Czech Banking Sector 2010/2011
The economy has gone through an unprecedented slump
In 2009 the Czech economy went through a slump: an unprecedented event in its modern economic history. The fall in real economic growth was 4.1%, leading to a slump in the nominal gross domestic product created for the first time since 1995. The altered dynamic of this variable exceeded 10% in comparison with 2007.
This was definitely caused by an external factor: the consequences of the global financial and economic crisis. Indeed, as early as the beginning of 2008 there were strong reasons for a substantial deceleration of economic growth. It seems that, at that time, the economy had already peaked in the economic cycle and that the extremely fast appreciation of the exchange rate became one of the significant factors to slow economic growth (the Czech crown achieved a high value of about CZK 23 to the Euro).
While the stable, liquid and well capitalised financial sector was in a position to ensure that the economy ran relatively smoothly, and it was definitely neither the initiator nor the catalyst of the crisis in the Czech environment, the import of the crisis and its effect on the real economy was fast and fierce. After the export growth rate slowed down in 2008 to almost one-third that of the previous year (6% growth vs. 15% in 2007), the real decrease of goods and services export in 2009 was ultimately almost 11%, and was saved from an even greater drop thanks largely to extensive fiscal measures in our principal business partners' countries and supported sale of new cars.
The crisis had an even more dramatic impact on investment. The gross capital formation rate dropped from growth of almost +10% in 2007 to an initial decline of -2.7% for 2008. In 2009, the slump reached -17.1%.
Conditions for banks changed dramatically
Objectively, the change in economical environment from fast-paced and partially investment-driven economic growth to a slump in both demand and investment was brought about by entirely diverse conditions for the banking sector, regardless of the fact that the combination of the Czech financial system's good starting position and the speedy relaxation of the monetary policy was held back by the risk of inadequate tightening of the approach to loans.
Although the economy as a whole probably bottomed out in the first half of 2009 and there has been a very gradual improvement in the economic situation since that time, this is far from meaning that the slump will not affect further development of the economy and the financial system. Above all, it holds that a number of sectors will bottom out significantly later than the "average economy" (this is true, for example, of the building sector and partially of the services sector). The sole fact that the sector or undertaking in question has already bottomed out does not necessarily also mean that these are consolidated sectors or firms. Most firms paid the price of the unexpected economic slowdown: their financial standing was greatly weakened. Moreover, the impact of the investment slump (both global and regionally or locally targeted) will span a good few quarters at the very least.
Development in the banking sector
The aforementioned situation markedly impacted development of the banking sector during 2009. Clearly, the driving trends will change in 2010 only gradually.
In 2010 the Czech banking sector is made up of 40 banks (39 in 2009), of which 18 operate as branches of foreign banks. The banks' overall activity was CZK 4,111 billion as at the end of March 2010, which was only CZK 17 billion less than the previous year, representing a slight increase (0.4%) compared with 2009.
As at the same date, client deposits amounted to CZK 2,695 billion, which represents year-on-year growth of CZK 118 billion and a 2.5% increase compared with the end of 2009. It is also thanks to this that the Czech banking sector has retained a very strong position in terms of the loan-deposit ratio: the ratio of loans (exclusive of central banks and credit institutions) to deposits is 76%, which is one of the lowest values in the EU (the average is 116%). The banks' liquidity level is also high (the current assets to total assets ratio is roughly 27%).
Their strong balance position has contributed to the relatively stable situation on the financial market over the last 12 months. Long-term interest rates (10-year swap rate) dropped from their peak in 2008 (almost 5%) to an initial value of less than 4% in the second half of 2009, continuing to drop to below 3% this year. Short-term rates (3 months PRIBOR) also gradually went down from values of about 3.5% at the beginning of 2009 to the current values of about 1%.
This trend corresponds to the situation on advanced markets, particularly within the eurozone - the EUR 10-year interest swap rate moves in similar intervals – after reaching 5% in 2008 it dropped to 3.5% in 2009 and is now oscillating at less than 3%. In connection with the eurozone problems, the 3M EURIBOR rate has been increasing since April 2010 (to current values of about 0.9%). Even so, however, there has still been a dramatic drop from the peak at the end of 2008 (about 5%).
In the situation where markets are relatively stabilised and financial institutions' liquidity is good (market liquidity remains lower), the main obstacles to active banking business are the very results of the economic crisis themselves.
At the same time, the following two channels in particular are key:
· An objectively lower demand for financing combined with a drop in the magnitude of the economy and the number and volume of export orders (decreased short-term operating financing) and, in particular, with the marked slump in investment activities,
· The consequences of the economy's rising risk, manifested in both the weaker financial standing of loan applicants and the deterioration of banks' loan portfolios.
These economic trends are also documented by banking sector financing data: the volume of short-term loans to non-banking businesses has dropped steadily since the crisis began, with a year-on-year drop of 16.45% as at 31.5.2010. The long downward trend in the volume of investment loans was brought to a halt as of April 2010, but even further development in this area will depend on the economic situation.
The general upshot of the economic trend was a pronounced deceleration of the growth rate of resident lending to the economy, but this slowdown was differentially manifested throughout various sectors. The overall change in the dynamic lending growth was seen in a slowdown of the entire year-on-year lending growth rate from more than 10% growth (up until April 2009, year-on-year growth had been higher) to less than 1% in May 2010. By way of comparison, the lending growth rate in the eurozone was naturally slower: in January 2009 the aggregate volume of monetary financial institution (MFI) loans grew by a further 6.4% year-on-year; nevertheless, from September 2009 to April 2010 a negative dynamic was seen in respect of eurozone MFI lending with as much as 4% drops year-on-year. In May 2010 the eurozone experienced overall year-on-year lending growth of 1.7%.
In the Czech Republic, there was a dramatic slump primarily in respect of loans to non-banking businesses (-6.6% year-on-year at the end of May 2010, bottoming out at -8.1% at the end of 2009). These loans represent approximately one-third of resident loans.
By contrast, the volume of loans to households continued to boom (10.5% year-on-year at the end of May 2010), but it gradually decreased from the doubled growth seen at the end of 2008. This is the principal contributing factor that sustained the overall positive lending trend. These loans represent over half (54%) of total resident loans.
The volume of loans to government institutions also rose sharply (by almost 20%), although they represent only a very small portion (about 3%) of the banks' overall loan portfolios.
The banks did, therefore, continue to lend despite the fact that asset quality deteriorated greatly. In March 2010 the proportion of client non-performing loans reached 5.8%, which is more than double what it was at the end of 2007.
Structure and stability of the banking sector
Apart from the Czech banks' favourable balance structure, a fundamental factor in their future stability is a sufficient and expanding capital cushion. Taking a strict view of the capital structure, the Czech banking sector is in a very strong capital position. The forthcoming new regulatory measures will, with all probability, place more emphasis on Tier 1 capital (the most valuable capital). The Czech banking sector reports continuous growth of this indicator (the Tier 1 volume rose year-on-year by 6% to a value of CZK 241 billion). In March 2010 capital adequacy (Tier 1) was almost 13% (one-fifth higher than in 2006 and 2007). By way of comparison, this indicator is about 8.7% in the eurozone.
The banks' capital position is also strengthened by their ability to maintain profitability despite a certain drop in profits which is taking place in the Czech banking sector due to a combination of the aforementioned factors (the ratio of profit after tax to average activities dropped to the 2007 level, and in March 2010 it amounts to 1.34% vs. 1.46% at the end of 2009). By way of comparison, asset profitability in the eurozone in 2009 was only 0.19% (following the extremely crisis-stricken 2008, when asset profitability in the eurozone was a negative value of -0.11%).
Despite the fact that the impacts of the economic and financial crises on individual banks were differentiated (usually depending on the effect the crisis had on the owner), the structure of banks on the Czech banking market changed only slightly. The group of large banks maintained their market share at around 57% of assets in 2008 and 2009, but this did drop slightly compared with previous years. The market share of medium-sized banks rose the fastest (to almost 14% compared with approximately 10% in 2006 and 2007).
The question of future stability of the Czech banking sector depends largely on two factors. The first is the quality of the environment in which banks are to operate. The second is the conditions that will hamper banking enterprise. The data presented indicate that the banks themselves are capable of surviving even a very conservative economic crisis trend. This is supported by the ČNB's findings about the stability of the Czech financial sector (the ČNB says that "according to the stress tests, the Czech financial sector seems to be resistant to a wide range of risks, and banks are resistant to lending and market risks").
Nevertheless, if economic revival were to take longer than expected - for example, in combination with external shock (e.g., unsubstantiated currency strengthening) - this would handicap the conditions for banking enterprise. Similarly, a failure to manage fast stabilisation of the state's public funds would not uphold either the country's credibility or, as a consequence, its financial sector. This poses a significant risk for financial institutions, and one that is de facto very hard to eliminate.
Another key factor is the manner of introducing new, stricter regulation of the financial and (above all) the banking sector. The crisis has shown that in particular, some financial institutions' models and the behaviour of market participants (which, of course, did not affect the Czech financial market to any great extent) necessitate consideration of certain banking regulation changes. However, there is still the question of maintaining equal conditions for market competition. Above all, the phasing in of tighter regulation is the key to ensuring that the financial system operates smoothly and that it supports growth across the entire economy. Although it seems that most of the regulatory proposals under consideration will have an insignificant primary impact on Czech banks, the secondary impacts (a combination of weakened economic growth, mainly in the EU, and weakened financial standing of the Czech banks' owners) pose a significant risk for the functioning of the Czech banking market.