This Selected Issues paper and Statistical Appendix examines external competitiveness and the exchange rate for the Slovak Republic. The paper describes two simple types of competitiveness indicators: (i) real effective exchange rate measures, which examine underlying fundamentals thought to influence external performance; and (ii) indicators of actual export performance. The results suggest that the unfavorable outcomes in the merchandise trade balance and the current account from 1996 to 1998 reflected, at least in part, competitiveness problems. The paper also presents an assessment of banking conditions and the supervision system in the Slovak Republic.


This Selected Issues paper and Statistical Appendix examines external competitiveness and the exchange rate for the Slovak Republic. The paper describes two simple types of competitiveness indicators: (i) real effective exchange rate measures, which examine underlying fundamentals thought to influence external performance; and (ii) indicators of actual export performance. The results suggest that the unfavorable outcomes in the merchandise trade balance and the current account from 1996 to 1998 reflected, at least in part, competitiveness problems. The paper also presents an assessment of banking conditions and the supervision system in the Slovak Republic.

II. Assessment of Banking Conditions and the Supervision System in the Slovak Republic11

A. Introduction

16. This chapter examines the state of the Slovak Republic’s banking sector, stressing the links between financial sector stability, macroeconomic developments, and sound banking supervision.12 In doing so, the chapter analyzes indicators of the health of the banking sector and identifies prudential, regulatory, and legislative measures to support further improvements in banking sector health. It also discusses developments and recommendations in the area of bank restructuring.

B. Structure of the Banking System

Concentration and ownership

17. Since the breakup of the monobank system in 1990, the number of banks operating in the Slovak Republic increased markedly to a total of 27 at end-1998, comprising 5 majority state-owned banks, 20 privately-controlled banks, and 2 branches of foreign banks. Developments in the structure of the banking system in recent years exhibited two main trends: (i) foreign capital entry increased dramatically, particularly during 1994-1996, resulting in an increase in the foreign equity share of total banking sector equity to over 37 percent at end-1998; and (ii) competition in the banking sector subsequently increased, resulting in a decline in the share of state-controlled banks in total banking sector assets. The share of state-controlled banks decreased from about 69 percent at end-1995 to 49 percent at end-1998. However, despite the increase in the number of banks operating in the Slovak Republic, the banking sector remains highly concentrated, with about 41 percent of banking assets concentrated in the two largest state-owned banks, the Slovak Savings Bank (SLSP) and the General Credit Bank (VUB). Furthermore, over 70 percent of banking sector assets are concentrated in the eight largest banks.

18. Based on ownership and banking operations, the banking system in the Slovak Republic can be categorized into five distinct groups (Table II-1):

Table II-1.

Slovak Republic: Banking Sector Indicators

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Sources: National Bank of Slovakia, and staff estimates.

Official data (presented here) on risk -weighted capital/asset ratio take into account shortfalls i n loan provisioning.

Data on return on asset and return on equity is adjusted by staff to take into account shortfalls in loan provisioning.

One month lending rate minus one-month deposit rate.

  • Group 1: This group comprises the three major state-owned banks, SLSP, VUB, and the Investment and Development Bank (IRB). Banks in this group have a significant share of nonperforming loans in their portfolios, which amounted to more than 37 percent at end-1998. The SLSP is fully state-owned and is the largest in the banking system, commanding over 21 percent of total banking assets. This bank has a dominant, but declining, position in the retail deposit market, deriving its deposits from its large branch network in all regions of the country. The VUB, the second largest bank, is majority state-owned (51 percent of is shares are state-owned), and has 20 percent of total banking assets. This bank has been operating under tight liquidity conditions and is highly dependent on the interbank market for liquidity. The IRB is the fifth largest bank in the banking system with about 5 percent of total banking assets. This bank was placed under the conservatorship of the National Bank of Slovakia (NBS) in December 1997 following liquidity problems and a consequent run on the bank’s deposits. The Slovak Insurance Corporation (which is state-controlled) has a majority share in this bank, holding about 67 percent of the bank’s equity, and the National Property Fund (NPF) has about an 11 percent share. The relative size of banks in this group declined to about 46 percent of total banking assets at end-1998, compared with 63 percent at end-1995.

  • Group 2: This group comprises 18 privately-owned banks with full commercial banking licenses. Five banks in this group are fully foreign-owned, three banks are majority foreign-owned, and five banks have foreign capital participation. The share of this group of banks in total banking assets increased steadily in recent years to about 37 percent at end-1998, compared with less than 20 percent at end-1995.

  • Group 3: This group includes two special savings banks. Foreign capital participation in these banks amount to 50 percent and 65 percent, respectively, at end-1998. Banks in this groups are in the early stages of their operations which are limited, on the asset side, to government securities and housing loans. The group has less than a 6 percent share of total banking assets.

  • Group 4: This group includes two fully state-owned specialized banks: the Slovak Guarantee and Development Bank and the Consolidation Bank. The Slovak Guarantee and Development Bank supports private sector development, but has only about 0.6 percent of banking assets. The Consolidation Bank is an asset resolution company that does not conduct banking operations. Banks in this group have about a 3 percent share of total banking assets.

  • Group 5: This group comprises two branches of foreign banks, the Československá Obchodná Banka (Czech Republic), the third largest bank in the Slovak Republic with more than 7 percent share in total banking assets, and the Internationale Nederlanden Bank (The Netherlands).13 The two banks combined hold about 9 percent of total banking assets.

Main operations of the banking sector

19. The banking sector in the Slovak Republic is relatively large, as indicated by the ratio of total banking sector deposits to GDP of more than 59 percent at end-1998. This figure is relatively high when compared to other transition economies (Figure II-1).14 The deposits-to-GDP ratio, however, fell in 1998 from its 1997 level, largely due to increased “dollarization”. The increase in dollarization in 1998 was also reflected in the increased share of foreign currency deposits in total deposits: after relative stability in past years at around 11–13 percent, this share increased to more than 16 percent at end-1998.

20. The banking sector in recent years has had a large exposure to the enterprise sector, with bank credit to enterprises amounting to more than 41 percent of bank assets, and about 90 percent of net domestic credit (more than 42 percent of GDP). Credit to households, although generally increasing in relation to GDP, is less than 6 percent of banking sector assets (less than 6 percent of GDP). The share of nonperforming (classified) loans in total banking sector loans increased dramatically in 1998 to around 37 percent, compared with about 24 percent at end-1997.15 All banking groups observed increases in classified loans, but the increases experienced by the three major state-owned banks and group 5 banks were the most significant. Banking sector securities holdings are moderate at around 18 percent of total banking assets.

21. As a result of new entry to the banking sector in recent years and the increase in competition among banks, the spread between lending and deposit interest rates steadily declined (except for only short episodes when this spread increased). For example, the short-term spread declined from an average of 6.1 percent in 1997 to an average of 2.1 percent in 1998 (Figure II-2).

C. Banking Conditions

Nonperforming assets

22. The determination of the amount of problem loans in the Slovak banking sector is difficult. Although existing rules regarding loan classification do not deviate significantly from international best practices, evasion of strict implementation of these standards is possible, particularly in view of the limited resources available to the NBS for on-site supervision. More significantly, collateral valuation seems to be unrealistic under current conditions of a highly illiquid market and prolonged bankruptcy procedures.16 All this suggests that bank capital adequacy ratios may be overstated. This issue could prove to be highly problematic in the three largest state-owned banks, particularly in view of the large share of nonperforming loans in their portfolios, while the implications for the rest of the banking sector could also be significant.

Figure II-1.
Figure II-1.

Slovak Republic: International Comparison of Deposits/GDP Ratio, end-1997

Citation: IMF Staff Country Reports 1999, 112; 10.5089/9781451835380.002.A002

Figure II-2.
Figure II-2.

Slovak Republic: Interest Rates and Lending-Deposit Spread

Citation: IMF Staff Country Reports 1999, 112; 10.5089/9781451835380.002.A002

Source: National Bank of Slovakia

23. With this caveat in mind, official data on the banking sector indicate a relatively large share of nonperforming loans and, more importantly, the preliminary data indicate a marked increase in the share of nonperforming loans in total loans in 1998: this share increased from 31.9 percent to 37.3 percent in the three state-owned banks, from 5.7 percent to 7.2 percent in the 18 privately-owned banks, and from 10.8 percent to 35.0 percent in foreign bank branches. This deterioration is attributed to the declining profitability in the enterprise sector in 1998, which was further exacerbated for some enterprises with large foreign debts by the recent depreciation of the koruna.

24. Whereas private banks (Group 2, 3, and 5) adhere to official provisioning requirements, state-owned banks (Group 1 and 4) have substantial shortfalls in loan-loss provisioning, which were intensified in 1998 as a result of the significant increase in classified loans. For the three state-owned banks, the provisioning shortfall doubled in 1998, from about Sk 10 billion at end-1997 to more than Sk 20 billion at end-1998. For Group 4 banks, this shortfall increased by about 50 percent from around Sk 2.3 billion to about Sk 3.5 billion, resulting in a total shortfall in loan-loss provisions of both categories of banks of around Sk 23.5 billion (3 percent of GDP). The actual shortfall in loan provisioning in the banking system, including in private banks, is expected to be higher when taking into account potential loan classification weaknesses and collateral overvaluation.

25. As a result of the absence of legal options for write-offs of nonperforming loans at banks’ discretion, the level of nonperforming loans in the banking sector in the Slovak Republic has been persistently high. In this connection, the tax and bankruptcy laws dissuade banks from writing-off nonperforming loans. On the one hand, by allowing tax deductions only on loans determined to be categorized as “loss” by a bankruptcy court decision, the Tax Law provides disincentives for banks to write-off bad loans without the necessary court decision. On the other hand, the Bankruptcy Law and bankruptcy procedures are inefficient, and the number of bankruptcy cases that were actually ruled on, compared with the number of cases filed, were minimal. 17 The persistence of bad loans on banks’ balance sheets decreases the transparency of their accounts, and can adversely affect the reputation of otherwise profitable banks.

Capital adequacy

26. The capital adequacy of the banking sector in the Slovak Republic declined across the board in 1998. The most dramatic decline was in the capital adequacy ratio (CAR) of the three state-owned banks, from 6.7 percent at end-1997 to 2.7 percent at end-1998, mostly on account of losses related to the substantial increase in classified loans in the portfolios of these banks (Table II-2).18 Based on official data, Group 2 banks continue to be well-capitalized with a CAR at end-1998 of around 12.5 percent.19 Group 3 banks are still at the early stages of their operations; the group’s CAR is very high.

Table II-2.

Slovak Republic: Capital Adequacy Ratio by Banking Groups, end-1998

(Official data, billion koruna)

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Source: National Bank of Slovakia.Notes: RWA indicates risk-weighted assets; CAR indicates risk-weighted capital adequacy ratio. Group 5 banks are not subject to minimum capital requirements.

27. A sensitivity analysis of capital adequacy ratios for Group 1 and Group 2 banks (together comprising around 83 percent of banking sector assets), assuming strengthened loan classification and provisioning requirements and adjustments to collateral values which might reflect better market prices is presented in Table II-3. These calculations are illustrative. Three scenarios are presented. All three scenarios assume strengthened provisioning requirements (which, from a quantitative perspective, could be viewed also as strengthened loan classification). Required provisions are assumed at 2,10, and 100 percent for standard, special-mention and classified (substandard, doubtful, and loss) loans, respectively. The first scenario presents the effects of these assumptions (without any adjustments to collateral values) on the CARs of the two banking groups. The second and third scenarios assume, respectively, a 25 percent and a 50 percent discount on the value of collateral held by banks in the two groups.

Table II-3.

Slovak Republic: Capital Adequacy Sensitivity Analysis

(Billion koruna; unless specified otherwise)

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Sources: National Bank of Slovakia and staff calculations.Notes: In addition to the individual assumptions related to collateral valuation, Scenarios 1 through 3 assume strengthened provisioning requirements as follows: 100 percent for all classified loans (substandard, doubtful, and loss), 10 percent for special-mention loans, and 2 percent for standard loans. Existing NBS provisioning requirements are 5, 20, 50, and 100 percent for special-mention, substandard, doubtful, and loss loans, respectively. The assumption of a 100 percent provisioning for all classified loans may be strict but is made to reflect the possibility that loans may have been misclassified to better-performing categories.

28. The results of the analysis give rise to concern, particularly for Group 1 banks. The combined CAR for banks in this group becomes deeply negative under the first scenario and reaches up to minus 29 percent under the third scenario. As for Group 2 banks, the CAR declines substantially under the first scenario to 8.9 percent, and the CAR for the group falls below the minimum prudential ratio of 8 percent under the second and third scenarios. The results for Group 2 point to a possible undercapitalization of some banks in this group. These results are worrisome, particularly for Slovak banks, to the extent that the ability of domestic shareholders to provide capital injections would be much less than for foreigners. 20


29. The increase in nonperforming loans resulted in a noticeable decrease in the banking sector’s net interest margin (NIM), from 1.8 percent in 1997 to 1.2 percent in 1998.22 The MM decreased from 1.0 percent to minus 0.7 percent for Group 1 banks, and from 3.0 percent to 2.7 percent for Group 2 banks. Banks with tight liquidity conditions (particularly VUB) were also hard hit by the increase in interbank rates in the second half of 1998. On the other hand, in view of higher interest rates on short-term securities, banks, except for Group 1 and Group 4 banks, were able to offset the costs associated with decreasing net interest income largely from proceeds from securities operations.

30. Accordingly, whereas the profitability of Group 1 banks worsened in 1998, the profitability of private banks continued to be adequate by comparison with other regions and country groups (Figure II-3): the return on assets (ROA) of Group 2 banks, while lower than the average for transition economies for the period 1988-95, is slightly higher than the regional averages for Africa, Asia, Latin America, and the Middle East and North Africa, and is substantially higher than the average for industrialized economies.23 The ROAs for Group 3 and Group 5 banks are the highest relative to all regions and also in comparison to transition economies.

Figure II-3.
Figure II-3.

Banking Sector Profitability: International Comparison

Citation: IMF Staff Country Reports 1999, 112; 10.5089/9781451835380.002.A002

Source: Determinants of Commercial Bank Interest Margins and Profitability: Some International evidence, Asli Demirguc-Kunt and Harry Huizinga, 1998.Note: Data for Slovakian banks (Groups 2,3 and 4) reflect 1998. Data for other regions/country groups reflect average return on assets during 1988-1995.

31. The return on equity (ROE) for private sector banks was strong for 1998 at around 26 percent and 97 percent for Group 2 and Group 3 banks, respectively. Profitability indicators for the three state-owned banks continued to be inadequate with substantial deterioration in 1998; the combined losses for these banks increased from around Sk 3 billion in 1997 to an estimated Sk 13.2 billion in 1998 resulting in substantial negative ROAs and ROEs.

D. Banking Sector Vulnerabilities

Macroeconomic linkages: interest rate, exchange rate, and credit risks

32. The implications for banks of unattended macroeconomic imbalances are worrisome. Liquidity problems in some banks, widespread maturity mismatches, and large exposures to the enterprise sector, which borrowed heavily in foreign exchange, render the banking sector vulnerable to further exchange rate depreciation and/or tighter monetary conditions and rising domestic interest rates. This vulnerability reflects both direct effects and indirect effects because of enterprise credit risk.

• Interest rate risk

33. Banks, in general, appear to have shifted some of the burden of higher interest rates on to borrowers. This was evidenced, for example, by the increase in the lending to deposit rate spreads that accompanied tighter monetary conditions in late 1998 and effectively transformed (a part of) interest rate risk into credit risk.24 Banks dependant on interbank funds for liquidity would, however, continue to be more vulnerable to higher interest rates, with VUB being the most vulnerable among the three-state-owned banks.25 For the rest of the banking sector, data indicate that 4 of the 18 privately-owned bank could not meet prudential liquidity requirements (which require the ratio of the sum of liquid assets, cash, and assets with maturities of up to one month to the sum of liabilities with maturities of up to one month to be at least 100 percent) at end-1998. Furthermore, this group of banks had substantial funding gaps at maturities between one to three months which makes them vulnerable to a sustained increase in interbank interest rates: the ratio of assets to liabilities in this maturity range was 53 percent at end-1998 (Table II-4). In contrast, bank income from securities operations would be expected to increase with increasing interest rates: the banking sector holds about 18 percent of its total assets in securities, more than 85 percent of which are short-term with less than one month to maturity (Table II-5).

Table II-4.

Slovak Republic: Maturity Mismatches, end-1998

(Billion koruna; unless otherwise specified)

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Source: National Bank of Slovakia.Note: Ratio is the ratio of assets to liabilities.
Table II-5.

Slovak Republic: Banking Sector Securities Holdings, end-1998

(Billion koruna; unless otherwise specified)

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Source: National Bank of Slovakia.

• Exchange rate risk

34. Among the three-state-owned banks, VUB had a short foreign currency exposure at end-1998 that has left it vulnerable to an exchange rate depreciation, particularly in view of its noncompliance with the overall foreign currency exposure prudential limit.26 By comparison, the 18 privately-owned banks had, in aggregate, a long foreign exchange position at end-1998 of about US$23 million and, except for one bank, all banks in this group adhered to the overall foreign currency exposure prudential limit. More significantly, the increase in enterprise credit risk as a result of further exchange rate depreciation could be significant: enterprises have taken large unhedged foreign exchange loans, and it is expected that exchange rate depreciation would further erode their ability to service their debt including to the domestic banking sector. Off-balance sheet losses, occurring because of domestic bank guarantees for enterprises’ foreign debt, could also rise: these claims currently amount to around Sk 57 billion (about 7 percent of total banking assets), of which, around Sk 31 billion are in foreign currency.

• Enterprises credit risk

35. Domestic banks are heavily exposed to the enterprise sector (recall that credit to enterprises accounts for about 90 percent of total domestic bank credit). The enterprise sector, in turn, is vulnerable to currency depreciation in view of its large (unhedged) foreign currency indebtedness: at end-1998, total enterprise foreign currency debt amounted to almost US$8 billion (36.8 percent of GDP), of which US$1.2 billion was owed to domestic banks and US$2.5 billion was short-term external debt. In these circumstances, a 10 percent depreciation of the koruna would increase enterprise debt by the equivalent of about Sk 28.7 billion (3.7 percent of 1998 GDP). An increase of this size would necessarily affect the ability of the enterprise sector to service all of its debts, including to domestic banks.

36. Furthermore, the substantial koruna-denominated indebtedness of the enterprise sector (36.5 percent of GDP) makes it highly sensitive to increases in domestic interest rates. Based on end-1998 data, a one percentage point increase in average lending rates, all else being equal, would reduce enterprise profits by about 0.4 percentage point of GDP.

Credit concentration and large credit exposure

37. Noncompliance with prudential regulations on large credit exposures is widespread, a factor which increases the banking sector’s vulnerability because of weak diversification of banks’ loan portfolios (Table II-6). At end-1998, all three state-owned banks could not comply with credit exposure regulations to nonbanking and banking clients, and two of the three banks could not comply with the aggregate net credit exposure limits. Compliance among banks in Group 2 was also weak: of the 18 banks in the group, six banks did not comply with the credit exposure limits to nonbanking clients, three banks did not comply with credit exposure limits for banking clients, and three banks did not comply with the aggregate net credit exposure limit. The performance of Group 3 and Group 5 banks Was satisfactory in this respect and none of the banks in these groups failed to comply with credit concentration regulations.

Table II-6.

Slovak Republic: Compliance with Credit Exposure Prudential Regulations, end-1998

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Source: National Bank of Slovakia.

A large credit is defined as one in which exposure is more than 15 percent of capital.

Enterprise restructuring

38. The lack of progress in the area of enterprise restructuring could result in a further worsening of conditions in this sector, increased liquidity shortages, and a higher rate of loan defaults. Also, any enterprise liquidity shortages would be expected to be exacerbated if there were a continued decline in banking sector credit to this sector: as a result of increasing enterprise risk, credit to enterprises declined from around 43 percent of total banking assets in 1997 to around 41 percent in 1998. In addition to its adverse effect on overall bank income, banking sector cash flow would be restricted and liquidity problems in banks could easily occur if the share of non-earning assets in bank portfolios were to increase.

E. Bank Restructuring

39. Progress in bank restructuring has been slow and past attempts at restructuring the three largest state-owned banks were not successful. In 1991, during the Czechoslovak Federation, the Consolidation Bank (KB) was created to function as an asset resolution company for problem assets inherited from the past regime. About 25 percent of VUB’s portfolio (which comprised working capital loans to socially-owned enterprises) was transferred to KB. In 1992, a program was created to prepare enterprises and banks before mass privatization. Under this program, VUB wrote-off about 10 percent of its outstanding loans and correspondingly reduced its liabilities to enterprises. Further loan carve-outs, involving VUB and IRB, were effected in 1993 and 1994. These attempts did not involve any operational restructuring of these banks or effective work out of bad loans. Furthermore, these transfers did not effectively clean up the banks or restore their capital adequacy level to the minimum standard. More recently, in early 1996, the NBS exempted the three banks from the minimum capital adequacy standard and declared these banks to be under restructuring. However, short of this exemption, no restructuring measures were implemented and the exemption expired toward end-1997.27

40. The new government, which came into power at the end of 1998, indicated its intentions to implement a comprehensive program for bank and enterprise restructuring. At its request, SLSP’s and VUB’s new management submitted restructuring proposals for the two banks. The government has not yet confirmed specific restructuring plans.

41. In the face of slow progress in bank restructuring and the declining financial performance of the three major state-owned banks, the prompt launching of a comprehensive restructuring program, and rapid privatizing of the banks, is a matter of high priority. Such a program would have to be based on a realistic evaluation of the quality of the overall bank assets, which could only be established by undertaking extended audits of these banks.


42. The most immediate concern is the rapidly deteriorating condition of VUB, which posted substantial losses in 1998, and is preserving its liquidity by offering high deposit rates.28 New management was appointed in mid-1998 and indicated its intentions to strengthen the bank’s credit activities, to effectively work out more problem loans, and to cut-down on operating costs. But despite a highly needed operational restructuring, VUB’s worsening financial conditions suggest that a write-down of a substantial segment of its classified assets and a subsequent capital injection would be required to enable it to grow. In view of its systemic importance, there are advantages to pursuing a rehabilitation strategy that embraces financial and operational restructuring of VUB, and a subsequent rapid privatization.29


43. Although IRB has been placed under NBS conservatorship since December 1999, progress in the resolution of its condition, or in the restructuring of its operations, has been insufficient.30 In fact, during the last fifteen months, IRB lost most of its deposit base, and it is now mainly dependent on NBS funding for its operations.31 Prompted by the maximum time period allowed for conservatorship of two years, after which the bank must be either recapitalized or liquidated, the authorities made progress recently in the preparations for IRB’s privatization, as an extended audit of the bank was completed and contacts with potential strategic investors have been initiated. However, resolution strategies for IRB are constrained by the fact that this bank has limited commercially attractive loans.32 Thus, its privatization would probably need to be accompanied by almost a full carving out of its portfolio. Accordingly, the authorities should consider a strategy of selling parts of the bank (its infrastructure, cash, securities, and the small deposit base it maintained) to a strategic investor followed by the liquidation of the remainder of the bank.


44. Despite its high liquidity deriving from its monopoly position in the retail market in many regions of the country, the Slovak Savings Bank has performed poorly. Because of its size and large branch network, and because it provides interbank liquidity (particularly to VUB, IRB, and the Consolidation Bank), the Savings Bank is seen as being of systemic importance. Thus, the authorities’ resolution strategy rests first on operational and financial restructuring, then privatization. As in the case of VUB, the management of the Slovak Saving Bank is still new (appointed in mid-1998), and it must undertake significant operational restructuring. The government announced plans to partially privatize this bank (up to 49 percent) by 2000.

Measures to be considered to support bank restructuring

45. Until privatization is realized, the managements of the state-owned banks would be well advised to pursue immediate measures to avoid further deterioration of the banks’ financial performance, including undertaking ambitious operational restructuring, and strengthening credit policies, collection practices, and governance more generally. A strategy to minimize fiscal costs and to facilitate the process of restructuring could be adopted to include most immediately:

  • legislative amendments to the Bankruptcy Law and other related legislation to enable banks to more effectively workout their less problematic loans;

  • accelerated restructuring of the enterprise sector, which would be closely associated with the resolution strategy for state-owned banks;

  • a clear and comprehensive cut-off criteria, in conjunction with the enterprise restructuring program, determining loans eligible for “carving out” from the three state-owned banks’ loan portfolios so as to engage the banks themselves in the workout of the remaining loans.

  • legislative amendments to allow for the involuntary writing down of shareholders’ capital; and

  • the withdrawal of the banking license from the Consolidation Bank and the passage of independent legislation to support its asset resolution function. To ensure serious effort by its management for resolving problem loans, the life-span of KB should be limited to, at most, five years.

F. Assessment of Banking Regulations and Supervision

Issues related to loan classification and provisioning

• Loan Classification

46. Loan classification standards and provisioning requirements were improved significantly in 1995. Despite this improvement, loan classification guidelines for doubtful and loss loans could be strengthened further. These regulations define five categories for loan classification based on the period of arrears and also on the repayment capability of borrowers.33 NBS regulations specify a repayment delay period of 180–360 days for the classification of loans as doubtful and litigious, and a delay of over 360 days for the classification of loans as loss. In comparison, international best practices require that loans be classified as doubtful if payments are delayed over 90 days and if loans cannot be classified as substandard. Furthermore, if payments are delayed over 90 days and if loans cannot be classified as substandard or doubtful, such loans should be classified as loss.34

47. The NBS implemented strict guidelines for the classification of restructured and refinanced loans in 1995. Currently, restructured loans cannot be reclassified in categories better than substandard. If loans were restructured several times, they must be classified as doubtful, but could be reclassified as special-mention only if they meet one of the following conditions: (i) the loan was standard or special-mention before restructuring; or (ii) the loan was restructured without extending the maturity. In the case of refinanced loans, they can be classified as special-mention if they are properly paid (including interest, fees and commissions). If interest, fees and commissions were not paid, the original classification is to be continued.

48. Strict enforcement of loan classification regulations is weak. Although NBS regulations require banks to classify their loans based on cashflow and repayment capabilities of borrowers, most banks base their loan classification on mechanical rules, particularly, on delays in loan repayment.35 Furthermore, weaknesses in NBS on-site examinations, particularly the low frequency of these examinations, gives banks leeway to avoid strict loan classification.36 The NBS, however, is considering measures to strengthen current regulations on loan classification to ensure the implementation of cashflow analysis.37

• Provisioning and collateral

49. Properly administered loan classification and provisioning for impaired loans is an essential element of prudent risk management and capital adequacy measurement. Provisioning for loan losses is a method for recognizing the reduction in the value of a bank’s loan portfolio. Thus, provisioning against total or partial loan losses is crucial for determining a bank’s net income and assessing the size of its capital. When these are not in place, capital adequacy figures may be severely distorted,

50. Provisioning requirements in the Slovak Republic are consistent with international best practices. Mandatory provisions for loans are as follows: provisions for special-mention loans are set at 5 percent; substandard loan provisions at 20 percent; doubtful and litigious loan provisions at 50 percent; and provisions for loss loans at 100 percent. Full provisioning is required for unpaid interest, fees, and commissions classified as substandard or less.38

51. The appraisal of collateral in the Slovak Republic is, however, difficult and tends to be overestimated. Current market turnover is very weak and there are essentially no markets for some types of collateral. Furthermore, bankruptcy procedures to realize collateral value are lengthy and expensive. Therefore, for collateral valuation purposes, the NBS specifies a percentage of the initial collateral value—typically 70 percent—in the first year, with a slowly declining percentage thereafter. This method does not relate collateral value to market value and also does not consider the cost of foreclosure.

52. NBS regulations allow collateral value to be deducted from the loan principal in calculating provisioning requirements. In view of difficulties in evaluating the true market value of collateral, the adequacy of bank provisions for loan losses is a great concern. In a related vein, efforts to ensure better (and perhaps more conservative) valuation of collateral value based on more realistic appraisals would be welcome, and helpful in enforcing adequate provisioning.

• Non-loan valuation

53. The NBS does not have the legal authority to regulate the classification and provisioning of non-loan assets of banks. It is strongly recommended that the NBS establish the legal basis to issue such regulations, including establishing guidelines for security classification and the establishment of appropriate valuation reserves for such securities.

• Writing-off of bad loans

54. Banks’ ability to write-off bad loans against provisions is greatly impeded by inefficient bankruptcy and tax legislation. The. total amount of bad loans which were written-off in 1998 amounted to only Sk 1.9 billion, compared to total provisions of more than Sk 36.9 billion. In addition to time-consuming bankruptcy procedures and inadequate infrastructure to support these procedures (including an inadequate number of bankruptcy judges, courts, and administrators), a number of large enterprises were granted special protection under the Revitalization Act, which was cancelled in 1998, and banks were for some time unable to pursue bankruptcy procedures against these enterprises. Since the Tax Law does not allow for tax deductibility against these loans without a court decision on bankruptcy, this Act hindered creditors from writing-off a number of large problem loans.

55. The new bankruptcy legislation, introduced in 1998, represents an improvement and could result in a more rapid writing-off of bad loans. The new legislation introduces automatic triggers for bankruptcy procedures, in which the debtor is obligated to file a bankruptcy settlement petition if the individual has been unable to repay his commitments for more than 60 days. Non-compliance with this obligation is an infraction under the Criminal Code. However, the authorities’ willingness to fully implement this legislation, and the capacity of the courts to handle an increased caseload, have yet be tested. The limited powers of creditors in bankruptcy procedures continue to hinder the quick resolution of bankruptcy cases.

56. Rapid writing-off of bad loans can improve asset quality of banks considerably.39 Banks should also be encouraged, after adequate amendments to the Tax Law, to allow tax deductibility without a legal court decision and to use out-of-court settlements, so that bad loans can be written-off without creditors having to wait for a judicial ruling on bankruptcy.

• Income recognition: interest accrued but not earned

57. Inappropriate income recognition policies can rapidly distort banks’ financial statements, especially when nominal interest rates are high. When interest payments, fees, and other revenues accrue in a bank’s account, and their future collectibility is doubtful, a bank overstates its income and thus, ultimately, its capital and revenues. Furthermore, banks might be obligated to pay taxes on income that they have not actually received.40 To avoid such a situation, nonperforming assets should be placed on a non-accrual status so that income is recorded only when it has actually been received in cash.

58. Accounting practices in the Slovak Republic in this area deviate substantially from international best practices. Under the Slovak Accounting Act, interest is accrued on nonperforming loans and is recognized as income. Best international practices require that, when interest on an asset is due and is unpaid for 90 days, interest should cease to be accrued. Furthermore, banks are required to reverse unpaid interest out of income, and book it in the interest-in-suspense-account.

• Tax deductibility

59. Taxation should be based on a concept of profits that is correct and realistic. Hence, a clear definition of taxable income is critical. Tax deductibility for provisioning is very limited in the Slovak Republic. According to the Law on Provisions and Reserves, only statutory provisions, as defined in this Law, can be deducted at cost for tax purposes. The volume of statutory reserves is defined as follows: (i) 2 percent of the increase within the fiscal year of the volume of loans classified as standard or special-mention; (ii) 10 percent of the increase within the fiscal year of the volume of loans classified as substandard, doubtful, or loss; and (iii) 2 percent of the increase within the fiscal year of the volume of off-balance items. These reserves are effectively specific loan provisions but are presented in banks’ books under a separate category (statutory reserves) for tax payment purposes. All additional specific loan loss provisions that are made by banks in order to fulfill NBS regulations for provisioning are then booked under the category specific provisions and are not tax exempt.

60. Such limited tax deductibility of specific loan provisions does not provide incentives for banks to acknowledge impaired credits, or to make adequate provisions for these credits. Specific loan provisions should be viewed as costs that are a part of normal banking operations, and their early acknowledgment by banks should be encouraged by all underlying legislation. Therefore, full tax deductibility of all specific provisions is advisable to encourage banks to acknowledge impaired loans, and to provision for these loans, at a faster rate.41

61. Existing regulations require full taxation of interest accrued on nonperforming loans. Only the penalty (premium) interest on overdue interest is deducted from the tax base. Accordingly, actual income of banks as defined for tax purposes is overstated, and banks are consequently overtaxed. The authorities acknowledge this serious shortcoming and are currently in the process of revising the Law on Provisions and Reserves to allow for the deduction of accrued interest on nonperforming loans from the tax base.

Capital adequacy requirements

62. The current minimum paid-in capital requirement for a full banking license is Sk 500 million. NBS Decree No. 2/1994 introduced rules for calculating the capital adequacy ratio and set end-1996 as the deadline for all banks to meet a capital adequacy ratio of 8 percent.42 Banks report their capital adequacy to the NBS on quarterly basis.

63. NBS regulations for the calculations of the capital adequacy ratio are generally adequate. These regulations require that capital investments in other banks or companies be deducted from the bank’s core capital. In the absence of consolidated supervision, as in the case of the Slovak Republic, this practice is sound and is necessary to prevent the multiple use of capital.43 Furthermore, uncovered losses (shortfalls in specific provisions) on nonperforming loans are deducted from capital. This deduction is also necessary for the proper calculation of the capital adequacy ratio where specific loan provisions should be treated as losses and thus be fully deducted from the capital base. Specific provisions for loan losses are not allowed as Tier II capital. Although NBS regulations used to allow the inclusion of subordinated debt as Tier II capital (up to 50 percent of Tier I capital), current regulations, which came into effect on June 30 June 1997, do not allow for the inclusion of subordinated debt as Tier II capital.44 This modification was introduced since the legal system in the Slovak Republic did not recognize the qualification of subordinated debt.

64. Notwithstanding the above, NBS regulations of capital adequacy could be strengthened to reflect more adequately developments in international best practices in the area of market risk, including the EU Capital Adequacy Directive (March 1993) which addresses market risks, and the Basle Committee amendment to the Capital Accord which implements a capital charge related to market risk.45 The absence of regulations on market risk in the Slovak Republic does not pose an immediate risk as bank trading activities are limited. However, if bank trading activities increase considerably, prudential regulation on market risk should be introduced.

Other prudential regulations

65. Credit exposure, connected lending, and foreign exchange limits do not deviate largely from international best practices. However, liquidity regulations should be improved substantially to provide more adequately for sound liquidity management.

66. Large exposure regulations, specified in NBS decree No.3/1994, require that the sum of individual exposures that exceed 15 percent of a bank’s capital not to exceed 800 percent of its capital. These regulations are less stringent than those specified in EU Large Exposure Directive (December 1992) where a limit of 10 percent of a bank’s own funds is specified to define large exposures as opposed to the Slovak Republic’s limit of 15 percent.

67. Other NBS regulations on credit exposure do not deviate from international best practices. Exposure to a single borrower (nonbank client) is limited to 25 percent of a bank’s capital. Furthermore, credit exposure to a single bank or banking group is limited to 80 percent; total insider lending (to shareholders or employees) to 5 percent; and connected lending limits to 25 percent of a bank’s core capital. NBS regulations require the correction of any violation of these limits within six months, and banks are required to maintain an information system to monitor credit exposure.

68. Foreign exchange regulations are consistent with best international practices. Foreign exchange exposure limits are regulated by the NBS decree No. 11/1997. Total overnight foreign exchange positions in convertible currencies (which includes off-balance sheet exposure) is limited to 25 percent of a bank’s capital. The decree regulates open positions in individual foreign currencies at 10 percent and non-convertible currencies at 2 percent.

69. Prudential regulations on liquidity require that the ratio of the sum of liquid assets (cash and assets with maturities of up to one month) to the sum of liabilities with maturities of up to one month to be at least 100 percent.46 The ratios are calculated on an end-month basis. To insure a more adequate maintenance of liquidity positions, it is desirable that liquidity positions be enforced on a monthly-average basis, rather than on an end-month basis. Other desirable improvements include the introduction of other liquidity ratios such as the ratio of fixed assets to total assets, and the specification of a maturity ladder which expands the limits of the ratio of assets to liabilities to the other maturity ranges.

Prompt corrective action

70. The persistence of a close relationship between the government, state-owned banks, and enterprises created a situation of wide-spread moral hazard in the banking sector for several years. At the same time, it has made it difficult for banking supervisors to exercise their authority appropriately when there has been a need to deal with problem banks swiftly and firmly. In the absence of a prompt corrective action system that is based on explicit quantified criteria, such as capital adequacy ratios, supervisory forbearance has often been practiced. This absence has also made it difficult for the banking supervision authorities to implement corrective measures.

71. To deal with this weakness, it would be highly desirable that a prompt corrective action system be introduced in the Banking Act to include clearer exit policies and procedures in order to ensure the rapid exit of nonviable banks and the timely remedial action of current banking problems.47 Although the current Banking Law contains several provisions with regard to conservatorship and revocation of banking licenses, these measures are not binding and should be reinforced. Remedial measures specified in a prompt corrective action system could require certain supervisory actions based on the shortfall of a bank’s capital adequacy ratio relative to the minimum required standard.

72. These measures should include the revocation of the banking licenses of insolvent banks. Prompt corrective actions would enable the bank supervision authorities to exercise necessary measures to deal with problem banks before bank problems become critical, and would not allow for political interference or regulatory forbearance. Such a system would minimize the eventual costs of restructuring problem banks. In addition to the introduction of such a system, the power of the NBS to revoke banking licenses should be strengthened: the Banking Law now requires that the NBS consult with the Ministry of Finance (MOF) before the revocation of a banking license. This requirement could hinder an immediate action by the NBS against insolvent banks and should be removed.

Compliance with the Basle Core Principle for Effective Banking Supervision

73. Banking activities are changing rapidly and international best practices are rapidly evolving. It is now internationally acknowledged that the Core Principles (CPs) should be viewed as minimum standards, and that there is a constant need for the upgrading of supervisory capabilities practices to keep up with developments in banking operations and to ensure best practices in banking supervision.

74. The NBS completed a self-assessment of its compliance with the CPs and concluded that it is in compliance with 13 CPs, in partial compliance with 11 CPs, and is not compliant with one CP.48 To achieve fully compliance, it would be highly desirable if the NBS actively seek improvements in its supervisory system to complete the implementation of all CPs. Furthermore, the NBS should continuously seek the enhancement of its supervisory capabilities even in the areas of CPs that it is in compliance with. For example, although the NBS fulfills CP22 (formal powers of supervisors) which describes supervisory corrective measures, the NBS could further enhance its supervisory system and its compliance with CP22 by introducing a prompt corrective action system.

Supervision on a consolidated basis

75. An essential element of sound banking supervision is the ability to supervise financial institutions on a consolidated basis. This includes the ability to review both banking and other financial activities conducted by a bank, either directly or indirectly, and activities conducted at both domestic or foreign offices, and to assess compliance with prudential standards on a consolidated basis. For supervision on a consolidated basis to function effectively, cooperation and exchange of information are essential between the relevant supervisory bodies. When supervision is not done on a consolidated basis, supervisors fail to obtain a global view of all the risks faced by a bank and its group, and a bank may easily escape supervision by transferring some of its activities to a nonbank financial subsidiary. Furthermore, supervisors need to take into account risks to the bank posed by non-financial activities of a bank or group. Accordingly, sound banking supervision should take into account the overall structure of the banking organization or group.

76. Supervision in the Slovak Republic is not conducted on a consolidated basis, and the legal basis for conducting consolidated supervision is lacking. In particular, the Banking Act does not define banking supervision on consolidated basis, and does not authorize the NBS to demand, review, and verify information concerning companies in financial groups.

77. However, the Slovak banking system is based on the universal banking model, where banks are allowed to directly engage in a range of financial activities, including leasing, insurance and investment in securities, and are allowed to own other nonbank financial institutions as their subsidiaries. In addition, with the prior approval of the NBS, a bank can own more than 10 percent of the equity of nonbank corporations (but may not exceed 25 percent of a bank’s capital). Combining financial firms with industrial and commercial companies creates some fundamental concerns. This combination may cause considerable risks to banks, notably the risk of contagion from nonbank companies to banks. Financial subsidiaries pose additional contagion risks to parent banks.

78. In order to minimize possible contagion to parent banks, the Banking Act should be amended to provide the legal basis for consolidated supervision. Furthermore, the NBS should define and monitor relevant prudential regulations, including regulations on capital adequacy ratios, on a consolidated basis. Consolidated supervision could be facilitated through the conclusions of agreements or memoranda of understanding between the relevant overseas supervisory agencies to allow the NBS to conduct consolidated supervisions including on subsidiaries, branches, and representative offices of Slovak banks in other countries. It would also be useful to allow foreign countries’ supervisors to obtain supervisory information on foreign banks operating in the Slovak Republic.49

Internal controls and auditing

79. The Banking Act requires every licensed bank to have a supervisory board, consisting of at least three members. The supervisory board is the organizational unit responsible for the system of internal controls, and is required to submit to the NBS an annual report on the performance of the internal control system. Consistent with Basle Committee recommendations, the Law also provides for the complete independence of the internal audit sections from bank management.

80. Notwithstanding the above, on-site examination procedures of bank internal control systems are somewhat lacking. The NBS requires bank management, typically before a bank commences its operations, to submit the bank’s internal control policies and procedures designed to ward off attempts to abuse the banking system for money laundering, but does not follow up on developments in bank internal control systems during on-site examinations.

81. Regulations with regard to the appointment and operations of bank external auditors are appropriate. The Banking Act requires that banks notify the NBS of the appointment of external auditors. The NBS in turn is entitled to reject an appointed auditor within 30 days after the receipt of the bank’s official notification. Furthermore, the Banking Law requires external auditors of banks to notify the NBS immediately of any eventuality that may jeopardize bank operations. Notwithstanding the above, a shortage of high quality professional training in this area tends to weaken external auditing in the Slovak Republic.

Accounting and public disclosure

82. The Slovak Republic made significant improvements in accounting standards and reporting requirements in recent years. However, weak external auditing and banking supervision continue to be problematic, and further reconciliation of Slovak accounting rules with international standards is needed, particularly in the area of consolidated financial reporting and disclosure requirements.

83. Currently, the MOF is charged with setting Slovak accounting standards including for banks. However, in view of the strong link between accounting regulations and capital standards, it is appropriate that the responsibility for issuing accounting standards for the banking sector be transferred to the NBS. This would resolve the apparent conflict in the Banking Act in this area: whereas Article 15 of the Banking Act stipulates that the definition of “capital,” “reserves,” “asset,” and “non-secured foreign exchange positions” are subject to the rules set by the NBS, Article 21, paragraph (1) stipulates that the method of accounting and the preparation of financial statement by banks are governed by the MOF.

84. Disclosure requirements are in general appropriate. The March 1996 amendment to the Banking Act requires all banks to disclose credits larger than SK 3 million to the Central Credit Registry. The Banking Act also requires banks to publish data from their audited financial statements, in a manner set forth in a separate regulation, and to prepare annual reports for publication.

Deposit insurance scheme

85. The objective of a deposit-guarantee scheme is to reinforce the confidence of the depositors in the banking system by providing (limited) protection to depositors. The Deposit Security Fund came into effect on July 1,1996. The scheme limits the guarantee to deposits of natural persons (with the exception of accounts established for the purpose of business) and provides a guarantee up to a limit of 30 times the average monthly salary in the Slovak Republic. This scheme is not fully consistent with the EU Directive on Deposit Guarantees (May 1994) which requires coverage of all deposits, including those of legal persons.

On-site examination

86. Although the banking supervisory process, through on-site examination and off-site monitoring, has improved in recent years, there are some persistent weaknesses in the process. On-site examinations were introduced around end-1993, permitting the NBS to better assess loan portfolio quality, bank operations, and risk management capabilities. However, intensive on-site examinations and monitoring compliance with prudential requirements continue to be limited because of the limited resources available to the Banking Supervision Department of the NBS. Particularly, the number of staff available for on-site examinations is insufficient and accordingly, the frequency of on-site examinations is inappropriate: the NBS conducts eight on-site examinations on average per year, which implies that each bank receives one on-site examination every three years.50

87. This issue is of substantial importance, particularly in view of the deteriorating asset quality of banks and the increasing cases of bank non-compliance with prudential regulations. On-site examination capabilities should be reinforced further through increasing qualified staff and intensifying training. Furthermore, banking supervision in the Slovak Republic could be improved through better coordination between off-site monitoring and on-site examination.

G. Legislative developments

88. The legal framework for the banking system in the Slovak Republic is established by the National Bank of the Slovak Republic Act and the Banking Act. The National Bank of the Slovak Republic Act was adopted in November 1992, and a modern Banking Law became effective in 1992.

89. The National Bank of the Slovak Republic Act defines the powers of the central bank, The responsibility of banking supervision in the Slovak Republic was transferred, based on this Act, from the MOF to the NBS (effective January 1, 1993). Accordingly, the NBS is granted the legal powers to issue binding prudential regulations and to verify that financial institutions comply with these regulations. Notwithstanding these improvements, the credibility of the NBS as a banking supervisor could be further enhanced by eliminating any risk of duplication of supervision exercised by the NBS. Specifically, Article 37 of the NBS Act specifies responsibility sharing between the MOF and the NBS with regard to on-site examinations. Such sharing of responsibility is inefficient and could undermine the accountability of each organization in the performance of supervision. Although in practice the NBS conducts on-site examinations independently, the responsibility-sharing provisions of the Act could be repealed.

90. Banking supervision capabilities of the NBS were enlarged and improved upon since the modern Banking Act became effective in 1992. Although the Act has been amended several times since 1992, there remain several areas which need to be improved. Specifically, the Banking Act requires that the NBS acquire MOF agreement for granting banking licenses and that it consult with the MOF in the case of a revocation of a banking license. These provisions could limit the independence of the NBS and also could result in unnecessary and inefficient use of scarce staff resources. Furthermore, the Banking Act lacks sufficient explicit authority for the NBS to issue key regulations related to provisioning and income.


Prepared by May Khamis and Inwon Song.


The analysis in this paper focuses on Group 1 and Group 2 banks (defined below), which together comprise over 83 percent of total banking assets.


The parent bank of the Československá Obchodná Banka is a state-controlled bank. It is currently being restructured and the prospects for a quick privatization of the parent bank are positive.


Household deposits account for more than 55 percent of total deposits. Country comparisons are based on end-1997 data.


Nonperforming (classified) loans are defined as the sum of loans classified as substandard, doubtful, and loss.


Although many banks tend to base real estate collateral valuations on at least a yearly appraisal, appraising the market value of real estate tends to be difficult, particularly in view of the low turnover of the market. Appraisers base their evaluations on the statutory prices of real estate that are used for tax purposes, which do not necessarily reflect market conditions. Furthermore, the appraisal does not reflect liquidation costs (which could be significant) as well as potential encumbrances on the collateral by state claims which are given priority status under the current Bankruptcy Law. The NBS bases its collateral evaluation on the initial collateral value—typically 70 percent—in the first year, with a slowly declining percentage thereafter. This method does not relate collateral value to market value and also does not consider the cost of foreclosure.


The Bankruptcy Law suffers from multiple weaknesses, including an inherent bias in the law in favor of liquidation as opposed to restructuring. This limits the powers of creditors, and creates inflexibility concerning allowable actions in regard to the implementation of restructuring plans (such as options related to debt/equity swaps). The implementation of the Bankruptcy Law is also very weak, particularly in regard to the availability of qualified enterprise restructuring experts and administrators. Furthermore, the number of bankruptcy judges in the Slovak Republic—which is currently 18 judges sitting on three bankruptcy courts located in Bratislava, Banska Bystricam, and Kosice—is insufficient to resolve the increasing number of loss-making enterprises in the Slovak economy.


Official CARs take into account shortfalls in loan-loss provisioning. NBS regulations require banks to deduct shortfalls in loan provisioning from the capital base.


One bank in Group 2, however, did not comply with the minimum CAR of 8 percent at end-1998.


Some smaller banks in the system are reportedly already experiencing problems and potential mergers with larger banks, or capital injections by prospective investors, have been explored.


In this chapter, official data on banks’ net income and profitability indicators are adjusted to reflect the shortfalls in loan loss provisioning.


Net interest margin is defined as the ratio (in percent) of net interest income to average performing assets (assets excluding classified loans).


The ROA for Group 1, Group 2, and Group 3 banks in 1998 was 1.6 percent, 2.6 percent, and 2.2 percent, respectively. The regional ROA for the period 1988–95 for Africa, Asia, and Latin America was 1.5 percent for each of the three regions and 1.1 percent for the Middle East and North Africa. The ROA for the same period for industrialized economies was 0.4 percent. It should be emphasized, however, that profitability indicators for Slovak banks based on official data might be overstated in view of potential loan classification weaknesses and collateral overvaluation.


An increase in the spread, as opposed to a constant spread, would be needed to offset increases in the cost of other funding sources (besides deposits), such as interbank borrowing. These other funding costs are generally more volatile and respond quicker than deposit rates to changes in securities interest rates. It is not clear, however, whether the increased spread would have been sustainable for longer periods (longer than a few months), in view of the strong competition in the banking sector.


IRB is currently fully dependent on the NBS for liquidity, and the Slovak Savings Bank has excess liquidity.


Foreign currency exposure regulations in the Slovak Republic cover the overall on- and off-balance sheet positions. At end-1998, the net foreign currency exposure of the banking sector was as follows (in millions of U.S. dollars, minus sign indicates a short foreign currency exposure): Group 1: -22.9, Group 2: 23.3, and Group 4: -28.75. Banks in Group 3 do not have a foreign exchange license and foreign branches (Group 5) are not subject to regulations on foreign currency exposure.


Near the end of its term, the previous government approved the Program of Revitalizing Selected Banks. This program involved a transfer of Sk 7.6 billion from the NBS’ provisions to the state budget for the purpose of restructuring SLSP, VUB, IRB, and the resolution of assets at KB. This program was called off by the new government.


For example, published rates for April 1999 indicated that VUB offered the second highest rate in the banking system on 7-day deposits (the highest rate was offered by IRB).


VUB is currently in the list of strategic enterprises and cannot be privatized until end-1999.


Initial action in 1998 to increase the bank’s equity failed with only domestic participation being sought. Furthermore, the process did not include any restructuring of the bank’s portfolio. Only a partial recapitalization of the bank, through a capital injection by the Slovak Insurance Company of Sk 2 billion, was effected and the bank continued to be insolvent.


At end-1998, NBS funding amounted to around Sk 26.4 billion, of which Sk 12.7 billion was redistribution credit to fund IRB’s social housing loans and, partially, the power plant loan. The rest comprised short-term liquidity support. The NBS has fully provisioned for the redistribution credit on account of the housing and power plant loans, but the rest of NBS liquidity support is neither provisioned nor collateralized.


Of a total credit portfolio of Sk 31 billion (comprising 80 percent of its assets), Sk 13 billion is in a single exposure to the Mohovce nuclear power company, and SK 8.7 billion consists of social housing loans. Interest rates charged to these two types of loans are fixed at below-market rates of 15 percent and 1 percent, respectively. Although the government is committed, in principle, to compensate IRB for the difference between the interest rate charged on the housing loans and the discount rate which is paid to fund them, the budget allocation for this purpose was canceled in 1998. A budget allocation was reinstated in 1999, but it was insufficient to cover IRB’s costs on these loans (about Sk 800 million per year in 1998 and 1999). The remainder of the portfolio (about Sk 9.3 billion) is almost entirely classified credit to the enterprise sector.


The categories are as follows: (i) Standard: the client is solvent; delays in payment do not exceed 30 days; the securitization is of high quality; (ii) Special-mention: the client is solvent but subject to slight economic or financial problems; delays of payment are between 30 and 90 days; (iii) Substandard: there is considerable risk of the claim not being paid in full; delays of payment between 90 and 180 days; (iv) Doubtful and litigious: repayment in full seems highly improbable or questionable; clients is insolvent; delays in payment between 180 days and 360 days; and (v) Loss claims: the claim is uncollectible; delays in payment in excess of 360 days; client is in bankruptcy or liquidation.


For example, if a loan is overdue for more than 90 days and is backed partially by liquid collateral such as a deposit or marketable securities, this portion of the loan can be classified as substandard or above, but the remaining portion of the loan must be classified as doubtful or loss.


Also, the deterioration in the solvency and liquidity of the enterprise sector affected banks’ ability to produce reliable forecasts of enterprise repayment abilities.


On-site examinations are carried out, on average, once every three years for each bank compared to a recommended frequency of one examination per year. Accordingly, cases of problematic loan classification are not corrected on a timely basis by the banking supervisory authorities.


These measures could include a detailed stipulation of the methodology for analyzing the financial conditions and cashflows of borrowers, and the expansion of bank reporting to the NBS.


Fees and commissions which stay in arrears for more than 90 days are classified as substandard.


A bank’s asset quality is usually based on its nonperforming loan ratio. If a bank writes-off its bad loans in a speedy way, it can maintain good asset quality and thus mobilize funds on favorable terms.


This situation applies for the Slovak Republic, as the Tax Law treats accrued income on nonperforming loans as actual income.


In the event that such deductions exceed net income, this loss should be carried forward in accordance with pre-arranged procedures.


Capital adequacy calculation rules were later amended in Decree No. 5 of May 16, 1997 (which was effective on June 30,1997). In early 1996, the NBS Board of Directors exempted the three largest state-owned banks (VUB, SLSP, and IRB), which were characterized as undergoing restructuring, from minimum capital adequacy requirements. This exemption expired at end-1997 but none of the three banks were able to comply with the minimum standard.


Basle Committee’s Capital Accord and the EU Directive on capital adequacy (December 1989) require that solvency ratios be calculated on a consolidated basis when a financial institution is the parent entity of a group of undertakings.


The new regulations, however, did not affect the treatment of subordinated debt that was issued prior to the date on which the new regulations came into effect. Tier I, or core capital, comprises share capital and so-called disclosed reserves. Tier II capital includes undisclosed reserves, asset revaluation reserves, general provisions/loan-loss reserves, hybrid (debt/equity) capital instruments, and subordinated debt.


The amended Accord came into effect at end-1997.


The NBS raised the liquidity ratio gradually as follows: 70 percent (effective September 30, 1997); 85 percent (effective December 31, 1997); and 100 percent (effective March 31, 1998).


Country experiences indicate that the lack of early intervention in problem banks are generally attributed to political pressures, undue optimism on the part of supervisors, reluctance by the supervisory authorities to undertake unpleasant actions, and reluctance to admit the failure of good supervision. To avoid such situations, several countries introduced provisions in their banking laws that require certain supervisory actions based on banks’ specific conditions, including the closure of insolvent banks.


CP11 “country and transfer risk” has not been implemented. Partially implemented Core Principles (CPs) are as follows: CP1 “preconditions for effective banking”; CP2 “licensing process”; CPS “major acquisition or investment by a bank”; CP9 “concentration of risks and large exposures”; CP12 “market risk management”; CP13 “other risk management”; CP20 “consolidation supervision”; CP21 “information requirements of banking organization”; CP23 and 24 “obligation of home country supervisors”; and CP25 “obligation of host country supervisors.”


The CPs specify consolidated supervision as a minimum standard for sound banking supervision. According to CPs recommendations, host supervisory authorities should refuse the establishment on their territory of a subsidiary of a financial institution which is not supervised on a consolidated basis by the supervisory authorities in its home country. In 1993, the NBS signed the Agreement on Banking Supervision with the Czech National Bank in 1993 (after the division of the Czechoslovak Federation), and a new agreement is planned to be signed in the near future. Besides a Czech bank branch, one branch of a Dutch bank is operating in the Slovak Republic. Currently, there is no agreement between the supervisory authorities of the Slovak Republic and the Netherlands.


Currently, 20 officers are working at the on-site supervision department.

Slovak Republic: Selected Issues and Statistical Appendix
Author: International Monetary Fund