"In view of the international financial crisis and the economic slowdown in Austria and Central and Eastern Europe, the Austrian financial system is facing serious challenges," Andreas Ittner, Governing Board Member of the Oesterreichische Nationalbank (OeNB), said on the occasion of the presentation of the 16th issue of the OeNB’s Financial Stability Report in Vienna on Monday. The anticipated significant rise in loan loss provisions, which had been at a historical low, as well as increased capital requirements in the markets compel the major Austrian banks to strengthen their capital positions. “Thanks to the comprehensive set of measures launched by the Austrian government and the fact that Austrian banks employ a business model that relies on a broad basis of deposits, Austrian banks will, however, continue to be able to support the economy by maintaining lending to businesses,” Ittner pointed out.
Financial Turbulence Triggers Slowdown in Growth
Since the beginning of 2008, sustained financial turmoil worldwide has led to a gradual downward revision of the economic outlook for both industrialized countries and emerging market economies. Similarly, the growth outlook for the economies of Central, Eastern and Southeastern Europe (CESEE) has deteriorated notably although forecasts for the CESEE countries mostly still exceed those for the euro area by a wide margin. In some countries of the region, high external imbalances and the significant role of foreign currency loans increased interest rate and exchange rate risks, which have already materialized in part.
In response to the intensification of the financial turmoil, a number of countries, including Austria, have put together packages to strengthen both the liquidity and capital base of their banking sectors. These measures aimed at increasing confidence among financial market participants and ensuring the availability of loans to strengthen demand in the real economy, Ittner said. In fact, they helped alleviate to some extent the crisis of confidence in stock, bond and interbank markets.
Deteriorating Financing Conditions for Austrian Economy
The growth prospects for the Austrian economy have continued to worsen. While corporate profits remained healthy until mid-2008, financing conditions for businesses deteriorated in the course of the year. At the same time, external corporate financing started to be affected by the turbulence in the financial markets. Financing through quoted shares almost dried up, and growth in bond-based financing slowed from a high level. Loan growth remained buoyant until the third quarter of 2008, but the figures for October already reflected first signs of weakening.
The household sector also felt the impact of the international financial turbulence, facing, in particular, valuation losses in capital market products. In the first three quarters of 2008, households shifted their financial assets from capital market instruments to bank deposits. The continued volatility in foreign exchange and capital markets confirms the critical stance maintained by the Austrian Financial Market Authority (FMA) and the OeNB toward foreign currency loans; the increased volatility of the Swiss franc against the euro and the valuation losses in repayment vehicles clearly highlight the risk potential of foreign currency loans.
Indirect Effects of Financial Turmoil Hit Austrian Banks
While the Austrian financial sector was relatively mildly hit by the direct effects of the turmoil stemming from the U.S. subprime market, it cannot escape the impact of its worldwide repercussions. Earnings are down for the first time after years of growing profits, mainly due to a negative trading result and a sharp decline in fee income in the first three quarters of 2008. All in all, however, banks expect to still post comparatively high profits for the whole of 2008.
Austrian banks have so far been able to avoid a sharper deterioration in profitability not least thanks to continued strong business in CESEE. In view of significant external imbalances in some countries of the region, however, the further increase in the importance of CESEE business represents also a risk that should not be over looked as regards the future profitability of banks active in this region.
In light of the marked deterioration in the business environment over the past few months, trading and fee income must be expected to decrease further and loan loss provisions are set to rise. Since the latter are at historical lows in both Austria and CESEE, a notable and longer-lasting increase should be assumed. “Maintaining bank profitability will become more and more difficult in the months to come,” Ittner concluded, “therefore it is crucial to take capital-strengthening action in time.”