The macroeconomic outlook is prompting the Romania banks to recalibrate strategy. What are the vulnerabilities they need to pay attention to?

After almost a decade of very strong GDP growth, Romania is preparing itself for a steep slowdown. According to the latest European Commission report (11.11.2022), Romania will close 2022 with a 5.8% GDP growth signaling post pandemic recovery, mainly driven by internal consumption. However, 2023 projected GDP growth is below 2%, with a negative outlook trend, as Romania has delayed the design and implementation of the Recovery and Resilience plan, reducing prospective investments. According to the Commission, Romania is not expected to get significant support from the external sector. Inflation is expected to remain high throughout 2023 and taming all time high deficit will remain a challenge given the macro environment and the 2024 elections.

According to IMF’s Chapter IV for Romania (26.09.2022), the Fund advises Romania to adhere to fiscal discipline by decreasing spending (including the energy cap), increasing taxation (personal income, VAT) and devaluing the RON. The austerity proposition from the fund will of course reduce disposable income and consequently reduce the dynamic of the consumption led GDP growth. ING’s CEEMEA FX Outlook 2023 forecasts a significant RON depreciation in the first half of 2023.

Finally, from a geopolitical perspective, Romania, much like Poland, finds itself in direct proximity to Russian aggression. It is no coincidence that in 2023 Romania is increasing its defense spending to 2.5% of GDP, following Poland in a more ambitious defense budget. Geopolitical tensions will continue as Moldova faces increasing threat from Russia and the region faces a higher probability of contagion.

That said, it seems that the macro forecast for Romania is still more positive than the general outlook for the European Union. According to CNBC, “Euro zone predicted to have a deep recession and a difficult, slow recovery”. The article cites ECB’s Lagarde on the increased probability of recession and European Bank economists on a deep recession to drag through the first semester of 2023 and a slow recovery due to energy market dynamics and supply chain interruptions. The article is highlighting Germany with a negative 2023 GDP growth of -1%, and in the past gloomier scenarios have been made for Italy, while Austria and Belgium are estimated to be already contracting.

The macro-outlook in EU and Romania is indeed prompting the banking sector to recalibrate strategy. Romanian banks have never been better capitalized to enter a correction phase, however there will be vulnerabilities that need to be attended to.

The supervisors have prompted the banks to reassess their strategy and business model in order to demonstrate viability of current strategy and profitability, within the banks’ risk appetite. To achieve an effective strategy recalibration for a viable business model (short, medium, long term) one has to align the bank’s risk appetite, its competitive landscape and financial projections. The biggest challenge in financial projections is the asset quality forecast and provisioning model. After 3 extraordinary years whose data is, unfortunately, unreliable, as it does not reflect the real asset quality - because of multiple factors, including the government support measures, such as moratoria, which makes default rates still not visible in the balance sheets -, the bank has to recalibrate IFRS9 methodology and provisioning models.

The supervisors and the national resolution authority, similar to all EU states, are pressing the banks to comply with MREL capital requirements. The current status of European capital and money markets is making the issuance of MREL bonds by Romanian lenders a significantly costly venture, putting additional pressure on the prospective profitability of the business model.

The presence of Romanian banks in Moldova (subsidiaries or branches of Romanian owned banks or those of Eurozone subsidiaries in Romania) is causing concern in terms of recovery/resolution and business continuity in the event of a war contagion in Moldova. The geopolitical pressure is forcing banks to consider how to handle their presence; whether to exit or to shield with a more rigorous hybrid and business continuity model. The experience from Ukraine provided valuable lessons to European and Romanian banks.

The worsening of the economic climate has increased credit risk and will lead to a deterioration of the asset quality in the loan book. A shift from stage 1 (performing credits that did not have an increased credit risk) to stage 2 (performing credits that have increased credit risk than predicted at the moment of the loan origination), or a shift from stage 2 to stage 3 (borrowers in default) will alter the provisioning outlook of the bank and in the adverse scenario increase the NPL ratio of the bank. In either case, the bank needs an adjusted early warning indicator framework to be able to identify loans that need restructuring and ultimately banks need a proactive balance sheet optimization plan to discard stage 3 loans. The current tax environment is proving to be an obstacle, therefore special attention is needed of how the regulator coordinates with the state for the banks to be able to divest from costly non-performing exposures.

Despite the geopolitical and financial turmoil, the ECB and NBR have shown little appetite to slow down the Green transition. On the contrary, the ECB has communicated a final warning to Eurozone banks to identify, report and manager their vulnerabilities, while NBR is working on a very elaborate climate risk supervisory framework that will challenge the Romanian lenders in an equal way. Romania’s climate risk supervisory framework is expected to be one of the first of its kind in EU. The banks will need in essence to re-segment their portfolios introducing climate risk KPIs, a way to quantify their risks and a strategy to address them.

Finally, the Romanian banks will need to step up their efforts when it comes to shielding themselves from cyber risk. The intensification of the cyber warfare and the unstable geopolitical situation provide a higher degree than ever of war contagion in CE and Romania including nonconventional measures such as cyber-attacks. Although Romanian banks have made progress, the aggressive digital transformation program in the last years is leaving Romanian banks more vulnerable than ever.