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THE JOURNAL FOR MONEY AND BANKING

LJUBLJANA, VOLUME 63, No. 11, NOVEMBER 2014

SPECIAL ISSUE Bančni LEARNING FROM HISTORY – NO MORE vestnik CREDIT EXCESSES VSEBINA/CONTENT

EDITORIAL Boštjan Jazbec: Banking sector recapitalisation, corporate sector leverage and ways out in Slovenia 1

ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH Bernhard Winkler: Flow-of-funds perspective on unconventional monetary policy 2 Daria Zakharova and co-authors: Reviving credit growth for strong and sustainable recovery 11 Marko Simoneti: Quantitative easing and non-bank debt financing in Slovenia 22

REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS Robert Priester: Structural changes in European banking and influence on banking business models 31 Tina Žumer: Sectoral indebtedness and balance sheet repair in euro area 35 Marko Košak: In search for sustainable funding structure of commercial banks 43 Ivan Ribnikar: Banks’ capital and their funding 52 Timotej Jagrič and Rasto Ovin: Positioning Slovenian banking sector in EU 59 Božo Jašovič and Matej Tomec: Financial instability, government intervention and credit growth 64 Bojan Ivanc: Concept of business restructuring and sustainable funding of Slovenian companies 74

BEST PRACTICE CASES Carmelina Carluzzo and Milen Kassabov: CEE banking: Switching to sustainable track 78 Gvido Jemenšek: Potential for restructuring and new business models for banks 83 Janko Medja and co-authors: Transforming NLB, Slovenian market leader 91 Lars Nyberg: Bank Assets Management Company – Experiences so far 101

CONCLUDING REMARKS Emil Lah: Monetary policy paradoxes and banking crisis 113

STATISTICAL APPENDIX 120

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Uredniški odbor: mag. Božo Jašovič (predsednik), mag. Janez Fabijan (namestnik predsednika), mag. Peter Kupljen (mag. Kristijan Hvala), mag. Damijan Dolinar, Davorin Leskovar, univ. dipl. ekon., mag. Emil Lah, dr. Damjan Kozamernik, dr. Mojmir Mrak, dr. Ivan Ribnikar (dr. Marko Košak), dr. Rasto Ovin (dr. Dušan Zbašnik), dr. Marko Simoneti, odgovorni urednik: mag. Emil Lah, strokovna sodelavka: Azra Beganović, lektorica: Alenka Regally, AD in obli kovanje: Edi Berk/KROG, oblikovanje zna ka ZBS: Edi Berk/KROG, Bančni fotografija/ilustracija na na slov nici: Kreb Ide, prelom: Camera, tisk: Roboplast, naklada: 1000 izvodov. Izhaja enkrat mesečno, letna naročnina 80 EUR, za študente 40 EUR. Razmnoževanje publikacije v celoti ali deloma ni dovo ljeno. Uporaba in objava podatkov in delov besedila je dovoljena le z navedbo vira. Rokopisov ne vračamo. Poštni na je plača na pri pošti 1102 Ljubljana. Revijo subvencionira Banka Slovenije. vestnik Revija je indeksirana v mednarodni bibliografski bazi ekonomskih revij EconLit. REVIJA ZA DENARNIŠTVO IN BANČNIŠTVO Editorial Board: Božo Jašovič (Chairman), Janez Fabijan (Deputy Chairman), Peter Kupljen (Kristijan Hvala), THE JOURNAL FOR MONEY AND BANKING Damijan Dolinar, Davorin Leskovar, Emil Lah, Damjan Kozamernik, Mojmir Mrak, Ivan Ribnikar (Marko Košak), Rasto Ovin (Dušan Zbašnik), Marko Simoneti, Editor-in-Chief: Emil Lah, English-language editing: Vesna Mršič; Cover design and ZBS logo: Edi Berk/KROG; Cover photography/illustration: Kreb Ide; Graphic pre-press: Camera; Printed by: Roboplast; Number of copies: 1000. Bančni vestnik is published monthly. Annual sub- scriptions: EUR 80; for students: EUR 40. Reproduction of this publication in whole or in part is prohibited. The use and publication of parts of the texts is only allowed if the source is credited. Manuscripts will not be returned to the author. Postage paid at the 1102 Ljubljana Post Office. This journal is co-financed by the Bank of Slovenia. ISSN 0005-4631 The journal has been indexed and abstracted in the international bibliography of economic literature EconLit. Uredništvo in uprava Bančnega vestnika pri Združenju bank Slovenije / The Bank Association of Slovenia, Šubičeva 2, p.p. 261, 1001 Ljubljana, Slovenija, Telefon / Phone: +386 (0) 1 24 29 756, Telefax / Fax: +386 (0) 1 24 29 713, E-mail: [email protected], www.zbs-giz.si, TRR / Bank account: SI56 0201 7001 4356 205. FOREWORD Banking sector recapitalisation, corporate sector leverage and ways out in Slovenia Boštjan Jazbec*

he global has hit Slovenia particularly Bank rehabilitation is only a necessary condition for hard and the country continues to face difficult times. unlocking credit growth to the Slovenian economy. The protracted decline in economic activity and a Successful corporate restructuring is also essential relatively weak recovery have their roots in the pre- to lay the foundation for productive investment and crisis boom period. Economic growth during the pre- strong employment creation. Slovenian enterprises crisis period was fuelled by excessive borrowing and remain overleveraged, both when compared to their risk taking by banks and enterprises. euro area peers and historical trends. Unless en- The onset of the crisis in 2008 soon drained away terprise restructuring is undertaken decisively in a external financing. Slovenia was caught in a vicious timely fashion, the capital buffer of banks created cycle of reduced credit availability, deleveraging, by the recent recapitalisation will erode and further T a cutback in corporate investment and output, and injections will be needed once again. The enabling soaring non-performing loans. The balance sheets of legislative framework for enterprise restructuring is both banks and the corporate sector were impaired, in place, but systematic restructuring is yet to begin. causing a balance-sheet . This should be given priority by the new government. Balance sheet usually fail to respond to A decision must be made with regard to the most ur- traditional demand management measures. This is gent restructuring cases. because the monetary policy transmission channel is A critical constraint that Slovenia faces is the avail- impaired by the weak balance sheets of banks and the ability of funding for corporate restructuring and in- corporate sector, and credit demand is weighed down creasing investment activities. The feasibility of using by corporate debt overhang. Thus, policies need to go state resources for these purposes is limited because beyond theire traditional focus on the . further increases in the size of the already large pub- Repairing the balance sheets of both the banking sec- lic debt would threaten debt sustainability. Therefore, tor and corporate sector is a priority for unlocking privatisation and entry of private investors should be credit growth and promoting output growth. The Bank the key vehicles for the required non-debt capital infu- of Slovenia, in cooperation with the government, has sion. An appropriate business environment has to be embarked on restructuring the banking sector with created to facilitate this. Steps should be taken to ease the objective of creating well-capitalised and profit- regulatory and other barriers that inhibit investment. able banks that perform financial intermediation ef- To sum up, putting the economy back on track will ficiently, practice good governance and do not indulge require a coherent, integrated national strategy to in credit exuberance seen during the boom years. restore the health of the financial sector, restructure Based on the findings of a comprehensive asset quali- the corporate sector, and sustainability of the public ty review and stress tests in late 2013, balance sheets finances. The must be based on of five banks have been repaired through recapitali- equity-financed investment and not on debt-financed sation and transferring non-performing loans to the investment. Successful and timely policy implemen- Bank Asset Management Company. Five banks were tation will require political determination and social also instructed to increase their capital from private consensus. Government agencies and stakeholders sources within specific time periods in 2014. For the will have to coordinate their policies in order to adopt cases where private funding sources do not material- comprehensive implementing measures designed to ise, the commitment by the state to implement state reverse the downturn of the economy. In the absence aid measures will be realised. The rehabilitation of a determined follow-through on resolution policies, strategy also involves bank resolution through liqui- the fragile economic recovery will stall and problems dation, consolidation and privatisation. will intensify.

* Boštjan Jazbec, Governor of the Bank of Slovenia.

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UDK 336.711:336.02 Flow-of-funds perspective on unconventional monetary policy Bernhard Winkler*

FLOW-OF-FUNDS entral banks around the world have employed a wide PERSPECTIVE ON UNCONVENTIONAL range of unconventional monetary policy measures in MONETARY POLICY response to the financial crisis that erupted in 2007- This paper looks at central banks’ unconventional 2008. These measures resulted in large changes in their monetary policies via the C use of their balance sheet balance sheet size and composition and can be seen to serve two capacity through the lens kinds of purposes: (1) imparting additional monetary once of the sectoral framework offered by the financial the standard tool of setting short term policy rates has reached the accounts (financial flows and balance sheets). lower bound, (2) addressing impairments in the monetary transmis- Consistent with the traditional monetarist and sion mechanism (such as disruptions in segments of financial mar- portfolio balance channels of monetary transmission kets or blockages in the bank lending channel). In both cases the our approach suggests a central bank’s balance sheet capacity is employed, either directly taxonomy of standard and non-standard measures via size and composition or indirectly as a backstop, as set out in by issuing (debtor) sector as well as by counterpart Cour-Thimann and Winkler (2014). (holding) sector, while distinguishing lending versus outright operations, I. Introduction the maturity and the degree of liquidity of When the lower bound on the standard (short-term) policy instruments. The paper illustrates the impact of rates is approached, the distinction between actions aimed at sup- measures on bank lending and non-bank credit in the porting monetary policy transmission of a given monetary policy case of the euro area’s bank-based financial stance vs. altering the stance, e.g. by activating additional trans- system, including some mission channels, becomes increasingly blurred. When standard comparison with the US. The relevance of a broad monetary policy has reached its limits and/or turns to “balance range of financing sources of corporates is recalled, sheet policies” when regular monetary transmission is impaired, including trade credit and intercompany loans. financial markets are malfunctioning or segmented, there is a need

JEL: E02, E40, E50, E58 to look at quantities over and above any information conveyed by market prices and interest rates.

* Bernhard Winkler, Senior Adviser, Directorate Monetary Policy, European Central Bank. Views expressed are those of the author and should not be attributed to the European Central Bank. Valuable contributions and comments from Philippine Cour-Thimann, Philippe de Rougemont and Celestino Giron are gratefully acknowledged. The paper draws in part on Cour-Thimann and Winkler (2012, 2014)

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Hence, the flow-of-funds framework, II. The central bank balance asset purchases or predominantly comprising both financial flows and sheet and financial structure reflect lending operations, where the balance sheets, seems well suited to quantitative take up is a choice of help our understanding of uncon- In the wake of the financial crisis the counterparties. The ECB’s non-stan- ventional monetary policies, as well size and evolution of central bank dard actions to date focused mainly as conventional policies, in such balance sheets has come to be inter- on collateralised lending while the circumstances. This contrasts with preted as an indicator of the mone- Federal Reserve made larger use most of the New-Keynesian literature tary policy stance, in addition to the of outright operations (after a first and central bank practice in normal short term interest rate and related phase of exceptional lending opera- times, typically focusing analysis on communication, such as forward tions in late 2008-early 2009). From the transmission via interest rates and guidance. Figure 1 shows the size this perspective the Eurosystem’s rate expectations. of selected central banks as a share balance sheet contraction observed From a flow-of-funds perspective, cen- of GDP, where a different scale is since mid-2012 was not necessarily tral bank actions in crisis times can applied in the case of the Swiss signalling a less accommodative be broadly interpreted as mobilizing National Bank, whose balance sheet monetary policy stance but rather the economy’s “balance sheet of last in relative terms has grown much reflected an attenuation in funding resort”, comprising the classical lend- more and become much larger than market tensions and tail risks with di- er of last resort (offering liquidity to for the other central banks in recent minishing demand by banks for hold- solvent banks), the “intermediary of years. ing pre-cautionary balances (Praet, last resort” (substituting or backstop- In interpreting this chart and hence Cour-Thimann and Heider, 2014). ping intermediation between private balance sheet size as an indicator The ECB's decisions in September borrowers and lenders) and the of the monetary policy stance, a 2014 to embark on new outright related function of the “market-maker number of caveats are in order. purchases (of covered bonds and of last resort” (in fostering activity First, the starting levels of balance ABS) may, however, signal a more and price formation in markets where sheets differed significantly prior to active use of balance sheet policies, private activity has dried up). These the crisis in 2007 due to institutional while not establishing an additional three functions relate to a “flow” factors. Second, a distinction needs target for monetary policy (Constan- perspective on the lender of last to be made between active and cio 2014, Praet 2014). resort in bridging disrupted mon- passive (endogenous) evolution of Third, the “contingent” use of the etary transmission. From a “stock” balance sheet size. This depends on central bank’s balance sheet capac- perspective the central bank puts to whether balance sheets are driven ity needs to be taken into account. use its balance sheet capacity as actively by central banks outright In the SNB case, this pertains to the “leverage-provider” of last resort and/or as “insurer” / ”risk-taker” of Figure 1: Balance sheets of major Central Banks, last resort (in the case of contingent total assets as % of GDP use of its balance sheet), where the central bank can counteract adverse developments by providing liquidity to support asset prices and pre-empt fire sales at times of crisis (Bindseil and Jabłecki, 2013). While in operational terms the use of the central bank’s balance sheet is confined to transactions with its counterparties in monetary policy operations, the ultimate impact of conventional and unconventional monetary policy depends on the interaction with assets and liabilities across all sectors of the economy, beyond the financial institutions as Source: ECB, Federal Reserve, Bank of England, Bank of Japan. immediate counterparties. Last observations: September 2014 (August 2014 for BoJ)

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Figure 2: Sectoral debt ratios (as % of GDP)

Euro Area US

Source: ECB and Eurostat, Federal Reserve. Last observation: 2014 Q1. the overriding role of the exchange sectors went hand-in-hand with ing in the euro area was facilitated to rate cap since September 2011. In rapid deleveraging in the household a lesser extent than in the US, where the case of the ECB non-standard sector since 2009 (partly due to the Federal Reserve’s asset purchas- measures of a contingent nature write-downs and repossessions), both es allowed the private and public comprise the fixed rate full allotment more pronounced than in the euro sectors to offload some of their debt regime in the ECB’s refinancing oper- area, while non-financial corpora- onto the central bank’s balance ations after October 2008 (offering tions have even started to increase sheet (Cour-Thimann and Winkler, unlimited liquidity to counterparties their debt ratio in the recent period. 2012). against adequate collateral), which At the same time US government has been successively prolonged, debt went up more rapidly in the III. A flow-of-funds taxonomy and the announcement of Outright early stages of the crisis, compen- of balance sheet measures Monetary Transactions in 2012. Both sating for private deleveraging, measures provided insurance against together with the expansion of the Transmission channels certain adverse outcomes (respec- Fed’s balance sheet. By contrast, in tively the risk of liquidity shortages the euro area, while expanding until From a quantity (and quantity the- faced by individual banks, and the mid-2012 the balance sheet size of ory) perspective the first traditional risk of adverse self-fulfilling equilibria the Eurosystem has been declining transmission channel to consider is in sovereign bond markets). since, as banks reduced recourse the loan-deposit channel. The simple More broadly, from a flow-of-funds to central bank liquidity, which had textbook “money-multiplier” charac- perspective, the evolution of central temporarily boosted financial sector terization often starts from central bank balance sheets needs to be balance sheets. At the same time bank (outside) money translating into interpreted jointly with the balance domestic private sectors continued broad (inside) money created in the sheets of other sectors in the econ- deleveraging, especially the non-fi- banking system, which needs to be omy. (Winkler and de Rougemont, nancial corporate sector, while the underpinned by the banks capacity 2013) Figure 2 shows the evolution government debt ratio resumed it to supply credit and the demand of sectoral debt ratios for the euro upward momentum. for loans by the private sector (in area and the US, showing the central In this context, the prevalence of turn creating deposits). From the banks separately from the remaining lending operations among the monetarist perspective non-standard financial institutions sector. ECB’s non-standard measures – as measures aim at boosting narrow It can be observed that for the opposed to outright transactions – and ultimately broad monetary US deleveraging in the financial implied that private sector deleverag- aggregates. This can be achieved

4 BV 11/2014 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH via liquidity provision increasing lend to the private sector and new financial structure of the economy, bank reserves and via the bank deposits are created. If the ultimate namely the relative weight of bank lending channel or, alternatively, by seller is the non-bank private sector and market financing on the liabil- placing money directly in the hands deposits will, by contrast, indeed go ity side of the private sectors and, of the non-bank private sector, e.g. up in the first instance and can lead similarly, on the relevance of money/ via asset purchases from non-bank to portfolio rebalancing. Whether the deposits vs. market instruments in investors. From this perspective the private sectors will be willing to hold investors’ and ultimately household holding sector (not the issuing sector) extra money balances will depend portfolios. In turn this has a bearing of assets would seem to matter in the on their use of the additional money on central banks operating more via first place and how holding sectors and substitution across the spectrum collateralised lending with (bank) rebalance their portfolios with the of alternative assets (Winkler, 2010). counterparties or resorting to outright money received for the assets pur- Whether the loan-deposit channel purchases in the markets. Figure 3 chased by the central bank (Cloyne or the portfolio balance channel is shows that debt financing of firms in et al. 2014).1 most pertinent for monetary trans- the euro area is more bank-based From a monetarist perspective mission clearly depends on the than for the US, but reliance on bank increases in the size of central bank financing has been declining in both balance sheet work via changing areas. the quantity (rather than the price) Differences in financial structure of money, which in turn affects the ECB’s non- help explain the preponderance of balance sheets of the counterpart bank-focused lending measures in sectors involved in asset purchases. standard actions the case of the ECB compared to the However, whether an increase in Federal Reserve’s focus on outright central bank money (reserves held to date focused purchases of debt issued by the by at the central bank) leads to non-bank sectors: government bonds, boost to broad monetary aggregates mainly on government-guaranteed mortgaged ultimately depends on the behaviour backed securities, commercial paper, of banks and of the money holding collateralised portfolios of long-term bonds or sectors. In the case of banks, broad securitised loans, thus to large extent money will rise only if the extra lending. bypassing the banking system. In reserves alter banks’ propensity to contrast, the ECB has mainly pro- vided liquidity support to Monetary financial institutions (MFIs), relying Figure 3: Funding of the non-financial corporate sector in the euro on financing intermediated via the area and the US (shares in cumulated debt transactions) banking sector.

A sectoral taxonomy of non-standard monetary policies in the euro area

For the narrow and broad money channel of transmission, what matters is the creation of reserves (base money) and whether assets are ultimately purchased from money holding sectors thus increasing money holdings. From a flow-of-funds

1 For a flow-of-funds based assessment of the Fed’s asset purchases see Carpenter et al. (2013), Thornton (2012) for a sceptical view on the portfolio balance channel in the case of government bonds. Bertaut et al. (2011) estimate asset demand equations for bank deposits, treasury securities and Source: Eurostat, ECB, US Federal Reserve. corporate debt in a portfolio balance model.

BV 11/2014 5 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH perspective, in addition the issuing short-term lending to banks against (with direct lending ruled out by the sector of assets and the characteris- collateral, the least risky of all prohibition of monetary financing tics of instruments matters as relevant operation, as in the ECB's regular by the Treaty), namely the securities for the demand and supply of assets main refinancing operations (MRO) market program (SMP) launched and ultimately for financing condi- at weekly frequency. A first type in 2010 and the outright monetary tions across sectors and instruments. of non-standard measures has thus transactions (OMT) decided in Figure 4 proposes three key funda- been to take more risk vis-à-vis the 2012. mental characteristics affecting credit same counterpart sector (banks) by A third type of non-standard mea- and market risk of conventional and accepting a wider range of eligible sures involves liabilities of the private unconventional monetary policy collateral, by lending longer term sector, circled in blue in Figure 4, operations of relevance for the ECB: or by purchasing bonds issued by such as commercial paper or cor- (1) the sector of the issuer of the debt banks but benefiting from additional porate bond purchase programmes acquired: banks, government or securities. This applies to the several that had been launched by the Fed non-financial corporations (NFC) rounds of longer-term refinancing and the Bank of England in the early (2) the presence or absence of collat- operations (LTRO), specifically the phase of the financial crisis. Com- eral two VLTROs conducted in December mercial paper is a traded short-term (3) the maturity/duration of the 2011 and February 2012 as well as instrument issued by very large com- instrument the targeted lending scheme (TLTRO) panies usually benefiting from well-es- Another important characteristic is decided in June 2014. A second tablished external ratings. For the risk whether the instrument acquired is extension of non-standard measure characteristics and the borderline of tradable/marketable or an illiquid involved moving away from the focus central banks engaging in short-term claim (such as individual bank on banks to purchasing liabilities liquidity provision as opposed to loans). from non-bank issuers, namely gov- intervening in longer term allocation Standard monetary policy relies on ernment debt, on secondary markets of and capital (as might be the case for longer dated corporate bonds or loan markets), what matters Figure 4: A sectoral perspective on the ECB’s non-standard measures is the maturity of assets purchased, whether they are traded in liquid Sector of the debtor secondary markets and whether they Less conventional benefit from guarantees. Accordingly, the ECB’s main BanksNFC(/HH) Gov non-standard measures have been mainly directed towards facilitat- Lending

in ing and extending collateralised

MRO cr easi lending to banks, by providing on Short -term ng LTRO incrementally generous terms: (a) ri Medium -term sk full allotment, (b) increasing the list of collateral, (c) extending maturity Long -term to 3-month, then 1-year, then 3-year Outright (VLTROs) and up to 4 years under in purchases cr the new targeted lending scheme eas in Trade credit/bills* (TLTROs). ABCP ABCP OMT g ri

Short -term CommercialPaper sk In some sense, one could also CBPP classify the ECB’s Covered bond Medium -term OMT purchase programmes (CBPP) CBPP ABS bond in this category, as covered bonds Long -term purchases SMP are a major bank funding instrument and in some ways similar to collater- : Forbidden by the Treaty alised lending, although with the two *trade credit with recourse, or guaranteed; including bills endorsed differences: (1) in the regular lending Collateral** No operations the collateral is generally collateral **or guarantees liquid, while the covered bonds,

6 BV 11/2014 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH which themselves are liquid, contain on countries entering an adjustment practice of using Treasuries for open illiquid pledges (also originated by programme prior to any purchases in market operations in the US, Jobst the borrower), and (2) the maturity is order to guarantee solvency. and Ugolini, 2014). very different. However, when (a) the Figure 4 also includes asset backed collateral list for lending operations securities (ABS) and asset backed Transmission impact is extended such as to encompass commercial paper (ABCP), which many loans, and (b) the LTRO goes package loans or other claims (credit Liquidity provision to the banking up to 3 years or more, the strong card, leasing, trade receivables), sector is only one element, but not distinction between these two types where the underlying claim is on the a sufficient condition for supporting of operations diminishes. non-financial private sector (NFCs bank lending and broad money. The In contrast, the Securities Markets or households). ABS vehicles are balance sheet situation of financial Programme (SMP), active during often sponsored by banks or other and non-financial sectors has to be 2010-2011, as in the case of the financial intermediaries, but unlike taken into account and the bank Fed’s LSAPs, involved purchasing covered bonds they do not remain lending channel may be impaired debt issued by non-banks. It should on balance sheet and do not benefit in the presence of deleveraging be noted that the ECB’s motivation from double recourse protection pressures, debt overhang and capital was related to countering dysfunc- (ie. with claim on issuer and on constraints. On the asset side, there tional markets and intervene in the collateral). Trade credit is also are alternative uses of funds for several national government bond included as a short-term NFC liability liquidity provided by central banks markets, which were regarded as in Figure 4. Indeed, trade credit, via lending or outright purchases. important for the even transmission of “securitised” in the form of trade bills Figure 5 shows the development the single monetary policy across the (or bills of exchange), which were of broad money and loans (banks area. This motivation also applied to typically endorsed/guaranteed by loans and broader flow of funds defi- the Outright Monetary Transac- multiple signatures (from both seller nition) for the euro area and the US. tions (OMT) launched in 2012 to and buyer), discounted and under- It can be seen that in the first phase address unwarranted redenomina- written by banks and rediscounted of the financial crisis bank lending tion risk premia that had appeared in by central banks were the most contracted much more sharply in the bond markets. Unlike the SMP, while traditional instrument for liquidity pro- US with much more rapid delever- ex ante unlimited in scope, the OMT vision by central banks over centuries aging (namely related to mortgage was limited to maturities of up to 3 (before the onset of repo securities defaults and repossessions) in the years and was made conditional operations in Europe and before the household and banking sectors,

Figure 5: Money and credit growth

Euro area US

Last observation: 2014 Q3 (2014 Q1 for FoF) Notes: Annual percentage changes. FoF = flow of funds / financial accounts

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Figure 6: Net acquisitions of loans and debt securities of the non- durable recovery in bank lending financial sector by MFIs (4-quarter sums, bn euro) to date, even if surely preventing disorderly bank deleveraging and much more adverse counterfactual scenarios. This raises the question what use have banks made of the funds provided to them via the longer term refinancing operations. Figure 6 shows that banks have invested heavily in government securities during the period of one- year LTROs in 2009-10 and again at the time of the two three-year LTROs in 2012-2013, coinciding with weak or negative loan flows to households and non-financial corporations. Hence, from a flow of funds perspective it can be argued Last observation: 2013 Q4. that the two longer-term lending Source: ECB operations launched in December 2011 and February 2012 VLTRO with subsequent gradual recovery via the LTROs amounting to nearly also appeared more effective in in money and lending growth. In the EUR 1 trn – fundamental for stabi- supporting bond markets than in euro area a double-dip profile can lizing the banking system – and the supporting bank lending. This all be seen, with a renewed decline in SMP, CBPP and OMT programmes the more so, if we take into account money and lending after the intensi- – essential for addressing tail risk that central bank funding displaced fication of the sovereign debt crisis and supporting impaired bank and previous bond investors, who might in 2011. government funding markets – have also have substituted bank bonds in This suggests that liquidity support nonetheless not translated into a their portfolios with adjacent asset classes, likely benefitting government and corporate bonds. Figure 7: NFC financing: MFI loan borrowing, net issuance of To some extent, the VLTROs could debt securities and quoted shares (4-quarter flows, bn euro) hence be seen as an indirect chan- neling of funds in support of bond markets under stress, also working to compress government bond yields and supporting private bond markets as a side effect. However, only the more direct, if conditional, commit- ment of the OMT from 2012 brought about a lasting reduction in risk premia and a return of domestic and foreign long-term investors.

The transmission to non-financial corporations

Even though most of the ECB’s non-standard measures were motivat- ed by supporting the monetary trans- Last observation: 2013 Q4. mission mechanism and namely and Source: ECB ultimately credit to the real economy,

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Figure 8: Corporate debt finance (including inter-company claims)

Stock of NFC non-consolidated debt (12.7 trn euro) Trade credit and NFC loans (bn euro)

Sources: Eurostat, ECB (internal estimates for trade credit). Last observation: 2013 Q4. bank lending to the private sector at debt instruments (ie. abstracting and non-financial corporations, in from quoted shares and unquoted particular, has continued to contract, Standard equity) in non-consolidated presenta- against the background of continued tion. It emerges that MFI loans only deleveraging needs and increased monetary policy make up for 1/3 of external debt regulatory demands. The same financing (outstanding amounts), disintermediation pattern from bank relies on short- which is significantly more than debt to market financing, attributable in securities. At the same time, other part to the need for bank balance term lending to sizeable sources of financing relate sheet repair, and in part to the extent banks against to inter-corporate claims, namely that ECB liquidity provision to banks trade credit and inter-company mostly “spilled out” into the bond collateral. loans, both important elements in the markets (rather than being used for financial supply chains and inter-link- bank lending) can also be seen by ages in the corporate ecosystem. looking at the sources of external The right-hand side shows that NFC financing of non-financial corpora- sources of funding, tapping/reviving loans to other NFCs and trade credit tions in Figure 7. securitisation markets with relevance have fulfilled a stabilising role in the Market based funding (from stock for SMEs as part of the ABS pur- financial crisis by contracting much markets and corporate bonds) chase programme, or making liquid- less than bank lending and also less substituted to a significant extent ity provision to banks conditional on than activity and value added. Loans for shrinking bank loans both in the on-lending to the private sector in the from non-bank financial intermediar- wake of the Lehman 2009- targeted lending operation (TLTROs), ies (special purpose vehicles often 2010 and again after 2011-12 after similar to the Bank of England’s issuing debt securities on behalf of an intermittent period of normaliza- “funding for lending” scheme. NFCs in other jurisdictions) have tion, where bank lending had seen a The flow of funds data can be used risen in recent quarters. Car- tentative recovery. However, it needs to show a more complete picture bó-Valverde et al. (2014) show on to be recognized that most SME do of the corporate funding sources, the basis of firm-level Spanish data not have access to bond or equity in particular exploiting the non-con- that credit constrained SMEs depend markets and remain heavily bank-de- solidated presentation, which also more on trade credit, in place of pendent. Hence attention has recent- includes intra-sector claims. bank loans, and that the intensity of ly turned to unlocking alternative Figure 8, on the left-hand side, looks this dependence increased during

BV 11/2014 9 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH the financial crisis. Unconstrained balance effects, rather than relying policies using a sectoral empirical model of money and credit”, paper presented firms, in contrast, rely more on bank on the bank lending channel. at the MMF conference on “Monetary loans and less on trade credit. Among the portfolio of non-standard analysis and monetary policy framework”, Edinburgh, 9-10 April 2014. This underlines the critical role of measures implemented or considered Constancio, V. (2014), "A new phase of trade credit (among corporates) by central banks around the globe teh ECB's monetary policy", speech at offering relationship based finan- it remains it remains somewhat of a ECB workshop on non-standard monetary policy measures, Frankfurt am Main, 6 cial buffers at times when the bank puzzle that attention has not turned October. lending channel is impaired and to rediscover or re-engineer instru- Cour-Thimann, P. and Winkler, B. (2012), SMEs can rely less on relationship ments like the trade bill, as the most “The ECB’s non-standard monetary policy measures: the role of institutional factors lending from banks. There is a standard and traditional means of and financial structure”, Oxford Review of widespread perception that SMEs in refinancing the real economy used Economic Policy, Vol. 28, No. 4, 765-803. many countries remain liquidity and in Europe as recently as 1999, until Cour-Thimann, P. and Winkler, B. (2014), “Central banks as balance sheets of credit constrained, with low cash the onset of monetary union and as last resort: a flow-of-funds perspective”, flow, with banks cutting lending and successfully and very swiftly revived presented at the MMF conference on “Monetary analysis and monetary policy credit lines. At the same time ample by the Bank of England during the framework”, Edinburgh, 9-10 April 2014. provision of central bank liquidity 1980s (Allen, 2014). Jobst, C. and S. Ugolini (2014), "The seems not to have filtered through to Coevolution of Money Markets and Monetary Policy, 1815-2008), ECB SMEs, nor have buoyant asset mar- REFERENCES working paper (forthcoming). kets, while large corporates continue Allen, William (2014), “Eligibility, bank Praet, P (2014), "Recent monetary policy to hoard cash. liquidity, bank credit and macro-prudential measures supporting the euro area This has been one motivation to policy”, mimeo, Cass Business School, recovery", speech at IIF Annual Meeting, London Washington, 10 October. opening or supporting additional Bertaut, C., DeMarco, L. P., Kamin, S. and Praet, P. Cour-Thimann, P. and Heider, channels for monetary transmission, R. Tryon (2011), “ABS Inflows to the United F. (2014) “Ensuring the transmission of in particular the ECB’s ABS purchase Staes and the Global Financial Crisis”, the policy signal: a review of the ECB’s International Finance Discussion Papers monetary policy from 2007 to 2013”, in programme in conjunction with reg- No. 1028, Board of Governors of the Vallés, J. (ed.) Monetary Policy after the ulatory initiatives to support “simple, Federal Reserve System, Washington. , FUNCAS, Madrid. transparent and real” securitisation Bindseil, U. and Jabłecki, J. (2013), Thornton, D. (2012), “Evidence on the “Central bank liquidity provision, risk-taking Portfolio Balance Channel of Quantitative activity. In addition, the TLTROs aims and economic efficiency”, ECB Working Easing”, Working Paper Series 2012-015A, to strengthen incentives for banks Paper 1542. Federal Reserve Bank of St. Louis. to use liquidity received under the Carbó-Valverde, S., Rodríguez-Fernández, Winkler, B. (2010) ‘Cross-checking and F., and Udell, G. (2014), ‘Trade credit, the the Flow of Funds’, in L. Papademos and J. programme for additional lending. financial crisis and SME access to finance’, Stark (eds), Enhancing Monetary Analysis, Finally, the CBPP 3, while directed at mimeo, Bangor University. Frankfurt am Main, European Central Bank, 355–80. a bank funding instrument, involves Carpenter, S., Demiralp, S., Ihrig, J and E. Klee (2013), “Analyzing Federal Reserve Winkler, B. and de Rougemont, P. (2013) an asset class also widely held by Asset Purchases: From whom does the Fed ‘The Financial Crisis in the Light of the non-bank investors and hence might buy?”, Finance and Economics Discussion Euro Area Accounts’, in B. Winkler, A. Series 2013-32, Federal Reserve Board, van Riet and P. Bull (eds), A Flow-of-Funds open up a transmission channel that Washington. Perspective on the Financial Crisis, Vol. II: puts money directly into the hands Macroeconomic Imbalances and Risks to Cloyne, J., R. Thomas, A. Tuckett and S. Financial Stability, Palgrave Macmillan, of investors, with possible portfolio Wills (2014), “Analysing unconventional Basingstoke, New York, 155-198.

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UDK 336.71(497.4) Reviving credit growth for strong and sustainable recovery Engin Dalgic, Davide Lombardo and Daria Zakharova*

REVIVING CREDIT lovenia was hit hard by the global financial crisis. GROWTH FOR STRONG AND SUSTAINABLE The crisis caused a sudden stop in the externally funded RECOVERY construction and investment boom. The combination of The Slovenian economy is finally recovering from an overly indebted corporate sector, weak banks, and a deep and protracted S recession. But credit is still limited financing precipitated a vicious cycle of deepening reces- contracting. A creditless sion, mounting bankruptcies, rising nonperforming loans (NPLs), recovery would be a poor prospect. Such recoveries and further deleveraging. All in all, real GDP dropped by 11¼ from tend to be weak and are likely to be followed by its 2008:Q2 peak to its 2012:Q4 trough—the largest output loss subpar growth. Reviving credit is thus essential to among euro area members after Greece. achieving a more vigorous and durable . This paper I. Introduction analyzes the supply- and the demand-side constraints to credit growth The economy is now starting to recover. Quarterly growth in Slovenia and proposes measures to address them. turned positive in 2013:Q2, helped by recovering euro area de- mand. A small positive growth is projected this year, largely driven JEL G01 G21 G28 by the ongoing strength of exports. At the same time, domestic demand is expected to remain subdued, with investment weighed down by the balance sheet problems in banks and corporates. Meanwhile, credit is still contracting. Firms appear to be largely relying on their own resources to support the recovery, in- cluding using the excess capacity resulting from the deep recession (see chart on next page).

* Engin Dalgic, Davide Lombardo and Daria Zakharova, International Monetary Fund. The authors would like to thank the Bank of Slovenia (BoS) staff for their help with the data used in this article; Uroš Herman from BoS for useful discussions and help in accessing and analyzing the AJPES database; Phil Gerson, Jaime Jaramillo-Vallejo, and colleagues from Legal and Monetary and Capital Markets departments for valuable comments; and Tingyun Chen for excellent research assistance. The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.

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Slovenia: Output and Real Credit Growth (y-o-y percent change) corporate sector. Thus, credit (and robust economic growth) cannot be restarted without addressing the demand side of the equation. This calls for a comprehensive strategy to facilitate the restructuring of corpo- rate debt. But before we discuss how these demand and supply constraints could be tackled, it is important to understand how these constraints developed in the first place.

II. The build-up of vulnerabilities in the pre-crisis period Source: Haver Analytics. EU accession (2004) and euro adoption (2007) triggered a Slovenia could thus be facing a investment and weaker productivity.1 reduction of Slovenia’s borrow- “creditless recovery”—arguably a Enabling a resumption of credit ing costs towards those of the poor prospect. Recent studies find growth is therefore essential to euro area core. As a result, and that the risk of creditless recover- achieving more vigorous and dura- in the context of abundant global ies is especially high in situations, ble output growth. Unlocking credit liquidity, the country significantly like Slovenia’s, where an economic supply requires completing the repair increased its external borrowing. downturn follows a foreign-financed of banks’ balance sheets. The recent Most of the external borrowing was credit boom and banking crisis. They recapitalization of the largest banks done by banks, while the corporate also document that creditless recover- is an important step in this direc- and—at least through 2006—the ies tend to be weaker (by as much tion. But further efforts are needed official sectors kept their exposure as a half) than those supported by to restore banks’ financial viability, broadly unchanged. Cheap external stronger lending—because eventually including through a further meaning- funding fuelled a rapid expansion capacity constraints start to bind— ful reduction in NPLs. Moreover, and are more likely to be followed weaknesses in Slovenia’s banking by mediocre growth, reflecting the system in large part reflect continued 1 See Abiad et al. (2011); Bijsterbosch and Dahlhaus (2011); IMF Global Financial Stability long-term adverse effects of lower financial stress in its overleveraged Report (2013); and Barkbu et al. (2014).

Interest rate convergence (percent) External borrowing (EUR, Billions)

Sources: Bloomberg, Haver Analytics and IMF staff calculation Source: Haver Analytics.

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Credit-to-GDP Ratio Total Debt as a Percent of GDP

Sources: Bank of Slovenia, IMF IFS and WEO. Source: Haver Analytics. Note: NPISHs = non-profit institutions serving households.

in bank credit. The ratio of bank ment financial operations, including averaged 1.6 percent of GDP per assets to GDP increased from about funding corporate mergers and buy- year since euro adoption, against an 78 percent in 2000 to a peak of outs. In many cases, the seller of the average for the euro area of 29.4 146 percent in 2009, despite the companies was the state itself, which, percent of GDP. concomitant growth in nominal guided by the notion of ‘national Slovenian banks also took signifi- GDP. On a macroeconomic level, interest’, preferred domestic owners cant liquidity risks. On the eve of the the credit boom was reflected in over foreign candidates. In practical crisis (2008), wholesale funding rep- rising current account deficits and terms, this led to giving a secondary resented 30 percent of their liabilities external debt. Slovenia’s current role not only to prices fetched, but (against 7 percent in the average account deficit reached 5.5 percent also to key qualifications for owner- euro area bank), and liquid instru- of GDP in 2008, and its external ship, such as financial strength2. Fi- ments accounted for only 10 percent debt doubled to 105 percent of GDP nancial holding companies, where a of their assets (versus 30 percent in between 2003 and 2008. diverse set of companies are brought the average euro area bank). Bank lending was largely chan- under an umbrella ownership, prolif- The 2008–09 global crisis exposed neled to corporates in the non- erated in this environment. these vulnerabilities. The global loss tradable sector. Domestic bank The result was a significant increase of confidence crippled interbank credit to the non-financial corporate in corporate leverage, which put markets. Despite sovereign guaran- sector grew by 25 percent per year bank lending at risk. While the rapid tees, Slovenian banks effectively lost during 2005–08, and 35 percent credit expansion was not unique access to external markets, and were at its peak in 2008. Fixed investment to Slovenia (see left chart above), thus forced to repay their large ex- increased from 24.3 percent of GDP and Slovenia’s private sector debt ternal debts as these came due. Be- during 1997–2004 to 27.1 percent remained relatively low (right chart tween August 2008 and end-2013, during 2005–08, almost entirely on above), it did take place against the net reduction in external liabili- account of the increase in non-trad- very limited equity capital, resulting ties of the banking system reached able investment, of which half went in one of the largest corporate debt- 11.8 billion euros, roughly a quarter into real estate and construction. to-equity ratios (see charts below). of the aggregate balance sheet as of Credit became the primary funding This makes bank debt more exposed end-2008. The (longer-term) liquidity source for investment and corporate to a downturn, because companies support from the European Central takeovers. The ratio of new bank have limited equity buffers to absorb Bank (ECB) provided a breather, in loans to investment spiked dur- losses. In part, the relative scarcity that banks used it to help pay off ing 2007–08 as firms increasingly of equity capital reflected Slovenia’s relied on credit, rather than retained reluctance to embrace foreign direct earnings, to finance investment. investment (FDI), a key source of po- 2 For an interesting take on the privatization and the notion of national interest in Loans were also used for non-invest- tential equity: FDI into Slovenia has this period, see Lindstrom and Piroska (2007).

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Corporate Debt-to-Equity Ratio in Slovenia, Corporate Leverage, 2012 1/ 2001-2013 (Percent) (Percent)

Sources: ECB and Eurostat. Source: Haver Analytics. 1/ Defined as total liabilities minus equity over equity in non- Note: NPISHs = non-profit institutions serving households. financial corporates.

their maturing external liabilities, but total classified claims3 at end 2007 performing” (i.e., in arrears for more did not turn the fundamental dynam- to 18.1 percent in November 2013.4 than 90 days) reached 28 percent ics around. The acceleration was particularly by November 2013. At the level of A vicious circle of mounting NPLs pronounced among the large do- the individual sector, the NPL share and deepening recession ensued. mestic banks, where the NPL ratio reached 50 percent in construction With capital flows reversing and reached 21.6 percent in mid-2013. and 33 percent in accommodation foreign funding drying up, banks At end-2012 NPLs net of provisions and food service activities. NPLs reduced their lending dramatically. accounted for about 86 percent of were even higher—reaching a peak Facing rapidly tightening financial banks’ capital, some 23 percentage share of 37 percent in August 2013 constraints, the corporate sector points more than in the euro area — among classified claims on “other cut investment sharply, aggravating average, which was itself on a steep financial intermediaries”, namely the recession. In turn this reduced upward trajectory (right chart below). holding companies (through which borrowers’ expected cash flows and Corporate borrowers were the main many leveraged buyouts were creditworthiness, leading banks to source of problem loans. Among implemented). The 50 corporates further contract their credits. NPLs in- claims on non-financial compa- with the largest exposure in arrears creased rapidly, from 2.6 percent of nies, the share classified as “non- accounted for some 43 percent of all banking sector arrears (by value) by November 2013. On the other NPLs to Total Gross Loans (percent) hand, claims on households, includ- ing mortgages, are in much better shape (with only 4 percent of them in arrears).

3 Classified claims include financial assets at amortised cost and some risk-bearing off-balance- sheet items on which a payment liability could arise. 4 The text charts show annual end-year NPL ratios. The decline in the NPL ratio for Slovenia by the end of 2013 reflects the December 2013 transfer of NPLs to the asset management company, as discussed in the next section. Source: IMF FSI. 14 BV 11/2014 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH

III. Repairing bank (BoS) carried out a comprehen- tal shortfall of EUR 4.8 billion.5 For balance sheets to unlock sive diagnostic of the main banks, the three large state-owned banks credit supply in conjunction with the Ministry of the shortfall amounted to some Finance and with the help of inter- EUR 3.7 billion. This was addressed A number of important measures national consultants. This exercise by a transfer of NPLs to the BAMC, have been taken over the past two consisted of an Asset Quality Review burden-sharing with qualified subor- years to address problems in banks. (AQR) and stress tests of the eight dinated instruments, and an outright But further efforts are needed to largest Slovenian banks and aimed strengthen bank balance sheets and at determining the requisite capital reduce vulnerabilities. injections and establishing the price 5 This figure emerged from the adverse scenario in the bank-level bottom-up stress tests. The BoS also for the transfer of NPLs to a newly commissioned a top-down system-level stress test What has been done? established Bank Asset Management which yielded a somewhat lower aggregate capital shortfall (about EUR 3.3 billion). The BoS took the Company (BAMC). findings of the top-down stress tests as evidence that the bottom-up stress tests had been sufficiently In 2013 the Bank of Slovenia The exercise identified a total capi- conservative.

Key components of P&L NPL Net of Provisions to Capital (Percent of average assets) (percent)

Souce: Figure 6.39, 2014 Financial Stability Report, Bank of Slovenia Source: IMF FSI.

Arrears of more than 90 days as a proportion of banks' classified claims by bank group (left) and client segment (right) 1/ (Percent)

Source: Figure 6.13, 2014 Financial Stability Report, Bank of Slovenia 1/ The decline of the NPL ratios in December 2013 reflects the transfer of NPLs to the asset management company BAMC (see next section).

BV 11/2014 15 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH capital injection.6 Banka Celje also in arrears. In its first annual report, crisis. Governance can be improved turned out to require public capital the BAMC management indicated through privatization. The BoS (the authorities now plan to merge that, at least for the transfers already estimates that, as of mid-2014, the it with Abanka), while Gorenjska implemented (i.e., from NLB and Slovenian government owns 62 per- Banka has been given until the end NKBM), these did not include—as cent of the banking system capital. of 2014 to raise the required capital recommended by the BAMC and Privatizing the intervened banks in from private sources, failing which endorsed by the Bank of Slove- due course would ensure that their it will also be recapitalized by the nia—each bank’s full exposure to management responds solely to state. Two other small banks (Factor company groups with significant commercial motives and weaken the Banka and Probanka, accounting for non-performing loans, but only the link between the creditworthiness 4.5 percent of the system’s assets) worst-performing exposures for each of the government and that of the were separately put under an order- borrower. This, they note, unduly banks — a key source of vulnerability. ly wind-down procedure by the BoS undermines the BAMC’s hand in Efforts in the supervision area should in September 2013, with the neces- restructuring negotiations with non- focus on improving the control of sary capital (some EUR 445 million) cooperative business owners.9 connected lending. This requires the provided by the state. Thus additional transfers of problem BoS (and the Single Supervisory loans to the BAMC are in order, Mechanism) to have access to a What remains to be done? both to further cleanse banks’ bal- comprehensive database of groups ance sheets from legacy problem of connected clients based on a uni- Despite the above-mentioned inter- loans and to strengthen BAMC’s form definition of connectedness. ventions, domestically-owned banks capacity to act as a catalyst for the Finally, the BoS should ensure that remain saddled with a high share much-needed corporate restructur- banks deal effectively with their of NPLs. ing. The recently completed AQR NPLs. The amendment to the regula- Following the December 2013 and Stress Tests conducted under the tion on the assessment of credit risk transfer of NPLs to the BAMC, the aegis of the ECB and the European losses introduced earlier this year, banking system NPL ratio declined Bank­ing Authority offer, at least for enabling banks to write off claims to 13.4 percent at end-2013, from the two largest banks, an opportunity they assess to be uncollectible even 18.1 percent in November 2013 to determine the value of the assets in the absence of court-sanctioned (Bank of Slovenia (2014) reports to transfer and quantify the size of bankruptcy, is thus welcome. The that the transfer of NPLs to the their existing capital buffers. This is BoS should now monitor that banks BAMC more than explains this de- important because, to the extent that fully use this additional leeway, and cline, accounting for a 4.9 percent- the transfer price is below the book encourage banks to dispose of prob- age point reduction in the system’s value of the loans (net of relevant lem loans via regulatory measures overall NPL ratio). NPLs have, provisions), the transfer would gener- (such as maximum time limits for however, increased again in the first ate a loss for the transferring bank.10 bad loan retention). A mandatory two months of 2014, bringing the While such additional transfers system-wide NPL ratio to 13.9 per- would help, bank profitability is cent, and could increase further likely to remain subdued. New 6 The total capital injection across the three large domestic banks (NLB, NKBM and Abanka) in the absence of effective debt activity is unlikely to reach the pre- amounted to about EUR 3 billion (of which EUR 2.1 billion in cash). The face value of the NPLs restructuring, especially of overlever- crisis levels any time soon, and new transferred to BAMC amounted to EUR 4.6 billion. 7 For the EUR 3.3 billion NPLs already acquired from aged corporates. High NPLs divert income-generating opportunities will NLB and NKBM, BAMC paid an average price of bank resources from core activities emerge only slowly, as the economic about 30 cents on the euro. 7 Bank of Slovenia (2014) reports that 7 percent to NPL workouts, weigh on banks’ recovery gradually takes hold. This of claims against non-financial corporates were profitability, hinder extension of new calls for reducing administrative already in arrears, but not for more than 90 days, and thus not included in the NPL count. credit, and push up interest rates on costs accordingly, including through 8 According to Bank of Slovenia (2013, page 43), genuinely new loans. Ever‑greened further banking sector consolidation. loans to restructure loans in arrears (ever-greening) accounted for 47 percent of loans for the overall loans also crowd out the flow of Going forward, there is a need banking system in 2012 (and as high as 55 percent among the large state-owned banks). 8 credit to viable firms. to strengthen the banks’ govern- 9 See, in particular, the last paragraph on page 16 Moreover, the BAMC’s effective- ance and supervision frameworks of BAMC (2014). 10 If the transfer takes place at a value which ness in facilitating restructuring to prevent the re-emergence of the exceeds the market value of the loans, then has been impeded by incomplete vulnerabilities that led to the accumu- transferring banks would be in effect receiving state aid, and thus the transaction would need to be transfers of exposures of borrowers lation of problem loans following the approved by DG COMP.

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Corporate savings and investment 2005-2013 cent of all firms that have some debt. (4-quarter moving average, billion euros) The debt overhang is macro-eco- nomically relevant: firms for which the interest bill exceeds earnings account for 16 percent of total em- ployment. Within this broad picture of financial stress, debt to earnings ratios are especially high for large corporates, which helps explain the NPL concentration pattern, and for micro enterprises (those with fewer than 10 employees), which poses additional challenges to restructuring frameworks. Corporate debt overhang weighs on credit growth, investment, and eco- Source: Statistical Office of the Republic of Slovenia. nomic recovery. On a macro level, evidence suggests debt overhang leads to worse macroeconomic out- transfer of all written-off corporate leverage ratio benefitted from the sta- comes. This is most starkly evident in claims to the BAMC would increase tistical write-off of loans transferred to the investment expenditure; Slovenia’s its effectiveness in restructuring over- the BAMC to the transfer price levels investment to GDP ratio declined indebted corporates. in the last quarter of 2013.11 to 18 percent during 2012–13, the Notable variations in company lowest rate recorded in the country’s IV. Tackling corporate debt performance by sector, size, market history. There is also micro evidence overhang to revitalize credit orientation, and ownership shed light in the Slovenian context that leverage demand on the origins of the problem as well indeed damages firm performance. as on possible solutions. Leverage is For example, Gabrijelcic et al (2013) Corporate debt overhang is weigh- lower and debt service is more man- find a significant negative link be- ing on investment and growth. ageable in exporters. While there is tween leverage and firm performance Urgent progress is therefore needed not a significant difference in leverage in both pre-crisis and post-crisis peri- to reduce corporate leverage and to levels between foreign-owned and ods. Similarly, Damijan (2014) finds create conditions for a healthy revival domestically-owned firms, the former that the extent of financial leverage in the demand for credit. have significantly better earnings rela- and ability to service debt reduces tive to their interest expense. These firms’ productivity growth, as well as What is the situation now? stylized facts suggest that the origin of the growth of exports, employment, the problem likely lies in the pre-crisis and investment. Corporates remain overleveraged, non-tradable investment boom, and both relative to their euro area peers concomitant leveraged mergers and What is the way out? and historical trends. This is mainly buyouts. A similar picture arises from due to a lack of equity, as corporate the sectoral distribution of leverage Debt restructuring and subsequent debt to GDP is about the euro area ratios where real estate, construction, equity injections are key to restoring average. After peaking at 146 per- and financial sector (mostly financial the health of many highly-indebted cent in 2008, the overall debt to holding companies) stand out in terms corporates and restarting sustain- equity ratio has moderated gradually of leverage ratios, whereas manufac- able credit growth. Continued to 123 percent in 2013. The delever- turing remains below average. gradual debt repayment from these aging initially reflected the winding Financial distress is widespread. firms’ own resources implies years down of failed companies, and in the Damijan (2004) reports that more last two years net repayment of debt than 15,000 companies suffer from 11 This treatment had an impact of about 6 percentage points in the leverage ratio (Bank of by going concerns, as corporates debt overhang (defined as having Slovenia, 2014). From an economic viewpoint, the have turned into net lenders to other net debt in excess of four times their statistical treatment does not provide actual relief to the borrowers who are still legally liable for the full sectors (see chart). Finally, observed EBITDA), comprising about 45 per- amount.

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Exporters are less leveraged and are better able to cover their interest expenses with earnings. Net debt to equity (percent) EBIT to interest expense 1/ (percent)

While private domestic firms’ leverage has declined, their interest coverage lags that of foreign firms. Net debt to equity (percent) EBIT to interest expense 1/ (percent)

Debt-to-equity ratio remains high in the non-tradable sectors. Net debt to equity (percent)

Sources: AJPES, and IMF and BoS staff calculations.1/ EBIT stands for earnings before interest and taxes.

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Slovenia: Investment to GDP (percent) Leverage in 2008 and investment decline, 2012-2014

Source: Eurostat Sources: ECB and Eurostat. of corporate underperformance and distress. Such a strategy could benefit state-owned banks as described in financial volatility, which Slovenia from regular monitoring to identify and the previous section, covering both cannot afford. Equity injections are address any bottlenecks and gaps. new debtors and remaining assets of needed; however, it is clear that debt On the legal front, an effective debtors that already saw part of their overhang makes voluntary equity corporate insolvency regime would debts transferred to the BAMC to injections less likely to take place in be necessary to swiftly rehabilitate maximize recovery. firms where they are most needed. viable companies and liquidate non- Rebuilt financial buffers need to be Moreover, debt restructuring is only viable ones. In this respect, the 2013 put to good use. Strengthening the worthwhile in cases where the firm’s amendment to Slovenia’s bankruptcy balance sheet of the financial sector underlying business model is vi- law is a step in the right direction. The and realistic provisioning for inevi- able, or else the firm will find itself in prior legal framework proved com- table losses is a necessary but not financial strains again in the future. plex and rigid, and overly protective sufficient condition to resume credit In some cases, viability requires op- of debtors, allowing them to block or growth. As long as banks refrain from erational restructuring as well as debt delay restructuring. It also reportedly drawing on provisioning and entering restructuring. did not provide useful tools for reha- into restructuring, corporate debt International experience suggests bilitating viable firms. The amendment overhang will persist. There may be that there are great benefits from helps reduce these problems by in- managerial, legal, and tax-related corporate debt restructuring when it troducing a simplified pre-insolvency incentives in banks to avoid write-offs takes place within a comprehensive regime and an enhanced compulsory and debt restructurings which need to strategy. For policy-makers, the key settlement procedure. be addressed. is to create an environment which The recently established BAMC For the small- and medium-size incentivizes debtors and creditors to can be helpful, if supported by all enterprises (SMEs) in need of debt engage in meaningful debt resolution stakeholders. The high concentration restructuring, additional measures and attracts potential deep-pocketed of NPLs in a few corporates suggests may be needed. While creditor coor- new investors with the expertise and that a large reduction in leverage can dination problems take a back seat, resources needed to turn viable be achieved by involving relatively small enterprises are particularly at businesses around. A comprehensive few parties in restructuring negotia- risk from debt distress, as restructuring strategy should encompass legal and tions. By collecting claims from the is held back by the generally secured tax incentives for debt restructuring, three biggest banks and potentially nature of claims that incentivizes fore- adequate capitalization and provision- supplementing these claims with closure over rehabilitation. Moreover, ing in banks, effective use of an asset NPLs purchased from other banks, claim sizes are too small for banks management company, provision of the BAMC can drastically reduce to negotiate over especially in the new financing for distressed but viable creditor coordination problems. The absence of good financial data and firms, and outreach and financial effectiveness of the BAMC could be information about business prospects. counselling services for companies in increased by further transfers from To address the specific needs of small

BV 11/2014 19 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH enterprises, a multi-pronged strategy Currently, the state owns and controls recapitalize the largest banks, further that encompasses legal reform, incen- substantial sections of the economy measures are needed to cleanse tives for debt restructuring, improving through an elaborate (and often non- bank balance sheets from the remain- the health of the banking sector, transparent) holding structure.12 The ing overhang of NPLs and to unlock possible use of an asset management state can divest its holdings through credit supply. On the corporate side, company (as in Korea (1997), Ma- privatization and strengthen corpo- work has already begun to strength- laysia (1998), and Sweden (1992)), rate governance by encouraging the en the bankruptcy regime and use the provision of new financing for consolidation and simplification of BAMC for corporate restructuring. distressed but viable SMEs, and debt ownership structures. Relinquishing Looking ahead, it will be important to counselling services for SMEs would ownership and control of state-owned fully avail of the BAMC and improve be useful. Standardized approaches banks can be particularly helpful, its effectiveness by completing NPL for restructurings (used in Iceland as the notable underperformance of transfers from banks. At the same (2011) and Turkey (2001)) can also state-owned banks in terms of asset time, privatization of government- help simplify negotiations by provid- quality (documented above) attests. owned and controlled companies ing simple tests for viability and a set For remaining state-owned enterpris- should continue to improve their of harmonized restructuring terms. es, unified, professional, independent, financial and economic performance Foreign capital can play an im- and accountable management is of and attract investors capable of portant role in revitalizing the key importance. The new Slovenian injecting much-needed additional corporate sector. As the restructur- Sovereign Holding, d.d. can prove equity (including through FDI). ing and deleveraging process goes useful in this regard. The road ahead is difficult. While the on, banks and the BAMC will find reforms discussed in this paper are themselves in ownership of equity necessary, they are unlikely to gener- and equity-like claims. The BAMC is ate immediate results — it will take intended as a temporary institution some time before credit resumes and with a sunset clause five years from A comprehensive the economic activity reaches its pre- its establishment. And banks are not crisis levels. Even if bank recapitaliza- well positioned to become long-term strategy for debt tion can be carried out relatively fast, corporate owners. Thus these claims completing corporate restructuring will need to be sold to financially and restructuring is may take years, given the size and operationally sound buyers. Here, the complexity of the problem. Yet, FDI is the most plausible source of needed. successful corporate restructuring is fresh equity and should be provided essential to prevent bank problems with a level playing field. from recurring in the future and to lay Nonbank financing sources can be the foundation for productive invest- considered. To the extent that banks ment and stronger employment crea- are the factor that constrains credit, V. Conclusion tion. This underscores the importance nonbank financial channels can be of timely action by the government to helpful. For larger corporates, direct Slovenia is at a crossroads. The put in place the necessary reforms. access to capital markets may be a economy has started to recover from plausible alternative, most likely out- the worst financial crisis and deep- side Slovenia. Efforts to reduce legal est recession in the country’s history. and tax-related complexity of bond Yet, corporate and bank balance issuance can help expand this option sheets remain weak, holding back an to a wider set of companies. Such expansion in bank credit, investment, efforts helped start a ‘mini-bond’ and employment. A strong and sus- market in Italy, which is not large but tainable recovery is far from assured. holds promise. Early and decisive action is there- Looking ahead, strengthening fore needed to address balance corporate governance would guard sheet weaknesses, restore credit 12 Georgieva and Riquelme (2013) estimates at least 11 percent of employment is in enterprises against a repetition of the current growth, and support a durable directly or indirectly owned by the state, including problems. This would involve reduc- recovery. While important steps the banks. Using a broader definition, Ogorevc and Verbic (2013) estimate one third of assets in the ing state involvement in the economy. have been taken to restructure and economy can be traced to the state.

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REFERENCES: Article IV Consultation Selected Issues “Assessing Policies to Revive Credit Damijan, J. (2014), “Corporate Markets”, in Global Financial Stability Abiad, A.G. Dell’Ariccia, B. Li (2011), Report, chapter 2. “Creditless Recoveries”, IMF Working Paper financial soundness and its impact WP/11/58 on firm performance: Implications for International Monetary Fund (2013), corporate debt restructuring in Slovenia”, “Republic of Slovenia: Staff Report for the Bijsterbosch, M and T. Dahlhaus (2011), Working Papers 168, European Bank for 2013 Article IV Consultation”. “Determinants of Creditless Recoveries”, Reconstruction and Development, Office of ECB Working Paper 1358 Lindstrom, N., D. Piroska (2007), ‘The the Chief Economist. Politics of Privatization and Europeanization BAMC (2014), “Unaudited Annual Report Gabrijelcic, M., U. Herman, A. Lenarcic in Europe’s Periphery: Slovenian Banks 2013”, April 2014 (2013), “Debt Financing and Firm and Breweries for Sale?’ Competion and Bank of Slovenia (2013), “Financial Stability Performance before and during the Crisis: Change, vol 11, no. 2, pp. 117-135 Review”, May 2013 Micro-Financial Evidence from Slovenia”, Ogorevc M. and M. Verbic (2013) Bank of Slovenia (2014), “Financial Stability unpublished manuscript. “Ownership and wages: Spatial Review”, May 2014 Georgieva S., and D. M. Riquelme (2013), econometric approach”, International Barkbu, B., P. Berkmen, P. Lukyantsau, S. “Slovenia: State-Owned and State- Journal of Sustainable Economy, vol. 5(2), Saksonovs, and H. Schoelermann (2014), Controlled Enterprises”, ECFIN Country pp. 207-224. “Investment in the Euro Area: Why Has It Focus, vol 10, no 3. Been Weak?”, in Euro Area Policies 2014 International Monetary Fund (2013),

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UDK 336.71:336.76(497.4) Quantitative easing and non-bank debt financing in Slovenia Marko Simoneti*

QUANTITATIVE EASING here are two big themes for post crisis banking in the AND NON-BANK DEBT FINANCING IN SLOVENIA Eurozone: financial stability and monetary measures to The objective of the paper support growth. The Eurozone solutions are sought in is to explore why the development of non-bank the context of a modern well-developed financial system financial institutions has T become a precondition composed of commercial banking, investment banking, shadow ban- for Slovenia to increase king, non-bank financial institutions and functioning capital mar- the benefits of being a part of the Eurozone. kets. On the other hand, commercial banks in Slovenia are predo- The existence of modern banking integrated with minant financial institutions by holding 75% of all financial assets non-bank institutions is assumed when and companies are financed almost exclusively by bank loans. strategic decisions are made in the Eurozone. Introduction First, we review how monetary policy works in the complex financial Stability of the banking sector has been clearly the first short system and what are the main challenges for term priority with massive government sponsored bank rehabilita- implementing quantitative easing (QE) effectively in tion programs in most Eurozone countries. The developed non-bank the Eurozone. Second, we financial institutions are the advantage as they offer the alterna- analyse why not many direct benefits should be tives for financing at the time when the banking sector is blocked. expected in countries like Slovenia with a small non- They also offer additional opportunities to take actions on time, to bank financial sector. We conclude by proposing design a broad range of bank rehabilitation instruments and to in- financial reforms needed in Slovenia to change this volve the private sector and banks in rehabilitation process as well: in the future. sale of non-core businesses, sale of tradable securities, securitisa- JEL G01 G21 G22 tion of loan portfolios, sale of bad assets, guarantees on borrowing and lending, private sector recapitalisations, issuing of preferred shares, hybrid and other debt funding instruments. In Slovenia the solutions chosen for bank rehabilitation were late coming, simple and expensive for taxpayers: the government was the only impor- tant player buying bad assets from banks and providing liquidity, funding and capital for troubled banks.

* Marko Simoneti, associate professor for money and finance, Faculty of Law, University of Ljubljana.

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In the complex financial systems structure of the paper is as follows: households - that can destroy newly financial stability by definition has to first, we review how monetary created money by paying back old take a broader view of banks and policy works in the complex finan- loans, (3) by micro and macro pru- non-banks. We have learnt in the cial systems and what are the main dential regulation and (4) above all last global financial crisis that both challenges for implementing QE ef- by the monetary policy. (BoE, 2014) types of institutions can be: too big, fectively in the Eurozone; second, we In the normal situation the cen- too important, too complex or too analyse why not many direct benefits tral bank is therefore focusing on interlinked to fail. Long term solutions should be expected for countries the price of base money and not for maintaining financial stability like Slovenia with limited non-bank the quantity of base money as it in the Eurozone are the new micro financial sector and last, we propose is described by the money multi- and macro prudential regulations, what type of financial reforms are plier model in most textbooks. The the banking union, separation of needed to change this. quantity of broad money is therefore investment banking from commercial endogenous, the money multiplier is banking and regulation and super- Conventional monetary policy not stable and the quantity of base vision of shadow banking1. These money depends on the amount rules will change the way how the Monetary policy consistent with needed by banks to carry out their banking business is operated in stable and low target of business profitably. The oldest central Slovenia as well, but they should not around 2% in the modern economy bank in the world has described have dramatic effects on the overall these textbook misconceptions in its financial structure given the simplicity recent report very openly: “Rather of the system. than banks receiving deposits when To support growth and to fight There is no households save and then lend- in the Eurozone ECB has automatic ing them out, bank lending creates been using conventional interest rate deposits. In normal times, the central setting monetary measures, comple- multiplication of bank does not fix the amount of mented by mid-term low cost financ- money in circulation, nor is central ing operations for banks. In Slovenia reserve money. bank money ‘multiplied up’ into more these measures have not been loans and deposits.” (BoE, 2014) channelled through the banking sec- tor to the real economy. The lending is implemented by setting the nomi- Unconventional monetary interest rates remain to be high and nal interest rates on central banks re- policy the volume of lending is stagnating serves or the base money. This base for many years. The low cost ECB short term rate is then influencing In the time of recession and deflation- funding was mainly used by troubled interbank interest rates and the range ary pressures, once the basic nomi- banks for repayments of debt on the of other interest rates in the economy. nal interest rate is set close to zero, wholesale market. ECB has recently This base rate is the main input for the conventional monetary policy announced new broad quantitative setting lending and deposit rates has reached its natural limit. On the easing measures (QE) following the by banks and for determining the other side, the short term real interest examples of FED and Bank of Eng- size of their lending activities. In the land (BoE) in fighting recession and modern economy most of the money deflation. Details of this program are is created by commercial banks’ 1 Former Federal Reserve Chair Ben Bernanke provided a definition in April 2012: “Shadow yet to be announced, but securitisa- lending and simultaneously creating banking, as usually defined, comprises a diverse set of institutions and markets that, collectively, tion, non-banks and shadow bank- matching deposits in the account carry out traditional banking functions--but do ing institutions will be important as of the borrower. On the other side, so outside, or in ways only loosely linked to, the traditional system of regulated depository institutions. additional channels for allocation of the amount of overall broad money Examples of important components of the shadow banking system include securitization vehicles, new money in the economy. creation and bank lending is limited asset-backed commercial paper (ABCP) conduits, money market mutual funds, markets for repurchase The objective of this paper is to (1) by the profitability concerns of agreements (repos), investment banks, and mortgage explain why the development of non- banks in the competitive financial companies.” Shadow banking has grown in importance to rival traditional depository banking bank financial institutions and capital environment; (2) by the macroeco- in debt financing and was a primary factor in the subprime mortgage crisis of 2007-2008 and global market in Slovenia has become a nomic situation and the behaviour of recession that followed. Regulated non-bank financial precondition to increase benefits bank customers – mainly corporates, institutions like insurance companies, pension funds and equity mutual funds are not considered to be a of being part of the Eurozone. The non-bank financial institutions and part of shadow banking (see FSB, 2013).

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Figure 1: Impact of QE on balance sheets of banks and non-banks rectly to customers and they will not be automatically multiplied into more Before asset purchase After asset purchase loans and deposits (see Figure 1). Pension fund Assets Liabilities Assets Liabilities How QE works in today´s complex financial systems? Government Other Deposits Other debt Economists generally agree that the interest rate that matters for stimulat- ing investment and consumption (b) Central bank is not the short but the longer term Assets Liabilities expected real interest rate. Any real long term rate is technically a func- Government tion of the main components: average debt expected short term interest rates for Assets Liabilities the period (i.e., the one that can in Reserves principal be influenced by traditional monetary policy every period), a Other assets Reserves Other assets term (duration) risk premium and a credit risk premium, and expected inflation (Fawley and Juvenal, 2013). Commercial bank The monetary policy, being con- Assets Liabilities ventional or unconventional, has to influence these components through various channels to be effective. QE does work on expectations as it Assets Liabilities Reserves Deposits is signalling to markets that economic conditions are worse than previously Reserves Deposits thought and that low short-term rates will be warranted for longer than expected. In a sense by QE the

(a) Balance sheets are highly stylised for ease of exposition: quantities of assets and liabilities shown do central bank even financially com- not correspond to the quantities actually held by those sectors. The figure only shows assets and liabilities mits itself to easy monetary policy relevant to the transaction. (b) Government debt is actually purchased by the Bank of England’s Asset Purchase Facility using a loan from and low interest rates for the longer the Bank of England, so does not actually appear directly on the Bank’s official consolidated balance sheet. time period. After QE is implemented the central bank is holding a large Source: Bank of England (2014) portfolio of bonds and if the interest rate and other longer term real inter- companies. QE initially increases rates are to be increased very shortly est rates can still be too high. One the amount of bank deposits those the potential losses on portfolio can possible response to provide ad- companies hold (in place of the be spectacular.2 The effects of QE ditional stimulus to economic activity assets they sell). Those companies on long term inflation expectations by the central bank is to undertake a will then wish to rebalance their critically depend on when and how series of asset purchases, increasing portfolios of assets by buying higher- the exit from this policy is to be the amount of central bank reserves yielding assets, raising the price of implemented which is at present the in the system or so called quantity those assets and stimulating spend- main topic in US. Effects of QE on easing. ing in the economy. As a by-product expectations are generally referred The BoE report (2014) is describing of QE, new central bank reserves to as the signalling channel.3 the basic logic behind this measure are created. But these are not an very clearly: “QE is intended to important part of the transmission 2 For example, FED and BoE have increased boost the amount of money in the mechanism.” Therefore, the same as their balance sheets five times during the current economy directly by purchasing as- in the conventional monetary policy, economic recession and they hold respectively about one third and one half of the outstanding sets, mainly from non-bank financial these reserves cannot be lend out di- government issued securities.

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Figure 2: Key channels for the impact of The Bank of England´ gilts purchases on domestic demand

Portfolio substitution channel (always operates) Term premia ↓ Yields on long-dated Wealth ↑ risky assets ↓ Gilt yields ↓

Bank of Cost of accessing Credit risk Domestic England gilt credit in financial premia ↓ demand purchases markets ↓

Bank deposits and liquid Availability of assets ↑ bank credit ↑

Bank funding channel (may operate in conditions of stressed bank funding)

Source: Miles, D., Bank of England (2012)

QE may also directly impact term funding channel through which corporations as well. Therefore, and/or credit risk premiums on the QE works, particularly at times of premiums for longer maturity and for financial markets for the range of stress in bank funding markets. This credit risk in debt instruments were debt instruments. If the central bank happens when banks themselves both reduced to support economic purchases longer term bonds, remov- take advantage of lower long term activity and resume economic growth ing them from the market, prices will interest rates on the market to obtain in UK. The same channel has worked go up and required long term returns more stable and low cost funding for strongly in the USA as well where down. New money issued to inves- themselves (e.g., as a result of banks due to the size of the intervention tors in exchange for bonds acts like issuing new bonds or taking in long the impact of additional liquidity on “hot potato”. It is pushing the inves- term deposits from non-bank institu- the markets has been felt globally tors out of balance in their chosen tions selling the bonds) which is likely by reducing long term interest rates portfolios and they start to buy other to facilitate bank lending, particu- for foreign sovereign debt as well more risky assets like non-govern- larly for those entirely dependent on (Neely, 2012).4 ment bonds and equities, raising their banks for credit, for example SMEs The evidence for the working of bank price, reducing the required returns (see Figure 2). funding channel on economic activity and the spreads above risk free re- is less convincing. The banks might turns. There are wealth effects for the QE in the market based well choose to participate in this new owners of these financial instruments financial systems asset price really on the financial and reduced rates for new issuing markets instead of looking for new of these instruments, both stimulating There is strong empirical evidence opportunities in the financing of the consumption and investment. With that the portfolio rebalance channel reduced returns on longer term and of QE is working well in the current more risky assets the moral hazard recession in the economies with well- 3 The best example of effectively using the signalling channel to influence the selected markets and negative selection problems on developed non-bank financial sector. was the statement of the ECB President Mr. Draghi at the pick of the euro sovereign bond crisis that the bank lending are mitigated as Miles (2012) is reporting for UK that ECB is ready to do whatever it takes to protect euro. well, improving the bank lending the purchase of longer term govern- This OMT program from 2012, with potentially unlimited capacity to buy sovereign bonds, has conditions in support of economic ment bonds has reduced not only the never been even implemented in practice but market participants reacted with substantially lower activity. Effects of QE on premiums, longer term returns on government required returns for troubled euro member countries. or relative asset prices, are referred securities (changing the 4 Slovenia was a non-intended beneficiary of this policy, selling new bonds when this window of to as the portfolio rebalance for government bonds), but reducing opportunities opened on the high yield market and channel (see Figure 2). the spreads for more risky debt instru- avoiding the international financial assistance that would include conditionality by troika (IMF, ECB, There is another possible bank ments of financial and non-financial EU).

BV 11/2014 25 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH real economy. There are many other interventions during the crisis had to out the ECB intervention in providing side effects of these measures on take these structural and institutional refinancing for over-leveraged banks foreign exchange and equity markets limitations into account. The largest the credit crunch in the Eurozone as well. Only the future will tell if ECB programs - long term repur- would be much deeper (Rant and this general inflation of asset prices, chase operation (LTRO) and the new Gregorič, 2014). It should not come which has been the key part to revive targeted LTRO, being conditional on as a surprise that banks with capital the growth in the short term, will be new financing of non-financial sector adequacy concerns would be very translated into long term and sustain- - can hardly be compared with QE reluctant to increase lending as well. able growth of US economy as well programs in US and UK. ECB is cre- The non-participation of the EU banks or it is only the beginning of the next ating additional reserve money by in the first round of TLTRO in the fall asset price bubble. For the rest of the providing banks with medium term 2014 is the case in point. Systemi- world, including EU, this is more or financing at low cost and expending cally important banks are waiting for less an academic issue as they have its balance sheet with wider range the final results of stress tests and they practically no choice but to follow of eligible assets taken as collateral. find little interest in new funding and the US and UK lead in this area. The purchase of sovereign bonds implicit commitments to new lending from banks is therefore indirect and before they now how much addition- QE in the Eurozone with al capital will be needed for existing no “Eurobonds”? portfolio of loans. QE measures in the US and the UK It is interesting to note that the real are targeted at non-bank financial intention of QE programs is to lower ECB measures institutions holding large portfolio of interest rates for private debt, while government bonds and banks serve the purchase in US and UK is made can hardly be only as intermediaries to unbalance almost exclusively of risk free govern- their asset mix. For participating ment debt. Why the central bank compared with banks (prime dealers in the US) this is not buying these private debts QE in US and “dancing with the central bank” is directly? This would imply that the rather lucrative and low risk activity central bank is taking on the bal- UK. as long as the program last as prom- ance sheet not only the market risk ised. Therefore, banks willingness associated with the change in the to participate in QE to unbalance interest rate level but the credit risk of the portfolios of non-banks is really individual issuers as well. This is very temporary. But additional reserves in not a problem, but willingness of relevant for the ECB as there are no banks do not automatically multi- banks to increase their own lending bonds issued on the level of the Euro- ply into cheaper new lending and depends on many other factors in the zone while they are institutional limits money creation as in the textbook economy. on buying bonds of the member money multiplier model. countries. In addition, at present sov- Precondition for this bank funding QE in the Eurozone ereign bonds of some of the member channel to work at all is that banks and securitisation countries are not really risk free.5 The are financially stable and new financial system in the Eurozone (and lending is profitable. Many of the The ECB has already announced the Japan as well) is also much more banks used this ECB facility simply to beginning of its own version of QE bank based than in US and UK and refinance their liabilities on the whole- that will be focused on purchasing the portfolio unbalance effect in the sale banking market (including the non-banking sector will be auto- banks from Slovenia) but the overall 5 Buying such bonds in large quantities for monetary purposes would be far from neutral operation for matically smaller (Fawley and Neely, lending to non-financial corporate member countries. As critics are quick to say this would be the same as bailing out troubled countries 2013). The banking channel has to sector has remained stagnant. In and subsidizing their banking institutions which are play more direct and important role addition, the fragmentation of the usually holding a large portion of domestic sovereign bonds. One can argue that similar credit risks are in fighting the deflationary pressures banking sector in the Eurozone in this present at least partially in US where government agencies guaranteed mortgage backed securities in the Eurozone as this is the only period has been further increased (MBS) were part of the QE purchase as well. FED has already announced the exit from QE program large enough channel that exists in with wider dispersion of bank interest at the end of 2014 with the intention to hold many member countries. rates for corporate clients. On the accumulated assets till maturity. This in turn means that FED will be an important participant in housing The ECB unconventional monetary other side, it can be argued that with- finance in US for many years to come.

26 BV 11/2014 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH structured products like asset back the capital markets to complement for professional investors. Offering securities (ABS) and collateralised traditional bank financing. These disclosures and regular reporting debt obligations (CDO) in support of policy measures will be reviewed requirements for minibonds are lower financing SME sector in the Euro- in the next section as we believe than for retail bonds, no prospectus zone. Paradoxically, securitization of there are lessons to be learned for is needed, and sensitive information loans and practice of distributional Slovenia. It seems that the future of reporting is limited to major events, banking used for subprime hous- corporate financing in the Eurozone all reducing the costs of issuing for ing loans in US that were the main will become much more like in US SMEs. To issue short term notes reasons for the global financial and UK, where securitisation, capital SME has to nominate professional meltdown are proposed by the ECB markets, non-bank financial institu- sponsor. Minibonds can be partici- as a solution to overcome recession tions and shadow banking will play patory providing they have at least in the Eurozone. It will be interest- an important role beside commercial three years duration and they pay ing to observe what will be the size banks. To benefit from these develop- at minimum the ECB base interest of the program and the eligibility ments Slovenia should, like it or not, rate. Therefore, bondholders can criteria. Will it be possible to include adjust to this new trend as soon as participate in the profit of the SMEs in the programme the mezzanine possible. and share the risk with the owners of tranche in addition to senior tranche the SMEs. Corporate tax treatment of these structured securities? More Minibonds and of this profit sharing with creditors is broad definition of eligibility will be securitisation in Italy the same as for regular interest pay- needed to have large enough vol- ments, providing that bondholders do umes to make an economic impact Italy, like most continental European not have more than 2% ownership but that would imply the ECB helping countries, have had for many years a stake in SME. Minibonds are traded banks to save regulatory capital and typical bank based financial system on the special segment of the stock assuming additional credit risk that with the great majority of companies exchange reserved for professional might well be larger than in the case almost exclusively relaying on do- investors trading in bonds, commer- of buying directly sovereign bonds. mestic banks for short and long term cial papers and project bonds. It With the fully integrated financial financing. Bond financing was used should be very easy to use the same markets one can argue that simula- only by a few large listed companies market infrastructure to organise tive effects of increased asset prices and financial institutions which could centralised book building process on and reduced required returns are attract international investors as well. the primary market for minibonds as broadly distributed to investors in With the objective to improve SMEs well. All these institutional arrange- all asset classes and to all poten- and unlisted companies access to ments are making transactions with tial issuers. But the reality of the debt financing on the capital market minibonds cheaper and more easy Eurozone is that financial sector is and support economic growth, Italy to use by institutional investors who fragmented and capital markets are introduced in December 2012 a received also some regulatory reliefs less important than in the market special legislation for minibonds and in Italy to buy minibonds. based financial systems. Who owns commercial papers. In December The minibond instrument is risky by the assets to be purchased, who can 2013 this was accompanied by a its nature as it issued by SMEs and, generate new assets to be purchased new securitisation law, regulating in addition, interest payment can be and who is to be chosen to “dance establishing of SPVs to acquire cor- participatory. As they are not ap- with the central bank” in the Euro- porate loans and securitise them. The propriate for retail investors, require- zone might well become the major legal framework to build up domestic ments can be lowered, but some political issue. shadow banking is in place. Banks standardisation is needed to achieve Countries like Slovenia, with no can now set up investment funds with the main objectives, to support the domestic market for corporate debt securitisation of existing portfolio of program by favourable tax regime securities and limited experience in loans by retain a large part of first and to promote the broader use of securitisation will likely receive mini- loss equity tranche or start new debt mal direct and indirect benefits. On funds with outside investors.6 6 See for example Vestini, Tancredi (2014) and Linhard (2014). It seems that Italy has anticipated the other side, some larger member Minibonds can now be issued by well in advance the ECB measures focused on the support to SME financing. In addition, institutionally countries like Italy have already SMEs that are not listed on the Italy is well positioned to take the advantage of QE made major steps forward to encour- stock exchange and they are not program focused on ABS and CDO securities, once details are disclosed by ECB President Mr. Draghi in age debt financing of SMEs on intended for retail investors but only October 2014.

BV 11/2014 27 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH new instruments. These instruments in during the financial crisis from 30% institutions. At the same time, domes- Italy seem to be well adjusted to the in 2009 to 45% in 2013. The mutual tic insurance companies and pension financing and operational reality of funds, mostly equity or mixed funds funds are forced to look for better SMEs as they are half-way between are 70% to 80% invested in foreign returns in alternative investments at bank financing and public bond securities. A few money market funds home and abroad. On the regula- financing. Extensive financial cov- and debt funds have been created tory front, the introduction of the new enants as in the banking loans are recently but they are still small in size. life-cycle investment policies in pen- combined with the standard public Real estate funds and hedge funds sion funds will increase the demand bonds provisions of negative pledge, are not present at all. Foreign asset for shares and corporate bonds, “pari passu” and limited restrictions management companies have mostly while the introduction of solvency 2 on asset disposal and extraordinary left the country during the financial in insurance industry will likely switch transactions. crisis. Pension funds have at present demand from longer term to shorter very conservative investment policy term debt instruments. Therefore, in Debt financing and the due to legally required minimum the near future some changes in in- capital market in Slovenia return and they are mostly invested in vestment policies are expected, some government bonds and deposits. additional de-satisfied retail and The size of the Slovenian financial institutional bank depositors might system has been reduced to 161% of be attracted, but the overall organic GDP during the financial crisis and it growth of the non-bank institutions remains small compared to the 612% Banks' will depend mostly from the improve- of GDP in the Eurozone. Banks with ments in disposable income of house- 75% of the assets under manage- deleveraging in holds due to economic recovery and ment are dominating players despite reduced . the contraction of the lending activi- Slovenia was Financial crisis always leads to ties in recent years, while the other deleveraging of banks and cor- non-bank financial institutions have »brutal« porates, but “good” deleveraging been underdeveloped in terms of would try to minimise the negative size, structure and variety of financial to corporates. impact of this process on economic instruments. In addition, the cross- growth. The deleveraging of banks in linkages with the banking sector are Slovenia was “brutal” to the cor- not very strong as the main investors Contrary to the banking sector this porate sector that depends almost in all non-bank institutions, includ- part of the domestic financial indus- entirely on bank financing. Between ing the investment funds, are retail try was able to survive the implosion October 2008 and March 2014 investors. The organized domestic of equity and real estate price bub- the banks´ repayment of debt on capital market is small and suffers bles and the long lasting economic the wholesale markets exceeded from low liquidity and remains off recession without the assistance of 32% of GDP. The main counterpart limits to companies and other entities the government. It also showed a of these repayments was reduced as an alternative source of financ- lot of resilience in the recent tur- bank financing for corporate sector ing. The five most heavily traded moil caused by the collapse of the and sharp increase in cost of debt prime market shares accounted for domestic banking sector where the financing (BoS, 2014, p. xii). The LTD more than four-fifths of total volume losses due to investments in shares, ratio in the banking sector was in this of trading with 64 listed companies hybrid and subordinated debt instru- period reduced from 160% to 103% and two most heavily traded bonds ments issued by domestic banks were and business models of both foreign- accounted for nearly one-half of the substantial. The consolidation of the owned and domestic-owned banks total volume of trading. (BoS, 2014, industry is close to complete and were transformed into simple savings p. 84- 98) surviving institutions are financially and loans institutions on the domestic At present non-bank financial strong and profitable. market. With the government assis- institutions are not very relevant for In 2014, the bank deposit rates in tance in the amount of close to 12% domestic corporate financing as they Slovenia were sharply reduced due of GDP the banking sector is now mostly invest in government bonds to BoS intervention which might in- well capitalised and liquid, but the and foreign assets. The insurance duce some bank depositors to switch lending activity is still low and inter- sector has increased its foreign assets their savings to alternative non-bank est rates for corporate lending about

28 BV 11/2014 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH

3% to 4% higher than in Eurozone Figure 3: Interest rates on corporate loans of more than euro (see Figure 3). 1 million in percentages in comparison with the euro area The precondition for overall credit growth is the restructuring of over- indebted corporate sector that is lagging behind banking sector in re- structuring of their balance sheets. It is estimated that this excessive corpo- rate debt might be around one third of GDP and is not limited only to a few large debtors but to thousands of SMEs as well (UMAR (2014) and Damijan (2014)). It is clear that organised and coordinated efforts of the BAMC, banks and the govern- ment will be needed to financially restructure these companies and secure them new equity financing before they can take on new loans ( Source: Bank of Slovenia (2014) Simoneti and Jašovič (2013), Simon- eti (2014a, 2014b)). even on domestic market as deposit were not really welcomed (Šušteršič, Based on the BoS survey on the ac- rates were sharply decreased. There IER, 2010). cess to finance from 2011 to 2013 have already been first transactions With the banking crisis and the availability of bank loans has dete- indicating that a handful of qualified collapse of this development riorated, bank rejected more applica- domestic companies will seize the model many new opportunities have tions and companies received fewer opportunity to replace expensive opened for the debt and equity funds than they demanded. They domestic bank financing with debt capital market development to as- increased their demand for external financing on the capital market. But sist in solving the main economic financing in the period while the sup- for most of the companies in Slove- challenges of Slovenia: restructuring ply did not follow and the financial nia, being SMEs, this is not a solution of banks and companies, privatisa- gap has increased. Most compa- unless there is a radical change in- tion, corporate governance in state nies still do not expect that external troduced on the supply and demand owned sector, new equity financing, financing in Slovenia will improve in side of the market. foreign financing of domestic econ- 2014 (Geršak, 2014). omy through non-bank channels, Good companies are trying to es- Conclusions long term households savings and cape from this long lasting financial pension reforms. An extensive study repression on domestic bank loan The underdeveloped capital market from 2010 served to form a broad market by borrowing from abroad, and non-bank financial institutions in consensus of the financial industry which is available to big traditional Slovenia are by-product of the distri- participants what should be done exporters and by issuing debt instru- butional model of mass privatisation, for the revival of the capital market ments on the capital markets, which non-transparent and bank supported in Slovenia.7 A comprehensive and is limited to large and financially domestic consolidation of ownership, consistent package of measures to in- sound companies. Financial experts large residual state ownership and of crease confidence in the market and estimate that only 5 to 10 Slovenian the key role played by state owned quality of the market, to strengthen companies can issue debt instru- banks in the gradual transition to the the supply side and demand side of ments on international markets due market economy. In the transition and to minimum size and rating require- development model based on strong ments. Additional 50 companies relationship among the state and 7 The new strategy for development of the capital might have the size and the quality domestic financial and corporate market was drafted based on the initiative proposed by the Ljubljana Stock Exchange, proposals by market to issue bonds and notes on the sector, supported by the ideology of participants and the research conducted by the domestic market. The demand for “national interest”, transparency and Slovene Institute for Economic Research (IER) entitled »Development Opportunities for the Capital Market in these instruments is at present strong disclosure rules of the capital market Slovenia Following the Financial Crisis« (2010).

BV 11/2014 29 ECONOMIC ACTIVITY, BUSINESS CYCLES AND CREDIT GROWTH the market and to improve market they are making big steps forward in Linhard, Stefanie: Italy innovates with minibonds to fill SME lending vacuum, infrastructure was agreed upon that closing this gap. Is there a lesson for Global Capital, 03 March 2014. 8 is still relevant four years later. This Slovenia, to use minibond concept McLeay, M., Radia, A. & Thomas, R.: paper only adds one more opportu- for alternative new financing of Money creation in the modern economy, Quarterly Bulletin, Bank of England, nity for non-bank institutions to play a SMEs and, above all, to use secu- (2014). positive role in the economy: increas- ritisation of existing corporate loans Miles, D: Asset prices, and the ing the benefits of the Eurozone once the financial restructuring of wider effects of monetary policy, Bank of England (2012).www.bankofengland. membership for Slovenia. over-indebted borrowers is complet- co.uk/blications/Documents/ The expansionary monetary meas- ed. For such a program to work we speeches/2012/speech549.pdf. ures of the ECB have not been trans- need (1) a supportive legal, tax and Neely, Christopher: “The Large-Scale Asset Purchases Had Large International Effects.” mitted into new lending and lower institutional environment, (2) motivat- Federal Reserve Bank of St. Louis Working interest rates for the real sector in Slo- ed and capable issuers in corporate Paper 2010-018D, April 2012. venia. Therefore, the new monetary and banking sector and (3) strong Rant, V. and Gregorič, J.: ECB policy policy of ECB focusing on corporate foreign and domestic demand. With measures and their effects during financial crisis, Bančni vestnik, 2014, letnik 63, and SME financing through TLTRO the ECB announcing QE programs številka 7-8. and QE seems like a very timely and the main constraint is no more on Marko Simoneti, Kruno Abramovič, Aleš relevant measure for Slovenia. But the demand side but on the limited Berk Skok, Jože P. Damijan, Igor Masten, Simon Mastnak, Mojmir Mrak, Matija how can these proposals work in the domestic professional capabilities to Rojec, Janez Šušteršič, Luka Vesnaver: system which is dominated by banks design the overall framework and to Razvojne priložnosti trga kapitala v Sloveniji po finančni krizi - Development that are still burdened with more than execute transactions. The by-product Opportunities for the Capital Market in 20% of corporate NPLs after the of the suppression of capital market Slovenia Following the Financial Crisis, IER 2010. http://www.ljse.si/cgi-bin/jve.cgi?d transfer of bad assets to the BAMC development in Slovenia for many oc=12608&sid=oy1xTzkXkWzjxjN3 at the end of 2013? They cannot years is that there is a lack of invest- Simoneti, Marko. Razvojne priložnosti trga because the bank funding channel ment banking skills that are needed kapitala v Sloveniji po finančni krizi? IB does not function if banks are still today to efficiently restructure banks revija, 2011, letn. 45, št. 1/2, str. 67-83. Simoneti, Marko in Jašovič, Božo. under stress and preoccupied with and their corporate clients and Prestrukturiranje podjetij s strani bank upnic their internal problems and most of to take full advantage of the new : kako skupaj iz blokade. Bančni vestnik, the companies are still over indebt- growth promoting initiatives within 2013, letn. 62, št. 7/8, str. 9-17. ed. But even if Slovenian banks and the Eurozone. Simoneti, Marko (2014a). Prestrukturiranje dolžnikov po spremembi insolvenčne companies are once financially re- zakonodaje. Bančni vestnik, jan./feb. structured there would be a problem 2014, letn. 63, št. 1/2, str. 13-17. REFERENCES: as there is no infrastructure available Simoneti, Marko (2014b). »Dobro« Damijan, J. P. (2014), Corporate razdolževanje podjetij v Sloveniji po to securitise bank loans. For many financial soundness and its impact on firm začetku sanacije bank, Dnevi slovenskih years Slovenian banks were using performance: Implications for corporate pravnikov, Podjetje in delo, letnik 40, debt restructuring in Slovenia, Working oktober 2014. wholesale market and parent banks´ papers No. 168, EBRD. UMAR, Ekonomski izzivi (2014), loans for additional funding and they Fawley, B.W. and Juvenal, L.: Quantitative Zadolženost in razdolževanje slovenskih have no experience in securitisa- Easing: Lessons We’ve Learned, The podjetij, junij 2014. regional economist, Federal Reserve Bank tion. The financial system in Slovenia Vestini Luca, Tancredi Marino: The of St. Louis, July 2012. “Destinazione Italia” Decree: New life is operating so differently that the Fawley, B.W. & Neely, C.J.: Four Stories for Minibonds and Trade Receivables proposed instruments cannot be used of Quantitative Easing, Federal Reserve Securitizations, Diritto Bancario, Gennaio Bank of St. Louis Review, January-February 2014. effectively in the near future. (2013). Some countries with traditional bank- Financial Stability Board: Global Shadow based systems and a strong SME Banking Monitoring Report 2013 (2013). sector have already realised that Geršak, Uroš: Raziskava o dostopnosti being different and less developed virov za podjetja – Access to finance 8 See »Slovene capital market development survey, Bančni vestnik, 2014, letnik 63, strategy«, http://www.ljse.si/cgi-bin/jve. in the Eurozone comes at cost and številka 6. cgi?doc=1468

30 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

UDK 336.71:061.1EU Structural changes in European banking and influence on banking business models Robert Priester*

BANK STRUCTURAL fter the financial crisis of 2007 and the international CHANGES response among policymakers to address deficiencies The regulatory reform agenda of the G20 has in bank supervision, the European banking system is at been implemented in the EU via some 40 legislative present seeking to implement and comply with a wide and regulatory measures A that already constitute range of reforms following a sweeping re-regulation with a view to a full structural reform. strengthening banks’ resilience and focussing their role on suppor- The increased and higher quality capital requirements ting the real economy. The new rules will in themselves lead to a combined with new liquidity buffers set banks change in the structure of banking in Europe. on a more solid footing and will force a sharper It is clear that measures such as the new capital and liquidity focus on the capital cost of business lines and activities. requirements, which in principle were meant to be phased in gradu- In addition, measures to ally until 2019, already apply today through market pressure and in make a bank resolvable in an orderly manner and themselves entail a full structural reform. Europe’s banks have been to have banks absorb any losses internally first via busy building the capital levels at an accelerated pace, and some bail-in mechanisms without having to rely on taxpayers EUR 450 billion of the 550 billion capital shortfall identified by the in emergencies will also force bank management Basel Committee at the outset of the crisis have been found alrea- to review their firm’s dy by means of gross new issuance, retained earnings, convertible organisation and structure to satisfy supervisors, who bond issuance and shedding non-core assets or business lines. now already have powers to force a separation of The new liquidity rules, and esp. the long-term liquidity ratio, activities if not satisfied. Europe’s banks are very are expected to change the funding structure of European banks, sceptical whether an additional measure such some of which had in the past a high propensity to seek cheap as proposed on bank short-term funding on the wholesale markets to grow their longer- structural reform with forced separation of -term lending business. The crisis has put paid to this model and some trading activities is still necessary and will has reinforced the attractiveness of a higher proportion of deposits distract from the focus on stimulating growth in as a more stable base of funding. Europe.

JEL G21

* Robert Priester, Deputy Chief Executive, European Banking Federation, Brussels.

BV 11/2014 31 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

Other key pieces of financial services supervisory calls. of supervisors under BRRD they can legislation address excessive risk- A BRRD-inspired process that will be decide that certain activities need to taking by banks in significant ways. mandated from the banks already at be separated out of the main bank Capital Requirements (CRR) and a much earlier stage is the establish- structure. This is, however, not a man- Capital Requirements Directive (CR- ment of a recovery and resolution datory step but one that is triggered DIV) call for substantially higher and plan, or the so-called ‘living wills’, if the supervisors are increasingly better capital layers to build inherent which must pass muster of the super- concerned over the accumulation of resilience of the banks. The cost of visory authorities. Such recovery and risk in certain activities of the bank capital to the banks themselves alone resolution plans demand of manage- under closer scrutiny. will force about a sharper atten- ment that they take a long and hard The bail-in component of the BRRD tion on the uses of the capital and look at their banks’ organisation and will also cause a structural shift in will shape business models to shed structure to put in place processes Europe’s banking sector, where the marginal business lines and markets. whereby parts of a wider banking largest banks will indeed rush to Banks are already refocussing their group can come to the assistance have sufficient bail-inable liabilities attention to core activities and mar- in terms of capital or liquidity for in their balance sheets. It is expected kets as a result. another part of the bank without that the larger banks in Europe will The governance demands of the endangering the survival of the wider be able to find sufficient investors in CRDIV will also make banks’ boards group. In a worst-case scenario the the market for these types of bonds and senior management more atten- resolution side of the plan will guide that deliver a higher return due to the tive to the business lines and activities the supervisory community on the conversion or haircut risk they carry to pursue. The sharper responsibility steps that can and need to be taken in case of crisis. The larger banks that these officers will carry within to salvage the viable parts of a non- also have an inherent advantage of the bank they preside should cause a viable bank if all earlier measures already having a more diversified shift in the composition and skillset in have been to no avail. Rather than range of creditors and correspond- the boards of many banks, and first facing these tough decisions over a ing liabilities. The challenge will signs are appearing that non-execu- weekend with little clarity on a crum- be for smaller banks with less such tive board members are shying away bling bank’s positions and structure, diversity in their balance sheets to from such responsibility levels. Es- the recovery and resolution plans will find under wider market pressure the pecially when in other sectors more give supervisors insight into structure investors at affordable pricing levels. attractive remuneration is combined as well as steps to take and whom to with less personal or collective risk contact among the other supervisors European Commission attached to the decision making. involved that will allow a much more proposal for bank structural The Bank Recovery and Resolution orderly resolution of a failed bank. reform Directive (BRRD) is also a key piece These plans therefore serve a very of legislation which obliges Mem- serious purpose, esp. for cross- Against this backdrop, the European ber States to put in place recovery border active banks in the EU but Commission (EC) released on 29 and resolution tools that offer all even more so for the globally active January 2014 its proposal for a supervisors in the EU a same set of banks. The fact that supervisors must regulation on structural measures processes to ensure an escalation of approve these plans will help in this improving the resilience of EU credit interventions in a bank before it is regard to balance the home-host institutions. The proposal suggests considered a failing institution, which relationship in a college of supervi- a prohibition of proprietary trading can be resolved by means of an or- sors of cross-border banks. The fact and engagements in hedge funds, as derly process that does not put at risk that the first set of recovery and well as a requirement for separation the stability of the financial system of resolutions plans of US banks have of trading activities into a separate that Member State or beyond. It is to not fully satisfied their supervisors is entity when a set of as yet undefined be expected that the mere possibility a clear indication that these plans separation limits are met. The super- that incumbent bank management are not to be taken lightly and form visor can, however, allow the bank can be replaced by a supervisory an encouraging sign that supervisors to carry out trading activities above intervention as a critical step in the will be able to rely on each other’s the separation limits if the bank can escalating measures to avoid a bank assessments to an increasing degree. prove that this does not endanger failing, will have a strong impact on It is interesting to note that as part of financial stability. The supervisor can bank managers’ responsiveness to the escalating intervention powers also decide to separate out trading

32 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS activities below the separation limits. termine if there is a deficiency in the banking sector. Especially, the EBF The bank structural reform provisions rules and tools that the supervisory finds the Commission proposal for will apply to EU banks that are community has received to address structural reform to be in contradic- G-SIBs (as defined in the CRD) or the perceived excessive risk taking or tion to the aim of the Commission’s that for three consecutive years have an implicit subsidy of the deposit-tak- Europe 2020 growth agenda and total assets that equal or exceed EUR ing side of the bank to the investment the Communication on Long-Term 30 billion and trading activities that banking side. Commissioner Barnier Financing of the European Economy. equal or exceed EUR 70 billion or has indeed in the final stages of his According to the European Commis- 10% of total assets. It is not entirely mandate released a start to this over- sion the proposal in its current form clear from the proposal whether the all assessment, but concedes that in would target only 29 banks out of supervisor could apply the separa- many cases it concludes that it is too a total of around 8.000 European tion requirements to banks below this early to assess the impact of the rules banks. The major part (80%) of the general threshold. in their entirely, including possible European investment bank’s sector Foreign subsidiaries and branches unintended consequences. has been covered meanwhile by na- of EU banks can be exempted from The Federation would like to reiter- tional legislation on structural reforms the regulation if they are subject to ate the message of its response to (Germany, UK, Belgium and France). an equivalent legal framework. Also, the Commission consultation in June The European proposal should there- supervisors are granted the power to 2013. The EBF does not see the fore be assessed according to the exempt from separation foreign sub- principles of subsidiarity and propor- sidiaries of groups with autonomous tionality provided for in the Treaty. geographic decentralised structure Also, the Commission proposal is not pursuing a multiple point-of-entry Supervisory compatible with national structural (MPE) resolution strategy. EU subsid- reform approaches, but goes beyond iaries and branches of third country intervention is those approaches by suggesting banks that do not have equivalent both to introduce a ban on propri- structural reform rules in place must a critical step etary trading and to separate out a also comply with the regulation. broader range of trading activities, The proposal contemplates the in measures to for example market making. possibility for EU Member States The EBF is especially concerned to derogate from the separation avoid a bank about the Commission proposal requirements if they already have for separation of trading activi- equivalent and compatible structural failing. ties that could potentially be very reform primary legislation in force far-reaching as many important on 29 January 2014. Banks will then activities would be inside the range have to comply with the proprietary additional value of the Commission of possible separation. Furthermore, trading ban from 1 January 2017, proposal for structural reform for the the proposal creates considerable and the provisions on separation of European banking sector in the cur- uncertainty around the definition trading activities from credit institu- rent context where key pieces of the and status of separation limits; the tions will become effective from 1 financial services regulatory reform potential additional instruments to be July 2018. agenda have not yet been finalised left out of the separation scope; the and/or fully implemented (for ex- process for the supervisory assess- The industry reaction ample Banking Union, BRRD, DGS, ment of trading activities and the CRD IV/CRR, MIFID, EMIR). supervisory decision for separation. The EBF has from the outset chal- The EBF is uncertain about the These features add further to the lenged the European policy makers overall purpose of the Commission EBF’s concerns that the proposed need for further regulation on the proposal on bank structural reform separation requirements would harm too-big-to-fail viewpoint with a man- since it does not appear to contrib- the ability of European banks to datory ring-fencing or separation of ute to enhancing financial stability play their continued important role in certain activities without taking into but instead introduces a substantial financing of the European economy. consideration the full raft of regula- amount of uncertainty and has likely EBF believes that there is a sub- tory reforms. This comprehensive im- adverse effects on the financing of stantial risk that activities that are pact assessment would serve to de- the European economy and the EU customer-driven and useful for

BV 11/2014 33 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS the real economy, as for example would potentially imply serious system or the creation of incentives market-making, securitisation and disruptive consequences for Euro- for regulatory arbitrage. derivatives trading, executed on pean banks - especially for universal behalf of clients, could end up being banks. Their business position would Conclusion subject to separation. These activities be negatively impacted due to the are fundamental for the proper func- lack of diversification and a greater Overall, the regulatory reform pro- tioning of the financial markets and volatility in revenues, and their fund- gramme delivered to date - signifi- fulfil two essential functions: (i) the ing ability compromised by the lack cantly enhancing capital and liquidity provision of liquidity to all financial of a diversified funding base. buffers, and facilitating credible cross instruments in the secondary market; Overall this proposal creates consid- border resolution for banks, including and (ii) the supply of risk manage- erable uncertainty in the European creditor bail-in - means that banks will ment tools (derivatives) to end-users banking sector at a critical time need to adjust to a new reality and (e.g., corporates, financial compa- related to the conduct of the Asset are significantly safer than before the nies, public entities, pension funds, Quality Review and the European crisis. Hence, the benefits of addi- and mutual funds). stress test, in the view of the imple- tional specific structural reform are not In addition to lending to customers, mentation of the single supervision immediately obvious. banks’ balance sheets also offer by the end of 2014. It could also Although the worst of the financial other valuable services to the real hamper the ability of some banks to crisis has abated the current prob- economy. For example the ability to lems facing banks are almost as carry inventory to support market daunting when taken altogether. making is essential to the provision Regulation continues to increase of liquidity in European financial Bail-in in both complexity and stringency markets, which in turn delivers lower across the board: new rules for capi- funding costs to corporates and component tal, liquidity, and funding; surcharges governments. for financial institutions deemed It seems contradictory to advocate will cause a systemically important; and a raft of for developing the European capital consumer-protection initiatives. Col- markets, both in equity and bonds, structural shift lectively, the new rules could have as the Commission does in its recent significant consequences, including “Communication on Long-Term in Europe’s a longer-lasting negative impact on Financing of the European Economy” return on equity (RoE). and then, at the same time, hamper banking sector. After decades of consistent success, the market-making activity necessary banking faces a period of profound for such development by allow- change. ing regulators to require banks to raise capital on the markets – if and separate market-making activity into when necessary - given the potential REFERENCES: a trading entity and, as a result, threat of this European regulation on European Commission, “A new financial system for Europe - Financial reform at the increasing costs of corporate capital their business model. service of growth”, State of Play: 27 June markets. It should also be noticed that the 2014 (http://ec.europa.eu) Furthermore, the possible separa- FSB announced in parallel supple- European Commission, Proposal for a Regulation of the European Parliament tion of certain activities related to mentary measures for Global SIBs and of the Council on structural measures derivative instruments reduces the to ensure they have sufficient loss improving the resilience of EU credit institutions (COM/2014/043 final - capacity of banks’ clients to manage absorbency capacity in resolution 2014/0020 (COD)) of 29 January 2014 their risks. This burden is particularly (GLAC), whilst to date structural (http://eur-lex.europa.eu) unnecessary since EMIR already reform has not been a part of the European Banking Federation, EBF response to the European Commission deals with the vulnerabilities arising G20 measures introduced to ad- consultation on reforming the structure of from these activities. In EBF’s view Eu- dress financial crisis. Furthermore, the EU banking sector, of 10 July 2013 ropean banks should be allowed to the emerging G20 discussion on the (http://www.ebf-fbe.eu) do proper treasury management and issue especially stresses that careful European Banking Federation, Preliminary EBF view on the European Commission’s provide hedging services without any consideration should be given to Proposal for a Regulation on Structural restrictions. avoid unnecessary constraints on the measures improving the resilience of EU credit institutions, of 2 May 2014 (http:// The proposed separation measures integration of the global financial www.ebf-fbe.eu)

34 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

UDK 336.77:061.1EU Sectoral indebtedness and balance sheet repair in euro area Tina Zumer*

SECTORAL INDEBTEDNESS In the run-up to the global financial crisis, credit growth AND BALANCE SHEET REPAIR IN EURO AREA accelerated throughout the EU, resulting in the significant The global financial crisis build-up of private sector indebtedness in a number of coun- has left a number of economic sectors across tries. Accordingly, the risks associated with debt exposure the euro area reeling from I high debt levels and debt and debt servicing obligations have mounted, and were revealed servicing obligations. when the crisis hit. Since 2008, debt accumulation process of the Against this background, the paper analyses private sector has been largely interrupted, and the process of sectoral exposures to risks stemming from balance sheet repair started – a necessary and welcome process, indebtedness in the euro area countries. The which however, further contributed to a slack in domestic demand, heavy debt burdens, as well as the unfavourable thus propagating the real-financial cycle. At the same time, the in- autonomous debt debtedness of the public sector increased significantly as countries dynamics have triggered the on-going repair of implemented counter-cyclical policies and in some cases engaged overleveraged balance sheets of the private in banking sector bail-outs, while lower domestic absorption crea- sector, while governments absorbed some of the ted fiscal revenue shortfalls. slack in domestic demand created by the private sector deleveraging. Introduction Looking ahead, the gradual deleveraging process in several Against this background, the paper i.) analyses sectoral indebte- euro area countries indicates more scope dness in the euro area countries), with a focus on Slovenia; ii.) for deleveraging in the future, which could, in looks at how the deleveraging process and balance sheet repair turn, propagate negative feedback loops between progressed across individual sectors in euro area countries since the financial and real cycles, thus remaining a the start of the global financial crisis and how this has impacted on drag on growth for some real economy; iii.) it concludes with some discussion looking ahead. time.

JEL G01 G21 H63

* Tina Zumer, European Central Bank, [email protected]. The standard disclaimer applies. The paper has benefitted from fruitful discussions with Plamen Iossifov (IMF) and data support from Jelena Ristic (European Central Bank)

BV 11/2014 35 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

Figure 1a and Figure 1b: Private and public sector indebtedness in the euro area

(2012, % of GDP)

400 160 Household debt Government debt 350 140 Corporate debt MIP treshold (60% of GDP) MIP treshold for non-financial 300 120 private sector debt (160% of GDP)

250 100

200 80

150 60

100 40

50 20

0 0 LU IE CY PT BE NL MT ES FI AT FR EE GR IT SI DE LV SK EA GR PT IT IE BE ES FR AT CY DE NL MT FI SK SI LV LU EE EA Euro Area Euro Area Source: EUROSTAT and own calculations. Note: The debt stock includes the outstanding amounts of loans and debt securities. Data is unconsolidated within each sector, except in the case of the general government.

1. Indebtedness across on the deleveraging needs and bal- vulnerable EU countries in terms of the euro area: a sectoral ance sheet adjustments. It has been indebtedness on the aggregate level, overview widely recognised that the pre-crisis do turn out to have significant risk “flow problem” has now become a exposure in some sectors based on Debt levels in the EU are high “stock problem”. While in the EU the our risk metrics. (Figure 1a and 1b). In its 2014 Alert discussion on indebtedness focused High debt levels expose borrowers Mechanism Report, the European initially on the public sector, with the to liquidity risks, solvency risks, and Commission concludes that despite launch of the European Semester risks to autonomous debt dynamics. on-going deleveraging, the private also private sector indebtedness has A liquidity risk reflects the potential and public sector debt exceed the been monitored in the context of inability of borrowers to service debt MIP indicative thresholds in most Macroeconomic Imbalance Proce- obligations (principal and interest Member States (EC, 2013b). Prior to dure (MIP). However, the focus so rates) out of their current income and the crisis, debt of the private sector far has been largely put on monitor- liquid assets (i.e. without recourse to was increasing rapidly in most EU ing the debt of the private sector in more debt). Solvency risk measures countries, largely in the form of bank total and with relation to the GDP. the potential inability of each sector lending. It was often associated with Our metrics, in contrast, offers analy- to keep the value of its assets above the (income) catch-up process and sis of risks stemming from indebt- that of liabilities to other sectors. The its prospects and warranted financial edness for each of the four major risk to autonomous debt dynamics deepening. The risks associated economic sectors and is based on signals that higher the interest rate with debt accumulation were often indicators which better measure the – income growth differential over underestimated, as their assessment underlying debt servicing burden/ the medium- to long-term, higher the was based on, in hind sight, errone- capacity as well leverage across sec- risk of the autonomous dynamics of ous (too high) estimates of potential tors, while they also add a forward the debt-to-income ratio becoming output, erroneous (too optimistic) looking component to debt servicing unsustainable (so called “snowball- income expectations and hence mis- prospects by looking at the sectoral ing” effect). The main triggers of judged debt repayment capacity. interest rate – income growth dif- these risks are negative external and The analysis of indebtedness has ferentials. In this way the exposure domestic real shocks, and unfavour- gained interest following the crisis, and the associated risks stemming able fluctuations in exchange rates, especially as credit activity abruptly from indebtedness in a country are interest rates, and consumer and slowed down and economic environ- flagged more accurately. Indeed, asset prices. Changes in investor ment remained persistently weak. some countries, like Slovenia, which sentiment are another frequent cause This in turn has triggered discussions do not appear among the very of financial distress of borrowers.

36 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

Figure 2. Euro area countries: Debt-to-Income Ratio by Sector of Economy

(in percent) Corporates Households 1200 300

2012 1000 250 2012 2008 2008 Cut-off point of the top quartile of Cut-off point of the top quartile of 800 EU-wide distribution in 1995-2007 200 EU-wide distribution in 1995-2007

600 150

400 100

200 50

0 0 LU CY PT BE ES IE SI FI FR IT AT GR NL EE LV DE SK MT EA NL IE CY LU ES PT FI GR BE AT DE FR EE IT LV SI SK MT EA Euro Area Euro Area

Government 1000

900 2012 800 2008 Cut-off point of the top quartile of 700 EU-wide distribution in 1995-2007 600

500

400

300

200

100

0 GR PT IE ES IT CY BE AT FR DE SK NL SI FI LV LU EE MT EA Euro Area

Source: EUROSTAT and own calculations. Note: Ratio of stock of debt to gross disposable income. Data for Malta are not available.

Figures 2-4 present the three metrics private sector debt exposure1. In the large majority of euro area countries that capture the three aspects of case of the general government, the for the corporates, and governments, debt-related risks: liquidity risk (debt findings from this analysis should be while the exposure of households is burden/affordability measure), seen as complimentary and sub- somewhat lower, although most of the solvency risk (leverage measure) and ordinated to assessments of fiscal the risk to autonomous debt dynam- sustainability, based on national and ics (interest rate-income growth dif- internationally-agreed legal and 1 Data are currently available until 2012 for most EU countries. The debt stock includes the ferential). Figures 2-4 also include as regulatory regimes. outstanding amounts of loans and debt securities on the liability side of sectoral balance sheets. Data a benchmark the cut-off values of the Most euro area countries are highly are unconsolidated, except for the government. upper quartile of the EU distribution exposed to liquidity and solvency Interest rate includes “ESA interest” and a financial intermediation service charge indirectly measured of these variables over the period risks stemming from indebtedness, (FISCIM). Gross disposable income is taken before interest payments and, in the case of corporates, 1995-2007. This is in line with the while they also face unfavourable also before payments to shareholders (i.e., scoreboard of the EU Macroeconom- autonomous debt dynamics. The most reinvested earning on FDI and distributed income of corporations). Net worth is proxied by the ic Imbalance Procedure (MIP) for recent readings on liquidity risk met- difference between financial assets and liabilities for households and by the value of “Shares and Other assessing vulnerabilities arising from rics exceed the indicative threshold in Equity” for financial and non-financial corporations.

BV 11/2014 37 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS euro area countries are either above vate sectors (Figure 3). Since 2008, As the crisis hit, risks were revalued, or close to the threshold (Figure 2). debt-related solvency risks have de- interest rates rose sharply in an envi- Euro area member states from Central creased or remained broadly stable ronment of low income growth, and and Eastern Europe, which started the in most euro area countries. this indicator worsened substantially, process of financial deepening more In the aftermath of the global finan- signalling potential risks to debt recently and thus still have lower in- cial crisis, all euro area countries are financing going ahead. debtedness levels, are relatively less experiencing unfavourable autono- exposed. At the same time, countries mous debt dynamics, which if they Summary of risk indicators of with more developed financial sectors persist, can put debt on unsustain- sectoral indebtedness in Slovenia: may have overall better capability to able path relative to income (with the deal with debt, while there could also notable exception of some individual Slovenia faces significant risks due to be other mitigating factors at play that sectors) (Figure 4). The interest rate- high indebtedness of the economy in are not explicitly taken into account income growth differential, depicting the EU-wide comparison. This finding in this analysis (for example longer the autonomous debt dynamics, has is in contrast to the conclusion based maturity structures and fixed interest been particularly high in the corpo- on “standard” indicators as used in rates generally lower the risks). Since rate sector and governments. This the MIP (and shown in Figure 1), 2008, debt-related liquidity risks have is in sharp contrast to the pre-crisis as in the MIP scoreboard debt of increased or remained broadly un- period, when all euro area coun- both the public and the non-financial changed across euro area countries tries benefited from historically low private sector were below the indica- for corporates and households (re- (and in most cases negative) interest tive thresholds. We find that while the flecting low income growth and only rate-income growth differentials. This, estimated risks are high in all main gradual deleveraging of the private in turn, fuelled unsustainable credit economic sectors, they are particu- sector). For the governments, increas- growth in many countries, in particu- larly high – and above the indica- es in debt played the major role.2 lar in the euro area periphery and tive threshold – in the non-financial The most recent readings on the lev- the CEE countries, while the associ- erage ratios depicting the solvency ated consumption and investment risks exceed the EU-wide threshold in binges depressed further the interest 2 In the case of the general government, gross disposable income is equal to total revenues minus several countries across all three pri- rate – income growth differential. social benefits other than social transfers in kind.

Figure 3. Euro area countries: Leverage Ratio by Sector of Economy

(in percent)

Corporates Households 250 350

2012 300 2012 200 2008 2008 Cut-off point of the top quartile of Cut-off point of the top quartile of EU-wide distribution in 1995-2007 250 EU-wide distribution in 1995-2007

150 200

150 100

100

50 50

0 0 GR MT LV IE AT FI PT IT SI ES CY DE EE NL SK BE FR LU EA LV FI IE CY EE GR ES LU SK PT NL AT DE SI FR MT BE IT EA Euro Area Euro Area

Source: EUROSTAT and own calculations. Note: Ratio of stock of debt to firms’ capital/households’ net worth. This metric cannot be used for the general government, as the concept of “going concern” is not applicable in the case of sovereign states.

38 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

Figure 4. Euro area countries: Interest Rate - Income Growth Differentials

(in percent)

Corporates Households 15 15

10 10

5 5

0 0

-5 -5 -10

-10 -15

-15 -20 LU GR SI FI IT FR NL BE DE SK ES PT AT LV EE CY IE MT EA GR IE LV NL ES SK SI PT IT EE CY DE FR BE AT FI LU MT EA Euro Area Euro Area

Government 15

10

5

0

-5

-10 Avg 2009-12 2006-08 -15 Cut-off point of the top quartile of EU-wide -20 distribution in 1995-2007 IE PT CY ES GR SI IT SK FI NL LV FR BE AT LU DE EE MT EA Euro Area Source: EUROSTAT and own calculations. Note: Difference between the implicit interest rate on debt and the nominal growth rate of gross disposable income. The implicit interest rate is calculated as the ratio of interest payments (including both “ESA interest” and FISIM) over the average of beginning and end-period stock of debt of each sector. Data for Malta are not available, while data for Portugal end in 2011. corporate sector. In 2012, the debt risks indicators, namely liquidity to the sector), reflecting slow exposure of non-financial firms – as risk (reflecting poor debt servic- deleveraging of the sector, while measured by the proposed risks met- ing capacity of that sector), at the same time incomes were rics was second highest in the euro solvency risk (reflecting high low, asset prices had fallen and area. Risks stemming from indebted- leverage of the sector) and risk interest rates were high, reflecting ness are elevated also for Slovenia of unsustainable debt dynamics higher risk premium for Slovenian households, although they do not (reflecting a wide gap between companies (which, however, is turn out to be above the indicative interest rate and income growth partly associated also with high threshold. of that sector, signalling risks to indebtedness). Looking at the individual indicators, debt repayment looking ahead). • Risks stemming from households’ the main findings are: Following the crisis, these risks indebtedness are elevated, but • the corporate sector in Slovenia have even increased somewhat not yet above the indicative is highly exposed to all three (despite a reduction in debt threshold. In particular, debt

BV 11/2014 39 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

servicing capacity of households Figure 5. Link between Risk to Autonomous Debt Dynamics and compares relatively well in (De)leveraging Effort in the euro area EU-wide comparison, while the leverage ratio is closer to the in- (Percent) dicative threshold. Despite a halt (Percent) in accumulating new debt by the 50 d e sector, the risks related to indebt- t n

e 40

edness have increased somewhat m u g a

since the crisis, primarily on ac- f 30 Average o

nt 2009-12

count of the widening of interest e e

c Average r m 20 rate-income differential, while the o 2006-08 p e n c n i

i

e deleveraging has been slow. e

b l 10 n c a a s • Government’s exposure to indebt- l p o b a

s i y d edness risks as computed by the r 0

a m os s i

proposed metrics was elevated in r g p r

2012, but still relatively contained y -10 m n o

in EU-wide comparison. How- o

c -20 e

ever, as debt of the government l -20 -15 -10 -5 0 5 10 15 t a o increased significantly since T Economy- wide interest rate - income growth differential 2012 (following banks’ recapi- talizations) and the economic Source: EUROSTAT and own calculations. recession hit again, a significant Notes: The total economy primary balance is the sum of the total economy net deterioration of these risks has lending/borrowing position and interest payments to the rest of the world. An increase likely happened. (decrease) in the primary balance relative to gross disposable income indicates deleveraging (leveraging) effort of the sector. 2. Sectoral deleveraging, balance sheet adjustments in have often moved to net creditor thereby widening of the net debtor the euro area and links position, which in effect enabled positions, the most in the stressed/ to growth them to deleverage. The adjustments programme countries. were particularly large in countries The interlinkages between sectors in The heavy debt burdens, the sharp that exhibited the largest imbal- the process of balance sheet repair drop in incomes, negative asset prices ances in pre-crisis period, including are very important and, therefore, valuations as well as the unfavour- Slovenia. The large and wide-spread should not be overlooked. On the able autonomous debt dynamics adjustments of non-financial corpo- one hand, the repair of overlever- have triggered the on-going repair rations indicate the severity of the aged balance sheets by either of overleveraged balance sheets of over-indebtedness in this sector, as the government, the corporate, or the private sector throughout the euro along the balanced growth path household sectors generally makes area. When the interest rate – income firms are typically net borrowers, put- the adjustment by the other two growth differential moved abruptly ting household savings to productive sectors more difficult. A simultaneous from negative to positive territory (i.e. uses. In most countries, households deleveraging by all three sectors the autonomous debt dynamics were returned to being net savers. This is a would reduce domestic absorp- suddenly put on an unsustainable welcome development, as along the tion, which in a fragile external path relative to income), the econo- path of balanced growth households environment could translate in lower mies switched from leveraging to are typically net savers, with the domestic output and income. This deleveraging (Figure 5). financial system intermediating the would complicate the task of repair The balance sheet adjustment is funds to the (productive) corporate of overleveraged balance sheets. captured by the improvement in the sector. On the other hand, govern- Indeed, countries that experienced economy-wide saving-investment ments absorbed some of the slack the largest pre-crisis increases in balances in nearly all euro area in domestic demand created by the indebtedness were usually those countries (Figure 6). Corporations private sector deleveraging, in an that also experienced the steepest and households have improved their environment of steep revenue short- declines in domestic demand (Figure net debtor positions since 2008 and falls and high social expenditures, 7). The post-crisis adjustment was

40 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

Figure 6. Net Lending/Borrowing by Sector of Economy in the euro area Figure 6. Net Lending/Borrowing by Sector of Economy in the euro area (in percent of GDP)

(in percent of GDP) 20

15

10

5

0

-5

-10

-15

-20

-25 2 8 2 8 2 8 2 8 2 8 8 2 8 2 8 1 8 2 8 2 2 8 2 8 2 8 2 8 2 8 2 8 2 8 2 8 2 8 1 0 1 0 1 0 1 0 1 0 0 1 0 1 0 1 0 1 0 1 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 09 - 06 - 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

2 2 2 g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g g v v v v v v v v v v v v v v v v v v v v v v v v v v v v v v v v v v v A v A A A A A A A A A A A v A A A A A A A A A A A v A A A A A A A A A A A A A A A LV EE ES SI IE SK GR CY NL PT IT DE FR AT LU BE FI MT EA Euro Area

Non-financial corporations Households General government Financial corporations Statistical discrepancy External position (current and capital account)

Source: EUROSTAT, ECB and own calculations. Note: The figure focuses on flow adjustment in the post-crisis period (2009-12) compared to the pre-crisis period (2006-08). For the total economy, except for statistical discrepancies, domestic sectors’ net lending/borrowing is equal to the sum of the current and capital account balances. Data for Malta are not available, while data for Portugal end in 2011. Country ranking is according to the size of total economy post-crisis adjustment. particularly pronounced in the cor- lower investment ratios in many euro deleveraging process of the banking porate sector, as investment growth area countries. On the other hand, sector, as repaid amounts can be rates often plunged into very nega- paying down of debt by the private used to lower foreign liabilities. This tive territory, resulting in persistently non-financial sector facilitates the is particularly relevant for the CEE

Figure 7: Pre-crisis debt accumulation and post-crisis real economy adjustment in the euro area

(in percent)

4 1

t 2 n 0 e m 0 ve s t

n -2 -1 i

e

a t -4

-2 o r 00 9- 12 ) p 2

-6 o r c -3 ag e a l

r -8 e e r a v o f ( -4 -10 h t (average 2009-12)

o w -12 -5 r G -14 Growth of real household consuption -6 -16 -10 0 10 20 30 0 5 10 15 20 25 Growth of real household debt (average 2006-08) Growth of real corporate debt (average 2006-08) Source: EUROSTAT and own calculations. Note: Growth rate of debt is calculated from notional stocks that are adjusted for reclassifications, other revaluations, exchange rate variations and any other changes which do not arise from transactions. The debt stock includes the outstanding amounts of loans and debt securities other than shares. The transactions are deflated by GDP deflator.

BV 11/2014 41 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS

Figure 8a: Household (De)leveraging Effort Figure 8b: Corporate (De)leveraging Effort and Consumption Growth in the euro area and Investment Growth in the euro area

(Percent) (Percent)

10 15

8 10 6 Average 5 2006-08 4

Average 2 0 2006-08

0 -5

-2 Average -10 2009-12 Average -4 2009-12 Growth of real corporate investment (percent) -15

Growth of real household consumption (percent) -6

-8 -20 -10 -5 0 5 10 15 20 -40 -20 0 20 40 60

Households' primary balance in percent of augmented Corporates' primary balance in percent of augmented gross disposable income gross disposable income

Source: EUROSTAT and own calculations. Note: For each sector, the primary balance is given by the sum of its net lending/borrowing position and interest payments, including both “ESA interest” and FISCIM. An increase (decrease) in the primary balance relative to gross disposable income indicates deleveraging (leveraging) effort of the sector. countries, where banks’ the pre-crisis 3. Conclusions Overall, countries’ ability to over- lending was funded mainly from come legacy debt overhang would abroad (often via parent banks). Indebtedness of both private and depend on their success in returning The negative impact the private sec- public sectors remains a key source to economic growth and to a sustain- tor deleveraging has on economic of vulnerability for several euro area able path of economic convergence, growth can be simplistically pre- countries. The deleveraging process which will require the implementation sented in cross-plots between (de) has been gradual and several euro of structural reforms. leveraging efforts of the household area countries still face elevated risks and corporate sectors and the real associated with the accumulated debt REFERENCES: growth rates of consumption and levels or debt overhangs across sec- EC, 2012, “Scoreboard for the investment, respectively. (Figures 8a tors. The crisis has highlighted risks Surveillance of Macroeconomic Imbalances: Technical Explanations on the and 8b). In the boom phase of the associated with (too) fast debt ac- Scoreboard,” EC Occasional Paper, 92. credit cycle, both corporate and cumulation and resulting debt stocks, EC, 2013a, “Indebtedness, Deleveraging households borrowed to finance which are difficult to repay, especial- Dynamics and Macroeconomic Adjustment,” EC Economic Papers, 477. the acceleration in their absorption. ly in economic downturns. Therefore EC, 2013b, Alert Mechanism Report 2014. In the bust phase, debts became debt exposure should be watched ECB, 2013, “Structural Issues Report: more difficult to roll over, the burden with caution. The risks should be Corporate Finance and Economic Activity in of debt servicing increased and analysed on the sectoral level, as the Euro Area,” ECB Occasional Paper, 151. the households and corporations aggregate monitoring could mask IMF, 2012, “Chapter 3. Dealing with Household Debt,” in World Economic started to repay their debts, which important sectoral differences. This is Outlook “Growth Resuming, Dangers has crowded out consumption and also important if we want to properly Remain,” Apr. investment. understand the impact that deleverag- Koo, Richard, 2014, “ is the Reason for Secular Stagnation,” in ing will have on growth and what the C. Teulings and R. Baldwin, Eds, Secular optimal policy responses should be. Stagnation: Facts, Causes, and Cures.

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UDK 336.71(497.4) In search for sustainable funding structure of commercial banks Marko Košak*

IN SEARCH FOR ne of the consequences of the recent financial crisis for SUSTAINABLE FUNDING STRUCTURE OF the European banks and the financial sector in gene- COMMERCIAL BANKS ral has been the process of deleveraging, which has The deleveraging process in banks triggered with been manifested not only in a reduced credit activity of the onset of the recent O financial crisis has banks but also in considerable adjustments in the funding structure revealed weaknesses in of banks. Blundell-Wignall and Atkinson (2012) distinguish good the funding strategies of banks. In times of from bad deleveraging as two possible ways for deleveraging to accelerated credit growth banks tend to rely take place. excessively on wholesale funding, incur maturity 1. Introduction and currency mismatch and underestimate the problem of funding With bad deleveraging Wignall and Atkinson (2012) denote either sources concentration. In this article we scan the asset contraction or risk-weighted assets manipulation activi- the main characteristics of the funding structures ties of banks, while according to them good deleveraging occurs in European and non- European banking, when banks raise more capital. Regardless of its character a de- compare briefly the leveraging process is eventually reflected in the changing funding funding structures of banks in Slovenia with those in structure of banks and always puts a significant pressure on the the selected euro area countries and summarize funding policy and liquidity management of banks. At the same the lessons that should be taken by banks time adjustments in the credit activity of banks are unavoidable, with unsound funding practices. Based on these which inescapably leads to credit rationing behaviour by banks. lessons banks should The intensity of the deleveraging process usually differs among be able to implement corrective measures and banks if observed at the micro level, and among countries, if obser- set up viable, robust and sustainable funding ved at the aggregate level. Similarly, the differences in the duration structures that would support sustainable of the deleveraging process and in the adjustments to a new stable credit growth without compromising the equilibrium level are also expected to be different among banks. A profitability expected by strongly pronounced levering cycle followed by a rapidly evolving bank owners and without weighing on government deleveraging process have been detected also with Slovenian banks budgets and taxpayers. in last ten years. JEL G01 G21 G28 * Faculty of Economics, University of Ljubljana.

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The leveraging cycle started with an tried to increase their reliance on reduction in the leverage of the intense upswing in the credit activity more stable funding in the aftermath banks in the euro area. of banks in the 2004 – 2008 period, of the financial crisis, by reducing Some characteristics of the funding accompanied with substantial chang- their dependence in interbank fund- models of European banks can be es in their funding structures, which ing and increasing the significance recognized as common and typical can, to a large extent, be also blamed of deposits among their liabilities. and those can also be blamed for for the banking crisis that followed in Additionally banks also managed to the raised vulnerability and sen- the Slovenian banking market after substitute partially the declining inter- sitivity of banks to market shocks. 2008. The deleveraging process that bank funding by the increased share Le Leslé (2012, p. 6) lists several has been commenced in banks in Slo- of central bank funding in the 2008 characteristics of the troublesome venia after 2008 is unavoidable and – 2013 period, where the impact of European funding models such as should lead to a new more sustain- the LTRO instrument was substantial. a high loan-to-deposit ration, an able banking model, characterized So, on average the share of inter- unsustainable funding gap, exces- by greater stability and predictability bank funding in banks’ total assets in sive reliance on wholesale funding, in banking operations. A new, more the euro area decreased from about insufficient deposit funding and core sustainable funding structure of banks 30% in 2008 to roughly 20% at the funding ratio, high level of interbank is expected to be established in the end of the second quarter of 2013. exposures and the level of deposit course of this process, which means rates vs 3-month Euribor. Some of that banks will have to restructure their these characteristics are clearly inter- funding in favour of more stable and related and describe problematic reliable funding sources. A similar The loan to bank funding characteristics from funding restructuring process has also somewhat different perspectives. Le been started in Slovenian corporate deposit ratio Leslé (2012) specifically points out at sector as a result of the deleveraging two distinguishing features describing pressures and should end up in a in European the specificities of the funding model more sustainable funding structure of prevailing in European banking: (1) the nonfinancial companies, which banks remains a high level of the loan to deposit have traditionally over-relied on bank ratio and (2) excessive reliance on funding and have neglected alterna- relatively high. wholesale funding. tive funding possibilities. For both, the The loan to deposit ratio in European deleveraging in banks and deleverag- banks remains relatively high in ing in corporates the duration of the Similarly the monetary financial the aftermath of the financial crisis entire process is unpredictable, as institutions statistics reveal that the if compared to the average ratio much as are unpredictable the new share of non-bank deposit liabilities values in non-European banking equilibria, that are expected to be in banks’ total assets increased from systems. So, according to Le Leslé reached at the end of this process. 38% (i.e. median value) at the begin- (2012) the average LTD ratio for The purpose of this article is to evalu- ning of 2008 to more than 42% in selected set of European countries1 ate the transition from the pre-crisis the first quarter of 2013. Of course, went from 140 % in 2006 down to to the post-crisis funding structure in as noted in the ECB report, despite 118 % in 2012, while the LTD reduc- banks in Slovenia and to draw atten- the common dynamic in the euro tion in the same time span was from tion to best practices in other Euro- area countries there were significant 80 to 62 % in the USA and from 87 pean banking sectors together with differences between countries and to 78 % in Japan. As claimed by some theoretical guidelines that could between individual banking firms. Le Leslé (2012) the bank led credit be helpful in the search for a sustain- The increasing reliance of banks on model for corporate financing and able funding structure. customer deposits, accompanied high asset-to-deposit ratios have to with the reduced availability of credit be blamed for relatively high levels 2. Bank funding structures in for the economy has resulted in of average LTD ratios in Europe. The the EU area and comparison declining loan-to-deposit ratio, that latter being a result of a large asset to non-European banks dropped from 138% in 2008 to less than 126% at the end of the second As reported by the ECB (Banking quarter in 2013, which is also a 1 Le Leslé (2012) included in her study a sample of 109 banks from 23 countries in Europe, Americas Structure Report, Nov. 2013) banks clear manifestation of a noticeable (Western Hemisphere) and Asia Pacific area.

44 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS base, which reflects a substantial on shorter term funding makes banks market fluctuations and make them reliance on non-lending operations more vulnerable to the external more susceptible to market shocks among European banks. shocks. Again, as reported by Le like we witnessed during the recent The excessive reliance on wholesale Leslé (2012) the proportion of short financial crisis. funding, as the second distinguishing term wholesale funding is about 20 feature, is a consequence of a high % higher with European than with US 3. The developments in funding gap in European banking, banks, which on average maintain funding structure of banks in where “funding gap” is defined as a about 16 % share. Slovenia and selected euro difference between customer loans The recent developments in bank area countries and customer deposits. Le Leslé funding structures and differences (2012) estimates the funding gap on between euro area and US banks A closer look at the developments a sample of large European and US are also discussed in the Banking in the funding structure of banks in banks and shows a persistent fund- Structures Report by ECB (2013) and Slovenia in the last decade clearly ing gap in case of European banks, the conclusions are pretty much the reveals a cyclical transformation of while US banks manage to operate same. First, US banks on average the funding structure that mirrors the with a funding surplus. Similarly, the rely significantly more on non-bank entire business cycle, embracing the share of wholesale funding in total deposits than euro area banks, as pre-crisis upswing and the reces- liabilities, as an alternative measure share of non-bank deposits exceeded sion in the aftermath of the crisis reveals that with European banks 70 % on average for US banks, while onset. Due to the interconnectedness wholesale funding represents more it was only slightly over 40 % for euro between the banking and corporate than 60 % of total liabilities while area banks in 2012. Second, the sector the transmission of the effects this percentage is roughly 33 % with dependence on wholesale funding is between both of them was virtu- Asian banks and about 37 % on av- substantially lower with US banks, as ally immediate, leaving very little of erage with banks in emerging econo- compared to euro area banks, which maneuvering space (time) for the mies as categorized by Le Leslé is reflected in the LTD ratio. preventing activities and adjustments (2012). Additionally, the unfavorable The presented characteristics of that could effectively alleviate all maturity structure can even further the bank funding structures in the the consequences of the compelling aggravate a heavy dependence on European banks clearly augment deleveraging process that has taken wholesale funding, as the reliance the exposure of banks to financial place in banks and corporate sector.

Figure 1: The proportion of the individual types of funding in total liabilities of the banking sector for banks in Slovenia at the aggregate level for years 2004 (end of year), 2008 (end of year) and mid-year 2014

2004 2008 2014 Remaining External Remaining External External liabilities; liabilities; liabilities; liabilities; liabilities; 4,7% 4,6% 4,3% 5,3% 3,7% Capital and Deposits Capital and Capital and Deposits reserves; Central reserves; reserves; Central Deposits Govmnt; Govmnt; 9,8% 8,4% 9,2% Deposits MFI; 1,4% Remaining 4,2% 14,9% MFI; liabilities; 16,8% Deposits 14,5% MFI; 36,5%

Deposits Deposits Deposits non-MFI; non-MFI; non-MFI; 60,3% 39,0% 48,3%

Deposits Central Debt security Money Debt security Money Govmnt; Debt security Money issued; Market Funds; issued; Market Funds; 2,9% issued; Market Funds; 4,3% 0,0% 3,6% 0,0% 3,4% 0,1%

Source: Own calculations and data from the ECB Statistical Data Warehouse, Monetary Statistics, MFI Balance Sheets. (Note: 2014 data is for end of June)

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As shown in Figure 1 the funding of Figure 2: The proportion of total deposits in total liabilities for Slovenian banks2 at the year end banking sectors in the euro area (average), Slovenia, Austria, of 2004 was based on deposits by Germany, Ireland, Portugal and Slovakia. non-MFIs, representing more than 90,0% 60% of total liabilities of the banking 76,6% 76,7% 78,1% 76,6% 78,4% 80,0% 75,9% 71,9% 72,4% 72,5% sector. At the same time deposits by 69,5% 69,2% MFIs represented close to 15% and 70,0% capital and reserves 9.8% of total 60,0% liabilities. All other funding compo- nents of banks, as reported by the 50,0% ECB national Monetary Statistics, 40,0% represented less than 5% of total liabilities each, including debt securi- 30,0% ties issued by banks, which constitute 20,0% 4.3% of total liabilities only. The four year period from 2004 to 10,0% 2008, that was characterized by an 0,0% unprecedentedly accelerated growth 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 in credit activity of banks, ended up EA SLO AUS GER IRE POR SLK in a substantially restructured funding position of banks. The proportion of Source: Own calculations and data from the ECB Statistical Data Warehouse, Monetary Statistics, MFI Balance Sheets. (Note: 2014 data is for end of June) the most significant funding source for banks, i.e. the proportion of the non-MFI deposits was reduced to Figure 3: The proportion of non-MFI deposits in total liabilities for 39% of total liabilities, which is a banking sectors in euro area (average), Slovenia, Austria, Germany, change by minus 21 percentage Ireland, Portugal and Slovakia points in four years, while on the 80,0% other side the proportion of MFI’s deposits expanded to 36.5% of 70,0% total liabilities, which is a change 60,3% 60,0% by plus 21.6 percentage points. The 51,4% 48,2% 48,3% total nominal increase in total assets 50,0% 44,9% 42,0% 41,1% of the Slovenian banking sector 39,2% 40,7% 39,0% 37,4% from the end of 2004 till the end of 40,0% 2008 amounted to approximately 30,0% 24 billion Eur and about 76% of this increase can be explained by the 20,0% raise in MFI and non-MFI deposits. Of course the contribution of MFI 10,0% deposits clearly dominates and 0,0% explains about 58% while non-MFI 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 deposits explain only 18% of the EA SLO AUS GER IRE POR SLK total increase in total assets. After 2008 the dynamics of the Source: Own calculations and data from the ECB Statistical Data Warehouse, banking sectors’ balance sheet Monetary Statistics, MFI Balance Sheets. (Note: 2014 data is for end of June) changes has reversed dramatically, because of the intense deleveraging pressures put on banks. The rollover of the MFI deposits in total bank- year) period. Clearly it was impos- possibilities for MFI funding have ing sector’s liabilities; MFI deposits sible to expect that the funding void become limited and refinancing in shrank by almost 20 percentage many cases impossible which has led points from 36.5% to 16.8% of total 2 All the data are taken from the ECB Statistical Data Warehouse, Monetary Statistics, MFI Balance to a sharp decline of the proportion liabilities in the 2008 – 2014 (mid- Sheets.

46 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS could be completely replaced by structure in Slovakian banks, with With the intensified deleveraging the non-MFI deposits, although the one important difference. Namely, pressures in Slovenian banking sec- proportion of the latter has improved as revealed in Figure 3, there is a tor the government deposits have from 39% to 48.3% of total liabilities clear divergence in the proportion of become a noticeable source in until end of June 2014. In addition non-MFI deposits between Slovenian banks’ funding structure. In Figure 4 to non-MFI deposits banks had to and Slovakian banks after 2006, we display the proportion of govern- rely on central government deposits because of the persistent decline of ment deposits in total deposits for that increased from 2.9% to 4.2% the non-MFI deposits in the funding Slovenian banks and selected euro in proportion to total liabilities and structure of Slovenian banks from area peer countries for the 2004 also on central bank funding which 2004 until the end of 2009, when – 2014 period. The data evidently is displayed in Figure 1 under label this proportion stabilised and started demonstrate extremely high propor- “remaining liabilities” as reported to increase slightly and reached tion of central government deposits in the ECB statistics. Since “remain- 48.3% in June 2014, while non-MFi in the funding structure of Slovenian ing liabilities” contain several deposits in Slovakian banks repre- banks after year 2008 if compared inseparable items we show central sented about 69% of total liabilities to other countries in the sample. So bank funding separately in Figure at the same time. the share of government deposits 5, based on ESRB Risk Dashboard amounted to 6.6% in 2009 and did data. Recapitalizations of banks of not fall below 5% of total deposits till course also helped to fill the fund- end of 2012, while a drop to 2.8% ing gap, therefore the portion of Recapitaliza- in 2013 reflects also the conversion capital and reserves in total liabilities of some government deposits in gov- as displayed in Figure 1 improved tions of banks ernment shareholdings in troubled from 8.4% (2008) to 9.2% (June banks. Interestingly, a comparably 2014). Interestingly, the proportion also helped to high level of government deposits of debt securities issued by the banks can only be detected in Slovakian has even lessened slightly, i.e. from fill the funding banks (5.2%) in 2007, but it has 3.6% to 3.4% of total liabilities in the decreased rapidly in years that fol- period from December 2008 to June gap. lowed. 2014.. Banks in liquidity distress typically A distinctive funding pattern of banks in Slovenia is easy to identify if we Figure 4: The proportion of central government deposits in total observe the dynamics of changes in liabilities for banking sectors in euro area (average), Slovenia, the funding structure also in the con- Austria, Germany, Ireland, Portugal and Slovakia text of a selected set of other euro 7,0% area countries. We included in our 6,6% comparison Germany, Austria and 6,0% 5,4% Slovakia as examples of relatively 5,1% 5,0% stable euro area banking sectors and 5,0% Ireland and Portugal as typical rep- 4,2% resentatives of the euro area periph- 4,0% eral countries. In addition also the 2,9% 2,8% average values for the euro area are 3,0% 2,4% displayed in all the Figures based on 2,2% 1,8% the data as reported by the ECB. 2,0% 1,4% By jointly observing Figure 2 and Figure 3 we can easily see from 1,0% Figure 2 the prevalence of total 0,0% deposits in banks’ liabilities in 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Slovenian banking sector throughout EA SLO AUS GER IRE POR SLK the observed period (i.e. 76.6% in 2004, 69.2% in 2014), which has Source: Own calculations and data from the ECB Statistical Data Warehouse, been very much alike the funding Monetary Statistics, MFI Balance Sheets. (Note: 2014 data is for end of June)

BV 11/2014 47 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS revert to central bank funding if Figure 5: The share of ECB funding in banks’ liabilities in euro area available. This kind of funding (averge), Slovenia, Austria, Germany, Ireland, Portugal and Slovakia pattern can be observed for Irish, 20,00 Portuguese and Slovenian banks in Figure 53. For Slovenian banks the 18,00 ECB funding clearly picked up after 16,00 2010 and reached its peak propor- 14,00 tion in total liabilities with 10.3% in 12,00 10,29 year 2013, which could be char- 9,61 acterized as the most critical year 10,00 for Slovenian banks since the onset 8,00 of financial crisis. Obviously with 5,46 6,00 4,54 the relieved situation in 2014 the 3,94 proportion of ECB funding has also 4,00 2,87 1,32 decreased to 5.5% until the mid-year 2,00 0,41 2014, although it still remains sub- 0,00 stantially above the levels in Austria, 2006 2007 2008 2009 2010 2011 2012 2013 2014 Germany and Slovakia. AUS GER IRE POR SLO SLK Both the adjustments on the asset and liability side of banks’ balance Source: ECRB data. sheets have been simultaneously reflected in the loan-to-deposit (LTD) ratio of the banks (Figure 6). The Figure 6: Loan-to-deposit ratio for banking sectors in euro area LTD ratio as calculated by using (average), Slovenia, Austria, Germany, Ireland, Portugal and the ECB Monetary Statistics data Slovakia clearly demonstrates a considerable 200,0% volatility of the ratio for Slovenian banks through the cycle. While the 180,0% 162,8% 159,3%156,5% 149,0% LTD was kept below 90% in 2004 it 160,0% 144,3% 143,8% escalated significantly in years that 140,0% followed and reached the histori- 117,0% 119,0% 120,0% 109,6% cally highest level of 163% in 2008, 100,2% when the credit expansion came 100,0% 85,4% to an end and the phase of strong 80,0% deleveraging set in. Consequently 60,0% banks had to respond not only by the adjustments on the liabilities side 40,0% of their balance sheets but also by a 20,0% rapid accommodation on the asset 0,0% side, which has resulted in declin- 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 ing LTD ratio that has fallen towards EA SLO AUS GER IRE POR SLK 100% and according to the interme- diate data published by the Bank of Source: Own calculations and data from the ECB Statistical Data Warehouse, Monetary Statistics, MFI Balance Sheets. (Note: 2014 data is for end of June) Slovenia has reached 97% in mid year 2014. Among the countries included in the comparison only Irish LTD ratio is definitely not expected 4. Lessons for banks banks demonstrated similar volatility to climb the levels as seen before of the LTD ratio in the observed pe- the beginning of the financial crisis, Can we identify the properties of riod, while in all other countries the which means that the credit activity a robust bank funding model? Le fluctuations in the ratio were much of banks may remain hampered and less intense and ratios more stable. dependent on the deposit potential 3 Central bank funding data is based on the ESRB As for Slovenian banks the average of the bank customers. Risk Dashboard.

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Leslé (2012) advocates a holistic Very similar findings are also pre- with higher probability of bank approach, based on dynamic, ef- sented in the IMF (2013) paper in distress ficient and forward looking asset- which the resilience of bank funding • Higher concentration of funding liability management in the bank. structures and factors influencing sources is seen as a factor lead- As regards the liability side of this these structures are examined by ing on average towards higher approach banks should really focus empirically investigating a sample of probability of bank distress. on diversity, stability and simple- 751 banks worldwide in the 1990 ness of the engaged liability instru- – 2012 period. The main findings In addition authors (IMF, 2013) also ments. Diversity of funding should be suggest that bank funding is mainly elaborate more on the significance reached in several aspects, starting affected by bank specific factors and of wholesale funding as a major with the diversity of investors and to a lesser extent by macrofinancial, source of instability in banks in crisis financial instruments, further with market specific or institutional factors, periods. First of all it seems that regard to a viable mix of curren- although the regulatory characteris- popularity of wholesale funding has cies and finally also geographical- tics proved to be important as well. increased in modern banks as a wise. Funding stability is the second The authors of the empirical study response to financial innovation and quintessential element that has to be concentrate on exploring the rela- a build-up of excess savings in the taken into account when it comes to tion between funding characteristics corporate sectors of some countries both retail and wholesale funding of banks and probability of their (IMF, 2013, p. 113). On the other sources and should be based on distress. The results show that banks’ hand, wholesale funding has be- investors’ investment constraints and stability hinges on their funding struc- come more attractive for banks as a preferences as well as on investors’ tures that should be stable, sufficient- funding source in times of accelerat- resilience and behavior. Limited level ly diversified and should involve less ed growth that had to be supported of over-complex funding instruments leverage. Furthermore, the mismatch by additional funding. is recommended and a high level between loans and deposits should Wholesale funding has become a of capital and deposits seems to be be limited, as this way the need for source of instability due to several a necessary condition for funding wholesale funding is effectively con- reasons, of which we should expose stability. Additionally Leslé (2012) fined. More specifically the following the following ones: proposes only a limited mismatch factors are exposed in the study: • Banks borrowed at short ma- between assets and liabilities, both • Sufficient capitalisation of banks, turities due to lower interest in terms of maturity and currencies. in the sense of a higher equity- rates and seemingly unlimited Specifically she recommends the use to-asset ratio, is recognized as refinancing possibilities that could of medium to long term funding that decisive for bank stability in both, in fact easily vanish in case of exceeds medium to long term assets advanced and emerging market any significant financial distress. and more short term assets (with economies. Only systemically Namely the uninsured depositors maturities less than one year) than important banks seem to be less as wholesale funds providers use short term wholesale funding that sensitive to the capitalization ef- their claims as disciplining device could dry up in periods of prolonged fect, which might be due to their (Calomiris and Kahn, 1991) for market malfunctioning. too-big-too-fail status in most of bank managers not to take exces- Importantly, an integral part of the the countries during the sample sive risks. In case such depositors holistic approach proposed by Le period. suspect or anticipate any signs of Leslé (2012) is also an adequate • Short term debt is recognized bank instability they would run consideration of the asset side of as harmful for bank stability, as and withdraw their deposits from banks’ balance sheets. So, strong greater dependence on short the bank. Additionally, Brunner- asset quality, based on borrowers’ term debt is significantly related meir and Oehmke (2013) also resilience and stable collateral val- to higher probability of bank dis- show that the incentive to shorten ues is recommended. Further, the as- tress. The result specifically holds the maturity structure of funding is set encumbrance should be limited, for banks in emerging markets particularly strong during periods preferably simple assets should be and for systemically important of high volatility, such as financial considered and appropriate disclo- banks in the entire sample. crisis In such circumstances banks sure policies applied, as well as suf- • The dependence on wholesale as wholesale borrowers would ef- ficient level of liquid and marketable funding, measured by the loan-to- fectively shorten funding structure assets should be available. deposit ratio, is also associated and actually make themselves

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even more vulnerable. In addition they argue that banking- financial crisis has affected not • Mismatch between assets and sector leverage procyclicality is only globally active banks but also liabilities in terms of maturity important for aggregate economy banks with regionally and locally and liquidity, or even a currency by providing empirical evidence oriented business models, which mismatch may deteriorate the that banking-sector leverage procy- were to an unproportionally large sensitivity of banks to distress in clicality forecasts aggregate market extent supported by unsustainable financial markets. volatility in the equity market. funding sources in the long run. It • Most of the wholesale funding As the volume and forms of whole- has turned out that not only sufficient is based on collateralization of sale funding have been broadly capitalisation of banks but also a borrowed funds, which means recognized as important triggers stable, sound, robust and sustainable that any concerns about the qual- and catalysts of instability during the funding structure is absolutely neces- ity or liquidity of the collateral recent financial crisis some implica- sary for banks in order to maintain may lead to the withdrawal of tions should be acknowledged and their credit activity throughout the wholesale creditors. This par- lessons for the banks and regulators business cycle intact. Unfortunately, ticular aspect was for example should be taken. From the perspec- the evidence from the recent finan- investigated by Gorton and tive of banks the alternative funding cial crisis has shown very different Metrick (2012) who describe the models should be taken into consid- developments in banking markets behavior of creditors as “a run on of the euro area and the European repo”. Union, as credit activity of banks has • An extensive use of wholesale slowed down across most of Europe. funding may also cause intercon- Banks in Credit crunch has proved to be even nections between banks and more intense in the so called euro other financial institutions and liquidity distress area peripheral countries, where the therefore increase the sensitivity accelerated credit growth before the of the whole system to shocks typically revert crisis was to a large extent supported and distress in financial markets. by intense wholesale funding, very Several other studies also discuss a to central bank often not properly adjusted to the controversial role of wholesale fund- maturity, currency and credit risk ing in banks. So, for example Huang funding if structures of the banks’ assets. The and Ratnovski (2011) model what consequences in some of the banks they call a “dark side” of wholesale available. were unprecedentedly devastating funding and suggest that wholesale and costly for the taxpayers in the funds can be beneficially used in affected countries. traditional banks that hold mostly eration, although growth oriented Slovenian banking sector and spe- relationship loans, while wholesale banks business models could be cifically some of the banks were af- funding can create significant risks in compromised this way. Furthermore, fected as well and the consequences contemporary banks that hold mostly the banking sector regulators and are still visible, as the credit activity arm’s length assets with available supervisors should pay much more has not recovered yet and some of but noisy signals on their values. attention to the viability and sustain- the banks still depend on the gov- Likewise, Agur (2013) raises some ability of the funding policies applied ernment support. The unbalanced, warnings regarding the overuse of by banks and due to the increased vulnerable and in the long run unsus- wholesale funding because accord- interconnectedness and complexity tainable funding structures that have ing to his findings the wholesale also by other non-banking financial been developed in a relatively short funding increases the impact of institutions in order to prevent the ac- period of an intense credit growth capital requirements on banks as cumulation of liquidity management between 2003 and 2008, are to be compared to retail funding, and the related risks. blamed (although not exclusively) for collateralization of loans to banks the difficulties in the most affected can expand credit rationing. Further, 5. Discussion and conclusions banks and also in a brother sense in Damar, Meh and Terajima (2013) the entire Slovenian banking sector. empirically prove that banks with A rapidly developing deleverag- The lessons for Slovenian banks as wholesale funding are expected to ing process that was triggered in regards their funding structure could exhibit higher leverage procyclicality. the aftermath of the recent global be multifold and should incorpo-

50 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS rate several considerations. First, and considered when the funding Capital Markets Banking and the Urgent Need to Separate and Recapitalise over-reliance on wholesale funding structure of banks is planned. The G-SIFI Banks”. OECD Journal: Financial combined with the domination of assets side considerations should Market Trends, Volume 2012, Issue 1, pp. 1-44. short-term debt in the funding struc- also include the volume and quality Brunnermeier, M. and Oehmke, M. (2013). ture is unacceptable and proved to of the collateral taken by the banks, “The Maturity Rat Race”. Journal of be lethal for many banks in Europe. as it has been evident that banks’ Finance, Vol. 68, No. 2, pp. 483–521. It seems that this particular lesson creditors adjust their behaviour also Calomiris, C. W., and Kahn, C. M. (1991). “The role of demandable debt in has already be taken, as banks have by observing the developments in structuring optimal banking arrangements”. clearly reoriented their funding struc- the collateral markets. All in all it The American Economic Review, pp. 497- 513. tures more towards retail deposits, has been evidenced that sound and Damar H. E., Meh C. A. and Terajima Y. where greater stability is anticipated in the long run sustainable funding (2013). “Leverage, Balance-Sheet Size and but unfortunately the deposit base structures are necessary for estab- Wholesale Funding”. Journal of Financial Intermediation, Vol. 22, pp. 639-662. itself is not likely to be sufficient for lishing stable and robust banking ECB (2013). “Banking structures report”. supporting a desired credit growth. sectors, which would be able to European Central Bank, November 2013, The alternative will have to be found. adequately support businesses with p. 39. Second, greater diversification of credit and other accompanying Gorton, G. and Metrick, A. (2012). “Securitized Banking and the Run on funding sources should be estab- financial services without compromis- Repo”. Journal of Financial Economics, Vol. lished and maintained in order to ing the expected profitability of their 104, No. 3, pp. 425–51. minimize the dependency of banks owners and without weighing on Huang, R. and Ratnovski, L. (2011) “The dark side of bank wholesale funding”. on only few or even on one prevail- government budgets and taxpayers. Journal of Financial Intermediation, Vol. ing funding source. The diversifica- 20, pp. 248-263. tion issue should be considered also REFERENCES: IMF (2013). “Changes in bank funding patterns and financial stability risks”, when it comes to the retail deposits Agur, I. (2013). “Wholesale bank funding, International Monetary Fund, October as a very important funding source capital requirements and credit rationing”. 2013 Journal of Financial Stability, Vol. 9, pp. for commercial banks. Third, the 38-45. Le Leslé, V. (2012). “Bank Debt in Europe: structure and quality of the assets Are Funding Models Broken?”, IMF Blundell-Wignall, A. and Atkinson, P. E. Working Paper, WP/12/299, December has to be permanently evaluated (2012). “Deleveraging, Traditional versus 2012, 39 p.

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UDK 336.71:336.76 Banks’ capital and their funding Ivan Ribnikar*

BANKS' CAPITAL AND anks, their capital and funding, is what we are predo- THEIR FUNDING minantly interested in. Not only in banks in Slovenia Bank capital is at the same time bank funding, but its but also in banks in other similarly small (post)transi- function is predominantly different. One can say tional countries. One could say in the countries of the that it is more important B than funding but it may former Yugoslavia and in few other neighbouring countries, but the not be so. As trust is the name Yugoslavia is usually politically incorrect. And, we are not most important for banks than funding should be just interested in banks as such, but more in connection with EU. of the same importance. And one of the things What these countries are demanded to fulfil, how these demands the paper wants to pay attention to is, for instance, have been explained, justified and, of course, the claim that the the importance of bank funding that is not properly fulfilment of those demands is necessary in their own interest. recognized. For instance, However, we will see that it is not always true. this has been obvious during the process of Banks in the region, if we stay with this geographical identifica- bank rehabilitation. In addition, there are other tion, were not affected by the financial crisis at the very beginning. wrong explanations, wrong terms and lies They had almost no “toxic assets”. Sometime later, because of the that have been used in the communications and lack of confidence among banks in the USA and Europe, interbank relations between the EU money market stopped functioning. Although the central banks or Brussels and the so- called peripheral countries. stepped in, starting to supply banks with liquidity and replacing The paper wants to draw special attention to those horizontal flows of money between banks by vertical flows, bank wrong explanations, wrong terms and lies. loans to business enterprises started to decrease. Uncertainty They are, for instance, what privatisation prevailed and risks increased. Partly because the banks were highly really means, how free indebted they were afraid that they would not be able to refinance movement of capital is understood, the problem of themselves. And even more important was that business enterprises financial intermediation in the small post transitional suddenly discovered that they were highly indebted just at the time countries, why budget deficit is considered the when economic activity started to go down. Banks and business en- main problem and not the balance of payments terprises would have come in problems even if there had not been deficit and. Why double financial crisis, although probably not so great and long lasting. talk, wrong explanations and lies are used.

JEL G01 G21 * Ivan Ribnikar, prof. Emeritus of Economy, University of Ljubljana.

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If we add to this the so-called fiscal and structural reforms, for instance, it on the assets side of the balance consolidation, structural reforms and greater flexibility of labour market is sheet. As we will talk about Piketty privatisation, as we know, almost all not of our direct focus of interest. We later on, of course, in connection banks have more or less the same will, nevertheless, come across them. with capital, let us say immediately problems. There are bad assets, But also in the case of banks, we are that Piketty is a realist when capital is not because of the so-called “toxic not interested in the things that are in question. assets” but because of problems permanently agenda in Brussels; at Although capital is fund, at least also with their customers, predominantly least not in the same way. We are fund, we have in the title capital and business enterprises as their debtors. interested in issues such as: (1) bank funding as they are two different Further on, they must be recapital- capital and funding, (2) savings things. When we talk about capi- ised because their bad assets had (S) as a basis for capital forma- tal, for instance, bank capital, we destroyed a substantial part of their tion, (3) free movement of capital have in mind equity and when we capital. There is additional reason among countries or just free import talk about funding we have in mind for their recapitalisation, namely of capital, (4) financial intermedia- other items on the liability side of the higher capital requirements from their tion in small and financially unde- balance sheet – like, for instance, regulators at home or abroad, i. e. veloped countries, (5) relevance of deposits. in Brussels. And if the banks are able Piketty (2014), his book on capital Capital is without doubt both – to expand their credit activities, they and labour, for us. In this way, i.e. capital as equity and funding. It need additional capital. indirectly by using different concepts enables banks to give loans. If there We come to the demands that are and different words, we may better is a financial institution that gives permanently coming from Brussels, understand what it is all about than loans only on the basis of the money Frankfurt, and sometimes from Wash- by using standardised and in many brought to it as equity it is not a bank ington, instructions and guidelines cases wrong words and concepts. as financial intermediary but just what these countries should do. The point is that we do not think that moneylender. But the primary pur- However, these words have become thorough changes are not necessary, pose of capital is not this but some- empty slogans. In most cases those many demands coming from Brus- thing different. Bank finance itself or who use them, do not know what sels are the proper ones, but official its main way of funding are deposits they mean and even less how these arguments and even goals are and, of course, issue of various debt required changes can be achieved in sometimes just wrong, on purpose or securities. And this at least partly particular country. by accident. We should not make the different role of capital and funding Disregarding all this, there is no same mistake when we choose sup- is good to have in mind. But it is not doubt, that countries must solve posedly the best, the most just and always the case even in financially their economic problems, it means economically the best way for the much more developed countries than problems of banks and business abolishment of the social ownership we are. enterprises, but their solutions should of nonfinancial business enterprises. In the case of bank rehabilitation not be proscribed across the board in Slovenia, for instance, one can in such a primitive and faulty way. 1. Bank capital and see through experts and politicians’ Not to mention vocabulary used – their funding discussions and statements that they using words and explanations that are not quite aware of the difference are in most cases simply wrong. The title may provoke some hesitation between capital and funding. With When looking for proper solutions, or doubt, namely capital and fund- recapitalisation of banks, they should countries will find out that at the end, ing. According to one understand- be getting funds to increase loans to the solutions will be sometimes very ing of capital, and it is generally businesses. But it may not happen, unpleasant. Mistakes that were made accepted in finance, capital is fund. although there is no credit crunch1. in the past, and made without any re- It means that we can find it on the sistance at home or from abroad, are liabilities side of the balance sheet. 1 We can talk about the so-called credit crunch, to be paid for. Here, we do not think We can find it at J. Hicks (Hicks, when banks have enough capital and funding, and this should be some kind of consola- 1979). Hicks talks about “fundists”, if there are customers that are willing to get loans, and although being also creditworthy, they do tion, because it does not exist. they think that capital is fund. On the not get loans. When we cannot logically explain why loans are not given, we can talk about credit We are interested in the first place in opposite side there are so-called “re- crunch. It is probably because of uncertainty. We banks – in their capital, recapitalisa- alists”, for whom capital are assets, it have been talking about credit crunch at least for five years, although it probably appeared only tion and funding. Fiscal consolidation means real assets, and one can find recently once the banks were recapitalised.

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Banks may have enough capital as has been already said, money funding, a part of savings, and it but not necessarily at the same time lenders. So, at the end, we can say may be of very different size, does enough funds. And if they do not that for banks the most important not appear as bank funding. Bank have enough funds, they cannot give thing is trust in them. Without funding funding is smaller because of auto additional loans.2 It is simply not true there is no banking. If there is only financing of investments, transfer that bank recapitalisation will enable a bank capital, we can have, as we of savings from savers via financial banks to give additional loans. This is said, money lenders and their loans. markets and capital export. At the can be found in Slovenia, as we will For money lenders only trust in their end, it may remain for bank funding see, after recapitalisation of banks. It borrowers is required. Banks need very little or even nothing – if there is probably not quite unexpected to to be trusted both by their depositors is no trust in banks. It is something have a mess as concerning capital and borrowers. in “the clouds” that may disappear and funding in Slovenia, but it is a bit very quickly. Therefore it is very bad strange when at Wall Street Journal, 2. Saving, bank capital when financial authorities in times of experts are not quite sure about and their funding crisis, when there are holes in banks’ the difference (Miller, 1995: Miles, balance sheets, do not take into Young & Marcheggiano, 2011). Trust is, as we have seen, the most account how delicate the banks are It is understandable that if the bank important non-material condition for and that with irresponsible statements capital increase is only enough for existence of banks. But beside this, trust in banks may be undermined.3 filling up black holes in their balance banks of course need something They are supposedly angry with sheet and/or just the required capital material, namely they need funding. banks because tax-payers would be ratio is achieved, banks would be And this is, if we go to the source, obliged to pay the bill again. There- unable to increase loans. But even fore banks’ recapitalisation is not if they have enough capital, and as all. When the importance of trust is concerns capital they are able to ignored, worries for tax-payers turns increase loans, it will not happen if When we talk into the opposite, i.e. they believe funding does not allow that it hap- that the authorities just do not care pens. about bank for them. Importance of bank funding is not As a solace for bank funding, if there sufficiently taken into account. It is for capital, we have is not enough domestic saving that instance true for Slovenia. Everything would go to banks and increase their has been concentrated on additional in mind equity. funding, there are foreign countries capital. Importance of trust in banks – import of capital via banks. In not has not been taken into account so distant past, funding abroad was at all. Without trust in banks there savings (S). If we for the moment quite substantial; otherwise bank cannot be bank funding and cannot leave aside foreign countries, these loans would not have increased as be banks. But with their behaviour, are savings; it means the part of much. It ended with the beginning for instance, the behaviour of the income (Y) that does not go for of the financial crisis – generally most responsible man for rehabilita- consumption (C) and government not in a very pleasant way. Even for tion of banks incited the citizens, the spending (G) are additional funds their subsidiaries in foreign countries, so-called tax-payers to leave one of or potential additional capital. It mostly transitional countries, big the banks, because, of course, sup- appears in concrete or material form foreign banks changed their strategy. posedly so, there is no solution for as an increase of real assets and net Local funding is taking hold. the bank. Because of this, its funding claims on other countries. It is ad- is encroached and its very existence ditional bank funding only as much jeopardised. Tax-payers, if we stay as additional real assets belong to 2 There may be no increase in bank loans because the best customers go for loans abroad where with this expression favoured by poli- somebody who got bank loan and the interest rates are lower. This is an additional reason why the dynamics of bank loan cannot be ticians, are the ones that lose most. these real assets are via bank as in- simply deduced whether there is or there is not Bank capital is not everything, al- termediary claim of bank depositors credit crunch. It may be relevant in the periphery countries. though it is vital for banks to be able or bank lenders in general. It means 3 It may even happen, as for instance it happened some time ago in Slovenia, when the most to give loans. It would be the most that at the end or at the beginning responsible person for bank restructuring and important and even everything for there must be savings. recapitalisation, with his statement more or less openly incited citizens, i.e. tax-payers, to leave one banks if they would not be banks but, Although saving is the basis for bank of the banks because there is no viable solution for it.

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3. Free movement of later abolished. Everybody knows, new and additional demands what capital among countries if one has no special interests, that the state should do. Financial sector or something else budget deficit does not mean living and especially banks are a good ex- beyond one’s means. It is the bal- ample of how the state can become Transitional countries we are talking ance of payments that gives us that smaller. It is still more emphasised in about opened up and abolished ob- information. the case of small countries, and the stacles for free movement of capital Nevertheless, as we know, govern- countries we are talking about are across border. Balance of payment ment budget and public debt are just such countries. It does not matter has neither been taken as a con- very suitable targets. Owing to the very much whether they are already straint for them nor for the countries fact that countries generally cannot in the EU or preparing themselves to on the other side – non-transitional stay within their limits, budget and become members. developed countries. The required public debt are imposed on them But there are still some other strange and at the same time quick privatisa- as constraint, and without curtailing things as concerns the balance of tion would not be possible without social transfers and public goods for payments. We come across them foreign savings, i. e. without import their citizens what is really desired when we look at what in reality of capital from developed countries. is achieved. . They talk about the economic benefits of free movement This has gone so far that in even increased competitiveness of the of capital among countries are. We very severe Maastricht requirements economy that will benefit all. But have in mind how these benefits are there is no requirement concern- what lies between the lines is some- perceived by the countries we are ing balance of payments4. If there talking about. It is well known, that would be, for instance, requirement as concerns balance of payments, of longer term sustainability of the it is not just the balance, surplus balance of payments, it probably Importance of or deficit that are important. If we would not be desirable message to simplify a bit, economic benefits are transitional countries to take care of bank funding is in the fact that we can, for instance, the balance of payments. This would import goods and services that we have meant that they should not not sufficiently would produce at higher costs, and/ allow almost unrestricted import of or we export what we can produce capital. Countries cannot be net im- taken into cheaper than our trading partners. porters of capital without balance of Majority of big and developed payments deficit, i.e. current account account. economies have neither current deficit, in the amount of net import of account surplus nor deficit. Such is capital. There is no other reasonable the case, for instance, of the EU and explanation why balance of pay- thing different. It may mean, if we Euro area. The USA, China and oil ments does not matter. call Piketty for help, it may be a de- exporting countries are the excep- This standpoint on balance of pay- sire to prevent that a big state should, ments especially prevails during the to some degree, neutralise bigger financial crisis. So-called peripheral “r”, average rate of return on capital, 4 The required stability of the exchange rate within countries are being criticised for than “g”, rate of growth of the GDP. a band of 15 per cent around the central rate is no genuine restriction and does not mean anything excessive budget deficit, more than In this way the difference between important. 3 per cent of the GDP, and public greater “r” and smaller “g” is not 5 Until some time ago public debt of more than 90 per cent of the GDB should be economically debt, more than 60 per cent of substantially diminished. It means excessive and dangerous for the economy. It should 5 be almost scientifically confirmed on the basis of GDP . Behind all this is probably that the difference of income from the book written by C. M. Reinhart and K. S. Rogoff something else. “Living beyond one’s capital is predominantly at the top of (Reinhart & Rogoff, 2009) until it was found out that the authors unintentionally made a mistake when means” has got a completely new the income ladder, and income from they made calculations. There is, of course, no such limit that is not good to meaning. In Brussels, Frankfurt and labour is mostly at the bottom and surpass. It may become economically dangerous sometimes also in Washington they keeps increasing. much earlier or there is no such limit. It may be even more than 200 per cent as Japan has. What namely think, or at least they preach, Diminishing of the state may mean is important is, where the debt is, i. e. who are the lenders. If they are abroad, than especially in the that it means having or living with diminishing of administration and case of small countries it may become dangerous much earlier. If the lenders are at home, there is no budget deficit. More than 3 per cent bureaucracy. But there is probably such dangerous limit. Japan is the case. But in this of the GDB is already intolerable not much room for such diminishing case we can see again that the most important is the balance of payments and foreign indebtedness and must be punished and sooner or of a state. Almost each day there are and not budget and public debt.

BV 11/2014 55 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS tion that proves the rule, i.e. what sides are on equal footing. No side 4. Financial intermediaries in we have just claimed. Even if the is subordinate and/or superior.7 small, financially not countries have a balanced current In this context, if we make a short well-developed countries account, nevertheless, foreign trade detour, we can understand president is of vital importance to them. Eco- Obama, when he has recently an- We have already said that as nomic benefits are great. nounced that he is proud and happy concerns capital what is important The same is true for capital and fi- as concerns the USA because they are gross and not net capital flows; it nancial account. These accounts are are again the most attractive country means not net imports or net exports also in balance in the big countries for foreign investment. He did not of capital. In developed economies, or areas; we know that net import say that the USA were technologi- net flows of capital among countries or export of capital requires deficit cally and as concerns management are usually near zero. Neverthe- or surplus of the current account of backward and foreigners should less, the capital flows among them the same size. If current account is in help them. Neither he did mention are economically very important. balance, than capital and financial that because they needed foreign In our case, if we take what experts account must be balanced, too. For funds or capital, they were happy and politicians think, these are net the countries that are neither net ex- to get foreign funds again. They do flows of capital, i.e. net import of porters nor net importers of capital, need foreign funds, they are big net capital that are important. But just in cross border capital flows are of a importers of capital, but it is not the small economies, gross capital flows great economic benefit for them. point. They have been able to solve should be considered as much more But when in Slovenia and neighbour- this problem easily, some would say important than in big countries. The ing countries it is talked about free too easily, by selling government point is that within small economies, movement of capital among coun- bonds to foreign investors. Therefore and even more if they are not so tries, the free movement of capital is their concern for the balance of pay- financially developed, it is impossible of course firmly supported, but what ment and exchange rate is usually for various transformations of funds is usually in mind is free import of called “benign neglect”. Funds are or savings to be properly accom- capital. And import of capital is not for them not the problem, at least has plished. Maturity transformation is, welcome because it means import of not been so far. for instance, especially important. new and better technology and man- We cannot behave as concerns Similar problem we are facing nowa- agement of business enterprises. Ad- balance of payments and foreign days appeared after the World War ditionally it is not welcome because indebtedness in a similar way. Nev- II in relation between the USA and it would enable the capital importing ertheless, free movement of capital countries to export capital as well, should not mean only free import of 6 Various self-proclaimed experts on foreign direct and with it their better technology capital or funds, which is eagerly investments usually knowingly explain how the country, for instance Slovenia, or its people, are and management, without necessity expected when it will happen, to against foreigners and that it is something queer to run current account deficit. Export finance something that cannot be in national character of its inhabitants and/or that some individuals, usually professors are to be of capital is sometimes considered financed with our savings. It looks blamed that ownership of business enterprises is not in foreign hands yet. The experts should look at in our countries as something very that we lack money for everything data of the balance of payments or foreign claims strange. Finally, we should add what important and therefore foreigners and foreign indebtedness of the countries with normal people. They would see that capital flows is not unimportant, but it is not taken are called to help. Foreigners should are more or less balanced flows in two directions – similarly as flows of goods and services are. into account at all, that foreigners help us to privatise. But it is not the 7 This looks now, namely not to be in subordinate would not be looked at critically as right word for what foreigners should position, more or less utopian. But it was not so at the beginning of nineties. Now we belong to intruders, as is usually the case6, and do. Privatisation means that business countries in which foreign capital is coming and with it industrial production and we are happy we would not be similarly looked enterprises are left to foreign com- with this and jealous if other countries are more at abroad, what may be something panies to transform them into their attractive for such activities. James Dylon (Dylon, 2014) inventor and owner of enterprise, that very hypothetical now. Free move- subsidiaries. The government does produce aspirators without cables for electricity and VREČE for rubbish, says, for instance, what ment of capital means in the case of not have money and others may benefits the Britain has because the production was transferred to Singapore and Malaysia. In Britain Slovenia and similar countries in the have money but they do not want there are 3000 engineers. In addition there are first place free import of capital and to become owners. The latter is to a great financial benefits as well form intellectual ownership, taxes and repatriated profits. In not free flow of capital in both direc- great extent true but not because of Singapore and Malaysia value added is very small. It means, in plain language, that wages and various tions as it should be. More or less not having enough domestic savings contributions are very low. “Made in France” means the same amount of capital flowing or domestic capital, as one can hear nothing or, we can say that “Made in Slovenia” means nothing. To be proud of it is just a stupid in both directions means that both almost permanently. idea.

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Europe. European countries needed popular understanding the only remind us of something important. external liquidity, and the US dollar thing that matters, we have seen that Besides his main thesis that looking was the only currency available the gross flows are the flows that historically, the rate of return on and acceptable as international are important for us. Otherwise, the capital (“r”) is greater than the rate monetary reserve and as working necessary transformations of funds of growth of GDP (“g”), what means balances of banks. To be able to would not happen. On one side, to that the difference between incomes stay liquid, European countries had satisfy preferences of savers, and from capital and incomes from work to get loans in the USA and these they may be very diverse, and at the has becoming greater, there are loans had to be longer term loans. same time desires of nonfinancial other things of interest. We may In this way Europe had short term or investors on the other side, that may mention his four forms of capital. very short term claims towards the also be diverse, huge cross border Capital is for him assets, and these USA banks. On one side, a substan- gross flows of capital are required. assets are agricultural land, houses tial part of these claims were simply or residences in general and all American bank notes and demand 5. The relevance of Piketty’s other assets. Of course, there is also deposits with American banks, and book on capital and labour the fourth form of capital and that is on the other side, Europe had long for us the net foreign capital or net foreign term debt towards USA. Relations assets or claims. It is this form of capi- between Europe, her banks and Although a lot of things are required tal that might of interest for us. Net business enterprises, and banks in from us to make and/or achieve, foreign capital that may be negative the USA were similar to relations let us not mention again phrases is the difference between all foreign between the banks and their custom- claims of a country and all its foreign ers. Europe was a customer with debts or liabilities. If the difference is short term bank deposits and long positive than the country, besides its term bank indebtedness. The USA, Banks are a agricultural land, houses and other it means its banks and financial real assets, also has net foreign capi- markets, played the role of financial good example tal. If that difference is negative than intermediaries8. the country has as much as is the Relations between the small transi- of how the state difference less capital than the sum tional or, as it is sometimes said, post of three forms of real capital. transitional countries and Europe, her can become In developed countries the difference banks and financial markets, is simi- is around zero, although gross flows lar to relations between Europe and smaller. are substantial. Exceptions are, as the USA after the World War II. It is we already said, the USA, China impossible that within small econo- and oil exporting countries. In the mies, and in addition, financially or clichés and we’d better not use former colonies the difference was not well-developed, transformation Aesopian language. In many cases it negative and in colonial monopo- of funds or savings would be done is not just double talk, but simply lies. lies the difference was positive and properly. Although it might be very Public media are supposedly helpful. rather large. According to Piketty, important, it is not only maturity but They make efforts that lies should not colonial powers had in Africa and also other transformations that are be discovered. In this way they make Asia three quarters of their industrial required and preferences of various us accepting all those ‘necessary’ institutions and individuals as con- reforms, changes and so on easily 8 We should remind us what the French President said for the USA. The idea came from the economist cerns financial assets and financial and quickly. They seem to behave in Jacques Rueff that the USA had the unique privilege. They may be running the balance of payments liabilities within a small country is a socially responsible way. But in a deficit without tears (“sans larmes”). He had in mind almost impossible to fullfil. reality they are making damage. We the USA bank notes in the hands of foreigners and short-term bank deposits owned by foreigners. Owing to this fact, in small countries should just have in mind what abol- 9 Foreign indebtedness of a country usually that are financially not quite devel- ishment of social ownership promised means net indebtedness. But in our country gross indebtedness is usually taken as foreign oped, gross capital flows are much and what we have got. indebtedness. Probably because it looks for 9 whatever reason more. But there is another catch. more important . Even if the country Maybe Piketty’s book came just at Why gross indebtedness if it is net indebtedness, it means net import of capital, we are predominantly has a balanced current account the right time, primarily because interested in. Gross indebtedness and gross foreign with no net capital flows in either of dealing with the issues we have claims should be used once we will discover the problems of financial intermediation in small direction, which is according to our just talked about. Namely, it can economy.

BV 11/2014 57 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS capital and little less of capital as proper names that will be in accord- people all the time”, i.e. to sell them defined by Piketty. Today’s former ance with their meaning should be permanently false things. colonial powers have approximately used. There should be less double zero of “net foreign capital”. Will talking and intentionally unclear or this be improved for them and for the false explanations. And in the first REFERENCES: countries we are talking about, once place, lies that have crept in either Dayson, J., 2014, interview, “Le made in all of them have achieved what Brus- on purpose or by accident should be France? Une idée stupide”. L’Express, Paris, no. 3289, July 16, pp. 11-13. sels demand from them? eliminated. We have, for instance, in Hicks, J., 1977, “Capital controversies: If it is really impossible to do some- mind “to live beyond one’s means”, ancient and modern”, Paris, in: J. Hicks, thing for the economy to recover, “strategic partnership”, “privatisa- Economic Perspectives”, Clarendon Press, besides what Brussels demands, tion”, “free movement of capital”, Oxford, pp. 149-165. Miles, D. , J. Young & G. Marcheggiano, and local politicians are eager to “fiscal consolidation”, “rehabilitation 2011, “Optimal bank capital”, Discussion fulfil, than at least, we should try of banks”, “lack of domestic savings Paper, no. 31, Revised and expanded to change the way and manners and therefore capital formation”. edition, April, Bank of England, 52 p. the advice, recommendations and Without clear talking or writing there Miller, M., 1995, “Do the MM proposition apply to banks?”, Journal of Banking and commands coming from Brussels are cannot be clear thinking and without Finance, pp. 483-489. interpreted and explained locally. clear thinking proper solutions can- Piketty, T., 2014, “Capital in the twenty-first First of all, we should get rid of home not be found. We should bear in century”, The Belknapp Press, 685 p. produced lies. These are the things mind that one can “fool some people Reinhart, C. M., Rogoff, K. S., 2009, “This time is different: eight centuries of financial that are at least in our hands. The some time, but cannot fool all the folly”, Princeton Univ. Press, 463 p.

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UDK 336.71(497.4):061.1EU Positioning Slovenian banking sector in EU Timotej Jagrič and Rasto Ovin*

POSITIONING he Slovenian national banking sector is seeking the way SLOVENIAN BANKING SECTOR IN EU out of a vicious circle: the banks are trying to fulfil the In order to define the regulator’s requirements on capital, to deleverage due to position and performance of the banking sector in optimistic loan policy in the past and to serve the econo- Slovenia within banking T sectors of EU, we study the my. The latter mainly consists of companies which in the years after process of the integration Slovenia’s accession to the EU and the euro area participated in of the banking sector in the EU. Using a new domestic and international transactions with too much optimism. method based on neural networks we conclude In 2004 and in the following years, also the curtain on management that the Slovenian banking system can be placed takeovers was lifted in Slovenia and all this propelled credit transac- between the two clusters: old EU members and new tions into the skies. Supported by overpriced shares on the dome- EU members. Although stic stock exchange and overpriced land and real property as loan fiscal imbalances were not included in calculations, guarantee, the door for today’s straits opened dramatically in 2009. the results show clear placement of the domestic Now the great part of companies needs to deleverage, lacking at the banking sector next to the banking sector of Greece. same time the finances to support the current business needs let alo- Such outcome supports the evaluations that ne the need for the investment in new technology. They are hard to the shortcomings of the get as they rarely meet the loan criteria of now very cautious banks. Slovenian banking system do not derive just from cyclical developments but Introduction also from the abnormality of the Slovenian economy response to economic Banks’ rush entering into the EU markets was accompanied by stimulus after joining the EU in 2004 and the euro overwhelming optimism that the system will sustain such economic area in 2007. upspring and that the domestic knowledge and experience in the JEL G21 field allows independent entrance in the international capital mar- kets by the means of foreign credits. In this paper we analyse the comparative Slovenian banking system position in the EU by means of topological data analysis and try to locate the reasons for its placement.

* Prof. Timotej Jagrič, PhD, University of Maribor, Faculty of Economics and Business, Maribor and Prof. Rasto Ovin, PhD, DOBA Faculty, Maribor

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1. Topological data period from 2000-2011, resulted the national banking sector and the comparative analysis from the EU-wide study and are de- relative presence in the observed pe- veloped in Jagric (2014) and have riod. In this way we tried to capture In order to determine the position been presented and discussed in banks, which have been present in and performance of the banking sec- Jagric et al. (2014). In cases of both the market for as long as possible tor in Slovenia within banking sectors topologies the data is unbalance and have played a substantial role in of EU, we study the process of the panel for the period 2000-2011. The the market (Jagric 2014 and Jagric integration of the banking sector in databases for both models include a et al. 2014). the EU using two topologies, which wide range of indicators. The macro These results have clearly shown the are calculated using optimized spiral database includes 20 variables on persistence of the two groups of the spherical SOM due to its expected 27 national EU banking sectors, national banking sectors throughout abilities of overcoming methodologi- collected from statistical data bases of the analysed period, on both cal shortcoming of the conventional of ECB, World Bank and Eurostat. levels of the analysis, the micro and analysis, like handling unbalanced The macro data basis does not macro topology. The first cluster data panel, nonlinearities, outliers, include indicators on public finance, comprises Austria, Germany, France, multicollinearity and, nevertheless, but national banking sector data. Ireland, Belgium, Netherlands, high dimensional input data space On the other hand, the micro data Spain, Portugal, Italy, Luxembourg, (see Jagric 2013). The selected base includes 19 variables on the UK, Sweden, Denmark and Fin- method uses an unsupervised learn- performance and characteristics of land. It is seen that the first cluster is ing algorithm and belongs to the selected commercial banks collected formed of “old” EU member states, family of neural networks. from their annual reports. The sample except Greece, which appears in Two topologies, appearing as of 125 analysed banks was selected the second one. The second cluster 3-dimensional maps of the analysed using the criteria of market share in is formed by the Czech Republic,

Figure 1: TWO DIMENSIONAL DYNAMIC ANALYSIS OF THE MACRO TOPOLOGY

3 BE02 BE03 BE06 NE02 BE00 BE01 BE04 BE07 BE09 BE11 NE09 BE05 BE08 NE10 NE03 NE00 BE10 NE08 NE01 NE11 NE04 NE07 DE03 CY 08 CY 10 NE06 DE04 CY 09 CY 11 PT07 2.5 DE05 PT09 PT03 NE05 DE10DE07 PT08 PT02 DE08 DE11 DE06 PT10 PT05 PT01 DE09 PT11 PT06PT00 IR09 IR08 LU11 PT04 IR06 LU10 FR10 SP02 2 IR07 IR05 LU07 SP09 MA 08 GR09 LU06 FR09 SP00 SP10 LU08 FR06FR11 SP04 SP08MA 07MA 10SL07SL06 IR11 LU05 LU01 SP03 SP11 MA 11 GR08 LU09ATFR0007 AT06 SP05 MA 09SL08 LU02AT01GE00 SP01 SP07 SL05 LA03 IR03 FR08 SE11 LU03 AT02GE01AT05 SP06 GR10 LA05 IR10 GE05 GR11 LA04 SE10 IR04 AT03GE02 AT07 LA06 SE08 LU04 GE0706 AT09 GR07 ES08 FI08 SE01 IR02 AT04GE03 LA07 SE09 SE04 1.5 IR01 GE08GE10 AT10 LA08 GR05 LA11 ES09 FI09FI00 SE05 IR00 GE04 GR04 FI01 SE03 FR01 FRGE0009GE11 AT11 SL10 GR06 ES10 FIFI1003 SE06 FR02 AT08 GR03 LI07 FI02 SE07 SL09 GR00 GR02 ES11 FIFI1104 SE02 FR05 FR03 UK03 LA09 LI08 IT01 IT05 SL11 GR01 LI04 FI0605 FR04 IT06 UK04 LA10LI09LI05LI06 FI07 IT00 IT03 SK09 IT07 UK05 BG10 LI10 1 IT04 IT08 UK06 SK10 LI11 IT02 UK08UK10 BG11 CZ10 IT09 IT10 UK07 UK11 BG09 SK11 UK09 BG06 SK06RO04 IT11 UK02 BG04BG07CZ09 RO07 UK00 BG05 BG08CZ11 SK07RO05 RO08 UK01 CZ07 CZSK0408RO06RO10 PL10 CZ08 CZ05 RO11 PL09 RO09 0.5 PL08 PL07 PLP11L04 CZ06 PL06 CZPL0502 HU07 CZ03 HU05 HU06 HU08 HU10 HU11 HU09 -3 -2 -1 0 1 2 3

Source: Jagric 2014.

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Figure 2: MICRO TOPOLOGY

Note: The cluster of the old EU member states is present in the graph on the left side and cluster of new EU member states and Greece is shown on the right side. The positions of winning neurons of commercial banks from the Slovenian banking sector are also presented in third graph in the bottom of the figure. Source: Adapted and modified from Jagric (2014).

Cyprus, Estonia, Hungary, Latvia, for the year 2009, when the winning Lithuania, Malta, Poland, Slovakia, neuron is positioned downwards and Slovenia, Bulgaria and Romania, as Dynamic remains relatively stable there also well as Greece. for the years 2010 and 2011. How- We shell next turn to the question of analysis shows ever, in the closest neighbourhood the relative position of the Slovenian to this position, there are winning banking sector on these EU maps, that Slovenian neurons for the Greek banking sector at both levels. On both topologies, banking sector from2000 to 2006, when the move micro and macro, Slovenian banking upwards on the map is noticed. In sector is positioned in the cluster of is moving away the very same neighbourhood an EU member states, which joined the isolated winning neuron for Latvia in EU together with Slovenia at 2004, from Malta. 2008 is position, just next to the win- or later, and Greece. Within this ning neurons for Slovenian banking cluster one can recognize groups of sector in 2009 and 2010. countries, which are closer together. In Figure 1 dynamic analysis of the The macroeconomic topology has winning neurons, in whose neigh- macro topology is shown. It should shown Slovenian banking sector bourhood are winning neurons of be noted that when the three dimen- to be positioned in the group with Greek banking data for the years sional map is projected into a two di- Malta and Greece. This group is 2008 and 2009 on the right hand mensional map, elements positioned placed on the equatorial position of side and Maltese banking data for on the north or south pole appear to the sphere. The macroeconomic data the years 2007 to 2010 on the left be apart from each other, while they base includes the Slovenian banking hand side. Additionally, on the north are close together on a sphere. sector data from 2005 to 2011. of the described 3-country position In order to study dynamics of the in- The dynamic analysis shows that the we find Portugal, while on the left tegration process we also calculated Slovenian banking sector is moving hand side from Malta one finds the path of a particular country. For away from Malta. First four included Spain. An interesting move of the Slo- the Slovenian banking sector the years (2005 to 2008) have found venian banking sector is then noticed total displacement in the analysed

BV 11/2014 61 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS period is 1.10 units. For comparison: Table 1: GDP GROWTH 2006 – 2013 IN SELECTED EU ECONOMIES in the same period (2005-2011) Greece shifted by 1.44 countries, Country 2006 2007 2008 2009 2010 2011 2012 2013 while Germany shifted only by 0.22. Austria 3.6 3.7 2.2 -3.9 1.8 2.8 0.9 0.4 What should be pointed out is the Croatia 4.9 5.1 2.4 -5.8 -2.3 -0.2 -1.9 -1.0 maximum shift, which the Slovenian Estonia 11. 2 7.1 -5.1 -14.1 2.6 9.6 3.9 0.8 banking sector realised from 2008 France 2.2 2.4 0.2 -2.6 1.7 2.0 0.0 0.2 to 2009, that is, by 0.55 units. Germany 3.4 2.7 1.0 -4.7 4.0 3.3 0.7 0.4 The number of the observed units in Italy 2.0 1.5 -1.3 -5.0 1.7 0.4 -2.4 -1.9 the micro model is compared to the Slovakia 8.5 10.6 6.2 -6.2 4.2 3.0 1.8 0.9* macro model substantially higher, Slovenia 5.8 6.8 3.5 -7.8 1.4 0.7 -2.5 -1.1* since each national banking sector is now represented on average by 4 Source: World Bank. or 5 banks. Each selected bank for * Source: Eurostat. each observed year is assigned to its winning neuron. Therefore, the first in- Table 1 above we present some com- attributed to the general self-confi- teresting question of this analysis was parative data in the years preceding dence and perception that favour- whether banks from the same bank- the financial and economic crisis and able economic conditions resulted ing sectors tend to the same neigh- its aftermath. from the domestic knowledge and bourhoods. On Figure 2 we can see The data demonstrates that the Slove- experience with business and finan- that clusters, which were identified nian economy was still quite resilient cial transactions. So despite the cool- by the macro topology, very much in 2008 but reacted strongly in ing of the economy in 2008 with the hold also in the micro topology. This 2009 when reserves of high growth GDP growth of 3.5% (as opposed means that individual banks will were spent. The way this growth was to 6.8% in 2007), the borrowing of more probably be more similar to financed is in a way predicting, that domestic non-financial companies banks from the same national bank- the path to sustainable economic grew by 17%. Characteristically ing sector or national banking sector growth will be difficult. here are statements presented at from the same cluster than to banks According to the data available at the “Financial – stock exchange from another cluster although some the Slovenian national bank (Banka conference (Finančno – borzna outliers are present in both clusters. Slovenije 2014,33) the relationship konferenca) held in Portorož in May We can explore the position of Slo- between debt and equity financing of 2006 (Dnevnik 2006), where the venian banks in the micro topology the Slovenian companies in 2012 was message was that debt financing of map on the lower part of Figure 2, 135% (compared to the euro area the companies’ growth is not neces- which shows the isolated winning with 95%) in favour of debt financing. sarily a threat meaning that loan neurons for all included observa- In this respect worse relationship was financing should prevail from equity tions of commercial banks from the recorded only in Greece and Malta, capital with financing of companies’ Slovenian banking sector. It is seen both exceeding 160%). With 104% growth. Here the majority of the that with the exception of 3 outliner in 2007 (equity financing reaching discussions attracting this daily’s inter- observation winning neurons are 49%) it has rocketed in 2008 to est came from the representatives of positioned into the cluster of new EU 146% (reducing equity financing the companies - national champions: member states and Greece, which share to 41%). During the process Prevent, Mercator, Istrabenz and are positioned on the southern hemi- of deleveraging this relationship was Sava - today representing examples sphere of the topology. reduced to 133% (Q2 2013), while of companies, whose management the equity financing rose by less than took wrong business decisions and is 2. Main contributing factors 2 percentage points. even subject to criminal persecution. to such positioning of the One has to be aware of the fact that Ovin et al. (2011) systemise the Slovenian banks such abnormal structure of compa- reasons which help us understand nies’ financing is not just a conse- positioning of the Slovenian bank- Optimistic acting of Slovenian com- quence of the banks’ management ing system as shown in the former panies and banks on the eve of the misjudgement or of the regulators’ chapter, as follows: crisis was surely nurtured by favour- overlooking that the capital import • Joining the EU in 2004 and inclu- able domestic economic growth. In structure is abnormal. It is also to be sion in the euro area in 2007

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eliminated reservations towards After the stress test performed at the EMU, despite introducing the euro lack of experience in business end of 2013 and the approval of already in 2007. The persistence and financial transactions and the European Commission, the state of its relative position in the cluster Slovenian banks and companies has assured 3.2 billion of euro for of “new” EU member states might adopted the policy of uncritical recapitalisation of five Slovenian indicate that there are other factors using of finances available on banks – among them are two big- influencing the characteristics of foreign markets. gest banks NLB and NKBM as well the national banking sectors much • The emerging of the financial as two banks (Probanka and Factor more than the impact of the com- and economic crisis disclosed banka) who are now subject to con- mon monetary policy with the single abnormal financial grounds of trolled liquidation. This propelled the euro currency. The dynamics and the the industrial and ownership con- public debt towards 80% of GDP (in displacement will be of our inter- solidation – their loan guarantees 2008 it was 22%) demonstrating the est in our future analysis when we were mostly based on overpriced complexity of the economic policy expect to discover some shifts of the land and shares or were given task trying to assure functioning of Slovenian banking sector, due to the with blind faith into the future the banking system along with fiscal intensified process of unification in performance of the companies sustainability. the banking business rules and the subject to management takeo- introduction of the Single Supervi- vers. The whole burden of such sory Mechanism, all influencing the developments fell on the banks; business conditions and environment • Ricochet came when due to Relationship of E(M)U banks. contaminated balances the banks between loan were no more ready or able to REFERENCES: support growing demand for and equity Banka Slovenije (2014). Stabilnost loans reprogramming. Additional- slovenskega bančnega sistema. Ljubljana, ly faced with more severe regula- financing of the January. tor’s demands regarding balance Dnevnik (2006). Dolžniški capital ni le grožnja. 23rd Ljubljana Stock Exchange sheets they have reacted with companies in Conference. Portorož. Available on high interest rates thus repressing September, 14th 2014. the economy even more. 2012 was 135%. Jagrič, T. (2013). Kako izboljšati merjenje bančne integracije v evrskem območju. • The state as a majority owner of Bančni vestnik, Vol. 62, No. 6, pp. 36-40. biggest Slovenian banks had no Jagrič, T., Bojnec, Š., Jagrič, V. (2014). back up strategy for economic 3. Conclusions Micro and macro topologies of the EU banking sector - optimized spiral spherical developments arising with the SOM approach. In: BÓTA, Gábor (ur.). financial and economic crisis and The results of our study show that Proceedings of the SSEM EuroConference 2014 : the International Conference on hesitated with recapitalisation the Slovenian banking sector is Emerging Markets Business, Economics, on time as well as with sufficient positioned closely to the Greek one, and Finance, July 6-8, 2014, Budapest, Hungary. Budapest: Society for the Study funds. which is surprising since no public of Emerging Markets: Budapest University The intensity of the Slovenian bank finance data was used. It might be of Technology and Economics, Department of finance, 2014. system’s problems grew bigger with worrying that the Slovenian banking Jagrič, T. (2014). Mikro in makro topologiji the lasting of the economic downturn sector characteristics resemble more integracije bančnega sektorja Evropske causing greater and greater number the countries in a crisis, especially unije. Doktorska disertacija. Koper: Univerza na Primorskem, Fakulteta za of companies proving unable to Greece, but also Malta, and the two management. service their debts. Additionally tra- Iberian states. The obtained results Ovin, R., Pušnik, B., Smodiš, S. (2011). ditional reservation towards foreign show that the Slovenian banking sec- Gospodarsko okolje v Sloveniji pred in ob izbruhu finančne krize in učinki prenosov capital and knowledge prevented tor, as observed on both the macro med sektorji. Bančni vestnik, jun. 2011, letn. entering of needed foreign funds in and micro level, did not manage to 60, št. 6, str. 16-22. form of equity capital. integrate closely to the core of the World Bank (2011). World Bank Indicator.

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UDK 336.02:338.23:336.74 Financial instability, government intervention and credit growth Božo Jašovič and Matej Tomec*

FINANCIAL INSTABILITY, he reasons for government intervention once a financial GOVERNMENT INTERVENTION AND (banking) crisis breaks out came under scrutiny a couple CREDIT GROWTH of years ago (Jašovič, 2011). Then it seemed natural to con- Government intervention as a policy response at clude that given the intensity of State aid poured into the the onset of a crisis has T been the most frequent financial systems in so many countries, competent institutions have reaction of authorities been doing whatever it takes to preserve financial stability. At this when financial stability was at stake. Governments point it makes sense to ask what scale and scope the consequences exercise intervention in effort to maintain smooth of banking crises may have if governments have spared no effort flow of bank credit to non-financial sectors, to avert them. In this paper we start by establishing who may be which has alleged effect on economic growth. affected at the onset of financial crises, particularly if banks beco- The simple empirical me distressed and conclude that shareholders of troubled banks research presented in this paper shows that are in the first line of fire and then also savers are asked to shoul- the recapitalisation of banks by government der bank losses, if their volume is substantial. Not so much small resources in times of crises did not have the savers protected by all sorts of deposit guarantee schemes, but no expected positive effect on growth of credit activity. eyebrows should be raised if bank creditors or subordinated debt In contrast, banks which holders who were prepared to take on ex ante higher risk have to were not recapitalised demonstrated on average share the burden of rescue. It has been recently incorporated in higher growth of lending volume. The explanation the State aid rules as a precondition for granting public subsidies for such a finding could be that banks which that shareholders and subordinated debt holders are first in the needed recapitalisation were in a financially much line of the burden-sharing approach. worse condition than other banks. In addition, 1. Safeguarding financial stability – potential consequences state aid rules require from recipient banks to of the financial system instability refrain from expansionary strategies financed by The key finding made is that when credit institutions face state resources. However bank credit growth is financial troubles, the real victims are businesses – borrowers that influenced by many other factors which should be depend on banks to provide funding. taken into consideration.

JEL G01E52 E6 * Mag. Božo Jašovič, Gorenjska banka, d.d. and Matej Tomec, B.Sc.., Bank of Slovenia. The views expressed in this article are those of the author(s) and do not necessarily represent those of the institutions in which they are employed.

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The contraction of credit activities welfare and material living standard to boost confidence of investors and and seeking alternative sources of eventually drop. The banking and rating agencies in credit institutions. funding incurs adjustment costs. If economic crisis in Slovenia has been Stakeholder trust should be restored there are no alternative sources of dominated by autonomous inertia when a distressed bank divides its funding to be tapped, businesses both due to certain specific features assets into strategic and non-strategic have to make adjustments due to in operation of the Slovenian banks and by providing transparency into lack of funding by downsizing the and the absence of adequate gov- the bank’s core performance (Mar- volume of operations. In turn, this is ernment measures for the banking tini et. al., 2009, p. 7). Drawing the directly reflected on lower economic system. line between the two structures is of growth that it could have been with- The aim of the paper is to explain key importance. In the first wave of out the storm clouds of the financial what benefits are to be expected of the financial crisis, banks carved out crisis. the state intervention measures from toxic financial instruments; later on, Official authorities with a mandate the angle of promoting credit growth. they did it also with assets that due to provide for financial stability To this end, we try to establish wheth- to recession impact reflect a higher have been trying to mitigate the er these expectations are plausible probability of default and non-core consequences of the crisis described also by examining the empirical data investments, they wish to divest to above. To that end, they have referring to bank recapitalisations in comply with the changed business intervened by taking corresponding the past. The sections in the paper models or simply to deleverage. measures. This is how we arrive at are structured to start by presenting The key objectives of setting up ultimate social group that bears costs an empirical review of costs of finan- state-sponsored bad banks include of financially troubled credit institu- cial crises followed by an evaluation ensuring the banking sector stability, tions – taxpayers. Taxpayers’ costs of how effective the measures taken avoiding a credit crunch and minimis- are direct due to fiscal expenses gov- are in giving impetus to credit growth ing costs to the taxpayers. The last ernments allocated to rehabilitation and the economic activity, then we two goals are in a conflict, since to of the financial system and indirect take a look by taking into account avoid the threat of a credit crunch, as social welfare and standard of liv- the empirical data at the impact the price, at which the toxic asset can ing decline – standard companions made by recapitalisation on credit be transferred to the bad bank, plays of economic recessions. activity of systematically important a crucial role. (Hauck et. al., 2011, What happens first in a crisis hit- banking groups and we close with p. 3). The supply of loans is positive- ting the banking system is fast and obstacles still standing in the way of ly correlated with the transfer value unexpected contraction in the money credit growth. and thus with the costs borne by the supply, and then this adjustment is state for ensuring bank stability. If the transmitted through the credit chan- 2. Empirical review of looming threat of a credit crunch is nel of monetary policy transmission financial crises costs big, then the transfer value (or recap- into the contraction in the supply of italisation as its substitute) should be credit and the economy eventually Policy-makers in the countries hit by sufficiently high to reduce that risk. enter into recession (Kashyap and a financial crisis take various crisis- When weighing up pros and cons of Stein, 1993; Hoggarth and Saporta, response measures to contain its establishing a state-sponsored bad 2001; Schwierz, 2004, Laeven and negative impact. Besides guarantees bank, it should be remembered that Valencia, 2013). It leads to im- for bank debt, deposit guarantee different bad bank schemes also paired quality of loan portfolio and schemes, direct financing and re- mean different allocation of risks liquidity problems, forcing credit insti- capitalisations, the concept of “bad between the original bank and the tutions to respond by quick disposing bank” as one of more radical inter- bad bank i.e. taxpayers. This is why of assets. It builds up pressure on ventions was also used in numerous the key circumstances of the bank- prices of financial assets and real past crises. The main objective of set- ing crisis and the priority of ultimate property and, in turn, these prices ting up a bad bank was to improve goals have to be considered care- add up to deteriorating quality of economics of a certain portfolio fully before deciding. Banking system bank portfolios. The vicious circle of segment by putting in place a better stability and averting credit crunch shrinking bank balance sheets and incentive system and specialised should be the key objectives, the downsizing their business gets more management of assets in liquidation. objective to minimise engagement of vicious as it further impacts economic In the most recent crisis, the key ob- public funds should be subordinate agents and as a consequence social jective of setting up a bad bank was to the first two objectives.

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Figure 1: State aid approved to financial institutions in the period gnificantly on the depth and duration 2008-2012 (in % GDP 2012)* of the financial (banking) crisis, the si- gnificance of banks in financial inter- mediation, the level of development of the economy and the modalities of state intervention plan (for more on this topic see Hoggarth and Saporta, 2001; Schwierz, 2004; Laeven and Valencia, 2008 and 2013). In addition to direct costs, there are also indirect costs of lost GDP in financial crisis. There are methodo- logical dilemmas about measuring output losses to capture as many elements as possible and the appro- ach offered by Laeven and Valencia (2013) provides a fairly complete picture. It calculates indirect loss as the cumulative loss in income relative Source: State Aid Scoreboard, 2013 and authors’ calculation. to a pre-crisis trend.1 * For Slovenia the amounts allocated to bank recapitalisation in December 2013 Figure 2 illustrates the method de- have been included. ployed to calculate losses of GDP by country, which at the end of the day Figure 2: Output losses in the financial crisis since 2008 in % of GDP is reflected in lower social standard and welfare of individuals. Given the size of GDP/output losses the countries incurred at the onset of the financial (banking) crisis, we can draw the following conclusions: • the countries that have reacted quickly and sufficiently and have staved off a slump in bank credit activity and economic contraction have suffered lower output losses, • the countries in which the finan- cial system is large and signifi- cant for channelling savings have suffered higher output losses at the onset of the banking crisis. Source: Laeven and Valencia, 2013. In the light of the above data and the conclusions drawn, we should bear in mind that the approach to display Before we start assessing effective- to 2012 as a share of GDP for the output losses may not be optimal ness of state intervention from the last year of that period. The measures since it is derived from a statistically position of delivering credit growth, taken by the countries that translate computed pre-crisis trend, which or rather averting a credit crunch, it into direct, fiscal costs of the financial may not reflect the effective level of is worth checking the size of fiscal crisis are divided in two categories: domestic output in crisis situations expenditure of the EU Member States government guarantees and recapi- in the most recent financial crisis. talisations and/or purchases of non-

Figure 1 shows in the increasing -performing loans and other assets. 1 Under the described approach not only order state aid approved to financial The key finding is that the volume of differences between trend real and actual GDP growth rates are added up, but the cumulative sum institutions over the period from 2008 state aid varies vastly and depends si- of difference between the GDP levels is determined.

66 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS when available capacities have crises, the situation in banks and sation is statistically significant and drastically changed. Besides, it is not monetary and fiscal policy measures disproportionally positively affects possible to determine the cause-and- on the one hand and bank credit real economic activity of the compa- effect link for output losses. There is activity on the other (Bernanke and nies dependent on external financ- no evidence for the claim that these Lown, 1991; Kashyap and Stein, ing (Laeven and Valencia, 2011, p. losses have been incurred due to the 1993; Schwierz, 2004; Laeven and 4). The effects of other intervention banking crisis; we may claim, how- Valencia, 2008). The findings leave measures (state guarantees, liquidity ever, that these losses have incurred no doubt since empirical data prove support, purchase of assets) individu- simultaneously with the break out of that the financial situation of lenders ally are not statistically significant the banking crisis. This is even more (banks) influence their decisions to but these measures taken collectively true if the crisis has been caused by grant loans. But these studies are not have a statistically significant impact external factors, which have subse- categorical regarding the effects of on added value of the observed quently led to unfolding of the crisis changes in the supply of credit on companies. Another interesting also in the banking sector. When the real economic activity (Laeven and finding is that fiscal policy actions presented results for output losses of Valencia, 2011, p. 4). It is conven- are more effective than monetary the banking (financial) crises are in- tional wisdom that, in general, a measures in alleviating the effects terpreted, these reservations have to financial crisis causes a shock in of the financial crisis on financially- be borne in mind. Without prejudice the supply of credit and economic dependent companies. It seems that to the above, it is fair to say that a policy-makers strive to prevent it monetary policy actions in a crisis delayed and inadequate response by taking various measures. At this situation are directed more to a short- by authorities is known to have led point a question that comes to mind term mitigation of the consequences to a situation in which, due to the is: what are the effects of these of liquidity woes of financial institu- financial crisis, indirect losses may be measures on the supply of credit and tions, whereas effects on economic substantially higher than direct, fiscal what is their impact on economic activity are less pronounced. costs. activity? We may ask a more specific Bank recapitalisation is key meas- question: does the supply of credit ure according to the findings of 3. Effectiveness of government have a positive impact on economic the paper cited above capable to intervention in connection with activity? Laeven and Valencia (2011) positively affect economic activity of credit activity and economic have tried to give an answer to this companies in a financial crisis situ- growth question and have developed a ation by alleviating any constraints model deployed to evaluate effec- on the supply of credit. Since the The paradigm on the neutrality of tiveness of various measures taken by onset of the financial crisis in 2008, finance vis-à-vis economic activ- authorities and designed to ensure a number of governments have itiy was accepted by mainstream the supply of credit by choosing reached out for that measure, and economics long ago. The paradigm company real value-added growth recapitalisation efforts have become was built on unrealistic assumptions as an observed variable. The empiri- a mantra of supervisory authorities of the Modigliani-Miller theorem cal model Laeven and Valencia used with the EBA leading the way. In repeatedly proven to be incorrect; comprised various measures ad- this context we have looked into the hence, economists embraced the dressed to banks and the effects of degree in which the recapitalised thesis that financial markets do not those measures on changes in value bank have contributed to growth in function perfectly without deficien- added generated by companies. The lending to the non-bank sector during cies and glitches. In turn, it all arises dependence of companies on bank the period from 2008 until the end of from the information asymmetries lending is a significant factor in the 2013, i.e., whether there is any differ- and risks associated with financing described model and this is the rea- ence in the supply of credit between that are reflected on costs of com- son for having a separate variable the recapitalised banks in compari- pany bankruptcies, i.e. losses borne for the dependence of businesses on son with those that have not been by financiers. Therefore the provision external finance. They have used it to recapitalised. In order to be able to of financial resources, i.e. company describe the importance of the sup- give answers to these questions we financing matters for real economic ply of credit for the examined com- have conducted a shorter empirical activity. panies. They have proven with the analysis on a sample of 82 systemi- A number of empirical studies have results obtained that of all interven- cally important credit institutions in examined the link between financial tion measures only bank recapitali- the EU.

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4. A description of the tions being a consequence of paying the second group had positive credit empirical approach and out bonuses to employees in the form growth; also the difference in aver- findings of shares. We have chosen to simpli- age credit growth rates is statistically fy the matter, since for certain banks significant. We arrive at a similar We have included in the sample sys- such increase in capital is not clear result if we exclude from the previous- temically important banks assessed from the reports. As state-sponsored ly described division all the banks, as banks critical for the stability of recapitalisation we have taken into which were after recapitalisation or the financial system according to the account capital injections specified even before that in majority state ECB and placed under its direct su- as such by the European Commission ownership. In other words, we have pervision within the framework of the and/or recapitalisations executed divided the sub-group of privately- banking union. There are 130 credit directly by the national governments. owned banks in two groups based institutions in the euro area that fit the The criteria applied were the same on how the recapitalisation bill was description and the principal factors as for other recapitalisations. paid: by public or private funds. The for a credit institution to be on the list We have performed a compara- average credit growth in the banks is its size and its importance both for tive analysis by classifying banks in in private ownership, which used the economy of the home country different groups according to the private funding for recapitalisation, and the whole of the EU. We have selected criteria (see Table 1) and was positive and statistically signifi- added to the sample the systemically then we tried to establish whether cantly higher than in the banks, for important banks with the registered there was a statistically significant which the rescue package came from office in the EU Member States and difference between the average public funds. The results may appear which fulfil the ECB criteria for being rates of growth in gross loans to the surprising at first sight; nevertheless, classified as systemically important. non-banking sector during the period an explanation for these differences We have used the data at the con- between 2008 and 2013 between may be the finding that the banks, solidated level and to avoid double the compared couples of selected which receive state aid, must present counting excluded subsidiaries groups. The computed variables (the their programmes for restructuring. owned by a banking group already average growth rate, the value of the These programmes comprise also the comprised in the study. Moreover, variable t and its probability p) on burden-sharing activities because of we have excluded special purposes the basis of the described statistical the received state aid, which often banks such as »Landesbanken« and analysis are shown in Table 1. The take the form of scaling down, i.e. special development banks such as recapitalised banks posted during winding up certain activities. We the Slovenian SID. The sample does the period under review significantly could also add another explanation not include those banks that in the slower average credit growth than for the noted difference in average course of the observation period the banks, which have not been re- credit growth also by a negative experienced unusually high changes capitalised (the difference in average selection: the banks that needed in loan volume (more than 100%), growth rates is statistically significant recapitalisation but were not able to since it wold probably be a conse- at 5% confidence level). The result attract private investors, were prob- quence of a merger or an acquisition shown does not prove effectiveness ably in a worse shape than those or substantial divestiture processes. of the recapitalisation measure as that managed to obtain new capital Several banks posted negative equi- illustrated in the paper from the previ- by tapping private funding. ty in particular year and such banks ous section. Perhaps this result could We have also compared the banks, have also been eliminated from the be explained by saying that credit which have not been recapitalised sample. The final sample comprised growth would fare far worse without and those, which have been recapi- 82 banking groups. recapitalisation, i.e. negative, but talised with private funds and con- The data regarding recapitalisations we have no empirical proof to make cluded that both groups demonstrate have been gathered from the banks’ such a statement. If the banks, which positive average credit growth. The annual reports. We have counted as have been recapitalised, are divided difference between these two groups recapitalisation only new capital that into those that needed public finance is minor and statistically insignificant. arrived in a bank as issued shares and those, which have been able In conclusion, it is worth reflecting and/or conversions of convertible to attract private capital, we may on the comparison between banks bonds. Only recapitalisations in ex- conclude that the first group had in majority state ownership (irre- cess of 5% of equity qualified and it on average negative credit growth spective of the difference being a has enabled us to avoid recapitalisa- during the period under review and consequence of recapitalisation or

68 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS of being state-owned even before that in comparison with other banks, Sluggish economic recovery recapitalisation) and private banks: the banks in private ownership had and different views on the second group has a higher on average higher growth regardless adequate economic policy average credit growth rate than of the fact that they needed addi- the state-owned banks in which the tional capital injections or not. Which Despite a rather loose monetary average growth rate in credit sup- are the key factors for the obtained policy, the economic recovery in the ply was negative during the period result is also a subject-matter of euro area has been frail and on top under review. We could also look for further research. deflationary risks have emerged. The the explanations for this difference ECB has pulled out from the arse- in different efficiency of corporate 5. Obstacles to credit growth nal of unconventional measure the governance in two groups of banks, targeted longer-term refinancing of but the reasons lie also in the restruc- The data regarding bank lending is credit institutions designed to boost turing measures carried out by quite not encouraging: in the euro area lending to small and medium-sized a few banks, which are in majority loans extended to the non-bank enterprises. The architects of the state ownership and the previously sector keep falling with shrinking of measure believe that anaemic lend- mentioned negative selection on the credit exposure vis-à-vis the non- ing is a key reason for frail recovery aforementioned group. financial companies sector and stag- of the economy and deflationary The described empirical analysis nating household lending. Slovenia is pressures. Bank analysts do not see opens a possibility for additional, no exception and bank credit activity eye-to-eye whether the ECB measure in-depth empirical researches in has the minus sign and the level of will be a success. The offered longer- connection with recapitalisation of credit contraction is even higher. term financing is not targeted in one banks. An interesting question to ask Against the backdrop of adverse part and it is general, and only in its is whether private funding is used data, the question to ask is: which second part it provides a stimulus for more efficiently than public finance. are the key factors that influence those banks that will lend to the real A plausible thesis is that the banks bank lending and what will be their sector. At this point one may wonder that needed state aid were worse hit expected impact over a shorter time where are the obstacles for more than their peers and the recapitali- horizon? We will start by examining vigorous credit activity – on the part sation mostly served to cover past the factors that operate across the of credit institutions as provider of losses and not to increase the volume euro area, and end with certain local credit (a shortage in long-term fund- of bank operations, i.e. lending. Nev- factors that still determine bank activ- ing and capital, regulatory restric- ertheless, we may draw a conclusion ity in Slovenia. tions, modified business models) or

Table 1: Growth in volume of lending to the non-banking sector (gross loans) in period 2008 – 2013 (in %)

Povprečna rast v % s t P (t) n Recapitalised banks 4,80 32,9889 67 2,3811 0,0259 Non-recapitalised banks 24,58 28,1236 15 Banks recapitalised with public funds -12,68 26,5524 29 -4,3486 0,0001 Banks recapitalised with private funds 18,14 31,3903 38 Non-recapitalised banks 24,58 28,1236 15 -0,72539 0,4740 Banks recapitalised with private funds 18,14 31,3903 38 Privately-owned banks not recapitalised 23,44 29,9818 13 0,71549 0,48219 Privately-owned banks recapitalised with private funds 16,51 30,1535 37 Privately-owned banks not recapitalised 16,51 30,1535 37 2,84051 0,00674 Privately-owned banks recapitalised with private funds -5,10 25,8160 20 Privately-owned banks recapitalised with private funds -10,29 40,7822 12 -1,77802 0,0988 Privately-owned banks recapitalised with public funds 11,63 30,5684 70

Source: authors’ calculations

BV 11/2014 69 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS on the part of demand (absence that provides for the wheels of the makes us reflect on the plausibility of of investments in fixed assets due economy to keep turning somehow, the targeted longer-term refinancing to entrepreneurial pessimism and or against the backdrop of a less measure put in place by the ECB. overgeared companies and over- stimulating monetary policy that indebted households). The answers forces entities into unavoidable and Regulatory changes in to the question asked do not speak hasty fixing of balance sheets (read banking and a comprehensive with one voice to the point that even “deleveraging”), meant to deliver review of asset quality the architects of economic policies sustainable economic growth. Even if advocate different approaches. we know the answer to the question Banks are subject to numerous On one side there is the IMF and asked, a new question follows almost regulatory changes. The dynamics majority of important central banks instantly: Can a loose monetary and volume of changes are such that that swear by the standard measures policy actually set the wheels of the it all borders on entropy. The key of loose monetary policy (read it economy in motion? The U.S. central requirements these changes impose as zero interest rate policy) and are bank has shown in practice that it on the business of credit institutions tempted to reach out for unorthodox works, but we should bear in mind are: more capital, lower financial measures that will blow up central that their financial market is not so leverage, more effective and consist- banks’ balance sheets so that cash monolithic and it has a higher share ent risk management, etc. All these, flows would finally reach those in a of capital market institutions that it as well as other measures, have position to use money productively. is the case in Europe, where bank been out in place with the aim to fix On the other side there is the BIS financing prevails. Therefore, it is not bank balance sheets – a process with its Annual Report (Bank for by chance that the ECB has given the credit institutions embarked on some International Settlements, 2014) pro- centre stage place to the measure of time ago and still remaining “work- moting a completely different way of longer-term financing through banks in-progress” with no end in sight. contemplating solutions and ques- designed to reach the segment of High financial leverage booming tioning the central bankers’ stance up small and medium-sized enterprises during the “fat” years is one of the to now. Their view is that loose mon- by providing them with an access to main vulnerabilities of banks. It is, etary policy with low interest rates so much needed financing and has therefore, not a surprise to watch the and purchasing bonds encourages put on the second place direct pur- fast pace at which bank capital is additional borrowing by already chases of covered bonds. Regardless being beefed up and outpacing by a overindebted entities, price growth of the speculations about the meas- great length the phasing in of tighter of financial instruments and real ures hitting the target or not in effort requirements laid down in effec- property and postpones urgent debt to revive bank credit activity, we may tive regulations. Not only financial restructuring. Excessive debt (compa- conclude that, for the time being, markets expect banks to walk the nies and households) has a hand- monetary policy in the eurozone will extra mile, but also for the industry brake action on growth of productive not create headwinds. The question regulators beefing up capital is the investments by the private sector and, arises, nevertheless, whether the unconditional objective, in spite consequently, stands in the way of a monetary softening measures due of its potential short-term negative sound economic recovery. to swell the central bank’s balance consequences. In general, when a Confusion over what appropriate sheet are adequate and effective for bank has more capital, its capacity conduct of economic policy should dismantle the hurdles on the side of to lend increases. The yardstick for be is linked to different views and credit supply. The European Invest- financial soundness of a bank in assessments of what will be a lesser ment Bank (2014, p. 16) has arrived absorbing a reasonable amount of of two evils for the economy of a at a conclusion based on a survey loss is its capital ratio as a propor- certain country. There is no doubt of the banks operating in the CESEE tion between capital (e.g. Core Tier) whatsoever that indebted companies region that among the key obstacles and risk-weighted assets. The value will have to reduce their leverage on the supply side of credit there is a of the ratio can be increased either levels as credit institutions are doing high share of non-performing loans, by increasing the numerator (capi- already. However, the question to changes in regulations, restrictions tal) or by lowering the denominator ask is what is less costly and more on capital and macroeconomic pros- acceptable from the social perspec- pects. The aforementioned survey in- tive: to deleverage in a stimulating dicates that bank financing does not 2 CESEE is the abbreviation for Central Europe and environment of low interest rates pose hurdles to credit activity, and it South and Eastern Europe.

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(bank assets). It is the choice of how affect credit supply and put credit undertake a systematic cleaning up to boost capital ratios that creates growth in the reverse across the euro of balance sheets in cases in which a huge difference between the U.S. area, as opposed to the U.S. and it might be eventually discovered and the European banks: in the other emerging countries where the that there are more contingent losses U.S. banks were increasing capital volume of bank loans granted to the arising from credit risks than it was (nominator) at a higher rate that the non-financial sector is already above disclosed. Many banks have fretted rate at which assets were going up the pre-crisis levels. for some time already haunted by (denominator). What took place in The source of strong headwinds potentially bad scenarios and are the euro area was just the opposite in bank credit activity can then racing to beef up capital, others fo- – most banks were shrinking their as- be detected in stricter regulations cus effort on reducing risk-weighted sets, risk weightings followed suit and (more capital for the same volume of assets with the aim to improve capital increasing capital directly proved to operations, lower financial leverage), ratios. Regardless of the tactics be the weakest factor. The described more restrictive risk taking, a need deployed so far for achieving capital boosting of capital ratios has not for fixing banks’ balance sheets ratios, what really matters at the positively affected credit activity in and changed business models. The end of the day is a bank’s potential the euro area so far. Demand for result of such situation is a shrinking for generating own capital (profit- credit remains subdued and under role banks have in financial interme- ability). The trends seen so far in the a strong influence of the stagnating diation when it comes to financing eurozone suggest that profitability is economic activity with banks taking companies in the euro area. The flagging as a consequence of falling advantage of the situation to amplify empty space is filled up by the capi- credit portfolio quality and contrac- capital adequacy by credit contrac- tal market which plays an important tion in the volume of operations. The tion. Sluggish credit activity dents the role in the provision of funding by interest rates at historically low levels quality of the existing credit portfolio enabling companies to borrow can compensate only partly the as the share of non-performing loans directly and non-bank financial inter- negative impact on profitability as it increases and negatively affects mediaries (shadow banking), which will be revealed eventually also by bank profitability. Banks may get are not subject to the same pruden- stress tests. Over a short term, also caught up in a vicious circle in which tial regulation as banks with balance this activity will not have a beneficial they are not able to generate capital sheets free of the suffocating legacy effect on credit activity. with profits since the requirements of unsustainable expansion seen in to form additional impairments will the past. Growth in the volume of Local factors – overleveraged make profits crumble. It has been operations enjoyed by non-bank fi- companies empirically validated that retained nancial institutions (without insurance earnings are by far the most impor- undertakings and pension funds) The Slovenian banks will enjoy their tant source of bank capital (Berger has been steep over the past few share of benefits brought along by et al., 2008; Cohen and Scatigna, years and accounts in global terms low interest rates (the BIS claims 2014). for approximately half of bank assets that such a policy moves away in The BIS annual report addresses this (Financial Stability Board, 2013). time urgent restructuring of banks’ issue and draws attention in particu- The disintermediation process in the balance sheets) and the targeted lar to banks in peripheral countries banking industry has been intensive longer-term refinancing by the ECB, of the euro area, which due to the also thanks to »shadow banking«. while the effects of direct purchases vulnerability of their balance sheets At this point the comprehensive asset of covered bonds will be felt only cannot obtain new credit. The key quality review (AQR) and the stress indirectly in Slovenia, since local reason for such a situation lies in the tests of bank should be accorded banks have not issued these instru- uncompleted process of fixing banks’ special attention for the scale and ments. The systemically important balance sheets also encouraged by scope of the operation. Even by banks have got capital injections low interest rates. Thanks to low inter- abstract and logical reasoning we (increasing the denominator of the est rates, banks are earning hefty in- see that the exercise will not result in capital ratio) and these measures terest margins and keep postponing reversing impairments and generat- should have produced beneficial restructuring of their balance sheets ing capital, but the other way round. effects on credit activity. These are and recognising losses arising from It does not mean that it is an im- good news and now we have to give the existing credit portfolio. A com- proper activity. On the contrary, it is you bad news as well: our banks bination of these factors negatively welcome, but the question is how to are still struggling to shake off the

BV 11/2014 71 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS burden of loans that have turned Figure 3: Share of loans to non-financial corporations in total assets sour in their balance sheets, we are (as at end-September 2014, in %) in the group of countries with the highest outstanding corporate debt and therefore a high probability of default, our capital market is unde- veloped and shallow and, conse- quently, the non-bank segment of the financial sector that could take over the financial intermediation function is also underdeveloped and last but not least, banks are already overex- posed to the domestic entrepreneuri- Source: ECB Statistical Data Warehouse, authors’ calculations al sector with their existing portfolios (see Figure 3). What it means is that these banks will have to scale down 2008-crisis away in the future. to their creditors (banks) to provide exposure to domestic companies and Corporate clients (non-financial cor- sufficient capital in the first phase as not the other way round in order to porations) geared to too high levels a lifeline for the drowning company reduce risks inherent in excessively are one of the fundamental causes to survive, provided it has a viable high dependence on local compa- for the impasse in lending activities business model, then attention turns nies. These are the arguments that of bank in Slovenia. The Slovenian to a search for an owner with a leave little room for optimism when companies are among the most log-term mind-set. Banks are reluc- it comes to a giving impetus to credit indebted borrowers in the euro area tant to reduce debt by converting growth. Similar »headwinds« are when measured by the ratio between the debt into equity. And they have blowing also in other parts of the debt and equity financing (lever- a legitimate reason for their stance euro area, but they are still stronger age ratio). Under the circumstances, since governing companies under in Slovenia for the set-out reasons. when the non-financial corporations restructuring calls for knowledge There is something else that can be sector is dominated by overlever- and experience banks usually lack. noted in Slovenia: we have devel- aged, poorly capitalised entities, we From this angle it becomes highly oped a monocultural financial model could claim based on the anecdotal important for the banks with share- in which banks prevail. It is eleventh evidence that a portion of banks’ holdings in companies to provide for hour to have the capital market play claims on these customers have de the proper corporate governance. a more important role in financial facto the nature of equity. If banks To this purpose the regulator should intermediation in the Slovenian assess that certain claims they have demand that banks have to transfer financial sector, but without taking vis-à-vis their corporate customers will their holdings of shares, i.e. stakes adequate structural measures, we not be repaid in full, it means that to special purpose vehicles and should not expect it anytime soon. credit risk has materialised to such leave day to day management of Regrettably, there are hardly any a level that the losses arising from troubled companies under restructur- company going public in Slovenia it spread over to creditors of such ing to third-party providers with high and offering shares of stocks to companies. It is up to the owners of reputation. Such outsourcing would the public on the primary markets the companies (domestic or foreign, achieve several goals: professional (IPOs) and there is just a handful of if there are no domestic sharehold- governance that demands constant listed corporations with international ers) to provide capital in the first control of management and their ratings and among them there are place. Many Slovenian companies carrying out of rehabilitation pro- practically no non-banking financial face the situation of severe capital grammes, possibility to pro-actively institutions in a position to provide shortage and practically penniless seek investors for those companies financing to small and medium-sized shareholders. Efforts to attract poten- and, last but not least, also efficient companies. The strategy for the tial foreign owners, i.e. investors fail and transparent disposal of compa- development of Slovenia’s financial as there is no interest in an overlever- nies as the ultimate objective. How market should not be monocultural aged company or a company with successful banks will be in the future and left to contingent development, a muddled financial position. Under depends to a high extent on the if we are to keep crises like the these circumstances, debtors first turn outcome of restructuring programmes

72 BV 11/2014 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS for financially distressed companies. lower at the banks, which needed Activity, 1991(2), 205 – 247. By making headway in this direction a capital injection from the state for Cohen H. B., & Scatigna M. (2014). Banks and Capital Requirements: Channels of will eventually take care of the key recapitalisation and it has led us to Adjustment. BIS Working Paper No 443, reason for the present impasse in draw the following conclusion: state Monetary and Economic Department, credit activity. aid was given to the banks, which Bank for International Settlements. European Commission. (2013). State Aid were in a rather bad shape and Scoreboard > Aid in the context of the 6. Concluding remarks would not be able to look for inves- financial and economic crisis. tors themselves plus their room for Financial Stability Board. (2013). FSB Providing financial stability by resort- manoeuvre was limited by restructur- Publishes Global Shadow Banking Monitoring 2013. Press Release, 87/2013. ing to state intervention measures ing programmes that call also for Basel: Bank for International Settlements. has proven to be a crucial measure divestiture. Hauck, A., Neyer, U., & Vieten, T. (2011). during the recent crisis by enabling Generally, state intervention meas- Reestablishing Stability and Avoiding a Credit Crunch: Comparing Different Bad faster exit from the crisis and return- ures should remove obstacles to Bank Schemes. Discussion Paper No. 31. ing to economic growth. Some bank lending to corporate customers. Düsseldorf: Heinrich Heine University of Düsseldorf, Department of Economics. countries have been better at it than In the wider environment, however, Hoggarth G., & Saporta V. (2001). Cost of others. The speed at which interven- there may be also other factors at Banking System Instability: Some Empirical tion measures were launched and work, which affect bank business. Evidence. Financial Stability Review, London, Bank of England, 2001, str. 148 the size of the financial system mat- Loose monetary and stimulating fis- – 165. tered the most. Direct recapitalisation cal policy certainly have an impor- Kashyap K. A., & Stein C. J. (1993). has been a wide-spread form of the tant influence as long as the actions Monetary Policy and Bank Lending. NBER Working Paper Series, Working Paper support schemes undertaken both by taken go in the right direction. Re- No. 4317. Cambridge: National Bureau of private investors and governments gardless of the undisputed long-term Economic Research. that delivers the fastest and the most positive effects of intensive prudential Jašovič B., & Simoneti M. (2013). Sanacija bank ter razdolževanje podjetij in bank. effective results in providing finan- regulation of the banking sector, its Finance, 14. maj 2013. cial stability. Two problems arise, current impact on bank credit activ- Jašovič B. (2011). Razlogi za državni however, when it comes to funding ity is not beneficial. In Slovenia we intervencionizem ob izbruhih finančnih kriz. capital shortfall: vested interests of are faced also with specific factors, Bančni vestnik, 60(6), 30 – 34. private investors and with it as limited which are not seen as beneficial for Laeven L., & Valencia F. (2008). Systemic Banking Crises: A New Database. as possible state intervention, as well bank credit growth over the short IMF Working Paper, WP/08/224. as also commitment to deliver on one term. Banks will have to participate Washington, D.C.: International Monetary Fund. of the key objectives of recapitalisa- actively in restructuring of their cor- Laeven L., & Valencia F. (2011). The Real tion: arriving at a higher volume of porate debtors to reduce the share Effects of Financial Sector Interventions lending and with more finance give of non-performing loans. By playing During Crises.. IMF Working Paper, WP/11/45. Washington, D.C.: impetus to the economy to grow. their part, the key obstacle standing International Monetary Fund. As demonstrated by the empirical in the way of credit supply will be Laeven L., & Valencia F. (2013). Systemic findings presented in the paper, the dismantled. Banking Crises Database. IMF Economic Review, Vol. 61, No.2, 225 – 270. recapitalised banks have shown Washington, D.C.: Intenational Monetary slower growth in credit supply than REFERENCES: Fund. the banks, which have not been Banka Slovenije. (2014, maj). Poročilo Martini L., Stegemann U., Windhagen E., o finančni stabilnosti. Ljubljana: Banka Heuser M., Schneider S., Poppensieker recapitalised. We are led to believe Slovenije. T, Fest M., & Brennan G. (2009). Bad that the recapitalised banks were banks: finding the right exit from the Bank for International Settlements. (2014). financial crisis. McKinsey Working Papers hit by the crisis in rather badly and 84th Annual Report. Basel: Bank for on Risk, No. 12, August 2009. New York: deployed additional capital primarily International Settlements. McKinsey&Company. to cover losses from operations. In a Berger, A., De Young R., Flannery M., Lee Schwierz C. (2004). Economic costs D., & Oztekin O. (2008). How Do Large associated with the Nordic banking crises. non-crisis period, we would expect to Banking Organization Manage Their V G. T. Moe, A. J. Solheim & B. Vale (ur), get different results knowing that ad- Capital Ratios? RWP 08-0I, The Federal The Norwegian Banking Crisis. (str. 117 – Reserve Bank of Kansas City, Economic 144). Oslo: Norges Bank. ditional capital is largely allocated to Research Department. Simoneti M., & Jašovič B. (2013). expand the bank’s business. Moreo- Bernanke, B. & Lown C. (1991). The Credit Razdolževanje bank v EU in Sloveniji. ver, credit growth was significantly Crunch. Brookings Papers on Economic Bančni vestnik, 62(11), 75 – 84.

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UDK 658.14:005.915(497.4) Concept of business restructuring and sustainable funding of Slovenian companies Bojan Ivanc*

CONCEPT OF BUSINESS orporate or business restructuring is defined in business RESTRUCTURING AND SUSTAINABLE FUNDING literature as a way for a company to get smaller by sel- OF SLOVENIAN COMPANIES ling, splitting off, or otherwise shedding assets (divestitu-

The comments are re). It can be defined as a »major change in the composi- structured in two pillars. C The first outlines the tion of a firm’s assets combined with major change in its corporate definition of business strategy« (Hoskinsson and Turk, 1990). Corporate restructuring is a restructuring, the rationale behind it, self-assessment process that can take many forms but should be differentiated from tests and the agency problem. This part of the only financial restructuring which is a narrower concept. Three dis- analysis is not country- specific but gathers tinct types of corporate restructuring can be defined (Bowman and the data from the most important international Singh, 1993): portfolio, financial and organisational restructuring. sources. Sustainable funding of the Slovenian corporate Three types of corporate restructuring sector is the second pillar. It analyses reduced profitability of the Slovenian corporate sector Portfolio restructuring involves a reconfiguration of the firm’s also due to deleveraging. Companies invested less main lines of business through acquisitions and divestitures. It than depreciation and, therefore, their capacity usually follows a change in managerial insight as to what the score to retain profitability of the firm should be. Managers may believe that more diversifica- likely deteriorated. It is, therefore, vital that tion is appropriate to utilise capabilities company has in place, or, business restructuring pursues not just shedding inversely, that downsizing through programs of strategic divestiture of non-core assets (portfolio restructuring) is necessary (Hoskinsson and Hitt, 1994). Financial restructuring but also the organisational one which involves is different from portfolio restructuring, in that it is not principally doing things differently concerned with changing strategic scope of the organisation, but (organisational restructuring) and with altering its capital and ownership structure. Financial restruc- increasing the profitability and, therefore, reducing turing is appropriate when debt-to-equity ratio is high and debt the leverage to a more sustainable level. service management is insufficient.

JEL G34 G38

* Bojan Ivanc, CFA, CAIA, director of project-head of SKEP, [email protected], Chamber of Commerce&Industry of Slovenia

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Organisational restructuring is Table 1: Priority Lines of Action for Business Clusters (see: excel file) undertaken when managers want to stress the importance of increas- STABLE STRONG ing the organisation’s efficiency or High Stregthen and improve Take the offensive-drive reshaping effectiveness. It is often a by-product the industry. Continue strengthen- ing already advantaged positions of portfolio or financial restructuring, FAILING STRUGGLING as significant changes in the strategic Stabilize and survive-key focus on Stabilize and survive-consider scope and capital structure of the cash preservation-consider exit selling competitive lines of business Financial strength Low firm need to be accompanied by cor- in return for financial stability or merging with an industry winner responding changes in authority and Low High decision-making hierarchy (Prechtel, Competitive advantage 1994). At lower levels of integration, many corporate restructuring at- Source: Booz&Co. tempts consist of several transactions. It can include a range of organi- • Reverse synergy. It is possible than just postpone bad loans recog- sational developments - leveraged that division and parent company nition and companies may reduce buy-outs, management buy-outs and are worth more separately than their profitability due to high cash simultaneous changes in the owner- combines. A segment of a com- flow from operations that has to be ship, financial structure and incentive pany may be undervalued by allocated to creditors what implies systems of firms. Corporate restructur- the market just because of poor less cash flow for capex and working ing can lead to efficiency gains for performance of overall company. capital needs. the restructuring firm and hence to better corporate governance. On Divesting assets & self- the other hand, that disrupts social assessment test and political counter forces, due to Financial their effects on personal lives and Three basic ways that a company on economic prosperity of communi- restructuring divests assets are a sale to another ties (Pursey P.M.A.R Heugens and company, a spin-off to sharehold- Schenk H., 2004). is appropriate ers, or liquidation (Clayman et al., 2008). Reasons for restructuring when debt-to- A sale to another company involves offering to sell the assets of a division Most often reasons for restructuring equity ratio is or an equity carve out. Last involves are (Clayman et al., 2008): creation of a new legal entity and • Change in strategic focus. Com- high. sales of equity in it to outsiders. panies often become engaged In a spin-off, shareholders of parent in multiple markets through company receive a proportional acquisitions or other investments. • Financial or cash flow needs. number of shares in a new, separate Management may decide to During recession or secto- entity. This does not result in inflow improve performance by eliminat- rial headwinds, managers may of cast to parent company. A spin-off ing divisions or subsidiaries that decide to sell off divisions of simply results in shareholders owning are outside core strategic focus. company to raise cash or cut stock in two different companies. • Poor fit. This includes when a expenses. This reason is currently Liquidation involves breaking up a company does not have exper- the most pressing in Slovenia as company, division or subsidiary and tise to fully exploit opportunities restructuring is being suggested selling off its assets piece by piece. It pursued by specific division and by company’s creditors which is typically associated with bank- may decide to sell the segment to may impose a chief restructuring ruptcy. another company that has neces- officer or a consulting/turna- Companies can use self-assessment sary resources. A division may round company. tests (Institute of Management & simply not be profitable enough to Business restructuring is especially Administration, 2010), that help justify continued investment based performed as financial restructuring companies review, and perhaps on the company’s cost of capital. due to high indebtedness. Creditors reformulate their strategies. Key point

BV 11/2014 75 REHABILITATION OF BANKS AND COMPANIES IN CREDIT STAGNATION CONDITIONS is that the starting point for man- is difficult at this time, they should run structure; (2) portfolio restructuring agement discussion is strength of a these businesses for cash only. involving divestments and acquisitions business, not the macro environment. Financially strong but with com- and refocusing on core business, Companies place their companies petitive disadvantages. In such resulting in change of diversity of within grid by: stable businesses, managers should businesses in the corporate portfolio, • Assessing financial strength strengthen and improve operations. (3) operational restructuring includ- by agreeing or disagreeing Even though the core businesses ing retrenchment, reorganisation, and with statement: My company is aren’t threatened, managers should changes in business level strategies. financially strong today and is nevertheless reassess their product These types of restructuring are not not in immediate need of external portfolio and engage in process en- mutually exclusive. Financial restruc- financial support. hancements and strategic cost-cutting turing involves distributing free cash • Assessing competitive status. initiatives. This is time that companies flow to shareholders, limiting the Managers gauge whether their remove complexity in their service management’s ability for new invest- companies are better or worse offerings. Such companies should ments outside their core business. But, than their rivals in five competi- focus in their most valuable custom- management’s promise to distribute tive dimensions: costs, products ers and address how to serve them free cash flow to shareholders is not and positioning, technology and better. Shedding marginal customers credible if existing corporate govern- capabilities, leadership and man- is just as important as shedding mar- ance mechanisms are ineffective in agement and ability to influence ginal business. In difficult economy, monitoring and controlling manage- and collaborate with regulatory stable companies that serve their ment’s actions. Leveraging the firm authorities. most valuable customers better may beyond its ability to service debt These two assessments place compa- gain a market share. from current operating cash flow acts nies in one of four quadrants in this Financially strong with competi- to constrain self-serving behaviour grid. For each quadrant, different tive advantages. These strong com- and creates the crisis necessary to strategies should company follow: panies are in a position to leverage overcome organizational inertia or Financially weak with com- their balance sheets and cash flow. resistance to change. To reduce high petitive disadvantages. These They should spend time reviewing debt, management is forced to cut are failing companies. Managers where their industry is headed, deter- expansion programs and sell those should focus on securing funding mining the capabilities they want to assets which are more valuable to and ensuring their cash flow, trying develop, which products they want to others. to survive. These companies should introduce. Managers have personal incen- exit underperforming businesses, cut In a time of high uncertainty and tives (e.g. minimize risk, increase costs where possible, manage their rapidly changing external factors, income and power) to diversify the working capital to improve cash flow, improved responsiveness becomes a corporate business portfolio and to and reduce their exposure to op- competitive advantage. grow the firm beyond the point that erational and non-operational risks. optimises shareholder value (Jensen They should engage with suppliers, Agency problem in and Meckling, 1976; Amihud and customers, investors, and employees corporate restructuring Lev, 1981; Murphy, 1985). Reten- to accept temporary wage reduction tion of excess cash flow allows and shortened workweeks. Often, According to Jensen’s (1996) agen- managers to avoid monitoring by managers of failing companies cy problem plays an important role in the financial market (banks) and to should hunt for buyers. corporate restructuring. Top man- invest in expansion, diversification, Financially weak but with competi- agement in firms with free cash flow and organisational slack which yield tive advantages. These are strug- invests in overdiversification and or- below market return. gling and should focus on stabilizing ganisational inefficiencies. As agency operations and strengthening their costs increases, a threat of hostile Reduced profitability of balance sheets. This way they can cre- takeover arises forcing management slovenian corporate sector ate their own investment capital and to restructure the corporation. Three ensuring strategic flexibility. These types of corporate restructuring Companies can finance their capex companies should stick with their transactions occur: financial restruc- and working capital either through core assets and monetize all noncore turing including recapitalisation, stock internal or external sources. Internal business. If selling noncore businesses repurchases, and changes in capital resources involve financing through

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EBITDA, which nominally fell for Graph 1: Net financial debt and EBITDA 2007-2013 development corporates from 2007 to 2013 for (EUR mn) 17.6 % to EUR 5.35 billion. EBITDA 40.000 8,00 margin fell from 8.9% to 7.2% reducing the capacity to fund capex 35.000 7,00 and working capital. Net working 30.000 6,00 capital-to-sales fell from 6.6% to 25.000 5,00 Net financial debt (left axis) 4.5% reflecting deleveraging in the 20.000 4,00 corporate sector. Therefore, inter- NFD/EBITDA (right axis) 15.000 3,00 nal funding sources shrank in the EBITDA (left axis) period 2007-2013 (Chamber of 10.000 2,00 Commerce&Industry, 2014). 5.000 1,00 External funding sources, which 0 0,00 consist of bank loans, loans from 2007 2008 2009 2010 2 011 2012 2013 parent companies and other finan- cial liabilities rose from EUR 32.5 Source: KAPOS, SKEP Chamber of Commerce&Industry billion in 2007 to EUR 34 billion (up by 10%). Bank loans fell from EUR 24.5 billion in 2007 to EUR 21.9 debt rose, net debt-to EBITDA in REFERENCES: billion (by 10 %). Loans from parent corporate sector rose from 4.63 Clayman, Michelle R., Fridson Martin S., and Troughton George H (2008) companies (intra-group loans) rose in 2007 to 5.74. Deleveraging ac- »Corporate Finance: A practical by EUR 1 billion in the same period celerated in 2010-2013 period and approach«. CFA Institute (from EUR 3.7 to EUR 4.7 billion). net debt-to EBITDA fell from local Institute of management & Administration (2010) »Booz Self-Assessment Grid Guides Other financial liabilities rose from high of 6.72 in 2010. Compared Business Restructuring in 2010«. The EUR 4.6 billion to EUR 6.8 billion to 2010, when debt-to-EBITDA ratio Controller’s Report, issue 10-01, January, (up by 32%). Corporates therefore started to fall, fixed assets fell by 2010 Pursey P.M.A.R Heugens and Schenk reduced their exposure to bank loans 2.9%. Value of land fell by 5% to H. (2004) »Rethinking corporate but increased exposure to parent EUR 4.4 billion (not subject to de- restructuring«. Utrecht School of Economics, Journal of Public Affairs, financing and other financing. preciation but of impairment), value Volume 4, Number 1, p. 87-101 Aggregate interest expense fell of buildings fell by 2.7% to EUR A. Gibbs, Philip (1993) »Determinants from EUR 697 million to 616 million 18.2 billion. The most concerning of corporate restructuring: The relative importance of corporate governance, (down by 11.5%). Weighted interest part is a 7.4% reduction in value of takeover threat, and free cash flow«, Strategic rates (calculated as interest expense- machinery (to EUR 5.7 billion) what Management Journal, Vol. 14, p.51-68 to-total financial liabilities) on exter- may imply reduction in future profit- Chamber of Commerce&Industry of nal funding sources fell in the period ability capacity, reflecting in lower Slovenia (2014), database KAPOS 2007-2013 from 2.1% to 2.05%. future EBITDA margin. Other fixed Prechel, H. (1994) »Economic crises and the centralization of control over EBIT-to-interest expense ratio rose assets and equipment fell by 10% the managerial process: Corporate from 0.96 in 2010 to 1.59 in 2013, to EUR 3.1 billion. One has to note restructuring and neo-Fordist decision- making«, American Sociological Review, the level not seen before 2007 also survivorship bias in data as 59 (October): 723–45 (2.18). Liquidity ratios improved as most of the companies which went Bowman, E. H. and Singh, H. (1993) quick ratio increased from 0.77 in bankrupt in the period 2007-2013, »Corporate restructuring: Reconfiguring the firm«, Strategic Management Journal, 14, 2008 to 0.82 in 2013, the level not reported lower EBITDA margin on p. 5–14. seen before 2007 (0.86). average. Taking this into account Hoskisson, R. E. and Turk, T. A. (1990) this profitability figure deterio- »Corporate restructuring: Governance and control limits of the internal capital market«, Dark side of improved rated markedly. It is therefore vital Academy of Management Review, 15(3): debt ratios that corporate sector improves its 459–77. profitability and reverses the subpar Hoskisson, R. E. and Hitt, M. A. (1994) »Downscoping: How to Tame the As profitability deteriorated in the investments in machinery and other Diversified Firm«. New York, NY: Oxford period 2007-2013 and financial equipment. University Press.

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UDK 336.71(4-191.2) CEE banking: Switching to sustainable track Carmelina Carluzzo and Milen Kassabov*

CEE BANKING: he CEE banking sector has been characterized by remar- SWITCHING TO SUSTAINABLE TRACK kable lending growth into the new millennium. As the new The banking sector in market economies began opening to a new world of oppor- the CEE region was quite underdeveloped at the tunities, households and businesses saw a rapidly growing beginning of the current T need for financing fresh consumption and investment ideas. millennium. Following a rapid lending growth phase through 2009, driven by pent-up Lending growth shifts to a more moderate pace, demand, a period of more following a phase of rapid catch-up moderate growth has settled-in. Looking forward in 2015 expectations are that lending growth Between the end of 2004 and 2008, with the European Union should remain healthier on enlargement to Eastern Europe countries and just before the onset average. In the meantime, there of the financial crisis in 2009, lending in CEE1 was growing on ave- has been an important transformation in the way rage at around 30% per year2. During the same time, retail lending balance sheet growth 3 was funded in the past was outpacing corporate lending growth (35% vs 27% respective- few years, following the financial crisis from 2009. ly), due to relatively lower banking penetration in the former. Still, A significant shift took at the onset of the financial crisis, at the end of 2008, the CEE regi- place, as external liabilities were partially substituted on remained with quite an under-penetrated banking market judging by domestic sources. Capital and reserves have by the loans to nominal GDP ratio, which on average was at 41%. expanded their share of total liabilities too. With all the economies except Poland dipping into recession Profitability levels, as measured by return on in 2009, annual lending growth suddenly crumbled to around assets, have deteriorated 1.9% (Table 1). Lending growth acceleration was reignited in the significantly following the fast growth phase, following year, but growth dynamics were reset at a slower pace driven by slower revenue growth but also a rapid during 2010-2013, with an average annual rate of 12.4%. increase in provisions for non-performing loans. Going forward, in 2015, expectations are that profitability will improve * Carmelina Carluzzo and Milen Kassabov, UniCredit CEE Strategic Analysis. on average for the CEE 1 CEE in this analysis includes Bosnia-Herzegovina, Bulgaria, the Czech Republic, Croatia, Hungary, Poland, Romania, countries included in this Russia, Serbia, Slovakia, Slovenia, Turkey and Ukraine. study. 2 All averages unless otherwise stated in this report are CAGR (Compound Average Growth Rate); all figures in this report are in local currency terms and aggregates are computed at constant 2008 year-end local currency exchange rates versus the euro currency. JEL G01 G21 3 Corporate includes non-financial corporations, government and non-bank financial institutions.

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Importantly though, the double digit Table 1: Lending growth measured in local currency, % growth rate in this more recent peri- od has been driven to a large extent Lending growth, % 2005-2008 2009 2010-2013 by Turkey and Russia, which posted Bosnia and Herzegovina 25,1% -3,2% 4,0% average growth rates of 27.8% and Bulgaria 37,5% 3,9% 2,1% 19.4%, respectively. Croatia 17,7% 2,2% 3,4% Czech Republic 17,8% 1,5% 3,5% In the meantime, several countries in Hungary 17,5% -3,5% -3,6% the CEE region underwent a signifi- Poland 25,1% 8,7% 6,7% cant adjustment, with declining loan Romania 48,4% 3,5% 2,1% books. Excluding the heavyweights Russia 43,1% -2,2% 19,4% Russia and Turkey, the countries con- Serbia 40,7% 25,1% 11,5% sidered in this study registered decel- Slovakia 22,2% 1,4% 4,6% erating lending growth to 3.6% on Slovenia 26,4% 2,8% -5,2% average in the period 2010-2013, Turkey 36,5% 6,0% 27,8% significantly down from the 24.1% Ukraine 69,6% -1,5% 5,9% annual growth pace in 2005-2008. CEE countries* 29,9% 1,9% 12,4% Importantly, following the period CEE countries ex. Russia and Turkey* 24,1% 3,1% 3,6% of fast lending expansion through 2008, in the following years deposits * CEE aggregates are computed via constant 2008 year-end local currency rates against the euro. Growth rates are calculated as CAGR (Compound Average Growth Rate). grew faster than loans or at least al- most in line with loans in all countries besides Turkey, indicating a switch in 2013. Considering the group of lack of an inherited stock of financial to a more sustainable and balanced countries excluding Russia and Tur- wealth - a healthier funding structure local funding driven banking model. key, the adjustment was even more has been pursued thereafter. The Looking at the figures between the pronounced, as the loans-to-deposits financial crisis made evident the end of 2004 and 2008, the loans- ratio declined from 117% in 2008 to vulnerabilities of the CEE banking to-deposits ratio (loans divided by 104% in 2013 (Chart 1). model developed during the years of deposits) of the CEE countries in Although there are historical structur- booming lending growth. Leveraging this analysis increased from 82% to al reasons behind the high loans-to- on abundant international liquidity, 113%, before a major reversal took deposits ratios in the region - mainly banks financed domestic lending via part with the ratio falling to 106% the domestic savings gap and the international capital inflows. That

Chart 1: Loans-to-deposits ratios, %

Czech Republic 2013 Slovakia 2008 Bulgaria Poland Romania Russia Hungary Turkey Bosnia and Herzegovina Croatia Slovenia Ukraine Serbia CEE ex. Russia and Turkey* CEE countries* 0 20 40 60 80 100 120 140 160 180 200 220

* CEE aggregates are computed via constant 2008 year-end local currency rates against the euro.

BV 11/2014 79 BEST PRACTICE CASES model was unsustainable and the from 51.0% to over 57.0% between 2015 to be marked by financial crisis provided an incen- the end of 2008 and 2013, while healthier lending growth tive for banks to make the switch, capital’s share increased from 10.6% and further funding structure replacing external financing sources to 13.9%. When adding Turkey and adjustment with domestic ones, driven by core Russia the adjustment was less pro- deposits. nounced, due to different dynamics Despite the dynamic developments Balance sheet restructuring has been in Turkey, where the declining share so far, as of December 2013, lend- a major theme for the CEE banking of deposits was mostly replaced by ing penetration in the CEE region sector in the most recent years. From external liabilities, but the overall remains relatively low compared to the end of 2008 through 2013, trend was still in the same direction. major Western European countries, total assets grew at an average rate Capital buffers have also increased highlighting a potential for further of 10.8%, while excluding the two in response to higher risks, increasing banking sector growth. The loans-to- big markets – Russia and Turkey – non-performing loans and as a result GDP ratios (Chart 3) illustrate that a growth was 4.1%. Within the com- of new regulatory requirements. gap remains, although the different ponents of the balance sheet, on the economic structures should also be assets side the fastest growing have taken into consideration before draw- been the securities. Within liabilities, ing conclusions. debt issued and customer deposits Financial crisis Similar to 2014, measured in local grew the fastest, while capital buff- currencies, lending growth in the CEE ers have also gained a significant made evident countries taken together is expected amount. On the other hand, external to be in the high single digits in liabilities showed the slowest growth vulnerabilities 2015, and should be driven by the and even declined on average big countries, Turkey and Russia, when excluding Turkey and Russia, of CEE banking and to a lesser extent, Poland. Still, leading to their lower significance as growth in Russia is expected to slow a source of funding. For illustration model. down while in Ukraine lending may (Chart 2), the share of deposits grew contract (due also to the ongoing cri-

Chart 2: Balance sheet structure evolution of CEE countries excluding Russia and Turkey

Assets Liabilities

12% 11 % 11 % 14% 3% 6% 5% 10% 14% 13% 18% 22% 4% 8%

58% 57% 51% 57%

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13

Other Assets Securities Other Liabilities External Liabilities Loans MFIs Loans Capital Debt Issued External Assets Deposits MFIs Deposits

*Calculations based on local currency volumes, with currencies kept at constant 2008 year-end exchange rates versus the euro. Data for Croatia is as of December 2012, and for Ukraine as of September 2013.

80 BV 11/2014 BEST PRACTICE CASES sis). In Hungary, further contraction Chart 3: Loans to Nominal GDP*, 2013 % is likely in 2015 too, impacted by CEE countries the FX conversion scheme. The rest CEE ex. Russia, Turkey of the countries should see lending Croatia growth at a moderate low-single-digit Slovenia Ukraine percentage pace, with at least half Bulgaria of the countries showing improving Turkey performance. By segments, in retail Bosnia and Herzegovina lending Turkey and Russia (despite a Serbia slow-down in the latter) are likely to Czech Republic Poland retain the fastest growth pace, while Slovakia in the corporate segment also Poland Hungary is set to closely follow them. Russia In 2015, in most countries the loans- Romania to-deposits ratio is likely to remain Austria Germany virtually flat or even slightly contract Italy in Poland, Croatia, Bulgaria, Hun- 0 20 40 60 80 100 120 gary, Romania, Bosnia-Herzegovina, * Data on all Western European countries excluding loans of Monetary Financial and Ukraine. The ratio is expected Institutions. to expand only in Turkey and to a lesser extent in the Czech Republic and Slovakia. 2.1% at the end of 2007. In 2008, increase in provisions due to rising By segments, in retail deposits the as provisions for non-performing NPLs. Country specifics continued fastest expansion is expected in loans increased rapidly, ROA to drive the averages. As in Turkey, Turkey and Russia, while Poland and deteriorated to 1.9%. In 2009, ROA where revenue growth remained Bosnia-Herzegovina are also posed was further negatively impacted very strong, ROA actually was quite to expand briskly. In the corporate and dropped to 1.0%, as revenue solid also in 2009 at 3.2%, returning segment, Turkey, Russia and Poland growth registered a sharp reversal to the level seen in 2006, and in the are likely to be the leaders in terms from the double-digit annual growth Czech Republic, where the ratio also of deposit growth. rates in the previous years. In ad- remained little changed at 1.7%. In The trend towards further rebalanc- dition, there was a continued solid all other countries the dynamics were ing of the balance sheet structure should remain in place. In most countries the shift from external Chart 4: Return on Assets (ROA)*, 2013 % liabilities to deposits is likely to CEE countries continue. In Russia, in particular, also CEE ex. Russia, Turkey as a result of the imposed sanctions, Turkey there is likely to be a further shift Russia in the funding structure away from Czech Republic Poland external liabilities, which would be Slovakia largely compensated by central bank Bulgaria funding. Croatia Ukraine Profitability is expected to Bosnia and Herzegovina Serbia improve following a bumpy Romania phase Hungary -6,8 Slovenia ROA4 was on average at compara- Austria Germany tively high levels before the crisis – Italy -1,0 0,0 1,0 2,0 4 ROA is return on assets, computed based on profit before tax. * Germany data is for year 2012 instead of 2013.

BV 11/2014 81 BEST PRACTICE CASES unfavourable. Nevertheless, with a decline in CAGR of provisions in basis, the highest ROA in 2015 is the adjustment unfolding, profitabil- Slovakia. expected to be retained in Turkey ity measured by ROA moderately It is important to mention that profit- and Russia, followed by the Czech improved on average, increasing ability in CEE continued to compare Republic, Slovakia and Poland. to 1.4% in 2013. In should be favourably with major Western Eu- noted however, that the average ropean countries, including Austria, Conclusion was driven by improvements in Germany, and Italy, highlighting selected countries. The major driver also in this respect the convergence The CEE countries are likely to shift in this phase was actually Russia, potential for the CEE banking sector. to a period of moderate lending where ROA increased from 0.7% in Looking forward, we expect profit- growth, following a rapid catch-up 2009 to 1.9% in 2013. Poland and phase and a period of adjustment. Slovakia also contributed signifi- Future balance sheet expansion is cantly, while in Slovenia, following expected to continue to be funded the major asset quality review and Capital buffers predominantly by local sources, as the significant provisions and loss an important shift away from external registered, ROA deteriorated sharply have also liabilities has been taking place in in 2013, to -6.8%. Interestingly, in most countries. Profitability levels are Turkey profitability started to erode, increased in unlikely to return to pre-crisis levels as growth in profit before tax slowed in the short term, but nevertheless down, while assets continued to response to they should improve from the current expand more briskly. In all other status, which mainly reflects provision- countries profitability deteriorated, higher risks. ing cost. driven by stagnating or declining rev- enues and, in many cases, increasing provisioning cost. REFERENCES: Rapidly deteriorating loan books in ability in the CEE countries, as many countries led to higher levels of measured by ROA, to improve to Bloomberg provisions. Looking at the individual 1.3% in 2015 after another sizable International Monetary Fund countries, between 2008 and 2013 deterioration to 1.0% expected in National Central Banks provisions expanded most in Slove- 2014 - trends again largely driven by National Statistics Offices nia, with a CAGR of 73%, Croatia, shifts in provisioning cost dynamics, UniCredit Research with 40%, and Bulgaria, with 27%. this time particularly in Russia and UniCredit Strategic Planning On the other hand there has been Ukraine. On a country by country UniCredit CEE Strategic Analyses

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UDK 336.71(497.4) Potential for restructuring and new business models for banks Gvido Jemenšek*

POTENTIAL FOR t the beginning of the crisis, the Slovenian banking RESTRUCTURING AND NEW BUSINESS MODELS sector was in a relatively good shape in comparison with FOR BANKS the larger part of the EU banking sector. With the onset In this article we will show why banks in Slovenia of the global crisis, there was little direct influence on have to restructure their A operations and look for Slovenia’s economy . Exports were hit, but local demand was still new business models. relatively high. There was almost no immediate effect on the real We will focus on a group of foreign-owned estate market and on the unemployment rate. Back then it seemed banks in Slovenia which have certain common that the global crisis was not going to affect Slovenia too much. The characteristics but some measures can be applied only real problem in 2007 and 2008 was liquidity. Banks already also to other banks. The main goal is to show how started to feel that money market was not working as it used to. to carry out potential On the interbank market there was almost no money available for restructuring of a bank with a focus on RWA Slovenian banks anymore. (risk weighted assets) optimisation, liquidity optimisation and cost Introduction reduction. We will also show how to find a business model which can generate a decent income In 2010 and 2011, banks faced first significant increase of and profitability for a bank. non-performing loans (NPL), especially domestic banks. The group of non-domestic banks had much lower NPL ratio than the average JEL G21 on the market but this group was also heavily affected by the crises. The rise of NPLs started in financial institution and large corporate segment, later it was transferred also to the SME (small and medium-sized enterprises) segment. At the same time the unemployment rate started to rise: therefore, it became clear that an increase in NPLs was to be expected also in the retail segment.

* Gvido Jemenšek, Chairman of the Management Board and CEO, Raiffeisen Banka d.d.

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Moreover, high volumes and low Figure 1: Liquid assets / deposits and short-term funding margins created a very high lever- - average for ten biggest banks in Slovenia (in %) age of debt in companies making them highly vulnerable. Capital market could not serve its purpose to raise fresh capital for corporates. In addition, there were number of companies where management embarked on a management buyout spree. For many of them at that time this seemed to be a reasonable decision because some banks were willing to finance these management buyouts. And the peak of all this was just one year before the global crisis. An additional challenge was that Source: Bankscope (2014) the Slovenian market was a low margin environment over the last ten years. In 2004, Slovenia entered the Figure 2: Non-Performing Loans / Gross Loans in Slovenia (in %) EU and in 2007 Slovenia adopted the euro as its legal tender. All this had additional effect on margins. Slovenia at that time was flooded with liquidity from abroad which of course again lowered margins. This was partly accepted by all partici- pants in the market, because banks could generate enough potential for profit and growth. But, unfortunately, this was mainly a consequence of the fact that at the same time, risk costs were also very low. Immediately after risk costs increased, banks Source: Bankscope (2014) started to face problems and since margins and interest rates were so low, there was very little motivation for corporates to raise capital. It was Figure 3: Net interest margins for ten biggest banks in the selected much easier to get cheaper lending CEE countries (in %) facilities since banks were also com- peting to find opportunities to place liquidity and find additional potential for business with good companies. In addition, the business models of a lot of banks at that time were based on economy of scale to expand lending and to grab as much as possible of the market to earn enough income also with low margins. Since the effect of the global crisis on Slovenia was limited at that time, there was also no real political will to implement structural reforms which Source: Bankscope (2014)

84 BV 11/2014 BEST PRACTICE CASES would improve the state budget and existing resources, which will be able overall operating expenses). consequently help the economy. to generate its own capital needed • Issue of new equity to existing There was no structured measure for new business in the future. shareholders or equity offering implemented to help the banking Adequate capital ratios are priori- on the open market. system, besides government unlimited ties in banks, because more capital • Reducing loan portfolio, or sell guarantee on deposits for a short means possibility to do more busi- assets; slow down lending growth period of time to prevent outflow of ness or that the bank can better and in some cases an asset sale deposits mainly from the state-owned cover the losses during a crisis, can boost capital through an ac- banks. There were only some capital comply with the current minimum counting gain, as the assets are injections into the state-owned banks capital regulatory requirement ,and, revalued to their purchase costs. where government had to act as an also very important, they maintain cli- Although capital increase and selling owner to maintain capital adequacy ent confidence, which is crucial in the of assets are very effective ways to of these banks. Because of these banking sector, especially during a strengthen balance sheets, both can facts, risk cost for provisioning was crisis. And it is also, well known that be achieved very difficult in time of increasing while on the other hand “better capitalized banks are better crisis. Besides, fresh capital will not margins and consequently interest in- able to maintain lending during the improve the bank’s business model, come were still relatively low. At the crisis” (Kapan and Minou, 2013; it can only strengthen its capital ratio same time, globally capital for the Kok in Schepens, 2013). and give the bank some more time to banks became very scarce resource. create and implement a strategy of It was clear that long-term sustain- a new business model, which will be ability of the Slovenian banks was successful in the future. threatened. Therefore, a need for restructuring the banks and changing A need for Implementation of a new the business models was recognised restructuring business model in 2011. the banks was The main goals of a potential busi- Bank restructuring ness model have to be stability, recognised effectiveness and profitability. The The first question to aks at the start most important measures the bank of restructuring is how to have a in 2011. has to take to achieve these goals profitable bank which will generate are changes in risk-weighted assets enough return on capital invested (RWA), optimisation of liquidity, in the bank. Therefore, the optimal management of bad assets and cost capital structure has to be defined In general, banks that seek to optimisation. first. Because capital became a increase their risk-adjusted capital scarce resource during the global ratio have a number of options at Funding crisis, banking groups started to allo- their disposal (Cohen and Scatigna, Before a bank embarks on a restruc- cate capital to different markets very 2014): A bank that seeks to increase turing process and implementation carefully and on a highly selective its risk-adjusted capital ratio has a of new business model, it has to basis. It goes without saying that for number of options at its disposal. ensure stable funding, such as retail any banking group it makes sense to • Banks can reduce their risk- deposits, longer-term funding and allocate more capital to the markets weighted assets by replacing equity. Funding structures should be where there are more possibilities to riskier loans with safer ones, or well balanced in terms of maturity achieve better return on this capital. with government securities. and other risk exposures (van Rixtel Because of the characteristics of • Reducing the share of its profit it and Gasperini, 2013). Moreover, the Slovenian market described at pays out in dividends or alterna- events have shown that funding the begging of this article, there is tively, it may increase the volume structures should be well balanced only a small chance that the Slo- of profit (increasing the spread in terms of maturity and other risk venian market could compete with between interest rates it charges exposures. However, in general, we other CEE markets in this sense. As a on loans and those it pays on its could say that funding in the crises consequence, a restructuring project funding; increasing profit margins times is a problem for all banks. It has to identify a business model on on other business lines or reduce does not bring any help to restructur-

BV 11/2014 85 BEST PRACTICE CASES ing efforts. On the contrary, it brings of two small local banks. These two weights with the purpose of reducing additional costs which would have to banks did not have an access to for- the quantity of capital that is needed be compensated with an increase of eign money markets. They also had to support a given level and structure interest rates and margins on the as- liquidity problems and, therefore, of total assets (Beltratti and Paladino, set side. But since the general situa- they could not afford to lose deposits 2013). On one side, there should be tion in the Slovenian banking system and, consequently, they were pricing measures for decrease of RWA with- is that average maturity of liabilities deposits very high. The main advan- out reducing total assets and if this is is very short, while on the other hand tage of foreign banks is that they still not enough, next steps have to follow maturity of loans on the asset side is had somebody who could provide how to optimize total assets. sometimes extremely long, this takes funding, while local banks had very Banks usually first analyse the usage time. There is also the also issue of limited access to the foreign market of RWA and with that underlying the impact of higher interest rates on and maintaining liquidity has to be capital in different client segments. the economy. the highest priority for every bank, Some segments are more efficient There is a wide-spread opinion that especially in crises, when it is meas- than others, thus logical conclusion non-domestic banks in Slovenia ured in days. On the other hand, the would be to simply exit none or less controlled by larger banking groups cost of funding is important, but the efficient segments and concentrate have an easy access to cheap effects are only on the profit and loss on the most efficient ones. All of this funding. Of course, this is not true. account and we see these effects has to be accompanied by heavy There is an access to the interna- only after some time. cost reduction, having in mind that tional money market through parent income in such reduction will also banks, but the price for such funding Risk weighted assets decrease faster than costs. has to be the market price. In other optimisation But because of the small size of the words, at the peak of the crisis, when When a bank embarks on the Slovenian banks and Slovenia’s the interest rates for the Slovenian process of restructuring and imple- small market, it would be impossible government bonds were also at the mentation of a new business model, to just exit certain segment of clients peak, all foreign funding became risk-weighted asset optimisation is in a short period of time. Namely, in extremely expensive. Because of this naturally the first to look at. RWA such a case, it would be very difficult and because of the fact that foreign optimisation are steps to improve to compensate for lost income in one banks in Slovenia historically had the coverage and granularity of risk segment with an immediate increase higher loan/deposit ratio, they were models, the quality of data entered of business in the other segment. affected by higher cost of funding into models, the eligibility of col- Thus, instead to simply exiting certain immediately. Thebanks that have lateral, and improvements in RWA- client segments, a bank has to look many retail clients with a lot of à relevant processes (Babel et al., for a different solution, which would vista money were at the beginning in 2012). Because equity capital is the enable it to keep enough income, to a much better position. most expensive source of financing have a sustainable business with re- During the crisis, Slovenian banks for banks, the main goal is to set risk quested return on equity. To be able slowly started to lose deposits as their most important source of fund- ing. To mitigate a flee of deposits Figure 4: Loan-to-Deposit Ratio (in %) to foreign banks on a larger scale, domestic banks (especially smaller ones) increased their interest rates on deposits. Consequently, that signifi- cantly increased their funding costs and also the costs for non-domestic banks, although foreign banks did not follow the market with an immedi- ate increase on deposit interest rates. Still the price for maintaining depos- its for foreign banks in Slovenia was also high. The situation on the market started to improve after liquidation Source: Bankscope (2014)

86 BV 11/2014 BEST PRACTICE CASES to find such a solution, a bank has Figure 5: Possibilities of defining the future business model of the to analyse and calculate profitability existing client portfolio not only on segment, but also on the client level. Therefore, the starting point for defin- ing a future business and operating model is an analysis of the existing client portfolio. First question that has to be answered is: does the bank has enough healthy business/clients which could be a basis for a new business model. A bank has to evalu- ate a potential of income which can be kept out of this portfolio. After- wards this has to be compared on one hand, to the potential of cost re- bank has to define a clear strategy in all segments on the client level. It duction and on the other hand to the how to exit business relationship with can also keep the majority of good potential of decrease of RWA and them. Of course also a non-profitable business and income in the bank and with that a potential capital relief. client can become profitable for the the same time reduce assets and cap- Using RWA, a bank can divide cli- bank if e.g. Increase of income with ital need on the part of the business, ents into different groups, according this client or decrease of underlying which is not profitable for the bank. to the fact how efficient these groups RWA is possible. This would make Last but not least, if the bank is cut- are and consequently how profitable this client profitable and it would be ting off certain segments, it increases are for the bank. In general, bank preferable for the bank to keep busi- potential concentration risk. With can divide clients in two main groups ness relationship with it. keeping more segments and cutting - profitable and non-profitable and This is much more difficult to do then down only on non-profitable clients, this has to be done through all seg- to simply exit certain client segments, it reduces the concentration risk. ments of clients. After analysing prof- but because of the small size of itable clients, bank has to recognize majority of the banks, especially in Management of if it can generate enough income to the group of foreign-owned banks non-performing and cover decreased costs and having in Slovenia, this seems to be a much non-profitable assets in addition enough profit to have a better solution for long-term sustain- There are several ways how to split sustainable bank with these clients in ability of the bank. With this, bank good and bad business and how to the future. For non-profitable clients, can carve out non-profitable business manage bad assets:

Figure 6: Types of bad banks

On-balance-sheet guarantee Internal restructuring unit • No balance-sheet • No balance-sheet »deconsolidation« »deconsolidation« • Transfer of asset info one separate • Capitalization Accounting model On balance • High structural complexity business unit (locations, subsidiaries) available sheet - External guarantee • Separate org. and operations • Faster, simpler - Specific regulatory/legal • Internal risk/profit split between • Limited risk transfer framework business units and bad bank Special-purpose entity Bad–bank spinoff • Limited asset scope (living loan • Structural complexity portfolios) • Maximum risk Off balance - Legal, tax, accounting, regulatory • Complexity in current market transfer/protection sheet - Asset transfer vs carve out - External rating/funding • Higher complexity • Capitalization and funding restrictions - Asset transfer, P&L implications • Operational complexity and setup - Capitalization needs Structured solution Banking entity Management model/risk transfer

Source: Brenna et al. (2009)

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In such split of business, a clear seg- for retail clients, with low priced mort- preferred. This can be a very good regation of portfolio and manage- gage loans from the past, who are solution, if there is a market for such ment responsibility for this portfolio normally repaying their loans, but transaction and if the price is favour- is needed. Solutions to do that, can are not having other products with able. KPIs (Key Performance Indica- vary from the possibility to do only the bank and are therefore not profit- tors) like NPL can improve very fast separate reporting for both busi- able. There is no legal possibility to with such action, but at the end of the nesses in the bank, to the solution ask such client to repay loan faster. day the impact on the profit and loss to split non-profitable business or to Of course bank can always try to sell account of the bank should not be separate unit inside or even outside additional products to such clients, too much different, if the bank sells of the organisation. The best solution but usually response rate of clients to bad assets or tries to collect as much for a single bank should be defined mass activities in such cases is very as possible with its own resources. after analysing all impacts of single limited. Therefore this is too costly Therefore, we should treat selling solution on different areas, such as and it makes more sense to have pas- or any other transfer of bad assets management responsibility, proximity sive approach with these clients. more as a tool - how to arrive at a to clients, competence of involved An example of a pro-active ap- final solution to clean up the bank specialists, segregation of clients, proach the bank can have vis-à-vis balance sheet. implementation complexity, etc. Here Because of all these reasons, bad as- we have to point out that we are set management is extremely impor- not talking only about segregation tant for successful restructuring of the of problematic clients with non-per- bank and requires a lot of resources. forming loans (which is a common Main goals Thus this area of the bank is in the solution), but also about other clients, time of restructuring probably the which can honour their obligations of business only area that will require even more to the bank when due, but are not resources then usually. The bank profitable enough for the bank. After model have needs a clear plan how and when taking a decision about organisa- to be stability, these assets will be reduced and tional handling of non-performing when these extraordinary resources and non-profitable clients, a strategy effectiveness can be afterwards reduced as well. for managing these assets has to be defined. and profitability. Cost optimisation For non-performing assets, a poten- After restructuring reduction of as- tial strategy is more or less clear - we sets on non-profitable business and need a pro-active strategy for the replacement of this business with reduction of these assets. We can corporate clients (there are usually profitable one, which would use very have different solutions from relative- more products in use and contracts little or no risk-weighted assets in a ly simple collection activities for retail are made for single deals) where short period of time, it is very likely clients, to the most sophisticated usually shorter tenors are used. In that the bank will consequently see “work-out” activities for mostly corpo- that case, the bank has a possibility an impact on its income. Therefore, rate clients, where a lot of legal and not only to sell additional products to already from the beginning of the economic know-how is required. This such client, but also to re-negotiate restructuring, the bank has to focus topic is in times of severe crises prob- low pricing from the past and to also on cost reduction. ably the most important in the bank turn such client from non-profitable Usually for different historical and in short-term, bank can profit a to profitable. It is important that the reasons, banks are not the most ef- lot from collection activities and from bank defines these strategies not ficient institutions. Nevertheless, the recovery of “work-out” cases. only for all client segments, but also Slovenian banks are among the ef- On the other hand, we can have a for different groups of clients with ficient ones when compared to other lot of different strategies for non-prof- different characteristics (products) CEE markets due to the low margin itable clients. Since these clients are within the segments. It can be even environment in the past. normally serving their obligations to defined on a single client level for Usually the problem is more on the the bank, there are also limited legal large corporate clients. income, rather than on the cost side, possibilities to react. Bank can for There is also a possibility that a bank where again the size of the bank example define a passive strategy sell parts of portfolios, which are not plays an important role. However,

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Figure 7: Cost-to-Income Ratio for ten biggest banks in some of the can be outsourcing, organisational CEE countries (in %) optimisation, process optimisation and IT optimisation. Outsourcing is always a possibility, but there has to be a very clear business case behind such activities, otherwise we can achieve very limited results, with a lot of efforts. A danger in outsourc- ing is also that in this case we only shift costs from one group of costs to another - e.g. from staff cost to sup- plier costs. Organisational optimisation is on the other hand a lever, which can bring Source: Bankscope (2014) a bank a lot of potential for cost reduction. Here we can think about horizontal merge of several depart- Table 1: Indicative Cost Savings ments, or about vertical decrease of management levels. In both cases, a lot of synergies can be found Cost reduction Steps Themes Indicative Cost Savings which can lead to a reduction in 1.5 Strategic cost savings T1: IT Optimization / 10-30% of overall IT cost the number of employees. Under opportunities Rationalization organisational optimisation, we have 2.5 Asset & people T2: Remote Infrastructure 25-40 % of Infrastructure to mention also optimisation of sales Reorganization Management Services Management cost T3: Shared Services 20-30% of Development / channels, where especially the right Operations cost size of the branch network is very T4: Testing Centre 15-45% of Quality Of Excellence Assurance cost important for a bank. T5: Data Centre / 30-40% of the hardware Probably the biggest potential for Server consolidation costs optimisation in a bank is the process 3.5 Optimization through T6: IT & Operations 10-15% of IT / Operations and IT optimisation. Comparing to an efficient Operating – Standardization of cost model processes the production industry, banks are usually much worse in their pro- Source: Singh et al. (2009) cesses. Historically this can be a consequence of the fact that banks in every bank there is a potential for model levers for cost optimisation. were not so much under pressure of cost reduction. So where to look for The lever for the business model can cost optimisation and were rather this potential? be to carve-out certain business line focusing on growth and developing There are three major groups of costs or product line. In this case, bank new products and not optimizing the in an average bank: staff cost, IT can have significant cost reduction old product range at the same time. costs and all other (rents, deprecia- through the whole process starting in Lately, banks are burdened with a lot tion, material). Usually every bank front office, through the risk analyses of reporting to regulators and other first tries to focus on the last group. and back office, and even in control- institutions and are legally obliged to There can be a significant cost reduc- ling and accounting functions. The perform certain activities, which are tion also in that group, but since danger in smaller banks is they have not core business of a bank. Practi- these costs are the lowest, success to be very careful what is in this case cally all main processes in a bank can be only limited. There is no real a real cost reduction, which can be are affected by such activities and restructuring and cost reduction in actually achieved and which costs optimisation of such processes then the bank possible, if first two groups will be at the end of the day shifted becomes a very difficult task. But are not tackled. Therefore, cost to other business lines or products nevertheless, process optimization saving opportunities derived from a because of the certain minimum size can bring a significant cost reduc- change of the business model must of banks operations. tion. It makes sense that bank starts be combined with general operating The levers in the operating model with processes where it has most

BV 11/2014 89 BEST PRACTICE CASES of capacities allocated, because banking system in a couple of years’ Restructuring and forming a new the biggest short-term impact can time. Even now, after big recapitali- business model for a bank, should be achieved in that area. From the sation of the banking system, these be a value preserving way forward. point of IT, processes can be auto- problems are still present and without It should have a positive impact on mated, but this requires investment to improving, profitability and efficiency capital by reducing RWA compar- achieve cost savings. A bank has to of banks on long-term bank cannot ing to total assets which are used be very careful, that clear business be sustainable. for client business and consequently case behind such investment is avail- For the purpose of this article, we improving return on equity. It should able in order not to automate every concentrated on banks and we did first preserve and afterwards in the process which could be performed not assess other external economic future, increase an income from efficiently also manually. This is even factors which are preconditions for profitable clients as much as possible more important in a small bank. sustainable business in banks, such and improve efficiency by optimis- A bank also has to be very careful as recovery of the economy with sta- ing cost structure of the bank. With that the time benefit, after process ble economic growth, deleveraging that, it should have a positive effect is automated, is efficiently used for of corporates (in case of Slovenia), a on producing positive income - cost something else or that the number stable real estate market, a stronger jaws between so that in the future of employees engaged in such a capital market, etc. Impacts of these the bank is able to digest all costs process is reduced. If not, there will factors on banks are of course arising from risk provisioning and still be savings only on paper for one produce profits which could gener- process but on the overall level, the ate its own equity for future growth. bank will have additional cost be- cause of investment in the automation REFERENCES of the process. The bank has also a There is also a Babel B., Gius D., Gräwert A., Lüders E., possibility in optimisation of IT cost Natale A., Nilsson B., & Schneider S. (2012). Capital management: Banking’s by reducing the number of applica- possibility that new imperative. Mckinsey Working tions which are in use. Consequently, Papers on Risk, Number 38. Mckinsey & Company. it can improve efficiency by reducing a bank sell parts Beltratti A., & Paladino G. (2013). Why do complexity of its IT function. banks optimize risk weights? The relevance In theory, there is also a number of portfolios. of the cost of equity capital. MPRA Paper No. 46410, Munich Personal RePEc of possibilities to work on process Archive. improvement with instruments like Six Brenna G., Poppensieker T., & Schneider sigma or Lean, which were proven S. (2009). Understanding the bad bank. Insights & Publications, Mckinsey & in other industries. These instruments substantial, as we can say that banks Company. can probably give good results in are mirrors of the economy. We also Cohen B. H., & Scatigna M. (2014). Banks big banks with scalable processes, did not assess the impact of risk man- and Capital Requirements: Channels of Adjustment. BIS Working Paper No 443, while on the other hand, benefit of agement, different credit policies in Monetary and Economic Department, performing these activities can be the banks and potential for recovery Bank for International Settlements. helpful, but unfortunately only limited from non-performing loans granted Kapan T., & Minoiu C. (2013). Balance Sheet Strength and Bank Lending During for small banks. in the past. All these factors will have the Global Financial Crisis. IMF Working much bigger impact on P&L of the Paper 13/102, Research Department, International Monetary Fund. Conclusion Slovenian banks in the near future Kok C., & Schepens G. (2013). Bank and, therefore, efforts for restructur- Reactions After Capital Shortfalls. ECB Restructuring and implementation ing and forming new business mod- Working Paper Series No 1611, European of new business models for banks els may be not so visible or, in the Central Bank. Singh M., Kalyanaraman G., & Jesudas in Slovenia is absolutely necessary worst case, all these efforts might not N. (2009). Cost Reduction for Financial to have profitable and sustainable be enough to have successful banks Services Organizations. Infosys. banks in the future. Simply to con- in the future, if economy does not Van Rixtel A., & Gasperini G. (2013). tinue to do business as it was usual in recover. But without these efforts we Financial crises and bank funding: recent experience in the euro area. BIS Working the past is not a solution for the future cannot have successful and sustain- Paper No 406. Monetary and Economic Department, Bank for International and may create a new crisis in the able banks. Settlements.

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UDK 337.71(497.4) Transforming NLB, Slovenian market leader Janko Medja, Tanja Šajnič and Mitja Učakar*

TRANSFORMING NLB, fter a prolonged period of being the main financial SLOVENIAN MARKET LEADER problem in Slovenia, the NLB Group is back to positive Alongside with the figures and set to actively pursue its vision and stra- approval of the state aid for the Slovenian tegic goals. The core entities of the NLB Group in the largest bank in form A of recapitalisation, EU mid-term at least 10 % return on equity on a self-sustainable basis Commission has also and / or maintain above 15% market share on each target market approved an extensive restructuring plan that or customer segment. We will execute the transformation plan to foresees cleaning up a balance sheet and building improve C/I ratios below 60% and will maintain high liquidity and a profitable business model that will make it security for depositors. sound again. According to the plan NLB was entrusted the capital which it will manage responsi- NLB started a very bly by improving profitability, delivering proactively solutions that complex transformation programme, organised meet client needs, proactively looking for new business opportuni- through seven interdependent streams. ties, optimizing cost base and distribution channels. Moreover, we The business model and underlying strategy will actively help to contribute to the society via various initiatives are client-centric with an emphasis on further and will improve the quality of work for the entire NLB team. development. To achieve that, the bank needs to transform completely, 1. Changes in the environment require banks from processes, products, and bankers to adapt distribution channels and technological support to changes of mind-set and Change has become the constant, the norm. Demographic proactive orientation of its staff. The bank is also trends, consumer habits, globalization and consolidation of putting a lot of effort in the innovative approaches industries, technology accelerators, mobility, social networks and to start making positive impact in Slovenia’s much more are just some of the drivers. economic and social environment.

JEL G01 G21

* Janko Medja, MBA, President of Management Board of NLB d.d., Tanja Šajnič, MSc, General Manager at NLB d.d. and Mitja Učakar, Advisor for retail business at NLB d.d.

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The trend doesn’t seem to be slow- Figure 1: Slovenia’s banking sector suffered heavily ing. But – is that the whole picture? from 2011 to mid-2014, resulting in negative profitability. What about human nature? There (Banking System, 2014 and NLB internal data, based on seems to be plenty of evidence we unpublished monthly report from the Bank of Slovenia) change our basic responses, rela- 2,00 20 tions, assumptions, cultural traits just 5 slightly, if at all. This causes friction 0,5 0,00 0 and supports the idea of the general -1,1 -1,6 -1,1 -7,7 resistance to change, inherent in our -2,00 -12,5 -12,8 nature. We also need firm ground, -19 -20 things to rely on. We find the answer -4,00 in the good old values, communi- -40 cation, strategy development and -6,00 execution, as well as invention (and -60 re-invention) of one’s own unique -8,00 in % and ROE ROA character. Only organizations and ROA -80 individuals that learn to understand in % growth Loans and total assets Y-o-Y -10,00 both – the inevitability of change ROE Loans to non-banking -100 and the strength in preserving posi- -12,00 sector (Y-o-Y growth) -100 tive values and building their own Total assets character – can become drivers of -14,00 -120 positive change. 2 011 2012 2013 2013 (I-VI) 2014 (I - VI) The banking industry and bank customers have been confronted Figure 2: The share of NPLs in total claims in Slovenian banking with grass-root going through some market is rising again. Does this indicate further deterioration of potentially ground-breaking changes. Slovenian economy? (Bank of Slovenia, 2014) Conventional wisdom tells us that 18% NPL % the awareness of change came with 17% the global crisis in 2008-09 and the 16% initial response of most was to slam on the brakes, be it in the investing 15% in development or in the risk we are 14% willing to take. Some of the banking 13% (like lending in over-leveraged envi- 12% ronments) went back to the basics, 11 % using lessons learned to improve.

Sometimes this leads to avoiding risk dec. 11 feb. 12 apr. 12 jun. 12 avg. 12 okt. 12 dec. 12 feb. 13 apr. 13 jun. 13 avg. 13 okt. 13 dec. 13 feb. 14 apr. 14 jun. 14 rather than mitigating it. But some banks and some new non-banking of the very slow (several years late) lenge. On one hand, the banking competitors have in time gone on the response to the banking crisis in Slo- system is more stable thanks to quest for offering better services and venia, forcing banks to focus on the extraordinary measures put in place it now seems to be a clear move to healthy basics first before being able by the Slovenian government and the looking for opportunities in niches to leap ahead, and also caused by Bank of Slovenia at the end of 2013 and segments, as well as using the structure of this market with too- and banks that are no longer under technical innovation to support new high state ownership, over-leveraged threat of failing are re-focussing business models. and poorly competitive economy, on the business, as well as on their Slovenian banks try to follow these labour market inflexibility and simply own efficiencies. The liquidity of the trends with varying success, but on too many banks with too few (clas- banking system is solid and there is average with a significant lag to sic) revenue pools. no obstacle to finance good projects some the best practice examples As the end of 2014 is drawing closer, for growth. Exports remain a driv- found in some other European some things have changed for the ing force as the Slovenian exporters markets. The lag is mainly the result better, while others remain a chal- continue to sharpen their competitive

92 BV 11/2014 BEST PRACTICE CASES edge. On the other hand, the eco- in terms of funding, capital, and ent evaluators following the central nomic environment for companies, adequate profitability, in order to be bank’s request and NLB’s new including exporters, is far from kind. able to attract possible investors and management reviewed the bank’s The economy (companies) has not finally be privatised within a 5-year portfolio against the backdrop of yet deleveraged nor restructured or restructuring period. deteriorating market circumstances. increased its competitiveness overall, NLB has developed direction for The results of the AQR/ST revealed pointing to further stagnation or slight its new Strategy and the Slovenian in December 2013 deficit capital contraction of the banking system government delivered a Restructuring shortfall. Consequently, the Restruc- total balance sheet; investments are plan for the NLB to the EC at the end turing plan of the NLB, as the first extremely scarce and so is FDI; pri- of 2012. Both defined a framework pillar of the NLB’s return to viability, vatisation is a patchwork rather than for the future development of the NLB was approved along with an ap- a transparent and finely running pro- Group and were basis of changes proval of state aid by EC at the end cess; most structural reforms are still that the bank needs to implement in of 2013, coupled with the Slovenian in the waiting room and alignment on order to regain viability. government adopting commitments solutions is low; state budget deficit, The Strategy has been fine-tuned dur- to EC with regard to the NLB, the public sector efficiency and effective- ing 2013 (while important parts of its Slovenian government (under MS- ness don’t seem to have a near-by so- implementation started in the first half BSA1) implementing the measures of lution; consumer confidence is shaky. transfer of some NPLs to the Bank as- Even though some of the forecasts set management company (BAMC) for EU are getting slightly better, for and the recapitalization of the NLB Slovenia the economic activity might The Slovenian in the amount of EUR 1,5bn. The lat- even decline further. ter was together with other needed The Slovenian economy has not economy has steps enacted by the extraordinary restructured or increased its com- measures of the Bank of Slovenia un- petitiveness as a result of its aggres- not restructured der the Banking Act (ZBan) with the sive expansionary strategy in the aim of preventing failure of the NLB, previous decade (in terms of credit or increased its which would have caused extremely growth, business fields in addition to high and irreparable damage to the banking and of course geographical competitiveness Slovene banking sector stability as footprint), the failure to re-focus in well as its economy. time on core business efficiency and the Slovenian market crisis starting in of 2013) and formally adopted in 2. Transformation aims to 2009,. Subsequently, NLB had two the start of 2014. The Strategy serves reinvigorate the bank recapitalisations in 2011 and 2012. as an overall direction for the NLB After restructuring plan enabled the Even though NLB has been majority (beyond the Restructuring plan as its survival of the bank, the Transfor- state owned, both re-caps (by the first and key milestone pillar) as the mation Programme was launched Slovenian government) were deemed bank aspires to further develop into consisting of 22 projects and 3 state aid, which led to formal state one of the top regional players by business initiatives that enable the aid procedure led by the European implementing certain best practises organisation’s future capabilities and Commission against the Republic in its focus areas of development. implementation of the strategy of the of Slovenia and a request for a bank. The process started by analys- comprehensive restructuring plan. As 2. Three processes of change ing existing operating models and new management took over the bank defining target operating models in at the end of 2012, NLB worked in Bank runs three major change many business areas, and continues parallel on the new Strategy as well processes in parallel as they mutually with the implementation of changes. as on a Restructuring Plan for the support and complement each other. A set of quantified measures define European Commission. each project, combining into overall As per EU rules EC’s main request 1. Restructuring plan and was for the Slovenian government to the Slovenian government prove that NLB can – after it clearly commitments to the EC 1 Measures of the Republic of Slovenia to needed another, but last state aid In 2013, an asset quality review Strengthen the Stability of Banks Act (MSBSA) – Zakon o ukrepih Republike Slovenije za krepitev – achieve self-sustained viability (AQR) was performed by independ- stabilnosti bank MSBSA.

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Figure 3: 7 areas of Transformation Programme feature a highly purposes of efficiency, effectiveness complex structure that calls for sensible management. and flexibility. In 2013 and 2014 deeper, some- 1 times structural changes were needed to set up the bank to prop- erly start implementing the Strategy. GOVERNANCE These have been taking place in 7 2 several stages, most of which should be finalised by the end of 2014. Af- BUSINESS MODEL COMMUNICATION REVIEW ter that, NLB will focus on improving processes and organisation with lean methodologies and with continuous NLB improvement. TRANSFORMATION RISK POLICY 3. What will the NLB become HUMAN PROGRAMME AND in the following years? RESOURCES PROCESS 6 REVIEW 3 The successful execution of the Strategy (including fulfilling the Slo- venian government EC commitments, PROCESS ENSURE CAPITAL Transformation Programme and REDESIGN ADEQUACY improvements in organisation of the NLB Group) will contribute mostly to 5 4 implement the NLB Group’s vision for the year 2020: • NLB will be a sustainably profit- transformation plan. Most projects 3. Reorganisation is supporting able banking group, predomi- should be completed by mid-2015. core transformation principles nantly working with customers Naturally, some IT intensive and non- Organisation of the bank should in those core markets (or market core wind-down related projects will reflect market circumstances, segments, niches) where it can continue past that date. competitiveness, and prioritisation achieve and hold a top three The Transformation Programme is of activities with implementation of competitive position in terms of organised in seven streams: govern- the Strategy. It is no longer true that (relative) profitability and/or ance, business model review, risk organizations can be static – quite market share. policy and process review, ensure the opposite: flexible organization • In its core business NLB will capital adequacy, process redesign, and quick adaptation of relationships differentiate by in-depth client human resources, communication. and processes (in order to become understanding, by service level Considering the scope and great or stay competitive) will become a and advisory competence, by complexity of interdependent activi- key competence going forward, and bank accessibility and by a com- ties the Transformation Programme changes will both follow as well as petitive product / channel mix. It requires active participation of most enable and support the execution of will compete mainly in traditional of the NLB team. Constant monitor- the NLB strategy. banking services, complemented ing is crucial not only to take timely Reorganisation efforts in the NLB aim by new offerings in line with mar- corrective measures, but also to to follow core principles of lean or- ket needs. The NLB Group will be provide sufficient upfront information ganisation. The bank is re-engineer- focused on quality and efficient and motivation for the team. There- ing its structures and organisation to day-to-day client service and will fore, a comprehensive management achieve higher degree of optimisa- achieve top client satisfaction structure has been set involving man- tion of operations and processes. rankings. agement and direct supervision by We are actively reducing organisa- • The NLB Group will be the em- the Management Board supported tional layers and units, trying to set ployer of choice (family friendly), by the Program Management Team up better information flow, effective steadily investing in developing to coordinate all the activities. decision making and similar, for the NLB team competence and

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experience based on regular ments and are actively looking for it will linger on low levels over a goal achievement. Finally, the optimal ways to satisfy them, with the considerable period before starting NLB Group will support notable goal of building long-term business to slowly recover. projects of local environments relationships to mutual benefit. This In order to allow for specialized where it is present, especially in is done through extensive work with treatment with the right focus on the the fields of (social) entrepreneur- the NLB team, best practise sharing activities most needed per particular ship, sports for youth, culture and and education. Occasional glitches group of clients, the whole corporate philanthropy. in the service quality will of course segment has been split into core per- • By end of 2020, the NLB Group still occur, but we are trying to learn forming, restructuring and workout will complete divesting its non- from them and are using them as cases. Efforts of the NLB in the core core business activities. examples in the continuous improve- corporate segment are to maintain We are placing NLB‘s new corpo- ment process. our leading market position while rate values at the very heart of all improving profitability and stability our endeavours. These have to be Business strategy is client centric of business over time. embedded in every development and focused on development The core corporate segment model activity, every encounter with client The NLB business model relies on encompasses eight fields of improve- and other stakeholders. Basically, we two strong pillars: Retail (including ment that will assure a long term strive for these positive values in eve- Small Enterprises, “SE”) and Corpo- sustainable and improved corporate rything we do. By that we transform rate that are characterized by the banking business: our work into added value and posi- segment specific treatment of clients 1. Initial high-level division of the tive change for NLB, its stakeholders and corresponding processes. Both portfolio parts of bank’s corpo- and our environment. pillars are further sub-segmented to rate portfolio were carved out adequately address specifics and to to specialized units for non-core We emphasize: develop in-depth understanding of and the non-performing core • Responsibility towards clients, col- client groups. The bank has started assets. The sales units within the leagues and society at large; to focus on: corporate division today focus on • Commitment to deliver on our • constantly improving professional- the performing part of the core promises and objectives; ism in dealing with clients (speed, portfolio; • Efficiency in the fulfilment of our knowledge, win-win, open com- 2. Sub-segmentation of the core commitments; munication, simplicity), going for performing portfolio: segmenting • Open communication and coop- increasing client satisfaction; the corporate into medium sized eration; • proactive approach to clients and large corporate segments to • Nurturing a win-win attitude. (vs. the “sit and wait for request address the specifics of groups to come in”) and active develop- of companies based on their 4. The NLB’s new strategy ment of sound business with them, characteristics, complexity and and business models including cases of restructuring; proximity (local regional pres- • cross selling efforts as well as ence vs. fully centralized client The NLB describes its strategic fostering joint support services management); goals in two groups. The first deals and development wherever ap- 3. Changing the client management with clients, financial markets, core propriate. approach: subsidiaries and non-core activities. • from the transactional relation- The second focuses on knowledge Corporate segment as a strong ship approach and geography centres and processing activities (or- professional pillar distribution to a holistic client ganisation and HR, processing and The corporate segment is the most management approach based IT, risk management). troubled in Slovenia, as the firms on client characteristics and We propagate a customer centric suffered heavily from the negative needs. Introducing a dedi- strategy that stretches beyond pure macroeconomic developments and cated relationship manager product sales to (pro)active relation- are generally excessively leveraged. principle to develop quality ship (and in the future, client experi- It is thus anticipated that the overall client relationships; ence) management. Hence we are loan volumes and the demand for • from the historic reactive cul- developing deep understanding of banking products will be further ture to a client oriented, proac- various client needs and require- declining for some time, afterwards tive, solution oriented sales

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culture, enabling the bank to represented the historic core of the related products (investment and identify and target desired bank and is an important source of insurance products) while reduc- clients and businesses; future stability. Deposits generated ing overall bank costs. • introducing the contemporary within the retail segment serve as Due to high market shares in the client management model, the most important funding source in retail segment the focal point of our with parent account managers terms of both volume and stability. relationship management strategy is steering the relationship with Furthermore, the segment is a key the reduction of negative churn. The particular group of borrowers contributor to the overall profitability centre of our attention is in regain- across the whole network of and economic value added of the ing client trust, supported by good the NLB Group; bank, having relatively low risk and communication, attractive product 4. Further micro-segmentation of key consuming little capital. We realized solutions and quality as well as segments to target the desirable that small enterprises require the speed of service. In addition we aim (potential) client niches and op- same level of flexibility and ubiqui- to introduce and use contemporary portunities; tous access to banking services as marketing approaches, already suc- 5. Adapting the product mix to private individuals. Therefore it was cessful in other markets and indus- relevant business segments to not efficient to treat them in different tries (loyalty programs, frictionless achieve cost effectiveness: focus- segments, so we have joined the seg- service, and communication through ing on an upgraded client ap- ments within united retail segment in social media). proach rather than on increasing order to effectively offer those clients Small (family run) business represent complexity of the products; standardised automated processes the backbone of every mature and 6. Managing client relationships’ and to secure faster service, which stable economy. Hence we assess profitability in addition to product are beneficial for clients and for the that small enterprises will in view (or transaction) profitability; bank. of current macroeconomic develop- 7. Redesigning the sales process With respect to the market maturity ments most likely be the main drivers to allow for a more efficient of the private individuals segment of revitalisation of the Slovenian (proactive and risk aware) sales the goal is to strengthen the leading economy. For this reason the NLB approach and to properly meas- position in the market: firmly believes in the necessity of ure, manage and reward sales • “our client as our first focus” – lis- professional support and services of- performance; tening to our clients and under- fered to this segment. Moreover this 8. Teaching risk awareness: trans- standing market trends leads to is the only segment where the bank forming relationship managers into segmenting client groups in order can count on increasing its market “the first line of the risk manage- to understand their needs, their share in certain niches (for example ment” to assure smart lending and development cycles and their lending), since the segment hasn’t achieve a balanced risk underwrit- potential, and respond to those been actively targeted in a structured ing culture (somewhere between responsibly, as well as achieve way before. The bank has already risk abandon and risk avoidance, increasing levels of client satisfac- established independent segment neither of which are desirable). tion; management, with corresponding Sound risk awareness to appro- • addressing them with customized organisational changes, that will priately structure new deals with service models: standard level of implement the new business model. “healthy” corporate as well as service, personal (premium) level Although competitors have also specialized knowledge and decisive of service for affluent clients and already started targeting small approach in restructuring cases are private banking approach with enterprises segment, the NLB market paramount in order to ensure that the a focus on assets under manage- position along the different sub-seg- Slovenian economy stabilizes and ment services; ments could be retained and even gains its momentum again. • boosting sales activities through improved. The fact that the bank’s targeted campaigns and proac- market share with various target Retail segment still offers tive sales approach; groups has been consistently on a lot of banking potential • improving sales performance similar levels indicates that competi- management (Sales Force Effec- tion hasn’t yet proficiently adopted Retail segment of the NLB performs tiveness principles); similar strategy. Primary client in the very mature Slovene retail • simplifying and enhancing prod- relationship management direction banking market. This segment has uct portfolio, including banking- for this segment should obviously be

96 BV 11/2014 BEST PRACTICE CASES focused towards acquisition, having hours, the bank is considering pro- NLB took a leading role in in mind development of mid to long- cess (campaigns) that should secure financial restructuring of term client relationships. a loan to eligible companies in 48 Slovenian corporates To support the achievement of set hours from initiation till disbursement. Based on the OECD Economic goals, specialised process has been Survey Slovenia 2013, the average introduced to constantly monitor Optimizing and modernising debt-to-equity ratio of Slovenian non- client potential in order to allocate distribution channels financial corporations is with 141.4 its SE clients over three basic service At the end of 2013 the bank operat- – well above OECD averages that levels – resulting in promotion of ed the network of 143 branches that amounted 118.7. While there is still different product packages as well were organized under 10 regions. potential with private individuals to as pricing differentiation. We do As part of the restructuring of distri- increase borrowing, we are reason- want to serve clients with standard- bution network / channels, during ably concerned that with corporate ized needs more effectively and thus 2013 we have carefully examined entities. Therefore, Slovenian banks be able to provide quick response the viability of the whole branch are now largely engaged in the also to those with special banking network (every individual outlet) as financial restructuring of the overlev- requirements. The analysis of the cur- well as the ATM network. The find- eraged companies. rent portfolio shows great potential in ings clearly pointed to and resulted As the market leader, NLB took over activating dormant clients as well as in closing down of 22 non-profitable the responsibility to be in a driving focusing on special target groups. branches and removing almost seat of the most essential and biggest The NLB determined its regional dif- restructuring corporate cases in the ferentiation (core, development and country. We have managed to suc- other regions), based on the poten- cessfully wrap up financial restructur- tial and our presence in a particular It’s now high ings of some of the complex client region, and adjusted relationship groups like Mercator, Pivovarna management capacities accordingly. time for Slovenia Laško, Trimo and others. We reduced a number of business However, international competitive- centres and have introduced a spe- to create an ness of Slovenia’s economy remains cialised new mobile force to reach the most important national mid-term prospective clients in the remote investment goal as the key element for creating areas. Our sales activity is para- added value and stability. It should mount in order to win good clients, friendly become one of the main drivers of proactive approach is therefore also development. Therefore, only finan- an important part of KPIs within the environment. cial restructuring will not do the job! addopted Sales force effectiveness Slovenia’s economy needs to use a principles. temporary (1-2 years) window of We realised that special efforts will stability provided by financial restruc- still be required at optimizing pro- 1/10 of ATMs. As for the remaining turing of companies to also tackle cesses, particularly those of onboard- branches, the strategy foresees their their business restructuring. The best ing and well as lending, where we revitalisation and redesign in order to candidates are those that have the have to assure fast and smooth ser- bring us closer to clients with open- potential to compete not only in vice. When it comes to lending, the ness, approachability and contempo- performing their daily business, but small enterprises are rather specific rary concepts. also use their innovativeness and in their business models and transpar- We have performed an extensive investment capabilities. They are the ency of true financial position. Hence review of the electronic channels. best guarantees for developing and the bank is constantly developing a Assessment of their maturity levels sustaining international competitive- special segment-wise understanding shows a lot of potential especially in ness in the long term. and has already achieved a major improvements of user experience and Not all companies will be able to breakthrough in the lending process introduction of additional functionali- restructure in financial or business by introducing first scoring models. ties. As also mobile banking is gain- terms. Therefore, also effective dis- As appropriate credit limits for com- ing in the market, we will continue to solution processes are needed to turn panies and sole proprietors can now invest in both areas E-banking and over the corner of Slovene economy. be effectively assessed in a matter of mobile banking apps. The topic will ultimately also require

BV 11/2014 97 BEST PRACTICE CASES a decisive role of the state. Slove- asset management business with NLB 2017. This is one of the most impor- nia needs a clear legislation (some skladi, a fully owned subsidiary with tant challenges of the NLB Strategy improvements were introduced in practically the same activity, to lever- with impact on banks overall profit- 2014) and effectively run insolvency age of efficiency and development ability, capital strength, the possibili- procedures to efficiently address potential. As for the other businesses, ties for growth of the core businesses the motivation as well as interests of we engaged in the business model (the quicker we decrease non-core, stakeholders in restructuring pro- analysis activities throughout 2014 more we can grow the bank business cesses. and the implementation of changes in the core segments) and reduction Equally important is the understand- will start towards the end of the year, of complexity. ing that it is now high time for Slove- bringing both efficiencies to the bank Towards the end of 2014 the bank is nia to create an investment-friendly as well as value added to clients in ahead of all its plans with regard to environment, with support and coop- the mid-term. exiting the non-core activities. eration of all government institutions and openness to FDI and privatisa- Core subsidiaries Risk management, IT and tion. We firmly believe that such In addition to product factories NLB Operations, HR and Organisation cooperation between all participants Skladi (asset management), NLB Risk strategy, policies, processes, in Slovenia’s economy is crucial to Vita (life insurance) and Bankart operations and risk management reach the restructuring goals. (processing) where NLB intends to culture of the NLB have been under further develop co-operation and scrutiny since the end of 2012. We 5. The whole strategy of NLB keep a majority stake, the core group entered a wide-ranging number of had or still has to transform. encompasses six universal banks: in improvements, both quick wins and Skopje, Belgrade, Podgorica, Pristina, long-term process development in Financial markets Tuzla and Banja Luka. Each of these order to bring risk management to This segment, in addition to the banks has their own various market the best practice levels within the Asset Liability Management (ALM) and internal development dynamics, restructuring period. With the execu- function, works with several client from a restructuring modus in Serbia tion of the Asset Quality Reviews in businesses: corporate finance, bro- to focusing on profitable growth in 2013 and again in 2014 (the latter kerage, custody and other. Macedonia. Within restructuring, the was run by the ECB as a part of Within the regular ALM, NLB has at NLB worked mainly on challenges the Single Supervisory Mechanism the beginning of 2013 made some of leadership, governance, risk preparation) we included further important changes to the price policy management and other key policies methodological and other changes of products and the repayment of with these banks; however, in Serbia to the risk management agenda. third party funding as much as pos- and Montenegro we entered ambi- In IT and operations NLB developed sible, while at the same time looking tious restructuring programs that are its strategy in 2013. We structured to maximize stability of bank funding already showing improvements and the main implementation directions in and liquidity. Within a year it is clear bring optimism that all of these the a group of IT projects. These will run these decisions were one of the banks, if not yet so, will be stable and their course over a multi-year period, most important for improved results profitable in the future. simplifying and re-focusing the infra- – while we (also due to recapitaliza- structure of the bank in order to op- tion) now keep very good liquid- Non-core activities timise time and cost of the processes ity, the NLB has also substantially Even though NLB d.d. had sold a and ultimately improve services to increased profitability of its balance portion of its NPL portfolio to the customers of the NLB Group. sheet (non-banking sector business) BAMC, significant chunks remained, In the organisation and HR, includ- and its profitability overall. as these assets failed to fulfil the MS- ing the corporate culture change, In the commercial part of financial BSA criteria for transfer. In addition, NLB set its goals early in 2013. We markets, the client business, the NLB the NLB has a number of non-core believe that a modern bank needs has set itself goals to review the best subsidiaries and other assets. For the above all to: international practices for manag- entire non-core business, the goal • Size its team to the potential in ing these businesses, prepare a gap (and partially a commitment of the the market and then develop it in analysis and a development plan. Slovenian government to the EC) is a clear direction, using contem- One of the first solutions was to to decrease by several times in the porary managerial tools which merge (in the beginning of 2014) the restructuring period, i.e. towards NLB has already started these

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activities and some are already Figure 5: In first 6 months of the year we have managed to increase finished (the sizing of the NLB our market shares in all key banking products. d.d. team started in the second half of 2013, is now coming to an end). Change in H1 2014 0,1 2013-12 • Structure its organisation for higher flexibility, speed, respon- siveness to the market and the 0,4 0,1 customers, with as few layers 30,3 0,5 as possible. We implemented 23,6 22,2 several organisational changes to 20,0 that effect throughout 2013 and

2014, and believe that adapt- Corporate Retail Corporate Retail ing the organisation needs to Loans Deposits become a regular practice.

6. Midterm results show the Figure 6: After the transfer of assets to BAMC the size of Slovenian bank is well on track banking market is still declining. NLB will strive to maintain its market position. 25.000 Halfway through its transformation, NLB has much to show: proac- tive sales approach and active 20.000 18.506 relationship management reflected 14.888 in improved market shares in all 15.000 13.804 elementary banking products across segments, as well as in non-basic 10.000 banking products (investment and 5.018 5.000 insurance products). 3.310 3.108 The very important message is that through the exhibited stability and 0 service quality improvements bank is jul. 13 jul. 14 regaining clients’ trust. This is greatly jan. 13feb. 13mar. 13apr. 13maj. 13 jun. 13 avg. 13sep. 13 okt. 13nov. 13dec. 13 jan. 14feb. 14mar. 14apr. 14maj. 14 jun. 14 shown also trough the increasing Corporate loans NLB Corporate loans Slovenian banking sector deposit volumes as well as the ever increasing volumes and market shares of its subsidiaries NLB Vita Figure 7: The trust is returning to Slovenia’s banking sector and NLB Skladi. after the uncertainty reached its peak in December 2013. 16.000 Last but not least, profitability has 14.556 14.450 13.983 stabilised and improved. The results 14.000 before provisions and one-offs, 12.000 have now stabilised and have been 10.000 rising slowly in 2014. After the third quarter of 2014 the NLB group al- 8.000 ready shows profit after taxes in the 6.000 amount of 47,9 mio EUR. In addition 4.000 to positive effects of recapitalisa- 4.763 4.243 4.397 tion the 2/3 of the results can be 2.000 attributed to sales activities of NLB 0 with customers and to diligent cost jul. 13 jul. 14 rationalisation. According to the jan. 13feb. 13mar. 13apr. 13maj. 13 jun. 13 avg. 13sep. 13 okt. 13nov. 13dec. 13 jan. 14feb. 14mar. 14apr. 14maj. 14 jun. 14 results of stress tests conducted by Retail deposits NLB Retail deposits Slovenian banking sector ECB in 2014, the bank is sufficiently

BV 11/2014 99 BEST PRACTICE CASES capitalised for the base scenario, issues, following lean principles and phase), which will provide space while a manageable capital shortfall assuring the right support also by and special services to promote the in the amount of 34.3 mio EUR was appropriate management tools, natu- development of entrepreneurship. detected based on adverse scenario. rally not overnight. The changes in The Centre as such will serve as the ECB has already confirmed that due processes that the bank has already business accelerator and will be to improved profitability NLB can implemented have contributed to providing co-working environment. manage to cover that shortfall from major increase of NLB’s effective- It should offer a one stop shop for its profits alone. ness. Following that path should business and financial consulting bring even greater improvements in performed either by the bank or by 7. Innovation centre as an the near future. partnership companies (tax advisory, additional support to economy This leaves us with the third charac- business management, innovative or teristic: innovation. Considering that alternative funding options for start- At the end of 2013 The Economist the whole banking industry is being ups). The Centre should also encour- Intelligence Unit conducted a survey endangered by many organisational age its clients to actively participate to start inducing a break up from the and technology disruptors, it is of in best practice sharing and business bad publicity that banking industry vital importance that the incumbent functions support. A flagship hub will has regularly been receiving ever banks somehow secure their spot for be established at the headquarters since the beginning of the financial the future. It’s not just about introduc- of the bank, but we will start the crisis. Their question was simple: tion of new services and technolo- initiatives also in other locations in What does it take to be the Good gies that aim at making managing across Slovenia. Bank? (The Economist Insights, 2014) finances easier for the customers. We believe such approach should The debate by financial industry They are still important and as is even further increase the recogni- experts finally came up with three stated throughout this paper NLB is tion of the bank and will hence top characteristics: A good bank already entering the development facilitate its market operations. More needs to be effective, trustworthy phases for many of those. importantly raising and fostering and innovative! The greater challenge will be to the entrepreneurial culture should Understanding that finding in the con- change basic concepts of what a actively contribute to improving of text of the Slovenian economy and bank can really do for its customers the Slovenian economy. Such an NLB the question is obvious: when that would allow it to stand out from innovative initiative may provide can we say NLB fits the profile and others. NLB has identified such po- an important step in promoting the deserves to be widely recognised as tential in active involvement in inno- growth Slovenia will need to regain a good bank? vative entrepreneurship. Our vision in its status of healthy and sustainable We believe that a constant adher- this area is to provide positive effects economy. ence to our corporate value system on social and economic environment will together with our professional ap- locally and nationwide by following REFERENCES: proach to sales and service concept and co-creating global economic Banka Slovenije (2014). Poslovanje bank v continue to contribute towards further trends such as small business acceler- tekočem letu, gibanja na kapitalskem trgu increase of trust. The deposit inflow is ation, new forms of self-employment in obrestne mere - Banka Slovenije. already a good sign that our custom- and economy of sharing. Banking System. (2014). Monthly Bulletin of Bank of Slovenia, [online] (Vol. 23 No.: ers value our undertakings. We shall respond to such require- 7 - 8), pp.I.-26-28. The transformation programme very ments with the Innovation Centre (the The Economist Insights, (2014). The Good well addresses the effectiveness project beginning its implementation Bank. 30 September 2014

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UDK 336.71:658.16(497.4) Bank Assets Management Company – Experiences so far Lars Nyberg*

BANK ASSETS n February 2013 I was asked by the Slovenian government MANAGEMENT COMPANY – to become a non-executive director of the Bank Asset Mana- EXPERIENCES SO FAR gement Company and help to start it up. Arne Berggren and Transferring bad assets from banks to Carl Lindgren got the same question. Presumably we were separate entities – Asset I Management Companies – asked because we had long experience from similar cases – and in the process of handling perhaps because we were outsiders and could be expected to crea- a banking crisis is not a new idea. The further te an independent board, three out of four non-executive directors. away from the bank the NPLs are handled, the We all accepted: two Swedes and one Finn. In this paper, I will give greater the credibility of the solution. BAMC has you my view of what has happened since then – as I see things at made it possible to handle the process in Slovenia mid-September 2014. Let me say at once that it is my own view in a structured way even and that my colleagues in the board may not necessarily share it - though the road towards the successful asset although I think they will agree with most. transfer was bumpy. The main purpose of BAMC is to regain as much 1. Introduction money as possible from the assets transferred from the banks. Another Establishing an AMC without conflicts and misunderstandin- task of BAMC is the restructuring of number gs is difficult, if at all possible. Clearly, we have not in all matters of big conglomerates. Right now BAMC is in agreed with the Ministry of Finance and the Bank of Slovenia. But the first phase of the life of an AMC, the one of there have been no attempts of political influence outside the nor- transferring and handling credits. Recovery and mal and formal channels. The two state secretaries that, in diffe- restructuring operations rent periods, joined the board as non-executive directors have both are speeding up and the final phase of selling will acted with integrity and independence, as indeed we had expected. soon be initiated.

JEL G01 G21

* Lars Nyberg, BAMC.

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Why AMCs? special department of the bank (as turing and real estate management Transferring bad assets from banks in the Baltic crisis of 2008-2010), a that are not usually available in the to separate entities – Asset Manage- subsidiary (as done by a number of banks – simply because there is no ment Companies – in the process Swedish banks in the early 1990s) demand for them in normal times. of handling a banking crisis is not a or a separate company. Note that Involving people without the heritage new idea. It was used successfully this is a question of organising the of relations between the bank and in the US during the Savings and workout, not a question of owner- its customers has also proven to be Loan crisis in the late 1980s, in the ship. The shareholders keep all a good idea in many cases. Taking Sweden during its banking crisis in economic responsibility. The choice care of the nonperforming assets on the early 1990s, in Asian countries depends on how serious the problem arms lengths from the bank is simply during the Asian crisis of the late is and what is required to restore more efficient. 1990s and most recently in Ireland confidence. The further away from Thirdly, when the NPLs are managed and Spain. the bank the NPLs are handled, the separately, the bank management But why transfer bad assets out of more independence and the greater and the board will again be able the banks? Should not the banks the credibility of the solution. to focus on normal banking busi- (and their owners) take care of their Many AMCs entities are set up by ness, which is essential to help the mistakes themselves? What signals individual banks. A centralized AMC bank – and often country - out of the will it send if bankers are relieved may be created if the NPL problems financial crisis. You may argue that and forgiven and can continue as cover many banks or if the banks are the management should be able to if no money had been lost? These handle the problems and plan for the are relevant questions, particularly future simultaneously. But in reality when public money is involved. And this is seldom the case. In my experi- furthermore, are the banks not in fact The transfer ence, there is little room for future best suited to handle their problems, initiatives in the minds of a manage- given that they know their customers? prices determine ment trying to survive. Having the Normally, banks take care of their bad assets taken care of separately nonperforming loans (NPLs) as a where the losses makes it a lot easier to look forward. part of their day-to-day business. All banks have customers that fail show up. Two important issues to pay in time and in some cases When setting up an AMC entity it go bankrupt. Banks have people, matters how you do it. Judging in usually lawyers and other specialists, the future whether the AMC was an to handle these problems and they state owned - like in Slovenia. economic success or a failure will do not absorb much time in manage- As I see it, separating the bad asset depend on this. When the entity is a ment and board discussions. has three main advantages. Firstly, subsidiary or a separate company - In a financial crisis things are dif- if done correctly, the transfer of i.e. having a separate balance sheet ferent. The NPLs grow in number bad assets will make the process of - you will have to decide on two and become more complicated. handling the crisis more transpar- important things: The capital structure In a deep crisis, which is often ent. If accompanied by a sufficiently and the transfer prices. nationwide, large customers with large capital injection by the owners The capital structure – the mix of subsidiaries at home and abroad an important step towards regaining equity and borrowed funds – is and intricate financial networks may confidence is taken. Of course, this important since the assets taken over run into trouble. Gradually, the bank assumes that a sufficient part of the are by definition nonperforming. management will move into a crisis bad assets have been transferred They will give a very small cash flow mode. Eventually, the balance sheet to the new unit. If a large number during the initial period until they of the bank may be questioned and of NPLs remain in the bank, it will are restructured and sold, which funding will drain up. be difficult to convince the market will usually take at least a couple In such a situation, transferring a ma- that the bank is cured and can work of years. If the assets are funded by jor part of the NPLs into a separate normally. borrowed money, e.g. interest bear- entity may be a way of addressing Secondly, the new entity may ing securities, the company will run the problem. The entity may be a employ experts on business restruc- losses every month. To avoid losses,

102 BV 11/2014 BEST PRACTICE CASES the company must get access to • The transfer phase, when assets, skills and therefore the number and cheap funding from the owner and/ mainly nonperforming credits, are expertise of employees will change or enough equity to compensate for transferred, legally and physi- through the lifetime of the AMC. the minimal cash flow from the assets cally. This work involves checking taken over. all the files provided by the bank 2. The Slovenian background The transfer prices determine where to see whether they are complete, the losses show up – in the bank or whether the collateral is avail- The 1990 Slovenian in the AMC. Before the transfer of able as recorded etc. This phase Development Corporation assets from a bank to an AMC there includes an initial valuation of After the turbulent political and is usually a large difference between the assets to be used in the AMC economic start of the 1990s, the the book value in the balance sheet reporting. Slovenian government decided to of the bank and the real value of the • The credit management and create a development fund, which assets, however calculated. This dif- workout phase, where the as- in 1997 was transformed into the ference is usually referred to as “the sets are handled one by one Slovenian Development Corporation, hole”. The higher the transfer prices, to preserve and improve their SRD. Formally a joint stock com- the better the bank will appear. If the value. Particularly important and pany, fully owned by the Republic of transfer is done using book values time-consuming are the “live” Slovenia, it was supposed provide (after impairments) the bank may assets, e.g. corporates that have project finance, promote and co- need only a limited capital injection finance technological development and “the hole” is completely trans- and, most importantly, to take over, ferred to the AMC – where it will restructure and privatize a number of appear in its financial statements and The government major companies in financial trouble. where it will have to be covered by SRD took over nearly 100 compa- a capital injection. If the transfer is can use BAMC nies with over 54.000 employees. done using market values, “the hole” SRD was created as a mixture of a will appear in the balance sheet of as a tool for development bank and an AMC, a the bank – where it will have to be combination that may well work if filled with new capital sooner rather recapitalising given sufficient independence. The than later. problem was the corporate govern- In practice, the transfer prices are the banks. ance. SRD was run close to the gov- usually set somewhere between ernment, with government employees the book values and the current, in the board, and had to compromise distressed, market values. But it is im- between business logic and political portant to realise that whatever trans- to be restructured financially or interests. Restructuring of a company fer prices you choose, “the hole” technically to survive. But “dead” into long run survival often requires remains the same. I have met politi- assets, e.g. real estate to be tough measures, including substan- cians who think that transferring as- recovered in a bankruptcy, may tial downsizing of the work force in sets at high prices makes “the hole” also have to be restructured and the short run. Such measures may smaller because there is less need to combined with other assets into be hard to digest for any govern- recapitalise the bank. This is not true, marketable units. ment. As has been the case for state of course. “The hole” is there, in the • The sales phase, where the as- owned companies in many other AMC, but its public discovery may sets are eventually sold. This is a countries, conflicts in governance be somewhat postponed. complicated process, particularly objectives prevented SRD from work- for the “live” assets. Typically, ing efficiently. The phases of an AMC the assets remaining at the end SRD was liquidated in 2002. The Although all AMCs are different due of the AMC lifetime are mostly general view seems to be that it to their financial set up and asset real estate and AMCs may be had largely failed to deliver on its portfolios, there are some common transformed into real estate mission. features. They all have a limited companies and even sold on the lifetime and they pass through some stock exchange. distinct but overlapping phases: These three phases require different

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The 2012 BAMC debate The ZUKSB a similar legislation. In this sense, Slo- When in 2012 the idea of BAMC The BAMC is a state owned com- venia has set an important example surfaced and the government pre- pany, designed to take over non- internationally. sented “The Act Defining the Meas- performing assets primarily from A few issues in the ZUKSB are of ures of the Republic of Slovenia to the three banks where the state and particular interest for the develop- Strengthen Bank Stability” (ZUKSB), various public entities had a major- ment of BAMC. The first one re- the SRD experience was still in close ity ownership, NLB, NKBM and lates to the choice of assets to be memory. The debate on BAMC Abanka. The law envisaged that transferred and the transfer prices. came to be much more political than other banks might follow. Notice that To assure transparency, the non- is usually the case when establishing the Slovenian BAMC is not related to performing assets to be transferred an AMC, normally considered as a particular bank and that it has no and the transfer prices should be one means among others to handle private ownership. discussed between the bank and the a banking crises, a rather technical BAMC was set up to help regain AMC. This is not the way the process issue with little political content. confidence and credibility in the Slo- was set up in the ZUKSB. The law An argument appearing in the venian financial system, trust in the certainly states what assets that can debate was that establishing an country’s most important banks and be transferred. But the legal set up AMC was an expensive way to as much of taxpayers’ money as pos- was complicated by the involve- address the problems in the bank- ment of the European Commission, ing sector and that mergers, private notably the Directorate General recapitalizations and selling off part for Competition (DG Comp), which of the troubled banks should be tried What BAMC according to the EU Treaty should first. From an outsider’s view, part of assess the amount of state aid that this debate seems odd, particularly tries to do could be given to each bank without considering the serious situation in unduly affecting the competitive the banking system, with the major is to take a situation. In practice this meant that banks moving towards capital ratios the Commission had their experts that no longer would have allowed lead in the doing independent valuations of all them to operate. assets suggested by the banks and In the autumn of 2012 the issue be- restructuring the supervisor (the Bank of Slovenia) came so politically affected that voic- for transfer to BAMC. When the list es were raised in favour of bringing process. of assets and the prices had been it to a national referendum – indeed decided in Brussels there was little an interesting idea in the history of room for further discussions. The banking crises. It was realised that sible. Ambitious targets, no doubt, BAMC had no say in the selection or voters could hardly be expected to and certainly not to be attained by valuation of the transferred assets. know much about the subject but that BAMC alone. The second issue relates to the it might nevertheless be necessary The legal backing for the BAMC BAMC funding. The law is very clear to resolve the political controversy. (the ZUKSB) was passed in parlia- on what kind of bonds that should In the end, the Constitutional Court ment in October 2012. It covers the be issued by BAMC to finance the ruled against a referendum. process for a bank wanting to apply acquisition of nonperforming assets In October 2012 the National As- for public support in the form of a and how these bonds could be sembly passed the ZUKSB. But a capital transfer from the government guaranteed by the government. But lot of confusion regarding what an and transfer of nonperforming assets the need for equity to bridge the gap AMC really is and what it can be to the BAMC. between assets with a minimal cash expected to do remains from the From an international viewpoint, flow and bonds with a coupon to be political debate – and of course ZUKSB (and BAMC) is the evidence paid regularly is not covered. The from the SRD experience. In this that Slovenia has addressed the BAMC could in principle, without way, BAMC got a very unusual and problems in the banking system in a coming into conflict with the law, quite unfavourable start compared to constructive way. Many European run the business with very limited many other AMCs. countries where banks struggle with equity and rely only on funding in huge NPL ratios would have use for government guaranteed bonds – if

104 BV 11/2014 BEST PRACTICE CASES the owner were willing to accept ment never used the option. I can of June, BAMC should be ready to substantial negative results for an understand that. Having BAMC as a recapitalize the first bank (NLB) and initial period. Running an AMC with major owner of the big banks on top to start transferring nonperforming no equity and substantial losses of all other assets transferred to it, in- assets from that bank. In addition, would not be credible internationally, cluding some big corporates, would BAMC was asked to give an opinion of course, and eventually the govern- have been too much, politically if not on the first corporate restructuring ment decided to inject € 200 mn as economically. case, Cimos d.d. from Koper. a start-up capital. Finally, there is a task that is not in This was a tremendous challenge, A third issue concerns the lifespan the law, but nevertheless has become particularly considering that the of BAMC. The law stipulates that very important for the BAMC, company yet had no staff except the company should be closed after not least publicly. This is the task for three executive and four non- five years, i.e. at the end of 2017, of restructuring – financially and executive directors. Outside help and that at least ten per cent of the sometimes operationally - a number was needed to handle a number of assets be sold each year. The short of big conglomerates, where the issues, including the legal and regu- lifespan is unusual internationally, but BAMC after taking over NPLs from latory set up of the company. At that perhaps not a big problem. What the banks has become a major stake- point, with the task to recapitalize is left of the assets after five years, holder. Reading the papers, it is clear NLB as defined in ZUKSB, BAMC probably mostly real estate could be that views of how these restructurings would be investing large amounts of taken over by another government should be done vary widely. I was money into the bank and be respon- entity. But the requirement to sell ten told in parliament that this is the most sible for its reconstruction. For a start, per cent every year, including the important task for the BAMC. But there was a need for considerable first year (in this case 2014, since there is no explicit legal mandate preparatory work on how to value no assets were transferred until this for restructuring of businesses and the bank’s equity and to form an year), is unfortunate. An important BAMC has not been given any par- opinion on how much capital that idea with an AMC is to avoid forced ticular tools. BAMC has to act as any was needed to credibly restore its sales and instead seek to maximize major creditor in competition - and balance sheet. BAMC had no staff asset values. Indeed the desire often in conflict - with other creditors to do this. Furthermore, due diligence to avoid forced sales is explicitly and owners. I will return to this issue of a sample of nonperforming assets spelled out in the ZUKSB. later. to be transferred from the NLB had The fourth issue is more unusual. to be made and the legal framework The main purpose of BAMC is to 3. The BAMC start up1 for the takeover of assets had to be regain as much money as possible set up. Consultants were engaged to from the assets transferred from the An intense April and May 2013 work with all these issues. banks. This is very straightforward; The BAMC was established in late BAMC also made a study of the in fact it is the job of any AMC. But March 2013. The non-executive Cimos case. No easy solution was in addition to that, the law opens for directors named three temporary identified. It was clear that Cimos another task, which is unfamiliar to executive directors and during the already had been the subject of a an AMC. The government can use following weeks the new board inten- long string of unsuccessful restructur- BAMC as a tool for recapitalising the sively discussed plans for the build- ing efforts driven by its owners and banks. Technically the government up of the company and a strategic creditor banks. The Board concluded would inject the money for recapi- road map. The road map assumed that very little could be done until talising the banks into BAMC and that the transfer of assets and the BAMC had an ownership position BAMC would use that money to buy recapitalisation of banks should be of equity or loan exposures in Cimos newly issued shares in the banks. made during the autumn. from which it could lead the restruc- BAMC would then become the On April 8, in a meeting with the turing. dominant owner of the banks and finance minister, who had just taken On May 16, the Inter-Ministerial have to take responsibility for their office, and the vice governor at Committee decided that NLB restructuring. Whether this would the Bank of Slovenia in charge of would be eligible for support by have been good for the recovery of supervision, new instructions were the Slovene banking system or not given. These instructions involved a 1 Sections 3 and 4 draw extensively on the BAMC annual report for 2013 and first half-year report for can be discussed, but the govern- very tight time schedule. By the end 2014.

BV 11/2014 105 BEST PRACTICE CASES the Government under the ZUKSB. of July. A decision by the European tainly avoidable - was the difficulty BAMC engaged a transaction team Commission regarding the transfers in getting hold of data. Already in of consultants, which started inten- was to be expected in September, 2012 there had been a review of the sive preparations for the upcoming at the earliest. The government set a asset portfolios in NLB, NKBM and transactions. new end-September deadline for the Abanka performed by an interna- On May 31, however, the Ministry NLB transfers and BAMC started to tional consultant, but this review was of Finance informed BAMC that plan accordingly. not shared with BAMC. Furthermore, the scope of BAMC’s work would In July, however, after having the assets chosen for transfer and the be changed substantially: the State analyzed a sample of assets, DG suggested transfer prices existing in would carry out all the recapitaliza- Comp decided that further informa- April were known to the supervisor, tion of banks directly – rather than tion was needed. They insisted that the Bank of Slovenia, but were not through BAMC. Consequently, the transfers would have to await shared with BAMC. Neither was the BAMC would not be investing in the outcome of an Asset Quality valuation methodology for deter- banks and would not become a Review (AQR) and Stress-Testing (ST) mining the transfer prices or later bank owner. The preparatory work exercise to be undertaken for the the AQR values. This reluctance to for a BAMC ownership function was ten largest Slovenian banks, includ- provide necessary information cost a abandoned. ing the three banks set up for state lot of money, since BAMC had to use recapitalization. consultants to get hold of data from Transfer prices and DG Comp The BAMC Board was deeply banks, asset by asset, and prepare When BAMC started in March, concerned about the delay, as it separate valuations. Not until late assets to be transferred and transfer was clear that the financial situation in the autumn were data made prices had already been proposed in the banks was deteriorating and available in a way that is common by the banks and discussed with the that urgent restructuring of a number practice elsewhere. Access to the Bank of Slovenia. The price estimates of corporates was delayed. BAMC methodology came even later. I still were a year old, however, and sent a letter to DG Comp suggesting find it difficult to understand that this when BAMC analyzed the sample that the asset transfers should start initial reluctance to share information of assets from the NLB that was immediately as planned and that the was in the interest of Slovenia. provided, the prices were found to prices could be determined when be far too high. Reasonable transfer the AQR results were known. After Which assets to transfer? prices would be approximately half all, the transfers were to take place Normally the assets to be transferred of those indicated. The BAMC Board between two state owned entities, from a bank to an AMC and the informally shared our worries with NLB and BAMC. But DG Comp did corresponding prices are discussed the Ministry of Finance and the Bank not approve this idea. and agreed between the bank and of Slovenia, since lower transfer As it turned out, the transfer prices the AMC. These discussions are not prices would mean bigger holes in were not released from the Com- always easy, but at least the bank the balance sheet of the banks and mission until early December. Half and the AMC will know in the end a need for bigger recapitalizations. a year had been lost in the process what is actually being transferred. But BAMC continued preparations and a number of deadlines set by the In Slovenia, these discussions never for the takeover of asset from NLB as government had been broken. But took place. As a consequence it planned. more time had been given for discus- was in many cases unclear, which During a visit in June, the team from sions between the banks and BAMC assets the transfer prices agreed DG Comp made clear that they and preparing for an orderly transfer with DG Comp really referred to. In would not allow any transactions to during the first half of 2014. a financial group, for instance, the be executed at the initially proposed The involvement of DG Comp cer- different credits may not have been transfer prices. DG Comp was of the tainly complicated the life of BAMC specified in detail. Hence it became view that these prices were unrealisti- between April and December. But possible for the bank to keep the cally inflated and thus would entail that was unavoidable, given the cash generating credits and transfer an inappropriate amount of state circumstances, although in my view the nonperforming credits to BAMC. aid. DG Comp demanded that the far more bureaucratic than neces- This may seem logical – after all valuation process be repeated and sary. Another complication – in this BAMC was created to take over the scheduled to be ready by the end case particular to Slovenia and cer- bad stuff – and it is certainly rational

106 BV 11/2014 BEST PRACTICE CASES from the bank perspective. But it cre- Figure 1: Exposure and transfer price for NPLs. ates huge problems when the group BAMC annual report 2013. is eventually to be restructured. Then the bank, that has a performing credit in a subsidiary, may take a completely different position than BAMC, which has the nonperforming credits and is responsible for restruc- turing the group. The state owned bank and the state owned BAMC end up at different sides of the table in the restructuring discussions, which is indeed a strange and hardly desir- able outcome. This would not have happened, of course, if discussions had taken place beforehand, as they usually have between a bank and an AMC. In Slovenia, BAMC did not even know the total exposure to a group by each bank. Only the bank and the supervisor knew, but they did not share that information. and transferred from the other two all non-performing assets earmarked A similar problem related to the fact banks). The Governor of the Bank of for transfer to BAMC to be legally that not only one bank, but three Slovenia supported these principles transferred from the two banks to would transfer assets to BAMC. It and indicated that the Bank of Slove- BAMC before Christmas vacations. happened that a group was consid- nia would enforce the banks’ compli- Needless to say, it was completely ered nonperforming in one bank and ance. But in a number of cases, this unrealistic to expect the banks to transferred to BAMC, but considered turned out to be too late. physically transfer the documentation to be performing and kept in another and the managerial control of the bank. Again BAMC ended up with 4. The transfer process assets to BAMC so quickly. Neither only part the group exposure, which would it be possible for BAMC to made the restructuring of the group The legal transfer receive all the assets at once. Instead difficult. The plan, as it had been worked out it was decided that the legal owner- In mid-October, BAMC sought the together with NLB and NKBM during ship of the NPLs would be trans- support of Bank of Slovenia for some the autumn, was to transfer the assets ferred to BAMC before year-end but principles that should rule the asset successively over a 6-month period the credit files of the loans would be transfer process in the banks. BAMC in a series of transactions grouped transferred during a transition period proposed that the exposures with re- into tranches. It was assumed that the similar to the originally scheduled gard to a group of companies should first transaction was to be executed 4-month period. The banks would act be transferred to BAMC in their before year-end and all tranches as BAMC’s trustee or asset manager entirety (i.e. both performing and transferred before the end of June over the physical transfer period. non-performing assets) in order to en- 2014. A period of intense discussions with sure that effective loan restructuring On December 6, BAMC was in- the banks and the supervisor fol- is possible. Further BAMC proposed formed by the Bank of Slovenia and lowed. Finally, on December 20, all that the scope of transfers should be Ministry of Finance that the strategy legal documentation was in place on equal terms for all three eligible had changed fundamentally and that and the transfer of assets could be banks (i.e., if a group exposure was a completely different type of trans- completed. considered non-performing and action was required to enable the Figure 1 illustrates the portfolio of transferred from one bank, it should state to recapitalize the two banks by assets transferred to the BAMC from also be considered non-performing year-end. The new situation required NLB and NKBM respectively. The

BV 11/2014 107 BEST PRACTICE CASES gross value of the assets transferred Figure 2: The BAMC loan portfolio. (the banks’ book value after impair- BAMC half-year report, August 2014. ments) was € 3.3 bn, € 2,3 bn from NLB and € 1 bn from NKBM, and the amount paid was just over € 1 bn. In percentage points BAMC paid 27 per cent of the book value for the NLB assets and 36 per cent for the NKBM assets. Most of the assets were loans, but the purchase also included € 24 mn of equity. Al- though a large number of the loans transferred related to companies in bankruptcy, loans to operating companies dominated the portfolio. About one third of the assets relates to the real estate and construction sector, one third to financial holding and manufacturing and one third to a mixture of various industries. BAMC in the allocation of time and the front pages of the Slovenian The real transfer expertise. The majority of cases were newspapers. At the end of January 2014, the considered to be of medium difficulty I am overall very impressed with cumbersome process of transfer- (212), while the difficult and complex the people we have hired. They are ring the physical assets started. The cases (101) were far more important bright, well-educated and hardwork- process was complicated by the fact in value. ing, in competence equal to or that many files were incomplete with All assets transferred so far come above what I have seen elsewhere. essential information and documenta- from NLB and NKBM. The asset I hope and trust that their work with tion missing. transfer from Abanka has been the international experts hired by Figure 2 illustrates the split up of delayed several times, waiting for BAMC will give them some knowl- loans made after internal evaluations a decision by DG Comp, and is edge and experience that will be of strategy and difficulty in handling. expected to start in October. Assets useful for them in the future – and The left part of the figure shows that from Banka Celje are also expected. useful for the Slovenian financial and there are more than 300 recovery Discussions with the two banks in corporate sectors as well. cases but less than 100 restructuring liquidation, Probanka and Factor cases. For the recovery cases the Banka, have taken place, but DG 5. What is “fair value”? initial focus will be on liquidation. Comp is not involved with these For the restructuring cases, on the banks and transfer prices had to be In January 2014 BAMC had to start other hand, focus will be on actively negotiated in the traditional way. An writing the annual report for 2013. In improving the value of the running agreement where BAMC has bought the annual report, according to the business, e.g. by debt rescheduling, assets from the two banks for € 39 IFRS, the portfolio has to be valued debt to equity swaps, business reor- mn has been reached in September. at “fair value”. But what was “fair ganization etc. At the end of 2013, BAMC had a value” for a portfolio of nonperform- In the right part of the figure, dif- staff of 12 employees. By end-August ing assets such as the one just taken ficulty is assessed in three categories, 2014 this figure had risen to around over by BAMC? depending on factors like group 70. There were 22 case managers Could the transfer prices be con- structure and ownership, amount of taking care of just over 400 cases. sidered to represent “fair value”? exposure, the various positions of Some 20 of these cases involved According to ZUKSB and DG Comp, creditors, whether all credits have particularly complex restructurings of the transfer prices should be set to been transferred to BAMC etc. financial groups or commercial com- show “long run market prices”, which While admittedly subjective, this panies in active operation. Hence could reasonably mean prices estab- spit according to difficulty helped BAMC has appeared regularly on lished when markets have returned

108 BV 11/2014 BEST PRACTICE CASES to normal conditions, whatever that annual report, arguing that they had not pay according to the contracts. is. Anyway, the transfer prices should no way to check the methodology Some assets may be sold quickly, but be higher than present market prices. underlying the values of the trans- generally the process of restructuring They could hardly be seen to repre- ferred assets. And they were right, and recovery will take a couple of sent “fair value”. of course. The methodology was un- years. During this period costs have Could the recently calculated known to them as well as to BAMC.2 to be covered. AQR-values be considered as “fair By the end of June BAMC had The biggest costs relate to funding. values”? Possibly, but, as with the concluded valuations of the assets To buy the assets from NLB and transfer prices, BAMC had no infor- in the 100 top companies making NKBM, BAMC issued bonds for mation about the methodology used up approximately 80 per cent of around € 1 bn, half with a two-year to determine them. In fact, BAMC the total value of transferred assets. maturity and half with a three year did not even have access to the The negative difference between the maturity. The first one had a coupon relevant AQR values for the assets transfer values and the BAMC valua- of 3.75 per cent paid annually and transferred. Establishing a balance tions had now shrunk from € 93 mn the second a coupon of 4.5 per sheet with credible and auditable as- to € 40 mn, which was used in the cent.3 Both were guaranteed by set values for the year-end turned out BAMC final annual report for 2013. the state of Slovenia, a guarantee to be a real challenge. There were The 80 companies added to the 20 that costs 1.25 per cent per annum. the transfer prices, nothing else. evaluated in March had been better Hence, for 2014, the cost of funding In late March BAMC managed to than feared. € 30 mn of the differ- amounts to approximately € 54 mn get hold of a sample of AQR-values ence was in the loan portfolio and € for the NLB and NKBM assets. for companies transferred from the 10 mn in the equity portfolio. Since To the costs of funding BAMC should banks and could compare them with BAMC now had valued a significant be added the cost of operation. All the corresponding transfer prices. part of the assets according to an in all, the cost of funding and opera- On the average, they turned out to established and robust valuation tion should be around, say, € 200 be nearly the same. But averages methodology (i.e. established a “fair mn, spread out over a four year pe- are dangerous. When looking at the value”), the annual report could riod. Costs will fall towards the end different cases in details, some had finally be audited. of the period, when assets are sold transfer prices a lot higher than the No doubt there will be further dis- off and bonds can be repaid. AQR-values and some had transfer crepancies between transfer prices The gap between the tiny cash flow prices considerably lower than the and the BAMC internal valuation on the income side and the cost of AQR-values. There was a negative when the remaining 20 per cent of funding and operation was foreseen difference of more than € 90 mn the BAMC assets have been evalu- in the ZUKSB, where it is clearly and a positive difference of slightly ated. The final results will enter into stated that the costs should be paid less. It was not even obvious that the the BAMC accounts and the amount by the banks. They should be de- transfer prices and the AQR values will be written off against the BAMC ducted from the gross transfer prices referred to the same assets. € 200 mn of equity .It is clear, to obtain net transfer prices, at which Against this background, the exter- however, that BAMC bought the the transfer would take place.4 nal auditors advised BAMC to take assets from the banks at prices that As it seems, however, the distinc- account of the negative differences, were higher than reasonably cal- tion between gross and net transfer but not the positive, when calculating culated “fair values”. The assertion prices somehow disappeared in the the “fair value”. An internal valuation that BAMC bought the assets from process. DG Comp, when asked, of assets from 20 companies with a the banks at “discounted” prices is negative difference was made, which simply not correct. 2 When the Commission wrote its reports on NLB (SA 33229) and NKBM (SA 35709) (both dated confirmed the AQR-values. Hence, December 18, 2013 but published in April 2014, available on the DG Comp webpage) the amount in the preliminary report delivered 6. BAMC financing of state aid was calculated by comparing the transfer value for each bank with the current market in late April, BAMC took a loss of value. The difference for NLB was € 130 mn and € 93 mn on the assets transferred, The nonperforming assets transferred for NKBM it was € 195 mn, totalling € 325 mn. 3 These bonds were bought by the banks and can directly recognised in the balance to BAMC give a very tiny cash flow. be discounted in the European Central Bank at a sheet of 2013-12-31. This is as should be expected and considerably lower rate, thus providing a net margin for the banks. In essence, this is a transfer from the In spite of the cautious approach, this is the story in most AMCs. Non- government to the banks via BAMC. the auditors refused to conclude the performing assets are nonperform- 4 In practice it was supposed to be done by adjustments of the discount rate when calculating audit and issue an opinion on the ing simply because customers do the net present values of the assets to be transferred.

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“assumed” that the costs had been BAMC will restructure and sell the What BAMC tries to do is to take deducted, but no one apparently assets bought in the professional way a lead in the restructuring process. checked that this was the case. If expected and service and eventually There are often several banks handled correctly according to the pay off on its bonds. If losses are big, involved, some of which have better law, the transfers could have been the government will have to provide collateral than others and judge their made at gross values and payments additional capital, but the tasks given chances of getting their money back for operations and funding should to BAMC will be performed. as reasonably good. Others may have been made to BAMC and deem their loans to be of little value recognized as cost in the bank ac- 7. Restructuring since they will be paid last. Getting counting. But there is no trace of that all banks to agree on a compromise in the annual reports of the banks BAMC is involved in the restructuring is a tough job – and often nego- and no payments have been made. of a number of financial groups and tiations between the banks just get Alternatively, the transfers could have of active companies, both within and stuck. been made at net transfer values, outside such groups. Some of these If the banks manage to agree inter- clearly recognizing and document- companies are clearly viable in the nally and also agree with the owners ing the difference between gross and long run, for others considerable and the management, a restructuring net. But there is no documentation (at uncertainty remains. Some of the plan may be signed. The banks may least shown to BAMC) on how costs companies may be restructured as then prolong their credits and accept have been deducted before fixing going concerns; others may have to reduced interest payment or in other the actual transfer prices as required go through bankruptcy proceedings ways help the company to survive in the law. To this date, it remains before continuing operations. Some financially over a period. Some debt unclear whether the transfer prices require only a financial restructur- may be changed to equity in a debt- are gross or net, i.e. whether the ing; others are not competitive in equity swap to restore the balance estimated cost of running BAMC are their business and also need an sheet. Then the banks – and BAMC subtracted or not. operational restructuring. There is no - will enter as owners, at least to a Of course, if costs were not ac- solution that will fit all – in fact they part of the company. counted for, this implies that the need are all different. If BAMC, alone or together with to recapitalize the two banks were The objective of BAMC is always to other banks, becomes a major underestimated and should have contribute to professional restructur- owner, the board of directors and been some € 200 mn bigger. The ings that will help restore the long the management can be changed, government would have had to put run competiveness of the Slovenian and most often this is what happens. in € 2.6 bn into the banks instead of corporate sector. This is the best way If in that context there are suspicions € 2.4 bn. to regain as much money as possible of fraud, this will be reported to the Now you may argue that it does for the taxpayers. Of course, others police. If there are signs of corrup- not really matter, because the banks may have different interests. Banks tion, this will be reported to the CPC. are state owned and BAMC is state want their loans paid back, own- But the responsibility of BAMC stops owned. In fact, it says in the ZUKSB ers do not want to lose their money here. It is the task of the legal authori- that the BAMC cost of funding and (although it is often in reality already ties to investigate possible corruption operation should be paid by the gone), management wants to keep and economic fraud – naturally with banks or by their owners – the latter their positions etc. full support from BAMC. being the state. When BAMC enters the scene it is It is yet too early to comment in de- However, not taking account of the usually as a creditor among other tail on most of the restructuring cases. costs as stated in the law will mean creditors. The company in trouble Cimos will be the only exception. red figures in BAMC for a number of does not service its debt, so much is Cimos is mainly a producer of high years. In the economic plan, there is clear, otherwise BAMC would never quality car parts, selling to custom- no credible way to compensate for had acquired the loans. But BAMC ers like Ford, BMW and Honeywell. some € 200 mn of costs that were is not an owner and neither are the Every third car running on the not paid. other creditors. The creditors cannot European highways has parts made In this context one should note that immediately change the board and by Cimos. The company employs BAMC can and will perform its kick out the management, even if this some 7000 people and has impor- expected role in Slovenia even if would be the desirable first step in a tant subsidiaries in Croatia, Bosnia it shows losses rather than profits. restructuring. and Serbia. Around 3000 suppliers

110 BV 11/2014 BEST PRACTICE CASES provide material and parts used in executive directors. Negotiations talize NLB and NKBM before the production. The company has with the customers and the suppliers yearend 2013. And the success- been financially restructured several are proceeding. Even though the ful asset transfer and recapitaliza- times during the last decade and the outcome is still uncertain, the process tion helped increase confidence government has provided consider- is a lot more credible than in any and substantially lower the able financial support. previous reconstruction process. If all interest rates paid by Slovenia When, in the winter of 2014, BAMC efforts succeed, Cimos should again on the international bond market. took over the NPLs to Cimos from become a major competitive export If the asset transfer had failed, NLB and NKBM, another reconstruc- company in Slovenia. things would have looked very tion plan was already discussed. differently. Three things were clear: Firstly, the 8. Concluding reflections • The road towards the successful company needed a substantial asset transfer was extraordinary operational restructuring to become Let me end by some reflections bumpy. Several changes in viable, not only a financial one. concerning the development so far. direction, some initiated politi- Secondly, the financial reconstruction They are, to say it again, my own cally, some due to actions by DG needed was so extensive that not reflections, and all my colleges in Comp, required considerable only the banks, but also the custom- the BAMC board may not necessar- flexibility in the set up and work ers and the suppliers had to partici- ily agree. As I see it, Slovenia is in of BAMC – the last major change pate. And thirdly, the big customers a better position for recovery than coming as late as December 6, in particular, but also the main suppli- many other European countries. 2013. This is now history, but last ers were willing to do so. There is a strong industrial tradition autumn should be remembered As BAMC became the main credi- and unit labour costs have not risen as a period of great confusion tor, it could take the lead in the as much as in a number of other and uncertainty. reconstruction work. Some 20 banks countries competing with Slovenia • The reluctance by the banks and formed a consortium (NLB and on the export markets. There is good authorities to provide adequate NKBM were still there, in spite of potential for growth when demand and timely information and the having transferred NPLs to BAMC). in Europe increases. Furthermore, difficulties in getting access to A number of foreign banks and important problems in the financial pricing methodology was unfortu- banks serving the foreign subsidiar- sector have been addressed. There nate, unnecessary and costly. ies of Cimos also became involved. is much more to do, of course, in the • The story around the transfer Needless to say, running a recon- financial sector and elsewhere, and prices is a mess. In the process of struction case of this size is very there are political obstacles to neces- setting the prices, the distinction complicated. All stakeholders – the sary reforms. But the process has between gross and net transfer owners, the creditors, the customers started in the right direction. prices should have been made and the suppliers may agree on that • BAMC has helped Slovenia to clear. The banks and the Bank of a reconstruction is necessary. But address the nonperforming assets Slovenia should have agreed in they disagree on who should pay in the major banks in a structured advance on how to handle the for it. In the Cimos case the owners, way, in this manner setting an BAMC financial and operative dominated by a state owned insur- example for many other Euro- costs in accordance with ZUKSB. ance company and an Italian bank, pean countries, which still have • Given the circumstances and fought to keep in control. Consider- considerable problems to face in the involvement of state aid, DG ing that the external auditors found the banking sector. Furthermore, Comp had an important role to that the value of their equity was BAMC has made it possible to play in the process. This is not to zero, they had a bad bargaining handle the process on arm’s question. But the cost to Slovenia position. Eventually the banks had to length from the political system, of delaying a number of impor- put Cimos into compulsory settle- which is important – in Slovenia tant restructuring cases for half a ment, which eliminated the owners. as well as in other countries. The year was substantial. Doing some When this is written, the work with bad experience from the SRD transfers and starting the restruc- the reconstruction plan and agree- can and should be avoided. turing in June (and setting the ment is still going on. Two experi- • The successful legal transfer of transfer prices later) would have enced German car specialists have assets was necessary for the saved time and money. been added to the board as non- Slovenian government to recapi- • The selection of assets to be trans-

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ferred should have observed the difficult to explain to the public political governance, which need to facilitate reconstruction of and also to potential external has penetrated far down in the a number of important financial investors. organisations. So far I have seen groups and companies in opera- • BAMC will obey the law and no serious attempt to address tion. All assets in such groups and sell 10 per cent of the acquired this issue. Why not create an companies should have been assets during 2014. This may Accreditation Committee with in- sold to BAMC, whether perform- however hardly be done without ternational participation to assure ing or nonperforming. Situations “forced sales” and unnecessary that the Board of Directors have where state owned banks have losses. An AMC should keep the sufficient competence, integrity incentives to block restructurings assets until they are restructured and independence? This would that are in the interest of Slovenia and the market has returned to substantially increase credibility are embarrassing, particularly normal. – both domestically and abroad. in a situation when the need to • The banks still seem to have a All change must start at the top! restore corporate balance sheets considerable amount of NPLs left are pressing. in their balance sheets. This is not • The balance sheet of BAMC strictly an issue for BAMC, but it REFERENCES: could have been better handled is important for the banks’ abil- Poročilo o izvajanju zakona o zaključku lastninjenja in privatizaciji pravnih oseb in ZUKSB. Sufficient risk capital ity to help getting the economy v lasti slovenske razvojne družbe d.d. - v in the form of equity is important moving by giving new loans likvidaciji. for an AMC. Furthermore, the to commercial companies and Zakon o Slovenskem državnem holdingu (EPA 516-VI) (ZSDH), Zakon o ukrepih government expectations for it is important for the interna- Republike Slovenije za krepitev stabilnosti return on equity must be adjusted tional credibility of Slovenia. To bank (EPA 637-VI) (ZUKSB). according to the economic and “Strengthen Bank Stability”, as Zakon o ukrepih Republike Slovenije za financial conditions given the is the purpose of ZUKSB, the krepitev stabilnosti bank (ZUKSB). company, e.g. the cost of finance remaining NPLs have to be ad- Revizijsko poročilo o smotrnosti poslovanja Slovenske razvojne družbe v obdobju od and the transfer prices. dressed. Creating BAMC is just leta 1997 do leta 2002. • An AMC can be successful in its not enough. Zakon o ukrepih Republike Slovenije za restructuring work and in pay- • It seems to me that a major krepitev stabilnosti bank (ZUKSB). ing back its bonds and still make problem with the state owned Annual Report 2013 BAMC. losses. But it will be much more Slovenian banks is their strong Semi-Annual Report 2014 BAMC.

112 BV 11/2014 CONCLUDING REMARKS Monetary policy paradoxes and banking crisis Emil Lah*

Six years after the collapse of the not come as a surprise that also ficient and unscrupulous behaviour. If Wall Street institution Lehman Broth- Greece and other most vulnerable we take Greece as an example – by ers on 15 September, the European countries find it difficult to comply. the end of 2013, the government banking has still not fully recovered Over the period 2007-2013, the handed out roughly 24% of GDP from the blow and the deep financial public debt across the euro area for bank recapitalisation, Slovenia crisis that followed. This is particu- soared from 66% of GDP in 2008 to and Cyprus allocated approximately larly true of the peripheral euro area 92% in 2014. What comes to mind 12% of GDP respectively, Portugal banks that lost access to short- and is that the Stability and Growth Pact paid some 7% of GDP to shore up longer-term wholesale funding practi- was first breached (even before the the stability of its banking sector, cally overnight, forcing them to shrink worldwide crisis) by France and Ger- and Spain’s bill was “only” 4.6% of their balance sheets. many, and the list of the euro area GDP. However, saying that the only countries disregarding the constraints culprits for this world-wide financial Introduction is getting longer with Slovenia and economic crisis are the financial being no exception. Another point sector and its greedy actors would As opposed to the 2004 – 2008 worth noting is that the rising public be one-sided. The uncontrolled inflat- credit cycle in the eurozone when debts and yawning budget deficits ing the mortgage, stock exchange lending grew faster than real GDP, are largely attributable to the bank and debt bubbles was destined to with the exception of 2012, credit resolution models serving to bail burst sooner rather than later causing growth was negative between 2009 out the distressed banks with public the financial crisis but it all went on and 2013 and the euro area subsidies by making taxpayers pick for quite some time before the eyes economy was again in recession in up the bill. As an illustration: poten- of the (ir)responsible governments, 2012 and 2013. True as it is that tially more than 33% of the current corporate managers and speculative the burden of non-performing loans Irish public debt that currently stands trading activities by private investors weighed the most on the banks in at approximately 120% of GDP is a lavishly supported by credit offer in PIIGS – the troubled and heavily-in- consequence of the run to rescue of many countries. debted countries of Europe: Portugal, the Irish credit institutions. In order The financial crisis unfolded in the Ireland, Italy, Greece and Spain, as to prevent a full-scope collapse of U.S. market for sub-prime mortgage well in Cyprus and Slovenia, bank the banking system, the European bonds and dealt a heavy blow to profitability plunged in the post-crisis governments wrapped up rescue the liquidity of the U.S. banks. The period also in the credit institutions packages for their credit institutions ripple effects have been massive of the most developed countries in only during the period from 2008 to and the U.S. central bank (Fed) is the eurozone. It is also clear that 2011 worth approximately 1.5 tril- still smoothing these effects out with also the most developed eurozone lion euros or 13% of the annual GDP the quantitative easing programme countries (such as France, the U.K. of the European Union. By the end of of buying bonds. The latest analy- or the Netherlands) are struggling 2013, the debt was already repaid ses confirm that the Fed and the to keep public finance in line with in some EU countries showing that U.S. government involvement in the the EU-imposed ceilings and it does not all governments subsidised inef- market has been much more effective

* Emil Lah, Chief Editor of Bančni Vestnik. The information and views set out and this article are those of the author and do not necessarily reflect the official opinion of the Bank Association of Slovenia.

BV 11/2014 113 CONCLUDINGCONCLUSION REMARKS than the response by the European provisions1. Between 2011 and a couple more. Besides, return on Central Bank (ECB) and the Eu- 2013, the six largest U.S. banks not equity (after tax) was constantly ropean Commission to the 2008 only enjoyed stable earnings but rising between 2011 and 2013 in economic meltdown in the euro area. at end-2103, their combined profit the U.S. banks as opposed to the The European banks in general and was at the highest level since 2006. European credit institutions posting in the PIIGS countries, Cyprus and On the other hand, European banks ROE in 2011 close to zero. In 2013, in Slovenia in particular continue had lacklustre earnings. While the the U.S. banks posted over 10% in to struggle under the heavy burden U.S. banks were making more loans return on equity after tax and the of toxic assets and non-performing to corporates, the European banks European banks managed ROE in loans. Moreover, the funding crisis were particularly reluctant to lend the 6% bracket. However, we should of the banking sector has affected to small firms even though they are bear in mind that commercial banks lending to the real economy and seen as the lifeblood of Europe’s are far less important in the U.S. the consequences of the bank credit economy. Consequently, provisions financial sector that it is the case in crunch have been devastating for for impaired assets as share of total the European Union and that the many small and medium-sized enter- assets of the U.S. banks were falling development of the so-called shadow prises. Since initial liquidity shocks in contrast to the developments in the banking in the U.S. was particularly feed through the financial system, the European banks. However, accord- fast over the past decades. As an advanced euro area countries have ing to the ECB, there are encourag- illustration: the combined assets of rescued their “too big to fail” banks ing signs as lending standards have the European banking sector in 2012 with generous State aid packages eased for all corporate borrowers, totalled approximately 350% of and substantial capital injections, including small firms, for the first time GDP or 45 trillion euros, whereas the raising concerns about systemic risks since 2007. combined assets of the U.S. banking and moral hazard. To relieve banks’ sector arrived only to approximately balance sheets from risks, govern- 90% of the U.S. GDP. Corporations ments in some country have imple- in the U.S. go far more often than mented the bailout approach where U.S. banks have their European counterparts to debt banks that fail are resolved through markets to obtain capital by issuing some form of governmental, tax- been much more corporate bonds and other securities. payer-backed initiative, as opposed According to the analysis made to the bail-in model the European profitable over by Deutsche Bank, the U.S. banks Commission has imposed on Cyprus, qualified for a clean bill of health Spain and Slovenia. The failed banks the past two rather quickly also thanks to higher of the first two countries are still be- economic growth from 2011 to ing propped up, whereas Slovenia’s years. 2013: it was in the range of 2% to banking sector has managed without 3% on average and the unemploy- a rescue deal. ment rate in the U.S. was much lower According to Bloomberg, the write than in Europe2. As a consequence 1. Why are U.S. banks doing downs made by the U.S. financial of the double-dip recession lending better than their European institutions during the financial crisis to the private sector in 2012 and in counterparts in the aftermath between 2007 and 2010, added up 2013 was shrinking in Europe, just of the crisis to 1.1 trillion US dollars, as opposed the opposite of more than 5% growth to approximately 0.5 trillion US A tell-tale sign for the performance of dollars in Europe. The market value 1 For more information see Deutsche Bank, DB Research, Bank performance in the USA and the U.S. and European banks before of bank shares has plunged in the Europe, September 26, 2013. the financial crisis broke put was that post-crisis period in Europe mostly 2 Fed chair Janet Yellen warned that there was “a possibility that severe recession caused persistent the U.S. banks enjoyed record-high attributable to low profitability of the changes in the labour market’s functioning … along profits until the watershed events in European banks. After-tax income with cyclical influences, significant structural factors have affected the labour market, including the 2008. In general, the U.S. banks of 22 largest European banks was ageing of the workforce and other demographic trends, possible changes in the underlying have been much more profitable decreasing between 2011 and 2013 degree of dynamism in the labour market, and the phenomenon of ‘polarization’ – that is, the over the past two years than their largely due to double-dip recession reduction in the relative number of middle-skill European counterparts as illustrated affecting the European countries jobs”. For more information see The Guardian, Janet Yellen cautious and speech on ‘damaged’ US by data on income, lending and such as Greece, Italy, Slovenia and economy, Friday, 22 August 2014.

114 BV 11/2014 CONCLUDING REMARKS in the U.S. in 2013. The opinions as banks is higher than in the U.S. credit other problems of commercial banks. to the cause for the credit crunch in institutions, it was in the 12% bracket The Federal Reserve is generally Europe being attributable to lower in 2013, the European banks have seen as being efficient by putting credit offering by the European been struggling to raise their capital in place the quantitative easing banks or to weak demand for credit, buffers. The debt crisis across the programme designed to assist the are still opposing. According to the euro area has dealt heavy blows to country’s economy in getting back analyses and estimates made by many European banks – moaning on track relatively fast. In comparison the ECB, dwindling lending experi- in 2011 and 2012 under the heavy with the ECB, the Fed’s intervention enced in 2012 and 2013 is largely burden of financing, Greek sovereign on the financial markets has been a consequence of weak demand for debt crisis and losses piled on Greek more aggressive and direct resulting loans and only partly a reaction to government bonds and recession. in reducing price volatility. In com- tighter credit standards followed by parison with the summer 2007, its credit institutions. For lending to get 2. How to overcome the balance sheet increased four times, an impetus, there is also the issue of credit crunch whereas the total assets of the ECB the real property market in the EU was only twice the size it had before Member States. If we take France, The European Central Bank and the financial crisis. It is a logical Sweden or the United Kingdom as national regulators have been busy consequence of the liquidity support an example, real property prices are trying to work out the answer to the the Fed provided to the U.S. banks still too high in those countries and it key question of overcoming the credit following the collapse of Lehman may be an adverse factor if house- crunch and giving impetus to the Brothers when banks could tap into hold lending is to grow. euro area economic growth. The cur- approximately 1.6 trillion short-term A comparison between balance rent trends in the European banking liquidity loans. The Fed also used sheets of the U.S. banks and the larg- sector indicate that we have still not approximately 400 billion dollars for est European banks is rather enlight- identified the right solution. The truth the purchases of Asset Backed Secu- ening and even more so against the is that European banks have been rities or covered bonds (ABS), and background of corporate lending reducing the volume of their opera- it poured approximately 1.3 trillion and the volume of loans that have tions and applying a handbrake on dollars into the mortgage markets for turned sour. lending dynamics since »capital is the purchases of mortgage-backed What could be observed between the king« and that is the only way securities (MBS). It appears that the 2011 and 2013 is that the volume for banks to maintain high capital Fed used also approximately 300 of non-performing loans in the U.S. adequacy. In the most vulnerable billion dollars to purchase Treas- banks declined, where it moved CESEE countries, including Slovenia, ury bonds. On the other hand, the in the opposite direction in Greek, banks have been forced due to busi- ECB acted in line with conventional Italian, Portuguese, Spanish and Irish ness restructuring to pull out of less policies and “rode to the rescue” of banks. The largest Slovenian banks important lines of business and scale banks by lowering the key interest are state-owned and, for one reason down their international operations. rate that gradually slipped from or another, managed to pile up When it comes to economic growth, 4.25% in August 2008 to 0.05% In more than a 20% share of NPLs of the forecasts are more optimistic September this year, by purchasing at the end of 2013 before unload- for the U.S. than for the European bonds and by putting in place LTRO. ing their NPL portfolio to the BAMC, economy both due to demographic The ECB purchased in the post-crisis Slovenia’s “bad bank”. In addition, trends and other reasons. Given period slightly less than 500 billion deleveraging has been more painful poor quality of banks’ assets and euros in the euro area bonds and for the European banks that for their overleveraged enterprises, banks covered bonds. In addition, the ECB U.S. counterparts also due to stricter and state-owned enterprises primar- approved to banks in the euro area capital and liquidity requirements im- ily in the EU peripheral countries will liquidity facilities know as longer- posed by Basel III. The advantages be forced to sell assets at fire-sale term refinancing operations (LTRO) of the U.S. banks include a higher prices, far below their book value. and targeted longer-term refinancing Tier 1 ratio than in most European When the going got rough, the operations (TLTRO) with the maturity banks with less prime equity capital central bank in the U.S. and the of one and three years in the amount and burdened by a higher capital European Central Bank rose to the of approximately one trillion euros leverage3. Even though the new capi- occasion and developed the models tal ratio Core Tier 1 in the European expected to mitigate liquidity and 3 Ibid. p. 12.

BV 11/2014 115 CONCLUDING REMARKS with maturity in December this year than doubled the ECB’s balance credit institutions in the EU periph- and in February next year. sheet), there has been a double-dip eral countries are concerned, it is We should note, however, that recession and a credit crunch in the mostly attributable to the whopping the ECB’ room for manoeuvre to European banks. It is obvious that amount of non-performing loans in take monetary policy measures to the transmission mechanism on the their balance sheets, lending seen as enhance the functioning of the mon- ECB’s monetary policy is not fully too risky given the fact that potential etary policy transmission mechanism functional, since credit flows to the borrowers are already overindebted, is not as big as the Fed’s given the real economy has been reduced to a the EBA’s ever-increasing capital focus on the sole objective of 2% trickle in many countries of the euro requirements, and, last but not least, inflation over a medium term. The area. It shows that the ECB accepts low demand for bank credit by macroeconomic situation, faster risks of important banks, whereas corporates. In other words, in light of deleveraging of the U.S. corpora- the banks remain reluctant to share the requirement forcing credit institu- tions, higher capital strength of banks risks with their corporate customers tions to beef up their capital and in the U.S., more trust of the financial despite the ECB’s liquidity support. improve capital adequacy, they are markets in the U.S. dollar and the The ECB took another unconvention- putting in place funding plans poised U.S. economic policy have contrib- al measure in June this year when it to affect the supply of credit to the uted to making the Fed’s rather easy- introduced a negative deposit facility real economy. At the European level going monetary policy more effec- interest rate to apply also to aver- it means a 20% decrease in their tive. True as it may be that the ECB age reserve holdings in excess of the exposure to corporate customers. subscribes to a rather conservative minimum reserve requirements and policy, it has been often criticised for other deposits held with the Euro- 3. Lessons for the its allegedly low (!) conservatism by system designed to motivate banks Slovenian banks one of the most powerful countries of the eurozone such as Germany4. It Since the annual inflation rate in has been only lately that the critical August 2014 was as low as 0.3%, voices have become less load with GDP of which is considerably below the the weakening of the economy. medium-term inflation target of 2%, a At this point the question to ask is Germany is now threat of deflation or even a stagfla- whether the ECB and the Fed were tion is looming over the euro area. sufficiently effective in the post-crisis by some 13% The ECB is faced with the fact that period in effort to give a boost to a the recovery of the euro area econo- faster recovery of the euro area and higher than my has been frail and uncertain with of the U.S. economy and whether Italy falling into triple-dip recession. they will be effective also in the before the crisis. Being constrained to follow blindly future. The voices criticising the mon- the policy dictated by Germany and etary policies of the central banks advocated by the European Com- on both sides of the Atlantic argue for more courageous lending to the mission that leaves no choice to the that there is a risk of secular stagna- real sector. The ECB was guided by PIIGS countries but to cut public tion when advanced economies are the same motive when in July 2012 spending, carry out full-scope fiscal trapped in the persistent state of eco- it slashed the deposit interest rate to consolidation and axe investments by nomic depression in which monetary zero per cent. So far, the ECB’s en- the state, the EU peripheral countries policy becomes ineffective as there deavours in the first half of this year have suffered yet another fall in eco- is a lower bound on nominal returns have not been fruitful since banks nomic growth and yet another round – the real interest rate becomes preferred to use fresh money to of recession in Greece and other negative. This apparent paradox of purchase sovereign bonds or insisted the ECB monetary policy is shown on placing deposits at the ECB rather in the latest developments where than to increase their corporate 4 According to the governor of the German despite cutting the key interest rate, lending operations. The next ques- Bundesbank President Jens Weidmann, a large- scale buying of private-sector bonds issued by the a surge in money offered and the tion to be asked is why the European euro area countries means that such measures focus on the symptoms and don’t cure the causes of the generous (special) LTRO intervention banks are so reluctant to extend crisis in the euro area. For more information see the interview in Spiegel with the German Central Bank and buying government bonds (these credit to corporate customers? As Head Weidmann: ‘The Euro Crisis Is Not Yet Behind combined measures have more seen from the analyses, as far as the Us’, 24 September 2014.

116 BV 11/2014 CONCLUDING REMARKS countries of the euro area5. Obvi- fact matters most when it comes to numerous corporations. There is ously, the EU peripheral countries banks in less developed economies little doubt that those were politi- have fallen in a vicious circle of low where the domestic capital market is cal projects, since the management or even negative economic growth, shallow. The analysis of the macro- buyouts turned sour were carried falling credit growth and dwindling economic trends that characterised out without equity capital and with investments. In the second half of this the period preceding the financial very low, symbolic contributions of year, the year-on-year growth in lend- crisis confirms that the Slovenian future owners. The burned of risk was ing by credit institutions to the private bank regulator paid too little at- practically on banks that generously sector has been negative in Cyprus, tention to the consequences of the funded these shopping sprees and Greece, Ireland, Latvia, Malta, the credit boom reflected, among other now also on the taxpayers. Netherlands, Portugal, and Slovenia things, on the current account deficit and in Spain. As stated by the au- in the years 2004 to 2010 and the 4. Exit strategy of the thors Carmelina Carluzzo and Milen country’s swelling external debt (it Slovenian banks Kassabov (Unicredit Group) in their is worth noting that there was no net article for Bančni Vestnik, also in the external debt in 2004 in comparison The Slovenian state-owned banks CEE countries credit growth before with the period from 2004 to 2012 and the Republic of Slovenia as their the year 2009 was approximately when it increased to just over 40% majority owner have embarked on 30%, during the period 2010-2013, of GDP). According to the available resolution programmes in the post it was still 12.4% p.a. Also in Slove- data, credit growth during the period crisis period and it is still work-in- nia credit growth during the period 2005-2008 in the Slovenian real progress. They have been more or 2005-2008 was around 26% p.a.6, less forced to do it when access between 2010 and 2013, credit to cross-border funding, investors growth was negative, approximately demanded high yield on ten-year -5.2% p.a. What draws attention is Cyclical government bonds9 and there was a that among the CEE countries, credit protracted recession. It was revealed growth during those years was nega- unemployment that during the period preceding the tive only in Hungary (-3.6%). Against the backdrop of protracted recession, is becoming 5 The analysis made by the IMF experts has weaker credit demand, swelling non- shown that in the economically advanced countries structural fast fiscal consolidation causes lower economic performing loans and stricter credit growth. If it applies to the most advanced standards, credit institutions operating economies, it applies to an even higher extent to the less developed countries as best seen in the in the CEE countries were forced to unemployment. case of Greece. For more information see the IMF Working Paper, Growth Forecast Errors and Fiscal set aside higher provisions. Between Multipliers, January 2013. 2008 and 2013, provisions jumped 6 Credits to the non-bank sector in Slovenia soared by nearly 40% in 2007, not out of line in the Slovenian banks and specifical- sector was approximately 25%, and with the developments from 2003 to 2008 when domestic credit growth was record-high also in ly by 73%, in the Croatian banks they in 2008 it jumped to as much as certain advanced countries, such as Denmark (over went up by 40%, and in the Bulgar- 35%. The bankers and the national 50%), Great Britain (approximately 50%) or the Netherlands (more than 45%). ian banks this rise was 27%. regulator were aware of the fact that 7 For more information see the speech by Benoît In line with other credit institutions the credit boom was at its highest Cœuré, Member of the Executive Board of the ECB, at IMF/Banka Slovenije high-level seminar on that operate in the euro area, level in the construction sector and in “Reinvigorating Credit Growth and Central, Eastern and Southern European Economies”, Portorož, 26 Slovenian bankers are trying to get the real property market. September 2014. to the bottom of the developments There is no official statistics for 8 The crucial problem of the largest Slovenian corporations is low profitability, excessive financial that have brought to the financial privatisation financing, since it has leverage and an overwhelming impact of the state or politics on governance of those corporations. crisis and to learn a lesson. We are been treated as a taboo topic, but For the Slovenian privatisation model based on all coming to terms with the fact that the leaked figures reveal that before management buyouts where the bill is footed by bank loans only, it is more than obvious that it was credit flows towards unproductive and after the crisis banks allocated in economic terms a complete failure and that those 7 investment were all but productive. investment projects sooner rather to financing management buyouts 9 In March 2013, the ten-year Slovenian than later end up in a tight corner approximately 2.3 billion euros8. It government bond was priced at a yield of 5%, in the wake of the Cyprus bank crisis it was above the and falls short of the objective to should be noted that certain portions psychological limit of 7% for a shorter period of time, after the measures for enhancing bank stability support long-term economic perfor- of the sales proceeds were allocated were taken at the end of 2013, the price of the mance. The quality of credit matters also to the state-owned KAD and bond started to slide down and stood at 2.68% on 7 September – the record-low level since entering as much as their quantity and this SOD as the significant owners of the eurozone.

BV 11/2014 117 CONCLUDING REMARKS crisis, the Slovenian state-controlled and clearly indicating that banks’ the economies in the euro area that banks were exposed also to high li- corporate customers are unable to still feel the after-effects. The U.S. quidity risk – funding tapped abroad deleverage any time soon. The au- economy has managed to wade accounted for approximately 30% thor Daria Zakharova argues in her through the general glut with relative of total bank liabilities. Therefore, in paper for this issue of Bančni Vestnik ease, while the BRIC countries, some the years following the financial crisis that the ratio between net debt and Scandinavian countries, Germany, and the general economic meltdown, equity capital is lower in exporting Austria and a few other advanced these banks took steps to strengthen companies owing to the fact that countries have escaped barely their balance sheets by getting rid of their earnings are higher in compari- scathed by the crisis. The macroeco- debt paying back to foreign creditor son with their interest expense. Banks nomic indicators paint a bright pic- from 2008 until 2013 approximately are weary that approximately half ture of Germany where GDP is now 10 billion euros, bringing down their of corporate clients are struggling to by some 13% higher than before the outstanding borrowings to only some repay outstanding debts, they have crisis as opposed to GDP of Spain 4.7 billion euros at mid-year 2014 no money to increase productivity, and Italy shrinking by approximately or approximately 12% of their total exports and make new investments. 6% and 1.5%, respectively. If we liabilities. Although the Republic of This means that over indebted corpo- compare the euro area economy Slovenia recapitalised the biggest rate customers will have to carry out with the U.S. economy, we see that state-owned banks in December last financial, business and ownership the U.S. GDP is approximately 7% year by injecting approximately 4.6 restructuring and get access to fresh above the pre-crisis level and GDP billion euros serving to improve sig- shareholder capital. It is a tall order in the euro area has not achieved nificantly the capital adequacy ratios made more complicated to resolve the pre-crisis level. Some high-calibre of those banks, efforts to restore trust only by arcane insolvency legisla- European macroeconomic experts to the extent that credit can again tion, but also due to the fact that estimate that for GDP per capita (at flow to the real economy are still whether we want foreign capital or constant prices) to achieve the pre- fruitless for all the reasons already not is not an easy question to answer crisis level across the eurozone and examined in this paper. The volume and there is shortage of domestic United Kingdom, it will take no less of banks’ operations continues to capital as we all know. than two years, in Spain and Ireland shrink. The share of bank’s combined Slovenia’s economic policy is no it can be expected in four years, in assets was roughly 146% of GDP exception when it comes to fighting Portugal and Italy ten years or more in 2009 (the combined assets of all the crisis. Just like in other countries will be necessary. Nevertheless, banks operating in Slovenia totalled in the euro area, the Slovenian some German economists including 52 billion euros) and in comparison government(s) undertook sorting reputable Hans Werner Sinn argue with the share of banks’ combined out public finances the easy way: that despite high the unemployment assets accounting for 110% of GDP by raising taxes and drastic cutting rate of 27% in Greece, 24% in Spain this summer, it is a significant fall of investments. Although Slovenia’s and in other vulnerable countries, (the combined assets of all banks GDP shrunk by approximately 7% in the key problem of those countries operating in Slovenia totalled 39 the aftermath of the financial crisis, is a low level of competitiveness of billion euros). Client over indebted- in the double-dip recession the cuts ness remains a “bridge too far” for made into public spending and 10 According to the available data, the number of the banks: their financial leverage private consumption did not keep overindebted companies in Slovenia is in the range is way too high, which means that abreast with slashes made to the in- of 15,000 as revealed by their net debt being four times higher than their net cash flow (EBITDA). the debt-to-equity ratio has reached vestment budget. On the other hand, Some Slovenian economists argue that other 10 national economies in the EU are equally indebted the unsustainable level . True as it is the banks operating in Slovenia will and that the debt to EBITDA ratio for the entire economy of, for example, Sweden and Denmark that there has been a step in the right have to come to terms with consoli- exceeds indebtedness in Slovenia, while Finnish direction when the ratio between net dation of the banking sector11 and leverage is at the same level with Slovenia’s. 11 The European Commission expects the corporate debt and GDP decreased unavoidable privatisation. consolidation of the Slovenian banking sector from 90% in 2008 to approximately and mergers of medium-sized banks. However, the question to ask is whether these steps will 80% in 2013, there is still one third Conclusion remarks improve banks’ performance. As the bar for capital requirements is raised, banking supervision of corporations saddled with unsus- expense goes up and EU banks will have to pay into standing funds that would be tapped to protect tainable debt as seen in the ratio Six years since the fall of Lehman depositors when lenders fail, income risk looms high between net debt and cash flow from Brothers signifying the financial crisis on the Slovenian banks. If the banks fail to achieve organic growth and generate sufficient profit, operations (EBITDA) looming high it is mostly the credit institutions and economies of scale won’t help much either.

118 BV 11/2014 CONCLUDING REMARKS their corporations, believe that real functional autonomy, international Slovenian banks and, above all, for depreciation (cutting back prices and markets and development vision. those owned by the state, as well salaries) and continuing extensive These “stock-taking” thoughts about as for credit institutions in other EU structural reforms are necessary. the financial crisis and banks have peripheral countries, it is true beyond Also the president of the ECB Mario completed the round and we are reasonable doubt that they cannot Draghi and the highest-ranking rep- back at the starting position: the afford «waiting for Godot« policy, resentatives of the European Com- bankruptcy of one of the U.S. largest but they have to carry on balance- mission say that for the peripheral investment banks Lehman Brothers sheet clean-ups and focus attention countries it is absolutely necessary with more than 600 billion US dol- on putting in place new business to undertake deep structural reforms, lars in assets. The rule »too big to models. reduce the number of employees fail« has lost its sacrosanct meaning working in the public sector and since then in the financial sector and REFERENCES: lower salaries and pension benefits it will be ever more true also for the Bank of Slovenia, Report on Financial across the board. The fact remains European banks. The bailout model Stability, May 2012, 2013 and 2014. that the countries of the euro area for bank rescue is becoming ever Institute of Macroeconomic Analysis and Development, Development Report, July are at different development levels more difficult to implement due to 2014. and have different economic struc- the size of credit institutions and the IMF Working Paper, What Caused the tures in place. The cliché structural re- bail-in bank rescue model is here Global Financial Crisis? Evidence on the 12 Drivers of Financial Imbalances 1999 – forms, liberalisation, privatisation and to stay . To reverse the economic 2007, December 2010. economic policy of consistent market meltdown without credit growth Deutsche Bank, Bank performance in the fundamentalism are not advised as will not get us far and the time for US and Europe, September 26, 2013. universal solutions to the crucial eco- overcoming the credit and capital ECB, Working Paper Series, Identifying Excessive Credit Growth and Leverage, nomic and development problems of crunch is running out both across the August 2014. all countries. If we take Slovenia as euro area and in the most vulner- Speech by Benoît Cœuré, Member of the an example, already some two thirds able countries. We are careful what Executive Board of the ECB, at IMF/Banka Slovenije high-level seminar of employees have salaries that are we wish for, and falling down into on “Reinvigorating Credit Growth in below the average Slovenian salary, a deflationary scenario with slug- Central, Eastern and Southern European Economies”, Portorož, 26 September approximately 90% of the retired gish or even negative growth of the 2014. people are on the brink of poverty. economy is nobody’s wish. Against Spiegel, Interview with German Central Cyclical unemployment in Slovenia the backdrop of recession hitting the Bank Head Weidmann, The Euro Crisis is and in other peripheral countries is economy of the euro area in 2012 not Yet Behind us, 24 September 2014. becoming structural unemployment and 2013, GDP growth is expected The Guardian, Fed chair Janet Yellen cautious in speech on ‘damaged’ US with all negative social, psychologi- to be below one per cent with flat economy, Friday, 22 August 2014. cal and development consequences. economic growth in France and IMF Working Paper, Growth Forecast Put differently, the peripheral coun- even Germany in the second quarter Errors and Fiscal Multipliers, Olivier Blanchard and Daniel Leigh, January tries in the European Union, their of 2014 and all eyes are turned to 2013. commercial banks and corporate the ECB as the lender of last resort customers have been experiencing ready to ride to the rescue should business problems due to the double- the German economy grind to a dip recession and, in addition, their halt. Since “in the long run we are all economies lag behind the euro area dead” as John Maynard Keynes put 12 Since just below two thirds of the Slovenian banks by total assets is still state-controlled, average performance. For the state- it, the ECB will have to take timely risks associated with the bailout model for bank resolution and socialisation of potential new owned banks in those countries it is measures and do it right. When and bank losses is still too high in Slovenia. This is the painful that because of privatisation how it will take place, if necessary argument that makes the opposing voices of the Slovenian authorities against bank privatisation they put at stake their financial and at all, remains to be seen. For the problematic.

BV 11/2014 119 STATISTICAL APPENDIX

SELECTED MACROECONOMIC INDICATORS

Luka Žakelj*

Figure 1: Slovenia - projection of expenditure Figure 3: Differences in y-o-y growth rates contributions to GDP growth rate of GDP components between Slovenia and the euro area - expenditure side

Figure 2: Slovenia - projection of Figure 4: Differences in y-o-y growth rates of GDP contributions to inflation by components components between Slovenia and the euro area - production side

* Luka Žakelj, Analitsko - raziskovalni center, Banka Slovenije

120 BV 11/2014 STATISTICAL APPENDIX

Figure 5: Employment growth Figure 7: Fiscal position of the general government

Figure 6: LFS unemployment rate Figure 8: Slovenia - limiting factors to business activity - financing

BV 11/2014 121 STATISTICAL APPENDIX

BANKING SECTOR INDICATORS

Franc Remšak*

Figure 1: Comparison of the EURIBOR and Figure 3: Credit to nonfinancial enterprises and ECB refinancing rate households (in %) (annual growth in %)

6 40 40

ECB main refinancing rate 35 Euro area 35 5 3-m EURIBOR 30 Slovenia 30 12-m EURIBOR 25 25 4 20 20 15 15 3 10 10 5 5 2 0 0 -5 -5 1 -10 -10 -15 -15 0 -20 -20 2006 2007 2008 2009 2010 2 011 2012 2013 2014 2006 2007 2008 2009 2010 2 011 2012 2013 2014

Source: ECB, Bank of Slovenia Source: ECB Statistical Data Warehouse (http://sdw.ecb.europa.eu)

Figure 2: Total assets/liabilities of the Eurosystem Figure 4: Ratio of loans to non-banking sectors to (in EUR billion) deposits by non-banking sectors (in %) 4,000 190.0 3,600 Euro area 170.0 3,200 Slovenia

2,800 150.0 2,400 130.0 2,000

1,600 110.0

1,200 90.0

400 70.0 0 50.0 2006 2007 2008 2009 2010 2 011 2012 2013 2014 H1 2011-W01 2011-W01 2012-W01 2012-W01 2013-W01 2013-W01 2013-W01 2014-W01 2010-W16 2010-W40 2009-W21 2008-W01 2008-W25 2008-W49 2009-W45 Source: ECB Statistical Data Warehouse (http://sdw.ecb.europa.eu) Source: ECB Statistical Data Warehouse (SDW)

* Franc Remšak, Finančna stabilnost in makrobonitetna politika, Banka Slovenije

122 BV 11/2014 STATISTICAL APPENDIX

Figure 5: Bank Nonperforming Loans to Total Loans Figure 7: Tier 1 ratio in EMU member states (in %) (in %)

40% 60%

2010 2008 35% 2 011 50% 2009 2012 2010 30% 2013 2 011 2014 40% 2012 25% 2013

20% 30%

15% 20% 10% 10% 5%

0% 0%

Italy Spain Malta Cyprus Slovak Austria Cyprus Estonia France Ireland Belgium Italy 12 Spain 3 Belgium Finland Greece Portugal Austria 3 EstoniaFinland 3 France 5 6 Ireland 3 Malta 15 Slovenia Germany SloveniaSlovakia Denmark 4 Greece 8,9 Portugal 17 SwedenSwitzerland 19 Luxembourg United States Luxembourg Netherlands Germany 7,8 Netherlands 3 Czech Republic United kingdom

Source: IMF, Financial Soundness Indicators, October 2014 Source: ECB, Statistics on Consolidated Banking Data http://fsi.imf.org/fsitables.aspx (See Notes under “Table 3. (Domestic banking groups and stand alone banks, foreign Bank Nonperforming Loans to Total Loans”) (EU and non-EU) controlled subsidiaries and foreign (EU and non-EU) controlled branches), October 2014

Figure 6: Capital adequacy; Overall solvency ratio Figure 8: Return on equity in EMU member states in EMU member states (in %) (in %)

60% 40%

2008 20% 50% 2009 2010 0% 2 011 -20% 40% 2012 2013 -40%

30% -60%

-80% 20% -100% 2 011 -120% 10% 2012 2013 -140% 2014 H1 0% -160%

Italy Italy Spain Malta Spain Malta Austria Cyprus Estonia France Ireland Austria Cyprus Estonia France Ireland Belgium Finland Greece Portugal Belgium Finland Greece Portugal Germany SloveniaSlovakia Germany SloveniaSlovakia Luxembourg Netherlands Luxembourg Netherlands

Source: ECB, Statistics on Consolidated Banking Data Source: Bank of Slovenia, ECB, Statistics on Consolidated (Domestic banking groups and stand alone banks, foreign Banking Data (Domestic banking groups and stand alone (EU and non-EU) controlled subsidiaries and foreign (EU and banks, foreign (EU and non-EU) controlled subsidiaries and non-EU) controlled branches), October 2014 foreign (EU and non-EU) controlled branches), October 2014

BV 11/2014 123 STATISTICAL APPENDIX

CORPORATE SECTOR INDICATORS

Jelena Ćirjaković*

Figure 1: Total pre-tax profit and loss of Figure 3: Leverage by sector in Slovenia non-financial corporation in Slovenia (in %) (in EUR billion)

5,0 450 4,5 Total profit - loss All firms 2008 4,0 Total profit 400 All firms 2012 3,5 Total loss All firms 2013 350 Going concerns 2013 3,0 2,5 300 2,0 3,86 1,5 3,09 250 2,37 1,0 1,92 2,21 1,55 1,30 0,5 1,04 1,12 1,07 0,87 200 0,38 0,0 -0,5 -0,98 150 -1,0 100 -1,5 -2,0 50 -2,5 -3,0 0

2 011 2012 2013 2010 2001 2007 2004 2002 2003 2005 2006 2008 2009 Overall storage Construction retail trade Financial and Manufacturing Wholesale and service activities Source: AJPES, Bank of Slovenia Transportation Accomm.and and food Real estate activities insurance activities Note: Leverage is calculated as percentage debt-to-equity ratio Source: AJPES, Bank of Slovenia

Figure 2: Number of bankrupcy proceedings Figure 4: Net financial debt to EBITDA in terms initiated against firms in Slovenia of years by sector in Slovenia.

1200 30 All corporates All firms 2008 Non-financial corporations All firms 2012 981 1000 950 25 All firms 2013 896 Going concerns 2013 837 800 20 861

600 587 590 15 515 517 436 400 10

242 199 200 5 88 64 0 0 2008 2009 2010 2 011 2012 2013 sep. 14

Overall storage Source: AJPES, Bank of Slovenia, Supreme Court Construction retail trade Financial and Manufacturing Wholesale and Transportation Accomm.and service and activitiesfood insurance activitiesReal estate activities Source: Ajpes, Bank of Slovenia * Jelena Ćirjaković, Finančna stabilnost in makrobonitetna politika, Banka Slovenije

124 BV 11/2014