Press releases
14. 6. 2011
  • Regulation, supervision

The financial system remains strong but faces risks from the fading crisis

  • The starting position of the Czech financial system remains very good for future years
  • The intensity of the risks to the financial system has increased, mainly as a result of adverse fiscal developments in the euro area
  • Developments in the global environment will be of key importance for maintaining financial stability in the years ahead
  • Stress tests show that the banking sector is highly resilient to a wide range of risks
  • The banking sector could be threatened only by very extreme shocks such as a long-term decline in GDP or the collapse of the three largest debtors of each bank
  • For the stability of the financial system it is vital that financial institutions maintain sufficient capital and liquidity buffers

The financial system in the Czech Republic remains stable. The starting position of its key segment, the banking sector, is strong thanks mainly to sufficient profitability and capital adequacy and good balance-sheet liquidity. Nevertheless, the economy is exposed to a high degree of uncertainty at a time of fading financial crisis and economic recession. This is generating numerous risks that could disrupt financial stability over the next two years. These are the main conclusions of the Financial Stability Report 2010/2011 published today by the Czech National Bank.

The intensity of the risks faced by the domestic financial system has increased compared to the previous year as a result of adverse fiscal developments in the euro area and their potential impacts on the domestic economy. The main risk scenario for the Czech economy over the next two years remains a sharper slowdown in economic growth in Germany and other countries that are major trading partners of Czech corporations. A strained labour market situation and measures needed to reduce the structural public budget deficit will dampen income growth and negatively affect households’ ability to repay loans.

“Developments in the global economy will be of key importance for maintaining financial stability over the next two years. It is important to warn against over-optimistic expectations given developments abroad, where the problems of some indebted euro area economies are coming to a head. The situation in the domestic economy does not yet provide sufficient support for claiming that the crisis is coming to an end either,” said Czech National Bank Governor Miroslav Singer.

“For the stability of the financial system it is vital for domestic financial institutions to maintain the capital and liquidity buffers created during the crisis. High dividend payments from retained earnings could be a risk to the banking sector in the near future, as they would reduce the capital buffer,” added the Governor.

Given the high degree of uncertainty about the speed of recovery of the domestic economy, overly optimistic expectations could lead to a build-up of new risks to the Czech banking sector stemming from attempts by banks and their owners to boost profitability through more intensive credit expansion. The increase in the volume of new house purchase loans is not currently being underpinned by any apparent improvement in clients’ creditworthiness. Since the risks of movements in property prices are still on the downside, this trend may represent an increased risk to banks and their clients.

Developments in the credit union sector can be regarded as a potential risk. The volume of client deposits in this sector has almost tripled over the last three years, but the ratio of non-performing client loans in this segment is also double that in the banking sector.

With regard to the risks identified above, the resilience of the domestic financial system was assessed by means of stress tests on banks, insurance companies and pension funds using three future economic scenarios entitled Baseline Scenario, Asymmetric Developments and Renewed Recession. The Baseline 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 adverse financial market developments.

According to the stress test results, banks and insurance companies are resilient to relevant risks despite the significantly conservative settings of the two stress scenarios. This is due not only to a high initial capital buffer, but also to the ability to generate income even in an adverse scenario. However, if the economy were to develop in line with the alternative scenarios, some institutions would suffer losses which might require capital injections from shareholders. The pension fund sector has limited capital and in the event of financial market turmoil shareholders would have to supply new capital.

Marek Petruš
ČNB spokesman