In recent months, the situation in our banking system has worsened considerably. All institutions responsible for the economic security silently allowed these fraudulent mega-transactions to materialize, therefore leading to the de-capitalization of these three systemic banks. The weakening economy, along with the inefficient activity of the state institutions will affect the banking assets’ quality and generate new challenges for the banking sector. Also, exchange rate volatility and low confidence in public authorities and banks pose a risk to the financial stability of the entire banking sector.
Key trends in banking sector
The banking sector was disturbed by a series of dubious “mega-transactions” at the end of 2014. As a result, three involved banks have been drawn into a critical situation. During 2014, Banca de Economii, Banca Sociala and Unibank have significantly increased their balances on investments abroad. Thus, in Oct:14 the three banks held external investments of about MDL 9.4 billion, which represented 63.9% of the outstanding debts of foreign banks to financial institutions in Moldova. In Nov:14, the three banks withdrew their overseas investments (at least such operations have been reflected in the banks’ activity reports). Also, in Nov:14 Banca de Economii obtained funds from the interbank market and reallocated resources amounting approximately 11.1 billion MDL to Banca Sociala. Based on the information on banks’ economic and financial activity, it may be presumed that the amount offered by Banca de Economii was covered by the money withdrawn from abroad. Based on the same sources of information, it may be stated that the following operations were performed at the Banca Sociala: it withdrew its investments from abroad, received funds from Banca de Economii, and used these sources in a suspicious way. The suspicious use of the funds has been reflected in the accounting records of Banca Sociala as an excessive “thickening” of about 17.8 billion MDL in the category of “other assets”. Additionally, Unibank has also granted a transfer of funds in favour of Banca Sociala.
As a result of dubious transactions in the banking sector, a large capital gap has been created. Thus, whereas the minimum limit for principle 2 on current liquidity is 20%, in Feb:15 this indicator was much lower in all 3 banks: Banca de Economii (-3.6%), Banca Sociala (-69.2%) and Unibank (8.2%). At the same time, due to the enormous volume of toxic assets held by the 3 problematic banks, these financial institutions did not meet the criteria concerning the risk weighted capital adequacy, which is regulated to a minimum of 16%. By the end of February, the three banks had the following capital adequacy ratios: Banca de Economii (2.4%), Banca Sociala (2.9%) and Unibank (15.8%). The alarming situation at these banks motivated the NBM to establish a special administration over these institutions. Additionally, the operations performed by the three banks, along with other factors, such as decrease of exports and remittances and depreciation of the Russian ruble, have fuelled the depreciation of the MDL.
As a result of the suspicious transactions from the banking sector, large amounts of foreign currency have “vanished”. This fact is also supported by the foreign currency interventions made directly by NBM in favour of the 3 banks, operations that have been performed during Dec:14-Feb:15. Thus, the NBM performed special interventions by selling foreign currency to the Banca de Economii, Unibank and Banca Sociala in Dec:14 (USD 221 million, of which USD 167.1 million were designated to close the previously opened foreign currency swaps), in Jan:15 (USD 4.1 million) and in Feb:15 (USD 6.8 million).
National currency depreciation has caused a redistribution of deposits in favour of foreign currency deposits. During Dec:13-Feb:15, the depreciation of MDL led to increased foreign currency deposits, while the balance of deposits in MDL has decreased. In order to protect from the purchasing power downturn caused by the depreciation of the national currency, the population and economic agents have oriented their savings to foreign currency deposits. Thus, the decrease of MDL deposits was due to withdrawals made by the population and legal entities (excluding banks). At the same time, the balance of deposits in foreign currency increased continuously for all categories of depositors.
Monetary policy tightening, that started in Dec:14, caused the growth of interest rates. The increasing rates of monetary policy instruments influenced the rising costs for loans in MDL. The interest rates on deposits grew faster compared to the rising costs of credit. Thus, in Feb:15 compared to Nov:14, interest rates on deposits in MDL increased by 3.2 p.p., while bank rates for loans in MDL increased by 2.1 p.p. The faster growth of deposit interest rates could have also been influenced by the banks intention to increase liquidity in MDL. In this context, while striving to make placements of household savings in MDL more attractive, banks increased interest rates on deposits. On the other hand, increasing foreign exchange resources allowed banks to decrease interest rates associated to deposits and loans in foreign currency. In Feb:15 compared to Nov:14, interest rates on currency deposits decreased by 1 p.p., while rates on foreign currency loans decreased by about 0.9 p.p.
In the context of economic uncertainty, increasing rates of monetary policy and the decrease of banks' activity under special administration, the banks’ lending activity has decreased. After the „anomalous explosion” of loan granting as of Nov:14, within Dec:14-Febr:15, the volume of new bank loans decreased by 16.2% y-o-y, although this decrease has slowed down: in Nov:14 the slump was of -40,9% y-o-y, while in Feb:15 it was of -5.6% y-o-y. Decreases were recorded for both loans granted in MDL and foreign currency. One factor behind this development was the monetary policy tightening that led to more expensive bank loans, which consequently made the population and economic agents be reluctant to access loans. Additionally, the significant depreciation of MDL also generated increased costs related to servicing the loans in foreign currency. In these circumstances, companies are more reluctant to take foreign currency loans and attempt to identify other solutions to finance their economic activities. Also, given the worsening economic perspectives, banks became more cautious in granting loans. Another obvious factor is the reduction in the lending activity of the three banks placed under special administration.
The worsening trend of the loan quality portfolio was resumed from Dec:14. The worsening of the loan portfolio is specific to the entire banking sector. Although this development is more critical for the three problematic banks: Banca de Economii, Banca Sociala and Unibank, the rest of the banking sector also registered an increase of the amount calculated for loss in assets and conditional commitments. Thus, in Feb:15 the amount calculated for loss in assets and conditional commitments decreased by 19.8% y-o-y for the entire banking sector, and, if to exclude the 3 problematic banks, the decrease was of 6.3% y-o-y. The deterioration of loan quality should be related to the worsening economic situation, which makes it more difficult to repay loans, but also to the tightening of monetary policy, which leads to restrictions in loan granting activity.
In the banking sector (excluding the three problematic banks) an accumulation of liquid assets is recorded. In the banking sector, except for Banca de Economii, Banca Sociala and Unibank, in Feb:15, the current liquidity level increased by about 3 p.p. y-o-y and then in Jan:14 the growth was of 3.4 p.p. This development is a result of the diminished volume of granted loans. Another cause of the increase in liquid assets is the fact that banks have significantly decreased the supply of liquidity by purchasing NBM Certificates, despite the fact that the increasing rates of monetary policy made this instrument more attractive.
Challenges and short term forecasts
The Increase in non-performing loans is an imminent risk to the banking sector. The worsening of economic perspectives for 2015 will reduce the revenues of households and firms and cause serious difficulties in loan repayment. On the other hand, MDL depreciation already generates additional costs upon payments for borrowers in foreign currency.
- A potentially stronger oscillation on the foreign exchange market along with the pessimistic expectations of the population could result into significant withdrawals of bank deposits. Such evolution could hamper the liquidity of banks, and this risk will remain persistent throughout 2015. However, the Moldovan banks, over the last years, have accumulated reserves of liquid assets, which could mitigate to certain extend the negative impact of funds withdrawals from bank deposits.
- Another issue is the population’s lack of confidence in public institutions. All institutions responsible for economic security have tacitly “green lighted” the fraudulent transactions in the financial sector. Lamentable performance of the state authorities caused drastic reduction of public confidence in these institutions. Additionally, permanent disruption of the financial sector also diminished public confidence in banks. The economic uncertainty and distrust in public authorities and financial institutions are prerequisites that may intensify certain harmful behaviour among the population. Thus, in the context of unfavourable financial oscillations, the population may be irritated by the messages delivered by representatives of public authorities and act in a manner opposite to the recommendations given by public officials.
- The public institutions responsible for ensuring the state’s economic security are also liable for the deteriorating situation in the banking sector. Generally, the actions undertaken by these institutions were limited to filing warnings to the governing bodies of the 3 banks on the risks related to the operated transactions, including discussions within the National Commission for Financial Security or the Security Council. The appointment of a special administration over the Banca de Economii, Banca Sociala and Unibank, granting loans to these banks or measures taken by the Parliamentary Committee were delayed actions which merely had the role to mitigate the consequences caused by the fraudulent transactions. Although the public authorities had all the necessary instruments at hand, the latter have not make use of them in order to counter the obscure operations. The Law on Financial Institutions expressly provides that the NBM may limit the bank's activities (Article 38, paragraph 1, item f)) and may restrict, suspend or prohibit certain transactions or operations (Article 38, paragraph 2, item 3 e) if the interests of depositors are jeopardized or if the bank is engaged in risky or suspicious operations. The Presidency and the Government could use the platform of the Security Council or of the National Commission for Financial Security in order to raise the involvement of other institutions such as the Prosecutor's Office or the National Anti-corruption Centre to counter the transactions. In turn, the Prosecutor's Office or the National Anti-corruption Centre could commence serious investigations on their own on the suspicious transactions made by the 3 banks. The Parliament could have had a decisive role, being entitled to remove the inefficient leaders from the public authorities and use legislative tools in order to combat the obscure operations.
- Whichever solution shall be taken for the 3 banks: rescue or bankruptcy - a huge capital injection will be needed. Upon choice of the rescue option, recapitalization funds and supply of liquidity to the troubled banks will be needed, whereas if opting for liquidation of the banks, monetary resources will be necessary to repay the amounts deposited. It is possible that the solution of liquidating the banks might be much more expensive, as it may result in numerous undesired consequences. Liquidation of a bank might alarm the population, which could wrongly predict a collapse of the entire financial sector and would soar to a massive withdrawal of deposits. This would lead to a sharp drop in the amount of cash held by banks and to additional financing of the financial institutions by the NBM. It is possible that the final solution could be a combination of both rescue and liquidation measures. And in this context, in order to mitigate risks, the bank which has the lowest social importance should be liquidated.
- It is absolutely necessary to ensure a stable development of the foreign exchange market, without causing large volatility. To have the required amount of resources that would allow the market stabilization, the NBM should urgently identify sources to increase the foreign exchange reserves. One solution at this end is an immediate negotiation and signing of a new agreement with the IMF. At the same time, the status of the banking sector could become the “apple of discord” in the negotiations. Certainly, the IMF will insist on this point: the Moldavian side will be required to offer real guarantees on sector rehabilitation and detailed information on the suspicious transactions. On the other hand, political-oligarchic groups do not wish any disclosure of information about their interests in the financial sector and their possible involvement in certain suspicious transactions. In these circumstances the discretion of the Moldovan negotiators will be stimulated, and this will affect the dialogue with the IMF.
- It is absolutely necessary to change the approach on financial sector supervision and increase the efficiency of investigating the shadow transactions from the banking system. It takes a responsible and severe attitude on behalf of the relevant public authorities towards the banks that ventured into suspicious transactions and the individuals who performed or were accomplices in fraudulent operations. Currently some success in this regard may be achieved only under pressure from development partners, particularly the IMF and the EU.