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Metu Ataskaita 2004-EN.P65 ANNUAL REPORT OF THE BANK OF LITHUANIA 2004 VILNIUS 2005 ISSN 1392-4702 ISSN 1648-9039 (ONLINE) The Annual Report was prepared on the basis of the information systems of the Bank of Lithuania, Ministry of Finance of the Republic of Lithuania, Department of Statistics to the Government of the Republic of Lithuania, the company Central Securities Depository of Lithuania, the company Vilnius Securities Exchange, the company Maþeikiø Nafta, Eurostat, Bloomberg and other data. The amounts and percentages in some tables and figures do not correspond to total data due to rounding (total and 100%). © Lietuvos bankas, 2005 The year 2004 was marked by important events: Lithuania became a member of NATO and the European Union. On Lithuania’s accession to the European Union, the Bank of Lithuania became a member of the European System of Central Banks. When implementing its primary objective of maintaining price stability, the Bank of Lithuania continued to apply the strategy of a fixed exchange rate of the litas against the euro. The fixed exchange rate regime has served as a major factor of macro- economic stability of the country since 1994, whereas the stability of the national currency against the euro has been a very important factor for the economic development of Lithuania. According to provisional data, in 2004 the real gross domestic product grew by 6.7 per cent and the gross domestic product per capita increased by 7.3 per cent. In 2004, the average annual inflation was 1.2 per cent. When acceding to the European Union, Lithuania was committed to adopting the euro. Therefore, the year 2004 witnessed active preparation for the participation in Exchange Rate Mechanism II. After competent European Union institutions adopted relevant decisions, on 28 June 2004 Lithuania became a member of Exchange Rate Mechanism II. Lithuania assumed a unilateral obligation to maintain the current fixed exchange rate regime and the current exchange rate of the litas against the euro during its participation in Exchange Rate Mechanism II. The convergence reports of the European Central Bank and the European Commission published in 2004 acknowledged that Lithuania was in compliance with the criteria on price stability, general government budgetary position and long-term interest rates. In order to be fully prepared for the adoption of the euro and to guarantee smooth implementation of this process, at the end of 2004 the Bank of Lithuania prepared a comprehensive action plan for the adoption of the euro. The plan outlines the necessary measures for the alignment of the legal framework, preparation for the changeover, conduct of monetary policy in the new environment, the public information campaign, institutional preparation by the Bank of Lithuania, and other organisational measures. The entry to Exchange Rate Mechanism II has not changed the national monetary policy, but it strengthened the expectations about the adoption of the euro immediately after the minimal two-year participation in Exchange Rate Mechanism II. This boosted confidence in the national economy and financial stability, and encouraged investment in Lithuania. The Bank of Lithuania’s monetary policy instruments are used to ensure the liquidity in the banking system under the conditions of the fixed exchange rate of litas and self-regulation of money supply. These instruments include the exchange of the anchor currency into the litas and vice versa, reserve requirements and lending facilities of the Bank of Lithuania. On 24 March 2004, the revised Rules for Concluding and Executing Litas and Anchor Currency Euro Exchange Transactions between the Bank of Lithuania and Banks came into effect. The Bank of Lithuania concludes unlimited litas and euro exchange transactions with the banks that are authorised to carry out foreign exchange transactions and are subject to reserve requirements. The new rules reinforced the bank liquidity management potential and approximated the safety assurance standards for the operations of the Bank of Lithuania to the practices of the European Union central banks within Exchange Rate Mechanism II. The Bank of Lithuania applies reserve requirements to domestic commercial banks and foreign bank branches to ensure liquidity in the banking system. In view of Lithuania’s aspirations to become a member of the euro area in the near future, the macroeconomic situation and the stability of the banking system, the Bank of Lithuania has been gradually bringing the system of reserve requirements in compliance with the system applied by the European Central Bank. The reserve requirement ratio was reduced from 10 to 6 per cent. In 2004, the Bank of Lithuania continued work in implementing the credit institution supervisory system complying with the international practice, encouraged banks to improve their internal control systems, adequately assess, control and manage traditional risks, identify emerging problems in time and provide for measures to maintain the stability of banking activities under unfavourable circumstances in the market. While conducting off-site monitoring and on-site inspections of credit institutions, the Bank of Lithuania monitored their adherence to the established prudential and other requirements of sound banking. As a result of Lithuania’s accession to the European Union and new provisions of the Republic of Lithuania Law on Banks and the Law on the Bank of Lithuania, a number of amendments to legal acts regulating banking operations were introduced. Several rules regulating the licensing procedure were amended and changes in the calculation of the capital adequacy ratio were approved. In order to establish equal competitive conditions for the Lithuanian banks in the European Union environment, the capital adequacy ratio was reduced from 10 to 8 per cent and the requirement on the maximum open position in foreign currency and precious metals was changed by removing the limit on the euro position. The legislation regulating accounting and reporting was adjusted. The revised Rules on Consolidation of Financial Group Accounts and Joint (Consolidated) Supervision, and the Rules for Outsourcing Bank Ancillary Services were adopted. A new procedure for calculating the liquidity ratio was introduced, whereby the banks are encouraged to entrust their funds to the financial and credit institutions in more reliable and stable countries. A new revision of the General Provisions Pertaining to the Organisation of the Internal Audit of the Bank was approved. The provisions expand the functions of internal audit committees, define the composition, subordination and accountability of the audit committee, and assign a more important role to the supervisory council of a bank. One of the most important tasks of the Bank of Lithuania in the area of supervision of credit institutions in 2004 was the preparation for the implementation of the New Capital Accord and the new European Union Capital Directive. To this end, the Bank of Lithuania organised a number of meetings with bank representatives. At the end of 2004, the Bank of Lithuania started developing the procedure for the calculation of capital adequacy under the requirements of the new European Union Capital Directive with respect to the planned calculations in the transitional period. Taking into consideration the progressive practices of foreign supervisory authorities, the Bank of Lithuania further enhanced its supervisory methods and tools. In 2004, the Bank of Lithuania reviewed its inspection procedures as one of the key tools of ongoing supervision. The previous CAMELS rating-based inspection methodology was replaced by the risk-focused inspection system. In 2004, considerable attention was given to issues of cross-border cooperation: the Bank of Lithuania concluded an agreement with the Swedish financial supervisory authority, participated in a working meeting with representatives of German and Finish financial supervisory authorities and the staff of the National Bank of Ukraine. In 2004, four banks increased their share capital and three banks strengthened their capital base with subordinated loans to ensure the basis for the development of their business. At the end of 2004, the total bank share capital amounted to LTL 1.3 billion and increased by 8.6 per cent, the assets of domestic commercial banks totalled LTL 29.2 billion and rose by 32.3 per cent. Foreign bank branches were also active in expanding their business. Their assets increased from 8.7 per cent to 9.8 per cent of the total banking system assets. Domestic banks started expanding to the neighbouring markets in 2004. The Board of the Bank of Lithuania authorised Ûkio Bank to open its representative office in the Ukraine (Kiev) and, later, in Moscow. An authorization was granted to Vilniaus Bank to acquire a qualifying holding in the Ukrainian Bank AGIO. All domestic banks and foreign bank branches were profitable in 2004 earning a total profit of LTL 299.3 million. Bank profits grew for a third consecutive year, while the profit in 2004 was the largest from the re-establishment of the independence. The number of credit unions continued to increase in 2004. The Board of the Bank of Lithuania issued licences to four newly established credit unions. Over the year, the membership of credit unions grew by more than 12 thousand and their share capital went up by 50.6 per cent. At the end of 2004, the assets of credit unions amounted to LTL 185.2 million with the share of loans granted by credit institutions accounting for 70.5 per cent. The Central Credit Union of Lithuania, whose membership included 53 credit unions, also continued to develop its business. At the end of the year, assets held by the Central Credit Union of Lithuania made up LTL 45.0 million. In 2004, 45 credit unions were profitable. The total profit of credit unions amounted to LTL 907.5 thousand and was the largest from 1995. The profit of the Central Credit Union of Lithuania of LTL 137 thousand was 3.3 times higher than in 2003.
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