Banking system during the coronavirus pandemic

In the difficult situation brought by the coronavirus pandemic, the economies of the euro area and of Slovenia are facing a decline in activity. Monetary policy measures have aimed to calm the financial markets and to provide sufficient liquidity to banks, and hence to businesses and households. In addition, the Banka Slovenije measure to freeze profit distributions at banks for a year has brought an increase in bank capital, and thus in their resilience to risks. The measure relating to household lending also remains in place. The emergency laws are also affecting banking: the level of moratoria on bank loans to corporates and households in Slovenia is among the highest in the EU. In this situation bank performance is declining: the banking system remains profitable, but next year and, in particular, the following years are expected to see a deterioration in credit portfolio quality and growing pressure on bank profitability.

This year has been marked by the coronavirus pandemic, which alongside a health crisis has unleashed unprecedented and difficult challenges at the global level. One of the consequences was a sharp decline in economic activity in the euro area overall and in Slovenia, particularly in the second quarter of this year, while a slightly smaller decline is also expected in the final quarter as the situation worsens.

The vast majority of sectors in the domestic economy have recovered since the containment measures were lifted in May, but there are considerable differences between them. The situation in services has worsened in particular in recent months. Banka Slovenije’s assessment is that in this segment of the economy, which was hit hardest by the epidemic, there is a high probability of a lasting crisis. The services hit hardest by the containment measures accounted for approximately 22% of jobs and 20% of value-added in the domestic economy before the crisis, and 25% and 19% respectively in the euro area overall.

The banks have differing exposures to the sectors hit hardest by the crisis. The accommodation and food service activities sector, which was worst hit during the crisis, accounted for 5.4% of the total stock of bank loans to the corporate sector in October, followed by administrative and support service activities, with 1.3%. The other worst-affected sectors (arts, entertainment and recreation) did not account for more than 1% of the total.

Economic policymakers were quick in responding to the health crisis, and the resulting economic crisis, with coordinated and extensive action. The monetary policy response aimed to calm the financial markets, and to provide sufficient liquidity to banks and businesses to address the liquidity crunch.

Banka Slovenije also used macroprudential measures to help maintain financial stability. The measure to freeze profit distributions until April 2021 has succeeded in increasing the available capital at banks, and with it their resilience to risks. The measure relating to household lending also remains in place, and has been tailored to the circumstances to allow banks to ignore a temporary loss of income when calculating creditworthiness.

The moratoria provided for by the emergency laws are making it easier to repay loans, and are mitigating the economic consequences of the health crisis. Borrowers have been able to claim moratoria practically since the outbreak of the crisis. The share of exposure for which a moratorium has been approved is highest at firms in sectors whose operations were most curtailed or even shut down by the containment measures in the first wave of the epidemic. The majority of the total loan stock in the worst-hit sector (accommodation and food service activities) is now covered by a moratorium. The Slovenian banking system has one of the highest levels of moratorium coverage of corporate and household loans (the share stood at almost 13% in October).

Measures have also partly addressed corporate liquidity: a guarantee scheme for corporate loans has been introduced. The available quota of loan principal is EUR 2 billion, but for various reasons no more than just over EUR 50 million of this sum had been taken up by the beginning of December.

Bank performance in highly adverse circumstances is currently still being alleviated by anti-crisis measures. Given the situation, the banks recorded relatively high profits over the first nine months of the year (EUR 414 million), largely as a result of a one-off effect (the merger of two banks). Bank lending activity declined sharply, while the large inflow of deposits into the banking system was reflected in an increase in the most liquid forms of asset. Banks are facing a decline in income driven by the decline in credit growth and falling returns on assets, while impairment and provisioning costs are increasing at the same time. The NPE ratio continued to decline until September inclusive, despite the bad situation. It is encouraging that the banking system’s liquidity and capital positions have remained good. Banka Slovenije is forecasting pre-tax profits of more than EUR 300 million in the banking system this year, although the figure would be just a third of that if the one-off effect were ignored.

The risks to financial stability have increased sharply. Alongside the high risk 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 was particularly important, calming global financial markets and making a key contribution to the financing conditions in euro area countries remaining favourable.

Next year and in the following years, as the moratoria and other emergency measures expire, Banka Slovenije is forecasting a deterioration in credit portfolio quality and greater pressure on bank profitability. The trend in non-performing exposures has remained favourable this year, but there is an increasing risk that after the measures expire numerous exposures will be downgraded or even classed as non-performing. In light of the effects of Covid-19, our forecast is that there could be a significant increase in the stock of NPEs and the NPE ratio by the end of 2022. It nevertheless appears that the banking sector will remain robust in capital and liquidity terms over the next two years, thanks to a solid starting position and all the measures taken.