The Benefits of Prudence in Times of Uncertainty
Published in: Prishtina Insight, Issue 83 (March 2, 2012), p. 21.
Available in Shqip
World Bank Country Office in Kosovo
The title page of the World Bank’s recently published Global Economic Prospects shows a sailing ship adrift in impenetrable fog, bereft of a clear view on the dangers ahead. More than storms and heavy seas, sailors fear the disorienting mist, depriving them of certainty, of their ability to assess (and react to) hazards ahead. In these situations, they must rely on their senses, focus on the immediate risks ahead, and take speed out of their journey while retaining the ability of rapid manoeuvres. In essence, the same challenge applies to policymakers, central bankers, firms, and households caught in the Great Fog of Uncertainty that is 2012. The ability to forecast economic developments is hampered by the high degree of insecurity of whether (i) the sovereign debt and competitiveness crisis in the Southern euro area; (ii) the deteriorating fiscal position in the US; and/or (iii) heightened vulnerabilities to China’s turbo economy can be managed politically or will result in disaster and calamity As a result, banks and investors worldwide—faced with immense difficulty in charting their course—have become considerably more cautious (anxious) in their decision-making. While the European Central Bank’s €500-billion lending facility to eurozone-based banks and the recent political agreement on the second rescue package for Greece appear to herald in a gradual recovery from the enduring eurozone woes, the geographical proximity to the crisis epicentre has exposed countries in Southeastern Europe—more than other regions of the world—to the risks emanating from the potential deepening of the financial and economic crisis. The 17-country eurozone (the Balkans’ single most important trading partner, provider of diaspora employment, and region of origin for productivity-enhancing capital inflows) is forecast to slide into a mild recession in 2012, with negative effects on foreign direct investment and aggregate remittance income.
In the current economic context, two factors have contributed most directly to (the perception of) economic vulnerabilities, namely unsustainable fiscal positions and banking sector fragilities. And it is exactly with respect to these two risk factors that the relatively buoyant economy in Kosovo—with an estimated growth rate of 5 per cent in 2011—has stood out as an example of prudent economic management. With a fiscal deficit of less than 2 per cent of GDP last year and a stock of public debt of around 6 per cent of GDP, Kosovo finds itself well inside the fiscal Maastricht criteria and in direct vicinity of Europe’s star performers Estonia, Finland, and Luxembourg. The banking sector, as well, has proven astonishingly resilient to the deterioration of the external environment—largely in consequence of its conservative outlook and risk-averse lending decisions before, during, and after the last crisis. The largely foreign-owned banking system has remained well-capitalised, liquid, and profitable throughout this period. In 2011, Kosovars entrusted the banks with about €2.1 billion in deposits (45 per cent of GDP), while borrowing about €1.7 billion (36 per cent of GDP) from them. The growth rates for both deposits (8.5 per cent) and credits (16.4 per cent) were steady and generally healthy. Contrary to the situation in neighbouring countries, the credit-to-deposit ratio—a key risk factor in an environment of tightening liquidity—has remained constant at close to 80 per cent, signifying robust bank balance sheets. Similarly, a relatively low percentage of non-performing loans, representing 5.7 per cent of total loans in December 2011 (down from 5.9 per cent a year earlier), has been provisioned at a rate of 117 per cent and, as such, is fully absorbed by the banking system itself. As a result, banks have been able increase their profits, as per information provided by the Central Bank of the Republic of Kosovo (CBK), by 12.8 per cent to altogether €37 million in 2011.
Already in 2009, the banking sector had been required to “prove” its strength. While the other countries in the region saw deposits fall in response to the global financial and economic crisis set off by the collapse of Lehman Brothers in late 2008 (most dramatically in Montenegro), banks in Kosovo saw only a mild deceleration in deposit growth. Similarly, the post-crisis credit crunch seen in neighbouring countries (again, most severely in Montenegro) did not materialise in Kosovo, with the impact having been minor and temporary. While longer-term crisis effects, such as those caused by high and rising rates of non-performing loans, have been constraining the economic recovery in Montenegro, Serbia, and Albania, the percentage of credit defaults in Kosovo has remained manageable and broadly stable over the course of the business cycle. Other banking-sector indicators, including those on liquidity, capital adequacy, and profitability, have also reacted less to the previous crisis than in other countries of Southeastern Europe, thereby (i) providing the market with an assurance of the banking sector’s ability to absorb further shocks (if need be); and (ii) minimising the risk that foreign parent banks require dramatic balance-sheet consolidations in Kosovo (which would further limit the private sector’s access to financing).
Kosovo’s economy “paid” for the banking sector’s health and robustness through (i) relatively high interest rates charged on credits; and (ii) the general difficulty in accessing bank financing. These two features reflect the relatively high degree of concentration in a financial sector that is dominated by three banks, the limited supply of financial products, and the banks’ internal risk assessment of proposed projects. A combination of insufficient financial literacy, limited consumer protection, inaccurate financial information, imprecise business plans, unenforceable or unavailable collaterals, and post-crisis headquarter requests for balance sheet consolidations have contributed to the banks’ conservative lending conduct and, in so doing, helped to avoid a boom-bust cycle of the type seen in Montenegro and, to a lesser extent, in other countries of the Western Balkans.
However, in the absence of corporate bond markets, commercial banks are the key channel through which the private sector finances its investments. If banks cannot or are (increasingly) unwilling to do this, effects are immediate and detrimental to the economy as a whole. The most extreme example of the consequence of a credit crunch on economic activities can be observed Montenegro, now having suffered through 13 consecutive quarters of negative private-sector credit growth. In the wake of the pronounced boom-bust cycle, non-performing loans and unpaid bills increased dramatically in Montenegro’s private sector, affecting also the balance sheets of otherwise healthy companies. The risks in Kosovo are an entirely different nature, but they are much more difficult to predict in terms of likelihood and effects. In principle, financing conditions in Kosovo would worsen if (i) parent banks (the largest banks are headquartered in the eurozone) face problems with their capital bases and funding conditions; and (ii) domestic banks are exposed to secondary effects from potentially lower inflows of remittances, export receipts, and foreign direct investments (which would result in a deterioration of banks’ credit quality).
In the end, there is only one type of fresh wind that can cut through the fog and improve overall visibility. The CBK will have to build on its achievements, further increase its capacities to carefully monitor developments in the banking sector, including those areas where commercial banks feel least comfortable in sharing accurate information—namely, proper loan classification. Banks themselves, the supervisory agency, and all other market participants rely on this information and ultimately benefit from it. When nothing can be seen, it is most likely that collisions happen.