Introductory remarks

The macroprudential diagnostic process consists of assessing any macroeconomic and financial relations and developments that might result in the disruption of financial stability. In the process, individual signals indicating an increased level of risk are detected, according to calibrations using statistical methods, regulatory standards or expert estimates. They are then synthesised in a risk map indicating the level and dynamics of vulnerability, thus facilitating the identification of systemic risk, which includes the definition of its nature (structural or cyclical), location (segment of the system in which it is developing) and source (for instance, identifying whether the risk reflects disruptions on the demand or on the supply side). With regard to such diagnostics, instruments are optimised and the intensity of measures is calibrated in order to address the risks as efficiently as possible, reduce regulatory risk, including that of inaction bias, and minimise potential negative spillovers to other sectors as well as unexpected cross-border effects. What is more, market participants are thus informed of identified vulnerabilities and risks that might materialise and jeopardise financial stability.

Glossary

Financial stability is characterised by the smooth and efficient functioning of the entire financial system with regard to the financial resource allocation process, risk assessment and management, payments execution, resilience of the financial system to sudden shocks and its contribution to sustainable long-term economic growth.

Systemic risk is defined as the risk of events that might, through various channels, disrupt the provision of financial services or result in a surge in their prices, as well as jeopardise the smooth functioning of a larger part of the financial system, thus negatively affecting real economic activity.

Vulnerability, within the context of financial stability, refers to the structural characteristics or weaknesses of the domestic economy that may either make it less resilient to possible shocks or intensify the negative consequences of such shocks. This publication analyses risks related to events or developments that, if materialised, may result in the disruption of financial stability. For instance, due to the high ratios of public and external debt to GDP and the consequentially high demand for debt (re) financing, Croatia is very vulnerable to possible changes in financial conditions and is exposed to interest rate and exchange rate change risks.

Macroprudential policy measures imply the use of economic policy instruments that, depending on the specific features of risk and the characteristics of its materialisation, may be standard macroprudential policy measures. In addition, monetary, microprudential, fiscal and other policy measures may also be used for macroprudential purposes, if necessary. Because the evolution of systemic risk and its consequences, despite certain regularities, may be difficult to predict in all of their manifestations, the successful safeguarding of financial stability requires not only cross-institutional cooperation within the field of their coordination but also the development of additional measures and approaches, when needed.

1 Identification of systemic risks

At the end of the second quarter of 2024, total exposure to systemic risks remained at a moderate level amid robust economic growth. The strong rise in income and consumer confidence imparted momentum to consumer lending, while housing lending stabilised on an elevated level, reflecting growing residential real estate prices and a reduced number of housing loans. On the other hand, corporate lending has remained subdued. Favourable economic developments are reflected in the continued improvement in the performance of non-financial corporations, and, in turn, in the operation of credit institutions. The share of non-performing loans dropped further from a historically low level, contributing to the maintenance of the high profitability generated by increased interest rates. This, in addition to favourable capital and liquidity positions, strengthens the resilience of the banking system to potential shocks. The greatest risks to the stability of the financial system stem from developments in the international environment and on financial markets. As for domestic risks, the aforementioned strong growth in consumer loans and the worsening of the debt servicing ratio for new housing loans stand out. On the other hand, the decrease in the number of purchase and sale transactions and the slowdown in the growth of residential real estate prices are mitigating the risks related to the housing market.

Figure 1 Risks to financial stability remain moderate

Note: Arrows indicate changes from the risk map published in Macroprudential Diagnostics No. 23 (July 2024).
Source: CNB.

The brief period of increased volatility on global financial markets seen in early August shows that market developments are exceptionally vulnerable to any significant deviation of economic indicators from expectations and to changes in the direction of economic policy. The unexpectedly poor figures from the US market during the summer and the decision of Japan’s central bank to raise the key interest rate triggered a change in the expectations of financial market participants, accompanied by a widespread reaction. The value of shares on the global market fell, yields on bonds of major global economies shrank, the US dollar weakened against the majority of global currencies and the Japanese yen strengthened significantly. Volatility also increased on the goods markets, which points to a strong interconnectedness between various segments of the global financial system. The financial system showed a certain resilience even in such circumstances, and prices of shares and yields on bonds rapidly returned to initial levels, proving that fears of a significant deterioration of the economic outlook were exaggerated. However, financial market participants remain exceptionally vulnerable to sudden changes in economic policies and signals from key economies, which may aggravate the effects of possible unfavourable economic developments.

The growth of the Croatian economy continues to accelerate, reflecting strong domestic demand. The continued strong increase in employment and the higher real increase in wages are boosting consumer confidence and supporting the growth in personal consumption. Investments are growing as well, supported by the inflow of EU funds and vigorous activity in the residential construction sector. On the other hand, foreign demand remains weak amid subdued euro area growth and unfavourable trends witnessed by certain important trading partners, such as Germany. Weakness is particularly noticeable in the manufacturing sector, which, compounding weak global demand, may be linked to structural difficulties, such as higher energy prices on the European market and lower competitiveness in the area of new technologies. Inflation continued to decelerate, with a slowdown seen in all inflation components except the inflation of service prices, which remained elevated amid the increase in wages and strong demand for services. Inflation in the euro area also decreased, but the most recent projections still suggest that the inflation target will only be reached by the end of 2025. Therefore, the Governing Council of the European Central Bank reduced the interest rate by 25 basis points on two occasions, in June and in September, which resulted in improved financing conditions in the euro area.

Household lending picked up further in the segment of general-purpose cash loans, while in housing loans, the repayment burden increased noticeably. The strong growth in employment and wages coupled with increased consumer optimism triggered an upswing in consumer lending in the second quarter of the current year. The momentum in consumer loans, i.e., the quarterly rate of growth in annual terms, reached almost 20% in mid-2024, so that the annual growth rate picked up to 15.5% in August (see Box 1 Does history repeat itself or does it rhyme only? Risks associated with excessive growth in general-purpose cash loans, Figure 1). The growth in housing loans stabilised on a high single-digit level, with the growth reflecting higher amounts of individual loans in the context of increasing residential real estate prices and elevated interest rates, while the actual number of loans granted decreased. The average debt service-to-income ratio (DSTI) for newly-granted loans increased by two percentage points in annual terms, reaching 40%, and almost half of the loans were granted with a DSTI of above 40%. At the same time, the average loan-to-value ratio (LTV) for new housing loans dropped, with a significant decrease in the share of loans with an LTV ratio above 90%, which reflects the abolition of the government housing loans subsidy programme, under which loans were typically granted with an LTV ratio above 90%. The quality of household loans is continuously improving and the share of non-performing loans and loans with increased credit risk since initial recognition (so-called stage 2 loans) is declining. However, the strong growth in cash loans coupled with an increase in the share of housing loans granted with elevated debt servicing ratios may pose a risk for the stability of the financial system.

Figure 2 Cash loans have been contributing the most to the increase in household loans for the third consecutive quarter

Note: Transactions are calculated as new business in a given month, reduced by repayments.
Source: CNB.

Figure 3 The share of non-performing household loans decreased further from a historically low level

Source: CNB.

The slowdown in the residential real estate market reflects a decrease in domestic, and to an even greater extent, foreign demand. The number of purchase and sale transactions continued to drop, with foreign demand decreasing faster than domestic demand and the decrease in transactions being more prominent on the Adriatic coast. Residential real estate prices in Croatia continue to grow faster than in most other EU member states (in the second quarter of 2024 they increased by 10%, versus 2.9% on average in the EU), supported by the strong growth in economic activity and the relatively moderate deterioration of financing conditions. Current developments point to a gradual easing of risks related to elevated residential real estate prices in relation to fundamental variables determining them. However, in the case of a strong macroeconomic or financial shock, the possibility of a rapid reversal of residential real estate market trends resulting in a decrease in prices and, consequently, the value of collateral in the balance sheets of banks cannot be excluded. The commercial real estate market is still characterised by a stable increase in prices and low availability of free space. Still, the shallow and inactive market makes turnover and prices very vulnerable to various disruptions.

Figure 4 The increase in residential real estate prices is slowing down

Source: CBS.

Figure 5 In the 2nd quarter of 2024, the annual rate of growth of residential real estate prices in Croatia remains one of the highest in the EU

Source: Eurostat.

Corporate lending is still subdued, with a noticeable increase in loans to the construction and real estate sectors and to particular activities of the services sector (Figure 6). Firms are still recording favourable performance, reflected in the significant increase in the amount of fiscalised invoices, although due to inflation, the increase is somewhat lower than in 2023 (Figure 7). The number of active firms also continues to grow. Still, banks covered by the Bank Lending Survey carried out in the second quarter of 2024 report a decline in the corporate demand for loans. The drop in demand is mostly related to reduced needs for financing investments as the drop of interest rates from elevated levels remains moderate. A significant portion of investments is likely financed from own funds, facilitated by favourable corporate business performance. At the same time, banks reported further moderate tightening of corporate lending standards, which could continue in the third quarter. Corporate lending remains subdued amid elevated interest rates, weak demand and tightened lending standards. Lately, more considerable lending activity has been noticeable only in sectors related to housing and construction and certain activities in the services sector (Figure 6).

Figure 6 Lending is mostly directed at construction and real estate activities

Source: CNB.

Figure 7 The amount of fiscalised invoices is still growing relatively strongly

Source: Tax Administration.

Indicators of credit risk continue to improve against the backdrop of robust economic growth, employment and wage increase and good corporate business performance. The share of stage 2 loans decreased significantly after a temporary increase in 2023 (in the first half of 2024, it went down by over seven percentage points). The risk perception of firms from the energy and manufacturing sectors decreased the most, and, to a lesser extent, that of firms from the tourism and construction sectors. In addition, the share of non-performing loans continued to decline both in the corporate and the household sector. Although this indicator, observed at the level of total loans, decreased slightly from an already historically low level to below 2.6%, it is still higher than the EU average.

Figure 8 Total capital ratio continued to decline

Source: CNB and EBA (Risk Dashboard).

Figure 9 Capital in excess of regulatory requirements almost halved from March 2022

Note: The calculation of capital surplus does not include the minimum requirement for own funds and eligible liabilities (MREL).
Source: CNB.

The capitalisation rate of the banking system is still significantly above regulatory requirements, although it is decreasing slowly as a result of an increase in assets (Figure 9). Strong lending activity, particularly in portfolios with greater risk weights, such as consumer loans, and the placement of a portion of funds that were deposited with the central bank and considered non-risky to foreign financial institutions, noticeably increased the risk-weighted assets in the first half of 2024. At the same time, own funds increased, albeit slightly, as dividends in the amount of 70% of the previous year’s profits were paid out in the first half of the year (Figure 11). The downward trend in capital adequacy thus continued, with the capital ratio having gone down by 2.1 percentage points over the past two years, from 25% in mid-2022 to 22.9% in mid-2024, the lowest level since the first quarter of 2019. Since capital requirements grew at the same time as well (the combined capital buffer has increased by 1.64 percentage points since the beginning of 2023 due to the introduction and subsequent increase of the countercyclical capital buffer and the recalibration of buffers for some systemically important banks), the capital in excess of regulatory requirements almost halved from mid-2022, so that the capital surplus ratio above regulatory requirements^[1] amounted to 5.7% in June 2024, or 5% if Pillar II requirements are included in accordance with the guidelines (P2G).

Indicators of banking system liquidity are stable and high. The liquidity of credit institutions, measured by the liquidity coverage ratio (LCR), stood at 224% at the end of July, and the net stable funds ratio (NSFR) was 169% at the end of June. Both indicators are at exceptionally high levels, significantly above regulatory limits, which points to the domination of stable funding sources and significant amounts of liquid assets.

Figure 10 Net interest income is beginning to decline due to the increase in interest expense

Source: CNB.

Figure 11 Dividend payments and the increase in the average risk weight contributed to the drop in the total capital ratio

Note: Data for 2024 cover the first half of the year.
Source: CNB.

Bank profitability could decrease slightly after peaking in the first half of 2024, depending on the developments in key interest rates and the intensity of the increase in operating expenses. In the first half of 2024 banks generated record profits, with a return on equity of 18.5% and a return on assets of 2.1%. The exceptionally high level of profitability reflects a rise in net interest income amid elevated interest rates as well as the increase in non-interest income and an additional release of impairments against the backdrop of strong economic growth. Administrative expenses also went up, mainly due to the increase in expenses on employees, which grew by almost 10%; however, operating income grew more strongly. Bank profitability thus peaked with noticeable first signs of trend reversal in terms of stagnating interest income, which, coupled with a continued increase in interest expenses in the second quarter, led to lower net interest income relative to the first quarter of the current year (Figure 10). The lowering of ECB key interest rates in June and September and the possible additional decreases will continue to have an unfavourable effect on net interest income. Banks will continue to face growing operating expenses in terms of demands for wage increase and need for additional investments in digitalisation. In addition, exceptionally low levels of non-performing loans left no room for further reduction of impairments, which could even increase in an environment of pronounced uncertainty. All this could have an unfavourable effect on bank profitability in the upcoming years.

2 Potential risk materialisation triggers

Financial markets are exceptionally sensitive to unexpected news and sudden events, which, in addition to the activation of risk of contagion, can lead to rapidly occurring systemic disruptions. The market turmoil seen in August (Figure 13) highlighted the strong interconnectedness of global markets, where unexpected changes in monetary policy direction, such as the recent move by the central bank of Japan and poor economic indicators in the US (Figure 12), can have a rapid and strong effect on changes in the valuation of various asset classes on a global scale. A high valuation of shares makes investors even more sensitive to unfavourable macroeconomic data (Figure 13) and poor corporate financial performance. Such news is reflected in expectations of future monetary policy, which, if liquidity continues to gradually decline, could further enhance market volatility. In addition, new fiscal expenditures faced by governments amid geopolitical and climate threats could hamper the attainment of long-term public debt sustainability in many countries and increase the risk premium on their debt, particularly for countries which already have a weak fiscal position, which could have an additional unfavourable effect on market developments.

Figure 12 Over the recent months, economic results were continuously lower than expected

Notes: Citigroup Economic Surprise Index (CESI) measures the difference between actual economic results and market expectations. A positive index points to results exceeding expectations, which usually has a positive effect on market sentiment, while a negative index means that results have fallen short of expectations, which may signal poor economic performance and have a negative impact on markets.
Source: Refinitiv.

Figure 13 Strong increase in market volatility in early August

Notes: The VIX for the US measures the weighted average of the 30-day implicit volatility of S&P 500 options, while the same indicator for the euro area is equivalent for Eurostoxx 50. The figures refer to the maximum daily value.
Source: Bloomberg.

Geopolitical risks, primarily linked to conflicts in Ukraine and the Middle East, remain a significant source of systemic risks and a possible trigger of their materialisation (Figure 14). Although the initial shocks of increases in food and energy prices caused by the war in Ukraine have mostly waned, their possible intensification could have significant negative effects, particularly on the European economy. In the Middle East, conflict spreading could seriously threaten global oil and gas flows considering the key role of that area in the global energy supply system, increasing the risk of price increases and inflationary pressures in most countries in the world. In addition, the Asia-Pacific region is still an area of high geopolitical tensions, particularly in the relations between China and Taiwan and stakeholders in the region such as the USA and Japan. Although the risk of immediate escalation remains relatively low, a potential conflict in that region would have far-reaching consequences for global trade considering the key roles of China and ASEAN countries in global manufacturing and logistic chains.

Figure 14 Geopolitical risk index is elevated

Notes: Caldara, D. and M. Iacoviello (2022), Measuring Geopolitical Risk, American Economic Review, April, 112(4), pp. 1194-1225. The geopolitical risk index reflects the results of an automated text-search of the electronic archives of ten newspapers.
Source: Data taken from https://www.matteoiacoviello.com/gpr.htm

Figure 15 The number of politically motivated cyberattacks worldwide is growing

Note: Data collected from more than 200 public reports about cyber incidents.
Source: European Repository of Cyber Incidents (EuRepoC).

Possible sudden changes in economic policies that could ensue after elections are an additional source of potential disruptions in the global economy and the financial system. Particularly noteworthy in that respect are US elections, especially in the context of a possible change in the direction of the new US administration which could take a turn towards a more pronounced bloc division and new protectionist measures, disrupting global trade flows and, consequently, impacting the technology, manufacturing and energy sectors.

The increasing reliance of the financial sector on technology is accompanied by a rise in cyber-attacks that may activate systemic risks. Although digitalisation leads to increased efficiency and flexibility of services, it also creates new challenges in terms of security. Cyber-attacks, the number of which has increased significantly over the past years (Figure 15), may result in operational disruptions, particularly due to the dependency on key infrastructures and third-party service providers, and jeopardise critical functions such as payment systems. The undermined trust of market participants may cause panic and trigger a massive sale of assets, deepening financial instability.

3 Recent macroprudential activities

Cyclical risks remained moderately high in the mature phase of the financial cycle characterised by a continued decline in activity, a further slowdown in the growth of prices on the residential real estate market and strong bank lending to households. In such circumstances, the countercyclical capital buffer rate of 1.5% continues to apply with a view to preserving the resilience of the banking system to the potential materialisation of systemic risks. The stricter approach to calculating the riskiness of exposures secured by immovable property also continues to apply, as the CNB, in performing the regular annual review, assessed that it adequately reflects existing risks and contributes to the strengthening of capital buffers in relation to risks associated with the real estate market.

3.1 The countercyclical capital buffer rate to remain at 1.5%

Against the backdrop of increasingly stronger consumer lending and the simultaneous slowdown in activity on the residential real estate market, the CNB assessed that the countercyclical capital buffer rate of 1.5%, effective from the end of June of the current year, still corresponds to the level of cyclical vulnerability. The domestic financial cycle is still in the mature phase of expansion in which risks mostly stem from relatively strong household lending. The robust growth in employment and wages and high consumer confidence contributed to the pick-up in general-purpose cash loans. In contrast, the rise in housing loans stabilised on an elevated level, with a noticeable increase in the average loan amount, while the number of loans is decreasing. Lending to non-financial corporations remains subdued. On the residential real estate market, the number of transactions continued to decline with a gradual slowdown in the growth of prices, a trend noticeable from the beginning of 2023 (see Chapter 1). While the current level of the countercyclical capital buffer was assessed as commensurate with accumulated cyclical vulnerabilities, if vulnerabilities continue to deepen (especially the accelerated growth in general-purpose cash loans), an additional increase of the buffer could be necessary.

3.2 Annual assessment of appropriateness of risk weight for real estate-secured exposures

The CNB continues to require credit institutions to apply the stricter approach in calculating the riskiness of exposures secured by immovable property, to ensure that capital requirements remain commensurate with the elevated level of systemic risks associated with the real estate market. Stricter measures are part of the national discretions under the European Capital Requirements Regulation^[5], which allow competent national authorities to apply stricter parameters in the calculation of riskiness of exposures secured by immovable property on the territory of a Member State if the authorities assess that the measures envisaged by the Regulation do not adequately reflect associated risks. In relation to exposures secured by residential real estate, in 2014 the CNB laid down stricter criteria for the application of the preferential risk weight (35%) than those specified in the Regulation, while in 2016, it prescribed the application of a risk weight of 100% instead of 50% for exposures secured by commercial real estate^[6]. In June 2024, the CNB performed the annual review of the adequacy of applicable risk weights, taking into consideration actual and expected losses under these exposures as well as systemic risks associated with real estate market trends. As regards exposures of credit institutions to the residential real estate market, losses recorded at system level were low (0.24% of total exposures secured by residential real estate as at 31 December 2023) and are not expected to increase significantly in the upcoming period. Considering that systemic risks associated with the residential real estate market are assessed as moderately elevated (see Financial Stability No. 25), the system could generate more substantial losses, so that the application of the preferential weight remains justified only under the stricter definition of residential real estate. On the other hand, losses recorded in bank exposures to the commercial real estate market at system level are somewhat higher (1.04% of total exposures secured by commercial real estate as at 31 December 2023), while the shallowness of the market increases its vulnerability to possible shocks, which justifies the application of the higher weight of 100%. The aforementioned national discretions remain in application by the end of the year, when the amended Capital Requirements Regulation enters into force ^[7] which, among other things, will contain significant changes with regard to provisions related to exposures secured by real estate under the application of the standardised approach for credit risk.

3.3 Implementation of macroprudential policy in other European Economic Area countries

Against the backdrop of an orderly contraction of the financial cycle, after significant vulnerabilities were accumulated in the earlier phase of the cycle, most EEA countries continued to apply the existing macroprudential instruments in the second quarter of 2024. With a view to reinforcing the resilience of the financial system, some countries introduced new capital-based measures, which was enabled, among other things, by the favourable business performance of banks.

The Czech Republic introduced a systemic risk buffer of 0.5% for all credit institutions, to be applied as of the beginning of 2025 to all domestic exposures. The reasons for introducing this buffer are elevated structural systemic risks in the banking sector, primarily linked with the openness of the Czech economy and the high concentration of its foreign trade and economy. Systemic risks are also intensified by possible costs stemming from the green transition and the increase in cybercrime and further strengthened by geopolitical tensions and growing uncertainty. In addition, the countercyclical capital buffer rate in application was reduced to 1.25% from July 2024 due to the assessed decrease of cyclical risks in the banking sector amid falling housing prices and lower credit activity.

The central bank of Hungary decided to introduce the positive neutral countercyclical capital buffer rate strategy, with the rate set at 1% in a neutral risk environment. The rate applicable from 1 July 2024 stands at 0.5%, while the target level of 1% will start to apply as of 1 July 2025.

Spain announced the activation of the countercyclical capital buffer of 0.5%, to be applied as of 1 October 2025 with the intention of gradually building up the target positive neutral rate of 1%, which, based on stress testing, the central bank of Spain deemed to be an adequate capital buffer rate for the standard level of risk. The target rate of 1% is planned to enter into force in the last quarter of 2026.

Belgium started to apply the higher countercyclical capital buffer rate of 1%, as announced earlier, from 1 October 2024, with the aim of boosting the resilience of its banking system.

The Netherlands announced the extension of the application of its macroprudential measure aimed at addressing the risks associated with the real estate market, in force since the beginning of 2022, for two more years. The measure lays down the average risk weight floor for credit institutions that are authorised in the Netherlands and apply the internal ratings-based (IRB) approach for exposures to natural persons secured by immovable property in the Netherlands.

Table 1 Overview of macroprudential measures in EEA member countries

Table 2 Implementation of macroprudential policy and overview of macroprudential measures in Croatia

1. The calculation of capital surplus does not include the minimum requirement for own funds and eligible liabilities (MREL). ↑

2. Recommendation on actions in granting non-housing consumer loans of February 2019, credit institutions are recommended “that, in determining a consumer’s creditworthiness for all non-housing consumer loans with original maturity equal to or longer than 60 months, they apply minimum costs of living that may not be less than the amount prescribed by the act governing a part of salary exempted from foreclosure. This ensures the consistency of criteria for determining a consumer’s creditworthiness for housing loans and non-housing consumer loans with longer initial maturities.” ↑

3. See, for example Mian, A. and Sufi, A. (2014): House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again, Chicago and London: The University of Chicago Press and Bunn, P. and Rostom, M. (2015): Household Debt and Spending in the United Kingdom, Bank of England Working Papers, p. 554. ↑

4. See, for example, Jorda, O., Schularick, M. and Taylor, A. M. (2013): When Credit Bites Back, Journal of Money, Credit and Banking, Volume 45, pp. 3- 28 and Jorda, O., Schularick, M. and Taylor, A. M. (2015): Leveraged Bubbles, Journal of Monetary Economics, Volume 76, pp. 1- 20 ↑

5. Regulation (EU) 2024/1623 of the European Parliament and of the Council ↑

6. https://www.hnb.hr/c/document_library/get_file?uuid=cfe344f7-2616-2d85-8acc-c35df2fe3477&groupId=20182&p_auth=jSgUhza4 ↑

7. https://eur-lex.europa.eu/eli/reg/2024/1623/oj ↑