Financial Stability Review: Systemic risks to financial stability have increased sharply

The risks to financial stability have increased sharply as a result of the Covid-19 pandemic, which constitutes a profound shock to the Slovenian economy and the global economy. Alongside the high risk to financial stability coming from the weakened macroeconomic environment, Banka Slovenije is also highlighting the elevated income risk and credit risk at banks, who have suffered a sharp deterioration in their business conditions. In these circumstances the quick, wide-ranging policy action at national and supranational levels in earlier months was particularly important, calming global financial markets and making a key contribution to the financing conditions in euro area countries remaining favourable. Partly as a result of the actions taken, the banks’ resilience to risk remains high, amid a sound capital and liquidity position, according to the findings of the Financial Stability Review presented today. 

Banka Slovenije actions

Under the aegis of the ECB we took quick and wide-ranging actions at the outbreak of the crisis. In the area of monetary policy, asset purchases were expanded and longer-term refinancing operations were provided under exceptionally favourable terms. The Eurosystem balance sheet has thus increased by 40% this year. In the area of regulatory activities, capital and regulatory reliefs were adopted within the framework of the Single Supervisory Mechanism and the European Banking Authority, thus increasing the banks’ credit capacity. Among the macroprudential measures, we should highlight the recommendation regarding the freezing of dividend payments.

All the measures applying to the systemically important banks were also applied to the other banks in the Slovenian banking system by Banka Slovenije. The measure to freeze dividend payments was implemented as mandatory, albeit temporary, expiring in one year; meanwhile leasing companies were issued with a recommendation to retain their earnings. This ensured the retention of capital at banks, so that the Slovenian banking system is better able to withstand potential losses, and to continue supplying credit to businesses and households.

Key risks to the banking system

Banka Slovenije assesses the risks inherent in the macroeconomic environment as the greatest risk to financial stability. The decline in economic activity in Slovenia as a result of the crisis triggered by the Covid-19 pandemic was the largest since the country achieved independence.

The conditions for banks to generate profits have deteriorated markedly because of the Covid-19 crisis, and we therefore assess income risk as elevated, and also rising. Low interest rates and the expectations of a deterioration in the conditions for generating interest income had made the situation uncertain even last year, but in recent months it has worsened.

Impairment and provisioning costs have risen at almost all of the banks, after the net release of impairments and provisions had been a major factor in bank profitability over the last few years. The banking system’s profits in the first half of this year were just a third of those recorded in the same period last year, when they hit a record high. In the wake of the economic downturn, bank profitability can be expected to decline further.

Credit risk in the banking system is increasing: we also expect indicators of the quality of the credit portfolio to deteriorate in the future as a result of the uncertain economic situation and the loan moratoria in place. The NPE ratio at the level of the banking system is not yet reflecting a deterioration in the quality of credit portfolio, thanks to the favourable impact of anti-crisis measures. Consumer loans are for now the only major segment of bank exposure where the NPE ratios have begun to rise in 2020.

Funding risk is moderate, despite the crisis, as household deposits and corporate deposits increased further at the outbreak of the pandemic, and remained the key source of bank funding. Households spent less on consumption and also received financial assistance from the government, while firms drew down previously approved credit lines, most likely for precautionary reasons, keeping the money in bank accounts. Growth in household deposits is expected to slow in the future with the downturn on the labour market. Growth in corporate deposits will also slow, as firms will need funds to bridge liquidity difficulties and other issues.

The risk to the banking system from the real estate market remains moderate. The crisis has only had a partial impact on the real estate market to date; the number of transactions was depressed by the containment measures, but prices remained stable until the end of the first quarter, growing at a moderate rate. Bank exposure to the sectors of construction and real estate activities is much smaller than during the previous crisis, and growth in housing loans has been restrained in recent years.

Resilience of the banking system

Amid the economic downturn caused by the Covid-19 pandemic, the Slovenian banking system remains highly resilient for now, while the banks’ capital position and liquidity position are significantly better than they were prior to the global financial crisis. The resilience of the banking system could worsen in the future, primarily on account of a deterioration in the quality of the credit portfolio and the corresponding decline in bank profitability.

The banking system’s liquidity position also remained sound in the first half of the year: resilience actually increased as primary liquidity grew to a record high. This brought an improvement in the capacity to absorb any adverse effects that might result from the realisation of funding risk.

Figure 1: Risk and resilience dashboard

Source: Banka Slovenije

Publication is available here.