The Vicegovernor of the Croatian National Bank, Damir Odak moderated the panel discussion "Implementation of Article 114 of the Regulation 575/2013/EU and its effects on the Croatian financial markets", held today at the 19th conference Croatian Money Market. The participants in the discussion on this extremely important regulation for financial operations and financial stability of the Republic of Croatia were Zvonimir Akrap, Management Board Member of Societe General-Splitska banka d.d., Ivan Gerovac, Management Board Member of Privredna banka Zagreb d.d., Domagoj Karadjole, Management Board Member of Hrvatska poštanska banka d.d., Zoran Košćak, Management Board Member of Raiffeisenbank Austria d.d., Christoph Schoefboeck, Chairperson of the Management Board of Erste&Steiermarkische Bank d.d., Zorislav Vidović, Management Board Member of OTP banka d.d. Hrvatska and Mario Žižek, Chairperson of the Management Board of Hypo Alpe-Adria-Bank d.d.
Opening the discussion on the implementation of Articles 114 and 400 of the Regulation (EU) 575/2013 and its possible impact on the Croatian financial markets, Vicegovernor Odak addressed the following key issue: the definition of assets which are "denominated and funded" in the domestic currency and which, in accordance with the said regulations, may carry a risk weight of 0% and as such are not subject to the prescribed exposure limits. Unless otherwise determined based on a country's credit rating, from January 2020 a risk weight of 100% will be applied to all central government debt of EU member states. A risk weight of 20% will be applied from January 2018. By way of exception, debt denominated and funded in the domestic currency of a member state has a risk weight of 0% and until January 2018, debt denominated and funded in the currency of any member state will also be treated in such a way. From January 2018, large exposure limits will also apply on all debt with risk weight higher than 0%.
The Croatian National Bank maintains that there are arguments speaking in favour of treating exposures indexed to a foreign currency as those denominated in kuna, Vicegovernor Odak stressed. Firstly, they are accounted for as kuna items with an embedded currency derivative. And secondly, their key determinant is that they are paid in, pay interest and will be paid out in kuna, making the risk associated with their collection equal to the risk of non-indexed loans.
The total exposure of banks to the RC at the end of 2015 amounted to HRK 88bn. Out of this amount, HRK 68bn are direct exposures to the RC, while the remaining amount are exposures to users that do not carry a 0% risk weight, but may carry it under a government guarantee. According to the findings of a CNB's research on the possible effects of the implementation of these regulations, only a small portion (27.47%) of the total exposure of Croatian banks to the RC is contracted in kuna and not indexed to a foreign currency, while the remaining amount is either indexed to (20.15%) or contracted in a foreign currency (52.38%).
When referring to the possible consequences of applying the same treatment to indexed and foreign currency exposures in the implementation of the regulations mentioned, Vicegovernor Odak emphasised that potential consequence could be decreased supply of retail and corporate kuna loans on the market: kuna government loans would be assigned a 0% risk weight, with the result that the alternative assets could not be competitive at a reasonable price. Furthermore, due to a shortage of kuna funds, banks would not be able to refinance all or a significant part of their maturing foreign currency loans and bonds. As a result, most of the maturing loans and bonds would be refinanced abroad, with Croatian banks being left with an excessive liquidity surplus. This could reduce the profitability of their business models, inducing them to assume hard-to-manage risks.
As Vicegovernor Odak pointed out, should foreign currency indexed kuna loans be assigned a 0% weight, exposures exceeding the large exposure limit would be estimated at a maximum of HRK 34bn. The surplus could be significantly reduced by the beginning of 2018, as the portfolio contracted in foreign currency could be partially refinanced or contracted again in kuna and indexed to a change in the euro exchange rate. Should kuna indexed to a foreign currency be treated as a foreign currency, the large exposure limit surplus could exceed HRK 50bn and would be very difficult to reduce. The treatment of a potential surplus exposure to the RC will be allowed an adjustment period, in line with the condition of individual banks' portfolios, as the sale of potential surplus exposures in the period until the beginning of 2018 could generate unnecessary pressure on the Croatian debt market, needlessly increasing the cost of debt refinancing.
Engaging in an open discussion, all participants in the panel agreed to the proposed reporting treatment. Vicegovernor Odak announced follow-up discussions with auditors and the Croatian Financial Services Regulatory Agency (HANFA).
Given its central importance for the financial stability of the Republic of Croatia, it is necessary that auditors, supervisory authorities and banks reach a timely agreement on this issue.