The 30.01.2018 decision on setting the countercyclical capital buffer rate
The countercyclical capital buffer (CCyB) rate for the exposures to Latvian residents has been set at 0%. The established CCyB rate will be used to calculate a credit institution-specific CCyB rate from 1 February 2019. The Financial and Capital Market Commission (FCMC) will decide about the necessity to set the CCyB rate above 0%, as soon as a significant rise in cyclical systemic risks is recorded in Latvia's financial sector.
FCMC, as an institution responsible for the application of the CCyB according to Article 35.5 of the Credit Institution Law, analyses the credit-to-GDP ratio every quarter, as well as its deviation from the trend and the additional indicators to justify the decision on the CCyB rate.
Using the broad credit definition, the credit-to-GDP ratio was 93% at the end of Q2 2017 while its standardized gap was -39%, implying the benchmark buffer rate of 0%. Using the narrow credit definition, the credit-to-GDP ratio at the end of Q3 2017 was 41% and the respective gap was -27%, as a result the benchmark buffer rate calculated under the narrow credit-to-GDP gap also was 0% (see the graph).
Credit-to-GDP, its deviation from the trend and the respective benchmark buffer rate according to the narrow credit definition
In 2017, the economic performance in Latvia has exceeded the projections made at the beginning of the year. The updated GDP growth forecast for 2017 has been increased up to 4.2%. Practically all economic sectors show development. More vigorous external demand on a global scale, also including across the European Union, enables progress in exporting sectors, including processing industries and transport services. A smoother use of private investments and EU funds contributes to the growth in the construction sector and related industries; whereas a household income increase has been a stimulus to private consumption.
Notwithstanding an improving macro-financial situation, no sustainable lending growth has been observed yet. A moderate increase in non-financial corporates' credit portfolio, observed in the second half of 2016 and the first half of 2017 has now come to a halt, even showing a 4.7% decline in September of 2017 (y-o-y). However, it should be noted that it was affected by a one-off factor related to the bank merger process and the rebooking of the part of loan portfolio to parent bank. Excluding the impact of above process the annual growth rate of domestic corporate credit portfolio would be approximately 0.3%. The stock of loans to households in September showed a 0.4% annual reduction.
The lending growth was still limited by both – demand (especially with regard to large corporates) and supply factors (especially with regard to small and medium-sized corporates). Though there had been observed individual slight credit standard weakening indicators in mortgage lending to households, overall in the Q3 2017 the credit standards mostly remained unchanged and still rather stringent. Credit demand from households continued to grow slightly, whereas demand from non-financial corporates overall did not change with a decrease in demand from large corporates and an increase in demand from small and medium-sized corporates.
The growth rate of house prices was high reaching 9.6% at the end of Q2 2017. However, it should be noted that this price index was determined by the still relatively low market turnover. The activity on the real estate market has slowed down compared to 2016, and overall in terms of the number of transactions still was about 30% lower than before the 2008 crisis. An increase in the price index was mainly due to an increase in prices of less expensive housing segment (standard apartments mainly in the secondary market) due to the growing demand for and limited supply of such affordable housing. Housing price dynamics were affected by household sentiment and improvements in the household financial situation, with a declining debt burden and increasing wages and salaries in practically all economic sectors, as well as better availability of loans in the context of the state support for the programme for mortgage loan guarantees for families with children. The program was launched in 2014 and aimed to facilitate making first instalment for the state-guaranteed loans for the families with children. The limited guarantee of 10%-20% depends on the number of children in the family. The amount of mortgage loans granted within this programme constitutes approximately one-third of all new housing loans granted, and the role of this program in the real estate market and lending is no longer increasing. Modifications are made to the program in 2018, broadening the pool of households eligible to apply for the program. As a result, there is an increase projected in the sales on the real estate market in 2018.
In the near future and medium-term, risks to the Latvian financial sector stability will be mainly arising from an external macro-financial environment, not an internal environment, related to the openness of the Latvian economy, international and geopolitical risks, as well as second-round effects from possible shocks in the Scandinavian countries' housing markets.
In general, activities of credit institutions had minor impact on economic growth in 2017, and the indicators do not show signs of excessive accumulation of financial imbalances and the necessity to set the CCyB above 0%. The FCMC will continue to analyse relevant ratios and trends when deciding on the setting of CCyB rate for subsequent quarters.