Uncertainties do not inevitably mean problems

Zdeněk Tůma (Top finance page 1, annex Bankovnictví 23.5.2008, Ekonom 22.5.2008)

Despite the many uncertainties currently relating to the world economy and financial markets, the Czech financial sector once again recorded substantial growth in most segments last year. Financial institutions in the Czech Republic have also shown a high level of resistance to the problems affecting many players on the developed world markets connected with the American subprime mortgage crisis. The Czech National Bank has not yet observed any substantial or direct effect of this crisis on the Czech financial system. This can be attributed to the minimum engagement of Czech financial institutions in structured investment instruments derived from risky mortgages and to the high liquidity of the Czech banking sector, which reduces banks’ reliance on loans from the interbank market. However, with market cohesion and the dominant ownership position of foreign capital in Czech institutions, it is essential for financial market players and supervisory authorities to continue exhibiting a high level of prudence.

MONETARY POLICY

The unrest on world markets since the second half of last year is also having an indirect effect on the CNB’s monetary policy decision-making on its main objective - sustaining price stability. There is uncertainty concerning what the overall effects of the American mortgage crisis will be on the Czech Republic’s main business partners. Thus, to a certain extent, this factor is inhibiting the growth of inflation expectations triggered by the government measures adopted last year related to stabilising public budgets and by the recent global rise in food prices. Accordingly, the Bank Board tightened the CNB’s monetary policy last year with several interest rate hikes. These measures were justified mainly by the fact that the robust economic growth in the Czech Republic, which has continued for several years, together with the record figures for employment and wage growth, had increased consumption, especially household consumption. This, in turn, was putting upward pressure on prices. Despite the current rise in inflation, the Czech National Bank will attempt to preserve the low-inflation environment in the Czech Republic. In this respect, it is worth mentioning that the Bank Board agreed in March last year to a change in the CNB’s inflation target, as expressed by the year-on-year rise in the consumer price index, from 3% to 2% with effect from January 2010. Effective from the beginning of this year, we have also agreed to publish the nominal voting of the Board Members during monetary decision-making and the interest rate path consistent with the macroeconomic forecast. In this way, further improvements in the central bank’s transparency and responsibilities can be monitored while meeting its main objective. In addition, the Bank Board decided to reduce the number of regular monetary policy meetings starting this year from 12 to 8 per year.

FINANCIAL SECTOR RESULTS

The positive Czech economic performance in 2007 (a rise in GDP of 6.5%) contributed to further development of the Czech financial market. All of the most important sectors experienced growth in the volume of assets managed and very positive economic results last year. The net profit of the banking sector increased by 23.4% year on year, reaching CZK 47.1 billion. The favourable economic situation for banks is mainly due to steady growth of loans, especially housing loans for the private sector and also a rising volume of business loans. The balance sheet total of the banking sector reached CZK 3.7 trillion. Credit unions last year generated a profit of CZK 83.8 million, while the balance sheet total of this sector was approximately CZK 9 billion. In the insurance sector, total assets rose by about 7% to CZK 345 billion. In addition, according to preliminary figures, insurance companies registered a favourable net profit of CZK 12.8 billion, similar to the previous year. The growth rate of premiums written almost doubled against the previous period, to 8.8%. The positive trend in premiums written relates, in particular, to life insurance. The volume of assets invested in Czech collective investment funds increased by 10.6% year on year to CZK 173 billion. Pension fund assets rose by 14.5% to CZK 167.2 billion. Clients’ managed funds amounted to approximately CZK 2 trillion. Overall in 2007, transactions made on Czech regulated markets amounted to more than CZK 1.5 trillion. The Czech capital markets managed to maintain a significant growth rate despite the unexpected developments affecting world markets.

SUPERVISION AND REGULATION

Last year, when evaluating the integration of the financial market supervisory authorities into the central bank in 2006, I commented that the integration of supervision and regulation of the financial market was perceived as a continuous process at the CNB. This process should work towards the goals of development and stability of the financial market, while reducing the regulatory costs of participants, and foster high transparency and effective decision-making by the supervisory authorities. Therefore, the debate on the optimal internal organisational structure for financial market supervision at the central bank continued in 2007. The result was that the Bank Board decided as of 1 January 2007 to abandon the sectoral organisational setup dividing the supervision of credit institutions, the capital market and insurance companies, and to switch over to a functional model. The basis for this new model is the creation of three new sections for the financial market as a whole, i.e. regulation and analysis, administrative proceedings with financial market participants, and off-site and on-site supervision. This organisational change is a necessary step towards harmonising the regulatory rules and integrating supervisory practice across the financial market. To increase the predictability and public responsibility relating to the decision-making of the supervision authorities, a document entitled The Mission of the Czech National Bank for the Supervision of the Czech Financial Market was written and published at the end of last year. This document formulates the basic goals, principles and rules that the CNB intends to implement in its regulatory and supervisory activities. Looking to the future, I can see many challenges in front of us. One very topical issue is to firmly establish supervision of certain regulations for the protection of consumers on the financial market from an organisational and functional standpoint - a task recently entrusted to the central bank. With some delay, the new Markets in Financial Instruments Directive will also come into force in the Czech Republic. With respect to the planned pension reform, attention must also be given to the pension fund sector, a sector that has been growing in importance in recent years. The regulations for this sector must be set so that a firm third pillar can be created for the pensions of an ageing population. In a European or even global context, discussions are taking place on the reformulation of rules for the cross-border supervision of international financial institutions and groups. In the light of the most recent, rather disheartening news from the important financial centres, the demands to strengthen the powers of domestic regulators with respect to host authorities may not seem to be entirely justified.

SUMMARY At present, the Czech National Bank is exposed to a number of uncertainties and risks when performing its most important functions, i.e. monetary policy-making and financial market supervision. The situation, of course, is no different for financial market participants. The current macroeconomic and microeconomic developments, together with the internal and external pressures to comply with the regulatory rules of prudent business on the financial market, are a necessary condition for preventing the existing uncertainties from becoming real problems.

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