07/21/2020 6:48 AM

Financial Sector Stability In Lithuania Post COVID-19 (is there any cause for optimism?)

The relentless spread of COVID-19 since early 2020 has damaged the economies and asset markets of countries all over the world. With experts predicting a second wave of the virus, the long-term implications of this crisis remain highly uncertain.

Accordingly, it is useful to consider how resilient the Lithuanian financial system might prove to be in the event of a further deterioration in external conditions. Are there any glimmers of hope amid the gloom?

COVID-19 has brought a new set of challenges for the financial sector

Prior to the onset of COVID-19, Lithuania was in a decent vein of economic growth. Annual GDP growth accelerated to around 4% in 2019, and the purchasing power of households was bolstered by rapidly rising wages (+14% y/y in 2019) . At the same time, household debt levels were among the lowest in the EU. Businesses were in good financial shape with rising revenues and profits, ample liquidity and moderate leverage. Against this backdrop, loans to the private non-financial sector continued to grow at a decent clip heading into 2020. Non-performing loans were declining and banks’ capital buffers and liquidity ratios offered solid protection against external shocks.

Although national accounts data for Q2 2020 has yet to be released, the signs are not encouraging. It’s more than likely that weakening domestic and external demand have put the brakes on wage growth and driven up unemployment. With default risk rising, banks have tightened lending conditions, restricting the flow of credit to businesses and households. In May 2020, the loan portfolio of MFIs to non-financial corporations was 7.5% smaller than in the same month of last year. Furthermore, the flow of new loans was down by almost a third, reaching lows not seen for a decade.

Lithuanian economy is on course for a severe contraction in 2020

According to the latest projections from the Bank of Lithuania, the country’s economy will shrink by about 10% in 2020. Internal and external demand for goods and services is forecast to fall, pushing down wage growth and leading to a spike in joblessness. These trends will exacerbate financial strains facing local companies and households, and most likely lead to a rise in loan delinquencies. All of this could have knock-on impact on banks’ balance sheets and their willingness to lend.

It’s a pretty gloomy picture. The question is: are there any rays of light for Lithuania? And how will the domestic financial sector fare in the event of a second wave of COVID-19 disruption?

Financial system is well equipped to deal with further economic turmoil

The good news is that the Bank of Lithuania expects to see a ‘V-shaped’ recovery in the coming years. After an inevitable sharp decline this year, the economy is forecast to expand by over 8% in 2021, as imports and exports bounce back with double-digit growth. Several factors underpin this assessment.

First, following the recent lifting of quarantine restrictions, domestic demand immediately recovered and consumer confidence shot back up. Demand for workers is rising again and real estate prices have held their ground surprisingly well. All of the indications suggest that the financial sector remains in good health. Stress tests measuring capital and liquidity ratios have determined that Lithuanian banks would be able to withstand a 10% economic contraction. What’s more, profitability and efficiency in the financial sector are among the highest in the EU. Non-performing loan metrics are not currently pointing to significant problems ahead. This is partly due to the fact that banks have eased the repayment schedules facing customers who are experiencing cash flow problems.

Businesses are holding up well despite tighter bank credit requirements

There are several other factors that have helped to preserve financial sector stability during the recent market gyrations. For example, the debt burden of Lithuanian businesses is among the lowest in the EU. In addition, despite the fact that banks are more reluctant to lend, companies are finding new ways to fund themselves via alternative (non-bank) sources. The Bank of Lithuania has also helped to prevent the business sector from stalling by cutting back on regulatory requirements.

All told, while the near-term economic and financial outlook is certainly bleak, there is no need for excessive pessimism. Much will depend on whether the second wave of COVID-19 arrives in the autumn, and how severe it proves to be. Whatever the case, the Lithuanian financial system looks to be in good shape to withstand further economic and market turmoil.