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Croatian central bank governor talks down Agrokor impact

The restructuring of indebted retail giant Agrokor shook Croatia earlier in 2017, but central bank governor Boris Vujčić tells Stefanie Linhardt that the country's economy is still on course for growth, though some banks could take a hit on their profit sheets.
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Boris Vujčić

Q: Croatia has made headlines in 2017 with the troubles at its largest retailer, Agrokor. Some experts assume the potential economic impact on the country will be significant, and talk of a potential widening of the government deficit by 0.6 percentage points. How significant a risk do you assess Agrokor to be for Croatias economy?

A: We’re expecting the impact of Agrokor’s restructuring on economic activity to remain modest. Our current forecast for gross domestic product [GDP] growth in 2017 of 3% – which incorporates the impact of the restructuring – is the same as the one we had before Agrokor’s troubles emerged. Had there been no Agrokor case, growth in 2017 would probably exceed 3%, which gives our assessment of Agrokor in terms of impact on growth of 0.3 to 0.4 percentage points.

The main channels of Agrokor’s negative impact are through a reduction of investments in the company itself, and some of the suppliers connected to the company, as well as through a slight negative effect on personal consumption due to prospect for cuts to labour costs in these companies, as well as general negative confidence shock.

Regarding Agrokor’s negative fiscal impact, the main channel will be through lower profits in the banking and corporate sectors in 2017, which will reduce the intake of profit tax in 2018 somewhat. However, this should not derail the fiscal adjustment path, as confirmed by Croatia exiting the excessive deficit procedure in June.

Admittedly, there is still some uncertainty whether restructuring continues to proceed in the orderly manner observed so far. However, risks are being balanced by a very good tourist season and the potential for a substantial increase in tourist revenues, which we have projected in a fairly conservative way in our forecast. In the medium term, we see the Agrokor restructuring as an upside for economic activity due to potential for facilitating foreign direct investment inflows as well as a reduction of external debt.

Q: Will the Agrokor case require a change to your monetary policy strategy?


A: There is no need to adjust monetary policy because Agrokor has not altered macro developments in any significant manner. The trend of reduction in sovereign risk premium remains unaffected; also appreciation pressures due to the strong external position continue unabated. Our monetary policy stance is already hugely accommodative, with excess liquidity in the banking system exceeding 5% of GDP.

The central bank had announced plans, before the Agrokor case, to loosen the monetary policy stance even further. We plan to do this by continuing the four-year structural repo facility introduced in 2016 with somewhat eased rules for bank collateral management, as well as responding to currency appreciation pressures with activity in the foreign exchange market. Financing conditions are responding to monetary policy deliberations as we see interest rates decline further and lending volumes pick up.

Q: How big a risk is the Agrokor issue for the country’s banks?

A: Agrokor doesn’t represent a risk for the Croatian banking system. The Croatian National Bank [CNB] both timely and successfully initiated proper regulatory and supervisory steps to prevent such a development. We have made sure that all systemically important banks respect the regulatory confines of large exposure limits as stipulated by the capital requirements regulation.

Our measures aimed at banks’ capital strengthening maintained an average capital adequacy ratio of more than 20%. Consequently, all major institutions can afford a 100% loss on their exposure to Agrokor without breach of regulatory requirements.

Having said that, though the financial situation of Agrokor is still unclear, we are confident that a radical write-off will not take place. Agrokor is a big company with good products, strong brands and overall positive earnings before interest and tax. If the process continues to be properly run, creditors will almost certainly recover a significant part of their receivables. Still, due to uncertainty about the financial situation in the company, we cannot base our regulatory actions on optimistic assumptions.
 
Q: Will it have an impact on the banks’ health?

A: If we talk about the health of the banking system, no. Still, with some institutions it could have a certain effect. Some banks, none of them systemically important, could, in the case of a high haircut, experience capital shortage. Such problem could be augmented by the need to radically change their business model.

Those banks used to finance Agrokor up to the regulatory limits; some of them sometimes even beyond. Their returns on that portfolio were well above today’s market standards. Some of the interest rates were in double digits, contributing greatly to their profitability. In spite of that, their operational profitability was weaker than average.

After losing that income, it is questionable whether they would be able to remain profitable and find fresh capital if the need arises. But even if we assume failure of the banks mostly affected, that shouldn’t influence financial stability and even in the worst-case scenario, major banks will be able to continue their going concern business without any regulatory breaches.

Q: How high will the need for provisions be?

A: That is a good question, but it should be addressed to management and auditors of Agrokor. The answer depends on the financial position of the company, which will remain opaque until annual accounts for 2016 are finally published. Our task, as regulators and supervisors, has been to make sure that the banking system will walk away even if banks lose all their exposures to the company. We have achieved that.

How much will they really need to provide and finally write off is something that now bothers banks’ shareholders. If they have such worries, we certainly hope they will share them honestly and openly with their banks’ managers.  

Q: Profitability in Croatia’s banking sector was hit by the Swiss franc conversion law in 2015. Profits returned in 2016, but what are your expectations for 2017?

A: In 2017, overall profitability of the banking system will be significantly affected by Agrokor. In case of extremely high haircuts, profitability could also be affected in 2018. As I have already said, at this particular moment we have no trustworthy financial accounts of the firm, so we can only try to guess about the extent of Agrokor’s impact on banks' profitability. Anyway, to be on the safe side, we would require banks to assume significant haircuts. It is important to mention that the Croatian banking system, in spite of all external shocks, has demonstrated strong and sustainable operational profitability. Until now, after covering all imposed risk and regulatory costs, banks gave shareholders a mid-term return above the EU average.

Q: With 25 banks in a country of 4.2 million people, is there a need for consolidation in the banking sector?

A: Most likely the answer is yes. Sometimes I say that banking will be in the 21st century what the textile industry was in 20th. The only reasonable strategy in the industry is tight cost management. Combined requests to maintain regulatory compliance, achieve expected returns for shareholders and keep accounting prudent enough to sustain all expected shocks could be too much for some institutions. 

Just look at regulation. Today, the Croatian banking system is regulated by eight laws, 54 CNB regulations and guidelines, 71 EU regulations and 44 European Banking Authority guidelines. Just to enumerate all those acts takes 26 pages. The regulation itself covers many thousands of pages. The size of institution is important if one wishes to remain profitable and compliant within such a complex regulatory framework. We do apply the principle of proportionality, but it is not a big help for smaller institutions.

Bigger banks not only enjoy economy of size, but most of them also receive strategic support from their internationally active owners. Therefore, smaller institutions need to develop and execute more demanding strategies than their larger competitors if their shareholders require similar results – and that is not an easy challenge.

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Read more about:  Central & Eastern Europe , Croatia