No. 11 Year 6 VII 2013 ISSN (online)

Transcription

1 No. 11 Yer 6 VII 13

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3 Finncil Stbility No. 11, Zgreb, July 13

4 PUBLISHER Crotin Ntionl Bnk Publishing Deprtment Trg hrvtskih velikn 3, 1 Zgreb Phone: Contct phone: Fx: Those using dt from this publiction re requested to cite the source. ISSN (online)

5 Contents Introductory remrks 5 Overll ssessment of the min risks nd chllenges to finncil stbility policy 7 Mcroeconomic environment 9 Box 1 Systemic risk indictors 18 Government sector Household sector 6 Rel estte sector 9 Non-finncil corporte sector 31 Box Models of bnk finncing in the corporte sector 35 Bnking sector 39 Box 3 Mrket power nd stbility of bnks in the countries of Centrl nd Estern Europe 6

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7 Introductory remrks Finnce plys key role in the lloction of resources, i.e. the process of trnsforming svings into investments, nd therefore into economic growth nd n increse in the overll level of socil welfre. At the sme time, becuse finncil stbility is bsed on the confidence of finncil mrket prticipnts, it lrgely depends in turn on their perceptions nd behviour, which re subject to cyclicl swings. As finncil crises crete considerble economic nd socil costs, the mintennce of finncil stbility hs the chrcter of public good nd is thus n importnt economic policy objective. Finncil stbility is chrcterised by the smooth functioning of ll finncil system segments (institutions, mrkets, nd infrstructure) in the resource lloction process, in risk ssessment nd mngement, pyments execution, s well s in the resilience of the system to sudden shocks. This is why the Act on the Crotin Ntionl Bnk, in ddition to the min objective of the centrl bnk mintennce of price stbility nd monetry nd foreign exchnge stbility lso lists mong the principl centrl bnk tsks the regultion nd supervision of bnks with view to mintining the stbility of the bnking system, which domintes the finncil system, s well s ensuring the stble functioning of the pyment system. Monetry nd finncil stbility re closely relted, for monetry stbility, which the CNB ttins by the opertionl implementtion of monetry policy, performing the role of the bnk of ll bnks nd ensuring the smooth functioning of the pyment system, lowers risks to finncil stbility. At the sme time, finncil stbility contributes to the mintennce of monetry nd mcroeconomic stbility by fcilitting efficient monetry policy implementtion. The CNB shres the responsibility for overll finncil system stbility with the Ministry of Finnce nd the Crotin Finncil Services Supervisory Agency (HANFA), which re responsible for the regultion nd supervision of non-bnking finncil institutions. Furthermore, owing to the high degree to which the bnking system is interntionlised, s reflected in the foreign ownership of the lrgest bnks, the CNB lso coopertes with the home regultory uthorities nd centrl bnks of prent finncil institutions. The publiction Finncil Stbility nlyses the min risks to bnking system stbility stemming from the mcroeconomic environment of credit institutions nd the sitution in the min borrowing sectors, s well s credit institutions bility to bsorb potentil losses should these risks mterilise. Also discussed re CNB mesures to preserve finncil system stbility. The nlysis focuses on the bnking sector, due to its predominnt role in finncing the economy. The purpose of this publiction is systemticlly to inform finncil mrket prticipnts, other institutions nd the generl public bout the vulnerbilities nd risks thretening finncil system stbility in order to fcilitte their identifiction nd understnding s well s to prompt ll prticipnts to undertke ctivities providing pproprite protection from the consequences should these risks ctully occur. It lso ims t enhncing the trnsprency of CNB ctions to ddress the min vulnerbilities nd risks nd strengthen the finncil system s resilience to potentil shocks tht could hve significnt negtive impcts on the economy. This publiction should encourge nd fcilitte broder professionl discussion on finncil stbility issues. All this together should help mintin confidence in the finncil system nd thus its stbility. Finncil Stbility 5

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9 Overll ssessment of the min risks nd chllenges to finncil stbility policy Figure 1 Finncil stbility mp Finncil system resilience Actul/optiml interntionl reserves Euroistion Stress test Z-score EU-7 economic growth Economic growth in the RC EU interest rtes Mcroeconomic environment EMBI Croti Blnce of pyments current ccount The risks to finncil stbility deriving from the interntionl finncil system hve reduced, while weknesses in the rel sector hve tended to increse the risks. The bnking system is highly cpitlised nd is cpble of withstnding even strong, not very likely shocks, nd the level of interntionl reserves is sufficient to cushion ny possible externl shocks. Growth dynmics of corporte nd household debt Net externl debt/gdp Corporte debt/gdp Household debt/income Public debt Vulnerbility of the economy 1 13 The min indictors of finncil stbility in Croti re summrised in Figure 1. The finncil stbility mp shows the chnges in the min indictors of the likelihood of risks rising tht relte to the domestic nd the interntionl mcroeconomic environment nd the vulnerbility of the domestic economy, s well s indictors of the resilience of the finncil system tht could eliminte or reduce costs in the event of these risks mterilising. The mp shows the most recent developments or projections of selected indictors nd their vlues in the reference periods. Incresed distnce from the centre of the mp for ech vrible indictes rise in risk or the vulnerbility of the system, tht is, of diminution of its resilience, nd ccordingly greter thret to stbility. Any increse in the re of the mp, then, indictes tht the risks for the finncil stbility of the system re incresing, while diminution of the re suggests they re slckening. Finncil Stbility 7

10 Overll ssessment of the min risks nd chllenges to finncil stbility policy The resilience of the finncil system hs remined t high level. Risks to finncil stbility from the interntionl finncil system hve reduced, but the weknesses in the rel sector hve cted in such wy s to increse the risks. The expected rtes of growth in Croti nd in the min trding prtner countries in 13 hve fllen, nd grdul recovery is expected only t the end of the yer. On the other hnd, the decline in risk premiums in the interntionl finncil mrkets nd the very low reference interest rtes enble the Republic of Croti to borrow t reltively cceptble rtes. Nevertheless, it is importnt to point out tht the position of Croti reltive to similr sttes hs deteriorted, nd comprison of risk premiums shows tht the mrkets perceive Croti s being ttended by more risks thn most of the countries of Centrl nd Estern Europe. This is cused primrily by the reltively weker performnces of the economy in the pst few yers, which hs frustrted the implementtion of fiscl djustment nd led to rise in the public debt. In the lst few yers, public debt hs been rising with incresing speed nd hs pproched the of GDP level to which it is tied by the Budget ct, nd which is lso one of the criteri for joining the eurozone. The chllenge for economic policy mkers is still the implementtion of reforms enbling n increse in the rte of growth over the medium term, nd thus keeping public debt t sustinble level, while voiding the negtive short-term effects of fiscl djustment. Such n economic policy will tend to bring down risk premiums, nd the positive effects of such reduction will be felt by ll domestic sectors for the cost of borrowing will come down. For sustinble greter rtes of growth it is necessry to increse exports, for in conditions of reltively high externl debt, it is not relistic to found economic growth on domestic consumption. The unsustinbly high deficit in the current ccount of the blnce of pyments from the pre-crisis period ws eliminted, s result of the fll in imports becuse of reduced income nd rise in privte sector svings. A rise in externl debt ws thus hlted, nd foreign risks were contined. The need to retin deficit in the current ccount t considerbly lower level thn those of the pre-crisis period thus implies tht growth of exports hs to be trnsformed into the principl genertor of future economic growth. Contrction of domestic demnd, fter period of long-term unsustinble growth in foreign debt nd credit in the period before the crisis, is reducing the demnd for bnk lons. In conditions of incresed uncertinty on the lbour mrket, the household sector deleverges. Although the reduction of consumer optimism hs been diminished, deleverging will probbly continue until there re visible improvements on the lbour mrket. the yer. For the moment this trend is to quite lrge extent concentrted on firms tht hve foreign owners, which re the most desirble source of finncing in period of tightened credit stndrds nd reltively high prices for credits from domestic bnks. Nevertheless, it is importnt to point out tht for ny considerble rise in corporte optimism nd the concomitnt rise in demnd for lons, which t the present time continues to be wek, there need to be clerer indictions of recovery of demnd for their products nd services on the domestic nd foreign mrkets. In the bnking sector the process of grdul reduction of foreign libilities in conditions of reduced demnd, incresed risks on the domestic mrket nd high levels of liquidity hs continued together with grdul introduction of the model of finncing by domestic deposits in the subsidiries of big Europen bnks tht operte in the Centrl nd Estern Europe. Still, the dynmics of this progress were considerbly toned down in 13. The process hs lso ffected the reduction of the likelihood of renewing the finncing of long-term insolvent debtors (whom only the persistent renewl of bnk lons hs sved from insolvency). We hve lredy wrned of the negtive consequences of this kind of finncing in this publiction (Box Ptterns of corporte loning in crisis conditions, Finncil Stbility, No. 6, Jnury 11), nd we re still monitoring chnges in these reltions (Box Models of bnk finncing in the corporte sector). Still reltively long nd expensive judicil proceedings hve n dverse effect on the process of recognising nd collecting on non-performing lons. On the other hnd, the current processes of pre-bnkruptcy rrngements nd chnges in the rules concerning the clssifiction of plcements, s well s the expected shortening of judicil procedures fter entry into the EU, will in the coming period speed up the recognition nd collection of non-performing lons. Stopping the prctice of renewing the lons of bd debtors should result in the movement of cpitl to new nd profitble projects, in the medium term mitigte the problem of non-performing lons nd hve positive effect on the cretion of dded vlue in the economy. Although this process is pinful for the bnks in the short term, becuse of the reduction of current profitbility, in the medium term it will give rise to more stble nd profitble bnking system. From the point of view of finncil stbility, it is importnt to point out tht the profitbility nd cpitl dequcy of the bnking system, which ws ccumulted in timely mnner before the crisis, re sufficient for the grdul implementtion of the process described, nd the conducted stress test hs shown tht the bnking system is lso cpble of withstnding possible if not very probble lrge mcroeconomic shocks. Privte non-finncil compnies provide slight bsis for optimism, hving registered grdul increse in borrowing during 8

11 Mcroeconomic environment Notwithstnding certin improvement on the finncil mrkets nd in bnking, the prolongtion of the recession in the eurozone is the min source of risk for finncil stbility nd is t the sme time constrint on the recovery of domestic economy founded on exports. The bsence of ny economic recovery in the eurozone is the min source of risks to finncil stbility. ECB ctivities imed t stbilising the sovereign bond mrket nd estblishing bnking union clmed the finncil mrkets (Figures, 5, 6 nd 7); nevertheless, risks to finncil stbility in the eurozone re still gret nd on the whole derive from the prolongtion of the recession which cretes risk of dditionl losses in bnk blnce sheets nd hinders fiscl consolidtion (Tbles 1 nd ). Additionl uncertinty derives from the difficulties in formtion system for the hndling of problemtic bnks nd the problems of implementing reforming policies in the peripherl countries becuse of rising socil nd politicl tensions. Also present re the pro-cyclicl effects of the introduction of Bsel III nd the nchoring of mrket plyers to the new stndrds, which encourge bnks to increse cpitl dequcy in dverse mrket conditions. These events enhnce the process of bnk deleverging, which hs negtive effect on lons nd economic recovery. The recovery of the eurozone economy from wht is clled blnce sheet recession typicl of period fter finncil crisis is extremely long nd difficult. The process is excerbted by the simultneous deleverging of the privte sector nd the necessity for fiscl consolidtion in the peripherl countries, which becuse of the lck of fiscl spce hve to run procyclicl fiscl policy, s well s the bsence of mechnism Finncil Stbility 9

12 Mcroeconomic environment Tble 1 Economic growth, exports nd industril production in selected developed nd emerging mrket countries Annul GDP growth rte Qurterly GDP growth rte, Q t /Q t-1 Annul rte of chnge in exports of goods Annul rte of chnge in industril production (sesonlly djusted) Q/1 Q1/13 Q/1 Q1/13 Q/1 Q1/13 USA EU Germny Itly Sloveni Slovk R Czech R Polnd Hungry Estoni Ltvi Lithuni Bulgri Romni Croti b Forecst. b The sesonl djustment methodology of Croti's GDP hs been presented in the mnuscript titled Description of the X-1 sesonl djustment methodology tht is vilble t request. Sources: Eurostt, CBS, Bloomberg, OECD nd CNB (for Croti). for coordinting economic policies cpble of ensuring fiscl expnsion in the countries of the eurozone tht hve the necessry fiscl spce (Tbles 1, nd 3). In such conditions the only impulse to eurozone recovery in the rel sphere cn come from the improvement of externl blnces, which is not enough for ny very strong recovery, becuse of the considerble imblnces within the eurozone nd the ggregte surplus in current ccount blnces in the eurozone. In ddition, this process hs on the whole to dte unfolded vi contrction of the imports of the peripherl Europen countries, while potentil growth cn be strengthened only by n expnsion of their exports (Tble ). Aprt from the insufficient structurl reforms cpble of incresing competitiveness, prticulrly in the non-price segment, slow export growth is lso ffected by the wekening of economic growth in Chin, Russi nd other lrge economies. uthorities in the USA nd Jpn is hving positive effect on rel economic ctivity in these countries. But t the sme time concern is growing tht such policy cn result in overheting on the finncil mrkets nd bring bout gp between sset prices nd economic fundmentls, which in consequence cn increse the probbility of the outbrek of new finncil crisis (Tble 1, Figure 3). Figure Business nd consumer confidence indices index points Eurozone business confidence index Eurozone consumer confidence index 7 5 US business confidence index Crotin consumer confidence index right 8 16 index points A long-term solution of the crisis requires much higher level of economic nd politicl integrtion. Mitigtion of the usterity policy in the over-indebted countries, which hs been prtilly implemented by extending the dedlines for fiscl consolidtion, could possibly hve short-term positive effects on demnd nd growth. But for sustinble long-term growth, it will be necessry to plce the debts of hevily indebted countries under supervision /6 5/6 9/6 1/7 5/7 9/7 1/8 5/8 9/8 1/9 5/9 9/9 1/1 5/1 9/1 1/11 5/11 9/11 1/1 5/1 9/1 1/13 5/ Expnsion of the blnce sheets of the min centrl bnks helps recovery, but lso increses the risk of future finncil crisis. The ggressive esing of the policy crried out by the monetry Sources: Bloomberg nd CNB. 1

13 Tble Fiscl blnce nd current ccount blnce in selected developed nd emerging mrket countries Fiscl blnce, s of GDP (ESA 95) Current ccount blnce, s of GDP USA EU Germny Itly Portugl Irelnd Greece Spin Sloveni Slovk R Czech R Polnd Hungry Estoni Ltvi Lithuni Bulgri Romni Croti Forecst. Sources: Europen Commission, Europen Economic Forecst, spring 13 nd CNB (for Croti). Tble 3 Public nd externl debt in selected Europen emerging mrket countries s of GDP Public debt Externl debt Itly Portugl Irelnd Greece Spin Sloveni Slovk R Czech R Polnd Hungry Estoni Ltvi Lithuni Bulgri Romni Croti Forecst. Sources: Eurostt, World Bnk, Qurterly Externl Debt Sttistics nd CNB (for Croti). Figure 3 Key interest rtes of the min centrl bnks nd leding mrket interest rtes Fed EONIA ON USD LIBOR Sources: Fed, ECB nd Bloomberg. ECB 6M EUR LIBOR Fed benchmrk rte forecst ECB benchmrk rte forecst 1/7 5/7 9/7 1/8 5/8 9/8 1/9 5/9 9/9 1/1 5/1 9/1 1/11 5/11 9/11 1/1 5/1 9/1 1/13 5/13 9/13 1/1 5/1 Figure CDS spreds for 5-yer bonds of selected eurozone countries bsis points Portugl Greece right /9 5/9 Belgium Spin Irelnd Itly Credit defult swps (CDS) spred is n nnul premium tht CDS buyer pys for protection ginst credit risk ssocited with n issuer of n instrument. 1/1 Source: Bloomberg. 9/9 1/1 5/1 9/1 1/11 Figure 5 CDS spreds for 5-yer bonds of selected bnks Unicredit S.p.A. Intes Snpolo S.p.A. Commerzbnk 5/1 Source: Bloomberg. 9/1 1/11 5/11 5/11 Deutsche Bnk Société Générle Bnco Sntnder 9/11 1/1 9/11 5/1 1/1 5/1 9/1 1/13 BNP Pribs Riffeisen Zentrlbnk 9/1 1/13 5/13 5/ bsis points bsis points Finncil Stbility 11

14 Mcroeconomic environment Figure 6 CDS spreds for 5-yer bonds of selected emerging mrket countries 1/8 1/7 Bulgri Czech R. Croti Hungry Polnd Romni Sloveni 5/8 9/8 Source: Bloomberg. 1/9 5/9 9/9 1/1 Figure 7 EMBI spreds EMBI Europe EMBI globl EMBI Croti 5/1 5/7 9/7 1/8 5/8 9/8 1/9 5/9 9/9 1/1 5/1 9/1 1/11 5/11 9/11 1/1 5/1 9/1 Source: J. P. Morgn. 9/1 Figure 8 Yields on Crotin nd benchmrk Germn bonds mturing in 18 nd their spred 5/7/11 1/11 Yield on Crotin eurobonds Yield on Germn bonds Yield spred between Crotin eurobonds nd Germn bonds 9/9/11 Source: Bloomberg. 1/11/11 19/1/1 5/3/1 3/5/1 /8/1 5/11 9/1/1 9/11 1/1 1/1/1 5/1 18//13 9/1 1/13 1/13 5//13 5/13 1/13 3/6/ bsis points bsis points bsis points In its endevours to help in the wy out from the recession the ECB, s well s offering progrmmes for expnding blnce sheets, hs reduced its key rte of interest, but hs not mnged to re-estblish the functioning of trnsmission mechnism, nd finncil mrkets in the eurozone hve remined frgmented, which holds up recovery (Figure 3). The nnouncement of the possibility of the introduction of outright monetry trnsctions (OMT), lthough they hve not relly been implemented, ided by the decision to estblish bnking union, mnged to convince the mrkets tht investment in the bonds of peripherl countries ws less risk-lden. This resulted in fll of the risk premium nd yields on sovereign bonds nd smller short-term oscilltion connected with the crisis of the Cypriot bnking sector (Figures nd 5). This hs been ided by blncing of externl blnces of the peripherl countries, which shows tht budget deficits, s long s there is no cpitl outflow, could be finnced t the expense of domestic sector surpluses without resorting to ny considerble net finncing from brod (Tble ). The trends described lso resulted in fll in the costs of finncing for mjor corportes, but interest rtes on lons to smll nd medium-sized firms in the peripherl countries re still high. The ECB ccordingly is endevouring to find new models with which to incentivise the flow of lons to tht sector nd thus set off the recovery of ctivities nd employment. Recent inititives for chnnelling considerble resources in the form of fvourble EIB lons to smll firms nd youth employment re imed in the sme direction. Wek lon ctivities re lso ffected by the fct tht good del of the bnking sector in the eurozone is still burdened with nonperforming lons tht continue to grow becuse of the recession, which discourges bnks from relxing lon conditions. This is excerbted by the demnds of regultors for n increse in bnk cpitlistion, concomitnt with simultneous megre supply of long-term cpitl, which encourges bnk deleverging. The poor supply of long-term finncing to bnks is prtilly ffected by the model for solving the Cyprus bnking crisis, which, so s to mintin the long-term sustinbility of the public debt, involved not only shreholders nd bond holders in covering the losses, but lso unsecured deposits. This mnner of resolving the bnking crisis ws interpreted by mrkets s probble sign of the forms of future mechnisms for resolving bnking crisis t EU level. For this reson for further clming of the finncil nd economic crisis in the eurozone the solution tht by the middle of 13 will supplement the proposl for single resolution mechnism for bnks in difficulties will be of gret importnce. It should provide cler imge s to who will ber the burden of resolving bnk insolvency, nd lso determine the connection between the bnk system nd public finnces in individul countries Compromise proposls im t strong relince on the involvement of shreholders nd creditors ( bil-in, s it is clled), with protection of deposits, nd, if necessry, finncing from common fund. It seems tht, in ddition to the legl problems, the gretest obstcles for finding solution re of politicl chrcter, which reflect in ddition to dy to dy politicl fctors the still 1

15 unresolved problems of long-term vision for the eurozone nd the EU nd disgreements bout the level of fiscl nd politicl integrtion up to which member sttes re redy to trnsfer their ntionl sovereignty to the common Europen institutions. In such conditions, bnks from the eurozone continue to be restrined in the finncing of the needs of Europen countries from the emerging mrkets. Hence minly to be credited with slight rise in the flow of cpitl is n incresed inflow of portfolio investment of globl investors in serch of higher yields in conditions of wsh of liquidity on the min world mrkets (Figure 9). Figure 9 Cpitl inflows to Europen emerging mrket countries Investment of commercil bnks, net Direct equity investment, net Portfolio equity investment, net Investment of other privte creditors, net billion EUR At the sme time bnks re chnging their operting models in the region of SE Europe, mking subsidiry bnks more relint on domestic finncing. This results in grdul reduction of the exposure of prent bnks from the eurozone to their subsidiries, on the whole by the reduction of lons nd deposits, but only in rre cses by cpitl withdrwl. In conditions of reduced demnd for lons, this does not hve t the present time ny very considerble negtive effects on the supply b 1 b Estimte. b Forecst. Source: Interntionl Institute of Finnce, Cpitl Flows to Emerging Mrket Economies, Jnury 13. Figure 1 Foreign cpitl inflows nd GDP growth in Croti This progress is coordinted within the frmework of the Vienn inititive, nd with the estblishment of unified control by the ECB, of single resolution mechnism nd deposit insurnce system s the min pillrs of bnking union, which members of the EU outside the eurozone cn lso join; this will crete still stronger frmework, reducing the possibility of creting excessive vulnerbilities, nd t the sme time of unexpected disturbnces in cross-border interbnk cpitl flows. Processes chrcteristic of peripherl eurozone countries re present in Croti s well. Becuse of the gret finncil integrtion vi prent bnks nd rel connections vi the business cycle, becuse the min export mrkets re eurozone countries, Croti in prcticl terms hs to shre the problems nd ftes of eurozone member countries nd hs no very gret mnoeuvring spce for n utonomous mcroeconomic policy. in nd s of GDP Current ccount blnce Rel GDP growth rte Annul growth of domestic bnk lons right Annul growth of totl lons right Forecst. Sources: CBS nd CNB s of GDP Thus the negtive growth of the Crotin economy in the lst qurter of lst nd the first qurter of this yer is correlted with dverse trends in the eurozone (Tble 1, Figure 1). Poor foreign demnd is n dditionl obstcle to demnd in conditions in which domestic demnd, becuse of the reltively high debt levels of ll domestic sectors nd of vigorous imports, in other words of restricted possibilities for n increse of foreign nd domestic debt, cnnot provide n impulse to sustinble growth (Figures 11, 13 nd 1). Figure 11 GDP growth pttern (contribution to growth) Net domestic demnd Exports GDP 6 Such trends resulted in n overll fll of GDP in 1, nd the trnsferred low level from the end of the yer, in spite of the slower decline in the first qurter nd the expected grdul recovery in the second hlf of the yer, will lso tend to bring bout n nnul fll of GDP in 13 s well, estimted to come to bout 1. (Figures 1 nd 11). In such conditions the fll in employment nd the rise in unemployment s well s of the totl inctive popultion will continue (Figure 5) Forecst. Source: CBS. 6 8 Finncil Stbility 13

16 Mcroeconomic environment Figure 1 Svings nd investment totl nd by sector Figure 15 Short-term externl debt Privte sector svings Privte sector investment Svings-investment gp of consolidted generl government Svings-investment gp of privte sector Forecst. Sources: MoF nd CNB (estimte). Consolidted generl government svings Consolidted generl government investment Svings-investment gp in the country s of GDP Short-term externl debt by remining mturity Short-term externl debt by originl mturity b c Short-term externl debt by remining mturity is the mount of debt mturing in the reference yer, representing the sum of the blnce of short-term debt t the end of the previous yer nd long-term debt mturing in the reference yer. b Since end-7, externl debt hs been clculted ccording to the new methodology. c Forecst. Note: From 8 on, short-term debt by remining mturity includes round-tripping trnsctions, which represent n ccounting item tht hs neutrl effect. For more detils on round tripping, see CNB Bulletin, No. 15, Box Round tripping nd its impct on Crotin sttisticl dt s of GDP Figure 13 Externl debt by domestic institutionl sector Figure 16 Selected indictors of externl vulnerbility 1/7 Government Bnks Other domestic sectors + direct investment Totl 3/8 6/8 9/8 1/8 3/9 6/9 9/9 1/9 3/1 6/1 9/1 1/1 3/11 6/11 9/11 1/11 3/1 6/1 9/1 1/1 3/ index, December 7 = 1 Net externl debt/exports of goods nd services (t+1) Short-term externl debt by remining mturity (t+1) /(Gross interntionl reserves of the CNB t + Liquid f/c reserves of bnks t ) (Short-term externl debt by remining mturity t+1 + Current ccount deficit t+1 )/(Gross interntionl reserves of the CNB t + Liquid f/c reserves of bnks t ) Since end-7, externl debt hs been clculted ccording to the new methodology. Note: Net externl debt is clculted s difference between gross externl debt nd gross interntionl reserves nd bnk foreign ssets Figure 1 Totl externl debt by creditor Externl debt to other creditors Corporte externl debt to ssocited compnies Deposits nd lons received from prent bnks s of GDP Figure 17 Projection of externl debt principl pyments in 13 by sectors Government Public nd mixed enterprises 9 Privte enterprises domestic ownership Privte enterprises foreign ownership Bnks Since end-7, externl debt hs been clculted ccording to the new methodology. b Forecst. 1

17 Figure 18 Optiml interntionl reserves contribution of individul components Deposit outflow Foreign ssets growth Output loss CNB reserves Prent bnk deposits nd lons Externl debt growth less prent bnk deposits nd lons Optiml reserves if prent bnks re not lenders of lst resort Optiml reserves if prent bnks re lenders of lst resort billion EUR Figure 1 Totl debt by sector Corportes Government Households Source: CNB finncil ccounts s of GDP Figure 19 Rel kun/euro exchnge rte Index of the rel HRK/EUR exchnge rte deflted by unit lbour cost in industry Q1/ Q3/ Q1/1 Q3/1 Q1/ Q3/ Q1/3 Q3/3 Q1/ Q3/ Q1/5 Q3/5 Q1/6 Q3/6 Q1/7 Q3/7 Q1/8 Q3/8 Q1/9 Q3/9 Q1/1 Q3/1 Q1/11 Q3/11 Note: A fll in the index indictes rel pprecition of the kun ginst the euro. Sources: CBS, CNB nd CNB clcultions. Q1/1 Q3/1 Q1/ indices, 5 = 1 Figure Net position of domestic sectors with respect to the rest of the world by instrument Currency nd deposits Lons Other Source: CNB finncil ccounts. Securities other thn shres Equities Totl s of GDP Figure Unit lbour cost Industry Construction Trde Q1/ Q3/ Q1/1 Q3/1 Q1/ Q3/ Q1/3 Q3/3 Q1/ Q3/ Q1/5 Q3/5 Q1/6 Q3/6 Q1/7 Q3/7 Q1/8 Q3/8 Q1/9 Q3/9 Q1/1 Q3/1 Q1/11 Q3/11 Sources: CBS nd CNB clcultions. Q1/1 Q3/1 Q1/ indices, 5 = 1 Figure 3 Net finncil position of selected domestic sectors with respect to the rest of the world by equity nd debt instrument Government (centrl, locl nd centrl government funds) equity libilities Bnks nd other finncil institutions equity libilities Corportes equity libilities Government (centrl, locl nd centrl government funds) debt libilities Bnks nd other finncil institutions debt libilities Corportes debt libilities Source: CNB finncil ccounts s of GDP Finncil Stbility 15

18 Mcroeconomic environment Figure Kun/euro exchnge rte nd overnight interest rtes Overnight interbnk interest rte Averge monthly kun/euro exchnge rte right / 5/ 9/ 1/5 5/5 9/5 1/6 5/6 9/6 1/7 5/7 9/7 1/8 5/8 9/8 1/9 5/9 9/9 1/1 5/1 9/1 1/11 5/11 9/11 1/1 5/1 9/1 1/13 5/13 Figure 5 Chnges in employment registered with the Crotin Employment Service (CES) Newly employed persons from the register Newly registered unemployed persons directly from employment Net chnge, sesonlly djusted 1/ 6/ 11/ /5 9/5 /6 7/6 1/6 5/7 1/7 3/8 8/8 1/9 6/9 11/9 /1 9/1 /11 7/11 1/11 5/1 1/1 3/13 Sources: CES nd CNB clcultions. Figure 6 Gross domestic product, sesonlly djusted dt in constnt prices Itly Bulgri Croti Sources: Eurostt, CBS nd CNB. Germny Hungry Sloveni Romni Q1/ Q3/ Q1/3 Q3/3 Q1/ Q3/ Q1/5 Q3/5 Q1/6 Q3/6 Q1/7 Q3/7 Q1/8 Q3/8 Q1/9 Q3/9 Q1/1 Q3/1 Q1/11 Q3/11 Q1/1 Q3/1 Q1/ EUR/HRK number of persons, in thousnd index, = 1 Spce for fiscl stimulus to recovery is restricted becuse of the reltively high risk to the sustinbility of the public debt (Tble 3). In conditions of generl improvement of the conditions on the finncil mrkets, or the fll of globl risk version linked with the mentioned undertkings of the chief centrl bnks nd the clming of the debt crisis in the eurozone fter the move of the ECB, the government hs mnged to obtin considerble prt of this yer s needs for borrowing by issuing bonds on the Americn mrket. This ws lso ssisted by budget revision, ccording to which the plnned deficit of generl government, which originlly cme to HRK 13.8bn, ws reduced to HRK 1.1bn, becuse of which the need for borrowing ws reduced. But the 5.65 yield sked on the bond t issue, lthough much more fvourble thn tht produced in the previous borrowing in 1, still indictes the reltively high risk premium tht the mrkets require (Figure 6). This is bove ll reflection of the concern bout the sustinbility of the debt in view of the negtive rtes of economic growth; in the shortge of fiscl spce, getting growth moving by incresing competitiveness nd improving the investment climte will remin the min orienttion of economic policy. Fvourble trends in the blnce of pyments fcilitte the implementtion of the monetry strtegy of stble exchnge rte imed t the preservtion of low infltion nd finncil stbility. The closing of the deficit in the current ccount blnce in 1 nd 13, which is on the whole of cyclicl nture, nd somewht fewer finncil obligtions due, reduced the need for foreign finncing nd creted spce for the slight reduction of the foreign debt (Figures 1, 13, 1 nd 15). Such trends in the blnce of pyments nd in foreign libilities improved foreign liquidity indictors nd kept interntionl reserves t level cpble of mitigting ny potentil shocks to the foreign currency liquidity of the country (Figures 16 nd 18). This lso ensured the successful implementtion of the monetry strtegy for preserving the exchnge rte of the kun ginst the euro, which is imed t sustining reltively low rte of infltion (bout 3 in 1 nd, ccording to expecttions,. in 13) s well s the stbility of the finncil system, which, on ccount of the high degree euroistion, is vulnerble to ny mjor chnge in the exchnge rte (Figure 3). Although they re well cpitlised, becuse of the long-lsting recession the bnks re burdened with high nd rising level of non-performing lons, nd show gret risk version nd re restrined in mking lons, prticulrly to smll firms. Accordingly, the mkers of economic policy re still fced with the importnt chllenge of finding effective models, following up those in existence tht go vi the CBRD, for the government to shre risks with bnks nd thus stimulte growth in lons to those compnies whose ctivities cn hve positive effects on the blnce of pyments. 16

19 Tble Finncil ccounts for Croti s of GDP Clims Libilities Corportes Finncil sector Domestic sectors Generl government Households Totl Rest of the world Totl libilities Totl Rest of the world Households Generl government Finncil sector Corportes Monetry gold nd SDRs Currency nd deposits Securities other thn shres 3 6 Lons Shres nd equity Insurnce technicl provisions Other clims nd libilities Totl Monetry gold nd SDRs Currency nd deposits Securities other thn shres Lons Shres nd equity Insurnce technicl provisions Other clims nd libilities Totl Monetry gold nd SDRs Currency nd deposits Securities other thn shres Lons Shres nd equity Insurnce technicl provisions Other clims nd libilities Totl Monetry gold nd SDRs Currency nd deposits Securities other thn shres Lons Shres nd equity Insurnce technicl provisions Other clims nd libilities Totl Monetry gold nd SDRs Currency nd deposits Securities other thn shres 1 Lons Shres nd equity Insurnce technicl provisions Other clims nd libilities Totl Monetry gold nd SDRs Currency nd deposits Securities other thn shres Lons Shres nd equity Insurnce technicl provisions Other clims nd libilities Totl Finncil Stbility 17

20 Mcroeconomic environment Box 1 Systemic risk indictors There is gret likelihood tht over the course of time finncil system will ccumulte certin risk level tht might threten it nd compromise its stbility s well s mking the unhindered process of finncil intermedition impossible. If such risk is mterilised, it is referred to s systemic event 1, which is defined s n cute episode of finncil instbility, while systemic risk is the risk of systemic event ctully occurring. Although systemic events occur reltively rrely, their consequences re usully mnifested in extremely high costs shred by the whole of the society. Hence understnding systemic risk hs key plce in considertions of finncil stbility, i.e. in decision mking bout mesures nd instruments for it to be preserved nd strengthened. One of the bsic objectives of nlysing nd monitoring systemic risk is to provide timely recognition of the ppernce of finncil vulnerbilities connected with given kind of instrument, finncil mrkets nd finncil institutions nd n evlution of the likelihood of the occurrence of systemic event nd its consequences to the finncil nd rel sector. From the perspective of mcroprudentil policy mkers it is importnt to point out tht erly observtion of n ccumultion of systemic risk cn be crucil for the prevention of future crisis episode, for it provides the regultors nd the finncil sector time enough to ct preventively with dequte mesures nd instruments on the ccumultion of risks nd to increse the resilience of the system nd provide dequte cpitl nd liquidity buffers cpble of being implemented if the shocks should occur. 3 The selection of proper indictors cpble of giving timely wrning of the ppernce or ccumultion of systemic risks in system is thus one of the biggest chllenges of mcroprudentil policy. The problem in the process of nlysing finncil stbility, tht is, of potentil sources of systemic risk nd resilience of the finncil system to possible crisis episodes is the existence of lrge number of vribles tht might perhps be importnt for the finncil stbility nd trends in the rel sector. For this reson in the literture, composite indices re often used, summing up much informtion obtined on the bsis of individul mcroeconomic finncil nd other indictors. Such indictors reflect the stte of finncil stbility or systemic risk nd cn mke it esier for economic policy mker nd mrket prticipnts s well to monitor nd understnd the degree of finncil stbility in the system nd enble them to predict possible sources nd triggers of finncil stress nd crisis episodes. Such indictors cn lso be useful tool in the communictions of economic policy mkers nd the public, in explining the decisions bout the use of mesures imed t strengthening nd preserving the risk-resilience of the finncil system. 1 Models nd tools for mcroprudentil nlysis, Working Pper No. 1, My BIS. Schou-Zibell, L., J. R. Albert nd L. L. Song (1): A Mcroprudentil Frmework for Monitoring nd Exmining Finncil Soundness, Discussion pper series No. 1-, 1, Philippine Institute for Development Studies. 3 Globl Finncil Stbility Report: Grppling With Crisis Legcy, Chpter 3 Towrd Opertionlizing Mcroprudentil Policies: when to ct, World Economic nd Finncil Surveys, IMF, September, 11. Gdnecz, B., nd K. Jyrm (9): Mesures of finncil stbility review, BIS, Proceedings of the IFC Conference on Mesuring finncil innovtion nd its impct, Bsel, August 6-7 8, Vol. 31, pp The vribles to be used in clcultion of composite index hve to reflect the structure of the finncil system nd the mcroeconomic specificities of given country. In order to void the use of rbitrry methods for determining the vribles to be included in the systemic risk nlysis nd to be ble to obtin single indictor out of lrge number of vribles, or composite index or fctor, in the literture the principl component nlysis method is often used. In this method the dt re trnsformed in such wy tht in smll number of constructed series s much informtion s possible is retined from the initil set of vribles. In this mnner it is lso possible to determine the reltive importnce of individul vribles tht ffect finncil stbility nd the trending of the min fctors obtined with this method. In order to obtin informtion bout finncil stbility in Croti, risk indictors re divided into indictors tht contin informtion bout the process of the ccumultion of systemic risk in the system nd indictors tht indicte the mterilistion of previously ccumulted risks. The counter-cyclicl ction of mcroprudentil policy would imply tht the process of the ccumultion of risk should be prevented nd slowed down nd tht in periods when the risks hve built up, before they ctully mterilise, policy directed t the strengthening of system resilience to possible shocks should be conducted, to be used for the stbilistion of the system if nd when the risks mterilise. The risk ccumultion index (IAR) is composed of 1 vribles (Tble 1), nd the risk mterilistion index (IMR) consists of seven vribles (Tble ). Qurterly dt for the period from the first qurter of to the first qurter of 13 re tken for the computtion. Both indexes re defined s the first principl component obtined by the principl components method nlysis: IAR t = x t α IMR t = y t α, where α is weight vector hving dimension 1 x 1 (or 7 x 1) nd x t (or y t ) is 1 x 1 (or 1 x 7) vector of the vlue of the indictor on the bsis of which the indices re evluted (Tbles 1 nd ). The weights reflect the contribution of given indictor in the explntion of the common Figure 1 Components of indictors of risk ccumultion Lons to corportes Indebtedness of households/gdp Current ccount blnce/gdp Q/ Q/1 Q/1 Q/ Q/ Q/3 Q/3 Q/ Q/ Q/5 Q/5 Q/6 Q/6 Q/7 Q/7 Q/8 Q/8 Q/9 Q/9 Q/1 Q/1 Q/11 Q/11 Q/1 Q/1 Sources: CNB, HANFA, MoF nd CBS. Lons to households Public debt/gdp yer-on-yer rte of chnge, s of GDP 18

21 Figure Indictor of risk ccumultion number of stndrd devitions lons mde by commercil bnks of more thn 16 yer, or qurter, which resulted in considerble decelertion of the speed of credit ctivity compred to the previous period. In the period from mid- to mid-7, the min genertors of the risk ccumultion process in the system were the high rtes of growth of lons to the corporte nd privte sectors nd strong increse of their totl indebtedness s mesured in terms of GDP. A high deficit in current ccount blnces lso contributed to the ccumultion of risks in the period observed. Reduction of the degree of euroistion mesured by the proportion of foreign currency deposits in totl deposits nd the rtio of foreign currency index lons to totl lons tht mrked lrger prt of the pre-crisis period worked in the opposite direction. Q1/ Q3/ Q1/3 Q3/3 Q1/ Q3/ Q1/5 Q3/5 Q1/6 Q3/6 Q1/7 Q3/7 Q1/8 Q3/8 Q1/9 Q3/9 Q1/1 Q3/1 Q1/11 Q3/11 Q1/1 Q3/1 Q1/13 Source: Author s clcultion. Tble 1 Indictors suggesting ccumultion or decrese of the systemic risk in the system Sources of ccumultion of systemic risk Structure of ssets with respect to interest rte vribility Currency structure of ssets nd libilities Corportes Households Rel estte Mcroeconomic trends Finncil mrkets Indictors Lons by interest rte vrible within 1 yer/ totl lons Lons indexed to foreign currency/totl lons Foreign currency deposits/totl deposits Indebtedness of corportes/gdp Rte of chnge in corporte lons Indebtedness of households/gdp Households debt/disposble income Rte of chnge in household lons Hedonic rel estte price index Externl debt/gdp Public debt/gdp Current ccount blnce/gdp Prices of shres trend of ll the indictors included into the clcultion of the individul index constructed on the bsis of the first principl component. The indictor of the process of ccumultion of risk in the system suggests tht the most risks were ccumulted in the system in the period before the recent finncil crisis (Figure ). On the bsis of the loding prmeters it cn be concluded tht the most influence ws exerted on the process of risk ccumultion in the system by the rtes of chnges of lons to the privte sector, the totl indebtedness of the household sector, the degree of euroistion nd the trend in the public debt. Risk ccumultion in the system strted s erly s ; decelertion of the process in 3 ws primrily relted to the then rule of the CNB directed t the cooling of the credit expnsion nd foreign borrowings of bnks. For t the beginning of 3, the CNB tightened mesures of monetry policy nd introduced snctions ginst the rise of domestic. The process of risk ccumultion strted to slow down in the first signs of the world finncil crisis, ppering in mid-7, nd in the period fter the escltion of the crisis in the lst qurter of 8 in essence held stedy. In n interprettion of Figure, it is importnt to relise tht the low level of risk ccumultion does not necessrily hve to men reduction of overll level of risk, which becomes clerer when the individul components of the index re considered, on the bsis of which it might be possible to conclude tht the totl chieved level of most of them (public debt, totl indebtedness of firms nd retil sector, foreign debt) indicted n incresed risk, which ws reduced slightly only in some segments, while the degree of euroistion ctully incresed. It hs to be pointed out tht during the whole of the period the CNB employed vrious monetry nd mcroprudentil mesures nd instruments with which, on the one hnd, the resilience of the system to shocks ws incresed nd on the other the process of risk ccumultion, which would hve been still more pronounced without them, ws mitigted. As well s the lon growth restriction in 3, worth mentioning mong the most importnt mesures nd instruments in this context re the high level of generl reserve requirements, the decision on the obligtion to mintin miniml foreign currency clims, the decision on the obligtion to set side mrginl reserve requirements ginst increses in the foreign libilities of bnks, the introduction of specil reserve requirement, introduction nd increse of cpitl requirements for currency induced credit risk, increse in the cpitl dequcy requirement, foreign currency interventions on the whole imed t lleviting pres- Tble Indictors suggesting mterilistion of previously ccumulted risks Sources of mterilistion of systemic risk Corportes Households Mcroeconomic trends Finncil mrkets Indictors NPL to totl lons rtio corportes NPL to totl lons rtio households Household interest/income Survey unemployment rte Infltion Weighted exchnge rte ccording to the structure of the ssets of commercil bnks Risk premium for Croti EMBI yield spreds Finncil Stbility 19

22 Mcroeconomic environment sures on the pprecition of the domestic currency tht resulted in n increse in interntionl reserves nd the introduction of the highest permissible non-penlised rte of credit growth of 1. 5 Aprt from the process of risk ccumultion, for the cretion of fuller imge of finncil stbility it is necessry to observe indictors of risk mterilistion. Index of risk mterilistion covers indictors of the qulity of the ssets of commercil bnks, mcroeconomic trends nd trends on the finncil mrkets. In the period up to the escltion of the finncil crisis most of the indictors observed hd improved considerbly. The rtio of non-performing to totl lons hd reduced for both the corporte nd the household sector, the survey unemployment rte ws lso continully flling, infltion ws low, the exchnge rte weighted ccording to the structure of the ssets of commercil bnks (lons in kun, euros nd frncs re included) hd on the whole slightly pprecited, nd the risk premium for the country, on which the cost of foreign borrowing depended, hd the lowest recorded level. Although this ws n pprently stble period mrked by positive trends nd reltively powerful economic growth, Figure 5 shows tht it ws then tht most of the imblnce nd systemic risk ws ccumulted, risk tht would begin to be mterilised in mid-7 nd with the strengthening of the world finncil crisis. Results of the nlysis indicte tht the mjor prt of the mterilised risk relted to risks in bnk blnce sheets tht were mnifested in surge in non-performing in totl lons to compnies nd on slightly smller scle to the retil sector, long with the trends in the exchnge rte weighted by the structure of commercil bnk ssets nd with powerful increse in the risk premium of the country, which resulted in considerble rise in the costs of borrowing t home nd brod. From ll this it cn be concluded tht the process of risk ccumultion in Croti ws to the gretest extent linked with strong borrowing from the privte sector nd government units, which is in line with the findings of most of the uthors who del with the crisis episodes. In numerous reserch ppers, it is seen to be precisely the excessive rise in lons nd exggerted optimism in lon ctivities tht hve been identified s the key chrcteristics of the finncil nd bnking crises. 6 A strong lon ctivity in the pre-crisis period might hve considerbly excerbted the effect of the trnsmission of the crisis from finncil meditors to the rel sector nd vice-vers 7, while the typicl pttern of risk ccumultion on this bsis implies tht strong growth of lons to the privte sector stimultes reltively even stronger rise in ggregte demnd s ginst potentil growth, which leds to the economy overheting nd the growth of mcroeconomic imblnces, for bnk lons often result in growth in spending nd imports, in other words n Figure 3 Components of indictors of risk mterilistion NPL corportes Survey unemployment rte 5 NPL households EMBI Croti right Q1/ Q3/ Q1/1 Q3/1 Q1/ Q3/ Q1/3 Q3/3 Q1/ Q3/ Q1/5 Q3/5 Q1/6 Q3/6 Q1/7 Q3/7 Q1/8 Q3/8 Q1/9 Q3/9 Q1/1 Q3/1 Q1/11 Q3/11 Q1/1 Q3/1 Q1/13 Sources: CNB nd CBS. Figure Components of indictors of risk mterilistion Annul rte of chnge in consumer prices Difference between interest rtes on foreign currency deposits nd foreign currency lons Interest to income rtio: households Exchnge rte weighted by ssets structure right Q1/ Q3/ Q1/1 Q3/1 Q1/ Q3/ Q1/3 Q3/3 Q1/ Q3/ Q1/5 Q3/5 Q1/6 Q3/6 Q1/7 Q3/7 Q1/8 Q3/8 Q1/9 Q3/9 Q1/1 Q3/1 Q1/11 Q3/11 Q1/1 Q3/1 Q1/13 Sources: CNB, CBS nd Bloomberg. Figure 5 Indictors of risk mterilistion bsis points number of stndrd devitions.5 5 For more bout the mesures nd instruments of the monetry policy nd the mcroprudentil policy, see Annul Reports of the CNB. 6 The role of mcroprudentil policy, Bnk of Englnd Discussion Pper, November 9, Bnk of Englnd; Kminsky, G., nd C. M. Reinhrt (1999): The Twin Crises: The Cuses of Bnking nd Blnce-of-Pyments, Americn Economic Review. Q1/1 Q3/1 Q1/ Q3/ Q1/3 Q3/3 Q1/ Q3/ Q1/5 Q3/5 Q1/6 Q3/6 Q1/7 Q3/7 Q1/8 Q3/8 Q1/9 Q3/9 Q1/1 Q3/1 Q1/11 Q3/11 Q1/1 Q3/1 Q1/ Globl Finncil Stbility Report: Grppling With Crisis Legcy, Chpter 3 Towrd Opertionlizing Mcroprudentil Policies: when to ct, World Economic nd Finncil Surveys, September 11, IMF.