The Czech financial sector successfully copes with crisis thus far

Mojmír Hampl (Ekonom 21.5.2009, Bankovnictví 22.5.2009)

In 2008, the culminating financial turbulence brought about relatively dramatic events in a number of world economies. In particular, the failure of the US investment bank, Lehman Brothers, last September significantly increased the lack of confidence in the interbank markets around the world. In an attempt to alleviate the situation, central banks in many countries began to gradually introduce new, non-standard instruments to their arsenals. In some countries, the first signs of an unusually rapid and strong recession also appeared. Certain problems could not be avoided in the Czech financial system either. During the year, risk premiums on the money market gradually increased, and there was a temporary decline in liquidity on the government bond market. However, fears that the problems of foreign parent companies would spill over to the Czech banking sector were not confirmed, thanks, among other things, to the regulatory restrictions on the volume of liquidity transferred from Czech subsidiaries to foreign parent banks.

UNWARRANTED FEARS

Though similarly unsubstantiated, fears to the contrary had paradoxically begun to spread over time, i.e. Czech and Central and Eastern European banks in general could be a threat to their Western European parent companies should the regional economies experience problems. At least in the case of the Czech Republic, the propagators of these fears – certain journalists, analysts and unfortunately even some international institutions – seemed to have forgotten that banks in the Czech Republic are, for the most part, subsidiaries of foreign parent companies and that Czech subsidiaries are exclusive lenders to their parent banks. The difficulties faced by these subsidiaries could only have an indirect impact on the financial health of their parent companies, such as negative effects on their reputation or lower dividends. However, any direct impact through a decline in the value of assets or a decrease in the capital of the parent banks would be very unlikely. In addition, it was necessary to stress when communicating with the foreign media and investors that the financial situation with respect to the public and private sector is very different in various countries of Central and Eastern Europe. While, for instance, the recent popularity in Hungary or the Baltic states of granting loans in foreign currencies made the financial situation of debtors very sensitive to changes in the exchange rates, no similar trend had occurred in the Czech economy.

IMPACT ON THE FINANCIAL SECTOR

Consequently, the world financial crisis did not have a very strong direct effect on the Czech banking sector. One risk for the upcoming period, however, is the indirect effect of the recession brought on by the crisis. The growing number of insolvent firms and households has led to an increase in outstanding debts. Certain signs that banks and their clients had been preparing for this situation were already evident in 2008, when growth in lending in the Czech Republic had slowed by the end of the year to 16.4%. The share of outstanding loans in total loans at the end of 2008 was 3.3%, which is an increase of 0.6 of a percentage point over the previous year. However, this is still a relatively low figure. The CNB’s forecast accounts for a certain decline in the Czech economy. Nevertheless, this should only be a temporary effect resulting in particular from lower foreign demand, which is a key factor for the very open Czech economy. From the standpoint of meeting the CNB’s inflation target, which will be at 2% in January 2010, the anti-inflationary effects of an economic decline should be set off by the inflationary character of the exchange rate, which has recently been at weaker levels.

LESS IMPACT ON INSURANCE COMPANIES

The effects of the world financial crisis on the insurance sector were less visible last year than on the banking sector. Nevertheless, even this important segment of the financial market was not totally immune to the impact of the crisis. Prescribed premiums rose year-on-year by 5.2%. Life insurance grew by 5.1%, and non-life insurance registered an increase of only 0.2 of a percentage point lower. According to the audited results for 2008, insurance companies’ own funds were at the required level of solvency or higher. Aggregate disposable solvency, as defined in the current regulations, reached 2.7 times the required solvency on the life insurance market and 3.3 times on the non-life insurance market. Average return on earnings of 14% and average return on assets of 2.7% supported the financial stability of insurance companies. On the other hand, the rapid rise in costs for drawing up contracts should be mentioned. Last year’s slowdown in growth in the volume of resources in the pension system to 15%, down from a rate of 19% in the previous year, had in all probability little correlation to the financial crisis. The resources invested in supplementary pension funds by participants at yearend 2008 amounted to CZK 186.7 billion, which is approximately 5% of GDP. As a part of the legislation regulating pension funds, 87% of the resources of participants’ resources were invested in bonds issued by government institutions, deposits at domestic banks, and other bonds. Investment in shares and participation certificates amounted to 6.2%. It is no secret that investments in shares and certain bonds had registered an overall loss in 2008. The capital increases made by the fund shareholders during 2008 were, therefore, desirable. A key factor for the whole sector will be the development of bond prices this year.

MOST AFFECTED SEGMENTS

One of the segments of the Czech financial market most affected by developments abroad was mutual funds. The fears of shareholders from the continued decline in the prices of shares led to a situation in which the total value of the funds of the purchased participation certificates in 2008 exceeded the overall value of sold participation certificates by CZK 29 billion. Traders in non-banking securities were also significantly affected and had to cope with a decline in loans and other client receivables of more than 60%. However, the capital adequacy of nonbanking traders was at a sufficient level of 23.3%. The leasing segment experienced a certain decline in 2008, and yearonyear growth of loans for leasing reached only 5.6% (in comparison with 16.4% for bank loans). This was related to the impact of restrictions on tax benefits for leasing finance. Consumer loans, instalment loans, and credit card loans from other credit institutions increased yearonyear by 16% (while the growth rate of bank consumer loans was 20%). Although non-banking credit institutions do not fall under the direct supervision of the CNB, many of them are controlled by banks or other large financial institutions. It can be said overall that the financial crisis had affected the Czech financial sector in relatively good condition. After our neighbouring main business partners have recovered from the recession, which will hopefully be in 2010, the Czech economy and its “financial backbone” should return to its former level of health and stable growth. We can only hope that the economy comes out of the crisis without any visible wounds or scars.

Macroeconomic data

Average Gross Monthly Wage of Employees in the Banking and Insurance Business in the Czech Republic (in CZK)