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THE IMPLICATIONS OF THE GLOBAL FINANCIAL CRISIS ON THE ROMANIAN BANKING SECTOR Student: Ana-Maria-Georgiana ZAPAN Faculty of Economics and Business Administration,“Alexandru Ioan Cuza” University, Iasi, Romania [email protected] Student: Ştefania AGACHE Faculty of Economics and Business Administration, „Alexandru Ioan Cuza” University, Iasi, Romania [email protected] Abstract In terms of the difficult economic environment characterized by global economic crisis, our study aims to present the implications of the current crisis on the banking sector in Romania. The international financial crisis that currently exists is a serious event that confronted modern economy, because it affected many banking systems globally and implicitly Romanian banking system. Although the Romanian banking sector was not exposed to toxic assets, it has been affected by the economic crisis because of the high degree of connectivity with the European banking system by the large share of foreign capital held by banks in Romania, which caused a transfer of crisis from European banks to subsidiaries. So, the paper aims to highlight the effects generated by the economic crisis on the Romanian banking sector and main challenges post-crisis. Keywords: banking sector, financial crisis, non-performing loans JEL Classification: G01, G21 1. INTRODUCTION Financial and economic crisis appears to be unprecedented in the last half century. In the current situation, the financial and economic crisis has spread rapidly worldwide, the economies of the EU Member States confronted with serious difficulties, both in the banking system and the real economy. In this research we will present the causes of the current financial crisis and how it affects the Romanian banking sector. Crisis in the U.S. mortgage market, called the "subprime" crisis, was the trigger of the global financial crisis. The deep causes were both macroeconomic and microeconomic nature. Romania had to adjust their macroeconomic policies to the new context created by the international financial crisis, imposing the need for recalibrating the mix of economic policies in line with the challenges determined by the crisis. Also extremely negative effects of the crisis have determined unprecedented reactions from the National Bank of Romania, materialized in the adoption of measures, to help restore financial balance. In this context, our paper is divided into three parts: first part contains introduction remarks regarding the importance and relevance of the approached theme, the second part present the main effects from the global crisis on the Romanian banking sector and the last part provides the concluding remarks of the research. 2. THE INTERNATIONAL FINANCIAL CRISIS AND ITS IMPLICATIONS ON THE ROMANIAN BANKING SECTOR The banking sector is an important part of the financial system and it holds an important role in the development of socio-economic activity. The proper functioning of the banking system and ensuring its stability and viability contribute to the economic development of a country. Although, the quality and level of development of the banking sector depends on the economic environment in which it operates. The banking activity has an important role in the contemporary economic life because it encourages domestic and foreign trade transactions of a state and allows investment both through direct participation in the financing and the placement and management of savings. In an economy, the banking sector should ensure attraction and concentrate of monetary resources from population and channelling them through the process of loan allocation to investments more efficient. Banks are the main channel of monetary policy transmission. The international financial crisis that currently exists is a serious event that confronted modern economy, because it affected many banking systems globally. This crisis started in 2007 in the United States, the main cause being mortgage loans with promotional interest rates and overvalued collateral and having the effect of bankruptcy of some of the largest banks in the world. Therefore, this crisis is also known as the “subprime crisis”. In the years preceding the financial crisis, 2005-2006, Romania was in a favourable situation in terms of financial stability and it is considered that the Romanian banking sector is able to resist systemic shocks, it can efficiently allocate resources to the real economy and identify and manage risks. In this period the banking sector consolidated its leading position in the system, supported by a dynamic credit by maintaining financial stability indicators to acceptable levels. However, given the fact that Romania is an emerging country, it has a lower capacity to cope with possible tensions that may arise because of the visible signs of the global crisis. In the banking sector in Romania, the current international financial crisis began to unfold in the fall of 2008, when there was a speculative attack against the national currency. The economic crisis has appeared due to an underestimation of the risk associated with holding cash. This risk was determined by changes in the cost of the main freely convertible currency, leading to an increase in illusory wealth. When liquidity which supported this growth disappeared, there was a strong adjustment in the price of all assets, resulting a recession and the need to adopt austerity measures. In Romania, the financial crisis of the banking system did not have the same basis as international level because the share of housing loans was much smaller compared with the Eurozone and banks had no investments in derivative instruments based on the securitization of loans. The banking sector in Romania was not directly affected by this crisis, because it was not exposed to toxic assets, but due to the high degree of connectivity with the European banking system, with large share in the structure of banking institutions holding foreign capital, there was a transfer of the crisis from parent banks to their subsidiaries. Thus, our country has confronted liquidity shortages, which were provided by banking groups in Western Europe (Roman & Chirlesan, 2012). Table 1: The evolution of the number of credit institutions in the banking sector in Romania, in the period 2008-2013 Credit institution Credit institutions with fully or majority stateowned capital Credit institutions with major private capital Credit institutions with majority foreign capital Branches of foreign banks 2008 2009 2010 2011 2012 2013 43 42 42 41 40 40 3 2 2 2 2 2 41 40 40 39 38 39 37 35 35 34 34 36 10 10 9 8 8 9 (Source: NBR, 2013, p.28) The financial crisis has not led to major changes in the structure of the banking sector in Romania (Table 1), the number of banks in the system are approximately the same. The main challenges for the banking system in Romania in the context of the current financial crisis were (NBR, 2008): decrease in the volume of loans to customers, especially population; increasing the share of overdue loans, especially for small loans, for consumption and unsecured; increase interest rates on bank deposits and loans; the growth of deposits volume with banks, especially from the population; Diminishing trends expansion of banking activity in the area and reducing the number of employees. Romanian banking sector was confronted with a growth in lending to the private sector and in particular for consumer credit that had a very large increase. It is considered to be the factor that triggered the economic crisis in the Romanian banking system. Thus, in the period following the onset of the economic crisis has been a tendency to reduce their, due to the tightening of lending condition by banks, because of the reluctance of the population, due to the uncertainty manifested by the crisis. Figure 1: Evolution of private sector credit by categories of beneficiaries, in Romania, in the period 2008-2013 (Source: NBR, 2013, p.58) In the period 2008-2013 the trend of growth of volume credit to the private sector was tempered (figure 1). If we follow the evolution of the credits in the period analyzed we find that the loans decreased from 2008 until early 2010 and then recorded a slight increase. Also it can be seen that the volume of loans to households followed a descending trend, this being the one of the main problems confronting by the banking sector. However, the banking sector has proven to be strong during the crisis, it continues to provide financing of the Romanian economy, in the proportion of about 92% of total funding granted by the Romanian financial system. Economic growth prospects generated by the stake of attracting European funds, the degree of financial intermediation, of almost 40% and 57%, make Romania an attractive destination for investors in the banking system. The crisis has left its mark on the number of employees and banking units, because the credit institutions want to reduce the costs by reducing their number. An important indicator to measure the impact of the international economic crisis on the banking system in Romania is the level of non-performing loans. NPL ratio is calculated based on prudential reporting about loan classification. The dynamic still modest in economic activity, so appear the tendency to restrict lending, which led to the further accumulation of non-performing loans, which affect the quality of banks loan portfolio. NPL in Romania has increased significantly in 2008-2013 (figure 2), as effect of the recession, because individuals and corporations was confronted with difficulties in repaying outstanding loans. Thus, if in March 2008 the NPL in Romania was 1.7%, in December 2013 it equalled 21.87%, while analysts expected an increase of this indicator in 2014. Figure 2: Evolution of the non-performing loans in Romania, in period 2008-2013 (Source: NBR, 2013, p.28) The main reason for these negatives changes are worsening economic environment and financial resources more expensive. Also rising unemployment in Romania, significantly reducing public sector wages and reduced activity or bankruptcy of companies were determined continuous decrease repayment capacity and thus the increase in non-performing loans. These factors had a significant influence on the quality of the loan portfolio of commercial banks and led to a significant rise in provisions, fact which also affect the profitability of banks in the Romanian banking sector. The deterioration of the loan portfolio was a common feature in European banking system and manifested simultaneously with the decrease of growth, so that the situation of credit institutions was exacerbated by losses from the sovereign debt crisis (ECB, 2010). Countries such as Greece, Bulgaria, Hungary, and Slovenia have a much more negative situation than Romania (figure 3). Figure 3: Comparative evolution of NPLs in some countries of the European Union, in period 2008-2012 (Source: NBR, 2013, p.28) To improve the effects of the global crisis on the lending process and to reduce the numbers of non-performing loans in the banking system were adopted more severe conditions for providing loans. Figure 4: Evolution of the main profitability indicators in the Romanian banking sector in 2008-2013 (Source: NBR, 2013, p.72) The difficult economic environment, characterized by the current financial crisis has had a major impact on the financial results of the Romanian banking institutions, these have reported in 2010-2012 a negative results, due to the substantial increase in the volume of credit risk provisions, amid the depreciation of the quality of financial assets and the revaluation of collateral. According to the NBR, in 2013 the main indicators of profitability, Return on Equity (ROE) and Return on Assets (ROA) had positive values (figure 4). During the crisis, banks have become more cautious, these passing from the providing of quantitative loans to the qualitative loans and trying to implement a new business model, but that would require the additional costs. The crisis caused a slowdown in lending in our country; banks have changed their orientation from a fast expansion to a prudence-oriented strategy. The banking institutions had to adapt strategy, the territorial expansion plans and the range of products and services offered to customers and perform a more careful control of operational costs. The main short and medium term trends of the banking system in Romania will be (Ensight Management Consulting, 2011): increasing financing pressures; reducing lending activity: attracting projects co-financed from EU funds; controlling costs and optimizing the branch network; changes in the competitive environment; enhanced competition to attract customers. Also, are expected constraints on the lending to small and medium enterprises (SMEs) because of European recommendations to restrict foreign currency lending and to apply the provisions of the new agreement on capital requirements - Basel III. Application of the European Systemic Risk Board recommendations which aim discouraging foreign currency lending to nonfinancial entities that do not have income foreign currency, will reduce the lending capacity and will follow appropriate risk management. A difficult economic environment, the implementation of Basel III, credit risk and reduce exposure in the absence of alternative investment also remain important challenges to the Romanian banking system. The crisis has multiple effects on Romania. From a financial perspective, it resulted in a decrease liquidity of the banking system, increase interest rates, reducing current transfers from abroad, increase costs, both private sector and budget deficit financing. Approached by the economic nature as crisis manifested by reducing economic growth, decrease in foreign investment, increase unemployment and leaving the market of a large number of small and medium enterprises. On the social side, the crisis affected population by decreasing job security, which determining the possibility or impossibility of returning the loan. During the economic recession, National Bank of Romania acted to stimulate aggregate demand. Thus, was gradually reduced the interest rate monetary policy, to the 3.5% minimum established in February 2014 and have been performed ample reductions in minimum reserve requirements. Besides the two main measures taken by the National Bank of Romania, to reduce both the interest rate monetary policy and the level of the reserve requirement, also observes that it introduced stricter requirements for loans to unhedged borrowers for moderate the boom of foreign currency loans, took steps to flexible lending to households, it introduced the regulation and supervision of non bank financial institutions, took measures provided to improve the liquidity of banks, has provided temporary liquidity of credit institutions to prevent systemic risk and has modified regulatory measures in the solvency. Although the National Bank of Romania has taken measures to counteract the crisis, did not achieve the desired effects, because the banking system is still affected and not achieved the desired economic growth. 3. CONCLUSION As regards the banking sector in Romania, we can affirm that in the previous period of financial crisis, this had financial stability and has managed an efficient allocation of resources to the real economy, through sustained dynamics of credits. However, the international economic crisis has made its mark on the banking sector in our country; its effects are felt since the fall of 2008. The main factor behind the crisis in the Romanian banking system has been the development of lending to the private sector, mainly of consumer loans, in our country level, compared to other countries where real estate loans have a smaller share. The impact of the current financial crisis caused a moderation in lending activity and restriction of banking activities by reducing the number of banking units and the number of employees. Also, in the context of difficult economic environment, commercial banks have had to increase interest rates to increase the volume of deposits attracted. The internal and external climate has had a negative effect on the quality of loan portfolios, NPL has registered significant increase, also and the financial results of the banking institutions was negative, in the years 2011 and 2012. The National Bank of Romania intervened to counter the effects of the crisis, mainly by reducing interest rates of monetary policy and by reducing reserve requirements. It can not determine exactly when Romania will overcome this period of economic recession, but must take the advantage by any opportunity of economic relaunching. Currently, the banking system is trying to implement a new business model, based on the relationship between bank and customer and that avoid repeating past mistakes. 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