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Croatian banks face short-term challenges and long-term gains with euro adoption

By on August 16, 2022 0

Croatia will adopt the euro in January 2023, becoming the 20th country to do so.
Credit: Laszlo Szirtesi/Getty Images News via Getty Images Europe

Croatian banks stand to lose around 20% of their annual profits once the nation’s impending changeover to the euro triggers lucrative foreign exchange trading. The long-term benefits of change can make it a price worth paying.

The abandonment of the kuna will cost the industry some 1.4 billion kuna a year, mainly due to lost foreign exchange profits, reduced fees and lower interest income, according to the Bank. Croatian national.. Lenders, including units of UniCredit SpA, Intesa Sanpaolo SpA and Erste Group Bank AGwill also incur around 900 million kuna of one-time costs due to the change, the central bank told S&P Global Market Intelligence.

Reimbursement to lenders for these expenses may come from a stronger local economy, reduced currency risk and regulatory benefits once under the supervision of the European Central Bank. Expectations of a stronger banking system have also contributed to S&P Global Ratings, Moody’s and Fitch all raised Croatia’s sovereign ratings after confirmation that the country would become the 20th member of the euro zone in January 2023.

“Regardless of all the challenges and costs, banks strongly support and welcome the introduction of the euro in Croatia,” the Croatian banking association told Market Intelligence via email. This decision “will be extremely important to stimulate investment, financing conditions and the long-term growth of the Croatian economy”.

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Joining the euro will boost the Croatian economy by giving it greater resilience to external shocks and improving access to financial markets, the central bank said. Lower trade costs for exporters and importers can also stimulate foreign trade and investment.

Banks should benefit from a “positive ripple effect” as joining the euro strengthens the local economy, said Regina Argenio, credit analyst at S&P Global Ratings.

The country’s banking system is dominated by five foreign banks, which accounted for more than 80% of total assets and net profit in 2021, according to Market Intelligence data. Zagrebačka banca dd, owned by Italian lender UniCredit, is Croatia’s largest bank by assets, ahead of Intesa’s Privredna banka Zagreb dd, Erste&Steiermärkische Bank dd of Erste and units of OTP Bank Nyrt. and Raiffeisen Bank International AG.

None of the five banks responded to requests for comment.

Adoption of the euro will reduce exchange rate risks for lenders even if they lose profits in forex because about half of Croatian bank deposits and loans are denominated in euros, according to the central bank. Such exposure meant banks would face a “substantial increase in non-performing loans” following an adverse currency shift, the central bank said.

Another benefit for banks will come from an increase in liquidity of €5 billion once an exchange buffer is removed. This industry-wide cushion will become superfluous after Croatia adopts the euro, and its elimination will allow banks to reduce costly foreign borrowing, according to the central bank.

Lenders will also receive an additional 34.2 billion kuna in liquidity, the central bank said, as the reserve requirement rate is gradually reduced to 1% from 9% by December. This would bring lenders into line with the ECB standard.

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The changeover to the euro will entail costs for lenders beyond lost foreign exchange transactions and the need to overhaul IT systems. Banks will also lose part of the net interest income when converting their kuna-denominated loan and deposit portfolios into euros due to interest rate differences between Croatia and the euro zone. That disadvantage could ease now that the ECB has started raising borrowing costs, Argenio said.

The lingering effects of COVID-19 and fallout from the war in Ukraine could also delay some of the economic benefits of adopting the euro. The Croatian economy could grow by 5.5% this year and 2.5% in 2023, based on data from the Croatian central bank, compared to the 10.2% rebound from the lockdown in 2021.

“The continuing uncertainties associated with the Russian-Ukrainian conflict could have an impact,” Argenio said. “The country is heavily dependent on Russian energy.

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Still, local banks have cushions to deal with the upheavals. The sector’s liquidity coverage ratios averaged 202.5% in 2021, according to the central bank. This exceeds an average of 173% in the fourth quarter of 2021 for banks supervised by the ECB. The ratio is calculated by dividing banks’ highly liquid assets by 30-day net cash flows.

Croatian banks also outperform their European peers in terms of profitability and costs. The overall return on equity was 8% in 2021 compared to a European average of 7.1%, according to data from Market Intelligence. Cost/income ratios were 59.4% versus 64.3%. This efficiency helped Croatian lenders increase profits for the whole sector by more than 70% last year to 5.7 billion kuna.

Lenders may now be able to build on these strengths, as euro membership reduces risk in the sector and in the wider national economy.

Croatia’s adoption of the euro “will reduce foreign exchange risks for the banking sector,” Moody’s said when upgrading the country last month. The move “will also have a positive impact on our assessment of government liquidity and external vulnerability risks.”

As of August 15, 1 dollar was equivalent to 7.37 Croatian kunas.

These P News article on Global Market Intelligence may contain credit information ratings issued by S&P Global Ratings. The descriptions in this news article were not preparationby S&P Global Ratings.