IMF: The four vulnerabilities of the Romanian financial system in case of an economic downturn

Anca Alexe 12/06/2018 | 13:00

A report released by the International Monetary Fund (IMF) as part of the Financial Sector Assessment Program shows the main vulnerabilities in the Romanian financial sector.

The concerns about Romania’s financial system, identified by the FSAP team, can be organized around four main isssues:

  • Banks’ exposure to the government through large positions in domestic sovereign debt and guarantees for Prima Casa loans;
  • Growing exposures of banks to the real estate market at variable interest rates;
  • Exposures of banks and NBFLs (non-banking financial institutions) to an increase in NPL (non-performing loans), both on domestic and foreign currency loans, with corporates leverage still high;
  • Growing lending by NBFLs leading to vulnerabilities and reputational risks for the banking sector.

In this context, IMF experts say that measures need to be taken soon to respond to these risks and consolidate financial stability and note that authorities are “already contemplating a debt-service-to-income limit on mortgages and calibration of this limit could draw on the mission’s analysis of loan-level information from the Romanian credit register.”

The report recommends a gradual scaling back of the Prima Casa program, which would mitigate risks of housing sector imbalances and support the effectiveness of the existing loan-to-value limits. The mission also recommends the introduction of capital buffers to increase resilience and guard against risks from large sovereign exposure.

The IMF warns that banks’ exposure to the Romanian sovereign was about 22 percent of assets, increasing steadily from below 8 percent in 2008 to one of the highest in the EU. “In an environment of very short-term funding, the relatively long duration of domestic sovereign debt means that banks are heavily exposed to losses from increases in interest rates. The government guarantees issued in the context of the Prima Casa loan program create an additional indirect exposure of the banking sector to the sovereign.”

The report also shows that the Romanian banking system is becoming increasingly exposed to real estate. “Housing loans increased from 21 percent of loans to households to more than 54 percent between 2008 and 2017,” the report shows, and house prices have grown as a result of increased provision of mortgages. “Moreover, since the large majority of mortgage contracts are at variable rates, loan performance could deteriorate and default rates rise if interest rates increase,” IMF experts warn.

According to the IMF, growing provision of loans by NBFLs may lead to vulnerabilities and reputational risks for the banking sector. “NBFLs are providing credit to SMEs, mainly in FX, and alongside a growing leasing business, as well as to households, often to those at lower income and at high interest rates. A macroeconomic downturn may negatively impact highly indebted households and increase NPLs in this sector. The conduct of NBFLs can create reputational risk for the financial sector that already has a negative public reputation.”

The IMF team worked with representatives of the Romanian National Bank (BNR) to evaluate the banking sector’s resilience to the identified vulnerabilities based on a three-year negative scenario that includes an increase of sovereign spreads and a sharp initial depreciation of the currency, a large hike in domestic policy rates, a shock to GDP growth as well as a drop in property prices.

“In the event of a sharp increase in interest rates, combined with a shock to growth that is comparable to the 2008 crisis, banks’ capital is impacted significantly. Stress test results indicate that, over a three-year horizon, banks face losses of close to 900 basis points in capital. A number of the 12 stressed banks fail to meet the minimum threshold for the common equity Tier 1 capital ratio (CET1). The overall impact of the scenario on banks’ profitability is significant as banks’ net interest income decreases by almost 40 percent through the stress test horizon.”

Among the IMF’s recommendations for immediate policy action (over the next year) are: additional investment in IT specialists, especially cybersecurity; eliminating deficiencies in the regulatory framework regarding anti-money laundering and combating the financing of terrorism; preparing a simulation exercise in crisis management which should include the BNR, the Finance Ministry, the Financial Supervision Authority and the Bank Deposits Guarantee Fund.

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