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© Romanian Central Bank |
CHAPTER 1. OVERVIEW
The world economy is undergoing a period of heightened tensions, which brought to the fore a number of risks that were taking shape as early as 2006, i.e. slower growth and asset price corrections. Since the latter half of 2007, financial markets have shown new features, originating in the US sub-prime mortgage market turbulence, the thorniest issues being the significant worsening of investors’ risk perception and the decrease in liquidity. In 2008 too, global financial stability will face, even on a larger scale, risk aversion and higher oil, food and commodity prices.
Given that Romanian banks do not have exposure to the financial instruments that were at the root of the current international market turmoil, such turbulence may affect Romania’s financial stability indirectly, via the real sector and bank liquidity channel. There were only limited consequences of the external environment in Romania so far, which materialized in larger foreign financing costs.
Forecasts point to further robust economic growth in Romania, with investment rate staying on an uptrend, in line with the characteristics of the region. However, the decline in domestic demand in Romania’s major trade partners may challenge the financial positions of local firms engaged in foreign trade. Financing of the country’s rather wide external deficit may become more critical if external liquidity remains tight and economic activity in the main countries hosting Romanian workers – who ensure consistent autonomous liquidity inflows – confirms the slowdown projections. Short-term foreign debt (STFD) saw rapid expansion and, against the background of liquidity squeeze on global markets, could remain fast-growing, to the detriment of medium- and long-term funding.
Companies and households – the financing of which is to a large extent in foreign currency – are exposed to a potential worsening of global liquidity worldwide. In addition, hikes in global oil, food and commodity prices that tend to be manifest in 2008 as well may have an adverse effect on domestic financial stability by impairing the bank debt servicing capacity of economic agents.
Finally, the worsening external environment would reinforce aversion towards risk perceptions relating to Romania, as reflected by rating agencies’ assessments. In this context, some macroeconomic developments are also a cause for concern: wide external deficit, fast-paced credit growth, and weak policy co-ordination in regard to the resumption of disinflation.
Looking at developments in the domestic macroeconomic environment which may impair financial stability, the report concludes that risks are on the increase, but they remained moderate. Tighter monetary policy will have a bearing on heavily-indebted companies and households. The movements in the exchange rate of the domestic currency from 2007 onwards, which became more difficult to predict, brought about new uncertainties and financial leverage on borrowers, entailing possible consequences on loan repayment capacity. The persisting unfavorable conditions on global financial markets point to the need, more pressing than before, for a likely adjustment of the current account deficit. Such an adjustment, even through a soft landing, is a serious challenge for the Romanian economy, as (i) the external disequilibrium is relatively large and (ii) external financing addresses mainly the non-tradables sector, which can only partly accommodate the new financing and exchange rate conditions.
A rather new challenge to financial and macroeconomic stability is manifest on the labor market whose steady tightening, as a result of a considerable workforce migration and fast-paced economic growth over the past six years, puts sizeable upward pressure on wages. Should these wage claims be accommodated, the profitability of many companies would be hurt and, in turn, the capacity of ensuring domestic bank debt service and withstanding shocks would weaken.
exchange rate performance weighs heavily on financial (and macroeconomic) stability. External financing of the banking sector is high, with companies and households resorting to domestic and foreign currency borrowings in almost equal shares (whereas the former sector is funded by foreign entities on a large scale). The exchange rate recorded a great degree of volatility compared to the volatility experienced by other currencies in the region – the explanation for these developments lies also with the structural features of the FX market that make it different from its region peers: a relatively low volume of trading, most operations are concluded for a short term, and dealings in financial derivatives (performed almost entirely by nonresidents) hold a small share in total volume of trading. This relatively high volatility of the exchange rate of the RON, having mainly dire consequences, can be mitigated by developing the FX market and especially by implementing more coherent macroeconomic policies.
The narrowing of the current account deficit as a result of a softer domestic currency depresses importers. Available statistics (as of mid-2007) show a good financial position of importing companies, which allows them to adapt with no major consequences. By contrast, the increase in importers’ overdue payments hints at difficulties. Short-term foreign debt is a matter of concern due not only to its dynamics, but also to its structure: in the real sector, most of the companies incurring short-term debt do not bring in foreign currency, but they are exposed to currency risk (e.g. real-estate companies).
The risks posed by non-financial companies increased, but their financial results secure protection against a moderate shock. On aggregate, the debt servicing capacity improved slightly, yet the structural analysis shows opposite developments. The risk premium attached to corporate borrowings declined (EUR-denominated loans included) while the overdue payments ratio and debt at risk went up (the latter is still relatively well covered by provisions). An exchange rate shock or an interest rate shock would trigger a moderate shock onto financial stability, whereas a liquidity shock could have more serious consequences. In 2007, risks associated with household sector grew higher, but they remain sustainable: debt service and unsecured loans rose further; the foreign exchange position reversed, with financial liabilities exceeding financial assets; the household sector became a net debtor to the banking sector; consumer credit recorded the highest dynamics (and the largest share in total credit stock) and ever longer maturities; foreign currency loans grew faster than local currency borrowings. Such features and developments in loans to households substantiate the central bank’s ongoing concern over dampening the growth rate of such loans and enhancing risk management.
The banking sector, the main component of the financial system in Romania, has followed from 2007 onwards a path similar to that seen in previous years, i.e. strong growth of financial intermediation, underpinned by both demand and supply, staying however below the EU average; fast dynamics of household loans; steady decline in the deposits-to-loans ratio, which fell to below par, and also banks’ increased recourse to external financing. Solvency indicators kept contracting due to credit expansion in particular, but the financial sector remains relatively well capitalized. Furthermore, profitability ratios followed a slightly downward course, along with the improvement of operational efficiency.
In line with maintaining a good loan portfolio quality, credit risk rose significantly, especially on the back of foreign currency-denominated loans to households. Higher credit risk also stems from fast-paced lending activity in recent years (which fuelled excess aggregate demand growth, having an adverse impact on the current account and disinflation). Over the near run, credit dynamics is expected to post a slowdown, as a result of larger funding costs generated by a tighter monetary policy stance and dearer external finance against the background of the ongoing global financial market turmoil. It is essential to counter the increase in credit risk, which is likely to become more pronounced insofar as loans maturities grow and approach maturity date, by taking further regulatory and prudential steps aimed at enhancing the risk management in banks and/or the correlation between the interest rate and the risk profile of various borrower types.
Local bank liquidity, albeit on the wane, remains atcomfortable levels and the stronger vulnerability arising from interbank financing, which is rising quickly and persistently in the case of some banks, has a low potential of systemic risk. However, inter-bank market developments call for close monitoring. On the other hand, increased reliance of banks on external financing added to their vulnerability to external liquidity. This vulnerability is deemed low, since most external funding of local banks is provided by parent undertakings. So far, there has not been any case of a Romanian bank resorting to its contingency plan because of the global financial market turbulence. Nevertheless, such plans should be revised and strengthened in order to maximize their effectiveness.
At national level, a Memorandum of Understanding between the Ministry of Economy and Finance, the National Bank of Romania, the National Securities Commission, the Insurance Supervisory Commission and the Private Pension Scheme Supervisory Commission for cooperation in the field of financial stability and financial crisis management was signed on 31 July 2007. As a result, the National Committee for Financial Stability was established. The said document aims to promote co-operation between the central bank, the other authorities responsible for financial supervision and the Ministry of Economy and Finance under normal and crisis situations in the Romanian financial system abiding by the following principles: clear segregation of duties, transparency, efficiency, and exchange of Information (in order to fulfill the specific tasks in light of observing professional secrecy consistent with the laws in force).
As for the non-bank financial sector, the report looks at the insurance market and the non-bank financial institutions. The insurance market follows an upward trend and is in the final stage of harmonization with European legislation. Moreover, this market was left unscathed by the ongoing financial market turbulence for reasons pertaining to its specific activity as well as its development and integration with external financial markets. The major issues that require close monitoring are the increase in the claims ratio for non-life insurance and the dynamics of the return on investments in movable assets for life insurance. Non-bank financial institutions (engaged in lending) hold a small weight in the overall financial system. The possible vulnerabilities associated with such institutions may pose limited risks, which can be easier identified once they have been brought under the central bank supervision and regulation umbrella.
The Romanian capital market continued the convergence towards the Europeanmarkets from the previous report. At the same time, stock exchange risks grew as a result of the impact from the financial market turbulence and the domestic economic environment on market capitalization and turnover. The analysis of daily levels of correlation adjusted by the volatility between the BET index of the Bucharest Stock exchange and the indices of advanced and emerging markets shows a relatively loose connection to the advanced markets, while in regard to the emerging markets it points to a similar (close) movement during downturns and non-synchronization during upturns. Such comparisons prove the poor integration of the Romanian capital market with its European peers (weak correlations under normal circumstances), on the one hand, and level-playing field for nonresidents on emerging markets during downturns, on the other hand.
Contents
CHAPTER 1. OVERVIEW
CHAPTER 2. INTERNATIONAL ECONOMIC AND FINANCIAL ENVIRONMENT
CHAPTER 3. FINANCIAL SYSTEM AND ITS RELATED RISKS
3.1. Structure of the financial system
3.2. Banking sector
3.2.1. Structural developments
3.2.2 Structure of assets and liabilities
3.2.3. Capital adequacy
3.2.4. Loans and credit risk
3.2.5. Liquidity risk
3.2.6. market risk
3.2.7. Profitability and efficiency
3.3. Non-bank financial sector
3.3.1. Insurance market
3.3.2. Non-Bank Financial institutions
3.4. Capital markets
3.5. Financial crisis management framework in the European Union and in Romania
3.5.1. The European financial crisis management framework
3.5.2. ECOFIN Council decisions on strengthening European Union arrangements for financial stability
3.5.3. The role and importance of setting up a domestic standing group .
3.5.4. Financial stability domestic framework
CHAPTER 4. DOMESTIC MACROECONOMIC RISKS
4.1. Real sector
4.2. Economic policies
4.2.1. Price stability and financial stability.
4.2.2. Implications of exchange rate developments on financial stability
4.3. External balance
4.3.1. Current account deficit and its financing
4.3.2. Short-term foreign debt
CHAPTER 5. COMPANIES AND HOUSEHOLDS
5.1. Risks arising from non-financial companies
5.1.1. Companies’ resilience to a systemic shock
5.1.2. Financial resources allocation efficiency
5.2. Household sector risks
5.2.1. Household balance sheet
5.2.2. Household indebtedness
ANNEX
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