Stability of the Slovenian Banking System-Press release -Meeting of the Governing Board of the Bank of Slovenia

1) The Governing Board of the Bank of Slovenia discussed and approved the January 2014 Stability of the Slovenian Banking System report. 

The main influences on the development of systemic risks in the Slovenian banking system in 2013 were the ongoing economic recession and a sharp contraction in financial intermediation. The two factors remain strongly interacting, as a result of high corporate indebtedness and the degree to which corporates’ recovery depends on them obtaining investment resources at banks. The banks’ debt repayments in the rest of the world also entail constraints on the possibility of changing the structure of corporate financing. Corporates remain relatively highly indebted, despite net loan repayments in the last year. 

The persistence of high corporate debt relative to equity is not improving their creditworthiness, which is forcing them into further disinvestment or into restraint with regard to new investments. The relatively high corporate sensitivity to the financial crisis is the result of the high dependence on debt (loan) financing via banks and the relatively low proportion of equity. The amplitude of the financial cycle is therefore significantly larger than the amplitude of the business cycle, and has stronger adverse consequences for economic activity than is observed in certain comparable economies. Only an increase in the amount of equity at corporates and a reduction in the dependence on the prevailing debt financing at banks will reduce corporate sensitivity to the persistence of the financial crisis. The assessment of corporate indebtedness reveals the relatively high concentration of debt in certain sectors, while as the financial crisis has persisted the problem of corporate over-leveraging has also been seen in sectors that are considered less cyclically sensitive. For corporates to reduce their relative indebtedness to the level of the best-performing corporates in their sector, i.e. those with above-average value-added, equity would have to increase by around EUR 5 billion. However, correcting the structure of corporate and bank balance sheets is a mutual process: the faster it takes place in the banking sector via net repayments of debt to the rest of the world, the more slowly it takes place in the corporate sector.

It is not only corporate recapitalisations that will facilitate a reduction in corporate indebtedness. It might also be facilitated by debt-to-equity conversions in accordance with the legislation, while increases in corporate equity could also come from rises in the market value of equity in the context of economic growth. In addition to corporate financial restructuring, there is a need for responsible ownership restructuring in the corporate sector and business restructuring by means of suitable business models that will contribute to increased value-added at Slovenian corporates.

Despite the lengthy crisis and its impact on falling standards of living, the household sector remains among the lower-risk bank investments. The household sector has also maintained a level of indebtedness that is half lower than the euro area average, thanks to a rational attitude to borrowing during the high point of the economic cycle. As one of the rare sectors with a positive net financial position, households can also make a significant contribution to economic recovery via demand. 

Negative economic growth has contributed to a further deterioration in the quality of the banks’ investments. Credit risk declined in December after the asset quality reviews at the banks and the transfer of the two largest banks’ non-performing claims to the Bank Asset Management Company (BAMC). There nevertheless remains a risk of a renewed deterioration in bank asset quality in the event of continued economic stagnation. 

After the capital increases at the banks in December and the realisation of all the restructuring measures and capital increases envisaged for the remaining banks by the middle of 2014, the banks’ capital adequacy will increase. The additional level of capitalisation at the banks provides a good basis for increased lending to corporates that show healthy creditworthiness and have business models with good prospects, and also a basis for addressing the remaining portion of the banks’ non-performing portfolio that has not yet been transferred to the BAMC. Higher capital adequacy in the banking system is also diminishing the arguments for reducing lending activity as a lever to increase capital ratios. 

The high proportion of non-performing claims at the banks and the contraction in lending activity brought increased income risk at the banks last year. The increased income risk at the banks was seen in a sustained decline in net interest income, a decline in net non-interest income and a sharp rise in impairment and provisioning costs. December’s transfer of non-performing claims to the BAMC at values below book value entailed the disclosure of additional losses, with an adverse effect on equity. The banking system’s losses were also increased sharply in December by the booking of additional impairments as a result of the asset quality review. After four years of losses in the banking system, 2014 will be important from the point of view of the banks’ ability to adapt their business models in a way that ensures profitability and the internal generation of capital. The crisis has confirmed that excessive bank funding via the wholesale financial markets increases their sensitivity to the fast-changing conditions on the international financial markets, and that growth in bank turnover is also conditioned by the ability to increase autonomous funding, thus maintaining a more stable loan-to-deposit ratio.

After the stress tests and the immediate measures by the government and the Bank of Slovenia to increase bank stability, the banks’ refinancing risk on the wholesale markets declined, and the conditions for their regaining access to funding in the rest of the world can be expected to ease. In the short term the banks do not face high refinancing risk, as a large proportion of the debt to the rest of the world has already been repaid. There will be a greater need for refinancing at the beginning of 2015, when the banks face the maturing of EUR 3.3 billion of liabilities from long-term refinancing at the ESCB, which the banks intend to partly prepay in the early part of 2014. 

The development of systemic risks in the banking system remains uncertain, despite an effective beginning of bank restructuring in December 2013 under the Government Measures to Strengthen Bank Stability Act. The process of the contraction in the banks’ financial intermediation is strongly dependent on economic recovery, and on the success of the restructuring of bank funding, which will continue in 2014. The latter should be reflected in a further decline in dependence on unstable short-term funding on the international financial markets and in a further increase in the proportion of funding accounted for by autonomous and long-term resources. This year of 2014 will be decisive for the banks that have embarked upon the restructuring process in order to adapt their business models to the new business conditions, which will ensure that they return to profitability and have sufficient ability to generate capital internally. Improvements in the banks’ efficiency must be reflected in a rise in the net interest margin, which will ensure an adequate return on the capital invested and the proper evaluation of the risks taken up. Because not all of the banks in the relatively saturated banking market will be capable of making these adaptations, further consolidation in the banking system is vital.