CEE banking sectors over-liquid, could support demand for bonds

Extra liquidity could be used to buy mostly shorter-dated government bonds

‘How much extra liquidity is there in the banking system?'

Croatia: The Croatian banking system remains highly liquid in both LCY and FX terms. LCY liquidity remains boosted by the lax monetary policy stance, but also by the shifting preference towards sight deposits (favoring LCY funding vs. traditional EUR term deposits). In the recent period, excess liquidity has been in the 3-4% of GDP band, while banks are running a positive NFA position at around 5% of GDP, suggesting a buffer as far as FX liquidity is concerned. Liquidity positions indicate that banks are adequately positioned to support credit growth, while flows to the private sector should remain moderate. We hence see room to maneuver for banks to support sovereign funding both via the bond market and bilateral credit lines.

Czech Republic: The extra liquidity in the banking sector reached approx. CZK 1351bn (29% of GDP in 2016) at the end of 2016. Compared to the previous year, the excess liquidity increased by 47%, driven primarily by the central bank's interventions in the foreign exchange market to weaken the Czech koruna. The growing excess liquidity and relatively muted supply of Czech government bonds (besides other factors) account for the downward pressures on Czech government yields. Foreign investors have increased their holdings of Czech government bonds with maturity up to three years in expectation of currency appreciation after FX cap termination. In contrast, banks are rather reluctant to invest in bonds, due to their low yields, and would rather deposit their funds at the central bank.

Hungary: Due to the complete overhaul of the Hungarian monetary framework, the amount of system-wide excess liquidity substantially decreased in the central bank's facilities. The primary 3-month deposit, which pays 0.9% interest, was capped at HUF 900bn in 4Q16 and the cap will be reduced to HUF 750bn in 1Q17 (roughly 2% of GDP). In addition, the MNB offers the so-called preferential deposit, which is capped at about HUF 390bn and pays the 0.9% key rate on the holdings. This facility held roughly HUF 350bn on average in the last 30 days. There is only one deposit facility to which banks have unlimited access, the O/N depo; however, it offers a -0.05% interest rate. In net terms (subtracting the O/N collateralized loans out of the O/N depos), the banking system held roughly HUF 350bn in the O/N facility over the last 30 days, on average. In comparison, the MNB's deposits held roughly HUF 4000bn in early 2016 before the complete phase-out of the 2W deposit and the quantitative limitation of the 3M deposit. We note that a substantial amount, HUF 1810bn worth of liquidity, flew into HGBs, due to the MNB's Self-Financing Program between mid-2014 and mid-2016, which is locked into the banks' balance sheets by the IRSs.

Poland: The excess liquidity of the banking sector amounts to roughly PLN 125bn (as of November 2016), around 7% of GDP. The liquidity position of the banks has not changed in comparison to last year. As Poland is facing an outflow of foreign investors holding Treasury securities (they have reduced their holdings by PLN 18.6bn since the beginning of the year), extra liquidity in the banking sector allows banks to maintain high demand for Polish papers. On top of that, legislation on the banking tax incentivizes the banks to hold government papers. Not surprisingly, the share of banks holding Treasury papers has been increasing lately.

Romania: Extra liquidity in the Romanian banking sector defined as deposits placed by commercial banks with the NBR is estimated at RON 32bn in December 2016 (4.3% of GDP). If we exclude minimum reserves in RON and FX, extra liquidity was RON 4.5bn in December. Liquidity probably improved in January to around RON 14bn (excluding minimum reserves), due to a significant increase in the monthly budget deficit in December, coupled with modest bond issuance. We see this monthly increase in liquidity in January as temporary. Should liquidity conditions deteriorate in the market, the NBR could cut minimum reserves for RON and/or FX, but this is likely to alleviate the pressure only on the short end of the yield curve. The long end of the curve is linked to non-residents' holdings of FI instruments and remains sensitive to a sell-off triggered either by external developments, like a change in investor sentiment towards EMs, or local factors, like 2017 fiscal risks.

Serbia: The data and conclusions provided in the NBS report on the banking sector in Serbia indicate that, based on the basic liquidity indicators, the banking sector is characterized by considerable liquidity. A narrower look at the data on the excess liquidity in the NBS balance sheet also leads to similar conclusions, as the November 2016 figure (including both LCY and FX ) stood at a high RSD 106bn. As for the activity on the domestic bond market, we expect that local banks will continue to play an important role in T-note roll-over and have the potential to act as a 'buffer' in case of stronger withdrawals of foreign (mainly US-based) investors from local papers, amid a potential outburst of jitters on international markets during 2017.

Slovakia: The Slovak banking sector still has a sound liquidity position, with a gross L/D ratio of 96% as of November. However, loans have been outgrowing deposits for quite some time, which limits the space for Slovak banks to buy government bonds. Compared to a year ago, securities holdings of Slovak commercial banks, which mostly comprise Slovak government bonds, declined by EUR 600mn (4% y/y). The multi-year trend since 2010 also shows stability to a mild decline. However, demand for Slovak bonds is still affected by the ECB's continuing quantitative easing program.

Slovenia: The liquidity position of Slovenian banks remains ample and supported by a decreasing LTD ratio and still fairly weak demand for credit from the private sector. Banks' exposure to sovereign debt in the recent period has overall exhibited a steady pattern, also likely shaped by the low yield environment. This is the pattern that is likely to prevail going forward. However, clearly the liquidity buffer remains adequate to support strong demand from both the private and public sides.

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