Czech financial market is more resilient, fast credit growth is potential risk
- The resilience of the Czech financial sector to potential adverse shocks remains high and is even stronger than a year ago
- Systemic risks remain only potential in all areas
- Faster credit growth is a potential source of domestic risks to financial stability in the future
- Highly relaxed standards applied to mortgage loans necessitate a tightening of the conditions for their provision by credit institutions
- Stress tests confirm the banking sector’s ability to cope with even a very strong recession
- Given the favourable results of the public finance stress test, the CNB will not apply additional capital requirements to holdings of Czech government bonds over the next three years
The Czech financial sector’s high resilience strengthened in year-on-year terms. Highly relaxed standards for the provision of mortgage loans are a risk. Consequently, the Czech National Bank will tighten the existing rules as from October 2016, as stated in its Financial Stability Report 2015/2016.
“The domestic banking sector remains highly stable thanks to good capitalisation, a strong client deposit base and a sufficient amount of high-quality and liquid assets,” said CNB Governor Miroslav Singer.
The Czech economy continues to be in a growth phase of the financial cycle. In December 2015, the CNB reacted to rapid credit growth, increasing household debt relative to income and growth in residential property prices by setting the countercyclical buffer rate at 0.5% of exposures located in the Czech Republic with effect from January 2017. As there has been no significant change in cyclical risks indicating growth in systemic risk this year, the CNB Bank Board decided at its meeting on financial stability issues in May to leave the buffer rate at the current level for the time being. However, if credit growth remains high, credit standards ease further and investor optimism continues to grow, the CNB will stand ready to increase this buffer rate further.
The new Financial Stability Report pays increased attention to the property market and the provision of house purchase loans. The CNB does not assess the trends in the area of house purchase loans as an acute market overheating giving rise to direct risks to financial stability. However, it considers credit standards to be highly relaxed and has identified the taking on of higher risks by some institutions.
The combination of exceptionally low interest rates and easy access to house purchase loans is creating conditions for growth in residential property prices above levels consistent with fundamentals. Consequently, the CNB will tighten its current Recommendation on the management of risks associated with the provision of retail loans secured by residential property as from October 2016, mainly by lowering the maximum LTV levels (the ratio of the loan amount to the value of collateral). The CNB will also seek enactment of the power to set risk parameters for house purchase loans.
The banking sector’s resilience was assessed by means of macroeconomic stress tests using alternative economic scenarios. The Baseline Scenario is based on the CNB’s May forecast and is considered by the CNB to be the most probable. The Adverse Scenario, whose probability is very low, assumes a strong recession and a fall of the economy into deflation.
The banking sector has a large capital buffer which enables it to withstand highly adverse shocks and maintain its overall capital adequacy sufficiently above the regulatory threshold of 8% even in the Adverse Scenario. The banking sector is also highly resilient to short-term liquidity risk.
The CNB also conducted a stress test of public finance. Its results indicate that the current fiscal situation does not represent a threat to the stability of the banking sector, which holds a large part of the Czech government debt. Consequently, the CNB will not apply additional capital requirements to credit institutions at the three-year horizon.
Marek Zeman
Director, CNB Communications Division