IMF Issues Report on 2019 Article IV Consultation with Slovak Republic

The staff report highlighted that the banking sector is stable but less systemic institutions are vulnerable to economic downturns. The overall capital levels are well above the regulatory minimum while the liquidity position remains comfortable, with most banks still largely relying on deposits for funding. The overall NPL ratio has declined to a post-crisis low of 3% at the end of 2018; however, less systemic banks and building societies show higher average NPL ratios as well as lower coverage ratios. The staff analysis shows that these institutions, which constitute roughly a fifth of banking sector assets, could lose all or a large part of the capital buffers if their NPL ratios double. Profitability has been robust but faces risks from compressed lending margins. Declining risk-weight estimates in the internal models and low credit risk spreads, reflecting historically low default rates on mortgages, have resulted in significant compression of lending margins in the mortgage market—the largest in the EU.

The report also mentions that the authorities’ proactive macro-prudential policy stance is welcome and could be strengthened as follows:

• Reduce NPLs of less systemic institutions. The authorities’ initiative to require banks with high NPL ratios to develop an NPL-reduction strategy is welcome and their efforts to reduce NPLs should be sustained. To contain credit risks, building societies should be required to increase the NPL coverage ratio. The recently introduced regulatory cap on the share of long-maturity loans in new loans extended by building societies should be complemented by a cap on the share of uncollateralized loans in total loans.
• Enhance capital buffers of weaker banks. The staff supported incremental use of CCyB and supervisory (Pillar II) capital requirements to enhance resilience of banks to shocks and the authorities’ readiness to further increase CCyB. In addition, considering the uneven asset quality across banks, the authorities should strongly consider imposing non-zero Pillar II capital guidance for less systemic institutions in 2019, taking into account the supervisory stress test results.
• Better internalize mortgage credit risks. The average risk-weights in the internal models of systemic foreign bank subsidiaries in Slovakia are lower than in most other EU peers, reflecting the historically low default rates. To discourage excessive risk-taking, the authorities should strongly consider introducing a risk-weight add-on on housing loans to require banks to better internalize credit risks, which can be complemented with a floor on risk-weights on housing loans. 

Given the dominance of foreign banks in the Slovak banking system, strong home-host cooperation is critical. With limited domestic capacity to absorb bail-in-able bonds, encouraging banks to have higher non-regulatory capital buffers may also help them meet minimum requirement for own funds and eligible liabilities (MREL). To fill the gaps identified at the European level regulations by the recent euro area Financial Sector Assessment Program (FSAP), the domestic regulatory regime should require banks to obtain authorities’ pre-approval in acquiring qualifying holdings of non-bank entities and to periodically report the ultimate beneficial owners of their qualifying holdings.

Related Link: Staff Report

Keywords: Europe, Slovak Republic, Banking, Securities, Article IV, FAP, CCyB, NPLs, Macro-Prudential Policy, MREL, Credit Risk, Pillar 2, Capital Requirements, IMF