common Czechoslovak communist banking system. In the early 1990s, the Slovak banking system still had many characteristic features inherited from the previous regime and commercial bank activities were concentrated in a few specialized banks.
Beyond the procedural difficulties faced at the very beginning in the newly stabilizing banking sector, the transformation process was impeded by the fact that most of the main financial market institutions had to be newly created, because the majority of the processes were originally managed from Prague—former capital of the Czech-Slovak Republic. The role of the newly formed National Bank of Slovakia was not only to supervise the development of a new banking system, but above all it was responsible for introducing a new currency and maintaining an independent monetary policy.
A consequent period of hectic changes in Slovak society involved also the financial sector. The market has witnessed a dramatic increase in the number of financial institutions with a banking license (that peaked in 1996, when reaching 34). Within a few years, the share of foreign ownership in the sector increased to 50 percent. Simultaneously, employment in the banking system increased and so did the banks’ assets, liabilities, and loans.
However, buoyant evolution in the unclear environment brought a significant increase in NPLs. The share of classified loans rose to almost 30 percent of total loans. This unpleasant development was fuelled by inefficient banking institutions, inexperienced
banks with an underdeveloped methodology for assessment of creditors, weak risk management, relatively widespread partisan rating of clients, and financially illiterate customers.
Accumulation of NPLs was prevalent in the corporate sector. In the unhealthy political environment, coupled with an unstable economic environment, unfair practices of business managers were relatively common, coupled with political pressures to provide unprofitable loans to friendly businessmen.
In the nonstandard economic environment, interest rates were very high. Interest rates on deposits were around 15 percent and the interest rates on loans were at the level of 20 percent per annum. The need for tightened monetary policy and a massive defense of the exchange rate was to a large extent a consequence of very loose fiscal policy and a lack of structural reforms.
A natural component of transformation was privatization of state banking institutions. The inevitable intermediate step in this process was cleaning the banks of the accumulated NPLs. This happened in 2000 and 2001. Based on available estimates, NPLs represented one of the biggest costs of the overall transformation process, exceeding 11 percent of GDP in Slovakia. The value of the NPLs in state banks reached EUR 3 billion (more than 9 percent of GDP). NPLs of well-connected local private equity accounted for another EUR 660 million (i.e., 2 percent of GDP).
This is a huge cost that is fully comparable to what many observers would consider to be the biggest cost—a broad-based privatization process involving local friends during the 1994–98 Meciar era. The price difference between the revenue and the accounting value of those companies was comparable at 10.7 percent of GDP (EUR 3.2 billion). Hence, the state ownership of universal big banks turned out to be extremely expensive in a post-communist country.
The early negative experience (the stigma of the banking crisis) and its high public costs helped shape the more conservative behavior of clients, bank regulators, and supervisors in Slovakia in the following years.
Next, the development of the Slovak banking system took place in an environment of low inflation supported by inflation targeting monetary policy. Interest rates declined substantially.
At the same time, cleaning of the banking sector asset side and low inflation, which helped protect deposits, resulted in a small loan to deposit ratio in Slovakia. Loans and deposits in foreign exchange have been very limited.
Based on theory, foreign ownership of banks brings several benefits and costs. Undisputed benefits include transfer of know-how, higher competition, and better or “more independent”
allocation of resources in the host country. Besides benefits, we may identify some costs related to weaker longer-term commitments. We may expect fewer financial resources to be available for corporates, because lending to corporates is more complex and requires stronger effort and more analysis. In general, the volume of available finances depends on the value of collateral and costs or complexity of monitoring. These factors may lead to higher lending to households and fuel real estate booms.
However, the existence of these relationships in practice is not so straightforward. The experience of the Slovak Republic is based on the gradual creation of three different groups of commercial banks. The first group present in the market can be called “pure”
foreign banks. These banks usually relied on capital from their home countries and concentrated on corporate private-sector clients. Therefore, they usually strongly supported policies that strengthened corporate balance sheets and investments, mainly structural reforms and low taxation. The second group represents
“mixed” foreign banks. These are former state banks acquired by large Austrian or Italian banks, and they retained their positions of biggest players in the Slovak market. In these banks, we could observe gradual corporate culture changes, and in general their services are more expensive. The third group comprises small local banks that are often owned by local equity firms. These banks have tended to finance their owners and sometimes engage in more risky activities (e.g., Greek bonds).
As already indicated, the three groups differ not only in terms of their ownership, but also in terms of their behavior and historical development (Figure 1).
1) “Pure” foreign banks could not rely on a wide branch network and they did not perceive Slovakia as their key market due to its small size. They focused on medium and large enterprises, and thanks to their connections with mother banks, they were able to dramatically improve their price competitiveness and introduce new investment banking products (structural finance).
2) “Mixed” (foreign) banks took over mortgage and consumer finance as the theory would predict. These segments have remained the most dynamically growing until now. But the banks did not stop there and continued to service a corporate clientele as well, including SMEs. In fact, at present, there are some signs that the “mixed” banks are trying to price out “pure” foreign banks in the large and mid-corporate sector.
3) The group of small local banks relied on central bank financing due to limited access to money market activities. Also, their capital adequacy ratios are usually not as strong as those of the other groups.
Euro adoption and the economic, financial, and debt crises influenced the three groups differently. Despite the ability to adapt to euro area prices and increase their price competitiveness (among the top seven lowest prices in the eurozone at present), we can observe a decrease in profit and market shares of “pure”
foreign banks. The main reason seems to be the fact that foreign-owned companies tend to finance themselves via corporate headquarters on a larger scale than before. In contrast, our
“mixed” banks continue to benefit from a growing retail sector.
Retail loans are growing at double-digit rates and the banks maintain very favorable returns on equity or assets. The prices of mortgages have been the highest in the eurozone. The last
relatively small group of local banks keeps on maintaining lower capital adequacy ratios and, due to worse access to the money market, they continue to prefer central bank financing.
Based on our experience, the presence of foreign banks brings a lot of advantages for the stability of the banking sector. These include the transfer of know-how, liquidity, and capital support.
The existence of large universal state banks turned out to be extremely costly.
As a small disadvantage, unlike domestic banks, foreign banks tend to be more prone to limit their lending activities in the event of an economic downturn or uncertainty. As shown in the Figure 1, domestic banks continued lending while foreign banks slowed down their lending activities in recent bad times.
Figure 1. Differences in Behavior of Domestic and Foreign Banks
Source: NBS.