Robert Holman (Ekonom 20.5.2010, Top finance - introduction)
Without any doubt, the Czech financial sector will provide support for the economic recovery in the period ahead. The banking system, which is the core of the entire financial system, remained stable throughout the crisis and required no financial support from the government or the central bank, unlike in many other countries.
During the global boom, Central and Eastern European countries, including the Czech Republic, experienced noticeably higher rates of economic growth than the euro area average. The financial crisis triggered by the fall of Lehman Brothers in 2008 did not affect the Czech Republic directly. However, it meant an unexpected external shock in the form of a rapid decline in demand for Czech exports and a sudden and sizeable decrease in the inflow of foreign capital. The Czech koruna responded to this shock by depreciating significantly in the first months of 2009. The subsequent trend of renewed appreciation of the Czech currency is proof that confidence has been maintained in the stability of the Central European region, and above all the Czech economy, which has done well in the crisis despite a number of domestic problems.
INDICATOR OF FINANCIAL HEALTH
One of the indicators of the Czech economy’s financial soundness is its stable financial sector, which performed well during 2009 despite the financial crisis and remains in a very good position, a fact confirmed by banking sector stress tests conducted regularly by the Czech National Bank. These stress tests have proved that the Czech banking sector would withstand the shocks in all three alternative scenarios. The traditionally high capital adequacy ratio of the banking sector was not jeopardised even during the financial crisis. At the end of 2009, the sector’s regulatory capital in fact rose by CZK 33.8 billion (14.7%) year on year and no domestic bank reported a capital adequacy ratio below 10% during the year. As usual, the most important factor was the retention of part of the previous year’s profits in banks’ capital in the form of retained earnings. Thanks among other things to a very low share of bad assets and risky investments in securitised instruments, the Czech banking sector maintained high profitability in 2009 (net profit was CZK 60.3 billion, up by CZK 14.5 billion on a year earlier) despite its traditional focus on the conservative business model. Interest profit is the most important component of the total profit of Czech banks. Although the 2W repo rate is a full 2.50 percentage points lower than at the end of 2007, the average rate on new loans to non-financial corporations fell only by around 1.16 percentage points. As expected, banks responded to the increase in business risk during the recession by raising the risk premium. The higher interest rate spread manifested itself very quickly, as loans with a floating rate and interest rate fixation of up to one year represent around 95% of all loans to businesses.
EFFICIENT FINANCIAL SECTOR REGULATION
The very low foreign currency debt of Czech economic agents also contributed to the stability of the financial sector. The share of foreign currency loans in total loans in the Czech Republic stood at 8.8% at the end of 2009. For Czech households, this indicator is a mere 0.1%, meaning that Czech households have virtually zero foreign currency debt. The financial crisis and the significant losses on the high risk exposures of foreign banks, which control most of the Czech banking sector, generated concerns about possible transfers of liquidity from Czech subsidiaries to foreign parent companies. These concerns did not materialise, owing among other things to effective regulation of the Czech financial market, which traditionally focuses on risk management and control mechanisms in bank and non-bank institutions. Drawing on the experience of individual countries with plans to rescue banking sectors hit by significant losses, the CNB together with the Ministry of Finance prepared a preventive amendment to the Act on Banks which allows the central bank as the financial market supervisor to respond flexibly to possible, albeit unlikely, problems in banks, for example in the area of balance sheet liquidity or problems due to the accumulation of losses stemming from credit risk.
LIMITED IMPACT OF LOSSES
Without any doubt, the Czech financial sector will provide support for the economic recovery in the period ahead. The banking system, which is the core of the entire financial system, remained stable throughout the crisis and required no financial support from the government or the central bank, unlike in many other countries. Just as before the financial crisis, the strengths of the Czech banking sector are good balance sheet liquidity, sufficient capital adequacy, high profitability, independence from external financing (stemming to some extent from an extraordinarily high deposits-to-loans ratio, which will allow banks to meet the private sector’s demand for loans in the recovery period) and a very low share of foreign currency loans, which protects domestic borrowers against foreign exchange risk. The last two characteristics in particular give the Czech banking system an advantage not only over Central European countries, but also over the EU as a whole, and are significantly reducing the impact of losses stemming from adverse economic developments on banks’ financial soundness.