The International Monetary Fund (IMF) in 2002 released a report on the findings of its Financial System Stability Assessment (FSSA) of Croatia, in which it indicates Croatia either complies or largely complies with the Bank for International Settlements' Basel Core Principles (BCPs). The two attributes the IMF found lacking in Croatia were deemed to be of little importance at the time. In 2004 the IMF released an update of the 2002 FSSA, in which it notes that most of the recommendations made to the Croatian authorities in the 2002 report had been implemented. The Banking Law of 2002 and several by-laws issued by the Croatian National Bank (CNB) incorporate many of the IMF's 2002 recommendations. A European Commission report issued in 2006 notes that the CNB has made arrangements to implement the European Union's new capital requirements (Capital Requirements Directive) by January 2009. Finally, in 2006 the IMF issued a new Article IV Consultation report that judged Croatia's banking supervision, overall, to be robust, but cautioned that there remained some areas of vulnerability.

General Overview

The IMF in 2002 released a report on Croatia's compliance with the Basel Core Principles (BCPs), based on the findings of a Financial System Stability Assessment (FSSA) it conducted. This report indicates that Croatia either complies or largely complies with most Basel BCPs for Effective Banking Supervision. At the time of the report, however, Croatia was found to be noncompliant with two BCPs that the IMF considered to be of limited importance.

Subsequently, in 2004, the IMF conducted an update of its FSSA for Croatia, which indicated that with the passage of a new Banking Law in 2002 as well as several additional new by-laws, Croatia had implemented most of the recommendations made by the IMF in its 2002 report. The 2004 IMF report noted that the most important of these changes dealt with "the legal immunity of supervisors, coverage of market risks in capital adequacy calculation, inclusion of options in net open foreign exchange positions, consolidated supervision of banks, and cooperation with foreign supervisory agencies" (p. 4). The report also lauded the adoption of on-site supervision that employs a more risk-based approach.

The main laws governing banking supervision in Croatia are the Banking Law of 2002 and the Law on the Croatian National Bank of 2001. The agency responsible for the supervision of banks in Croatia is the Croatian National Bank (CNB) which, according to the IMF 2002 FSSA, has "sufficient authority and independence to ensure a stable, sound, and safe banking system" (p. 27).

The latest available annual report filed by the CNB was published in 2006 and covers fiscal year 2005. The report indicates that in 2005 there were 34 banks, a decline from past years owing to the consolidation of the banking system. According to the European Commission's (EC) 2006 publication "Croatia 2006 Progress Report," 95% of the banks in Croatia are privately owned and foreign ownership in banks is about 91.3%. As for developments in the banking sector, the EC report notes that the CNB has made arrangements to implement the European Union's new capital requirements (Capital Requirements Directive) by January 2009 and has made amendments to the Banking Act so as to make financial reporting consistent with International Accounting Standards and International Financial Reporting Standards requirements.

The IMF's 2006 Article IV Consultation report on Croatia states that "although the financial sector is healthy and much progress has been made in improving its supervision, vulnerabilities remain" (2007, p. 20). The report further notes that the banking sector is well capitalized, with declining nonperforming loan ratios, nonetheless it recommends that the Croatian authorities request a second FSAP update from the IMF (IMF 2007).

The Principles

1. (1) Clear responsibilities and objectives for each supervisory agency.

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The 2002 IMF report notes that the objectives of the CNB are defined in the Law on the CNB and the Banking Law, albeit indirectly and not too clearly. The IMF's 2007 report reiterates this shortcoming, and states that the main objectives of banking supervision by the CNB are yet be stated clearly. Nonetheless there insufficient information publicly available addressing the compliance level of this Principle.

1.(2) Operational independence and adequate resources.

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According to the 2002 IMF report, the CNB "is granted sufficient authority and independence to ensure a stable, sound and safe banking system" (p. 27). However, there is insufficient information as to Croatia's compliance with this Principle.

1.(3) A suitable legal framework for authorization and ongoing supervision.

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The CNB is authorized by the Banking Law to perform its duties in terms of banking supervision, according to the 2002 IMF FSSA. As such, it is permitted to issue regulations to ensure a safe and sound banking system. However, there is insufficient information as to Croatia's compliance with this Principle.

1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

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The CNB is authorized by the Banking Law to perform its duties in terms of banking supervision, according to the 2002 IMF FSSA. As such, it is permitted to issue regulations to ensure a safe and sound banking system. The report goes on to add that the CNB is empowered to take remedial action for banks that do not comply with the law. However, there is insufficient information as to Croatia's compliance with this Principle.

1.(5) Legal protection for supervisors.

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At the time of the FSSA in 2002, the IMF noted that there weren't sufficient provisions for legal immunity for supervisory staff. However, the 2004 IMF update of the FSSA asserted that this issue was addressed by Croatian authorities. Nonetheless, there is insufficient information as to Croatia's compliance with this Principle.

1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

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In its 2002 FSSA, the IMF noted that there were no formal agreements in place with other supervisory agencies; but the 2004 update countered that, with the passage of the 2002 Banking Law, a legal environment for agreements with foreign supervisors had been established. However, there is insufficient information as to Croatia's compliance with this Principle.

2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

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The Banking Law restricts the use of the term "bank" to designate only those defined under the law and which have been granted operating licenses, according to the IMF's 2002 FSSA. Only the CNB can grant, or revoke, such licenses. However, there is insufficient information as to Croatia's compliance with this Principle.

3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

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In its 2002 FSSA, the IMF reported that there is a clear criteria for structure and the operating procedures and documents to be submitted are clearly defined. Further, the report notes that a bank's permitted activities are described based on its license.

4. Authority to review and reject transfer of ownership.

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The 2002 IMF report points out that in order to acquire more than 10 percent of share capital of a bank, prior permission of the CNB must be granted. However, there is insufficient information as to Croatia's compliance with this Principle.

5. Authority to review major acquisitions and investments.

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In its 2002 FSSA, the IMF reports that the acquisition of more than 10 percent of share capital of a bank requires the permission of the CNB. A quarterly shareholders report is sent to the CNB. The 2002 IMF report adds that "the investment in land, buildings, equipment, business premises shall not exceed 30 percent of risk-based capital, and including equity participation in companies, shall not exceed 70 percent" (p. 28). However, there is insufficient information as to Croatia's compliance with this Principle.

6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

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The regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards, according to the IMF's 2002 FSSA. The report also notes that Croatia has established a minimum capital ratio at 10 percent, which exceeds the Basel requirement of 8 percent. The report did recommend that Croatia consider adding other risk criteria, in addition to credit risks, when calculating capital adequacy. In its 2004 FSSA update, the IMF notes that the 2002 Banking Law and subsequent by-laws have implemented this recommendation. However, there is insufficient information as to Croatia's compliance with this Principle.

7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

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The 2002 IMF FSSA indicates that the regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards. The report adds that "guidelines issued regarding credit policies, loss provisioning, assessment of bank exposure and loan classification are strict' (p. 30). However, there is insufficient information as to Croatia's compliance with this Principle.

8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

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The regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards, according to the IMF's 2002 FSSA. The same report indicates that the "CNB has issued minimum standards for the banks concerning the assessment of asset quality and strict instructions about the provisioning broadly consistent with international practice" (p. 29). However, there is insufficient information as to Croatia's compliance with this Principle.

9. Prudential limits and management information system on concentration of exposure.

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The 2002 IMF FSSA indicates that the regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards, and adds that "the limits of large exposures and connected lending are consistent with international benchmarks" (p. 29). However, there is insufficient information as to Croatia's compliance with this Principle.

10. Arm's length rule and monitoring for connected lending.

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The 2002 IMF FSSA indicates that the regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards and adds that "the limits of large exposures and connected lending are consistent with international benchmarks" (p. 29). However, there is insufficient information as to Croatia's compliance with this Principle.

11. Policies and procedures for country risk and transfer risk.

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The 2002 IMF FSSA indicates that the regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards. The report recommended that Croatian banks better incorporate country risk in its risk calculations, assuming that this risk would become more important in the future. However, in its 2004 update, the IMF indicates that country risk in Croatia remains negligible. Nonetheless, there is insufficient information as to Croatia's compliance with this Principle.

12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

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The 2002 IMF FSSA indicates that the regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards and the report states. The 2004 IMF update shows that Croatia covers market risk in its calculation of capital adequacy, as per the requirements of the banking law. However, there is insufficient information as to Croatia's compliance with this Principle.

13. Comprehensive risk management processes.

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The 2002 IMF FSSA indicates that the regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards and the report states. However, there is insufficient information publicly available as to Croatia's compliance with this principle.

14. Adequate internal controls.

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The 2002 IMF FSSA indicates that the regulatory framework in Croatia with regards to prudential regulation largely conforms to international standards and the report states. However, there is insufficient information publicly available as to Croatia's compliance with this principle.

15. Strict "know-your-customer" rules and high ethical and professional standards.

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According to a 2005 report issued by the U.S. Department of State, Croatia's 1997 Law for the Prevention of Money Laundering (with its 2003 revisions) requires all banks and non-bank financial institutions to report suspicious transactions and any transactions above $30,000. The report included a Comparative Table in which it was shown that Croatian banks have the following requirements: (1) to record large transactions in currency or other monetary instruments; (2) to keep records, especially of large or unusual transactions, for a specified period of time; (3) to record and report suspicious or unusual transactions to designated authorities; (4) to identify and verify their customers identity using reliable independent source documents, (5) to identify beneficial ownership and control; (6) to conduct ongoing due diligence and scrutiny. Apart from the above descriptive information, there is little information publicly available as to Croatia's compliance with this principle.

16. Effective supervisory system consisting of on-site and off-site supervision.

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The 2002 IMF FSSA states that "the Banking Law enables the CNB to perform off-site and on-site supervision of banks" (pp. 30-31). The 2004 IMF update to this FSSA notes that, beginning 2004, on-site supervision is more risk-based, with officers with greater specialization in different areas of banking activities. However, there is insufficient information as to Croatia's compliance with this Principle.

17. Regular contact with bank management and understanding of bank's operations.

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The 2002 IMF report notes that there is contact between the CNB and bank management through the extensive on-site inspection program. However, there is insufficient information as to Croatia's compliance with this Principle.

18. Analytical reports and statistical returns on solo and consolidated basis.

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The 2002 IMF report notes that there is contact between the CNB and bank management through the extensive on-site inspection program. However, there is insufficient information as to Croatia's compliance with this Principle.

19. Independent validation of supervisory information through on-site examination or external auditors.

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According to the 2002 IMF report, information provided by banks to the CNB are validated both through on-site examinations as well external auditors. However, there is insufficient information as to Croatia's compliance with this Principle.

20. Ability to supervise on a consolidated basis.

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At the time of the 2002 FSSA, the IMF noted that consolidated supervision has not been implemented in Croatia. However, in the 2004 update to the FSSA, the IMF states that "the new banking law introduced consolidated supervision of banking groups, and a supporting by-law was issued and came into force in mid-2003. There are currently four banking groups in Croatia to which the consolidated supervision applies" (p. 6). However, there is insufficient information as to Croatia's compliance with this Principle.

21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

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According to the 2002 IMF report, banks in Croatia are required to use International Accounting Standards, and financial statements that include the auditors report must be published annually. However, there is insufficient information as to Croatia's compliance with this Principle.

22. Adequate supervisory measures to ensure timely corrective action.

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In its 2002 FSSA, the IMF notes that the CNB has extensive authority to sanction banks that do not comply with regulations and can undertake several measures against non complying banks, e.g., revoking licenses, forbid transactions, etc. However, there is insufficient information as to Croatia's compliance with this Principle.

23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

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There is insufficient information as to Croatia's compliance with this Principle.

24. International exchange of information with other supervisors.

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According to the 2002 IMF report, agreements with foreign supervisory agencies are regulated through the 2002 Banking Law. The CNB website discloses that memoranda of understanding (MoU) have been signed with Austria, France, Slovakia, Germany, the U.S., Belgium, Italy, and the Netherlands. However, there is insufficient information as to Croatia's compliance with this Principle.

25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

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The 2002 IMF report states that domestic and foreign banks are subject to identical licensing rules. Similarly, the branches of foreign banks must comply with the reporting requirements imposed on domestic banks, and must submit to on-site examinations. However, there is insufficient information as to Croatia's compliance with this Principle.