20072008September
FINANCIAL STABILITY REPORTУ NATIONAL BANK OF SERBIA Belgrade, Kralja Petra 12, Tel.: +381 11 3027-100
Belgrade, Nemanjina 17, Tel.: +381 11 333-8000
www.nbs.rs Number of copies: 250 ISSN 1820-9106 Article 3 of the Law on the National Bank of Serbia (“RS Official Gazette,“ No. 72/2003 and 55/2004) defines preservation of financial stability as one of the principal tasks of the central bank of the Republic of Serbia:
Article 3.
The primary objective of the National Bank of Serbia shall be to achieve and maintain price stability.
In addition to its primary objective, the National Bank of Serbia shall also pursue the objective of financial stability.
Without prejudice to its primary objective, the National Bank of Serbia shall support the economic policy of the Government of the Republic of Serbia (hereinafter: Government), acting in accordance with the principles of a market economy.
Financial stability, as defined by the National Bank of Serbia, means having safe and sound financial institutions which, being resilient to risks inherent to financial operations and external shocks, enable efficient financial intermediation and promote trust in the entire financial system supervised by the central bank.
The purpose of the Financial Stability Report of the Republic of Serbia (hereinafter: Report) is, therefore, to timely identify all risks, whether present or potential, to the financial system at large and the banking sector in particular, evaluating at the same time the system’s capacity to absorb such risks without any disruptions to its stability and to continue settling all its obligations as they fall due.
In the exercise of its supervisory capacity, the National Bank of Serbia wishes to ensure that financial institutions are resilient to risks to a degree which not only guarantees the protection of interests of financial services consumers, but is also conducive to sustainable development of financial institutions themselves. To this end, the National Bank of Serbia has engaged in extensive and transparent public communication activities, aimed at raising public understanding of the financial system. Therefore, in addition to its primary purpose of reporting to the legislative authorities on the state of the financial system, this Report also forms an integral part of the National Bank’s communication efforts aiming to inform financial system participants and the general public about financial stability in the Republic of Serbia.
Contents
I. Overview 9
II. International environment 11 1. Global financial crisis – causes and effects 11 Text box: Action taken by governments to fight the financial crisis 17 2. Effects of the crisis across CESEE 18 Text box: Effects of the global financial crisis on Serbia 21
III. The impact of macroeconomic developments on financial stability in Serbia 23
IV. Financial system, markets and financial infrastructure 27 1. Financial system structure and market concentration 28 2. Financial services consumer protection and financial education 30 3. Developments in Serbian financial markets 30 4. Money market 34 5. Property market in Serbia 35 6. Financial infrastructure 38
V. Banking sector performance and main risks to its stability 41 1. Sources of funding 41 2. Lending activity 46 3. Quality of banking sector assets 54 4. Foreign exchange risk 56 5. Banking sector profitability
VI. Insurance sector 59
VII. Voluntary pension funds 63
Introduction
The National Bank of Serbia presents its Financial Stability Report (hereinafter: the Report) for the period January-September 2008.
Section 1 gives an overview of macroeconomic and financial movements worldwide. The global financial crisis, triggered by the collapse of the US subprime mortgage market is again the focus of our Report, but this time primarily from the aspect of its effects on the financial stability of Serbia and the region in general. Chronology of events relating to the crisis is illustrated with a detailed account of its effects in advanced European countries and the channel through which they spilled over into Central, Eastern and Southeastern Europe (CESEE). The impact of the crisis on Serbia is only outlined in Section 1, but presented in more detail in further text.
Section 2 covers movements in the key domestic macroeconomic indicators. The emphasis is placed on potential risks arising from the evidently deteriorating macroeconomic environment, and their impact on the stability of financial institutions.
Section 3 provides analyses of financial market developments, the main factors affecting the Serbian financial system and changes in its structure. The Report also features a new subsection on the domestic capital, money and real estate markets. In addition to the overall financial system outlook, this section presents an analysis of the risks that may arise from developments in the domestic financial markets. Finally, the Report looks into the country’s payments system and assesses its risk absorption capacity.
The subsequent sections analyse in detail individual segments of the financial system. The emphasis is on the resilience of financial institutions to the fallout of the global crisis, as well as on the assessment of hot spots in terms of individual risks in the period ahead. Again, most attention is paid to the banking sector due to the bank-centricity of the domestic financial system. However, by contrast to the previous Report, the focus of analyses has shifted from household credit boom to the quality of the sources of finance and the crisis spill-over effects on this segment of banking operations. Subject of our in-depth analysis and assessment are also the risks coming from a slowdown in cross-border borrowing by enterprises and the banking sector capacity to accommodate the potentially increased real sector demand. The section on financial leasing is supplemented with data on operational leasing, which is not subject to NBS supervision.
The Report covers and analyses movements in relevant indicators in the first nine months of 2008 and uses data available as at 30 September. In cases when no data were available for the period observed, the most recent data were used. The National Bank of Serbia assumes no responsibility for the accuracy of data from sources other than its own.
The Financial Stability Report is approved by the Governor of the National Bank of Serbia.
The Report is available on the National Bank of Serbia’s website: www.nbs.rs.
Financial Stability Report National Bank of Serbia
Negative trends in the capital market prevailed throughout I. Overview 2008. Such trends, combined with lower liquidity, political uncertainties and monetary policy tightening, led to the worsening of capital market indices. Like in most other countries of the region, bank interest rates rose in Serbia, while the interest rate margin climbed in the course of the year to the regional record level. Following expansive growth, property market faced a sudden slowdown Stability of the Serbian financial system was primarily on account of price cuts induced by lower maintained in the course of the first nine months of 2008 despite the effects of indirect exposure of our construction development activity. Owing to successful country to the global financial crisis. In the short run, functioning of the payments system, financial lower propensity to investment risk and drastic decline infrastructure in Serbia is contributing to the sturdiness of in global liquidity will reflect adversely on a number of the financial system and its resilience to outside shocks. macroeconomic indicators; financial institutions in general, and banks in particular, were able to rather A slowdown in banking sector growth in 2008 is smoothly accommodate the spill over of the crisis as primarily attributable to restrictive monetary and the conservative prudential and monetary policies in prudential measures, while the effects of the financial the prior period had built high external shock crisis in the fourth quarter only worsened the outlook for absorption capacity of those institutions. In the the sector. Psychologically induced spreading of the medium run, the main challenge to the stability of the reputational risk resulted in diminished accessibility of banking sector is no longer rapid credit expansion, but the sources of funds and withdrawal of substantial savings maturity and currency restructuring of the sources of deposits by households, causing short-run negative funds and battling the impact of financial crisis on the quality of investment. Further development of non- effects on foreign liquidity of banks in Serbia. High banking financial institutions will also hinge on the capital ratio and solid domestic deposit base contributed duration and intensity of global financial turbulences. to the sector’s strong shock resilience in October. On the other hand, lower liquidity highlighted the need to further improve maturity and currency structure of the sources of Rapid spilling of the crisis across Europe induced a funds. Credit expansion slowed down, but the indirect drastic downward revision of the short-term projection of credit risk, grown stronger on added depreciation economic growth, while the growing threat of inflation pressures caused by the crisis, continues to be the main lurks despite a hefty cut in liquidity. Due to the general risk to the sector as both households and the real sector atmosphere of mistrust among financial institutions, remain insufficiently hedged against the currency risk. access to funds is all but closed and is having a negative effect on East and South-East European countries where Insurance sector continues to improve both in terms of branches of leading European banks dominate domestic performance indices and stability indicators. Despite financial systems. relatively modest share in total assets of the financial sector, insurance sector continues to grow primarily in Macroeconomic indicators for Serbia in 2008 continued terms of life insurance premia. More than adequate on a downward path. Inflationary pressures are growing; growth in technical reserves (faster than the increase in new forecasts indicate slowdown of economy while premia) is coupled with improved structure of their sources for financing the growing current account deficit investment. Solid growth in solvency margins and of the balance of payments are dwindling rapidly due to guarantee reserves during the period under review the global crisis. Lowering of the inflow of capital has indicates favourable position of insurance companies in magnified the risk of asset quality downgrading under terms of their solvency ratios. depreciation pressures in countries of the region where bank products are generally indexed in foreign currency. Two years into operation, voluntary pension funds in Serbia are showing signs of a slowdown in development Serbian financial system remains heavily bankcentric. Its primarily due to the shallowness of the domestic capital growth in the course of the first three months of 2008 market, but also under the impact of unfavourable slackened from a year earlier primarily due to the international financial climate. Still, this sector grew slowdown in credit expansion. Relative share of non- substantially during the period under review in terms of banking financial institutions in the financial system of both net worth and membership, which speaks in favour the country remains unchanged and the ownership of the great developmental potential of this type of long structure stays under the dominance of foreign investors. term savings in Serbia.
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Financial Stability Report National Bank of Serbia
II. International environment
Global economy remains under the sway of the current financial turmoil. The slowdown in growth, most notably in advanced economies, will spread via commercial, financial and reputation channels through to emerging markets that managed to escape the first-round effects of the crisis. Rising inflation and global liquidity squeeze will impose a change in the conduct of monetary policy. Serbian financial system, however, remains resilient to external shocks despite evident indirect effects of the crisis.
1. Global financial crisis – capital and made it accessible to a large number of developing countries. Finally, the emergence of new causes and effects markets with strong development potentials as well as high domestic demand, sparked by the rapid rise in International developments remain under the dominant income levels, opened the door to high return impact of the global financial crisis; general liquidity investments. squeeze has not only led to the collapse of some large financial institutions, but has also brought some At the time, the state of the US economy was very much countries to the verge of bankruptcy. Broad dispersion like that of the global economy. High liquidity and easy of risk and the existence of a large number of channels access to funding prompted investment in riskier deals. of contagion have prompted global response to crisis and highlighted the need for most sweeping regulatory reform. In some parts of the world, the general Chart 2.1 Structured financial products economic slowdown will be reflected in increased in Europe and USA threats of inflation and liquidity crunch caused by the (in USD billion) system-wide loss of confidence. Although Serbia, like 3,000 other countries in the region, has been only indirectly 2,500 affected by the global financial turmoil, risks to its financial system should be closely monitored, especially 2,000 with regard to liquidity ratios. 1, 5 0 0
1, 0 0 0 Following turbulences of 2001, global economy entered a period of prosperity. Vigorous economic expansion led by 500 the United States was suddenly brought to an end by the 0 onset of tensions in the world financial markets. During 2000 2001 2002 2003 2004 2005 2006 2007 the period of prosperity, however, a large number of MBS ABS CDO advanced, as well as developing countries, recorded robust economic growth and low inflation. Low interest Note: CDO - collateralized debt obligations, MBS - Mortgage- backed securities (excluding US f ederal agencies MBS), ABS - rates reflected on the climate of confidence fostered by Asset backed securities (excluding MBS). the simultaneous effect of different factors. The growing value of real estate gave a sense of security, while a step- Source: International Monetary Fund, Global Financial Stability Report. up in international integrations facilitated the flow of
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Economic growth was chiefly driven by the construction industry which gained momentum on the back of a loose Chart 2.3 Bank writedowns by region housing-credit policy, supported by the US (in USD billion) administration (federal loan insurance scheme). 350 A bulk of household loans were approved under unprecedented conditions – high interest rates and low 300 standards or almost none in terms of the borrower’s credit rating. Credit institutions issued securities backed 250 by such risky mortgage loans only to transfer them off- balance, beyond the reach of regulations, and finally, 200 place them on the market as ready-for-sale structured 150 financial products.1 The problems became evident when the very 100 foundations of this financial construct crumbled down 50 under their weight. The number of personal bankruptcies kept rising from day to day as debtors could no longer 0 service their obligations at such interest rates. Banks USA Europe Asia began auctioning off the rep ossessed property in large Source: International Monetary Fund, Global Financial Stability numbers thereby further reducing their market value. Report. Risk repricing of the underlying financial instruments resulted in their downgrading and investors began fleeing away from the toxic assets.
Chart 2.2 One-year rating downgrades of Chart 2.4 Bank losses reported as subprime mortgage backed securities of May 2008 in 2007 and 2008 (in USD billion) (in %, dow ngrades from original issue rating) Barclay s
B Mizuho Financial BB Wachovia BBB Washington Mutual A Roy al Bank of Scotland AA
Bank of America AAA
0 20406080 Merrill Ly nch
1 c a t e g o r y 2 categories 3+ categories Citigroup
0 1020304050 Source: International Monetary Fund, Global Financial Stability Report. Source: Bloomberg.
1 For further information on the spill-over effects of the crisis on interbank money market and confidence levels see Financial Stability Report for 2007.
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fourth largest investment bank in New York) and the Chart 2.5 International exposure to merger of Merrill Lynch with the Bank of America (the "contaminated" securities US largest consumer bank) unmistakably signalled the (in %) onset of recession in the United States and triggered more severe manifestations of the crisis throughout Europe.
Other 17 % Europe – Dwindling liquidity as the first Japan UK 11% 9% effect of the crisis LUX 7% Europe Already in its first phase, the crisis spread fast to the rest China 39% NETH 6% of the world, most notably to Europe, through both direct 15 % BEL 4% (commercial and financial) and indirect channels. The GER 4% IRA 4% September developments in the United States triggered a Cayman SUI 3% chain reaction, bringing a number of Europe’s leading 16 % banks under threat. It proved very soon that despite their Bermuda low direct exposure, the indirect vulnerability of 4% European banks to turbulences was much higher than originally believed. The crisis swept across the European Source: US Treasury. markets as confidence and real estate prices spiralled
Effects of the crisis – three phases Interest rates in European 3-month The effects of the financial crisis have so far been felt in Chart 2.6 money markets three rounds. The first round effects came in the second (in %) half of 2007 - immediately after the outbreak of the financial turmoil. This period saw a sharp drop in stock 5.500 indices in advanced economies and a hefty rise in interbank interest rates due to a drastic erosion of 5.000 confidence among financial market players. In a 4.500 concerted effort to unfreeze short-term money markets, central banks injected enormous amounts of liquidity 4.000 into the system.
3.500 The second phase was marked by the disclosure of massive losses by the world’s leading financial 3.000 institutions. It covered the first two quarters of 2008 and 2.500 culminated with the acquisition of the crisis-beset Bear 02/ 01/2007 10/05/ 2007 12/09/ 2007 18/ 01/2008 27/05/ 2008 29/ 09/2008 Stearns by JP Morgan Chase&Co with an unprecedented cushion from the Federal Reserves. The second phase 3m EURIBOR ECB key interest rate also saw marked volatility in the money markets, a 3m EONIA swap rate number of ad hoc measures implemented by central The chart shows periods of turbulence in the European 3-month banks and the first downward adjustments in economic money markets. The spread between the 3-month EONIA swap growth forecasts. and 3-month EURIBOR is a good indicator of liquidity , because the widening of this spread points to an increase in credit premium i.e. lower conf idence in the interbank market. Finally, hitting at its strongest, the third phase of the crisis began in Q3 2008. Bringing home the severity and Source: Bloomberg, ECB. depth of the crisis, the collapse of Lehman Brothers (the
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Chart 2.7 European banks' cross-border Chart 2.8 ECB deposit facility in October 2008 liabilities, end-2007 (in EUR billion, daily stock) (in % of GDP)
300 30 400
250 25 350 Switzerland 1,056
200 20 300
15 0 15 250
10 0 10 200
50 5 15 0
0 0 10 0
50 16/10/08 21/10/08 26/10/08 31/10/08 10/01/2008 10/06/2008 10/11/2008 0 AUS BEL DAN FRA GER IRA HOL SPA SWE SUI Deposit facility M arginal lending facility
Source: Bank for International Settlements. Source: European Central Bank. down. Thus, what began in the United States as the crisis of assets (asset quality) manifested in Europe as the crisis Chart 2.9 Core inflation of liabilities i.e. sources of finance (liquidity crisis). (in %)
The analysis of movements in the European three-month 5 money markets clearly shows the sensitivity of market players to the US financial woes. In a bid to overcome 4 liquidity problems and resuscitate interbank lending, the ECB engaged in a series of actions to pump the money into the system. 3
Heavy bank dependence on money markets and the markedly cross-border nature of such dependence have 2 worked as yet another catalyst to the European liquidity crisis. While the dry-up in short-term money markets 1 created serious financing problems for banks, their cross- I 02 VII I 03 VII I 04 VII I 05 VII I 06 VII I 07 VII I 08 VII border exposure widened the channels of contagion and 02 03 04 05 06 07 08 further dented confidence among financial players. That Wo rld Developed economies this is a crisis of confidence is best illustrated by the fact Developing economies that from mid-October banks, reluctant to lend to one another, placed an incredible EUR 200 billion on Source: International Monetary Fund, World Economic Outlook. overnight deposit with the ECB. At the same time, the ECB extended liquidity loans, but in much smaller amounts (Chart 2.8). increase, which in itself speaks volumes of the severity Some of the largest European banks requested of the problems they faced. It turned out that the ECB’s government assistance, primarily in the form of capital response in the first three quarters (liquidity injections
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Chart 2.10 Real GDP growth Chart 2.11 Capital market indices (in %, p.a. grow th) (index, January 2, 2007=100)
9 130
8 120
7 110
6 100 5 90 4 80 3 70 2
1 60
0
1993 1997 2001 2005 2009 2013 02/01/2007 09/05/2007 11/09/2007 18/01/2008 26/05/2008 25/09/2008
Dow Industrial DAX
Developed economies Developing economies NIKKEI225 FTSE100
Source: International Monetary Fund, World Economic Outlook. Source: Bloomberg. through open market operations) only managed to postpone the crisis and that some banks could stay afloat Chart 2.12 Central bank key interest rates only with the ECB’s support. In this context, the new (in %) form of government assistance – injecting capital into some banks – appears to be aimed not only at boosting 7 the solvency, but also at raising the general level of trust, 6 and thereby indirectly bolstering liquidity of the whole 5 financial system.2 4
3 Effect on economic developments 2 Global economic slowdown, begun in the summer of 1 2007, is forecast to continue into the second half of 2008 and beyond. A modest recovery is not to be expected until 0 2010. As the slowdown is evident in all parts of the world - in both developed and emerging countries, the global 02/01/2007 09/02/2007 21/03/2007 03/05/2007 12/06/2007 20/07/2007 29/08/2007 08/10/2007 15/11/2007 27/12/2007 06/02/2008 17/03/2008 28/04/2008 06/06/2008 16/07/2008 25/08/2008 02/10/2008 economy is projected to grow 4.1% in 2008. Although the projected figure is lower than the growth rate recorded FED funds rate ECB refinancing rate last year (5%), it appears all the less likely as the crisis BoE official bank rate moves on. Global economy is forecast to weaken still Source: Bloomberg. further — to 3.9% — next year. The economy is cooling down as a result of a significant weakening of demand in developed countries and rising inflation worldwide. emerging and BRIC countries3. Economic growth in the Surging commodity and energy prices have created strong Unites States for 2008 is projected at 1.3% vs. 2.2% in inflationary pressures in advanced, and particularly in 2007. It may yet turn out to be even lower considering the
2 The absence of supranational response is quite understandable given the 3 Brazil, Russia, India and China. significant portfolio dispersion of large banking groups and the fact that the ECB does not function as the lender of last resort. Until mid-October 2008, European countries announced the allocation of more than EUR 2.2 trillion.
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most recent deepening of the crisis in the US financial Stock indices in China plummeted most sharply by as market and a slowdown in bank credit activity. In much as 57%, while those in Europe, Asia and Latin addition, high commodity and food prices have acted to America dropped by 20-40%. Thus, after five consecutive dampen aggregate demand. years of unrelenting growth, FTSEurofirst 300 and MSCI Emerging Markets Index recorded respective losses of 27% The euro zone is also heading for a sharp slowdown. Its and 33% from the beginning of the year to date. All in all, economic growth is forecast at 1.7% this year, which is it will take a lot of time and effort before we see the end of slightly higher than in the United States, but still the crisis and the recovery of stock exchange indices. significantly lower than the 2.6% recorded in 2007. Growth in emerging and developing economies is expected to decline from 8.0% in 2007 to 6.9% in 2008. No country in any of the above regions is going to record Monetary policy in times of crisis stronger or at least unchanged level of economic growth In late 2007, the fed funds rate equalled 4.25% and the in 2008 relative to 2007. For instance, after nearly 12% ECB refinancing rate 4%, whereas at end-July 2008, the growth last year, China will record one-digit growth rate former stood at 2% and the latter at 4.25%. Such in 2008. divergent movements in reference rates within the span of Risks to the economic outlook are evident. First, eroded seven months only best illustrate the difference in the confidence among financial market players has made conduct of monetary policy by the two leading central access to the sources of finance rather tight. Second, there banks. While the FED relaxed its monetary policy stance are inflationary pressures stemming from continued rise because of the scale of the financial crisis and danger of in commodity and energy prices. Finally, a gloomy slipping into recession, the ECB tightened its monetary outlook for the world is also painted by the risks from grip fearing the consequences of high inflation. The global economic imbalances, reflected primarily in high divergence of action is explained by the fact that the ECB US current account deficit and an equal-size current has the exclusive mandate to preserve price stability, account surplus posted by the newly-industrialized while the FED’s mandate is dual – to achieve maximum countries of Asia. employment and price stability.
The sheer scale of the financial crisis and its knock-on effects on the economy prompted the FED to use various Capital markets monetary instruments to boost liquidity. In addition to With the spread of the financial crisis from the United rate cuts, the FED pumped enormous amounts of money States to the rest of the world, from early 2008 until end- into the system. It approved USD 300 billion under the September, all major stock indices tumbled down. There discount window facility for commercial banks and, in is practically no stock exchange in the world that has not cooperation with the ECB, Bank of Japan and Bank of seen a dramatic decline in the value of observed indices. England opened up a USD 620 billion swap credit line for Curiously enough, the US stock indices recorded weaker foreign central banks so as to enable them to supply dollar decline than those in the European, Asian and Latin funding to commercial banks. Finally, on 9 October 2008, American stock markets. This means that the United five central banks4 coordinated a joint rate cut by half a States, the birthplace of the financial crisis, has suffered percentage point. Further rate cuts are announced for less damage than other parts of the world. November and December.
.
4 Federal Reserve, Bank of England, ECB, Bank of Canada and Sveriges Riksbank.
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Action taken by governments to fight the financial crisis
The consequences of the global financial crisis may be divided into two categories: direct losses caused by the devaluation of assets underlying financial derivative instruments, which hit the balance sheets of financial institutions worldwide, and indirect losses, generated primarily by the climate of mistrust, which induced an unprecedented sterilisation of liquidity, slowed down the circulation of money and brought the entire system of financial intermediation under threat.
To resolve the problem of the diminished availability of capital needed to bail out financial institutions and prevent the collapse of the entire banking system, national governments resorted to the often criticized recapitalisation i.e. injection of state capital into the most threatened financial institutions. This capital was injected via newly founded entities in the form of fixed-rate preference shares, involving in most cases voting rights. In this way, the governments tried to strengthen the capital base and jumpstart bank lending activity. One of the explicit eligibility criteria for government assistance programs is that the financial institution has good chances of recovery or that it is vital for the functioning of the whole system. Other terms of the rescue scheme vary from country to country, but they usually involve a ban on payment of any dividends as long as there is evidence of state-owned capital in the financial institutions’ balance sheets. There are also limitations on executive pay and bonuses (explicit prohibition of “golden parachute” severance payments), as well as government interference in banks’ business policies to boost lending to SMEs and to relax borrowing conditions for households.
Chart B1 Rescue packages In an atmosphere of general mistrust, the private (in EUR bln, end-October 2008) sector shifted its focus onto sovereign debt instruments, thus blocking the transactions needed to 600 maintain liquidity of the financial institutions. National governments stepped in by taking measures 500 that relate primarily to the guaranteeing of interbank 400 transactions. Potential costs will be financed from the fees charged by the government for guaranteeing 300 interbank lending. The other part of the problem 200 referring to “longer-term instruments” (up to three years) was solved either through issuing government 10 0 guarantees or purchase of such instruments by newly 0 founded entities with government funds and at prices ESP A UT NLD RUS FRA GB R GER USA set in advance.
Recapitalisation Other* Rescue schemes were financed in different ways, but
* Includes guarantees on interbank transactions, buying up troubled most often directly, i.e. by issuing fixed-rate assets from banks, debt guarantees for financial institutions and government securities, which are currently in great enterprises, etc. Source: MoFs of selected countries, media agencies. demand on account of their security, or indirectly – by state-owned banks and financial institutions.
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Chart 2.13 Private sector loans and current Chart 2.14 External position vis-à-vis BIS account in selected countries in 2007 reporting banks (in %) (in % GDP)
70 0 Romania 60 EST LAT CRO HUN LIT ROM POL BUL KAZ SER Bulgaria Russia -10 50 Private -20 credit p.a. growth 40 Lithuania -30 Serbia Poland 30 -40 Kazahstan Latvia Estonia 20 -50 Hungary Croatia 10 -60 -25 -15 -5 5 -70 Current account (% GDP) -80 Source: International Monetary Fund, National Bank of Serbia. Source: Bank f or International Settlements.
2. Effects of the crisis across CESEE Direct channel of the sources of finance As the banking sectors of CESEE countries are in Although most experts argued until recently that majority ownership of banks from developed countries, CESEE countries would escape the direct effects of the there are fears that the liquidity crunch in the crisis, it turned out that fears from the workings of international markets could lead to problems in the contagion channels were well-founded as some had financing of their daughter banks incorporated in already found their way. CESEE countries. Currently strong resilience of domestic banks to shocks (high capital adequacy and The general belief is that the current financial crisis liquidity ratios), and the fact that a large part of bank will leave a mark on CESEE countries, and that its liabilities arises from stable (domestic) sources of effects can be divided into direct and indirect, short- finance, have a soothing effect. Nevertheless, banks in term and long-term, those affecting the financial this region will not be spared the negative effects of the system and the spill-over effects on the real sector. crisis, which are expected primarily in terms of the maturity and currency structure of their liabilities. Direct credit channel This channel involves risks arising from domestic Direct market channel bank exposure to financial market players that have suffered losses. Looming largest was the risk of Danger from the market channel, relating primarily to “reverse liquidity support” to parent banks given that the financial instruments directly hit by the crisis, may CESEE countries were far better off in terms of be completely discarded as none of the banks operating liquidity than developed countries. At this point, there in CESEE countries has made any major investments is no reliable evidence of “reverse liquidity support”, into such instruments. Therefore, the possibility of but such arrangements have to be taken into account losses on account of the severe decline in their prices is when analysing the extreme directions in which the reduced to minimum. crisis may evolve.
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Indirect transmission channels Chart 2.16 Movements of exchange rates The indirect effects of the global financial crisis have against the Euro in selected transition countries first shown in interbank money and capital markets in in October 2008 the form of pricier credits and investor flight from risk. (Oct 1 2008=100, grow th impiles depreciation) The second channel of transmission will be the real 112 sector due to a slowdown in GDP growth in advanced economies, which represent the key trade partners of 110 CESEE countries. 10 8 The spill-over of effects of the rising costs of borrowing 10 6 in Western interbank markets onto foreign banks’ subsidiaries in developing countries is inevitable. As the 10 4 lending interest rates in those countries are mainly linked 10 2 to the benchmark rates in interbank money markets, loans are set to become pricier and to affect the economic 10 0 activity as well. The focus of banks is likely to shift to the 1/10/08 3/10/08 7/10/08 9/10/08 13/10/08 15/10/08 domestic market, leading to stronger competition in Serbia Czech Slovakia attracting domestic deposits, especially in countries Romania Poland Hungary where interbank rates are lower than those in Western Europe. This may feed through into tighter margins and Source: Bloomberg. higher expenditures, taking toll on bank profits.
Chart 2.15 Movements of exchange rates Chart 2.17 Republic of Serbia bonds in dollars against the Euro in selected transition (in %) countries until September 2008
(Sept. 3 2007=100, increase implies depreciation) 100 10
12 0 95 115 9 110 90
10 5 85 8 10 0
95 80
90 7 75 85
80 70 6 03/09/2007 03/12/2007 03/03/2008 03/06/2008 03/09/2008 01/01/2008 25/02/2008 18/04/2008 13/06/2008 07/08/2008 01/10/2008
Serbia Czech Slovakia Price Yield, right scale Romania Poland Hungary
Source: Bloomberg. Source: Bloomberg.
It is possible that economic growth in CESEE countries reflected primarily in lower propensity to invest in will fall victim to the simultaneous effect of the above developing countries and shrinking loan maturities amid factors, because of the bankcentricity of their financial volatility in short-term money markets. Another factor systems. Apart from this, the real sector will face likely to work in the direction of economic slowdown is significant difficulties in getting access to direct foreign the adjustment of growth rates for advanced European borrowing. Tighter access to foreign credit will be economies, the main trade partners of CESEE countries.
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The inflow of remittances sent home by guest workers rating of these countries making their borrowing much from advanced Western countries is also bound to costlier. In late October, Hungary received a EUR 25 decline. Such lower inflow of remittances will lead to billion support package from the IMF, EU and World deterioration in the balance of payments as, next to Bank as its high current account deficit, growing borrowing, it represents one of the key sources of the external debt and depreciation of the forint from the financing of the balance of payments deficit. This could in turn directly impact on the position of local banks through lower level of currency hedging for households, Chart 2.18 EMBI which used to be secured by remittances. (in bp)
To finance their balance of payments deficits, CESEE 650 countries will be compelled to take increasingly costly loans of ever shorter maturities. Movements in the price 600 and yield on RS government bonds on the Luxembourg 550
Stock Exchange best illustrate the position of Serbia in 500 terms of new borrowing. The yield on these bonds was 450 more than 12% at end-November, up by 5 pp on end- 400 2007 and most of 2008. In addition to increased costs, the terms of borrowing will worsen further as the 350 maturities shorten and loan volumes dwindle. On the 300 upside, around 80% of the public external debt is in the 250 hands of non-private creditors and most of it is medium- 200 and long-term. 1/2/2008 2/27/2008 4/25/2008 6/23/2008 8/18/2008 10/13/2008
Currently, the countries running the highest risk with Serbia Composite Europe regard to financial overheating are Hungary and the 5 Baltic countries. Their banking sectors are primarily Source: JP Morgan. reliant on foreign financing, and the bulk of their loans are short-term. This is by no means conducive to the stability of the sources of finance in an environment of beginning of the crisis, coupled with high euroisation of plummeting liquidity in the European money markets. A the banks’ credit portfolios, represented a severe threat number of rating agencies have downgraded credit to the stability of its financial system.
5 From the beginning of the third phase of the crisis, Baltic countries saw a sharp slowdown in economic growth and a steep decline in consumption and real estate prices (by as much as 40% in Estonia).
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Effects of the global financial crisis on Serbia
The global financial crisis has arrived in Serbia. It is reflected in diminished availability of foreign funds and a psychologically-induced decline in confidence among savers, which led to withdrawal of some foreign currency deposits. The decline in foreign exchange liquidity gave rise to strong depreciation pressures in early October. The dinar weakened notably despite hefty interventions of the National Bank in the forex market.
And whereas most central banks of developed economies responded to the crisis by cutting their policy rates, central banks of emerging countries decided on monetary policy tightening to combat increased depreciation pressures. As Serbia faces problems with foreign exchange rather than dinar liquidity, monetary policy relaxation and downward revision of the key policy rate would, in fact, only add to the already strong depreciation pressures.
In order to boost foreign exchange liquidity, the National Bank of Serbia decided on a set of prudential measures, abolishing the reserve requirement on fresh external borrowing by banks and increasing the dinar- denominated share of required reserves on foreign currency accounts. Banks were given the option to apply a more favourable reserving base when calculating required reserves on foreign currency savings deposits. In addition, penalties for failure to allocate required reserves at the end of the period were lowered. These measures induced a mild, but fairly short-lived, strengthening of the dinar.
The country’s real economy will not go unscathed by the current financial crisis, either. Namely, if depreciation pressures persist, they will produce inflationary effects over the short run. Escalation of the global financial crisis has already led to a steep slump in global demand and a fall in prices of oil and other commodities. Further decline in global demand could induce notable dampening in export growth. The companies will respond either by focusing on domestic markets or by cutting down their production, both of which are likely to have disinflationary effects.
Global financial crisis Global economic crisis Drop in global prices Increase in risk premium Drop in global liquidity Drop in global demand of commodities
Limited and costlier financing for Slowdown in domestic Depreciation pressures domestic banks and enterprises exports
Rising domestic interest rates Slowdown in economic (on savings and loans) growth (drop in demand) Credit growth slowdown
Inflation
Rising international real interest rates and the decline in availability of external funding will put a further strain on the country’s economic growth, with negative implications for domestic demand. As a drop in domestic demand, coupled with a decline in global commodity prices, could lead to a slackening of imports, end-effects on the foreign trade deficit seem on the whole to be uncertain.
21 National Bank of Serbia Financial Stability Report
The global financial crisis has, therefore, produced depreciation pressures and led to a decline in global commodity prices, rising real interest rate trends, slowdown in economic activity, and a slackening of both exports and imports. The ultimate effects of the crisis, however, will depend on both its severity and duration. The results of the latest measures taken by central banks of the most developed economies are yet to be assessed. For its part, Serbia should try to alleviate any negative consequences of the crisis by pursuing a responsible fiscal and monetary policy. Already in its October meeting, the Monetary Policy Committee decided to tighten the monetary policy stance, thereby sending a clear signal to the public that the National Bank remains firmly committed to achieving its primary objective – preservation of price stability.
Finally, the National Bank did not only deal with the consequences of the crisis. In fact, it had acted pre-emptively by pursuing a responsible monetary policy and enacting prudential measures, which greatly mitigated the effects of the global financial crisis. Namely, the National Bank conducted a restrictive monetary policy (high key policy rate and excess liquidity sterilization), enacted prudential (more comprehensive and conservative risk weights, reducing of the foreign exchange risk exposure, limiting of household borrowing) and administrative measures (high reserve requirement on foreign currency savings deposits and foreign borrowing by banks, limiting the ratio of gross household lending to the level of capital, limiting household borrowing) and tightened the supervision of commercial banks (setting up of the Credit Bureau).
Although the NBS has often been criticized for its restrictiveness, it is now clear that the conduct of exactly such policy has helped preserve the stability of the banking system, despite the strong shock it has received. At the end of the day, it is the policy directly opposite to that implemented by the National Bank of Serbia (deregulation of financial markets and banking systems and conducting an expansive monetary policy) which may be singled out as the key cause of the global financial crisis.
22 Financial Stability Report National Bank of Serbia
III. The impact of macroeconomic developments on financial stability in Serbia
Macroeconomic outlook deteriorated in the first nine months of 2008. Economic growth has slowed down due the effects of the world financial crisis. The composition of GDP changed on the back of declining household demand, lower investment spending and higher public spending, while inflation continues to record high growth rates. The estimates are that the current account deficit will reach 18% of GDP and its financing will be significantly tighter due to sluggish inflow of foreign direct and portfolio investment.
Chart 3.1 Gross domestic product Chart 3.2 Core inflation projection (in RSD billion) (y-o-y rates, in %)
3,000 9 objectiv e f or 2008 2,500 8 3-6% objectiv e f or 2,000 7 objectiv e end-2009 6 f or 2007 2.5-5.5% 1,500 4-8% 5 1,000 4
500 3
2 0 2003 2004 2005 2006 2007* 2008** 1
0 GDP Imports Exports I II III IV IIIIIIIVIIIIII 2007 2008 2009 * National Bank of Serbia estimate. ** M inistry of Finance estimate. Source: National Bank of Serbia. Source: National Bank of Serbia.
As all available indicators show, the current financial Based on current estimates, real GDP growth in 2008 will crisis will strongly reflect on economic growth reach the last year’s level of 7% due to good harvest worldwide, and will, no doubt, lead to substantial yields and lower 2007 base (on account of an overhaul in weakening of demand. Such weakened demand in US Steel). Other than in agriculture, Serbian economy is Serbia’s major trading partners (euro zone countries) will slowing down as suggested by the output gap6 revolving consequently weigh down on its performance in foreign around neutral level in H1, and subsequently slipping into trade and economic activity. the negative zone in Q3.
6 Key indicator of aggregate demand.
23 National Bank of Serbia Financial Stability Report
Chart 3.3 Inflation movements Table 3.1 Balance of payments in % of GDP (quarterly grow th, in %) IX 2007 IX 2008 4.0 16 Current account -14.1 -17 3.5 14 Balance of goods and services -22.3 -22.7 3.0 12 Income -1 -1.3 2.5 Current transfers 9.1 7.1 10 2.0 Capital account 0.1 0 8 1. 5 Financial account (excluding changes 6 1. 0 in foreign exchange reserves) 19 18.9 4 Direct investment - net 5.8 1.5 0.5 Portfolio investment - net 1.6 0.3 0.0 2 Commercial credits - net 1.2 -1.9 -0.5 0 II III IV I II III IV I II Financial credits - net 10 15.1 2006 2007 2008 Currency and deposits - net 0.3 3.9
Retail prices Other 0.2 0 Core inflation Errors and omissions - net 0.2 0.9 Year-on-year retail price growth Overall balance 5.2 2.8 Year-on-year core inflation
Source: National Bank of Serbia. Source: National Bank of Serbia.
Household demand has been on a declining path ever working in the opposite direction. The dinar strengthened since the start of the year, and will most likely be further as a result of implementation of restrictive NBS measures dampened by unfavourable terms of borrowing and and constitution of the new Government, which reflected potential slump in the inflow of remittances. As suggested on the decline in imported inflation. Owing to good by the negative trends displayed by nearly all relevant indicators, investment spending also declined in the past three months. Only public spending sent upward pressures on aggregate demand in Q3, although much Chart 3.4 Current account deficit financing (in EUR billion) weaker than in H1. Hence, as both consumption and investment activity declined, the composition of GDP 8 growth changed – by contrast to 2007 when the key factor behind the slowdown in economic activity was material 6 production, this time it is the services sector. 4
Dampened aggregate demand failed to produce the 2 expected disinflationary effects and core inflation continued to record high growth rates. Since the 0 beginning of the year, it has been running above the upper 2002 2003 2004 2005 2006 2007 IX -2 2008 bound of the targeted range (3–6%), measuring at end- October 10.6% year-on-year. At the same time, headline -4 RPI inflation came to 10.5% year-on-year. -6
Vigorous growth in core and headline inflation in H1 was Loans, net induced by the supply-side shocks (surging world oil NBS foreign reserves (increase -) prices, rising prices of processed food products and FDI, net pronounced depreciation pressures engendered by Other political instability). By mid-year, however, most of the Source: National Bank of Serbia. factors that produced disinflationary pressures started
24 Financial Stability Report National Bank of Serbia
weather conditions, food prices became an inflation- dampening factor. In addition, world oil prices Chart 3.5 Foreign direct investments experienced a sharp reversal in trend by mid-July. Due to (in EUR million) nominal strengthening of the dinar, the appreciation gap of the real exchange rate widened further, while imported 4,500 inflation dipped into the negative zone. 4,000
3,500 Notwithstanding all of the above, core inflation growth continued unabated in Q3 primarily due to inflation 3,000 expectations that kept rising from one month to the next. 2,500
High inflation expectations neutralized the effect of 2,000 higher interest rates and stronger dinar, as well as the indirect effects of lower prices of agricultural products 1, 5 0 0 and the declining world oil prices. Higher-than-expected 1, 0 0 0
price growth in Q3 may also be explained by downward 500 price rigidity in the short run, and the fact that half of the 0 core inflation growth came from the increase in prices of 2004 2005 2006 2007 IX 2008 meat and construction materials induced by earlier shocks (last year’s drought and hike in world prices of iron). Non-financial sector Financial sector
The balance of payments also deteriorated in the course of Source: National Bank of Sebia. 2008. It is estimated that the current account deficit will reach around 18% of GDP, which is almost the highest in the region. Until recently there were no problems in its financing – inflow from FDI and foreign borrowing by Chart 3.6 Daily RSD/EUR volatility* the real and financial sectors was more than sufficient. (in %) However, the financing of the current account deficit is 86 4 becoming increasingly uncertain against the backdrop of
downturn in FDI and portfolio investment and tight 84 3 access to foreign credit. Foreign direct investment 2 plummeted to mere 15% of total inflow in Q3, as opposed 82 1 to 59% and 41% in Q1 and Q2, respectively. The structure 80 of capital inflow deteriorated with the increase in the 0 share of short-term financial loans. 78 -1
76 Since early October the domestic financial system has -2 been faced with dwindling foreign exchange liquidity and 74 -3 weakening of the dinar against the euro. To prevent excessive daily fluctuations in the exchange rate, the NBS 72 -4 1/3/2007 4/19/2007 8/2/2007 11/13/20072/28/2008 6/16/2008 9/25/2008 engaged in sizeable interventions in the IFEM and sold EUR 269 million to banks. Nevertheless, the exchange RSD/EUR, left scale Daily volatility* rate for the dinar depreciated by around 10.11%.
Measures passed by the NBS on 17 October to boost * Negative rates imply depreciation. liquidity of the banking sector7 had only a temporary Source: National Bank of Serbia. positive impact on the interbank foreign exchange market. In fact, though banks were able to meet their obligations towards the clients, their demand for foreign protracted, may generate inflation-push effects in the short- exchange gathered pace as the prospects of obtaining run. A decline in core inflation can be expected from Q2 2009 external financing became gloomier. This only gave and its retreat within the target range by the end of that year. further impetus to depreciation pressures, which, if If depreciation pressures persist, they may threaten the
7 Change in the manner of calculation and structure of foreign currency required reserves.
25 National Bank of Serbia Financial Stability Report
achievement of core inflation objective for 2009, in which at all conducive to the real sector’s debt servicing case the monetary policy stance will be further tightened. capacity. Lower foreign exchange inflow will most probably lead to real depreciation of the dinar, reflecting Consequences of the global financial crisis are expected adversely on the overall financial stability by way of to manifest through further economic slowdown and putting pressure on the debt servicing capacity of bank slackening in both exports and imports. Real economic clients, most notably households, which are not hedged growth for 2009 is estimated at around 3.5%, which is not against the currency risk.
26 Financial Stability Report National Bank of Serbia
IV. Financial system, markets and financial infrastructure
Banks continue to play a leading role in the development of our national financial system. Although the share of other financial institutions supervised by the National Bank of Serbia in the overall financial system is relatively low, these institutions display notable potential for growth and are constantly increasing both their contribution to the volume of financial intermediation and their share of GDP. The ownership structure of the financial system remained broadly unchanged. In 2008, Serbian financial markets reflected the volatility prevailing in international financial markets, while the property market continued its expansive growth until October. The country’s payment system functions impeccably.
Table 4.1 Key indicators of financial system development (in RSD, %)
Change y/y y/y Sept. 2008 2007 2006 IX 08/XII 07 change change
Number of financial institutions 82 104 79 113 70 96 Banks 34 97 35 95 37 93 Insurance companies 22 110 20 118 17 89 Leasing companies 17 100 17 113 15 107 VPF management companies 9 129 7 700 1 - Balance sheet, in RSD bn 1,903 110 1,732 134 1,293 148 Balance sheet/GDP 74% 106 70% 114 61% 122 Balance sheet per capita 258,443 111 231,964 133 173,772 148 Total loans, in RSD bn 945 110 858 149 577 135 Total deposits, in RSD bn 983 102 960 144 666 137 Total insurance premium, in RSD bn* 40 118 45 118 38 110 Claims in respect of financial leasing, in RSD bn 84 111 76 131 58 123 VPF assets, in RSD bn 4 133 3 1500 0.2 - Market concentration, HHI** Banking sector 617 107 578 94 614 92 Insurance sector 1629 107 1523 82 1,857 103 Fin. leasing sector 1,455 97 1,505 90 1,671 90 VPF 2,920 88 3,309 33 10,000 - Number of employees 44,142 109 40,617 112 36,356 109 Banking sector 32,010 106 30,246 108 28,103 109 Insurance sector 11,389 117 9,697 123 7,876 108 Fin. leasing sector 530 111 478 123 388 118 VPF 213 109 196 270 73 -
*YoY total premium ** Herfindahl-Hirschman index (HH index) is calculated by squaring the share of a specific variable (e.g. balance sheet total, deposits, credits) of all market participants in a sector. An index below 1,000 indicates no market concentration. An index between 1,000 and 1,800 indicates moderate concentration, while an index above 1,800 indicates high concentration. Source: National Bank of Serbia.
27 National Bank of Serbia Financial Stability Report
Although growth in banking sector assets slackened on the back of a slowdown in lending activity, the catching Chart 4.2 Market concentration in insurance up process in the financial system continued in the first and financial leasing sectors nine months of 2008. In the first three quarters of the year, (HHI) credit growth came to only 10% while overall financial system assets increased by 9.9%. 1, 9 0 0 1, 8 5 0 Growth in financial leasing receivables slackened 1, 8 0 0 whereas that in total premium was stable. As a result, at 1, 7 5 0 end-Q3, financial institutions supervised by the National 1, 7 0 0
Bank of Serbia managed assets worth RSD 1,903 billion 1, 6 5 0 or 74% of GDP. In view of the above, the pace of financial 1, 6 0 0 deepening of 10 pp relative to GDP per annum will 1, 5 5 0 continue in 2008. 1, 5 0 0
1, 4 5 0
1, 4 0 0 Chart 4.1 Financial system structure 2005 2006 2007 IX 08 (in %) Insurance sector Fin. leasing sector
90.0 Source: National Bank of Serbia.
the first nine months of the year, another factor that could lead to minor changes in financial market
0.2 5.6 4.2 structure are the effects of the global financial crisis on individual segments of the financial system.
Banking sector Insurance sector The number of financial institutions rose marginally, Fin. leasing sector VPF assets mostly as a result of opening of new voluntary pension fund management companies.
Source: National Bank of Serbia.
Chart 4.3 Market concentration in the banking sector (HHI)
1. Financial system structure and 2,000 1, 8 0 0
market concentration 1, 6 0 0
1, 4 0 0
Serbia’s financial system remains markedly bank- 1, 2 0 0 centric; although the volume of operations of non- 1, 0 0 0 banking financial sectors increased in absolute terms, 800 their relative share of financial system assets rose only 600 mildly; a general trend of declining market concentration is apparent. 400 XII 06 III 07 VI 07 IX 07 XII 07 VI 08 IX 08 Banks have retained a markedly dominant position, Assets Off-balance sheet assets managing 90% of total financial system assets. The Total loans Total deposits position of the insurance sector remained broadly Foreign borrowing unchanged, with insurance companies managing 4.5% of total financial system assets. In addition to the Source: National Bank of Serbia. slowdown in the volume of banking sector operations in
28 Financial Stability Report National Bank of Serbia
High market concentration persists in non-banking financial sectors. Chart 4.5 Banking sector ownership structure by country of origin By contrast to the financial system at large, in the first (in %, share of balance sheet total) nine months of 2008 market concentration increased 30 mildly in the banking and insurance sectors, and decreased in the financial leasing and voluntary pension 25 funds sectors. 20 The expansion of banking sector off-balance sheet activities continued in H1 2008, but they were spread 15 out more equitably across banks than in the prior year. 10 As a result, the index of market concentration for this segment of banking operations declined (primarily on 5 item ‘issued payable guarantees’ standing for bank guarantees of direct cross-border borrowing by 0 enterprises and on item ‘receivables in respect of foreign AUS ITA GRE FRA GER CYP SLO HUN BEL currency savings bonds’). 2006 2007 IX 08
Ownership structure Source: National Bank of Serbia.
Most players within Serbia’s financial system are foreign-owned.8 As a result, the global financial crisis of financial system reforms, foreign banking groups have has led to a spill over of the reputational risk exposure been making an important contribution to upgrading the to the domestic financial system. performance of the domestic banking sector and ensuring stable foreign sources to finance credit expansion. During In 2008, most participants in Serbia’s financial system were the most recent phase of the global financial crisis, foreign-owned, as financial institutions in foreign however, the disadvantages of being a part of a large ownership managed close to 80% of the balance sheet total international financial group became apparent. Namely, as of the banking and financial leasing sectors.9 Since the start the liquidity squeeze affected parent banks, the reputational risk spilled over into Serbia’s economy, triggering a fall in depositors’ confidence, though banks in Serbia are Chart 4.4 Ownership structure independent legal entities. (in %, share of balance sheet total) Breakdown by country of origin reveals a dominant 10 0 presence of Italian shareholders in the first nine months of 90 80 2008, who in 2007 took over the lead from Austrian 70 shareholders. The exposure of shareholders’ countries of 60 origin to Serbia is low, both relative to total foreign 50 exposure of such countries and their exposure to CESEE 40 countries. 30 20 Ownership changes were particularly pronounced in the 10 insurance sector, where private ownership gained 0 dominance in H1 2008 following privatization of one of the 05 06 07 IX 05 06 07 IX 05 06 07 IX 08 08 08 two large socially-owned companies in Q4 2007. B anking sect o r Insurance sect o r Financial leasing sector
Foreign ownership Domestic ownership
State ownership 8 Foreign ownership means majority ownership of foreign legal entities and natural persons – down to end shareholders.. Source: National Bank of Serbia. 9 In the case of leasing, this share is in effect much higher if we take into account the ownership structure of majority shareholders of leasing companies, as domestic shareholders of leasing companies are mostly banks in majority foreign ownership.
29 National Bank of Serbia Financial Stability Report
In H1 2008, the activities taken by the National Bank of Chart 4.6 Geographic exposure of banks by Serbia in this field were not only reactive, but also country of origin, June 2008 preventive and proactive. (in %, share of balance sheet total) In the first six months of the year, the NBS Call Centre 18 . 6 15 . 8 received close to 14,000 calls. The number of written complaints and queries relating to financial institutions 11. 3 remained very high. Mediation procedures were a very efficient method of resolving disputes arising from 5.7 financial intermediation.
Ongoing proactive support to improve financial education -0.04 -0.33 -0.09 of the public (through numerous brochures, leaflets, Austria Italy France Germany -1.73 -1.3 newspaper inserts covering different aspects of financial -2.3 -2.8 -3.9 intermediation) also continued. In addition, the central bank issued a set of recommendations to financial Share in balance sheet total of banks in Serbia institutions with a view to ensuring that financial services Exposure to Serbia relative to total foreign exposure (reverse consumers take informed decisions and that parties in scale) Exposure to Serbia relative to total exposure to CESEE countries financial intermediation contracts have a level playing (reverse scale) field. The recommendations referring to variable interest rates, foreign currency clause and life insurance contracts Source: National Bank of Serbia, BIS. aim to additionally reinforce consumer trust and upgrade good business practices and operational transparency of financial institutions.10 2. Financial services consumer protection and financial education 3. Developments in Serbian financial markets Intensive activities of the National Bank aimed at strengthening financial education of the general public The global crisis has had only a limited impact on continued in 2008. Serbia’s financial market due to its level of development and specific features. Negative effects of the crisis were One of the strategic priorities of the National Bank of first felt in the country’s capital market and then in the Serbia in 2008 has been to intensify activities aimed at foreign exchange market. The effects on the money improving financial education of the general public and market are limited. upgrading financial services consumer protection. The purpose of these activities was to promote good business practice and fair client relations in the country’s financial Capital market sector. Both at times of rapid credit expansion and financial innovation, as well as during slowdown in Capital market movements were mostly influenced by lending and financial intermediation, financial education a global loss of trust in the financial system reflected remains of key importance in spurring healthy through a drop in expectations, but also by episodes of competition and strengthening transparency of financial political uncertainty in the country in the first half of institutions as it directly contributes to a build up of trust the year. in the financial system. And, as the current crisis has In the Belgrade Stock Exchange, the value of blue-chip shown, the level of such trust is of key importance to shares as measured by the Belex15 index dropped by financial system stability.
10 Recommendations in electronic form are available on the web site of the National Bank of Serbia: www.nbs.rs.
30 Financial Stability Report National Bank of Serbia
23.1%, returning to their January 2007 level. Prices of shares comprising the Belex line index basket declined Chart 4.7 Movements in Belexline and Belex15 comparatively less (by 19.3%), as these are mostly non- indices in 2008 liquid shares whose price changes less frequently. As a (in index points) result, this index tends to be overvalued in the conditions 4,000 of declining market prices. 3,500 Negative tendencies emerge in the shares market when the average price of one dinar of profits of enterprises 3,000 quoted on the continuous market falls to its two-year low, 2,500 which leads us to conclude that the causes of negative developments are outside enterprises’ domain. 2,000
1, 5 0 0 Downward trend in stock exchange indices, begun in May 2007, was briefly discontinued in early February and 1, 0 0 0 May, on the eve, and right after presidential and 500 parliamentary elections, when share prices went up amid 1/3/08 2/27/08 4/18/08 6/16/08 8/6/08 9/26/08 increased investor optimism and the resultant rise in profits and activity of foreign investors. This rebound, Belex15 Belexlinɟ however, was only short-lived, as the negative effects of other factors set in. Source: Belgrade Stock Exchange.
The drop in market liquidity was the key factor behind such developments. As measured by all indicators (value of share turnover per unit of capitalization11 and impact of Chart 4.8 P/E ratio of enterprises in continuous number of transactions and turnover on price change12), trading liquidity has been on a decline since H1 2007. Share market liquidity was lowest in March and April and 10 0 highest in June.
Poor liquidity in the share market was caused by investor 80 restraint amid negative expectations regarding 13 movements in share prices . In such circumstances, the 60 activity of foreign investors had a major impact on movements in the BSE. Namely, as foreign investors withdrew from the market in March and April, liquidity 40 went up but share prices declined. Sudden sales of shares 14 by small investors ensued, creating additional liquidity 20 and triggering a further drop in share prices. May and I III V VII IX XI I III V VII June saw reverse movements, when notable investment 07 07 07 07 07 07 08 08 08 08 by foreign investors in shares of domestic enterprises boosted overall liquidity and pushed up share prices. This Source: Belgrade Stock Exchange. time, however, the share of small shareholders in overall trading did not go up. Still, the above two episodes failed to reverse the downward trend in market liquidity. Share The increase in the key policy rate and other interest rates market liquidity troughed in Q3 with the deepening of the in the country’s money market placed further downward global financial crisis. As a result, both turnover and share pressure on share prices, as money market investment is a prices in the BSE decreased further. direct alternative to capital market investment.
11 Total value of share turnover excluding turnover in block trading. 13 The expectations index – Belex Sentiment – exceeded 100 (which indicates 12 The impact of the number of transactions on price change is obtained as the ratio positive expectations) only in June, July and August. of the sum total of absolute daily changes in value of the Belex15 index and the total 14 The presence of small investors is measured as the value of turnover per number of transactions in the continuous market, while the impact of turnover on transaction. Smaller turnover per transaction corresponds with higher presence of price change is obtained as the ratio of monthly turnover in shares included in the small investors. Belex15 basket and the sum total of absolute values of daily changes in this index.
31 National Bank of Serbia Financial Stability Report
Chart 4.9 Liquidity in the share market Chart 4.10 Net share purchases in the Belgrade in 2008 Stock Exchange by foreign investors and average value of share transaction 2.2 (in RSD mln) 2.0 1. 8 2,500 0.65 1. 6 1. 4 0.6 1. 2 1, 5 0 0 0.55 1. 0 0.8 0.5 0.6 500 0.45 0.4 0.2 0.4 -500 0.0 0.35 I II III IV V VI VII VIII IX -1,500 0.3 Impact of turnover on price change I II III IV V VI VII VIII IX Impact of number of transactions on price change Ratio of turnover and capitalization Net share purchases by foreign investors, left scale
Average value of transaction in shares trading, right scale Source: Calculation based on the data of the Belgrade Stock Exchange. Note: The calculation of the average value of share transaction excludes block transactions. Source: Calculation based on the data of the Belgrade Stock Exchange.
Other markets of the region saw similar movements in yield curve slope, typical for our market, increased in the share prices. In H1, the highest correlation with first four months, but returned to its end-2007 level movements in the Belex15 index was recorded for the following market stabilization in May and June. In Q3, Sofix index of the Sofia and Crobex index of the Zagreb yield curve slope increased, partly on account of a drop in Stock Exchange (correlation coefficients of 0.85 and 0.83, (short-term) money market interest rates15. Finally, in respectively). The lowest correlation was recorded for the October and November, liquidity in this market increased Mbi10 index of the Skopje and Moste index of the slightly, primarily on account of continuing depreciation Podgorica Stock Exchange (correlation coefficients of and instability of the dinar exchange rate and the increase 0.71 and 0.72, respectively). in money market interest rates. Liquidity increased more for series with later maturities (A2015 and A2016), The liquidity of the frozen foreign currency savings bonds prompting investors to demand relatively higher yields on market was similar to that of the share market, as the two bonds with earlier maturities to offset the liquidity risk. markets were affected by broadly the same factors. In this segment of the capital market, liquidity troughed in With the culmination of the global financial crisis in early March but picked up in June. Similarly to share prices, October, investor confidence in the domestic capital prices of frozen foreign currency savings bonds were on a market slumped further. The Belex 15 index hit its decline until April when they rallied and were on the historic low, while trading volumes plummeted to their increase until June. As a result, the yield on such bonds lowest point since the start of the year. Similar increased in H1 2008, the most for series А2015 and the movements were recorded in October and November. least for series А2009 and А2016. As a result, the After a slump in October, liquidity rallied somewhat in negative slope of the yield curve on frozen foreign November on account of increased purchases by foreign currency savings bonds declined further. The negative investors. As foreign investors and large domestic
15 According to NBS research, yield curve slope is affected by both movements in the exchange rate and in money market interest rates. The analysis of the impact of other factors is restricted by a lack of data.
32 Financial Stability Report National Bank of Serbia
Chart 4.11 Movements in Belex15 index and Chart 4.12 Average yield on RS frozen foreign stock exchange indices in the region and currency savings bonds worldwide (in %, per annum) (standardized, end 2007=100) 9 10 0 8.5 90 8 80 7.5 70 7 60 6.5 50 6 40 5.5 30 1/3/08 2/27/08 4/18/08 6/16/08 8/6/08 9/26/08 5
Belex15 NTX NEX20 Crobex 1/3/2008 5/5/2008
MBI10 Moste SBI20 Sofix 2/12/2008 3/21/2008 6/11/2008 7/18/2008 8/26/2008 10/2/2008 BET BIRS DJ DAX Source: Calculation based on the data of the Belgrade Stock Source: Calculation based on the data of the Belgrade Stock Exchange. Exchange.
investors are practically the only participants left in the fact prevented negative expectations of stock exchange market, future movements will largely depend on their players from materializing and the financial crisis from decisions as to whether to use the current state of things spilling over from the Belgrade Stock Exchange to other to acquire positions in certain economic entities. Finally, segments of the domestic financial market. it is important to note that such trading volumes have in
Chart 4.13 Yield curve on RS frozen foreign Chart 4.14 Interest rate movements currency savings bonds (daily data, annual level, in %) (in %, per annum) 20
7.5 18
16
14 7.0 IX 2008 12
VI 2008 10 6.5 8 III 2007 6
6.0 4 X XI XII I II III IV V VI VII VII IX XII 2007 07 07 07 08 08 08 08 08 08 08 I 08
5.5 2-week BELIBOR, in percent per annum Ⱥ2009 Ⱥ2010 Ⱥ2011 Ⱥ2012 Ⱥ2013 Ⱥ2014 Ⱥ2015 Ⱥ2016 BEONIA 2-week repo Interest rate on deposit facility Source: Calculation on the basis of data of the Belgrade Stock Interest rate on lending facility Exchange. Source: National Bank of Serbia and Reuters.
33 National Bank of Serbia Financial Stability Report
4. Money market Chart 4.15 Interbank money market yield curve (monthly average, annual data) In H1 2008, money market interest rates moved in line with the key policy rate of the National Bank of 17 . 0 % Serbia. As deposit rates of commercial banks increased more than lending rates, the interest rate 16 . 5 % margin shrank, but still remained higher than in other countries of the region. 16 . 0 % Money market interest rates moved in line with the key policy rate. After a period of pronounced instability in Q1, the interbank money market began to calm down from 15 . 5 % one month to the next as expectations levelled off. The volatility of the BEONIA interest rate lessened following 15 . 0 % a change in the methodology of calculating required BEɈNIA T/N S/N 1W 2W 1M 2M 3M 6M reserves. Namely, from June onwards, the days of the weekend were included in the calculation of required BELIBOR reserves, which put an end to the banks’ practice of VI 08 VII 08 withdrawing money from their accounts on Fridays and VIII 08 IX 08 depositing such money over the weekend in order to earn Source: National Bank of Serbia and Reuters. interest on excess deposits.16
Commercial banks’ interest rates went up in H1 2008 under the sway of numerous factors in the domestic and NBS key policy rate and commercial international money markets. The weighted average Chart 4.16 bank interest rates lending rate rose from 11.13% to 16.61% p.a. on the back (w eighted average, per annum, in %) of a major upward revision of the NBS key policy rate and a resultant rise in interbank money market interest 18 rates. The increase in the deposit rate was less pronounced 16 (from 4.08% to 6.15% per annum), as this rate, given the 14 high share of euro-denominated deposits, is most often set 12 with reference to the EURIBOR rate which recorded relatively modest growth in the period under review. As a 10 result, the interest margin widened from 7.05 to 10.78 8 percentage points. 6 4
A look at the weighted average interest rate on bank loans 2 reveals a different picture. Namely, this interest rate X 07 XII 07 II 08 IV 08 VI 08 VIII 08 increased less than the interest rate on total bank lending Commercial bank lending rates (from 14.81% to 16.89% per annum), as it is most often Commercial bank deposit rates set with reference to the EURIBOR rate due to the high NBS key policy rate share of euro-indexed loans. As a result, the interest rate margin calculated by applying this interest rate shrank Source: National Bank of Serbia. marginally in H1 2008 (from 10.73 to 10.64 percentage points). As the EURIBOR interest rate continued rising in July and August while domestic money market rates went widened by 47 basis points, while the rate calculated by down, the weighted average interest rate on banking loans using the interest rate on total bank lending shrank by 49 and deposits increased more than the interest rate on total basis points. During the entire third quarter, NBS key bank lending. For that reason, the interest rate margin policy rate hikes were the main factor behind the increase calculated by using the interest rate on banking loans in banks’ lending rates, while rises in the EURIBOR were
16 On Fridays money supply increased and BEONIA usually declined on that day.
34 Financial Stability Report National Bank of Serbia
than through repo operations of the National Bank of Chart 4.17 Interest rate margins of banks in Serbia. Recently, the Ministry of Finance announced the Serbia and countries of the region government’s intention to start with larger-scale issues of (in %, per annum) government bonds which, however, will only be competitive if the interest rate they bear is close to the key 14 policy rate of the National Bank of Serbia. 12
10
8 6 5. Property market in Serbia 4
2 The current global financial crisis has revealed the full
0 significance of the property market for the financial stability VI 07 IX 07 XII 07 III 08 VI 08 of any economy. Not only is the growth in property market a determinant of the overall economic growth, but it can Albania Bulgaria Hungary Croatia also have a strong effect on the stability of financial BH Romania institutions which finance its development. Finally, in Serbia Czech Rep. transition economies such as ours, the property market is Macedonia frequently a factor of development of other markets, e.g. So urce: Natio nal B ank o f Serbia, IM F. capital market, as it represents an alternative to other forms of investment at times of sudden price growth.
the key contributor to growth in interest rates on banking Property prices in selected European loans and deposits. In this period, the interest rate margin Chart 4.18 countries 2002-2008 calculated by applying either of the above two criteria (in %, anual change) continued widening.
25 Interest rates went up in most other Central and East European countries as well,17 though less than in Serbia 20 which recorded the highest interest rates in the region. In H1 2008, lending and deposit rates increased most in 15
Hungary (by 1.34 pp and 0.89, respectively) to reach 10 10.13% and 7.7% per annum, respectively. On the other hand, Macedonian banks saw the steepest drop in 5 weighted average lending rates (by 20 bp), down to 9.7% per annum in June. In Croatia, deposit interest rates 0 GER FRA UK DAN SPA IRA NETH decreased most (by 15 bp), down to 2.52% per annum. -5
Therefore, the widest interest rate margins were recorded -10 in Serbia (of 10.78 pp), followed by Albania (7.03 pp) and Croatia (6.95 pp), while the narrowest such margin was -15 recorded by banks in Hungary (2.43 pp). Source: International M onetary Fund, OECD. Interest rates in the RS treasury bills market stopped declining. In Q2, the weighted average interest rate on Although many developed economies faced a housing these bills came to 4.49% per annum, up by 22 basis market downturn, property prices in Serbia were growing points on Q1. As the interest rate on treasury bills is still rapidly from end-2006 until September 2008. And while much lower than that on NBS bills, it is no surprise that any in-depth analysis of the domestic property market is much less money is withdrawn through this instrument
17 We used available IFS data for Albania, Bulgaria, Czech Republic, Croatia, Macedonia and Slovakia.
35 National Bank of Serbia Financial Stability Report
Chart 4.19 Growth in prices of square meter of Chart 4.20 Contribution to housing loan growth newly built residential property (index, May 2007=100) (average prices for period under review ,
index, 2003=100) 240
19 0 220 200 18 0 18 0 17 0 16 0 16 0 14 0 15 0 12 0 14 0 10 0 13 0 80 12 0 60 110 V 07 VIII 07 XI 07 II 08 V 08 VIII 08 10 0 2003 2004 2005 2006 2007 VI 2008 Total debt on housing loans Number of loans
Serbia Belgrade Kragujevac Novi Sad Average loan amount
Source: Republic of Serbia Statistical Of f ice. Source: National Bank of Serbia, Association of Serbian Banks. hampered by a lack of official statistics, it is still possible average amount of housing loans reveal that the number of to single out trends, their causes and potential effects on housing loans is the main contributor to growth, as the financial stability. The analysis in this report will be based average loan amount has remained almost unchanged (or on the available data on property supply and demand, even declined in some periods) relative to the period when including in particular data on the volume and composition the current growth trend in property prices began. This is at of residential financing. least partly due to central bank’s prudential measures which limit monthly instalment payment on any housing In Serbia, strong demand for residential units pushed up loan to 50% of net regular monthly income of the client. property prices. Such demand was heated by real income We may, therefore, conclude that growth in property prices growth in certain population segments in the conditions of is not placing upward pressure on the average housing loan continued strong economic growth, as well as by increased amount, but that property prices are rising due to increased availability of housing loans and declining interest rates on availability of housing loans and a higher number of credit this type of borrowing.18 lines. In transition economies, this is a customary and, from the viewpoint of financial stability, favourable trend. In In Serbia, there are no reliable data on the share of property addition, according to data provided by the National trade which is financed from loans. Although, theoretically Mortgage Insurance Cooperation, Serbia’s loan-to-value speaking, there is a two-way causal relationship between (LTV) ratio until end-June was a sound 65.5%. property prices and growth in housing loans, the impact on prices of growth in total loans remains dominant, which, In transition economies, expansion in housing loans is a from the viewpoint of financial stability, is the more usual process, which is often supported by the government favourable direction of causality.19 as part of its housing policy. In Serbia, the housing loan insurance scheme, implemented on behalf of the Namely, though data time series are rather short, the government by the National Mortgage Insurance correlation between growth in housing loans and current Corporation (NMIC), was a major catalyst of sudden prices of residential property is strong and confirms the growth in housing loans. Since the housing loan insurance above causality. In addition, data on the number and scheme was first introduced in 2005, over 36 thousand or
18 Though practically non-existent in 2004, in June 2008 mortgage loans 19 As demographic factors did not change much in the recent past, their impact on represented the largest item of total household lending. increase in demand is negligible. On the other hand, heavier migration flows towards larger regional centres, and especially Belgrade, have had a major effect on the level of demand, inducing a rise in property prices in such centres.
36 Financial Stability Report National Bank of Serbia
Chart 4.21 Number of loans insured with the Chart 4.22 Number of issued construction NMIC by years and the average insured loan permits for residential buildings by quarter amount (number of loans, in %, in EUR) 3,500
18 , 0 0 0 45,000 3,000 16 , 0 0 0 40,000
14 , 0 0 0 35,000 2,500
12 , 0 0 0 52% 30,000 2,000 10 , 0 0 0 40% 25,000
8,000 20,000 1, 5 0 0 6,000 15 , 0 0 0 55% 1, 0 0 0 4,000 48% 60% 10 , 0 0 0 2,000 5,000 45% 500 92%8% 0 0 2005 2006 2007 VI 2008 0 I II III IV EUR-indexed loans
CHF-indexed loans 2006 2007 2008
Average amount of insured EUR-indexed loan (right Source: Republic of Serbia Statistical Of f ice. scale) Average amount of insured CHF-indexed loan (right scale)
Source: NMIC. almost three quarters of all housing loans were insured, availability will induce a slowdown in both borrowing and which well reduced the cost of such loans. In addition to the number of new credit lines.21 This will, in turn, dent influencing the price, the insurance scheme also had a demand which, if the above correlation is true, will trigger major impact on the volume and currency structure of a corresponding decrease in the price of newly built banks’ housing loans portfolio. Expansive growth in property in particular. On the other hand, diminished housing loans together with a sudden increase in the share household investment in property could threaten that part of Swiss franc indexation fuelled fears of heightened long- of the construction industry that had itself relied on bank term exposure of households to currency and interest rate loans to finance its construction projects. risks.20 At the same time, the prices of property pledged as collateral for such loans kept rising. The key long-term In the period ahead, particular attention should be paid to risk, therefore, related to the sustainability of such growth monitoring property prices in Serbia, primarily their impact as, in fact, any sudden halt or decrease in property prices on the LTV ratio of the existing stock of housing loans. Any was likely to reduce the value of the borrower’s property abrupt change or lasting decline in prices of property could and of the provided collateral. result in revaluation of the collateral pledged to banks, hence directly affecting the quality of banking sector assets, However, one of the immediate effects of the global and indirectly, banks’ capital adequacy ratios. financial crisis on Serbia was the fear of a sudden slowdown in lending in general, and a decline in housing On the other hand, it remains to be seen whether loans in particular. Analysis of the latest unofficial statistics insufficient supply will manage to substitute growth in on the volume and price of housing loans reveals that the housing loans as the catalyst of growth in (or at least increase in the cost of such loans and their limited preservation of) property prices.
20 All mortgage loans are indexed to foreign currencies, while the interest rate is 21 According to the latest available data, October 2008 saw a drop in the number of based on variable reference rates in international money markets (e.g. 6M housing loan beneficiaries which had been on a robust rise since the start of the EURIBOR for euro-indexed loans and 3M LIBOR for Swiss Franc-indexed loans). housing loan expansion.
37 National Bank of Serbia Financial Stability Report
6. Financial infrastructure Chart 4.23 RTGS turnover and number of interbank transactions (in RSD) NBS RTGS and clearing system availability and performances 45,000 18 0 40,000 16 0
In H1 2008, the availability of the RTGS and clearing 35,000 14 0 system was 100%, which is an important achievement 30,000 12 0 compared to the experience of other payment systems. 25,000 10 0 There was no downtime during a total of 55,425 minutes 20,000 80 of production. 15 , 0 0 0 60 In the course of 118 business days from 1 January until 23 10 , 0 0 0 40 June 2008, turnover equalled RSD 21.9 thousand billion. 5,000 20 It peaked in January at RSD 4.2 thousand billion. In the 0 0 above period, the share of turnover in clearing in the total 2003 2004 2005 2006 2007 VI 08 came to 1.5%. No of interbank transactions, mln, right scale On 13 September 2007, the National Bank of Serbia and RTGS turnover, bln. the central banks of Bosnia and Herzegovina and Source: National Bank of Serbia. Montenegro signed the Agreement on the Clearing of International Payments. The earliest payment transactions pursuant to this Agreement were performed on 5 February 2008 as net settlement in euros. Risk absorption capacity A total of seventeen Serbian and five Bosnian banks The RTGS system is based on non-transparent waiting regularly take part in interbank clearing of foreign lines, which act to effectively pre-empt credit risk. Owing exchange payments. As clearing enables faster and to the prescribed limits, the clearing system is not cheaper money transfer to and from signatory countries, exposed to the credit risk either, as all payments are other banks from Bosnia and Herzegovina are also secured by cash held with the National Bank of Serbia. expected to join in. The National Bank of Serbia has been participating in the clearing of international foreign Since banks regularly meet their obligation to manage exchange payments since 10 March 2008. liquidity in the RTGS in their own systems, the use of waiting lines in the RTGS has been reduced to a In coordination with the Central Bank of Montenegro, all minimum. Since this acted to remove the threat of technical preparations were made for Montenegrin possible gridlocks in the system, gridlock resolution participants to join in the clearing of international foreign procedures have never been applied. This is due to strong exchange payments. The success of the operational tests liquidity of Serbia’s banking sector. conducted in Montenegro showed that the clearing system, technically speaking, is fully prepared to include In order to maintain their daily liquidity, banks may use Montenegrin banks. The Central Bank of Montenegro has required reserve assets during the day. In addition, the provided all Montenegrin banks with copies of draft National Bank of Serbia approves daily liquidity loans agreements on joining the international clearing system. (lending facilities) to banks against collateral of
38 Financial Stability Report National Bank of Serbia
Chart 4.24 Share of ten largest participants in interbank payment transactions, by month (in %)
18
16
14
12
10
8
6
4
2
0 12345678910
Aug-06 Aug-07 Aug-08
Source: National Bank of Serbia. securities issued by the central bank and/or by the Republic of Serbia.
In order to remove any operational risks, the National Bank of Serbia provided the hot backup and disaster recovery infrastructure consistent with the standards for systemically important payment system. So far, there was no need to use the above infrastructure to remove operational risks.
It is also important to note that there have so far been no complaints regarding transactions performed in the NBS payment system, which means that all transactions were accurately, authentically and timely effected.
39
Financial Stability Report National Bank of Serbia
V. Serbian banking sector
Serbian banking sector was stable throughout 2008 in the face of a number of risks intensified by the spilling of the crisis to South East Europe. Conservative prudential policy by the central bank ensured a well-capitalised, resilient banking system displaying high capital adequacy ratios and basking in liquidity. Psychologically-induced withdrawal of foreign currency savings and tighter access to foreign funding had negative effects on banks’ foreign currency liquidity. The maturity composition of the sources of finance needs to be further improved. Credit expansion lost some of its momentum in 2008 as a result of measures implemented by the central bank. Indirect credit risk and the increasing interest risk continue to represent key threats to the banking sector stability.
Chart 5.1 Sources of funding of the banking Chart 5.2 Loan to deposit ratio sector* (in %) (in %, share of liabilities)
45 250
40 LAT 35 200 30 EST IRE 25 15 0 LITH 20 HUN FRASLO 15 NETH SPA 10 10 0 AUS SRB 5 ROM III VI IX XII III VI IX XII III VI IX XII III VI IX GER BUL 50 2005 2006 2007 2008 POL SLK RSD deposits FX deposits 0 Foreign borrowing Capital
* Deposits of foreign legal entities and private individuals excluded. Source: European Central Bank, National Bank of Serbia. Source: National Bank of Serbia.
1. Sources of funding triggered currency and maturity shifts in the composition Conduct of prudential and monetary policies and hefty of liabilities. Credit and liquidity risks represent key capital increases of banks in the prior period rendered the threats to banking sector stability. Serbian banking sector highly resilient to the spill over of the global financial crisis; highest capital adequacy ratio In terms of sources of funding, the banking sector in Europe, low dependence on foreign borrowing and continues to be stable. As the trend of heavy reliance on wide deposit base greatly alleviated the effects of liquidity foreign borrowing in 2005 was suddenly reversed around disruptions experienced by parents of banks operating in mid-2006, this type of borrowing now accounts for only Serbia; in the period ahead, a close eye should be kept on 7.6% of banking sector sources of funds and comprises liquidity trends, as global liquidity disruptions have mostly long-term loans.
41 National Bank of Serbia Financial Stability Report
Chart 5.3 Structure of sources of funding (in RSD billion)
1, 8 0 0
1, 6 0 0
1, 4 0 0
Capital 1, 2 0 0
1, 0 0 0 Repo Sight deposits 800
600 Foreign borrowing
400 Total loans Short-term deposits 200
Long-term deposits 0 I 07 III 07 V 07 VII 07 IX 07 XI 07 I 08 III 08 V 08 VII 08 IX 08
So urce: Natio nal B ank o f Serbia.
As regards the stability of the domestic sources of funding and resilience of the banking sector to external Chart 5.4 Structure of total deposits shocks, Serbia is in a better position than many other (in RSD billion)
European countries as local household and enterprise 500 deposits account for more than 70% of all liabilities 450 (excluding capital which makes up as much as 24% of 400 the balance sheet total). In the first nine months of the 350 year, the domestic deposit base, as the main source of 300 funding, was dominated by foreign currency (63% of 250 total deposits) and sight deposits (53% of total deposits). 200 150 In H1, nominal growth in long-term deposits came to 100 64%, but slowed down in Q3 on the back of appreciation 50 of the dinar. Thus, at end-September, these deposits 0 made up only 4.5% of total deposits. Breakdown by IIIVIIXXIIIIIVIIXXIIIIIVIIXXIIIIIVIIX sector reveals that households held the highest share of 2005 2006 2007 2008 total deposits (49%). In the first nine months of the year, a half of all household deposits were short-term. In Corporate Public sector terms of the asset/liability match, it is worth noting that Households Other* lending to households was almost entirely covered from time household deposits, and the lending to deposits Includes deposits by financial institutions. ratio was much higher than in most European countries. Source: National Bank of Serbia.
Breakdown by maturity of time deposits, however, reveals a mismatch between assets and liabilities as higher thanhy foreign currency-denominated short-term long-term loans were several times higher than long- lending22, long-term foreign currency deposits sufficed term deposits. And whereas end-of-period short-term to cover less than one fifth of foreign currency- foreign currency deposits were close to three times denominated long-term lending.
22 Foreign currency loans and foreign currency-indexed dinar loans.
42 Financial Stability Report National Bank of Serbia
At present, the reduced availability of foreign sources of other countries of the region were also ensured direct funds seems to confirm the remark from the Financial access to European interbank money markets. At times of Stability Report for 2007 that “in the conditions of crisis and plummeting confidence in the global financial reduced foreign (mainly long-term) borrowing by banks, markets, however, it is precisely this connection with larger such movements call for additional maturity adjustments economic groups that opens up additional channels for the of sources of funds”. Namely, if the share of shorter- spill over of the crisis. This, however, did not lead to an term sources in total deposits were to increase further, abrupt decline in the exposure of Serbian banks to parent the resultant maturity mismatch would hamper future entities as their exposure had already been substantially financing of lending activity. downsized. But, liquidity problems faced by parent banks triggered a spill over of the reputational risk to Serbia Impact of the liquidity crisis on bank which produced psychological effects, prompting a number funding in Serbia of depositors to withdraw their foreign currency savings deposits. Although this did not threaten the overall stability As a consequence of the banking crisis which shook of the Serbian banking sector, it still left its mark on the Serbia in the 1990s, the immediate response to the foreign currency liquidity position of individual banks. current global financial crisis was the withdrawal of (mostly foreign currency) deposits from banks in Serbia’s banking sector stood ready to tackle the October 2008. Given the dominant importance of the challenges posed by the effects of the global crisis, deposit base as a source of funding, this posed a primarily owing to the environment created by the temporary risk to financial system stability, but the conservative policy pursued by the central bank over Serbian banking sector has responded effectively. the past several years.
As a result of the policy of high reserve requirement on foreign borrowing and domestic foreign currency Chart 5.5 FX savings, required reserve and central bank repo securities in 2008 deposits, foreign exchange reserves were sufficient to (in RSD billion) cover 86.3% of total deposits at the onset of the third stage of the financial crisis, which is well above the average for most countries of the region (35%). In
600 FX reserves addition, NBS’ restrictive monetary policy induced 500 and repo changes in balance sheets of commercial banks which with the 400 central bank came to include highly liquid securities refinanceable
300 with the central bank (repo securities). As a result, overall
200 liquidity of banks’ assets went up, with liquid assets accounting for one third of the banking sector balance 10 0 FX savings sheet total. End-September stock of repo securities thus - I 08 II 08 equalled RSD 233 billion, but declined by around RSD 60 III IV 08 V VI billion in the course of October. In fact, faced with deposit 08 08 VII VIII 08 IX withdrawals by clients, banks abstained from rolling over 08 08 X 08 08 a part of the existing stock of these securities to improve their daily liquidity position and placed them as cash Source: National Bank of Serbia. holdings in gyro accounts, thereby pre-empting any negative effects on the ratio of liquid assets to total assets.
Currency and maturity re-matching of liabilities and the resultant slowdown in, primarily foreign currency indexed, Before the outbreak of the crisis, dominant foreign lending will be the main consequence of the liquidity crisis ownership of the national banking sector in European on banking sectors in the region, including Serbia. transition economies was seen as the pillar of their stability as it ensured easy access to sources of finance. Moreover, Liquidity disruptions, among other things, have being part of a larger European group, banks in Serbia and encouraged banks to seek to increase their deposit
43 National Bank of Serbia Financial Stability Report
Chart 5.6 Maturity and currency structure of Chart 5.7 Balance sheet structure private sector loans and deposits (in %) (in RSD billion, in %) 100% 700 Other assets Capital and 600 provisioning 304% 500 283% 80% Liabilities to 400 Loans to enterprises 206% government 300 60% 200
10 0 Loans to Enterprise deposits 14 % 16 % households 0 11% 40% 2006 2007 Jun-08 Foreign loans Household deposits Short-term FX denominated loans to the private sector 20% Bank assets with the Long-term FX denominated loans to the private sector NBS Foreign liabilities
Coverage of short-term FX denominated loans with 0% short-term FX deposits Assets Sources Coverage of long-term FX denominated loans with long-term FX deposits Source: National Bank of Serbia. Source: National Bank of Serbia.
potential which is reflected in increased demand for long- term deposits as a stable source of funding. Hence, in Chart 5.8 3Ɇ CHF LIBOR in 2008 October, interest rate on foreign currency deposits rose to (in %) as much as 9.5% and 22% on dinar deposits. Increased competition will continue to place upward pressure on 3.20 1. 7 0 deposit rates until confidence in international interbank 3.10 1. 6 5 money markets is restored. If domestic deposits remain 3.00 the “only source of funding” on a longer term basis, 1. 6 0 competition among banks will affect their profitability 2.90 1. 5 5 through narrowing down of credit margins. 2.80 1. 5 0 The global crisis will also cause major changes in the 2.70 1. 4 5 currency structure of banks’ liabilities. Namely, as foreign 2.60 currency liquidity is in short supply and access to money 2.50 1. 4 0 markets is limited, banks will gradually decrease their lending indexed to foreign currencies, especially to the 2.40 1. 3 5 Swiss franc, in order to better match their assets to 1/2/08 2/20/08 4/11/08 6/3/08 7/22/08 9/10/08 10/29/08 restructured liabilities. If access to foreign sources of 3m LIBOR CHF/EUR finance regains momentum after the lifting of the reserve requirement on this type of borrowing, euro-indexed Source: Bloomberg. loans may continue to account for a dominant share of lending. Otherwise, dinar products will gain further popularity on both sides of the banks’ balance sheet. In response to ongoing currency hedging of commercial Banking sector capital bank liabilities, some central banks of the region are The experience of American and European banks and already calling for a ban on indexed (especially Swiss national regulatory authorities shows that strong franc-indexed) lending. capitalization continues to be the key buffer to serious threats to the stability of financial institutions. In the USA, for instance, the central bank supported market liquidity through capital injections which helped restore capital
44 Financial Stability Report National Bank of Serbia
Chart 5.9 Banking sector capital and monthly Chart 5.10 Comparative overview of the capital capital increase adequacy ratio, 2005 - March 2008 (in RSD billion) (in %) (%) 450 30 35
400 Capital adequacy 25 25 350
300 20 15 250 15 200 5 15 0 10
10 0 -5 MON SRB MAC* ALB ROM BH BUL CRO 5 50 Share of capital in -15 0 0 balance sheet total, I 07 V 07 IX 07 I 08 V 08 IX 08 reversed scale -25 Capital M onthly capital increase (right scale) Source: International M onetary Fund. Source: National Bank of Serbia.
adequacy ratios of threatened institutions to satisfactory economies, was not due to a slowdown in credit levels. Implementation of relaxed prudential policies in expansion, but to regulatory changes effective as of July some countries enabled very high leverage of banks in 2008 subject to which the calculation of the above ratio earlier years, thereby increasing their vulnerability to takes into account additional risks as well. However, the shocks. By contrast, the period ahead will be marked by capital adequacy ratio in Serbia remains high as a result a deleveraging and strengthening of the banks’ capital base, conservative regulatory policy pursued in the prior often involving direct participation of the state. period, which further strengthened the position and resilience of commercial banks. At the present time of In 2007, the capital of Serbian banks increased by 52% and served primarily to back growth in credits. Capital growth by 27.2% in the first nine months of 2008 had in Chart 5.11 Capital adequacy ratios fact created a buffer zone for the turbulences that would (in RSD billion, in %) break out later in the year. In the first six months of 2008 alone, capital increase came to over RSD 60 billion as 450 banks complied with the prescribed ratio of gross 400 28.5 29.5 27.9 28.1 350 household lending to the level of capital (150%). Currently 26.0 24.7 24.4 24.2 24.1 23.4 300 capital makes up 23.4% of the banking sector balance 22.2 20.9 sheet total, which points to very high resilience of the 250 sector at large. 16 . 0 15 . 6 200 15 0 Capital adequacy ratio continued rising in H1 2008 only 10 0 to drop at end-Q3. Although it declined by 4.5 pp in the 50 first nine months of the year, this ratio (23.4%) is still two 0 times higher than the prescribed minimum (12%) and as 2005 2006 2007 VI 2008 IX 2008 much as 15 pp higher than the minimum prescribed in Banking sector capital most other European countries (8%). Capital adequacy Tier 1 capital/total risk assets Strong capital base contributed much to the resilience of Capital/assets Serbia’s banking system. In 2008, the trend of decline in Source: National Bank of Serbia. the capital adequacy ratio in Serbia, typical of transition
45 National Bank of Serbia Financial Stability Report
crisis, it is of particular significance that over 75% of banking sector assets is managed by banks with a capital Chart 5.13 Sectoral distribution of loans adequacy ratio of over 20%. (in RSD billion)
In the period ahead, the majority of developed countries 1, 0 0 0 will focus not only on de-leveraging but also on 900 improving the capital adequacy ratio, as an indicator of 800 the relation of capital to the quality of assets.23 In Serbia, 700 this ratio for the entire sector is well above the European 600 average. Until end-September 2008, capital adequacy of 500 the Serbian banking sector equalled 23.4%. 400 300 Stress tests conducted in Q2 2008 revealed continuing 200 strong resilience of the banking sector to extreme 10 0 shocks. Like in late 2007, the findings indicate that 0 XII 06 III 07 VI 07 IX 07 XII 07 VI 08 IX 08 capital adequacy ratio will not fall below the regulatory minimum even if faced with extremely Corporate (exl. public enterprises) strong credit, market and liquidity risks. On the other Households hand, the sensitivity of the capital adequacy ratio Other increased only marginally. Source: National Bank of Serbia.
Chart 5.12 Distribution of the capital Chart 5.14 Share of private sector loans in GDP adequacy ratio (in %) (in %, share of balance sheet total)
33.9 Number of banks 52.4 29.4 11 5 5 6 9 10 11 14 14 7 7 7
43.1 25.0 23.2 39.6 20.3 17 . 3 31.2 17 . 2 29.0 15 . 5 13 . 3 13 . 6 24.7 12 . 7 12 . 1 20.4 23.4 9.5 18 . 2 7.1 4.5
6.7 6.0 5.3 2004 2005 2006 2007 VI 2008
06 07 VI 06 07 VI 06 07 VI 06 07 VI Private sector loans/GDP Corporate loans/GDP 08 08 08 08 Household loans/GDP <20% 20-30% 30-50% >50%
Source: National Bank of Serbia. Source: National Bank of Serbia.
2. Lending activity slowdown to September came mostly as a result of central bank’s measures aimed at containing rapid expansion in In the first nine months of the year, growth in banking household lending. Nine-month growth in total loans of sector assets came to 9.6% only and was much slower 10.2% was mostly due to lower growth in lending to than in the corresponding period in 2007 (21.5%). Such households (13.7%) and enterprises (15.7%).
23 Major regulatory changes may be expected with regard to the assessment of the quality of assets.
46 Financial Stability Report National Bank of Serbia
As an indicator of sustainability of credit growth, the ratio further until September 2008 – by 1 pp down to 24%. of total growth in private sector lending (including Such stagnation of financing of passenger vehicles lending to households and enterprises24) to GDP was first corresponds with a continuing decline in the share of introduced in the Financial Stability Report for 2007. This private individuals as lessees, since they made up only ratio continued rising until end-June, with growth in 7.2% of financial lessees at the end of the first three enterprise lending exceeding that in household loans. quarters of 2008. Although slackened, credits still increased faster than GDP. This ratio is lower in Serbia than in other European This, however, does not mean that household borrowing countries and even some other countries of the region. is slowing down. Namely, “operational leasing” contracts From the viewpoint of financial stability this is a have come to account for the bulk of contracts of favourable development, as rapid growth in lending purchase and sale of passenger vehicles by private relative to GDP would only further aggravate the negative individuals. Most financial leasing companies have set up effects of a “sudden stop”. the so-called rental companies, through which they provide services by concluding rental contracts. In effect, this represents regulatory arbitrage, as rental companies Leasing are not supervised or subject to regulations that are binding on financial leasing companies. As neither the exact number nor the scope of operations of such No analysis of private sector indebtedness and lending companies are known, it is of great concern that a part of activity in a broader sense would be complete without private individuals’ indebtedness has effectively been including financial leasing, as well as the increasingly placed beyond reach of the supervisory mechanisms and important operational leasing that emerged as a consequence of regulatory arbitrage by financial institutions. Chart 5.15 Financial leasing and rental Serbia’s leasing companies are heavily reliant on foreign companies borrowing. Foreign loan obligations make up close to (in RSD billion) 85% of their total liabilities, while domestic loans are only a negligible source of funds. Although leasing 17 , 5 0 0 14 0 companies’ foreign creditors are either their founders or 12 0 17 , 0 0 0 legal entities operating within the same banking group, 10 0 the global financial crisis will certainly leave its mark on 16 , 5 0 0 the volume of operations of the leasing sector in the 80 60 period ahead. In order to boost liquidity, the National 16 , 0 0 0
Bank of Serbia abolished the reserve requirement on 40 foreign borrowing by leasing companies, which will 15 , 5 0 0 facilitate availability of funds. 20 15 , 0 0 0 0 In the first nine months of 2008, total financial lease XII 06 IX 07 VI 08 investment increased by 10.9% to reach RSD 84 billion. Financial leasing claims As a result, assets of the financial leasing sector grew Total assets of rental companies faster during the past year than banking sector assets. Number of financial lessees, left scale
Breakdown by sector reveals that the most significant growth Source: National Bank of Serbia. in total lease investment during the year was recorded for transport, warehousing and communications sector, by contrast to end-2007 when the trade sector was dominant. is not even included in the sum of indebtedness calculated by the Credit Bureau of the Association of Serbian Banks. Breakdown by lease object reveals that the share of financing of freight vehicles, minibuses and buses The most recent analyses conducted by the National Bank continued rising. Following a sharp slump in 2007 (by 10 of Serbia show that there were 246 companies at end- pp), the share of financing of passenger vehicles declined 2007 whose core activity was related to that of rental
24 Excluding public enterprises.
47 National Bank of Serbia Financial Stability Report
companies, while rental companies running operating Lending risks and effects of the global crisis lease contracts were much fewer. However, the assets of on lending activity only three rental companies related to financial institutions already operating in Serbia come to over 60% Lending activity slowed down in H1 2008, foreshadowing of total assets of all rental companies. This is an instance the events to come in Q3 and Q4. As the ratio of private of regulatory arbitrage as shown by the fact that only 6 of sector lending to GDP of almost 30% was lower in Serbia 17 financial lessors had no established relation to rental than in most other European countries, the domestic companies, either through founding or management. financial system proved to be more resilient to the effects of the global financial crisis. And although credit As regards the volume of activities of such companies, it expansion slowed down, borrowers’ exposure to risks is evident that a part of investments spilled over from the inherent to credit expansion only increased with the spill financial leasing to the operational leasing sector. And over of the financial crisis. whereas at end-2006 the assets of rental companies related to financial leasing providers came to only 13%, Domestic indebtedness rose substantially during the the projection for the first half of 2008 pointed to asset preceding four years of credit expansion, primarily in the growth of rental companies to as much as 88% of assets household sector. As banks most often set their lending of financial leasing providers. rates by adding a margin to an interbank money market rate (quarterly adjusted 6M EURIBOR for euro-indexed or Similarly to financial leasing companies, rental 3M LIBOR for franc-indexed loans), households’ companies are mostly reliant on foreign borrowing via exposure to interest rate risk was very high. With the related financial institutions, which increased the stock plummeting of confidence in global money markets and a of foreign borrowing of the Serbian economy. surge in interbank rates in early Q4, this exposure has Moreover, financial institutions from Serbia were often increased still further. those which provided guarantees against such borrowing, thus retaining a part of the related risk in the In addition, in Serbia, as in a number of other CESEE and country. Slowdown in capital inflows following the Baltic countries, foreign currency-indexed loans account spill over of the global financial crisis could, however, for a very high share of total loans. Roughly 70% of total further dampen growth in the operational leasing sector. private sector lending is indexed to the euro or to the Swiss This is confirmed by the latest available data on the franc. This makes indirect credit risk one of the key risks number of financial leasing contracts which rallied in to Serbia’s financial system. Given the low level of October and early November. currency hedging by households and low real sector export
Chart 5.16 Household exposure to interest Chart 5.17 Real credit growth rates rate and FX risk (year-on-year, in RSD billion, %) (in RSD billion, in %) 600 60
250 6 500 50
200 400 40 5 300 30 15 0 4 200 20 10 0 10 0 10 3 50 0 0 I II III IV V VI VII VIII IX X 0 2 2008 I 07 IV 07 VII 07 X 07 I 08 IV 08 VIII 08. X 08 Corporate loans CHF indexed loans Household loans EUR indexed loans Real growth rate, corporate 6m EURIBOR, right scale Real growth rate, households 3m LIBOR, CHF, right scale Note: Adjusted for FX volatility. Source: National Bank of Serbia. So urce: Natio nal B ank o f Serbia, B lo o mberg.
48 Financial Stability Report National Bank of Serbia
base plus the volatility of the exchange rate and strong Lending activity will certainly slow down in the period depreciation pressures emerging in the third phase of the ahead, both globally and in Serbia. Plummeting confidence global financial crisis, currency structure of lending has in global financial markets will restrict availability of loans come to pose one of the main threats to the quality of and affect their volume, cost and maturity. assets and may induce a rise in defaults on bank loans. Another major cause of concern is that the currency Even the flows of financing from foreign parent to structure of household landing changed rapidly over the domestic daughter banks have been disrupted by the past 2 years, as the share of Swiss-franc indexed loans rose current liquidity squeeze, causing stagnation in lending from marginal levels to almost 20% of total household activity in most countries of the region. Over the short lending in mid-2008. run, the volume of bank lending will depend primarily on the availability and cost of foreign borrowing. And At the initiative of the National Bank of Serbia, the largest precisely in order to lower the costs of foreign banks in the country agreed to offer a set of loan borrowing, a number of central banks, including the repayment facilities to their clients. These facilities National Bank of Serbia, decided to lift reserve primarily relate to foreign currency-indexed loans as they requirement on this type of financing. If the financial enable currency restructuring (converting a Swiss franc- crisis in Europe continues unabated, no major “support” indexed into a euro-indexed loan and converting foreign by parent or other foreign banks can be expected. The currency-indexed loans into dinar loans). This set of latest available data for October 2008, however, reveal facilities also envisages early loan repayment free of any that lending activity continued growing in real terms, penalties and extension of the loan repayment period by though at a slower pace. Real growth in private sector one year. Banks must not charge a fee on any of the loan lending thus came to 2%, mostly on account of growth repayment facilities. The repayment period of a loan can in loans to entrepreneurs and natural persons. Real be extended without any implications on the classification growth in loans to enterprises was negligible. of loan receivables provided that the borrower has always regularly settled its obligations, that it is solvent and having only temporary liquidity problems, and provided Exposure of banks to the real sector that such extension ensures full and timely settlement of obligations. The bank must also prepare an annex to the In the first nine months of 2008, the real sector relied original loan contract, envisaging the same or more more on foreign than domestic borrowing; although a favourable terms and conditions for the client. part of banks’ corporate portfolio was thus dislocated abroad, it is still effectively kept on banks’ off-balance sheets in the form of payable guarantees.
As the domestic capital market is fairly shallow, loans Chart 5.18 Stock of domestic and foreign were the key source of funds for Serbian enterprises. enterprise borrowing Therefore, enterprises were the most significant client of (in RSD billion) the country’s banking sector in 2008, accounting for the 25 800 highest share of total loans. At end-September, enterprise loans reached RSD 512 billion or 54% of total 700 loans, resuming the trend of growth in the share of 600 enterprise loans in total lending. Lending to enterprises 500 was slow, however, both in absolute terms and relative to 400 other sectors, as enterprises relied more on direct cross-
300 border borrowing which recorded rapid growth until
200 September this year. In October, growth in enterprise loans was practically negligible. 10 0 0 By encouraging enterprises to engage in direct cross- I 07 IV 07 VII 07 X 07 I 08 IV 08 border borrowing, banks channelled a portion of their Banking sector enterprise loans corporate portfolios to related institutions abroad, which Total foreign borrowing Payable guarantees issued by the banking sector
Source: National Bank of Serbia. 25 Excluding public enterprises.
49 National Bank of Serbia Financial Stability Report
Chart 5.19 Corporate loans distribution (in RSD billion)
Other
,Activ ities relating to property , rental and business activ ities other utility , social and personal serv ices
Hotels, restaurants, transport, warehousing and communications
Wholesale and retail trade
Construction industry
Production and supply of electricity , gas and water
Mining and processing industry
Agriculture, hunting, f orestry , water management and f ishing
0 20406080100120140160180
So urce: Natio nal B ank o f Serbia. is an alternative to foreign borrowing by banks themselves, against which they, until recently, had to Chart 5.20 Initial maturity of foreign borrowing allocate required reserves. According to latest available by enterprises data, the stock of foreign borrowing by enterprises (in EUR billion) reached over EUR 9.5 billion in October (close to 30% of 10 GDP). Such loans were guaranteed by parent, related or other institutions abroad, entering an additional RSD 71 9 billion on the off-balance sheet of the banking sector in 8 the first six months of 2008 alone, which is an increase in 7 payable guarantees by 35%. Hence, at least a fraction of 6 the risk has been retained on the books of the Serbian 5 banking sector. However, available data indicate that even 4 direct cross-border borrowing slowed down since early 3
October. Namely, though foreign loan disbursements in 2
October were still notable, they only came to around 60% 1 of monthly average disbursements in 2008. If cross- 0 border borrowing by enterprises slows down further, the XII 05 VI 06 XII 06 VI 07 XII 07 VI 08 real sector may be expected to re-direct its demand to the domestic banking sector already in November. This M edium- and long-term debt Short term debt should act to offset limited access to foreign borrowing and spur continued growth in lending activity. Source: National Bank of Serbia.
Latest data releases point to sound performance indicators of the enterprise sector in 2007. The rate of return on remained a sound 47.3%. The maturity structure of assets was 2.0%, while return on equity equalled 1.6%. As enterprise borrowing is favourable, with the dominant over the past several years growth in real sector liabilities share of medium- and long-term loans. was matched by growth in its assets, own capital ratio
50 Financial Stability Report National Bank of Serbia
However, strong increase in enterprise borrowing since slowdown on financial stability, much will depend on its 2004 is also a source of a number of potential weaknesses speed, as hard landing would pose a much graver of the sector. Low export base and low hedging capacity problem. According to forecasts, confirmed by the latest expose enterprises to high exchange rate risk where any IMF estimates, GDP growth will reach around 3.5% in sudden depreciation could threaten their capacity to repay 2008 despite the global financial crisis and the Serbian borrowed funds, especially foreign loans. Moreover, as economy will most likely experience a soft landing. This the bulk of credit lines granted to enterprises came at is also due to the fact that many sectors of the economy variable interest rates, increased volatility in money have already flattened out due to a slowdown in real markets exposes the real sector to a substantial interest wages and a drop in loan-fuelled demand. rate risk. These risks have only been accentuated further by the global financial crisis. On the other hand, cross-border borrowing has not suddenly discontinued either and the pace of its If foreign borrowing by banks increases after removal of slowdown will largely depend on the capacity of the reserve requirement on this type of borrowing, a part of domestic banking sector to “make up for” foreign the high-quality corporate demand may be expected to loans. It remains to be seen if the lifting of the reserve resurface within the Serbian banking sector. The question requirement on foreign borrowing by banks will lead remains, however, whether the Serbian banking sector to a revival in foreign borrowing by enterprises and if will have the capacity to absorb strong enterprise demand domestic savings deposits, as the remaining dominant for foreign loans, even in ideal conditions regarding source of financing, will be sufficient for banks to sources of funding. To illustrate, enterprises disbursed offer competitive terms of borrowing to the country’s foreign loans worth EUR 2.5 billion in the year to date, real sector. which is three times absolute growth in domestic loans to enterprises in the first six month of 2008. Exposure of banks to households However, both direct cross-border and domestic borrowing will certainly be costlier and will represent Until end-H1 2008, rapid expansion in household a heavy burden on the real sector balance sheets. lending was the key potential threat to banking sector stability. Strong loan demand resulted in pronounced concentration of foreign currency clause-indexed long- Chart 5.21 Household loans in selected term loans within total household lending. Rapid growth countries of the region in cash loans, as the dominant type of lending in 2007, (in % of GDP) induced a sudden change in the composition of the overall credit portfolio. As these loans were both long- Albania 50 term and fully indexed, they also brought about an 4 increase in indirect credit risk exposure. Finally, the Croatia 0 BH 3 macroeconomic effects of increased demand heated by 20 0 such loans were yet another argument for issuing 10 Serbia 0 Bulgaria measures to contain credit expansion.
Slov enia Hungary Measures to contain lending and associated risks Macedonia For the purpose of containing lending to households, in Q3 2003 2004 2005 2007 the National Bank of Serbia issued a set of measures, 2006 2007 Jun 2008 some of which were prepared in cooperation with the Association of Serbian Banks. Subject to these measures, Source: National Bank of Serbia, central banks of selected the ratio of gross household lending (excluding lending to countries. agricultural producers and entrepreneurs, but including subsidised housing loans) to the level of capital was lowered from 200% to 150%. The maturity of general In view of the above, limited access to financing will purpose cash loans was limited to 2 years, while inevitably lead to an economic slowdown, which could mandatory down payment for foreign currency-indexed affect the servicing of existing financial obligations of cash loans to households was raised from 20% to 30% of economic entities. As regards the impact of such the loan amount.
51 National Bank of Serbia Financial Stability Report
Chart 5.22 Credit expansion 2004-2007, Chart 5.23 Household loan portfolio structure stock growth and share of GDP growth (in RSD billion, %) (in %)
800 350 NBS prudential 700 300 measures
600 Household loans 250
500 200 34% 27% 400 150 24% 300 100 Change in share of GDP 200 Total private sector 50 42% 37% 28% loans 100 0 Enterprise loans XII 06 III 07 VI 07 IX 07 XII 07 III 08 VI 08 IX 08 0
0 500 1000 1500 Cash loans Consumer loans
Change in stock Housing loans Credit cards
Source: National Bank of Serbia. Source: National Bank of Serbia.
The effects of central bank’s measures were soon evident. Lending expansion began to slacken already in late 2007 Chart 5.24 Household loan growth and during the first six months of this year. At the same (index, XII 06=100) time, household lending kept rising, primarily on 340 account of continuing expansion in housing loans, but its composition changed with a decline in the stock of 290 NBS prudential cash loans. measures
And whereas growth in household lending slackened, its 240 share of total lending edged up, primarily at the expense 19 0 of a decline in lending to the National Bank of Serbia and public enterprises. These effects excluded, a sudden 14 0 change in the composition of the overall credit portfolio has been prevented for the time being. 90 XII 06 III 07 VI 07 IX 07 XII 07 III 08 VI 08 IX 08 X 08 Slowdown in lending activity over the past 10 months helped alleviate the effects of the global financial crisis on Total household loans Cash loans Serbia. Namely, the drop in household lending on the Consumer loans Housing loans back of a gradual decline in, especially cash, loans Credit cards induced a moderate slackening of activity in a number of sectors of the economy. Source: National Bank of Serbia.
In the circumstances of a global crisis, such developments can be seen as favourable. Namely, had landing” would have had drastically graver the central bank not taken the above measures and had repercussions for the private sector of Serbia. the rapid expansion in lending continued, the spill over of the crisis to Serbia would have caused a sudden By contrast, central bank’s measures had next to no effect slowdown or even stop in household lending, inducing on expansion in housing loans. These loans increased by an equally sudden and negative spill over of reduced 42% in the first nine months of 2008 alone, while the stock demand on economic activity. The consequent “hard of household borrowing for this purpose rose more than
52 Financial Stability Report National Bank of Serbia
Chart 5.25 Concentration of long-term and Chart 5.26 Net financial position of households FX denominated household loans (in RSD billion) (in %) 200 105 Housing 15 0 October 100 2008 10 0 Housing 50 Cash 95 Consumer 2007 0 2007 2007 I 07 IV 07 VII 07 X 07 I 08 IV 08 VII 08 X 08 -50 90 Cash October -100 85 2008 -150
80 -200 Consumer October -250 Share ofFX denominated loans 75 2008 -300
70 Net position of households 88 90 92 94 96 98 100 Net long-term position of households Share of long-term loans Source: National Bank of Serbia.
Source: National Bank of Serbia.
2.5 times since end-2006. Looking forward, some set only indirectly. And whereas foreign remittances had slackening in housing loans can be expected, as their cost previously been a stabilizing factor in the countries of the will go up and their availability will diminish. In addition, region, their volume is now likely to be affected by the demand will be further dented by households’ expectations global liquidity squeeze. of a drop in real estate prices. If there proves to be a strong correlation between growth in household loans and real Interest rate risk exposure is also rising. As a number of estate prices, Serbia’s residential construction sector will credit lines came at a variable margin, margins on be powerfully hit by the global crisis. outstanding loans were raised to account for the increase in risk premium. Such increase in costs of repayment Robust growth in foreign currency-indexed household could deal a heavy blow to the financial position of loans over the past 4 years, despite a slowdown in 2008, households and reduce the quality of bank assets, leading still represents a potential challenge for banking sector to an increase in the share of non-performing loans. And stability. Though lower, the concentration of long-term while adjustments of interest rates linked to interbank rates foreign currency-indexed loans remains very high, with are inevitable, inclusion of risk premium in the margin at strong indirect credit and interest rate risks. times of liquidity shocks will only lead to a contamination of bank assets through higher credit risk. Although banks eliminate their currency risk exposure through loan indexation, hence transferring such exposure The net financial position of households improved in H1 to clients, credit risk remains on their books as exchange 2008 as lending activity slowed down. With a mild rate volatility can threaten the loan repayment capacity of improvement in the maturity structure of household mostly unhedged households. In some countries, this deposits, both the negative net position of long-term practice proved very dangerous as sudden withdrawal of household exposure and the net long-term position of foreign capital triggered depreciation shocks which, in household currency exposure somewhat bettered. some cases, toppled the value of the domestic currency by Although the net household position is likely to improve as much as 15% in a short time period. In addition, in with the fourth quarter slowdown in lending activity, Serbia, as in some other countries of the region, especially in indexed household loans, it will depend households face high exposure to risks related to loans primarily on the level of new foreign currency savings indexed to the Swiss franc (around 20% of total deposits and the effects of the spill over of the crisis on the household loans in Serbia), the exchange rate for which is sectoral composition of banks’ liabilities.
53 National Bank of Serbia Financial Stability Report
Table 5.1 Asset quality of the banking sector (in RSD billion) A+B C+D+E Total Total BA and OA 1 3,260 Gross risk-weighted assets 2 1065 537 1,602 Share in gross risk-weighted assets 3 66.50% 33.50% 100,0% Deductions (total) 4=5+6+7 388 254 643 collateral* 5 352 158 511 special reserves against income 61183 94 special reserves against capital 72513 38 Net risk-weighted assets 8=2-4 677 283 959 Share in net risk-weighted assets 9 70,5% 29,5% 100,0%
* Deductions do not represent the total value of collateral, but only a part of such value, in line with the prescribed conversion factor which is used as the basis for calculating reserves against potential losses.
Source: National Bank of Serbia.
Chart 5.27 Share of allowances for impairment Chart 5.28 Corporate portfolio asset in gross bank lending* quality (in %) (in %)
30 600 2004 25 500 2005 20 400 2006
15 300 2007
10 200 Jun 08
5 10 0 010203040
0 0 Share of allowances for impairment in gross lending XII 03 II 06 VI 06 X 06 II 07 VI 07 X 07 II 08 VI 08 Share of assets classified in C, D and E categories in total classified assets after deductibles* Share of allowances for impairment in gross lending Corporate loans * For 2006 and 2007, total net risk-weighted assets are used as the denominator. Source: National Bank of Serbia. Source: National Bank of Serbia.
on receivables from borrowers classified in categories C, D and E, banks formed special reserves of RSD 96 billion against their income and capital. As a consequence, the 3. Quality of banking sector assets share of net risk-weighted items in total net risk-weighted balance sheet assets and off-balance sheet items came to Asset quality indicators were stable in the first six months 29.5%, which is an increase by 4.8% pp on a year earlier. of 2008. As at 30 June 2008, total gross risk-weighted Despite this increase, the level of regulatory capital of the assets and off-balance sheet items came to RSD 1,602 banking sector was more than sufficient to absorb all billion or 49% of total balance sheet assets and off- potential losses. balance sheet items combined. A third of total gross risk- weighted items referred to items classified in the three The share of allowances for impairment in total gross least favourable categories and was backed by collateral lending continued declining, as these allowances did not of RSD 158 billion. To provision against potential losses grow at the same rate as lending. However, the share of
54 Financial Stability Report National Bank of Serbia
Chart 5.29 Share of outstanding debt in arrears Chart 5.30 Loan portfolio quality in an in total enterprise loans environment of credit expansion (in %) (in %, in RSD billion)
16 400 12 9 94 57 55 35 350 14 5.4 p.a. growth rate of 300 4.2 12 household loans 3.7 250 3.5 10 3.1 200
15 0 8 10 0
6 50
4 0 2004 2005 2006 2007 Jun 2008 I 07 IV 07 VII 07 X 07 I 08 IV 08 VII 08 X 08 Household loans
15 day s past due 90 day s past due Share of allowance for impairment in household lending
Source: National Bank of Serbia. Source: Credit Bureau of the Association of Serbian Banks.
non-performing loans in total loans went up, primarily on account of faster growth recorded in Q1 2008. Chart 5.31 Share NPL in total loans In the period ahead, asset quality indicators should be (net book value) monitored with particular care. Namely, in the prior (in %) period, asset quality indicators were mostly satisfactory 7 and displayed no major departures. However, quality
indicators have limited value in the conditions of rapid 6 credit growth, as they are obtained by using the stock of gross lending as the numerator. In other words, rapid credit 5 expansions artificially create sound quality indicators. In addition, as Serbia has a relatively short credit history, 4 newly approved loans are often classified in lower risk 3 categories, since problems with credit servicing, as a rule, occur only in the later stages of repayment. 2
For this reason, the comparison of pace of growth in 1 lending with that in non-performing loans should be used 31/12/2006/ 30/06/2007/ 31/12/2007/ 30/06/2008/ as an early indicator of asset quality. Findings of regular surveys on the level of non-performing loans conducted Enterprises Households Total on a sample of nine largest banks in Serbia are favourable: Source: National Bank of Serbia. overall loans increased by 59% since end-2006, while NPL26 rose by 49%. However, breakdown of loans by sector reveals a different correlation, where growth in non-performing loans is much faster than growth in household lending, which is the main catalyst of overall credit growth.
26 In Serbia – total loan (net, after deduction of allowances for impairment) which is in default for over 90 days (interest or principal).
55 National Bank of Serbia Financial Stability Report
Some research shows that the average rate of participation of non-performing loans in total loans increases from Chart 5.32 Comparative ROE 2.5% to as much as 10% once credit boom is exhausted.27 2004 - March 2008 In Serbia, it is unlikely that the quality of the credit (in %) portfolio will deteriorate either so drastically or so 35 suddenly, as its lending activity growth has been greatly 30 moderated over the past two years and the period of rapid credit expansion was relatively brief compared to other 25 transition economies. 20 15 High exposure of the domestic private sector to currency 10 and interest rate risks represents the key threat to the quality of banking sector assets. In case of another round 5 of increase in interest rates (due to changes in interbank 0 ME BA RS MK* HR RO AL HU* BG money markets and upward revisions of variable -5 margins) together with strong depreciation of the -10 domestic currency (as was the case in October), asset quality indicators may deteriorate on account of rising * Data for M arch 2008 are not available . Note: Due to differences in national accounting, taxation, and defaults. The decline in the market value of real estate, supervisory regimes, data are not strictly comparable across which represents the bulk of collateral of the country’s countries. banking sector, could have a further negative impact on Source: International M onetary Fund. the quality of assets.
4. Foreign exchange risk Chart 5.33 Comparative ROA 2004 - March 2008 The end-June open foreign currency position came to RSD (in %) 29 billion or RSD 10 billion less than at end-2007. At the 4 same time, banking sector resilience to sudden negative tendencies in the foreign exchange market improved. 3 Foreign exchange risk ratio28 came to 9.4%, which is as much as 5.4 pp less than at end-2007. Foreign exchange 2 risk exposure of banking sector clients is of fundamental significance for the medium- and long-term stability of 1 banks, as its materialization would immediately trigger a larger-scale credit risk for the entire banking sector. 0 ME BA RS MK* HR RO AL HU* BG
-1
5. Banking sector profitability -2
* Data for M arch 2008 are not available . Serbia’s banking sector is profitable, which is yet Note: Due to differences in national accounting, taxation, and another feature that contributes to its resilience; supervisory regimes, data are not strictly comparable across countries. wide credit margin and investment in repo operations have led to a positive financial result of over RSD 20 Source: International M onetary Fund. billion in H1 2008.
27 Mendoza and Terrones “An Anatomy of Credit Booms – Evidence from Macro 28 Total risk weighted foreign currency position of a bank (sum total of long and Aggregates and Micro Data” , NBER Working Paper 14049. short open net foreign currency positions by individual currencies and precious metals) may not be higher than 30% of the bank’s capital.
56 Financial Stability Report National Bank of Serbia
Table 5.3 Banking sector profitability indicators (in %)
Operational Gross income/total Net interest Operational costs/interest and Financial result assets income/total assets costs/total assets commissions net (in RSD billion) income Dec. 31 2005 33.63 4.47 5.55 80.95 7.3 Dec. 31 2006 39.46 4.13 5.20 86.30 16.5 Dec. 31 2007 42.31 3.97 4.54 78.09 23.5 Dec. 30 2008 55.03 5.23 4.75 65.23 21
Source: National Bank of Serbia.
In H1 2008, nominal profits before tax came to RSD 20.8 exchange rate gains are excluded from revenue, it is the billion. On a bank by bank basis, 26 banks operated with basic banking activities that contributed most to banking profits, while eight banks recorded losses. In nominal sector profits. terms, net interest income (RSD 43.8 billion) was higher in H1 2008 than that recorded in the entire year 2006. Interest revenue equalled RSD 72 billion, of which Exchange rate gains contributed RSD 6.7 billion to enterprises accounted for 38% and households for 31%. banking sector profits in the period under review. If gross Another major contributor to banking sector profitability
Chart 5.34 RoA and RoE of the banking Chart 5.35 Efficiency indicators, per employee sector (in RSD million) (in %) 60
14 50 12 11.6 40 10 9.7 8.5 8 30
6.6 6 20
4 10 2.6 2 1.7 1.7 1.1 0 0 B alance Total income Operational Loans Dep osit s sheet expenses 2005 2006 2007 Jun 08
XII 06 XII 07 VI 08 ROE ROA
Source: National Bank of Serbia. Source: National Bank of Serbia.
57 National Bank of Serbia Financial Stability Report
was the inflow of interest received from the NBS, primarily in respect of repo operations, which made up Chart 5.36 Operational expenses of the 20% of total interest revenue. The composition of revenue banking sector reflected the slowdown in lending activity, as the (in RSD billion, %) respective shares of interest charged from enterprises and 45 18 0 households in total revenue declined by 2 pp each. It is 40 16 0 also important to note that a substantial drop in the repo 35 14 0 stock in Q4 2008 will have a negative effect on 30 12 0 profitability as, through such withdrawal, banks 25 10 0 employed a part of interest-bearing assets to improve their 20 80 daily liquidity. The six-month ROE came to 11.51, which 15 60 is an improvement on end-2007. In this sense, Serbia did 10 40 not change its position relative to other countries of the 5 20 region, where ROE is higher.29 Although high 0 0 capitalization could affect profitability of the banking 2005 2006 2007 VI 08 sector and, consequently, its ability to attract additional capital, the banking sector of Serbia has managed to Operational expenses p.a. growth rate, lhs record enviably high profitability indicators, while Coverage of operational expenses by net income from maintaining sound capital levels. A look at the potential interest and fees risks posed by the current financial crisis reveals that it is precisely such combination of high capitalization and Source: National Bank of Serbia. comparably moderate but rising profitability that has promoted the resilience of Serbia’s banking system and now represents its comparative advantage. Return on fees continued its upward trend in place since end-2007. assets (ROA) was sound as a result of the high share of Despite an ongoing operational expansion, growth in capital in total balance sheet assets. At end-H1 2008, operating expenditure slowed down. Revenue from basic ROA rose to 2.6%. A comparison with other countries of banking operations thus came to 153% of such the region reveals that Serbian banks have the highest rate expenditure. That the efficiency of the banking sector has of asset management efficiency. Operational efficiency of improved is also evident from indicators per employee, as the banking sector improved further, as coverage of the amounts “managed” by employees increased in H1 operating expenditure by net revenue from interest and 2008 relative to end-2007.
29 In addition to differences in accounting, taxation and prudential standards across countries, another reason for a lower level of this indicator in Serbia is a stronger capital base of our country’s banking sector.metals) may not be higher than 30% of the bank’s capital.
58 Financial Stability Report National Bank of Serbia
VI. Insurance sector
Four years after the reform of the Serbian insurance sector, its performance is still below the average of EU member countries. However, its development potential is strong. The share of insurance sector in the overall financial sector assets remains unchanged. As the premium continues to grow, its composition changes to the benefit of life insurance. Serbian insurance companies show solid solvency indicators.
Chart 6.1 Insurance business in selected Chart 6.2 Total insurance premium countries (in %) (in %, total premium/GDP) 45 12 40
10 35
30 8 SWI 25 SWE 6 20 ITA GER 4 15 SPA HUN 10 SLO 2 CRO SRB BUL 5 TUR ROM 0 0 IX 05 IX 06 IX 07 IX 08 Life insurance Non-life insurance Non-life premium Life premium Source: National Bank of Serbia. So urce: Natio nal B ank o f Serbia.
Four years after the reform of the Serbian insurance sector, development progress over the past four years. At end-Q3 its performance and relative significance in the domestic 2008, total premium was by as much as 51% higher than in financial system are still below the average of EU member the matching period of 2005, while insurance sector countries. The share of premium in GDP remained balance sheet total doubled over the past three years. As the unchanged from 2006 – 1.8% vs. 8% in the EU. According performance indicators showed solid growth, the relative to this indicator, Serbia ranks 66th in the world, two notches size of the insurance sector remained unchanged. Namely, down from the previous year, whereas in terms of premium despite strong growth of the banking sector in the previous per capita, Serbia is 64th (USD 103 per capita). period, the insurance sector retained around 4.5% of the overall financial system assets. Its position in the financial Although stabilization was the primary focus since the system even improved in the first nine months of 2008 as beginning of reform, the insurance sector has shown strong the sectors of banking and financial leasing slowed down.
59 National Bank of Serbia Financial Stability Report
As the premium increased, its composition continued changing to the benefit of life insurance. Namely, life Table 6.1 Composition of insurance assets insurance premium grew at a faster pace than its non-life (in %) counterpart. At end-September 2008, life insurance premium equalled RSD 4.3 billion, which is a 22% VI 07 VI 08 increase on the same period a year earlier or a 200% increase on end-2005. As a result, life insurance premium Short-term financial investment 20.9 26.2 came to account for 11% of total insurance premium, Cash and cash equivalents 10.8 9.4 testifying to the significant development potential of non- banking types of savings in Serbia. If we compare the Other 6.4 8.2 Real estate, equipment and investment share of life insurance premium in Serbia in total premium 18.1 20.3 real estate or in the country’s GDP, with comparable data in advanced Long-term financial investment 25.6 19.7 European economies, it becomes clear that the catch-up Claims 18.2 16.2 process in this area of financial intermediation has only begun here. On the other hand, the implications of the Source: National Bank of Serbia. global liquidity crunch for life insurance industry are yet to be seen. A few existing analyses of this issue almost invariably point to the conclusion that the effects of the insurance premium reveals that a bulk of it is accounted for crisis on life insurance will be much weaker than those on by companies in majority foreign ownership. the banking industry. Considering that Serbian insurance companies are not directly exposed to global turbulence, Steady growth in technical reserves, begun in 2005, is of potential slowdown in life insurance could come about paramount significance for the stability of the insurance primarily as a side effect of the withdrawal of foreign sector. Having risen by 36.8% in 2007, technical reserves currency savings deposits triggered by the psychological gained an additional 21.7% in the first nine months of and reputation factors. Insurance companies could also feel 2008, meaning that they grew faster than capital and the impact of the crisis through the capital market as some reserves. Standing at RSD 48.1 billion in late September, of their assets are exposed to stock exchange movements. technical reserves accounted for more than 60% of total insurance sector liabilities. In terms of ownership structure, total premium underwent a significant change in the course of 2008 as one of the two The stability of the insurance sector hinges not only on the largest companies transformed from a socially-owned to a size and structural position of technical reserves in overall privately-owned company in late 2007. Analysis of life liabilities, but also on the structure of their investment
Chart 6.3 Structure of non-life insurance Chart 6.4 Technical reserves premium by ownership (in RSD billion) (in %)
VI 06 70 80% M athematical 60 60% reserves
40% 50 VI 08 XII 06 20% 40 0%
30
20 XII 07 VI 07 10
State and social ownership 0
Foreign ownership 2004 2005 2006 2007 VI 08 IX 08
Domestic private ownership So urce: Natio nal B ank o f Serbia.
Source: National Bank of Serbia.
60 Financial Stability Report National Bank of Serbia
portfolios. It should be noted that the trends in this respect faster than total premium. This is largely attributable to the are positive as short-term financial investments account for introduction of uniform criteria for the calculation of the major portion of insurance sector assets, which means technical reserves, owing to which the Serbian insurers are that companies’ investment decisions are motivated now making more realistic assessments. primarily by their commitment to performing the undertaken obligations. As the Serbian insurance industry On 30 September 2008, the solvency margin stood at is dominated by non-life insurance, improvements in the RSD 10.6 billion and the guarantee reserve at RSD 19.6 maturity match between investments and undertaken billion. While the solvency margin rose by 7.1% in the obligations will strongly contribute to a more adequate span of one year, the guarantee reserve declined by protection of the interests of users of insurance services. around 10%. The ratio of guarantee reserve to solvency margin for companies engaging primarily in non-life Another guarantee of substance for the insurance insurance came to 192.6% against 150.6% for companies beneficiaries is the fact that technical reserves are growing engaging primarily in life insurance.
61
Financial Stability Report National Bank of Serbia
VII. Voluntary pension funds
Two years after the start of operations, the growth of voluntary pension funds has slowed down in a shallow domestic capital market and against globally unfavourable financial climate; nevertheless, VPF assets are growing and their membership is increasing, both testifying to a large development potential of this type of long-term savings in Serbia.
Voluntary pension funds have been operating in our market for nearly two years now, which is a relatively Table 7.1 Net VPF assets short period of time from which to draw any conclusions (in RSD million) given the character of operations of these financial institutions. There is, however, plenty of room for the IX 07 XII 07 III 08 VI 08 IX 08 development of this sector considering that only 7.4% of 2,563 3,046 3,177 3,719 3,976 the employed are VPF members and that net fund assets participate with around 0.15% in GDP, which is Source: National Bank of Serbia. significantly below both the European (15%) and the regional averages (5%).
At end Q3 2008, there were ten VPF management Chart 7.1 Composition of net VPF assets* companies operating in Serbia, up by three on end-2007. (in %) At the same time, the number of banks providing Shares custody services to voluntary pension funds increased by one. Stronger competition in the custody market is Government expected to spur improvement in the quality of services, securities and the security of the VPF system. The number of Term deposits broker firms that VPF management companies cooperated with in 2008 increased by three on a year Transaction earlier. The density of a fund management company’s account organisational network is an important factor in holdings Real estate increasing the fund’s market share. This is where commercial banks come into the picture as they are the only financial institutions engaged in intermediation, * End-Q3 2008 - the outer circle, end-2007 - the innner circle. have a branched-out network and are easily accessible. Source: National Bank of Serbia. Hence, using them as channels of sale may give management companies a comparative advantage. For the time being, most such companies have head offices The number of VPF services users30 came to 156,977 at only and four have hired banks as intermediaries in end-Q3. At the same time, the number of users holding order to indirectly broaden their o utreach. accounts in several funds declined to 24,370, or 15.5% of
30 User means an individual, with a personal identification number or passport number (foreign persons), holding one or more accounts in one or more funds.
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the total number of users. Average amount of holdings per user equals RSD 25,328.70, or RSD 30,058.77 not Table 7.2 VPF share of BSE trading counting in the users who never paid in the contribution. (in RSD million)
During the first nine months of the year, net fund assets Volume of Volume of rose 30.6% in nominal terms. As the conditions in the Share of securities Share of VPF financial market changed, so did the composition of VPF BSE trading purchase BSE trading trading assets. The most important change is reflected in the by VPF decrease of shares and increase in transaction accounts. VI 07 625.6 1.17% 434.6 0.81% IX 07 622.9 1.94% 506.7 1.58% On the other hand, currency composition of fund assets XII 07 610.0 1.72% 473.9 1.33% remained stable. At end-Q3, around RSD 1.3 billion or III 08 495.8 2.85% 353.5 2.03% 33% of total assets were foreign currency denominated VI 08 160.0 0.54% 141.7 0.48% (only in euro for the time being) while RSD 2.6 billion or IX 08 298.9 2.19% 234.9 1.72%
67% were dinar-denominated. Euro-denominated assets Source: National Bank of Serbia. are for their major part made up of bonds issued against frozen foreign currency savings. founding of two new management companies and three At end-2006, market concentration index in the voluntary voluntary pension funds also tells of significant interest pension funds sector was at its maximum of 10,000, as in the VPF sector on the part of both founders and only one company operated at the time. At end-Q3 2008, service users. VPF market is still heavily concentrated. It should be noted, though, that the market concentration index is Serbian capital market remains underdeveloped, though. steadily declining with the entry of new funds and the The array of financial instruments eligible for investment increase in the share of VPF funds which did not transfer of VPF assets is narrow and limits the possibilities of VPF their insurance assets. portfolio diversification. The share of trading by voluntary pension funds in total trading in the Belgrade There is, however, potential both for setting up new and Stock Exchange is small, and revolves around 2% since for further development of the existing funds, as shown the start of their operations. Despite significant increase by the fact that in slightly over a year of operations, one in the volume of trading in the BSE in Q3, the presence of fund managed to gain over 5% of the market share. The management companies declined significantly in 2008
Chart 7.2 Concentration in the VPF sector Chart 7.3 FONDEX in 2008 (HH Index) (in RSD)
4,000 1,200
1,180
1,160 3,500 1,140
1,120
1,100 3,000 1,080
1,060
2,500 1,040 IX 07 XII 07 III 08 VI 08 IX 08 31/01/ 29/02/ 31/03/ 30/4/ 31/05/ 30/06/ 31/07/ 29/08/ 30/09/
Source: National Bank of Serbia. Source: National Bank of Serbia.
64 Financial Stability Report National Bank of Serbia
reflecting deteriorated conditions in the Serbian capital market. We must not lose sight of the restrictions on investment and the fact that the voluntary pension funds are still in the initial phase of capital accumulation.
Notwithstanding recovery registered in Q2, most VPF saw a decline in their investment unit values in 2008. A markedly sharp drop recorded in Q3 resulted from the global financial turmoil that found its way to the BSE as well. Belex15, index of the most liquid Serbian shares, lost around 44% in Q3, while the dinar picked up by around 3%. FONDex, weighted average value of investment units of all VPFs, has shed around 10% in 2008.
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List of tables and charts
Charts
2.1. Structured financial products in Europe and USA 11 2.2. One-year rating downgrades of subprime mortgage backed securities in 2007 and 2008 12 2.3. Bank writedowns by region 12 2.4. Bank losses reported as of May 2008 12 2.5. International exposure to "contaminated" securities 13 2.6. Interest rates in European 3-month money markets 13 2.7. European banks' cross-border liabilities, end-2007 14 2.8. ECB deposit facility in October 2008 14 2.9. Core inflation 14 2.10. Real GDP growth 15 2.11. Capital market indices 15 2.12. Central bank key interest rates 15 B1. Rescue packages 17 2.13. Private sector loans and current account in selected countries in 2007 18 2.14. External position vis-à-vis BIS reporting banks 18 2.15. Movements of exchange rates against the Euro in selected transition countries until September 2008 19 2.16. Movements of exchange rates against the Euro in selected transition countries in October 2008 19 2.17. Republic of Serbia bonds in dollars 19 2.18. EMBII 19
3.1. Gross domestic product 23 3.2. Core inflation projection 23 3.3. Inflation movements 24 3.4. Current account deficit financing 24 3.5. Foreign direct investments 25 3.6. Daily RSD/EUR volatility 25
4.1. Financial system structure 28 4.2. Market concentration in insurance and financial leasing sectors 28 4.3. Market concentration in the banking sector 28 4.4. Ownership structure 29 4.5. Banking sector ownership structure by country of origin 29 4.6. Geographic exposure of banks by country of origin 30 4.7. Movements in Belexline and Belex15 indices in 2008 31 4.8. P/E ratio of enterprises in continuous trading 31 4.9. Liquidity in the share market in 2008 32 4.10. Net share purchases in the Belgrade Stock Exchange by foreign investors and average value of share transaction 32 4.11. Movements in Belex15 index and stock exchange indices in the region and worldwide 33 4.12. Average yield on RS frozen foreign currency savings bonds 33 4.13. Yield curve on RS frozen foreign currency savings bonds 33 4.14. Interest rate movements 33 4.15. Interbank money market yield curve 34 4.16. NBS key policy rate and commercial bank interest rates 34 4.17. Interest rate margins of banks in Serbia and countries of the region 35 4.18. Property prices in selected European countries 2002-2008 . 35 4.19. Growth in prices of square meter of newly built residential property 36
66 Financial Stability Report National Bank of Serbia
4.20. Contribution to housing loan growth 36 4.21. Number of loans insured with the NMIC by years and the average insured loan amount 37 4.22. Number of issued construction permits for residential buildings by quarter 37 4.23. RTGS turnover and number of interbank transactions 38 4.24. Share of ten largest participants in interbank payment transactions, by month 38
5.1. Sources of funding of the banking sector 41 5.2. Loan to deposit ratio 41 5.3. Structure of sources of funding 42 5.4. Structure of total deposits 42 5.5. FX savings, required reserve and central bank repo securities in 2008 . 43 5.6. Maturity and currency structure of private sector loans and deposits 44 5.7. Balance sheet structure 44 5.8. 3М CHF LIBOR in 2008 44 5.9. Banking sector capital and monthly capital increase 44 5.10. Comparative overview of the capital adequacy ratio, 2005 - March 2008. 45 5.11. Capital adequacy ratios 45 5.12. Distribution of the capital adequacy ratio 45 5.13. Sectoral distribution of loans 46 5.14. Share of private sector loans in GDP 46 5.15. Financial leasing and rental companies 46 5.16. Household exposure to interest rate and FX risk 47 5.17. Real credit growth rates 48 5.18. Stock of domestic and foreign enterprise borrowing 48 5.19. Corporate loans distribution 49 5.20. Initial maturity of foreign borrowing by enterprises 50 5.21. Household loans in selected countries of the region 50 5.22. Credit expansion 2004-2007, stock growth and share of GDP growth 51 5.23. Household loan portfolio structure 52 5.24. Household loan growth 52 5.25. Concentration of long-term and FX denominated household loans 52 5.26. Net financial position of households 53 5.27. Share of allowances for impairment in gross bank lending 53 5.28. Corporate portfolio asset quality 54 5.29. Share of outstanding debt in arrears in total enterprise loans 54 5.30. Loan portfolio quality in an environment of credit expansion 55 5.31. Share NPL in total loans (net book value) 55 5.32. Comparative ROE 2004 - March 2008 56 5.33. Comparative ROA 2004 - March 2008 56 5.34. ROA and ROE of the banking sector 57 5.35. Efficiency indicators, per employee 57 5.36. Operational expenses of the banking sector 58
6.1. Insurance business in selected countries 59 6.2. Total insurance premium 59 6.3. Structure of non-life insurance premium by ownership 60 6.4. Technical reserves 60
7.1. Composition of net VPF assets 63 7.2. Concentration in the VPF sector 64 7.3. FONDEX in 2008 64
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Tables
3.1. Balance of payments in % of GDP 24
4.1. Key indicators of financial system development 27
5.1. Asset quality of the banking sector 54 5.2. Banking sector profitability indicators 58
6.1. Composition of insurance assets 60
7.1. Net VPF assets 63 7.2. VPF share of BSE trading 64
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