Introductory address at the Banking Summit by Primož Dolenc, deputy-governor of Banka Slovenije
Ladies and gentlemen, a warm welcome. Thank you so much for the invitation to your famous summit, and the opportunity to present you our views of the banking system, and the measures and challenges we face in light of the current situation.
When I was getting ready for this event, I looked over my speech at the same event two years ago, and, well, let’s say the situation in the economy then was somewhat rosier. Although those of us in finance never like to look back, and our gaze is usually firmly set forward, allow me to highlight just two of my thoughts from that time: “the macroeconomic environment in which the banking system is doing business is stable, and forecasts for the coming years are good” and “firms saw record net profits of EUR 3.7 billion in 2017”.
The situation in the banking system was already slightly less rosy by that time – not because of any threat to profits, but because banks were facing a problem with credit demand. In actual fact, Slovenia’s economic expansion after the global economic and financial crisis could be seen as a creditless recovery, which hit banks hard in their performance. The excellent performance of non-financial corporations, the large liquidity reserves in the real sector, and the process of corporate deleveraging, whether driven by the previous factors or not, led banks to consider whether changes were needed to their business models.
This has since been reflected in a complete change in the structure of banks’ credit assets. Banks have focused on marketing loans to households, particularly in the consumer financing segment. At that time, and later, they were performing very well, if we judge by current profits. But it is of no little significance, and this can also be said for 2019, that the net release of impairments and provisions was a major factor, if not yet the decisive factor, in the good current results.
This time last year there were already signs of the economy cooling, although not yet a contraction in economic activity. The awareness grew over the summer that the economic situation was deteriorating, and that economic growth and inflation would remain low for the rest of the year and beyond. These facts were addressed at September’s monetary policy meeting of the Governing Council of the ECB, when the euro area governors adopted a comprehensive package of six measures to further increase the accommodative stance of monetary policy.
Bank performance nevertheless remained excellent until the end of last year, at least judging by certain key parameters. Banks generated a record pre-tax profit of almost EUR 600 million in 2019. The net release of impairments and provisions was still a major factor in this performance. The investment portfolio expanded last year, most notably in the household segment, and less so in the corporate segment. The stock of NPEs at system level fell to around the billion euro mark, while the largest stock of NPEs was in the non-financial corporations portfolio. The Slovenian banking system remained well-capitalised, although there remained considerable variations from bank to bank.
This was followed by a shock this year. A scenario worse than the adverse scenario in the stress tests was actually realised. The latter have on occasion seemed to be merely a theoretical exercise in testing the robustness of the economy and specifically the banking system, with many experts quietly assuming that the adverse scenario could never be realised. But in fact it was realised in an even more extreme form. Because the shock was exogenous, unknown and unprecedented, we had to respond even more decisively as monetary policymakers and bankers. For the public to understand the magnitude of the potential effects of the crisis, in late March we published analysis of the impact of coronavirus on the Slovenian economy. The analysis outlined three potential scenarios of future developments, based on which their potential impact on the economy was estimated. Under all three scenarios we found that the impact of the current crisis on the Slovenian economy would be huge in the absence of appropriate economic policy measures.
As the custodian of financial stability, we worked with the banks and also separately to deliberate what the consequences of the downturn and the uncertainty might be, how savers would interpret the current crisis, and what needed to be done to avoid inappropriate reactions. Now I can say that the response from banks was very good, as things never came to a head at bank counters, or anywhere else. We might say that all of us in the banking sector withstood a practical examination of our business continuity plans, liquidity stress tests, etc.
In getting ready for today’s event I came to one other conclusion: the previous global economic and financial crisis taught us economic policymakers that hesitating when responding to a crisis or shock does not work out well, and that the price paid by the economy in the end is significantly worse than if action had been taken immediately. This time it seems economic policymakers have learned that lesson.
Now I come to our response to the current situation. It was comprehensive, both in terms of monetary policy, and in supervisory and regulatory terms. By mid-March the ECB had put comprehensive monetary policy measures in place, which were further expanded in subsequent weeks. The package of anti-crisis measures broadly encompasses an expansion of asset purchases (in the APP and PEPP), and the provision of liquidity via refinancing programmes (the TLTRO III, LTRO bridging operations, and the PELTRO). The monetary policy measures focus on i) ensuring that the stance remains accommodative, ii) stabilising the financial conditions for the smooth transmission of monetary policy, and iii) providing sufficient liquidity to support bank lending activities. The accommodative stance of monetary policy and the stabilisation of the financial markets will also directly help the Slovenian economy in our opinion.
The response in the areas of supervision and regulation was also decisive. Without citing all the measures and reliefs relating to capital, liquidity, reporting, risk management, etc., we have kept you all updated on these at meetings or via our letters. All of them focused primarily on easing any difficulties in your operations, while also addressing the problem of capital, liquidity and regulatory restrictions on lending to businesses, as the reliefs and exemptions in meeting capital requirements alone “released” so much capital that neither an extreme rise in the need for liquidity loans to businesses and/or a drastic increase in non-performing loans could threaten the capital adequacy of the banking system as a whole. Of course there are differences between banks, which is why we monitored and continue to monitor the course of events not only at system level, but in great detail at individual banks. We also put in place certain measures of a temporary nature, such as a macroprudential measure to restrict profit distributions, and a temporary extension of the reporting of liquidity ratios, which will be lifted as soon as the conditions allow.
A major contribution to limiting the impact of the crisis, as I said earlier, came from fiscal policy, in coordination with monetary policy. The measures to preserve jobs and income levels will have a decisive impact on credit quality in the household segment. Given its broader nature, which also extends to firms, the loan moratorium measure will have an even greater impact. The government guarantee scheme should also play a significant role in risk management.
Despite fiscal measures and regulatory policies, it is here where it will become clear what the actual credit standards were, and how cautious banks were being during the time of increased approval of household loans, particularly in the higher-risk segment, which was also addressed last year in essence by a macroprudential measure.
Returning to the economic situation as we currently see it, the economy is gradually recovering after the lifting of containment measures, but activity is still well below last year’s level. We recently released our formal projections for the upcoming three-year horizon, as we always do at this time of year. This year’s decline in GDP is forecast at 6.5% under the core scenario, while the forecast ranges from 4% to 10% under the more extreme scenarios. These forecasts are better than our original forecasts from March, as the assessment is that an even deeper recession will be prevented by the comprehensive anti-crisis measures of monetary policy and, even more so, fiscal policy, which we forecast will mitigate the decline in GDP by about a third. There is no expectation of deflation, despite the economic contraction, but inflation will be lower than forecast in the previous projections, with several factors driving prices down. The economic recovery over the next two years will be relatively strong, assuming there is no major second wave of the disease, and a vaccine is developed. Domestic and foreign economic policy measures will also play a part.
But what is the situation in the banking system, and what is the prognosis over the medium term? The banking system’s balance sheet total continued to strengthen over the first four months of this year, while loans recorded favourable year-on-year growth (as expected, it was higher in the corporate lending segment, and lower in the household segment). The banks were continuing to see a reduction in non-performing exposures even after the reversal in economic growth, albeit slightly more slowly than in 2019. However, the banks have of course seen their conditions for operating profitably worsen this year. Even before the pandemic was declared, as seen earlier, the situation was expected to be less conducive to generating a profit, given the inferior economic outlook and the low interest rate environment. Bank profitability had already declined: their pre-tax profit over the first third of the year was down more than a half on the same period last year. The economic downturn means that, in contrast to previous years, the banks are again creating net impairments and provisions, although they still account for a small proportion of the disposal of gross income across the system. The banking system generated a pre-tax profit of almost EUR 100 million over the first four months of the year. It is highly encouraging that deposits by the non-banking sector have been retained and have even increased, although they remain primarily in the form of sight deposits.
Let’s look a little into the future, over the next one or two years. Our analysis published in May suggests that under the milder scenario the banking system would most likely be close to breaking even this year. Under the more severe scenario, which is less likely according to May’s projections, but assumes an extremely large contraction in the economy, the banking system would end 2020 with a large loss. The estimated parameters of bank performance would also deteriorate accordingly. Over the longer horizon, we estimate that the majority of risks in the Slovenian financial system would be significantly higher than at the end of 2019, while resilience to risks would be lower.
To finish, might I touch on a few subjects at the heart of our work and activity over the coming months? The situation in the economy is highly uncertain, as the epidemiological picture changes from day to day, and a second wave of the epidemic is also being forecast. Irrespective of the course of events over the coming months, it is already clear that thanks to the shutdown of major parts of the economy in previous months, non-performing loans are sure once again to be one of the major challenges facing the banking system. In previous years Banka Slovenije has often warned that banks need to go into any new crisis with cleaned-up credit portfolios. Here I would again like to highlight two aspects. Banks have made great progress in recent years in reducing non-performing loans. The banking system has seen an above-average fall in its NPE ratio, which is now at the EU average level. However, the current circumstances bring major risks, in part because legacy NPEs remain in the system, in the very segments of the portfolio that are likely to be hit harder by the crisis this time. In this context, at Banka Slovenije we have organised ourselves similarly to the approach adopted after the global economic and financial crisis. We will closely monitor bank activities and portfolio developments, and will take action when necessary. In addition to monitoring actual NPLs, we will also pay particular attention to transitions from stage 1 to stage 2.
Another significant factor in these developments will be moratoria on loan repayments driven by legislative requirements, which also have a special regulatory regime put in place at European level. Based on your latest reporting, we can reveal that by mid-June banks had received just over 24 thousand applications from customers in connection with Covid-19, worth around EUR 3 billion, the vast majority of which relate to loan moratoria. Approximately a quarter of the applications are yet to be processed, but this figure has fallen significantly in recent weeks. It is encouraging that as of the beginning of May there have been very few applications received for moratoria and liquidity loans, the vast majority of applications having been received by the end of April. We can therefore conclude that there will be no significant increase over the coming months, unless there is a drastic deterioration in business conditions.
Ladies and gentlemen, Two years ago I ended my speech by suggesting “preparations for less favourable times begin during good times, and whoever makes best use of this opportunity will have the advantage in the next crisis”. The coming months and perhaps the next few years will show how successful we have all been together in our implicit preparations for a new crisis, and how we have dealt with the new emergency. I wish you all an interesting summit, and every success in your work going forward.