HNB: Increased Exposure of the Financial System to Systemic Risks

The Council of the Croatian National Bank (HNB) stated on Tuesday that the total exposure of the domestic financial system to systemic risks has increased due to the impact of the war events in Ukraine and sanctions against Russia, and noted that an increase in key interest rates by central banks is expected, which will gradually raise the cost of new borrowing and the burden of repaying loans with variable interest rates, as announced by the central bank.

At the meeting, the HNB Council discussed current economic and financial trends, emphasizing that statistical indicators suggest that economic growth strengthened at the beginning of this year, but that a visible weakening of consumer confidence is evident, which remained at a relatively low level in April, despite a slight recovery.

Employment growth, on the other hand, halted in March, although nominal wages are rising increasingly faster, while inflation has significantly accelerated as the increase in oil and food raw material prices in global markets, partly influenced by the war in Ukraine, spills over to domestic prices of oil derivatives and food, the announcement states.

Due to the expected change in the direction of monetary policy by the central banks of the largest economic areas, the short-term and long-term costs of financing the state continued to rise, and interest rates on loans to companies have also slightly increased, the HNB Council noted. In such conditions, there has been a strong acceleration in lending to non-financial enterprises, while lending to households continues to increase at stable rates, mainly reflecting strong housing lending, they highlighted.

The total exposure of the financial system to systemic risks has increased due to the impact of the war events in Ukraine and sanctions against Russia, whose consequences on the economy mainly spill over through the movement of raw material prices and other goods in global and regional markets. Uncertainties related to the pandemic and recent geopolitical tensions have not yet jeopardized the stability of the financial sector in Croatia, HNB officials state, adding that good liquidity and capitalization of the banking sector, supported by previously built capital buffers, played an important role in this.

In the upcoming period, challenges and risks for the domestic financial system in Croatia are related to the development of geopolitical instabilities and inflationary pressures, the effects of the expected normalization of monetary policy, and the continued rise in housing prices, the central bank states.

Gradual increase in the cost of new borrowing and the burden of repaying loans with variable interest rates

The duration of the war in Ukraine and the intensity of its consequences will determine the strength of the impact on macroeconomic, fiscal, and financial movements.

As they state, disruptions in supply chains that further drive up prices can pose a significant burden for businesses and households. In conditions of rising inflation, a tightening of monetary policies is expected along with an increase in key interest rates by the central banks of the largest economic areas. This will gradually increase the cost of new borrowing as well as the burden of debt repayment for existing borrowers with variable interest rates, HNB officials note.

However, they also state that any adverse effects of rising interest rates on the financial system are mitigated by the long-term trend of reducing the overall indebtedness of households and enterprises, with a relatively low level of household debt and a small number of loans for which repayments could significantly increase. Additionally, the expected introduction of the euro could further alleviate the rise in the cost of new borrowing for the state, as well as for other sectors, they add.

The tightening of financing conditions in international financial markets, and then the increase in domestic interest rates, could mitigate some risks to financial stability that have strengthened during a prolonged period of low interest rates, such as strong borrowing in the private sector, low profitability of banks, and the search for risky alternative forms of investment that offer higher returns. Such is the risk associated with the strong rise in housing prices, which is supported, among other things, by a large volume of housing lending, it is emphasized in the announcement from the Council.

The HNB continuously monitors and analyzes the development of systemic vulnerabilities in order to act on them with measures within its jurisdiction if necessary. They remind that at the beginning of 2022, an increase in the counter-cyclical capital buffer rate was announced, which will further strengthen the resilience of credit institutions to potential losses related to exposure to cyclical systemic risks in the downward phase of the financial cycle or in the event of a sudden outbreak of a crisis.

The HNB continues to closely monitor the lending conditions at the level of individual borrowers, so that potential sources of systemic risks can be timely diagnosed and measures can be introduced to mitigate them, including prescribing stricter consumer lending conditions. However, in conditions where a large part of transactions in the real estate market is not financed by loans, macroprudential policy measures have limited reach in reducing imbalances, and joint action of various economic and other policies is needed to create an efficient and balanced real estate market, the announcement states.

The HNB Council has given consent to the Supervisory Board of Privredna banka Zagreb for Andrea Pavlović to perform the function of a member of the management board of that bank, and has made a decision on the issuance and sale of commemorative gold coins of 5 kuna from the series “Golden Kuna,” the announcement concludes.