Open and historically highly profitable, the Czech banking system performed better than expected in 2020. While profits halved, sectors including mortgage lending maintained momentum and the central bank and leading commercial lenders were well prepared to handle the fallout from the Covid-19 pandemic. Interest rate rises in the coming months should give scope to raise margins again, as banks look to focus on a digital future.
Guardian of stability
The industry is overseen by the Czech National Bank (CNB), which is the supervisory body for financial markets as well as the country’s monetary and macroprudential authority. As the Czech Republic is outside the eurozone, the bank sets an independent monetary policy, which is generally regarded as having proved successful in recent crises. The bank’s primary objective – as outlined in the Czech constitution – is price stability, and it has a reputation for hawkishness on inflation.
More accurately, the bank has a strong record of working to keep inflation within a percentage point band either side of its 2% target, says Mateusz Szczurek, lead economist for central and south-eastern Europe at the European Bank for Reconstruction and Development. “It has been a frontrunner in some of the more unorthodox [measures] when deflation was an issue – 0% rates, an active foreign exchange policy to weaken the Czech koruna, and trying to push inflation higher,” Mr Szczurek says. “It’s done intellectually ground-breaking work.”
It seems like the country’s reputation for banking sector stability hasn’t been threatened by the crisis so far
The CNB acted swiftly when the pandemic hit the country and the government imposed a tough lockdown. As well as slashing its core rate from 2.25% to 0.25% between March and May 2020, the bank introduced measures specifically targeted at boosting lending. This included reducing banks’ obligatory countercyclical buffer from 1.75% to 0.5% over time, and relaxing most recommendations to banks for new mortgage assessments. The loan-to-value (LTV) ratio limit increased from 80% to 90%, and the CNB suspended income criteria including the debt-to-income limit. At the same time, the government introduced a new loan moratorium act, under which customers could postpone instalment payments for three or six months.
Strong position
This approach seems to have paid off. Total banking sector assets reached Kcs8.03tn ($385bn) at the end of 2020, up from Kcs7.63tn at end-2019, according to CNB statistics. Total sector profit fell by 48% in 2020, to Kcs48bn, though this should be seen in the context not only of the pandemic but the strong years in the run up to 2020. Czech banks are particularly sensitive to rate changes, and the CNB’s rapid rate cuts in the spring led to considerable pressure on net interest margins. Nonetheless, profitability remained well above the European average, according to Miroslav Zámečník, chief economist of the Czech Banking Association (CBA).
Banks are well placed for recovery — and to weather potential further turbulence. Liquidity is high; the sector-wide liquidity coverage ratio increased 13.7 percentage points year-on-year to 198.6% at the end of 2020, while the sector-wide capital adequacy ratio reached 22.7%, up 2.8 percentage points from end-2019, and one of the highest levels in the EU.
Miroslav Zámečník, CBA
Non-performing loans (NPLs) remain low. Those to non-financial corporations increased from 4.2% to 4.6% in 2020, while for households the level rose from 1.7% in 2019 to 1.8% at the end of 2020, and stood at just 1.9% at the end of March 2021, according to the CNB. At the end of March 2021, residential mortgages reported an NPL ratio of just 0.93%, though the figure for the unsecured consumer loan portfolio was 5.56%, up 1.46 percentage points year-on-year, says Mr Zámečník.
Sam Goodacre, head of central and eastern Europe (CEE), Middle East and Africa banks equity research at JPMorgan, says the cost of risk (CoR) is lower than had been anticipated. He gives the example of Komerční banka, which was expecting CoR of up to 40-50 basis points (bps) at the end of 2020, but saw just 25bps in the first quarter of 2021, and retail CoR as low as 10bps.
He adds that just under 10% of Komerční banka’s total loan book was delayed or restructured, and the share of defaulted exposures is less than 10% of that, so less than 1% of the bank’s total loan book is currently considered problematic following the repayments moratorium.
While NPLs and CoR may tick up as the economy reopens and economic support eases, Czech banks are in a good position to manage the impact. “It seems like the country’s reputation for banking sector stability hasn’t been threatened by the crisis so far, and I don’t think that will change in 2021,” says Mr Szczurek. “The country ranks among the bottom 10 in the EU for CoR. The sector’s culture, costs and competition are all healthy.”
Leading banks going strong
The sector’s strength is not only due to the regulator, but individual banks. It is dominated by foreign-owned banks, most prominently Erste Bank’s Česká spořitelna, KBC’s ČSOB, Société Générale’s Komerční banka (KB), and UniCredit Bank Czech Republic and Slovakia. Some 25 of the 49 banks on the market are foreign branches, according to the CBA. Unlike Poland or Hungary, there has been no drive to bring more of the sector under domestic ownership.
Overall, the top five banks have a market share of 66%, according to JPMorgan research — a proportion likely to increase with forthcoming mergers. Česká spořitelna is the market leader in assets, and in 2020 saw its net profit slip less than the sector as a whole, by 43.6% to Kcs10.0bn. This was “far above initial expectations”, says Juraj Garaj, a member of the bank’s investor relations team, with the bank benefiting from its focus on digitalisation.
KB — which represents the biggest ‘pure play’ Czech banking stock to investors — also beat expectations, with a 45% drop in profit to Kcs8.2bn and net interest income down 11%. The bank was also relatively well prepared, as in early 2020 it was completing a transformation programme launched in 2018 that increased business agility and digitalisation, says Jiří Šperl, KB’s executive director for strategy and finance. KB used the crisis to accelerate cost-reduction plans, including cutting its branch network by a third by the end of 2020. It now aims to reduce its cost-to-income ratio to below 40% and raise return on equity to 15% by 2025 through new revenues and savings from its new digital banking offerings.
Rates move upwards
Banks’ efforts to secure medium-term growth should be boosted by an expected rise in profit in the coming year. Eyes are now turning to the CNB’s expected tightening of monetary policy in the second half of 2021. The central bank signalled its intent in May by increasing the countercyclical buffer requirement to 1%, albeit with effect from mid-2022. Analysts expect two to three 25bps increases by the end of the year, most likely starting in August, but potentially as early as June. This will increase banks’ ability to broaden interest rate spreads, and while it may take until 2022 for the effect to feed through, there is a sense that margins have now bottomed out and are headed on an upward trend.
“Net interest margins as of 2020 were about 2%, down by about a fifth as a result of rate cuts,” says Mr Goodacre. “Rates going up will be positive for Czech banks. I expect that banks will be able to add about 20bps in the coming year. Currently banks are paying next to nothing for deposits, but can replace lending books without a commensurate rise in lending costs. Though the top four are very competitive, with similar market share, so that does lessen the impact of rate hikes.”
Mortgage boom may slow
Interest rate increases may also cool the booming mortgage market. New mortgages grew a remarkable 34.3% to a record Kcs217bn in 2020, despite the recession, and hit another high in the first quarter of 2021, with nearly Kcs100bn dispensed and a record amount for a single month recorded in March. The CNB has voiced its concerns, saying in November 2020 that homes were 17% overpriced on average, and, as of June 2021, it looked set to tighten LTV and debt-to-income requirements again.
Mr Zámečník at the CBA notes a range of factors driving the growth. First, and most importantly, low interest rates in 2020, with negative real rates as inflation picked up. The expectation of CNB rises in response and banks moving their lending rates up from April led to a surge of applications as Czechs looked to secure home loans before it was too late. A third of mortgage sales in early 2021 comprised refinancing of existing mortgages, with holders looking to secure better terms while rates were low, backed by a CNB decree minimising costs for early repayment of current loans. Brokers hunting for deals intensified competition.
Second, flight to safety during an uncertain period. Nearly 80% of Czech households own their own homes, and ownership is widely regarded as a hedge against inflation and insecurity, as well as a retirement option.
Third, the market was also significantly boosted by the scrapping of a 4% tax on real estate sales in 2020. And a final factor, as elsewhere, was a renewed desire from buyers to acquire a more spacious property due to repeated lockdowns.
An insurgent to emerge?
The big four banks should be joined by a fifth in 2021 if the proposed merger between Moneta Money Bank and smaller challenger Air Bank gets shareholder and regulatory approval. The $1.2bn deal would be the largest of its kind in the country, according to Air Bank CEO Michal Strcula.
The deal was driven by Moneta’s largest shareholder, the investment fund PPF, founded by late Czech billionaire Peter Kellner. Mr Kellner’s sudden death in March 2021 does not seem to have derailed the merger, which would also see Moneta acquire the Czech and Slovak branches of PPF’s Home Credit and peer-to-peer lender Zonky. Together with Air Bank, the companies had a combined operating income of €219m in 2020, with net profit of €57m.
The deal would create a bank with the third largest customer base in the Czech market, at around 2.4 million. It would combine Moneta’s more traditional offering of a large branch network and its strengths — which include small and medium-sized enterprise lending, mortgages and pensions — with one of the region’s best-regarded neobanks and its affluent young client base.
Growing trends
The Air Bank-Moneta merger combines two of the growing trends in CEE banking: digitisation and consolidation. The Czech market has not been viewed as ripe for consolidation as others in the region, thanks partly to its dominance by a few major players and its profitability. However, incumbent banks have acquired and made investments in fintech companies, for example, KB taking stakes in Czech factoring start-up Roger and B2B financing solutions developer Lemonero. The bank plans to continue acquisitions as pressure on the sector grows.
“Sufficient scale is becoming a prerequisite for successful development of a bank, as it is increasingly difficult and costly to cope with advances in technology and regulation, and with intensifying competition,” says KB’s Mr Šperl. “Established banks make attractive potential partners for innovative companies as they can connect fintech providers with their large client bases, and shelter start-ups with the trust the banks have earned with their clients. Consolidation within the banking sector and absorption of companies from the non-bank space should continue.”
As Air Bank’s Mr Strcula notes, these partnerships are increasingly likely to be cross-border, as smaller banks struggle with the cost of regulatory and legal requirements, but global players face complications from local regulations.
Consolidation of the banking sector makes a lot of sense in absorbing all these additional costs
“Consolidation of the banking sector makes a lot of sense in absorbing all these additional costs,” says Mr Šperl. “Fintechs and the so-called monoline, or single, service providers increase competition in the segments where banks don’t develop quickly enough.”
And while fintech has not developed in the Czech Republic as quickly as in some parts of Europe, the uptake of online banking has accelerated due to the pandemic. In 2020, ČSOB saw active users of online banking grow 34%, and the number of consumer loans initiated online rose by 28%.
“It is clear that digitisation is the future,” says the CBA’s Mr Zámečník. “It is an existential necessity for the banking sector to be able to respond to emerging competition and technological innovation.”
He warns that regulation on banks may grow more burdensome over the coming years as proposals shelved due to the pandemic are dusted off. Domestic changes are likely to tilt legislation further towards debtors and consumers and away from creditors. At the EU level, the Green Deal and associated directives will have a significant impact on risk management and portfolio structuring for Czech banks, operating in an economy with substantial automotive and fossil fuel industries.
Bucking the trend
Regulation and competition aside, the clearest downside risk to the outlook in the short term is from a possible resurgence in Covid-19. But entering the second half of 2021, Czech banks have a renewed sense of confidence.
“What’s different in the Czech Republic is that other parts of CEE have foreign banks exiting, whereas here it’s seen as an attractive growth market with decent potential,” says Mr Goodacre. “We expect the market to continue to be dominated by foreign players. It bucks the trend of the rest of the region. Growth will feature on the agenda in the mid-term; even potentially some of these successful banks could look to expand abroad.”
Continue reading: Czech Republic confident of rebound despite looming inflation and election
