Šimonyte: Lithuanian central bank eyes euro ambition

By:
Lucy Fitzgeorge-Parker
Published on:

Bank of Lithuania deputy chief Ingrida Šimonyte discusses the country’s euro-adoption plans, the challenges for the foreign-owned banking system, and the asset quality review in a wide-ranging interview.

Do you expect Lithuania to receive approval for euro adoption in 2015? What do you expect to be the impact of euro adoption on Lithuania’s banking sector, in financial and regulatory terms?

We are looking for approval for euro adoption in 2015 and are taking all necessary steps to become a member of the euro-area and, consequently, to join the banking union.

First of all, we expect that joining the euro-area and the SSM [single supervisory mechanism] will help to increase public confidence and strengthen resilience of the banking sector to external shocks. In addition to that, Lithuanian banks shall get access to ECB lending facilities, which would stand as an additional guard against possible liquidity risk.

Bank of Lithuania deputy chief Ingrida Šimonytė
As for the possible negative impact on the Lithuanian banking sector, it is likely that costs for the banking sector will increase (costs related to the introduction of the euro and costs related to the access to the SSM: asset quality review (AQR) exercise with participation of external experts from international audit companies, supervisory fee paid to the ECB, adoption of IT systems for the new ECB reporting requirements). Nevertheless, we expect it would be offset by the positive effect.


As for regulatory environment, we should take into account risks related to the one-size-fits-all approach to financial supervision. It is important that local authorities that are in a better position to spot the local sources of unstable lending booms would retain sufficient policy space to take preventive actions. Hopefully, we will reach a common view on the sharing of supervisory duties with our counterparties from the ECB, which will be responsible for the direct supervision of a major part of our banking sector.

Lithuania’s banking sector is majority-owned by banks outside the eurozone. What are the implications of this for the sector if Lithuania does adopt the euro? And what challenges would this present in the event of further steps towards banking union within the eurozone?

We belong to the Nordic-Baltic region which is likely to remain very heterogeneous in the nearest future. Some of the Nordic-Baltic countries are members of the euro-area and the banking union, and some will remain outside both structures. In this regard, it is particularly important to ensure equal treatment among all member states.

In our view, the recently adopted SSM strikes a good balance between different views, and responds to our earlier concerns about the equal treatment of euro ins and outs to the extent possible under the EU Treaty. However, we still need to reach an agreement on EU-level backstop arrangements that would not discriminate non-euro member states of the SSM and SRM [single resolution mechanism]. We also see a challenge related to the final agreement on how costs of resolving cross-border financial institutions will be shared among different member states.

Does Bank of Lithuania support further steps towards banking union within the eurozone? Does the bank support other forms of coordination and integration between national regulators?

That’s true – the Bank of Lithuania sees the membership at the banking union as part of euro introduction project. In case, as anticipated in the most probable scenario, our country will become a member of the euro-area, we will join the SSM, the first pillar of banking union. We are of the opinion that joining SSM would help to strengthen our national supervisory framework.

Since the EU financial markets are highly integrated, responsibility for supervision cannot remain purely national, but needs to be dealt with at the European level. Inadequate supervision of parts of the European banking sector allowed problems to fester, while uncoordinated national responses intensified fragmentation within the single market in the area of bank lending and funding.

We see many advantages of SSM compared to individual national supervision regimes: high-quality and uniform supervision across the eurozone (single rule book, common supervisory standards); preconditions for more efficient control of risks assumed by national banks and at the same time minimizing risks to the public sector; the problem of fragmentation of national financial market supervision systems is being solved and overall functioning of the financial services market is assured.

The creation of the second pillar, SRM, at the European level is a crucial element in the designing of the banking union. Therefore, we support the intention to have a strong and harmonized resolution mechanism with adequate financing resources. We see SRM as an effective layer to ensure financial stability in case of a failure of domestic Sifi.

We strongly support the notion that the cost of resolving banks, first of all, should be borne by the shareholders and creditors (bail-in tool will be available starting from 2016), whereas taxpayers should be protected and the SRF should be created within a reasonable timeframe. In our view, it is of the utmost importance to make the SRM decision-making process efficient, effective and speedy.

Besides the single supervision and resolution, it is equally important to continue efforts on ensuring the robustness of national deposit insurance schemes in each member state, as proposed by the agreed DGSD [deposit guarantee schemes directive]. In the longer term we should, however, not avoid discussions on the best ways of concluding the banking union with a European deposit guarantee scheme. In our opinion, it should constitute the banking union’s final pillar.

Coming to the second part of your question, it is essential to preserve close cooperation with counterparties outside SSM – first of all cooperation between central banks in the Nordic-Baltic region, which has quite a long history. Our cooperation is based on trust and open communication as well as mutual support and a willingness to take a responsibility.

Annual meetings of governors and various forums of banks’ experts served as a good basis for policy discussions. Moreover, cooperation became even considerably closer since the beginning of the crises, and was strengthened and enhanced in the area of financial stability.

We see supervisory colleges as powerful tools of cooperation in the supervision area. As subsidiaries in Lithuania belong to large financial groups, colleges are the forum for regular cooperation with supervisory authorities. Particularly intensive cooperation is maintained with supervisors of Sweden and the Baltic states. Joint supervisory strategy is prepared, quarterly risk reviews of banking groups are organized, and yearly comprehensive risk assessment is performed. We are of the opinion that this cooperation should be continued after our joining to the SSM as well.

What is the rationale for including the top-three Lithuanian banks in the ECB’s AQR? Does Bank of Lithuania support the inclusion of Lithuanian banks in the AQR? Will Lithuanian banks also be included in the ECB’s stress tests after the AQR?

After Lithuania gets the green light for euro adoption, joining the SSM becomes mandatory, so all the tasks related to joining the SSM (AQR/stress testing) should be completed before that. Nonetheless, Bank of Lithuania doesn’t expect that either AQR or stress testing could reveal any surprises, as all three banks which potentially will fall under supervision of SSM and for which comprehensive risk assessment should be completed are adequately capitalized and their assets conservatively evaluated (all credit losses in their portfolios were disclosed during the crisis period in 2009-2010).

Overall, joining the eurozone and SSM should have a positive impact on Lithuanian banking-sector stability, as well as enhance transparency.

Does deleveraging by parent banks in Lithuania and the wider Baltic region still pose a threat to Lithuania’s economy?

Lack of financing for productive investments is unwelcome for any economy. However, over indebtedness (as could be seen from some euro-area countries) is not acceptable either.

Reasons behind weak credit recovery lay not only in credit supply but in credit demand. After the economic downturn, the private sector in Lithuania became more cautious in making investment decisions. First of all, companies and households try to look after their own eligible financing sources and only then search for external ones (eg the share of funding from the banks in tangible investment structure has increased in 2013).

It should be mentioned that banks’ loan portfolio is showing steady signs of recovery. Credit flow analysis indicates that there was a slight increase of newly issued loans in 2013 as compared to 2012, with interest rates remaining at historic lows. According to the bank lending survey, credit standards in the last quarters eased somewhat. The survey also showed that banks are planning to ease standards further in the near future and expect approximately 3% year-on-year increase in total loan portfolio in 2014. However, risk aversion, judging by historical standards, is still elevated and banks remains careful in making lending decisions.

What has been the longer-term impact on Lithuania’s banking sector of the failures of Snoras Bank and Ukio Bankas? What regulatory reforms have been implemented since the failures and is Bank of Lithuania confident these will be sufficient to prevent future bank failures?

The failures of two non-systemic banks during 2011-2013 did not undermine the stability of the whole sector. Banks’ capital adequacy ratios are high; liquidity buffers are sufficient. Stress-test results as of June 2013 show that banks would withstand a severe economic shock without breaching current capital requirements. Also, the quality of loans is improving: after the surge in 2008-2009 due to the economic crisis, the ratio of non-performing loans to total loan portfolio has been gradually decreasing since end-2010.

The International Monetary Fund also acknowledged in a country review that supervisory interventions have forcefully addressed weaknesses in some domestically owned banks, thereby strengthening financial stability. All three major credit rating agencies – Fitch, Moody’s and Standard & Poor’s – also noted the preservation of financial stability.

One can never be sure that current instruments at hand are going to be sufficient to prevent banks from failure in the future. However, a large number of European initiatives (new capital and liquidity regime, recovery and resolution directive, single supervisory mechanism, etc) and close dialogue with the sector is ensuring that failures in the future should be less devastating.

It’s worth mentioning that supervision function was enhanced in 2012 after merging three separate supervisory institutions into one supervisory institution under Bank of Lithuania, which was empowered by all spectrum of supervisory functions, ie micro-prudential supervision, market conduct and consumer protection. Moreover, Bank of Lithuania recently was empowered with macro-prudential supervision function as well.

Has public confidence been fully restored in Lithuania’s banking sector? What can Bank of Lithuania do to promote public confidence in the banking sector?

Absolutely yes: Lithuanian banking sector is viewed as stable and recent failures of credit institutions didn’t have a major impact on the overall stability of Lithuania’s banking sector. The total amount of private sector deposits within the banking sector reached new record levels, suggesting public confidence in the banking sector. One of the main reasons which helped to retained stability in the banking sector was the prompt and smooth process of deposit insurance compensation.

What is the overall outlook for the Lithuanian banking sector over the next two to three years?

The outlook for the Lithuanian banking sector is favourable [but] with limited growth opportunities that are going to be in line with economic development. It is difficult for banks to find profitable investment opportunities as credit portfolio is not growing; banks are keeping money in liquid but low-profitability assets. On the other hand, currently bank profitability is remaining strong (9% ROE, higher than in some other EU member states) so currently profitability is not at risk.

As the bank lending survey suggests, over this year an increase of loan portfolio should reach 3%. The prospects for credit growth in the nearest future are quite bright. Manufacturing companies have reached the highest point of capacity utilization level, thus at least part of them will need new investments, which in turn could be financed via banks’ loans. Future expectations of non-financial companies and households are becoming better (in 2013 they were above the long-term average).

Read Euromoney magazine’s April edition for an in-depth look at euro convergence and the health of banks in the Baltics.