The threat to the financial system from systemic risks has fallen slightly from a moderately elevated level. However, in addition to the possible escalation of geopolitical developments, the continued growth in property prices continues to contribute to the risks, according to the Croatian National Bank (HNB).

This is stated in the HNB publication “Financial Stability 25”, which also points out that the strong economic growth has supported household income and the business results of the corporate sector, which also has a positive impact on the stability of the financial system.

The main structural weaknesses of the economy in the form of the high exposure of the banking system to the state and the low labour force participation rate, which together with unfavourable demographic and migration trends limit the economic growth potential, have remained unchanged. The overall exposure of the financial system to systemic risks has therefore fallen only slightly from a moderately higher level, according to the publication.

The main sources of risk to financial stability arise from a possible escalation of geopolitical tensions, which could have a negative impact on global economic development and indirectly on the domestic economy.

Strong growth trend in short-term rents

The increase in risk is also due to the continued growth in property prices, which was much stronger in 2023 than in other eurozone countries, although the number of transactions continued to fall. The property market was additionally affected by investor demand for properties for short-term rental purposes, particularly on the Adriatic coast.

Nevertheless, risks to financial stability were mitigated by the relatively low level of household debt, banks’ moderate exposure to housing loans and the setting of interest rates in line with regulatory limits on interest rates on existing loans, according to the HNB.

Pressure from short-term rentals is highest in cities and towns along the coast. Prices for short-term rentals nationwide were 26% higher in August 2023 than in August 2022.

Although short-term rental prices rose faster than long-term rental prices from the end of 2022 and in 2023, their indices developed similarly, and strong growth in long-term rental prices and even more so in short-term rental prices was observed during 2022 and 2023, with signs of slowing in early 2024, according to the HNB.

Increase in national reference rate may have very limited impact on financial stability

The HNB notes that the strong labour market and income growth have boosted lending to private households, particularly in the segment of non-earmarked cash loans. Their growth at the end of 2022 was 2.4% on an annualised basis, while at the end of March 2024 it was 12.6%.

On the other hand, growth in housing loans has stabilised at a moderately high level, according to the central bank.

It notes that the growth in interest rates on fixed deposits and the associated increase in the national reference rate would slightly and gradually increase the cost of paying existing household loans.

Under the conditions of rising interest rates and property prices, the increasingly long terms of housing loans and the growing ratio of debt repayment and debt service to income increase the vulnerability of consumers to possible unfavourable financial circumstances, according to the HNB.

High profits for the banking sector in 2023

The banking sector recorded high profits in 2023 and its high resilience was also confirmed by solvency and liquidity stress tests against unlikely, very intense shocks.

However, the outlook for profitability will be affected in the medium term by the continued rise in funding costs, a possible deterioration in asset quality and increased interest rate risks.

The focus of HNB’s macroprudential policy remains on maintaining high capital buffers, which will help maintain the bank’s resilience in the event of a deterioration in macroeconomic or financial conditions without negatively impacting the availability of credit, the bank said.