4.4. Expected trends in the economy in 2015 and their impact on the banking sector

In the opinion of mBank’s Chief Economist, economic growth should accelerate in 2015: the growth rate may cross the mark of 4% in Q4 while the average annual growth will be 3.5%. Domestic demand will remain the key growth driver in 2015 although consumption is likely to become the key force in this category while investments will grow less dynamically. This is due to the continued effect of factors bolstering consumption (good household sentiment, very high increase of real disposable income) combined with the phasing out of drivers which boosted investments in 2014 (“catching up” with postponed investment demand of enterprises).

Inflation will hit new lows in 2015 (in the opinion of the Chief Economist, annual inflation may fall to -1.5% in February and March) and then turn around, most likely at the turn of Q1 to Q2. However, deflation (understood as negative annual inflation) will persist in the Polish economy at least until the summer. This means that the average annual consumer price index will be negative for the first time in history. This will give the Monetary Policy Council the comfort to continue with interest rate cuts: the cycle is likely to being in March and to bring the NBP’s main interest rate to 1.5% or less (i.e. 50 bps below the current rate).

The continuation of economic recovery will impact the monetary aggregates. In the opinion of mBank’s Chief Economist, the following trends will develop in 2015:

  • The growth of corporate deposits will continue in 2015 as a proxy to improving financial results of companies, which is even more likely considering that it will take place in the context of accelerating economic growth. According to the Bank’s current projections, the growth rate of corporate deposits should reach 10% on average in 2015, compared to 7.8% in 2014.
  • In the opinion of the Bank, corporate loans will continue to grow at a rate exceeding the average growth rate of loans in the economy. This is driven by the still considerable investment needs of enterprises, as well as attractive terms of new lending (low interest rates, relaxed criteria and terms of bank loans). Corporate loan volumes are expected to increase by 6.6% on average in 2015 (compared to 4.7% on average in 2014) while investment loans should make the biggest contribution, similar to 2014.
  • According to mBank’s projections, the annual growth rate of retail deposits will stabilise around 10%. Growth of household deposits will be supported mainly by continued improvement on the labour market and an increase of nominal household incomes (as a result of rising salaries and low inflation). The availability of certain, stable, high real returns on savings will remain an important decision-making factor to choose deposits as the main form of household savings.
  • Finally, the volumes of retail loans should significantly increase in 2015. For mortgage loans, the adverse impact of Recommendation S (minimum down-payment requirement) should be more than offset by the impact of improving consumer sentiment. The volumes of consumer loans are also expected to continue growing although the base effect in the latter half of the year will mitigate the growth rate of consumer loans.

The Polish banking sector will also be faced with the CHF appreciation after the SNB decision on January 15, 2015. For more information, please see section “Impact of the appreciation of the Swiss franc on the position of borrowers, the banking sector, and mBank” in the following chapter.

In addition to these macroeconomic trends, the banking sector (including mBank) will operate under the following conditions in 2015:

  • Regardless of the scale of further monetary policy easing, the banking sector will face an environment of historically low interest rates. This will exert pressures on financial results due to both lower interest income and higher costs of funding (the need to maintain high interest rates on deposits, especially household deposits).
  • Another challenge for the banking sector is the increase of the contribution to the Bank Guarantee Fund; the aggregate costs are estimated at PLN 1.1 billion in the first year of the new rules. The effect of the change will be augmented by the concentration of payments in time (one-off payment in Q1) as well as the risk of further increase of the contribution in view of the continued restructuring of the co-operative savings and loans associations SKOK.
  • Additional pressures on the financial results of the banking sector will be exerted by reduced income from payment card services. According to the Bank’s estimates, the reduction of the interchange fee in 2014 (from 1.3% to 0.5%) entails a decrease of income of the banking sector by ca. PLN 700 million per year. The effect of a further reduction (from 0.5% to 0.3%) is estimated at ca. PLN 200 million per year. According to the Bank’s expectations, the direct effect will be offset in the long term by growing volumes of card transactions.
  • A further increase of the down-payment requirement for mortgage loans (from 5% to 10%) will impact the banking sector mainly by way of limited demand for household loans, as was the case in 2014. On the other hand, it is expected that the down-payment requirement will bolster the propensity of households to save and, consequently, support the inflow of cash to deposits, providing banks with stable funding for loans.
  • Other changes in the regulatory environment, i.e. restrictions on sales of insurance products by banks as well as changes in consumer lending (additional personal bankruptcy options and more restrictive “anti-usury” rules), will play a smaller role. The former may slightly boost the cost of funding for banks; in the opinion of the Bank, the latter will affect banks much less than it will other credit institutions.

Changes in the market environment, regulations and recommendations issued by the Polish Financial Supervision Authority may be a challenge for the banking sector in Poland in 2015 and may have an adverse effect on its financial results are presented in the table below:

 

 
Factor

Short overview of a factor

Influence on the main areas of banks

YES –  the factor has impact on a given area

NO – the factor has no impact on a given area, or has a limited impact on a given area

The lowest interest rates in history

In October the Monetary Policy Council (MPC) reduced the reference rate by 50 bps (to 2.0%), and lowered the lombard rate by as much as 100 bps (to 3.0%). The decision resulted from the inflation being continuously below the NBP target (deflation in H2 2014) and slowdown in economic growth. During its December meeting the Monetary Policy Council upheld its October decision, however, in 2015 new cuts are expected.en area

 

Revenues

 

Costs

 

LLP

red-triang  YES

green-triang  NO

green-triang  NO

Lower limit of interest on loans and advances

Since the MPC lowered the lombard rate by 100 bps to 3.0%, the maximum nominal interest on the loans and advances offered by banks cannot exceed 12%. It results from the so-called Anti-Usury Law applicable from 2006 under which the interest charged per annum on loans and advances cannot exceed the 4-fold lombard rate of the National Bank of Poland, that is 12% at present.

Revenues

 

Costs

 

LLP

red-triang  YES

green-triang  NO

green-triang  NO

Limiting income from servicing payment cards

As of July 1, 2014, the amended Act on Payment Services dated August 30, 2013, has entered into force. The aim of this amendment was to regulate the basic operation principles of the market of domestic payment transactions made with the use of payment cards. Under the amendment the maximum interchange rate cannot be more than 0.5% of the commission charged for payment card transaction. This represents a decrease from 1.2%-1.3% of the previously applicable commissions. At the beginning of 2015 the maximum interchange rate will be reduced to 0.2% and 0.3% of transaction value of debit and credit cards, respectively.

 

 

Revenues

 

Costs

 

LLP

red-triang  YES

green-triang  NO

green-triang  NO

Higher fee for the Bank Guarantee Fund

In 2015 the annual fee will grow from 0.1% to 0.189% of the 12.5-fold of total capital requirements. In addition, the prudential levy introduced in November 2013 grew from 0.037% to 0.05% of the 12.5-fold of total capital requirements calculated for each of the banks.

 

 

Revenues

 

Costs

 

LLP

green-triang  NO

red-triang  YES

green-triang  NO

Obligatory higher own contribution to mortgage loans

From 2014 the PFSA tightened the rules for granting mortgage loans in the new Recommendation S. In line with the guidelines issued by the PFSA, from January 2014 the own contribution required when purchasing a real property was at least 5%, and from the beginning of 2015 it has been increased to 10% of the value of the real property. The amount of the own contribution will rise each year by 5%, to reach 20% in 2017. Moreover, the amount of own contribution will depend on the additional loan collateral, and the loan cannot be taken out for a period longer than 35 years.

 

 

Revenues

 

Costs

 

LLP

red-triang  YES

green-triang  NO

red-triang  YES

Introducing additional curbs on insurance product distribution by banks

Pursuant to Recommendation U concerning good practices relating to bancassurance of June 2014, from April 1, 2015, banks will be obliged to ensure that the client has a free choice of insurance company. The bank cannot simultaneously act in the role of the insurer and insurance intermediary, and the consideration of the bank for offering insurance products is to be set in a relevant proportion to the amount of the costs incurred by the bank.

 

 

Revenue

 

Costs

 

LLP

red-triang  YES

red-triang  YES

green-triang  NO

Consumer bankruptcy

An amendment to the Bankruptcy and Reorganisation Law, the Act on the National Court Register and the Act on Court Fees in Civil Cases, entered into force on January 1, 2015. The major change resulting from the new regulations is simplification of procedures concerning consumer bankruptcy. The consumer has now easier access to the procedure of declaring bankruptcy in the case of excessive debt. It will be a new chance for the persons who ran into financial troubles, including the banks’ clients who took out loans.

 

 

Revenue

 

Costs

 

LLP

red-triang  YES

green-triang  NO

red-triang  YES

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Impact of the appreciation of the Swiss franc on the position of borrowers, the banking sector, and mBank

On January 15, 2015, the Swiss National Bank (SNB) after nearly three years of keeping a capped exchange rate of the Swiss franc to the euro decided to drop the cap. As a result, the Swiss franc appreciated strongly against the euro and the zloty. At the same time, the SNB cut the interest rate to -0.75%, resulting in a decrease of LIBOR CHF. The sharp appreciation of the Swiss franc affects the households budgets of some 550 thousand families which hold housing loans denominated in the Swiss franc, and impacts the financial position of banks.

The Polish Financial Stability Committee (KSF) at its meeting on January 20, 2015, with the participation of representatives of some commercial banks holding significant portfolios of FX mortgage loans confirmed that the banking sector is stable and resilient to external shocks, including major volatility of the FX rate, despite the relatively high share of the CHF housing loan portfolio. The value of the Swiss franc loan portfolio has been decreasing steadily due to repayments. The impact of the appreciation of the Swiss franc on principal and interest payments should be seen in the context of the decrease of LIBOR since the original loan disbursement as well as growing average household incomes.

The following decisions were made:

  • Banks should include the negative LIBOR in interest rates on loans;
  • Banks should not require additional collateral for loans where the borrower’s debt increases due to an increase of the FX rate of the Swiss franc against the zloty. The Polish Financial Supervision Authority announced that it will not require banks to impose additional collateral;
  • Banks should reduce their FX spreads.

The Financial Stability Committee recommended that banks apply restructuring solutions which meet the individual needs and capacity of each client and match them to the prevailing market conditions.

The position of the Polish Bank Association (ZBP) is consistent with the recommendations of the Financial Stability Committee. The Polish Bank Association has proposed that banks should include the negative LIBOR CHF in calculating interest rates on loans; reduce the FX spread for a period of six months; and extend the timeline or temporarily suspend the payment of Swiss franc loans at the request of clients.

The Ministry of the Economy published its position on January 28. The proposed solutions include recommendations for banks, as well as recommended legal and regulatory amendments. The recommendations for banks are as follows:

  • Interested borrowers should have the option of converting the currency of the loan from CHF to PLN with no extra fee at a rate equal to the mid-rate published by the NBP on the conversion date;
  • Credit holidays for a period up to three years should be introduced into active credit agreements (also for PLN loans) and instalments should be capped at the 2014 YE level;
  • No additional collateral should be required for loans due to the FX rate volatility.

The recommended legal and regulatory amendments include:

  • The FX risk of borrowers should be capped;
  • Additional collateral required within the term of an agreement in the event of FX rate volatility should be subject to restrictions;
  • Cancellation of a loan in part should not be considered the borrower’s taxable income;
  • Credit cancellation costs should be considered eligible tax-deductible expenses of banks;
  • Claims under mortgage loans (granted for up to 100% of property value) should be capped at property value for new credit agreements;
  • Solutions which support flexible reaction to credit repayment problems should be introduced and promoted (for PLN and foreign currency loans);
  • Solutions applicable where the borrower’s personal situation is extremely difficult should be introduced (for PLN and foreign currency loans).

In recognition of the provisions of existing Swiss franc mortgage loan agreements where the interest rate is based on a margin and LIBOR, mBank follows the rule whereby the negative LIBOR CHF reduces the credit margin. In addition, the Bank reduced the FX spread and provide clients in a difficult position with a package of solutions including among others extension of the term of the loan in order to keep the amount of instalments close to that paid prior the decision of the Swiss National Bank. The new solutions include also the option of transferring CHF mortgage to a new property.

The elevated exchange rate of CHF v. PLN, if persists, will have a moderate adverse impact on the financial performance of mBank in 2015. In particular, applying an exchange rate of 4.20 to calculate mBank Group’s capital ratios as of December 31, 2014, would reduce the reported Common Equity Tier 1 Ratio and Total Capital Ratio by roughly 40 basis points.

While a large majority of mBank’s CHF mortgage borrowers should see their monthly instalment reduce compared to December 2014, benefiting from negative Libor rate, certain increase in loan loss provisions, reflecting higher loan values relative to underlying collaterals may be registered. Finally, reduced FX spreads for mBank customers, a slightly delayed adjustment of the bank’s funding cost to the negative LIBOR regime compared to the adjustment speed for customer loans and potentially increased competition for domestic deposits (as some Polish banks other than mBank might seek additional liquidity to fund their CHF loan exposures through SWAP instruments) will have a moderately negative impact on mBank’s revenues in the medium term horizon.

The chart below presents the distribution of mBank’s CHF borrowers by percentage change of their instalment compared to December 2014 – as of January 29, 2015.