Marcin Liberadzki (© private archives)
Obserwator Finansowy: The Polish banking sector, like any other sector, has suffered heavily due to the pandemic. Mainly because it was forced to shut down its branches or limit operations, but also because of the interest rate cuts and looser monetary policy. What effect will this have on the commercial banks?
Professor Marcin Liberadzki: First of all, we should clarify that the looser monetary policy utilizes two types of tools. The first is low nominal interest rates, while the second consists in carrying out open market operations on an increased scale and on an extended range of financial instruments.
As for the permanently lowered interest rates, we will have two opposing effects that impact banks’ earnings. On the one hand, interest income will be heavily depleted. In the case of the largest banks in Poland, it is said that interest income could be reduced by up to several hundred million PLN a year for each institution. This means that for the sector as a whole the decrease in interest income may exceed PLN2bn (EUR454.3m) per year. At the same time, it should be pointed out that it is difficult to precisely estimate these values.
On the other hand, a reduction in interest rates will reduce the amount of the loan instalment payments, because the vast majority of loans are variable interest rate loans. In this case the value of the debt service-to-income ratio decreases. This, in turn — in the case of banks applying the IFRS 9 accounting standard — will reduce the probability of the borrowers’ default, and consequently, will make it possible to reduce the loan loss provisions.
Which effect will be stronger?
Of course, the effect of the decline in the net interest income will be stronger than the effect of a decline in loan-loss provisions resulting from interest rate cuts, because in general the level of provisions will increase along with the growing risk of the borrowers’ insolvency. Moreover, a decline in interest rates will result in a one-off effect of an increase in the prices of treasury bonds held by banks, but the increase in valuations will only be felt in the case of securities included in portfolios evaluated through profit or loss and other comprehensive income. In summary, the net effect of a drop in interest rates will be clearly unfavorable for the banks over the course of the year
And what about open market operations? In this case there doesn’t seem to be any doubt that they will have a positive effect, supporting the sector’s liquidity?
Yes, the purchases of debt securities will allow maintaining the liquidity of the banking sector and the economy and will enable the financing of increasing government expenditures along with a simultaneous decline in government bond yields. This second activity will undoubtedly help the banking sector.
Is it possible that Poles will “fall out of love” with bank deposits? As we know, they keep around PLN893bn (EUR203bn) in bank deposits. The interest on deposits is already very low. With an inflation rate of several per cent this means that deposits are actually generating losses. Will Poles start withdrawing their savings from the banks, and investing them somewhere else?
I wouldn’t worry about an excessive outflow of deposits from the banking system as a whole. Let’s keep in mind, that in the current regulatory architecture, banks enjoy a virtual monopoly on offering deposits guaranteed by the Bank Guarantee Fund. Few other financial products can become a substitute for bank deposits, if that’s even fully possible at all.
I would be more worried about the impact of the interest rate cut on the condition of a number of weaker banks, which usually attracted their clients, or rather depositors, with high interest rates on deposits. This will now become more difficult.
How are Polish commercial banks behaving in supporting Polish companies with affordable loans? Will these loans actually be cheap and easily available? In other words, will Poland’s central bank, NBP be able to achieve its goal?
At this moment it is still difficult to accurately assess the impact of the pandemic on the banks’ lending policy. There is a lot of uncertainty and we don’t have reliable forecasts of further economic developments. However, you should expect an increase in the margins imposed on borrowers along with the expected increase in the loss ratio on the banks’ loan portfolio.
And let’s be frank, a lot of businesses will lose their ability to borrow as a result of a real collapse in the demand for their products or services. As for the availability of loans, I’m moderately optimistic. I mainly see the chance for the sustained financing of Polish companies in the successful implementation of the state support for businesses.
Of course, we know that the banks will be seriously affected by the recession through the bankruptcies of their corporate clients and the decreasing ability of their individual consumers to service debts. The question is how strongly could the loan portfolios of Polish banks deteriorate in the coming months?
Unfortunately, there is a high risk that the crisis in the real sector will also spread to the banks. As for the impact of the pandemic on the quality of the loan portfolio, a lot will depend on the duration of the crisis, because we can already observe its depth.
The quality of the loan portfolio has never been a strong suit of Polish banks, even in the recent years, which have been very favorable economically. The level of NPLs observed right before the outbreak of the crisis, is two times higher than the average in EU countries. This means that the starting point is not very good. Fortunately, the introduction of a broad program of moratoria, or “credit payment holidays”, will allow — at in relation to the groups of customers covered by them — for delaying the classification of exposures as non-performing by a quarter or two.
How do you assess banks’ behavior from the business point of view with regard to the provision of the “loan payment holidays” during the pandemic?
Firstly, it should be noted that we are talking about “credit holidays” introduced for homogeneous groups of customers in the face of a pandemic. Moreover, the granting of these payment holidays was not the result of any assessment of borrowing capacity or the existence of any delays in payments.
I believe that in the current situation “payment holidays” should be granted upon the request of the customers, without undue delay, of course taking into account the current operating conditions. And here it must be said that the banks have acted pretty efficiently, despite the limitations affecting their personnel.
However, some experts criticized the way in which banks acted.
It is difficult to expect that “credit holidays” will result in the cancellation of a part of the borrowers’ liability towards the banks, whether relating to the principal or the interest. Therefore, it is ultimately better to use the term “loan moratorium”. Because what we are talking about, is an operation in which the burden of loan repayment is spread out over time, so that in the end the bank doesn’t suffer any losses, nor makes any profits on this operation. However, the price parameters of the loan for the customers also cannot deteriorate because of the moratorium, which means that no additional charges can be introduced, and the bank’s margin may not be increased.
The compliance with the rules would probably improve if there was a clear standard developed by the banks themselves and properly communicated to the public. I’m under the impression that the banks haven’t done a very good job in explaining to their customers what the credit moratorium really is about.
The requirement — applied by some banks — for the client to provide a written confirmation of their balance of liabilities raises some questions. There are concerns that such a confirmation could be interpreted as an “inappropriate recognition of debt” and, as such, could block the legal path for customers to challenge their liabilities, for example, in pending or future lawsuits in which borrowers seek to invalidate mortgage loans denominated in the CHF.
It seems that the so-called social distancing measures will last longer than we thought. Will bank branches disappear as a result of it? How could banks change, in the operational sense, as a result of the pandemic?
The whole economy will change in the “operational” aspect, as a result of the pandemic. I think that remote work has become an important discovery in many industries over the past couple of months. Banking, especially in Poland, has already been in the process of transition to the remote access model. The pandemic will only accelerate this trend. The habits of bank customers will also likely change: many of those who were forced — perhaps for the first time in their life — to use the remote access channels and contactless payment due to the present circumstances, will not go back, to the same degree, to using cash or to direct contacts with bank employees at the branch.
One trend that has been observed in the banking sector for quite some time is the big increase in IT costs. This factor has already served as a catalyst for the consolidation of the banking sector. The smaller institutions simply aren’t able to bear the high costs associated with the development of technology. These expenditures will exceed the savings from the shutdown of brick-and-mortar branches, but they are necessary in order for banks to maintain their competitive position, especially in the areas of the market where entities from the fin-tech industry are vigorously growing their market share.
When we look at the banks listed on the stock market, their capitalization and index valuation, we are faced with the question could the valuation of banks listed on the Warsaw Stock Exchange be even lower than it is now? Could the value of the WIG Banks index fall to the level seen during the financial crisis of 2008?
Firstly, we have to be clear about one thing: the 2008 crisis was a banking crisis, and the current crisis is a crisis of the real economy, which may turn into a banking crisis, but doesn’t necessarily have to. The banks are well prepared for this current crisis, with high capital buffers, which will help in absorbing the losses.
Whether the current valuation of the banks listed on the WSE is fair depends on the duration and severity of the crisis for the economy. If the crisis proves to be transitory, then in the long term the banks could — paradoxically — turn out to be among the beneficiaries of the whole situation. It should be noted that all across the world the burden of many regulatory restrictions on banks has been lifted, and such changes are continued. The regulatory bodies claim that these are only temporary measures, but I wouldn’t rule out the possibility that these changes will remain in force for longer.
We already know that some banks spent billions of PLN on the purchase of bonds issued by the Polish Development Fund and the Polish National Economy Bank. What do you think about it? How did banks’ shareholders see it?
In order for the government aid to companies to succeed, the Polish Development Fund (PFR) had to issue and sell bonds for a total amount of PLN100bn (EUR22.7bn). All this had to happen within really quickly because the PFR had to immediately allocate funds to the beneficiaries. Meanwhile, under “normal” conditions the Polish State Treasury issues bonds for the amount of less than PLN200bn (EUR45.4bn), but this happened over the course of an entire year, with many of the buyers coming from abroad. I would like to add, that the amount of PLN100bn in bonds issued by the PFR constitutes an additional supply of debt to the market, because the State Treasury will have to borrow money anyway.
The bonds were purchased on the primary market by the banks, and without their involvement it wouldn’t be possible to implement the public aid. NBP has pledged to repurchase the bonds, but the central bank is only authorized to purchase the securities of the PFR on the secondary market in order to ensure that the process is neutral for the profits of the banks taking part in the operation.
The whole operation has been planned in a way, which ensures that — apart from the banks’ huge operational and organizational commitment — its impact on the so-called financial standing of the participating institutions remains neutral. In this way the banks enable the implementation of a public support program that is important for the economy.
A few months ago, there was a rumor on the financial market that state-owned banks are planning to create a consortium that would purchase a significant stake in Deutsche Bank. Could the coronavirus crisis provide an opportunity for Polish banking sector to make some big acquisitions outside of Poland?
International expansion is a logical step in the development of a business, which also applies to banking, after reaching a strong enough position on the domestic market. This is especially true considering that banking is based on the economies of scale and can successfully utilize the effects of geographical diversification. However, expansion also generates risk and may contribute to a significant erosion, and even the collapse of a major institution or banking group.
Could you give an example?
The Deutsche Bank, which you’ve mentioned, is instructive. The primal cause of the current weakness of the German giant has been its unsuccessful expansion into the US market in the segment of lucrative investment banking, which started with the acquisition of the struggling Bankers Trust in the mid- 1990s. Therefore, I would like the Polish sector to succeed in the area of international expansion, but it shouldn’t be rushed. It needs to be well-thought and planned in the long term.
How much will the consequences of the pandemic — that is, the interest rate cuts and the recession, the growing problems with the loan portfolios — affect the Polish banks’ ability to meet the MREL requirements?
Let’s begin with the fact, that even without the pandemic the banks in Poland would have some difficulty in meeting the MREL requirements. At the same time, problems of this sort weren’t reported by banks in the Eurozone, or in Hungary and the Czech Republic. Obviously, meeting the MREL requirements in conditions of uncertainty in the economy and in the capital markets is not a comfortable situation for the banks.
Fortunately, the deadline to meet the MREL targets remains quite distant. As part of the anti-crisis package, the Bank Guarantee Fund extended the deadline for the fulfillment of the mid-term MREL target designated for entities subjected to forced restructuring, which also positively affects the banks’ situation.
As shown by the current experience of banks in the Eurozone, the environment of low interest rates is conducive to obtaining financing by issuing MREL instruments. This is due to fact that under these conditions there is a growing demand among investor for instruments that provide higher profitability than bank deposits, even at the price of a sizeable risk.
How much will the net profit of Polish commercial banks decrease in 2020, and the subsequent years? Some analysts estimate that the interest rate cuts will contribute to a net profit decline of 10 per cent y/y. Do you have your own estimates?
The profits of commercial banks in Poland will be determined by the amount of the provisions that they will have to create for the expected loan losses, and in the subsequent periods — by the actual value of the NPLs. This, in turn, depends on the adopted scenario of the course of the crisis in the real economy and the actual developments in the future. The loan loss provisioning policy will prove decisive for the scale of the decline in the profits of banks in the coming quarters.
In the IFRS 9 accounting standard the creation of provisions for credit risk follows a prospective approach: the provisions are created in the amount corresponding to the expected loss within a certain time horizon in the future. The problem with such a is that its direct application could prove devastating to the sector’s performance. The supervisory authorities in other countries are aware of the limitations of accounting standards, mainly the IFRS 9, and are either partially suspending the applicability of the existing standards (GAAP in the US) or are encouraging the banks and their auditors to adopt an adequately flexible approach within the framework provided by the standard.
This means that in the effort to estimate the profits of banks in this year and in the coming years we are facing two big unknowns: the approach of banks and their auditors to the expected loan loss provisioning, and in the longer term, the scale of the actual damage in the economy as a result of the pandemic.
Marcin Liberadzki is a professor at the Warsaw School of Economics.