V. Vasiliauskas: Risks to the financial system do exist, yet banks would withstand major shocks

‘Our testings show that even if the economy faced a sudden and deep recession and the number of insolvent borrowers increased significantly, banks would still have enough capital to absorb the losses and be capable of further operating in a stable manner,’ said Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania. He emphasised that ‘even if the circumstances took a particularly unfavourable turn, additional capital requirement would be insubstantial, while the liquidity ‘cushion’ would be safe enough for banks to independently withstand major fits of depositors’ panic’.

The Bank of Lithuania has tested the financial system’s resilience under a hypothetical scenario, which provided that the domestic economy would be declining by approximately 5 per cent for two consecutive years. Under this scenario, banks would incur losses to the amount of EUR 642 million, but the capital adequacy ratio would remain high, whereas additional capital requirement would be low, at EUR 0.6 million only. The results of liquidity testing are good as well: if, due to the depositors’ run on banks, as many as 30 per cent of deposits would be withdrawn, banks would have sufficient liquid assets to bridge the gap (on the coming into force of the current deposit insurance scheme, the largest short-term fall in deposits in Lithuania was about 6%).

The Financial Stability Review specifies the real estate market situation in some Nordic countries, especially Sweden, as one of the major risks. There, real estate prices have been rising fast for a few years already, while the indebtedness of the private sector is not decreasing. With a change in the real estate market trends, parent banks’ risk appetite is likely to decrease, which could lead to constrained lending in Lithuania, in particular of riskier sectors.  

‘The risk is mitigated by the fact that the dependence of banks in Lithuania on Scandinavian parent banks has decreased in recent years: our banks finance most of their activities by attracting local deposits, while the significant capital stock accumulated gives much room for independent crediting of the domestic economy. Moreover, after joining the euro area, the possibilities for banks operating in Lithuania have widened as liquidity and long-term loan facilities, guaranteed by the European Central Bank, became available to them,’ said V. Vasiliauskas.  

The environment of low interest rates poses another risk. While low interest rates ease the loan burden and intensify credit, if staying for long, they may have negative effects, i.e. reduce financial institutions’ interest income and encourage residents and businesses to invest in real estate, which would lead to market heating.  

According to V. Vasiliauskas, there are no grounds for concern over a real estate bubble in Lithuania so far. While market activity has intensified, the growth rates of prices and housing loans are sustainable. The risk of a bubble swelling is also mitigated by the Bank of Lithuania’s updated Responsible Lending Regulations and additional requirements for bank capital. 

Unsustainable activities of credit unions remain a major challenge for the financial system. According to the Chairman of the Board of the Bank of Lithuania, if necessary reform, which is approved of by the majority of credit unions, the Government, the International Monetary Fund, and associations uniting credit union customers, is postponed, this sector will further encounter systemic issues and potential bankruptcies.  

The Financial Stability Review is published by the Bank of Lithuania annually. Its purpose is to assess potential risks to Lithuania’s financial system and identify possibilities to withstand them. The detailed Financial Stability Review 2016 is published on the website (1.8 MB download icon) of the Bank of Lithuania.

Financial stability, Credit unions