The Czech financial system remains resilient, euro area developments are the main risk

• In 2011 and 2012 Q1, the Czech financial sector maintained or even strengthened its resilience in terms of both capital and liquidity
• The developments in the euro area, where the situation is very fragile and the crisis may re-emerge at virtually any time, pose a risk to financial stability in the Czech Republic
• The results of stress tests show that the Czech financial sector is well prepared for unfavourable external developments
• The exposures of Czech banks to their parent groups are at a safe level and are closely monitored by the CNB
• A potential deterioration of the quality of the credit portfolio resulting from weak economic growth remains the main domestic risk to the Czech banking sector
  

The financial sector in the Czech Republic continues to show sufficient stability. Banks, the basis of the financial system, are sound, well-capitalised, profitable over the long term, and maintain an excess of deposits over loans. According to the Financial Stability Report published today by the Czech National Bank, the major risks to the financial sector are stemming from a potential sizeable downturn in economic activity resulting from an escalation of the euro area crisis.

“To maintain public and investor confidence in the stability of the Czech banking sector in the tight situation in the euro area, banks must maintain a high ability to absorb potential credit and market losses,” said CNB Governor Miroslav Singer. “The CNB will therefore pay increased attention to the monitoring of the quality of the credit portfolios of banks and credit unions and also to relationships between domestic banks and their parent groups.”

The main risk scenario for the Czech economy over the next few years remains a sharper slowdown in economic growth in Germany and other countries where our major trading partners are established. The tight situation particularly in the euro area is accompanied by commodity and energy price growth reflecting geopolitical uncertainty and the dynamic growth in demand from emerging economies. The unfavourable evolution of disposable income owing to the tight labour market conditions is a risk in the household sector.

Credit risk in the banking sector saw a modest improvement in 2011 and 2012 Q1. At the aggregate level, credit risk can be regarded as sufficiently covered by provisions, but there are quite large differences in NPL coverage across domestic banks. Loan portfolio concentration is falling steadily, but the collateralisation of the largest loans is declining.

With regard to the risks mentioned above, the CNB assessed the resilience of the financial system by means of stress tests on banks, insurance companies and pension funds using the extended three-year scenarios entitled “Baseline Scenario” and “Europe in Depression”. The Baseline Scenario is considered by the CNB to be the most probable. The Europe in Depression stress scenario foresees a prolonged contraction in economic activity and a related sharp fall in property prices, a rise in NPLs and a drop in operating profits of financial institutions. The variants of stress scenarios then work with additional adverse shocks, such as write-downs of claims on indebted EU countries, losses on domestic banks’ exposures to foreign parent companies and the collapse of the largest debtors of each bank.

The stress test results confirm that banks and insurance companies are resilient to adverse economic and market developments. This is due not only to their high initial capital buffer, but also to their ability to generate income even in an adverse scenario. Even in the case of the extremely stressed variants of the Europe in Depression scenario assuming collapses of large debtors or problems in Czech banks’ parent companies, the capital adequacy ratio of the banking sector remains above the 8% regulatory minimum, although some banks would have to strengthen their capital.

Marek Petruš, CNB spokesman