The Czech Financial Sector is Sound and Resilient to Risks

The Czech financial sector is sound and, according to stress tests, remains resilient to market, credit and other risks. No sector as a whole falls below the critical values of relevant capital indicators of solvency in any of the stress scenarios. However, the potential impact of a worse-than-expected trend in the economy should not be underestimated, according to the Financial Stability Report 2009/2010 published today.

“The stability of the Czech financial system is good and it is pleasing to see how financial institutions are coping with the crisis. The tough and comprehensive tests reveal that even strongly adverse conditions should not endanger the stability of the financial system,” said CNB Governor Zdeněk Tůma.

The high resilience of the Czech financial system is based on the fact that financial institutions entered the recession in good condition and were able to create a capital buffer during the recession. The Czech banking sector’s strong position is supported not only by sufficient profitability, but also by good funding liquidity, a high deposit-to-loan ratio, a low proportion of foreign currency loans, independence from external financing and in particular sufficient capital adequacy.

However, the risks to financial stability remain heightened and strong. The main risk scenario for the Czech economy and thus also for the financial sector over the next two years is a renewed recession in its major trading partner economies and a subsequent slowdown in domestic economic activity. The economic recovery ongoing since mid-2009 is fragile, since it is based not only on renewed private sector confidence, but also on vigorous supportive economic policy measures.

The second key risk is the deteriorating fiscal trend in many countries, including the Czech Republic. Contagion of concerns about the ability to finance government debt in critically indebted countries to other countries whose public finance is also showing some signs of potential unsustainability is considered a current threat in this regard.

The resilience of the domestic financial system to these and other risks was assessed by means of stress tests on banks, insurance companies and pension funds using three scenarios of future economic developments entitled Baseline Scenario, Return of Recession and Loss of Confidence. The first scenario is considered by the CNB to be the most probable. The other two alternative scenarios are characterised by a sizeable contraction in economic activity and lead to a higher loan default risk in the household and corporate sectors.

Tomáš Zimmermann
CNB Communications Department