Crisis in eurozone could mean pricier mortgages here

IT SEEMS that barely a leaf can fall on world markets, without an army of Slovak market watchers, central bank analysts and media commentators pondering the slightest impact it might have on Slovakia.

IT SEEMS that barely a leaf can fall on world markets, without an army of Slovak market watchers, central bank analysts and media commentators pondering the slightest impact it might have on Slovakia.

While the North American, British and eurozone financial markets continue to suffer from a lack of liquidity, there is still plenty of cash in the Slovak market, with over Sk300 billion deposited by commercial banks at the central bank, analysts say.

However, the market is not immune and with the country’s approaching entry to the eurozone, scheduled for January 1, 2009, the situation might change.

Banks in Slovakia admit that the price of borrowing is likely to grow, especially for clients with variable-rate loans and, in the medium-term, for those with short-term fixed rates.

The Slovak Bank Association has already said that mortgage loans will become more expensive and that the willingness of banks to finance the entire purchase price of real estate through a mortgage will also decrease, according to the SITA newswire.

One of the main effects of the financial crisis on foreign banks has been to restrict their access to credit; an increasing lack of confidence among them has meant that they have been charging ever-greater premiums when lending to each other, if they are willing to lend at all.

The options for banks which are experiencing a lack of liquidity are either to borrow money from the central bank or from other banks on the market, Poštová Banka analyst Zuzana Holeščáková told The Slovak Spectator. By cutting their interest rates, central banks have made the loans that commercial banks can take from them cheaper, she added.

To ease some of the global monetary woes, first, the European Central Bank reduced the minimum bid rate on the main refinancing operations of the euro system by 50 basis points to 3.75 percent on October 8. The interest rate on the marginal lending facility was thus reduced by 50 basis points to 4.75 percent and the interest rate on the deposit facility was reduced by 50 basis points to 2.75 percent.

Then, on 9 October, the ECB reduced the corridor of standing facilities from 200 basis points to 100 basis points around the interest rate on the main refinancing operation. Therefore, as of 9 October, the rate of the marginal lending facility was reduced from 100 to 50 basis points above the interest rate on the main refinancing operation, i.e. currently to 4.25 percent, and the rate of the deposit facility will be increased from 100 to 50 basis points below the interest rate on the main refinancing operation, i.e. currently to 3.25 percent.

In Slovakia, the situation is different: since Slovak banks are not experiencing liquidity problems they are still continuing to deposit money (through sterilization repo tenders) with the central bank.

“The National Bank of Slovakia in reality does not have a reason to cut interest rates,” Holeščáková told The Slovak Spectator. “It would reduce the revenues of the banks from [sterilization] repo tenders. With the help of higher interest rates, the [central] bank can continue for a certain time to have a positive impact on [inflation], which is one of the global problems to have reached Slovakia.”

According to Holeščáková, another reason why the central bank does not have reason to cut rates quickly is that in Slovakia the market interest rates that the banks use for lending money to each other have for some time been lower than European market rates, which are at around 5 percent.

Despite the fact that the situation in Slovakia does not demand a rate cut, the NBS will have to harmonise its rates with those of the European Central Bank by the end of the year as part of Slovakia’s entry to the eurozone, Holeščáková added.

Vladimír Dohnal, director of Symsite Research, agrees that there is a surplus of liquidity in the Slovak money market and that banks have over Sk300 billion on deposit with the central bank.

“In the eurozone the opposite is the case, with banks borrowing from their central banks. So it is a different situation,” Dohnal told The Slovak Spectator.

Ľubomír Krošňák, an analyst with UniCredit Bank, said that Slovakia’s impending membership of the eurozone as well as the change to the conditions in the domestic market will mean Slovakia’s surplus liquidity will be dispersed in the eurozone market; and considering the small size of the Slovak market this will have a negligible impact on liquidity in the eurozone, but will push domestic interest rates up.

The effect of the inter-bank market

Interest rates on the inter-bank market in the eurozone are rising because of the lack of liquidity there, Dohnal said.

“Normally, these rates should stand slightly above the key central bank interest rates, but in the current environment of uncertainty and lack of liquidity the banks are charging much higher risk margins than normal,” Dohnal told The Slovak Spectator.

According to Dohnal, the banks are not enthusiastic about lending money to each other since they cannot be sure that the other banks will not go bankrupt and default on the loaned money.
Krošňák agrees that the interest rates on the inter-bank market in the eurozone are significantly above the level of the key interest rates.

“This development is influenced mostly by the prevailing distrust between institutions in the market and the long-term liquidity shortage in the eurozone market,” Krošňák told The Slovak Spectator.

As for the effect that these developments might have on the price of loans in Slovakia, market watchers say that if the crisis does not abate they will climb.

“After Slovakia’s entry to the eurozone the country will take on the interest rates of both the [European] central bank and also the inter-bank,” Dohnal said. “If problems with liquidity are not solved by then – and obviously they won’t be - the rates on the money market for Slovak banks will be 0.5 to 1 percentage point higher than they are now.”

Impact on Slovak clients

For Slovak clients, Dohnal said, this would mean an immediate increase in mortgage interest rates, by the same 0.5 to 1 percentage point, but most probably not higher interest rates for deposits or consumer loans. Krošňák said that a mild increase in inter-bank rates might emerge even before the end of the year considering how close Slovakia is to joining the eurozone, despite the fact that the Slovak money market is still functioning and the Slovak banking sector has long-term liquidity.

Krošňák too said that the rise in interest rates on the inter-bank market will be reflected in a rise in the rates charged to clients.

However he also says that the trend is reversible once the market calms.

“Next year, after at least a partial calming of the turbulence on the markets and after the expected dramatic cut in key interest rates in the eurozone, we assume that the upward trend in rates will be reversed and that clients’ rates will start dropping,” said Krošňák.

The upward trend will be immediately reflected in the rates charged on variable-rate loans and, thereafter, on loans whose rates are fixed only for a short period, for example one year, said Krošňák.

“These loans are the ones that reflect the development of interest rates on the inter-bank market and considering the frequent movements on the market they get reflected relatively quickly in the terms of the rate that the client pays,” Krošňák explained.

However, analysts agree that banks will become more cautious when evaluating the risks of lending money which, according to Krošňák, might be reflected either in more difficult-to-obtain loans or in mild increases in their cost to clients.

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