The banking system is the solution to Romanian economy’s recovery from the upcoming recession. Under the impact of the COVID-19 pandemic, Romania’s economic recovery could have a “V” shape, with declining production and investment, temporary stagnation of business, the phase of temporary decline in economic activity, followed by a rapid recovery, or there could be a U-shaped recovery, with the extension of the stagnation period.
The COVID-19 pandemic has created additional challenges with unprecedented economic and social consequences globally. The effects of the pandemic could push the world economy into the biggest recession since the Great Depression. Before this health crisis, the world economy was expected to grow, but now it is estimated to decline by 4-5%. Globally, the closure of non-essential activities produces a monthly loss estimated by experts at 3-4% of GDP. The magnitude of the impact on the economy depends on the duration of the health crisis. In addition to the effects of the pandemic, we are going through a period of transformations and challenges at international level, generated by Brexit, the rise of populism and extremism, Basel IV, and the erosion of investor confidence. Romania must be careful not to internalize these problems through the measures it adopts, given that Romania has the highest level of twin deficits in the European Union.
Romania cannot eliminate the effects of the COVID-19 pandemic in the economy, but it can mitigate them and it could prevent a financial crisis by eliminating the legislative risk in the banking sector.
The effect of contagion is inevitable. The financial system is the heart of the economy. If the heart pumps properly, the flow of much-needed funding is ensured during the nearing recession. The circulation of capital is essential. Capital flows between economic sectors slow down in a crisis. Any deviation only delays economic recovery.
Now, the banking system is the solution to economic recovery, and dialogue is the key. There is an urgent need for sound economic thinking and balanced initiatives and measures.
The banking system in Romania is better prepared for the coming economic crisis, compared to 2008-2009, but there are a number of exogenous and potentially endogenous risks. Solvency and liquidity indicators are well above the minimum required levels under national and international regulations. The solvency ratio stood at 20% at the end of last year, while the immediate liquidity level was 41%. Even the non-performing exposure rate fell very close to the European average, standing at 3.98% in February 2020. The positive aspect is that some of these risks can be avoided and, thus, the banking system remains strong and capable to cover the financing needs of the economy. The challenges to financial stability lie in a mix of risks amplified by the COVID-19 pandemic. On the one hand, there are heightened legislative risks in the context of an election year, and, on the other hand, macroeconomic tensions, aspects that are followed with interest by the rating agencies.
The exogenous risks lie in the unpredictable legislative framework that also affects lending. Currently, there are at least eight laws/ bills that can irreparably affect the activity in the banking industry. With such legislative initiatives, Romania is taking steps back in the process of economic development.
Depriving credit institutions of a large chunk of revenues resulting from lending operations, including repossessed properties, under a law to be analyzed by the Romanian Constitutional Court, could have a negative impact on lending. Moreover, the need for more provisions for the incident portfolio is likely to seriously affect lending in Romania. Let’s not forget that Romania has the lowest degree of financial intermediation (25%) among European Union states (83% average). Access to loans also shows disparities at national level. In Bucharest, about 65% of adults have loans, compared to the national average of 36%.
Because of these legislative initiatives, lending activities may be affected both on the supply and demand side, with the latter hopefully affected for a short while. The balance of non-government loans increased by 6.9% annually in March, compared to March 2019, and by 0.6%, compared to February. It is a relatively normal increase in lending, but there is a slowing down trend. We will probably see the effects of the crisis on lending reflected in statistics starting April. Banks will focus on financing companies to ensure a speedy recovery of the economy. In this segment, a potential risk can be generated by insolvencies, as commercial loans are prevalent in Romania, with a 3:1 ratio compared to bank loans.
It is very likely that this health crisis will turn into a financial crisis. States are going to need funding to cover deficits.The economic stimulus solutions include financing. That is why it is advisable for the banking system to be a partner in this crisis. The banking system calls for a constructive partnership with the authorities to finance the restart of the economy’s engines in predictable conditions.
This is also available in our print edition of Business Arena.