Euroization is a common phenomenon in the Central, Eastern, and Southeastern European (CESEE) region. Hence, the global environment of low interest rates and the ensuing lower interest rate differentials between local and foreign currencies also have a notable impact on euroization. In this chapter, we will focus on this important aspect within the broader topic that the conference sketches. We present here empirical evidence from the Oesterreichische Nationalbank (OeNB) Euro Survey2 building on a number of research papers published by OeNB researchers on the topic of euroization in CESEE.
First, we will illustrate some facts sketching the extent of euroization in the CESEE region. Second, we will briefly reflect on how very low interest rates would, in general, impact households’ saving and borrowing decisions before we discuss more specifically the choice of currency for savings and borrowings. Third, we will look at the empirical evidence based on OeNB Euro Survey data, and finally we will draw some policy conclusions.
1. Euroization and Interest Rate Developments in Central, Eastern, and Southeastern Europe (CESEE)
Figure 1 depicts the asset euroization index for CESEE households.3 Asset euroization is defined as euro cash holdings (taken from the OeNB Euro Survey) and foreign currency deposits (from monetary statistics of central banks) in relation to total cash holdings, and total deposits in each economy. Asset euroization is not an issue in countries like the Czech Republic, Hungary, or Poland, where its level is low. In countries like Albania, Bosnia, Bulgaria, and Romania, and more recently in the Former Yugoslav Republic of Macedonia (FYR Macedonia), asset euroization is at a medium level. Yet, Croatia and, in particular, Serbia continuously show very high levels of euroization.4
High and persistent degree of asset euroization in CESEE
Sources: National central banks and OeNB Euro SurveyNote: Euroization index = (euro cash + foreign currency deposits) / (total cash + total deposits).High and persistent degree of asset euroization in CESEE
Sources: National central banks and OeNB Euro SurveyNote: Euroization index = (euro cash + foreign currency deposits) / (total cash + total deposits).High and persistent degree of asset euroization in CESEE
Sources: National central banks and OeNB Euro SurveyNote: Euroization index = (euro cash + foreign currency deposits) / (total cash + total deposits).It is a well-established fact that asset euroization in Southeastern Europe is a persistent phenomenon, even though we have been observing some decrease in countries like Bulgaria, Bosnia, and the FYR Macedonia. The question arises why households in Southeastern Europe still prefer to save in foreign currency, despite sustainable macroeconomic stabilization over the past decade.
Looking at the empirical evidence, deposit substitution is to a large extent demand driven (Brown and Stix, 2015; Zettelmeyer et al, 2010). We know from the OeNB Euro Survey that households have broad access to a wide range of saving products in domestic and foreign currencies, yet they choose to save primarily in foreign currency (Beckmann et al, 2013). Brown and Stix (2015) provide evidence that deposit euroization is strongly related to monetary expectations – whereby foreign currencies are considered to act as insurance against high exchange rate volatility and network effects. However, network effects can partly explain the observed degree of persistence. Furthermore, the authors show that monetary expectations are related to both individual experiences of past financial crises in the early 1990s as well as to respondents’ assessments of current policies and institutions. Surprisingly, there are no differences between age cohorts. Even young people who lack personal experience of the past crises in the 1990s seem to be convinced in their thinking that foreign exchange deposits are safer than domestic currency deposits.
Looking at the liability side of households, recent research concludes that both demand and supply factors play a role. Again, most borrowers have a choice between a local currency loan and a foreign currency loan. Main determinants of households’ demand for foreign currency loans are low interest rates, a lack of trust in the local currency, and high inflation or exchange rate volatility. (Crespo Cuaresma et al, 2011; Fidrmuc et al, 2013). Furthermore, expectations of euro introduction play a role in some countries as well as weak knowledge of the risk inherent in foreign exchange loans (Beckmann and Stix, 2015).
Turning to supply side explanations for high liability euroization, as mentioned before, the preference by households for foreign-currency deposits implies that banks are highly euroized on the liability side. Therefore, in order to avoid currency mismatch in their balance sheets, banks have an incentive to lend in foreign currency. Obviously, while a major source of foreign-currency funding for the banks are foreign-currency deposits of their custumers, foreign-owned banks will also have access to foreign-currency funding from their parent banks. On the other hand, Beckmann et al (2015) show that this factor was not the main driver of loan euroization, since lending practices between foreign-owned and domestically owned banks did not differ much, except in countries like Croatia andHungary.
Let us now turn to developments in interest rates before discussing the impact of low interest rates on euroization. We have observed a notable decline in interest rates over the past years.
The left panel in Figure 2 shows that interest rates declined strongly between 2012 and 2016. This holds true not only for euro deposits (to be read from the y-axis), but also for domestic currency deposits (x-axis). The green diamonds represent the situation at the beginning of 2012 and the red diamonds show interest rates at the end of 2016 for individual CESEE countries. Clearly, interest rates on euro deposits always remained below those for domestic currency deposits (that is, below the diagonal).
While the international interest rate environment certainly induced some spillovers leading to a decline in interest rates, the right panel in Figure 2 clearly shows that also the spread between foreign-currency and local-currency interest rates has decreased substantially. Hence,
also domestic developments must have played a role. Particularly in Serbia (green line), this trend is likely related to the successful macroeconomic stabilization in recent years. So, we observe for the CESEE region the impact of both policy spillovers from a low interest rate environment and a reduction in the spread leading to very low interest rates. Interest rates even turned negative in Bosnia and Bulgaria and became very low in Croatia, the FYR Macedonia, and Romania. They were slightly higher, but still low given the stage of economic development in countries like Albania and Serbia.
2. Impact of (Very) Low Interest Rates on Saving and Borrowing Decisions and Choice of Currency
Let us briefly recap from economic theory what outcome we would expect for saving decisions if interest rates were falling to (very) low levels. In general, as opportunity costs are reduced, cash hoarding will become more attractive. Yet, in this particular region, the preference for saving in cash is strongly related to mistrust in banks and weak institutions (Stix, 2013). Yet, against the backdrop of an observed increase of trust in banks in some Southeastern Europe countries, this may countervail the expected effect.
With respect to borrowing and lending decisions, the borrowing costs for households is certainly reduced. This should lead to an increase in lending or higher demand for new loans. Moreover, banks experience a compression in their interest margin, which would induce them to issue more loans in an attempt to substitute price for quantity. This change in business model was observed in Denmark, Sweden, and Switzerland during the recent years of ultra-low interest rates, when banks compensated for compressed interest rates via new lending and an increase in fees (Scheiber et al., 2016). Yet, in the Southeastern Europe region, some banks still deleveraged as a legacy from the crisis, which might give room to alternative forms of non-bank lending.5
For small open economies, especially in countries where the use of foreign currency is high – as in Southeastern Europe, on which we focus here – not only the level of domestic interest rate matters for savings and borrowing decisions, but also the spread between local and foreign currency. Hence, we will briefly review the impact of a compressed interest rate spread between local and foreign currency. The majority of households save in foreign currency in order to protect their purchasing power. A lower spread actually compresses the insurance premium; as a result it should become even more attractive to save in euro or in other foreign currencies. In contrast to this, some households may search for yield and may prefer the relatively higher remunerated local currency deposits. This would make saving in the local currency more attractive. Again, the net effect remains an empirical question, and we will present some empirical evidence in the next section.
Turning to the borrowing decision of households, it is clear that borrowing in foreign currency becomes relatively less attractive in an environment of low domestic interest rates, provided consumers are able to judge foreign currency risk correctly. Again banks could compensate for the decline in spread through an increase in the volume of lending. If for the reasons outlined before, foreign currency deposits of banks increase in the low interest rate environment, the increase in the volume of lending could be tilted toward foreign currency driven by their attempt to reduce the currency mismatch. To sum up, in the presence of low interest rates and a low spread between interest rates on local versus foreign currencies, demand for foreign currency deposits may well go up while at the same time foreign currency loans may become less attractive to households.
3. Empirical Evidence from the OeNb Euro Survey
The OeNB Euro Survey provides a good source of data to test most of the hypotheses outlined before. This survey is conducted among households in 10 CESEE countries, six EU member states (Bulgaria, the Czech Republic, Croatia, Hungary, Poland, Romania), and four non-EU countries (Albania, Bosnia and Herzegovina, the FYR Macedonia, Serbia). From 2007 to 2014, surveys were conducted twice a year; since 2015, the survey frequency was reduced to once a year (autumn). Using a standardized and hence comparable questionnaire across countries, the Euro Survey collects unique information about (euro) cash holdings, saving behavior, and debt, and looks into respondents’ economic opinions, expectations, and experiences. Samples consist of 1,000 randomly selected respondents per country and represent the population over 14 years. Samples are representative with respect to age, gender, and regional distribution. In the following, we will combine information from the OeNB Euro Survey with data from national central banks to obtain a comprehensive picture of the impact of low interest rates and a reduced interest rate spread on euroization.
Let us look at three major channels through which the impact of reduced interest rate spread would spill over in the region: via cash holdings, via deposits, and via loan demand.
Figure 3 shows both preferences and actual developments in real cash holdings per capita. Preferences for cash holdings and their evolution over time can be read from the left panel of the chart, while the right panel shows the actual behavior of households.
As a first result, we observe a high preference for savings in cash in Southeastern Europe. Even households with a savings account tend to agree with the statement that they would prefer to save in cash. Households’ cash preference is highly persistent and related to a number of factors such as weak institutions, tax evasion, lack of trust in banks, and network effects in the use of foreign currency cash (Stix, 2013). Against the backdrop of the low interest rate environment and the decrease in the interest rate spread, we can identify two countries, Bosnia and Romania, where preferences have increased notably, whereas cash preferences in the other five countries here seem to be unaffected by these developments.6
Turning to developments in actual cash holdings (right hand panel of Figure 3), we observe some increase in cash holdings in Bosnia, Bulgaria, Croatia, and Romania, and more or less unaffected levels in Albania, the FYR Macedonia, and Serbia.
Apart from the low interest rate environment, there might be other reasons for the observed increase in real cash holdings in some countries. Lacking hard facts, we can only point to some events that might possibly be related to this behavior. In Romania, cash holdings have increased since autumn 2016, which could be also related to the political protests during that time. In Bulgaria, the banking turmoil in 2015 could have undermined trust in banks. Both of these factors would point to a high sensitivity of households in the region with respect to any crisis, which in turn induces an increase in cash holdings.
Let us turn to the second channel. The evidence on the impact of low interest rate spreads on deposit substitution is rather mixed. As mentioned before, foreign currency deposits should increase in response to a decrease in the spread. However, the evidence presented in the left panel of Figure 4 shows that in almost all countries, the share of foreign currency deposits has declined at the same time as the interest rate spread declined. Only Albania, Croatia, and Romania exhibit the expected pattern.
A simple country-wise time series regression allows identifying some factors that correlate with the changing share of euro deposits in total deposits.7 Results indicate that the change in the spread had a significant effect on the decline in euro deposits in Croatia, the FYR Macedonia, and Serbia, but turned out insignificant for Albania and Romania. Hence, even when we control for some important variables, such as inflation, exchange rate developments, and exchange rate volatility, we find no evidence for the expected behavior in most of the countries except for Croatia. This is in line with the literature on euroization we presented before that deposit euroization in the region is driven by other factors and not strongly related to the interest rate differential or interest rate movements. For Serbia, these findings point in the direction that recent efforts of macroeconomic stabilization (which is the main driver of the observed compression of the spread) contribute to dinarization of household deposits.
The right-hand panel of Figure 4 shows that the preference for foreign currency deposits has actually decreased in Croatia and Serbia. In all other countries, it has remained relatively unchanged, except for Bosnia and Herzegovina, where the preference for euro deposits increased.
Finally, let us now discuss the last channel, the response of loan demand to low interest rate spreads. Based on the theoretically guided considerations above, we would expect an increase in loan demand to reduced interest rates. The left panel of Figure 5 reports the share of respondents who plan to take out a loan within the subsequent year for the years 2008 to 2016. After the global financial crisis, loan demand was depressed considerably for several years. More recently, loan demand re-emerged in Albania, Bosnia and Herzegovina, Bulgaria, Croatia, and Romania. We would expect this loan demand to be tilted, in theory, toward local currency loans given the reduction in interest rate spread and a correct perception of exchange rate risk. Surprisingly though, the right panel of Figure 5 reveals that among those respondents who plan to take out a loan, the share of households planning to take out a foreign currency loan is on the rise as well. Again, region-specific factors are driving this result.
From a policy perspective, it is worthwhile to investigate in more detail this surprising, and not necessarily desired, behavior. Beckmann (2017) presents evidence that recent debt relief measures for borrowers in CESEE countries have increased expectations of future government interventions (Figure 6). Interestingly, expectations of government bailout do not influence loan demand as such, but they increase the demand for foreign currency loans. These results are robust to controlling for knowledge of exchange rate risk and expectations about exchange rate developments and they hold throughout the region. While debt relief measures were of particular importance in countries like Croatia, Hungary, and Poland and less so in Southeastern European countries, the econometric evidence from this study shows more generally that debt relief for borrowers influences expectations so that people expect future bailouts. This leads them to underrate exchange rate risk even though they are aware of such risk. As a result, demand for foreign-currency loans may soar again. Hence, any such measure should be accompanied on the macro-prudential level with measures that would simultaneously rein in the demand for foreign currency loans, such as regulation prohibiting issuance of new foreign currency loans to households. Otherwise, well-intended policies targeted at relieving the debt burden of foreign currency borrowers may in the medium- to long-term lead to a re-emergence of foreign currency borrowing rather than the desired decline.
Impact of foreign currency debt relief measures on loan demand
Source: Beckmann (2017) using OeNB Euro Survey, fall 2015.Note: Abbreviations represent the two-digit ISO country code.Impact of foreign currency debt relief measures on loan demand
Source: Beckmann (2017) using OeNB Euro Survey, fall 2015.Note: Abbreviations represent the two-digit ISO country code.Impact of foreign currency debt relief measures on loan demand
Source: Beckmann (2017) using OeNB Euro Survey, fall 2015.Note: Abbreviations represent the two-digit ISO country code.At the same time, however, banks will also react and most likely lower their supply of foreign currency loans, as they have to shoulder the cost of the bailout. Similarly, the interest rate on foreign currency loans may increase.
4. Policy Implications
In this section, we reviewed descriptive and econometric evidence on the relationship between low interest rates, compressed interest rate spreads, and saving and borrowing decisions of households in CESEE countries in the recent era of very low interest rates. We have drawn on data from the OeNB Euro Survey as well as on a wide range of recently published articles based on this data and complemented the picture by statistics from national central banks, with a focus on Southeastern Europe.
We have found that a compressed interest rate spread fosters deposit euroization. In order to address this, measures such as reserve requirements, taxes, and the like should be taken to raise the “insurance premium” for foreign currency savings. Yet, policymakers in the region have to be aware that the alternative for households in their countries may not be to move to local currency deposits but to increase their euro cash holdings. Hence, a comprehensive policy mix has to accommodate all these potential reactions.
The evidence also shows that compressed interest rate spreads increases both supply and demand for foreign currency loans. Addressing the associated re-emergence of risks to financial stability requires both macro-prudential measures and micro-prudential supervision of lending practices. Furthermore, policymakers need to raise borrowers’ awareness of foreign currency risks. In addition to stepped-up communication efforts, there is clearly a need to regulate foreign currency lending so that only hedged borrowers or unhedged borrowers with sufficient risk-bearing capacity can borrow in foreign currency. Complementary tools, such as higher provisions for foreign currency loans, can be considered, too.
Finally, a particularly characterizing feature of the Southeastern European region is the high level of cash holdings. Evidence from the OeNB Euro Survey suggests that knowledge about the existence of deposit insurance schemes is still rather limited in the region. Sometimes more than 50 percent of respondents were not aware of a deposit insurance scheme in their country, even though it existed. This suggests that there is still ample scope to build trust in the local banking sector. Of course, building trust is a long-term project. Yet, a lack of trust seems to be the crucial point driving euroization in the region. Hence, fostering trust in the institutions and a comprehensive policy mix of macro- and micro-prudential measures help to maintaining financial stability and to reduce euroization.
References
Beckmann, E., M. Hake, and J. Urvova. 2013. “Determinants of Households’ Savings in CESEE.” Focus on European Economic Integration Q3/13, Oesterreichische Nationalbank, 8–26.
Beckmann, E., A. Roitner, and H. Stix. 2015. “A Local or a Foreign Currency Loan? Evidence on the Role of Loan Characteristics, Preferences of Households and the Effect of Foreign Banks.” Focus on European Economic Integration Q1/15, Oesterreichische Nationalbank, 24–48.
Beckmann, E, and H. Stix. 2015. “Foreign Currency Borrowing and Knowledge About Exchange Rate Risk.” Journal of Economic Behavior & Organization 112, 1–16.
Beckmann, E. 2017. “How does foreign currency debt relief affect households’ loan demand? Evidence from the OeNB Euro Survey in CESEE.” Focus on European Economic Integration Q1/17, Oesterreichische Nationalbank, 8–29.
Brown, M., and H. Stix. 2015. “The Euroization of Bank Deposits in Eastern Europe.” Economic Policy 30(81), 95–139.
Crespo Cuaresma, J., J. Fidrmuc, and M. Hake. 2011. “Determinants of foreign currency loans in CESEE: A Meta-Analysis.” Focus on European Economic Integration Q4/14, Oesterreichische Nationalbank, 69–87.
Fidrmuc, J., M. Hake, and H. Stix. 2013. “Households’ Foreign Currency Borrowing in Central and Eastern Europe.” Journal of Banking and Finance 37(6), 1880–1897.
Scheiber, T., M. Silgoner, and C. Stern. 2016. “The development of bank profitability in Denmark, Sweden and Switzerland during a period of ultra-low and negative interest rates.” Focus on European Economic Integration Q3/16, Oesterreichische Nationalbank, 8–28.
Stern, C. 2017. “Fintechs and their emergence in CESEE.” Focus on European Economic Integration Q3/17, Oesterreichische Nationalbank, 42–58.
Stix, H. 2013. “Why do people save in cash? Distrust, Memories of Banking Crises, Weak Institutions and Dollarization.” Journal of Banking and Finance 37(11), 4087–4106.
Zettelmeyer, J., P. Nagy, and S. Jeffrey. 2010. “Addressing private sector currency mismatches in emerging Europe.” EBRD Working Paper 115.
Based on an article from Scheiber, T., J. Wörz. “How are reduced interest rate differentials affecting euroization in Southeastern Europe? Evidence from the OeNB Euro Survey,” forthcoming in: Focus on European Economic Integration 1Q/18, Oesterreichische Nationalbank. The opinion expressed by the authors does not necessarily reflect the official viewpoint of the Oesterreichische Nationalbank or of the Eurosystem. The authors are grateful to Elisabeth Beckmann (OeNB) for her helpful comments and valuable suggestions.
The OeNB regularly conducts a survey of households in CESEE: the OeNB Euro Survey collects unique information about (euro) cash holdings, saving behavior and debt, and looks into respondents’ economic opinions, expectations, and experiences. See https://www.oenb.at/en/Monetary-Policy/Surveys/OeNB-Euro-Survey.html
Note that throughout this chapter we adopt the households perspective. So, when talking about asset euroization we refer to households, which is the counterpart to liability euroization of banks. Of course, given banks’ net open foreign currency positions and the need to reduce exchange risks, a high degree of asset euroization of households will also act as an incentive for banks to increase their extent of asset euroization as well.
Note that the household sector includes non-profit institutions serving households. If those were excluded, the ratio for Serbia would be even higher at around 90 percent.
There is not much evidence on this subject to date. Stern (2017) provides a first stocktaking of Fintech activities in the region.
Note that we ignore changes that are below 5 percentage points here as variation in the data – like in any survey data – is rather high.
Bosnia is excluded because of a lack of data.
