(401(K) 2012, CC BY-SA)
Credit risk is the risk of loss due to the debtor’s default. Since banks hold an adequate amount of equity concerning the value of assets, it is sufficient for a certain portion of total loans to become uncollectible and the bank may be on the verge of collapse. Many studies have shown that credit risk is by far the most significant of all risk exposures in credit institutions. A World Bank study by Caprio and Klingebiel, found that over 90 per cent of bank failure worldwide is due to credit risk exposure.
Credit risk occurs in two ways: at the level of an individual credit party, and at the level of an entire credit portfolio. At the individual credit party level, banks seek to reduce the likelihood that a customer will not settle his obligations by the end of the credit relationship through a credit rating of the clients. This is particularly complex in countries of Southeast Europe (SEE) where the share of the shadow economy is still high. On top of that, in some cases, financial statements of companies are not a reliable sources of information. In addition to credit rating, collateral is also extremely important. The situation with collateral recovery in the SEE is bad, with extremely long periods of forced collection of claims (about ten years or more).
At the portfolio level, banks use a variety of measurement and credit risk management tools. The most important measure is certainly diversification: banks seek to lend to diversified clients, to disburse various types of loans, all to ensure a low correlation of billing problems, as diversity reduces the likelihood that more debtors will have problems at the same time.
The Croatian, Bulgarian, Bosnian and Albanian banking system have always had relatively high rates of non-performing loans (NLP) and extremely slow collateral recovery. Total NPLs have been declining for just over 4 years, due to several reasons. There is a macroeconomic improvement this is primarily reflected in a GDP growth and increased purchasing power. Secondly, banks have made a significant change in focus from mere loan placement to the construction of real recovery centers. On top of that there is the strengthening NPLs buying and selling market:
In the last few years, the Placement Buying Industry has grown strongly, where NPLs are moving from the banking (highly regulated) industry to less demanding regulatory frameworks with payroll specialists. Such a change seems a good thing but the situation looks different when comparing data for these countries (except for Bulgaria) with data for EU member states, where the average NPL ratio is slightly higher than 4 per cent. Only a few countries have higher NPL ratios: Greece (about 44 per cent), Cyprus, Portugal, Italy, and Hungary.
On the other hand, when discussing NPLs, drawing any conclusions without analyzing the coverage of NPLs by value adjustments would be wrong. The average coverage of NPLs with value adjustments in the EU is around 46 per cent, with only a few countries having coverage higher than Croatia. The „champion” is Hungary (with a coverage of 66.2 per cent), followed by the Czech Republic, Poland, Romania and Slovakia. Croatia is high on the coverage list, and Croatian banks also have a very high total capital ratio (22.95 per cent at end-June 2019).
Overall coverage of NPLs has increased significantly (especially in the past 4 years). This increase is the most significant in corporate and residential loans, and is closely related to the change in the 2013 Classification of Placements Decision. It is important to point out that, as of January 2018 and forwards, many banks have been applying the IFRS 9 (International Financial Reporting Standard that addresses the accounting for financial instruments) and have significantly changed the way to calculate value adjustments. Now it’s more oriented towards expected losses than before. Nevertheless, there were no major changes in the coverage of NPLs with value adjustments after IFRS 9 was applied, which means that a conservative, provisioning policy has been applied to banks for a long time.
The situation with NPLs is developing relatively well and is significantly better than a few years ago. However, there are some other “potentially problematic” facts that could affect SEE banks’ operations in the future. The increase of bank loans in the last few years has been recorded primarily in the segment of non-purpose cash loans, which are most often placed without a solid collateral and therefore represent a higher potential risk. Current interest rates are extremely low and a potential future increase may result in an “escalation” of an interest-induced credit risk. Rising interest rates may reduce the creditworthiness of borrowers, i.e. their ability to pay credit obligations, and thus increase credit risk with the lender.
Banking sector in Bosnia and Herzegovina
The banking sector continues to be adequately capitalized, liquid and profitable, and a decrease in credit risk has been noted. In the previous years, credit risk was a key factor that threatened the stability of the BiH’s banking sector. 23 banks were operating in the BiH’s market in 2018, which — according to provisional data for the end of 2018 — made a net profit of EUR175m. NPLs and their share in total loans (8.77 per cent) have been continuously declining for the past two years, and according to provisional data for the end of 2018, they amounted to EUR870m.
Several factors have contributed to the reduction of poor-quality loans in the Bosnian banking sector. Positive trends in the macroeconomic environment and the real sector of the economy have been recorded for the past few years, which has led to a slight recovery in lending activity. By the end of 2017, the annual growth rate of credit to the private sector was 7.43 per cent. In December 2018, it was 5.58 per cent. At the same time banks have taken steps to clean up the balance sheet by permanently writing off bad receivables and selling them to repurchase companies.
Increase of non-purpose loans in Croatia
For the past two years, the largest contribution to household borrowing from credit institutions (primarily banks) has been made by non-purpose loans. Looking at the figures, by the end of last year, the Croatians owed EUR16.7bn to commercial banks. This is 4.6 per cent more than the year before. Non-purpose loans with no pledges and those with a ten-year maturity are the fastest growing. Influenced by such dynamics, household debt reached the record level and the share of cash loans in total debt of the household sector is around 38 per cent. Specifically, compared to the end of 2010, when they amounted to EUR4.5bn, non-purpose cash loans exceeded EUR6.4bn at the end of 2018. This represents an increase of EUR1.89bn, more than 41 per cent. But at the same time all other forms of household loans (housing, account overdrafts, credit card loans, mortgage loans, car loans, consumer loans) decreased their value. The quality of repayment of non-purpose cash loans has been improving for several years. Since the end of 2014, the share of hard-to-pay and uncollectible non-interest-bearing cash loans has declined from about 10 per cent to about 6 per cent. This trend suggests that the quality of this type of loans is relatively high. However, due to the rapid growth of the value of non-purpose NPLs, their share in the total amount of hard-to-pay and NPLs of the household sector rose to over 31 per cent at the end of last year. This was record high. In comparison from 2010 to 2017, the share of NPLs in the total amount of NPLs of the household sector remained in the range of 25-28 per cent.
Bulgarian banks with stronger capital buffers
According to the Economic and Financial Affairs of the European Commission, important steps have been made towards ensuring the continued stability of the banking sector in Bulgaria, while many actions are yet to be finalized or implemented. Banks have addressed the capital buffer recommendations after the 2016 asset quality review. In addition to stronger capital buffers, efforts to improve banks’ robustness have included enhancing provisioning policies and credit-granting practices, as well as reducing the nonperforming portfolios and de-risking balance sheets, e.g. by selling and writing off repossessed collateral. NPLs are decreasing and the secondary market has become more dynamic. The NPLs ratio has been on a downward trend across individual banks and segments, declining to 8.5 per cent at the end of September 2018 (from 11.4 per cent a year earlier). The current stock represents mainly the legacy of the credit boom before the 2009 recession. Increased lending activity and reduced stock contributed to this decline. At the same time, the secondary market for NPLs has become more dynamic, also in the corporate segment. Ample liquidity is generating demand for NPL portfolios and collateral sales. On the supply side, banks are more active in selling large NPL portfolios. The market continues to be driven by subsidiaries of Eurozone banks.
Albanian banking sector is improving
The quality of the loan portfolio improved in 2018 and in November alone the NPLs ratio of Albania’s banking system dropped to 12.7 per cent of all loans, the central bank declared in its latest report. According to the Bank of Albania (BoA), the banking sector in Albania is continuously improving. The BoA said that at the end of the Q3’18 the indicator of the NPL ratio stood at 12.43 per cent. In the previous year it was 13.23. The improved quality of loan portfolio is mainly attributed to their repayment, and in the meantime, recoverability provided additional contribution as well. The Albania’s central bank has drafted a special regulation for the systematic and formalized treatment of NPLs, especially in the case of large borrowers.
Major changes in the SEE banking sector
In the SEE region banking has changed significantly in the last ten years. While the growth of banks ‚assets before the 2008 crisis was the largest in the part of housing loans, today the growth of banks’ assets is noticeable, first of all, in the portion of non-purpose cash loans. Cash loans are placed on longer maturities, with fixed interest rates, and usually in local currency. Specifically, bank clients have learned from the past (for instance, the CHF-denominated mortgages (read more) and most often seek out banks that can extend their long-term domestic currency loans at a fixed interest rate. On the other hand, austerity habits have remained similar to the ones from a decade ago: clients save in the short term, at least with automatic savings prolongation. On the liabilities side, there is another significant problem — the substitution of earlier long-term loans from abroad with demand deposits. All of this leads to a further deepening of the maturity mismatch between banks’ assets and liabilities which is a growing problem for the whole financial sector.
Vedran Obućina is an analyst and a journalist specializing in the Croatian and Middle East domestic and foreign affairs. He is the Secretary of the Society for Mediterranean Studies at the University of Rijeka and a Foreign Affairs Analyst at The Atlantic Post.