Financial Stability Review: recent decline in systemic risks to the banking system
Banka Slovenije’s assessment is that the general level of systemic risks to the banking system has improved over the recent period. The major factors in this improvement are the uptick in the banks’ income position brought by the rise in interest rates, and the lesser realisation of risks than had been suggested by the figures from the early part of the year. We should also highlight that the level of uncertainty remains high, on account of the persistence of high inflation even as the global economy cools.
The interest rate risk assessment is being held at elevated, although the risk to banks from the rising share of fixed-rate loans is gradually diminishing. All other risks, including credit risk, where the impact of the recent floods might be greater than currently estimated, are assessed as low or moderate. Meanwhile the banking system’s resilience to any realisation of risks remains solid: it is assessed as medium in the segment of solvency and profitability, and high in the segment of liquidity.
Banka Slovenije is supporting the resilience of the banking system through the capital-based measures of its macroprudential policy, while the risks are mainly being reduced by our restrictions on household lending. The current circumstances favour the preventive strengthening of the banking system’s resilience.
Key systemic risks to the Slovenian banking system
After domestic economic growth strengthened in the second quarter, the available indicators for the third quarter suggest a slowdown in economic activity even while certain figures remain favourable. Meanwhile the labour market remains tight, and wage growth remains high. Inflation remains high, primarily on account of strengthened service price inflation, supported by elevated wage growth. The consequences of the severe weather events are also affecting economic developments.
Under these circumstances we have held the assessment of interest rate risk in the banking system at elevated, although we anticipate a decline in the future. There has been a slowdown in the rise in the share of fixed-rate loans, which in the absence of hedging increase exposure to interest rate risk. At the same time the rising interest rates on deposits are gradually increasing the share of fixed-term deposits, while the share of sight deposits is declining. Given the slow rise in interest rates on deposits by the non-banking sector, the banks are still largely reliant on funding at very short maturities, which exposes them to the risk of a rapid decline in this funding, although it has proven to have great stability when viewed historically. Funding risk therefore remains moderate.
The credit risk assessment was lowered, but the complexity of interactions in the economy means that the impact of the recent floods might be greater than currently estimated. Current assessments are that there should be no significant deterioration in the quality of bank assets on this account. Credit portfolio quality has undergone continual improvement, this year even in segments of the portfolio where high NPE ratios had persisted the longest. The proportion of non-performing claims reached a new record low in the first half of this year. Rising corporate profits and high employment with low indebtedness are indicative of the sound financial position of customers of banks, who are operating in a stable environment with a positive, albeit weaker, outlook.
The assessment of the risk inherent in the real estate market has been lowered in comparison with the spring issue of the FSR. Since prices on the Slovenian real estate market peaked in the first quarter of 2022, sales of residential real estate have been declining, and growth in residential real estate prices has also slowed sharply. The slowdown in growth in residential real estate prices entails a correction to move closer to fundamentals, but not yet any realisation of risks to financial stability.
The income risk assessment was lowered from moderate to low, given the current increase in income generation at banks driven by net interest. Here we should reiterate that the favourable conditions, which currently reflect the large gaps between interest rates on assets and those on funding, will remain in place for a limited time only.
Resilience of the banking system
The resilience of the banking system from the perspective of solvency and profitability remains medium. Our assessment is that the increase in income being driven by rapidly strengthening net interest income is currently increasing bank resilience. Additional positive effects on profitability and solvency alike can be anticipated on this account this year. The banks’ currently sound solvency position might deteriorate in the future as a result of an increase in the tax burden, which would adversely affect future growth in regulatory capital, and any rise in exposure to credit risk in response to the floods. Current assessments are that the current high earnings could absorb the consequences of any such deterioration in the portfolio. The resilience of the banking system from the perspective of liquidity remains high. Although the various liquidity indicators have improved at the level of the banking system, we should reiterate that there remain considerable differences between the banks in their resilience to systemic risks.
Action to address risks in the financial system
Macroprudential policy is focused primarily on strengthening the banking system’s resilience, and also on limiting the risks to which the banks are exposed. An adjustment to the previous macroprudential restrictions on consumer lending entered into force on 1 July 2023. The banking system’s resilience will also be raised by the application of the modified methodology for setting the buffers for systemically important institutions. The same is true of the countercyclical capital buffer rate in the amount of 0.5% introduced at the end of 2022, which will have to be met by the banks as of 31 December 2023. From the perspective of macroprudential policy, the consequences of the emergence from the period of low interest rates and low variability in various economic categories into a period of elevated inflation and higher nominal interest rates will be of huge importance. This will result in greater variability in nominal and real economic and financial categories. This transition requires a more preventive pitch in the macroprudential instruments focused on strengthening the resilience of the banking system.
Table: Banka Slovenije’s risk and resilience dashboard for the Slovenian financial system
Note: The risk and resilience dashboard is based on an analysis of key risks and resilience in the Slovenian banking system, and is defined as the set of quantitative and qualitative indicators for defining and measuring systemic risks and resilience. The colour code in the risk and resilience dashboard relates to the assessment for up to one quarter in advance. The arrow illustrates the expected change in risk or resilience in the scale (up or down) over a slightly longer horizon of around one year. For risks, an up arrow means an increase in risk, and vice-versa, while for resilience it means strengthening, and vice-versa.
* Transition risks are taken into account under climate risks.
Source: Banka Slovenije