ECB Assesses Financial Stability Challenges for EU Candidate Countries

Banks dominate the financial sectors of EU candidate countries and potential candidates and the majority of the banks in the Western Balkans (Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia) are owned by foreign banks. These are mainly EU-headquartered banks, which have, however, been losing market share to other foreign banks since 2014. The non-bank financial sector is generally very small in EU (potential) candidates. For the Western Balkans, the paper analyzes recent trends in financial intermediation as well as the main challenges that have been identified in the past. Asset quality continues to improve, but the share of non-performing loans, or NPLs, is still high in some countries, while regulatory, legal, and tax impediments are still to be resolved in most cases. High unofficial "euroisation" is a source of indirect credit risk for countries with their own national legal tender and this calls for continued efforts to promote the use of domestic currencies in the financial system. 

Compared with certain EU countries, banking systems in EU candidate countries and potential candidates seem less prone to financial stress from maturity mismatches, but related risks should be closely monitored. While maturity mismatches are less pronounced in the region than in the selected EU countries, the funding of long-term lending via long-term deposits has declined in recent years. In addition, maturity mismatches appear most problematic in foreign currencies, where the central bank cannot fully act as a lender of last resort. This strengthens the case for promoting the use of domestic currencies.

The paper mentions that Turkey has experienced periods of heightened financial stress recently, with strong currency depreciation, falling equity price, and increasing yields. This follows economic overheating, which was partly due to buoyant credit growth supported by policy stimuli and the expansion of the credit guarantee fund. While the banking system in Turkey appears to have buffers to absorb shocks, there are considerable financial stability risks owing to significant foreign-exchange borrowing in the corporate sector, rising credit risk, and high rollover needs of banks in the wholesale market.

Related Link: Occasional Paper (PDF)

Keywords: Europe, EU, Turkey, Banking, Financial Stability, NPLs, Western Balkans, Credit Risk, ECB