Andrijana B. Danevska
Assistant Professor
Faculty of Economics and Administrative Sciences

Recessionary tendencies in the world economy, as well as the slowdown in domestic growth are negatively reflecting on the financial capacity of enterprises and their ability to regularly service liabilities. These problems in the corporate sector spill over into the “households” sector over certain time delay. After the global financial crisis in 2007, which was considered as one of the most serious financial crises after the Great Depression in 1929, new adverse macroeconomic conditions emerge globally. COVID 19 caused a collapse of financial markets, breakdown of global value chains, disappearance of public life and the service sector. In contrast to the Global Financial Crisis in 2007-2009, this was triggered by a number of factors such as, lack of supervision or control over credit securitization, credit rating agencies, and market policy, COVID 19 crisis started as a government measure for maintaining the public health and not overloading the health care systems.

The collapse of the Lehman Brothers Bank in 2008 started a chain reaction characterized by panic on the markets and a lack of trust, which led to spreading of the financial crisis into the global economy. The governments supported the financial system by increasing deposit insurance ceilings, providing guarantees for bank liabilities, and recapitalising banks being bailed out or wound down. They implemented fiscal measures to reduce the fall-out of crisis on the rest of the economy. This resulted in a mix of ‘automatic stabilisers’ (decreasing tax receipts coupled with increased government welfare payments as the economy slowed down) and targeted discretionary fiscal measures, such as additional public investment, tax relief and subsidies for part-time employment. These actions led to dramatic escalation of public debt and the creation of European sovereign debt crisis in 2009, which had its peak between 2010 and 2012.

The Macedonian banking system was not directly affected by the world economic crisis in 2008, but it could not avoid the indirect effects of the global economic crisis that was spilled over the domestic real sector. The stable financial condition of our banking system was derived from its “closure” to international financial markets, the non-existence of exposure to the so-called “toxic products”, its relative strong capital and liquidity position, caution when taking risks, as well as macro prudential measures taken by the National Bank.

The performance of the Macedonian banking sector was visibly deteriorated in 2009, one year later after the Global Financial Crisis. Given the fact that macroeconomic instability has significant impact on banking sector performance, the performance of the Macedonian banking sector during the last financial crises will be analyzed, from aspect of profitability and risk profile, so that we can derive assumptions about the impact that COVID 19 will have on the performance of the Macedonian banking system.         

Banks’ profitability, as an important indicator of banks’ performance, and represented here by ROAA on figure 1, had its greatest declines in 2009 and 2011. The main factors that contributed to this reduced profitability by Macedonian banks can be derived by using the Du Pont Formula. According to Du Pont Analysis, the formula for calculating ROAA can be broken down in two parts: profit margin and asset utilization. The Profit margin, calculated as a ratio between the net-income and total revenues, acts as an indicator of а bank’s effectiveness in cost control and in generating revenues. In figure 1, the profit margin in 2009 and 2011 has its low values, 12.1% and 7.3%, respectively. According to the data presented to the National Bank by the Macedonian banks, the cost to income ratio in 2009 and 2011 is 70.1 and 67.8% respectively, and it shows that operating expenses were sharply increased. The increase of operating expenses was mostly due to the deteriorating quality of loan portfolios, and the increase of provision for loan losses.

Figure 1 ROAA as a profitability indicator of the Macedonian Banking System

Source: Own data processing according to Banking system indicators publicly available on: http://www.nbrm.mk/bankarska_supervizija_i_rieghulativa-en2.nspx

Furthermore, the analysis conducted by Nikolov and Popovska-Kamnar in 2016, shows that non-performing loans are results of macro and bank determinants and that the decline in economic activity in the country contributes to asset deterioration of banks and an increase in non-performing loans. Additional factors that contributed to the decrease of the profit margin in the banking system were: the decreased rate of growth of bank activities, especially the credit activity, which was reflected in the decrease of the net-interest income by 5.8% and the intense competition in the banking market for sustaining a stable deposit base which increased the passive interest rates and created an additional raising in operating expenses.

Asset utilization, calculated as a ratio between the total income and total assets, reflects the bank’s management efficiency in investing in different types of assets which have different yield interest. In 2009, the Asset utilization has a value of 5.2%, and this lowered value comes as a result of the increase in the total assets and decrease in total income. However, the growth in total assets came as a result of the increased share of cash and balances at the National Bank, and the placements at domestic and foreign banks. This increase of cash and balances at the National Bank was a result of legislation changes regarding the calculation and meeting the requirements for reserve requirement of banks[1]. In 2009, there was also an increase in the placements in banks, mostly as a result of the introduced obligation (in December 2008) for banks to achieve minimum liquidity rates prescribed by the National Bank. By analyzing the total income in the banking sector, one can note that its growth rate declined, but mostly due to the decrease in the credit demand, i.e. the sale of loans, especially to the corporate sector. In disrupted economic flows, the corporate, and household sector sustain from investment activity. Therefore, banks’ management teams decide to invest their available funds in securities in order to overcome the loss from net interest income.

The risk profile of the Macedonian banking sector will be analyzed by using several indicators of credit, liquid, and solvency risk. In addition, the risk profile of the banking sector will be analyzed, starting from credit risk, because it plays a crucial role in the arising problems in all areas of banking operations, such as liquidity or the usage of capital for covering credit losses.

Credit risk, or risk of default, is a subject to numerous theoretical and empirical researches, and many of them connect credit quality of loan portfolio with economic activity. Generally, credit risk is associated with the traditional lending activity of banks and it is simply described as the risk of a loan not being repaid in part or in full. The rising share of non – performing loans (NPLs) in total loans in the banking sector is one of the biggest problems in economic stagnation. According to figure 2, the greatest increase in the share of NPLs occurs in 2009, and looking further in 2010 and 2011, there is only a slight increase to 9.5%, but the share of gross loans in total active has decreased from 2009 and onwards to 2012, when its value remains constant at 61%. These two indicators show a decline in the credit activity of the banking sector with a simultaneous increase in the NPLs. The banking sector reduced its credit activity, due to the reduced credit demand, and the increased share of NPLs. According to Rother (2010), because of the increased share of problematic loans, banks raise their interest margins (to cover up the costs of impairment), and tighten the credit policy for approving loans, in order to protect themselves from the risks of loan write-off.

  Figure 2 Credit risk indicators

Source: Own data processing according to Banking system indicators publicly available on: http://www.nbrm.mk/bankarska_supervizija_i_rieghulativa-en2.nspx

The banking sector in Republic of North Macedonia is characterized with high liquidity. The share of the liquid active in the total active has its greatest rate of growth in 2009 and 2010 (as shown in figure 3), when the banking system notes reduced share of gross loans in total active, but also high share of investment in treasury bills and government securities. This additionally supports the assertion that banks were especially efficient when allocating the available funds. The liquidity position of banks in RNM was enhanced by the dominant role of domestic deposits as a source of funding, thanks to which the banking system did not face difficulties in providing sources of funding, during the period of global liquidity shortages.

Figure 3 Liquidity risk indicators

Source: Own data processing according to Banking system indicators publicly available on: http://www.nbrm.mk/bankarska_supervizija_i_rieghulativa-en2.nspx

The risk of solvency as an inability of banks to meet their long-term debts and financial obligations is measured as a ratio between the banks’ capital and total assets. Two types of indicators are shown on figure 4, because of the possibility for complementary analysis. The capital adequacy ratio actually shows the available capital of banks in relation to overall risks they face. It is an especially important indicator that regulators track to ensure that the banks can withstand significant – but not unreasonable – losses or fluctuation in revenues. The primary function of CAR is to effectuate efficient and stable financial systems. It indicates the extent to which assets are funded by other than own funds and is a measure of capital adequacy of the deposit-taking sector. The capital to assets ratio as an indicator of banks’ capital adequacy shows the financial leverage. The rationale behind this indicator is that if the market value of а bank’s total assets is lower than its obligations, then the bank is insolvent. It indicates the extent to which assets are funded by other than own funds and is a measure of capital adequacy of the deposit-taking sector. The proper capitalization of banks enables them to absorb the losses and to reduce the solvency risk. Solvency and capitalization of the banking system remained high during the Global Financial Crisis and even improved due to the higher growth rates of capital positions of the banks compared to the growth rates of the banking system activities (risk weighted assets). Our banking system is characterized with continuous high quality of capital positions, mostly due to the increase of Tier I capital.  

Figure 4 Solvency and capitalization indicators

Source: Own data processing according to Banking system indicators publicly available on: http://www.nbrm.mk/bankarska_supervizija_i_rieghulativa-en2.nspx

By reviewing the indicators of the banking sector’s performance during and after the Global Financial Crisis, the following key points can be derived:

1. The operational capability of banks to generate revenue that cover operating expenses, started enhancing from 2013 onwards. At the end of 2019, the net profit margin of Macedonian banks was 29%, and it was especially under the influence of the low share of non-performing loans in gross loans (4.62%) and increased non-interest revenues. The credit activity of banks was normalized after 2012, and they were able to focus on diversifying their portfolio of banking activities and providing additional sources of income, e.g. bancassurence. Today, when facing the COVID 19 crisis, the banking management in RNM is efficient in the usage of the banks’ profit-generating assets.

2. Due to the fact that credit activity is the core banking activity in the Macedonian banking system, the share of non-performing loans in total loans is one of the most significant factors with the greatest impact on bank’s performance, especially in economic downturns. At the end of 2019, the Macedonian banking sector faced historically the lowest level of non-performing loans, which gives space for the banking sector to focus on efficient allocation of available funds towards creditworthy borrowers and restructuring of problematic loans.

3. The Macedonian banking sector is characterized with high liquidity and high quality capital positions, as of December, 2019, but if there is a prolonged influence on the causes of profitability deterioration, in conditions of limited opportunities to provide new external sources for financing, there could be limited possibilities for increasing the capital position of banks from internal sources, through reinvestment of profit.

COVID 19 has globally disrupted all the economic flows and all these adverse events are happening promptly and simultaneously in every national economy. On one hand, the policy makers undertook fast and efficient measures, which indirectly facilitated the financial burden of credit borrowers, households and legal entities. On the other hand, by understanding the importance of functioning of the real sector, in terms of servicing its financial obligations towards banks, the National Bank took an effective response regarding the credit risk. Actually, the National Bank undertook measures that have a direct influence on the most significant factors of a bank’s performance during economic downturns, and that is the share of non-performing loans and reduced credit activity. Non-performing loans act as one of the most vulnerable category in the bank balance sheet that has direct impact on banks’ liquidity and solvency.

By applying this measure banks are deducting one source of liquidity supply till September 2020 and have greater exposure of risk tied to lowering the market value of assets. The National Bank justifies this measure by relying on the solid liquidity position of banking sector that comes from the stable deposit base. In addition, the National Bank through the monetary instrument – open market operations released in total amount of 15 billion denars, which is expected to provide further support to banks’ credit activity, which in turn expects to have greater impact on their performance. What is important to note here is that the banking sector and the National Bank should preserve the confidence of depositors, because any kind of instability can cause deposit withdrawal, and this was one the main pillars of the banking sector stability during the Global Financial Crisis.

The performance of the banking system will be disrupted, because of the decrease in operating revenues, especially due to decrease in net – interest income and decrease not only in the credit demand, but in the overall demand for financial services. In addition, despite the postponement of the banks’ obligation for recognizing the loan loss provisions, not later than 31.12.2020, this impairment has to happen due to the reduced creditworthiness of corporate clients and households. This will result in low, and even negative growth rate of profitability in the banking sector in 2020 with high degree of probability that it will continue by 2022, according to the latest macroeconomic projections by the NBRNM. It is still uncertain to determine the intensity and duration of adverse effects on banks, but if the mass extension for loan repayments is to be continued, the liquidity risk will be increased. Banks would be left out with less available funds for supporting the growth of credit activity (despite the effort of decreasing the base interest rate) and will have an immediate impact on banks’ profitability and through that on banks’ solvency.

[1] The rates of mandatory reserve increased from 10% to 11.5% for liabilities in foreign currency for the period of July (or 13% for the period of August) and from 10% to 20% for the Denar liabilities with currency clause.