The Slovenia Times

Banking and the New Terms of Trade


On 1 January 2019, the euro is celebrating its 20th birthday. Born into a family of 11 European states, a political decision was made that the euro would be accepted in two states that failed to meet the Maastricht criterion for public debt which had been set at 60% GDP, namely Italy and Belgium, which set a bad example for the future and bore consequences that, to this day, still raise many a question about the common European currency.

"The past is a lesson for the future." Cicero

The beginning of the financial crisis challenged the member states with a Hamletian 'to be or not to be' concerning banks and their impact on both the European economy and public trust. To limit the damage, a clear decision was made: member states would help banks, regardless of who they are owned by, with money and guarantees. The European Commission announced that in the period from 2009 to the end of 2011, the total monetary state aid to banks amounted to EUR 1.6 trillion, while the amount of state guarantees was three times as high. Let us not forget that the fear of losing public trust resulted in the adoption of special laws which ensure that, in the event of bankruptcy, savers receive 100% of their deposits back, irrespective of the amount deposited. In Slovenia, such a law was passed in November 2008, remaining in force until the end of 2010.

The beginning of the banking crisis in Slovenia was not in sync with the events that unravelled across Europe and in the USA. This was due to the different structure of the banking system's balance sheets which indicated up to 75% of claims on companies and the population. As seen in Liikanen's report on where to look for the cause of the banking crisis, which was drawn up for the European Commission in October 2012, the assets of Deutsche Bank, the largest European Bank, only comprised 23% of such claims, while the remainder was in financial assets. The French, Banque Agricole, reported an even lower share of such claims, which was at 18%. In other words, the European average amounted to less than 50%. Based on the analyses and findings contained therein, the report recommended the European Commission to start a structural reform of banking that would demand all major banking systems to have a legal entity designated for trading and a separate legal entity for operations of the universal bank. Six years later, we can see that this reform remains confined to paper. Major banking systems are clearly not in favour of such a division and what is more, even senior politicians have refrained from voicing their support for it, meaning that not everyone has to abide by the same rules.

The next among the consequences of the crisis, aimed at consolidating financial stability, was the decision to establish the European Banking Union, which was to be based on three pillars: the Single Supervisory Mechanism (SSM), which directly supervises 118 European systemic banks; the Single Resolution Mechanism (SRM) with a fund dedicated to aiding failing banks, which was supposed to raise capital of EUR 65bn; and the European Deposit Insurance Scheme (EDIS). SSM was established in November 2014. In the first year of their operations it was found that despite the uniform European regulations - namely the Basel Accords, European directives, ECB decisions and EBA provisions - banks still use 7,000 different models to assess risk; that member states used a total of 155 local competencies for different interpretations of the directives; and that banks - for instance in Italy, France and the UK - have defined default of the debtor in mortgage loans not as 90 days, but rather as 180 days. It is difficult to foresee when exactly the banking union will be brought to life. EDIS is especially problematic as the situation differs from one member state to another.

But, over the course of the last 10 years, it was the European Central Bank (ECB) that contributed the most to solving the banking and economic crisis. With its unconventional monetary policy, it has completely changed the terms of trade in the financial market. Primarily, the two measures which have been taken so far: the implementation of the zero base interest rate, which has influenced the formation of negative values of EURIBOR variable interest rates and the associated negative deposit interest rates, meaning that banks have to pay 0.4% for their excess liquidity to the ECB - the creditor pays interest to the debtor, which is something banking history has not yet witnessed. This interest policy has forced the member states into additional borrowings, both within and outside the European Monetary Union - irrespective of the Maastricht provisions. At the same time, it is an abatement to member states to preserve their domestic status quo and not implement any structural reforms (Italy's debt has been increasing consistently, already having surpassed 130% of Italian GDP, and it is projected to increase an additional EUR 274bn; Slovenian debt is also more than 70% of GDP and accounts for a nominal EUR 33bn). In other words, peacetime public debt has never been as high in modern history as it is today. Moreover, due to the symbolic interest rate, the transfer of proceeds from creditors to debtors that are now being witnessed has not been recorded in decades.

As the growing inflation causes the interest rate to normalise once again, the question that will remain is, "How will Member States service their debt or are we in for a new wave of bankruptcies?" This policy works in tandem with a measure that the ECB has been implementing since March 2015, which comes in the form of purchasing government bonds as well as some commercial bonds, with numbers as high as hundreds of billions. Combined with high liquidity rates, this monetary policy has 'broken down' the money market, which is home to commercial banks, as there is no longer a need for the latter to borrow from one another. Aside from that, this interest policy has a direct impact on banks net interest margins and consequently, their entire income policies. Ultimately, it also increases systemic risk. Why is that so? In most universal banks, the so-called "primary sources" comprise deposits made by the population and businesses, and these represent the most important source for the operation of financial intermediaries. If a bank is facing an insufficient demand for credit, it places its assets in various financial forms but is, at the same time, unable to charge negative interest rates to depositors. If that were to happen, depositors would demand payouts of their deposits in banknotes, as these represent interest-free receivables from the central banks that issued them. But as this does not happen, such a passive interest rate is symbolic and close to zero value. As a result, savers do not decide to report their financial assets, meaning that insight into these assets is only available a vista, increasing the liquidity risk in the event of fear or distrust, which can originate from domestic or foreign markets. 

All these facts, along with a number of others related to money and political decision making, greatly impact the operation of banks and their results. The declining net interest margin, which in Slovenia accounts for approximately 1.80%; high level of own capital, which with a balance sheet total of EUR 38bn amounts to EUR 4.7bn; low credit demand; and new investments in banking technology brought about by digitalisation, are making it difficult to achieve the desired results in the form of return on invested capital. When inspecting last year's results, we can find that the latter amounted to around 5.6% in Europe, whereas it peaked at 9.6% in Slovenia. That being said, we must not forget that the results are also better due to the release of provisions for bad credit, as the economic conjuncture is the best and most just form of rehabilitation.

The consolidation of the banking system in the form of shrinking the banking network, the operation of an unregulated 'financial system in the shadows' which according to ECB's estimations accounts for 40% of all financial transactions, demands for higher capital, an interest policy with no historical basis and a number of other motives all impact bank prices on the free market. Since we know that for the most part of this year the shares of renowned European banks quoted lower than last year - e.g. Deutsche Bank at 30%, BNP Paribas the highest at 70%, Commerzbank at 40%, Unicredit at 50% and Societe Generale at 50% of the book value - we can assess that the sale of NLB shares at EUR 51.50 per share was successful, especially since the market knew that the sale was forced by EU requirements, and because a significant share still remains with the state and, thus, the largest possible impact on the business policy and daily operations of the bank.

Final remarks

In his work, Rhetoric, Aristotle noted that "a man is ready to face the truth once they are shocked or experiencing a crisis." I hope that the banking crisis has shaken everyone, especially the 'living capital' which cannot not seem to find its place in the asset balance sheets of banks and which are listed under expenses in the balance sheet of success. I am referring to people: to owners, to bank employees at all levels, to politicians and to the entire population. Calls to ethical and professional behaviour have become an additional imperative that in some countries - e.g. in the Netherlands - reflects in the form of a banking oath taken in the presence of two witnesses who act as guarantors for the fair and faultless acting vis-à-vis the contracting parties. At the same time, we must not forget that the multitude of regulations and different commandments must never replace human trust as the latter must be earned with actions through a longer period of time. 

About the Author

Dr France Arhar has been a senior adviser to the President of State since 1 January 2018. In the past, Dr Arhar was the General Manager of the Slovenian Banking Association and a member of the European Banking Federation; he was Chairman of Bank Austria Creditanstalt and later UniCredit Banka Slovenije; he served 10 years as the first Governor of Banka Slovenije; and was the Governor for Slovenia at the IMF. In 2001, Dr Arhar was awarded by the President of Slovenia for his role in establishing the Slovenian monetary system and in 1994, Wirtschaftspolitischer Club Berlin-Bonn recognised his guiding role in monetary policy as the Governor of the Central Bank of Slovenia, awarding him 10,000 German marks which he donated to the children's hospital in Ljubljana.


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