bank of Lithuania assets. Longer-term, riskier investment generates higher return, yet sometimes the return on it over a one-year horizon can be negative. Interest rate risk is managed by setting benchmarks and their modified durations (MD) for each functional part of foreign reserves and then placing limits on portfolio real investment deviations (in terms of MD) from benchmark MD and also limiting the longest permissible maturity of individual investments.

Table 9. MD of foreign reserves and their functional parts (31 December; year)

Functional parts 2010 2011 Current operations portfolio 0.09 0.09 Investment portfolio 1.05 0.93 Gold portfolio 0.14 0.02 Total 0.68 0.50

Source: Bank of Lithuania.

To measure market risk, the value-at-risk indicator is used. On 31 December, it amounted to EUR 4.6 million, which means that there is a 95 per cent probability that due to interest rate, gold price and exchange rate developments the value of foreign reserves will not decrease by an amount higher than EUR 4.6 million or 0.07 per cent during the next business day.

Table 10. Return on functional parts of foreign reserves (percentages)

2007 2008 2009 2010 2011 Current operations portfolio 4.05 4.09 1.19 0.67 1.04 Investment portfolio 3.76 5.57 4.47 0.19 0.22 Gold portfolio 0.04 0.09 0.04 0.00 0.24 Held-to-maturity portfolio – – – 2.24 3.19 Return excluding contribution of exchange rates and gold price 3.81 5.00 3.85 0.53 0.54 Return including contribution of exchange rates and gold price 4.15 5.22 4.45 1.86 1.35

Source: Bank of Lithuania. Note: Cost price instead of market price is held to be the value of held-to-maturity portfolio securities, thus return on this portfolio consists only of accumulated yield. 61  Annual Report of the Bank of Lithuania

The Bank of Lithuania pursues conservative foreign reserve investment policy in terms of risk; however, with a complicated situation in the euro area government debt securi- 2011 ties market, it became a very difficult task to implement it. In 2011, investment results were determined by the lowest ever yields in the safest euro area countries in terms of credit risk and increasing yield spreads between debt securities of these and other euro area countries.

HANDLING OF STATISTICS The Bank of Lithuania is the major institution handling financial statistics in the country. To increase transparency in the domestic financial market, it developed, compiled and disseminated MFI balance sheet and interest rate statistics, investment fund assets and liabilities statistics, interbank lending and foreign exchange market statistics, payment instrument statistics, official reserve asset statistics, balance of payments and international investment position statistics, external debt statistics, foreign direct investment statistics, quarterly financial accounts and government finance statistics in 2011. The major part of these statistics is prepared following EU and ECB legal acts, international statistics standards and guides. To improve and develop MFI balance sheet and interest rate statistics, a regular compilation of new statistical data on MFI balance sheet, securitisation and interest rates on loans and deposits and their submission to the ECB was started in 2011, in observance of the requirements of ECB Regulations ECB/2008/32 and ECB/2009/7 and of Guideline ECB/2009/23. After the amendment of the definition of MFIs due to the updated definition of electronic money institutions by ECB Regulation ECB/2011/12 and the tightening of the definition of money market funds, the Board of the Bank of Lithuania adjusted accordingly the requirements for the statistical reporting of MFI balance sheet and collective investment undertakings. As regards external statistics, the Bank of Lithuania relieved the burden of statistical reporting and prepared to reorganize statistics in line with the new international requirements. It started conducting a selective quarterly FDI survey. As a result, the number of surveyed enterprises declined almost in half. The Bank carried out a pilot recalculation of the balance of payments to implement the updated standards for international external statistics: the 6th edition of the IMF Manual on Balance of Payments and the International Investment Position Manual (BPM6), the 4th edition of the OECD Benchmark Definition of Foreign Direct Investment and related new ECB and Eurostat requirements. In the course of 2011, the Bank of Lithuania improved the management of securities and foreign loan databases and the quality of data by revising historical data and harmo nizing the terms used. To simplify registration of foreign loans with the Bank of Lithuania, online registration was introduced, which enables enterprises to view information on the loans registered by them. The introduction of additional security measures and tools for the drawing-up of statements, reporting and data processing was continued in the local securities database. Additional interfaces among the Bank’s securities database and other databases available at the Bank were installed. Information from these databases is used to compile investment funds statistics, securities issuance statistics, external statistics, and to draw quarterly financial accounts. The Bank of Lithuania substantially improved and extended its Loan Risk Database (Central Credit Register). Its purpose is to ensure efficient functioning of the credit system and the Bank of Lithuania’s right to access information necessary for supervision, monetary 62 policy and financial stability analysis and statistics. From November 2011, banks and II. FUNCTIONS OF THE BANK OF LITHUANIA

foreign bank branches started submitting data on loans in excess of LTL 1 thousand (previously, only data on loans in excess of LTL 50 thousand was submitted), new data about the purpose of loans, interest rates, credit liabilities, and loans overdue for over 60 and 90 days. This will enable assessing borrower credibility still more accurately and analysing Lithuania’s credit market. To increase dissemination of the Bank of Lithuania’s statistical information, the Bank’s website publishes increasingly comprehensive data of quarterly financial accounts classified by institutional sector and subsector, and data on the backing of the overall amount of litas in circulation with gold and convertible foreign currency reserves. The ECB was provided with the data necessary for publishing Lithuania’s financial accounts in the ECB’s database. Data on the accumulated foreign portfolio investment assets classified by sector of the issuer began to be submitted.

PAYMENT AND SECURITIES SETTLEMENT SYSTEMS One of the functions of the Bank of Lithuania is to encourage stable and efficient ope ration of payment and securities settlement systems. The Bank of Lithuania provides settlement services, conducts the oversight of payment and securities settlement systems and coordinates the activity of market entities of Lithuania in international projects.

LITAS AND EURO PAYMENT SYSTEMS The Bank of Lithuania manages the real-time gross settlement system (LITAS-RLS) and the designated time retail payment system (LITAS-MMS) and performs the function of their operator. It ensures reliable operation of the systems, consults their participants, maintains management information, ensures business continuity of the systems and performs other administrative tasks. On 31 December 2011, the systems LITAS-RLS and LITAS-MMS each had 24 participants.

Table 11. LITAS-RLS and LITAS-MMS transactions

Year Volume of transactions, thousand Value of transactions, LTL million Total Daily average Concentration Total Daily average Concentration ratio*, % ratio, % 301 (LITAS-RLS) 1.2 59.8 286,850 1,133.8 49.0 28,262 2010 (LITAS-MMS) 111.7 71.0 206,883 817.7 57.0 393 (LITAS-RLS) 1.6 57.7 326,755 1,291.5 50.0 30,205 2011 (LITAS-MMS) 119.4 69.9 194,499 768.8 57.8

Source: Bank of Lithuania calculations. *Concentration ratio is the share of transactions of three banks with the largest volume of payments in total payment transactions.

In 2011, LITAS-RLS functionality was supplemented with a new possibility to participate in the system for payment intermediaries operating from another state and using the SWIFT network for the interface to the system. Cross-border card schemes (VISA, MasterCard) will be able to use this functionality by creating the conditions for their members to settle their mutual liabilities via their accounts with the Bank of Lithuania. After the suspension of AB bankas SNORAS activity, the liquidity situation of payment systems participants was monitored more intensively and relations were maintained with AB bankas SNORAS temporary and bankruptcy administrators. Conditions were created 63  Annual Report of the Bank of Lithuania

for AB bankas SNORAS and its customers for convenient renewal of the acceptance of funds for fulfilling obligations to AB bankas SNORAS, consultations were provided 2011 to bank customers (natural and legal entities). The operation of the systems was not disturbed by this event. TARGET2-LIETUVOS BANKAS, a real-time gross settlement system for euro transactions, is operating in Lithuania. It enables domestic financial institutions to provide better services to their customers that make settlements in euro. On 31 December, TARGET2-LIETUVOS BANKAS included 13 participants. The new – fifth – release of TARGET2 went live on 21 November 2011. The Bank of Lithuania coordinated the preparation of participants from our country for the innovations, monitored their testing, performed central bank actions necessary for the performance of tests and organised the activity of the TARGET2 national user group.

Table 12. TARGET2-LIETUVOS BANKAS transactions

Year Volume of transactions Value of transactions, EUR million Payment orders submitted Cross-border Payment orders submitted Cross-border payments Domestic Cross-border Total payments Domestic Cross-border Total received received 2010 17,368 24,829 42,197 111,210 3,577 93,353 96,930 93,510 2011 16,432 37,438 53,870 119,998 2,892 120,179 123,071 120,088

Source: Bank of Lithuania.

OVERSIGHT OF PAYMENT AND SECURITIES SETTLEMENT SYSTEMS The Bank of Lithuania conducts the oversight of three payment systems (LITAS-RLS, LITAS- MMS and KUBAS9) and the securities settlement system (SSS)10. The Bank of Lithuania participates in the cooperative oversight of TARGET2 together with the Eurosystem and in the cooperative oversight of the TARGET2-Securities platform, which is under development, together with other supervisory authorities. The Bank of Lithuania conducted the oversight assessment of compliance of the SSS with the Recommendations for Securities Settlement Systems established by the ESCB and the Committee of European Securities Regulators. The assessment revealed that the SSS observes 15 out of 19 recommendations, broadly observes 3 recommendations, and the requirements of 1 recommendation were not applicable to it. Taking into consideration the requirement of the said recommendations, the guarantee fund managed by AB “NASDAQ OMX Vilnius” securities exchange was also evaluated. Recommendations to be implemented in order to increase reliability of the SSS were submitted to the CSDL and AB “NASDAQ OMX Vilnius” securities exchange.

NON-CASH PAYMENTS The use of modern non-cash payment instruments (credit transfers initiated via internet, card payments and direct debit operations) intensified further: a significant increase in the number of credit transfer operations was determined by the operations of payment institutions, whose data were not collected earlier. Cheque operations continued to decline.

9 The CCUL is the owner and operator of the system KUBAS. 64 10 The owner and operator of SSS is the CSDL. II. FUNCTIONS OF THE BANK OF LITHUANIA

Table 13. Non-cash payments

Volume of transactions Value of transactions Average value per transaction, Million Compared to 2010; LTL Compared to 2010; more, less (–), % million more, less (–), % LTL thousand Total non-cash payments 278.1 22.1 771,300 –10.6 2.8 Credit transfers 155.6 35.8 760,848 –10.8 4.9 Direct debit 14.7 5.2 2,240 2.4 0.2 Payment cards (debit, credit and virtual) 107.6 8.6 6,838 13.7 0.1 Cheques 0.2 –10.7 1,374 –17.6 8.2

Source: Bank of Lithuania calculations.

The number of payment cards was 3.95 million on 31 December 2011, down by 8.8 per cent, compared to 31 December 2010. This was largely determined by the suspension of activity of AB bankas SNORAS. The decline of credit cards was especially prominent: they declined by 28.3 per cent and made up 406 thousand on 31 December. The number of debit cards went down less (by 6.2%) and stood at 3.5 million. Only the number of virtual cards increased over the year. Compared to 31 December 2010, the number of these cards went up by 14.3 per cent. They take a small share of the market (1.8%), but are valued for security when making settlements in the electronic domain.

Table 14. Payments by payment cards

Volume of transactions Value of transactions Average value per transaction, LTL Thousand Compared to LTL million Compared to 2010; % 2010; % Debit cards 95,372 7.7 5,093.2 11.0 53 Credit cards 11,695 15.4 1,667.8 22.1 143 Virtual cards 560 34.6 76.8 30.6 137

Source: Bank of Lithuania calculations.

On 31 December 2011, 1,305 ATMs operated in Lithuania, of which 1,206 ATMs had a cash withdrawal function and 138 ATMs had a cash deposit function (39 ATMs had both functions). Compared to 31 December 2010, the number of ATMs went down by 16.9 per cent. This was determined by the suspension of activity of AB bankas SNORAS. There were 408 ATMs per 1,000,000 residents in Lithuania on 31 December (compared to 484 ATMs in Lithuania and 866 ATMs in the EU on 31 December 2010). In 2011, cash issued by ATMs amounted to LTL 24.4 billion. Compared to 2010, this amount increased by 8.7 per cent. The average value of a cash withdrawal transaction performed at an ATM increased by LTL 20 and amounted to LTL 370. Cash issued by banks through their branches amounted to LTL 8.5 billion, whereas cash received by customers from merchants through POS terminals made up LTL 86 million.

SEPA AND TARGET2-SECURITIES PROJECTS The purpose of the Single Euro Payments Area (SEPA) project is the standardisation of payment instruments at the European level. European institutions agreed on the final dates for the migration to SEPA payment instruments. Clear terms for this project’s implementation will help market participants to properly plan and introduce the required instruments. The Bank of Lithuania coordinates the preparation of credit institutions for the introduction of SEPA standards in our country. For this purpose, the national coordination 65  Annual Report of the Bank of Lithuania

committee has been created and operating. In 2011, the usage rules for ISO 20022 XML standard messages were approved. They are important for the interaction of customers 2011 and banks. In addition, the agreement on the usage of the Lithuanian letters in SEPA transfers was prepared, the issues related to the conversion of local message formats to SEPA formats were considered further and discussions took place on retaining the current functionality of payment instruments. In order to ensure a systemic distribution of information, maintain relations with payment service users and encourage them to use SEPA payment instruments more actively, representatives of payment service users were also included in the activity of the national coordination committee in 2011. The Eurosystem’s project TARGET2-Securities (T2S) intends to create a technical platform that will allow concentrating the transfers of securities and associated funds related to the settlement of securities transactions. T2S will allow performing both domestic and cross-border settlements. It will be open to other currencies as well. It is planned that T2S will be launched in June 2015. T2S National User Group is operating in Lithuania; its activity is coordinated by the Bank of Lithuania. This group is monitoring the implementation of the project, participated in consultations organised by the ECB and discussed the possibilities and challenges of connection to the platform.

ADMINISTRATION OF THE ACCOUNTS OF THE STATE TREASURY AND INSTITUTIONS The Bank of Lithuania, acting as a fiscal agent for the state as established by the Law on the Bank of Lithuania, administered litas and foreign currency accounts of the State Treasury in 2011. The state monetary resources held on these accounts, which are accumulated and used in accordance with the procedure set forth by the State Treasury Law of the Republic of Lithuania and other legal acts, are managed by the state institutions of our country. The Ministry of Finance of the Republic of Lithuania manages the largest share of these resources. The Bank of Lithuania also administered litas and foreign currency accounts of other state institutions, EU institutions, foreign banks and international financial institutions (hereinafter – institutions). On 31 December 2011, 245 accounts of the State Treasury and institutions were administered by the Bank of Lithuania (267 in 2010), of which 88 were litas accounts and 157 were foreign currency accounts (87 and 180, respectively, in 2010). These accounts were opened at the national central bank in accordance with the legal acts of the Republic of Lithuania and the Bank of Lithuania, whereas the terms of their administration and the services provided are established by agreements. The Bank of Lithuania provides the following services to the State Treasury and institutions: the transfer of funds according to the payment orders of fund managers, crediting of funds into accounts, currency exchange, acceptance of time deposits in euro and US dollar, preparation and submission of statements of accounts and of other information. For some institutions of our state, the service of litas cash collection and issue is provided.

PARTICIPATION IN THE ESCB AND INTERNATIONAL COOPERATION As part of the ESCB, the Bank of Lithuania participates in the preparation and adoption of decisions related to EU institutions and the ESCB. It cooperates with international financial institutions and takes part in their activities. The Bank of Lithuania’s cooperation 66 II. FUNCTIONS OF THE BANK OF LITHUANIA

with foreign central banks is based on different bilateral and multilateral initiatives with the aim of sharing experience on the issues of relevance to central banking.

PARTICIPATION IN THE ESCB The Bank of Lithuania is a full member of the ESCB, which consists of the ECB and the national central banks of all the EU Member States. The principle objective of the ESCB is to maintain price stability, and its main tasks and functions are defined in the Treaty on the Functioning of the European Union and in the Protocol on the Statute of the ESCB and of the ECB. The ECB ensures implementation of the ESCB tasks acting on its own or through national central banks. The ESCB is governed by the decision-making bodies of the ECB: the Governing Council and the Executive Board. The General Council is the third decision- making body of the ECB, which will exist as long as there are EU Member States which have not yet adopted the euro. The Chairman of the Board of the Bank of Lithuania together with other governors of NCBs participates in the work of the General Council. The Council usually meets four times per year. In 2011, the members of the General Council discussed the macroeconomic situation in the EU, money and financial market developments, the functioning of ERM II, assessed the progress achieved by the EU Member States in meeting economic policy obligations as well as compliance with the requirements in relation to the prohibi- tion to finance Government and to grant privileges to financial institutions. At a General Council’s meeting held in autumn it was noted that the regular products prepared by the ECB, which analyse the economies of the countries outside the euro area, did not include specific recommendations for the Member States with regard to the prevention of macroeconomic imbalances and surveillance. Taking this into account, it was decided to prepare and submit for discussion by the members of the General Council a new ECB Surveillance Report of the Member States. It would assess the Member States’ economic and financial development, major macroeconomic risks, and provide recommendations. Representatives of the Bank of Lithuania participate in the work of the ESCB committees and working groups on a regular basis. The committees address all issues of central banking and assist the ECB’s decision-making bodies in fulfilling their tasks. Employees of the Bank of Lithuania participate in the work of 12 ESCB committees, the Human Resources Conference and almost 30 different working groups. Participation in the ESCB committees and their working groups provides favourable conditions for experts of the NCBs to discuss and exchange views on various issues of central banking. The Bank of Lithuania jointly with other members of the ESCB signed amendments to the agreements on TARGET2 in relation to the national bank of Romania’s joining TARGET2. The national authorities of the EU Member States must consult the ECB regarding the provisions of any draft legal act on the issues within the ECB’s competence. In reply to the respective authorities, the ECB states its opinion. The national central banks are entitled to submit their comments and proposals relating to the ECB’s draft opinions. The Bank of Lithuania consulted about the national rules of monetary policy operations, the Responsible Lending Regulations and the allocation of the Bank of Lithuania’s profit, whereas the Ministry of Finance of the Republic of Lithuania consulted with the ECB on the amendments to Republic of Lithuania Laws on settlement finality in payment and securities settlement systems and on financial collateral arrangements, as well as on the reform of the financial market supervision system in our country. 67  Annual Report of the Bank of Lithuania

PARTICIPATION IN THE ACTIVITIES OF EU INSTITUTIONS

2011 The Bank of Lithuania maintains relations with the Economic and Financial Affairs Council of the EU (ECOFIN Council) and the European Commission on an ongoing basis. It is also part of the new European system of financial supervision and therefore participates in the work of the General Board of the European Systemic Risk Board and its Advisory Technical Committee. Employees of the Bank of Lithuania participate in the work of over 80 different committees and task groups which have been set up by the EU Coun- cil, the European Commission, the ESRB’s Advisory Technical Committee and European Supervisory Authorities. The EU Member States’ Ministers of Economics and Finance attend the meetings of the ECOFIN Council. The Bank of Lithuania, within its competence, provides its opinion and judgements in the formulation of the Republic of Lithuania’s position regarding the issues addressed at the ECOFIN Council. The Chairman of the Board of the Bank of Lithuania semi-annually attends the ECOFIN Council’s informal meetings arranged in a country holding the EU presidency. While decisions having legal power are not adopted at informal meetings, they provide an important forum for the Finance Ministers and governors of the national central banks of the EU Member States to discuss relevant economic and financial issues and to agree on necessary legal and political decisions. In 2011, the economic situation, financial stability, sustainability of sovereign debt, stress testing of banks at the EU level, the most recent EU financial market supervision as well as other issues were dealt with at the ECOFIN Council’s informal meetings. Representatives of the Bank of Lithuania are involved in the activities of one of the most important advisory committees of the ECOFIN Council, the Economic and Financial Committee (EFC). In 2011, the Committee discussed both overall assessments of the economic situation in the EU and financial stability issues, such as stress testing of banks, support for the banking sector by states, assessment of systemically important financial institutions, etc. The Chairman of the Board of the Bank of Lithuania together with other governors of NCBs participates in the work of the General Board of the ESRB. In 2011, it held five meetings. As it was the General Board’s first year of functioning, considerable attention was devoted to its organizational issues: the ESRB’s Rules of Procedure and Code of Conduct were approved, members of the Steering Committee and the Advisory Scientific Committee were elected, the issues of potential cooperation with other EU institutions (ECOFIN Council, the European Commission, the EFC and the European Parliament) were discussed. The ESRB’s main available instruments necessary for the implementation of its objectives are warnings and recommendations. The main difference between warnings and recommendations is that the aim of the former is to inform about specific systemic risks without offering any specific actions, whereas the latter offer specific measures to reduce systemic risk. While ESRB recommendations are not legally binding, the addressees (the EU as a whole or one or more Member States, European or national supervisory authorities) must inform or provide justification for any inaction. Warnings and recommendations can be confidential, only placed to specific addressees, or public. The ESRB adopted three public recommendations in 2011: with regard to lending in foreign currencies, US dollar denominated funding of credit institutions, and the macroprudential mandate of national authorities.

COOPERATION WITH THE IMF Our country is represented in the IMF’s supreme decision-making body, the Board of 68 Governors, by the Chairman of the Board of the Bank of Lithuania. The Board of Gover II. FUNCTIONS OF THE BANK OF LITHUANIA

nors usually meets twice a year – during Spring and Annual Meetings of the IMF and the World Bank Group. At the meetings, the key issues of the global economy, IMF policies ad reforms, as well as cooperation of international economic and financial fora are discussed. In 2011, the meetings mainly focussed on addressing the euro area crisis, IMF governance, lending facilities and surveillance. After coming into effect of respective amendments to the Articles of Agreement of the International Monetary Fund and the 13th quota review in March 2011, Lithuania’s IMF quota was increased from SDR 144.2 million to SDR 183.9 million. The IMF proposes increasing it additionally to SDR 441.6 million during the 14th quota review. The IMF further reformed its lending facilities to be able to react more flexibly to the needs of countries with strong economic fundamentals but subject to short-term external shocks. The Precautionary Credit Line was improved and renamed to the Precautionary and Liquidity Line. It will now be available to countries not only with potential, but also with actual needs of the balance of payments, and for shorter periods than one or two years. To increase the effectiveness of surveillance, in 2011 the IMF prepared for the first time ever a report on the systemic effects of five major world economies (the euro area, USA, the United Kingdom, China and Japan) on other countries and a report on multilateral surveillance on a consolidated basis. An IMF’s Triennial Surveillance Review was carried out, which took into consideration the progress made since 2008 and identified the main shortcomings in the surveillance. The Bank of Lithuania cooperated with the IMF on a regular basis, participating in the activities of the Nordic-Baltic Constituency. The Constituency’s joint positions on IMF policy issues discussed at the IMF‘s Executive Board were coordinated. Strategic issues of the IMF Nordic-Baltic cooperation were addressed at the meetings of the Monetary and Financial Committee and its Alternates Committee. The EU’s joint position on IMF policy issues was coordinated at the meetings of the Economic and Financial Committee and its IMF subcommittee. Lithuania’s cooperation with the IMF is based on annual economic consultations under Article IV of the Articles of Agreement of the IMF. IMF representatives on the missions in Lithuania in May and October 2011 analysed macroeconomic and financial stability in Lithuania, assessed general forecasts for the development of the Lithuanian economy and the implementation of economic policies. During Lithuania’s economic consultations at the IMF Executive Board’s meeting in No- vember, Lithuania’s efforts in carrying out fiscal consolidation and preserving confidence in the banking sector received a positive assessment. The IMF recommended to proceed with the implementation of measures to enhance fiscal consolidation, structural reforms, and to ensure stability of the financial system.

RELATIONS WITH FOREIGN CENTRAL BANKS AND FINANCIAL SUPERVISORY AUTHORITIES Banks governed by parent banks from abroad and foreign bank branches are the most important players in the Lithuanian banking sector. Therefore, the Bank of Lithuania, when conducting the supervision of banks within different bank groups, regularly cooperates with the financial supervisory authorities of other countries. It also actively cooperates at supervisory colleges whose activities involve participation of representatives of the financial supervisory authorities of all countries a certain bank group operates in. The Bank of Lithuania has signed seven multilateral agreements on 69  Annual Report of the Bank of Lithuania

the supervision of international groups whose branches are operating in our country.

2011 These colleges remain highly important in carrying out the function of banking supervision, as relevant information on the activities and performance of banks and their groups, the economic situation in individual countries is exchanged, the prospects for the supervision of financial institutions are discussed, a joint supervisory strategy is devised there. In 2011, representatives of the Bank of Lithuania were involved in the activities of colleges established by the Danish, Latvian, Norwegian and Swedish Financial Supervisory Authorities. At the meetings of supervisory colleges, significant attention was paid to the process of assessment by individual countries of the risk related to the operation of individual banks within the bank group subject to their supervision, adoption of decisions on capital adequacy, problems of individual bank groups and the processes taking place within the groups were discussed. While conducting inspections or reviews11 of foreign bank units – subsidiaries and branches – the Bank of Lithuania cooperates with foreign financial supervisory authorities by informing them about pending inspections or reviews and, once they have been conducted, about their results, and by exchanging other important information. Foreign financial supervisory authorities advise of the results of inspections of parent banks carried out by them. Such cooperation is very important, as the units of foreign banks opera ting in Lithuania belong to groups of large banks which recently have been increasingly centralising the management of different risks and application of advanced methods for risk assessment to calculate their capital requirement. The Bank of Lithuania continued the cooperation with Scandinavian and Baltic banks and supervisory authorities. The meeting of their top management took place on 23 March 2011 in Sweden with the key objective of enhancing cooperation.

COOPERATION IN OTHER AREAS The Bank of Lithuania closely cooperates with international institutions which prepare and publish statistical information, particularly the ECB, Eurostat, the IMF and the Bank for International Settlements (BIS), and is involved in the activities of their committees as well as working and task groups. Specialists of the Bank actively participated in the preparation of new standards, requirements and means for the implementation of mone tary and finance, quarterly financial accounts and external sector statistics, provided their comments and suggestions regarding the draft documents prepared by the ECB, the IMF and Eurostat. The central bank regularly submits the financial statistics data that it handles and the data on the domestic economy prepared by Statistics Lithuania to the Data Bank of the BIS, as one of its shareholders. In 2011, the Bank of Lithuania provided further technical support to the national central banks of the Caucasian States in the field of statistics. A meeting of statisticians from the Caucasian States was held. It addressed the issues of preparation of central banking statistics, improvement of its handling and the quality of statistics. The meeting was held with the assistance from the Deutsche Bundesbank. Technical support was provided to the national central bank of Ukraine on the issues pertaining to information technologies, and to the central bank of Armenia on those pertaining to internal audit.

11 Banks in operation in Lithuania are inspected, foreign bank branches holding licenses from other EU Member States 70 are reviewed. III. ORGANISATION OF ACTIVITIES OF THE BANK OF LITHUANIA

III. oRGANISATION OF ACTIVITIES OF THE BANK OF LITHUANIA

STAFF AND ORGANIZATIONAL STRUCTURE The Bank of Lithuania has set itself a target to perform the functions provided by the law by using its human resources optimally, create a simpler organisational structure oriented towards the performance of its main functions, efficiently manage its assets and seek continuous institutional progress.

MISSION, VALUES AND ETHICS The mission of the Bank of Lithuania is to ensure sustainability and integrity of the state’s money and financial market, its stable, reliable and efficient functioning, thereby creating favourable conditions for optimal development of the national economy. The activities of the Bank of Lithuania are based on the following values: adherence to the public interest, competence and quality, non-partisan attitudes and professional analysis, transparency and integrity of activity. Ethics is regulated by the Code of Ethics for the staff and by the Code of Ethics for the Board of the Bank of Lithuania. They establish the principles of conduct and the standards of professional ethics. The Codes are to ensure adequate separation between public and private interests as well as observance of high standards of professional ethics.

STAFF On 31 December 2011, the Bank of Lithuania actually employed 728 members of staff (of these, 11 were employed on fixed-term contracts)12. Over the year, the number of staff decreased by nearly 7 per cent. At the end of the year, the average age of staff was 46.1 years. Staff aged 40 to 50 accounted for the largest proportion of the staff (36.9 %). Staff aged 50 to 60 accounted for 28.5 per cent, those aged 30 to 40 comprised 19.4 per cent, and those under 30 made up 8.1 per cent. Staff aged over 60 accounted for the smallest proportion of the staff, 7.1 per cent. The average length of staff service at the Bank of Lithuania was 14.1 years. More than a half of the staff (58%) had worked at the Bank for over 15 years. Female staff members accounted for 52 per cent, male staff members for 48 per cent of total staff. The Bank of Lithuania employed one professor doctor habilitatus, twenty one staff members held a doctorate degree.

12 The number of staff actually employed does not include the staff who were on maternal/paternal leave or unpaid leave during the period of their work at the ECB or the IMF. 71  Annual Report of the Bank of Lithuania

Chart 43. Number of staff actually employed at the end of the period

2011

ORGANIZATIONAL DEVELOPMENT AND SOCIAL DIALOGUE On 31 December, the Bank of Lithuania had 11 departments, 6 autonomous divisions and 2 branches in Kaunas and Klaipėda. Implementing institutional objectives and in an effort to efficiently use the human resour ces, the Bank of Lithuania was subject to structural changes in 2011. Aiming at optimal organization of work, effective use of staff working hours and centralised performance of the functions of financial accounting and control, the Accounting Department took over the accounting functions from Kaunas and Klaipėda branches. Following the Republic of Lithuania Law on the Reform of the Financial Market Supervi- sion System as well as other respective legal acts, the structural reform of the Credit Institutions Supervision Department was planned and preparations for integrating the functions of the Securities Commission of the Republic of Lithuania and the Insurance Supervisory Commission of the Republic of Lithuania were finalised. The reform of the above Department was performed following not only the organisational principle, but also the functional principle, aiming at most effective performance of the functions and management of human resources. Social dialogue at the Bank of Lithuania has been developed since 2007, when the Staff Association was elected at the Bank. Agreements on human resources management policy and social guarantees have been arrived at. Representatives of the Staff Associa- tion attend social dialogue meetings at the ECB twice a year.

STAFF TRAINING Training and continuous development of competences is a major element of human resources management policy. It is employed with the aim of constant improvement of knowledge and skills of the Bank of Lithuania staff and to ensure efficient operation of the national central bank and its adequate functioning within the ESCB. The share of funds dedicated for the improvement of staff skills is determined by the Rules of Pro- cedure of the Bank of Lithuania. 1.3 per cent of the payroll budget was used for staff training in 2011 (1.8% in 2010). Shared introductory training was organized for students on practice at the Bank of Lithuania and for new staff members to present the structure and activities of the Bank. 72 III. ORGANISATION OF ACTIVITIES OF THE BANK OF LITHUANIA Chart 44. Organizational chart of the Bank Lithuania (31 December 2011) 73  Annual Report of the Bank of Lithuania

The ESCB regulates and encourages gaining work experience through working at other central banks. In this regard, 3 Bank of Lithuania staff members worked at the ECB on short- 2011 term contracts during unpaid leave from the Bank of Lithuania. They had an opportunity to obtain expert knowledge on economic issues. One member of staff worked in Washington as an Advisor to the Executive Director of the Nordic-Baltic Office of the IMF for a third year.

VLADAS JURGUTIS AWARD AND SCHOLARSHIP When commemorating the 75th anniversary of the establishment of the Bank of Lithua nia and the issue of the litas, the Bank of Lithuania established Vladas Jurgutis (the first Governor of the Bank of Lithuania) Award in 1997. It is granted for significant works in the areas of banking, finance, monetary and macroeconomic research in our country. In 2008, the regulations for granting the Award were changed: it is now granted by the Bank of Lithuania jointly with the Lithuanian Academy of Sciences. In 2011, Vladas Jurgutis Award was not granted. Vladas Jurgutis Scholarship was established in 1990. It is awarded to two best-performing full-time students of banking and finance at universities in Lithuania for one academic year. Candidates for the Scholarship are nominated by university faculties, which have banking and finance departments. Decisions on awarding the Scholarship are taken by the Board of the Bank of Lithuania. The Scholarship amounts to one minimum monthly wage. In 2011, Vladas Jurgutis Scholarship was awarded to two female students from Vilnius University and Vytautas Magnus University for excellent academic performance and active participation in scientific activity.

TRANSPARENCY OF ACTIVITIES AND PUBLIC COMMUNICATION The Bank of Lithuania ensures transparency of activities – as a principle of a national central bank’s accountability to the public – through the employment of various public information or communication means. Usual and new, they are chosen considering the public interest to receive detailed and urgent information, with the aim of presenting it to most different target audiences.

ACCOUNTABILITY AND TRANSPARENCY The Bank of Lithuania issues and publishes annual reports in Lithuanian and English. Twice a year, the central bank’s Chairman of the Board submits reports to the Seimas of the Republic of Lithuania on the implementation of the Bank’s primary objective, the situation in the financial market and the performance of the Bank’s functions. The reports are also published on the website of the Bank of Lithuania. The Bank of Lithuania regularly provides information about domestic banking and the financial system to the press, radio, television, Lithuanian and world news agencies, and websites. The Bank of Lithuania’s website www.lb.lt is a most important source of information about the central bank. The website’s design was renewed substantially in early 2011, which provided possibilities to present more information for the public in a more convenient and attractive way. The content of information films about the Bank presented on the website was updated. The website urgently informs in Lithuanian and English about resolutions of the Board, presents financial statistics, information on payments, financial stability reviews, macroeconomic forecasts, reviews of activities of credit institutions operating in Lithuania, and provides information about the Bank’s participation in 74 the ESCB and its international relations. III. ORGANISATION OF ACTIVITIES OF THE BANK OF LITHUANIA

Forms of communication not employed at the Bank thus far began to be used. An event “Open Doors at the Bank of Lithuania” was held for the first time on 2 October 2011. Nearly 5 thousand visitors attended it. In 2011, the public was consistently and comprehensively informed about the Bank’s initiative to apply the Responsible Lending Regulations. They were presented during many interviews, on the Bank’s website, at press conferences. In 2011, the Bank of Lithuania pursued more active communication with the media and the public. It began holding press conferences more frequently than in previous years, presenting to the public comprehensive information about significant works of the Bank and economic developments in the country. Thus the Financial Stability Review prepared by the Bank of Lithuania, banking sector performance and other important matters were presented to the media and, through it, to the public. Aiming at higher transparency in the fees commonly applied by commercial banks and other institutions, the Bank of Lithuania started publishing the fees applied by domestic banks and credit unions on its website since October 2011. A possibility to compare them was provided. Providers of the cheapest standard services are indicated. The aim is to educate users by providing them with a possibility to obtain as detailed as possible information about services. While implementing this project, the Bank of Lithuania cooperated intensively with domestic commercial banks and credit unions. Aiming at reporting to the public about the project to the widest extent possible, various ways have been employed (fees and new possibilities for users to compare them were presented at press conferences, press releases and interviews were published, etc.).

PUBLIC COMMUNICATION UNDER EXTRAORDINARY CIRCUMSTANCES The Bank of Lithuania had to organize public information and communication under extraordinary circumstances after the suspension of activity of AB bankas SNORAS and institution of bankruptcy against it by the court. 13 press releases were published and 11 special press conferences were held at the Seimas and the Government of the Republic of Lithuania, the Bank of Lithuania and AB bankas SNORAS during the first week after the suspension of its activity. Over 150 interviews and comments by members of the Board of the Bank of Lithuania and other staff members were published in the press, internet media, and provided during television and radio broadcasts. The Bank operated a hotline seven days a week; answers were provided to the requests for information by telephone from more than 11 thousand persons concerned both from Lithuania and abroad, or from visitors who came to the Bank’s branches in Vilnius, Kaunas and Klaipėda. A few hundred answers to the requests from the media and residents were sent by post or e-mail. Special pages were created on the Bank of Lithuania’s website for AB bankas SNORAS customers in Lithuanian, English and Russian (important information for depositors, creditors, the most frequently asked questions, etc.). The media and the public were openly and urgently informed about AB bankas SNORAS bankruptcy and therefore resisted panic, acted in a fair and dignified manner and relied on objective information rather than rumours in taking their decisions and actions. Adequate communication with other state institutions prevented from depositor panic and a turmoil in the banking sector.

PRESENTATION OF ACTIVITIES In order to inform the public about performance of its functions in the greatest possible detail, the Bank of Lithuania devotes much attention to the preparation and distribution of publications about its activities and major economic phenomena. Periodical publications 75  Annual Report of the Bank of Lithuania

feature monetary and banking, balance of payments, and financial statistics. Informative publications about litas banknotes and coins provide information on currency in circula- 2011 tion and its security features. The Bank of Lithuania undertakes initiatives which encourage scientific activities. The journal Monetary Studies published by the Bank features research and survey papers by Lithuanian and foreign authors on the development of economics, finance, money and banking, simulation and forecasting of macroeconomic processes, as well as other topi- calities, scholarly comments and reviews of research papers. The monograph “Banking in Lithuania 1795–1915” by Vladas Terleckas published in 2011 by the Bank of Lithuania presents a lot of interesting and important information about banking at that time, the process of Lithuania’s russification, credit institutions which had been unknown thus far – Jewish interest-free credit societies, other phenomena and personalities of the financial world from the discussed period.

Table 15. Publications of the Bank of Lithuania in 2011 Report on the Implementation of the Primary Objective of the Bank of Lithuania, Performance of its Functions and the Situation in the Banking System (to be presented to the Seimas of the Republic of Lithuania twice a year) Annual Report of the Bank of Lithuania 2010 (separately in Lithuanian and English) Monthly Bulletin of the Bank of Lithuania (in Lithuanian and English) External Statistics (quarterly and annual; in Lithuanian and English) Annual Financial Statements of the Bank of Lithuania 2010 (separately in Lithuanian and English) Banking Statistics Yearbook 2010 (separately in Lithuanian and English) Financial Stability Review 2010 (separately in Lithuanian and English) Lithuanian Economic Review (biannual, separately in Lithuanian and English) Academic Journal Monetary Studies (biannual) Working Paper Series publications (in English) Booklets of collectors (commemorative) coins to present the collectors (commemorative) coins issued in 2011 (separately in Lithuanian and English) Catalogue Lithuanian Collectors Coins 1993–2011 (in Lithuanian and English) Brochure What we should know about money Monograph Banking in Lithuania 1795–1915 by Vladas Terleckas

As part of the ESCB, the Bank of Lithuania closely cooperates with ECB specialists; jointly with them, it prepared the following ECB publications in Lithuanian in 2011: the ECB Annual Report 2010, editorials of the ECB Monthly Bulletin as well as editorials and summaries of the quarterly versions of the Monthly Bulletin, “The implementation of monetary policy in the euro area: General documentation on Eurosystem monetary policy instruments and procedures”. Electronic versions of all these publications are available on the Bank’s website.

ECONOMIC EDUCATION The national central bank is paying increasingly more attention to economic education of current and future users of financial services. Its staff participates in public discussions, publishes articles in the press and on the Internet, delivers lectures to university students, businessmen, representatives of other target groups on the Bank of Lithuania, the macroeconomic situation in the country and its finance, provides answers to public inquiries. The first educational event for elderly people was held at the end of August 2011. The organisation of seminars for schoolchildren was started. From October to December 2011, over a thousand senior schoolchildren from nearly 30 schools all over 76 Lithuania visited the Bank of Lithuania. Bank of Lithuania experts prepared a cycle of III. ORGANISATION OF ACTIVITIES OF THE BANK OF LITHUANIA

12 relevant lectures and seminars on the role of central banks in the economy, financial stability, macroeconomic forecasting, etc. A significant educational and enlightenment role is played by the Money Museum of the Bank of Lithuania located in the centre of Vilnius. It introduces visitors to the global and national history of money with a particular focus on the presentation of the national central bank and its activities. The Bank’s branch in Kaunas houses another exposition of the Museum. In 2011, the Money Museum in Vilnius and its exposition in Kaunas were visited by nearly 14 thousand people, who attended the events organized there. The profile of the Money Museum was created on the social network Facebook in October; it provides diverse information and photo albums. Like in previous years, publications on the Economic and Monetary Union and the single currency euro issued by the European Commission and the ECB in Lithuanian were distributed. Information on the SEPA project was presented. Our country’s commercial banks actively participate in this project. Media monitoring and public opinion research were conducted regularly, their results were analysed. The results are taken into consideration while implementing public information and communication policy, preparing financial stability and other reviews. A quarterly magazine “Apie mus” (“About Us”) was published for Bank of Lithuania staff.

IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

BALANCE SHEET OF THE BANK OF LITHUANIA

LTL million

Notes 31 December 31 December 2011 2010

ASSETS 1. Gold 1 786.01 688.25 2. Claims on foreign institutions denominated in foreign currency 21,304.60 17,112.43 2.1. Receivables from the International Monetary Fund 2 565.55 549.58 2.2. Deposits, securities and other investments denominated in foreign currency 3 20,739.05 16,562.84 3. Claims on domestic institutions denominated in foreign currency 4 81.13 0.04 4. Securities of domestic institutions held for monetary policy purposes denominated in litas 5 171.80 – 5. Other assets 365.51 387.91 5.1. Tangible fixed and intangible assets 6 139.67 144.60 5.2. Investments into equity instruments 7 18.94 18.94 5.3. Accruals and deferred expenses 8 187.47 205.36 5.4. Sundry 9 19.43 19.01 Total 22,709.04 18,188.63 LIABILITIES 6. Banknotes and coins in circulation 10 10,827.02 8,823.95 7. Liabilities to domestic credit institutions related to monetary policy operations denominated in litas 11 6,250.57 3,044.42 8. Liabilities to other domestic institutions denominated in litas 12 107.82 219.82 9. Liabilities to foreign institutions denominated in litas 13 90.73 101.30 10. Liabilities to domestic institutions denominated in foreign currency 14 1,814.19 3,026.17 11. Liabilities to foreign institutions denominated in foreign currency 14 994.66 474.32 12. Counterpart of special drawing rights allocated by the International Monetary Fund 2 565.12 549.16 13. Items in the course of settlement 19.23 12.38 14. Other liabilities 15 18.44 11.56 14.1. Off-balance-sheet instruments revaluation differences 16 8.81 0.38 14.2. Accruals and deferred income 5.40 5.13 14.3. Sundry 4.24 6.05 15. Revaluation accounts 17 534.08 503.04 16. Capital 18 1,359.15 1,332.00 16.1. Authorised capital 200.00 200.00 16.2. Reserve capital 1,159.15 1,132.00 17. Profit for the year 27 128.04 90.49 Total 22,709.04 18,188.63

81  Annual Report of the Bank of Lithuania

PROFIT AND LOSS ACCOUNT OF THE BANK OF LITHUANIA

2011 LTL million

Notes 2011 2010 Interest income 19 404.71 226.73 Interest expense 20 (36.57) (20.57) 1. Net interest income 368.14 206.16 Realised gains (losses) arising from financial operations 21 118.57 110.30 Unrealised losses from revaluation 22 (288.55) (158.57) 2. Net result of financial operations and revaluation losses (169.98) (48.27) Fees and commissions income 13.71 19.19 Fees and commissions expense (2.85) (2.58) 3. Net income from fees and commissions 23 10.85 16.61 4. Dividend income 7 4.93 4.38 5. Other income 1.66 4.65 TOTAL NET INCOME 215.60 183.52 6. Staff costs 24 (54.83) (52.35) 7. Administrative expenses 25 (17.01) (16.67) 8. Depreciation and amortisation of tangible fixed and intangible assets 6 (10.84) (11.30) 9. Banknote and coin production services and circulation expenses 26 (4.89) (12.71) PROFIT FOR THE YEAR 27 128.04 90.49

The Annual Financial Statements 2011 of the Bank of Lithuania were approved on 26 April 2012 by Resolution No. 03-98 of the Board of the Bank of Lithuania.

Chairman of the Board Vitas Vasiliauskas

82 IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

EXPLANATORY NOTES

FUNCTIONS OF THE BANK OF LITHUANIA The Bank of Lithuania shall perform the following functions:

- issue the currency of the Republic of Lithuania; - formulate and implement monetary policy; - determine the litas exchange rate regulation system and announce the official exchange rate of the litas; - manage, use and dispose of the foreign reserves of the Bank of Lithuania; - act as a State Treasury agent; - in the manner and cases established by laws and other legal acts, issue and revoke licenses of credit institutions and payment institutions of the Republic of Lithuania as well as branches of credit institutions of foreign states, and supervise the activities thereof; it shall also perform other functions related to the activities of credit institutions and payment institutions established by laws; - establish principles and procedures for financial accounting and reporting of credit institutions and payment institutions of the Republic of Lithuania and branches of credit institutions of foreign states operating in the Republic of Lithuania; - encourage sound and efficient operation of payment and securities settlement systems; - collect monetary, banking and balance of payments statistics, as well as the data of financial and related statistics of the Republic of Lithuania, implement standards on the collection, reporting and dissemination of the said statistics and compile the Balance of Payments of the Republic of Lithuania. From 1 January 2012, as the amendment of the Law on the Bank of Lithuania entered into force, the Bank of Lithuania also supervises securities and insurance markets and investigates disputes between consumers and participants of financial markets.

After Lithuania’s accession to the European Union (EU) on 1 May 2004, the Bank of Lithuania became a part of the European System of Central Banks (ESCB). Lithuania has been participating in the Exchange Rate Mechanism II from 28 June 2004.

BASIS FOR PREPARATION AND PRESENTATION OF THE ANNUAL FINANCIAL STATEMENTS The financial accounting of the Bank of Lithuania is managed and the Annual Financial State- ments are prepared in accordance with the Law on the Bank of Lithuania, other legislation of the Republic of Lithuania applicable to the Bank of Lithuania and the Accounting Policy approved by the Board of the Bank of Lithuania, which is in line with the accounting and financial reporting guidelines established by the European Central Bank (ECB) to the extent that such requirements are applicable to a national central bank of the Member State which has not yet adopted the euro. If a specific accounting treatment is not laid down in the Ac- counting Policy of the Bank of Lithuania and in the absence of the decisions and instructions to the contrary by the ECB, the Bank of Lithuania shall follow the principles of the international accounting and financial reporting standards as adopted by the European Union relevant to the activities and accounts of the Bank of Lithuania.

Following the principles of consistency and comparability, the respective comparable financial data for 2010 have been presented.

Due to rounding, the totals included in the Balance Sheet, Profit and Loss Account and Notes of the Bank of Lithuania may not equal the sum of the individual figures. 83  Annual Report of the Bank of Lithuania

ACCOUNTING POLICY

2011 GENERAL PRINCIPLES

In managing financial accounting and drawing up the financial statements, the Bank of Lithua- nia follows the following general accounting principles: economic reality and transparency, prudence, materiality, going concern, accrual, consistency and comparability.

Gold, debt securities and other on-balance-sheet and off-balance-sheet foreign reserves assets and liabilities (hereinafter - financial items) denominated in foreign currency are recorded in financial accounting at acquisition cost (transaction price), and in the Annual Financial State- ments are presented at official exchange rate1 and market price, with except for securities classified as held to maturity.

Results arising from revaluation of gold holding, foreign currency (on a currency-by-currency basis), securities (on a code-by-code basis, i.e. same ISIN number), future contracts and forward transactions in securities (on an item-by-item basis) are accounted for separately.

Unrealised revaluation loss arising at the end of the financial year from revaluation of a separate financial item at market price and official exchange rate and exceeding previous unrealised revaluation gain registered in corresponding revaluation account, is recognised as expense of the current financial year. Unrealised loss taken to Profit and Loss Account cannot be reversed in subsequent years against new revaluation gain of the same financial item resulting from changes in market price and official exchange rate or offset by the revaluation gain of another type of the financial item.

Unrealised revaluation gain arising at the end of the financial year from the revaluation of a separate financial item at market price and official exchange rate is presented at revaluation accounts.

The average rate and average price method is used in order to compute the acquisition costs for gold, securities and foreign currency. Such acquisition costs are used for the purpose of calculating the realised and unrealised results.

Income and expense are recognised in the accounting period in which they are earned or incurred and not in the period in which they are received or paid.

GOLD

Gold holdings are revalued on the last business day of each month on the basis of the gold market price in US dollars per one Troy ounce. This price is converted into litas at the official exchange rate of the litas against the US dollar on the revaluation day.

No distinction is made between the gold market price and US dollar revaluation differences for gold, but a single gold revaluation gain or loss is recorded in the gold revaluation account.

In the event of recognition of unrealised revaluation loss on gold at year-end, the average cost of gold is correspondingly adjusted to the gold market price and US dollar exchange rate prevailing on the last business day of the financial year.

Transactions related to gold swaps are accounted for in the same way as repurchase agreements.

1 Official exchange rate is the official exchange rate of the litas against the euro or exchange rate of the litas against 84 foreign currency determined by the Bank of Lithuania. IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

FOREIGN CURRENCY

Financial items denominated in foreign currency are revalued on each business day at the official exchange rate prevailing on that day.

Official Exchange Rates of the Litas Against Major Foreign Currencies Determined by the Bank of Lithuania Litas (LTL) per unit

Currency Code 31 December 2011 31 December 2010 Euro EUR 3.4528 3.4528 US dollar USD 2.6694 2.6099 100 Japanese yen JPY 3.4347 3.2024 Special Drawing Rights (SDR) XDR 4.1178 4.0015

The average rate of foreign currency is recalculated on a daily basis in case of an increase of a respective foreign currency position.

In the event of recognition of unrealised revaluation loss on a separate foreign currency at year-end, the average rate of that currency is correspondingly adjusted to the official exchange rate on the last business day of the financial year.

FOREIGN EXCHANGE TRANSACTIONS

Foreign currency to be received or paid according to foreign exchange spot, forward and swap transactions influences a respective foreign currency position on a trade date and is recorded in off-balance-sheet accounts from the trade date to the settlement date.

The difference in the value at the spot and forward rates of the transaction is recognised as interest income or expense and is accrued on a daily basis over the remaining duration of the transaction.

SECURITIES

Securities are recorded in on-balance-sheet accounts at acquisition cost on the settlement date.

The revaluation of domestic and foreign institutions’ securities (other than those classified as held-to-maturity) is performed on the last business day of each month at mid-market prices prevailing at the revaluation date. Revaluation results of securities related with changes of the market price of securities and the official exchange rate of the foreign currency are accounted for in separate revaluation accounts.

Securities classified as held-to-maturity are accounted at cost subject to impairment and taking into account amortised premiums and discounts.

The average price of each issue of securities is recalculated at the end of the business day in consideration of all purchases of the same issue of securities made during the day and their average acquisition costs. Realised gain (loss) for the same day sales of these securities is calculated according to this new average cost.

Coupon purchased together with security is presented in a separate balance sheet item as other assets and is not included in the acquisition cost of the security.

The difference between the security acquisition cost and its nominal value – discount or premium – is recognised as income or expense according to the straight-line method on a daily 85  Annual Report of the Bank of Lithuania

basis from the settlement date of purchase transaction to the maturity date or settlement date of sale transaction. 2011 Discount on non-coupon bearing securities is amortized according to the Internal Rate of Return (IRR) method and discount or premium on coupon bearing securities is amortized according to the straight-line method.

If at the end of the financial year unrealised revaluation loss on valuation of a separate type of securities is recognised as expense, the average cost of such issue of securities is adjusted according to its market price prevailing on the last business day of the financial year.

FORWARD TRANSACTIONS IN SECURITIES

Forward purchases or sales of securities are recognised in off-balance-sheet accounts from the trade date to the settlement date at the forward price of the transaction. Securities to be purchased or sold under these transactions are revalued on the last business day of each month at forward market price. The revaluation result on these securities is recorded for separately on item-by-item basis in on-balance-sheet assets or liabilities accounts.

On the settlement date of forward transactions in securities, purchases or sales of the securities are recorded on the on-balance-sheet accounts at the actual market price, and the difference between this price and the forward price of the transaction is recognised as realised income or expense.

EQUITY INSTRUMENTS

Long-term investments into equity instruments held for the Bank’s specific purposes are investments into equities in order to participate in the activities of a specific enterprise whose equity instruments are non-marketable and their price is not quoted in the market. They are recorded at acquisition cost.

REVERSE TRANSACTIONS

A repurchase agreement is recorded as a collateralised inward deposit: the commitment to repay funds is recorded on the liabilities side of the balance sheet, while the financial asset that has been given as collateral (sold and repurchased under this agreement) remains on the asset side of the balance sheet for the period of the transaction.

A reverse repurchase agreement is recorded as a collateralised outward loan on the asset side of the balance sheet. The collateral acquired during the transaction period is not reported in the balance sheet and is not revalued.

The difference between the purchase and repurchase price of the collateral acquired under repurchase and reverse repurchase agreements is recognised on a daily basis as interest income or expense over the remaining duration of the transaction.

FUTURES

Interest rate futures and gold futures are recorded in off-balance-sheet accounts at nominal value of contracts from the trade date to the closing or maturity date. Daily changes in the variation margins of these contracts are recognised as realised income or expense.

86 IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

TANGIBLE FIXED AND INTANGIBLE ASSETS

Tangible fixed assets include such tangible items whose acquisition cost (including VAT) is not less than LTL 500 and whose useful life is longer than one year. The Museum stocks, pieces of art and tangible assets included into the list of historical and art valuables are also treated as tangible assets with no regard to their acquisition cost. Intangible assets include items without physical substance whose useful life is not less than one year. Tangible fixed and intangible assets are recorded in the balance sheet at cost less accumulated depreciation (amortisation). Depreciation (amortisation) is calculated on a straight-line basis over the estimated useful life of the asset. Assets acquired free of charge are booked at the value indicated in the good delivery note or, when the value is not indicated, at the value not exceeding the market value of the assets. The value of the tangible fixed and intangible assets acquired free of charge is recognised as income accordingly to their depreciation (amortisation).

Depreciation (Amortisation) Rates of Tangible Fixed and Intangible Assets

Assets Annual rate, %

Tangible fixed assets Buildings and structures 2.5–10 Cash count and computer equipment 10–50 Vehicles 20 Furniture, office equipment and other fixed assets 5–50 Intangible assets 25–100

If there are signs of a significant decline in the market value of real estate, then at the end of the financial year the acquisition cost of such assets is reduced by the amount of impairment loss.

BANKNOTES AND COINS IN CIRCULATION

Banknotes and coins in circulation are presented at nominal value as liabilities in the balance sheet. The cost of printing of banknotes and minting coins, as well as other expenses associa ted with the issue of the national currency into circulation, are recorded as expenses when incurred, irrespective of when the coins and banknotes were put into circulation.

RECOGNITION OF INCOME AND EXPENSE

Interest income and expense related to financial items denominated in foreign currency (including premiums and discounts of securities) are calculated and booked daily.

Realised gain and loss arising from financial items denominated in foreign currency are taken to the Profit and Loss Account on the trade date, except for the realised gain and loss on securities which are recognised on the settlement date.

Unrealised revaluation gain is not recognised as income and is presented in revaluation accounts. Unrealised revaluation loss, exceeding previous revaluation gain related to the corresponding financial item, is taken to the Profit and Loss Account at year-end.

Interest income and expense related to financial assets and liabilities denominated in litas are booked monthly, except interest income and expense related to the monetary policy instruments, which are booked daily. Other income and expense of the year denominated in litas are booked till the year-end.

87  Annual Report of the Bank of Lithuania

POST-BALANCE SHEET EVENTS

2011 Annual Financial Statements are adjusted for post-balance sheet events that occur between the balance sheet date and the date on which the Annual Financial Statements are approved by the Board of the Bank of Lithuania, if those events provide evidence of conditions that existed on the balance sheet date and therefore that amounts reported in the Annual Financial Statements have to be adjusted.

No adjustment is made for the data of the Annual Financial Statements of post-balance sheet events that are indicative of conditions that arose after the balance sheet date. Events which are of such importance that their non-disclosure could influence the economic decisions of users taken on the basis of the Annual Financial Statements are disclosed in the Explanatory Notes to the Annual Financial Statements.

RECLASSIFICATIONS

In 2011 the structure of the Balance Sheet and the Profit and Loss Account of the Bank of Lithuania has been changed, thereafter following the principles of consistency and comparability the respective comparable amounts of 2010 have been adjusted.

LTL million

Balance Sheet and Profit and Loss Account items 31 December 2010 Adjustment owing to 31 December 2010 balances as published reclassification balances as published in 2010 in 2011 Claims on domestic institutions denominated in foreign currency – 0.04 0.04 Sundry (assets) 19.05 (0.04) 19.01 Interest income 226.61 0.12 226.73 Interest expense (20.45) (0.12) (20.57)

FINANCIAL RISK AND ITS MANAGEMENT The main object of the financial risk of the Bank of Lithuania is foreign reserves that as at 31 December 2011 accounted for 97 per cent of the total assets of the Bank of Lithuania.

In managing foreign reserves the Bank of Lithuania is exposed to different types of financial risk such as market, credit, liquidity and settlement risk. These risks are managed by an established system of limits for risk exposures and other means aimed at reducing risks.

Exchange rate risk has been mainly eliminated – practically all foreign reserves not related to liabilities in foreign currencies are invested in the anchor currency – the euro. The part of foreign reserves corresponding to liabilities is invested in the currency of the liabilities (see Note 28).

The Bank of Lithuania uses the indicator of the modified duration (MD)2 as the main tool for managing interest rate risk. Interest rate risk is managed by setting benchmarks to each portfolio of foreign reserves, its MD and largest allowed deviations of portfolio real investment MD from the MD of the benchmarks. In 2011 the part of foreign reserves (EUR 321.50 million at nominal value) has been invested into foreign governments’ securities classified as held-to-maturity. The average MD of foreign reserve investments (other than those classified as held-to-maturity) was 0.81 in 2011 (0.85 in 2010).

2 MD shows approximately how much will the percentage value of an investment change, if the profitability rates 88 increase by 100 basis points. IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

Market risk is valued applying the “value-at-risk” (VaR) indicator. At the end of 2011 VaR indicator for market risk was EUR 4.6 million3 (EUR 3.9 million in 2010), for gold price and exchange rate risk VaR indicator was EUR 3.8 million (EUR 3.2 million in 2010), for interest rate risk VaR indicator was EUR 2.9 million (EUR 2.5 million in 2010).

For the purpose of managing exchange rate risk and interest rate risk, the Bank of Lithuania also uses financial derivatives. All financial derivatives are included in the measurement of the foreign reserves investment market and credit risk.

Credit risk is managed by establishing limits of the liabilities to the Bank of Lithuania by issuers, counterparties and their groups. These limits indicate the requirements for the financial reliability of those issuers and counterparties.

Liquidity risk is managed by setting liquidity ratios and a minimum amount of highly liquid financial instruments in foreign reserves.

Various correspondent account management instruments are applied for managing settlement risks: the delivery-versus-payment principle, matching of debt and credit turnovers, ISDA Master Agreement. These measures facilitate the reduction of the risk of loss due to settlement defaults by counterparties.

OTHER ISSUES The profit (loss) of the Bank of Lithuania contribution (coverage) rules were changed for the year 2012 and onwards, as the Law amending Article 23 of the Law on the Bank of Lithuania (No. XI-1800, 15 December 2011; (Valstybės žinios (Official Gazette) No. 160-7567, 2011) came into force. The essential characteristics of this Law are the following:

1) The net distributable profit (loss), which consists of the profit (loss) for the last financial year and undistributed profit (if any) carried over from the previous financial periods, is distributed (covered) after the end of the financial year;

2) The net distributable loss shall be covered from the reserve capital of the Bank of Lithuania. When reserve capital is not sufficient to cover the net distributable loss, remaining unco vered losses are carried forward to be covered by the distributable profit of the succeeding financial years;

3) The net distributable profit shall be allocated in the following sequence:

- to cover the uncovered loss carried forward;

- to the authorised capital up to the amount specified in the Law on the Bank of Lithuania;

- to the reserve capital up to the amount, independently established by the decision of the Board of the Bank of Lithuania taking into account potential impact of risks, however this capital shall be not less than five amounts of the authorised capital of the Bank of Lithuania;

- to the State Budget as the profit contribution of the Bank of Lithuania. This contribution shall not exceed the amount corresponding to 70 per cent of the calculated average of the profit (loss) of the Bank of Lithuania of the last three financial years.

The surplus of the distributable profit after the allocation shall be carried forward as undistributed profit and shall be distributed in succeeding financial years.

3 The indicator is calculated using parametric approach based on RiskMetrics methodology. It shows a probability of 95 per cent that adverse developments of gold price, exchange rates or interest rate will not reduce the investment value during the next business day by the amount exceeding the value of the indicator. Data and calculations provided in the section “Financial Risk and Its Management” are prepared by the Market Operations Department of the Bank of Lithuania and RiskMetrics. 89  Annual Report of the Bank of Lithuania

NOTES

2011 Note 1. Gold

31 December 2011 31 December 2010 Gold holdings in: Troy ounces 187,012.75 186,994.08 Kilograms 5,816.75 5,816.17 Price of one Troy ounce, USD 1,574.50 1,410.25 Value of gold, LTL million 786.01 688.25

Gold Investment Troy ounces

31 December 2011 31 December 2010 Non-invested reserves 167,650.57 86,716.20 Swaps 19,362.19 100,277.88 Total 187,012.75 186,994.08

Gold swaps, spot gold purchase and sale transactions, as well as gold futures were used to manage gold reserves. The influence of these transactions on the financial result of the Bank of Lithuania is disclosed in Note 20 and Note 21.

Note 2. Receivables from the International Monetary Fund

LTL million

31 December 2011 31 December 2010 Reserve tranche position with the International Monetary Fund 0.14 0.14 Balance in Special Drawing Rights account with the International Monetary Fund 565.41 549.45 Total 565.55 549.58

The reserve tranche position with the International Monetary Fund (IMF) holdings belongs to the Republic of Lithuania, which is a member of the IMF since 1992. The Bank of Lithuania performs the function of depository of the IMF funds.

Reserve Tranche Position with the International Monetary Fund SDR million

31 December 2011 31 December 2010 Lithuania’s Quota in the IMF (total value) 183.90 144.20 Claims of the IMF corresponding to the promissory note of the Government of the Republic of Lithuania in litas (183.33) (143.66) IMF accounts with the Bank of Lithuania in litas (0.53) (0.51) Reserve tranche position with the IMF 0.03 0.03

Pursuant to Resolution No. 63-2 adopted by the Board of Governors of the IMF on 28 April 2008 the quota of Lithuania in the IMF was increased by SDR 39.70 million on 28 March 2011. As at 31 December 2011 the value of the quota totalled to SDR 183.90 million. Lithuania’s quota in the IMF is secured by the non-interest-bearing promissory note denominated in litas and issued by the Government of the Republic of Lithuania.

The major part of the SDR balance in the SDR account with the IMF managed by the Republic 90 of Lithuania is comprised of SDR 137.24 million (LTL 565.12 million) allocated by the IMF in IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

2009, the counterpart of which is disclosed under the balance sheet of the Bank of Lithuania liability item “Counterpart of Special Drawing Rights allocated by the International Monetary Fund”. The interest payable and receivable on SDR funds coincide.

Note 3. Deposits, Securities and Other Investments Denominated in Foreign Currency LTL million

31 December 2011 31 December 2010 Debt securities (other than those classified as held-to-maturity) 14,441.93 12,735.90 Debt securities classified as held-to-maturity 1,151.35 1,281.74 Accounts with foreign institutions 3,079.25 508.62 Reverse repurchase agreements 1,760.93 1,415.34 Claims on the ECB (TARGET24 account) 305.59 621.24 Total 20,739.05 16,562.84 4 The market value of held to maturity securities at market rates prevailing on the balance sheet date was LTL 963.70 million. At the date when the financial statements for 2011 of the Bank of Lithuania were authorised for issue, the Bank of Lithuania had not had securities with ISIN GR0110021236, because these securities had been replaced by other securities on the conditions defined by the issuer. Liabilities of the Bank of Lithuania to participants of TARGET2 related to the claims of the Bank of Lithuania on the ECB arising due to operations performed via TARGET2 are presented in Note 14. The majority of the Bank of Lithuania accounts with foreign institutions are balances held with international finance institutions. Balances on these accounts comprise of LTL 2,315.95 million (LTL 0.01 million on 31 December 2010). The breakdown of deposits, securities and other investments by currency is presented in Note 28.

Breakdown of Deposits, Securities and Other Investments Denominated in Foreign Currency by the Economic Area of Residence of the Issuer and Counterparty LTL million

31 December 2011 31 December 2010 Euro area EU Member States 16,213.74 14,864.04 Non-euro area EU Member States 945.22 1,429.17 Other countries 1,063.56 123.26 International financial institutions 2,516.53 146.37 Total 20,739.05 16,562.84

Breakdown of Deposits, Securities and Other Investments Denominated in Foreign Currency by Maturity LTL million

31 December 2011 31 December 2010 Demand 3,384.84 1,129.86 Up to 1 year 10,711.19 7,775.95 1–5 years 5,540.35 6,987.63 Over 5 years 1,102.67 669.41 Total 20,739.05 16,562.84

4 TARGET2 is a Trans-European Automated Real-time Gross settlement Express Transfer system operating on the basis 91 of a single shared platform and providing harmonised services according to a unified price system.  Annual Report of the Bank of Lithuania

Note 4. Claims on Domestic Institutions Denominated in Foreign Currency

LTL million 2011 31 December 2011 31 December 2010 Securities of the Government of the Republic of Lithuania 81.10 – Claims on domestic credit institutions 0.03 0.04 Total 81.13 0.04

Securities of the Government of the Republic of Lithuania were acquired in the secondary market and classified as held-to-maturity. As at 31 December 2011 the market value of these securities amounted to LTL 81.66 million.

Note 5. Securities of Domestic Institutions Held for Monetary Policy Purposes Denominated in Litas As from December 2011 the Bank of Lithuania has arranged securities purchase auctions for the purpose of banking system liquidity regulation. As at 31 December 2011 the value of securities acquired totalled to LTL 171.80 million. The Bank of Lithuania earned LTL 0.07 million interest income on these securities (see Note 19).

Note 6. Tangible Fixed and Intangible Assets LTL million

Tangible fixed assets Intangible Total assets Buildings and Cash count Vehicles Other construction in and computer tangible progress equipment assets (including (including asset under asset under construction) construction) Acquisition cost as at 31 December 2010 161.30 69.90 5.79 37.76 16.03 290.78 Additions in 2011 – 3.44 – 1.02 1.44 5.91 Acquisitions – 3.17 – 0.99 0.84 4.99 Acquired free of charge – 0.27 – 0.04 0.61 0.92 Disposals in 2011 – (1.44) – (0.56) (0.77) (2.76) Acquisition cost as at 31 December 2011 161.30 71.91 5.79 38.23 16.70 293.93 Accrued depreciation as at 31 December 2010 (39.10) (57.93) (4.21) (29.42) (15.51) (146.18) Depreciation in 2011 (3.84) (4.41) (0.63) (1.28) (0.67) (10.84) Written-off depreciation in 2011 – 1.44 – 0.55 0.77 2.76 Accrued depreciation as at 31 December 2011 (42.95) (60.91) (4.84) (30.15) (15.42) (154.26) Net book value as at 31 December 2011 118.36 11.00 0.95 8.08 1.28 139.67 Net book value as at 31 December 2010 122.20 11.97 1.58 8.34 0.51 144.60

The Bank of Lithuania has not concluded any transactions with the mortgage of tangible assets of the Bank of Lithuania. Pursuant to a resolution of the Board of the Bank of Lithuania a part of the real estate with the residual value LTL 25.78 million was retired as not necessary for the Bank’s activities. In 2012 this property is envisaged to be transferred to the State institutions in accordance with laws of the Republic of Lithuania. The Bank of Lithuania should receive the compensation at the market value of transferred property under the provisions set in the Law amending 92 Article 23 of the Law on the Bank of Lithuania (see Note 27). IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

Note 7. Investments into Equity Instruments

The Bank of Lithuania is a member of the ESCB. In accordance with Article 28 of the Statute of the ESCB and of the ECB, the Bank of Lithuania is the subscriber to the capital of the ECB. Shares of the national central banks in the subscribed capital of the ECB depend on the established key for the ECB capital subscription, which is adjusted in accordance with Article 29.3 and Article 48.3 of the Statute of the ESCB and of the ECB. The share of the Bank of Lithuania in the capital of the ECB as of 1 January 2009 comprises 0.4256 per cent.

As Lithuania does not participate in the euro area, the transitional provisions of Article 47 of the Statute of the ESCB and of the ECB shall apply. According to these provisions, the Bank of Lithuania paid up 3.75 per cent of its subscribed capital of the ECB. As a non-euro area national central bank, the Bank of Lithuania is not entitled to receive any share of the distributable profits of the ECB, nor is it liable to fund any loss of the ECB.

Distribution of the Subscribed and Paid-up Capital of the European Central Bank Euro

Central Bank Subscribed capital as at Paid-up capital as at 31 December 2011 31 December 2011 Nationale Bank van België/ Banque Nationale de Belgique 261,010,384.68 220,583,718.02 Deutsche Bundesbank 2,037,777,027.43 1,722,155,360.77 Eesti Pank 19,261,567.80 16,278,234.47 Central Bank of Ireland 119,518,566.24 101,006,899.58 Bank of Greece 211,436,059.06 178,687,725.72 Banco de España 893,564,575.51 755,164,575.51 Banque de France 1,530,293,899.48 1,293,273,899.48 Banca d’Italia 1,344,715,688.14 1,136,439,021.48 Central Bank of Cyprus 14,731,333.14 12,449,666.48 Banque centrale du Luxembourg 18,798,859.75 15,887,193.09 Central Bank of Malta 6,800,732.32 5,747,398.98 De Nederlandsche Bank 429,156,339.12 362,686,339.12 Oesterreichische Nationalbank 208,939,587.70 176,577,921.04 Banco de Portugal 188,354,459.65 159,181,126.31 Banka Slovenije 35,381,025.10 29,901,025.10 Národná banka Slovenska 74,614,363.76 63,057,697.10 Suomen Pankki – Finlands Bank 134,927,820.48 114,029,487.14 Subtotal for euro area NCBs 7,529,282,289.35 6,363,107,289.36 Българска народна банка (Bulgarian National Bank) 93,467,026.77 3,505,013.50 Česká národní banka 155,728,161.57 5,839,806.06 Danmarks Nationalbank 159,634,278.39 5,986,285.44 Latvijas Banka 30,527,970.87 1,144,798.91 Lietuvos bankas 45,797,336.63 1,717,400.12 Magyar Nemzeti Bank 149,099,599.69 5,591,234.99 Narodowy Bank Polski 526,776,977.72 19,754,136.66 Banca Naţională a României 265,196,278.46 9,944,860.44 Sveriges Riksbank 242,997,052.56 9,112,389.47 Bank of England 1,562,145,430.59 58,580,453.65 Subtotal for non-euro area NCBs 3,231,370,113.23 121,176,379.25 Total 10,760,652,402.58 6,484,283,668.61

93  Annual Report of the Bank of Lithuania

The Bank of Lithuania is a member of the Bank for International Settlements (BIS) with 1,070 shares, which acquisition cost is LTL 11.51 million and the nominal value is SDR 5,000 per 2011 share. The Bank of Lithuania has paid 25 per cent of the value of these shares. In 2011 the Bank of Lithuania received dividends of LTL 1.21 million for BIS shares (LTL 3.01 million in 2010).

As at 31 December 2011 the Bank of Lithuania owned 60 per cent of the shares of the Central Securities Depository of Lithuania AB (CSD) which acquisition cost was LTL 1.50 million. In 2011 the Bank of Lithuania received dividends of LTL 3.72 million for these shares (LTL 1.38 million in 2010). At the beginning of 2012 the Bank of Lithuania sold it’s CDS shares portfolio at the public tender for LTL 13 million.

The Bank of Lithuania holds one SWIFT share with the acquisition cost of LTL 3,249. Dividends are not paid for this share.

Note 8. Accruals and Deferred Expenses

LTL million

31 December 2011 31 December 2010 Accrued interest income 134.11 154.78 Accrued coupon on securities 133.66 154.69 Interest on reverse repurchase and repurchase agreements 0.33 0.07 Interest on financial derivatives 0.07 – Other accrued interest 0.04 0.02 Coupon purchased with securities 51.18 48.62 Other accrued income 0.07 0.11 Deferred expenses 2.11 1.85 Total 187.47 205.36

Note 9. Sundry

LTL million

31 December 2011 31 December 2010 Staff loans 14.88 17.09 Advances 2.68 0.10 Other receivables 0.08 0.06 Inventories 1.79 1.76 Total 19.43 19.01

Pursuant to a resolution of the Board of the Bank of Lithuania, staff loans were ceased to be issued as of 27 August 2009.

Note 10. Banknotes and Coins in Circulation

This balance sheet item presents the nominal value of litas banknotes and coins in circulation. In 2011 the value of banknotes and coins (including collector (commemorative) coins and numismatic sets of coins) put into circulation by the Bank of Lithuania was LTL 4,638.56 million (LTL 3,334.16 million in 2010) and the value of those withdrawn from circulation was LTL 2,635.49 million (LTL 2,442.40 million in 2010).

94 IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

Banknotes and Coins in Circulation LTL million

31 December 2011 31 December 2010 Banknotes 10,597.93 8,613.07 Coins (including collector (commemorative) coins and numismatic sets of coins) 229.09 210.88 Total 10,827.02 8,823.95

Note 11. Liabilities to Domestic Credit Institutions Related to Monetary Policy Operations Denominated in Litas

LTL million

31 December 2011 31 December 2010 Accounts (including required minimum reserves) 6,172.07 3,044.42 Fixed-term deposits 78.50 – Total 6,250.57 3,044.42

This item consists of the holdings of required minimum reserves held by commercial banks in their current accounts with the Bank of Lithuania. From November 2008 credit institutions are subject to 4 per cent reserve requirement.

The Bank of Lithuania pays interest for the part of commercial bank required reserves that does not exceed the required reserve ratio used by the ECB for that period by applying marginal interest rates of the main refinancing operations of the Eurosystem set by the ECB (see Note 20). In 2011 the interest rate used for calculations of interest paid by the Bank of Lithuania for the part of required reserves of commercial banks fluctuated from 1.00 to 1.50 per cent (in 2010 was 1.00%).

Since December 2011 the Bank of Lithuania has arranged fixed-term deposits auctions for the purpose of liquidity regulation in the banking system. The average interest rate of these fixed-term deposits was 0.45 per cent. In 2011 the Bank of Lithuania incurred LTL 0.03 million interest expense on these deposits.

Note 12. Liabilities to Other Domestic Institutions Denominated in Litas

LTL million

31 December 2011 31 December 2010 Liabilities to Government institutions 50.45 123.12 Liabilities to other domestic institutions 57.37 96.70 Total 107.82 219.82

Note 13. Liabilities to Foreign Institutions Denominated in Litas

LTL million

31 December 2011 31 December 2010 Balances in current accounts of international organisations 90.63 101.20 Balances in current accounts of foreign banks 0.10 0.10 Total 90.73 101.30

95  Annual Report of the Bank of Lithuania

Note 14. Liabilities Denominated in Foreign Currency

2011 Liabilities to Domestic Institutions Denominated in Foreign Currency LTL million

31 December 2011 31 December 2010 Fixed-term deposits of Government institutions 860.06 1,967.27 Balances in current accounts of Government institutions 790.87 357.52 Balances in current accounts of TARGET2 participants 163.12 621.22 Balances in current accounts of other domestic institutions 0.14 – Fixed-term deposits of other domestic institutions – 80.16 Total 1,814.19 3,026.17

Liabilities to Foreign Institutions Denominated in Foreign Currency LTL million

31 December 2011 31 December 2010 Repurchase agreements 787.03 142.48 Balances in current accounts 124.23 14.33 Gold swaps 83.40 317.52 Total 994.66 474.32

Breakdown of Liabilities to Foreign Institutions in Foreign Currency by the Economic Area of Counterparty LTL million

31 December 2011 31 December 2010 Non-euro area EU Member States 870.42 335.18 Other countries – 124.81 International financial institutions 124.23 14.33 Total 994.66 474.32

Breakdown of Liabilities Denominated in Foreign Currency by Maturity LTL million

31 December 2011 31 December 2010 Demand 1,078.22 992.94 Up to 1 year 1,730.49 2,507.42 Without term 0.14 0.14 Total 2,808.85 3,500.50

Note 15. Other Liabilities

LTL million

31 December 2011 31 December 2010 Accruals and deferred income 5.40 5.13 Accrued interest expenses 1.17 2.02 Other accruals 3.12 2.92 Deferred income 1.10 0.19 Sundry 4.24 6.05 Off-balance sheet instruments revaluation differences (see Note 16) 8.81 0.38 96 Total 18.44 11.56 IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

A major part of the deferred income consists of the value of the tangible and intangible asset acquired by the Bank of Lithuania at the end of 2011 free of charge from the Insurance Supervisory Commission and the Lithuanian Securities Commission (LTL 0.92 million; see Note 6).

Note 16. Off-Balance-Sheet Instruments Revaluation Differences

Off-balance-sheet instruments revaluation differences represent the revaluation results of off- balance-sheet accounted foreign exchange transactions and forward transactions in securities due to changes in the official exchange rate and the forward price.

Off-Balance-Sheet Instruments Revaluation Differences LTL million

Value on a trade date Value on Value adjustment 31 December 2011 differences Foreign Exchange Receivables 1,035.84 1,035.84 – Swap transactions Payables 1,035.84 1,044.58 8.74 Foreign Exchange Receivables 0.31 0.31 – Forward transactions Payables 0.31 0.31 0.00 Forward transaction in Receivables 161.28 161.28 – securities Securities transferrable 161.28 161.35 0.07 Total 8.81

Note 17. Revaluation Accounts

LTL million

31 December 2011 31 December 2010 Revaluation accounts Gold 474.03 497.63 Securities 59.97 5.32 Foreign currency 0.08 0.09 Total 534.08 503.04

Revaluation accounts represent revaluation balances arising from unrealised gains on gold, securities and foreign currency.

Unrealised revaluation loss of securities and derivatives, when exceeding previous corresponding revaluation gains, was recognised as expenses at the last working day of 2011 (see Note 22).

Note 18. Capital

LTL million

31 December 2010 Increase 31 December 2011 Capital Authorised capital 200.00 – 200.00 Reserve capital 1,132.00 27.15 1,159.15 Total 1,332.00 27.15 1,359.15

97  Annual Report of the Bank of Lithuania

The reserve capital of the Bank of Lithuania rose following the distribution of the profit of the Bank of Lithuania for 2010 in accordance with provisions laid down in the Law on the 2011 Bank of Lithuania.

Note 19. Interest Income

LTL million

2011 2010 Interest income on: Securities other than those classified as held-to-maturity 334.04 193.95 Securities classified as held-to-maturity 41.54 28.40 Reverse repurchase agreements 15.15 1.69 Repurchase agreements 6.85 0.12 Accounts balances and fixed-term deposits 4.09 1.72 Financial derivatives 2.29 0.07 Staff loans 0.68 0.78 Monetary policy instruments 0.07 – Total 404.71 226.73

In 2011, 99.8 per cent (99.7% in 2010) of interest income was earned in foreign currency.

Note 20. Interest Expense

LTL million

2011 2010 Interest expense on: Fixed-term deposits of Government institutions 15.46 5.40 Monetary policy instruments 12.63 9.84 Balances in current accounts of Government institutions 3.38 2.89 Gold swaps 3.17 1.29 Fixed-term deposits of other domestic institutions 1.23 0.98 Repurchase agreements 0.69 0.14 Other 0.00 0.02 Total 36.57 20.57

In 2011, 65.5 per cent (52.2% in 2010) of interest expense was incurred in foreign currency.

Note 21. Realised Gains (Losses) Arising from Financial Operations

LTL million

2011 2010 Realised gains (losses) arising from: Sale of gold 120.16 – Sale of securities 33.66 161.33 Gold futures 0.86 – Forward transactions in securities 0.30 (1.90) Sale of foreign currency (0.05) 0.06 Interest rate futures (36.36) (49.19) Total 118.57 110.30

98 IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

Note 22. Unrealised Losses from Revaluation

LTL million

2011 2010 Unrealised revaluation losses on: Securities 288.48 158.55 Derivatives 0.07 0.02 Total 288.55 158.57

Note 23. Net Income from Fees and Commissions

LTL million

2011 2010 Fees and commissions from: Settlement services 7.13 6.72 Sale of numismatic valuables 6.33 12.22 Usage of the Loan Risk Database 0.13 0.13 Other services 0.11 0.12 Total 13.71 19.19 Expenses relating to fees and commissions (2.85) (2.58) Net income from fees and commissions 10.85 16.61

Note 24. Staff Costs

LTL million

2011 2010 Expenses on wages and salaries: 39.58 39.38 To the members of the Board 1.13 1.07 To the heads of structural divisions 2.24 2.10 To other staff of the Bank of Lithuania 36.21 36.21 Termination benefits 2.13 0.38 To the members of the Board 0.23 – To the heads of structural divisions 0.17 0.01 To other staff of the Bank of Lithuania 1.73 0.37 Other emoluments 0.19 0.25 Contributions to State Social Insurance Fund 12.93 12.34 Total 54.83 52.35

The Board of the Bank of Lithuania consists of the Chairman of the Board of the Bank of Lithuania, two Deputy Chairmen and two Board Members.

On 31 December 2011 the Bank of Lithuania had eleven departments, six independent divisions and branches in Kaunas and Klaipėda. The total number of employees was 743 (2010: 796 employees) of which 11 were on fixed-term labour contract (2010: 5 employees) and 15 were on parental leave or unpaid leave for short-term contracts with the ECB and IMF or for the studies in abroad (2010: 17 employees).

On 29 December 2011 the Board of the Bank of Lithuania approved the conception of a new structure of the Bank of Lithuania, on the implementation of which in 2012 the activities of the structural divisions will be optimised and restructured. In addition, the branch in Klaipėda will cease its activities. These structural changes will not impact the going concern of the Bank of Lithuania. 99  Annual Report of the Bank of Lithuania

Note 25. Administrative Expenses

LTL million 2011 2011 2010 Expenses Maintenance expenses 8.29 8.61 Information subscription expenses 2.32 2.19 Mail and communication 1.58 1.50 Business trips 1.28 1.13 Public relations 0.62 0.56 Training of the staff 0.54 0.68 Library acquisitions and press subscriptions 0.21 0.16 Honorarium 0.11 0.24 Other 2.06 1.59 Total 17.01 16.67

Note 26. Banknote and Coin Production Services and Circulation Expenses

LTL million

2011 2010 Coin minting expenses 4.63 12.51 Cash circulation expenses 0.26 0.20 Total 4.89 12.71

Note 27. Distribution of the Profit of the Bank of Lithuania

Pursuant to Article 23 on the profit allocation of the Law on the Bank of Lithuania, the profit of the Bank of Lithuania of the financial year 2011 is allocated by the contribution to the State budget of 70 per cent of the amount of the profit of the Bank of Lithuania and the remaining part of the profit is transferred to the reserve capital. The authorised capital of the Bank of Lithuania has been completely formed.

Pursuant to provisions of Article 2 of the Law amending Article 23 of the Law on the Bank of Lithuania (No. XI-1800, 15 December 2011; (Valstybės žinios (Official Gazette) No. 160-7567, 2011), on the basis of the Board of the Bank of Lithuania decision following the approval of the Annual Financial Statements of the Bank of Lithuania for 2011, LTL 16.68 million of the profit contribution, dedicated to be transferred to the State budget, is withheld for the compensation at the market value of the real estate retired from active use, which is recognised as unnecessary by a decision of the Board of the Bank of Lithuania and is envisaged to be transferred to the State institutions in accordance with laws of the Republic of Lithuania.

LTL

2011 2010 2009 Profit allocation Transfer to the state budget 72,947,773 63,341,216 363,606,065 Compensation at the market value of real estate envisaged to be transferred 16,677,000 – – Allocation to the reserve capital of the Bank of Lithuania 38,410,617 27,146,235 155,831,171 Total 128,035,390 90,487,452 519,437,236

100 IV. THE ANNUAL FINANCIAL STATEMENTS OF THE BANK OF LITHUANIA 2011

Note 28. Assets and Liabilities of the Bank of Lithuania by Currency

LTL million

LTL EUR USD JPY XDR XAU Other Total 31 December 2011 ASSETS Gold – – – – – 786.01 – 786.01 Claims on foreign institutions denominated in foreign currency – 19,690.83 2.32 1,044.63 565.55 – 1.27 21,304.60 Receivables from the IMF – – – – 565.55 – – 565.55 Debt securities – 14,548.82 – 1,044.46 – – – 15,593.28 Deposits and other investments – 5,142.01 2.32 0.16 – – 1.27 5,145.76 Claims on domestic institutions denominated in foreign currency – 81.11 0.02 – – – – 81.13 Securities of domestic institutions related to monetary policy operations denominated in litas 171.80 – – – – – – 171.80 Other assets 175.41 190.03 – 0.07 – – 0.00 365.51 Total on-balance-sheet assets 347.20 19,961.97 2.34 1,044.70 565.55 786.01 1.27 22,709.04 LIABILITIES Banknotes and coins in circulation 10,827.02 – – – – – – 10,827.02 Liabilities to domestic credit institutions related to monetary policy operations denominated in litas 6,250.57 – – – – – – 6,250.57 Liabilities to other domestic institutions denominated in litas 107.82 – – – – – – 107.82 Liabilities to foreign institutions denominated in litas 90.73 – – – – – – 90.73 Liabilities to domestic institutions denominated in foreign currency – 1,810.80 2.42 – 0.14 – 0.83 1,814.19 Liabilities to foreign institutions denominated in foreign currency – 994.66 – – – – – 994.66 Counterpart of special drawing rights allocated by the IMF – – – – 565.12 – – 565.12 Items in the course of settlement 19.23 – – – – – – 19.23 Other liabilities 8.67 1.03 – 8.74 – – – 18.44 Revaluation accounts 477.78 56.28 – 0.03 – – – 534.08 Capital 1,359.15 – – – – – – 1,359.15 Profit for the year 128.04 – – – – – – 128.04 Total on-balance-sheet liabilities 19,269.00 2,862.76 2.42 8.77 565.26 – 0.83 22,709.04 NET ON-BALANCE-SHEET ASSETS (LIABILITIES) (18,921.79) 17,099.21 (0.08) 1,035.93 0.29 786.01 0.44 0.00 Off-balance-sheet assets included into currency position Receivables under foreign exchange transactions 20.72 1,036.15 – – – – – 1,056.86 Off-balance-sheet liabilities included into currency position Payables under foreign exchange transactions – 20.72 – 1,036.15 – – – 1,056.86 Net off-balance-sheet assets (liabilities) included into currency position 20.72 1,015.43 – (1,036.15) – – – 0.00 NET ASSETS (LIABILITIES) (18,901.08) 18,114.64 (0.08) (0.22) 0.29 786.01 0.44 0.00 31 December 2010 Total on-balance-sheet assets 177.98 16,603.41 168.85 0.03 549.58 688.25 0.53 18,188.63 Total on-balance-sheet liabilities 14,131.43 3,370.74 137.15 – 549.30 – 0.02 18,188.63 NET ON-BALANCE-SHEET ASSETS (LIABILITIES) (13,953.45) 13,232.67 31.69 0.03 0.29 688.25 0.52 0.00 Off-balance-sheet assets included into currency position – 359.38 – – – – – 359.38 Off-balance-sheet liabilities included into currency position 328.02 – 31.36 – – – – 359.38 Net off-balance-sheet assets (liabilities) included into currency position (328.02) 359.38 (31.36) – – – – 0.00 NET ASSETS (LIABILITIES) (14,281.47) 13,592.05 0.33 0.03 0.29 688.25 0.52 0.00 101  Annual Report of the Bank of Lithuania

ANNEXES 2011

RESOLUTIONS PASSED BY THE BOARD OF THE BANK OF LITHUANIA AND PUBLISHED IN VALSTYBĖS ŽINIOS (OFFICIAL GAZETTE) IN 2011 Declaring Legal Tender and Issuing into Circulation 50 Litas Collectors (Commemorative) Silver Coin Dedicated to the 150th Birth Anniversary of Gabrielė Petkevičaitė-Bitė; passed on 17 February 2011 (Valstybės žinios (Official Gazette) No 22, 22 February 2011, Issue No 1097). Bank of Lithuania Board Resolution No 03-22 Amending Resolution No 85 of the Board of the Bank of Lithuania of 20 May 2004 on Approval of the Rules for Supervision of Foreign Bank Branches and Cooperation with Supervisory Authorities of Other European Union Member States Carrying out the Supervision of Branches; passed on 17 February 2011 (Valstybės žinios (Official Gazette) No 22, 22 February 2011, Issue No 1098). Declaring Legal Tender and Issuing into Circulation 10 Litas Collectors (Commemorative) Silver Coin Dedicated to Theatre (from the “Lithuanian Culture” Series); passed on 15 March 2011 (Valstybės žinios (Official Gazette) No 33, 19 March 2011, Issue No 1593). Amending Resolution No 138 of the Board of the Bank of Lithuania of 9 November 2006 on the Ge- neral Regulations for the Calculation of Capital Adequacy; passed on 15 March 2011 (Valstybės žinios (Official Gazette) No 35, 24 March 2011, Issue No 1697). Amending Resolution No 149 of the Board of the Bank of Lithuania of 25 September 2008 on the Regulations for the Organisation of Internal Control and Risk Assessment; passed on 15 March 2011 (Valstybės žinios (Official Gazette) No 35, 24 March 2011, Issue No 1698). Approving Methodology for Statistical Survey of Financial Position of Households with Loans; passed on 15 March 2011 (Valstybės žinios (Official Gazette) No 35, 24 March 2011, Issue No 1699). Amending Resolution No 154 of the Board of the Bank of Lithuania of 15 November 2007 on Approval of the Rules for Selection, Valuation and Publishing of Assets Eligible for Use as Collateral in Credit Operations of the Bank of Lithuania and Amendments to the Respective Resolutions of the Board of Bank of Lithuania; passed on 7 April 2011 (Valstybės žinios (Official Gazette) No 46, 16 April 2011, Issue No 2214). Approving Regulations on Granting Vladas Jurgutis Award; passed on 7 April 2011 (Valstybės žinios (Official Gazette) No 46, 16 April 2011, Issue No 2215). Amending Resolution No 94 of the Board of the Bank of Lithuania of 29 June 2000 on Approval of the Forms of Statistical Statements Used for the Compilation of the Balance of Payments of the Republic of Lithuania; passed on 14 April 2011 (Valstybės žinios (Official Gazette) No 47, 21 April 2011, Issue No 2274). Amending Resolution No 138 of the Board of the Bank of Lithuania of 9 November 2006 on the General Regulations for the Calculation of Capital Adequacy and Resolution No 151 of the Board of the Bank of Lithuania of 7 December 2006 on Approval of the Requirements for the Publicly Disclosed Informa- tion; passed on 19 May 2011 (Valstybės žinios (Official Gazette) No 62, 24 May 2011, Issue No 2979). Supplementing Resolution No 175 of the Board of the Bank of Lithuania of 11 November 2004 on Approval of the Code of Ethics of the Board of the Bank of Lithuania; passed on 19 May 2011 (Valstybės žinios (Official Gazette) No 62, 24 May 2011, Issue No 2980). Supplementing Resolution No 5 of the Board of the Bank of Lithuania of 13 January 2005 on Approval of the Code of Ethics of Employees of the Bank of Lithuania; passed on 19 May 2011 (Valstybės žinios (Official Gazette) No 62, 24 May 2011, Issue No 2981). Amending Resolution No 145 of 23 November 2006 on Approval of the General Regulations for the Internal Capital Adequacy Assessment Process and for the Supervisory Review and Evaluation Process; 102 passed on 2 June 2011 (Valstybės žinios (Official Gazette) No 71, 11 June 2011, Issue No 3459). ANNEXES

Declaring Legal Tender and Issuing into Circulation 50 Litas Collectors (Commemorative) Gold Coin and 1 Litas Collectors (Commemorative) Copper–Nickel Alloy Circulation Coin Dedicated to Basketball; passed on 7 June 2011 (Valstybės žinios (Official Gazette) No 71, 11 June 2011, Issue No 3460). Amending Resolution No 173 of the Board of the Bank of Lithuania of 28 December 2006 on the Pay- ment System LITAS-RLS and the Retail Payment System LITAS-MMS; passed on 23 June 2011 (Valstybės žinios (Official Gazette) No 79, 30 June 2011, Issue No 3894). Amending Resolution No 84 of the Board of the Bank of Lithuania of 4 September 2003 on Amendment to the Procedure of Registration of Payment and Securities Settlement Systems and of Management and Announcement of Their Data; passed on 23 June 2011 (Valstybės žinios (Official Gazette) No 79, 30 June 2011, Issue No 3895). Repealing Resolution No 27 of the Board of the Bank of Lithuania of 25 March 2004 on Approval of the Procedure for Submitting Information Related with Payment and Securities Settlement Systems, Their Operators and Participants to the Commission of the European Communities, Responsible Authorities of the Member States of the European Union and the European Free Trade Association and System Opera- tors; passed on 23 June 2011 (Valstybės žinios (Official Gazette) No 79, 30 June 2011, Issue No 3896). Responsible Lending Regulations passed on 1 September 2011 (Valstybės žinios (Official Gazette) No 111, 8 September 2011, Issue No 5262). Declaring Legal Tender and Issuing into Circulation 50 Litas Collectors (Commemorative) Coin Dedica- ted to Vilnius Upper Castle (Series “Historical and Architectural Monuments of Lithuania”); passed on 6 September 2011 (Valstybės žinios (Official Gazette) No 112, 10 September 2011, Issue No 5293). Amending Resolution No 138 of the Board of the Bank of Lithuania of 9 November 2006 on the Ge- neral Regulations for the Calculation of Capital Adequacy; passed on 29 September 2011 (Valstybės žinios (Official Gazette) No 122, 11 October 2011, Issue No 5808). Amending Resolution No 145 of 23 November 2006 on Approval of the General Regulations for the Internal Capital Adequacy Assessment Process and for the Supervisory Review and Evaluation Process; passed on 29 September 2011 (Valstybės žinios (Official Gazette) No 122, 11 October 2011, Issue No 5809). Bank of Lithuania Board Resolution No 03-154 Amending and Supplementing Resolution No 151 of the Board of the Bank of Lithuania of 7 December 2006 on Approval of the Requirements for the Publicly Disclosed Information; passed on 29 September 2011 (Valstybės žinios (Official Gazette) No 122, 11 October 2011, Issue No 5810). Amending Resolution No 153 of the Board of the Bank of Lithuania of 7 December 2006 on Approval of the Rules on Consolidation of Accounts of the Financial Group and on Joint (Consolidated) Super- vision; passed on 29 September 2011 (Valstybės žinios (Official Gazette) No 122, 11 October 2011, Issue No 5811). Amending Resolution No 85 of the Board of the Bank of Lithuania of 20 May 2004 on Approval of the Rules for Supervision of Foreign Bank Branches and Cooperation with Supervisory Authorities of Other European Union Member States Carrying out the Supervision of Branches; passed on 29 September 2011 (Valstybės žinios (Official Gazette) No 122, 11 October 2011, Issue No 5812). Bank of Lithuania Board Resolution No 03-168 Amending Resolution No 173 of the Board of the Bank of Lithuania of 28 December 2006 on the Payment System LITAS-RLS and the Retail Payment System LITAS-MMS; passed on 13 October 2011 (Valstybės žinios (Official Gazette) No 125, 18 October 2011, Issue No 5986). Amending Resolution No 03-144 of the Board of the Bank of Lithuania on the Responsible Lending Regulations; passed on 27 October 2011 (Valstybės žinios (Official Gazette) No 136, 15 November 2011, Issue No 6482). Amending Resolution No 125 of the Board of the Bank of Lithuania of 21 December 1995 on Approval of the Rules for Managing the Loan Risk Database; passed on 10 November 2011 (Valstybės žinios (Official Gazette) No 136, 15 November 2011, Issue No 6483). Amending Resolution No 03-15 of the Board of the Bank of Lithuania of 16 March 2010 on Approval of the Principal Guidelines for the Management of Foreign Reserves of the Bank of Lithuania; passed on 29 September 2011 (Valstybės žinios (Official Gazette) No 137, 17 November 2011, Issue No 6524). Amending Resolution No 137 of the Board of the Bank of Lithuania of 18 October 2007 on Approval of the Rules of Operation of LITAS-PHA System; passed on 15 November 2011 (Valstybės žinios (Official Gazette) No 140, 19 November 2011, Issue No 6609). 103  Annual Report of the Bank of Lithuania

Amending Resolution No 136 of the Board of the Bank of Lithuania of 18 October 2007 on Approval of the Rules of Operation of TARGET2-LIETUVOS BANKAS Payment System; passed on 15 November 2011 2011 (Valstybės žinios (Official Gazette) No 140, 19 November 2011, Issue No 6610). Amending Resolution No 148 of the Board of the Bank of Lithuania of 8 November 2007 on Approval of the Rules on Granting Euro-Denominated Intraday Credits; passed on 15 November 2011 (Valstybės žinios (Official Gazette) No 140, 19 November 2011, Issue No 6611). Amending Resolution No 54 of the Board of the Bank of Lithuania of 22 June 1995 on Approval of the Regulations on Granting of Loans to Commercial Banks; passed on 17 November 2011 (Valstybės žinios (Official Gazette) No 140, 19 November 2011, Issue No 6612). Repealing Resolution No 166 of the Board of the Bank of Lithuania of 28 October 1999 on Establishing the Interest Rate on Loans Granted to Commercial Banks; passed on 17 November 2011 (Valstybės žinios (Official Gazette) No 140, 19 November 2011, Issue No 6613). Declaring Legal Tender and Issuing into Circulation 50 Litas Collectors (Commemorative) Coin Dedicated to XXX Olympic Games in London; passed on 24 November 2011 (Valstybės žinios (Official Gazette) No 148, 3 December 2011, Issue No 6985). Amending Resolution No 109 of the Board of the Bank of Lithuania of 20 November 2003 on Pro- viding Information Relating to the Taking up and Pursuit of the Business of Credit Institutions to the Commission of the European Communities and to the Supervisory Authorities of Credit Institutions of the European Union Member States; passed on 22 December 2011 (Valstybės žinios (Official Gazette) No 162, 30 December 2011, Issue No 7737). Repealing Resolution No 149 of the Board of the Bank of Lithuania of 2 September 2004 on Approval of the Regulations for Determining the Value of Bank Shares Taken for Public Needs; passed on 22 December 2011 (Valstybės žinios (Official Gazette) No 162, 30 December 2011, Issue No 7738). Amending Resolution No 46 of the Board of the Bank of Lithuania of 8 May 2003 on Balance Sheet Statistics of Monetary Financial Institutions; passed on 29 December 2011 (Valstybės žinios (Official Gazette) No 4, 6 January 2012, Issue No 136). Amending Resolution No 127 of the Board of the Bank of Lithuania of 20 August 2008 on Statistical Reporting of Collective Investment Undertakings; passed on 29 December 2011 (Valstybės žinios (Official Gazette) No 4, 6 January 2012, Issue No 137).

104 ANNEXES

Banknotes and Coins in Circulation*

10 litas

1997 issue

2001 issue

2007 issue

20 litas

1997 issue

2001 issue

2007 issue 105 * Excluding collectors (commemorative) coins.  Annual Report of the Bank of Lithuania

50 litas

2011

1998 issue

2003 issue

100 litas

2000 issue

2007 issue

200 litas

1997 issue

500 litas

106 2000 issue ANNEXES

1 centas – 1991 issue 2 centas – 1991 issue 5 centas – 1991 issue

10 centas – 1991 issue 20 centas – 1991 issue 50 centas – 1991 issue

10 centas – issues since 1997 20 centas – issues since 1997 50 centas – issues since 1997

1 litas – issues since 1998 2 litas – issues since 1998 5 litas – issues since 1998

Circulation collectors (commemorative) coins

1997

1 litas coin issued to mark the 75th anniversary of the Bank of Lithuania and the litas Designed by Rimantas Eidėjus Vytis adapted by Arvydas Každailis Alloy of copper and nickel. Cu 75%, Ni 25% The edge of the coin rimmed at intervals Diameter 22.30 mm. Weight 6.25 g Mintage 200,000 pcs.

1999

1 litas coin issued to mark the 10th anniversary of the Baltic Way Designed by Antanas Žukauskas Alloy of copper and nickel. Cu 75%, Ni 25% The edge of the coin rimmed at intervals Diameter 22.30 mm. Weight 6.25 g Mintage 1,000,000 pcs. 107  Annual Report of the Bank of Lithuania

2004

2011 1 litas coin issued to mark the 425th anniversary of Vilnius University Designed by Rytas Jonas Belevičius Alloy of copper and nickel. Cu 75 %, Ni 25 % The edge of the coin rimmed at intervals Diameter 22.30 mm. Weight 6.25 g Mintage 200,000 pcs.

2005

1 litas coin dedicated to the Palace of the Grand Dukes of Lithuania Designed by Giedrius Paulauskis Alloy of copper and nickel. Cu 75 %, Ni 25 % Regular dodecagon coin The edge of the coin rimmed at intervals Diameter 22.30 mm. Weight 6.25 g Mintage 1,000,000 pcs.

2009 1 litas coin dedicated to Vilnius – European Capital of Culture 2009 Designed by Vytautas Narutis Alloy of copper and nickel. Cu 75 %, Ni 25 % The edge of the coin rimmed at intervals Diameter 22.30 mm. Weight 6.25 g Mintage 1,000,000 pcs.

2010

1 litas coin dedicated to the 600th anniversary of the Battle of Grunwald Designed by Rytas Jonas Belevičius Alloy of copper and nickel. Cu 75 %, Ni 25 % The edge of the coin rimmed at intervals Diameter 22.30 mm. Weight 6.25 g Mintage 1,000,000 pcs.

2011 m. 1 litas coin dedicated to Basketball Designed by Liudas Parulskis and Giedrius Paulauskis Alloy of copper and nickel. Cu 75%, Ni 25% The edge of the coin rimmed at intervals Diameter 22.30 mm. Weight 6.25 g Mintage 1,000,000 pcs.

For more information on the currency of the Republic of Lithuania and its security features, see the website of the Bank of Lithuania (http://www.lb.lt/lt/banknotai/index/htm).

108 ANNEXES

Glossary

This glossary contains selected terms that are used in the Annual Report.

Balance of payments: a statistical statement that summarises, for a specific time period, the economic transactions of an economy with the rest of the world. The transactions considered are those involving goods, services and income; those involving financial claims on, and liabilities to, the rest of the world; and those (such as debt forgiveness) that are classified as transfers. Central government: the government as defined in the European System of Accounts 1995, but excluding regional and local governments. Central securities depository (CSD): an entity that: enables securities transactions to be pro- cessed and settled by the book entry; plays an active role in ensuring the integrity of securities issue. Securities can be held in physical (but immobilised) or dematerialised form (i.e. so that they exist only as electronic records). Collateral: assets pledged or otherwise transferred (e.g. by credit institutions to central banks) as a guarantee for the repayment of loans, as well as assets sold (e.g. by credit institutions to central banks) under repurchase agreements. Commissions and other charges: the total amount of commissions and other charges paid and received when providing payment services and closely related ancillary services. Credit institution: an undertaking whose business is to receive deposits or other repayable funds from the public and to grant credit for its own account or an enterprise or any other legal entity, with the exception of those indicate above, which issues means of payment in the form of electronic money. Credit risk: a probability that a counterparty will not settle the full value of an obligation when due or at any time thereafter. Credit risk consists of cost compensation risk, main risk, as well as the risk that the bank will not be able to settle. Debt security: a promise on the part of the issuer (i.e. the borrower) to make one or more payment(s) to the holder (the lender) on specified future dates. Such securities usually carry a specific rate of interest (the coupon) and/or are sold at a discount to the amount that will be repaid at maturity. Debt securities issued with an original maturity of more than one year are classified as long-term. Direct investment: cross-border investment for the purpose of obtaining a lasting interest in an enterprise resident in another economy (assumed, in practice, for ownership of at least 10% of the ordinary shares or voting power). Included are equity capital, reinvested earnings and other capital associated with inter-company operations. Economic and Financial Affairs Council (ECOFIN Council): the EU Council meeting in the composition of the ministers of economy and finance. Economic and Financial Committee (EFC): a consultative Community body which contributes to the preparation of the work of the European Commission and the ECOFIN Council. Its tasks include reviewing the economic and financial situation of the EU Member States and of the Community, as well as budgetary surveillance. EURIBOR: euro interbank lending rate at which a prime bank is willing to lend funds in euro to another prime bank, as reported by a panel of contributing banks. Euro area: the area encompassing those EU Member States, in which the euro has been adopted as the single currency in accordance with the Treaty and in which a single monetary policy is conducted. The euro area currently comprises Ireland, Austria, Belgium, Estonia, Greece, Spain, Italy, Cyprus, Luxembourg, Malta, the Netherlands, Portugal, France, Slovakia, Slovenia, Finland and Germany. European Central Bank (ECB): the ECB lies at the centre of the Eurosystem and the European System of Central Banks. It has its own legal personality. The ECB ensures that the tasks conferred upon the Eurosystem and the ESCB are implemented either through its own activities or through those of the NCBs, pursuant to the Statute of the ESCB. The ECB is governed by the Governing Council, the Executive Board, and, as a third decision-making body, by the General Council. 109  Annual Report of the Bank of Lithuania

European System of Central Banks (ESCB): European System of Central Banks, which is compo- sed of the ECB and the NCBs of all 27 EU Member States, i.e. it includes, in addition to the members 2011 of the Eurosystem, the NCBs of those Member States that have not yet adopted the euro. The ESCB is governed by the ECB’s Governing Council, the Executive Board and the General Council. Eurosystem: it comprises the ECB and the NCBs of the Member States that have adopted the euro. Excessive deficit procedure: the provision set out in Article 126 of the Treaty and specified in Protocol No 12 on the excessive deficit procedure requires EU Member States to maintain budgetary discipline, defines the criteria for a budgetary position to be considered an excessive deficit and regulates steps to be taken following the observation that the requirements for the budgetary balance or government debt have not been fulfilled. Article 126 is supplemented by Council Regulation (EC) No 1467/97 of 7 July 1997 on speeding up and clarifying the implementation of the excessive deficit procedure (as amended by Council Regulation (EC) No 1056/2005 of 27 June 2005), which is one element of the Stability and Growth Pact. Exchange Rate Mechanism II (ERM II): the exchange rate mechanism which provides the frame work for exchange rate policy cooperation between the euro area countries and the non-euro area EU Member States. ERM II is a multilateral arrangement with fixed, but adjustable, central rates and a standard fluctuation band of ±15%. Decisions concerning central rates and, possib ly, narrower fluctuation bands are taken by mutual agreement between the EU Member State concerned, the euro area countries, the ECB and the other EU Member States participating in the mechanism. All ERM II participants, including the ECB, have a right to initiate a confidential procedure for changing central rates. Financial stability: a condition in which the financial system, comprising financial intermediaries, markets and market infrastructures, is capable of withstanding shocks and the consequences of financial imbalances and in which the likelihood of disruptions in the financial intermediation process, which are severe enough to significantly impair the allocation of savings to profitable investment opportunities, is low. Foreign exchange swap: simultaneous spot and forward transactions exchanging one currency against another. General Council: one of the decision-making bodies of the ECB. It comprises the President and the Vice-President of the ECB and the governors of all of the NCBs of the European System of Central Banks. General government: a sector defined in the European System of Accounts 1995 as comprising resident entities that are engaged primarily in the production of non-market goods and services intended for individual and collective consumption and/or in the redistribution of national income and wealth. Included are central, regional and local government authorities, as well as social security funds. Excluded are government-owned entities that conduct commercial operations, such as public enterprises. Governing Council: is the supreme decision-making body of the ECB. It comprises all the members of the Executive Board of the ECB and the governors of the NCBs of the Member States whose currency is the euro. Harmonised Index of Consumer Prices (HICP): a measure of the development of consumer prices that is compiled by Eurostat and harmonised for all EU Member States. Interest expenses: interest paid by a credit institution on borrowed and other funds. Interest income: interest received by a credit institution for the invested funds of service users and other service providers, as well as other available funds. Investment portfolio: net transactions and/or positions of securities issued by residents (“assets”) and non-resident net transactions and/or positions of securities issued by residents (“liabilities”). It comprises equity securities, debt securities (bonds and notes, money market instruments), with the exception of amounts included in direct investment or reserve assets. ISIN: an International Securities Identification Number or code assigned to securities issued in financial markets. It is assigned by a competent issuing authority. Key ECB interest rates: the interest rates, set by the Governing Council, which reflect the monetary policy stance of the ECB. They are the rates on the main refinancing operations, the marginal 110 lending facility and the deposit facility. ANNEXES

Liquidity risk: a probability of disruptions in a credit institution’s settlements due to imbalances of cash flows. Market risk: the probability that a credit institution may suffer losses due to a price change of market variables, such as interest rates, foreign exchange rates, equity securities or commodities. Monetary financial institutions (MFIs): financial institutions which together form the money- issuing sector of the euro area. These include the Eurosystem, resident credit institutions (as defined in Community law) and all other resident financial institutions whose business is to receive deposits and/or close substitutes for deposits from entities other than MFIs and, for their own account (at least in economic terms), to grant credit and/or invest in securities. The latter group consists of money market funds. Monetary policy income: income earned by NCBs from performing the Eurosystem’s monetary policy. They are earned from the assets indicated in the Governing Council’s guidelines that comprise banknotes in circulation and deposit obligations to credit institutions. Operational risk: the risk of losses resulting from people, systems, inadequate or failed internal processes or from external events, including legal risk. Payment institution: a legal entity that holds a license of a payment institution or a license of limited operations of a payment institution. Price stability: the primary objective of the Eurosystem. The Governing Council of the ECB defines price stability as a year-on-year increase in the Harmonised Index of Consumer Prices for the euro area of below 2%. The Governing Council also aims at inflation rates of below, but close to, 2% over the medium term, when seeking price stability. Refinancing operation: a regular open market operation executed by the Eurosystem in the form of reverse transactions. Such operations are carried out through a weekly standard tender and normally have a maturity of one week. Repurchase agreement and reverse repurchase agreement: a contract to sell and subsequ- ently repurchase securities, commodities or a guaranteed title to securities or commodities when such a guarantee is issued by a licensed stock exchange holding the title to the said securities and commodities, whereby the institution cannot assign or pledge certain securities or commodities to more than one counterparty at a time and makes a commitment to repurchase them (or the same type securities or substitutes of commodities) at a specified price and on a specified date, that had been indicated or will be indicated by the seller. In the case of the securities or commodities seller, it is a repurchase agreement, while for the buyer it is a reverse repurchase agreement. Risk: the risk of losses (in both on and off-balance-sheet positions) arising from movements in market prices. Securities settlement system (SSS): a transfer system for settling securities transactions. It comprises all of the institutional arrangements required for the clearing and settlement of securities trades and the provision of custody services for securities. SEPA: the single euro payments area; the aim of this project is the standardisation of payment instruments in Europe. Shares: equity securities representing ownership of a stake in a corporation. They comprise shares traded on stock exchanges (quoted shares), unquoted shares and other shares. Shares usually produce income in the form of dividends. Systemic risk: the risk that the inability of one participant to meet its obligations in a system will cause other participants to be unable to meet their obligations when they become due. Such a failure to meet liabilities may cause significant liquidity or credit problems that could threaten the stability of the financial system. Such inability may be caused by operational or financial problems. TARGET2: the new generation Trans-European Automated Real-Time Gross Settlement Express Transfer system. It functions on the basis of a single shared platform and provides harmonised services with a uniform pricing scheme. VILIBOR (Vilnius Interbank Offered Rate): an average interbank interest rate for which banks are willing (ready) to lend funds in litas to other banks.

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Annual Report of the Bank of Lithuania 2011 Order No. 16475 Published by the Bank of Lithuania Printed by UAB “Baltijos kopija” Kareiviø g. 13B, LT-09109 Vilnius, Lithuania