23 July 2013

IMF: Republic of Poland - Financial System Stability Assessment

Poland’s key task ahead lies in diversifying its financial system to support economic growth while preserving its stability. Risks have been managed well as the system grew rapidly. It will be important to develop non-bank financial intermediation, prepare for possible further consolidation and exit of financial institutions, especially cooperatives, credit unions and small banks, while relying less on foreign funding. Addressing these challenges requires enabling regulatory reform and strengthening of the financial oversight framework.

Poland’s financial system appears to be resilient. Skilful policy management and sound fundamentals have allowed the economy to weather the global financial crisis and the euro area turmoil. Risk drivers are well known: slow growth abroad and domestically; rising unemployment; and declining residential real estate prices. Vulnerabilities lie in interconnectedness with the euro area and exposure to foreign exchange risk and foreign investors, which in turn may pressure bank funding, especially in the absence of long-term domestic funding sources. The banking system has been profitable and induced to hold high levels of core tier-1 capital.

Stress tests suggest that vulnerabilities are not likely to become systemic, though some pockets of weakness were identified. Although foreign exchange-denominated lending has been curbed, the outstanding stock remains high. Nonetheless, only in the most severe scenarios would some smaller banks fail to meet solvency standards or run into liquidity problems. Contagion risk is limited as there are few direct interbank connections. Credit unions are a weak but small segment of the financial system. Regulatory arbitrage has pushed some consumer finance transactions outside the regulated system, but modifications to the regulation in question, accompanied by better risk management, are likely to stem this phenomenon.

Securing asset quality has moved up the supervisory agenda, given persistent non-performing loans and cyclical deterioration in credit quality. A thematic supervisory review of impaired assets is getting under way that should lead to updated regulatory guidance, if warranted. Tax disincentives, income accrual practices, and obstacles to out-of-court restructurings need to be removed to secure rapid progress in addressing the stock of impaired loans. Further improvements in restructuring, accounting practices and the insolvency framework would be helpful. Ongoing regulatory revisions should avoid contributing to rising non-performing loans: the removal of uniform debt-to-income (DTI) thresholds will need to be accompanied by tighter oversight of bank risk management practices. While the proposed tightening of loan-to-value (LTV) ratios and currency matching of income and borrowing for mortgages are welcome, regulatory LTV ratios should be set below 100 per cent. It will be helpful to harmonise the calculation of DTI ratios, and increase oversight of restructured loans through more granular reporting by banks.

Financial oversight and safety nets have been improving. Poland is broadly compliant with Basel Core Principles for Effective Banking Supervision (BCP), Insurance Core Principles (IAIS), and International Association of Deposit Insurers (IADI) Core Principles. Banking supervision has improved, as the frequency of targeted inspections has increased and onsite/offsite coordination has been enhanced. However, under the Polish legal system it remains difficult to provide the supervisor with sufficient powers, independence, and resources, which is of particular concern considering its expanding mandate. Consultations with banks and other stakeholders in the industry could be further strengthened. The deposit guarantee fund’s prospective role in bank resolution—when it becomes the designated resolution agency—will fill an important gap.

The structure of the financial system will need to evolve in the face of domestic and external pressures. Competition is likely to increase in the commercial and cooperative banking sectors, leading to consolidation and exit of weaker financial institutions. Scarcer foreign funding means that financing requirements to support economic development will have to be met more from domestic sources of finance. Even though mutual and pension funds have become more important, nonbank finance remains embryonic. These structural developments together with impending changes in the regulatory landscape, require a more risk-based and systemic supervisory approach.

Further strengthening of the financial oversight framework is essential. Constraints on supervisory room for manoeuvre from membership in the European Union (EU) and the implications of the prospective banking union will shift the onus of oversight onto sound risk management. Legislation to set up a state-of-the-art bank resolution framework should be expedited, designating the deposit guarantee fund as the resolution agency and putting a complete suite of resolution tools at its disposal, in line with the FSB’s Key Attributes. Similarly, a systemic risk board should be set up as soon as possible at the heart of an explicit macro prudential policy framework.

It should provide the opportunity to adopt a supervisory approach to systemic risks and systemic institutions and clarify the objectives and the roles of the respective macro prudential, micro prudential, and financial safety net institutions.

Establishing a similar reform momentum to rebalance the financial system toward capital market development will be important. The authorities should carefully consider the design and parameters of the various pension pillars. For financial market development, pension funds can play an important role as a domestic source of demand for assets. Similarly, robust capital market funding frameworks—including mortgage covered bonds and securitisation—can address the funding needs and mitigate the foreign exchange and asset quality risks facing the banking system.  A number of recent regulatory initiatives strive to remedy the situation, focusing on improved asset quality, loan transferability, and reviving the mortgage banks.

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