HNB: The Risk to Financial Stability is the Further Rise in Housing Prices

The overall exposure of the financial system to systemic risks has slightly decreased from a moderately elevated level, but the risk of possible geopolitical escalations continues to be exacerbated by the ongoing rise in housing prices, with investment demand for residential properties for short-term rental purposes also impacting this market, HNB reported.

As highlighted in the summary of HNB’s publication ‘Financial Stability 25‘, strong economic expansion has supported household incomes and corporate performance, which has positively affected the stability of the financial system.

The main structural weaknesses of the domestic economy, in the form of high exposure of the banking sector to the state and low labor force participation rates, which, along with unfavorable demographic and migration trends, limit the potential for economic growth, have remained unchanged. Therefore, the overall exposure of the financial system to systemic risks has only slightly decreased from a moderately elevated level, it is stated.

At the same time, the most important sources of risk to financial stability arise from a possible stronger escalation of geopolitical tensions, which could adversely affect global economic flows, and indirectly the domestic economy, which, as a small and open economy, is particularly susceptible to spillover effects from the environment.

Visible Strong Trend in the Rise of Short-Term Rental Prices

The rise in risks is also contributed by the continued increase in housing prices, which in 2023 was significantly stronger than in other euro area member states, although the number of transactions continued to decline. The housing market is further influenced by investment demand for residential properties for short-term rental purposes, most pronounced along the Adriatic.

– However, the risks to financial stability are mitigated by relatively low household indebtedness, moderate exposure of banks to housing loans, and the practice of fixing interest rates along with regulatory limits on the height of interest rates on existing loans, emphasize the Croatian National Bank (HNB).

In reviewing the short-term rental market in Croatia, HNB utilized data from the Airbnb platform, which connects potential travelers with a variety of accommodation options.

In addition to being predominantly concentrated in coastal areas, the operations of properties advertised on the Airbnb platform also show significant seasonality that corresponds with the tourist season, and broader use of the platform began in 2017, with a peak in August 2019, when 206,000 properties generated rental income through that platform.

The pressure of short-term rentals is greatest in cities and municipalities along the coast, where active properties on the platform account for an average of about seven percent of the total number of housing units, while in some coastal municipalities such properties account for as much as 25 percent of the total number of housing units. Thus, a strong trend in the rise of short-term rental prices is visible, especially in 2023, with short-term rentals across Croatia being 26 percent more expensive in August last year compared to August 2022.

– A significant increase in prices is visible along the Adriatic during the summer months, and in Zagreb, which has positioned itself as an Advent destination, in December. In other local government units, summer fluctuations in the index are also observed, although to a lesser extent, HNB notes.

Although they relate to different markets, the price indices for short-term and long-term rentals show similar movements, and such correlation reflects the interconnection of different segments of the real estate market in Croatia.

– At the national level, short-term rental prices have risen faster than long-term rental prices until the end of 2022 and in 2023. However, although short-term and long-term rental residential properties are used for different purposes and are influenced by different factors, their indices move similarly, indicating a strong increase in both long-term and even more so short-term rental prices during 2022 and 2023, with signs of slowing at the beginning of this year, HNB states.

Increase in the National Reference Rate (NRS) May Have Very Limited Effects on Financial Stability

The Croatian National Bank (HNB) emphasizes that a strong labor market and rising incomes have stimulated household lending, particularly in the segment of cash non-purpose loans. Their growth at the end of 2022 was thus 2.4 percent year-on-year, while at the end of March this year it reached 12.6 percent. On the other hand, the growth of housing loans has simultaneously stabilized at moderately high levels, the central bank notes.

They also point out that the rise in interest rates on time deposits and the associated increase in the national reference rate (NRS) will slightly and gradually increase the repayment cost of part of the existing loans to households.

In conditions of rising interest rates and housing prices, the increasingly longer maturity of housing loans and the rising debt repayment-to-income ratio increase consumer vulnerability to potential adverse financial circumstances, the central bank states.

The possible increase in the cost of loan repayment in conditions of rising financing costs for banks, and then indirectly the NRS, has been simulated by HNB in two scenarios that differ in the intensity of the increase of that reference parameter.

In the scenario of an increase in the NRS by 70 basis points, the increase in repayment costs would be very mild, so for more than 4/5 of housing loan parties, or about 55,000 parties, the monthly repayment cost would increase by at most five percent, or an average of seven euros, while the repayment cost for 99 percent of non-housing loan parties, slightly less than 110,000, would increase by less than five percent, averaging three euros, HNB states.

In the scenario of an increase in the NRS by 150 basis points, however, the increase in repayment costs would be less than five percent for approximately 4/5 of non-housing (about 85,000 parties) and for slightly less than a third of housing loans (about 19,000 parties) with variable interest rates linked to the NRS.

Furthermore, for slightly more than a third of housing and the remaining fifth of non-housing loans, the increase in debt repayment costs would be greater than five percent but less than ten percent (24 euros), while the increase in repayment costs would exceed ten percent for slightly more than a third of housing loans, averaging 46 euros for slightly less than 24,000 parties, and for only one percent of non-housing loans, averaging 58 euros, calculated HNB.

In the latter scenario, the cost of debt repayment would increase the most, averaging about 16.5 percent, for borrowers with housing loans with remaining maturities longer than 20 years, where in that class of remaining maturity the initial level of the interest rate does not significantly affect the increase in repayment costs.

On the other hand, HNB states, the impact of the interaction of the initial legal limit on interest rates is explicitly considered in the scenario with a simulated increase in interest rates of 70 basis points. Thus, borrowers with interest rates at the level of the limit will not see an increase in repayment costs in the short term, and the repayment cost for borrowers with an interest rate of up to three percent could increase on average by about 6.5 percent.

“However, loans with very long remaining maturities, over 20 years, and relatively low current interest rates, below three percent, are very few, or slightly less than 6.5 percent of the principal of loans linked to the NRS that will have a variable interest rate during 2024. This suggests that the increase in the NRS may have very limited effects on financial stability,” conclude HNB analysts.

The Banking Sector Achieved High Profits in 2023

HNB also notes that the good performance results of non-financial companies are currently reducing their vulnerability to tightened financing conditions, although a slight increase in already relatively high indebtedness raises risks for debt repayment capacity in the event of reduced business activity.

The banking sector achieved high profits in 2023, and its high resilience was confirmed by the results of stress testing of solvency and liquidity under unlikely, very intense shocks. However, medium-term profitability prospects are undermined by the continued rise in financing costs, possible deterioration in asset quality, and increased interest rate risk.

The focus of HNB’s macroprudential policy remains on maintaining a high level of capital buffers, which help preserve the resilience of banks in the event of a deterioration in macroeconomic or financial conditions without adverse effects on the availability of credit, concludes the summary of the publication.