Vladimír Tomšík (Bankovnictví 28.6.2013 page 3, Top finance 2013)
From the economic perspective, 2012 certainly was a year of disappointment. While at its beginning it looked as if we could finally expect economic recovery, later it became obvious that the Czech economy got stuck from a range of external as well as internal reasons in the recession; the longest one in the modern history of the Czech Republic.
Monetary policy naturally had to respond to the worsening economic outlook with a further decrease in interest rates and as result an unprecedented situation occurred: the CNB two-week Repo rate dropped practically to zero. The decrease of the market rates at the long end of the yield curve was even more distinct – the yields of the Czech government bonds with a ten-year maturity fell under 2%. The interest rates at the short end of the yield curve thus cannot function as a driver of the economy. Instead, the CNB has committed to hold the interest rates at zero for long enough to prevent “undershooting” of the inflation target or even an occurrence of deflation expectations. However, if the zero interest rates and the commitment to hold rates low do not prevent a worsening of the economic situation and a further decrease in inflation, we will be forced to use some other tool. The CNB announced in autumn 2012 already that this other tool would consist of foreign exchange interventions aimed at the weakening of the Czech crown exchange rate. The effect of foreign exchange interventions is strong. Although the GDP has been still decreasing since the beginning of this year, recovery is expected to commence in 2014.
In spite of the protracted recession, 2012 was a positive year for the financial sector, though the year-on-year growth of its balance sheet total reduced due to the decline of economic activity. The banking sector showed increases in capital adequacy, profitability and liquidity. During last year, the volume of client deposits of households was rising, with the highest absolute increments occurring in the segment of small banks thanks to higher average interest rates offered thereby. Regular stress tests document that the banking sector remains highly resistant against negative development scenarios, despite the recession. Banks have at their disposal a cushion of capital, enabling the absorption of negative shocks and keeping the overall capital adequacy of the sector over the 8% regulatory limit even in the case of an extremely negative scenario. They succeeded in regular liquidity stress tests. The sector of insurance companies also showed, thanks to their capital cushion, a sufficient rate of resistance against negative development. The sector of pension funds still remains sensitive to the volatility of their securities prices; however, their resistance boosted compared to the past year, thanks to an increase in capital during 2012.
Although the financial sector remained in good condition last year, it could not remain constantly unaffected by the development in the sector of non-financial businesses and households. The financial sector is exposed to various risks from several sources. First of all there is the fact of the worsening performance and financial position of the business sector. Although credit risk stabilized over the past year, the outlook into future is not too optimistic. The aggravated situation in the area of household income showed only moderately in the size of the credit risk; low-income households nevertheless became highly vulnerable. If the recession protracted, the impacts of the credit risk could non-linearly intensify as the reserve cushions of the equity owned by businesses and households gradually becomes depleted. The CNB does not underestimate this risk and its stress tests factor in possible continuing recession accompanied by “discontinuous” behaviour of businesses and households in the form of repayment of their existing financial obligations.
Another risk consists of the development of real estate prices. There has already been a complete deregulation of rents in the Czech economy, and the sector is therefore fully exposed to the market mechanisms. Both the demographic factors and the protracted recession nevertheless bring the risks of a decrease in real estate prices.
Besides that, there is a risk of so-called chase for yield. We can expect that the record profits of the financial sector will not repeat themselves, since the market interest rates have decreased, the competition within the market has been growing, the charges have been dropping or disappearing and a significant rise in the demand for credits still has not been observed. All of that may result in the financial subjects not only choosing to reduce their costs but, at the same time, boosting their yields at the cost of higher risk acceptance.
An independent development could be observed in the sector of cooperative savings banks. The risk for cooperative savings banks consists mainly in maintenance of relatively hight interest rates on deposits in the present period of low rates, which instigates them to grant risky credits with higher interest rate. The segment of cooperative banks also shows a high concentration of granted credits. In the event of problems with repayment of financial obligations by important clients, this could threaten the stability of the whole sector.
Finally, a risk of its own kind is the wave of new regulation. In the recent years we could witness literally precipitous development in the area of legislation relating to the financial sector. Last year was no exception and it is obvious that we cannot expect any higher stability in this respect. Let us mention at least some changes in the Czech and European legislation. In the past year we could see liberalization in the regime of bond issues, since the assessment of the terms of issue and checking of the issuer’s actions are henceforth the responsibility of creditors and, while the CNB concentrates on supervision of their public offering. In this respect the regime of bonds became similar to the one of shares. Preparatory works for launching of so-called second pension pillar culminated in the past year and since January of this year there has been space for the founding of new pension companies. For the time being, the second pension pillar funds are operated by six pension companies. Along with establishment of the pension companies, the assets and liabilities related to supplementary pension insurance (the so-called third pension pillar) were earmarked for the transformed funds and the property of the pension fund shareholders was thus separated in the accounts from the property of the supplementary pension insurance participants. This was definitely a step in the right direction, outlining the third pillar and shifting it closer to the common standard.
However, important legislative changes were also initiated at the international level. A key decision on initiating changes in supervision over the EU banking sector was adopted in 2012. The European Commission (EC) put forward proposals of a single supervisory system, on the basis of which certain competences would be entrusted to the European Central Bank within the scope of its vigilance supervision. Besides that, the EC introduced a related legislative draft amendment to the European Banking Authority (EBA) regulation. This gave birth to a legislative concept of what has been termed “banking union” since the second half of the past year. The project of the intended banking union is formed of four principal elements: a single European supervision over banks residing in the ECB, single rules for banking regulation, common European system of deposit insurance scheme, and common European system of the banking system recovery and restructuring. Owing to high concentration of the Czech banking sector, the aforementioned intents of the group interest and of a potential solidarity within the group, in the long term, result in certain risks to the Czech Republic consisting not only in the stability of individual banks but mostly in the stability of the whole economy. During the discussions on the proposals, the CNB pushed for preservation of the state where the national supervisory authorities could retain key powers needed for fulfilment of the objective to maintain stability of the financial system as a whole. The CNB’s priorities remain in the maintenance of a balance between responsibility and authority of the separate supervisory bodies aimed at preservation of the Czech banking sector stability, in the possibility to refuse obligatory participation in sharing of costs and resources for EU banks recovery and restructuring, in maintenance of the domestic market integrity, and in equilibrium of voting procedures in the European Banking Authority. The consequences of these legislative changes as well as of the newly adopted directive on capital requirements (CRD IV) will nevertheless become evident in our financial sector later in the next years. This directive enables the national regulatory authority to set out requirements for the domestic banks depending on their size and importance. The national regulator has right to set additional capital surcharges for the banks playing key role in the system. Considering the dominant role of banks within the Czech financial sector and the high concentration of the Czech banking sector, the CNB is ready to apply these capital surcharges in order to maintain stability. The CRD IV directive and the CRR regulation will in future enable national supervisory authorities to apply some other, formerly unavailable, macro-vigilance instruments.
In the coming years we can nevertheless expect some major legislative changes prepared on the “home battlefield” too. The new Business Corporations Act approved in 2012 will come into force next January and will present a change which all the market participants will have to get used to. The area of collective investment may await a major change in form of the Act on Investment Companies and Investment Funds (AICIF), which is about to replace the existing Act on Collective Investment. The AICIF will present substantial extension of the product offer, important changes in the area of the fund administration and in the area of free movement of financial services as well as significant changes in the responsibilities of CNB, related mainly to the issue of entering the sector.
To summarize the situation, we are navigating through legislative and regulatory heavy seas. The new regulation is so complex that, in many cases, it is impossible to think of what impact it would really have on the financial sector. The CNB makes efforts to weigh carefully even the “unintended” impacts of the new regulation and to ensure stable functioning of the financial market in the Czech Republic.