IMF Flags Systemic Risks in Andorra's Robust Banking Sector

Andorra's banking sector remains robust but faces significant systemic risks amid a more demanding international environment, according to a recent International Monetary Fund (IMF) report on the country's financial system.

The sector's scale—consolidated assets equivalent to 5.5 times gross domestic product—makes it a cornerstone of the national economy, yet also a potential vulnerability without careful management. Lacking a central bank, Andorran banks maintain high capital and liquidity reserves as a self-insurance mechanism. This approach restricts direct access to liquidity facilities like those of the European Central Bank, which prove vital during market stress in other nations.

Key risks include credit concentration in specific sectors, ties to local businesses, and exposure to international markets, exacerbated by the small domestic market and focus on private banking. The report downplays credit risks, given that many loans are secured, but highlights reputational, operational, and regulatory compliance threats. The 2015 BPA crisis serves as a stark reminder of the need for rigorous, ongoing supervision.

The IMF urges proactive oversight and alignment with European standards, particularly under Andorra's association agreement with the European Union. This pact includes a 15-year transition period to harmonise banking, insurance, asset management, and securities markets regulations. It enables Andorran banks to access the single market via a "European passport" regime, cutting compliance costs and broadening client bases, while exposing the local market to greater competition from EU firms.

Both banks and the Andorrana Financial Authority (AFA) must adapt swiftly to ensure a smooth shift. Liechtenstein offers a positive example: after a similar deal, it expanded its financial sector and integrated successfully into Europe.

Despite challenges, the IMF notes strengths. Three Andorran-owned banking groups dominate, blending private and commercial banking. Assets under management—mostly off-balance sheet—reached €95 billion in 2024, or 20 times GDP, mainly from clients in Andorra, Spain, Europe, and the Americas.

Domestically, lending remains brisk, targeting businesses and households, with 41% of credits to non-residents, often other banks for liquidity management. Geographic diversification has driven top profitability among comparable European microstates: return on assets hit 0.6% and return on equity 6% in 2022. Banks fund nearly exclusively through deposits—90% of total funding—with a third from international clients. High capitalisation and a 200% liquidity ratio far exceed requirements, bolstering resilience. Elevated expense ratios of 70-85%, typical for private banking, are offset by rising interest margins from higher rates.