OREANDA-NEWS. June 23, 2009. By publishing the Financial Stability Review, the Bank of Lithuania aims to review the development of Lithuania’s financial system and evaluate its capacity to operate under less favourable conditions of the macroeconomic environment, reported the press-centre of Bank of Lithuania.

The Review indicates that this year and the coming years will be full of challenges to the financial system of Lithuania. Falling economic activity in the country, still inadequate functioning of the global financial markets and falling risk appetite will have a large impact on the functioning of the Lithuanian financial system. Unfavourable domestic macroeconomic situation resulted in a deterioration of the situation of borrowers: the losses of enterprises and the number of bankruptcies increased and a larger share of households faced difficulties in meeting their liabilities to credit institutions, compared to the previous year.

The situation in the global financial markets entailed higher risk premia on lending to new economies, including Lithuania. Although the risk premia of new economies remain elevated, the assessment of this risk has declined recently and will continue to do so, once the development of the national economy stabilises and returns to the path of sustainable growth and the global economy recovers.

The first signs of credit growth deceleration that appeared in the second half of 2007 became apparent in 2008, whereas at the end of the year and in the beginning of 2009 the bank loan portfolio started to shrink. In the second half of 2008, the bank loan portfolio quality also started to deteriorate. This deterioration was mainly determined by lending to businesses. However, the deterioration in the quality of loans to households is also likely in the future due to the growth of unemployment and a decline in household income.

The banking system was profitable in 2008. On the other hand, the loan impairment losses have started to increase and the banking system has already suffered minor losses in the fourth quarter of 2008 and the first quarter of 2009. Bank risks were reduced by a further increase of capital adequacy, which reflected better risk coverage by capital and larger reserves for the absorption of unexpected losses. In terms of liquidity risk, the banking system’s resilience to external shocks was ensured by the fact that the banks mainly borrowed in the domestic market and from parent banks.

The liquidity risk associated with withdrawal of deposits, which increased at the end of 2008, subsided and liquidity shortage was not observed in the domestic banking system. The reduction of the bank reserve requirement ratio from 6 per cent to 4 per cent and the increase of the maximum insurance coverage to EUR 100 thousand made a positive contribution to the improvement of liquidity situation. In addition, parent banks fully covered liquidity shortage in the market by additional lending to their subsidiaries.

The stress-testing results confirmed that liquidity tensions subsided in the market, whereas credit risk is the most important challenge to the domestic banking system in the medium term. The credit risk stress testing showed that the banking system has adequate capital resources to absorb expected loan portfolio losses. Capital buffers of the banking system used to cover unexpected losses increased in 2008 and in the beginning of 2009. In addition, banks have individual plans to increase capital. Further increase in capital is an important element in the strengthening of financial stability, ensuring adequate preparedness of banks to absorb probable, although unlikely, credit losses in case of highly unfavourable domestic and global macroeconomic environment.

The Review indicates the most important financial system risk mitigation measures implemented in 2008 and in the beginning of 2009.

The Bank of Lithuania publishes financial stability reviews once per year since 2006. They are prepared by the Economics Department of the Bank of Lithuania in cooperation with other departments of the Bank.

The Financial Stability Review for 2009 in English will be soon available on the website of the Bank of Lithuania: www.lb.lt.