Banks’ exposure to poor loans clouds upbeat assessment of Czech financial sector

The doctrine of infallibility is certainly not one which applies to Czech banks. In spite of the painful lessons from the recent past, poor loans represent a persistent and growing problem with the central bank expressing its concern.

Photo: Barbora Němcová

Italian banking houses made fortunes in the Middle Ages by lending at high premiums to European kings and nobles as they financed expensive wars against each other. Two large banking houses collapsed largely as a result of English kind Edward III deciding he had enough of the huge repayments and announcing a default on his sizeable debts.

In spite of that lesson about the risks of loans to sovereigns, the Italians were at it again and pouring more money into the poor risk Plantagenet line a few generations on. And when Edward IV decided to limit his debt repayments to the Medici bank in Florence, it almost caused its downfall as well.

The idea that individuals and institutions learn from their own and others’ mistakes is a commonly held fallacy which persists in spite of fact that mistakes do not seem to be on the path to extinction.

Czech banks, like their illustrious Italian forefathers, appear to amply testify to the fact that mistakes are a repeat rather than a one –off phenomenon. One of the main takeaways from the latest report by the Czech National Bank on the local financial sector’s health is the fact that local banks continue to make bad loans in spite of the lessons which should have been learnt when many of these turned sour in the long lasting recent recession.

The central bank warned on Tuesday that the potential risk to banks from their loans portfolio has actually increased due to the latest profile of their non-performing loans. It warned in addition that banks’ provisions for poor or bad loans were almost unchanged in spite of the increased exposure.

Figures from the bank show that the proportion of bad loans put into the worst case loss-making category has increased consistently over the last four years to just under 60 percent of the total. This compares with 47.4 percent in 2010.

What’s more, banks have an increasing tendency to prolong the problem loans for more than three months rather than stopping them dead in their tracks once worries have been raised. The proportion of problem loans extended for more than three months climbed to 51.5 percent in 2013 from 38.5 percent three years earlier.

Czech business daily Hospodářské Noviny reported on Wednesday that Czech banks are burdened with 122.5 billion in bad loans. This amounts to 5.48 percent of their total loan portfolio. This compared with 3.52 percent in 2007.

Local banks’ ability to generate fresh bad loans is a matter for concern but not for alarm. Another facet of the Czech economic landscape that might cause problems is the high exposure of local banks to government bonds. That could conceivable be a problem if the current low bond yields caused investors to desert the sector and spark a liquidity crisis.

But the overall message of the Czech National Bank report is that the financial sector is in largely robust health and is not at great risk even from a sharp economic downturn.

Positive signals include that general economic upturn which means that both companies and individuals are less likely to get into economic difficulties and default on their loans. House prices are climbing mildly with no danger of a real estate ‘bubble’ and most of the home loans, around two-third, taken out by Czechs are for less than 80 percent of the value of the property so there is little risk to banks that they will not get their money back in case of default.