Higher Capitalization of Banks Necessary to Strengthen Financial Stability

In 2014, European financial markets operated in an environment characterized by low interest rates and the expansive monetary policy pursued by the ECB in response to subdued inflation and weak economic activity. “The ECB stepped up its measures to improve the credit supply of European businesses in 2014, thus supporting the overall economy. Moreover, confidence in Europe’s banking sector has been strengthened with the creation of the European banking union, which became operational in early November, thus increasing financial stability,” Governor Ewald Nowotny said at the presentation of the 28th issue of the OeNB’s Financial Stability Report.

Given considerable uncertainties relating to the external environment and weak domestic demand, the Austrian economy clearly lost steam in 2014, causing a decrease in corporate profits in the first six months of 2014 as compared to the previous year. Corporate loan demand in Austria remained subdued, as investment activity was still weak and businesses continued to substantially rely on internal financing. Lending to households primarily took the form of housing loans in the first three quarters of 2014.

Real estate prices in Austria continued to rise in the first three quarters of 2014, but price increases have abated somewhat recently. On aggregate, property prices in Austria are still in line with economic fundamentals. The only exception is Vienna, where residential property remains overpriced judging from the OeNB’s fundamentals indicator for residential property prices.

In preparation of the banking union, Europe’s significant banks were subject to a comprehensive assessment carried out by the ECB in 2014. As expected, five of the six participating Austrian banks successfully passed this test and showed that they have sufficient capital, even under the severe stress scenario. The results of the comprehensive assessment were thus in line with the OeNB’s and the FMA’s expectations and confirmed the positive impact of measures Austrian banking supervisors have taken to strengthen financial stability. For instance, supervisory action prompted by OeNB analyses contributed to a decrease in the volume of Austrian households’ foreign currency loans by half over the past years, markedly improved the local funding situation of Austrian banks’ foreign subsidiaries and steadily raised the capitalization of the overall Austrian banking sector. These supervisory efforts need to be pursued further, in particular because, with an aggregate common equity tier I (CET1) ratio of 11.8% (mid-2014), the capitalization of Austria’s credit institutions remains below average in an international comparison. The OeNB’s Vice Governor Andreas Ittner emphasized: “In view of the phasing-in of the new Basel III capital requirements and the Austrian banking sector’s risk exposure in Central, Eastern and Southeastern Europe (CESEE), Austrian banks need to continue their efforts to strengthen their capital levels.”

The consolidated profitability of Austrian banks has remained under pressure in 2014. In the first half of the year, they posted an aggregate loss of EUR 0.6 billion, reflecting among other things losses by Hypo Alpe-Adria-Bank International AG and goodwill impairments suffered by other credit institutions. The structural weaknesses affecting Austrian banks’ earnings situation on the domestic market persisted. Moreover, higher credit risk provisions made necessary, inter alia, by the current geopolitical tensions, weighed on Austrian banks’ profits in CESEE. The latter still amounted to EUR 1 billion in mid-2014, but were concentrated in a few markets, such as the Czech Republic, Russia or Slovakia. The weak economic situation in Europe is also reflected in a deterioration of the Austrian banking sector’s credit quality, which is primarily driven by adverse developments in some CESEE countries.

To sustainably strengthen Austrian banks’ profitability and risk-bearing capacity, the Oesterreichische Nationalbank recommends that banks continue to improve their cost efficiency, proactively address credit risks and raise their capital levels.