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Are Romanian banks prepared for an economic slowdown?

Having strengthened their balance sheets in recent years, Romanian banks are hopeful they can withstand stresses such as an economic slowdown and controversial government plans over tax and pensions. Kit Gillet reports.
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Banca Transilvania

Romania’s banking sector has been posting impressive results over the past few years, aided by a strong domestic economy, but regulatory uncertainty and increasing concerns over a global slowdown – at a time of rising domestic government spending – are creating a sense of trepidation.

Meanwhile, a controversial tax on banking sector assets, enacted in late 2018, has added to the unease and altered many banks’ investment plans, even after the bill was watered down. Even so, many believe the banks are in a far better position to overcome future challenges than they were in the past.

“I think the banking sector is well positioned,” says Ionut Dumitru, chief economist at Raiffeisen Bank Romania, one of the largest banks operating in the country. “The capital-to-debt ratio is quite high, much higher today than in many other countries in Europe. Balance sheets have improved significantly. Banks have struggled in the past few years to clean up their balance sheets, and now all the financial indicators are looking good.”

Strong growth

The 2008 financial crisis hit Romania hard, and the banking sector was no exception, with non-performing loans (NPLs) ballooning to more than 20% of the total loan book. However, in recent years banks in the country have benefited from the national economy expanding at one of the fastest rates in the EU in 2018; the country’s economy grew by 4.1%, though this was down from almost 7% in 2017.

Since joining the EU 12 years ago, Romania’s nominal gross domestic product (GDP) has risen by 160%, to about Ä200bn, with GDP per capita in purchasing power standards reaching 64% of the EU average, compared with 44% in 2007. Romania’s banking sector assets, meanwhile, have grown by 80% over that period. 

According to the National Bank of Romania (NBR), the 34 credit institutes operating in Romania had total assets of 458.8bn lei ($106.8bn) at the end of June 2019, up 5.6% year on year, with 91.9% of assets belonging to privately owned institutions. Foreign-owned lenders accounted for almost 75% of total assets, highlighting the strong presence of lenders from other EU member states. 

At the same time, the aggregate market share of loss-making banks stood at a 10-year low in 2018, according to the NBR, at just 4.1%, with 25 out of 34 credit institutions recording positive net financial results at the end of the year. “The banking sector is in good shape. We’re coming from a previous period where we had NPLs in excess of 20%. Now, it is around or even slightly below the 5% mark, which is a tremendous improvement,” says François Bloch, chief executive of BRD, a Société Générale subsidiary that has a 12% market share in Romania.

Credit concerns

Lending to households in Romania has continued to grow swiftly, with unsecured consumer loans increasing 12.2% in 2018 and housing loans up by 10.8%. The annual growth rate of credit extended to non-financial companies and households is expected to average 5.8% between 2019 and 2021. At the same time, the share of local currency loans to the private sector reached 66% in December 2018, its largest share since 1996. In January 2019, the central bank introduced a 40% ceiling on household debt, with foreign currency lending capped at half of that, applicable to both banks and non-bank financial institutions.

One source of concern for banks, however, is that this economic growth in recent years has been largely funded by rising levels of consumption. “It is not credit that’s driving economic growth in the main, but rising wages and incomes,” says Daniel Daianu, chairman of Romania’s Fiscal Council. “The bottom line is that it is a very low volume of credit extended to the private sector.”

According to the NBR, the banking sector’s loan-to-deposit ratio stood at 74.69% in June 2019, slightly down from 75.22% in June 2018. Romania’s loan-to-GDP ratio is currently among the lowest in central and eastern Europe (CEE). “At 27%, when judged with our peers in CEE, it is very low. It was 70% before the crisis,” says Sergiu Manea, chief executive of Banca Comerciala Romana (BCR). However, he adds that the reduction of NPLs from about 22% to below 5% since 2014 was always going to take its toll on financial intermediation. 

“I think banks are more aware when they are lending, to whom they are lending, to the point of them being overcautious,” he says. “At the same time, in the past 10 years the European regulatory environment [has become] much tougher for the banks [with regards to] the capital they need to set aside.”

Negative equity

Another part of the problem is that about 270,000 companies in Romania, more than half of active companies, are showing negative equity. Mr Manea suggests that banks, together with the state, need to work towards establishing a buyer of last resort, a fund that would enable risk sharing in order to grow small and medium-sized enterprises and companies in strategic industries. “We are currently discussing this,” he adds.

Banks are also being encouraged to develop more non-credit-based income. Net fee and commission income has grown steadily, but still represents just 19.6% of total operating income. At the same time, Romanian banks’ exposure to the state was among the highest in the EU in 2018, approaching 20% of assets. The exemption of government bond holdings to a new bank tax could further incentivise banks to increase their exposure to government bonds, according to an August 2019 International Monetary Fund (IMF) country report on Romania.

Financial inclusion is still a major issue in Romania, as is financial literacy and the adoption of digital banking. “At the headline level, technology penetration is quite high. Romanians are more prone to moving [between] technology eras, jumping through the desktop age and just moving straight to smartphones for their homes or businesses,” says Mr Manea. 

However, he adds that just 64% of Romanians have a current bank account. “Financial literacy levels are low everywhere, even in parts of the urban population where you would not expect it,” says Mr Manea. BCR is investing considerable resources in educating its clients and the population at large.

The size of the grey, or informal, economy is another concern. “If you look at the currency in circulation in Romania, you see the increase of cash in circulation is greater than the increase in GDP,” says BRD’s Mr Bloch. “The more we grow, the more the economy becomes a cash economy, which is unbelievable. This is something that all actors should be concerned with.” 

Consolidation on the cards

In recent years, Romania’s banks have undergone significant ownership changes. Greek banks have largely exited the market; Piraeus Bank sold its local operations to US private equity house JC Flowers and local lender Banca Transilvania acquired Bancpost from Eurobank Group. 

National Bank of Greece announced that it had sold its 99.28% stake in Banca Romaneasca to Hungary’s OTP Bank in 2017, though the deal was subsequently terminated, with the shares sold to EximBank, a Romanian state-owned bank, earlier in 2019. That deal is currently under scrutiny by the country’s competition council, but if it goes ahead it would see EximBank enter the retail banking space for the first time in its 27-year history.

Still, many believe more consolidation is needed. “Consolidation should happen, and in my view it should happen faster,” says Raiffeisen’s Mr Dumitru. “Small banks, 1% market share banks, need to team up with other players in order to become more efficient. I think this should be a core trend in the next few years.”

On August 23, Romania’s finance ministry launched for public debate a draft bill that would allow the establishment of national development banks in the country. “There are promotional banks in many developed countries in Europe, and such banks are useful,” says the Fiscal Council’s Mr Daianu. “Commercial banks do not fund infrastructure, so Romania needs a promotion bank. But it has to be well managed; it should use local and external resources. It can help the economy.”

Spending on infrastructure in Romania has fallen in recent years as a percentage of overall spending, as the government struggles to keep the country’s budget deficit below 3% of GDP. “Now investment expenditure is about 2.6% of GDP, which is the lowest figure among the emerging economies of CEE,” adds Mr Daianu.

Tax fears

While many countries are seeing positive regulatory developments for their financial services industry, Romania stands accused of going in reverse. “Over the past five years, the unpredictability of the banking legal framework has worsened,” says Sergiu Oprescu, chief executive of Alpha Bank Romania and president of the Romanian Association of Banks. According to Mr Oprescu, between 2014 and 2018, 50 new laws and regulations related to the banking sector were enacted in Romania, five of which were declared at least partly unconstitutional.

The most troubling of these came in December 2018, when Romania’s government introduced a new tax on banking assets, as well as on energy and telecommunications companies. Ordinance 114 required banks to pay, quarterly, a tax of between 0% and 0.5% on all their assets, depending on the Romanian Interbank Offer Rate (Robor). The bill was met with shock and confusion by the banking industry, and while the measures were eventually watered down, with a reduction in the amount due and a decoupling of the tax from the Robor, the impact appears likely to be far reaching. 

“Although the impact of a tax on financial assets affects only banking institutions, the final cost will be paid by society as a whole,” says Mr Oprescu. “There is high risk that the tax on banks’ financial assets produces a negative chain of effects across the economy, with a direct impact on overall economic growth and, consequently, on government revenues.”

BRD, for one, has announced publicly that the impact for the bank on a yearly basis will be about 70m lei. “Beyond the financial impact, it also impacts on the way we look at our investments,” says Mr Bloch. “Because when you operate in an environment where this kind of decision can happen from one day to the next, you have to incorporate that into your long-term strategy. This creates some instability in the financial sector, which is very detrimental to the economy.” He adds that BRD has had to review some of its investment plans, diverting funds to pay the tax.

Others say that the bill, and the subsequent fallout, highlight a need for greater communication between stakeholders. “There should be more dialogue between policy-makers and bankers, a more candid dialogue,” says Mr Daianu. “The way Ordinance 114 was enacted is mind-boggling. Linking the tax to the monetary policy rate, that was total nonsense. Fortunately, the NBR and other stakeholders were capable of limiting the damage. We reversed the ordinance. There are some leftover [elements], but if you compare it with the initial version there is a major difference.” 

Eurozone aspirations

Romania is still pushing hard to join the eurozone in the near future, with the government targeting an entry date of 2024, or soon after. However, this is seen as an unrealistic target by some, with the country yet to enter the Exchange Rate Mechanism. “Romania has a long road ahead to join the euro area,” says Mr Oprescu. “To accomplish this, our convergence rate needs to accelerate and maintain an overall growth advantage over the group. There are indeed concerns regarding the budget deficit, and the long-term sustainability of both the pension system and the public sector wage policies.”  

Romania’s budget deficit grew by 52% between January and July 2019, compared with the first seven months of 2018, and in recent years the country has registered a budget deficit very close to the 3% of GDP limit allowed by the EU. The IMF predicts a 3.7% deficit in 2019, if measures are not taken to increase revenue or reduce spending.

At the same time, a potential new pension law, if enacted in its current state, could double Romania’s fiscal deficit, substantially increase current account deficits and raise external financing needs to excessive levels, according to the IMF. It points to “potentially devastating” medium-term consequences, with Romania’s fiscal and current account deficits both reaching 8% of GDP by 2022 and public debt increasing by 20 percentage points of GDP. “When it comes to the state of public finance, the new pension law would involve more than 3.5% of GDP as additional public expenditure in 2022. This would imply a budget deficit of close to 7% in that year. This is a non-starter,” says Mr Daianu. 

With or without the new pension law, belts are likely to need tightening in the near future, if the global economy, along with that of Romania, continues to slow down. The banking sector will increasingly need to prove its stability. “The dynamics of the economy of the past three years are not sustainable. There’s going to be an inevitable slowdown,” says Mr Daianu. “In the banking sector we may see more consolidation, with some of the stronger banks taking over smaller banks. Frankly, I’m glad that some of the very weak links have been cut out. They were making our economy more fragile. We need solid banks that are ready to undertake full due diligence and provide lending.”  

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Read more about:  Central & Eastern Europe , Romania