Slovakia's banks saw their profits shrivel by almost one-third in 2013 thanks in large part to the impact of the economic crisis, except that in this case the hit did not come directly from a lacklustre economy expanding at only 2%, but rather because of governmental determination to reduce the country's deficit.
In an effort to bring the deficit to below 3% of gross domestic product (GDP) in 2013 (down from 4.8% in 2012), the government of premier Robert Fico imposed an extraordinary banking tax set at 0.4% of liabilities which raised €170m from the sector, or 35% of its aggregate profits.
The tax increase was the main reason that the Slovakian banking sector's net profits dropped to €480m last year, down by 29% from the level in 2011. This year is unlikely to provide any better news.
Further measures
Banks will also be affected by Mr Fico's policy of scrapping some of the liberal economic reforms brought in by his centre-right predecessors. A flat corporate tax of 19% was hiked to 23% at the beginning of this year as the government scrambled for funds to bring down the deficit.
“All countries in the eurozone had to consolidate public finances in 2012 and 2013,” says Mr Fico in an interview in Bratislava. “We had to collect approximately €3bn to consolidate public finances, and to keep the deficit below 5% in 2012 and below 3% in 2013 – this goal will be kept.”
The continued bank levy and higher corporate taxes are likely to drag down this year's profits as well.
“We estimate a similar amount in 2013, thus reducing the banking system’s net profit by approximately one third,” wrote analyst Simone Zampa of ratings agency Moody's in a recent assessment of the Slovak banking sector.
The goal of the levy is to pump €1bn into a resolution fund, aimed at helping prevent any future banking crisis. The government has promised to halve the levy rate when the fund raises €500m, something it expects to happen by 2014. The fund is expected to be fully financed by the end of the decade.
Although the levy and tax increase have hurt profits among Slovakia's banks, the prudential steps help shore up what is already one of the eurozone's most solid banking sectors, one that has sailed through the fifth year of crisis with much less turbulence than many of its counterparts elsewhere in the common currency area.
“The sector is pretty strong and stable. Banks are liquid and well financed,” says Jozef Sikela, CEO of Slovenska Sporitelna, a unit of Austria's Erste Bank.
The foreign factor
Slovakia's banks are in the upper range of eurozone financial institutions, with a capital adequacy ratio of 15.3% and a Tier 1 ratio of 14.7%, up from 12.4% at the end of 2011, according to the National Bank of Slovakia (NBS). There are several reasons for the relatively good performance of Slovakia’s banks. One is that 97% of the sector is in foreign hands – one of the highest ratios in the EU. Although having such a tiny proportion of banks in native hands is controversial politically, it has helped insulate banks from turmoil outside the country because these foreign-owned financial institutions mostly finance local companies. The large foreign multinationals that drive most of Slovakia's exports are usually largely financed by institutions from their home countries.
“Given the relatively low lending activity of domestic banks to Slovakia's largest exporters, the decline in exports did not affect the banking sector's corporate loan portfolio,” notes the NBS in a recent report.
Being local affiliates of foreign banks has also made Slovak banks relatively conservative. While banks in countries such as Ireland and Cyprus were growing wildly and taking risky foreign bets, Slovakia's banks have largely focused on buying local government debt and engaging in the conservative business of taking deposits and making local corporate and retail loans.
Unlike banks in Hungary and Poland, which binged on mortgage loans denominated in euros and Swiss francs, a practice that ended up backfiring once the crisis hit and local currencies fell sharply, Slovak banks never did much foreign exchange lending. The issue, already marginal, disappeared completely after 2009, once the country joined the euro.
That conservative approach has left local banks very well financed. The sector's loan-to-deposit ratio is about 80%, meaning that Slovak banks are not dependent on external financing, which helps insulate them in the event that their parent banks get into trouble.
Slow demand
These factors meant when the first wave of the crisis struck in 2009, Slovak banks did not need any assistance from the government or from their parent banks to pull through. The sector seems to be even more resilient now than it was five years ago. Slovak banks are net contributors to their parent financial groups – with intra-group liquidity increasing from €700m at the beginning of 2012 to €2bn by the end of the year.
Stress-tests run by the NBS also show that local banks are fairly well positioned, with only one bank facing potential problems in the event of either an international crisis or of a 10% drop in GDP (more than double the recession suffered in 2009). The sector has also seen non-performing loans improve somewhat, coming to 5.3% at the end of the first quarter of 2013, down from 5.5% a year earlier.
“[The] Slovak banking sector is one of the healthiest banking sectors in the EU,” says Marek Licak, director of the macroprudential policy department at the NBS. “It is a consequence of the traditional model of banking focusing on lending activities within Slovakia.”
Although it is positive that banks are well capitalised, there is definitely a sense of slack in the system, especially on the corporate lending side, where demand is quite soft. “We register the economic slowdown mainly in a lower demand for corporate loans,” says Igor Vida, chief executive of Tatra Bank, an affiliate of Austria's Raiffeisen Bank International.
Motoring along
The bulk of the Slovak economy's growth last year came through exports, especially from the car industry, dominated by three big manufacturers – Volkswagen, with an enormous €2.4bn factory just north of Bratislava; South Korea's Kia making cheap but high-quality cars in Zilina in the north of the country; and Peugeot-Citroën, which operates out of a plant in Trnava, 60 kilometres from Bratislava. Volkswagen and Kia in particular have been doing very well despite the broader slump in the European car market.
Part of Slovakia's unexpectedly strong GDP growth last year was the result of a one-off effect from a boost in car production thanks to recent investments. The car sector accounts for about one-third of Slovakia's industrial production, a quarter of exports and 10% of GDP, so any increase in capacity is quickly felt in the broader economy.
“We have three main producers of cars in Slovakia, and these three firms are like engines of the Slovak economy,” says Mr Fico. “In general, looking at the situation in Europe and the eurozone, we have to be satisfied.”
But domestic industry has been much less resilient – one reason that corporate lending last year slumped by 3.5%. “Corporate lending is decreasing,” says Mr Sikela. “It is partially driven by the fact that real estate financing is basically stagnating. Banks are more reluctant to finance real estate projects.”
The corporate loan book, particularly for commercial property loans (which account for one-fifth of commercial lending), is the sector's most significant source of credit risk. Tenant vacancies are rising and commercial real estate is proving to be relatively illiquid as investors steer clear of smaller central European markets. The related construction sector is also being hurt by the downturn in domestic demand.
Retail boost
Retail lending is doing better, however, up by almost 10% last year thanks to growing demand for mortgages. Part of the pick-up is due to the eurozone's very low interest rates, coupled with low property prices, which have fallen from their peak before the onset of the crisis. That has made Slovakia the EU's fastest growing housing loan market – although levels are still less than two-thirds of what they were before the crisis hit in 2008. Banks are not willing to loosen their requirements much to drive new business, and the average loan-to-value ratio for new loans is about 70%.
“We keep a prudent and selective approach and see no reason for a general loosening of credit standards,” says Mr Vida.
That prudence is further enhanced by the one big worry hovering over consumer lending – the high unemployment rate. The rate is above 14%, the highest in six years. “The persistently weak labour market poses risks to the banks’ asset quality. Of particular concern is the high share of unemployed people in the high- and medium-income categories,” notes Mr Zampa at Moody’s.
Although low interest rates are driving the increase in demand for new retail loans, they are putting pressure on banks' net interest margins. Low rates are also changing the make-up of the deposit base, as customers shift from long-term to short-term deposits. There are signs that smaller banks are becoming more aggressive in trying to drum up new deposits, part of a strategy by their corporate parents to make their Slovak affiliates self-financing.
“Competition for domestic deposits could potentially be triggered by small-scale players, given the attractive low cost of customer funding. Such competition could erode the traditionally strong margins reported by Slovak banks,” warns Olga Ignatieva, an analyst at ratings agency Fitch.
External risks
The most formidable new competitor to enter the Slovak market is Russia's Sberbank, which has become a factor in central Europe after buying the non-Austrian operations of Volksbank in a €500m deal in 2012.
Another change on the local banking market is the decision by Italy's UniCredit to unify its subsidiaries operating in Slovakia and the Czech Republic, which would leave the Slovak bank (currently with 8% of the country's deposits and 6.5% of loans) operating as a branch of the Czech bank. Although the change could produce some cost savings, it does create some risks. Mr Zampa says: “[We] believe there are integration challenges and regulatory uncertainties associated with the merger of the two banks, as well as potential risk that the market position in Slovakia could weaken following the transformation of the subsidiary into a branch network.”
The bulk of the risks faced by Slovak banks this year and next come from outside the country. If the eurozone slump continues or worsens, it would be very difficult for such a small and very open economy in a country of only 5 million people to insulate itself from the turbulence outside.
“Slovakia is a very small country and it is a really open economy,” says Mr Fico. “We very much follow the situation in Germany and France and if something happens in January in Germany, in July it is in Slovakia – that is the reality in my country.”
The NBS expects economic growth this year to slow to only about 0.7%, the lowest since the recession in 2009, and a rate that will do little to reduce unemployment and revive domestic demand. The economy is expected to revive in 2014, however, posting growth of 2.8%.
“We are facing difficult but also challenging times, as we have to cope not only with a weak performance of the real economy, but also with additional tax burdens and an ever increasing volume of regulations,” says Mr Vida. “On the other hand, the Slovak banking sector still has very solid potential for growth compared to the other markets in the region.”
