Financial Sector Assessment Program (FSAP) calls for further strengthening of the underlining of the supervisory framework, even though unified supervision under a single supervisory agency was considered premature. Capital and money markets are small or nonexistent. At this stage of development it is necessary that the policy of regulatory institutions should focus on enhancing infrastructure and governance. -  Banking system in the region is close 100 percent privately owned, with clear dominance of foreign capital. The banking system in the region amounts from 40 percent of total assets to GDP in Macedonia to 119 percent of total assets to GDP in Croatia and is dominated by private foreign owned/joint ventures banks. The privatization of large state owned banks has been completed in all countries, except Serbia and representing approximately only 38 percent of total capital in the banking system respectively. The system is dominated by a restricted number of big European banks that have set presence across all countries in the region. Lately there is evidence of increasing interest of other banking groups as well. -  Increased financial intermediation of the recent years has lead to a rapid credit expansion. This trend reflects increasingly deep financial integration with EU Member States and supports rising trade, investment flows, and institutional  6  BIS Review 119/2007  strengthening. The expansion of the financial sector and inflows of foreign savings can strongly support real convergence.
Thus, prudential tightening may not be able to be transmitted to a significant part of the banking sector but it may affect only smaller locally-owned banks. It follows from our discussion that the supervisory authorities may gain by the increasing transparency in financial markets which will allow consumers and other bank borrowers to be more aware of the risks inherent in foreign currency borrowing. Efforts to enhance this transparency could be encouraging or requiring banks to discuss exchange rate risks explicitly with borrowers before contracts are signed. On the other hand there is a need to discuss with banks means of assessing the risks arising from foreign currency denominated loans and adjust existing loan classification schemes or provisioning if warranted (FSAP recommendation for Albania). Monetary policy is constrained by the degree to which policy instruments are able to transmit into the economy. A tightening of policy interest rates’ effect may be constrained even in floating rate or adjustable peg regimes. A moderate tightening of policy may not be very effective in slowing the economy because of the high degree of euroization and the uncertainty associated with the final effect of exchange rate changes in balance sheets and the real economy. Many of the above issues require a significant degree of co-ordination between home and host authorities that can help fill supervisory gaps, given the very high levels of foreign bank ownership. In the process of improving the regulatory base, standards set by international institutions and especially the ECB are crucial in orienting regulators. 6.