Financial Stability Review, December 2018
Highlights:
- The risks in the banking system in the second half of 2018 remained at the same level as in the first half of the year, while the risks increased on the real estate market on account of the high, long-lasting growth in real estate prices. However, high capital adequacy and high credit standards mean that the banking system is today more resilient to potential shocks on the real estate market than during the last financial crisis.
- Despite the profitability of the banking sector and the reversal in growth in net interest income, income risk remains among the most significant risks over the medium term, primarily on account of slower growth in net interest income, while there remains a net release in impairments and provisions.
- The quality of the banks’ credit portfolio has improved significantly in recent years. Individual banks with a large proportion of legacy non-performing exposures need to be more active in reducing their non-performing loans.
- The ongoing shortening of the average maturity of funding and the lengthening of the average maturity of investment is widening the maturity gap between funding and investments. The banks’ favourable liquidity position means that the risk of maturity mismatch remains moderate.
The Financial Stability Review for the end of 2018 highlights the key systemic risks to the financial system in Slovenia. Risks deriving from the real estate market are increasing. Residential real estate prices have risen sharply over the last two years, particularly in Ljubljana, Koper and certain tourist areas, the rate of growth reaching 13.4% in the first and second quarters of 2018. Residential real estate prices are already comparable to those of 2008, although housing affordability is still better than before the crisis, as household purchasing power has now increased, and lending terms are also better. An assessment of the overvaluation or undervaluation of residential real estate prices on the basis of the number of annual wages required for the purchase of an average housing unit compared with its long-term average suggests that residential real estate prices are still in balance, or have already become slightly overvalued in Ljubljana, and the overvaluation will increase as prices rise. Given the current price developments and the outstripping of supply by demand, the price-elastic demand and diminishing housing affordability, the imbalances on the real estate market could increase further in the future.
However, high capital adequacy means that the banking system is today more resilient to potential shocks on the real estate market than during the last financial crisis. Growth in housing loans to households was moderate and stable in 2018, at 4.5%. The credit standards for new housing loans remain high, according to the LTV and DSTI indicators. The average LTV for new housing loans was relatively low in the third quarter of 2018, at 58.6%. The Bank of Slovenia issued two recommendations for housing loans in September 2016, with regard to the maximum allowable LTV and DSTI, and upgraded them further in late 2018. According to the latest assessment of compliance with the macroprudential recommendations for the residential real estate market, the average LTV and DSTI have not changed significantly over time and remain within the bounds of the Bank of Slovenia recommendation. It is recommended that banks maintain high credit standards for housing loans in the future, thereby reducing risks and the potential adverse consequences for the banking system in the event of a price reversal on the real estate market.
In 2018 the banks continued to strengthen household lending, particularly consumer loans, which recorded year-on-year growth of 11.4% in September. The Financial Stability Review also highlights the measure adopted by the Bank of Slovenia in October 2018 under which the macroprudential recommendation for housing loans was extended to consumer loans. The aim of the measure is preventing an easing of credit standards in the area of consumer loans, and a large influx of new non-performing loans in this investment segment. The risks in the consumer loans market are moderate and manageable for now, but in the event of a reversal in the economic cycle and a consequent deterioration in the situation on the labour market, the risks to banks and households could increase, which could lead to a rise in the default rate among households.
The indebtedness of Slovenian households remains low; the ratios of financial debt to GDP and to disposable income are among the lowest in euro area countries. The situation on the labour market is favourable, which is additionally improving the financial position of households. The risks to banks from the household sector currently remain low. In 2018 the banks continued to strengthen household lending, particularly consumer loans. Given the high growth in ever-higher-risk consumer loans, which is being reflected in the approval of unsecured loans with very long maturities, in the event of a reversal in the economic cycle these risks could be realised.
After several years of deleveraging, corporate borrowing is increasing again, albeit on a healthier basis than in the pre-crisis period. Corporate financing flows, both debt and equity, have been positive since 2016, and are strengthening. Loans at domestic banks are growing, by 2.8% in year-on-year terms, while loans are continuing to record net repayments in other major credit sectors. Despite firms’ favourable access to financing at banks, and the significant improvement in their financial position compared with several years ago, growth in bank loans remains low. The reduced demand for loans is primarily the result of a change in corporate financing methods, where other instruments have gained in importance, namely internal resources and trade credits. Corporate equity financing is increasing more than debt financing, which is contributing to a further reduction in leverage, which stood at 95% in the third quarter of 2018. The growth in trade credits over the last year is indicative of the still-existent need for corporate debt financing, and of a highly specific segment of the credit market that the banking sector could also approach with the right offer.
Bank profitability is improving, but the risk that the banks will not be able to generate stable income in the future remains relatively high. Pre-tax profit over the first three quarters of 2018 amounted to EUR 421 million, up 14.4% on the same period a year earlier. The recent growth in pre-tax profit has been attributable to the release of impairments and provisions, which has slowed since the summer of 2018, and growth in interest income on loans, which remains low for the moment. The stability of this growth in uncertain in the current conditions. Bank lending activity is focused on households, particularly on fast-growing consumer loans. Corporate loans are still increasing, but at rates that remain outpaced by economic growth. In contrast to previous years, when the main limits on financing via bank loans came from the supply side (tighter credit standards in the years following the crisis, which curbed lending to heavily indebted and less creditworthy firms), it is now demand-side factors that are to the fore. The low corporate demand for bank loans despite low interest rates is primarily attributable to a change in the methods of corporate financing, and a shift in corporate ownership to foreign investors, who are changing the methods of financing at acquired firms.
The quality of the banks’ credit portfolio is much better than several years ago, and given the stable macroeconomic environment and the current forecasts for the coming years the inflow of new non-performing exposures (NPEs) does not entail increased risk to the banking system. The NPE ratio at the level of the banking system stood at 4.5% in September 2018. Asset quality remains lowest in the corporate segment, despite a significant improvement in recent years. The further reduction of existing NPEs is mainly important at individual banks, particularly those that have a larger stock of legacy NPEs. The potential inflow of new non-performing claims as a result of increased lending will also require greater attention in the future, particularly in the event of a decline in credit standards for fast-growing consumer loans. However, given the favourable financial position and low default rate of households, these risks are currently assessed as manageable, while a favourable impact in the reduction of risks in the future can also be anticipated from the aforementioned extension of the macroprudential recommendation to the area of consumer lending.
Deposits by the non-banking sector are continuing to increase, primarily on account of sight deposits by households. The proportion of total deposits by the non-banking sector accounted for by sight deposits is still increasing, albeit more slowly than in previous years; the figure reached 72% in September 2018. The extremely low deposit rates remain the reason for the increase in sight deposits. As a result of the simultaneous growth in long-term loans to the non-banking sector, the maturity mismatch between assets and liabilities is increasing, which is introducing potential instability in bank funding in the event of a sudden withdrawal of savers’ assets from the system or switching between banks. The banks’ favourable liquidity position means that funding risk remains moderate; given the high proportion of liquid assets, the banks’ vulnerability to the potential adverse effects of maturity mismatch is low. The relatively low elasticity of sight deposits to the interest rate spread within the banking system is also highlighted in the thematic section of the FSR.
The banking system remained well-capitalised in the first half of 2018, although there are considerable variations from bank to bank. The banking system’s capital adequacy improved as a result of growth in regulatory capital, and is higher than the euro area average. The banks are generating internal capital through good performance, which is important to the maintenance of stable capital adequacy, particularly at banks with higher credit activity.
Leasing companies are continuing to increase their equipment leasing business, while the value of new real estate lease agreements remains low. Portfolio quality is further improving, and profitability is continuing to increase. The systemic risks deriving from the performance of leasing companies remain at a low level.
Insurance corporations are continuing to record growth in gross written premium in all three insurance segments, while profitability has been affected by the presence of mass loss events and lower returns on financial assets. The nature of the insurance business means that underwriting risks and market risks constitute the majority of their capital requirements.
The cash surplus that arose in the corporate and household sectors as a result of high economic activity has not been transferred to the capital markets, but instead has remained in the most liquid forms of saving in 2018, such as sight deposits. This is attributable to the poorly developed domestic capital market, with low liquidity even when the stock market index has been rising.