Slovak banks enjoy stable rating outlook, says Moody’s

The rating outlook for the Slovak banking sector remains stable, reflecting their focus on domestic retail and SME activities and healthy financial fundamentals, Moody’s Investors Service says in its new Banking System Outlook report for Slovakia. In addition, the banks’ local currency deposit ratings are underpinned by their foreign ownership and Moody’s assessment of the probability that the Slovak authorities would extend support in the event of need.

“Slovak banks are focusing on their domestic activities, and the retail and SME segments in particular, as they offer good growth prospects and wider margins than corporate lending. Although this should improve overall profitability and increase revenue diversification, it is resulting in fiercer competition,” said Gabriel Kadasi, a Moody’s Associate Analyst and author of the report.

Although there has been some evidence of banks relaxing their strict lending standards for SMEs, which has been traditionally a more risky segment due to lack of transparency and lower risk awareness, Moody’s believes the overall risk profile of the Slovak banks is improving, with progress in terms of credit risk management and declining non-performing loan ratios. However, credit risk remains the banking system’s main threat, as banks’ risk-management systems have yet to be tested through  an economic downturn.

“The Slovak banking sector benefits from ample liquidity thanks to their large deposit base and substantial securities portfolios, primarily consisting of Slovak government bonds,” Kadasi explained. Funding is mainly based on customer deposits, which still represent a dominant proportion of total funding at around 60% of total liabilities on average for the system and some 80% for the largest banks.

Pre-provision profitability of the sector remains good, with the shift towards SME and retail lending leading to higher net interest margins.

Although Slovakia‘s anticipated entry into the Eurozone in 2009 is likely to result in a decline of FX revenues and will lead to extraordinary costs related to the transition, the negative impact on profitability should, in Moody’s view, be mitigated to some extent by the banks’ increasing emphasis on non-interest income products and cross-selling efforts. Meanwhile, the continuing need for the banks to invest in modernising their branch networks, processes and IT systems means any future improvements in cost-to-income ratios are likely to be revenue-driven.

“Capital adequacy ratios have been declining due to the shift the structure of the balance sheet and rapid asset growth. However, Slovak banks have a potential to increase their capitalisation through Tier 2 sources aided by their foreign parents, as most their capital is currently Tier 1,” said Kadasi.

The foreign owners of Slovak banks are, in general, western banks that are well established in Central and Eastern Europe (CEE), with extensive experience of the region, built up over the last few years.

Moody’s expects the banks’ strategic shareholders to provide their subsidiaries with not only expertise and knowledge transfer, but also financial support in the event of need. The Slovak banking sector has undergone wide-ranging restructuring since its privatisation started in the late 1990s and the presence of major foreign banks should continue to strengthen the sector in terms of stability, strategies, risk management, quality of service and client focus, product expertise and technological expertise.