Financial Stability Review, June 2018

07/05/2018 / Press release

The favourable macroeconomic environment with high economic growth and a positive outlook for the future contributed to the continuation of the favourable trends in the banking system in 2017 and the early part of 2018. The most significant risks in the banking and financial systems have remained unchanged over the last six months. Income risk at the banks remains at medium level, despite their profitability. In the wake of relatively favourable economic developments, the banks are faced with a highly uneven recovery in lending activity, both in terms of sector (the gap between growth in corporate lending and growth in household lending), and in terms of the type of lending (the gap between growth in consumer loans and growth in housing loans), and also the type of remuneration. Growth in loans to the non-banking sector has begun to be reflected in increased interest income, although the sustainability of further growth in corporate lending is still uncertain. Stable, even growth in loans is the key to greater stability in the banks’ profitability in the future. The favourable growth in household loans is having a positive impact on the average quality of the banks’ credit portfolio, but at the same time could increase credit risk should there be a decline in credit standards, particularly in the area of consumer loans. The banking system’s portfolio continues to feature a relatively large proportion of legacy non-performing claims, which are continuing to burden the average return on bank investments, and demand action from the banks for their resolution. The high growth in prices on the real estate market has the potential to increase cyclical risks, particularly from the perspective of the redirection of built-up savings and investments into this asset segment.

Corporate indebtedness, which increased sharply before the crisis and reduced debt repayment capacity, thereby introducing instability into the banking system, has declined sharply over the last decade, although the deleveraging process is still to a lesser extent underway. At the end of 2017 the total stock of corporate debt was equal to equity, and was thus at an acceptable level. Firms have thus seen improvements in their Figure: Corporate debt indicators creditworthiness and debt repayment capacity, and in their resilience to interest rate rises. Recent years have seen a sharp decline in firms’ excessive debt, which last year reached its pre-crisis level of EUR 6.6 billion. The concentration of excessive debt is still high, as a third of the excessive debt is concentrated among the 50 firms with the largest excessive debt. In recent years firms have improved their financing structure primarily via increases in equity, and less via debt repayments, which is a good basis for further growth. There was a significant improvement in the terms and possibilities of corporate borrowing at banks relative to previous years. After several years of decline, year-on-year growth in corporate bank loans re-entered positive territory in 2017, and reached 3.4% in March 2018. Corporate investment is currently based primarily on financing via internal resources. An answer to the question of how much bank financing will contribute to corporate investment in the near future is still uncertain, although surveys suggest that corporate demand for bank loans is likely to increase in the future. Although corporate indebtedness is at an acceptable level, it is important for the successful balancing of systemic risks that firms continue to show concern for debt sustainability in the future.

The systemic risk to the banking system from the household sector remains low. Household indebtedness expressed as the ratio of debt to GDP was less than half of the euro area average last year. The structure of the household sector’s assets remains conservative, despite the improvement in the situation on the labour market and the low interest rates. Consumer confidence is high, and the rise in disposable income is being reflected in strengthened growth in final consumption expenditure. The banks’ exposure in the consumer loans segment has increased rapidly since the second half of 2016, particularly at the longer maturities of more than 10 years and in unsecured loans approved via simplified procedures and with the incomplete documentation of purpose. The proportion of total exposure accounted for by the stock of consumer loans is relatively small, but a further increase in the figure could increase the systemic risks to the banking system. In the event of a deterioration in the macroeconomic environment and the financial standing of households, higher interest rates might not suffice to cover the losses in connection with non-performing loans. It is important that the banks diligently monitor and manage the risks inherent in an increase in loans of this type. Here it is also necessary to monitor the purpose of consumer loans, i.e. whether a portion of long-term consumer loans might be used to finance real estate purchase. This could increase credit risk in the event of a price reversal on the real estate market, or a deterioration in the financial standing of borrowers.

Growth in residential real estate prices in 2017 reached its highest since the outbreak of the crisis, and was among the highest in the euro area. At the same time further evidence of the high demand on the real estate market comes from the high number of transactions in residential real estate, which has drawn level with the pre-crisis period. Growth in housing loans has nevertheless not tracked the high growth in the number of transactions on the real estate market in recent years. Growth in housing loans to private individuals was stable and moderate in 2017 at 5%, before falling to 4% in the first quarter of 2018. This is an indication that growth in housing loans is currently not encouraging growth in real estate prices, and is not encouraging imbalances on the real estate market. It also means that households are not using bank loans alone to make real estate purchases.

In the wake of an increase in demand and the anticipated further growth in prices, investment in residential real estate is increasing. The current gap between supply and demand on the real estate market entails further upward pressure on prices, which could also result in short-term fluctuations in prices of residential real estate. The indicators of overvaluation and undervaluation of real estate show residential real estate prices to be below their pre-crisis level, although the gap is diminishing. The risk to the banking system could increase in the event of a sharp price reversal on the real estate market, although the banks are less vulnerable than during the last financial crisis.

Compared with the situation before the crisis, the banking system is less sensitive to the risks inherent in cyclical developments and imbalances on the real estate market, on account of the banks’ smaller exposure to the construction sector, and higher household disposable income and, above all, because the credit standards on housing loans are higher than at the outbreak of the last financial crisis and remain stable at the level of the banking system. Other factors in the banks’ low vulnerability to potential risks are the structural attributes of the Slovenian real estate market, such as low household indebtedness, the large proportion of owneroccupied residential real estate, and the smallest proportion of housing owners with a mortgage in the euro area. It is recommended that the banks continue to maintain adequate credit standards with regard to housing loans, despite the increased optimism on the market. A macroprudential recommendation including the recommended maximum level of the LTV (loan-to-value) ratio and the recommended maximum level of the DSTI (debt service-to-income) ratio when a loan is concluded was adopted during the period of stable growth in real estate prices at the end of 2016, for the purpose of limiting the transmission of risks from the real estate market to the banking sector or borrowers. The LTV and DSTI ratios for new loans were stable overall in 2017. However, the stability of the LTV ratio in a situation of rising real estate prices does not necessarily entail no change in risks. Further analysis of the aforementioned risks will form the basis for a decision on any change in the macroeconomic recommendation.

Despite the current very solid growth in bank profitability, the banks’ income risk remains at a medium level in the low interest rate environment. The banking system has been profitable in the last three years, although in 2017 and the first quarter of 2018 growth in profit was based in part on the release of impairments and provisions. The banks’ net interest income is still declining, although the contraction slowed in 2017 and the first quarter of 2018. At the turn of the year the favourable effects of the increase in bank lending were being reflected in growth in interest income from loans. At the same time growth in the banks' net fees and commission, which account for the largest proportion of non-interest income, turned positive again in the final months of 2017 after several years in negative territory. In the future the banks’ income position will increasingly depend on growth in interest income, which the banks can only achieve through increased lending activity, which must be sustainable and prudent. Given a combination of several altered factors, i.e. the gradual evening-out of the favourable impact of the release of impairments, insufficient lending and cost pressures, the banks could be exposed to more unfavourable income developments even over the medium term.

The traces of the banks’ past bad credit decisions still remain. For several years now the banks have been endeavouring to improve the quality of the credit portfolio by reducing the burden of non-performing exposures. The NPE ratio across the banking system’s total exposure had declined to 5.4% by March 2018, as NPEs declined to EUR 2.3 billion. Corporate exposures continue to account for two-thirds of total NPEs, most notably the SMEs portfolio. Claims more than 90 days in arrears account for a smaller proportion of the NPEs to corporates, while a larger proportion consists of forborne exposures or other exposures with smaller likelihood of payment. NPEs to corporates amounted to EUR 1.6 billion in March 2018, of which forborne exposures accounted for EUR 1.0 billion. The coverage of total NPEs by impairments and capital remained high. Regulatory capital in March 2018 was almost four times higher than the stock of NPEs, after allowing for impairments already created. Coverage varied from bank to bank, while there were also differences in the banks’ capacity to further reduce NPEs, particularly with regard to the sale or write-off of non-performing claims, which could have an impact on the level of available capital. Simultaneously with their active approach to the resolution of NPEs, the banks also improved their monitoring of credit risk through the early warning system for increased credit risk.

The banks’ refinancing risk remained moderate, as a result of their favourable liquidity position and the large proportion of secondary liquidity. The large proportion of liquid assets on the balance sheet is reducing the banks’ sensitivity to any adverse effects that might result from the increasing maturity mismatch between assets and liabilities. The growth in sight deposits and long-term loans is increasing the maturity mismatch between funding and investments, and in the wake of extraordinary developments and the switching of deposits between banks or outside the banking system could lead to instability in bank funding, which is less likely in the short term. Last year’s increase in deposits by the non-banking sector strongly exceeded the increase in loans to the non-banking sector. This will be joined this year by an even larger amount of funds released from investments in securities, which could encourage the banks in relaxation of credit standards that is undesirable from a systemic perspective.

The banking system’s capital position remained appropriate last year. The banking system’s capital adequacy declined as a result of an increase in capital requirements. In the wake of further credit growth and the accompanying growth in capital requirements, the decline in capital adequacy could continue, unless the banks adjust their capital as appropriate by means of recapitalisations or retained earnings.

Leasing companies and banks that provide finance leasing services continued to increase their equipment leasing business in 2017 and the first quarter of 2018, while real estate leasing business is at a low level. Leasing companies saw an improvement in their portfolio quality and profitability. The systemic risks inherent in leasing companies’ operations are declining.

An increase in gross written premium and a decline in insurance technical provisions brought an improvement in the insurance sector’s performance. The capital adequacy of insurance corporations and reinsurance corporations increased. The low interest rate environment meant that market risk and refinancing risk account for a significant proportion of the systemic risk in the insurance sector.

A high concentration of volume in a few domestic securities, the low volume of trading on the Ljubljana Stock Exchange and the ongoing fall in the number of share issuers are continuing to reduce the primary role of the domestic capital market. The role of the domestic capital market should in part be based on providing additional financing to economic operators and on ensuring growth in capital at firms. This would provide a more sustainable basis for lending growth in the future.

In general it can be assessed that the risk level in the banking sector is relatively low, and comparable to the risk level at the time of the release of the previous Financial Stability Review, although there is the possibility of an increase in certain segments. At the same time it is found that the banking system is currently more resilient to the consequences of any realisation of systemic risks than during the last financial crisis.

Financial Stability Review, June 2018