The economic and financial crisis from the point of view of Czech banks

Chamber of Commerce Switzerland – Czech Republic Prague,12 May 2009 The economic and financial crisis from the point of view of Czech banks Miroslav Singer Vice-Governor, Czech National Bank M. Singer: Banking and financial sector of the Czech Republic: latest development and key challenges 1 M. Singer: Financial Crisis: Impacts on the CR and Lessons for the Supervisors 1 M. Singer: Financial Crisis: Likely Impacts on the CR and Lessons for the Supervisors 1 M. Singer: Present Conditions, Monetary Policy and Outlook for CR 1 M. Singer: Consumer protection in financial services: CNB approach 1 M. Singer: Inflation and Monetary Policy in a Small Open Economy 1 M. Singer: Capital Market in the Czech Republic1

Outline Banking sector during crisis CNB forecast (May 2009)

Structure of presentation External financial sector External demand Real economy Firms Domestic financial sector Households Supervision of financial sector Monetary policy CNB

Collapse in confidence between financial institutions (at time of Lehman Brothers failure) generated: Increased risk premium on markets Fall in liquidity Increased volatility Cooling of housing market Stock market fall (limited significance in Czech Rep.) Impacts of financial crisis on domestic financial sector The financial crisis snowballed, having major impacts on some sectors

Risk premia on interbank market (in %) L.B.’s collapse led to sharp growth in risk premia

Volatility on domestic and foreign markets(historical volatilityover last 90 days) Market uncertainty led to increased volatility

Domestic financial (banking) sector Has excess liquidity (CNB withdraws money) Is relatively “isolated” (has enough funds to provide loans from primary deposits) Has traditional conservative model (sufficient growth opportunities) Has low NPL ratio Banks have not provided foreign currency loans to large extent (are not dependent on functioning of exchange rate risk hedging markets) Ratio of “toxic”assets is negligible (< 1% of assets) Is well capitalised and remains profitable The Czech financial system is less vulnerable than elsewhere

Profit in banking sector Unlike their foreign parents, Czech subsidiaries suffered hardly any profit losses in 2008

Liquidity ratio in banking sector (in %) Source: CNB The liquidity situation remains favourable – banks have a high proportion of quick assets

Withdrawal and provision of liquidity (in CZK bn) The good liquidity situation is also demonstrated by the low take-up of the CNB’s new liquidity-providing facilities by banks in recent months

Deposit-to-loan ratios in new EUmember states(in %) The Czech Republic had the highest deposit-to-loan ratio …

Forex loan ratios for households and corporations (2007, in %) Source: European Commission … and a virtually zero share of foreign currency loans in loans to households

Net external positions of selected countries’ banking sectors(in % of GDP and in USD bn, 2008) Source: IFS, IMF The Czech Republic is the only new EU member state that is independent of external funds (positive net external position)

Growth forecasts Source: IMF, World Economic Outlook, April 2009 Growth will be negative in many countries in 2009

External demand (Consensus Forecasts) All the external demand growth forecasts for 2009 are heading downwards and the recovery is “receding”

New orders from abroad, direct export sales and domestic energy consumption (y-o-y in %) Source: CSO New orders from abroad recorded a fall at the turn of the year

Growth in loans to firms and households(y-o-y in %) Source: CNB Loans to firms and households rose at quite a high rate even in January and February 2009

Non-performing loans(% of total loans in segment) The NPL ratio is rising only slowly, mainly because of deteriorating corporate loans

12M default rate on bank loans to corporations and NPL ratio(in %) Source: CNB The CNB expects the default rate to be just over 7% at one year

12M default rate on bank loans to households and NPL ratio(in %) Source: Czech Credit Bureau, CNB In the case of households, the default rate at one year should stay below 4%

Financial system: summary In response to rising risks, the domestic banking sector is continuing to reduce the rate of financing of the economy and to tighten the non-interest conditions in many segments of the credit market However, banks are not the cause of the slowing economic growth; the main cause is the worsening situation abroad (the falling credit growth is largely due to falling demand for loans) Loan interest rates are mostly flat – the CNB’s rate cuts are being offset by growing bank risk margins A gradual rise in the default rate on bank loans and other debt can be expected; this will be reflected in worsening results and balance sheets of banks and other financial institutions The domestic financial sector should be capable of withstanding incoming shocks to a large extent The Czech financial system remains stable and public confidence in banking institutions persists

CNB measures to support liquidity Introduction of liquidity-providing facility (banks can obtain liquidity from CNB for 2 wks or 3 mths) in oreder to boost money market – modest improvement seen Option of using govt bonds as collateral in such operations in order to increase liquidity CNB and FinMin planning to introduce HTM for insurers and pension funds The measures taken have improved the functioning of the financial market; the present instruments seem adequate and there are no signs of liquidity problems in the financial sector

Monthly government bond trading volumes (in CZK bn) Source: CNB The CNB’s measures have helped to preserve market liquidity on the secondary government bond market

CNB measures: intensive monitoring Daily information gathering (introduced 1 day after decisioní): Cash requirements (1 and 2 days ahead) Money market and govt bond market (in real time) Financial institutions (banks and other key players) with 1-day lag: 1) liquidity, 2) intra-group exposures, 3) deposits, 4) limits, 5) withdrawals from money market funds Ad hoc gathering of information on toxic asset holdings (after CDOs, Iceland, Lehman Brothers collapse, etc.); information from all parts of financial groups (i.e. banks, insurers, investment funds, pension funds) at same time on same day Consultations between Governor and Vice-Governor and Banking Association (weekly or fortnightly) The CNB has had instant information at its disposal since the crisis began

Regulatory lessons of the crisis Need to achieve effective consolidated supervision on country level: Ideally in strong, independent central bank (integrated supervision + instant info on markets) Before any unification of supervision takes place at European level, supervisors should be consolidated at national level (Europe currently has 80 supervisors); could take 3–5 years Consolidation at supranational level needs to leave room for diversity of regulatory and supervisory opinion (even on fundamental issues) within framework of identical principles The ability to finance any damage caused by supervisory failure must be the main principle of the distribution of responsibilities (cf. Iceland)

Regulatory lessons – cont. Czech Rep. does not recommend: Regulations requiring deposit payout in 10 (+10) days due to liquidity constraints (currently unworkable) Hasty consolidation of supervision at supranational level – would be counterproductive Czech Rep. recommends: Cutting costs for financial sector: Removal of national discretions Reporting Ratings, suggestions (bank employees vs. rating agency employees) We need to pursue practical, useful and achievable objectives

CNB position on de Larosière report Report is good basis for further discussion on shape of financial regulation and supervision in EU Its many proposals and recommendations: a) sometimes overstep group’s mandate, b) fail to define priorities, c) do not cover entire financial sector Some key recommendations lack detailed specification, making it difficult to assess their feasibility: Creation of European Systemic Risk Council – CNB agrees provided numerous issues are clarified (status; ECB interventions; relationship to national supervisors, etc.) Creation of European System of Financial Supervisors – CNB disagrees (national vs. supranational supervisors; legislation; LoLR) The report is useful, but unacceptable in its full form

Interest rates during crisis Like other central banks, CNB has cut monetary policy rates several times: by 0.75 p.p. on 7 Nov.2008, by 0.50 p.p.on 18 Dec.2008, by 0.50 p.p. on 6 Feb.2009 andby 0.25 p.p. on 11 May 2009 Koruna depreciation in Jan and Feb narrowed room for lowering rates in March Decisions to lower rates fostered by: Adverse external outlook Low external inflation pressures Fall in foreign market interest rates Renewed appreciation of koruna and its relative stability recently Further CNB rate cuts cannot be ruled out if the negative external trends intensify and the inflation pressures weaken further

Monetary policy uncertainties Monetary policy-making is complicated by several factors in crisis: High volatility of most macroeconomic variables (especially exchange rate) Structural breaks in economic series, making modelling difficult (or impossible) Uncertain intensity of transmission of koruna exchange rate to inflation Looser linkage between CNB rates and market rates Monetary policy faces extraordinarily high uncertainties during the crisis

Repo and market rates Source: CNB The acute phase of the crisis marked an increase in the difference between the CNB’s monetary policy rates and market rates – that difference has recently narrowed somewhat

Monetary policy and communication In recent months, monetary policy-makers have been communicating more than in the past: Verbal interventions: Governor in July 2008 (during appreciation bubble) Vice-Governor in February 2009 (when koruna was weak) When confronting campaign in which foreign media classed Czech Rep. alongside countries with far worse economic fundamentals In the past 3 months, CNB communication has been an effective addition to its standard monetary policy instruments

Monetary policy and koruna exchange rate Floating rate has become adjustment mechanism during crisis (cf. Slovakia) Depreciation of koruna during 2008 H2 and at start of 2009 supported price competitiveness of producers and exporters and also helped to reduce disinflationary demand pressures (inflation was 0.6% in euro area and 2.3% in Czech Rep. in March ) The floating rate is an “automatic MP instrument” between the Bank Board’s monetary policy meetings

CZK/EUR rate(1 Jan.2007-30Apr.2009) Source: Eurostat The rapid appreciation of the koruna in 2008 H1 has been replaced by a rapid depreciation

Czech economy: summary Microeconomic flexibility Highly competitive structure Macroeconomic balances Sound financial sector Low external debt Sustained low inflation and low inflation expectations Relatively low public finance deficits Flexible exchange rate Immunity factors: Risks: • 2008 exchange rate shock and forwards • High share of net exports in GDP • High proportion of cyclically sensitive sectors in economy • Insufficiently flexible labour market • Political situation (caretaker government) • Selective “support” policies The Czech economy is weathering the crisis better than many other countries

CNB Forecast May 2009 M. Singer: The economic and financial crisis from the point of view of Czech banks41

The forecast for headline inflation The inflation will be low during 2009 but will reach the inflation target at the end of 2010 M. Singer: The economic and financial crisis from the point of view of Czech banks42

The forecast for GDP The economic growth will be negative in 2009 but positive in 2010 M. Singer: The economic and financial crisis from the point of view of Czech banks43

The forecast for interest rates (3M PRIBOR) Consistent with the forecast is a decline in market interest rates (3M PRIBOR) in 2009 and their modest increase in 2010 M. Singer: The economic and financial crisis from the point of view of Czech banks44

The forecast for exchange rate (CZK/EUR, quarterly averages) Koruna will appreciate somewhat in the short run but will remain stable afterwards M. Singer: The economic and financial crisis from the point of view of Czech banks45

Forecast in numbers Headline inflation in: 2010 Q2 1.1% 2010 Q3 1.7% GDP growth in: 2009 -2.4% 2010 1.4% Nominal interest rates (3M PRIBOR) in 2010 Q2 2.0% 2010 Q3 2.1% Exchange rate (CZK/EUR) in: 2009 26.6 CZK/EUR 2010 25.9 CZK/EUR

Miroslav Singer Miroslav.Singer@cnb.cz Tel: +421 224412008 Thank you Česká národní banka Na příkopě 28 115 03 Praha 1

The economic and financial crisis from the point of view of Czech banks

The economic and financial crisis from the point of view of Czech banks

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