V. Vasiliauskas: The financial system should take advantage of the economic upswing to accumulate additional buffers
The domestic financial system is stable and resistant to shocks. Lithuania’s economy is currently in an upswing: households and enterprises are getting financially stronger, lending is growing, and the real estate market remains active. Such a point in time is highly favourable for strengthening the financial system and accumulating a reserve for downturns.
‘The economy has recovered, loan portfolio growth is sustainable, banks are more willing to not only grant housing loans or loans for large companies – their growth is surpassed by lending to small and medium enterprises. However, at this moment it is important to stay alert. Economic development is cyclical, the upswing will not last forever; hence, financial market participants should use the moment to prepare for future downturns,’ said Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania.
According to him, the key priority is to strengthen the capital, which, at times of economic shocks, serves as armour. The robust economy and financial sector as well as high housing market activity enable banks to strengthen their resilience by accumulating capital reserve, the so-called counter-cyclical capital buffer. By the end of this year, banks must accumulate a capital buffer of 0.5 percentage points, i.e. about €60 million of capital. The Bank of Lithuania consistently keeps the position that, at times of balanced growth, the counter-cyclical capital buffer rate should amount to 1%; hence the plan is to increase the above-named capital requirement to this level in the course of this year. Most banks already hold sufficient capital to meet additional requirement. Some smaller banks for which it is most relevant to increase their capital buffer are presently already doing this at their own initiative, allocating part of their profit or additional funds of shareholders for that.
This year lending is likely to remain active and driven by growth in enterprise investment, positive business and consumer expectations, and the strengthening financial position of households. High housing market activity is likely to remain at similar levels in 2018, whereas growth in prices is likely to moderate compared to 2017. The real estate market is protected from the risk of overheating by a flexible supply of new housing and the Bank of Lithuania’s Responsible Lending Regulations.
The results of banks’ annual stress testing show that the banking sector is resilient to shocks. Even if the domestic GDP fell more than 7% and the real estate prices by more than 20%, banks would be able to absorb a €835 loss, while their additional capital requirement would be relatively low, at €3 million. Moreover, with the holdings of their liquid assets, banks would be able to cover a decline in deposits of 28%.
The highest risk to the domestic financial system remains the real estate price bubble in the Nordic countries and the consequences of its burst for banks in those countries as well as their subsidiaries in Lithuania. The economic and financial stability issues in the Nordic countries would lead to adverse consequences in our country as well. Banks with Nordic capital could cut lending volumes in Lithuania and the other Baltic States; loan interest rates would increase.
‘Real estate price adjustments in Sweden have so far been moderate and not posing a threat to its financial system; however, we are closely monitoring the situation. The financial links between banks in Lithuania and Scandinavian parent banks have for the last few years been weakening, and currently their activities are basically funded not with loans from parent banks, as was the case before the previous crisis, but deposits attracted domestically,’ said Mr Vasiliauskas.
One of the major challenges for the financial system is to ensure cyber security. The number of cyber incidents in the country has still been increasing, while financial system participants see the possible damage of cybercrimes as one of the major risks for the country’s financial system. The Bank of Lithuania was the first in the euro area to conduct a cyber exercise, assess banks’ resilience to cyber-attacks, and identify the areas to be enhanced. This year, the Bank of Lithuania will focus in particular on the assessment of cyber resilience of not only large financial institutions but new market participants as well – FinTech companies. It will test cyber risk and prepare minimum requirements for information, IT and cyber security management.
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.