The Czech financial sector is stable, risks persist
- The Czech financial sector remained stable and financially strong enough in 2013 and in spring 2014
- The main risks to the financial sector stem above all from a possible return of the recession due to adverse developments in trading partner countries and a deterioration in domestic demand
- Given its orientation on bond portfolios, the Czech financial sector could be adversely affected by bond market volatility
- The stress tests showed that banks and insurance companies would withstand a strong recession accompanied by deflation thanks to their capital buffers
- Insurance companies are facing risks related to persisting very low long-term yields; pension management companies would probably have to increase capital in the event of a sharp rise in bond yields
The Czech financial sector remains sufficiently stable. It is financially strong and ready to comply with new European regulatory rules. Banks, which are the foundation of the financial system, remain profitable and managed to increase their capitalisation even amid adverse economic conditions. Stress tests of banks demonstrated their sufficient resilience even in an adverse economic scenario involving a strong recession accompanied by deflation, as shown in the Czech National Bank’s tenth Financial Stability Report 2013/2014.
“Developments observed last year confirmed that if banks have sufficient capital and liquidity buffers, they are able to maintain stability and profitability even in a period of weak economic activity,” said CNB Governor Miroslav Singer.
The current situation in the global economy, on which the Czech Republic – as a small open economy – is strongly dependent, is exceptional because of a combination of risks from before the crisis and new risks stemming from efforts to seek more profitable investments amid historically low long-term yields. Central banks and supervisory authorities are facing the task of avoiding a renewed decline in demand and a fall of the economies to the deflation trap, and at the same time preventing excessive risk-taking on the financial markets. The CNB is actively preventing the risk of a drop in demand and deflation by using the exchange rate as a monetary policy instrument, which is contributing to the stability of the financial system.
The resilience of the Czech financial system was assessed by means of stress tests using a stress scenario called Europe in Deflation, which captured the risks of a long-running drop in economic activity and financial market fluctuations over the next three years. The stress tests demonstrate that the banking sector remains highly resilient even in a strong recession accompanied by deflation and maintains its capital adequacy above the 8% regulatory threshold thanks to its financial buffers. Insurance companies also showed sufficient resilience to adverse developments. The pension management company sector remains sensitive to developments in prices of securities holdings and would probably have to increase its capital in the event of a sharp future rise in yields.
The credit union segment is still riskier compared to banks. The ratio of non-performing loans to total loans rose sharply year on year to almost 23%, and other indicators of credit union activity also remain unfavourable. Therefore the CNB prepared and submitted to the Ministry of Finance a proposal of legislative changes based on its experience in supervision of credit unions.
Marek Petruš
CNB spokesman