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The Czech Republic and Slovakia tread similar banking paths

The Czech and Slovak republics headed down different paths when Slovakia adopted the euro in 2009, but the business model and performance of the two countries’ banks remain remarkably similar.
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The Czech Republic and Slovakia tread similar banking pathsSlovakia adopted the euro in 2009 but its economic and banking performance still run along similar lines to the Czech Republic

The Czech Republic and Slovakia shared a state for most of the last century, and their similarities are striking – from baroque capital cities and mutually intelligible languages to political systems that have both elected shaky centre-right coalitions now embarking on painful budget cuts.

For the most part they are also economic twins – small, open economies where the car sector looms large and trade, overwhelmingly with Germany, accounts for about 80% of gross domestic product (GDP). When both countries were hit by the 2009 recession, their economies even contracted by similar amounts, 4.1% for the Czech Republic and 4.7% for Slovakia.

One stark difference is the currency used by both countries, something that has had a passing impact on local banks. Slovakia gave up the koruna at the beginning of 2009 for the euro, while the Czech Republic's affection for its koruna shows no sign of abating.

The decision to adopt the euro was lauded by Robert Fico, the Slovak prime minister in 2009, who called it “a shield” against the economic storms that were buffeting Slovakia's neighbours, while the Czech Republic's rulers extolled the advantage of having a floating currency able to absorb some of the shock of the recession.

However, the impact of euro adoption in Slovakia was of only temporary importance and the biggest impact for Slovak banks was a loss of revenue from foreign exchange (FX) transactions.

“The euro did represent a big loss for us but we made it up in other areas,” says Jozef Síkela, CEO of Slovenská Sporitel'ňa, Slovakia's largest bank and a unit of Austria's Erste Bank.

Economic slowdown

In 2009, the Slovak banking sector's net profit of €279m was down 48% from the previous year, in part due to the lower FX income, and also because of a drop-off in business activity as banks imposed much tighter credit conditions for mortgage and consumer loans. As a result, the annual rise in retail lending dropped from 30% before the crisis to 10% by the end of 2009. Overall lending increased by just 1%.

“As a result of the conservative balance sheet structure, Slovak banks were not hit by the first wave of the crisis,” says Jozef Makuch, governor of the National Bank of Slovakia. “The impact was visible only in the second stage of the crisis, when the domestic economy dropped as a consequence of decreased foreign demand.”

In the Czech Republic, where banks were obviously unaffected by the euro issue, the system's operating income in 2009 increased by more than 30% to Kcs59.7bn (€2.4bn), with trading income accounting for about 10% of that. Meanwhile, lending growth slowed dramatically, but did not contract and banks undertook dramatic cost-cutting measures.

“The crisis was purely externally driven. [The Czech Republic] had an unbelievably stable banking sector,” says Pavel Kysilka, CEO of Česká Spořitelna, the Czech unit of Austria's Erste Bank.

Regulators in both countries responded by pressing the parents of local banks to retain profits to build up capital, but did not have to step in to rescue any banks. “If someone wants to pay dividends, I want them to show they have enough capital to cover adverse scenarios,” says Vladimir Tomsik, the deputy head of the Czech National Bank.

“In 2009, we decided to retain the total amount of record high profit earned in 2008,” says Ignacio Jaquotot, CEO of Slovakia’s VUB bank, a unit of Italy's Intesa Sanpaolo.

Quick recovery

However, the differences were less stark by 2010 as Slovak banks absorbed the profit hit from being in the eurozone. Meanwhile, the Slovak economy recovered more strongly than its Czech counterpart, also in part due to the euro as foreign investors were keen to invest in a low-wage country that carried no currency risk, which is an issue in Slovakia's non-euro neighbours.

In 2010, Slovak banks saw their profit more than double to €514m on the back of GDP growth of 4%. In the Czech Republic, bank profits fell slightly to Kcs55.7bn, harmed in part by rising loss provisions and by an overall economy that grew by only 2.3%. As the effects of the adoption of the euro are absorbed, the banking systems of the two countries are again looking very similar.

Although Czechoslovakia was split into the Czech Republic and Slovakia in 1993, the two countries that emerged from the federation shared a tradition of financial probity that helped ensure their banking sectors remained conservative at a time when many countries in western Europe, as well as the US, were experiencing banking booms.

“Another key feature of the sector is the relatively conservative business model of most of the banks,” says Mr Makuch. “In general, banks are interested in the domestic retail and corporate segment.”

Unlike Poland to the north or Hungary to the south, Czech and Slovak banks never really dabbled in the foreign currency mortgage loans that were so popular in those two countries, and are posing a continuing balance sheet problem due to a currency mismatch between loans denominated in euros or Swiss francs, and customers’ salaries paid in złoty or forint.

“The Czech financial sector has no problem with FX exposure,” says Mr Tomsik, pointing out that Czech interest rates – with the central bank's benchmark rate currently at 0.75% – have in recent years been below those of the eurozone for periods of time, meaning few borrowers have wanted to take the risk of borrowing in a foreign currency. Slovakia was similarly conservative before joining the euro and FX loans are no longer an issue now that it is in the eurozone.

Traditional models

The two regions also share a similar banking structure. In both countries, more than 90% of the sector is in foreign hands, one of the highest levels of foreign bank ownership in the world, and three big banks dominate each market (see chart).

The biggest three banks in the Czech Republic are Česká Spořitelna, ČSOB, owned by Belgian KBC Bank, and Komerční Banka, a subsidiary of Société Générale, which between them account for more than 60% of the banking market.

In Slovakia, the largest banks are Slovenská Sporitel'ňa, owned by Erste, VUB and Tatra, a unit of Austria's Raiffeisen, as well as mid-sized banks such as ČSOB and UniCredit, owned by the Italian bank of the same name.

The foreign banks brought in modern technology and risk-management techniques, and their Czech and Slovak subsidiaries ended up becoming significant profit centres. Cut off from international markets because their corporate owners already own banks around the region and have no need for their Czech or Slovak operations to expand internationally, the banks stuck to their knitting – the staid business of taking deposits and granting loans.

“The banks were profitable because the Czech banking sector has never left the traditional banking business,” says Mr Tomsik. “They were not forced to go into risky business and invest in new financial products.”

Czech Republic and Slovakia bank market shares

Market liquidity

The banking sectors in both countries are also very liquid. Slovakia has a loan-to-deposit ratio of 81% and the Czech banking system has an EU-leading ratio of 74%.

“Banks in general are financing their activities via client deposits, which also supports the resilience of the sector,” says Mr Makuch.  Mr Tomsik adds: “The Czech financial market is in a different condition because there is a surplus of liquidity.”

The capital base in both countries is also solid. Slovakia's Tier 1 ratio is 12.5%, while the Czech Republic's is closer to 14%. Both countries saw an uptick in problem loans in 2009, especially in the corporate sector – which was hit by the temporary drought in demand from leading export markets – as well as in riskier consumer loans. In the Czech Republic, bad loans have stabilised above 6% compared with 3.3% in 2008, similar to the level in Slovakia. As the economic revival takes hold in both countries, banks are beginning to lend again.

“A new credit cycle is starting,” says Petr Knapp, a board member responsible for corporate banking for the Czech Republic's ČSOB. “Credits are rising and will continue to rise, first and foremost with companies.”

Czech business loans have started to increase from the second half of 2010, although it is still unclear if this is a one-off resulting from a controversial solar subsidy programme halted at the end of the year or the beginning of a deeper trend.

“Business implemented very deep cost-savings programmes at the beginning of the recession, and they were able to survive the impact of the global downturn,” says Česká Spořitelna's Mr Kysilka. “Initially, when demand for their production started to grow, they were able to reach the same output as before at much lower cost. However, for the first time over the past year we have seen an increase in demand for loans.”

Cautious on real estate

The real-estate sector is also starting to revive. House prices fell by about 10% from their peak in both countries and potential buyers held back for many months, expecting prices to continue to fall. However, they are starting to edge back into the market as prices have stabilised.

“With the worst of the crisis behind us, we are turning to growth again, aiming to capitalise on our healthy liquidity profile and capital adequacy,” says Mr Jaquotot. “Continued recovery of the economy gradually improves the financial situation of corporates, which are now thinking to turn expansionary again, especially in fast-growing, export-oriented industries.”

Still, borrowers have been chastened by the downturn, which showed real estate is an asset that can also fall in value, and they have become increasingly conservative. Faced with reluctant borrowers, banks in both countries are becoming more aggressive about lending.

“Banks have loosened their mortgage criteria, with some returning to pre-crisis origination practices,” says ratings agency Moody's. “They have also reintroduced 100% loan-to-value mortgages and resumed more aggressive marketing campaigns.”

Slovenská Sporitel'ňa's Mr Síkela says: “We are not happy that some of our competitors seem to have forgotten there was a crisis and have returned to irresponsible practices.”

Part of the increase in lending growth in the Czech Republic comes from unsecured consumer loans, which have higher levels of problems than mortgage loans. Czech banks are also loosening their mortgage lending requirements, a development Moody's sees as “risky”. Still, well supplied by domestic deposits and with solid capital adequacy ratios, there is little sign of Czech or Slovak banks getting into trouble in the near future. 

Eyes on Germany

With economic growth expected to come in well above EU averages for the foreseeable future, the financial sectors of both countries seem to be through the worst, which was in any case much less severe than the crisis experienced by many of their counterparts in southern and western Europe.

The big risk factor is Germany. If its unexpectedly strong economic expansion and furious export growth slows, Czech and Slovak factories supplying parts and components to Germany will see their sales fall. That could potentially cause problems for companies and any resulting increase in unemployment could also impact consumer and mortgage lending. “At the moment, we are enjoying a recovery thanks to the German locomotive,” says Mr Kysilka.

The long-term outlook is buoyed by the fact that, 22 years after the end of communism, both Slovakia and the Czech Republic are still underbanked compared with western Europe. Household loans are below 40% of GDP in Slovakia and just above 30% in the Czech Republic, far below the almost 70% in the EU overall, and the more than 100% in countries such as the UK and Denmark. Deposits to GDP are also far below EU levels.

Despite the growth possibilities, both countries have proven remarkably resilient to new banking sector entrants. The big banks that dominate their respective markets are profitable and stable, and have not left an obvious opening for new competitors. One exception is in online banking, where mBank, a unit of Poland's BRE Bank, in turn majority-owned by Germany's Commerzbank, has made inroads.

At the bottom end of the market, Dexia, a Slovak bank that posted losses for two of the past three years, was sold by the Franco-Belgian group to Penta Investments, a local investment fund. This move came after the European Commission demanded Dexia sell its subsidiaries in return for receiving state aid from France, Belgium and Luxembourg. Mr Síkela says he expects further consolidation among the smaller banks in his country. So far, the big players appear confident their dominance is not in danger.

“There have been entries in some niche markets, which we will still see from time to time,” says Mr  Knapp. “However, established banks on the Czech banking market have proved several times to be resistant to attacks from new entrants.”

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