The pandemic has not endangered the stability of BH banking system „Business Magazine“

Senad Softić, Governor of the Central Bank of BH, in the interview published in Business Magazine, explains how much citizens and business entities in Bosnia and Herzegovina can feel relieved with regard to the fear of money shortage, which was present during the entire period of the pandemic equally as the fear of contagion

Since the very beginning of the coronavirus pandemic, the fear of money shortage was equal, if not stronger than the fear of the contagion, particularly in economically and financially weak societies, such as the one of Bosnia and Herzegovina. How much citizens and business entities in Bosnia and Herzegvina can feel relieved at least in respect of surviving the pandemic financially and view the year 2021 with optimism, is explained for Business Magazine by Senad Softić, Governor of the Central Bank of BH.

BM: What do you think of 2020 in respect of the stability of BH banking and financial system on the whole?

SOFTIĆ: We can say that by now, banks have been successful in coping with the consequences of the pandemic, being significantly helped in those efforts by the timely and synchronised measures of the Entity Banking Agencies. 

The measures to mitigate the economic consequences of COVID-19 virus included the possibilities of granting moratorium, grace period, prolongation of repayment period and loan maturity period, and the possibility of approving additional funds for clients whose creditworthiness deteriorated due to negative effects of the pandemic. At the same time, regulators took care to preserve banks' capital, so special rules were set for credit risk management and also preventive measures to preserve capital, including the retaining of the 2019 profits, ban or delay for dividend and bonus payments, and use of capital buffers. Some reliefs were also provided for clients of leasing companies and microcredit organisations. In the end of March, immediately after the pandemic had been declared and the lockdown had been introduced in economy, the withdrawal of household deposits increased, but the situation stabilised by June. Banks had a key role, proving they were able to meet all depositors' demands, so excessive withdrawal of deposits from the system did not take place, which could have been expected given the circumstances.

All this impacted the keeping of banking system stability in 2020. The system kept very good indicators of capitalization, liquidity and asset quality, so the impression is that the corona crisis did not bring about any significant consequences on the banking system.

However, only after the expiry of provisional measures, in the end of 2020, banks will be faced with the economic consequences of the pandemic, and it will be possible to estimate the size of the shock only in the years to come. The strongest pressure is expected in mid 2021 when a significant part of credit portfolio, which is under certain provisional measures, could be under enhanced pressure of being moved into the category of non-performing loans.

During 2020, low lending activity was evident as well as considerable decrease of bank profitability compared to the previous year, resulting from changes in banks' operation dynamics in the circumstances of the pandemic, but also the situation and demand of real sector. Similar trends are likely to continue in the next year, which will, with the expected growth of non-performing loans, make additional pressure on banks' financial result.     

BM: Which weaknesses of BH banking and financial system have maybe become evident during the corona crisis?

SOFTIĆ: Since the beginning of the pandemic, systemic risks, resulting from operating weaknesses and banking sector regulation in BH, have not been observed. Banking sector at the moment of crisis beginning, had very good performance, which had been impacted for years by the regulatory framework which was upgraded and adjusted with the EU standards, keeping at the same time some conservative features in respect of keeping some regulatory requirements stricter compared to the EU standards.

The weaknesses of any banking system, including the domestic one, include the procyclical behaviour of banks. So, in the situation when economic activity increases, banks are inclined to intensify their lending activity and increase risk aversion. In crises, banks enter loan arrangements in a more cautious way, and they are more cautious in estimating clients' creditworthiness, which to a certain extent, influences a lower intensity of economic growth in the recovery stage.

With the underdeveloped non-banking financial system and capital market, as the case is in BH, banks’ business polices have a more significant effect on the total level of debt of private sector in the country. Adverse effects might be mitigated by various measures for the recovery of economy, indirectly stimulating market revival and banks' lending. Banks' potential for adequate financing of domestic sectors in this moment can be estimated as satisfactory, on the basis of funding sources available to banks, capital positions and the level of lending and deposit interest rates.

It is very important, as a sound banking system is necessary when a stronger recovery of BH economy starts.

BM: What about the other side of the coin – which advantages of BH banking and financial system have become obvious during the pandemic?

SOFTIĆ: Banks' operations in BH are traditionally conservative. Banks are still engaged in core bank operations, with basic financial instruments dominating in their assets structure.

In crises, banks' conservative operations are an advantage in preserving financial stability, as risks arising from banks' operations are transparent and easily seen and measurable. On the other hand, the lack of complex bank operations and instruments, due to the financial market in BH not being very developed, is a restrictive factor in the development of private sector in good times.

BM: Generally speaking, to what extent have the competent institutions, including the CBBH, appeared ready to respond to the challenges such as the pandemic?

SOFTIĆ:During the pandemic, the Central bank has acted with measure, reasonably, independently and within its authorities, which has proved to be crucial to keep the confidence in the local currency and banking system liquidity, particularly immediately upon the declaration of emergency and natural disaster situation in BH. Stability and full convertibility of convertible mark have never been questioned by the public, despite numerous individual tactless statements in the media. It is obvious that the public expected the Central Bank to act independently, to work according to the law and in the best interest of the public, regardless of circumstances, so panic withdrawal of deposits from banks and their conversion into euro were not recorded.

I am proud to be able to stress that we have met the expectations of the local and foreign public. We have provided the undisturbed supply of a significantly higher demand of banks for KM banknotes in March, which convinced their clients that any request for the payment of funds from holders' accounts would be carried out instantly. Perceiving the system as liquid additionally calmed down the public.

The required reserve policy which we have implemented from the beginning of the pandemic also proved to be appropriate in the current combination of macroeconomic factors and the factors impacting banks' liquidity. The transaction settlement platforms in interbank payment system, established and maintained by the Central Bank, have been functioning perfectly. Finally, the Central Bank has also met other obligations towards international institutions without any delays, either as a reporting institution or on the basis of its fiscal agent role.

Responding to the current crisis, fiscal measures have the key role, and, accordingly, the Entity governments took some activities, particularly related to increasing the costs for subsidies for wages and expenses for health sector. Due to a significant part of the government stabilisation measures being focused on ensuring the functioning of health system and large emergency procurements in public health sector, the effect of government spending on economic activity may have not been as significant as desired.

However, this is really unprecedented crisis and I think it is not useful to express opinion on what another institution, or level of authority could have done better, within their competences.

Could we have had stronger economic effects if we had more funds available or if some of structural reforms had been implemented earlier? Probably. Yet, I believe that everybody contributed to the efforts to mitigate the waves of the pandemic negative effects within the current possibilities.

Regulators adopted a number of measures which made possible redefining of conditions to service the existing liabilities in order to mitigate a strong growth of non-performing loans, which takes place after macroeconomic shocks. Also, the Entity governments formed guarantee funds, helping the companies to obtain loans from banks easier. All the mentioned measures are focused on demand for loans. Current frictions in financial intermediation are not related to offer, as banks have plenty of sources of funding. Average interest rates have remained almost the same compared to the pre-crisis period, however, banks estimate clients’ creditworthiness in a more conservative way. They cannot be blamed for managing their exposure more carefully in periods of uncertainty, as banks need to allocate provisions for each loan.

BM: In the interview for Business Magazine in the very beginning of the pandemic you said that “even in case of a longer duration of emergency situation due to the pandemic, disturbances in cash supply by the Central Bank are not expected..“, which was confirmed as correct in the meantime. Is the situation in that respect currently stable and were there in the recent months, except in March as we mentioned, additional periods with noticeably stronger demand for cash?

SOFTIĆ: In the beginning of the pandemic, there was a large demand for cash by citizens and commercial banks which the Central Bank successfully reacted to, i.e. all requests to withdraw KM and EUR cash were fulfilled, the situation stabilised and it is so today.

To illustrate this, during the first way of the pandemic caused by COVID-19 virus, in the period from 16 March to 31 May 2020, KM 745,182,900 and EUR 102,968,000 was paid from the Central Bank vault to commercial banks.

The Central Bank has sufficient stocks of KM cash to meet all the requests of commercial banks in the period ahead. In the period of the pandemic, the Central Bank convinced BH citizens once again that they can trust this institution and the local currency stability.

BM: The beginning of the pandemic was marked by the pressures on the Central Bank in the form of requests to use foreign exchange reserves „to keep financial and economic stability of the country“, i.e. „acrobatics“ such as releasing excess holdings of commercial banks above the required reserve – did such initiatives in the meantime really stop or were just moved from the public scene to some other channels?

SOFTIĆ: You are right. With more or less intensity, there are initiatives that the Central Bank do something which is not in accordance with its authorities. The Central Bank, experts and scientists agree that the use of foreign exchange reserves for fiscal purposes, in the currency board arrangement, would undermine confidence in the full convertibility of the local currency. Those are simple economic principles which are studied on undergraduate studies in economics.

Experts and academic community have understood from the beginning that releasing additional liquidity, which was not needed, by decreasing the required reserve rate, would only be a cost for banks in the period of a strong macroeconomic shock, without any effect on demand for loans. The Central Bank, or any one from the expert community, did not expect demand for loans at the moment when the economy was in almost full lockdown and uncertainty increased strongly in respect of the changes in available household income.

It is generally known that reserve requirement is the only monetary policy instrument which the Central Bank has available. Those are funds (deposits) of commercial banks, i.e. their depositors (citizens, companies, governments). The current required reserve rate is 10 per cent, which in the absolute amount as of 14 December 2020 was KM 2.72 billion. In addition, on the same date, commercial banks were holding KM 3.07 billion above that amount (excess reserves). Those are funds belonging to banks, and, ultimately, their depositors.

In that respect, we stressed several times that if it appears necessary, we are ready to react promptly and, by decreasing the required reserve, to increase banks' liquidity. However, we do not see any need to do so at the moment.

I would stress that the Central Bank in the current situation, conducted a responsible and proactive policy, according to the CBBH Law and it would continue to undertake all the possible measures within its monetary regime to help economy and citizens.

It is important to stress once again what the Central Bank is not allowed to do. Monetary policy cannot solve the issues such as the necessary structural changes which should be started by other institutions in this country, cannot increase public investments, or improve the functioning of other institutions etc... In other words, monetary policy has a clearly defined framework, and our first task is to guarantee stability and thus enable economic prosperity. The Central Bank will continue to follow up with all available information on the situation in economy and inform the public in a timely manner.

BM: The critics of the currency board concept are silent now –would it be exaggeration to conclude that in the corona crisis it has appeared to be a perfect solution for BH and that any other model would take it to hyperinflation and much deeper crisis?

SOFTIĆ: The currency board model which is in effect has proved to be justified generally, and particularly in the corona crisis.

There are examples of the countries, i.e. central banks, such as Turkey, Croatia and other, which were forced to allocate considerable funds from reserves for the stability of their currencies.

It is quite clear that in case of abandoning currency board, hypothetically speaking, many negative consequences would occur. It would imply printing of currency without coverage, lending for the budget etc…—and in the future, high inflation would be inevitable.

Sometimes monetary policy is expected to do more than it really can, so I often stress that monetary policy is not an adequate compensation for structural reforms and other relevant policies.  

BM: You mentioned reforms several times, which also, include single registry of natural persons, and there is not even close to agreed attitude about it at the level of entire BH. What is your opinion about it?

SOFTIĆ: Single registry of accounts of natural persons has multiple benefits for all participants in the financial sector, including citizens.

Single payment and settlement systems in BH are a strong instrument for preventing money laundering and terrorism financing, and the Central Bank has all legal and technical preconditions to set up the registry of accounts of natural persons.

The Central Bank supports the reforms included in the Letter of Intent which are related to financial sector, particularly, the upgrade of the existing Single Account Registry, which would include accounts of natural persons in BH. All this is aimed at strengthening financial stability and meeting the objective of the arrangement with the International Monetary Fund (IMF), i.e. improving the framework for preventing money laundering and terrorism financing.  

Economic area of BH is single – banks, natural and legal persons operate and perform transactions in the territory of the entire country, without any restrictions. Any activity in the direction of restricting participants in the payment transaction, economically and financially, to one Entity only, can be described as unconstitutional. For the very reason of reducing the possibility of illegal transactions, it is very important to upgrade Single Account Registry at BH level. It does not limit the possibility and right to keep Entity registries, and no transfer of authority is carried out.

The Central Bank is an institution of Bosnia and Herzegovina which has been defined by the Constitution, which has a legal objective, beside ensuring the stability of the currency, to help and maintain payment and settlement systems in BH and to implement actions to help combating money laundering and terrorism financing.

The legal basis to maintain the registry of legal and natural persons is absolutely unquestionable and the Central Bank, for a number of years has established Single Registry of Accounts of Business Entities and Central Registry of Credits of Business Entities and Natural Persons. By upgrading the Registry, which would include also the natural persons’ accounts, this process would be completed and the work for all participants in financial sector, particularly banks, and indirectly citizens in BH, would be made easier.

Credit rating

BM: BH credit rating has remained at the pre-pandemic level – how should we interpret that fact (as a confirmation that BH has well responded to the corona crisis or as a message that BH is incurable patient that being at the bottom anyway, cannot be further endangered by any global disturbances)?

SOFTIĆ: The fact that the rating agencies did not downgrade the country's rating during the spring emergency assessments or regular summer assessments, is a positive signal. Keeping the rating the same in the pandemic means it is estimated that the authorities, within their possibilities and without jeopardising long-term outlooks for public foreign debt servicing, have taken appropriate measures to stabilise the economy. Revision of outlook downwards was seen in almost all the countries and was expected given the circumstances. Upgrade of the rating in short-term period is not likely in any country seriously hit by the pandemic, and that is what the outlook implies. Finally, it is important to mention that political environment, slow implementation of structural reforms and slow EU integration process have always been marked as key factors for the low rating of BH.

I believe that continuing small but related reforms and steps to the EU integrations would lead to a considerable upgrade of credit rating in rather short period.