CNB reduced the bank reserve requirement rate

After the Government of the Republic of Croatia had determined models of funding measures for economic recovery and development, the Croatian National Bank Council decided to reduce the bank reserve requirement rate from 14% to 13%.
The new rate of 13% will be applied from mid of this week when the new reserve requirement period starts. According to estimates this measure will release approximately HRK 2.9 bn of additional liquidity for banks (about 2.4 bn in the kuna component and 0.5 bn in the foreign exchange component of reserve requirements), thus increasing their credit potential and reducing unit operating costs.

However, in its regular statement central banks strongly stressed that if the realised liquidity would be used as in previous year e.g. to stimulate consumer goods imports or to invest in foreign exchange, destabilising the exchange rate as a result, the CNB would take all measures at its disposal, including liquidity management, to preserve macroeconomic stability.

The objective of new anti-recession government measures is the creation of conditions for economic growth sustainable over the long term. Through these measures government wants to encourage banks to make loans to those firms that were otherwise operating successfully but got into difficulties because of the downturn in global financial and economic trends. While under the first model the government actively co-finances bank loans to sustainable economic projects (via the Croatian Bank for Renovation and Development that assumes 30% of the risk and banks 70%), the second scheme will see a HRK 2 bn guarantee fund where the state's exposure to individual firms does not exceed HRK 60 mn or 50% of the loan amount.


Market reaction
The CNB measure was already widely anticipated by the market since CNB several times repeated it’s readiness to relax monetary policy (cut the mandatory reserve ratio during year from 14% to 11% and thus releasing about HRK 9bn) in order to speed economic recovery by larger and more favourable loans to be granted for projects contributing to healthy growth, rational employment and balance of payment improvement. So this could be the first step in further cuts of reserve requirement rate (towards 11%).

The FX market response was rather calm as the EUR/HRK barely moved above 7.32. On the money market we did not see any significant changes since the liquidity has been on a high level for the last three months. Furthermore, money market interest rates continue to touch the lowest historical levels. Thus, with the approximate HRK 5bn of free liquid assets already present in the banking system, it is considered that there are sufficient funds to start the recovery of the economy.


Expectation
The government funding measures are divided in three models:
·        short-term oriented club loans where the Croatian Bank for Renovation and Development share has a cheaper pricing than the commercial banking loan,
·        medium term oriented investment loans with the partial government guarantee,
·        long-term oriented government participation in venture capital funds, not yet defined in details.

In the short run the corporate lending volume is expected to increase based on the risk sharing between the commercial banks and the government.
A prompt result is to be seen through a reduction of illiquidity in the corporate segment that could slow down the negative movements on the labour market. A potential major problem in the implementation of this new government support package is a question whether the recession weary entrepreneurs have enough high-quality programs that can quickly penetrate the relatively stagnant market. Namely, demand for products and services in the domestic market is still falling and the recovery on traditional export markets is just at the beginning and there is no indication that it will be fast.

The main consequence of risk sharing would be a lower interest rate on loans disbursed from the government models compared to the market interest rates. Corporate clients, who are able to participate in the lower financial costs models, could increase their indebtedness level without the proportional increase of financial expenses, and be more competitive than other corporates. That would create a high demand for loans from the government models and would decrease a demand for commercial loans, pushing the market interest rates down.

It is likely that the fiscal effects over the short term will be positive, as a result of the anticipated reduction of illiquidity. Namely, the measures anticipate that companies will have to settle any outstanding debts to the government they might have with the funds obtained via these programs, if such debts are not regulated or rescheduled. On the long run these measures will surely increase budget deficit and public debt. Furthermore, state aids in Croatia are already high, and the application of these measures could adversely affect competition on the domestic market.