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Views/ Managing Risk in CEE Finance Transactions
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Darko JovanovićAdvokat / Senior Partnerdarko.jovanovic@karanovicpartners.com
11/03/2014
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​This article, authored by Darko Jovanović is published in Freshfields Bruckhaus Deringer.

Regulatory update - Serbia

There are 30 banks in Serbia, of which six are state-owned (wholly or partially) and 21 foreign-owned. Banking assets in Serbia are 75 per cent owned by ultimately foreign banks, of which 71 per cent are owned by EU-based banking groups. The top 10 banks hold 73.2 per cent of assets while seven are foreign-owned one Russian, the rest EU/eurozone. In the past two years, three banks that were under ultimate state control lost their licences.

Key risks and mitigating measures

The Serbian banking sector is exposed to a number of risks which can be categorised into those of a foreign nature, and those that are domestic. The main foreign risks are that EU-based banks have been reducing their cross-border exposure, and that the prolonged negative effect of the economic crisis in the EU has reduced foreign direct investment. Another factor that must be reviewed, as it remains unclear, is whether the establishment of the European banking union presupposes a single regulatory mechanism or supervision.

The primary domestic risks are public debt, the foreign exchange market, non-performing loans and the bank-based financial system. Serbia's public debt has exceeded not only the ceiling defined by the Law on the Budget System 45 per cent of GDP, but also the limit above which a public debt crisis becomes possible 50 per cent of GDP, and the Maastricht limit of 60 per cent of GDP. A potential public debt crisis would also affect the stability of the financial system, despite relatively low exposure to government securities. The financial system is exposed to foreign credit exchange risk, while the volume of NPLs increases the banks' risk aversion, jeopardises the profitability of the banking sector and threatens to evolve into a systemic risk.

Another point to be addressed is the financial system in Serbia, which is almost entirely bank-centric. The banking sector makes up 92.6 per cent of total financial sector assets. Though faced with limited availability of foreign sources of finance, Serbia's banks are liquid and well-capitalised. However, as the economy rebounds and the demand for loans grows, a reduced loan supply may become an effective constraint on credit growth.

A strong fiscal adjustment in 2013-2015 wold be necessary to alleviate these issues and deal with both the internal and external risks facing the Serbian banking sector, but would not come about easily considering that higher public investment is also needed.

An important mitigating factor is Serbia's participation in the Vienna and Belgrade initiatives. The Belgrade Initiative is in effect a permanent channel of communication and co-operation with banking groups, regulators, home supervisors and working groups within the Vienna Initiative itself - as well as European and other international financial institutions such as IFIs - for the purposes of tackling the issue of NPLs and ensuring the support of IFIs and parent banks, developing the domestic capital market, monitoring the effects of application of Basel III standards and monitoring developments relating to the banking union, among other things.

The Vienna Initiative

Serbia is faced with two issues that are common to Europe's emerging courtiers, namely its high level of NPLs and high public debt. According to the National Bank of Serbia, as of June 2013 NPLs made up 19.9 per cent of total loans, which is the largest proportion in central, eastern and south-eastern Europe (CESEE) according to the IMF, October 2013. As per data announced by the Association of Serbian Banks, the level of NPLs in October 2013 reached 24.5 per cent. Serbia's public debt, according to official figures, was 58.1 per cent of GDP as of September 2012, and has subsequently moved closer to 70 per cent, the third largest in CESEE according to the IMF October 2013.

New regulations are being developed to tackle these issues. One, the Decision on Risk Management of Banks, provides for a new regime for sale of NPLs which presupposes greater involvement of the National Bank of Serbia and the imposition of higher prudential requirements from October 2013. Another takes the form of a set of stabilisation measures adopted by the government in October 2013, including sovereign debt restructuring based on cheaper bilateral loans e.g. the announced $3bn loan from UAE.

It should be said that even though the Serbian regulatory framework in respect of the sale of NPL portfolios has been relatively relaxed in recent times, it still remains rather rigid and stringent because retail loans may be transferred only to another locally licensed bank, and due and matured corporate loans may be transferred to another legal entity subject to the sending of a 30-day prior notice to the BBS and the delivery of certain supporting document and risk analysis.

Banking Union

As an EU candidate country, Serbia is not part of the banking union. However, most of its banks are subsidiaries of EU-based banks which would be subject to the Single Supervisory Mechanism tentatively 19 out of 30 operating banks, and eight of the top 10 by assets. Further deleveraging may be expected state aid requirements - KBC; sovereign debt restructuring - Greek banks, but it should be noted that a growing presence of banks owned by non-EU based banks might compensate deleveraging, meaning that financing South Stream the pipeline to transport Russian gas through the Black Sea to Europe will probably cause portfolios of Russian-owned banks to be increased, while UAE investments will probably be backed by incorporation of the UAE owned bank. Questions have also been raised relating to the expansion of the local syndication market. Specifically, due to strict provisioning and mandatory reserve requirements, local banks are actively contemplating syndication options. It is still too early to say whether this anticipated syndication of certain loans will lead to the development of a local secondary loan market, and while it is more likely that this will not happen the situation should be watched in the coming years.

Basel III

Basel III has not yet been implemented in Serbia although the implementation strategy was announced in 2012. It is questionable the extent to which the practical implications of Basel III will affect the Serbian market, given the amount of funding provided or committed to be provided by the IFIs EBRD, IFC, EIB and development finance institutions such as microfinance or structured trade and commodity finance.

Expectations and ways to progress (IMF recommendations)

A better restructuring framework could allow several improvements to be made. This could be done by further relaxing NPL transfers especially in respect to retail loans; pre-packing in bankruptcy procedures these have already been introduced; enhancing judicial and bailiffs' capacity, and especially the stalled out-of-court mortgage enforcement procedures.

The diversification of financing options should not be overlooked and may be performed by primarily developing local capital markets that at present do not really exist, improving and enhancing the issuing of corporate bonds and reviewing the options for the implementation of securitisation and financial derivatives structures.

Progress could also be made via domestic funding supported by IFI programmes, taking into consideration the fact that foreign sources of funding supported by IFI programmes, taking into consideration the fact that foreign sources of funding are scarce. Domestic funding sources could then be developed by strengthening domestic institutional investors - primarily insurance companies and voluntary pension funds.

Further bank consolidation is expected in medium term (three banks have lost their licences while the sale of Hypo, Cacanska and potentially more is expected in near future).

Lastly, institutionalised co-ordination of creditors and debtors is also important. Serbia has adopted voluntary financial restructuring legislation based on INSOL principles and the London approach (with basic principles of establishing rules governing voluntary work-outs; standstill; providing protection to new money collaterals; tax waivers, etc.) but has not yet seen this implemented in practice, inter alia, due to the specifics of the players active in the Serbian banking sector. 

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