With Croatia set to join the eurozone in January 2023, the country’s banks are likely to play a significant role in the transition to the single currency. Kit Gillet reports.

Croatia’s banks will be at the forefront of the move to the single currency, being the main conduit for the disbursement of euro banknotes and coins to the country, as well as dealing with payment transactions and converting financial assets and liabilities. This will put a lot of pressure on Croatia’s banks, at a time when they are already dealing with major changes brought about by the coronavirus pandemic, which has increased the focus on digital offerings and non-bricks-and-mortar financial services.

Speaking about the benefits of joining the single currency in May, Boris Vujčić, governor of the Croatian National Bank, said that public finances will no longer be exposed to currency risk, while regulatory costs for banks will be reduced due to the reduction in the reserve requirement from 9% to 1% under eurozone stipulations and the abolishment of the obligation to cover foreign currency liabilities with foreign currency claims.

So long, kuna

While some in Croatia will mourn the passing of the kuna, Croatia’s currency since 1994, which has long been a part of the national identity, those in the banking sector see clear benefits.

“It may be challenging to lose its currency, but we are all aware that Croatia is currently the smallest EU country that still has its own currency, and it can be hardly justified with economic arguments,” says Hrvoje Dolenec, head of macroeconomic and market analysis at Zagrebačka banka, part of UniCredit Group.

Dinko Lucić, president of the management board of Privredna banka Zagreb, says that joining the single currency will help to resolve long-lasting risks that Croatian banks have been facing, including foreign exchange-induced credit risk, and that it will also help to decrease regulatory costs.

“On the other hand, the banking industry will bear the chief burden of adoption of the euro,” he says. “This year’s costs of preparation for joining the euro area will be high and will suppress the operating income increase. Also, when joining the euro area, the largest part of the income derived from the currency exchange and exchange rate gains will be lost,” he adds.

Mr Lucić suggests that the reduction of interest and fee income will also be significant and that the estimated net cost arising from the euro introduction for the banking system will be high, estimated at about €300m. “However, the entire sum will not impact the business in only one year, and partly it will be disclosed as investment. Hence, in the medium to long term, the benefits of joining the euro area are seen as outweighing the costs.”

The change also comes at a time when Croatian banks, like lenders around the world, are dealing with new technological demands from their customers, sped up by changes brought about by the coronavirus pandemic. Banks also need to factor in rising interest and inflation rates. Croatia is expected to see inflation jump by almost double digits this year.

“The most significant pressure that the banks are dealing with is the sustained interest margin narrowing,” says Mr Lucić.

The most significant pressure that the banks are dealing with is the sustained interest margin narrowing

Dinko Lucić

Historic moment

Balázs Békeffy, CEO of OTP Bank Croatia, the fourth largest bank in the country, describes accession to the eurozone as a historic move, given that Croatia only joined the EU in 2013 and the exceptional demands that are required to carry out all the necessary preparations and adjustments to join the single currency.

These preparations have put a lot of pressure on Croatia’s banks, with resources focused on the transition, at the expense of other initiatives. “As we approach the second half of 2022, most banks are concentrating only on euro adoption and are putting other initiatives on hold because their resources are exhaustively committed to the euro adoption,” says Mr Békeffy.

He likens the dual process of euro adoption and making large-scale digital changes – which have become increasingly important since the pandemic – as the equivalent of needing to build or upgrade an airplane mid-flight.

Even so, the introduction of the euro should be a positive factor in raising Croatia’s liquidity, attractiveness for investments and lowering interest rates, he says. “Those benefits will be welcome, as the economy has been sharply affected by the pandemic.”

Solid banking fundamentals

Despite fears for the worst, the Croatian banking sector weathered the global pandemic in far better shape than it did the 2008 financial crisis, aided by a sharp rebound in economic activity. Croatia’s gross domestic product (GDP) grew by 10.2% in 2021, after contracting by 8.6% in 2020, and is expected to expand by around 3.4% in 2022.

The performance of Croatian banks also improved strongly in 2021.

According to Zagrebačka banka’s Mr Dolenec, the systemic risk for credit institutions decreased in 2021, under the influence of lower credit risk, which led to a recovery in profitability.

The sector’s return on equity (ROE) hit 9.6% in 2021, comparable to 2019 figures, with the capitalisation of credit institutions remaining high. According to unaudited data for 2021, the total capital ratio of the banking sector remained at 25.6%, among the highest in Europe, Mr Dolenec adds.

Croatian credit institutions generated HRK5.6bn ($748.8m) in profit in 2021, up 108.8% from 2020 figures. Meanwhile, growth in assets of credit institutions accelerated, while interest rates continued to decline. The liquidity coverage ratio of the banking sector increased from 182% to 202.5% year-on-year in 2021.

The first four months of 2022 saw continued positive signs. Credit demand from corporations gained pace, with loans rising 8.5% year-on-year in April, and household lending was up 4.5%. Meanwhile, non-performing loans dropped to 4.3% in 2021, down 1.1% year-on-year, and fell further to 4.2% in the first quarter of 2022.

Croatian credit institutions booked an overall profit of HRK1.6bn in the first quarter of the year, according to the central bank, with total assets up 1.1% to reach HRK506.2bn.

However, Mr Dolenec says that despite the strong start to 2022, business for local banks will be challenging throughout the rest of 2022 and 2023, in part due to preparations to join the euro and also due to the economic conditions, such as the increasing rate of inflation.

Rising interest rates will impact lending activity and revenues, as well as costs on the other side, and higher risks of a recession could also weigh on the sector.

“Banks should face an inflow of deposits – cash in circulation transferred to banks – due to the conversion process and release of liquidity when adjusting the mandatory reserve regulation with that of the eurozone,” says Mr Dolenec.

As such, “profitability will likely decline in such an environment, although liquidity and capital positions are likely to remain strong,” he adds.

Challenging transition

Over the past two years, Croatia (along with Bulgaria) has been part of the European Exchange Rate Mechanism II, a system for managing rate fluctuations that aims to offer a smooth path of entry into the single currency.

Even so, the process of joining the eurozone is likely to be a challenging and somewhat costly one for Croatia’s banks.

Christoph Schoefboeck, CEO of Erste Bank Croatia, says that one-off costs for banks, arising from the transition to the new currency, are expected to reach €80m-€100m. “It is, from a technical point of view, an extremely complex process that started, at least as the banks are concerned, back in 2021,” he says.

“The process itself has a significant impact on the banks’ operations, having in mind substantial system requirements to be fulfilled, the network and ATM adjustments, as well as clients’ requirements and needs when it comes to the respective cash front-loading,” he adds.

Croatia also has around 4700 ATMs, which will need to be adapted for euro banknotes in the last few weeks of December, with banks also needing to ensure a steady supply of Croatian kuna for withdrawals. Mr Vujčić has said that 60% of ATMs in the country will switch to euros by January 1, with the remainder to be done by January 15.

Throughout the second half of this year Croatia will begin to mint euro coins, with banknotes procured and double-pricing introduced. The country benefits from the fact that it is already strongly aligned with the euro – 87% of household savings deposits are in euros, as well as more than 90% of foreign debt, which should help to make the transition easier.

Changes in revenue models

The introduction of the euro is likely to have some profound impacts on the revenue streams of the domestic banking sector, which were already changing due to global developments and the arrival of more agile and zero-fee challenger banks.

“Net fee and commission income will come down,” says Goran Šaravanja, chief economist at Hrvatska gospodarska komora, the Croatian Chamber of Commerce. “You certainly won't have the foreign exchange trading revenues anymore. And I would expect net interest income to go up over time. There’ll be a change in the business structure.”

Mr Šaravanja describes the Croatian banking sector as highly capitalised, with the Croatian National Bank arguably the most credible public sector institution in the country.

In many ways the banking sector in Croatia is also simpler than in many other EU member states, says Mr Šaravanja, in terms of balance sheet activity. “It’s stable,” he says. “It’s one of the pillars of Croatia’s macroeconomic stability and has been for a while because of private capital.”

Mr Šaravanja sees strong benefits in joining the eurozone. “When you’re a small country, next to a behemoth like the eurozone, if there’s an extreme event you might as well have access to all of the available instruments, [and] have your banks regulated the same way,” he says. “It’s safety in numbers, leveraging knowledge, experience and learnings.”

Foreign players

In 2021, foreign banking groups accounted for 90% of Croatia’s total banking sector assets, highlighting their importance to the country’s banking sector. The top three banks in Croatia account for just under 65% of total banking sector assets, with all three being large foreign banking groups: Italy’s UniCredit and Intesa Sanpaolo, and Austria’s Erste Bank.

Even so, Mr Dolenec points out that 13 of the 20 banks currently operating in Croatia have individual assets below 1% of Croatia’s GDP, and that they may become subject to mergers or acquisitions driven by needs of economy of scale when faced with significant regulatory requirements or investment needs within a more challenging economic environment.

Over the years there has been significant merger and acquisition activity in the Croatian banking sector. One of the most recent bank mergers was in May 2017 with the acquisition of Splitska Banka by OTP Bank, creating the country’s fourth largest bank.

More recently, in March, the Croatian subsidiary of Russian-owned Sberbank was acquired by Hrvatska Poštanska Banka (Croatian Postbank), Croatia’s sixth largest bank, for HRK71m after the European Central Bank announced that Sberbank Europe and its subsidiaries in Croatia and Slovenia were likely to fail due to worsened liquidity as a result of the sanctions imposed on Russia following its invasion of Ukraine. Sberbank’s name has since been changed to Nova Hrvatska Banka ahead of its expected merger with Hrvatska Poštanska Banka in 2023.

Erste Bank’s Schoefboeck says that the relatively high number of banks in the Croatian market, coupled with even fiercer competition resulting from Croatia’s entry into the European Monetary Union, will increase pressure on more efficient and cost-optimised operations, and that “further consolidation can be expected in the Croatian banking market going forward”.

However, some believe further consolidation is unlikely to take place any time soon. Mr Békeffy, for example, says that, while from an economic perspective, further banking sector consolidation in Croatia would make a lot of sense, “in the existing circumstances, investors will wait for the global economic uncertainties to wither before making their money work for them”.

In addition to the economic situation, banks operating in Croatia will also likely be too busy dealing with the changes related to the adoption of the euro and other issues than thinking about consolidation.

“Eurozone entry, huge liquidity excess that will increase with the adjustment of reserve requirements and consequent release of funds of over €4bn, amid moderate credit demand, will also create a very competitive environment,” says Privredna banka Zagreb’s Mr Lucić.

However, he stresses that “there is no doubt that Croatia joining the euro will have a positive impact on banks and the society as a whole.”


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