THE ROLE OF BANKS IN THE ECONOMIC RECOVERY Toma ž Ko š ak, Banka Slovenije UMAR

1. THE ROLE OF BANKS IN THE ECONOMIC RECOVERY Tomaž Košak, Banka Slovenije UMAR "Why Slovenia should embark on structural reform" March 15, 2016

2. Outline • How the financial crisis reflects in banking sector? • Deleveraging • Credit activity (credit supply) • The quality of credit portfolio • How the financial crisis reflects in corporate sector? • Deleveraging through the debt repayment. • Corporate indebtedness and lack of equity • Cross-border financing. • How to revive the credit market? • Short-term activities • Long-term activities / process

3. Financial crisis in Slovenia Slovenian economy went through the typical boom-bust financial cycle: High credit growth until 2008 and credit contraction since 2010. Double-dip recession in real economy. That reflects in the savings - investment gap development. Figure: GDP growth rate and credit growth rate to NFC and non-banking sector (L) Savings investment gap in Slovenian economy in % of GDP (R)

4. Financial crisis in Slovenia The banking intermediation prevailed in the structure of financial sector in 2008 and in 2015: Banking based financial intermediation (Bank's BS 76% and 73% of fin. sect. respectively). Financial sector achieved up to 170% GDP at the outbreak of financial crisis. The real sector highly dependent on bank financing. After outbreak of crisis the consequences for SLO corporate sector were more sever than in the economies with the developed capital markets. Table: Structure of Slovenian financial sector

5. Deleveraging of banks At the outbreak of crisis the banking sector was affected on the liability side: High indebtedness of banks on wholesale market: >36% of total bank's liabilities. The crisis affected the interbank confidence (depleting cross-border interbank financing) From 2008 until 2015 the banks net repayment amounted to more than €12 bn or 1/3 of GDP. Deleveraging in banking sector was necessary, but it remains open: what form the deleveraging should take and at what speed. Figure : Net repayments of liabilities to wholesale market and balance sheet shrinking in % GDP Figure: Strukture ofbanking liabilities in %

6. Deleveraging of banks Three types of deleveraging in banking sector (Banoit Coeure): Good deleveraging  involves banks raising capital and getting rid of impaired assets in a rapid manner (among Slovenian banks since 2013 large domestic banks). Bad deleveraging  an indiscriminate reduction in balance sheet size, regardless of the quality of assets. Motivation is to reduce indebtedness. The upshot is a potentially prolonged, across-the-board reduction of credit to the real economy. Ugly deleveraging  comprises banks specifically discarding good assets while keeping distressed assets in the banking book and recording them at close to nominal value (at certain Slovenian banks in the first phase of crisis). The "bad" and "ugly" deleveraging have real economy effects on liquidity, funding access… Financially weak banks tend to roll over unprofitable loans that do not support GDP growth. "Wrong" type of deleveraging harms the transmission of monetary policy.

7. Deleveraging of banks Financial leverage of banks grew since 2008 until 2013, afterwards is it has been declining : At the beginning too slow recapitalization of banks  pressure on further decrease in total assets (and capital request). Regulatory capital: -18% & capital request: -31% After 2013 "good" deleveraging. Regulatory capital: +12% & capital request: -24% Figure: Net repayments of liabilities to wholesale market and balance sheet shrinking in % Figure: Capital adequacy in % and the changes in CR and recapitalization of banks in p.p.

8. Deleveraging and CAR After the rehabilitation of banks in 2013-2014 the CA ratio improved and cannot be treated as a restriction factor: CARin 2015 stood at 20,9% (on consolidated level at 18,6%, Tier 1 ratio grew to 17,9%)  both exceeding EMU average. Moderate decrease of RWA (€-57 mio): a) contraction of lending activity, b) restructuring the assets (less risky)  ↑securities/ total assets & ↓loans / total assets. ↑ own funds (€ +103 mio): a) profit, b) recapitalizations.  "good" deleveraging. Internal generation of capital (credit growth) and optimization of existing capital (↓NPL  ↓ RWA) efforts to keep sufficient capital adequacy and fulfilment of all regulatory requests (CRR). Figure: Net repayments of liabilities to wholesale market and balance sheet shrinking in %

9. Deleveraging and more sustainable funding Through the deleveraging the LTD ratio lowered to 81% what reflectsin more sustainable funding than before the crisis. Increase in the share of "core funding" in the banks, however Increased share of demand deposits / total deposits of NBS, in 2015 +9,3 p.p. (55,4%). Growing gap between maturity of investments (lengthening) and funding (shortening) increases the importance of secondary liquidity. Stable growth of HH deposits and sufficient liquidity are supportive factors for potential credit supply. Figure: The term-structure of NBS' deposits in % Figure: Loan to deposit ratio in %

10. Deleveraging and credit standards Adequate CAR and sustainable funding reflect in expected turn in the dynamics of lending to NFC: The decline in corporate loans is slowing (-10% p.a. at the end of 2015). Increase of newly approved long-term loans (+1,9% p.a.) and lengthening of the average maturity of loans. However some factors slow down credit recovery: Tightened credit standards for corporate loans (but change in Q4-2015) & lack of bankable projects. Commitments to EC for banks that received the state aid during rehabilitation (divestment, restriction on min RoE). Regulatory uncertainty regarding capital (CRD & CRR,..) and debt requirements (MREL,..) Still high level of NPL (in arrears >90 days), that hampers new credit supply and profitability. Figure: Y-o-y growth of loans to NFCs by bank group in % • Figure: Credit standards for corporate loans

11. Factor: Tightened credit standards & lack of bankable projects Despiteof low IR and adequate banks liquidity and funding condition, there isstill slow recovery in creditworthiness credit demands of corporate sector: In 2015 the IR for corporate loans up to €1 mil converge to EA average value. However, the structure of credit demand was still modestly underpinned by private investments in 2015 (according to BLS). Banks are competing for low volume of bankable projects, what can further affect banks' profitability. Figure: IR for loans to NFCs to 1 mil EUR in Slovenia and in EA Figure: Factors of corporates credit demands according to BLS, index

12. Factor: level of NPL NPL levels (CC in arrears >90 days) remains elevated despite visible progress and accelerating NPL resolution since 2013: The share of CC in arrears >90 days 9,9%; decreased by 1,9 p.p. or by €966 mio in 2015. Contraction in CC by -5,6%. High volume of write-offs: €880 mio. Segments of portfolio with high arrears >90 days: NFC: 15,4% (60% of CC in arrears), SME 24,6%. Manufacturing decreased most, by -3,6 p.p. to 8,8%. Construction decreasing, still represent 25% of CC in arrears >90 days in NFC. Figure: CC in arrears more than 90 days in EIR million, proportion in CC (L) and proportion of CC in arrears over 90 days by client type (R)

13. Factor: level of NPL (2) Coverage of CC in arrears >90 days by impairments increase by 3,8 p.p. to 64,5%, although decrease in volume. Level of "NPL" and "sufficient coverage ratio" have two consequences  1.) Robust balance sheet of banks but, 2.) High share of NPLs affects the bank profitabilityand increase risk aversion of banks ( hampering new credit supply!). Figure: Coverage of non-perfomring claims by impairments and provisions over 90 days in arrears in %

14. Factor: Tighten credit standards and corp. deleveraging Risk aversion of banks originates from funding structure of corporates and cause their deleveraging: Corporates have reduced their indebtedness in the last four years. Debt-to-equity ratio is at a pre-crisis level. Debt-to-equity ratio in Q3 2015: 119% (-27 p.p. from 2008) But decrease in leverage from 2008 mostly due to reduction of debt (-17%)and less to increase of equity (+2%). Level of corporate indebtedness is not problematic, but the structure of funding is (growth of equity is too slow and not sufficient). Debt / GDP(Q3-2015)76%. Figure: Corporate debt-to-equity ratio

15. Factor: corporate indebtedness and lack of equity In deleveraging, corporates should put more emphasis on increasing equity and less to reduction of debt: D/E of SI corporates in Q32015 stood at 119%. SI corporates would "need" addition € 2 billion of equity to get to the median value of debt-to-equity - D/E 113% in EA18 countries. Recapitalization, revaluation of capital, retained profits…  to improve creditworthiness of firms. Figure: Comparison of corporate indebtedness in EA in 2014

16. Factor: corporate indebtedness and lack of equity • The structure of corporate financial liabilities in Slovenia changed from 2008 up to Q32015: the share of long-term loans increased (+3%), while the share of short-term loans decreased (-7%) from 2008 to 2015Q3 • In comparison to EA19, • a substantially lower share of equity in SI (SI:46%, 51% EA19 in 2015Q3) • a higher share of trade credits in SI (as in other). Figure: The structure of corporate financial liabilities in Slovenia (L) and EA (R) by years

17. Factor: corporate indebtedness and lack of equity • Compared with large enterprises, SMEs are more indebted, although their indebtedness has fallen faster and to agreater extent since 2008 than that of large enterprises: • Debt-to-equity of all firms stood at 123% in 2014, while debt-to-equity ofSMEs stood at 168%. • SMEs’ leverage in 2014 fell below its level of 2004, while large enterprises’ leverage in2014 was still a quarter higher than in 2004. • How to find alternative financing for SME? Figure: Debt-to-equty of all firms and SMEs (L) and debt-to-capital of firms by size (R) by years

18. Factors: corporate indebtedness and lack of equity • Loans from the rest of the world account for a large proportion of corporate loan financing, with 26% of all corporate loans at the end of Q3 2015 • The growth in the corporate loans from ROW in the last years was in greater extent influenced by firms in ROW and less so by banks. • Loans at banks have decreased in H2-2015, as well as loans at international institutions. Corporate loans from ROW have increased in 2015. Figure: Stock of corporate loans from the rest of the world by foreign creditor’s sector in EUR million

19. How to improve the conditions for credit reviving? Current state of play: banks' pf' under pressure and coroprates deleveraging. Relative high solvency of banks due to recapitalizations 2013 – 2014. Still high level of NPL's Continues pressure on banks margins and capability to generate income due to deleveraging and LIRE. Deleveraging in corporate with a lack of bankable projects. A) Measures on short-term to improve banks' capability to work-out NPLs: A strategy how to work-out is necessary due-to different stakeholders' interest and complexities of process. a) Developments in corporate restructuring: "Slovenska nacela financnega prestrukturiranja dolgov v gospodarstvu" for large corporates restructuring principles from 2014 ZBS, BS, MF (based on ZM form 2011). Result of MRA monitoring: Number of MRAs signed: app. 72 (mainly financial restructuring). Amount of restructured claims: > EUR 2 bn. (as of 31 Nov. 2015) Average number banks involved: 7

20. How to improve the conditions for credit reviving? b) Regulatory activities for improving banks' capacity to reduce NPLs: Objectives: Improve the efficiency of restructuring process. Monitoring and supervision of banks' activity on the field of corporate restructuring Supporting the financial restructuring of SME. BS has implemented the objectives through the guidelines, requests… : Guidelines for impairments of restructured loans (Dec. 2014). Guidelines for NPE management (May 2015). Guidelines for SME restructuring (Nov. 2015). Requests for banks to prepare individual plans for NPE management for 3-years period (incl. implementation of operational plans and describe measures to achieve NPL target). c) Other systemic activities for improvement of corporates restructuring: Setting up infrastructure to support financing SMEs (ie. factoring). Establishment of private SPV for NPLs restructuring….

21. How to improve the conditions for credit reviving? B) Measures / process on long-term: Banks business plans adjustment to new long-lasting LIRE and to the bank disintermediation. That reflects in pressure for banking sector consolidation: M&A. Specialization. Exit the market. A strategy how to build up financial infrastructure for equity and alternative debt financing of corporates and particular SMEs: Developing alternative source of financing to cater for specific needs of smaller firms (crowdfunding, mini-bonds…). Developing Private Placement markets for medium-sized and unlisted companies. Enhancing the availability of SME credit and accounting info. Start-up companies VC-funded, should be able to become public through an IPO. Taxation creates incentives (e.g. reducing the preferential treatment of debt financing). ….

22. Thank you for attention!