Press release after the Governing Board of the Bank of Slovenia meeting on 27 May 2014

Economic and financial developments, international economic relations, financial stability

1. The Governing Board of the Bank of Slovenia discussed current supervisory matters.
    
2. The Governing Board of the Bank of Slovenia was briefed on current economic and financial developments, and approved the release of the May 2014 report on Economic and Financial Developments and the March 2014 report on Slovenia’s International Economic Relations.
    
   During the first quarter of this year, Slovenia’s economic recovery continued. Growth remains driven by the export sector, which is successfully exploiting the relatively weak recovery in the euro area. This is reflected in the current account, where a substantial merchandise trade surplus was recorded in March. At the same time, contribution to growth by construction remained notable, as growth in investment in public infrastructure continued. Relative to the end of last year, the situation in retail trade and some other service activities, primarily tied to domestic final consumption, deteriorated slightly. This is in line with firms reporting weak domestic demand as the main limiting factor for their business activities.
    
   In the first quarter of this year, developments on the labour market were stable. The number of registered unemployed has continued to fall. Unemployment has primarily been decreasing as a result of lower inflows of those losing temporary employment, which can be at least partly attributed to the last year’s labour market reform. Simultaneously, the number of new hires continues to rise. These developments are reducing the year-on-year fall in the workforce in employment, which had virtually come to an end by March. During the first quarter, wage growth increased in the export-oriented part of the economy, which together with the increase in employment is an indication of an improvement in the export sector’s business conditions.
    
   In April inflation fell below the euro area average. It stood at just 0.5%, down 0.1 percentage points on March. The largest factor was a fall in prices of non-energy industrial goods, which also reduced core inflation. Excluding the effect of taxes, inflation would have been negative in Slovenia since last September, and would have averaged -0.5% over the first quarter of this year. These figures might indicate that, after a certain lag, some firms have reduced their margins significantly more than was suggested in the first months after the rise in VAT, when its pass-through into prices was higher than expected.
    
   In the early part of the year, the consolidated general government deficit was stable as growing revenues, also due to improved economic situation, were accompanied mainly by the increasing burden of interest payments on public debt. According to the latest European Commission estimates, public debt is expected to exceed 80% of GDP this year . In the period before the formation of a new government it is vital to prevent any increase in uncertainty, in particular with respect to the commitments regarding fiscal consolidation targets and privatisation of government-owned firms. It is important that these commitments are met transparently, which would further strengthen Slovenia's credibility on the international financial markets.
    
3. The Governing Board of the Bank of Slovenia discussed and approved the May 2014 Financial Stability Review.
    
   The start of the process of the recovery and restructuring of the banking system had a series of positive effects on the indicators of the stability of the banking system and bank performance: an increase in capital adequacy, a decline in the proportion of non-performing claims in the portfolio, an increase in liquidity across the system, a fall in lending and deposit rates, and improved performance in the first quarter of 2014. Confidence in the banking system is being restored, particularly at the large domestic banks.
    
   December’s measures for the recapitalisation of five banks and the transfer of non-performing claims from NLB and NKBM to the BAMC brought fundamental changes to the structure of the banking system’s balance sheet, namely a decline in loans and an increase in securities, with an improvement in the risk breakdown of bank investments, a decline in the proportion of non-performing assets in portfolios, and an increase in capital adequacy. Additional positive effects on portfolio quality and balance sheet structure are anticipated after the transfer of claims from Abanka and Banka Celje to the BAMC, which will take place after the procedure at the European Commission is completed. However, the operational, financial and ownership restructuring of the real sector is now vital for a sustained improvement in the situation at the banks and an increase in credit growth. The slow pace of change in corporate financing models is primarily the result of the prevailing funding via banks and the absence of alternative forms of corporate financing, in particular via equity. Corporate deleveraging solely via divestment and repayment of existing debt cannot ensure a faster economic recovery, as it primarily results in a deterioration in corporate liquidity with the consequence of a further deterioration in the credit portfolio at the banks. Continuing to pursue corporate deleveraging solely by means of debt repayments and without new financial resources could result in firms missing out on the opportunities for growth offered by the renewed encouraging trends in the international environment.
    
   The transfer of certain claims to the BAMC reduced credit risk. The two largest banks and thus the banking system as a whole were relieved of a large portion of the lowest-quality claims, particularly those against firms undergoing bankruptcy proceedings, which accounted for just over a half of all the claims transferred. Investment quality has improved profoundly at the large domestic banks, and a further improvement is anticipated after the additional transfers of non-performing claims. Credit risk nevertheless remains high, and is the most significant systemic risk. In addition to institutional factors related to the method of bank recovery, a sustained improvement in the quality of bank investments will need healthy credit demand from corporates on one side, and sufficient and stable bank funding on the other.
    
   Income risk at the banks was reduced after the initiation of measures for the recovery of the banking system. In light of the reduction in credit risk, and the large amount of impairments, which partly derived from the findings of the comprehensive asset quality review under conservative conditions, the banks can be expected to see reduced pressure on profitability this year. The banks recorded positive growth in net interest income, a positive operating result and a higher net interest margin in the first quarter of this year. The fall in liability interest rates will have a favourable impact in reducing income risk, and also on the interest margin. Interest rates on long-term household deposits fell by an average of 1.8 percentage points over last year and the first quarter of this year. The falling cost of funding also allowed for a start to be made to cuts in lending rates, which have fallen by 0.5 percentage points since September. Given the positive macroeconomic forecasts for 2014, the initial cuts in lending rates could have a beneficial impact on growth in demand for loans, particularly at firms that switched their financing from domestic banks to foreign banks. Financing in the rest of the world accounted for 24% of all corporate loans last year, more than in 2004.
    
   More than in previous years, bank funding relies on household deposits and deposits by the entire non-banking sector. Deposits accounted for 57.9% of bank funding in March, up 14.3 percentage points on the end of 2008. Repayments of funding obtained on the wholesale markets accelerated last year, which sharply reduced the banks’ dependence on the financial markets. The banks have repaid a total of EUR 11.4 billion of wholesale funding, or two-thirds of the total, since October 2008, including 30% last year alone. Refinancing risk, which in previous years was one of the largest risks in the banking system, is now lower, particularly at the large domestic banks. The banks will again be strongly exposed to a refinancing burden in the first quarter of 2015, when they see EUR 2.6 billion of long-term liabilities to the Eurosystem mature. They had made early repayments of 29% of these liabilities by the end of March, thereby reducing the refinancing burden at maturity.
    
   Capital adequacy improved sharply to 14.0% at the end of last year. It stood at 13.7% on a consolidated basis, close to the euro area average for the first time since 2006. After the realisation of all of the restructuring measures and the projected recapitalisations for the remaining large banks, it can be expected to increase further, although the euro area average is also increasing.