What is the outlook for your economy in 2010?
HG, Simor The Hungarian economy is expected to recover more slowly than its neighbours. The global crisis had similar initial impacts across the region: external demand slumped and capital inflows halted, pushing most of Central and Eastern Europe into recession. However, Hungary has had some specific difficulties including high private and public debt stocks, much of it in foreign currency. Private indebtedness has forced banks to cut back lending more radically than elsewhere. High public debt necessitated fiscal tightening in the midst of the crisis. Monetary policy was unable to loosen its stance quickly due to financial stability constraints. Most of these country-specific factors will weigh on domestic consumption and investment in 2010 although external demand will gradually recover, domestic consumption and investment are likely to remain subdued. We expect robust economic growth to return only in 2011.
CZ, Tuma The economic decline bottomed out the November 2009 Czech National Bank forecast and so now we expect the Czech economy to return to moderate year-on-year growth of 1.4% in 2010, after an expected year-on-year decline of 4.4% in 2009. Inflation should increase during 2010 from near-zero values in the first quarter to values close to the 2% inflation target by the end of the year. The nominal exchange rate of the koruna is expected to be roughly stable in 2010. Consistent with the current forecast is a decline in market interest rates this year  followed by a gradual rise during 2010; on average, three-month Pribor should be around 1.6% in 2010.
ES, Lipstok According to the autumn forecast, Bank of Estonia was expecting the economic cycle to turn towards the end of 2009. In 2010 we will see the economic situation stabilize with growth resuming in 2011, assuming that external demand is revived. The adoption of the euro is also important as it will support economic expansion through various channels, such as reviving investment activity and contributing to the pick-up in 2011 growth. It will have a limited impact in 2010.
LI, Sarkinas Recently there have been signs of the Lithuanian economy stabilizing industrial production and foreign trade indicators have improved. According to the Bank of Lithuanias latest forecasts GDP will fall by 15.2% in 2009 and by 1.5% in 2010. The level of real GDP will become basically stable. Some recovery is expected in the first half of 2010 with an increase in external demand and improving export prospects. However, private consumption will stay weak. The recovery of consumer expenses will be hampered by a weak labour market and a planned cut in government expenditure.
MN, Krgovic There is a high degree of uncertainty at the moment. Despite the current trend towards stabilization and an increase in deposits in the banking system, negative growth will be recorded this year due to a decrease in the transmission of assets from the banking into the real sector, a low level of aggregate demand (domestic and foreign), a high degree of illiquidity in the economy (postponing the solution of structural problems), lower FDI inflow and so on. We expect the negative economic growth rate to be 1.5% of GDP, which is very close to the IMF forecast of -1.7%. Trade, construction and industrial production will stagnate due to a decline in internal and external demand. Finally, a low increase of nominal wages and low aggregate demand point, excluding the influence of external shocks such as an increase in oil and fuels prices, will limit price increases next year meaning inflation should be stable. Public consumption is still too high in relation to the public revenues, thus slowly causing a structural deficit problem. The deficit could reach 3% to 4% of GDP. However, we should note that any type of unpredictable changes, primarily in the most important Montenegrin import or export markets, may substantially change projections in either direction.
SB, Jelasic After a decline in economic activity of 2.8% in 2009, moderate recovery of 1.5% is expected in 2010. As a result of economic recovery, the current account deficit is expected to widen slightly, from 7.2% in 2009 to around 8% in 2010. The fiscal deficit is expected to be slightly lower down from 4.5% GDP in 2009 to 4.0% in 2010 due to restrictive fiscal policy measures undertaken by the government: primarily, freezing nominal pensions and wages in the public sector in 2009 and 2010, and reducing the number of employees in public administration in 2010. In 2010, the National Bank of Serbia (NBS) will continue pursuing an inflation-targeting regime. The inflation target for December 2010 is 6%, while central projection is slightly lower at 5.4%. Temporary undershooting of the target range may take place in the first half of 2010.
B&H, Kozaric The world economic crisis will continue to impact Bosnia and Herzegovina in 2010 although there are indications of a gradual recovery. Although the economic forecasts for 2010 are slightly optimistic, the situation in Bosnia and Herzegovina is still unsatisfactory. The government at all levels should continue to take the lead in dealing with the consequences of the crisis they have to continue to work on development and strengthening local capacities. Priority should be given to a social policy that will protect the most at-risk members of the population. We must continue to reduce public spending and push forward the reforms already started, as required by the International Monetary Fund, which approved the 1.2 billion stand-by arrangement for Bosnia and Herzegovina. In the last couple of years Bosnia and Herzegovina recorded growth of 5.5%. This year negative growth of 3% was recorded. Next year we forecast positive growth, with a real increase of 0.5%. By the end of next year inflation should be close to 1.5%.
LV, Rimsevics Economic activity in Latvia is expected to benefit from a rebound in the global economic environment and improving cost competitiveness domestically. We currently expect an export-based economic recovery in the second half of 2010. At the same time, ongoing wage correction, adjustment in the labour market and commitment to fiscal consolidation will set the scene for subdued domestic demand, which leaves us with a real GDP forecast in 2010 of about a 2% contraction, while the annual average decline in consumer prices will reach 3.8%. Adjustment in domestic demand, with the expected export upturn, is projected to keep the countrys current account in surplus.SV, Sramko In line with the gradual rise in world demand the Slovak economy is expected to recover in 2010 to 3.1% growth, from the fall of 4.8% predicted in 2009. The expected strengthening of foreign demand would lead to an increase of export performance. Domestic demand should also contribute positively to GDP growth. The acceleration of economic growth in 2010 should also be supported by the continuing replenishment, or moderate increase, of stocks.
A gradual revival in economic activity will feed through into the employment figures, but since the labour market tends to react to economic revival with a certain delay, in 2010 we still expect a further decrease in employment of 1.2%. Compensations per employee in 2010 should reflect the base effect of higher severance payments, a drop in productivity and a low-inflation environment in 2009. For that reason compensations are expected to rise in 2010 but at a slower pace (2%) than in the previous year (expected to be 4.8%).
"The government should continue to take the lead in dealing with the consequences of the crisis they have to continue to work on development and strengthening local capacities"
Kemal Kozaric, Bosnia and Herzegovina
What are non-performing loans likely to be in 2010 in your country?
B&H, Kozaric A problem that started this year, and will continue into next year, is a decrease in the ability of clients to get and service credit regularly. Increasingly bad business conditions and the general decline of citizens ability to pay credit because of the crisis have brought about a significant increase of non-performing loans, which caused the decline in asset quality. NPLs reached 2.8% of total assets and this figure is expected to increase to 4% next year.
HG, Simor The ratio of NPLs, defined as loans more than 90 days overdue, to the total credit portfolio of the banking system was 7.2% for household loans and 8.4% for non-financial corporate loans at the end of September 2009. We expect further portfolio deterioration during 2009, mainly due to the effects of the recession, with increasing bankruptcy rates for corporates and sharply rising unemployment for households. At the end of 2009 the ratio of NPLs is expected to be around 9-10% for households and 11-12% for non-financial corporates. Loan-loss rates on non-financial corporates may continue to increase due to slowly improving profitability, while it may decrease slightly for households, thanks to more subdued growth in unemployment, higher real wages, and improving efficiency in banks work-out activities. At the end of 2010 NPLs will probably be around 9-10% for households and 15-16% for non-financial corporations.
SB, Jelasic The Serbian banking sector experienced a rapid growth of NPLs during the first half of 2009 and recorded a major slowdown in the four months to December, bringing NPLs to around 10% of total loans. Considering the current outlook, this trend is likely to remain within acceptable levels during 2010, especially considering the fact that credit growth is likely to recover from stagnation during most of 2009. Additionally, stress tests show that even under a highly pessimistic scenario, which would lead to increase in NPLs by another 14%, there would be no disturbing drop in the cumulative capital adequacy ratio of the banking sector due to high existing capitalization.
LV, Rimsevics Loans unpaid for more than 90 days, used as indicator of NPLs, are expected to increase during 2010, but at a much slower pace than in 2009 in line with smaller deceleration of the economy and slower growth of unemployment. The share of loans overdue for more than 90 days could grow by 4-5% in 2010. By the end of October the share of loans without overdue payments constituted 73.5% of the total banking loans, at the end of September this was 74.8%. In October, the volume of loans that were more than 90 days overdue rose by 3.2%, and their share in the banking loan portfolio amounted to 15% at end-October.
LI, Sarkinas Domestic banks have encountered growing credit risk, meaning that negative economic developments have had a big impact on loan portfolios. These negative impacts have pressed banks not only to evaluate the losses they have incurred but also to be ready for future ones they might incur. However, with growing economic stabilization, efforts by the government to help economic recovery and the business promotion programme, we hope a serious deterioration of the loan portfolio quality and linked losses will be avoided.
MN, Krgovic On the basis of macroeconomic projections made for 2009 and 2010 by the Central Bank of Montenegro, we expect non-performing loans to trend upwards until the 2009 year-end, and then gradually decline in 2010. It is expected that the share of NPLs in total loans will decreased from the projected 11.8% at the end of 2009 to 9.16% by the end of 2010.
ES, Lipstok The NPL ratio, measured as ratio of loans overdue more than 60 days, has increased compared with 2008, reaching 6.4% by the end of September 2009. Even though the growth rate of NPLs has slowed and NPLs even declined in September, the NPL ratio is likely to increase during the following months before starting to improve, mainly reflecting the impact of labour market developments. NPLs are expected to improve more quickly in the corporate sector than in the household sector.
CZ, Tuma The October 2009 aggregate NPL ratio was 5.0% (non-financial corporations 7.3%, households 3.8%). In 2010, we expect the aggregate NPL ratio to increase on average to around 7% (non-financial corporations around 11%, households around 5%).
SV, Sramko During the first three quarters of 2009, the NPL ratio increased from 3.2% to 4.8%, and we expect this trend to continue. The precise figure is largely influenced by developments in the domestic real economy, which depends heavily on external demand. Some positive signs can be seen in the corporate sector, but their sustainability is still questionable. Although the increase in unemployment has concerned mainly the less indebted portion of households, the gradual transfer of negative developments in the corporate sector to households will further impair the retail portfolio.KZ, Marchenko Due to an economic slowdown caused by the crisis, NPL ratios jumped from 8.1% at the beginning of the year to 35.8% by the end of October. We should mention that the NPL definition used by the Kazakh Financial Supervision Agency differs from the one used internationally and is much wider than 90-days overdue loans. Using the international definition, our NPL level is more encouraging at only 19.7%, and is impacted to some extent by Alliance Bank and BTA Bank. The 90-days overdue NPL level in the banking system without those two banks is only 14.2%.
The surge in NPL growth happened due to the materialization of risks that had been accumulated by banks during credit expansion in the pre-crisis years. We think the deterioration of the credit portfolio has been close to its peak this year, after which we will observe a reverse process. We think that next year portfolio quality would improve gradually but its volume will depend on the speed of economic recovery and banks writing-off policies.
How solvent is your banking industry and how well prepared is it for the expected pick-up in NPLs?
MN, Krgovic Regulators worldwide are facing the challenge of creating a banking or financial system that is resistant to shocks, both internal and external. Shocks in the banking system are only absorbed by an adequate level of capital and liquid assets. The Montenegrin banking system has a solvency ratio of 12.85% and so is solvent, but this raises the question of lacking capital in periods of financial market turbulence. The Central Bank of Montenegro has therefore started the process of on-site diagnostic assessments and stress-testing so that the capital needs could be determined.
LI, Sarkinas Well before the start of the financial crisis, the Bank of Lithuania took preventative measures to limit bank risk and strengthen the capital base. Particular attention was given to consolidating and raising bank capital. To this end, for several years the Bank of Lithuania has recommended that banks allocate some profits to reserves and to cover operational risks. With regard to these recommendations, 100% of the profit earned in 2008 remained the equity of bank shareholders and was allocated to strengthening banks capital base. Moreover, all banks annually perform the internal capital assessment process (ICAAP) to evaluate not only key risks (credit, market and operational) but also other material risks affecting bank activities. The banks have set higher internal capital adequacy requirements (9.5-10%) than the minimum prescribed level, and when approaching them they try to find ways to increase their capital base. The Bank of Lithuania, in its turn, performs an annual supervisory review and assessment process of each bank, which check the risk management and capital sufficiency to cover these risks. On November 1 2009 the average capital adequacy ratio in the banking system was approximately 15% even though the minimum requirement is 8%.
CZ, Tuma The Czech Republics banking sector is considered sufficiently solvent and well-prepared to bear the potential credit losses that could stem from the expected increase in NPL ratios. The capital adequacy ratio has long been around 12%, and during 2009 it even increased, reaching 13.7% at the end of Q3 09 with a tier 1 ratio of 12.8%. In contrast to many other European countries, the Czech banking system has stayed profitable over recent years, with a return on equity above 20%. It is able to generate sufficient pre-provision profits as a first-line buffer against potential credit losses. Stress tests run in the Czech National Bank on a quarterly basis confirm the resilience of the Czech banking sector to an increase in NPL ratios that well exceed expectations.
"The high level of external debt accumulated in the past means that the debt service level in Hungary is still high. But we think the risks related to external financing and debt servicing have decreased substantially"
András Simor, Hungary
SB, Jelasic The Serbian banking sector has kept a steady level of capital adequacy at over 20%, even though the minimum regulatory requirement is 12%, for the past five years. Stress tests conducted during the 2009 Financial Sector Assessment Programme (FSAP) mission showed that under an extremely pessimistic scenario the composite capital adequacy ratio of the top 16 banks, representing over 80% of the banking system, would not drop below 16.5%, which allows us to conclude that the Serbian banking sector is very resilient to a possible pick-up in NPLs.
B&H, Kozaric The banking sector in Bosnia and Herzegovina has maintained a high level of liquidity, with banks holding around 700 million above reserve requirements. Also, commercial banks have become more restrictive in their operations, including their assessment of risk. Therefore, banks behave rationally and take care of their exposure to credit risk. They adjust their investments to be in line with their own risk assessments on the one hand, and the quality and availability of projects that require the co-financing by banks, on the other hand.
LV, Rimsevics According to supervision data, the performance indicators of all Latvian banks complied with regulatory requirements the average liquidity ratio at the end of October was sound, namely 57.4%, which is an increase both from September (54.4%) and the regulatory minimum (30%). The capital adequacy ratio at the end of October remained high in the banking sector 13.6% against a regulatory minimum of 8% as banks continued to increase their capital. Since the beginning of 2009, the banks have strengthened their total capital base by some Lats955 million ($2 billion).
ES, Lipstok Estonias banking sector is expected to withstand the increase in the NPLs quite well as banks are well-capitalized and the banking sector is almost fully integrated with Nordic banking groups. Generally speaking, the banking sector can guard itself against more adverse circumstances by accumulating reserves in good times. In Estonia, the creation of capital buffers has largely been supported by previous years high profits and counter-cyclical measures introduced by the authorities. Today all banks fulfil capital requirements with a sufficient buffer.
"Decline in credit risk and imprudent lending should be executed by other, primarily prudential, measures and not by lowering assets available for offering credit"
Ljubisa Krgovic, Montenegro
Are you planning to impose regulatory limits on foreign currency exposure for banks, companies and households?
CZ, Tuma No such plans are being discussed. In the Czech Republic, foreign currency borrowing of Czech households is a negligible 0.1% of total household borrowing, mainly because interest rates in the Czech Republic have mostly been equal to or even lower than euro-area interest rates for the past few years and thus koruna-denominated loans have been cheaper. Foreign currency denominated bank loans to the corporate sector are also relatively low given the high economic openness and export orientation of the country, amounting to about 17% of total bank loans. As regards banks, the net open FX position of the Czech banking sector is also very low, amounting only to around 1% of regulatory capital in absolute terms on average over the past three years. Until June 2007, there was a strict limit of 15% for the absolute net open FX position to capital for each foreign currency and 20% for the total absolute net open FX position. Since the implementation of Basle II in 2007, banks only have to report to the regulator (the Czech National Bank) if they overstep these limits.
ES, Lipstok In Estonia housing loans are predominantly given in euros, reflecting very strong financial integration, stability provided by the fixed exchange rate regime and strong commitment for euro adoption in the near future. The share of other currencies is negligible. The regulatory framework should address all risks that borrowers and lenders are facing the exchange rate risk is only one component of the overall risks, complemented by interest rate, rollover and credit risk. In Estonia there is no evidence of excessive exchange rate risks and hence no need for specific regulatory measures.
HG, Simor The National Bank of Hungary (MNB) aims to reduce risks associated with foreign currency household lending and indebtedness by proposing regulatory changes. The proposed regulation would set up loan-to-value (LTV) and property tax international (PTI) limits for household loan products by prescribing different conditions for forint, euro and other foreign currency-based loans based on their implied exchange rate risk. The proposed regulation would prevent excessive easing of credit conditions and a build-up of household indebtedness in the future, thus would contribute to more sustainable economic growth and lower external vulnerability.
LI, Sarkinas The Bank of Lithuania allows its licensed credit institutions a maximum open position in foreign currencies and precious metals. The maximum overall open position, excluding euros, may not exceed 25% of the banks capital and the ratio of the open position in one currency, excluding euros, or precious metals may not exceed 15% of the banks capital. This requirement must be fulfilled by banks on a daily basis. It should be stressed that although the ratio of the position in euros is not limited, due to a fixed litas to euro exchange rate, the capital requirement for the euro position is calculated in the same manner as for other foreign currencies.
MN, Krgovic Being a euro-ized economy, Montenegro is in a very specific position. The euro is considered as domestic currency in our country, and the exposure of banks to foreign exchange risk is negligible. Therefore we do not foresee imposing such limitations.
SB, Jelasic NBS tries to avoid straightforward administrative bans and limitations wherever possible. So far we have only introduced indirect regulations on FX borrowing, which oblige the banks to provide 125% provisioning for unhedged borrowers.
B&H, Kozaric Nine banks with foreign mother banks have signed the so-called Vienna Initiative and committed themselves to maintaining exposure in terms of capital financing (ie capital adequacy) starting December 31 2008. This is very important for the total safety of the banking-sector operations in Bosnia and Herzegovina and is a positive signal for depositors, savers and the overall business climate.
"NPLs are expected to increase during 2010, but at a much slower pace than in 2009 in line with smaller deceleration of the economy and slower growth of unemployment"
Ilmars Rimsevics, Latvia
What are your foreign debt servicing needs at both sovereign and corporate level for 2010 and how confident are you that those needs will be serviced?
ES, Lipstok Low government debt has been a characteristic of the Estonian economy. Currently the total government debt level, both domestic and foreign, is at around 6% of GDP. Furthermore, the Estonian government has assets exceeding its debt obligations. Therefore there is absolutely no reason to be concerned about the governments ability to service its debt. Foreign debt for the corporate sector is substantially higher, with net external debt at 60% and gross external debt at 117% of GDP as of second quarter 2009. But there is no need to be concerned about its sustainability either. One needs to take into account Estonias uniqueness the majority of external debt comes from liabilities that Estonian enterprises, mostly banks, have against their parent companies. Such forms of financing have proved to be very efficient, even during the global financial crisis.
MN, Krgovic I do not expect any difficulties paying our public private debt because Montenegro is in the group of countries with low debt and therefore it is in more a favourable position than many EU member states. At the end of the third quarter, public debt amounted to around 20% of GDP. Liabilities for repayment of public external debt amounted to about 2.17% of GDP, which is a relatively low share. I am therefore convinced that Montenegro will regularly service its liabilities for external debt, as has been the case so far. There is no available data for corporative (private) external debt, therefore I cannot give a precise answer to this part of the question at the moment.
HG, Simor Maturing external debt in 2010 is approximately 31 billion, of which about 10 billion is bank liabilities vis-à-vis their parents. The forecast gross interest payment is 3.5 billion, hence the total debt service for 2010 is estimated to be 34.5 billion. In recent quarters the Hungarian economy has adjusted: the persistently high level of external financing needs has disappeared and in the third quarter the current account posted a surplus. Due to the adjustment, the external debt level started to decrease and we now expect debt dynamics to follow a sustainable path in the future. However, the high level of external debt accumulated in the past means that the debt service level is still high. But we think that the risks related to external financing and debt servicing have decreased substantially. In recent months we havent faced any stresses from external financing and the exchange rate was relatively stable. Parent banks are all committed to their subsidiaries. In July, the State Debt Management Agency had a successful sovereign bond issuance, which will also have a positive effect on private financing. Buffers for a possible deterioration in external financing circumstances have increased substantially. FX reserves have doubled compared with the pre-crisis period and cover the short-term external debt, and now there is a further 5.2 billion fund available from the IMF/ EU/ World Bank loan package.
SB, Jelasic According to the latest data, planned external debt repayment in 2010 is as follows: 508 million by the public sector, 292 million by banks, 2.5 billion by enterprises. Total external debt repayment thus comes to 3.3 billion. The projections are based on already concluded loan agreements, whereas the Memorandum on Budget also envisages repayments for loans to be disbursed. All external public debt repayments are planned by the Memorandum on Budget for 2010, meaning that funds have been earmarked to that end. Hence, it can be said with a lot of certainty that all public debt obligations will be serviced regularly and on time.
CZ, Tuma Foreign debt servicing needs for 2010 will be roughly $8.5 billion $6.5 billion in principal plus $2 billion in interest paid. The needs of the sovereign sector will be only $1 billion and those of the corporate sector $6.5 billion, while the final $1 billion is for the financial sector. Servicing needs of such a scale can easily be financed by autonomous balance of payments flows. The trade balance, for example, has been improving significantly during the past few years and the Czech National Bank estimates the trade surplus for 2010 to be $9-10 billion. Besides this, the short-term foreign debt is approximately $23 billion, while domestic entities have short-term foreign assets of this magnitude. On top of that, the foreign exchange reserves of the Czech National Bank currently stand at $41 billion.
LI, Sarkinas As the state budget for the next year is not yet approved, the need for borrowing is not set. I think Lithuania will be capable of borrowing the amount it needs.
B&H, Kozaric Total public foreign debt of Bosnia and Herzegovina is around 2.3 billion, while the total foreign debt of the public and private sectors amounts to around 7 billion, which is 40% of GDP. Bosnia and Herzegovina is considered a moderately indebted country with repayment of its public debt not endangered. The servicing of foreign debt is a legal obligation and a priority following the recent budget.SV, Sramko The total external debt in Slovakia at the end of June 2009 increased to 44.9 billion and as a share of GDP it reached 68.7%, which could be assessed as acceptable and safe. Furthermore the main factor regarding the increase of debt is related to the operations of the central bank within the euro system. The structure of short-term external debt relating to corporate debt does not seem to be problematic in Slovakia as the share of short-term financial credits is several times lower than the share of short-term delivery credits for corporations. All in all, no disruptions are expected in corporate debt servicing.
In view of the general progress in servicing debt in Slovakia since 1993, and taking into account the expected volume of the states debt servicing obligations in the forthcoming period, it is realistic to expect Slovakia to service its debt owed to foreign creditors smoothly.
One reform that international regulators are considering is ring-fencing capital and funding for subsidiaries of foreign banks in each country where they operate. What would be the implications of such reform for your banking industry?
CZ, Tuma We support ring-fencing of the capital of subsidiaries only to the extent that any bank should have adequate capital on both a solo and a consolidated basis to support its domestic as well as its cross-border exposures. We strongly disagree with the opinion that only the consolidated capital of a banking group matters and that subsidiaries can be stripped of capital whenever the parent bank deems it useful to implement its business strategy. Such an approach, which is euphemistically called group support, blurs the difference between a branch and a subsidiary. Claims on a branch are directly claims on the bank that established it, whereas claims on a subsidiary are separated from claims on the parent bank because the subsidiary has its own capital and its own shareholders. Blurring this difference creates a huge parent-bank moral hazard as well as huge risk to the stability of the banking sector and the interests of the host countrys taxpayers. From the Czech Republics perspective these risks mustnt be underestimated, because the bulk of the banking sectors assets and capital are owned by subsidiaries and branches of foreign, mostly European, banks. Needless to say, the basic principles of the single European market allow the parent bank to convert its subsidiaries into branches, assume indivisible liability for all cross-border operations and in such a way avoid the above-mentioned moral hazard. Funding has become an important issue during the recent crisis, which has revealed, among other things, a big discrepancy between credit creation and the funding thereof by the deposit base in a number of important institutions. As far as Czech banking is concerned, up to now this sector has had a strong deposit base and a systemic liquidity surplus and has not been dependent on foreign funding. The issue is complex, but we believe that the idea of keeping domestic savings at home in order to finance domestic credit expansion is not the right tool for fixing this problem. Similarly to capital adequacy, we oppose the idea of funding liquidity being transferred freely within banking groups, whether or not it has a negative impact on the stability of subsidiaries.
"Next year portfolio quality would improve gradually but its volume will depend on the speed of economic recovery and banks writing-off policies"
Grigoriy Marchenko, Kazakhstan
HG, Simor Ring-fencing has several advantages and disadvantages. It can limit contagion by keeping funding in the country but it can also limit risk-diversification and growth opportunities. One should also take into account that the banking sectors of several countries in the region relied heavily on foreign funding, given low savings rates. The adjustment has already started, with a slowdown in lending and an increase in household deposits. Regulation should not disturb this adjustment process and should not induce an excessive adjustment in lending.
LI, Sarkinas All banks in Lithuania, whether they are foreign subsidiaries or domestic, have to operate under the same requirements and perform the same prudent supervisions as specified by the Bank of Lithuania. For example, even though many foreign bank subsidiaries have their liquidity management organized on a centralized group level, the subsidiary banks also have to fulfil the daily liquidity requirements set by the Bank of Lithuania. Also, these banks are obliged to have their own liquidity risk management policies envisaging, inter alia, alternative liquidity-maintenance resources alongside funds from their parent banks. With this in mind, I think that ring-fencing capital and funding for foreign banks subsidiaries should not have a very profound impact on the domestic banking system.
MN, Krgovic I believe that such a strategy would be a limiting factor to countries with a dominant and economically strong presence of banks that are foreign bank subsidiaries. Montenegro is a member of such a group, with 83% of total banking assets in banks that are majority foreign-owned. Namely, if the prudential intention should prevail at the global level, establishing limitations in financing subsidiaries by the parent banks, it would primarily protect interests of home supervisors as well as national economies. It is natural that the interests of home and host supervisors are not always compatible because it is in the interest of each to primarily maintain the stability of their bank, or the banking system. In the long run, such measures would negatively impact the levels of liquidity in the Montenegrin banking system. The levels of credit in the real sector and being extended to households would decline and could lead to a slowing down of the economy, and thus have negative implications for the whole system.
SB, Jelasic Taking into consideration the solvency and liquidity level of our banks, Serbia could only benefit from ring-fencing during crisis times. But generally speaking I do not consider ring-fencing a good strategy because it would force local supervisors to be stricter and that would backfire in terms of efficiently using capital and cash. If I turn back to Serbia, the current level of solvency and the liquidity positions of our banks allow them to take up more risk than they currently do. At the same time the loan-to-deposit ratio of the Serbian banking sector is constantly in a range of 0.97-1.0, indicating that traditional bank lending does not closely depend on foreign financing from parent banks. What is important to emphasize is that direct lending via cross-border borrowing is recognized as one of the most important prerequisites for further recovery and development of the real sector economy. Thus, from a systemic point of view these trends will not bring into question the stability of the banking sector, but could have an indirect effect on the economy as a whole in the medium term.B&H, Kozaric As mentioned, nine banks have signed the Vienna Initiative, so these banks have committed themselves to maintaining levels of financing and capital that correspond to the positions held at the end of 2008. By doing so, the mother banks are helping their subsidiaries to continue operating. The crisis made it a realistic danger that there would be a dramatic decrease of capital flows, which would represent an additional attack on the economies of Central and Eastern Europe, which were hit hard by the global crisis.
Therefore, discussions were held on an international level to work out how to help countries that had majority foreign-owned banking systems, which had already had serious problems with their balance-of-payments position. International financial institutions were willing to provide official assistance to the countries with the biggest balance-of-payments problems, but it was certain that such assistance would not be effective without the participation of the private banking institutions, which had to accept their share of responsibility in the new situation and also to protect their long-term interests in those countries. These discussions resulted in the signing of the Vienna Initiative, which included system-important banks, six banks in five countries in Central and Eastern Europe, including Bosnia and Herzegovina. Banks kept, more or less, the agreed level of exposure.
SV, Sramko As the National Bank of Slovakia is a host regulator for the majority of banks and none of our banks has a significant subsidiary or branch in foreign countries, there would be no important impact if such a regulation were adopted by other countries.KZ, Marchenko Large foreign banks are not represented in Kazakhstan as widely as they are in Eastern Europe. In our country, foreign banks part in lending is not so big and refers mostly to crediting large companies, which can use alternative sources of financing in the event of a lack of lending from the subsidiaries of foreign banks
Do you think such reform would sufficiently reduce systemic risk and discourage imprudent lending? Or do you think that it would lead to a withdrawal in liquidity and funding from foreign banks, placing greater emphasis on improving national savings rates?
MN, Krgovic On the one hand, these measures would lead to better credit risk management, because banks would check candidates more thoroughly before granting a loan, which would have a positive effect by decreasing systemic risk. On the other hand, substantial absence of such support might negatively be reflected in liquidity risk, as well as the increase of both lending and deposit interest rates, because the assets received by banks in Montenegro from their parent banks at relatively favourable conditions have a substantial influence on the creation of deposit interest rates. The increase of lending interest rates would have a negative impact on investments, and consequently on employment and production rates. It would simultaneously mean that the host countries would have the higher offer in loan assets that would lead to a decline of both lending and deposit interest rates. On the one hand it would discourage savings in these countries, and on the other hand it would substantially decrease the profitability of banks. Therefore, I believe, costs would be higher than benefits. The decline in credit risk and imprudent lending should be executed by other, primarily prudential, measures and not by lowering assets available for offering credit.
CZ, Tuma No regulatory tool is perfect, but capital adequacy rules uncompromisingly applied to all banks, including subsidiaries of foreign banks, are an indispensable tool for reducing systemic risk at the country level. Since international financial stability must be based on the stability of the financial systems of individual countries, this tool is therefore also of crucial importance for global financial stability. Needless to say, if the goal is to discourage imprudent lending, strict credit classification and provisioning rules are as important as capital adequacy rules. On the other hand, we do not currently see how ring-fencing could significantly contribute to discouraging imprudent lending. It is also necessary to distinguish between the national savings rate and the volume of banking deposits. It is not possible to make a simple conclusion, owing to the complexity of the issue and the necessity of taking into account very important macroeconomic factors.
HG, Simor Measures that induce a higher reliance on domestic savings for bank funding can limit some systemic risks but cannot prevent all of them. It is essential to harmonize macroeconomic and macroprudential policies in order to maintain financial stability. Before the crisis, in the absence of a prudent fiscal policy, such regulations would have induced a higher reliance on non-bank financial intermediaries thus leading to less control over financial intermediation. Today a rash introduction of these reforms could further aggravate the effects of the crisis on the real economy by inducing an excessive adjustment in liquidity and lending.
LI, Sarkinas It is difficult to forecast the reform effect in other countries. This would largely depend on the structure of banks operating on an international scale, risk-management processes in them, and also on relations and cooperation of home and host supervisory services. Because of the above-mentioned reasons, this should not entail a more evident influence on the Lithuanian banking system, the major part of which is composed of subsidiary banks.
"National Bank of Serbia tries to avoid straightforward administrative bans and limitations wherever possible. So far we have only introduced indirect regulations on FX borrowing"
Radovan Jelasic, Serbia
B&H, Kozaric The biggest banks in Bosnia and Herzegovina have committed themselves to keep the level of financing and capital that corresponds to the positions held at the end of 2008. As already said, banks act more rationally now and pay more attention to their credit risk exposure. Also, their investments are now adjusted to their own risk assessments, which consider the quality and availability of projects requiring money. This has resulted in a decrease in the riskiness of investments and a reduction of careless lending. However, this shift has also had some negative consequences, ie decreased lending activities. According to the data available for September 2009, the credit growth rate was negative, amounting to -1.9% at the annual level. The credit growth rate in the same period in 2008 was 27%.
ES, Lipstok Estonia supports financial integration. Possible systemic risks should be addressed by improving cross-border supervision and crisis resolution within the common EU framework. Possible changes have to be consistent with the principles of the EU single market and free movement of services.
SV, Sramko The above-mentioned type of reform would provide a framework to reduce the transfer of risk and to diminish the possible contagion effects, which could result in the mitigation of systemic risk. As every central bank and supervisory authority is responsible for the financial stability of its own country, we believe there should be appropriate tools available for those institutions in order to fulfil this function.KZ, Marchenko For Kazakhstan, the exposure of the subsidiaries of large foreign banks is not chiefly allocated in the most imprudent areas such as mortgage and retail banking. That is why our banking system will not see the consequences of the regulatory measures you are mentioning. But in countries where the banking system is mostly owned by large international banks, for example some countries in Eastern Europe and the Baltic region, the problem of a lack of external financing will affect banking activity significantly. That is why those countries will have to pay more attention to internal sources of financing.
What reforms are you introducing to prevent asset bubbles in the future?LI, Sarkinas The uncertainty created by the lack of information and insufficient quality, over-optimistic future expectations unsubstantiated by fundamental reasons, as well as speculative operational possibilities are the main causes of asset price bubbles. Since implementing the Currency Board Arrangement, the Bank of Lithuania has no effective measures to regulate money supply in the economy. Under a fixed foreign currency regime, money supply in the economy is determined by money demand: in other words, money supply just accommodates to the demand for money. In order to limit possibilities for new asset price bubbles in the future, the Bank of Lithuania has taken measures to improve the quality and quantity of analytical and statistical information made public. This public information increases the transparency of the financial and real estate sectors and reveals more information on the supply and demand equilibrium.
"Well before the start of the financial crisis, the Bank of Lithuania took preventative measures to limit bank risk and strengthen the capital base"
Reinoldijus Sarkinas, Lithuania
The current economic downturn and drop-off in real estate prices with the associated losses incurred by financial institutions were a strong argument for banks to change the lending practice in 2008. Presently the banks use more stringent lending conditions and more cautious risk management to avoid over-intensive growth of asset prices in the future.
We think that additional measures such as limiting bank credit or flows of attracted funds in order to avoid price bubbles would entail exaggerated market regulation and promote occurrence of various arbitration mechanisms, and thus would be ineffective and useless.
ES, Lipstok We have to ensure that the financial sector is well-capitalized and possible risks are appropriately taken into account. An important initiative at the EU level is to strengthen macro-prudential supervision by creating the European Systemic Risk Board, which will analyze possible risks and give relevant policy recommendations.
HG, Simor MNB has been monitoring the price changes of assets regularly. Hungary has not experienced the asset bubbles, such as in housing, which other countries in the region have. Real house prices have not increased since 2004. Nevertheless it is important to prevent potential asset bubbles in the future. Lending based exclusively on the value of the collateral can fuel asset bubbles by allowing a continuous revaluation of the collateral. Higher loans against higher collateral values can further drive up asset prices. The MNB regulatory proposal on responsible lending aims to introduce an obligatory income test thus preventing lending based only on collateral value. PTI and LTV limits in household lending can also prevent excessive household indebtedness.
CZ, Tuma The Czech Republic will in the future adopt EU regulations aimed at reducing the pro-cyclical behaviour of financial institutions. Nevertheless, the Czech National Bank has already instituted a number of important steps to prevent asset booms and busts. Between 2004 and 2006, the Czech National Bank modified its organization in a way that supports the achievement of macroeconomic, microprudential and macroprudential goals. One of the key reforms was the establishment of an integrated supervisor of the whole financial system in the central bank. In reaction to the crisis, the Czech National Bank has further strengthened the interconnections and exchange of information among all departments responsible for individual aspects of financial system stability. Our involvement in the activities of the European Systemic Risk Board may also provide some new stimulus in this respect.
SB, Jelasic NBS supervision has been introducing counter-cyclical measures since 2006 for lowering credit growth trends. Some measures include: limitation of household loans to capital at 150% and 200%, imposing additional provisioning requirements for asset growth over 15% annually, high reserve requirement ratios for liabilities for example, cross-border loans and domestic savings at 40% and 45% and high provisioning rates to limit sources of asset growth. These measures have already shown results, and slowed down expansion and created strong buffers for the crisis period. Simultaneously we are working to improve the banking industrys risk management function, internal controls, internal auditing and transparency, communication with the market and consumer protection. NBS is going to continue to act counter-cyclically, which means that if rapid expansion of banking assets is recognized in the future we will be able to maintain it within acceptable levels.
LV, RimsevicsA number of steps were taken back in 2007, including the introduction of a tax on speculative housing and land sales, a mandatory loan-to-value ratio not greater than 90% and an obligation on banks to require borrowers statement of income, issued by the State Revenue Service. These moves have been recently supplemented by the introduction of a housing tax. All in all these measures could be expected to serve as obstacles to a recurrence of real estate asset bubbles.
MN, Krgovic Since the Central Bank of Montenegro only has access to instruments that can influence the banking system, our actions will primarily be focused on this segment of the financial market. It means that we will request capital increases in banks so there is an adequate level of capital proportional to the risks taken. We will insist on an improvement of risk management and allocation of adequate reservations and will also rigorously supervise asset quality, as well as increase our scope of supervision. If necessary, we will take other measures as well. However, taking into account the current situation, it is unlikely that asset bubbles will appear in 2010.
B&H, KozaricThe Central Bank of Bosnia and Herzegovina operates under the Currency Board Arrangement, therefore reserve requirement is the only mechanism that can be used. No other mechanisms can be used. The Committee for Stability of the Financial Sector has also been established. Its basic task is to follow up on developments in the financial sector based on reports and stress tests, and undertake certain measures as and when needed.KZ, Marchenko According to the concept of financial sector development of the Republic of Kazakhstan in the post-crisis period, developed by the National Bank and other governmental bodies, some measures will be taken in order to prevent price bubbles in the markets of real and financial assets. Specifically, rules prohibiting the direct use of structured products for capitalizing and funding of financial institutions will be launched. In addition, measures aimed at prohibiting the issue and acquisition of financial instruments that are circulating in unorganized markets will be taken. Mechanisms to minimize speculation on derivative instruments will also be developed.
In addition, to minimize pro-cyclicity in regulation, a counter-cyclicity principle in the regulation of financial organizations will be implemented through increasing financial leverage requirements, reserves and liquidity requirements in periods of economic growth and the application of the accumulated potential in periods of recession. This counter-cyclicity approach will be applied to all segments of the financial market.
Also, this work will be supported by the Agency of the Republic of Kazakhstan on Regulation and Supervision for Financial Market and Financial Organizations in order to prevent systemic risks appearing. For these purposes the system of macroprudential regulation of systemic financial risks will be implemented.
To improve banking liquidity and reduce refinancing risk there is a plan to decrease the excess foreign debt level. This means getting the ratio of banks foreign debts to total liabilities, corresponding to the world experience, to a level of no more than 30%. In addition, banks will hold their loan-to-deposit ratio at the level of 1.5 in order to help diversify banking liquidity resources.