In the more than 10 years since the country declared its independence, Kosovo's banks have performed admirably in often-difficult conditions. Kit Gillet assesses the challenges the lenders now face as they look to captalise on the country's strong economic growth.
As Europe’s newest country, Kosovo has seen plenty of challenges in the decade or so since it declared independence from Serbia in 2008. However, the banking sector has proven to be a stabilising influence on the economy, even through regular periods of political unrest.
While Kosovo’s unemployment rate was above 30% at the end of 2018, and the country is still plagued by weak contract enforcement and issues related to rule of law, its economic output has been growing by about 3.5% a year in recent years; it is one of only four European countries to have experienced economic growth every year since the 2008 financial crisis.
Kosovo, with a population of 2 million, is currently targeting economic growth of 4.7% in 2019, with the International Monetary Fund predicting that the country’s economy will grow by 4.2% in the year, up from 4% in 2018. Credit growth in the country has also consistently been in double digits, supported by low non-performing loans (NPLs) and high NPL coverage rates from the banks. Deposits held in the banking sector have continued to rise, growing 10.1% between March 2018 and March 2019 to reach €3.38bn; this followed annualised growth of more than 6% in eight of the past nine years.
“We’ve maintained a steady rate of growth in deposits, and significantly reduced loan interest rates in the past five years,” says Petrit Balija, CEO and a member of the board of directors at the Kosovo Banking Association (KBA). “These main indicators of credit growth, deposit growth and low interest rates are really a positive indicator that the banking sector is able to do its job as an accelerator of economic development.”
Strong growth
Ten banks currently operate in Kosovo, including eight that are foreign owned, with total assets of €4.2bn at the end of March 2019, up from €3.9bn a year earlier. The sector saw a net profit of €19.1m in the first quarter of 2019, up from €17.9m in the same period the previous year, with return on asset levels dropping from 2.1% to 1.8% and return on equity down from 16.6% to 14.9% in this time.
Meanwhile, the sector’s outstanding loan portfolio reached €2.8bn at the end of March 2019, an 11.4% rise on the same month in 2018, according to the Central Bank of Kosovo, with the NPL ratio at 2.6%, down from 2.9% a year earlier. NPLs peaked in 2013 at 8.7% of total loans.
Overall, between 2010 and March 2019 lending in Kosovo effectively doubled (up 93.6%), while deposits in the banking system grew by 74.7%. Robert Wright, CEO of Raiffeisen Bank Kosovo, one of the largest banks operating in the country, says: “If you take the period between the conflict [in the late 1990s] and independence, there wasn’t much banking activity at all. The 11 years since then has seen dramatic change.”
Despite this, he says that use of the banking system is still low in Kosovo compared with European standards, with just 51% of the adult population having some sort of banking relationship, though this is up from about 31% before independence. Banking sector penetration compares unfavourably with neighbouring Serbia at 71% and North Macedonia at 77%.
Foreign impact
The presence of so many foreign-owned banks in Kosovo, including banks from Turkey, Slovenia and Austria, has had a strong impact on the development of the country's banking sector. Foreign-owned banks hold about 88% of total banking sector assets, and their parent companies often require local subsidiaries to operate to the same high standards as in other markets.
“The importance of these banks is crucial for the Kosovar banking sector and it cannot be imagined that the banking sector can work without these banks being part of it,” says Oğuzhan Ceylan, country manager for İşbank, one of four Turkish lenders operating in Kosovo, alongside TEB, Ziraat Bank and Banka Kombetare Tregtare (BKT, Turkish-owned but headquartered in Albania). He adds that the foreign banks have played a key role in educating bank employees and clients with respect to banking products and services.
Others agree that the impact has been high. “Foreign banks have driven behaviour, both with the regulators and the central bank, and the customers to comply with European standards," adds Mr Wright. "We insist on [deposited] salaries into banks if you want a loan, we insist on audited accounts and transparent accounts from businesses for any sort of lending.”
Regulatory standards have also been improving, in line with the country’s hopes of eventually joining the EU. A February 2019 report by rating agency Moody’s suggested that EU convergence in the western Balkans will continue to strengthen key fiscal and monetary policy institutions in countries such as Kosovo, including independent fiscal councils and central banks. (“Dangling the carrot of EU membership is great for Kosovo, even if EU membership is decades away,” says one banker.)
In 2018, Kosovo's central bank signed a memorandum of understanding with the European Central Bank, paving the way for increased co-operation between the institutions.
At the same time, amendments to the domestic banking laws, considered by some to be the final piece in the jigsaw, are currently being finalised. “I feel that we have made great improvements in this draft banking law,” says the KBA’s Mr Balija. “We have increased the exposure limits, we have improved the governance of the banking institutions, and we have also addressed the resolution standards for any potential crisis in the future.”
While the banking sector would like to see the new banking laws come into force in 2020, Mr Balija believes this is unlikely. "Not many laws are being proceeded in parliament these days; the agenda is quite light. We are sceptical that we will be able to have it enforced by January 2020,” he says.
Geopolitical concerns
While Kosovo is not part of the eurozone, the country uses the euro as its national currency. This has helped with issues of financial stability and improving confidence for foreign investors. Even so, corruption and political instability continues to deter many investors, and foreign direct investment into Kosovo dropped to €231.5m in 2018, down from €281.3m in 2017, according to central bank figures.
Geopolitical tensions are one problem affecting this. In November, Kosovo increased customs tariffs on Serbian and Bosnian goods entering the country from 10% to 100%, after Serbia blocked Kosovo from joining international police organisation Interpol. As a result, negotiations with Serbia and Kosovo’s EU accession talks stalled.
Kosovo also relies heavily on remittances sent back from its sizeable diaspora. It is estimated that Kosovars send home upwards of €800m every year through traditional channels, with some believing the overall figure is double that when money brought in via suitcases and in jacket pockets is taken into account.
“The diaspora continues to play a very big role – it has brought in a lot of money to the banking sector,” says Hamide Pacolli Gashi, deputy CEO of Banka Ekonomike, one of two locally owned lenders.
Kosovo benefits from its diaspora being largely based in wealthier economies such as Germany, Switzerland and the UK, where employment is strong and wages are high. This contrasts with neighbouring Albania, which sees the bulk of its remittances coming from Greece and Italy, countries that have been much less stable in recent years. Worryingly for Kosovo, however, there are signs that remittance flows may be slowing, linked to lower growth prospects in the eurozone.
Banking pulls ahead
Kosovo’s banking sector is strongly tied to the development of the country's wider economy. “I would say the banking sector is one of the most reliable sectors in the country,” says Arton Celina, CEO of locally owned Banka per Biznes (BPB). “The whole sector is well capitalised, with an average capital adequacy ratio of 16% to 17%. Every bank is distributing dividends.” However, he adds that while the banking sector continues to develop at a clip, other sectors are not moving at the same pace. “Being ahead in terms of development is actually one of the disadvantages the banking sector has,” says Mr Celina.
It is estimated that more than 90% of registered companies in Kosovo are micro-enterprises, employing fewer than nine people, meaning most lending is focused on the small and medium-sized enterprise sector. Still, says Mr Celina, “it is difficult serving micro-clients, and this is why the micro lending rates are about 20% to 30%”. Companies are not only after capital, they need a transfer of knowledge, a transfer of technology, and expertise in expanding in the market, he adds.
At the same time, the informal economy continues to represent one-third of the country’s gross domestic product, with the head of the EU’s office in Kosovo, Nataliya Apostolova, urging state institutions in July to push through a new programme of economic reforms to bring the country closer to the EU.
Risk difficulties
With so much of the market dominated by small companies, and given the resilience of the informal economy, risk management in Kosovo can be difficult. The banking sector’s loan-to-deposit ratio was 83.5% in March 2019, while the average effective interest rate on loans was down to 6.7%, half of what it was in 2010 and in line with other countries in the western Balkans region. Even so, while interest rates on loans continued to decline in 2018, pointing to increased access to bank financing, lenders in Kosovo are often forced to undertake extensive due diligence before granting loans, given the level of tax avoidance and the unreliability of existing company records in the country.
“This is a lose-lose position for all,” says BPB’s Mr Celina. “The government is taking measures on it [and] the banks are making an impact, because if a company is fully formalised then you have open doors; but if you are not, then you still have some other restrictions – people cannot believe you.”
Another source of concern is the lagging mortgage market. “The residential mortgage market is an area that is definitely underdeveloped and needs more attention,” says KBA’s Mr Balija, who adds that attention has to come from both sides: from the banking sector as well as from the government and local municipalities. “We need the local counties, local governments, to improve the title of properties, because this is a major problem that has caused this stagnation in the residential mortgage market, considering that most buildings do not have titles of ownership in Kosovo.”
With the lack of confidence in their ability to repossess properties through the courts if things go bad, banks are cautious about offering mortgages, which has led to a residential mortgage market of just €100m, the lowest in the western Balkans. “This needs a lot of attention considering it is one of the pillars of the retail banking sector anywhere,” says Mr Balija.
Competitive growth
With 10 banks and about 12 microfinance institutions competing in a relatively small market, competition in Kosovo is strong. “It's very hard to keep a customer so you have to be willing to stay up to date with every kind of product and service,” says Banka Ekonomike’s Ms Pacolli Gashi. “Maybe for corporate banking there is room for more banks,” she adds, but she does not see it in the commercial sector. “The market is quite busy with the banks and the non-banks.”
Kosovo's population has an average age of 28, which, combined with its recent troubled history, does put pressure on financial service providers to adapt quickly to modern banking technologies if they are to remain competitive. “What the UK did in 30 years we've done in 10 years, in terms of adoption and usage of remote channels. The speed of change here is great because the population is hungry for everything, whether that is houses, cars or holidays,” says Raiffeisen’s Mr Wright. “They were denied so much for so long, they are hungry to catch up with their European counterparts.”
However, for Raiffeisen Bank “the problem we face is [that we have] 24% to 25% of the market share and we've got to be all things to all people," says Mr Wright. "We've still got pensioners and the unemployed and the rural communities learning how to use an ATM.”
A lack of overall coordination has, however, resulted in important unresolved issues for Kosovo's banking sector. "We have six banks with six different point-of-sale [POS] machines and processes; we don’t have a combined processing system where you can just use one card and one POS," says Mr Wright. "Customers are confused, retailers are confused. We have this situation with six ATMs in a row on the street, six POS machines on the counter of a small retailer. Pessimistically we could be having the same conversation in 10 years time if the central bank doesn’t address this issue."
Some banks have also been closing physical branches and increasingly pushing their customers online at a pace that others worry has damaged the short-term reputation of the banking sector. As of March 2019 there were 218 bank branches in Kosovo, down from 311 in 2010, with the sector employing just under 3300 people, a drop of 300 in eight years.
Even so, overall progress is seen as positive. “I believe that the modernisation of the banking industry [means it is heading] in the right direction and in line with the general economic developments and technological environment created so far in Kosovo,” says İşbank's Mr Ceylan. “Banks are continuously working on taking advantages of the fast development of technology in order to provide faster and modernised services to their customers.”
Attractive market
Despite the remaining challenges, those involved in the sector consider Kosovo’s banking space to be a bright spot in the western Balkans. Albanian lender Credins Bank is among those rumoured to be looking to enter the market.
“I think that with the credit growth rates, with the return on equity that we have, and with the low NPLs, Kosovo is one of the most attractive banking sectors in the region for new banks to come into,” says KBA’s Mr Balija, adding that additional competition would spur the development of new products and penetration into segments of the economy that so far have not been reached.
“It would also cover an area that is right now being covered by microfinance institutions,” he adds. “I think there's a lot of untapped potential that the current banks have not been able to tap into, especially if we continue this stable economic growth of about 4% that we have seen for many years now.”
